[Senate Hearing 112-386]
[From the U.S. Government Publishing Office]
S. Hrg. 112-386
FINANCIAL STABILITY OVERSIGHT COUNCIL ANNUAL REPORT TO CONGRESS
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED TWELFTH CONGRESS
FIRST SESSION
ON
EXAMINING THE FINANCIAL STABILITY OVERSIGHT COUNCIL ANNUAL REPORT TO
CONGRESS
__________
OCTOBER 6, 2011
__________
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
TIM JOHNSON, South Dakota, Chairman
JACK REED, Rhode Island RICHARD C. SHELBY, Alabama
CHARLES E. SCHUMER, New York MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey BOB CORKER, Tennessee
DANIEL K. AKAKA, Hawaii JIM DeMINT, South Carolina
SHERROD BROWN, Ohio DAVID VITTER, Louisiana
JON TESTER, Montana MIKE JOHANNS, Nebraska
HERB KOHL, Wisconsin PATRICK J. TOOMEY, Pennsylvania
MARK R. WARNER, Virginia MARK KIRK, Illinois
JEFF MERKLEY, Oregon JERRY MORAN, Kansas
MICHAEL F. BENNET, Colorado ROGER F. WICKER, Mississippi
KAY HAGAN, North Carolina
Dwight Fettig, Staff Director
William D. Duhnke, Republican Staff Director
Charles Yi, Chief Counsel
Laura Swanson, Policy Director
Catherine Galicia, Counsel
Pat Grant, Counsel
Colin McGinnis, Professional Staff Member
Marc Jarsulic, Chief Economist
Jana Steenholdt, Legislative Assistant
Andrew Olmem, Republican Chief Counsel
Mike Piwowar, Republican Chief Economist
Dawn Ratliff, Chief Clerk
Riker Vermilye, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
(ii)
?
C O N T E N T S
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THURSDAY, OCTOBER 6, 2011
Page
Opening statement of Chairman Johnson............................ 1
Opening statements, comments, or prepared statements of:
Senator Shelby............................................... 2
WITNESS
Timothy F. Geithner, Secretary, Department of the Treasury....... 3
Prepared statement........................................... 30
Additional Material Supplied for the Record
Financial Stability Oversight Council 2011 Annual Report......... 33
(iii)
FINANCIAL STABILITY OVERSIGHT COUNCIL ANNUAL REPORT TO CONGRESS
----------
THURSDAY, OCTOBER 6, 2011
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:11 a.m., in room SD-538, Dirksen
Senate Office Building, Hon. Tim Johnson, Chairman of the
Committee, presiding.
OPENING STATEMENT OF CHAIRMAN TIM JOHNSON
Chairman Johnson. Today we hear from Secretary Geithner on
the first ever Financial Stability Oversight Council Annual
Report to Congress. FSOC was created to be an early warning
system for our financial system, and the timing of today's
hearing could not be more appropriate as the global economy
faces real systemic threats as the European Union struggles
with its sovereign debt crisis.
As the Committee continues its oversight of the Dodd-Frank
Wall Street Reform and Consumer Protection Act, I welcome this
opportunity to receive updates on FSOC as efforts to identify
systemic risk and enhance financial stability and the possible
impacts of the European situation on our economy and financial
system. In addition, I look forward to hearing about FSOC's
progress as it continues to work on rules to designate large
risky, nonbank financial institutions for enhanced supervision.
It is also important to note that as this Committee votes
on the nomination of Rich Cordray to be CFPB Director, Mr.
Cordray will also be the tenth member of FSOC. This is the last
remaining voting spot on the FSOC to be filled.
Having all hands on deck at FSOC is important, especially
when we consider that our last financial crisis was caused in
part by widespread lack of consumer protections. CFPB has an
important role to play on FSOC, and Mr. Cordray needs to be
confirmed.
While we will never be able to anticipate every possible
cause of a future crisis, I believe the creation of FSOC was an
important step toward a better understanding of the threats
facing our interconnected financial system.
Secretary Geithner, I hope that the interagency cooperation
that we have seen on FSOC to this point will continue in the
coming months and years.
Senator Shelby.
STATEMENT OF SENATOR RICHARD C. SHELBY
Senator Shelby. Thank you. Thank you, Mr. Chairman. Welcome
again to the Committee, Mr. Secretary.
Today Secretary Geithner appears before this Committee as
the Chairman of the Financial Stability Oversight Council to
discuss the Council's annual report. It has been over a year
since the Council was established as the centerpiece of Dodd-
Frank. The Council is charged with three primary tasks: to
identify risks to U.S. financial stability, the so-called
systemic risk; to promote market discipline; and to respond to
emerging threats to the stability of the U.S. financial system.
Secretary Geithner will have an opportunity to tell the
Committee here how he and his Council are fulfilling these
ambitious mandates. I had hoped that the Council would have
provided the information in their annual report. Unfortunately,
the report fails to address these significant areas. Rather
than being a forward-looking study of the risks to the U.S.
financial system, the report is largely a lengthy summary of
statistics with lots of colorful graphs.
For example, the annual report does not provide much
evidence that the Council was ahead of the euro zone crisis.
The countries of Spain and Italy are not even mentioned in a
discussion of sovereign credit risk. In addition, the report
does not address or even attempt to address many of the key
economic issues that we presently face.
Perhaps the most fundamental question left unanswered by
the Council is: What is systemic risk? The term ``systemic
risk'' is mentioned 37 times in Dodd-Frank. It is among the
most important concepts embodied in the new law because any
firm designated systemically significant is to receive
additional scrutiny by the Federal Reserve. If the Council
cannot define ``systemic risk,'' it will be hard pressed to
identify growing risk to the U.S. financial system, making it
exceedingly difficult to make sure that those risks do not
threaten the health of the economy as a whole, to use your
words, Mr. Secretary. Consequently, the promise of Dodd-Frank
and its creation of the Financial Stability Oversight Council I
believe could go largely unfulfilled.
In the year since the passage of Dodd-Frank, it has become
clear, I believe, that the Administration and the regulators
exaggerated their ability to measure and to regulate systemic
risk in the rush to pass the legislation. The Council devotes
only one page in its 149-page annual report to ``measuring
systemic risk'' and admits that directly measuring systemic
risk is challenging and that the development of systemic risk
measures and models is in the early stage.
Secretary Geithner himself stated, and I will quote, ``You
will not be able to make a judgment about what is systemic and
what is not until you know the nature of the shock.''
I hope that we can all agree that it would be a bit too
late by then. I hope not.
This sentiment was echoed by the Federal Reserve Board
Governor Daniel Tarullo at a recent Fed conference on systemic
risk, where he spoke on the need for additional academic
research in this very area. He admitted, the Fed Governor said,
``The complexity of some of these issues will require
continuing attention by researchers who are still at the very
early stages of defining systemic risk and analyzing the
Government's role in reducing it.''
These difficulties arise from the fact that Congress
instructed the Council to mitigate all systemic risk before it
bothered to determine whether they could identify such risks,
let alone mitigate them. This is a recurring theme with the
passage and implementation of Dodd-Frank. Practically speaking,
this means that regulators will be making ad hoc decisions
about which firms should be designated as systemically
significant and how they should be regulated. Accordingly, I
hope to hear from Secretary Geithner today whether he believes
the Council can establish a framework for effective systemic
risk regulation that provides clear mandates for regulators and
legal certainty for market participants, Mr. Secretary.
In the interim, the present challenge is whether the
Council can clearly assess the risks posed by politically
sensitive problems like the European debt crisis, the mounting
Federal debt, or the excessive regulation of the U.S. economy.
If the annual report is an accurate representation of the
Council's progress, I remember skeptical of its chances of
success, as I was when my friends on the other side of the
aisle proposed the legislation.
Much of the Dodd-Frank Act was focused on the idea that if
financial regulators are given broad enough grants of
authority, they can prevent any harm and avoid any crisis. I do
not believe that you can write enough regulations or build a
bureaucracy big enough to achieve that goal. It would be ideal.
Nevertheless, Secretary Geithner sits at the head of a new
Government body whose promise is just that. Perhaps today he
can allay my fears and the fears of others and tell us how he
intended to prevent all future financial crises. It will be a
big chore.
Thank you for appearing with me, Mr. Secretary.
Chairman Johnson. Thank you, Senator Shelby.
I want to remind my colleagues that the record will be open
for the next 7 days for opening statements and any other
materials you would like to submit.
Welcome back to the Committee, Mr. Secretary. You may begin
your testimony.
STATEMENT OF TIMOTHY F. GEITHNER, SECRETARY, DEPARTMENT OF THE
TREASURY
Secretary Geithner. Mr. Chairman and Ranking Member Shelby,
thanks for inviting me to come testify on this, and I want to
just start by thanking the Committee for approving or
forwarding the nominee recommendations you acted on this
morning. In that context, I want to encourage you, those of you
who did not vote for Mr. Cordray, to spend some time with him.
I think you are going to find he is an exceptionally talented
and thoughtful leader, an excellent record. And I know some of
you have said that there is no person you would confirm to this
job ever without fundamental changes in the structure of the
Bureau, and, again, I would encourage you to spend some time
with him and take a look at him and ask a lot of questions, and
I think you will find yourself reassured.
I would just remind you that if the Senate fails to confirm
a Director for the CFPB, then what will happen is we will leave
a vast array of nonbank institutions, financial institutions,
and consumer finance companies outside the scope of consumer
protection, which was exactly the same mistake that left us so
vulnerable to the financial crisis we went through. So delay in
confirming a nominee does not help close that fundamental gap
in the financial system, and as I said, I think if you could
spend time with him, you will find him an exceptionally
qualified, thoughtful person.
In setting up this Council, Congress asked us to provide
each year a comprehensive view of financial market developments
and potential threats to the financial system. Let me just
start with a few comments on the broad backdrop of the global
economy, which, of course, is the fundamental determinant of
financial stability.
