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ENDING ‘‘TOO BIG TO FAIL:’’ 

WHAT IS THE PROPER ROLE OF 

CAPITAL AND LIQUIDITY? 

HEARING 

BEFORE THE

COMMITTEE ON FINANCIAL SERVICES 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED FOURTEENTH CONGRESS 

FIRST SESSION 

JULY 23, 2015 

Printed for the use of the Committee on Financial Services 

Serial No. 114–45 

( 

(II) 

HOUSE COMMITTEE ON FINANCIAL SERVICES 

JEB HENSARLING, Texas, Chairman 

PATRICK T. MCHENRY, North Carolina, 

Vice Chairman 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

SCOTT GARRETT, New Jersey 

RANDY NEUGEBAUER, Texas 

STEVAN PEARCE, New Mexico 

BILL POSEY, Florida 

MICHAEL G. FITZPATRICK, Pennsylvania 

LYNN A. WESTMORELAND, Georgia 

BLAINE LUETKEMEYER, Missouri 

BILL HUIZENGA, Michigan 

SEAN P. DUFFY, Wisconsin 

ROBERT HURT, Virginia 

STEVE STIVERS, Ohio 

STEPHEN LEE FINCHER, Tennessee 

MARLIN A. STUTZMAN, Indiana 

MICK MULVANEY, South Carolina 

RANDY HULTGREN, Illinois 

DENNIS A. ROSS, Florida 

ROBERT PITTENGER, North Carolina 

ANN WAGNER, Missouri 

ANDY BARR, Kentucky 

KEITH J. ROTHFUS, Pennsylvania 

LUKE MESSER, Indiana 

DAVID SCHWEIKERT, Arizona 

FRANK GUINTA, New Hampshire 

SCOTT TIPTON, Colorado 

ROGER WILLIAMS, Texas 

BRUCE POLIQUIN, Maine 

MIA LOVE, Utah 

FRENCH HILL, Arkansas 

TOM EMMER, Minnesota 

MAXINE WATERS, California, Ranking 

Member 

CAROLYN B. MALONEY, New York 

NYDIA M. VELA ́ ZQUEZ, New York 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

WM. LACY CLAY, Missouri 

STEPHEN F. LYNCH, Massachusetts 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

GWEN MOORE, Wisconsin 

KEITH ELLISON, Minnesota 

ED PERLMUTTER, Colorado 

JAMES A. HIMES, Connecticut 

JOHN C. CARNEY, JR., Delaware 

TERRI A. SEWELL, Alabama 

BILL FOSTER, Illinois 

DANIEL T. KILDEE, Michigan 

PATRICK MURPHY, Florida 

JOHN K. DELANEY, Maryland 

KYRSTEN SINEMA, Arizona 

JOYCE BEATTY, Ohio 

DENNY HECK, Washington 

JUAN VARGAS, California 

SHANNON MCGAHN, Staff Director 

JAMES H. CLINGER, Chief Counsel 

(III) 

C O N T E N T S 

Page 

Hearing held on: 

July 23, 2015 ..................................................................................................... 1 

Appendix: 

July 23, 2015 ..................................................................................................... 49 

WITNESSES 

THURSDAY, JULY 23, 2015 

Calomiris, Charles W., Henry Kaufman Professor of Financial Institutions, 

Columbia University Graduate School of Business ........................................... 5 

Chakravorti, Sujit ‘‘Bob,’’ Managing Director and Chief Economist, The Clearing House Association L.L.C. .............................................................................. 7 

Michel, Norbert J., Research Fellow in Financial Regulations, The Heritage 

Foundation ............................................................................................................ 10 

Parsons, John E., Senior Lecturer, Sloan School of Management, Massachusetts Institute of Technology ............................................................................... 8 

APPENDIX 

Prepared statements: 

Calomiris, Charles W. ...................................................................................... 50 

Chakravorti, Sujit ‘‘Bob’’ .................................................................................. 64 

Michel, Norbert J. ............................................................................................. 74 

Parsons, John E. ............................................................................................... 85 

(1) 

ENDING ‘‘TOO BIG TO FAIL:’’ 

WHAT IS THE PROPER ROLE OF 

CAPITAL AND LIQUIDITY? 

Thursday, July 23, 2015 

U.S. HOUSE OF REPRESENTATIVES, 

COMMITTEE ON FINANCIAL SERVICES, 

Washington, D.C. 

The committee met, pursuant to notice, at 10:04 a.m., in room 

2128, Rayburn House Office Building, Hon. Jeb Hensarling [chairman of the committee] presiding. 

Members present: Representatives Hensarling, Royce, Lucas, 

Garrett, Neugebauer, Pearce, Posey, Luetkemeyer, Huizenga, 

Duffy, Hurt, Stivers, Fincher, Stutzman, Mulvaney, Hultgren, 

Ross, Pittenger, Barr, Rothfus, Messer, Schweikert, Guinta, Tipton, 

Williams, Poliquin, Love, Hill, Emmer; Waters, Sherman, Hinojosa, 

Lynch, Scott, Himes, Foster, Kildee, Delaney, Sinema, Beatty, 

Heck, and Vargas. 

Chairman HENSARLING. The Financial Services Committee will 

come to order. 

Without objection, the Chair is authorized to declare a recess of 

the committee at any time. 

Today’s hearing is entitled, ‘‘Ending ‘Too Big to Fail’: What is the 

Proper Role of Capital and Liquidity?’’ 

I now recognize myself for 5 minutes to give an opening statement. 

I woke up, I guess it was the day before yesterday, to an article 

in one of the Hill publications, I think it was Politico. The article 

dealt with the Dodd-Frank Act, since we have either celebrated or 

bemoaned the fifth anniversary of Dodd-Frank. The subtitle to the 

article was, ‘‘Suddenly, Democrats are resisting any changes to the 

5-year-old financial regulation law.’’ The article goes on to say that 

a number of moderate Democrats are quite frustrated that their 

leadership is preventing them from engaging in meaningful bipartisan work on the issue. 

I do not know the article to be accurate. It certainly feels like it, 

from this position, from this Chair. I just want to again say publicly what I have said privately to my friends on the other side of 

the aisle: The Majority stands ready to work with you to clarify, 

to improve, and to deal with any unintended consequences of the 

law. 

Both Mr. Dodd and Mr. Frank have previously indicated areas 

of the law that they would work on to improve. I trust that they 

continue to be Democrats in good standing. I would hope you could 

2 

be a Democrat in good standing and work with the Majority. I hope 

there is not a knee-jerk ideological reaction to anything that deals 

with Dodd-Frank. Again, but it certainly feels that way. 

I guess, to some extent, though, there is good news, because today’s topic, capital and liquidity, is barely mentioned in DoddFrank. There is a differentiation where Dodd-Frank empowers the 

regulators, who already had, pre-Dodd-Frank, the authority to set 

prudent capital and liquidity standards. They provide for a differential for SIFIs. But outside of that, they are largely silent on 

the issue. 

And regardless of what you believe to be the genesis of the financial crisis, I think we can all agree, looking through the rearview 

mirror, that clearly, capital and liquidity standards were insufficient, to put it mildly. 

Prior to the crisis, there were very complex, risk-based capital 

standards in place. And in implementing these various complex, 

risk-based capital standards—as we know, they were principally 

designed by the Basel Committee out of Switzerland. And regulators in both the United States and in Europe were essentially encouraged to crowd in to both mortgage-backed securities and sovereign debt. Think Fannie Mae, Freddie Mac, and Greek bonds. 

Thus, rather than mitigating financial instability, as the capital 

standards were intended to do, it appears that Basel helped fuel 

the financial instability, rather than continue with Basel help concentrated. 

Now since the crisis, U.S. banks have raised more than $400 billion in new capital, and regulators have required institutions to 

maintain higher capital buffers—again, an authority they possessed pre-Dodd-Frank. I, for one, believe that generally, this is a 

good thing. But the capital standards that were already complex 

have become even more complex with Basel III. I do not necessarily 

believe this to be a good thing. 

Again, relying on regulators to calibrate risk and predict future 

economic conditions according to highly complex models, models 

that neither market participants nor regulators themselves fully 

understand, clearly appears to be a recipe for financial crisis. We 

have seen the danger of one global view of risk. 

So there are a number of questions that this committee must explore. Although capital and liquidity standards have increased 

post-crisis, do we really know by how much? How opaque do balance sheets still appear? How many items that were once off-balance-sheet will find their way back onto balance sheet? What 

amount of capital is the proper amount? Too much, economic 

growth can stall; too little, and too many failures could yet ensue. 

So at today’s hearing, we will explore, is there a better way? For 

example, are we better off measuring capital adequacy according to 

a more straightforward leverage ratio, which takes discretion away 

from regulators and seeks to give greater weight to market forces 

in allocating resources and achieving financial stability? 

Are there specific forms of capital, such as those that convert 

debt to equity? In the event of predetermined market triggers, 

could they promote greater market discipline and better risk management at large, complex financial institutions? 

3 

And to help us with these questions, we have assembled a panel 

of noted experts, and I certainly look forward to hearing their testimony. 

The Chair now recognizes the gentleman from California, Mr. 

Sherman, for 2 minutes. 

Mr. SHERMAN. Thank you. 

I notice here in the audience is Marc Shultz, who up until recently was sitting behind me. Marc is now with the Office of Financial Research, which is housed in Treasury and advises the FSOC. 

And, Marc, I just want to say for the record, you didn’t stop 

working for me; I just stopped paying you. 

You know, Mr. Chairman, the title of this hearing begins with 

the words ‘‘Ending Too Big to Fail.’’ The best approach to end ‘‘toobig-to-fail’’ is to end ‘‘too-big-to-fail.’’ The title should not be, 

‘‘Strengthening Too-Big-to-Fail,’’ ‘‘Improving Too-Big-to-Fail,’’ ‘‘Better Governing Too-Big-to-Fail, ‘‘Watching Too-Big-to-Fail,’’ or ‘‘Scrutinizing Too-Big-to-Fail.’’ We have to end ‘‘too-big-to-fail.’’ 

That is why you ought to join me and Senator Bernie Sanders 

in sponsoring legislation to say ‘‘too-big-to-fail’’ is too big to exist; 

break them up. 

And, Mr. Chairman, this is not a bill supported only by Socialists. It is a bill supported by the ICBA, which represents 90 percent 

of the bankers in this country, or 90 percent of the banks in this 

country, most of whom are not Socialists. 

Until we end ‘‘too-big-to-fail,’’ we will be having ineffective hearings on how to watch the ‘‘too-big-to-fail.’’ They enjoy a basis-point 

advantage when they seek capital, so they are going to keep getting 

bigger and bigger. They are going to put regional banks at a disadvantage. That is why the ICBA endorses this bill, and I hope 

very much that the chairman will, as well, but I am not holding 

my breath. 

The fact is that when we classify entities as SIFIs or ‘‘too-big-tofail,’’ we should be focusing on their liabilities. Lehman Brothers 

did not fail because it had too many assets. And that is why, when 

they start classifying as SIFIs organizations that have no liabilities, whose failure would not leave a single creditor without being 

paid, then I think it is just a desire by the regulators to regulate 

anybody that is big and juicy. 

Instead, we ought to be breaking up those entities whose actual 

and contingent liabilities are of such a magnitude that if they fail 

to pay those liabilities, they take the economy down with them. 

I yield back. 

Chairman HENSARLING. The gentleman yields back. 

The Chair now recognizes the ranking member for 3 minutes for 

an opening statement. 

Ms. WATERS. Thank you, Mr. Chairman. 

Over the years, as this committee has debated, passed, and overseen the implementation of the Dodd-Frank Wall Street Reform 

Act, we have heard a number of doomsday scenarios about the consequences of new liquidity and capital requirements for financial 

institutions. Well, as we celebrate the 5-year anniversary of DoddFrank and as these requirements have gone into effect, I am 

pleased to report that the world hasn’t ended. 

4 

Today, our financial markets are stable and secure. Banks are 

making record profits. Lending is up. And we have a financial system that is stronger, safer, and more resilient than ever before. 

Prior to the financial crisis, regulators were asleep at the switch. 

As banks leveraged up and concentrated their activities in risky 

mortgages while being allowed to rely on their own risk models, 

bank executives made huge bonuses on these short-term gains, but 

when the music stopped, it was taxpayers who took the losses. 

Dodd-Frank mandates that regulators work together to closely 

monitor the Nation’s large banks, setting a floor for capital and liquidity standards to ensure financial companies are risking their 

own capital rather than taxpayer money. Just this week, regulators 

finalized a rule that would require even higher capital standards 

at the largest globally systemic banks that actively seek out the 

riskiest lines of business. 

While the implementation of Dodd-Frank is incomplete, it is already working. A staff report by committee Democrats, released 

this week, found that Dodd-Frank has made our financial system 

more transparent, more stable, and more accountable by arming 

our regulators with vital tools to monitor the financial system for 

risk, increase transparency, and institute new investor protections. 

And to make certain this approach is not overly onerous, DoddFrank has created a flexible and tiered regulatory framework to ensure these heightened standards are tailored to banks of different 

sizes. 

Since the passage of Wall Street reform, the American economy 

has stabilized, adding around 12.8 million private-sector jobs over 

64 consecutive months of job growth, dropping the unemployment 

rate from its peak of 10 percent in 2009 to 5.3 percent currently. 

Mr. Chairman, when discussing the proper role of capital and liquidity, it is important to keep in mind that today our financial 

system is safer and stronger than it has been in a generation, regardless of the claims we hear from the most fervent opponents. 

I thank you, and I yield back the balance of my time. 

Chairman HENSARLING. The gentlelady yields back. 

We are all familiar with the celebrated question, ‘‘Is there a doctor in the house?’’ Today, we appear to have four of them at the 

witness table. 

So, going left to right, today we will welcome the testimony of Dr. 

Charles Calomiris, who is the Henry Kaufman Professor of Financial Institutions at the Columbia University Graduate School of 

Business. His research spans several areas including banking, corporate finance, financial history, and monetary economics. He received a B.A. from Yale University, and a doctorate in economics 

from Stanford. 

Our next witness, Dr. Bob Chakravorti, is the managing director 

and chief economist of The Clearing House Association. He was 

previously a senior economist at the Federal Reserve Banks of Chicago and Dallas. He is the author of more than 40 articles for industry, academic, and Fed publications. He received his Ph.D. and 

M.A. in economics from Brown University, and his B.A. from UC 

Berkeley. 

Next, Dr. John Parsons is a senior lecturer at the Sloan School 

of Management at MIT. He previously worked at the economics 

5 

consulting firm of CRA International, where he was a vice president and principal. He earned his B.A. from Princeton, and a Ph.D. 

in economics from Northwestern University. 

Finally, Dr. Norbert Michel is a research fellow in financial regulations at The Heritage Foundation. He previously taught finance, 

economics, and statistics at Nicholls State University’s College of 

Business. He holds a B.A. from Loyola University, and a doctorate 

in financial economics from the University of New Orleans. 

I do not recall if all of you all have testified before. If not, we 

have this lighting system: green means go; when the yellow light 

comes on, it means you have a minute left; and red means stop. 

Each of you will be recognized for 5 minutes to give an oral presentation of your testimony, and without objection, each of your written statements will be made a part of the record. 

Professor Calomiris, you are now recognized for your testimony. 

STATEMENT OF CHARLES W. CALOMIRIS, HENRY KAUFMAN 

PROFESSOR OF FINANCIAL INSTITUTIONS, COLUMBIA UNIVERSITY GRADUATE SCHOOL OF BUSINESS 

Mr. CALOMIRIS. Chairman Hensarling, Ranking Member Waters, 

and members of the committee, it is a pleasure and an honor to 

share my thoughts on the ‘‘too-big-to-fail’’ problem and, more generally, the problems of bank instability, credit collapses, and financial burdens on taxpayers that result from private risk-taking at 

public expense. 

