should we be giving some federal entities in the regulatory field new powers that are not now heavily regulated particular from the standpoint of avoiding systemic risk and then  the question is there are different functions yeah there was investor protection and download pennsylvania and i were just telling the chairman of the f c c privately publicly that we were very pleased with the actions taken regarding  short selling and we think those have been very helpful from the standpoint of having it protecting the integrity of the market but there is a question as to what extent actions that are taken to protect the integrity of the market and in the chairman cox and president in new york guyon are you've actually been at the center of the governors of the government's response to recent turmoil in the financial markets and i commend you both on the job  begin a serious discussion of government involvement in our capital markets we need to have a clear understanding of exactly where we are and how we got to where we are and i know the chairman has also said that we need to know how we arrived at a system in which the credit default swaps are allowed to provide far exceed their capital reserves and that there's virtually no possibility that they can pay in the event of default of the underlying obligation to commit themselves to obligations as they cannot possibly cover worst case scenario we need a better understanding of w regulations allow credit default swaps to remain essentially unregulated when they have such a profound effect and are so intertwined with our larger financial markets and even our ensure that our regulators maintain a framework in which individual farms while the system continues to function i think been referred to an orderly liquidation we know that leverage capital and credit must continue to flow where they are most needed but our financial institutions should not be taking outsized require repeated government interventions to save the system from recurring crisis  cox you've taken significant steps to protect the integrity of our capital markets i think your efforts have been under appreciated one of your most important initiatives has been to help make sure complex financial products and markets remains our goal striking an appropriate balance don't answer protection is also a difficult task for just as the markets continue to change and evolve so much regulation explosive growth of complex financial instruments is well documented credit default swaps and collateralized debt obligations are just two examples of comparatively new exotic products being our market s in a silly regulated or unregulated market is a recipe for disaster so in order to better understand these instruments two days ago a request to the government accountability office that it began a study on structured financial products this study will examine the nature of these instruments and the degree of transparency and market regulation surrounding them from this study we should have a clearer picture of how to improve regulation in the sector of our financial system another area of regulation we should consider is the consolidation of regulation of our securities and commodities markets the treasury's recommendation to merge the securities exchange commission and the commodity futures trading commission is something we ought to be that ought to be discussed today such a merger the kind of streamlined regulatory system to which we should aspire additionally last week's emergency order on short selling has received much attention this committee is do an explanation as to the reason for the order the effect to date on the market its possible extension and whether it will be expanded to broader market here we do appreciate your hard work on the commission especially on behalf of investors especially on behalf of the securities industry during these rather difficult and challenging times with our capital markets and welcome back chairman i find it somewhat ironic that we would be holding this hearing twenty four hours after we gave the secretary of treasury a blank check to help bail out fannie and freddie since that we took a huge step in the wrong direction with respect halls of congress you can indeed figure out a way to privatized your profits and socialize your losses and just in case somebody missed the message we are having a serious discussion now about giving the federal reserve increased responsibility and ultimate authority for financial stability in our markets may be a good thing and may be a bad thing but it's also a very risky thing and i fear that the markets will interpret this is meaning again  back in is around the corner if investment banks trouble i fear that we continue to lose market discipline we substantially increase the chances of having yet another fannie and freddie debacle perhaps another s n l debacle i'm very concerned also about where we find the role of the federal reserve today in all the different directions they are pool starting with price stability in monetary policy minimizing unemployment on top of that we had a healthy dose of consumer protection now we're about to add potential financial stability at least heard the chairman say once he cared about taxpayer protection as well that's pulling the f in a lot of different directions i do know that some believe that the ultimate answer more regulation certainly believe we could have better regulation we may need smarter regulation i don't know we necessarily need more regulation served this nation well over the intervening decades even today in the midst of the current strains in the financial sector the us capital market is larger deeper more liquid than any other market in the world in large measure that's due to the world class protections that investors enjoy in the united states and those are protections that we should secure in the decades since our regulatory agencies were chartered the capital markets and the broader economy have