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THE CHANGING ROLE OF THE FDIC

HEARING

BEFORE THE

SUBCOMMITTEE ON TARP, FINANCIAL SERVICES

AND BAILOUTS OF PUBLIC AND PRIVATE PROGRAMS

OF THE

COMMITTEE ON OVERSIGHT

AND GOVERNMENT REFORM

HOUSE OF REPRESENTATIVES

ONE HUNDRED TWELFTH CONGRESS

FIRST SESSION

JUNE 22, 2011

Serial No. 112–68

Printed for the use of the Committee on Oversight and Government Reform

(

Available via the World Wide Web: http://www.fdsys.gov

http://www.house.gov/reform

(II)

COMMITTEE ON OVERSIGHT AND GOVERNMENT REFORM

DARRELL E. ISSA, California, Chairman

DAN BURTON, Indiana

JOHN L. MICA, Florida

TODD RUSSELL PLATTS, Pennsylvania

MICHAEL R. TURNER, Ohio

PATRICK T. MCHENRY, North Carolina

JIM JORDAN, Ohio

JASON CHAFFETZ, Utah

CONNIE MACK, Florida

TIM WALBERG, Michigan

JAMES LANKFORD, Oklahoma

JUSTIN AMASH, Michigan

ANN MARIE BUERKLE, New York

PAUL A. GOSAR, Arizona

RAU ́ L R. LABRADOR, Idaho

PATRICK MEEHAN, Pennsylvania

SCOTT DESJARLAIS, Tennessee

JOE WALSH, Illinois

TREY GOWDY, South Carolina

DENNIS A. ROSS, Florida

FRANK C. GUINTA, New Hampshire

BLAKE FARENTHOLD, Texas

MIKE KELLY, Pennsylvania

ELIJAH E. CUMMINGS, Maryland, Ranking

Minority Member

EDOLPHUS TOWNS, New York

CAROLYN B. MALONEY, New York

ELEANOR HOLMES NORTON, District of

Columbia

DENNIS J. KUCINICH, Ohio

JOHN F. TIERNEY, Massachusetts

WM. LACY CLAY, Missouri

STEPHEN F. LYNCH, Massachusetts

JIM COOPER, Tennessee

GERALD E. CONNOLLY, Virginia

MIKE QUIGLEY, Illinois

DANNY K. DAVIS, Illinois

BRUCE L. BRALEY, Iowa

PETER WELCH, Vermont

JOHN A. YARMUTH, Kentucky

CHRISTOPHER S. MURPHY, Connecticut

JACKIE SPEIER, California

LAWRENCE J. BRADY, Staff Director

JOHN D. CUADERES, Deputy Staff Director

ROBERT BORDEN, General Counsel

LINDA A. GOOD, Chief Clerk

DAVID RAPALLO, Minority Staff Director

SUBCOMMITTEE ON TARP, FINANCIAL SERVICES AND BAILOUTS OF PUBLIC AND

PRIVATE PROGRAMS

PATRICK T. MCHENRY, North Carolina, Chairman

FRANK C. GUINTA, New Hampshire, Vice

Chairman

ANN MARIE BUERKLE, New York

JUSTIN AMASH, Michigan

PATRICK MEEHAN, Pennsylvania

JOE WALSH, Illinois

TREY GOWDY, South Carolina

DENNIS A. ROSS, Florida

MIKE QUIGLEY, Illinois, Ranking Minority

Member

CAROLYN B. MALONEY, New York

PETER WELCH, Vermont

JOHN A. YARMUTH, Kentucky

JACKIE SPEIER, California

JIM COOPER, Tennessee

(III)

C O N T E N T S

Page

Hearing held on June 22, 2011 ............................................................................... 1

Statement of:

Bair, Sheila, chairman, Federal Deposit Insurance Corporation ................. 6

Letters, statements, etc., submitted for the record by:

Bair, Sheila, chairman, Federal Deposit Insurance Corporation, prepared

statement of ................................................................................................... 9

McHenry, Hon. Patrick T., a Representative in Congress from the State

of North Carolina, prepared statement of ................................................... 4

(1)

THE CHANGING ROLE OF THE FDIC

WEDNESDAY, JUNE 22, 2011

HOUSE OF REPRESENTATIVES,

SUBCOMMITTEE ON TARP, FINANCIAL SERVICES AND

BAILOUTS OF PUBLIC AND PRIVATE PROGRAMS,

COMMITTEE ON OVERSIGHT AND GOVERNMENT REFORM,

Washington, DC.

The subcommittee met, pursuant to notice, at 1:34 p.m. in room

2157, Rayburn House Office Building, Hon. Patrick T. McHenry

(chairman of the subcommittee) presiding.

Present: Representatives McHenry, Meehan, Gowdy, Ross, and

Quigley.

Staff present: Will L. Boyington and Kate Dunbar, staff assistants; Katelyn E. Christ, research analyst; Pete Haller, senior counsel; Ryan M. Hambleton, professional staff member; Rebecca Watkins, press secretary; Kevin Corbin, minority staff assistant; and

Justin Kim and Davida Walsh, minority counsels.

Mr. MCHENRY. The subcommittee will come to order.

Today’s hearing on the TARP, Financial Services and Bailouts of

Public and Private Programs Subcommittee is entitled, ‘‘The

Changing Role of the FDIC.’’

We have before us today the 19th chairman of the Federal Deposit Insurance Corporation, Sheila Bair, who has served honorably

during some of our Nation’s toughest times. Chairman Bair, we realize this is your last hearing before Congress and you have had

quite a career in your service to our Government and to our people,

and I want to thank you for that. It has been through some of the

most challenging times in our Nation’s history.

