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50–368 2010

S. HRG. 110–958 

THE STATE OF THE UNITED STATES ECONOMY 

AND FINANCIAL MARKETS 

HEARING 

BEFORE THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED TENTH CONGRESS 

SECOND SESSION 

ON 

THE STATE OF THE UNITED STATES ECONOMY AND FINANCIAL 

MARKETS 

THURSDAY, FEBRUARY 14, 2008 

Printed for the use of the Committee on Banking, Housing, and Urban Affairs 

( 

Available at: http://www.access.gpo.gov/congress/senate/senate05sh.html 


dcolon on DSK2BSOYB1PROD with HEARING
(II) 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

CHRISTOPHER J. DODD, Connecticut, Chairman 

TIM JOHNSON, South Dakota 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

EVAN BAYH, Indiana 

THOMAS R. CARPER, Delaware 

ROBERT MENENDEZ, New Jersey 

DANIEL K. AKAKA, Hawaii 

SHERROD BROWN, Ohio 

ROBERT P. CASEY, Pennsylvania 

JON TESTER, Montana 

RICHARD C. SHELBY, Alabama 

ROBERT F. BENNETT, Utah 

WAYNE ALLARD, Colorado 

MICHAEL B. ENZI, Wyoming 

CHUCK HAGEL, Nebraska 

JIM BUNNING, Kentucky 

MIKE CRAPO, Idaho 

ELIZABETH DOLE, North Carolina 

MEL MARTINEZ, Florida 

BOB CORKER, Tennessee 

SHAWN MAHER, Staff Director 

WILLIAM D. DUHNKE, Republican Staff Director and Counsel 

DAWN RATLIFF, Chief Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor 


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C O N T E N T S 

THURSDAY, FEBRUARY 14, 2008 

Page 

Opening statement of Chairman Dodd .................................................................. 1 

Opening statements, comments, or prepared statements of: 

Senator Shelby .................................................................................................. 5 

Senator Johnson 

Prepared statement ................................................................................... 52 

Senator Dole 

Prepared statement ................................................................................... 53 

WITNESSES 

Henry M. Paulson, Jr., Secretary, Department of the Treasury ......................... 6 

Prepared statement .......................................................................................... 55 

Response to written questions of: 

Senator Akaka ........................................................................................... 68 

Senator Tester ........................................................................................... 70 

Senator Crapo ............................................................................................ 71 

Senator Dole .............................................................................................. 72 

Ben S. Bernanke, Chairman, Board of Governors of the Federal Reserve 

System ................................................................................................................... 8 

Prepared statement .......................................................................................... 57 

Response to written questions of: 

Senator Crapo ............................................................................................ 72 

Senator Tester ........................................................................................... 73 

Christopher Cox, Chairman, Securities and Exchange Commission ................... 10 

Prepared statement .......................................................................................... 62 

Response to written questions of: 

Chairman Dodd ......................................................................................... 74 

Senator Akaka ........................................................................................... 89 

Senator Crapo ............................................................................................ 91 

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

‘‘A Building Storm: The Housing Market and the Pennsylvania Economy’’, 

Mark Price and Stephen Herzenberg, The Keystone Research Center ........... 94 


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(1) 

THE STATE OF THE UNITED STATES 

ECONOMY AND FINANCIAL MARKETS 

THURSDAY, FEBRUARY 14, 2008 

U.S. SENATE, 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, 

Washington, DC. 

The Committee met at 10:10 a.m., in room SR–325, Russell Senate Office Building, Senator Christopher J. Dodd (Chairman of the 

Committee) presiding. 

OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD 

Chairman DODD. Good morning. Let me first of all welcome everyone here this morning to this hearing on the state of the economy and capital markets. A couple of things, if I may. 

What I would like to do this morning, given the limited amount 

of time—we have got a couple of hours. The Secretary has, I know, 

an appointment at noon, or thereafter, and I am confident the 

other two witnesses probably do as well. Normally what we would 

do is allow everyone here to make opening statements. Needless to 

say, the simple math, it would probably eat up the 2 hours. I see 

smiles now appearing on the witnesses’ faces at the prospect of listening here for 2 hours to all of us make statements about the 

state of the economy. 

What I would like to suggest—and it is merely a suggestion 

here—is that I make an opening statement, Senator Shelby make 

an opening statement, and then we will get right to the statements 

of our witnesses, and then go to questions and use the question period to make any comments you would like to, as well as engage 

in the questions you would like to ask of our witnesses. That may 

allow us to move along in that period, which I think is probably 

the most interest to most Members. 

Second, when we end up with a quorum here, I want to apologize 

to my colleagues, but we need to re-vote the ILC bill yesterday. 

Under the rules of this Committee, if there is not a majority of the 

majority present at the time the vote occurs, then the vote does not 

count in the sense. We had only 12 people here. It was a 6–6 vote. 

And so we have to re-vote the issue under the rules, and I apologize to my colleagues. We did not have 13 Members, so we did not 

have a majority of the majority on that issue present at the time. 

As soon as a majority arrives, we will do that. All statements, by 

the way, will be included in the record. If people have any opening 

statements or information you want to include in the record, I will 

make sure that is all included. 


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With that, let me proceed with some opening comments quickly, 

turn to my colleague Senator Shelby, and then we will get right to 

our witnesses this morning. 

This is a historic room, of course. We were talking outside; there 

have been many historic hearings that have been held in this room. 

I remember as a child being here watching my father actually chair 

hearings on violence in television back in the late 1950s, early 

1960s. President Kennedy and Robert Kennedy announced their 

candidacies for the Presidency in this room. The Watergate hearings, Teapot Dome, the McCarthy hearings—this is a historic room, 

so maybe some historic suggestions this morning here from our witnesses might be an appropriate response. 

Anyway, today the Committee meets to discuss the state of our 

Nation’s economy and capital markets. We are very pleased to welcome before the Committee three of the country’s leading economic 

figures: Secretary of the Treasury Hank Paulson, Federal Reserve 

Chairman Ben Bernanke, and Securities and Exchange Commission Chairman Chris Cox. And we welcome all three of you. 

Gentlemen, thank you for coming before us today, and I want to 

note that the last time the heads of all three of these agencies appeared jointly before this Committee to discuss the state of our Nation’s economy was in the immediate aftermath of the tragic attacks of September 11, 2001. And while the challenges that the Nation’s economy faces today are very different from those we faced 

then, today’s economic challenges are, unfortunately, no less serious. I think we would all agree on that. 

The current economic situation is more than merely a slowdown, 

in my view, or a downturn. It is more even than a mere recession— 

or near recession, I might add. Instead it is a crisis of confidence, 

I feel, among consumers and investors. Consumers are fearful of 

borrowing and spending. Investors are fearful of lending. Financial 

transactions which generate new businesses and new jobs are 

shrinking in number and in size. 

The incoming economic data shows how serious the problem is. 

The Nation’s economy slowed to a near standstill in the fourth 

quarter of last year, with overall GDP growth by less than 1 percent, and private sector GDP growing only one-tenth of 1 percent. 

The country had a net loss of jobs in January, the first time we 

have had a loss of jobs of that nature in over 4 years. Incoming 

data on retail sales have been very weak, and most projections for 

economic growth this year have been revised down sharply. Credit 

card delinquencies are on the rise, as consumers find themselves 

increasingly unable to tap the equity in their homes to pay down 

credit card debt and other bills. 

Last, inflation increased by 4.1 percent last year, the largest increase in 17 years, driven mainly by the rise in costs of energy, 

food, and health care. Industrial production is falling, and we have 

been hemorrhaging jobs in the construction and manufacturing sector. This decline has been reflected in falling stock prices and increased volatility in the securities markets. Our economy is clearly 

in trouble, in my view, and the most important thing we can do 

right now is restore that consumer and investor confidence, which 

is absolutely critical if we are going to get back on our feet again. 


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To that end, I want to commend Fed Chairman Bernanke for 

taking an active role in addressing the weakness in our economy, 

for injecting much needed liquidity, and cutting interest rates. I am 

also pleased that the administration and the Congress have been 

able to reach agreement on a stimulus package that provides some 

support for working families who are bearing the brunt of these difficult times. However, more needs to be done, in my view, to address the root cause of our economic problems, and I say respectfully that includes by the three agencies led by our witnesses here 

this morning. 

The catalyst of the current economic crisis in my view is the 

housing crisis. The housing starts are at their lowest levels in a 

quarter of a century. The inventory of existing home sales is nearly 

at 4 million units—almost double the number in January of 2005. 

This is equal to about 10 months of supply. And while many of us 

have experienced home price drops in our own States and regions, 

overall 2007 was the first year since data has been kept that the 

United States had an annual decline nationwide in home and housing prices. A recent Moody’s report forecasts that home sales will 

drop in 2008 by as much as 10 to 15 percent—in fact, even in 2009 

an additional drop. Others are predicting similar declines in 2009, 

as I just mentioned. This will be the first time since the Great Depression that national home prices will have dropped in 2 consecutive years. 

If the catalyst of the current economic crisis is the housing crisis, 

then the catalyst of the housing crisis is the foreclosure crisis. This 

foreclosure crisis was triggered by what Secretary Paulson himself 

has called ‘‘bad lending practices,’’ and I commend him for making 

that statement. These are lending practices that no sensible banker 

would ever engage in. Reckless, careless, and sometimes unscrupulous actors in the mortgage lending industry essentially allowed 

loans to be made that they knew hard-working, law-abiding borrowers would not be able to repay. And they engaged in practices 

that the Federal Reserve in previous years under different leadership under the Bush administration had absolutely nothing—did 

nothing effectively to stop, in my view. 

The problems were compounded by inaccurate and misleading 

corporate disclosures and asset valuations, inflated credit ratings, 

and poor risk management, so investors could not act as a check 

on these problems. As a result of failures throughout the chain of 

mortgage finance from origination to securitization, foreclosures 

are at record levels. There are 1.5 million homes that are seriously 

delinquent or in foreclosure right now. And what we have seen— 

and we have not seen the worst of it. 

Economist Mark Zandi estimates that 3 million homes will default between 2007 and mid-2009, and 2 million of those homes will 

end up in foreclosure. This crisis affects more than families who 

lose their homes. Property values for each home located within oneeighth of a square mile of a foreclosed home will drop by an average of $5,000. This will affect somewhere between 44 and 50 million homes. 

The foreclosure crisis could result or will result in an increased 

demand for social services, obviously, police and fire and further 

services to ameliorate the impact of increases in foreclosures and 


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abandoned property. Yet State and local governments will have 

fewer resources with which to meet these demands as property values and tax collections drop. Localities could lose as much as $4.5 

to $5 billion in property taxes and other revenues due to this wave 

of foreclosures. 

Any serious effort to address our economic woes must include, in 

my view, an effort to take on the foreclosure crisis. That is a crucial 

step toward restoring the confidence of consumers and investors in 

our economy. 

We on this Committee have already taken several steps to address these problems, and I want to thank Senator Shelby and 

Members of the Committee for their efforts. We worked to reform 

the FHA program and passed FHA modernization legislation 

through the U.S. Senate by a vote of 93–1. Now we need to make 

sure that this becomes law. We have appropriated close to $200 

million to facilitate foreclosure prevention efforts by borrowers and 

lenders. In addition, the recently enacted stimulus package includes a temporary increase in the conforming loan limits for GSEs 

to try and address the problems that have spread throughout the 

credit market into the jumbo mortgage market. While this is helpful, we still need to implement broad-based GSE reform, and I am 

committed to doing just that. As I have told the Secretary and others. Certainly Senator Shelby and Members of this Committee I 

have mentioned that to as well. And I have spoken about my belief 

in the need for additional steps to mitigate the foreclosure crisis in 

a reasonable manner. These steps include targeting community development block grants to communities struggling to counter the 

impact of foreclosed and abandoned properties within their communities, and they include establishing a temporary homeownership 

loan initiative, either using existing platforms or a new entity that 

can facilitate mortgage refinancing. 

But it is not just the Congress that needs to do more. The administration, including the agencies represented here this morning, I 

think need to do more as well—much more. Almost a year ago, I 

convened, with Senator Shelby, a summit of leading lenders and 

servicers. The attendees at that summit agreed to a set of principles that requires them to create a permanent, affordable solution, wherever possible, for at-risk borrowers. Unfortunately, the 

administration has been working, in my view, at cross purposes 

with us. Instead of helping us hold leaders and servicers to the 

commitments that they made back in the spring of 2007, they have, 

in essence, sanctioned backsliding from the kind of aggressive, 

broad-based effort that is more urgently required by the day. The 

latest administration effort, dubbed ‘‘Lifeline,’’ is a lifeline more to 

lenders than to borrowers, in my view, and the Treasury Department, HUD, and others in the administration need to do more. 

Similarly, the Federal Reserve as the lead financial regulator 

needs to break with its past and become more vigilant about policing indefensible lending practices. Now, I want to commend the 

Chairman of the Federal Reserve when last year the Fed finally accepted its duty under the Homeownership and Equity Protection 

Act to protect consumers from unfair and deceptive lending practices, and there were many steps taken and recommendations 

made in those regulations which I strongly agree with. The ChairVerDate Nov 24 2008 01:45 Mar 12, 2010 Jkt 050368 PO 00000 Frm 00008 Fmt 6633 Sfmt 6633 E:\HR\OC\A368.XXX A368

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man and I have talked about this. We have some disagreements 

about some of those suggestions, and I applaud the efforts, but my 

hope is that they will strengthen them in the coming days so that 

we can deal with some of these problems that have persisted and 

caused, as the Secretary of the Treasury has pointed out, bad lending practices that led us to this situation we are in today. 

As for the SEC, I want to commend Chairman Cox—Chris—for 

the oversight and credit rating agencies and for enforcement efforts 

related to subprime-related cases. But here, again, I think greater 

vigilance is urgently needed. The SEC needs to help restore investor confidence in the markets by more vigorous enforcement, by 

more comprehensive regulation of credit rating agencies, and increased accountability and transparency of publicly traded companies that are engaged in the mortgage finance system. 

Despite these unprecedented challenges, I remain confident in 

the future of the American economy. We may need to change some 

of our policies, regulations, and priorities. But the ingenuity, productivity, and capability of the American worker and entrepreneur 

ought to never be underestimated. I look forward, of course, to 

working with the Ranking Member, Senator Shelby, and other 

Members of this Committee so we can move forward on some of 

these critical issues, as well as working with the administration, 

the Department of the Treasury, obviously the Federal Reserve, 

and the SEC to restore that sense of confidence and optimism that 

is so critical to economic growth and prosperity in our country. 

With that, let me turn to Senator Shelby for some opening comments, and then we will turn to our witnesses. 

STATEMENT OF SENATOR RICHARD C. SHELBY 

Senator SHELBY. Thank you. Thank you, Chairman Dodd, for 

calling today’s hearing on our financial system and economy. This 

is an opportune time to discuss the challenges that our economy 

faces in our housing and financial sectors. We have a distinguished 

panel here today to provide us with their perspectives regarding 

the current and future economic conditions. 

Mr. Chairman, one thing that is now clear to all of us is that the 

subprime problems are not contained. Sectors of the global financial system have lost confidence largely due to the subprime mortgage problem. Financial institutions in the U.S. and abroad have 

lost billions of dollars and have had to raise new capital as a result. Concerns about the valuation of assets have led financial institutions to become reluctant to borrow or lend money within the 

system. 

We are seeing signs of an economic slowdown. After several years 

of rapid expansion, the housing sector is now paying the price. Residential investments have declined for eight straight quarters. The 

most recent Blue Chip Economic Survey forecasts growth for this 

year at 1.7 percent when just a month ago they forecasted a 2.2- 

percent growth. The blue chip forecasters now see the recession’s 

odds at almost 50 percent, although the majority of them continue 

to say a recession will be avoided. 

The administration and our financial regulators have taken a variety of actions intended to address the weakness in the housing 

sector and the slowdown in our overall economy. The Congress has 


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already enacted and the President has signed an economic stimulus 

package. Even if every consumer spends their rebate check, I believe the impact to the overall economy will be negligible. I have 

equated it to pouring a glass of water in the ocean and expecting 

it to make a difference. I hope I am wrong. 

It will have one effect that is undeniable, however. It will put 

more debt on our children and grandchildren because we are borrowing the money to pay for it. And, yes, a year from now it is 

going to help balloon our deficits. Unfortunately, we may never 

know whether the benefit was worth the cost. 

Certainly, Mr. Chairman, the effects of these actions will take 

some time to work their way through the economy. I look forward 

to hearing from our witnesses this morning as to what factors they 

will be watching to judge the success of these efforts. 

Mr. Chairman, as we consider what action we may take, my hope 

is that we will take the time to examine thoroughly all facets of 

market conditions. Any Federal intervention I believe should be 

carefully considered and targeted to encourage and reward the 

right behavior. The market is already punishing certain risky behaviors at all levels, and it is not necessarily the American taxpayers’ responsibility to mitigate those risks. 

I thank our witnesses for being here today, and I look forward 

to their views and other issues. 

Chairman DODD. Thank you, Senator, very, very much. 

I will turn to you, Secretary Paulson. Thank you for being with 

us this morning. 

STATEMENT OF HENRY M. PAULSON, JR., SECRETARY, 

DEPARTMENT OF THE TREASURY 

Secretary PAULSON. Thank you, Chairman Dodd, Senator Shelby, 

Members of the Committee. Thank you very much for the opportunity to be here today. I am pleased to appear with my colleagues 

Chairman Bernanke and Chairman Cox. I appreciate their leadership on the challenges confronting our economy and capital markets and look forward to continued close, productive working relationships. 

The U.S. economy is fundamentally strong, diverse, and resilient, 

yet after years of unsustainable home price appreciation, our economy is undergoing a significant and necessary housing correction. 

The housing correction, high energy prices, and capital market turmoil are weighing on current economic growth. I believe that our 

economy will continue to grow, although its pace in coming quarters will be slower than what we have seen in recent years. 

Four weeks ago, recognizing the downside risks to our economy 

and that the short-term cost of doing nothing was too high, President Bush called for an economic growth package to provide a temporary boost to our economy as we weather the housing correction. 

The Congress responded with bipartisanship, cooperation, and 

speed to pass an economic growth package that is temporary, 

broad-based, and will assist our economy quickly. We have demonstrated to the Nation and the world that we can come together 

to address the needs of the American people as we weather the 

housing downturn. 


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Yesterday, the President signed the economic package into law, 

and Treasury is already working to send payments out to more 

than 130 million American households. The IRS will manage the 

current tax filing season and simultaneously prepare to issue these 

additional payments starting in early May. Payments will be largely completed this summer, putting cash in the hands of millions of 

Americans at a time when our economy is experiencing slower 

growth. Together, the payments to individuals and the investment 

incentives for businesses will help create more than half a million 

jobs by the end of this year. 

In addition to this growth plan, the Administration will continue 

to focus on aggressive action to try to provide alternative options 

to foreclosures. This includes encouraging the Hope Now Alliance, 

a coalition representing over 90 percent of the subprime servicing 

market, and nonprofit mortgage counseling organizations, trade associations, and investors. 

This industry-wide effort employs multiple tools to reach and 

help struggling homeowners, including streamlining able subprime 

borrowers into refinancings and loan modifications. 

The Hope Now effort is making progress. According to updated 

statistics, in the second half of 2007 the industry assisted 869,000 

homeowners, including 545,000 subprime borrowers who received 

loan modifications and repayment plans. The progress rate is accelerating; the number of subprime modifications in the fourth quarter doubled over the rate in the third quarter. In Q4 alone, of the 

estimated 1.5 million homeowners of all types delinquent 60 or 

more days, over 470,000 received help from their servicer, and almost 30 percent of those received a loan modification. 

I expect that this progress will accelerate in 2008. In January, 

the industry began implementing a new framework to streamline 

mortgage modifications for able but struggling subprime borrowers. 

As announced by the American Securitization Forum, this framework will greatly speed the financial evaluation process. Borrowers 

who have made their initial payments but cannot afford the interest rate reset may be fast-tracked for modification or refinance, allowing mortgage counselors and servicers to devote more time and 

resources to the more difficult cases. 

Currently, I am focusing on two aspects of this effort: first, on 

ensuring that the ASF framework is adopted throughout the industry so that the industry is better prepared to deal with the rising 

volume of subprime mortgage resets; and, second, on ensuring that 

the Hope Now Alliance produces timely metrics so that policymakers and industry participants can evaluate progress and make 

adjustments as needed. 

I appreciate this Committee’s leadership and specific efforts to 

address issues that have arisen during the housing downturn. Finalizing the FHA modernization bill will provide additional tools to 

help homeowners, and I encourage you and the House to reach consensus as soon as possible. Enactment of GSE regulatory reform is 

also a very high priority for Treasury and the Administration, and 

I commend the Chairman and the Committee Members for your 

willingness to move forward promptly. While not under this Committee’s jurisdiction, the Administration has also proposed legislation that will allow States to issue tax-exempt bonds for innovative 


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refinancing programs. This tax proposal is in addition to that 

signed into law in December, which provides temporary tax relief 

for homeowners facing increased taxes due to forgiven mortgage 

debt. All of these initiatives may help mitigate the housing 

headwinds, and we remain open to other good ideas as we move 

forward. 

Treasury continues to monitor capital markets closely and to advocate strong market discipline and robust risk management. 

While we are in a difficult transition period as markets reassess 

and re-price risk, I have confidence in our markets. They have recovered from stressful periods in the past, and they will do so 

again. 

Working through the current stress is our first concern. Through 

the President’s Working Group on Financial Markets, we are also 

reviewing underlying issues ranging from enhancing risk management to market infrastructure, to reporting and disclosure, to ratings and investor practices. We know a short-term boost to our 

economy is needed. We also know that it is just as important to get 

the long-term policy response right. 

Thank you and I look forward to taking your questions later. 

Chairman DODD. Thank you very much, Mr. Secretary. 

Chairman Bernanke, thank you for being with us. 

STATEMENT OF BEN S. BERNANKE, CHAIRMAN, BOARD OF 

GOVERNORS OF THE FEDERAL RESERVE SYSTEM 

Mr. BERNANKE. Thank you. Chairman Dodd, Senator Shelby, and 

other Members of the Committee, I am pleased to be here to offer 

my views on financial conditions, the near-term economic outlook, 

and related issues. 

As you know, financial markets in the United States and in a 

number of other industrialized countries have been under considerable strain since last summer. Heightened investor concerns about 

the credit quality of mortgages, especially subprime mortgages with 

adjustable interest rates, triggered the financial turmoil. However, 

other factors, including a broader retrenchment in the willingness 

of investors to bear risk, difficulties in valuing complex or illiquid 

financial products, uncertainties about the exposures of major financial institutions to credit losses, and concerns about the weaker 

outlook for the economy, have also roiled the financial markets in 

recent months. 

As the concerns of investors increased, money center banks and 

other large financial institutions have come under significant pressure to take onto their own balance sheets the assets of some of 

the off-balance-sheet investments that they had sponsored. Bank 

balance sheets have swollen further as a consequence of the sharp 

reduction in investor willingness to buy securitized credits, which 

has forced banks to retain a substantially higher share of previously committed and new loans in their own portfolios. Banks 

have also reported large losses, reflecting marked declines in the 

market prices of mortgages and other assets that they hold. Recently, deterioration in the financial condition of some bond insurers has led some commercial and investment banks to take further 

markdowns and has added to strains in the financial markets. 


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The banking system has been highly profitable in recent years 

and entered this episode with strong capital positions. Some institutions have responded to their recent losses by raising additional 

capital. Notwithstanding these positive factors, the unexpected 

losses and the increased pressure on their balance sheets have 

prompted banks to become protctive of their liquidity and balance 

sheet capacity and, thus, to become less willing to provide funding 

to other market participants, including other banks. 

Banks have also become more restrictive in their lending to firms 

and households. For example, in the latest Senior Loan Officer 

Opinion Survey conducted by the Federal Reserve, banks reported 

having further tightened their lending standards and terms for a 

broad range of loan types over the past 3 months. More expensive 

and less available credit seems likely to continue to be a source of 

restraint on economic growth. 

In part as the result of the developments in financial markets, 

the outlook for the economy has worsened in recent months, and 

the downside risks to growth have increased. To date, the largest 

economic effects of the financial turmoil appear to have been on the 

housing market, which, as you know, has deteriorated significantly 

over the past 2 years or so. The virtual shutdown of the subprime 

mortgage market and a widening of spreads on jumbo mortgage 

loans have further reduced the demand for housing while foreclosures are adding to the already elevated inventory of unsold 

homes. Further cuts in home building and related activities are 

likely. 

