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STRENGTHENING AND STREAMLINING 

PRUDENTIAL BANK SUPERVISION 

HEARING 

BEFORE THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED ELEVENTH CONGRESS 

FIRST SESSION 

ON 

STRENGTHENING AND STREAMLINING PRUDENTIAL BANK SUPERVISION TO BETTER PROVIDE THE SAFETY, SOUNDNESS, AND STABILITY OF THE FINANCIAL MARKETS 

AUGUST 4 AND SEPTEMBER 29, 2009 

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

( 

Available at: http://www.access.gpo.gov/congress/senate/senate05sh.html 
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

CHRISTOPHER J. DODD, Connecticut, Chairman 

TIM JOHNSON, South Dakota 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

EVAN BAYH, Indiana 

ROBERT MENENDEZ, New Jersey 

DANIEL K. AKAKA, Hawaii 

SHERROD BROWN, Ohio 

JON TESTER, Montana 

HERB KOHL, Wisconsin 

MARK R. WARNER, Virginia 

JEFF MERKLEY, Oregon 

MICHAEL F. BENNET, Colorado 

RICHARD C. SHELBY, Alabama 

ROBERT F. BENNETT, Utah 

JIM BUNNING, Kentucky 

MIKE CRAPO, Idaho 

MEL MARTINEZ, Florida 

BOB CORKER, Tennessee 

JIM DEMINT, South Carolina 

DAVID VITTER, Louisiana 

MIKE JOHANNS, Nebraska 

KAY BAILEY HUTCHISON, Texas 

JUDD GREGG, New Hampshire 

EDWARD SILVERMAN, Staff Director 

WILLIAM D. DUHNKE, Republican Staff Director 

AMY S. FRIEND, Chief Counsel 

DEAN V. SHAHINIAN, Senior Counsel 

CHARLES YI, Senior Policy Adviser 

BRIAN FILIPOWICH, Legislative Assistant 

DEBORAH KATZ, OCC Detailee 

MATTHEW GREEN, FDIC Detailee 

MARK JICKLING, CRS Detailee 

MARK OESTERLE, Republican Chief Counsel 

JIM JOHNSON, Republican Counsel 

ANDREW J. OLMEM, JR., Republican Counsel 

JEFFERY L. STOLTZFOOS, Republican Counsel 

HEATH P. TARBERT, Republican Special Counsel 

CHAD DAVIS, Republican Professional Staff Member 

DAWN RATLIFF, Chief Clerk 

DEVIN HARTLEY, Hearing Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor 

(II)
C O N T E N T S 

TUESDAY, AUGUST 4, 2009 

Page 

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

Opening statements, comments, or prepared statements of: 

Senator Johnson 

Prepared statement ................................................................................... 43 

Senator Reed 

Prepared statement ................................................................................... 43 

WITNESSES 

Sheila C. Bair, Chairman, Federal Deposit Insurance Corporation .................... 2 

Prepared statement .......................................................................................... 44 

Responses to written questions of: 

Senator Bunning ....................................................................................... 79 

John C. Dugan, Comptroller of the Currency, Office of the Comptroller of 

the Currency ......................................................................................................... 4 

Prepared statement .......................................................................................... 48 

Responses to written questions of: 

Senator Bunning ....................................................................................... 82 

Daniel K. Tarullo, Member, Board of Governors of the Federal Reserve 

System ................................................................................................................... 5 

Prepared statement .......................................................................................... 66 

Responses to written questions of: 

Senator Bunning ....................................................................................... 89 

John E. Bowman, Acting Director, Office of Thrift Supervision .......................... 7 

Prepared statement .......................................................................................... 72 

Responses to written questions of: 

Senator Bunning ....................................................................................... 90 

TUESDAY, SEPTEMBER 29, 2009 

Opening statement of Chairman Dodd .................................................................. 99 

Prepared statement .......................................................................................... 132 

WITNESSES 

Eugene A. Ludwig, Chief Executive Officer, Promontory Financial Group, 

LLC ........................................................................................................................ 101

Prepared statement .......................................................................................... 132 

Martin N. Baily, Senior Fellow, Economic Studies, The Brookings Institution . 104 

Prepared statement .......................................................................................... 144 

Richard S. Carnell, Associate Professor, Fordham University School of Law .... 107 

Prepared statement .......................................................................................... 153 

Richard J. Hillman, Managing Director, Financial Markets and Community 

Investment Team, Government Accountability Office ...................................... 109 

Prepared statement .......................................................................................... 159 

(1) 

STRENGTHENING AND STREAMLINING 

PRUDENTIAL BANK SUPERVISION 

TUESDAY, AUGUST 4, 2009 

U.S. SENATE, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, Washington, DC. 

The Committee met at 9 a.m. in room SD–538, Dirksen Senate 

Office Building, Senator Christopher J. Dodd (Chairman of the 

Committee) presiding. 

OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD 

Chairman DODD. The Committee will come to order. Let me welcome our guests who are in the hearing room this morning, as well 

as to welcome our very distinguished panel of witnesses, and we 

thank the four of you and the second panel that is going to come 

as well. 

I have informed our colleagues already, those who are here, and 

others, we are under some time constraints. We have a couple of 

votes around 10:30 that are coming up on the floor of the Senate. 

There is a meeting that we are going to have that begins a little 

after noon that many of us are going to have to attend later. So 

we are not going to make any opening statements, including the 

Chairman and the Ranking Member. We have agreed this morning 

just to get right to our witnesses. 

I know my colleague from Tennessee would like that precedent, 

I tell you. He has been dying for that moment for 2 years. 

[Laughter.] 

Senator SHELBY. Mr. Chairman, when he was mayor, nobody 

spoke. 

Chairman DODD. No, no. Just the mayor spoke. We are not setting precedent here, but we are certainly going to, this morning, 

move in that direction. 

So let me thank again everyone for being with us this morning. 

Obviously, strengthening and streamlining prudential bank supervision is a major subject matter. We have had I do not know how 

many hearings. What is the number? Twenty-eight hearings since 

January on this subject matter of financial modernization regulations. And, obviously, this is a very critical piece to the extent we 

are going to have consolidation of our financial regulators. 

And so I welcome our witnesses here this morning. Many—well, 

all of you have been before us on numerous occasions to talk about 

the various aspects of the financial troubles our Nation has been 

in over the last number of years. And I just want to make one 

point, and I know all of you at the table pretty well, and I know 
2 

you understand this because I believe you care about this as well. 

Our job, obviously, here is not to protect regulators. Our job is, obviously, to protect the people who count on us and you and the system to provide the safety and soundness and the stability of the financial markets. That is what this is all about. And I know you 

get that and understand that, but I sometimes think we need to 

clear the air a little bit to make sure people understand what we 

are talking about as we describe the structure and the architecture 

that will provide that sense of stability and safety and soundness 

that we are looking for. 

So, with that, let me just turn directly, if I can, to you, Sheila, 

to start in on this. I will ask you to try and be brief. Again, all the 

documents and all of my colleagues’ opening statements will be included in the record at this point here. 

We will try and be a little more careful on the clock than we 

might otherwise be because of time constraints. 

Jim, I am just explaining we have got some votes in an hour and 

a half or so. We are going to try and move along to the extent possible. 

Sheila, we thank you again for being with us. 

STATEMENT OF SHEILA C. BAIR, CHAIRMAN, FEDERAL 

DEPOSIT INSURANCE CORPORATION 

Ms. BAIR. Thank you, Senator Dodd, Ranking Member Shelby, 

and Members of the Committee. Today you have asked us to address the regulatory consolidation aspects of the Administration’s 

proposal and whether there should be further consolidation. 

The yardstick for any reform should be whether it deals with the 

fundamental causes of the current crisis and helps guard against 

future crises. Measured by that yardstick, we do not believe the 

case has been made for regulatory consolidation of State and Federal charters. 

Among the many causes of the current crisis, the ability to 

choose between a State and Federal charter was not one of them. 

As a consequence, we see little benefit to regulatory consolidation 

and the potential for great harm and its disruptive impact and 

greater risk of regulatory capture and dominance by large banking 

organizations. 

The simplicity of a single bank regulator is alluring. However, 

such proposals have rarely gained traction in the past because prudential supervision of FDIC-insured banks has, in fact, worked well 

compared to the regulatory structures used for other U.S. financial 

sectors and to those used overseas. Indeed, this is evidenced by the 

fact that large swaths of the so-called ‘‘shadow banking sector’’ 

have collapsed back into the healthier insured sector. 

And U.S. banks, notwithstanding the current problems, entered 

this crisis with stronger capital positions and less leverage than 

their international competitors. 

A significant cause of the crisis was the exploitation of regulatory 

gaps between banks and the shadow nonbank financial system and 

virtually no regulation of the over-the-counter derivatives contracts. There were also gaps in consumer protection. To address 

these problems, we have previously testified in support of a systemic risk council that would help assure coordination and harmo-
3 

nization of prudential standards among all types of financial institutions. 

And a council would address regulatory arbitrage among the various financial sectors. 

We also support a new consumer agency to assure strong rules 

and enforcement of consumer protection across the board. However, 

we do not see merit or wisdom in consolidating all Federal banking 

supervision. The risk of weak or misdirected regulation would be 

exacerbated by a single Federal regulator that embarked on a 

wrong policy course. Prudent risk management argues strongly 

against putting all your regulatory and supervisory eggs in one 

basket. 

One of the advantages of multiple regulators is that it permits 

diverse viewpoints to be heard. For example, during the discussion 

of Basel II, the FDIC voiced deep and strong concerns about the 

reduction in capital that would have resulted. Under a unified regulator, the advanced approaches of Basel II could have been implemented much more quickly and with fewer safeguards, and banks 

would have entered this crisis with much lower levels of capital. 

Also, there is no evidence that shows a single financial regulatory structure was better at avoiding the widespread economic 

damage of the past 2 years. Despite their single-regulator approach, the financial systems in other countries have all suffered 

during the crisis. 

Moreover, a single-regulator approach would have serious consequences for two mainstays of the American financial system: the 

dual banking system and deposit insurance. The dual banking system and the regulatory competition and diversity that it generates 

is credited with spurring creativity and innovation in financial 

products and the organization of financial activities. State-chartered institutions tend to be community-oriented and very close to 

the small businesses and customers they serve. They provide the 

funding that supports economic growth and job creation, especially 

in rural areas. Main Street banks also are sensitive to market discipline because they know they are not too big to fail and that they 

will be closed if they become insolvent. 

A unified supervisory approach would inevitably focus on the 

largest banks to the detriment of community banking. In turn, this 

could cause more consolidation in the banking industry at a time 

when efforts are underway to reduce systemic exposure to very 

large financial institutions and to end ‘‘too big to fail.’’ 

Concentrating examination authority in a single regulator also 

could hurt bank deposit insurance. The loss of an ongoing and significant supervisory role would greatly diminish the effectiveness of 

the FDIC’s ability to perform a congressional mandate. It would 

hamper our ability to reduce systemic risk through risk-based premiums and to contain the costs of deposit insurance by identifying, 

assessing, and taking actions to mitigate risk to the Deposit Insurance Fund. 

To summarize, the regulatory reforms should focus on eliminating the regulatory gaps I have just outlined. Proposals to create 

a unified supervisor would undercut the many benefits of our dual 

banking system and would reduce the effectiveness of deposit in-
4 

surance, and, most importantly, they would not address the fundamental causes of the current crisis. 

Thank you. 

Chairman DODD. Thank you very much, and I apologize, Sheila, 

for not properly introducing you here as the Chairperson of the 

Federal Deposit Insurance Corporation. I kind of assume everybody 

knows who you are, so I kind of jumped into that, and I apologize. 

John Dugan is the Comptroller of the Currency, and we thank 

you very much, a well-known figure to this Committee, having 

served on this side of the dais for a number of years and now at 

the OCC. So we thank you, John. 

STATEMENT OF JOHN C. DUGAN, COMPTROLLER OF THE CURRENCY, OFFICE OF THE COMPTROLLER OF THE CURRENCY 

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

Chairman Dodd, Ranking Member Shelby, and Members of the 

Committee, I appreciate this opportunity to discuss the Administration’s proposal for regulatory reform. 

The OCC supports many elements of the proposal, including the 

establishment of a council of financial regulators to identify and 

monitor systemic risk and enhanced authority to resolve systemically significant financial firms. We also believe it would be appropriate to establish a consolidated supervisor of all systemically significant financial firms. 

The Federal Reserve already plays this role for the largest bank 

holding companies, but during the financial crisis, the absence of 

a comparable supervisor for large securities and insurance firms 

proved to be an enormous problem. The proposal would fill this gap 

by extending the Federal Reserve’s holding company regulation to 

such firms, which we believe would be appropriate. 

However, one aspect of the proposal goes much too far, which is 

to grant broad new authority to the Federal Reserve to override the 

primary banking supervisor on standards, examination, and enforcement applicable to the bank. Such override power would fundamentally undermine the authority and accountability of the 

banking supervisor. 

We also support the proposal to effectively merge the OTS into 

the OCC with a phase-out of the Federal Thrift Charter. My written testimony responds in detail to the Chairman’s questions about 

options for additional banking agency consolidation by: first, establishing either the Federal Reserve or the FDIC as the single Federal agency responsible for regulating State-chartered banks; second, establishing a single prudential supervisor to supervise all national and State banks; and, third, transferring all holding company regulation from the Federal Reserve to the prudential supervisor. 

While there are significant potential benefits to be gained from 

all three proposals, there are also potential costs, especially with 

removing the Federal Reserve altogether from the holding company 

regulation of systemically important companies. 

Finally, we support enhanced consumer financial protection 

standards and believe that a dedicated consumer protection agency 

could help to achieve that goal. However, we have significant concerns with the parts of the proposed CFPA that would consolidate 
5 

all financial consumer protection rulewriting, examination, and enforcement in a single agency which would completely divorce these 

functions from safety and soundness regulation. 

It makes sense to consolidate all consumer protection rulewriting 

in a single agency with the rules applying to all financial providers 

of a product, both bank and nonbank. But we believe the rules 

must be uniform and that banking supervisors must have meaningful input into formulating them. Unfortunately, the proposed CFPA 

falls short on both counts. 

First, the rules would not be uniform because the proposal would 

expressly authorize States to adopt different rules for all financial 

firms, including national banks, by repealing the Federal preemption that has always allowed national banks to operate under uniform Federal standards. This repeal of a uniform Federal standards option is a radical change that will make it far more difficult 

and costly for national banks to provide financial services to consumers in different States having different rules, and these costs 

will ultimately be borne by the consumer. The change will also undermine the national banking charter and the dual banking system 

that have served us well for nearly 150 years. 

Second, the rules do not afford meaningful input from banking 

supervisors, even on real safety and soundness issues, because in 

the event of any disputes, the proposed CFPA would always win. 

The new agency needs to have a strong mechanism for ensuring 

meaningful bank supervisor input into CFPA rulemaking. 

Finally, the CFPA should not take examination and enforcement 

responsibilities away from the banking agencies. The current bank 

supervisory process works well where the integration of consumer 

compliance and safety and soundness supervision provides real 

benefits for both functions. Moreover, moving bank examination 

and enforcement functions to the CFPA would only distract it from 

its most important and daunting implementation challenge—that 

is, establishing an effective enforcement regime for the shadow 

banking system of the literally tens of thousands of nonbank providers that are currently unregulated or lightly regulated, like 

mortgage brokers and originators. The CFPA’s resources should be 

focused on this fundamental regulatory gap rather than on already 

regulated depository institutions. 

Thank you very much. 

Chairman DODD. Thank you very much. 

Dan Tarullo, from the Federal Reserve Board, we thank you, 

Dan, once again for coming before the Committee. Happy to hear 

your testimony. 

STATEMENT OF DANIEL K. TARULLO, MEMBER, BOARD OF 

GOVERNORS OF THE FEDERAL RESERVE SYSTEM 

Mr. TARULLO. Thank you, Mr. Chairman, Ranking Member Shelby, and other Members of the Committee. 

Before the final history of the financial crisis is written, I am certain that supervisory shortcomings in all kinds and sizes of financial institutions, will have been revealed. The crisis has also shown 

that the framework for prudential supervision and regulation has 

not kept pace changes in the structure, activities, and interrelationships of the financial sector. 
6 

In my prepared testimony, I have suggested and tried to elaborate the elements of an effective framework for prudential supervision, including a number of recommendations for legislative actions. Knowing of your time constraints this morning, let me confine these introductory remarks to three quick points. 

First, prudential supervision must be required for all systemically important institutions. It is noteworthy that a number of the 

firms at the heart of the crisis had not been subject to mandatory 

prudential supervision of any sort. Improving the quality of supervision will fall short of realizing the maximum potential gains for 

financial stability if important institutions can escape the rules and 

requirements associated with the supervisory process. 

Second, there must be effective supervision of the companies that 

own insured depository institutions, a task that is distinct from the 

supervision of the banks themselves. Large organizations increasingly manage their businesses on an integrated basis, with little regard for the corporate boundaries that typically define the jurisdiction of individual functional supervisors. There is need for close 

scrutiny of the linkages between the banks and other affiliates 

within a holding company—not just straightforward financial or 

contractual ties, but also managerial, operational, and reputational 

linkages. The premise of so-called ‘‘functional regulation’’—that 

risks within a diversified organization can be successfully evaluated and controlled through supervision within each individual 

firm—has been belied by the experience of the financial crisis. 

Third, it is important to emphasize that much of what needs to 

be done to improve and adapt our system of prudential supervision 

lies within the existing authorities of the agencies represented at 

this table. Together, we have acted to shut down the practice of 

converting charters in order to escape enforcement actions or adverse supervisory ratings. We are working together in international 

fora to assure that all internationally active financial institutions 

are subject to effective regulation. The Federal Reserve is adjusting 

its approach to prudential supervision, particularly of the largest 

banking organizations. 

Building on the experience of the unprecedented Supervisory 

Capital Assessment Program, or SCAP, we are expanding our use 

of horizontal examinations to assess key operations, risks, and risk 

management of large institutions. We are creating an enhanced 

quantitative surveillance mechanism that will draw on a multidisciplinary group of economists and other experts to create and 

evaluate scenarios that cross large firms. These top–down analyses 

will provide an independent supervisory perspective on the bottom– 

up work of supervisory teams. The two perspectives will be joined 

in a well-coordinated process involving both the supervisory teams 

and Washington staff. 

Thank you all for your attention. I look forward to discussing 

both agency and congressional initiatives to strengthen further our 

prudential supervisory system. 

Chairman DODD. Thank you very much, Governor. 

I will now turn to our last witness, John Bowman, who is the 

Acting Director of the Office of Thrift Supervision. John, we welcome you once again to the Committee. 
7 

STATEMENT OF JOHN E. BOWMAN, ACTING DIRECTOR, 

OFFICE OF THRIFT SUPERVISION 

Mr. BOWMAN. Good morning, Chairman Dodd, Ranking Member 

Shelby, and other Members of the Committee. Thank you for the 

opportunity to testify on the Administration’s proposal for financial 

regulatory reform. It is my pleasure to address this Committee for 

the first time in my role as Acting Director of the Office of Thrift 

Supervision. I will begin my testimony by outlining the core principles I believe are essential to accomplishing true and lasting reform. Then I will address specific questions you asked regarding 

the Administration’s proposal. 

Let me start with the four principles. 

One, ensure that changes to the financial regulatory system address real problems. We all agree that the system has real problems and needs real reform. What we must determine, as we consider each proposed change, is whether the proposal would fix what 

is broken. In the rush to address what went wrong, let us not try 

to fix nonexisting problems or try to fix real problems with flawed 

solutions. 

Two, ensure uniform regulation. One of the biggest lessons 

learned from the current economic crisis is that all entities offering 

financial products to consumers must be subject to the same rules. 

Underregulated entities competing in the financial marketplace 

have a corrosive, damaging impact on the entire system. Also, complex derivative products such as credit default swaps should be regulated. 

Three, ensure that systemically important firms are effectively 

supervised and, if necessary, wound down in an orderly manner. 

No provider of financial products should be too big to fail, achieving 

through size and complexity an implicit Federal Government guarantee to prevent its collapse. The U.S. economy operates on the 

principle of healthy competition. Enterprises that are strong, industrious, well managed, and efficient succeed and prosper. Those that 

fall short of the mark struggle or fail, and other stronger enterprises take their places. Enterprises that become too big to fail subvert the system. When the Government is forced to prop up failing 

systemically important computers, it is, in essence, supporting poor 

performance and creating a moral hazard. 

Let me be clear. I am not advocating a cap on size, just effective, 

robust authority for properly regulating and resolving the largest 

and most complex financial institutions. 

Number four, ensure that consumers are protected. A single 

agency should have the regulation of financial products as its central mission. That agency should establish the rules and standards 

for all consumer financial products, regardless of the issuer of those 

products, rather than having multiple agencies with fragmented 

authority and a lack of singular accountability. 

Regarding feedbacks on the questions the Committee asked, the 

OTS does not support the Administration’s proposal to eliminate 

the Office of the Comptroller of the Currency and the Office of 

Thrift Supervision, transferring the employees of each into a national bank supervisory agency or for the elimination of the Federal 

Thrift Charter. Failures by insured depository institutions have 
8 

been no more severe among thrifts than among institutions supervised by other Federal banking regulators. 

If you look at the numbers of failed institutions, most have been 

State-chartered banks whose primary Federal regulator is not the 

OTS. 

If you look at the size of failed institutions, you see that the Federal Government prevented the failures of the largest banks that 

collapsed by authorizing open bank assistance. These too-big-to-fail 

institutions are not and were not regulated by the OTS. 

The argument about bank shopping for the most lenient regulator is also without merit. Most financial institutions and more assets have converted away from OTS supervision in the last 10 

years than have converted to OTS supervision. 

In the same way the thrift charter is not part of the problem, we 

do not see any reason to cause major disruptions with the hundreds of legitimate, well-run financial businesses that are operating 

successfully with the thrift charter and making credit available to 

American consumers. My written testimony contains detailed information you requested about the proposed elimination of the exceptions in the Bank Holding Company Act for thrifts and certain special-purpose banks and about the Federal Reserve System’s prudential supervision of holding companies. 

Thank you again, Mr. Chairman, and I would be happy to answer any questions. 

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

Let me ask the clerk to put the clock on here for about 6 minutes 

per Member, and I have two questions I want to raise with you, 

if time permits, and then I will turn to Senator Shelby. 

First of all, for decades—and I have been on this Committee for 

a number of years, and we have had commissions and think tanks 

and regulators, presidents, Banking Committee Chairs. John, you 

will remember sitting behind us back here at that table with parties recommending the consolidation of Federal banking supervision. Bill Proxmire, who sat in this chair for a number of years, 

proclaimed the U.S. system of regulation to be, and I quote, ‘‘the 

most bizarre and tangled financial regulatory system in the world.’’ 

Former FDIC Chairman, Sheila, Chairman William Seidman, 

called it ‘‘complex, inefficient, outmoded, and archaic.’’ 

In the wake of the last bank and thrift crisis, when hundreds of 

institutions failed, the Clinton administration urged Congress to 

consolidate the Federal banking regulators into a single prudential 

regulator. So here we have seen Administrations, Chairs of this 

Committee, and others over the years, all at various times, in the 

wake of previous crises, call for consolidation, and yet we did not 

act after those crises. We sat back and basically left pretty much 

the system we have today intact. And as a result, we have had 

some real costs ranging from inefficiencies and redundancies to the 

lack of accountability and regulatory laxity. We are now paying a 

very high price for those shortcomings. 

So my first question is—the Administration, as you all know and 

you have commented on, has proposed the consolidation of the OCC 

and OTS, but leaves in place the three Federal bank regulators. My 

question is simply: Putting the safety and soundness of the banking system first, is the Administration proposal really enough? Or 
9 

should we not be listening to the admonition of previous Administrations? And people have sat in this chair who have recommended 

greater consolidation that ought to be the step taken. 

Sheila, we will begin with you. 

Ms. BAIR. As I indicated in my opening statement, we do not 

think that the ability to choose between the Federal and State 

charter was any kind of a significant driver or had any kind of an 

impact at all on the activities that led to this current crisis. The 

key problems were arbitrage between more heavily regulated banks 

and nonbanks, and then the OTC derivatives sector, which was 

pretty much completely unregulated. 

I do support merging OCC and OTS. That is reflective of market 

conditions, but that doesn’t need to be about whether there is a 

weak regulator or strong regulator. I think that is just a reflection 

of the market and the lack of current market interest in a specialty 

charter to do just mortgage lending or heavily concentrate on mortgage lending. In fact, some of the restrictions on the thrift charter 

perhaps have impeded the ability of those thrifts to undertake additional diversification. 

So, Mr. Chairman, I would have to respectfully disagree in terms 

of drivers of what went on this time around. I really do not see that 

as a symptom of the fact that you have four different regulators 

overseeing different charters for FDIC-insured institutions. And I 

do think that the banks held up pretty well compared to the other 

sectors. They did have higher capital standards and more extensive 

regulation. 

Chairman DODD. Let me just ask you and the other panelists to 

comment on this. Clearly, we are looking back in the rearview mirror as to what happened, and that is certainly a motivation here. 

But it is not the sole motivation. It is not just a question of addressing the problems that occurred, but going forward, in the 21st 

century, in a very different time, in a global economy today—we 

saw the implications of what happened not only here in this country but around the world. The idea that we would maintain the 

same architecture we have for decades is not only a question about 

what has occurred and whether or not the system responded well 

enough to it, but looking forward as to whether or not this architecture and structure is going to be sufficient to protect the safety and 

soundness in a very different economic environment than existed at 

the time these agencies emerged through the process of growth 

over the years. It seems to me that is just as important question 

as looking back. 

Ms. BAIR. I think it is a very important question, and I am very 

glad you are having these hearings. But I do not think that this 

is going to solve the problems that led to this crisis. Looking at the 

performance of other models in European countries that have a single regulator, the performance is not particularly good. 

I do think there is a profound risk of regulatory capture by very 

large institutions if you collapse regulatory oversight into one single entity. I think having multiple voices is beautiful. We testified 

before this Committee on the Advanced Approaches under Basel II. 

We resisted that, and we slowed it down. And because of that, our 

banks—commercial banks, FDIC-insured banks—had not 

transitioned into that new system, which would have significantly 
10 

lowered the amount of capital they would have had going into this 

crisis, unlike what happened in Europe and with investment 

banks. 

So we think having multiple voices can actually strengthen regulation and guard against regulatory capture. If you have a single 

monopoly regulator, there is not going to be another regulator out 

there saying, ‘‘We are going to have a higher standard,’’ ‘‘We are 

going to be stronger,’’ or ‘‘We are going to question that.’’ I think 

you lose that with a single regulator. So you should look carefully 

at the European models and how they functioned during the crisis. 

Chairman DODD. We are talking here—John, let me ask you, we 

are talking about a consumer financial product safety agency. Obviously, the Fed is very much here. We are talking about that as well 

and having a prudential regulator. Why is that not necessarily the 

kind of checks and balances we are talking about in the system? 

Mr. DUGAN. I cannot really defend the current system of so many 

regulators. As one of my predecessors used to say, it does not work 

in theory, but we have worked hard to make it work in practice. 

And having said that, I think there is more you could do if you 

were so inclined, and you have gone from four regulators to three 

prudential regulators in the proposal. You could go the next step 

to have a single regulator for State-chartered institutions, which 

would bring you down to two. You could go to one regulator for the 

banks, and you could even bring in the holding company regulation 

to the prudential supervisor. 

As I mentioned in my testimony, there are advantages and disadvantages in each of those steps. I think at the end of the day, 

if you put everything all in one place, it would be probably too 

much. And so I think that is probably a bridge too far, but there 

are things that you could do that would simplify things for the future. 

I do not believe, and agree with Sheila, that this was a principal 

contributing cause of this crisis. But I think going forward we do 

have to think hard about what is the best system for the future, 

and giving those matters real thought is a good thing. 

