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Hearing of the House Committee on Financial Services - Perspectives on Regulation of Systemic Risk in the Financial Services Industry

Location: Washington, DC




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REP. FRANK: (In progress) -- will come to order. The purpose of this hearing is to continue and focus even more on a very important question. The importance of it in fact has been underlined by recent events, and by the considerably larger crowd we will have here tomorrow when we deal with the probably three most fearsome words in the English language, "A," "I," "G." We will deal with that tomorrow.

But what we need to do is to figure out how we avoid ever again being in this situation, ever again -- overstates it. I should -- how do we make it much less likely that we are not again in this situation?

So this begins a set of hearings we are going to be having on what if anything should be done at the legislative level and then carrying through obviously to the executive level, to prevent some of the problems that we are now dealing with from recurring. There will be a series of hearings.

As you know, the secretary of the Treasury will be at our hearing on March 26th in which I -- we will be hearing from him. But we want to hear from a wide range of people who are in the -- from people on the consumer side, on the labor side, and on the financial industry side, former regulators, other commentators, people living in the street. We will have a series of hearings on this.

We have several hearings planned between now and the break. We will resume and continue the hearings. And it is my hope that we will be able to begin the drafting of legislation sometime in early May. That is when we will come back and have a couple more weeks of hearings.

I urge people to be thinking seriously about what we are doing. This will be a lengthy process. It will go through all of the regular order. The Senate is also engaged in this. The White House and the Treasury are engaged in it. It is a very important task. And we will be addressing it with great seriousness and with full input.

I am not at this point going to get any substantive, unless we really -- I really hope that we will have a full and unfettered conversation with a variety of people about this. And I would hope people would feel totally free to make whatever recommendations they think. Everyone who is here will, I'm sure, be asked again to comment on this, and you don't have to wait to be asked.

We have as important a task as we've had in this general area, I believe, since the '30s, but I will just say briefly what seems to me is the situation. We are a society that understands the value of free enterprise and a capitalist system in creating wealth.

Some political rhetoric to the contrary that's not in question now, won't be in question in the future. No one seriously is talking about diminishing the role of the private sector as a wealth creator. And for this committee's jurisdiction of the financial services industry as the intermediary, as the entity that helps accumulate wealth from a wide variety of sources and makes it available for those who will be taking the lead in the productive activity. That is the intermediation function and it is a very important one.

From time to time, in economic life, the private sector, which is constantly innovating, but achieved the level of innovation that's almost a qualitative change, when a very new set of activities comes forward. Now, by definition, if those activities do not provide value to the society, they die of their own weight. Only those that are in fact genuinely adding significant value thrive.

But also by definition, because they are innovative, as they thrive, they do a lot of good, but there is some damage because they are operating without rules. They are new. And that's why I think the problem here is not deregulation, but non-regulation.

It is not that rules that had been in place were dismantled, it is that as new activities come forward, there need to be new rules that are put in place that, to the maximum extent possible, provide a structure in which the value of these innovations can continue. But some of the abuses are restricted.

I'll give two examples where it seems to me we went through that process. In the late 19th century, the formation of the large industrial enterprises, then called trusts; this country could not have industrialized, the wealth could not have spread to the extent that it has here or elsewhere without large enterprises.

But because they were new, there weren't rules. So while they were formed and thrived in the late 19th century and on into the next century, the presidencies of Theodore Roosevelt and Woodrow Wilson were aimed at preserving the value, containing the damage that could be done, the Antitrust Act, the Federal Trade Act. Even the Federal Reserve Act itself came out of that situation.

Because you had the large enterprises, you then had the stock market become so important. Because you've now gone beyond what individuals could finance. And the stock market obviously provided important means of support for this process, but with some abuses. So in the New Deal period and after, we had rules adopted that gave us the benefits of this finance capitalism, but tried to restrain some of the abuses, the SEC and other factors.

I believe that securitization, the ability to use pools of money not contributed by depositors, and are therefore relatively unrestricted to finance activities and to sell the right to be repaid, obviously has a lot of advantages. If mortgage loans can be made, securitized and remade, that money can support a lot more activities.

Securitization greatly increases the ability to use the money. But like these other innovations, it comes in an area without regulations. And our job now, I believe, is in some ways comparable of what I'm -- under Franklin Roosevelt and others, Theodore Roosevelt and Woodrow Wilson, to come up with a set of rules that create a context in which a powerful valuable tool can go forward in its contributions, but with some restriction on the negative side.

And that is never easy to do, and you never do a 100 percent. I regard it, by the way, as very much a pro-market enterprise. Because one of the problems we have now is an unwillingness on the part of many who have the money to make it available. We have investors who are reluctant to get involved. That's a great problem. It is nice from the standpoint of calculating our interest costs to have treasuries be so popular. But it's not healthy for the economy for treasuries to be disproportionately the investment people want to make.

One of the advantages of this being done properly is to get a set of rules that will tell investors that it is safe to get back into the business of investing. So we regard this again as very pro-market, of taking a market-driven innovation, in this case securitization, trying to preserve its value while limiting some of the harm that comes when it doesn't -- when it acts in a totally unregulated atmosphere, and in a manner that would give a great deal of confidence to investors so that we can resume this function of intermediation, of gathering up resources and making them available for productive uses.

The gentleman from Alabama.

REP. SPENCER BACHUS (R-AL): Thank you, Mr. Chairman. Yield one- and-a-half minutes?

REP. FRANK: I'm sorry, yes, sir. Whatever time you want to have. You want to take one-and-a-half minutes?

REP. BACHUS: One-and-a-half minute, thank you.

Mr. Chairman, done in the right way, a systemic risk entity can be a positive step. However, if done in the wrong way, it can be a very bad idea. Let me be very clear. It is time that we extricate ourselves from the cycle of multibillion dollar taxpayer-funded bailouts.

Before we agree on the creation of a systemic risk regulator or observer, we need to agree on one important pre-condition. And that is that this so-called systemic risk regulator should not have the power to commit or obligate billions or hundreds of billions of dollars of taxpayer money to bailing out the so-called too-big-to-fail institutions.

If it does, I can't support it. In the event of a failure of one of these too-big-to-fail institutions, I believe that this newly created entity role should be to the advance -- to the advance on orderly resolution, not to add taxpayer funding.

If we've learned one lesson in the last year, it's this. When the government tries to manage and run these large corporations, no one wins. Government ownership and management of the private sector didn't work in Russia, it didn't work in China, it's not working in Cuba, it didn't work in -- it's not working in North Korea. And it's clearly not working here.

Thank you, Mr. Chairman.

REP. FRANK: Does anyone have a second, the member had -- (inaudible) -- five, you've got a minute-and-a-half. Do you have another --

The gentleman from California, Mr. Royce, for a minute-and-a- half.

REP. EDWARD R. ROYCE (R-CA): Thank you, Mr. Chairman. I'd like to thank our witnesses for coming. And also considering the topic of today's hearing, systemic risk, I'd like to briefly welcome Mr. Wallison from AEI who for years warned and wrote about the systemic risk posed by Fannie Mae and Freddie Mac to our system.

And with trillions of dollars being allocated to prop up our financial system, we must begin to rethink, I think, the relationship between the federal government and the private companies. If we allow this line to be permanently blurred, the invitation for political and bureaucratic manipulation will remain as we saw with the GSEs.

Further, the market distortions caused by the implied government guarantee of government-sponsored enterprises allowed them to operate as a duopoly, walled off from forces such as market discipline that would have significantly lessened the ability of these firms to play their part in inflating the U.S. housing market and allowed them eventually to over-leverage -- over-leverage by over 100 to 1.

With that said, I believe that we've got to reevaluate our financial market's regulatory structure. That is what this hearing is about. We need a thoughtful reevaluation. We have a patchwork system put together over the last 75 years in this country, and we cannot discuss systemic risk regulation in a vacuum.

Duplicitous and ineffective regulatory bodies must be consolidated or eliminated and gaps exploited in recent months like -- by AIG must be filled. Thank you, Mr. Chairman.

REP. FRANK: The gentleman from California for two minutes.

REP. BRAD SHERMAN (D-CA): Thank you. I think the ranking member points out something interesting, and that is, if the Fed is a systemic risk regulator, or any kind of regulator, they could see their regulation called into question. Oops, you made a mistake, and they could cover themselves by using their powers under 13-3 to make unlimited loans from the Fed.

And I think we need to divorce the rescue authority from the regulatory authority. Or a regulator may do a rescue in order to cover up the fact that they are regulating -- regulatory authority was not used all that prudently.

Secondly, if the Fed is going to be a systemic risk regulator, we ought to make sure that all of its officers and decision makers are appointees of the president or appointees of appointees of the president. That none are appointed by committees of private bankers. The Fed needs to be clearly just a government agency and not also an association of banks.

As to systemic risk, it can be prevented perhaps by higher capital requirements. But when we do confront systemic risk that has to be acted, this systemic risk regulator needs to respond with receiverships not with bailouts. That never again should the taxpayer be called upon to bear risks or to bear costs.

And no activity which is too big to be covered by a receivership, should be allowed, because nobody should be allowed to bet if the taxpayer is going to be called upon under the theory of systemic risk or any other theory to bail them out. No casino should be too-so-big, that we can't let those who break the bank deal with it in the private sector.

Finally, and this is off point. I look forward to working with other colleagues on a tax law that would impose a substantial surtax on excessive compensation paid to executives of bailed out firms, especially AIG. It is clear that by -- we have until April 15, 2010, to act on the 2009 tax code. And I think we could act on 2008 as well.

REP. FRANK: The gentleman from Illinois for a minute-and-a-half.

I apologize. The gentleman from Texas for a minute-and-a-half.

REP. JEB HENSARLING (R-TX): Thank you, Mr. Chairman. Note that we would all love to figure out a way to properly end systemic risk, but it kind of begs the question, who, what, how, and at what cost. I have a number of questions.

Number one, do we have any other examples where this has been tried before and tried successfully? Has it worked? And if not, why not? Who are the so-called experts on the subject?

Second of all, what is our accepted definition of systemic risk? Is it too-big-to-fail, too interconnected-to-fail? I know that mutual funds have worldwide assets of $26.2 trillion at the end of the last fourth quarter.

Are they too big to fail? Are they representative of systemic risk?

Next, which of our regulators is to be trusted with this responsibility? Should it be the Federal Reserve that many economists view helped lead us into this housing bubble in the first place? Perhaps, it should be the SEC who apparently knew about the Madoff fraud and did nothing about it? Perhaps OTS who is responsible for IndyMac, the largest bank failure in American history? If not, then who?

The next question is, to what extent does this become a self- fulfilling prophesy? Once you designate a firm too-big-to-fail, then is this not Fannie and Freddie revisited with only the taxpayers left to pick up the tab?

Many questions to be asked. I look forward to hearing from our witnesses. I yield back the balance of my time.

REP. FRANK: Gentleman from Jersey, Mr. Garrett for a minute-and- a-half.

REP. E. SCOTT GARRETT (R-NJ): Thank you, Mr. Chairman. And while we look at systemic risk, and there are some that are calling for consolidating even more regulatory power and risk within the Fed, to look at systemic risks, I find myself on the other side, increasingly adverse to the idea.

Now, the Fed has already been the de facto systemic risk regulator for at least much of our banking sector, which by the way, is already the most regulated portion of our economy. Institutions like Citigroup and other large banks have some of the thorniest problems that we are facing in our financial markets. So instead of giving the Fed even more powers, despite its regulatory failures, I'm convinced that we should actually reduce the regulatory powers, and maybe at best let it concentrate on its monetary policy.

You know, the Fed's regulatory role, if it were to be increased, compromises its independence, and threatens to undermine the value of the dollar. Now, the reason for the Fed's independence in the first place is its monetary policies duties, not its regulatory role.

It's difficult to see a scenario where the Feds responsible for the health of our nation's largest financial institutions would be reluctant to raise interest rates in order to assist the financial institutions under its regulatory purview. Furthermore, in addition to my concerns about the conflict of nature of the Federal, as I mentioned at last week's hearing, I also have concerns about consolidating so much additional power in any entity that does not have to answer to the American people.

Finally, beyond my specific concerns about the Fed, I have broader concerns as Mr. Hensarling raises about a new systemic regulator. What powers would it have? Would we be able to say what it is and what it is not allowed to invest in? And its -- in its zeal to eradicate risk, and remember ours is a -- this is a capitalist economy, would it fundamentally alter the nature of the American economy, the greatest economic engine in the history of the world by doing so?

I thank you, Mr. Chairman.

REP. FRANK: The gentleman from Massachusetts is recognized for two minutes. Mr. Capuano.

REP. MICHAEL CAPUANO (D-MA): Thank you, Mr. Chairman. Which one? Stephen or me?

REP. FRANK: Mr. Capuano.

REP. CAPUANO: Thank you. Stephen. Thank you, Mr. Chairman.

REP. FRANK: Gentleman applies here.

REP. CAPUANO: That's why I didn't think it was me.

REP. FRANK: I wasn't sure you were uncertain, yes.

REP. CAPUANO: Mr. Chairman, I was going to comment on your comment about AIG being the main word of the week. But -- and you're right about that. But that's short term.

The biggest word that we've dealt with for 30 years and I think the reason you're here is the word "regulation." It's been a swear word in Washington for 30 years. We don't regulate anything. We haven't overseen anything or anybody. And the few regulator we have, have chosen not to do anything with the powers that they have.

Yet, I have to be honest. I think you've just heard the major problem that we in Congress will have, I don't think anybody in America today thinks there is too much regulation in the financial services industry except some of my friends on the other side of the aisle.

And I have to be honest. I thought that debate was over. I think it is over for most of us and for most of America. What I want to hear today and what I want to hear from this point forward, is not whether regulation is a swear word. But how do we do it? Who should be included? Who should be excluded, if any one?

I can't imagine any arguments why anybody would say that bank SIV, Special Investment Vehicle, should be excluded from regulation, where the bank isn't. I can't imagine anybody today telling me that hedge funds should have absolutely no regulation.

I can't imagine anybody today telling me the private equity firm should have absolutely no regulation. I can't imagine anybody today, certainly not telling me, the credit rating agency shouldn't be regulated by anybody.

Those things are past. The lack of regulation is unequivocally clearly un-debatably the reason that we have the economic crisis we have today. The fair and only questions left is how do we regulate in a reasonable and thoughtful manner? No ones wants to over-regulate, but no one in the right mind wants to under-regulate any more.

It's a fair question and a moving question as to how to do it in format, how to structure this, and who should be included, to what degree. Those days of lack of regulation, of somehow the government is always the problem, always in the way, are over. And I would suggest that anybody that doesn't get that read any paper any day, anywhere in America today.

Mr. Chairman, I yield back. Thank you.

REP. FRANK: The gentleman from South Carolina for a minute-and- a-half.

REP. J. GRESHAM BARRETT (R-SC): Thank you, Mr. Chairman.

Panel, recently, we've been hearing a lot about a systemic risk regulator, but it's the details, guys, that matter. Before evaluating any proposal we need to know who that regulator will be, what the regulator will do, and who or what the regulator will oversee. We need reform, not more regulation. And we need to ensure that our current regulators are fulfilling their current mandates before we assign them new duties. I look forward to hearing your insights and how we can ensure that any changes to the regulatory system can bring certainty and trust back into the economy, but do not prevent American families and small businesses from the capital that they much sorely need it.

I yield back, Mr. Chairman.

REP. FRANK: The gentleman from Georgia, Mr. Price for a minute- and-a-half.

REP. TOM PRICE (R-GA): Thank you, Mr. Chairman. I am struck by the servitude of some of my friends on the other side of the aisle that may only be exceeded by their potential lack of appreciation for the dangers of a political economy. I would ask all of us to think about what industry is more regulated than the U.S. financial industry.

Despite layers of regulation, we still find ourselves in the midst of a major economic contraction. We ought not to lose sight of that fact. I'm extremely concerned with the idea of a systemic risk regulator.

If a specific institution is designated as, quote, "systemically significant," unquote, it certainly sends the message that the government will not let it fail.

This clearly gives these institutions a huge competitive advantage over non-systemically significant institutions. This classification takes us even further into the realm of a political economy, I would suggest, the wrong road.

A market-based economy allows institutions to fail for a number of reasons, allowing the government to prop up systemically significant institutions that would otherwise fail, doesn't improve competition or efficiency in our financial system. This reminder should caution all of us as we consider a proposal that might potentially completely change the way our financial system operates, who wins, who loses, and who decides.

I yield back.

REP. FRANK: The gentleman from Texas, Mr. Green, for one-and-a- half minutes.

REP. AL GREEN (D-TX): Thank you, Mr. Chairman. Mr. Chairman, I believe that our affair with invidious laissez faire is over. We don't expect football teams to regulate themselves. We don't expect self-regulation in basketball. I don't think that we can expect it in the economic order with reference to economic institutions.

I believe that too-big-to-fail is just right to regulate. Because when we don't regulate, too-big-to-fail, the potential to decimate society exists. We have to have an office of systemic risk analysis, if for no other reason than to identify institutions that are too-big-to-fail, so that they can be properly and positively regulated.

I yield back the balance of my time.

REP. FRANK: And finally, the gentleman from Texas, Mr. Neugebauer for one-and-a-half minutes.

REP. RANDY NEUGEBAUER (R-TX): I thank you, Mr. Chairman for holding these hearings. A lot of changes are being proposed in our regulatory structure in our country and we have to be very careful that we get this right.

One of the questions that comes up is, did we have systemic risk because we didn't have the proper regulatory structure in place, and the fact the there were holes in that system, created systemic risk within our economy? Or did we have systemic risk because we didn't have a systemic risk regulator?

I would tell you that I believe that we've had a regulatory structure that allowed systemic risk to begin to transpire in our economy. But quite honestly, I believe that the actions that we are taking today, unprecedented actions, are all also creating major systemic risk in our economy. What does this all point out to?

It all points out to that we must go very carefully and very slowly here as we look at reforming and -- our financial markets. Because we have to get this right. Because some people believe if we get this right, we will take risk out of the market. It is not the role, nor can government take risk out of the market. But we can make sure that there is integrity and transparency in the market as we move forward.

And so, Mr. Chairman, I would hope that as we move down this road of regulatory reform that we would be extremely careful here. It's not going to be the speed with which we do our work, but the quality of work we do. Because it is important to the American people that we get this right.

REP. FRANK: We will now begin the testimony and in the order in which they are put here, which is probably random, unlike the testimony. We will begin with Mr. Bartlett -- Steve Bartlett, president and chief executive officer of the Financial Services Roundtable and a former member of this committee.

MR. BARTLETT: Thank you, Mr. Chairman.