Title II of Dodd-Frank is supposed to ensure orderly liquidation 

of ‘‘too-big-to-fail’’ banks, now called SIFIs, but is more likely to institutionalize bailouts by establishing specific procedures through 

which they will occur. Rather than pretending that we will have 

the legal mechanisms and political will to liquidate SIFIs, we 

should focus on preventing them from becoming insolvent. That 

means focusing on the adequacy of bank capital and cash. 

Book equity is a poor measure of the true value of equity. When 

banks suffer losses on tangible assets, such as loans, they typically 

delay loss recognition. Overstating equity capital allows them to 

avoid curtailing risky activities. Furthermore, the book value of equity does not capture losses of intangible assets. Lost servicing income, other fee income, and reduced values of relationships with 

depositors and borrowers have been the primary drivers of loss in 

bank values since 2006. 

We should raise equity capital ratio requirements further, but we 

cannot rely only on book equity ratios to measure bank health. We 

need to measure the economic value of equity and put in place reliable regulatory requirements which ensure that banks will maintain adequate and meaningfully measured equity capital. 

I propose requiring alongside a book equity requirement that 

large banks maintain a substantial proportion of funding in contingent convertible debt, CoCos, that converts into equity on a dilutive 

basis when the market value of equity persistently falls below 10 

percent of assets. Dilution ensures that bank managers face strong 

incentives to replace lost equity in a timely manner to avoid the 

dilutive conversion of CoCos. 

Bank CEOs would have a strong incentive to maintain a significant buffer of equity value above the 10-percent trigger. They 

6 

would increase that buffer voluntarily if the riskiness of banks’ assets rose, resulting in a self-enforcing, risk-based equity requirement based on credible self-measurement of risk, in contrast to the 

current system of risk-measurement gaming by banks. 

This CoCos requirement would virtually preclude SIFI bailouts. 

Bailouts cannot occur if banks remain very distant from the insolvency point. 

Additionally, stress tests could be a promising means of encouraging bankers to think ahead, but, as they are structured, stress 

tests are a Kafkaesque Kabuki drama in which SIFIs are punished 

for failing to meet unstated standards. That not only violates the 

rule of law, the protection of property rights, and adherence to due 

process; it makes stress tests a source of uncertainty rather than 

a helpful guide to identifying unanticipated risks. 

And the penalties for failing a stress test are wrong. Limiting 

dividends makes sense for a capital-impaired bank but not for a 

healthy bank in compliance with all its regulatory requirements. In 

that case, it is inappropriate to try to decide the dividend decision 

for the board of directors. 

Finally, the stress-testing standards currently being applied are 

not very meaningful. 

We can do much better. The Fed should be required to provide 

clear guidance. Stress tests should be an input into capital requirements, not used to control dividend decisions. Finally, stress tests 

should focus on the loss of economic value, by analyzing consequences for bank cash flows, divided by line of business, using 

data from bank managerial accounts. That is not happening now. 

Liquidity requirements are another good idea being implemented 

poorly. A better, simpler approach would require SIFIs to maintain 

reserves at the Fed of 25 percent of their debt. To avoid turning 

that into a tax, reserves should bear market interest. This would 

require banks to hold a significant proportion of their assets in 

riskless debt. 

This would not bind on SIFIs today, given their huge excess reserve holdings, nor would this have been binding in the early 

1990s. But it would have been very helpfully binding on SIFIs leading up to the recent crisis. Large banks held 25.8 percent of their 

assets in cash form in January 1994. That fell to 17.2 percent by 

January 2001 and to 13.5 percent by January of 2008. 

Applying to SIFIs the right combination of regulations governing 

book equity, CoCos, stress tests, and reserves would virtually eliminate the risk of ‘‘too-big-to-fail’’ bailouts. 

But that is not the only bank bailout risk we face. The most important source of systemic risk for small banks, the ones that cost 

us so much in both the 1980s and the 2000s with their cost of failure, one that was visible both in the 1980s and the 2000s, was 

their excessive exposure to real estate lending. Real estate risk is 

highly correlated, and it is hard to shed in a downturn. 

As of January 2008, roughly three-quarters of small-bank lending 

was in real estate loans. Large banks had lower exposures but still 

very large ones. The obvious answer is to limit bank real estate 

lending, forcing real estate financing to emigrate to REITS, insurance companies, and other more natural providers of real estate finance. 

7 

These reforms not only would virtually eliminate the ‘‘too-big-tofail’’ problem; they would stabilize the entire banking system, protect taxpayers, reduce regulatory uncertainty, and improve the performance of banks. 

Thank you for your attention. 

[The prepared statement of Dr. Calomiris can be found on page 

50 of the appendix.] 

Chairman HENSARLING. Thank you. 

Dr. Chakravorti, you are now recognized for 5 minutes for your 

testimony. 

STATEMENT OF SUJIT ‘‘BOB’’ CHAKRAVORTI, MANAGING DIRECTOR AND CHIEF ECONOMIST, THE CLEARING HOUSE ASSOCIATION L.L.C. 

Mr. CHAKRAVORTI. Chairman Hensarling, Ranking Member 

Waters, and members of the committee, thank you for inviting me 

to testify today on the critical topic of capital in the banking system. 

My name is Bob Chakravorti, and I am the chief economist at 

The Clearing House, where I oversee empirical studies on financial 

regulations. The Clearing House is a nonpartisan organization that 

represents the interests of our owner banks by developing and promoting policies to support a safe, sound, and competitive banking 

system. I appreciate the opportunity to share my observations on 

regulation of bank capital. 

The strength and resilience of the American banking system are 

essential. Banks serve as unique financial intermediaries between 

those who save and those who borrow and those who are unwilling 

to take risk and those who are willing to bear risk for a price. Our 

modern economy relies on banks to provide these critical financial 

intermediation functions. 

Next, I will offer five key observations. 

First, robust capital requirements are clearly an essential tool for 

promoting the safety and soundness of individual institutions and 

enhancing the stability of the financial system as a whole. Simply 

put, capital acts as a cushion that can absorb potential losses from 

all activities in which banks engage. That, in turn, supports their 

strength and resilience. 

Second, very significant improvements to the regulation of bank 

capital have occurred since 2008, including measures proactively 

adopted by banks themselves. Between early 2008 and late 2014, 

the largest bank holding companies more than doubled the amount 

of their common equity Tier 1 capital relative to risk-weighted assets and substantially increased their leverage ratio. 

U.S. regulators have similarly responded to the crisis by rapidly 

overhauling the bank regulatory capital framework, including: increasing requirements for the quantity and quality of capital; making various asset risk weights more conservative; introducing capital stress-testing and supplemental leverage ratio for larger banks; 

finalizing the U.S. G-SIB surcharge earlier this week; and introducing a total loss-absorbing capacity requirement, which is forthcoming. 

In addition to these very significant improvements in bank capital regulation, other parts of the regulatory landscape are very difVerDate Nov 24 2008 18:30 Oct 12, 2016 Jkt 097158 PO 00000 Frm 00011 Fmt 6633 Sfmt 6633 K:\DOCS\97158.TXT TERI
8 

ferent from what existed in 2007. Many of these improvements are 

specifically designed to reduce systemic risk—for example, a new 

comprehensive liquidity regime which includes the liquidity coverage ratio, the upcoming net stable funding ratio, and liquidity 

stress-testing. Taken together, these measures reduce the probability of default and the systemic impact of that default. 

Third, along with these clear benefits, capital has costs. As 

economists, we like to say there is no such thing as a free lunch. 

My written statement details that, at some point, increasing bank 

capital levels may result in a reduction in key banking activities 

that support our overall economy, including mortgage and smallbusiness lending, commercial lending, market-making, and other financial intermediation services. 

Fourth, I wish there was a clear consensus around how much 

capital is the right amount, but unfortunately, academics and policymakers continue to disagree on this difficult question. What is 

clear, however, is that there are tradeoffs. For example, there is a 

tradeoff of the benefits of increased financial stability at the expense of potential reduction in economic growth. And there are 

competitive impacts for U.S. banks in the global economy that are 

subject to capital standards higher than internationally agreed 

upon. 

Finally, as we wrestle with the question of how much capital is 

enough and where we go from here, I urge you to take into account 

the full consequences of the new regulatory regime, particularly in 

terms of the downstream impact to the real economy that have not 

been fully realized. 

Additional empirical analysis is essential to inform these decisions. This is a good time for policymakers to pause and evaluate 

where we have landed in the tradeoff between financial stability 

and the banking system’s contribution to the U.S. economy. 

Thank you again for the opportunity to testify today. I look forward to answering your questions. 

[The prepared statement of Dr. Chakravorti can be found on 

page 64 of the appendix.] 

Chairman HENSARLING. Dr. Parsons, you are now recognized for 

5 minutes for your testimony. 

STATEMENT OF JOHN E. PARSONS, SENIOR LECTURER, SLOAN 

SCHOOL OF MANAGEMENT, MASSACHUSETTS INSTITUTE OF 

TECHNOLOGY 

Mr. PARSONS. Thank you, Chairman Hensarling, Ranking Member Waters, and members of the committee. It is a pleasure to meet 

here with you today and discuss this subject. 

I think it is very interesting that there is significant unanimity 

here that, in the last number of years, as the chairman pointed out 

and others have, supervisors have substantially improved bank 

capital requirements, and, in many diverse ways, the analysis of 

capital in banking institutions has been improved, which has made 

the system substantially safer. 

So maybe I should just pause for one moment about that substantial agreement. I guess, as an economist, I have to agree that 

there is no such thing as a free lunch. But there are places you can 

get cheap eats, and when you do, you should definitely go for them. 

9 

So, in my opinion, we are nowhere near worrying about major costs 

from these capital requirements to the financial system. 

Let me address very specifically one that has been floated in the 

press for a number of years, and try to flesh out one or two issues 

about that cost. There has been a lot of discussion about perhaps 

liquidity in the corporate bond market has declined and perhaps 

that decline has to do with the regulations on banks and their inability to act as dealers. 

So, first of all, what we really have heard in the press is vague 

worries and discussions about this, identifications of one or two statistics that have changed in the last number of years, vague 

phrases that ‘‘something’’ has changed. So I have a couple of points 

to say about those changes. 

Certainly, some of those changes are a feature and not a bug. 

When the banks have been asked to move their propriety trading 

operations outside the bank and stop doing proprietary trading, 

that is a good thing for the safety of the system, and that trading 

can still go on. Hedge funds can still operate outside of the banking 

system. But that trading is no longer financed by a taxpayer backstop. How much trading is right to be done is something that is determined by the costs and benefits of that trading and the decisions 

of the individual traders, but it is no longer subsidized by taxpayers. That is a benefit to society and not a cost. 

But it is also true that an awful lot of other things are going on 

in the bond market right now. We have watched over the last few 

decades how the equity markets have changed because computing 

power and communication have transformed trading. We have also 

noticed that that has happened in the U.S. Treasury market dramatically over the last few years and seen the report about last October’s problem, because there are difficulties when that happens. 

The trading is cheaper in this newer way, but it has new problems. 

The same thing is beginning to happen in the corporate bond 

market. It is far from what has happened in Treasuries, but it nevertheless is happening. That is technology changing. We need to respond to that, we need to welcome it, and we need to watch for the 

problems that it has. But it has nothing to do with capital standards, and capital standards can’t solve the glitches that arise in 

doing it and make it more effective for society. 

So, that is one thing on the costs. 

The other thing I wanted to raise out of my testimony is, as we 

hear so many different capital standards thrown around, one particular item that has been discussed that I think bears fleshing out 

a little bit is stress tests and how important stress tests are. Several of us agree about that, as well. 

I just want to highlight two ways in which stress tests are very 

important. First of all, they are very forward-looking, which is 

something we need and we all agree is needed. Second of all, they 

allow you to question, sort of, convenient assumptions that are relatively weak in important ways. 

Some people criticize stress tests the way the Fed has applied 

them because they have been ‘‘vague.’’ But really what the Fed is 

doing is inviting bank officers to come to the table and provide 

leadership about what kinds of things we should be worrying 

10 

about, provide leadership in identifying the major risks and showing that the bank is going to be ready for those major risks. 

We should welcome that kind of demand for the major banks in 

the United States to identify and play an active role in ensuring 

that the system is safe. It shouldn’t be a system where the regulators are the only ones involved in determining what counts as a 

safe and healthy system. We should be doing that in partnership, 

and the stress tests are a very good opportunity to do that in partnership. 

Thank you very much, and I look forward to talking more on the 

subject. 

[The prepared statement of Dr. Parsons can be found on page 85 

of the appendix.] 

Chairman HENSARLING. And Dr. Michel, you are now recognized 

for your testimony. 

STATEMENT OF NORBERT J. MICHEL, RESEARCH FELLOW IN 

FINANCIAL REGULATIONS, THE HERITAGE FOUNDATION 

Mr. MICHEL. Thank you. 

Chairman Hensarling, Ranking Member Waters, and members of 

the committee, I am Norbert Michel, a research fellow in financial 

regulations at The Heritage Foundation. The views that I express 

in this testimony today are my own, and they should not construed 

as representing any official position of The Heritage Foundation. 

The aim of my testimony this morning is to argue that a key step 

toward ending ‘‘too-big-to-fail’’ is to promote market discipline by 

eliminating risk-based capital requirements. 

There are three main issues that I would like to address. 

First, recent efforts to restrict the Federal Reserve’s direct lending to firms so that it will closely conform to the classic prescription for a last-resort lender are counterproductive because they do 

not increase this market discipline. 

This classic prescription says that the central bank should readily provide short-term loans to solvent firms on good collateral at 

high rates of interest. But we have to ask ourselves, why would a 

large group of private lenders not make loans on these terms? And 

one of the reasons is because strict regulatory requirements can 

prevent firms from making these loans. 

In this case, the absence of private lending is a regulatory failure, not a market failure. And the removal of these restrictions 

would allow private lenders to make prudent loans rather than 

hold idle funds. 

Unfortunately, Title I of Dodd-Frank has only magnified this 

problem by ensuring that new versions of the Basel requirements 

will be forced on financial firms. These rules, along with other regulatory policies, literally create the need for government-sponsored 

lending under the guise of providing liquidity that the market 

failed to provide. But we should make no mistake that this is a regulatory failure, and major regulatory failures contributed to the 

2008 crisis. 

And that brings me to my second main issue, which is that the 

Basel requirements contributed to the meltdown not because they 

required too little capital per se but because regulators failed to 

properly measure risk. 

11 

The Basel rules were forced on commercial banks in the late 

1980s, and the regulators assured the public at that time that 

these new requirements would, in fact, force banks to hold a cushion against unexpected losses. To build that cushion, regulators literally specified risk levels for bank assets by assigning different 

risk weights. Lower weights required lower capital; higher weights 

required higher capital. 

The system specifically required less capital to be held against 

GSE-issued mortgage-backed securities than against either home 

mortgages or commercial loans. Unsurprisingly, most commercial 

banks followed the same practice. They sold their customers’ mortgages to the GSEs, and they held, instead, the GSE securities. 

So, when the GSEs became insolvent, virtually all banks were 

stuck with nearly the same asset structure and exposed to the 

same losses, even though the typical bank at that time had exceeded its minimum capital requirements by 2 to 3 percentage points 

for the 6 years leading up to the crisis. 

There is no doubt that these statutory capital requirements 

failed and the whole concept is flawed. The only reason that DoddFrank gave us Basel III, indirectly, is because the crisis exposed 

Basel II as deeply flawed before it was even fully implemented. 

And that brings me to my third and final point, which is that 

there is no reason to think that Basel III will perform any better, 

because it maintains the main regulatory flaw that we have basically always had in the United States, which is that regulators, 

rather than markets, determine bank capital standards. 

If we want to improve bank safety, we should scrap this overly 

complicated, top-down system and replace it with a simple set of 

rules that allows markets to adequately price risk and to discipline 

firms that take on too much. 