Conditions in the labor market have also softened. Payroll employment, after increasing about 95,000 on average per month in 

the fourth quarter, declined by an estimated 17,000 jobs in January. Employment in the construction and manufacturing sectors 

has continued to fall while the pace of job gains in the service industries has slowed. The softer labor market together with factors 

including higher energy prices, lower equity prices, and declining 

home value seem likely to weigh on consumer spending in the near 

term. 

On the other hand, growth in U.S. exports should continue to 

provide some offset to softening in domestic demand, and the recently approved fiscal package should help to support household 

and business spending during the second half of this year and into 

the first part of next year. 

On the inflation front, a key development over the past year has 

been the steep run-up in the price of oil. Last year, food prices also 

increased exceptionally rapidly by recent standards, and the foreign exchange value of the dollar weakened. All told, over the four 

quarters of 2007, the price index for personal consumption expenditures, or PCE, increased by 3.4 percent, up from 1.9 percent during 

2006. Excluding the prices of food and energy, PCE price inflation 

ran at a 2.1-percent rate in 2007, down a bit from 2006. 

To date, inflation expectations appear to have remained reasonably well anchored, but any tendency of inflation expectations to 

become unmoored or for the Fed’s inflation-fighting credibility to be 

eroded could greatly complicate the task of sustaining price stability and reduce the central bank’s policy flexibility to counter 

shortfalls in growth in the future. Accordingly, in the months 


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ahead we will be closely monitoring inflation expectations and the 

inflation situation more generally. 

To address these developments, the Federal Reserve has moved 

in two main areas: 

To help relieve the pressures in the inter-bank markets, the Federal Reserve, among other actions, recently introduced a term auction facility through which pre-specified amounts of discount window credit can be auctioned to eligible borrowers. And we have 

been working closely and cooperatively with other central banks to 

address market strains that could hamper the achievement of our 

broader economic objectives. 

In the area of monetary policy, the Federal Open Market Committee, or FOMC, has moved aggressively, cutting its target for the 

Federal funds rate by a total of 225 basis points in September, including 125 basis points during January alone. As the FOMC noted 

in its most recent post-meeting statement, ‘‘The intent of these actions is to help promote moderate growth over time and to mitigate 

the risks to economic activity.’’ 

A critical task for the Federal Reserve over the course of this 

year will be to assess whether the stance on monetary policy is 

properly calibrated to foster our mandated objectives of maximum 

employment and price stability, and in particular, whether the policy actions taken thus far are having their intended effects. 

Monetary policy works with a lag. Therefore, our policy stance 

must be determined in light of the medium-term forecast for real 

activity and inflation, as well as the risks to that forecast. 

At present, my baseline outlook involves a period of sluggish 

growth, followed by a somewhat stronger pace of growth starting 

later this year as the effects of monetary and fiscal stimulus begin 

to be felt. At the same time, overall consumer price inflation should 

moderate from its recent rates, and the public’s longer-term inflation expectations should remain reasonably well anchored. 

Although the baseline outlook envisions an improving picture, it 

is important to recognize that downside risks to growth remain, including the possibilities that the housing market or the labor market may deteriorate to an extent beyond that currently anticipated 

or that credit conditions may tighten substantially further. 

The FOMC will be carefully evaluating incoming information 

bearing on the economic outlook and will act in a timely manner, 

as needed, to support growth and to provide adequate insurance 

against downside risks. 

Thank you, Mr. Chairman. 

Chairman DODD. Thank you very much, Mr. Chairman. 

Chris Cox, we welcome you to the Committee. 

STATEMENT OF CHRISTOPHER COX, CHAIRMAN, 

SECURITIES AND EXCHANGE COMMISSION 

Mr. COX. Thank you, Mr. Chairman, Senator Shelby, and Members of the Committee. I appreciate the opportunity to be here 

today to update you on the work that the Securities and Exchange 

Commission is doing in this area. 

The deterioration of credit and liquidity conditions stemming 

from problems in the U.S. residential mortgage market has posed 

a number of challenges for our agency. We have been working 


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closely with the other members of the President’s Working Group 

on Financial Markets, including, of course, Secretary Paulson and 

Chairman Bernanke, with whom it is my privilege to appear today. 

We have also been working closely with our international regulatory counterparts, which is a reflection of the global impact that 

these U.S. market events have had. 

To coordinate the Commission’s subprime efforts across each of 

our divisions and offices, Erik Sirri, who is the Director of the Division of Trading and Markets, is leading an agency-wide task force. 

As you know, the Commission is not a front-line regulator of the 

mortgage lending business, the derivatives industry, or the 

monoline insurance industry. But the securities markets and the 

market participants that the Commission does regulate—not to 

mention the investors whom it is our mission to protect—have been 

deeply affected by the problems with residential mortgage-backed 

securities and collateralized debt obligations. 

Among the questions that have been raised within our jurisdiction are the accounting treatment of the special purpose trusts and 

their assets; the adequacy of capital and liquidity at the Nation’s 

major investment banks, and the strength of their risk management practices; the impact on money market funds from the devaluation of what had previously been presumptively safe assets; 

the quality of issuer disclosure by public companies involved in 

structured finance; the role of the credit rating agencies, over 

which the SEC gained regulatory jurisdiction 8 months ago; and 

the possibility of violations of the securities laws by subprime lenders, investment banks, broker-dealers, and other market participants. 

The accounting issues have centered around the questions of balance sheet consolidation and valuation. Twice in recent months— 

first in July of 2007 and again in January of this year—the SEC 

has provided guidance on the application of current accounting 

rules in the case of limited modifications for loans where default 

is reasonably foreseeable. In that circumstance, we have said, the 

limited modification would not invalidate off-balance-sheet treatment. This guidance has allowed refinancings and other work-out 

arrangements to proceed, with the advantage of keeping people in 

their homes and maximizing the value of the securitized assets. 

This is, however, a short-term response. For the longer term, the 

Commission’s Chief Accountant has asked the Financial Accounting 

Standards Board to revisit the underlying accounting issues to determine whether or not the experience of the last several months 

points to the need not only for further clarifying guidance, but also 

for changes in the applicable rules. 

Another important aspect of our oversight responsibility is our 

Consolidated Supervised Entities program. Through this program 

the Commission supervises five of the systemically important U.S. 

securities firms on a consolidated, or group-wide, basis. Those firms 

are Bear Stearns, Goldman Sachs, Lehman Brothers, Merrill 

Lynch, and Morgan Stanley. This prudential supervision of the Nation’s largest investment banks is designed to be broadly consistent 

with Federal Reserve oversight of commercial bank holding companies, and its overarching purpose is to monitor for any weakness 

in any part of the firm that might place the regulated bank or 


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broker-dealer at risk. In particular, the Commission focuses on capital adequacy, liquidity, and liquidity risk management at the CSE 

firms. 

Subprime issues have also had an impact on the mutual fund industry, and, in particular, we have been active in working with the 

managers of money market funds as they cope with the downgrading of ratings and the declines in value of securities in which 

their funds have invested. We are also working in the area of public company disclosure to improve the quality of disclosure by 

banks and other financial institutions about subprime-related 

issues. 

In December 2007, the Commission wrote to 25 leading financial 

institutions, highlighting several disclosure areas that they should 

consider in relation to their exposure to off-balance-sheet entities 

and structured finance products. 

Last summer, using the new statutory authority that the Congress gave the SEC effective in June of 2007, the Commission 

began examinations of the role of the credit rating agencies in the 

subprime market turmoil. These examinations are focused on 

whether the rating agencies diverged from their stated methodologies for determining credit ratings in order to publish higher ratings, and whether their role in bringing residential mortgagebacked securities and collateralized debt obligations to market impaired their ability to be impartial in their ratings. 

Beyond these ongoing examinations, we are also taking a fresh 

look at the wisdom of the legislative and regulatory provisions that 

grant a central role to the rating agencies in our markets. 

During the past 30 years, regulators, including the Commission, 

have increasingly used credit ratings as a proxy for objective standards in a variety of contexts. In addition, a number of Federal, 

State, and foreign laws and regulations today use credit ratings in 

this and analogous ways. The recent market disruptions have 

shown the limitations of this arrangement. As a result, I have directed the Commission staff to explore alternatives to the existing 

regulatory reliance on credit ratings where feasible. I have also directed the staff to develop proposals for new rules under the Credit 

Rating Agency Reform Act that respond directly to the shortcomings we have seen through the subprime experience. 

Finally, but perhaps most importantly, policing our markets to 

ensure compliance with the securities laws is also a critical aspect 

of borrower responsibility in connection with the subprime market 

turmoil. Our Division of Enforcement currently has over three 

dozen cases that are related to subprime activity. These investigations involve several areas of potential violations of the securities 

laws, but because they are still ongoing, the specific details remain 

confidential. Each of the actions we are taking and each of those 

that we are contemplating is designed to safeguard the health of 

our capital markets, to protect investors, and to promote capital 

formation. 

I appreciate the opportunity, Mr. Chairman, to describe the main 

aspects of the Commission’s work in this area, and I would be 

happy to answer the Committee’s questions. 

Chairman DODD. We thank you very, very much, and we appreciate your testimony, all three of you, here this morning. 


dcolon on DSK2BSOYB1PROD with HEARING
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First, let me announce that there has been an objection expressed, so we will have to take this vote on the ILC issue at another time, and I will schedule a time for that at the convenience 

of Members. I again apologize for the glitch yesterday on a technical matter in terms of how that vote occurred. 

What I would like to do now is I am going to have the clock on 

for about 8 minutes per Member. I counted up here. We have got 

a tremendous turnout here, almost the entire membership of the 

Committee, and that should make it possible for us to complete at 

least one round here before our witnesses have to leave at noon or 

a little after noon. So I will try and keep an eye on the clock myself 

as we go forward. 

Let me begin, if I can, with our witnesses. When this problem 

first began to emerge, I think it was expressed by some of you here 

at the witness table and I think many people certainly hoped that 

this problem would be contained within the housing sector, be limited to that. Obviously, we are learning as each week and month 

goes by that this problem is spreading, and your testimony this 

morning reflects the recognition of that. 

It has been deeply troubling—and I am sure my colleagues from 

New York and New Jersey are going to want to focus on this as 

well, but I could not help but note yesterday the lead story in the 

Wall Street Journal talking about how this credit crunch issue now 

could affect student loans, that some—I forget the number—colleges in the State of Michigan may be adversely affected as a result 

of the lack of availability of credit, forcing families to rethink how 

they are going to finance their children’s education. 

The decline in home values, certainly we have seen, as I mentioned in my opening comments, the first time since the Great Depression we have had nationally a decline in values occurring, and 

the predictions of where those values may go. Literally, as people 

are watching, their values are declining. That equity they had built 

up over the years with the hopes of utilizing that equity for many 

different ideas, certainly not the least of which is possibly to finance their children’s higher education, is certainly disappearing. 

So that pressure is mounting here, both the availability of credit 

and the lack of equity in homes. 

Then this morning’s news about the headline, ‘‘Train Pulls Out 

of New Corner of Debt Market,’’ talking about the Port Authority 

of New Jersey and New York, that increase from 4.2 percent to 20 

percent, raise in the weekly interest rates to something around 

$300,000, this is one example—I presume there are many more 

around the country—to just once again highlight how this is expanding, this problem, beyond just a housing issue. 

And so my first basic question is: What are you going to do about 

it? I mean, this is a—what are we going to do about it? What are 

we going to do about it? This is not an issue that can—we can discuss it and the details of it, but this is growing. Should parents, 

for instance, be thinking about alternative means of financing their 

children’s education as a result of this credit crunch and student 

loan availability? Is it that serious here? And I would be very interested in hearing some response as to what you think else can be 

done, what actions Congress should or should not be taking, what 

steps further the administration could be taking, and what admoniVerDate Nov 24 2008 01:45 Mar 12, 2010 Jkt 050368 PO 00000 Frm 00017 Fmt 6633 Sfmt 6602 E:\HR\OC\A368.XXX A368

dcolon on DSK2BSOYB1PROD with HEARING
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tions or warnings should be given to the American public. As we 

try to rebuild that confidence, it is also important, I think, at hours 

like this that we express to them the steps they ought to be thinking about in light of some of these facts we are seeing. 

Mr. BERNANKE. Mr. Chairman, the examples that—— 

Chairman DODD. You have to push that button, I think, Mr. 

Chairman. 

Mr. BERNANKE. Sorry. Mr. Chairman, the examples that you are 

referring to illustrate the complex chains of causality that we are 

seeing promulgating throughout the financial markets at this 

point. The sequence in this event is that the losses in housing affected the value of CDOs, which in turn has hurt the bond insurance corporations, which in turn has reduced the value of their 

guarantees for these particular securities that make up municipal 

bonds and student loans and has disrupted that market, as you 

point out. So there is this very complex chain. 

I think with respect to municipal bonds and student loans, the 

good news is that the underlying quality of those credits is generally very good. No one is really doubting that the Port Authority’s 

credit quality is any worse than it was before or thinking that it 

was worse than it was before. So I do not think that this is a longterm situation. I think it is going to require some adjustment, some 

rethinking in terms of how best to market these securities in ways 

that will be attractive to investors. It illustrates, though, the unexpected effects and consequences. 

I think the best thing we can do—there are a whole number of 

measures that we can do, but from the Federal Reserve’s point of 

view, one of the best things we can do, of course, is to try and 

maintain a strong economy that will help cause, you know, eventually stabilization in the housing markets, stabilization in the credit 

markets, and that will allow these unexpected consequences to reverse themselves. 

Chairman DODD. Mr. Secretary. 

Secretary PAULSON. Yes, I very much agree with that and would 

just make a couple of additional points here. 

What we are seeing is, although it was subprime that maybe produced the spark that got this going, we had a dry forest out there, 

because for some time we had a lot of seemingly excess liquidity, 

low levels of inflation around the world, and investors reached for 

yield and mispriced risk in a number of markets. Now what we are 

seeing is a reaction, and the areas of the market that are under 

the most stress today are those that are the most complex products 

or auction products for municipals, preferreds, and so on. 

The example you have given is one that will solve itself pretty 

easily because the Port Authority will refinance, they will not pay 

20-percent interest rates. But it is indicative of a broader problem. 

And to me, in addition to what the Chairman said, the other thing 

that needs to be done is to keep encouraging our financial institutions to recognize their losses, let the market work, and raise capital. And if there is any doubt they need capital, they need to go 

and raise capital, recapitalize so that they get the capital base they 

need. We do not want to see them shrink their balance sheets and 

pull back from doing the things they need to do in the economy. 


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So, again, as risk is being re-priced, these things are not pretty 

while you are going through them, but these adjustments are necessary, and I believe the markets are going to work. But again, if 

we do anything, it is encouraging institutions to recognize the 

losses and raise capital. 

Chairman DODD. What about the student loan issue here? The 

same answer? Would you have the same answer regarding the 

availability of student loans? 

Secretary PAULSON. I would say, Mr. Chairman, I believe it is 

the same answer, but this is something we are looking at carefully. 

I think the underlying credits, I agree with the Chairman, are 

good. But there have been a number of changes, regulatory changes 

and others, that have impacted some of these companies. They 

have reduced profit margins. There are a number of things working 

here, and so this is something that we at Treasury are going to 

look at very carefully in the next couple of months. But I agree 

with the Chairman’s general comment. 

Chairman DODD. Is it a legitimate matter of concern, however, 

in light of what we—— 

Secretary PAULSON. Of course. Every one of these issues as we 

work our way through the markets impact real people. So we are 

talking about it in terms of the institutions and the markets, but 

they impact real people. And even when we are talking about 

things like some of these auction prefers and municipal auctions, 

if the auction fails and there is a 20-percent interest rate, then 

there will be a refinancing. There will be some auctions that may 

fail where there is a lower interest rate and there will not be a refinancing, and individual investors will end up losing money. 

So, yes, they are all legitimate concerns, and student loans is 

something that we need to watch very carefully. 

Chairman DODD. Let me jump quickly, if I can, in the time remaining here, to these projections regarding economic growth. And, 

again, I looked at yesterday—was it yesterday that the Philadelphia Federal Reserve Bank released an estimate of economists that 

revised their projections for economic growth to 1.8 percent in 

2008. The Congressional Budget Office is projecting 1.7 percent as 

the growth rate for 2008 as what they call their blue chip economics report. 

I would like to ask both the Chairman of the Federal Reserve 

and the Secretary of the Treasury: One, is it fair to conclude—and 

I think you suggested this, maybe, in your testimony, but let me 

ask it again. Is it fair to conclude then that the Fed’s economic projections that were made earlier—and correct me if I am wrong, Mr. 

Chairman. Somewhere between 1.8 and 2.5 percent I think were 

the earlier projections, that range. Is it fair then to conclude today 

that the projections for 2008 need to be downgraded in your view? 

And, second—let me just ask the questions together to save time. 

The administration had a 2.7-percent growth rate. Again, I realize, 

look, predictions are exactly what they are. No one has an absolute 

crystal ball here. But that seems to be an excessively high projection in light of even the ones made earlier, Mr. Secretary. What 

was the purpose of that? It is not even close to being the reality 

of what you projected then. 


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Secretary PAULSON. That was made in November, and as you 

will recall, Mr. Chairman, as we watched—and we have been 

watching this economy very, very carefully—that consumer spending and business spending held up right into the fall. You will recall that the GDP growth was almost 5 percent in the third quarter, and then spending fell off very quickly. We would not have a 

similar forecast today. 

Chairman DODD. What would be your forecast today? What do 

you—— 

Secretary PAULSON. I do not have a single-point forecast, but I 

will tell you it would be less, but I do believe we are going to keep 

growing here. I think that the risks are to the downside. We are 

watching it carefully. I think it is very important, this economic 

growth package. We are all focused on this, and there are no guarantees. But I continue to believe this economy is going to keep 

growing. 

Chairman DODD. Will there be an adjusted number the Treasury 

will be coming out with shortly here that we can look to? 

Secretary PAULSON. This was not a Treasury forecast. This was 

a forecast that was a joint forecast by CEA, the Treasury, OMB, 

and we come out with those periodically. 

Chairman DODD. Mr. Chairman? 

Mr. BERNANKE. Mr. Chairman, the Federal Reserve has recently 

changed to making quarterly projections, so you are referring to 

the October projection. 

Chairman DODD. Right. 

Mr. BERNANKE. In about a week, we will have a new set of projections, and it will show lower projections of growth, and they will 

be reasonably consistent with what we are seeing with private forecasters and so on. They do show, as I suggested in my testimony, 

that growth looks to be weak but still positive during the first half 

of the year, and with some expectation of strengthening later in the 

year. But, again, that is a baseline, and there are risks to that forecast. 

Chairman DODD. Thank you very much. 

Senator Shelby. 

Senator SHELBY. Thank you. 

Chairman Bernanke, Congress is facing a range of choices in addressing housing market conditions. Some of my colleagues seem to 

be suggesting that we should protect the entire home market from 

a decline in value, while others suggest allowing market forces to 

provide the solution. 

What do you think as Chairman of the Fed that our goal should 

be as we consider how or even if we should respond to current conditions? 

Mr. BERNANKE. Well, Senator Shelby, first of all, I think we 

should all be open-minded and creative and keep thinking about 

different options. For the moment, we are working trying to support the Treasury in getting the private sector to be aggressive, to 

scale up its activities, to try to be more effective in meeting this 

large number of delinquencies that they are facing. The Federal 

Reserve is also working in communities, working with community 

groups and supporting counseling efforts and so on. So I think that 

is the first line of defense, is to make sure that the private sector 


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is scaling up and is being aggressive and effective in dealing with 

these delinquencies. 

I think immediately what I would commend to the Congress in 

terms of making further progress would be to address the FHA and 

GSE bills. The FHA provides an opportunity to refinance troubled 

borrowers into more stable, long-term, Government-supported 

mortgages. And an effective reform of supervision of the GSEs 

would allow the GSEs faithfully to expand their activities and to 

support the housing market, you know, more effectively. 

Senator SHELBY. Are you still concerned about the long-term systemic risks that our GSEs have out there? 

Mr. BERNANKE. I do think that is the concern. I would like to see 

a reform bill, a supervisory bill that addresses those concerns, that 

creates a strong, world-class regulator, that provides for adequate 

capital, receivership, and a public purpose for the portfolios. But I 

do believe that if that were all done, then the GSEs would be much 

better placed to raise capital, which they need to do, and with more 

capital to assist the housing market in particular by securitizing 

more mortgages. 

Senator SHELBY. Chairman Bernanke, we appear to have swung 

from a cycle of credit being too freely available to the possibility 

that credit is now priced too highly or not available at all. 

You noted in your testimony, and I will quote, ‘‘considerable evidence that banks have become more restrictive in their lending to 

firms and households. The Fed has attempted to counter this problem in part through its term auction facility.’’ 

Do you believe that financial institutions are now in a position 

of overly stringent underwriting? And if so, what are your bank examiners doing to counter any overly stringent action by financial 

institutions in the current—due to the current situation? 

Mr. BERNANKE. Senator, well, first you are correct, as Secretary 

Paulson mentioned, that we started out in a period probably where 

risks were underpriced and where credit was too freely available. 

We are going through a retrenchment, and it is a painful retrenchment. Some of that is certainly necessary to get back to a more normal level of underwriting and credit availability. 

We do have some concerns that the combination of losses by 

banks which reduced their capital and the expansion of their balance sheets as they took on off-balance-sheet vehicles or they are 

unable to securitize some of their loans have made some of these 

banks less able to extend credit than they would under normal circumstances. And we think that is going to be a drag on the economy. Our surveys show that terms and conditions have tightened. 

I agree very strongly with Secretary Paulson that the best remedy to that is for the banks to reveal their losses, to get them behind them, then to go out and raise more capital so that they can 

operate in a safe way and in a normal way. 

With respect to the supervisors, we need to achieve an appropriate balance. On the one hand, we certainly in no way want to 

sacrifice our important responsibility to maintain the safety and 

soundness of the banks. And to the extent that they have less capital and they are facing a more risky situation, then it is appropriate from that perspective for them to be more careful in their 

lending. 


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On the other hand, we do not want to overreact so strongly to 

go far beyond what is reasonable and balanced to create an unnecessary credit crunch, and we are trying to make sure that we balance those important objectives, maintaining safety and soundness 

while not unnecessarily constricting credit to the American economy. 

Senator SHELBY. Do you believe that there is a strong likelihood 

that there will be more charge-offs, you know, downgrading of a lot 

of our subprime securities, and even perhaps others, that will have 

an effect on some of our banks’ capital? 

Mr. BERNANKE. Well, it seems likely that there will be additional 

charge-offs. But an important consideration at this point is the evolution of the housing market and the economy. Many banks have 

already written down their mortgage holdings, for example, essentially under the assumption that the housing market will contract 

considerably further. Should the housing market do better than expected, some of those writedowns might be reversed, potentially. 

But I think it is a good guess, given recent trends, that we will see 

some additional writedowns in banks, in investment banks, in the 

coming quarters. 

Senator SHELBY. As a bank regulator, do you see any possibility 

that some of our big banks might fail? You know, the U.K. has had 

the Northern Rock problem. Do you envision that here? Is that 

something that capital will keep from happening? 

Mr. BERNANKE. Senator, our concern is primarily about the ability of the banks to make credit available. The banks came into this 

episode very well capitalized, with very strong earnings. They have 

been able to go out and raise new capital, and so all the banks— 

I will let Chairman Cox talk about the investment banks, but I believe it is the case there as well. But certainly all the banks that 

we supervise remain at strong capital positions, and at this point 

we do not see any imminent risk of any insolvencies. 

Senator SHELBY. Secretary Paulson, given the importance of 

bond insurance to the national economy—the Chairman alluded to 

that earlier—what has been the Treasury Department’s involvement with the New York Insurance Department’s efforts to rescue 

the bond insurers that a lot of people believe we have got to bolster? 

Secretary PAULSON. OK, well, we have obviously a strong interest in this because the bond insurers play an important role in the 

markets. And as you know, these institutions are regulated at the 

State level. So we, along with the Fed and others, have been actively monitoring what is going on there. We were supportive of the 

efforts, which are private sector efforts, to get all of the relevant 

people together—the parties: the rating agencies; the advisers, the 

financial advisers to these companies; investors are involved. And 

so we are watching this very closely. 

Senator SHELBY. Can I ask one quick question? 

