[Senate Hearing 111-228]
[From the U.S. Government Publishing Office]
S. Hrg. 111-228
THE ADMINISTRATION'S PROPOSAL TO MODERNIZE THE FINANCIAL REGULATORY
SYSTEM
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED ELEVENTH CONGRESS
FIRST SESSION
ON
EXAMINING THE ADMINISTRATION'S PROPOSAL TO MODERNIZE THE FINANCIAL
REGULATORY SYSTEM
__________
JUNE 18, 2009
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
Available at: http: //www.access.gpo.gov /congress /senate/
senate05sh.html
----------
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
CHRISTOPHER J. DODD, Connecticut, Chairman
TIM JOHNSON, South Dakota RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York JIM BUNNING, Kentucky
EVAN BAYH, Indiana MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey MEL MARTINEZ, Florida
DANIEL K. AKAKA, Hawaii BOB CORKER, Tennessee
SHERROD BROWN, Ohio JIM DeMINT, South Carolina
JON TESTER, Montana DAVID VITTER, Louisiana
HERB KOHL, Wisconsin MIKE JOHANNS, Nebraska
MARK R. WARNER, Virginia KAY BAILEY HUTCHISON, Texas
JEFF MERKLEY, Oregon
MICHAEL F. BENNET, Colorado
Edward Silverman, Staff Director
William D. Duhnke, Republican Staff Director
Amy S. Friend, Chief Counsel
Dean V. Shahinian, Senior Counsel
Julie Chon, Counsel
Jonathan N. Miller, Professional Staff Member
Deborah Katz, Legislative Fellow
Drew Colbert, Legislative Assistant
Charles Yi, Senior Advisor and Counsel
Matthew Green, Senior Counsel
Lisa Frumin, Legislative Assistant
Misha Mintz-Roth, Legislative Assistant
Neal Orringer, Professional Staff Member
Laura Swanson, Legislative Assistant
Kara Stein, Legislative Assistant
Randall Fasnacht, Legislative Detailee
Grace Katabaruki, Legislative Assistant
David Stoopler, Legislative Assistant
Jayme Roth, Legislative Assistant
Michael Passante, Legislative Assistant
Matt Pippin, Legislative Assistant
Patrick Jackson, Legislative Assistant
Jason Rosenberg, Legislative Assistant
Hilary Swab, Legislative Assistant
Nathan Steinwald, Legislative Assistant
Andrew Green, Legislative Assistant
Layth Elhassani, Legislative Assistant
Mark Oesterle, Republican Chief Counsel
Andrew J. Olmem, Jr., Republican Counsel
Chad Davis, Republican Chief Counsel
Hester Peirce, Republican Counsel
Brandon Barford, Republican Legislative Assistant
Mike Nielsen, Republican Professional Staff Member
William Henderson, Republican Legislative Assistant
Gregg Richard, Republican Legislative Assistant
Jennifer Gallagher, Republican Legislative Assistant
Courtney Geduldig, Republican Legislative Assistant
Travis Johnson, Republican Legislative Assistant
Scott Douglas, Republican Legislative Assistant
Mark Sanchez, Republican Legislative Assistant
Dawn Ratliff, Chief Clerk
Devin Hartley, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
(ii)
C O N T E N T S
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THURSDAY, JUNE 18, 2009
Page
Opening statement of Chairman Dodd............................... 1
Prepared statement........................................... 50
Opening statements, comments, or prepared statements of:
Senator Shelby............................................... 4
Senator Johnson
Prepared statement....................................... 51
Senator Brown
Prepared statement....................................... 51
Senator Crapo
Prepared statement....................................... 52
WITNESS
Timothy Geithner, Secretary, Department of the Treasury.......... 6
Prepared statement........................................... 53
Responses to written questions of:
Chairman Dodd............................................ 59
Senator Shelby........................................... 60
Senator Reed............................................. 82
Senator Akaka............................................ 85
Senator Kyl.............................................. 87
(iii)
THE ADMINISTRATION'S PROPOSAL TO
MODERNIZE THE FINANCIAL REGULATORY SYSTEM
----------
THURSDAY, JUNE 18, 2009
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 9:34 a.m., in room SH-216, Hart Senate
Office Building, Senator Christopher J. Dodd (Chairman of the
Committee) presiding.
OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD
Chairman Dodd. The Committee will come to order.
Again, I want to welcome my colleagues, welcome the
Secretary. We are pleased to have you before us again, Mr.
Secretary, this morning. I welcome our audience that is here
this morning.
We will proceed in the following manner: I will make some
opening remarks. I will ask Senator Shelby as well if he would
care to make any opening remarks. And then to move things
along, unless any Member here is so compelled, I would like to
get right to the Secretary for his comments, then get right to
the questioning if we can as well. So that is the manner in
which we will proceed, but I thank everyone for making it here
this morning. Again, Mr. Secretary, thank you for being with
us.
This morning we are going to conduct this hearing on the
administration's proposal to modernize the financial regulatory
system, and for those of us--I was there yesterday at the White
House to hear the President make his presentation, along with
many others. So good morning and thank you again for being with
us. I would like to welcome the Secretary, who is here to
discuss the administration's proposal.
Mr. Secretary, we applaud your leadership on a very complex
set of issues intended to restore confidence and stability in
our financial system, and I, along with my colleagues, look
forward to exploring the details of your plan and working with
you and our colleagues here and the other body on this truly
historic endeavor.
In my home State of Connecticut and around the Nation,
working men and women who did nothing wrong have watched the
economy fall through the floor, taking with it their jobs, in
many cases their homes, their life savings, and the economic
security that has always been the cherished promise of the
American middle class. These people, our constituents across
the contractor, the American taxpayer, are hurting. They are
very angry and they are worried, and they are wondering who is
looking out for them.
I have seen firsthand how hard people work in my State, as
I know my colleagues here--and you have, too, Mr. Secretary,
what they do to support their families, to build financial
security for themselves. I have seen, as well as my colleagues
have, how devastating this economic crisis has been for them.
And I firmly believe that someone should ``have their backs,''
as the expression goes.
So as we work together to rebuild and reform the regulatory
structures whose failures led us to this crisis, I, along with
my colleagues here, will continue to insist that improving
consumer protection be a first principle and an urgent
priority.
I welcome the administration's adoption of this principle,
and I am pleased to see it reflected in the plans that we will
be discussing this morning.
At the center of this effort will be a new, independent
consumer protection agency to protect Americans from poisonous
financial products. This is a very simple, common-sense idea.
We do not allow toy manufacturers to sell toys that could hurt
our children. We do not allow electronic companies to sell
defective appliances. Why should a usurious payday loan be
treated any differently than we treat an unsafe toy or a
malfunctioning toaster? Why should an unscrupulous lender be
allowed to dupe a borrower into a loan the lender knows cannot
be repaid? There is no excuse for allowing a financial services
company to take advantage of American consumers by selling them
dangerous financial products. Let us put a cop on the beat so
that this spectacular failure of consumer protection at the
root of this mess is never repeated again.
We have been engaged in an examination of just what went
wrong in the lead-up to this crisis since February of 2007 when
experts and regulators from across the spectrum testified
before this very Committee that poorly underwritten mortgages
would create a tsunami of foreclosures. Those mortgages were
securitized and sold around the globe. The market is supposed
to distribute risk, but because for years no one was minding
the store, these toxic assets served to amplify risk in our
system.
Everything associated with these securities--the credit
ratings applied to them, the solvency of the institutions
holding them, and the creditworthiness of the underlying
borrowers--became suspect. And as the financial system tried to
pull back from these securities, it took down some of the
country's most venerable institutions--firms that had survived
world wars, great depressions, down for decades and decades,
and wiped out over $6 trillion in household wealth since last
fall alone.
Stronger consumer protection I believe would have stopped
this crisis before it started. Consumers were sold subprime and
exotic loans they could not afford to repay and were, frankly,
cheated. They should have been the canaries in the coal mine.
But instead of heeding the warnings of many experts, regulators
turned a blind eye, and it was regulatory neglect that allowed
the crisis to spread to the point where the basic economic
security of my constituents and millions more around the
country here, including folks who have never seen or heard of
mortgage-backed securities, was threatened by the greed of some
bad actors on Wall Street and elsewhere and the failure of our
regulatory system.
To rebuild confidence in our financial system, both here at
home and around the world, we must reconstruct our regulatory
framework to ensure that our financial institutions are
properly capitalized, regulated, and supervised. The
institutions and products that make up our financial system
must act to generate wealth, not destroy it.
In November, I announced five principles which would guide
the Banking Committee's efforts in the coming weeks and months.
First and foremost, regulators must be focused and
empowered aggressive watchdogs rather than passive enablers of
reckless practices.
Second, we have to remove the gaps and overlaps in our
regulatory structure that have encouraged charter shopping and
a race to the bottom in an effort to win over bank and thrift
clients.
Third, we must ensure that any part of our financial system
that poses a systemic wide risk is carefully and sensibly
supervised. A firm too big to fail is a firm too big to leave
unmonitored.
Fourth, we cannot have effective regulation without more
transparency. Our economy has suffered from the lack of
information about trillion-dollar markets and the migration of
risks within them.
And, fifth, our actions must help Americans remain
prosperous and competitive in a global marketplace.
These principles will guide my consideration of the plan
that you bring to our Committee this morning, Mr. Secretary,
and I believe that we can find common ground in a number of the
areas contained in your proposal. And I want to thank you again
for your leadership on these issues as well as for your
willingness to consider different perspectives in forging this
plan. I hope you will view this as a continuation of the
dialogue that you have had with Members of this Committee, both
Democrats and Republicans, as we work together to shape a
regulatory framework that will serve our Nation well into the
21st century.
I want to thank all of my colleagues on this Committee as
well, by the way, who have demonstrated a strong interest in
this issue and are determined to work together. Senator Shelby
will obviously give his own opening remarks, but he and I have
talked on numerous occasions about how this issue that we will
grapple with here as a Committee may be the most important
thing this Committee will have done in the last 60 or 70 years
or the most important thing any one of us is going to do as a
Members of this Committee for years to come--getting this
right.
I do not sense on this Committee any great ideological
divides. What I do sense is a determination to figure out what
works best, to get it right, and to get the job done. So I am
really excited about the opportunity that is being posed by the
proposal you have put forward and the work in front of us. And
I want to urge everyone on our Committee and elsewhere to
remember that at the end of the day, at the end of all of this,
the success of what we attempt will be measured by its effect
on the borrower, on the shareholder, on the investor, the
depositor, the consumers, and taxpayers seeking not to attain
extravagant wealth but simply to grow a small business, pay for
college, buy a home, and pass on something to their children.
That is the American dream, and that is what we are gathered to
restore.
Let me just say, while it is not part of my remarks I
prepared for this morning, when I pick up the morning newspaper
and I read the first headline here, ``Fault Lines Emerge as
Industry Groups Blast Plan to Create Consumer Agency,'' what
planet are you living on? The very people who created the damn
mess are the ones now arguing that consumers ought not to be
protected. They are the people who have paid this price. And
the idea that you are going to first want to attack the very
clients and customers who depend upon you every day is not the
place to begin.
And so I am somewhat upset when I see those kinds of
remarks when we are trying to look for cooperation and building
some common ideas.
With that, I turn to Senator Shelby.
STATEMENT OF SENATOR RICHARD C. SHELBY
Senator Shelby. Thank you, Mr. Chairman.
I have said on a number of occasions that reforming our
financial regulatory system may be, as Senator Dodd has
indicated, the most significant thing many of us will do while
serving in the U.S. Senate. We all know how difficult it can be
to shepherd even minor bills through the legislative process,
let alone anything as significant as financial regulatory
reform. We also know equally well that the opportunity to
accomplish something of this magnitude can be fleeting, which
presents a bit of a conundrum. We certainly want to strike
while the iron is hot, but we also want to make the most of the
opportunity that has been presented.
The philosopher William James once said, ``He who refuses
to embrace a unique opportunity loses the prize as surely as if
he has failed.'' I hope that we do not collectively refuse to
embrace this unique opportunity because here failure I believe
is not an option.
The President has put forward his plan. It deserves our
careful consideration. That consideration will involve not only
an evaluation of his proposed reforms but, more importantly, a
close examination of the facts upon which he based his
recommendations. The administration's factual predicate can
then be compared with the Committee's findings as soon as we
complete our examination of the crisis.
I have said many times this Committee must first clearly
identify what went wrong before we even began to consider a
response. It is my hope that we can take advantage of some of
the work done by the Secretary and others in the
administration. It would be helpful if Secretary Geithner could
share with Congress any and all documents and information used
in their process in their recommendation.
As is the case with all legislative efforts, laws are built
around consensus, and consensus is achieved when all parties
can agree on either facts or principles. There is one fact upon
which I believe we have reached a complete agreement. Our
financial regulatory system is antiquated and inadequate. I am
not as confident, however, that we have reached agreement on
what principles should guide our efforts yet.
As we begin evaluating the President's plan, I want to
highlight the key considerations that I believe should guide
our process as we move forward.
First, notwithstanding the great difficulties we have
recently experienced, private markets still provide the best
means for achieving our full economic potential. Risk taking is
an essential ingredient in these markets, and while we should
improve our ability to manage risk, we cannot simply eliminate
risk taking without sacrificing the foundation of our free
market system. We must also remember that risk is a two-way
street. Those who take risk must be prepared to suffer the
losses as well as enjoy the gains. Any reforms we adopt must
reduce expectations that some firms are simply too big to fail.
Second, we must establish regulatory mandates that are
achievable. This is especially true with respect to the
regulation of systemic risk. And while there is wide agreement
that we have experienced a systemwide event, we have spent very
little time discussing the concept of systemic risk,
determining how best to regulate it, or even establish whether
it can be regulated at all.
Third, I believe that regulators should have clear and
manageable responsibilities and be subject to oversight and
proper accountability. I am concerned that we already have a
number of regulators that do not currently meet these criteria,
and the administration is contemplating giving them additional
responsibilities. For example, the Federal Reserve already
handled monetary policy, bank regulation, holding company
regulation, payment systems oversight, international banking
regulation, consumer protection, and the lender-of-last-resort
function. These responsibilities conflict at times, and some
receive more attention than others. I do not believe that we
can reasonably expect the Fed or any other agency effectively
play so many roles.
In addition, the Federal Reserve was provided a unique
independent status to assure world markets that monetary policy
would be insulated from political influence. The structure of
the Federal Reserve involves quasi-public reserve banks that
are under the control of boards with members selected by banks
regulated by the Fed. By design, the board and the reserve
banks are not directly accountable to Congress and are not
easily subject to congressional oversight. Recent events have
clearly demonstrated that the structure is not appropriate for
a Federal banking regulator let alone a systemic regulator.
Finally, while we have a responsibility to identify and
repair the weaknesses of our current regulatory structure, we
also have a duty to position our regulatory system for the
future. Since World War I, we have been the world's financial
market of choice. That is rapidly changing. We must do
everything we can to not only ensure the safety and soundness
of our financial system, but also its competitive standing in
the world.
The President has now added his voice to the debate, and it
is now up to us to add ours. As we do, I hope that we will not
allow the administration's recommendations to limit the debate
that we are about to undertake. While we have a very difficult
task before us, I also believe we have a unique opportunity to
do something significant.
I urge my colleagues to focus on creating a regulatory
system for the next century, not one that merely seeks to
remedy the mistakes of the last few years.
Thank you, Mr. Chairman.
Chairman Dodd. Thank you very much, Senator.
Mr. Secretary, we welcome you once again before the
Committee and look forward to your testimony. And, by the way,
any supporting documents and other materials--Senator Shelby
recommended that it might be helpful for the Committee to see
and discuss with you and your staff and others the background
material that you used in formulation of this could be helpful
as well as we move forward. So I welcome that suggestion by my
friend from Alabama.
I would say, by the way, all statements of my colleagues as
well and any data and supporting material they would like to be
included in the record of this hearing will be--we will just
consider that done as well as we move forward.
Mr. Secretary, welcome.
STATEMENT OF TIMOTHY GEITHNER, SECRETARY, DEPARTMENT OF THE
TREASURY
Secretary Geithner. Mr. Chairman, Ranking Member Shelby,
and Members of the Committee, it is a pleasure to be here. I
welcome this debate. This is a critically important debate for
our country, and I think it is time we get to it.
Over the past 2 years, our Nation has faced the most severe
financial crisis since the Great Depression. Our financial
system failed to perform its critical functions. The system
magnified risks. Some of the largest institutions in the world
failed. The resulting damage affected the country as a whole,
affecting virtually every American. Millions have lost their
jobs and their homes. Hundreds and thousands of small
businesses have shut down. Students have deferred college and
education, and workers have had to shelve their retirement
plans.
American families are making essential changes in response
to this crisis. It is our responsibility to do the same, to
make our Government work better. And that is why yesterday
President Obama unveiled a sweeping set of regulatory reforms
to lay the foundation for a safer, more stable financial
system, one that can deliver the benefits of market-driven
financial innovation even as it guards against the dangers of
market-driven excesses.
Every financial crisis of the last generation has sparked
some effort at reform, but past efforts have been begun too
late, often after the will to act has subsided. We cannot let
this happen this time. We may disagree about the details, and
we will have to work through these issues. But ordinary
Americans have suffered too much. Trust in our financial system
has been too shaken, and our economy was brought too close to
the brink for us to let this moment pass.
In crafting our plan, the administration has sought input
from all sources. We consulted extensively with Members of
Congress, regulators, consumer advocates, business leaders,
academics, and the broader public. And we looked at a range of
proposals made by a number of bodies here in the United States
over the last several months. We considered a full range of
options, and we made the judgment that now was the time to
pursue the essential reforms, those that address the core
causes of the crisis and those that will help prevent or
contain future crises.
I want to be clear. Our plan does not address and does not
seek to address every problem in our financial system. That is
not our intent, and we do not propose reforms that, while
desirable, would not move us toward achieving those core
objectives of creating a more stable system and addressing
those vulnerabilities that are critical to our capacity to
prevent future crises.
We have laid out the details of our proposals in public, so
I just want to spend a few minutes explaining some of the broad
principles that guided our proposals.
First, if this crisis has taught us anything, it is that
risks to our system can come from almost any quarter. We must
be able to look in every corner and across the horizon for
dangers, and our system was not able to do that.
While many of the firms and markets at the center of the
crisis were under some form of Federal regulation, that
supervision did not prevent the emergence of large
concentrations of risk. A patchwork of supervisory
responsibility, loopholes that allowed some institutions to
shop for the weakest regulator, and the rise of new
institutions and instruments that were almost entirely outside
the Government's supervisory framework left regulators largely
blind to emerging dangers. And regulators were ill equipped to
spot systemwide threats because each was assigned to protect
the safety and soundness of individual institutions under their
watch. None was assigned to look out for the broader system as
a whole.
That is why we propose establishing a Financial Services
Oversight Council to bring together the heads of all the major
Federal financial regulatory agencies, and this council will
help ensure that we fill gaps in the regulatory structure where
they exist and where they emerge. It will improve coordination
of policy and help us resolve disputes across agencies. And,
most importantly, it will have the power to gather information
from any firm or market to help identify and help the
underlying regulators respond to emerging risks.
The council will not have the responsibility for
supervising the largest, most complex, interconnected
institutions, and the reason for that is simple. That is a
highly specialized, complicated task, and it requires
tremendous institutional capacity and organizational
accountability.
Nor would the council be an appropriate first responder in
a financial emergency. You cannot convene a committee to put
out a fire. The Federal Reserve is the best positioned to play
that role. It already supervises and regulates bank holding
companies, including all major U.S. commercial and investment
banks. Our plan is to give it a carefully designed, modest
amount of additional authority, and clearer accountability for
the Fed to carry out that mission, but we also take some
important authority and responsibilities away from the Federal
Reserve.
Specifically, we propose removing from the Federal Reserve
and other bank regulators oversight responsibility for
consumers. Historically in those agencies, consumer interests
were often perceived to be in conflict with the broader mandate
of the institutions to protect safety and soundness.
That brings me to our second key priority: consolidating
protection for consumers and ensuring they understand the risks
and rewards associated with financial products sold directly to
them. Before this crisis, many Federal and State regulators had
authority to protect consumers, but few viewed it as their
primary mission. As abusive practices spread, particularly in
the market for subprime and nontraditional mortgages, our
regulatory framework proved inadequate. And this lack of
oversight, as the Chairman said, led millions of Americans to
make bad financial decisions that emerged as a core part, a
core cause of this crisis. Consumer protection is not just
about individuals, but it is also about safeguarding the system
as a whole.
Now, this Committee, the Congress, and the administration
have already taken important steps to address consumer problems
in two key markets--those for credit cards and the beginning
mortgages--and our view is that those are a sound foundation on
which to build more comprehensive reform.
We propose the establishment of a Consumer Financial
Protection Agency to serve as the primary Federal agency
looking out for the interests of consumers of credit, savings,
payments, and other financial products. This agency will be
able to write rules that promote transparency, simplicity, and
fairness, including standards for standardized, simple, plain
vanilla products that have straightforward pricing.
Our third priority is to make sure that reform, while
discouraging abuse, encourages financial innovation. The United
States remains the world's most vibrant and most flexible
economy in large measure because our financial markets create a
continuous flow of new products, services, and capital. That
makes it easier for the innovator to turn a new idea into a
growing company.
Our core challenge, though, is to design a system which has
a proper balance between innovation and efficiency on the one
hand and stability and protection on the other. We did not get
that balance right, and that requires substantial reform. We
think the best way to keep the system safe for innovation is to
have stronger protections against risk with stronger capital
buffers, to have greater disclosure so that investors and
consumers can make more informed financial decisions, and a
system that is better able to evolve as innovation advances and
the structure of our financial system changes in the future.
Now, I know that some suggest we need to ban or prohibit
specific types of financial instruments as too dangerous, and
we are proposing to strengthen consumer protections and
investor protections and enforcement by, among other things,
prohibiting a range of abusive practices, such as paying
brokers for pushing consumers into higher-priced loans or
penalties for earlier repayment of mortgages.
In general, however, we do not believe you can build a
system based on--a more stable system based on an approach of
banning on a periodic basis individual products because those
risks will simply emerge quickly in new forms. Our approach is
to let new products develop, but to bring them into a
regulatory framework with the necessary safeguards in place.
Our tradition of innovation in the financial sector has
been central to our prosperity as a country, so our reforms are
designed to strengthen our markets by restoring confidence and
accountability.
Finally, Mr. Chairman, a fourth priority is to address the
basic vulnerabilities and our capacity to manage future crises.
We came into this crisis without an adequate set of tools to
confront and deal with the potential failures of large, complex
financial institutions. That left the Government with extremely
limited choices when faced with the failure of the largest
insurance company in the world and some of the world's largest
investment banks. And that is why, in addition to addressing
the root causes of this crisis, putting in place a better
framework for crisis prevention in the future, we have to act
to give the Government better tools to manage future crises.
At the center of this, we propose a new resolution
authority modeled on the existing authority of the FDIC to
manage the failure of weak thrifts and banks, and that will
give us more options in the future that we should have had
going into this crisis. This will help reduce moral hazard by
allowing the Government to resolve failing institutions in ways
that impose costs on owners, creditors, and counterparties,
making them more vigilant and prudent.
Now, we have to also minimize moral hazard created by
institutions that emerge with a scale and size that could
threaten stability. No one should assume that the Government in
the future will step in to bail these institutions out if they
fail. We will do this by making sure financial firms follow the
example of families across the country and build bigger
protections, bigger cushions, bigger safeguards as a precaution
against bad times. We will require all firms to keep more
capital and more liquidity on hand as a greater cushion against
future losses and risks, and the biggest, most interconnected
firms will be required to keep larger cushions, larger shock
absorbers against future shocks.
Now, the critical test of our reforms will be whether we
make the system strong enough to withstand the stress of future
recessions and strong enough to withstand the failure of large
institutions in the future. These are our basic objectives. We
want to make the system safer for failure and safer for
innovation. We cannot afford inaction. As both the Chairman and
Ranking Member said, I do not think we can afford a situation
where we leave in place vulnerabilities that will sow the seeds
for future crises, so we look forward to working with this
Committee in the weeks and months ahead to put in place a
stronger foundation for a more stable financial system in the
future.
Thank you very much, Mr. Chairman.
Chairman Dodd. Thank you very much, Mr. Secretary.
We have a full complement of Members here this morning, and
so I am going to be a bit more disciplined about the 5 minutes.
That way we can get through the Members who are here;
otherwise, if it goes on too long, we do not get a chance to do
that. So I will instruct the clerk to put that clock on, and if
Members would be careful to watch it themselves so we get to
include everyone in the questioning this morning.
Let me begin, Mr. Secretary, with a question regarding
mortgage protections. I strongly support your notion of a
Consumer Financial Protection Agency. I would point out to you,
as I know you are aware as well, we gave the authority back in,
I think, 1994 with the HOEPA legislation. It was not a request
but it was a mandate that they formulate regulations to protect
against some of the very abuses that led to the mortgage crisis
in the country. And so merely designating someone to do a job
does not always get the job done, obviously, as we have learned
painfully in all of that.
What I would like to know is, while it is not included
specifically--and the other body, the House, has dealt with
this differently--there is a strong interest on this Committee
to deal with the mortgage reform provisions in the bill. And
what I want to get from you, if I can, at the outset, would you
be willing to work with us on including language as part of
this overall reform effort that would do that as well?
Secretary Geithner. Yes. We think that is very important.
Chairman Dodd. Well, I appreciate the answer to that.
Let me go to the issue--and, again, I want to state--I
think all of us have had a chance to talk about this, and
obviously the debate about, one, whether or not you want a
systemic risk regulator, which I certainly do, and then the
question who does it and what authorities do you give them.
From my standpoint, I am open on the issue. I have not made
up my own mind what is the best alternative. Obviously, you
have submitted a plan that gives that authority to the Fed. But
let me raise some questions that have been raised by others
about the wisdom of that move to the Fed and not looking at the
more collegial approach or some other alternative.
A fellow by the name of Mark Williams, a professor of
finance and economics at Boston University and a former Fed
examiner, said the following: ``Giving the Fed more
responsibility at this point''--and he had a rather amusing
analogy--``is like a parent giving his son a bigger, faster car
right after he crashed the family station wagon.''
SEC former Chairman Richard Breeden testified before this
Committee, and he said the following: ``The Fed has always
worried about systemic risk. I remember in 1982 and 1985 the
Fed talking about that it worried about systemic risk. They
have been doing that, and still we had a global banking crisis.
The problems like the housing bubble, the massive leverage in
the banks, the shaky lending practices, and subprime mortgages,
those things were not hidden. They were in plain sight.''
And perhaps most significantly, Chairman Volcker in
response to a question by Richard Shelby back in February in a
hearing we had in this Committee testified that he had concerns
about giving the Fed too many responsibilities that would
undermine their ability to conduct monetary policy.
So the question that many are asking, not just myself but
others on this Committee and elsewhere, is: Given the concerns
that have been expressed by the former Chairman of the Federal
Reserve, the former Chairman of the SEC, and others about the
Fed's track record as well as the multiple responsibilities
that the Fed already has, why is it your judgment that the Fed
should be given this additional extraordinary authority and
power? And does it not conflict in many ways or could it not
conflict with their fundamental responsibility of conducting
monetary policy?
Secretary Geithner. Mr. Chairman, I agree with you. These
are some of the most important issues we are going to have to
confront together, and I think that you and many others have
expressed a number of thoughtful concerns about not just the
role of the Fed going forward, but how to think about the right
mix of accountability and authority in these areas. So let me
just say a few things in response.