In 2011, the world economy, like the U.S. economy, is still
healing from the devastating effects of the financial crisis.
On top of those basic challenges, we experienced a series of
additional challenges to recovery early this year from high oil
prices and the disaster in Japan. Europe's protracted economic
and financial crisis has added to these pressures on global
growth. And the destructive debate we saw in the United States
this summer about whether the United States as a country should
meet its obligations was very damaging to consumer and business
confidence.
Just to give you an anecdote, if you talked to businesses
across the country, as I did, particularly in the month of
August, they said, ``Why should we make an investment, hire a
new a person, if Congress is debating whether to meet its
obligations as a country?'' It was a very damaging vote of
confidence in the United States, and you feel it now in terms
of how slow growth is.
Some of these factors have eased in recent months, as oil
prices have fallen and Japan has begun to recover. But the
cumulative effects of the pressures have resulted in slower
growth in the United States and around the world and lowered
expectations for growth over the next 18 months to 2 years.
The crisis in Europe presents a very significant risk to
global recovery. We are working alongside the IMF to encourage
European leaders to move more forcefully to put in place a
comprehensive strategy to stabilize their crisis. The critical
imperative is to ensure that the governments and the financial
systems that have been under pressure have access to a more
powerful financial backstop, conditioned on policy actions that
can credibly address the underlying causes of the financial
pressures they are facing.
Now, in the face of the situation in Europe and the general
slowdown in growth around the world, the most important thing
we can do here in the United States is to act to strengthen our
economy. And in our judgment, the most effective strategy for
doing that is to enact steps now that will accelerate economic
growth and tie those to long-term reforms to restore fiscal
sustainability.
The American Jobs Act which the President proposed provides
a substantial package of tax cuts and investments that,
according to estimates by outside economists, would raise
economic growth by 1 to 2 percentage points and help create 1
to 2 million jobs. And in the President's proposal to the Joint
Committee of Congress that is charged with recommending reforms
to reduce our long-term deficits, he outlined a comprehensive
package of reforms to spending programs and to our tax system
that would bring our deficits down to the level where our
overall debt burden starts to decline as a share of the
economy.
Now, this Council is comprised of each of the agencies at
the Federal level responsible for oversight of the financial
system and the firms and markets that make up our financial
system. And it is the judgment of this Council that the United
States' financial system is in a significantly stronger
position today and better able to withstand the new risks we
face in the global economy because of the actions we took at an
early stage of the crisis to repair and reform our system:
The weakest parts in our financial system, the ones that
took the most risk, no longer exist or have been fundamentally
restructured;
The largest banks in the country, the largest 19, have
increased their common equity, their capital buffers, by over
$300 billion since the beginning of 2009; and the level of
common equity to risk-weighted assets across these banks is now
approximately 10 percent, up from roughly 6 percent at the
beginning of 2009;
Banks are funding themselves more conservatively and are
maintaining much larger cushions of safe and liquid assets.
These improvements are very significant. Together they
represent much more progress on the path to a more stable and
resilient financial system than has been achieved in the other
major economies that were caught up in this crisis.
U.S. financial institutions, including our major banks and
the money market funds as a group have substantially reduced
their exposure to the economies of Europe that have been under
the most pressure. Our direct financial exposure to these
governments and their institutions is quite small, but it is
important to recognize that Europe is so large and so closely
integrated with the U.S. and world economies that a severe
crisis in Europe could cause significant damage to growth here
and around the world. And this makes it even more important
that Congress act to strengthen growth now and put our fiscal
position on a more sustainable path.
Economic and financial developments since the release of
our report reinforce the importance of the Council's
recommendations, and let me just summarize those
recommendations quickly.
First, the Council recommends--and it will always recommend
this, in my judgment--that the core institutions in our system
and the basic institutions critical to markets continue to act
to strengthen their financial position over time. We want the
largest institutions in the country to manage their businesses
so that they have the ability to withstand more challenging
future environments without Government assistance in crisis.
And toward this objective, the responsible regulators will
gradually phase in, over a period of several years, the much
tougher standards we have negotiated for capital and liquidity
with the other major financial centers around the world.
Second, the Council recommends reforms to strengthen a
number of key funding markets in the United States, markets
that were a critical source of vulnerability, a source of
contagion in our crisis. The most important of these
recommendations relate to the tri-party repo markets,
repurchase markets, and the money market funds. The essence of
these recommendations is to make these markets--the tri-party
repo markets and the money market funds--less vulnerable to the
classic dynamic in which an abrupt rush for the exits forces a
damaging spiral of asset sales, deleveraging, and broader
contagion. We have made very substantial progress toward this
objective, but we have some more work to do.
Third, the Council recommends reforms to the housing
finance system. It recommends actions to establish national
standards for mortgage servicing, and the Council, of course,
emphasizes the importance of broader reforms--these reforms
will require legislation--to return private capital to the
housing market, strengthen mortgage underwriting, and reduce
over time the Government's role in the housing markets. As we
proceed with these reforms, however, we want to make sure that
we are encouraging, not undermining, the prospects for broader
recovery in the housing market.
Finally, the Council emphasizes the importance of closer
cooperation and coordination in the implementation of financial
reforms, both here in the United States and around the world.
This is crucial because if we allow large gaps to emerge as we
did in the years before the crisis, risk will migrate to those
gaps, leaving the system as a whole more vulnerable to crisis.
Differences in the design of standards create opportunities
for firms and investors to take advantage of weaker standards.
And as we act to contain risk in the United States, we want to
minimize the chances that risk simply moves to other markets
around the world, which could also make us more vulnerable. The
hardest thing in this area, in this challenge of building a
level playing field, and the hardest challenges lie in the
design and application of capital requirements and the
framework over derivatives.
Although our system today is much stronger than it was
before the crisis, we have more work to do on reform of the
system. And as we proceed with these reforms, we are going to
adopt a balanced approach, weighing the benefits of regulation
against the costs of excessive restraint. We need to move at a
pace that fully recognizes the fragility of the global economic
recovery, phasing in reforms over time so that we limit the
risks to economic growth.
Mr. Chairman, in closing, I just want to thank the other
members of the Council and their staff for the work they have
done over the past year in building an institution for closer
cooperation and in creating a very substantive, very strong
first report to provide this overview of potential challenges
to the system.
Thank you.
Chairman Johnson. Thank you for your testimony. Good
morning. As we begin the questions, I will ask the clerk to put
5 minutes on the clock for each member.
Secretary Geithner, what are the risks to the U.S. economy
if financial turmoil in the EU? Are there policies steps that
we ought to take to limit any negative impact on the U.S.?
Secretary Geithner. Well, as we have already seen,
developments in Europe can have big effects on the United
States economy, big effects on confidence, big effects on
financial markets; and we are living with the pressures today.
They have hurt growth here and they have reduced expectations
about future growth.
The three most important things we can do are the
following. The first, of course, is to help Europe get on top
of this. We cannot want it more than they do. We cannot compel
them to act, but we have a strong interest as a country.
We do not want to see Europe weakened by a protracted
financial crisis. They have invited the IMF in. They are taking
advantage of swap lines provided by the Federal Reserve, and we
have a strong stake in seeing them act more forceably to
address this.
The second thing we can do is act to make our economy
stronger at home. As I said in my testimony, we have given the
Congress what we think is a very strong, very powerful set of
tax incentive and investments, proposals that have always
enjoyed quite broad bipartisan support in this body, and that
is our best protection as always against developments outside
of the United States, act to do things to make this economy
stronger.
And finally, of course, the supervisors are watching very
closely the broad financial linkages between our institutions,
our markets and Europe.
And as I said in my testimony, you have seen a very
substantial reduction in our direct exposure, and our
institutions hold substantial cushions of capital against the
potential risk they might face ahead. But of course, that is
something we have to keep monitoring closely.
But those are the things I would focus on.
Chairman Johnson. Secretary Geithner, FSOC continues to
work on rules to designate nonbank financial institutions as
systemically important financial institutions or SIFIs.
Can you provide us an update on this practice?
Secretary Geithner. The Council meets next week, and it
will consider at that point a new piece of guidance that we
would make public that, if adopted, would lay out a framework
for making these judgments.
But let me just explain what we are trying to do. We had a
financial crisis that was caused in significant part by the
fact that this country allowed a huge amount of risk to buildup
outside the banking system without constraints on leverage,
without the basic types of protections that all financial
systems require.
And that was very damaging to us because when the crisis
hit, markets just sucked all of the oxygen out of that parallel
shadow financial system that came crashing down, put enormous
pressure on the rest of the system and that was one of the huge
accelerants and amplifiers of our crisis.
So, one of the most important things that this legislation
did was to give us authority we did not have to make sure we
can apply a prudential framework of safeguards on capital
liquidity leverage for institutions that pose that type of risk
to the system.
Senator Shelby is absolutely right that it is very hard to
judge who can be systemic in a crisis, but we have a basic
obligation to make sure that institutions that operate like
banks, provide the same function as banks to the economy, are
large and leveraged and vulnerable to liquidity pressures and
the basic utilities markets require, are subject to very strong
prudential safeguards.
And the framework that the Council is going to consider on
Tuesday is designed to give the markets more guidance, more
clarity about what types of institutions, what types of
structures we would want to consider making sure that they are
subject to these kind of prudential safeguards.
Chairman Johnson. In addition to international bodies who
are working on efforts to designate globally systemically
important financial institutions, or G-SIFIs, how is FSOC
working with global entities to ensure that SIFIs designation
guidelines both domestically and globally are coordinated and
do not put U.S. nonbank financial insurance committees at a
disadvantage?
Secretary Geithner. A very important point and I thank you
for raising it.
There are two things we need to do to make sure there is a
level playing field. One is to make sure we have uniform
standards for required capital ratios and liquidity
requirements that are applied, set at the global level, agreed
at the global level, and enforced at the global level. That is
not enough though.
We need to make sure that they are designed in a way that
they are going to be applied in a way that is as uniform. And
we are very concerned that we make sure we build in additional
protections into the system so the playing field will actually
be level.
