[Senate Hearing 112-743]
[From the U.S. Government Publishing Office]
S. Hrg. 112-743
THE 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
SECOND SESSION
ON
EXAMINING THE FINANCIAL STABILITY OVERSIGHT COUNCIL ANNUAL REPORT TO
CONGRESS
__________
JULY 26, 2012
__________
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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
Glen Sears, Senior Policy Advisor
Brett Hewitt, Legislative Assistant
Andrew Olmem, Republican Chief Counsel
Mike Piwowar, Republican Chief Economist
Jelena McWilliams, Republican Senior Counsel
Dawn Ratliff, Chief Clerk
Riker Vermilye, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
(ii)
?
C O N T E N T S
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THURSDAY, JULY 26, 2012
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....... 4
Prepared statement........................................... 42
Responses to written questions of:
Chairman Johnson......................................... 46
Senator Shelby........................................... 47
Senator Reed............................................. 48
Senator Corker........................................... 49
Senator Kohl............................................. 52
Senator Toomey........................................... 53
Senator Kirk............................................. 55
Additional Material Supplied for the Record
Washington Post article submitted by Senator Bennet.............. 59
Financial Stability Oversight Council 2012 Annual Report......... 60
(iii)
THE FINANCIAL STABILITY OVERSIGHT COUNCIL ANNUAL REPORT TO CONGRESS
----------
THURSDAY, JULY 26, 2012
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:04 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. Good morning. I call this hearing to
order.
Today we welcome Treasury Secretary Geithner to deliver the
Financial Stability Oversight Council Annual Report to
Congress, as required by the Wall Street Reform Act.
Having recently marked the 2-year anniversary of Wall
Street reform, I believe we have made important progress to
enhance our financial system's stability. Critics are quick to
point to the unfinished rules, but the improved regulatory
structure was not going to appear overnight. In 2 years, we
have a mechanism in place to unwind failing nonbank financial
firms, the regulators have proposed rules to enhance capital
and prudential standards for our Nation's largest and most
complex financial institutions, and we have improved consumer
and investor protections, among other efforts.
The Financial Stability Oversight Council is a key part of
these efforts to enhance financial stability and eliminate
regulatory gaps. It manages the process to designate financial
firms as systemically important, coordinates interagency
rulemakings, monitors developments in the financial markets,
and provides a forum for all of the financial regulators,
Federal and State, to identify areas that need to be addressed
to strengthen our Nation's financial stability. I look forward
to hearing from Secretary Geithner about the FSOC's progress.
The FSOC has had some early challenges too. The Office of
Financial Research, FSOC's data arm, has yet to have a
confirmed Director, despite the President nominating a well-
qualified candidate. Without the certainty of a Director in
place, the OFR has struggled to attract the staff it needs to
put the systems in place to raise red flags when our Nation's
financial institutions and economy are in trouble. I urge my
colleagues to confirm Dick Berner in this role as quickly as
possible.
But the FSOC has also had many successes. The Annual Report
we are reviewing today is solid. It provides important insight
into the workings of the Council. It identifies many important
issues of concern and provides recommendations for the
regulators to address these concerns. From the Banking
Committee's oversight perspective, this report provides a
tangible way to measure the FSOC's progress.
The FSOC also recently designated eight financial market
utilities as systemically important. This is a major step
forward and is another example of how Wall Street reform is
helping to provide financial stability. The FSOC has finalized
the criteria and is in the process of designating nonbank
financial companies as systemically important, another critical
step.
The FSOC also has its finger on the pulse of the economy's
most important issues. For example, as we can see from the
public minutes and the Annual Report, the FSOC has been
focusing on the situation in Europe, an issue that this
Committee also has been monitoring.
As I have previously stated, I asked Secretary Geithner to
come prepared to speak about LIBOR. As the President of the New
York Fed in 2008, he raised some early warning signs about the
integrity of the LIBOR submission process and called on the
Bank of England to specifically ``eliminate incentive to
misreport'' LIBOR submissions by the banks. Shortly thereafter,
the CFTC began its investigation leading to an international
effort resulting in the recent enforcement actions by the CFTC,
DOJ, and FSA. As additional investigations into this matter
continue, I hope we can have a conversation today about what
happened during the crisis and how, going forward, we can have
more reliable benchmark rates that accurately reflect the cost
of borrowing in both normal and crisis periods, protecting both
borrowers and investors.
While this Committee will continue to exercise oversight of
regulators, we cannot lose sight of the fact that the LIBOR
issue, at its core, is about fraud. There are some who seek to
put the entire blame on the cops instead. But it would be a
mistake to shift the focus away from the continued effort to
hold the companies and individuals who committed fraud
accountable.
Our economy continues to face many challenges and it is
unlikely that we will be able to stop every future crisis, but
I do believe because of the work of the FSOC and Wall Street
reform, we are better prepared.
I will now turn to Senator Shelby for his opening
statement.
STATEMENT OF SENATOR RICHARD C. SHELBY
Senator Shelby. Thank you, Mr. Chairman.
As you said, Mr. Chairman, Secretary Geithner comes before
the Banking Committee today to report on the work of the
Financial Stability Oversight Council. The Council, as we all
recall, was established by Dodd-Frank and is required to report
annually on the State of the U.S. economy, threats to financial
stability, and the Council's activities.
In this year's report, the Council describes a stagnating
U.S. economy with a mere 1.9-percent growth rate in the first
quarter and a Federal deficit exceeding 7 percent of GDP. It
also reports that U.S. households have seen only modest income
growth, that access to mortgage credit is constrained, and that
investment is restrained by continued subdued confidence and
elevated uncertainty--their words.
As the Council reports, the unemployment rate is still
above 8 percent while labor force participation has fallen to
its lowest rate in 30 years. Nearly 4 years into this
Administration, not even a Council headed by its own Treasury
Secretary I believe can hide the President's failure to revive
the economy and put Americans back to work.
Also troubling is the Council's view of Dodd-Frank. Its
report describes at length all of the new Dodd-Frank rules, but
fails to mention their enormous cost to the economy. Nowhere
does the report mention that these rules will require Americans
to spend more than 24 million hours and billions of dollars
every year to comply with them.
If the Council wanted to understand why unemployment is
high and mortgage lending is constrained, then examination of
Dodd-Frank would have been a good place to start. More
fundamentally, the Council's report overlooks the serious
structural flaws in our regulatory system, which Dodd-Frank
only made worse.
For all of the President's talk about the need to reform
Wall Street, Dodd-Frank has merely strengthened the advantage
that large financial institutions possess in our financial
system.
First, Dodd-Frank Act imposes huge compliance costs on
banks, conferring a competitive advantage on the large
financial institutions that can more easily bear that burden.
As a result, the banking system has and will become even more
concentrated in the largest firms thanks to Dodd-Frank.
Second, Dodd-Frank failed to address the preferential
treatment that our largest banks receive from bank regulators.
For far too long, regulators have viewed themselves as
advocates and not supervisors of large banks. They have
developed cozy relationships with their banks and actively
sought bank-supported regulatory changes, such as lower capital
requirements. Those close relationships, however caused
regulators to ignore red flags from subprime loans to
insufficient capital to dubious securitization practices.
Regulators also adopted a mind-set that none of their large
banks should ever fail on their watch. Consequentially,
regulators have orchestrated a series of bailouts to benefit
our largest banks, including the 1995 bailout of Mexico, the
rescue of Long Term Capital Management, and most recently here
TARP. Unfortunately, Dodd-Frank preserved and codified the
preferential treatment for large financial institutions.
Dodd-Frank solidified the close relationships between
regulators and big banks by maintaining their preexisting
prudential regulators. In contrast, the regulator for the
smallest banks, the OTS, was abolished.
It also protected the big banks from bankruptcy by creating
a new resolution mechanism to ensure that large institutions do
not fail. And all the while Dodd-Frank did nothing to make
financial regulators more accountable. Instead, Dodd-Frank I
believe made it more difficult to remove regulators who become
captured by their banks.
For example, the structure of the Consumer Financial
Protection Bureau makes it effectively impossible to remove its
Director. I have said many times through the years here that
nothing focuses the mind like the specter of being fired. Not
one regulator, however, was held accountable in the wake of the
financial crisis.
To add insult to injury, the very same regulators that
missed the warning signs were then closely consulted on how to
draft Dodd-Frank. In fact, staff from the very same agencies
that failed us were detailed to Congress to help write the
bill.
This is the type of thing that outrages the American
people, but it is, sadly, business as usual in Washington.
Mr. Geithner is no stranger to bank bailouts or bank
regulation. He has played a key role in financial regulation
for the past 20 years. However, recent news reports about his
handling of the alleged LIBOR manipulations suggests that he,
too, may have tempered his response to what can be
characterized as a significant problem within the banking
industry.
Accordingly, today's hearing gives Secretary Geithner
before the Banking Committee an opportunity to explain when he
first learned of the allegations of LIBOR manipulation and how
he did everything he could to protect the American taxpayer
from any potential harm.
Mr. Geithner I believe will also have an opportunity to
explain to this Committee and to the American people how the
President's policies are improving the economy. It should not
take too long.
Thank you.
Chairman Johnson. Thank you, Senator Shelby.
In order to get to the questions of our witness as soon as
possible, opening statements will be limited to the Chair and
Ranking Member. 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 statement.
STATEMENT OF TIMOTHY F. GEITHNER, SECRETARY, DEPARTMENT OF THE
TREASURY
Mr. Geithner. Thank you, Mr. Chairman. Chairman Johnson,
Ranking Member Shelby, and Members of the Committee, thanks for
the chance to come before you today to talk about the Council's
annual report.
As the Council's report outlines, we have made significant
progress repairing and reforming our financial system since the
crisis. We have forced banks to raise more than $400 billion in
capital, to reduce leverage, and to fund themselves more
conservatively.
The size of the shadow banking system, where much of the
risk was concentrated, has fallen by trillions of dollars. The
Government has closed most of the emergency programs put in
place during the crisis and recovered most of the taxpayers'
investments made in the financial system. On current estimates,
as you know, the TARP bank investments will generate an overall
profit of approximately $20 billion. Credit is expanding, and
the cost of credit has fallen significantly for businesses and
individuals since the crisis. These improvements have made the
financial system safer, less vulnerable to future economic and
financial stress, more likely to help rather than hurt future
economic growth, and better able to absorb the impact of
potential future failures of large financial institutions.
But, of course, we still face a number of very significant
challenges. The ongoing European crisis presents the biggest
risk to our economy. The growing recession in Europe is hurting
economic growth around the world, not just in the United
States, and the ongoing financial stress caused by the crisis
in Europe is causing a general tightening of financial
conditions, exacerbating the global slowdown in growth.
In the United States, the economy is still expanding, but
the pace of economic growth has slowed significantly during the
past two quarters. In addition to the pressures from Europe and
the broader global economic slowdown, U.S. growth has been hurt
by the earlier rise in oil prices, the ongoing reduction in
Government spending at all levels of Government, and slow rates
of growth in household income.
The slowdown in U.S. growth could be exacerbated by
concerns about the approaching tax increases and spending cuts
and by uncertainty about the shape of the reforms and, frankly,
the political will of this town to put in place reforms to both
tax policy and spending that are necessary to restore long-run
fiscal sustainability. And these potential threats underscore
the need for continued progress in repairing the remaining
damage from the financial crisis and enacting financial reforms
to make the system stronger for the long run.
The regulators responsible have made important progress
over the past 2 years designing and implementing the
regulations necessary to implement financial reform. Roughly 90
percent of the rules that had deadlines before July 2nd have
been proposed or finalized, and the key elements of the law
will largely be in place by the end of this year.
As part of this, we have negotiated much tougher, new
capital requirements on the banking system, including higher
levels of capital on the largest banks. We now have the ability
to put the largest financial institutions under enhanced
supervision, tougher prudential standards, whether they are
banks or nonbanks, and we have the ability to subject key
elements of the market infrastructure to tougher and more
carefully designed safeguards against risk.
The SEC and the CFTC are putting in place a comprehensive
new framework of oversight to the derivatives market, providing
new tools for combating market abuse and bringing this market
out of the shadows. The FDIC has designed an innovative way to
put large financial institutions through an equivalent to
bankruptcy while protecting the taxpayers from the risk of any
loss and protecting the broader economy from the fallout of
those failures. And the Consumer Financial Protection Bureau
has worked to simplify and improve disclosure of mortgage and
credit card loans so that consumers can make better choices
about how to borrow responsibly.
Now, these reforms are very complicated. It is a
complicated process. It is challenging, in part because our
financial system is very complex. It is challenge because we
need to be careful to target damaging behavior without damaging
access to capital and credit. It is complicated and challenging
because we want the reforms to endure as the market evolves and
innovates. And it is challenging because we need to make sure
we are coordinating the work of multiple agencies, not just in
this country but across the major financial centers.
Now, beyond the reforms enacted in Dodd-Frank, the Council
has put forward a list of additional recommendations for other
changes to help strengthen our financial system. Further
reforms are needed to reduce vulnerabilities in wholesale
funding markets, including to mitigate the risk of runs on
money market funds and to reduce intra-day credit exposure in
what is called the tri-party repo market, which is an important
secure funding market.
Regulators need to establish and enforce strong protections
for customer funds that are deposited for trading. Financial
firms and regulators need to continue to improve risk
management practices with stronger capital buffers, better
stress testing disciplines, and better internal risk management
disciplines and controls for over complex trading and hedging
strategies.
The Council recommends further improvements in the quality
and availability of financial data. The Office of Financial
Research is going to continue to lead this effort, and I
appreciate Mr. Chairman reminding people that we hope the
Senate will act on the nomination of Richard Berner to head
that office.
And, finally, the Council continues to push for progress
toward comprehensive housing reform so we can bring private
capital back into the housing market.
Now, these recommendations will help build on the
considerable progress made by the Council over the past few
years in making the system safer and stronger, both more
resilient and less vulnerable to crisis, with better
protections for investors and consumers.
We still have a lot of work ahead of us, however, and we
need your support to make these rules strong and effective, and
we need your support to make sure that the enforcement agencies
have the resources they need to prevent fraud, manipulation,
and abuse.
I want to convey my compliments and thanks to the members
of the Financial Stability Oversight Council and their staff,
and I want to emphasize again that we look forward to working
with this Committee and with the Congress as a whole to build
on this progress and address the remaining challenges we face
in the financial system.
Thank you, Mr. Chairman.
Chairman Johnson. Secretary Geithner, thank you for your
statement.
We will now begin asking questions of our witness. Will the
clerk please put 5 minutes on the clock for each Member?
With regard to the LIBOR issue, last week I asked Chairman
Bernanke what he knew, when he knew it, and what did he do
about it. Secretary Geithner, you stated that you were aware of
weaknesses and vulnerabilities with LIBOR, that you made
recommendations on this matter in 2008. Were you aware of any
actions any members of the President's Working Group took after
they were briefed at that time? In light of the recent
enforcement action, is there more that should be done?
Mr. Geithner. Mr. Chairman, in early 2008, as the financial
crisis intensified, as concern about the strength of banks in
Europe in particular, and as those banks found it harder to
borrow dollars--and they needed to borrow dollars--you saw the
LIBOR rates increase. LIBOR, as you know, is a reference to the
London interbank offered rate, which is a rate set in London by
the British Bankers' Association, which is an average of
estimates of what a group of banks, predominantly foreign
banks, might pay to borrow in 10 currencies at 15 different
maturities.
At that time, as the rate went up, there was a lot of
concern in the market about the design of the rate and the
potential that created for misreporting and the incentives
banks faced to underreport as particularly foreign banks faced
higher borrowing costs.
At the New York Fed, we took a very careful look at those
concerns in the market. Many of those concerns made it into the
press. The Wall Street Journal and the Financial Times wrote
about this in April of 2008. We looked at those concerns, and
we thought they were justified. We were very concerned about
them, and on that basis, we took the following steps:
We briefed the President's Working Group on Financial
Markets, which is a group composed of the Secretary of the
Treasury, the Chairman of the Federal Reserve Board, the
Chairman of the SEC and the CFTC, among others, and my staff
subsequently briefed the Treasury and the CFTC and the SEC
following that initial meeting.
But in addition to that, because, again, this was a rate
set in London by the British Bankers' Association, I raised
this directly and personally with the Governor of the Bank of
England, and I wrote a detailed memorandum to the Governor
outlining a series of reforms to reduce the vulnerability in
the rate. And the Bank of England was very receptive to those
recommendations and indicated they supported them and would act
on them.
Now, it turns out, as the CFTC has testified, roughly at
about the same time, the CFTC initiated a far-reaching
confidential investigation that, as you have seen, ultimately
resulted in the initial settlement announced earlier this
month. And that investigation, which is still ongoing, has come
to involve a range of other regulatory authorities.
Now, if you think about what is ahead, I want to just take
a minute and outline what we think is important and necessary
going forward.
In addition to this ongoing enforcement investigation--
which, of course, is very important to the integrity of our
system because a simple, important, necessary test for any
financial system is do we have the capacity to hold people
accountable when they do these kinds of things. So the
investigation are still very important. But in addition to
those, I want to highlight some of the additional work ahead of
us.
The Council and the relevant agencies are taking a very
careful look at the potential implications for the functioning
of the financial system of these remaining challenges. We are
carefully examining--this is the members of the Council--other
survey-based measures of financial prices or interest rates to
assets whether there is any other potential out there for the
kind of problems we have seen in LIBOR. These entities are
carefully examining potential reforms to LIBOR and alternatives
to LIBOR.
A broad global effort is underway, led by the Chairman of
the Financial Stability Board, which is a group that includes
all the world's major central banks and market regulators, like
the SEC and the CFTC and their global counterparts, also
examining reforms to the system.
Now, in addition to these additional challenges ahead, we
need to take a very careful look as a Council at how we deal
with the circumstances in which a confidential investigation,
enforcement action, reveals evidence of behavior or practices
that could have implications for the financial system as a
whole. This is a challenge because, as you know, we have to
have very careful safeguards to protect the confidentiality of
those investigations, and yet I think we have to find a way to
make that information, if it has systemic implications,
available to key members of the Council in this context. We are
taking a careful look at that.
