Hearing of the Senate Committee on Banking, Housing, and Urban Affairs - The State of the Banking Industry

Statement

SEN. DODD: (Sounds gavel.) The hearing will come to order. My apologies to our witnesses and my colleagues here, who have been a couple of minutes late. I believe Senator Shelby will try and get by; there's a large Alabama meeting this morning, I think regarding the recent announcement of the -- Jack -- fuel tanker issue and Alabama has a strong interest in that, and for that reason we will not be here at least for a while this morning.

But what I'll do is I'll begin with opening statements. Let me -- I'll turn to any other members, who would care to make a brief opening comment, but I'd like to -- we could get to the questions. And hear from our witnesses this morning I want to thank all of them for participating.

The committee this morning examines the state of the banking industry and our nation. And such an examination by this committee should not be could not be more important or timely in my view. It's important, it is our first duty obviously as legislatures and this committee is to ensure that ensured depository institutions operate in the safe and sound manner.

These institutions currently hold over $4.3 trillion in deposits. They are ensured by the American taxpayer. Therefore, the taxpayers, of course has the right to know, that the appropriate agencies are ensuring that any risk to those deposits are being managed prudently and with taxpayers ultimate liability in mind.

I well remember sitting on this desk two decades ago, in fact, I think Senator Shelby was here and others, clearing up the mess caused by the reckless and wanton practices in the savings and loan industry. Those practices and the regulatory failure is going to allow them to occur required a taxpayers bail out of some $150 billion. Those are very difficult days in this committee.

None of us, not a single person on this committee nor I suggest anyone of our colleagues, wants to go through that kind of exercise again, ever again. That is why this hearing is not only important, but I think timely as well. Credit markets are experience unprecedented disruptions right now - the markets for mortgages, credit cards, student loans, auto loans, corporate debt, municipal debt, in short for all of the economic activities that are indispensable to growth and prosperity. These markets have chilled and in some cases have frozen entirely. These markets have seized up most as a direct result of problems in the subprime market. Recent estimates indicate that ensured depositories and other financial institutions could lose an additional 300(billion dollars) to $400 billion due to exposure mortgages, residential as well as commercial.

It is no surprise therefore, that many of these institutions has sought infusions of over $30 billion in capital from foreign sovereign wealth funds since November last year. The federal insured banks, thrifts, and credit unions of our nation, and I just have a group of financial intermediaries.

There, a success or failure is not merely a concern to their employees and shareholders; it should be and must be a concern for all of us, because these institutions in a very real sense form the corner stone of our nation's economic foundation. If these lenders do not or cannot lend then our economy cannot and will not go obviously.

President Kennedy is reported to have once said that if the economy is wrong then nothing is right. If that is the case then it is no less true that if the banking industry is wrong, then the economy is not right as well.

The regulatory agencies that oversees -- oversee this industry; therefore play an indispensable role not only in the economic activities of the lenders they oversee, but in the economic life of our nation. They do want to merely apply and enforce the laws, as important as that job is, and they do not always ensure that the deposits which are ensured by the America taxpayer are managed in a safe and sound manner, but they do that as well.

Fundamentally, fundamentally you all serve as the gatekeepers of credit for the entire economy of our nation. That is an awesome responsibility, and the men and women who work at our nation's financial regulatory agencies understand that responsibility. And by and large they discharge that doing those duties with diligence and with distinction I would add.

But the dedication is not tantamount in fallibility, that point was made a-year-and-a-half ago when Senators Allard and Bunning conveyed hearings on irregular practices in the mortgage lending industry. I have commended them before, I do so again this morning for those hearing which were impressive in many ways.

The point was made again a year ago when this committee convened a hearing to examine the turmoil in our nation's mortgage markets. At that time I detailed what I determined a chronology of neglect by federal regulators, principal of the Federal Reserve on the previous leadership.

We presented evidence of the Federal Reserve examiners it was far back as late 2003 of the deterioration of lending standards and the origination of adjustable rate and non traditional mortgages. Yet, the fed did nothing to intervene in my view; on the contrary its chairman at the time actually encouraged such loans.

And then he simultaneously embarked on a series of interest rate hikes that would make adjustable rate mortgages less affordable to homeowners. The impact of these policies is now felt of course by millions and millions of American consumers, who face interest rates -- who face interest rates slides that have led or will lead to foreclosure.