Chairman DODD. Yes. 

Senator SHELBY. Chairman Cox, could you update the Committee 

on the status of the SEC’s examination of the rating agencies and 

whether the SEC has reached any conclusions about why the rating agencies appear to have grossly underestimated the riskiness 


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of many securitized assets? I know you have talked to us about 

that before. Is that an ongoing thing? 

Mr. COX. Yes, it is, and we are in the process of inferring lessons 

even now. As you know, our authority given to us by the Congress 

is months old, but we have aggressively used that authority. We 

have ongoing investigations—I should say ‘‘inspections’’—of the 

credit rating agencies underway for the purpose of determining, 

among other things, whether or not, first, they followed their own 

procedures with respect to conflicts of interest, and then whether 

those procedures, if properly followed, were sufficiently sturdy in 

practice to prevent the conflicts which we know exist in the current 

model from interfering with the ability of the analysts to be independent. 

My estimation is that we will have ideas based on this experience for making that process more sturdy in plenty of time to inform our planned rule writing this year. 

Senator SHELBY. Are you looking at the possibilities of ways to 

avoid the conflict of interest that looked so prevalent to so many 

people between the rating agencies, the advice they give them, the 

consulting they give them, and then rate the securities themselves? 

Mr. COX. We are. The issuer-pays model, and the subscription 

model, all have potentials for conflicts of interest, and so what is 

most important is designing structures, procedures to deal with 

those conflicts. We cannot make them all go away. They are embedded in the market. 

One of the ways that the Congress, I think rightly, anticipated 

in the Credit Rating Agency Reform Act that we can deal with 

these conflicts is through competition. There are two kinds of competition—bad and good—in this area. The bad kind of competition, 

of course, would adhere in an issue where they are going first to 

one rating agency, then another, then another, until finally they 

get the high rating that they are willing to purchase. The good 

kind of competition is one in which the track records of these rating agencies are ruthlessly compared in the marketplace, and the 

SEC, I think, is going to be able to help facilitate that kind of headto-head comparison. Comparability is difficult to achieve given the 

kinds of disclosure that currently are made. 

Senator SHELBY. Thank you, Mr. Chairman. 

Chairman DODD. Thank you very much. 

After speaking with Senator Shelby, I realized we are not going 

to be able to get to everyone if I keep to 8 minutes. So we are going 

to restrict that time down to 5 minutes. I will not bang down the 

gavel, but so that everybody gets a chance here—and, obviously, if 

we can get through one round, we will go back for a second round 

with people. So I just did the math, and I realized we are not going 

to get to everybody. And I want everybody to have a chance to raise 

questions. 

Senator Reed. 

Senator REED. Thank you very much, Mr. Chairman, and thank 

you, gentlemen, for your testimony today. 

We are all engaged in dealing with a host of very complicated, 

interrelated issues, but when you step back, one of the most sobering factors that has been alluded to by the Chairman is that if we 

just let things sort of work out over the next several months, there 


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could be as much as a 20- to 30-percent devaluation in the value 

of homes in the United States, which some people have estimated 

to be on the order for $4 to $6 trillion on household wealth. That 

is going to be a huge shock to the quality of life of most Americans. 

It is going to translate into whether children go to college or which 

college they go to. It is going to translate into whether they are 

prepared for retirement. It is going to translate into whether or not 

they can cope with a serious health crisis without insurance. And, 

frankly, that is a concern on the minds of my constituents right 

now, and the clock is ticking much faster, and I get the sense that 

the market is moving to these corrections, which puts, I think, 

huge pressure on not simply letting the market work out but to 

take much more deliberate, much more focused, much more concentrated action, because at some point the American people will 

demand it even more affirmatively than they are today. 

That said, I think there are two major challenges: one, timely, 

effective action to ease this liquidity crisis; but, second, a very 

sober, careful review of how we got here by the regulatory agencies 

so that we do not repeat these mistakes. And we have seen this 

happen before. Enron collapsed. We had FASB produce rules about 

special purpose entities. FASB got beaten back to move from a 

more specific rule to more principles based, and now, as Chairman 

Cox indicated, they are rethinking that. We have been there before, 

and I will ask just a question to Chairman Bernanke. 

First, you are not only the monetary policy leader in the country, 

but you also are the major regulator of financial institutions. You 

have on a daily basis, I would presume, hundreds of Federal Reserve examiners, agents in these institutions looking at everything 

they are doing. Have you looked back now and begun a searching 

review, an after-action report of the lapses that allowed these situations to develop? 

Mr. BERNANKE. Senator, certainly we are looking at all those 

issues. I think I should say that this is very much an international 

issue, that other countries as well are very much involved in this, 

and there is, in fact, an elaborate process underway which is involving, first of all, each individual agency doing extensive analysis. We at the Federal Reserve have looked at our practices, have 

looked at a variety of other issues. Those are being combined together in a joint analysis of the President’s Working Group, of 

which we all three are members. That in turn is feeding into international bodies, such as the Financial Stability Forum and the 

Basel Committee, which are trying to develop lessons learned not 

just for the Federal Reserve or for the United States, but for the 

entire world in terms of our regulatory processes and approaches. 

So we have thought about it very extensively both in terms of 

our own agency but there is, in fact, a very substantial international effort underway. And, in fact, the Financial Stability 

Forum at the G–7 meetings last weekend just released a preliminary report. We expect to see an extensive report at the next meetings in Washington, I think it is in April. 

Senator REED. And these reports will be publicly distributed with 

very specific analysis of the steps that might have been taken previously by the Fed, SEC, and the Treasury Department? 


dcolon on DSK2BSOYB1PROD with HEARING
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Mr. BERNANKE. They will be very principles based. They will be 

talking about the kinds of approaches we need to take in order to 

make sure these problems do not happen again, but yes. 

Senator REED. I appreciate that, Mr. Chairman, but I think at 

some point you have got to drill down to the specifics of adequacy 

of your procedures, adequacy of your staffing, cooperation from financial institutions. You know, we were aware of these SIVs and 

these SPEs for years and years and years. Suddenly, they are roaring and, you know, unstable—destabilizing balance sheets. 

Let me switch to a slightly related question. Both you and the 

Treasury Secretary have said that the banks have to reveal very 

quickly their losses. Have they revealed their losses to you? You 

say in your statement there is still some uncertainty about what 

they have on their balance sheets. I would think that would be the 

first point of clarification. Do you feel that you are getting the kind 

of—— 

Mr. BERNANKE. We are getting very good information. The difficulty is that for many of these assets, a clear, succinct, sharp 

measure of the loss is not always easy because many of them are 

not traded frequently in markets, they are very idiosyncratic, and 

their valuations can change from day to day depending on, for example, how the market is valuing subprime mortgages. So it is not 

an easy problem. 

The FASB has set up a set of standards which divides measurements into three levels: those assets which have a market value; 

those which can only be addressed through modeling, which means 

using some market information but also some assumptions and 

models internally; and, third, those categories which are mostly 

judgment. And so inherently it is very difficult to get sharp answers, but—Chairman Cox can add to this, but we certainly are 

getting good cooperation, and we are urging our institutions to disclose as promptly and as effectively as possible. 

Senator REED. My time has expired, Mr. Chairman. Thank you. 

Chairman DODD. Thank you very much. 

Senator Allard. 

Senator ALLARD. Thank you, Mr. Chairman. I serve on the Budget Committee, and I am looking forward to getting our budget reported out around the 1st of March, the first week in March, at 

least. And we put out 5-year budgets, and in the next 5 years here 

are some of the problems that I see facing our economy and facing 

the Congress as a challenge. I would like to have you comment on 

these, if you would. 

First of all, if the surge continues to work in Iraq, then that 

means that we will be pulling back troops to the United States 

homeland, and we will probably see a cranking down of the industrial-military complex. Historically, after a major conflict, you 

know, unemployment goes up because of them returning home. We 

also are looking at in the next 5 years, if Congress does nothing, 

a tax increase that will happen that will amount to about a $1.3 

trillion increase in taxes over the next 10-year period, I am told by 

the Finance Committee. We are looking at growth in entitlements. 

We are looking at persistent deficits and high energy costs. 

Do you have any suggestions or any priorities that we should be 

looking at when we put this budget together and those problems 


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that need to be addressed? I thought I would start with Dr. 

Bernanke and then perhaps Secretary Paulson and then hopefully 

Chairman of the SEC, Chris Cox, would comment. 

Mr. BERNANKE. Well, I will be quick. You have, obviously, a 

number of difficult issues in the next 4 or 5 years. The alternative 

minimum tax remains an issue. If you are going to eliminate that 

permanently, how are you going to replace that revenue or reduce 

the spending? 

Domestic programs, the administration’s budget requires a very 

tough lid on domestic spending. That is going to be very trying. It 

is very demanding for the Congress. 

Management of Iraq and Afghanistan spending, as that comes 

down. 

Those are some of the issues you will be facing in the near term, 

but as I said on a number of previous occasions, it is likely to see 

some—there is likely to be some near-term improvements in the 

deficit over the next 5 years or so. As we move into the next decade, the entitlement issues are really going to begin to be seen in 

the annual budgets, as, for example, Social Security stops producing a surplus each year and begins to be a net drain on the Federal budget. 

So from a longer-term fiscal perspective, I think the entitlement 

issues are the dominant question. The CBO estimates that in 2030 

the entitlement spending plus interest payments will essentially 

take up the entire Government budget. And even so, the deficit 

might be as high as 9 percent of GDP. 

So the critical issue for the medium term and the long term is 

the entitlement question. 

Senator ALLARD. Secretary Paulson. 

Secretary PAULSON. Yes, I will be brief because I agree with that. 

There are some short-term issues, but they all pale with the 

longer-term issues. When you look at our long-term competitiveness and financial flexibility and the big structural issues, No. 1 or 

right up there has got to be entitlements. And I am sure we as a 

country will come to some solution, but the longer we wait, the bigger burden we place on the next generation. And that is a huge 

problem staring us in the face, and it is one that is solvable. 

I would say energy security ranks right up there with that when 

you are looking at big structural economic issues, and then we are 

just going to have to continue to also look at other issues of competitiveness, and I think we know what they are. When we look at 

keeping our technology spending up, R&D spending, there are 

some issues that very much relate to immigration and making sure 

we have the talent here and that the people that are graduating 

from our top universities with degrees in engineering and other 

sciences, and we do not ship them out. Many of them are foreign 

nationals, and we are shipping them back overseas—— 

Senator ALLARD. I want to cut you short here because I want to 

give Mr. Cox an opportunity to respond, too. When you were a 

Member of Congress, you always concerned yourself about high tax 

rates, and maybe you want to elaborate on what the other two said. 

And then also I would like to hear what you think about the $1.3 

trillion tax increase that we could be facing in the next 5 years because the temporary taxes will be expiring. 


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Mr. COX. Well, Senator Allard, at the Securities and Exchange 

Commission, we look at things from the perspective of the investor, 

and so, as you and the Congress formulate fiscal policy, I hope that 

you will continue to be attentive to effects, both intended and sometimes unintended, on incentives for savings and for investment. It 

is vitally important to our mission that Americans make proper 

choices about how they spend their money. We, at your direction 

and with your funding, spend a good deal of money on investor 

education, all designed for these purposes. If Government policy in 

other ways provides disincentives for what we all consider to be 

wise and good behavior, then the country, the whole savings mechanism, intermediation, and ultimately our Nation’s and global economic growth pay. 

Senator ALLARD. Mr. Chairman, I see my time has expired. 

Chairman DODD. Thank you very much, Senator. 

Senator Menendez. Bob. 

Senator MENENDEZ. Thank you, Mr. Chairman. Thank you all for 

your testimony. 

You know, nearly a year ago, when we had one of the first hearings on the foreclosure issue in this Committee, I said that we were 

looking at a tsunami of foreclosures, and the response then by 

members of the administration was—we had variations on the 

theme that the mounting waves of foreclosure, it was not a crisis; 

that it was contained; that it soon would be over. And instead of 

warning bells from those who are supposed to keep tabs on the 

pulse of the markets, we had timid responses. And instead of a 

clarion call to securitizers, lenders, brokers, and everyone who had 

a hand in the mortgage chain to take responsible action, we a let’swait-and-see approach. And I think we have seen what the let’swait-and-see approach has produced and where it has gotten us. 

Now, certainly when it comes to our markets, a knee-jerk reaction isn’t in the Nation’s interest, and that is certainly not what 

I am talking about. But when there is a real crisis at bay, when 

there is a storm brewing on the horizon, we count on those at the 

top—and certainly that is all of you—to sound the alarm. And to 

many of us, I think what we got was a snooze button. We have 

been behind the curve. 

And so I say that as a premise to two sets of questions that I 

hope to get some honest answers on. One is that I know the topic 

of this hearing is the economy. Mr. Secretary, are we headed toward or in danger of being in a recession? 

Secretary PAULSON. Senator, I do not know how to answer it any 

more clearly than I did in my testimony, so I will say again I believe that we are going to continue to grow, albeit at a slower rate. 

The risks are to the downside. I do not have a crystal ball, but we 

did not sit back and wait. What we have done is move very quickly, 

I believe—you know, Congress and the Administration—with a 

stimulus package. 

Senator MENENDEZ. Well, we appreciate the stimulus, but there 

are those of us who believe that that in and of itself is not sufficient. Let me just go through a few statistics. Last quarter, the 

economy grew at six-tenths of a percent, too slow to promote robust 

job growth. We lost 17,000 jobs last month. A number of Wall 

Street firms—including your former firm, Mr. Secretary, Goldman 


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Sachs, Morgan Stanley, Merrill Lynch—predict a recession this 

year. A survey of the Federal Reserve Bank of Philadelphia released just this Tuesday, on average forecasters said there was a 

47-percent chance the economy would shrink in the first quarter of 

this year and a 43-percent chance that the economy would shrink 

in the following quarter, the second quarter of 2008. Every time it 

has risen above 40 percent, the economy has gone into a recession. 

In a recent survey of economists by USA Today, more economists 

are increasingly predicting a recession compared to last October 

when only a third, now nearly half. 

So my point is for us to be able to move forward, we have to have 

some honest assessments and not be suggesting that—I do not 

want to talk down the economy, but at the same time we need to 

be able to work to build it up if we know we have challenges. And 

part of that challenge is the housing crisis, as the Chairman so 

aptly said at the beginning of his statement. 

You know, Mr. Secretary, you characterize the administration’s 

efforts as ‘‘aggressive action.’’ I have to be honest with you. I remain unconvinced. I do not know that Hope Now is aggressive action when we are seeing foreclosures outpacing loan modifications 

7 to 1. For subprime ARMs, which are at the root of the crisis, it 

is even worse—13 to 1. That does not even deal with the payment 

option ARMs that are looming on the horizon. 

And so are you telling the Committee that what the administration has proposed to date, particularly on the foreclosure crisis, 

which is at the root of our economic challenge where many of us 

feel that either we are in or headed toward a recession, that the 

voluntary actions are sufficient to stem the hemorrhaging and to 

ultimately—not only the hemorrhaging and the losses of homes for 

Americans, but at the same time the consequential effect it has on 

the economy? 

Secretary PAULSON. I would say to begin with, if you are trying 

to talk the economy up, I would hate to see you try to talk it down. 

Senator MENENDEZ. I am just not trying to hide my head in the 

sand either. 

Secretary PAULSON. I am not either. But I would say that the 

Hope Now Alliance in my judgment has been an aggressive approach to stem avoidable foreclosures. To have 90 percent of the 

subprime market covered for adjustable rate mortgages—and, 

again, as I have said, I believe that what we are going to see as 

we go forward here. We are going to see that those mortgage holders that have their interest rates reset and, if they have been able 

to make the initial rates, they are going to be able to stay in their 

home if they want to stay in their home. 

Now, it took us until early January to get this group together. 

There were all sorts of technical hurdles. As Chairman Cox said, 

we obtained guidance from the SEC in early January. We are going 

to be very transparent. We are going to look at how it is working 

and if the industry is not performing, we will be all over them. 

Now, that deals with one part of this, and one part only. And the 

housing market is going through a correction. As you know, we 

have a number of other things. We would like to get the FHA modernization legislation signed. We have some proposals for tax-exempt financing. I am very open to looking at other ideas. I look at 


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many ideas, look at them all the time, and it is a lot easier for people to say, ‘‘Do something,’’ than to say what it is we should do. 

So, again, we are going to keep looking at it and watching this 

quickly and watching it carefully. 

Senator MENENDEZ. Well, Mr. Chairman, my time is up. I just 

want to say that there are several other initiatives. We look forward to having you consider them because we believe that just the 

voluntary aspect alone is not going to make us whole, either in 

stopping the American dream from being an American nightmare 

and too much debt that will result from that, too much loss in property values across the landscape of the country, and at the same 

time too much of a negative ripple effect in the economy. 

Thank you, Mr. Chairman. 

Chairman DODD. Thank you, Senator Menendez. And I raise 

this, as the Chairman knows and the Secretary knows, we started 

this process last March with the industry, the stakeholders, Senator Shelby and I did when we had those meetings. And I think 

other members may have shown up in those days, and we worked 

on a set of principles. And I am hoping it works as well. We all 

would like to see this work. You can understand Senator 

Menendez’s skepticism and the skepticism we feel about it, just 

worried this is not going to be enough or is too timid and not catching up, Mr. Secretary. 

Secretary PAULSON. Yes. I would just simply say it will certainly 

not be enough if the test we are using is going to somehow or other 

prevent all foreclosures. 

Chairman DODD. No, no. 

Secretary PAULSON. Or to prevent a necessary market correction. 

Our principle here has been: How do we prevent a market failure? 

How do we prevent those foreclosures that are avoidable? And so 

we are open—and I am open, I know the Chairman is—for other 

ideas. But, again, we are watching it carefully. I think we have 

been pretty active and pretty proactive on this. And, again, we are 

open to suggestions. 

Chairman DODD. I hear that. 

Senator Hagel. 

Senator HAGEL. Thank you, Mr. Chairman. 

Gentlemen, welcome. Just a note regarding the line of questioning that Senator Allard reviewed with the three of you. We are 

all aware that recently S&P and Moody’s warned that if we do not 

deal with this entitlement issue, then our U.S. AAA bond ratings 

are in jeopardy, and we could see that as recently over the next few 

years. And I add that to the comments that you have made just 

to reconnect with not only the urgency of this issue but the reality 

of the consequences if we do not deal with these entitlement challenges that are ahead of us. 

I would like to talk for a moment about infrastructure. Senator 

Dodd and I have an infrastructure bill that we have introduced, 

and it would essentially leverage public and private capital—a little different approach than what we have seen in the past, and the 

reason for that is it is very clear to me that with the kind of deficits that we are running, will continue to run, with the obligations 

that you have noted here over the last few minutes, and most 

Americans are aware of, that the necessary capital for infrastrucVerDate Nov 24 2008 01:45 Mar 12, 2010 Jkt 050368 PO 00000 Frm 00029 Fmt 6633 Sfmt 6602 E:\HR\OC\A368.XXX A368

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ture is not going to be there. I do not know where we are going 

to get it. 

I noted, Secretary Paulson, that you did not think it should be 

included in the stimulus package—which I agree with, by the way. 

I think it is far larger than dropping rebate checks from an airplane. And I would be very interested in first understanding if the 

Treasury Department has looked at this infrastructure issue, will 

be making recommendations on what we should be doing. We clearly have an inadequate structure, and as we look down the road, 

again I do not know where we are going to find that capital, when 

the rest of the world is devoting an astounding amount of their resources to their infrastructure. And in a time when we are living 

at the most competitive time in the history of man, without an adequate infrastructure it will certainly have consequences on our 

ability to compete in the world. Secretary Paulson. 

Secretary PAULSON. Yes, Senator, I agree that infrastructure is 

a significant issue in this country and others over the intermediate 

and longer term. This is not an issue that falls right within the 

Treasury’s wheelhouse in the United States. We have other agencies that have responsibility for that. 

I would say to you, though, that, for instance, I was out late last 

year in California at an event, a trade event, where there was a 

good bit of discussion about infrastructure, because I think the infrastructure has a very important role to play. And, again, the 

focus there was on the private sector/public sector partnerships and 

how to structure infrastructure projects so there could be more private capital involved. In this country and almost anywhere else 

around the world, I have looked at it and the needs are so large 

that it is going to be very difficult for the public sector to do it 

alone. 

So a big part of this is going to be structuring infrastructure 

projects so that they attract private capital. 

Senator HAGEL. Thank you. 

I would also like to return to a line of questioning that, in particular, Senator Shelby has had regarding the GSEs. And we are 

all familiar with the fact that Fannie and Freddie are currently 

holding—either they own or are guaranteeing over $5 trillion in 

mortgage-backed securities, which are not registered with the Securities and Exchange Commission. 

I asked a question at a hearing last week on this, and I quoted 

your response back to me, Chairman Cox, on whether it would be 

important to have the GSEs registering their debt as well with the 

SEC, and one of the Assistant Secretaries of Treasury noted it 

would be helpful. 

I would like to address that issue specifically with you, Chairman 

Cox, as well as you, Secretary Paulson, on the importance of registering that debt and understanding what the securities are that 

Fannie and Freddie own or guarantee, $5 trillion worth. Do we 

really understand what they have? And would that registration 

with the SEC help us understand it? Chairman Cox. 

Mr. COX. Well, I think you are absolutely right, Senator, that because GSEs sell securities to the public, they have public investors, 

they do not have the full faith and credit of the Government backing them, their disclosures should comply with the Federal securiVerDate Nov 24 2008 01:45 Mar 12, 2010 Jkt 050368 PO 00000 Frm 00030 Fmt 6633 Sfmt 6602 E:\HR\OC\A368.XXX A368

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ties laws. This has been done essentially on a voluntary basis heretofore. As you know, we had accounting problems at both Fannie 

and Freddie that have resulted in delays in getting them into compliance with respect to their 1934 Act compliance. Fannie is now 

there. Their periodic reports are being filed on time. Their 10K is 

expected on time this year. Freddie is not there yet. 

I think there is no question about the benefit to the markets and 

to investors from the maximum amount of transparency. 

Senator HAGEL. Secretary Paulson, do you care to respond? 

Secretary PAULSON. Yes. I do not have much to add to that. It 

makes sense. I think Fannie has registered under the 1934 Act. 

Freddie is working to do that. That is, I think, very important, and 

I am also very focused on getting, as you all know, a GSE reform 

bill, which is, I think, at least as important. 

Senator HAGEL. Thank you. 

Mr. Chairman, thank you. 

Chairman DODD. Thank you very much, Senator Hagel, and I appreciate your raising the issue of the infrastructure bill that you 

and I are working on. 

In fact, we might ask the Treasury and others to take a look at 

this proposal, Mr. Secretary. We have not asked, I do not think, for 

comments on it. But this is one we worked on over the last 21⁄2

years, putting together this idea of exactly what you are talking 

about as a way to attract private/public capital, because you are 

not going to do it on the Appropriations Committee. 

Secretary PAULSON. Right. 

Chairman DODD. The needs are in the trillions of dollars. 

Secretary PAULSON. Yes. 

Chairman DODD. And it is going to take much more creative financing than what we have been accustomed to if we are going to 

do something about it. So I would be interested in your comments. 

Senator Brown. 

Senator BROWN. Thank you, Mr. Chairman. 

I remain a bit surprised and troubled, Secretary Paulson, that 

your comments tend to gloss over some structural problems in our 

economy. Every day 200 families in Ohio, for instance, lose their 

homes to foreclosure, and none of that surprises you. And the troubles—I mean, to be sure, the troubles are worse in my State than 

perhaps the, quote-unquote, national average. But they are also not 

much different—if different in magnitude, not much different from 

the rest of the country’s. Wages have been stagnant. Chairman 

Bernanke as long ago as 14 months talked about income equality 

and how the industry has repeated that message and some ideas 

about what to do about it. Job growth has been anemic in the last 

7 years. You know about gas prices, home heating costs. The food 

bank pantries around my State tell me it is worse than at any time 

in the last quarter century. And for the first time, as we know, in 

our lifetimes, families’ housing wealth across the country is 

evaporating, as Senator Reed had pointed out. 

The stimulus package that the President signed into law should 

help somewhat, but even there we need to do much more. And I 

want to ask you a specific question. 

If I understand correctly, rebates will be issued only to people 

who file tax returns, but millions of eligible Americans who receive 


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railroad retirement or Social Security retirement or disability benefits are not required to file tax returns. If they do somehow get 

word and do go to the IRS free-file program, they will be kicked 

out because the software is programmed to prevent them from filing. 