Finally, we have to take a careful look at other parts of
the financial system where the markets rely on private
organizations composed of private firms like the British
Bankers' Association that have some quasi-regulatory or self-
regulatory role. As you have seen in this case, we have got to
be careful to make sure that the system is not relying on
associations of private firms that leave us vulnerable to the
kind of things we have seen.
Of course, it is very important to the integrity of our
system that the enforcement authorities have the resources they
need to do their jobs. You know, if there is a small town in
America and its population grows by 10-fold or 100-fold in a 5-
year period, you need to increase the size of the police
department. It is absolutely important to do that.
Now, the members of the Council I am very confident will be
fully responsive to the oversight conducted by this Committee
and other bodies in Congress to examine this particular set of
challenges and how we are dealing with them going forward, and
we will continue to keep the Committee informed as we pursue
the things I just outlined.
Chairman Johnson. There has been continued criticism about
wrongdoers on Wall Street not being held accountable by
enforcement officials. We now know that investigations have
been ongoing on this matter since 2008, and so far there has
been one major settlement. I want you to commit to me and the
American people, will the Administration make sure that those
found to have been involved in LIBOR fraud are held accountable
and prosecuted to the full extent of the law?
Mr. Geithner. Absolutely. It is very important we do that,
and I am very confident that the Department of Justice and the
relevant enforcement authorities will make sure they meet that
objective.
Chairman Johnson. There have been additional developments
this week in Europe that have been troubling. Do you think
recently announced policy changes out of the EU, like the
creation of the Banking Union, are going far enough toward
solving the European financial crisis? Are there additional
steps that the U.S. should take?
Mr. Geithner. Europe is working through--working to put in
place a mix of very challenging reforms, reforms to make their
economies more competitive, but also reforms that put better
disciplines in place in how much countries can borrow, and
better oversight of their financial systems. But those reforms
are going to take some time, and in the interim, the European
authorities are going to need to do more to restore confidence
in the financial system to do more to make--to improve their
prospects for economic growth, and they are going to need to do
more to make sure the countries that are doing these reforms
are able to borrow at sustainable interest rates.
So there is absolutely more they need to do to underscore
their commitment and their stated commitment, which is to do
what is necessary to make sure the monetary union is going to
work and hold together. But it is a very challenging crisis for
them. The solutions to this have to be designed in Europe
because they have to be willing to live within them, within the
constraints, and make sure they work and pay the financial
costs of this working. They are going to have to be designed in
Europe if they are going to work. What we can do is what we are
doing--to make sure that we are encouraging them to go as far
as they can to protect the rest of us from a long and damaging
European recession. And there are specific areas where we can
help them financially in ways that are very much in our
interest, which, for example, the Federal Reserve is doing with
their swap lines. Again, that helps reduce the risk that
European banks cut back on credit around the world and hurt
prospects for growth here in the United States.
There are a lot of challenges ahead. They are making some
progress, but they have a lot more to do.
Chairman Johnson. Senator Shelby.
Senator Shelby. Thank you, Mr. Chairman.
Mr. Secretary, you referenced LIBOR. We all have. Tell us
why LIBOR and the setting of LIBOR rates is so important not
only to the American people but to the world financial, and
what it does and approximately how many billions of loans are
involved, billions of dollars involved in that?
Mr. Geithner. Well, as I said, LIBOR is set in 10
currencies, not just the dollar or the pound sterling, 15
different maturities. It has implications around the world, in
part because there are a variety of financial contracts--
mortgages is one example in the United States--around the world
that reference that rate. So it is important for that reason.
But it is also important, of course, because we have seen a
devastating loss of trust in the basic--of trust and confidence
in the integrity of the financial system. So when you see a
system vulnerable to banks' misreporting, that can have more
damage to the basic confidence people have about how the system
works than any of the direct finance implications of the rate
itself. And that is why it is consequential.
Senator Shelby. But historically a lot of banking has been
based on trust, has it not, integrity? So when people realized
that some people were perhaps manipulating the LIBOR rate or
manipulating this and that or fraud here and there, it hurts
the whole financial system, it hurts us all, does it not?
Mr. Geithner. I agree with that. As I said, I agree with
that completely.
Senator Shelby. Mr. Secretary, going back to when you first
learned about possible manipulation of LIBOR, was that in 2008,
early 2008, I believe you said?
Mr. Geithner. Yes, that is my judgment, looking back at
that time, which, again, it was--these reports in the market
and in the press and concerns started to come when the rates
started to go up as the financial crisis intensified.
Senator Shelby. Who did you notify besides Mervyn King, who
was chairman of the Bank of England, about your concerns and
others' concerns about the manipulation of the rate?
Mr. Geithner. Well, as I said, I briefed what was then
called the President's Working Group on Financial Markets,
which means the--that body includes the Secretary of the
Treasury, Chairman of the Fed, Chairman of the SEC, Chairman of
the CFTC, other officials, too. And then my staff briefed the
Treasury and the SEC and the CFTC after that. That was
important because, although it was clear that the reforms to
this problem were going to have to come in London, this had
implications for us.
Senator Shelby. Well, we had banks that fed into that rate,
did we not?
Mr. Geithner. Well, at that point, 16 banks were part of
the sample. Three of those banks were American banks.
Senator Shelby. OK. Did you follow up after notifying the
working group you talked about, did you notify the Attorney
General of the United States, the Justice Department?
Mr. Geithner. The New York Fed and my colleagues, my former
colleagues, are carefully looking through all the records of
whom the New York Fed staff informed at that point.
Senator Shelby. Did you, sir, as president of the bank, did
you personally inform----
Mr. Geithner. No, I did----
Senator Shelby. ----or someone on your staff to let the
Justice Department know about the implications of probably
manipulation of the rate?
Mr. Geithner. To the best of my knowledge, what I did was
to inform the President's Working Group and those regulatory
bodies, and the reason I did that is because those are the
bodies which have a range of different authorities that relate
to market manipulation and abuse. And so that was a very
important and necessary thing to do.
Senator Shelby. When you first learned of possible
manipulation of the rate, did you think this was a big deal?
Mr. Geithner. I absolutely----
Senator Shelby. Or a trivial thing?
Mr. Geithner. I absolutely thought this was a problem,
which is why I took the initiative to do the things we did.
Again, the problem was you had a rate in London overseen by the
British Bankers' Association where banks were asked to provide
an estimate of what they might pay to borrow, and then there
was an estimate that was averaged over time. And that itself
created this vulnerability to misreporting. So it was for that
reason that we were concerned about the problem in this
context, which is why we took the actions we did to brief the
broader regulatory community here in the United States and to
encourage the British to fix it, to reform it.
Senator Shelby. Going back to the Justice Department, do
you have any knowledge yourself of when the Justice Department
got involved in this? Was it late? Was it recently? Or was it
after the British hearings and regulators were involved, or
what?
Mr. Geithner. I do not--that is something you have to ask
them in the enforcement agencies. My recollection from what
other people have testified is that the CFTC's investigation,
which they started at about the same time, April of 2008,
ultimately came to include the SEC and Justice Department as
well as a mix of regulators in London and elsewhere.
Senator Shelby. Does the Federal Reserve Bank of New York
have the authority to oversee misconduct by banks that would be
under your jurisdiction?
Mr. Geithner. The Congress has given the Federal Reserve,
in this case the Board of Governors, a range of different
enforcement powers. Those powers are given to the Federal
Reserve as a whole, and the Reserve Banks, like the Federal
Reserve Bank of New York, do play an active role in enforcement
cases working with the Board of Governors when they implicate
our direct authorities.
Senator Shelby. Thank you, Mr. Chairman.
Chairman Johnson. Senator Reed.
Senator Reed. Mr. Secretary, when you reported to the
President's Working Group, including Secretary Paulson,
Chairman Bernanke, Chairman Cox, and I think Chairman Lukken,
did they direct you to do anything? Did they indicate that they
would do anything? Essentially what was their reaction?
Mr. Geithner. No, but as you know, as you now know, the
CFTC did at roughly the same time--I think in response to the
similar concerns we had, did begin this investigation,
ultimately involved other parties. And, again, it took quite a
bit of time, as these typically do. These are complicated
things. But you had the CFTC and ultimately a variety of other
regulatory enforcement authorities undertaking a very far-
reaching investigation that is resulting in very tough
enforcement actions.
Senator Reed. One of the things I think this illustrates
again is the rather ambiguous position of the President of the
Federal Reserve Bank of New York. This was brought to your
attention. Did you communicate with Mervyn King on your own
volition? Were you directed to do so?
Mr. Geithner. No, I did that on my own.
Senator Reed. And why would you do that if you were not
responsible for or clearly responsible for the policy of the
United States with respect to LIBOR or anything else? You were
simply chosen by the banking community of New York to regulate
that bank.
Mr. Geithner. Well, I thought it was the responsible thing
to do because it had broad implications not just for London but
for the United States, and so I thought that was the
appropriate and necessary thing.
Senator Reed. Again, I think one of the things we tried to
attempt in Dodd-Frank was to clarify the position of the
President of the Federal Reserve Bank, the only person that has
a statutory position, I believe, on the Open Market Committee,
by making that position subject to confirmation and--
appointment by the President and confirmation. And ironically
it was rejected--in fact, on a bipartisan basis, by all my
colleagues who are here. So that was one of my ideas that just
did not get any traction.
But I think you would have been better served had you had
much clearer authority and been on a level with the Secretary
of the Treasury and with the Chairman of the Federal Reserve
and had clear enforcement responsibilities. What is your view?
Mr. Geithner. Well, I think I would say it this way: We had
a financial system before the crisis where you had a huge
amount of risk and activity that had important implications for
the average American and the American economy that grew up
outside the basic protections and safeguards and authorities we
put in place after the Great Depression to deal with these kind
of problems, and that was a terribly damaging problem for us.
And neither the Federal Reserve Bank of New York nor the
Chairman of the Federal Reserve Board or even the Chairman and
Chairwoman of the SEC and the CFTC had authority at that stage
to deal with that huge growth of risk and activity, and as you
saw, a lot of manipulation and abuse and fraud came outside the
safeguards of the traditional banking system.
So the crisis was so severe in part because of that problem
but, of course, also because within the banking system the
constraints on leveraging capital were just not sufficiently
prudent or careful or conservative.
Senator Reed. Do you now feel, given the Dodd-Frank
legislation, that you have a much better capacity to deal with
issues like this?
Mr. Geithner. I do. I think, as I said in my opening
statement, you know, it is not just that we forced $400 billion
more capital into the banking system and negotiated much
tougher constraints on capital and leverage globally with much
tougher requirements on the largest banks so that large banks
have to hold much more capital against risk than do small
banks. We have given the authorities the ability to make sure
that where there is risk outside that in derivatives or in the
financial market infrastructure or in large institutions like
AIG that are not banks but still present risk, that we can put
similar constraints on leverage on them, too.
So I definitely believe that Dodd-Frank has put us in a
much stronger position than we were before the crisis, even
recognizing, of course, that you have to get these rules right
and there is a lot of work to do still to address the remaining
challenges.
Senator Reed. Let me raise a final point in the few
moments. Because of the ubiquity of the LIBOR, this presents
huge potential liabilities for the banking system, back then
and right now. On the one side, you might have a borrower that
is benefiting from depressed rates, but then you have a bond
holder that is not receiving what should be the rates that they
contract for. And obviously was that--first, was that a
consideration in your discussions with the Presidential Working
Group that there could be huge potential liabilities for
manipulation of this rate by particularly bond holders? And
then moving to today, is that a potential going forward now
where you have actively consideration of suits against multiple
institutions by numerous bond holders?
Mr. Geithner. Well, absolutely, that was a concern then,
and that is a critical concern going forward. And as I said in
my opening statement or my initial remarks to the Chairman's
question, one of the issues that the Fed and the SEC and the
CFTC are working on now, which the Council will review, is to
make sure they are carefully examining not just the remaining
implications for the integrity of the system but reforms and
alternatives to make sure we address those remaining problems.
That will be a critical focus of the remaining work ahead. And,
you know, again, that basic vulnerability and reality is what
motivated the actions I initiated in 2008.
Senator Reed. Thank you.
Chairman Johnson. Senator Crapo.
Senator Crapo. Thank you, Mr. Chairman. Thank you,
Secretary Geithner, for being here with us today.
I want to switch to the housing issues, and in your
testimony, you state, ``As we move forward, we must take care
not to undermine the housing market, which is showing signs of
recovery but is still weak in many areas.''
I am hearing a lot of concern about how Dodd-Frank will
reduce credit availability in the housing market through some
of the proposed rules for a qualified mortgage that increases
liability and a qualified residential mortgage that requires a
20-percent downpayment. Recently, the Director of the CFPB, Mr.
Cordray, said that if the qualified mortgage is drawn too
narrowly, that could upset the mortgage market. That could be a
notable example of a rule itself restricting access to credit.
I would like your opinion on this. Do you believe that
there needs to be a broad QM definition?
Mr. Geithner. Well, I want to just start by saying that I
completely agree that right now mortgage credit is tighter than
it should be, and it is tighter than the basic requirements put
in place by Fannie and Freddie and FHA, for example. And the
main reason for that is because banks and servicers, given all
the mistakes they made and the damage they made, feel much more
vulnerable now to what people call ``put-back,'' which is these
institutions protecting the taxpayer by putting back to those
originators loans that did not meet those initial tests, you
know, no-doc loans or some of the other loans they described in
that context.
Senator Crapo. And that is why we are working on the QM and
the QRM.
Mr. Geithner. Yes, but I think that concern is the biggest
remaining cause of the fact that credit is tighter in a
mortgage than it needs to be. And independent of that rule-
writing process ahead, I want to just make it clear that the
FHFA--Ed DeMarco, to his credit, and the FHA are looking at
ways even ahead of defining those rules that they can help
address some of those concerns, that it is residual uncertainty
about reps and warranties and put-back risk is leaving mortgage
credit harder to get for an average individual with a good
credit score than should be the case.
Now, you are right that those rules have to be designed
very carefully, and what the Chairman of the CFPB is doing,
what the other agencies responsible for what you call the
qualified residential mortgage rules are doing is they are
trying to figure out how to balance appropriately the obvious
need for more careful, prudent underwriting standards, more
standardization, better disclosure with the need to be careful
not to overdo it, not to go too far.
Senator Crapo. But wouldn't you agree that in that context
we need to be sure that we do not define the QMs too narrowly
so that we do not restrict access to credit more than is
necessary?
Mr. Geithner. Well, I would not say that. I agree with the
objective completely. I think you want to make sure that both
these two rules are designed together and carefully to reduce
the risk that you restrict mortgage credit more than it would
be prudent to do and is necessary to do.
Senator Crapo. All right. Thank you. I want to move to
another topic now since the time is obviously short in these 5-
minute sectors. I want to go to the end user issue.
You may recall that ever since the Dodd-Frank conference,
there has been a debate about whether nonfinancial end users
were intended to be exempted from the margin requirements by
the statute. That was clearly what the Members of Congress
intended. In fact, Chairman Dodd and Chairman Lincoln
acknowledged that the language was intended to exempt those
entities that used swaps to hedge or mitigate commercial risk.
The regulators, though, have read the statute otherwise and
have issued regulations now that do, in fact, require margin
from those nonfinancial end users, and they basically take the
position that, notwithstanding their understanding of
congressional intent, it was the exact language that they feel
bound by. Because of that, I have introduced legislation to
correct that and make it clear that there is an exemption for
the end users, and when he was before the Banking Committee
recently, I asked this question that I am going to ask you to
Chairman Bernanke: Would it be appropriate for us to correct
that language and provide an exemption for nonfinancial end
users so that it is very clear that that is what congressional
intent and what statutory language requires?
Mr. Geithner. In my own view, I do not think you need to do
that because I think the way the statute was designed, you gave
flexibility and discretion to the regulators to try to achieve
the objective you laid out. I think the concern is if you open
this up too much, you are going to let the exception undermine
the critical safeguards over financial institutions that the
law was absolutely intended to cover.
I do not think this requires a legislative fix. I think the
law gives the regulators the discretion to get that balance
right, but that is obviously something that we need to continue
to look at, and I would be happy to consult with you more, to
talk with you more closely about it to get a better feel for
how they are defining that balance.
Senator Crapo. So are you saying that you believe that the
statutory language as is currently gives the regulators the
authority to exempt nonfinancial end users?
Mr. Geithner. I think it gives the regulators--I want to be
careful about how I do this, how I say this. And it is not my
authority. It is the authority of the regulatory agencies. I
believe it gives them the ability and the discretion and the
authority to define an exception that I think meets your
objective.
Senator Crapo. You are not saying that there should be no
exception for end users. You are saying we need to get it
right.
Mr. Geithner. Yes, that is right. I agree. I believe the
law as you wrote it does try to make sure you are not capturing
people in risk you do not need to capture. But we are worried
always that if you create exceptions and loopholes in this
context that you will end up swallowing or undermining the
broader safeguards that are necessary. I know that is not your
intent, but that has to be our concern.
Senator Crapo. But if I understand you correctly, then you
are saying that you are worried that if Congress does this,
they may get it wrong and be too broad in the exception?
Mr. Geithner. I did not mean to quite imply that. I am just
saying that I think the balance the Congress struck in the law
I thought was right, and I think the regulators were given the
ability to try to get that balance right.
Senator Crapo. Then would you at least agree that if the
law is interpreted to mean otherwise--in other words, if the
regulators--I understand the prudential regulators to be taking
the position that they do not have that discretion. Would you
agree that the regulators need to have the discretion to
address this issue and provide an appropriately formed
exemption?
Mr. Geithner. I think I want to talk to them a little more
carefully about it and come back to you and follow up on it.
But, again, I just want to say this: In general, we are trying
to be very careful to make sure that we do not legislate--this
is not your intention--that we do not legislate things that
would weaken the overall protections in the bill, and we think
the law gave the regulators the ability to strike an
appropriate balance in this context.
Senator Crapo. And you are not saying there should be no
exemption, appropriately defined, for end users?
Mr. Geithner. No. What I am saying is I think they should
implement the law as you intended it.
Senator Crapo. Thank you.