It is felt by millions more who cannot obtain mortgage credit, because the market for subprime and jumbo loans has ceased up. It's felt by entrepreneurs, who cannot obtain loans or other forms of financing because lending institutions are in a virtual credit lock down

And it's felt by the lenders themselves obviously, were struggling in ways that they have not struggled in recent memory. It is no wonder that the feds or witnesses at a hearing before this committee last year said that retrospect this agency and I quote, "could have done more sooner to address predatory mortgage lending practices."

Again and again the question has been asked over the past year, as our credit markets have grown increasingly impaired.

Where were the regulators, why didn't they do more? Were they asleep at the switch, and when the alarm went off, did they merely hit the snooze button?

Four years ago Senator Shelby convened an oversight hearing similar in purpose to today's hearing. At that time the federal agencies represented here this morning, hailed innovations, a mismanagement that enabled banks to better quantify risks and take other corrective manners to contain undue risks.

They pointed to the secondary markets and merely developed structured finance products as tools of adult banks more effectively managed and diversified their risks. In the words of the then control of the currency bank supervision that provide, and I am quoting, "a layer of protection against the challenges posed by a changing economy." End of quote.

Four years later, we want to know what happened what happened to the new fangled risk management innovations that were supposed to sound an early warning about reckless lending practices. What about the promises of securitization as a way to manage critical risk, credit risk rather? Where was the layer of supervisory protection against excessive risk? Why didn't you more vigorously enforce good old fashion common sense underwriting?

Well, a loan is made based on the borrower's ability to pay and what are you doing now today to protect against new risk posed by instruments such as credit default slops, trillions of dollars of which are held by the institutions you regulate.

I have read your testimony and you seem to suggest that your study, what went wrong here. You've all said that we need to get back to the fundamentals that we need to return to core practices. That we need to abide the way banks manage risk underwriting in capital. But studying the problem is not enough, and I want to see some meaningful and substantial action from all of you as soon as possible.

Specifically, I want to know what you intend to do to change what have been lacks oversight of underwriting standards. I want to know what steps you intend to take to make sure that we rethink the assumptions underlying Basel II prior to its implementation. And I want to know what specific changes to the supervision of bank risk management you intend to implement moving forward.

I intend to reconvene this panel within 60 days to hear your responses to these very important questions. These are legitimate questions important questions, questions that American taxpayers have every right to ask and have answered for them.

We appreciate the willingness of our witnesses obviously to appear today to provide these answers. I am grateful to all of you.

And let me turn to Senator Bennett, if he has any opening comments he want to make and my other colleagues as well and then we'll hear from the testimony.

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SEN. DODD: Well, thank you very, very much.

And let me thank all of our witnesses. And I appreciate your brevity as well in allowing us to get to the questions here this morning.

And what I'll do is I'll turn the clocks on here for about -- let me say -- there are too many of us here -- seven or eight minutes, and so we get a decent amount of time for the first round of questioning.

There are lot of issues to be raised. Obviously Senator Bennett pointed out -- there's a fundamental question that was sort of raised this morning by the Wall Street Journal that will probably be a subject of all of our questions to one degree or another.

But let me, if I can, begin with just talking about Basel II, because this is a big issue. It's the center of a lot of attention in various articles here. The current problems in the market highlight, I think, the critical importance of adequate capital standards for banks. That's the core issue in many, many ways.

Although not the only one, I think, the risk management as well, and other questions here, but obviously the core element of having the adequate capital standards are fundamental in the upcoming implementation of Basel II.

And I gather, and those of you deeply involved with this can correct me -- but I gather just in terms of how fast this is moving, that while -- I think there is some talk that the spring is probably a greater likelihood, it's probably more in the fall, before really they begin to move.

So we got a little time here to look at this and respond to it if we can. There is a potential for some major changes in the capital requirements that banks will face.

There have been some concerns raised if the structure of Basel II would lead to some serious problems. I think you've all heard this, especially in the current environment we are in, specifically there have been concerns raised about the reliance of Basel II on internal bank models of risk, models which failed during the recent crisis, that we've experienced in the market.

A recent piece written here by Harald Benink and George Kaufman in last weeks Financial Times reads, headline, "Turmoil reveals the inadequacy of Basel II."

And let me quote from the article. It says, "A more fundamental problem is that Basel II creates perverse incentives to underestimate credit risk. Because banks are allowed to use their own models for assessing risk and determining the amount of regulatory capital, they may be tempted to be overoptimistic about their risk exposure in order to minimize required regulatory capital and to maximize return on equity."