Chairman DODD. Dan and John, some quick responses to my 

question. 

Mr. TARULLO. Mr. Chairman, among the many reasons why 

Members of this Committee will not be unhappy to see the summer 

recess come is they will not have to listen to me say, for about the 

third hearing in a row, that each proposal that comes before us is 

going to have some advantages and some disadvantages. 

I do think, as John and Sheila have suggested, that nobody 

would sit down and write the system we have now if they were 

starting from scratch. But the system having been in place, you 

have seen that there are some advantages to splitting bank supervision. I personally think it would be a very bad idea not to have 

the deposit insurer have a bank examination function, so that the 

deposit insurer understands how banks are functioning before they 

fail, and thus be better able to resolve them. 

I also think that it is important for the Federal Reserve, as the 

central bank and as the holding company supervisor, to have a 

window into how banks function. 
11 

Would there be efficiency gains in some sense from having a single regulator? There probably would be, but I think my colleagues 

to my right have already pointed out some of the disadvantages as 

well. 

Chairman DODD. John. 

Mr. BOWMAN. I would agree with some of the disadvantages that 

have been pointed out. I think the other question that we would 

have is the form that the current system holds, a multiple of regulators, really the cause of the issue we are dealing with today? And 

I would suggest that, in fact, the principal cause, as the Administration says in its proposal—high-cost loans, only 6 percent of the 

high-cost loans provided American consumers were provided by depository institutions that were regulated under the current system; 

94 percent were provided by the so-called ‘‘shadow banking regulator.’’ 

That is why we would suggest the focus really should be on filling the regulatory gaps that exist today and that really need to be 

filled. 

Chairman DODD. Senator Shelby. 

Senator SHELBY. Mr. Chairman, just for the record, just my observation, I would think that if you look at the record here of the 

failure of the regulatory bodies, that all roads seem to lead to the 

Federal Reserve. They don’t lead to the FDIC. They don’t lead to 

the Comptroller. They don’t lead to the Community Bank Supervisor. But just about all of them lead to the Fed, and let us be honest about it. 

I want to get into something else. Chairman Bernanke has testified before this Committee that this crisis has revealed that our 

Nation’s ‘‘too-big-to-fail’’ problem is much worse than many 

thought. After the bailouts of Bear Stearns, AIG, Chrysler, and 

GM, our markets now have good reason to expect that the Federal 

Government will bail out any prominent company that gets into financial trouble, perhaps. 

My question to you is, what steps need to be taken to restore 

market discipline and minimize the moral hazard created by the 

bailouts over the past year? Is this a problem that will not be 

solved until the Federal Government actually allows several prominent institutions to fail? In other words, we are going down a road, 

a dead-end road on the ‘‘too-big-to-fail’’ thing. 

Sheila. 

Ms. BAIR. Well, we very much agree with you, Senator, and that 

is why when I have testified before this Committee previously our 

priority focus has been on resolution authority. We need a mechanism that can resolve very large financial organizations in a way 

that is orderly, that protects the rest from any systemic implications, but makes sure that their creditors and shareholders take 

losses. We don’t have that right now and I don’t think we are going 

to get that restored market discipline until Congress puts something like that in place. 

Senator SHELBY. John. 

Mr. DUGAN. I agree that we need a better mechanism to have 

more orderly resolutions of companies that get into trouble so that 

you can have more instances where you don’t have threats to the 

system just by resolving them. I think you need to do more up front 
12 

by way of capital requirements and liquidity requirements so they 

don’t get into that position. And I think you will have more circumstances where larger institutions can be failed in an orderly 

manner. 

I do think, however, that you have to preserve some flexibility for 

the Government—— 

Senator SHELBY. Sure. 

Mr. DUGAN. ——in emergency circumstances where the entire 

system is threatened, like we were last fall, to be able to address 

that concern, and I know that is hard, but I think you really need 

to do that. 

Senator SHELBY. Governor. 

Mr. TARULLO. Senator, I certainly agree with the utility of the 

resolution mechanism, but when you ask about market discipline, 

I think there is more that we need to do. The resolution mechanism 

comes at the end of the day. It comes at the time of failure. It 

would be better to create additional incentives that preclude the 

failure. We surely need more transparency and disclosure by financial institutions, particularly the largest. 

And as I have indicated a couple of times in prepared testimony, 

I think we also need to be looking at alternative requirements for 

the capital structure of at least large institutions. There are a number of ideas out there that would require certain kinds of convertible debt to be in the capital structure of a company. That is good 

because there is market discipline as long as it is a debt instrument. The debt holders want to be paid. And they know if the financial institution gets into trouble, that that debt will be converted into equity. It will provide a buffer against loss and they 

will be subject to loss. 

So I think that market discipline has a number of different avenues that we should pursue, and market discipline itself should be 

pursued alongside of some other regulatory mechanisms. 

Senator, if I could, you know I was not at the Federal Reserve 

up until a few months ago, and as I have said repeatedly, I really 

do believe here is plenty of blame to go around everywhere. But I 

don’t honestly think that all roads lead to the Fed on this. I mean, 

Bear Stearns—— 

Senator SHELBY. Well, which don’t lead to them? 

[Laughter.] 

Mr. TARULLO. I would say, Senator, Bear Stearns, AIG, Lehman, 

Fannie and Freddie. There were a lot of problems in this system, 

and as I said earlier, I think before this crisis is over, we are going 

to have seen a lot of failures in a lot of kinds of institutions. I don’t 

say that to try to deflect any responsibility. In fact, I think part 

of what I was trying to say in my prepared remarks and in the introductory remarks was that I and everybody on the Board takes 

seriously where things didn’t get regulated as well as they should 

have and where the structure needs work, and that is why we 

started to make the changes we are already making. 

Senator SHELBY. Just for the record, and we all know this, but 

who is the regulator, the primary regulator of the holding companies, the big banks that got into trouble? You know it is your Federal Reserve, and you are now—you weren’t, but you are now a 

member of the Board of Governors. Let us be honest about it. 
13 

Mr. TARULLO. Well, that is absolutely true, Senator. In some 

cases, the bank is regulated by other regulatory agencies and there 

are also entities—— 

Senator SHELBY. But the primary regulator of the—— 

Mr. TARULLO. Of the holding companies, right. 

Senator SHELBY. ——is the Federal Reserve. 

I haven’t got much time, but I want to pick up on a couple of 

things. Today’s Wall Street Journal had a tough article dealing 

with Secretary Geithner when he met with a bunch of you, where 

he told the financial regulators that they should stop—can you 

imagine the gall here of the Secretary—that they should stop criticizing the Obama administration regulatory reform plan. My gosh. 

I hope you won’t quit. I think your honesty and your candor here 

is very important. 

We recognize the role of the Treasury to set some policy for financial regulation. But ultimately, it is going to be the Congress 

up here. This Committee, both sides of the aisle, and the House is 

going to set the tone and create the laws. And I appreciate you 

bringing this independent perspective with all kinds of pressure 

placed on you. 

Does the testimony that you have given here today, that you 

have provided, is that your own views, such as it was, not in any 

way influenced by Secretary Geithner’s tirade against you the other 

day? It is a serious question. Is this your—— 

Chairman DODD. Who are you asking the question of here? 

Which one of these—— 

Senator SHELBY. I was asking all of them. 

Mr. DUGAN. Yes, it is our own testimony. Congress requires and 

prohibits the Treasury Department from intervening in any legislative view we express to the Committee. We do not clear our statements through the Treasury Department and we take that independent function very, very seriously. 

Senator SHELBY. Sheila. 

Ms. BAIR. Yes. I don’t think anybody thinks we are not independent. It was absolutely our testimony. 

Senator SHELBY. We hope you are going to stay independent. 

Ms. BAIR. I will. 

Senator SHELBY. Governor. 

Mr. TARULLO. Absolutely, Senator. The only people I discussed 

this with are my fellow members of the Board and the staff of the 

Federal Reserve. 

Senator SHELBY. Mr. Bowman. 

Mr. BOWMAN. Senator Shelby, I think our testimony speaks for 

itself and we do take exception to the Administration’s approval, 

and yes, we are independent. 

Senator SHELBY. Thank you, Mr. Chairman. 

Chairman DODD. Thank you very much. 

Senator Brown. 

Senator BROWN. Thank you. I was a little surprised by Senator 

Shelby’s question, considering the positions that you have all 

taken. 

Let me look at this in kind of a different way. The public has a 

general understanding. The investing public and the victims of this 

financial disaster, which is my whole State and most of this coun-
14 

try, has a general understanding that regulation of financial institutions, putting it mildly, fell far short. Some have the belief that 

the most, I think the most egregious institutions found an agency 

that was too easy on them. In Washington, we call that regulator 

shopping. They just think that the Government, for whatever reason, was too easy on Wall Street greed. 

And I hear each of you. There may be some turf issues, and that 

may be a cynical way to look at it and I apologize if that is the 

way you take it, but I hear the—I see the President’s plan, the 

President’s proposed bank supervision framework. I hear each of 

you disputing major parts of it. How would you explain to the 

American public what the next step is? How do we fill the financial 

gaps in our financial regulatory system if consolidation of regulators is not the best move? How do you explain to the public why 

four very smart people playing very important roles in our financial 

institution regulatory system and an Administration that, I think, 

has equally smart people that understand this, why is there not 

more agreement? 

How do you explain in understandable terms, if you were talking 

directly to the American people now, not to this Committee, what 

we should do to fill these gaps so these kinds of egregious, awful 

things don’t happen again? I will start with you, Ms. Bair. 

Ms. BAIR. Well, I think there was arbitrage, but it was between 

the bank and the nonbank sectors. It was excess leverage with investment banks and hedge funds and other types of vehicles versus 

the higher leverage in risk-based capital requirements that we had 

for commercial banks. 

On consumer protection, it was third-party mortgage originators 

that were not affiliated with insured depository institutions originating loans being funded by Wall Street funding vehicles. The 

third-party mortgage originators were pretty much outside of any 

type of prudential or consumer protection standards that were 

within the purview of the banking regulators. 

So I think it is unfortunate the word ‘‘bank’’ is used for just 

about every institution, but in my world, a bank is an FDIC-insured institution. While we all made mistakes, the insured depository institution sector has held up pretty well. This is why you saw 

in December so many financial companies fleeing to become bank 

holding companies and trying to grow their insured institutions, 

because that was the sector that was left standing, which is hard 

for the FDIC because our exposure has increased significantly. We 

have tried to do the things we need to do to stabilize the system. 

But, this has increased our exposure significantly. 

As I have testified before, the arbitrage is between the banks and 

the nonbanks. Having a consumer agency with a focus especially 

on examination and enforcement of the nonbank sector and having 

a Systemic Risk Council that would have the authority to define 

systemic issues or systemic institutions, whether or not they voluntarily want to come in under the more stringent regulatory regime 

we have for banks and bank holding companies. 

The arbitrage was between the bank and the nonbank sectors. It 

was not among different types of bank charters, and certainly not 

between the choice of a State or Federal charter. There are 8,000 

community banks in this country. Most of them have a State char-
15 

ter, so consequently, we regulate about 5,000 banks. I don’t think 

they contributed to this, but you have seen traditional resistance 

among community banks to regulatory consolidation for fear, frankly, which I share, that inevitably there would be a regulatory viewpoint that would be dominated by the larger institutions if everyone was lumped in together. 

There is a valid reason for State charters. The community banks 

and State-chartered community banks tend to be more local in 

their interest and how they conduct their lending. To try to draw 

that issue into the much larger problems we had with arbitrage between banks and nonbanks and then the lack of regulation of derivatives, I think, is misguided and is not where you should be focusing your efforts or the American public should be focusing its 

efforts. 

Senator BROWN. Mr. Dugan, your thoughts? 

Mr. DUGAN. I agree with everything Sheila just said. I would 

point out that we also regulate about a quarter of the Nation’s community banks, so we do all different sizes of institutions. And most 

of the problems did not take place inside of the insured depository 

institutions that we supervise, which are the most extensively regulated parts of the system. 

Of course, we did make some mistakes and there were some 

problems. I am not discounting that. But that is not where most 

of them were. 

The second thing I would say is I think there are a number of 

very sound and strong proposals in the Administration’s reform 

proposal, which I do support, as I testified. There are just some 

places where we think it should be shaped differently, and carrying 

out our duty to provide our views independently, that is what we 

are trying to suggest. 

With the CFPA, for example, we agree that a strong Federal consumer protection rulewriter to provide a single set of rules that applies to everybody is a very powerful change. But we think taking 

that same step and applying it to the enforcement and examination 

of the depository institutions should stay with the bank regulators 

where it works well, and instead, all of that effort should go to the 

examination, enforcement, and implementation of the nonbanking 

sector where there were very substantial problems that have led to 

disproportionately higher levels of foreclosures, for example, in 

your State and many of the States represented in this room. 

Senator BROWN. Thank you. 

Governor Tarullo. 

Mr. TARULLO. Thank you, Senator. If you are asking, what 

should the public be focused on, my suggestion would be too big to 

fail. That is not the only problem by a long shot, but to me, it continues to be the central problem—the ability to avoid the moral 

hazard that comes with ‘‘too-big-to-fail’’ institutions. As I said a moment ago, I think we need a variety of supervisory and regulatory 

tools to contain that problem, whether it is resolution, bringing systemically important institutions into the perimeter of regulation, 

making sure that the kinds of capital and liquidity requirements 

that systemically important institutions have will truly contain untoward risk taking. 
16 

I think we are going to need a broad set of activities. ‘‘Too big 

to fail’’ was not the only cause, but it was at the center of this crisis and that is, I think, what we all need to focus on. 

The only other thing I would say harks back to a colloquy you 

and I had a couple of weeks ago when I was testifying. You and 

I were talking about attitudes and orientation and how people in 

the Congress and the regulatory agencies and the Administration 

think about issues and problems. It is not easy to ensure against 

people losing interest in issues. But I think that is a role that, in 

a system of Government that has a lot of checks and balances, we 

have to think about. 

How do we try to institutionalize skepticism and critical thinking, to look at developments in the financial world so that we don’t 

just say, well, that is just another market development; it must be 

benign. But instead, we must begin to distinguish intelligently between benign, useful innovations on the one hand and building 

problems on the other. 

Senator BROWN. Thank you. 

Mr. Bowman. 

Mr. BOWMAN. Thank you, sir. One of the advantages of being last 

on a panel like this is you usually get to agree and sort of dispel 

the notion that we disagree on so many things. I agree with what 

my colleagues have said, but I would also like to focus on the arbitrage position between banks and nonbanks. 

I think the CFPA provision of the Administration’s bill goes a 

long ways toward dealing with that situation. The difference is that 

you don’t get to sell a product at a nonregulated entity under different terms and conditions, a different regulatory structure, than 

you would if you were doing so in a depository institution or otherwise regulated entity. I think that is one of the critical components 

of this Administration’s proposal to fix that gap. 

Senator BROWN. Thank you. Thank you, Mr. Chairman. 

Chairman DODD. Thank you very much, Senator Brown. 

Senator Corker. 

Senator CORKER. Mr. Chairman, thank you, and as always, I 

thank each of you for your testimony. 

I also, like I am sure most people did, read the story this morning in the Wall Street Journal regarding the meeting on Friday, 

and generally speaking, did it capture the essence of the attitude 

in the meeting? 

Ms. BAIR. Who is going to take that one? 

[Laughter.] 

Senator CORKER. Very briefly. I just want to move on to 

other—— 

Mr. DUGAN. Senator, it was a candid conversation about our 

agencies’ different views on the different subjects and—— 

Senator CORKER. It was a generally fair article? 

Mr. DUGAN. A lot of it was true. 

Senator CORKER. OK. So here is—— 

[Laughter.] 

Senator CORKER. I guess what I would like to get at, it is my understanding that the original draft had the National Banking Supervisor not being actually a part of Treasury. I think we have 

seen today that—and we have known for some time—Treasury can 
17 

exercise—try to exercise influence over the organizations, and my 

understanding is that, again, in the beginning, the National Banking Supervisor was not a part of Treasury and at the last minute 

it was put back in. 

And I just wonder if one of the things we ought to be looking at 

is absolutely ensuring that this Banking Supervisor is not a part 

of Treasury and even more independent than has been laid out, 

very briefly. 

Mr. DUGAN. May I respond to that? 

Senator CORKER. Yes. 

Mr. DUGAN. This may surprise you, but I was a strong advocate 

of keeping it within the Treasury but subject to the same firewalls 

that we have now, which does give the agency a very strong ability 

to operate independently. I believe that making it independent and 

creating a new board, if you have three other regulators still in existence and everybody has got boards, I think it will confuse things. 

It is critical, however, that you do have those statutory firewalls 

that were put in place. And that was a position that I advocated. 

Senator CORKER. Any differing opinions from the panel? 

Ms. BAIR. As an independent agency that does the types of supervisory functions that the OCC and OTS perform, we look to them 

to help protect the Deposit Insurance Fund through their front line 

prudential supervision of banks that we insure. So, I think there 

are some merits in making it independent. As an independent 

agency, you do want to make sure it is as insulated as possible 

from any type of influences that might not be focused on prudential 

supervision and the safety and soundness of the institution. 

Senator CORKER. OK. Thank you. 

Mr. Tarullo, I think I have actually been very supportive of our 

Chairman of the Federal Reserve, differing from some of the folks 

on the panel. And yet at the same time, there is no doubt the Federal Reserve had some failings in this last go around. 

I read your 2005, the Federal Reserve Service Purposes and 

Function document, and it actually does, just for what it is worth, 

state that one of your responsibilities is maintain the stability of 

the financial system and containing systemic risk that may arise 

in financial markets and providing financial services to depository 

institutions. So I think it is fair to say that, in essence, you sort 

of did have responsibility there. 

I am wondering how harboring all of that at the Federal Reserve 

would alter, if you will, behavior. I think all of us understand today 

that we need to be more concerned about systemic risk. I am sure 

the Fed does, too. And again, I say this with respect for the organization, but obviously with concerns. I am just wondering what 

would be different if, in fact, the Fed was the systemic regulator— 

the systemic regulator. 

Mr. TARULLO. Senator, I don’t think there are any proposals on 

the table that would really make the Fed a systemic risk regulator 

in the sense of being able to swoop in anywhere, anytime, and say, 

we want to do something about this. The proposal that we have endorsed is making the Federal Reserve the consolidated supervisor 

of systemically important institutions. 

I would say in direct response to your question, there is certainly 

a responsibility there, and I would be the first to say that respon-
18 

sibilities of all the financial regulators, including the Fed, were not 

exercised as effectively as they ought to have been. But I would 

also say that when you give an entity responsibility, you do have 

to make sure that you give it authority to achieve that responsibility, to fulfill it, and that you have the mechanisms that will 

allow it to do the job. 

And when you have a circumstance in which large institutions 

that turned out to be systemically important—I think in some 

cases to the surprise of many—and were not within the perimeter 

of regulation, it was obviously not going to be an easy matter to 

contain the activities of those institutions, including a lot of the 

wholesale funding and a lot of the very tightly wound, complex 

securitization that was a major contributor to these problems. 

So I would say, first, you need to make sure that the appropriate 

legal authorities are present. Second, as I have often said, there 

needs to be a reorientation of our regulatory approach more generally toward systemic risk. And third, the Federal Reserve, I 

think, needs to take more advantage of the comparative abilities 

that it has. That is why we wanted to move forward, to make use 

of the economic and financial expertise to provide a monitoring of 

and a check upon the on-the-ground supervisors. That is where the 

advantages lie and that is where we ought to bring them together. 

Senator CORKER. Let me just ask one last question. I know there 

are differing thoughts on ‘‘too big to fail,’’ but each of you feel that 

that is a big issue, how to deal with that. I know that I would like 

to see a resolution mechanism in place where they resolve much 

like Chairman Bair proposes. 

Mr. Dugan, I don’t understand how, if you continue to give 

Treasury the ability to solve the problem with taxpayer money if 

they deem it an important thing to do, I don’t understand how that 

creates any market discipline. It seems to me that leaving that 

vague line in place defeats all market discipline. I don’t understand 

how you can cause those to measure up or how we could craft 

something that actually worked and caused people like the Senator 

from Ohio’s constituents and mine, which I think are different in 

thinking about some things, but I think they would agree that that 

is wrong, and yet you propose keeping it in place and I don’t understand that. 

Mr. DUGAN. I think there are ways that you have to limit it. I 

think there are presumptions so that you make it more difficult to 

exercise. I think there are measures that you have to take up front 

so you don’t get yourself in that position. 

My only point, though, is this: when you are in a crisis and you 

need to take action and you need to do it to protect the financial 

stability of the system, I don’t think we should tie the hands of the 

Government from being able to do it in a moment’s notice if we 

have to. I don’t ever want to be in some of the weekend situations 

that I was in last fall, and we did have mechanisms that ensured 

a wide variety of the Government was involved in the decisions. 

People can second-guess some of those judgments, but I really do 

not think it is a good idea to completely forbid the ability to address systemic situations and crises if we have to. 

Senator CORKER. Thank you. 

Chairman DODD. Thank you very much. 
19 

Senator Menendez. 

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

your testimony. 

I gather from the panel that, in fact, there is a sense that beyond 

maybe what the Administration is proposing, which is merging 

OTS into the OCC, there isn’t a view that there should be any further regulatory consolidation. So my question is, if we don’t do 

that, then there still seems to be the opportunity for regulatory arbitrage where the regulated companies would choose what they believe to be the most lax regulator. 

So what mechanisms can we put in place to prevent that, to prevent the shopping? For example, the Administration’s restrictions 

that are proposed on the ability of a troubled bank to switch charters, is that enough by themselves to prevent a regulatory arbitrage that we want? I would like to hear some of your ideas on 

that. 

Mr. TARULLO. Senator, I will start if that is OK. Congress has 

provided some mechanisms to contain regulatory arbitrage. A lot of 

restrictions that apply to national banks are made by Congress to 

apply to State banks if they are going to get Federal deposit insurance. That is an important backdrop, number one. 

Number two, the provision you just referred to, I think is an important one, and it is one on which the agencies have already tried 

to act. Actually I was going to tell the Chairman this—we had a 

break in your hearing in March during which Chairman Bair 

turned to me and said, you know, we have to figure out a way to 

do something about entities trying to get different charters when 

they are under enforcement actions or they see an enforcement action coming. And so she launched an initiative among the agencies 

to have us all reaffirm that charter conversion ought not to happen 

unless the institution is sound, there are no enforcement actions 

pending, and it is not being used to avoid supervisory ratings. 

A couple of the institutions shifting charters over the last several 

years that have become reasonably well known engaged in that 

sort of flight from enforcement. So I think this was a very important gap to plug. 

Senator MENENDEZ. Anything else? Is that enough? 

Mr. DUGAN. I think it is very important. We have seen over the 

years, a number of situations in which people have switched charters to avoid supervisory action. I totally support the action we 

have taken. If we wanted to go further and put some of that in legislative language, I would think that might be a very good idea, 

just to make sure that we don’t change it in the future. 

Senator MENENDEZ. Chairman Bair. 

Ms. BAIR. I would agree with that, and we indicate that in our 

written testimony. We are the insurer. We are not the chartering 

entity. So, once deposit insurance is granted, if the entity then decides later to shift charities, we really don’t have a role in that decision. We particularly feel that it is in our interest to ensure good, 

strong, robust prudential supervision. We do not want charter conversions to, in any way, be used to undermine that process. 

We would also be happy to work with you. Senator Reed and I 

had a conversation a while back about putting something like that 

in the statute to make sure the provision is there. 
20 

Senator MENENDEZ. Well, I would join Senator Reed in that effort. 

Let me ask you, some big banks—— 

Mr. BOWMAN. Senator Menendez, if I could address that question—— 

Senator MENENDEZ. Surely. 

Mr. BOWMAN. ——I think one of the charters, which I think is 

being used as an example of an arbitrage opportunity was the 

choice by Countrywide to move from regulation by the OCC and 

the Fed to regulation by the OTS. This was in March of 2007. In 

doing so, Countrywide brought approximately $92 billion in assets 

to the OTS. We undertook a very extensive coordination with the 

Fed, including the Fed Bank of San Francisco, the OCC, and others, as well as State regulators of various affiliates within the Fed’s 

holding company jurisdiction. We granted the charter to Countrywide. 

But one of the facts that seemed to be sort of lost in a lot of the 

discussion is that 3 months or 4 months before Countrywide came 

to the OTS, Citibank took two historic thrift charters totaling approximately $232 billion in assets to the national bank charter 

from the Federal thrift charter shortly after Countrywide came. 

Cap One took approximately $17 billion in assets from a thrift 

charter to the OCC. 

I would suggest that the mere action of an entity, a business entity choosing to change its charter based upon its business plan in 

and of itself does not necessarily suggest that they fleeing a particular set of regulatory structures or whatever else. 

Senator MENENDEZ. No, I appreciate that. 

Mr. BOWMAN. I just wanted to make myself clear on that point. 

Senator MENENDEZ. I appreciate that. 

Let me ask the question, several big banks have come here and 

argued before the Committee that we shouldn’t have a Consumer 

Financial Protection Agency because it is bad to separate safety 

and soundness regulations from consumer protection regulations. 

But that argue doesn’t, at least to make, make much sense because 

safety and soundness regulations and consumer protection regulations are currently together in the same agencies and that very 

system failed miserably to protect middle-class American consumers. 

So if there is concern about regulators having overlapping responsibilities, can’t that be solved by assigning clear responsibilities to each regulator and creating some solid procedures for resolving conflicts among regulators? 

Ms. BAIR. On the consumer protection side, rulewriting traditionally has been divorced from enforcement, so the FDIC and the OCC 

have no power to write consumer rules. We examine and enforce, 

but we have never had rulewriting authority. That is separate already. So I think the bank regulators generally—I do not want to 

speak for others—are supportive of this because the arbitrage, the 

choice, if you will, was not so much among bank charters, but between being a bank or being a nonbank. Mortgage brokers with 

very little regulation could originate loans without anybody looking 

over their shoulders, regarding undocumented income, or regressively marketing teaser-rate 2/28s and 3/27s. 
21 

The value added with this new agency is providing rules across 

the board for both banks and nonbanks. And as we have all testified, keeping the examination and enforcement function with the 

bank regulators for the banks and having this new agency focus its 

examination and enforcement resources on the nonbank sector 

where there is not much oversight would give consumers protection 

across the board. So, whether they are dealing with a bank or a 

nonbank, they have some baseline level of protection and a regulator actually coming in and making sure those rules are being enforced and adhered to. 

Does that answer your question? 

Senator MENENDEZ. Yes. Mr. Dugan, do you want to jump in? 

Mr. DUGAN. I was just going to say I agree completely with everything Sheila just said, and attached to my testimony are examples of a number of the ways in which integrated safety and soundness and consumer protection supervision has found issues for both 

safety and soundness purposes and for consumer protection purposes that otherwise would not have been found under the current 

system. We believe that under the examination and supervision 

system currently in place, bank examiners are good at implementing rules that are written, and to the extent that a new agency writes strong rules, they will be complied with by banks through 

this function better than any other alternative model. 

Senator MENENDEZ. So basically—and, Mr. Chairman, I will end 

on this. My understanding from the panel is that you are all in 

support of a consumer financial protection agency? 

Mr. TARULLO. No, Senator, that is not true. The Federal Reserve 

has not taken a position one way or another on the creation of 

the—— 

Senator MENENDEZ. Are you going to take a position? 

Mr. TARULLO. If we were specifically asked, I guess we would at 

least discuss among ourselves. I think our effort to this point has 

been to point out the virtues of integrated supervision and regulation of consumer products alongside the obvious virtues of a separate agency. 

Senator MENENDEZ. Thank you, Mr. Chairman. 

Chairman DODD. Thank you, Senator Menendez. 

Senator Bunning. 

Senator BUNNING. Thank you, Mr. Chairman. 