You have also served on Capitol Hill and we appreciate your

service there. We forgive you for serving on the Senate side, but

certainly understanding Capitol Hill as you do, we thank you for

your time.

It has been the tradition of this subcommittee to read the Oversight and Government Reform Committee’s Mission Statement.

The Oversight Committee’s Mission Statement begins, we exist

to secure two fundamental principles. First, Americans have a

right to know that the money Washington takes from them is well

spent. Second, Americans deserve an efficient, effective government

that works for them. Our duty on the Oversight and Government

Reform Committee is to protect these rights. Our solemn responsibility is to hold government accountable to taxpayers because taxpayers have a right to know what they get from their government.

We will work tirelessly in partnership with citizen watchdogs to deVerDate 17-JUN-2003 12:18 Dec 23, 2011 Jkt 000000 PO 00000 Frm 00005 Fmt 6633 Sfmt 6633 C:\KATIES\DOCS\71294.TXT KATIE PsN: KATIE
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liver the facts to the American people and to bring genuine reform

to the Federal bureaucracy.

This is the mission of the Oversight and Government Reform

Committee.

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

As I said, we are pleased to welcome the chairman of the FDIC,

Sheila Bair, for her last testimony before the U.S. House of Representatives. We certainly appreciate your role and your hard

work. We wish you well in your future endeavors.

Today’s discussion allows Members to better understand the role

of the FDIC during the financial crisis, the new regulatory authorities issued by Dodd-Frank and the health of FDIC-insured banks.

Since 2007, the FDIC has been called upon to resolve 370 failed

banks and thrifts. These efforts have cost the FDIC an estimated

$83 billion and depleted the balance of the Deposit Insurance Fund

pushing it into the red ink to the tune of $1 billion. Chairman Bair

has taken steps to replenish the fund and I think the American

people should know that this does not cost the taxpayers a dime

and, in fact, this is self-funded by the banking industry.

Due to the FDIC’s role as a safety and soundness regulator for

most of the world’s largest financial institutions, the Dodd-Frank

Act positions the Corporation as a key player in preventing a future financial crisis. Dodd-Frank requires or authorizes the FDIC

to implement 44 new regulations and grants the regulator various

enforcement authorities, many that stem directly from DoddFrank’s hope to end Too Big to Fail.

Among these regulations are risk retention rules that will dramatically impact the secondary mortgage market and other areas

of securitization as well as increase capital standards set out under

Dodd-Frank and being negotiated under Basel III.

Although these measures had some bipartisan support in theory,

concerns have been raised during implementation. New risk retention rules could reduce the amount of lending to an already crippled housing market, while extreme capital standards may jeopardize the global competitiveness of U.S. financial institutions.

Just yesterday, Acting Comptroller of the Currency, John Walsh,

stated that additional capital requirements for large firms should

be ‘‘modest,’’ noting that ‘‘capital levels are now extraordinarily

high by historical standards.’’ He specifically cautioned that ‘‘higher

capital fosters a safer banking system, but if carried too far, the

economy suffers when banking activity is not sufficient to support

the desired levels of real economic activity.’’ I think we all share

those concerns and finding that balance, as part of today’s hearing

is to understand your thought process on that.

Each member of this subcommittee hears from constituents and

businesses that are struggling to access capital. Thus, before instituting a regulation, it is imperative that regulators consider the

flexibility that our small and community banks need to serve our

communities. I look forward to Chairman Bair’s explanation as to

how the FDIC and other regulators will work to avoid one size fits

all regulations that would deteriorate job growth and our economy.

Additionally, while some insist that the FDIC’s new regulatory

authority under Dodd-Frank will put an end to the bailout culture

and Too Big to Fail, it appears the opposite is true. The Special InVerDate 17-JUN-2003 12:18 Dec 23, 2011 Jkt 000000 PO 00000 Frm 00006 Fmt 6633 Sfmt 6633 C:\KATIES\DOCS\71294.TXT KATIE PsN: KATIE
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spector General for the troubled Asset Relief Program has reported

to Congress that even after Dodd-Frank, ‘‘the largest institutions

continue to enjoy access to cheaper credit based upon the existence

of the implicit government guarantee against failure.’’

Ironically, Dodd-Frank has actually made big banks even bigger.

Five of the largest financial institutions in this country are 20 percent larger than they were before the crisis.

This is not directed at the FDIC, but rather, many of these

things are design failures in the legislation we passed and I will

have some questions about that and how you see that implementation, and perhaps some legislative relief on some things you don’t

think are quite appropriate going forward.

Even Secretary Geithner noted the possibility of future bailouts,

when months ago he stated that the Federal Government might

have to do ‘‘exceptional things again.’’ I know you have been questioned about that before, but the moral hazard of such explicit and

implicit guarantees cannot be overstated.

These concerns, along with others that Chairman Bair and I

have spoken about, are of critical importance to the economic future and well being of the United States and its citizens. Getting

that balance right is a struggle. In terms of capital requirements,

we would like to hear your thoughts on that.

[The prepared statement of Hon. Patrick T. McHenry follows:]

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Mr. MCHENRY. With that, I recognize the ranking member, Mr.

Quigley of Illinois, for 5 minutes.

Mr. QUIGLEY. Thank you, Mr. Chairman. Thank you for holding

this committee meeting.

Chairman Bair, thank you for attending and for your years of

service.

