[House Hearing, 114 Congress]
[From the U.S. Government Publishing Office]


                      ENDING ``TOO BIG TO FAIL:''
                       WHAT IS THE PROPER ROLE OF
                         CAPITAL AND LIQUIDITY?

=======================================================================

                                 HEARING

                               BEFORE THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                    ONE HUNDRED FOURTEENTH CONGRESS

                             FIRST SESSION

                               __________

                             JULY 23, 2015

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 114-45
                           
                           
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                HOUSE COMMITTEE ON FINANCIAL SERVICES

                    JEB HENSARLING, Texas, Chairman

PATRICK T. McHENRY, North Carolina,  MAXINE WATERS, California, Ranking 
    Vice Chairman                        Member
PETER T. KING, New York              CAROLYN B. MALONEY, New York
EDWARD R. ROYCE, California          NYDIA M. VELAZQUEZ, New York
FRANK D. LUCAS, Oklahoma             BRAD SHERMAN, California
SCOTT GARRETT, New Jersey            GREGORY W. MEEKS, New York
RANDY NEUGEBAUER, Texas              MICHAEL E. CAPUANO, Massachusetts
STEVAN PEARCE, New Mexico            RUBEN HINOJOSA, Texas
BILL POSEY, Florida                  WM. LACY CLAY, Missouri
MICHAEL G. FITZPATRICK,              STEPHEN F. LYNCH, Massachusetts
    Pennsylvania                     DAVID SCOTT, Georgia
LYNN A. WESTMORELAND, Georgia        AL GREEN, Texas
BLAINE LUETKEMEYER, Missouri         EMANUEL CLEAVER, Missouri
BILL HUIZENGA, Michigan              GWEN MOORE, Wisconsin
SEAN P. DUFFY, Wisconsin             KEITH ELLISON, Minnesota
ROBERT HURT, Virginia                ED PERLMUTTER, Colorado
STEVE STIVERS, Ohio                  JAMES A. HIMES, Connecticut
STEPHEN LEE FINCHER, Tennessee       JOHN C. CARNEY, Jr., Delaware
MARLIN A. STUTZMAN, Indiana          TERRI A. SEWELL, Alabama
MICK MULVANEY, South Carolina        BILL FOSTER, Illinois
RANDY HULTGREN, Illinois             DANIEL T. KILDEE, Michigan
DENNIS A. ROSS, Florida              PATRICK MURPHY, Florida
ROBERT PITTENGER, North Carolina     JOHN K. DELANEY, Maryland
ANN WAGNER, Missouri                 KYRSTEN SINEMA, Arizona
ANDY BARR, Kentucky                  JOYCE BEATTY, Ohio
KEITH J. ROTHFUS, Pennsylvania       DENNY HECK, Washington
LUKE MESSER, Indiana                 JUAN VARGAS, California
DAVID SCHWEIKERT, Arizona
FRANK GUINTA, New Hampshire
SCOTT TIPTON, Colorado
ROGER WILLIAMS, Texas
BRUCE POLIQUIN, Maine
MIA LOVE, Utah
FRENCH HILL, Arkansas
TOM EMMER, Minnesota

                     Shannon McGahn, Staff Director
                    James H. Clinger, Chief Counsel
                            
                            
                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    July 23, 2015................................................     1
Appendix:
    July 23, 2015................................................    49

                               WITNESSES
                        Thursday, July 23, 2015

Calomiris, Charles W., Henry Kaufman Professor of Financial 
  Institutions, Columbia University Graduate School of Business..     5
Chakravorti, Sujit ``Bob,'' Managing Director and Chief 
  Economist, The Clearing House Association L.L.C................     7
Michel, Norbert J., Research Fellow in Financial Regulations, The 
  Heritage Foundation............................................    10
Parsons, John E., Senior Lecturer, Sloan School of Management, 
  Massachusetts Institute of Technology..........................     8

                                APPENDIX

Prepared statements:
    Calomiris, Charles W.........................................    50
    Chakravorti, Sujit ``Bob''...................................    64
    Michel, Norbert J............................................    74
    Parsons, John E..............................................    85

 
                      ENDING ``TOO BIG TO FAIL:''
                      WHAT IS THE PROPER ROLE OF
                         CAPITAL AND LIQUIDITY?

                              ----------                              


                        Thursday, July 23, 2015

             U.S. House of Representatives,
                   Committee on Financial Services,
                                                   Washington, D.C.
    The committee met, pursuant to notice, at 10:04 a.m., in 
room 2128, Rayburn House Office Building, Hon. Jeb Hensarling 
[chairman of the committee] presiding.
    Members present: Representatives Hensarling, Royce, Lucas, 
Garrett, Neugebauer, Pearce, Posey, Luetkemeyer, Huizenga, 
Duffy, Hurt, Stivers, Fincher, Stutzman, Mulvaney, Hultgren, 
Ross, Pittenger, Barr, Rothfus, Messer, Schweikert, Guinta, 
Tipton, Williams, Poliquin, Love, Hill, Emmer; Waters, Sherman, 
Hinojosa, Lynch, Scott, Himes, Foster, Kildee, Delaney, Sinema, 
Beatty, Heck, and Vargas.
    Chairman Hensarling. The Financial Services Committee will 
come to order.
    Without objection, the Chair is authorized to declare a 
recess of the committee at any time.
    Today's hearing is entitled, ``Ending `Too Big to Fail': 
What is the Proper Role of Capital and Liquidity?''
    I now recognize myself for 5 minutes to give an opening 
statement.
    I woke up, I guess it was the day before yesterday, to an 
article in one of the Hill publications, I think it was 
Politico. The article dealt with the Dodd-Frank Act, since we 
have either celebrated or bemoaned the fifth anniversary of 
Dodd-Frank. The subtitle to the article was, ``Suddenly, 
Democrats are resisting any changes to the 5-year-old financial 
regulation law.'' The article goes on to say that a number of 
moderate Democrats are quite frustrated that their leadership 
is preventing them from engaging in meaningful bipartisan work 
on the issue.
    I do not know the article to be accurate. It certainly 
feels like it, from this position, from this Chair. I just want 
to again say publicly what I have said privately to my friends 
on the other side of the aisle: The Majority stands ready to 
work with you to clarify, to improve, and to deal with any 
unintended consequences of the law.
    Both Mr. Dodd and Mr. Frank have previously indicated areas 
of the law that they would work on to improve. I trust that 
they continue to be Democrats in good standing. I would hope 
you could be a Democrat in good standing and work with the 
Majority. I hope there is not a knee-jerk ideological reaction 
to anything that deals with Dodd-Frank. Again, but it certainly 
feels that way.
    I guess, to some extent, though, there is good news, 
because today's topic, capital and liquidity, is barely 
mentioned in Dodd-Frank. There is a differentiation where Dodd-
Frank empowers the regulators, who already had, pre-Dodd-Frank, 
the authority to set prudent capital and liquidity standards. 
They provide for a differential for SIFIs. But outside of that, 
they are largely silent on the issue.
    And regardless of what you believe to be the genesis of the 
financial crisis, I think we can all agree, looking through the 
rearview mirror, that clearly, capital and liquidity standards 
were insufficient, to put it mildly.
    Prior to the crisis, there were very complex, risk-based 
capital standards in place. And in implementing these various 
complex, risk-based capital standards--as we know, they were 
principally designed by the Basel Committee out of Switzerland. 
And regulators in both the United States and in Europe were 
essentially encouraged to crowd in to both mortgage-backed 
securities and sovereign debt. Think Fannie Mae, Freddie Mac, 
and Greek bonds.
    Thus, rather than mitigating financial instability, as the 
capital standards were intended to do, it appears that Basel 
helped fuel the financial instability, rather than continue 
with Basel help concentrated.
    Now since the crisis, U.S. banks have raised more than $400 
billion in new capital, and regulators have required 
institutions to maintain higher capital buffers--again, an 
authority they possessed pre-Dodd-Frank. I, for one, believe 
that generally, this is a good thing. But the capital standards 
that were already complex have become even more complex with 
Basel III. I do not necessarily believe this to be a good 
thing.
    Again, relying on regulators to calibrate risk and predict 
future economic conditions according to highly complex models, 
models that neither market participants nor regulators 
themselves fully understand, clearly appears to be a recipe for 
financial crisis. We have seen the danger of one global view of 
risk.
    So there are a number of questions that this committee must 
explore. Although capital and liquidity standards have 
increased post-crisis, do we really know by how much? How 
opaque do balance sheets still appear? How many items that were 
once off-balance-sheet will find their way back onto balance 
sheet? What amount of capital is the proper amount? Too much, 
economic growth can stall; too little, and too many failures 
could yet ensue.
    So at today's hearing, we will explore, is there a better 
way? For example, are we better off measuring capital adequacy 
according to a more straightforward leverage ratio, which takes 
discretion away from regulators and seeks to give greater 
weight to market forces in allocating resources and achieving 
financial stability?
    Are there specific forms of capital, such as those that 
convert debt to equity? In the event of predetermined market 
triggers, could they promote greater market discipline and 
better risk management at large, complex financial 
institutions?
    And to help us with these questions, we have assembled a 
panel of noted experts, and I certainly look forward to hearing 
their testimony.
    The Chair now recognizes the gentleman from California, Mr. 
Sherman, for 2 minutes.
    Mr. Sherman. Thank you.
    I notice here in the audience is Marc Shultz, who up until 
recently was sitting behind me. Marc is now with the Office of 
Financial Research, which is housed in Treasury and advises the 
FSOC.
    And, Marc, I just want to say for the record, you didn't 
stop working for me; I just stopped paying you.
    You know, Mr. Chairman, the title of this hearing begins 
with the words ``Ending Too Big to Fail.'' The best approach to 
end ``too-big-to-fail'' is to end ``too-big-to-fail.'' The 
title should not be, ``Strengthening Too-Big-to-Fail,'' 
``Improving Too-Big-to-Fail,'' ``Better Governing Too-Big-to-
Fail, ``Watching Too-Big-to-Fail,'' or ``Scrutinizing Too-Big-
to-Fail.'' We have to end ``too-big-to-fail.''
    That is why you ought to join me and Senator Bernie Sanders 
in sponsoring legislation to say ``too-big-to-fail'' is too big 
to exist; break them up.
    And, Mr. Chairman, this is not a bill supported only by 
Socialists. It is a bill supported by the ICBA, which 
represents 90 percent of the bankers in this country, or 90 
percent of the banks in this country, most of whom are not 
Socialists.
    Until we end ``too-big-to-fail,'' we will be having 
ineffective hearings on how to watch the ``too-big-to-fail.'' 
They enjoy a basis-point advantage when they seek capital, so 
they are going to keep getting bigger and bigger. They are 
going to put regional banks at a disadvantage. That is why the 
ICBA endorses this bill, and I hope very much that the chairman 
will, as well, but I am not holding my breath.
    The fact is that when we classify entities as SIFIs or 
``too-big-to-fail,'' we should be focusing on their 
liabilities. Lehman Brothers did not fail because it had too 
many assets. And that is why, when they start classifying as 
SIFIs organizations that have no liabilities, whose failure 
would not leave a single creditor without being paid, then I 
think it is just a desire by the regulators to regulate anybody 
that is big and juicy.
    Instead, we ought to be breaking up those entities whose 
actual and contingent liabilities are of such a magnitude that 
if they fail to pay those liabilities, they take the economy 
down with them.
    I yield back.
    Chairman Hensarling. The gentleman yields back.
    The Chair now recognizes the ranking member for 3 minutes 
for an opening statement.
    Ms. Waters. Thank you, Mr. Chairman.
    Over the years, as this committee has debated, passed, and 
overseen the implementation of the Dodd-Frank Wall Street 
Reform Act, we have heard a number of doomsday scenarios about 
the consequences of new liquidity and capital requirements for 
financial institutions. Well, as we celebrate the 5-year 
anniversary of Dodd-Frank and as these requirements have gone 
into effect, I am pleased to report that the world hasn't 
ended.
    Today, our financial markets are stable and secure. Banks 
are making record profits. Lending is up. And we have a 
financial system that is stronger, safer, and more resilient 
than ever before.
    Prior to the financial crisis, regulators were asleep at 
the switch. As banks leveraged up and concentrated their 
activities in risky mortgages while being allowed to rely on 
their own risk models, bank executives made huge bonuses on 
these short-term gains, but when the music stopped, it was 
taxpayers who took the losses.
    Dodd-Frank mandates that regulators work together to 
closely monitor the Nation's large banks, setting a floor for 
capital and liquidity standards to ensure financial companies 
are risking their own capital rather than taxpayer money. Just 
this week, regulators finalized a rule that would require even 
higher capital standards at the largest globally systemic banks 
that actively seek out the riskiest lines of business.
    While the implementation of Dodd-Frank is incomplete, it is 
already working. A staff report by committee Democrats, 
released this week, found that Dodd-Frank has made our 
financial system more transparent, more stable, and more 
accountable by arming our regulators with vital tools to 
monitor the financial system for risk, increase transparency, 
and institute new investor protections.
    And to make certain this approach is not overly onerous, 
Dodd-Frank has created a flexible and tiered regulatory 
framework to ensure these heightened standards are tailored to 
banks of different sizes.
    Since the passage of Wall Street reform, the American 
economy has stabilized, adding around 12.8 million private-
sector jobs over 64 consecutive months of job growth, dropping 
the unemployment rate from its peak of 10 percent in 2009 to 
5.3 percent currently.
    Mr. Chairman, when discussing the proper role of capital 
and liquidity, it is important to keep in mind that today our 
financial system is safer and stronger than it has been in a 
generation, regardless of the claims we hear from the most 
fervent opponents.
    I thank you, and I yield back the balance of my time.
    Chairman Hensarling. The gentlelady yields back.
    We are all familiar with the celebrated question, ``Is 
there a doctor in the house?'' Today, we appear to have four of 
them at the witness table.
    So, going left to right, today we will welcome the 
testimony of Dr. Charles Calomiris, who is the Henry Kaufman 
Professor of Financial Institutions at the Columbia University 
Graduate School of Business. His research spans several areas 
including banking, corporate finance, financial history, and 
monetary economics. He received a B.A. from Yale University, 
and a doctorate in economics from Stanford.
    Our next witness, Dr. Bob Chakravorti, is the managing 
director and chief economist of The Clearing House Association. 
He was previously a senior economist at the Federal Reserve 
Banks of Chicago and Dallas. He is the author of more than 40 
articles for industry, academic, and Fed publications. He 
received his Ph.D. and M.A. in economics from Brown University, 
and his B.A. from UC Berkeley.
    Next, Dr. John Parsons is a senior lecturer at the Sloan 
School of Management at MIT. He previously worked at the 
economics consulting firm of CRA International, where he was a 
vice president and principal. He earned his B.A. from 
Princeton, and a Ph.D. in economics from Northwestern 
University.
    Finally, Dr. Norbert Michel is a research fellow in 
financial regulations at The Heritage Foundation. He previously 
taught finance, economics, and statistics at Nicholls State 
University's College of Business. He holds a B.A. from Loyola 
University, and a doctorate in financial economics from the 
University of New Orleans.
    I do not recall if all of you all have testified before. If 
not, we have this lighting system: green means go; when the 
yellow light comes on, it means you have a minute left; and red 
means stop. Each of you will be recognized for 5 minutes to 
give an oral presentation of your testimony, and without 
objection, each of your written statements will be made a part 
of the record.
    Professor Calomiris, you are now recognized for your 
testimony.

