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Hearing Of The Senate Banking, Housing And Urban Affairs Committee - Improving The Financial Regulatory System

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SEN. DODD: The committee will come to order.

Again I want to welcome my colleagues. Welcome, Mr. Secretary. Pleased to have you before us again, Mr. Secretary, this morning. Welcome to our audience that's here this morning.

And we'll proceed in the following manner. I'll make some opening remarks. I'll ask Senator Shelby, as well, if he'd care to make any opening remarks. And then, in order to move things along, unless any member feels so compelled, I'd like to get right with the secretary for his comments, then get right to the questioning if we can, as well. And so that's the manner in which we'll proceed. But I thank everyone for making it here this morning. Again, Mr. Secretary, thank you for being with us.

This morning, we're going to conduct this hearing on the administration's proposal to modernize the financial regulatory system. And for those of us -- I was there yesterday at the White House to hear the president make his presentation, along with many others. So, good morning, and thank you again for being with us.

I'd like to welcome the secretary who is here to discuss the administration's proposal. Mr. Secretary, we applaud your leadership on a very complex set of issues intended to restore confidence and stability in our financial system. And I, along with my colleagues, look forward to exploring the details of your plan and working with you and our colleagues here and in the other body on this truly historic endeavor.

In my home state of Connecticut and around the nation, working men and women, who did nothing wrong, have watched the economy fall through the floor, taking with it their jobs, in many cases their homes, their life savings and the economic security that has always been the cherished promise of the American middle class. These people -- our constituents across the country, the American taxpayer -- are hurting. They're very angry, and they're worried. And they are wondering who's looking out for them.

I've seen firsthand how hard people work in my state, as I know my colleagues here and you have, too, Mr. Secretary; what they do to support their families and to build financial security for themselves. I've seen, as well as my colleagues have, how devastating this economic crisis has been for them, and I firmly believe that someone should have their backs, as the expression goes.

So as we work together to rebuild and reform the regulatory structures whose failures led us to this crisis, I, along with my colleagues here, will continue to insist that improving consumer protection be a first principle and an urgent priority. I welcome the administration's adoption of this principle, and I'm pleased to see it reflected in the plans that we'll be discussing this morning.

At the center of this effort will be a new independent consumer protection agency to protect Americans from poisonous financial products. This is a very simple, common-sense idea. We don't allow toy manufacturers to sell toys that could hurt our children. We don't allow electronic companies to sell defective appliances. Why should a usurious payday loan be treated any differently than we treat an unsafe toy or a malfunctioning toaster? Why should an unscrupulous leader -- lender, rather -- be allowed to dupe a borrower into a loan the lender knows can't be repaid? There's no excuse for allowing a financial services company to take advantage of American consumers by selling them dangerous financial products. Let's put a cop on the beat, so that the spectacular failure of consumer protection at the root of this mess is never repeated again.

We've been engaged in the examination of just what went wrong in the lead-up to this crisis since February of 2007, when experts and regulators from across the spectrum testified before this very committee that poorly underwritten mortgages would create a tsunami of foreclosures. Those mortgages were securitized and sold around the globe, as a market is supposed to distribute risk. But because for years no one was minding the store, these toxic assets served to amplify risk in our system. Everything associated with these securities -- the credit ratings applied to them, the solvency of the institutions holding them and the creditworthiness of the underlying borrowers -- became suspect. And as the financial system tried to pull back from these securities, it took down some of the country's most venerable institutions, firms that have -- that had survived world wars, great depressions, down for decades and decades, and wiped out over $6 trillion in household wealth since last fall alone.

Stronger consumer protection, I believe, would have stopped this crisis before it started. Consumers were sold subprime and exotic loans they couldn't afford to repay, were frankly cheated. They should have been the canaries in the coal mine. But instead of heeding the warnings of many experts, regulators turned a blind eye, and it was regulatory neglect that allowed the crisis to spread to the point where basic economic security of my constituents and millions more around the country here, including folks who'd never seen or heard of mortgage-backed securities, was threatened by the greed of some bad actors on Wall Street and elsewhere, and the failure of our regulatory system.

To rebuild confidence in our financial system, both here at home and around the world, we must reconstruct our regulatory framework to ensure that our financial institutions are properly capitalized, regulated and supervised. The institutions and products that make up our financial system must act to generate wealth, not destroy it.

In November I announced five principles which would guide the Banking Committee's efforts in the coming weeks and months.

First and foremost, regulators must be focused and empowered, aggressive watchdogs rather than passive enablers of reckless practices.

Secondly, we have to remove the gaps in overlaps in our regulatory structure that have encouraged charter shopping and a race to the bottom in an effort to win over bank and thrift clients.

Third, we must ensure that any part of our financial system that poses a systemic -- wide risk is carefully and sensibly supervised. Affirmed too big to fail is affirmed too big to leave unmonitored.

Fourth, we can't have effective regulation without more transparency. Our economy has suffered from the lack of information about trillion-dollar markets and the migration of risk within them.

And fifth, our actions must help Americans remain prosperous and competitive in the global marketplace.

These principles will guide my consideration of the plan that you bring to our committee this morning, Mr. Secretary. And I believe that we can find common ground in a number of these -- of the areas contained in your proposal.

And I want to thank you again for your leadership on these issues, as well as for your willingness to consider different perspectives in forging this plan. I hope you will view this as a continuation of the dialogue that you've had with members of this committee, both Democrats and Republicans, as we've worked together to shape a regulatory framework that'll serve our nation well through the 21st century.

I want to thank all of my colleagues on this committee as well, by the way, who have demonstrated a strong interest in this issue and are determined to work together. Senator Shelby will obviously give his own opening remarks, but he and I have talked on numerous occasions about how this issue that we will grapple with here as a committee may be the most important thing this committee will have done in the last 60 or 70 years, or the most important thing any one of us are going to do as a member of this committee in the years to come -- getting this right.

I don't sense on this committee any great ideological divide. What I do sense is a determination to figure out what works best, to get it right and to get the job done. So I'm really excited about the opportunity that's being posed by the proposal you've put forward and the work in front of us.

And I want to urge everyone on our committee and elsewhere to remember that at the end of the day, the end of all of this, the success of what we attempt will be measured by its effect on the borrower, on the shareholder, on the investor, the depositor, the consumers and taxpayers seeking not to attain extravagant wealth but simply to grow a small business, pay for college, buy a home and pass on something to their children. That's the American dream, and that's what we're gathered to restore.

And let me just say -- and while it isn't part of my remarks, Secretary -- this morning, when I pick up the morning newspaper and I read the first headline here, that "Fault Lines Emerge as Industry Groups Blast Plan to Create Consumer Agency" -- what planet are you living on? The very people who created the damn mess are the ones now arguing that consumers ought not to be protected.

They're the people who paid this price. And the idea that you're going to first of all attack your very clients and customers, who depend upon you every day, is not the place to begin. And so I am somewhat upset when I see those kind of remarks. We're trying to look for cooperation and building some common ideas.

With that, I turn to Senator Shelby.

SENATOR RICHARD SHELBY (R-AL): Thank you, Mr. Chairman.

I've said, on a number of occasions, that reforming our financial regulatory system may be, as Senator Dodd has indicated, the most significant thing many of us will do while serving in the United States Senate.

We all know how difficult it can be to shepherd even minor bills through the legislative process, let alone anything as significant as financial regulatory reform.

We also know equally well that the opportunity to accomplish something of this magnitude can be fleeting, which presents a bit of a conundrum. We certainly want to strike while the iron is hot. But we also want to make the most of the opportunity that has been presented.

The philosopher William James once said, he who refuses to embrace a unique opportunity loses the prize, as surely as if he has failed. I hope that we do not collectively refuse to embrace these unique opportunities, because here failure I believe is not an option.

The president has put forward his plan. It deserves our careful consideration. That consideration will involve not only an evaluation of his proposed reforms but more importantly a close examination of the facts, upon which he based his recommendation.

The administration's factual predicate can then be compared with the committee's findings, as soon as we complete our examination of the crisis. I've said many times, this committee must first clearly identify what went wrong, before we even begin to consider a response.

It is my hope that we can take advantage of some of the work done, by the secretary and others in the administration. It would helpful if Secretary Geithner could share with Congress any and all documents and information used, in their process, in their recommendation.

As is the case with all legislative efforts, laws are built around consensus. And consensus is achieved when all parties can agree, on either facts or principles. There is one fact upon which, I believe, we've reached a complete agreement. Our financial regulatory system is antiquated and inadequate.

I'm not as confident however that we have reached agreement on what principles should guide our efforts yet. As we begin evaluating the president's plan, I want to highlight the key considerations that I believe should guide our process, as we move forward.

First, notwithstanding the great difficulties we have recently experienced, private markets still provide the best means for achieving our full economic potential. Risk-taking is an essential ingredient in these markets. And while we should improve our ability to manage risk, we cannot simply eliminate risk-taking without sacrificing the foundation of our free market system.

We must also remember that risk is a two-way street. Those who take risk must be prepared to suffer the losses as well as enjoy the gains. Any reforms we adopt must reduce expectations that some firms are simply "too big to fail."

Secondly, we must establish regulatory mandates that are achievable. This is especially true with respect to the regulation of systemic risk. And while there is wide agreement that we have experienced a system-wide event, we have spent very little time discussing the concept of systemic risk, determining how best to regulate it, or even establish whether it can be regulated at all.

Third, I believe that regulators should have clear and manageable responsibilities and be subject to oversight and proper accountability. I'm concerned that we already have a number of regulators do not -- that do not currently meet this criteria, and the administration is contemplating giving them additional responsibilities.

For example, the Federal Reserve already handles monetary policy, bank regulation, holding company regulation, payment systems oversight, international banking regulation, consumer protection and the lender of last resort function. These responsibilities conflict at times, and some receive more attention than others. I do not believe that we can reasonably expect the Fed or any agency -- or any other agency effectively play so many roles.

In addition, the Federal Reserve was provided a unique independent status to assure world markets that monetary policy would be insulated from political influence. The structure of the Federal Reserve involves quasi-public reserve banks that are under the control of boards, with members selected by banks regulated by the Fed.

By design, the board and the reserve banks are not directly accountable to Congress and are easily -- are not easily subject to congressional oversight. Recent events have clearly demonstrated that the structure is not appropriate for a federal banking regulator, yet (sic) alone a systemic regulator.

Finally, while we have a responsibility to identify and repair the weaknesses of our current regulatory structure, we also have a duty to position our regulatory system for the future. Since World War I, we have been the world's financial market of choice.

That is rapidly changing. We must do everything we can to not only ensure the safety and soundness of our financial system, but also its competitive standing in the world.

The president has now added his voice to the debate, and it is now up to us to add ours. As we do, I hope that we will not allow the administration's recommendations to limit the debate that we're about to undertake.

While we have a very difficult task before us, I also believe we have a unique opportunity to do something significant. I urge my colleagues to focus on creating a regulatory system for the next century, not one that merely seeks to remedy the mistakes of the last few years.

Thank you, Mr. Chairman.

SEN. DODD: Thank you very much, Senator.

Mr. Secretary, we welcome you once again before the committee and look forward to your testimony. And by the way, any supporting documents and other materials -- Senator Shelby represented it might be helpful to the committee to see and discuss with you or your staff and others the background material that you used in formulation. This could be helpful as well as we move forward. So I welcome that suggestion by my friend from Alabama.

And with that -- I say that, by the way, all statements of my colleagues, as well, and any data and supporting material they would like to be included in the record of this hearing will be -- we'll just consider that done, as well, as we move forward.

Mr. Secretary, welcome.

SEC. GEITHNER: Mr. Chairman, Ranking Member Shelby, members of the committee, it's a pleasure to be here. I welcome this debate. This is a critically important debate for our country, and I think it's time we get to it.

Over the past two years, our nation has faced the most severe financial crisis since the Great Depression. Our financial system failed to perform its critical functions. The system magnified risk. Some of the largest institutions in the world failed. The resulting damage across -- affected the country as a whole, affecting virtually every American. Millions have lost their jobs and their homes. Hundreds and thousands of small businesses have shut down. Students have deferred college and education. And workers have had to shelve their retirement plans.

American families are making essential changes in response to this crisis. It's our responsibility to do the same -- to make our government work better. And that is why yesterday President Obama unveiled a sweeping set of regulatory reforms to lay the foundation for a safer, more stable financial system, one that can deliver the benefits of market-driven financial innovation even as it guards against the dangers of market-driven excesses.

Every financial crisis of the last generation has sparked some effort at reform, but past efforts have begun too late, often after the will to act has subsided. We cannot let this happen this time. We may disagree about the details, and we will have to work through these issues. But ordinary Americans have suffered too much, trust in our financial system has been too shaken, and our economy was brought too close to the brink for us to let this moment pass.

In crafting our plan, the administration has sought input from all sources. We consulted extensively with members of Congress, regulators, consumer advocates, business leaders, academics and the broader public. And we looked at a range of proposals made by a number of bodies both -- here in the United States over the last several months. We considered a full range of options, and we made the judgment that now was the time to pursue the essential reforms, those that address the core causes of the crisis and those that'll help prevent or contain future crises.

I want to be clear: Our plan does not address, and does not seek to address, every problem in our financial system. That isn't our intent, and we do not propose reforms that, while desirable, would not move us towards achieving those core objectives of creating a more stable system and addressing those vulnerabilities that are critical to our capacity to prevent future crises.

Now, we've laid out the details of our proposals in public, so I just want to spend a few minutes explaining some of the broad principles that guided our proposals. First, if this crisis has taught us anything, it's that risk to our system can come from almost any quarter. We must be able to look in every corner and across the horizon for dangers. And our system was not able to do that.

While many of the firms and markets at the center of the crisis were under some form of federal regulation, that supervision did not prevent the emergence of large concentrations of risk. A patchwork of supervisory responsibility, loopholes that allowed some institutions to shop for the weakest regulator, and the rise of new institutions and instruments that were almost entirely outside the government's supervisory framework left regulators largely blind to emerging dangers.

And regulators were ill equipped to spot system-wide threats, because each was assigned to protect the safety and soundness of individual institutions under their watch. None was assigned to look out for the broader system as a whole.

That's why we propose establishing a Financial Services Oversight Council to bring together the heads of all the major federal financial regulatory agencies, and this council will help ensure that we fill gaps in the regulatory structure where they exist and where they emerge. It will improve coordination of policy and help us resolve disputes across agencies. And, most importantly, it will have the power to gather information from any firm or market to help identify and help the underlying regulatories (sic) respond to emerging risks.