Chairman Johnson. Senator Tester.
Senator Tester. Yes, thank you, Mr. Chairman. Secretary
Geithner, welcome.
In the Council's report, one of the emerging threats that
you identify in the fiscal policy outlook of the United States
and the uncertainty posed by the impending fiscal cliff. Over
the past year the cost of dysfunction here in Washington has
caused volatility in the financial markets, frustration on Wall
Street, and uncertainty in an already tenuous economic
recovery. This week, the GAO released a report showing that the
Treasury Department was forced to spend $1.3 billion in
additional borrowing costs associated with the actions taken to
avoid the default last year. That was a self-inflicted wound
which was completely irresponsible. That was people putting
political agendas ahead of the country, and I do not like the
situation that we found ourselves in.
We do need a long-term plan to get our fiscal house in
order. There is no doubt about that. But I also do not like
having to tell folks that because folks in Washington could not
get it together to solve our country's problem, it cost us over
a billion bucks. That happened because some were willing to see
the Federal Government default on its debt. As a result our
credit rating was downgraded by Standard & Poor's. There is a
real cost associated with our lack of action on this important
issue. Our debt and the costs associated with it increased by
billions every day, and Washington does not act.
Just this week, we had a made-in-Washington fight
encouraged by interest groups over competing tax plans that we
know have little chance of being signed into law. And instead
of working to address the debt, we are no closer to resolving
our problems. We can spend the next few weeks pointing fingers
and blaming each other, but if we continue to play political
games, nothing is ever going to get done. We have to get a lot
more urgent about this issue.
The bottom line is we do need a bipartisan, balanced
deficit reduction plan that is broad in scope and large enough
to address the magnitude of the problem. It is going to have to
cut spending. It is going to have to include revenue. And I
think we all know that there is only one bipartisan plan that
has achieved this broad scale and scope necessary to begin to
tackle the challenges before us. That plan was developed by the
President's Commission on Fiscal Responsibility and Reform, a
Commission that the Administration did not initially support.
And when we tried to create that Commission through
legislation, seven Senators who had previously supported that
idea turned around and opposed it.
Now, I do not support everything in the Commission's plan,
but it is a real starting point. It is a real plan. The
Commission's efforts are now in their third iteration with
input and compromise from a number of Members from this
Committee and renewed support by a number of CEOs. I am
concerned that the President has given only lukewarm support to
these efforts so far, and that came after the Gang of Six
introduced a plan last July and it was evident that there was
wide spread support for it.
Given the experiences of the past few years, do you regret
that the Administration did not engage earlier on this issue
and get behind the framework presented by the Fiscal
Commission?
Mr. Geithner. Senator, I completely agree with you that
this problem of the unsustainable long-term deficits we face is
a very serious economic problem, and it is not something we can
avoid and defer. And I completely agree that the solution to
this is going to lie in the broad frame of what Bowles-Simpson
laid out in the sense that it is going to require a substantial
amount of carefully designed deficit reduction with a balance
of revenues through tax reform tied to significant changes to
help reduce the rate of growth of costs in health care and
other parts of spending. That is where this began. That is
where it is going to end. And even if you and others have some
disagreements with the precise composition of that, or the
design, we have been very, very supportive of that basic
strategy.
As you know, the President of the United States in April of
2011 and September of 2011 and the budget in 2012 they released
in February laid out a detailed set of recommendations, both on
the tax reform side but also on the spending side, that would
meet that basic test of restoring our deficits to a sustainable
level. And I think it is very important to keep reminding
people that we face these two critical challenges. One is we
have an economy that is not growing fast enough, and we need to
make sure that we are doing everything we can to make growth
faster so we are healing the remaining damage caused by the
crisis. But we also have to get Congress to come together on a
bipartisan basis and agree on a set of reforms to start to
restore sustainability, and you have got to do those carefully
so they do not hurt growth. They have to be designed carefully.
We have got to make sure they are going to make us more
competitive over the long run, things for education, for
infrastructure, for private investment that make sense. But
absolutely we need to get the country to come together around a
set of these reforms, and we have to demonstrate we can make
some tough choices in this area.
You expressed concern about the actions the Senate took on
the tax side yesterday, but I just want to speak in favor of
what happened, because what the Senate did was to extend tax
rates for 98 percent of Americans but also demonstrate they are
prepared to do the fiscally responsible and the fair thing by
allowing those tax rates for the top 2 percent to expire. And I
think that was a good example of what you can do that is good
for the economy for certainty, but also demonstrating that this
town can make some tough choices to start to restore
sustainability.
Senator Tester. My concern was more with the fact that if
it ever comes to fruition, I am not sure it will. I just want
to ask one more thing, and my time has run out. I think the
country is ready for a long-term, well-thought-out plan to take
care of our deficit and debt in the long term. I think the
country is far ahead of Washington, DC, on that. The question
that I have--and Congress has its own faults. I talked about it
in my opening. The question I have is: What have you learned,
what are you going to recommend to the President when the time
is right to push forth a real plan to get our deficit under
control?
Mr. Geithner. Well, I have been a long and consistent
supporter of action on a balanced framework of tax reforms that
raise revenue tied to long-term reforms across Government on
the spending side that are designed not just to protect the
safety net but make it more sustainable over time, but also
preserve the ability for us to invest in things that matter for
growth. I am a longstanding supporter of that. I will continue
to be. And that is just driven by a basic recognition that if
we are going to do more for growth to make the economy
stronger, we also have to deal with these long-term fiscal
needs.
We cannot just do the long-term fiscal stuff, though. If we
do that alone and do not address this broad range of major
challenges that middle-class America still faces, the erosion
of competitiveness we face, then we will leave the country
worse off as well. So we have to do both those two things.
Senator Tester. OK. Well, thank you very much.
Thank you, Mr. Chairman.
Chairman Johnson. Senator Corker.
Senator Corker. Thank you, Mr. Chairman, and thank you, Mr.
Secretary, for being here.
I want to talk to you mostly about the things FSOC has the
ability to look at, and I know that in Title II, as we wrote
the bill, there were lots of words like ``liquidate''
throughout it. And as the FDIC has come forth with their
proposal, what really is happening--and I think you know this--
is that in these large, highly complex institutions, they found
out that they were so intertwined that the best way to deal
with them was to let the entity continue to operate but to take
the stockholders out and some of the creditors at the holding
company level, but continue to allow the institution to
operate, which is very different than liquidation. And for
people who are concerned about consolidation of banking, on the
one hand that solves that problem, but it does not deal with
really, you know, said over and over and over, we want to put
these banks out of business. We have heard some of the leaders
in the industry say that.
The FDIC mechanism really does not do that. I mean, it is a
process where they in essence operate these entities for up to
5 years and then re-IPO them. I mean, in essence, everything
stays the same. I know the stockholders obviously, though, are
crushed, thankfully, and the leadership is gone, and those are
all good things if the institution fails.
But I am just wondering--I mean, I think I have accurately
discussed how that is going to be, and we spent a lot of time
with them. I am just wondering if you feel comfortable about
that, or would we be better off, if there is systemic risk, for
the FDIC to step in potentially during the immediate phase but
then move it on to an orderly bankruptcy at that time, because,
again, that is what happens in a bankruptcy, the entity
continues to operate. But you would really move away from any
kind of potential--I am not saying this would happen--potential
crony capitalism where certain creditors were dealt with
differently because they knew the right people.
Mr. Geithner. Senator, I understand your concerns, but I do
not share them in this case, and let me explain. I think what
the FDIC designed is designed to do exactly what you said the
objective should be, which is to come in, if necessary, and
dismember the institution, put it out of its misery, sell
whatever is remaining viable--that is viable remaining back
into the market----
Senator Corker. That is not what they are doing.
Mr. Geithner. I believe that is exactly what they are
doing. Now, you are----
Senator Corker. No, they are just doing it at the holding
company level.
Mr. Geithner. No, I think that is a slight misimpression,
but, again, I understand your concerns about this. What they
are trying to do is to make sure they have a practical way to
do the practical equivalent of bankruptcy for a large, complex
financial institution. And what Congress did, which is very
important, is to deprive them and the Fed and the other
relevant agencies of the ability to protect them from their
mistakes and to leave them to survive to fight another day.
You deprived them of that ability, which you should have
done. And I know Ranking Member Shelby's longstanding concern
about this, and you said in your opening remarks you have the
same basic concern. And I do not think it sounds right for
these reasons. Again, what the bill does is force the largest,
most complicated institutions to hold more capital against risk
than would a normal commercial bank, a small regional bank, a
community bank. And it means that if they end up making
mistakes that put them in jeopardy, the Government can do
nothing but step in and dismember them safely at no risk to the
taxpayer.
Now, your concern, I understand your concern, but I do not
think it is justified by their strategy.
Senator Corker. What I would like to do, because I do not
want to spend the whole 5 minutes on this, but I do not think
the word ``dismember'' is appropriate, and I would love to--we
do not necessarily have to talk to you.
Mr. Geithner. That is not really a technical term. I just
meant----
Senator Corker. Well, ``dismember'' means--and I think what
the FDIC has found is that these organizations are so
intertwined, they are not like stovepipes that you can just
move off to the side.
Mr. Geithner. That is absolutely----
Senator Corker. That because of that they are not
dismembering them. They are going to allow them to operate up
to 5 years and then re-IPO them. And so that is a different
concept. And, by the way, I see some of the benefits of not
creating concentration, because another large institution might
have to take those pieces. I understand the problem. But I do
not think that is exactly what Congress intended, and I just
think that if it is going to be laid out the way that it is,
one of the things we might think about is a real bankruptcy
taking place, because, in essence, the institution continues to
operate under background.
Let me just move on to one other point. This took longer
than I thought. The money market funds. I think you all believe
that they create systemic risk as they are currently set up,
the FSOC. Is that true or false? There could be systemic risk--
--
Mr. Geithner. Well, I believe that although they are in the
stronger position and smaller in size because of the reforms
that were taken by the SEC, I still think--I still believe, as
does the SEC and the Fed, that they are still vulnerable to
runs that could not just disadvantage the investors but could
hurt the system as a whole.
Senator Corker. So the SEC obviously--and, by the way,
contrary to some of the folks on my side of the aisle, I do not
understand why we are protecting them exactly the way that we
are right now, and I think the SEC maybe has not come up with
the right solution. But I am wondering if you happen to know
what that right solution might be. It seems to me we still have
not quite come to the right conclusion on the money markets.
And if the SEC does not take action, I think the FSOC can. And
I am just wondering what your thoughts might be in that regard.
Mr. Geithner. Well, I think it is important that the SEC
propose a range of options for how to go forward on this so
that the market can assess those and comment on them, and the
SEC and others can reflect on what that means for trying to get
this balance right. I think the SEC has to go further than they
have gone. There are a range of options people are considering,
as you know. One option is to go to a full floating NAV. One
option is----
Senator Corker. And that would take a tax change to make
that work, right, a Tax Code change.
Mr. Geithner. That would take a range of things. One option
is to have a mix of investment restrictions, liquidity
requirements and capital requirements to protect against this
risk. And another option is to have a mix of those things and
some type of hold-back provision. And it is a very complicated
question in that context. And my own judgment is the SEC needs
to go further--they can go further, and we should get on with
the business of letting them expose to the world and to the
market a set of options that the world can comment on and help
refine.
Senator Corker. And I agree, it should be more market based
than what it is, and I think a de minimis floating NAV should
not create tax consequences, and that might be a way of solving
it.
If I could just ask one more question, a lot of the
community banks are in here lobbying us about the transaction
account guarantee. I think it expires at year end. I am
reticent to want to continue things like that. I mean, if you
look at a transaction accounts, there is almost--it does not
take much activity to have a transaction account, and so if you
have got excess reserve with money markets paying almost
nothing and you can move into a transaction account that is
fully guaranteed--as a matter of fact, I think there has
already been tremendous flight into transaction accounts for
this reason, because it is fully insured. I would just love to
have your thoughts as we consider this at year end. I mean,
should we continue to extend full guarantees on transaction
accounts--full guarantees? Or should we end Government
involvement in that way?
Mr. Geithner. Very good question, and the relevant parts of
the FSOC are thinking through that question now. Our judgment
so far has been that it is not necessary to extend it. That has
been the judgment of the relevant authorities so far. But I
know this is an issue and a concern to many people, and we are
going to look at those concerns carefully. I am happy to talk
to you about it.
Senator Corker. You are good.
Chairman Johnson. Senator Merkley.
Senator Merkley. Thank you, Mr. Chair, and thank you, Mr.
Secretary.
A section of your report addresses housing finance reforms
as an issue to be concerned about, and you note that differing
State standards on foreclosure practices, the lack of national
service standards, the lack of agreed standards for mortgage
underwriting, all of these are relevant to restoring a market
for private capital in financing. But I wanted to focus on a
different piece of that puzzle, and that is, we have about 4
million families who are underwater who do not have Fannie and
Freddie loans, and they are essentially locked into high
interest loans with no chance of refinancing. And I consider
this a systemic risk from my perspective because those families
become high risk for foreclosures, foreclosures drive down the
price of the market, and the high amount of money they are
paying every month compared to what they would pay under a
lower interest means that they do not have extra spending
money, if you will, that would strengthen other parts of the
economy.
So all of those are interconnected, and so that is a piece
the President identified in his State of the Union and
certainly I have been immersed in, and I would like to ask if
you share concern about those 4 million families with no
refinancing options, and if we can kind of get an effort, as
much support as you can possibly give to help us address that
piece of the puzzle.
Mr. Geithner. We share your view completely. As you know,
the President has been very supportive of legislation in that
context. Your own leadership in this stuff we fully support. We
like the way you designed it. I think it would be--it is good
economic policy, good for the country for that to become law
just for the reason you said. It is not just a fairness
question, but it would help reduce the remaining pressures that
housing is putting on the economy as a whole. There is a very
good economic case for doing it. You could do it in ways that
do not leave the taxpayer exposed to any meaningful risk in
that context. So we would be very supportive of progress in
that area.
Senator Merkley. Thank you. Well, and I would encourage you
to help in any way you can with launching pilots. I realize
there are questions that have to be resolved legally about
whether a program is a modification of an existing program, but
we have a number of these funds out there congressionally
approved that are being underutilized, and if one refinancing
program is a modification of another, it seems like launching a
few pilots in the balance of this year would really help pave
the path for us to build some momentum.
Mr. Geithner. Well, I think the policy is very good. It is
very well designed. We would like to work with you on it. And
the question is whether we can find legal authority and
resources to test on a pilot basis.
Senator Merkley. Great. Thank you.
I wanted to turn to another issue that I thought carried
some systemic risk. There was an article in the Financial Times
just about a week and a half ago about banks' stepping up their
oil trade role, and what the article basically says is that
several of the largest banks have got into close relationships
with refineries in order to have contracts to provide the crude
to the refinery, to buy the refined products after they are
refined. And this is essentially because under the draft rules,
spot commodities are exempted from proprietary trading
restrictions, and banks are also pressing for forward commodity
contracts to be exempted as well.
My question is, you know, 3 years from now are we going to
have a situation where, because one entity is both affecting
the supply of oil and trading over the contracts related that
are affected by the price of oil, essentially a conflict of
interest that is going to be an Enron-style issue?
Mr. Geithner. Good question. So I think you need to think
about this in two different ways. First, it is very important
that we have in place safeguards that limit the risk. Banks
take risks in these areas that could threaten the ability of
the firm or the markets more generally. That is about making
sure they hold capital against the risks they hold, we limit
the risks they hold. And provisions like the Volcker Rule are
part of that important objective.
But in addition to that, you need to make sure that the
market regulators have the authority that they need to make
sure that they can police and deter manipulation, and one of
the things that is very important--the most important
consequences of the fact that the SEC and the CFTC have now
adopted the definitions they adopted earlier this month on
swaps is that that will unlock now a range of additional
authorities they have to police abuse and manipulation.
Both those two things are important to address the risks
they pointed out, and we are going to be very focused on making
sure we are not just limiting the risk they take too much risk
in those areas but that the market is not vulnerable to
manipulation and abuse.
Senator Merkley. Well, thank you very much, Mr. Secretary.
Thank you, Mr. Chair.
Mr. Geithner. Senator Vitter.
Senator Vitter. Thank you, Mr. Chairman, and thank you, Mr.
Secretary.
I also wanted to ask some things about this very concerning
LIBOR issue. As we sit here today, do we know whether Citibank,
Bank of America, and JPMorgan, which participate in the LIBOR
process like Barclays, did or did not similarly manipulate
LIBOR?
Mr. Geithner. We do not know that, but I think that is a
question you need to refer to the enforcement agencies, and I
suspect you are going to find that because this is still a
confidential investigation, they will not be in a position to
answer that question until the remaining investigation is
brought to its natural conclusion. So I do not----
Senator Vitter. So we do not know that as we sit here
today?
Mr. Geithner. Well, I can only tell you what I know, and I
do not know that. I do not know what they know. And the reason
I do not is because, as you would expect, they have very
careful protections around their investigations to preserve
confidentiality.
Senator Vitter. When did you first know about this LIBOR
issue and manipulation?
Mr. Geithner. Well, as I said, in roughly the spring of
2008.
Senator Vitter. So spring of 2008.
Mr. Geithner. Right.
Senator Vitter. So we are now over 4 years later, and we
have not answered that question. Doesn't that----
Mr. Geithner. No, I do not think that is quite right in the
sense that--you know, again, what we did at a very early stage
in this process is bring this to the attention at the highest
levels of the relevant agencies with authority to prevent
manipulation and abuse and push----
Senator Vitter. You brought it to the highest levels, but
we have not gotten to the bottom of it 4\1/2\ years later?
Mr. Geithner. Well, no, I do not----
Senator Vitter. Doesn't that unequivocally suggest somebody
dropped the ball?
Mr. Geithner. Well, I do not think you should look at it
this way, but the CFTC at that same time started this
investigation, ultimately involved the SEC and the Justice
Department in it, and it is true it took 4 years for them to
find the evidence they disclosed in the settlement. I do not
know that that is surprising if you look at what is typical in
financial cases like this. Again, if you look at a cross-
history of these things, these things take a lot of time. You
have to do them very carefully. But they were----
Senator Vitter. Do you think it is reasons to take 4\1/2\
years and we do not know as we sit here today whether Citi,
Bank of America, or JPMorgan were involved in this activity?