undergone profound changes the regulatory system in the man has adapted well to some of these changes but other changes have presented new challenges that are rightly the subject of this committee's review as you consider legislative solutions but i hasten to add that given the many strengths of the current regulatory system we don't need to start from scratch instead we can build on what we know has worked at the same time we can take lessons from what has not worked and modernize rather than replace the current system one thing that has worked exceptionally well is the regulatory concept of an agency chartered to protect investors to maintain fair orderly markets and to promote capital formation if the f c c didn't already exist congress would have to invent it each of the elements of the mission is mutually reinforcing of the others the agency's work to protect investors through our enforcement program has been greatly benefited by the expertise of the staff who specialize in the regulation and supervision of broker dealers and investment advisors the agency's regulatory program including our commitment to ensuring full disclosure of information about public companies has been informed by the experience and turn of the enforcement and examination staff but i hasten to add that given the many strengths there are many problems as well in the current system today when derivatives compete with securities and futures and insurance products are sold for their investment features it's no longer true that we can  regulation as we approach the end of the first decade of the twenty first century the growing gaps and crevices in our regulatory system are beginning to show we all know that the current market crisis began with the deterioration of mortgage origination standards as a result it could have been contained to banking and real estate if only our markets weren't so interconnected but in today's world these problems quickly spread throughout the capital markets through securit and at the same time the explosive growth of the over the counter derivatives market is drawn the world's major financial institutions into a tangled web of deeper interconnections this is led to the realization that  or investment bank is threatened so to maybe the entire marketplace and it's cast a spotlight on the significant regulatory gap that currently exists when it comes to the regulation of investment banks when this committee devised the gram leach violent act in one thousand nine hundred nine or perhaps i should say i because along with many of you i served on the conference committee that wrote the legislation decided that the f c c would serve as a functional regulator with responsibility over broker dealers investment advisors and mutual funds and we decided that the federal banking regulators similarly would be functional regulators for banking activities under this approach the securities related activities would be regulated by the which would also continue to be responsible for regulating broker dealers that are the central entities and investment banks the fed would be given consolidated oversight of holding companies that contain broker dealers and also most types of depositary institutions and finally the would retain the authority to regulate the net capital of the broker dealers within the financial holding company but no explicit arrangement was established for the regular sharing of information between the fed and the f c c in order to take into account the need to view capital and liquidity on an entity wide basis and that is what the memorandum of understanding between the federal reserve board and the c is accomplishing today likewise neither the commission nor the fed was authorized to exercise mandatory consolidated supervision over investment bank holding companies as a result today there is simply no provision in  that requires investment bank holding companies to compute capital measures and maintain liquidity on a consolidated basis in two thousand and four the commission adopted our voluntary program called the consolidated supervised entities program to fill this regulatory gap but now recent events have highlighted the need for legislative improvements as well we need to fill the grammys bliley regulatory gap by amending the existing statutory authorization for voluntary supervision of investment bank holding companies to make it mandatory for all firms that today are regulated as the commission should be given a statutory mandate to perform this function at the holding company level along with the authority to require compliance in addition legislation should prescribe explicitly how the resolution of financial difficulties and investment bank holding companies will be organized and funded any regulatory reform that you undertake should recognize the very fundamental business accounting and regulatory differences between investment banks and commercial banks rather than extend the current approach of commercial bank regulation to investment banks i believe congress and regulators must recognize that different regulatory structures are needed for oversight of these industries and in particular that investment banks should not be treated like commercial banks by providing them with permanent access to government provided backstop liquidity the added regulation that this would necessitate following the commercial bank model would fundamentally alter the role that investment banks play in the economy reserved for exceptionally rare cases the securities and bankruptcy laws currently provide an explicit statutory framework for liquidating the failed securities brokerage firm and for protecting customer cash and securities act mandates a least cost resolution analysis and imposes intentionally onerous restrictions on a bank's ability to receive lender of last resort funding this is a useful model for resolving investment banks as well for scribes a detailed process involving supermajority approval by the interested