The council will not have the responsibility for supervising the largest, most complex, interconnected institutions. And the reason for that is simple: That is a highly specialized, complicated task. It requires tremendous institutional capacity and organizational accountability.

Nor would a council be an appropriate first responder in a financial emergency. You cannot convene a committee to put out a fire. The Federal Reserve is the best positioned to play that role. It already supervises and regulates bank holding companies, including all major U.S. commercial and investment banks. Our plan is to give it a carefully designed, modest amount of additional authority and clear accountability for the Fed to carry out that mission.

But we also take some important authority and responsibilities away from the Federal Reserve. Specifically, we propose removing from the Federal Reserve and other bank regulators oversight responsibility for consumers. Historically, in those agencies, consumer interests were often perceived to be in conflict with the broader mandate of the institutions to protect safety and soundness.

That brings me to our second key priority: consolidating protection for consumers and ensuring they understand the risks and rewards associated with products -- financial products sold directly to them. Before this crisis, many federal and state regulators had authority to protect consumers, but few viewed it as their primary mission.

As abusive practices spread, particularly in the market for subprime and nontraditional mortgages, our regulatory framework proved inadequate. And this lack of oversight led -- as the chairman said, led millions of Americans to make bad financial decisions that emerged as a core part, a core part, core cause of this crisis. Consumer protection is not just about individuals, but it's also about safeguarding the system as a whole.

Now this committee, the Congress, the administration have already taken important steps to address consumer problems in two key markets, those for credit cards and the beginnings of mortgages, and our view is that those are a sound foundation on which on more comprehensive reform. We proposed the establishment of a Consumer Financial Protection Agency to serve as a primary -- as THE primary federal agency looking out for the interests of consumers of credit, savings, payments and other financial products. This agency will be able to write rules that promote transparency, simplicity and fairness, including standards for standardized simple "plain vanilla" products that have straightforward pricing.

Our third priority is to make sure that reform, while discouraging abuse, encourages financial innovation. The United States remains THE most vibrant -- the world's most vibrant, most flexible economy, in large measure because our financial markets create a continuous flow of new products, services and capital. That makes it easier for the innovator to turn a new idea into a growing company.

Our core challenge, though, is to design a system which has a proper balance between innovation and efficiency, on the one hand, and stability and protection on the other. We did not get that balance right, and that requires substantial reform.

We think the best way to keep the system safe for innovation is to have stronger protections against risk, with stronger capital buffers; to have greater disclosure, so that investors and consumers can make more informed financial decisions; and a system that is better able to evolve as innovation advances and the structure of our financial system changes in the future.

Now I know that some suggest we need to ban or prohibit specific types of financial instruments as too dangerous. And we are proposing to strengthen consumer protections and investment protections and enforcement by, among other things, prohibiting a range of abusive practices, such as paying brokers for pushing consumers into higher- priced loans or penalties for early repayment of mortgages.

In general, however, we do not believe that you can build a system based on -- a more stable system based on an approach of banning, on a periodic basis, individual products, because those risks will simply emerge quickly in new forms. Our approach is to let new products develop, but to bring them into a regulatory framework with the necessary safeguards in place.

Our tradition of innovation in the financial sector has been central to our prosperity as a country. So our reforms are designed to strengthen our markets by restoring confidence and accountability.

Finally, Mr. Chairman, a fourth priority is to address the basic vulnerabilities in our capacity to manage future crises. We came into the current crisis without an adequate set of tools to confront and deal with the potential failures of large, complex financial institutions. That left the government with extremely limited choices when faced with the failure of the largest insurance company in the world and some of the world's largest investment banks.

And that is why, in addition to addressing the root causes of this crisis, putting in place a better framework for crisis prevention in the future, we have to act to give the government better tools to manage future crises.

At the center of this, we propose a new resolution authority modeled on the existing authority, of the FDIC, to manage the failure of weak thrifts and banks. And that will give us more options in the future that we should have had going into this crisis.

This will help reduce moral hazards by allowing the government to resolve failing institutions, in ways that impose costs on owners, creditors and counterparties, making them more vigilant and prudent.

Now, we have to also minimize moral hazards created, by institutions that emerge with a scale and size that could threaten stability. No one should assume that the government of the future will step in, to bail these institutions out, if they fail.

We will do this by making sure financial firms follow the example of families, across the country, and build bigger protections, bigger cushions, bigger safeguards as a precaution against bad times.

We will require all firms to keep more capital and more liquidity on hand, as a greater cushion against future losses and risks. And the biggest, most interconnected firms will be required to keep larger cushions, larger shock absorbers against future shocks.

Now, the critical test of our reforms will be whether we make the system strong enough, to withstand the stress of future recessions, and strong enough to withstand the failure of large institutions, in the future.

These are our basic objectives. We want to make the system safer for failure, safer for innovation. We can't afford inaction, as both the chairman and the ranking member said. I don't think we can afford a situation where we leave in place vulnerabilities that will sow the seeds for future crisis.

So we look forward to working with this committee, in the weeks and months ahead, to put in place a stronger foundation for a more stable financial system, in the future.

Thank you very much, Mr. Chairman.

SEN. DODD: Thank you very much, Mr. Secretary. And I'm -- we have a full complement of members here this morning. And so I'm going to be a bit more disciplined about the five minutes. That way, we can get through the members here that were here. Otherwise if it goes on too long, we don't get a chance to do that.

So the clerk I've instructed to put that clock on. And if members would, be careful to watch it themselves, so we get to include everyone in the questioning this morning.

Let me begin, Mr. Secretary, with a question regarding mortgage protections. I strongly support your notion of a Consumer Financial Protection Agency. I would point out to you, as I know you are aware as well, we gave the authority back in, I think, 1994, with the hope of legislation.

It wasn't a request. It was a mandate that they formulate regulations, to protect against some of the very abuses that led to the mortgage crisis in the country. And so merely designating someone to do a job doesn't always get the job done obviously, as we've learned painfully in all of that.

And what I'd like to know is, while it's not included specifically, and the other body, the House, has dealt with this differently, there's a strong interest on this committee to deal with -- to deal with the mortgage reform provisions in the bill.

And what I want to get from you if I can, at the outset, would you be willing to work with us on including language, as part of this overall reform effort, that would do that as well?

SEC. GEITHNER: Yes. We think that's very important.

SEN. DODD: Well, I appreciate the answer to that.

Let me -- let me go to the issue. And again I want to state, I think, all of us have had a chance to talk about this.

And obviously, the debate about, one, whether or not you want a systemic risk regulator, which I certainly do; and then, the question, who does it and what authorities do you give them.

And from my standpoint, I'm open on the issue. I have -- I haven't made up my own mind what is the best alternative. Obviously, you've submitted a plan that gives that authority to the Fed. But let me raise some questions that have been raised by others about the wisdom of that move to the Fed, and not looking at the more collegial approach of some other alternatives.

A fellow by the name of Mark Williams, who is a professor of finance and economics at Boston University and a former Fed examiner, said the following. He said, give the Fed more responsibility -- "giving the Fed more responsibility at this point --" and he had a rather amusing analogy "-- is like a parent giving his son a bigger ... faster car right after he crashed the family station wagon," end of quote.

SEC former Chairman Richard Breeden testified before this committee, and he said the following: "The Fed is always worried about systemic risk. I remember in '82 and '85 the Fed talking about that it worried about systemic risk. They've been doing that, and still we had a global banking crisis. The problems like the housing bubble, the massive leverage in the banks, the shaky lending practices and sub-prime mortgages, those things weren't hidden. They were in plain sight," end of quote.

And perhaps most significantly, Chairman Volcker, in response to a question by Richard Shelby back in February at a hearing we had in this committee, testified that he had concerns about giving the Fed too many responsibilities that would undermine their ability to conduct monetary policy.

So the question that many are asking -- not just myself, but others on this committee and elsewhere -- is, given the concerns that are expressed by the former chairman of the Federal Reserve, the former chairman of the SEC and others, about the Fed's track record, as well as the multiple responsibilities that the Fed already has, why is it your judgment that the Fed should be given this additional extraordinary authority and power? And does it not conflict in many ways, or could it not conflict with their fundamental responsibility of conducting monetary policy?

SEC. GEITHNER: Mr. Chairman, I agree with you, these are some of the most important issues we're going to have to confront together. And I think that you and many others have expressed a number of thoughtful concerns about not just the role of the Fed going forward, but how to think about the right mix of accountability and authority in these areas. So let me just say a few things in response.

I think you need to start -- we need to start with the recognition that central banks everywhere around the world -- in this country and everywhere else -- were vested with the dual responsibility at the beginning for both monetary policy and some role in systemic financial stability. That's true here; it's true everywhere. And there is no -- I believe, no necessary conflict between those two roles. For example, the Fed's got an exemplary record of keeping inflation low and stable over the last 30 years, even though it had these -- the set of responsibilities you outlined that take it into the areas of financial stability. So I see no conflict.

The second point I would make is the following. If you look at the experience of countries in this financial crisis who have taken away from their central bank, from their equivalent of our Federal Reserve, and given those responsibilities for financial stability, for supervision, for looking across the system, to other agencies, I think they found themselves in a substantially worse position than we did as a country, with in many ways a worse crisis, with more leverage in their banking systems, with less capacity to act when the crisis unfolded, for a simple, basic reason, I think.

If you require a committee to act, if the people that have to act in the crisis -- if the fire department -- has no knowledge of the underlying institutions they may have to lend to in crisis, it's likely to make less good judgements in that context. It may be too tentative to act, or it may act less -- with -- too indiscriminately in a crisis in that context.

So if we look at the experience of many countries and adopt a different model, it is not encouraging. The model where you take those responsibilities away from the central bank -- (inaudible) -- is not an encouraging model, in our judgment. I think you see those countries, if you listen carefully, moving the other direction.

Just a few other quick things in response. Our proposals for the additional authority we're giving the Fed are actually quite modest and build on their existing authority. So for example, the Fed already is the financial -- the holding company supervisor of the major firms in the United States that are banks, that are built around banks. But it was not given in Gramm-Leach-Bliley clear accountability and authority -- was required to defer to the functional supervisors responsible for overseeing the banks and the broker dealers. That's a bad mix of responsibility without authority, but we're proposing just to tighten that up and clarify it so they feel perfectly accountable for exercising that authority.

In the payments area, the Fed has a general responsibility for looking at payment systems, but very limited, weak authority in terms of capital, which is central to our reform proposals and central to any effort to create a more stable system. The Fed has some role today in helping set capital requirements, but that role is very constrained by the requirements of consensus across a very complicated mix of regulatory authorities.

Those are the key areas where we propose giving the Fed modest additional authority and clarify accountability for responsibility. They are not a dramatic increase in powers. We are proposing to take away from the Fed responsibility for writing rules for consumer protection and enforcing those rules. That is a substantial diminishment of authority and preoccupation and distraction. We are also proposing to qualify their capacity to use their emergency powers to lend to an institution they do not supervise in the future, and to require that to exercise that authority, they require the concurrence of the executive branch.

So we propose what we believe is a balanced package over this set of independent regulatory authorities for consumer protection, for market integrity, for resolution authority. We propose establishing a council that will play the necessary coordinating role, that will provide some checks and balances against the risk that those underlying agencies get things wrong; provides the capacity to deal with (gaps, adapt ?) in the future.

So those are some of the reasons. I want to just say one -- one more thing to end.

I don't think there is any regulator or any supervisor in our country -- and I think this is true for all of the other major economies -- that can look at their record and not find things that they did not do well enough.

That's certainly true of the Fed.

On the other hand, if you look at where risks were most acute in our country, where underwriting standards were weakest, where consumer protections were least adequate -- again, where systemic risk that threatened the system was most acute -- those developed largely outside the direct and indirect purview of the Fed. And the Fed was left with no responsibility and no ability to contain those basic risks. And that's an important thing for us to change if we're going to build a stronger system.

SEN. DODD: Well, thank you for that. I only wish that the consumer protection had been more of a distraction at the Fed. And the HOEPA legislation in '94 was certainly an example where they dropped the ball entirely and had that authority.

My time is up, but I -- it is an underlying concern. Anyway, let me turn to Senator Shelby.

SEN. SHELBY: Thank you, Mr. Chairman.

Accountability of the Fed: Mr. Secretary, the Federal Reserve system was not designed to carry out this systemic-risk-oversight mission the administration proposes to give it.

It is not a sole institution run under the direction of a single, ultimately responsible leader. Rather, it's a federal system composed of a central governmental agency, the Board of Governors and 12 regional quasi-public Federal Reserve banks. The board, as you well know, contains seven members. The reserve banks are run by presidents -- you were one -- who are selected by and subject to the oversight of each individual bank's board. Within the system, the board and the reserve banks share responsibility for supervising and regulating certain banks and financial institutions.

With decision-making authority dispersed to the board and reserve banks, who will be accountable to Congress for the systemic-risk- regulation function, as the, quote, "system" cannot appear to testify right here before Congress?

SEC. GEITHNER: Senator Shelby, you are right that the federal -- Federal Reserve structure -- the system that was established by the Congress almost 90 years ago for the Federal Reserve is a complicated mix of different things. You're absolutely right.

And we are suggesting -- we do propose in our recommendations that the Fed take a closely look -- close look in consultation with outspert -- outside experts and the Treasury, and come forward with proposals by, I believe we say, the end of October for how to adapt that basic governance structure to respond to some of the concerns you've raised and we've talked about before. And I think there are things that the Fed should reflect on there that would provide a better balance, reduce the risk of perceived conflicts in these areas.

But this -- I think the short answer to your question is to say the chairman of the board of the Federal Reserve would be accountable, as he is now. And I think in the current framework of the Fed, as designed by the Congress, the responsibilities for supervision, to the extent the Fed has them now, are concentrated at the Board of Governors, overseen by a board of people appointed by the president, confirmed by the Senate. And that board and that chairman would be the one accountable to you.

SEN. SHELBY: Mr. Secretary, the administration's proposal chooses to grant the Fed authority to regulate systemic risk because, quote, "it has the most experience to regulate systemically significant institutions."