I think you need to start--we need to start with the
recognition that central banks everywhere around the world, in
this country and everywhere else, were vested with the dual
responsibility at the beginning for both monetary policy and
some role in systemic financial stability. That is true here.
It is true everywhere. And there is no, I believe, no necessary
conflict between those two roles.
For example, the Fed has got an exemplary record of keeping
inflation low and stable over the last 30 years, even though it
had the set of responsibilities you outlined that take it into
the areas of financial stability. So I see no conflict.
The second point I would make is the following. If you look
at the experience of countries in this financial crisis who
have taken away from their central bank, from their equivalent
of our Federal Reserve, and given those responsibilities for
financial stability, for supervision, for looking across the
system to other agencies, I think they found themselves in a
substantially worse position than we did as a country, with in
many ways a worse crisis, with more leverage in their banking
systems, with less capacity to act when the crisis unfolded,
for a simple basic reason, I think.
If you require a committee to act, if the people that have
to act in the crisis, if the fire department has no knowledge
of the underlying institutions it may have to lend to in
crisis, it is likely to make less good judgments in that
context. It may be too tentative to act or it may act less
with--too indiscriminately in a crisis in that context.
So if we look at the experience of many countries in the
docu-differ model, it is not encouraging. The model where you
take those responsibilities away from the central bank and vest
them somewhere is not an encouraging model, in our judgment. I
think you see those countries, if you listen carefully, moving
in the other direction.
Just a few other quick things in response. Our proposals
for the additional authority we are giving the Fed are actually
quite modest and build on their existing authorities. So, for
example, the Fed already is the holding company supervisor of
the major firms in the United States that are banks, or built
around banks, but it was not given in Gramm-Leach-Bliley clear
accountability and authority. It was required to defer to the
functional supervisors responsible for overseeing the banks and
the broker dealers. That is a bad mix of responsibility without
authority, but we are proposing just to tighten that up and
clarify it so they feel perfectly accountable for exercising
that authority.
In the payments area, the Fed has a general responsibility
for looking at payment systems, but very limited, weak
authority in terms of capital, which is essential to our reform
proposals and central to any effort to create a more stable
system. The Fed has some role today in helping set capital
requirements, but that role is very constrained by the
requirements of consensus across a very complicated mix of
other regulatory authorities.
Those are the key areas where we propose giving the Fed
modest additional authority and clarify accountability for
responsibility. They are not a dramatic increase in powers. We
are proposing to take away from the Fed responsibility for
writing rules for consumer protection and enforcing those
rules. That is a substantial diminishment of authority and
preoccupation and distraction. We are also proposing to qualify
their capacity to use their emergency powers to lend to an
institution they do not supervise in the future and to require
that to exercise that authority, they require the concurrence
of the executive branch.
So we proposed what we believe is a balanced package over
this set of independent regulatory authorities for consumer
protection, for market integrity, for resolution authority. We
propose establishing a council that will play the necessary
coordinating role. That will provide some checks and balances
against the risk that those underlying agencies get things
wrong. It provides the capacity to deal with gaps, adapt in the
future. So those are some of the reasons.
I want to just say one more thing to end. I don't think
there is any regulator or any supervisor in our country, and I
think this is true for all the other major economies, that can
look at their record and not find things that they did not do
well enough. That is certainly true of the Fed. On the other
hand, if you look at where risks were most acute in our
country, where underwriting standards were weakest, where
consumer protections were least adequate, again, where systemic
risk that threatened the system was most acute, those developed
largely outside the direct and indirect purview of the Fed and
the Fed was left with no responsibility and no ability to
contain those basic risks, and that is an important thing for
us to change if we are going to build a stronger system.
Chairman Dodd. Well, thank you for that. I only wish that
the consumer protection had been more of a distraction at the
Fed. In the HOEPA legislation in 1994, it was certainly an
example where they dropped the ball entirely and had that
authority. My time is up, but that is an underlying concern.
Anyway, let me turn to Senator Shelby.
Senator Shelby. Thank you, Mr. Chairman.
Accountability at the Fed--Mr. Secretary, the Federal
Reserve System was not designed to carry out the systemic risk
oversight mission the administration proposes to give it. It is
not a sole institution run under the direction of a single,
ultimately responsible leader. Rather, it is a Federal system
composed of a central governmental agency, the Board of
Governors, and 12 regional quasi-public Federal Reserve Banks.
The Board, as you well know, contains seven members. The
Reserve Banks are run by presidents--you were one--who are
selected by and subject to the oversight of each individual
bank's board. Within the system, the Board and the Reserve
Banks share responsibility for supervising and regulating
certain banks and financial institutions.
With decision-making authority dispersed to the Board and
Reserve Banks, who will be accountable to Congress for the
systemic risk regulation function as the ``system'' cannot
appear to testify right here before Congress?
Secretary Geithner. Senator Shelby, you are right that the
Federal Reserve structure, the system established by the
Congress almost 90 years ago for the Federal Reserve, is a
complicated mix of different things. You are absolutely right.
And we are suggesting--we do propose in our recommendations
that the Fed take a close look, in consultation with outside
experts and the Treasury, and come forward with proposals by, I
believe we say the end of October, for how to adapt that basic
governance structure to respond to some of the concerns you
have raised and we have talked about before. And I think there
are things that the Fed should reflect on there that would
provide a better balance, reduce the risk of perceived conflict
in these areas.
But I think the short answer to your question is to say the
Chairman of the Board of the Federal Reserve would be
accountable, as he is now. And I think in the current framework
of the Fed as designed by the Congress, the responsibilities
for supervision, to the extent the Fed has them now, are
concentrated at the Board of Governors, overseen by a board of
people appointed by the President, confirmed by the Senate, and
that Board and that Chairman would be the one accountable to
you.
Senator Shelby. Mr. Secretary, the administration's
proposal chooses to grant the Fed authority to regulate
systemic risk because, ``it has the most experience to regulate
systemically significant institutions.'' I personally believe
this represents a grossly inflated view of the Fed's expertise.
Presently, the Fed regulates primarily bank holding companies
and State banks. As a systemic risk regulator, the Fed would
likely have to regulate insurance companies, hedge funds, asset
managers, mutual funds, and a variety of other financial
institutions that it has never supervised before.
Since I believe the Fed lacks much of the expertise it
needs to have as an effective systemic regulator, why couldn't
the responsibility for regulating systemic risk just as easily
be given to another or a newly created entity, as some have
proposed?
Secretary Geithner. Excellent question, and let me say a
couple things in response. First is we did not envision quite
that sweeping a scope or authority as you implied in your basic
question. Our judgment is the core institutions at the center
of the system that require a stronger framework of consolidated
supervision and higher capital requirements at this stage--we
have to go through a careful process to assess this--at this
stage would largely entail the major banks and investment banks
in the country today. Now, there are some exceptions to that.
But we also believe that we want to have a system that is
flexible enough in the future if other institutions emerge that
could present the same kind of risks to the system that we saw
emerge from AIG or from Bear Stearns and Lehman Brothers, that
we want the system to be able to adapt and bring those
institutions under the same basic framework of constraints on
leverage that we think are appropriate for those banks at the
core of the system that could threaten stability. But we do not
envision quite as sweeping and broad a net as you suggested in
your initial remarks, and that is one reason why we think the
natural place for this is the Fed.
Now, the Fed--again, the Fed has, relative to any other
entity in our current system today, much more knowledge about
how payment systems work. It is, because it does execute
monetary policy on behalf of the Federal Reserve of the FOMC,
and because it does fund the government on behalf of the
Treasury, it has a greater knowledge and feel for broader
market developments than is true for any other entity in that
context. These things are all about alternatives and about
choices. We don't think it is tenable to give those
responsibilities to a committee, for reasons I think you
understand. And we do not believe there is another place in the
system better able to handle those responsibilities. And we
think to create a new institution from scratch would leave us
with a risk of losing, or not having in a moment of significant
challenge, having the necessary expertise and experience.
Senator Shelby. Thank you, Mr. Chairman.
Chairman Dodd. Senator Schumer.
Senator Schumer. Thank you, Mr. Chairman, and I want to
thank you and congratulate you on the blueprint that you put
together, Secretary Geithner, because I do believe it will
close many of the most important regulatory gaps in our system.
There are a few issues where I think the administration should
have pushed a bit farther, but this is an excellent framework
and charts a clear course to fix the problems that led us to
the crisis.
Two places I would like to just give you a pat on the back,
I agree with Senator Dodd, a Financial Consumer Product Safety
Commission is essential. The Fed failed significantly in this
responsibility. So while you have got to be leery of starting
over, in this case, you have to start over and a new agency is
what is called for.
Second, of less noticed but of great importance is the idea
that the mortgage issuer and securitizer must hold a piece of
the mortgage. That would have stopped Countrywide and others
like it in its tracks. It certainly would have greatly lessened
the crisis. It might have even avoided it. So that is a great
addition, because now they can't issue these junky mortgages
and then just not hold them and sell them.
On the systemic risk regulator, we need one, there is no
question, and the old way is certainly bad. We can criticize
any proposal, but keeping the present system is worse. Every
agency had a piece of the system to oversee and protect, but
nobody had responsibility to mind the whole store rather than
just looking after individual aisles. I agree with Senator
Shelby, it is really hard to do. But, tackle it we must, or we
risk having the same kind of widespread financial crisis that
we have just been going through. You cannot let the perfect be
the enemy of the good here or we end up with less, and believe
me, it is hard to do.
Who predicted--you could probably count on your hands and
toes the number of people in financial services, the
commentators, the press, in government, who predicted 5 years
ago that mortgages and this mortgage crisis would bring the
whole system down. It is very hard to see around the corner.
And my view, I tend to agree--I am not certain, but I tend
to agree that the Fed is the best answer. There are no great
ones. A council? That is a formula for disaster in something
like this. A council, everyone will pass the buck and it will
stop nowhere. You must have the buck stop somewhere with
systemic risk.
So then maybe you should have a new regulator, just someone
new. The problem is, you need deep, deep knowledge of how the
financial system works and a new council is going to be much
slower to start. The Fed has that knowledge. You could argue
the reason the Fed failed in the past, and it did, was because
of the attitude of some of the people at the top who were for
abject deregulation rather than the structure, but to me at
least, until shown a better example, I think the Fed, at least
tentatively, is the best one.
The question I wanted to ask you is about bank
responsibility. For years, everybody has said one of the
problems of banking regulation is that it is too divided up.
The system allowed banks, most recently and notably again
Countrywide--that has been a nemesis to me--to game the system
for the slightest regulation possible, yet your plan, while
consolidating OTS and OCC, leaves significant prudential
supervisory authority with the Fed and FDIC. If you count the
new consumer watchdog agency, which I am all for, there would
be four bodies involved in bank supervision, the same as we
started with, no consolidation. A multiplicity of regulators
tends to produce less oversight overall. The whole is greater
than the sum of its parts when it comes to a symphony orchestra
or the New York Giants, but with our patchwork system of
banking regulators, the whole is less.
So please tell us why you didn't do more consolidation, and
particularly with the Fed gaining these powers, why do they
have to be the supervisor of State banks, setting up this
duplication of systems where you have a Fed regulator, the OCC,
for the same exact bank who then shops around to be State
chartered? If you want to remove another power from the Fed,
which is getting a lot, take it away. Don't have them regulate
State banks. Why didn't you consolidate the banking regulators
more?
Secretary Geithner. Senator, we thought a lot about that,
and I think nobody would argue if we were starting from scratch
today that we would replicate the current structure that we
have of 50 State-level supervisors of banks, one at the Federal
level--we are proposing one at the Federal level--and it is a
complicated structure and I don't think anybody would advocate
starting from that if we were starting from scratch.
But I think it is fair to say, and the basic principle that
guided our proposals was we wanted to make sure we are focusing
on those problems that were central causes of this crisis, and
we do not want to put you in the position of having to spend a
lot of time on changes that may be desirable, may leave us with
a neater system, maybe a more efficient system, but were not
central to the cause of the problem.
And in our judgment, the central source of arbitrage
opportunity, the central problems we had were banks were able
to evade stronger standards applied by one supervisor--in this
case, it was the Fed's stronger standards that left Countrywide
and others to flip their charter to a thrift. The basic problem
we faced was in the thrift charter.
Now, there are thousands of thrifts across the country that
are well managed, were very conservative, demonstrated
admirable capacity to meet the needs of their community, but in
the case of too many of the celebrated failures that helped
magnify this crisis, that arbitrage opportunity was central to
the problem. So if you just look at AIG, Countrywide, you have
described many of them, you can see examples of that basic
problem.
So we thought it was necessary to fix that problem, but
while it was not essential to take on that more complicated
challenge of fundamentally transforming the rest of the system
where there is a balance now between State and Federal
supervision of State-chartered banks.
Now--and again, if you look at the opportunities that exist
now, problems created by the potential to shift from a State
charter to a national charter, I think because there are
stronger, more uniform standards in place now across those
banks, those problems--they are material in some cases, but
they are much, much less significant. So we are making a
pragmatic choice to focus on things that were a central cause
of the crisis, leaving aside for the moment changes that many
would support but we don't think are necessary to do just now.
Senator Schumer. Thank you.
Chairman Dodd. Senator Bennett.
Senator Bennett. Thank you very much, Mr. Chairman.
Mr. Secretary, good to see you and you continue to have
interesting days in the Chinese sense of that term.
I don't want to be overly parochial about this, but there
is one section of this thing that does affect my State pretty
directly, and since I only have 5 minutes, that is what I will
focus on.
Right now, one of the problems we have in the economy is
that there is not enough credit. We keep hearing, well, I can't
get a loan. I have got a good deal, but I can't get a loan. I
can't get any help. And in this proposal, you are killing one
very major source of credit where there has been no difficulty
with respect to the crisis. You said, we are trying to deal
with those that were essential to the crisis. I am talking
about ILCs. There is not a single ILC that contributed to the
crisis. There is not a single ILC that went down. And
interestingly, when Lehman Brothers went down, one of the crown
jewels of the bankruptcy was, well, at least they have got an
ILC that is functioning and that is financially sound.
And you talk about adding a modest amount of increased
power to the Fed. In this case, it is not a modest amount of
increased power, it is actually a destruction of the industry.
We are going to cancel the ILC charter. We are going to cancel
the industry as a whole.
So my basic question to you is, why does the elimination of
ILC, thrifts, and commercial ownership of banks make the system
stronger and safer when you have a track record, at least with
the ILCs, that says that they, in fact, by virtue of their
ownership have been stronger than the banks? So you are going
to wipe them out as a source of credit, take them out of the
marketplace where they are providing niche credit for people
that don't otherwise get it, and I would like to compare that
track record with the track record of bank holding companies if
you are going to say, where do you have a source of strength.
Secretary Geithner. Senator, I agree, this is a very
complicated issue and it is hard to be sure what the right path
is here. But let me just try to explain the basic principles
that underpin this basic reform.
Institutions that do things like take deposits and make
loans, institutions that do things that are basic banking
activities, they transform short-term liabilities into long-
term assets, need to come within a common framework of
standards and constraints and oversight. That is the basic
principle we establish. If we do not do that, then people--all
the risk in the system will migrate to those parts of the
system where you can do similar activities but not be subject
to the same basic standards. So our basic principle is a simple
one, is that we want to eliminate those gaps and loopholes that
allow institutions to evade those basic standards.
Now, again, we are trying to be careful to take on things
that are essential, but that principle, I think, is an
essential principle. Now, we may disagree on how best to do
that, and we would be happy to work carefully with you. We want
to be careful not to do what you suggest that we are doing,
which is to, in either the near-term or the long-term, diminish
the credit-creating capacity of this financial system, and I
don't think our proposal carries that risk. But I understand
your concern and we will be happy to work with you to make sure
that we do this carefully.
Senator Bennett. I just want to make the point that the
theory is fine. The practice says that this is an area that
worked. So one of the first things I notice in the President's
proposal is we are going to take an area that worked and we are
going to abolish it in the name of trying to make the system
that hasn't worked a little bit stronger. I just have a very
serious problem with that.
Secretary Geithner. Well, as I said, I understand your
concern and we are happy to work with you and we will work with
you closely and try to address that concern. But again, it is
true that the basic opportunity created by our structure,
particularly in the area of some thrifts, to evade the stronger
protections that exist for other institutions, did create and
did add to the substantial degree of vulnerability we saw in
our system. So we don't want to leave in place the same type of
vulnerability, allow people to shop for a weaker regime with
less rigorous standards.
Senator Bennett. You are engaged in overkill, in my view,
here. I know that the Fed has been after regulation of the ILCs
for as long as they have been around. The Fed seems offended
somehow that the regulation of ILCs is left to people like Utah
and the FDIC. And so as a matter of principle, the Fed wants to
control these. We have always prevented the Fed bureaucracy
from getting their hands on these. So now, well, if we can't
get our hands on them in the normal fashion, we will just kill
them. So I think the message I want to give and I hope I have
given is that we are going to look at this one very, very
closely.
Secretary Geithner. One of the great virtues of our system
is we can't do this without your support and encouragement of
this body here, and so we recognize in all these areas where
legislation is required we are going to have to work to try to
persuade you of the merits of these proposals and take your
concerns into consideration.
Senator Bennett. Thank you very much.
Chairman Dodd. Thank you, Senator, very much.
Senator Akaka.
Senator Akaka. Thank you very much, Mr. Chairman.
Mr. Secretary, our current regulatory structure, I feel has
failed to adequately protect working families from predatory
practices. Working families are exploited by high-cost fringe
financial service providers, such as payday lenders and check
cashers. Individuals trying to cope with their debt burdens are
pushed into inappropriate debt management plans by disreputable
credit counselors or harmed by even debt settlement agencies.
Mr. Secretary, agencies already have had the
responsibilities in these areas, but what will be done to
ensure that the Consumer Financial Protection Agency will be
able to effectively protect working families?
Secretary Geithner. Senator, that is an excellent question.
As you know, we are proposing the following things to try to be
responsive to those basic failures in consumer protection. The
first is to create a new agency that would take the existing
authority, responsibility, and the expertise, put it into one
place with a single core mission of better protecting consumers
from the risks they have been exposed to in the marketing of
products, particularly credit products to consumers. We are
going to give that agency new--we are going to give it
exclusive rule-writing authority and primary enforcement
authority in one single place of accountability.
We have laid out a set of broad standards and principles
built in many ways on the credit card legislation that moved
through this Committee and a range of other proposals from the
consumer advocates and others that would guide the writing of
rules and regulations in these areas.
The basic principles are: Much stronger disclosure, more
simple disclosure so that consumers understand the risks in the
products they are being sold; the creation of an option to
elect for a more simple standardized instrument, standardized
mortgage product, for example, so that, again, you are less
vulnerable to the risks of predation in these areas; and, of
course, there are some practices that we think fundamentally
are untenable and should not be permitted which we would
propose to ban. We have laid out some of those broad principles
in our paper, but that is the approach we recommend.
Senator Akaka. Mr. Secretary, I have concerns about
mandatory arbitration clause limitations. I believe we share a
concern on that and that it has been harmful to consumers. I
have reintroduced my Taxpayer Abuse Prevention Act. The Act is
intended to protect Earned Income Tax Credit recipients from
predatory refund anticipation loans and expand access to
alternative forms of receiving refunds. The legislation also
includes a provision that would prohibit mandatory arbitration
clauses for refund anticipation loans to ensure that consumers
have the ability to take future legal action if necessary.
Please share with the Committee why the Consumer Financial
Protection Agency should have the authority to restrict or ban
mandatory arbitration clauses.
Secretary Geithner. Senator, I would ask you to give me a
chance to reflect on that more carefully and get back to you in
writing with a more thoughtful response. But I will work with
your staff, you and your staff and try to make sure we
understand that risk and see if we can be responsive to that
concern.
Senator Akaka. Thank you. Too many Americans, Mr.
Secretary, lack basic financial literacy. Without a sufficient
understanding of economics and personal finance, individuals
cannot appropriately manage their finances, evaluate credit
opportunities, successfully invest for long-term financial
goals, or even cope with difficult financial situations. One of
the root causes of the current economic crisis was that people
were steered into mortgage products with costs or risks that
they could not afford.
Mr. Secretary, the proposal indicates that the Consumer
Financial Protection Agency will have important financial
education responsibilities. How will the CFPA interact with the
Financial Literacy and Education Commission and the President's
Advisory Council on Financial Literacy?
Secretary Geithner. Senator, I just want to agree with you
that I think a better basic education about economics and
finance is a very important thing for us to work to promote. I
think it has to happen early in life. It has to happen in what
we teach people in schools. Experience is the best teacher, and
this experience will be a searing--this crisis provides a
searing set of lessons that will, I think, change behavior
fundamentally.
But I think we can do a better job as a government in
trying to support programs that do a better job of promoting
financial literacy and I think the best thing I can say is they
are going to work closely together to try to make sure that we
are using the taxpayers' money as effectively as possible in
support of those programs.
Senator Akaka. Mr. Secretary, I appreciate all of your
efforts to better protect, educate, and empower consumers. I
look forward to continuing to work with you, the rest of the
administration, and the Members of the Committee to better
educate, protect, and empower consumers. This issue is so
important because it has tremendous potential to improve the
quality of life for our working families.
Mr. Chairman, I also appreciate all of your efforts to
protect consumers. Thank you very much, Mr. Chairman.
Senator Johnson [presiding]. Senator Vitter.
Senator Vitter. Thank you. Thank you, Mr. Secretary, for
being here.
Mr. Secretary, did Fannie Mae and Freddie Mac, problems
there, play a role in the recent financial crisis?
Secretary Geithner. Absolutely.
Senator Vitter. So going back to the fundamental focus you
said you all have for this plan to take care of the core
problems that we saw over the last year, why are we punting to
the future Fannie Mae and Freddie Mac, maybe we will get around
to it next year----
Secretary Geithner. Good point.
Senator Vitter. ----at the same time regulating areas that
were not part of the problem in the last year, as Senator
Bennett mentioned? I mean, to me, at least, it seems like we
are ignoring a core problem in the governmental sector and we
are regulating areas in the private sector that were not part
of the problem in terms of the last year, and that seems very
much at odds with what you said was your rationale in focusing
on these items and not others.
Secretary Geithner. Accepting Senator Bennett's point as I
did, which we will have to talk--we will have to spend some
time talking through--I did not believe we are proposing here
to try to solve problems that were not problems.
Fannie and Freddie were a core part of what went wrong in
our system, but Congress did legislate last year a
comprehensive change in their oversight regime, and just to be
fair and frank, we did not believe that we could at this time,
in this timeframe, lay out a sensible set of reforms to
determine what their future role should be as we get through
this crisis. We want to do that carefully and well and we did
not think that was necessary to do at this stage. But as we
said in the report, we are going to begin a process of looking
at broader options for what their future should be and what
should be the future role of those agencies in the housing
market in the future. We just didn't think it was essential to
do just now, but it is an essential thing to do. We couldn't do
it carefully enough, thoughtfully, in this timeframe.
But as you know, Congress did legislate last year a
comprehensive new oversight regime in place over those
institutions. If that had been in place before, that might have
helped mitigate this crisis.
Senator Vitter. Well, I just underscore the point that if
we can consider all of these changes on the private sector
carefully and thoughtfully in this timeframe, and I have my
doubts about that, but if we can do that in this timeframe, I
think we can attack the Fannie-Freddie issue in this timeframe,
as well.
Secretary Geithner. Can I just--I think this is a very
important issue and you are asking a very good question. It is
a very different challenge. Our challenge with Fannie and
Freddie now, and this is true about the government's role in
the housing market more generally, is more a challenge for
exit, what the future should be. We have to fundamentally
rethink what the appropriate role of the government is in the
future. We did not get that right. It was not a tenable balance
we struck in that situation.
But it is a different challenge now that we face in putting
in place the foundations of a more stable system, a clearer set
of rules of the game, stronger consumer protections. It is more
about a range of questions we face about how the government
gets out of and dials back and reverses these extraordinary
interventions we have been forced to undertake to help protect
the system from this crisis.
Senator Vitter. Mr. Secretary, the creation of this Tier 1
of institutions, tell me why that isn't a big flashing neon
sign, ``too-big-to-fail''?
Secretary Geithner. We are very worried about the same
basic problem, designed as carefully as we could to mitigate
that risk, but we haven't eliminated it completely. So let me
just say a few things in response to that concern.
Right now in the United States of America, we have a set of
institutions that are of a--play a role in markets, it is
probably because of size, but it is not principally because of
size--you know, Bear Stearns and Lehmans were not that large--
but play a role where their health and safety is critical to
the stability of financial markets. Those institutions need to
be subjected to stronger, more conservative constraints and
leverage and we need to have the capacity through resolution
authority, like we have for banks and thrifts now, to deal with
their prospective failure in the future.
Our judgment is the combination of those two things, the
explicit change in policy now to recognize that those
institutions need to be subjected to more conservative
constraints on risk taking, combined with resolution authority
to give the government better tools to manage their failure
when that happens, will help mitigate the inherent moral hazard
risk in any system that comes from the emergence of large
institutions.
Now, just one final thing, because this is an important
kind of thing--an important issue. If you look at our system
today, we are substantially less concentrated than the banking
system of almost--I think of any major economy in the world.
Less so than Canada. Less so than most of the countries in
Western Europe. We have thousands of small institutions that
play a critical role in creating a more resilient, more stable
system. We want to preserve that balance. And by establishing
this important change in principle of higher standards, higher
capital requirements on the largest, we will help mitigate the
risk in the future that we see future consolidation to a point
that would leave us with a more vulnerable system.
Senator Vitter. Mr. Chairman, if I could just ask one more
question quickly, a lot of my concerns also go to the role of
the Fed and the independence of the Fed and I would note two
huge concerns. One is that under this plan, to use certain
expanded powers and emergency steps, the Fed needs approval
from Treasury. I think that is a big change in terms of the
independence of the Fed. I think that is really crossing a line
and a sort of fundamental change in terms of the nature of the
Fed and I just point that out as a big concern, because all of
a sudden, the Fed is acting more like a department of the
government than an independent bank. It is asking Treasury for
permission in that circumstance.
Second, my other big concern is that we would be very much
diluting the focus of the Fed from stable monetary policy. To
me, getting monetary policy right is a big job, and to me it is
a crucial job. And I don't think it is any coincidence that
when we look at the periods of sustained, robust growth, at
least in my lifetime, they coincided with sustained,
predictable monetary policy and management. So I also have a
fundamental fear of diverting the attention of the Fed on what
is already a really big job and a really important job.
I know my time has expired. Thank you, Mr. Chairman.
Senator Johnson. Senator Warner.
Secretary Geithner. Mr. Chairman? Mr. Chairman, would it be
possible for me to respond briefly to his two questions at the
end? I think these are----
Senator Johnson. Yes. Go ahead.
Secretary Geithner. I know that we are going to spend a lot
more time on these issues, but I would like to respond quickly
on these two points.
It is very important to our country and exceptionally
important to the executive branch of the United States and I
think to the Congress, that the Fed preserve its independence
and its accountability for achieving sustainable growth and
price stability over time. At its inception, the Fed was given
this mix of responsibilities, both for price stability and for
a range of other responsibilities that stray into the areas of
financial stability. It is the lender of last resort to the
country.
I don't believe there is any conflict between those two
responsibilities, and I think the record of the Fed justifies
that judgment. But we want to preserve that. In part because of
that, we are being careful to make sure the Fed isn't
overextended. We are scaling back some of their existing
responsibilities even as we tighten the accountability and
authority in those core areas.