I will just give you an example. There is a lot of evidence
that the major financial centers apply the risk weights that
are critical to determining how much capital you have to hold
against risk with varying degrees of rigor.
So, you want to make sure that as we proceed, and we have
the time to get this right, that these countries are not just
committing to meet the letter of the requirement but the actual
enforcement of that requirement is as vigorous outside the
United States as we expect it to be here.
And this proposal to make sure we have the largest
institutions hold enough capital is something we are going to
phase in over time, quite a long period of time. So, we have
time to make sure now that as we apply them in the United
States, they will be applied as uniformly as possible outside
the United States.
Chairman Johnson. Senator Shelby.
Senator Shelby. Thank you.
Mr. Secretary, Dodd-Frank, as I understand it, establishes
the council to, quote, ``identify risk to the financial
stability of United States.''
In your written testimony, you state, and I will quote you,
``We cannot predict the precise threats that may face the
financial system.'' I understand that.
But what types of threats can the council predict? I think
it is very important.
Secretary Geithner. Essentially, it might surprise you to
find that I agree with a lot of what you said in your opening
statement, and I agree and very much endorse your skepticism
about the capacity of people who sit in my job or my
counterparts on the council to look to the future and
anticipate the types of sources of risk we face.
And so, the basic strategy that underpins the design of
this framework is not a strategy that depends on the wisdom and
foresight of governmental officials. It is a strategy that
relies on building much stronger shock absorbers, safeguards in
the system so that we are protected against a whole range of
potential risk.
Senator Shelby. Like capital for example?
Secretary Geithner. Capital is the most important of those.
Liquidity is another. Those things go together.
So, of course, we want to do the best we can to look at
emerging risks but we are quite humble in our capacity as
anyone would be looking at the history of financial crises, and
we want to have a system that recognizes the basic limits on
the capacity to anticipate and preempt.
Senator Shelby. But you also want to do no harm too, do you
not? And that is a dangerous thing.
Secretary Geithner. Yes, there is a risk. I think if you
look at the U.S. economy today, I would say the biggest risk we
face is institutions not taking enough risk, not taking too
much risk at the moment. That is a natural aftermath of crises
when people are still scarred by the trauma of the crises.
But I agree, you want to make sure that people are willing
to take risks. You do not want to lose that capacity.
Senator Shelby. Mr. Secretary, Chairman Johnson got into
this some, but I will ask you again. What are the two top, two
or three potential emerging threats as you see it to the
financial stability of the United States? I know debt is one.
Secretary Geithner. Well, the list I would say is you have
to start with the European crisis. Because Europe is big----
Senator Shelby. OK. That is right on us now.
Secretary Geithner. And slower growth globally matters
because with growth now in the United States somewhere in the 2
percent range it is not strong enough, and we are more
vulnerable with growth this week, to other things happening
that we can anticipate that would make it weaker.
I would focus overwhelmingly on those two things. But you
are absolutely right that if the United States does not put in
place the framework to reduce our long-term deficits over time,
that too in the future, it will not happen soon but that too in
the future could reduce growth and hurt the financial strength
of the United States.
Senator Shelby. So basically, the failure to stabilize the
Federal Government's debt burden if we don't do not get on the
right trajectory in the next few years could represent a threat
to the financial stability of our whole country, could it?
Secretary Geithner. It could if Congress, and I do not
think Congress would do this, if Congress sits here and lets--
--
Senator Shelby. If we did not do our job.
Secretary Geithner. If you did not do anything, if you do
not do your job, then at some point----
Senator Shelby. If we rock along like we are doing now,
with huge deficits piling up debt after debt----
Secretary Geithner. I would be a little more optimistic in
the sense that what Congress did in August, even though it was
a bit messy, was a pretty good down payment on fiscal reform.
But they only did about a quarter of the problem, and so we
have about three quarters of that problem left to define. That
is why the super committee is so important.
Senator Shelby. If I could for a minute just get into the
derivatives area. One of the unfortunate side effects, I
believe, of the Dodd-Frank derivatives clearing mandate is that
market participants could possibly stop doing their own credit
analysis because clearinghouses will take on all of the credit
risk.
Instead of hundreds of analysts that we have today trying
to analyze the credit risk, only a few clearinghouses, as I
understand it, would be monitoring credit risk.
Does this create any systemic risk or could it by
concentrating so much credit risk in so few clearinghouses? And
are clearinghouses too big to fail? We would hope they would
never fail. And would the Administration bail out
clearinghouses?
We have talked about this before but this could be an
important part. We hope we never go down this road.
Secretary Geithner. Senator, you are right that
clearinghouses do not eliminate all risk. And you are right
that they do centralize and concentrate risk for products that
they can clear.
But they provide a lot of offsetting benefits, and we think
on balance the system will be more stable if you see the
standardized products move through clearinghouses.
You know, we have had the experience with a market that was
primarily bilateral, and it was a very messy, damaging
experience because in the world where it is all bilateral, all
the risk is off clearinghouses, not all of it, but a
substantial part of it.
Then we found, and you saw this, firms did not really know
what their exposure was, and the virtue of moving the
standardized stuff to clearinghouses is it is much more simple
to understand what your exposure is and how protected you are
against that.
So, we think, on balance, if you get the safeguards right,
the system is more stable with central clearing.
Senator Shelby. Mr. Secretary, my time is limited here. Has
the council thought about or discussed whether Operation Twist
or other monetary policy actions could create systemic risk?
Secretary Geithner. That is an excellent question, and we
do not, have not in the Council talked about the implications
of monetary policy judgments and partly just out of deference
to protect the independence of the Fed.
But to say it a little bit more carefully, as you saw in
the report, the Council members did make the sensible
observation that one thing you want to make sure banks do is
not just be careful of managing their credit risk but their
interest rate risk over time.
We are in a really extraordinary period with rates where
they are today and it is very important that over time this is
not the biggest risk we face right now that banks are careful
to look at those risks.
Senator Shelby. Thank you.
Thank you Mr. Chairman.
Senator Reed [presiding]. Thank you very much, Senator
Shelby.
Thank you, Mr. Secretary.
Mr. Secretary, let me follow-up with one of the, I think,
very thoughtful insights that Senator Shelby raised in his
opening statement and reiterated, and that is, part of the
FSOC's mission is to understand systemic risk, to try to
anticipate growing risk.
It would seem to me from my recollection that the
operational agency most capable of doing it is the Office of
Financial Research. If you have an apolitical, analytical
organization that are thinking carefully along with their
colleagues in academia and on the financial sector that you
will have a much better chance of doing this.
And I would again urge you, and you've been doing I think
yeoman's work to try to get a nominee up here to do that soon.
Secretary Geithner. Coming, and we have talked about this.
I am glad that you remind us of the importance of this office.
You cannot effectively oversee a financial system without
much better information than we had access to before the crisis
about where risk is and where it shapes.
One of the key roles of this office is to make sure there
is better data available not just to supervisors but to the
markets as a whole so markets can make better judgments about
where risk is, and of course, that will not happen until we
have a confirmed director.
But we expect to give a nomination to the Senate relatively
soon, and we are, of course, not waiting. We are starting to
build the institutional capacity and the people, and we have
seen an extraordinary amount of academic interest and support
for this project. And so I am really quite confident we are
going to have, we are going to be able to take advantage of lot
of the best talent in the country to build this.
Senator Reed. Well, we need the nomination so then we can
go along with the confirmation process.
Just in an abundance of caution is that, and I think
Senator Shelby is exactly right about the need for this type of
very thoughtful approach, and I would just regret immensely if
that nomination was not moved with deliberate speed, and we get
this office up and running fully so that the burden is on you
initially and then it becomes on us. If we are really sincere
about the need to get good knowledge and good information, then
we will do it quickly and we will get it done.
Let me change direction is just a bit, and again, it is
another comment that Senator Shelby made that one of the most
challenging aspects today is trying to regulate the derivatives
market place.
The clearinghouse he talked about, definitions of swaps,
exemptions particularly when you get into the era of synthetic
derivatives. I am still trying to get my hands around good old-
fashioned derivatives, and there is a whole other world of
synthetic and ex-prime synthetic derivatives.
If we cannot effectively sort of deploy these regulations
in a timely way, it seems to me the only stopgap for the
uncertainty is increased capital levels in those firms that
deal extensively with derivatives.
Is that the FSOC view too, because you certainly through
your agencies have the ability to do that?
Secretary Geithner. That is right but, you know, we are
very confident that we are going to be able to put in place a
regime, for example, that mandates margin requirements in
derivatives, and that combined with the stronger capital
buffers and the move to central clearing with stronger
safeguards in the clearinghouses, that that mix of factors will
leave us with a much more stable system than we had, not immune
to any crisis, not immune to any shock, but much more stable
than we had.
You know, we are trying to get that balance right. This is
a terminally complicated task, and we are slower than we had
hoped to be, but we are slower because we are trying to err on
the side of getting it right and not to rush it.
And we want to make sure that we not just get the substance
right but we have the SEC, the CFTC, and the Fed aligned so we
have a better chance of getting London, Frankfurt, Paris,
Zurich, Singapore, Hong Kong aligned too, because we cannot put
ourselves in a situation where the stuff just moves to markets
where there is more risk.
So, if we are a little slower than we hoped, it is because
we are trying to make sure that we land sensibly and on a more
level playing field.
Senator Reed. Well, I concur. I think you have to be
careful and deliberate. This is very, very complicated. But I
think if you reach your point where you cannot pull together
all of these very difficult aspects, in an abundance of
caution, I think the only remedy is capital.
Secretary Geithner. Use capital, and that is the way the
system works. If you have margin and collateral, you do not
have to hold as much capital against it.
So, it works that way. We have that basic safeguard built
in.