regulators and formal approval of the secretary of the treasury after consultation with the president it also requires detailed findings of serious adverse effects on economic conditions financial stability and a finding that the proposed action would mitigate any adverse effects of these two are important  control the liquidation of investment bank holding companies or their own regulated affiliates that generally hold most of the derivative positions mr chairman i hope that these observations from the be of assistance to you and to the committee as you consider the broad questions of whether and if so how to reform the existing federal regulatory system for financial services thank you again for this opportunity to discuss these important issues i look forward to taking your questions thank you jim you really do exactly what we were hoping to engage and thank you mr chairman baucus and other members of the committee appreciate the opportunity here with you today we're dealing with some very consequential issues support and cooperation the u s and the global financial systems are going through a very challenging period of adjustment an exceptionally challenging period is just and this process is going to take some time a lot of adjustments already happened but this process will necessarily take time and the critical imperative of policymakers today is to help ease that process of adjustment and cushion its impact on the broader economy first ability and repair and then reform looking forward the united states substantial reforms to our financial system there was a strong case for reform before this crisis our system was designed in a different era for a different set of challenges but the case reform of course is stronger today reform is important of course because a strong and resilient financial system is integral to the economic performance of any economy financial assets held by non bank financial institutions funds and complex financial structures a gradual blurring of the line between banks and non banks as well as between institutions and markets extensive rapid innovation that have made it easier to trade and hedge credit risk a dramatic growth in the extension of credit particularly for less credit where they were the borrowers as a consequence of these changes and other changes are phonetic to our financial system a larger share of financial assets ended up in institutions in vehicles with substantial leverage and in many cases these assets were financed with short term obligations and just as banks are vulnerable to a sudden withdrawal of deposits  banks and funding vehicles are vulnerable to an erosion in market liquidity when confidence deteriorates the large share of financial assets held an institution's without direct access to fed to the feds traditional lending facilities complicated our ability as a central bank the ability of our traditional policy instruments to help contain the damage to the financial system and their broader economy presented by this crisis i want to outline a course  principles objectives that i believe should guide reform i offer these from the my perspective at the federal reserve bank of new ork the critical imperative is to build a system that is more robust to shocks this is not the only challenge facing reform we face a broad set of changes in how to better protect consumers how the mortgage market should evolve the appropriate role of the in others how to think about market integrity investor protection going forward i want to focus on the systemic dimensions of reform and regulatory restructure first on capital the shock absorbers for financial institutions the critical shock absorbers are about capital and reserves about margin and collateral about liquidity resources and about the broader risk management and control regime we need to ensure that in periods of expansion is a relative stability financial institutions and the centralized infrastructure of the system hold adequate resources against losses against the losses and liquidity pressures that can emerge in economic downturns is important both in the institutions and the infrastructure and the best way i think that we know how to simplification of consolidation it's very important i believe that central banks and supervisors and market regulators together move to adopt a more integrated approach to the design and enforcement of these capital standards and other potential regulations that are critical to financial stability we need a more consistent set of rules more consistently applied substantially reduce the opportunities for arbitrage in our our existing our current very segmented fragmented system reducing moral hazard is critical as we change the framework of regulation over say we need to do so in a way that strengthens market discipline over financial institutions and limits the moral hazard risk that is present  regulated financial system the loquitur the tools of central banks and to some extent the emergency powers of other public authorities were created in the recognition of the fact of the basic reality that individual financial  cannot protect themselves fully from an abrupt evaporation and market liquidity or the ability to liquefy their assets now the moral hazard that just so that is associated with the lender of last resort tools needs to be mitigated by strong supervisory authority over the consolidated financial entities that are critical to the financial system on crisis management the congress gave the federal reserve very substantial tools very substantial powers to mitigate the risk to the economy and the financial crisis but i think going forward there are things we could put in place would help strengthen the capacity of governments to respond to crises as sec institution may pose risks to the stability of the of the financial system finally we need a clearer structure of responsibility and authority over the payment systems these payment systems settlement systems play a very important