You were right that to change the way 13(3) now acts--13(3)
is the provision of the Federal Reserve Act that gives the
ability of the Fed in unique and exigent circumstances to lend
to an institution it does not supervise--to require that action
require the approval of the Secretary of the Treasury is an
important change. But we believe, and I believe the Chairman of
the Federal Reserve believes that is an appropriate,
justifiable change, in part because of the concerns expressed
by many of your colleagues, understandably, about the Fed being
pulled into doing things that go well beyond the classic
responsibilities of the lender of last resort.
And I think it is a very consequential act for the Fed to
lend to an institution it has no supervisory relationship over.
It creates an enormous risk of moral hazard. And to limit that
authority in the future, I think is a way to help reduce the
risk of moral hazard created by the exceptional response that
the government has made in this case, and if the Congress
provides resolution authority, it gives us a better ability to
deal with the potential failure of large systemic institutions
in the future and there will be less need for the Fed in the
future to use that 13(3) authority to lend to institutions that
were not under its supervisory mandate.
One final point. The Fed was very careful, and I think
appropriately so, when it acted in this crisis to lend to
individual institutions. I will just speak directly about Bear
Stearns, in the JPMorgan and Bear Stearns context and about
AIG. In that context, because the taxpayer would ultimately
bear the losses that might come with any of those basic
judgments, the Fed required the concurrence in writing of the
Secretary of the Treasury before it took those actions. I think
that was an appropriate step then, because ultimately this was
the taxpayers' money at risk, and ultimately it is the
taxpayers' burden if the government fails to get this balance
of moral hazard and safeguards right.
So I think those are some of the reasons why I think this
is an important step, but I agree with you that it is a
consequential step.
Senator Johnson. Senator Warner.
Senator Warner. Thank you, Mr. Chairman, and thank you, Mr.
Secretary. I too have some concerns about the administration's
proposals, but let me perhaps acknowledge as at least a marker
here, I think there was a piece that Steve Pearlstein wrote in
The Washington Post recently that if somebody would have said 9
months ago, 6 months ago, or even 3 months ago that we would be
sitting near the end of June with the stock market up almost 30
percent, with banks trying to repay some of their TARP funds,
and some stabilization in the housing market, I think almost
any economist or any market maker would have said that was
perhaps a too optimistic a prediction. So while we have
concerns, overall directionally I think we are headed in the
right direction, and I commend your leadership--although I
would ask--and I know under Senator Reed's leadership, he has
raised this issue as well. We still have great concerns about
what we are going to do with the warrants as these banks go
through a repayment process and that we need an overall policy
there.
I also want to echo what Chairman Dodd and Senator Shelby
have said. I think we realize the responsibility that we have
got to get it right; that if we mess this up, the unintended
consequences to not only our economic recovery but the overall
long-term financial stability for the world is really at stake.
So I hope with that caveat I can then issue some of my
concerns.
I share a lot of my colleagues' concerns about this
expansion of authority within the Fed. I also share some
concerns that putting restrictions on the 13(3) powers of the
Fed could potentially further politicize. I have made
statements already that I actually believe systemic risk ought
to be put in a council that would include the Fed, that would
include the Treasury Secretary, that would include the
prudential regulators, including the SEC, with an independent
Chair and a staff that would be solely focused on systemic risk
evaluation and have the ability and power to act. I do not
believe it would have to be a debating society, and I actually
believe that the advisory council that you have set up
unfortunately, because it has the ability to gather information
but does not have the ability to act in any way, that it is
really emasculated, and it will not provide the kind of
nonsiloed approach that I think we are looking for. I think
systemic risk by its very nature is not something you can
predict ahead of time and that the bias out of the Fed will be
too much financial institution as opposed to securities
concerns, insurance concerns, or others. So I look forward to
that conversation.
But I want to come to--I am happy to address those issues--
have you address those issues, but I would also like you to
explore a little more on the resolution authority.
I concur with you that an expanded resolution authority for
financial institutions inside the FDIC may make some sense. I
am concerned about how we fund that. I am concerned about
additional fees placed on community or local banks to, in
effect, take care of the potential failure of a Citibank.
I am also concerned that if we fully fund that on the front
end, though, with these major institutions, that pot of money
could be too tempting for diversion for other purposes.
I am also concerned about a resolution authority funding
cost for nonfinancial institutions that then might be allocated
against the banking industry.
If you could spend a little more time--and I think your
paper acknowledged there were still questions to be answered in
this area, but you are happy to attack my approach on a
systemic risk council, but I would also love to hear some
additional thoughts on resolution authority and how we fund it.
Secretary Geithner. Excellent questions, and we have not
claimed to get the details perfectly right on this, and it is
going to require a substantial amount of additional effort and
care to get the balance right.
Let me start with resolution authority first. Again, we are
proposing a model that takes the structure that works well, we
have had lots of experience with, and simply adapt it to the
somewhat more complicated challenge of large institutions built
around banks but are not only banks in some sense.
As our funding mechanism, we are proposing no ex ante fund,
no ex ante fee to fund a fund. What we are proposing is a
mechanism whereby in the event the Government were to act under
this authority and were to incur a loss as part of that action,
then it would be able to recoup that loss--have the obligation
to recoup that loss--by assessing a fee over time in the future
applied to bank holding companies.
That will help make sure that the burden for that is borne
by bank holding companies, not by the 8,000 other financial
institutions in the United States that are not smaller
community banks in that case that were not responsible for that
error. The scope of this authority would be limited to bank
holding companies and institutions we designate at the Tier 1
financial holding companies. We expect those to be principally,
at least as we see the system today, built around institutions
that have banks as part of their structure. And we think that
is a better model than the alternatives. And we have been
careful, again, not to create something that would be unfair on
the burden proposed and limit the moral hazard created by the
existence of authority like that.
Senator Warner. I know my time has expired, but let me
just--much more on this, but that would still require, though,
the public to step in with taxpayer funds as an effective
short-term bridge until you can assess that. And I would--
assess that additional fee. I might simply add amongst those
Tier 1 financial institutions--and there are clearly questions
about designating those Tier 1 financial institutions, which
other colleagues have raised, I wonder if there might not be
some, in effect, contingent liability that they could hold on
their books rather than the public funding this in the interim
and then coming back. And if they had that contingent liability
on their books that they could keep as their additional equity,
that also might help them self-police better amongst their
colleagues.
Secretary Geithner. We actually did spend a fair amount of
time thinking through an idea like that, and it may be that
something like that would be feasible as part of this. But we
did not see a way to design that that would provide quite the
same practical solution to this problem. But it is an
interesting idea, and I would be happy to talk to you about
that further.
I want to come back on the council thing, but we will have
a chance to come back on it.
Senator Johnson. Senator Bunning.
Senator Bunning. Thank you, Mr. Chairman.
I was glad to see last month, Secretary Geithner, in an
interview with Charlie Rose that ``loose money policy was one
of the primary causes of the mess we are in.'' That is a quote
from you. So tell me which part of the plan reins in the Fed's
loose money policies.
Secretary Geithner. Our plan does not address a range of
other causes of this crisis, including policies pursued around
the world that helped produce a long period of very low
interest rates and a very, very substantial boom in asset
prices, housing prices, not just in this country but in
countries around the world. And I think you are right to
underscore the basic fact that a lot of things contributed to
this crisis. It was not just failures in supervision and
regulation. And as part of what the world does, major countries
around the world, in trying to reduce the risk we have a crisis
like this in the future, it will require thinking better
through how to avoid the risk that monetary macroeconomic
policies contribute to future booms and asset prices and credit
bubbles of this magnitude.
Senator Bunning. Your plan puts a lot of faith in the
Federal Reserve's ability to spot risk and exercise its power
to prevent the next crisis. However, if the Fed and other
regulators have been doing their jobs and paying attention to
what the banks and other firms were doing earlier this decade,
they almost certainly could have prevented the mess. And the
Fed has proven it is unwilling to use its power it has. Let me
give you an example.
Just look how slow it addressed the credit card abuses, and
it took 14 years for the Fed to write one regulation on
mortgages after we gave them the power to do that. So giving
them the power and making them act are two different things.
What makes you think that the Fed will do better this time
around?
Secretary Geithner. Well, Senator, as you know, we are
proposing--and partly for the reasons you said--to take both
rule writing and enforcement authority for the protection of
consumers, particularly in the credit product area, and give it
to a new agency with sole accountability and responsibility.
Now, that will not ensure that that agency acquits itself
perfectly over time, but we think that is a necessary step.
Now, on your first point about the capacity of any
institution, much less the Fed, to predict and anticipate and
preempt any future financial crisis, let me just say a basic
view that I have about this stuff. I think we need to be
realistic in recognizing that. It will be very hard, perhaps
impossible, for any authority, any individual to anticipate and
preempt all potential sources of future risk. And I do not
think we can design a system that is premised on the ability of
any institution to carry that out effectively.
I think the real important thing to do, though, is to make
sure we establish much stronger cushions in the system, shock
absorbers in terms of capital and liquidity, better capacity to
absorb losses, withstand shocks, so that we are better
positioned to deal with potential sources of risk wherever they
emerge--and they will emerge. They will emerge. I think that is
the only real effective defense, the necessary defense, and I
think the critical failure of policy in this country and many
countries around the world in coming into this was not to
establish up front more conservative constraints on leverage in
good times so the system was better positioned to deal with
failure wherever it was going to happen.
Senator Bunning. Thank you. Do you believe these financial
reforms need to be bipartisan?
Secretary Geithner. I do.
Senator Bunning. Then why did the administration provide
detailed briefings to the entire Democratic side of this
Committee on Tuesday before the plan was released but refused
to do the same for all Republicans until after the plan was
released?
Secretary Geithner. Senator, I will say personally what I
did. I did personally host a meeting and invited Members of
both sides of the aisle to the Treasury several weeks ago to
talk through broad elements of strategy. We have been careful
to do that, and we will try to be careful going forward,
careful to do it in a balanced way, both sides of the aisle
going forward.
Senator Bunning. I am speaking about this week on Tuesday.
Secretary Geithner. Well, as I said, I have been careful to
try to make sure we are consulting broadly both sides of the
aisle, and I will do so going forward.
Senator Bunning. My last question has something to do with
TARP, because the TARP law allows you as the Secretary of the
Treasury to extend from the end of this year until next
October. I think that is a terrible mistake we made, but I also
thought that the entire TARP program was wrong.
Yes or no, are you going to use the power to extend your
TARP authority past December 31st of this year?
Secretary Geithner. I have not made that judgment yet, and
I do not think we are in a position today to make that
judgment. As Senator Warner said, you know, there are some
important signs of stability, some important signs of healing
in the financial sector. But I think it is still early yet,
premature to make that judgment.
Senator Bunning. Then you think that Treasury should have a
slush fund of $700 billion under their control, which is what
TARP is, because if you do not go above $700 billion, you can
use all the money for other purposes.
Secretary Geithner. I think what Congress designed in the
fall of 2008 gave the executive branch an important set of
authorities for trying to respond to the worst financial crisis
in generations. I think they did a good job in designing that
authority. We are being very careful to use it well.
I want to point out that $70 billion of capital invested by
my predecessor have now come back into the Treasury. An
equivalent amount of common equity has now been raised by our
major banks. And we have not provided any capital to any large
institution, with one exception--in this case, it is the
substantial problem we inherited in AIG since the
administration came into office. So we have been very careful
to use those funds prudently to protect the taxpayer, and we
will be going forward. But, on the other hand, we are still in
the midst of a very challenging recession on a global scale,
and there are a lot of risks ahead still, and we want to be
careful and prudent and not prematurely declaring victory and
depriving ourselves of the capacity to respond if this were to
intensify again.
Senator Bunning. Thank you.
Senator Johnson. Senator Tester.
Senator Tester. Thank you, Mr. Chairman, and I want to
thank you, Secretary Geithner, for being here today. I also
want to thank you very, very much for putting forth an
initiative that we can start this debate on a real basis.
That being said, there was a question asked by Senator
Schumer about starting over, and you said you did not want to
start over from scratch. When we have a crisis like we have
had--your own words, ``the biggest since the Great
Depression''--why not start with a framework that really will
be the kind of framework we need going into the 21st century
and beyond?
Secretary Geithner. I think, Senator, this framework will
meet that test. I mean, it is designed to make sure we are
looking forward, not just solving the core problems of this
crisis. So we are trying to design a framework that has that
capacity, that is flexible in the future, and we made the
judgment that--you know, we are proposing--we are proposing for
your consideration, we made the judgment that much more
substantial changes to force much more consolidation in our
oversight structure, although it has much appeal, is not
necessary and would not necessarily provide substantial return
in addressing the core vulnerabilities in our system.
Senator Tester. I look at this from the outside because I
am not from the banking industry or the insurance industry or
any part of either one of them. But I can tell you some of the
concerns brought up by the Chairman and the Ranking Member
about gaps and overlap, I still have concerns with this
proposal. And I commend you for the combination of the OTS and
OCC. I will give you another one that I think could and should
be combined, and I want to know why not if just for turf, and
that is SEC and CFTC.
Secretary Geithner. Excellent question. The Congress has
considered many times in the past proposals for merging both
entities. There is a simple, compelling rationale for doing
that. What we are proposing, though, is to begin by bringing
the underlying statutes, which are very substantially
different, even for products that have very similar attributes,
to bring those underlying statutes more into conformity. We
think that helps solve most of the substantive problems that
exist by having separate regulation of securities and futures.
It will not solve all those problems. But it is a necessary
step toward any effort to merge anyway, and so we think that is
a good place, a good challenge to take on right now.
Senator Tester. So do you anticipate into the future having
a recommendation to merge those two agencies?
Secretary Geithner. I do not anticipate that now, but that
is something, again, the Congress has considered many times in
the past, and I would expect it to be part of what Congress
would reflect on now.
Senator Tester. With some leadership from your office?
Secretary Geithner. With appropriate leadership,
suggestions, help, persuasion, analysis from our office.
Senator Tester. Thank you. Accountability--I think it is
absolutely critical. It has been brought up here with many of
the questions that have been brought up with my fellow Senators
here. I think--and correct me, and I hope you can. I think
there are still gaps in accountability, holding people's feet
to the fire that are there to do their job that, quite frankly,
are either pushing it off on somebody else because we have a
patchwork system or buffaloing somebody because they are not
doing their job.
Can you tell me how this plan improves accountability to a
point where we can reinstate consumer confidence in the
marketplace that they are being protected?
Secretary Geithner. We are trying to do two difficult
things. One is to make sure there is much clearer
accountability, matched with authority, in the areas that are
critical to building a more stable, stronger system, and those
areas are market integrity, investor protection, combined
responsibility now of the CFTC and SEC; consumer protection;
supervision of banks; resolution authority; and the ability to
deal with systemic threats to the system, which we are
investing--proposing to invest more clearly with the Fed.
That will not close all gaps in the system, but those are
the core functional responsibilities of policy in any financial
system.
Now, to make sure that we take an integrated look at the
system as a whole, to make sure the system has the capacity to
evolve in the future, we are going to establish this council
with a mandate to play that basic role, and the council will
have the ability to make recommendations for changes by the
underlying functional supervisors where there are gaps and
problems, boundaries, conflicts, overlap in that context.
Now, Senator, we are not proposing an elegant, neat
structure. We are not proposing to put together all those
functions. I would just say in part because if you look at
other countries that have done that, I do not believe you can
show sufficient improvements in outcomes in building a more
stable system. Many of the countries that adopted a much more
streamlined, simplified regulatory system still got themselves
in the position where their banking system grew to a point
where it is much, much larger relative to the economy than
happened in the United States. Our banks are roughly one times
GDP now, even with the investment banks now as bank holding
companies. In many of the major economies in Europe, banking
systems got to the point where they were 2, 3, 4, 5, 8 times
GDP in Switzerland, even with neat consolidations, more elegant
appearing, simple accountability.
So the core thing to making the system more stable is
getting the rules better, smarter, to induce thicker cushions,
better shock absorbers, better able to withstand risk.
Senator Tester. My time is up. I look forward to working
with you on these issues as we go forward. I am not sure that
the accountability is there for actually getting rough with
folks, but I appreciate--and I mean this. I appreciate your
bringing forth an initiative that we can sit down and have an
honest discussion about how to move this forward.
Thank you very much.
Senator Johnson. Senator Johanns.
Senator Johanns. Mr. Chairman, thank you. And, Mr.
Secretary, thanks for being here today. Your proposal I do
think gives us some things to consider and debate, and I think
your testimony has been very, very thoughtful. But I, like so
many of my colleagues, do have some concerns.
Let me, if I could, start with some comments that my
colleague Senator Warner made about the economy. We certainly
cannot dispute the fact that the market is better. We can look
at some other things. Certainly it is painful for all of us to
see unemployment going up. It does not show any signs of
subsiding at the moment. That hurts real people.
We are on this just historic spending spree that I think
just grows exponentially. You were in China recently. I have
worked with China as a Cabinet member. I remember the many
times China, when I wanted to talk about them opening their
market to beef, they wanted to remind me of how much debt they
had bought the week before. I think that puts us in a very
precarious position.
To use very inartful terminology, I really worry today if
what we are seeing is kind of a dead cat bounce where all we
are doing is pushing so much borrowed liquidity into our
marketplace that we are just setting ourselves up for the next
cliff.
So I wanted to say that because I think our debt, our
spending, our taxing, all of that is a very, very troublesome
trend, especially as we are starting to think about a whole new
initiative to spend over a trillion dollars, the health care
initiative.
But let me focus in on your proposal. The issue with the
Fed I think is really a fundamental issue, and I can argue it
from a lot of different directions about how uncomfortable I am
to see the Fed get in the middle of this.
On the one hand, I must admit, although some of my
colleagues on this side of the aisle would probably argue with
me, the independence of the Fed has served us well over time. I
really believe that. I have watched Presidents avoid
criticizing the Fed as interest rates went up and this and
that, so that independence I think is a good thing.
The more we entangle them in managing systematic risk or
overseeing systematic risk, et cetera, the more we are going to
be tempted--maybe not us so much, but the next generation, the
next generation of Congress, the more the temptation is going
to be to demand that oversight--justifiably so, I might add--
then all of a sudden the independence I believe starts to go
away.
I would like to hear your thoughts on that issue, and then
I would also like your thoughts on--on page 3 of your proposal,
you talk about the Financial Services Oversight Council dealing
with identifying emerging systemic risk and then the new
authority of the Federal Reserve. Was it your attempt there to
try to blend maybe the idea of this collegial oversight of
systemic risk with the Federal Reserve actually being a
regulator here? Talk us through that, because I find that to be
an interesting concept, actually.
Secretary Geithner. Senator, let me just begin by saying
you are right to underscore the risk we still face in the
economy going forward. You know, what we have achieved is some
stabilization. Output and demand are no longer falling at the
same pace it was at the end of last year. That is an important
beginning. But it is just a beginning. There are substantial
risks ahead. And I think you are absolutely right that a
critical part of getting a recovery in place is going to be to
convince the American people and investors around the world
that we are going to have the will, working with the Congress
to bring those deficits down over time. But, remember, we
started with deficits in the range of 10 percent of GDP when
the administration came into office because of both the cost of
the crisis and the impact of policies put in place the last 8
years, and the additions we have made--we have proposed with
the Congress to get us out of recession were modest increments
to those deficits, and we believe they were necessary to avoid
the risk of a deeper recession, and even higher future
deficits. But I understand those concerns, and we share those
concerns. It will be absolutely critical to get our fiscal
position down to a sustainable position once we get recovery
back on track.
In terms of the Fed, I think I just would say it this way:
We are very committed and it is very important that we preserve
the independence of the Fed and its basic credibility over its
responsibilities for monetary policy. And we would not
recommend proposals that would limit that flexibility or put
that at risk in some sense because that is important to any
effort to build a well-functioning economy in the future. If we
lose that credibility, that would be very damaging.
So I share that concern very much, and we have been very
careful not to create risk. In fact, as I said, some of the
proposals we are making to scale back and limit are designed to
reduce the risk that in carrying out its core financial
stability functions we do not put them in the position where it
would risk greater tensions with that core mandate for price
stability and sustainable growth in the future.
You are right, and the council does try to strike a
balance. The council does bring together at one place around
one table with clear responsibility for looking at the system
as a whole. Each of these underpinning parts of the system we
are preserving do have responsibility because I think they
could cause systemic damage. That is an important check and
balance in some sense on the scope of independence, without
confusing accountability. I think it does not change their
statutory framework. It does not qualify their authority in
that context, but it does provide the ability to recommend and
induce changes if they are behind the curve or their big gaps
are not closing.
So we are trying to get that balance right. I agree some
people will say it is too weak, but we do not believe we could
give a council the authority and the accountability for doing
core supervision, for example, of large institutions or for
responding to crises given the speed with which they can
evolve.
Senator Johanns. Mr. Chairman, thank you very much, and,
again, Mr. Secretary, thanks for giving us this starting point
here.
Senator Johnson. Senator Menendez.
Senator Menendez. Thank you, Mr. Chairman.
Mr. Secretary, thank you for your service and particularly
at incredibly challenging times. You know, I have heard some of
the criticisms already leveled, and while I do not agree with
every element, I think it is a great foundation, actually. But
I think it takes a pretty short memory to ignore what got us
into this crisis and dismiss the need for accountability. That
is basically like saying let us do this all over in 10 years
again, and I do not think the American people want to go down
that road. So I appreciate the effort here.
You know, throughout these hearings, I have asked a
fundamental question--at least for me it is a fundamental
question. If we have institutions that are too big to fail,
have we not failed already because they create systemic risk,
and they also leave for potentially bad decisions along the way
because they know that they will ultimately be bailed out?
So I saw the road that you have traveled here in trying to,
I think, deal with that question with reference to increased
capital requirements, but is that really sufficient to get to
the heart of that question? You know, I understand bringing up
those capital requirements now, but how is it going to be a
continuing function so that we ensure that if that is one of
our major vehicles to avoid too big to fail, that it will be a
constant movement that will ensure us that that is a break on
that possibility?
Secretary Geithner. Senator, again, this is a critical
issue. Again, I think the acid test or the critical test of
credibility of any system is: Is it strong enough to withstand
the pressures that could come with a failure of a large
institution? Because if you do not build the system strong
enough to withstand those pressures, then the Government will
be forced over time in future crises to intervene to prevent
their failure, and that will create the risk of greater crises
in the future. So that is critical to the objective of what we
are trying to achieve.
I believe the best way to do that and the really only
effective way to do that is, again, to make sure there are
tougher constraints on leverage and risk taking in the future,
applied not just to every institution that is a bank does
those--takes those kind of risks, but to the largest in
particular; that the core markets where institutions come
together to transact also have thicker safeguards, thicker
cushions to prevent the contagion that can be caused by default
of a major institution, and to have better tools for managing
an orderly failure of a large institution through resolution
authority.
I think that mix of proposals I think represents the best
hope of limiting the moral hazard risk that comes from any
modern financial system where you can have some institutions
whose role in markets by definition is so important that, if
they get in trouble, it is going to risk undermining the
broader health of the economy as a whole.
So I think that is the best mix. A lot of people, a lot of
thoughtful people have ideas in this area. We will be open to
ideas, and we will look at whatever we think the best balance
of proposals are to deal with that challenge.
Senator Menendez. You know, one of the things you propose
and some of my colleagues have already raised is the oversight
council, and I think that has a valuable function in watching
for developments that pose risk to the banking system and
better coordinating the regulators. My concern, again, is that
it is basically advisory and it has no power to carry out
corrective actions that will be needed in response to the
council's own findings.
So give me a sense of how do you envision--so the council
comes up with a series of findings that say, hey, this poses
risk. What happens if an individual regulatory agency
disagrees? What happens when, in fact, the council's conclusion
that a particular product or activity poses a risk to the
financial system, how is the corrective action going to be both
considered and acted upon if it is only advisory at the end of
the day?
Secretary Geithner. You are right. That goes to the core of
the basic judgment we are making. We are giving the council the
power to collect information, the responsibility to look across
the system, and the power to recommend changes, but not the
power to compel or force changes because that would
fundamentally change and qualify the underlying statutory
responsibilities of those agencies and I think that would
create the risk of more confusion and less accountability,
frankly. But that is a difficult balance to get. I am not sure
we have got the balance perfect, but I think that to invest in
a committee responsibility to force those kind of changes
would, I think, lead to more diffusion of accountability and
more uncertainty.
Senator Menendez. But under your proposal, you give the
Federal Reserve significantly, for example, significantly more
authority, yet the reality is they had knowledge and authority
to address the mortgage problem long before it became a crisis
and they didn't act. And so in my mind, how is it that we
ensure that at the end of the day, the regulators do their job,
because from my perspective, they were asleep at the switch
instead of being the cop on the beat. So how do we ensure that
in this policy?
Secretary Geithner. Well, that is an important
responsibility of the Congress. This council does bring them
together. It does have to provide reports to the Congress. Its
recommendations will be public. That gives you a little more
reinforcement in carrying out their oversight responsibility
and I think that is worth doing.
Will it--it will not--I cannot tell you, standing here
today, and say it will prevent all regulatory failures in the
future, and there may be issues in the future where we fail to
adapt quickly enough. But it is a substantially better
structure than we have today and I think it is a better balance
of authority and accountability than an alternative model that
would give the council the ability to override qualified change
fundamentally the existing statutory responsibilities of those
agencies. I think that would be confusing, confusing to the
markets, and it would lead to more of this going on.
Senator Menendez. Mr. Chairman, I know my time is up. I
look forward to working with you. I have some suggestions and I
look forward to working with you as we move forward. Thank you.
Senator Johnson. Senator Martinez.
Senator Martinez. Thank you, Mr. Chairman.
Secretary, thank you for being here and thank you for the
hard work you have been undertaking in the many months you have
been on the job. I have a question about this whole notion of
systemic risk. In the past, we saw the government-sponsored
enterprises, that they, in fact, had an implicit, which became
explicit, government guarantee. By doing so, they were able to
borrow at cheaper rates. As they borrowed cheaper than the
private sector, they essentially squeezed out competition, grew
larger. As they grew larger, their risk to the economy became
systemic. They grew yet larger. Competition went further away.
And they are, as we have discussed here earlier already, a key
component of what went wrong with our system.
How do we not come right back into this in a broader sector
of the economy--this was just securitized mortgages--but doing
the same thing now in insurance, in other financial services,
et cetera, by creating a group of entities that are too big to
fail, therefore having an implied guarantee from the
government, therefore being able to borrow cheaper money?
Secretary Geithner. Excellent question and a core concern
that shaped our recommendations. Just to go back to where you
started on the GSEs, remember, these institutions were allowed
to operate with this implicit guarantee. As you said, lower
borrowing costs take on a huge amount of leverage. They were
not subjected to remotely conservative--sufficiently
conservative capital requirements and there was no mechanism
established in the law for dealing with their potential
failure.
Congress created, at least laid a foundation for fixing
both those problems in the legislation it passed last year.
That is a beginning, but it is only a beginning. As I said to
one of your colleagues earlier, we are going to have to come--
we are going to make recommendations once we get through this
proposing what we do with those institutions in the future.
What we are proposing for the rest of the system is based
on that lesson, in many ways, which is stronger, more
conservative capital requirements where there is the risk of
moral hazard in the system and a resolution authority that
gives us the capacity for managing failure. Those are the two
critical things to do and our core responsibility, I think, is
to do those key things and that will help mitigate the risk
that you referred to which we, of course, are deeply concerned
by, that the actions that we have created and that we have
taken in this crisis to contain the damage will sow the seeds
of future crisis by leading people to believe they will be
insulated from the cost of future mistakes.
