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EXPERTS’ PERSPECTIVES ON SYSTEMIC 

RISK AND RESOLUTION ISSUES 

HEARING 

BEFORE THE

COMMITTEE ON FINANCIAL SERVICES 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED ELEVENTH CONGRESS 

FIRST SESSION 

SEPTEMBER 24, 2009 

Printed for the use of the Committee on Financial Services 

Serial No. 111–78 

( 

(II) 

HOUSE COMMITTEE ON FINANCIAL SERVICES 

BARNEY FRANK, Massachusetts, Chairman 

PAUL E. KANJORSKI, Pennsylvania 

MAXINE WATERS, California 

CAROLYN B. MALONEY, New York 

LUIS V. GUTIERREZ, Illinois 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

GARY L. ACKERMAN, New York 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

DENNIS MOORE, Kansas 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

MELISSA L. BEAN, Illinois 

GWEN MOORE, Wisconsin 

PAUL W. HODES, New Hampshire 

KEITH ELLISON, Minnesota 

RON KLEIN, Florida 

CHARLES A. WILSON, Ohio 

ED PERLMUTTER, Colorado 

JOE DONNELLY, Indiana 

BILL FOSTER, Illinois 

ANDRE ́ CARSON, Indiana 

JACKIE SPEIER, California 

TRAVIS CHILDERS, Mississippi 

WALT MINNICK, Idaho 

JOHN ADLER, New Jersey 

MARY JO KILROY, Ohio 

STEVE DRIEHAUS, Ohio 

SUZANNE KOSMAS, Florida 

ALAN GRAYSON, Florida 

JIM HIMES, Connecticut 

GARY PETERS, Michigan 

DAN MAFFEI, New York 

SPENCER BACHUS, Alabama 

MICHAEL N. CASTLE, Delaware 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

RON PAUL, Texas 

DONALD A. MANZULLO, Illinois 

WALTER B. JONES, JR., North Carolina 

JUDY BIGGERT, Illinois 

GARY G. MILLER, California 

SHELLEY MOORE CAPITO, West Virginia 

JEB HENSARLING, Texas 

SCOTT GARRETT, New Jersey 

J. GRESHAM BARRETT, South Carolina 

JIM GERLACH, Pennsylvania 

RANDY NEUGEBAUER, Texas 

TOM PRICE, Georgia 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

ADAM PUTNAM, Florida 

MICHELE BACHMANN, Minnesota 

KENNY MARCHANT, Texas 

THADDEUS G. McCOTTER, Michigan 

KEVIN McCARTHY, California 

BILL POSEY, Florida 

LYNN JENKINS, Kansas 

CHRISTOPHER LEE, New York 

ERIK PAULSEN, Minnesota 

LEONARD LANCE, New Jersey 

JEANNE M. ROSLANOWICK, Staff Director and Chief Counsel 

(III) 

C O N T E N T S 

Page 

Hearing held on: 

September 24, 2009 .......................................................................................... 1 

Appendix: 

September 24, 2009 .......................................................................................... 55 

WITNESSES 

THURSDAY, SEPTEMBER 24, 2009 

Cochrane, John H., AQR Capital Management Professor of Finance, The 

University of Chicago Booth School of Business ............................................... 41 

Levitt, Hon. Arthur, Jr., former Chairman of the United States Securities 

and Exchange Commission; Senior Advisor, The Carlyle Group ..................... 35 

Miron, Jeffrey A., Senior Lecturer and Director of Undergraduate Studies, 

Department of Economics, Harvard University ................................................ 37 

Volcker, Hon. Paul A., former Chairman of the Board of Governors of the 

Federal Reserve System ...................................................................................... 6 

Zandi, Mark, Chief Economist and Co-Founder, Moody’s Economy.com ............ 39 

APPENDIX 

Prepared statements: 

Bachmann, Hon. Michele ................................................................................. 56 

Cochrane, John H. ............................................................................................ 57 

Levitt, Hon. Arthur, Jr. .................................................................................... 62 

Miron, Jeffrey A. ............................................................................................... 66 

Volcker, Hon. Paul A. ....................................................................................... 93 

Zandi, Mark ...................................................................................................... 112 

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Written statement of The Aspen Institute ............................................................ 118 

(1) 

EXPERTS’ PERSPECTIVES ON SYSTEMIC 

RISK AND RESOLUTION ISSUES 

Thursday, September 24, 2009 

U.S. HOUSE OF REPRESENTATIVES, COMMITTEE ON FINANCIAL SERVICES, Washington, D.C. 

The committee met, pursuant to notice, at 9:05 a.m., in room 

2128, Rayburn House Office Building, Hon. Barney Frank [chairman of the committee] presiding. 

Members present: Representatives Frank, Kanjorski, Watt, Sherman, Meeks, Moore of Kansas, McCarthy of New York, Baca, 

Lynch, Miller of North Carolina, Scott, Green, Cleaver, Bean, 

Klein, Wilson, Perlmutter, Foster, Carson, Minnick, Adler, 

Driehaus, Kosmas, Himes, Maffei; Bachus, Castle, Royce, Lucas, 

Manzullo, Jones, Biggert, Capito, Hensarling, Neugebauer, Price, 

Posey, Jenkins, Lee, Paulsen, and Lance. 

The CHAIRMAN. This hearing of the Committee on Financial 

Services will come to order. 

We will be having this hearing today and one tomorrow—well, 

actually, this is the last of the general hearings that we will be 

having on this subject. Tomorrow, we will begin legislative hearings because we will have a hearing tomorrow on the legislation 

submitted by our colleague, Mr. Paul of Texas, which is a piece of 

legislation dealing with auditing of the Federal Reserve. 

And we are concluding today, and one topic that has been a very 

significant concern is that there is universal dislike of the doctrine 

of ‘‘too-big-to-fail’’ and even more, the practice of ‘‘too-big-to-fail.’’ 

Unfortunately, there does not appear to be a single, simple solution 

to it. Passing a statute that says nobody is ‘‘too-big-to-fail’’ doesn’t 

resolve the problem. 

One of our major goals in drafting legislation has been to come 

up with a series of measures that will avoid our facing that situation of ‘‘too-big-to-fail.’’ We will try to keep institutions from being 

so overleveraged that they are likely to fail. We will try to prevent 

imprudent decisions, for instance, that come from 100 percent 

securitization that come from derivatives that are overly leveraged 

without sufficient collateral. We will give some collection of Federal 

agencies the authority to step in when it appears that institutions 

or patterns of activity are being systemically threatening and order 

containment of these activities; and we will have, what I guess I 

am destined to have to continue to refer to as the ‘‘resolution authority’’ which, in English, is the ‘‘dissolution authority,’’ the ability 

of regulators to step in and put an institution to death without the 

kind of tremors that occurred or will occur today. 

2 

Now there does appear to be broad agreement, I think, in the 

committee on all sides about those goals. How we do them we will 

differ about. But it was clear yesterday that no one thinks that the 

current choice of straight bankruptcy or nothing is workable for the 

institutions. We have to come up with a method of resolving. We 

have done that, and we shouldn’t deny ourselves the regular sum 

successes. Where insured depository institutions are involved, we 

have a system that works pretty well. 

Wachovia is a pretty big institution. It failed. This didn’t cause 

systemic disruption. It wasn’t good for the people who were there. 

Other insured depository institutions have failed, and we have 

been able to deal with that. We need to extend that. 

On the other hand, non-depository institutions, Bear Stearns, 

Merrill Lynch, AIG, and Lehman Brothers all failed, and all were 

dealt with—each of these was dealt with in a different way and 

none were satisfactory to anybody, as nearly as I can see. A forced 

takeover of Merrill Lynch by Bank of America, the negative consequences of that are still reverberating. 

Paying nobody in the case of Lehman Brothers, none of the creditors, and causing, according to the Administration officials at the 

time, a terrible shock to the system; paying everybody in AIG, 

which no one, except the people who got paid, thinks was a good 

idea now. 

And Bear Stearns, which was the smallest of them and actually 

was probably handled in the least disruptive way but still because 

it was that hot caused some problems. 

So one of the things we expect people to address today, I hope 

they will address today, is what combination of measures we can 

take to get rid of the doctrine of ‘‘too-big-to-fail.’’ 

There was one proposal that came from some within the Administration that we would have a list of the institutions that would 

be considered ‘‘too-big-to-fail,’’ a list of the systemically important 

institutions so that we could deal with them, but the general view 

was that would be considered to be the list of those ‘‘too-big-to-fail,’’ 

and what the Administration thought would be a scarlet letter, 

would instead be a license to have people invest with you because 

they would think they were protected. 

So as I said, it is a high priority for this committee to deal with 

that and to have as nearly as it is humanly possible, a banishment 

from people’s minds. 

I will say this. I am resigned to the fact that cultural lag is one 

of the great constraints on what we do. And I accept the fact that 

until we reach the point where a large institution is put to death 

without there being ‘‘pay everybody’’ or other inappropriate compensations, people won’t believe us. We can arm the regulators to 

do this, we can arm people to do it, and I accept the fact that not 

until it is done will people believe it. 

But I will say this: When people are skeptical, listen to the members of this committee and our colleagues. We will give the regulators the power to step in and make it clear that no one is ‘‘toobig-to-fail,’’ that failure will eventuate, that it will be painful for 

those involved. There will be no moral hazard, no temptation to get 

that big. Any regulator who failed to use that power in the foreseeVerDate Nov 24 2008 16:54 Apr 06, 2010 Jkt 054869 PO 00000 Frm 00006 Fmt 6633 Sfmt 6633 K:\DOCS\54869.TXT TERRIE
3 

able future will, I think, feel a uniform wrath from this place. So 

I would hope that people would be a little less skeptical. 

We are not going away. The country’s anger about this isn’t 

going away. So we aren’t just setting up the tools; we are arming 

ourselves in a way that I think will be very effective. 

The gentleman from Alabama is now recognized for 5 minutes. 

Mr. BACHUS. I thank the chairman, and I agree with him that 

the problem of ‘‘too-big-to-fail’’ is one of the most pressing and contentious issues of the regulatory reform and debate. And how that 

is resolved I think will go a long way to moving regulatory reform 

ahead. 

Chairman Volcker, we know you as a gentleman and also someone whose opinion we respect very much. So we welcome you to 

this committee hearing. And I know you share some of the same 

concerns that the chairman shares and that I share and that most 

of our colleagues share. 

The chairman yesterday in the hearing with Treasury Secretary 

Geithner identified the ‘‘too-big-to-fail’’ problem as the one that 

most aggravates people in this country. And I agree with you, 

Chairman Frank, it not only aggravates them, it outrages them on 

many occasions. 

The American taxpayers are tired of paying for Wall Street’s mistakes, our guaranteeing their obligations. They see something 

manifestly and something wrong with a casino environment in 

which high rollers pocket the profits, often measured in millions, 

if not billions, of dollars while the taxpayers pay off the losses. 

The American people are justifiably outraged by a ‘‘heads I win, 

tails you lose’’ approach. When we designate 10 or 20 of our largest 

financial institutions as ‘‘too-big-to-fail,’’ we endorse a financial 

marketplace in which a handful of enormous financial institutions 

are supported by the promise of government-engineered, taxpayerfunded bailouts. 

We also pull people in, assuming they will be saved and assuming there is a guarantee. 

The time has come for every member of this body to reject once 

and for all the concept of taxpayer bailouts of these so-called ‘‘toobig-to-fail’’ institutions. Equally important is the fact that in concept and in practice, ‘‘too-big-to-fail’’ necessarily creates a much 

larger universe of companies and businesses which are deemed unworthy and too small to save. To establish, as law, such a disparate, inequitable, and discriminatory treatment not only should 

offend our sense of fair play and justice, its elitist operation should 

be rejected out of hand as contrary to our democratic principles. 

The Administration wants to codify a permanent bailout authority with its proposal to create a resolution authority. It really is a 

permanent TARP administered by government bureaucrats with 

even less accountability than was present in the current incarnation of TARP. The beneficiaries of the Administration’s plan are not 

the American people or the vast majority of small- and mediumsized companies and businesses that choose not to engage in the 

kind of risky financial activity that led to the financial market collapse. The more responsible individuals of the institutions and inevitably the taxpayers will pay for the bailouts but they will not 

benefit. 

4 

Indeed, just yesterday, in testimony before this committee, 

Treasury Secretary Geithner declined repeated invitations to rule 

out future taxpayer-funded rescues of systemically significant 

firms. In response to my question about taking assistance to these 

firms off the table, Secretary Geithner compared such an action as 

abolishing the fire station, which I took to mean he would not 

agree to stop bailouts. And when asked repeatedly by Congressman 

Brad Sherman, if the Secretary would accept even a trillion dollar 

limit on bailout authority, Secretary Geithner said, ‘‘I would not.’’ 

In conclusion, by contrast, Republicans have offered a workable 

alternative to the bailout status quo. In addition to curtailing the 

Fed’s authority to bail out individual firms, Republicans support 

enhanced bankruptcy for failed nonbank financial institutions similar to the authorities that the FDIC has for banks. By sending a 

clear, credible signal to the marketplace that failed nonbank financial firms will face bankruptcy and need to plan accordingly, and 

the people who do business with them, the Republican plan restores market discipline, mitigates moral hazard, and protects taxpayers. 

Mr. Chairman, no institution should be ‘‘too-big-to-fail.’’ Institutions can and should fail if their bad decisions render them insolvent and they cannot compete in the marketplace. To pretend otherwise is to weaken the foundation of our economic system. 

The better question is, will we have the courage to do the right 

thing, and reject the Administration’s effort to move us to a system 

of gigantic but weak banks kept on—well, that is it. And these are 

real questions. 

I thank the chairman, and I also thank the former Chairman of 

the Fed for being with us today. 

The CHAIRMAN. The gentleman from Georgia is recognized for 3 

minutes. 

Mr. SCOTT. Thank you, Mr. Chairman, and welcome, Mr. 

Volcker. 

We are at a juncture in our dealing with this in terms of putting 

the regulatory reforms to—I think at the same time do a little 

check on our record going forward of how well what we have done 

and is it doing the job? 

The American people are registering some great concerns. Poll 

after poll has indicated that there is a—while Wall Street and 

those at the top appear to be saying that this economy is changing, 

we are bottoming out. That is not so on Main Street because we 

have another set of parameters that are working there. 

And I would like to get your opinions on—I have a great deal of 

respect for you and your history and your knowledge. But I think 

as we look at this issue, we need to be concerned about any variations of what we would refer to as a double dip recession. 

There are people who are still expressing concerns over the economy and problems that will loom greater. I am particularly concerned, Mr. Volcker, about unemployment. The issue in our focus 

really needs to be on jobs now because if we don’t get to the bottom 

of that we gradually begin to lose the faith of the American people. 

The issue needs to be on jobs, the issue needs to be on our banks. 

For some reason, with all of the money we have given them, with 

the bailouts we have given them, with many of them going back 

5 

to their ways of directing bonuses and huge salaries, there is a 

hypocritical nature that is setting in because at the same time, 

these banks are not lending. So if you are not lending, especially 

to small businesses, they are going out of business. They are the 

ones that created the jobs. 

So I think as we go forward with our regulatory reforms we have 

to look at it with a very jaundiced eye and see as we put these regulatory reforms in place, what more can we do to prime the pump 

to get money flowing out into the communities. 

The other area of great concern to me—and certainly to my folks 

down in Georgia—is a record number of bank closures. And as we 

look at these regulatory reforms, one size does not fit all. What is 

the future of those small community banks that basically do the 

lending, that are the foundations in many of our smaller communities? Those are the banks that are being closed left and right. We 

lead the Nation in Georgia in those bank closures, and a part of 

the reason is they can’t get the capitalization. 

So I think as we go forward I would be very interested to hear 

some of your concerns on giving us a scorecard, giving us a report 

card. We have been at this now for basically a year. This thing 

happened a year ago. We have been moving at it, and I think it 

is about time to get a little report, and I would be interested to 

hear your comments on that. 

The CHAIRMAN. The gentleman from Delaware is recognized for 

11⁄2 minutes. 

Mr. CASTLE. Thank you, Mr. Chairman. I actually do not have 

an opening statement. I don’t know if the ranking member wanted 

to add to his time. 

The CHAIRMAN. I was given a list by the minority. I wasn’t trying 

to draft you. 

Mr. CASTLE. I will yield back my time, maybe in the hopes of actually hearing a witness. 

The CHAIRMAN. The other two listed aren’t here. I have 2 minutes from Mr. Green, and we can proceed. The gentleman from 

Texas is recognized for 2 minutes. 

Mr. GREEN. Thank you, Mr. Volcker, for being here. 

Mr. Volcker, sir, you are a sage, and we welcome your attendance. I eagerly anticipate what you have to tell us. You have shepherded this country in some very difficult times, and I think you 

should be commended for your history of being there when your 

country needed you. 

I want to concur with the ranking member when he talks of ‘‘toobig-to-fail’’ because quite candidly, I agree. ‘‘Too-big-to-fail’’ is the 

right size to regulate, but it is also the right size to prevent from 

becoming ‘‘too-big-to-fail,’’ and it is the right size to put in a position such that we can wind it down without costing the taxpayers 

any dollars. 

The idea is not to bail out ‘‘too-big-to-fail,’’ it is to put those that 

may be ‘‘too-big-to-fail’’ in such a position that we can wind them 

down and not allow another AIG to prevail. That is what it is really all about. 

We also want to do this. We don’t want to put ourselves in a position where we are designating by way of a list. We want to regulate such that we don’t have to designate. As a company, AIG 

6 

starts to become so large that it may fail, we want to start the regulatory process such that it won’t get there, and if indeed it does 

by some accident, then we want to have a way to do what we do 

with banks in this country, and that is wind them down and not 

cost the taxpayers any dollars. 