I am very happy to see all of you here today. After you kissed 

the ring of the Secretary of the Treasury, you finally got out of the 

room, and you are here in person to testify, independently. It is 

really nice to see that. 

Mr. Tarullo, I want to go back to something that you said earlier. 

You said that the Fed would like to have the authority and the 

power to enforce. We gave you that 14 years ago—more than 14 

years ago, actually. Now it is 15 or 16 years ago. And you did not 

write a regulation for 14 years to govern the banks that were 

under your control or the mortgage brokers that were under your 

control. I know you were not at the Fed. That is not the problem. 

The problem is the Fed had the ability to act and did not. 

So you might understand some of us not being agreeable to giving you more power when you failed in enforcing the power we 

gave you. So just for your information, you can take it back to 
22 

Chairman Bernanke and the rest of the board and say, ‘‘You know, 

it took you, Mr. Bernanke, 2 years after you became Chairman to 

write a regulation on mortgages. And it took Chairman Greenspan 

12 years not to write it.’’ So we are a little reluctant to give the 

Fed new additional authority. I just happen to agree with Chairman Bair on when the rubber hits the road, they are there to make 

something happen. 

Now, our panel is trying to figure out how to stop the rubber hitting the road—in other words, how to prevent systemic risk from 

becoming too big to fail. That seems to be the major problem. 

Senator Corker brought it up earlier today about, you know, we 

really need ideas, because we seem to have failed by not giving the 

authority to the right person or the right person not enforcing the 

authority we gave them. 

So my question to you is: What additional authority do you think 

we should give the Fed? 

Mr. TARULLO. Senator, as you know, I agree, personally—it is not 

a Board position—with you that the Fed took too long to use its 

existing authority to enact consumer protection associated with 

mortgages. I was referring a few moments ago—and I will elaborate on it now—to the authority to provide consolidated supervision 

for any systemically important institution. 

As you know, a year-and-a-half ago, that statement would have, 

in practical terms, meant that a whole set of institutions—at that 

point, the five free-standing investment banks—would likely have 

been brought in by law to the consolidate supervision program. 

Because of the financial crisis, and the fact that a couple of those 

institutions are no longer with us and others have become bank 

holding companies, the immediate practical importance of the authority would not be as great as it would have been a year-and-ahalf or 2 years ago. However, there is first the possibility that an 

institution which has become a bank holding company in the middle of the crisis, in an effort to get the imprimatur of having consolidated supervision, would, when things calm down, decide it 

does not so much like being a supervised entity, so it would diselect being a holding company. 

Senator BUNNING. We could prevent that. 

Mr. TARULLO. You could. 

Senator BUNNING. Yes. 

Mr. TARULLO. Absolutely. And, second, if in the future other institutions grow or activities migrate from the regulated sector to 

other institutions, we would want to make sure that any such institution which itself becomes systemically important would also be 

subject to consolidated supervision. That is what I referred to earlier. 

Senator BUNNING. Sheila, could you expound on the ability of the 

FDIC to preempt, in other words, to get in front of the foreclosure 

or the shutting down of our—in other words, looking prior to, with 

your regulatory regime into banks that you have under the FDIC 

jurisdiction? In other words, preventing. 

Ms. BAIR. I think Congress gave the FDIC helpful new tools— 

they were finalized in early 2006—to make risk-based adjustments 

to our premiums that we charge for deposit insurance, because at 

least for insured depository institutions, this helps us provide eco-
23 

nomic disincentives to high-risk behavior. This is a tool we are 

using and will continue to further refine. But, it has been helpful, 

I think. 

I think the big problem or the shortcoming that we have found 

is that when these larger entities get into trouble, so much of the 

activity is outside the insured depository institution that our traditional resolution mechanism does not work. We can only resolve 

what is in the FDIC-insured institution, which is why we believe 

it would be very helpful to us, at the FDIC collectively, to get 

ahead of this. First of all, it would be a strong disincentive. We 

need more regulation, clearly, of these very large institutions, but 

we also need greater market discipline and the certainty that investors and creditors will take losses if an institution gets in trouble and would have come to the Government for help. They will be 

put into a resolution regime. 

Senator BUNNING. Let me ask you this simple question. If an entity is listed on an exchange, wouldn’t the Securities and Exchange 

Commission have some kind of ability to examine all the aspects 

of that institution? I am looking at AIG, for instance. 

Ms. BAIR. Well, generally it is the holding company. 

Senator BUNNING. Correct. It is the holding company. 

Ms. BAIR. It is the holding company, not the bank, that is listed. 

The SEC’s regime is focused not on prudential supervision but on 

investor protection through a transparency regime. They do not do 

any kind of safety and soundness prudential oversight of listed 

companies. They are focused more on ensuring appropriate financial disclosure for the benefit of investors. 

Senator BUNNING. Thank you. 

Thank you, Mr. Chairman. 

Chairman DODD. Thank you. 

Senator Tester. 

Senator TESTER. Thank you, Mr. Chairman, and I thank the panelists for being here today. An interesting discussion. I think we all 

agree that the gaps exist. I think we all agree that we still have 

not sealed those gaps up. And so I guess referring to the testimony 

from a gentleman on the second panel, a former Comptroller of the 

Currency, Mr. Ludwig, he writes and, in fact, recommends to 

‘‘streamline the current ‘alphabet soup’ of regulators by creating a 

single world-class financial institution-specific regulator at the Federal level while retaining the dual banking system,’’ which is very, 

very close to what, quite honestly, I have in mind. And he goes on 

to lay out a system of critiques, and you guys have somewhat addressed this in some of your other questions. 

But going back to what Senator Menendez asked in that he 

wanted to know if it could be laid out to seal these gaps by rulemaking or some other method, I am not sure I got an answer to 

that question. 

So I want you to share your thoughts as concisely as possible, because each one of you could burn 4 minutes and 50 seconds with 

one answer if you wanted. 

As to why significant reform in this direction is not the direction 

to go, taking off your hat as your individual department leaders— 

because I know turf does play a role. If somebody said, ‘‘I am going 

to dissolve your farm,’’ I would be a little upset with it. But just 
24 

tell me how we can get these gaps closed without doing something 

like this and why this would not be a good idea. 

Go ahead, Sheila. We will just go down the line. 

Ms. BAIR. Again, I think the issue was not about the choice 

among bank charters. It was between being a bank or not being a 

bank and being much less regulated in the nonbanking sphere. I 

think that is the arbitrage that needs to be addressed. 

Senator TESTER. And what you are saying is that could not be 

addressed with one—— 

Ms. BAIR. No, it would not, because you would just be consolidating what we all do for insured depository institutions. That 

would not expand beyond the already heavily regulated sector. 

Senator TESTER. Could it? 

Ms. BAIR. I think with a systemic risk council it could, at least 

for risks that are systemic in nature. You would be able to give this 

new systemic risk council—which would also include the SEC and 

the CFTC—some ability to look across systems and to impose prudential requirements regarding capital and leverage where needed 

to mitigate systemic risk. And, yes, that would be across all sectors, 

not just for banks. 

Mr. DUGAN. Senator, I believe you could do more streamlining. 

You could move more in the direction you are talking about. We 

do not have an ideal system. But as my testimony suggests, there 

are some issues you are going to have to confront if you want to 

have an effective Federal Deposit Insurance Corporation. If you go 

for long periods without having any bank failures, they are not 

going to have a lot to do and will not know the system very well 

if they do not supervise banks. 

Likewise, the Federal Reserve has some things to offer to supervision, particularly of the very largest institutions at the holding 

company level that are engaged in a lot of nonbanking activities. 

And to think that a banking supervisor would do all of that as well 

without having the benefit of direct supervision raises some questions. 

Senator TESTER. OK. 

Mr. TARULLO. Senator, I would say, trying to be succinct, the two 

most important gaps to fill are: first, making sure that every systemically important institution does come within the perimeter of 

regulation; and, second, what we were discussing earlier, which is 

to say the assurance that there cannot be charter conversions motivated by efforts to escape enforcement and escape bad ratings. And 

just to be clear, I think it would be a perfectly good idea for the 

Congress to legislate on that matter so that in the unlikely event 

that our successors did not share the same view, they could not go 

in the opposite direction in which charter conversions could be done 

for the wrong reasons. 

Senator TESTER. I understand that, but what you are saying, 

then, a world-class financial institution, a specific regulator could 

work. 

Mr. TARULLO. Well, I actually think, as Sheila suggested early in 

the hearing, that what we have learned in this crisis is that there 

were lots of different models of supervision and regulation around 

the world, and none of them performed particularly well. And that 

seemed to me more of a lesson than anything about a particular 
25 

structure or anything else. None of them performed particularly 

well. 

Senator TESTER. OK. Go ahead. 

Mr. BOWMAN. And I would also pick up on the point, your concept is a world-class financial institution regulator. I think one of 

the lessons that we have learned—and Sheila has mentioned it a 

couple times—is that we have banks and nonbanks who are providing the same kinds of services in a different structure. If you are 

a financial institution, you do have world-class regulators currently. If you do not, you operate in a less than regulated or underregulated environment. 

One of the suggestions I would have is that if you wanted to 

close that gap, there is a process by which you can do that. It starts 

with the CFPA, the Administration’s proposal. The difficulty is how 

they carry out, how they enforce the regulations. The Administration proposes to use the CFPA as that. We suggest as bank regulators we can do it more effectively. But that is the start, because 

then you have to start looking at things like capital requirements, 

capital structure for those who are not financial institutions. 

Senator TESTER. OK. Currently, have we made any progress, and 

not necessarily—well, I think ‘‘we’’ as a general group as well—towards regulation of derivatives, credit default swaps, those kinds 

of things? Or are we in the same boat we were in a year ago? Same 

boat, Mr. Bowman? 

Mr. BOWMAN. Yes. I would say that we are. 

Senator TESTER. OK. Everybody agree with that? 

Ms. BAIR. Yes, and that does require legislation to fix. 

Senator TESTER. Yes. OK. Are we concerned about that? 

Ms. BAIR. I am. Yes, I think it is huge. 

Mr. DUGAN. I think it is very important. 

Senator TESTER. Mr. Chairman, have you gotten any recommendations from any of these folks or anybody else on how we 

should be regulating derivatives and credit default swaps? 

Chairman DODD. What we are trying to do here is fashion, obviously, a piece of legislation that comprehensively deals with all of 

this, and the hope is we are going to do that when we get back in 

the fall. That is the purpose of these hearings, to bring these ideas 

together. 

Senator TESTER. But has anybody given you any concrete ideas 

or—— 

Chairman DODD. Oh, there have been all sorts of suggestions 

made on how to do it, clearinghouses and so forth. We have got a 

lot of recommendations. 

Senator TESTER. Well, I just think it is—as we move forward 

here, I can just real quickly—— 

Chairman DODD. In fact, I would just say, John—and I will leave 

you more time—Senator Reed and Senator Bunning, in fact, are 

working on an idea that—in fact, a number of our colleagues here 

are working on various ideas to be part of the larger bill. The Subcommittee is working on it. 

Senator TESTER. I think it is good. It is somewhat distressing 

that, quite frankly, from my perspective—and I am not an expert 

in this field at all—we have a lot of people who are trying to do 

good work; but there are still gaps, and obvious gaps. And then at 
26 

the banking level, we have got a myriad of regulators out there. 

Quite frankly, if I was a banker, I would be going crazy. I would. 

I would not know—I really would not know which person to be— 

knowing who I have to deal with, let us just put it that way, because we are coming at it from a lot of different angles. 

Then, you know, if you take into consideration—I think, Sheila, 

you said this. Community banks were not really a problem here, 

but yet they are getting pressed just as hard as anybody, from my 

perspective, as far as regulation goes. And I just think that this is 

an opportune time in the middle of a potential—not a potential— 

in the middle of a crisis to really take a lot at our regulation system and say let us simplify it, let us make it lean and mean and 

simplified. And I do not think that can happen unless we are willing to think outside the box and do things differently than we have 

done in the past. 

Thank you all for being here. 

Chairman DODD. Thank you very much. 

Senator Vitter. 

Senator VITTER. Thank you, Mr. Chairman. 

Ms. Bair, I wanted to ask you a few things that are little bit off 

topic but that are important, and that has to do with the recent 

actions of the Financial Accounting Standards Board with regard 

to bringing certain things that have been off balance sheet, on balance sheet, and what impacts that will have on institutions. 

How will FDIC treat the consolidation of previously off-balancesheet entities? And, in particular, will the agency require additional capital for assets that are brought on balance sheet? 

Ms. BAIR. Well, yes, banks must follow U.S. GAAP. So if those 

are the accounting rules, if more assets are coming on balance 

sheet, capital levels are going to be impacted accordingly. 

Though we still have some concerns about the timing of all this, 

we support the general direction of bringing assets back on balance 

sheet. But the timing still gives me some heartburn—whether they 

really need to be on this accelerated framework. 

I think it also could be very damaging to efforts to get the 

securitization market back, because the way the rules are written 

now, as I understand, even if you just retain some portion of interest, the whole securitization might have to come back on balance 

sheet. That also goes at cross-purposes with our efforts to try to get 

originators to have some skin in the game. 

There are a lot of issues and questions we have about the timing, 

but we cannot control that. FASB is not an entity that we have any 

control over. We can file comment letters and that is about it. But 

banks must follow U.S. GAAP. 

Senator VITTER. So are the capital ratios set in law, or are 

they—— 

Ms. BAIR. Well, yes. Prompt Corrective Action capital levels are 

set by statute, yes. There is not a lot of flexibility there. 

Senator VITTER. And so there is no flexibility for any phase-in period? 

Ms. BAIR. Not very much at all, no. 

Mr. DUGAN. Senator, traditionally the leverage ratio follows 

GAAP completely. The risk-based ratio has some variations, and at 

times has been more restrictive than GAAP. There also is some 
27 

flexibility to look at this and phase it in over some time. This is 

an issue all the regulators are looking at now to try to address 

some of the issues that Chairman Bair just raised. 

The bottom line is this stuff is coming back on the balance sheet. 

Banks are going to have to hold capital against it. It is really a 

matter of timing and how it gets phased in. 

Senator VITTER. Well, I do not think anybody is arguing about 

the fundamental issue, but I am concerned with timing and phasein because it could have negative consequences if it were, you 

know, here tomorrow overnight. So what is the current thinking 

about how that should be handled? 

Mr. DUGAN. I think the regulators are still discussing how this 

affects regulatory capital. The accounting rules become effective at 

the end of this year, beginning of next year, and how the regulatory capital rules respond is something that we will be discussing 

and providing some notice to the public shortly. 

Senator VITTER. When do you think there will be fairly clear 

guidance for institutions about what to expect and what timetable 

and what phase-in, if you will? 

Mr. DUGAN. If I had to guess—and this is an interagency process—I would say weeks, not months. 

Senator VITTER. And I assume all of the agencies and regulators 

involved are in discussions about this? 

Mr. DUGAN. It is an interagency rule, as capital requirements 

like this always are. So there will be a discussion among the agencies. 

Senator VITTER. OK. Does anyone else have any comments about 

that? 

[No response.] 

Senator VITTER. OK. Thank you. That is all I have, Mr. Chairman. Thank you. 

Chairman DODD. Thank you very much, Senator. 

Senator Reed. 

Senator REED. Thank you, Mr. Chairman. 

Since Countrywide, was brought up, I just want to make sure I 

have got some facts right. It started off with a national bank subsidiary. You regulated the bank, Mr. Dugan, and the Fed regulated 

the holding company? 

Mr. DUGAN. That is correct. 

Senator REED. And under your policy and case law, a subsidiary 

mortgage company, an affiliate mortgage company was not subject 

to California law. 

Mr. DUGAN. We regulated the bank, and it did a portion of its 

business inside the bank. It did most of its subprime lending outside the bank, not in the bank. The affiliate was subject to California law. 

Senator REED. It was subject to California law. 

Mr. DUGAN. Yes, but the bank itself was subject to the uniform 

Federal standards of the National Bank Act, and was not subject 

to California law. They did not do their subprime lending that 

caused a number of problems in the bank. 

Senator REED. Just to be clear, the subprime lending was in an 

entity that was subject to California law. 

Mr. DUGAN. Correct. 
28 

Senator REED. Attorney General review, everyone else like that. 

Mr. DUGAN. Correct. 

Senator REED. The Fed would have responsibility to review or inspect that mortgage company as an affiliate. 

Mr. DUGAN. At that time, before they switched charters, yes. 

Senator REED. Right. And did they do that, to your knowledge? 

Or what template did they use? 

Mr. DUGAN. You would have to ask the Federal Reserve. I will 

say, as in my testimony, that philosophically, historically, there has 

been this anomaly where the bank in a holding company gets very 

heavily inspected and regulated and is subject to the most intensive regulation, but the holding company affiliates were not subject 

to the same requirements for annual inspections. And that needs 

to be fixed, and the Federal Reserve has recently been doing more 

in that area, but it is not the same, and I believe it should be the 

same. 

Senator REED. Let me switch to Mr. Bowman. When Countrywide came into your supervision, you were the holding company’s 

supervisor, and you were also the bank’s—the FSB, I presume. 

Mr. BOWMAN. Correct. 

Senator REED. And the company that did the bulk of the 

subprime was a California-regulated mortgage entity. 

Mr. BOWMAN. There were a number of State-related affiliates 

within the holding company structure. I do not remember how 

many or how many States. I do not remember the percentage of 

California State versus New York versus other States. 

Senator REED. When you reviewed, your organization reviewed 

and inspected these holding companies, did you notice anything— 

did you inspect them or did you just inspect the FSB? 

Mr. BOWMAN. We actually did a number of things. We spent a 

lot of time with both the Fed and the OCC, as I mentioned earlier, 

in previewing sort of what it was that was coming our way. 

We also convened shortly after granting the charter. Again, the 

charter was granted March of 2007. We convened what I would call 

a ‘‘regulators conference,’’ where we invited and, in fact, had regulators from many, many States—I do not remember the exact number—come in and discuss with us some of their particular concerns, 

if any, related to the operation of the affiliates within the holding 

company structure, including New York, California, and others. 

Senator REED. And did that alert you to any potential problems? 

Mr. BOWMAN. Yes, it started to. Yes, it did, sir. 

Senator REED. OK. Thank you. 

Let me switch gears. We had a few hearings ago Mr. Meltzer and 

Dr. Rivlin, who have a long-time association with the Federal Reserve. And their suggestion was that the Federal Reserve essentially get out of the business of supervising and regulating entities 

and concentrate on the issue of the monetary policy and perhaps, 

you know, other issues. 

My question is—and I will let you answer last, Governor. I think 

you have an opinion about this. But to the other panelists, if the 

Federal Reserve following this advice by two very knowledgeable 

people and experienced people, does not perform the role as the supervisor for large holding companies, who would or should? Do we 
29 

have to create another entity? What is your general comment about 

that? Then I will conclude with the Governor. 

Ms. BAIR. The Federal Reserve is the holding company supervisor for the vast majority, but not all of the very largest institutions. So, yes, I think you would have to create a new agency to 

do it if the Federal Reserve was not doing it. 

Senator REED. Mr. Dugan, do you have a comment? 

Mr. DUGAN. I think you could put the holding company supervisor and the bank supervisor in the same entity. That is how the 

OTS works. You could do it. And I think, frankly, for smaller institutions and a lot of institutions where the only subsidiary of the 

company is the bank, there is some logic to that. But where you 

have companies, as was talked about earlier, where a lot of different businesses were engaged in nonbanking kinds of activities, 

that is where the particular expertise of the Fed—because of its 

closeness to the capital markets, its open market operations, its 

international central banking, all of that comes into play. Replicating that would be the most difficult challenge for any agency 

that tried to re-create it, either separately or inside a prudential 

supervisor. 

Senator REED. Mr. Bowman—and quickly, because I have to give 

the Governor some—— 

Mr. BOWMAN. Yes, I would agree with that. We currently regulate both the holding company underlying institution. I think you 

could replicate that. The difficulty would be in dealing with Statechartered organizations where you did not already have a Federal 

regulator like the OCC or the OTS. 

Senator REED. Governor Tarullo, your comments, and I might 

just throw in one other issue. If the Fed is the regulator—and this 

is a common concern of all of you—you have to be able to sort of 

work through what is now the deference to functional regulators, 

which I think we have identified as a problem. So you might put 

that into your answer, too, Governor. 

Mr. TARULLO. Thank you, Senator. People are attracted—particularly once they get out of Government or if they have never been 

in Government—to neat solutions that look great on paper. I think 

that anybody who has dealt with this crisis and, indeed, dealt with 

financial supervision on an ongoing basis, will tell you that the 

whole point about the financial sector of our economy is that it 

reaches everywhere and it affects everything. 

And if one is looking to a central bank to perform the dual mandate given to it by the Congress of trying to maximize employment 

and achieve price stability, I do not think there is any way to do 

that effectively without paying an awful lot of attention to financial 

stability. And to achieve financial stability, one has to have an influence upon the major kinds of financial activities in the economy, 

which are, of course, largely though not exclusively being performed by the larger institutions. So the interrelationship between 

monetary policy aims and the goals of financial stability really undergird the case for our central bank, and central banks around the 

world, being involved in supervision. That is point one. 

Point two, a graphic illustration of what can happen when the 

central bank is not closely involved in supervision was observed a 

couple of years ago in the United Kingdom following the decision 
30 

to have a single financial services authority with all supervisory responsibility for all kinds of financial institutions. The Bank of England, the central bank, was not involved in supervision at all, and 

when a significant financial institution—Northern Rock—failed, 

the Bank of England was not in a position to be able to make judgments about the failure of Northern Rock or the ripple effects within the system. I think it is for that reason that you have a robust 

debate in the U.K. right now as to whether they need to return 

some supervisory authority to the Bank of England, I would assume, to coexist with the Financial Services Authority. 

Now, there have been some proposals to put everything back in 

the Bank of England. I personally would not think that would be 

a particularly good idea. 

You raised the question, and let me just address briefly, the 

issue of ability to get information and to enforce where necessary. 

I think it is important, if you are going to ask an entity to perform 

a role of consolidated supervision, to make sure that they have the 

tools to do so. 

Now, as it happens right now there is—and I have no reason to 

expect there will not be—quite a good relationship between the Fed 

and the Comptroller with respect to banks within holding companies. But we need to make sure that some kinds of information 

that are not gathered in bank supervision or, for that matter, certainly supervision of other kinds of regulated entities—insurance 

entities or securities entities—can, if necessary, be obtained in 

order to provide the kind of supervisory oversight of the whole institution that you are asking about or looking for. 

I do not personally anticipate that there is going to be much utilization of such an authority, but I think you do have to have that 

kind of back-up. 

Senator REED. I have gone way over my time and I—— 

Mr. DUGAN. Just very quickly—— 

Senator REED. I am abusing the—— 

Mr. DUGAN. Just if I could very quickly respond, just to that last 

point. On the functional regulator point, it may go too far the way 

it is now, but the way the Administration has proposed it has 

pushed it too far in the other direction so that you could override 

the authority of the primary supervisor and that is too much. 

Senator REED. Pointed noted. Thank you, my colleagues. 

Chairman DODD. Thank you. 

Senator Martinez. 

Senator MARTINEZ. Thank you, Mr. Chairman. 

Good morning to all of you and thank you for being here. I want 

to ask a question about the proposal of the Administration regarding the elimination of restrictions to interstate banking for national 

and State banks. I know that a lot of community bankers in Florida would be greatly concerned about that and I wonder if aggressive branching didn’t contribute to excessive risk taking in a desire 

to increase market share, which, in fact, may have had a lot to do 

with a lot of the problems we have seen lately. 

So would a limit on branch banking, how would it change the 

competitive landscape? Madam Chair? 

Ms. BAIR. Senator, the FDIC has not taken a position on that 

particular provision. I do know that there are several community 
31 

bankers that are concerned about it, but I am sorry, we don’t have 

a corporate position on it. 

Senator MARTINEZ. Does anyone else care to comment? 

Mr. DUGAN. I do not think it would be a good idea to reimpose 

limits on interstate branching. Right now, there are some limits 

left on the first branch into a State. But basically, the decades-long 

restrictions gradually evolved over the years to permit interstate 

branching and I think it did permit more diversification geographically which was helpful in some circumstances. I personally would 

not be in favor of further limits. 

Senator MARTINEZ. Any other thoughts on the matter? I 

guess—— 

Mr. TARULLO. I would just say, Senator, that you alluded to circumstances in which interstate operations became a problem, and 

I think that can be the case. But that is where it is important to 

focus upon the business model of the entity in question. It ought 

not to be allowed to engage in unsafe and unsound practices, 

whether they involve excessive branching that is unsupported by a 

sound business plan or other practices. 

Mr. BOWMAN. I would just simply point out the fact that thrifts 

do currently enjoy the ability to branch interstate without restriction, and in terms of the impact upon the community banks, my 

impression has been that that privilege that thrifts currently enjoy 

has had some impact, but I am not certain how great. 

Senator MARTINEZ. My colleague from Montana brought up the 

testimony that we have in writing from Mr. Ludwig, and I wanted 

to go into another area of his testimony that I found very interesting. He makes the point, and I am sure he could make it much 

better than I if he were making it, which he may get a chance to 

do later, but that he would suggest avoiding a two-tier regulatory 

system that elevates the largest ‘‘too-big-to-fail’’ institutions over 

smaller institutions, and he makes the point that perhaps there 

would be also two-tier regulators, the best regulators in one system, the others in another, and so anyway, he would urge not to 

create a ‘‘too-big-to-fail’’ category because it would, in fact, be contrary to what he thinks would be the best interest of not creating 

a bias in the system that would be in favor of those institutions 

considered too big to fail at the expense of those that were not 

viewed too big to fail. Again, could I just get a comment from each 

of you on that. 

Ms. BAIR. Well, I think there are a couple of questions there. One 

is whether there should be so-called ‘‘Tier 1’’ entities that are officially designated as too-big-to-fail, regardless of who regulates 

them. There may be some combination of OCC and Federal Reserve 

Board oversight. And second, whether, as part of regulatory consolidation, you want to have a regulator based on size as opposed 

to charter. 

I think on the former, we have some concerns about designating 

institutions formally as Tier 1. I think you can probably say who 

is not, based on asset size—who may not be systemic. But I think 

to have a clear line of who is systemically important, does contribute to moral hazard. Especially if you don’t have a resolution 

mechanism, it would be quite problematic. But I do believe the as-
32 

sumption is to have stronger capital and leverage constraints for 

those very large institutions than for the smaller institutions. 

In terms of bank regulation, unlike consolidated holding company supervision, I think you should maintain a Federal charter 

and a State charter. That generally breaks out along size lines, but 

not always. We have some fairly large State-chartered entities. The 

OCC has many community banks, as well. But the charter choice, 

I think, is good to maintain—not different regulatory policies, but 

policies that are perhaps more reflective of local conditions. With 

State charters, I think having some sensitivity and more immediacy of being able to deal with a State-level banking supervisor is 

helpful. So I would maintain regulation based on State or Federal 

chartering as opposed to employing size limitations. 

Senator MARTINEZ. I know we have a vote and I don’t know how 

much time we have left, so I will leave it at that, Mr. Chairman. 

Chairman DODD. Thank you very much, Senator. 

Senator Merkley. 

Senator MERKLEY. Thank you very much, Mr. Chair. 

I wanted to start by asking, Governor, it is my understanding 

that some of the problems at Citigroup and other major institutions 

resulted from moving risky activities back and forth between the 

holding company and the national bank to minimize supervision. 

So my question is whether by creating a similar structure, but instead of the Fed and the OCC it would be the Fed and the NBS, 

National Bank Supervisor, whether we are creating the same risk 

in the new system of moving activities back and forth. 

Mr. TARULLO. Senator, I think under any approach, you must 

have a common set of requirements across the system which minimize the opportunities for regulatory arbitrage. That means within 

institutions, and it also means between regulated institutions and 

nonregulated institutions. 