Senator Reed. One of the issues you raised in your
testimony is your concern about the reliance on short-term
funding by major financial institutions, and with tri-party
repos market, money market funds, et cetera, particularly in
the wake of the European crisis which many of their
institutions depend, as you point out, more so on short-term
money than we do we. We learned a very painful lesson in 2008
and 2009.
What is FSOC doing in terms of trying to deal with this
issue? And this might be in the category some of my colleagues
suggested, what is the biggest new threats approaching us?
Secretary Geithner. Well, a very important issue. The Fed
and the principal supervisors have been very effective in
getting banks to fund themselves much more conservatively.
So, the reliance on short-term funding in the United States
has fallen very dramatically, and in the repo markets and the
money market funds, there has been substantial shift toward a
more conservative regime in that context.
What the FSOC has done is to ask the competent agencies to
lay out a comprehensive plan for improving the basic resiliency
of those markets, and we get regular updates on progress
against that plan.
And because these things matter to the system as a whole,
we are trying to make sure, and the Fed and the SEC is doing a
great job. They are the ones in charge of this. They are being
very careful and good about making sure they are sharing their
judgments with us in advance.
And so, we try to make sure we are looking at the overall
interest of the system, not just the interest of those
particular parts of the system.
Senator Reed. Well, Mr. Chairman, I am in the rare
circumstance where I am ready to yield but my colleagues are
all voting. So, I do not need much more of an incentive to keep
asking questions so bear with me.
The housing market is instrikibly and inevitably linked to
our progress as a Nation economically in growth. It is
underperforming. Frankly, my impression was that there was a
sense a year or so ago that we were turning the corner, but I
think there is another corner.
And until, from my view, until we stabilize housing prices,
begin to deal with the foreclosure issues, we are not going to
have the foundation. I mean, that is certainly the perception
on Main Street when you see your neighbor's house, the grass
has not been cut in 2 months and you know they have been
foreclosed, that is a daily reminder that things are terrible.
So, FSOC, this is a systemic issue. You have got to provide
the leadership and I can ask you what are you doing both in
terms of the programs that are in place now but the next steps
because we have not done enough.
Secretary Geithner. Senator, I agree with you that things
are still terrible, and this is going to take time, it is going
to take years still.
What you see now is two things. You see the broader
weakness in the economy. Unemployment above 9 percent, income
growth slower. That is putting additional pressure on the
housing market as a whole, hurting housing demand, slowing the
pace, making more people vulnerable to losing their homes.
But even apart from that, we still have this foreclosure
process essentially broken, a servicing framework that is not
doing a good enough job of helping people stay in their home or
transition to other forms of housing.
And we are doing as much as we can with the authority we
have to help people caught up in this crisis still. You are
right to say it is still terrible.
I think the most important things we can do now, apart from
trying to do anything we can to make the economy stronger, is
to help more people refinance, even people underwater, and to
help transition more of the empty, vacant properties that exist
across the country into rental housing, and to make financing
more available is what we are working on.
But we need to continue to make sure that as many people as
we can have a chance to stay in their home if they can afford
to. And we need to see banks and servicers and everybody do a
much better job, more aggressive job of reaching out to them
and trying to make that possible.
As you know, I cannot comment on the details of this but
there is, you know, a very complicated effort to try to bring
to earth a global settlement of the legal problems in the
foreclosure process. If that is done well and sensibly, that
could make a big difference too.
Senator Reed. Just a comment, Mr. Secretary, your efforts
and your colleagues' efforts have been intensive and extensive
but we do not have ears.
Secretary Geithner. But disappointing.
Senator Reed. Yes. And we do not have ears. If the tools
that you have in the toolbox will help us a bit to get this
problem fixed in 2 or 3 years, then we have got to get new
tools. We have to think beyond the traditional, and we have to
do this. I will rest my case there.
Since there are no of my colleagues from our Republican
side, I am going to ask Senator Bennet to chair the hearing for
questions and then to recognize the first Republican that
returns.
Secretary Geithner. Senator, can I mention one quick thing
on housing that I forgot to mention?
Senator Reed. Yes.
Secretary Geithner. This is important. You are right to say
if we need more authority, we should ask for it. And one of the
pieces of the American Jobs Act is a proposal to provide
substantially more resources into neighborhoods most affected
by the foreclosure crisis. That is expensive but we cannot
afford not to do it, and it is a good use of scarce resources.
Senator Reed. I concur.
Senator Bennet [presiding]. I must have been here longer
than I thought, Mr. Secretary. Thirty years is what it takes to
get into this chair.
Secretary Geithner. Congratulations.
Senator Bennet. Thank you very much. I am not leaving. Lets
you and I solve all of the world's problems.
I apologize because I was voting but, and I may have missed
some of the discussion. But on the economy just stepping back
just for a second, the last estimates that I saw were that
there was something like $2.3 trillion of cash sitting on
balance sheets of companies in the United States not being
invested in the economy, not producing jobs in the economy.
I wonder if you could give your thoughts on why that is. It
seems to me that until that capital is deployed, we are going
to have a very hard time bringing this unemployment rate down
and creating jobs.
Secretary Geithner. You are right that corporate balance
sheets are very strong. People are sitting on a lot of cash
still.
But I think the best measure, the best measure of how
corporations feel about the outlook is to look at what they are
spending. And in the early stage of this recovery, if you look
at what corporations, businesses across the country are doing
in terms of spending on capital goods and software, equipment
and software, they are spending at a rate roughly triple the
rate of growth in the economy as a whole.
So even though they have a lot of cash, they are investing
in things that will make us stronger in the future. What
businesses say is that----
Senator Bennet. Although, just on that point, a lot of that
investment that you are talking about is investments in IT and
other things that are actually making people more productive,
the companies more productive.
It may not be creating jobs because as they become more
productive they figure out how to do what they are doing with
fewer people.
Secretary Geithner. That is true.
Senator Bennet. And we still have to figure out what we are
going to do.
Secretary Geithner. That is true although again not to just
temper the darkness a bit, I mean we are in a very tough
economy still. But if you look at private-sector job growth
since job growth started to recover, it is faster than the last
two recoveries.
So again, if you look at how corporations are behaving,
they are obviously cautious because growth is slower and they
are more worried about risk out there.
But they are investing, and you see in the private
investment numbers and in the export numbers other signs of
underlying resilience and strength here which is important. We
want to foster those things.
I do think that it would be good for Congress to put in
place some permanent reforms to the tax system that would give
corporations more certainty, better incentives for investing in
the United States. We are hoping that the Super Committee can
start to lay the foundations for a corporate tax reform that
would make it more compelling economically for corporations to
put that money at work in the United States, and for foreign
companies to invest more here at home too because ultimately we
are going to be stronger as a country if we meet more of the
huge demand we are going to see from the rest of the world.
Senator Bennet. Let us talk about that for a second. The
New York Times had a front page story that said one afternoon
that the House was going to pass a 4-day extension to the
continuing resolution and then we would come back and pass the
Times called a more ambitious 7-week extension of the
continuing resolution. I thought I was reading in The Onion,
not the New York Times.
You mentioned in your testimony at the outset the damage
that had been done by debate this summer over the debt ceiling.
I know you cannot prove it but my sense in talking to people is
that it was a real confidence destroyer.
And I wonder in that context, and just, by the way, at the
moment when we needed that least that is what we managed to
deliver. I wonder if you could talk a little bit in that
context about the importance of what the Super Committee is
doing and more broadly how important it is to get to a more
comprehensive approach to deal with his fiscal problem than the
charge we have given the committee which I know is an objective
that both the Senator Tennessee and I care a lot about.
Secretary Geithner. I agree with everything you said. The
U.S. economy in general in most times has a much longer view
than Washington. It can withstand prolonged periods of
Washington doing nothing.
We are not in one of those moments now because the things
that are burdening the economy, making growth weaker are things
that only Congress can solve, and the basic sense that you see
across the country that the political institutions in this
country are not up to the challenges we face, unable to act,
unable to solve problems, is absolutely weighing on confidence.
There is really no doubt about it.
I think to help that you have to show you can do some
things. Passing these trade agreements would be good. Passing
some tax incentives, investments to help strengthen growth,
would be good.
But as you said, to lay out a longer-term framework for
fiscal sustainability with entitlement reform and tax reform
would be very good for confidence as long as it is designed
sensibly and phased in over time. That would be very good for
confidence at a time when the world is watching us and, you
know, the world needs the U.S. to be stronger. And we cannot be
stronger without a political system in Washington, DC, the core
institutions, and on the economy that is the Congress,
demonstrating they can solve some problems.
Senator Bennet. Thank you, Mr. Secretary.
Mr. Chairman, I will turn it back over to you and Senator
Corker is in line.
Chairman Johnson [presiding]. Senator Corker.
Senator Corker. Thank you, Mr. Chairman, and, Mr.
Secretary, thank you for being here. I know you made a comment
on the front about consumer protection, and I agree with you
that those things outside the normal financial system, you
know, will not be regulated in the way that the bill attempts
to regulate them without somebody being put into this position.
I know that you, on the other hand, have come from a world,
at the New York Fed and other places, where you really focused
on checks and balances and those kinds of things. And I would
just say to you with good spirit that I think with a Treasury
Secretary weighing in and just causing there to be some
appropriate checks and balances put in place in this position--
you do not even have to make a comment on it--I think things
would sail through. And we have reached out to the
Administration and other places. I actually think there is a
lot of sympathy toward that. It has sort of become a political
issue. I understand that, by the way. But I would just say that
there is an easy way of resolving this that would
institutionalize the Department instead of making it
personality-based. And I think there are a lot of folks even on
your side of the aisle that would not think that would be such
a bad idea. But let me move on to the FSOC.
Secretary Geithner. Could I just say quickly--I will say it
quickly.
Senator Corker. I really did not want you to, but go ahead.
[Laughter.]