 STATEMENT OF CHARLES W. CALOMIRIS, HENRY KAUFMAN PROFESSOR OF 
FINANCIAL INSTITUTIONS, COLUMBIA UNIVERSITY GRADUATE SCHOOL OF 
                            BUSINESS

    Mr. Calomiris. Chairman Hensarling, Ranking Member Waters, 
and members of the committee, it is a pleasure and an honor to 
share my thoughts on the ``too-big-to-fail'' problem and, more 
generally, the problems of bank instability, credit collapses, 
and financial burdens on taxpayers that result from private 
risk-taking at public expense.
    Title II of Dodd-Frank is supposed to ensure orderly 
liquidation of ``too-big-to-fail'' banks, now called SIFIs, but 
is more likely to institutionalize bailouts by establishing 
specific procedures through which they will occur. Rather than 
pretending that we will have the legal mechanisms and political 
will to liquidate SIFIs, we should focus on preventing them 
from becoming insolvent. That means focusing on the adequacy of 
bank capital and cash.
    Book equity is a poor measure of the true value of equity. 
When banks suffer losses on tangible assets, such as loans, 
they typically delay loss recognition. Overstating equity 
capital allows them to avoid curtailing risky activities. 
Furthermore, the book value of equity does not capture losses 
of intangible assets. Lost servicing income, other fee income, 
and reduced values of relationships with depositors and 
borrowers have been the primary drivers of loss in bank values 
since 2006.
    We should raise equity capital ratio requirements further, 
but we cannot rely only on book equity ratios to measure bank 
health. We need to measure the economic value of equity and put 
in place reliable regulatory requirements which ensure that 
banks will maintain adequate and meaningfully measured equity 
capital.
    I propose requiring alongside a book equity requirement 
that large banks maintain a substantial proportion of funding 
in contingent convertible debt, CoCos, that converts into 
equity on a dilutive basis when the market value of equity 
persistently falls below 10 percent of assets. Dilution ensures 
that bank managers face strong incentives to replace lost 
equity in a timely manner to avoid the dilutive conversion of 
CoCos.
    Bank CEOs would have a strong incentive to maintain a 
significant buffer of equity value above the 10-percent 
trigger. They would increase that buffer voluntarily if the 
riskiness of banks' assets rose, resulting in a self-enforcing, 
risk-based equity requirement based on credible self-
measurement of risk, in contrast to the current system of risk-
measurement gaming by banks.
    This CoCos requirement would virtually preclude SIFI 
bailouts. Bailouts cannot occur if banks remain very distant 
from the insolvency point.
    Additionally, stress tests could be a promising means of 
encouraging bankers to think ahead, but, as they are 
structured, stress tests are a Kafkaesque Kabuki drama in which 
SIFIs are punished for failing to meet unstated standards. That 
not only violates the rule of law, the protection of property 
rights, and adherence to due process; it makes stress tests a 
source of uncertainty rather than a helpful guide to 
identifying unanticipated risks.
    And the penalties for failing a stress test are wrong. 
Limiting dividends makes sense for a capital-impaired bank but 
not for a healthy bank in compliance with all its regulatory 
requirements. In that case, it is inappropriate to try to 
decide the dividend decision for the board of directors.
    Finally, the stress-testing standards currently being 
applied are not very meaningful.
    We can do much better. The Fed should be required to 
provide clear guidance. Stress tests should be an input into 
capital requirements, not used to control dividend decisions. 
Finally, stress tests should focus on the loss of economic 
value, by analyzing consequences for bank cash flows, divided 
by line of business, using data from bank managerial accounts. 
That is not happening now.
    Liquidity requirements are another good idea being 
implemented poorly. A better, simpler approach would require 
SIFIs to maintain reserves at the Fed of 25 percent of their 
debt. To avoid turning that into a tax, reserves should bear 
market interest. This would require banks to hold a significant 
proportion of their assets in riskless debt.
    This would not bind on SIFIs today, given their huge excess 
reserve holdings, nor would this have been binding in the early 
1990s. But it would have been very helpfully binding on SIFIs 
leading up to the recent crisis. Large banks held 25.8 percent 
of their assets in cash form in January 1994. That fell to 17.2 
percent by January 2001 and to 13.5 percent by January of 2008.
    Applying to SIFIs the right combination of regulations 
governing book equity, CoCos, stress tests, and reserves would 
virtually eliminate the risk of ``too-big-to-fail'' bailouts.
    But that is not the only bank bailout risk we face. The 
most important source of systemic risk for small banks, the 
ones that cost us so much in both the 1980s and the 2000s with 
their cost of failure, one that was visible both in the 1980s 
and the 2000s, was their excessive exposure to real estate 
lending. Real estate risk is highly correlated, and it is hard 
to shed in a downturn.
    As of January 2008, roughly three-quarters of small-bank 
lending was in real estate loans. Large banks had lower 
exposures but still very large ones. The obvious answer is to 
limit bank real estate lending, forcing real estate financing 
to emigrate to REITS, insurance companies, and other more 
natural providers of real estate finance.
    These reforms not only would virtually eliminate the ``too-
big-to-fail'' problem; they would stabilize the entire banking 
system, protect taxpayers, reduce regulatory uncertainty, and 
improve the performance of banks.
    Thank you for your attention.
    [The prepared statement of Dr. Calomiris can be found on 
page 50 of the appendix.]
    Chairman Hensarling. Thank you.
    Dr. Chakravorti, you are now recognized for 5 minutes for 
your testimony.

 STATEMENT OF SUJIT ``BOB'' CHAKRAVORTI, MANAGING DIRECTOR AND 
     CHIEF ECONOMIST, THE CLEARING HOUSE ASSOCIATION L.L.C.

    Mr. Chakravorti. Chairman Hensarling, Ranking Member 
Waters, and members of the committee, thank you for inviting me 
to testify today on the critical topic of capital in the 
banking system.
    My name is Bob Chakravorti, and I am the chief economist at 
The Clearing House, where I oversee empirical studies on 
financial regulations. The Clearing House is a nonpartisan 
organization that represents the interests of our owner banks 
by developing and promoting policies to support a safe, sound, 
and competitive banking system. I appreciate the opportunity to 
share my observations on regulation of bank capital.
    The strength and resilience of the American banking system 
are essential. Banks serve as unique financial intermediaries 
between those who save and those who borrow and those who are 
unwilling to take risk and those who are willing to bear risk 
for a price. Our modern economy relies on banks to provide 
these critical financial intermediation functions.
    Next, I will offer five key observations.
    First, robust capital requirements are clearly an essential 
tool for promoting the safety and soundness of individual 
institutions and enhancing the stability of the financial 
system as a whole. Simply put, capital acts as a cushion that 
can absorb potential losses from all activities in which banks 
engage. That, in turn, supports their strength and resilience.
    Second, very significant improvements to the regulation of 
bank capital have occurred since 2008, including measures 
proactively adopted by banks themselves. Between early 2008 and 
late 2014, the largest bank holding companies more than doubled 
the amount of their common equity Tier 1 capital relative to 
risk-weighted assets and substantially increased their leverage 
ratio.
    U.S. regulators have similarly responded to the crisis by 
rapidly overhauling the bank regulatory capital framework, 
including: increasing requirements for the quantity and quality 
of capital; making various asset risk weights more 
conservative; introducing capital stress-testing and 
supplemental leverage ratio for larger banks; finalizing the 
U.S. G-SIB surcharge earlier this week; and introducing a total 
loss-absorbing capacity requirement, which is forthcoming.
    In addition to these very significant improvements in bank 
capital regulation, other parts of the regulatory landscape are 
very different from what existed in 2007. Many of these 
improvements are specifically designed to reduce systemic 
risk--for example, a new comprehensive liquidity regime which 
includes the liquidity coverage ratio, the upcoming net stable 
funding ratio, and liquidity stress-testing. Taken together, 
these measures reduce the probability of default and the 
systemic impact of that default.
    Third, along with these clear benefits, capital has costs. 
As economists, we like to say there is no such thing as a free 
lunch. My written statement details that, at some point, 
increasing bank capital levels may result in a reduction in key 
banking activities that support our overall economy, including 
mortgage and small-business lending, commercial lending, 
market-making, and other financial intermediation services.
    Fourth, I wish there was a clear consensus around how much 
capital is the right amount, but unfortunately, academics and 
policymakers continue to disagree on this difficult question. 
What is clear, however, is that there are tradeoffs. For 
example, there is a tradeoff of the benefits of increased 
financial stability at the expense of potential reduction in 
economic growth. And there are competitive impacts for U.S. 
banks in the global economy that are subject to capital 
standards higher than internationally agreed upon.
    Finally, as we wrestle with the question of how much 
capital is enough and where we go from here, I urge you to take 
into account the full consequences of the new regulatory 
regime, particularly in terms of the downstream impact to the 
real economy that have not been fully realized.
    Additional empirical analysis is essential to inform these 
decisions. This is a good time for policymakers to pause and 
evaluate where we have landed in the tradeoff between financial 
stability and the banking system's contribution to the U.S. 
economy.
    Thank you again for the opportunity to testify today. I 
look forward to answering your questions.
    [The prepared statement of Dr. Chakravorti can be found on 
page 64 of the appendix.]
    Chairman Hensarling. Dr. Parsons, you are now recognized 
for 5 minutes for your testimony.

STATEMENT OF JOHN E. PARSONS, SENIOR LECTURER, SLOAN SCHOOL OF 
       MANAGEMENT, MASSACHUSETTS INSTITUTE OF TECHNOLOGY

    Mr. Parsons. Thank you, Chairman Hensarling, Ranking Member 
Waters, and members of the committee. It is a pleasure to meet 
here with you today and discuss this subject.
    I think it is very interesting that there is significant 
unanimity here that, in the last number of years, as the 
chairman pointed out and others have, supervisors have 
substantially improved bank capital requirements, and, in many 
diverse ways, the analysis of capital in banking institutions 
has been improved, which has made the system substantially 
safer.
    So maybe I should just pause for one moment about that 
substantial agreement. I guess, as an economist, I have to 
agree that there is no such thing as a free lunch. But there 
are places you can get cheap eats, and when you do, you should 
definitely go for them. So, in my opinion, we are nowhere near 
worrying about major costs from these capital requirements to 
the financial system.
    Let me address very specifically one that has been floated 
in the press for a number of years, and try to flesh out one or 
two issues about that cost. There has been a lot of discussion 
about perhaps liquidity in the corporate bond market has 
declined and perhaps that decline has to do with the 
regulations on banks and their inability to act as dealers.
    So, first of all, what we really have heard in the press is 
vague worries and discussions about this, identifications of 
one or two statistics that have changed in the last number of 
years, vague phrases that ``something'' has changed. So I have 
a couple of points to say about those changes.
    Certainly, some of those changes are a feature and not a 
bug. When the banks have been asked to move their propriety 
trading operations outside the bank and stop doing proprietary 
trading, that is a good thing for the safety of the system, and 
that trading can still go on. Hedge funds can still operate 
outside of the banking system. But that trading is no longer 
financed by a taxpayer backstop. How much trading is right to 
be done is something that is determined by the costs and 
benefits of that trading and the decisions of the individual 
traders, but it is no longer subsidized by taxpayers. That is a 
benefit to society and not a cost.
    But it is also true that an awful lot of other things are 
going on in the bond market right now. We have watched over the 
last few decades how the equity markets have changed because 
computing power and communication have transformed trading. We 
have also noticed that that has happened in the U.S. Treasury 
market dramatically over the last few years and seen the report 
about last October's problem, because there are difficulties 
when that happens. The trading is cheaper in this newer way, 
but it has new problems.
    The same thing is beginning to happen in the corporate bond 
market. It is far from what has happened in Treasuries, but it 
nevertheless is happening. That is technology changing. We need 
to respond to that, we need to welcome it, and we need to watch 
for the problems that it has. But it has nothing to do with 
capital standards, and capital standards can't solve the 
glitches that arise in doing it and make it more effective for 
society.
    So, that is one thing on the costs.
    The other thing I wanted to raise out of my testimony is, 
as we hear so many different capital standards thrown around, 
one particular item that has been discussed that I think bears 
fleshing out a little bit is stress tests and how important 
stress tests are. Several of us agree about that, as well.
    I just want to highlight two ways in which stress tests are 
very important. First of all, they are very forward-looking, 
which is something we need and we all agree is needed. Second 
of all, they allow you to question, sort of, convenient 
assumptions that are relatively weak in important ways.
    Some people criticize stress tests the way the Fed has 
applied them because they have been ``vague.'' But really what 
the Fed is doing is inviting bank officers to come to the table 
and provide leadership about what kinds of things we should be 
worrying about, provide leadership in identifying the major 
risks and showing that the bank is going to be ready for those 
major risks.
    We should welcome that kind of demand for the major banks 
in the United States to identify and play an active role in 
ensuring that the system is safe. It shouldn't be a system 
where the regulators are the only ones involved in determining 
what counts as a safe and healthy system. We should be doing 
that in partnership, and the stress tests are a very good 
opportunity to do that in partnership.
    Thank you very much, and I look forward to talking more on 
the subject.
    [The prepared statement of Dr. Parsons can be found on page 
85 of the appendix.]
    Chairman Hensarling. And Dr. Michel, you are now recognized 
for your testimony.