I would say, without talking about any specific institution, there 

certainly were circumstances in which institutions may have taken 

advantage of different applicable capital requirements, or of bundling things in one form and moving them around the entity and 

that part of what needs to be done is to take regulatory steps that 

minimize those opportunities. 

Senator Vitter was asking earlier about bringing off-balance 

sheet assets back onto the balance sheet. That is one way to combat regulatory arbitrage. 

Senator MERKLEY. Well, let me just ask this. Do you think it 

would make more sense to have the holding companies and the 

banks under the same regulatory agency? 

Mr. TARULLO. I don’t, actually. Now, with respect to smaller 

holding companies, particularly those that have only a bank—it is 

basically a shell and there is a bank, there are no other entities— 

the amount of additional holding company supervision is actually 

quite modest. As the bank holding company picks up additional activities—if it does any of its own capital raising, if it has even a 

small additional subsidiary, if it does some management at the 

holding company level—that is when an independent scrutiny of 

those activities seems to me valuable. 

As you get to an even bigger institution, an even more complex 

institution, it does seem as though the task becomes more special-
33 

ized because you are now looking not just at immediate impacts on 

the bank—although that is important because we want to protect 

the deposit insurance fund—you now, as we have learned in this 

crisis, also need to examine how the whole entity, can be creating 

risk in and of itself. That involves different kinds of activities, different kinds of regulated entities that are, as you say, moving 

things back and forth or acting in parallel, and that is where I 

think you do need a different approach which looks at the holding 

company as an integrated whole, supplementing and complementing the rigorous functional regulation that takes place in the 

subsidiaries. 

Senator MERKLEY. Yes. Please be very quick, because I want to 

get in my second question. 

Mr. DUGAN. OK, I will. I would say the one area, as I mentioned 

earlier. I do think there are times where there are activities going 

on in the bank and the holding company that are the same types 

of activities but they are subject to different levels of supervision. 

We ought to try to fix that. 

Ms. BAIR. I would just say two things. We have suggested in 

prior testimony that large institutions have their own resolution 

plans so that they could be liquidated very quickly if they got into 

trouble and that a key to this would be greater legal separateness 

of the insured depository institution and what is in the insured depository institution versus what is not. Our resolution process is 

very complicated now with these large institutions because of the 

interrelationships between the bank and the nonbank activities. It 

is hard—you are right—to sometimes tell the difference. 

There is a provision called 23(a), which is designed to protect 

banks from being used as sources of strength for the holding company. We are consulted by the Federal Reserve Board regarding requests for exceptions to the 23(a) restrictions. However, the Fed 

has the sole authority to approve these requests that can move 

more higher-risk assets into banks where they are funded with insured deposits. So in terms of an incremental step, and I think that 

this is no surprise to the Federal Reserve Board, we would very 

much like to have a statutory role in the 23(a) approval process because this does increase our exposure. 

Chairman DODD. Let me interrupt here. I want to make sure I 

get Senator Bennett in before the vote. 

Senator MERKLEY. Not at all, Mr. Chairman. 

Chairman DODD. I thank you very much, Senator Merkley. We 

will leave the record open for further questions, by the way, for all 

of you. 

Senator Bennett. 

Senator BENNETT. Thank you very much. Probably, given the 

time, this will be more of a statement that you can ponder than 

questions that I want answers to, but I would like to get some answers later on. 

It will come as no surprise that I want to talk about ILCs, and 

no one has discussed the ILC charter in their written testimony. 

Let us point out that the growth of ILCs over the last 20 years has 

been one of the great successes in the financial services markets. 

They are the best capitalized and safest banks in the country. They 

were in no part a contributor to the financial crisis. They provide 
34 

credit in places that it has not been available before, niche markets, a diverse set of products, and the Administration’s proposal 

says, let us eliminate them. 

Now, I find that incredible, that something—we talk about 

Conseco, Lehman Brothers, CIT. All had ILCs, and as they were 

wound down, the ILCs were the assets that were the crown jewels. 

The ILCs were the assets that had the most value. And yet the proposal is, let us eliminate them. Let us eliminate the charter. 

Now, Mr. Tarullo, you made a comment that the center of this 

crisis is too big to fail and much of this discussion has been in that 

area of ‘‘too big to fail.’’ May I respectfully suggest that the center 

of the crisis is not ‘‘too big to fail.’’ ‘‘Too big to fail’’ is a manifestation that came out of the center of the crisis, and to put it in my 

very much layman’s terms, the crisis was caused because of this 

game of musical chairs with respect to risk. And we built more and 

more risk into the system because while the music was playing, 

more and more institutions passed the risk on to somebody else 

thinking, to use the phrase that Sheila used, I have no skin in this 

game anymore, this game being this particular instrument. 

And you go with the change. It starts with the borrower. He has 

no risk whatsoever because there is no equity in the house. He is 

getting a 100 percent loan. Sometimes it is a liar loan. The broker 

who arranges the loan has no risk in the game because he passes 

it on to the lender. The lender has no risk in the game because he 

passes it on to the GSE. The GSE has no risk because with the rating agency that has no risk has rated it, and he can pass it on, 

securitize it, to somebody else. And at every step in the way, in the 

path, somebody makes money, on a fee, on a commission, whatever 

it might be. And when the music stops, it turns out that everybody 

had risk in the game because the whole thing collapses. 

And I would like to know a regulator who can focus on that question, not how big you are, but where are you in this chain of musical passing on of risk, musical chairs, if you will, that says somebody can say, no more loans in the beginning. No more liar loans. 

To brokers, no, you can’t pass this on. You have to have some kind 

of a risk if you get involved in brokering this loan so you will then 

by market pressure do your job better to see to it that you don’t 

pass it on. To the lender, you maintain some kind of risk as the 

chain goes forward. The GSE, you maintain some kind of risk. The 

rating agencies, you will get a risk. 

But no one had any risk and the bubble, therefore, grew and 

grew and grew because everybody was making money with no exposure. And that is the problem that I want to solve with this restructuring rather than working around some of the turf battles 

that we have talked about. 

Now I will go save the republic and you can respond to Chairman 

Warner. 

[Laughter.] 

Senator WARNER [presiding]. Does anybody want to respond? 

Mr. TARULLO. I would just say a word, Senator, since this will 

be recorded. I actually agree with everything Senator Bennett said, 

except I think too-big-to-fail actually plays exactly into the narrative that he gave us. He was talking about the GSEs which were 

the biggest institutions of all that in the end were regarded ‘‘too 
35 

big to fail?’’ It was the GSEs. It is not the only problem, but I think 

it is a very important problem. 

I should be careful about speaking for people on the panel, but 

certainly making sure that risks are properly assessed by entities— 

and I would add, making sure that compensation systems and entities accurately reflect the risk that employees are assuming—are 

important pieces of a reform package. 

Ms. BAIR. I will just say, speaking for myself, I would agree that 

I don’t to eliminate the ability to choose a State charter instead of 

a Federal charter, including an ILC charter. We don’t think this 

was a driver or a contributor to this crisis. We were unaware that 

the Administration was going to propose that. But again, speaking 

for myself, I don’t see that the ILCs were in any significant way 

involved in what was going on. 

Senator WARNER. Thank you. Let me go ahead and ask my question and then I will call on Senator Schumer. Thank you, Senator 

Schumer. 

I want to go back to where Chairman Dodd started and Senator 

Tester went with his direction. I am still struggling with this question of whether we do a single end-to-end depository regulator. I 

think some of you all have raised some legitimate concerns. I know 

folks on the second panel will perhaps have a different view. Paul 

Volcker has got a different view. Past chairs have had a different 

view. 

I think, Chairman Bair, your point was valid. How do you make 

sure that you don’t infringe upon your insurance function? I do 

think you could achieve that by having backup authority and your 

ability to continue to go in and check particularly those institutions 

that got into trouble, to check on your ongoing role both as an insurer and what Senator Corker and I have talked about, an expanded resolution authority. I also tend to think that the notion of 

an enhanced Systemic Risk Council that would include the Fed, 

that would include the Treasury, that would include the FDIC and 

this end-to-end bank regulator as well as the SEC and others 

would give you that ability to have those variety of voices heard. 

And I would also just want to raise one other point that we have 

talked a lot this morning about, the chartering and the ability to 

change charters, and perhaps prohibiting that. I think you all have 

raised appropriately those questions. But since each of your organizations have had a licensing division, there is also the question of 

a selection of a charter when you start an institution. 

I guess my first question would be, having that very nature of 

that choice at the beginning, not switching midstream, but that selection choice at the beginning, doesn’t that create regulatory arbitrage? Don’t you by default find out who is going to offer you the 

best deal on the front end and go to that, within your respective 

agencies, that licensing operation? Doesn’t that create the arbitrage 

issue? 

Mr. TARULLO. Well, first, Senator, Sheila and I don’t have any 

authority to charter institutions. The banks we supervise are State 

chartered. 

I would say, though, that—and she can respond to this better 

than I—because we have similar regulatory requirements—— 
36 

Senator WARNER. If we could do it fairly quickly, because I do 

have another question I want to ask—— 

Mr. TARULLO. Sure. Some of the regulatory requirements are for 

all institutions and the FDIC has to decide whether to grant insurance to each depository institution, no matter by whom chartered, 

that wants to be insured. There is a way to contain that kind of 

arbitrage while permitting the useful, innovative kinds of experimentation that States have engaged in, such as allowing creation 

of NOW accounts, for example. 

Senator WARNER. Mr. Dugan, Mr. Bowman, do you want to—— 

Mr. DUGAN. I would agree. We do have a licensing function and 

I would just say that just because you have a choice when you 

begin operating, it is not necessarily arbitrage. There are differences that go along with the charters in terms of what banks 

can do and how they can do it, and some prefer to have local, State 

Government regulation even though we have local examiners on 

the ground. There is a choice, but the FDIC does grant deposit insurance to all of them. 

I don’t think that is where the arbitrage issue that we have confronted most has been. It has been after banks have been in operation where someone is facing a problem and they seek to change 

their charter to avoid a downgrade or an enforcement action. That 

is the thing that I think troubles all of us a great deal. 

Senator WARNER. Mr. Bowman. 

Mr. BOWMAN. Yes, I would agree with that. I mean, in terms of 

people choosing a charter at the outset, the thrift charter is somewhat unique in terms of some of the limitations that are placed 

upon the kinds of business that an entity would want to engage in. 

Our thought is that people choose a charter based upon their business plan. 

In terms of others who are attempting to switch charters because 

of some perceived favorable difference between, say, a State charter 

and a Federal charter, within the State charters you have got 50 

to choose from, or 52 to choose from. The Federal charter, you have 

two, the Federal thrift charter and the national bank charter. Anyone who is looking to avoid or evade some kind of supervisory action or enforcement action, I think as we have talked about here, 

we as a collective group, interagency basis, have tried to take steps 

to avoid that from happening or to slow it down, to make sure that 

it doesn’t happen for the wrong reasons. 

Senator WARNER. One common theme from all of you has been— 

and I think accurately—reflecting that a great deal of the source 

of the crisis has come from the nonbank financial sector. Another 

issue I am struggling with and would like to get all of your comments on is, assume whichever way, consolidating a single entity 

or maintaining the current structure, how do we get our arms 

around this nonbank financial arena? Clearly, one approach the 

Administration has talked about is on the consumer end, the consumer product end, looking at specific financial products coming 

from this array of institutions. Another is that if they kind of bump 

up to the level of becoming systemically risky, the Council, or in 

the Administration’s proposal the Fed would have oversight. 

What I am not clear on is should these nonbank—this nonbank 

financial sector have some level of day-to-day prudential regula-
37 

tion, and I have not seen anybody propose where that—one, is it 

needed, and two, where that day-to-day prudential regulation in 

terms of safety and soundness would land. Comments? 

Ms. BAIR. You have prudential supervision of banks because of 

deposit insurance and other vehicles as part of the safety net. With 

the nonbanks, you do not have that. They are not federally insured. 

Senator WARNER. Should you have some? 

Ms. BAIR. I don’t think you need to. I don’t think you need to go 

that far. I think the consumer abuses for the smaller entities were 

really more of a significant driver, the lax underwriting which then 

spilled over into the larger institutions because of the competitive 

situation it created. 

But no, I don’t think you do. I think if you have the ability to 

impose prudential requirements on systemic institutions or systemic practices, then I don’t think you need institutional—— 

Senator WARNER. So the Council up here for systemic and the 

consumer down here, but no need for—— 

Ms. BAIR. Yes. 

Mr. DUGAN. I generally think that is a daunting challenge to regulate the hundreds of thousands of different financial providers all 

on a safety and soundness basis. But I think the Administration 

would do so and have the authority to do so for consumer protection, as you suggested. It doesn’t get at what really is, and was, 

a fundamental issue. To the extent they engage in very banklike 

functions and there is a safety and soundness issue, like an underwriting standard or downpayment requirements, I would argue 

that is not really a consumer protection function in its traditional 

sense—— 

Senator WARNER. It almost goes to some of the comments Senator Bennett was making about making sure you have got skin in 

the game—— 

Mr. DUGAN. Yes. That is the consumer having skin in the game. 

But my point is, part of the mortgage legislation that passed the 

House last year had some common standards that I would say are 

prudential standards that apply. I think that would have been 

helpful for mortgage providers, but not necessarily all financial providers. So I think there may be some instances where some of that 

is warranted. 

Senator WARNER. But wouldn’t Senator Bennett’s approach, that 

if you originated a product, then you have to keep it in there, that 

is not so much just protecting the consumer, but it may be also protecting this—putting some requirements of safety and soundness 

on the institution—— 

Mr. DUGAN. Absolutely. 

Senator WARNER. ——quasi-prudential. 

Mr. DUGAN. Absolutely. 

Mr. TARULLO. Senator, I would say a couple of things. First, I do 

think that the question of where regulation stops, how broadly the 

perimeter is cast, is an important one going forward. We know that 

we are not going to have the same problems as we had a few years 

ago. There are going to be new problems, and that, I think, is what 

everybody is addressing. How do we stop it? 

I would have thought that one of the important roles of a Council, of some sort of an interagency council, is precisely to attend to 
38 

issues that don’t seem under anybody’s regulatory umbrella at that 

particular moment. If—— 

Senator WARNER. Beyond just being whether they are systemically risky, down to—— 

Mr. TARULLO. Well, I think you point out the problem. You have 

systemically risky institutions addressed, you have regulated institutions that are already regulated, and then you have consumer. 

But if you have a practice which is troublesome, then there ought 

to be a mechanism for somebody to be making an evaluation of 

that practice. And then perhaps if the Council saw that one of its 

members had authority to regulate, it could suggest it. Congress 

could also think about giving some sort of default or back-up authority to the Council in the event that no one had—— 

Senator WARNER. Very quickly, because the senior Senator from 

New York is anxious. 

Mr. BOWMAN. I think, Senator, that you really have hit the nub 

of the issue, which is the ability to regulate or somehow oversee 

this group in between the Council and the CFPA. Trust me that 

whatever scheme might be brought up or passed into legislation, 

there are very, very creative people out there who are going to look 

at that legislation, the regulations that are drafted by it and they 

are going to find a way to get around it, whether it is at the State 

level, the Federal level, whatever else. 

People create businesses every day. They have a business model 

of where they want to engage in a particular activity. I think the 

preference for a lot of people is to engage in a particular activity 

with a minimum of regulation attached to it. So it is a very, very 

difficult issue. 

Senator WARNER. Senator Schumer. 

Senator SCHUMER. Thank you, Mr. Chairman. 

I want to thank all of you for being here, very important subject. 

We have all gathered here today with one common goal, to make 

our financial regulatory system strong enough to prevent another 

severe financial crisis from happening. And I have read the written 

testimony. If I were in your shoes, I would probably make the same 

arguments. But some might argue there is a bit of turf protection 

here. That is natural, but it shouldn’t be the dominant consideration as we move forward. 

Mr. Bowman, in all due respect, almost everyone regards the 

OTS as having failed in its responsibilities. We have seen institution after institution after institution poorly regulated, and you are 

saying, keep the OTS. So I think even though, probably again, if 

I were sitting where you were, with hard-working men and women 

working for you, I would say, keep my agency, keep all the powers, 

don’t do any consolidation, I think we in the Committee have to see 

the testimony as coming from at least partially that perspective. 

So I would ask you this. There are reasons for one strong, powerful, efficient regulator, and I think people who are objective, who 

don’t have any turf considerations, when they look up from on 

high, tend to think that should happen in the banking area. There 

is more discussion in the Systemic Risk Regulator. I think there is 

a good argument that the insurer should be separate from the regulator because there are different concerns. 
39 

So let me ask you this, though, all of you. Here are four arguments for a consolidated regulator. One is that a consolidated regulator would prevent charter shopping, so a bank can’t flip its charter and pick up its own regulator—Countrywide did that, remember that, Mr. Bowman? 

A hodgepodge of different regulators adds to conflicts in regulation and creates confusing burdens for the banks. We have all 

heard from institutions who were told one thing by one regulator 

and another thing by another regulator, each of whom has authority. 

Third, a single regulator could keep better tabs of industry-wide 

risks, dangers, and developments. That is pretty apparent. 

And fourth, a single consolidated regulator can eliminate agency 

and regulatory arbitrage and gaps, and no bank could escape from 

being held accountable for violations or poor practices. 

So my question to you is, do you disagree that one consolidated 

regulator would avoid these four problems, or have these four benefits, even if you think other mechanisms might be better for other 

reasons? Who wants to go first? 

Mr. TARULLO. I will start, Senator. 

Senator SCHUMER. Thank you. 

Mr. TARULLO. I would say that each of the four things you mentioned is an important aim. Some of them, like avoiding charter 

conversion arbitrage, can be addressed short of a single regulator. 

That is one thing that the four of us at this table have tried to do 

already. 

The only thing I would add to what you say is there are also 

some costs to going the single regulator route. So one of the costs 

is that the Fed, for example, loses some insight into how banks are 

actually functioning, how they are moving money, why the volatility of money is what it is. 

I think, also, another potential cost is you have a single all-encompassing regulator and sometimes it loses perspective because it 

is the only game in town—— 

Senator SCHUMER. Right. Look, I wouldn’t deny there are arguments on the other side, but you would agree that these four arguments make some sense for a consolidated regulator? 

Mr. TARULLO. Right. I think a couple of them are stronger than 

others, but yes. 

Senator SCHUMER. Mr. Dugan is shaking his head. You agree? 

Mr. DUGAN. Yes, I would agree with that. Those benefits are definitely there and real, I think. This is the right equation. You have 

to ask, what are the costs, and again, I think there are certain 

things that the Federal Reserve brings to the table in terms of 

closeness to the markets and expertise from the open market operations that would be difficult, but not impossible, to replicate, but 

that are real, and you have to consider that. 

And second, as I have mentioned earlier with my colleague for 

the FDIC, it is hard to be—— 

Senator SCHUMER. Yes. 

Mr. DUGAN. ——good at it if you are not doing it all the time, 

and so you have to take those things into account. 

Senator SCHUMER. Ms. Bair. 
40 

Ms. BAIR. Yes. I think on the monitoring, if you look at the jurisdictions that had a single regulator, they really weren’t any better. 

If you have a single monopoly regulator, that can contribute to regulatory laxity as opposed to having competition among regulators. 

Also, regarding regulatory arbitrage it is not just a matter of 

picking bank charters. If you don’t include securities firms, derivatives dealers, hedge funds, and insurance companies, you still have 

the ability to choose a business model, on a legal model that would 

fall outside of the existing regulatory regime. So unless you include 

all of the various types of financial firms, I think you are going to 

still have some degree of arbitrage. 

Senator SCHUMER. Right. Mr. Bowman. 

Mr. BOWMAN. Yes, Senator Schumer. I would agree that the single form of regulator really hasn’t proven to be any more effective 

in terms of what we have now. And I would also be remiss to point 

if I did not point out that since 2008, 79 financial institutions, 

State chartered financial institutions have failed—— 

Senator SCHUMER. Yes. 

Mr. BOWMAN. ——15 national banks, and 11 thrifts. I think I 

also need to point out that OTS chartered Countrywide in March 

of 2007. We had the market impact in August of 2007, and 5 

months later, Countrywide was sold to Bank of America. The ability of we as the regulator to impact the events at Countrywide in 

a 10-month period was very, very limited. 

Senator SCHUMER. OK. I have another question if I might, Mr. 

Chairman, and this relates to the point Mr. Bowman just made. As 

you said, 54 out of the 69 banks that have failed this year were 

State chartered banks. This one thing, I mean, I guess it is a historical anomaly, but why the Fed supervises State chartered banks 

and Mr. Dugan supervises federally chartered banks. I mean, when 

I first got to the Banking Committee in 1981, I didn’t understand 

that. It just sort of happened, I guess. 

And so let me ask both, first Mr. Tarullo, it is true that most of 

this year’s failed banks were not regulated by the national supervisor, the OCC, or the national thrift supervisor, OTS. Explain to 

me—and then Ms. Bair could answer, as well—could you explain 

to me why the FDIC and the Fed should keep State chartered 

banking supervision, particularly if we are giving the Fed more responsibilities in other areas? If you think those functions should be 

kept apart from the proposed National Bank Supervisor, why 

shouldn’t we at the very least merge FDIC and Fed supervision of 

the State chartered banks, if you are not going to have the same 

supervisor? Mr. Tarullo. 

Senator WARNER. Excuse me. Could I just, Senator Schumer, just 

ask the panel all to try to answer quickly because we do want to 

try to get the second panel, at least get their statements in. 

Senator SCHUMER. You know what, I will ask unanimous consent 

that each panelist be asked to answer that question in writing, because I didn’t realize we had a second panel and I was the last one 

here. Thanks. 

[Pause.] 

Senator WARNER. It looks like we are going to have to reschedule 

the second panel, so I am anxious for you all to respond to Senator 

Schumer’s question. 
41 

Senator SCHUMER. Mr. Chairman, I am deeply grateful. 

[Laughter.] 

Mr. TARULLO. Senator, I would start by saying, as you noted, the 

national banks would be supervised by the OCC as well as chartered. State banks that are members of the Federal Reserve System are supervised by the Fed as their Federal supervisors, and if 

they are nonmember banks, then their primary Federal regulator 

is the FDIC. 

I think that there are two answers to the question. One is, as 

you suggest, history. The Comptroller was started in 1863 to create 

a new national charter and we have had a dual banking system 

ever since. I think there is probably some concern on the part of 

State Banking Commissioners that they not have as their overseer 

at the Federal level the same entity that charters national 

banks—— 

Senator SCHUMER. That is a little bit of what we would say in 

Brooklyn is turf. 

[Laughter.] 

Mr. TARULLO. It is, there is no question. But I think their concern is, Senator, whether or not there would be the same kind of 

treatment of national and State chartered institutions. 

Second, the question is, are there gains from having the FDIC 

and the Fed supervising banks as well as performing their other 

functions, and I would suggest that there are. 

Ms. BAIR. I would want to comment on the previous statement 

that 54 of the 69 banks were State-chartered. There are a lot more 

State-chartered banks, and a lot of these are very, very small institutions. 

Senator SCHUMER. A lot of the biggest failures were under not 

Mr. Bowman, I don’t blame him, but his predecessor’s watch. 

Ms. BAIR. We also have provided a lot of support for the larger 

institutions, as well, on an open bank basis. So I think that all 

needs to be taken into account. I do think—Senator, I know it is 

confusing that we have these multiple regulators and it is frustrating because it is hard to explain to the public. On the other 

hand, as a deposit insurer, we find it extremely helpful to have 

people on the ground in banks all the time. It helps us a lot. It 

gives us a window into seeing what is going on in banking, what 

emerging risks there might be. 

You are right, we could perhaps pick some of that up through a 

backup supervisory process, but I think if we were going to shift 

to that model, give up primary regulation of State chartered banks 

and go up just to that, we would have to be much more robust and 

on-site with our backup examination to keep those data points continually into our risk assessment of what our risks are. So that 

would, in turn, add to regulatory burden. 

So I think that supervisor perspective we get by regulating Statechartered banks is very helpful to us in our insurance function. 

Mr. BOWMAN. Senator, if I could just add to the confusion, as you 

know, the OTS is the back-up regulator for State chartered savings 

associations, so you have a Federal regulator regulating the same 

charter at the State level. 
42 

Senator WARNER. I would like to thank the panel for a very interesting morning and one that has been very helpful, I know, to 

all the Members. 

I want to also apologize to the next panel, Mr. Ludwig, Mr. 

Carnell, and Mr. Baily. I understand staff will be back to you about 

rescheduling. We do want to hear your views. I know some of the 

second panel views perhaps were more sympathetic to the single 

end-to-end depository regulator and we want to make sure we get 

those views on the record and get a chance to press questions, as 

well. But thank you very much of the first panel and we will reschedule the second. 

The hearing is adjourned. 

[Whereupon, at 11:11 a.m., the hearing was adjourned.] 

[Prepared statements and responses to written questions supplied for the record follow:] 
43 

PREPARED STATEMENT OF SENATOR TIM JOHNSON 

Thank you Chairman Dodd for holding today’s hearing. As we all know, the regulatory structure overseeing U.S. financial markets has proven unable to keep pace 

with innovative, but risky, financial products; this has had disastrous consequences. 

Congress is now faced with the task of looking at the role and effectiveness of the 

current regulators and fashioning a more responsive system. 

To date, it appears one of the Committee’s biggest challenges will be to create legislation that better protects consumers. I very much look forward to hearing from 

today’s panels of current and former regulators to see if they believe a new agency 

is needed to better protect consumers, or if consumer protection should remain a 

function of the prudential regulator. 

I am also interested in hearing from the regulators their views on ways to make 

the regulatory system more effective. For example, does it make sense to eliminate 

any of the bank charters to streamline the system? Last, I would also like to know 

from the witnesses if they believe the regulatory gaps that caused our current crisis 

would be filled by the Administration’s regulatory restructuring proposal. We must 

get this right, and the proposal we craft must target the most pressing problems 

in our financial regulatory system. 

As this Committee works through many issues to fashion what I hope will be a 

bipartisan proposal that creates an updated system of good, effective regulations 

that balance consumer protection and allow for sustainable economic growth, I will 

continue to advocate for increases in transparency, accountability, and consumer 

protection. 

PREPARED STATEMENT OF SENATOR JACK REED 

Today’s hearing addresses a critical part of this Committee’s work to modernize 

the financial regulatory system—strengthening regulatory oversight of the safety 

and soundness of banks, thrifts, and holding companies. These institutions are the 

engine of our economy, providing loans to small businesses and helping families buy 

homes and cars, and save for retirement. But in recent years, an outdated regulatory structure, poor supervision, and misaligned incentives have caused great turmoil and uncertainty in our financial markets. 

Bank regulators failed to use the authority they had to mitigate the financial crisis. In particular, they failed to appreciate and take action to address risks in the 

subprime mortgage market, and they failed to implement robust capital requirements that would have helped soften the impact of the recession on millions of 

Americans. Regulators such as the Federal Reserve also failed to use their rulemaking authority to ban abusive lending practices until it was much too late. I will 

work with my colleagues to ensure that any changes to the financial system are focused on these failings in order to prevent them from reoccurring (including by enhancing capital, liquidity, and risk management requirements). 

Just as importantly, however, we have to reform a fragmented and inefficient regulatory structure for prudential oversight. Today we have an inefficient system of 

five Federal regulators and State regulators that share prudential oversight of 

banks, thrifts, and holding companies. This oversight has fallen short in many significant ways. We can no longer ignore the overwhelming evidence that our system 

has led to problematic charter shopping among institutions looking to find the most 

lenient regulator, and has allowed critical market activities to go virtually unregulated. 

Regulators under the existing system acted too slowly to stem the risks in the 

subprime mortgage market, in large part because of the need to coordinate a response among so many supervisors. The Federal Reserve itself has acknowledged 

that the different regulatory and supervisory regimes for lending institutions and 

mortgage brokers made monitoring such institutions difficult for both regulators and 

investors. 