Again, the best protection against that is to make the
system safe for failure in the future, reduce the risk of large
pockets of excess leverage with conservative capital
requirements, and better tools for managing failure,
orchestrating an orderly unwinding of a large, complex
institution in the future.
Senator Martinez. I still don't know how we will avoid
the--and I agree with you completely that the GSEs were well
undercapitalized, underregulated, and there was no plan for
their dissolution. However, how do not a group of companies
become then those that are too big to fail, which in turn
allows them to borrow cheaper money? I mean, once the risk of
failure is diminished by government backing, implicit that
becomes explicit, aren't they in a position to borrow cheaper
and therefore squeeze out competition from those who are not
considered systemically important?
Secretary Geithner. That challenge is at the heart of bank
regulation. With the establishment of deposit insurance, with
access by banks to borrow from the Fed against collateral, you
do create the risk. You do create a lower borrowing cost and
you create the risk that there is an implicit support from the
government coming in crisis.
The only ways we know to counteract that risk are to make
sure there is strong oversight, a consolidated basis, more
conservative capital requirements, and better capacity to let
institutions fail when they get themselves to the point where
they have managed themselves to the point of vulnerability. I
am not trying to oversimplify it, but if we don't get those two
things right, nothing is possible and they will get us a
substantial distance to the point where we are limiting the
moral hazard created by the role they play in the system.
Senator Martinez. On the GSEs' future, I just wanted to
find out from you what your thoughts were in terms of when this
consultation process might conclude and would the FHFA be
involved in this process? I presume they would be. In other
words, who will be the coordinating council or whatever this
group is going to be called that is going to analyze and study
and make recommendations on the GSEs and what opportunity will
there be to comment, for people to participate, et cetera?
Secretary Geithner. To be honest, Senator, we have not
designed yet the full details of the process we think would be
helpful in terms of exploring all alternatives. But we will
involve the FHFA and Department of Housing and Urban
Development. Treasury will coordinate the process. We will
consult not just with this Committee, but with your
counterparts in the House, and we will try to consult broadly
in the markets and the academic community as we think through
broad options.
I actually can't recall what we proposed in the paper in
terms of a timeframe, but I think it would be reasonable for us
to start to bring forward recommendations and options sometime
in the first half of next year.
Senator Martinez. Thank you, Mr. Chairman.
Senator Johnson. Senator Bennet.
Senator Bennet. Thank you, Mr. Chairman.
Mr. Secretary, it is good to see you. Thank you for your
efforts here.
Over the last 5 months or 6 months or whatever it has been,
what I have discovered is that with respect to the Federal
intervention in the immediate crisis, I think it is fair to say
there is very little consensus about the details of that or
about it as a whole, and I know that presents a huge struggle
for you and for the administration because everybody is a
critic but not everybody has to come up with a solution and I
think you have worked hard to try to get through a lot of this.
I think there is also limited consensus still about what we
ought to do to fix the problem we have got prospectively.
What people have come to understand is that we have come
out of a decade where our savings rate as consumers dropped to
zero, the Federal debt ballooned from $5 trillion to $10
trillion, and banks or financial institutions on Wall Street
that historically have been levered at 12 times were levered at
25 and 30 times, all of which, as you said in your testimony at
the beginning, when it all came crashing down has left our
families in an unbelievably vulnerable position--jobs lost,
houses lost, college educations deferred for people all over my
State and all over the country.
And I know that we are designing this prospectively, but
for the folks watching this at home, if we could rewind the
movie that we just had play out of a period of an absurd amount
of leverage in our economy, of risky decisions that should
never have been made by people that should have been known
better, of risks that were taken actually in plain sight but we
missed it, all of us, in part because of the way our regulatory
system was designed, as you rewind that movie in your head,
looking back, let us imagine that the regime that is being
proposed was in place and how would things have been different
as a result of that?
Secretary Geithner. If what we are proposing today had been
in place, it is--banks would not have taken on so much risk.
Institutions that were not regulated as banks would not have
been permitted to take on that level of risk. Consumers would
have been less vulnerable to the kind of predation that we saw,
particularly in mortgage products, and the government would
have had the ability to act earlier, more swiftly, to contain
the damage posed by the inevitable pressures that come when
firms fail. You know, again, we want a system where innovation
can happen, when firms can fail, where investors are
accountable for the risks they take in some sense, but you have
to create a system that is strong enough to allow that to
happen.
So that is a simple way to say banks would not have been
able to take on this much risk. You wouldn't see this much risk
buildup, leverage buildup outside the banking system to a point
where it would threaten the stability of the system. And
consumers would have been less vulnerable to the kind of
predation we saw, and the government would have been able to
act sooner.
Senator Bennet. In sort of the combination of the council
versus the Fed versus the Consumer Protection Agency and all
this, who would have detected that we have got these things out
here called credit default swaps that are mounting on the
balance sheets of our banks and that is a cause for concern,
and to whom would they have communicated that and what action
would have been taken as a result?
Secretary Geithner. They were a bit of an orphan in the
current structure. But under this regime, we are giving the SEC
and the CFTC much more explicit authority. We are pushing the
standardized piece of those products onto central
clearinghouses, onto exchanges and transparent electronic
trading platforms and giving the SEC better authority to deal
with potential manipulation and fraud in those areas. That
would have helped. If they were behind the curve and failed to
act in that context, then the council would have the ability
and the authority to bring that to light and to urge them to
fix that problem.
So I believe under this model, you are going to have the
Secretary of the Treasury doing something I don't believe you
have ever asked the Secretary of the Treasury to do, which is
to come before the Congress on a regular basis and report on
evolution of risk in the system and whether the overall system
as a whole is doing an adequate job of responding to those
risks.
Now, we won't have the full authority that Congress has
given to the underlying regulatory agency. They will each have
a piece of responsibility for that. But in some sense, you will
be able to look to the executive branch to say, does the whole
thing work? Are we dealing with gaps? Are we adapting to
emerging risks? And I think that will be a substantial
improvement.
Senator Bennet. And then--Mr. Chairman, one more question--
and then if all that left us in the position where an
institution that was a bank holding company found itself in
crisis, we then have a new approach to resolution authority, as
well, that you are proposing.
Secretary Geithner. We would. We would have a capacity to
act earlier, I think more effectively, possibly at less cost to
the taxpayer to contain the damage to the economy from that
kind of specific challenge.
Senator Bennet. Thank you, Mr. Secretary. Thank you, Mr.
Chairman.
Senator Johnson. Senator Corker.
Senator Corker. Mr. Chairman, Mr. Secretary, always good to
see you. Thank you for your service.
Secretary Geithner. I am not Mr. Chairman yet, but I----
Senator Corker. You know, I read parts of this proposal and
I almost imagined a couple of folks sitting around at the White
House drinking Diet Cokes, and especially when a lot of the
heavy lifting wasn't addressed, the GSEs and CFTC and the SEC,
only portions were addressed, and I think numbers of people on
both sides of the aisle have alluded to that. And yet I saw
that the Fed was a clear winner in this. I think everybody on
this panel would agree with that.
This administration has received accolades in some quarters
for trying to make sure there are no conflicts of interests and
lobbyists can't be hired and all that. I wonder if it would
make sense, since there will be a lot of interaction with you
guys and obviously there will be some arm twisting and
consultations taking place, I am sure--would it make sense for
the President to, in writing, tell all of us that no one
involved in creating this at the White House or cabinet will be
appointed as Fed Secretary, or Fed Chairman?
Secretary Geithner. No, I don't think that would be
appropriate, nor do I think it would be necessary.
Senator Corker. It is interesting to look at the new----
Secretary Geithner. I think you expected that answer,
Senator.
Senator Corker. I actually expected that--I don't know. I
think it would be good for us to know as we move through that
none of the folks involved in helping create these new powers
under the Fed are potential Fed Chairmen. I think that would be
good to know. But I will leave that to you all.
Let me just move on. The resolution authority, you and I
have talked about this since the very first time you came up
here. It seems to me that what you are doing is, in essence,
making TARP exist in perpetuity. I know that you have the
authority to actually cause organizations to not exist, but you
also hold upon yourself the ability to do exactly what is
happening in TARP today. I think most of us don't like that
much. I think most of us would like to see that end.
I know you were asked earlier whether you were going to
extend it. And I just wonder, you know, the ad hoc nature of
what has occurred, I think is what has created much of the
instability, and yet you resume under yourself under this
resolution, the power--the ability to do exactly what is taking
place under TARP and I am just wondering why that makes much
sense and not going ahead and having something that is very
clear cut. Some people have talked about a special bankruptcy
court. Some people have talked about the FDIC resolving. But
you, in essence, are reserving to yourself the ability to cause
TARP to go on into the future.
Secretary Geithner. No, Senator. I know you have said that
many times, but it is not true and we wouldn't do that. TARP is
temporary. It will be temporary. It will, fortunately, go out
of existence when the statute expires, and maybe before that.
What we are proposing is to take this model that the FDIC
has presided over, its existing checks and balances, its
existing authorities, designed for a different financial system
than we have today, and adapt it to bank holding companies and
those complex institutions that present similar risks to banks.
So we are doing the essentially pragmatic, conservative thing
in taking a model that exists, has a lot of experience, has
good checks and balances, and adapting to the financial system
we face today.
We are not proposing to sustain some indefinite capacity to
do what Congress authorized on a temporary basis--appropriately
so--under the TARP. And I would share your concerns, any
concerns people express with that kind of authority.
Senator Corker. So you would work with us to make sure that
you didn't have the ability just to conserve into the future
and make ad hoc decisions at Treasury regarding entities that
were deemed to fail?
Secretary Geithner. Well, again, Senator, the way the FDIC
mechanism works today, and we are preserving that basic
balance, any action would require a vote by a majority of the
Board of the FDIC, a majority of the Governors of the Board of
Governors of the Federal Reserve System, and the concurrence of
the Secretary of the Treasury, and institutions that have banks
at their center. Again, we are preserving that basic balance.
There is a carefully designed set of statutory criteria for
exercising that authority which we think fundamentally we can
replicate in this context. So I think that has a--again, it has
an established record, good, well understood checks and
balances, a lot of merit in replicating that basic structure.
Senator Corker. I know my time is up and I know we are
going to be talking about this a lot more. The one thing that
was interesting, I looked at--you know, the 13(3) issue has
been raised a couple of times and that jumped out. It is
interesting, and I think a lot of people have asked sort of the
questions about priorities. You know, the Fed, a lot of people
think, and I am not necessarily in every one of these camps,
but some people think that the Fed earlier on failed with
monetary policy and helped create a bubble. Some people think
the Fed actually failed somewhat supervisorally. And yet they
did a pretty good job responding quickly to an emergency.
And what you all have done here is actually sort of
hamstrung them as it relates to dealing with an emergency, but
yet on the other hand given them even greater supervisory
authority. So it is just an interesting way that you all have
gone about this and very different than what history has shown
to be good practices at the Fed itself.
Secretary Geithner. I agree with some of what you said, and
I particularly agree that the Fed, I think, in being able to
move as quickly as it did played a decisive role in avoiding a
much more catastrophic outcome for the financial system and the
economy and I think we need to preserve that authority.
Now, what 13(3) does is to give the Fed the ability to lend
to institutions it does not supervise, as I said. We are trying
to fix that basic imbalance between institutions that play a
critical role in markets and those that come under the Fed's
basic supervision. By changing the authorities of that
authority, we will reduce the risk in the future, particularly
if you give us resolution authority. It will reduce the risk
the Fed has to use 13(3) in the future to lend to institutions
outside that basic framework of protection.
But as I said, even in this crisis, where the Fed acted, I
think, very swiftly and effectively to help contain the damage,
where it used 13(3) in particular cases with individual
institutions, it did ask for the explicit concurrence of the
Secretary of the Treasury in recognition again of the potential
losses to the taxpayer that were inherent in those judgments,
and I think that was appropriate for the Fed to do. As you
know, I was closely involved in that decision and I think that
those decisions--and I think that would be appropriate to put
in place in the future. And I do not believe, but I think this
is an important concern, that that would constrain the Fed's
ability in the future.
Now, it is necessary, though, to tighten up the
responsibility and authority the Fed has now for those core
institutions, for payment systems because of the risk they
present, and for capital. I think in those three areas, the
Fed's authority is too qualified now. It has got responsibility
without clear authority and accountability and I think that is
worth fixing, basic pragmatic case for fixing that.
Senator Johnson. The Secretary must leave at noon, so I
remind Members to abide by the 5-minute rule.
Senator Reed.
Senator Reed. Thank you very much, Mr. Chairman.
Thank you, Mr. Secretary. Senator Warner also brought up
the issue of the warrants and the guidance, and another issue
which is on your long, long list to do is private equity
involvement in resolutions of failed institutions, and any
guidance, we would appreciate it at your earliest convenience.
Let me raise the issue which is going to be debated
substantively for a long time, which is the Federal Reserve
role, et cetera. You have suggested, I think, in an earlier
answer, that the Fed would by October essentially report back
to us about the changes that they have to make to accommodate
these new responsibilities. So what are we doing between now
and October in terms of moving this debate along, if we have to
wait for the Fed to sort of say, well, this is how we are going
to do it?
Secretary Geithner. I don't think you need to wait for the
Fed on that to proceed with the legislative process on design.
There is the specific set of questions around how to deal with
some of the concerns Senator Shelby and others raised about the
role of the Reserve Bank Boards, the set of firewalls and
constraints that prevent involvement of Federal Reserve Bank
Boards in supervision, a range of things like that where we
think it would be appropriate for the Fed to try to clarify,
bring recommendations for how to tighten up those kind of
safeguards and constraints, and I think that can happen on that
path without getting in the way of your efforts to consider
legislation.
I know the Chairman is considering coming together, and
will be happy, I am sure, to come before the Committee and talk
about what role they think the Fed should play in looking at
systemic risk and how to respond to the concerns many of you
raised that that not distract them from their core
responsibilities for monetary policy.
Senator Reed. You know, my sense is that with these new
responsibilities, there has to come not only new organizational
arrangements, which we would like to, I guess, have them
suggest what their recommendations are, and then second, I
think, is even the issue of culture. That is this issue of is
it safety and soundness trumps everything else? I think also,
too, in terms of transparency, one of the--my sense from
talking in hearings and just generally is that, you know, there
were rather vigorous debates in the Fed about is there a
housing bubble, is there not a housing bubble, were savings
rates too low, et cetera. That never got out.
How do we have an agency that is going to be transparent in
terms of these issues? Similarly, will there be an independent
analytical staff? Will there be someone charged, not just at
the Board, but a Deputy for Systemic Regulation that may or may
not be subject to the confirmation process? And then this
raises the bigger issue which many of my colleagues have talked
about is just oversight. Ultimately, they are imposing
legislation. I can recall, along with many others, writing
several letters, I think, to the Fed about one of these HOEPA
regulations coming out.
So these are critical issues and I wonder if you could just
comment briefly.
Secretary Geithner. I think you are right that they are
important questions and you have relayed a number of important
suggestions about how the basic structure may need to adapt,
and I think the best way to deal with these is to work through
them together with the Fed. Again, we suggest that the Fed
start to think through about what they would propose in that
area for consideration by the Committee and I don't see any
reason why that process can't move quickly.
Senator Reed. Let me just add another issue, too, that will
be part of this debate about whether the principal systemic
regulator is the Fed or a committee. FDIC is run by a
committee, I think. Frankly, aren't you on it?
Secretary Geithner. I am not on the Board of the FDIC, but
the head of the OTS and the head of the OCC are.
Senator Reed. The OCC. Thank you, Mr. Secretary. But they
seem to do a pretty good job about supervision and also
resolution and other things. Does that argue for----
Secretary Geithner. I think you are exactly right. I think
you--in some ways, the ideal institution has a strong,
independent, professional, experienced, competent staff of
experienced people, a strong executive accountable, and a board
that can provide a broader framework of oversight. I think that
basic model can work. But I think that is different from
investing a council with formal statutory authorities to change
and compel judgments by independent agencies that have a
different set of statutory responsibilities. I think that is
the difference I would make.
Senator Reed. I am going to abide by the Chairman's
admonition to stay within 5 minutes, but just one final very
quick comment. That is, I understand your proposal does include
registration of advisors to hedge funds, which is legislation
that I proposed and I think it is on the right track and we
would like to work with you. Thank you.
Secretary Geithner. Absolutely.
Senator Johnson. Senator Hutchison.
Senator Hutchison. Thank you, Mr. Chairman.
Mr. Secretary, first, I want to say that I think you have
been very thoughtful and forthcoming today and I am not yet
ready to say that I am going to give the Fed this new power,
but I think the points you made in your first answer were very
compelling so I want to--I am conflicted about the
independence, which I think has served us so well through the
years, but yet the potential compromising of that by going into
more regulation.
Second, I think that your proposal is attempting to do
something that is good. I am not sure when the devilish details
come out that it will be so. But trying to level the playing
field between banks and S&Ls surely was one of your purposes
and also streamlining the whole oversight of that. But I think
S&Ls have had a special place in our country and I want to make
sure that we still have the services that they have been so
able to give, which really started out being mortgages but
evolved into more.
I also want to make the point that I agree with Senator
Schumer, who said something earlier today that was said to me
by one of the great bankers in our State, Tom Frost, who is
also now the biggest independent banker and has been very
successful with the Frost Bank. And he said as long as you do
not require a person who originates a mortgage to keep part of
it, you are going to have problems. And I think keeping a part
of it in the originator is a very important concept that we
need to incorporate into a reform, plus, of course, servicers
and second servicers and how many iterations of that they have.
I think we need to have skin in the game, as it is described,
for everyone that is connected with a mortgage going forward.
I want to switch just for a moment for my question on TARP,
and that is to say that every one of us who was here last fall
feels that we were misled by the original intention of the
Troubled Asset Relief Program, which was to take the money to
buy troubled assets in banks to stabilize the banking industry.
Last year, that was proliferating into other areas, and it has
continued in your administration as well. So we now have 11
different programs, none of which is buying assets of banks
that are troubled.
So my question is this--as Senator Bunning mentioned, you
will be able to sign a paper and extend TARP for 10 months at
the end of this year, and you said you were not sure if you
were going to. This is my question: Do you believe that these
11 funds that have been a part of TARP that were not all a part
of the original purpose of TARP should have more congressional
oversight? Because I am looking at introducing legislation that
would provide that. And if so, do you think it would be wise
for Congress to be able to vote on all of the 11 new programs?
Or if not, what do you think would be the proper role of
Congress? Because I am not comfortable with having been misled
last year, then currently going for 10 months and then--well,
actually about 6 or 7 months, plus another year in something
that seems to have no congressional oversight.
Secretary Geithner. Senator, at the beginning of this
administration, we said that there were five areas where we
thought it was going to be appropriate to consider using TARP
authority Congress provided, and those were to help address the
housing crisis, to make sure banks have capital where they need
capital, to help support bringing back the securitization
markets, targeted programs for small business lending, and a
program to help restart these markets for loans on the balance
sheets of banks.
Now, we have moved forward to put in place programs in each
of those areas, as we said we would do. We are on the verge of
putting in place the last of those programs, which is to help
create a set of funds to help restart these markets for--you
call them ``toxic.'' We call them ``legacy assets.''
These programs are subjected to an enormous amount of
carefully designed oversight, not just by the Congressional
Oversight Panel you provided, you established under statute,
but also by a Special Inspector General at the Treasury and by
the GAO. They report monthly on everything we are doing.
We have been fully transparent about the specific terms
underpinning each of these programs so that everyone can look
at exactly what we are doing and measure their impact and their
success. We are looking very carefully at every recommendation
those oversight bodies make for bringing more transparency and
accountability to them, and where we think they make sense and
we can do them, we have adapted those recommendations, and we
will keep doing that.
It is hard to know what might be necessary in the future in
terms of using this authority, if any further use will be
required, but my sense is that if we need to do more in the
future, that anything we do will fall within those core basic
framework, which, to reduce them, are about making sure the
banking system has capital and making sure these markets are
getting going again.
Senator Hutchison. So further congressional oversight would
not be necessary or prudent, in your view?
Secretary Geithner. Well, again, I think you have put in
place an enormously powerful set of oversight mechanisms, and I
think those have done a very good job of helping provide not
just a second pair of eyes, but three additional sets of eyes
looking over everything we do. Of course, we would be happy to
look at ways to sort of strengthen accountability and
transparency because it is important to our credibility, too.
But I do not believe you need new legislation in this area.
Senator Hutchison. Thank you, Mr. Chairman.
Senator Johnson. We have time for one more question apiece.
Senator Merkley.
Senator Merkley. Thank you very much, Senator Johnson. Am I
limited to just a single question?
Senator Johnson. Yes.
Senator Merkley. Thank you, Mr. Chair.
I would like to praise the plan that you put forward, and
three things that I had been advocating for were in the plan:
the Consumer Financial Protection Agency, having a housing
expert involved in the systemic risk council, and power to
reform predatory retail mortgage practices. So I certainly
appreciate those aspects having been addressed.
In regard to the Consumer Financial Protection Agency,
would they have the power without additional input--or not
input so much but authority from some other sector to do things
such as shut down new tricks and traps introduced into credit
cards or shut down new tricks and traps introduced into
mortgage lending practices?
Secretary Geithner. Yes. Where those practices threaten
basic standards of consumer protection, they would have that
authority to set rules to constrain that and to enforce those
rules.
Senator Merkley. Thank you.
Senator Johnson. Staff indicates that you may have your
full 5 minutes.
Senator Merkley. Thank you. Thank you very much, Mr. Chair.
Well, I wanted to go on to ask, in terms of the power that
would go to the Fed under this plan, I think I have a ways to
go to see the Fed as the right place to set capital adequacy
rules, in part because of the situation in the past, for
example, they fought against keeping leverage ratios. Is that
the right place to center this kind of power?
Secretary Geithner. I think so, because I think that if you
give it to too many people, you do not have accountability for
when you get it right. And I think that they have got the best
incentives to make sure that those basic safeguards are strong
enough to help us withstand future crises.
Senator Merkley. So let me frame it a little differently.
We gave power to the Fed in the past that sat unused and
unexercised in situations where, of course, with the power of
hindsight--which is always much better than foresight--we would
have wished they had exercised that power. Is there a way to
have them address their role in monetary policy at the same
time having them see this as a major mission, a major
responsibility, and that they will not fall asleep at the
switch?
Secretary Geithner. Senator, I think I need to just say one
thing which is important to point out. If you look at the
mortgage market in the United States where practices were
worse, they were worse the greater distance you had from a Fed-
supervised institution.
If you look at where the pockets of risk in the financial
system were worse, where you had leverage go to the point where
institutions were at the edge of the abyss, no longer could
decide independently, like in the case of Countrywide, for
example, and two of the world's largest investment bank, or if
you look at AIG, those were institutions that the Fed had no
ability to affect risk taking those institutions. So I do not
think it is fair to say, looking at the record of performance
of our system over this period of time--even though, as I said,
everybody part of this system, there are areas where they could
have done substantially better. But I do not believe either in
the mortgage area or in the core things that threaten the
stability of the system it is fair to say that where those
things were most acute, they were institutions that were under
the Fed's supervision. And I did not believe that the
additional accountability and clarity of responsibility we are
proposing to give the Fed, building on their existing
responsibilities today, has any significant risk of undermining
their capacity to keep growth stable, sustainable over time,
and keep inflation low and stable in the future.
Senator Merkley. Well, I appreciate your response. I am not
fully persuaded, but I do not pretend to be an expert in this
area. But I will try to dive into it a little more and follow
up with your team, and thank you very much.
Secretary Geithner. Again, I want to just say no part of
the system acquitted itself particularly well, and everybody is
going to have to do a better job in the future, and that is why
we are proposing, among many things, a comprehensive assessment
of the basic record of supervision across agencies in the U.S.
responsible for that.
But we have to make choices going forward about how to
build a stronger system, and what we have recommended, what the
President recommended I think vests authority where it needs to
be in institutions with the best capacity to discharge that
responsibility well.
Senator Merkley. Well, thank you, and I will yield back the
balance of my time, and I do feel like the administration has
put forward a very strong proposal for us to work with. Thank
you.
Senator Johnson. Senator Crapo.
Senator Crapo. Thank you very much, Mr. Chairman. And, Mr.
Secretary, thank you for being here. I want to indicate at the
outset that I share a number of the concerns that have been
raised by my colleagues here in reference to the new
authorities to be given to the Fed. But since that has been
gone over a lot, I want to in my short time focus on an issue
that I do not think has had much attention here yet today, and
that is the bifurcation of consumer protection from safety and
soundness regulation.
It seems to me that we can get the most effective consumer
protection by not bifurcating those two functions and moving
forward in a way that allows those who are really connected
with the regulatory system of our banks to have the ability to
implement statutory and regulatory policy on consumer
protection.
What I would like to do is to read you a statement by the
Comptroller of the Currency, John Dugan, when he testified
before our Committee in March, because he made the same points
and made a number of points about why that is the case, and I
would like you to respond to his points. He says, ``The best
way to implement consumer protection regulation of banks, the
best way to protect consumers, is to do so through the
prudential supervision.'' He gives these following reasons:
First, prudential supervisors' continual presence in the
banks through the examination process put them in the very best
position to ensure compliance with consumer protection
requirements established by statute and regulation;
Second, prudential supervisors' have strong enforcement
powers and exceptional leverage over bank management to achieve
corrective action;
And, third, the examiners are continually exposed to
practical effects of implementing consumer protection rules for
bank customers. The prudential supervisory agency is in the
best position to formulate and refine consumer protection
regulations for the bank.
Could you respond to those points?
Secretary Geithner. Those are thoughtful concerns, and they
have been made by supervisors in the United States for a long
period of time, and we have had some experience with that
model, and it did not work well enough. So our basic judgment
is we need to change the model, and separating that
responsibility from the core safety and soundness
responsibility of bank supervisors is a better way to get a
better balance on both those functions.
But you are right and that is a good version of those
concerns that you quote from John Dugan, and I think those are
good arguments. But I would just say we have had a good
experiment in whether that model works, and it did not work
well enough.
Senator Crapo. So you are saying that we had adequate
consumer protection statutory and regulatory authority, but
that it was not exercised?
Secretary Geithner. No. I would say that there were
limitations both in the strength of the rules that were
established and how those were enforced. The rules themselves
were probably, I think, almost certainly not sufficiently
strong, and it is certain that they were not enforced with
sufficient rigor and evenness across the range of institutions
that allowed to generate those products.
Senator Crapo. How do you respond to the concern, though,
that one of the needs we have to focus on, at least in my
opinion--and I think this is a pretty broadly held belief--is
to streamline and make more efficient our regulatory system?
Before we got into this crisis last October, you know, most of
the focus on regulatory reform was on how to stop our slide in
competitiveness with regard to our foreign capital markets or
the world capital markets. And one of the concerns there was
that we continue to have this increase in numbers of regulators
to the point where we have double-digit regulators for any
financial function, and here we are seeing a proposal once
again to increase the number of regulatory agencies that will
now be managing our financial economy.
Secretary Geithner. Well, on balance, we are not increasing
the number of agencies. We are reducing the one important
source of arbitrage and inefficiency, which is between a
national bank and a national thrift charter. But you are right,
we are proposing to separate the consumer function from the
existing safety and soundness function and the other
authorities that have that and put it in once place with
accountability for the reasons I said, which is the current
model with a long record in it, and it did fail in important
respects.