True reforms would include the repeal of, at the very least, Titles 

I and II of Dodd-Frank as well as the elimination of the Fed’s authority to make loans directly to firms. These changes would provide a credible basis for believing that it is unlikely financial firms 

will be bailed out in a future crisis. 

Then, and only then, will major improvements that expose firms 

to more market discipline be possible. For instance, in return for 

reducing regulations, a simple, flat capital ratio could easily replace the enormously complex Basel rules. Another good option is 

a contingent convertible debt requirement. 

But those ideas still fall short of purely market-determined capital ratios, and that is what our long-term goal should be. 

One way to get there would be to offer financial firms an optional 

escape clause. Allow them to opt out of the Federal regulatory 

framework, as well as the Federal safety net, in exchange for converting to a partnership entity. Thus, in return for real deregulation, financial firms’ owners would be fully liable directly for their 

companies’ losses, as it should be in any business. 

Thank you for your consideration, and I am happy to answer any 

questions you may have. 

[The prepared statement of Dr. Michel can be found on page 74 

of the appendix.] 

Chairman HENSARLING. Thank you. 

The Chair now yields himself 5 minutes for questioning. 

12 

So, Dr. Michel, it is pretty clear that you don’t think BASEL I 

and Basel II historically got it right. It doesn’t appear that you are 

a fan of Basel III either. 

Mr. MICHEL. Not exactly. 

Chairman HENSARLING. Do you have any hope that a Basel IV 

or a Basel V could ever get it right? Or could you simply expound 

upon your views of what is the systemic risk of having one world 

view of risk imposed upon the global financial system? 

Mr. MICHEL. The general problem is that, just sort of like what 

we saw happen last time, you have basically everybody forced into 

the same sort of structure and the same sort of investments or the 

same sort of capital allocations, and if one thing goes wrong, it hits 

everybody equally. 

We have a very long history in the United States of this sort of— 

what I would just sort of call a populist tendency to direct all of 

the bank capital requirements and standards, so to speak, and the 

entire structure of that industry. And it has driven it into the 

ground more than once. I don’t know how many times we have to 

go through this to figure out what we are doing wrong, but— 

Chairman HENSARLING. Dr. Calomiris, you have obviously contributed a very unique idea to the public debate here. 

I read your full testimony, your extended version. So I think you 

have maintained that CoCos would encourage banks to recognize 

losses earlier than they otherwise would because of the aspect of 

market discipline. They would have an incentive to build their capital buffer earlier. 

Can you expound on that view and how this is important to taxpayer protection? 

Mr. CALOMIRIS. Yes. Thank you, Mr. Chairman. 

The basic idea is simple. If banks had to maintain their true economic value of their equity ratio at above 10 percent—that means 

that the market believes that the banks actually have equity in excess of 10 percent of their assets—banks would never be anywhere 

near the insolvency point, and we wouldn’t ever worry about bailouts. 

If you create a penalty for banks in persistently getting below 

that which is credible, then bankers won’t get below it. And CoCos 

are really just a way to create that penalty through a very diluted 

conversion of debt instruments into equity. And if a CEO just stood 

by and let that dilution happen, he or she would be fired. 

And so we are working off the incentives of people to self-identify 

their losses and to self-identify their risks and to hold more capital 

when their risks are high and to replace lost capital very quickly 

because, number one, that CEO doesn’t want to get fired. 

When I was having breakfast with a vice chairman of one of the 

large banks in the summer of 2008, I said to him, ‘‘Why aren’t you 

raising more capital?’’ He said, ‘‘We don’t like the price. And did 

you notice what happened with Bear Stearns? So why should we?’’ 

And what didn’t he like? He didn’t like having to get dilutively 

offering new equity at a price that was too low. But if he had had 

those CoCos hanging over his head, he would have jumped to raise 

new capital to avoid the even greater dilution of that conversion. 

So, that is the basic argument. 

13 

Chairman HENSARLING. Speaking of interest, also in your 

writings you have spoken about a convergence of interest between 

large banks and their regulators that might diverge from the interest of taxpayers in times of stress. You spoke about the Bear 

Stearns scenario. Can you expand upon your views there, please? 

Mr. CALOMIRIS. There is a large literature, academic literature 

that has identified persistent, across many countries, the tendency 

for supervisors to allow banks not to identify losses during recessions. The reason is, if you identify losses, banks might have to curtail credit. That is not popular with politicians or regulators, especially in democracies that hold elections. 

For example, it wasn’t until the 1988 election in the United 

States was over that we recognized major losses in the S&Ls. 

There are some recent articles showing that the same thing happened during our crisis in 2008. 

So we know that we can rely upon supervisors to go along with 

bankers in understating losses, not just in the United States but 

around the world. 

Chairman HENSARLING. The opponents of your idea will say that 

this simply becomes a juicy target for those who will choose to 

short a bank’s equity, that this is a very rich target for short-sellers who wish to game the system. How do you address that concern? 

Mr. CALOMIRIS. A couple of ways. 

First of all, I would only allow qualified institutional investors to 

be holders of this, who are prohibited from short-selling. So they 

would have very little incentive to short-sell. 

Secondly, I said persistent declines in market value, meaning 

120 days. You can’t maintain a profitable short position in a deep 

market, like a market for JPMorgan or something like that, to try 

to push shares down for that long a period. 

So I don’t really think this is a realistic concern for both of those 

reasons. 

Chairman HENSARLING. My time has expired. I now recognize 

the ranking member for 5 minutes. 

Ms. WATERS. Thank you very much. 

I am looking at a definition of ‘‘capital,’’ and I am listening to 

ways that ‘‘capital’’ is defined by different people. 

I want to read something to you. This is for Dr. Parsons. 

Under a definition of what exactly is capital, ‘‘A bank’s capital, 

similar to shareholders’ equity, is the amount left over when a 

bank’s liabilities are subtracted from its assets, which also means 

that a bank’s assets are equal to its liabilities plus its capital. 

‘‘In other words, a bank’s capital ratio describes the mix of debt— 

that is, liabilities and equity—capital—the bank uses to fund its 

assets. Capital is not an amount set aside that cannot be lent. It 

is a source of funds for lending. To remain solvent, the value of a 

firm’s assets must not exceed its liability.’’ 

Now, for you: Banks subject to heightened capital standards 

often point out that these standards prevent them from lending 

into their communities. What would you say to critics of the DoddFrank Act who claim that capital standards hurt borrowers and 

small businesses that want access to credit? 

Mr. PARSONS. Thank you. 

14 

So, yes, you highlight the fact that a lot of people, in discussing 

bank capital, use this terminology, like banks ‘‘hold’’ capital— 

Ms. WATERS. Yes. 

Mr. PARSONS. —as if they immobilize it and don’t use it. And 

that is wrong. The bank is funded by equity, by debt, by a variety 

of sources. All of that money can be put to work in purchasing assets and making loans and so on. So all of that, all sources of capital, debt capital and equity capital, can go to work. It is not a cost 

for the company doing it. 

Some of what people think are costs are because we are subsidizing debt through the tax system, since interest is tax-free, and 

if we force the company to hold more equity instead of debt, in a 

sense the company loses some of its subsidy. But that is not a cost 

to society; that is a cost to that particular—where withdrawing a 

subsidy is not the same thing as a real cost paid out in real resources. 

Ms. WATERS. In addition to capital and liquidity standards, regulators have the authority under the Dodd-Frank Act to use the living-wills process to make the largest banks less risky. How well do 

you think regulators have implemented this provision so far? 

I am really looking at living wills, I am looking at stress tests, 

and I am looking at capital as a way of preventing us from ever 

having to bail out again. Could you give me some discussion on 

that? 

Mr. PARSONS. So, yes, in the financial crisis, of course, we suddenly found ourselves with institutions which were extremely large 

doing a lot of complex activities—activities which were crossing 

many international boundaries, the same units having components 

of their business crossing international boundaries. We found ourselves with regulators unable to really see what the bank was 

doing and to be able to take action because they had some understanding of the bank. 

We have addressed that complexity in a lot of ways—the DoddFrank Act that deals with derivatives in one title and so on and 

so forth. Living wills is one step where you can work with the bank 

to figure out a structure for the bank that is more rational and 

something that the regulators can understand and look to the need 

for resolution so that the bank can participate in structuring itself 

in a way that it can do its business but be prepared so that in the 

case of a crisis it can be resolved in a way which does not disrupt 

the activity, its business, its lines of business, that allows those 

lines of business to go forward. 

I would say that, so far, it has been useful, so we have improved 

things a lot. But we, obviously—as you can hear from the regulators in responding to the living wills, there is obviously a lot of 

complexity and uncertainty that remains and has yet to be worked 

out of the system. 

Ms. WATERS. Thank you so very much. 

Let me just wrap this up by saying, is it correct to say to those 

who claim that capital requirements are preventing banks from 

making loans, that that is just absolutely not true? 

Mr. PARSONS. Yes. 

Chairman HENSARLING. The time of the gentlelady has expired. 

15 

The Chair now recognizes the gentleman from New Jersey, Mr. 

Garrett, chairman of our Capital Markets Subcommittee. 

Mr. GARRETT. I thank the chairman. And I thank the chairman 

for this hearing. 

I would like to jump right into that last question, but before I 

do, one of the books that I really found fun reading that I recommend to everybody is, ‘‘The History of Money from 1776 up until 

the Great Depression.’’ 

And if you go through that and all the stats and everything else 

in between the lines, basically what the point of the book is—or, 

one of the side points of the book is that up until the creation of 

the Fed and the FDIC and what have you, the overriding principle 

in the financial markets was market discipline. 

Because all the local banks had to have their own market discipline because they knew there was not going to be any bailout for 

either the depositors through the FDIC nor bailout for the banks 

through the Federal Reserve or elsewhere. So that was a real incentive to be prudent in your investments and in your lending by 

your Main Street bank, and for the large banks as well, because 

the investors looked at it and said, if you are not prudent, we are 

not going to invest in it because you are a risky market. 

That changed at the turn of the last century, and that, of course, 

changed dramatically again with Dodd-Frank, which basically codifies the idea of ‘‘too-big-to-fail’’ and that the American public is now 

on the hook for bailing out these institutions. 

And this is not just my thought; this is a bipartisan thought. And 

I often give credit where credit is due, and that is my predecessor 

on this committee, the Democrat gentleman from Pennsylvania, 

who often said that we should, when he was working through 

Dodd-Frank, try to place in it some elements that would re-instill 

market forces. Unfortunately, I can’t speak for him, but most of us 

understand that Dodd-Frank did not do that, did not instill market 

forces, but went in the opposite direction. 

So I am going to just—I will try to go left to right. 

Dr. Calomiris, you did a paper I saw back a couple of years ago, 

in 2011, and you were looking at the build-up to the crisis, and you 

gave all the stats and numbers of 2007 and 2008. And you said the 

capital markets were wide open, and commercial banks’ investments were able to raise up to $450 billion in those 2 years. In 

other words, things were going well, as far as the build-up of assets 

and capital. But they were raising preferred shares, which goes 

along your last line of testimony. 

So part of the effective regime going forward is, what, making 

sure that they are holding the right type of capital, right? So if you 

would just comment on that in 30 seconds, because I have a followup on that. 

Mr. CALOMIRIS. My CoCos proposal gets right at your question— 

Mr. GARRETT. Okay. 

Mr. CALOMIRIS. —and has to do with how you bring market 

forces and market discipline into the capital adequacy discussion. 

So the point is, if you require bank CEOs to have to pay attention 

to whether the market equity ratio is falling and have to worry 

about those consequences, they will make sure to maintain capital 

adequacy. 

16 

So that is—I have been working on exactly the topic you are 

talking about for about 20 years, and I think that would be— 

Mr. GARRETT. So is there a perfect or a best number? A 5, 10, 

15, 20, higher percentage? 

Mr. CALOMIRIS. My view is—and it is not based on anything too 

precise or scientific, to be quite frank—is that alongside a 10-percent equity-to-assets minimum requirement, I would have an additional 10 percent of CoCos that would convert into equity if you 

ever got below that 10-percent market equity ratio. 

Mr. GARRETT. So we saw there was a complete failure of Basel 

II, and now we have Basel III. Is Basel III going in the right direction or is it going in the wrong direction with regard to all of this? 

Mr. CALOMIRIS. Basel III depends, as Mr. Michel said, on those 

risk weights being properly calculated by the banks. And I don’t 

really believe in that. 

But I do believe that if we had my proposal on the table— 

Mr. GARRETT. Okay. 

Mr. CALOMIRIS. —if the banks had to comply with that, that 

would incorporate market perceptions of risk and value, and we 

would have an automatic, real risk-weighted capital system. 

Mr. GARRETT. Let’s bring it down to the other end. 

Dr. Michel, you can comment on that, but can you also comment 

on the last question of the ranking member? Is it regulation in the 

market that is affecting lending in the marketplace today, or is it 

just the marketplace? 

Mr. MICHEL. So, first, since it is in my brain, I agree with Charlie’s proposal. It is a great idea. And if it were a question of Basel 

III or the convertible requirements, I am all for the convertible capital. 

Mr. GARRETT. There you go. We have agreement. 

Mr. MICHEL. Yes. 

And then as far as the liquidity and regulation issue, I think it 

depends on how we are defining the terms. In my testimony, I did 

not specifically address, in my mind anyway, higher regulation impacting liquidity in the market as we now stand. I think— 

Mr. GARRETT. I should say, not regulation, but the fallout of the 

regulation, which is the capital requirements. 

Mr. MICHEL. I personally believe that it is more of a supply issue 

than a liquidity issue. I think we are forcing banks to hold more 

liquid assets and hold more assets in general, and— 

Mr. GARRETT. Okay. And that affects their lending ability. 

Mr. MICHEL. And it affects, ultimately, liquidity and lending ability— 

Mr. GARRETT. Thank you. 

Mr. MICHEL. —in the long run, yes. 

Mr. GARRETT. Thank you. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair now recognizes the gentleman from Texas, Mr. Hinojosa. 

Mr. HINOJOSA. Thank you, Mr. Chairman, and thank you, Ranking Member Waters, for holding this important hearing today. 

My first question is going to be for Dr. Norbert Michel. 

In your testimony, you chide the Federal Reserve’s actions during 

the 2008 financial crisis. According to the GAO report cited in your 

17 

testimony, from December 1, 2007, through July 21, 2010, the Federal Reserve loaned financial firms more than $16 trillion through 

its broad-based emergency programs. If I understand your testimony correctly, you suggest that the Fed should not have loaned 

firms any money during that crisis, but rather conducted its traditional open market operation in order to provide market liquidity. 

Given that enormous amount of direct liquidity provided by the 

Fed, do you think the Federal Reserve could have similarly prevented the collapse of the financial system through the traditional 

open market operations alone? 

Mr. MICHEL. Okay, so, technically, I didn’t say that they 

shouldn’t have done that in the crisis. And I don’t think that they 

had any choice at that point, given the system that we have. 

Now, ideally, what I—so what I said is that, ideally, we would 

have a system that would not let them do that. That is what I said. 

And, yes, I do think that would be better. 

I do think that if we reformed the primary dealer system so that 

it is not just a small group of banks involved in Treasury auctions, 

that it is all banks, say, with top two CAMELS ratings, then, yes, 

that would greatly improve liquidity and greatly reduce the chance 

that we would ever need any sort of emergency lending at all. 

Mr. HINOJOSA. Dr. Parsons, I really enjoyed your presentation. 

Do you agree with Dr. Michel that we should get rid of the riskbased capital standards? Why yes, or why not? 

Mr. PARSONS. I don’t really see any alternative to the government playing some role in establishing capital standards. Banks 

are going to be a major part of our financial system, and the dangers of things like runs in different parts of the banks, different activities, are ever-present. And in order to ensure that the system 

will live through turbulent times, the public has to take a role in 

establishing some standards and in guaranteeing that the bankers 

have equity at risk. 