It is time to reduce the number of agencies that share responsibility for bank 

oversight. I support the Administration’s plan to merge the Office of the Comptroller 

of the Currency and the Office of Thrift Supervision, but I think we should also seriously consider consolidating all Federal prudential bank and holding company oversight. Right now, a typical large holding company is overseen by the Federal Reserve or the Office of Thrift Supervision at the holding company level, and then the 

banks and thrifts within the company can be overseen by the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, and often many 

others. 

Creating a new consolidated prudential regulator would bring all such oversight 

under one agency, streamlining regulation and reducing duplication and gaps be-
44 

tween regulators. It would also bring all large complex holding companies and other 

systemically significant firms under one regulator, allowing supervisors to finally 

oversee institutions at the same level as the companies do to manage their own 

risks. 

I appreciate the testimony of the witnesses today and I look forward to discussing 

these important issues. 

PREPARED STATEMENT OF SHEILA C. BAIR 

CHAIRMAN, FEDERAL DEPOSIT INSURANCE CORPORATION

AUGUST 4, 2009 

Chairman Dodd, Ranking Member Shelby, and Members of the Committee, I appreciate the opportunity to testify on behalf of the Federal Deposit Insurance Corporation (FDIC) on the importance of reforming our financial regulatory system. 

Specifically, you have asked us to address the regulatory consolidation aspects of the 

Administration’s proposal and whether there should be further consolidation. 

The proposals put forth by the Administration regarding the structure of the financial system and the supervision of financial entities provide a useful framework 

for discussion of areas in vital need of reform. The goal of any reforms should be 

to address the fundamental causes of the current crisis and to put in place a regulatory structure that guards against future crises. 

There have been numerous proposals over the years to consolidate the Federal 

banking regulators. This is understandable given the way in which the present system developed, responding to new challenges as they were encountered. While appealing in theory, these proposals have rarely gained traction because prudential supervision of FDIC insured banks has held up well in comparison to other financial 

sectors in the United States and against non-U.S. systems of prudential supervision. 

Indeed, this is evidenced by the fact that large swaths of the so-called ‘‘shadow 

banking sector’’ have collapsed back into the healthier insured sector, and U.S. 

banks—notwithstanding their current problems—entered this crisis with less leverage and stronger capital positions than their international competitors. 

Today, we are again faced with proposals to restructure the bank regulatory system, including the suggestion of some to eliminate separate Federal regulators for 

national- and State-chartered institutions. We have previously testified in support 

of a systemic risk council which would help assure coordination and harmonization 

in prudential standards among all types of financial institutions, including commercial banks, investment banks, hedge funds, finance companies, and other potentially 

systemic financial entities to address arbitrage among these various sectors. We also 

have expressed support for a new consumer agency to assure strong rules and enforcement of consumer protection across the board. However, we do not see merit 

or wisdom in consolidating Federal supervision of national and State banking charters into a single regulator for the simple reason that the ability to choose between 

Federal and State regulatory regimes played no significant role in the current crisis. 

One of the important causes of the current financial difficulties was the exploitation of the regulatory gaps that existed between banks and the nonbank shadow 

financial system, and the virtual nonexistence of regulation of over-the-counter 

(OTC) derivative contracts. These gaps permitted lightly regulated or, in some cases, 

unregulated financial firms to engage in highly risky practices and offer toxic derivatives and other products that eventually infected the financial system. In the 

absence of regulation, such firms were able to take on risks and become so highly 

levered that the slightest change in the economy’s health had deleterious effects on 

them, the broader financial system, and the economy. 

Gaps existed in the regulation and supervision of commercial banks—especially 

in the area of consumer protection—and regulatory arbitrage occurred there as well. 

Despite the gaps, bank regulators maintained minimum standards for the regulation of capital and leverage that prevented many of the excesses that built-up in 

the shadow financial sector. 

Even where clear regulatory and supervisory authority to address risks in the system existed, it was not exercised in a way that led to the proper management of 

those risks or to provide stability for the system, a problem that would potentially 

be greatly enhanced by a single Federal regulator that embarked on the wrong policy course. Prudent risk management argues strongly against putting all your regulatory and supervisory eggs in one basket. Moreover, a unified supervisor would unnecessarily harm the dual banking system that has long served the financial needs 

of communities across the country and undercut the effectiveness of the deposit insurance system. 
45 

1See, New York City Economic Development Corporation and McKinsey & Co., Sustaining 

New York’s and the U.S.’s Global Financial Services Leadership, January 2007. See, also Financial Services Roundtable, Effective Regulatory Reform, Policy Statement, May 2008. 

In light of these significant failings, it is difficult to see why so much effort should 

be expended to create a single regulator when political capital could be better spent 

on more important and fundamental issues which brought about the current crisis 

and the economic harm it has done. In addition, a wholesale reorganization of the 

bank regulatory and supervisory structure would inevitably result in a serious disruption to bank supervision at a time when the industry still faces major challenges. 

Based on recent experience in the Federal Government with such large scale agency 

reorganizations, the proposed regulatory and supervisory consolidation, directly impacting the thousands of line examiners and their leadership, would involve years 

of career uncertainty and depressed staff morale. At a time when the supervisory 

staffs of all the agencies are working intensively to address challenges in the banking sector, the resulting distractions and organizational confusion that would follow 

from consolidating the banking agency supervision staffs would not result in long 

term benefits. Any benefits would likely be offset by short term risks and the serious disadvantages that a wholesale reorganization poses for the dual banking system and the deposit insurance system. 

My testimony will discuss the issues raised by the creation of a single regulator 

and supervisor and the impact on important elements of the financial system. I also 

will discuss the very important roles that the Financial Services Oversight Council 

and the Consumer Financial Protection Agency (CFPA) can play in addressing the 

issues that the single Federal regulator and supervisor apparently seeks to resolve, 

including the dangers posed by regulatory arbitrage through the closing of regulatory gaps and the application of appropriate supervisory standards to currently 

unregulated nonbank financial companies. 

Effects of the Single Regulator Model 

The current financial supervisory system was created in a series of ad hoc legislative responses to economic conditions over many years. It reflects traditional themes 

in U.S. history, including the observation in the American experience that consolidated power, financial or regulatory, has rarely resulted in greater accountability 

or efficiency. 

The prospect of a unified supervisory authority is alluring in its simplicity. However, there is no evidence that shows that this regulatory structure was better at 

avoiding the widespread economic damage that has occurred over the past 2 years. 

The financial systems of Austria, Belgium, Hungary, Iceland and the United Kingdom have all suffered in the crisis despite their single regulator approach. Moreover, 

it is important to point out that the single regulator system has been adopted in 

countries that have highly concentrated banking systems with only a handful of 

very large banks. In contrast, our system, with over 8,000 banks, needs a regulatory 

and supervisory system adapted to a country of continental dimensions with 50 separate States, with significantly different economies, and with a multiplicity of large 

and small banks. 

Foreign experience suggests that, if anything, the unified supervisory model performed worse, not better than a system of multiple regulators. It should be noted 

that immediately prior to this crisis, organizations representing large financial institutions were calling aggressively for a move toward the consolidated model used in 

the U.K. and elsewhere. 1 Such proposals were viewed by many at the time as representing an industry effort to replicate in this country single regulator systems 

viewed as more accommodative to large, complex financial organizations. It would 

indeed be ironic if Congress now succumbed to those calls. A regulatory structure 

based on this approach would create serious issues for the dual banking system, the 

survival of community banks as a competitive force, and the strength of the deposit 

insurance system that has served us so well during this crisis. 

The Dual Banking System 

Historically, the dual banking system and the regulatory competition and diversity that it generates has been credited with spurring creativity and innovation in 

financial products and the organization of financial activities. State-chartered institutions tend to be community-oriented banks that are close to their communities’ 

small businesses and customers. They provide the funding that supports economic 

growth and job creation, especially in rural areas. They stay close to their customers, they pay special personal attention to their needs, and they are prepared 

to work with them to solve unanticipated problems. These community banks also 
46 

are more accountable to market discipline in that they know their institution will 

be closed if they become insolvent rather than being considered ‘‘too big to fail.’’ 

A unified supervisory approach would inevitably focus on the largest banks to the 

detriment of the community banking system. This could, in turn, feed further consolidation in the banking industry—a trend counter to current efforts to reduce systemic exposure to very large financial institutions and end too big too fail. 

Further, if the single regulator and supervisor is funded, as the national bank 

regulator and supervisor is now funded, through fees on the State-chartered banks 

it would examine, this would almost certainly result in the demise of the dual banking system. State-chartered institutions would quickly switch to national charters 

to escape paying examination fees at both the State and Federal levels. 

The undermining of the dual banking system through the creation of a single Federal regulator would mean that the concerns and challenges of community banks 

would inevitably be given much less attention or even ignored. Even the smallest 

banks would need to come to Washington to try to be heard. In sum, a unified regulatory and supervisory approach could result in the loss of many benefits of the community banking system. 

The Deposit Insurance System 

The concentration of examination authority in a single regulator would also have 

an adverse impact on the deposit insurance system. The FDIC’s ability to directly 

examine the vast majority of financial institutions enables it to identify and evaluate risks that should be reflected in the deposit insurance premiums assessed on 

individual institutions. The loss of an ongoing significant supervisory role and the 

associated staff would greatly diminish the effectiveness of the FDIC’s ability to perform its congressionally mandated role—reducing systemic risk through risk based 

deposit insurance assessments and containing the potential costs of deposit insurance by identifying, assessing and taking actions to mitigate risks to the Deposit 

Insurance Fund. 

If the FDIC were to lose its supervisory role to a unified supervisor, it would need 

to rely heavily on the examinations of that supervisor. In this context, the FDIC 

would need to expand the use of its backup authority to ensure that it is receiving 

information necessary to properly price deposit insurance assessments for risk. This 

would result in duplicate exams and increased regulatory burden for many financial 

institutions. 

The FDIC as a bank supervisor also brings the perspective of the deposit insurer 

to interagency discussions regarding important issues of safety and soundness. During the discussions of the Basel II Advanced Approaches, the FDIC voiced deep concern about the reductions in capital that would have resulted from its implementation. Under a system with a unified supervisor, the perspective of the deposit insurer might not have been heard. It is highly likely that the advanced approaches 

of Basel II would have been implemented much more quickly and with fewer safeguards, and banks would have entered the crisis with much lower levels of capital. 

In particular, the longstanding desire of many large institutions for the elimination 

of the leverage ratio would have been much more likely to have been realized in 

a regulatory structure in which a single regulator plays the predominant role. This 

is a prime example of how multiple regulators’ different perspectives can result in 

a better outcome. 

Regulatory Capture 

The single regulator approach greatly enhances the risk of regulatory capture 

should this regulator become too closely tied to the goals and operations of the regulated banks. This danger becomes much more pronounced if the regulator is focused 

on the needs and problems of large banks—as would be highly likely if the single 

regulator is reliant on size-based fees for its funding. The absence of the existence 

of other regulators would make it much more likely that such a development would 

go undetected and uncorrected since there would be no standard against which the 

actions of the single regulator could be compared. The end result would be that the 

damage to the system would be all the more severe when the problems produced 

by regulatory capture became manifest. 

One of the advantages of multiple regulators is that they provide standards of 

performance against which the conduct of their peers can be assessed, thus preventing any single regulator from undermining supervisory standards for the entire 

industry. 

Closing the Supervisory Gaps 

As discussed above, the unified supervisor model does not provide a solution to 

the fundamental causes of the economic crisis, which included regulatory gaps between banks and nonbanks and insufficiently proactive supervision. As a result of 
47 

these deficiencies, insufficient attention was paid to the adequacy of complex institutions’ risk management capabilities. Too much reliance was placed on mathematical 

models to drive risk management decisions. Notwithstanding the lessons from 

Enron, off-balance-sheet vehicles were permitted beyond the reach of prudential regulation, including holding company capital requirements. The failure to ensure that 

financial products were appropriate and sustainable for consumers caused significant problems not only for those consumers but for the safety and soundness of financial institutions. Lax lending standards employed by lightly regulated nonbank 

mortgage originators initiated a downward competitive spiral which led to pervasive 

issuance of unsustainable mortgages. Ratings agencies freely assigned AAA credit 

ratings to the senior tranches of mortgage securitizations without doing fundamental analysis of underlying loan quality. Trillions of dollars in complex derivative 

instruments were written to hedge risks associated with mortgage backed securities 

and other exposures. This market was, by and large, excluded from Federal regulation by statute. 

To prevent further arbitrage between the bank and nonbank financial systems, 

the FDIC supports the creation of a Financial Services Oversight Council and the 

CFPA. Respectively, these agencies will address regulatory gaps in prudential supervision and consumer protection, thereby eliminating the possibility of financial 

service providers exploiting lax regulatory environments for their activities. 

The Council would oversee systemic risk issues, develop needed prudential policies and mitigate developing systemic risks. A primary responsibility of the Council 

should be to harmonize prudential regulatory standards for financial institutions, 

products and practices to assure that market participants cannot arbitrage regulatory standards in ways that pose systemic risk. The Council should evaluate differing capital standards which apply to commercial banks, investment banks, investment funds, and others to determine the extent to which differing standards circumvent regulatory efforts to contain excess leverage in the system. The Council 

also should undertake the harmonization of capital and margin requirements applicable to all OTC derivatives activities—and facilitate interagency efforts to encourage greater standardization and transparency of derivatives activities and the migration of these activities onto exchanges or central counterparties. 

The CFPA would eliminate regulatory gaps between insured depository institutions and nonbank providers of financial products and services by establishing 

strong, consistent consumer protection standards across the board. It also would address another gap by giving the CFPA authority to examine nonbank financial service providers that are not currently examined by the Federal banking agencies. In 

addition, the Administration’s proposal would eliminate the potential for regulatory 

arbitrage that exists because of Federal preemption of certain State laws. By creating a floor for consumer protection and allowing more protective State consumer 

laws to apply to all providers of financial products and services operating within a 

State, the CFPA should significantly improve consumer protection. 

A distinction should be drawn between the macroprudential oversight and regulation of developing risks that may pose systemic risks to the U.S. financial system 

and the direct supervision of financial firms. The macroprudential oversight of systemwide risks requires the integration of insights from a number of different regulatory perspectives—banks, securities firms, holding companies, and perhaps others. 

Only through these differing perspectives can there be a holistic view of developing 

risks to our system. 

Prudential supervisors would regulate and supervise the institutions under their 

jurisdiction, and enforce consumer standards set by the CFPA and any additional 

systemic standards established by the Council. Entities that are already subject to 

a prudential supervisor, such as insured depository institutions and financial holding companies, should retain those supervisory relationships. In addition, for systemic entities not already subject to a Federal prudential supervisor, and to avoid 

the regulatory arbitrage that is a source of the current problem, the Council should 

be empowered to require that they submit to such oversight. Presumably this could 

take the form of a financial holding company under the Federal Reserve—without 

subjecting them to the activities restrictions applicable to these companies. 

There is not always a clear demarcation of these roles and they will need to coordinate to be effective. Industry-wide standards for safety and soundness are based 

on the premise that if most or all banking organizations are safe, the system is safe. 

However, practices that may be profitable for a few institutions may not be prudent 

if that same business model is adopted by a large number of institutions. From our 

recent experience we know that there is a big difference between one regulated bank 

having a high concentration of subprime loans and concentrations of subprime lending across large sections of the regulated and nonregulated financial system. Coordi-
48 

1See, U.S. Department of the Treasury, ‘‘Financial Regulatory Reform—A New Foundation: 

Rebuilding Financial Supervision and Regulation’’ (June 2009) (the ‘‘Proposal’’), available at 

www.financialstability.gov/docs/regs/FinalReport.web.pdf. Treasury also has released legislative language to implement most components of the Proposal. That proposed legislation is available at www.treas.gov/initiatives/regulatoryreform. 

nation of the prudential and systemic approaches will be vital to improving supervision at both the bank and systemic level. 

Risk management is another area where there should be two different points of 

view. Bank supervisors focus on whether a banking organization has a reasonable 

risk management plan for its organization. The systemic risk regulator would look 

at how risk management plans are developed across the industry. If everyone relies 

on similar risk mitigation strategies, then no one will be protected from the risk. 

In other words, if everyone rushes to the same exit at the same time, no one will 

get out safely. 

Some may believe that financial institutions are able to arbitrage between regulators by switching charters. This issue has been addressed directly by recent action 

by the Federal banking regulators to coordinate prudential supervision so institutions cannot evade uniform enforcement of regulatory standards. The agencies all 

but eliminated any possibility of this in the recent issuance of a Statement on Regulatory Conversions that will not permit charter conversions that undermine the supervisory process. The FDIC would support legislation making the terms of this 

agreement binding by statute. We also would support time limits on the ability to 

convert. The FDIC has no statutory role in the charter conversion process. However, 

as insurer of all depository institutions, we have a vital interest in protecting the 

integrity of the supervisory process and guarding against any possibility that the 

choice of a Federal or State charter could undermine that process. 

Conclusion 

The focus of efforts to reform the financial system should be the elimination of 

the regulatory gaps between banks and nonbank financial providers outside the traditional banking system, as well as between commercial banks and investment 

banks. Proposals to create a unified supervisor would undercut the benefits of diversity that are derived from the dual banking system and that are so important to 

a very large country with a very large number of banks chartered in multiple jurisdictions with varied local needs. As evidenced by the experience of other much 

smaller countries with much more concentrated banking systems, such a centralized, monolithic regulation and supervision system has significant disadvantages 

and has resulted in greater systemic risk. A single regulator is no panacea for effective supervision. 

Congress should create a Financial Services Oversight Council and Consumer Financial Protection Agency with authority to look broadly at our financial system and 

to set minimum uniform rules for the financial sector. In addition, the Administration’s proposal to create a new agency to supervise federally chartered institutions 

will better reflect the current composition of the banking industry. Finally, but no 

less important, there needs to be a resolution mechanism that encourages market 

discipline for financial firms by imposing losses on shareholders and creditors and 

replacing senior management in the event of failure. 

I would be pleased respond to your questions. 

PREPARED STATEMENT OF JOHN C. DUGAN 

COMPTROLLER OF THE CURRENCY, OFFICE OF THE COMPTROLLER OF THE CURRENCY

AUGUST 4, 2009 

Chairman Dodd, Ranking Member Shelby, and Members of the Committee, I appreciate this opportunity to discuss the modernization of financial services regulation in the context of the Administration’s Proposal for regulatory reform. 1 The 

events of the last 2 years—including the unprecedented distress and failure of financial firms, the accumulation of toxic subprime mortgage assets in our financial system, and the steep rise in foreclosures—have exposed gaps and weaknesses in our 

regulatory framework. The Proposal put forward by the Treasury Department for 

strengthening that framework is thoughtful and comprehensive, and I support many 

of its proposed reforms. But I also have significant concerns with two parts of it, 

i.e., (1) the proposed broad authority of the Federal Reserve, as systemic risk regulator, to override authority of the primary prudential banking supervisor; and (2) 

the elimination of uniform national consumer protection standards for national 

banks in connection with establishing the newly proposed Consumer Financial Pro-
49 

tection Agency (CFPA), and the transfer of all existing consumer protection examination and enforcement from the Federal banking agencies to the new CFPA. Both 

concerns relate to the way in which important new authorities would interact with 

the essential functions of the dedicated prudential banking supervisor. 

My testimony begins with a brief summary of the key parts of the Proposal we 

generally support. The second section focuses on the topics pertaining to regulatory 

structure on which the Committee has specifically invited our views; this portion includes a discussion of the Federal Reserve’s role and authority. The last section addresses our second area of major concern—uniform national standards and the 

CFPA. 

I. Key Provisions Supported by the OCC 

We believe many of the Administration’s proposed reforms will strengthen the financial system and help prevent future market disruptions of the type we witnessed 

last year, including the following: 

• Establishment of a Financial Stability Oversight Council. This council would 

consist of the Secretary of the Treasury and all of the Federal financial regulators, and would be supported by a permanent staff. Its general role would be 

to identify and monitor systemic risk, and it would have strong authority to 

gather the information necessary for that mission, including from any entity 

that might pose systemic risk. We believe that having a centralized and formalized mechanism for gathering and sharing systemically significant information, 

and making recommendations to individual regulators, makes good sense. It 

also could provide a venue or mechanism for resolving differences of opinions 

among regulators. 

• Enhanced authority to resolve systemically significant financial firms. The Federal Deposit Insurance Corporation (FDIC) currently has broad authority to resolve a distressed systemically significant depository institution in an orderly 

manner. No comparable resolution authority exists for large bank holding companies, or for systemically significant financial companies that are not banks, 

as we learned painfully with the problems of such large financial companies as 

Bear Stearns, Lehman Brothers, and AIG. The Proposal would extend resolution authority like the FDIC’s to such nonbanking companies, while preserving 

the flexibility to use the FDIC or another regulator as the receiver or conservator, depending on the circumstances. This is a sound approach that would 

help maximize orderly resolutions of systemically significant firms. 

• Strengthened regulation of systemically significant firms, including requirements 

for higher capital and stronger liquidity. We support the concept of imposing 

more stringent prudential standards on systemically significant financial firms 

to address their heightened risk to the system and to mitigate the competitive 

advantage they could realize from being designated as systemically significant. 

But these standards should not displace the standard-setting and supervisory 

responsibilities of the primary banking supervisor with respect to bank subsidiaries of these companies. And in those instances where the largest asset of the 

systemically significant firm is a bank—as may often be the case—the primary 

banking supervisor should have a strong role in helping to craft the new standards for the holding company. 

• Changes in accounting standards that would allow banks to build larger loan 

loss reserves in good times to absorb more losses in bad times. One of the problems that has impaired banks’ ability to absorb increased credit losses while 

continuing to provide appropriate levels of credit is that their levels of loan loss 

reserves available to absorb such losses were not as high as they should have 

been entering the crisis. One reason for this is the currently cramped accounting regime for building loan loss reserves, which is based on the concept that 

loan loss provisions are permissible only when losses are ‘‘incurred.’’ The Proposal calls for accounting standard setters to improve this standard to make it 

more forward looking so that banks could build bigger loan loss reserves when 

times are good and losses are low, in recognition of the fact that good times inevitably end, and large loan loss reserves will be needed to absorb increased 

losses when times turn bad. The OCC strongly supports this part of the Proposal. In fact, I cochaired an international task force under the auspices of the 

Financial Stability Board to achieve this very objective on a global basis, which 

we hope will contribute to stronger reserving policy both here and abroad. 

• Enhanced consumer protection. The Proposal calls for enhanced consumer protection standards for consumer financial products through new rules that would 

be written and implemented by the new Consumer Financial Protection Agency. 

The OCC supports strong, uniform Federal consumer protection standards. 
50 

2For example, current law provides the OCC with important independence from political interference in decision making in matters before the Comptroller, including enforcement proceedings; provides for funding independent of political control; enables the OCC to propose and 

promulgate regulations without approval by the Treasury; and permits the agency to testify before Congress without the need for the Administration’s clearance of the agency’s statements. 

While we generally do not have rulewriting authority in this area, we have consistently applied and enforced the rules written by the Federal Reserve (and 

others), and, in the absence of our own rulewriting authority, have taken strong 

enforcement actions to address unfair and deceptive practices by national 

banks. We believe that an independent agency like the CFPA could appropriately strengthen consumer protections, but we have serious concerns with 

the CFPA as proposed. We believe the goal of strong consumer protection can 

be accomplished better through CFPA rules that reflect meaningful input from 

the Federal banking agencies and are truly uniform, rather than resulting in 

a patchwork of different rules amended and enforced differently by individual 

States. We also believe that these rules should continue to be implemented by 

the Federal banking agencies for banks, under the existing, well-established 

regulatory and enforcement regime, and by the CFPA and the States for 

nonbank financial providers, which today are subject to different standards and 

far less actual oversight than federally regulated depository institutions. This 

is discussed in greater detail below. 

• Stronger regulation of payments systems, hedge funds, and over-the-counter derivatives, such as credit default swaps. The Proposal calls for significant enhancements in regulation in each of these areas, which we generally support 

in concept. We will provide more detailed comments about each, as appropriate, 

once we have had more time to review the implementing legislative language. 

II. Regulatory Structure Issues 

1. Proposed Establishment of the National Bank Supervisor and Elimination of the 

Federal Thrift Charter 

In proposing to restructure the banking agencies, the Proposal appropriately preserves an agency whose only mission is banking supervision. This new agency, the 

National Bank Supervisor (NBS), would serve as the primary regulator of federally 

chartered depository institutions, including the national banks that comprise the 

dominant businesses of many of the largest financial holding companies. To achieve 

this goal, the Proposal would effectively merge the Office of Thrift Supervision 

(OTS) into the OCC. 

It would eliminate the Federal thrift charter—and also, as I will shortly discuss, 

the separate treatment of savings and loan holding companies—with all Federal 

thrifts required to convert to a national bank, a State bank, or a State thrift, over 

the course of a reasonable transition period. (State thrifts would then be treated as 

State ‘‘banks’’ under Federal law.) We believe this approach to the agency merger 

is preferable to one that would preserve the Federal thrift charter, with Federal 

thrift regulation being conducted by a division of the merged agency. With the same 

deposit insurance fund, same prudential regulator, same holding company regulator, 

same branching powers, and a narrower charter (a national bank has all the powers 

of a Federal thrift plus many others), there would no longer be a need for a separate 

Federal thrift charter. In addition, the approach in the Proposal avoids the considerable practical complexities and costs of administering two separate statutory and 

regulatory regimes that are largely redundant in many areas, and needlessly different in others. Finally, the legislation implementing this aspect of the Proposal 

should be unambiguously clear—as we believe is intended—that the new agency is 

independent from the Treasury Department and the Administration to the same extent that the OCC and OTS are currently independent. 2

2. Enhancement of the Federal Reserve’s Supervision of Systemically Significant Financial Holding Companies 

The Federal Reserve Board already has strong authority as consolidated supervisor to identify and address problems at large, systemically significant bank holding companies. In the financial crisis of the last 2 years, the absence of a comparable authority with respect to large securities firms, insurance companies, and 

Government-sponsored enterprises that were not affiliated with banks proved to be 

an enormous problem, as a disproportionate share of the financial stress in the markets was created by these institutions. The lack of a consistent and coherent regulatory regime applicable to them by a single regulator helped mask problems in 

these nonbanking companies until they were massive. And gaps in the regulatory 

regime constrained the Government’s ability to deal with them once they emerged. 
51 

The Proposal would extend the Federal Reserve’s consolidated bank holding company regulation to systemically significant nonbanking companies in the future, 

which would appropriately address the regulatory gap. However, as discussed below, 

one aspect of this part of the proposal goes too far, i.e., the new Federal Reserve 

authority to ‘‘override’’ key functions of the primary banking supervisor, which 

would undermine the authority—and the accountability—of the banking supervisor 

for the soundness of the banks that anchor systemically significant holding companies. 

3. Elimination of the Thrift Holding Company and Industrial Loan Company Exceptions to Bank Holding Company Act Regulation 

Under the law today, companies that own thrifts or industrial loan companies 

(ILCs) are exempt from regulation under the Bank Holding Company Act. The Proposal would eliminate these exemptions, making these types of firms subject to supervision by the Federal Reserve Board. 

Thrift holding companies, unlike bank holding companies, are not subject to consolidated regulation; for example, no consolidated capital requirements apply at the 

holding company level. This difference between bank and thrift holding company 

regulation created arbitrage opportunities for companies that were able to take on 

greater risk under a less rigorous regulatory regime. Yet, as we have seen - AIG 

is the obvious example—large nonbank firms can present similar risks to the system 

as large banks. This regulatory gap should be closed, and these firms should be subject to the same type of oversight as bank holding companies. 