Beginning about three years ago, the Roundtable began to examine the questions of our current regulatory system, that are -- many of which are raised today. This dialog over that time has -- over those three years has evolved into a focus on how the current system also undermines the stability and the integrity of the financial services industry.

I've provided in my written testimony a format that provides at least our answer to many of the questions that were raised today in previous questions and comments. I want to summarize our conclusions as follows.

One; the financial services industry is regulated by hundreds of separate independent regulators at various levels. It is a system of fragmentation, inconsistency, and chaos. It is a fragmented system of national and state financial regulation that is based on functional regulation within individual companies and those companies are also regulated according to their charter type.

There is limited coordination and cooperation among different regulators, even though firms with different charters often engage in the same, similar, or sometimes exact activities. No federal agency is responsible for examining and understanding the risks created by the interconnections between firms and between markets, this chaotic system -- our conclusion, a financial regulation was a contributing factor to the current crisis.

Number two; it is not to say that the fragmented regulation is the only cause. The financial services industry accepts our share of responsibility, badly underwritten mortgages, compensation packages that pay for short-term revenue growth instead of long term financial soundness. Failure to communicate across sectors, even within the same company, and sometimes, even downright predatory practices, all of those and more have been part of this crisis.

Since early 2007, the industry has formally and aggressively taken actions to correct those practices. Underwriting standards have been upgraded, credit practices have been reviewed and recalibrated, leverage has been reduced and firms have rebuilt -- and firms have rebuilt capital, incentives have been realigned, and some management teams have been replaced.

We are not seeking credit for that. Clearly the horses are all out of the barn running around in the fields. But that has been the steps that have been taken in the last two years.

But the regulatory system that was in place two years and five years ago is still in place. An absence of coherent comprehensive systemic regulatory structure did fail to identify and prevent the crisis. And we still have that same regulatory system today.

Number three; reforming and restructuring the regulatory system in 2009 should be Congress's primary mission moving forward to resolve the crisis and prevent another crisis. Achieving better and more effective regulation does require more than just rearranging regulatory assignments. Better and more effective regulation requires a greater reliance on principle-based regulation, a greater reliance on a system of prudential supervision, a reduction in the pro-cyclical effects of regulatory and accounting principles, and a consistent uniform standard of which similar activities and similar institutions are regulated in similar ways.

Number four; we are proposing a comprehensive reform of the regulatory structure that includes clearer lines of authority, and uniform standards across both state lines and types of business. Within our proposal, we recommend the consolidation of several existing federal agencies into a single agency, a single national financial institutions regulator that would be a consolidated prudential and consumer protection agency for banking, securities and insurance. A new capital markets agency through the merger of the SEC and the CFTC to protect depositors and share holders and investors, we propose to create -- and to resolve a failing or failed institutions, we propose the creation of the national insurance and resolution authority to resolve institutions that fail in a consistent manner from place to place.

Number five; we also advocate a systemic regulator, what we prefer to call a market stability regulator. The market stability regulator would be as I said in a subcommittee testimony, "NIFO" -- Nose-In-Fingers-Out. That means, a market stability regulator should not replace or add to the primary regulators, but should identify risks and act through and with a firm's primary regulator.

We believe that designating the Federal Reserve is the natural compliment to the Federal Reserve Board's existing authority as the nation's central bank and the lender of last resort. The market stability regulator should be authorized to oversee all types of financial markets and financial services firms, whether regulated or unregulated, and we propose an exact definition of, at least our proposal, of that system of regulation of systemic regulator.

And number six; the U.S. regulatory system should be the U.S. system, of course, but it should be coordinated and consistent with international standards. Mr. Chairman, the time to act is now. We believe that these reforms should proceed in a comprehensive fashion, rather than a piecemeal fashion. The key is to do this correctly, not rapidly, but to do this with a sense of urgency of which the crisis calls. Thank you, Mr. Chairman.

REP. FRANK: I do note that our former colleague retains a respect for the five-minute rule that we don't always get from witnesses, and I appreciate the --


Our next witness, a former official, Timothy Ryan is here as the chief executive officer of the Securities Industry and Financial Markets Association.

MR. RYAN: Thank you, Chairman Frank, Ranking Member Bachus, and members of the committee, my testimony will detail the Securities Industry and Financial Markets Association's views on the financial markets stability regulator, including the mission, purpose, powers, and duties of such a regulator.

Systemic risk has been at the heart of the current financial crisis. While there is no single, commonly-accepted definition of systemic risk, we think of systemic risk as the risk of a system-wide financial breakdown, characterized by a probability of the contemporaneous failure of a substantial number of financial institutions or of financial institutions. Or a financial market controlling a significant amount of financial resources that could result in a severe contraction of credit in the U.S. or have other serious adverse effects on global economic conditions or financial stability.

There is an emerging consensus among our members that we need a financial markets stability regulator, as a first step in addressing the challenges facing our overall financial regulatory structure. We believe that the mission of the financial markets stability regulator should consist of mitigating systemic risk, maintaining financial stability, and addressing any financial crisis.

Specifically, the financial markets stability regulator should have authority over all financial institutions and markets, regardless of charter, functional regulator, or unregulated status. We agree with Chairman Bernanke that its mission should include monitoring systemic risks across firms and markets, rather than only at the level of individual firms or sectors; assessing the potential for practices or products to increase systemic risk; and identifying regulatory gaps that have systemic impact.

One of the lessons learned from recent experience is that sectors of the market, such as the mortgage brokerage industry, can be systemically important, even though no single institution in that sector is a significant player. The financial markets stability regulator should have the authority to gather information from all financial institutions and markets, adopt uniform regulations related to systemic risk, and act as a lender of last resort.

In carrying out its duties, the financial markets stability regulator should coordinate with the relevant functional regulators, as well as the president's working group, in order to avoid duplicative or conflicting regulation and supervision. It should also coordinate with regulators responsible for systemic risk in other countries.

Although the financial markets stability regulator's role would be distinct from that of the functional regulators, it should have a more direct role in the oversight of systemically important financial organizations, including the power to conduct examinations, take prompt corrective action, and appoint or act as the receiver or conservator of such systemically important groups. These are more direct powers that would end if a financial group were no longer systemically important.

We believe that all systemically important financial institutions that are not currently subject to federal functional regulation, such as insurance companies and hedge funds, should be subject to such regulation. We do not believe the financial markets stability regulator should play the day-to-day role for those entities.

The ICI has suggested that hedge funds could be appropriately regulated by a merged SEC and CFTC. We agree with that viewpoint. The collapse of AIG has highlighted the importance of robust insurance holding company oversight. We believe the time has come for adoption of a optional federal insurance charter for insurance companies.

In a regulatory system where a functional regulation is overlaid by financial stability oversight, how the financial markets stability regulator coordinates with the functional regulators is an important issue to consider. As a general principle, we believe the financial markets regulator should coordinate with the relevant federal functional regulators, in order to avoid duplicative or conflicting regulation and supervision.

We also believe, the federal regulator for systemic risk should have a tiebreaker, should have the ultimate, final decision where there are conflicts between the federal functional regulators. There are a number of options for who might be the financial markets stability regulator.

Who is selected as the financial stability regulator should have the right balance between accountability to and independence from the political process. It needs to have credibility in the markets and with regulators in other countries and most importantly, with the U.S. citizens.

Thank you, Mr. Chairman.

REP. FRANK: Thank you, Mr. Ryan.

And next, Peter Wallison, who is the Arthur Burns Fellow in Financial Policy Studies, American Enterprise Institute, and with whom I have a connection, because Mr. Burns and I -- you may not know this, are both from Bayonne, New Jersey. So I claim Mr. Burns as a landsman, Mr. Wallison.

MR. WALLISON: I too. Thank you, Mr. Chairman, and Ranking Member Bachus, for this opportunity to testify about a systemic risk regulator.

There are two questions here, it seems to me. First; will a systemic regulator perform any useful function? And second, should a government agency be authorized to regulate so called systemically significant financial institutions.

I'm going to start with the second question, because I believe it is, by far, the most important. Giving a government agency the power to designate companies as systemically significant and to regulate their capital and activities is a very troubling idea. It has the potential to destroy competition in every market where a systemically significant company is designated.

I say this as a person who has spent 10 years warning that Fannie Mae and Freddie Mac would have disastrous effects on the U.S. economy. And that ultimately, the taxpayers of this country would have to bail them out. Because they were seen as backed by the government, Fannie and Freddie were relieved of market discipline, and able to take risks that other companies could not take.

For the same reason, they also had access to lower cost financing than any of their competitors. These benefits enabled them to drive out competition and grow to enormous size. Ultimately, however, the risks they took caused their collapse and will cause enormous losses for U.S. taxpayers.

When Fannie and Freddie were taken over by the government, they held or guaranteed $1.6 trillion in subprime and Alt-A mortgages. These loans are defaulting at unprecedented rates, and I believe, will ultimately cost U.S. taxpayers $400 billion.

There is very little difference between a company that has been designated as systemically significant and a GSE like Fannie or Freddie.

By definition, a systemically significant firm will not be allowed to fail, because its failure could have systemic effects.

As a result, it will be seen as less risky for creditors and counterparties and will be able to raise money at lower rates than its competitors. This advantage, as we saw with Fannie and Freddie, will allow it to dominate its market, which is a nightmare for every smaller company in every industry where a systemically significant company is allowed to operate.

Some will contend that in light of the failures among huge financial firms in recent months, we need regulation to prevent such things in the future. But this is obviously wrong. Regulation does not prevent risk-taking or loss. Witness the banking industry, the most heavily regulated sector in our economy. Many banks have become insolvent, and many others have been or will be rescued by the taxpayers.

It is also argued that since we already have rescued a lot of financial institutions, moral hazard has been created. So now we should regulate all financial institutions as if they will be rescued in the next crisis. But there is a lot of difference between de jure and de facto especially, when we are dealing with an unprecedented situation.

Anyone looking at the Fed's cooperation with the Treasury today would say that the Fed de facto is no longer independent. But after the crisis is over, we would expect that the Fed's independence will be reestablished. That's the difference between de jure and de facto.

Extending regulation beyond banking, by picking certain firms and calling them systemically significant, would in my view be a monumental mistake. We will simply be creating an unlimited number of Fannies and Freddies that will haunt our economy in the future.

Let me now turn to the question of systemic regulation in general. Why choose certain companies as systemically significant. The theory seems to be that the failure of big companies caused this financial crisis or without regulation, might cause another in the future.

But is the U.S. banking system in trouble today because of the failure of one or more large companies? Of course not. It's in trouble because of pervasive losses on trillions of dollars of bad mortgages. So, will regulation of systemically significant companies prevent a recurrence of a financial crisis in the future? Not on the evidence before us.

An external shock that causes asset prices to crash or investors to lose confidence in the future, will have the same effect, whether we regulate systemically significant companies or not. And regulation, as with banks, will not even prevent the failure of systemically significant companies. It will only set them up for bailouts, when inevitably they suffer losses in their risk-taking.

Finally, the Federal Reserve would be, by far, the worst choice for a systemic regulator. As a lender of last resort, it has the power to bailout the companies it is supervising without the approval of Congress or anyone else. Its regulatory responsibilities will conflict with its central banking role, and its involvement with the politics of regulation will raise doubts about its independence from the political branches.

We should achieve -- we will achieve nothing by setting up a systemic regulator. If we do it at the cost of destroying faith in the dollar and competition in the financial services market, we will have done serious and unnecessary harm to the American economy.

Thank you, Mr. Chairman.

REP. FRANK: Next, Terry Jorde who is the president and CEO of CountryBank USA, and she is here on behalf of the Independent Community Bankers of America.

MS. JORDE: Thank you, Mr. Chairman, Ranking member Bachus and members of the committee, my name is Terry Jorde, I'm president, CEO of CountryBank U.S.A. I am also immediate past chairman of the Independent Community Bankers of America.

My bank is located in Cando, North Dakota, a town of 1,300 people where the motto is, "You Can Do Better in Cando." CountryBank has 28 fulltime employees and $45 million in assets. ICBA is pleased to have this opportunity to testify today on regulation of systemic risk in the financial services industry.

I must admit to you that I'm very frustrated today. I have spent many years warning policymakers of the systemic risk that was being created in our nation by the unbridled growth of the nation's largest banks and financial firms.

But, I was told that I didn't get it, that I didn't understand the new global economy, that I was a protectionist, that I was afraid of competition, and that I needed to get with the "modern" times. Well, sadly, we now know what the modern times look like and it isn't pretty. Excessive concentration has led to systemic risk and the credit crisis.

Banking and antitrust laws are too narrow to prevent these risks. Antitrust laws are supposed to maintain competitive geographic and product markets. So long as the courts and agencies can discern that there are enough competitors in a particular market, that ends the inquiry. This often prevents local banks from merging. But it has does nothing to prevent the creation of giant, nationwide, franchises.

Banking regulation is similar. The agencies ask only if a given merger will enhance the safety and soundness of an individual firm. They generally answer "bigger" is almost necessarily "stronger." A bigger firm can, many said, spread its risk across geographic areas and business lines. No one wondered what would happen if one firm, or a group of firms, jumped off a cliff and made billions in unsound mortgages. Now, we know, our economy is in crisis.

The four largest banking companies control more than 40 percent of the nation's deposits and more than 50 percent of U.S. bank assets. This is not in the public interest. A more diverse financial system would reduce risk, and promote competition, innovation, and the availability of credit to consumers of various means and businesses of all sizes.

We can prove this. Despite the challenges we face, the community bank segment of the financial system is still working and working well. We are open for business, we are making loans, and we are ready to help all Americans weather these difficult times. But I must report that community bankers are angry. Almost every Monday morning they wake up to news that the government has bailed out yet another too-big-to-fail institution.

On many Saturdays they hear that the FDIC summarily closed one or two too-small-to-save institutions. And, just recently, the FDIC proposed a huge special premium to pay for losses imposed by large institutions. This inequity must end, and only Congress can do it. The current situation will damage community banks and the consumers and small businesses that we serve.

What can we do? ICBA recommends the following strong measures. Congress should direct a fully-staffed interagency task force to immediately identify systemic risk institutions. They should be put immediately under federal supervision. The federal systemic risk agency should impose two fees on these institutions that would compensate the agency for the cost of supervision and capitalize a systemic risk fund, comparable to the FDIC.

The FDIC should impose a systemic risk premium on any insured bank that is affiliated with a systemic risk firm. The systemic risk regulator should impose higher capital charges to provide a cushion against systemic risk. The Congress should direct the systemic risk regulator and the FDIC to develop procedures to resolve the failure of a systemic risk institution.

The Congress should direct the interagency systemic risk task force to order the breakup of systemic risk institutions. Congress should direct the systemic risk regulator to block any merger that would result in the creation of a systemic risk institution. And finally, it should direct the systemic risk regulator to block any financial activity that threatens to impose a systemic risk.

The current crisis provides you an opportunity to strengthen our nation's financial system and economy by taking these important steps. They will protect taxpayers and create a vibrant banking system where small and large institutions are able to fairly compete. ICBA urges Congress to quickly seize this opportunity.

Thank you, Mr. Chairman.

REP. FRANK: Thank you.

And next we have Mr. Travis Plunkett, who is the legislative director of the Consumer Federation of America.

MR. PLUNKETT: Thank you, Mr. Chairman, Ranking Member Bachus, members of the committee. I'm Travis Plunkett, legislative director of the Consumer Federation of America, and I appreciate the opportunity to testify today about how to better protect the financial system as a whole in the broader economy from systemic risks.

I would like to make three key points. First; systemic regulation isn't just a matter of designating and empowering a risk regulator, as important as that may be. It involves a comprehensive plan to reduce systemic risk, including immediate steps, both to reinvigorate day-to-day safety and soundness and consumer and investor protection regulation of financial institutions and to address existing systemic risks, in particular, by shutting down the shadow- banking system once and for all.

Second; systemic risk regulation should not rely, only, on a crisis management approach, or focus on flagging a handful of large institutions that are deemed too big to fail. Rather, it must be an ongoing day-to-day obligation of financial regulators, focused on reducing the likelihood of a systemic failure, triggered by any institution or institutions in the aggregate.

Third; CFA has not endorsed a particular systemic regulatory structure. But, if Congress chooses to designate the Fed as systemic -- a systemic regulator, it must take steps to address several problems inherent in this approach, including the Fed's lack of transparency and accountability and the potential for conflicts between the roles of setting monetary policy in regulating for systemic risks.

The fact that we could've prevented the current crisis without a systemic regulator provides a cautionary lesson about the limits of an approach that is just focused on creating new regulatory structures. It is clear that regulators could have prevented or greatly reduced the severity of the current crisis, using basic consumer protection and safety and soundness authority.

Unless we abandon a regulatory philosophy, based on irrational faith in the ability of markets to self-correct, whatever we do on systemic risk regulation is likely to have a limited effect. The flip side of this point, the positive side, suggests that simply closing the loopholes in the current regulatory structure, reinvigorating federal regulators and doing an effective job at the day-to-day task of ensuring safety and soundness in investor and consumer protection, will go a long way toward eliminating the greatest threats to the financial system.

Chairman Frank and several members of this committee have been leaders in talking about the importance of a comprehensive approach to systemic risk regulation, and it focused on executive compensation is a factor that contributes to systemic risk. We agree about the compensation practices that encourage excessive risk taking and about the need to bring currently unregulated financial activities under the regulatory umbrella.

The experiences of the past year have demonstrated conclusively, the ineffectiveness of managing systemic risk, only when the nation finds itself on the brink of a crisis. It is of paramount importance, in our view, that any new plan provide regulators with ongoing day-to- day authority to curb systemic risk.

The goal of regulation should not be focused only or even primarily on the potential bailout of systemically significant institutions. Rather, it should be designed to ensure that all risks that could threaten the broader financial system are quickly identified and addressed to reduce the likelihood that a systemically significant institution will fail and to provide for the orderly failure of non-bank financial institutions.

Regardless of which structure Congress chooses to adopt, we urge you to build incentives into the system to discourage institutions from becoming too big or too interconnected to fail. One way to do this is to subject financial institutions to risk-based capital requirements and premium payments designed to deter those practices that magnify risks, such as growing too large, holding risky assets, increasing leverage, or engaging in other activities deemed risky by regulators. To increase the accountability of regulators and reduce the risk of group-think, we also recommend that you create a high level, systemic risk advisory council made up of academics and other independent analysts from a variety of disciplines.

Once again, I appreciate the opportunity to appear before you today and look forward to answering questions.

REP. PAUL E. KANJORSKI (D-PA): Thank you very much, Mr. Plunkett.

Mr. (Silver ?).