I think we all agree it is equity at risk that we want as a way 

to help guarantee that the banks are prudent in their borrowing. 

And the only way to guarantee that that equity is at risk is a public authority has to mandate it when you allow the bank to have 

a charter and do its banking rules. 

I think, as I wrote in my testimony, banks are very complex institutions; they do a lot of different things. So you absolutely have 

to sometimes be differentiated when you are examining them and 

look for specific risks and look for different amounts of risk. There 

are lots of ways to do that. Risk-weighting was one way to do that, 

but also in the stress tests, that is another way to do it. 

So I think you have to have a public authority who gets in and 

pays attention to the risks. If you try to stand back, you will be 

sideswiped sooner or later. How the public authority, the supervisors, get engaged on the different kinds of risks can be done in 

many different ways. It is very complicated, and I am very openminded about all of those different ways. 

Mr. HINOJOSA. Thank you for your response. 

My next question is for Charles Calomiris. In your testimony, 

you suggest raising the minimum equity asset ratio to 10 percent 

and raising the minimum equity-to-risk weighted asset ratio to 15 

percent. 

18 

What is your advice to commentators trying to protect the ‘‘toobig-to-fail’’ banks if they were to follow your recommendations? 

Mr. CALOMIRIS. My idea in proposing the 10- and 15-percent increases—which aren’t very big increases, but they are increases 

from where we are now—my idea is those aren’t going to be very 

effective if we don’t combine them with other things that make the 

measurement of risk realistic. 

And that is why I really emphasize that my point to them would 

be that this isn’t going to work either unless you do something to 

credibly measure risk. Right now, we allow banks to measure risk 

for us. That is something anyone who has had children knows is 

not a very good strategy. So CoCos are an obvious way to get 

around this problem. 

I should also point out that there are some other good ideas 

which I didn’t have time to get into. We can use markets to measure risk, to some extent, too. Senator Barbara Boxer’s staff and I, 

when Dodd-Frank was being debated, came up with some ideas for 

that, and I am happy to go into it— 

Chairman HENSARLING. Dr. Calomiris, regrettably, the time of 

the gentleman from Texas— 

Mr. CALOMIRIS. And so, there are other ideas I would be happy 

to go into about how to improve it. 

Chairman HENSARLING. The time of the gentleman from Texas— 

Mr. HINOJOSA. Thank you. 

Chairman HENSARLING. —has expired. 

The Chair now recognizes the gentleman from Missouri, Mr. 

Luetkemeyer, chairman of our Housing and Insurance Subcommittee. 

Mr. LUETKEMEYER. Thank you, Mr. Chairman. 

And welcome to our guests this morning. 

Dr. Chakravorti, last week the European Commission published 

a consultation paper on the potential impacts of capital requirements on European financial institutions in the EU economy. The 

paper makes clear the importance of examining the impact of higher capital requirements on lending and the economy. 

European regulators are going to specifically look at the appropriateness of capital requirements, the impact of capital requirements on long-term investments and growth, and the impact of 

capital requirements on lending to small and medium-sized enterprises and consumers. They have also committed to hold public 

hearings on the issue. 

My question to you is, has the Federal Reserve or any U.S. financial regulator expressed the need to examine the implications of 

capital requirements? It looks like the Europeans are sitting down 

and studying it. Are we doing that? 

Mr. CHAKRAVORTI. Thank you for the question. 

Let me first say that I don’t follow the European context, but I 

applaud their decision to study the impacts. I think that is a very 

important factor in deciding regulation, and regulation is a continuous process. And it is very important that research is done in that 

direction, so I applaud their decision to do that. 

Mr. LUETKEMEYER. Don’t misunderstand me. I am not supporting 

them and their models and what they do. My concern is they are 

19 

willing to do the studying before they implement the rules and regulations. It looks to me like we failed to do that in this situation. 

My question is, do you see us, in any respect, studying this beforehand, before we make the rules and implement— 

Mr. CHAKRAVORTI. I hope in the future that we do study it before 

we go further in the rules, absolutely. 

Mr. LUETKEMEYER. Okay. 

Dr. Calomiris, we had a great discussion here with regards to 

capital Tier 1, risk-based assets. Tom Hoenig, who is the Vice 

Chairman of the FDIC—whom I know pretty well and have listened to on numerous occasions—has written extensively, and spoken extensively on capital and risk-based assets and things like 

that. He believes that we need to have about 10 percent Tier 1. 

And then, after that, he does not take into consideration a lot of 

the other risk-based assets that are there, believing that we need 

to have a Tier 1 solid capital structure to be able to be the initial 

backstop. The rest of it is fine, but he believes we need to have at 

least 10 percent Tier 1. 

It appears you are in agreement with that. Would you like to 

elaborate on that a little bit? 

Mr. CALOMIRIS. I agree that there should be a focus that we have 

a 10-percent Tier-1-to-asset ratio, but I don’t think that is enough. 

All that does is basically say that all assets have a risk weight of 

1. But if you do that, there is a danger that banks might decide 

to start making assets have higher risk weights than 1 without 

that simple leverage ratio really solving that problem. That is why 

the CoCos requirement kind of fixes that. 

So I think that is a necessary part of the solution, but it is not 

sufficient. 

Mr. LUETKEMEYER. One of the things that I heard Dr. Michel 

talk about was the CAMEL ratings. And CAMEL ratings basically 

rate the entire bank. It rates your management; it rates your earnings and your capital and also the risk that you take. And, to me, 

it is important that you have a bigger picture. 

We have been focusing just on the risk of the assets, but I think 

if you have somebody who is a CAMEL-1-rated bank, you have excellent loans, you have excellent management, they know what 

they are doing. And so I think it is harder to put a square peg in 

a round hole, and I think that is what we are trying to do here 

sometimes. But I think the CAMEL ratings are a good indication 

of the management of the bank and all of the—a bigger picture. Let 

me put it that way. 

What are your thoughts? 

Mr. CALOMIRIS. I have been doing research on exactly this, and 

it makes the same point I was just making. 

The leverage ratio is sort of all about capital, but it is not about 

earnings. And, in fact, it is what I call balance sheet fetishism. 

Banks lose value because their cash flows shrink. Banks aren’t just 

assets, they are not just tangible assets, and we are acting in our 

capital regulation as if that is true. And banks are in trouble, when 

they get into trouble, because their earnings fall. 

So the point of that camel story that you were you just saying 

is, we need more than just a leverage ratio. And that is why I am 

20 

focusing on those additional items. So the two actually fit together 

well. 

And I know that I am using your time, but I do want to point 

out that I would like to also, if someone is interested, talk about 

the cost of capital requirements on lending. Ms. Waters raised that. 

And I would like to have a chance to talk about that. Because I 

don’t agree with some of the panelists—I think those costs are 

there, but I think we should do it anyway. 

Mr. LUETKEMEYER. Okay. You managed to use up my time. But 

I have one quick question—you made a comment a while ago with 

regards to banks need to get out of real estate lending, and I would 

like to have somebody elaborate on that after a while. Because that 

is kind of a scary thought, to get completely out of real estate lending, unless I misunderstood you. 

Chairman HENSARLING. A very brief answer. 

Mr. CALOMIRIS. I am not suggesting they get completely out of 

it, although I would point out that 100 years ago national banks 

were prohibited from any real estate lending based on the correct 

perception that real estate lending is very— 

Mr. LUETKEMEYER. You realize you are making a really good case 

for GSEs this way. 

Mr. CALOMIRIS. There is more than one way to redirect real estate lending. 

Chairman HENSARLING. The time of gentleman has expired. 

The Chair now recognizes the gentleman from Massachusetts, 

Mr. Lynch. 

Mr. LYNCH. Thank you, Mr. Chairman. 

And, Dr. Calomiris, I might give you a minute or so to expand 

on what you have been talking about at the end of this. 

We are dealing with a situation now where, look, we have higher 

quality, and greater quantity of capital in banks than we did before 

Dodd-Frank, and what we are struggling with is how much capital 

to require banks to hold without leaking out into an area of growth 

where we may inhibit the banks from doing some of the other 

things we want them to do. And we are trying to rightsize this in 

a way that optimizes the use of capital in a way that creates that 

stable environment, yet, again, doesn’t limit growth and other activities. 

Dr. Parsons, we have a situation now where we have foreign affiliates of U.S. banks that are dealing in swaps, and in many cases 

they are not cleared swaps, and they are transferring the risk back 

to their deposit-backed banks here in the United States. And the 

risk that is being created there is not something that I think is 

being addressed in our discussion here today. 

If a foreign affiliate implodes because of uncleared and risky 

swaps transactions, that liability, that risk immediately comes 

right back to the FDIC and on that bank that should be carrying 

sufficient capital but it hasn’t because it is acquired, the risk has 

been acquired by a foreign affiliate. 

Is there anything that you see in either the risk-weighting analysis or the stress testing that could get at that risk that is offshore 

that we don’t require—the financial institutions are arguing that 

they shouldn’t be required to post collateral for their foreign swaps 

21 

affiliate, yet it does create risk, and there seems to be a disconnect 

here. 

Mr. PARSONS. So certainly the supervisors—the Fed certainly has 

authority to examine the company’s full trading in swaps, including 

the impact on its foreign affiliates into the American bank. It is a 

problem, as you indicated, that some of that trading would somehow be covered by the FDIC. That doesn’t necessarily make sense. 

But there are a number of actions going on that can address that. 

So capital requirements at the bank holding company level can 

take into account the riskiness of that swap dealer activity. The living wills effort is an effort that can help shape how that risk can 

travel across boundaries and units, allowing it to be brought back. 

As well as, in the process of trying to set up the orderly liquidation 

authority in the right way, there is this effort to prevent the swaps 

from being settled immediately so that there is time to move 

things. 

All of these are in process, but none of them have been completely implemented, except the authority for capital requirements 

is definitely an authority that the Fed has. 

Mr. LYNCH. Okay. Thank you. 

Dr. Calomiris, you wanted to talk earlier about some of the costs 

that you think this activity might require, but you also said that 

it is stuff we should do anyway. Could you go ahead and elaborate 

on that? 

Mr. CALOMIRIS. Thanks very much for giving me the chance. 

Mr. LYNCH. No problem. 

Mr. CALOMIRIS. I will just mention this because you may want 

to have a staff person look at this. So if you look at page 12, which 

is a reference list for my testimony, you will see there are 4 articles 

there by Shekhar Aiyar and several other people, including myself, 

all published in refereed journals. What these articles do is they 

look at the U.K.’s experience with what effect capital requirement 

changes have on lending supply, because that is the environment 

where we can observe it, because they are varying them a lot on 

a bank-specific basis. There is also research in Spain. 

And they all corroborate the same conclusion, and this is a scary 

conclusion: If you increased capital requirements for a bank in the 

U.K. from 11 percent, which was the mean, to 12 percent of assets, 

you would cause them to reduce the supply of lending to nonfinancial firms by about 7 percent. It is a huge effect. It is about 

10 times what the Basel Committee thought the effects were when 

they were contemplating capital requirement increases. 

So I want to emphasize, it is not correct to say that this doesn’t 

have a social cost. It does. But it is worth it. It is worth it because, 

if the banking system implodes, that is going to be an even worse 

contraction of credit. So you have to run a safe banking system 

even if it means in the short run you are having some negative effects on loan growth. 

That is my answer to your question and also Ms. Waters’ question. It is not a free lunch. It is not even close to a free lunch. 

Mr. LYNCH. I yield back. 

Chairman HENSARLING. The time of the gentleman has expired. 

22 

The Chair now recognizes the gentleman from Michigan, Mr. 

Huizenga, chairman of our Monetary Policy and Trade Subcommittee. 

Mr. HUIZENGA. Thank you, Mr. Chairman. 

Over here, gentleman. This new configuration makes it feel like 

you are in the park across the street from Rayburn. 

Dr. Calomiris, I would like to bite on your debate that you threw 

out there a question or so ago. I am a former licensed REALTOR®. 

I would love for you to hit on the cost of capital on lending ability, 

which you said you wanted to address, and then as you started to 

address, real estate lending and how that may be affected. 

And then I would like to move on, Dr. Michel, to Basel and transparency there. 

Mr. CALOMIRIS. So let’s think about where we are. Let’s just take 

January 2008 for the banking system. Seventy-five percent of loans 

are in real estate, which means either real estate development 

loans or mortgages. 

Real estate is highly correlated and in tune with the business 

cycle, and it is very hard to shed, as a bank, those real estate risks 

during a downturn, which is why, historically, banks have not been 

real estate lenders. 

If you go back to the 1920s, real estate lending was done in the 

United States by insurance companies and building and loans, neither of which financed real estate lending with short-term debt because it is crazy to finance real estate lending with short-term 

debt. 

We do it because we decided politically to do it. We decided with 

deposit insurance to make that happen. It wasn’t a good idea. And 

as banks have lost market share, deposit insurance has kept them 

from shrinking, which they should have done, and instead they 

have pushed them into doing more real estate lending. 

Real estate lending should be done by maturity-matched intermediaries, real estate investment trusts, insurance companies, capital markets of various kinds. It should not be done by short-term 

debt. That is a mistake that we did in the 1930s and since and it 

has cost us. It is politically almost impossible for people sitting in 

this room on both sides of the aisle. 

I am not talking about eliminating it. I am talking about reducing it. Seventy-five percent is a ridiculous number. We should be 

phasing it down. 

Mr. HUIZENGA. Thank you for getting both the REALTORS® and 

the bankers to call my office here very shortly. Very few people can 

unite them that way. 

So I do want to then, really quickly, if you could touch on the 

liquidity standards, capital and liquidity standards. You seemed to 

be indicating that there is a cost of that on lending ability for 

banks. If you could really quickly hit that, and then I want to hear 

from Dr. Michel. 

Mr. CALOMIRIS. There is no avoiding the fact that if you tell 

bankers they have to keep some of their portfolio in cash, that tells 

them that they can’t keep all of it in loans. 

My point is, if you look prior to the runups in the late 1990s and 

2000s, banks in the United States always had riskless securities, 

23 

that is Treasuries plus cash, in excess of 25 percent. In fact, it was 

more like 40 percent during most of the post-World War II era. 

What we have done is, look at where we got by January 2008 

where it was 13.5 percent for the largest banks. They were doing 

that because they could, because they had the safety net. 

The point is, sure, of course, if you require banks to hold more 

cash, it means they will do less lending, but that is not bad. You 

should require them to operate safely. They shouldn’t be able to 

have 100 percent of their assets in loans. 

Mr. HUIZENGA. Okay. 

Dr. Michel, Basel, is there enough transparency there on the 

banking supervision, and your thoughts on that? 

Mr. MICHEL. Okay. And I know I am screwing things up, but I 

would love to add something to what Charlie just said. 

Mr. HUIZENGA. Yes, but you have a minute and 15 seconds. Go. 

Mr. MICHEL. All right. On the transparency stuff, I don’t know 

how we are—I hate to say this—but it depends on exactly what we 

are talking about. Again, if you go back and look at a 1993 Boston 

Fed paper, a 1996 OCC press release, a 2006 OCC press release, 

they basically all say the same thing, that roughly 80 percent of 

the swaps market is in the large banks, we know it is in the banks, 

and don’t worry about anything, the right people are taking care 

of this. We are looking at it. We are dealing with it. 

So that is transparent. The whole thing was transparent. Everybody knew what they were doing. So I don’t know what we added. 

It was already transparent, as far as I am concerned. 

And then I still have 30 seconds. So I agree with Charlie that 

it is a stupid idea to do short-term lending to fund long-term 

projects like real estate. We had a crazy system before the 1930s, 

it got crazier after the 1930s, and we haven’t stopped doing that. 