Companies controlling ILCs also are not subject to bank holding company regulation, but admittedly, ILCs have not been the source of the same kinds of problems 

as thrift holding companies. For that reason, it may be appropriate to continue to 

exempt small ILCs from bank holding company regulation. If this approach were 

pursued, the exemption should terminate once the ILC exceeds a certain size 

threshold, however, because the same potential risks can arise as with banks. Alternatively, if the ILC exemption were repealed altogether, appropriate grandfathering 

of existing ILCs and their parent companies should be considered. 

4. The Merits of Further Regulatory Consolidation 

It is clear that the United States has too many bank regulators. We have four 

Federal bank regulators, 12 Federal Reserve Banks, and 50 State regulators, nearly 

all of which have some type of overlapping supervisory responsibilities. This system 

is largely the product of historical evolution, with different agencies created for different legitimate purposes reflecting a much more segmented financial system from 

the past. No one would design such a system from scratch, and it is fair to say that, 

at times, it has not been the most efficient way to establish banking policy or supervise banks. 

Nevertheless, the banking agencies have worked hard over the years to make the 

system function appropriately despite its complexities. On many occasions, the diversity in perspectives and specialization of roles has provided real value. And from 

the agencies has been a primary driver of recent problems in the banking system. 

That said, I recognize the considerable interest in reducing the number of bank 

regulators. The impulse to simplify is understandable, and it may well be appropriate to streamline our current system. But we ought not approach the task by prejudging the appropriate number of boxes on the organization chart. The better approach is to determine what would be achieved if the number of regulators were reduced. What went wrong in the current crisis that changes in regulatory structure 

(rather than regulatory standards) will fix? Will accountability be enhanced? Will 

the change result in greater efficiency and consistency of regulation? Will gaps be 

closed so that opportunities for regulatory arbitrage in the current system are eliminated? Will overall market regulation be improved? 

In testimony provided earlier this year, I strongly urged that Congress, in reforming financial services regulation, preserve a robust, independent bank supervisor 

that is solely dedicated to the prudential oversight of depository institutions. Banks 

are the anchor of most financial holding companies, including the very largest, and 

I continue to believe that the benefits of dedicated, strong prudential supervision 

are significant—indeed, necessary. Dedicated supervision assures there is no confusion about the supervisor’s goals and objectives, and no potential conflict with competing objectives. Responsibility is well defined, and so is accountability. Supervision 

takes a back seat to no other part of the organization, and the result is a strong 

culture that fosters the development of the type of seasoned supervisors that are 

needed to confront the many challenges arising from today’s banking business. The 

strength of national banks at the core of many of the largest financial holding com-
52 

panies has been an essential anchor to the ability of those companies to weather 

recent financial crises—and to absorb distressed securities and thrift companies. 

While there is arguably an agreement on the need to reduce the number of bank 

regulators, there is no such consensus on what the right number is or what their 

roles should be. As I have mentioned, we support reducing the number of Federal 

banking regulators from four to three by effectively merging the OTS into the OCC, 

leaving just one Federal regulator for federally chartered banks. There are reasonable arguments for streamlining the regulatory structure even further, but there 

would be advantages and disadvantages at each step. 

For example, the number of banking regulators could be further reduced from 

three to two by creating a single Federal regulator for State-chartered banks, whose 

Federal supervision is now divided between the Federal Reserve Board and the 

FDIC, depending on whether the State bank is a member of the Federal Reserve 

System. Today there is virtually no difference in the regulation applicable to State 

banks at the Federal level based on membership in the System and thus no real 

reason to have two different Federal regulators. It would be simpler to have one. 

Opportunities for regulatory arbitrage—resulting, for example, from differences in 

the way Federal activities restrictions are administered by one or the other regulator—would be reduced. Policymaking would be streamlined. Fewer decision-makers would have to agree on the implementation of banking policies and restrictions 

that Congress has required to be carried out on a joint basis. 

On the other hand, whichever agency loses supervisory authority over State banks 

also would lose the day-to-day ‘‘window’’ into the condition of the banking industry 

that today informs the conduct of other aspects of its mission. This may present a 

greater problem for the FDIC, which would have much less engagement with the 

banking sector during periods with few bank failures, especially if the Federal Reserve retained holding company jurisdiction, an issue I discuss below. 

Still further consolidation could be achieved by reducing the number of bank regulators to one dedicated prudential supervisor. If this were done, the single Federal 

supervisor should be structured to be independent from the Treasury Department 

and headed by a board of directors, with the Chairmen of the FDIC and the Federal 

Reserve Board serving as board members. This is the simplest, and arguably the 

most logical, approach. It would afford the most direct accountability—there would 

be no confusion about which regulator was responsible for the Federal supervision 

of a bank—and it would end opportunities for regulatory arbitrage. Moreover, it 

could be done within the framework of the dual banking system by preserving both 

State and national charters. It would be desirable, however, for the single regulator 

to maintain separate divisions for the supervision of large and small institutions, 

given the differences in complexity and types of risk that banks of different sizes 

present. 

The disadvantages of such an approach include removing both the Federal Reserve and the FDIC from day-to-day bank supervision (although that concern would 

be mitigated for the Federal Reserve to the extent it retained holding company regulation). In addition, States may be concerned that the State charter would be significantly less attractive if the same Federal regulator supervised both State and Federal institutions, especially if State-chartered institutions were required to pay for 

Federal supervision in addition to the assessments charged by the State (although 

that issue could be addressed separately). 

Finally, the Committee has asked whether a consolidated prudential bank supervisor also could regulate the holding company. While this could be done, and has 

significant appeal with respect to small and ‘‘bank-only’’ holding companies, there 

would be significant issues involved with such an approach in the case of the largest 

companies where the challenges would be the greatest. 

Little need remains for separate holding company regulation where the bank is 

small or where it is the holding company’s only, or dominant, asset. (The previously 

significant role of the Federal Reserve, as holding company supervisor, in approving 

new activities was dramatically reduced by the provisions in the Gramm-Leach-Bliley Act that authorized financial holding companies and specifically identified and 

approved in advance the types of activities in which they could engage.) For these 

firms, the holding company regulator’s other authorities are not necessary to ensure 

effective prudential supervision to the extent that they duplicate the Federal prudential supervisor’s authority to set standards, examine, and take appropriate enforcement action with respect to the bank. Elimination of a separate holding company regulator thus would eliminate duplication, promote simplicity and accountability, and reduce unnecessary compliance burden for institutions as well. 

The case is harder and more challenging for the very largest bank holding companies engaged in complex capital markets activities, especially where the company 

is engaged in many, or predominantly, nonbanking activities, such as securities and 
53 

insurance. Given its substantial role and direct experience with respect to capital 

markets, payments systems, the discount window, and international central banking, the Federal Reserve Board provides unique resources and perspective to supervision. Eliminating the Board as holding company regulator would mean losing the 

direct effect of that expertise. The benefits of the different perspectives of holding 

company regulator and prudential regulator would be lost. The focus of a dedicated, 

strong prudential banking supervisor could be significantly diluted by extending its 

focus to nonbanking activities. It also would take time for the consolidated banking 

supervisor to acquire and maintain a comparable level of expertise, especially in 

nonbanking activities. 

5. Delineation of Responsibilities Between the Systemic Supervisor and Prudential 

Supervisor 

If, as under the Administration’s Proposal, the Board is the systemic holding company supervisor, then it is essential that clear lines be drawn between the Board’s 

authority and the authority of the prudential banking supervisor. As I will explain, 

the Proposal goes too far in authorizing the systemic supervisor to override the prudential supervisor’s role and authorities. 

The Proposal would establish the Federal Reserve Board as the systemic supervisor by providing it with enhanced, consolidated authority over a ‘‘Tier 1’’ financial 

holding company—that is, a company that poses significant systemic risk—and all 

of its subsidiaries. In essence, this structure builds on and expands the current system for supervising bank holding companies, where the Board already has consolidated authority over the company, and the prudential bank supervisor is responsible 

for direct bank supervision. 

In practice, many of the companies likely to be designated as Tier 1 financial 

holding companies will have at their heart very large banks, many of which are national banks. Because of their core role as financial intermediaries, large banks have 

extensive ties to the ‘‘Federal safety net’’ of deposit insurance, the discount window, 

and the payments system. Accordingly, the responsibility of the prudential bank supervisor must be to ensure that the bank remains a strong anchor within the company as a whole. Indeed, this is our existing responsibility at the OCC, which we 

take very seriously through our continuous on-site supervision by large teams of 

resident examiners in all of our largest national banks. As a result, the bank is by 

far the most intensively regulated part of the largest bank holding companies, which 

has translated into generally lower levels of losses of banks within the holding company versus other companies owned by that holding company—including those large 

bank holding companies that have sustained the greatest losses. 

In the context of regulatory restructuring for systemically significant bank holding 

companies, preserving the essential role of the prudential supervisor of the bank 

means that its relationship with the systemic supervisor should be complementary; 

it should not be subsumed or overtaken by the systemic supervisor. Conflating the 

two roles undermines the bank supervisor’s authority, responsibility, and accountability. Moreover, it would impose major new responsibilities on and further stretch 

the role of the Board. 

Parts of the Proposal are consistent with this type of complementary relationship 

between the Board and the prudential bank supervisor. For example, the Board 

would be required to rely, as far as possible, on the reports of examination prepared 

by the prudential bank supervisors. This approach reflects the practical relationship 

that the OCC has with the Board today, a relationship that works, in part because 

the lines of authority between the two regulators are appropriately defined. And it 

has allowed the Board to use and rely on our work to perform its role as supervisor 

for complex banking organizations that are often involved in many businesses other 

than banking. It is a model well suited for use in a new regulatory framework where 

the Board assumes substantial new responsibilities, including potential authority 

over some Tier 1 companies that do not have bank subsidiaries at all. 

In one crucial respect, however, the Proposal departs dramatically from that 

model and is not consistent with its own stated objective of maintaining a robust, 

responsible, and independent prudential supervisor that will be accountable for its 

safety and soundness supervision. That is, the Proposal provides the Board with authority to establish, examine, and enforce more stringent standards with respect to 

the ‘‘functionally regulated’’ subsidiaries of Tier 1 financial holding companies— 

which under the proposal would include bank subsidiaries—in order to mitigate systemic risk posed by those subsidiaries. This open-ended authorization would allow 

the Board to impose customized requirements on virtually any aspect of the bank’s 

operations at any time, subject only to a requirement for ‘‘consultation’’ with the 

Secretary of the Treasury and the bank’s primary Federal or State supervisor. This 

approach is entirely unnecessary and unwarranted in the case of banks already sub-
54 

3See, e.g., Chairman Alan Greenspan, ‘‘Insurance Companies and Banks Under the New Regulatory Law’’, Remarks Before the Annual Meeting of the American Council of Life Insurance 

(November 14, 1999) (‘‘The Gramm-Leach-Bliley Act is designed to limit extensions of the safety 

net, and thus to eliminate the need to impose banklike regulation on nonbank subsidiaries and 

affiliates of organizations that contain a bank.’’), available at www.federalreserve.gov/ 

boarddocs/speeches/1999/19991115.htm. 

ject to extensive regulation. It would fundamentally alter the relationship between 

the Board and the bank supervisor by superseding the bank supervisor’s authority 

over bank subsidiaries of systemically significant companies, and would be yet another measure that concentrates more authority in, and stretches the role of, the 

Board. 

In addition, while the Proposal centralizes in the Board more authority over Tier 

1 financial holding companies, it does not address the current, significant gap in supervision that exists within bank holding companies. In today’s regulatory regime, 

a bank holding company may engage in a particular banking activity, such as mortgage lending, either through a subsidiary that is a bank or through a subsidiary 

that is not a bank. If engaged in by the banking subsidiary, the activity is subject 

to required examination and supervision on a periodic basis by the primary banking 

supervisor. However, if it is engaged in by a nonbanking subsidiary, it is potentially 

subject to examination by the Federal Reserve, but regular supervision and examination is not required. As a policy matter, the Federal Reserve had previously elected not to subject such nonbanking subsidiaries to full bank-like examination and supervision on the theory that such activities would inappropriately extend ‘‘the safety 

net’’ of Federal protections from banks to nonbanks. 3 The result has been the application of uneven standards to bank and nonbank subsidiaries of bank holding companies. For example, in the area of mortgage lending, banks were held to more rigorous underwriting and consumer compliance standards than nonbank affiliates in 

the same holding company. While the Board has recently indicated its intent to increase examination of nonbank affiliates, it is not clear that such examinations will 

be required to be as regular or extensive as the examination of the same activities 

conducted in banks. 

I believe that such differential regulation and supervision of the same activity 

conducted in different subsidiaries of a single bank holding company—whether in 

terms of safety and soundness or consumer protection—doesn’t make sense and is 

an invitation to regulatory arbitrage. Indeed, leveling the supervision of all subsidiaries of a bank holding company takes on added importance for a ‘‘Tier 1’’ financial 

holding company because, by definition, the firm as a whole presents systemically 

significant risk. 

One way to address this problem would be to include in legislative language an 

explicit direction to the Board to actively supervise nonbanking subsidiaries engaged 

in banking activities in the same way that a banking subsidiary is supervised by 

the prudential supervisor, with required regular exams. Of course, adding new required responsibilities for the direct supervision of more companies may serve as a 

distraction both from the Board’s other new assignments under the Proposal as well 

as the continuation of its existing responsibilities. 

An alternative approach that may be preferable would be to assign responsibility 

to the prudential banking supervisor for supervising certain nonbank holding company subsidiaries. In particular, where those subsidiaries are engaged in the same 

business as is conducted, or could be conducted, by an affiliated bank—mortgage or 

other consumer lending, for example—the prudential supervisor already has the resources and expertise needed to examine the activity. Affiliated companies would 

then be made subject to the same standards and examined with the same frequency 

as the affiliated bank. This approach also would ensure that the placement of an 

activity in a holding company structure could not be used to arbitrage between different supervisory regimes or approaches. 

III. The Proposed Consumer Financial Protection Agency and the Elimination of Uniform National Standards for National Banks 

Today’s severe consumer credit problems can be traced to the multiyear policy of 

easy money and easy credit that led to an asset bubble, with too many people getting loans that could not be repaid when the bubble burst. With respect to these 

loans—especially mortgages—the core problem was lax underwriting that relied too 

heavily on rising house prices. Inadequate consumer protections—such as inadequate and ineffective disclosures—contributed to this problem, because in many 

cases consumers did not understand the significant risks of complex loans that had 

seductively low initial monthly payments. Both aspects of the problem—lax under-
55 

4Some have suggested that the Community Reinvestment Act (CRA) caused the subprime 

lending crisis. That is simply not true. As the Administration’s Proposal expressly recognizes, 

and as I have testified before, far fewer problem mortgages were made by institutions subject 

to CRA—that is, federally regulated depository institutions—than were made by mortgage brokers and originators that were not depository institutions. The Treasury Proposal specifically 

notes that CRA-covered depository institutions made only 6 percent of recent higher-priced 

mortgages provided to lower-income borrowers or in areas that are the focus of CRA evaluations. 

Proposal, supra, note 1, at 69–70. Moreover, our experience with the limited portion of subprime 

loans made by national banks is that they are performing better than nonbank subprime loans. 

This belies any suggestion that the banking system, and national banks in particular, were any 

sort of haven for abusive lending practices. 5See, e.g., Proposal, supra note 1, at 69 (discussing the proposed CFPA, observing that 

‘‘[f]airness, effective competition, and efficient markets require consistent regulatory treatment 

for similar products,’’ and noting that consistent regulation facilitates consumers’ comparison 

shopping); and at 39 (discussing the history of insurance regulation by the States, which ‘‘has 

led to a lack of uniformity and reduced competition across State and international boundaries, 

resulting in inefficiency, reduced product innovation, and higher costs to consumers.’’). 

writing and inadequate consumer protections—were especially acute in loans made 

by nonbank lenders that were not subject to Federal regulation. 4

In terms of changes to financial consumer protection regulation, legislation should 

be targeted to the two types of fundamental gaps that fueled the current mortgage 

crisis. The first gap relates to consumer protection rules themselves, which were 

written under a patchwork of authorities scattered among different agencies; were 

in some cases not sufficiently robust or timely; and importantly, were not applied 

to all financial services providers, bank or nonbank, uniformly. The second gap relates to implementation of consumer protection rules, where there was no effective 

mechanism or framework to ensure that nonbank financial institutions complied 

with rules to the same extent as regulated banks. That is, the so-called ‘‘shadow 

banking system’’ of nonbank firms, such as finance companies and mortgage brokers, provides products comparable to those provided by banks, but is not subject 

to comparable oversight. This shadow banking system has been widely recognized 

as central to the most abusive subprime lending that fueled the mortgage crisis. 

A new Consumer Financial Protection Agency could be one mechanism to target 

both the rulewriting gap and the implementation gap. In terms of the rulewriting 

gap, all existing consumer financial protection authority could be centralized in the 

CFPA and strengthened as Congress sees fit, and that authority could be applied 

to all providers of a particular type of financial product with rules that are uniform. 

In terms of the implementation gap, the CFPA could be focused on supervision and/ 

or enforcement mechanisms that raise consumer protection compliance for nonbank 

financial providers to a similar level as exists for banks—but without diminishing 

the existing regime for bank compliance. And in both cases, the CFPA could be 

structured to recognize legitimate bank safety and soundness concerns that in some 

cases are inextricably intertwined with consumer protection—as is the case with underwriting standards. 

Unfortunately, the Proposal’s CFPA falls short in addressing these two fundamental consumer protection regulatory gaps. Let me address each in turn. 

1. Rulewriting 

a. Lack of Uniform Rules and National Bank Preemption—To address the 

rulewriting gap, the Proposal’s CFPA provides a mechanism for centralized authority and stronger rules that could be applied to all providers of financial 

products. But the rules would not be uniform; that is, because the Proposal authorizes States to adopt different rules, there could be 50 different standards 

that apply to providers of a particular product or service, including national 

banks. 

A core principle of the Proposal is its recognition that consumers benefit from uniform rules. 5 Yet this very principle is expressly undermined by the specific grant 

of authority to States to adopt different rules; by the repeal of uniform standards 

for national banks; and by the empowerment of individual States, with their very 

differing points of view, to enforce Federal consumer protection rules—under all 

Federal statutes—in ways that might vary from State to State. In effect, the resulting patchwork of Federal-plus-differing-State standards would effectively distort and 

displace the Federal agency’s rulemaking, even though the CFPA’s rule would be 

the product of an open public comment process and the behavioral research and 

evaluative functions that the Proposal highlights. 

In particular, for the first time in the nearly 150-year history of the national 

banking system, federally chartered banks would be subject to this multiplicity of 

State operating standards, because the Proposal sweepingly repeals the ability of 
56 

6 12 U.S.C. §1831a(j); See, also id. at 1831d (interest rates; parity for State banks). 

national banks to conduct any retail banking business under uniform national 

standards. 

This is a profound change and, in my view, the rejection of a national standards 

option is unwise and unjustified, especially as it relates to national banks. Given 

the CFPA’s enhanced authority and mandate to write stronger consumer protection 

rules, and the thorough and expert processes described as integral to its rulemaking, there should no longer be any issue as to whether sufficiently strong Federal consumer protection standards would be in place and applicable to national 

banks. In this context there is no need to authorize States to adopt different standards for such banks. Likewise, there is no need to authorize States to enforce Federal rules against national banks—which would inevitably result in differing State 

interpretations of Federal rules—because Federal regulators already have broad enforcement authority over such institutions and the resources to exercise that authority fully. 

More fundamentally, we live in an era where the market for financial products 

and services is often national in scope. Advances in technology, including the Internet and the increased functionality of mobile phones, enable banks to do business 

with customers in many States. Our population is increasingly mobile, and many 

people live in one State and work in another—the case for many of us in the Washington, DC, metropolitan area. 

In this context, regressing to a regulatory regime that fails to recognize the way 

retail financial services are now provided, and the need for an option for a single 

set of rules for banks with multistate operations and multistate customers, would 

discard many of the benefits consumers reap from our modern financial product delivery system. The Proposal’s balkanized approach could give rise to significant uncertainty about which sets of standards apply to institutions conducting a multistate 

business, generating major legal and compliance costs, and major impediments to 

interstate product delivery. 

This issue is very real for all banks operating across State lines—not just national 

banks. Recognizing the importance of preserving uniform interstate standards for 

all banks operating in multiple States, Congress expressly provided in the ‘‘RiegleNeal II’’ Act enacted in 1997 that State banks operating through interstate branches 

in multiple States should enjoy the same Federal preemption and ability to operate 

with uniform standards as national banks. 6

Accordingly, repealing the uniform standards option would create fundamental, 

practical problems for all banks operating across State lines, large or small. For example, there are a number of areas in which complying with different standards set 

by individual States would require a bank to determine which State’s law governs— 

the law of the State where a person providing a product or service is located, the 

law of the home State of the bank employing that person, or the law of the State 

where the customer is located. It is far from clear how a bank could do this based 

on objective analysis, and any conflicts could result in penalties and litigation in 

multiple jurisdictions. 

Consider the following practical examples of the potential for multiple State 

standards: 

• Different rules regarding allowable terms and conditions of particular products; 

• Different standards for how products may be solicited and sold (including the 

internal organizational structure of the provider selling the product); 

• Different duties and responsibilities for individuals providing a particular financial product; 

• Different limitations on how individuals offering particular products and services may be compensated; 

• Different standards for counterparty and assignee liability in connection with 

specified products; 

• Different standards for risk retention (‘‘skin in the game’’) by parties in a chain 

of origination and sale; 

• Different disclosure standards; 

• Different requirements, or permissible rates of interest, for bank products; and 

• Different licensing and product clearance requirements. 

Taking permissible interest rates as an example, today the maximum permissible 

interest rate is derived from the bank’s home State. Under the proposal, States 

could claim that the permissible rate should be the rate of the State in which the 
57 

customer resides, or the rate of the location where the loan is made, or someplace 

else. States could also have different rules about the types of charges that constitute 

‘‘interest’’ subject to State limits. And States could have different standards for exerting jurisdiction over interest rates, creating the potential for the laws of two or 

more States to apply to the same transaction. And even if the bank figures all this 

out for a particular customer, and for all the product relationships it has with the 

customer, that could all change if the customer moved. Does that mean the customer would have to open a new account to incorporate the new required terms? 

Such uncertainties have the real potential to confuse consumers, subject providers 

to major new potential liabilities, and significantly increase the costs of doing business in ways that will be passed on to consumers. It could also cause product providers to pull back where increased costs erase an already thin profit margin—for 

example, with ‘‘indirect’’ auto lending across State lines—or where they see unacceptable levels of uncertainty and potential risk. 

Moreover, a bank with multistate operations might well decide that the only sensible way to conduct a national business is to operate to the most stringent standard 

prevailing in its most significant State market. It should not be the case that a decision by one State legislature about how products should be designed, marketed, or 

sold should effectively replace a national regulatory standard established by the 

Federal Government based on thorough research and an open and nationwide public 

comment process. 

Finally, subjecting national banks to state laws and state enforcement of Federal 

laws is a potentially crippling change to the national bank charter and a rejection 

of core principles that form the bedrock of the dual banking system. For nearly 150 

years, national banks have been subject to a uniform set of Federal rules enforced 

by the OCC, and State banks have been subject to their own States’ rules. This dual 

banking system has worked, as it has allowed an individual State to serve as a ‘‘laboratory’’ for new approaches to an issue—without compelling adoption of a particular approach by all States or as a national standard. That is, the dual banking 

system is built on individual States experimenting with different kinds of laws, including new consumer protection laws, that apply to State banks in a given State, 

but not to State banks in all States and not to national banks. Some of these individual State laws have proven to be good ideas, while others have not. When Congress has believed that a particular State’s experiment is worthwhile, it has enacted 

that approach to apply throughout the country, not only to all national banks, but 

to State banks operating in other States that have not yet adopted such laws. As 

a result of this system, national banks have always operated under an evolving set 

of Federal rules that are at any one time the same, regardless of the State in which 

the banks are headquartered, or the number of different States in which they operate. This reliable set of uniform Federal rules is a defining characteristic of the national bank charter, helping banks to provide a broader range of financial products 

and services at lower cost, which in turn can be passed along to the consumer. 

The Proposal’s CFPA, by needlessly eliminating this defining characteristic, will 

effectively ‘‘de-nationalize’’ the national charter and undermine the dual banking 

system. What will be the point of a national charter if all banks must operate in 

every State as if they were chartered in that State? In such circumstances there 

would be a strong impetus to convert to a State bank regulated by the Federal Reserve in order to obtain the same regulator for the bank and the holding company, 

while avoiding any additional cost associated with national bank supervision—and 

that would further concentrate responsibilities in, and stretch the mission of, the 

Federal Reserve. 

In short, with many consumer financial products now commoditized and marketed 

nationally, it is difficult to understand the sense of replacing the existing, longstanding option of enhanced and reliable Federal standards that are uniform, with 

a balkanized ‘‘system’’ of differing State standards that may be adopted under processes very different from the public-comment and research-based rulemaking process that the CFPA would employ as a Federal agency. 
58 

b. Safety and Soundness Implications of CFPA Rulemaking—The Proposal would 

vest all consumer protection rulewriting authority in the CFPA, which in turn 

would not be constrained in any meaningful way by safety and soundness concerns. That presents serious issues because, in critical aspects of bank supervision, such as underwriting standards, consumer protection cannot be separated from safety and soundness. They are both part of comprehensive and effective banking supervision. Despite this integral relationship, the Proposal as 

drafted would allow the CFPA, in writing rules, to dismiss legitimate safety and 

soundness concerns raised by a banking supervisor. That is, if a particular 

CFPA rule conflicts with a safety and soundness standard, the CFPA’s views 

would always prevail, because the legislation provides no mechanism for striking an appropriate balance between consumer protection and safety and soundness objectives. 

For example, the CFPA could require a lender to offer a standardized mortgage 

that has simple terms, but also has a low down payment to make it more beneficial 

to consumers. That type of rule could clearly raise safety and soundness concerns, 

because lower down payments are correlated with increased defaults on loans—yet 

a safety and soundness supervisor would have no ability to stop such a rule from 

being issued. 

In short, as applied to depository institutions, the CFPA rules need to have meaningful input from banking supervisors—both for safety and soundness purposes and 

because bank supervisors are intimately familiar with bank operations and can help 

ensure that rules are crafted to be practical and workable. A workable mechanism 

needs to be specifically provided to incorporate legitimate operational and safety and 

soundness concerns of the banking agencies into any final rule that would be applicable to insured depository institutions. Moreover, I do not believe it is sufficient 

to have only one banking supervisor on the agency’s board, as provided under the 

Proposal; instead, all the banking agencies should be represented, even if that requires expanding the size of the board. 

2. Implementation: Supervision, Examination, and Enforcement 

Consumer protection rules are implemented through examination, supervision, 

and/or enforcement. In this context, the Proposal fails to adequately address the implementation gap I have previously described because it fails to carefully and appropriately target the CFPA’s examination, supervision, and enforcement jurisdiction 

to the literally tens of thousands of nondepository institution financial providers 

that are either unregulated or very lightly regulated. These are the firms most in 

need of enhanced consumer protection regulation, and these are the ones that will 

present the greatest implementation challenges to the CFPA. Yet rather than focus 

the CFPA’s implementation responsibilities on these firms, the Proposal would effectively dilute both the CFPA’s and the States’ supervisory and enforcement authorities by extending them to already regulated banks. To do this, the Proposal would 

strip away all consumer compliance examination and supervisory responsibilities— 

and for all practical purposes enforcement powers as well—from the Federal banking agencies and transfer them to the CFPA. And, although the legislation is unclear about the new agency’s responsibilities for receiving and responding to consumer complaints, it would either remove or duplicate the process for receiving and 

responding to complaints by consumers about their banks. 