Finally, this: There is, I believe, a desire on this side to work 

with persons on the other side to accomplish this mission. I am 

willing to work with the ranking member and anyone else who 

would like to put us in a position such that we don’t ever have to 

deal with another ‘‘too-big-to-fail,’’ such that we will always have 

that safety net to protect the American economy. 

Nobody was bailing out AIG. We bailed out the American economy, and in fact we were bailing out the economy on a global basis 

as well. 

I thank you for your sage advice and look forward to hearing 

from you. 

I thank you, Mr. Chairman 

The CHAIRMAN. Mr. Volcker, we thank you for joining us. Mr. 

Volcker has a very long list of titles which, under the 5-minute 

rule, I could not finish reading even at my speed. But we are very 

pleased that he came up today, especially to share his experiences 

with us. 

Please, Mr. Volcker. 

STATEMENT OF THE HONORABLE PAUL A. VOLCKER, FORMER 

CHAIRMAN OF THE BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM 

Mr. VOLCKER. Thank you, Mr. Chairman, and members of the 

committee. 

It has been a long time since I have been in the room. It is a 

familiar room, and I appreciate the opportunity because you are 

dealing with particularly important problems. 

Let me just say in a preliminary way, as you know, the President 

has said—as Mr. Geithner has said, if the market betters, the economy steadying, there has been some feeling of relaxation about 

some of these issues and some feeling of maybe just return to business as usual, return to making money, outside amounts of money, 

certain resistance to change. And from the comments that you have 

made, I am sure you will not respond to that by slowing down, but 

rather proceeding with all deliberate speed to get this right. It is 

really important. 

It is an incredibly complicated problem, and I want to concentrate on mainly the aspect that you have already emphasized. 

But before I do so, let me acknowledge that an awful lot of work 

is going on in various aspects by the regulatory agencies. They 

have taken important initiatives dealing with capital and liquidity, 

and they are working toward compensation practices. 

And I would point out it is relevant with the G–20 meeting that 

a lot of what needs to be done really does require a certain consistency internationally because these markets are global and that just 

adds another complication. You can’t have capital requirements, for 

instance, for American banks that are way out of line of capital requirements elsewhere, to take an easy example. But that is an additional complication. 

7 

But the central issue that I want to talk about really is what you 

have already said, moral hazard in financial markets. You know 

what that is all about. I don’t have to explain it. But I would note 

that this is front and center because the active use of long-dormant 

emergency powers of the Federal Reserve together with extraordinary action by the Treasury and Congress to support non-bank 

institutions has extended this issue well beyond the world of commercial banking. ‘‘Too-big-to-fail’’ has been an issue in commercial 

banking; now it is an issue for finance generally. 

I think it raises very important substantive questions. It raises 

some administrative questions that I want to touch upon, too. It 

raise legal questions. And one of those questions is the role of the 

Federal Reserve, which I will return to. 

In dealing with that, I submitted a long statement which deals 

with all of this in more detail. Just to cut to the chase, you know, 

the Administration has set out a possible approach, which I feel 

somewhat resistant to or more than somewhat resistant because I 

think it does suffer from conceptual and practical difficulties. 

Now what they suggested is setting out a group of particular institutions that, in their judgment, would pose a systemic risk in the 

event of failure. 

I don’t know what criteria would be used precisely in determining these institutions because the market changes, it is not always directly relevant to size. That in itself would be a great challenge. But I think it is fair to say that the great majority of systemically important institutions are today, and likely to be in the future, the mega-commercial banks. We are talking about in the center of things, the commercial banking problem. That is true here, 

that is true abroad, and in this case we already have an established safety net. The commercial banks that are at the heart of 

the problem are already subject to deposit insurance, central bank 

credit facilities, and other means of support. 

I have a little hobby of asking friends and acquaintances when 

they talk to me with experience in financial markets, I say, Now, 

outside of commercial banks, outside of insurance companies, 

which I would say parenthetically I hope better regulatory systems 

will be developed, maybe not as part of this legislation but next 

year. Apart from commercial banks and insurance companies, how 

many genuinely systemically important institutions do you think 

there are in the whole world, financial markets. I will tell you the 

answer I get consistently is somewhere between 5 and 25. The universe is not huge when you are talking about non-banking, non-insurance company, systemically important institutions. 

Now, if you extend this idea of developing a group of systemically 

important institutions for your own banks, then the moral hazards 

problem has obviously increased because the connotation is if they 

are systemically important, officially identified, they fall in the 

same category as banks, and the government better be especially 

alert to dealing with them in case of difficulty. 

Now, it does seem to me a better approach would be to confine 

the safety net to where it is, that is to commercial banking organizations. And as part of that organization now and even more so in 

the future, the banking supervisors would, I think, as a natural 

8 

part of their responsibility, be especially attentive to the risks 

posed by the largest banking organizations. 

So they ought to have the discipline to insist upon best practice 

among those organizations, not just in the United States but generally worldwide by agreement. We have to agree to more adequate 

capital, responsible cooperation with other supervisory concerns, 

and leave it as ambiguous as you can as to whether government 

assistance would ever be provided in these emergency situations. 

Now that approach recognizes, I think, the reality that the commercial banks are the indispensable backbone of the financial system. Mr. Scott talked a bit about the importance of community 

banks, regional banks and credit. That is part of it. They also act 

as depository, they take care of the payment system, they offer investment advice, they maintain international financial flows. These 

are all essential services that justify a special sense of protection. 

Now, when you get to what are called capital market activity, a 

lot of trading, hedge funds, private equity funds, a lot of other activity, credit default swaps,CDOs, CDO squared, all that stuff, it is 

a different business. It is an impersonal position. It is a trading 

business, and it is useful. We need strong capital markets, but they 

are not the same as customer-related commercial banking functions 

and they do have substantial risks. Banking itself is risky enough. 

You add capital market operations to that, you are just 

compounding the risk. And I would note it is—they present conflicts of interest for customer relationships. 

When a bank is rendering advice and maybe investment advice 

to a company, it is rendering underwriting services and then it is 

turning around and creating in those same activities, does it bias 

the customer advice? Does it undercut the customer relationship? 

Is it consistent with the customer relationship? Those problems are 

enormously difficult, and I think demonstrably have been a big distraction for bank management and led to weaknesses in risk management practices. 

So I would say the logic of this situation is to prohibit the banking organizations, and by ‘‘banking organizations,’’ I am talking 

about the bank and its holding company and all of the related operations. I would prohibit them from sponsoring or capitalizing hedge 

funds, private equity funds, and I would have particularly strict supervision enforced by capital and collateral requirements toward 

proprietary trading in securities and derivatives. 

Now, how do you approach all of this and deal with the big 

nonbank that might get in trouble? 

That I think is where this resolution authority comes into play. 

Can we have a system, knowledge as to what we have with banks, 

a government authority can take over a failed or failing institution, 

manage that institution, try to find a merger partner if that is reasonable, force the end of the equity if there is no equity really left 

in the company, ask debt holders, negotiate with debt holders to 

exchange dept for equity to make the company solvent again, if 

that is possible. If none of that is possible, arrange an orderly liquidation. And none of that necessarily involves the injection of government money and taxpayer money but it provides an organized 

procedure for letting down what I hope is a very rare occurrence 

of the failure of a systemically important nonbank institution. 

9 

Now who has all of this authority and how are the general regulatory and supervisory arrangements rejiggered, if at all, and I do 

think they do need some rejiggering. I would mention one aspect 

of that. The Treasury itself has correctly identified the need for 

what I call an overseer. Somebody, some organization that is responsible not just for individual institutions but responsible for 

surveying the whole financial system, identifying points of weakness, which may or may not lie in an individual institution. It may 

lie in new trading developments. But take two obvious examples. 

Who was alert to the rise of the subprime mortgage a few years 

ago? It may not have appeared to have presented a risk at the time 

for an individual institution, but it sure in its speed of increase and 

its weakness presented a risk to the whole system. Somebody 

should have been alerted to that. Who has been looking at credit 

default swaps and wondering whether they reach the point of creating a threat to the system? And the answer is basically nobody 

and not very well. And somebody should have that responsibility. 

The Treasury has been very eloquent on that point. They have 

suggested a kind of council or regulatory agency headed by the 

Treasury. I frankly don’t think that is a very effective way to do 

it because getting a bunch of agencies together and getting to 

agreement on anything, and they all have their particular responsibilities, their particular constituencies are a very tough business. 

So if you do it that way you have to be a Treasury. You have to 

build up a new staff in the Treasury. 

The alternative is the Federal Reserve. I spent a lot of time in 

the Treasury so I am not particularly prejudiced of the Federal Reserve, I would argue, but I think this is a natural function for the 

Federal Reserve. I think consciously or unconsciously we have 

looked to the Federal Reserve. Whether the responsibility has been 

discharged effectively or not, there is a sense that the Federal Reserve is the agency, the major agency to be concerned with the 

whole financial market, and there is no doubt when you get in 

trouble, when anybody in the financial markets gets in real trouble 

they run to the Federal Reserve. 

The Federal Reserve has the authority, the money. It presumably 

has the experience and capabilities, and I think that simple fact 

ought to be recognized. It is a very important institution. It seems 

to be logical that they ought to be kind of assigned explicitly what 

I always thought they had implicitly, a kind of surveillance of a 

whole system. 

[The prepared statement of Mr. Volcker can be found on page 93 

of the appendix.] 

The CHAIRMAN. Obviously, this has been very helpful on a broad 

range. 

I want to talk about one issue that you care a lot about and in 

which your experience really gives you a great deal of authority. It 

hasn’t gotten much attention, and that is the concern you have 

about the problems raised by proprietary trading within the banks, 

the bank holding companies. You have some fairly strong views 

about restricting that. You mentioned it, but I would ask you to 

elaborate on that because I think that is, as I look at it, is one of 

the important topics. It hasn’t gotten discussed much. I know it 

10 

was raised by some others, there is Mr. Levitt, Ms. Donaldson who 

had that in their—I think in their investors’ list of concerns. 

So is it feasible to just ban it, or how would you deal with the 

question of proprietary trading by the institutions? 

Mr. VOLCKER. When I comment that I think banks should be restricted in their, what I think of as truly capital market impersonal 

activity, it is pretty easy to talk about hedge funds and equity 

funds because they are identifiable institutions. Proprietary trading 

is not an identifiable institution in the same way, although many 

financial institutions will have a proprietary trading desk. That is 

the way they label it themselves. 

The CHAIRMAN. That is the way they have labeled it, before you 

get through. That is the way it has traditionally been labeled by 

some, but by the time you are through testifying, they will probably have a new name for it. 

Mr. VOLCKER. However it is labeled, I think conceptually there 

is a difference and can’t be denied that a company, a bank, or 

whatever it is, is trading actively in the market, the securities that 

bear no customer relationship, no continuing interest. They are interested in making a profit on a particular trade or making a speculative profit. And that activity, in some institutions anyway, has 

become increasingly important and it is inherently risky, it inherently presents a conflict of interest. It inherently is hard to manage. Some people are good at it, some people are not so good at it. 

It takes a lot of concentration. 

How do you deal with it because there is some perfectly legitimate trading that goes on in a bank or financial institution, and 

it is an outgrowth of their customer interest. If they are underwriting securities and lending securities for a particular customer, 

they may want to trade in those securities that they have underwritten, to take a simple example. And if they are going to do some 

trading, they have to maintain a certain liquidity, a certain staff 

that is able do that. How do you distinguish between a kind of routine, low-level trading activity and proprietary trading as an active 

part of the money making business of the firm? 

It is partly a matter of judgment and partly a matter of volume, 

but I think what you have to rely upon is supervisory discretion. 

You tell the supervisor that part of the concern of banking regulation should be cutting down on this kind of speculative activity, 

trading activity. And the supervisor certainly has the authority to 

arrange capital requirements that could be increasingly severe as 

the trading activity increased, and they could take other supervisory steps to assure that trading activity is in reasonable alignment with the customer orientation of the banks. 

The CHAIRMAN. Thank you. So in essence, this is something that 

could be handled by underlining the supervisory authority, not by 

some kind of statutory bar but in the statute make it very explicit 

the grants of authority. 

Mr. VOLCKER. I don’t think you can write a bright line law to say 

what is proprietary and what isn’t. 

The CHAIRMAN. Just to be clear, because in the legislation we 

have been contemplating, that is already clearly identified as one 

of the tools that could be used in an institution which is being 

treated as a systemic risk. But your point is that it ought to be a 

11 

generic authority and that it is not a matter of the systemic risk 

but is a conflict in other ways. 

On the question of the death panels, which is otherwise called 

the resolving authority—‘‘death panel’’ has such a wonderful ring 

to it. Just because it is entirely inaccurate in one area, it doesn’t 

mean it should pass from the debate. I think we ought to—we will 

save the phrase and use it where it makes some sense, and that 

is the resolving authority. 

On the question about whether or not they should—I am out of 

time. So let me pose the question and you can elaborate on it. 

There is obviously a big debate about whether or not public funds 

ought ever to be available in resolving the mess left behind by one 

of these institutions. If you could answer it briefly now and elaborate in writing, I would appreciate that. 

Mr. VOLCKER. In terms of the resolution authority, which would 

give extraordinary authority to whatever agency is designated to 

control the institution, I do not think it is desirable to provide in 

that same arrangement authority to lend money or to provide 

money because that will encourage the ‘‘too-big-to-fail’’ kind of syndrome. 

So if you give it strong enough authority to control the institution and to manage such things as forcing, negotiating or forcing, 

whatever word you want use, let us say a conversion of debt into 

equity, hopefully you would avoid the need for injecting money and 

the stockholder would lose, the creditor might lose, and the creditor 

should be concerned about whether he is going to lose. 

Now, I would also say—I guess I didn’t mention in this preliminary statement—that if the overseer, for instance, identified an institution or several institutions as being so large and so extended 

as to present a real risk, there would be some residual authority 

to place capital requirements on that institution, leverage requirements, maybe liquidity requirements. But that doesn’t involve government money. 

The CHAIRMAN. I appreciate it. 

The gentleman from Alabama. 

Mr. BACHUS. I thank the chairman. 

Chairman Volcker, Secretary Geithner declined to rule out any 

more government bailouts of troubled institutions. And I think 

what we usually assume by that, we are not talking about the 

FDIC’s traditional power to resolve depository institutions. He declined to do so. 

Do you think that is a mistake? 

Mr. VOLCKER. I would answer that question this way: I think you 

have the emergency power of the Federal Reserve, section 133. I 

am not proposing that be abolished. I have mixed feelings about 

that because I squirm when it is used, frankly. We spent a lot of 

time trying to avoid its use because we knew if it ever got used it 

would become a precedent for the future, and if we used it for New 

York, people will say we should use it for Chicago or the State of 

California. And we didn’t use it for Chrysler 20 years ago, whenever it was. Well, demands arose because we didn’t want to set the 

precedent of using it. 

12 

Well, our precedent has been set now in very strange circumstances, very radical circumstances. So understandably, it has 

been set. 

But I think we want to develop attitudes and policies that say 

this is extremely extraordinary. It is part of the apparatus of the 

bank safety net, although it could be extended beyond that. I don’t 

think I would promote that, but I wouldn’t take it away. 

Mr. BACHUS. We have sort of scrambled the egg. We have the 

commercial banks and the investment banks. Last September, 

some of the investment banks came under the safety net— 

Mr. VOLCKER. Right. 

Mr. BACHUS. —I think you have indicated, and I think many of 

us realize there is a difference in what was a commercial bank, a 

lending facility, and an investment or trading bank. In fact, if you 

look at the two investment banks, the two largest ones, their last 

report showed substantial profits from trading, which indicates a 

trade that they are still basically—their profits are being derived 

from trading derivatives and some of the things that you described. 

Do we go back to that system? 

Mr. VOLCKER. Well, we can have investment banks again. I guess 

there is only one big investment—well, two, one very active in trading, the other less active in trading. But I don’t want those investment banks brought under the general safety net. There ought to 

be a distinction. And if they want to go out and do a lot of trading 

and that is a legitimate function, if they want to do whatever they 

want to do in the financial world, okay, but don’t bring them under 

the safety net. 

Mr. BACHUS. And if they fail, they go into an enhanced— 

Mr. VOLCKER. If they fail, you use the resolution that is already 

as necessary. 

Mr. BACHUS. Let me ask you another question, and I really have 

two. 

One is I just want to acknowledge something and see—we did 

have—some of our failures were a result of the derivative trading 

and instruments that didn’t exist 20 years ago. And you have 

talked about that. 

You had another problem and that is depository institutions that 

went out and bought subprime affiliates that were not regulated at 

all. And I think that was a tremendous threat to the system. 

Mr. VOLCKER. Absolutely. 

Mr. BACHUS. Would you comment on that? You could go down 

the list of banks. 

Mr. VOLCKER. The subprime phenomena is interesting because, 

you know, I am not in the middle of the markets these days, and 

I wasn’t conscious of the speed in which they were increasing. They 

were a phenomena of practically a standing start to a trillion, trillion and a half dollar business in the space of 3 or 4 years that 

arose very rapidly, and apparently there was no clear sense in the 

regulatory community of the potential threat that this posed; and 

it probably, because they were obscured by the same thing that obscured bank managements and others, that we had some fancy financial engineering here that somehow presto magic, the risks go 

away if we put it in a big package and get a good credit rating, 

which is what they were getting. 

13 

But I think that was a failure in risk management, a failure of 

the credit rating agencies, but it also was a failure of the regulators 

that weren’t on top of this. And this arose not in the traditional 

banks. They may have participated, and they did participate in the 

end, but it arose in kind of fringe operations, but nobody sat there 

and said look, this is a potential threat if it increases at this rate 

of speed to the financial system. Nobody that I know of. Somebody 

should have been raising that question. 

And in my view, you know, as the Federal Reserve was already 

given clearance to do it, they are in the best position to do it. 