But we have based all of this on the wrong premise. If we were 

talking about a company like Walmart, Walmart has hundreds of 

millions of customers, and millions of suppliers. Many of those 

businesses depend on Walmart for their living. You can make exactly the same arguments about Walmart that you can about 

banks. And if we were talking about putting a Federal regulator 

in charge of saying who Walmart can sell to, and who they can buy 

from, we would all say that is insane, but that is exactly what we 

are doing now with the banks. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair now recognizes the gentleman from California, Mr. 

Sherman. 

Mr. SHERMAN. Dr. Michel, the one difference with Walmart is 

they don’t have hundreds of billions of dollars of liabilities. And I— 

Mr. MICHEL. Technically, they do. 

Mr. SHERMAN. And reclaiming my time. I certainly don’t see hundreds of billions of liabilities on their balance sheet. Of course, 

there are contingent liabilities. 

I want to shift over to credit rating agencies. We have to have 

risk-based capital, so bank examiners have to determine risk. 

Banks all too often just decide to put all their money in marketable 

securities. So you might have a portfolio of 1,000 marketable securities. 

24 

Now, the credit rating agencies say: Don’t regulate us. Don’t sue 

us. Let us do what we do. And if we ever screw up, it is your fault 

for relying on us. 

Now, let’s say you are a bank examiner. You go in to examine 

a bank and they have 1,000 different portfolio securities, every one 

of which has a rating. The easiest thing to do is to just say, ‘‘Okay, 

well, here is your risk base. You have some B-plus, you have some 

A-minus. Those are your risks.’’ What the credit rating agencies 

say is, ‘‘Ignore our ratings.’’ 

How could a bank regulator independently evaluate the creditworthiness of every marketable bond and CBO in that portfolio 

given the fact that the bond rating agencies charge about a million 

dollars per issue, so in theory, at their rates, that is a billion dollars’ worth of work? 

Dr. Calomiris, can you tell me, could a bank regulator do anything other than rely upon the ratings if they are examining a 

bank with 1,000 different marketable bonds? 

Mr. CALOMIRIS. I came to the conclusion that they can’t. And 

that was the basis for the work that Senator Boxer’s staff and I did 

during the Dodd-Frank discussion, and we drafted an amendment 

that would require the reform of the ratings so that they would be 

useful credibly. I won’t go into that— 

Mr. SHERMAN. I will also point out that we had the Frank and 

Sherman amendment which ends the idea that the issuer selects 

the underwriter, just as—selects the evaluator. I assure you that 

if I could have picked the person to grade my tests in law school, 

I would have done better, especially if I also paid them, and especially if they made a million dollars per test. So the idea that we 

can just let the credit rating agencies sell their ratings to be selected and then say the solution is that nobody should rely upon 

them is manifestly false. 

In evaluating risk, you have not only the default risk, but the interest rate risk. In the materials that were prepared for us for this 

hearing, they describe risk-based capital and said, in effect, sovereign debt of the United States would be given a zero risk because 

there is no default risk. 

There is a huge interest rate risk. If you take in a bunch of 30A 

deposits to buy a bunch of 30-year Treasuries, is it true that under 

Basel III you assign a zero risk to a bank that borrows for 30 days 

and lends to the U.S. Government for 30 years, Doctor? 

Mr. CALOMIRIS. Yes. 

Mr. SHERMAN. Is there anybody in the business world who thinks 

it is risk-free to lend for 30 years and borrow for 30 days? 

Mr. CALOMIRIS. No. 

Mr. SHERMAN. I would also point out the effect this has on our 

districts and the small businesses. A few people have been bored 

in this room listening to me. 

So if you take a huge risk by buying a 30-year bond when you 

are borrowing your money for 30 days, the regulators come in and 

kiss you on both cheeks. If instead you make a 1-year loan to 

Jack’s Pizzeria in my district, they come in, and what kind of reserve do they require? 

Mr. CALOMIRIS. The capital weight would be 100 percent, probably, for that loan, risk-weighted assests. 

25 

Mr. SHERMAN. A hundred. 

Mr. CALOMIRIS. Yes, instead of zero. 

Mr. SHERMAN. So if you play on Wall Street and you invest your 

money on Wall Street, you can have enormous upside and downside risk, and if the upside comes through, you can get a big bonus, 

and the regulators come in and say, ‘‘You are not risky.’’ Even 

though the riskiest thing you could do, that I can think of, is to 

borrow money short, and lend it long, but if you lend to small businesses in our district, pow. 

I yield back. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair now recognizes the gentleman from Wisconsin, Mr. 

Duffy, chairman of our Oversight and Investigations Subcommittee. 

Mr. DUFFY. Thank you, Mr. Chairman. 

It is fascinating listening to my friends across the aisle as they 

have grown over the last 41⁄2 years. They started off telling us how 

Dodd-Frank was going to end ‘‘too-big-to-fail.’’ It was a sure fix to 

end ‘‘too-big-to-fail,’’ if you listened to the debates with former 

Chairman Frank. That is the reason why we have a 2,000-pluspage bill while we have 400 new rules. 

But the tone has changed. They are now admitting that DoddFrank, in all of its sweeping reform, does not end ‘‘too-big-to-fail.’’ 

Does the panel agree with my Democrat friends that Dodd-Frank 

doesn’t end ‘‘too-big-to-fail?’’ There is no disagreement on that? 

Okay. I didn’t think so. 

Mr. PARSONS. I disagree. 

Mr. DUFFY. You disagree with Republicans and Democrats that 

it ends ‘‘too-big-to-fail?’’ 

Mr. PARSONS. I think it makes very important efforts that are 

having an impact on preventing that from happening. 

Mr. DUFFY. But it doesn’t end it. And I think maybe we could 

start, instead of having a movement and a push now to say 2,000- 

plus pages, 400 new rules, we didn’t get it right, so let’s add more 

legislation, more rules, and more regulations onto the ones that already exist, I would actually buy into, let’s repeal Dodd-Frank because it doesn’t work, and it was a failure, and let’s work together 

with a blank sheet and see how we can learn from the lessons of 

2008 and work together to get reform that is actually effective. 

But I want to move on to risk-weighted assets. Risk-weighted assets, does that concentrate risk? 

Mr. MICHEL. Do the risk-weighted assets themselves concentrate 

risk? Because they don’t necessary address risk concentration, if I 

am correct there. I believe they left that out. I don’t believe they 

have addressed that. So— 

Mr. DUFFY. But would it encourage banks to uniformly buy similar assets? 

Mr. MICHEL. Oh, I see. Well, yes, in that sense, yes. You have 

particular assets that have lower weights, so those are going to 

tend to be favored. So in that sense, yes. 

Mr. DUFFY. And if we have more banks holding similar assets, 

does that create more systemic risk? 

Mr. MICHEL. I would argue yes. 

26 

Mr. DUFFY. Yes. So risk-weighted assets actually can create more 

risk, more systemic risk, than actually alleviating that risk in the 

marketplace. Am I wrong on that? 

Mr. MICHEL. No, I think you are correct on that. 

Mr. DUFFY. And how well have our— 

Mr. MICHEL. And the weights have to be right, and we have already messed that up. So— 

Mr. DUFFY. I want to ask you about that. How well have the regulators actually done in getting this right? 

Mr. MICHEL. Personally, I don’t want to—I would say the regulators are not clairvoyant, just like anybody else. So I don’t mean 

this in a bad way necessarily; I just don’t think that you could expect anybody to get it right. 

Mr. DUFFY. Say that again. 

Mr. MICHEL. I just don’t think that we could expect anybody to 

get that right. The stress tests are a great example. I have a lot 

of experience with economic projections, and I think if you gave me 

10 minutes, I could teach pretty much anybody with an Excel 

spreadsheet to do what I can do. It is really not as sophisticated 

as we pretend in economics. If we look at inflation, something like 

inflation, over the last 10 or 15 years you can’t beat a one-period 

forecast of using last period’s inflation. 

Mr. DUFFY. And so, we are trying to find this right balance. We 

all agree that we need sound, smart regulation in our financial sector. No one disputes that. But we need to have some balance between regulation and market discipline. Is that a fair statement? 

Do you think we now have, to the panel, the right balance with 

sound regulation and market discipline? 

Mr. MICHEL. No. 

Mr. DUFFY. Yes? 

Mr. PARSONS. I think we shouldn’t think necessarily of market 

discipline and regulation as if they are opposed to one another. You 

have heard from the panel ideas for ways to structure incentives 

by regulation, the CoCos that are being proposed, that is regulation 

to create market incentives. When we talk about capital standards, 

we are talking about demanding that the equity owners have skin 

in the game to create market incentives to manage the bank right. 

So what we are trying to do in crafting good regulation is to create a healthy market. That is that we are trying to do. 

Mr. DUFFY. Right. And do you think we have been successful in 

the United States in doing that? 

Mr. PARSONS. I think you heard from lots of people that we have 

made great strides since the crisis to right the ship. There are still 

problems, obviously, and there are going to be debates going on for 

a long time. But I think it is important to say we have made some 

really great strides. 

Mr. DUFFY. It seems like my friends across the aisle will oftentimes blame markets for the crisis, and because, they will allege, 

markets fail, we need to look to regulators and give them more 

power and authority. But isn’t it fair to say that the regulators 

failed in the lead-up to the 2008 crisis? 

Dr. Calomiris? 

Mr. CALOMIRIS. Absolutely. And I don’t know if we have time for 

me to answer your first question, we probably don’t, but yes. 

27 

Mr. DUFFY. I haven’t heard the gavel yet. So maybe you can 

start. 

Okay. 

Chairman HENSARLING. Now, the gentleman has heard the gavel. 

The time of the gentleman has expired. 

The Chair now recognizes the gentleman from Georgia, Mr. 

Scott. 

Mr. SCOTT. Thank you, Mr. Chairman. 

I would like to talk about, get the panel’s thoughts on Basel III’s 

leverage ratio and its impact on banks. The crux of the matter is 

this: These new capital requirements for our prudentially regulated 

financial institutions are indeed vast in scope, and indeed, they are 

a necessary means to ensuring that banks are properly capitalized, 

as warranted under Dodd-Frank. 

But there is one narrow aspect that seems to be working at odds 

with the principles of the Dodd-Frank Act, as well as long-established market regulations, and that fact is this: End-user customer 

margins, which have long been posted to bank-affiliated clearing 

members for the clearing of derivatives, are treated punitively. 

Recently finalized capital rules consider client margins something the bank can leverage, even though Congress has for decades 

required that customer margins posted by clients for cleared derivatives must remain segregated from the bank-affiliated clearing 

members’ own accounts and that it should be treated as belonging 

to the customer. 

Now, here is the first question. How is it now assumed that the 

margin can be used by the bank as leverage? More specifically, the 

Basel III leverage ratio now extends to off-balance-sheet exposures 

that are not driven by accounting rules. 

And in this off-balance-sheet context, my second question is, why 

is customer margin collected by a bank-affiliated member of a 

clearinghouse being treated as something the bank can leverage 

when Congress has long required such margin to be segregated 

away from the bank’s own resources? 

Could I get a comment on that from Dr. Parsons or Dr. Michel, 

and—I don’t want to murder those last two names there, so I will 

say the two gentlemen on the end whose names begin with the letter ‘‘C.’’ 

Mr. PARSONS. I think the basic issue you are bringing up about 

customer margin, the reason why it has become an issue as you 

highlighted, the problem is you are dealing with a business to be 

a futures commission merchant or a swap dealer collecting margin, 

that is a business, and that business has some risks. They are trying to measure the size of that business as a proxy for measuring 

the risk of that business. 

And the customer margin is part of what defines the size of the 

business. If you have one company offering more swaps to its customers and having larger margin, you have a larger business. And 

so you need to think about the riskiness of that business and 

charge capital for it. 

Now, if it is true that you can successfully segregate it and guarantee that there is never any real risk of those funds getting back 

to the customers, there might be some way around that. And it is 

also true that there should be a way of improving the measurement 

28 

of risk. So with derivatives themselves, with the market value of 

the derivatives themselves, they calculate these potential exposures 

instead of using book value of the assets. And that is one, I think 

it is clunky, but it is an effort to do what you want done. 

Mr. SCOTT. But don’t you feel, though, that the Basel III leverage 

ratio misinterprets the exposure-reducing effect of segregated margin? 

Mr. PARSONS. I think the problem is people want to either treat 

things one way or another, and we need to arrive somehow at a 

better destination. Treating it, that dollar, as being 100 percent exposed maybe is the wrong thing, but saying because it is segregated, legally there is no risk in that business, that is clearly also 

wrong. So we are sort of—we are finding that we need to get a 

more sophisticated appreciation of the problem. So something 

needs to get done to improve it. 

Mr. SCOTT. Okay. My time is up. I’m sorry. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair now recognizes the gentleman from South Carolina, 

Mr. Mulvaney. 

Mr. MULVANEY. I thank the chairman. 

Gentlemen, I want to talk about something a little bit different 

here today. We had the opportunity to talk to Mr. Hoenig about 

ways to relieve regulatory burdens on various entities. 

Some interesting work, by the way, that other members of the 

committee and I have been discussing—myself, Mr. Schweikert, 

and Mr. Hill have tried to figure out a way to carve out certain 

banks from the larger regulatory scheme, to say, look, there are 

some banks that don’t need the extra level of oversight that we get 

with Dodd-Frank. They aren’t sophisticated. They aren’t interconnected. They don’t present a systematic risk. And many times 

that is not based on their size, but by their business models. 

I am just curious if anybody has given any thought to that, if 

they are familiar with what Mr. Hoenig had talked about, and if 

they had any thoughts on this concept of creating, not a second 

banking system, but a different type of system where you could opt 

out of certain regulatory requirements if you were a very simple, 

well-capitalized, well-run bank. And I would be curious to know 

opinions in favor of that and opinions against that as we simply try 

and gather information and do our research. 

Dr. Parsons, do you want to start? 

Mr. PARSONS. As I indicated in my testimony, it is true that 

there are lots of different types of banking activities, and this effort 

to have many, many different ratios is an effort to cope with the 

many different activities sometimes bundled into one bank. If you 

can find a way to carve some out and define them and say, ‘‘I am 

only doing this, and therefore I only have certain risks,’’ and if that 

is real, then that should be a sensible way to adjust the capital 

ratio. 

Mr. MULVANEY. Yes, sir. 

Mr. MICHEL. I would be in favor of it as well. In a more expansive way, I would be in favor of it for everybody. Instead of letting 

the regulators decide what is really risky and what is really complicated and what is really simple, let the markets decide. Have the 

29 

carve-out. Let them do that. Let the investors decide on their own 

and let them take the loss. 

Mr. MULVANEY. Yes, sir. 

Mr. CHAKRAVORTI. I think if you tailor according to the underlying risks and what you outline, that is definitely an advantage 

for the system as a whole. 

Mr. MULVANEY. Dr. Calomiris? 

Mr. CALOMIRIS. I agree. I think if we can get to the point where 

we know bankers are playing with their own money and not ours, 

and we also know that they are not doing things that are very hazardous in terms of highly correlated risks, so that they are not creating credit crunch risk for the whole economy when we have a 

downturn, then we don’t have to micromanage with this excessive 

interference in how they run their business. And I think, again as 

Dr. Michel said, this applies to all banks. 

I would point out that the regulatory costs are very different 

from different regulations for different kinds of banks. If you ask 

small banks, they will tell you QM compliance, qualified mortgage 

compliance is very costly for them. If you ask large banks, they 

might come up with a different answer. 

So I think the point is, this micromanagement is a lose-lose. It 

makes our banks not perform well, and it makes them not perform 

well for us, not just for their stockholders. So, yes, that is why we 

want to have good capital rules, and I think the CoCos for the large 

banks would get us there. 

Mr. MULVANEY. The one criticism I have of what Mr. Hoenig has 

suggested is that he seems to want to limit it to community-based 

financial institutions and he doesn’t want to take it to the larger 

scale. 

By the way, for purposes of the discussion, his brief summary is 

that banks that hold effectively zero trading assets or liabilities, 

banks that hold no derivative positions other than interest rate 

swaps and foreign exchange derivatives, and banks whose total notional value of all the derivatives’ exposures would be less than $3 

billion, that is the basic concept that he is trying to lay out there. 