 STATEMENT OF NORBERT J. MICHEL, RESEARCH FELLOW IN FINANCIAL 
              REGULATIONS, THE HERITAGE FOUNDATION

    Mr. Michel. Thank you.
    Chairman Hensarling, Ranking Member Waters, and members of 
the committee, I am Norbert Michel, a research fellow in 
financial regulations at The Heritage Foundation. The views 
that I express in this testimony today are my own, and they 
should not construed as representing any official position of 
The Heritage Foundation.
    The aim of my testimony this morning is to argue that a key 
step toward ending ``too-big-to-fail'' is to promote market 
discipline by eliminating risk-based capital requirements.
    There are three main issues that I would like to address.
    First, recent efforts to restrict the Federal Reserve's 
direct lending to firms so that it will closely conform to the 
classic prescription for a last-resort lender are 
counterproductive because they do not increase this market 
discipline.
    This classic prescription says that the central bank should 
readily provide short-term loans to solvent firms on good 
collateral at high rates of interest. But we have to ask 
ourselves, why would a large group of private lenders not make 
loans on these terms? And one of the reasons is because strict 
regulatory requirements can prevent firms from making these 
loans.
    In this case, the absence of private lending is a 
regulatory failure, not a market failure. And the removal of 
these restrictions would allow private lenders to make prudent 
loans rather than hold idle funds.
    Unfortunately, Title I of Dodd-Frank has only magnified 
this problem by ensuring that new versions of the Basel 
requirements will be forced on financial firms. These rules, 
along with other regulatory policies, literally create the need 
for government-sponsored lending under the guise of providing 
liquidity that the market failed to provide. But we should make 
no mistake that this is a regulatory failure, and major 
regulatory failures contributed to the 2008 crisis.
    And that brings me to my second main issue, which is that 
the Basel requirements contributed to the meltdown not because 
they required too little capital per se but because regulators 
failed to properly measure risk.
    The Basel rules were forced on commercial banks in the late 
1980s, and the regulators assured the public at that time that 
these new requirements would, in fact, force banks to hold a 
cushion against unexpected losses. To build that cushion, 
regulators literally specified risk levels for bank assets by 
assigning different risk weights. Lower weights required lower 
capital; higher weights required higher capital.
    The system specifically required less capital to be held 
against GSE-issued mortgage-backed securities than against 
either home mortgages or commercial loans. Unsurprisingly, most 
commercial banks followed the same practice. They sold their 
customers' mortgages to the GSEs, and they held, instead, the 
GSE securities.
    So, when the GSEs became insolvent, virtually all banks 
were stuck with nearly the same asset structure and exposed to 
the same losses, even though the typical bank at that time had 
exceeded its minimum capital requirements by 2 to 3 percentage 
points for the 6 years leading up to the crisis.
    There is no doubt that these statutory capital requirements 
failed and the whole concept is flawed. The only reason that 
Dodd-Frank gave us Basel III, indirectly, is because the crisis 
exposed Basel II as deeply flawed before it was even fully 
implemented.
    And that brings me to my third and final point, which is 
that there is no reason to think that Basel III will perform 
any better, because it maintains the main regulatory flaw that 
we have basically always had in the United States, which is 
that regulators, rather than markets, determine bank capital 
standards.
    If we want to improve bank safety, we should scrap this 
overly complicated, top-down system and replace it with a 
simple set of rules that allows markets to adequately price 
risk and to discipline firms that take on too much.
    True reforms would include the repeal of, at the very 
least, Titles I and II of Dodd-Frank as well as the elimination 
of the Fed's authority to make loans directly to firms. These 
changes would provide a credible basis for believing that it is 
unlikely financial firms will be bailed out in a future crisis.
    Then, and only then, will major improvements that expose 
firms to more market discipline be possible. For instance, in 
return for reducing regulations, a simple, flat capital ratio 
could easily replace the enormously complex Basel rules. 
Another good option is a contingent convertible debt 
requirement.
    But those ideas still fall short of purely market-
determined capital ratios, and that is what our long-term goal 
should be.
    One way to get there would be to offer financial firms an 
optional escape clause. Allow them to opt out of the Federal 
regulatory framework, as well as the Federal safety net, in 
exchange for converting to a partnership entity. Thus, in 
return for real deregulation, financial firms' owners would be 
fully liable directly for their companies' losses, as it should 
be in any business.
    Thank you for your consideration, and I am happy to answer 
any questions you may have.
    [The prepared statement of Dr. Michel can be found on page 
74 of the appendix.]
    Chairman Hensarling. Thank you.
    The Chair now yields himself 5 minutes for questioning.
    So, Dr. Michel, it is pretty clear that you don't think 
BASEL I and Basel II historically got it right. It doesn't 
appear that you are a fan of Basel III either.
    Mr. Michel. Not exactly.
    Chairman Hensarling. Do you have any hope that a Basel IV 
or a Basel V could ever get it right? Or could you simply 
expound upon your views of what is the systemic risk of having 
one world view of risk imposed upon the global financial 
system?
    Mr. Michel. The general problem is that, just sort of like 
what we saw happen last time, you have basically everybody 
forced into the same sort of structure and the same sort of 
investments or the same sort of capital allocations, and if one 
thing goes wrong, it hits everybody equally.
    We have a very long history in the United States of this 
sort of--what I would just sort of call a populist tendency to 
direct all of the bank capital requirements and standards, so 
to speak, and the entire structure of that industry. And it has 
driven it into the ground more than once. I don't know how many 
times we have to go through this to figure out what we are 
doing wrong, but--
    Chairman Hensarling. Dr. Calomiris, you have obviously 
contributed a very unique idea to the public debate here.
    I read your full testimony, your extended version. So I 
think you have maintained that CoCos would encourage banks to 
recognize losses earlier than they otherwise would because of 
the aspect of market discipline. They would have an incentive 
to build their capital buffer earlier.
    Can you expound on that view and how this is important to 
taxpayer protection?
    Mr. Calomiris. Yes. Thank you, Mr. Chairman.
    The basic idea is simple. If banks had to maintain their 
true economic value of their equity ratio at above 10 percent--
that means that the market believes that the banks actually 
have equity in excess of 10 percent of their assets--banks 
would never be anywhere near the insolvency point, and we 
wouldn't ever worry about bailouts.
    If you create a penalty for banks in persistently getting 
below that which is credible, then bankers won't get below it. 
And CoCos are really just a way to create that penalty through 
a very diluted conversion of debt instruments into equity. And 
if a CEO just stood by and let that dilution happen, he or she 
would be fired.
    And so we are working off the incentives of people to self-
identify their losses and to self-identify their risks and to 
hold more capital when their risks are high and to replace lost 
capital very quickly because, number one, that CEO doesn't want 
to get fired.
    When I was having breakfast with a vice chairman of one of 
the large banks in the summer of 2008, I said to him, ``Why 
aren't you raising more capital?'' He said, ``We don't like the 
price. And did you notice what happened with Bear Stearns? So 
why should we?''
    And what didn't he like? He didn't like having to get 
dilutively offering new equity at a price that was too low. But 
if he had had those CoCos hanging over his head, he would have 
jumped to raise new capital to avoid the even greater dilution 
of that conversion.
    So, that is the basic argument.
    Chairman Hensarling. Speaking of interest, also in your 
writings you have spoken about a convergence of interest 
between large banks and their regulators that might diverge 
from the interest of taxpayers in times of stress. You spoke 
about the Bear Stearns scenario. Can you expand upon your views 
there, please?
    Mr. Calomiris. There is a large literature, academic 
literature that has identified persistent, across many 
countries, the tendency for supervisors to allow banks not to 
identify losses during recessions. The reason is, if you 
identify losses, banks might have to curtail credit. That is 
not popular with politicians or regulators, especially in 
democracies that hold elections.
    For example, it wasn't until the 1988 election in the 
United States was over that we recognized major losses in the 
S&Ls. There are some recent articles showing that the same 
thing happened during our crisis in 2008.
    So we know that we can rely upon supervisors to go along 
with bankers in understating losses, not just in the United 
States but around the world.
    Chairman Hensarling. The opponents of your idea will say 
that this simply becomes a juicy target for those who will 
choose to short a bank's equity, that this is a very rich 
target for short-sellers who wish to game the system. How do 
you address that concern?
    Mr. Calomiris. A couple of ways.
    First of all, I would only allow qualified institutional 
investors to be holders of this, who are prohibited from short-
selling. So they would have very little incentive to short-
sell.
    Secondly, I said persistent declines in market value, 
meaning 120 days. You can't maintain a profitable short 
position in a deep market, like a market for JPMorgan or 
something like that, to try to push shares down for that long a 
period.
    So I don't really think this is a realistic concern for 
both of those reasons.
    Chairman Hensarling. My time has expired. I now recognize 
the ranking member for 5 minutes.
    Ms. Waters. Thank you very much.
    I am looking at a definition of ``capital,'' and I am 
listening to ways that ``capital'' is defined by different 
people.
    I want to read something to you. This is for Dr. Parsons.
    Under a definition of what exactly is capital, ``A bank's 
capital, similar to shareholders' equity, is the amount left 
over when a bank's liabilities are subtracted from its assets, 
which also means that a bank's assets are equal to its 
liabilities plus its capital.
    ``In other words, a bank's capital ratio describes the mix 
of debt--that is, liabilities and equity--capital--the bank 
uses to fund its assets. Capital is not an amount set aside 
that cannot be lent. It is a source of funds for lending. To 
remain solvent, the value of a firm's assets must not exceed 
its liability.''
    Now, for you: Banks subject to heightened capital standards 
often point out that these standards prevent them from lending 
into their communities. What would you say to critics of the 
Dodd-Frank Act who claim that capital standards hurt borrowers 
and small businesses that want access to credit?
    Mr. Parsons. Thank you.
    So, yes, you highlight the fact that a lot of people, in 
discussing bank capital, use this terminology, like banks 
``hold'' capital--
    Ms. Waters. Yes.
    Mr. Parsons. --as if they immobilize it and don't use it. 
And that is wrong. The bank is funded by equity, by debt, by a 
variety of sources. All of that money can be put to work in 
purchasing assets and making loans and so on. So all of that, 
all sources of capital, debt capital and equity capital, can go 
to work. It is not a cost for the company doing it.
    Some of what people think are costs are because we are 
subsidizing debt through the tax system, since interest is tax-
free, and if we force the company to hold more equity instead 
of debt, in a sense the company loses some of its subsidy. But 
that is not a cost to society; that is a cost to that 
particular--where withdrawing a subsidy is not the same thing 
as a real cost paid out in real resources.
    Ms. Waters. In addition to capital and liquidity standards, 
regulators have the authority under the Dodd-Frank Act to use 
the living-wills process to make the largest banks less risky. 
How well do you think regulators have implemented this 
provision so far?
    I am really looking at living wills, I am looking at stress 
tests, and I am looking at capital as a way of preventing us 
from ever having to bail out again. Could you give me some 
discussion on that?
    Mr. Parsons. So, yes, in the financial crisis, of course, 
we suddenly found ourselves with institutions which were 
extremely large doing a lot of complex activities--activities 
which were crossing many international boundaries, the same 
units having components of their business crossing 
international boundaries. We found ourselves with regulators 
unable to really see what the bank was doing and to be able to 
take action because they had some understanding of the bank.
    We have addressed that complexity in a lot of ways--the 
Dodd-Frank Act that deals with derivatives in one title and so 
on and so forth. Living wills is one step where you can work 
with the bank to figure out a structure for the bank that is 
more rational and something that the regulators can understand 
and look to the need for resolution so that the bank can 
participate in structuring itself in a way that it can do its 
business but be prepared so that in the case of a crisis it can 
be resolved in a way which does not disrupt the activity, its 
business, its lines of business, that allows those lines of 
business to go forward.
    I would say that, so far, it has been useful, so we have 
improved things a lot. But we, obviously--as you can hear from 
the regulators in responding to the living wills, there is 
obviously a lot of complexity and uncertainty that remains and 
has yet to be worked out of the system.
    Ms. Waters. Thank you so very much.
    Let me just wrap this up by saying, is it correct to say to 
those who claim that capital requirements are preventing banks 
from making loans, that that is just absolutely not true?
    Mr. Parsons. Yes.
    Chairman Hensarling. The time of the gentlelady has 
expired.
    The Chair now recognizes the gentleman from New Jersey, Mr. 
Garrett, chairman of our Capital Markets Subcommittee.
    Mr. Garrett. I thank the chairman. And I thank the chairman 
for this hearing.
    I would like to jump right into that last question, but 
before I do, one of the books that I really found fun reading 
that I recommend to everybody is, ``The History of Money from 
1776 up until the Great Depression.''
    And if you go through that and all the stats and everything 
else in between the lines, basically what the point of the book 
is--or, one of the side points of the book is that up until the 
creation of the Fed and the FDIC and what have you, the 
overriding principle in the financial markets was market 
discipline.
    Because all the local banks had to have their own market 
discipline because they knew there was not going to be any 
bailout for either the depositors through the FDIC nor bailout 
for the banks through the Federal Reserve or elsewhere. So that 
was a real incentive to be prudent in your investments and in 
your lending by your Main Street bank, and for the large banks 
as well, because the investors looked at it and said, if you 
are not prudent, we are not going to invest in it because you 
are a risky market.
    That changed at the turn of the last century, and that, of 
course, changed dramatically again with Dodd-Frank, which 
basically codifies the idea of ``too-big-to-fail'' and that the 
American public is now on the hook for bailing out these 
institutions.
    And this is not just my thought; this is a bipartisan 
thought. And I often give credit where credit is due, and that 
is my predecessor on this committee, the Democrat gentleman 
from Pennsylvania, who often said that we should, when he was 
working through Dodd-Frank, try to place in it some elements 
that would re-instill market forces. Unfortunately, I can't 
speak for him, but most of us understand that Dodd-Frank did 
not do that, did not instill market forces, but went in the 
opposite direction.
    So I am going to just--I will try to go left to right.
    Dr. Calomiris, you did a paper I saw back a couple of years 
ago, in 2011, and you were looking at the build-up to the 
crisis, and you gave all the stats and numbers of 2007 and 
2008. And you said the capital markets were wide open, and 
commercial banks' investments were able to raise up to $450 
billion in those 2 years. In other words, things were going 
well, as far as the build-up of assets and capital. But they 
were raising preferred shares, which goes along your last line 
of testimony.
    So part of the effective regime going forward is, what, 
making sure that they are holding the right type of capital, 
right? So if you would just comment on that in 30 seconds, 
because I have a follow-up on that.
    Mr. Calomiris. My CoCos proposal gets right at your 
question--
    Mr. Garrett. Okay.
    Mr. Calomiris. --and has to do with how you bring market 
forces and market discipline into the capital adequacy 
discussion. So the point is, if you require bank CEOs to have 
to pay attention to whether the market equity ratio is falling 
and have to worry about those consequences, they will make sure 
to maintain capital adequacy.
    So that is--I have been working on exactly the topic you 
are talking about for about 20 years, and I think that would 
be--
    Mr. Garrett. So is there a perfect or a best number? A 5, 
10, 15, 20, higher percentage?
    Mr. Calomiris. My view is--and it is not based on anything 
too precise or scientific, to be quite frank--is that alongside 
a 10-percent equity-to-assets minimum requirement, I would have 
an additional 10 percent of CoCos that would convert into 
equity if you ever got below that 10-percent market equity 
ratio.
    Mr. Garrett. So we saw there was a complete failure of 
Basel II, and now we have Basel III. Is Basel III going in the 
right direction or is it going in the wrong direction with 
regard to all of this?
    Mr. Calomiris. Basel III depends, as Mr. Michel said, on 
those risk weights being properly calculated by the banks. And 
I don't really believe in that.
    But I do believe that if we had my proposal on the table--
    Mr. Garrett. Okay.
    Mr. Calomiris. --if the banks had to comply with that, that 
would incorporate market perceptions of risk and value, and we 
would have an automatic, real risk-weighted capital system.
    Mr. Garrett. Let's bring it down to the other end.