Mr. BACHUS. There were loans that banks couldn’t make. They 

wouldn’t make it under their own underwriting standards. They 

wouldn’t originate them in the banks so they went out and bought 

an unregulated subprime lender to make loans that they would 

never make. 

The CHAIRMAN. The Federal Reserve was given that authority in 

1994 because that is exactly the authority that Mr. Bernanke invoked in 2007 when he did finally promulgate rules, but that was 

unchanged from the authority that existed from 1994. 

The gentleman from North Carolina. 

Mr. WATT. Thank you, Mr. Chairman. 

Chairman Volcker, thank you for being here. I have been on this 

committee now for 17 years and there seem to be two acknowledged gurus in the financial services industry. Alan Greenspan was 

one. When he spoke, I never understood a darn thing that he ever 

said but he seemed very eloquent in his positions. And you are the 

second one, and I have heard you speak 3 times now. 

I understand, I think, what you are saying, but it seems to me 

that your testimony this morning and the other times that I have 

heard you address the systemic risk issue leads us back exactly to 

where we are right now. 

If we didn’t do anything on systemic risk, we already have regulation of—we have all of the banks who are currently under regulations, and I am just trying to understand how—what you are proposing with respect to systemic risk differs from what we have 

now. That is the one question. 

And I am going to put both of them out there and then I will 

shut up and listen to you talk. 

The second question is, you have done a lot of work. I have read 

your report on the international monetary situation, and you led a 

group or participated in an international group that looked at this 

from an international perspective. And I didn’t hear you address 

any of that this morning. I know we are here to deal with our domestic situation, but how do you see this being intertwined in the 

systemic issue being addressed on a worldwide basis unless we address it somehow more aggressively than you have proposed on the 

domestic side? 

Mr. VOLCKER. Two relevant questions. 

On the first question, I am not recommending anything particularly different so far as banks are concerned that already have 

lender of last resort, they already have deposit insurance, and we 

have some history of intervening with Federal Reserve money or 

government money in the case of failure of very large banking institutions. So that I take is a given. And that is common around 

14 

the world. There isn’t a developed country that doesn’t have a similar system to protect banks because banks are, I think, the backbone of the system. 

Now it is also true in the United States the relevant importance 

of banks has declined in terms of giving credit because more of the 

credit creation has been going into securities, which is the province 

of the capital market. 

What is different is the situation has changed where some of the 

benefits anyway, the safety net, has been extended outside the 

banking system. That is what I want to change. 

But you can’t change it just by saying it is not going to happen 

because you are going to have problems. You have to develop some 

other possibilities and arrangements to minimize the chances of a 

crisis. So that is what we are proposing. 

Mr. WATT. So basically what you are proposing is taking some 

of the people who are now covered under the FDIC, have some kind 

of implicit backing and separating them out and making it clear 

that they don’t have any kind of implicit backing. They are just 

going to be allowed to fail. 

But I don’t understand how that squares with your position that 

you retain, that the Fed retain emergency authority. Why wouldn’t 

they still then in emergency situations continue, now that the 

precedent has been set, to use that emergency authority rather 

than whatever implicit authority? 

Mr. VOLCKER. That is a legitimate question. Do you want to take 

the emergency authority away from the Federal Reserve and give 

it to nobody? I am not quite that radical at this point, given what 

we have been through. But it is a reasonable question. You are 

quite right, what I am trying to do is diminish the sense that it 

is there and available for nonbanks. 

Now on the international side, if what you say is true, I deal a 

little bit with it in my long statement I have issued to the committee. And there are some issues where international cooperation 

will be clearly necessary and, in fact, it has a pretty good history 

so far and that is in the area of capital requirements. 

There already is a high degree of uniformity in capital requirements. They are going to have to be reviewed, they are being reviewed nationally, they are being reviewed here and they are being 

reviewed in the U.K., but there is a body at the BIS, separate from 

the BIS, but a joint body of regulatory authorities to consider that 

issue. And they also have now extended their authority, encouraged by heads of state, to consider other matters of banking supervision and regulation where international consistency is important. 

And there are quite a few of those areas, and they have done quite 

a lot in trying to regularize practice. It is a big challenge, but it 

is important. 

On some of these other things, it is equally important. I think 

you already have a framework where practically all big banks or 

big countries with relevant banking systems already have a safety 

net. That is different in detail but it is a common factor. 

Now we have to deal with how all of these countries deal with 

their nonbanks. And I think some consistency there is important. 

The other really big financial center, as you well know, is London. And these matters are under intense consideration by the regVerDate Nov 24 2008 16:54 Apr 06, 2010 Jkt 054869 PO 00000 Frm 00018 Fmt 6633 Sfmt 6633 K:\DOCS\54869.TXT TERRIE
15 

ulatory authorities in London. And at the end of the day, I think 

it is important that there be some consistency between what we do 

here and what they do in the U.K., just as a start. And I think that 

is quite possible. It won’t be perfect, but that is the way we started 

actually with capital requirements. We got an agreement between 

the U.K. and the United States, and then it got extended around 

the world. So maybe we can duplicate that. 

The CHAIRMAN. Now I am going to try again. The gentleman 

from Delaware. 

Mr. CASTLE. Thank you, Mr. Chairman. 

Mr. Volcker, like probably everybody else on this committee, I 

have a tremendous amount of respect for your comments on the 

economy and this particular problem of banking in general. I want 

to thank you for being here. I have some questions concerning the 

Federal Reserve itself. 

Let me throw a couple of things out and you can respond to 

them. 

As we all know, the Federal Reserve has great responsibilities in 

the economy today—you know that better than any of us—all the 

way from monetary policy to interest rates, the emergency powers 

that you have discussed here today, and consumer protection. 

The consumer protection may, in accord with whatever we do 

here in Congress, change and go over to be handled otherwise. But 

other than that, the remaining powers would be there. 

You have suggested strongly that it is the best agency. You have 

suggested in your writing—I am not sure if you spoke it or not— 

appointing someone else who would have this responsibility confirmed by the Senate, etc., with respect to the systemic risk, etc., 

and I understand that. 

But my question is, is the Federal Reserve taking on too much 

responsibility with respect to the monetary circumstances of this 

country and its policy, one, and then the second question is should 

there be or have you recommended someplace—I haven’t seen it— 

some sort of a council that would meet with whomever the appointment of the Federal Reserve person would be to help guide this? 

And I am thinking about the other banking regulators who seem 

to have a great deal of knowledge and input. Would they serve on 

some sort of group that would advise or would all that be informal, 

or would they be formally members? 

I would be interested in your comments about the Federal Reserve’s ability to manage this kind of emergency at this point. 

Mr. VOLCKER. Well, obviously, a very relevant question, is the 

Federal Reserve proposing or are other people proposing as things 

exist? Does the Federal Reserve take on too much? I don’t think so. 

These are big responsibilities. But as I see it, there is a close relationship between banking and financial supervision and monetary 

policy. 

I don’t think monetary policy should be a matter of domain of a 

few economists sitting in a room deciding on the basis of various 

theories which are probably controversial, and what interest rates 

should be precisely where, and so forth. That is part of it. But I 

think that process ought to be leavened by knowledge and close 

contact with what is going on in financial markets. 

16 

Now, we have an example of that recently. The Federal Reserve 

was counting on monetary policy, but that got thrown off course 

and the economy got thrown off course completely by what was 

happening in the financial system outside the realm of monetary 

policy. Now, I think the regulators should have been on top of that 

a little better, although they are never going to be perfect. But we 

want to—I think we need a cross kind of fertilization between monetary policy and supervisory policy, myself. 

It is an old concern—go back and you read the history of the Federal Reserve. Marriner Eccles in the 1930’s, who was then the 

Chairman, complained bitterly about the fact that the Federal Reserve didn’t have enough control over supervisory policy because in 

the middle of the Depression, he thought those other banking supervisors were being way too tough on banks and inhibiting bank 

lending. And he thought they were too easy earlier, when the economy was doing well. 

Now, is the Federal Reserve going to do a better job? I don’t 

know. I don’t think they should be the only regulator. But I do 

think they are the logical ones to have this oversight responsibility. 

And I also think, as you mentioned, if the Federal Reserve is 

going to remain in the regulatory supervisory business, I think the 

Congress should reinforce their responsibility by doing such things 

as having a particular Vice Chairman of the Board who is responsible for supervisory policy, and he knows that is his statutory 

function. There is nobody in that position now. The staff is going 

to have to be strengthened and enlarged and various other measures made. 

Now, should there be a council? I have no problem with a council, and I think it would be useful, so long as there is somebody 

who is driving the process and is, in the end, responsible. 

And the Treasury, as I read it, they don’t quite say it this way, 

but I think what it amounts to, at the end of the day, the way the 

Treasury would do it is have the Treasury in that position. And I 

guess the way I would do it is I would have the Federal Reserve 

in that position, because I think it is a part of a natural central 

banking function. 

It is interesting, this is in controversy all over the world, frankly, 

but in the U.K., which has gotten a lot of attention, supervisory authority was taken away from the Bank of England 10 years ago, 

more or less. And then when the crisis arose, they were kind of at 

sixes and sevens as to who was responsible and how the crisis 

arose; how did the regulatory agency—how was that too insensitive 

and why didn’t the Bank of England know what was going on? And 

they had trouble coordinating the effort. And the Treasury got involved, too, as it naturally would, but at one point that was considered best practice: Take the regulation out of the Federal Reserve. 

I don’t think that is a strong opinion internationally anymore, 

after seeing the primary exponent, the U.K.—I can’t say it fell on 

its face, but it didn’t do very well when push came to shove, because the locus of responsibility was not clear. 

The CHAIRMAN. Mr. Volcker, thank you. There is a lot of interest, 

so we are going to have to move on. 

The gentleman from New York, Mr. Meeks. 

17 

Mr. MEEKS. Thank you, Mr. Chairman. Good to see you Mr. 

Volcker. We have been debating something within my office. I am 

going to make a quick statement and then just ask you if, in fact, 

you can give me your opinion on it; that we when we consider the 

issue of ‘‘too-big-to-fail’’ and moral hazard, we are basically trying 

to get firms and their investors to internalize the cost of negative 

externalities that they may present to the system as a whole. In 

other words, we want the capital costs and the capital structure 

and the appetite for the risk to reflect all the costs of the institution, both internally and externally. 

And I think Larry Summers, when he was speaking before this 

committee earlier, said that if a firm is too big to resolve in an orderly manner, it is undoubtedly too big to run in a professional 

manner. In other words, if the senior management of a financial institution cannot present a plan that will convince the public and 

its regulators that it can disentangle and wind down its operations 

in an orderly manner, there is no reason to believe that this same 

management team can run the institution on a daily basis, because 

they themselves don’t fully understand their own company. 

And for this reason, I believe that a properly structured, comprehensive resolution authority is, in fact, the most critical pillar 

to managing the moral hazard of the ‘‘too-big-to-fail’’ and systemic 

risk going forward. And the reason for that is different than what 

has been commonly discussed. It seems to me that the strength of 

the resolution authority is that it makes debt capital markets work 

in concert with regulators, and debt presents multiples of equity on 

financial institutions’ balance sheet and debt holders have the 

power of covenants to manage what they perceive as risk or threats 

to their privileges as debt holders. 

With effective, credible resolution authority, bondholders will 

know that they can no longer rely on the government as an informal insurance policy on their debt. It is this expectation in the past 

that has allowed firms to become ‘‘too-big-to-fail’’ as debt markets 

and every incentive to provide nearly unlimited financing to the 

largest institutions, knowing that the larger it got, the more likely 

it was that the investment would be backed by the government in 

case of institution failure. 

So I think that is the crucial area we are looking at, and I would 

like just to get an idea of what you think in that regard, because 

I think that is absolutely key as we move forward with reform, 

with regulation reform in this particular instance. I would love to 

get your opinion on that. 

Mr. VOLCKER. I agree with the thrust of what you are saying. 

That is the burden of my testimony here this morning is that we 

do need such a resolution authority, for the reasons you described. 

Some of the approaches that the Administration has surrounded 

that with, I don’t agree with. But the basic idea that you need that 

kind of authority is, I think, central. 

Mr. MEEKS. Do you believe that, as a consequence of capital more 

accurately reflecting the full risk of investing in an institution, that 

it will increase with that the institution size and the level of global 

risk? 

Mr. VOLCKER. Well, I hope we can get a realization of that; that 

the institution will be more careful and less risk-prone and less— 

18 

and the financial system and the economy will be less subject to 

their failure. 

Mr. MEEKS. Thank you. I yield back. 

The CHAIRMAN. The gentleman from New York, Mr. Lee, I believe, would be next. 

Mr. LEE. Thank you, Mr. Volcker. It is a pleasure to have been 

listening to you this morning. I appreciate many of your thoughts. 

You touched on a lot of areas and I, like you in many cases, feel 

that you have to be very careful in how much farther we go along 

with expanding the Federal regulation. I think we need to have the 

right type of regulation in place with the right type of authority to 

those—in this case, the Federal Reserve. In many cases, I agreed 

with what you said. 

You touched briefly on the issue when you have banking institutions getting in more riskier-type trades. And in your mind, how 

do you—is there a way to decouple that and ensure we provide solvency to this industry? 

Mr. VOLCKER. Couple that with— 

Mr. LEE. With the banking institutions right now. How do we decouple where they are getting into riskier trading type activities— 

do you have a solution on how we would be able to separate these 

in a logical manner? 

Mr. VOLCKER. Well, I think some of the activities that I am concerned about are clearly enough defined so you can just, in effect, 

either put it in law or have clear that the supervisory authority 

will prohibit it. 

The tricky area is I think trading, which we discussed a little bit 

earlier, because there is a kind of legitimate area of trading that 

a large bank anyway is going to engage in that is, in fact, considerably in the area of customer service. If a customer comes in and 

wants to sell some securities, they ought to be able to sell through 

a bank. And if a bank is going to handle that, it is going to have 

to have some kind of a trading operation, a foreign exchange operation. 

But I think there is a—the borderline is fuzzy, but there is a 

clear distinction between customer-related trading activity and 

pure proprietary trading, which some of the big institutions label 

it that way. They have a proprietary trading desk, separately operated, sitting someplace else, as in the case of— 

The CHAIRMAN. Mr. Volcker, could you speak into the microphone? You have to sacrifice politeness for audibility. So we need 

you to speak directly into the microphone. It is less important to 

be polite than to be audible, so don’t look at who you are talking 

to. 

Mr. VOLCKER. AIG is a good example of what I am worried 

about. It is not a bank, but it should be regulated, I think, naturally. But they had this trading operation, a little trading operation 

that made a lot of money for a while, and it got out of hand, mostly 

credit default swaps. Nobody was much looking at it. No regulator 

was looking at it. 

It is an activity that if, better informed now, if a supervisor was 

looking at it and AIG was supervised—and they should be supervised—somebody should have raised a question. That is an activity 

that had nothing to do with your insurance business directly, or 

19 

out there on a trading operation to make a lot of money, and similarly to profit-making but not to the insurance business. Stop it. I 

mean, that was a clear enough case that you— 

Mr. LEE. I am just bringing up AIG. With the knowledge that 

you have now, in retrospect, going back a year ago, how would you 

have handled this situation with AIG? 

Mr. VOLCKER. It is a complicated situation. They had to make a 

very quick decision about an area that nobody could understand 

the full implications of. The regulators I am sure were not on top 

of this operation in London or Connecticut, or wherever it was 

being operated. And everybody got in over their heads, and they 

did what was necessary in a very disturbed situation to provide 

money. And it has become now, as you know, $150 billion, $180 billion, whatever it is; it is, you know, outrageous. But I understand 

how they got there. That is what we want to avoid. 

And I might say, while it is not on the agenda today, and the 

Treasury didn’t put it on the agenda, I would hope this committee 

would look at the question of national charters for insurance companies and bring them under—at least the big ones—under a 

framework so that something like AIG with similar problems can’t 

arise in the future. I think a lot of the big insurance companies 

would welcome a national charter and the consistency that would 

provide, because—I don’t want to commit them into the safety net, 

but I do think that they ought to be regulated in a consistent way. 

Mr. LEE. Thank you. 

The CHAIRMAN. Thank you, Mr. Volcker. 

Let me just say, for your information, the question of an optional 

Federal charter for the insurance, particularly life insurance, is on 

the committee’s agenda for probably next year. It just would be 

more weight than I think this issue could carry. 

There will be a proposal made by some for a national insurance 

office to do some monitoring. But the question of an optional charter is a very important one. It is a request we get from the international community. There is a lot of resistance to it at the State 

Insurance Commission level here. But I did want to assure you— 

Mr. VOLCKER. I know there is something short of a charter. I 

hope you would go further than what has been proposed. 

The CHAIRMAN. Well, right now—that, right now, is much short 

of a charter. For next year, on this committee’s agenda next year, 

will be the question of a charter, of an optional charter. 

The gentlewoman from Illinois, for instance, has been very much 

interested in that, along with the gentleman from California, Mr. 

Royce. And I have assured them they will get a full hearing. 

But it just, with the agenda this year, complicated by needing to 

deal with the issues from last year—but it is on the agenda. 

Mr. VOLCKER. I am unaware of any other AIGs out there, so 

maybe you are all right at the moment. 

The CHAIRMAN. Well, of course, AIG’s regulator was the fearsome 

Office of Thrift Supervision, and we will be addressing that issue. 

The gentleman from Kansas. 

Mr. MOORE OF KANSAS. Thank you, Mr. Chairman. And, Chairman Frank, I ask unanimous consent that the resolution authority 

proposal by Tom Hoenig, president of the Federal Reserve Bank of 

20 

Kansas City, and his colleagues, as well as two of his recent 

speeches, be entered into the record. 

The CHAIRMAN. Without objection, it is so ordered. 