But he limits it to community banks, to smaller banks. 

Is there any reason to do that, in your mind, Dr. Calomiris? 

Mr. CALOMIRIS. I would say no. I know Tom pretty well. He 

comes from Kansas. And the banks that are sort of in his experience, in his frame of reference, are pretty small banks, and I think 

he has a lot of sympathy for them, especially since a lot of them 

have to also compete with the subsidized farm credit system, which 

doesn’t have to retain branches but gets to raise its money through 

a GSE. 

So small banks in places like Kansas are really taking it on the 

chin. But that doesn’t mean we should only focus on them. I think 

it needs to be a broader focus. 

Mr. MULVANEY. I thank the gentleman. 

I yield back the balance of my time. 

Chairman HENSARLING. The gentleman yields back. 

The Chair now recognizes the gentleman from Illinois, Mr. Foster. 

Mr. FOSTER. Thank you, Mr. Chairman. 

30 

And I would like to say that as the author of the Dodd-Frank 

amendment that authorized contingent capital but did not mandate 

contingent capital, I am thrilled with the fact that there appears 

to be the possibility of some bipartisan, maybe even consensus, that 

this could be part of the solution to strengthening capital requirements beyond what is already in Dodd-Frank. 

It is interesting to go through the history of this. To my knowledge, it is Mark Flannery of the University of Florida who first significantly—for the record, Dr. Calomiris gave me a strong nod on 

that—whom I think deserves credit for raising this in a significant 

way. Then the Squam Lake Working Group later picked it up and 

identified it as one of the major elements of strengthening bank 

capital requirements. 

I was particularly influenced by an analysis by Steve Strongin’s 

group at Goldman Sachs where they did a retrospective analysis of 

the failure and concluded that had banks been required to hold 

contingent capital, they would have raised capital early in the crisis when they still could have, and that at least the banking part 

of the crisis would have largely been avoided. 

And this has to do with a point that Dr. Calomiris has made, 

which is that they would be worrying not about being insolvent, 

but being in violation of capital requirements or the trigger mechanism. 

The Squam Lake Group worked through a variety of trigger 

mechanisms. You appear to be an advocate of a market-based one. 

There are regulatory. There are a variety of these. 

At the time of the Dodd-Frank hearings and the amendment that 

I got adopted into both the House-passed and eventually the final 

bill, it was difficult to mandate, to adopt a mandate, because there 

was no experience with these. Since that time, the Europeans have 

a lot of experience, successful experience, I believe, with CoCo 

bonds with a variety of trigger mechanisms. So I think there is a 

lot to be learned, but I think they are generally viewed as a successful experiment. 

Now, that is particularly the case with the Swiss banking system. Switzerland is in a tough place because they have giant 

banks, which they want to have, but their economy isn’t big enough 

to realistically backstop. So they have had to have a very deep capital stack to handle their ‘‘too-big-to-fail’’ problem, which is handled 

significantly with CoCo bonds. 

And so I think that there is a lot more experience today than 

there was at the time we passed Dodd-Frank, and I think that proceeding in this direction is something that, on a bipartisan basis, 

we really should proceed on. 

Okay. So the first question I have here is, what has been learned 

by the European experience in this, particularly in terms of the 

pricing of these instruments? 

Dr. Calomiris? 

Mr. CALOMIRIS. We have learned a few things. One is that these 

issues were oversubscribed by the market. A lot of people said the 

market wouldn’t want to buy them. They were oversubscribed. So 

obviously the market does want to buy CoCos. Institutional investors were very attracted to them. 

31 

But we haven’t really tested them because the test of them comes 

on the downside. And my own view is that the market trigger is 

a much better idea than what the Swiss have used, which is a regulatory trigger, precisely because regulators and supervisors are 

not dependable during downturns to really identify the losses and 

to trigger the mechanism, because it is going to be very politically 

difficult to do it. 

And, by the way, all the things you cited, from Flannery through 

Goldman Sachs, are cited in my study, which is a review of that 

whole literature. And I would associate myself strongly with everything you said. 

Mr. FOSTER. Let’s see. So I will give you also the pricing. There 

is the question of whether they oversubscribed. The thing that I 

found particularly encouraging about it, if you looked at the presentations to potential debt investors by organizations like Credit 

Suisse, is they have exactly the kind of transparency that you 

would love to see. In order to get a good price, they have to reveal 

their books to the market. And so you really get this market-based 

feedback that I think is a fundamentally good addition to regulatory oversight. 

My next question is, what areas of U.S. law would need to be 

changed in order to actually implement contingent capital? These 

are changes in tax law, for example. You mentioned that there 

would be requirements or prohibitions from different groups on investing in these, because obviously you don’t want the ‘‘too-big-tofail’’ firms investing in each other’s contingent capital. 

So what are the specific other legal changes that would be necessary to actually get this implemented in the United States? 

Mr. CALOMIRIS. I think the most desirable obvious one is to make 

it clear that, at least for my version of CoCos, they should be treated as deductible debt. 

Now, the key issue here, and it also affects pricing, is are we 

talking about bail-in CoCos, which I am not talking about, or are 

we talking about these sort of preventative CoCos that make banks 

raise capital? In my version, I would say that these CoCos are almost never going to convert because the whole point is to make 

banks avoid conversion. Whereas the bail-in CoCos that some people have devised, including, unfortunately, I think the Swiss model, 

they convert at very low regulatory trigger ratios. And so those are 

going to have to be priced with higher yields because there is more 

risk associated with those. 

So my answer is, I think the tax law has to recognize that if the 

CoCos is as CoCos does, if they are my kinds of CoCos, they should 

be treated as debt. If they are bail-in CoCos, maybe they should be 

treated as a mix of debt and equity for tax purposes. So there is 

a little bit in the weeds here. I am sorry to give such a technical 

answer. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair now recognizes the gentleman from North Carolina, 

Mr. Pittenger. 

Mr. PITTENGER. Thank you, Mr. Chairman. 

And I thank each of you for being with us today. 

Senators Vitter and Brown have recommended that the banks 

maintain a leverage ratio of 15 percent. Do you believe that this 

32 

is an appropriate means by which we should address this, and 

would you be supportive of it? 

Dr. Michel? 

Mr. MICHEL. It gets to one of the problems, which is that this is 

an arbitrary—these are all arbitrary numbers. So, that is one 

issue. But if we are talking about simply raising the number and 

leaving all the other regulations and requirements in place, then, 

no, I am not. 

Mr. PITTENGER. No, I am not saying they need to be. It was an 

offset to that. It would require a less intrusive regulatory environment to do that. 

Mr. MICHEL. I am sympathetic to the idea that you want them 

to hold more capital, but I would still think that the contingent 

convertible debt is a much better way to go than something like 

that. And it has to have the offset. 

Mr. PITTENGER. Sure. 

And, Dr. Calomaris, you have already spoken to that, but I would 

be glad to have you— 

Mr. CALOMIRIS. Just to say briefly, my version has 20 percent absorption capacity, but it mixes it in equity and CoCos 10 and 10, 

rather than just 15 in equity. And the point is that during a downturn, this is more robust, and it relies on the incentives of banks 

to make sure that we are measuring real capital. That is, I think, 

what is missing in the Brown-Vitter proposal. 

But I have supported the idea of the Brown-Vitter proposal, 

which is we need to increase the absorptive capacity. I want to 

make it 20 percent, but make it 10 and 10 rather than 15 all equity. 

Mr. PITTENGER. Dr. Chakravorti, do you have a perspective on 

this? Is there a sweet spot as it relates to capitalization and credit 

access? 

Mr. CHAKRAVORTI. What I think needs to be done in the capital 

space is you need to have a belts-and-suspenders approach. So we 

have multiple ways to regulate capital. One is risk-based, one is leverage, one is stress testing, and the other that hasn’t been talked 

about right now is something called the TLAC requirement, that 

you have to hold debt that would convert once you are a going certain. 

So I think once you combine all of these different regulations, 

and you need them because they do different things, as we have 

discussed, just a straight-out leverage ratio doesn’t weight risk appropriately, but at the same time, risk-based regulation may not 

get it right. We discussed that stress testing actually has the benefit of having scenarios to look at it. So to try to calibrate that 

number, one has to look at the totality of those regulations. 

Mr. PITTENGER. Thank you. 

Dr. Michel, please just expand on your perspective of how DoddFrank has exacerbated ‘‘too-big-to-fail.’’ 

Mr. MICHEL. How has it exacerbated ‘‘too-big-to-fail?’’ 

Mr. PITTENGER. Yes. 

Mr. MICHEL. In the first place, if you want to end ‘‘too-big-tofail,’’ you don’t have regulators identify the banks that we say we 

can’t live without. So if you are identifying systemically important 

financial institutions, systemically important financial market utiliVerDate Nov 24 2008 18:30 Oct 12, 2016 Jkt 097158 PO 00000 Frm 00036 Fmt 6633 Sfmt 6633 K:\DOCS\97158.TXT TERI
33 

ties, and saying that, look, the regulators believe these guys go 

down and they kill the economy, you have a really tough case to 

make for having ended ‘‘too-big-to-fail.’’ 

If you go beyond that and you look at Title II, Title II takes the 

parent holding company and basically wipes it out in order to keep 

the subsidiaries going. So everybody knows that going in. 

And the bridge company is exempt from taxes, and the bridge 

company can only get funding really and truly from the Federal 

Reserve or the FDIC. If you look at it and say, well, they are prohibited from getting these funds, that is not quite right, I don’t believe. The fact is that they can only go into the Title II proceeding 

after the Fed and the FDIC certify that there is no private funding 

available for the bridge company. 

So I think Title I and Title II, easy. Title VIII is a sort of newfangled entity, the financial market utility, that comes under this 

umbrella as well. So those three titles alone pretty much seal the 

deal in terms of perpetuating ‘‘too-big-to-fail.’’ 

Mr. PITTENGER. Yes, sir. Thank you. 

I yield back. 

Mr. NEUGEBAUER [presiding]. I thank the gentleman. 

And now. the Chair recognizes himself for 5 minutes. 

On Monday, as many of you know, the Federal Reserve finalized 

its G-SIB capital surcharge rule, which would be applied to eight 

of the United States G-SIB bank holding companies. And the final 

rule imposed a surcharge that almost doubled the surcharge proposed by the Basel Committee in some cases. Thus, U.S. financial 

institutions will be required to hold significantly more capital than 

their foreign competitors. 

Vice Chairman Stanley Fischer raised that question, the global 

financial competitiveness, at the Board’s opening meeting. His concerns were kind of summarily dismissed by the Federal Reserve 

staff. 

This is not the first time, and likely not the last time, that we 

are seeing the United States go beyond the Basel standards. We 

have seen the Federal Reserve do this with the supplementary leverage ratio. We are likely to see it do the same with the net stable 

funding ratio and TLAC proposal. 

Dr. Chakravorti, do you worry about the U.S. competitiveness if 

we keep making the U.S. banks play by a different set of rules 

than the international banking community? 

Mr. CHAKRAVORTI. Thank you for the question, Mr. Chairman. 

The way I view it is we have done a lot of work on the G-SIB 

when the G-SIB proposal was announced, and what we found is 

that there have been various improvements in the systemic risk of 

these banks because of various regulations, and that really wasn’t 

incorporated. 

So the idea that the Federal Reserve would increase over and 

above the Basel requirement and come up with its own metric, 

which is called Method 2, certainly leaves the banks at a disadvantage to foreign competition. And it is something that it wasn’t really well justified in doing so, especially when they agreed upon the 

standard coming out of Basel. 

Mr. NEUGEBAUER. Dr. Michel, do you have anything to add to 

that? 

34 

Mr. MICHEL. No. I don’t have anything to add to that. I think 

that is accurate. I don’t have anything additional to say there. 

Mr. NEUGEBAUER. One of the issues that I have heard this week 

from one of the larger financial institutions is that there is a disincentive now for them to hold certain kinds of assets because the 

more assets that they hold, the more capital they have, maybe the 

more liquidity, and that certain kinds of assets just don’t generate 

that same kind of return to justify having to go out and bring in 

additional capital or to bring in additional liquidity, which in many 

cases may not earn a return to justify holding those kind of assets. 

How do we address this displacement and this understanding 

that some of these assets are actually going to global banks outside 

the United States because they are able to deal with those assets 

in a different way regulatorily than these domestic banks? 

Mr. CHAKRAVORTI. Sir, you are absolutely correct in saying that 

when you regulate you are going to have some market impacts on 

certain products. And those products, sometimes they are an intended effect, and sometimes they are an unintended effect. But 

what is clear is that if the regulated banking sector does not provide it, there is a risk that that product will be provided outside 

the banking system, whether it be in the United States or outside 

the United States. 

When that occurs, it is not clear that where it is going to is as 

strongly regulated as the banking sector. So in fact you might actually increase systemic risk, something that you don’t really want to 

do, by proposing the regulation if your intent is to reduce it overall 

in the financial system. 

Mr. NEUGEBAUER. Dr. Parsons, I wasn’t here, but I think Mr. 

Duffy asked all of the panel if they thought that Dodd-Frank had 

ended ‘‘too-big-to-fail.’’ And I believe you said that you thought it 

had ended ‘‘too-big-to-fail.’’ Is that correct? 

Mr. PARSONS. I think it has reduced ‘‘too-big-to-fail’’ significantly. 

I think having a healthier financial market with better capital requirements that reduce the taxpayer backstop is a good thing. And 

if another society wants to lower their capital requirements and 

have their taxpayers subsidize their banking business, I don’t think 

it is good for the United States to get into competition in putting 

the taxpayers’ money behind the banks. 

I also think having a healthy financial system here is competitively good for the United States. And so I don’t think getting into 

a competition to keep our capital requirements low is going to help 

business here. We have always had extremely good financial markets that have been attracted capital to the United States. 

Mr. NEUGEBAUER. The reason I ask that question is because I believe in April of 2013 you wrote an article with your colleague 

Simon Johnson in which you basically dismissed the arguments 

that Dodd-Frank had ended ‘‘too-big-to-fail.’’ So have you changed 

your position now? I am a little confused by that. 

Mr. PARSONS. No. First of all, I was very careful to say we have 

reduced it because there are a lot of problems that remain. The fact 

that we haven’t taken care of the living wills, the fact that we still 

don’t understand the orderly liquidation authority, we haven’t fully 

implemented it, those are very critical problems that we need to resolve. 

35 

Also, we just on Monday had these surcharges placed on the GSIBs. So those surcharges will make those banks reevaluate activities which are activities potentially that the taxpayer has to backstop. 

And so we are watching a process, and that process is still not 

complete. But we have made great progress. 

Mr. NEUGEBAUER. Okay. My time has expired. 

I now recognize the gentleman from Kentucky, Mr. Barr, for 5 

minutes. 

Mr. BARR. Thank you, Mr. Chairman. 

And thanks to our witnesses here today. 

Dr. Michel, a quick question for you. We have heard a lot about 

the causes of the financial crisis. And one of those narratives is 

that deregulation and unrestrained free markets were the cause of 

the financial crisis. 

Can you elaborate a little bit more on your testimony about the 

fact that there was plenty of regulation, in fact quite a bit more 

regulation was added to the Federal Register in the run-up to the 

financial crisis, but that it was dumb regulation? And in particular, 

can you amplify your testimony about the risk-weighting approach 

of the Basel capital standards and how that may have contributed 

to the financial crisis? 

Mr. MICHEL. The Basel portion—and so, yes, I agree. And I have 

written quite a bit about this and listed a lot of other regulations 

that were supposedly deregulations that were just different kinds 

of regulations. 

The Basel portion, though, we have developed a system that literally weights certain things heavier than others. So there is a 

built-in incentive in that system to buy more assets that have 

lower risk weights—or, I’m sorry, to hold more assets that have 

lower risk weights. 