I personally believe this represents a grossly inflated view of the Fed's expertise. Presently, the Fed regulates primarily bank holding companies and state banks. As a systemic risk regulator, the Fed would likely have to regulate insurance companies, hedge funds, asset managers, mutual funds and a variety of other financial institutions that it has never supervised before.

Since I believe the Fed lacks much of the expertise it needs to be a -- to have as an effective systemic regulator, why couldn't the responsibility for regulating systemic risk just as easily be given to another or a newly created entity, as some of them have proposed?

SEC. GEITHNER: Excellent question. And let me say a couple things in response.

First is, we did not envision quite that sweeping a scope for authority as you implied in your basic question. Our judgement is, the core institutions at the center of system that require a stronger framework of consolidated supervision and higher capital requirements, at this stage -- we have to go through a careful process to assess this -- at this stage would largely entail the major banks -- investments banks in the country today. Now, there are some exceptions to that.

But we also believe that we want to have a system that's flexible enough in the future, if other institutions emerge, that could present the same kind of risk to the system that we saw emerge from AIG or from Bear Stearns and Lehman Brothers, so we want the system to be able to adapt and bring those institutions under the same basic framework of constraints on leverage that we think are appropriate for those banks at the core of the system that could threaten the stability.

But we do not envision quite as sweeping and broad a net as you suggested in your initial remarks. And that's one reason why we think the natural place for this is the Fed.

Now, the Fed -- again, the Fed has, relative to any other entity in our current system today, much more knowledge about how payment systems works. It is -- because it does execute monetary policy on behalf of the Federal Reserve -- the FOMC, and because it does fund the government on behalf of the Treasury, it has a greater knowledge and feel for broader market developments than is true for any other entity in that context.

These things are all about alternatives and about choices. We don't think it's tenable to give those responsibilities to a committee, for reasons I think you understand, and we do not believe there is another place in the system better able to handle those responsibilities. And we think to create a new institution from scratch would leave us with the risk of losing -- and now we're not having, in a moment of significant challenge -- having the necessary expertise and experience.

SEN. SHELBY: Thank you, Mr.Chairman.

SEN. DODD: Senator Schumer.

SEN. CHARLES SCHUMER (D-NY): Thank you, Mr. Chairman.

And I want to thank you and congratulate you on the blueprint that you've put together, Secretary Geithner, because I do believe it will close most -- many of the most important regulatory gaps in our system. There are few issues where I think the administration should have pushed a bit farther, but this is an excellent framework and charts a clear course to fix the problems that led us to the crisis.

Two places I'd like to just give you a pat on the back.

I agree with Senator Dodd; a financial consumer product safety commission is essential. The Fed failed significantly in this responsibility. So while you got to be leery of starting over, in this case, you have to start over, and a new agency is what's called for.

Second, of less notice but of great importance is the idea that the mortgage issuer and securitizer must hold a piece of the mortgage. That would have stopped Countrywide and others like it in its tracks. It certainly would have greatly lessened the crisis. It might have even avoided it. So that is a great addition, because now they can't issue these junky mortgages and then just not hold them and sell them.

On the systemic risk regulator, we need one; there's no question. And the old way is certainly bad. We can criticize any proposal, but keeping the present system is worse. Every agency had a piece of the system to oversee and protect, but nobody had responsibility to mind the whole store rather than just looking after individual aisles. I agree with Senator Shelby; it's really hard to do.

But tackle it we must, or we risk having the same kind of widespread financial crisis that we've just been going through. You cannot let the perfect be the enemy of the good here, or we end up with less. And believe me, it's hard to do.

Who predicted -- you could probably count on your hands and toes the number of people in financial services, the commentators, the press and government who predicted five years ago that mortgages and this mortgage crisis would bring the whole system down. It's very hard to see around the corner.

And my view -- I tend to agree -- I'm not certain, but I tend to agree that the Fed is the best answer. There are no great ones.

A council? You will -- that's a formula for disaster in something like this. A council -- everyone will pass the buck, and it'll stop nowhere. You must have the buck stop somewhere with systemic risk.

So then maybe you should have a new regulator, just someone new. The problem is, you need deep, deep knowledge of how the financial system works. And a new council is going to be much slower to start. The Fed has that knowledge. You could argue the reason the Fed failed in the past -- and it did -- was because of the attitude of some of the people at the top who were for abject deregulation, rather than the structure. But to me, at least, until shown a better example, I think the Fed, at least tentatively, is the best one.

The question I wanted to ask is you about bank responsibility. For years, everybody has said one of the problems of banking regulation is that it's too divided up. The system allowed banks, most recently and notably, again, Countrywide -- that's been a nemesis to me -- to game the system for the slightest regulation possible. Yet your plan, while consolidating OTS and OCC, leaves significant prudential supervisory authority with the Fed and FDIC. If you count the new consumer watchdog agency, which I'm all for, there would be four bodies involved in bank supervision, the same as we started with, no consolidation.

A multiplicity of regulators tends to produce less oversight overall. The whole is greater than the sum of its parts when it comes to this -- a symphony orchestra or the New York Giants. But with our patchwork system of banking regulators, the whole is less.

So please tell us why you didn't do more consolidation, and particularly, with the Fed gaining these powers, why do they have to be the supervisor of state banks, setting up this duplicit -- duplicity of -- or duplication -- thank you -- duplication of systems, where you have a Fed regulator, the OCC, for the same exact bank, who then shops around to be state chartered. You want to remove another power from the Fed, which is getting a lot. Take it away; don't have them regulate state banks.

Why didn't you consolidate banking -- the banking regulators more?

SEC. GEITHNER: Senator, we thought a lot about that. And I think -- I think nobody would argue, if we were starting from scratch today, that we would replicate the current structure we have of 50 state-level supervisors of banks, one at the federal level -- (proposing ?) one at the federal level. And it's a complicated structure. And I don't think anybody would advocate starting from that, if we were starting from scratch.

But I think it's fair to say, and the basic principle that guided our proposals was, we wanted to make sure we were focusing on those problems that were central causes of this crisis. And we did not want to put you in the position of having to spend a lot of time on changes that may be desirable, may leave us with a neater system, maybe a more efficient system, but were not central to the cause of the problem.

In our judgment, the central source of arbitrage opportunity, the central problems we had were banks who were able to evade stronger standards implied, by one supervisor. In this case, it was the Fed's stronger standards that led Countrywide and others to flip their charter to a thrift. The basic problem we faced was in the thrift charter.

Now, there are thousands of thrifts across the country that are well managed, were very conservative, demonstrated admirable capacity to meet the interests and needs of their community. But in the case of too many, of the celebrated failures that helped magnify this crisis, that arbitrage opportunity was central to the problem.

So if you just look at AIG, Countrywide, WaMu, you've described many of them. You can see examples of that basic problem. So we felt it was necessary to fix that problem. But while it was not essential to take on that more complicated challenge, of fundamentally transforming the rest of the system, where there's a balance now between state and federal supervision of state-chartered banks.

Now, and again if you look at the opportunities that exist now, problems created by the potential to shift from a state charter to a national charter, I think, because there are stronger, more uniform standards in place now, across those banks, those problems, they're material in some cases. But they are of much, much less significance.

So we're making a pragmatic choice to focus on things that were a central cause of the crisis, leaving aside for the moment changes that many would support but we don't think are necessary to do just now.

SEN. DODD: Sorry.

Senator Bennett.

SENATOR BOB BENNETT (R-UT): Thank you very much, Mr. Chairman.

Mr. Secretary, good to see you. And you continue to have interesting days, in the Chinese sense of that term. I don't want to be overly parochial about this, but there's one section of this thing that does affect my state pretty directly. And since I only have five minutes, that's what I'll focus on.

Right now one of the problems we have, in the economy, is that there's not enough credit. We keep hearing, "Well, I can't get a loan. I've got a good deal but I can't get -- I can't get any help."

And in this proposal, you are killing one very major source of credit where there has been no difficulty with respect to the crisis. You said we're trying to deal with those that were essential to the crisis. I'm talking about ILCs. There is not a single ILC that contributed to the crisis. There is not a single ILC that went down. And interestingly, when Lehman Brothers went down, one of the crown jewels of the bankruptcy was, well, at least they've got an ILC that is functioning and that is financially sound.

And you talk about adding a modest amount of increased power to the Fed. In this case, it's not a modest amount of increased power; it's actual -- a destruction of the industry. We're going to cancel the ILC charter, we're going to cancel the industry as a whole.

So my basic question to you is, why does the elimination of ILCs, thrifts and commercial ownerships of banks make the system stronger and safer, when you have a track record, at least with the ILCs, that says that they in fact, by virtue of their ownership, have been stronger than the banks? So you're going to wipe them out as a source of credit, take them out of the marketplace where they're providing niche credit for people that don't otherwise get it. And I'd like you to compare that record with the track record of bank holding companies, if you're going to say where do you have a source of strength.

SEC. GEITHNER: Senator, I agree, this is a -- a very complicated issue, and it is hard to be sure what the right path is here. But let me just try to explain the basic principle that underpinned this basic reform. Institutions that do things like take deposits and make loans, institutions that do things that are basic banking activities -- they transform short-term liabilities into long-term assets -- need to come within a common framework of standards and constraints and oversight. That is the basic principle we established.

If we do not do that, then people -- all the risk in the system will migrate to those parts of the system where you can do similar activities but not be subject to the same basic standards. So our basic principle is a simple one; is that we want to eliminate those gaps and loopholes that allow institutions to evade those basic standards.

Now, again, and we're trying to be careful to take on things that are essential, but that principle, I think, is an essential principle. Now, we may disagree on how best to do that, and we'd be happy to work carefully with you. We want to be careful not to do what you proposed -- what you suggested we're doing, which is to, in either the near term or the long term, diminish the credit-creating capacity of this financial system.

And I don't think our proposal carries that risk. But I understand your concern, and we'd be happy to work with you to make sure that we do this carefully.

SEN. BENNETT: I just want to make the point that the theory is fine. The practice says that this is an area that worked. So the -- one of the first things I notice in the president's proposal is we're going to take an area that worked and we're going to abolish it in the name of trying to make the system that hasn't worked a little bit stronger. I just have a very serious problem with that.

SEC. GEITHNER: Well, as I said, I understand your concern, and we're happy to work with you more -- work with you closely on -- try to address that concern. But again, it is true that the basic opportunity created by our structure, particularly in the area of some thrifts, to evade the stronger protections that exist for other institutions did create and did add to the substantial degree of vulnerability we saw in our system.

So we don't want to leave in place the same type of vulnerability, allow people to shop for a weaker regime with less rigorous standards.

SEN. BENNETT: You're engaged in overkill, in my view, here. I know that the Fed has been after regulation of the ILCs for as long as they've been around. The Fed seems offended somehow that the regulation of ILCs is left to people like Utah and the FDIC. And so, as a matter of principle, the Fed wants to control these. We've always prevented the Fed bureaucracy from getting their hands on these, so now, "Well, if we can't get our hands on them in the normal fashion, we'll just kill them."

So I think the message I want to give and I hope I've given is that we're going to look at this one very, very closely.

SEC. GEITHNER: One of the great virtues of our system is we can't do this without your support and encouragement of this body here, and so we recognize in all these areas where legislation is required we're going to have to work to try to persuade you of the merits of these proposals and take your concerns into consideration.

SEN. BENNETT: Thank you very much.

SEN. DODD: Thank you, Senator, very much.

Senator Akaka?

SEN. DANIEL K. AKAKA (D-HI): Thank you very much, Mr. Chairman.

Mr. Secretary, our current regulatory structure has -- I feel has failed to adequately protect working families from predatory practices. Working families are exploited by high-cost, fringe financial-service providers such as payday lenders and check cashers. Individuals trying to cope with their debt burdens are pushed into inappropriate debt-management plans by disreputable credit counselors or harmed by even debt-settlement agencies.

Mr. Secretary, agencies already have had responsibilities in these areas, but what will be done to ensure that the consumer financial protection agency will be able to effectively protect working families?

SEC. GEITHNER: Senator, that's an excellent question. As you know, we're proposing the following things to try to be responsive to those basic failures in consumer protection.

The first is to create a new agency that would take the existing authority responsibility and the expertise, put it into one place with a single core mission of better protecting consumers from the risks in -- they've been exposed to in the marketing of products, particularly credit products, to consumers. We're going to give that agency new -- we're going to give it exclusive rule-writing authority and primary enforcement authority in one single place of accountability.

We've laid out a set of broad standards and principles built in many ways on the credit-card legislation that moved through this committee and a range of other proposals from the consumer advocates and others that would guide the writing of rules and regulations in these areas.

The basic principles are much stronger disclosure, more simple disclosure, so that consumers understand the risks in the product they're being sold; the creation of an option to elect for a more simple standardized instrument -- standardized mortgage product, for example -- so that, again, you're less vulnerable to the risks of predation in these areas.

And of course, there are some practices that we think fundamentally are untenable and should not be permitted, which we would propose today. And we've laid out some of those broad principles in our paper. But that's the approach we recommend.

SEN. AKAKA: Mr. Secretary, I have concerns about mandatory- arbitration-clause limitations. I believe we share a concern on that, and that it has been harmful to consumers. I've -- I have reintroduced my Taxpayer Abuse Prevention Act. The act is intended to protect Earned Income Tax Credit recipients from predatory refund- anticipation loans and expand access to alternative forms of receiving refunds. This -- the legislation also includes a provision that would prohibit mandatory-arbitration clauses for refund-anticipation loans to ensure that consumers have the ability to take future legal action if necessary.

Please share with the committee why, why the consumer financial protection agency should have the authority to restrict or ban mandatory-arbitration clauses.

SEC. GEITHNER: Senator, I -- I'd ask that you give me a chance to reflect on that more carefully and get back to you in writing with a more thoughtful response. But I -- I'll work with your staff -- you and your staff and try to make sure we understand that risk and see if we can be responsive to that concern.

SEN. AKAKA: Thank you.

Too many Americans, Mr. Secretary, lack basic financial literacy. Without a sufficient understanding of economics and personal finance, individuals cannot appropriately manage their finances, evaluate credit opportunities, successfully invest for long-term financial goals or even cope with difficult financial situations.

One of the root causes of the current economic crisis was that people were steered into mortgage products with costs or risks that they could not afford. Mr. Secretary, the proposal indicates that the consumer financial protection agency will have important financial- education responsibilities.

How will the CFPA interact with the Financial Literacy and Education Commission, and the President's Advisory Council on Financial Literacy?