I'd like each of you to respond to that concern if you would. And then a follow-up question with regard to t, is whether Basel II, if it were -- had been in effect -- let's move the calendar to the opposite direction.

Let's assume it had been in effect in the last couple of years. What impact would Basel II, as proposed, have been on the current situation in your views?

Will we be looking at a better or a worse situation, if those -- if Basel II were in place. And again, there is background here. We obviously know what happened in the -- at the -- at this recent financial institution in England.

Here we had -- this one bank, sort of enabled them to increase our 2007 interim dividend by 30 percent. You may have all read it -- this report. "And going forward, our dividend payout rate increases to 50 percent of underlying EPS were around 40 percent.

"Future capital planning including reduction of capital hungry assets will allow us to return capital to shareholders through a share buyback program. The medium-term outlook for the company is very positive." End of quote.

That CEO is Adam Applegarth of the Northern Rock Bank on June 30th of last year. And as all of you know, he had shortly afterwards -- they became insolvent, were nationalized, had the largest run since 1866 here.

So despite the positive predictions here under Basel II, I'm very interested in how each of you would respond to the question that what would our situation look like today had Basel II been in place?

And then, of course, responding, if you can, to the concerns raised by Mr. Benink and Mr. Kaufman.

Sheila, we'll begin with you.

MS. BAIR: We've got headlong standing -- the FDIC institution has headlong standing questions and concerns about the use of internal models to drive capital into Basel II.

And my personal view is that, you know, we are taking a very, very slow approach in implementations. We got plenty of time to make adjustments as we try to work through some of these issues.

The problem with model-driven capital is it relies on past performance. And when you have new higher risk products that were developed and performed during a very benign -- favorable economic environment, your past performance is not going to tell you how we are sure we are going to perform when economic circumstances change. And that's exactly what we saw of mortgages.

Our QIS impact study -- the QIS -- the Quantitative Impact Study --

SEN. DODD: Isn't that -- shouldn't that be a part of it? I mean, if your past performance has been sort of rosy, shouldn't you be anticipating these matters here if things don't go well as well as when things are going well.

MS. BAIR: The issue absolutely stressed that. But again models are only as good as the data you put into them. And these models rely on historical data.

So the historical data -- yeah, that's one of the issues we've had. If the quantitative impact study show that there would have been a 73 percent median reduction risk-based capital for residential mortgage lending -- and for home equity lending it would have been 79 percent. And again that was because it was very benign; it is sort of better being dead into the models when these curious studies were done.

So I think it would have put us in worse shape. And I think, no I would we've had a lower capital going into this. But I think we would have banks -- banks who are already having to raise capital would have had to raise a lot more. So you have a perfect locality with -- you have these reduced capital levels using models on for benign economic times that spike up sharply.

So we think this has been a -- always been a crucial issue -- a critical issue with the Basel II -- (inaudible) -- I think there is many good elements of Basel II too. I think it's important that there are other aspects of it that are positive.

We are also going to be going out for comment on the Basel II standardized approach which does not use internal models, but has more of a bucket system where you -- for each asset category you have hard and fast floors under each bucket.

And of course, nobody is talking at this point about getting ready to leverage ratio, which would be our feel safe under all these new frameworks.

SEN. DODD: But let me -- I should have said -- I want to get to my question quickly. And I don't want anyone of you, or anyone here to walk out of this room with the assumption that the chairman of the committee is hostile to Basel II. I mean, it is a very, very positive element of Basel II.

The question is, are we rushing ahead a little too fast without thinking about these other implications.

So I have a positive attitude about Basel II. I'm just concerned about how some of this may work.

John.

MR. : Mr. Chairman, I guess I would -- as I do in some of these issues with my colleague, have a little different take on this.

Number one, the losses that we've really seen happen in the Basel I world, not a Basel II world, which is not directly responsive to your question.

I think of the Basel II question, there are some things that I think it clearly would have done better and will do better. I think it factors more risk management processes into the capital framework, and that's a good thing.

I think it does a better job with not creating incentive between off-balance sheet and on-balance sheet risk. They are more treated equally under that program.

And as -- with respect to the notion of dealing with historical data, well, that is an issue with respect to Basel II. It was more of an issue when we only had the nine data going into it, because of all the benign credit issues had gone on.