And if you go back to the history of that, in the 1950s the Federal Reserve started the risk-bucket approach. It was picked up 

and used in the 1970s by the Basel Committee. The whole idea was 

to better match risk and capital to lower capital. That is the whole 

idea. 

Mr. BARR. Specifically, can you speak to the risk weighting of 

GSE mortgage-backed securities? 

Mr. MICHEL. Sure. My numbers might be off. I know they are in 

my written testimony. I think you could lower your capital by 60 

percent if you held the GSE mortgage-backed security instead of 

the actual mortgage. 

Mr. BARR. So Fannie Mae and Freddie Mac led to the largest 

taxpayer bailout in American history primarily because of bad government policies that induced the origination of subprime mortgages, and yet the regulators got it wrong in terms of the risk 

weighting of those assets. Is that correct? 

Mr. MICHEL. Yes, that is correct. They also got the private label 

mortgage security weight wrong. 

Mr. BARR. And Dodd-Frank, although it doesn’t specifically require adoption of Basel III, it does, as you said, in Sections 165 and 

171 direct Federal banking agencies to implement Basel III proposals. Do the Basel III proposals in any way make adjustments 

36 

that signal that they have learned from their mistakes in the runup to the financial crisis? 

Mr. MICHEL. The GSE mortgage-backed security risk weight is 

the same. The private label has been restructured completely. 

There is not really one number. That is kind of a mess. 

Mr. BARR. Let me just move on really quickly. You have talked 

about how Dodd-Frank, obviously through the designation process 

designating systematically important financial institutions, enshrines ‘‘too-big-to-fail,’’ but what about exacerbating ‘‘too-big-tofail?’’ And what I mean there in particular is all of the additional 

capital requirements, the regulatory compliance costs imposed on 

small community banks—we know that since 2010, we have lost 

1,200 banks. There have been only four de novo charters. There 

has been a dramatic consolidation of banking. 

Dr. Parsons thinks that Dodd-Frank has reduced the problem of 

‘‘too-big-to-fail,’’ but how have we done that if we have fewer banks 

and there is concentration of risk in larger, more systemic institutions now, much more so than before 2008? 

Mr. MICHEL. We have a long-term trend that has been exacerbated by regulation in general. Dodd-Frank has certainly made 

that worse. And we have literally concentrated the banks more. So 

it is, again, pretty hard to argue that we have reduced that problem in that respect. Yes, I would agree there. 

Mr. BARR. Let me just go to any one of you on the opaque nature of stress tests, and specifically for regional banks over $50 billion. 

I am thinking of small regional banks whose management has expressed to me and others that the CCAR requirements are very 

opaque, that there is not really any predictability in terms of knowing whether or not they are going to pass or fail these stress tests, 

and specifically this Comprehensive Capital Analysis and Review. 

What they have told me is that it has dramatically increased 

their compliance costs and that the increase in compliance cost 

means less capital deployed in their community. 

Dr. Calomiris, could you speak to that? And, in fact, I would 

want to reference back to your testimony where you described the 

stress testing process as ‘‘Kafkaesque Kabuki’’ drama. Can you 

elaborate on that a little bit? 

Mr. CALOMIRIS. Thanks for asking. So Kafkaesque because what 

Kafka, of course, made fun of was governments that would sort of 

make up the rules after they saw what you did. And that is exactly 

what we do with the stress tests. You don’t have to reveal what the 

rules are. You are going to be held accountable. 

And even if the Fed’s own secret quantitative measure of your 

risk shows that you don’t have a problem, they still reserve the 

right based on qualitative, whatever that means, beliefs to make 

you fail. That is Kafka incarnate. 

Kabuki, because it is a particular sort of drama that is very 

staged. So it is both a staged drama and a Kafkaesque drama, so 

hence ‘‘Kafkaesque Kabuki.’’ 

For small banks, of course, they are just not set up. As you pointed out, they can’t deal with the overhead of actually doing this on 

a credible basis. This is a fairly complicated thing to do. 

But my view is that stress tests, if the Fed is held accountable 

for a framework, can be extremely useful for large banks. But we 

37 

have to make it based on real data, not based on what the Fed is 

doing. But looking at cash flows and making banks think about 

themselves, line of business by line of business, modeling their cash 

flows, I can tell you, could be done a lot better. 

Mr. BARR. Thank you for your testimony. 

Mr. NEUGEBAUER. The time of the gentleman has expired. 

The gentleman from Pennsylvania, Mr. Rothfus, is recognized for 

5 minutes. 

Mr. ROTHFUS. Thank you, Mr. Chairman. 

Dr. Calomiris, I want to follow up on a couple of those points. 

The capital and liquidity standards developed by the Basel Committee are intended for large internationally active banking organizations. U.S. regulators have defined that concept as any banking 

organization with: (A) $250 billion or more in total assets; or (B) 

more than $10 billion in on-balance-sheet foreign exposure. 

Do you believe the threshold set by regulators based on assets or 

foreign exposure is appropriate for capturing those large and internationally active banking organizations the Basel standards were 

intended and designed for? 

Mr. CALOMIRIS. Quick answer, no. And more generally, I don’t 

think there is any intellectual basis, either in logic or fact, that 

stands behind these liquidity standards as they are constructed. 

They were simply arbitrarily constructed. There is no theory and 

there is no fact supporting them, much less the cutoff, which I 

think runs against the whole history of how we think about cash 

regulations. 

Remember back in U.S. history, we required money center banks 

in New York to maintain 25 percent in cash, but then we required 

country banks to not have to maintain quite so much in cash because banks that are at the center of the system have a more important systemic liquidity risk. So I don’t think that this—I think 

it is almost for sure. 

Mr. ROTHFUS. Well, yes, because there is an issue that these regulations bleed over into areas that they maybe weren’t intended to. 

For example, how could regulators adapt these thresholds to ensure that regional banking organizations focused on predominantly 

domestic banking activities and that are not internationally active 

are not subject to capital liquidity requirements designed for more 

complex global banking organizations? 

Mr. CALOMIRIS. Yes, I agree with you that it is a misfit. But I 

do want to caution that small banks also have systemic risk. It is 

called real estate. So it is a different kind of systemic risk. 

But remember, we had banking crises in the 1980s. What were 

they? Ag banks, commercial real estate problems, primarily in the 

east, and mortgage crisis, and also oil and gas and also some other 

things. 

But the point is, all of these things were done by small banks. 

Small banks can be a source of systemic risk too. You don’t have 

to be big. If you all fail at the same time, that is also a risk. 

Mr. ROTHFUS. Well, if you all fail. But, for example, one small 

bank is not going to bring down the entire U.S. system. 

Mr. CALOMIRIS. But if the small banks as a whole, and this 

isn’t— 

38 

Mr. ROTHFUS. As a whole. But, again, I think we have had a conversation with this committee before about whether it is going to 

be one bank or an entire group of them. 

But I want to go to Dr. Michel. In explaining the problems with 

a system in which regulators determine capital adequacy by risk 

weighting the assets in banks’ portfolios, noted banking analyst 

Richard Bove wrote this: 

‘‘Outwardly, risk weighting would appear to make sense. In practice, it causes funds to be directed to whatever sectors of the economy the government favors and away from sectors that the government does not like. It results in differing interest rates based upon 

the amount of capital required. The power to make these crucial 

decisions is given to the banking regulators who do so in private. 

Thus, one of the most important factors in moving funds through 

the economy is done behind closed doors by a small number of nonelected officials.’’ 

Dr. Michel, do you share Mr. Bove’s concern that Basel’s riskbased capital system is especially a license for regulators to engage 

in credit allocation, some might call it picking winners and losers, 

and to manage the economy? Is this really a role that we want regulators playing? 

Mr. MICHEL. I think that is a concern, and I don’t think that it 

is a role that a regulator should be playing. And if you go a little 

bit deeper into the details, the Basel rules have risk weights for individual bank loans. And the largest banks, they actually get to— 

they are literally allowed to work with the regulators to come up 

with that, which just is a license for regulatory capture. The entire 

system is a mess. 

Mr. ROTHFUS. Dr. Michel, what have been the consequences for 

economic growth and the vitality of our financial system of the decision by the authors of Dodd-Frank to really essentially double 

down on regulatory complexity, as we see was in place before and 

after Dodd-Frank? 

Mr. MICHEL. Just having to divert so many resources to compliance is a major problem. If you talk to smaller bankers in particular, even smaller regional banks, they have been getting hit 

with these things for years. 

The Basel requirements were never intended for anybody other 

than internationally active banks. That was the original intention. 

And U.S. regulators decided, no, we are going to put them on everybody. 

It doesn’t make any sense to have smaller community banks 

going with these standards. And I would argue that it doesn’t make 

any sense to have them anyway. But if you are going to have them 

on, you shouldn’t have them on the smallest banks and probably 

not on a lot of the regional banks. 

Mr. ROTHFUS. Mr. Chairman, I yield back. 

Mr. NEUGEBAUER. I thank the gentleman. 

Now the gentleman from Indiana, Mr. Messer, is recognized for 

5 minutes. 

Mr. MESSER. I thank the panel. I appreciate the lengthy conversation today about the Byzantine nature of the capital and liquidity standards under Basel. I would like to start by focusing my 

testimony towards Mr. Chakravorti and Mr. Calomiris. 

39 

As I think you are probably aware, Federal banking regulators 

excluded all American municipal bonds from being treated as highquality liquid assets under the LCR rule. This creates a remarkable situation where certain German subsovereign debt qualifies as 

high-quality liquid assets when American investment grade municipal bonds do not. 

This makes no sense to me. These investments are some of the 

safest investments in the world. And, of course, by not qualifying 

these assets in that way, it could raise borrowing costs for American local municipalities as they borrow. 

I have, looking at that, coauthored bipartisan legislation with 

Congresswoman Maloney that would essentially direct the FDIC, 

the Federal Reserve, and the OCC to classify investment grade municipal securities as level 2A high-quality liquid assets. 

And I would just like your feedback on that. As several of you 

have testified, the situation is far too complex as it is, but it certainly makes no sense to me to be penalizing investment grade 

American municipal bonds. 

Mr. CHAKRAVORTI. I support the view that high-quality liquid assets, given its risk profile and liquidity profile, should be as broad 

as possible. And if these munis do satisfy that requirement, I am 

fully supportive of them being in the 2A category. 

Mr. MESSER. Mr. Calomiris? 

Mr. CALOMIRIS. We have a little difference of opinion here. So I 

don’t think we want to play the game of the in and out. And the 

way we do that is we focus on cash at the Fed bearing interest, basically banks holding Treasury bills, and that is what cash is, and 

we should just focus on a cash requirement. 

But what your point really illustrates is that the Basel Committee is the political equilibrium of people sitting at a table. They 

push for including covered bonds as a cash asset. Covered bonds 

are, from a systemic standpoint, a terrible thing to include. They 

cause what we call asset stripping. 

So Basel is a political G7 dining room table where deals are 

made and tradeoffs are made, and we shouldn’t have to deal with 

and have to accept those definitions of what our liquidity requirement should be. 

Mr. MESSER. Would anyone else like to chime in? 

Mr. MICHEL. I would agree with Charlie. I wish I had come up 

with the dining room table analogy. I like that. 

It makes no sense. It is purely political. It is almost wholly arbitrary, except for the fact that it is political, and it is a terrible system. 

Mr. MESSER. Yes. And there are a host of other things that ought 

to be included as well. 

I yield back the balance of my time. Thank you. 

Mr. NEUGEBAUER. Thank you. 

I now recognize the gentleman from California, Mr. Royce, for 5 

minutes. 

Mr. ROYCE. Thank you, Mr. Chairman. 

I think the need for cross-border resolution of compromised financial institutions was made pretty painfully apparent during the 

2008 global financial crisis. Rightfully, cross-border resolution is 

40 

today at the forefront of the international regulatory reform agenda. 

I thank these witnesses for being with us. 

During a recent update on the FDIC’s efforts to create a framework for the resolution of SIFIs and G-SIBs, Chairman Martin 

Gruenberg said that there has been no greater or more important 

regulatory challenge in the aftermath of the financial crisis than 

developing the capability for the orderly failure of a systemically 

important financial institution. 

Now, I agree with him that this is an issue of paramount importance. However, I question the comment in describing the work to 

date in solving this cross-border resolution conundrum as: The 

progress has been impressive. 

I wanted to ask Dr. Chakravorti, do you share Chairman 

Gruenberg’s assessment on the progress made on ending ‘‘too-bigto-fail’’ around the world and eliminating taxpayer liability in the 

case of a financial downturn or do you side with the IMF, which 

believes that there remains considerable additional work, in their 

words, to be done to establish an effective regime for cross-border 

resolution? 

Mr. CHAKRAVORTI. That is a tough tradeoff, Mr. Congressman, to 

choose between the IMF and the FDIC. What I would like to say 

is that it is a very difficult issue. I have visited the FSB and Basel. 

It is a complex issue. 

I know that much of the cross-border that we should worry about 

is in a few countries. So I think there is great movement in the direction to get a cross-border agreement with some of these countries, but it is very difficult. And I think we have to start somewhere, and we are certainly going in the right direction. 

Mr. ROYCE. Then, let me ask Dr. Michel, what steps do policymakers around the globe need to take to actually ensure a method 

of cross-border resolution exists, one that does not place American 

companies at a competitive disadvantage while still preventing future taxpayer bailouts? 

Mr. MICHEL. On the specific details of the cross-border issue, I 

would have to defer. I am not comfortable with the specific details 

there. But in general, I think what we need to do is worry about 

making the American system as competitive as possible. And bankruptcy law change would be much better than the Title II that we 

got in Dodd-Frank. 

Mr. ROYCE. Let’s open it up to the rest of the panel then very 

quickly. But we have had some time to think about this. Ever since 

2008, it should have been on our mind. 

Mr. CALOMIRIS. Let me just talk about that. I agree with you. In 

fact, if you look at what the problem was in terms of cross-border 

with the failure of Lehman, it was which regulator is in charge of 

which assets? That was the major problem. That was the major 

disruption and confusion. And I think that is something that we 

are really moving to solve, and I think it can be solved. That is different from orderly liquidation, which I think is a pipe dream. 

So my own view is, in terms of Realpolitik, the only way we are 

going to solve this problem is with some kind of ringfencing where 

there is clear allocation of authority over which assets and which 

liabilities will be adjudicated and controlled by which regulatory 

41 

entities. And we can’t have a completely fluid international balance 

sheet. It is simply not pragmatic. 

So my view is international financial institutions can have operations that are international, but they have to have legal entities 

that are well-defined within national borders. 

Mr. ROYCE. Thank you. 

I am going to yield back, Mr. Chairman, because I see Mr. 

Schweikert is pensively waiting, and I know time is short. 

Mr. NEUGEBAUER. I thank the gentleman. 

And now the gentleman from Arizona, Mr. Schweikert, is recognized for 5 minutes. 

Mr. SCHWEIKERT. Thank you, Mr. Chairman. 

To my friend from California, was that ‘‘pensive’’ or just too 

much caffeine? 

This actually has been an interesting conversation, and you always run into the situation when you are last, that a number of 

your questions have already been answered. So could we do a quick 

lightning round, because there are a handful of things I would love 

to get my head around? 

Dr. Michel, in your opening statement you talked about if you 

would also charter certain institutions as partnerships and then 

the loss piece moves to the partners. Can you give me like 20, 30 

seconds on that? 

Mr. MICHEL. Sure. Before the Depression, what we had was basically sort of a double liability system, and it wasn’t a corporate limited liability. It was you are responsible for your losses as well as 

an amount up to the amount that you had put in. During the 1930s 

and RTC and a lot of details, we basically killed that. And I think 

for the last—I think the last investment banking firm to get rid of 

that entity was Bear. I could be wrong, but it was one of them. 