I am sure you aware of this. I would just like to know, Mr. Secretary, what steps you plan to take to ensure that everyone receives what Congress believes they are due. 

Secretary PAULSON. That is the question we are really focused on 

right now. There is going to be a huge effort getting those people 

who normally do not file to file, and file as soon as possible. So in 

addition to the IRS website, there is going to be a big outreach effort, and we are going to go to a number of agencies, and to Members of Congress, because we have some experience in the past 

with the telephone excise tax and doing things on a smaller scale. 

But you have pointed your finger at an issue, because we have got 

to get to 130 million people and a good number of those are not 

normal filers. 

Senator BROWN. And your job is both to find them and to make 

sure the software does not kick them out when you do find them. 

You can assure us of that? 

Secretary PAULSON. Our idea is to find them, get to them, and 

encourage them to file and make it easy for them to file, because 

there should be a very easy basis for doing this. 

Senator BROWN. OK. Thank you. 

Chairman Cox, nice to see you again. I appreciate the attention 

you are giving to sovereign wealth funds. I am curious why there 

is not much concern attached to this issue as many think there 

should be. As you will recall, President Clinton in, I believe, 1999 

proposed to invest a quarter of the Social Security surplus, about 

$50 billion a year, in equity index funds. The reaction to that proposal in some quarters was pretty energetic. The esteemed Chairman of the House Republican Policy Committee called it ‘‘the largest nationalization in history, threatening the very soundness of 

the economy.’’ A Presidential candidate at the time called it a blatant Big Government power grab. 

I do not want to relitigate the Social Security question, but when 

we are looking at much greater amounts of money being invested 

selectively by foreign governments, and often governments very 

hostile, if not hostile to us certainly very different in their makeup 

in terms of being democratic and sharing the values that we have, 

we are looking at much greater amounts of money being invested 

selectively by foreign governments. Shouldn’t there be a little more 

concern about their investment in U.S. private concerns—banks, 

other financial institutions, manufacturing companies, service companies—in this country? 

Mr. COX. Well, these are important questions for the Congress, 

for the markets, certainly for all of us in the President’s Working 

Group, and in some special ways for the Securities and Exchange 

Commission, because sovereign wealth funds, as any other large investors, come directly into contact with our regulatory system. 

As you know, sovereign wealth funds have recently made investments in Citigroup, in Merrill Lynch, Morgan Stanley, UBS. These 

investments from the standpoint of the Securities and Exchange 


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Commission have been treated in the same fashion as would any 

investments by any large investor. And I think the reason for that 

cannot be said often enough in this context. It is because the 

United States welcomes and will continue to welcome with open 

arms both foreign investment in U.S. capital markets and the opportunity for Americans to invest beyond our borders. But in this 

context it is certainly worth paying attention to the unique features 

of sovereign wealth funds. They are not, first of all, all the same, 

as you know. But, because they are fundamentally arms of governments, they raise all the familiar questions about government ownership of industry, to which you alluded in your statement. They 

are growing in size, but they have been around for a long time. 

And so, in one sense, there is certainly no cause for alarm. Kuwait started its first sovereign wealth fund, which was not called 

that, over a half-century ago. Today one estimate from the Federal 

Reserve of New York puts the size of all of these funds combined 

at about $2.5 trillion. That is a lot of money. To be sure, it is more, 

for example, than all the world’s hedge funds combined. On the 

other hand, as a percentage of assets that are managed by SECregistered investment advisers, it is about 6.5 percent of that $38 

trillion. And as a percentage of all of the world’s investable assets—equities, bonds, and bank holdings—it is about 1.2 percent, 

although the Federal Reserve of New York estimates it is going to 

grow to about 4 percent. 

So I think that we have the opportunity to watch this phenomenon and to understand it. It is not something that we have 

to deal with definitively this week. On the other hand, if the trends 

that are being identified are correct, if they really do grow, as is 

expected, to some 4 percent of global financial markets in 7 years, 

that could at some point have a qualitative impact on our markets. 

And I think you are right to focus on it, but I would also caution 

that if what we do first is regulate and restrict, then we may have 

the kinds of impacts on our own capital markets that we are concerned about governments of other countries imposing upon us. So 

the remedy can also be a problem. We have to be very thoughtful 

about what we do in response. And, as you know, this question is 

being looked at by a lot of people in a lot of ways, including a focus 

on transparency I know that Secretary Paulson is leading as Chairman of the President’s Working Group, because we have all agreed 

that both the sovereign wealth funds and the countries in which 

they invest will all be better off if they behave like any other commercial actors and if they are completely transparent. 

Thank you. 

Senator BROWN. I appreciate the work—— 

Chairman DODD. Your microphone, please. 

Senator BROWN. I appreciate the work of Senator Biden. I am 

just still a little bit confused that there was such anger and outrage that the U.S. Government would consider investing, but there 

is sort of tepid acceptance or indifference to investment by a Chinese or Dubai fund. I just remain a bit confused by that. But thank 

you. 

Chairman DODD. All right. Senator Bunning. 

Senator BUNNING. Thank you, Mr. Chairman. 


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I have got 5 minutes and lots of questions, so if you would keep 

your answers short, I would appreciate it. 

Chairman Bernanke and Secretary Paulson, how much of the 

stimulus in the bill signed by the President yesterday needs to get 

into the economy and how quickly does it need to get there to have 

an impact in the second half of the year? 

Mr. BERNANKE. Senator, I think that the provisions made for the 

very quick action by Congress, the fact that the Treasury is working hard to get the IRS to send the money out very quickly, I think 

it will have an impact as early as the third quarter, maybe even 

a little bit in the second quarter. So it is a very timely bill in that 

respect, and I think it will be helpful. 

Senator BUNNING. But how much of the stimulus package—we 

have got $160 billion. How much of that has to get in? 

Mr. BERNANKE. Secretary Paulson could help me, but I believe 

that the money is going to be disbursed—over about 10 weeks or 

so? 

Secretary PAULSON. Yes, it will get out quickly, Senator. We are 

going to get the first payments out in the very beginning of May, 

and I think the vast majority of the payments going out to individuals will be out by mid-summer. 

Senator BUNNING. So it can have a significant impact. 

Secretary PAULSON. Yes, it will—we are going to get this out 

quickly. 

Senator BUNNING. There are a lot of us who worried that it was 

not going to. OK. 

Chairman Bernanke and Secretary Paulson, with Fed fund rates 

at 3 percent and the President having just signed the economic 

stimulus package, do you have the proper tools today to react to 

an external energy shock or a disruption or a terrorist attack? 

Mr. BERNANKE. Well, certainly, as I said, the monetary and fiscal 

stimulus we have should give us a better second half than otherwise would have been the case, and that should make the economy 

more resilient in the face of some kind of external shock. It would 

depend on the size of the shock, the nature of the shock, but it certainly makes us more resilient. 

Secretary PAULSON. I would agree with that. We could all envision shocks that would be more severe than others. We are a bit 

more fragile than we were before we went into this period because 

the economy is slowing down and our institutions are not as well 

capitalized. They are adequately capitalized, but they are a bit 

more fragile. But I believe we are doing what we need to do, and 

if there is a shock, we will figure out how to react to it. 

Senator BUNNING. All right. Well, thank you. 

Chairman Bernanke, our unemployment rate last month was 4.9 

percent. The average rate has been from 4.5 percent to 5.5 percent. 

How close do you consider that to full employment? What is the 

natural rate of unemployment for our economy today? 

Mr. BERNANKE. Senator, that is very contentious, and we are not 

very sure. People differ considerably. But recently the U.S. economy has shown an ability to maintain an unemployment rate somewhat a little bit below 5 percent. So we are not far from what many 

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size that there is an enormous amount of uncertainty about exactly 

where that is. 

Senator BUNNING. Well, 10 years ago, 6 percent was considered 

full employment. 

Mr. BERNANKE. Well, the economy has changed. I mean, the—— 

Senator BUNNING. That is why I am asking. 

Mr. BERNANKE. Yes, and I think it is not a question of changing 

estimates. I think it is the fact that the economy, the demographics 

have changed, the ability to find jobs has improved, for example, 

using the Internet. A number of other factors have gone in to bring 

down that rate, and I think that is consistent with evolution of the 

economy. 

Senator BUNNING. You have, I believe, answered this before, Secretary Paulson, but do you believe the banks and other financial 

institutions are adequately stating their exposure relating to the 

mortgage mess, including risks to prime in all types of other loans? 

Secretary PAULSON. I believe that there is a big effort being 

made to do that, and as Chairman Bernanke said, some of the securities they are holding, there is not a—— 

Senator BUNNING. A free market or open market. 

Secretary PAULSON. A market, and so what they are doing is 

they are marking these securities based upon ratings and based 

upon changes in the economy. And so this is difficult, but I think 

a lot of progress has been made, and I think that I am doing everything I can—and I know the Chairman is and Chairman Cox is— 

to encourage banks to take the losses and raise capital. 

Senator BUNNING. Chairman Bernanke, I just want to give you 

a heads up. When you see something coming, don’t put it off as the 

Chairman of the Fed. Take action immediately, because this housing market has been coming to us for a year, a year and a half, 

and we did not react properly to it. 

Thank you. 

Chairman DODD. Let me inquire—I appreciate it, Senator Casey. 

Thanks very much. 

Senator Schumer. 

Senator SCHUMER. Well, thank you, Mr. Chairman, and I want 

to thank my colleagues and my colleague from Pennsylvania as 

well. I have a few questions. 

First, you know, being from New York, I talk to a lot of people 

who are involved in the credit markets, and more and more it 

seems there is a disconnect. They are in a state of severe worry, 

even some I talk to panic about the brittleness, the frozenness of 

the credit markets, which affects everything. And the statements 

that both Secretary Paulson and Chairman Bernanke have made 

have said, well, this is a problem, but it will not even take us into 

recession. 

My question is: When we are now seeing credit really damaged 

in corporate lending, lower-grade corporate lending, this 20 percent 

that the Port Authority paid shows a brittleness and an inflexibility. That is a good, safe investment, the Port Authority. I do not 

know how many people think the Port Authority is going broke, 

and you have got to pay 20 percent when the previous rate was 4.2 

percent? 


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Aren’t we reaching a point where the lack of confidence overall 

in credit in this country—not just in housing, not just in student 

loans, but throughout, with the combination of the complex credit 

tools that have been used and the fact that people seem to have 

a sort of rather happy attitude about all of this until the housing 

crisis hit, aren’t you underestimating not paying enough attention 

to the severity of the problem in the credit markets, which could 

become a much greater problem to the economy than the lack of— 

you know, the slowdown in consumer spending? 

Secretary PAULSON. Yes, I would just say one thing, Senator. 

Yesterday and today, I talked with six or seven CEOs of the major 

firms in New York and continually get updates. I understand what 

happened in the auction and looking at other auctions that are 

coming up. It is one thing to identify a problem; it is another to 

know exactly what to do about it. 

I do believe, though, that what you are seeing here is the market 

pulling back from complexity, from any kind of instrument that is 

going to finance longer-term assets on a shorter-term basis. 

Senator SCHUMER. Aren’t they more worried than your testimony 

or Chairman Bernanke’s—— 

Secretary PAULSON. Well, I—— 

Senator SCHUMER. I talked to them, too, and they seem much 

more worried than you guys are. 

Secretary PAULSON. Well, let me say some seem more worried 

than others. I will tell you this: I have watched these things before, 

and it will take a while to get through this, and it is something 

we are watching carefully. But, again, the situations you talked 

about, like, for instance, the 20-percent rate. That is an overreaction. It is more of a reaction against the structure than the 

credit. It will be very quickly refinanced. And, again, I do not mean 

to be overly complacent, but I do say that one of the things we are 

going to have to do is re-price risk, mark securities to market, and 

raise capital. 

Senator SCHUMER. Right, OK. I am going to—since you and I 

talked on the phone about this yesterday, Mr. Chairman, I will go 

to my next question because I want to stay—the problem that we 

have had with the mortgage insurance is a problem, of course, not 

with mortgage insurance itself where the State regulators have 

done a good job, but when these companies then went over and did 

CDOs in—I am sorry, with bond insurance, with the Government 

bond insurance. When these companies like MBIA stepped into 

some new territory, CDOs, mortgage bonds, et cetera, led to their 

problems, not necessarily the insuring of State and local risk. And 

this brings in a problem of systemic risk. So I am considering introducing legislation that would regulate them when they do get involved in other types of activities, at least have some kind of Federal oversight greater than we have now. I am not sure if it should 

be by the Fed or by some other agency. 

I would like, Chairman Bernanke, your opinion of that and, Secretary Paulson, your opinion of whether there should be some 

greater oversight, Federal, on the systemic risk side, not necessarily on the insuring government side, of these bond agencies— 

these bond insurers. 


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Mr. BERNANKE. Senator, I am not quite sure what you have in 

mind. From a microeconomic point of view, the State insurance department regulates them, and we have no complaints about their 

regulation. But from a macroeconomic or from a market stability 

point of view, we are obviously watching that situation very carefully. 

I am not quite sure what additional powers you would have in 

mind, but, you know, I think that it is important to note the 

monoline problem is in some sense a reflection of the deeper underlying problem, which is the problems in the CDOs, the problems in 

the underlying assets. 

Senator SCHUMER. Yes. 

Mr. BERNANKE. The best way to address this issue is to strengthen the underlying economy, the housing market and so on. 

Senator SCHUMER. Maybe they should not be able to buy such a 

high percentage of these types of things in terms of systemic risk 

without any regulation. 

Secretary Paulson. 

Secretary PAULSON. Yes, I would say something, Senator Schumer, that addresses this, at least in part. One of the things we are 

working on very diligently right now at Treasury is developing a 

blueprint, a regulatory blueprint, for today’s world and today’s 

markets, because if someone came down from Mars and you were 

trying to explain the regulatory structure and how this works the 

way, it does. The regulatory structure has not evolved with the 

markets, and it is a patchwork quilt in many ways. 

And so hopefully when we are ready to unveil this, we can have 

some good discussion. 

Senator SCHUMER. I think it is a good idea for you to look at 

that, and I am, too. 

Thank you, Mr. Chairman, and I thank my colleague from Pennsylvania. 

Chairman DODD. Thank you very much, Senator. I appreciate it. 

Senator Dole. 

Senator DOLE. Yes, thank you, Mr. Chairman. 

First, I certainly want to echo the favorable comments that we 

have heard this morning regarding GSE reform. I have been a 

sponsor of that legislation, a cosponsor with Senator Hagel, and am 

very pleased to hear the strong support,and I hope we can move 

on that expeditiously. 

Chairman Cox, since the passage of Sarbanes-Oxley, there have 

been a number of complaints from smaller companies, from financial institutions, with regard to Section 404 and the burdensome 

nature of compliance, especially from the financial institutions because they are heavily regulated. 

Has there been any thought of easing the Section 404 requirements for these institutions? 

Mr. COX. Most definitely, Senator. In fact, both at the Securities 

and Exchange Commission and at the Public Company Accounting 

Oversight Board, which implements the audit rules for SOX 404, 

we have taken it upon ourselves to slay the 404 beast. It has been, 

more than any part of Sarbanes-Oxley, the subject of criticism both 

here in the United States and abroad, not so much because of what 


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Congress intended this provision to do, but because of the way that 

it was implemented. 

And so, to begin with, the SEC issued guidance for companies 

that had not existed before. The companies were having to use the 

guidance that was intended for auditors so that they could do their 

own internal assessment without the auditors under 404(a). And, 

second, we repealed entirely the long and cumbersome and very expensive auditing standard that had been adopted under very urgent conditions right after the passage of Sarbanes-Oxley, Audit 

Standard No. 2, and replaced it with something that is shorter, 

simpler, more principles based, top down, risk focused, guided by 

materiality and scaled to companies of all sizes. That is now going 

to kick in for this year, and we have a cost-benefit study underway 

at the SEC to make sure that it is working as we intended. 

Finally, with respect to the smaller public companies, we have on 

multiple occasions extended their time for compliance, and we have 

just done so one more time into 2009. 

Senator DOLE. Thank you. 

Secretary Paulson, on January 24th, Business Week reported 

that sovereign wealth funds were the main topic of the Davos 

World Economic Forum talks. This has been mentioned already 

this morning, but I wanted to get you to reflect on this a moment 

because I know that some countries, like Norway, have a more 

transparent investment process while other countries, like China 

and Russia, have less so. 

What is the current status of the Treasury’s work in this area 

with appropriate international entities to come up with a way that 

these funds can be at least more transparent or better understood? 

Secretary PAULSON. Senator Dole, thank you very much. We are 

quite focused on this topic, and as Chairman Cox says, although 

they are a growing part of the capital markets in terms of their 

size, on a relative basis they are still fairly modest. But we are 

quite focused, and what we are focused on is to make sure that 

what they are driven by is commercial and economic purposes. We 

have had a history for many years with sovereign wealth funds, 

and for the most part, they are driven by getting a higher risk-adjusted return. They are driven by economic purposes. 

We at Treasury have spent a lot of time meeting with the sovereign wealth funds. We had a breakfast at Treasury where we had 

25 or 30 of them there, and they all assure us that they are driven 

by economic intent. But our purpose there is to come up, and we 

are encouraging the IMF to work with them and others, with a set 

of business practices, best practices, principles that have to do with 

governance and transparency, and that will help them convince so 

many of the countries that are going to be the recipients of their 

investment that their intent is for economic purposes. 

Again, I want to reiterate what Chairman Cox says. In this country, we welcome foreign investment. That is the highest vote of confidence anyone can pay, is to make a direct investment in our economy. We want to be welcoming to that investment, but we also 

want to be vigilant. 

Senator DOLE. Thank you very much. 

Chairman DODD. Thank you very much, Senator. 


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Senator CASEY. And thank you, Senator Casey, for yielding to 

Senator Schumer. I appreciate it. 

Thank you, Mr. Chairman. Thanks for calling this hearing, and 

it is great to have these three individuals here—Secretary Paulson, 

Chairman Bernanke, and Chairman Cox. We appreciate your testimony and your service to the country. 

I want to speak first with regard to the subprime prices. Secretary Paulson, I wanted to just lay some Pennsylvania facts on the 

table. Two overall facts for the State—three, really. When you look 

at the third quarters of 2005 versus 2007, the number of delinquencies in our State has increased by some 40,000. Then if you 

go forward and talk about foreclosures, full-blown foreclosures, the 

projection is third quarter 2007 versus third quarter 2009, that is 

supposed to go up by some 45,000. They are statewide numbers. 

One number which I do not think many of us talk about is a 

number that I just came across recently that was in a report by 

the Keystone Research Center. I would ask, Mr. Chairman, consent 

that this report be made part of the record. 

Chairman DODD. It will be made a part of the record. 

Senator CASEY. It is entitled, ‘‘A Building Storm: The Housing 

Market and the Pennsylvania Economy.’’ It is by the Keystone Research Center, Mark Price and Stephen Herzenberg. 

An interesting fact in here, which I put on the table as a foundation for my first question, is that we all know that subprime mortgages affect principally, in many cases, in many communities almost exclusively, low-income families. However, we sometimes 

think about that as an urban issue. 

This report found that the highest subprime mortgage rates are 

at least in Pennsylvania, in addition to the city of Philadelphia, the 

other eight in the top nine were rural counties. Overwhelming 

numbers, almost half the mortgages subprime. I say that in the 

context of my question in terms of the people we are worried about 

here and that I know you are worried about, and to ask you how 

you respond to some of the recent criticism that we have seen in 

the press. 

I know that, for example, the Wall Street Journal—not what I 

would call a left-leaning newspaper—from yesterday, ‘‘Earlier 

subprime rescue falters.’’ I know you have seen that story. That is 

a national story that says in part in the first paragraph, ‘‘Earlier 

efforts have done little to help the most troubled borrowers.’’ It 

goes on to talk about criticisms of what has been happening so far. 

And then just yesterday, as well, the Pittsburgh Tribune Review 

newspaper—again, not a left-leaning newspaper—the headline is 

‘‘Mortgage lifeline falls short,’’ and it talks about the Allegheny 

County Sheriff’s Department, a big county in Pennsylvania, second 

largest county, saying that they are doing what the new initiative 

sets forth to do. And I would ask you to respond to that because 

I think people are worried that there is not the sense of urgency 

and we are not getting the results that we should have in the last 

couple of months. 

Secretary PAULSON. Well, Senator, I understand that, and I 

spent time myself going around visiting communities where there 

are the most foreclosures. So I spent time on the ground. I have 


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spent I would say a third of my time on this issue. And it is a difficult issue. It is not an easy issue. 

Take the case of the initiative that was announced earlier this 

week, Project Lifeline. There was a lot of criticism that it is not 

enough, et cetera, et cetera. That effort is aimed at anyone in the 

U.S. that has a mortgage and that is delinquent 90 days. So they 

are right on the verge of losing their home. And one very sad fact 

is that over 50 percent of the foreclosures take place where the 

homeowner never talks to anyone. 

Now, it is very difficult to help someone if they will not try to 

help themselves or talk to anyone. So we have a hotline, 888–995– 

HOPE, and we are urging people to call. This effort, again, is a 

last-ditch effort to get to people and get to them with a mailing and 

say here are some simple, pre-set procedures you can go through, 

and if you go through them, there may be an opportunity to have 

a modification in your loan agreement. 

Now, some people criticize that, and I frankly do not understand 

where their criticism comes from, because it is something we all 

should be doing. Now, is that going to help all those people stay 

in their homes? No. But it will help some people stay in their 

homes. 

The other effort that we have been working very, very hard on 

is the number of adjustable rate mortgages. And you are right, the 

next 2 years are going to be the toughest 2 years. The poorest quality mortgages in terms of underwriting procedures were made in 

2006, so there are almost 2 million adjustable rate mortgages 

where the rates are going to be reset and move up. So we have 90 

percent of the industry working very hard overcoming many technical issues and accounting issues. We have the industry telling 

us—and I believe they are very sincere in doing this—that they are 

going to move very quickly to deal with those homeowners that are 

able to make their initial payments and aren’t able to afford the 

others, and help them avoid foreclosure. There are going to be fasttrack modifications which are interest rate freezes. There are going 

to be refinancings. They are going to give us the information. 

So I did not create this problem. I am working to try to do something about it. If this effort does not work, then we will make adjustments to it. I do not mean to sound heartless because, I will 

tell you, when you are there and you look at the predatory lending 

abuses it is heart-rending. But what we are doing is trying to deal 

with it. 

All I can say to you is if you have other ideas for me for Pennsylvania, send them on in, because I think the tax-exempt financing 

can be helpful if that gets passed. We are going to try to make all 

of these programs work to the extent they can. And I agree with 

you, it is not just an urban problem. It is a serious problem, and 

we are doing everything we can to deal with it. 

Senator CASEY. Well, and we are working on it here, too, as you 

know, but I am out of time. 

Chairman DODD. Thank you, Senator, very, very much. 

Let me turn to Senator Corker. 

Senator CORKER. Mr. Chairman, thank you. And to our panel, I 

want to say that I followed your careers and have tremendous reVerDate Nov 24 2008 01:45 Mar 12, 2010 Jkt 050368 PO 00000 Frm 00040 Fmt 6633 Sfmt 6602 E:\HR\OC\A368.XXX A368

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spect for you being in the positions that you are in, and I am glad 

that you are. 

I will also say that I think the most discouraging moment of my 

13-month career here has been this so-called economic stimulus 

package. We spent most of our morning talking about credit, and 

sprinkling $160 billion around the country and asking people to 

spend it as quickly as possible to solve this problem to me was not 

a solution worth debating or passing. But we have done that, and 

I just—obviously, these entities that are losing billions of dollars in 

the mortgage business, that is not a good thing for them either. 

And we have seen that when you can make a little money doing 

some conduit and securitized lending, you make a whole lot doing 

more, and so excesses occur. 

What do we see happening, Secretary Paulson, in the private sector to—obviously, the borrower and the lender are now separated. 

In some cases, the files may be in a warehouse in Kansas or Europe someplace, and so it is very difficult to solve these individual 

problems. What do we see the private sector—not today but over 

time—doing adjustment-wise to keep this kind of thing from occurring in the future? 

Secretary PAULSON. Well, clearly there will be an aversion for 

some period of time to complexity, because one of the real problems 

we have here is complexity and an over reliance on credit ratings. 

So that will be one reaction. 

You pointed to the conduits and SIVs, which are very interesting. 