SEC. GEITHNER: Senator, I just want to agree with you that I think better basic education about economics and finance is a very important thing for us to work to promote. I think it has to happen early in life. It has to happen in what we teach people in schools. Experience is the best teacher. And this experience will be a searing -- this crisis provides a searing set of lessons that'll, I think, change behavior fundamentally.

But I think we can do a better job as a government in trying to support programs that do a better job of promoting financial literacy. And I think the best thing I can say is they're going to work closely together to try to make sure that we're using the taxpayers' money as effectively as possible in support of those programs.

SEN. AKAKA: Mr. Secretary, I appreciate all of your efforts to better protect, educate and empower consumers. I look forward to continuing to work with you, the rest of the administration and the members of the committee to better educate, protect and empower consumers. This issue is so important, because it has tremendous potential to improve the quality of life for our working families.

Mr. Chairman, I also appreciate all of your efforts to protect the consumers. Thank you very much, Mr. Chairman.

SEN. TIM JOHNSON (D-SD): Senator Vitter.

SEN. DAVID VITTER (R-LA): Thank you.

Thank you, Mr. Secretary, for being here.

Mr. Secretary, did Fannie Mae and Freddie Mac, problems there, play a role in the recent financial crisis?

SEC. GEITHNER: Absolutely.

SEN. VITTER: So going back to the fundamental focus you said you all have for this plan to take care of the core problems that we saw over the last year, why are we punting to the future Fannie Mae and Freddie Mac --maybe we'll get around to it next year -- and at the same time regulating areas that were not part of the problem in the last year, as Senator Bennett mentioned?

I mean, to me, at least, it seems like we're ignoring a core problem in the governmental sector and we're regulating areas in the private sector that were not part of the problem in terms of the last year. And that seems very much at odds with what you said was your rationale in focusing on these items and not others.

SEC. GEITHNER: Accepting Senator Bennett's point, as I did, which we'll have to talk -- we'll have to spend some time talking through, I do not believe we're proposing here to try to solve problems that were not problems.

Fannie and Freddie were a core part of what went wrong in our system. The Congress did legislate last year a comprehensive change in their oversight regime. And just to be fair and frank, we did not believe that we could at this time, in this time frame, lay out a sensible set of reforms to guide -- to determine what their future roles should be as we get through this crisis.

We want to do that carefully and well. And we did not think that was necessary to do at this stage, but we -- as we said in the report, we're going to begin a process of looking at broader options, for what their future should be and what should be the future role of those agencies in the housing market in the future. We just didn't think it was essential to do just now, but it is an essential thing to do; couldn't do it carefully enough, thoughtfully, in this time frame.

But as you know, Congress did legislate last year a comprehensive new oversight regime in place over those institutions. If that had been in place before, that might have helped mitigate this crisis.

SEN. VITTER: Well, I'd just underscore the point that if we can consider all of these changes on the private sector carefully and thoughtfully in this time frame -- and I have my doubts about that, but if we can do that in this time frame, I think we can attack the Fannie/Freddie issue in this time frame, as well.

SEC. GEITHNER: And can I just -- I think this is a very important issue, and you're making a -- you're asking a very good question. It is a very different challenge. Our challenge with Fannie and Freddie now -- and this is true about the government's role in the housing market more generally -- is more a challenge for exit, what the future should be. We have to fundamentally rethink what the appropriate role of the government is in the future. We did not get that right. It was not a tenable balance we struck in that situation.

But it's a different challenge now than we faced in putting in place the foundations of a more stable system, a clearer set of rules of the game, stronger consumer protections. It's more about a range of questions we face about how the government gets out of and dials back and reverses these extraordinary interventions we've been forced to undertake to help protect the system from this crisis.

SEN. VITTER: Mr. Secretary, the creation of this tier 1 of institutions, tell me why that isn't a big, flashing neon sign, "Too Big To Fail"?

SEC. GEITHNER: Yeah. We are very worried about this same basic problem; designed this carefully as we could to mitigate that risk, but we haven't eliminated it completely. So let me just say a few things in response to that concern.

Right now, in the United States of America, we have a set of institutions that are of a -- play a role in markets -- probably because of size, but it's not principally because of size; you know, Bear Stearns and Lehman's were not that large -- but play a role where their health and safety is critical to the stability of financial markets. Those institutions need to be subjected to stronger, more conservative constraints and leverage, and we need to have the capacity through resolution authority, like we have for banks and thrifts now, to deal with their prospective failure in the future.

Our judgment is the combination of those two things -- the explicit change in policy now to recognize that those institutions need to be subjected to more conservative constraints on risk-taking, combined with resolution authority to give the government better tools to manage their failure when that happens -- will help mitigate the inherent moral hazard risk in any system that comes from the emergence of large institutions.

Now, one final thing, because this is an important kind of thing -- an important issue. If you look at our system today, we are substantially less concentrated than the banking system of almost -- I think of any major economy in the world -- less so than Canada, less so than most of the countries in Western Europe.

We have thousands of small institutions that play a critical role in creating a more resilient, more stable system. We want to preserve that balance. And by establishing this important change in principle, of higher standards, higher capital requirements on the largest, we will help mitigate the risk, in the future, that we see future consolidation, to a point that would leave us with a more vulnerable system.

SEN. VITTER: Mr. Chairman, I could just ask one more question quickly, a lot of my concerns also go to the role of the Fed and the independence of the Fed. And I would not two huge concerns.

One is that under this plan, to take certain -- use certain expanded powers and emergency steps, the Fed needs approval from Treasury. I think that is a big change, in terms of the independence of the Fed.

I think that's really crossing a line and a sort of fundamental change, in terms of the nature of the Fed. And I just point that out as a big concern because all of a sudden, the Fed is acting more like a department of the government than an independent bank. It's asking Treasury for permission in that circumstance.

Secondly my other big concern is that we're -- we would be very much diluting the focus of the Fed from stable monetary policy. To me, getting monetary policy right is a big job. And to me, it's a crucial job. And I don't think it's any coincidence that when we look at the periods of sustained, robust growth, at least in my lifetime, they coincided with sustained, predictable monetary policy and management.

So I also have a fundamental fear of diverting the attention of the Fed, on what is already a really big job and a really important job. And I know my time has expired.

Thank you, Mr. Chairman.

SEN. JOHNSON: (Off mike.)

SEC. GEITHNER: Mr. Chairman, would it be possible for me to respond briefly, to his two questions at the end? I think these are --

MR. : (Off mike.)

SEC. GEITHNER: Yeah. I know that we're going to spend a lot more time on these issues. But I'd like to respond quickly on these two points.

It is very important to our country and exceptionally important to the executive branch of the United States, and I think to the Congress, that the Fed preserve its independence and its accountability for achieving sustainable growth and price stability over time.

At its inception, the Fed was given this mix of responsibilities, both for price stability and for a range of other responses that stray into the areas of financial stability. It is the lender of last resort for the country.

I don't believe there is any conflict between those two responsibilities. And I think the record of the Fed justifies that judgment. But we want to preserve that.

In part because of that, we're being careful -- (inaudible) -- the Fed is overextended. We are scaling back some of their existing responsibilities, even as we tighten accountability and authority in those core areas.

You were right that to change the way 13(3) now acts -- 13(3) is the provision of the Federal Reserve Act that gives the ability to the Fed in unique and exigent circumstances to lend to an institution it does not supervise -- to require that action require the approval of the secretary of the Treasury is an important change.

But we believe -- and I believe the chairman of the Federal Reserve believes -- that is a(n) appropriate, justifiable change, in part because of the concerns expressed by many of your colleagues, understandably, about the Fed being pulled into doing things that go well beyond the classic responsibilities of the lender of last resort.

And I think it is a very consequential act for the Fed to lend to an institution it has no supervisory relationship over. It creates an enormous risk of moral hazard. And to limit that authority in the future, I think, is a way to help reduce the risk of moral hazard created by the exceptional response that the government's made in this case.

And if the Congress provides resolution authority, it gives us a better ability to deal with the potential failure of large, systemic institutions in the future. Then there'll be less need for the Fed in the future to use that 13(3) authority to lend to institutions that were not under its supervisory mandate.

One final point: We -- the Fed was very careful, and I think appropriately so, when it acted in this crisis, to lend to individual institutions -- I'll just keep this directly about Bear Stearns -- J.P. Morgan in the Bear Stearns context, and about AIG -- in that context. Because the taxpayer would ultimately bear the losses that might come with any of those basic judgments, the Fed required the concurrence in writing of the secretary of the Treasury before it took those actions. I think that was an appropriate step then, because ultimately this was the taxpayers' money at risk, and ultimately it was the taxpayers' burden if the government fails to get this balance of moral hazard and safeguards right.

So I think those are some of the reasons why I think this is a(n) important step. But I agree with you it's a consequential step.

SEN. JOHNSON: Senator Warner.

SEN. MARK R. WARNER (D-VA): Thank you, Mr. Chairman. And thank you, Mr. Secretary.

I, too, have some concerns about the administration's proposals. But let me perhaps acknowledge at least a marker here. I think there was a piece that Steve Pearlstein wrote in The Washington Post recently that if somebody would have said nine months ago, six months ago or even three months ago that we'd be sitting, near the end of June, with the stock market up almost 30 percent, with banks trying to repay some of their TARP funds, and some stabilization in the housing market, I think almost any economist or any market maker would have said that was perhaps a too-optimistic prediction. So while we have concerns overall, directionally I think we're headed in the right direction.

And I commend your leadership -- although I would ask -- and I know under Senator Reid's leadership he's raised this issue as well -- we still have great concerns about what we're going to do with the warrants as these banks go through a repayment process, and that we need a -- an overall policy there.

I also want to echo what Chairman Dodd and Senator Shelby have said. I think we realize the responsibility that we've got to get it right; that if we mess this up, the unintended consequences to not only our economic recovery but the overall long-term financial stability for the world is really at stake. So I hope with that caveat, I can then issue some of my concerns.

I share a lot of my colleagues' concerns about this expansion of authority within the Fed. I also share some concerns that putting restrictions on the 13(3) powers of the Fed could potentially further politicize. I've made statements already that I actually believe systemic risk ought to be put in a council that would include the Fed, that would include the Treasury secretary, that will include the prudential regulators, including the SEC, with an independent chair and a staff, that would be solely focused on systemic risk evaluation and have the power -- ability and a power to act. I don't believe it would have to be a debating society.

And I actually believe that the council, advisory council that you've set up, unfortunately -- because it has the ability to gather information but does not have the ability to act in any way -- that it is really emasculated and it will not provide the kind of non-siloed approach that I think we're looking for. I think systemic risk by its very nature is not something you can predict ahead of time and that the bias out of the Fed will be too much financial institution as opposed to securities concerns, insurance concerns or others. So I look forward to that conversation.

But I want to come to -- happy to address those issues, but I -- have you address those issues, but I'd also like you to explore a little more on the resolution authority. I concur with you that an expanded resolution authority for financial institutions inside the FDIC may make some sense. I am concerned about how we fund that. I am concerned about additional fees placed on community or local banks to, in effect, take care of the potential failure of a Citibank. I am also concerned that if we fully fund that on the front end, though, with these major institutions, that that pot of money could be too tempting for diversion for other purposes.

I'm also concerned about a resolution authority funding costs for nonfinancial institutions that then might be allocated against the banking industry.

So if you could spend a little more time -- and I think your paper acknowledged there were still questions to be answered in this area. But (you're ?) happy to take on my -- attack my approach on systemic risk council, but I'd also love to hear your -- some additional thoughts on resolution authority and how we fund it.

SEC. GEITHNER: Excellent questions. And we have not claimed to get the details perfectly right on this, and it's going to require a substantial amount of additional effort and care to get the balance right.

Let me start with the resolution authority first. Again, we're proposing a model that takes a structure that works well, we've had lots of experience with, and simply adapt it to this somewhat more complicated challenge of large institutions built around banks but are not only banks in some sense.

As our funding mechanism, we're proposing no ex ante fund, no ex ante fee to fund a fund. What we're proposing is a mechanism whereby, in the event the government were to act under this authority and were to incur a loss as part of that action, then it would be able to recoup that loss -- have the obligation to recoup that loss by assessing a fee over time in the future, applied to bank holding companies. That will help make sure that the burden for that is borne by bank holding companies, not by the 8,000 other financial institutions in the United States that are not -- smaller community banks, in that case, that were not responsible for that error.

The scope of this authority would be limited to bank holding companies and institutions we designate as these tier 1 financial holding companies. We expect those to be principally -- at least, this is as we see the system today -- built around institutions that have banks as part of their structure. And we think that's a better model than the alternatives. And we've been careful, again, not to create something to be unfair in the burden proposed and limit the moral hazard created by the existence of authority like that.

SEN. WARNER: Let me -- and I know my time has expired, but let me just -- much more on this. But that would still require, though, the public to step in with taxpayer funds as, in effect, a short-term bridge, until you can assess that, and I would -- assess that additional fee. I might simply add, amongst those tier 1 financial institutions -- and there are clearly questions about designating those tier 1 financial institutions which other colleagues have raised -- I wonder if there might not be some, in effect, contingent liability that they could hold on their books, rather than the public funding this in the interim and then coming back. And if they had that contingent liability on their books that they could keep as their additional equity, that also might help them self-police better amongst their colleagues.

SEC. GEITHNER: We actually did spend a fair amount of time thinking through an idea like that, and it may be that something like that would be feasible as part of this, but we did not see a way to design that that would provide quite the same practical solution to this problem. But it's an interesting idea, and I'd be happy to talk to you about that further.

I want to come back on the counsel thing, but we'll have a chance to come back on it.

SEN. JOHNSON: Senator Bunning.

SEN. JIM BUNNING (R-KY): Thank you, Mr. Chairman.

I was glad to see last month, Secretary Geithner, that in an interview with Charlie Rose, that loose money policy was one of the primary causes of the mess we are in. That's a quote from you. So tell me which part of the plan reins in the Fed's loose money policies.

SEC. GEITHNER: Our plan does not address a range of other causes of this crisis, including policies pursued around the world that helped produce a long period of very low interest rates and a very, very substantial boom in asset prices, housing prices, not just in this country but in countries around the world.

And I think you're right to underscore the basic fact that a lot of things contributed to this crisis. It wasn't just failures in supervision and regulation.