Obviously, the FDIC played a central role in navigating the 2008

financial crisis, specifically overseeing two of the largest bank failures in U.S. history, Washington Mutual and IndyMac Bank. In

addition, in the aftermath of the crisis, Chairman Bair has actively

engaged in implementing the necessary reforms to prevent another

financial crisis.

As the chairman’s tenure comes to a close, I believe her insight

and perspective will be invaluable to the subcommittee’s oversight

of the events that comprised the financial crisis as well as the implementation of Dodd-Frank and other reforms aimed at bringing

greater transparency and stability to our financial markets.

While there were multiple causes of the financial crisis, it is

widely acknowledged that regulatory failure through gaps in oversight, insufficient tools and weakening of bank regulations was a

significant factor. Therefore, Dodd-Frank addresses these failures

by creating the Financial Stability Oversight Council to ensure coordination among multiple banking regulators.

It also extends the FDIC’s resolution authority for failing depository institutions to large non-bank financial firms and requires

strong capital standards for the largest financial institutions. These

and other provisions have significantly altered the authority and

responsibility of the Federal banking regulators including the

FDIC.

I was heartened by the chairman’s past statements that through

the orderly liquidation authority and capital requirement provisions, the regulators have the tools to end Too Big to Fail. Still, I

am concerned by the fact that in 2009, Bank of America, Chase,

Citi Group and Wells Fargo controlled 56 percent of domestic banking assets up from 35 percent in 2000, while the top 10 U.S. banks

controlled 75 percent of domestic deposits, up from 54 percent. I

hope today’s hearing will provide an update on the implementation

of these Too Big to Fail provisions.

There are also a number of FDIC-related provisions under DoddFrank that are critical not only to ensuring financial stability, but

also to leveling the playing field between the largest financial institutions which have only expanded since the crisis, and the community banks and credit unions.

These provisions relate to capital standards, as well as the manner in which the FDIC is assessed and I look forward to hearing

from Chairman Bair regarding the status and implementation of

these reforms.

Last, Chairman Bair has been praised as guiding the FDIC to

‘‘greater prominence through her fierce advocacy, not just for community banks, but also for consumers.’’ In this regard, I commend

you for your tireless efforts to hold accountable our Nation’s mortgage-servicing industry. This is an industry that continues to engage in alleged systemic abuses and misconduct against homeowners across the country.

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In your own words, ‘‘the mortgage-servicing and documentation

problems are yet another example of the implications of lax underwriting standards and misaligned incentives in the mortgage process.’’ Despite numerous investigations and regulatory actions taken

by Federal and State regulators and law enforcement officials

against the mortgage servicers, more allegations of misconduct

have surfaced.

Therefore, I look forward to hearing from the chairman regarding

further steps that can be taken by both regulators and policymakers to hold the servicers accountable and protect our constituents and communities from wrongful foreclosures.

Again, I thank you. I thank the chairman for appearing before

us today and your service to our country.

Thank you.

Mr. MCHENRY. I thank the ranking member.

With that, Chairman Bair, it is the tradition of the Oversight

and Government Reform Committee and policy of the committee

that all witnesses be sworn. So if you please rise and raise your

right hand.

[Witness sworn.]

Mr. MCHENRY. Let the record reflect that the witness answered

in the affirmative.

Again, thank you, Chairman Bair. You have served under Republican and Democratic Presidents, you have had a distinguished career in government service and we wish you the best going forward.

With that, we recognize you for 5 minutes for an opening statement. You know the drill with the lights and we look forward to

hearing your testimony.

STATEMENT OF SHEILA BAIR, CHAIRMAN, FEDERAL DEPOSIT

INSURANCE CORPORATION

Ms. BAIR. Thank you very much, Chairman McHenry, Ranking

Member Quigley and members of the subcommittee. Thank you for

the opportunity to testify today on the Changing Role of the FDIC.

My testimony today is focused on two very important lessons

learned from the crisis. First, in order to restore discipline in the

marketplace, large, complex banks and other financial companies

must, without exception, be allowed to fail if they become non-viable.

The problem of financial companies that are perceived by the

market as too big to fail unfortunately has been about for decades,

but the bailouts of several badly managed, systemically important

financial institutions during the crisis removed all doubt about

their implicit government backing.

These bailouts were made necessary by the absence of FDIC

style resolution powers for non-bank financial institutions as well

as for bank holding companies and their non-bank affiliates. The

massive disruptions caused by the Lehman failure made clear that

the bankruptcy process was ill suited to the orderly resolution of

large financial entities. Forcing bank holding companies into a

bankruptcy process was not a risk the government was willing to

take.

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The bailouts have consequences. They undermine market discipline. They inhibit restructuring of troubled financial companies

and the recognition of losses. They keep substandard management

in place and preserve a suboptimal allocation of economic resources.

In contrast, smaller banks are fully exposed to the discipline of

the marketplace. Some 370 FDIC-insured institutions have failed

since I became FDIC chairman. This is how capitalism is supposed

to work. Failed companies give way to successful companies and

the remaining assets and liabilities are restructured and returned

to the private sector.

Bailouts are inherently unfair. They violate the fundamental

principles of limited government on which our free enterprise system is founded. That is why the FDIC was so determined to press

for a more robust and effective SIFI resolution framework as a centerpiece of the financial reform legislation.

We were early advocates for a SIFI receivership authority that

operates like the one we have applied thousands of times to insured banks in the past. We pushed for liquidation plans by the

SIFIs that would prove they could be broken apart and sold in an

orderly manner and for greater oversight and higher capital in relation to the risk these companies pose to financial stability.