Mr. Geithner. I think that you have to address that to
them, but I think that, again, what they did--and to their
credit, they started very early, like we did, in trying to make
sure that they were examining carefully what there was any not
just risk of this behavior but it was actually happening in
that context. And they deserve enormous credit for doing that.
Senator Vitter. As the prudential regulator through the New
York Fed of these three institutions, did you and the New York
Fed look into the issue directly?
Mr. Geithner. I believe that we did the necessary and
appropriate things, as I said, in bringing this to the
attention not just to the Fed and the SEC and the CFTC, which
was a very important thing to do at that early time, but also
to the attention of the British. And, remember, these
concerns----
Senator Vitter. Can I just follow up on the question? You
do not think this issue with regard to those three institutions
potentially impacted their safety and soundness?
Mr. Geithner. I thought this was----
Senator Vitter. The New York Fed was the primary regulator
of that.
Mr. Geithner. I thought this was a very important issue not
just for our financial system but for the global financial
system, which is why we did what we did. And, again, I think
that----
Senator Vitter. Do you think it directly potentially went
to the safety and soundness of those three institutions?
Mr. Geithner. I do not know, but I am not sure that I
needed to know that because I thought the concerns themselves
were sufficiently troubling to justify a very substantial
response.
Senator Vitter. Given what we all now agree is very
troubling information about LIBOR, why was it allowed to be
essentially the repayment metric for TARP?
Mr. Geithner. Well, what you are referring to, I believe,
is that in a series of specific programs that the Fed and the
Treasury undertook in the financial crisis, we, like many
investors, used LIBOR as a reference rate. In many ways, we
were in the position of investors around the world, which is we
had to make use of the best available index at that time.
Now, you are raising the concern of were we disadvantaged
by that. We do not know whether we were or not, but we are
looking very carefully at that question, and we will obviously
be in a position to brief you on that once we have looked at it
carefully enough.
Senator Vitter. When LIBOR was used in those contracts, you
and others had knowledge of the fundamental systemic concerns
about its validity, right? So why was it used in those
contracts? Surely there were some other alternatives, and
surely the Federal Government was calling the shots about the
repayment metric.
Mr. Geithner. Well, no, you are right. We, the Fed and the
Treasury, at that point needed to choose what rate to
reference, and we made a judgment at that time what was the
best rate at that time. And it is true that in that same broad
timeframe, we knew this rate was vulnerable to the type of
practice we faced. But what we do not know is whether we were
disadvantaged by that choice.
Again, it is not clear at this stage--although this is
really a question you should talk to the SEC and the CFTC
about, we do not know at this point what impact that behavior
had the rate up or down for investors and borrowers. As one of
your colleagues said earlier, it is possible that people who
borrowed money were advantaged by this. It is possible people
who borrowed money were disadvantaged. But we do not really
know the extent that happened.
Senator Vitter. It is certainly easy to imagine--let me put
it this way--that mega banks that borrowed money were
advantaged by manipulation of LIBOR that artificially pushed it
down, correct?
Mr. Geithner. It is possible, but, again, if----
Senator Vitter. And if that happened, the taxpayer was
disadvantaged.
Mr. Geithner. But I think if you read carefully the SEC
settlement documents, you will find that the attempted behavior
went in both directions. So what you do not now know is what
impact that had on the rate itself or the direction of the
impact. But, again, that is a very important issue, and it is
an issue which those agencies and the other agencies that are
part of the Council are going to examine very carefully. And,
of course, it is going to be a matter of litigation as well.
Senator Vitter. But you knew when using LIBOR that it was
manipulated so there was that potential, so why did we use it?
Mr. Geithner. No, that is not quite accurate, what you
said. What we knew is that the way the rate was designed, as I
said--and this was fully in the public domain--that the rate
was designed where banks, mostly foreign banks, presented
estimates of what they might pay to borrow across these
different currencies. And, therefore, as you might expect, any
rate that is an average of estimates, there is some risk in
that context. And it was just that risk that caused us to push
for broader reforms and make sure we briefed the enforcement
agencies. But----
Senator Vitter. But beyond that, you knew of reports of
manipulation.
Mr. Geithner. No. We knew of reports of underreporting in
that context, misreporting in that context, but, again, what we
did, in terms of choosing a reference rate, which is we do what
investors around the world did, which is we had to make a
choice among alternatives, and that was the best alternative
available at the time. And I cannot say now with confidence
that that choice in any way disadvantaged the American
taxpayer. I think it is quite unlikely, but we are going to
take a careful look at that.
Senator Vitter. Well, again, let me just wrap up because I
am over time. It seems to me that Treasury and the Fed and the
New York Fed knew of basic problems with LIBOR, knew of charges
of manipulation that underreported and pushed down the rate,
and then the Treasury adopts that very metric for TARP
repayment.
Now, it is very clear that that raises the huge potential
of advantaging those mega banks and disadvantaging the
taxpayer.
Chairman Johnson. Senator Menendez.
Senator Vitter. Thank you, Mr. Chair.
Senator Menendez. Thank you, Mr. Chairman. Mr. Secretary,
thank you for your service and your testimony.
You know, I was reading, as someone who wrote a letter to
you on this issue on LIBOR, that documents that were released
by the Fed banks show that as early as August 2007 Barclays
told Fed analysts about possible problems. And you testified
earlier that some time in early 2008 you made not only
recommendations to the Bank of England but you informed--and
correct me if I am wrong--the Securities and Exchange
Commission, the Commodity Futures Trading Commission, and the
Fed under Federal Reserve that had the control here. Those are
all 2008. Now, let me just see my history. In 2008, who was the
President of the United States?
Mr. Geithner. Well, you know the answer to that question,
Senator. President Bush was President.
Senator Menendez. Right. And who were the appointees in
those respective agencies made by?
Mr. Geithner. By the President of the United States and
confirmed by the Senate.
Senator Menendez. OK. So we start off with a reality that
this was known to entities going back into the Bush
administration, and when you became aware of it, you raised it
to all of those appropriate entities that had the wherewithal
to conduct investigatory abilities to pursue. Is that a fair
statement?
Mr. Geithner. That is absolutely a fair statement.
Senator Menendez. All right. So with that in mind, so that
we cast this in the appropriate context, it still is
challenging and troubling because, obviously, the reason that
Barclays enters into a consent agreement is they did something
wrong. And when they did something wrong, there is a
manipulation of some sort.
Now, depending upon that moment that you borrowed, as has
been said, you might have actually benefited, or you might have
actually been caused harm. And considering how many mortgages
and other commercial instruments are indexed to LIBOR, that is
a real concern.
My question is: As we move forward here, has the Treasury
or the Fed considered issuing our own American LIBOR or using
banks' data when calculating a number? Is that feasible? And
how do we prevent this from happening again? Because one of my
frustrations is that we can in the Congress pass and have the
President sign laws that define what is acceptable and
unacceptable practices. But we cannot seem to get the culture
in financial institutions--many, not all, but in many financial
institutions--to accept that.
So, one, can we have an equivalent of an American LIBOR or
other index that would be more transparent, less subject to any
manipulation? And how do we get the culture here to turn
around?
Mr. Geithner. Let me start with the latter question. You
need tough rules, tough safeguards, enforced by people who have
the resources to enforce them. There is no alternative to that.
You cannot regulate for ethics. You cannot regulate for
culture. You have to assume these institutions are going to
have incentives to do the wrong things sometimes, take risks
they understand or do not understand. That is inherent in
finance. The job of Washington and Government is to make sure
there are tough rules in place that can be enforced, and that
requires resources, not just authority.
Now, we are looking very carefully at not just what reforms
make sense to how LIBOR is determined, but what alternatives
might be better for the system of LIBOR going forward. And we
are going to so that very carefully and involve all the
relevant people, and we will brief this Committee and the
Congress as we go through that process.
As you are pointing out, it is an interesting thing that an
interest rate that affects the price at which Americans might
borrow in dollars was set in London by a group of foreign
banks, largely by a group of foreign banks who needed to be
able to borrow dollars occasionally under a process overseen by
the British Bankers' Association. It is a strange thing. And so
it is right to think about what is a better alternative to that
now, and that is one of the things we are very focused on.
Senator Menendez. Well, I think the question is very ripe
to think about what is an appropriate alternative here, and I
appreciate your answer to my question of culture. But let me
just say that if we have the rules, the regulations, the laws,
and even if we give--which I support--the regulators the
resources to pursue this, what we need is vigorous sanctions at
the end of the day so that people get the message this is not
simply the cost of doing business.
Mr. Geithner. I agree. That is what enforcement means.
Senator Menendez. And I have a challenge here with many of
my colleagues who actually want to retract from those vigorous
sanctions and the essence of the process that would bring those
to a determination when someone should be sanctioned, because
otherwise we are not going to change the culture, and the
American people are ultimately going to be subject to the risk
of those who make decisions that ultimately create collective
risk. And that is a huge problem.
Finally, I would like to ask you, can you tell us at a time
that your testimony talks about the European debt crisis
remaining a looming challenge for the United States, with the
possibility of defaults in certain countries, what have we done
to know the full exposure of U.S. banks and other institutions
to the debt of European countries, and if they were to
materialize at this point in time, what are we doing to limit
the effects on Americans in that context?
Mr. Geithner. A very good question. The Federal Reserve has
throughout the past 3 years not just carefully looked at how
best to measure the potential exposure--actual and potential
exposure of U.S. banks and other financial institutions to
those parts of Europe, but as I said in my opening testimony,
we force banks to hold much, much more capital against the
risks than they held before the crisis, $400 billion more
capital than they held before the crisis. And banks have moved
very aggressively to significantly reduce and limit their
exposure to the risks you pointed out. That has happened in
money market funds, too, by the way, which is important in this
context.
Now, it is important to recognize, though, that Europe is a
very large part of the global economy, and the strongest
economies in Europe still are very big and very consequential.
So a prolonged serious financial crisis in Europe that goes
well beyond a long recession would still have significant
implications for our economy because, you know, export growth
would be weaker, financial conditions would be tighter here,
and that would add to the pressure we are facing on the U.S.
economy.
But U.S. institutions have much less exposure, they hold
much more capital against the risk in that exposure, and that
is a good thing for us.
Senator Menendez. Thank you.
Chairman Johnson. Senator Toomey.
Senator Toomey. Thank you, Mr. Chairman. Mr. Secretary,
thanks for being with us.
Just briefly, I want to follow up on the discussion that we
had in the anteroom earlier about the money market funds. I
just want to strongly urge you to reconsider the position that
the SEC needs to adopt a new round of regulations now, for
several reasons.
First, I am not aware--we certainly have not seen the
evidence--that the new wave of regulations that was already
imposed in 2010 is somehow inadequate, and we have seen that
this industry is now on a stronger footing and got through some
very difficult times last summer without a single hitch,
suggesting, in fact, that they are in pretty good shape.
The second point I would make is this notion that I see
repeated often that they are somehow very susceptible to runs
is quite ironic to me given that over the 40-year history of
hundreds and hundreds of funds through all kinds of
extraordinary historical moments, there have not been runs.
So to suggest that we need this new wave of regulations,
some of the proposals of which I am concerned would destroy the
product--I mean, the capital requirement I do not think
achieves its stated objective. I think it is unaffordable.
Withholding requirements I think badly damaged the product. So
I would like to just urge you to reconsider this. I think this
is the wrong way to go.
The question I would like to get to, if I could, is on
LIBOR. First of all, there has been some suggestion that some
of the British regulators may have known and, in fact, may have
condoned or even encouraged some misreporting during the
financial crisis for fear that otherwise a perception of risk
at these banks might cause problems. So I think I know the
answer, but just for the record, did you or any of the
regulators that you are aware of ever actually condone or
encourage misreporting of LIBOR?
Mr. Geithner. Absolutely not.
Senator Toomey. OK. That is what I thought.
Here is what I do not understand, and that is, how you were
aware of this in early 2008, and for the last 4 years you never
used the bully pulpit that you had to, A, warn the American
people--all right? So there are literally hundreds of
municipalities across Pennsylvania that were engaging in
interest rate swaps where they were paying a fixed rate
typically and receiving LIBOR payments, and we know and you
knew that those LIBOR payments may not be the correct payments,
in fact, might very well be less than what they ought to be
getting. These municipalities did not know that, and they
should have.
The second thing--and then I will let you answer. But the
second thing is: Why did you not use the enormous influence
that you have had, both at the Fed and at Treasury, to persuade
the financial institutions to adopt a different mechanism that
would not be subject to this kind of manipulation when there
are other alternatives available?
Mr. Geithner. On your first question, again, I did what I
thought was the most effective way to get to the heart of this.
In general, you are right, there are some problems that you can
address by talking about them, but generally, I am of the view
that it is better to act on these things, and that is what we
tried to do.
Now, these concerns that you refer to, as you know, were in
the public domain at that time. The Wall Street Journal, among
others, did a very good job of reporting these concerns. And
the vulnerability that we were worried about was there for
people to see.
Now, in this period between that time, the spring of 2008,
when we acted, and when the CFTC announced the settlement
earlier this month, they were involved, to their credit, in a
far-reaching, complicated, difficult investigation which
ultimately uncovered the damage that you referred to. And,
again, they ultimately involved the SEC and Justice in that
context, fully appropriate I am sure in this context, and that
process took some time.
But in the interim, the British did do some things to try
to reform the way the rate was structured. I do not think those
reforms went far enough. But our system has to work this way,
which is you have to combine reforms to the underlying problem,
which we set in motion, with enforcement action, with
consequences. And that is exactly what happened in this
context.
Senator Toomey. I am not at all suggesting that we should
not have had enforcement.
Mr. Geithner. Right.
Senator Toomey. I think we should have, absolutely. My
concern is that knowing that this rate did not have integrity,
you nevertheless stood by while thousands of transactions were
being executed, you know, interest rate swaps, loans, all kinds
of agreements, and it seems to me you could have used the
enormous persuasive power that the Secretary of the Treasury
has to encourage and, in fact, persuade the financial
institutions to fix this or start using an alternative
mechanism.
Mr. Geithner. Well, that was exactly the objective of the
actions I took at that early stage in the process. I do think
it is important to recognize that the market began some time
ago because the market was broadly aware of these concerns,
both investors, borrowers, and lenders were aware of these
concerns, has started to evolve toward other alternatives, and
that is happening. And that was driven by the recognition that
their interests might be better served.
Again, I want to just caution, though, that it is important
to take some time to carefully examine what was the impact of
the behavior on those rates. Again, I do not think we know with
confidence now the direction of the impact or the magnitude of
the impact, but that is a very important issue and critical to
restoring trust and confidence in the system. And I think the
relevant authorities are doing a careful job now of looking
through that.
Senator Toomey. And my time has expired. I will just close
by saying I understand that we do not yet know exactly the
direction or magnitude of the costs, but we know that this was
a process that lacked integrity, and I would suggest that some
of the transactions that were entered into, and subsequently
resulted in significant losses, might never have been entered
into in the first place had the participants understood the
lack of integrity in this rate-setting process.
Mr. Geithner. Well, I think that is one reason why it was
so important that we did what we did, which is to try to set in
motion reforms--not just reforms to the process, but make sure
that the authorities responsible for abuse and manipulation had
the ability to act on those concerns.
Chairman Johnson. Senator Bennet.
Senator Bennet. Thank you, Mr. Chairman, and thank you, Mr.
Secretary, for your testimony.
Just on the LIBOR point, when the Chairman of the Fed was
here the other day, he talked about the possibility of moving
toward a more market-based alternative to LIBOR, and you had
mentioned to Senator Menendez maybe we should be thinking about
that. What would those alternatives look like? And I think the
point he was making was that rather than having a rate that is
sort of voluntarily reported by a small set of banks, security
might actually find yourself in a place where you could have
rates that were stress-tested by the market so that we could
really have confidence in what we were getting. Could you tell
us a little more?
Mr. Geithner. You are absolutely right, and I think one of
the dominant questions before the Council and the people
looking at this question is exactly what would be a better
alternative and what transaction-based rate would better serve
the broader interests of the market.
There are other parts of the financial markets where they
rely on survey-based estimates, and they do that for very
practical reasons. And doing that does not necessarily make it
vulnerable to the types of incentives to misreport that you saw
in this case. But you have to design the safeguards around that
very, very carefully so it is not vulnerable to that. But, of
course, we will look at all those options, and we will be happy
to brief this Committee as the thinking evolves on that.
Senator Bennet. I think we would like to hear about that. I
think there are probably some situations where the market is
lagging or transactions are not actually happening, and you can
see why in that circumstance you might not have a market rate
that would work. But it would seem that there ought to be one
that could replace LIBOR. That would be very interesting to me.
Robert Samuelson had a piece in the Washington Post this
week called ``The $12 Trillion Misunderstanding'', and in this
piece he accounts for how we got from a projected budget
surplus of $5.6 trillion that was made in 2001 to where we are,
which is $6.1 trillion--an $11.7 trillion swing, he says. And
he goes through and he says this is how we got here: The
biggest cause of it was the recession itself, which was about
27 percent. If you add up the recession and the tax cuts from
the early 2000s, you are at 40 percent. If you add up the Iraq
and Afghanistan war, you are at 10 percent. That is 50 percent
of where we are. Increases in defense spending, 5 percent; the
Obama stimulus, 6 percent; and so on and so forth until he gets
to 100 percent. And his conclusion is: ``So, most theories
(often partisan) of the $11.7 trillion shift turn out to be
wrong, exaggerated or misleading. There were lots of causes; no
single cause dominates.''
And I think I would like to enter that article in the
record, Mr. Chairman, with your permission.
Chairman Johnson. Without objection.
Senator Bennet. I think he very clearly lays out the
comprehensive nature of how we created this problem and the
reason why we are going to need, as you have testified, a
comprehensive solution to get out of this problem.
So as we think about coming to the end of the year here, it
seems to me maybe there are four alternatives to what we face.