    Dr. Michel, you can comment on that, but can you also 
comment on the last question of the ranking member? Is it 
regulation in the market that is affecting lending in the 
marketplace today, or is it just the marketplace?
    Mr. Michel. So, first, since it is in my brain, I agree 
with Charlie's proposal. It is a great idea. And if it were a 
question of Basel III or the convertible requirements, I am all 
for the convertible capital.
    Mr. Garrett. There you go. We have agreement.
    Mr. Michel. Yes.
    And then as far as the liquidity and regulation issue, I 
think it depends on how we are defining the terms. In my 
testimony, I did not specifically address, in my mind anyway, 
higher regulation impacting liquidity in the market as we now 
stand. I think--
    Mr. Garrett. I should say, not regulation, but the fallout 
of the regulation, which is the capital requirements.
    Mr. Michel. I personally believe that it is more of a 
supply issue than a liquidity issue. I think we are forcing 
banks to hold more liquid assets and hold more assets in 
general, and--
    Mr. Garrett. Okay. And that affects their lending ability.
    Mr. Michel. And it affects, ultimately, liquidity and 
lending ability--
    Mr. Garrett. Thank you.
    Mr. Michel. --in the long run, yes.
    Mr. Garrett. Thank you.
    Chairman Hensarling. The time of the gentleman has expired.
    The Chair now recognizes the gentleman from Texas, Mr. 
Hinojosa.
    Mr. Hinojosa. Thank you, Mr. Chairman, and thank you, 
Ranking Member Waters, for holding this important hearing 
today.
    My first question is going to be for Dr. Norbert Michel.
    In your testimony, you chide the Federal Reserve's actions 
during the 2008 financial crisis. According to the GAO report 
cited in your testimony, from December 1, 2007, through July 
21, 2010, the Federal Reserve loaned financial firms more than 
$16 trillion through its broad-based emergency programs. If I 
understand your testimony correctly, you suggest that the Fed 
should not have loaned firms any money during that crisis, but 
rather conducted its traditional open market operation in order 
to provide market liquidity.
    Given that enormous amount of direct liquidity provided by 
the Fed, do you think the Federal Reserve could have similarly 
prevented the collapse of the financial system through the 
traditional open market operations alone?
    Mr. Michel. Okay, so, technically, I didn't say that they 
shouldn't have done that in the crisis. And I don't think that 
they had any choice at that point, given the system that we 
have.
    Now, ideally, what I--so what I said is that, ideally, we 
would have a system that would not let them do that. That is 
what I said. And, yes, I do think that would be better.
    I do think that if we reformed the primary dealer system so 
that it is not just a small group of banks involved in Treasury 
auctions, that it is all banks, say, with top two CAMELS 
ratings, then, yes, that would greatly improve liquidity and 
greatly reduce the chance that we would ever need any sort of 
emergency lending at all.
    Mr. Hinojosa. Dr. Parsons, I really enjoyed your 
presentation.
    Do you agree with Dr. Michel that we should get rid of the 
risk-based capital standards? Why yes, or why not?
    Mr. Parsons. I don't really see any alternative to the 
government playing some role in establishing capital standards. 
Banks are going to be a major part of our financial system, and 
the dangers of things like runs in different parts of the 
banks, different activities, are ever-present. And in order to 
ensure that the system will live through turbulent times, the 
public has to take a role in establishing some standards and in 
guaranteeing that the bankers have equity at risk.
    I think we all agree it is equity at risk that we want as a 
way to help guarantee that the banks are prudent in their 
borrowing. And the only way to guarantee that that equity is at 
risk is a public authority has to mandate it when you allow the 
bank to have a charter and do its banking rules.
    I think, as I wrote in my testimony, banks are very complex 
institutions; they do a lot of different things. So you 
absolutely have to sometimes be differentiated when you are 
examining them and look for specific risks and look for 
different amounts of risk. There are lots of ways to do that. 
Risk-weighting was one way to do that, but also in the stress 
tests, that is another way to do it.
    So I think you have to have a public authority who gets in 
and pays attention to the risks. If you try to stand back, you 
will be sideswiped sooner or later. How the public authority, 
the supervisors, get engaged on the different kinds of risks 
can be done in many different ways. It is very complicated, and 
I am very open-minded about all of those different ways.
    Mr. Hinojosa. Thank you for your response.
    My next question is for Charles Calomiris. In your 
testimony, you suggest raising the minimum equity asset ratio 
to 10 percent and raising the minimum equity-to-risk weighted 
asset ratio to 15 percent.
    What is your advice to commentators trying to protect the 
``too-big-to-fail'' banks if they were to follow your 
recommendations?
    Mr. Calomiris. My idea in proposing the 10- and 15-percent 
increases--which aren't very big increases, but they are 
increases from where we are now--my idea is those aren't going 
to be very effective if we don't combine them with other things 
that make the measurement of risk realistic.
    And that is why I really emphasize that my point to them 
would be that this isn't going to work either unless you do 
something to credibly measure risk. Right now, we allow banks 
to measure risk for us. That is something anyone who has had 
children knows is not a very good strategy. So CoCos are an 
obvious way to get around this problem.
    I should also point out that there are some other good 
ideas which I didn't have time to get into. We can use markets 
to measure risk, to some extent, too. Senator Barbara Boxer's 
staff and I, when Dodd-Frank was being debated, came up with 
some ideas for that, and I am happy to go into it--
    Chairman Hensarling. Dr. Calomiris, regrettably, the time 
of the gentleman from Texas--
    Mr. Calomiris. And so, there are other ideas I would be 
happy to go into about how to improve it.
    Chairman Hensarling. The time of the gentleman from Texas--
    Mr. Hinojosa. Thank you.
    Chairman Hensarling. --has expired.
    The Chair now recognizes the gentleman from Missouri, Mr. 
Luetkemeyer, chairman of our Housing and Insurance 
Subcommittee.
    Mr. Luetkemeyer. Thank you, Mr. Chairman.
    And welcome to our guests this morning.
    Dr. Chakravorti, last week the European Commission 
published a consultation paper on the potential impacts of 
capital requirements on European financial institutions in the 
EU economy. The paper makes clear the importance of examining 
the impact of higher capital requirements on lending and the 
economy.
    European regulators are going to specifically look at the 
appropriateness of capital requirements, the impact of capital 
requirements on long-term investments and growth, and the 
impact of capital requirements on lending to small and medium-
sized enterprises and consumers. They have also committed to 
hold public hearings on the issue.
    My question to you is, has the Federal Reserve or any U.S. 
financial regulator expressed the need to examine the 
implications of capital requirements? It looks like the 
Europeans are sitting down and studying it. Are we doing that?
    Mr. Chakravorti. Thank you for the question.
    Let me first say that I don't follow the European context, 
but I applaud their decision to study the impacts. I think that 
is a very important factor in deciding regulation, and 
regulation is a continuous process. And it is very important 
that research is done in that direction, so I applaud their 
decision to do that.
    Mr. Luetkemeyer. Don't misunderstand me. I am not 
supporting them and their models and what they do. My concern 
is they are willing to do the studying before they implement 
the rules and regulations. It looks to me like we failed to do 
that in this situation.
    My question is, do you see us, in any respect, studying 
this beforehand, before we make the rules and implement--
    Mr. Chakravorti. I hope in the future that we do study it 
before we go further in the rules, absolutely.
    Mr. Luetkemeyer. Okay.
    Dr. Calomiris, we had a great discussion here with regards 
to capital Tier 1, risk-based assets. Tom Hoenig, who is the 
Vice Chairman of the FDIC--whom I know pretty well and have 
listened to on numerous occasions--has written extensively, and 
spoken extensively on capital and risk-based assets and things 
like that. He believes that we need to have about 10 percent 
Tier 1. And then, after that, he does not take into 
consideration a lot of the other risk-based assets that are 
there, believing that we need to have a Tier 1 solid capital 
structure to be able to be the initial backstop. The rest of it 
is fine, but he believes we need to have at least 10 percent 
Tier 1.
    It appears you are in agreement with that. Would you like 
to elaborate on that a little bit?
    Mr. Calomiris. I agree that there should be a focus that we 
have a 10-percent Tier-1-to-asset ratio, but I don't think that 
is enough. All that does is basically say that all assets have 
a risk weight of 1. But if you do that, there is a danger that 
banks might decide to start making assets have higher risk 
weights than 1 without that simple leverage ratio really 
solving that problem. That is why the CoCos requirement kind of 
fixes that.
    So I think that is a necessary part of the solution, but it 
is not sufficient.
    Mr. Luetkemeyer. One of the things that I heard Dr. Michel 
talk about was the CAMEL ratings. And CAMEL ratings basically 
rate the entire bank. It rates your management; it rates your 
earnings and your capital and also the risk that you take. And, 
to me, it is important that you have a bigger picture.
    We have been focusing just on the risk of the assets, but I 
think if you have somebody who is a CAMEL-1-rated bank, you 
have excellent loans, you have excellent management, they know 
what they are doing. And so I think it is harder to put a 
square peg in a round hole, and I think that is what we are 
trying to do here sometimes. But I think the CAMEL ratings are 
a good indication of the management of the bank and all of 
the--a bigger picture. Let me put it that way.
    What are your thoughts?
    Mr. Calomiris. I have been doing research on exactly this, 
and it makes the same point I was just making.
    The leverage ratio is sort of all about capital, but it is 
not about earnings. And, in fact, it is what I call balance 
sheet fetishism. Banks lose value because their cash flows 
shrink. Banks aren't just assets, they are not just tangible 
assets, and we are acting in our capital regulation as if that 
is true. And banks are in trouble, when they get into trouble, 
because their earnings fall.
    So the point of that camel story that you were you just 
saying is, we need more than just a leverage ratio. And that is 
why I am focusing on those additional items. So the two 
actually fit together well.
    And I know that I am using your time, but I do want to 
point out that I would like to also, if someone is interested, 
talk about the cost of capital requirements on lending. Ms. 
Waters raised that. And I would like to have a chance to talk 
about that. Because I don't agree with some of the panelists--I 
think those costs are there, but I think we should do it 
anyway.
    Mr. Luetkemeyer. Okay. You managed to use up my time. But I 
have one quick question--you made a comment a while ago with 
regards to banks need to get out of real estate lending, and I 
would like to have somebody elaborate on that after a while. 
Because that is kind of a scary thought, to get completely out 
of real estate lending, unless I misunderstood you.
    Chairman Hensarling. A very brief answer.
    Mr. Calomiris. I am not suggesting they get completely out 
of it, although I would point out that 100 years ago national 
banks were prohibited from any real estate lending based on the 
correct perception that real estate lending is very--
    Mr. Luetkemeyer. You realize you are making a really good 
case for GSEs this way.
    Mr. Calomiris. There is more than one way to redirect real 
estate lending.
    Chairman Hensarling. The time of gentleman has expired.
    The Chair now recognizes the gentleman from Massachusetts, 
Mr. Lynch.
    Mr. Lynch. Thank you, Mr. Chairman.
    And, Dr. Calomiris, I might give you a minute or so to 
expand on what you have been talking about at the end of this.
    We are dealing with a situation now where, look, we have 
higher quality, and greater quantity of capital in banks than 
we did before Dodd-Frank, and what we are struggling with is 
how much capital to require banks to hold without leaking out 
into an area of growth where we may inhibit the banks from 
doing some of the other things we want them to do. And we are 
trying to rightsize this in a way that optimizes the use of 
capital in a way that creates that stable environment, yet, 
again, doesn't limit growth and other activities.
    Dr. Parsons, we have a situation now where we have foreign 
affiliates of U.S. banks that are dealing in swaps, and in many 
cases they are not cleared swaps, and they are transferring the 
risk back to their deposit-backed banks here in the United 
States. And the risk that is being created there is not 
something that I think is being addressed in our discussion 
here today.
    If a foreign affiliate implodes because of uncleared and 
risky swaps transactions, that liability, that risk immediately 
comes right back to the FDIC and on that bank that should be 
carrying sufficient capital but it hasn't because it is 
acquired, the risk has been acquired by a foreign affiliate.
    Is there anything that you see in either the risk-weighting 
analysis or the stress testing that could get at that risk that 
is offshore that we don't require--the financial institutions 
are arguing that they shouldn't be required to post collateral 
for their foreign swaps affiliate, yet it does create risk, and 
there seems to be a disconnect here.
    Mr. Parsons. So certainly the supervisors--the Fed 
certainly has authority to examine the company's full trading 
in swaps, including the impact on its foreign affiliates into 
the American bank. It is a problem, as you indicated, that some 
of that trading would somehow be covered by the FDIC. That 
doesn't necessarily make sense. But there are a number of 
actions going on that can address that.
    So capital requirements at the bank holding company level 
can take into account the riskiness of that swap dealer 
activity. The living wills effort is an effort that can help 
shape how that risk can travel across boundaries and units, 
allowing it to be brought back. As well as, in the process of 
trying to set up the orderly liquidation authority in the right 
way, there is this effort to prevent the swaps from being 
settled immediately so that there is time to move things.
    All of these are in process, but none of them have been 
completely implemented, except the authority for capital 
requirements is definitely an authority that the Fed has.
    Mr. Lynch. Okay. Thank you.
    Dr. Calomiris, you wanted to talk earlier about some of the 
costs that you think this activity might require, but you also 
said that it is stuff we should do anyway. Could you go ahead 
and elaborate on that?
    Mr. Calomiris. Thanks very much for giving me the chance.
    Mr. Lynch. No problem.
    Mr. Calomiris. I will just mention this because you may 
want to have a staff person look at this. So if you look at 
page 12, which is a reference list for my testimony, you will 
see there are 4 articles there by Shekhar Aiyar and several 
other people, including myself, all published in refereed 
journals. What these articles do is they look at the U.K.'s 
experience with what effect capital requirement changes have on 
lending supply, because that is the environment where we can 
observe it, because they are varying them a lot on a bank-
specific basis. There is also research in Spain.
    And they all corroborate the same conclusion, and this is a 
scary conclusion: If you increased capital requirements for a 
bank in the U.K. from 11 percent, which was the mean, to 12 
percent of assets, you would cause them to reduce the supply of 
lending to nonfinancial firms by about 7 percent. It is a huge 
effect. It is about 10 times what the Basel Committee thought 
the effects were when they were contemplating capital 
requirement increases.
    So I want to emphasize, it is not correct to say that this 
doesn't have a social cost. It does. But it is worth it. It is 
worth it because, if the banking system implodes, that is going 
to be an even worse contraction of credit. So you have to run a 
safe banking system even if it means in the short run you are 
having some negative effects on loan growth.
    That is my answer to your question and also Ms. Waters' 
question. It is not a free lunch. It is not even close to a 
free lunch.
    Mr. Lynch. I yield back.
    Chairman Hensarling. The time of the gentleman has expired.
    The Chair now recognizes the gentleman from Michigan, Mr. 
Huizenga, chairman of our Monetary Policy and Trade 
Subcommittee.
    Mr. Huizenga. Thank you, Mr. Chairman.
    Over here, gentleman. This new configuration makes it feel 
like you are in the park across the street from Rayburn.
    Dr. Calomiris, I would like to bite on your debate that you 
threw out there a question or so ago. I am a former licensed 
REALTOR. I would love for you to hit on the cost of capital on 
lending ability, which you said you wanted to address, and then 
as you started to address, real estate lending and how that may 
be affected.
    And then I would like to move on, Dr. Michel, to Basel and 
transparency there.
    Mr. Calomiris. So let's think about where we are. Let's 
just take January 2008 for the banking system. Seventy-five 
percent of loans are in real estate, which means either real 
estate development loans or mortgages.
    Real estate is highly correlated and in tune with the 
business cycle, and it is very hard to shed, as a bank, those 
real estate risks during a downturn, which is why, 
historically, banks have not been real estate lenders.
    If you go back to the 1920s, real estate lending was done 
in the United States by insurance companies and building and 
loans, neither of which financed real estate lending with 
short-term debt because it is crazy to finance real estate 
lending with short-term debt.
    We do it because we decided politically to do it. We 
decided with deposit insurance to make that happen. It wasn't a 
good idea. And as banks have lost market share, deposit 
insurance has kept them from shrinking, which they should have 
done, and instead they have pushed them into doing more real 
estate lending.
    Real estate lending should be done by maturity-matched 
intermediaries, real estate investment trusts, insurance 
companies, capital markets of various kinds. It should not be 
done by short-term debt. That is a mistake that we did in the 