While all of these proposals were ultimately enacted in DoddFrank, there does remain skepticism as to whether the SIFIs can

actually be made resolvable in a crisis. For the very largest institutions, it will be difficult, but we have many important tools which

if used correctly can end Too Big to Fail.

Under Dodd-Frank, we will have more information about these

institutions on an ongoing basis, stronger prudential requirements,

living wills prepared in advance, as well as the authority to require, if necessary, organizational changes that rationalize business

lines and legal entities to assure that they can be broken up and

sold back to the private sector in an orderly way.

I hope this is an area where the industry will work collaboratively with the government. The expectation of bailouts creates

funding advantages for weak, large banks, creating competitive disadvantages not only for smaller institutions, but also for the better

managed larger institutions. Most importantly, the reputation of

the entire industry is damaged when poorly managed institutions

are bailed out by taxpayers and escape responsibility for their own

actions. Because of the bailouts, popular resentment and cynicism

toward the banking sector remains very high.

The second lesson of the crisis involves the dangers of excessive

debt and leverage. The single most important element of a strong

and stable banking system is its capital base. Capital is what allows and institution to absorb losses while maintaining the confidence of its counter parties and its capacity to lend.

After the last banking crisis in the early 1990’s, Congress passed

a number of important banking reforms that included stronger capital requirements. The capital requirements were watered down

over the years through rules that permitted use of capital with

debt-like qualities that encouraged banks to move assets off the

balance sheet and that set regulatory capital thresholds based on

internal risk models.

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The result was an increase in financial system leverage, particularly at bank holding companies and on-bank financial companies

that weakened the ability of the industry to absorb losses during

the crisis and that has led to a dramatic de-leveraging of banking

assets in its wake.

The problems of excess leverage extend far beyond banking. Our

tax system rewards the use of debt financing over equity for businesses and households alike, making them more vulnerable to financial distress. Governments too have relied on debt to postpone

the cost of paying for services that the constituencies are reluctant

to do without.

As the crisis has shown, over reliance on leverage is a short term

strategy with a big down side over the longer term. That is why

the FDIC has been so committed to following through on the capital reforms that are taking place through the Basal III International Capital Accord. That is also why we have been such strong

supporters of other measures to enhance capital including the Collins Amendment to Dodd-Frank, the elimination of trust preferred

securities and the SIFI capital surcharge.

Since 1933, public confidence and financial stability have been

the core missions of the FDIC. We understand the economic cost

of financial crises. One of the most important lessons I have drawn

from my experience has been the need for regulators to have the

political courage to stand firm against weak practices and excessive

risk taking in the good times.

My main regret is that we did not have better information and

better resolution tools in place at the height of the crisis to prevent

the bailouts of a number of our Nation’s largest financial companies. Yes, the bailouts were necessary under the limitations we

faced, but they have slowed the recovery, they have undermined

support for government in all forms, tainted the reputation of well

run banks and tilted the competitive balance toward weak, mega

banks.

Our support for a more robust SIFI resolution regime and stronger capital standards in the wake of the crisis speaks to our determination that this experience never be repeated.

Thank you and I would be happy to take your questions.

[The prepared statement of Ms. Bair follows:]

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Mr. MCHENRY. Thank you for your testimony.

I now recognize myself for 5 minutes.

As I said in my opening statement, the Acting Comptroller of the

Currency, John Walsh, stated in an interview the other day that

additional capital requirements for large firms should be ‘‘modest,’’

noting that capital levels are now extraordinarily high by historical

standards and higher capital fosters a safer banking system, but if

carried too far, the economy suffers when banking activity is not

sufficient to support desired levels of economic activity.’’

Chairman Bair, we noted that you and the Acting Comptroller of

the Currency have had disagreements on capital levels. Is there a

capital level requirement that is too high?

Ms. BAIR. I think there certainly could be, but I don’t think the

numbers we are talking about really come anywhere close to that.

We are working through the Basal Committee process. I think it

is very important to have international agreement on the appropriate standards and the Basal Committee has done a lot of analytical work on this, looking at the cost of the crisis, the amount of

losses on financial institution balance sheets and how much additional capital would have been needed to absorb those losses to

avoid this massive de-leveraging that we experienced.

It has also tried to weigh those costs against incremental increases in lending from higher capital standards. So I think the

numbers have very much tried to strike the right balance.

The 7 percent Basal III standard, which I don’t think Acting

Comptroller Walsh has a disagreement with, has been agreed to

but as part of that agreement, there was broad based consensus on

the Basal Committee, including with Mr. Walsh, that we would be

looking at higher loss absorption capacity for the very largest institutions. That is the process now.

I have been on record as thinking at 300 basis points, a 10 percent standard would be about right. That is actually moderate

when you look at most of the studies that have been independently

done by academics or the government. These studies generally support much high capital levels based on the type of analytics I described.

The Wall Street Journal, in a recent editorial endorsing much

higher capital standards, actually threw out 15 percent. I thought

it was interesting. The benchmark they were using was what the

market demands of a smaller finance company which clearly has

no government support whatsoever and the market demands a 15

percent capital requirement. I think the 10 percent actually is moderate by all analytics we have looked at.

I would also add though that this is going to go out for comment.

Whatever the number the Basal Committee agrees to will go out

for comment. It will explain the analytics behind the number and

people will have a chance to provide public comment.

Mr. MCHENRY. How are your metrics different from the OCC’s?