We could go over the cliff--and when I say we are going
over the cliff, it is not the U.S. Congress. We are driving the
American people over the cliff if we do not do something. That
is one option, so we could let the sequester go into effect,
the tax cuts expire.
We could do as we have done for a long time and continue to
kick the can down the road and just say, well, we did not
really mean it. When we put this tough sequester in place, we
did not really mean it, so we are going to turn around and just
lift it or extend the tax cuts.
We could solve the problem in a comprehensive way during
the lame-duck session.
Or we could put some process in place to try to get us to a
solution in the new year.
I wonder if you could talk a little bit about, first of
all, are those the only alternatives? Maybe there is something
I have not thought about. And, second, how the financial
markets would respond to those, or maybe what would be the most
reassuring thing we could do for the American people at the end
of the day not to repeat the travesty of the debt ceiling
discussion last summer.
Mr. Geithner. Well, I agree that if Congress were to choose
to try to defer everything--tax cuts, tax expiry, and
sequester--and do nothing about the long-term fiscal position
and nothing to help growth in the short term, that would be
very damaging to the interests of the country. And I think to
say that as a Nation we have no capacity to come together on a
set of reforms to address these problems and have to go, as you
used the phrase, off the cliff seems deeply irresponsible.
So I think the solution to this problem has to lie in--and
there has been a lot of foundation laying by you and others and
your colleagues in this direction over the last year in
particular. The solution has to lie in replacing those expiring
tax cuts for middle-class Americans and the sequester with a
balanced mix of reforms that will raise a modest amount of
revenue and lock in some carefully designed savings to make our
commitments to seniors more affordable over time and still
preserve some room to invest in things necessary for us to
grow.
That is the way this has to be resolved, and if were to do
that as a country, that would be good for confidence and good
for the economy, good for certainty, and it would demonstrate
again what the world has always believed about this country,
which is ultimately we come together and do the necessary
thing. We do not wait until it is too late.
Senator Bennet. I think--and, Mr. Chairman, I apologize,
because I know that my light is red, but I have been here for
the whole hearing, so I will just ask one follow-up question.
[Laughter.]
Senator Bennet. And I have learned so much, so it has been
good. One follow-up question to that is--and I do not believe
there is enough of this around this place, but at home, people
do have a sense that we are all in this together, that we have
to come together and fix this together. And at least in
Colorado they really are sick of the partisanship in this place
on this topic.
Could you give us, in that spirit, a sense of what the
scale we would be asking ourselves to commit to versus what
they have to do in Europe, for example, and what we would be
asking our generation to do to secure the future for the next
generation, as a relative matter, and what the people in these
other countries are going to have to face?
Mr. Geithner. Excellent question. Let me just try and do it
very briefly. To get our deficits down to level where the debt
stops growing as a share of the economy, we need to do--on top
of the trillion dollars of savings Congress enacted last, we
have to agree on roughly $3 trillion, at least $3 trillion of
additional savings. That seems like a lot to people, but it
only about 2 percent of the national output income this economy
creates. It is roughly 2 percent of GDP. And that is a very
manageable challenge for a country like us. And if you do it
carefully, with sensible reforms on the tax side and carefully
designed savings on the spending side, you can do it without
causing any damage to the growth prospects of the U.S. economy
and to the basic confidence and security retirees have or what
people have for health care, even the basic safety net for low-
income Americans.
The challenges faced by every other major industrial
economy in the world, from Japan to Europe, are vastly greater
because their growth potential is weaker, their populations are
much older, the size of their Governments are dramatically
larger, the generosity of their commitments are much higher. So
our challenges, although they feel daunting to us and cannot be
deferred forever, are completely within our capacity to act
again without asking Americans or the business community or the
retirees to accept an unacceptable basic burden in that
context. And that is why this should be within our capacity to
solve.
You know, we cannot control what Europe does. It has big
effects on us, but they are not within our capacity to control.
These things are completely within our capacity to control, and
they are completely within the ability of this body to come
together and agree on some sensible reforms.
Senator Bennet. Thank you, Mr. Chairman.
Chairman Johnson. Senator Wicker.
Senator Wicker. Mr. Secretary, I sure appreciate Senator
Bennet being here the whole time. I can assure you I have been
watching on television, and I have learned a lot, too. I admire
Senator Bennet for being here the whole time. I have got some
prepared questions, but let me just follow up on what he says.
Two things.
These carefully structured savings, let us not talk about
the revenue stuff, but the carefully structured savings, they
have to include savings in the entitlement programs like
Medicaid and Medicare. That is correct, right?
[Secretary Geithner nodding head.]
Senator Wicker. The witness is nodding his head.
Mr. Geithner. That is correct, and the President has
proposed hundreds of billions of dollars of savings in that
area because, as you know, the long-term deficits are driven by
mostly the aging of America and the rising health care costs.
Senator Wicker. Right. And, for example, the Medicare
program, I think we all concede--Senator Bennet has been
outspoken on this--a program that grows at 3 times the rate of
inflation just simply cannot be sustained, and that is Medicare
at the present time.
Mr. Geithner. That is right. I think that even with the
long-term savings in the Affordable Care Act and even with what
you might call promising slower growth in health care costs,
long-term projections still show unsustainably rapid growth,
again, mostly because more Americans are retiring and because
the cost of health care is still rising.
Senator Wicker. And I think also most of us, while
appreciating the importance of the savings in the Budget
Control Act, I think we agree with Secretary Panetta and other
members of the Administration that the meat axe approach of the
sequester by the end of this year is not helpful to the
economy. Is that your view also?
Mr. Geithner. Well, again, the sequester was designed by
the Republican and Democratic leadership not because it was
good policy. It was designed to force this body to make some
compromises on a set of long-term reforms. That was its
purpose.
Senator Wicker. And yet, Mr. Secretary, now it is the law
of the land, and we did not get the result out of the super
committee that we wanted. And so back to my question: You agree
that it is unsettling for the economy to be facing this meat
axe approach, particularly in the defense and other important
discretionary programs between now and the end of the year.
Mr. Geithner. I would say it a little differently. I think
what is damaging to the economy now is the combination of
inability of Congress to find legislative majorities to do
things that would help growth, short term and long run, as well
as an inability to come together and agree on a balanced
package of long-term fiscal reforms to replace the sequester. I
think both those concerns are weighing on the economy. I do not
think they are as big now as the direct effects of Europe or
the fact that spending is actually falling across the
Government. But it is a risk, and it is referred to in this
Council report, and I think we all have a responsibility to try
to demonstrate to the American people and the private sector
that, again, this body is going to be able to come together and
make some tough choices on a balanced package of reforms. And
then what the sequester is designed to do is to force that, and
if Congress in the face of concerns about the impact of the
spending cuts were to simply defer them--you are not advocating
that, but simply defer them--that would not be good for
confidence because it would leave the world and the markets
concerned that it is another symptom of inability of Democrats
and Republicans to compromise on things that are in the
interest of the country.
Senator Wicker. My clock is ticking too fast for us to go
on with this, but let me just say that I think the looming
sequester is hurting economic confidence, even as we speak. It
is going to make the economy worse between today and the end of
the year, and I do not think I want that, I do not think you
want that, and I do not think the President wants that.
Let me just ask one other question. I have in my hand here
a report from SIGTARP, Office of the Special Inspector General
for the Troubled Asset Relief Program. It is dated yesterday,
but it has been out for a while. Have you had a chance to look
at it?
Mr. Geithner. I have not read the report, but I have read a
summary of it.
Senator Wicker. OK. Well, in your testimony you state,
``The TARP bank investments have already produced a profit for
the taxpayer of over $19.5 billion and on current estimates
will generate an overall profit''--from TARP--``of
approximately $22 billion.''
The SIGTARP report appears to contradict that quite
substantially. This is a quarterly report. It states that
taxpayers are owed $109.1 billion as of June 30, 2012, and the
Treasury Department has written off or realized losses of $15.6
billion that taxpayers will never get back, leaving $93.5
billion in TARP funds outstanding.
This seems to be a huge inconsistency, and I would like to
ask you to explain why there is such a different take from your
testimony and the Inspector General's report.
Mr. Geithner. Thank you for raising that. The $20 billion
estimate refers to the investments in banks made with the
authority the Congress gave us at the peak of the crisis, and
we have already realized $20 billion in returns. And if you
look at estimates of the remaining exposure, we will earn a bit
more for the taxpayer.
Now, if you look at the full complement of exposure that
the Treasury and the Fed took to AIG, again, to protect the
economy from a failing AIG, on current estimates the taxpayer
in that case, too, is likely to realize a modest return,
looking at the full complement of exposure and risk the
Government took, not just the Fed but the Treasury as a whole.
Now, we still own some common equity in AIG which we have
begun to sell and we expect to sell down significantly over
time. We are moving to do that as quickly as we can. And as
important as the results on how carefully we have managed the
taxpayers' exposure, I think it is important to recognize that
the Fed and the Treasury move very aggressively to note just
replace the management and board of the institution but to
bring down the risk and the risky parts of the entity that put
it in jeopardy very dramatically. So alongside what the State
insurance companies have been doing to make sure the insurance
business of AIG is carefully supervised and monitored, we have
been very aggressive in bringing down the risk. I will just
give you one example.
The notional derivative exposure of AIG which so famously
was at the center of their vulnerability has been reduced by
roughly 90 percent. So AIG is in a less risky position today, a
very different firm, and most estimates look all into the
Government's exposure--and this is a remarkable thing--are
likely to show that the taxpayer earned a modest return. Of
course, life is uncertain, the world is uncertain. We still
have substantial exposure in the equity stake we placed, but
that is a remarkable outcome foreseen by no one at the time.
Senator Wicker. So you disagree with the conclusion of the
Inspector General that says----
Mr. Geithner. I do no think----
Senator Wicker. ----we are unlikely to get some of these
funds back ever?
Mr. Geithner. Well, again, we cannot--all we can know is
what our remaining exposure is and what the market value is of
that exposure today. But what I just said is not a matter of
dispute. It is a matter of fact.
Now, people might take different views of what happens to
the taxpayers' remaining exposure in the common equity of AIG
as the world evolve going forward, and that is something we do
not have any certainty over. And, of course, there are some
places in the world where that may not turn out as well, but on
current estimates, it looks pretty favorable, and most of the
exposure has already been recovered for the Fed and the
Treasury.
Senator Wicker. Thank you.
Chairman Johnson. Senator Hagan.
Senator Hagan. Thank you, Mr. Chairman. I appreciate,
Secretary Geithner, you being here today and your testimony.
The FSOC recently exercised one of its key authorities when
it designated eight firms as financial market utilities. As I
understand it, these companies, which are often referred to as
the plumbing of the financial system, have not challenged those
determinations. The timing of these mid-July determinations
made it impossible for the FSOC to include a discussion of the
selection process in its most recent annual report. Can you
talk about the determination process? Why were those eight
firms selected? Will there be other firms selected for
designation? What does that designation mean for these firms
going forward?
Mr. Geithner. There are two types of what is called
``designation authority'' provided in the financial reforms
Congress enacted. The ones you are referring to specifically
involve key parts of the financial market infrastructure, and
we designated eight firms. And what that means is we have the
authority--and this is very important, it did not exist
before--to make sure that they are run with conservative
cushions against risk so we are protecting the system from
systemic risk.
We went through a very, very careful process within the
Council to identify the criteria we should use to decide where
we needed to extend that authority, and we went through a very
carefully designed process to make sure we gave the firms the
opportunity to provide better information for our judgments and
to contest it. And as you said, they seemed broadly comfortable
with the outcome in that context.
We have remaining authority that we have not yet executed,
but we will, to designate large nonbank financial
institutions--AIG is one potential example of this, but we have
not made that judgment yet--who, as we saw in a way could pose
risk to the broader economy and the taxpayer. And the reason
why that is so important, again, is that if all you do is limit
leverage and capital for the core of the banking system--and
there is some risk over time, as we saw over the last few
decades--you have a huge parallel banking system emerge with a
lot of risk in it, and so it is very important to protect the
system to make sure you have the authority to extend those
prudential safeguards, leverage limitations, for example, to
firms that are in the business of things like banks do that
might threaten the system. That is what we are examining now.
But, again, in each of these cases, we have to move very,
very carefully because we want to do so in a way that is fair
and gives the firms a fair opportunity to contest those
judgments and that we can sustain them legally.
Senator Hagan. Thank you.
Thank you, Mr. Chairman.
Chairman Johnson. Senator Warner.
Senator Warner. Thank you, Mr. Chairman, and thank you,
Senator Hagan.
Let me, first of all, start with just following up on what
Senator Wicker said. I would concur with him that, you know, we
want to try to avoid the sequester at all costs. My State is
very contingent upon defense costs, but I would find it just
stunning to me that if all we did was simply buy off $55
billion in 1-year defense sequester costs and say that is the
extent of our responsibility. I mean, we need a minimum of $4
trillion, as you and everyone else from left to right have
said. We all care about our country's security and national
defense, but I wholeheartedly believe the former Chairman of
the Joint Chief, Admiral Mullen, when he said the greatest
single threat to our country is not the threat of terrorism but
the threat of our debt and deficit. And those who say, well,
all we have to deal with is sequester or even a subset of
sequester, just the defense half of the house, to me--and I do
not think Senator Wicker said this, but, I mean, there are
others who say that should be our only top priority--is
stunning to me and I do not think addresses the concern that we
face. And I would hope that we could perhaps, with your
assistance or others', size, as you mentioned, the challenge of
$4 to $5 trillion over a 10-year frame that would both move
revenues closer to historic numbers, bring spending down, start
to reform our entitlement programs. The relative ask of the
American people is so much smaller than what is being asked of
people all across the world. Senator Bennet pointed out Europe,
but, you know, slowing circumstances in India and China and
elsewhere. And the more we could frame that I think would be
helpful.
I want to come back to LIBOR for a moment, but I listened
with some irony, and as somebody who has kind of not fully
followed as closely as you and others, but, you know, here was
a circumstance that was reported in the press, in the Wall
Street and other papers at the time. We had regulators in
Britain. We had a host of regulators in the United States. We
had Treasury officials in the United States. And to my
knowledge, the only guy that actually sounded the alarm and
said we ought to be looking at this was the then-New York Fed
President, and yet you seem to be getting perhaps a
disproportionate share of ``Why not more?'' when there were a
host of other folks who would at least have equal or greater
responsibility in acting on this matter.
There is going to be a question here.
You know, one of the things that I think one of my other
colleagues pointed out--and I think we all kind of scratch our
head. You pointed this out. We moved to the CFTC to start an
enforcement action. I think we all kind of scratch our heads
saying, ``Gosh, does it really take 4 years to get an
enforcement action through?''
One of the things that concerns me is the nature of these
enforcement actions, because of their confidentiality, what
would happen if an enforcement entity feels they have got to do
this in a confidential basis, and yet the actions may end up
posing a systemic risk, how do we get that right so that under
the guise of confidentiality a regulator is free to at least
reveal to the FSOC, hey, this is not only potentially criminal
or otherwise, but the action in itself may be systemically
risky, and we cannot wait for 3 or 4 years for the
investigation to finish before we kind of bring it forward?
Mr. Geithner. Well, I think it is a very good question, and
I thank you for raising it. I think that this is a solvable
problem, but what it requires is that the enforcement agencies
have in place safeguards so that if they find it necessary to
bring to the attention behavior that has systemic implications
to other agencies, like, for example, the Fed, they are able to
do that without jeopardizing the investigation. There is lots
of precedent for doing this, but we do not yet have in place
the types of MOUs and other types of agreements that would give
them that satisfaction. And we are on that and trying to fix
that quickly.
Senator Warner. And, Mr. Chairman and Ranking Member, this
would be something I think we ought to look into a bit more to
make sure that I could just see some systemically risky action
being caught up inside an investigation, and we sure as heck--
we created an FSOC to try to make sure we have got that broad
overview. We ought to urge the Treasury and others to get these
MOUs in place.
Let me follow up with a second question. A lot of concern,
again, raised by both sides of the aisle about the kind of
voluntary actions of the financial institutions to contribute
to LIBOR and then maybe the sense that some of the incentives
may not have been right to make sure folks were coming clean.
You know, aren't there across the whole financial system a
whole series of other voluntary actions where financial
institutions are asked to contribute information that could
also be subject to manipulation, and we have whole swaths, I
think, about--again, with the Chairman and the Ranking Member,
as we sorted through after the financial crisis, organizations
like FINRA and others that are more kind of self-policing; you
know, not that we want to create massive new amounts of rules
and regulations, but how do we make sure that if it is LIBOR
this month that there is not one of these other voluntary
industry-generated self-regulatory bodies? How do we put a
warning out that, hey, guys, everybody needs to be coming
forward with clean, nonmanipulated information?
Mr. Geithner. A very good question, and this is something
the Council is looking at right now. Again, there are two
different sets of examples we have had recently that create
this vulnerability. One is what you saw with the British
Bankers' Association and LIBOR, and as I said earlier, we are
looking carefully at other survey-based measures of financial
prices that are set by industry bodies to make sure they are
not vulnerable to this, and we will do that very carefully.
But there is a different example we had recently in the
failure of Peregrine, for example, which points out--and this
is true in a variety of areas--that the market regulators rely
on so-called self-regulatory bodies to carry some of the burden
for examination and audit. And as you saw in that case, and as
the report refers to in a different context, that puts us in a
position where you might have customer funds more vulnerable to
fraud than would otherwise be the case.
So the Council is going to take a careful look at all those
things, too. I do not know where that is going to take us yet,
but we want to address both of them, not just the first
question.
Senator Warner. Well, Mr. Chairman, one of the things may
be that many of these entities I think works, do self-police.
Rather than trying to create some huge new governmental
structure, we may want to look at how, again, we can look at
the penalty side if there is bad behavior within these
voluntary organizations, what we might--to make sure we do not
have to create a whole new artifice. And I was hoping I was
going to--you know, that maybe being the last Member I had one
more question, but I see my colleague is coming--no, no. Hey,
listen, I am 3 minutes over.
Senator Schumer. I need to get settled.
[Laughter.]
Senator Schumer. Ask a nice long one.
Senator Warner. Can I get one more little brief one in?