role in financial stability and our current system is overseen by a patchwork of authorities with responsibilities diffused across several agencies with significant gaps very important underscore that as we move to adapt the u s framework we have to we have to work to bring a consensus among the major economies about complimentary changes in the global framework moving forward will require a very complicated set of policy choices including determining what level of conservatism should be built into future potential regulations and capital requirements what institutions should be subject to that framework of constraints or protections which institutions should have access to central bank liquidity under what conditions and many other questions a few points finally about how to think about the role of the federal reserve in promoting financial stability first the federal reserve has a very important role today working in cooperation with bank supervisors in the in establishing the capital and other potential safeguards that are applied in a consultative basis to institutions that are critical to proper functioning of markets second the federal reserve as the financial systems lender of last resort should play an important role in the consolidated supervision of those institutions that have access to central bank liquidity and play a critical role in market functioning the judgments we're required to make about liquidity and solvency of institutions in the system require the knowledge that can only come from a direct established ongoing role in prevention supervision third the federal reserve should be granted clear authority over systemically important payments and settlement systems forth the federal reserve board should have an important consultative role in judgment about official intervention in crises whether is potential for sin the systemic risk as this established as is currently the case for bank resolutions underfoot disha and finally the federal reserve's approach to supervision and to market oversight we need to look beyond disability just of individual banks to market broadly to the infrastructure that's critical to market functioning and the role played by other leverage financial institutions i want to side in concluding that we are not very actively now today in close cooperation with the  ter banks supervisors and with our international counterparts to take to put in place steps now that off the prospect of improving the capacity of the financial system it withstand stress we're doing this in the derivatives markets we're doing it in secure funding markets and we're doing it with respect to centralized infrastructure i very much look forward to working with you and your colleagues as we move ahead in working to build a more effective financial regulatory framework in this country thank you very much thank you  system you're going down to the rudimentary roles and approaches perhaps even from a whole new philosophical view is that correct over reacting to what you're saying i think you have to look at everything you have to be fair to look at everything our system has many strengths but i think the challenges we've seen in this crisis justify a very broad base fundamental look  and i agree with that proposition and i think it would take a number of congress has exceeded along those lines and we're particularly acutely aware of the international accounting standards that are going to come into play we ran into a situation that people will argue that we ought to have the race to the bottom or prevent the race to the bottom for shopping and i see that is if we you know we could write great regulatory reform here and have all our companies go to bermuda well how do we prevent two and how do we get adequate good  responsible reform and on the other end don't run into the escape psychology and you can do better in another jurisdiction i think you're absolutely right as we think about what makes sense for us we have to figure out ways to get the world to move with us and it's i don't believe it's possible given how integrated our markets are for us moving alone to adequately address the challenges we face here so a critical part of everything we do will report will be to try to improve the odds that we get are more resilient system in place united states and get the primary supervisors of other major global financial solutions in the other major financial centers to move with us and we have a very active cooperated effort now underway including with chairman cox and his colleagues today and i i believe we have a reasonable prospect if we identify sensible settlement systems there are there is a group called the fantasy ability forum established in the late one nine hundred ninety s that brings together central banks markets supervisors market regulators supervisors together and i believe that framework provides a lot of opportunity for us to build consensus but i i just want underscore your point i think you're exactly right that we can't achieve what we need in this country that in the united states without achieving  different is to execute a memorandum of understanding so that we work together as closely as possible in some respects i have observed over a period of many years include when i first worked in the executive branch in the so and we have worked i think in the best interests of investors in the marketplace to make sure that for example new product approvals are done in a consultation way not seriously by the f t c and by the  c this kind of deep and personal and organizational cooperation and collaboration between regulators is something that i think works very well and it typifies what we're doing with the fed and we've also had a great deal of experience euronext merger and by the nasdaq combination we are working with regulators in those countries of necessity and we've deepened our collaboration also on the enforcement front so in all of these ways i think that starting with the f t c the question