There was a great deal of focus on private pools of capital, hedge 

funds, and a lot of other issues. I think the regulators overall had 

to be surprised to see that some of the biggest issues were in the 

big regulated entities and the lack of transparency. And there is a 

lot of work being done to address this. 

I do not come from the school that says that the private sector 

itself will deal with it. I believe there needs to be a regulatory response, a policy response. The first thing we need to do is get 

through this period with minimizing the impact on the real economy. But as both Chairman Bernanke and Chairman Cox have 

mentioned, we are working and thinking about what the right response is. 

The last thing I would just say very quickly, which, without 

being overly defensive on the stimulus, when you look at housing 

overall, and you see estimates of the degree to which housing 

prices in some areas of the country are overvalued, there are two 

ways you can have a correction: housing prices going down or the 

economy continuing to grow and growing into that. 

So one way of minimizing the extent of the correction is to keep 

our economy healthy and growing. The focus of this Administration 

has been let us get in and do things aggressively to avoid those 

foreclosures that are preventable, to prevent a market failure with 

the kinds of things we have been doing, and let us do what we can 

to keep the overall economy growing, recognizing that this correction is necessary. 

So that is the response there. 

Senator CORKER. Well, I did notice you said the focus of this Administration. I still have to believe that at night you are receiving 

cell phone calls from some of your former colleagues wondering 


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what in the world we were doing. And I am sure that explanation—— 

Secretary PAULSON. Well, I will tell you: they have not. 

Senator CORKER [continuing]. Has been developed. 

Secretary PAULSON. The interesting thing is every colleague that 

I have talked to or CEO of the financial services industry wanted 

a response like the stimulus plan and believe it will be helpful, but 

believe it is not sufficient. 

When they say not sufficient, they all recognize that as helpful 

as monetary policy is and as helpful as the stimulus is that those 

programs alone will not be sufficient; that the industry is going to 

need to re-price risk, recognize losses, raise capital, and that given 

the degree of integration of our capital markets into the global capital markets and the degree of complexity means, it is going to take 

time and some pain before we work through this. 

Senator CORKER. Just—I know my time is up, just a quick one 

word response from you and Chairman Bernanke, if we could. 

But there have been a lot of descriptions about where we are in 

the housing sector, whether it is a crisis or whether this is a correction. And I am wondering if each of you might chose a word to describe where we are today. 

Secretary PAULSON. I do not use loaded words. And so I have 

been using a correction, because it is a correction. And I would say 

this: that 93 percent of the mortgage holders in this country are 

making their mortgage payment on time. But what we have and 

why we have different voices is again this is a nationwide issue. 

There is a different degree of a problem in different areas of the 

country. And at the end of December, I went around and I visited 

a number of communities that had the highest rates of foreclosure. 

And they fit into two categories. 

They fit into—either those communities that may have a strong 

underlying economy, but where there had been very, very rapid appreciation of home prices, to the point that when you look back on 

it, it is hard to even imagine home prices going up 15 percent, 18 

percent a year and not sustainable. 

When you look at parts of—I was in Orlando, Florida; I was in 

Stockton, California, where you had home prices going up very 

quickly. And then, you would go to a place like Kansas City, Missouri, or you look at parts of Pennsylvania or Ohio or Michigan, 

where you maybe did not have the same appreciation, lower appreciation, but where we have a tough economy. 

Where the economy is weaker and that, coupled with some of the 

very bad lending practices, have put us where we are. 

Mr. BERNANKE. I think the mortgage payment rate is probably 

closer to 98 percent, but in any case it is—most people—obviously, 

the great majority of Americans are paying their mortgages on 

time. 

I agree with what the Secretary said, in particular there is two 

phenomena—on the one hand, in parts of the country where there 

was enormous price appreciation, that has been vulnerable to correction. So that is really in some sense an offsetting of what happened over the last 5 to 10 years in those markets. 

There are, however, other places in the upper Midwest, for example, where they never got that much appreciation. Now, prices are 


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falling because of general weakness in the economy, and that is one 

of the reasons why there is a direct connection between broad economic health and job creation and prices of housing, and there is 

a link there. 

Senator CORKER. Thank you, Mr. Chairman. 

Chairman DODD. Thank you, Senator, very much. I was—I could 

not help resist when you are asking whether it is a correction or 

crisis. Where you stand on that issue depends on where you sit. 

Senator CORKER. That is right. 

Chairman DODD. And if you are sitting there watching your 

house get foreclosed, believe me, it is a crisis. And we can move 

around with these numbers all we want. The fact is this is a big 

problem. And I agree I do not want to see the—it would be inappropriate for the Secretary or the Chairman to start putting a label 

of a word on there. That could have its own self-fulfilling prophecy 

here, so we ought to be careful about language. Language has significance and implications. 

But needless to say, I think we all agree here. We would not be 

sitting here if this were not a major issue we need to grapple with 

here, and I do not want to—I am not trying to engage in hyperbole, 

but I do not think we ought to underplay it either. I think you have 

got to be honest with people about this is serious and requires a 

lot of work. And I think that is the point worth making. 

Secretary PAULSON. We have both said for some time by far the 

biggest risk to the economy is the housing downturn. 

Chairman DODD. Thanks very much. 

Senator Carper. 

Senator CARPER. Thanks, Mr. Chairman. Gentlemen, welcome. 

Thanks very much for joining us and for your testimony today. 

I want to especially thank you, Mr. Secretary, for the good work, 

for the leadership that you demonstrated in working with the 

House and Senate to craft a stimulus package, which I think does 

no harm and hopefully will do some good as we get into the summer and the latter part of this year. 

I want to commend Chairman Bernanke. I want to commend you 

and those with whom you work on the work that you have done— 

lowering the Fed Funds rate I thought in an unprecedented way, 

not once but twice last month. 

But thank you for being there. And I think what you have done 

is actually more important than what we have done in terms of the 

stimulus side. And we—I am anxious to know when do you think 

these—when will we know whether or not these steps are working? 

And how will we know. Let us just start with that. 

When will we know whether these steps are working and how 

will we know? 

Mr. BERNANKE. Well, Senator, we will be looking over the next 

few quarters obviously at the general performance of the economy, 

but as I mentioned in my testimony, I think there are a few areas 

of particular sensitivity we need to watch. First is the housing market. We need to begin to see some stabilization in starts and sales. 

That would be very productive in terms of both of the economy and 

the credit markets. 


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Second is the labor market. We would like—we do not expect a 

rip-roaring labor market by any means, but it would be nice if the 

labor market would begin to stabilize close to current levels. 

And third, the credit markets. Senator Schumer was correct that 

there is a lot of concern among participants in the financial markets about the state of the credit markets. Much of that is connected with uncertainty about the broad economy. A significant 

worsening in financial conditions or in credit availability would certainly be a warning bell that we need to take further action. 

Senator CARPER. OK. Good. 

Treasurer Paulson, any—Secretary Paulson, anything you want 

to add or take away to what the Chairman has said? 

Secretary PAULSON. I would just simply say looking at the Housing Initiative, the HOPE Now Alliance, we are going to be getting 

numbers every month. And so in terms of that initiative, we are 

going to look at it and we are all going to see that they are doing 

what they say they are going to do and how it is working. 

Senator CARPER. All right. Thank you. 

Mr. BERNANKE. Senator, if I could just add a word on that? 

Senator CARPER. Please. 

Mr. BERNANKE. I mean, one of the big problems with the foreclosure issue is we have not had good numbers. We have had numerous studies that are not comparable. We do not know exactly 

what they refer to. It is hard to know how much progress is being 

made. 

So I think getting consistent numbers over time will be extremely helpful. 

Senator CARPER. Good. There is an interest on both sides here, 

Democrat and Republican, in doing more on the housing side and 

trying to address one, the properties for which—which have been 

foreclosed, the properties that are sitting vacant, then trying to 

make sure that there—we somehow encourage homeowners to 

come in, new owners to come in, purchase those properties, and 

bring—and live in them. 

And there is an interest in doing some other things to restore liquidity in this area of our economy. Among the steps that have 

been suggested that would be helpful—one, reauthorize FHA. Do so 

in a way that we bring the FHA into the 21st century and make 

it relevant. There are a number of aspects of that that would be 

helpful. 

So our proposal to work with our State housing authorities to 

give them greater flexibility to refinance troubled mortgages, because Senator Isakson has an idea that we provide a $5,000 tax 

credit to anybody that would move into a home that has been foreclosed and to live in that home. 

Or there has been a suggestion that we enlarge, appropriate a 

little more money to CDBG, Community Development Block Grant 

funds, with a stipulation that those monies be used to help in this 

regard. 

There has been talk about us passing a strong GSC bill, strong 

regulator, and somehow include in there the—make permanent or 

more permanent the increase in the mortgage that can be financed 

through GSEs. And also we have this idea about government-era— 

or actually Depression-era government corporation, sort of a quasiVerDate Nov 24 2008 01:45 Mar 12, 2010 Jkt 050368 PO 00000 Frm 00044 Fmt 6633 Sfmt 6602 E:\HR\OC\A368.XXX A368

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government corporation, to kind of revisit that and try to bring 

that into the 21st century and see if it could be made relevant. 

That is sort of a menu that has been suggested to us, and there 

are other ideas, good and bad. 

Of that list, which one or two seems to make the most sense to 

you for us to take as a next step? 

Secretary PAULSON. Well, first of all, I am familiar with all of the 

ideas, and we review every idea and continually review them. 

And clearly, among the things that we believe should be done 

now is GSE reform. So put that at the top of the list right there 

with the FHA modernization, and, of course, you have all said that. 

So we just now need to get them into the law. We have a Senate 

bill. We have a House bill. We need to get legislation passed that 

can be signed. 

So I put those at the top of the list, along with the tax exempt 

financing authority for the State and municipal governments to let 

them come up with their own programs to assist with mortgage financing and help as the situation may warrant at the State and 

local level. 

I have been very interested and talked with Senator Isakson 

about his bill. We continue to study it, think about it, think about 

other alternatives, but the issues—the initiatives that we are for 

right now are the ones that I mentioned. 

Senator CARPER. Thank you. Last question for Chairman 

Bernanke. Just give us a quick update on Regulation Z. Where we 

are going? Where you are going? And when we can likely see that 

so we will have better disclosure with respect to credit cards and 

other items. 

Mr. BERNANKE. Thank you. Senator, as you know, we did a very 

extensive review of disclosures for credit cards. We have a new 

Schumer box. Senator Schumer is not here. 

Senator CARPER. Cannot we come up with a better name for it 

than the Schumer box? 

Mr. BERNANKE. Do you have a suggestion, Senator? 

Senator CARPER. Carper box. 

Mr. BERNANKE. Among the benefits are a much clearer disclosure 

of penalties and other issues. 

We have—the comment period has closed. We received lots of 

comments. We are working through them now. So we expect to 

have a final rule soon. And we are hopeful that it will be a major 

help to making people better understand their credit cards and 

what their responsibilities are. 

Senator CARPER. When you say soon, today is the day that the 

pitchers and catchers report for spring training. You think soon 

might be opening day of baseball season? 

Mr. BERNANKE. I am sorry? 

Senator CARPER. I am trying to understand what soon might be. 

I am in a baseball mode today. 

Mr. BERNANKE. Yes. I—we will shoot for opening day. 

Senator CARPER. Good. Thank you very much. That would be a 

good way to start the season. Thank you. 

Chairman DODD. Thank you. Senator Bennett. 

Senator BENNETT. Thank you much, Mr. Chairman. 


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Chairman Cox, you and I have had a number of discussions 

about naked short selling. I have a lot of opinions about the mortgage thing. We have beaten that horse to death. And I will move 

on to another subject without sending the signal that I am not interested in the other issues, the economy and so on. It is just that 

it has all been plowed before. 

Let me give—I have done some investigating on my own, and let 

me give you some of the benefit of that and then ask you to comment, and I have a suggestion for you. 

Three months prior to the SHO Regulation, which you issued to 

try to deal with naked short selling, the volume in Fails to Deliver 

on NASDAQ was 150 million shares a day, and 3 months after, it 

was 20 million shares, which would show great progress. 

Unfortunately, there is an indication that all it shows is that the 

people who are involved in naked short selling have hidden their 

activities a little more carefully than they did before. 

Let me give you some examples. First, for those listening in that 

do not understand exactly what we are talking about, when a 

broker dealer purchases the sale of a short share, he has 3 days 

to deliver a borrowed share to the purchaser and the purchaser has 

3 days to deliver his money. 

And in the old days, when I was short selling and losing money 

doing it, the buyer did not—if the buyer did not receive his shares 

by settlement day, 3 days after the trade, he took his money back 

and undid he transaction. 

So he got a crinkly piece of paper that said I really do have these 

shares. Well, we have done away with that now with the DTCC. 

Everything is electronic, and what he gets in his account is an electronic blip that says you own that share, and he does not know 

whether it is a real share or a counterfeit share. 

And increasingly, it is easier in this electronic world to give you 

a counterfeit share. 

Now, many of the people who engage in short selling have multiple entities, many of them offshore, and they sell large naked 

short positions from entity to entity. Position rolls is what they call 

it, and they are frequently done broker to broker or hedge fund to 

hedge fund in block trades that do not appear on any exchange. 

And each movement resets the time clock for the naked position so 

that the Fail to Deliver, which you monitor, never shows up. 

And it is a way of keeping the company off the SHO threshold 

list. And the stock lend of these kinds of counterfeit shares is enormously profitable for the broker dealers who do it, because they 

charge short sellers fees for the ‘‘borrowed’’ shares. They are really 

manufactured shares, whether they are real or counterfeit. 

And when the shares are loaned to a short, they are supposed 

to remain with the short until he covers his position by purchasing 

real shares. 

Well, the broker dealers do 1 day lends, which enables the short 

to identify to the SEC the account that the shares were borrowed 

from and as soon as the report is sent in, the shares are returned 

to the broker dealer to be loaned to the next short. 

This allows eight to 10 shorts to borrow the same shares, resetting the SHO Failed to Deliver clock each time, which makes the 


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counterfeit shares look like legitimate shares and the broker dealer 

charges each short for it. 

We have the situation, which we have talked about before, that 

illustrates this. Robert Simpson, an investor, in 2005 bought every 

single issued and outstanding share of a company called Global 

Links Corporation, every single one, and then filed with the SEC 

his report that he now owned 100 percent of the shares and then 

he watched that share—that stock trade 37 million shares the next 

day and 22 million shares the day after that. They were obviously 

trading counterfeit shares. 

All right. My concern is with the DTCC, which is the clearinghouse that handles all of these electronic shares and through whom 

the creation of counterfeit shares becomes possible. They are totally 

opaque. It becomes impossible to find out what is going on. 

I have had a number of conversations with you personally and 

with your staff and I salute publicly the work that the SEC is 

doing to try to curb this. 

But I have seen companies in my own State see their share 

prices driven down virtually to nothing when there are more shares 

trading than there are shares outstanding. They have tried to solve 

it by getting the DTCC to give them physical control of their 

shares. The DTCC will not. One of the investment bankers involved in this helping a new company that said we want to go public said all right, I will help you go public on the condition that you 

never allow physical control of your shares to disappear. You cannot allow a single share to go to the DTCC because as soon as you 

do, you expose yourself to the creation of counterfeit shares. 

So my question to you is what can we do to get more transparency over the DTCC? And do you have any authority to deal 

with them to try to create transparency so that the creation of 

counterfeit shares begins to stop? 

Mr. COX. Well, Senator, thank you for describing some of the 

pathologies that surround this phenomenon of naked short selling 

and also for your compliments to the Agency for the work that we 

have been doing on this. 

We take, as you know, illegal naked short selling very, very seriously, and we are pursuing wrongdoing very seriously. 

What you have described, in part, with the daisy chaining of 

share lending and with resetting the Reg SHO clock and so on 

could amount to market manipulation in violation of Rule 10(b)(5) 

so that what we might have on our hands is not just insufficient 

regulation, but outright fraud. And certainly, in those cases, the 

Commission—— 

Senator BENNETT. I am convinced you do. 

Mr. COX [continuing]. Is equipped with tools to deal with this. 

The net settlement aspect of the way that DTCC operates has 

other consequences that we are trying to deal with in related contexts as well, as you know, such as over voting in elections and the 

related question of broker voting. All of this relates, in turn, to the 

way our proxy system works. 

And so we have an abiding interest not only in the clearing and 

settlement system, which is a fundamental piece of the infrastructure of the financial markets of the United States, but also we 


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want to make sure that our proxy voting system works and that 

people have confidence that the markets work as they are intended. 

So we will continue to work with you on this. 

I just want to update you on further amendments that we are 

making to Reg SHO to make it work better, because each time we 

have taken an aggressive step, we have solved part of the problem, 

but we have seen it manifest in other ways. 

We had a grandfather provision, as you know. It was thought, 

once that went into effect, that the grandfathering was itself contributing to the problem, so we have now repealed the grandfather 

provision. The phase-in period for putting this new rule into effect, 

which gets everything down to 13 consecutive days, was just 6 

weeks ago. 

And so, we are going to monitor very closely whether that has 

been useful. 

The other thing that we were doing is disclosing aggregate fail 

to deliver data on our own Web site for the first time. And we hope 

that that contributes to people getting at this problem. 

So we look forward, Senator, to working with you and your staff 

and being as public and open as we can about our fight to stop abusive naked short selling. 

Senator BENNETT. Thank you. 

Chairman DODD. Thank you very much, Senator, and I—just to 

take before I turn to Senator Bayh, I just want to reiterate the concern Senator Shelby has, I have as well, Chairman Cox, on the rating agency issues. We have had one hearing on it already. We may 

want to do it again, but we are very interested in hearing—I know 

you responded to Senator Shelby’s questions regarding this, but we 

are very interested in following up with you; obviously, Secretary 

Paulson as well, having almost a lifelong experience in this area; 

and the publicly traded company issue, looking at these companies 

to determine whether or not any wrongdoing occurred is something 

I want to make a request of you to maybe report back informally, 

at least initially to Senator Shelby and I in this area, and then possibly make it the subject for another hearing to focus on that specifically, the publicly traded companies and the rating agency 

ideas, if any. 

As you said in your testimony here, there are a number of ideas 

out there. We want to make sure we do the right thing, understanding what is going on, what percentage; obviously a relatively 

small percentage of the market, but nonetheless, a very important 

and critical area. 

So we will invite that comment from the SEC. 

Mr. COX. We will look forward to reporting back to you, Mr. 

Chairman. 

Chairman DODD. Thanks very much. Senator Bayh. 

Senator BAYH. Thank you, Mr. Chairman. In fact, my first comment was going to be about the rating agencies. But before I get 

to that, I would like to thank all three of you for your public service. 

I have a high regard for each of you and you take your fair share 

of criticism, but I think you also deserve a fair amount of praise 

for what you do on behalf of all of us. 


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Chairman Cox, I listened with interest to—and I am going to 

look with interest for the recommendations that you have actually 

come up with about how do we prevent these conflicts of interest 

that were apparent. 

And I think it is good that you are thinking about requiring 

greater disclosure so that the discipline of the marketplace can 

function. 

But the losses here have been so staggering and the adverse consequences to our economy have been so great, this may have—and 

the damage to our global brand as a safe and secure place from 

which investments originate that this may be one area where some 

minimum standards for conduct mandated by regulation or law 

may be in order. 

So I encourage you to take a very rigorous look at this. Human 

nature being what it is, abuses can tend to reoccur, and so more 

information is great. The discipline of the market is great, but 

some minimum standards for conduct may be in order here, and I 

would just encourage you along those lines and along with the 

Chairman and Senator Shelby await with interest your report because so many people bought what they thought was AAA rated 

stuff, and it was infected with anything but. And we have got to 

make sure that that kind of thing does not reoccur. 

That said, I would like to turn to Chairman Bernanke and Secretary Paulson. 

I am—in follow up on something that both Senator Dole and Senator Brown raised, and that is the whole issue of the sovereign 

wealth fund, and both of you encourage—you said one of the most 

important things our financial institutions can do is to raise capital. They have been busy doing that. A good chunk of it has come 

from the sovereign wealth fund area. 

And, Secretary Paulson, I want to follow up on something that 

you said and the President said, I think it is very important that 

our country remain a safe and secure place for capital investment 

from abroad, including from sovereign wealth funds. 

As you had pointed out to date, and I think maybe the Chairman 

mentioned this—oh, no the—Commissioner Cox mentioned this, to 

date the experience has been a very positive one. The investments 

have been passive. But a recent behavior by the Russian government, China’s relentless pursuit of economic advantage, using any 

number of levers to obtain that, does give some pause. 

And I want to follow up on something that Senator Brown was 

asking, and I am being somewhat of a devil’s advocate here, but 

let me just put it to you this way: I am fascinated by the prospect 

that this Administration could be standing for the proposition that 

U.S. Government ownership of U.S. businesses is an acceptable 

thing. 

Chairman Bernanke, your predecessor came before the Congress 

and stated very clearly that in his view, it was not an acceptable 

thing because of unavoidable risk of political interference with economic decisionmaking. 

And, Mr. Secretary, one of your predecessors, Secretary O’Neill, 

said the same thing. I think his direct quote was the U.S. Government has no business owning U.S. businesses. 


dcolon on DSK2BSOYB1PROD with HEARING
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And so my question to both of you is would you agree with those 

statements? And, if not, the left wing of my party will be delighted. 

And so I am kind of curious. If our own government, the Federal 

Government, of our country let us say to solve the Social Security 

problem, or any number of other things were proposing taking 

major equity stakes in U.S. companies, would that be OK? If not, 

what should we do to safeguard against the risk of political interference? 

Secretary PAULSON. Well, Senator Bayh, clearly, I do not believe 

that the U.S. Government should be owning our companies or parts 

of the private sector. We are an economy that has been open for 

a long time. We have privatized. But we are in a situation where 

in various parts of the world, their economies are still privatizing 

or they have huge pools of money. 

And even in our economy, you know, we have State pension 

funds. We have CALPERS. Alaska has its fund. There are different 

forms of funds, and the overriding question is do we want our capital markets to be open and competitive. We do not want them 

after having privatized, to be not open to market forces. 

So I think the real question we are getting at is, are the investments coming into our country driven by market forces or are they 

being driven by political forces? And that is where the focus is, and 

being vigilant there. That is why the focus on best practices, transparency, and so on. 

Senator BAYH. If I could be indulged to just follow up, Mr. Chairman. Mr. Secretary, thank you for your response. I would observe 

a couple of things. 

First, our State pension funds, which are sometimes raised as an 

analogy, as you know, are subjected to all sorts of transparency requirements, governance restrictions, which I think the sovereign 

wealth funds would probably bridle at. 

So that is No. 1. It is sort of an imperfect analogy. 

Second, some of the shareholder activism that our State pension 

funds engage in proves the point that they are susceptible to sometimes having political agendas, which—and I think you would 

agree that just as our own government would be susceptible to 

that, foreign governments would be no less susceptible. So how do 

we attract the capital and yet protect against the potential, not yet 

the reality, but the potential as these become bigger and bigger 

players for something other than economic motivations to be driving decisionmaking? 

Secretary PAULSON. I think we are saying the same thing. And 

what we are doing because we are approaching this at Treasury 

from two angles, two ends. 

First, we have been very actively engaging with sovereign wealth 

funds, the newer ones and some of the established ones that have 

some very good procedures, processes, transparencies, and we have 

been talking with them about their motives, about their governance, about their processes and procedures, and we have been encouraging them and saying you want to make investments around 

the world. There are these very natural and understandable concerns. You can assuage these concerns by developing best practices 

and by living by those best practices. 


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And so there has been a lot of work done at Treasury and at the 

G–7 and to do this right now. The IMF is helping lead an effort 

to get more transparency. 

Then, on the other side, we are working with the countries that 

are going to be the recipients of a lot of this investment—the 

OECD countries coming up with also best practices so countries 

will not dress up protectionist sentiments as being, you know, 

using the sovereign wealth funds as an excuse—to close their markets from investment. 

There has been in this country for some time and in many countries in the world a concern about foreign investment. 

I can remember back in the 1970s and 1980s, when Japanese 

companies were buying the Rockefeller Center or golf courses or investing, and there was just this huge concern. 

So there is a concern in our country that I think has been for 

a long time somewhat unfounded, and there is a concern in many 

other countries that would try to hold back foreign investment. 

I think it is a two-pronged approach. We need to be vigilant, as 

Chairman Cox says, although the amount of money has increased, 

as a percentage of global wealth, it has not really increased that 

much. 