Senator Schumer. With the Chairman's permission, of course.
Chairman Johnson. Permission granted.
Senator Warner. Although, you know, I am falling into the
hypocrisy category as well. I was going to suggest maybe we
ought to go to 4-minute rounds to make us all do 5 minutes, but
I have just violated it as well.
The only last quick comment I would like to have is a very
interesting comment by one of the architects of the collapse of
Glass-Steagall yesterday to say let us put Glass-Steagall back
in case. You know, interesting transformation there.
I think one of the things, you know, as we were trying to
sort through how you kind of get the right balance, was the
ability of these liquidation plans or funeral plans to help try
to regulate size. You are seeing a lot of the banks trade below
book value. Maybe the market is saying size may not be this big
of asset in terms of how the market views it. Are you starting
to see any of these tools change any behavior? And thank you,
Mr. Chairman.
Mr. Geithner. You know, Congress thought about this
question long and hard in considering financial system, and it
put in place, I think to its credit, a set of, again, pretty
tough new safeguards in the system. And among those are, again,
higher capital requirements or authority on the largest
institutions. So it means if you are among the largest in the
world, you have to hold more capital against the risk you take
than is true for a typical bank. That is one.
Two, it is not just living wills, but there is broad
authority in the law to limit the ability of the Government in
the future to come in and save these firms from their mistakes,
cannot protect them from that. That is very consequential.
There is authority in the law for regulators to break up or
limit the size and scope of those institutions in advance of a
crisis if they believe they pose too much risk to the system.
And my own sense is what is happening right now is the full
effect and impact of those reforms as they get traction are
starting to have people reassess what is the right mix of scale
and scope and size that is appropriate for investors in this
kind of thing. That is what is forcing this examination.
What we are going to do is continue to look at any idea
that helps satisfy this basic obligation we have to create a
system that is more stable, more resilient, and less vulnerable
to what we saw in 2008. But we have a much tougher framework in
place today than we had before the crisis, and we want to make
sure that we do not see that weakened by all the pressure we
are facing to weaken those reforms.
Chairman Johnson. Senator Schumer.
Senator Schumer. Thank you, Mr. Chairman. I appreciate your
being here and waiting, and I appreciate the Secretary.
First, you know, Mr. Secretary, there has been a lot of
discussion about LIBOR in recent weeks, about who knew what and
when and whether various regulators should have done more to
crack down on alleged manipulation of LIBOR. Obviously this is
a serious issue. The potential impact is vast, although it goes
in different directions. If people wanted a low LIBOR, they
would lower mortgage rates and lower credit card rates and
things like that. So it is hardly as clear-cut as some are
making it.
But I am puzzled by repeated claims that you and other
regulators stood by and did nothing and that somehow we are
just learning about this 4 years later. You and the New York
Fed were proactive, not only by raising concerns but also
proposing structural solutions. Moreover, Barclays just reached
a large settlement with--guess who?--the U.S. regulators--not
the U.K. regulators or anybody else--and it was the Fed, DOJ,
CFTC working on this investigation. And those did not just
startup 2 weeks ago. They have been going on for a long time.
So I think the idea that we did nothing for 4 years is
obviously false, and I think some are taking unfair shots at
you. Obviously you have to answer every question and every
criticism, and overall I would say this, since I heard one or
two comments were talked about even here today and a lot in the
House yesterday: I think you have been just a very, very fine
public servant. From the days when we first met when we were
dealing with the TARP and the stimulus, both of which saved our
country from what I think would have the Great Depression, and
you have been smart on the merits, down the middle, you have
stood up to the financial services industry when you thought
they were wrong--the Volcker Rule as an example--but you also
did not just bash them needlessly. And so I give you kudos for
that, and I think somebody should say it, so I did.
I have a question for you on our favorite subject where we
disagree: some big country over there at the other side of the
Pacific Ocean. Under Secretary Brainard recently gave a speech
which reminds us that China's economy is now too large for it
to pick and choose which rules it follows, which is what the
Chinese have done constantly. President Hu, at the fourth
meeting of the U.S.-China Strategic Economic Dialogue, made
significant commitments to create opportunities for Americans
to export and sell to China by increasing market access and
leveling the playing field by eliminating several barriers to
trade from foreign firms. These reforms, if implemented, would
significantly bolster U.S. investment in China, but you know
what? I do not put much credence in them because we have heard
commitments like this over and over and over again with very
little result.
What progress, if any, has China made to live up to the
commitments they made this spring to increase foreign market
access? What concretely have they done since that speech by
President Hu, particularly in light of the proposed acquisition
of Nexon by the China National Offshore Oil Corporation, which
obviously provides increased Chinese access to the U.S. market?
Mr. Geithner. Senator, I do not actually think you and I
disagree on this, although sometimes we disagree a little bit
on how best to promote our interests in this context. But on
the basic problem, I agree with you and you are right to
continue to give it a lot of attention in this context. I would
be happy my staff, or do it directly, lay out to you exactly
where they are on that specific piece, which is opening up the
broader investment opportunities to U.S. firms. But our
interests go much broader than that. I mean, they are not just
about making sure the exchange rate appreciates over time, that
it is more market determined, their trade surplus comes down,
it has dramatically. But we need to provide much stronger
protection for intellectual property rights for U.S.
innovators.
There is a whole range of other disadvantages U.S. firms
that compete in China face today that we need to address over
time, and it is not tenable for China, which now has a world-
class manufacturing sector, to continue to sustain and maintain
this range of protections for its own basic firms.
Senator Schumer. OK. Well, I would like some specifics on
anything that has happened specifically since President Hu gave
his speech. I would say that the Chinese trade deficit has come
down significantly, but not with the U.S. Not with the U.S. It
has come down worldwide and with Europe a lot, but not with us,
as I read the numbers.
Mr. Geithner. True, but U.S. exports, just to take the
other side of it, are growing very rapidly to China, and that
is a very good thing, a sign of our strength and
competitiveness, too.
Senator Schumer. OK. One final question, if I might, Mr.
Chairman?
Chairman Johnson. Yes.
Senator Schumer. This is about the fiscal cliff and the
middle-class tax cut bill the Senate passed yesterday. As you
noted in your opening statement, the slowdown in U.S. growth
could be exacerbated by concerns about approaching tax
increases and spending cuts. And yesterday the Senate took
significant action to eliminate a major piece of that
certainty, so let me just ask a few questions to highlight
that.
What percentage of the fiscal cliff does the extension of
middle-class tax cuts take care of?
Mr. Geithner. The extension of the rate itself avoids $100
billion tax increase on 98 percent of Americans. So that is a
very substantial piece of what you called the full complement
of fiscal measures.
Senator Schumer. The numbers I have are it takes $130
billion out of $607 billion, or about 21 percent. That is a
lot, right?
Mr. Geithner. That is a lot, absolutely. And it has a big
effect because, again, it goes to the tax rates that 98 percent
of American pay.
Senator Schumer. How about the 1-year AMT patch?
Mr. Geithner. That is also about $100 billion.
Senator Schumer. Right, so that is another--I have 92 out
of 607, so that is 15 percent. If you add those two things up,
36 percent, that is a lot. And all together, how much
protection from the anticipated GDP hit would the House's
passage of our tax bill afford the country? My numbers are 41
percent.
Mr. Geithner. I would say a very substantial part of it,
but I think that 40-percent number slightly understates it,
because what people count in the overall number to some extent
is already expected and planned for. The thing that would be
most damaging to confidence and economic activity would be the
tax of middle-class Americans to go up in this context. And as
you know, if you let them expire, it is a very substantial tax
increase on middle-class Americans. And, remember, it is not
just--you all recognized this in the Senate. You do not need
just to extend the rates and AMT, but you need to make sure you
extend the expanded tax credits that we put in place in 2009
that go to 25 million Americans. If you do not extend those tax
credits, then taxes go up for 25 million Americans as well. So
you need to do that full mix of things. And if the Congress
were to enact that, the House were to enact that, that would
take care of the most damaging piece of the end-of-the-year
uncertainty for----
Senator Schumer. So, clearly, I mean, there are other
issues here, who should pay what, what percentage the
Government should pay in taxes. But if you are caring about
uncertainty, which we hear from our Republican colleagues all
the time, the number one thing they could do is pass our tax
cut, which we all agree on. We may not agree on what to do with
people above 250, but we all agree it should be below 250. So
you could take a huge amount of the uncertainty off the table.
So my view--I do not know if you agree with this. If they do
not pass our tax cut, they should stop talking about
uncertainty.
Mr. Geithner. I think it is necessary to do but it needs to
go beyond that, and there are other things you can do for the
economy now that would make growth stronger and infrastructure,
involving teachers or incentives to hire. And, of course, we
all want to see Congress come together on some set of reforms
to help reduce the long-term deficits.
Senator Schumer. Thank you, Mr. Chairman. I appreciate your
indulgence.
Chairman Johnson. Thank you again, Secretary Geithner, for
being here today. Your work and the work of the Council is
greatly appreciated.
Thanks again to my colleagues and our panelist for being
here today. This hearing is adjourned.
[Whereupon, at 12:15 p.m., the hearing was adjourned.]
[Prepared statements, responses to written questions, and
additional material supplied for the record follow:]
PREPARED STATEMENT OF TIMOTHY F. GEITHNER
Secretary, Department of the Treasury
July 26, 2012
Chairman Johnson, Ranking Member Shelby, and Members of the
Committee, thank you for the opportunity to testify today regarding the
Financial Stability Oversight Council's (the ``Council'') annual
report.
Each year, the Council is required to prepare a public report
reviewing financial market and regulatory developments, potential
threats to financial stability, and recommendations to strengthen the
financial system. My testimony today reviews the conclusions and
recommendations made by the Council in its second annual report, which
is being submitted in full alongside this testimony.
Measures of Strength in the Financial System
The strategy adopted by the United States to repair and reform the
financial system after the crisis has helped produce a stronger and
more resilient system.
We have forced banks to substantially increase the amount
of capital they hold, so that they are able to provide credit
to the economy and absorb losses in the future. Tier 1 common
capital levels at our country's banks are up by $420 billion,
or 70 percent, from 3 years ago. The ratio of tier 1 common
equity to risk-weighted assets at these institutions increased
from 6 percent to over 11 percent during this period.
We have forced a significant reduction in overall leverage
in the financial system. Financial sector debt has dropped by
more than $3 trillion since the crisis, and household debt is
down $900 billion.
Banks are funding themselves more conservatively, relying
less on riskier short-term funding.
The size of the ``shadow banking system''--which had been a
key source of financial stress during the crisis--has fallen
substantially, by several trillion dollars.
The Government has closed most of the emergency programs
put in place during the crisis and recovered most of the
investments made into the financial system, which were
originally expected to result in a loss to taxpayers of several
hundred billion dollars. The TARP bank investments have already
produced a profit for the taxpayer of over $19.5 billion, and
on current estimates will generate an overall profit of
approximately $22 billion.
Credit is expanding, and the cost of credit has fallen
significantly from the peaks of the crisis. Commercial and
industrial lending at commercial banks increased 10 percent in
2011 and increased at an annual rate of 11 percent in the first
5 months of 2012.
The overall impact of these changes is very important. They have
made the financial system safer, less vulnerable to future economic and
financial stress, more likely to help rather than hurt future economic
growth, and better able to absorb the impact of failures of individual
financial institutions.
Threats to Financial Stability
The Council's report identifies a number of potential threats to
the stability of the financial system. Among the most important of
these is the fact that the financial system still confronts a
challenging and uncertain overall economic environment.
The ongoing European crisis presents the biggest risk to our
economy. The economic recession in Europe is hurting economic growth
around the world, and the ongoing financial stress is causing a general
tightening of financial conditions, exacerbating the global slowdown.
Over the past 2 years, U.S. financial institutions have
significantly reduced their exposure to the most vulnerable economies
of Europe, and they hold substantial levels of capital against the
remaining exposures. The combined economies of the euro area constitute
the second largest economy in the world and are home to many of the
world's largest and most interconnected financial institutions. As a
result, a severe crisis in Europe would necessarily have very
substantial, adverse effects on the United States.
Europe's leaders are putting in place a package of long-term
reforms--economic reforms to restore competitiveness, improve fiscal
sustainability, and restructure their financial systems, and governance
changes to transfer more responsibility to European institutions for
oversight of national financial systems and how much Nations can
borrow. For these reforms to work, they need to be complemented by
actions in the near term to restore financial stability and support
economic growth, including strengthening the stability of the banking
systems and bringing sovereign borrowing rates down in the countries
implementing reforms.
Global economic growth has slowed and forecasts for future economic
growth have been reduced. Europe is responsible for much of this, but
not all of it. Growth in China, India, Brazil, and other large emerging
economies has slowed for a variety of reasons unique to those
countries.
In the United States, the economy is still expanding, but the pace
of economic growth has slowed during the last two quarters. In addition
to pressures from Europe and the global economic slowdown, U.S. growth
has been hurt by the rise in oil prices earlier this year, the ongoing
reduction in spending at all levels of Government, and slow rates of
growth in income.
The slowdown in U.S. growth could be exacerbated by concerns about
approaching tax increases and spending cuts, and by uncertainty about
the shape of the reforms to tax policy and spending that are necessary
to restore fiscal responsibility. As the Council's report discusses,
the United States faces fiscal deficits that are unsustainable over the
long run. The failure of policy makers to enact reforms in a timely and
credible manner will be damaging to future economic growth.
These potential threats underscore the need for continued progress
in repairing the remaining damage from the financial crisis and
enacting reforms to make the system stronger for the long run.
Progress Implementing Financial Reform
Regulators have made important progress over the past 2 years
designing and implementing the regulations necessary to implement
financial reform. Nine out of 10 rules with deadlines before July 2,
2012, have been proposed or finalized. The key elements of the law will
largely be in place by the end of the year. The financial system is
already in the process of adapting to these reforms.
We have taken important steps to limit risk-taking at the
largest financial institutions. The Federal Reserve and other
supervisors have negotiated new, stronger global capital and
liquidity requirements. As part of this effort, Federal banking
regulators will impose even higher requirements on the largest
banks.
We now have the ability to put the largest financial
companies under enhanced supervision and prudential standards,
whether they are banks or nonbanks, and the ability to subject
key market infrastructure firms to heightened risk-management
standards.
We are implementing the provisions of the law designed to
protect taxpayers and the financial system from the failure of
a large financial firm. Regulators, led by the FDIC, have
established the new ``orderly liquidation authority,'' a
mechanism to unwind responsibly large, complex financial
companies. This authority will help make sure that culpable
management is fired and that investors pay for the failure of a
firm, not taxpayers. Nine of the largest banks have now
submitted ``living wills,'' providing contingency plans for an
orderly bankruptcy.
The SEC and CFTC are putting in place a new framework for
derivatives oversight, providing new tools for combatting
market abuse and bringing the derivatives markets out of the
shadows. Their recent joint adoption of a swaps definition will
trigger the effectiveness of more than 20 key rulemakings and
marks a major milestone in the implementation of derivatives
reforms.
Regulators are working to strengthen protections for
investors and consumers. The CFPB has worked to simplify and
improve disclosure of mortgage and credit card loans to help
consumers make more informed financial decisions. The CFPB has
also launched its supervisory program for very large depository
institutions (in coordination with prudential regulators) and
for certain nonbanks.
As we put in place these reforms in the United States, we
are working with supervisors and regulators in Europe, Japan,
and around the world to provide a more level playing field. In
addition to the new global standards for capital and liquidity
requirements, we are negotiating global margin requirements for
derivatives. On these and a range of other issues, we are
trying to improve the prospect of tougher and broadly
equivalent global standards and requirements, so that financial
risk cannot simply move to where it cannot be seen or
effectively constrained.
These are complicated reforms. This process is challenging because
our financial system is complex, because we want to target damaging
behavior without damaging access to capital and credit, because we want
the reforms to endure as the market evolves, and because we need to
coordinate the work of multiple agencies in the United States and many
others around the world.
Recommendations To Improve Financial Stability
In addition to these important reforms, the Council has put forward
recommendations in a variety of other areas to help strengthen our
financial system.
Risks in Wholesale Short-Term Funding Markets
The Council recommends a set of reforms to address structural
vulnerabilities, particularly in wholesale short-term funding markets
such as money market funds (MMFs) and the tri-party repo market. As we
saw during the crisis, these sources of funding were particularly
vulnerable to disruption that can quickly spread through the markets.
The SEC adopted a number of reforms to money market funds in 2010,
but they remain vulnerable to runs. The Council supports SEC Chairman
Schapiro's efforts to address certain weaknesses, including (1) the
lack of a mechanism to absorb a sudden loss in value of a portfolio
security and (2) the incentive for investors to redeem at the first
indication of any perceived threat to the value or liquidity of the
MMF. The Council recommends that the SEC publish structural reform
options for public comment and ultimately adopt reforms that address
money market funds' susceptibility to runs. The Council further
recommends that, where applicable, its members align regulation of cash
management vehicles similar to MMFs within their regulatory
jurisdiction to limit the susceptibility of these vehicles to run risk.
In tri-party repo markets, the Council supports additional steps
toward reducing intraday credit exposure within the next 6 to 12
months. In addition, the Council recommends that regulators and
industry participants work together to define standards for collateral
management in the tri-party repo market, particularly for lenders (such
as MMFs) that have certain restrictions on the instruments that they
can hold.
Customer Fund Protection
The Council highlights the importance of establishing and enforcing
strong standards for protecting customer funds deposited for trading.
For example, the Council recommends that regulators consider
strengthening regulations governing the holding and protection of
customer funds deposited for trading on foreign futures markets. The
Council also recommends that regulators seek ways to strengthen risk-
management standards for clearinghouses and to develop and monitor best
practices across their respective jurisdictions.
Risk Management and Supervisory Attention
The Council recommends continued work to improve risk-management
practices, highlighting a number of specific challenges facing firms
and their supervisors. The Council supports continued attention to
strengthening capital buffers and stress testing. Firms also need to
continue to guard against potential disruptions in wholesale short-term
funding markets and bolster their resilience to interest rate shifts.