1930s and since and it has cost us. It is politically almost 
impossible for people sitting in this room on both sides of the 
aisle.
    I am not talking about eliminating it. I am talking about 
reducing it. Seventy-five percent is a ridiculous number. We 
should be phasing it down.
    Mr. Huizenga. Thank you for getting both the REALTORS and 
the bankers to call my office here very shortly. Very few 
people can unite them that way.
    So I do want to then, really quickly, if you could touch on 
the liquidity standards, capital and liquidity standards. You 
seemed to be indicating that there is a cost of that on lending 
ability for banks. If you could really quickly hit that, and 
then I want to hear from Dr. Michel.
    Mr. Calomiris. There is no avoiding the fact that if you 
tell bankers they have to keep some of their portfolio in cash, 
that tells them that they can't keep all of it in loans.
    My point is, if you look prior to the runups in the late 
1990s and 2000s, banks in the United States always had riskless 
securities, that is Treasuries plus cash, in excess of 25 
percent. In fact, it was more like 40 percent during most of 
the post-World War II era.
    What we have done is, look at where we got by January 2008 
where it was 13.5 percent for the largest banks. They were 
doing that because they could, because they had the safety net.
    The point is, sure, of course, if you require banks to hold 
more cash, it means they will do less lending, but that is not 
bad. You should require them to operate safely. They shouldn't 
be able to have 100 percent of their assets in loans.
    Mr. Huizenga. Okay.
    Dr. Michel, Basel, is there enough transparency there on 
the banking supervision, and your thoughts on that?
    Mr. Michel. Okay. And I know I am screwing things up, but I 
would love to add something to what Charlie just said.
    Mr. Huizenga. Yes, but you have a minute and 15 seconds. 
Go.
    Mr. Michel. All right. On the transparency stuff, I don't 
know how we are--I hate to say this--but it depends on exactly 
what we are talking about. Again, if you go back and look at a 
1993 Boston Fed paper, a 1996 OCC press release, a 2006 OCC 
press release, they basically all say the same thing, that 
roughly 80 percent of the swaps market is in the large banks, 
we know it is in the banks, and don't worry about anything, the 
right people are taking care of this. We are looking at it. We 
are dealing with it.
    So that is transparent. The whole thing was transparent. 
Everybody knew what they were doing. So I don't know what we 
added. It was already transparent, as far as I am concerned.
    And then I still have 30 seconds. So I agree with Charlie 
that it is a stupid idea to do short-term lending to fund long-
term projects like real estate. We had a crazy system before 
the 1930s, it got crazier after the 1930s, and we haven't 
stopped doing that.
    But we have based all of this on the wrong premise. If we 
were talking about a company like Walmart, Walmart has hundreds 
of millions of customers, and millions of suppliers. Many of 
those businesses depend on Walmart for their living. You can 
make exactly the same arguments about Walmart that you can 
about banks. And if we were talking about putting a Federal 
regulator in charge of saying who Walmart can sell to, and who 
they can buy from, we would all say that is insane, but that is 
exactly what we are doing now with the banks.
    Chairman Hensarling. The time of the gentleman has expired.
    The Chair now recognizes the gentleman from California, Mr. 
Sherman.
    Mr. Sherman. Dr. Michel, the one difference with Walmart is 
they don't have hundreds of billions of dollars of liabilities. 
And I--
    Mr. Michel. Technically, they do.
    Mr. Sherman. And reclaiming my time. I certainly don't see 
hundreds of billions of liabilities on their balance sheet. Of 
course, there are contingent liabilities.
    I want to shift over to credit rating agencies. We have to 
have risk-based capital, so bank examiners have to determine 
risk. Banks all too often just decide to put all their money in 
marketable securities. So you might have a portfolio of 1,000 
marketable securities.
    Now, the credit rating agencies say: Don't regulate us. 
Don't sue us. Let us do what we do. And if we ever screw up, it 
is your fault for relying on us.
    Now, let's say you are a bank examiner. You go in to 
examine a bank and they have 1,000 different portfolio 
securities, every one of which has a rating. The easiest thing 
to do is to just say, ``Okay, well, here is your risk base. You 
have some B-plus, you have some A-minus. Those are your 
risks.'' What the credit rating agencies say is, ``Ignore our 
ratings.''
    How could a bank regulator independently evaluate the 
creditworthiness of every marketable bond and CBO in that 
portfolio given the fact that the bond rating agencies charge 
about a million dollars per issue, so in theory, at their 
rates, that is a billion dollars' worth of work?
    Dr. Calomiris, can you tell me, could a bank regulator do 
anything other than rely upon the ratings if they are examining 
a bank with 1,000 different marketable bonds?
    Mr. Calomiris. I came to the conclusion that they can't. 
And that was the basis for the work that Senator Boxer's staff 
and I did during the Dodd-Frank discussion, and we drafted an 
amendment that would require the reform of the ratings so that 
they would be useful credibly. I won't go into that--
    Mr. Sherman. I will also point out that we had the Frank 
and Sherman amendment which ends the idea that the issuer 
selects the underwriter, just as--selects the evaluator. I 
assure you that if I could have picked the person to grade my 
tests in law school, I would have done better, especially if I 
also paid them, and especially if they made a million dollars 
per test. So the idea that we can just let the credit rating 
agencies sell their ratings to be selected and then say the 
solution is that nobody should rely upon them is manifestly 
false.
    In evaluating risk, you have not only the default risk, but 
the interest rate risk. In the materials that were prepared for 
us for this hearing, they describe risk-based capital and said, 
in effect, sovereign debt of the United States would be given a 
zero risk because there is no default risk.
    There is a huge interest rate risk. If you take in a bunch 
of 30A deposits to buy a bunch of 30-year Treasuries, is it 
true that under Basel III you assign a zero risk to a bank that 
borrows for 30 days and lends to the U.S. Government for 30 
years, Doctor?
    Mr. Calomiris. Yes.
    Mr. Sherman. Is there anybody in the business world who 
thinks it is risk-free to lend for 30 years and borrow for 30 
days?
    Mr. Calomiris. No.
    Mr. Sherman. I would also point out the effect this has on 
our districts and the small businesses. A few people have been 
bored in this room listening to me.
    So if you take a huge risk by buying a 30-year bond when 
you are borrowing your money for 30 days, the regulators come 
in and kiss you on both cheeks. If instead you make a 1-year 
loan to Jack's Pizzeria in my district, they come in, and what 
kind of reserve do they require?
    Mr. Calomiris. The capital weight would be 100 percent, 
probably, for that loan, risk-weighted assests.
    Mr. Sherman. A hundred.
    Mr. Calomiris. Yes, instead of zero.
    Mr. Sherman. So if you play on Wall Street and you invest 
your money on Wall Street, you can have enormous upside and 
downside risk, and if the upside comes through, you can get a 
big bonus, and the regulators come in and say, ``You are not 
risky.'' Even though the riskiest thing you could do, that I 
can think of, is to borrow money short, and lend it long, but 
if you lend to small businesses in our district, pow.
    I yield back.
    Chairman Hensarling. The time of the gentleman has expired.
    The Chair now recognizes the gentleman from Wisconsin, Mr. 
Duffy, chairman of our Oversight and Investigations 
Subcommittee.
    Mr. Duffy. Thank you, Mr. Chairman.
    It is fascinating listening to my friends across the aisle 
as they have grown over the last 4\1/2\ years. They started off 
telling us how Dodd-Frank was going to end ``too-big-to-fail.'' 
It was a sure fix to end ``too-big-to-fail,'' if you listened 
to the debates with former Chairman Frank. That is the reason 
why we have a 2,000-plus-page bill while we have 400 new rules.
    But the tone has changed. They are now admitting that Dodd-
Frank, in all of its sweeping reform, does not end ``too-big-
to-fail.'' Does the panel agree with my Democrat friends that 
Dodd-Frank doesn't end ``too-big-to-fail?'' There is no 
disagreement on that? Okay. I didn't think so.
    Mr. Parsons. I disagree.
    Mr. Duffy. You disagree with Republicans and Democrats that 
it ends ``too-big-to-fail?''
    Mr. Parsons. I think it makes very important efforts that 
are having an impact on preventing that from happening.
    Mr. Duffy. But it doesn't end it. And I think maybe we 
could start, instead of having a movement and a push now to say 
2,000-plus pages, 400 new rules, we didn't get it right, so 
let's add more legislation, more rules, and more regulations 
onto the ones that already exist, I would actually buy into, 
let's repeal Dodd-Frank because it doesn't work, and it was a 
failure, and let's work together with a blank sheet and see how 
we can learn from the lessons of 2008 and work together to get 
reform that is actually effective.
    But I want to move on to risk-weighted assets. Risk-
weighted assets, does that concentrate risk?
    Mr. Michel. Do the risk-weighted assets themselves 
concentrate risk? Because they don't necessary address risk 
concentration, if I am correct there. I believe they left that 
out. I don't believe they have addressed that. So--
    Mr. Duffy. But would it encourage banks to uniformly buy 
similar assets?
    Mr. Michel. Oh, I see. Well, yes, in that sense, yes. You 
have particular assets that have lower weights, so those are 
going to tend to be favored. So in that sense, yes.
    Mr. Duffy. And if we have more banks holding similar 
assets, does that create more systemic risk?
    Mr. Michel. I would argue yes.
    Mr. Duffy. Yes. So risk-weighted assets actually can create 
more risk, more systemic risk, than actually alleviating that 
risk in the marketplace. Am I wrong on that?
    Mr. Michel. No, I think you are correct on that.
    Mr. Duffy. And how well have our--
    Mr. Michel. And the weights have to be right, and we have 
already messed that up. So--
    Mr. Duffy. I want to ask you about that. How well have the 
regulators actually done in getting this right?
    Mr. Michel. Personally, I don't want to--I would say the 
regulators are not clairvoyant, just like anybody else. So I 
don't mean this in a bad way necessarily; I just don't think 
that you could expect anybody to get it right.
    Mr. Duffy. Say that again.
    Mr. Michel. I just don't think that we could expect anybody 
to get that right. The stress tests are a great example. I have 
a lot of experience with economic projections, and I think if 
you gave me 10 minutes, I could teach pretty much anybody with 
an Excel spreadsheet to do what I can do. It is really not as 
sophisticated as we pretend in economics. If we look at 
inflation, something like inflation, over the last 10 or 15 
years you can't beat a one-period forecast of using last 
period's inflation.
    Mr. Duffy. And so, we are trying to find this right 
balance. We all agree that we need sound, smart regulation in 
our financial sector. No one disputes that. But we need to have 
some balance between regulation and market discipline. Is that 
a fair statement?
    Do you think we now have, to the panel, the right balance 
with sound regulation and market discipline?
    Mr. Michel. No.
    Mr. Duffy. Yes?
    Mr. Parsons. I think we shouldn't think necessarily of 
market discipline and regulation as if they are opposed to one 
another. You have heard from the panel ideas for ways to 
structure incentives by regulation, the CoCos that are being 
proposed, that is regulation to create market incentives. When 
we talk about capital standards, we are talking about demanding 
that the equity owners have skin in the game to create market 
incentives to manage the bank right.
    So what we are trying to do in crafting good regulation is 
to create a healthy market. That is that we are trying to do.
    Mr. Duffy. Right. And do you think we have been successful 
in the United States in doing that?
    Mr. Parsons. I think you heard from lots of people that we 
have made great strides since the crisis to right the ship. 
There are still problems, obviously, and there are going to be 
debates going on for a long time. But I think it is important 
to say we have made some really great strides.
    Mr. Duffy. It seems like my friends across the aisle will 
oftentimes blame markets for the crisis, and because, they will 
allege, markets fail, we need to look to regulators and give 
them more power and authority. But isn't it fair to say that 
the regulators failed in the lead-up to the 2008 crisis?
    Dr. Calomiris?
    Mr. Calomiris. Absolutely. And I don't know if we have time 
for me to answer your first question, we probably don't, but 
yes.
    Mr. Duffy. I haven't heard the gavel yet. So maybe you can 
start.
    Okay.
    Chairman Hensarling. Now, the gentleman has heard the 
gavel. The time of the gentleman has expired.
    The Chair now recognizes the gentleman from Georgia, Mr. 
Scott.
    Mr. Scott. Thank you, Mr. Chairman.
    I would like to talk about, get the panel's thoughts on 
Basel III's leverage ratio and its impact on banks. The crux of 
the matter is this: These new capital requirements for our 
prudentially regulated financial institutions are indeed vast 
in scope, and indeed, they are a necessary means to ensuring 
that banks are properly capitalized, as warranted under Dodd-
Frank.
    But there is one narrow aspect that seems to be working at 
odds with the principles of the Dodd-Frank Act, as well as 
long-established market regulations, and that fact is this: 
End-user customer margins, which have long been posted to bank-
affiliated clearing members for the clearing of derivatives, 
are treated punitively.
    Recently finalized capital rules consider client margins 
something the bank can leverage, even though Congress has for 
decades required that customer margins posted by clients for 
cleared derivatives must remain segregated from the bank-
affiliated clearing members' own accounts and that it should be 
treated as belonging to the customer.
    Now, here is the first question. How is it now assumed that 
the margin can be used by the bank as leverage? More 
specifically, the Basel III leverage ratio now extends to off-
balance-sheet exposures that are not driven by accounting 
rules.
    And in this off-balance-sheet context, my second question 
is, why is customer margin collected by a bank-affiliated 
member of a clearinghouse being treated as something the bank 
can leverage when Congress has long required such margin to be 
segregated away from the bank's own resources?
    Could I get a comment on that from Dr. Parsons or Dr. 
Michel, and--I don't want to murder those last two names there, 
so I will say the two gentlemen on the end whose names begin 
with the letter ``C.''
    Mr. Parsons. I think the basic issue you are bringing up 
about customer margin, the reason why it has become an issue as 
you highlighted, the problem is you are dealing with a business 
to be a futures commission merchant or a swap dealer collecting 
margin, that is a business, and that business has some risks. 
They are trying to measure the size of that business as a proxy 
for measuring the risk of that business.
    And the customer margin is part of what defines the size of 
the business. If you have one company offering more swaps to 
its customers and having larger margin, you have a larger 
business. And so you need to think about the riskiness of that 
business and charge capital for it.
    Now, if it is true that you can successfully segregate it 
and guarantee that there is never any real risk of those funds 
getting back to the customers, there might be some way around 
that. And it is also true that there should be a way of 
improving the measurement of risk. So with derivatives 
themselves, with the market value of the derivatives 
themselves, they calculate these potential exposures instead of 
using book value of the assets. And that is one, I think it is 
clunky, but it is an effort to do what you want done.
    Mr. Scott. But don't you feel, though, that the Basel III 
leverage ratio misinterprets the exposure-reducing effect of 
segregated margin?
    Mr. Parsons. I think the problem is people want to either 
treat things one way or another, and we need to arrive somehow 
at a better destination. Treating it, that dollar, as being 100 
percent exposed maybe is the wrong thing, but saying because it 
is segregated, legally there is no risk in that business, that 
is clearly also wrong. So we are sort of--we are finding that 
we need to get a more sophisticated appreciation of the 
problem. So something needs to get done to improve it.
    Mr. Scott. Okay. My time is up. I'm sorry.
    Chairman Hensarling. The time of the gentleman has expired.
    The Chair now recognizes the gentleman from South Carolina, 
Mr. Mulvaney.
    Mr. Mulvaney. I thank the chairman.
    Gentlemen, I want to talk about something a little bit 
different here today. We had the opportunity to talk to Mr. 
Hoenig about ways to relieve regulatory burdens on various 
entities.
    Some interesting work, by the way, that other members of 
the committee and I have been discussing--myself, Mr. 
Schweikert, and Mr. Hill have tried to figure out a way to 
carve out certain banks from the larger regulatory scheme, to 
say, look, there are some banks that don't need the extra level 
of oversight that we get with Dodd-Frank. They aren't 
sophisticated. They aren't interconnected. They don't present a 
systematic risk. And many times that is not based on their 
size, but by their business models.
    I am just curious if anybody has given any thought to that, 
if they are familiar with what Mr. Hoenig had talked about, and 
if they had any thoughts on this concept of creating, not a 
second banking system, but a different type of system where you 
could opt out of certain regulatory requirements if you were a 
very simple, well-capitalized, well-run bank. And I would be 
curious to know opinions in favor of that and opinions against 
that as we simply try and gather information and do our 
research.
    Dr. Parsons, do you want to start?
    Mr. Parsons. As I indicated in my testimony, it is true 
that there are lots of different types of banking activities, 
and this effort to have many, many different ratios is an 
effort to cope with the many different activities sometimes 
bundled into one bank. If you can find a way to carve some out 
and define them and say, ``I am only doing this, and therefore 
I only have certain risks,'' and if that is real, then that 
should be a sensible way to adjust the capital ratio.
    Mr. Mulvaney. Yes, sir.
    Mr. Michel. I would be in favor of it as well. In a more 
expansive way, I would be in favor of it for everybody. Instead 