Secretary Geithner. We did propose initially in the bill a
different set of checks and balances than what Congress
adopted, and it is very important we have good checks and
balances. But I believe--I know that you disagree, but I
believe that the bill has very strong protections in place,
good checks and balances, checks and balances that do not exist
through other parts of the system, and that is why I think you
have got a pretty good framework. But I know you----
Senator Corker. But, you know, the checks and balances, I
think we talked about, in no way dissipate the ability of this
organization to function in a sound manner. I do not want to
debate that much longer. You and I spent a lot of time last
March on this, and I appreciate it. Maybe two Marches ago, I
cannot remember.
The FSOC, as set up, just give me a sense of--you know,
this is your first annual meeting. I know Congress has all
kinds of formal annual things that in many cases mean nothing.
Is this organization actually functioning in a way where there
is a real discussion, not just at the staff level but among
folks like you and Bernanke and others, about real systemic
risk that is taking place in a real fluid manner?
Secretary Geithner. I think it does. I think the other test
of this Council, though--that is one important test. Another
test of the Council is does it help engender closer cooperation
and integration in the design of the rules so we do not have
this hugely complicated network of different rules over what
are essentially the same types of activity, because that is
enormously burdensome for the economy and complicates life for
everybody and makes it probably harder to manage risk.
So one of the things we are trying to do is not just make
sure there is much more integration to keep out future risk,
but that the rule-writing process is done in a way that leads
to better outcomes across the system.
Senator Corker. You know, there is a lot of discussion
about jobs bills right now, and I know much of it from my
perspective is sort of a distasteful political exercise. To me,
you know, as you look out and you talk with most employers, the
thing they are concerned the most about is the structural long
term. Would you not agree that maybe there are some things that
could be done short term? I do not want to take away from your
side of the aisle in any way, but isn't the best thing we could
possibly do here for our country's economy and the world
economy is to go ahead and tackle some of the long-term
structural issues that we have like tax reform, like
entitlement reform, like going ahead and putting in place a
long-term highway bill, those kinds of things that would just
give confidence to the economy that we here in Washington have
the ability to actually take on the bigger issues?
Secretary Geithner. I agree with you, you should do that,
but it is not enough. Again, just to point out about, you know,
the thing about in the long run we are all dead. If Congress
does not act on these tax provisions or on the investments and
infrastructure things, then what happens to the American
economy? What happens is that every American who has a job will
see their taxes go up by $1,000 on average next year. That is
without action on a jobs act. Without action, businesses will
see taxes go up. So as many on your side argued last December
when we were facing the expiration of the Bush tax cuts, there
are things we have to do in the short term to make sure the
economy is not weakened by the inaction of Congress.
And you are right that that is not enough and we should be
doing the long-term things, too, but you cannot just do the
long-term things if you want to make sure the economy comes out
of this more strongly.
Senator Corker. Yes, we actually tried to vote on the
President's jobs bill yesterday and were denied that ability.
Secretary Geithner. I think you will have another chance.
Senator Corker. Yes, well, thank you.
Let me ask you about some of the proposals around housing.
There have been lots of things, and I know that that is one of
the areas that the FSOC addressed recently. There have been
discussions about a massive refi where instead of having, you
know, appraisals and all of that take place, people that are
actually current and paying their mortgages, not those that are
delinquent, would be able to go ahead and just refi from 6.4 to
4, and I wonder if you might give a brief comment. And, Mr.
Chairman, I would like to ask one more question, if that is OK.
Secretary Geithner. Right now, as you know, as you said,
mortgage interest rates are very low, as low as 4 percent, a
little lower in some cases. But you are not seeing as much
refinancing to take advantage of that as you might, for a whole
range of reasons. And the Director of the FHFA, Ed DeMarco, is
examining a set of proposals that would make it much easier for
people to refinance to take advantage of the lower rates,
including people who at the moment have loans that are worth
less than their outstanding mortgage obligations.
We are very supportive of those reforms. We think that
would make a big difference. They are like a tax cut. It is
like a larger tax cut on average for people than even the tax
cuts that are now before the Congress. But we need to see them
move to make it easier for it to happen, and they seem to be
moving in that direction, and we are hopeful that we are going
to be able to lay out some clarity--he is going to be able to
lay out some clarity to the broader markets and to homeowners
in the next few weeks.
Senator Corker. We had one of the major hedge funds in our
office last night, and we were seeking guidance on how to work
through the GSEs. You know, there are all kinds of models out
there, and I think all of us, you know, agree with your opening
comments that we need to move away from as much Government
involvement and maybe to almost none, but we certainly need to
do it in a way that does not implode our economy, and we need
to be thoughtful about it.
But in the conversation, we began talking about the
European crisis, and he asked me this question. He said, ``What
would happen if that contagion spreads here and it affects
numbers of banks? Would you all use the resolution mechanism?''
And I said no, the resolution mechanism is basically for one-
off situations. It is not for systemic issues.
I want to talk to you more in private about this whole
issue, and our office is working on an enhanced bankruptcy
code, which I think you actually support. I am not sure about
that. But are we worried right now we are getting to a point--
and I know you have to keep a stiff upper lip on these issues,
but on the European crisis that is unfolding and just our
exposure to it, 17 different countries, very difficult for them
to act in unison, are we beginning to think about, should that
contagion come here, how we might respond since the mechanisms
we have in place are not adequate?
Secretary Geithner. Of course, but the best thing we can do
is to get the Europeans to move and to do things to make growth
stronger here. Those are the best protections we can have. But
Dodd-Frank did leave in place very substantial and important
protections that, you know, of course, we hope never to use
again, but they exist for a purpose.
Senator Corker. Thank you, Mr. Secretary.
Thank you, Mr. Chairman.
Chairman Johnson. Senator Kirk.
Senator Kirk. Thank you, Mr. Secretary. I just want to
quickly lay down a marker because I think the Committee has a
hearing on Iran next week. Is that right, Mr. Chairman?
Chairman Johnson. Yes.
Secretary Geithner. In fact, my colleague David Cohen I
think is going to testify.
Senator Kirk. Correct. So you got a letter from 92 Senators
saying collapse the central bank of Iran, and you wrote us back
basically saying, ``Call you back,'' which is not----
Secretary Geithner. I think ``Stay tuned'' was the----
Senator Kirk. Yes, ``Stay tuned,'' correct. That is music
to my ears, and so I just want to lay down the marker for next
week, if you could work with David.
I want to focus on the subject du jour today, which is euro
contagion. According to the CRS, our exposure, U.S. bank
exposure to Greece, $1.5 billion in direct loans to the
government, $7.3 billion in direct loans to the economy, $34
billion in other exposure, so about $42 billion in exposure by
U.S. banks to Greece.
The CRS memo highlights Italy, about $36 billion in direct
loans from U.S. banks, $230 billion in other exposure, about
$256 billion total to an Italian problem for U.S. banks.
CRS added up exposure in Greece, Ireland, Italy, Portugal,
and Spain with other exposures. It is a $641 billion problem,
and yesterday we saw this with problems at Morgan Stanley. Can
you talk about the Morgan Stanley problem and whether we are
seeing a potential Lehman Brothers situation with regard to a
major U.S. financial institution and euro contagion?
Secretary Geithner. No, absolutely not, but I would just
say the following: As I said in my testimony, the direct
exposure of the financial system to the countries under the
most pressure in Europe is very modest. Europe as a whole,
though, is a big deal, and our firms--and this is true across
the largest institutions in the United States--again, are in a
much stronger position if you look at their capital levels,
levels of leverage, how they are funded, they are in a much
stronger position to withstand the pressures we are seeing
there. But, of course, you know, we want Europe to move, and we
want to make sure that they move more aggressively to address
this because, you know, Europe is big enough to matter.
But I would just caution you. Those numbers are--you know,
it is very hard to just look at the direct exposure you can see
and capture how these things unfold. But the overall picture is
very limited direct exposure, a lot more capital in the system,
a much stronger, more resilient financial system in the United
States. We are very fortunate because we moved so aggressively
at the beginning, and that is going to serve us well.
Senator Kirk. I would just note here, the BIS latest data,
your point is exactly well taken. It shows our direct exposure
is, for example, significantly less than U.K., Germany, and
France, but if you add our direct and other exposure, we are
actually far more exposed than the U.K. and as exposed as
Germany.
Secretary Geithner. No, I do not think that is right
because that does not still capture the full balance of it. I
think, again, the simple way to say it is Europe is big. And
the countries under the most pressure are not that large, but
Europe as a whole is big. And when Europe is weaker, growth is
going to be weaker, and that will matter for us. But, you know,
it is very important to recognize this. This is a complicated
crisis for them, there is no doubt, and it is politically
difficult. But this is not--the costs of resolving this are not
large relative to the resources of Europe, and they have
committed at the highest levels of Europe to hold the system
together, to make sure they protect their broader banking
system, and to make sure they can support the governments that
are under the most pressure, as they are actually doing now.
And they recognize they need to do more to make that credible,
and we have an interest in them doing that.
Senator Kirk. We do. I want to turn to one other thing,
which is I read the report, the FSOC report, what this hearing
is concerning, and while they did not identify up front State
and municipal debt as a systemic risk, at least they had a
section about it in the enabling environment. But I represent
the State of Illinois that is now in the throes of a classic
debt spiral, where the Governor increased taxes by 66 percent
on individuals and 46 percent on corporations.
Secretary Geithner. From a low level, I think, is my
recollection but----
Senator Kirk. Well, unfortunately, now he is higher than
all his Midwest competitors, and so we now see that, for
example, unpaid bills in the State of Illinois have grown
tenfold in 10 years, now totaling over $8 billion, with a
steadily deteriorating credit rating and an increasing margin
that the State has to pay.
I am worried that systemically the FSOC is not--maybe it is
too politically correct and we have a Democratic administration
so we cannot talk about State debt. You know, we want to grow
the size of the Government, and so we talk about State
governments that have overgrown and are in death spirals. And
my worry is this: Have you contemplated a State defaulting?
Because the State of Illinois is now--all the classic symptoms
are there.
