[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

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs


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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

                              ----------                              

                       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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