of letting the regulators decide what is really risky and what 
is really complicated and what is really simple, let the 
markets decide. Have the carve-out. Let them do that. Let the 
investors decide on their own and let them take the loss.
    Mr. Mulvaney. Yes, sir.
    Mr. Chakravorti. I think if you tailor according to the 
underlying risks and what you outline, that is definitely an 
advantage for the system as a whole.
    Mr. Mulvaney. Dr. Calomiris?
    Mr. Calomiris. I agree. I think if we can get to the point 
where we know bankers are playing with their own money and not 
ours, and we also know that they are not doing things that are 
very hazardous in terms of highly correlated risks, so that 
they are not creating credit crunch risk for the whole economy 
when we have a downturn, then we don't have to micromanage with 
this excessive interference in how they run their business. And 
I think, again as Dr. Michel said, this applies to all banks.
    I would point out that the regulatory costs are very 
different from different regulations for different kinds of 
banks. If you ask small banks, they will tell you QM 
compliance, qualified mortgage compliance is very costly for 
them. If you ask large banks, they might come up with a 
different answer.
    So I think the point is, this micromanagement is a lose-
lose. It makes our banks not perform well, and it makes them 
not perform well for us, not just for their stockholders. So, 
yes, that is why we want to have good capital rules, and I 
think the CoCos for the large banks would get us there.
    Mr. Mulvaney. The one criticism I have of what Mr. Hoenig 
has suggested is that he seems to want to limit it to 
community-based financial institutions and he doesn't want to 
take it to the larger scale.
    By the way, for purposes of the discussion, his brief 
summary is that banks that hold effectively zero trading assets 
or liabilities, banks that hold no derivative positions other 
than interest rate swaps and foreign exchange derivatives, and 
banks whose total notional value of all the derivatives' 
exposures would be less than $3 billion, that is the basic 
concept that he is trying to lay out there. But he limits it to 
community banks, to smaller banks.
    Is there any reason to do that, in your mind, Dr. 
Calomiris?
    Mr. Calomiris. I would say no. I know Tom pretty well. He 
comes from Kansas. And the banks that are sort of in his 
experience, in his frame of reference, are pretty small banks, 
and I think he has a lot of sympathy for them, especially since 
a lot of them have to also compete with the subsidized farm 
credit system, which doesn't have to retain branches but gets 
to raise its money through a GSE.
    So small banks in places like Kansas are really taking it 
on the chin. But that doesn't mean we should only focus on 
them. I think it needs to be a broader focus.
    Mr. Mulvaney. I thank the gentleman.
    I yield back the balance of my time.
    Chairman Hensarling. The gentleman yields back.
    The Chair now recognizes the gentleman from Illinois, Mr. 
Foster.
    Mr. Foster. Thank you, Mr. Chairman.
    And I would like to say that as the author of the Dodd-
Frank amendment that authorized contingent capital but did not 
mandate contingent capital, I am thrilled with the fact that 
there appears to be the possibility of some bipartisan, maybe 
even consensus, that this could be part of the solution to 
strengthening capital requirements beyond what is already in 
Dodd-Frank.
    It is interesting to go through the history of this. To my 
knowledge, it is Mark Flannery of the University of Florida who 
first significantly--for the record, Dr. Calomiris gave me a 
strong nod on that--whom I think deserves credit for raising 
this in a significant way. Then the Squam Lake Working Group 
later picked it up and identified it as one of the major 
elements of strengthening bank capital requirements.
    I was particularly influenced by an analysis by Steve 
Strongin's group at Goldman Sachs where they did a 
retrospective analysis of the failure and concluded that had 
banks been required to hold contingent capital, they would have 
raised capital early in the crisis when they still could have, 
and that at least the banking part of the crisis would have 
largely been avoided.
    And this has to do with a point that Dr. Calomiris has 
made, which is that they would be worrying not about being 
insolvent, but being in violation of capital requirements or 
the trigger mechanism.
    The Squam Lake Group worked through a variety of trigger 
mechanisms. You appear to be an advocate of a market-based one. 
There are regulatory. There are a variety of these.
    At the time of the Dodd-Frank hearings and the amendment 
that I got adopted into both the House-passed and eventually 
the final bill, it was difficult to mandate, to adopt a 
mandate, because there was no experience with these. Since that 
time, the Europeans have a lot of experience, successful 
experience, I believe, with CoCo bonds with a variety of 
trigger mechanisms. So I think there is a lot to be learned, 
but I think they are generally viewed as a successful 
experiment.
    Now, that is particularly the case with the Swiss banking 
system. Switzerland is in a tough place because they have giant 
banks, which they want to have, but their economy isn't big 
enough to realistically backstop. So they have had to have a 
very deep capital stack to handle their ``too-big-to-fail'' 
problem, which is handled significantly with CoCo bonds.
    And so I think that there is a lot more experience today 
than there was at the time we passed Dodd-Frank, and I think 
that proceeding in this direction is something that, on a 
bipartisan basis, we really should proceed on.
    Okay. So the first question I have here is, what has been 
learned by the European experience in this, particularly in 
terms of the pricing of these instruments?
    Dr. Calomiris?
    Mr. Calomiris. We have learned a few things. One is that 
these issues were oversubscribed by the market. A lot of people 
said the market wouldn't want to buy them. They were 
oversubscribed. So obviously the market does want to buy CoCos. 
Institutional investors were very attracted to them.
    But we haven't really tested them because the test of them 
comes on the downside. And my own view is that the market 
trigger is a much better idea than what the Swiss have used, 
which is a regulatory trigger, precisely because regulators and 
supervisors are not dependable during downturns to really 
identify the losses and to trigger the mechanism, because it is 
going to be very politically difficult to do it.
    And, by the way, all the things you cited, from Flannery 
through Goldman Sachs, are cited in my study, which is a review 
of that whole literature. And I would associate myself strongly 
with everything you said.
    Mr. Foster. Let's see. So I will give you also the pricing. 
There is the question of whether they oversubscribed. The thing 
that I found particularly encouraging about it, if you looked 
at the presentations to potential debt investors by 
organizations like Credit Suisse, is they have exactly the kind 
of transparency that you would love to see. In order to get a 
good price, they have to reveal their books to the market. And 
so you really get this market-based feedback that I think is a 
fundamentally good addition to regulatory oversight.
    My next question is, what areas of U.S. law would need to 
be changed in order to actually implement contingent capital? 
These are changes in tax law, for example. You mentioned that 
there would be requirements or prohibitions from different 
groups on investing in these, because obviously you don't want 
the ``too-big-to-fail'' firms investing in each other's 
contingent capital.
    So what are the specific other legal changes that would be 
necessary to actually get this implemented in the United 
States?
    Mr. Calomiris. I think the most desirable obvious one is to 
make it clear that, at least for my version of CoCos, they 
should be treated as deductible debt.
    Now, the key issue here, and it also affects pricing, is 
are we talking about bail-in CoCos, which I am not talking 
about, or are we talking about these sort of preventative CoCos 
that make banks raise capital? In my version, I would say that 
these CoCos are almost never going to convert because the whole 
point is to make banks avoid conversion. Whereas the bail-in 
CoCos that some people have devised, including, unfortunately, 
I think the Swiss model, they convert at very low regulatory 
trigger ratios. And so those are going to have to be priced 
with higher yields because there is more risk associated with 
those.
    So my answer is, I think the tax law has to recognize that 
if the CoCos is as CoCos does, if they are my kinds of CoCos, 
they should be treated as debt. If they are bail-in CoCos, 
maybe they should be treated as a mix of debt and equity for 
tax purposes. So there is a little bit in the weeds here. I am 
sorry to give such a technical answer.
    Chairman Hensarling. The time of the gentleman has expired.
    The Chair now recognizes the gentleman from North Carolina, 
Mr. Pittenger.
    Mr. Pittenger. Thank you, Mr. Chairman.
    And I thank each of you for being with us today.
    Senators Vitter and Brown have recommended that the banks 
maintain a leverage ratio of 15 percent. Do you believe that 
this is an appropriate means by which we should address this, 
and would you be supportive of it?
    Dr. Michel?
    Mr. Michel. It gets to one of the problems, which is that 
this is an arbitrary--these are all arbitrary numbers. So, that 
is one issue. But if we are talking about simply raising the 
number and leaving all the other regulations and requirements 
in place, then, no, I am not.
    Mr. Pittenger. No, I am not saying they need to be. It was 
an offset to that. It would require a less intrusive regulatory 
environment to do that.
    Mr. Michel. I am sympathetic to the idea that you want them 
to hold more capital, but I would still think that the 
contingent convertible debt is a much better way to go than 
something like that. And it has to have the offset.
    Mr. Pittenger. Sure.
    And, Dr. Calomaris, you have already spoken to that, but I 
would be glad to have you--
    Mr. Calomiris. Just to say briefly, my version has 20 
percent absorption capacity, but it mixes it in equity and 
CoCos 10 and 10, rather than just 15 in equity. And the point 
is that during a downturn, this is more robust, and it relies 
on the incentives of banks to make sure that we are measuring 
real capital. That is, I think, what is missing in the Brown-
Vitter proposal.
    But I have supported the idea of the Brown-Vitter proposal, 
which is we need to increase the absorptive capacity. I want to 
make it 20 percent, but make it 10 and 10 rather than 15 all 
equity.
    Mr. Pittenger. Dr. Chakravorti, do you have a perspective 
on this? Is there a sweet spot as it relates to capitalization 
and credit access?
    Mr. Chakravorti. What I think needs to be done in the 
capital space is you need to have a belts-and-suspenders 
approach. So we have multiple ways to regulate capital. One is 
risk-based, one is leverage, one is stress testing, and the 
other that hasn't been talked about right now is something 
called the TLAC requirement, that you have to hold debt that 
would convert once you are a going certain.
    So I think once you combine all of these different 
regulations, and you need them because they do different 
things, as we have discussed, just a straight-out leverage 
ratio doesn't weight risk appropriately, but at the same time, 
risk-based regulation may not get it right. We discussed that 
stress testing actually has the benefit of having scenarios to 
look at it. So to try to calibrate that number, one has to look 
at the totality of those regulations.
    Mr. Pittenger. Thank you.
    Dr. Michel, please just expand on your perspective of how 
Dodd-Frank has exacerbated ``too-big-to-fail.''
    Mr. Michel. How has it exacerbated ``too-big-to-fail?''
    Mr. Pittenger. Yes.
    Mr. Michel. In the first place, if you want to end ``too-
big-to-fail,'' you don't have regulators identify the banks 
that we say we can't live without. So if you are identifying 
systemically important financial institutions, systemically 
important financial market utilities, and saying that, look, 
the regulators believe these guys go down and they kill the 
economy, you have a really tough case to make for having ended 
``too-big-to-fail.''
    If you go beyond that and you look at Title II, Title II 
takes the parent holding company and basically wipes it out in 
order to keep the subsidiaries going. So everybody knows that 
going in.
    And the bridge company is exempt from taxes, and the bridge 
company can only get funding really and truly from the Federal 
Reserve or the FDIC. If you look at it and say, well, they are 
prohibited from getting these funds, that is not quite right, I 
don't believe. The fact is that they can only go into the Title 
II proceeding after the Fed and the FDIC certify that there is 
no private funding available for the bridge company.
    So I think Title I and Title II, easy. Title VIII is a sort 
of newfangled entity, the financial market utility, that comes 
under this umbrella as well. So those three titles alone pretty 
much seal the deal in terms of perpetuating ``too-big-to-
fail.''
    Mr. Pittenger. Yes, sir. Thank you.
    I yield back.
    Mr. Neugebauer [presiding]. I thank the gentleman.
    And now. the Chair recognizes himself for 5 minutes.
    On Monday, as many of you know, the Federal Reserve 
finalized its G-SIB capital surcharge rule, which would be 
applied to eight of the United States G-SIB bank holding 
companies. And the final rule imposed a surcharge that almost 
doubled the surcharge proposed by the Basel Committee in some 
cases. Thus, U.S. financial institutions will be required to 
hold significantly more capital than their foreign competitors.
    Vice Chairman Stanley Fischer raised that question, the 
global financial competitiveness, at the Board's opening 
meeting. His concerns were kind of summarily dismissed by the 
Federal Reserve staff.
    This is not the first time, and likely not the last time, 
that we are seeing the United States go beyond the Basel 
standards. We have seen the Federal Reserve do this with the 
supplementary leverage ratio. We are likely to see it do the 
same with the net stable funding ratio and TLAC proposal.
    Dr. Chakravorti, do you worry about the U.S. 
competitiveness if we keep making the U.S. banks play by a 
different set of rules than the international banking 
community?
    Mr. Chakravorti. Thank you for the question, Mr. Chairman.
    The way I view it is we have done a lot of work on the G-
SIB when the G-SIB proposal was announced, and what we found is 
that there have been various improvements in the systemic risk 
of these banks because of various regulations, and that really 
wasn't incorporated.
    So the idea that the Federal Reserve would increase over 
and above the Basel requirement and come up with its own 
metric, which is called Method 2, certainly leaves the banks at 
a disadvantage to foreign competition. And it is something that 
it wasn't really well justified in doing so, especially when 
they agreed upon the standard coming out of Basel.
    Mr. Neugebauer. Dr. Michel, do you have anything to add to 
that?
    Mr. Michel. No. I don't have anything to add to that. I 
think that is accurate. I don't have anything additional to say 
there.
    Mr. Neugebauer. One of the issues that I have heard this 
week from one of the larger financial institutions is that 
there is a disincentive now for them to hold certain kinds of 
assets because the more assets that they hold, the more capital 
they have, maybe the more liquidity, and that certain kinds of 
assets just don't generate that same kind of return to justify 
having to go out and bring in additional capital or to bring in 
additional liquidity, which in many cases may not earn a return 
to justify holding those kind of assets.
    How do we address this displacement and this understanding 
that some of these assets are actually going to global banks 
outside the United States because they are able to deal with 
those assets in a different way regulatorily than these 
domestic banks?
    Mr. Chakravorti. Sir, you are absolutely correct in saying 
that when you regulate you are going to have some market 
impacts on certain products. And those products, sometimes they 
are an intended effect, and sometimes they are an unintended 
effect. But what is clear is that if the regulated banking 
sector does not provide it, there is a risk that that product 
will be provided outside the banking system, whether it be in 
the United States or outside the United States.
    When that occurs, it is not clear that where it is going to 
is as strongly regulated as the banking sector. So in fact you 
might actually increase systemic risk, something that you don't 
really want to do, by proposing the regulation if your intent 
is to reduce it overall in the financial system.
    Mr. Neugebauer. Dr. Parsons, I wasn't here, but I think Mr. 
Duffy asked all of the panel if they thought that Dodd-Frank 
had ended ``too-big-to-fail.'' And I believe you said that you 
thought it had ended ``too-big-to-fail.'' Is that correct?
    Mr. Parsons. I think it has reduced ``too-big-to-fail'' 
significantly. I think having a healthier financial market with 
better capital requirements that reduce the taxpayer backstop 
is a good thing. And if another society wants to lower their 
capital requirements and have their taxpayers subsidize their 
banking business, I don't think it is good for the United 
States to get into competition in putting the taxpayers' money 
behind the banks.
    I also think having a healthy financial system here is 
competitively good for the United States. And so I don't think 
getting into a competition to keep our capital requirements low 
is going to help business here. We have always had extremely 
good financial markets that have been attracted capital to the 
United States.
    Mr. Neugebauer. The reason I ask that question is because I 
believe in April of 2013 you wrote an article with your 
colleague Simon Johnson in which you basically dismissed the 
arguments that Dodd-Frank had ended ``too-big-to-fail.'' So 
have you changed your position now? I am a little confused by 
that.
    Mr. Parsons. No. First of all, I was very careful to say we 
have reduced it because there are a lot of problems that 
remain. The fact that we haven't taken care of the living 
wills, the fact that we still don't understand the orderly 
liquidation authority, we haven't fully implemented it, those 
are very critical problems that we need to resolve.
    Also, we just on Monday had these surcharges placed on the 
G-SIBs. So those surcharges will make those banks reevaluate 
activities which are activities potentially that the taxpayer 
has to backstop.
    And so we are watching a process, and that process is still 
not complete. But we have made great progress.
    Mr. Neugebauer. Okay. My time has expired.
    I now recognize the gentleman from Kentucky, Mr. Barr, for 
5 minutes.
    Mr. Barr. Thank you, Mr. Chairman.