Secretary Geithner. Senator, let me just say a few things
about your question. You are right to say that States are under
enormous pressure across the country, not just in Illinois. And
although some of those pressures are easing as recovery
continues, it is going to take years for them to get themselves
in a better position.
The people in the FSOC are very sensible people, and they
look at everything, and they know that debt matters. And they
look at all the basic fiscal challenges we face going forward.
You said one thing, though, that I just want to correct. The
proposals the President has laid out for the role of Government
in the economy and the size of Government in the economy would
reduce the level of Government spending relative to the economy
very substantially if Congress were to hold to those proposals
over a 10-year period of time. That is true across Government.
The only exception to that is where, because Americans are
aging, more Americans become eligible for health care and
Social Security, and those basic benefits--which Congress sets,
not us--those grow with aging, with eligibility, and with
rising costs of health care.
But if you look outside those basic benefits Congress sets,
under the President's plan, even with the investments we want
to make in education and infrastructure and a lot of things
like that, Government spending falls as a share of the economy.
Senator Kirk. But I will say creditors do not look outside.
Creditors do not----
Secretary Geithner. No, no, but----
Senator Kirk. Creditors simply ask the question: Do you
need to borrow more money next year than last?
Secretary Geithner. And, again, if Congress were to--I know
we are not holding our breath, but if you were to enact the
President's proposals, our deficits would fall very
dramatically over the next 3 to 5 years, and our debt burden
would start to fall as a share of the economy. So we agree with
that basic imperative----
Senator Kirk. Right, but you switched to Federal, and I
want to focus you on State. I am very worried because I think
the FSOC should say that States pose a systemic risk to the
system. I think that FSOC should then generate----
Secretary Geithner. Well, I do not think they do, but we
will look at them and pay attention to them, as we always do,
and look at the implications of scenarios, as we always do. And
we are not underweighting, underappreciating any of the broad
threats we face out there.
Senator Kirk. Right, because we do not want political
correctness to say that we do not want to issue financial
guidelines that would cause States to reduce their payroll. But
if they are borrowing too much and representing a systemic risk
to municipal bonds----
Secretary Geithner. Senator, let me just reassure you, if
you look at the members of this Council and you look at them
and you spend time with them, there is no risk of political
correctness interfering with the broad judgment of these
members. But I take your question and, of course, will be
careful and cognizant of those things.
Senator Kirk. Thank you.
Thank you, Mr. Chairman.
Chairman Johnson. Senator Merkley.
Senator Merkley. Thank you very much, Mr. Chair, and
welcome, Mr. Secretary. I want to follow up on a question
Senator Kirk was asking about Europe, but a little more of a
point on derivatives themselves.
We had members of the bond rating council or bond rating
companies that met with us a couple weeks ago, and they said
basically they had no idea of who is writing and who is holding
and what American exposure is and that they were not sure if
any one of their firms did, which for a group that specializes
in understanding the exposure on bonds took us right back to
America's experience with not knowing the American Insurance
Group, what they were writing and what was being held where.
This is a big problem.
Secretary Geithner. These were rating agencies you referred
to?
Senator Merkley. Yes, rating agencies.
Secretary Geithner. Well, as you have seen, they do not
have perfect foresight in these judgments but----
Senator Merkley. No, they are in the business of studying
these issues, so----
Secretary Geithner. I would offer the following judgment,
and, you know, we are all careful and cautious about things we
cannot know and you want to be conservative about these things.
But I think the Federal Reserve and the primary supervisors or
overseers of our system have a pretty good feel of the overall
exposure, not just directly but through derivatives and
hedging, and have a pretty good sense about how good those
hedges are.
Now, there is inherent uncertainty in these things, and, of
course, it ultimately depends on how effectively Europe acts in
this context. But I think we are in a better position than they
are, the rating agencies, and I think they are reasonably
encouraged by what they have seen.
Senator Merkley. I think it would be helpful if we could
get the Fed to give us their vision of that transparent world
out there so that we could share the same sense of confidence
about not being as linked as we might fear to the European
troubles.
I wanted to turn to the housing system, and I appreciate
your support for national servicing standards, which I think
are hugely needed. And as you were answering as I came in here,
I believe, you support the strategy the President mentioned in
his jobs speech of having a strong effort to reduce the
interest rate on loans, to put more money in folks' pockets.
But we have not seen details of the President's plan, and it
strikes me as strange a bit that on something so important in
terms of the huge tsunami of foreclosures that we are facing,
we still do not have details this far after the speech. Will we
see those details soon? And can we create a program that will
affect enough Americans to make a difference not only in terms
of those families but in terms of our national economy?
Secretary Geithner. I think we can make a big difference,
and you are going to see from the FHFA Director, I think in the
next couple weeks, very detailed proposals. This is their
authority. That is why you have not seen details yet. It is not
within my power or the President's power. They are an
independent agency established by Congress with that authority.
But they are going to lay out some specific proposals next
week, and I think that they will make a difference.
Now, we have been very careful not to estimate the number
of Americans who could be reached by this because, as you have
seen, we dramatically overestimated at the beginning of all our
housing programs, the number of people we could reasonably
reach who could qualify and be eligible. So we will be
cautious. But my sense is, based on what I have seen and what
he has told us, it is going to make--it is meaningful enough to
make a difference.
Senator Merkley. Is there any sense to using soft seconds
for the balance that is underwater as a way to create loans
that could re-enter the marketplace?
Secretary Geithner. That is one of the issues that they are
looking at trying to fix because that is one of the things that
stands in the way of allowing more people to take advantage of
lower rates. But I cannot tell you today, I do not know yet, to
what extent they feel they have a fix to that.
Senator Merkley. Yes, that is one way of--one possibility
of certainly taking the whole--saying refinance the whole thing
regardless of the amount that you are underwater, and that is
easier and simpler.
Secretary Geithner. Yes, that is true, but they are looking
at a range of things, and you will see more details in a couple
weeks.
Senator Merkley. OK. I look forward to that.
Finally, in terms of rules related to implementing the
Volcker Rule, certainly the goal is to say that commercial
banks are in the business of making loans to businesses and
families, that that is extremely important. If you want to be a
hedge fund, become a hedge fund, but not mix the two to the
detriment or the increase in systemic risk.
There is some concern out there in regards whether the
rules are going to have substantial loopholes. Is this
something that you are engaged in? And can I sleep well knowing
we will have a clear distinction?
Secretary Geithner. I think you can, and I should say--and
I think you are aware of this--there has already been a very
substantial change across that industry moving away from
dedicated internal hedge funds--not to use the pejorative--in
anticipation of the rule. But you are going to see the
agencies, I think this week and next, lay out detailed
proposals. Those will go out for comment. Everybody will have a
chance to look at where the balance is. They are going to ask
some questions about issues we have not resolved yet. And so we
will have a chance at that point to make sure we get the
balance right. But I am very confident this is going to meet
the objectives of the legislation.
Senator Merkley. I think that the plans on compensation for
market-making trades is very, very helpful because it creates a
huge distinction between one business and the other.
Thank you very much.
Secretary Geithner. Thank you.
Chairman Johnson. There are a couple other members who tell
us they are coming back, and in the meantime, the claim has
been made that the standard for the FSOC to set aside a final
CFPB rule is ``a pretty high threshold.'' Would you please
explain the appropriateness of the standard? comments
Secretary Geithner. Well, as one of the checks and balances
that exist in the law--and as I said, I think that combined
with the others make it a pretty strong set of checks and
balances--I know that some members up here would like to alter
them. But that specific provision allows the Council to, in
effect, block or overrule a judgment by the Bureau if it is
inconsistent with safety and soundness. I think that is the
basic standard. As I said, that is a quite unique safeguard
check and balance, a very strong check and balance, but not the
only one. And as I discussed earlier with Senator Corker, I
think the balance is pretty strong.
Chairman Johnson. Last year the SEC adopted new rules to
strengthen money market funds, and last October the President's
Working Group recommended several possible reforms to reduce
the potential systemic risk of money market funds. Do you and
the FSOC members agree that further reforms are needed to make
money market funds more resilient and less susceptible to runs?
What risks are we currently facing?
Secretary Geithner. The Chairman of the SEC agrees with
that, that more reforms are necessary, and I think the broad
sense of the Council--and I share this--is that she is right.
She is examining a range of ideas. Some of those have elicited
a lot of opposition and concern; some of them more support.
They are working through those.
But my sense is that although we have more work to do, we
have made quite a lot of progress, and we want to build on that
progress, do so carefully, and I think the Chairwoman of the
SEC is supportive of a careful balanced look at further reforms
to make, as you said, those funds more resilient.
Chairman Johnson. In the FSOC Annual Report, you noted that
the U.S. is leading a global effort to develop minimum
standards for margins on swaps. Could you provide us an update
on the progress of international coordination to harmonize swap
rules in a way that both reduces systemic risk and promotes
U.S. competitiveness?
Secretary Geithner. Absolutely. You know, we have three
decades of experience with global capital standards, trying to
make those better; there is no precedent, no previous attempt
to make sure we have in place common rules on margin around the
world for derivatives. So what we have proposed is a major
international effort to establish those. We have formed a
special international task force that is led by the Federal
Reserve, I believe, or led jointly by the Federal Reserve, that
brings together central banks, bank supervisors, market
regulators to try to design a common framework that will match
what we are doing in the United States. We are at the early
stage of that process, but my sense from talking to the
European officials and those in Asia and U.K. officials that
there is very broad support for that and they share our
interest in making sure there is a global level playing field
in that area.
Chairman Johnson. Senator Shelby, do you have additional
questions?
Senator Shelby. Thank you, Mr. Chairman. I do have a few.
First of all, Mr. Secretary, I want to try to answer what
you--you made a pitch for the nominee, the former Attorney
General, to be confirmed. Forty-four of us have sent a letter
that you are very familiar with to the President, and----
Secretary Geithner. And I think you sent it to me, too.
Senator Shelby. If I could finish.
Secretary Geithner. Yes.