MR. SILVERS: Thank you, Congressman Kanjorski. Good morning and good morning to Ranking Member Bachus and the committee. My name is Damon Silvers. I am associate general counsel of the AFL-CIO and I am the deputy chair of the Congressional Oversight Panel. My testimony today though is on behalf of the AFL-CIO, and though I will refer to work of the panel, in which I'm honored to serve together with Congressman Hensarling, my testimony does not reflect necessarily, the views of the panel, its chair, or its staff.

The AFL-CIO has urged Congress since 2006 to act to re-regulate shadow financial markets and AFL-CIO supports addressing systemic risk. The Congressional Oversight Panel made the following recommendations with respect to addressing systemic risk, recommendations which the AFL-CIO supports.

First; there should be a body charged with monitoring sources of systemic risk in the financial system. The AFL-CIO believes that systemic risk regulation should be the responsibility of a coordinating body of regulators, chaired by the chairman of the Board of Governors of the Federal Reserve System. This body should have its own staff, with the resources and expertise to monitor diverse sources of systemic risk in institutions, products, and markets throughout the financial system.

Secondly; the body charged with systemic risk management should be a fully public body accountable and transparent. The current structure of regional Federal Reserve Banks, the institutions that actually do the regulation of bank holding companies, where the banks participate in the governance is not acceptable for a systemic risk regulator.

Three; we should not identify specific institutions in advance as too-big-to-fail, but rather have a regulatory framework in which institutions have higher capital requirements and pay more on insurance funds on a percentage basis than smaller institutions, which are less likely to be have to be rescued as being too systemically significant.

Fourth; systemic risk regulation cannot be a substitute for routine disclosure, accountability, safety, and soundness, and consumer protection regulation of financial institutions and financial markets. Consequently, the AFL-CIO supports a separate consumer protection agency for financial services rather than having that authority rest with bank regulators. And here we see this consumer protection function as somewhat distinct from investor protection, which the SEC should do.

Fifth; effective protection against systemic risk requires that the shadow capital markets, institutions like hedge funds and private equity funds, and products like credit derivatives must not only be subject to systemic risk-oriented oversight, but must also be brought within a framework of routine capital market regulation by agencies like the SEC. We can no longer tolerate a Swiss cheese system of financial regulation.

And finally; there will not be effective re-regulation of the financial markets without a global regulatory floor that ought to be a primary goal of the diplomatic arms of our government. The Congressional Oversight Panel urged attention to be paid to executive compensation in financial institutions.

This is an issue of particular concern to the AFL-CIO that I want to turn to now on the remainder of testimony in relation to systemic risk.

There are two basic ways in which executive pay can be a source of systemic risk. When financial institution pay packages have short- term time horizons that enable executives to cash out their incentive pay before the full consequences of their actions are known, that is a way to generate systemic risk.

Secondly; there is the problem that is technically referred to as risk asymmetry. When an investor holds a stock, the investor is exposed to upside and downside risk in equal proportion. For every dollar of value lost or gained, the stock moves proportionately. But when an executive is compensated with stock options, the upside works like a stock, but the downside is effectively capped. Once the stock falls well below the strike price of the option, the executive is relatively indifferent to further losses.

This creates an incentive to focus on the upside, and be less interested in the possibility of things going really wrong. It is a terrible way to incentivize the manager of a major financial institution, and a particularly, terrible way to incentivize the manager of an institution the federal government might have to rescue.

This is highly relevant, by the way, to the situation of sick financial institutions. When stock prices have fallen close to zero, stocks themselves behave like options from an incentive perspective. Thus it is very dangerous to have sick financial institutions run by people who are incentivized by the stock price.

You are basically inviting them to take destructive risks from the perspective of anyone, like the federal government, who might have to cover the downside. This problem today exists at institutions like AIG and Citigroup, not just for the CEO or the top five executives, but for hundreds of members of the senior management team.

A further source of asymmetric risk incentives is the combination of equity-based compensation with large severance packages. As we have learned, disastrous failure in financial institutions sometimes leads to getting fired, but rarely leads to getting fired for cause. The result is the failed executive gets a large severance package.

If success leads to big payouts, and failure leads to big payouts, but modest achievements either way, do not, then there is a big incentive to shoot the moon without regard to downside risk. These sorts of pay packages in just one very large financial institution can be a source of systemic risk.

But when they are the norm throughout the financial services sector, they are a system-wide source of risk; much like unregulated derivatives, or asset backed securities. Consequently, this is an issue that the regulators of systemic risk ought to have the authority to take up. I thank you for your time.

REP. FRANK: Thank you.

And finally Mr. Edward Yingling, who is the president, CEO of the American Bankers Association.

MR. YINGLING: Thank you, Mr. Chairman, Ranking Member Bachus, members of the committee. The ABA congratulates this committee on the approach that it is taking to the financial crisis.

There is a great need to act, but to do so in a thoughtful and thorough manner and with the right priorities. That is what this committee is doing. Last week, Chairman Bernanke gave a speech which focused on three main areas.

First, the need for a systemic risk regulator, second, the need for a method of orderly resolution of systemically important financial firms, and third, the need to address gaps in our regulatory system. Statements by the leadership of this committee have also focused on legislative plan to address these three areas.

We agree that these three issues, a systemic regulator, a new resolution mechanism, and addressing gaps should be the priorities. This terrible crisis should not be allowed to happen again and addressing these three areas is critical to make sure it does not.

The ABA strongly supports the creation of a systemic regulator. In retrospect, it is inexplicable that we have not had such a regulator. To use a simple analogy, think of the systemic regulator as sitting on top of Mount Olympus, looking out over the land.

From that highest point, the regulator is charged with surveying the land, looking for fires. Instead, we have had a number of regulators, each of which sits on top of a smaller mountain, and only sees part of the land. Even worse, no one is effectively looking over some areas.

While there are various proposals as to who should be the systemic regulator, most of the focus has been giving -- on giving the authority to the Federal Reserve. It does make sense to look for the answer within the parameters of the current regulatory system.

It is doubtful that we have the luxury, in the midst of this crisis, to build a new system from scratch, however appealing that might be in theory. There are good arguments for looking to the Fed.

This could be done by giving the authority to the Fed or by creating an oversight committee chaired by the Fed. ABA's one concern in using the Fed relates to what it may mean for the independence of the Federal Reserve in the future. We strongly believe in the importance of Federal Reserve independence in setting monetary policy.

ABA believes that systemic regulation cannot be effective if accounting policy is not part of the equation. That is why we support the Perlmutter-Lucas bill, H.R. 1349. To continue my analogy, the systemic regulator on Mount Olympus cannot function if part of the land is held strictly off limits and under the rule of some other body, a body that can act in a way that contradicts the systemic regulator's policy.

That is, in fact, exactly what happened with mark-to-market accounting. I want to take this opportunity to thank this committee for the bipartisan efforts in the hearing last week on mark-to-market. Your efforts last week will significantly aid in economic recovery. We hope that the FASB and the SEC will take the final action you clearly advocated.

ABA strongly supports a mechanism for the orderly resolution of systematically important non-bank firms. Our regulatory bodies should never again be in the position of making up a solution to a Bear Stearns or an AIG, or not being able to solve a Lehman Brothers.

The inability to deal with those situations in a predetermined way greatly exacerbated this crisis. A critical issue in this regard is too-big-to-fail. Whatever is done on the systemic regulator, and on a resolution system, will in a major fashion determine the parameters of too-big-to-fail. In an ideal world, there would be no such thing as too-big-to-fail, but we know that the concept not only exists, it has grown broader over the last few months. This concept has profound moral hazard and competitive effects that are very important to address.

The third area of our focus is where there are gaps in regulation. These gaps have proven to be a major factor in the crisis, particularly the role of largely unregulated mortgage lenders. Credit default swaps and hedge funds should also be addressed in the legislation to close gaps.

There seems to be a broad consensus to address these three areas. The specifics will be complex, and in some cases, contentious that this very important time, with Americans losing their jobs, their homes, and their retirement savings, all of us should work together to develop a stronger regulatory structure. The ABA pledges to be an active and constructive participant in this critical effort. Thank you.

REP. FRANK: Thank you. Well, this is all very useful, and I think we are having -- I mean, we have a crisis and the crisis is not conducive to kind of calmness, and I'm pleased that we appear to be able to separate that out. And as we deal with the crisis under a lot of human drama we can have a rational conversation about the way to go forward. I appreciate everybody's approach. A couple of brief points.

Ms. Jorde, you know, if we are able to get through the Senate and we would then concur an increase in the FDIC's lending authority to deal with potential problems up to the ($)500 billion mark, the increase in the assessment will be substantially reduced. They are talking now about a $0.13 increase and it would go down to a $0.03 increase. So that's on the community banks, as you correctly pointed out, being hit with the assessment that's based on some of it. Whether or not that should be risk-based, many of us think it is, and if that could be worked out, that's separate. But we are on track, I think, to -- it's now $0.063, instead of going to $0.20, it would go to $0.10 which is a very substantial reduction, and we will try to do that.

Mr. Wallison, on the insurance issue -- important one, and you mentioned the problem with the regulated AIG and to these -- the insurance companies, then the money went up to unregulated (ph), and you said an optional federal charter is a part of -- that would be very much on the agenda of this committee, there are members who put forth -- but what would you do for those that opted not to opt? Would you give some federal power -- and I think you pointed out to a problem here that with AIG, you had regulated companies, but an unregulated entity at the top.

If you had an optional of federal charter and the entity became a federal charter that could be federally regulated, what would you do for situations where the companies did not opt for a federal charter? Would you extend some federal regulation at that top level?

MR. WALLISON: First of all, Mr. Chairman, AIG is regulated. It's regulated by OTS. It is a thrift-holding company. Now, it might not have been effectively --

REP. FRANK: Well, I thought you were calling -- and maybe I misunderstood your testimony. I thought you were calling for a change and saying that we should have an optional federal charter that could improve regulation of insurance. I apologize if I misinterpreted that.

MR. WALLISON: Well, I didn't actually speak about an optional federal charter. I happen to favor that, but I didn't speak about it in this testimony.

REP. FRANK: Oh, it's Mr. Ryan, I apologize. I --

MR. WALLISON: We look so alike, I guess.

REP. FRANK: Yeah, well, from here -- I apologize and then, let me ask that to Mr. Ryan. I'm sorry, Mr. Wallison.

MR. RYAN: So the direct answer is that if a company did not opt for a federal charter, but it was systemically important or involved in systemically important activities, then under our proposal, the regulator would have authority to --

REP. FRANK: So if they had an optional federal charter, it would be the federal insurance regulator, but then it would go over --

MR. RYAN: Not that they would --

REP. FRANK: Let me ask one other issue. And I -- Mr. Silvers made an important point about the compensation. But I have one other question I'd like everybody to talk about. And that is -- it is my impression, part of the problem, and Mr. Yingling, you mentioned the subprime loan, if enough bad decisions were made at the outset, it seems to me it's very hard to recover from that.

The ability to securitize 100 percent of the loans appears to me to be part of the problem. Should we explore some limitation on the ability to securitize? Should there be some risk retention requirement in that area?

Mr. Bartlett, let's begin with you.

MR. BARTLETT: We've concluded that then this is a reversal of our previous positions, where -- there should be some risk retention. We think that's going to happen in Europe and it's the prudent thing to do, a risk retention some kind.

REP. FRANK: Mr. Ryan.

MR. RYAN: We think it's practical that at least here and in Europe that there will be some risk retention, so we're -- we've cozied up to that requirement, how much is -- we're still debating.

REP. FRANK: I agree, both how much and as -- is it first dollar or what percentage is it proportionally -- I mean, obviously saying that, but that begins an inquiry.

Mr. Wallison?

MR. WALLISON: Yeah, I think there is good reason to at least make sure that someone is bearing a risk at every level. But we also ought to, Mr. Chairman, begin to look at other methods of financing our mortgage system, covered bonds for example.

REP. FRANK: Okay, Mr. Wallison, I agree with that. But I -- and we will be getting that. But I did want to get -- and I appreciate that.

Ms. Jorde?

MS. JORDE: You know, I certainly can understand the philosophy of retaining risk. I think the one caveat would be how that would affect the community banking industry in terms of servicing, for example. We don't have the mortgage departments geared up to handle servicing.

So most of the banks of my size will sell their mortgages with servicing released. So I guess there would be, you know, whether or not the economies of scale would be sufficient enough that community banks would be able to continue to participate in that market.

REP. FRANK: Well, yeah -- but it is theoretically possible that you can still sell off the servicing, but retain a small percentage of the risk?

MS. JORDE: Certainly.

REP. FRANK: Mr. Plunkett?

MR. PLUNKETT: Yes, we would support additional risk retention requirements for securitization. And Mr. Chairman, on the question of an optional federal charter, it seems like a valuable lesson of the current crisis. If we've learned anything, it's that giving the regulated party their choice of regulator will lead to downward pressure on the part of the --

REP. FRANK: All right, thank you, gentleman. I do want to get the --

Mr. Silvers?

MR. SILVERS: Yes, I think that risk retention -- retaining some skin in the game is a good idea not just -- but not just for the originator. I think there's been a lot of learning about how damaging it's been that servicer, say in mortgages, are disconnected from the economics of the mortgage. And I think they are the real problem.

REP. FRANK: Right -- and a gentlewoman from California is here, and she early on focused on the problem in the servicing model, and over and above the risk retention. But in dealing with the whole question of mortgages, I believe we will be trying -- it seems that there is a great mistake in the -- for the ward to allow important decisions that have to be made, but not -- but can't be made, that there should not be a situation where nobody is in charge in -- from important decisions. And we will approach that.

Mr. Yingling, on the risk retention?

MR. YINGLING: I would agree with your analysis, and I know you are well aware there are some very thorny accounting issues that we have to work our way through. But it's something that we definitely all ought to look at to see if we can't make people have some skin in the game.

REP. FRANK: I thank the witnesses, and the gentleman from Alabama.

REP. BACHUS: Thank you, Mr. Chairman.

Let me pick up on Mr. Yingling's analogy of the systemic risk regulator sitting up on Mount Olympus, you know, surveying the scene. And what he said is, you know, putting out the fires. And one of my problems is that we're -- he wouldn't put out all the fires. He would only put out the big fires, it is our understanding. Is that correct?

MR. YINGLING: That's correct. And more importantly, identifying the fires and then deciding who puts out the fires.

REP. BACHUS: But you know, the little fires would be allowed to burn.

MR. YINGLING: To some degree, or the regulator on the smaller mountain would be in charge of putting them out.

REP. BACHUS: Yeah. But you know, to me that's one of the really unfair aspects of too-big-to-fail. It implies -- and I've said this in September, it implies too small to save.

MR. YINGLING: Correct.

REP. BACHUS: And as we see in Alabama, that's just flat out unfair. And we're -- seem to be endorsing with legislation in a regulatory approach like this. The other thing is that you have a regulatory agency sitting up there on Mount Olympus, and I agree, and they're not only putting out fires, but they're also repairing the structures at taxpayer expense.

I mean, they go in and they are doing it with taxpayer dollar. And is that wrong, or should we -- you know, as I said in my opening statement, let's try to agree on something going in, and that's that we don't have these multibillion dollar taxpayer bailout.

I'd ask all the panelists what's your position on giving the regulator? And -- you know, all we're basing that on right now is a Federal Reserve Act, some language in there, and -- but let me just start with you, Mr. Bartlett, do you think that we ought to empower this --

REP. FRANK: And let me just announce there's a recess. So we have plenty of time, there won't be any --

(Cross talk)

REP. FRANK: -- keep going, so that's just a recess.

REP. BACHUS: -- risk regulator to use billions of dollars worth of taxpayer money?

MR. BARTLETT: No, Congressman. I don't other than what we now have, which is no analysis of systemic risk, no oversight of systemic risk, no one to notice systemic risk.

REP. BACHUS: Hold on, let me --

MR. BARTLETT: And the unlimited Federal Reserve dollar, so none of the systemic risk regulator proposals propose any additional authority on the solution problem. What we have proposed, what we've proposed, is Federal Reserve as a systemic risk oversight, but then followed by a coherent comprehensive resolution authority to resolve the failures in a coherent consistent manner, which does not now exist.

REP. BACHUS: Yeah, advance -- and I would agree with that. Advance a resolution, but I think we ought to put a provision in there that they don't use taxpayer dollar to -- you know, and another thing that I think -- what do you think about advancing local lending? You know, in this -- in the past several years with a consolidation, we are getting further away from, sort of, main street lending. Did that -- is that a problem?

MR. BARTLETT: Congressman, I don't see it that way. I think lending is up. I think that the lending of all -- from all sizes of banks, both largest and smallest, is actually up, regions in Birmingham and Compass BBVA in Birmingham, and -- have in fact increased their lending. Whitney has increased their lending.

So it's not size that either causes more commercial lending or less, it's the capital underneath the banks. So don't see it as a size issue.

REP. BACHUS: Of course, size here is an issue when it comes to too-big-to-fail, I guess.

MR. BARTLETT: We haven't seen -- I mean, we are not ones that agree with too-big-to-fail.

REP. BACHUS: Oh, okay, okay.

MR. BARTLETT: Wachovia failed, WaMu failed, National City failed. The issue is whether we can identify and prevent --


MR. BARTLETT: -- prevent the problems earlier, and then whether the failures and resolutions can be done in an orderly way.

REP. BACHUS: And I'm onboard with all that. Although I have to agree with Mr. Wallison, I prefer say -- by saying, yeah, could this be an incentive to take even more risk. I mean, when you have a perception out there that you have a government agency that's going to make sure that it -- that an institution doesn't fail, you -- it seems that you identify them as systemically important.

You are implying that there is some sort of guarantee, now, even if you don't give it. We saw that in Fannie and Freddie. As soon as they began to fail, we all said there was an implicit guarantee.

Mr. Wallison, you -- is there anyway, without just simply saying that we're not -- that the government is not going to bail these companies out. I don't see any way to avoid at least an implicit guarantee, which I think we've learned is a bad thing.

MR. WALLISON: No, I think you're correct, Mr. Bachus. The markets are very clear-eyed about this sort of thing. And where the government seems to be backing a company in some way and making sure that the company will not fail through their -- through government resources, then, the market follows that lead, and they will make funds available to these companies.

That will be easier for these companies to raise it at lower rates than others they compete with. So we will have a Fannie and Freddie kind of situation developing in every market.

REP. BACHUS: And I think the government can guarantee things, and that's treasury bonds and debt obligations to the U.S. government. And that's where it ought to end, and if people think they are investing in something the government is going to back, they ought to invest in government bonds, or securities, or instruments.