And, without objection, there will be general leave for any of the 

members or the witnesses to introduce into the record any material 

they would wish to insert. 

Mr. MOORE OF KANSAS. Thank you, Mr. Chairman. 

Chairman Volcker, how do we end ‘‘too-big-to-fail?’’ I don’t know 

if you have seen the recent proposal offered by Kansas City Fed 

President Hoenig and his colleagues. Their proposal on resolution 

authority lays out more explicit rules than the Administration’s 

proposal of how a large financial institution Like Lehman Brothers 

or AIG could be resolved so the debt holders, shareholders, and 

management would be held accountable before taxpayers are asked 

to step in. If you haven’t seen the Kansas City Fed proposal, I 

would like to provide to you a copy and I would appreciate your 

written comments, if you would please. Others suggest that we require the largest financial firms to undergo a regular stress test 

that would have aggregate information publicly released, even in 

good times. I know some have argued the list of these firms should 

remain confidential. But doesn’t the market already know who 

these firms are, based on the last round of stress tests? How do you 

propose we create the right incentives for firms to maintain reasonable leverage ratios and strongly discourage ‘‘too-big-to-fail?’’ 

Mr. VOLCKER. Well, I might say I become aware yesterday that 

a Kansas City bank had made such a proposal, but I haven’t read 

it so I can’t comment on it in detail. 

Mr. MOORE OF KANSAS. I will forward this to you, sir. 

Mr. VOLCKER. I am sure these are all directed toward the same 

problem that we have been discussing; in fact, all these questions 

this morning. How do you reduce the moral hazard problem? How 

do you— 

Mr. MOORE OF KANSAS. Sir, excuse me. Could you pull the microphone just a little closer? I am having a little difficulty hearing 

you. 

Mr. VOLCKER. I said, we have discussed in a number of these 

questions, and my opening statement, how we deal with this moral 

hazard problem. And in all these cases, I think, I believe in the 

Kansas City proposal, this idea of a resolution authority looms very 

large. 

Just how you do that, you are going to find not the easiest drafting problem in the world, because it raises a lot of technical issues 

and legal issues, even constitutional issues, which have to be carefully thought through. But I do think it is possible. 

There is clear precedent or clear analogous arrangements for the 

banking world. And so what needs to be done is extending that to 

the nonbanking world, without the implicit promise—and of course 

this is key—without the implicit assumption that Federal money 

will be provided in the case of the failing institution. 

Mr. MOORE OF KANSAS. Chairman Volcker, as we consider monitoring for systemic risks, it seems to me that it would be helpful 

to ensure our inspectors general, the various financial agencies be 

also asked to help identify weaknesses in the regulatory structure 

and propose solutions. 

21 

Would you support formally connecting these IGs to create a financial watchdog council, where they would meet on a quarterly 

basis and be required to provide Congress an annual high-risk assessment report on the greatest risks and gaps in our financial regulatory system that need to be addressed? Would you support a 

proposal like that, sir? 

Mr. VOLCKER. I think I would have to look at that before I have 

any comment. When I respond on the Kansas City thing, I will respond on that point. 

Mr. MOORE OF KANSAS. Thank you, sir, very, very much. I yield 

back, Mr. Chairman. 

The CHAIRMAN. The gentlewoman from West Virginia, Mrs. Capito. 

Mrs. CAPITO. Thank you, Mr. Chairman. I think I am out of sync 

here. Sorry. 

The CHAIRMAN. Yes. Well, I take— 

Mrs. CAPITO. Well, I am in sync. 

The CHAIRMAN. Well, on this issue I take instructions from the 

Minority, so Mr. Lance is next. 

Mrs. CAPITO. Thank you, sir. 

Mr. LANCE. Thank you very much, Mr. Chairman. Good morning 

to you, Mr. Volcker. 

Regarding the whole issue of ‘‘too-big-to-fail’’—and this is obviously of great concern to all of us—and regarding the issue of 

moral hazard, yesterday the Secretary of the Treasury indicated 

that in identifying tier one candidates, there would not be a list but 

the market would know who they were, based upon the criteria. 

Is there any real way to resolve this situation? It seems to me 

that Wall Street will know who they are and that there will inevitably be moral risk, more hazard, as a result of the identification 

of tier one entities. 

Mr. VOLCKER. I don’t think—Put it positive. I think it is extremely difficult to designate in advance who is systemically important and who isn’t, because you may even find some fairly small 

institutions, not mega-institutions anyway, that are playing a particular role in the market at a particular time and have had a lot 

of interconnections with other institutions that create a big problem. They create a clog in the resolution of credit default swaps or 

something. Arranging all this in advance, I don’t know whether the 

Treasury would intend to announce it or not announce it or set out 

criteria or what. 

Mr. LANCE. Not as I understand it, sir. There would not be an 

announcement as to which entities actually are on the list, and the 

list would not be public; but that based upon the criteria, that Wall 

Street could figure out who they are. 

Mr. VOLCKER. Yes, well, I would think that is true. Wall Street 

would figure it out, so you would have to probably announce it in 

the end. And then you have the problem, is a particular institution 

in, or is a particular institution out? And I think we will find in 

calm circumstances, the institutions that are in would hate it, because they would have particularly tough capital requirements and 

feel uncompetitive. But as soon as a problem arose, the institutions 

who were out would complain that we are vulnerable and they are 

not. 

22 

Mr. LANCE. Yes. I perceive a situation where, at one stage in the 

economic cycle, people would lobby not to be in it, and then later 

they would lobby to be in it. 

Mr. VOLCKER. I think it is not the happiest thing in the world, 

but I think you properly have to leave some ambiguity in this situation. 

Mr. LANCE. Thank you, sir. This is a continuing issue on this 

committee, on both sides of the aisle, and it is not easily resolved. 

And I appreciate your thoughts on that. 

I yield back the balance of my time. Thank you. 

The CHAIRMAN. The gentlewoman from New York. 

Mrs. MCCARTHY OF NEW YORK. Thank you, Mr. Chairman. And 

it is good to see you again. 

I guess my line of questioning is, being that we are seeing, you 

know, the banks starting to come back and starting to loan—not 

as much as what they should—we are seeing the market coming 

back up a little bit. We see on TV that the banks and the financial 

institutions are spending millions of dollars with very nice fluffy 

ads to get customers to come back. 

And I guess the question is: With all that we are going to be trying to do, how long is it going to be before they start taking more 

risk again? 

And that is one of the concerns I have. You know, it used to be 

that all these corporations, they ran their business because of 

trust, trust of the American people. They have ruined that trust. 

We can stand here and sit here and try and make it better, but 

millions of people have lost their IRAs, they have lost their retirement funds. Many have had to stop their thoughts of even retiring. 

We can’t make that up. 

But one of the things that I am afraid of, and I am already starting to see it, is the financial system is prone to more systemic risks 

today than I think ever before. I think it would be a tribute to the 

creation of complex investments products such as credit defaults. I 

mean, they are already starting on coming out with new products. 

And yet, you know, I think everybody was sleeping at the wheel. 

You talk about the Federal Reserve. No one did anything to really bring the attention to the authorities on the way they were supposed to. So how do we make that better? How do we get the industry, I guess, to have a moral backbone? That is the main point, and 

we can’t legislate for that. 

Mr. VOLCKER. Well, I agree with your concerns, and we have lost 

the sense of fiduciary responsibility that should inherently— 

The CHAIRMAN. Into the microphone, please, Mr. Volcker. 

Mr. VOLCKER. I am going to have to eat it. 

The CHAIRMAN. Bring it closer to you. It will move, you don’t 

have to bend. Move the whole thing closer to you. 

Mr. VOLCKER. I have a lot of sympathy with what the Representative from New York is saying about the loss of a sense of fiduciary 

responsibility. And I would like to restore that to the banks as 

much as possible, because they should have it. I think it is kind 

of hopeless in terms of—just in personal capital market operators. 

A tremendous amount of money, as you well know, was made in 

the financial system. So the incentive to get back to the situation 

as normal, or what was considered normal before, is pretty strong 

23 

by the people who were participating. But, of course, it is that system that led us over the cliff, and with all the adverse consequences that were mentioned. And that is what we want to avoid 

in the future. 

And you talk about the capacity to make up more and more new 

products, get around more and more regulation. It occurs to me, as 

I heard you speaking, that maybe the best reform we could make 

is have a big tax on financial engineers so that they can’t make up 

all these new things quite so rapidly; because it is this highly complex, opaque financial engineering which gave a false sense of confidence, which broke down. 

But you have outlined the challenge, and Treasury has tried to 

address it. The Administration has tried to address it. Many other 

people have made suggestions. I am making a few suggestions this 

morning. And you are going to have to decide. But you can’t let it 

go without some important action. 

Mrs. MCCARTHY OF NEW YORK. No, I agree with you. And I think 

important action is certainly where we are trying to go. And we are 

trying to find the right balance. Again, you know, we have a younger generation that we have been trying to convince that they 

should start saving. Saving in this Nation was at a zero rate before 

all this started. 

Mr. VOLCKER. That is part of how we got in this problem. 

Mrs. MCCARTHY OF NEW YORK. Exactly. And with that being 

said, though, always try to look for something good. People are cutting back on some of their extraordinary expenses. They are cutting 

back on using their credit cards. And I think it is a lesson that everybody has made. But with that lesson, I think the punishment 

was too much. And I hope that we do find the right balance, especially for the consumers. We have to start taking care of the consumers this time around. Thank you. 

The CHAIRMAN. The gentlewoman from Kansas. 

Ms. JENKINS. Thank you, Mr. Chairman. 

Mr. Chairman, the Administration has said that one of the goals 

of its resolution authority is to inflict the cost of failure upon shareholders and bondholders. At the same time, Mr. Geithner has been 

unable to say that further bailouts of creditors will be off the table. 

In a world where the mantra has become ‘‘no more Lehmans,’’ is 

the promise that haircuts will be inflicted upon creditors the least 

bit credible? And if it is not credible, doesn’t that mean that the 

next crisis will be still bigger? 

Mr. VOLCKER. The danger is that the spread of implicitly a moral 

hazard could make the next crisis bigger. It is not going to be next 

year. It is not going to be probably 4 or 5 years. But memories are 

dim. And we want to make a system such that we don’t have a still 

bigger crisis 10 years from now. And if we do nothing and let moral 

hazard become even more accepted, I am afraid there is a real danger. 

So you want this resolution system to do such things as creditors 

taking a haircut if they have to; or convert into stocks, and the 

stockholder will probably lose and lose completely. In many cases, 

there will be a forced merger or other actions that will not require 

the injection of government money that can stabilize the situation. 

24 

Now, that is more forceful than what happened in the midst of 

the great crisis a year ago when, by and large, with the exception 

of Lehman, the bondholders were pretty much protected in the financial world. They weren’t protected in General Motors and 

Chrysler, but they were protected in the financial. And even some 

of the stockholders were protected. 

Now, they did not lose as much as you might have thought they 

should have lost. We want to minimize that kind of result to the 

extent possible so that the lesson gets through: You creditors are 

taking a risk and you ought to understand that. And the government isn’t going to come to your aid if this institution fails. 

And this is the game. I hate to call it a game, but this is, I think, 

the approach that we are trying to instill, and make sure there is 

what is appropriate uncertainty, or maybe certainty, that if these 

nonbank institutions are going to fail, the creditors are at risk and 

the stockholders are at risk. And we do the best we can to do that 

without destroying the system. 

Ms. JENKINS. Thank you. I appreciate your input. I yield back 

the balance of my time. 

The CHAIRMAN. The gentleman from Massachusetts. This time, I 

saw you. 

Mr. LYNCH. Mr. Volcker, thank you for your attendance and for 

helping the committee with its work. I was listening to your testimony outside and I was wondering, this whole framework that we 

are considering here—given the complexity of some of this, some of 

the instruments that are being traded now, the derivatives that we 

are now going to put on exchanges, and some that are not but necessarily require oversight, where we are entering new territory 

here which we hope will bring more effective regulation to the entire financial services industry. The question for us in part will be 

how to pay for that, how to pay for that structure. 

And I know that the last time we had a great disruption here, 

the Great Depression, Congress and the financial services industry 

sat down and they derived a system that—I think it was one threehundreth of 1 percent of every share traded on the exchanges 

would go in to pay for the SEC, for example. That number has been 

reduced over time because of the volume of trades. 

But would you favor some type of—when we have to grapple with 

how to pay for all this, would you favor some type of system, some 

transaction fee, for example, that would help fund all of this? We 

have many, many of our constituents who don’t have any—they 

don’t have an IRA, they don’t have money in the stock market. And 

yet if we use the general taxation authority, they too will be paying 

for this system that they don’t necessarily benefit directly from. 

And I was wondering if we could have your thoughts on how we 

might as a Congress pay for some of the regulation that we are 

about to implement. 

Mr. VOLCKER. Well, just a general question has arisen from time 

to time in the past. It rose quite poignantly 20 or 30 years ago with 

respect to foreign exchange crises or foreign exchange operations, 

as to whether a little tax wouldn’t do some good, both in raising 

revenues and in discouraging speculative activity. I think the conclusion of people who looked into that in the past was kind of twofold. First of all, it is very hard to do it for one country in any sigVerDate Nov 24 2008 16:54 Apr 06, 2010 Jkt 054869 PO 00000 Frm 00028 Fmt 6633 Sfmt 6633 K:\DOCS\54869.TXT TERRIE
25 

nificant amount, because you force then, competitively, the market 

to another country that doesn’t charge. So that is the number one 

problem. You have to get some consistency internationally. 

The more general problem, I think, is if the fee is low enough not 

to be disruptive of markets, it is not going to raise much revenue. 

If it is high enough to raise some revenue, it will be disruptive. So 

you are kind of caught; and is there any middle ground? 

But I think it might be interesting if the Congress suggested 

somebody look at this and see whether there is anything to the 

idea at all. You probably are aware that the head of the British Supervisory Authority has proposed—and I think he says he doesn’t 

think it is going to happen—but he says just what you say: Maybe 

a little tax on the financial transactions would be a good thing. 

It is very interesting. He says maybe the financial world, financial system, got too big in the U.K., it got too dominant. It made 

a lot of money, but it really didn’t contribute to the national wealth 

of the United Kingdom. And he has raised some very interesting 

questions, including, I don’t know how seriously, the question of 

this tax. But he has a point. 

You are probably familiar with the fact that the world of finance 

at one point, in terms of its total profits, came to almost 40 percent 

of all the profits in the United States. And that doesn’t even count 

all the bonuses. That is after the bonuses. 

And you know, some people raised the question, I raised a question of whether the value, really, of the world of finance is 40 percent of the United States and things haven’t gotten a little out of 

bounds here, which is what you are struggling with in a general 

sense. How is this great industry of finance, harnessed to do the 

job it is going to do, an absolutely indispensable job, without taking 

risks that for a while were very profitable, and then it turned very 

sour. How do you get the job done, done in a way that—of course, 

smart men can make reasonable returns without placing the whole 

economy at risk. 

The CHAIRMAN. The time has expired. Mr. Volcker can stay until 

11:30. There are 10 members present who haven’t asked questions. 

I will announce on the Democratic side that I will give priority to 

the people who were here. That should accommodate everybody 

who was here. If no new members come on either side, everybody 

who sat through it can do it. The Minority can make its decisions. 

But with Mr. Volcker’s agreement, that will give us 10 people an 

hour. We will hold people strictly to 5 minutes. And in fairness to 

the people who were here, that is the way we will go. 

So now it is up to Mrs. Capito. 

Mrs. CAPITO. Thank you, Mr. Chairman. Thank you, Mr. Chairman, for being here. 

I would like to go to the resolution authority that the Administration has proposed. Those of us—we put together a Republican 

plan to deal with re-regulation and new regulation. And one of the 

ideas that we put forward was an enhanced bankruptcy rather 

than a resolution authority by the Reserve. And I think in doing 

that, I think we were—we feel that it creates more transparency, 

accountability; it can go into the bankruptcy court, with the accompanying experts in that bankruptcy court that would understand 

the complexity of what is going on. And also, it would remove, I 

26 

think, any kind of appearance of a bailout or another implicit or 

implied government backstop. 

Do you have an opinion on an enhanced bankruptcy as opposed 

to the resolution before you? 

Mr. VOLCKER. I haven’t seen your proposal so I can’t comment 

in detail. But I think the problem that we are all dealing with is 

when the emergency comes, you don’t have much time. And it looks 

efficient anyway, to say okay, the government had to take action 

immediately. We are going to put somebody in there to run this organization, and it can do what it can do in terms of, for instance, 

doing the kind of thing with the creditors that a bankruptcy court 

might eventually do. But you don’t have a month to work it out. 

You don’t have 2 months to work it out. You don’t have a week to 

work it out. You don’t have days to work it out. You have to do 

it right away, or at least plan it right away. 

So that is, I think, the problem that we are dealing with, the ordinary bankruptcy-type negotiated settlements which work okay 

when you don’t have a systemic risk. That is a day-by-day affair. 

You have to deal with it immediately. And that is, of course, the 

problem we ran into a year ago. 

So within that constraint, if you have a better way of doing it, 

good; but I think it has to recognize that constraint. 

Mrs. CAPITO. All right, thank you. 

My last question is, so many of these matters—I mean you have 

dealt with these matters your entire life and done such a wonderful 

job. They are so darn complicated for the man on the street who 

is listening to this hearing. 

Or any time I go to my district and try to talk about the need 

for new regulation in the financial markets, people’s eyes start to 

glass over. And I know you have made many speeches and many— 

is there any way, in a concise way, besides, you know, this is going 

to protect you from losing your retirement in the future—is there 

any way that you find is most effective to convey the message to 

the man on the street that this is an issue that really does impact 

them every day in their life? 