And as part of what the world does, major countries around the world, in trying to reduce the risk we have a crisis like this in the future, it'll require thinking better through how to avoid the risk that monetary macroeconomic policies contribute to future booms in asset prices and credit bubbles of this magnitude.

SEN. BUNNING: Your plan puts a lot of faith in the Federal Reserve's ability to spot risk and exercise its power to prevent the next crisis. However, if the Fed and other regulators had been doing their jobs and paying attention to what the banks and other firms were doing earlier this decade, they almost certainly could have prevented the mess. And the Fed has proven it's unwilling to use its power it has.

Let me give you an example. Just look how slow it addressed the credit card abuses. And it took 14 years for the Fed to write one regulation on mortgages, after we gave them the power to do that.

So giving them the power and making them act are two different things. What makes you think that the Fed will do better this time around?

SEC. GEITHNER: Well, Senator, as you know, we are proposing -- and partly for the reasons you said -- to take both rule writing and enforcement authority for the protection of consumers, particularly in the credit product area, and give it to a new agency with sole accountability, responsibility. Now that will not ensure that that agency acquits itself perfectly over time, but we think that's a necessary step.

Now on your first point about the capacity of any institution, much less the Fed, to predict and anticipate and preempt any future financial crisis, let me just say a basic view that I have about this stuff. I think we need to be realistic in recognizing that it will be very hard, perhaps impossible, for any authority, any individual to anticipate and preempt all potential sources of future risk. And I don't think we can design a system that's premised on the ability of any institution to carry that out effectively.

I think the real important thing to do, though, is to make sure we establish much stronger cushions in the system, shock absorbers in terms of capital and liquidity, better capacity to absorb losses, withstand shocks, so that we are better positioned to deal with potential sources of risk wherever they emerge.

And they will emerge. In a market economy, they will emerge. I think that is the only real effective defense, but necessary defense. And I think the critical failure of policy in this country and many countries around the world in coming into this was not to establish up front more conservative constraints on leverage in good times so the system was better positioned to deal with failure wherever it was going to happen.

SEN. BUNNING: Do you believe these financial reforms need to be bipartisan?


SEN. BUNNING: Then why did the administration provide detailed briefing to the entire democratic side of this committee on Tuesday before the plan was released, but refuse to do the same for all Republicans till after the plan was released?

SEC. GEITHNER: Senator, I -- I'll state personally what I did. I did personally host a meeting and invite members, both sides of the aisle, to the Treasury several weeks ago to talk through broad elements of strategy. We've been careful to do that, and we'll try to be careful going forward, careful to do it a balanced way, both sides of the aisle, going forward.

SEN. BUNNING: But this -- I'm speaking about this week on Tuesday.

SEC. GEITHNER: Well, as I said, I have been careful to try to make sure we're consulting broadly both sides of the aisle, and I will do so going forward.

SEN. BUNNING: My last question has something to do with TARP, because the TARP law allows you, as the secretary of the Treasury, to extend from the end of this year until next October. I think that's a terrible mistake we made, but I also thought that the entire TARP program was wrong. Yes or no, are you going to use the power to extend your TARP authority past December 31st of this year?

SEC. GEITHNER: Haven't made that judgment yet. And I don't think we're in a position today to make that judgment. As Senator Warner said, you know, there is some important signs of stability, some important signs of healing in the financial sector, but I think it's still early let, premature to make that judgment.

SEN. BUNNING: Then you think that the Treasury should have a slush fund of $700 billion under their control, which is what TARP is? Because if you (don't ?) go above $700 billion, you can use all the money for other purposes.

SEC. GEITHNER: Senator, I think what Congress designed in the fall of 2008 gave the executive branch an important set of authorities for trying to respond to the worst financial crisis in generations. I think they did a good job in designing that authority. We're being very careful to use it well.

I want to point out that $70 billion of capital invested by my predecessor has now come back into the Treasury. Equivalent amount of common equity has now been raised by our major banks.

And we have not provided any capital to any large institution, with one exception. In this case, the substantial problem we inherited, in AIG, since the administration came in office.

So we have been very careful to use those funds prudently, to protect the taxpayer. And we will be going forward. But on the other hand, we're still in the midst of a very challenging recession, on a global scale. And there are a lot of risks ahead still. And we want to be careful and prudent and not prematurely declaring victory and depriving ourselves of the capacity to respond, if this were to intensify again.

SEN. BUNNING: Thank you.

SEN. JOHNSON: Senator Tester.

SEN. JON TESTER (D-MT): Thank you, Mr. Chairman.

And I want to thank you, Secretary Geithner, for being here today. I also want to thank you very, very much for putting forth an initiative that we can start this debate on a real basis.

That being said, there was a question asked by Senator Schumer about starting over. And you said you didn't want to start over from scratch. When we have a crisis like we've had, your own words: the biggest since the Great Depression. Why not start with a framework that really will be the kind of framework we need, going into the 21st century and beyond?

SEC. GEITHNER: I think -- I think, Senator, this framework will meet that test. I mean, it's designed to make sure we're looking forward, not just solving the core problems of this crisis. We're trying to design a framework that has that capacity, that's flexible in the future. And we made the judgment that, you know, we're proposing, we're proposing for your consideration.

We made the judgment that much more substantial change, as to force much more consolidation in our oversight structure, although it has much appeal, is not necessary. It wouldn't necessarily provide substantial return, in addressing the core vulnerabilities in our system.

SEN. TESTER: I look at this from the outside because I'm not from the banking industry or the insurance industry or any part of either one of them. But I can tell you, some of the concerns brought up by the chairman and the ranking member, about gaps and overlap; I still have the concerns with this proposal.

And I commend you for the combination of the OTS and OCC. I'll give you another one that I think could and should be combined. And I want to know, why not, if just for turf? And that's SEC and CFTC.

SEC. GEITHNER: Excellent question. The Congress has considered many times, in the past, proposals for merging both entities. There is a simple, compelling rationale for doing that.

What we're proposing though is to begin by bringing the underlying statutes, which are very substantially different, even for products that have very similar attributes, to bring those underlying statutes more into conformity.

We think that helps solve most of the substantive problems that exist, by have separate regulation of securities and futures. It won't solve all those problems. But it is a necessary step towards any effort to merge anyway.

And so we think that's a good place to -- good challenge to take on right now.

SEN. TESTER: So do you anticipate, in the future, having a recommendation to merge those two agencies?

SEC. GEITHNER: I don't anticipate that now. But I -- that's something that, again, the Congress has considered many times in the past, and I would expect it to be part of what Congress would reflect on now.

SEN. TESTER: With some leadership from your office?

SEC. GEITHNER: With appropriate leadership, suggestions, help, persuasion, analysis from our office.

SEN. TESTER: Thank you.

Accountability. I think it is absolutely critical. It's been brought up here with many of the questions that have been brought up with my fellow senators here. I think -- and correct me, and I hope you can -- I think there are still gaps in accountability -- holding people's feet to the fire that are there to do their job that, quite frankly, are either pushing it off on somebody else because we have a patchwork system or buffaloing somebody because they aren't doing their job.

Can you tell me how this plan improves accountability to a point where we can reinstate consumer confidence in the marketplace that they're being protected?

SEC. GEITHNER: We are trying to do two difficult things. One is to make sure there is much clearer accountability matched with authority in the areas that are critical to building a more stable, stronger system. And those areas are market integrity and investor protection; combined responsibility now with the CFTC/FTC; consumer protection; supervision of banks; resolution authority; and the ability to deal with systemic threats to the system, which we're investing -- proposing to invest more clearly with the Fed.

That will not close all gaps in the system, but those are the core functional responsibilities of policy in any financial system.

Now, to make sure that we take an integrated look at the system as a whole, to make sure the system has the capacity to evolve in the future, we're going to establish this council with a mandate to play that basic role. And the council will have the ability and the obligation to make recommendations or changes by the underlying functional supervisors where there are gaps and problems, boundaries, conflicts overlap in that context.

Now, Senator, it is not -- we're not proposing an elegant, neat structure. We are not proposing to put together all those functions -- I would just say in part because, if you look at other countries that have done that, I do not believe you can show sufficient improvement in outcomes, in building a more stable system.

Many of the countries that adopted a much more streamlined, simplified regulatory system still got themselves in the position where their banking system grew to a point where it was much, much larger relative to the economy than happened in the United States. You know, our banks are roughly one times GDP now, even with the investment banks now as bank holding companies. In many of the major economies in Europe, banking systems got to be -- the point where they were two, three, four, five, eight times GDP, in Switzerland -- even with neat consolidation, more elegant-appearing, simple accountability.

So the core thing to making the systems more stable is getting the rules better, smarter, to induce thicker cushions, better shock absorbers, better able to withstand risk.

SEN. TESTER: My time is up. I look forward to working with you on these issues as we go forward. I'm not sure that the accountability is there for actually getting rough with folks. But I appreciate -- and I mean this -- I appreciate you bringing forth an initiative that we can sit down and have an honest discussion about how to move this forward. Thank you very much.

SEN. : Senator Johanns.

SEN. MIKE JOHANNS (R-NE): Mr. Chairman, thank you.

And Mr. Secretary, thanks for being here today. Your proposal, I do think, gives us some things to consider and debate. And I think your testimony has been very, very thoughtful. But I, like my -- so many of my colleagues do have some concerns.

And let me, if I could, start with some comments that my colleague Senator Warner made about the economy. Certainly cannot dispute the fact that the market is better. We can look at some other things. Certainly is painful for all of us to see unemployment going up. Doesn't show any signs of subsiding at the moment. That hurts real people. We're on this just historic spending spree that I think just grows exponentially.

You were in China recently. I've worked with China as a Cabinet member. I remember the many times China, when I wanted to talk about them opening their market to beef, they wanted to remind me of how much debt they had bought the week before. I think that puts us in a very precarious position.

To use very inartful terminology, I really worry today that what we're seeing is kind of a dead-cat bounce, where all we are doing is pushing so much borrowed liquidity into our marketplace that we're just setting ourselves up for the next cliff. So I wanted to say that, because I think our debt, our spending, our taxing, all of that is a very, very troublesome trend, especially as we're starting to think about a whole new initiative to spend over a trillion dollars, the health care initiative.

Let me focus in on your proposal. The issue with the Fed, I think, is really a fundamental issue. And I can argue it from a lot of different directions about how uncomfortable I am to see the Fed get in the middle of this.

On one hand, I must admit, although some of my colleagues on this side of the aisle would probably argue with me, the independence of the Fed has served us well over time. I really believe that. I've watched presidents avoid criticizing the Fed as interest rates went up and this and that. So that independence, I think, is a good thing.

The more we entangle them in managing systematic risk or overseeing systematic risk, et cetera, the more we're going to be tempted -- maybe not us so much, but the next generation, next generation of Congress -- the more temptation is going to be to demand that oversight, and justifiably so, I might add, then, all of a sudden, the independence, I believe, starts to go away.

I'd like to hear your thoughts on that issue, and then I would also like your thoughts on page three of your proposal. You talk about the Financial Services Oversight Council dealing with identifying emerging systemic risk, and then the new authority of the Federal Reserve.

Was it your attempt there to try to blend maybe the idea of this collegial oversight of systemic risk with the Federal Reserve actually being a regulator here? Talk us through that, because I find that to be an interesting concept, actually.

SEC. GEITHNER: Senator, let me just begin by saying you're right to underscore the risk we still face in the economy going forward. You know, what we've achieved is some stabilization; output in demand no longer falling at the same pace it was at the end of last year. That's an important beginning, but it's just a beginning; substantial risks ahead.

And I think you're absolutely right that a critical part of getting recovery in place is going to be to convince the American people and investors around the world that we're going to have the will, working with the Congress, to bring those deficits down over time.

But remember, we started with deficits in the range of 10 percent of GDP when the administration came in office because of both the cost of the crisis and the impact of policies put in place the last eight years. And the additions we've made, we've proposed with the Congress, to get us out of recession were modest increments to those deficits. And we believe they were necessary to avoid the risk of a deeper recession and even higher future deficits. But I understand those concerns and we share those concerns. It'll be absolutely critical to our fiscal position down to a sustainable position once we get recovery back on track.

In terms of the Fed, I think I just would say it this way. We are very committed and it is very important that we preserve the independence of the Fed and its basic credibility over its responsibilities for monetary policy. And we would not recommend proposals that would limit that -- put that at risk in some sense, because that is important to any effort to build a well-functioning economy in the future. If we lose that credibility, that would be very damaging. So I share that concern very much.

And we've been very careful not to create risk. In fact, as I said, some of the proposals we're making to scale back and limit are designed to reduce the risk that, in carrying out its core financial stability functions, we don't put it in the position where it would risk greater tensions with that core mandate for price stability and sustainable growth in the future.

You're right, and the council does try to strike a balance. The council does bring together at one place, around one table, with clear responsibility for looking at the system as a whole. Each of these underpinning parts of the system we're preserving do have responsibility for things that could cause systemic damage. That's an important check and balance in some sense on the scope of independence, without confusing accountability. It doesn't change their statutory framework. It doesn't qualify their authority in that context, but it does give -- provide the ability to recommend and induce changes if they're behind the curve where their big gaps are not closing. So we're trying to get that balance right.

I agree, some people say it's too weak. But we did not believe we could give the council the authority and the accountability for doing poor supervision, for example, of large institutions or for responding to crises, given the speed with which they had evolved.

SEN. JOHANNS: Mr. Chairman, thank you very much.

And again, Mr. Secretary, thanks for giving us this starting point here.

SEN. : Senator Menendez.

SEN. ROBERT MENENDEZ (D-NJ): Thank you, Mr. Chairman.

Mr. Secretary, thank you for your service, and particularly in incredibly challenging times. You know, I've heard some of the criticisms already leveled, and while I don't agree with every element, I think it's a good -- a great foundation, actually.

But I think it takes a pretty short memory to ignore what got us into this crisis and dismiss the need for accountability. That's basically like saying, "Let's do this all over in 10 years again." And I don't think the American people want to go down that road. So I appreciate the effort here.

You know, throughout these hearings, I've asked a fundamental question. At least for me it's a fundamental question. If we have institutions that are too big to fail, have we not failed already? Because they create systemic risk, and they also lead for potentially bad decisions along the way because they know that they will ultimately be bailed out.