MS. JORDE: Congressman Bachus --


MS. JORDE: To go back to your fire analogy, you know, I think really what we are looking at is whether we need a big huge large fire department. And I don't think that's what we're talking about here. I think we need to figure out ways to keep these fires from starting.

You know, if you look at the national -- at the systemic risk of some of these largest institutions and the national dependence on those, I would question whether or not the failure of AIG and Bear Stearns, if -- you know, if they had been allowed to go down, what would the impact have been on City Corp and Bank of America?

I mean, I think that's really what we're talking about is the interconnectedness of these huge financial institutions. They are too large and they can't fail, and if they do, everything else goes down with them. We have to keep the fires from starting.

REP. BACHUS: Sure and that was his analogy. That was Mr. Yingling's analogy.

But I appreciate that.

MS. JORDE: Thank you for that.

REP. BACHUS: And I agree with you. I think that's the -- but once they start, I don't think that government ought to put them out at taxpayer expense. Unless, we've -- what we will pay for little -- we have guaranteed deposits, and we are -- that's where it ought to end. We ought to guarantee deposit and whether we -- that level is 250,000 or 500,000, it ought to end where that guarantee ends.

REP. KANJORSKI: Thank you very much, Mr. Bachus. I'll take my five minutes while we are waiting for the chair to return.

First of all, let me thank the panel for their testimony and for their unanimous support of having skin in the game. That really is a revolutionary concept that we would have seven members of panelists, diverse as this panelists, and everybody agreeing, this time we do put skin in the game. I think it's very responsible for us to do that.

Mr. Yingling, I think that you've made an observation to this committee on these issues that we have attempted to, as best as possible, remove ourselves from the temptation of talking to political issues. But in fact, look at these questions in a much more bipartisan way and I hope that continues.

And if it does, I would think that to a larger extent, we may be able to get some progress yet unappreciated by the general public. On that question, though of systemic risk, I'm still one of the slight doubters.

It sounds to me that it is structured to be able to say, so this shall never happen again. And every time I hear that phase -- phrase, I shudder, because we all know it's not going to happen again the same way. This is capitalism's attempt to escape the confines of control and regulation.

They proved very healthy for 80 years until in the last decade, the escape was there. And I think it has a lot to do with the unregulated banking system that allowed this leveraging to occur, allowed the situation to get out of hand, to the extent that, I think, most of us saw this potential happening, maybe 2005, in 2006, that it was going to be clear. Something was going to happen that was not necessarily intended or desirable for the public.

Now, my question is though -- so that we don't run down this road very quickly to create, quote, "a systemic risk regulator?" Have you all given deep thought as to what powers a systemic risk regulator would have to have? And how deep could they go, and what could they inquire into? And that it wouldn't necessarily be limited just to, quote, "financial institutions." It would go into other institutions.

Because as you all may recall, just several weeks ago, we had the auto industry in here testifying to the fact that they were going to be a systemic risk situation. Because if any one of the three American auto manufacturers were to go down, it would bring the other two down, because it constituted systemic risk in so far as they were coordinated and intertwined with their dealers and with their suppliers.

And it has almost been a given up, until this time that if one company goes down, all three American companies go down, and possibly even the entire industry, even foreign manufacturers in the United States would be gravely, if not, totally disadvantaged by that occurrence.

Now, that being the case, and adding to that, that there is a financial structure that exists in the auto industry, that is the arms of financing, Chrysler Financial, and General -- GMAC and Ford Financial, again blend right into the fact -- I don't know exists.

Would you all consider the automobile manufacturing companies just auto manufacturing, or are they financial institutions, or are they an ugly blend of the two that are very difficult to separate if not impossible to separate? That's just a side question.

But now, how far do you want us to go, once you go down this path of empowering a, quote, "systemic risk regulator," who would have to have tremendous information, almost clairvoyance in terms of determining what the ambitions of certain people in the financial market were to determine whether it's some future event these actions that were contemplated would cause systemic risk?

And in fact, if anybody who wants to -- yes, Mr. Silvers?

MR. SILVERS: Congressman, I think you -- there are three ways of cutting your -- three ways of answering your question. First, if we're going to be serious about watching systemic risk across the financial system, in a realm where people innovate, and people who do most innovating in this area are lawyers, then you really do have to have a pretty sort of comprehensive writ of authority to look where you need to look.

GE Capital, clearly an institution capable of generating systemic risk, although GE is a manufacturing enterprise. Secondly, though this is not sufficient, the -- I think much of the problem here in terms of shadow markets comes from not giving routine regulators, the ability to follow the action.

And I think that it'll be very difficult for some of the reasons you were alluding to, to capture the full range of market activity if you -- if the day-to-day regulators don't have the kind of broad jurisdiction that they enjoyed in the Post-New Deal era, and that was taken away gradually over the last 20 years or so.

But there is a trick here. And I'm not sure what the answer to it is, but I think the committee ought to be well aware of it. It's one thing to give oversight and surveillance power. It's another thing to give the systemic risk regulator the ability to override judgments of day-to-day regulators. And particularly, this is true in relation to investor and consumer protection.

There is a natural and unavoidable tension between anyone charged with essentially the safety and soundness of financial institutions. And agencies charged with transparency and investor protection and consumer protection, that tension has always been there, if you give a systemic risk regulator the authority to hide things.

All right, there was a real danger they will use it. And that will actually not -- that will actually not protect us against systemic risk, but rather do the opposite.

REP. KANJORSKI: Mr. Yingling?

MR. YINGLING: First, Congressman Kanjorski, I really want to thank you for your efforts last week in holding that hearing on mark- to-market. It was so important. I think from our point of view, the systemic regulator has somewhat limited authority in the sense that they -- that regulator can broadly look and have information. But we don't see that as "the ultimate authority," "the regulator" of regulators.

So that primarily, it is an information gatherer and has some ability to go in and say, okay, we have a problem now, let's coordinate it. But one part of this equation that I think, it's too little emphasis, and that is the method for resolving systemic failures in the future.

That is so important. If you look at the mess we're in today, a lot of it is because we did not have a good system for resolving. Let's take the big example, AIG. We had a system for resolving Wachovia and WaMu. And I think if we really focus our efforts on getting that resolution mechanism there in advance, that not only affects how you resolve institutions, it has ripple effects back on what it mean -- may mean or not mean to be too-big-to-fail. And so that resolution mechanism is very, very important in all of this.

REP. KANJORSKI: Very good point.

Yes, Mr. Wallison?

MR. WALLISON: Thank you, Congressman. Your point about auto manufacturers, I think, suggests how plastic and unclear this whole idea of systemic risk really is. I mean, we all talk about it as though it's something that we understand. But it's highly theoretical and we don't really have an example yet of systemic risk being created by anything other than, as I said in my oral testimony, anything other than some kind of external factor affecting the entire market.

The market is the financial system around the world, and especially in the United States, is seriously troubled now, but not because of the failure of any particular company, but rather because of all of the bad mortgages that were spread throughout the world.

Regulation did not prevent that from happening. We had a very strong regulatory system in place. The banks were subject to it. FIDICIA, which I think you would remember well from your service at the time, FIDICIA was intended to be the end of all bad banking crises. It's a very strong law, and yet we now have the worst banking crisis of all time.

So I think before Congress acts on the question of systemic risk, there ought to be some understanding of what we are really talking about. Because if an agency is empowered to regulate systemic risk, and yet we -- it could apply to auto manufacturers as well as anyone else, Congress is handing over a blank check to a government agency and that would be a very bad precedent.

REP. KANJORSKI: Thanks, Mr. Wallison. I know I'm taking up a large time, but I think your answers are important for the record. Yes.

MR. RYAN: I'd like to make a comment that goes to the chairman's question and your comment about the uniqueness of all of us having a view on retention and put this in perspective. Securitization, as the chairman noted, is an essential ingredient in how we provide financing for consumers in this country, '07 about 2.8 trillion.

We are now inching along very little, the business is basically dormant. So when people are complaining about credit availability for consumers, a large part of that is because securitization is basically dormant.

As you approach, whatever you're going to be doing on securitization, I would urge you to think through not only the retention issue, and retention is very complicated, how much by whom. I mean, we all know what we are trying to achieve here, which is basically to incent people such that they are not originating or underwriting poor assets.

But when you look at retention, think more broadly, think about transparency, think about how these securities or structured evaluation, think also about the credit rating agencies, because that is an integral part of fixing this situation. We need modification there. Thank you.

REP. KANJORSKI: Thank you. Anyone else? Thank -- oh, yes.

MS. JORDE: Thank you. I think one more thing that is important to consider when we look at systemic risk is that it's being exacerbated as we move toward more mixing of banking and commerce. We referred to the auto manufacturers, but the auto manufacturers are also making mortgage loans and financing their own vehicles.

We talk about GE Capital and GE. You know, as we have moved toward more mixing of banking and commerce, certainly we are creating greater systemic risk. It was what ruined the Japanese financial system back in the '90s, and it's something that we need to look very closely at as we move forward, close the ILC loophole, and keep banking and commerce separate.

REP. KANJORSKI: Thank you very much.

Mr. Royce, I'm sorry, I took extra time.

REP. ROYCE: Thank you, Mr. Chairman. I wanted to just start with the observation that it was Mr. Wallison who warned us many years ago about the systemic risks of the broader financial system.

In '92 we passed the GSE Act in Congress. And as a consequence of passing that act, we set up goals -- affordable housing goals, and when the Federal Reserve looked at the consequences of that, they began to see the same thing that Mr. Wallison saw. And they sought to get Congress involved in this because as was observed banks are regulated. And so they can only leverage 10:1, right.

But we were allowing Fannie Mae and Freddie Mac to leverage a 100:1 and to go into arbitrage. And the reason they were allowed to do that was because there was an attempt to have them meet these goals. Somebody had to buy those subprimes from Countrywide. And it was Fannie and Freddie that had the requirement in terms of the goals to buy these subprime loans and these Alt-A loans.

In 2005, I brought an amendment to the floor of the House of Representatives to regulate these GSEs or to allow the Fed and allow the regulator to regulate them for systemic risk because the regulator had asked for this ability to regulate them for systemic risks to the wider financial system. And at that time that amendment was voted down.

In the meantime, as you know, we also passed legislation here that allowed the government basically to bully the market, to bully the banks in terms of the types of loans that they would make. So -- and to rig the system so that originally, which -- what was a 20 percent down, became 10 percent down, became a 3 percent down, became a zero percent down, because we had to meet those goals for very low income and low income affordable housing.

Now, the reason I think is important that Mr. Wallison be here, is because through all of this debate, he and the Federal Reserve were the ones coming up here warning of -- warning us that because of the power they had in the market, they were crowding out the competition. They were becoming the majority holder of -- and purchasers of these mortgage-backed security -- securitization. They were the market. And as a consequence of the risks they were taking, and the excessive leverage, we had a situation where it was helping to balloon the market and create a situation where once these standards had been lowered, 30 percent of the market participants were now flippers.

In other words, we did it for a good cause. Congress did it for a good cause. We lowered these standards, we pushed affordable housing. But we forgot, or some of us forgot that flippers would come in and take advantage of those new 3 percent down or zero percent down programs and would be able to eventually constitute 30 percent of the entire market, which is what happened come 2005 according to the Federal Reserve, 2006, 2007. And that further, of course, you know, ballooned up this problem.

Now, understanding the potential implications of labeling certain companies as systemically significant, as you explained in your testimony, Mr. Wallison, do you believe it's important to take steps in overhauling our regulatory structure, because, you know, the previous Treasury secretary issued this blueprint for regulatory reform in March of last year.

And in many respects, at least from my perspective, that would close systemic gaps in the system. It merged duplicative regulatory bodies. It ended those who were redundant, who weren't necessary any more as a result of consolidating them.

And the central idea in that treasury plan was that in many respects banks, security firms, insurance companies actually represent a single financial services industry not three separate industries and ought to be regulated as such. And these firms are all competing with one another. And as long as this is true, it makes no sense to regulate them separately from the standpoint of Treasury. While the Treasury blueprint was not perfect, I believe that was a step in the right direction. It's important that this Congress not talk about systemic risk regulation in a vacuum, but rather consider the regulatory framework as a whole.

So I'd ask if you agree with this sentiment. Should Congress be looking at the broader structure that has been in place for 75 years when it debates systemic risk and looking at a way to give -- well, anyway, let me ask your response, Mr. Wallison.

MR. WALLISON: Yes, I absolutely agree with that, Congressman Royce. I think it's exceedingly important that we understand what is happening in the financial services industry as a whole. Those companies -- all the different industries are competing among themselves.

It makes no sense anymore to try to regulate them in separate silos. So the Treasury blueprint was a very sensible way, I think, for Congress to begin to look at how the financial services industry would be regulated. And I certainly agree with everything you said.

REP. FRANK: The gentlewoman from California is now recognized for five minutes.

REP. MAXINE WATERS (D-CA): Thank you very much, Mr. Chairman. I'd like to thank all of our witnesses who have appeared here today. I'm particularly pleased about the testimony of Ms. Terry Jorde, president and chief executive officer of CountryBank U.S.A. on behalf of the Independent Community Bankers of America.

Let me just say, Ms. Jorde, that I am -- I heard your testimony about your bank. The only thing wrong with your bank is it sounds too much like Countrywide. And you ought to be worried about that, because despite all of the testimony about Fannie and Freddie, it was Countrywide who threatened Fannie that if they didn't take their products that they would just kind of squeeze them out of the market. And, of course, Countrywide was non-bank that was non-regulated by anybody.

I'm from California. I think we have at least repaired part of the problem where we require the licensing of all these brokers. Countrywide only had one license, and it had anybody who could brief to go out and initiate loans. And there is a lot of fraud that was involved in that.

But -- and I appreciate the testimony of all of those who understand that it is not simply a systemic regulator someone who I think was indicated sitting on the top of all of this that's going to make it work. We really do need consumer protection. And if we think we're going to get it from the same people who've been in the system, I don't think so, not because they are evil people, they just don't think that way.

All of our regulators think about how to notice the banks, how to warn the banks, how to talk with the banks, but they never talk about how to stop them, because of the way that they think. They absolutely believe that you should let the marketplace work.

All of those exotic products that were placed on the market, whether they were Alt-A loans, or adjustable-rate option loans, et cetera, as long as these kinds of products can be put on the market without any scrutiny, without any real interference by regulators, we're going to have a problem. The mailboxes of citizens are being swapped now with new products because of the foreclosure meltdown. Now, the insurance companies, many of them I guess owned by maybe some of these banks, I don't know, are flooding the mailboxes with mortgage protection. What is it? How does it work?

I don't think the regulators have been here to talk about it. And out of this crisis that we have, now we have all of the loan modification companies that have sprung up. And all they need is $3,500 to start to work to help someone get a loan modification. No regulator has said a word about this.

And so we sit here and, of course, we think that they know what they're doing. But I'm afraid that if we have a systemic regulator, are they going to come from Goldman Sachs. And it seems to me Goldman Sachs is everywhere. Not only was it our past treasure, it's our -- now present treasure.

I understand that Eddie Liddy over at AIG worked for Goldman Sachs. And we find that Goldman Sachs was kind of taken care of when they were brought into snatch up Bear Stearns for pennies on the dollar. And then we find that now Goldman Sachs is taken care of again through AIG. And, of course, we took care of them in our TARP program with the Capital Purchase Program. And I guess they're sitting on top of all of this.

Am I to expect that the systemic regulator who would probably come out of the same market that caused those problems is going to cure all of this? We need a consumer protection agency to deal with all of this. Don't forget, it was the activist and the consumers who went before every bank merger attempt, and went to the hearings held by the Feds and everybody else saying, don't do this. And they talked about the problems that would be caused.

Now, I want to ask again, the idea of the consumer protection agency that came from labor, to please explain what you --

REP. FRANK: Well, you have time for a brief answer.

MR. SILVERS: The consumer -- the congressional oversight panel recommended a consolidation of consumer protection and financial services, by which we meant financial services like mortgages, credit cards, commercial bank deposits, perhaps insurance that those functions should not be with the same institutions charged with safety and soundness because there is an inherent tension.

And as -- Congresswoman, as you put it, the safety and soundness arguments always win out over the consumer protection arguments in those institutions. So we recommended that, in our report, the AFL- CIO supports that recommendation strongly. We see that function as distinct from the kind of work that is done with investments that are at risk by the SEC. We see those as two separate important functions.

And by the way, with respect to the Paulson blueprint, though I have great respect for the former secretary, that blueprint clearly envisioned dismantling investor protection. It clearly envisioned, in the guise of re-regulation, actually weakening regulation of our financial markets and in that respect it would be a terrible thing to fall.

REP. FRANK: The gentleman from Texas, Mr. Hensarling.

REP. HENSARLING: Thank you, Mr. Chairman. Just to set the record straight, if I heard my colleague, the gentle lady from California, correctly speaking that Countrywide was not regulated, that will come as news to both the OCC and the OTS, who at different times during the Countrywide's existence regulated those institutions.

Mr. Wallison, you have a lot in your written testimony that you were unable to speak about in your oral testimony. I thank you for being here. I thank you for your very thoughtful op-ed in the Wall Street Journal today. Certainly, you bring your wealth of credibility to this panel as being one to have the clarion call that Fannie and Freddie were presenting a huge amount of systemic risk to our economy.

In your testimony, you speak of the design of a systemic regulator could cause more Fannie and Freddies to take place in the future. Although I don't remember the exact quote, our president in his State of the Unions had something along the lines before we can correct the -- we can correct our economy going forward, we have to understand how we got into this situation in the first place. That's a paraphrase.

Can you speak exactly how significant was the role of creating a federally-sanctioned duopoly in Fannie and Freddie, giving them affordable housing goals that ultimately brought down their lending standards? What role do you believe that played in the economic debacle we see today?

MR. WALLISON: I think that structure is largely responsible for the financial crisis that this country is experiencing, and that is because what Fannie and Freddie essential were, were a distortion of the credit system. Congress had a good idea; it seems to me, in attempting to support homeownership in the United States. There are a lot of benefits that come from homeownership, and it's a good idea to support it.

But Congress chose to support it through Fannie and Freddie and CRA by distorting the credit system and asking private organizations -- private profit-making organizations to bear the cost, and hide the cost in their balance sheets and in their income statements. And so we never really understood the risks that they were required to take in order to support this congressional objective.

If Congress wants to accomplish something, it should accomplish it by appropriating funds, so the taxpayers can understand what the objectives of this government are and what it is spending on those things, not to push all of those costs onto private sector balance sheets and income statements.

REP. HENSARLING: So in many respects, in retrospect, the market viewed Fannie and Freddie as systemically significant, and as much as they had an implicit government guarantee, which we all know now is explicit.