Well, we've taken care of that problem. They are a lot of losses now that would be set into the system. It's taken into account and how the data adjust to those actual events and causes more capital be raised.

I think it is quite an open question given the current events, whether capital in the system would go up, not down, as a result of what's happened. But having said all of that, I think there are some very specific things that happened that really need a look in the Basel II process, particularly with these ABS CDOs that were backed by subprime related securities.

Senator Bennett referred earlier -- the credit ratings. The irony of this whole situation is that the very high -- most highly rated, best securities, ones that were thought to be least likely to default was where all the huge share of the losses have been concentrated.

And the things with the most highest rating get the least attention from management, from regulators and from our capital regime. And the fact of the matter is the AAA in this context perform much differently and much worse than AAA and any other type of security we've ever witnessed before. There has to be a need to look at that.

And one of the places we need to look at is whether the Basel II capital risk weights for this particular kind of security needs to be adjusted. I think that is extremely important going forward along with some other measures.

The last point I'll make is although the rule is final, it is a quite deliberate pace that's going on in the United States. These firms had three years to begin. The first parallel year, we are a year running, which is not actually the year you get on it. There's another year, and then you have a three year transition period. No firm has actually even started that.

As you were saying before, the first one may become in the summer. I think it will be staggered over time. And meanwhile we do have these systems of floors where we can have those in place and fine-tune things as we go along.

But you are raising very good questions that need to be looked at and adjusted as we go forward.

SEN. DODD: JoAnn, do you have any comments on this. I want to hear from the feds point of view on this. But I want to also hear if you have any thoughts on this.

Yes, go ahead Ms. --

MS. JOHNSON: I'd like to add a point. While credit unions don't fall under Basel, we do have a risk-based capital proposal on the table for Congress to take a look at it. And I would ask your serious consideration, because this would give us as a regulator a real tool to identify problems more quickly, and it would help the credit unions manage their risk more effectively.

And it's our risk based capital, Prompt Corrective Action proposal we've been working for over three-and-a-half years on it. But we need legislative action in order to get it done.

So I would just please ask for your serious consideration. It would really give us a tool as a regulator.

SEN. DODD: -- (inaudible)--

MR. REICH: Mr. Chairman, I would like to make a comment. I began my banking career about 47 years ago. And I grew up in a generation of bankers who believed that you cannot have too much capital, and you can't have too much money in your loan loss reserves. I still believe that today.

When I entered the Basel discussion as a banking regulator about two-and-a-half years ago, I was a skeptic about Basel II. I'm still sort of skeptical today, but I feel a lot more comfortable today about it than I did two-and-a-half years ago.

And one of the reasons is that I've been talking with my fellow regulators at this table about Basel II over the past two-and-a-half years, and I know that there is one thing that we are all committed to, and I believe that every single individual is committed to making whatever changes need to be made between now and full implementation in 2012.

We have -- we also have the authority which is not discussed a great deal in pillar two of Basel II, for the regulators to have the latitude and the flexibility to require whatever additional levels of capital we think are necessary over and above what the models predict.

So we are not totally dependant upon the model. Our examiners in the field and their supervisors and their regional offices will be reviewing capital, will be reviewing the risk profiles of these institutions. And if we feel we need more capital over and above what the models call for, we'll -- we will call for that additional capital.

SEN. DODD: And Mr. Kohn, I'm asking you to respond to this. Let me pick on something that John Dugan said that --- I'll just take a little at it. John mentioned about how this was all operating under Basel I. Well, that's true in this country. It wasn't true in Europe.

Europe was operating under Basel II and the quote I had from that British bank here was under Basel II regulations. Again, not to -- again, I'm a supporter of Basel -- the -- (inaudible) -- but it seems to be me here that looking at what has occurred here, under a regime that we're talking about adopting, raises some questions and why shouldn't I be concerned about Basel II having watched what happened in Europe, why that couldn't be here or why it would be missed, if in fact Basel II had been in place over the last several years.

MR. : Mr. Chairman, I think they're implementing Basel II this year in Europe, not last year, so --

SEN. DODD: Wasn't this in fact -- wasn't that British bank under those rules, am I wrong about that?

MR. : It might have been.

MR. : It had a parallel run here, but the final of that -- (Cross talk).