So I saw the road that you traveled here in trying to, I think, deal with that question with reference to increased capital requirements. But is that really sufficient to get to the heart of that question? And, you know, I understand bringing up those capital requirements now, but how is it going to be a continuing function so that we ensure that if that's one of our major vehicles, to avoid too big to fail, that it will be a constant movement that will ensure us that that is a break on that possibility?

SEC. GEITHNER: Senator, again, this is a critical issue. Again, I think the acid test or the critical test of credibility of any system is, is it strong enough to withstand the pressures that could come with a failure of a large institution? Because if you don't build a system strong enough to withstand those pressures, then the government will be forced over time in future crises to intervene to prevent their failure, and that will create the risk of greater crises in the future. So that is critical to the objective of what we're trying to achieve.

I believe the best way to do that, and the really only effective way to do that, is, again, to make sure there are tougher constraints on leverage and risk-taking in the future, applied not just to every institution that is a bank, takes those kind of risks, but to the largest in particular; that the core markets where institutions come together to transact also have thicker safeguards, thicker cushions, to prevent the contagion that can be caused by default of a major institution, and to have better tools for managing an orderly failure of a large institution through resolution authority.

I think those mixes -- that mix of proposals, I think, represents the best hope of limiting the moral-hazard risk that comes from any modern financial system where you can have some institutions whose role in markets, by definition, is so important that if they get in trouble, it's going to risk undermining the broader health of the economy as a whole. So I think that's the best mix.

A lot of thoughtful people have ideas in this area. We'll be open to ideas, and we'll look at whatever we think the best balance of proposals are to deal with that challenge.

SEN. MENENDEZ: Well, you know, one of the things you proposed, and some of my colleagues have already raised, is the oversight council. And I think that has a valuable function in watching for developments that pose risks to the banking system and better coordinating the regulators. My concern, again, is that it's basically advisory and it has no power to carry out corrective actions that will be needed in response to the council's own findings.

So give me a sense of how do you envision -- so the council comes up with a series of findings that say, "Hey, this poses risk."

What happens if a(n) individual regulatory agency disagrees? What happens when, in fact, the council's conclusion that a particular product or activity poses a risk to the financial system -- how is the corrective action going to be, you know, both considered and acted upon, if it's only advisory at the end of the day?

MR. GEITHNER: You're right. That goes to the core of the basic judgment we're making. We're giving the council the power to collect information, the responsibility to look across the system and the power to recommend changes, but not the power to compel or force changes, because that would fundamentally change and qualify the underlying statutory responsibilities of those agencies. And I think that would create the risk of more confusion and less accountability, frankly.

But, you know, that's a difficult balance to get. I'm not sure we got the balance perfect, but I think that to invest in a committee responsibility to force those kind of changes would, I think, lead to more diffusion of accountability and more uncertainty.

SEN. MENENDEZ: But, you know, you gave -- under your proposal, you give the Federal Reserve significantly -- for example, significantly more authority, yet, you know, the reality is they had knowledge and authority to address the mortgage problem long before it became a crisis, and they didn't act. And so, in my mind, you know, how is it that we ensure that at the end of the day, the regulators do their job? Because, you know, from my perspective, they were asleep at the sweet -- the switch instead of being the cop on the beat. So how do we ensure that in this --

MR. GEITHNER: Well, I think, you know, that's an important responsibility of the Congress. This council does bring them together. It does have to provide reports to the Congress. Its recommendations will be public. That gives you a little more reinforcement in carrying out that oversight responsibility. And I think that's worth doing.

Will it -- it will not -- I cannot tell you that -- stand here today and say it will prevent all regulatory failures in the future. And there may be issues in the future where we fail to adapt quickly enough. But it is a better -- substantially better structure than we have today, and I think it's a better balance of authority and accountability than in an alternative model that would give a council the ability to override, qualify, change fundamentally the existing statutory responsibilities of those agencies. I think that would be confusing, confusing to the markets, and it would lead to more of this going on.

SEN. MENENDEZ: All right. Mr. Chairman, I know my time is up. I look forward to working -- I have some suggestions and I look forward to working with you, as in before. Thank you.

SEN. : Senator Martinez.

SENATOR MEL MARTINEZ (R-FL): Thank you, Mr. Chairman.

Secretary, thank you for being here and thank you for the hard work you've been undertaking in the many months you've been on the job.

I have a question about this whole notion of systemic risk. In the past, we saw the government-sponsored enterprises, that they, in fact, had an implicit -- which became explicit -- government guarantee. By doing so, they were able to borrow at cheaper rates. As they borrowed cheaper than the private sector, they essentially squeezed out competition, grew larger. As they grew larger, their risk to the economy become systemic. They grew yet larger; competition went further away. And they are, as we've discussed here earlier already, a key component of what went wrong with our system.

How do we not come right back into this in a broader sector of the economy -- this was just securitized mortgages -- but doing the same thing now in insurance, in other financial services, et cetera, by creating a group of entities that are too big to fail, therefore having an implied guarantee from the government, therefore being able to borrow cheaper money?

MR. GEITHNER: Excellent question, and a core concern that shaped our recommendations. Just to go back to where you started, in the GSEs, remember, these institutions were allowed to operate with this implicit guarantee, as you said, lower borrowing costs, take on a huge amount of leverage. They were not subjected to remotely conservative -- sufficiently conservative capital requirements, and there was no mechanism established in the law for dealing with their potential failure.

Congress created -- at least laid a foundation for fixing both those problems in the legislation that passed last year. That's a beginning, but it's only a beginning. As I said to one of your colleagues earlier, we're going to have to come -- we're going to make recommendations once we get through this --


MR. GEITHNER: -- for proposing what we do -- what we do with those institutions in the future.

With -- what we are proposing for the rest of the system is based on that lesson, in many ways, which is stronger, more conservative capital requirements where is the risk -- where there's the risk of moral hazard in the system and a resolution authority that gets at the capacity for managing failure. Those are the two critical things to do. And a core responsibility, I think, is to do those key things. And that will help mitigate the risk that you referred to, which we, of course, are deeply concerned by, that the actions we've created in the -- we've taken in this crisis to contain the damage will sow the seeds of future crisis by leading people to believe they'll be insulated from the cost of future mistakes.

Again, best protection against that is to make the system safe for failure in the future, reduce the risk of large pockets of excess leverage with conservative capital requirements and better tools for managing failure, orchestrating an orderly unwinding of a large, complex institution in the future.

SEN. MARTINEZ: I still don't know how we will avoid the -- and I agree with you completely that the GSEs were well under-capitalized, under-regulated and there was no plan for their dissolution. However, how do not a group of companies become, then, those that are too big to fail, which in turn allows them to borrow cheaper money? I mean, once the risk of failure is diminished by government backing -- implicit that becomes explicit -- aren't they in a position to borrow cheaper and therefore squeeze out competition from those who are not considered systemically important?

MR. GEITHNER: That challenge is the heart of bank regulation. With the establishment of deposit insurance, with access by banks to the -- to borrow from the Fed against collateral, you do create the risk -- you do create a lower borrowing cost and you do create the risk that there's implicit support from the government coming in crisis. The only ways we know to counteract that risk are to have -- make sure there is strong oversight, (consolidate basis?), more conservative capital requirements and better capacity to let institutions fail when they get themselves to the point where they've managed themselves to the point of vulnerability.

I don't -- I'm not trying to oversimplify it, but if you don't get those two things right, nothing is possible. And they are -- they will get us a substantial distance to the point where we're eliminating the moral hazard created by the role they play in the system.

SEN. MARTINEZ: On the GSEs' future, I just wanted to find out from you what your thoughts were in terms of when this consultation process might conclude. And would the FHFA be involved in this process? I presume they would be. In other words, who will be the coordinating council or whatever this group is going to be called that is going to analyze and study and make recommendations on the GSEs? And what opportunity will there be to comment, for people to participate, et cetera?

MR. GEITHNER: To be honest, Senator, we have not designed yet the full details of the process we think will be helpful in terms of exploring all alternatives. But we will involve the FHFA and the Department of Housing and Urban Development. Treasury will coordinate the process. We will consult not just with this committee, but with your counterparts in the House. And we'll try to consult broadly in the markets and in the academic community as we think through broad options.

I actually can't recall what we've proposed in the -- in the paper in terms of a time frame, but I think it would be reasonable for us to start to bring forward recommendations and options sometime in the first half of next year.

SEN. MARTINEZ: Thank you, Mr. Chairman.

SEN. : Senator Bennet.

SEN. MICHAEL BENNET (D-CO): Thank you, Mr. Chairman.

Mr. Secretary, it's good to see you. Thank you for your efforts here.

Over the last five months or six months or whatever it's been, what I've discovered is that with respect to the federal intervention in the immediate crisis, I think it's fair to say there's very little consensus about the details of that or about it as a whole. And I know that presents a huge struggle for you and for the administration, because everybody's a critic, but not everybody has to come up with a solution. And I think you've worked hard to try to get through a lot of this. I think there's also limited consensus still about what we ought to do to fix the problem we've got prospectively.

What people have come to understand is that we've come out of a decade where our savings rate as consumers dropped to zero, the federal debt ballooned from $5 trillion to $10 trillion, and banks or financial institutions in -- on Wall Street that historically have been levered at 12 times were levered at 25 and 30 times, all of which -- as you said in your testimony at the beginning -- when it all came crashing down have left our families in an unbelievably vulnerable position, jobs lost, houses lost, college educations deferred for people all over my state and all over the country.

And I know that we're designing this prospectively, but for the folks watching this at home, if we could rewind the movie that we just have played out of a period of an absurd amount of leverage in our economy, of risky decisions that should never have been made by people that should have known better, of risks that were taken actually in plain sight but we missed it, all of us, in part because of the way our regulatory system was designed.

As you rewind that movie in your head, looking back, let's imagine that the regime that's being proposed was in place and how would things have been different as a result?

SEC. GEITHNER: If what we're proposing today had been in place, it is -- banks would not have taken on so much risk. Institutions that were not regulated banks would not have been permitted to take on that level of risk; consumers would have been less vulnerable to the kind of predation we saw -- particularly in mortgage products; and the government would have had the ability to act earlier, more swiftly to contain the damaged posed by the inevitable pressures that come when firms fail.

Again, we want a system where innovation can happen, where firms can fail, where investors are accountable for the risks they take in some sense. But you have to create a system that's strong enough to allow that to happen.

So that's a simple way of saying banks would not have been able to take on this much risk. You wouldn't see this much risk build up, leverage build up outside the banking system to a point where it threatened the stability of the system and consumers would have been less vulnerable to the kind predation we saw and the government would have been able to act sooner.

SEN. BENNET: Who -- in the sort of the combination of the council versus the Fed versus the consumer protection agency and all this -- who would have detected -- we've got these things out here called credit default swaps that are mounting on the balance sheets of our banks and that is a cause for concern. And to whom would they have communicated that and what action would have been taken as a result?

SEC. GEITHNER: They were a bit of an orphan in the current structure. But under this regime, we're giving the SEC and the CFTC much more explicit authority.

We're going to -- we're pushing the standardized piece of those products onto central clearing houses, onto exchanges and transparent electronic trading platforms and giving the SEC an authority -- better authority to deal with potential manipulation fraud in those areas. That would have been -- that would have helped.

If they were behind the curve, failed to act in that context, then the council would have the ability and the authority to bring that to light and to urge them to fix that problem.

So I believe under this model, you're going to have the secretary of the Treasury I don't believe you've ever asked the secretary of the Treasury to do, which is to come before the Congress on a regular basis and report on evolution of risk in the system and whether the overall system as a whole is doing an adequate job of responding to those risks.

Now, we won't have the full authority that we've given -- Congress has given to the underlying (particular agency ?). They will each have a piece of responsibility for that, but in some sense, you will be able to look to the executive branch to say, does the whole thing work? Are we dealing with gaps; are we adapting to emerging risks? And I think that will be a substantial improvement.

SEN. BENNET: And then -- Mr. Chairman, just one more question.

And then if all that left us in the position where an institution -- it was a bank holding company -- found itself in crisis, we then have a new approach to resolution authority as well -- that you're proposing?

SEC. GEITHNER: We would. We would have a capacity to act earlier, I think more effectively, possibly at less cost to the taxpayer to contain the damage to the economy from that kind of specific challenge.

SEN. BENNET: Thank you, Mr. Secretary.

Thank you, Mr. Chairman.

SEN. JOHNSON: Senator Corker.

SEN. BOB CORKER (R-TN): Thank you, Mr. Chairman.

Mr. Secretary, always good to see you. Thank you for your service.

SEN. JOHNSON (?): I'm not "Mr. Chairman" yet.

You were --

SEN. CORKER: The chairman, yeah.

You know, I read parts of this proposal and I almost imagined a couple of folks sitting around at the White House drinking diet Cokes -- especially when a lot of the heavy lifting wasn't addressed -- the GSEs and the CFTC and the SEC. Only portions were addressed and I think numbers of people on both sides of the aisle have alluded to that. And yet, I saw that the Fed was a clear winner in this. I think everybody on this panel would agree with that.

This administration has received accolades in some quarters for trying to make sure there's no conflicts of interest and lobbyists can't be hired and all that. I wonder if it would make sense, since there'll be a lot of interaction with you guys and obviously, there'll be some arm-twisting and consultations taking place, I'm sure.

Would it make sense for the president to, in writing, tell all of us that no one involved creating this at the White House or Cabinet will be appointed as Fed secretary or Fed chairman?

SEC. GEITHNER: No, I don't think that would appropriate nor do I think it would be necessary.

SEN. CORKER: It's interesting to look at the new --

SEC. GEITHNER: I think you expected that answer, Senator.

SEN. CORKER: I actually expected -- I don't know. I think it would be good for us to know, as we move through, that none of the folks involved in helping create these new powers under the Fed are potential chairmen. I think that would be good to know. But I'll leave that to you all. I think -- let me just move on.

The resolution authority. You and I've talked about this since the very first time you came up here. And it seems to me that what you're doing is, in essence, making TARP exist in perpetuity. I know that you have the authority to actually cause organizations to not exist, but you also hold upon yourself the ability to do exactly what is happening in TARP today. And I think most of us don't like that much. I think most of us would like to see that end. I know you were asked earlier whether you were going to extend it.

And I just wonder, you know, the ad hoc nature of what has occurred, I think, is what has created much of the instability. And yet, you resume under yourself -- under this resolution of power -- the ability to do exactly what is taking place under TARP. And I'm just wondering why that makes much sense and not going ahead and having something that's very clear cut -- some people have talked about a special bankruptcy court, some people talked about SEC resolving -- FDIC resolving.