you put collaboration among regulators generally we can do a lot even if it is difficult to rationalize the whole thing with a with an entirely new statutory regime  let me ask you on our committee right now we're working on the consideration of providing legislation to have an optional federal charter insurance and of course we were considerably on the line when it's a good idea it's certainly important for this committee to be considering it in a very serious way there are obviously significant issues to be worked out with the states  the background of state regulation in this area is rich with history and people understand it this is it optional charter that we're talking about it is not unduly intrusive in that  sense but that kind of very close working relationship with the states as you consider this legislation i think would serve the subject matter well and on the question of whether you need to do it now i think that in general across the across the set of issues i think that it's going to be hard to get the ideal balance and mix until we're through this crisis and so i think most of the big questions need to be thought of in overall context once we get through the other to the other side of this downturn but i think right now there needs to be a spirit i think there is a spirit of pragmatism for different treatment different regulatory treatment i think that there are and i think that the object of reform in this area should be to create the conditions in the marketplace  that give a lot of transparency to investors so they can see where the risk lies we've had shortcomings that have been clearly identified in that respect of late in addition that can make it possible for interconnectedness which can be a good thing to be only a good thing and not also a bad thing with the dark side because we don't know where risk lies so that when a firm is mismanaged it can fail as in a free enterprise economy it should without threatening the entire financial system we need to get to a better place in that respect than we are i think it's for that reason that the authorities the emergency authorities that regulators have exercised in these circumstances are temporary but the object should be to let market discipline govern risk and investment in risk and not to have the federal government to have to step in each of these cases central clearinghouse for these derivatives and to automate automate their trading and settlement and those are welcome initiatives how can or how have credit default swaps been able to provide guarantees it vastly exceed their capital reserves to the point where there is virtually no possibility that they can and the defendant in the event of a default on airline obligations  retain but they come with a lot of challenges so i think the two really critical things are that the institutions the dealers that are at the center of this market carefully manage their exposures in this area relative to their capital so the first thing first most important thing is to make sure that these institutions and this is largely a group of twelve to eighteen of the largest finances in the world banks investment banks carefully manage those exposures the second thing as you noted is to try to make sure that trade processing infrastructure that supports what is now a bilateral  market is modernized to the point that it offers a little level of automation a reduction in operational risk capacity for dealing with the faults in the underlying data is more appropriate to part of this market on to a central clearinghouse and moving to greater automation but a range of other things that are critically important and you're going to see in the public in the in the couple weeks a nother set of clear objectives and targets and commitments from those thank you time when we see a lot of abusive and manipulative short selling especially in an economic climate where people are very mistrustful and lack confidence  that we would not reinstate the uptick rule i'd introduce legislation that would mandate that it be that it be reinstated seems to work very very well when we had it for all of those years and have all these problems now the uptick rule ineffective in achieving its original purpose the question that you raise however is very good one and it should there be a test that does work should there be something that is meaningful if it can't be a tick because a tick is now just a penny and even when a stock is dropping like a stone it tends to drop with penny upticks along the way is there a price test that could work with an increment of nickel or dime or what have you very successful the hustlers in that game would go out and sell one hundred fifty percent of five hundred percent or one thousand percent of the play and try to make it bad enough that it would definitely lose so that they could make money when at last i think we're dealing with a market that's very very rumor sensitive especially in this day and age and while betting on something going down is a legitimate game i think that pounding it down and hammering it down is something that's disastrous and again a game that we should be protecting again so that there's transparency and people understand what they're and at the at the same time tied this in with the issue of naked short selling where people can actually sell one hundred fifty percent because they're not really borrowing the stock and you combine that with the with the the tick rule or the lack of such i think we're heading for an absolute total disaster and i'd like to know why the change in rules have basically given a cloak of insecurity to nineteen firms and not protected the entire banking institutions on the naked short selling who are we protecting if we're not protecting everybody but there is a regulation  recently put into effect and recently tightened even further called regulation show that targets naked short selling it applies across the entire market and so the norm that you need to borrow