Mr. VOLCKER. Well, it would be no comfort to you that I find it 

too damn complicated myself, so it is very complicated. But I think 

the message that you have to give them is, the whole object of this 

exercise is to prevent a repeat of what has happened. And it is not 

just a loss of finance, which is obviously important, particularly the 

loss of retirement funds and all that kind of thing. That is serious 

enough. But it has also affected the operation of the economy. So 

people lost jobs, and we are left with a big recession, we are left 

with a situation where it is going to be a tough recovery. 

So we are dealing with a big problem—you are dealing with. And 

I wish it was simpler, but it is not very simple because the finance 

system itself has gotten so complicated. I think that is part of the 

problem, frankly. I mean, I think I have made remarks about financial engineers. I am more than half serious about that, because 

it has gotten so complicated. I am sure the management of most 

financial institutions don’t understand what people are doing down 

in the bowels of the institution, in some very fancy bit of financial 

engineering. And they get told, as I am sure in the case of the 

subprime mortgage, we have it all figured out. These are lousy 

27 

mortgages but we have them all put together in a way that is perfectly safe and they are triple A. So you can buy them and you can 

pay. 

And I don’t think the managements in most cases, you know, 

were able to see through that, understandably, because it is very 

complicated. Now I think the cloud before the eyes has been removed, and we ought to take advantage of that and try to make 

sure it doesn’t return. 

Mrs. CAPITO. Thank you. I yield back. 

The CHAIRMAN. The gentleman from North Carolina, Mr. Miller. 

Mr. MILLER OF NORTH CAROLINA. Thank you, Mr. Volcker. Last 

fall when Lehman collapsed and AIG was rescued, I felt like I was 

not a sufficiently conscientious member of this committee, because 

I so little understood credit default swaps which had played such 

a huge role in all that. And then I came to realize that no one understood them, which made me feel a little better about my own 

level of conscientiousness, but maybe feel worse for the economy of 

the country and of the world. 

In your testimony, you identified credit default swaps as something that had exacerbated the risks that our entire economy faced, 

the Nation’s economy and the world’s economy. The usual justification is risk management. They are like insurance. But the great, 

great bulk of credit default swaps and other derivatives are between parties, none of whom have any risk to manage. They have 

no interest in the underlying whatever it is. 

You, in your testimony, said some kinds of risky behavior should 

not be allowed of institutions that are systemically important. Do 

you think credit default swaps, for instance, where nobody in the 

contract has any interest in the underlying security, should be allowed of systemically important institutions? 

Mr. VOLCKER. Well, let me just make a general kind of philosophic question, and then credit default swaps. My general position 

is you make a distinction between banks and others. Banks are 

going to be protected. They are protected in other countries. They 

have been protected here for a century. That is not going to change, 

shouldn’t change, I don’t think. But let’s not extend that protection 

to the whole world. 

Now we get the credit default swaps which are out there in the 

market and arguably serve a legitimate function in a trading operation of protecting the holding of a bond against the default on the 

bond. But it became a big kind of speculative market, trading market, so you had many more credit default swaps outstanding than 

there were credits, which raises some questions about the functioning of the market, and how the basic purpose it was serving 

was underlying and had a purpose. But the market was developed 

in a way that it was vulnerable to collapse—if that is the right 

word—if it came under great strain. And it came under great 

strain because AIG was so central to the market. Now, that had 

been of concern, frankly, before. Some people understood this before the crisis, and, on a voluntary basis, began introducing measures— 

Mr. MILLER OF NORTH CAROLINA. You do need to eat your microphone. I am having a really hard time hearing you. Sorry. 

28 

Mr. VOLCKER. I said people had begun working on the credit default swap problem in terms of the clearance and settlement procedures, even before the crisis, on a voluntary basis, with some success and some great effort. Now the crisis has exposed it and the 

government stepped in and made proposals. I don’t know how 

many of them require legislation. At some point, it will require 

some legislation. 

But now there is a lot of progress in forcing this trading into 

clearinghouses or organized exchanges with the whole panoply of 

rules that implies, collateral requirements, protection against default and so forth. So that is a big step forward. 

You might not have had the AIG problem which has loomed so 

large, had all those arrangements been in place before, because 

there were no agreed—well, there was an appropriate basis in that 

respect, some agreed conventions, but AIG did not sufficiently 

collateralize and protect against risk, given what happened. They 

thought they had no risk because they were so big and strong. 

Well, when they weren’t so big and strong, you had a problem. 

That is a big problem, and it is one of the areas in which I am sure 

that big progress is going to be made and is being made. 

Mr. MILLER OF NORTH CAROLINA. Do you think that the margin 

requirements to the collateral requirement is sufficient with respect to— 

Mr. VOLCKER. Well, somebody ought to be in a position to make 

sure that it is sufficient. I am not an expert. I can’t judge whether 

they are sufficient or insufficient. Somebody ought to be deciding 

that. 

Mr. MILLER OF NORTH CAROLINA. Are there any collateral default 

swaps, credit default swaps, other derivatives, that should require 

an insurable interest by somebody in the transaction? Should there 

be a requirement with respect to any credit default swaps of an insurable interest? 

Mr. VOLCKER. I think this whole market needs to be brought 

under surveillance, and you ought to provide the authority that 

somebody can have adequate authority to satisfy themselves the 

market is sanitized. 

Mr. MILLER OF NORTH CAROLINA. My time has expired. Thank 

you. 

The CHAIRMAN. The gentleman from Texas. 

Mr. NEUGEBAUER. Thank you, Mr. Chairman. Thank you, Chairman Volcker, for being here. 

Looking back at your experience at the Federal Reserve, one of 

the things that is out there today is that the Federal Reserve 

would designate these tier one companies in financial institutions. 

And a lot of people believe that when you say that company is tier 

one, that they are in fact ‘‘too-big-to-fail.’’ And so there is an implicit guarantee there that these are entities that we are not going 

to let fail. 

The question I have for you is: Is that good for the marketplace, 

and is that good policy? 

Mr. VOLCKER. No, I don’t like that idea. That is part of what I 

am saying here. Trying to identify these institutions in advance as 

a special interest, whether they say it or not, then carries the connotation in the market that they are ‘‘too-big-to-fail.’’ And I think 

29 

that adds to the moral hazard problem. Most of what we have been 

discussing this morning is how to corral moral hazard. And I don’t 

think that is—that is not the way to do it. It doesn’t corral it, it 

extends it. 

Mr. NEUGEBAUER. I have heard you say—and I think this is 

something that you and I agree on—that capital could have cured 

a lot of the ills that we faced in the country over the last year if 

these companies had actually been capitalized to a level sufficient 

and commensurate with the risks and exposure that they were taking. 

Is it a better strategy, in your opinion, for the regulatory agencies, the regulators, that when these entities are very diverse, involved in a lot of different activities, that they actually do a better 

job of breaking down the businesses that each one of these entities 

is in, and assigning capital requirements for those activities; and 

so then, if that entity wants to continue that business activity, it 

understands that it will have to have a certain amount of capital 

to do that, and the marketplace then, in effect, begins to analyze 

those businesses and ascertain whether they want to furnish the 

capital to those institutions? And so don’t you have a check and 

balance from the marketplace as well as the regulatory structure? 

Mr. VOLCKER. I think capital requirements and amount of capital 

are obviously important. But if you try to fine-tune it too far—the 

banking regulators have struggled with this—how much capital in 

each particular kind of risk basket? It is very hard to define different risks very precisely. 

And they went from a system, or trying to go from a system that 

was very crude, back when I was Chairman of the Federal Reserve—which we had installed—to say it is not sophisticated 

enough, it doesn’t have all those baskets that you are talking 

about. But boy, they have run into more difficulty. They have spent 

10 years trying to define this and they put a lot of weight on credit 

rating agencies. Now, that no longer looks so great. But that is illustrative of the kind of problem you run into. 

So I am kind of on the side of, yes, adequate capital. Yes, make 

sure capital is big enough, but recognize it has to be pretty crude, 

and don’t try to be too sophisticated about it. 

I do think, and you may be getting at this, when you get into 

nonbanks, bank capital is already—whether it is adequate or not, 

no doubt it is a matter of a supervisory concern. When you get outside of the banking system, then I think there ought to be some 

residual authority for those few institutions that get so big they 

really look dangerous from the standpoint of financial stability, 

somebody has the authority to say, look, you are too leveraged. You 

have to provide some more capital, or you have to cut down on your 

assets; or you cut down on your activities and you have to hold 

more liquidity. I think the need for that will be rare. 

I do believe in registration of hedge funds, I do believe there 

ought to be some reporting of hedge funds. But I think there are 

very few hedge funds that present a systemic risk. They are a different kind of operation, a different kind of financing. We have 

seen failures of hedge funds that were successfully absorbed without much difficulty. Interestingly enough, where that was not true 

was the hedge funds owned by Bear Stearns. What sent Bear 

30 

Stearns in the beginning of its downward slide was the failure of 

or losses in its own hedge funds, which is illustrative of why I don’t 

want commercial banks to be holding hedge funds, because that 

would be a point of vulnerability. 

Mr. NEUGEBAUER. Thank you, Mr. Chairman. 

The CHAIRMAN. Thank you. We have votes, unfortunately. We 

can’t hold Mr. Volcker after this. We will have time for two more 

questions for people who have been here, and then we will break. 

We will resume, and we will start with those who were here and 

didn’t get to ask. 

The gentleman from Georgia. 

Mr. SCOTT. Thank you, Mr. Chairman. 

Mr. Volcker, let me ask you to comment on the whole issue of 

‘‘too-big-to-fail,’’ because I think that we have not paid attention to 

what happens as a result of that. The consequence becomes what 

do we do; do we have a strategy; does that strategy lead to another 

strategy called too-small-to-save? And I think that is where we are. 

Historically, if we looked at the Depression that we went 

through, it was these smaller banks, banks went under, they never 

came back. Eventually, smaller banks began to serve a niche. I am 

very concerned about the future of our smaller banks, our community and regional banks. And are we at the point, as a result of this 

rush to save these large banks, holding companies, there isn’t that 

much attention that we are faced with in terms of these smaller 

banks. Bank after bank after bank has gone under across this 

country. They haven’t been the Bank of Americas or the SunTrusts 

or the national banks, the big banks. They have been these community banks that actually provide the monies for these communities. 

One of the big problems we had, for example, with the automobile dealers was the fact that once the automobile manufacturers had a problem, the automobile dealers had a problem, but it 

wasn’t—their problem was the inability to get money. 

So the problem here becomes, I think, we are glossing over a 

deeper problem here of getting down to the grass roots in these 

communities. Unemployment is not going to bounce back until we 

get these small businesses thriving. The small businesses are getting their monies from the smaller community regional banks. And 

yet because of this overemphasis on this ‘‘too-big-to-fail’’ strategy, 

we are losing the bigger picture, it seems to me; and as a result, 

we are left with too-little-to-save. 

Could you comment on this particular predicament we are in? 

Mr. VOLCKER. Well, I am not sure how helpful I can be. I think 

there is a problem. Obviously you are seeing a lot of failing of small 

banks, and they are kind of easy to take care of in terms of the 

capacity of the FDIC, and disturbance or lack thereof, and the failure of a particular small bank. But I do think that it takes judgment. But in a particular case of a small bank, to what extent is 

the problem one of accounting practice maybe, and I think bank accounting needs some review. I am not sure how important that is 

to these smaller banks. 

Are their cases where—bad word, but I will use it—that forbearance would have been justified, and the benefit of the doubt in 

some sense given to the small bank to see whether it can hold together for a while without forcing it into either a merger or liquidaVerDate Nov 24 2008 16:54 Apr 06, 2010 Jkt 054869 PO 00000 Frm 00034 Fmt 6633 Sfmt 6633 K:\DOCS\54869.TXT TERRIE
31 

tion? I don’t know. That takes a very sophisticated and understanding regulatory regime, which may be beyond us. 

Mr. SCOTT. Do you see a future for the small community regional 

banks? 

Mr. VOLCKER. Look, I am old-fashioned. I see a future for smalland medium-sized community banks because they have some inherent advantages in dealing with local communities and the small 

borrowers and the individuals that are concerned. I think they can 

be quite competitive. And they are not a danger to the country. 

Quite the contrary. What I think we ought to do is we ought to be 

conscious that we are not unconsciously undercutting them. But I 

don’t have any magic answers to that. 

Mr. SCOTT. All right. Well, thank you very much. 

Let me just ask you one other question here. I have a few more 

minutes. Over the past 6 months, loans and leases have declined 

at a record annual rate of 8 percent with no hint of an upturn, despite the Fed’s massive effort to get credit flowing. Credit is still 

not flowing sufficiently to assure a strong and sustainable economy. 

Do you believe this to be a two-sided problem? One, reduced willingness of banks to lend amid the record loan delinquencies; and, 

two, the subdued desire to borrow. 

Mr. VOLCKER. Well, bank lending, I guess, is declining. This is 

an area of the market that is still clogged up. It is a matter of confidence in part, in large part. And a lot of them are in financial difficulty. And I think it is going to take time for that to unlock. The 

big market has opened up considerably, but the small bank market 

has not, although there are some signs it is beginning to change. 

So I hope that we can see evidence of that before too long. 

Mr. SCOTT. Thank you, Mr. Volcker. 

Mr. MILLER OF NORTH CAROLINA. [presiding] Thank you. Mr. 

Hensarling. 

Mr. HENSARLING. Thank you, Mr. Chairman. And, Chairman 

Volcker, over here. The good news is I appear to be your last questioner of the morning. Thank you for your time, sir. 

I want to follow up on a line of questioning from my colleague 

from Texas, Mr. Neugebauer, and try to put a very fine point on 

it, perhaps a theoretical point. He was inquiring about, in retrospect, could the regulators, had they had I suppose more perfect 

knowledge in being able to assess risk, could they not have applied 

the proper capital and liquidity standards, be it to our insured institutions or our investment banks? At least, theoretically, had 

they known, could you have applied proper capital and liquidity 

standards to perhaps have prevented the economic turmoil that we 

saw? 

Mr. VOLCKER. I think the answer is, theoretically, yes. But the 

answer may also be, practically, no. I don’t mean to be that negative. But the problem with banking supervision, the chronic problem is when things are going well, nobody wants to hear from the 

supervisor, including Congress, doesn’t want to hear about restrictions. And you will get complaints from your constituencies: ‘‘What 

are those big bad regulators doing demanding higher capital requirements and preventing me from doing this or that?’’ ‘‘I never 

failed,’’ the argument will be, ‘‘and I am doing fine. Leave me 

alone.’’ And then, of course, when things happen, where were they? 

32 

Mr. HENSARLING. But I guess for a historical perspective—and I 

guess I would ask if you agree or disagree—at least with respect 

to our insured institutions, the prudential regulators had the ability to take prompt and correct action. 

Mr. VOLCKER. I think there was some failure in banking supervision. 

Mr. HENSARLING. Perhaps they lacked the expertise, perhaps 

they lacked the courage, forethought, but they didn’t really didn’t 

lack the regulatory authority to have imposed a capital or liquidity 

standard that would have been commensurate with the risk. 

Mr. VOLCKER. I think there are two things in particular that I 

would say directed toward that. First of all, I do think that the idea 

of having an overall overseer to kind of look at things, whether capital standards generally are adequate, whether the liquidity standards are adequate, whether some trading operations are developing 

that are destabilizing. We haven’t had anybody overtly and specifically charged with that kind of responsibility. We have individual 

agencies looking at individual banks, yes, and they are worried 

about capital. But they don’t take a fully systemic view, by nature 

of their responsibilities. 

I also think, so far as the Federal Reserve specifically is concerned, if they are going to carry heavy supervisory responsibility, 

I think there does need to be some internal reorganization in the 

Federal Reserve to make sure that the Board itself, the Chairman 

and the Board itself, are sufficiently invested with the responsibility for regulation and supervision. And explicitly I have suggested, other people have suggested, that there be created a position of Vice Chairman of the Board for Regulatory and Supervisory 

Practice, so that there is no doubt on your part as a Congressman 

as to who in the Federal Reserve is supposed to be on top of that. 

Mr. HENSARLING. Chairman Volcker, let me turn to the question 

of resolution authority. And clearly, there are differences within 

this body on how best to do that, be that through some type of 

greater expert enhanced bankruptcy process versus perhaps the 

Federal Reserve undertaking this particular duty. 

I believe I heard Chairman Frank, yesterday, say that whatever 

the resolution authority—and I know he is not in the Chair at the 

moment—what I believe I heard he said, at least from his perspective, is that resolution authority essentially ought to be a death 

sentence, which I believe I interpreted to mean that he would favor 

receivership over conservatorship. 

We presently have Fannie Mae and Freddie Mac and AIG in 

forms of conservatorship, with massive transfusions of taxpayer 

money, with no exit strategy, no end in sight for the taxpayer. 

Whatever resolution authority may come out of the United States 

Congress, could you speak to us about your opinion on whether or 

not it should have the ability to place these into conservatorship 

versus receivership and the pros and cons associated with that? 

Mr. VOLCKER. I think there ought to be authority for both. Conservatorship, implying this is an institution that has enough viability to be reorganized and be merged and revitalized; and receivership, liquidator. 

Mr. HENSARLING. Would you put AIG in the category of a firm 

that— 

33 

Mr. VOLCKER. I am not the regulator of AIG. I don’t have any 

knowledge of all of AIG. I know it is very, very complicated, complicated enough that I haven’t wanted to get involved. 

Mr. HENSARLING. We are out of time. Thank you, Mr. Chairman. 

Mr. GREEN. [presiding] Thank you. 

Mr. Volcker, because time is of the essence, I am going to move 

rather quickly to my questions, and there are only two. The first 

has to do with the notion that, metaphorically speaking, this economy had a toothache. And many times when you have a toothache, 

you will do anything to get rid of it. But once you are rid of it, you 

don’t have the same memory of the pain that you had at the time 

you had the toothache. 