But you, in essence, are reserving to yourself the ability to cause TARP to go on into the future.

SEC. GEITHNER: No, sir. I know you've said that many times, but it's not true and we wouldn't do that.

TARP is temporary; it will be temporary. It will, fortunately, go out of existence when the statute expires and maybe before that.

What we're proposing is to take this model that the FDIC has presided over -- its existing checks and balances, its existing authorities designed for a different financial system than we have -- and adapt it to bank holding companies and those complex institutions that present similar risks to banks.

So we're doing the essentially pragmatic conservative thing in taking a model that exists, has a lot of experience, has good checks and balances in adapting to the financial system we face today.

We are not proposing to sustain some indefinite capacity to do what Congress authorized on a temporary basis -- appropriately so -- under the TARP. And I would share your concerns, any concerns people express, for that kind of authority.

SEN. CORKER: So you would work with us to make sure that you didn't have the ability just to conserve into the future and make ad hoc decisions at Treasury regarding entities that were deemed to fail?

SEC. GEITHNER: Well, again, Senator, the way the FDIC mechanism works today -- and we're preserving that basic balance -- any action would require a vote by a majority of the board of the FDIC, a majority of the governors of the board of governors of the Federal Reserve system and the concurrence of the secretary of the Treasury in institutions that had banks at their center.

Again, we're preserving that basic balance. There is a carefully designed set of statutory criteria for exercising that authority, which we think fundamentally we can replicate in this context.

So I think that has a -- again, it has an established record, good well understood checks and balances, a lot of merit in replicating that basic structure.

SEN. CORKER: So I know my time is up and I know we're going to be talking about this a lot more.

The one thing that was interesting -- I looked at, you know, the 13(3) issue's been raised a couple of times and that jumped out. It is interesting -- and I think a lot of people have asked sort of the questions about priorities that, you know, the Fed, a lot of people think -- and I'm not necessarily in every one of these camps -- but some people think that the Fed earlier on failed with monetary policy and helped create a policy bubble.

Some people think the Fed actually failed somewhat "supervisorially".

And yet they did a pretty job responding quickly to an emergency. And what you all have done here is actually sort of hand strung them as it relates to dealing with an emergency, but yet on the other hand given them even greater supervisory authority.

So it's just an interesting way that you all have gone about this. And very different than what history has shown to be good practices at the Fed itself.

SEC. GEITHNER: I agree with some of what you said, and I particularly agree that the Fed I think in being able to move as quickly as it did, played a decisive role in avoiding a much more catastrophic outcome for the financial system and the economy. And I think we need to preserve that authority.

Now what 133 does is to give the Fed the ability to lend to institutions it does not supervise as I said. We are trying to fix that basic imbalance between institutions that play a critical role in markets and those that come under the Feds basic supervision. By changing the boundaries of that authority, we will reduce the risk in the future, particularly if you give us resolution authority, to reduce the risk the Fed has to use 133 in the future to lend to institutions outside that basic framework of protection.

But as I said, even in this crisis, where the Fed acted I think very swiftly and effectively to help contain the damage where it used 133 in particular cases with individual institutions, it did ask for the explicit concurrence of the Secretary of the Treasury in recognition again of the potential losses of the taxpayer that were inherent in those judgments. And I think that was appropriate for the Fed to do. As you know I was closely involved in that decision and I think that those decisions and I think that would be appropriate to put in place in the future. And I do not believe but I think this is an important concern that that would constrain the Fed's ability in the future.

Now it is necessary though to tighten up the responsibility and the authority the Fed has now for those core institutions, for payment systems because of the risk they present, and for capital. I think in those three areas, the Fed's authority is too qualified now, it's got responsibility without clear authority and accountability and I think that's worth fixing, basic pragmatic case for fixing that.

SEN. JOHNSON: The secretary must leave at noon so I remind members to abide by the five minute rule. Senator Reed.

SEN. JACK REED (D-RI): Thank you very much, Mr. Chairman.

Thank you Mr. Secretary and Senator Warner also brought up the issue of the warrants and the guidance and another issue which is on your long, long list of to do is private equity involvement and resolutions of failed institutions and any guidance we'd appreciate it at your earliest convenience.

Let me raise the issue which is going to be debated substantively for a long time which is the Federal Reserve role, et cetera. You suggested I think in your early answer that the Fed would be October essentially report back to us about the changes that they have to make to accommodate these new responsibilities. So what are we doing between now and October in terms of moving this debate along if we have to wait for the Fed to sort of say well this is how we're going to do it?

SEC. GEITHNER: I don't think you need to wait for the Fed on that to proceed with the legislative process on design. There is this specific set of questions around how to deal with some of the concerns Senator Shelby and others raised about the role of the reserve bank boards, the set of firewalls and constraints that prevent involvement of Federal Reserve Bank boards and supervision, a range of things like that where we think it would be appropriate for the Fed to try to clarify, bring recommendations for how to tighten up those kind of safeguards and constrains. And I think that could happen on that path without getting in the way of your efforts to consider legislation.

I know the chairman is considering coming together you know we'll be happy I'm sure to come before the committee and talk about what role they think that that should play in looking at systemic risk and how to respond to the concerns many of you raised that that not distract them from their core responsibilities for monetary policy.

SEN. REED: Well you know my sense is that with these new responsibilities there has to come not only new organizational arrangements which we'd like to I guess have them suggest what their recommendations. And then second I think there's even the issue of culture, I mean, that is issue of is it safety and soundness trumps everything else?

I think also too in terms of transparency and one of the my sense from talking to hearings and just generally is that you know there were rather vigorous debates on the Fed about is there a housing bubble, is there not a housing bubble, you know, were savings rates too low, et cetera, that never got out, how do we, you know, have an agency that's going to be transparent in terms of these issues?

Similarly, you know, will there be independent analytical staff? Will there be someone charged not just the board but a, you know, deputy for systemic regulation that may or may not be subject to confirmation process?

And then it raises the bigger issue which many of my colleagues have talked about is just oversight. You know, ultimately they're proposing legislation, I can recall along with many others writing several letters I think to the Fed about when are these Hope regulations coming out?

So these are critical issues and I wondered if you could just comment briefly?

SEC. GEITHNER: Well I think you're right that they're important questions and you made a number of important suggestions about how the basic structure may need to adapt. And I think the best way to deal with these is to work through them together with the Fed. And again we suggested the Fed start to think through about what they would propose in that area for consideration by the committee. And I don't see any reason why that process can't move quickly.

SEN. REED: Let me just add another issue to this, it will be part of this debate about whether the principle systemic regulator is the Fed or committee, FDIC is run by a committee I think frankly aren't you on it?

SEC. GEITHNER: I'm not on the board of the FDIC but the head of the OTS and head of the OCCR.

SEN. REED: OCCR, thank you Mr. Secretary. But they seem to do a pretty good job about supervision and also resolution and other things. Does that argue for --

SEC. GEITHNER: I think you're exactly right, I think in some ways the ideal institution has a strong independent professional experience competent staff of experienced people, a strong executive accountable, and a board that can provide a broader framework of oversight. I think that basic model can work.

But I think that's different from investing a council with formal statutory authorities to change and compel judgments by independent agencies that have a different set of statutory responsibilities. I think that's the difference I would make.

SEN. REED: I'm going to abide by the Chairman's admonition to stay within five minutes, but just one final very quick comment that is I understand your proposal does include registration advises to hedge funds which is legislation that I proposed and I think it's on the right track and we'd like to work with you. Thank you.

SEC. GEITHNER: Absolutely.

SEN. DODD: Senator Hutchinson.

SEN. KAY BAILEY HUTCHINSON (R-TX): Thank you Mr. Chairman.

Mr. Secretary, first I want to say that I think you have been very thoughtful and forthcoming today and I'm not yet ready to say that I'm going to give the Fed this new power, but I think the points you made in your first answer were very compelling. So I want to, I'm conflicted about the independence which I think has served us so well through the years, but yet the potential compromising of that by going into more regulation.

Secondly I think that your proposal is attempting to do something that is good, I'm not sure when the devilish details come out that it will be so, but trying to level the playing field between banks and S&Ls surely was one of your purposes. And also streamlining the whole oversight of that. But I think S&Ls have had a special place in our country and I want to make sure that we still have the services that they have been so able to give, which really started out being mortgages but evolved into more.

I also want to make the point that I agree with Senator Schumer, who said something earlier today that was said to me by one of the great bankers in our state, Tom Frost, who is also now the biggest independent banker and has been very successful with the Frost Bank. And he said, as long as you don't require a person who originates a mortgage to keep part of it, you are going to have problems.

And I think keeping a part of it in the originator is a very important concept that we need to incorporate into a reform. Plus, of course, servicers and second servicers and how many iterations of that they have, I think we need to have skin in the game as it is described for everyone that is connected with a mortgage, going forward.

I want to switch just for a moment for my question on TARP. And that is to say that every one of us who was here last fall feels that we were misled by the original intention of the Troubled Asset Relief Program, which was to take the money to buy troubled assets in banks, to stabilize the banking industry. Last year, that was proliferating into other areas, and it has continued into your administration as well.

So we now have 11 different programs, none of which is buying assets of banks that are troubled. So my question is this. As Senator Bunning mentioned, you will be able to sign a paper and extend TARP for 10 months at the end of this year. And you said you weren't sure if you were going to. This is my question. Do you believe that these 11 funds that have been part of TARP, that were not all a part of the original purpose of TARP, should have more congressional oversight, because I'm looking at introducing legislation that would provide that?

And if so, do you think it would be wise for Congress to be able to vote on all of the 11 new programs? Or if not, what do you think would be the proper role of Congress, because I'm not comfortable with having been misled last year then currently going for 10 months and then, well, actually about six or seven months plus another year in something that seems to have no congressional oversight?

SEC. GEITHNER: Senator, at the beginning of this administration, we said that there were five areas where we thought it was going to be appropriate to consider using TARP authority Congress provided. And those were to help address the housing crisis, to make sure banks have capital where they need capital, to help support bringing back the securitization markets, targeted programs for small-business lending and a program to help restart these markets for loans on the balance sheets of banks.

Now, we have moved forward to put in place programs in each of those areas, as we said we would do. We are on the verge of putting in place the last of those programs, which is to create a set of funds to help restart these markets. You called them toxic, we call them legacy assets.

These programs are subjected to an enormous amount of carefully designed oversight, not just by the congressional oversight panel you've provided, you established under statute, but also by a special inspector general at the Treasury and by the GAO. They report monthly on everything we're doing.

We have been fully transparent about the specific terms underpinning each of these programs so that everyone can look at exactly what we're doing and measure their impact and their success. We look very carefully at every recommendation those oversight bodies make for bringing more transparency and accountability to them. And where we think they make sense and we can do them, we have adapted those recommendations, and we'll keep doing that.

It is hard to know what might be necessary in the future in terms of using this authority, if any further use would be required. But my sense is that if we need to do more in the future, that anything we do will fall within those core basic framework, which to reduce them are about making sure the banks -- (inaudible) -- capital and making sure these federal markets are getting bullion.

SEN. HUTCHISON: So further congressional oversight would not be necessary or prudent in your view?

SEC. GEITHNER: Well, I don't -- again, I think you've put in place an enormously powerful set of oversight mechanisms. And I think those have done a very good job of helping provide not just a second pair of eyes but three additional sets of eyes looking over everything we do.

Of course, we'd be happy to look at ways to sort of strengthen accountability and transparency because it's important to our credibility, too. But I don't believe you need new legislation in this area.

SEN. HUTCHISON: Thank you, Mr. Chairman.

SEN. JOHNSON: We have time for one more question a piece.

Senator Merkley.

SEN. JEFF MERKLEY (D-OR): Thank you very much, Senator Johnson. Am I limited to just a single question?


SEN. MERKLEY: Thank you, Mr. Chair.

I'd like to (praise ?) the plan that you've put forward, and three things that I have been advocating for were in the plan -- the consumer financial protection agency, having a housing expert involved in systemic risk counsel and power to reform predatory retail mortgage practices. So I certainly appreciate those aspects having been addressed.

In regard to consumer financial protection agency, would they have the power, without additional input, or not input so much, but authority from some other sector to do things such as shut down new tricks and traps introduced into credit cards or shut down new tricks and traps introduced into mortgage lending practices?

SEC. GEITHNER: Yes. Where those practices threaten basic standards of consumer protection, they would have that authority to set rules to constrain that and to enforce those rules.

SEN. MERKLEY: Thank you.

SEN. JOHNSON: Staff indicates that you may have your full five minutes.

SEN. MERKLEY: Oh, thank you. Thank you very much, Mr. Chair.

Well, I wanted to go on to ask, in terms of the power that would go to the Fed under this plan, I think I have a ways to go to see the Fed as the right place to set capital adequacy rules, in part because of situations in the past. For example, they fought against keep leverage ratios. Is that the right place to center this kind of power?

SEC. GEITHNER: I think so, because I think that if you give it to too many people, you don't have accountability for when you get it right. And I think they've got the best incentives to make sure that those basic safeguards are strong enough to help us withstand future crises.

SEN. MERKLEY: So let me frame it a little differently. We gave power to the Fed in the past that said unused and unexercised in situations where, of course, with the power of hindsight which is always much better than foresight, we would have wished they had exercised that power. Is there a way to have them address their role in monetary policy, at the same time having them see this as a major mission, a major responsibility and that they won't fall asleep at the switch?

SEC. GEITHNER: Senator, I think I need to just say one thing which is important to point out. If you look at the mortgage market in the United States, where practices were worse, they were worse the greater distance you had from a Fed-supervised institution. If you look at where the pockets of risk and the finances were worse, where you had leverage (rate ?) go to the point where institutions were at the edge of the abyss and -- (inaudible) -- independently, like the case of Countrywide, for example, and in two of the world's largest investment banks, or if you look at AIG. Those were institutions that the Fed had no ability to effect risk-taking in those institutions.

So I do not think it is fair to say, looking at the record of performance of our system over this period of time, even though, as I said, everybody part of this system, there are areas where they could have done substantially better, but I do not believe, either in the mortgage area or in the core things that threaten -- (inaudible) -- and it's fair to say that where those things were most acute, they were institutions that were under the best supervision.