Senator Shelby. And we have not heard one word about that,
asking for some modifications to this. It is not the nominee. I
think the nominee, as far as I know, is probably a well-
qualified, very honorable, very smart man. But we are waiting
for that dialog, and I hope we hear from you. But short of
that, I think the nominee is not going anywhere. But I wanted
to answer that. Go ahead, sir.
Secretary Geithner. Well, I understand that position, and
we received that message. You have been very clear about it,
and you had a pretty powerful show of strength. But I was just
encouraging you to reconsider because I think that----
Senator Shelby. Well, we would hope you would consider, you
and the President, changing three modest things in the Dodd-
Frank bill, and if you do, I am sure that we will have a good
piece of legislation, at least a better piece, and we will go
from there. But short of that, I do not believe that we are
moving that nomination.
Secretary Geithner. I am always optimistic. I do think the
three things you suggested----
Senator Shelby. Do not get optimistic on that.
[Laughter.]
Secretary Geithner. I would say the three things you
suggested, Senator, in combination I think would be a
significant weakening of the Bureau.
Senator Shelby. Well, we do not think so. We think it would
strengthen the Bureau. But, you know, we have a difference of
opinion. But I thought I would answer that. I have a few
questions I----
Chairman Johnson. What comes around goes around.
Senator Shelby. Absolutely, and that is why we plan on
coming around.
Secretary Geithner, the Bank of England Governor, Mervyn
King, as well as some prominent academic economists have said
that Basel III capital standards they believe are insufficient
to prevent another crisis. Do you agree with them? Or do you
have second thoughts----
Secretary Geithner. I do not.
Senator Shelby. I have thought myself that Basel III to
strengthen the capital standards was positive.
Secretary Geithner. The framework that we call Basel III is
a dramatic increase in the basic conservatism of the capital
regime in the United States and around the world. A substantial
increase in capital relative to what was required before the
crisis, combined with the liquidity provisions in place, too,
creates better protections.
Now, just one quick qualification. We have proposed that
the largest institutions hold--and this was required by the
legislation, too--an additional buffer of capital reflecting
the greater risk they pose to the system. And our judgment is
the combination of those two things, as long as you phase them
in--you want to phase them in carefully over time.
Senator Shelby. But not too much time. I mean, not 25 years
from now.
Secretary Geithner. No, you do not want to wait too long.
But you do not want people building capital too much too
quickly or having to sell assets to meet those requirements too
quickly when the recovery is still trying to get----
Senator Shelby. They have got to get on the right road,
have they not?
Secretary Geithner. And they are, and U.S. firms are very,
very far along to meeting those new standards?
Senator Shelby. Do you have confidence that the European
banks and the regulators there will comply with Basel III, the
spirit as well as the letter of it?
Secretary Geithner. Well, we are going to do everything we
can to make sure they do, of course, and as I said, we have the
time to try to make sure we are confident that is going to
happen, because these rules only start to bite over the next
several years. And so we are working very hard to make sure we
have better protections in place.
Senator Shelby. Mr. Secretary, do you know of a financial
institution--you have been around a while--that has been
adequately--in other words--and I will not say adequately well
capitalized and had liquidity that has failed?
Secretary Geithner. That is a very interesting question. I
think that in a really systemic financial crisis, just to think
back to the experience of this country in 2008, for example,
certainly it was the case in the Great Depression and other
examples of this stuff, you can have a situation when even very
well capitalized financial institutions are subject to acute
pressure. In some sense, that is the best way of thinking of
your definition of what is a systemic crisis.
Senator Shelby. But if they have liquidity, doesn't that
help?
Secretary Geithner. It does help. But, you know, this is an
interesting conversation, but you cannot--it is not sensible to
try to force the system to hold capital and reserves that would
cover any foreseeable, imaginable risk or shock.
Senator Shelby. Well, that makes no sense.
Secretary Geithner. Exactly. So in a really systemic
financial crisis, even the strong will be affected by the
pressures you see more broadly.
Senator Shelby. This week----
Secretary Geithner. But to be clear, that is no comment on
the present. We are in, I think, as I said--and you could look
at capital liquidity, classic measures--in a really strong
relative position.
Senator Shelby. This week, earlier this week, the Bank of
America--I guess it is our largest bank; I know it is in
deposits--announced that it would charge a monthly fee to
consumers, I guess on credit cards. When asked about the fee,
the President stated, as I understand it, that the banks do not
have a right to get a certain amount of profit. Mr. Secretary,
how much profit should the Government allow a bank to make? And
does the President's comments mean that this Administration
supports Government-mandated price controls on financial
products? Or is it taken out of context, what he said? Or is
that just political rhetoric?
Secretary Geithner. The President does not believe that we
get to determine how profitable individual financial
institutions are or other companies across the country. That is
not the system we believe in or----
Senator Shelby. The market should determine a lot of that,
should it not?
Secretary Geithner. It should, of course, but what we do
believe, though, is that you want to have a system of oversight
in consumer protection where consumers have the ability to
understand what they are being charged for financial services,
what they are being charged to borrow. And part of what we are
trying to do is encourage much more transparency and clarity so
that consumers are a little less vulnerable to being taken
advantage of.
Senator Shelby. So the consumer can make the decision and
not a bureaucrat, right?
Secretary Geithner. That is exactly right.
Senator Shelby. OK.
Secretary Geithner. Now, there are things that Government
officials have to do, though, it is our responsibility to do.
But the basic strategy we have adopted that the President
supported, and the CFPB is designed to establish, puts the
overwhelming burden on better transparency and disclosure as a
way to make sure consumers have the better chance to protect
themselves.
Senator Shelby. But you are basically saying this
Administration is not in any way coming out for any type of
wage and price controls of any kind?
Secretary Geithner. No.
Senator Shelby. OK.
Secretary Geithner. Or yes, I am saying we are not.
Senator Shelby. Thank you.
Mr. Secretary, the Council's annual report that we have
been talking about all morning, the efforts to coordinate Dodd-
Frank implementation, it goes across a number of agencies, as
you well know. The CFTC and the SEC have consistently, a lot of
people believe, failed to harmonize some of the substance and
the time frame of the Dodd-Frank rules.
Has the Council been involved in this? Are they making any
success here in improving the coordination of the SEC and the
CFTC? I think that is important that they are drinking out of
the same cup, so to speak.
Secretary Geithner. I completely agree with you, although
Congress did leave in place this complicated set of independent
agencies with independent statutory requirements. Our basic
approach has been to say that as you meet those requirements,
we would like you to do so in the way that is as closely
aligned as the law permits. Where the law permits you to be
aligned, you should be aligned, because if you are not, all you
are going to do is leave a complicated system with big
distortions, opportunities for arbitrage, and gaps. And that
matters for us here, but it also makes it harder for us to get
the world to come to a more level playing field. If we are in
different places, it is harder to get the world to come to a
sensible place.
Senator Shelby. Thank you.
Thank you, Mr. Chairman.
Chairman Johnson. Senator Vitter.
Senator Vitter. Thank you, Mr. Chairman. Thank you, Mr.
Secretary.
I wanted to focus in my questions on the housing finance
agencies and market and the need to bring reform there,
including a return of the private capital and the private
market into that now very Government-dominated sector.
My concern for a while, including all through the Dodd-
Frank discussion, is that that was put on the side with the
promise that we will get to that, we will get to that next
year. Well, it is now next year, and I do not particularly see
us getting to it.
Now, I do know the FSOC report includes the statement that
the member agencies need to strengthen the system, ``which
includes developing a framework for the return of private
capital to the system.'' What does that mean exactly? And what
is the timetable for concrete action?
Secretary Geithner. I just want to start with one
observation, which is that Congress did enact a fundamental
change to the basic framework of oversight of the GSEs and the
home loan bank system in September of 2008 ahead of Dodd-Frank.
But you are right that with that foundation, which did not
solve our problems, Dodd-Frank did not go further and lay out
this fundamental challenge of fixing the broader housing
finance system. That is still ahead of us.
So what are we trying to do? We want to set up a framework
where private capital, private investors, the private system
plays the more dominant role in housing finance once again, and
that we gradually phase down the Government's role to a more
limited, more targeted, more sensible role. For that to happen,
we need to have a clearer set of rules in place across the
securitization markets, clarity on the amount of capital you
have to hold against a mortgage loan if you are a private
institution, and we need to gradually wind down the exceptional
measures, the exceptional expansion of Fannie and Freddie and
the FHA's rule that happened in the crisis as private capital
withdrew.
We laid out a comprehensive set of options, proposals, and
objectives last February. We are in the process of designing
legislative proposals to present to Congress. We have been
consulting very broadly with academic experts in the industry
and Members of Congress on how best to do that. And I do not
know what is going to be possible in terms of legislating in
this environment in the next 18 months or so, but we would like
to get that process moving. And as we said last February, we
are going to take the burden of initiative in laying out to the
Congress a proposal for how to get us to a better place. And
you are right to point out--and I say this all the time--that
we are at only the very earliest stages in trying to put in
place a better housing finance system.
Senator Vitter. So that work will include a concrete
legislative proposal?
Secretary Geithner. Well, we might--we have not quite
decided how to do it. We might start with another--we had
options. We might start with a proposal and get comment on it
before we give legislation. We have not decided yet. But we are
going to propose something to you so that you have something
you can consider.
Senator Vitter. And what is the timetable for all of this,
broadly?
Secretary Geithner. We have not decided. As you know, we
are kind of busy. But we have got a team of people who have
been working on this all summer, and they are making a lot of
progress, and we are getting closer.
Senator Vitter. There were elements of Dodd-Frank which in
my opinion pushed that sector in the wrong direction, further
protecting or advantaging the GSEs. Will that----
Secretary Geithner. Such as?
Senator Vitter. Will that be directly addressed? Such as
the exemptions for the GSEs for certain standards and
requirements in Dodd-Frank.
Secretary Geithner. I do not think those stand in the way
of us proposing very substantial reforms, but we will look at
them if they do.