REP. HENSARLING: And can you elaborate on your fear of having a systemic regulator designate other firms as -- we'll try to say that, systemically significant?

MR. WALLISON: Well, this is --

REP. HENSARLING: And how that might further exacerbate future Fannie and Freddies?

MR. WALLISON: Sure. Well, it offers the opportunity to create an unlimited number of future Fannies and Freddies. The essence of Fannie Mae and Freddie Mac -- the reason they became so powerful, so large, and ultimately were able to take so much in the way of risk is that they were seen by the markets as backed by the government. And on the matter of what the government said about whether it was backing them, the markets were quite clear-eyed about this, the government was going to back them if they failed.

Now, that means -- that's the kind of situation that we are creating when we are talking about systemically significant companies, because if we create such companies, if we have a regulator that is blessing them as systemically significant, we are saying they are too big to fail. If they fail, there will be some terrible systemic result. And therefore the market will look at that and say, well, we're going to be taking much less risk if we lend to company A that is systemically significant rather than lending to company B that is not.

REP. HENSARLING: Mr. Wallison, you may have to give a very short answer to this question as I see the yellow light is on, but the risk of making the Federal Reserve the systemic regulator, can you elaborate upon your thoughts?

MR. WALLISON: Well, the problem with that is that it just adds credibility to what I just said, and that is that the market will believe that in any event that systemically significant companies are backed by the government. But if they are regulated by the Fed, the problem there is that the Fed has the money available already without congressional by-your-leave, without any kind of further authority, to cover up any problems that occur in the regulation of these systemically significant companies by providing the funds under its existing authority to deal with special exigent circumstances of various kinds. So making the Fed the regulator would be the one thing that would sort of cap the whole question of whether we are creating companies that are backed by the federal government. And it would make it perfectly clear without doubt.


REP. FRANK: Gentlewoman from New York.

REP. CAROLYN B. MALONEY (D-NY): Thank you, Mr. Chairman. Since we are discussing systemic risk regulator would be appropriate to see how systemic risk is being evaluated now by our government, and most recently, or very much in front of us today is AIG, which was saved because it was a systemic risk to the American economy. Yet when we saw the counterparties that were released this week because of the constant request from this committee, we find out that a significant amount, billions and billions, tens of billions of dollars went to foreign banks.

Now, I'd like to ask the panelists, do you feel that bailing out foreign banks is important to systemic risk of the financial institutions of our country? I would think that bailing out foreign banks would be important to the governments of their country, but why is our government bailing out foreign banks?

And the reason I ask this is when we're talking in a general sense about systemic risk, we have an example before us in concrete terms of how it's being interpreted by our own government. I do not believe we should be bailing out foreign banks. I believe other governments should bail out their own banks. I'd like to ask the panelists, do you feel that that's a proper use of taxpayers' money under the guidelines that it protects the systemic risk of the financial institutions of America? Do you believe we should be bailing out foreign banks? Are they a systemic risk to the American economy?

MR. WALLISON: Let me try to start on that, Congresswoman, and just say that if you were to bailout any U.S. bank of any size, you were going to be bailing out foreign banks, because banks are all interconnected. They make loans to one another. And that's -- in fact the essence of the financial system is banks are all intermediaries. They are moving money from one place to another.

REP. MALONEY: So are you saying we should be bailing out all foreign banks --


REP. MALONEY: -- because we're interconnected with our banks?

MR. WALLISON: I'm saying the opposite. But I am saying that if we were to create a systemic regulator and systemic risk -- a systemic risk regulator that has the power to bail out U.S. banks, you would in effect always be bailing out foreign banks because all banks especially at the international level, are interconnected.

REP. MALONEY: My question was not American banks such as Citibank and JPMorgan Chase that are international banks. Obviously, we have a huge stake in saving these financial institutions. My question is should we be bailing out the Bank of Germany which is owned by the German government, or the French owned bank in their countries.

So you -- personally, I don't feel that that is systemic risk to the American financial system. Maybe we could go down the line and people could give their opinions. To me, I don't believe that -- in my opinion, bailing out a French and German bank poses systemic risk to the financial security, safety and soundness of financial institutions.

If anyone else would like to speak, Mr. Silvers, Mr. Plunkett, Mr. Ryan --

MR. SILVERS: Yes, Congresswoman, I think --

REP. MALONEY: Mr. Yingling, I'd like to hear your opinion too.


MR. SILVERS: I think your question raises a somewhat broader question which is, what do we mean when we say saving? If we mean by saving that we are going to make good on every obligation of a financial institution with taxpayer dollars, and keep the stock of that institution alive, when left to its own devices, it might have to file chapter 11; if we're talking -- if that's what we mean, we are always in every case talking about enormous expense, and frankly a transfer of wealth from the public at large to what are essentially wealthier parties within our society.

Historically, and I think this goes to the comments made of many of -- by many of the panelists here, historically we have had a resolution process for financial institutions that we -- where we were worried that there would be systemic or larger societal consequences if they did not make good on obligations. So we insured deposits, and we have a resolution process for insured depository institutions. We do the same thing at the state level for insurance companies.

When we move, as we did last fall, into a world in which we guarantee everything, and at AIG, we actually didn't guarantee everything. AIG is not the most extreme example of this. AIG, we just guaranteed all the fixed obligations. But when we move into a world where we guarantee everything, we inevitably end up guaranteeing institutions such as perhaps foreign banks that perhaps we might not be comfortable doing so if we had more of a resolution process.

Perhaps in a resolution process, it would be possible to sit down with foreign governments who obviously have a stake in the same matter and work that out. But when you begin with the assumption that, quote, "rescuing a financial institution," it means that everyone gets made good at taxpayer expense, then you got a problem.

REP. FRANK: Gentleman from New Jersey.

REP. GARRETT: Thank you, Mr. Chairman. And I think that the bankers who sit on this panel were probably astonished and shocked that the opening of today's hearing when you heard it from the other side of the isle that -- what they say, we don't regulate anything in this country anymore. You're probably wondering who were those guys with green eyeshades that call themselves examiners, who come into your banks every so often. Who are they, if we are not regulating anything, but I digress.

Mr. Silvers, on the line of deregulation and what have you, you did make a comment to one of the questions that we have deregulated in over the last dozen years or so. There has been a taking back of so many powers. Just very briefly, aside from Gramm-Leach, which we know some people say is deregulation, other people argue it allowed for the diversification which is helping the big banks out there to stay on foot, can you just run down four or five of the major acts of Congress we passed in the last dozen years that you're referring to where we deregulated the financial situation in this country?

MR. SILVERS: Well, you've certainly mentioned one, which is Gramm-Leach-Bliley.


MR. SILVERS: The second was the commodities act and I can't recall the formal title --


MR. SILVERS: -- which deprived the CFTC of the ability to regulate financial futures and -- I mean, financial derivatives and other derivatives. A third was not Congress, at least, Congress didn't act formally. It was the court decision that took away from the SEC the ability to regulate hedge funds. Congress then failed to act in response to that. Fourth was -- here is an instance where Congress was responsible, but the regulators didn't act, where Congress gave the Fed the power to regulate mortgages comprehensively, Congress didn't use it. The fifth is somewhat older, which is and I think goes to the --

REP. GARRETT: Well, most of these are not regulatory -- these are not taking away. This is not Congress action and the action on the hedge funds, that you -- which I think was number three -- hedge funds really aren't as much problems as all the other areas in the banking sector which have been continuously regulated.

MR. SILVERS: Yeah, no, I don't see it that way. I think a key issue in the --

REP. GARRETT: Well, the losses are certainly less.

MR. SILVERS: Let's say that the key -- well, they are less because we -- the taxpayers have propped them up. A key issue in Bear Stearns for example, was the interweaving of Bear Stearns' business with some large amount of hedge fund money. No one really knew for sure how much, because it wasn't regulated. My point about deregulation is that it's -- the responsibility doesn't rest solely with Congress in this matter. The courts have contributed, the failure of agencies to act when they've been given powers have contributed.

REP. GARRETT: Okay, and that --

MR. SILVERS: But Congress has actually been quite significant --

REP. GARRETT: I appreciate that. And it's on that last point, on not acting is maybe my main point.

Mr. Plunkett, I'll just say on your point, I was with you on most of what you were saying, and you are saying that we can do a lot of this, what we need to do with the existing regulation is sharing the information, and I think I was following you and I agree with you on lot of those points. You lost me when you talked about solving it by regulating salaries, or executive compensation, but up until that point I was right with you. But I appreciate a lot of your testimony.

Ms. Jorde, a quick question. The suggestion that was made here with regard to all of that requiring the banks to hold a portion of it on their books on securitization, wouldn't that be actually problematic for some of your smaller banks who right now have to sell it all and that's how they're able to lend? Just very briefly, could that cause a little bit of a problem for some of the small banks?

MS. JORDE: Well, and that was my point initially is that to hold the part of it, then you're in effect servicing it, and you won't be able --

REP. GARRETT: And not even the -- it's not even the servicing. As the chairman said, you might be able to get rid of that somehow, but even just the fact you have to hold it your ability to loan might be -- has --

MS. JORDE: Well, certainly, the more that you can sell off, that leaves your capital available for lending. But for the most part we are portfolio lenders. It's whether or not you can give the -- you know, the advantage to the borrower as far as 30-year fixed-rate mortgages, how you price those things, so that community bank doesn't end up with asset liability issues. I think those are the things that would need to be worked out.

REP. GARRETT: Yeah, I really appreciate that. And finally, Mr. Yingling, you always have to be careful when you bring an analogy like that, because somebody is going to jump on it, and -- about Mount Olympus. Who was on Mount Olympus was Zeus, and I came up with the acronym of that'd be "zero errors under supervision," that this person would have to be providing us with, there'd be no errors anymore. But the problem is we have all these regulators, and they haven't been able to provide us with that lack of errors.

And matter of fact, in the Wall Street Journal, we have this comment from Scott Polakoff, who is the acting director of the Office of Thrift Supervision, and he said it is a myth about AIG, about them not being regulated. The regulation was regulated by a collage of global bureaucrats, and the financial product division did not slip through the regulatory cracks. They -- he goes on to say that the agency should have taken an entirely different approach in regulating the contracts written by their product.

So this goes back to Mr. Silvers' comments, we had the regulators there. They were sitting up on high. They were working with the global folks, as Mr. Silvers also suggested that we need to on a global perspective, but still they couldn't see it, and only -- it's only in retrospect that they're able to look back now and say, ah, this is what we should have done.

And I guess, Mr. Wallison, isn't that the ultimate problem that we're going to get to that even if we have all this in place, the regulators will always be saying after the fact, that's what we should have done?

REP. FRANK: Mr. Wallison, very quickly. Time is -- we've run out of time, so if you want to respond it has to be very quick.

MR. WALLISON: (Off mike.)

REP. FRANK: Your mike's off.

REP. GARRETT: He said I was exactly correct I think.

REP. FRANK: Your mike --


MR. WALLISON: We keep thinking that we've solved the problem like with FIDICIA, never going to happen again. But in fact, regulation is not an affective way of preventing risk-taking and keeping --

REP. FRANK: Thank you.

MR. WALLISON: Thank you.

REP. FRANK: The gentlewoman from California, she has consent to speak for one minute.

REP. WATERS: Thank you very much, Mr. Chairman.

I asked for time so that I can make a correction, and a clarification that Bear Stearns was actually purchased by JPMorgan. And on Countrywide, yes, they were formally regulated, but they didn't do a very good job of it.

REP. FRANK: The gentleman from North Carolina.

REP. MELVIN L. WATT (D-NC): Thank you, Mr. Chairman. If there is one thing I'm learning pretty quickly about this whole subject area is this kind of discussion is important, and don't necessarily buy into the first reaction that you usually have on these issues. Two examples I'll give right you quick.

I'm not so sure that I'm ready to jump onto the retention of risk, the skin in the game philosophy. Although, it sounded very intriguing initially, it seems to me at some level there's a tradeoff between regulating so that people stay out of these risk and incentivizing people to stay out of it by requiring that they have skin in the game. And I would hate to think that we would get to the point where we seize to look at the regulatory side, using as an excuse that you've got a market incentive because we're requiring you to keep skin in the game.

It also seems to me as you go on down the line, if you're going to require the original lender to have skin in the game, you got to have the first securitizers and the second securitizers, and the impact of that would be to in some fashion reduce the amount of credit that's out there in the market. So I'm not going to ask you to comment on that, because I want to go to the second reaction that I initially got to was that it might be a good idea to have the Fed be the systemic regulator. And I'm beginning to have second thoughts about that too.

I don't know how you have a systemic regulator who also has day- to-day regulatory authority without shielding that regulatory authority in some way, or compromising it. I don't know how you have a systemic regulator who does monetary policy without shielding monetary policy, insulating it from the systemic regulation function. I don't know how you have a systemic regulator, and have that regulator have responsibility for consumer protection without insulating it. And if you're going to insulate it to the extent that that it seems to me it needs to be insulated, you've basically taken some department or a part of the Fed, if it's all inside the Fed, and created a separate entity anyway. And I'm not sure that it wouldn't make more sense to actually go ahead and create a separate entity.

Mr. Bartlett, and Mr. Wallison, react to my concerns about the prospect that putting systemic regulation on the Fed would compromise in some way monetary policy, responsibilities of the Fed, and consumer -- consumer protection responsibilities of the Fed.

MR. BARTLETT: Thank you, Congressman, and like you, our thinking has evolved on this over the course of three years, and specifically in the last six months. First, we do not propose to create additional day-to-day regulatory authority by the Fed, and in fact we would move the --

REP. WATT: So you take -- you take some of the regulatory -- day-to-day regulatory authority from the Fed to give it to somebody else?

MR. BARTLETT: We put it -- that's right.

REP. WATT: Okay. All right, that would solve the problem.

MR. BARTLETT: We would not create additional regulatory. We would take some of it and then second is, is that we would give the --

REP. WATT: But you can't take the monetary policy from the Fed?

MR. BARTLETT: No, but we -- that was the second point is we see monetary policy and systemic risk regulation is quite consistent, because they're both engaged in trying to provide for an orderly economy -- economic issues. And so they both -- they are consistent goals. We don't see that as inconsistent at all.

Third is I'd take the point is that we specifically reject the idea that there should be created a list of systemic companies, or a list of firms, or we reject a size criteria. We think six months ago that we were in those same conversations, but I have to tell you after the same considerations with some of the comments that were made by Mr. Wallison and others, the idea of creating a list of companies that are systemic is the wrong approach. Instead it should be those activities and practices that cross over lines that affect the entire financial sector.

And then last is we think that if you give the power to regulators who have the safety and soundness power and then you give them the power, and the authority, and the mandate to act for consumer protection, you can profoundly provide a great deal more consumer protection that we're getting with a separate agency.

REP. FRANK: Mr. Neugebauer.

MR. : Sorry.

REP. NEUGEBAUER: Thank you, Chairman. I think one of the things that I want to follow, I think that some of my colleagues have made this point, and I think it's -- it's in a more simplistic point of view is, you can talk about crime, and you know, you have a crime problem in your city, and so the first inclination is we need to add more police officers. And many cities have tried that model, they added more police officers. But the bottom-line is maybe crime statistics went down, but you still had crime, while other cities have employed a system where they've changed the patrol patterns, and other activities, and basically got the same results.

And Mr. Wallison, I tend to agreeing with you. I think what we have to be careful here is didn't we just have an oversight problem in that -- in some respects at the regulatory area. But we also just had quite honestly a corporate governance problem. We had people taking risk that there didn't seem to be consequences for. And now what I'm afraid of is that we're almost creating more systemic risk in that patterns and activities that we're doing right now by showing that the government will step up and take away the consequences if the bill gets too big.

And so I think the -- I share the same concerns that if you -- once you -- in fact I told Secretary Paulson this on a telephone conversation last fall. I said, Secretary Paulson, I don't want to be a triple-A credit, I just want to be on your systemic risk list, because what that allowed me to do is not to have to behave in any particular way because the marketplace knew right away if I was on the big boys list that I was going to be okay, and it was all right to do business with me. I don't want to recreate that scenario in this country where people say, you know, our whole business model here is we're trying to get on the systemic risk list. It needs to be a punitive list if anything.

But the question I have to the panel is, isn't a part of the safety and soundness analysis that the current regulatory structure should be looking at as these entities get extremely large and get into extremely complex types of investment activities, shouldn't that in fact trigger some additional capital requirements, or leverage requirements that in fact begin to manage that company in a way that we don't let it get to quote -- to systemic risk, and I'll start with you, Steve.

MR. BARTLETT: Quick answer is yes, it should. And we think that a systemic regulator than in working with and through the powers of the primary supervisor could accomplish exactly that. If I could take 30 seconds on crime, because when I was mayor of Dallas we faced something similar. It is a great analogy. City of Dallas, it had an increase in the numbers of violent crimes every single month, every single month for 20 years, hadn't missed one. And they tried everything they thought, incarceration, but it was all -- more police on the beat, and such as that. And then we tried systemic prevention.

We identified the locations, times of day, times of week, and individuals that were engaged in crime, and went out and talked with them. Had a 42 percent of reduction of violent crime within two years. So systemic -- and a systemic approach to these problems can work, it worked in that case to use your example, Congressman.


MR. RYAN: As I've said before this committee before we're in favor of a systemic risk regulator so that we have someone who has the capacity to look over the horizon. Right now, regulators are restricted either by charter or geography. We need a regulator that has all of the information so that they can look at all of these interconnected entities, notwithstanding their charter with activities or products that does not exist today.

REP. NEUGEBAUER: Mr. Wallison?

MR. WALLISON: I think there's no reason why we couldn't have some organization that looked over the entire economy, and looked for questions like systemic difficulties. The question would be whether there is then any authority in that body to actually regulate. And that I think would raise some very serious questions. I think we ought to keep our eye on the ball in one respect, and that is that regulation is not a panacea, it does not cure problems. And we ought to -- we have to regulate all those companies that are backed by the government.

But when you're not backed by the government, you should be allowed to fail. It's one of the most important things we have in our economy that makes sure that the bad managements go out of business, the bad business models go out of business, and they are replaced by better managements and better business models.

REP. NEUGEBAUER: Failure may be the best regulator that there is.

MR. WALLISON: Exactly.

REP. FRANK: The gentleman from California.

REP. SHERMAN: Thank you, Mr. Chairman.