The trend lines say it is going to increase. Sovereign wealth 

funds are going to increase. I never am quite sure I believe all the 

trends, because the past is very seldom a great predictor of the future, but we are watching it carefully, and we are very vigilant 

here. 

Senator BAYH. My time has expired, Mr. Chairman. Chairman 

Bernanke, you get off the hook here today, because we have exhausted our time. 

I would only observe, Secretary, that we are talking about government investment, not private. We would not even be having this 

discussion if it was about private foreign investment. 

And with regard to best practices and the IMF and all that sort 

of thing, perhaps with some of the more traditional investors with 

a long-term track record that might work well. Some of the newer 

actors—let us take China, for example. I know you have worked 

very diligently to try and convince them about the best practices 

of allowing the marketplace to set exchange rates. 

Their progress has been, let us say, halting to date. As a matter 

of fact, it is that practice that has led to some of the reserves they 

have accumulated which now lead us to the sovereign wealth fund 

issue. 

So some of us are a bit skeptical that moral suasion and best 

practices alone will be enough to convince some of the new actors 

on the stage to behave in a way that the American people would 

view as good for our economy and yet insulating us from the potential for political abuse. 

Secretary PAULSON. Can I make one other point that is related 

to all of this? And, as Chairman of the CFIUS process, I work very 

hard to look at national security and other issues and enforce the 

law. 

I would say the other thing that we have got going for us is once 

any investment comes into this country, we have the full force of 

the SEC, the Justice Department, all of the laws, all of the regulaVerDate Nov 24 2008 01:45 Mar 12, 2010 Jkt 050368 PO 00000 Frm 00051 Fmt 6633 Sfmt 6602 E:\HR\OC\A368.XXX A368

dcolon on DSK2BSOYB1PROD with HEARING
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tions we have to protect us, protect us against abuses and so on. 

So, again, I think we need to be vigilant. I do not think we need 

to be fearful, and I know you are not suggesting that. You are I 

think in a very careful way raising the issues, and these are issues 

we are all focused on. 

Senator BAYH. Thank you. 

Chairman DODD. Thank you very much. Let me just—you know, 

since you have raised CFIUS and I thought this was important. I 

want to thank Senator Bayh and others who raised this. We had 

a very good hearing Senator Bayh chaired earlier in the year. This 

is a very important subject matter for the very reason. The last 

thing we want to be is xenophobic about this subject matter. It has 

been a—there has been a great source of wealth creation in the 

country to attract capital to come here. 

On the CFIUS, I am having—we did a good job I think here 

working with the Administration and writing that legislation. And 

there is some, I think, maybe a little confusion about the question 

of these bright lines, and you sort of alluded to it right there, which 

provokes this point. 

And that is we set a line on a certain amount of investment in 

the country that would trigger CFIUS and the kind of examination—national security issues. 

As I recall having written this, along with other members here, 

that line is not that bright. I mean there are ways in which actually, as you point out, I think we need to be clear on this that we 

are—the CFIUS process can actually be engaged far short of a minimum amount of investment in the country, where there are some 

controlling interests, board members, other matters here that 

would allow the Treasury and others to take a good hard look at 

this. 

And it might be helpful, Mr. Secretary, to clarify that a bit. In 

light of Senator Bayh’s question, I think we might reduce some of 

the concerns about the ability of us to actually make the very examination you just suggested in your last point. 

Secretary PAULSON. Well, right. Well, first of all, CFIUS is—— 

Chairman DODD. National security motivated. 

Secretary PAULSON. National security—— 

Chairman DODD. I agree. And it is—— 

Secretary PAULSON [continuing]. It is focused on national security, so that is paramount. 

Chairman DODD. But Senator Bayh’s point here when you are 

talking about some of these issues, that line gets blurred a bit between national security and economic investment. 

Secretary PAULSON. It is so. It is focused on national security, 

and then, as you said, when you look at control, what is control 

and there we do not have bright lines. It can be different in different situations. So I think it is very important that we have the 

flexibility when we look at this, because, as someone who has 

worked in the capital markets for a long time, I can just tell you 

depending on the size of the company, the composition of the shareholder base, the composition of the board, control can take place at 

different shareholding levels. 

So, again, we have flexibility, and we are vigilant there. 


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Chairman DODD. I do not want to dwell on the point, but I think, 

in fact, Senator Bayh talking the other day, we made the point that 

it was recent major investment in a major bank in New York, and 

then the—and then there was an investor that had less than 10 

percent, but before they decided on the new CEO, they went out 

and checked with that latest investor, which raises the issue. 

Anyway, we are going to run out of time here. The last questioner is Senator Akaka, and then we are going to be through. 

Thanks. 

Senator AKAKA. Thank you very much, Mr. Chairman. I want to 

add my welcome to Secretary Paulson, Chairman Bernanke, and 

Chairman Cox to this Committee’s hearing on our economy and financial markets. 

I want you to know that the years I have been here, I have been 

very interested in financial literacy and raising the level of information to our people in this country so they may work with the financial industry. 

Mr. Secretary, the Fair and Accurate Credit Transactions Act 

created the Financial Literacy and Education Commission, of which 

you are the designated chairman. And because of my feelings, I feel 

this is very, very important to our country. 

Without a sufficient understanding of economics and personal finances, individuals would not be able manage their finances appropriately or evaluate credit opportunities successfully, invest in 

long-term financial goals in an increasingly complex marketplace; 

or to be able to cope with difficult financial situations. 

It is essential that we work toward improving education, consumer protections as well, and empowering individuals and families through economic and financial literacy in order to build 

stronger families and businesses and communities. 

So I want to see the Commission improve the financial literacy 

of all Americans. 

The GAO has recommended that the Financial Literacy and Education Commission incorporate additional elements into the national strategy to help, and these are the two: to help measure results and ensure accountability. 

So my question to you is what has the Financial Literacy and 

Education Commission done to address the issue of measuring results and ensuring accountability? 

Secretary PAULSON. Senator, first of all, thank you very much for 

the question, and thank you for your leadership in this area, which 

is absolutely critical. 

As you have said, I chair the Commission, and the President had 

asked me to put together a plan, which we have put together, 

which we have rolled out, and it is one that is aimed not just at 

educational institutions, but it is aimed at the workplace. It is 

aimed at communities, and it is really quite a comprehensive plan. 

And I would very much welcome the opportunity to come up and 

spend some time with you on this and really to talk to you about 

this in some detail. 

Senator AKAKA. Thank you. 

Secretary PAULSON. Thank you. 

Senator AKAKA. Thank you for that. I appreciate it. 


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Chairman Bernanke, in my home State of Hawaii, remittances 

are extremely important to many of my constituents, and a portion 

of their hard-earned wages are sent to relatives abroad. 

I am concerned that the fees that are often paid are too high. 

And our banks and our credit unions often provide lower-cost remittances. 

So my question to you is what do you think must be done to encourage more people to utilize mainstream financial institutions for 

remittances services? 

Mr. BERNANKE. Senator, you are correct. That is a very important question, one the Federal Reserve has been very much involved in. I think there is, in some cases, a tendency for new arrivals to be distrustful of the banks or less willing to be involved in 

the banking system. And it is incumbent on the banks and the 

credit unions to reach out to a new group of customers who not 

only will be remittance customers, but once they become acquainted with the bank could become depositors or savers or borrowers as well. 

So we have encouraged banks and other financial institutions to 

reach out, to get people, staff, who speak the relevant language, to 

have community outreach, to try to bring people into their organizations. As you point out, frequently they can offer remittance services at reasonable prices. 

The Federal Reserve has also been trying to support these efforts 

by establishing relationships with, for example, banks in Mexico 

that will help transmit remittances at the lowest possible cost. 

So I think by, you know, through all these efforts, we will accomplish several goals. One is to increase competition and improve 

service and reduce costs for remittances in particularly immigrant 

neighborhoods; at the same time, bring more people into the mainstream of our financial system and it relates, of course, to financial 

literacy so they can be full participants in our economy. 

Senator AKAKA. Thank you very much, Mr. Chairman. My time 

has expired. I will submit a question for the record. 

Chairman DODD. Thank you very much, Senator. I appreciate it 

very much. 

And I am going to—this has been very patient. We have kept you 

a long time today, but very, very important and very valuable. 

Chairman Cox, Senator Shelby has a question for you, but I am 

going to excuse our two other witnesses. I know they have other 

appointments to make. I want to thank both of you. This is an ongoing obviously conversation. I think this is a very serious problem. 

Obviously, language is important, but I think we need to emphasize how important it is we work together to do everything we can 

to get this moving in the right direction. 

Let me just also suggest to you here—I am going to leave the 

record open for written questions. I would ask that because we 

have had some problem in getting answers back within 2 weeks, 

and I would ask the respective offices of the Treasury and the Fed 

if you could have the answers back within 2 weeks, it would be 

very, very helpful. Thank you very much. 

Senator Shelby. 

Senator SHELBY. Chairman Cox, I will be brief. One of the factors 

that has not helped the current crisis in our credit markets is our 


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lack of transparency. There is no price reporting mechanism for 

collateralized debt obligations in credit default swaps, for example. 

One of the biggest shocks to our financial system was the rapid 

loss of confidence in complex instruments like these that were sold 

by banks to a handful of investors. 

Do you believe it would be beneficial to our markets to allow the 

investors to see the actual prices for these complex instruments? 

And what steps could you take as a regulator, as the Chairman of 

the SEC, to make that happen? 

Mr. COX. Senator, transparency is helpful in any market, and 

certainly that is the case here. 

Senator SHELBY. It helps set the market, does it not? 

Mr. COX. In particular, when one combines the lack of transparency with complexity of the instruments—— 

Senator SHELBY. Yes. 

Mr. COX [continuing]. Part of the reason that the ubiquity of 

these products has resulted in consequences that one might not 

have predicted on the face of it all is that there was a whole lot 

of reliance on other parties, on other guarantors of quality, and 

what the market now insists on doing is finding out for itself 

whether or not investments are of sufficient investment grade that 

funds and firms will make these investments themselves. 

So all that we can do to help to provide transparency in this market, the SEC will do. 

Senator SHELBY. That is good. Thank you. 

Chairman DODD. Very good. Chairman Cox, we thank you very 

much as well. Thanks for staying around a few extra minutes for 

Senator Shelby’s question. 

Mr. COX. Thank you. 

Chairman DODD. It was a very good hearing. We had—I think 

virtually every—almost member attend, indicating obviously the interest in the broad subject matter here. 

I want to thank my colleague, Senator Shelby, and other members of the Committee, and the Committee will stand adjourned. 

[Whereupon, at 1:02 p.m., the hearing was adjourned.] 

[Prepared statements, responses to written questions, and additional material supplied for the record follow:] 


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RESPONSE TO WRITTEN QUESTIONS OF SENATOR AKAKA 

FROM HENRY M. PAULSON 

A. RESOURCES FOR FLEC ACTIVITIES

In its review of the Financial Literacy and Education Commission (FLEC), the GAO indicated that effective national strategies 

should include discussions of cost, the sources and types of resources needed, and where those resources should be targeted. 

Q.1. What resources will be needed to ensure that FLEC can adequately fulfill its mandates? 

A.1. The Commission is presently fulfilling its mandates through 

the existing resources of the 20 agencies that comprise the Commission. 

Q.2. What additional resources will be required to support the 

President’s Financial Literacy Council? 

A.2. Additional resources to support the President’s Advisory Council on Financial Literacy are not required. It is expected that the 

Council will work closely with the private sector to accomplish its 

objectives. 

Q.3. Will you commit that this new council will not take resources 

away from the Commission? 

A.3. The President’s Advisory Council on Financial Literacy will 

not divert resources away from the Financial Literacy and Education Commission. 

B. THE UNBANKED

Secretary Paulson, approximately 10 million households in the 

United States do not have accounts at mainstream financial institutions. Unfortunately, too many of these households depend on 

high-cost fringe financial services. The unbanked lose too many resources to check cashers and refund anticipation loan providers. 

They also miss out on opportunities to save and borrow at credit 

unions and banks. 

Q.4. In addition to efforts to increase financial literacy, what is the 

Department of the Treasury doing to help bring the unbanked into 

mainstream financial institutions? 

A.4. On behalf of the Financial Literacy and Education Commission, Treasury held four regional conferences entitled ‘‘How to 

Bank the Unbanked’’ in 2006 and 2007. The conferences were held 

in Chicago, New York, Seattle, and Edinburg, Texas. Treasury is 

using findings from these conferences to implement its Community 

Financial Access Pilot. This new initiative will provide assistance 

to eight demonstration sites throughout 2008 and 2009. In each 

pilot location, Community Consultants (Treasury staff) will provide 

technical assistance to implement community initiatives. At the 

conclusion of the pilot Treasury will release to the public information on effective practices. As of February 2008, the Community 

Consultants have begun the process of assessing community needs, 

facilitating partnerships, working with local organizations to develop financial products to bring the unbanked into mainstream financial institutions, and implementing financial education services. 


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C. CFA RECOMMENDATIONS FOR THE COMMISSION

During a financial literacy oversight hearing held in April, Mr. 

Steve Brobeck from the Consumer Federation of America outlined 

several strategies to achieve significant and measurable improvements in specific financial decisions made by most Americans. Examples of these include encouraging self-measurement of net personal wealth, use of automatic savings opportunities, periodic 

checking of credit records, and on-time repayment of loans. He also 

recommended that the Commission develop an online tool that 

could be widely promoted as an annual financial checkup instrument. This was a very interesting recommendation that could lead 

to the development of concrete proposals that would result in positive behavioral change. 

Q.5. Will the Commission be developing similar strategies to 

achieve significant and measurable improvement in the decision 

making of consumers? 

A.5. The Commission tracks its progress in two ways: Completion 

of tasks listed in Taking Ownership of the Future: The National 

Strategy for Financial Literacy (‘‘National Strategy’’), and the level 

of distribution of financial education information. 

The Commission’s National Strategy includes enumerated ‘‘Calls 

to Action’’ to improve the nation’s financial literacy. The primary 

method used by the Commission to measure its progress is the 

completion of the Calls to Action. Of the 32 Calls to Action, 22 of 

them require implementation by the Federal government. Of the 22 

Calls to Action for the Federal government, 12 have been completed. 

The Commission also records the volume of its material distribution. Since April 2006, more than 2,140,000 English-language publications and 41,700 Spanish-language publications have been ordered through the My Money Web site and 1–888–My Money hotline. In addition, approximately 106,500 combined English- and 

Spanish-language versions of the Commission’s National Strategy 

have been distributed. 

The Commission has also measured approximately 35,000 

monthly visits to the My Money Web site (or 1,150 per day), with 

a total of nearly 1.5 million visits since the site launched in October 2004. 

Additionally, during the first meeting of the newly created President’s Advisory Council on Financial Literacy (Council), the Council advised the Treasury Department to consult with the Financial 

Industry Regulatory Authority Investor Education Foundation 

(Foundation) on an upcoming baseline survey the Foundation will 

be conducting on the financial knowledge, attitudes and behaviors 

of the adult population in the United States. Treasury and the 

Council will use the results of the survey to assess the nation’s current level of financial literacy and to measure future changes in financial literacy. The survey will be helpful in targeting and monitoring the effectiveness of both the Council’s and the Commission’s 

financial literacy initiatives. 


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D. STIMULUS ANTICIPATION LOANS

I am concerned that working families will have their stimulus 

checks unnecessarily diminished by payday lenders. With a completed 2007 tax form, payday lenders will be able to provide a stimulus anticipation loan to taxpayers. The interest rates on payday 

loans are outrageously high. 

Q.6. What will the Department of the Treasury do to prevent predatory lenders from exploiting working families? 

A.6. 

Weblink: On behalf of the Financial Literacy and Education Commission, the Department of the Treasury has provided a link on the 

front page of MyMoney.gov leading to a fact sheet on the economic 

stimulus package on the IRS website. This information contains 

stimulus payment scenarios, answers to frequently asked questions, and a rebate scam alert. 

Mailing: Also, for 20.5 million recipients of Social Security or 

Veterans Affairs benefits the Internal Revenue Service has mailed 

informational packages on the stimulus payment to help them get 

their payment. Many of these recipients receiving the informational 

package are unlikely to have filed a tax return for 2006 but must 

file for 2007 to receive the stimulus payment. The tax package contains everything the recipients will need to file a 2007 tax form immediately. The package is specially designed for people who may 

qualify for a stimulus payment but who normally aren’t required 

to file a tax return. The mailing is separate from the more than 

130 million other economic stimulus letters that were sent to taxpayers who filed tax returns in 2006. Both of these mailings list 

the IRS website as a resource to visit with any questions or concerns regarding the stimulus payment. 

Pilot Outreach Campaign: In the second half of 2008, the Department of the Treasury will develop messages to educate adults on 

how to determine actual lending needs, consider total lending costs, 

and comparison shop for the best alternatives. These materials will 

be delivered in selected markets through a number of channels 

such as targeted radio announcements, printed materials, and 

Internet advertisements. Adults will be directed to educational materials available at MyMoney.gov. These materials will focus on 

how to avoid predatory loans and obtain low-cost financial services. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR TESTER 

FROM HENRY M. PAULSON 

Q.1. As many have noted, the strength of a country’s economy dictates the strength of its currency. As the dollar has rapidly declined in currency markets—down almost 30% over the last five 

years—what will continued stagnation in growth mean for the dollar? And will the recent interest rate cuts strengthen or lessen the 

dollar’s position? What will it mean for American consumers? 

A.1. As I have stated before, a strong dollar is in our nation’s interest. Economies have their ups and downs, but I am confident that 

the long-term strength and vitality of the U.S. economy will eventually be reflected in currency markets. 


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Q.2. In the course of previous critical economic situations—recessions—we have witnessed a wave of bank failures due to a variety 

of factors. Do you have any concern that banks will be in similar 

situations in the coming months? Or will the failure of non-bank 

mortgage lenders (finance companies) that operate outside the 

banking reserve system be the only casualties from the housing 

and credit crunch that we are currently facing? 

A.2. Our financial institutions entered this period of turmoil wellcapitalized. A number of financial institutions have experienced 

problems associated with the current dislocation in mortgage and 

other credit markets. To date, most of the failures have been concentrated in non-bank mortgage lenders, although there have been 

a few failures of federally-insured depository institutions. I have 

encouraged financial institutions broadly to continue raising capital 

should they think it necessary, so they can continue to lend and 

support our economy. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR CRAPO 

FROM HENRY M. PAULSON 

Q.1. Considerable work has already been done establishing that 

our capital markets are at risk of falling behind and providing specific regulatory, tax, and liability reforms to revive the leadership 

position of the U.S. capital markets. Do you agree that it is past 

time for all of us to resolve these outstanding issues and action is 

required now? 

A.1. A strong financial system is vitally important—not for Wall 

Street, not for bankers, but for working Americans. When our markets work, people throughout our economy benefit—Americans 

seeking to buy a car or buy a home, families borrowing to pay for 

college, innovators borrowing on the strength of a good idea for a 

new product or technology, and businesses financing investments 

that create new jobs. 

The current regulatory framework for financial institutions is 

based on a structure that has been largely knit together over the 

past 75 years. It has evolved in an accretive way in response to 

problems without any real focus on overall mission: Congress established the national bank charter in 1863 during the Civil War, 

the Federal Reserve System in 1913 in response to various episodes 

of financial instability, and the federal deposit insurance system 

during the Great Depression. Changes were made to the regulatory 

structure in the intervening years in response to other financial crises (e.g., the thrift crises of the 1980s) or as enhancements (e.g., 

the Gramm-Leach-Bliley Act of 1999 (‘‘GLB Act’’)), but for the most 

part the underlying structure resembles what existed in the 1930s. 

Q.2. What are the top initiatives that your agency is pursuing to 

meet this need, when will you propose them, and have you set 

deadlines for implementation? 

A.2. Last March, Treasury convened a blue-ribbon panel to discuss 

U.S. capital markets competitiveness. Industry leaders and policymakers alike agreed that the competitiveness of our financial services sector and its ability to support U.S. economic growth—is constrained by an outdated financial regulatory framework. As the 


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conclusion to a process that began in June 2007, on March 31, 

2008, Treasury released its ‘‘Blueprint for a Modernized Financial 

Regulatory Structure.’’ 

In this report, Treasury presents a series of short, intermediate 

and long-term recommendations for reform of the U.S. regulatory 

structure. The short-term recommendations present actionable 

changes to improve regulatory coordination and oversight immediately. The intermediate recommendations focus on eliminating 

some of the duplication of a functional regulatory system, but more 

importantly try to modernize the regulatory structure for certain financial services sectors within the current framework. Finally, we 

also include a long term model for discussion. This model holistically addresses the inadequacies of the current functional regulatory system. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR DOLE 

FROM HENRY M. PAULSON 

Q.1. Secretary Paulson, I want to commend you for this Administration’s efforts to assist distressed borrowers—Treasury’s collaboration with the HOPE NOW coalition, Project Lifeline, the cooperation with the private sector on the 30-day foreclosure freeze—these 

are all important initiatives. But I would like to ask you if there 

is even more we could be doing to provide distressed borrowers 

with refinancing options, too, so we can get them back into mortgages that are appropriate for them? 

A.1. Treasury recognizes the critical importance of refinancing as 

an option to help distressed borrowers avoid foreclosure; several 

key actions have been taken in this area. 

In September, HUD announced FHA Secure, a program targeted 

at helping borrowers with adjustable-rate mortgages refinance into 

a lower-rate loan. Since the announcement of the program, FHA 

has closed more than 140,000 refinancing loans, and expects to 

close 300,000 loans by the end of 2008. FHA Modernization is essential to allow FHA to achieve even further progress, and Treasury urges Congress to enact this legislation. 

In December, the American Securitization Forum announced the 

ASF fast-track framework for streamlining the refinancing and 

modifying of subprime loans facing rate resets. The ability to identify loans that qualify for refinancing is a key element of the framework, and Treasury has encouraged Hope Now Alliance members 

to make refinancing an even more central part of their toolkit in 

addressing the needs of distressed borrowers. 

We have also called on Congress to complete GSE reform and 

pass legislation to encourage states to encourage refinancing by 

issuing tax exempt bonds. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR CRAPO 

FROM BEN S. BERNANKE 

Q.1. Considerable work has already been done establishing that 

our capital markets are at risk of falling behind and providing specific regulatory, tax, and liability reforms to revive the leadership 

position of the U.S. capital markets. Do you agree that it is past 


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time for all of us to resolve these outstanding issues and action is 

required now? 

Q.2. What are the top initiatives that your agency is pursuing to 

meet this need, when will you propose them, and have you set 

deadlines for implementation? 

A.1. and A.2. The Federal Reserve currently is engaged in diagnosing the causes of financial market turmoil and developing regulatory responses to address the problems that have been identified. 

Efforts to put markets and market participants on a sound footing 

are our top priorities, and they will remain so for some time. That 

said, however, these efforts also are consistent with the long-term 

goal of ensuring that U.S. markets deliver financial services in a 

competitive and efficient manner. Regulatory policies are being 

evaluated carefully to ensure that they do not exacerbate strains 

on markets or market participants. In addition, responses are 

being coordinated with authorities in other jurisdictions to maintain a level playing field for global market participants going forward. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR TESTER 

FROM BEN S. BERNANKE 

Q.1. As many have noted, the strength of a country’s economy dictates the strength of its currency. As the dollar has rapidly declined in currency markets—down almost 30% over the last five 

years—what will continued stagnation in growth mean for the dollar? And will the recent interest rate cuts strengthen or lessen the 

dollar’s position? What will it mean for American consumers? 

A.1. In the long run, exchange rates tend to be set by markets on 

the basis of an economy’s fundamental strengths. Over shorter horizons, however, a wide array of factors may influence the exchange 

rate, including movements in interest rates here and abroad, expectations of future economic policies, and the evolution of the nation’s 

trade and current account balances. For much of the period since 

2002, the U.S. economy has expanded solidly, even as the value of 

the dollar has declined in foreign exchange markets. Most recently, 

the dollar has weakened alongside indicators of U.S. economic 

growth. 

Recent cuts in U.S. interest rates have reduced the rate of return 

on liquid, dollar-denominated debt instruments, and thus, all else 

equal, may have had some effect on the near-term trajectory of the 

dollar. However, we believe that responding to slowing economic 

activity through monetary policy actions helps to safeguard the 

economy’s essential dynamism and thus, in the medium and long 

run, should be reflected in the exchange value of the dollar. Such 

a development, in turn, would restrain increases in the cost of living that owe, in part, to rising import prices. 