MS. : They had approved the reductions that were referenced and they were promising a dividend based on the reductions. They just bid a reduction risk rated asset which have been approved.

MR. : And then, I think to pick up one point that John Dugan made, some of the issues in Europe and to some lesser extent in the United States, involved capital arbitrage, losing things off of balance sheet, because it was less capital intensive to do that.

And one of the things that Basel II does is it tries to even that out. It tries to reduce the capital incentive, to move something off your balance sheet, and I think things -- losing it off the balance sheet clearly gave banks a sense that they didn't need to manage that risk as intensely as they would have if it was directly on their balance sheet and a lot of that stuff ended up coming back on to their balance sheet.

So I think from some very important perspectives, Basel II actually addresses some of the issues that have come to light in the most recent turmoil.

That's not to say it's perfect. It's a huge step in the right direction, and I appreciate, Mr. Chairman, your support for this basic structure because I think it is an important step forward to make the capital requirements more risk-sensitive so there is less of this arbitrage opportunities for banks.

John pointed out one in the securitization area, that's heavy reliance on the credit rating agencies. I think we need to take a look at that and how close that reliance is, but there are a lot of safeguards here. There's the Pillar 2 safeguard.

The banks cannot implement these models before the supervisors have looked at them and given their okay, that these are good models. There's the phase-ins (ph) that Sheila and John talked about.

So this is -- there'll be a year of parallel running. Then there will be a three year phase-in and changes can be made at any time and John Reich is absolutely right, the regulators are committed to make this work for a safe and sound U.S. banking system.

We will have a period of years to watch how the implementation is occurring and to make adjustments if necessary. So I think it's important to move forward, recognizing the issues and keeping a careful -- supervisors keeping a careful eye on how it's working -- it's working out, but I think at the end, we'll have a better capital system in four years than we had last year.

SEN. DODD: Can I -- and I hesitate to ask anyone the fairly simple yes or no question, knowing your resistance to those kind of answers.

(Laughter)

SEN. DODD: But I -- would we have been better off or worse off had Basel II been in place under the recent crisis?

MR. : I -- the honest answer is I don't know. I think in many -- in some respects we would have been better off, and I don't think we would have been worse off if the whole implementation process had been moved back two or three years.

So we had the same safeguards in place and if we started implementing at 2004, with the safeguards that are in place in 2008 and 2009, I do think on balance, we would have been better off.

SEN. DODD: Do you have any comments on this? I've taken a lot time on this question.

MR. : Thank you. I think the answer to your second question is that we probably would have had lower dollar amounts of capital per assets and that makes it more challenging to deal with issues when times get rough, as being a banker in 80s and out on a prairie in Iowa, there is no substitute for capital when things get rough, so I think we would agree that we don't want to see capital standards reduced, and we want to make sure that as Basel II is implemented, that it provides an opportunity for regulators to make sure that we can require institutions to have adequate capital at all times.

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SEN. DODD: Thank you, Jack, very much. There's some related issues, by the way, on the credit rating agency. I appreciate Jack bringing it up again and this -- the parallelism in terms of how various instruments are rated, there have been some articles written about that.

You know, I'm going to take advantage again just so the issue that Jack has raised and your responses to it. But I said at the outset here about reconvening this group in somewhere -- 30 to 60 days.

I know you're all studying these things, but what can be -- what kind of private institutions do -- what do you need to do as regulators and what -- depending on what we need to do, appear to provide additional authority for regulators to implement regulations in these areas.

So I'm very interested in getting down to some nitty-gritty here. What specific steps need to be taken? I think we're going to study this stuff endlessly, but my sense of urgency about this, I think, is very strong and so I'd like to get back fairly quickly with you on some very specific ideas on how we move forward. With that, Senator Bennett.

SEN. BENNETT: Thank you very much, Mr. Chairman. This has been a very interesting hearing and I keep moping through my notes to try to come up with a worthwhile question that's responsive to your response.

So, if I might wander through some of my notes and then get your comments.

Mr. Dugan, you talked about the models that were used. Models are stupid. They don't do neurons and the question is at which -- what level should the judgment came in -- human judgment.

The model may say this, your point was well taken that all of the data fed into the model was optimistic because we had a good time, so the model will naturally project optimistic results.

Now, we're going to feed it a bunch of bad data into the model and the model is going to tell us the future is going to be terrible, and at some point we need to inject some judgment in this and I don't know whether that's at your level, or whether it's something that the banks should do and you folks just look at.