I believe that this basic concern about the competitiveness
of our system remains a very important concern that has to
guide everything we do. But I do believe our system will be
stronger, more effective, more competitive, greater
confidence--enjoy greater confidence around the world if we
have better safeguards and protections, not just around
disclosure, which is very important, where I think we still
lead the world, but in terms of basic protections against
stability.
Our system will not be competitive, our institutions will
not be competitive if we have a system in the future that has
been as vulnerable as ours had to period crises like this every
2 to 3 to 4 years.
Now, this is the first crisis we have had in a long time of
this severity, but we have had a record over the last three
decades where every 3 to 5 years we have had a shock of
significant magnitude, and I think that does not make our
system or our institutions competitive, and a better foundation
to stability would be supportive of trying to make sure that
our system remains in many ways the envy of the world in doing
this core job of taking the savings of American investors and
channeling them to where they can be best used in support of
innovation, new ideas, growing companies.
Senator Crapo. Thank you. My time is up. I would like to
pursue this further with you, though.
Senator Johnson. Senator Bayh.
Senator Bayh. Thank you, Mr. Secretary. I would like to
start off with a comment and then two questions.
First, my comment is I would like to thank you for your
openness and the dialogue you have established with Members of
this Committee. There was a comment made previously about the
timing of briefings and that sort of thing. I was at the
breakfast that you had a few weeks ago. It was bipartisan. You
elicited comments from all of us. So I want to just go on the
record as thanking you for that.
Second, I want to commend you on the work product you have
produced here. Very difficult dilemmas to wrestle with. It
seems to me you have struck the right balance here focusing on
the core mission, putting off until later some things that are
desirable, but perhaps can be left to another day.
That takes me to my question, the first of my two
questions. I am concerned--and you alluded to this--that there
were a number of causes of the crisis that we face right now,
some macroeconomic in nature. I am concerned that your
excellent work product will go for naught and that we will be
overwhelmed once again in 5 years, 6 years, 7 years, in a ways
we cannot anticipate if those are not dealt with. And I refer
specifically to the imbalance of savings and consumption in the
world.
As the crisis, God willing, appears to be abating, I simply
do not see the willingness on the part of some countries to
rethink their basic economic models. And so I would be
interested in your comment about--I am deeply concerned that we
are going to see a recurrence of this if that is not dealt
with, so I am interested in your comment about that. In
particular, you know, on the savings side, I see Americans are
beginning to save a little bit more. That harms consumption in
the short run, but in the long run it is probably a prudent
thing. But isn't it also true that one of the best ways to
increase national savings is to get our deficit down? And I am
concerned that if you look at the size of the deficit, this
year and next year is understandable, but in the out-years it
looks like it may be larger than GDP growth, that is a
concerning thing.
So what about these macroeconomic factors and their ability
to overwhelm this architecture if they are not addressed? That
is number one.
Secretary Geithner. I think you are absolutely right. We
share that concern, and I think that it is very important as we
put in place the exceptional measures to try to address the
crisis, that we don't lay the basis for reigniting those basic
imbalances which, of course, are the problem.
Let me just try to take the encouraging side of that
argument for a second. You are right, private savings now are
significantly positive. They moved from modest negative to 5
percent, which is a good start. Historical levels before the
last three decades were more in the 8 to 9 percent and may go
that place over time, and that is a healthy development,
although you are right, it does--it will slow the pace of
recovery.
You are absolutely right that we have to bring the fiscal
deficit down over time. The Government is going to have to
spend substantially less relative to its resources over time,
and the President, as you know, is deeply committed to that.
Our current account balance has now come down from a level
that was approaching 7 percent of GDP to now below 3 percent of
GDP. That is helpful and important.
I would say as consequential, I think there is a
recognition, not just in China but in many countries around the
world, that the U.S. consumer is not going to be able to leave
the global economy out of this crisis, and you are seeing in
the basic strategy of economic policy, including in China, a
much greater attention to policies that will shift the sources
of future growth to domestic demand and consumption and
bringing about a transition from a less export- , less
investment-intensive model of growth to one more relying on
domestic demand. That would be healthy.
But we are at the beginning of that, but it has to start
with a recognition. I think you are seeing that recognition,
but I agree with you, without getting that world economy a more
balanced foundation of growth, these protections, although
necessary, could be overwhelmed in the future.
Senator Bayh. Well, I am glad that they recognize the need
to transition to a different global economic balance. I hope
they follow through once the crisis is abated because, as you
know, the economic models they have pursued are there for a
reason. They have worked pretty well for them up until now, and
you do tend to have strong vested interests within those
societies for maintaining the status quo. But it is just not
going to work anymore, and we are going to see a repetition of
this unfortunate situation if that does not change.
My final question deals with regulatory arbitrage. You have
dealt with that here domestically. My question is: What about
global regulatory arbitrage? And just as an example, in the
whole derivatives area we used to be told, well, we have got to
deal with this. And then the counter argument was, well, they
are just going to go to another country, the risky behavior
will take place, but we will lose jobs and revenue, so it is a
loss-loss.
How are we cooperating with other countries to avoid, you
know, global regulatory arbitrage?
Secretary Geithner. A very important point, and as you
know, that is a central piece of the proposals we are making.
We think there needs to be a level playing field and higher
standards globally if this is going to work; otherwise, our
safeguards will be undermined, and our institutions will be
less competitive.
We are trying a different approach this time. Rather than
putting reforms in place here, which raise standards here, and
then engaging in a long process of negotiations to get the
world to come to those higher standards, we are going to try
and do it in parallel from the beginning so we get more quickly
to a better place and are not left with these big disparities
where risk will shift where the regulatory standards are worse.
And there is a very elaborate system of cooperation in place
under the auspices of this new institution we call the
Financial Stability Board that is designed to drive consensus
and change on those core areas, capital, liquidity, resolution
of large institutions going forward. It is a critical part, and
we are going to--we should be able to report regularly on how
much progress we are making as we put in place these reforms.
Senator Bayh. Thank you very much.
Senator Johnson. Senator Kohl.
Senator Kohl. Thanks very much, Mr. Chairman.
Secretary Geithner, earlier this year I asked the FDIC
Chairwoman about the possible separation of safety and
soundness, compliance exams, and consumer protection
activities, and she replied, and I quote: ``Placing consumer
compliance examination activities in a separate organization
apart from other supervisory responsibilities ultimately will
limit the effectiveness of both programs. Over time,'' she
said, ``staff at both agencies would lose the expertise and
understanding of how consumer protection and safe and sound
conduct of a financial institution's business operations
interrelate.''
So how do you explain their objections as well as the
objections at the OCC to what you have proposed before us
today? Do you intend to work with them to remedy and alleviate
their concerns?
Secretary Geithner. Absolutely, and I think that the
Committee will have the opportunity to hear from all sides on
this and from people with lots of experience on both sides. But
I think I would just say what I said to one of your colleagues,
which is that we have had a rather searing experience with the
model that was built on integrating those two functions, and it
did not work well enough. And a core part of what went wrong in
our system was because of basic failures in consumer protection
and in some parts of safety and soundness capital regulation.
And so I do not think the current model served us well enough,
and it requires change.
But, of course, we want a system that is going to work
better on both those fronts, and our objective is to try to
make sure this new agency has the right degree of
accountability and expertise to carry out these important
functions for rule writing and enforcement of consumer
protections effectively. But I think Commissioner Bair is a
thoughtful advocate of those concerns, as is John Dugan and
others, and, of course, we will listen carefully to those
concerns because what we want to do is have a more effective
model.
Senator Kohl. Thank you, Mr. Secretary.
Second, I would like to express similar concerns that were
stated earlier by Senator Bennett about shifting industrial
loan corporation charters to bank holding charters and the
possible impact on access to consumer credit as well as
possible unintended consequences that the changes may have on
parent companies of ILCs. Are you sensitive to that. Do you
expect that we can alleviate those problems?
Secretary Geithner. Again, we would like to work with you
to try to address your concerns. You know, what we need to do--
and I think we all share this obligation--is to make sure we do
not leave gaps in the system that in the future could emerge as
another source of ways to get around stronger safeguards
applied to a bank. And what we do not want to do is allow
institutions that do similar functions, create similar risks to
the economy, to be able to operate outside the set of
protections we try to put in place.
We had a kind of searing experience with getting that
balance wrong, although I think it is fair to say that ILCs at
the moment were not a principal source of that concern. But
that kind of gap unevenness is a core vulnerability we need to
address. But, of course, we will try to work with you to
address your concerns in that area.
Senator Kohl. And you are not looking for unintended
consequences. We anticipate them.
Secretary Geithner. In everything we do, we have to be
careful that we are making the system stronger and not making
it more vulnerable. And we try to be very careful and try to
anticipate the potential adverse consequences of these changes.
And, again, we want a system that can adapt in the future,
because we will not have the foresight today to anticipate and
deal with preemptively any potential source of a risk. We want
a system that can adapt more flexibly in the future as our
system evolves, as innovation proceeds.
Senator Kohl. Thank you.
Thank you so much, Mr. Chairman.
Senator Johnson. Thank you.
Mr. Secretary, I applaud your recommendation to create an
Office of National Insurance in your reform proposal. Can you
expand on other ways the Treasury envisions modernizing and
improving our system of insurance regulation?
Secretary Geithner. Senator, we have laid out in this white
paper a set of broad principles that we should guide policy as
the Congress considers how to make sure we have a framework for
insurance regulation in the future that allows us to have that
competitive, efficient, and stable market for insurance
products. So with an entity established in the Treasury, with
accountability for thinking about these things, building up
expertise, and those broad set of principles, we think we can
begin a process of thinking about broader reforms.
Senator Johnson. Does the administration agree that
reinsurance has a good case for regulation at the Federal level
rather than the State level? What about life insurance and
property and casualty insurance?
Secretary Geithner. Senator, we have not made that judgment
yet. There are a lot of thoughtful proposals out there for
establishing the ability to have a Federal charter to engage in
a range of financial products, insurance products. Some people
would cast that license, that charter more narrowly. Some
proposals would cast it very broadly. But we have not taken a
view yet on what we think the ideal model is.
Senator Johnson. Thank you, Mr. Geithner, for your
presence, Mr. Secretary. This hearing is adjourned.
Secretary Geithner. Thank you, Mr. Chairman.
[Whereupon, at 12:06 p.m., the hearing was adjourned.]
[Prepared statements and responses to written questions
supplied for the record follow:]
PREPARED STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD
Good morning. Thank you all for being here. I would like to welcome
Secretary Geithner, who is here today to discuss the Administration's
proposal to modernize the financial regulatory system. Mr. Secretary,
we applaud your leadership on a very complex set of issues intended to
restore confidence and stability in our financial system. I look
forward to exploring the details of your plan and working with you and
my colleagues on this truly historic endeavor.
In my home State of Connecticut and around the country, working men
and women who did nothing wrong have watched this economy fall through
the floor--taking with it jobs, homes, life savings, and the economic
security that has always been the cherished promise of the American
middle class. These folks are hurting, they are angry, they are
worried. And they are wondering: who's looking out for me?
I've seen first-hand how hard people work in Connecticut to support
their families and build financial security. I've seen how devastating
this economic crisis has been for them. And I firmly believe that
someone should have their backs.
So as we work together to rebuild and reform the regulatory
structures whose failures led to this crisis, I will continue to insist
that improving consumer protection be a first principle and an urgent
priority. I welcome the Administration's adoption of this principle,
and I'm pleased to see it reflected in the plans we'll be discussing
today. At the center of this effort will be a new, independent consumer
protection agency to protect Americans from poisonous financial
products.
This is simple common sense. We don't allow toy companies to sell
toys that could hurt our kids. We don't allow electronics companies to
sell defective appliances. Why should a usurious payday loan be treated
any differently than we'd treat an unsafe toy or a malfunctioning
toaster? Why should an unscrupulous lender be allowed to dupe a
borrower into a loan the lender knows can't be repaid? There's no
excuse for allowing a financial services company to take advantage of
American consumers by selling them dangerous financial products. Let's
put a cop on that beat so that the spectacular failure of consumer
protection at the root of this mess is never repeated.
We have been engaged in an examination of just what went wrong in
the lead-up to this crisis ever since February 2007, when experts and
regulators testified that poorly underwritten mortgages would create a
tsunami of foreclosures. Those mortgages were securitized and sold
around the world. The market is supposed to distribute risk, but
because for years, no one was minding the store, these toxic assets
served to amplify risks in our system.
Everything associated with these securities--the credit ratings
applied to them, the solvency of the institutions holding them, and the
creditworthiness of the underlying borrowers--became suspect. And as
the financial system tried to pull back from these securities, it took
down some of the country's most venerable institutions--firms that had
survived world wars and the Great Depression--and wiped out over $6
trillion in household wealth since last fall.
Stronger consumer protection could have stopped this crisis before
it started. Consumers who were sold subprime and exotic loans they
couldn't afford to repay were, frankly, cheated. They should have been
the canaries in the coal mine. But instead of heeding the warnings of
many experts, regulators turned a blind eye. And it was regulatory
neglect that allowed the crisis to spread to the point where the basic
economic security of my constituents in Connecticut--including folks
who'd never even heard of mortgage-backed securities--was threatened by
the greed of some bad actors on Wall Street and the failure of our
regulatory system.
To rebuild confidence in our financial system, both here at home
and around the world, we must reconstruct our regulatory framework to
ensure that our financial institutions are properly capitalized,
regulated, and supervised. The institutions and products that make up
our financial system must act to generate wealth, not destroy it.
In November, I announced five principles that would guide the
Banking Committee's efforts.
First and foremost, regulators must be focused and empowered--
aggressive watchdogs, rather than passive enablers of reckless
practices.
Second, we have to remove the gaps and overlaps in our regulatory
structure that have encouraged charter-shopping and a race to the
bottom in an effort to win over bank and thrift ``clients.''
Third, we must ensure that any part of our financial system that
poses systemwide risk is carefully and sensibly supervised. A firm
``too-big-to-fail'' is a firm too big to leave unmonitored.
Fourth, we can't have effective regulation without more
transparency. Our economy has suffered from the lack of information
about trillion-dollar markets and the migration of risks within them.
And, fifth, our actions must help America remain prosperous and
competitive in the global marketplace.
These principles will guide my consideration of the plan you bring
to the Committee today. Mr. Secretary, I believe that we can find
common ground in a number of areas contained in your proposal. I want
to thank you, Mr. Secretary, for your leadership on these issues, as
well as for your willingness to consider different perspectives in
forging your plan. I hope you will view this as a continuation of the
dialogue you've had with Members of this Committee as we work together
to shape a regulatory framework that will serve our country well
through the 21st century.
I want to thank all of my colleagues on the Committee who have
demonstrated a strong interest in this issue. Our continued, bipartisan
collaboration will be critical to ensuring that we enact sound and
needed reforms to put our financial system back on solid footing.
And I want to urge everyone to remember that, at the end of the
day, the success of what we attempt will be measured by its effect on
the borrower, the shareholder, the investor, the depositor, and
consumers seeking not to attain extravagant wealth, but simply to grow
a small business, pay for college, buy a home, and pass on something to
their kids. That's the American Dream. That's what we've gathered here
to restore.
Thank you.
______
PREPARED STATEMENT OF SENATOR TIM JOHNSON
Thank you, Mr. Chairman, for holding today's hearing with Secretary
Geithner to discuss the Administration's new proposal to restructure
our Nation's financial services regulatory structure.
As we all know, Federal regulators were forced to make unpopular
decisions last year based on the belief that weakened financial firms
were so big and so interconnected that their failure would devastate
the world economy. Our economy began to nosedive as we faced the worst
recession since the Great Depression.
When the TARP bill came through Congress last year, I felt it did
not go far enough to improve regulation. Instead, we sent companies the
message that if they are bad actors, the government will step in and
buy the assets that are dragging their companies down.
Many of these troubled firms were deemed ``too-big-to-fail,'' and
thus we bailed them out with tens of billions of dollars in taxpayer
funds.
Yesterday, President Obama and his economic team announced some of
the biggest regulatory changes to our financial system since the 1930s.
Overall, this is a very complicated task to reform and modernize
the financial services regulatory structure. All reforms Congress
considers must help prevent a repeat of the events of the past 9 months
and must shift the burden away from the American taxpayer and to the
financial institutions that were reckless.
While the devil is in the details, it appears that the President's
plan will give regulators the teeth they need to do the job, but also
the flexibility to make sure our economy grows.
Over the coming months, the Banking Committee will work closely
with the Administration to develop legislation that should make the
needed changes to our regulatory structure and clear the way for a
stronger, brighter and more stable economic future. I look forward to
your testimony, Secretary Geithner, as we learn more details about the
Administration's proposal.
______
PREPARED STATEMENT OF SENATOR SHERROD BROWN
Thank you, Mr. Chairman, for convening this hearing on the
President's plan to improve the regulatory structure of the Nation's
financial services system.
Thank you, Secretary Geithner, for appearing before us today and
for your hard work on this plan.
Let me say at the outset that I agree with the President that we
must reform our Nation's financial regulatory system. Why? All you have
to do is pick up a paper or turn on the television to learn about homes
being lost, Americans losing their jobs because businesses can't get
access to credit, and banks being shuttered.
I believe that one of our Nation's forefathers, James Madison, said
it best when he wrote that ``If men were angels, no government would be
necessary.''
Much has been said and written about how we got here, how we
arrived at the point of needing a comprehensive overhaul of the
financial system.
One way we got here is through the free-wheeling creation and sale
of complex financial instruments that only a small percentage of the
world understands. These instruments were largely based on bets that
the mortgage market would reap huge gains indefinitely and funded by
loans to homeowners and investors, who often did not fully understand
their loan terms and in many cases could not afford them.
The other route we took involved the failure of those charged with
ensuring the health of our banking and financial services sector. I am
referring to the patchwork quilt of regulators on whom we have relied
to ensure that our bank accounts are safe and that we can invest with
the confidence that all risks have been fully disclosed.
My priorities for reform are the protection of consumers,
investors, and jobs and ensuring the stability of the Nation's
financial infrastructure.
We must put in place a regulatory structure that will not only
protect consumers and investors but protect valuable financial sector
jobs. In the news we heard about the collapse of AIG, Lehman, Fannie,
Freddie, and Bear Stearns and the numerous banks that have either
closed down or been purchased by other banks.
This really hits home in Ohio. National City, an institution that
has been a pillar of the community for more than a century and a half,
vanished over the course of a few months. We cannot forget about those
Americans as we work to put a plan in place.
It boils down to this: People in my State want their hard-earned
savings protected. They want to be able to get an affordable loan to
purchase a home--on terms that they can understand. They want to know
that when they invest, the institutions handling their investments
aren't so over-extended that a light breeze causes their house of cards
to tumble. And small businesses want access to credit without
impossible-to-meet requirements.
The Administration plan seeks to:
promote strong supervision and regulation of financial
firms;
establish comprehensive supervision and regulation of
financial markets;
protect consumers and investors from financial abuse;
provide the government with tools it needs to manage
financial crises; and
raise international regulatory standards and improve
international cooperation among financial institutions and
markets.
As we consider the Administration's plan and what I am sure will be
numerous competing proposals for regulatory reform, I have several
questions:
How will the Administration's plan actually protect the
average consumer of credit products and the average investor?
How can we have confidence that the Fed will be able to
effectively execute its new responsibilities?
How will the components of the new scheme be integrated?
How will this plan prevent us from coming back to this same
spot years from now?
We need vision and courage going forward. We also need to do more
than pay lip service to the American consumer that we are ``getting
tough'' on the institutions that caused this mess. We need to ensure
that any new powers we give to existing institutions and any new
agencies we create are designed to produce real results and not more of
the same.
We need regulatory reform because, left to their own devices, too
many financial institutions will act to preserve themselves at the risk
of the system as a whole. Sensible bankers and insurers will have to
pay the price for their selfish colleagues who think only in the short
term. And so will the rest of us.
We cannot afford the status quo. We must act now to put a plan in
place that protects consumers and investors, saves jobs, and ensures
the integrity of our financial system.
______
PREPARED STATEMENT OF SENATOR MIKE CRAPO
I intend to push for reforms that modernize and rationalize our
Federal financial regulatory system to handle the challenges of 21st
century markets while ensuring American financial companies can compete
in a global economy. Although the Administration's plan takes some
important steps, it does not link the regulatory structure to the
reasons why we regulate. Seven Federal regulators with overlapping
missions and fragmented supervision oversee our markets and financial
institutions. With the abolishment of the Office of Thrift Supervision
and the creation of a Consumer Financial Protection Agency we will
still have seven Federal regulators with overlapping missions.
Increasing the complexity and fragmented approach to our regulatory
structure is counter to reports that have identified several regulatory
problems that hinder the ability of the U.S. to maintain its leadership
role in financial services globally.
The goal should be to promote stable, orderly, and liquid financial
markets so that our financial institutions can support the economy by
making credit available to consumers and businesses. The recent
taxpayer funded bailouts and investment scandals demonstrate our
regulatory system is outdated and largely irrelevant. From banks and
securities firms to insurance companies and money market funds, nearly
all sectors of our financial system have experienced failures and
received significant amounts of government assistance.
The implications of modernizing our financial regulatory structure
are significant and we need to fully understand what the intended and
unintended consequences of these changes are. For example, certain
companies have not been allowed to fail and taxpayers have paid
unprecedented amounts to cover the costs of bank failures and to bail
out financial institutions. Does this white paper institutionalize
government bailouts in a new resolution authority and does designating
large and interconnected companies as Tier 1 Financial Holding
Companies send a signal to the markets that these companies will not be
allowed to fail?
Bifurcating safety-soundness oversight from consumer protection
raises many questions. Good supervision should incorporate elements of
both safety and soundness and consumer protection. For example, the
absence of adequate underwriting, which played a role in some of the
financial market problems that we have recently experienced, was as
much a safety and soundness issue as a consumer protection issue. By
putting the two areas into entirely different operations, each agency
will lack the expertise to understand the issues that matter to the
other, and the result could be less comprehensive oversight.
We should proceed carefully and deliberately in creating a new
systemic risk regulator. Having the Federal Reserve become the systemic
risk regulator for all large financial institutions concentrates
enormous power in one agency.
How does this plan encourage investment and responsible lending to
spur economic growth and help get our economy moving again?
______
PREPARED STATEMENT OF TIMOTHY GEITHNER
Secretary,
Department of the Treasury
June 18, 2009
Financial Regulatory Reform: A New Foundation
Introduction
Over the past 2 years we have faced the most severe financial
crisis since the Great Depression. Americans across the Nation are
struggling with unemployment, failing businesses, falling home prices,
and declining savings. These challenges have forced the government to
take extraordinary measures to revive our financial system so that
people can access loans to buy a car or home, pay for a child's
education, or finance a business.
The roots of this crisis go back decades. Years without a serious
economic recession bred complacency among financial intermediaries and
investors. Financial challenges such as the near-failure of Long-Term
Capital Management and the Asian Financial Crisis had minimal impact on
economic growth in the U.S., which bred exaggerated expectations about
the resilience of our financial markets and firms. Rising asset prices,
particularly in housing, hid weak credit underwriting standards and
masked the growing leverage throughout the system.
At some of our most sophisticated financial firms, risk management
systems did not keep pace with the complexity of new financial
products. The lack of transparency and standards in markets for
securitized loans helped to weaken underwriting standards. Market
discipline broke down as investors relied excessively on credit rating
agencies. Compensation practices throughout the financial services
industry rewarded short-term profits at the expense of long-term value.
Households saw significant increases in access to credit, but those
gains were overshadowed by pervasive failures in consumer protection,
leaving many Americans with obligations that they did not understand
and could not afford.
While this crisis had many causes, it is clear now that the
government could have done more to prevent many of these problems from
growing out of control and threatening the stability of our financial
system. Gaps and weaknesses in the supervision and regulation of
financial firms presented challenges to our government's ability to
monitor, prevent, or address risks as they built up in the system. No
regulator saw its job as protecting the economy and financial system as
a whole. Existing approaches to bank holding company regulation focused
on protecting the subsidiary bank, not on comprehensive regulation of
the whole firm. Investment banks were permitted to opt for a different
regime under a different regulator, and in doing so, escaped adequate
constraints on leverage. Other firms, such as AIG, owned insured
depositories, but escaped the strictures of serious holding company
regulation because the depositories that they owned were technically
not ``banks'' under relevant law.
We must act now to restore confidence in the integrity of our
financial system. The lasting economic damage to ordinary families and
businesses is a constant reminder of the urgent need to act to reform
our financial regulatory system and put our economy on track to a
sustainable recovery. We must build a new foundation for financial
regulation and supervision that is simpler and more effectively
enforced, that protects consumers and investors, that rewards
innovation, and that is able to adapt and evolve with changes in the
financial market.
In the following pages, we propose reforms to meet five key
objectives:
1. Promote robust supervision and regulation of financial firms.
Financial institutions that are critical to market functioning should
be subject to strong oversight. No financial firm that poses a
significant risk to the financial system should be unregulated or
weakly regulated. We need clear accountability in financial oversight
and supervision. We propose:
A new Financial Services Oversight Council of financial
regulators to identify emerging systemic risks and improve
interagency cooperation.
New authority for the Federal Reserve to supervise all
firms that could pose a threat to financial stability, even
those that do not own banks.
Stronger capital and other prudential standards for all
financial firms, and even higher standards for large,
interconnected firms.
A new National Bank Supervisor to supervise all federally
chartered banks.
Elimination of the Federal thrift charter and other
loopholes that allowed some depository institutions to avoid
bank holding company regulation by the Federal Reserve.
The registration of advisers of hedge funds and other
private pools of capital with the SEC.
2. Establish comprehensive supervision of financial markets. Our
major financial markets must be strong enough to withstand both
systemwide stress and the failure of one or more large institutions. We
propose:
Enhanced regulation of securitization markets, including
new requirements for market transparency, stronger regulation
of credit rating agencies, and a requirement that issuers and
originators retain a financial interest in securitized loans.
Comprehensive regulation of all over-the-counter
derivatives.
New authority for the Federal Reserve to oversee payment,
clearing, and settlement systems.
3. Protect consumers and investors from financial abuse. To rebuild
trust in our markets, we need strong and consistent regulation and
supervision of consumer financial services and investment markets. We
should base this oversight not on speculation or abstract models, but
on actual data about how people make financial decisions. We must
promote transparency, simplicity, fairness, accountability, and access.
We propose:
A new Consumer Financial Protection Agency to protect
consumers across the financial sector from unfair, deceptive,
and abusive practices.
Stronger regulations to improve the transparency, fairness,
and appropriateness of consumer and investor products and
services.
A level playing field and higher standards for providers of
consumer financial products and services, whether or not they
are part of a bank.
4. Provide the government with the tools it needs to manage
financial crises. We need to be sure that the government has the tools
it needs to manage crises, if and when they arise, so that we are not
left with untenable choices between bailouts and financial collapse. We
propose:
A new regime to resolve nonbank financial institutions
whose failure could have serious systemic effects.
Revisions to the Federal Reserve's emergency lending
authority to improve accountability.
5. Raise international regulatory standards and improve
international cooperation. The challenges we face are not just American
challenges, they are global challenges. So, as we work to set high
regulatory standards here in the United States, we must ask the world
to do the same. We propose:
International reforms to support our efforts at home,
including strengthening the capital framework; improving
oversight of global financial markets; coordinating supervision
of internationally active firms; and enhancing crisis
management tools.