Firms need to continue to strengthen internal disciplines and
safeguards in underwriting standards, the development of new financial
products, and complex trading strategies. The report also notes that
high-speed trading is an area where increased speed and automation of
trade execution may require a parallel increase in trading risk
management and controls.
Housing Finance Reform
The Council continues to support progress toward comprehensive
housing finance reform. The U.S. housing finance system has required
extraordinary Government support since the financial crisis, and the
market continues to lack sufficient private capital. As recognized in
the framework for housing finance reform developed by certain member
agencies of the Council, the return of private capital is crucial to
reestablishing confidence in the integrity of the market and better
aligning incentives.
However, in order for private capital to come back into the market,
there needs to be greater clarity from regulators and Congress on new
rules for all participants in the market. Challenges include the lack
of broadly agreed upon standards for mortgage underwriting (which are
necessary to support the valuation and liquidity of mortgage-backed
instruments), nonuniform foreclosure practices across different States,
and uncertainty surrounding the potential liability of mortgage loan
securitizers.
In addition, reform should address servicer compensation models and
the need for national mortgage servicing standards, and it should
strengthen protections for borrowers. Members of the Council are
addressing many of these challenges through existing authority and the
implementation of Wall Street Reform, yet comprehensive reform will
require significant legislation, and the leadership of this Committee
will be central to the effort. As we move forward, we must take care
not to undermine the housing market, which is showing signs of recovery
but is still weak in many areas.
Improving Transparency and Financial Data
One of the weaknesses in our old system of regulation was a lack of
information--information that could be used to help identify threats
and more effectively understand the financial system. Gaps in data and
analysis remain a threat to financial stability, and an important part
of reform efforts will continue to be the improvement and availability
of financial data and information.
This project is being spearheaded by the Office of Financial
Research (OFR), which was established by Wall Street Reform. The OFR's
work is crucial to improving transparency, our understanding of how the
financial system supports the economy, and our capacity to identify
threats to financial stability. The OFR has done tremendous work over
the past year, undertaking a number of initiatives, including steps to
create a ``legal entity identifier'' for financial contracts, which
will help us understand exposures in the market. Last week, the OFR
released its first annual report, which analyzes threats to financial
stability along with ways to address data gaps and promote data
standards.
Conclusion
The member agencies of the Council have made considerable progress
over the past few years in making our financial system safer and
stronger--more resilient and less vulnerable to crisis, with better
protections for investors and consumers.
We still have a lot of work ahead of us, however. We need your
support to make these rules strong and effective. And we need your
support to make sure the enforcement agencies have the resources they
need to prevent fraud, manipulation, and abuse.
I want to thank the other members of the Financial Stability
Oversight Council, as well as the staff of the members and their
agencies, 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.
RESPONSES TO WRITTEN QUESTIONS OF
CHAIRMAN JOHNSON FROM TIMOTHY F. GEITHNER
Q.1. One of the purposes of FSOC was to increase coordination
among the agencies to better spot risks to the financial
system. Can you offer specific examples of how FSOC
coordination has benefited the financial system? If Congress
were to repeal or undermine Wall Street Reform, as some have
suggested, what would be the impact on financial stability?
A.1. The FSOC has benefited the financial system through
increased, ongoing information-sharing among its members and
their staffs, and through new joint accountability for the
monitoring and identification of threats to financial stability
pursuant to the Dodd-Frank Act.
While statutorily required to meet quarterly, the FSOC has
met over 25 times since its formation. For example, the FSOC's
principals have come together to share information on a range
of important financial developments, such as the situation in
Europe, housing markets, the interaction of the economy and
energy markets, the tri-party repo market, and lessons to be
drawn from recent errors in risk management at several major
financial institutions, including the failure of MF Global and
trading losses at JPMorgan Chase. More recently, the FSOC met
to discuss the impact of Hurricane Sandy on the functioning of
our markets and has proposed for public comment recommendations
to the SEC regarding reforms of money market funds. Staffs of
FSOC members and member agencies continue to work on these
issues.
Under the Dodd-Frank Act, the FSOC is required to report on
its view of potential emerging threats to financial stability
and significant financial market and regulatory developments.
This requirement informs the FSOC's work throughout the year,
and allows the public to be informed of the FSOC's views on
important matters regarding financial stability and the
financial services marketplace.
Q.2. As Wall Street Reform and Basel III rulemakings on SIFIs
progress, what steps did FSOC take to analyze the differences
between banks and nonbank SIFIs and to incorporate those
findings into the rulemakings? Do you think that the actions
and rulemakings to date recognize the differences between banks
and nonbank SIFIs? How do you plan to synchronize designation
of nonbank SIFIs with regulations that would govern the
different types of nonbank SIFIs? What role did FIO and the
Independent Insurance member of FSOC play in the rulemakings?
A.2. The Dodd-Frank Act and subsequent work of the Financial
Stability Oversight Council recognize the various distinctions
between bank holding companies and nonbank financial companies
as well as between different types of nonbank financial
companies. Unlike bank holding companies, for which the statute
provides a specific threshold for the application of enhanced
prudential standards, nonbank financial companies must be
considered by the Council based on specific statutory criteria
and the Council's determination that a particular firm could
pose a threat to U.S. financial stability. The designation of
nonbank financial companies also differs from that of
systemically important financial market utilities, which are
considered under another designation process set forth in Title
VIII of the Dodd-Frank Act.
In general, before being designated by the Council, a
nonbank financial company will be evaluated in a three-stage
process which goes well beyond the consideration of a firm's
size (as measured through total consolidated assets) that
occurs under the Dodd-Frank Act for a bank holding company. The
Council's six-category framework for evaluating nonbank
financial companies focuses on a firm's size,
interconnectedness, substitutability, leverage, liquidity risk
and maturity mismatch, and existing regulatory scrutiny.
Furthermore, the Council has consulted with the Federal Reserve
Board on the potential differences between the supervision of
and enhanced prudential standards for nonbank financial
companies and for bank holding companies.
The Federal Insurance Office and the Council's independent
member with insurance expertise were instrumental in developing
the rulemaking and processes for designating nonbank financial
companies which allow for more effective and fully informed
evaluations of insurers for potential designation.
Regarding Basel III rules, Treasury is not a rule writer.
Nevertheless, the banking agencies have consulted with the
Federal Insurance Office as they consider public comments
received on their proposed capital rules and work toward final
rules to implement Basel III.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR SHELBY
FROM TIMOTHY F. GEITHNER
Q.1. While you were President of the Federal Reserve Bank of
New York (the ``New York Fed''), did you:
A. Take any action to further investigate allegations of
LIBOR manipulations before or after the President's
Working Group on Financial Markets met in May of 2008?
B. Instruct your staff to request information about
allegations of LIBOR manipulation from any LIBOR-
reporting bank supervised or regulated by the New York
Fed?
C. Instruct your staff to send inspectors or examiners to
LIBOR-reporting banks supervised or regulated by the
New York Fed to investigate allegations of LIBOR
manipulation?
D. Recommend to the Board of Governors of the Federal
Reserve System to exercise its statutory authority and
commence formal enforcement action (including imposing
fines or penalties) against LIBOR-reporting banks
supervised or regulated by the New York Fed for
manipulations of LIBOR?
If you answer ``yes'' to any of the above questions,
provide a full explanation, including the dates of any actions
taken.
A.1. During the financial crisis, market participants began to
raise concerns about the reliability of the LIBOR and the
possibility that banks were not reporting their actual cost of
borrowing. Some of these concerns were reported in articles in
the the Wall Street Journal and the Financial Times in 2008.
The New York Fed took a number of actions in response to
these concerns. The New York Fed informed U.S. regulators and
other Government officials, including the key agencies with
responsibility and authority for market manipulation and abuse.
As you noted, I raised the issue personally with the
President's Working Group on Financial Markets in May of 2008.
This meeting included the leaders of the CFTC, SEC, OCC, FDIC,
the Federal Reserve Board of Governors, and Treasury.
The New York Fed also raised concerns with the Bank of
England and pushed for reforms to the LIBOR process that would
make the rate less vulnerable to misreporting. I raised
concerns in person with Bank of England Governor Mervyn King in
May of 2008. Shortly thereafter, I sent Governor King a
memorandum with six specific recommendations for ways to
address this problem. The Bank of England responded favorably
to our recommendations and indicated that they would act on
them. New York Fed staff continued to communicate with British
authorities in follow-up.
At roughly the same time, the CFTC began a 4-year long,
far-reaching, confidential investigation, which ultimately
involved the SEC, the DOJ, and a number of foreign regulators.
The CFTC's investigation resulted in the very substantial fines
and other measures related to Barclays and other firms.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR REED
FROM TIMOTHY F. GEITHNER
Q.1. It is my understanding that despite serious questions
about LIBOR's accuracy and relevance raised throughout the
spring and summer of 2008, the Federal Reserve and the Treasury
Department continued to use LIBOR as a benchmark in connection
with the emergency liquidity and credit facilities created
during the financial crisis. For example, this measure was used
to set the interest rate for the Term Asset-Backed Securities
Loan Facility (TALF), which was established by the Federal
Reserve Bank of New York and the Treasury Department in March
2009. Why did the Federal Reserve use this measure to set the
loan rates in the TALF? Did the Federal Reserve use this
measure to set the rates used in the other credit and liquidity
programs established during the financial crisis? If so, which
programs? Did the Federal Reserve consider using other rates?
Why or why not?
A.1. As you noted, Treasury worked with the Federal Reserve to
establish the Term Asset-Backed Securities Loan Facility (TALF)
to increase the availability of credit for U.S. households and
small businesses. Because of Treasury's involvement in the
program, we are happy to address your question as it relates to
the TALF.
Under the TALF, the Federal Reserve Bank of New York
extended loans to finance purchases of certain highly rated
asset-backed securities that were in turn backed by loans to
businesses and households. TALF loans with both fixed and
floating interest rates were extended, and the floating-rate
loans were based on several base rates, including LIBOR, prime,
and the FOMC's target Federal funds rate. Each TALF borrower
was required to choose a TALF loan rate that corresponds to the
interest payments on the securities financed by and
collateralizing the TALF loan. If the interest rate on the
securities is based on LIBOR, the TALF loan rate is also based
on LIBOR.
The TALF is now being wound down. Whereas approximately $70
billion in loans were extended, there were approximately $850
million in loans outstanding as of December 2012. We do not
expect to have any losses from the program.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR CORKER
FROM TIMOTHY F. GEITHNER
Q.1. Yesterday you said at the House hearing that regulation is
not meant to protect institutions from their own mistakes but
to prevent the system from the consequences of these mistakes.
I wholeheartedly agree and, in fact, I think we have taken too
much of a focus on protection institutions as a regulatory
paradigm. Would you elaborate on what you meant by this, and
tell us if you think regulators or policy makers are too
focused on protecting institutions, not protecting the system?
A.1. Previously, I testified that the Dodd-Frank Act prohibits
regulators from bailing out financial firms from their own
mistakes. Further, the Dodd-Frank Act is designed to make sure
that when financial firms do make mistakes, the broader economy
and the U.S. financial system are not imperiled.
Reforms include provisions designed to make sure that firms
are able to absorb the costs of their own mistakes. Higher
capital requirements, better quality capital, and mandatory
stress testing are important parts of these reforms along with
enhanced prudential standards for nonbank financial companies
that are designated as systemically significant. Mandatory
clearing reduces the interconnection risks that can come with
complex derivatives contracts by creating a central
counterparty. Additionally single counterparty exposure
ceilings further constrain the size of risks that individual
firms can assume to each other.
In addition, the Dodd-Frank Act creates an orderly
liquidation authority so that when a complex financial company
does fail, it can be wound down in a way that mitigates
potential adverse effects on the U.S. financial system and the
economy at large.
Q.2. Some people have talked about various ``silver bullet''
fixes to systemic risk. A few ideas include making banks
smaller or separating types of activities that one firm can
engage in. As the Chairman of the FSOC, have you given thought
to these approaches? Why hasn't the FSOC advocated for a more
aggressive approach to dealing with risk?
A.2. The ideas that you mention have been the subject of
discussions of the Council and within its member agencies.
While different policies have the potential to reduce risk in
different ways, I do not agree that there is a single ``silver
bullet'' fix.
With regard to making big banks smaller, the Dodd-Frank Act
reduced the probability of failure of large institutions and
helped ensure that the rest of the financial system can absorb
or contain losses. Reforms included new liquidity requirements
for large financial institutions, limits on leverage,
concentration limits on relative size of financial
institutions, activity restrictions, margin rules for
derivatives, and stronger financial cushions for central
counterparties. The FSOC has also been active, pursuing reforms
with its members on money market funds and the tri-party repo
market.
It is important to remember that the U.S. banking system is
less concentrated than that of any other major developed
economy. The three largest U.S. banks account for 32 percent of
total banking assets in the United States, compared to 46
percent for the three largest in Japan, 58 percent in Canada,
63 percent in the U.K., 65 percent in France, 70 percent in
Germany, 71 percent in Italy, and 76 percent in Switzerland.
With regard to separating types of activities that one firm
can engage in, this is being addressed most importantly by the
Volcker Rule. In Treasury's role as a coordinator of the
rulemaking, we are working with the Council's relevant member
agencies to implement the Volcker Rule in a manner that will
prohibit banking entities from engaging in proprietary trading
and restrict their ability to invest in or sponsor hedge or
private equity funds, while protecting statutorily permitted
activities. This is, however, a complex process that involves
coordination of rulemakings by five different agencies that
have received thousands of comment letters from the public.
Q.3. Has BASEL effectively killed LIBOR because the capital
requirements of BASEL make interbank lending prohibitively
expensive? This is what some banks are telling us. Do you agree
with this assessment?
A.3. The Basel Committee on Banking Supervision's Basel II
agreements introduced harmonized global liquidity standards for
banks known as the Liquidity Coverage Ratio (LCR). An important
provision to promote financial stability, the LCR would reduce
a bank's liquidity risk by requiring that a bank have
sufficient resources to survive an acute short-term stress
scenario: banks would be required to have a sufficient amount
of unencumbered, high quality and liquid assets to offset net
cash flows the bank could experience under an acute short-term
stress scenario over a 30-day horizon. Unsecured lending from
financial institutions is assumed to completely run-off under
the proposed LCR stress scenario suggesting that a bank's
funding through the interbank market is not a stable source of
financing. While the U.S. banking regulators have yet to
propose a rule to implement the LCR and it is anticipated that
there could be an impact on interbank funding rates, the
markets do not show evidence of a correlation between the
advent of such rules and cost of interbank lending at this
time.
Q.4. We now have an unlimited guarantee on ``transaction
account.'' This guarantee provides insurance to accounts
greater than $250,000. Since this guarantee was put into place,
$1.3 trillion have come into TAG accounts. Many of these have
of course come from money market funds. Is this a systemic risk
in your view?
A.4. The Non-interest Bearing Transaction Account program
extended in 2010 by the Dodd-Frank Act expired on December 31,
2012. It is estimated that at the time of expiration, $1.4
trillion was deposited in such accounts at small and large
banks. The expiry may cause some larger depositors to withdraw
their deposits from the banking system because these deposits
are no longer insured, while other depositors may elect to keep
their deposits in uninsured accounts. Those depositors that
leave the banking system may invest previously deposited funds
into cash-like vehicles such as money market mutual funds,
short-term securities, or off-shore investment vehicles, or
short-term securities. To date, we have seen no evidence of
disorderly flows of funds and will continue to monitor these
flows over the coming weeks and months.
Q.5. The Treasury Department is responsible for managing the
term structure of U.S. debt issuance. According to the Office
of Debt Management the weighted average maturity of outstanding
U.S. debt has increased from about 73 months to roughly 77
months. Could we be lengthening it more as a way to lock in
today's low long-term rates?
A.5. In 2008, the weighted average maturity of the Treasury's
portfolio was approximately 48 months. Since that time, through
prudent debt management, we have increased the portfolio's
weighted average maturity to approximately 64 months, which is
above both precrisis levels and the long-term average of 58
months.
On numerous occasions, I have stated our intention to
continue the extension of the average maturity of our debt
outstanding. However, while we remain steadfast in this goal,
Treasury must also adhere to the same principles that have made
the Treasury market the deepest and most liquid in the world.
One of these principles is that we do not act opportunistically
and try to ``time'' our issuance with the overall level of
interest rates. Another is that we strive for our auctions to
be regular and predictable. While these principles may limit
how quickly we can extend the weighted average maturity of the
debt, they also help Treasury to attain the lowest cost of
funding over time.
Q.6. Looking at various possible structures on MBS, if we had
had just a 7 percent first loss tranche in front of the
taxpayer on GSE MBS, the taxpayer would have been insulated
from loss during this latest crisis. In fact Fannie and
Freddie's multifamily models show that this can be done. Should
the private sector be in a first loss position in mortgage-
backed securities?
A.6. The Treasury's white paper on housing finance reform
released in February 2011 (Reforming America's Housing Finance
Market) presents three options for long-term, structural
change--all three of which are conditioned upon placing private
investors and lenders in a first-loss position on mortgage-
backed securities. Treasury staff continues to explore these
options by engaging with stakeholders on alternatives that
would best facilitate a more robust return of private capital
to mortgage lending.
Q.7. If you have had a chance to review the proposals from the
FDIC on Title 2, do you still agree that liquidation is the way
the FDIC is viewing their authority? Is a better way to do this
to make Title 2 more of a temporary ``holding bin'' where we
would take a firm ``off the grid'' during a time of financial
stress then put that firm into bankruptcy once the systemic
risk has passed?
A.7. Title II is meant to take the place of bankruptcy under
limited circumstances; specifically, where the resolution of
the failed financial company under the Bankruptcy Code would
have serious adverse effects on U.S. financial stability. The
purpose of Title II is to provide the FDIC with the necessary
authority to resolve failing financial companies that pose a
significant risk to U.S. financial stability. As receiver under
Title II, the FDIC is prohibited from using taxpayer funds to
prevent the liquidation of the failed financial company. Equity
holders in the failed financial company are expected to be
wiped out.
The notion of placing a large financial company into a
temporary ``holding bin'' and taking it ``off the grid''
assumes that it could be accomplished in a seamless manner.