Ms. BAIR. I don’t know. Apparently OCC has done some independent analysis. I just haven’t seen it and would welcome looking

at it. I think perhaps he is looking at historical number but historically I think there is probably a prudent case that this financial

system has not had sufficient capital which is why we continue to

have these cycles, a very severe one recently.

30

Also, if you are looking at risk weighted assets, unfortunately,

there is a lot of subjectivity in capital levels based on how a bank

is risk weighting its assets. I don’t know what the analytical underpinning is for his views. I would be happy to take a look at them

but I haven’t seen them.

Mr. MCHENRY. I am not asking about the health of European

banks, but in terms of international competitiveness, isn’t it important that we are harmonized globally with these capital requirement levels so we are not disadvantaged?

Ms. BAIR. I think it is important we have international agreement. I think strong capital is a competitive strength and I think

European banks are having some trouble now because the way

they risk weight their assets does not have the confidence of the

market. I think also the problems they are having with Greece and

other distressed countries with their sovereign debt and the inability to restructure that is related to the high levels of leverage in

their banking system and the inability of some of their banks to

withstand the writedowns on that debt if there was a debt restructuring.

I worry about capital levels in Europe and I worry about the impact that could have coming back to the United States. I think

international agreement is important to get those capital levels up

in Europe.

Mr. MCHENRY. Finally, in terms of the Dodd-Frank law as it is

proposed by Congress, are there items that we should address as

you are walking out the door, items we should address to fix, to

correct, to improve, to change Dodd-Frank? It is intended to be an

open ended question.

Ms. BAIR. It is not a perfect law. Certainly there were things that

we would like to have seen differently and we can share those

views with you. I think it is a law we can work with. I think on

the Title II authority, we feel we do have the tools that we need.

I do believe that net-net, it is a good law. We are better having it,

than not having it, at least the parts of it where the FDIC has a

mandate that we can work with, the authorities given to us.

Mr. MCHENRY. You didn’t take the bait?

Ms. BAIR. I didn’t take the bait. Sorry.

Mr. MCHENRY. Perhaps in another month, we can have a conversation and you can tell me your thoughts.

With that, I recognize the ranking member, Mr. Quigley.

Mr. QUIGLEY. Thank you.

Coming from Illinois, small banks, community banks, you

touched a little bit on competitive disadvantages. What else can we

do?

Ms. BAIR. I think the good news is that the banking sector is

healing and it is really all about the economy and getting the economy on a stronger footing so borrowers will want to start borrowing

more money again. Even smaller banks, we are seeing many instances where they are raising capital. A lot of them that had been

on our rejected failure list are actually coming off because they

have raised capital. I think there are some positive improvements

in the community banking sector.

It has been tough for them, but if you look at the number of community banks that got in trouble as a percentage of assets as well

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as numbers, it is much, much smaller than the kind of distress we

saw with the large institutions. Most of them actually managed

through this very well. They managed their commercial real estate

concentrations pretty well and in our supervisory process, we are

trying to take lessons learned from the success with community

banks and fine tuning our own supervisory process.

I do think regulatory burden is an issue. Chairman McHenry

mentioned this as well. I have endorsed some type of two tier regulatory approach. I do think that regulatory requirements that may

be driven by problems we have seen with larger banks, if you apply

them across the board to small banks even if they have not much

to do with the business model of small banks, can make it very expensive for small banks. They don’t have the huge compliance departments that large banks have. I think a two tiered regulatory

approach is important.

I think simplification of consumer rules and consumer disclosures would help consumers. It would also help community banks.

A lot of community banks have gotten out of consumer lending just

because the rules are so complex and complicated. They don’t have

the compliance capability to deal with it.

Mr. QUIGLEY. That is a specific point we hear quite a bit about

the regulatory process. The terms they are using—harsh regulatory

examinations, depressing impacts these practices have on their

ability to lend and support the fragile economic recovery—some

very specific stuff. The senior regulators in D.C. keep saying they

are properly instructing their field examiners but bankers are saying the field examiners are not following the rules.

We hear there are inconsistencies in their decisions. The people

higher up are saying their plans are not being implemented locally.

The examiners are telling the bankers their decisions are being

changed above but then there is a time lag in how these decisions

get back to the banks which creates inconsistencies and a real

problem moving forward.

Ms. BAIR. I do hear this a lot. I can tell you the measures we

have taken. I am kind of beside myself to try to figure out what

else to do. We have told our examiners directly that loans shouldn’t

be criticized because collateral has fallen. If you have a credit worthy borrower that can make the loan, if the collateral has gone

down, it is still a good loan.

We have not required new appraisals unless more credit is being

extended. Then obviously you do want to get an appraisal. I have

said this specifically, we have said it in writing. We have disseminated this information to banks so they know what the rules are.

If they feel examiners are doing it inconsistently, they can tell that

to the examiner.

We have told our examiners they need to be independent of the

banks. They have a job independent of the bank, but they do need

to listen to bank management and hear their side of it and discuss

directly with them their concerns.

We have done all this and set up special hotline numbers for

bankers who feel the policies are not being applied. We have an

ombudsman program that will keep it confidential if they don’t

want their names used. We have frankly worked hard on this. We

are not perfect. We have a lot of examiners and more banks than

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anybody, so perhaps the challenge of getting all this communication out to examiners is more pronounced because of the sheer

numbers.

On the other hand, when we have received complaints and have

drilled down into it, sometimes examiners are being blamed for

bringing the bad news. Bank management is not always realistic

about the extent of their troubles. Sometimes I find the complaints

are not actually coming from the community banks but from borrowers who were not able to get a loan. Especially in the construction industry, there are a lot of folks who are not creditworthy anymore.