The likely results will be that: (1) nonbank financial providers will not receive the 

degree of examination, supervision, and enforcement attention required to achieve 

effective compliance with consumer protection rules; and (2) consumer protection supervision of banks will become less rigorous and less effective. 

In relative terms, it will be easy for the CFPA to adopt consumer protection rules 

that apply to all providers of financial products and services. But it will be far harder to craft a workable supervisory and enforcement regime to achieve effective implementation of those rules. In particular, it will be a daunting challenge to implement rules with respect to the wide variety and huge number of unregulated or 

lightly regulated providers of financial services over which the new CFPA would 

have jurisdiction, i.e., mortgage brokers; mortgage originators; payday lenders; 

money service transmitters; check cashers; real estate appraisers; title, credit, and 

mortgage insurance companies; credit reporting agencies; stored value providers; financial data processing, transmission, and storage firms; debt collection firms; investment advisers not subject to SEC regulation; financial advisors; and credit counseling and tax preparation services, among other types of firms. Likewise, it will be 

daunting to respond to complaints from consumers about these types of firms. 

Yet, although the Proposal would give the CFPA broad consumer protection authority over these types of financial product and service providers, it contains no 

framework or detail for examining them or requiring reports from them—or even 
59 

knowing who they are. No functions are specified for the CFPA to monitor or examine even the largest of these nonbank firms, much less to supervise and examine 

them as depository institutions would be when they engaged in the same activities. 

No provision is even made for registration with the CFPA so that the CFPA could 

at least know the number and size of firms for which it has supervisory, examination, and enforcement responsibilities. Nor is any means specified for the CFPA to 

learn this information so that it may equitably assess the costs of its operations— 

and lacking that, there is a very real concern that assessments will be concentrated 

on already regulated banks, for which size and operational information is already 

available. 

In short, the CFPA has a full-time job ahead to supervise, examine, and take enforcement actions against nonbank firms in order to effect their compliance with 

CFPA rules. In contrast, achieving effective compliance with such rules by banks 

is far more straightforward, since an extensive and effective supervisory and enforcement regime is already in place at the Federal banking agencies. It therefore 

makes compelling sense for the new CFPA to target its scarce implementation resources on the part of the industry that requires the most attention to raise its level 

of compliance—the shadow banking system—rather than also try to assume supervisory, examination, and enforcement functions with respect to depository institutions. 

Similarly, State consumer protection resources would be best focused on examining and enforcing consumer protection laws with respect to the nonbank financial 

firms that are unregulated or lightly regulated—and have been the disproportionate 

source of financial consumer protection problems. If States targeted their scarce resources in this way, and drew on new examination and enforcement resources of the 

CFPA that were also targeted in this way, the States could help achieve significantly increased compliance with consumer protection laws by nonbank financial 

firms. Unfortunately, rather than have this focus, the Proposal’s CFPA would 

stretch the States’ enforcement jurisdiction to federally chartered banks, which are 

already subject to an extensive examination and enforcement regime at the Federal 

level. We believe this dilution of their resources is unnecessary, and it will only 

make it more difficult to fill the implementation gap that currently exists in achieving effective compliance of nonbank firms with consumer protection rules. 

Finally, I firmly believe that, by transferring all consumer protection examination, 

supervision, and enforcement functions from the Federal banking agencies to the 

CFPA, the Proposal would create a supervisory system for banks that would be a 

less effective approach to consumer protection than the integrated approach to 

banking supervision that exists today. Safety and soundness is not divorced from 

consumer protection—they are two aspects of comprehensive bank supervision that 

are complementary. As evidence of this, attached to my testimony are summaries 

of our actual supervisory experience, drawn from supervisory letters and examination conclusion memoranda, which show the real life linkage between safety and 

soundness and consumer protection supervision. These summaries demonstrate that 

the results would be worse for consumers and the prudential supervision of these 

banks if bank examiners were not allowed to address both safety and soundness and 

consumer protection issues as part of their integrated supervision. 

Indeed, we believe that transferring bank examination and supervision authority 

to the CFPA will not result in more effective supervision of banks—or consumer protection—because the new agency will never have the same presence or knowledge 

about the institution. Our experience at the OCC has been that effective, integrated 

safety and soundness and compliance supervision grows from the detailed, core 

knowledge that our examiners develop and maintain about each bank’s organizational structure, culture, business lines, products, services, customer base, and level 

of risk; this knowledge and expertise is cultivated through regular on-site examinations and contact with our community banks, and close, day-to-day focus on the activities of larger banks. An agency with a narrower focus, like that envisioned for 

the CFPA, would be less effective than a supervisor with a comprehensive grasp of 

the broader banking business. 

Conclusion 

The OCC appreciates the opportunity to testify on proposed regulatory reform, 

and we would be pleased to provide additional information as the Committee continues its consideration of this important Proposal. 
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66 

PREPARED STATEMENT OF DANIEL K. TARULLO 

MEMBER, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

AUGUST 4, 2009 

Chairman Dodd, Ranking Member Shelby, and other Members of the Committee, 

thank you for your invitation to testify this morning. The financial crisis had many 

causes, including global imbalances in savings and capital flows, the rapid integration of lending activities with the issuance, trading, and financing of securities, the 

existence of gaps in the regulatory structure for the financial system, and widespread failures of risk management across a range of financial institutions. Just as 

the crisis had many causes, the response of policymakers must be broad in scope 

and multifaceted. 

Improved prudential supervision—the topic of today’s hearing—is a necessary 

component of the policy response. The crisis revealed supervisory shortcomings 

among all financial regulators, to be sure. But it also demonstrated that the framework for prudential supervision and regulation had not kept pace with changes in 

the structure, activities, and growing interrelationships of the financial sector. Accordingly, it is essential both to refocus the regulation and supervision of banking 

institutions under existing authorities and to augment those authorities in certain 

respects. 

In my testimony today, I will begin by suggesting the elements of an effective 

framework for prudential supervision. Then I will review actions taken by the Federal Reserve within its existing statutory authorities to strengthen supervision of 

banks and bank holding companies in light of developments in the banking system 

and the lessons of the financial crisis. Finally, I will identify some gaps and weaknesses in the system of prudential supervision. One potential gap has already been 

addressed through the cooperative effort of Federal and State banking agencies to 

prevent insured depository institutions from engaging in ‘‘regulatory arbitrage’’ 

through charter conversions. Others, however, will require congressional action. 

Elements of an Effective Framework for Prudential Supervision 

An effective framework for the prudential regulation and supervision of banking 

institutions includes four basic elements. 

First, of course, there must be sound regulation and supervision of each insured 

depository institution. Applicable regulations must be well-designed to promote the 

safety and soundness of the institution. Less obvious, perhaps, but of considerable 

importance, is the usefulness of establishing regulatory requirements that make use 

of market discipline to help confine undue risk taking in banking institutions. Supervisory policies and techniques also must be up to the task of enforcing and 

supplementing regulatory requirements. 

Second, there must be effective supervision of the companies that own insured depository institutions. The scope and intensity of this supervision should vary with 

the extent and complexity of activities conducted by the parent company or its 

nonbank subsidiaries. When a bank holding company is essentially a shell, with 

negligible activities or ownership stakes outside the bank itself, holding company 

regulation can be less intensive and more modest in scope. But when material activities or funding are conducted at the holding company level, or when the parent 

owns nonbank entities, the intensity of scrutiny must increase in order to protect 

the bank from both the direct and indirect risks of such activities or affiliations and 

to ensure that the holding company is able to serve as a source of strength to the 

bank on a continuing basis. The task of holding company supervision thus involves 

an examination of the relationships between the bank and its affiliates as well as 

an evaluation of risks associated with those nonbank affiliates. Consolidated capital 

requirements also play a key role, by helping ensure that a holding company maintains adequate capital to support its groupwide activities and does not become excessively leveraged. 

Third, there cannot be significant gaps or exceptions in the supervisory and regulatory coverage of insured depository institutions and the firms that own them. Obviously, the goals of prudential supervision will be defeated if some institutions are 

able to escape the rules and requirements designed to achieve those goals. There 

is a less obvious kind of gap, however, where supervisors are restricted from obtaining relevant information or reaching activities that could pose risks to banking organizations. 

Fourth, prudential supervision—especially of larger institutions—must complement and support regulatory measures designed to contain systemic risk and the 

too-big-to-fail problem, topics that I have discussed in previous appearances before 
67 

1See, Daniel K. Tarullo (2009), ‘‘Regulatory Restructuring’’, statement before the Committee 

on Banking, Housing, and Urban Affairs, U.S. Senate, July 23, www.federalreserve.gov/ 

newsevents/testimony/tarullo20090723a.htm; and Daniel K. Tarullo (2009), ‘‘Modernizing Bank 

Supervision and Regulation’’, statement before the Committee on Banking, Housing, and Urban 

Affairs, U.S. Senate, March 19, www.federalreserve.gov/newsevents/testimony/ 

tarullo20090319a.htm. 2See, Basel Committee on Banking Supervision (2008), ‘‘Principles for Sound Liquidity Risk 

Management and Supervision’’ (Basel, Switzerland: Bank for International Settlements, September), www.bis.org/publ/bcbs144.htm. 3See, Office of the Comptroller of the Currency, Board of Governors of the Federal Reserve 

System, Federal Deposit Insurance Corporation, Office of Thrift Supervision, and National Credit Union Administration (2009), ‘‘Agencies Seek Comment on Proposed Interagency Guidance on 

Funding and Liquidity Risk Management’’, joint press release, June 30, www.federalreserve.gov/ 

newsevents/press/bcreg/20090630a.htm. 

this Committee. 1 One clear lesson of the financial crisis is that important financial 

risks may not be readily apparent if supervision focuses only on the exposures and 

activities of individual institutions. For example, the liquidity strategy of a banking 

organization may appear sound when viewed in isolation but, when examined alongside parallel strategies of other institutions, may be found to be inadequate to withstand periods of financial stress. 

Strengthening Prudential Supervision and Regulation 

The crisis has revealed significant risk-management deficiencies at a wide range 

of financial institutions, including banking organizations. It also has challenged 

some of the assumptions and analysis on which conventional supervisory wisdom 

has been based. For example, the collapse of Bear Stearns, which at the end was 

unable to borrow privately even with U.S. Government securities as collateral, has 

undermined the widely held belief that a company can readily borrow against highquality collateral, even in stressed environments. Moreover, the growing codependency between financial institutions and markets—evidenced by the significant role 

that investor and counterparty runs played in the crisis—implies that supervisors 

must pay closer attention to the potential for financial markets to influence the safety and soundness of banking organizations. These and other lessons of the financial 

crisis have led to changes in regulatory and supervisory practices in order to improve prudential oversight of banks and bank holding companies, as well as to advance a macroprudential, or systemic, regulatory agenda. 

Working with other domestic and foreign supervisors, the Federal Reserve has 

taken steps to require the strengthening of capital, liquidity, and risk management 

at banking organizations. There is little doubt that, in the period before the crisis, 

capital levels were insufficient to serve as a needed buffer against loss, particularly 

at some of the largest financial institutions, both in the United States and elsewhere. Measures to strengthen the capital requirements for trading activities and 

securitization exposures—two areas where banking organizations have experienced 

greater losses than anticipated—were recently announced by the Basel Committee 

on Banking Supervision. Additional efforts are under way to improve the quality of 

the capital used to satisfy minimum capital ratios, to strengthen the capital requirements for other types of on- and off-balance-sheet exposures, and to establish capital 

buffers in good times that can be drawn down as economic and financial conditions 

deteriorate. Capital buffers, though not easy to design or implement in an efficacious fashion, could be an especially important step in reducing the procyclical effects of the current capital rules. Further review of accounting standards governing 

valuation and loss provisioning also would be useful, and might result in modifications to the accounting rules that reduce their procyclical effects without compromising the goals of disclosure and transparency. 

The Federal Reserve also helped lead the Basel Committee’s development of enhanced principles of liquidity risk management, which were issued last year. 2 Following up on that initiative, on June 30, 2009, the Federal banking agencies requested public comment on new Interagency Guidance on Funding and Liquidity 

Risk Management, which is designed to incorporate the Basel Committee’s principles and clearly articulate consistent supervisory expectations on liquidity risk 

management. 3 The guidance reemphasizes the importance of cash flow forecasting, 

adequate buffers of contingent liquidity, rigorous stress testing, and robust contingent funding planning processes. It also highlights the need for institutions to better 

incorporate liquidity costs, benefits, and risks in their internal product pricing, performance measurement, and new product approval process for all material business 

lines, products, and activities. 

With respect to bank holding companies specifically, the supervisory program of 

the Federal Reserve has undergone some basic changes. As everyone is aware, many 
68 

4See, Board of Governors of the Federal Reserve System (2009), Supervision and Regulation 

Letter SR 09-4, ‘‘Applying Supervisory Guidance and Regulations on the Payment of Dividends, 

Stock Redemptions, and Stock Repurchases at Bank Holding Companies’’, February 24 (as revised on March 27, 2009), www.federalreserve.gov/boarddocs/srletters/2009/SR0904.htm. 

of the financial firms that lay at the center of the crisis were not bank holding companies; some were not subject to mandatory prudential supervision of any sort. During the crisis a number of very large firms became bank holding companies—in part 

to reassure markets that they were subject to prudential oversight and, in some 

cases, to qualify for participation in various Government liquidity support programs. 

The extension of holding company status to these firms, many of which are not primarily composed of a commercial bank, highlights the degree to which the traditional approach to holding company supervision must evolve. 

Recent experience also reinforces the value of holding company supervision in addition to, and distinct from, bank supervision. Large organizations increasingly operate and manage their businesses on an integrated basis with little regard for the 

corporate boundaries that typically define the jurisdictions of individual functional 

supervisors. Indeed, the crisis has highlighted the financial, managerial, operational, and reputational linkages among the bank, securities, commodity, and other 

units of financial firms. 

The customary focus on protecting the bank within a holding company, while necessary, is clearly not sufficient in an era in which systemic risk can arise wholly 

outside of insured depository institutions. Similarly, the premise of functional regulation that risks within a diversified organization can be evaluated and managed 

properly through supervision focused on individual subsidiaries within the firm has 

been undermined further; the need for greater attention to the potential for damage 

to the bank, the organization within which it operates, and, in some cases, the financial system generally, requires a more comprehensive and integrated assessment 

of activities throughout the holding company. 

Appropriate enhancements of both prudential and consolidated supervision will 

only increase the need for supervisors to be able to draw on a broad foundation of 

economic and financial knowledge and experience. That is why we are incorporating 

economists and other experts from nonsupervisory divisions of the Federal Reserve 

more completely into the process of supervisory oversight. The insights gained from 

the macroeconomic analyses associated with the formulation of monetary policy and 

from the familiarity with financial markets derived from our open market operations and payments systems responsibilities can add enormous value to holding 

company supervision. 

The recently completed Supervisory Capital Assessment Program (SCAP) heralds 

some of the changes in the Federal Reserve’s approach to prudential supervision of 

the largest banking organizations. This unprecedented process involved, at its core, 

forward-looking, cross-firm, and aggregate analyses of the 19 largest bank holding 

companies, which together control a majority of the assets and loans within the financial system. Bank supervisors in the SCAP defined a uniform set of parameters 

to apply to each firm being evaluated, which allowed us to evaluate on a consistent 

basis the expected performance of the firms under both a baseline and more-adverse-than-expected scenario, drawing on individual firm information and independently estimated outcomes using supervisory models. 

Drawing on this experience, we are prioritizing and expanding our program of 

horizontal examinations to assess key operations, risks, and risk-management activities of large institutions. For the largest and most complex firms, we are creating 

an enhanced quantitative surveillance program that will use supervisory information, firm-specific data analysis, and market-based indicators to identify developing 

strains and imbalances that may affect multiple institutions, as well as emerging 

risks to specific firms. Periodic scenario analyses across large firms will enhance our 

understanding of the potential impact of adverse changes in the operating environment on individual firms and on the system as a whole. This work will be performed 

by a multidisciplinary group composed of our economic and market researchers, supervisors, market operations specialists, and accounting and legal experts. This program will be distinct from the activities of on-site examination teams so as to provide an independent supervisory perspective as well as to complement the work of 

those teams. 

Capital serves as an important bulwark against potential unexpected losses for 

banking organizations of all sizes, not just the largest ones. Accordingly, internal 

capital analyses of banking organizations must reflect a wide range of scenarios and 

capture stress environments that could impair solvency. Earlier this year, we issued 

supervisory guidance for all bank holding companies regarding dividends, capital repurchases, and capital redemptions. 4 That guidance also reemphasized the Federal 
69 

5See, Financial Stability Forum (2009), FSF Principles for Sound Compensation Practices, 

April 2, www.financialstabilityboard.org/publications/rl0904b.pdf. The Financial Stability 

Forum has subsequently been renamed the Financial Stability Board. 

Reserve’s long-standing position that bank holding companies must serve as a 

source of strength for their subsidiary banks. 

Commercial real estate (CRE) is one area of risk exposure that has gained much 

attention recently. We began to observe rising CRE concentrations earlier this decade and, in light of the central role that CRE lending played in the banking problems of the late 1980s and early 1990s, led an interagency effort to issue supervisory 

guidance directed at the risks posed by CRE concentrations. This guidance, which 

generated significant controversy at the time it was proposed, was finalized in 2006 

and emphasized the need for banking organizations to incorporate realistic risk estimates for CRE exposures into their strategic- and capital-planning processes, and 

encouraged institutions to conduct stress tests or similar exercises to identify the 

impact of potential CRE shocks on earnings and capital. Now that weaker housing 

markets and deteriorating economic conditions have, in fact, impaired the quality 

of CRE loans at many banking organizations, we are monitoring carefully the effect 

that declining collateral values may have on CRE exposures and assessing the extent to which banking organizations have been complying with the CRE guidance. 

At the same time, we have taken actions to ensure that supervisory and regulatory 

policies and practices do not inadvertently curtail the availability of credit to sound 

borrowers. 

While CRE exposures represent perhaps an ‘‘old’’ problem, the crisis has newly 

highlighted the potential for compensation practices at financial institutions to encourage excessive risk taking and unsafe and unsound behavior—not just by senior 

executives, but also by other managers or employees who have the ability, individually or collectively, to materially alter the risk profile of the institution. Bonuses 

and other compensation arrangements should not provide incentives for employees 

at any level to behave in ways that imprudently increase risks to the institution, 

and potentially to the financial system as a whole. The Federal Reserve worked 

closely with other supervisors represented on the Financial Stability Board to develop principles for sound compensation practices, which were released earlier this 

year. 5 The Federal Reserve expects to issue soon our own guidance on this important subject to promote compensation practices that are consistent with sound riskmanagement principles and safe and sound banking. 

Finally, I would note the importance of continuing to analyze the practices of financial firms and supervisors that preceded the crisis, with the aim of fashioning 

additional regulatory tools that will make prudential supervision more effective and 

efficient. One area that warrants particular attention is the potential for supervisory agencies to enlist market discipline in pursuit of regulatory ends. For example, supervisors might require that large financial firms maintain specific forms of 

capital so as to increase their ability to absorb losses outside of a bankruptcy or formal resolution procedure. Such capital could be in contingent form, converting to 

common equity only when necessary because of extraordinary losses. While the 

costs, benefits, and feasibility of this type of capital requires further study, policymakers should actively seek ways of motivating the private owners of banking organizations to monitor the financial positions of the issuing firms more effectively. 

Addressing Gaps and Weaknesses in the Regulatory Framework 

While the actions that I have just discussed should help make banking organizations and the financial system stronger and more resilient, the crisis also has highlighted gaps and weaknesses in the underlying framework for prudential supervision of financial institutions that no regulatory agency can rectify on its own. One, 

which I will mention in a moment, has been addressed by the banking agencies 

working together. Others require congressional attention. 

Charter Conversions and Regulatory Arbitrage 

The dual banking system and the existence of different Federal supervisors create 

the opportunity for insured depository institutions to change charters or Federal supervisors. While institutions may engage in charter conversions for a variety of 

sound business reasons, conversions that are motivated by a hope of escaping current or prospective supervisory actions by the institution’s existing supervisor undermine the efficacy of the prudential supervisory framework. 

Accordingly, the Federal Reserve welcomed and immediately supported an initiative led by the Federal Deposit Insurance Corporation (FDIC) to address such regulatory arbitrage. This initiative resulted in a recent statement of the Federal Financial Institutions Examination Council reaffirming that charter conversions or other 
70 

6See, Federal Financial Institutions Examination Council (2009), ‘‘FFIEC Issues Statement 

on Regulatory Conversions’’, press release, July 1, www.ffiec.gov/press/pr070109.htm. 

actions by an insured depository institution that would result in a change in its primary supervisor should occur only for legitimate business and strategic reasons. 6

Importantly, this statement also provides that conversion requests should not be entertained by the proposed new chartering authority or supervisor while serious or 

material enforcement actions are pending with the institution’s current chartering 

authority or primary Federal supervisor. In addition, it provides that the examination rating of an institution and any outstanding corrective action programs should 

remain in place when a valid conversion or supervisory change does occur. 

Systemically Important Financial Institutions 

The Lehman experience clearly demonstrates that the financial system and the 

broader economy can be placed at risk by the failure of financial firms that traditionally have not been subject to the type of consolidated supervision applied to 

bank holding companies. As I discussed in my most recent testimony before this 

Committee, the Federal Reserve believes that all systemically important financial 

firms—not just those affiliated with a bank—should be subject to, and robustly supervised under, a statutory framework for consolidated supervision like the one embodied in the Bank Holding Company Act (BHC Act). 

Doing so would help promote the safety and soundness of these firms individually 

and the stability of the financial system generally. Indeed, given the significant adverse effects that the failure of such a firm may have on the financial system and 

the broader economy, the goals and implementation of prudential supervision and 

systemic risk reduction are inextricably intertwined in the case of these organizations. For example, while the strict capital, liquidity, and risk-management requirements that are needed for these organizations are traditional tools of prudential supervision, the supervisor of such firms will need to calibrate these standards appropriately to account for the firms’ systemic importance. 

Industrial Loan Companies and Thrifts 

Another gap in existing law involves industrial loan companies (ILCs). ILCs are 

State-chartered banks that have full access to the Federal safety net, including 

FDIC deposit insurance and the Federal Reserve’s discount window and payments 

systems; have virtually all of the deposit-taking powers of commercial banks; and 

may engage in the full range of other banking services, including commercial, mortgage, credit card, and consumer lending activities, as well as cash management 

services, trust services, and payment-related services, such as Fedwire, automated 

clearinghouse, and check-clearing services. 

A loophole in current law, however, permits any type of firm—including a commercial company or foreign bank—to acquire an FDIC-insured ILC chartered in a 

handful of States without becoming subject to the prudential framework that the 

Congress has established for the corporate owners of other full-service insured 

banks. Prior to the crisis, several large firms-including Lehman Brothers, Merrill 

Lynch, Goldman Sachs, Morgan Stanley, GMAC, and General Electric—took advantage of this opportunity by acquiring ILCs while avoiding consolidated supervision 

under the BHC Act. 

The Federal Reserve has long supported closing this loophole, subject to appropriate ‘‘grandfather’’ provisions for the existing owners of ILCs. Such an approach 

would prevent additional firms from acquiring a full-service bank and escaping the 

consolidated supervision framework and activity restrictions that apply to bank 

holding companies. It also would require that all firms controlling an ILC, including 

a grandfathered firm, be subject to consolidated supervision. For reasons of fairness, 

the Board believes that the limited number of firms that currently own an ILC and 

are not otherwise subject to the BHC Act should be permitted to retain their nonbanking or commercial affiliations, subject to appropriate restrictions to protect the 

Federal safety net and prevent abuses. 

Corporate owners of savings associations should also be subject to the same regulation and examination as corporate owners of insured banks. In addition, grandfathered commercial owners of savings associations should, like we advocate for corporate owners of ILCs, be subject to appropriate restrictions to protect the Federal 

safety net and prevent abuses. 

Strengthening the Framework for Consolidated Supervision 

Consolidated supervision is intended to provide a supervisor the tools necessary 

to understand, monitor, and, when appropriate, restrain the risks associated with 

an organization’s consolidated or groupwide activities. Risks that cross legal entities 
71 

7Similarly, the creation of a resolution regime that would provide the Government the tools 

it needs to wind down a systemically important nonbank financial firm in an orderly way and 

impose losses on shareholders and creditors where possible would help the Government protect 

the financial system and economy while reducing the potential cost to taxpayers and mitigating 

moral hazard. 

and that are managed on a consolidated basis cannot be monitored properly through 

supervision directed at any one, or even several, of the legal entity subdivisions 

within the overall organization. 

To be fully effective, consolidated supervisors need the information and ability to 

identify and address risks throughout an organization. However, the BHC Act, as 

amended by the so-called ‘‘Fed-lite’’ provisions of the Gramm-Leach-Bliley Act, 

places material limitations on the ability of the Federal Reserve to examine, obtain 

reports from, or take actions to identify or address risks with respect to both 

nonbank and depository institution subsidiaries of a bank holding company that are 

supervised by other agencies. Consistent with these provisions, we have worked 

with other regulators and, wherever possible, sought to make good use of the information and analysis they provide. In the process, we have built cooperative relationships with other regulators—relationships that we expect to continue and strengthen further. 

Nevertheless, the restrictions in current law still can present challenges to timely 

and effective consolidated supervision in light of, among other things, differences in 

supervisory models—for example, between the safety and soundness approach favored by bank supervisors and the approaches used by regulators of insurance and 

securities subsidiaries—and differences in supervisory timetables, resources, and 

priorities. Moreover, the growing linkages among the bank, securities, insurance, 

and other entities within a single organization that I mentioned earlier heighten the 

potential for these restrictions to hinder effective groupwide supervision of firms, 

particularly large and complex organizations. To ensure that consolidated supervisors have the necessary tools and authorities to monitor and address safety and 

soundness concerns in all parts of an organization on a timely basis, we would urge 

statutory modifications to the Fed-lite provisions of the Gramm-Leach-Bliley Act. 

Such changes, for example, should remove the limits first imposed in 1999 on the 

scope and type of information that the Federal Reserve may obtain from subsidiaries of bank holding companies in furtherance of its consolidated supervision responsibilities, and on the ability of the Federal Reserve to take action against subsidiaries to address unsafe and unsound practices and enforce compliance with applicable law. 

Limiting the Costs of Bank Failures 

The timely closing and resolution of failing insured depository institutions is critical to limiting the costs of a failure to the deposit insurance fund. 7 The conditions 

governing when the Federal Reserve may close a failing State member bank, however, are significantly more restrictive than those under which the Office of the 

Comptroller of the Currency may close a national bank, and are even more restrictive than those governing the FDIC’s backup authority to close an insured depository institution after consultation with the appropriate primary Federal and, if applicable, state banking supervisor. The Federal Reserve generally may close a state 

member bank only for capital-related reasons. The grounds for which the OCC or 

FDIC may close a bank include a variety of non-capital-related conditions, such as 

if the institution is facing liquidity pressures that make it likely to be unable to pay 

its obligations in the normal course of business or if the institution is otherwise in 

an unsafe or unsound condition to transact business. We hope that the Congress 

will consider providing the Federal Reserve powers to close a state member bank 

that are similar to those possessed by other Federal banking agencies. 

In view of the number of bank failures that have occurred over the past 18 

months and the resulting costs to the deposit insurance fund, policymakers also 

should explore whether additional triggers—beyond the capital ratios in the current 

Prompt Corrective Action framework—may be more effective in promoting the timely resolution of troubled institutions at lower cost to the insurance fund. Capital is 

a lagging indicator of financial difficulties in most instances, and one or more additional measures, perhaps based on asset quality, may be worthy of analysis and consideration. 

Conclusion 

Thank you for the opportunity to testify on these important matters. We look forward to working with the Congress, the Administration, and the other banking 

agencies to ensure that the framework for prudential supervision of banking organi-
72 

zations and other financial institutions adjusts, as it must, to meet the challenges 

our dynamic and increasingly interconnected financial system. 