However, a firm that is placed into a Title II receivership is
expected to be highly interconnected. In addition, placing a
large, interconnected financial firm into a ``holding bin'' is
analogous to conservatorship, which Congress rejected.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR KOHL
FROM TIMOTHY F. GEITHNER
Q.1. On the second anniversary of the signing of the Dodd-Frank
legislation the SEC was scheduled to provide a report on the
current credit rating agency industry.
What actions have you and Financial Stability Oversight
Council taken to insure that rating agencies will not repeat
the same error of over rating issues? Has the FSOC and the SEC
evaluated what types of reforms to the current structure would
mitigate conflict of interest and avoid inaccuracies in the
future?
A.1. The FSOC has highlighted the role that credit rating
agencies played in the lead-up to the financial crisis, and
continues to consider the role of credit ratings in specific
markets and more generally.
In its 2011 annual report, the FSOC noted the role that
credit rating agencies played in the structuring and sale of
residential mortgage backed securities and collateralized debt
obligations. Moreover, the annual report stated that credit
rating agencies did not understand well the complex ways that
these products allocated credit risk, and that these products
contributed to the buildup of the housing boom, the severity of
the subsequent bust, and the broadening of the financial crisis
beyond its origins in the subprime mortgage market.
Further, in its 2012 annual report, the FSOC noted that
credit ratings are critical for institutions that rely on
short-term funding, and that the continued reliance on short-
term funding for illiquid assets can be a source of instability
for the financial system. The FSOC recommended reforms to
mitigate the risk of instability in these short-term wholesale
funding markets in its 2011 and 2012 annual reports.
Additionally, the SEC has proposed rules designed to
improve the integrity of credit ratings and increase
transparency in the ratings process. These proposed rules would
require Nationally Recognized Statistical Rating Organizations
to disclose information on internal controls, the methodology
used to determine ratings, and the performance of past ratings.
The proposed rules would also establish strengthened
protections against conflicts of interest.
The FSOC will continue to monitor the role of credit
ratings in the wholesale short-term funding markets and in the
financial services marketplace more generally. The FSOC will
also discuss the SEC's work to reform the oversight of credit
rating agencies, as appropriate and consistent with the FSOC's
duties.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY
FROM TIMOTHY F. GEITHNER
Q.1. Are you or do you plan to consult with State insurance
regulators in the evaluation of any insurance companies for
possible designation as systemically important financial
institutions? If so, when and with whom? If not, why?
A.1. As required by the Dodd-Frank Act and as set out in the
Council's rule and interpretive guidance on nonbank financial
company designations, the Council will consult with the primary
financial regulatory agency, if any, for each nonbank financial
company or subsidiary of a nonbank financial company that is
being considered for designation before the Council makes a
final designation of such nonbank financial company. We have
been actively consulting with appropriate State insurance
regulators and will continue to benefit from their expertise
and perspective throughout the Council's analysis of any
insurance company being considered for designation.
Q.2. Please explain how SIFI determination criteria for
nonbanks such as interconnectedness and substitutability will
be measured as part of the evaluation process. For example, how
will FSOC determine how much interconnectedness is enough to
lead to a firm being designated as a SIFI? Do all the factors
weigh equally or are particular factors more (or less)
important? When does the combination of factors lead to SIFI
designation? Please share any metrics that will be used in this
regard.
A.2. The Council generally uses a broad range of company-
specific and industry-specific quantitative and qualitative
information to evaluate nonbank financial companies. The
Council's rule and interpretive guidance on the designation of
nonbank financial companies extensively describes the Council's
analytic framework and the types of analysis that the Council
intends to carry out.
During Stage 1 of the analysis, the interpretive guidance
sets forth specific quantitative thresholds that the Council
use to identify nonbank financial companies for further
evaluation. With regard to interconnectedness, the thresholds
of $30 billion in outstanding credit-default swaps for which
the company is the reference entity, $3.5 billion of derivative
liabilities, and $20 billion in total debt outstanding are all
relevant. In addition to these Stage 1 thresholds, the
interpretive guidance provides numerous examples of
quantitative metrics that the Council can use in its Stage 2
and Stage 3 analyses.
Substitutability, however, is not as easily measured
quantitatively and is one reason that the Council does not
believe that a determination decision can be reduced to a
formula. Because each company considered for designation may
present unique risks to financial stability, the Council must
approach each decision based on the particular facts relevant
to that company, which will include a mix of quantitative and
qualitative factors not weighted according to a formula but
evaluated in a manner that holistically considers whether the
company could pose a threat to U.S. financial stability.
Additionally, the Council will provide any nonbank
financial company subject to a proposed designation with a
written explanation of the basis for the Council's proposed
designation. This explanation provides companies with clarity
with respect to the Council's reasoning in arriving at proposed
designations.
Q.3. What is the current timing for designations? Roughly how
many designations do you anticipate in first round? Roughly how
many designations do you anticipate overall?
A.3. In accordance with the Council's interpretive guidance on
nonbank financial company designations, the Council has been
applying the Stage 1 thresholds to nonbank financial companies
on a quarterly basis, and those companies that exceed the Stage
1 thresholds are reviewed in Stage 2.
Each analysis is company-specific, and the timing of
designations depends on the amount of existing public and
regulatory information as well as the amount of information
sought from the companies directly. The Council continues to
work expeditiously on this front. At the Council's September 28
and October 18, 2012, meetings the Council voted to advance an
initial set of companies to Stage 3 of its designations
process, which is the final stage before a proposed
designation.
The Council's rulemaking notes that, based on data
currently available to the Council through existing public and
regulatory sources, the Council has estimated that fewer than
50 nonbank financial companies meet the Stage 1 thresholds. It
is not possible to predict the number of companies likely to be
designated, due to the company-specific analysis that is
required for each designation.
Q.4. Given that the Treasury is a member of the Financial
Stability Board (FSB), which will make G-SIFI determinations,
can you clarify how a company that is designated a G-SIFI but
not designated a SIFI in the U.S. will be regulated?
For instance, how would an insurance company that is
currently regulated at the State level be regulated as a G-
SIFI?
A.4. Council members are working closely with their
international counterparts on a number of initiatives,
including the process for identifying globally systemically
important financial institutions (G-SIFIs). This international
coordination is being undertaken with the goal of creating
international standards that are as consistent as possible with
domestic standards to create a level playing field and minimize
the risk of regulatory arbitrage. In particular, FIO is a
member of the International Association of Insurance
Supervisors (IAIS) and serves on its Financial Stability
Committee and Executive Committee. In this role, FIO has worked
to align the IAIS methodology, criteria, and timing with the
Council's designation process in order to minimize the
possibility that a U.S. insurance firm could be recommended by
the IAIS for designation but not designated by the Council
under section 113 of the Dodd-Frank Act.
The aforementioned efforts should minimize the likelihood
that a company would be designated as a G-SIFI without being
designated by the Council. However, if such a situation arose,
the Council would make a determination as to the appropriate
course of action at that time. In relation to an insurer, until
the IAIS finalizes prescribed policy measures to be applied to
a G-SIFI, it would be inappropriate to speculate about the
enforcement mechanism.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR KIRK
FROM TIMOTHY F. GEITHNER
Q.1. As implied in Secretary Geithner's testimony and
reinforced by recent Ford Motor 2012 earnings projection, the
eurozone recession will impact U.S. firms (http://
www.chicagotribune.com/classified/automotive/sns-rt-us-ford-
resultsbre86o0ky-20120725,0,6348895.story).
How will FSOC monitor and measure the systemic risk
of a eurozone recession on the U.S. economy?
Is there a possibility that FSOC would recommend
delay of regulatory rules that are shown to carry high
costs until the eurozone crisis subsides, if such delay
might minimize the risk of U.S. recession?
A.1. The prospect of a eurozone recession or credit market
disruption is a principal risk to the stability of U.S.
financial markets today. As such, the FSOC and its members will
continue to monitor exposures of U.S. financial institutions to
euro-area risks. It will also continue to monitor potential
asset price declines that could arise from euro-area shocks,
which could in turn translate into stresses on balance sheets
within the U.S. financial system. Decreased market confidence
resulting from euro-area struggles could lead to greater risk
aversion in U.S. financial markets. The FSOC will remain alert
to indications of such behavior and any potential consequences
that it may have on the stability of the financial system.
The FSOC's member agencies are implementing regulations in
a thoughtful manner that is effective and supports the
financial system's ability to grow, innovate, and better serve
our economy. Delays in rulemaking could increase uncertainty,
since clear rules are most necessary when markets are under
stress. The United States has taken a leading role in an
extensive international effort to improve financial regulation
around the globe. The FSOC's member agencies are playing an
important part in coordinating this effort globally to enhance
the safety and soundness of the financial system and to close
gaps in financial regulation.
Q.2. Weaker eurozone countries are struggling to issue the debt
that they need to fund current deficits. Spain currently pays
an interest rate over 7 percent for debt with a 2-year
maturity.
Do all sovereign borrowers need to learn that
credit may not be available to them in public markets?
If so, what are credible funding alternatives?
A.2. The eurozone is undergoing a difficult, but necessary
adjustment of the large economic imbalances that developed in
the decade before the global economic crisis. Countries that
are reforming deserve strong support from their European
partners. European fiscal and monetary authorities have
committed to stabilize markets with a credible firewall to
limit market contagion and reinforce access to market financing
at sustainable rates for countries undertaking difficult long-
term reforms to stabilize public finances, restore
competiveness, and repair banking systems.
While much work remains to be done, progress toward putting
in place Europe's permanent crisis response facility, the
European Stability Mechanism, and the introduction of the ECB's
new instrument aimed at restoring order and ``remov[ing] tail
risks for the euro area,'' are welcome.
Q.3. This year's FSOC annual report notes a shift toward
deleveraging across the U.S. economy.
Is this shift a factor in the slower-than-expected
economic growth seen in the past year?
What is its long-term impact on the financial
sector?
A.3. The shift toward deleveraging by both households and firms
has been a contributing factor to the pace of economic activity
over the past year. Increased uncertainty stemming from
domestic economic growth and eurozone concerns has led to
greater risk reduction by consumers and institutions. Debts are
being paid down and credit flows remain substantially below the
levels observed prior to the recent financial crisis. These
trends have led to higher savings rates and stronger balance
sheets, but have also acted to reduce overall consumption in
the economy.
The longer-term effects of deleveraging will depend on the
extent to which this trend continues or is reversed. The FSOC
will continue to closely monitor the use of leverage in the
financial sector to identify and respond to possible risks to
financial stability.
Q.4. A recent study published by the Federal Reserve Bank of
New York finds that more than 80 percent of equity premiums
earned since 1994 occurred in the 24 hours preceding an
announcement by the Federal Open Market Committee (http://
libertystreeteconomics.newyorkfed.org/2012/07/the-puzzling-pre-
fomc-announcement-drift.html). Does this concentration of
return present a systemic threat?
A.4. I appreciate you bringing this report to my attention. The
FSOC has established an ongoing interagency process, in
collaboration with the OFR, to analyze trends in financial
markets and to identify and monitor threats to the financial
system. The FSOC makes an annual report to Congress on
identified emerging threats and recommendations to promote
financial stability.
Q.5. In January 2009, U.S. banks started closing Government-
guaranteed SBA loans using a new LIBOR-based index set by the
Small Business Administration, shifting from Prime Rate-based
loans to LIBOR.
Considering the concerns that the Federal Reserve
Bank of New York had expressed about the efficacy of
LIBOR in 2008, why did the Treasury Department not
recommend that SBA programs return to a Prime Rate base
before expanding SBA lending as part of the stimulus
plan?
Is there are possibility that the SBA's LIBOR index
set artificially low rates that may have discouraged
banks from participating in the SBA programs while the
economy was still in recession?
A.5. As you know, there is a broad, global effort currently
underway to analyze and seek reform to LIBOR and explore
alternatives. Your specific question refers to a decision
announced by the Small Business Administration in 2008 pursuant
to its authority under Section 7(a) of the Small Business Act.
The Treasury Department does not have authority over the 7(a)
program.
In an SBA Procedural Notice, dated November 14, 2008, which
can be found on the SBA's Web site, the SBA observed that
``[d]ue to the globalization of the financial markets, many SBA
lenders' source and cost of funds (and/or internal yield model)
is partially or completely based on the London Interbank
Offered Rate (LIBOR) rather than the Prime Rate, which
traditionally has been SBA's base interest rate for
establishing the maximum interest rate lenders can charge for
SBA-guaranteed loans.'' \1\ According to the SBA, due to market
turmoil, spreads between the Prime Rate and LIBOR narrowed such
that lenders were unable to profitably make SBA loans based on
the Prime Rate. As a result, lenders ``substantially reduced or
eliminated their SBA lending.'' Following discussions with
lenders, the SBA ``concluded that allowing lenders to use an
adjusted thirty day (one month) LIBOR rate as a base rate for
pricing SBA loans [would] ameliorate several of the factors
impeding small businesses' access to capital through SBA's
guaranteed loan programs.'' Allowing an adjustment of three
percentage points to the thirty day (one month) LIBOR rate
``reflect[s] the historical 3 percentage point spread between
the LIBOR and the Prime Rate and [helps] reduce the uncertainty
and the financial risk to lenders and to secondary market
participants.''
---------------------------------------------------------------------------
\1\ Procedural Notice 5000-1081, http://www.sba.gov/sites/default/
files/bank_5000-1081.pdf. See also, 73 Fed. Reg. 67101 (2008).
Q.6. Currently, various financial regulators, including the
Treasury, are finalizing rules for Qualified Residential
Mortgages (QRMs), intended to assure a liquid secondary market
for mortgage securities. Should a final rule include criteria
for the borrowing index used to set secondary market securities
---------------------------------------------------------------------------
and/or the underlying mortgages in a QRM?
A.6. While the Secretary of the Treasury, as Chairperson of the
FSOC, is a coordinator of the credit risk retention rule for
asset-backed securities, Treasury is not a rule writer. The
Dodd-Frank Act directs the Board of Governors of the Federal
Reserve, the Office of the Comptroller of the Currency, the
Federal Deposit Insurance Corporation, the Securities and
Exchange Commission, the Federal Housing Finance Agency, and
the Department of Housing and Urban Development to define QRM
based on characteristics that indicate a ``lower risk of
default.'' In adopting the final QRM definition, the Dodd-Frank
Act provision directs agencies to consider, among other
standards, underwriting and product features that historical
data indicate reduce the risk of default, such as documentation
and verification of the financial resources relied upon for
qualification, residual income and debt-to-income standards,
mitigation of the potential for payment shock on adjustable
rate mortgages, mortgage guarantee insurance or other credit
insurance, and restriction the use of balloon payments,
negative amortization, prepayment penalties, interest only
payments, and other features where data show a higher risk of
default.
Additional Material Supplied for the Record
``WASHINGTON POST'' ARTICLE SUBMITTED BY SENATOR BENNET
THE $12 TRILLION MISUNDERSTANDING: WHOSE BUDGET BLUNDER?
The Washington Post, July 24, 2012
By Robert J. Samuelson, Washington Post Columnist
Call it the $12 trillion misunderstanding.
It ranks among the biggest forecasting errors ever. Back in 2001,
the Congressional Budget Office projected Federal budget surpluses of
$5.6 trillion for 2002-2011. Instead we got $6.1 trillion of deficits--
a swing of $11.7 trillion. Naturally, political recriminations
followed. Who or what caused the change? President Bush's tax cuts for
``the rich''? The Iraq and Afghanistan wars? The Medicare drug benefit?
The financial crisis? President Obama's ``stimulus''?
Doubtlessly, the question will emerge as a campaign issue. But any
intellectually honest answer--perhaps futile in today's politically
charged climate--will admit that no single cause explains the change.
We now have evaluations from the CBO and two nonpartisan groups: the
Committee for a Responsible Federal Budget (CRFB) and the Pew Fiscal
Analysis Initiative. They all point in the same direction.
For starters, a weak economy was the largest cause. The CBO
attributes $3.2 trillion of the $11.7 trillion shift (about 27 percent)
to ``economic and technical changes.'' ``We overestimated how good the
economy would be, even before the Great Recession,'' says Marc Goldwein
of the CRFB.
Consider. In 2001, the CBO projected that the economy would grow
about 3 percent a year over the 2002-2011 period. Actual growth from
2002 to 2007 averaged only 2.6 percent. From 2008 through 2011--the
Great Recession started in late 2007--growth averaged only about 0.2
percent annually. Slow economic growth reduces tax revenues and
increases spending for jobless benefits and other assistance.
After the CBO issued its report, Sen. Rob Portman (R-Ohio), a
former director of the Office of Management and Budget who is often
mentioned as a vice presidential possibility, put out a press release
claiming that Bush tax cuts for wealthier Americans (generally $250,000
or more for couples and $200,000 for singles) explained only 4 percent
of the debt shift. The CRFB checked his math and concluded he was
right. But all of Bush's 2001 and 2003 tax cuts--which, except for
benefits for the rich, are now supported by Obama--had a bigger effect,
accounting for about 13 percent of the debt swing.
Together, the weaker economy and 2001-2003 tax cuts explain 40
percent of the debt shift. Here's how Pew allocates the rest. Its
estimates parallel the CBO's and the CRFB's, which either cover
slightly different time periods or use slightly different budget
categories.
Iraq and Afghanistan wars: 10 percent
Increases in discretionary domestic spending: 10 percent
Other increases in defense spending: 5 percent
Obama stimulus: 6 percent
2010 tax cuts: 3 percent
Medicare drug benefit: 2 percent
Other tax cuts and means of financing: 12 percent
Higher interest costs on larger Federal debt: 11 percent
So, most theories (often partisan) of the $11.7 trillion shift turn
out to be wrong, exaggerated or misleading. There were lots of causes;
no single cause dominates.
One other thing: Even projecting surpluses from 2002 to 2011, the
CBO cautioned then that large deficits would ultimately return.
``Over the longer term,'' then-deputy CBO director Barry Anderson
testified before the Senate Budget Committee in January 2001,
``budgetary pressures linked to the aging and retirement of the baby
boom generation threaten to produce record deficits and unsustainable
levels of Federal debt.''
Unfortunately, that hasn't changed.