    And thanks to our witnesses here today.
    Dr. Michel, a quick question for you. We have heard a lot 
about the causes of the financial crisis. And one of those 
narratives is that deregulation and unrestrained free markets 
were the cause of the financial crisis.
    Can you elaborate a little bit more on your testimony about 
the fact that there was plenty of regulation, in fact quite a 
bit more regulation was added to the Federal Register in the 
run-up to the financial crisis, but that it was dumb 
regulation? And in particular, can you amplify your testimony 
about the risk-weighting approach of the Basel capital 
standards and how that may have contributed to the financial 
crisis?
    Mr. Michel. The Basel portion--and so, yes, I agree. And I 
have written quite a bit about this and listed a lot of other 
regulations that were supposedly deregulations that were just 
different kinds of regulations.
    The Basel portion, though, we have developed a system that 
literally weights certain things heavier than others. So there 
is a built-in incentive in that system to buy more assets that 
have lower risk weights--or, I'm sorry, to hold more assets 
that have lower risk weights.
    And if you go back to the history of that, in the 1950s the 
Federal Reserve started the risk-bucket approach. It was picked 
up and used in the 1970s by the Basel Committee. The whole idea 
was to better match risk and capital to lower capital. That is 
the whole idea.
    Mr. Barr. Specifically, can you speak to the risk weighting 
of GSE mortgage-backed securities?
    Mr. Michel. Sure. My numbers might be off. I know they are 
in my written testimony. I think you could lower your capital 
by 60 percent if you held the GSE mortgage-backed security 
instead of the actual mortgage.
    Mr. Barr. So Fannie Mae and Freddie Mac led to the largest 
taxpayer bailout in American history primarily because of bad 
government policies that induced the origination of subprime 
mortgages, and yet the regulators got it wrong in terms of the 
risk weighting of those assets. Is that correct?
    Mr. Michel. Yes, that is correct. They also got the private 
label mortgage security weight wrong.
    Mr. Barr. And Dodd-Frank, although it doesn't specifically 
require adoption of Basel III, it does, as you said, in 
Sections 165 and 171 direct Federal banking agencies to 
implement Basel III proposals. Do the Basel III proposals in 
any way make adjustments that signal that they have learned 
from their mistakes in the run-up to the financial crisis?
    Mr. Michel. The GSE mortgage-backed security risk weight is 
the same. The private label has been restructured completely. 
There is not really one number. That is kind of a mess.
    Mr. Barr. Let me just move on really quickly. You have 
talked about how Dodd-Frank, obviously through the designation 
process designating systematically important financial 
institutions, enshrines ``too-big-to-fail,'' but what about 
exacerbating ``too-big-to-fail?'' And what I mean there in 
particular is all of the additional capital requirements, the 
regulatory compliance costs imposed on small community banks--
we know that since 2010, we have lost 1,200 banks. There have 
been only four de novo charters. There has been a dramatic 
consolidation of banking.
    Dr. Parsons thinks that Dodd-Frank has reduced the problem 
of ``too-big-to-fail,'' but how have we done that if we have 
fewer banks and there is concentration of risk in larger, more 
systemic institutions now, much more so than before 2008?
    Mr. Michel. We have a long-term trend that has been 
exacerbated by regulation in general. Dodd-Frank has certainly 
made that worse. And we have literally concentrated the banks 
more. So it is, again, pretty hard to argue that we have 
reduced that problem in that respect. Yes, I would agree there.
    Mr. Barr. Let me just go to any one of you on the opaque 
nature of stress tests, and specifically for regional banks 
over $50 billion. I am thinking of small regional banks whose 
management has expressed to me and others that the CCAR 
requirements are very opaque, that there is not really any 
predictability in terms of knowing whether or not they are 
going to pass or fail these stress tests, and specifically this 
Comprehensive Capital Analysis and Review.
    What they have told me is that it has dramatically 
increased their compliance costs and that the increase in 
compliance cost means less capital deployed in their community.
    Dr. Calomiris, could you speak to that? And, in fact, I 
would want to reference back to your testimony where you 
described the stress testing process as ``Kafkaesque Kabuki'' 
drama. Can you elaborate on that a little bit?
    Mr. Calomiris. Thanks for asking. So Kafkaesque because 
what Kafka, of course, made fun of was governments that would 
sort of make up the rules after they saw what you did. And that 
is exactly what we do with the stress tests. You don't have to 
reveal what the rules are. You are going to be held 
accountable.
    And even if the Fed's own secret quantitative measure of 
your risk shows that you don't have a problem, they still 
reserve the right based on qualitative, whatever that means, 
beliefs to make you fail. That is Kafka incarnate.
    Kabuki, because it is a particular sort of drama that is 
very staged. So it is both a staged drama and a Kafkaesque 
drama, so hence ``Kafkaesque Kabuki.''
    For small banks, of course, they are just not set up. As 
you pointed out, they can't deal with the overhead of actually 
doing this on a credible basis. This is a fairly complicated 
thing to do.
    But my view is that stress tests, if the Fed is held 
accountable for a framework, can be extremely useful for large 
banks. But we have to make it based on real data, not based on 
what the Fed is doing. But looking at cash flows and making 
banks think about themselves, line of business by line of 
business, modeling their cash flows, I can tell you, could be 
done a lot better.
    Mr. Barr. Thank you for your testimony.
    Mr. Neugebauer. The time of the gentleman has expired.
    The gentleman from Pennsylvania, Mr. Rothfus, is recognized 
for 5 minutes.
    Mr. Rothfus. Thank you, Mr. Chairman.
    Dr. Calomiris, I want to follow up on a couple of those 
points. The capital and liquidity standards developed by the 
Basel Committee are intended for large internationally active 
banking organizations. U.S. regulators have defined that 
concept as any banking organization with: (A) $250 billion or 
more in total assets; or (B) more than $10 billion in on-
balance-sheet foreign exposure.
    Do you believe the threshold set by regulators based on 
assets or foreign exposure is appropriate for capturing those 
large and internationally active banking organizations the 
Basel standards were intended and designed for?
    Mr. Calomiris. Quick answer, no. And more generally, I 
don't think there is any intellectual basis, either in logic or 
fact, that stands behind these liquidity standards as they are 
constructed. They were simply arbitrarily constructed. There is 
no theory and there is no fact supporting them, much less the 
cutoff, which I think runs against the whole history of how we 
think about cash regulations.
    Remember back in U.S. history, we required money center 
banks in New York to maintain 25 percent in cash, but then we 
required country banks to not have to maintain quite so much in 
cash because banks that are at the center of the system have a 
more important systemic liquidity risk. So I don't think that 
this--I think it is almost for sure.
    Mr. Rothfus. Well, yes, because there is an issue that 
these regulations bleed over into areas that they maybe weren't 
intended to. For example, how could regulators adapt these 
thresholds to ensure that regional banking organizations 
focused on predominantly domestic banking activities and that 
are not internationally active are not subject to capital 
liquidity requirements designed for more complex global banking 
organizations?
    Mr. Calomiris. Yes, I agree with you that it is a misfit. 
But I do want to caution that small banks also have systemic 
risk. It is called real estate. So it is a different kind of 
systemic risk.
    But remember, we had banking crises in the 1980s. What were 
they? Ag banks, commercial real estate problems, primarily in 
the east, and mortgage crisis, and also oil and gas and also 
some other things.
    But the point is, all of these things were done by small 
banks. Small banks can be a source of systemic risk too. You 
don't have to be big. If you all fail at the same time, that is 
also a risk.
    Mr. Rothfus. Well, if you all fail. But, for example, one 
small bank is not going to bring down the entire U.S. system.
    Mr. Calomiris. But if the small banks as a whole, and this 
isn't--
    Mr. Rothfus. As a whole. But, again, I think we have had a 
conversation with this committee before about whether it is 
going to be one bank or an entire group of them.
    But I want to go to Dr. Michel. In explaining the problems 
with a system in which regulators determine capital adequacy by 
risk weighting the assets in banks' portfolios, noted banking 
analyst Richard Bove wrote this:
    ``Outwardly, risk weighting would appear to make sense. In 
practice, it causes funds to be directed to whatever sectors of 
the economy the government favors and away from sectors that 
the government does not like. It results in differing interest 
rates based upon the amount of capital required. The power to 
make these crucial decisions is given to the banking regulators 
who do so in private. Thus, one of the most important factors 
in moving funds through the economy is done behind closed doors 
by a small number of nonelected officials.''
    Dr. Michel, do you share Mr. Bove's concern that Basel's 
risk-based capital system is especially a license for 
regulators to engage in credit allocation, some might call it 
picking winners and losers, and to manage the economy? Is this 
really a role that we want regulators playing?
    Mr. Michel. I think that is a concern, and I don't think 
that it is a role that a regulator should be playing. And if 
you go a little bit deeper into the details, the Basel rules 
have risk weights for individual bank loans. And the largest 
banks, they actually get to--they are literally allowed to work 
with the regulators to come up with that, which just is a 
license for regulatory capture. The entire system is a mess.
    Mr. Rothfus. Dr. Michel, what have been the consequences 
for economic growth and the vitality of our financial system of 
the decision by the authors of Dodd-Frank to really essentially 
double down on regulatory complexity, as we see was in place 
before and after Dodd-Frank?
    Mr. Michel. Just having to divert so many resources to 
compliance is a major problem. If you talk to smaller bankers 
in particular, even smaller regional banks, they have been 
getting hit with these things for years.
    The Basel requirements were never intended for anybody 
other than internationally active banks. That was the original 
intention. And U.S. regulators decided, no, we are going to put 
them on everybody.
    It doesn't make any sense to have smaller community banks 
going with these standards. And I would argue that it doesn't 
make any sense to have them anyway. But if you are going to 
have them on, you shouldn't have them on the smallest banks and 
probably not on a lot of the regional banks.
    Mr. Rothfus. Mr. Chairman, I yield back.
    Mr. Neugebauer. I thank the gentleman.
    Now the gentleman from Indiana, Mr. Messer, is recognized 
for 5 minutes.
    Mr. Messer. I thank the panel. I appreciate the lengthy 
conversation today about the Byzantine nature of the capital 
and liquidity standards under Basel. I would like to start by 
focusing my testimony towards Mr. Chakravorti and Mr. 
Calomiris.
    As I think you are probably aware, Federal banking 
regulators excluded all American municipal bonds from being 
treated as high-quality liquid assets under the LCR rule. This 
creates a remarkable situation where certain German 
subsovereign debt qualifies as high-quality liquid assets when 
American investment grade municipal bonds do not.
    This makes no sense to me. These investments are some of 
the safest investments in the world. And, of course, by not 
qualifying these assets in that way, it could raise borrowing 
costs for American local municipalities as they borrow.
    I have, looking at that, coauthored bipartisan legislation 
with Congresswoman Maloney that would essentially direct the 
FDIC, the Federal Reserve, and the OCC to classify investment 
grade municipal securities as level 2A high-quality liquid 
assets.
    And I would just like your feedback on that. As several of 
you have testified, the situation is far too complex as it is, 
but it certainly makes no sense to me to be penalizing 
investment grade American municipal bonds.
    Mr. Chakravorti. I support the view that high-quality 
liquid assets, given its risk profile and liquidity profile, 
should be as broad as possible. And if these munis do satisfy 
that requirement, I am fully supportive of them being in the 2A 
category.
    Mr. Messer. Mr. Calomiris?
    Mr. Calomiris. We have a little difference of opinion here. 
So I don't think we want to play the game of the in and out. 
And the way we do that is we focus on cash at the Fed bearing 
interest, basically banks holding Treasury bills, and that is 
what cash is, and we should just focus on a cash requirement.
    But what your point really illustrates is that the Basel 
Committee is the political equilibrium of people sitting at a 
table. They push for including covered bonds as a cash asset. 
Covered bonds are, from a systemic standpoint, a terrible thing 
to include. They cause what we call asset stripping.
    So Basel is a political G7 dining room table where deals 
are made and tradeoffs are made, and we shouldn't have to deal 
with and have to accept those definitions of what our liquidity 
requirement should be.
    Mr. Messer. Would anyone else like to chime in?
    Mr. Michel. I would agree with Charlie. I wish I had come 
up with the dining room table analogy. I like that.
    It makes no sense. It is purely political. It is almost 
wholly arbitrary, except for the fact that it is political, and 
it is a terrible system.
    Mr. Messer. Yes. And there are a host of other things that 
ought to be included as well.
    I yield back the balance of my time. Thank you.
    Mr. Neugebauer. Thank you.
    I now recognize the gentleman from California, Mr. Royce, 
for 5 minutes.
    Mr. Royce. Thank you, Mr. Chairman.
    I think the need for cross-border resolution of compromised 
financial institutions was made pretty painfully apparent 
during the 2008 global financial crisis. Rightfully, cross-
border resolution is today at the forefront of the 
international regulatory reform agenda.
    I thank these witnesses for being with us.
    During a recent update on the FDIC's efforts to create a 
framework for the resolution of SIFIs and G-SIBs, Chairman 
Martin Gruenberg said that there has been no greater or more 
important regulatory challenge in the aftermath of the 
financial crisis than developing the capability for the orderly 
failure of a systemically important financial institution.
    Now, I agree with him that this is an issue of paramount 
importance. However, I question the comment in describing the 
work to date in solving this cross-border resolution conundrum 
as: The progress has been impressive.
    I wanted to ask Dr. Chakravorti, do you share Chairman 
Gruenberg's assessment on the progress made on ending ``too-
big-to-fail'' around the world and eliminating taxpayer 
liability in the case of a financial downturn or do you side 
with the IMF, which believes that there remains considerable 
additional work, in their words, to be done to establish an 
effective regime for cross-border resolution?
    Mr. Chakravorti. That is a tough tradeoff, Mr. Congressman, 
to choose between the IMF and the FDIC. What I would like to 
say is that it is a very difficult issue. I have visited the 
FSB and Basel. It is a complex issue.
    I know that much of the cross-border that we should worry 
about is in a few countries. So I think there is great movement 
in the direction to get a cross-border agreement with some of 
these countries, but it is very difficult. And I think we have 
to start somewhere, and we are certainly going in the right 
direction.
    Mr. Royce. Then, let me ask Dr. Michel, what steps do 
policymakers around the globe need to take to actually ensure a 
method of cross-border resolution exists, one that does not 
place American companies at a competitive disadvantage while 
still preventing future taxpayer bailouts?
    Mr. Michel. On the specific details of the cross-border 
issue, I would have to defer. I am not comfortable with the 
specific details there. But in general, I think what we need to 
do is worry about making the American system as competitive as 
possible. And bankruptcy law change would be much better than 
the Title II that we got in Dodd-Frank.
    Mr. Royce. Let's open it up to the rest of the panel then 
very quickly. But we have had some time to think about this. 
Ever since 2008, it should have been on our mind.
    Mr. Calomiris. Let me just talk about that. I agree with 
you. In fact, if you look at what the problem was in terms of 
cross-border with the failure of Lehman, it was which regulator 
is in charge of which assets? That was the major problem. That 
was the major disruption and confusion. And I think that is 
something that we are really moving to solve, and I think it 
can be solved. That is different from orderly liquidation, 
which I think is a pipe dream.
    So my own view is, in terms of Realpolitik, the only way we 
are going to solve this problem is with some kind of 
ringfencing where there is clear allocation of authority over 
which assets and which liabilities will be adjudicated and 
controlled by which regulatory entities. And we can't have a 
completely fluid international balance sheet. It is simply not 
pragmatic.
    So my view is international financial institutions can have 
operations that are international, but they have to have legal 
entities that are well-defined within national borders.
    Mr. Royce. Thank you.
    I am going to yield back, Mr. Chairman, because I see Mr. 
Schweikert is pensively waiting, and I know time is short.
    Mr. Neugebauer. I thank the gentleman.
    And now the gentleman from Arizona, Mr. Schweikert, is 
recognized for 5 minutes.
    Mr. Schweikert. Thank you, Mr. Chairman.
    To my friend from California, was that ``pensive'' or just 
too much caffeine?
    This actually has been an interesting conversation, and you 
always run into the situation when you are last, that a number 
of your questions have already been answered. So could we do a 
quick lightning round, because there are a handful of things I 
would love to get my head around?
    Dr. Michel, in your opening statement you talked about if 
you would also charter certain institutions as partnerships and 
then the loss piece moves to the partners. Can you give me like 
20, 30 seconds on that?
    Mr. Michel. Sure. Before the Depression, what we had was 
basically sort of a double liability system, and it wasn't a 