My fundamental question -- as a policymaker, do you know this is -- where are we going? Are we going to work our way through this, in the next six to nine to twelve months?

This was a bubble that burst when the inventory overhang gets sold off -- is it going to go away?

Mr. Gronstal, you send real chills down my back when you say ag. land (ph) is on the edge of having the same kind of bubble because there has been tremendous bidding up of the value of agricultural land and there are we focusing so much on, gee, the banking system that we are not seeing that there's a potential out there and this again comes back to the question of judgment of what are we doing.

Comment was made, I think, Governor Kohn, about "It all froze up." Everybody was so anxious about getting capital into their institutions that they're unwilling to loan and people who had absolutely nothing to do with sub-prime or housing suddenly couldn't get credit. And I certainly heard about that and I'm sure a number of members of the committee did.

So, as I try to find out where we're going here, what's going to happen in the future, in addition to all of the things we've talked about, we need to fix the rating agencies, we need to change this, that and the other, what do you see in terms of the economy?

The Chairman quoted President Kennedy about if "The economy is right, there isn't anything right" -- "If the economy is not right, there isn't anything that's right."

How invasive is this crisis in terms of other areas -- just other areas besides the question of the safety and soundness of banks?

This is a judgment call, but you are all very knowledgeable, more knowledgeable perhaps than we and I'm sure you've thought about this and just share this -- your sense of where we are and how soon there's going to be a rebound and how vulnerable are we to other problems and how badly is the economy hurt by all of this? And respond, if you will. Okay.

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SEN. DODD: Thank you very much, Senator, and I'm going to -- that was a very good question Senator Casey's raised here, and I'd note that this morning, apparently the speech the chairman of the Federal Reserve has given to the community bankers this morning is suggesting, maybe something on the lines we've talked about earlier that the American Enterprise Institute and others of the ilk indicated, that I've been talking about and that is just, how long is your preservation idea, using existing platforms with very distressed mortgages. It's a complicated issue, the devil is in the deep, he knows those ideas. You can -- it sounds wonderful in the first couple of sentences. Then you start talking about that how you actually do this, it gets somewhat complicated.

But nonetheless I appreciate the chairman's at least acknowledging -- and I want to come back at my round here, and ask all of you to maybe comment on that concept and idea and whether or not we should at least be thinking about it rather than waiting for something to happen.

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SEN. DODD: Do we have the authority now to do it. That wouldn't require a legislation would it?

MR. : Under the current legislation in section 13, 3 the Federal Reserve Act we can make loans to individuals, partnerships, and corporations under unusual and exigent circumstances by a vote of no fewer than five members of the board of governors.

So Congress and they haven't made any such loans since the 1930s, so Congress saw this as an emergency very, very unusual situation that they didn't want us using. I would be very cautious about opening that window more generally.

I think the banks have access to the discount window but the quid pro quo in some sense or the control -- there is a more hazard issue here, having them have access and the control on that is this panel right.

You have an extensive amount of bank examinations, supervision you have constricted their activities in a number of ways relative to investment banks. I don't think that liquidity is the problem for the investment banks or liquidity is the issue behind restarting these markets right now.

I think it is about confidence, it is about the underlying economy, it is about the housing market. So I am not going to trade these securities until I can have some confidence that I can estimate the losses embodied in them that I can price them in a way that will be sustainable.

SEN. DODD: -- (cross talk) -- or two a little bit, isn't it I mean you get confidence in a sense if you also have access to liquidity.

MR. : I mean but I don't I think it is more a capital problem not so much capital in the banks per se but the while sense of losses and potential losses if the economy deteriorates further. So I don't think opening up credit to the investment banks will really be that helpful and in the end it could carry some very major --

SPEAKER: I certainly agree with you -- your cautionary note in all of this and that is why I raise it and frame it the way I did, it is an idea that has been kicking around. I don't know if there is any reaction to this at all. John Dugan your reaction to this issue.

MR. DUGAN: I am a treasury guy too I do have a reaction which is you have to be very careful about giving out the government's credit except to institutions that you really have -- pay very close supervisory attention to. And so I would maybe even be more cautious --

MR. : I think he is right I think the issue hasn't been primarily about getting access to liquidity, it has been about what is going to happen to house prices, that is what everybody is looking at before they should go back into them -- to the housing market. And so I would just echo the very extreme note of caution.