Mr. Bartlett, you've suggested in your opening statement principle-based standards, which tends to mean that we just have vague standards that say do the right thing, don't take unnecessary risks, treat people fairly, and we rely on the conscience of the individuals to interpret those terms and apply them. Do you think that we can get away from explicit standards and rely on loudly proclaimed broad principles? And do you think that those who have been attracted to the financial services industry in Wall Street have evidenced recently a willingness to just do the right thing and act in the national interest?

MR. BARTLETT: Well, Congressman, if I -- I'll review my testimony to make sure I didn't say it that way. I didn't call for vague standards, I called for -- I called for principle-based regulation. So you establish the principles. Our first principle is, treat your customer fairly. But then the regulations themselves are promulgated (ph) consistent with those principles.


MR. BARTLETT: So -- but you still have --

(Cross talk)

REP. SHERMAN: You mean all regulations should reflect the values and principles of the country. So you're not suggesting that we shouldn't also have numerical standards, detailed regulations, et cetera?

MR. BARTLETT: I'm suggesting that all regulations should reflect uniform standards, but they don't because the Congress has not established uniform standards, or uniform principles. I think that the principles should come from a consideration by Congress, and then the regulation should be developed to enforce those principles.

REP. SHERMAN: Okay. Let's move on to Mr. Silvers.

Do you think that it makes sense to have the Fed simultaneously be the regulator, who occasionally will make mistakes, and I know that the chairman has pointed out that regulators try not to admit mistakes, none of us do, and also be the agency with the -- that can spend billions and trillions of dollars to rescue firms, and in effect sweep the mistakes under the rug, delay the explosion, and maybe hope for the best?

MR. SILVERS: I think that we should have learned a lesson from the last year, which is that there are times and circumstances in which no matter whom is in political power, that certain institutions to some degree whether that is in the form of a restructuring, or a conservancy, or in the form of a flat-out rescue of the kind that we've been offering recently, that some institutions are going to be rescued in some circumstances. And that given that is the case, that Republicans and Democrats, Conservatives and Liberals seem to do it. That given that that is the case that we ought to have clear criteria for when to do it, that the people who make the decisions ought to be clearly, publicly accountable. And that these things ought to be setup in advance and not ad hoc --

REP. SHERMAN: I couldn't agree with you more on those things. Should we have the same entity --

MR. SILVERS: And consequently --

REP. SHERMAN: -- be the regulator and the bailer-outer.

MR. SILVERS: All right. And so consequently, all right, the Fed as it is currently structured does not meet those tests. Now, if it was structured to be a fully public agency, would it still be appropriate for it to be the regulator and the bailer-outer? In my view, although I don't think there is a perfect answer to this, is that there is some reason -- there are some reasons to have the people who have to foot the bills have to think about what structures you want to have in place beforehand to ensure they don't have to pay.

In doing so one runs the risk, and I think Congressman, you've pointed that out very clearly that particularly if you have governance structures that are essentially self-regulatory, you run the risk of essentially a partnership developing between the failed institutions and the regulator to keep those institutions to fully ensure and payoff everyone involved in those institutions at taxpayer expense, and I -- and to ignore the fundamental lesson I think of the last year which is that while some institutions maybe systemically significant, not all splits, not all layers of a capital structure institutions are.

REP. SHERMAN: Thank you.

MR. SILVERS: Thank you.

REP. SHERMAN: I'm going to try to squeeze in one more question for Mr. Bartlett. A lot of -- a number of us are working on tax legislation design to impose a surtax on excess executive compensation of those at bailed-out firms. Now, putting aside how we would define excess compensation, can you see a reason why we should allow executives to retain, without paying any particular surtax, compensation that you and I would agree is excessive?

REP. : I'm afraid the gentleman's time has expired.


Go ahead and answer the question briefly -- quickly if you can.


REP. : Okay. I think that's a pretty quick answer.


REP. SHERMAN: I'll take that as a maybe.

REP. : If you want to follow up, you can do so in writing.

Mr. Castle is recognized for five minutes.

REP. MICHAEL N. CASTLE (R-DE): Thank you, Mr. Chairman. I'll throw out two questions, and I'll just duck, and let you try to deal with them. And I think Mr. Bartlett touched on this a little bit in his opening statement, maybe not too definitively. But it's a little bit off the systemic risk regulation, but bank regulation in general.

We have many entities both at the federal level, and then you have state entities too who regulate different financial institutions in this country depending on what they do. And my question is do you believe that there should be some consolidation in that area, should there be more of a reaching out in terms of some of the leveraged type of circumstances that exist today, and hedge funds, et cetera, in terms of what we are regulating, or are we okay in terms of our basic regulations? That's one question I have.

The other question is more pertinent perhaps to the hearing today and that is the Federal Reserve in general. I mean, whenever we talk about systemic risk regulation, which I basically believe in, we talk about the Federal Reserve, and -- but I worry about the Federal Reserve in that they have responsibilities in terms of some regulation now, and they have other responsibilities that relate to our economy in a great way.

So if we were -- first off, if you have loud objections to the Federal Reserve, I'd like to hear that. And secondly, if you feel Federal Reserve perhaps should give up certain powers, if they were to take on a systemic risk regulation component, I would like to hear about that as well. So those are my two areas of concern. I open the floor to whomever is willing to --

MR. BARTLETT: Congressman, let me --

REP. CASTLE: -- step forward.

MR. BARTLETT: -- let me take them one at a time. Yeah, we do think that there should be some basic reformulation and convergence, that there should be a prudential supervisor that should supervise banks, insurance, and securities at the national level with uniform national standards. It should follow the "quack like a duck" theory, if it quacks like a duck, walks like a duck, talks like a duck, then it's a duck, and it should be regulated like a duck; same with banks, our insurance companies, and securities.

And today we have a hodgepodge of chaotic hundreds of agencies that regulate the same kinds of activities in widely different ways. We found -- and there's nothing perfect. We think that the Fed is the best equipped to be a systemic regulator as we've described, which is no list -- not a list of specific firms, but rather the systemic oversight. We think that's very consistent with their monetary policy which is the strengthening and stability of the economy.

We do recommend that the regulation of state chartered banks be moved over to the bank regulator. But we would -- and we've struggled with this. We do think that the bank holding company regulation should stay at the Fed. Probably the main reason for that is just they do it very well and there's no -- and we don't see a reason to change -- to change it. And then last is the Federal Reserve has the breadth and the scope and the institutional knowledge of almost a century of understanding both the economy and the financial markets. And we don't think that that can be duplicated or replicated in the space of half-a-dozen years perhaps. We think we should use that to the government's advantage.

REP. CASTLE: Mr. Yingling.

MR. YINGLING: Mr. Castle, I think, as I listen to this panel and a lot of the concerns of the members, we have to find what systemic regulation means. And I think a lot of us are talking not about detailed, in-depth regulation. We are talking about looking out and seeing where the problems are and then using the regulatory system as it exists to solve those problems, and then supplementing the regulatory system where we have gaps, so that we would not get into all the problems of having some super, super-regulator out there. That's not what we are taking about.

Again, I think, it's critical to look at that resolution process because that's going to work backward and affect who is considered too big to fail. And I think I've heard everybody here say we shouldn't have a list that identifies people as too big to fail. One thing I do think the Fed could give up is the holding company regulation of the small banks. It really makes no sense that the Fed regulate the holding company of a $100 million bank that's regulated by the FDIC, the state or even the controller. A lot of times, they go in and that holding company is nothing more than a shell. So as they get to new authority, I think they could give up the holding company authority over smaller institutions. Thank you.

REP. CASTLE: Yes, sir, Mr. Wallison.

MR. : (Off mike.)

REP. FRANK: MR. Wallison, your mike isn't on.

MR. WALLISON: -- is not working. Okay, two points that you made -- handled very quickly. The Fed would be a very poor choice as the systemic regulator if the purpose of systemic regulation is to identify and regulate individual companies. I don't -- I think I hear it that most people here do not favor that, but should that happen, the Fed would be very bad from that perspective, because it compounds the problem of making it look as though those companies have been chosen by the government not to fail, and there is the financial resource next to them regulating them that can actually bail them out. So depending on what the systemic regulator is chosen to do, the Fed would -- could be a very bad regulator.

The second point you've asked is do we have the right amount of regulation now, should we extend regulation beyond the banking industry. And my view is, no, that regulation is appropriate, and in fact necessary, essential, when companies are backed by the government, because then there is no market discipline, there is moral hazard, et cetera. Where they are not backed by the government, regulation tends to add moral hazard. And so what we ought to do is leave these companies alone and let them fail, because that's exactly the way we preserve good managements, and we finance good managements, and good business models, because they survive the tough periods.

REP. CASTLE: Thank you. I yield back, Mr. Chairman.

REP. FRANK: The gentleman from New York, Mr. Meeks.

REP. GREGORY W. MEEKS (D-NY): Thank you, Mr. Chairman.

And I want to thank all of you for testifying today. I think that your testimony lends to the fact that we really need to think this thing through. It's been very thought provoking for me. And I think that everyone would probably agree to at least -- surely the way I look at it that, you know, our regulatory system did work. We now have a problem because we have a new train running on old tracks. And so it -- I mean it worked for a period of time until now. Then that train ran off the track.

And what we are talking about now when we are talking about a systemic risk regulator, or how are we going to create new tracks for the train. I don't want to get rid of the train because capitalism ultimately evolves, and I think that we are evolving. But we need some type of regulation to make sure that the train doesn't go off the track, which then causes damage to society in general.

And then -- and so we've got to figure out who do we need, and what do we need, whether it's someone in the Fed, or whether it's an entirely new regulator, a systemic risk regulator to come in, combining others. I -- you know, I don't know, that's why I find some of your testimony intriguing. And I want to continue to listen and learn and move forward.

But also I think that, and I think that Mr. Silvers spoke of this a little bit, and of course Mr. Bartlett also, that in this new world that we currently live in, it is global, it is indeed global. And the question that, you know, that comes to my mind is, you know, is the areas -- unless we can fix our own system, you know, create these tracks for our own train, we'll be running right off the track again if we don't have some kind of global regulator, because I keep hearing consistently how everything is now intertwined.

They all, you know, run into one another at some point. You know, you're selling one thing to another bank. My colleague Carolyn Maloney was talking about banks across the ocean. And one of the answers -- when you help American bank, you're helping a foreign bank, because they are all interrelated.

But if that be the case, then isn't there a urgent need for also talking either simultaneously and trying to figure out what a global regulator would be? Do you think that we need to have one, and where -- and how can, if at all, we lead, you know, as Americans in that area? I guess I'd direct that question to Mr. Silvers, and then Mr. Bartlett.


REP. MEEKS: And then to Mr. Ryan.

MR. SILVERS: Congressman, I think it's a very good point. My -- you know, Angela Merkel, the chancellor of Germany came to Hank Paulson in 2007 and suggested that perhaps we ought to have more regulation of hedge funds. The Bush administration didn't like that idea, and thought that we didn't need more transparency, and then they found themselves in the middle of the night thinking about what to do about Bear Stearns without the very transparency that they could have had when Angela Merkel brought it to them.

We are now back facing the G-20 meeting, coming up where the -- where once again the proposition is going to be put on the table, by Europeans of all people, that we ought to be more serious about transparency and regulation of shadow markets on a routine basis. And we have the opportunity not to be the drag on that process, but to lead. It is not necessary to lead to have a global regulator. Global regulators are a thing that may be long in the future, but it is necessary, and quite possible to have coordinated action.

And if we don't have coordinated action, poor practices in other countries may leak into our markets, and we may be perceived as being the source of poor practices elsewhere, as we were say in Norway when our subprime loans blew up their municipal finance. That challenge is right in front of us, and we can lead, and it ought to be a priority of the administration, and I'm hopeful it will be, to do just that.

REP. MEEKS: Thank you.

Mr. Bartlett, quickly. And I want to have Mr. Ryan.

MR. BARTLETT: Yeah, quickly, and I think Mr. Ryan might have something. I think that we shouldn't have one global regulator, but we should harmonize our systems for our benefit as well as the world's, and specifically we should harmonize the accounting systems of IFRS and GAAP accounting. We've found that to be an increasingly problematic area.

REP. MEEKS: Mr. Ryan?

MR. RYAN: Yes, sir. Clearly, we have global financial institutions. We have global capital markets. We've been talking about securitization. We spent an awful lot of time in Brussels, and Iran, and Europe talking with regulators. This whole issue of retention is actually far afield -- far ahead in Brussels. That market is totally globalized, so we are already seeing the effects of global regulation and impact on some of our markets. And clearly, we're going to have to be in sync on a global basis; whether that means one regulator, we've not really faced that issue yet. We're more concentrated on what happens here right now.

REP. FRANK: Gentleman from Georgia.

REP. PRICE: Thank you, Mr. Chairman.

I want to thank the panelists as well for their testimony today and their forbearance with the questions in the time. I think it's important to remember that this -- that our nation has provided the greatest amount of freedom and opportunity and success for more people than any nation in the history of mankind. And I think it's incumbent upon us to appreciate that we haven't done that by virtue of excessive regulation.

It would seem that it would be important for us as members of Congress to attempt to define what has allowed that success -- if you define that a success, what has allowed that success to occur and attempt to embrace those fundamental principles. We have talked -- everybody has talked about systemic risk, but I don't know that we have a definition of it. Anybody care to give me a definition of systemic risk?

MR. BARTLETT: Dr. Price --

REP. PRICE: Mr. Bartlett?

MR. BARTLETT: -- I would share that we've come up with, and this is about our 18th draft.


MR. BARTLETT: Systemic risk is an activity or a practice that crosses financial markets or financial services firms and which if left unaddressed would have a significant material and adverse effect on financial services firms, markets, or the U.S. economy.

REP. PRICE: But somebody has got to decide what has a significant adverse effect on the rest of that sentence.


REP. PRICE: That you would suggest ought to be the systemic regulator?

MR. BARTLETT: Yes, or a market stability regulator, yes.

REP. PRICE: So somebody in the wonderful buildings around here will determine whether or not a financial institution ought to have explicit support of the federal government, is that what you're saying?

MR. BARTLETT: No, Congressman, we're not calling for explicit or implicit support of the federal government.

REP. PRICE: That may not have that --

MR. BARTLETT: We are not calling for identification --

REP. PRICE: Excuse me, I only get five minutes. Tell me how that isn't a consequence of that definition.

MR. BARTLETT: Because the outcome of identifying systemic risk is to go to the prudential supervisor and then supervise that firm in a different and a better way. That's the outcome. It's not to provide the implied bailout or the support.

REP. PRICE: Anybody disagree with that being the outcome?

REP. PRICE: So we all agree that systemic risk institutions no longer get explicit government support, is that correct?

MR. : I think --

REP. PRICE: That --

MR. BARTLETT: Congressman, I guess what I'm trying to say is that we don't see this as a -- the outcome of this is identifying systemically significant institutions. We see it as identifying systemic risk across those institutions so that a -- a poorly underwritten mortgage is not simply sold up to someone else the way (ph) it's still a bad mortgage.

REP. PRICE: No, I understand that, but at some point there has to be a consequence for the decision-makers here. We've determined -- somebody has determined that there's an entity that's a systemic risk. So what ought to occur to that entity? It has to be something, otherwise why not define it.

MR. : If we keep the entity from becoming a systemic risk by the -- through the kind of regulation Mr. Bartlett is talking about, then you don't have to face that problem. That's the prevention strategy.

REP. PRICE: Ms. Jorde?

MS. JORDE: Well, I think you're exactly on track.

We first have to define what systemic risk is. We have to figure out why --

REP. PRICE: What's your definition?

MS. JORDE: What's my definition?


MS. JORDE: Well, one is that the CEO doesn't know what the right hand and the left hand is doing. If the organization is so large that the very people at the top and the board of directors has no control over the organization --

REP. PRICE: So you believe it's appropriate for the government to determine whether or not a CEO knows whether the right and left hand know what they're doing?

MS. JORDE: Well, I think it's important that the company is not so large that their failure will bring back everybody under the house of cards. That's what I'm facing as a community banker. I'm paying tens of -- hundreds of thousands of dollars now for FDIC insurance premiums to cover the risks of these systemically largest institutions. And I think that before we figure out who is going to be the regulator, we need to identify the criteria of what this regulator is going to do.

REP. PRICE: I would agree, and I think that's almost an impossibility, and I would suggest --

MR. : That it is.

REP. PRICE: -- that community banks, independent community banks might find themselves out in the cold, that the federal government may determine that all of those big boys are systemically risky, systemically significant. Community banks aren't, and then therefore how are community banks going to compete?

Mr. Wallison, I would appreciate if you would just discuss that unequal or un-level playing field, when one defines something as systemically significant?

MR. WALLISON: You know, that's a thing that bothers me more than anything else, and worries me, and that is just from what I have experienced with watching Fannie Mae and Freddie Mac. And that is when the government chooses a winner, when the government chooses an institution that it is going to treat specially different from any other institution, then the market looks at that and decides, quite practically, this is going to involve less risk if I make loans to such a company. And when that happens those companies then become much tougher competitors for everybody else in the industry. And the result will be a collapse of a very competitive financial system we have today, and the consolidation of that system into a few very large companies that have been chosen by the government, whether they are banks, securities firms, insurance companies, hedge funds, or anything else.

REP. PRICE: Thank you, Mr. Chairman. I think that's a concern that many of us share. Thank you.

REP. FRANK: The gentleman from Kansas.

REP. DENNIS MOORE (D-KS): Thank you, Mr. Chairman.

And thanks to the witnesses for testifying. Like my constituents, I'm angry at the recent news reports of AIG handing out bonuses, or what they call retention payments, totaling a $165 million, and this happens after the federal government has committed a $173 billion in taxpayers' money to support AIG. As I understand it, these bonuses are going to employees of the same division that made hundreds of billions of dollars worth of very risky credit default swaps that fell apart and contributed to the financial meltdown. We also learned this week that Citi's CEO Mr. Pandit, who testified before this committee on February 11, made $10.82 million in '08.

When responding to my questions of how much the eight CEOs of the big banks made, Mr. Pandit told this committee that he was to receive a salary of $1 million with no bonus in 2008, but that he was going to take a salary of just $1 per year and no bonus until the company returns to profitability. Mr. Pandit neglected to tell this committee that he received a sign-on and retention award in January '08 that was valid at the time of over $34 million.

Mr. Yingling, Mr. Ryan, and Mr. Bartlett, in the context of creating a systemic risks regulator, should that regulator review executive compensation practices and submit guidelines to ensure incentives are properly administered? What else, if anything, should this committee consider doing to address this concern? I'd like to hear your thoughts on these.

