Hearing of the House Financial Services Committee - Systemic Risk and the Financial Markets
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REP. ED ROYCE: Thank you, Mr. Chairman.
I want to thank you, Secretary Paulson and Chairman Bernanke, for being with us. And I want to begin to question Secretary Paulson. And Chairman Bernanke, you might want to comment on this too.
There was a speech delivered by Federal Reserve Chairman -- former Fed Chairman Alan Greenspan to the Federal Reserve Bank of Chicago in May of 2005. And he said, "Market participants usually have strong incentives to monitor and control the risks they assume in choosing to deal with particular counterparties. In essence, prudential regulation is supplied by the market through counterparty evaluation and monitoring rather than by the authorities.
"Such private prudential regulation can be impaired, indeed, even displaced," said Greenspan, "if some counterparties assume that government regulators obviate private prudence. We regulators are often perceived as restraining excessive risk-taking more effectively than is demonstrably possible in practice. Except where market discipline is undermined by moral hazard -- for example, because of federal guarantees of private debt -- private regulation generally has proved far better at constraining excessive risk-taking than has government regulation."
And more recently, Jeffrey Lacker, who's the president of the Federal Reserve Bank of Richmond, he got into the details about the need for regulators to distinguish between fundamental and non- fundamental runs on financial institutions when considering intervention by the regulators. And he says, "There are models in which runs are self-fulfilling prophecies, are costly, and could be avoided, perhaps, through central bank intervention. Other runs arise from fundamental developments, and for these, central bank intervention -- interference with market discipline distorts market prices."
And so I would ask you both if it is possible to establish a regulatory model that can provide a sense of security to prevent self- fulfilling prophecies, to use, you know, Jeffrey Lacker's words, with respect to runs on our financial institutions, and at the same time avoid interfering with the type of market discipline that Mr. Greenspan believes is so critical to the health of our capital markets. And if I could start with you, Secretary Paulson.
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