SEN. DODD: Yeah. But let me also just if I can I mentioned earlier this issue and -- of jumping back to the issue of what do we do about those who are facing foreclosure, and as you all know we have resets coming along here, and then I am hopeful that the Hope Now Alliance is going to work and there is some reports this morning that the Navy maybe getting more -- (inaudible) -- last year was not terribly encouraging.

But obviously if things are picking up a bit that can be helpful but the numbers can increase here. Now, it looks as though a significant percentage of these foreclosures are not just in the subprime but prime and credit-worthy borrowers that are facing these problems as well.

And I want to raise the issue again of this idea. And again I don't want to put words in the chairman of the Federal Reserve. I didn't read his speech yet. But I gather something went along the lines of maybe being a bit more aggressive on this issue than -- than just the Hope Now Alliance would indicate may have some value here including the idea that I have raised and others have raised.

Senator -- Chairman Barney Frank is talking about some ideas over there that are not dissimilar to the ones we are talking about and again you can wait for this to happen -- but I am trying to do something.

But again, the idea of putting something in place requires some real work because there are legitimate issues that get raised when you start talking about establishing -- whether you are using a separate entity or utilizing one of the GSEs or using FHA, in any case it is the details of this get very, very complicated.

And my concern is that if we wait too long we find this problem getting worse and try to deal with it at that level that we may miss an opportunity to step up. And I just would like to get those of you who are interested in commenting on this idea.

As I pointed out earlier the American Enterprise Institute and others have testified favorably about the idea and -- Sheila do you want to comment on this so just run down the table quickly.

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SEN. DODD: Let me again -- I don't want to get anecdotal, but just in Connecticut now I think is ranking like number eight in the states with the foreclosure issue, had almost 50,000 of them in Connecticut last year. I mentioned before some 6,000 just in one city potentially in the city of Bridgeport, Connecticut.

And they are getting calls in our office that they were -- and I use their words, it is anecdotal but the runaround by the Hope Alliance -- and I have really used this forum here -- even some of the consultants involved in this are raising some issues about how well this is working, go to the very point you talk about.

If you don't -- if that confidence isn't there that borrower to call and feel as though there's going to be some effort made here -- I'm not suggesting that everyone of these callers deserve necessarily to get the help deserved -- but nonetheless, I can't -- I have to raise the issue here that -- it's what -- people need to make the calls.

But when that call comes in, they need to have a person on the other end of that line who's going to be sitting there very receptive to trying to help things -- work things out. So I want to mention that to you.

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SEN. DODD: I -- (inaudible) -- question to add on to this thing. But at the very time just going back, you had promoting the adjustable rate mortgages out of the Fed. You were raising interest rates at the time. Wasn't anybody -- this is not a complicated set of questions.

You're pushing arms and you're raising rates. Seems to me you got a perfect storm on the horizon here, that you had to be aware of the potential of that. Why did -- any answer to that why that -- any -- looking back and saying maybe that was not wise.

MR. KOHN: Right. I'm not sure that we were pushing arms. One person made a speech suggesting that. But I do think the consumers, households, the structure of interest rates anticipated the rise in rate. And people should have been able to see that if there were borrowing at a low rate now, when that reset after a year or three years or five years, it was going to be at a higher rate. So it's obvious that people didn't see that.

It's obvious that the lenders didn't take appropriate account of the affordability of the loans when they were being made as they reset. I think as several of us have mentioned today, a problem was that people were counting on those house prices to rise forever. And therefore especially in the mortgage market, the due diligence about whether these loans could be repaid under other circumstances just wasn't undertaken.

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SEN. DODD: Thank you very much. And I just -- thank you for this opportunity Senator Reed. I know a couple of you have to get going, been here a long time. But as Senator Shelby pointed out, when we were here in the S&L -- we're talking about thousand banks in the S&L crisis. We're talking here -- at least some members talk about while -- talking about for closure rates, but as many as 44 to 50 million homes could be adversely affected.

We're looking at prices dropping. When prices drop values drop, when foreclosures occur values drop, but otherwise people are very current in our obligations. Crime rates go up actually 2 percent -- neighborhoods where that occurs. There are some significantly profound implications of all this and 1,000 banks is one thing.

Talking about this issue makes that problem pale in many ways. The $150 billion bail that was not insignificant, but the pay of last resort is the American taxpayer in all of this. And so while others may have been complacent and so forth, they're looking around, the American taxpayer pays an awful price for this if we don't get this right.