MR. BARTLETT: On the broad -- not with regard to Citi but on the broad question, one of the items that I think a systemic risk regulator or other regulator could and are looking at, are short-term compensation strategies that reward short-term revenue growth, as I said in my testimony, rather than long-term value the company. I think boards of directors but also other regulators are looking at that, and I think we'll see a lot more of that. I think that's the systemic risk, as opposed to the outrage over somebody's making more money than you think that they should. I think it's a systemic -- there is a systemic risk question that's -- without regard to the politics.

REP. MOORE: Very good. Thank you, Mr. Bartlett.

Others? Yes, sir.

MR. RYAN: I see executive comp as a very complicated issue right now for you, for the public, for us, for -- specifically for directors, that the real responsibility on compensation lies with the directors who have been placed in their job by shareholders, and that's their job.

REP. MOORE: Yes, sir.

MR. YINGLING: Okay. I would commend to you this report by a group called the Institute for International Finance which is the large financial institutions all around the world including the United States, and they have a chapter on executive compensation. And the industry I think is committed to addressing these issues where compensation is just out of line, where the incentives are wrong, and you need to have a longer term perspective so that you don't have incentives, that you can get a lot of money for something that blows up two years later. And I think that's an issue that the industry believes needs to be addressed, and I would suspect that any regulatory agency is also going to want to have discussions with members of the industry on that topic.

REP. MOORE: Any other witnesses care to comment?

MR. SILVERS: Congressman, this was the --

REP. MOORE: Yes, sir.

MR. SILVERS: -- substantial part of my oral testimony earlier this morning. There are two directions in which I think Congress had to look to a solution in this area. I'm not sure what the solution is to people who mislead you, but I can tell you what I think the broader policy solution --

REP. MOORE: Well, I'll talk to you later about that.


MR. SILVERS: The first as was indicated, there's a responsibility with boards of directors here, one, that boards don't carry out when they are dominated by the CEOs themselves. And there needs to be an effective way for long-term investors to influence who's on those boards, and that's the proxy access issue at the Securities and Exchange Commission.

Secondly, with respect specifically to systemic risk and the issues of short-termism and asymmetry, which were identified by the representatives of the industry here, these are matters which at specific large firms, and across the industry as a whole, must be a subject for which the database safety and soundness regulator is aware of and monitors, and which a systemic risk regulator monitors. Finally, I say to you that there is no issue right now, and I'm sure you know this as well as I, there is no issue right now which the general public, working people, or union members are more concerned about, or are more outraged about.

And statements that we can't somehow get the money back just don't cut it.

REP. MOORE: Thank you, sir.

Any other witness care to comment? I thank the witnesses for their testimony. I yield back, Mr. Chairman.

REP. GREEN: Mr. Campbell is now recognized for five minutes.

REP. JOHN CAMPBELL (R-CA): Thank you, Mr. Chairman.

And thank you, panel. Everyone generally is supporting the idea of systemic regulators we discussed, and I'd like to pursue something Mr. Kanjorski talked about, and Dr. Rice -- Dr. Price followed up on is, what does this regulator do? Now, if an entity is deemed to be systemically significant, and thereby either too big or too interconnected to fail, what do we do? Now, Mr. Bartlett suggested I believe that there should be regulation that -- what the powers that this regulator should have would be regulation to keep it from getting too systemically important or too big to fail.

If that's the case, then my question would be how -- who do you apply it to then? If instead we determine that someone is -- or some entity is too big or too interconnected to fail and is systemically important, do we regulate it or do we break it up?

Is this space -- is this -- do we look at this as an antitrust situation -- and this would address some of your concerns, Mr. Wallison -- do we look at this as an antitrust situation and say that there's two types of antitrust now? There is monopolistic antitrust, which we've had in law for decades and decades, and now there is a new type of antitrust, a situation where an entity is so big and so interconnected that it can't fail which means that the government would have to support it, keep it from failing, which means that there is the moral hazard, some of which we're witnessing out there today. And I welcome comments from any of the panel on those two alternatives that I see, or a third one if you see one.

Mr. Silvers, yeah.

MR. SILVERS: The Congressional Oversight Panel in looking at this took the view that we ought definitely not to name systemically significant institutions. And what we ought to do instead is to have a regulatory structure that essentially as you get bigger, as an institution get bigger, it'd become more expensive to be there in our financial system, because you would have to have higher levels of capital, and more expensive essentially deposit insurance, or perhaps other forms of insurance that effectively pay into a systemic risk fund. That approach would not be the approach necessarily using legal action to break up firms, but it would be a potent disincentive properly structured for firms to grow to a level which we then would have no choice but to rescue them, in which we would be faced with the blazing saddles problem, if you know what I mean.


And the -- and that I think is -- that notion in which becoming more likely to be a systemically significant institution is something that's painful is I think the appropriate approach. And we ought to recognize in this respect that we don't really know who is systemically significant until the moment hits, right, that in very good times, very large institutions may not be, and in very bad times, rather small institutions may be.

MR. PLUNKETT: There is a hearing this morning by House Judiciary Subcommittee on this very topic. We're testifying there and while in extreme situations a consumer organization like mine might say, yes, wake them up. The more effective approach is what Mr. Silvers is talking about, which is to use prudential regulation, not antitrust regulation to keep an entity from getting too big to have to deal with that problem.

REP. CAMPBELL: Mr. Bartlett?

MR. BARTLETT: Congressman, I suppose I understand why the discussion keeps so trending over towards identifying specific firms, but let me try to offer some clarity. That's not the goal. It's a set of practice and activities across the markets that is, it's the system that we should focus on. There is no -- at least we don't have a proposal to identify quote "significantly significant firms." That should not be done. It should not be size mattered. It should be related to whether this system or the practices creates a systemic risk. And let me give you a real life example of one that we just went through. Hundreds of thousands of mortgage brokers, not big companies, but hundreds of thousands, had a practice of selling mortgage products not related to whether they were good mortgages or not without the ability to repay.

Thousands of lenders -- 42 percent were regulated banks, 58 percent were unregulated by anyone -- had a practice of originating those loans, and then without -- even though they were systemically a major risk, as it turned out, and then selling them to mortgage-backed securities on Wall Street, who then put them into pools, who then had them insured, that were regulated by 50 state insurance commissioners. So the system itself was the systemic failure. It wasn't anyone of those firms. And so the goal here I think is to identify -- create a regulatory system that can identify those patterns or practices that then can result in a systemic collapse before it happens.

REP. CAMPBELL: Mr. Ryan, and then Mister -- and then Ms. Jorde.

REP. GREEN: We'll hear the answer, and the gentleman's time has expired.

MR. RYAN: Can I?

REP. GREEN: Yes, sir.

MR. RYAN: Thank you very much. Just as to the role -- as we see the role here it's really -- early and prompt warning, prompt corrective action, the regulator, the systemic regulator needs a total picture of all of the interconnected risks. As I've said, this regulator needs to be empowered with information to look over the horizon. We do not do that job well as regulators right now, and it also needs the power to be the tiebreaker, because there are differences of opinion between primary regulators, and if there is a systemic issue, we need someone who can make that determination. Just one last comment here. We're talking about failure of institutions. As Ed Yingling said, we already have a system setup for banks in this country under the FDIC. We had no such system for securities firms. We had no such system -- we have no such system for large insurance companies, and we have no such system for other what I would call potentially systemically important entities. And we need to address that. Thank you.

REP. CAMPBELL: Mr. Chairman, can Ms. Jorde just answer?

REP. GREEN: Your time has expired. I'm sorry. We'll have to get the response in writing. The chair wants us to move along. We will now recognize Mr. Scott for five minutes.

Mr. Scott.

REP. DAVID SCOTT (D-GA): Well, welcome, committee. Let me ask you a couple of questions if I may. If Congress ultimately chooses not to create a systemic regulator, what suggestions would each of you have for improving our current regulatory system?

Mr. Bartlett?

MR. BARTLETT: Congressman, the fastest and easiest one -- well, one, would be for the President's Working Group to either obtain statutory authority, which they do not have, or exert greater executive authority to coordinate the regulation among the various regulators. And then secondly is just to provide some kind of relief on procyclical accounting principles, fair value accounting, which we think is a major contributor to the problem right now.


MR. PLUNKETT: I would say empower prudential regulators to stop these problems before they start through better product level regulation to prevent risk from being created first and foremost.

MR. SILVERS: Congressman --

MS. JORDE: And I would add to expand regulation to cover non- bank financial firms which really have been largely outside of the banking regulatory system, even those subsidiaries of banks that you know were regulated from the banking side, but not the non-bank side.

MR. SILVERS: Congressman, that's covering the shadow markets and giving full jurisdiction to the relevant regulators to regulate those activities, meaning to the extent that shadow markets are really credit granting functions, the bank regulators to the extent that they're really in the securities markets, the securities regulators. That is a critical thing to do here. And secondly, to create a consumer protection agency so that we put an end to giving that function to agencies that don't want to do it.


MR. WALLISON: Congressman, if I can respond, the idea of regulating additional parts of our economy is a simple idea, but one that seems totally worthless. The problem is that we have strong regulation already in the banking area. It has failed. And why it is that when we confront a situation like this the first reaction that so many people have is to extend a system that has failed is beyond me.

MR. PLUNKETT: Congressman, we've heard this several times today. We've heard that we have strong regulation. I just want to correct the record. When it comes to consumer products, we have extremely weak regulations.

MR. WALLISON: Well, yes, we're talking -- I'm talking here not about consumer products regulation.

MR. PLUNKETT: And that creates systemic risk and that's why we need an agency.

(Cross talk)

REP. GREEN: Excuse me, please. Excuse me, please. The gentleman, Mister --

MR. WALLISON: Mr. Wallison.

REP. GREEN: -- Wallison is speaking, and I will have to ask, sir, that you withhold comments until you're requested to speak.

You may continue.

MR. WALLISON: I was responding really to the question of safety and soundness regulation, not consumer products regulation. And on the question of safety and soundness regulation, banking regulation has failed completely. And so we ought not to have a knee-jerk reaction that says well, we have a problem, let's regulate it. We ought to step back and see what is wrong with regulation, why it isn't working. And one of the ideas that I think we ought to look at, at least, is the notion of making sure that we help the private sector to understand the risks that companies are undertaking.

And one of the ways to do that is to assure that companies put out financial information that responds to what the needs of the private sector lenders are. Now, one of the things that analysts can do is to supply the regulators with the kinds of indicators or metrics of risk taking, because that's the thing that isn't causing most of the trouble. And if the private sector were to have that information they could make much better decisions about where to make their --

REP. SCOTT: Okay, and Mr. Wallison, I don't want to interrupt you, but I have a few more minutes, I did want to get two more, and Mr. Plunkett, I know you're itching to get into this fight, so please do. We rely on you.

MR. PLUNKETT: Well, the only thing I'd add is I've heard this now several times, and the flaw in the safety and soundness approach is that the quality of the product wasn't evaluated. It turns out that if you protect consumers, you will better protect safety and soundness, you will better protect the economy. So that's the flaw in looking at this very narrowly in terms of just what is traditionally defined as safety and soundness regulation. And that's why we need an agency that's focused solely on protecting consumers.

REP. SCOTT: Good point.

Mr. Ryan, you may finish.

MR. RYAN: I'm going to take a very different fact. We have the Group of Thirty chaired by Chairman Volcker. We have the chair of the Fed, Mr. Bernanke, and we have the new secretary of the Treasury, and we have a very unique situation here. We have most of the people sitting here who represent the industry asking for something which is really new regulation. That is a good sign that we needed, and I think we need it in a very timely fashion, sir. Thank you.

REP. SCOTT: Thank you very much.

Thank you, Mr. Chairman.

REP. GREEN: Mr. Cleaver is now recognized for five minutes.

REP. EMANUEL CLEAVER II (D-MO): Thank you, Mr. Chairman.

The European Union is presently considering establishing a systemic risk council, the EU Systemic Risk Council, and from all that I have been able to read, it appears as if that is going to be established. Do we find ourselves -- this is for any of you -- do we find ourselves in an awkward spot as a nation if we fail to connect in some kind of way with an international systemic risk operation? Can -- I mean, if Europe, or maybe then there comes an Asian systemic risk council, what happens to us if we are over here in some kind of isolation?

Yeah, Mr. Timothy Ryan.

MR. RYAN: Thank you. That's what my mother calls me sometimes too, Mr. Timothy.


MR. RYAN: We think that there is a need for a strong global coordination. The college approach in Europe is principally a result of an inability of them to agree on one central entity to be the systemic risk regulator for the entire EU or EC. So you have the -- I would say unique authority within the United States to set something up. It would be the first. If done correctly, it would add an awful lot of value, and part of its function would be to coordinate with other groups around the world, whether it's a college or a specific regulator.

MR. WALLISON: One of the reasons, Congressman, I think that the United States is the engine of the world is that we are not subjecting our businesses to excessive regulation. It is clear that the EU wants more regulation, they can have it, and they can have systemic regulation if they want it. But the effect of that is going to reduce economic growth within the EU.

REP. CLEAVER: Why? Why? I mean --

MR. WALLISON: Because --

REP. CLEAVER: I hear people say that all the time.

MR. WALLISON: Because regulation imposes costs, it suppresses innovation, it reduces competition.

REP. CLEAVER: You know all of the --

MR. WALLISON: -- all of the things which make our system work better.

REP. CLEAVER: Excuse me. All the things you just declared -- how do you know that?

MR. WALLISON: Well, one thing --

REP. CLEAVER: It suppresses creativity and all that? I mean, how?

MR. WALLISON: There are lots of academics studies that have shown that costs are increased by regulation and it should -- should be clear that that happens because you have to respond to the regulator, you have to provide a lot of reports. You have to make sure that the regulators are approving what you're doing. All of these things add cost to businesses, which are ultimately imposed on consumers.


Mr. Silvers.

MR. SILVERS: I mean, I really appreciate that this is my friend Peter Wallison's religion, but I think that the facts are that when we had well-regulated financial markets, they channeled capital to productive activity. They were within a reasonable portion of our economy, and they were not over-leveraged, and we did not suffer from financial bubbles. And that when we -- and that describes the period from the New Deal until roughly 1980. And then we started deregulating and the result was financial markets that grew to unsustainable size, excessive leverage in our economy, an inability to invest capital in long-term productive purposes, an inability to solve fundamental economic problems and escalating financial bubbles.

That's the history of our country. When we had thoughtful proportionate financial regulation, it was good for our economy. Now, we are in a position pursuant to your question, right, where we have global financial markets and where a global financial regulatory floor is an absolute necessity if we're going to have a stable global economy. If we choose to be the drag on that process, it's not only going to impair our ability to have a well-functioning global financial system, it will damage the United States' reputation in the world.

This question is immediately before us. And I would submit to you that it's that -- that while systemic risk regulation is important here, underneath that are a series of substantive policy choices which will define whether or not we are serious about real re-regulation of the shadow markets or not. And if we choose to be once again the defender of unregulated, irresponsible financial practices and institutions that the world will not look kindly upon us for doing so, as they did not look kindly upon us for essentially bringing these practices to the fore in the first place.

REP. CLEAVER: Our children won't either. Our children won't look kindly on us either.

Ms. Jorde.

MS. JORDE: I think the point was made earlier that a vast majority of the taxpayer funds that went to AIG were used to make payments to foreign banks, and I don't think anybody here really understands why. Is it because foreign banks have a big stake with our U.S. banks? We really don't know, and I think that at the end of the day we need to get to the bottom of how interconnected is our entire economy, how much are we dependent on those foreign banks, what stake do they have with us.

REP. GREEN: The gentleman's time has expired. Mr. Perlmutter is recognized for five minutes.

MR. : Mr. Ellison -- (off mike.)

REP. GREEN: The chair retracts the statement. Mr. Ellison is recognized for five minutes.


REP. KEITH ELLISON (D-MN): Thank you, Mr. Perlmutter. And let me thank the entire panel, but my first question is to Mr. Bartlett. Mr. Bartlett, particularly given Goldman Sachs and Morgan Stanley are now holding companies, what are your thoughts on the recommendation of the G-30 report on financial reform that strict capital and liquidity requirements be placed on proprietary trading activities?

MR. BARTLETT: I guess I'm not familiar with that exact recommendation.


MR. BARTLETT: I think the G-30 report was by and large -- we don't agree with all of it, it was by and large a step in the right direction. Those two institutions became bank holding companies. As I understand, they have several years with their primary regulator to conform with all of the capital requirements. It is clear that more capital is one of the trends in this, or less leverage, and that's one of the outcomes in becoming a bank holding company.


Mr. Ryan, what are your views on this?

MR. RYAN: Excuse me?

REP. ELLISON: Do you have any reflections --

MR. RYAN: I do have views. I do have views on this. I think this issue of rules applying to specific activities or products within bank holding companies or within systemically important institutions is within the domain of the existing regulator today. So the Fed has authority to deal with this from a bank holding company's standpoint. And under our proposal the systemic regulator, who we think is a more appropriate entity with all of the information, should be making those determinations.

REP. ELLISON: Thank you.

Mr. Wallison, you know that in 1999 I believe legislation was passed in our Congress which exempted credit default swaps from regulation. I mean, do you agree that it is the fact that these derivative instruments were not regulated that has created part of the financial crisis we find ourselves in today?

MR. WALLISON: No, I do not.

REP. ELLISON: Well, let me ask you this question then. You know, mortgage originators who were largely unregulated as, you know, most of the mortgages, what we call subprime predatory mortgages were not originated by banks, but by unregulated mortgage originators. You'd agree that they contributed significantly to the problem, and were unregulated? Do you agree with that?

MR. WALLISON: Well, yes, they --


MR. WALLISON: I agree with the fact that unregulated mortgage originators did originate a lot of mortgages, but the reason they originated a lot of these mortgages is that they had a place to sell them which was Fannie Mae and Freddie Mac.

REP. ELLISON: But do you agree that if they had certain requirements on edge on, you know, continuing the education, bonding, certain standards of behavior, professional standards that we may not be in this situation to the degree we're in it right now?

MR. WALLISON: I think that's entirely possible.

REP. ELLISON: Oh, so you agree that regulation at least in that way is a good thing?

MR. WALLISON: That's consumer product regulation --


MR. WALLISON: -- and yes, I think that in many areas consumers need protection, and that might certainly be one of the areas.

But the point is that they -- all these things were originated because the money was available through Fannie Mae and Freddie Mac.

REP. ELLISON: Reclaiming my time.

Mr. Silvers, is Fannie Mae and Freddie Mac responsible for this financial crisis we're in now?

MR. SILVERS: The way Fannie and Freddie were managed, particularly since 2003, and that date is very important, is a substantial contributing factor. However, a narrative that has been put forward by essentially people who'd have a sort of principled disagreement with regulation that Fannie and Freddie are the primary cause of this problem is completely and utterly wrong, all right?