In addition to substantive reforms of the authorities and practices
of regulation and supervision, the proposals contained in this report
entail a significant restructuring of our regulatory system. We propose
the creation of a Financial Services Oversight Council, chaired by
Treasury and including the heads of the principal Federal financial
regulators as members. We also propose the creation of two new
agencies. We propose the creation of the Consumer Financial Protection
Agency, which will be an independent entity dedicated to consumer
protection in credit, savings, and payments markets. We also propose
the creation of the National Bank Supervisor, which will be a single
agency with separate status in Treasury with responsibility for
federally chartered depository institutions. To promote national
coordination in the insurance sector, we propose the creation of an
Office of National Insurance within Treasury.
Under our proposal, the Federal Reserve and the Federal Deposit
Insurance Corporation (FDIC) would maintain their respective roles in
the supervision and regulation of State-chartered banks, and the
National Credit Union Administration (NCUA) would maintain its
authorities with regard to credit unions. The Securities and Exchange
Commission (SEC) and Commodity Futures Trading Commission (CFTC) would
maintain their current responsibilities and authorities as market
regulators, though we propose to harmonize the statutory and regulatory
frameworks for futures and securities.
The proposals contained in this report do not represent the
complete set of potentially desirable reforms in financial regulation.
More can and should be done in the future. We focus here on what is
essential: to address the causes of the current crisis, to create a
more stable financial system that is fair for consumers, and to help
prevent and contain potential crises in the future. (For a detailed
list of recommendations, please see Summary of Recommendations
following the Introduction.)
These proposals are the product of broad-ranging individual
consultations with members of the President's Working Group on
Financial Markets, Members of Congress, academics, consumer and
investor advocates, community-based organizations, the business
community, and industry and market participants.
I. Promote Robust Supervision and Regulation of Financial Firms
In the years leading up to the current financial crisis, risks
built up dangerously in our financial system. Rising asset prices,
particularly in housing, concealed a sharp deterioration of
underwriting standards for loans. The Nation's largest financial firms,
already highly leveraged, became increasingly dependent on unstable
sources of short-term funding. In many cases, weaknesses in firms'
risk-management systems left them unaware of the aggregate risk
exposures on and off their balance sheets. A credit boom accompanied a
housing bubble. Taking access to short-term credit for granted, firms
did not plan for the potential demands on their liquidity during a
crisis. When asset prices started to fall and market liquidity froze,
firms were forced to pull back from lending, limiting credit for
households and businesses.
Our supervisory framework was not equipped to handle a crisis of
this magnitude. To be sure, most of the largest, most interconnected,
and most highly leveraged financial firms in the country were subject
to some form of supervision and regulation by a Federal Government
agency. But those forms of supervision and regulation proved inadequate
and inconsistent.
First, capital and liquidity requirements were simply too low.
Regulators did not require firms to hold sufficient capital to cover
trading assets, high-risk loans, and off-balance sheet commitments, or
to hold increased capital during good times to prepare for bad times.
Regulators did not require firms to plan for a scenario in which the
availability of liquidity was sharply curtailed.
Second, on a systemic basis, regulators did not take into account
the harm that large, interconnected, and highly leveraged institutions
could inflict on the financial system and on the economy if they
failed.
Third, the responsibility for supervising the consolidated
operations of large financial firms was split among various Federal
agencies. Fragmentation of supervisory responsibility and loopholes in
the legal definition of a ``bank'' allowed owners of banks and other
insured depository institutions to shop for the regulator of their
choice.
Fourth, investment banks operated with insufficient government
oversight. Money market mutual funds were vulnerable to runs. Hedge
funds and other private pools of capital operated completely outside of
the supervisory framework.
To create a new foundation for the regulation of financial
institutions, we will promote more robust and consistent regulatory
standards for all financial institutions. Similar financial
institutions should face the same supervisory and regulatory standards,
with no gaps, loopholes, or opportunities for arbitrage.
We propose the creation of a Financial Services Oversight Council,
chaired by Treasury, to help fill gaps in supervision, facilitate
coordination of policy and resolution of disputes, and identify
emerging risks in firms and market activities. This Council would
include the heads of the principal Federal financial regulators and
would maintain a permanent staff at Treasury.
We propose an evolution in the Federal Reserve's current
supervisory authority for BHCs to create a single point of
accountability for the consolidated supervision of all companies that
own a bank. All large, interconnected firms whose failure could
threaten the stability of the system should be subject to consolidated
supervision by the Federal Reserve, regardless of whether they own an
insured depository institution. These firms should not be able to
escape oversight of their risky activities by manipulating their legal
structure.
Under our proposals, the largest, most interconnected, and highly
leveraged institutions would face stricter prudential regulation than
other regulated firms, including higher capital requirements and more
robust consolidated supervision. In effect, our proposals would compel
these firms to internalize the costs they could impose on society in
the event of failure.
II. Establish Comprehensive Regulation of Financial Markets
The current financial crisis occurred after a long and remarkable
period of growth and innovation in our financial markets. New financial
instruments allowed credit risks to be spread widely, enabling
investors to diversify their portfolios in new ways and enabling banks
to shed exposures that had once stayed on their balance sheets. Through
securitization, mortgages and other loans could be aggregated with
similar loans and sold in tranches to a large and diverse pool of new
investors with different risk preferences. Through credit derivatives,
banks could transfer much of their credit exposure to third parties
without selling the underlying loans. This distribution of risk was
widely perceived to reduce systemic risk, to promote efficiency, and to
contribute to a better allocation of resources.
However, instead of appropriately distributing risks, this process
often concentrated risk in opaque and complex ways. Innovations
occurred too rapidly for many financial institutions' risk management
systems; for the market infrastructure, which consists of payment,
clearing, and settlement systems; and for the Nation's financial
supervisors.
Securitization, by breaking down the traditional relationship
between borrowers and lenders, created conflicts of interest that
market discipline failed to correct. Loan originators failed to require
sufficient documentation of income and ability to pay. Securitizers
failed to set high standards for the loans they were willing to buy,
encouraging underwriting standards to decline. Investors were overly
reliant on credit rating agencies. Credit ratings often failed to
accurately describe the risk of rated products. In each case, lack of
transparency prevented market participants from understanding the full
nature of the risks they were taking.
The build-up of risk in the over-the-counter (OTC) derivatives
markets, which were thought to disperse risk to those most able to bear
it, became a major source of contagion through the financial sector
during the crisis.
We propose to bring the markets for all OTC derivatives and asset-
backed securities into a coherent and coordinated regulatory framework
that requires transparency and improves market discipline. Our proposal
would impose record-keeping and reporting requirements on all OTC
derivatives. We also propose to strengthen the prudential regulation of
all dealers in the OTC derivative markets and to reduce systemic risk
in these markets by requiring all standardized OTC derivative
transactions to be executed in regulated and transparent venues and
cleared through regulated central counterparties.
We propose to enhance the Federal Reserve's authority over market
infrastructure to reduce the potential for contagion among financial
firms and markets.
Finally, we propose to harmonize the statutory and regulatory
regimes for futures and securities. While differences exist between
securities and futures markets, many differences in regulation between
the markets may no longer be justified. In particular, the growth of
derivatives markets and the introduction of new derivative instruments
have highlighted the need for addressing gaps and inconsistencies in
the regulation of these products by the CFTC and SEC.
III. Protect Consumers and Investors From Financial Abuse
Prior to the current financial crisis, a number of Federal and
State regulations were in place to protect consumers against fraud and
to promote understanding of financial products like credit cards and
mortgages. But as abusive practices spread, particularly in the market
for subprime and nontraditional mortgages, our regulatory framework
proved inadequate in important ways. Multiple agencies have authority
over consumer protection in financial products, but for historical
reasons, the supervisory framework for enforcing those regulations had
significant gaps and weaknesses. Banking regulators at the State and
Federal level had a potentially conflicting mission to promote safe and
sound banking practices, while other agencies had a clear mission but
limited tools and jurisdiction. Most critically in the run-up to the
financial crisis, mortgage companies and other firms outside of the
purview of bank regulation exploited that lack of clear accountability
by selling mortgages and other products that were overly complicated
and unsuited to borrowers' financial situation. Banks and thrifts
followed suit, with disastrous results for consumers and the financial
system.
This year, Congress, the Administration, and financial regulators
have taken significant measures to address some of the most obvious
inadequacies in our consumer protection framework. But these steps have
focused on just two, albeit very important, product markets--credit
cards and mortgages. We need comprehensive reform.
For that reason, we propose the creation of a single regulatory
agency, a Consumer Financial Protection Agency (CFPA), with the
authority and accountability to make sure that consumer protection
regulations are written fairly and enforced vigorously. The CFPA should
reduce gaps in Federal supervision and enforcement; improve
coordination with the States; set higher standards for financial
intermediaries; and promote consistent regulation of similar products.
Consumer protection is a critical foundation for our financial
system. It gives the public confidence that financial markets are fair
and enables policy makers and regulators to maintain stability in
regulation. Stable regulation, in turn, promotes growth, efficiency,
and innovation over the long term. We propose legislative, regulatory,
and administrative reforms to promote transparency, simplicity,
fairness, accountability, and access in the market for consumer
financial products and services.
We also propose new authorities and resources for the Federal Trade
Commission to protect consumers in a wide range of areas.
Finally, we propose new authorities for the Securities and Exchange
Commission to protect investors, improve disclosure, raise standards,
and increase enforcement.
IV. Provide the Government With the Tools It Needs To Manage Financial
Crises
Over the past 2 years, the financial system has been threatened by
the failure or near failure of some of the largest and most
interconnected financial firms. Our current system already has strong
procedures and expertise for handling the failure of banks, but when a
bank holding company or other nonbank financial firm is in severe
distress, there are currently only two options: obtain outside capital
or file for bankruptcy. During most economic climates, these are
suitable options that will not impact greater financial stability.
However, in stressed conditions it may prove difficult for
distressed institutions to raise sufficient private capital. Thus, if a
large, interconnected bank holding company or other nonbank financial
firm nears failure during a financial crisis, there are only two
untenable options: obtain emergency funding from the U.S. Government as
in the case of AIG, or file for bankruptcy as in the case of Lehman
Brothers. Neither of these options is acceptable for managing the
resolution of the firm efficiently and effectively in a manner that
limits the systemic risk with the least cost to the taxpayer.
We propose a new authority, modeled on the existing authority of
the FDIC, that should allow the government to address the potential
failure of a bank holding company or other nonbank financial firm when
the stability of the financial system is at risk.
In order to improve accountability in the use of other crisis
tools, we also propose that the Federal Reserve Board receive prior
written approval from the Secretary of the Treasury for emergency
lending under its ``unusual and exigent circumstances'' authority.
V. Raise International Regulatory Standards and Improve International
Cooperation
As we have witnessed during this crisis, financial stress can
spread easily and quickly across national boundaries. Yet, regulation
is still set largely in a national context. Without consistent
supervision and regulation, financial institutions will tend to move
their activities to jurisdictions with looser standards, creating a
race to the bottom and intensifying systemic risk for the entire global
financial system.
The United States is playing a strong leadership role in efforts to
coordinate international financial policy through the G20, the
Financial Stability Board, and the Basel Committee on Banking
Supervision. We will use our leadership position in the international
community to promote initiatives compatible with the domestic
regulatory reforms described in this report.
We will focus on reaching international consensus on four core
issues: regulatory capital standards; oversight of global financial
markets; supervision of internationally active financial firms; and
crisis prevention and management.
At the April 2009 London Summit, the G20 leaders issued an eight-
part declaration outlining a comprehensive plan for financial
regulatory reform.
The domestic regulatory reform initiatives outlined in this report
are consistent with the international commitments the United States has
undertaken as part of the G20 process, and we propose stronger
regulatory standards in a number of areas.
RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN DODD
FROM TIMOTHY GEITHNER
Q.1. One key issue that will need to be resolved is how the
Consumer Financial Protection Agency (CFPA) and the National
Bank Supervisor (NBS) will be funded. Would you subject their
funding to the appropriations process? Would you rely solely on
fees charged to the regulated entities? Would you use the
deposit insurance fund? Do you believe there should be parity
between State and national charters with respect to the costs
of their supervision? If so, how would you achieve that?
A.1. Under Treasury's proposed legislation, the CFPA is
authorized to appropriate ``such sums as are necessary'' for it
to fully discharge its duties under the statute, and recover
these appropriations through fees on covered entities. Such
fees could be assessed only after promulgating rules with
respect to such fees, which is consistent with methods employed
by other independent regulators. That rulemaking process would
include publishing any proposed fees for public notice and
comment.
The Office of Management and Budget (OMB) will exercise
apportionment authority over the CFPA. This authority will
provide OMB the opportunity for review and discussion with the
Agency to ensure that CFPA spending is planned and executed
according to law.
The CFPA's budget will include the resources used by the
existing regulators to carry out their financial consumer
protection functions, which will all be transferred to the new
agency. The agencies that will transfer functions to the CFPA
include the Federal Reserve Board and Federal Reserve Banks,
the Office of the Comptroller of the Currency (OCC), the Office
of Thrift Supervision (OTS), the Federal Deposit Insurance
Corporation (FDIC), the National Credit Union Administration
(NCUA), the Federal Trade Commission (FTC), and the Department
of Housing and Urban Development. In addition to these
resources, the CFPA will need funding to provide a level
playing field by extending the reach of Federal oversight to
the nonbank providers of consumer financial products and
services.
Under Section 1024 of the legislation, the CFPA would have
a mandate to allocate more of its resources to institutions
that pose more risks to consumers. Community banks are close to
their customers and have often provided simpler, easier-to-
understand products with greater care and transparency than
other segments of the market. Such banks will receive
proportionally less oversight from the CFPA. Moreover, the
Administration proposes that community banks will pay no more
for Federal consumer protection supervision after the
establishment of the CFPA than they do today.
Like the OCC, the newly constituted NBS, which will be
created through the consolidation of the activities of the OCC
and OTS, will continue to collect fees to cover the cost of
safety and soundness supervision of institutions with a
national charter.
Q.2. The Administration's proposal would fund the resolution of
a large nonbank financial company initially through the
Treasury, with any losses to the government recouped through an
assessment on holding companies. Other proposals have called
for an ex ante funding approach: financial organizations would
pay assessments into a fund that would be available to cover
all or part of the costs of resolving a systemically important
financial institution. Proponents of an ex ante approach argue
that the fund would reinforce the commitment of the government
to unwind troubled large financial organizations rather than
propping them up with taxpayer funds. The assessments, like the
Administration's proposed higher capital requirements, would
also provide a disincentive for a company to grow in size or
complexity to a level that could create systemic risk. Can you
elaborate on why the Administration instead proposes ex post
funding with initial reliance on Treasury funds?
A.2. Our proposal for a special resolution regime is intended
for use only in extraordinary circumstances and subject to very
high procedural hurdles. It is modeled on the existing systemic
risk exception under FDIC Improvement Act of 1991 (FDICIA). By
way of example, that exception was not used at all from the
time FDICIA became law until the current crisis. Under our
proposal, the special resolution regime would not replace
bankruptcy procedures in the normal course of business.
Bankruptcy is and will remain the dominant tool for handling
the failure of a bank holding company. The special resolution
regime would only be triggered by a threat to financial
stability.
Because this regime will be used only in exceptional
circumstances when the system is at risk, we believe that the
creation of an ex ante fund is not necessary. Moreover, the ex
ante regime could actually make intervention more likely
because firms that had paid into the fund would expect to be
able to access the monies held by the fund and because the
government may be more likely to expend money to stabilize a
firm if a readily available fund was accessible for that
purpose. In our proposal, the high procedural hurdles will help
ensure that these powers are only used when appropriate.
An ex post funding mechanism provides large financial firms
with stronger incentives to monitor the risk taking of systemic
firms. The funding mechanism entails no assessments on the
large firms if no systemic firms fail but potentially large
assessments on the firms if one or more systemic firms fail. As
such, ex post funding promotes ex ante market discipline of the
systemic firms.
Ex post funding provides large financial firms with strong
incentives to support a private sector recapitalization of a
systemic firm in severe distress--rather than a government
resolution with substantial assistance. If large financial
firms understand that they must pay after-the-fact for the
clean-up of a systemic firm if it fails, the large firms, which
will collectively make up a substantial portion of the
counterparties of the failing systemic firm, will have strong
incentives to arrange a private sector solution to the problems
of the failing firm (including, for example, by consenting to
debt-for-equity swaps).
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR SHELBY
FROM TIMOTHY GEITHNER
Q.1. Role of the Fed--Secretary Geithner, the Administration
proposes to expand the Fed's powers by giving it authority to
regulate systemically significant nonbank financial
institutions. This would mean that the Chairman of the Fed
would not only have to be an expert in monetary policy and
banking regulation, but also would have to be an expert in
systemic risk regulation.
Is it reasonable to expect that any one person can possibly
acquire the expertise in so many highly technical fields?
Do you think that one person could possibly oversee a
complex institution like Citigroup and still have time to be
fully prepared to make decisions on monetary policy?
A.1. As the supervisor of bank holding companies and financial
holding companies, the Federal Reserve already supervises all
large U.S. commercial and investment banking firms. As stated
elsewhere in my responses to these questions for the record, we
propose modestly expanding the Federal Reserve's regulatory
authority over the largest and most interconnected financial
institutions in large part because we believe that the Federal
Reserve is the only agency with the depth of expertise in
financial institutions and markets that such regulation would
require. The role of banking supervision is closely tied to the
Federal Reserve's role in promoting financial stability. To do
this, it needs deep and direct knowledge of the financial
system through direct supervision of financial firms.
Moreover, our proposals would also remove responsibility
for consumer protection supervision and regulation from the
Federal Reserve because we believe that this mission is better
conducted by one agency with market wide coverage and a central
mission of consumer protection. This mission is not closely
related to the core responsibilities of the Nation's central
bank. This step should make it easier for the Chairman and the
Board to focus on core responsibilities.
Q.2. Consumer Protection and Safety and Soundness--In making
the case for a separate consumer protection agency the
administration's white paper states ``banking regulators at the
State and Federal level had a potentially conflicting mission
to promote safe and sound banking practices, while other
agencies had a clear mission, but limited tools and
jurisdiction.''
Secretary Geithner, please articulate the ``potentially
conflicting mission'' between safety and soundness and consumer
protection. It seems clear that a prudently underwritten loan
will ensure that a consumer is protected, while also ensuring
that a bank operates in a safe and sound manner.
A.2. While in rare cases there may be conflicts between
prudential regulation and consumer protection, we agree that
strong consumer protection supports safety and soundness. We
reject the notion that profits based on unfair and deceptive
practices can ever be considered sound. Requiring all financial
institutions to act fairly and transparently will improve the
safety and soundness of banks while also providing consumers
with the protection they need to make sound financial
decisions.
For the Consumer Financial Protection Agency (CFPA),
protecting consumers will be its sole mission, whereas it is a
secondary mission at the existing prudential regulators. Under
the current system, consumer protection has always taken a back
seat to safety and soundness concerns within the prudential
regulators. In the lead-up to the current crisis, safety and
soundness regulators failed to protect consumers from exploding
subprime and exotic mortgages and unfair credit card features,
and were far too slow in issuing rules to address these
problems. The CFPA would have the responsibility and authority
to act more quickly to protect consumers when they face undue
risk of harm from changing products or practices.
Our proposals are designed so that the CFPA prescribes
regulations that are consistent with maintaining the safety and
soundness of banks. The CFPA would be required by statute to
consult with each of the prudential supervisors before issuing
a new regulation. In addition, we propose that the National
Bank Supervisor would be one of the five members of the CFPA
board. These measures provide further assurance that the CFPA
will consider safety and soundness interests when adopting
regulations. Finally, in the very rare instance that conflicts
do arise, we propose that the legislation incorporate
reasonable dispute resolution mechanisms to force the CFPA and
the prudential regulator to resolve any conflicts that they
cannot work out on their own.
Q.3. Role for Congress--Secretary Geithner, the
Administration's Proposal grants the Fed and several other
agencies vast new powers. It also gives the Treasury authority
over the use of the Fed's 13(3) loan window. It also gives the
Treasury, the FDIC, and the Fed authority to decide whether the
Federal Government will bailout a troubled financial
institution. Nowhere in the Proposal, however, does it consider
granting Congress more authority over our regulatory system.
There is not even a reporting requirement to Congress.
Do you think that Congress should have a decision-making
role in our financial regulatory system?
Do you think that it is consistent with our republican form
of government to concentrate so much power in independent
agencies, such as the Fed?
Would you support requiring Congressional approval before
the Federal Government could bail out financial institutions?
A.3. I believe that Congress has a strong role to play in
reforming the financial regulatory system. Critically, it is
Congress that will consider and enact the legislation that will
form the framework for our new financial regulatory system. Of
equal importance will be Congress' ongoing oversight role,
which will be enhanced by many of our proposals. For example,
the Financial Services Oversight Council will have the critical
responsibility of identifying emerging threats and coordinating
a response--because we know that threats to our economy can
emerge from any corner of the financial system.
The Council is required to report to Congress each year on
these risks and threats and to coordinate action by individual
regulators to address them. The Consumer Financial Protection
Agency (CFPA) will have reporting requirements related to its
rulemaking, supervisory and enforcement activity, and regarding
consumer complaints. In addition, the Director of the Office of
National Insurance will be required to submit an annual report
to Congress on the insurance market.
In formulating our proposals we were careful to include
appropriate checks and balances to avoid concentrating
authority in any single agency. For example, although our
proposals provide for a modest enhancement of the Federal
Reserve's powers, our proposals also move consumer protection
authority from the Federal Reserve to a dedicated agency with a
single mission and market-wide coverage. Moreover, our proposed
resolution regime, which is modeled on the existing resolution
regime for insured depository institutions, requires the
consent of three separate agencies; Treasury must consult with
the President, and it must receive the written recommendation
of two-thirds of the members of the boards of both the Federal
Reserve Board and the FDIC (or the SEC, if the SEC is the
institution's primary supervisor).
Moreover, even after the decision to use the resolution
authority is made, the choice of the appropriate resolution
method is not left to one agency. Under our proposals, the
agency responsible for managing the resolution and Treasury
must agree on the appropriate method. We expect this process
will allow for timely decision making during a crisis while
ensuring that there are appropriate perspectives included and
that this new authority is exercised only under extraordinary
circumstances.
Anytime that this authority is exercised, the Treasury
Secretary must submit a report to Congress regarding the
determination, and each determination is also reviewed by the
Government Accountability Office.
Q.4. Hedge Funds--Secretary Geithner, you favor the mandatory
registration of advisors to hedge funds, venture capital funds,
and private equity funds with the SEC. As the Madoff and
Stanford cases painfully illustrate, being registered with the
SEC does not guarantee that a firm will be closely monitored.
The administration white paper cites hedge fund de-leveraging
as a contributor to the crisis.
How will the registration of hedge fund advisors prevent
them from de-leveraging in future crises?
A.4. As noted in the Treasury's report to Congress, at various
points in the financial crisis, de-leveraging by hedge funds
contributed to the strain on financial markets. Because these
funds were not required to register with regulators, the
government lacked reliable, comprehensive data with which to
assess this market activity and its potential systemic
implications. Requiring registration of hedge fund advisors
would allow data to be collected that would permit an informed
assessment by the government of the market positions of such
funds, how such funds are changing over time and whether any
such funds or fund families have become so large, leveraged, or
interconnected that they require additional oversight for
financial stability purposes.
Among other requirements, all registered hedge fund
advisors would be subject to recordkeeping and reporting
requirements, including the following information for each
private fund advised by the adviser: amount of assets under
management, borrowings, off-balance sheet exposures, trading
and investment positions, and other information necessary or
appropriate for the protection of investors or for the
assessment of systemic risk. Information would be shared with
the Federal Reserve, which would determine whether such a firm
meets the Tier 1 Financial Holding Company (Tier 1 FHC)
criteria. Designation as a Tier 1 FHC would subject the firm to
robust and consolidated supervision and regulation as Tier 1
FHCs. The prudential standards for Tier 1 FHCs would include
capital, liquidity, and risk management standards that are
stricter and more conservative than those applicable to other
firms to account for the risks that their potential failure
would impose on the financial system.
Q.5. What other problems did hedge funds, private equity funds,
and venture capital funds cause and how will SEC registration
of advisors to those funds address the problems caused by each
of these types of funds?
A.5. Although these funds do not appear to have been at the
center of the current crisis, de-leveraging contributed to the
strain on financial markets and the lack of transparency
contributed to market uncertainty and instability. New advisor
registration, recordkeeping, and disclosure requirements will
give regulators access to important information concerning
funds in order to address opacity concerns. Information about
the characteristics of a hedge fund, including asset size,
borrowings, off-balance sheet exposure, and other matters will
help regulators to protect the financial system from systemic
risk and help regulators to protect investors from fraud and
abuse. In addition, this information will allow regulators to
make an assessment of whether a firm is so large, leveraged, or
interconnected that it poses a threat to financial stability,
and thus require regulation as Tier 1 FHC.
Q.6. How should the SEC allocate its examination resources
between advisors to private pools of capital, on the one hand,
and advisors to mutual funds and other advisors that serve the
less affluent in our society, on the other?
A.6. We defer to the SEC to address how resources should be
allocated. In testimony on July 14, SEC Chairman Mary Schapiro
addressed strengthening SEC examination and oversight and
improving investor protection. The Chairman noted that the SEC
is working towards improving its risk-based oversight,
including extending that oversight to investment advisers. The
SEC is recruiting additional professionals with specialized
expertise, creating new positions in its examination program,
and making use of automated systems to assist in determining
which firms or practices raise red flags and require greater
scrutiny.
Q.7. Credit Rating Agencies--Secretary Geithner, the
Administration's proposal calls for reduced regulatory reliance
on credit ratings, but seems focused only on reducing reliance
on ratings of structured products.
Will you be recommending a legislative mandate to the SEC
and other regulatory agencies to find ways to reduce their
reliance on ratings of all types, not just ratings on
structured products?
A.7. It is clear that over-reliance on ratings from credit
rating agencies contributed to the fragility of the system in
the current crisis--especially as the systematic
underestimation of risk in structured securities became clear.
While the regulatory reliance on ratings covers both structured
and unstructured products, we believe that the problems in the
markets for structured products were particularly acute.
Our legislative proposal includes a requirement that rating
agencies distinguish the symbols used to rate structured
products from those used for unstructured products. This will
not directly reduce the use of ratings, but it will require
that regulators and investors reassess their approaches to
ratings--in regulations, contracts, and investment guidelines.
In addition, we are working with the SEC and through the
President's Working Group to identify other areas in Federal
regulations where there is a need to reassess the use of
ratings, with respect to both structured and unstructured
products. For instance, as part of a comprehensive set of money
market fund reform proposals, the SEC requested public comment
on whether to eliminate references to ratings in the regulation
governing money market mutual funds.
Q.8. Fed Study of Itself--In the Administration's proposal,
after giving the Fed extensive new regulatory power, you would
ask the Fed to review ``ways in which the structure and
governance of the Federal Reserve System affect its ability to
accomplish its existing and proposed functions.''
Why should we give the Fed these additional
responsibilities prior to knowing if they are able to
administer them?
Why do you have the Fed study itself'?
Were other entities considered as alternatives for the
purposes of conducting the study?