And the reason I use this metaphor is because I want you to tell 

me just how bad it was. You spoke in terms of the economy going 

off a cliff. Tell me how bad was it when we interceded? How bad 

was it? 

Mr. VOLCKER. Bad. Very bad. 

Mr. GREEN. Compared to the Great Depression, let’s call the 

Great Depression a 10. If it was a 10, how bad was this situation, 

Mr. Volcker? 

Mr. VOLCKER. Well, the disturbance was very large, but of 

course, extremely forceful action was taken to curb the deterioration. But as you know, for a couple of quarters, the economy went 

down very rapidly, and part of the problem was it was not only in 

the United States. It became a worldwide phenomenon, a worldwide—I shouldn’t say worldwide. It became a phenomenon among 

almost all well-developed countries. 

So you had a situation that could feed upon itself, there was no 

strong point of growth in the world economy. So it was bad. 

It is impossible to tell what would have happened without the 

massive government support. But you knew at that point and even 

now, the financial system was based upon government support. 

And that is not the kind of financial system we want to have. It 

is not what we talk about as a free enterprise system. 

Mr. GREEN. When you use the term ‘‘going off a cliff,’’ sir, give 

me a little bit more of what that means, ‘‘going off a cliff.’’ 

Mr. VOLCKER. It meant that, the falling-off-the-cliff analogy applied to the rapid decline in the economic activity for 6 months or 

so, which found its expression, cause, the rapidity of it, in that the 

supply of credit dried up. Banks were not lending. Banks could not 

lend. The open market was constipated. So there was no availability of credit, and that led to, obviously, difficulties in carrying 

on economic activity. 

Mr. GREEN. I am going to ask one final question, and because my 

friend and I have different views on this, I am going to stay and 

give him an opportunity, because he may want to have a followup on this question. I think it is only fair to do so. 

Mr. Volcker, was the CRA the cause of this crisis that you and 

I just finished discussing? 

Mr. VOLCKER. What was the cause? 

Mr. GREEN. Was the CRA, the Community Reinvestment Act, the 

cause? 

Mr. VOLCKER. Was the Community Reinvestment Act the cause? 

34 

Mr. GREEN. I don’t mean to insult your intelligence, but it is important that I get this on the record. Was the Community Reinvestment Act the cause? 

Mr. VOLCKER. A cause? 

Mr. GREEN. The cause. 

Mr. VOLCKER. I don’t believe that it was a significant factor in 

this situation. 

Mr. GREEN. Now, because we are short on time, sir, could you— 

Mr. ROYCE. I will be very brief. 

And, by the way, we go through a routine where we ask if the 

Government-Sponsored Enterprises, Fannie Mae and Freddie Mac, 

were one of the causes, the lack of regulation over them, and then 

that gets translated, but that is not what I am interested in today. 

Mr. VOLCKER. I am willing to inject a comment here. 

Mr. ROYCE. Yes? 

Mr. VOLCKER. Please do not recreate Fannie Mae and Freddie 

Mac in the form of these hybrid institutions, half private, half public. 

Mr. ROYCE. So you think that the GSEs were one of the causes? 

Mr. VOLCKER. I think they were a factor, yes. 

Mr. ROYCE. Okay, then, let me ask you a question. The Richmond Fed economist, back in 1999, said 27 percent of all of the liabilities of firms in the U.S. financial sector were explicitly guaranteed by the Federal Government; another 18 percent enjoyed some 

implicit support. That would be 45 percent. Now that is back 10 

years ago. 

Now we look at March of 2008 when the New York Fed stepped in and assumed the risk of about $30 billion in the portfolio of the 

investment bank Bear Stearns. So we have seen this rapid expansion of both the perceived and the actual financial safety net, the 

explicit financial safety net. Do you think the expansion of this 

safety net has exacerbated the ‘‘too-big-to-fail’’ problem? 

Mr. VOLCKER. Yes, and I think the whole—90 percent of the discussion we have been having here is trying to figure out some way 

of pulling that back. 

Mr. CLEAVER. I am going to have to ask Mr. Volcker to give the 

rest of his response in writing. We have exceeded our time and are 

to zero on our voting— 

Mr. ROYCE. Sure enough. 

Mr. CLEAVER. If I may say so, Mr. Volcker, we thank you for 

being here, and I do this on behalf of our Chair, and we thank all 

of the other panelists for being here. We are coming back after this 

vote. 

Mr. Volcker, you are excused, and it is with great pleasure that 

we have had you here today. 

Thank you, sir. 

Mr. VOLCKER. Thank you for having me. 

[recess] 

Mr. CLEAVER. [presiding] I think we will go ahead and begin 

with our testimony. We appreciate all of you donating your valuable time and intelligence to this committee today. 

We are going to begin with the Honorable Arthur Levitt, Jr., the 

former Chairman of the SEC and Senior Advisor to the Carlyle 

Group. 

35 

Mr. Levitt. 

STATEMENT OF THE HONORABLE ARTHUR LEVITT, JR., 

FORMER CHAIRMAN OF THE UNITED STATES SECURITIES 

AND EXCHANGE COMMISSION; SENIOR ADVISOR, THE 

CARLYLE GROUP 

Mr. LEVITT. Thank you for the opportunity of appearing before 

the committee to discuss the critical issues of establishing a systemic risk regulator and a resolution authority. I will summarize 

my prepared statement, which I have submitted to the record. 

As a former Chair of the SEC and currently as an advisor to 

Getco, The Carlyle Group, and Goldman Sachs, I hope I can share 

with you important considerations to inform your efforts. 

Though the appetite for reform appears to move in inverse relationship to market performance, financial markets are no less risky 

and regulatory gaps remain. I am concerned that public investors 

may well be convinced because of the relative market calm of the 

last few months that all is well in our regulatory system, but all 

is not well and I am glad you are showing leadership in addressing 

these issues. 

Your success will be determined by how well you affirm the principles of effective financial regulations, principles relating to transparency and regulatory independence, the proper oversight of leverage and risk taking, the nurturing of strong enforcement, early 

intervention, and the imposition of market discipline. 

One of the key questions before this committee is how to authorize and hold accountable a systemic risk regulator and who should 

provide this function. I would like to suggest that the more critical 

question is whether any regulator or groups of regulators can have 

the same impact as well as a resolution authority. Such an authority would be created explicitly to impose discipline on those with 

the most power to influence the level of risk taking, the holders of 

both equity and debt in institutions which may be ‘‘too-big-to-fail.’’ 

A systemic risk regulator will not be effective unless you also create a resolution authority with the power to send these failing institutions to their demise and thus impact the holders of both their 

debt and equity. 

To give a simple analogy, it doesn’t matter who serves as the cop 

on the beat if there are no courts of law to send law breakers to 

jail. 

I strongly believe that a systemic risk regulator must serve as an 

early warning system with the power to direct appropriate regulatory agencies to implement actions. I am agnostic about who 

should lead such an agency and perform this function, and I would 

caution against making the Federal Reserve the systemic risk regulator in its present structure. 

The Fed’s responsibilities to defend the safety and soundness of 

financial institutions and to manage monetary policy creates inevitable and compromising conflicts with the kind of vigilance and 

independent oversight a systemic risk regulator requires. If, however, the Fed is deemed to be the best available place for this role, 

I would urge Congress to remove from the Fed some of its responsibilities, conflicting responsibilities, especially those of bank oversight. 

36 

In many respects, the surest way to cause investors, lenders, and 

management to focus on risk is not to warn them about risk but 

to give them every conceivable way to discover risk and tell them 

what will happen to them if they don’t pay attention. 

We can deal with this by establishing a resolution authority 

charged with closing out failed institutions which pose systemwide 

risk. Such an authority would have the power to do just about anything to put a failing bank in order or close it down in an orderly 

way without, if possible, further government assistance. It could 

terminate contracts, it could sell assets, cancel debt, cancel equity, 

and refer management for civil penalties for taking excessive risk 

even after multiple warnings. 

I would expect that managers, customers, creditors, and investors would become a good deal more careful, having foreknowledge 

of their potential rights and responsibilities should such a resolution authority be activated. They would see the advantage of greater transparency and developing more knowledge of individual institutions, and this market discovery may well do the work of many 

outside systemic risk regulators. 

Of course, your goal is to incentivise market discovery. You will 

also want to establish the value of transparency with respect to 

market information. I want to emphasize in particular the importance of fair value accounting for major financial institutions engaging in significant amounts of risk taking and leverage. Such accounting gives investors a true sense of the value of an asset in all 

market conditions, not just those conditions favored by asset holders. 

Greater transparency would make it possible for market participants to price risks appropriately and for a systemic risk regulator 

to demand fresh infusions of liquidity or higher margin requirements if needed. 

I would much prefer that a systemic risk regulator be so effective 

that a resolution authority would be unnecessary. But sadly, we 

know that always preventing failure is absolutely impossible. I 

think it is, therefore, in my opinion, your job to make failure possible. 

Thanks again for your attention to these issues, and I urge you 

to continue to accelerate your efforts. 

[The prepared statement of Mr. Levitt can be found on page 62 

of the appendix.] 

Mr. CLEAVER. Thank you, Mr. Chairman. The next witness, Mr. 

Jeffrey Miron, is a senior lecturer and director of undergraduate 

studies in the Department of Economics at Harvard University. 

Let me ask the three remaining witnesses, because of the possibility of another vote in maybe 25 or 30 minutes, I am going to ask 

if you can still push out the most significant parts of your testimony. But perhaps at the end if you could summarize them so we 

can make sure that all of you are able to complete your testimony 

before any vote call. 

Thank you. 

37 

STATEMENT OF JEFFREY A. MIRON, SENIOR LECTURER AND 

DIRECTOR OF UNDERGRADUATE STUDIES, DEPARTMENT OF 

ECONOMICS, HARVARD UNIVERSITY 

Mr. MIRON. Thank you, Mr. Chairman, Ranking Member Neugebauer, and committee members. Let me begin by expressing my 

thanks for the opportunity to present my views on this matter. The 

question I will address is whether Congress should adopt Title XII 

of the proposed Resolution Authority for Large Interconnected Financial Companies Act of 2009. This Act would grant the FDIC 

powers for resolving insolvent financial institutions similar to those 

that it currently possesses for revolving banks. My answer to this 

question is an emphatic, unequivocal ‘‘no.’’ 

Let me explain. The problem that resolution systems attempts to 

address is that when our financial system fails, the value of the 

claims on that institution’s assets exceed the value of the assets 

themselves. Thus, someone must decide who gets what, and it is 

impossible, by virtue of the assumption that we are dealing with 

a failed institution, to make everyone whole. The size of the pie 

owned by the failing institution has shrunk so those who are expecting a slice of that pie collectively face the necessity of going 

somewhat or substantially hungry. The resolution authority decides 

who gets what, but the reality is that someone has to go wanting. 

It is in society’s broad interest to have clear, simple, and enforceable procedures for resolving failed institutions, principally to ensure that investors are willing to commit their funds in the first 

place. If the rules about resolution were arbitrary and ever-changing, investors would be loathe to invest and economic investment 

productivity and growth would suffer. 

A well-functioning resolution process is part of a system for defining and enforcing property rights, which economists agree is essential to a smoothly functioning capital system. 

The crucial thing to remember here is that someone has to lose. 

Just as importantly, it is valuable to society as a whole, although 

not to the directly-harmed parties, that those invested in the failed 

institutions suffer economic losses. This releases resources to better 

uses, provides signals about good and bad investments and rewards 

those who have made smart decisions. 

The flip side of the fact that standard resolution systems, like 

bankruptcy, impose an institution’s losses on that institution’s 

stakeholders, is the fact that a standard of resolution authority, 

such as the courts, puts none of its own resources into that institution. The resolution authority is resolving claims and dividing the 

pie but is not adding any more pie. 

Under the bill being considered, however, the FDIC would have 

the power to make loans to the financial institutions to purchase 

its debt obligations and other assets, to assume or guarantee obligations and so on. This means the FDIC would be putting its own, 

that is, taxpayers’ skin in the game, a radical departure from 

standard bankruptcy and an approach that mimics closely the actions that Treasury took under TARP. Thus, this bill institutionalizes TARP for bank holding companies. 

A crucial implication of this departure from standard bankruptcy 

is the taxpayer funds foot the bill for the loans, asset purchases, 

guarantees, and other support that FDIC would provide to prevent 

38 

failing institutions from going under. These infusions of taxpayer 

funds come with little meaningful accountability, and it would be 

hard to know when they have been paid back and often that will 

not occur. The proposed new authority for the FDIC also generates 

the impression that society can avoid the losses that failure implies, but that is false. The proposed FDIC actions would merely 

shift those losses to taxpayers. The new approach is institutionalized bailouts, plain and simple. 

Thus, under the expansion of FDIC authority to cover nonbank 

financial institutions, bank holding companies will forever more regard themselves as explicitly, not just implicitly, backstopped by 

the full faith and credit of the U.S. Treasury. That is moral hazard 

in the extreme and it will be disastrous for keeping the lid on inappropriate risk taking. 

The right alternative to expanding FDIC authority is good oldfashioned bankruptcy. It has become accepted wisdom that bankruptcies by financial institutions cause great harm, and it is asserted in particular that letting Lehman Brothers fail was the crucial misstep last fall. In fact, nothing could be further from the 

truth. 

As I explain in more detail in my written testimony, the ultimate 

causes of the financial crisis were two misguided Federal policies; 

namely, the enormous subsidies and pressure provided for mortgage lending to non-creditworthy borrowers and the implicit guarantees provided by both Federal Reserve actions and the U.S. history of protecting financial institution creditors. These forces generated an enormous misallocation of investment capital, away from 

plant and equipment towards housing, created the bubble, and established a setting where numerous financial institutions had to 

fail because their assets were grossly overvalued relative to fundamentals. Lehman’s failure was one part of this adjustment, and 

it was a necessary part. If anything, too few financial institutions 

failed since the massive interventions in credit housing markets 

that have occurred in the past year have artificially propped up 

housing prices, delaying the adjustments. 

Thus, the better way to resolve nonbank financial institutions is 

bankruptcy, not bailout. That is not to say existing bankruptcy law 

is perfect. One can imagine ways it might be faster and more 

transparent, which would be beneficial, nor should one assume that 

had bankruptcy been allowed to operate fully in the fall of 2008, 

the economy would have escaped without any pain. A significant 

economic downturn, in particular, was both inevitable and necessary given the fundamental misallocation of capital that occurred 

in the years before the panic, but nothing in the data, historical 

data or recent experience, suggests these bankruptcies would have 

caused anything worse than what we experienced and broader 

bankruptcies would have helped eliminate more hazards going forward. 

In light of these assessments, I urge the members of this committee to vote against this bill since it codifies an approach to the 

resolution that is fundamentally misguided. We need to learn from 

our mistakes and trust bankruptcies, not bailouts, going forward as 

we should have done in the recent past. 

39 

[The prepared statement of Mr. Miron can be found on page 66 

of the appendix.] 

Mr. CLEAVER. Our next witness is Mr. Mark Zandi, the chief 

economist and co-founder of Moody’s Economy.com. 

MARK ZANDI, CHIEF ECONOMIST AND CO-FOUNDER, MOODY’S 

ECONOMY.COM 

Mr. ZANDI. Thank you to the members of the committee for the 

opportunity to testify today. My remarks are my personal views 

and not those of the Moody’s Corporation, my employer. 

The Obama Administration’s proposed financial regulatory reforms will, if largely enacted, result in a more stable and well-functioning financial system. I will list five of the most important elements of the reform, and I will make a few suggestions on how to 

make them more effective. 

First, reform must establish a more orderly resolution process for 

large, systemically important financial firms. Regulators’ uncertainty and delay in addressing the problems at Lehman Brothers 

and AIG, in my view, contributed significantly to the panic that hit 

the financial system last September. 

Financial institutions need a single, well-articulated, and transparent resolution mechanism outside the bankruptcy process. The 

new resolution mechanism should preserve the system of stability 

while encouraging market discipline by imposing losses on shareholders and other creditors and replacing senior management. 

Charging the FDIC with this responsibility is appropriate given the 

efficient job it does handling failed depository institutions. 

I think it would also be important to require that financial firms 

maintain an acceptable resolution plan to guide regulators in the 

event of their failure. As part of this plan, institutions should be 

required to conduct annual stress tests based on different economic 

scenarios similar to the tests that large banks engaged in this last 

spring. Such an exercise, I think, would be very therapeutic and 

would reveal how well institutions have prepared themselves for a 

badly-performing economy. 

Second, reform must address the ‘‘too-big-to-fail’’ problem, which 

has become even bigger in the financial crisis. The desire to break 

up large institutions is understandable, but I don’t think there is 

any going back to the era of Glass-Steagall. Taxpayers are providing a substantial benefit to the shareholders and creditors of institutions considered ‘‘too-big-to-fail,’’ and these institutions should 

meet higher standards for safety and soundness. As financial firms 

grow larger, they should be subject to greater disclosure requirements, required to hold more capital, satisfy stiffer liquidity standards, and pay deposit and other insurance premiums commensurate with their size and the risks they pose. Capital buffers and insurance premiums should increase in the good times and decline in 

the bad times. 

Third, reform should make financial markets more transparent. 

Opaque structured-finance markets facilitated the origination of 

trillions of dollars in badly underwritten loans which ignited the 

panic when those loans and the securities they supported started 

to go bad. 

40 

The key to better functioning financial markets is increased 

transparency. Requiring over-the-counter derivative trading takes 

place on central clearing platforms make sense; so does requiring 

that issuers of structured financed securities provide markets with 

the information necessary to evaluate the creditworthiness of the 

loans underlying the securities. Issuers of corporate equity and 

debt must provide extensive information to investors, but this is 

not the case for mortgage and asset-backed securities. Having an 

independent party also vet the data to ensure its accuracy and 

timeliness would also go a long way to ensure better lending and 

reestablishing confidence in these markets. 