And specifically, it's completely and utterly wrong because Fannie and Freddie functioned for example, for 10 years almost following the strengthening of the Community Reinvestment Act without bringing on systemic crisis, they began to do what my friend Peter was talking about. When deregulated mortgage markets began to encroach on their market share, and in a context in which credit was available broadly without regard to risk because of policies of the Fed and the Bush administration, and that began in 2003 and that's when you saw the explosion of subprime. Fannie and Freddie were participants in that conduct starting in 2003, but their existence, or the existence of GSEs, the existence of the Community Reinvestment Act are not the -- primarily responsible for this crisis and to assert so is to fundamentally distort the record.

REP. ELLISON: Mr. Bartlett, returning back to you. In a speech that FDIC Chairwoman Bair made recently, she expressed serious concern about the implementation of Basel II internationally. And it might allow for reduction in regulatory capital requirements at the height of a global financial crisis. To address this concern -- I think I'm all done there, Mr. Bartlett.

REP. GREEN: We'll receive a quick answer to the question.


REP. GREEN: Your time is up.

REP. ELLISON: Can I finish the question or --

REP. GREEN: Yes, sir.

REP. ELLISON: Okay. She advocated the application of a global leverage capital requirement which we already have in the United States. Could you express your thoughts on those requirements for banks both in the U.S. and internationally?

MR. BARTLETT: I think both we and our regulators, our government in Basel II is taking a whole new look at Basel II to determine what to do with it going forward. I think the world has changed in the last two years, and so I think we're all just taking a brand-new look at it, including Sheila Bair.

REP. GREEN: The gentleman's time has expired. Mr. Perlmutter is now recognized for five minutes.

REP. ED PERLMUTTER (D-CO): Thank you, Mr. Chairman, and I would note for the record that different regulators such as yourself now in the chair adhere to the five-minute rule, where other regulators, some of the other chairs didn't quite adhere to the five-minute rule.

So I just want to say to the panel, many of you have been here before. The information you're providing today, and the way you've been thinking about this, the way this has been evolving really for all of us over the course of last year, year-and-a-half, I think we're really developing a lot of agreements. And now, Mr. Wallison, as much as I want to debate on a lot of things, I do agree with you on your point about regulation can add to cost and potentially the loss of innovation. But I don't think that's the end of the question, because as we've been here, and have had hearing after hearing on this subject, the banking system, the financial system, in my opinion is a different animal that we have to look at in a different way.

Because as we relieved ourselves of regulations whether it was Glass-Steagall or you know, change mark-to-market, or different kinds of things, people may have been able to make that last buck, but the bottom fell out, so that the taxpayers are paying a ton of money, because this system itself is so critical to how our economy runs and the world's economy runs. I mean we're obviously seeing how interconnected everything is. So I agree with you that's why it's got to be reasonable regulation, and the pendulum always swings to too much, and we've seen too little in my humble opinion and it's costing us a ton of money. So having said that and it may be that I'm just going to give a statement and not ask questions. I generally ask questions, but I want to say -- and is it Ms. Jorde or Jord?

MS. JORDE: Jorde.

REP. PERLMUTTER: Jorde, I think you had -- you made a couple of points that in my opinion are critical to this whole discussion, that is, you know, the product mix what do banks -- what is their trade, what is their business? And has there been too much commerce and banking together so that we have products that get outside of a banking regulator's expertise, and then also the size of the institution.

And Congressman Bartlett and I've had this conversation about the size of the institution, when is -- in my opinion things can get too big, but within this system, in this. So I think we've got to look at the product mix, the regulators got to look at the product mix, got to look at the sizes of the institutions because they can get too big and outstrip whatever insurance we've put out there. And then there is sort of this systemic piece of this which is the group think.

Mr. Plunkett, you talked about where in Colorado in the '80s, the savings loans were not that big, but they all started thinking the same way, they all started doing the same things, and a lot of them got themselves in trouble. Now, if we'd had mark-to-market back then, we'd have lost every bank in Colorado. Thank goodness, we still had at least half of them, so Mr. Yingling's, you know, dead on the mark on the mark-to-market stuff.

Mr. Silvers, your point about the stock options and that all you -- you can go for the gusto (ph) because you have no downside, I really hadn't added that to the whole mix of this, and when it comes to the financial institutions we may have to look at that piece. I think that we do need a super regulator, because there are too many gaps within the system. So whether it's, you know, on top of Mount Olympus, Mr. Yingling as you have described, there are something -- there are too many gaps within the system. We need to have somebody looking at this as a whole. And so all of you have brought a lot of information to us in a very cogent fashion and I appreciate it. I mean, this is what is going to take for us to develop this.

So -- yes, Mr. Ryan.

MR. RYAN: I'd just like to comment on this issue of too large financial institutions.

REP. PERLMUTTER: Go forward.

MR. RYAN: Because I spent a lot of time before this committee when I was a regulator of the OTS and a director of the RTC. And we have large financial institutions for a lot of different reasons. We have them because of consolidation, some of it voluntary, some of it not, some of our largest institutions are really large because we have to resolve small banks, and the small banks became part of -- like a Bank of America, think of it back to NCND. The idea that we should not have large financial institutions will cut into productivity, it will cut into technology --

REP. PERLMUTTER: I understand that and I agree with you.

MR. RYAN: It will make us --

REP. PERLMUTTER: Wait, I agree with you and I think Mr. Wallison is on the same -- it's the same point, just a little different. It will cut into it. It will make it more inefficient, but on the other hand, smaller institutions will compete with one another and it will be so hard for the regulator to figure out everything that's going on within the institution. Even if you had to resolve them all together at some point, you know, they are too big in my humble opinion. But thank you, I appreciate it

REP. GREEN: Gentleman's time has expired.

REP. PERLMUTTER: Yes, sir. Thank you, Mr. Chairman. I'm glad you're keeping watch on the clock.

REP. GREEN: We will now recognize Mr. Grayson for five minutes.

REP. ALAN GRAYSON (D-FL): Thank you, Mr. Chairman.

Gentlemen, if you were interested in increasing lending at a time when the general perception is that credit is in short supply, and that we need to expand credit in order to keep the economy afloat, and you had a choice, and that choice was between bailing out huge institutions that had proven that they were not good at allocating credit by the fact that they lost billions upon billions of dollars, versus providing additional credit or even relaxing reserve requirements for healthy institutions that had shown they could take that money and make a profit with it, which would you choose?

Mr. Silvers?

MR. SILVERS: Well, you know, one of my observations from being on the oversight panel for TARP which I think is sort of what you're getting at, is that what is a healthy institution is a -- can be a puzzling thing. Every recipient, with the exception of AIG, of TARP money has in some respect been designated a healthy institution by the United States government. So perhaps your question is were we just giving money to healthy institutions already. I am not sure that's a very plausible statement, but it is more or less what the record shows. The question of increasing lending I think is complex. There's no question that there is a need for more credit in our economy right now.

On the other hand, the levels of leverage we had in our economy during the last bubble are not -- are not ones we ought to aspire to, to returning to or sustaining. Getting that balance right is extremely important, and further more it is also the case I believe that allowing very, very large institutions to come apart in a chaotic fashion would be very harmful to our economy.

The punch line is that I think that we have not learned enough about to what extent TARP's expenditures have produced the increased supply of credit that your question indicates, and to what extent that is because of I think as you put it, the fact that a majority of that money has gone to a group of very large institutions. Those are questions that I know the oversight panel is interested in and questions that I am very interested in, and I can't tell you what I believe the answer to them to be today.

REP. GRAYSON: Ms. Jorde, should we be helping healthy institutions help us, or should we be bailing out institutions that have a history of failure?

MS. JORDE: Oh, we should be helping healthy institutions help us certainly. I don't think anybody is advocating that we allow large institutions to come apart chaotically. I think that certainly if we start to work toward making these institutions small, I'm not saying we've got to have a hundred thousand community banks with less than $50 million in assets, but we can certainly make these institutions of such size that capital will come back into them from the sidelines. I don't think that investors out there are very anxious to be investing in these systemically risky institutions. And I think going forward we can have a lot of lending start up again if we plan this right.

REP. GRAYSON: Mr. Plunkett, if our goal is simply to expand credit, and give people the credit that they're used to getting and the credit that they need, and to keep the economy as a whole afloat, is it more effective to help healthy institutions expand their lending, or is it more effective to give money to failed banks and see that that money goes directly to having them meet their already overwhelming credit needs internally?

MR. PLUNKETT: Well, I'm going to talk about one aspect of this issue that hasn't been addressed, the need to assure that attempts to spur credit availability, whether through larger institutions or smaller institutions, are offered on a sustainable basis, that the TARP program, the TALF program. We're concerned, particularly with the TALF program, that it may end up subsiding for instance credit card loans with terms and conditions that are not sustainable for consumers. So I think that's an important aspect to the issue that we should think about.

REP. GRAYSON: I'm wondering if there's any way to meet systemic risk threats that does not involve transferring hundreds of billions of dollars from the taxpayers to failed banks?

Mr. Ryan?

MR. RYAN: Do you mind if I answer the question that you posed to everybody else just for a second, then I'll answer this question.

REP. GRAYSON: Sure, that's fine.

MR. RYAN: The key to credit availability for consumers right now is securitization. That market is dormant. That market provided over half of the funding for consumers, and if there's anything we could do right now to move that market back to its vibrancy, that would directly impact consumers. And I think the government could do something. I think they should have used TARP for its original purpose. I think they should have purchased troubled assets most of which would have been mortgages. They could have also restructured those mortgages and re-securitized them, which would have jumpstarted this system.

REP. GRAYSON: Well, fine, but I still would like with the chairman's indulgence an answer to my question, Mr. Ryan.

REP. GREEN: Mr. Grayson, sir, the time has expired. We will have to receive that response in writing.

MR. RYAN: And I'll do that for you.

REP. GREEN: We will now recognize Mr. Himes for minutes.

REP. JIM HIMES (D-CT): Thank you.

And to the panel, thank you, and congratulations; unless my colleagues from Michigan and New York show up, you are done in four minutes.


I have a small question and a large question. The small question is for Mr. Wallison.

Mr. Wallison, I've heard you say a number of occasions today let them fail. I wonder knowing what you know about the millions of contracts -- insurance contracts written by AIG, and of course now that we know who the counterparties were, too many of their CDSes, would you have applied that advice, would you have said simply, let AIG fail?

MR. WALLISON: Yeah, I think the Fed panicked on AIG. They should have let it fail.


MR. WALLISON: Fed panicked because right after Lehman Brothers failed the market froze and the Fed thought at that point that they had to step in and stop a further disintegration of the market by covering AIG. AIG has apparently -- the facts are not very well known, but AIG apparently has some substantial portion of what they had -- what they were committed to do were credit default swaps. Others were other kind of obligations. Most of the newspaper commentary and media commentary has been about the credit default swaps. Now, when an insurance company fails, and you have -- your house is insured by that company, what you have to do is go out and get another insurance company.

You haven't suffered any loss yet until you have that fire or that burglary or whatever it is. So if AIG had failed, the people who were protected by the credit default swaps, the companies that were so protected, would have had to gone out and get other credit default swaps, if they still thought they were at risk on the particular obligations. So that would not have caused any serious problem.

REP. HIMES: Okay, thank you. Let me reclaim my time, because I've actually got a larger question.


REP. HIMES: I appreciate that explanation. My larger question is, with the exception of Mr. Wallison, there's some consensus that we will form and should form a systemic regulator. I get really interested in the question of how do we make sure that that systemic regulator has the flexibility, the ability to range over the financial landscape, the ability to adapt to what we know is a very rapidly evolving industry.

What attributes, what characteristics, what incentives could we put into this systemic regulator to get it to act in a way that regulators don't typically act which is entrepreneurial. Given the limited time, I'd ask if we have time to hear from Mr. Bartlett, Mr. Ryan, and Mr. Yingling, very briefly on that question.

MR. BARTLETT: Congressman, I think you give it a broad mandate, and you make a mandate systemic and not individual firms. I think placing this mandate, or market stability regulator, at the Fed is important, because the Fed has that breadth of institutional knowledge. They count the shipment of corrugated -- or the ordering of corrugated containers. So this would be consistent with the breadth that they look at the economy. I think those two things, a broad mandate, and then putting it into an institution that's big enough.

MR. RYAN: Our view is the -- one of the most important things for this systemic regulator, and you've heard me say this before, is the ability to see over the horizon, which means information. They need information about all interconnected and important systemic institutions so that we can help the system and help the citizens avoid this type of problem in the future. And I don't think this is a cure-all for everything, but it certainly would give us something that does not now exist anyplace in the world. And I think we need it now.

MR. YINGLING: I think your question is very, very important because as you are pointing out there is a tendency in regulatory agencies to fight the previous war. We talk about the Fed being the systemic regulator. There is another option and that is you have a council that is headed by the Fed and whether you use that model, or the Fed, I think this needs to be a different group. It needs to be a smaller group, it needs to be people that are not there to fill out forms, or read forms, or read reports. It has got to be people who are looking out and looking at statistics and going out and talking to people.

And a prime example is somebody that would look at the growth in subprime mortgages in the 327s and 228s and look at that chart and say that's a big fire. And so whether it's in the Fed, or within a committee headed by the Fed, it ought to be a group that that's their role. They don't have a regulatory day-to-day role. Their role is to be entrepreneurial as you're saying.

REP. HIMES: Thank you. I yield back.

REP. GREEN: The gentleman yields back his time. I will now recognize myself for five minutes, and in so doing, let me thank all the witnesses for appearing today. I think your testimony has been most valuable and that will surely help us to come to some conclusions. Let's not talk about a systemic regulator for just a moment, and simply talk about systemic risk, because I think there's been some confusion that's developed. I think Mr. Bartlett, for example, has talked about a methodology by which we can ascertain whether or not systemic risk exists.

And Mr. Bartlett, I think you've been a little bit misunderstood. Now, that may have been by accident, or it may have been by design, but you have been a little bit misunderstood, because some have tried to attribute to your comments the notion that once you do this, you're somehow going to bail out an entity, or you're going to spend government money.

I don't think that's what you're saying. Is it at all what you're saying, sir?

MR. BARTLETT: We Texans listen to each other very carefully.


Mr. Green, you know that -- you have it exactly right, I said exactly the opposite, that is identifying the risk so you can avoid the consequences that we're suffering today.

REP. GREEN: And Mr. Yingling, I think that you too have been a proponent of risk identification without simply saying this entity is the entity that poses the risk, you too have talked about risk identification.

I think, Mr. Silvers, that seems to be your position as well, risk identification, is this correct, as it relates to the two of you? If you have a difference in opinion, kindly extend your hand? Okay, so now given that we've talked about risk identification, let me just ask this, if we do see that a systemic risk exist, is there a belief that we ought to take some action -- that we ought to take some action? My suspicion is that most would say yes, but I'm going to move now to Mister -- and the camera is in my way -- Mr. Wallison, is that correct?

MR. WALLISON: Yes, Wallison.

REP. GREEN: Mr. Wallison, I seem to have concluded that you after having identified systemic risk may not want to take systemic action?

MR. WALLISON: No, on the contrary I don't believe that it's possible to identify systemic risk.

REP. GREEN: But you don't think that it is possible to identify?

MR. WALLISON: No, I don't.

REP. GREEN: With AIG -- well, let's go back to the GSEs. I got the impression that you were the person who came forward, and while I'm not using the specific terminology "systemic risk," you identified them as entities that might provide some risk, significant risk, or considerable risk, is this true?

MR. WALLISON: I thought they could in fact create systemic risk --

(Cross talk)

REP. GREEN: Oh, I --

MR. WALLISON: -- of course, plus they were backed by the government.

REP. GREEN: Well, then let's pursue this, let's pursue this.

MR. WALLISON: A different --

REP. GREEN: If you conclude that an entity can cause systemic risk, as you came forward with your clarion call, then do you not want to see some action taken to prevent that cause from moving forward, from becoming the cause of the systemic risk?

MR. WALLISON: Yes. There --

REP. GREEN: All right. Well, if you conclude that you want, as you did, you came forward, you in fact were a sort of a systemic analyzer, if you will. You performed a systemic analysis in a sense, do you agree?


REP. GREEN: Okay. If you conclude that you want to do something about the GSEs, if they may be the cause of systemic risk, can you not conclude that AIG may have been the cause of systemic risk as well?

MR. WALLISON: Yes, it's entirely possible that AIG could have been a cause of systemic risk.

REP. GREEN: All right. And if you realize that AIG is a cause of -- or maybe a cause of systemic risk, would you not want to prevent AIG from being a systemic risk -- creating a systemic risk, if you will?

MR. WALLISON: If we were sure that any entity is a cause of systemic risk, and large enough to have in effect theoretically on the rest of the economy, yes, of course, we should do it.

REP. GREEN: All right.

MR. WALLISON: The downside of that --

REP. GREEN: Your --

MR. WALLISON: Congressman, the downside of that is --

REP. GREEN: Excuse me, please, I'm reclaiming my time.


REP. GREEN: You're with us then, because that's what I think most people are saying today, if we identify an institution that may pose systemic risk, then we ought to do something about it, which by the way is what the taxpayers are saying too. We all have our opinions, but the taxpayers will probably have the last word. And they want to see institutions for whatever reasons who are -- that are identified as systemic risk, they want to see us do something about that. That's what this is all about.

MR. WALLISON: Yes, I understand. This is your problem. I --

REP. GREEN: I agree. And because it is my problem --

MR. WALLISON: Congress --

REP. GREEN: Hold on just one second.

MR. WALLISON: Congress is required to act.

REP. GREEN: Because you've just said something that's exceedingly important. It is my problem.


REP. GREEN: And because it's my problem, I cannot allow the foxes that have allowed the raid on the henhouse to prevent me from securing the henhouse. It's time for us to secure the henhouse. Now, this is not directed at you, sir. But those foxes that allow the raid on the henhouse, they will have a voice, but what I have to do because it's my problem, is not allow those voices to prevent us from securing the henhouse. Sorry, I had to go back to my bucolic and rustic roots, but I thought it appropriate to make that --

MR. WALLISON: I think you ought to be aware of unintended consequences in particular --

REP. GREEN: And I will be, but I'll have to do it and voice it at another time, because my time has expired.

MR. WALLISON: Thank you.

REP. GREEN: And recognizing that my time has expired, I now have to indicate that some members may have additional questions. And if so, they can submit these questions in writing. And without objection the hearing record will be held open for 30 days such that members may submit written questions to these witnesses and place their responses in the record.

I thank all of you for coming, your commentary has been invaluable. The hearing is adjourned.

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