We do try to drill down and get to the truth of the matter and

we have found instances where mistakes were made and we try to

correct that. In some other cases, it may just be a bad situation,

examiners being blamed when they really have followed the appropriate policies.

Mr. QUIGLEY. Mr. Chairman, rather than go into a whole new

area, I will yield.

Mr. MCHENRY. I thank the ranking member.

At this point, I will recognize Mr. Gowdy of South Carolina for

5 minutes.

Mr. GOWDY. Thank you, Mr. Chairman.

Thank you for your service to our country.

I will yield the remainder of my time to Chairman McHenry.

Mr. MCHENRY. I thank the gentleman. That is quite kind and

gracious.

You mentioned the ombudsman program you have, the hotline.

I will be very honest with you. We were going to have a second

panel and we reached out to different associations here in town, invited bankers and no one wanted to appear on a second panel.

Ms. BAIR. How should I take that?

Mr. MCHENRY. That is really the question and it is not personal,

first of all, but it is either that the complaints, they don’t want to

air publicly. Why is that? Are they so fearful of their regulator or

are they fearful of what the public thinks of them complaining or

is it one of those things, they will grumble but really don’t want

to get into the specifics? It may just be Washington politics. Who

knows? I thought that was a little odd.

Wrestling with that concept, because I am concerned about regulatory overreach as we have discussed privately, but there is a balance. We look at our banks in our community, and Mr. Quigley

mentioned this as well, we don’t know the health of their balance

sheet, we don’t know if they have overexposure in raw land, for instance, so they are telling their customers it is the regulator that

won’t let me do it, when in reality it is an imbalance in their balance sheet or they have a capital problem, a challenge.

Do you have any comments about that?

Ms. BAIR. I do. I have been dealing with this a lot. We want a

high quality, second to none examination process. Our examiners

feel that way, our leadership feels that way, so it is important for

that process to be one where there is an issue that procedure has

not been followed appropriately, those can be brought to our attention in a way that we encourage, don’t penalize, so we can look into

it.

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It has frustrated me because I get a lot of generalized complaints

but when I say tell me what it is so I can fix it, let us look into

it and I will fix it if it is there, and I don’t get any specifics, so

I don’t know if maybe people just want to grumble and it may be

a little bit of both. All I can say is that it is my policy, it will be

Vice Chairman Gruenberg’s policy, it is the policy of our leadership

in our Risk Management Division to encourage, accommodate and

look into every single complaint and not the other way around.

That doesn’t mean we will always agree. We do look into them

and we find the examiner was doing things appropriately and there

have been instances where we found something else and we have

taken appropriate action, but I don’t know what else I can do. If

people don’t want to come forward, there is not much I can help

with.

Mr. MCHENRY. Thank you for commenting on that because it is

one of those things that we all deal with. We want to fix problems

where we can fix them.

Ms. BAIR. Right.

Mr. MCHENRY. There is another question that kind of goes hand

in hand with this. You saw the news last week or the week before

with Jamie Dimon’s question of Chairman Bernanke, sort of the cumulative effect of these regulations and the impact they will have

on the cost and availability of credit.

Has there been a holistic review by the regulators or at the

FSAC level about the cost of these regulations because certainly we

agree, and I think it is economic fact that they do have an impact—

additional capital does cost, but there is a tipping point for safety

and soundness by which you have to be there and over the long

term, it could be a net positive. Can you comment on that?

Ms. BAIR. I don’t think there has been at the FSAC level. I think

certainly with regard to capital, there has been a lot of cost benefit

analysis and also for the rules that we do. Our IG just looked at

this at the request of Congress, I believe, and we follow all the requirements of cost benefit analysis. We have a lot of economists, we

encourage that type of economic analysis of our rules.

We have also started looking into community bank impact and

actually for any rule or guidance we put out, we have a separate

line that says what the community bank impact will be. Yes, on an

individual agency basis, I think it is occurring. It might be very

worthwhile for the FSAC on an interagency basis to look at this.

I do think there are interrelationships especially with what we

are doing with the derivatives new rules and some of the restrictions on proprietary trading, what kind of impact that will be and

how they interrelate to capital I think would be a helpful interagency analysis. Just in terms of raising capital, I am actually very

confident that there has been very good analysis and the numbers

we are talking about now are more than justified.

Mr. MCHENRY. Thank you.

With that, I recognize Mr. Meehan of Pennsylvania for 5 minutes.

Mr. MEEHAN. Thank you, Mr. Chairman.

Thank you, Chairman Bair, for your service to our country during what was certainly a very challenging time for our Nation. I

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am sure you are looking for an opportunity to enjoy the life thereafter, but again, thank you for your service.

There are so many aspects of the impact of what we have tried

to do in response to the many problems that occurred, but I see it

through the eyes of many of the people in my district who are facing issues locally. I was intrigued by your comment that many of

the smaller banks are the ones that are competing now at a disadvantage because of the rules that have been focused on the large

banks.

I hear a lot in my community, particularly in the housing sector—homebuilders, realtors, bankers—and there seems to be a

game in which they are all sort of pointing to the other one and

saying, they are the ones responsible for not allowing us to get

going. Everything that I have studied certainly indicates that a robust housing market is a key to getting out of an economic slump.

Obviously with such an amount of under water mortgages, we

are not going to see robust, but I also see small community bankers

with responsible institutions who have weathered this area very

well and builders with very good reputations who have proven

their capacity to analyze the market. Right now, some are actually

saying this is a great time to take risks, if you understand your

market.