A.8. As the supervisor of bank holding companies and financial
holding companies, the Federal Reserve already supervises all
large U.S. commercial and investment banking firms. As stated
elsewhere in the responses to these questions for the record,
we propose modestly expanding the Federal Reserve's regulatory
authority over the largest and most interconnected financial
institutions in large part because we believe that the Federal
Reserve is the only agency with the depth of expertise in
financial institutions and markets that such regulation would
require. The role of banking supervision is closely tied to the
Federal Reserve's role in promoting financial stability. To do
this, it needs deep and direct knowledge of the financial
system through direct supervision of financial firms.
The proposed role for the Fed in supervising nondepository
financial firms will require the Federal Reserve to acquire
additional expertise in some areas of financial activity. But
the potential extension of its consolidated supervision
authority to some nonbanking financial institutions represents
an evolution rather than a revolution in the Federal Reserve's
role in the financial markets.
At the same time, the structure and governance of the
Federal Reserve System should be reviewed to determine whether
and, if so, how it can be improved to facilitate accomplishment
of the agency's current and proposed responsibilities. Every
agency has the responsibility to review itself periodically to
ensure that it is organized in a manner that best promotes its
mission.
Q.9. Congress Needs To Do Its Homework--Secretary Geithner, the
Administration's Proposal defers making decisions on how to
address the GSEs, improve banking supervision, modernize
capital requirements, update insurance regulation, improve
accounting standards, coordinate SEC and CFTC regulation, and
even how to define systemic risk. The Administration has said
that it will study these topics before proceeding.
Should not Congress wait to pass reform legislation until
after it has had the benefit of the Administration's studies on
these topics?
Would not that help ensure that Congress acts in an
informed manner and that the final legislation is based on the
best available information?
A.9. The reform proposals for which we have submitted draft
legislation in June and July do not depend on completion of the
studies. It is important that Congress move forward to enact
legislation to reform our financial regulatory system, while
regulators, at the same time, move forward to find ways to
improve the nuts and bolts of supervising U.S. financial firms.
Q.10. Fed v. Systemic Risk Regulator--Secretary Geithner,
despite strong opposition in Congress to expanding the powers
of the Fed, the Administration has proposed doing just that. Do
you recognize that this will create significant hurdles for
passing regulatory reform?
Is it more important to you that some entity be charged
with regulating systemic risk, or must the Fed be the systemic
risk regulator?
A.10. We chose not to make one agency the ``systemic risk
regulator'' or ``super regulator'' because our system should
not depend on the foresight of a single institution or a single
person to identify and mitigate systemic risks. This is why we
have proposed that the critical role of monitoring for emerging
risks and coordinating policy be vested in a Financial Services
Oversight Council rather than the Federal Reserve or any other
single agency. Each Federal supervisor will contribute to the
systemic analysis of the Council through the institution-
focused work of their examiners.
We did propose an evolution in the Federal Reserve's
authority to include the supervision and regulation of the
largest and most interconnected financial firms. The Federal
Reserve is the appropriate agency because of its depth of
expertise, its existing mandate to promote financial stability,
and its existing role as the supervisor for all large
commercial and investment banking firms, including bank and
financial holding companies.
Q.11. Basel Capital Accords--Secretary Geithner, in the Obama
Administration's white paper, you state that the administration
will recommend various actions to the Basel Committee on
Banking Supervision (BCBS).
Previously, the BCBS has approved capital plans that were
deemed inadequate by many in Congress, as well as the bank
regulators.
What will you do if the BCBS returns with measures and
definitions that raise concerns along the same lines as Basel
II?
For the record, will you seek alterations to their
standards as was done with Basel II, if the new standards are
considered inadequate?
A.11. The U.S. banking regulators have always played a
significant role in the Basel Committee's policy development
process and we strongly believe that they will be highly
influential in the next phase of capital proposals in ways that
will address flaws in the Basel II framework that have been
made manifest by the current economic crisis.
The U.S. regulatory community considers the Basel Committee
to be a useful and receptive forum in which international
supervisors can set consistent international supervisory
standards. U.S. supervisors have and will continue to push for
improvements to those standards. For example, the Basel
Committee just released in mid-July significant enhancements to
the Basel II framework that increase risk weights for the
trading book, certain securitizations, and off-balance sheet
activities, as supported by the President and myself at the G20
Leaders Summit in April.
Q.12. Basel Leverage Measurement--Mr. Secretary, in the white
paper, you clearly state that the Obama Administration will,
``urge the BCBS to develop a simple, transparent, nonmodel
based measure of leverage, as recommended by the G20 leaders.''
Please expand on this statement and what manner of
measuring leverage you envision, including what criteria will
be used and how you arrived at these answers?
A.12. As we explained in the Treasury Department's September 3,
2009, ``Principles for Reforming the U.S. and International
Regulatory Capital Framework for Banking Firms,'' risk-based
capital rules are a critical component of a regulatory capital
regime; however, it is impossible to construct risk-based
capital rules that perfectly capture all the risk exposures of
banking firms. Inevitably, there will be gaps and weak spots in
any risk-based capital framework and regulatory arbitrage
activity by firms will tilt asset portfolios and risk taking
toward those gaps and weak spots. A simple leverage constraint
would make the regulatory system more robust by limiting the
degree to which such gaps and weak spots in the risk-based
capital framework can be exploited. A simple leverage
constraint also can help reduce the threats to financial
stability from categorical misjudgments about risk by market
participants and the official sector.
In addition, imposing a leverage constraint on banking
firms would have macroprudential benefits. The balance sheets
of financial firms and the intermediation chains between and
among financial firms tend to grow fastest during good economic
times but become subject to rapid reversal when economic
conditions worsen. Supervisors generally have failed to
exercise discretion to constrain leverage leading into a boom.
A simple leverage ratio acts as a hard-wired dampener in the
financial system that can be helpful to mitigate systemic risk.
It is important to recognize that the leverage ratio is a
blunt instrument that, viewed in isolation, can create its own
set of regulatory arbitrage opportunities and perverse
incentive structures for banking firms. The existing U.S.
leverage ratio is calculated as the ratio of Tier 1 capital to
total balance sheet assets. To mitigate potential adverse
effects from an overly simplistic leverage constraint, the
constraint going forward should at a minimum incorporate off-
balance sheet items. It is also important to view the leverage
constraint as a complement to a well designed risk-based
capital requirement. Although it may be possible for banking
firms to either arbitrage any free-standing risk-based capital
requirement or any free-standing simple leverage constraint, it
is much more difficult to arbitrage both frameworks at the same
time.
Q.13. Supervisory Colleges--Mr. Secretary, in the white paper,
you state that, ``supervisors have established `supervisory
colleges' for the 30 most significant global financial
institutions. The supervisory colleges for all 30 firms have
met at least once.''
Will information from these meetings be made public; will
there be publication of any agendas, minutes, plans,
membership, etc.?
If this information will not be made public, will there be
the opportunity for Congressional staff to receive reports and
briefings of the conduct and actions of these colleges?
Will the firms that are being examined have any opportunity
to receive any information about these meetings?
A.13. Supervisory colleges are confidential meetings, held by
regulators from multiple countries, which function as an
information-sharing mechanism with regards to large cross-
border financial institutions. The information shared in these
meetings is governed by information sharing agreements signed
by the participating regulatory organizations.
Supervisory colleges are not themselves decision-making
regulatory bodies. The information shared within a supervised
institution's college is used to assist regulators in
conducting their supervisory responsibilities over that
institution. A particular firm may be invited to brief
regulators on specific topics. However, any resulting
regulatory actions are conducted by the respective regulatory
agencies. The Federal Reserve Board of Governors, the Office of
the Comptroller of the Currency, and the Securities and
Exchange Commission participate in the supervisory colleges and
can be contacted for further information.
Q.14. Implications of Resolution Regime--Mr. Secretary, in the
white paper, you state that the proposed resolution regime
would provide authority to avoid disorderly resolution of any
systemically critical firm. You also write that national
authorities are inclined to protect assets with their own
jurisdictions. I would hope that our regulators would continue
to have this mind-set, to spare the U.S. taxpayer from
additional costs. It seems that this paper takes a negative
view of this mind-set.
Can you explain your statement further?
Also, please explain to the Committee why protecting
assets, which protects the taxpayer, should not be the focus of
our national regulators?
A.14. Our proposal presents a new resolution regime, beyond
what the U.S. already has, only where the failure of certain
bank holding companies or nonbank financial firms threatens the
stability of the entire financial system. The authority to
invoke resolution procedures for these large entities would be
used only for extraordinary circumstances and would be subject
to strict governance and control procedures. Furthermore, the
purpose of the expanded resolution regime would be to unwind,
dismantle, restructure, or liquidate the firm in an orderly way
to minimize costs to taxpayers and the financial system; all
costs to exercise this authority would be recouped through
assessments and liquidation of any acquired assets, therefore
sparing the taxpayer.
The global nature of the current crisis has also shown that
in the failure of globally active financial firms, there needs
to be improved coordination between national authorities
representing jurisdictions that are affected. No common
procedure exists among countries with respect to the failure of
a large financial firm. The aim of this cross-border
coordination should be to establish fair and orderly procedures
to resolve a firm according to a system of laws and rules that
investors can rely on as well as to protect the interests of
U.S. taxpayers in globally active financial firms. The absence
of predictability in cross-border procedures was a contributing
factor to the contagion in our financial markets in the fall of
2008.
Q.15. Federal Reserve Supervision of Foreign Tier 1 Financial
Holding Companies--Secretary Geithner, you ``propose to change
the Financial Holding Company eligibility requirements . . .
but do not propose to dictate the manner in which those
requirements are applied to foreign financial firms with U.S.
operations.''
Please clarify this statement. Do you foresee the Federal
Reserve getting information from other national supervisors or
do you see the Federal Reserve conducting examinations of
foreign Financial-Holding Companies overseas?
What criteria would you recommend the Federal Reserve use
when they evaluate foreign parent banks? Many financial
products differ in other parts of the world, how should the
Federal Reserve evaluate those products' safety and soundness
for the parent company balance sheet?
A.15. Treasury intends to work with the Financial Services
Oversight Council and the Federal Reserve Board to create a
regulatory framework for foreign companies operating in the
United States that are deemed to be Tier 1 Financial Holding
Companies (FHCs). That framework will be comparable to the
standards applied to domestic Tier 1 FHCs, giving due regard to
the principle of national treatment and equality of competitive
opportunity.
In determining today whether a foreign bank is well
capitalized and well managed in accordance with FHC standards,
the Board, relying on the existing Bank Holding Company Act,
may take into account the foreign bank's risk-based capital
ratios, composition of capital, leverage ratio, accounting
standards, long-term debt ratings, reliance on government
support to meet capital requirements, the anti-money laundering
procedures, whether the foreign bank is subject to
comprehensive supervision or regulation on a consolidated
basis, and other factors that may affect analysis of capital
and management.
While not conducting examinations of foreign banks in a
foreign country, the Federal Reserve Board consults with the
home country supervisor for foreign banks as appropriate.
Treasury intends to work with the Federal Reserve Board to
determine what modifications to the existing FHC framework are
needed for new foreign Tier 1 financial holding companies.
Q.16. New Financial Stability Board (FSB)--Mr. Secretary, in
the white paper, you ``recommend that the FSB complete its
restructuring and institutionalize its new mandate to promote
global financial stability by September 2009.''
To whom will the FSB be accountable and from where will it
receive its funding?
Will the FSB make their reports and conclusions public?
Will the Congress be able to have access to FSB documents
and decisions?
A.16. The G20 Leaders in April 2009 agreed that the Financial
Stability Forum should be reestablished as the Financial
Stability Board (FSB) and be given a stronger mandate. Its
membership was expanded to include all G20 member countries.
The FSB is composed of finance ministries, central banks,
regulatory authorities, international standard-setting bodies,
and international institutions. It is supported by a small
secretariat provided by the Bank for International Settlements.
The FSB provides public statements following its meetings
and may issue papers on important issues from time to time. It
regularly posts information to its Web site
(www.financialstabilityboard.org), which is available to
Congress and the general public. The FSB can provide
coordination and issue recommendations and principles (e.g., on
crisis management; principles on compensation; protocols for
supervisory colleges). The FSB operates as a consensus
organization and it is up to each country whether and how to
implement the recommendations of the FSB. The point of
accountability for decisions and responses lies with each
national regulator. The U.S. will work through the FSB as an
effective body to coordinate and align international standards
with those that we will set at home.
Q.17. Adequacy of the Proposal--Secretary Geithner, the
Administration's Proposal aims to address the causes of the
financial crisis by closing regulatory gaps. I would like to
know more about which gaps in our financial supervisory system
the Administration believes contributed to the crisis.
What are two cases where supervisory authority existed to
address a problem but where regulators nevertheless failed act?
What are two cases where supervisory authority did not
exist to address a problem and regulators were unable to act?
Does the Administration's Proposal address all of the cases
you cited in your answers?
A.17. There were a number of cases in which supervisory
authority existed but supervisors did not act in a timely and
forceful fashion.
It was clear, at least by the early to mid-2000s, that
banks and nonbanks were making subprime and nontraditional
mortgage loans without properly assessing that the borrowers
could afford the loans once scheduled payment increases
occurred. Yet supervisors did not issue guidance requiring
banks to qualify borrowers at the fully indexed interest rate
and fully amortizing payment until 2006 and 2007. By
consolidating consumer protection authority into a single
agency with a focused mission, the CFPA will be able to
recognize when borrowers are receiving loans provided in an
unfair or deceptive manner earlier, and it will act more
quickly and effectively through guidance or regulation to
address such problems.
In the securitization markets, regulatory authority existed
to address the problems that emerged in the current crisis but
the regulatory actions were not taken. For instance, regulators
had the ability to address the treatment of off-balance sheet
risks that many institutions retained when they originated new
financial products such as structured investment vehicles and
collateralized debt obligations, but supervisors did not fully
grasp these risks and did not require sufficient capital to be
held. Our proposals would increase capital charges for off-
balance sheet risks to account more fully for those risks.
In addition, in many instances, regulators simply lacked
the authority to take the actions necessary to address problems
that existed.
For example, independent mortgage companies and brokers
were major players in the market for nontraditional and sub-
prime mortgages at the heart of the foreclosure crisis and
operated without Federal supervision. Under our proposals, they
would have been subject to supervision and regulation by the
proposed CFPA.
Similarly, AIG took advantage of loopholes in the SHC act
and was not adequately supervised on a consolidated basis.
Under our proposals, AIG would have been subject to supervision
and regulation by the Federal Reserve for safety and soundness,
with an explicit mandate to look across the risks to the
enterprise as a whole, not simply to protect the depository
institution subsidiary.
As discussed above, the Administration's proposals create a
comprehensive framework that would have addressed each of these
failures.
Q.18. Fed as Consolidated Supervisor--Secretary Geithner, I
find it interesting that, under your proposal, the entire
financial industry would be within the Federal Reserve's
regulatory reach. While you have created a shadow consolidated
regulator, you have not bothered to get rid of the other
regulators.
If you are intent on creating a single financial regulator,
why not move everything into an agency with political
accountability and eliminate the other regulatory agencies?
A.18. The entire financial industry would not be within the
Federal Reserve's regulatory reach and we are not intending to
create a single financial regulator. The Financial Services
Oversight Council will have the authority and responsibility to
identify emerging risks to the financial system and will help
facilitate a coordinated response. In critical markets, like
those for securities and derivatives, the SEC and CFTC will
play leading roles. We are also proposing to retain and enhance
crucial roles for the National Bank Supervisor and the FDIC on
prudential regulation, and resolution of banks. The Federal
Reserve would be the consolidated regulator of Tier 1 FHCs and
would be responsible, as it is today, for prudential matters in
the basic plumbing of the system--payment, settlement, and
clearance systems.
In formulating our proposals we were careful to include
appropriate checks and balances to avoid concentrating
authority in any single agency. For example, although our
proposals provide for a modest enhancement of the Federal
Reserve's powers, our proposals also strip power from the
Federal Reserve in the consumer protection area.
Q.19. Regulatory Overlap--Secretary Geithner, the
Administration's proposal states that jurisdictional boundaries
among agencies should be drawn clearly to avoid mission overlap
and afford agencies exclusive regulatory authority.
How do you reconcile that principle with the proposal to
expand the Fed's regulatory authority into so many different
areas, many of which already have primary regulators?
A.19. In Treasury's report to Congress, we articulate a
principle that agencies should be held accountable for critical
missions such as promoting financial stability and protecting
consumers of financial products. The consolidated supervisor of
the holding company and the functional supervisor of the
subsidiary each have critical roles to play.
Q.20. Over-the-Counter Derivatives--Secretary Geithner, the
Administration does not appear to have made much headway in
fleshing out the details of last month's outline for regulating
over-the-counter derivatives.
How will you encourage standardization of derivatives
without preventing companies from being able to buy derivatives
to meet their unique hedging needs?
A.20. As you know, we have now sent up detailed legislative
language to implement our proposal. Any regulatory reform of
magnitude requires deciding how to strike the right balance
between financial innovation and efficiency on the one hand,
and stability and protection on the other. We failed to get
this balance right in the past. If we do not achieve sufficient
reform, we will leave ourselves weaker as a Nation and more
vulnerable to future crises.
Our proposals have been carefully designed to provide a
comprehensive approach. That means strong regulation and
transparency for all OTC derivatives, regardless of the
reference asset, and regardless of whether the derivative is
customized or standardized. In addition, our plan will provide
for strong supervision and regulation of all OTC derivative
dealers and all other major participants in the OTC derivative
markets.
We recognize, however, that standardized products will not
meet all of the legitimate business needs of all companies.
That is why our proposals do not--as some have suggested--ban
customized OTC derivatives. Instead, we propose to encourage
substantially greater use of standardized OTC derivatives
primarily through higher capital charges and margin
requirements on customized derivatives, and thereby facilitate
a more substantial migration of these OTC derivatives on to
central clearinghouses and exchanges.
Q.21. Systemically Significant Firms--Secretary Geithner,
systemically significant firms, or Tier 1 Financial Holding
Companies, will be required to make enhanced public disclosures
``to support market evaluation.''
Don't you believe that giving these firms a special label,
a special oversight regime, and special disclosure will simply
send a signal to the market that these firms are too big to
fail and therefore do not need to be monitored?
A.21. Identification as a Tier 1 Financial Holding Company
(Tier 1 FHC) does not come with any commitment of government
support nor does it provide certain protection against failure.
Instead our proposals would apply stricter prudential standards
and more stringent supervision. For example, higher capital
charges for Tier 1 FHCs would be used to account for the
greater risk to financial stability that these firms could pose
if they failed. It is designed to internalize the externalities
that their failure might pose, to reduce incentives to
excessive risk-taking at the taxpayer's expense, and to create
a large buffer in the event of failure. In addition, in the
event of failure, our proposals provide for a special
resolution regime that would avoid the disruption that
disorderly failure can cause to the financial system and the
economy. That regime, however, would be triggered only in
extraordinary circumstances when financial stability is at
risk, and bankruptcy would remain the dominant tool for
handling the failure of a financial company. Moreover, the
purpose of the special resolution regime is to provide the
government with the option of an orderly resolution, in which
creditors and counterparties may share in the losses, without
threatening the stability of the financial system.
Q.22. Federal Reserve and Systemically Important Firms--
Secretary Geithner, under your proposal, the Federal Reserve
would identify and regulate firms the failure of which, could
pose a threat to financial stability due to their combination
of size, leverage, and interconnectedness. It is unclear just
what types of companies might fall into this new category of
so-called Tier 1 Financial Holding Companies, because it will
be up to the Fed to identify them.
Could Starbucks--which offers a credit card and would
certainly affect numerous sectors of the economy if it failed--
be classified as a Tier 1 Financial Holding Company and be
subjected to Fed oversight?
A.22. Starbucks is not a financial firm and therefore would not
qualify as a Tier 1 FHC. Starbucks currently offers a credit
card through an independent financial institution.
Q.23. Financial Services Oversight Council--Secretary Geithner,
the Administration recommends replacing the President's Working
Group on financial Markets with a Financial Services Oversight
Council.
Aside from having slightly enlarged membership and a
dedicated staff, how will this Council differ from the PWG?
Is this anything more than a cosmetic change?
A.23. There are important differences between the President's
Working Group (PWG) and the Financial Services Oversight
Council (FSOC or Council). As an initial matter, the PWG was
created by executive order and the Council would have permanent
statutory status. In addition, the Council would have a
substantially expanded mandate to facilitate information
sharing and coordination, identify emerging risks, advise the
Federal Reserve on the identification of Tier 1 FHCs and
systemically important payment, clearing, and settlement
activities, and provide a forum in which supervisors can
discuss issues of mutual interest and settle jurisdictional
disputes. It would also enjoy the benefit of a dedicated staff
that will enable it to undertake its missions in a unified way
and to effectively conduct analysis on emerging risks.
In addition, unlike the PWG, the Council will have
authority to gather information from market participants and
will report to Congress annually on financial market
developments and emerging systemic risks.
Q.24. Identifying Systemic Risk--Secretary Geithner, your
proposal gives the Federal Reserve the authority to identify
and regulate financial firms that pose a systemic risk due to
their combination of size, leverage, and interconnectedness.
Because neither ``systemic risk'' nor ``financial firm'' is
defined, it is unclear what types of firms will fall within the
Tier 1 Financial Holding Company designation. Theoretically,
the term could include large investment advisers, mutual funds,
broker-dealers, insurance companies, private equity funds,
pension funds, and sovereign wealth funds, to name a few
possibilities.
What further specificity will you be providing about your
intentions with respect to the reach of the Fed's new powers?
A.24. In the draft legislation sent to Congress in July, we
proposed the specific factors that the Federal Reserve must
consider when determining whether an individual financial firm
is a Tier 1 FHC. Our proposed legislation defines a Tier 1 FHC
as a financial firm whose material financial distress could
pose a threat to financial stability or the economy during
times of economic stress. Our proposed legislation requires the
Fed to designate U.S. financial firms as Tier 1 FHCs based on
an analysis of the following factors:
the amount and nature of the company's financial
assets;
the amount and types of the company's liabilities,
including the degree of reliance on short-term funding;
the extent of the company's off-balance sheet
exposures;
the extent of the company's transactions and
relationships with other major financial companies;
the company's importance as a source of credit for
households, businesses, and State and local governments
and as a source of liquidity for the financial system;
the recommendation, if any, of the Financial
Services Oversight Council.
Q.25. Expertise of the Fed--Secretary Geithner, the
Administration's Proposal chooses to grant the Fed authority to
regulate systemic risk because it ``has the most experience''
to regulate systemically significant institutions. I believe
this represents a grossly inflated view of the Fed's expertise.
Presently, the Fed regulates primarily bank holding companies
and State banks. As a systemic risk regulator, the Fed would
likely have to regulate insurance companies, hedge funds, asset
managers, mutual funds and a variety of other financial
institutions that it has never supervised before.
Since the Fed lacks much of the expertise it needs to be an
effective systemic regulator, why could not the responsibility
for regulating systemic risk just as easily be given to another
or a newly created entity?
A.25. We are not proposing that the Federal Reserve act as a
systemic risk regulator. In critical markets, like those for
securities and derivatives, the SEC and CFTC will play lead
roles. The bank regulators all play crucial roles as prudential
supervisors of banks. The Financial Services Oversight Council
will have the authority and responsibility to identify emerging
risks to the financial system and will help facilitate a
coordinated response. We have proposed that the Federal Reserve
act as the consolidated supervisor of the largest and most
interconnected financial firms. The Federal Reserve has broad
expertise in supervising financial institutions involved in
diverse financial markets through the exercise of its current
responsibilities as the supervisor of bank and financial
holding companies. We are confident that it can acquire
expertise where needed to oversee the supervision of Tier 1
Financial Holding Companies that do not own a depository
institution. As noted above, the potential extension of its
consolidated supervision authority to some nonbanking financial
institutions represents an evolution in the Federal Reserve's
responsibilities.
Q.26. Skin-in-the-Game--Secretary Geithner, your proposal would
require that mortgage originators maintain an unhedged 5
percent stake in securitized loans.
Will the administration adopt the same position with
respect to government programs that assist borrowers in
obtaining mortgages and require increased down payment
requirements and other such measures to increase ``skin-in-the-
game?''
A.26. One of the key problems that the financial system
experienced in the buildup to the current crisis, was a
breakdown in loan underwriting standards--especially in cases
where the ability to sell loans in a secondary market allowed
originators and securitizers to avoid any long-term economic
interest in the credit risk of the original loans. We are
proposing that securitizers or originators retain up to a 10
percent stake in securitized loans to align their interests
with those of the ultimate investor in those loans. This
directly addresses the incentives of originators and
securitizers to consider the performance of the underlying
loans after asset-backed securities were issued. A family
buying a home is in a different position from a loan originator
or securitizer. The household faces substantial tangible and
intangible costs if it is forced to move. Our proposal would
not require home owners to increase their down payment. Also
our proposal specifically gives regulators authority to exempt
government-guaranteed loans from the skin-in-the-game
requirement.
Q.27. Insurance Regulation--Secretary Geithner, the Proposal
states that the Administration will support measures to
modernize insurance regulation, but fails to offer a specific
plan. While we all recognize the difficulties involved in
modernizing insurance regulation, the problems with AIG's
insurance subsidiaries and the fact that several insurers
needed TARP money demonstrates that we need to reconsider how
we regulate insurance companies.
Will systemically significant insurance companies be
regulated by the Fed?
If so, will this effectively require the Fed to act as a
Federal insurance regulator so that it can properly supervise
the company?
Does the Fed have the necessary expertise in insurance to
regulate an insurance company?
Would it be more efficient to establish a Federal insurance
regulator that can specialize in regulating large insurance
companies?
A.27. Under the Administration's proposals, all firms
designated as Tier 1 Financial Holding Companies (Tier 1 FHCs)
will be subject to robust, consolidated supervision and
regulation. Tier 1 FHCs will be regulated and supervised by the
Board of Governors of the Federal Reserve System (Board).
Consolidated supervision of a Tier 1 FHC will extend to the
parent company and to all of its subsidiaries--regulated and
unregulated, U.S. and foreign. This could include an insurance
company, if it or its parent were designated as a Tier 1 FHC.
For all Tier 1 FHCs, functionally regulated subsidiaries
like insurance companies will continue to be supervised and
regulated by their current regulator. However, the Federal
Reserve will have a strong oversight role, including authority
to require reports from and conduct examinations of a Tier 1
FHC and all its subsidiaries, including insurance companies.
We believe that the current insurance regulatory system is
inefficient and that there is a need for a Federal center for
expertise and information on the insurance industry. The
Administration has proposed creating an Office on National
Insurance (ONI) to develop expertise, coordinate policy on
prudential aspects of international insurance matters, and
consult with the States regarding insurance matters of national
and international importance, among other duties. The ONI will
receive and collect data and information on and from the
insurance industry and insurers, enter into information-sharing
agreements, and analyze and disseminate data and information,
and issue reports for all lines of insurance except health
insurance. This will allow the ONI to identify the emergence of
problems within the insurance industry that could affect the
economy as a whole.
In addition, our proposal lays out core principles to
consider proposals for additional reforms to insurance
regulation: Increased consistency in the regulatory treatment
of insurance, including strong capital standards and consumer
protections, would enhance financial stability, result in real
improvements for consumers and also increase economic
efficiency in the insurance industry. One of our core
principles for insurance regulation is to increase national
uniformity of insurance regulation through either a Federal
charter or effective action by the States. We look forward to
working with you and others in the Congress on this important
issue.