a stock or you need to have a contract to buy all that stock or you have to have a reasonable expectation that you can you have two different standards of one one for one thousand companies and one for everybody else that's what the standard of showing  s the difference between reg show which applies across the market and our emergency order is that one of the three prongs of the test has been removed so that now you have to either b have a contract to borrow having a reasonable expectation that you can do so is no longer sufficient and the universe and it is to which this emergency order applies is precisely universe that the federal reserve has drawn and with the ones with extending the one thousand two hundred little test applies it seems be very effective if something is very effective why not use that as a template and apply it to everybody so that everybody has the same sense of confidence in the plane when the commission issued its order i made very clear that that's our intent that we're going to propose a rule making that will put in operational protections for the entire market beyond systemic risk and we had the chairman of the federal reserve here at this time of the treasury secretary and i mention a quote by former chairman alan alan greenspan and in that quote mr greenspan expressed his belief that private counterparty regulation or monitoring basically through market discipline generally has proved better constraining excessive risk taking th has government regulation in his view and i mention this quote again because as we look to potentially increase the regulatory authority of the fed over investment banks and a large broker dealers ask you mr chairman are you concerned that the potential increase in regulatory authority and overall regulation may in fact weaken the effectiveness of market discipline need for more regulation and supervision and ultimately if one takes that to the logical extreme the requirement would be for the government to have to supplant the wisdom of the entire market and to do everything through regulation supervision respect in this respect perhaps another question but there's no question what we should be trying to build and what we should be trying to build something in which the federal government is in this business let me ask you a last question here chairman cox it's been reported recently that many of the past three weeks by these institutions and what should we make of this pullback you know if there isn't this borrowing going on now through the discount window is a reflection of the health now the institutions  statement to regulators and law makers that these investment banks are not prepared to trade window in exchange for the burdens of a priest regulation i was just wondering  your your take on that i think we probably hear from both of us on this from the point of view of the f c c i don't think it's the latter i do think that it is a reflection of what secretary paulson has said on many occasions is much better to not use authority that people know exists to not have to rely on backing that people know exists because it does its job better that way i think that's a bit of what's going on here let me ask th in confidence as a backstop source of liquidity in extremis and i don't think you can really judge the value today to the firms themselves or to the people the fund them from looking at use day by day so my own sense is that  there's still plenty of common important role and even though you says decline progress of over time just to underscore one important point we have been very careful from the beginning along with t o try to make sure that while these facilities are in place the major investments move to adopt a more conservative mix of leverage and funding than they  that has been taken by the fed treasury and other central banks have done a good job in helping reduce risk raise capital and bill look quiddity and how can we improve upon the as the fad is beginning to fade added pressures from some regional federal bank presidents regarding starting to raise the cost of credit to curb expectation of higher inflation in your mind is inflation and greater concern right now and we try to be try to be careful to underscore a commitment to continue to do things as they said the bank will help ease this process of adjustment and that's important not just because the financial system is still on under under is still facing some pretty substantial pressures and we want to mitigate the risk of those pressures increase overall headwinds to the economy as a whole but it's important to try to make marjorie policy more able to deal with the full range of challenges we face we face as a central bank  i'd be happy to address your question as well as you know the f c c is not responsible for monetary policy but inflation is something that investors after when we look at a great deal about and one of the things that the f c c concerns itself with every day is making investors comfortable taking their money and putting it into investments where it can be productive in our economy what  maintaining market confidence is vitally important in this respect as well as in others that's what we are focused on thank you not a part of my question is on yesterday we made a very bold and i think a very very very good and substantial move with our housing package and given the fact that now that we have addressed our housing package let me ask you do you believe  that a second round of stimulus package is necessary and would you support a second round of stimulus in the face of what people are saying and economists that we still expect economics to last many say for the next two or three years so my point is we given the housing package given the earlier stand do you foresee down the road a necessity to empirical data that even now they're collecting of the stimulus package that's already been put into effect complimentary to the role and instilling maintaining market confidence is