Yet, what I am understanding from talking and meeting with my

homebuilders is that many of them are concerned about hard caps

for construction lending, development lending. What I really need

to understand is whether or not this 100 percent hard cap is really

that? Is it advisory or are we creating the kind of hardline standard that locks in the inability for local bankers and local builders

to do what they have been doing for generations, which is to make

sound judgments about each other?

Ms. BAIR. I think construction development lending is very high

risk lending and if you look at the figures we have had for the

smaller institutions, they have been almost heavily driven by losses

in construction development lending and high concentrations of

those. Yes, it is a benchmark, it is not a cap, but the general rule

is 100 percent, they shouldn’t go over 100 percent of capital and

if they do go over 100 percent of capital, you need to have special

risk management processes in place and board level involvement in

managing those risks.

There is a lot of scrutiny in C&D lending; it is not a hard cap,

but I would say there is a lot of scrutiny of it and well justified

given the number of banks we have seen that have failed because

of heavy concentrations in that area. Again, it depends on the local

market. Obviously in some areas they are heavily over billed already, so probably the last thing you need to do is start a new

housing tract. That is based on local conditions. Our examiner are

asked to look at the local conditions.

Mr. MEEHAN. They are taking into factor not only local conditions, but the history of both the builder and the institution. Obviously, they don’t analyze the builder, but the builder is living

through the analysis by the bankers. I am hoping that is an issue

that can continue to be analyzed on the local level and that the regulators will take into consideration that impact.

35

The other issue, which we are getting a lot from the realtors, and

I know you have made comments on the QRM and some of them

have included even you are not quite sure, if I am correct, if we

ought not let incentives deal with it rather than this hard and fast

rule. Can you give me your instincts on that, where we should be

going with it?

Ms. BAIR. I guess I am a market oriented person, so if we can

let economic incentives drive lending standards instead of regulators micromanaging it and saying this is what your lending

standards should be, yes, I prefer that approach. I think it is very

difficult. I think the distributing process got completely out of control—it was a huge driver of the crisis. It needs to be reformed.

My sense is that meaningful risk retention, skin and the game,

will be the best way that we can discipline underwriting standards

going forward. I would like to bring the securitization market back,

I think it is a healthy part. I would like to have banks have diversification in their funding of their lending activity, but it needs to

be brought back in the right way.

Already we are getting into debates. I think the staff put together what they felt objectively based on a lot of analytical work

or the ‘‘gold standard,’’ which was the directive of the legislation.

The QRM was mean to be an exception, not a rule. Now we have

into arguments about are we setting the standards too high, is this

going to disadvantage people.

Yes, my preference would be that everybody has to keep some

skin in the game, to discipline it that way as opposed to regulators

trying to micromanage what those lending standards should be. I

think I can say that freely because I won’t be part of the decisionmaking, as you know. That would be my preference.

That, plus I also agree, I think Chairman McHenry spoke of this,

we need loan level disclosure in these securitizations. Investors

buying these mortgage-backed securities need to see the loans inside the securitizations before they make an investment decision.

That would also be a very good check on underwriting standards.

Mr. MEEHAN. Your perspective is very important to us as we look

at these policies. Thank you again for your service.

Mr. Chairman, I yield back.

Mr. MCHENRY. I thank you, Mr. Meehan.

We have votes on the floor now and I just have two or three more

questions to ask and we will be able to adjourn.

Yesterday I read about a meeting you had yesterday, somehow

a meeting of all the bank minds.

Ms. BAIR. Sort of an advisory committee.

Mr. MCHENRY. Yet discussions about orderly liquidation was a

significant order of the day. I read there was no agreement really

on the proper way to approach this. Was there consensus? Can you

comment on that?

Ms. BAIR. I don’t think we were looking at consensus. It was the

first meeting of an Advisory Committee on Systemic Resolutions.

We have a lot of senior prominent people involved, representing a

lot of different segments of the industry as well academia. I think

they challenged us, raised good questions and I think it helped

clarify our thinking. That, frankly, is what we wanted to get out

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of it. We did not want someone to come in and nod their heads at

us.

I thought it was very valuable. I think the message I took away

was it is going to tough, but it is doable. There is no on and off

switch on this. I can’t just turn off Too Big to Fail and say it is

gone now after being around for decades. It is going to take a lot

of hard work on our part, on the banks part, on the Federal Reserve Board’s part.

We do have the tools now to tackle it in a meaningful way. At

least one rating agency has signaled a possible downgrade of some

of these large institutions, removing the bump up they have gotten

in the past from implied government support. I view that as a positive sign. I think we do have the tools to end it and over time, will

end it.

Mr. MCHENRY. In terms of the orderly liquidation authority,

some have knocked it saying it basically prioritizes systemic risk

over property rights. How do you reconcile that?

Ms. BAIR. I don’t understand that.

Mr. MCHENRY. Is that unfounded?

Ms. BAIR. I think it is. Our priority of claims is pretty much

what you have in bankruptcy. The thing that we can do that you

can’t do in bankruptcy is we can preplan, we can be in these institutions with the Fed on an ongoing basis, collecting information.

We can preplan with their living will. We can work with international regulators in advance of failure to navigate whatever their

requirements might be for facilitating an international resolution

and we have done that with smaller banks a lot already.