corporate limited liability. It was you are responsible for 
your losses as well as an amount up to the amount that you had 
put in. During the 1930s and RTC and a lot of details, we 
basically killed that. And I think for the last--I think the 
last investment banking firm to get rid of that entity was 
Bear. I could be wrong, but it was one of them.
    Mr. Schweikert. Would that be another way of also saying, 
okay, here is equity capital, but also the liability within 
that equity capital?
    Mr. Michel. Yes.
    Mr. Schweikert. Okay. Simple enough?
    Mr. Michel. I believe so, yes. And I know that a lot of 
those companies will not want to do that right off, but if you 
look at the amount of regulation that we force on them and you 
take some of it away, some may be willing to go for the 
tradeoff.
    Mr. Schweikert. We are going to come back to that 
opportunity and how do you incentivize either greater capital 
or either greater risk participation.
    And I always mispronounce, is it Dr.--
    Mr. Calomiris. ``Calomiris.''
    Mr. Schweikert. --``Calomiris.''
    Okay. Real estate concentration, particularly for those of 
us from the Southwest, we have seen our boom-and-bust cycles 
and our real estate often taking down our S&Ls back in the late 
1980s, what it has done to our banks.
    The ability for banking institutions to syndicate risk on 
their real estate book, saying we have this many real estate 
loans, is there a way to hedge it, sell it off to private 
equity, or even in today's world where I am watching the new 
crowdsourcing, the lending clubs of the world in the real 
estate market, but also taking that same model and allowing 
those same banking institutions that act as aggregators where 
that real estate debt ultimately is not sitting on their books, 
they are just acting as the collection, management, 
bookkeeping, and the risk is actually, shall we say, cascaded 
with the series of individual institution, private equity 
investors. Is that a model of breaking up that risk 
concentration?
    Mr. Calomiris. Any model that creates better 
diversification and better maturity matching of the financing 
of real estate is going to be a big improvement. And this isn't 
farfetched. This is what we are already seeing.
    Insurance companies do a lot of small local commercial real 
estate financing. The farm credit system now has very high 
capital requirements, and its mutual structure shares some of 
that risk. I am not a big fan of the farm credit system, but my 
point is that insurance companies, real estate investment 
trusts, and the farm credit system are all very different kinds 
of financing structures from traditional banks.
    And I can't resist just adding one more thing: You all know 
the story of, ``It's a Wonderful Life.'' That was a building 
and loan. That movie is inaccurate. Building and loans couldn't 
have runs, because they weren't funded by short-term debt. That 
movie is just wrong.
    Mr. Schweikert. Are you telling me Hollywood has lied to me 
again?
    Dr. Parsons, if I were sort of rebuilding the whole concept 
around Dodd-Frank, and saying, look, in a modern world, with 
modern technology, and modern information, how do I actually, 
at least from my view of the world--I want a broad financial 
system. We keep referring to it as the banking system, and then 
those who want to sound more sinister, the shadow banking 
system.
    But ultimately, how do I create a world here where my 
community bank may be where I go for that loan, but I also may 
go on the Internet, I may go to a fraternal organization. 
Wouldn't that breaking up of risk concentration ultimately make 
us much more robust when the markets are--when we go through a 
rough cycle?
    Mr. Parsons. I think that is a great idea. I think we got 
ourselves into a situation leading into the crisis where we had 
these gigantic universal banks where we were pushing into the 
portfolio every kind of activity that really wasn't even 
related, but we were also then finding ourselves with certain 
utilities, like the payment system and the like, hostage to 
losses on various portfolios. What you proposed is exactly a 
better financial system.
    Mr. Schweikert. So to that same concept, how do I turn to 
those same financial institutions and say: You should be able 
to participate in financial markets, but in many different 
ways. My particular fixation on the crowdsourcing of lending, 
because it minimizes the cascade effect if the loan goes back, 
because it is not either the bank or therefore the guarantors 
and the taxpayers in the chain of liability. There has to be a 
solution here that is much more dynamic for our markets.
    Mr. Parsons. I think the regulators are trying to do that 
kind of thing. When you look at the--
    Mr. Schweikert. There, I disagree with you.
    Mr. Parsons. --and you look at the G-SIB charge, they are 
attempting to identify the risk of the specific activity.
    Mr. Schweikert. Last comment: The regulators aren't doing 
that. As a matter of fact, the regulators in many ways are 
crushing the innovation right now.
    With that, I yield back.
    Chairman Hensarling. The time of the gentleman has expired.
    The Chair now recognizes the gentleman from Maine, Mr. 
Poliquin.
    Mr. Poliquin. Thank you, Mr. Chairman.
    And thank you, gentlemen, for being here today. I 
appreciate it.
    I am sure everyone agrees that our financial services 
industry is the envy of the world. The reason why we have such 
a strong economy, although we do have problems now, but over a 
long period of time is because our financial services industry 
provides the cash, the capital, the money, so businesses can 
borrow and expand and hire more workers and our families can 
borrow more money to buy a home or a new car.
    Now, I am very concerned, like a lot of folks in this room, 
that the Dodd-Frank set of regulations, parts of them, are 
really smothering our financial system and therefore impacting 
our economy and that is why we have had such anemic growth over 
the last 6 years of this recovery. And one of the parts of 
Dodd-Frank that I am concerned about, Mr. Messer spoke about a 
short time ago, dealing with our high-quality liquid assets 
issue.
    Now, when I was the State treasurer up in Maine for a 
period of time, we did lots of work with the municipal bond 
market, and we accessed the market to repave Route 1, for 
example, that brings all of our tourists up to Maine so they 
can have nice lobsters and good vacations. This is very 
important to our State. Our department also helped a lot of our 
small towns, like Greenville or Jackman or Machias, if they 
needed to build a new sewage treatment plant. And so having the 
access to cheap credit for our States, our counties, our 
cities, and our towns is critically important going forward.
    If you look at our municipal bond market today, it is very 
safe, it is very liquid, it is transparent, it has been around 
for about 80 years, and there is about $4 trillion today 
outstanding in our municipal bond market. A couple of years 
ago, 2013, there was about $325 billion one year that was 
issued. There are 1,600 broker-dealers that affect transactions 
on both sides of the trade, and every 15 minutes the results of 
transactions are posted on the electronic platform.
    So in addition to that, moms and dads and grandparents who 
are buying securities, who are saving for their retirement, 
hundreds of thousands of them across our country participate in 
this market, along with mutual funds, insurance companies, and 
they all provide, again, the cash, the cheap credit to our 
towns so they can grow, so we can build a new playground for 
the kids down the street, or you can make sure you have a new 
library if you need one.
    So this is really important. And I am very concerned that 
now the Fed and the FDIC are looking at this whole asset class 
and saying, for some reason, that these very safe liquid 
securities should not be included in the liquidity coverage 
ratio.
    So I would like to ask you, Dr. Chakravorti, if you don't 
mind commenting on this, tell me what your thoughts are. Am I 
missing anything here? Because it doesn't seem to be fair or 
right to me that we exclude this whole type of asset class from 
the liquidity coverage ratio for banks, because if we do, it is 
going to have a big impact on moms and dads who are struggling 
through this recession, because they are going to have to pay 
higher taxes to pay for higher interest rates if we restrict 
this type of whole asset class from this issue we have here.
    Mr. Chakravorti. As I mentioned before, I think it is very 
important when deciding characteristics of things that fall 
into the A1, A2, level 2 category of the LCR that these 
instruments truly be liquid and truly possess the underlying 
risk characteristics that you want.
    Mr. Poliquin. And do you feel that municipal bonds, in 
fact, do meet those requirements?
    Mr. Chakravorti. Let me just say, I haven't studied every 
municipal bond in the country to tell you those 
characteristics. I can tell you that I am sure there are some 
that qualify. I can't say whether they all do. I am not an 
expert in that area.
    Mr. Poliquin. How about general obligation bonds? In other 
words, if you look at the State of Maine, for example, is that 
individuals and businesses who pay income tax and folks who go 
visit our great State and pay sales tax when they buy a lobster 
or can of Coke, these are all of the assets, the revenues that 
backstop the interest payments on our GO bonds every 6 months 
and the principal backed every 10 years.
    Mr. Chakravorti. I understand how they are financed and 
things like that, but things that come to mind, and please 
don't take this the wrong way, are Greece, Orange County, and 
other sovereigns that--I am not saying Maine is in this 
category; I am not trying to say that.
    Mr. Poliquin. Thank you.
    Mr. Chakravorti. But what I am saying is that if there are 
municipal bonds that meet the characteristics of asset similar, 
then they should be--
    Mr. Poliquin. I would make a case to you, Dr. Chakravorti, 
in my final moments if I may, Mr. Chairman, that our sovereign 
States here, which are required to balance their books every 
year, are a much safer bet than some of the debt--
    Mr. Chakravorti. Absolutely. I don't--
    Mr. Poliquin. --accrued around here in Washington. Let me 
tell you that.
    But I thank you very much. I appreciate your comments, Dr. 
Chakravorti.
    Chairman Hensarling. The time of the gentleman has expired. 
The Chair now recognizes the gentleman from Arkansas, Mr. Hill.
    Mr. Hill. Thank you, Mr. Chairman.
    And I thank our panel for being with us today.
    I really want to get into a long, extended debate about 
these real estate comments I have listened to today, because I 
don't buy it. I have been in this business for almost 40 years 
now. And I think customers and banks fully share interest rate 
risk in traditional commercial real estate lending, portfolio 
lending. And so I really want to take issue with that, but I 
will not dwell upon it.
    Mr. Sherman talked about rating dependencies, and in my 
view, that is one of the more paper-oriented burdens actually 
coming out of Dodd-Frank, is requiring banks to do a lot of 
independent credit analysis and not be relying on the rating 
agencies. In fact, it was completely counter to the discussion 
I felt that you had, is that bank exams now do not allow you to 
simply state for the rating sheet in a bank looking at your 
portfolio. I think in some instances that is a good idea, and 
in some it is not. But it is a huge source of paper burden on 
small banks.
    An example: In Arkansas, school bonds, which is fully, 
gosh, 100 percent, I would say, of the municipal exposure of 
commercial banks in Arkansas, are AA rated and guaranteed by 
the State of Arkansas, so it is the equivalent of a GO in 
Arkansas, and yet every one of those has to have stapled to it 
the Bloomberg evaluation analysis and an independent credit 
review, some of which is virtually impossible to do. So I 
really think that is an area we could reform the regulatory 
practice as a result of Dodd-Frank.
    Also, you all talked about in the capital ratings, which 
are so geared to credit risk, and you didn't really mention 
interest rate sensitivity risk, which is also the ``S'' in the 
CAMELS rating. And it is not a one-stop shop. When we make a 
loan or buy a bond, we are taking credit risk, but we are also 
accounting for and graded on interest rate sensitivity risk. 
And I didn't hear any discussion of that today. Some of you 
acted as if it didn't go into the calculus of that. I want to 
give you a chance to talk about the balance between those two.
    Dr. Michel, would you like to start?
    Mr. Michel. As far as I know, Basel III does not include 
any sort of weight for interest rate risk.
    Mr. Hill. No, but your examine practice does. Every bank 
has an interest rate sensitivity component.
    Mr. Michel. I misunderstood.
    Mr. Hill. Yes, that is my point. You are all beating up on 
Basel III, but we are not taking into account that we have 
another binder on the shelf in the boardroom that is all about 
interest rate sensitivity, and the two work together. So really 
comment on that if you would, please. Meaning, you have Basel 
weight, sure, but it is not the only thing a bank takes into 
consideration.
    Mr. Michel. Well, no. There are certainly going to be 
things that they have missed. Aside from the fact that they are 
arbitrary, and aside from the fact that they are going to get 
certain things wrong in what they have accounted for, there 
would be some things that they would not account for. The 
CAMELS ratings is actually much better in terms of just 
accounting for sort of a comprehensive look at the bank.
    Mr. Hill. Yes.
    Mr. Calomiris. I think that after Basel II and going on to 
Basel III, large banks do have to, as part of their internal 
risk-based modeling, take account of their interest rate 
exposure--
    Mr. Hill. All banks, not large banks.
    Mr. Calomiris. But I am saying under Basel, this was 
reformed.
    Whether that is done accurately is a separate question. And 
I think that there is a lot of reason to believe that our 
models of doing that which are being used might not be 
accurate.
    Mr. Hill. Right. We can't eliminate risk in the banking 
business. That is the business that we are in. So I don't think 
we can regulate our way out of that. And I think that is one of 
the big flaws in the Dodd-Frank Act.
    How would you take into a CAMELS rating, even though they 
are confidential, in this idea of a market-based capital 
standard and market-based risk, to Mr. Mulvaney's point? Any 
suggestions or ideas there?
    Mr. Calomiris. My view is that there are several different 
pieces that you could use. I know that time is short. My CoCos 
suggestion goes right to the point.
    I would also point out that there are other simple things. 
Suppose that you said that the risk of a loan is going to be 
captured by its relative interest rate spread? There is a lot 
of evidence that is true, that nonperforming loans are closely 
linked to interest rate spreads. You could use that market 
information to measure loan risk.
    Now, that is not perfect, but if you had used the highest 
interest rate in a mortgage as a measure of its risk, you would 
have budgeted a lot more capital for subprime mortgages than we 
did.
    Mr. Hill. I would like to talk about that another day as 
well.
    Thank you, Mr. Chairman.
    Chairman Hensarling. The time of the gentleman has expired.
    The Chair asks unanimous consent that the gentleman of 
Georgia be granted an additional minute. Without objection, the 
gentleman from Georgia is recognized.
    Mr. Scott. Thank you very much, Mr. Chairman.
    Very quickly, I think we are overlooking, as I said, an 
unintended consequence of this leverage capital rule. And I 
hope you will have time to respond to me.
    And here is my concern. When you require capital be held 
against collateral for which banks are prohibited from 
leveraging their own benefit, this will increase the cost 
significantly of end users. And nobody has talked about that.
    I am very much concerned about this. This will affect all 
of our end users, people who had no issue with this meltdown. I 
am talking about our farmers, our agriculture businesses, our 
manufacturers, our energy producers.
    And my fear is that banks will be less likely to take on 
new clients for a derivative clearing, and as a result market 
participants will have fewer choices and will be less likely to 
use derivatives from hedging their own risk for management 
purposes.
    And as a result of mandatory clearing obligations for some 
derivatives, some market participants, like what I mentioned 
are innocent end users and agribusinesses, will not have any 
option available to them to hedge their underlying risk and 
will find this unwarranted capital treatment grounds against 
our banks a reason for discontinuing their customer-facing 
clearing businesses. This is an underlying but becoming more 
obvious unintended consequence.
    Mr. Calomiris, would you respond? I think you mentioned it 
a little bit.
    Mr. Calomiris. I think you are right, that we have to 
strike a balance, and we have to recognize that there are costs 
associated from imposing capital requirements, absolutely no 
question about it.
    At the same time, I just want to reiterate that if you 
aren't gearing your capital requirements to making your banking 
system safe, a collapsed banking system has much worse 
consequences for those end users.
    And let me point out, the United States has had since our 
origins, 17 major banking crises. We are one of the least 
stable banking systems in the world. And part of that reflects 
the fact that we have sometimes bent too far in the direction 
of short term, wanting to help borrowers politically, and at 
the expense of our stability.
    When we look at Canada to the north, they have never had a 
banking crisis. That is a very interesting thing to note. And 
they feel pretty well served by their banks, and I think they 
like their stability.
    Mr. Scott. Yes.
    Just, Mr. Chairman, I want to end with this, that hopefully 
we can pay a little closer attention to this, because we don't 
want to inadvertently affect very dramatically our end users, 
our manufacturers, and our agribusinesses and small businesses 
because of Basel III.
    Thank you, Mr. Chairman.
    Chairman Hensarling. The time of the gentleman has expired.
    There are no other Members in the queue, thus, I would like 
to thank all of our witnesses for their patience and their 
testimony today.
    The Chair notes that some Members may have additional 
questions for this panel, which they may wish to submit in 
writing. Without objection, the hearing record will remain open 
for 5 legislative days for Members to submit written questions 
to these witnesses and to place their responses in the record. 
Also, without objection, Members will have 5 legislative days 
to submit extraneous materials to the Chair for inclusion in 
the record.
    This hearing stands adjourned.
    [Whereupon, at 12:32 p.m., the hearing was adjourned.]

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