And I do not believe that the additional accountability and clarity of responsibility we're proposing to give the Fed -- building on their existing responsibilities today, has any significant risk of undermining their capacity to keep growth stable and sustainable over time and keep inflation low and stable in the future.

SEN. MERKLEY: I appreciate your response. I'm not fully persuaded, but I don't pretend to be an expert in this area. But, I'll try to dive into it a little more and follow up with your team. And thank you very much.

SEC. GEITHNER: Again, I want to just say no part of this system acquitted itself particularly well. And everybody's going to have to do a better job in the future, and that's why we're proposing -- (inaudible) -- many things, a comprehensive assessment of the basic record of supervision across agencies and the U.S. is responsible for that.

But, we have to make choices, going forward, about how to build a stronger system. And what we've recommended and what the president recommended, I think, vests authority where it needs to be, in institutions with the best capacity to discharge that responsibility well.

SEN. MERKLEY: Well, thank you.

And I'll yield back the balance of my time. And I do feel like the administration has put forward a very (responsible ?) proposal for us to work with. Thank you.

SEN. JOHNSON: Senator Crapo.

SEN. MIKE CRAPO (R-ID): Thank you very much, Mr. Chairman.

And, Mr. Secretary, thank you for being here.

I want to indicate at the outset that I share a number of the concerns that have been raised by my colleagues here in reference to the new authorities to be given to the Fed. But, although since that's been gone over a lot, I want to, in my short time, focus on an issue that I don't think has had much attention here yet today, and that is the bifurcation of consumer protection from safety and soundness regulation.

It seems to me that we can get the most effective consumer protection by not bifurcating those two functions and moving forward in a way that allows those who are really connected with the regulatory system of our banks to have the ability to implement statutory and regulatory policy on consumer protection.

What I'd like to do is to read you a statement by the Comptroller of the Currency, John Dugan when he testified before our committee in March, because he gave the same -- made the same points, and made a number of point about why that is the case, and I'd like you to respond to his points. He says, "The best way to implement consumer protection regulation of banks, the best way to protect consumers is to do so through the prudential supervision."

He gives these following reasons:

First, prudential supervisors' continual presence in the banks, through the examination process, put them in the very best position to ensure compliance with consumer protection requirements established by statute and regulation.

Second, prudential supervisors have strong enforcement powers and exceptional leverage over bank management to achieve corrective action.

And, third, the examiners are continually exposed to practical effects of implementing consumer protection rules for bank customers. The prudential supervisory agency is in the best position to formulate and refine consumer protection regulations for the bank.

Could you respond to those points?

SEC. GEITHNER: Those are thoughtful concerns and they've been made by supervisors in the United States for a long period of time. And we've had some experience with that model and it didn't work well enough.

So, our basic judgment is we need to change the model. And separating that responsibility from the core safety and -- (inaudible) -- responsibility of bank supervisors is a better way to get a balance on both of those functions.

But, you're right -- and that's a good version of those concerns that you quote from John Dugan, and I think those are good arguments, but I would just say we've had a good experiment in whether that model works, and it didn't work well enough.

SEN. CRAPO: So, you're saying that we had adequate consumer protection -- statutory and regulatory authority, but that it was not exercised?

SEC. GEITHNER: No. I would say that there were limitations both in the strength of the rules that were established and how those were enforced. The rules themselves were probably -- I think almost certainly not sufficiently strong; and it's certain that they were not enforced with sufficient rigor and evenness across the range of institutions that allowed it to generate those products.

SEN. CRAPO: How do you respond to the concern, though, that one of the needs we have to focus on -- at least in my opinion, and I think this is a pretty broadly held believe, is to streamline and make more efficient our regulatory system?

Before we got into this crisis last October, you know, most of the focus on regulatory reform was on how to stop our slide in competitiveness with regard to our foreign capital markets, or the world capital markets. And one of the concerns there was that we continue to have this increase in numbers of regulators to the point where we have double-digit regulators for any financial function. And here we're seeing proposal once again to increase the number of regulatory agencies that will now be managing our financial economy.

SEC. GEITHNER: Well, on balance, we're not increasing the number of agencies. We are reducing the one important source of our arbitrage and inefficiency, which is between a national bank and a national thrift charter.

But, you're right, we are proposing to separate the consumer function from the existing safety and soundness function, and -- (inaudible) -- authorities that have that, and put it in one place with accountability for the reasons I said, which is the current model -- we had a long record in it, and it did fail in important respects.

I believe that this basic concern about competitiveness of our system is -- remains a very important concern that has to guide everything we do. But, I do believe our system will be stronger, more effective, more competitive, greater confidence -- enjoy greater confidence around the world if we have better safeguards and protections, not just around disclosure, which is very important and where I think we still lead the world, but in terms of basic protections against (sic) stability.

Our system will not be competitive, our institutions will not be competitive if we have a system in the future that's been as vulnerable as ours has to periodic crises like this every two to three to four years. Now, this is the first crisis we've had in a long time, of this severity, but we have had a record over the last three decades where, every three to five years, we've had a shock of significant magnitude.

And I think that does not make our system or institutions competitive. And a better foundation of stability would be supportive of trying to make sure that our system remains, in many ways, the envy of the world in doing this core job of taking the savings of Americans' investors and channeling them to where they can be best used in support of innovation, new ideas, growing companies.

SEN. CRAPO: Thank you. My time's up. I'd like to pursue this further with you, though.

SEN. JOHNSON: Senator Bayh.

SEN. BAYH: Thank you, Mr. Secretary. I'd like to start off with a comment, and then two questions.

First, my comment is, I'd like to thank you for your openness and the dialogue you've established with members of this committee. And there was a comment made previously about the timing of briefings, and that sort of thing. I was at the breakfast that you had a few weeks ago. It was bipartisan. You elicited comments from all of us. So, I want to just go on the record as thanking you for that.

Secondly, I want to commend you on, you know, the work product you've produced here. Very difficult dilemmas to wrestle with. It seems to me you've struck the right balance here -- focusing on the core mission; putting off until later some things that are desirable but, perhaps, can be left to another day.

That takes me to my question -- the first of my two questions. I am concerned -- and you alluded to this, that there are a number of causes of the crisis that we face right now, some macroeconomic in nature. I'm concerned that your excellent work product will go for naught and that we will be overwhelmed once again -- in five years, six years, seven years in ways we can't anticipate if those aren't dealt with. And I refer specifically to the imbalance of savings and consumption in the world.

As the crisis, god willing, appears to be abating, I simply don't see the willingness on the part of some countries to rethink their basic economic models. And so I'd be interested in your comment about it. I'm deeply concerned that we're going the see a recurrence of this, if that's not dealt with. So, I'm interested in your comment about that in particular.

You know, on the savings side, I see Americans are beginning to save a little bit more. That harms consumption in the short-run, but in the long-run it's probably a prudent thing. But, isn't it also true that one of the best ways to increase national savings is to get our deficit down?

And I'm concerned that, if you look at the size of the deficit, this year or next year is understandable, but in the out-years it looks like it may be larger than GDP growth. That's a concerning thing. So, what about these economic -- macroeconomic factors and their ability to overwhelm this architecture if they're not addressed? That's number one.

SEC. GEITHNER: I think you're absolutely right. We share that concern. And I think that it is very important, as we put in place these exceptional measures to try to address the crisis, that we don't lay the basis for reigniting those basic imbalances which are, of course, are the problem.

Let me just try to take the encouraging side of that argument for a sec. You're right, private savings now are significantly positive. They moved from modest-negative to 5 percent, which is a good start. Historical levels, before the last three decades, were more in the 8 to 9 percent. It may go to that place over time, and that's a healthy development. Although you're right, it does -- it will slow the pace of recovery.

You're absolutely right that we have to bring the fiscal deficit down over time. The government is going to have to save -- spend substantially less relative to its resources over time. And the president, as you know, is deeply committed to that.

Our current account imbalance has now come down from a level that was approaching 7 percent of GDP, now to below 3 percent of GDP. That's helpful and important. I would say, as consequential, I think there is a recognition, not just in China but in many countries around the world, that the U.S. consumer is not going to be able to lead the global economy out of this crisis.

And you are seeing, in the basic strategy of economic policy, including in China, a much greater attention to policies that will shift the sources of future growth to domestic demand and consumption and bring about a transition from a less export-, less investment- intensive model of growth to one more reliant on domestic demand. That would be healthy.

But we're at the beginning of that, but it has to start with a recognition; I think you're seeing that recognition. But I agree with you; without getting that world economy in a slightly more balanced foundation of growth, these protections, although necessary, could be overwhelmed in the future.

SEN. BAYH: Well, I'm glad that they recognize the need to transition to a different -- to a global economic balance. I hope they follow through once the crisis has abated, because, as you know, the economic models they pursued are there for a reason. They've worked pretty well for them up until now. And you do tend to have strong vested interests within those societies for maintaining the status quo. But it's just not going to work anymore. We're going to see a repetition of this unfortunate situation if that doesn't change.

My final question deals with regulatory arbitrage. You've dealt with that here domestically. My question is, what about global regulatory arbitrage? And just as an example, in the whole derivatives area, we used to be told, "Well, we've got to deal with this." And then the counter-argument was, "Well, they're just going to go to another country. The risky behavior will take place. But we'll lose jobs and revenue, so it's a loss-loss."

How are we cooperating with other countries to avoid global regulatory arbitrage?

SEC. GEITHNER: A very important point. And as you know, that's a central piece of the proposals we're making. We think there needs to be a level playing field, higher standards globally, if this is going to work. Otherwise our safeguards will be undermined. Our institutions will be less competitive.

We're trying a different approach this time. Rather than putting reforms in place here, which raise standards here, and then engaging in a long process of negotiations to get the world to come to those higher standards, we're trying to do it in parallel from the beginning so we get more quickly to a better place and aren't left with these big disparities where risk will shift where the regulatory standards are worse.

And there is a very elaborate system of cooperation in place under the auspices of this new institution we call the Financial Stability Board. It's designed to drive consensus and change on those -- at least four areas: Capital, liquidity, resolution of large institutions, going forward. It's a critical part. And we should be able to report regularly on how much progress we're making as we put in place these reforms.

SEN. BAYH: Thank you very much.

SEN. JOHNSON: Senator Kohl.

SEN. HERB KOHL (D-WI): Thanks very much, Mr. Chairman.

Secretary Geithner, earlier this year I asked the FDIC chairwoman about the possible separation of safety and soundness compliance exams and consumer protection activities, and she replied, and I quote, "Placing consumer compliance examination activities in a separate organization, apart from other supervisory responsibilities, ultimately will limit the effectiveness of both programs."

Over time, she said, staff at both agencies would lose the expertise and understanding of how consumer protection and safe and sound conduct of the financial institutions' business operations interrelate.

So how do you explain their objections as well as objections at the OCC? With what you've proposed before us today, do you intend to work with them to remedy and alleviate their concerns?

SEC. GEITHNER: Absolutely. And I think that the committee will have the opportunity to hear from all sides on this and from people with lots of experience on both sides. But I think I would just say what I said to one of your colleagues, which is that we've had a rather searing experience with the model that was built on integrating those two functions, and it did not work well enough.

And a core part of what went wrong in our system was because of basic failures in consumer protection and in some parts of safety and soundness capital regulation. And so I don't think the current model served us well enough, and it requires change. But, of course, we want a system that's going to work better on both those fronts, and our objective is to try to make sure this new agency has the right degree of accountability and expertise to carry out these important functions for rule-writing and enforcement of consumer protections effectively.

But I think Commissioner Bair is a thoughtful advocate of those concerns, as is John Dugan and others. And, of course, we will listen carefully to those concerns, because what we want to do is have a more effective model.

SEN. KOHL: Thank you, Mr. Secretary.

Secondly, I'd like to express similar concerns that were stated earlier by Senator Bennet about shifting industrial loan corporation charters to bank holding charters and the possible impact on access to consumer credit, as well as possible unintended consequences that change may have on parent companies of ILCs. Are you sensitive to that? Do you expect that we can alleviate those problems?

SEC. GEITHNER: Again, we'd like to work with you to try to address your concerns. You know, what we need to do -- and I think we all share this obligation -- is to make sure we do not leave gaps in the system that in the future could emerge as another source of ways to get around stronger safeguards applied to banks.

And what we don't want to do is allow institutions that do similar functions, create similar risk to the economy, to be able to operate outside the set of protections we try to put in place. We had a kind of searing experience with getting that balance wrong, although I think it's fair to say the ILCs at the moment were not a principal source of that concern. But that kind of gap unevenness is a core vulnerability we need to address. But of course we will try to work with you to address your concerns in that area.

SEN. KOHL: And you're now looking for unintended consequences. You're trying to anticipate them.

SEC. GEITHNER: In everything we do, we have to be careful that we are making the system stronger and not making it more vulnerable. And we try to be very careful and try to anticipate the potential adverse consequences of these changes. And again, we want a system that can adapt in the future, because we will not have the foresight today to be able to anticipate and deal with preemptively any potential source of a risk. We want a system that can adapt more flexibly in the future as our system evolves, as innovation proceeds.

SEN. KOHL: Okay, thank you so much, Mr. Chairman.

SEN. JOHNSON: Mr. Secretary, I applaud your recommendation to create an office of national insurance in your reform proposal. Can you expand in other ways that Treasury envisions modernizing and improving our system of insurance regulation?

SEC. GEITHNER: Senator, we have laid out in this white paper a set of broad principles that should guide policy as the Congress considers how to make sure we have a framework for insurance regulation in the future that allows us to have that competitive, efficient and stable market for insurance products.

So with an entity established in the Treasury, with accountability for thinking about these things, building up expertise, and those broad set of principles, we think we can begin a process of thinking about broader reforms.

SEN. JOHNSON: Does the administration agree that reinsurance has a good case for regulation at the federal level rather than the state level? What about life insurance and property and casualty insurance?

SEC. GEITHNER: Senator, we have not made that judgment yet. There are a lot of thoughtful proposals out there for establishing the ability to have a federal charter to engage in a range of financial products -- insurance products. Some people would cast that license, that charter, more narrowly. Some proposals would cast it very broadly. But we have not taken a view yet on what we think the ideal model is.

SEN. JOHNSON: Thank you, Mr. Geithner, for your presence, Mr. Secretary.

This hearing is adjourned.

SEC. GEITHNER: Thank you, Mr. Chairman.

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