Bankruptcy courts really can’t do that. The other thing they can’t

do is they can’t provide temporary liquidity support which I think

is where was some of the ‘‘bailout’’ criticism comes from, but with

the financial institution, if you need to preserve the franchise

value, you do need to provide some ongoing liquidity support just

to keep the place operational as it is broken up and sold off.

Those are the things that are different, what we can do better

in bankruptcy and we can require continued performance in derivatives which was a huge problem during Lehman and one I hope

Congress will look at in the bankruptcy process as well.

In terms of how creditors are treated, it is very, very similar to

bankruptcy. Actually, I think creditors will come out better in our

process because we do have the ability to maintain the franchise,

it just doesn’t fall apart when the filing occurs, as you saw with

the Lehman process. I think in that sense it will help creditors but

the claims priority is the same.

In implementing OLA, we have tried to follow the bankruptcy

code as much as possible, as we do with bank receiverships.

Mr. MCHENRY. Your view is it is going to be a rules-based unwind?

Ms. BAIR. It will be rules-based, it will be transparent. There will

be lots of reports to Congress and it will be faster too, and less

laden with attorneys’ fees and other types of administrative expenses.

Mr. MCHENRY. But not situationally? It is going to be a rulesbased unwind that will be public?

Ms. BAIR. Yes.

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Mr. MCHENRY. You will set the standard?

Ms. BAIR. Yes, and it will be competitive too, as we do with

banks now. There is an advanced marketing process, we try to get

in as many bidders as possible. That is one of the key parts of the

living will process, to make sure that the business lines are a line

with legal entity so they can be broken up into marketable segments and sold in a very prompt manner.

Our process is to get back into the private sector as quickly as

possible. We don’t like setting up bridges and running them indefinitely. Having that preplanning is important. Some may need to do

some organizational changes to simplify their legal entities with

their business line so they can be broken up and sold off if they

get into trouble. That is good from a risk management perspective

as well.

Mr. MCHENRY. Will you speak to my small business owners, because they are talking to their banker and they have had a relationship, they may have good cash-flow, they may be profitable and

the banker is saying, the regulator won’t let us lend. Having met

with you, and we had this meeting 6 months ago, I said, respond

to this. Talk to the small business person who is trying to keep

things going and their banker is telling them it is the regulator,

the regulator is saying each bank is different. Who is speaking the

truth here?

Ms. BAIR. We have really strongly encouraged banks to make

prudent small business loans. We want them to make small business loans—especially the small banks have a big presence in this

area. We want them to make those loans.

I think sometimes the regulators are blamed and maybe the

bank is just feeling the small business may be a little too risky but

maybe it is easier for the customer relationship to say the regulator

is making them do it as opposed to saying they don’t think it is a

good credit risk. We have set up a hotline for small businesses who

feel they have been unfairly denied credit. They can call us, we will

look into it if it is our bank. We will refer it to another regulator

if it is not our bank.

That has been helpful. It has been educational for us to see the

kinds of complaints that are coming in. I think it has been helpful

to the small businesses as well to understand what our rules say

and do not say and what our examination processes allow banks

to do and perhaps discourage them to do.

I think part of the problem here is that the economy is uncertain.

It is making small business borrowers cautious, it is making banks

cautious. Getting the economy on a sounder footing, I cannot overestimate that is really what is going to cure this. We can keep

pushing banks and I think interim government programs to provide support for small business lending are good but at the end of

the day, it has to be get the economy going again in a more robust

way.

Mr. MCHENRY. What I am hearing from you today is you have

some concern about the transparency of derivative transactions and

the approach there?

Ms. BAIR. I think transparency for derivatives is extremely important. I would certainly put that at the top of my list of things.

I think a lot of the abuses that occurred in the CDS market would

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not have occurred if regulators and certainly the market in general

had a better picture of who was taking what position, what size of

exposure and what price. I think that is very important.

Derivatives are going to take a while. That market developed for

a long time without any kind of regulatory overlay. As I have said

before, I think doing that in some graduated way probably makes

sense.

Also, in terms of the problems during the crisis, I think derivatives all gets bunched together. It was really the credit default

swap market that was the big driver in the crisis, so perhaps paying particular attention to that segment would be a good thing.

Mr. MCHENRY. The second thing you mentioned is the cost benefit analysis and the cost of the totality of these financial regulations and rulemaking coming out of Dodd-Frank? That FSAC could

move forward on it.

Ms. BAIR. Yes, I think looking at the interrelationships of the

rules and their cumulative impact, I think that is good. We each

have individually been looking at this, but I think that would be

a good structure project for the FSOC. I think that makes a lot of

sense.

Mr. MCHENRY. Thank you. Thank you for your testimony.

Because we have votes on the House floor, the Members have departed and I took the liberty to ask a few questions before I depart,

but thank you for your service to the American people. You have

chaired the FDIC at what would seem like a pretty reasonable time

when you took your first term. We know you were very active in

the financial crisis in trying to make sure cooler heads prevailed

and to really preserve the insurance fund you are in charge of. We

really appreciate that.

I don’t think we will fully understand the impact you had or the

role you played for many years, unless you are writing a book and

we may know sooner.

Ms. BAIR. Very good. I hope I hold up. Thank you, Mr. Chairman.

I am sorry we didn’t have more of a chance to work together. I

have enjoyed this opportunity and wish you all the best as well.

Mr. MCHENRY. Thank you. Thank you for your service.

Before this meeting is adjourned, Members will have 7 legislative

days to submit questions for the record.

With that, the hearing is now adjourned.

[Whereupon, at 2:24 p.m., the subcommittee was adjourned.]

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