Q.2. In the course of previous critical economic situations—recessions—we have witnessed a wave of bank failures due to a variety 

of factors. Do you have any concern that banks will be in similar 

situations in the coming months? Or will. the failure of non-bank 

mortgage lenders (finance companies) that operate outside the 


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banking reserve system be the only casualties from the housing 

and credit crunch that we are currently facing? 

A.2. While most banking institutions continue to perform well 

amidst the ongoing financial turmoil, a few institutions—some 

larger, some smaller—are facing difficulties. These difficulties could 

be exacerbated by weakening economic fundamentals. As in past 

periods of financial distress, some banks will fail should challenges 

presented by the current environment continue. 

One must put any discussion of possible bank failures in perspective and recognize that even in good times, banks can fail. For 

more than a decade we have experienced few bank failures—no 

more than ten in any given year since 1995 and none in 2005 and 

2006. 

In general, U.S. banks entered the current period of financial distress with strong capital ratios, which should reduce any potential 

threats to their solvency. Through our examination, monitoring and 

surveillance programs we will work diligently to identify problem 

institutions and take the appropriate supervisory response. When 

bank failures do occur we will strive to minimize the risk to the 

deposit insurance fund. 

RESPONSE TO WRITTEN QUESTIONS OF CHAIRMAN DODD 

FROM CHRISTOPHER COX 

Q.1. Concerns have arisen that some NRSROs use the same letters 

for credit ratings for municipal debt, corporate debt and structured 

debt instruments which have different default rates. For example, 

one NRSRO’s cumulative five-year default rate for CDOs rated at 

its minimum investment grade was between eight and ten times 

higher than its default rate for corporate bonds that it similarly 

rated. 

Do you feel that this is a subject of concern? Do you think that 

investors would benefit from requiring clearer or different credit 

ratings scales or designations for municipal debt, corporate debt 

and structured debt instruments? 

A.1. Yes. Because a number of commenters have indicated that 

there should be greater differentiation of ratings of securitized 

products from corporate ratings, the Commission recently proposed 

new rules that would require credit rating agencies either to use 

distinct ratings symbols for structured products, or to make special 

disclosure of the differences between ratings for structured products and other securities, such as corporate bonds. 

Q.2. The full Committee held a hearing on ‘‘The Role and Impact 

of Credit Rating Agencies on the Subprime Credit Markets’’ on 

September 26, 2007, only a few days after the SEC’s new authority 

took effect under Public Law 109–291, the Credit Rating Agency 

Reform Act of 2006. At the Committee’s September hearing, Columbia University Professor Jack Coffee recommended that ‘‘the 

SEC . . . calculate the five year cumulative default rates on different classes of financial products and disclose this data on one 

centralized web site.’’ 

What is your view of this recommendation? 


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A.2. I believe that credit ratings performance measurement statistics are vital to users’ ability to understand how well a credit rating agency has assessed the creditworthiness of issuers and obligors. The rules that we proposed on June 11, 2008, include new 

disclosure requirements to facilitate reliable comparisons of performance between NRSROs. The disclosure of performance statistics for NRSROs would provide better comparability of ratings performance across the NRSROs. This could include specifying the 

time periods to be covered by the statistics (e.g., 1, 3, and 10 years) 

and requiring statistics for different ratings classes. As with Professor Coffee’s recommendation, the goal is to make the NRSROs’ 

performance statistics more useful and transparent. I have also 

asked the Commission staff to carefully review the recommendations suggested by Professor Coffee in considering possible future 

rulemaking. The staff is also reviewing what additional performance measurement statistics, including historical downgrade and 

default rates within each rating grade, would be useful to users of 

ratings. 

Q.3. Since the time of the hearing, what has the SEC learned 

about the NRSROs, including their ability to manage conflicts of 

interest and their role in the subprime crisis? Do you feel NRSROs 

should be subject to additional regulatory requirements, such as 

due diligence requirements or an obligation to update past ratings 

when rating model assumptions are changed? Does the SEC need 

more statutory authority to perform its mission in this area? 

A.3. Beginning last fall, using the new statutory authority that 

took effect in September 2007, the Commission began examinations 

of the role of the rating agencies in the subprime market turmoil. 

We have just released the findings from these exams and the Commission staff has provided a detailed briefing on our findings to 

your staff. A copy of the report has been separately provided to 

you. Given the recent enactment of the Rating Agency Reform Act, 

I believe the Commission has sufficient authority to address any 

problems that are identified through our examinations, including 

those relating to conflicts of interest and whether firms followed 

their stated procedures with respect to keeping ratings up to date. 

As I have indicated, the Commission staff is also preparing additional rulemakings using that new authority. If we should find that 

we lack needed authority, we would, of course, work with you to 

address any deficiency. 

Q.4. A key factor in restoring and maintaining investor confidence 

is having a Federal securities regulator that is fully funded and 

has sufficient authority to protect large and small investors while 

facilitating fair and efficient capital markets. 

The President’s proposed Budget would fund the SEC for FY 

2009 at $913 million, an increase of less than 1% over FY 2008 

($906 million). The Enforcement Division’s proposed budget for FY 

2009 ($318 million) is about 1% more than the budget for FY 2008 

($315 million). This year, the SEC will ramp up the examination 

and regulation of the NRSROs, investigate conduct related to the 

subprime crisis, review late filings for options backdating, review 

corporate disclosures, oversee rules for new markets and engage in 


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other important activities. Will this budget be sufficient to effectively perform your duties? 

A.4. As you know, the SEC has an enormous task, overseeing the 

nearly $44 trillion traded on U.S. equity markets; the disclosures 

of almost 13,000 public companies; and the activities of about 

11,000 investment advisers, nearly 1,000 fund complexes, and 

5,700 broker-dealers, among others. Given the size and complexity 

of the markets we regulate, even if the SEC’s budget were to double or triple, the agency still would need to carefully set priorities. 

The SEC must continue to think strategically about which areas of 

the market pose the greatest risk, and which areas of potential improvement hold the greatest benefit for investors. And given the 

fast pace of today’s capital markets, we must remain agile and 

flexible enough to redirect our resources with little notice. 

• The FY 2009 request would result in 4% overall increase over 

two years, which is sufficient for the SEC to fulfill its mission, 

continue its major initiatives, and deploy resources as needed 

to emerging issues. Nonetheless, any additional money that the 

Congress saw fit to provide would be put to good use. 

Q.5. Would you recommend that Congress make any statutory 

changes to allow the Commission to resolve the current subprime 

crisis or face the next crisis more effectively? 

A.5. Yes. As I testified to the Committee, the Consolidated Supervised Entities program should be authorized in statute and made 

mandatory for investment banks, as opposed to today’s voluntary 

program. In addition, last year, the Commission proposed numerous authorization proposals that would improve the functioning of 

the SEC, including by enhancing our enforcement authority. Finally, in July 2007 I wrote to the Committee’s leadership calling 

for improvements in the statutory regime governing municipal securities in order to improve the functioning of that important market, where we can expect further subprime and derivatives-related 

problems. 

Q.6. Public companies, including banks and securities firms, are required to make full and fair disclosures in their securities filings 

about collateralized debt obligation holdings and their valuation. 

As the subprime crisis has progressed, some investors have complained that corporations filed inadequate disclosures and inaccurate valuations about their holdings in certain mortgage-backed 

securities. In December 2007, the SEC staff asked public companies with investments in structured investment vehicles and other 

collateralized debt obligations to make specific types of disclosures 

in their filings. 

Will the SEC staff increase the frequency and thoroughness of its 

reviews of corporate filings, or take other appropriate steps, to 

make certain that investors are given appropriate information 

about such investments? 

A.6. Yes. Through its regular and systematic review of public company disclosure, the Division of Corporation Finance reviews, at a 

minimum, the financial statements of each public company at least 

once every three years. Also, consistent with the requirements of 

Sections 408 of the Sarbanes-Oxley Act of 2002, the Division of 


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Corporation Finance reviews the disclosure of the largest companies more frequently. Over the past eight months, Division of Corporation Finance staff noted that a number of large financial institutions could improve their disclosure regarding off-balance sheet 

arrangements by providing additional information to their investors. As a result, and in recognition of changing economic circumstances, the staff sent letters to certain large financial institutions in early December highlighting disclosure points that the 

staff recommended the institutions consider when responding to 

the Commission’s disclosure requirements relating to exposure to 

off-balance sheet arrangements. The staff posted a sample of the 

December 2007 letter on the Commission’s website so that all companies with material off-balance sheet arrangements could consider 

the disclosure suggestions. A similar effort is contemplated with respect to firms’ disclosure of how they are valuing complex and illiquid securities. 

The staff will continue to monitor the disclosure these financial 

institutions provide and will, as appropriate, make suggestions on 

how they can continue to improve their disclosure. The Division of 

Corporation Finance will also continue its regular and systematic 

review of public company disclosure and consider whether additional action is warranted. 

Q.7. Some large U.S. financial firms that took major write-downs 

resulting from their subprime holdings have raised capital by selling securities to sovereign wealth funds, which are owned by foreign governments. The partial ownership of U.S. companies by foreign governments offers additional sources of capital but also has 

raised questions involving conflicts of interest, transparency, market efficiency and the enforcement of securities laws abroad. These 

funds could invest for purely economic reasons or could attempt to 

influence a corporation’s policies and practices—such as location of 

business operations, allocation of credit or capital, hiring decisions 

or lobbying agenda. 

Chairman Cox, in a recent speech you raised two good questions: 

‘‘What are the logical and likely outcomes of growth in this kind 

of activity? Could the rise of sovereign business ultimately change 

the character of U.S. markets? How should we go about answering 

these questions? What are your views on these matters? 

A.7. Our market economy is not premised on government ownership of commercial enterprises. Governments have other important 

roles to play in the economy, including as regulators, and an armslength relationship to commercial and competitive concerns is 

healthy to the functioning of a genuine market. Nonetheless, in 

other nations government ownership of business, including increasingly through equity investments, is the norm. When such governments make portfolio investments in the U.S. capital market, there 

are—as with cross-border investment generally—potential benefits. 

Through their competition for investments in the United States, 

sovereign wealth funds can help offer U.S. companies a lower cost 

of capital and a more liquid market for their securities than might 

otherwise be available. But those same benefits would likely accrue 

to U.S. companies and markets if the foreign investment were privately directed, rather than government directed. A sovereign inVerDate Nov 24 2008 01:45 Mar 12, 2010 Jkt 050368 PO 00000 Frm 00081 Fmt 6602 Sfmt 6602 E:\HR\OC\A368.XXX A368

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vestor in a number of potential concerns for regulators and other 

market participants: 

• Because investor is a government, the incentives that normally 

drive private sector marketplace participants to make decisions 

may be absent, or at least very different. Sovereign wealth 

funds, and sovereign businesses, may therefore have a distorting effect on markets, the pricing of assets, and the allocation of resources. 

• In addition, neither sovereign wealth funds nor sovereign businesses are typically transparent in their motives or operations. 

Generally, the level of transparency is related to the degree to 

which the government itself is transparent to its citizens and 

to the public. Overall, disclosure by sovereign wealth funds 

leaves much to be desired, while public disclosure surrounding 

sovereign business tends to stop at the level of the company’s 

interaction with the government itself. 

• Another concern about sovereign wealth funds and sovereign 

businesses is not that they are foreign, but that their managers are sovereign. Conflicts of interest necessarily arise when 

government is both the regulator and the regulated. Rules that 

might be rigorously applied to private sector competitors will 

not necessarily be applied in the same way to the sovereign 

who makes the rules. 

• Governments that control sovereign wealth funds and sovereign businesses, because they are governments, can in some 

cases control certain economic events, and they may have information advantages over private market participants. Governments routinely are privy to certain types of information 

that most private investors are not. 

• In addition, there is the increased opportunity for political corruption. Graft, bribery, and other forms of financial corruption 

by governments and political figures is an unfortunate fact of 

life throughout the world—as the Commission’s enforcement 

responsibilities under the Foreign Corrupt Practices Act remind us on a daily basis. When individuals with government 

power also possess enormous commercial power and exercise 

control over large amounts of investable assets, the risk of misuse of those assets, and of their conversion for personal gain, 

rises markedly. 

Q.8. Congress approved our CFIUS reform law last year to address 

national security threats that might arise from a foreign agents’ access to sensitive U.S. technology, critical infrastructure, or important defense supplies. It is not necessarily meant to address some 

critics’ concerns over foreign companies’ potential use of passive investment as economic leverage on U.S. capital markets. 

In a speech at Harvard University’s Kennedy School of Government on October 24, 2007, you stated ‘‘the rise of sovereign wealth 

funds challenge our regulatory model in a number of ways...if government-owned investments lack transparency, they could contribute to market volatility stemming from uncertainty about the 

allocation of their assets.’’ What tools and enforcement authority 


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are currently available to the SEC to protect investors from such 

market volatility and to ensure fair and orderly markets? 

A.8. The SEC currently has rules that impose disclosure obligations on all large investment funds, including sovereign wealth 

funds. The primary disclosure requirements applicable to unregistered funds arise under Sections 13 and 16 of the Exchange Act. 

These provisions require the reporting of beneficial ownership of 

securities if the owner acquires more than a certain threshold percentages of the stock of an issuer. These provisions apply to fund 

advisers as the beneficial owners of the securities in the funds they 

manage. For example, if a fund adviser has acquired more than 5% 

of the stock of an issuer, Section 13 applies and the adviser must 

file a Form 13D or 13G. If a fund adviser has acquired more than 

10% of the stock of an issuer, Section 16 applies and the adviser 

must file a Form 3 or 4. The forms require the fund adviser to state 

whether the fund has any intent to change control of the company, 

or whether the acquisition is instead a passive investment. 

Investment advisers having investment discretion over $100 million or more in Section 130 securities (generally any equities registered pursuant to Section 12 of the Exchange Act) also must also 

file a Form 13F, which is a quarterly report of all the Section 13(f) 

securities positions held by the adviser. In filing Form 13F, an adviser to multiple clients may aggregate all of his clients’ positions 

in a particular security. The required filings provide the SEC and 

the public with a quarterly ‘‘snapshot’’ of the fund’s Section 13(f) 

securities holdings. 

The SEC has brought enforcement actions for violation of these 

disclosure requirements. See, e.g., In re Quattro Global Capital, 

LLC, Adv. Act Rel. No. 2634 (Aug. 15, 2007) (action against registered investment adviser having investment discretion over at 

least $100 million in relevant assets for failure to file quarterly 

Form 13F disclosing its Section 13(f) securities for a period of over 

three years); SEC v. Scott R. Sacane, et al., Lit. Rel. No. 20258 

(Aug. 29, 2007) (SEC settled action for disclosure violations under 

Sections 13 and 16 of the Exchange Act as part of a market manipulation scheme). If a fund were not complying with its reporting obligations, the Division of Investment Management would likely 

bring the filing requirements to the funds’ attention. If further 

steps are necessary to obtain the necessary disclosures, the Enforcement Division may file an injunctive action in federal court, or 

an administrative proceeding within the SEC, to compel compliance 

with the disclosure requirements. The difficulty with opaque investors such as sovereign wealth funds, of course, is that the SEC has 

no way of knowing whether they have failed to comply in the first 

place. 

Q.9. The press reports that there is growing uncertainty regarding 

the ability of bond insurers to meet their financial obligations in 

the event of downgrades to collateralized debt obligations, assetbacked securities, and other structured finance products containing 

subprime loans. In recent weeks, several bond insurers have seen 

their credit ratings lowered and analysts have speculated that bond 

insurers may face future ratings downgrades. These events could 


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1Michael McDonald and Christine Richard, ‘‘Insurance Drops for Municipal Debt, Undermines 

MBIA,’’ Bloomberg News, March 13, 2008. 

have serious implications for banks and other financial institutions 

which hold insured bonds or credit default swaps. 

What is your assessment of this situation and the efforts of State 

regulators and the private sector to address this? 

A.9. As a threshold matter, the Commission does not regulate these 

financial guarantors, known colloquially as monoline insurers; 

rather this is the domain of state insurance regulators. There are, 

however, various ways that the securities markets and their participants, which the Commission does regulate, may be impacted by 

ratings downgrades of monoline insurers. 

These bond insurers began by insuring against defaults on bonds 

issued by municipalities—a market that has not historically experienced many or sizable defaults. During the 1990s, some bond insurers migrated to insuring complex securities backed by home mortgages, including subprime instruments. In insuring such structured 

products, many of these bond insurers assumed that losses on 

mortgage-backed securities would stay within historical ranges. As 

the housing boom continued for many years, defaults were indeed 

low and housing-related assets were considered relatively safe. 

During 2006, however, there was increasing evidence of the deterioration in home prices and a related rise in mortgage default 

rates. As the deterioration has continued, market participants are 

questioning whether such bond insurers will in fact be able to pay 

on their bond guarantees and credit protection that they 

underwrote. 

Fortunately, the underlying credit of many insured municipal 

bonds is quite strong. Indeed, the municipal issuers are beginning 

to question the desirability of obtaining municipal bond insurance 

at all. Demand for municipal bond insurance is reportedly shrinking at the fastest pace in the industry’s 36-year history. State and 

local governments bought protection on only 26 percent of the $40.8 

billion in bonds they sold in January and February 2008, down 

from 53 percent a year earlier, according to data compiled by 

Bloomberg.1

The Commission staff recognizes that a significant downgrade in 

a monoline insurer’s rating could result in the securities becoming 

ineligible under rule 2a–7 for investment by money market funds. 

Also, in the long term, the inability of bond insurers to maintain 

high credit ratings may restrict the supply of high-quality paper for 

tax-exempt money market funds. 

There are other possible effects that a significant downgrade in 

a monoline insurer’s rating could have on money market funds. 

The municipal securities they hold include variable rate demand 

notes (‘‘VRDNs’’) and tender option bonds (‘‘TOBs’’) that typically 

have liquidity backstops, or ‘‘puts,’’ that are provided by a financial 

institution. These liquidity features serve to provide a source of 

cash to satisfy redemptions by fund shareholders, and also to shorten the municipal bonds’ maturities and make them eligible investments for a money market fund. A significant downgrade could terminate the put, and thus result in money market funds holding 

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taining a stable net asset value. The Commission staff has been in 

regular contact with fund management companies, which are 

aware of these risks and have taken steps intended to protect 

funds and thus fund investors from the loss of these puts. 

Monoline insurer downgrades also potentially affect systemically 

important securities firms. SEC staff have discussed frequently the 

various exposures to monolines with risk managers, treasurers, 

and business unit personnel at these firms. While the monolines 

are important market participants, the systemically important securities firms are highly aware of and actively manage their exposures to the monoline sector. The Commission staff is also in regular communication with other financial services supervisors, particularly the Federal Reserve Board, which directly oversees the 

holding companies of the most of the systemically important commercial banks, the OCC, which oversees nationally charted commercial banks, and the UK’s Financial Services Authority. Through 

a variety of formal and informal channels, the staff has worked 

with these other supervisors to understand the possible impact of 

downgrade or financial distress on individual institutions and on 

the broader financial system. 

Q.10. Does it appear to you that there will result potentially significant problems involving the securitization of credit card debt? 

A.10. The SEC does not regulate credit card debt markets and 

these securities are generally offered in private placements outside 

the Commission’s purview. Through the SEC’s supervision of systemically important securities firms the Commission does monitor 

the investment firms’ risk exposure to and risk management of 

securitized products supported by a range of assets, including credit card receivables. In our ongoing and frequent discussions with 

senior risk officers and market participants, the firms have represented that they are aware of their risk exposures to such products and have risk controls for managing such exposures. 

Q.11. What lessons has the Commission learned from the current 

subprime crisis? 

A.11. While the Commission is not a front-line regulator of the 

mortgage lending business, the derivatives industry, or the 

monoline insurance industry, the securities markets and the market participants that the Commission does regulate—not to mention the investors whom it is our mission to protect—have been 

deeply affected by the problems stemming from the widespread 

packaging and selling of residential mortgages as securities. Among 

the problems that have surfaced are the deterioration in lending 

standards that led to the creation of so much low-quality mortgage 

debt; the abuses stemming from the prevalence of the originate-todistribute model that diminished incentives to control risk, the accounting treatment of the trusts created to hold this risky debt in 

securitized form; the adequacy of commercial banking measures of 

capital and liquidity for determining the proper levels of assets at 

the nation’s major investment banks; the impact on money market 

funds from the devaluation of presumptively safe assets; the quality of issuer disclosure by public companies involved in structured 

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tured products employed by the credit rating agencies, over which 

the SEC gained regulatory authority last summer. 

The deterioration of lending standards that led to the creation of 

so much risky paper, as well as the role of commercial banks in 

originating and securitizing mortgage credit, falls outside the 

SEC’s jurisdiction. The accounting issues have centered around the 

questions of balance sheet consolidation. Current accounting rules 

limit the discretion of firms to manage special purpose trusts (and 

the underlying loans they hold) once a loan has been sold, if they 

wish to continue to maintain off-balance sheet treatment. Twice in 

recent months, first in July 2007 and again in January 2008, the 

SEC has provided interpretive guidance on the application of these 

rules in the case of limited modifications for loans where default 

is reasonably foreseeable. In that circumstance, we have said, the 

limited modification would not invalidate off-balance sheet treatment. As a result, these financial institutions were not required to 

consolidate these trusts—which would have had negative ramifications on the bank’s regulatory capital requirements. As a result, 

refinancings and other work-out arrangements have proceeded, 

with the advantage of keeping people in their homes and maximizing the value of the securitized assets. This is, however, a 

short-term response. The Commission’s Chief Accountant has also 

asked the Financial Accounting Standards Board to revisit the underlying accounting guidance to determine whether recent experience points to the need not only for further clarifying guidance, but 

also for changes in the applicable rules. 

The members of the President’s Working Group on Financial 

Markets play an active role in overseeing the stability of the financial system. One important aspect of that oversight is our Consolidated Supervised Entities (CSE) program, through which the Commission supervises the systemically important U.S. securities firms 

on a consolidated, or group-wide, basis. In my testimony to the 

Senate Banking Committee on April 3, 2008, I described in significant detail the CSE program as it related to the events leading up 

to the merger between Bear Stearns and JP Morgan Chase. We 

have learned from the Bear Stearns experience that investment 

banks can be subject to a ‘‘run’’ similar to the way deposit-taking 

institutions have been, and we have learned that the 2004 decision 

to apply commercial bank metrics for capital and liquidity to investment banks was inadequate to prevent such a run. 

Another aspect of our oversight is the mutual fund industry. 

Here, the Commission staff has been active in working with the 

managers of money market funds as they cope with the downgrading of ratings and the declines in value of securities in which 

their funds have invested. Commission rules limit money market 

funds to investing in high-quality, short-term investments in an effort to ensure that these bedrocks of the financial system are reliable in all market conditions. Losses by a money market fund 

would be reflected by the fund re-pricing its securities below $1.00 

(known as ‘‘breaking the buck’’). The Commission is closely monitoring the fund industry and while we have seen some instances 

of funds requiring infusions of capital from the corporate parents 

of fund advisers, no money market fund has repriced its shares 

below $1.00. 


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In light of recent events, we are also working to increase the 

transparency of the key publicly-traded financial institutions in 

their disclosures to markets and investors. In December 2007, 

Commission staff wrote to 25 leading financial institutions that are 

publicly owned companies, highlighting specific disclosure issues 

that the firms should consider in relation to their exposure to offbalance-sheet entities and certain structured finance products. Better illuminating the facts concerning these exposures should give 

counterparties increased confidence in the fundamental soundness 

of the financial system. We are planning a similar initiative to increase the transparency with respect to how firms are valuing their 

assets. 

Using the new statutory authority that took effect in September 

2007, the Commission recently concluded examination of the role 

of the rating agencies in the subprime market turmoil. A copy of 

our examination report has been separately provided to you. This 

examination is important, because more than just providing the 

markets one view of the likelihood of default, the past several 

months have demonstrated the power of credit ratings to move 

markets, and their potential to create cascading effects in those 

markets. Beyond these ongoing examinations, we have recently 

proposed rules aimed at reducing the extent to which our regulatory system grants a central role to the rating agencies. 