Mr. SCHWEIKERT. Would that be another way of also saying, 

okay, here is equity capital, but also the liability within that equity 

capital? 

Mr. MICHEL. Yes. 

Mr. SCHWEIKERT. Okay. Simple enough? 

Mr. MICHEL. I believe so, yes. And I know that a lot of those companies will not want to do that right off, but if you look at the 

amount of regulation that we force on them and you take some of 

it away, some may be willing to go for the tradeoff. 

Mr. SCHWEIKERT. We are going to come back to that opportunity 

and how do you incentivize either greater capital or either greater 

risk participation. 

And I always mispronounce, is it Dr.— 

Mr. CALOMIRIS. ‘‘Calomiris.’’ 

Mr. SCHWEIKERT. —‘‘Calomiris.’’ 

Okay. Real estate concentration, particularly for those of us from 

the Southwest, we have seen our boom-and-bust cycles and our real 

estate often taking down our S&Ls back in the late 1980s, what it 

has done to our banks. 

The ability for banking institutions to syndicate risk on their real 

estate book, saying we have this many real estate loans, is there 

a way to hedge it, sell it off to private equity, or even in today’s 

world where I am watching the new crowdsourcing, the lending 

clubs of the world in the real estate market, but also taking that 

42 

same model and allowing those same banking institutions that act 

as aggregators where that real estate debt ultimately is not sitting 

on their books, they are just acting as the collection, management, 

bookkeeping, and the risk is actually, shall we say, cascaded with 

the series of individual institution, private equity investors. Is that 

a model of breaking up that risk concentration? 

Mr. CALOMIRIS. Any model that creates better diversification and 

better maturity matching of the financing of real estate is going to 

be a big improvement. And this isn’t farfetched. This is what we 

are already seeing. 

Insurance companies do a lot of small local commercial real estate financing. The farm credit system now has very high capital 

requirements, and its mutual structure shares some of that risk. I 

am not a big fan of the farm credit system, but my point is that 

insurance companies, real estate investment trusts, and the farm 

credit system are all very different kinds of financing structures 

from traditional banks. 

And I can’t resist just adding one more thing: You all know the 

story of, ‘‘It’s a Wonderful Life.’’ That was a building and loan. 

That movie is inaccurate. Building and loans couldn’t have runs, 

because they weren’t funded by short-term debt. That movie is just 

wrong. 

Mr. SCHWEIKERT. Are you telling me Hollywood has lied to me 

again? 

Dr. Parsons, if I were sort of rebuilding the whole concept around 

Dodd-Frank, and saying, look, in a modern world, with modern 

technology, and modern information, how do I actually, at least 

from my view of the world—I want a broad financial system. We 

keep referring to it as the banking system, and then those who 

want to sound more sinister, the shadow banking system. 

But ultimately, how do I create a world here where my community bank may be where I go for that loan, but I also may go on 

the Internet, I may go to a fraternal organization. Wouldn’t that 

breaking up of risk concentration ultimately make us much more 

robust when the markets are—when we go through a rough cycle? 

Mr. PARSONS. I think that is a great idea. I think we got ourselves into a situation leading into the crisis where we had these 

gigantic universal banks where we were pushing into the portfolio 

every kind of activity that really wasn’t even related, but we were 

also then finding ourselves with certain utilities, like the payment 

system and the like, hostage to losses on various portfolios. What 

you proposed is exactly a better financial system. 

Mr. SCHWEIKERT. So to that same concept, how do I turn to those 

same financial institutions and say: You should be able to participate in financial markets, but in many different ways. My particular fixation on the crowdsourcing of lending, because it minimizes the cascade effect if the loan goes back, because it is not either the bank or therefore the guarantors and the taxpayers in the 

chain of liability. There has to be a solution here that is much more 

dynamic for our markets. 

Mr. PARSONS. I think the regulators are trying to do that kind 

of thing. When you look at the— 

Mr. SCHWEIKERT. There, I disagree with you. 

43 

Mr. PARSONS. —and you look at the G-SIB charge, they are attempting to identify the risk of the specific activity. 

Mr. SCHWEIKERT. Last comment: The regulators aren’t doing 

that. As a matter of fact, the regulators in many ways are crushing 

the innovation right now. 

With that, I yield back. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair now recognizes the gentleman from Maine, Mr. 

Poliquin. 

Mr. POLIQUIN. Thank you, Mr. Chairman. 

And thank you, gentlemen, for being here today. I appreciate it. 

I am sure everyone agrees that our financial services industry is 

the envy of the world. The reason why we have such a strong economy, although we do have problems now, but over a long period of 

time is because our financial services industry provides the cash, 

the capital, the money, so businesses can borrow and expand and 

hire more workers and our families can borrow more money to buy 

a home or a new car. 

Now, I am very concerned, like a lot of folks in this room, that 

the Dodd-Frank set of regulations, parts of them, are really smothering our financial system and therefore impacting our economy 

and that is why we have had such anemic growth over the last 6 

years of this recovery. And one of the parts of Dodd-Frank that I 

am concerned about, Mr. Messer spoke about a short time ago, 

dealing with our high-quality liquid assets issue. 

Now, when I was the State treasurer up in Maine for a period 

of time, we did lots of work with the municipal bond market, and 

we accessed the market to repave Route 1, for example, that brings 

all of our tourists up to Maine so they can have nice lobsters and 

good vacations. This is very important to our State. Our department also helped a lot of our small towns, like Greenville or Jackman or Machias, if they needed to build a new sewage treatment 

plant. And so having the access to cheap credit for our States, our 

counties, our cities, and our towns is critically important going forward. 

If you look at our municipal bond market today, it is very safe, 

it is very liquid, it is transparent, it has been around for about 80 

years, and there is about $4 trillion today outstanding in our municipal bond market. A couple of years ago, 2013, there was about 

$325 billion one year that was issued. There are 1,600 broker-dealers that affect transactions on both sides of the trade, and every 

15 minutes the results of transactions are posted on the electronic 

platform. 

So in addition to that, moms and dads and grandparents who are 

buying securities, who are saving for their retirement, hundreds of 

thousands of them across our country participate in this market, 

along with mutual funds, insurance companies, and they all provide, again, the cash, the cheap credit to our towns so they can 

grow, so we can build a new playground for the kids down the 

street, or you can make sure you have a new library if you need 

one. 

So this is really important. And I am very concerned that now 

the Fed and the FDIC are looking at this whole asset class and 

44 

saying, for some reason, that these very safe liquid securities 

should not be included in the liquidity coverage ratio. 

So I would like to ask you, Dr. Chakravorti, if you don’t mind 

commenting on this, tell me what your thoughts are. Am I missing 

anything here? Because it doesn’t seem to be fair or right to me 

that we exclude this whole type of asset class from the liquidity 

coverage ratio for banks, because if we do, it is going to have a big 

impact on moms and dads who are struggling through this recession, because they are going to have to pay higher taxes to pay for 

higher interest rates if we restrict this type of whole asset class 

from this issue we have here. 

Mr. CHAKRAVORTI. As I mentioned before, I think it is very important when deciding characteristics of things that fall into the 

A1, A2, level 2 category of the LCR that these instruments truly 

be liquid and truly possess the underlying risk characteristics that 

you want. 

Mr. POLIQUIN. And do you feel that municipal bonds, in fact, do 

meet those requirements? 

Mr. CHAKRAVORTI. Let me just say, I haven’t studied every municipal bond in the country to tell you those characteristics. I can 

tell you that I am sure there are some that qualify. I can’t say 

whether they all do. I am not an expert in that area. 

Mr. POLIQUIN. How about general obligation bonds? In other 

words, if you look at the State of Maine, for example, is that individuals and businesses who pay income tax and folks who go visit 

our great State and pay sales tax when they buy a lobster or can 

of Coke, these are all of the assets, the revenues that backstop the 

interest payments on our GO bonds every 6 months and the principal backed every 10 years. 

Mr. CHAKRAVORTI. I understand how they are financed and 

things like that, but things that come to mind, and please don’t 

take this the wrong way, are Greece, Orange County, and other 

sovereigns that—I am not saying Maine is in this category; I am 

not trying to say that. 

Mr. POLIQUIN. Thank you. 

Mr. CHAKRAVORTI. But what I am saying is that if there are municipal bonds that meet the characteristics of asset similar, then 

they should be— 

Mr. POLIQUIN. I would make a case to you, Dr. Chakravorti, in 

my final moments if I may, Mr. Chairman, that our sovereign 

States here, which are required to balance their books every year, 

are a much safer bet than some of the debt— 

Mr. CHAKRAVORTI. Absolutely. I don’t— 

Mr. POLIQUIN. —accrued around here in Washington. Let me tell 

you that. 

But I thank you very much. I appreciate your comments, Dr. 

Chakravorti. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair now recognizes the gentleman from Arkansas, Mr. Hill. 

Mr. HILL. Thank you, Mr. Chairman. 

And I thank our panel for being with us today. 

I really want to get into a long, extended debate about these real 

estate comments I have listened to today, because I don’t buy it. 

I have been in this business for almost 40 years now. And I think 

45 

customers and banks fully share interest rate risk in traditional 

commercial real estate lending, portfolio lending. And so I really 

want to take issue with that, but I will not dwell upon it. 

Mr. Sherman talked about rating dependencies, and in my view, 

that is one of the more paper-oriented burdens actually coming out 

of Dodd-Frank, is requiring banks to do a lot of independent credit 

analysis and not be relying on the rating agencies. In fact, it was 

completely counter to the discussion I felt that you had, is that 

bank exams now do not allow you to simply state for the rating 

sheet in a bank looking at your portfolio. I think in some instances 

that is a good idea, and in some it is not. But it is a huge source 

of paper burden on small banks. 

An example: In Arkansas, school bonds, which is fully, gosh, 100 

percent, I would say, of the municipal exposure of commercial 

banks in Arkansas, are AA rated and guaranteed by the State of 

Arkansas, so it is the equivalent of a GO in Arkansas, and yet 

every one of those has to have stapled to it the Bloomberg evaluation analysis and an independent credit review, some of which is 

virtually impossible to do. So I really think that is an area we 

could reform the regulatory practice as a result of Dodd-Frank. 

Also, you all talked about in the capital ratings, which are so 

geared to credit risk, and you didn’t really mention interest rate 

sensitivity risk, which is also the ‘‘S’’ in the CAMELS rating. And 

it is not a one-stop shop. When we make a loan or buy a bond, we 

are taking credit risk, but we are also accounting for and graded 

on interest rate sensitivity risk. And I didn’t hear any discussion 

of that today. Some of you acted as if it didn’t go into the calculus 

of that. I want to give you a chance to talk about the balance between those two. 

Dr. Michel, would you like to start? 

Mr. MICHEL. As far as I know, Basel III does not include any sort 

of weight for interest rate risk. 

Mr. HILL. No, but your examine practice does. Every bank has 

an interest rate sensitivity component. 

Mr. MICHEL. I misunderstood. 

Mr. HILL. Yes, that is my point. You are all beating up on Basel 

III, but we are not taking into account that we have another binder 

on the shelf in the boardroom that is all about interest rate sensitivity, and the two work together. So really comment on that if you 

would, please. Meaning, you have Basel weight, sure, but it is not 

the only thing a bank takes into consideration. 

Mr. MICHEL. Well, no. There are certainly going to be things that 

they have missed. Aside from the fact that they are arbitrary, and 

aside from the fact that they are going to get certain things wrong 

in what they have accounted for, there would be some things that 

they would not account for. The CAMELS ratings is actually much 

better in terms of just accounting for sort of a comprehensive look 

at the bank. 

Mr. HILL. Yes. 

Mr. CALOMIRIS. I think that after Basel II and going on to Basel 

III, large banks do have to, as part of their internal risk-based 

modeling, take account of their interest rate exposure— 

Mr. HILL. All banks, not large banks. 

Mr. CALOMIRIS. But I am saying under Basel, this was reformed. 

46 

Whether that is done accurately is a separate question. And I 

think that there is a lot of reason to believe that our models of 

doing that which are being used might not be accurate. 

Mr. HILL. Right. We can’t eliminate risk in the banking business. 

That is the business that we are in. So I don’t think we can regulate our way out of that. And I think that is one of the big flaws 

in the Dodd-Frank Act. 

How would you take into a CAMELS rating, even though they 

are confidential, in this idea of a market-based capital standard 

and market-based risk, to Mr. Mulvaney’s point? Any suggestions 

or ideas there? 

Mr. CALOMIRIS. My view is that there are several different pieces 

that you could use. I know that time is short. My CoCos suggestion 

goes right to the point. 

I would also point out that there are other simple things. Suppose that you said that the risk of a loan is going to be captured 

by its relative interest rate spread? There is a lot of evidence that 

is true, that nonperforming loans are closely linked to interest rate 

spreads. You could use that market information to measure loan 

risk. 

Now, that is not perfect, but if you had used the highest interest 

rate in a mortgage as a measure of its risk, you would have budgeted a lot more capital for subprime mortgages than we did. 

Mr. HILL. I would like to talk about that another day as well. 

Thank you, Mr. Chairman. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair asks unanimous consent that the gentleman of Georgia be granted an additional minute. Without objection, the gentleman from Georgia is recognized. 

Mr. SCOTT. Thank you very much, Mr. Chairman. 

Very quickly, I think we are overlooking, as I said, an unintended consequence of this leverage capital rule. And I hope you 

will have time to respond to me. 

And here is my concern. When you require capital be held 

against collateral for which banks are prohibited from leveraging 

their own benefit, this will increase the cost significantly of end 

users. And nobody has talked about that. 

I am very much concerned about this. This will affect all of our 

end users, people who had no issue with this meltdown. I am talking about our farmers, our agriculture businesses, our manufacturers, our energy producers. 

And my fear is that banks will be less likely to take on new clients for a derivative clearing, and as a result market participants 

will have fewer choices and will be less likely to use derivatives 

from hedging their own risk for management purposes. 

And as a result of mandatory clearing obligations for some derivatives, some market participants, like what I mentioned are innocent end users and agribusinesses, will not have any option 

available to them to hedge their underlying risk and will find this 

unwarranted capital treatment grounds against our banks a reason 

for discontinuing their customer-facing clearing businesses. This is 

an underlying but becoming more obvious unintended consequence. 

Mr. Calomiris, would you respond? I think you mentioned it a little bit. 

47 

Mr. CALOMIRIS. I think you are right, that we have to strike a 

balance, and we have to recognize that there are costs associated 

from imposing capital requirements, absolutely no question about 

it. 

At the same time, I just want to reiterate that if you aren’t gearing your capital requirements to making your banking system safe, 

a collapsed banking system has much worse consequences for those 

end users. 

And let me point out, the United States has had since our origins, 17 major banking crises. We are one of the least stable banking systems in the world. And part of that reflects the fact that we 

have sometimes bent too far in the direction of short term, wanting 

to help borrowers politically, and at the expense of our stability. 

When we look at Canada to the north, they have never had a 

banking crisis. That is a very interesting thing to note. And they 

feel pretty well served by their banks, and I think they like their 

stability. 

Mr. SCOTT. Yes. 

Just, Mr. Chairman, I want to end with this, that hopefully we 

can pay a little closer attention to this, because we don’t want to 

inadvertently affect very dramatically our end users, our manufacturers, and our agribusinesses and small businesses because of 

Basel III. 

Thank you, Mr. Chairman. 

Chairman HENSARLING. The time of the gentleman has expired. 

There are no other Members in the queue, thus, I would like to 

thank all of our witnesses for their patience and their testimony 

today. 

The Chair notes that some Members may have additional questions for this panel, which they may wish to submit in writing. 

Without objection, the hearing record will remain open for 5 legislative days for Members to submit written questions to these witnesses and to place their responses in the record. Also, without objection, Members will have 5 legislative days to submit extraneous 

materials to the Chair for inclusion in the record. 

This hearing stands adjourned. 

[Whereupon, at 12:32 p.m., the hearing was adjourned.] 

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