And so I want to underscore the points that we raised and just to say -- and I've got a couple other questions, I'll come back after Senator Reed. But that whole idea that you are the cops, I mean you're the ones that have got the -- on the beat here, so to speak, and when cops aren't on the beat and not watching it and keeping an eye on it here, we end up where we are to a large extent.

And so I want to come back to saying a few days we were all studying all of this, but I want some more specific answers on what we're going to do, what you're going to do, what the institutions have to do.

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SEN. DODD: I commended Mr. Reich about -- I didn't agree with him on everything, but I commended him with my time. And let me just say on the GSE issue, again, I -- you know, there were those who had ideas on GSEs Fannie and Freddie Mac a couple of years ago. Had they been adopted, this probably a lot worse today.

I mean I -- a strong regulator is absolutely essential, all of us agree on that here. I'm determined to get a bill done, but I want to make sure we do it right as well. The idea there is a 30-year or 40- year fixed rate mortgage in this country which is unique in the world -- exist because of Fannie Mae and Freddie Mac, in my view.

And the idea that someone brought to the table on this issue I think would do is some real damage, but I am interested in getting a bill done here, we'll get that done too.

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SEN. DODD: Is it something we ought to be more concerned about than we are?

MR. DUGAN: I think you are appropriately asking question about monitoring the situation, and we are doing the same. But I don't think it's something that we are suggesting, in any way, setting off alarm bells.

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SEN. DODD: Well. As I said the last question. Just -- and any one of you here could comment on this, we went to this issue back a few years ago with FASB and during the Sarbanes-Oxley effort here and coming up in a different way, this -- one of the same questions being raised by the credit rating agency was raised by FASB, some of the inherent -- people say conflicts because the FASB model that we ended up adopting here is that -- doesn't have any relevancy to this question of the credit rating agencies in terms of a resolution of that in your mind or is it just so different in terms of that -- how FASB operates and how -- I mean obviously very different entities.

But occurred to me there we ended up with FASB originally because you'll recall as was totally financed by the very people obviously that were having their account, so the very conflict and we changed that. Obviously it's a public entity in the sense as well as a credit rating agency, but any value of examining that as a comparison, no? Are you saying -- you're saying no?

MR. REICH: I'm saying I don't know actually -- that back and forth -- thing was I don't have a view.

SEN. DODD: John --

MR. DUGAN: I really -- I don't know. I think it's a question for the -- I've never looked at it. And it's an SEC-type question -- I got an oversight but --

MS. BAIR: Sir, I think it's quite -- working pretty well as compared to other things, so I'm not sure it's -- there may be other priorities, we need to look at that.

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SEN. DODD: Well, thank you to all witnesses. We kept you a long time, but I think you saw that the participation of the members here on both sides, the interest in the subject matter.

And John, we appreciate very much the state perspective being here. It's very valuable added element in all of this. And -- but I'm very appreciative of Dr. Kohn as well, for coming. I know back and forth and you had to get up here a lot of the last few weeks. And I am very sensitive -- the idea you got a lot of things to do other than just testify.

But it means an awful lot to have all of you here. As I said at the outset, I want to get back now. A lot of these hearings, it can end up in the ether. But I'm very interested -- I didn't press this, John, but you talked about some of the forward thinking that you had going on in your shop. And I want to see some of that forward thinking, what we're -- how we're addressing these questions.

I mean this is really -- the number -- that the questions raised and the Wall Street Journal this morning that Senator Bennett talked about in his opening comments are really at the heart of this. From our perspective here, obviously we watch what happens very carefully the private institutions, but the -- as the regulators, including the state regulators, here you play such a critical role. You are the backstop.

These are subject matters that very few people understand, including our service respectively of our colleagues are here despite their good intentions to really understand the totality of all of this. And not to have a stove pipe mentality about it, so they're looking at these things in sort of separate funnels failing to recognize the interrelationships that occur here.

And now all of this is critically important to our economic success. But we count on you. That's what really this has to be. And Jack raised the point here -- the culture of how you approach your public responsibilities, your regulatory responsibilities are critically important. So I look forward to having you back here. We'll forework out schedules and times so as to accommodate your busy schedules, but very grateful to you for your presence here today.

Committee stands adjourned. (Sounds gavel.)

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