Senator Vitter. And the risk retention provision, the
exemption, things like that?
Secretary Geithner. Again, when I referred generally to the
set of rules on securitization, that is what I was referring
to. Those we are trying to start to define. We laid them out
for comment. There have been a lot of comments. We are taking a
look at those rules. But what you need is those set in a
sensible place, and then we need to change the basic economics
of the GSEs' role. We need to do those things together, and
over time that will pull private capital back in.
Senator Vitter. There has been some suggestion, I have
read, that there is a specific working group on this topic. Is
that specifically defined? And who is a part of that?
Secretary Geithner. I do not know if we call it a specific
working group, but we have a team of very talented people at
Treasury and the Fed--sorry, Treasury and HUD. We consult with
the Fed very actively. We work very closely with the FHFA, the
overseer of Fannie and Freddie, and there is a team of talented
people in the NEC in the White House that are involved in those
discussions.
Senator Vitter. And does that formal or informal team
include folks from outside the Administration?
Secretary Geithner. Well, that team does not. That is just
people in--well, it includes some of the independent agencies
like FHFA and the Fed. But they do not meet as a team always
like that. But we have been very active in looking to academic
experts, people in the real estate market, the housing
community, the banking system, and the financial system to make
sure we are taking advantage of all the other ideas out there.
Senator Vitter. OK. Thank you, Mr. Chairman.
Chairman Johnson. Thank you again, Secretary Geithner, for
being here today. The Financial Stability Oversight Council is
important to the overall stability of this country's financial
economy. Your work and the work of all the members of the
Council is greatly appreciated.
Thanks again to my colleagues and the panelists for being
here today. This hearing is adjourned.
[Whereupon, at 11:41 a.m., the hearing was adjourned.]
[Prepared statements and additional material supplied for
the record follow:]
PREPARED STATEMENT OF TIMOTHY F. GEITHNER
Secretary, Department of the Treasury
October 6, 2011
Chairman Johnson, Ranking Member Shelby, and Members of the
Committee, thank you for inviting me to testify today on behalf of the
Financial Stability Oversight Council (the ``Council'').
In setting up this Council, you asked us to provide in a public,
annual report a comprehensive view of financial market developments and
potential threats to our financial system. My testimony today will
review the conclusions and recommendations made by the Council in its
first annual report, which is being submitted in full alongside this
testimony.
In 2011, the world economy is still healing from the devastating
effects of the financial crisis. On top of those challenges, we
experienced a series of additional shocks early this year, including
high oil prices and the disaster in Japan. Europe's protracted economic
and financial crisis has added to these pressures on global growth. And
the destructive debate surrounding the debt limit this summer has
damaged the confidence of American businesses and consumers.
Some of these factors have eased in recent months, as oil prices
have fallen and Japan has begun to recover. But the cumulative effect
of the pressures has resulted in slower growth in the United States and
around the world, with lowered expectations for growth next year.
The crisis in Europe presents a significant risk to global
recovery. We are working closely alongside the IMF to encourage
European leaders to move more forcefully to put in place a
comprehensive strategy to stabilize the situation. The critical
imperative is to ensure that the governments and the financial systems
under pressure have access to a more powerful financial backstop,
conditioned on policy actions that credibly address the underlying
causes of concern for a sustained period of time.
In the face of the situation in Europe, and the general slowdown
across the world, the most important thing we can do is take strong
steps to strengthen our economy at home. The most effective strategy
for doing that is to enact steps now that will accelerate economic
growth, tied to long term reforms to restore fiscal sustainability.
The American Jobs Act provides a substantial package of tax cuts
and investment that, according to estimates by outside economists,
would raise economic growth by one to two percentage points and help
create one to two million new jobs. And in the President's proposal to
the Joint Committee of Congress charged with reducing our long-term
deficits, we outlined a comprehensive package of reforms to spending
programs and the tax system that would bring our deficits down to the
level where our overall debt burden starts to decline as a share of our
economy.
The Council is composed of each of the agencies responsible for
oversight of the financial system and the firms and markets that
comprise it. In the judgment of this Council, the United States
financial system is in a significantly stronger position and better
able to withstand the new risks we face in the global economy.
Because of the actions we have taken to repair and reform our
system:
The weakest parts in our financial system--the entities
that took the most risk--no longer exist or have been
significantly restructured.
The firms that survived are better capitalized--large banks
have increased common equity by over $300 billion since the
beginning of 2009. And the level of common equity to risk
weighted assets across these banks is now approximately 10
percent, up from 6 percent at the beginning of 2009.
Banks are funding themselves more conservatively and are
maintaining much larger cushions of safe and liquid financial
assets. Debt maturing in 1 year or less at the largest
institutions, as a share of total liabilities, has declined
dramatically to roughly 40 percent of the precrisis level.
The major banks have reduced the size and overall risk in
their balance sheets, resulting in a substantial decrease in
leverage--a major source of risk--compared to precrisis levels.
The ``shadow banking system''--the financial firms that
operate outside of a framework of oversight and prudential
regulation--is much smaller, with assets at roughly half the
level of 2007.
These improvements are very significant. Together they represent
more progress on the path to a more stable and resilient financial
system than has been achieved in the other major economies.
The European financial crisis has placed significant pressure on
its financial institutions and slowed growth significantly in Europe
and around the world. U.S. financial institutions, including our major
banks and money market funds have substantially reduced their exposure
to the economies of Europe that are under the most pressure. Our direct
financial exposure to those governments and their financial
institutions is quite small, but Europe is so large and so closely
integrated with the U.S. and world economies that a severe crisis in
Europe could cause significant damage by undermining confidence and
weakening demand.
This makes it even more important that Congress act to strengthen
growth now and put our fiscal position on a more sustainable path.
Economic and financial developments since the release of the
Council's report reinforce the importance of its recommendations. Here
are those recommendations in summary form.
First, the Council emphasizes the importance of further actions to
strengthen the financial position of the core of the U.S. financial
system, particularly the largest institutions. We want the largest
institutions to manage their businesses so that they have the ability
to weather more challenging future environments without Government
assistance in crisis.
Toward this objective, regulators will gradually phase in, over a
period of several years, the much tougher standards for capital and
liquidity we have negotiated with the other major financial systems
around the world.
These efforts focused on the largest banks are complemented by
recommendations designed to make other key market participants more
resilient to future challenges to growth and financial stability.
And the report draws attention to new market structures and
financial products, such as exchange traded funds and structured notes,
where we have seen very rapid growth and innovation. A robust financial
system should encourage and foster innovation, but not at the expense
of overall financial stability.
Second, the Council recommends reforms to strengthen a number of
key funding markets in the United States, markets that were a critical
source of vulnerability in the crisis. The most important of these
recommendations are directed at the tri-party repo markets and the
money market funds. The essence of these recommendations is to make the
tri-party repo markets and money funds themselves less vulnerable to
the classic dynamic in which an abrupt rush for the exits forces a
damaging spiral of asset sales, deleveraging and broader contagion.
Substantial progress has been made toward this objective, but we have
more work to do.
Third, the Council recommends reforms to the housing finance
system. In this context, it recommends action to establish national
standards for the mortgage servicing market, in order to better align
incentives and help reestablish confidence in the integrity of the
housing market. And the Council emphasizes the importance of broader
reforms to help return private capital to the housing market,
strengthen mortgage underwriting, and reduce over time the role of the
Government in the housing markets. As we proceed with these reforms, we
want to make sure that we are encouraging, not undermining, the
prospects for broader recovery in the housing market.
Fourth, the Council emphasizes the importance of closer cooperation
and coordination in the implementation of financial reforms, both here
in the United States and around the world. This is crucial because if
we allow large gaps to emerge as we did in the years before the crisis,
risk will migrate to those gaps, leaving the system as a whole more
vulnerable to another crisis.
Differences in the design of standards in particular areas create
opportunities for firms and investors to take advantage of those weaker
standards. As we act to contain risk in the United States, we want to
minimize the chances that it simply moves to other markets around the
world, ultimately endangering our own system. The most important
challenges we face in building a level playing field lie in the design
of new capital standards and liquidity rules for the largest
institutions and reforms to the derivatives markets.
The Council's recommendations are designed to address the
challenges we see today, but also those inherent in a dynamic,
innovative financial system. We cannot predict the precise threats that
may face the financial system. The best way to prepare for this
uncertainty is to continue to build the shock absorbers and safeguards
that improve the resilience of the financial system. We need to
recognize that policy and regulation will often be behind the curve of
financial innovation. The best course is to plan for constant change
and the potential for instability and to recognize that the threats
will come in ways we cannot predict or fully understand.
Although our financial system today is much stronger than it was
before the crisis, our work is not complete. To preserve the gains we
have achieved and to reduce both the risk of and the damage from future
crises, we must continue to implement financial reform, pass
comprehensive housing finance reform, and move forward with the other
recommendations of the Council.
We will do this with a balanced approach, weighing the benefits of
regulation against the costs of excessive restraint. We need to move at
a pace that fully recognizes the fragility of the global economic
recovery, phasing in reforms over time so that we limit the risks to
growth.
As we move forward, I encourage Congress to strengthen our capacity
to continue repairing our financial system and to make sure that
investors and consumers are afforded better protections against abuses
and unfair practices. This means making sure that qualified people are
in place to run the financial agencies. And it requires that Congress
provide sufficient funding for enforcement agencies to do their jobs in
today's complicated and challenging financial environment. If we leave
the agencies responsible for enforcement underfinanced, then we will
leave the American consumers, investors, and businesses that depend on
our financial system more vulnerable.
In closing, I want to thank the other members of the Financial
Stability Oversight Council, as well as the Council's staff, for the
work they have done over the past year and their efforts to produce
this annual report.
We look forward to working with this Committee, and with Congress
as a whole, to build on the substantial progress we have made to create
a stronger financial system.
Additional Material Supplied for the Record
FINANCIAL STABILITY OVERSIGHT COUNCIL 2011 ANNUAL REPORT
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