Fourth, reform should establish the Federal Reserve as a systemic risk regulator. The Fed is uniquely suited for this task given 

its position in the global financial system, its significant financial 

and intellectual resources, and its history of political independence. 

The principal worry in making the Fed the systemic risk regulator is that its conduct of monetary policy may come under onerous oversight. Arguably one of the most important strengths of the 

financial system is the Fed’s independence in setting monetary policy. It would be very counterproductive if regulatory reform were 

to diminish even the appearance of that independence. To this end 

it would be helpful if oversight of the Fed’s regulatory functions 

were separated from the oversight of its monetary policy responsibilities. One suggestion would be to establish semi-annual reporting to the Congress on its regulatory activities much like its current reporting to Congress on monetary policy. 

Fifth, and finally, reform should establish a new Consumer Financial Protection Agency to protect consumers of financial products. The CFPA should have rulemaking, supervision, and enforcement authority. As is clear from the recent financial crisis, households have limited understanding of their obligations as borrowers 

or the risks they take as investors. 

It is also clear that the current fractured regulatory framework 

overseeing consumer financial protection is wholly inadequate. 

Much of the most egregious mortgage lending during the housing 

bubble earlier in the decade was done by financial firms whose corporate structures were designed specifically to fall between the regulatory cracks. There is no way to end the regulatory arbitrage in 

the regulatory framework. The framework itself must be fundamentally changed. 

The idea of a new agency has come under substantial criticism 

from financial institutions that fear it will stifle their ability to create new products and raise the cost of existing ones. This is not an 

unreasonable concern but it can be adequately addressed. The suggestion that the CFPA should require institutions to offer so-called 

plain vanilla financial products to households should be dropped. 

Such a requirement would create substantial disincentives for institutions to add useful features in existing products. 

Finally, let me just say I think the Administration’s proposed 

regulatory reform is much-needed and reasonably well-designed. 

Reform will provide a framework that would not have prevented 

the last crisis, but it would have made it measurably less severe 

and it certainly will reduce the odds and severity of future calamities. 

41 

[The prepared statement of Dr. Zandi can be found on page 112 

of the appendix.] 

Mr. CLEAVER. Our final witness is John H. Cochrane, AQR capital management professor of finance at the University of Chicago 

Booth School of business. 

STATEMENT OF JOHN H. COCHRANE, AQR CAPITAL MANAGEMENT PROFESSOR OF FINANCE, THE UNIVERSITY OF CHICAGO BOOTH SCHOOL OF BUSINESS 

Mr. COCHRANE. Thank you for giving me the opportunity to talk 

to you today. 

This wasn’t an isolated event. We are in a cycle of ever-larger 

risk taking punctuated by ever-larger failures and ever-larger bailouts, and this cycle can’t go on. We can’t afford it. This crisis 

strained our government’s borrowing ability, there remains the 

worry of flight from the dollar and government default through inflation. The next and larger crisis will lead to that calamity. 

Moreover, the bailout cycle is making the financial system much 

more fragile. Financial market participants expect what they have 

seen and what they have been told, that no large institution will 

be allowed to fail. They are reacting predictably. Banks are becoming bigger, more global, more integrated, more systemic, and more 

opaque. They want regulators to fear bankruptcy as much as possible. 

We need the exact opposite. We and Wall Street need to reconstruct the financial system so as much of it as possible can fail 

without government help, with pain to the interested parties but 

not to the system. 

There are two competing visions of policy to get to this goal. In 

the first, large integrated instructions will be allowed to continue 

and to grow with the implicit or explicit guarantee of government 

help in the event of trouble, But with the hope that more aggressive supervision will contain the obvious incentive to take more 

risks. 

In the second, we think carefully about the minimal set of activities that can’t be allowed to fail and must be guaranteed. Then we 

commit not to bail out the rest. Private parties have to prepare for 

their failure. We name, we diagnose, and we fix whatever problems 

with bankruptcy law caused systemic fears. 

Clearly, I think the second approach is much more likely to work. 

The financial and legal engineering used to avoid regulation and 

capital controls last time were child’s play. ‘‘Too-big-to-fail’’ must 

become ‘‘too-big-to-exist.’’ 

A resolution authority offers some advantages in this effort. It allows the government to impose some of the economic effects of failure, shareholders and debt holders lose money, without legal bankruptcy. But alas, nothing comes without a price. 

Regulators fear—their main systemic fear is often exactly the 

counterparties will lose money, so it is not obvious they will use 

this most important provision and instead bail out the counterparties. 

I think the FDIC, as often mentioned, is a useful model. It is useful for its limitations as well as for its rights. These constrain 

42 

moral hazard and keep it from becoming a huge piggybank for Wall 

Street losses. 

The FDIC applies only to banks. Resolution authority must come 

with a similar statement of who is and who is not subject to its authority. Deposit insurance and FDIC resolution come with a serious 

restriction of activities. An FDIC-insured bank can’t run a hedge 

fund. Protection, resolution, and government resources must similarly be limited to systemic activities and the minimum that has 

to accompany them. 

Deposit insurance in FDIC resolution address a clearly defined 

systemic problem, bank runs. A resolution authority must also be 

aimed at a specific defined and understood systemic problem, and 

the FDIC can only interfere with clear triggers. 

The Administration’s proposal needs improvement, especially in 

the last two items. It only requires that the Secretary and the 

President announce their fear of serious adverse effects. That is an 

invitation to panic, frantic lobbying, and gamesmanship to make 

one’s failure as costly as possible. 

It is useful to step back and ask, what problem is it we are trying to fix anyway? Regulators say they fear the systemic effects of 

bankruptcy. But what are these? 

If you ask exactly what is wrong with bankruptcy, you find fixable, technical problems. The runs on Lehman and Bear Stearns 

brokerages, collateral stuck in foreign bankruptcy courts, even the 

run on money market funds, these can all be fixed with changes 

to legal and accounting rules. And resolution doesn’t avoid these 

questions. Somebody has to decide who gets what. If Citi is too 

complex for us to figure that out now, how is the poor Secretary 

of the Treasury going to figure it out at 2 o’clock in the morning 

on a Sunday night? 

The most pervasive argument for systemic effective bankruptcy, 

I think, is not technical; it is psychological. Markets expected the 

government to bail everybody out. Lehman’s failure made them reconsider whether the government was going to bail out Citigroup. 

But the right answer to that problem is to limit and clearly define 

the presumption that everyone will be bailed out—not to expand it 

and leave it vague. 

Here I have to disagree with Mr. Volcker’s testimony. He said we 

should always leave people guessing, but that means people will always be guessing what the government is going to do, leading to 

panic when it does something else. And let me applaud Chairman 

Frank’s statement earlier that no one will believe us until we let 

one happen. I look forward to, not necessarily to that day, but to 

the clearer statement—clearer understanding by markets and the 

government of what the rules are going to be the day afterwards. 

[The prepared statement of Professor Cochrane can be found on 

page 57 of the appendix.] 

Mr. CLEAVER. We are going to begin the conversation with the 

gentleman from Texas, Mr. Neugebauer, who has an appointment 

that he needs to keep and so we will begin with him, and then we 

will move to the other side. 

Mr. Neugebauer. 

Mr. NEUGEBAUER. I thank the gentleman for accommodating me. 

One of the things that I hope that we all agree on, and I think I 

43 

hear, is that there are no more bailouts. That is bad for market discipline, that companies that make bad decisions have to suffer the 

consequences of that. And one of the elements of the Republican alternative is that we believe there are ways to do that. One is making sure that entities are adequately capitalized. But secondly, not 

having someone choose which companies are systemically risky to 

the marketplace and thereby giving them a free pass on their market activities. 

But I want to go to the resolution issue because I think it is 

probably as equally important in restoring market discipline. 

One of the things that I am very concerned about in the current 

bill is that it is a wheel of fortune, as I call it, when you get to 

the bankruptcy or to the dissolution of that entity. Because if someone is arbitrarily going to just choose which people get made whole 

and which aren’t and which people get a certain percentage and 

not follow some orderly discharge of those obligations, how am I 

going to estimate what my risk is when I am either buying equity 

or I am buying security or buying debt or I am buying subordinated debt or taking an unsecured position or secured position if 

somebody else is going to determine what my position is? 

So the Republican plan quite honestly has designed about, as I 

think Mr. Cochrane was talking about, is that if there are—we actually set up a special chapter in the Bankruptcy Code, and if there 

are special powers or additional expertise that are needed to make 

that discharge, but that way everybody that is making an investment in an organization knows that if this investment does go 

south, they understand what their position is and not relying on 

the wheel of fortune in some cases where if the wheel turns in my 

direction, I went from an unsecured to a more preferential position. 

Your comments, Mr. Cochrane? I will start with you and kind of 

just go down the line there. 

Mr. COCHRANE. Yes. I would agree with you. One thing that worries me about great power and no rules is precisely that means not 

only is it a wheel of fortune, it is a wheel of fortune that answers 

your phone calls. So there will be a lot of lobbying. 

It also means that the game of buying debt becomes not one of 

guessing what is the value of the assets, it is one of guessing what 

am I going to get out of the new resolution authority. 

And finally, we are acting as if it is simple. The whole reason we 

are worried about this is that the web of counterparties which are 

systemic, which aren’t systemic, who should get money, who not, 

too complicated to think about. Well, goodness gracious, it is going 

to be even more complicated to think about it at 2 o’clock on a Sunday morning. 

Mr. ZANDI. I agree with many of the things that you said. The 

one thing I worry about and am concerned about is putting these 

institutions into bankruptcy. That has its own set of uncertainties 

as any firm going into bankruptcy and creditors know. And the 

problem is that the uncertainty can drag on for quite some time, 

because of the nature of these financial institutions. We don’t have 

the time. So I think we need a resolution mechanism that is independent of the bankruptcy system. I don’t think the system can be 

fixed to a sufficient degree to address those issues, and to take our 

chances in using bankruptcy, of course, for this process would in 

44 

fact create greater uncertainty and cost taxpayers more in the long 

run. 

Mr. NEUGEBAUER. As a follow-up to what you are saying, I think 

what we envision is a separate actually—possibly judicially, have 

special courts to do that, to have the expertise to make those decisions relatively quickly so that if there is a continuation possibility 

in that entity that there is the ability for someone to make those 

decisions at that particular point in time. It is not much different 

than the resolution concept except that we are going to have an orderly disposition in the event of a liquidation and settling that everybody understands. 

Mr. Miron? 

Mr. MIRON. I would emphasize two aspects of your comments. 

One is I personally think there should be no more bailouts. Whatever the resolution system is, whether it is a bankruptcy court, a 

new kind of bankruptcy that no taxpayer money goes into it. 

Then the second point is, can we design a bankruptcy system, 

even for nonfinancial firms, that is smoother and faster than the 

current one. The answer is probably, but certainly it might be appealing to try to design something which is very fast and very 

smooth, say a default off the shelf and last will and testament that 

you have to create when you are incorporated. 

But I also think finally that the risks of the financial firm bankruptcies have been exaggerated. I don’t say they were zero by any 

means, but I think there was a lot of claiming that the sky was 

going to fall in, which was not based on evidence in the historical 

records. Particularly before 1914, we had many, many financial 

panics. The vast majority were not associated with major changes 

in the economy. They were short. They were limited to a few firms 

and a few cities and the economy recovered very quickly. 

Mr. LEVITT. You know, it is so hard to be formulaic about these 

issues and to try to define what is in the public mind and what 

isn’t. 

When you are going through a panic, and we went through a 

panic, it is scary, very, very frightening. And I wouldn’t take the 

position that there will be no more bailouts. We don’t know what 

there is going to be or how great the threat is going to be. But if 

the resolution authority is so established where the onus is put on 

both creditors and shareholders they will be, in my judgment, in 

a much better position to evaluate the condition of given institutions than any regulator might be. I think holding their feet to the 

fire in that fashion will go a long way toward avoiding the kind of 

calamity that you speak of. 

As to the need for a systemic risk overseer in terms of a council 

that would serve as an early warning system, I think that makes 

a good deal of sense. It would be a hands-on group that would be 

led by a presidential employee. As an alternative, if the Fed were 

to get rid of its conflicts—and I think they have very profound conflicts which make them a less than ideal systemic risk regulator— 

I think the combination of these two could do a great deal to restore public confidence. 

If the public loses total confidence in the system, all of our pronouncements about ‘‘too-big-to-fail’’ and we can’t afford the bailout, 

45 

or what have you, go up in smoke. It is a power that should not 

be underestimated. 

Mr. CLEAVER. Thank you. We are going to have votes in maybe 

15 or 20 minutes. I do think we can get all members in if the members will use the Reader’s Digest version of your questions and if 

you will give the Cliff Notes version of the answer, I think we can 

get through all of these. 

We will begin with the gentlelady from Illinois, Ms. Bean. 

Ms. BEAN. Thank you, Mr. Chairman, and to the witnesses for 

sharing your expertise today. 

Many of us have advocated for countercyclical capital requirements to avoid the kind of depth and width of the downfall that 

we recently experienced, specifically to discourage the type of leverage that we saw. And as Mr. Zandi said in his own testimony, if 

I understood it properly, suggesting that when we see a bubble in 

formation, obviously increasing capital requirements will maybe 

minimize how big that bubble gets. In a precipitous downfall we 

would ease up capital requirements as well, which we didn’t do, so 

it doesn’t get so wide as institutions divest themselves, even in this 

case non-subprime related assets. 

Given that history suggests that regulators, though they have 

the authority to impose those changes, tend not to want to be the 

buzzkill when the party is going, will regulators follow guidance 

from the Feds or does Congress really need to be more proscriptive 

in that regard and require those type of changes relative to capital 

requirements? 

I am asking Mr. Zandi specifically. 

Mr. ZANDI. I think it is a reasonable concern based on historical 

experience. Regulators don’t step in when they need to. It is very 

difficult to do that. And in tough times, they put more pressure on 

institutions, and it can be counterproductive. 

I don’t think it should be resolved legislatively. I think, though, 

it can be addressed through the various accounting rules that are 

adopted to try to effectuate a countercyclical effort to raise capital 

standards, various kinds of insurance. So I think if you can codify 

it in the accounting rules, I think that would be a more effective 

way of doing it. 

Once you start legislating it, then it becomes so binding that— 

we don’t really know what is going to work well. Part of it is going 

to be experimentation, and it is hard to change legislation easily. 

So I think if you can make sure that the accounting rules are set 

in a way that this is done to your satisfaction, then that would be 

the more appropriate thing. 

Mr. LEVITT. I think that is an important point. Accounting is 

really at the heart of much of the problem. We don’t really know 

what many of these institutions hold in their portfolios. I really believe that we need fair market accounting on the part of financial 

institutions, and I think that a lot of this depends upon whether 

you are a deposit-taking institution that engages in transactions 

involving risk or whether you are not a deposit-taking institution. 

I think fair value accounting conveying a clear picture to investors of precisely what risk they may be taking is terribly important. 

Ms. BEAN. Thank you, and I yield back. 

Mr. CLEAVER. The gentleman from California, Mr. Sherman. 

46 

Mr. SHERMAN. Mr. Levitt, you say we shouldn’t adopt the standard of no more bailouts. The Executive Branch believes not only 

that there should be a capacity for future bailouts but that it ought 

to be orderly. And by orderly, what they mean is no further congressional involvement, that if the Executive Branch wants to tie 

up $1 trillion, $2 trillion, and they think it is necessary, God, they 

are good people, they should be able to make that decision without 

the disorderliness that we saw last fall where Congress added a 

bunch of provisions, oversight, and even voted it down the first 

time. 

Do you believe that we ought to give the Executive Branch the authority to commit over $1 trillion to bail out systemically important firms in a time of crisis without further congressional approval? 

Mr. LEVITT. I would rather not be specific about that issue because again, it is so difficult to be in the eye of the storm and find 

yourself bound by formulaic restrictions. 

Mr. SHERMAN. Sir, you are an American. Do you believe in the 

Constitution or not? Is your loyalty to Wall Street greater than 

your loyalty to the Constitution? 

Mr. LEVITT. I don’t think anything in my public life would lead 

anyone to that conclusion, Mr. Sherman. 

Mr. SHERMAN. Doesn’t the Constitution say that appropriations 

are supposed to be made by Congress and that Congress doesn’t 

just give the Executive Branch the right to, in some future instance, spend $1 trillion, $2 trillion, $3 trillion of taxpayer money 

without any congressional involvement? Doesn’t it bother you as an 

American? 

Mr. LEVITT. I think Congress is intimately involved and has been 

intimately involved in this whole process or we wouldn’t be sitting 

here right now. 

Mr. SHERMAN. Briefing a few congressional leaders is constitutionally irrelevant. The Constitution calls for votes on the Floor of 

Congress where even bald guys from California get to vote. For you 

to say that the principles of the Constitution are achieved because 

a few congressional leaders are briefed— 

Mr. LEVITT. You are putting words in my mouth, Mr. Sherman. 

That is not what I said. 

Mr. SHERMAN. Perhaps you should speak for yourself. 

Mr. LEVITT. You are misinterpreting what I have said. And I 

don’t know that this is the appropriate forum to argue about constitutional support or constitutional values. 

Of course, I believe in the power of the Congress and the power 

of the people. 

Mr. SHERMAN. Let me move on. 

There is an argument that the only way we can have institutions 

that are ‘‘too-big-to-fail’’ is to have a system for bailing them out 

if they do fail and of course higher capital requirements in the hope 

that they won’t. The other approach is ‘‘too-big-to-fail’’ is too big to 

exist. 

We could have a rule that said no company can enter into contracts which caused them to be liable to American persons in excess of 1 percent of the U.S. GDP. This could be binding on foreign 

and domestic firms and so if a firm approached that limit, they 

47 

might choose to break up, otherwise they cannot enter into new 

contracts which obligated them. 