Q.28. Resolution Plans--Secretary Geithner, under your
proposal, systemically significant firms would be required to
devise their own plans for rapidly resolving themselves in
times of financial distress.
Will firms be able to incorporate into their death plans
the expectation of taxpayer money to cover wind-down expenses?
A.28. No. That is the opposite of what we have in mind. We
propose that the Federal Reserve should require each Tier 1 FHC
to prepare and periodically update a credible plan for the
rapid resolution of the firm in the event of severe financial
distress. Such a requirement would create incentives for the
firm to better monitor and simplify its organizational
structure and would better prepare the government, as well as
the firm's investors, creditors, and counterparties, in the
event that the firm collapsed. The Federal Reserve should
review the adequacy of each firm's plan on a regular basis.
It would not be appropriate for firms to incorporate in
such a plan the expectation of taxpayer money to cover wind-
down expenses. As I have stated elsewhere in my responses to
these questions for the record, identification as a Tier 1 FHC
does not come with any commitment of government support.
Moreover, any government support through our proposed special
resolution regime would be available only in extraordinary
circumstances when financial stability is at risk and only upon
the agreement of three different government agencies. In most
circumstances, bankruptcy would remain the dominant tool for
handling the failure of a financial company.
Q.29. Citigroup--Secretary Geithner, you mentioned AIG and
Lehman as being examples of untenable options for firms nearing
failure during a financial crisis. I would add Citigroup to
that list of untenable options.
As you surveyed the landscape to understand the types of
scenarios that might have to be handled by the new resolution
authority that you propose, are there any entities that would
still require ad hoc solutions as Lehman, AIG, and Citigroup
did?
A.29. Our proposals are designed to provide a comprehensive set
of tools to address the potential disorderly failure of any
bank holding company, including Tier 1 FHCs, when the stability
of the financial system is at risk. It is important to note
that after the TARP purchase authority expires this year, the
government will lack the effective legal tools that it would
need to adequately address a similar situation to that which we
have seen in the past 2 years.
We believe that our comprehensive regulatory reform
proposals would provide the government with the tools necessary
to wind down any large, interconnected highly leveraged
financial firm if such a failure would threaten financial
stability.
Q.30. Accounting Standards--Secretary Geithner, among the
changes recommended by your proposal are changes in accounting
standards.
What is the appropriate role of the administration in
directing the substantive determinations of an independent
accounting standard setter?
A.30. It is critical that the FASB be fully independent in
carrying out its mission to establish accounting and financial
reporting standards for public and private companies. The
health and soundness of capital markets depend critically on
the provision of honest and neutral accounting and financial
reporting, not skewed to favor any particular company,
industry, or type of transaction or purposefully biased in
favor of regulatory, social, or economic objectives other than
sound reporting to investors and the capital markets.
Governmental entities with knowledge and responsibility for the
health of capital markets have an interest and expertise in
maintaining the health of America's capital markets. These
entities include the SEC, which has specific oversight of
disclosure for publicly held firms, the Public Company
Accounting Oversight Board, which is tasked with overseeing the
auditors of public companies, and other financial regulators,
which have oversight over the soundness of the entities they
regulate.
Q.31. SEC-CFTC Merger--Secretary Geithner, the proposal
acknowledges the need for harmonization between the SEC and
CFTC, but stops short of merging the two agencies. Instead, you
direct the agencies to work their differences out among
themselves and report back in September.
Given the tortured history of compromise between the SEC
and CFTC, why do you anticipate that the two agencies can come
to agreement in a matter of months?
Wouldn't a merger of the agencies be a better way to force
them to work out their differences?
A.31. In the last few months, the SEC and the CFTC have made
great progress towards eliminating their differences. Treasury
worked closely with the SEC and CFTC to propose a comprehensive
framework for regulation of derivatives that is consistent
across both SEC and CFTC jurisdiction. In addition, the SEC and
CFTC held joint public hearings in early September to identify
issues in the process of harmonization and to collect public
comment on the process. The SEC and CFTC have produced a joint
report on reducing differences in their two frameworks for
regulation.
We considered whether to merge the SEC and CFTC. At bottom,
however, we are focused on the substance of regulation, not the
boxes and the lines. In terms of substance, the most necessary
reform is to harmonize futures and securities regulation
between these entities, and the SEC and CFTC have begun a
process to accomplish that.
Q.32. Broker-Dealers and Investment Advisors--Secretary
Geithner, the Administration's proposal recommends applying a
fiduciary standard to broker-dealers that offer investment
advice.
How will this change affect the way FINRA regulates broker-
dealer activities?
Do you anticipate recommending a self-regulatory
organization for investment advisors or eliminating FINRA as an
SRO for broker-dealers?
A.32. Treasury's report to Congress advocates a fiduciary
standard for investment advisers and broker-dealers offering
investment advice. We have not taken a position with respect to
the role of SROs.
Q.33. Barriers to Entry--Secretary Geithner, in many ways the
Administration's proposal rewards failure. The Fed, which
fumbled the responsibilities it had, will get more
responsibility. The SEC, which failed to properly oversee the
advisors registered with it, will have more registered
advisors. And some of the biggest financial firms, the ones
that made so many miscalculations with respect to risk
management, stand to benefit from the additional layers of
regulatory red-tape that your system creates. Yet in your
statement, you state that the changes you are proposing reward
innovation, often the product of smaller firms.
What specific changes in your proposal make the environment
more conducive to small, innovative firms?
A.33. Under existing law, financial instruments with similar
characteristics may be designed or forced to trade on different
exchanges that are subject to different regulatory regimes.
Harmonizing the regulatory regimes would remove such
distinctions and permit a broader range of instruments to trade
on any regulated exchange. For example, we propose the
harmonization of futures and securities regulation. By
eliminating jurisdictional uncertainties and ensuring that
economically equivalent instruments are regulated in the same
manner, regardless of which agency has jurisdiction, our
proposals will foster innovation resulting from competition
rather than the ability to evade regulation.
Permitting direct competition between exchanges also would
help ensure that plans to bring OTC derivatives trading onto
regulated exchanges or regulated transparent electronic trading
systems would promote rather than hinder competition. Greater
competition would make these markets more efficient and create
an environment more conducive to the most innovative
participants.
Innovation is advanced by promoting competition among firms
and between financial products. By eliminating arbitrary
jurisdictional differences and creating a regulatory regime
that is stable and promotes transparency, fairness,
accountability, and access, our proposals will increase
competition and reward innovation.
Q.34. Bank of America-Merrill--Secretary Geithner, last year,
Bank of America contemplated not going forward with a merger
with Merrill Lynch, but was strongly exhorted by the Fed and
Treasury to proceed with the merger.
Did you play a role in deliberations about how to handle
the Bank of America-Merrill merger?
If the Administration's proposed changes were in place,
would the Fed and Treasury have had any additional tools in
their arsenal to deal with the potential fallout of the failed
merger that would have made it unnecessary to exercise a heavy
hand behind the scenes to force the merger to close?
A.34. After President Obama advised me that I would be his
nominee for Treasury Secretary, I no longer participated in
policy decisions regarding the Merrill-Lynch situation,
including a possible merger with Bank of America. I was,
however, kept apprised of developments involving the merger in
my role as President of the NYFED. Consequently, I was not
involved in policy decisions regarding Bank of America
potentially exercising the materially adverse change clause and
not going forward with the merger.
While I will not comment on the specifics of the Bank of
America-Merrill Lynch merger, it is clear that the government
lacked the tools it needed during this crisis to provide for an
orderly resolution of a large, nonbank financial firm whose
failure could threaten financial stability.
That is why we have proposed a special resolution regime
for extraordinary circumstances and subject to high procedural
and substantive hurdles to fill this gap. Under our proposal,
the government would have the ability to establish a
receivership for a failing firm. The regime also would provide
for the ability to stabilize the financial system as a result
of a failing institution going into receivership.
In addition, the receiver of the firm would have broad
powers to take action with respect to the financial firm. For
example, it would have the authority to take control of the
operations of the firm or to sell or transfer all or any part
of the assets of the firm in receivership to a bridge
institution or other entity. That would include the authority
to transfer the firm's derivatives contracts to a bridge
institution and thereby avoid termination of the contracts by
the firm's counterparties (notwithstanding any contractual
rights of counterparties to terminate the contracts if a
receiver is appointed).
Q.35. Multiple Banking Regulators--The administration outline
states ``similar financial institutions should face the same
supervisory and regulatory standards, with no gaps, loopholes,
or opportunities for arbitrage.'' Your plan envisions a
national banking regulator that combines or eliminates many of
the various types of banking charters such as thrifts, ILCs,
and credit card banks. Your plan, however, seeks to eliminate
only one regulator, the Office of Thrift Supervision, while
adding one more Federal regulator solely for consumer
protection. Thus the total number of bank regulators remains
the same.
Why did you decide to leave the Federal Reserve and the
FDIC as the primary supervisor of some commercial banks? If the
desire is to achieve more accountability from our regulatory
system why not consolidate the commercial banking regulatory
structure into one Federal and one State Charter?
A.35. Our proposals for structural reform of our regulatory
system are focused on eliminating opportunities for regulatory
arbitrage. Most importantly, we address the central source of
arbitrage in the bank regulatory environment by proposing the
creation of a new National Bank Supervisor through the merger
of the Office of Thrift Supervision and the Office of the
Comptroller of the Currency. These agencies granted Federal
banking charters whereas the FDIC and Federal Reserve have
oversight regarding charters granted by the States. As such, we
are reducing the potential for arbitrage regarding Federal
charters. In addition, by recommending closing the loopholes in
the legal definition of a ``bank,'' we also make sure that no
company that owns a depository institution escapes firm-wide
supervision. Moreover, our proposals on preemption and
examination fee equalization would substantially reduce
arbitrage opportunities between national and State charters.
Q.36. Resolution Regime--Secretary Geithner, if Lehman had been
resolved under your proposed resolution regime, how would
Lehman's foreign broker-dealer have been handled?
A.36. The financial regulatory reform initiative that we are
proposing is comprehensive. Under the plan, all subsidiaries of
Tier 1 FHCs, including foreign entities, will be subject to
consolidated supervision. The focus of this supervision is on
activities of the firm as a whole and the risks the firm might
pose to the financial system.
First, United States Tier 1 FHCs will be required to
maintain and update a credible rapid resolution plan, to be
used to facilitate the resolution of an institution and all of
its subsidiaries (U.S. and foreign) in the event of severe
financial distress. This requirement will provide incentives
for better monitoring and simplification of organizational
structures, including foreign subsidiaries, so that the
government and the entity's customers, investors, and
counterparties may be better prepared in the event of firm
collapse. Second, in the event that the Tier 1 FHC is resolved
through the proposed special resolution regime, the appointed
receiver would coordinate with foreign authorities involved in
the resolution of subsidiaries of the firm established in a
foreign jurisdiction. This is the same process the FDIC would
use for failing banks with foreign subsidiaries.
Q.37. Would U.S. taxpayer funds have been used to satisfy
foreign customer liabilities?
A.37. The resolution regime that we are proposing is not
designed to replace or augment existing customer protections,
either domestically or internationally. We would expect
existing programs to protect insured depositors, customers of
broker-dealers, and insurance policyholders to continue. The
resolution regime would allow the receiver to create a bridge
institution in order to more effectively unwind the firm while
protecting financial stability and it is possible that
liabilities held by foreign counterparties could be put into
the bridge institution. However, the purpose of the special
resolution regime would be to unwind, dismantle, restructure,
or liquidate the firm in an orderly way to minimize costs to
taxpayers and the financial system. All holders of Tier 1 and
Tier 2 regulatory capital would be forced to absorb losses, and
management responsible for the failure would be fired. If there
are any losses to the government in connection with the
resolution regime, these will be recouped from large financial
institutions in proportion to their size.
Q.38. Over-the-Counter Derivatives--Secretary Geithner, the
Administration's plan does not provide much detail about the
Administration's views as to the proper allocation of
responsibility with respect to over-the-counter derivatives
between the Securities and Exchange Commission and the
Commodity Futures Trading Commission.
As you devise your recommendations for allocating
regulatory responsibility over derivatives, how are you taking
into account the importance of interest rate swaps and currency
swaps to the debt securities markets.
A.38. As a general matter, our plan allocates responsibility
for over-the-counter derivatives (swaps) between the SEC and
CFTC consistent with how existing law allocates responsibility
over futures. More specifically, we provide the SEC with
authority to regulate swaps based on a single security or a
narrow-based securities index; we provide the CFTC with
authority to regulate swaps based on broad-based securities
indices and other commodities (including interest rates,
currencies, and nonfinancial commodities). Given the functional
similarities between swaps and futures, we believed that it was
important to have the swaps regulatory jurisdictions parallel
those of the futures markets. In addition, to ensure that all
classes of swaps face similar constraints, we have required the
SEC and CFTC to issue joint rules on the regulation of swaps,
swap dealers, and major swap participants.
In designing our swaps framework, we took into account the
importance of interest rate swaps and currency swaps to the
debt markets. We believe that our proposals will enhance the
transparency and stability of those markets. Although our
proposals require central clearing of standardized derivatives,
we have preserved the ability of businesses to hedge their
interest rate and currency risks through customized derivatives
in appropriate cases.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR REED
FROM TIMOTHY GEITHNER
Q.1. If the Federal Reserve is given more regulatory
responsibilities, how can we ensure that Congress can fully
exercise its oversight role while also maintaining the Federal
Reserve's independence over monetary policy?
A.1. Congress has exercised vigorous oversight over Federal
Reserve regulation and supervision for decades and we are not
aware of any evidence that this oversight has infringed on the
independence of monetary policy. Congress can and does call
hearings on supervision and regulation where the Federal
Reserve and other agencies are called to testify. Moreover, all
of the Federal Reserve's supervisory and regulatory functions
are subject to review by the GAO. Recent GAO reports on the
Federal Reserve and other banking regulators have included
assessments of capital rules, http://www.gao.gov/new.items/
d08953.pdf; consolidated supervision, http://www.gao.gov/
new.items/d07154.pdf; and oversight of risk management systems
at major banking organizations, http://www.gao.gov/ncw.items/
d09499t.pdf. We believe that this oversight can and should
continue and we do not perceive a threat to the independence of
monetary policy.
Q.2. We have spoken about concerns I have about private equity
acquisitions of banks. As you know I feel strongly that there
should be a consistent and carefully thought out policy that
allows us to take advantage of the capital that private equity
has to offer, while at the same time include strong protections
to ensure that commercial interests of private equity and other
firms do not threaten the safety and soundness of institutions
or the overall stability of our Nation's financial system.
What is the status of efforts to develop a consistent
policy among regulators in this area?
A.2. The staff of the Department of the Treasury (Treasury) has
consulted with staff of the Board of Governors of the Federal
Reserve System (Board), the Federal Deposit Insurance
Corporation (FDIC), and the Office of Thrift Supervision (OTS),
respectively, regarding the standards used to assess proposals
by private equity investors (Investors) for controlling
investments in banking organizations. Even though these
standards have common features, each agency supervises
different types of banking organizations and must administer
separate laws with distinct mandates. As these agencies
continue to develop standards, as summarized below, Treasury is
mindful of the need to establish consistent policies for
promoting access to capital, ensuring appropriate supervisory
oversight over banking firms, aligning the incentives of
investors with the long-term health of banking organizations,
and strengthening the wall between banking and commerce. We
will be working through the President's Working Group on
financial markets (and in the future through the Financial
Services Oversight Council if Congress creates one as part of
regulatory reform) on these matters.
The Federal Banking Agencies Continue To Develop Policies for Investors
The Board
In September 2008, the Board adopted a policy statement
regarding noncontrolling investments in banks and bank holding
companies under the requirements of the Bank Holding Company
Act (BHCA). As individual transactions may present unique
structures, the Board addresses controlling investments in
banks and bank holding companies on a case-by-case basis. The
Board staff has advised Treasury that, in general, various
proposals by Investors to establish a fund to acquire control
of a banking organization have not appeared to satisfy the
requirements of the BCHA because the Investors also control
funds that make commercial investments. Although the Board has
permitted a few groups of investors to establish bank holding
companies notwithstanding their control of other funds with
commercial investments, the Board has not recently approved
such a transaction. According to the Board staff, in each of
those prior cases, the decision to permit the bank holding
company to be affiliated with a commercial firm was limited to
the particular circumstances surrounding the investment and the
Investors, such as ownership and control of the bank holding
company by individuals, as opposed to private equity
organizations.
The OTS
The OTS has approved private equity investments in thrifts
under the Home Owners' Loan Act (HOLA). In considering these
investments and new proposals, OTS staff has advised that the
agency is focused on balancing the needs to allow investments
in thrifts and thrift holding companies, as permitted by the
HOLA, with prudential measures designed to assure the safety
and soundness of those institutions. For example, OTS indicated
that in January 2009 the OTS approved the acquisition of
Flagstar Bank, FSB by eight newly formed private equity funds
and, among other measures, obtained commitments by the
Investors barring the Investors from exercising control over
the management, policies, or business operations of the thrift
organization and restricting transactions between their
affiliates and the thrift organization. In this regard, the
commitments obtained by the OTS were similar to commitments
obtained by the Board in other transactions by Investors
approved by the Board. Staff of the OTS has advised Treasury
that, subject to appropriate prudential measures, certain
controlling investments in thrifts and thrift holding companies
by Investors, including Investors that also maintain
controlling commercial investments, may satisfy the
requirements of the HOLA.
The FDIC
The FDIC issued final guidance in August establishing
principles that would apply to certain applications to acquire
failed banks (FDIC Policy Statement) by Investors. Under the
FDIC Policy Statement, certain Investors will have to satisfy
requirements regarding: capital commitments; cross guarantees;
transactions with affiliates; limits on entities based in
secrecy law jurisdictions; continuity of ownership; special bid
limits on insiders; and disclosure. In particular, Investors
will be required to ensure that the acquired depository
institution has a minimum Tier 1 leverage ratio of 10 percent
for at least 3 years, and thereafter is ``well capitalized''
during the remaining period of their ownership, and generally
will be prohibited from selling or otherwise transferring the
securities of the holding company or depository institution for
a 3-year period. In addition, the FDIC Policy Statement makes
Investors holding 10 percent or more of the equity of a bank or
thrift in receivership ineligible to be a bidder on that failed
depository institution. Finally, the FDIC Policy Statement
states that structure for owning depository institutions where
the beneficial ownership is not easily ascertained--so-called
``silo'' structures--will not be approved.
Treasury Is Working To Promote Consistent Policies
Private equity investments in banking organizations raise
potentially competing considerations. These investments can
strengthen our banking system by providing an important
component of private capital and spurring the timely resolution
of failed depository institutions. On the other hand, these
investments can entail risks and raise important policy issues
relating to the supervisory oversight necessary to protect the
safety and soundness of banks, such as aligning the incentives
of investors with the long-term health of banks and
strengthening the policy of separating banking from commerce.
Treasury is currently reviewing developments in this area, and
will continue to work through the President's Working Group on
Financial Markets (and in the future through the Financial
Services Oversight Council if Congress creates one as part of
regulatory reform) to engage independent banking agencies to
develop consistent policies regarding private equity
investments in insured depository institutions.
Q.3. Are there legislative changes that are required to
adequately address this issue?
A.3. The Administration has recommended the closing of certain
statutory loopholes that historically have permitted the mixing
of banking and commerce and evasion of supervision under the
Bank Holding Company Act. The banking agencies have authority
under current law to balance the Deed for capital in the system
with the need for appropriate safety and soundness supervision
with respect to private equity investments. We would be happy
to discuss the issue with you, including possible legislative
changes.
Q.4. As you know, I have urged Treasury to use its leverage to
sell, exercise, or hold warrants after financial institutions
repay TARP funds to ensure the best return for taxpayers.
What are Treasury's plans with respect to handling the
warrants of institutions that repay their TARP funds?
Will there be a clear written set of policies and
procedures on this?
A.4. In December 2009, Treasury conducted public auctions for
its warrants in Capital One Financial Corporation, JPMorgan
Chase & Co., and TCF Financial Corporation. Each of these banks
had fully repurchased Treasury's preferred stock investment.
The auctions were conducted as modified ``Dutch'' auctions
registered under the Securities Act of 1933, in a format where
qualified bidders may submit one or more independent bids at
different price-quantity combinations and the warrants will be
sold at a uniform price that clears the market.
Proceeds to Treasury from the auction of its warrants in
Capital One Financial Corporation, JPMorgan Chase & Co., and
TCF Financial Corporation, were approximately $148.73 million,
$950.32 million, and $9.59 million, respectively, with net
receipts to Treasury after underwriting fees and selling
expenses of approximately $146.50 million, $936.06 million and
$9.45 million, respectively. Treasury expects to conduct
similar auctions in the future.
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RESPONSES TO WRITTEN QUESTIONS OF SENATOR AKAKA
FROM TIMOTHY GEITHNER
Q.1. Mandatory Arbitration Clause Limitations--Mr. Secretary,
please provide the written response that you mentioned during
the hearing on why the Consumer Financial Protection Agency
should have the authority to restrict or ban mandatory
arbitration clauses.
A.1. Treasury's proposed legislation authorizes the CFPA by
rule to prohibit or impose conditions or limitations on pre-
dispute mandatory arbitration clauses if the Agency finds that
such prohibition, conditions, or limitations are in the public
interest and for the protection of consumers.
Many financial products and services providers require
their customers to agree to contracts containing provisions to
arbitrate all disputes. Although arbitration may be a
reasonable option for many consumers to accept after a dispute
arises, mandating a particular venue and up-front method of
adjudicating disputes--and eliminating access to courts--may
unjustifiably undermine consumer interests. There are several
aspects of mandatory pre-dispute arbitration that have raised
concern. Many consumers do not know that they often waive their
rights to trial when signing contracts for financial products.
Arbitrators are private parties dependent on large firms for
repeat business, which may give rise to conflicts of interest.
Rather than banning pre-dispute mandatory arbitration in
the legislation, our proposal gives the Agency the power to
study it and, if warranted, impose limitations or ban it to
ensure fairness for consumers. In addition, under our proposal,
even if mandatory arbitration were banned, parties would still
be free to agree to arbitration once a dispute has arisen.
Post-dispute arbitration is much more likely to be a fair
process because consumers can evaluate the arbitration process
in light of the potential or actual dispute before agreeing to
such an arbitration process.
Q.2. Financial Literacy--Mr. Secretary, what specific financial
literacy responsibilities will the Consumer Financial
Protection Agency have?
A.2. We believe that financial education is an important
component of consumer protection and financial stability. Thus,
the CFPA will play an important role in efforts to educate
consumers about financial matters, to improve their ability to
manage their own financial affairs. and to make their own
judgments about the appropriateness of certain financial
products. Once established, Treasury anticipates that the CFPA
will include an Office of Financial Literacy that will work to
promote consumer financial education. We also anticipate that
the Director of the CFPA will be a member of the Financial
Literacy and Education Commission established by the Financial
Literacy and Education Improvement Act (20 U.S.C. 9701 et
seq.), and that the CFPA will coordinate and work closely with
the FLEC.
Q.3. Promoting Access to Mainstream Financial Services--Mr.
Secretary, I remain concerned that consumer access to
mainstream financial services remains limited in underserved
communities. The proposal indicates that a critical part of the
Consumer Financial Protection Agency's mission will be
promoting access to financial services. Other than rigorous
enforcement of the Community Reinvestment Act, what will the
CFPA do to promote access to mainstream financial services and
ensure that the financial service needs of communities are
being met?
A.3. As part of a legislative requirement to consider the costs
and benefits of any new regulation, the CFPA will analyze how
regulations affect consumers' access to financial services.
Under the Administration's proposal, ensuring access to
traditionally underserved consumers and communities and
ensuring ample room for innovation would be a core part of the
CFPA's mission. As you mention, our proposed legislation gives
the Agency authority to rigorously enforce the Community
Reinvestment Act (CRA) in order to ensure that depository
institutions meet the credit needs of the communities in which
they operate. In addition, it requires the CFPA to establish a
community affairs unit with the mission of providing
information, guidance, and technical assistance regarding the
provision of consumer financial products or services to
traditionally underserved consumers and communities. The
proposed legislation would also require the CFPA to create a
research unit that will research, analyze, and report on market
developments, disclosures and communications, consumer
understanding of financial products, and consumer behavior.
This unit's work will inform regulatory and market innovation
that will expand access to financial services to the
communities that need it most.
Q.4. Financial Budget and Staffing for the CFPA--How large of a
budget and how many staff members will be needed to ensure that
the Consumer Financial Protection Agency will be able to
effectively educate, protect, and empower consumers?
A.4. The CFPA will require a budget and staff that are
commensurate with its responsibilities, which include both
existing functions performed by the current financial services
regulators, as well as expanded authority to strengthen
protections where they have been weak, particularly regarding
the nonbank sector. Strong, stable funding will ensure that the
agency can establish, monitor, and enforce high standards for
consumers across the financial services marketplace.
The CFPA's budget will include the resources used by the
existing regulators to carry out their financial consumer
protection functions, which will all be transferred to the new
agency. The agencies that will transfer functions to the CFPA
include the Federal Reserve Board and Federal Reserve Banks,
the Office of the Comptroller of the Currency (OCC), the Office
of Thrift Supervision (OTS), the Federal Deposit Insurance
Corporation (FDIC), the National Credit Union Administration
(NCUA), the Federal Trade Commission (FTC), and the Department
of Housing and Urban Development (HUD). In addition to these
resources, the CFPA will need to hire staff to provide a level
playing field by extending the reach of Federal oversight to
the nonbank providers of consumer financial products and
services.
We do not yet have an estimate of what amount will be
necessary to fund the CFPA. We are in the process of gathering
information on the resources expended from each of the agencies
where funds will be transferred, and estimating the additional
resources that will be required for the functions that are not
being performed now, including supervision of nonbank financial
companies that provide consumer financial products or services.
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RESPONSES TO WRITTEN QUESTIONS OF SENATOR KYL
FROM TIMOTHY GEITHNER
Q.1. Anecdotal reports suggest that the regional offices of
Federal bank regulators are not applying regulatory standards
uniformly across the Nation, may not be adequately coordinating
with their State counterparts, and are in some cases advising
banks not to make loans that would otherwise be profitable.
Are you aware of this problem?
If so, what can be done to facilitate coordination among
the regional offices of our Federal regulators to ensure
standards are applied uniformly?
What role would State bank regulators play under the
Administration's reform proposal?
How can States be better integrated into a seamless
regulatory scheme in order to leverage local regulators' unique
knowledge about their own marketplace?
A.1. Federal bank regulators seek to apply regulatory standards
uniformly across their organizations. However, this does
present challenges in that some degree of examiner discretion,
based on local knowledge and other factors, also plays an
important role. Moreover, regional economic differences may
necessitate some flexibility in the application of
requirements.
The Administration's regulatory reform proposal preserves
the role of State chartered banks and State supervision. Today,
Federal and State banking regulators coordinate their
examination programs and share information. In 2006, the State
Liaison Committee (SLC) was added to the Federal Financial
Institutions Examination Council (FFIEC) as a voting member.
The SLC includes representatives from the Conference of State
Bank Supervisors, the American Council of State Savings
Supervisors, and the National Association of State Credit Union
Supervisors. The FFIEC is a formal interagency body designed to
prescribe uniform principles, standards, and report forms for
the Federal examination of financial institutions by the
banking regulators and to make recommendations to promote
uniformity in the supervision of financial institutions. Having
State regulators represented on the FFIEC should help to
leverage local knowledge.