We have also proposed detailed rules under the new Credit Rating Agency Reform Act that respond directly to the shortcomings 

we have seen through the subprime experience. Our proposals 

would require credit rating agencies to make disclosures regarding 

past ratings, in a format that would improve the comparability of 

track records and promote competitive assessments of the accuracy 

of the agencies’ past ratings. In addition, the rules would enhance 

investor understanding of important differences between ratings 

for municipal and corporate debt and for structured debt instruments. 

Each of the regulatory actions we are taking and each of those 

that we are contemplating, both here and abroad, is designed to 

promote the health of our capital markets, to protect investors, and 

to promote capital formation. 

Q.12. The public expresses concern when they perceive that corporate executives receive excessive compensation, particularly 

when the corporation is losing money or its stock is falling value. 

For example, there was public concern last October, when the CEO 

of a large securities firm left with reportedly over $160 million in 

stock, options and retirement benefits a week after the firm reported its largest-ever quarterly loss, which included write-downs 

of $7.9 billion across CDOs and U.S. subprime mortgages, and the 

firm’s stock price fell significantly. 

In 2006, the SEC required public companies to disclose more information about executives’ compensation in annual filings, but 

that does not seem to have controlled the problem. Shareholders 

have offered proposals regarding executive compensation at the annual meetings of public companies. Recently, the SEC developed an 

Internet tool for investors to compare executives’ compensation online. 


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What are the Commission’s views and plans on how to address 

the executive compensation issue in the future? 

A.12. Shareholder proposals asking boards to implement advisory 

shareholder votes on executive compensation—commonly called 

‘‘say on pay’’ proposals—are one way that investors can use the enhanced information provided under the SEC’s new executive compensation rules. The Commission’s rules concerning such shareholder proposals allow ordinary shareholders meeting modest eligibility requirements to submit proposals that may be considered at 

the company’s annual meeting through the company’s proxy materials. The staff received 28 no-action requests to exclude ‘‘say on 

pay’’ proposals during the 2006–2007 proxy season and received 19 

during the 2007–2008 proxy season. Generally, the ‘‘say on pay’’ 

proposals request that shareholders be allowed to cast non-binding 

votes on executive compensation at the companies’ annual meetings. In most cases, the staff has found that companies must include these proposals in their proxy materials. 

The Commission staff is also working to ensure that the executive compensation rules are being applied in company proxy statements as intended. In an effort to both evaluate compliance with 

the new rules and provide guidance on how companies could improve their first-time disclosures in this area, the Division of Corporation Finance reviewed the 2007 proxy statements of 350 companies and published its ‘‘Staff Observations in the Review of Executive Compensation Disclosure.’’ This report provides an overview 

of the significant areas of comment on the first-year disclosures. 

Subsequently, the Division of Corporation Finance issued second 

comment letters to approximately 70% of the companies. Following 

its normal procedures, the Division of Corporation Finance is posting the correspondence relating to its completed reviews on the 

SEC website. This should provide greater information on the actual 

comments and how companies responded to them, and assist companies in enhancing future executive compensation disclosure. 

The Executive Compensation Reader on the SEC website was designed to alleviate the power of XBRL data tagging for making the 

compensation paid to top executives understandable to investors. It 

was a demonstration based on one year’s data for 500 of the largest 

American companies. We are currently working to develop XBRL 

data tags for general use by all public companies so that investors 

can do industry comparisons or perform analyses of particular 

forms of compensation, such as stock options, on a permanent 

basis. 

This will provide quicker and more efficient analysis of executive 

compensation and will enable all shareholders to be better-informed. 

Q.13. The SEC recently reported a significant decrease in the total 

dollar amount of penalties and disgorgements it ordered against 

violators in fiscal year 2007 when compared to fiscal year 2006, declining to $1.6 billion from $3.3 billion—a decline of about 50 percent. In 2007, the Division of Enforcement initiated only slightly 

fewer total investigations, civil proceedings, and administrative 

proceedings in fiscal year 2007 than in fiscal year 2006. 

What are the reasons for this decrease? 


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A.13. Last year the Commission filed the second highest number 

of enforcement cases in the agency’s history (655), resolving 92% of 

these cases successfully. The majority of the cited decline in monetary remedies is due to differences in the levels of disgorgement, 

a remedy requiring the securities law violator to forfeit all ill-gotten gains. Thus, the amount of disgorgement obtained depends on 

the circumstances of the specific case, not the discretion of the 

Commission. While legal, factual, and mathematical analyses are 

required to determine the appropriate amount of disgorgement in 

some cases, the amount of disgorgement is generally not subject to 

change by the Commission. When further sanctions are appropriate, the Enforcement Division and the Commission normally 

consider the amount of the disgorgement in determining the correlative size of a civil money penalty. It should be noted that in Fiscal 

2007, the Commission imposed more corporate penalties (15) than 

in any prior year in the agency’s history. The ratio of penalty to 

disgorgement was essentially the same in fiscal years 2006 and 

2007. 

In the years after the Enron scandal, the country witnessed a series of massive accounting frauds involving enormous amounts of 

disgorgement and penalties. These cases, including WorldCom, 

Qwest, AOL, Healthsouth, AIG, Fannie Mae, and Tyco, were 

brought in SEC fiscal years 2003 through 2006. Since these cases 

have made their way through the enforcement process, the level of 

penalties is still much higher than it had been previously, including throughout the 1990s, and as noted, corporate penalties are 

now much more frequent. 

Q.14. Proxy Access was the subject of a November 1, 2007 letter 

from several colleagues on this Committee and me and of a hearing 

held by this Committee on November 14, 2007. 

On November 28, 2007, the SEC in a split vote deprived shareholders of the right to offer proposals on proxy access. At the time, 

you stated ‘‘I believe we can move forward and re-open this discussion in 2008 to consider how to strengthen the proxy rules to better 

vindicate the fundamental state law rights of shareholders to elect 

directors.’’ 

Please describe your plans and timetable for reconsidering the 

shareholder proxy access issue at the Commission this year. 

A.14. The Commission’s careful and extensive review of the proxy 

process, which has included three Roundtables in 2007 that focused 

on the relationship between the federal proxy rules and state corporation law, proxy voting mechanics, and shareholder proposals, is 

ongoing. The November 2007 Commission action codified the staff’s 

longstanding interpretation of the ‘‘election exclusion’’ in Rule 14a– 

8(i)(8), but as I have stated then and subsequently, I will ask the 

full Commission to further consider these questions this year. It is 

my firm belief that we can better align the federally-regulated 

proxy system with the state-authorized rights of shareholders to 

determine the directors of the companies they own. 

Q.15. The SEC is budgeted nearly one billion dollars per year with 

which to protect investors, maintain fair, orderly, and efficient 

markets, and facilitate capital formation. The Commission is considering the concept of ‘‘mutual recognition’’ in which U.S. citizens 


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could purchase or trade securities directly with foreign broker-dealers or on foreign exchanges and be regulated not by the SEC but 

by the foreign regulator. When considering a mutual recognition 

framework that would allow U.S. citizens to directly invest in foreign markets and be solicited by foreign brokers, will the SEC consider not only the comparability of a foreign regulator’s regulations, 

but also the foreign regime’s enforcement and inspection resources, 

independence from the government, respect for the rule of law, culture of fair dealing, tradition of investor protection, impartial regulation over market participants, and related factors? 

A.15. Yes. Any mutual recognition arrangement must begin with 

comprehensive assessment of the foreign regulatory regime, including its enforcement and inspection resources, independence from 

the government, respect for the rule of law, culture of fair dealing, 

tradition of investor protection, and impartiality. Given the Commission’s investor protection mandate, the assessment would, of 

course, focus on the key regulatory principles underlying the U.S.’s 

own regulatory regime, and would entail a consideration of the results achieved by the foreign securities regulatory system in addressing these core securities regulatory principles. In addition, the 

assessment of the foreign regulatory regime would consider the 

principles and the regulatory system of a foreign regime overall. 

Comprehensive arrangements for both enhanced enforcement and 

supervisory cooperation would also be an important component of 

an approach to mutual recognition. Such arrangements would facilitate robust enforcement in the event of a cross-border violation 

of securities laws. 

Q.16. In response to a question about Section 404 of the SarbanesOxley Act, you stated that ‘‘we do have a cost study underway at 

the SEC to make sure that it’s working as we intended.’’ 

A careful assessment of the benefits can provide a useful perspective from which to view the costs. Will this study also include an 

assessment of the benefits to public companies that have resulted 

from Congressional passage of the Sarbanes-Oxley Act, such as 

consideration of: improved access to capital, lower cost of capital, 

increased stock market valuation of public companies listed in the 

U.S., improved internal controls, improved accounting, reduction or 

prevention of certain types of frauds, increased investor confidence 

in the information published by public companies, increased investor trust of the securities markets, more effective boards of directors, enhanced corporate governance and improved executive responsibility? 

A.16. Yes. The study will consider both the benefits and costs associated with Section 404 of the Sarbanes-Oxley Act. In reviewing the 

sources of benefit, the study will take into account such considerations as you have listed. 

Q.17. The Commission has pursued a number of investigations and 

enforcement actions to address the improper backdating of stock 

options issued to corporate executives. 

On September 6, 2006, you testified to the Committee: ‘‘Not only 

must option grants be reported now within two business days, but 

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tagging approach, economists, researchers, law enforcement and 

the investing public now have almost instant access to information 

about stock option grants in a form that they can immediately 

download into spreadsheets, analyze and compare.’’ 

During Fiscal Year 2007, over 2,900 Forms 4 reporting executive 

stock options grants were filed late with the Commission, including 

over 1,500 Forms 4 that were filed more than 21 business days 

late. Of these, over 1,100 Forms 4 were filed more than 100 business days late, and over four hundred Forms 4 were filed more 

than 300 business days late. 

Please confirm that the Commission staff on an ongoing basis reviews late filings reporting options grants to assess whether there 

has been improper options backdating. Please describe the Commission’s actions to deter improper options backdating. 

A.17. The Division of Enforcement currently has approximately 80 

open investigations regarding possible fraudulent reporting of stock 

option grants, including options backdating. The companies involved in the investigations are located throughout the country, are 

of various sizes, and span multiple industry sectors. The investigations arose from several sources, including staff investigations 

(with the assistance of the Office of Economic Analysis) in conjunction with late-filed Forms 4. Other sources of enforcement investigations are companies that self-report following internal investigations; companies that announce potential restatements; staff reviews and assessments of suspicious grants identified in analyses 

that were performed by independent research organizations, institutional investors, or analysts; and tips from the public. Although 

the staff cannot review all late-filed Forms 4 due to volume, the 

staff does review these forms in the context of specific investigations and does routinely review egregious and non-trivial cases. 

Also, the staff continues to review and evaluate other sources of information for indications of improper backdating. 

The SEC has taken many steps to stamp out backdating of employee stock options. The revised executive compensation disclosure 

rules the Commission adopted in 2006 include a number of provisions that address backdating of options. For example: 

• A company must now disclose how it determines when it will 

make equity awards. This requires a company to disclose how, 

and why, it backdates for its executives. 

• A company must disclose the grant date of equity awards. If the 

grant date is different than the date on which the board took 

action, the company must disclose the date of the board’s action. 

• A company must disclose the exercise or base price of an option 

if it is less than the market price of the underlying security on 

the grant date. If it is less than the market price on the grant 

date, the company must disclose the market price on the grant 

date. This disclosure is intended to provide an investor with a 

complete picture of the true terms of each option award by allowing the investor to compare the grant date market price to 

the in-the-money exercise price. 

• Further, if the exercise or base price of an option grant is not 

the closing market price per share on the grant date, a company 


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must describe its methodology for determining the exercise or 

base price. 

Q.18. At the Banking Committee hearing on September 6, 2006, 

Professor Erik Lie testified ased on his then-unpublished research, 

conducted with Professor Randy Heron, in which they examined a 

sample of 39,888 stock option grants to top executives across 7,774 

companies between 1996 and 2005. They estimated that ‘‘14% of all 

grants to top executives dated between 1996 and 2005 were 

backdated or otherwise manipulated.’’ 

How many cases involving improper backdating of stock options 

granted to executives has the Commission staff reviewed or investigated? 

A.18. The Commission’s Division of Enforcement currently has approximately 80 open investigations involving possible fraudulent 

reporting of stock option grants, including options backdating. The 

companies are located throughout the country, and include Fortune 

500 companies as well as small cap issuers. The companies span 

multiple industry sectors. 

Q.19. How many such cases have been the subject of enforcement 

proceedings or criminal referrals? 

A.19. As of March 19, 2008, the Commission has filed enforcement 

actions against eight public companies and 31 former executives 

(associated with 17 different companies) alleging securities law violations in connection with backdating stock options. Parallel criminal charges have been brought against 15 former executives, three 

of whom have been sentenced to serve, or have agreed to a plea involving, time in prison. The executives charged include former 

CEOs, general counsels, chief financial officers and other accounting personnel, human resources personnel, and a former compensation committee member. 

Q.20. What is your evaluation of this research of Professor Lie? 

A.20. The research of Professors Lie and Heron draws information 

from publicly available data concerning stock option awards to top 

executives from 1996 through 2005 and suggests that a large number of companies had an uncanny ability to choose grant dates that 

coincided with low stock prices. The research suggests that patterns of potential backdating significantly decreased after 2002, 

when the Sarbanes-Oxley Act shortened the time period for reporting option grants to two business days. 

Before the Sarbanes-Oxley Act, officers and directors were not required to contemporaneously disclose their receipt of stock option 

grants or exercise of their stock options. In many cases, the disclosure of this information—via a Form 5 filed by the company—was 

not required until after the end of the fiscal year in which the 

transaction took place, which, in some cases, meant an individual 

had more than a year to disclose a grant. 

This delay in reporting provided the opportunity for companies 

to misrepresent the date of an option award to make it appear that 

the option was granted at an earlier date, and at a lower price, 

than when the award was actually made. The intent of backdating 

option grants is to allow the option recipient potentially to realize 

larger eventual gains, but still characterize the options as having 


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been granted ‘‘at-the-money’’—disguising the fact that the company 

actually granted the options ‘‘in-the-money.’’ In this way, companies were able to give the option recipient a larger ‘‘upside’’ benefit 

while at the same time minimizing the compensation expense of 

the award to the company. 

Sarbanes-Oxley made these kinds of abusive practices much 

harder to conceal. Section 403 of the Sarbanes-Oxley Act, and the 

Commission’s rules governing ownership reports by company insiders, now require that officers and directors disclose any transactions in their companies’ equity securities within two business 

days. Not only must option grants now be reported within two business days, but this information is required to be filed electronically 

through the Commission’s EDGAR filing system. This allows the 

public almost instant access to information about stock option 

grants. The need to report option grants no later than two business 

days after the event, combined with the enhanced transparency of 

electronic filing, now make it exceptionally harder for companies to 

manipulate the grant date of option awards. 

The empirical evidence we have seen indicates that in combination, these steps have dramatically reduced if not eliminated backdating abuse, and they have effectively eliminated any easy opportunities for companies to secretively grant options. 

Q.21. If there is a significant difference between the number of 

cases estimated by Professor Lie’s research and the number of 

cases investigated by the Commission, please explain your understanding of the reasons for the difference. 

A.21. The estimates in the Lie/Heron research are based on statistical analysis. However, the determination of whether a particular 

company engaged in illegal backdating or other stock grant manipulations depends on the facts and circumstances of each case. For 

the government to make a successful case in a court of law, far 

more is required. The Commission has made an extraordinary commitment of resources to address the problem of stock option grant 

manipulation and to determine whether illegal backdating has actually occurred in specific cases. The Commission has focused its 

efforts on identifying intentional misconduct and alleged misconduct that postdates the executive compensation and option 

grant reforms enacted by Sarbanes-Oxley and the Commission’s executive compensation rules. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR AKAKA 

FROM CHRISTOPHER COX 

A. MUTUAL FUNDS

A. Mutual Funds are so important because they are the investment vehicle utilized by millions of middle-income Americans to 

prepare for retirement investment or other long-term financial 

goals and dreams. 

Q.1. When do you expect the Commission to move forward on its 

proposals to improve mutual fund disclosures? 

A.1. The Commission will consider final rulemaking on these proposals this summer. The Commission voted unanimously in NoVerDate Nov 24 2008 01:45 Mar 12, 2010 Jkt 050368 PO 00000 Frm 00093 Fmt 6602 Sfmt 6602 E:\HR\OC\A368.XXX A368

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vember 2007 to propose rule amendments that would require every 

mutual fund to provide investors with a concise, plain English summary of key facts about the fund. The proposals would permit 

funds to harness the power of the Internet in order to provide investors with information that is easier to use and more readily accessible, while retaining the comprehensive quality of the information that is available today. 

B. FINANCIAL LITERACY

Chairman Cox, I have been impressed by your commitment to 

protecting senior investors from fraud. I also appreciate the Commission’s willingness to work with the North American Securities 

Administrators Association and the Financial Industry Regulatory 

Authority on this important issue. 

Q.2. In addition to senior fraud related initiatives, what else is the 

SEC doing to ensure that average investors can make informed financial decisions? 

A.2. On June 25, 2008, the Commission voted to propose a new 

rule that would define most equity-indexed annuities as securities. 

This would permit ordinary investors to have the protections of the 

securities laws governing the sales practices and suitability requirements for these products that are so often the subject of investor complaints. 

The Commission’s Office of Investor Education and Advocacy 

(OIEA) provides investors with the foundational information they 

need to make informed investment decisions. In addition to specialized information geared towards seniors, the military, and online 

investors, OIEA’s webpages provide answers to Frequently Asked 

Questions on popular investor inquiries, including how to change 

the name on a stock certificate, how to check on the credentials of 

investment professionals, and how to file a complaint with the 

SEC. There’s also a mutual fund cost calculator, links to viewers 

that makes it easier for investors to analyze public companies’ and 

mutual funds’ financial results, and links to other financial education websites. 

OIEA’s advocacy function has contact with nearly 100,000 investors and other constituents annually. Our investor advocates research, resolve, or redirect common complaints, including complaints involving allegations of fraud or unsuitable sales practices 

and complaints about specific types of securities products. To expand the communication into more preventative and educational 

messages, OIEA is implementing technology to enable more direct 

communication with investors, including ‘‘mass customized’’ messages of interest to investors, interactive webpages, and opt-in 

email/phone alerts. OIEA is also developing an audio library targeted to those without internet access that will give investors telephone access to a range of recorded messages on investing topics. 

OIEA also plays a role in the Commission’s regulatory policy and 

disclosure agenda. OIEA is conducting focus groups on the proposed mutual fund summary prospectus that highlights key information in a concise, user-friendly format. This spring, OIEA is conducting a survey of 1,000 investors to gain insights into how understandable and how useful they find other SEC-mandated discloVerDate Nov 24 2008 01:45 Mar 12, 2010 Jkt 050368 PO 00000 Frm 00094 Fmt 6602 Sfmt 6602 E:\HR\OC\A368.XXX A368

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sures, such as proxy materials and annual reports. These are first 

steps in OIEA’s increasingly robust effort to test ‘‘usability’’—encompassing disclosures and interactive media—to ensure that what 

is delivered to investors is as effective as possible. 

As noted above, the Commission voted unanimously in November 

2007 to propose rules to authorize a ‘‘summary prospectus’’ for mutual funds—a short, investor friendly document that discloses a 

mutual fund’s investment objectives, as well as all of the information about fees, risks, performance, and other vital subjects that 

customers need to understand to make a sound investment decision. Using the Internet, investors could drill down from the summary prospectus to more detailed information, depending on their 

interests and needs. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR CRAPO 

FROM CHRISTOPHER COX 

Q.1. Considerable work has already been done establishing that 

our capital markets are at risk of falling behind and providing specific regulatory, tax, and liability reforms to revive the leadership 

position of the U.S. capital markets. Do you agree that it is past 

time for all of us to resolve these outstanding issues and action is 

required now? 

A.1. Yes. The Commission’s statutory missions are to protect investors, keep our markets healthy and vibrant, and promote capital 

formation. Each of the policy areas you cite can and does impact 

the accomplishment of these missions, and there are opportunities 

for improvement in each of them. Our regulatory system needs to 

be consistently reexamined with a view to the rapidly changing 

conditions of the global marketplace. As the SEC works to improve 

its rules and the implementation of our rules to better achieve 

these goals, we welcome any assistance other policymakers can 

offer. 

Q.2. What are the top initiatives that your agency is pursuing to 

meet this need, when will you propose them, and have you set 

deadlines for implementation? 

A.2. Rationalizing the implementation of section 404 of the Sarbanes-Oxley Act remains the most important action the SEC can 

take to help American businesses remain competitive in the global 

marketplace. To make sure that the U.S. capital markets remain 

robust and competitive, the SEC repealed the costly Auditing 

Standard No. 2, which had made Sarbanes-Oxley compliance so difficult, and replaced it with a completely new standard that is topdown, risk-based, materiality-focused, and scalable for companies of 

all sizes. The new standard was used for the first time with annual 

reports filed this spring. We are now monitoring implementation of 

the new standard to ensure that the desired cost efficiencies are 

being achieved. The SEC has also delayed application of the section 

404 audit requirement for smaller public companies while we conduct a benefit-cost study to ensure that the expected efficiencies 

from the new auditing standard and guidance for management are 

being realized. The study will be completed by the fourth quarter 

of 2008. 


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Additionally, in November of 2007, we adopted new rules designed to make it much simpler and easier for smaller companies 

to raise capital. We expanded the number of companies who can 

use the Commission’s scaled disclosure and reporting requirements 

for smaller companies. Now, companies with a public float of up to 

$75 million can use these simpler rules, compared to the $25 million cap that was in place under the old rule. That means another 

1,500 public companies will be eligible to use our simplified disclosure and reporting requirements. We also further simplified the 

rules themselves. We eliminated five forms, and 36 separate items 

that used to make up Regulation S-B. We made it more economical 

for smaller companies to sell restricted securities under Rule 144 

of the Securities Act. We reduced the holding period from one year 

to six months, and eliminated many of the other restrictions on 

using Rule 144. And non-affiliates won’t have to file forms any 

more—a change we expect will reduce the number of Form 144s 

filed with the Commission by nearly 60%. This is a way to cut the 

cost of capital for smaller companies without sacrificing investor 

protection. In taking these steps, we were responding to several 

key recommendations of the SEC’s Advisory Committee on Smaller 

Public Companies, which issued its final report in April 2006. 

We have also undertaken an initiative to reduce complexity in financial reporting. I appointed an Advisory Committee on Improvements to Financial Reporting which will recommend improvements 

that will keep America’s financial reporting system as the gold 

standard for the world. They have already issued interim recommendations, and their final recommendations are expected this 

August. 

Last year, the Commission voted unanimously to take the next 

step on the SEC’s International Financial Reporting Standards 

‘‘Roadmap’’ first announced three years ago. As a result, foreign 

issuers can now file their financial statements with the SEC using 

IFRS, without need of keeping a second set of books under U.S. 

GAAP. The Commission is also examining whether U.S. companies 

should be able to file with the SEC using International Financial 

Reporting Standards as published by the International Accounting 

Standards Board. Having a set of globally accepted accounting 

standards will be critical to the rapidly accelerating global integration of the world’s capital markets. We will consider proposed rules 

on IFRS this summer. 

Q.3. It is my understanding that the Commission is working on a 

rule proposal that would expedite the SEC’s processing of rules 

submitted by exchanges and is engaged in efforts to update the 

current regulatory structure including initiatives to foster a number of new approaches to cross-border regulation. Please describe 

the Commission’s efforts to update mutual recognition and expedite 

the processing of rules submitted by exchanges. 

A.3. On June 25, 2008, the Commission adopted a new rule of internal procedure to speed up the handling of SRO rules. Now, rules 

will be published and take effect within 15 days of filing and in 

non-controversial cases, rules can take effect immediately. This will 

make the rule approval process vastly more efficient. As to mutual 

recognition, the SEC is currently in various stages of discussions 


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with Australia, Canada, and the European Union concerning how 

cross-border activities of broker-dealers and markets are regulated 

in that country. On March 29, I met with Kevin Rudd, the Prime 

Minister of Australia, to announce that the SEC and the Australian government had begun initial discussions as a prelude to a 

possible formal mutual recognition arrangement for the two countries’ securities markets. Those discussions are continuing. We are 

also engaged in similar discussions with Canada. With the European Union we are discussing the establishment of a framework 

that would permit the U.S. and individual EU members to engage 

in bilateral talks. While countries vary widely in their approaches 

to securities regulation, we are exploring the extent to which the 

protections that particular foreign jurisdictions offer investors 

produce similar outcomes to our own regulatory system. 


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