Mr. Cochrane, is it better to have a system of larger and larger 

and larger tier 1 financial institutions where people know that if 

you are one of the top five you have a 50 percent chance at least 

of being bailed out if you get into trouble, or is it better to say ‘‘toobig-to-fail’’ is ‘‘too-big-to-exist?’’ 

Mr. COCHRANE. ‘‘Too-big-to-fail’’ is ‘‘too-big-to-exist.’’ 

Mr. SHERMAN. Mr. Zandi? 

Mr. ZANDI. I am a little nervous about answering, to tell you the 

truth, I think given what happened before. 

My sense is that in theory it would be nice to say that if you are 

‘‘too-big-to-fail,’’ you are ‘‘too-big-to-exist.’’ But in reality, in practice, that is not going to happen. That won’t happen. I don’t think 

it is efficient. Our institutions won’t be competitive globally. 

Mr. SHERMAN. If we impose on all institutions worldwide the 

same standard; that is, do not have liabilities to U.S. persons in excess of 1 percent of the U.S. GDP, that would allow all firms, no 

matter where headquartered, to have the same systemic risk to the 

U.S. economy. 

Mr. ZANDI. Two points. One is, why 1 percent? The second is, we 

live in a global financial system. We are not an island unto ourselves. 

Mr. CLEAVER. Mr. Manzullo, the gentleman from Illinois. 

Mr. MANZULLO. Sometimes the hearing that has the fewest members turns out to be one of the most unusual. I always enjoy somebody who teaches at Harvard and is a senior fellow at the Cato Institute. That is interesting. I have big problems with the message 

that we are going to set up the safety net for your guys who screw 

up on Wall Street. I mean, that is how I look at this legislation. 

It has created an America that is looking for a bailout for everything. And people are smart enough to realize that there is no bailout, that the people who are actually either the—probably the 

water in the buckets are the taxpayers who have to take care of 

this load. 

Why have a piece of legislation, Mr. Miron, that, for example, 

you say in the very last line on page 3 of your testimony, ‘‘thus this 

bill institutionalizes TARP for bank holding companies.’’ Tell us 

what is wrong. Just go into depth on your statement. 

Mr. MIRON. The crucial thing is that under this bill, it is not just 

that we have given the FDIC power to resolve, to settle the competing claims, which is similar to what a bankruptcy judge does, 

but we very explicitly said that the FDIC can borrow money from 

Treasury—that is explicitly in the bill—can use that money from 

Treasury to buy the debts of the failing institutions, to take equity 

stakes, to guarantee its obligations and all sorts of things. 

Now, there are provisions in the bill where allegedly the FDIC 

is going to recoup that money later on. The way it recoups it is 

truly bizarre. It recoups it by levying fees on all the remaining tier 

1 financial institutions. So it is kind of like the deposit insurance 

system except it is ex post, not ex anti. 

So the incentive it sets up is for every one of those firms, take 

as much risk as you can, sometimes you will make a lot of profit. 

If you fail and you disappear, then the people who pay for that are 

48 

all of the remaining firms in the industry. So of course every firm 

is going to be thinking that way, so they are all going to be simultaneously trying to outrisk each other. It is just an unmitigated 

recipe for disaster. 

Mr. MANZULLO. There is a new form of capitalism called joint 

and several liability. 

Mr. COCHRANE. It also gives them an incentive to make your failure as systemically fearful as possible, not just to make you get the 

bailout, but you want to hold a gun to everybody’s head that you 

are as dangerous to the financial system as possible so that you 

can get the bailout. 

Mr. MANZULLO. Does it bother you that institutions beyond financial institutions could be impacted by this legislation? 

Mr. MIRON. In what manner? 

Mr. MANZULLO. The broad swoop that could bring in a nonbank. 

Mr. MIRON. Absolutely. First of all, the definition of what is an 

institution covered by this ends up being extremely malleable. So 

GMAC is probably going to come in, and if GMAC is in, then somehow General Motors gets in. You are going to have people who 

make toaster ovens who buy a small brokerage service firm, put it 

on their books, and they are covered and they are ‘‘too-big-to-fail’’ 

and have access to all of these Treasury funds, yes. It is just incredible—it is a blank check. 

Mr. MANZULLO. Do you fellows feel that it would have been better if these banks and obviously the car companies had just filed 

straight Chapter 11 liquidation? Not Chapter 11, Chapter 7 or 

Chapter 11, that would be reorganization and Chapter 7 is straight 

bankruptcy. Use regular bankruptcy laws. 

Mr. MIRON. Absolutely. Now, people correctly point to the fact 

that there are all of these counterparty claims that banks have and 

so if one fails it is likely to spill over into other institutions. That 

is exactly right, but that is only half the story. 

The other half of the story is it happens a few times and all of 

these banks and nonbank financial institutions are going to start 

taking on fewer counterparty risks. They are going to start to 

hedge better, they are going to take less risks, and they are going 

to start to adjust their behavior so that then the spillovers when 

one fails will not be nearly as extreme. And it is going to be painful 

to get to that point where people do business in a different way. 

But as Chairman Frank said at the very beginning, it is not going 

to start happening until we actually stick it to somebody. 

Mr. LEVITT. I think the resolution authority is more effective 

than the bankruptcy law in terms of doing the job you want done. 

It is fairer. 

Mr. MIRON. It is fairer? 

Mr. CLEAVER. I am going to call on the gentleman from Colorado, 

Mr. Perlmutter. 

Mr. PERLMUTTER. Thank you, Mr. Chairman. Let us sort of get 

back to that last topic. That is the last thing that I need to understand. 

Chairman Levitt, how do we resolve broker-dealers? 

Mr. LEVITT. How do we resolve? 

Mr. PERLMUTTER. Broker-dealers. 

49 

We have a court proceeding through a liquidation. How do we resolve banks and credit unions? Mr. Miron, how do we liquidate 

banks and credit unions? 

Mr. MIRON. The way we liquidate them now in is through the 

FDIC. In the vast majority of cases until recently— 

Mr. PERLMUTTER. We liquidate them. We liquidate them and sell 

and then we offload whatever are the bad debt and we tried to sell 

them, parcel them out, do something with them. 

Mr. Cochrane, how do we liquidate or how do we resolve insurance companies? 

Mr. COCHRANE. The key component— 

Mr. PERLMUTTER. How do we resolve insurance companies? Do 

you know? We liquidate them through the insurance commissioner. 

Now, guys, I am a Chapter 11 lawyer. I did it for 25 years. So 

if the Republicans want to have more Chapter 11, God bless them. 

I just don’t see when you are dealing—when you have assets that 

are fairly liquid, whether they are stock certificates that you are 

holding or insurance policies you are holding or cash that you are 

holding, a Chapter 11 doesn’t work very well because now you are 

dissipating potentially during the course of the reorganization assets that really belong to somebody else. 

Now, you know, I have done—I can’t tell you how many Chapter 

11’s I have done. And you can see that by taking GM, Chrysler, 

they were able to go through Chapter 11, but they did a lot of work 

proceeding that to do the Chapter 11. 

So, in my opinion, if we have a holding company that may—part 

of the problem is, I think, that we have institutions that are just 

too big and they also have too many products. They are stockbrokers, they are insurance companies and they are banks, all at 

the same time. And so now how do we deal with them in an orderly 

way? Everybody is using resolution authority. I call it something 

where we need to have an orderly liquidation. Now, do you think 

we can do that in a Chapter 11, really, Mr. Miron? 

Mr. MIRON. Yes. I agree that you are going to end up in many 

cases just liquidating. In some cases, depending on the nature of 

the different things that have been put together, some pieces are 

easily sold off and can operate; some pieces were perfectly solvent 

and profit-making. 

Mr. PERLMUTTER. So how do you manage those really liquid assets that might be a depositor’s asset, or it is a bond or it is a stock 

certificate or something? See, the problem is, we have— 

Mr. MIRON. I don’t understand why we don’t just sell it to the 

highest bidder. I am confused. Why doesn’t it just get sold to the 

highest bidder? 

Mr. PERLMUTTER. Well, that would be a liquidation. That would 

be a Chapter 7. And I don’t mean to—you guys use bankruptcy as 

if it is some general term. You do things differently in bankruptcy 

court. 

Mr. ZANDI. Can I make a point? We had a case study of a firm 

that went into bankruptcy, and we saw how well it went. Lehman 

Brothers is a case in point that went into bankruptcy. It was a 

complete mess. It would have been a complete fiasco if the government had not stepped in, in response to that. 

50 

I think we saw pretty clearly what bankruptcy does. It does not 

work in the case of these large, very complicated institutions, 

which have very liquid assets that can go out the door immediately. 

It just didn’t work and I don’t think you can fix it to make it work. 

Mr. PERLMUTTER. I really would like to think that it could, okay? 

Now, I guess maybe I have done too many of them to recognize how 

long some of these things take and how complicated they get and 

how you fight about a particular subject in the court when these 

are the kinds of things that require resolution promptly, quickly, 

for the certainty that you are seeking, Mr. Miron and Mr. Cochran, 

the certainty that you are seeking for the marketplace? 

Mr. LEVITT. Or the certainty that resolution brings to the process 

by putting the creditors on notice that they, too, can lose everything before it happens. 

Mr. PERLMUTTER. Right. See, I don’t want any more bailouts. I 

am with you guys. And I subscribe to the ‘‘too-big-to-fail’’ is ‘‘toobig-to-exist.’’ Great. Those are nice goals and platitudes. But when 

you are in an emergency, you are in an emergency, and all rules 

seem to go by the wayside because you just have to get the job done 

and keep the system going. I want to separate stockbrokers from 

the bankers. 

Thank you, Mr. Chairman. I appreciate the time. 

Mr. CLEAVER. [presiding] Thank you. Mr. Foster from Illinois. 

Mr. FOSTER. Thank you. First, I would like to second my endorsement of Dr. Zandi’s endorsement of periodic stress tests for 

potentially systemically important firms. So, for example, if specifically, all firms that have balance sheets that exceed 1 percent of 

GDP would be required to report in appropriate detail what their 

situation would be like under conditions of mild, moderate, or depression-like economic downturn. I think this would be a tremendous benefit. If you have comments on that, I would be interested 

in hearing them. 

The second thing I would be interested in hearing your comments on is the concept of requiring large firms to maintain a living will, essentially a pre-negotiated private sector bailout. A variation of this are these reverse convertible debentures, if I am pronouncing that correctly, where you essentially have things that 

convert to equity, and requiring firms that are approaching ‘‘toobig-to-fail’’ to hold a significant amount of debt in that form, so 

that when the trigger gets pulled, they automatically have a prenegotiated, as I say, private sector bailout. 

And I think forcing institutions to confront the possibility of their 

demise, having the board of directors vote on, yes, this is the plan 

for dissolving ourselves if we fail, could have a tremendously positive cultural impact on Wall Street. So I would be interested. 

And finally, the last question is whether any of you are aware 

of anything that is understood about the efficiency of our economy 

as a function of the maximum allowable bank size. Like what is the 

hit in economic growth that we would take if we limited banks to 

certain sizes. If there is anything that is known about that academically, I would be very interested in hearing about it. 

Mr. ZANDI. Well, let me say I think the idea of requiring institutions to have a living will as part of that process, also engaging in 

regular stress testing, would be very therapeutic. I think it would 

51 

provide a lot of information to the marketplace, and I think it 

would be very therapeutic for the banks. It was actually surprising 

to me in the stress tests that were conducted back in the spring 

that it was such a chore for the institutions; you would think that 

they would have the mechanism for doing things like this. But in 

fact, they really did not. 

I think just going through that process was very enlightening for 

them, for the regulators and for, obviously, market participants, 

and it was very key to turning confidence around at a very important point in the crisis. I think it was very important and therapeutic. So I think that is vital. 

That is an interesting question about bank size and economic efficiency. I don’t know of any academic literature, but that would be 

an interesting thing to explore. 

Mr. FOSTER. It certainly gets mentioned qualitatively. Every time 

we talk about limiting bank size, they say, oh no, this would be a 

disaster for economic efficiency. I would like to see the curve of economic efficiency versus bank size limits. 

Mr. COCHRANE. It is a hard question, and I can’t tell you the answer, but I can tell you the question. Which is, are banks so large 

because that is the natural—they are more efficient by being more 

large, or are banks more large because this gets them better access 

to bailouts and government protection? I have suspicions it is in 

the other direction, but I wish I had better evidence. 

Mr. FOSTER. Any other comments on this? Then I yield back. 

Mr. CLEAVER. Thank you. The gentleman from Texas, Mr. Green, 

is recognized for 3 minutes. 

Mr. GREEN. Thank you, Mr. Chairman. But, Mr. Chairman, out 

of fairness, I am not sure that this young man has had— 

Mr. HIMES. No, no. Go ahead. 

Mr. GREEN. Thank you. And I will be as terse and laconic as possible. Permit me to say that I don’t have the time to lay the proper 

predicate, but, Mr. Levitt and Mr. Miron—Mr. Miron, following 

your logic, we would not use the FDIC for banks. We would use 

bankruptcy, following your logic. 

Now, with that aside, I would like to talk about this issue of pain 

that you use rather cavalierly. Pain needs to be defined, because 

pain can mean more than just a loss of money. It can also have 

something to do with the worth of money. 

Mr. Levitt, if you would, the pain of allowing AIG to go into 

bankruptcy, the pain of allowing Bear Stearns to go into bankruptcy, the pain of allowing Lehman to go into bankruptcy, the 

pain of allowing the auto industry—Chrysler and GM—to go into 

bankruptcy, what would that pain translate into locally, meaning 

within the United States and globally? 

Mr. LEVITT. That pain has a danger that reverberates not just 

throughout the United States, but throughout the world, because 

what you are talking about is the pain of public confidence. And 

that loss of public confidence could lead to catastrophic results. So 

it is very hard to quantify the implications of job loss, of the 

cratering of institutional creations that were looked upon as symbols of stability, and it just shakes the confidence of the people to 

its very roots. So that is a very, very severe penalty. 

52 

Mr. GREEN. My final comment would be this—and I will yield 

back. My concern is this; is that we are not paying enough attention to each other. My belief is that we all want a resolution authority, without spending tax dollars. But for some reason, we are 

saying such that it appears as though the other doesn’t want it, 

when I think the folk on the other side desire it, and the folks on 

this side desire it. 

But I do think that there has to be some credence given to what 

Mr. Levitt has said. You can never say never in a world that is dynamic. It is not static. I remember Ronald Reagan saying that he 

would never sign a certain piece of legislation. He said that his 

feet—he was sealed in cement. And when he signed it, he said 

what you hear is that cement cracking right now. 

My point is, I am with all of you. We should not bail out. Never 

bail out again as long as we live. Don’t want to do it, shouldn’t 

have done it this time. Never. God forbid, if we have to, how do 

we do it? 

Thank you, Mr. Chairman. I yield back. 

Mr. CLEAVER. Thank you. One of the questions that plagues me 

is the whole concept of ‘‘too-big-to-fail,’’ which may be also ‘‘toointerconnected-to-fail.’’ And I don’t know if those are synonymous, 

‘‘too-big-to-fail’’ and ‘‘too-interconnected-to-fail.’’ How do you read 

those, Dr. Zandi? 

Mr. ZANDI. I think they are synonymous. I think you can be 

large, and if your connections are limited, and you are not going 

to affect other institutions, then I think you can be resolved in the 

normal course of affairs. I don’t think that is significant. But generally, I mean, if you are large and big, that means you are interconnected. You can’t become large and big unless you are. You have 

all these different relationships and moving parts and, therefore, 

big generally is synonymous with— 

Mr. CLEAVER. So should we restrict the connectedness? 

Mr. ZANDI. I don’t think you can. 

Mr. CLEAVER. I mean, that prevents the snowball from rolling 

down the hill. 

Mr. ZANDI. I don’t think you can, because these institutions need 

to have relationships all over the globe in different markets, you 

know; they are providing different kinds of products and services 

to the economy. So I don’t think there is any logical way of doing 

that, no. 

Mr. COCHRANE. I do think, sir, that you are asking an extremely 

important question that I hope you will ask more and more. Toowhat-to-fail? Through last year I have heard lots of oh, there will 

be—the world will end. There will be systemic risk. And nobody 

says exactly what is the systemic risk that is going to cause the 

great calamity. Is it too big? Too interconnected? What exactly is 

the problem? Keep asking that question, please. 

Mr. ZANDI. Well, I could give an answer. Just go back to last September and October. It came to such a point that the—because of 

the failure of Lehman, because of the near failure of AIG, because 

of other various events, the Nation’s nonfinancial commercial paper 

market was frozen, literally. So blue chip companies that make everyday products were on the verge of shutting their businesses 

down. And I know this firsthand, because I was getting calls from 

53 

senior management of major retailers saying, ‘‘I am not going to 

get delivery of product to put onto my store shelf because this company can’t get credit.’’ 

So that was because of the interconnectedness of the financial 

system, and it bled right to the nonfinancial world, literally within 

a few days. 

Mr. COCHRANE. It wasn’t just because of Lehman Brothers failing. 

Mr. CLEAVER. Okay. Under normal circumstances I would like to 

keep going on this, because I am very concerned about it. And if 

I had time, I would like to juxtapose what the Swedish Government did with what we did. They separated the troubled assets and 

created—we kind of flirted with this for a moment about the bad 

bank, which is a bad term. But since we don’t have time, and since 

I don’t want to miss the vote, I appreciate very much you sharing 

with us, and your time and your intellect. This has been very, very 

helpful and informative. 

There are some things I am supposed to say. So whatever I don’t 

say that I am supposed to say, it is said. The committee is adjourned. 

[Whereupon, at 12:35 p.m., the hearing was adjourned.] 

(55) 

A P P E N D I X 

September 24, 2009 

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