PREPARED STATEMENT OF JOHN E. BOWMAN 

ACTING DIRECTOR, OFFICE OF THRIFT SUPERVISION

AUGUST 4, 2009 

I. Introduction 

Good morning, Chairman Dodd, Ranking Member Shelby, and Members of the 

Committee. Thank you for the opportunity to testify today on the Administration’s 

Proposal for Financial Regulatory Reform. It is my pleasure to address the Committee for the first time in my role as Acting Director of the Office of Thrift Supervision (OTS). 

We appreciate this Committee’s efforts to improve supervision of financial institutions in the United States. We share the Committee’s commitment to reforms to prevent any recurrence of our Nation’s current financial problems. 

We have studied the Administration’s Proposal for Financial Regulatory Reform 

and are pleased to address the questions you have asked us about specific aspects 

of that Proposal. Specifically, you asked for our opinion of the merits of the Administration’s Proposal for a National Bank Supervisor and the elimination of the Federal 

thrift charter. You also requested our opinion on the elimination of the exceptions 

in the Bank Holding Company Act for thrifts and certain special purpose banks and 

about the Federal Reserve System’s prudential supervision of holding companies. 

II. Goals of Regulatory Restructuring 

The recent turmoil in the financial services industry has exposed major regulatory 

gaps and other significant weaknesses that must be addressed. Our evaluation of 

the specifics of the Administration’s Proposal is predicated on whether or not those 

elements address the core principles OTS believes arc essential to accomplishing 

true and lasting reform: 

1. Ensure Changes to Financial Regulatory System Address Real Problems—Proposed changes to financial regulatory agencies should be evaluated based on 

whether they would address the causes of the economic crisis or other true 

problems. 

2. Establish Uniform Regulation—All entities that offer financial products to consumers must be subject to the same consumer protection rules and regulations, 

so under-regulated entities cannot gain a competitive advantage over their 

more regulated counterparts. Also, complex derivative products, such as credit 

default swaps, should be regulated. 

3. Create Ability To Supervise and Resolve Systemically Important Firms—No 

provider of financial products should be too big to fail, achieving through size 

and complexity an implicit Federal Government backing to prevent its collapse—and thereby gaining an unfair advantage over its more vulnerable competitors. 

4. Protect Consumers—One Federal agency should have as its central mission the 

regulation of financial products and that agency should establish the rules and 

standards for all consumer financial products rather than the current, multiple 

number of agencies with fragmented authority and a lack of singular accountability. 

As a general matter the OTS supports all of the fundamental objectives that are 

at the heart of the Administration’s Proposal. By performing an analysis based on 

these principles, we offer OTS’ views on specific provisions of the Administration’s 

Proposal. 

III. Administration Proposal To Establish a National Bank Supervisor 

We do not support the Administration’s Proposal to establish a new agency, the 

National Bank Supervisor (NBS), by eliminating the Office of the Comptroller of the 

Currency, which charters and regulates national banks, and the OTS, which charters Federal thrifts and regulates thrifts and their holding companies. 

There is little dispute that the ad hoc framework of financial services regulation 

cobbled together over the last century-and-a-half is not ideal. The financial services 

landscape has changed and the economic crisis has revealed gaps in the system that 

must be addressed to ensure a sustainable recovery and appropriate oversight in the 

years ahead. We believe other provisions within the Administration’s proposal would 

assist in accomplishing that goal. 
73 

1See, Office of Thrift Supervision Quarterly Market Monitor, May 7, 2009, (http:// 

files.ots.treas.gov/131020.pdf). 

While different parts of the system were created to respond to the needs of the 

time, the current system has generally served the Nation well over time, despite 

economic downturns such as the current one. We must ensure that in the rush to 

address what went wrong, we do not try to ‘‘fix’’ nonexistent problems nor attempt 

to fix real problems with flawed solutions. 

I would like to dispel the two rationales that have been alleged to support the 

proposal to eliminate the OTS: (1) The OTS was the regulator of the purportedly 

largest insured depository institutions that failed during the current economic turmoil, and, (2) Financial institutions ‘‘shopping’’ for the most lenient regulator allegedly flocked to OTS supervision and the thrift charter. Both of those allegations are 

false. 

There are four reasons why the first allegation is untrue: 

First, failures by insured depository institutions have been no more severe among 

OTS-regulated thrifts than among institutions supervised by other Federal banking 

regulators. OTS-regulated Washington Mutual, which failed in September 2008 at 

no cost to the deposit insurance fund, was the largest bank failure in U.S. history 

because anything larger has been deemed ‘‘too big to fail.’’ By law, the Federal Government can provide ‘‘open-bank assistance’’ only to prevent a failure. Institutions 

much larger than Washington Mutual, for example, Citigroup and Bank of America, 

had collapsed, but the Federal Government prevented their failure by authorizing 

open bank assistance. The ‘‘too big to fail’’ institutions are not regulated by the OTS. 

The OTS did not regulate the largest banks that failed; the OTS regulated the largest banks that were allowed to fail. 

Second, in terms of numbers of bank failures during the crisis, most banks that 

have failed have been State-chartered institutions, whose primary Federal regulator 

is not the OTS. 

Third, the OTS regulates financial institutions that historically make mortgages 

for Americans to buy homes, By law, thrift institutions must keep most of their assets in home mortgages or other retail lending activities, The economic crisis grew 

out of a sharp downturn in the residential real estate market, including significant 

and sustained home price depreciation, a protracted decline in home sales and a 

plunge in rates of real estate investment. To date, this segment of the market has 

been hardest hit by the crisis and OTS-regulated institutions were particularly affected because their business models focus on this segment. 

Fourth, the largest failures among OTS-regulated institutions during this crisis 

concentrated their mortgage lending in California and Florida, two of the States 

most damaged by the real estate decline, These States have had significant retraction in the real estate market, including double-digit declines in home prices and 

record rates of foreclosure, 1 Although today’s hindsight is 20/20, no one predicted 

during the peak of the boom in 2006 that nationwide home prices would plummet 

by more than 30 percent. 

The argument about regulator shopping, or arbitrage, seems to stem from the conversion of Countrywide, which left the supervision of the OCC and the Board of 

Governors of the Federal Reserve System (FRB) in March 2007—after the height 

of the housing and mortgage boom—and came under OTS regulation, Countrywide 

made most of its high-risk loans through its holding company affiliates before it received a thrift charter. 

An often-overlooked fact is that a few months earlier, in October 2006, Citibank 

converted two thrift charters from OTS supervision to the OCC. Those two Citibank 

charters totaled more than $232 billion—more than twice the asset size of Countrywide ($93 billion)—We strongly believe that Citibank and Countrywide applied to 

change their charters based on their respective business models and operating strategies. Any suggestion that either company sought to find a more lenient regulatory 

structure is without merit. 

In the last 10 years (1999–2008), there were 45 more institutions that converted 

away from the thrift charter (164) than converted to the thrift charter (119). Of 

those that converted to the OTS, more than half were State-chartered thrifts (64). 

In dollar amounts during the same 10-year period, $223 billion in assets converted 

to the thrift charter from other charter types and $419 billion in assets converted 

from the thrift charter to other charter types. 

We disagree with any suggestion that banks converted to the thrift charter because OTS was a more lenient regulator. Institutions chose the charter type that 

best fits their business model. 
74 

2 12 U.S.C. 1841(c)(2)(B) and (j). 

3 12 U.S.C. 1467a(c)(9)(C). 

4 12 U.S.C. 1843(k). 

If regulatory arbitrage is indeed a major issue, it is an issue between a Federal 

charter and the charters of the 50 States, as well as among the States. Under the 

Administration’s Proposal, the possibility of such arbitrage would continue. 

The OTS is also concerned that the NBS may tend, particularly in times of stress, 

to focus most of its attention on the largest institutions, leaving midsize and small 

institutions in the back seat. It is critical that all regulatory agencies be structured 

and operated in a manner that ensures the appropriate supervision and regulation 

of all depository institutions, regardless of size. 

IV. Administration Proposal To Eliminate the Thrift Charter 

The OTS does not support the provision in the Administration’s Proposal to eliminate the Federal thrift charter and require all Federal thrift institutions to change 

their charter to the National Bank Charter or State bank. We believe the business 

models of Federal banks and thrift institutions are fundamentally different enough 

to warrant two distinct Federal banking charters. 

It is important to note that elimination of the thrift charter would not have prevented the current mortgage meltdown, nor would it help solve current problems or 

prevent future crises. Savings associations generally are smaller institutions that 

have strong ties to their communities. Many thrifts never made subprime or AltA mortgages; rather they adhered to traditional, solid underwriting standards. Most 

thrifts did not participate in the private originate-to-sell model; they prudently 

underwrote mortgages intending to hold the loans in their own portfolios until the 

loans matured. 

Forcing thrifts to convert from thrifts to banks or State chartered savings associations would not only be costly, disruptive, and punitive for thrifts, but could also 

deprive creditworthy U.S. consumers of the credit they need to become homeowners 

and the extension of credit this country needs to stimulate the economy. 

We also strongly support retaining the mutual form of organization for insured 

institutions. Generally, mutual institutions are weathering the current financial crisis better than their stock competitors. The distress in the housing markets has had 

a much greater impact on the earnings of stock thrifts than on mutual thrifts over 

the past year. For the first quarter 2009, mutual thrills reported a return on average assets (ROA) on 0.42 percent, while stock thrifts reported an ROA of 0.04 percent. We see every reason to preserve the mutual institution charter and no compelling rationale to eliminate it. 

OTS also supports retention of the dual banking system with both Federal and 

State charters for banks and thrifts. This system has served the financial markets 

in the United States well. The States have provided a charter option for banks and 

thrifts that have not wanted to have a Federal charter. Banks and thrifts should 

be able to choose whether to operate with a Federal charter or a State charter. 

V. Administration Proposal To Eliminate the Exceptions in the Bank Holding Company Act for Thrifts and Special Purpose Banks 

A. Elimination of the Exception in the Bank Holding Company Act for Thrifts 

Because a thrill is not considered a ‘‘bank’’ under the Bank Holding Company Act 

of 1956 (BHCA), 2 the FRB does not regulate entities that own or control only savings associations. However, the OTS supervises and regulates such entities pursuant to the Home Owners Loan Act (HOLA). 

As part of the recommendation to eliminate the Federal thrift charter, the Administration Proposal would also eliminate the savings and loan holding company 

(SLHC). The Administration’s draft legislation repeals section 10 of the HOLA, concerning the regulation of SLHCs and also eliminates the thrift exemption from the 

definition of ‘‘bank’’ under the BHCA. A SLHC would become a bank holding company (BHC) by operation of law and would be required to register with the FRB 

as a BHC within 90 days of enactment of the act. 

Notably, these provisions also apply to the unitary SLHCs that were explicitly 

permitted to continue engaging in commercial activities under the Gramm-LeachBliley Act of 1999. 3 Such an entity would either have to divest itself of the thrift 

or divest itself of other subsidiaries or affiliates to ensure that its activities are ‘‘financial in nature.’’ 4

The Administration justifies the elimination of SLHCs, by arguing that the separate regulation and supervision of bank and savings and loan holding companies has 

created ‘‘arbitrage opportunities.’’ The Administration contends that the intensity of 

supervision has been greater for BHCs than SLHCs. 
75 

Our view on this matter is guided by our key principles, one of which is to ensure 

that changes to the financial regulatory system address real problems. We oppose 

this provision because it does not address a real problem. As is the case with the 

regulation of thrift institutions, OTS does not believe that entities became SLHCs 

because OTS was perceived to be a more lenient regulator. Instead, these choices 

were guided by the business model of the entity. 

The suggestion that the OTS does not impose capital requirements on SLHCs is 

not correct. Although the capital requirements for SLHCs are not contained in OTS 

regulations, savings and loan holding company capital adequacy is determined on 

a case-by-case basis for each holding company based on the overall risk profile of 

the organization. In its review of a SLHCs capital adequacy, the OTS considers the 

risk inherent in an enterprise’s activities and the ability of capital to absorb unanticipated losses, support the level and composition of the parent company’s and subsidiaries’ debt, and support business plans and strategies. 

On average SLHCs hold more capital than BHCs. The OTS conducted an internal 

study comparing SLHC capital levels to BHC capital levels. In this study. OTS staff 

developed a Tier 1 leverage proxy and conducted an extensive review of industry 

capital levels to assess the overall condition of holding companies in the thrift industry. We measured capital by both the Equity/Assets ratio and a Tier 1 Leverage 

proxy ratio. Based on peer group averages, capital levels (as measured by both the 

Equity/Assets ratio and a Tier 1 Leverage proxy ratio) at SLHCs were higher than 

BHCs, prior to the infusion of Troubled Asset Relief Program funds, in every peer 

group category. The consistency in results between both ratios lends credence to the 

overall conclusion, despite any differences that might result from use of a proxy formula. 

As this study shows, the facts do not support the claim that the OTS docs not 

impose adequate capital requirements on SLHCs. The proposal to eliminate the 

SLHC exception from the BHCA is based on this and other misperceptions. Moreover, in our view the measure penalizes the SLHCs and thrifts that maintained 

solid underwriting standards and were not responsible for the current financial crisis. The measure is especially punitive to the unitary SLHCs that will be forced to 

divest themselves of their thrift or other subsidiaries. 

We believe SLHCs should be maintained and that the OTS should continue to 

regulate SLHCs, except in the case of a SLHC that would be deemed to be a Tier 

1 Financial Holding Company. These entities should be regulated by the systemic 

risk regulator. 

B. Elimination of the Exception in the Bank Holding Company Act for Special Purpose Banks 

The Administration Proposal would also eliminate the BHCA exceptions for a 

number of special purpose banks, such as industrial loan companies, credit card 

banks, [rust companies, and the so-called ‘‘nonbank banks’’ grandfathered under the 

Competitive Equality Banking Act of 1987. Neither the FRB nor OTS regulates the 

entities that own or control these special purpose banks, unless they also own or 

control a bank or thrill. As is the case with unitary SLHCs, the Administration Proposal would force these entities to divest themselves of either their special purpose 

bank or other entities. The Administration’s rationale for the provision is to close 

all the so-called ‘‘loopholes’’ under the BHCA and to treat all entities that own or 

control any type of a bank equally. 

Once again our opinion on this aspect of the Administration Proposal is guided 

by the key principle of ensuring that changes to the financial regulatory system address real problems that caused the crisis. There are many causes of the financial 

crisis, but the inability of the FRB to regulate these entities is not one of them. Accordingly, we do not support this provision. 

Forcing companies that own special purpose banks to divest one or more of their 

subsidiaries is unnecessary and punitive. Moreover, it does not address a problem 

that caused the crisis or weakens the financial system. 

VI. Prudential Supervision of Holding Companies 

A. In General 

The Administration’s Proposal would provide for the consolidated supervision and 

regulation of any systemically important financial firm (Tier 1 FHC) regardless of 

whether the firm owns an insured depository institution. The authority to supervise 

and regulate Tier 1 FHCs would be vested in the FRB. The FRB would be authorized to designate Tier 1 FHCs if it determines that material financial distress at 

the company could pose a threat, globally or in the United States, to financial sta-
76 

5The FRB would be required to base its determination on the following criteria: 

(i) the amount and nature of the company’s financial assets; 

(ii) the amount and types of the company’s liabilities, including the degree of reliance on 

short-term funding; 

(iii) the extent of the company’s off-balance sheet exposures; 

(iv) the extent of the company’s transactions and relationships with other major financial 

companies: 

(v) the company’s importance as a source of credit for households, businesses, and State and 

local governments and as a source of liquidity for the financial system; 

(vi) the recommendation, if any, of the Financial Services Oversight Council; and 

(vii) any other factors that the Board deems appropriate. 

Title II, Section 204. Administration Draft Legislation. 

http://www.financialstability.gov/docs/regulatoryreform/07222009/titleII.pdf. 

bility or the economy during times of economic stress. 5 The FRB, in consultation 

with Treasury, would issue rules to guide the identification Tier 1 FHCs. Tier 1 

FHCs would be subjected to stricter and more conservative prudential standards 

than those that apply to other BHCs, including higher standards on capital, liquidity, and risk management. Tier 1 FHCs would also be subject to Prompt Corrective 

Action. 

The Proposal also calls for the creation of a Financial Services Oversight Council 

(Council) made up of the Secretary of the Treasury and all of the Federal financial 

regulators. Among other responsibilities, the Council would make recommendations 

to the FRB concerning institutions that should be designated as Tier 1 FHCs. Also, 

the FRB would consult the Council in setting material prudential standards for Tier 

1 FHCs and in setting risk management standards for systemically important systems and activities regarding payment, clearing and settlement. 

The Administration’s Proposal provides a regime to resolve Tier 1 FHCs when the 

stability of the financial system is threatened. The resolution authority would supplement and be modeled on the existing resolution regime for insured depository institutions under the Federal Deposit Insurance Act. The Secretary of the Treasury 

could invoke the resolution authority only after consulting with the President and 

upon the written recommendation of two-thirds of the members of the FRB, and the 

FDIC or SEC as appropriate. The Secretary would have the ability to appoint a receiver or conservator for the tailing firm. In general, that role would be filled by 

the FDIC, though the SEC could be appointed in certain cases. In order to fund this 

resolution regime, the FDIC would be authorized to impose risk-based assessments 

on Tier 1 FHCs. 

OTS’s views on these aspects of the Administration Proposal is guided by our key 

principle that any financial reform package should create the ability to supervise 

and resolve all systemically important financial firms. The U.S. economy operates 

on the principle of healthy competition. Enterprises that are strong, industrious, 

well-managed and efficient succeed and prosper. Those that fall short of the mark 

struggle or fail and other, stronger enterprises take their places. Enterprises that 

become ‘‘too big to fail’’ subvert the system when the Government is forced to prop 

up failing, systemically important companies in essence, supporting poor performance and creating a ‘‘moral hazard.’’ 

The OTS supports this aspect of the Proposal and agrees that there is a pressing 

need for a systemic risk regulator with broad authority to monitor and exercise supervision over any company whose actions or failure could pose unacceptable risk 

to financial stability. The systemic risk regulator should have the ability and the 

responsibility for monitoring all data about markets and companies, including, but 

not limited to, companies involved in banking, securities, and insurance. 

We also support the establishment of a strong and effective Council. Each of the 

financial regulators would provide valuable insight and experience to the systemic 

risk regulator. 

We also strongly support the provision providing a resolution regime for all Tier 

1 FHCs. Given the events of recent years, it is essential that the Federal Government have the authority and the resources to act as a conservator or receiver and 

to provide an orderly resolution of systemically important institutions, whether 

banks, thrifts, bank holding companies or other financial companies. The authority 

to resolve a distressed Tier 1 FHC in an orderly manner would ensure that no bank 

or financial firm is ‘‘too big to fail.’’ A lesson learned from recent events is that the 

failure or unwinding of systemically important companies has a far reaching impact 

on the economy, not just on financial services. 

The continued ability of banks, thrifts, and other entities in the United States to 

compete in today’s global financial services marketplace is critical. The systemic risk 

regulator should be charged with coordinating the supervision of conglomerates that 

have international operations. Safety and soundness standards, including capital 
77 

6With respect to this question we express our opinion only concerning thrifts and their holding companies. We express no opinion as to banks and BHCs. 

adequacy and other factors, should be as comparable as possible for entities that 

have multinational businesses, 

B. Role of the Prudential Supervisor in Relation to the Systemic Risk Regulator 

You have asked for our views on what we consider to be the appropriate role of 

the prudential supervisor in relation to the systemic risk regulator. In other words, 

what is the proper delineation of responsibilities between the agencies? 

Generally, we believe that for systemically important institutions, the systemic 

risk regulator should supplement, not supplant, the primary Federal bank supervisor. In most cases the work of the systemic regulator and the prudential regulator 

will complement one another, with the prudential regulator focused on the safety 

and soundness of the depository institution and the systemic regulator focused more 

broadly on financial stability globally or in the United States. 

One provision in the Proposal provides the systemic risk regulator with authority 

to establish, examine, and enforce more stringent standards for subsidiaries of Tier 

1 FHCs—including depository institution subsidiaries—to mitigate systemic risk 

posed by those subsidiaries. If the systemic risk regulator issues a regulation, it 

must consult with the prudential regulator. In the case of an order, the systemic 

regulator must: (1) have reasonable cause to believe that the functionally regulated 

subsidiary is engaged in conduct, activities, transactions, or arrangements that 

could pose a threat to financial stability or the economy globally or in the United 

States; (2) notify the prudential regulator of its belief, in writing, with supporting 

documentation included and with a recommendation that the prudential regulator 

take supervisory action against the subsidiary; and (3) not been notified in writing 

by the prudential regulator of the commencement of a supervisory action, as recommended, within 30 days of the notification by the systemic regulator. 

We have some concerns with this provision in that it supplants the prudential 

regulator’s authority over depository institution subsidiaries of systemically significant companies. On balance, however, we believe such a provision is necessary to 

ensure financial stability. We recommend that the provision include a requirement 

that before making any determination, the systemic regulator consider the effects 

of any contemplated action on the Deposit Insurance Fund and the United States 

taxpayers. 

C. Regulation of Thrifts and Holding Companies on a Consolidated Basis 

You have asked for OTS’s views on whether a holding company regulator should 

be distinct from the prudential regulator or whether a consolidated prudential bank 

supervisor could also regulate holding companies. 6

The OTS supervises both thrifts and their holding companies on a consolidated 

basis. Indeed, SLHC supervision is an integral part of OTS oversight of the thrift 

industry. OTS conducts holding company examinations concurrently with the examination of the thrift subsidiary, supplemented by offsite monitoring. For the most 

complex holding companies, OTS utilizes a continuous supervision approach. We believe the regulation of the thrift and holding company has enabled us to effectively 

assess the risks of the consolidated entity, while retaining a strong focus on protecting the Deposit Insurance Fund. 

The OTS has a wealth of expertise regulating thrifts and holding companies. We 

have a keen understanding of small, medium-sized and mutual thrifts and their 

holding companies. We are concerned that if the FRB became the regulator of these 

holding companies, it would focus most of its attention on the largest holding companies to the detriment of small and mutual SLHCs. 

With regard to holding company regulation, OTS believes thrifts that have nonsystemic holding companies should have strong, consistent supervision by a single 

regulator. Conversely, a SLHC that would be deemed to be a Tier 1 FHC should 

be regulated by the systemic regulator. This is consistent with our key principle 

that any financial reform package should create the ability to supervise and resolve 

all systemically important financial firms. 

VII. Consumer Protection 

The Committee did not specifically request input regarding consumer protection 

issues and the Administration’s Proposal to create a Consumer Financial Protection 

Agency (CFPA); however, we would like to express our views because adequate protection of consumers is one of the key principles that must be addressed by effective 

reform. Consumer protection performed consistently and judiciously fosters a thriving banking system to meet the financial services needs of the Nation. 
78 

The OTS supports the creation of a CFPA that would consolidate rulemaking authority over all consumer protection regulations in one regulator. The CFPA should 

be responsible for promulgating all consumer protection regulations that would 

apply uniformly to all entities that offer financial products, whether a federally insured depository institution, a State bank, or a State-licensed mortgage broker or 

mortgage company. Making all entities subject to the same rules and regulations 

for consumer protection could go a long way towards accomplishing OTS’s often stated goal of plugging the gaps in regulatory oversight that led to a shadow banking 

system that was a significant cause of the current crisis. 

Although we support the concept of a single agency to write all consumer rules, 

we strongly believe that consumer protection-related examinations, supervision authority and enforcement powers for insured depository institutions should be retained by the FBAs and the National Credit Union Administration (NCUA). In addition to rulemaking authority, the CFPA should have regulation, examination and 

enforcement power over entities engaged in consumer lending that are not insured 

depository institutions. Regardless of whether a new consumer protection agency is 

created, it is critical that, for all federally insured depository institutions, the primary Federal safety and soundness regulator retain authority for regulation, examination, and enforcement of consumer protection regulations. 

VIII. Conclusion 

In conclusion, we support the goals of the Administration and this Committee to 

create a reformed system of financial regulation that fills regulatory gaps and prevents the type of financial crisis that we have just endured. 

Thank you again, Mr. Chairman, Ranking Member Shelby, and Members of the 

Committee for the opportunity to testify on behalf of the OTS. 

We look forward to working with the Members of this Committee and others to 

create a system of financial services regulation that promotes greater economic stability for providers of financial services and the Nation. 
79 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR BUNNING 

FROM SHEILA C. BAIR 

Q.1. What is the best way to decrease concentration in the banking 

industry? Is it size limitations, rolling back State preemption, higher capital requirements, or something else? 

A.1. We must find ways to impose greater market discipline on systemically important institutions. We believe there are several ways 

to decrease concentration levels in the banking industry without 

the Federal Government setting size limits on banks. For example, 

certain requirements, such as higher capital and liquidity levels, 

could be established to mirror the heightened risk they pose to the 

financial system. Assessments also could be used as incentives to 

contain growth and complexity, as well as to limit concentrations 

of risk and risk taking. 

However, one of the lessons of the past few years is that regulation alone is not enough to control imprudent risk taking within 

our dynamic and complex financial system. You need robust and 

credible mechanisms to ensure that market players will actively 

monitor and keep a handle on risk taking. In short, we need to enforce market discipline for systemically important institutions. To 

end ‘‘too big to fail,’’ we need an orderly and highly credible mechanism that is similar to the process we use to resolve FDIC-insured 

banks. In such a process, losses would be borne by the stockholders 

and bondholders of a holding company, and senior managers would 

be replaced. There would be an orderly resolution of the institution, 

but no bail-out. Open bank assistance should not be used to prop 

up any individual firm. 

Q.2. Treasury has proposed making the new banking regulator a 

bureau of the Treasury Department. Putting aside whether we 

should merge the current regulators, does placing the new regulator in Treasury rather than as a separate agency provide enough 

independence from political influence? 

A.2. We believe independence is an essential element of a sound 

supervisory program. Supervisors must have the authority and resources to gather and evaluate sufficient information to make 

sound supervisory decisions without undue pressures from outside 

influences. The FDIC and State banking supervisors, who often 

provide a different and unique perspective on the operations of 

community banks, have worked cooperatively to make sound supervisory decisions without compromising their independence. 

As currently structured, two of the Federal banking agencies, the 

Office of the Comptroller of the Currency (OCC) and the Office of 

Thrift Supervision (OTS) are bureaus within the U.S. Department 

of the Treasury. Although subject to general Treasury oversight, 

the OCC and OTS have a considerable amount of autonomy within 

the Treasury with regard to examination and enforcement matters. 

Unlike Treasury, the bureaus within the U.S. Department of OCC 

and OTS are funded by examination and other fees assessed on 

regulated entities, and they have independent litigating authority. 

The other three Federal banking agencies—Governors of the Federal Deposit Insurance Corporation, the Board of Governors of the 

Federal Reserve, and the National Credit Union Association, are 

fully independent agencies, self-funded though assessments or 
80 

other fees, and have independent litigating authority. To the extent 

the OTS and OCC would be merged into a single regulator under 

Treasury, continued independence could be maintained through 

nonappropriated funding sources, independent litigating authority, 

and independent decision-making authority, such as currently afforded to the OCC and OTS. 

Q.3. Given the damage caused by widespread use of subprime and 

nontraditional mortgages—particularly low documentation mortgages—it seems that products that are harmful to the consumer 

are also harmful to the banks that sell them. If bank regulators do 

their job and stop banks from selling products that are dangerous 

to the banks themselves, other than to set standards for currently 

unregulated firms, why do we need a separate consumer protection 

agency? 

A.3. As currently proposed, the new Consumer Financial Protection 

Agency (CFPA) would be given sole rulemaking authority for consumer financial protection statutes over all providers of consumer 

credit, including those outside the banking industry. The CFPA 

would set a floor on consumer regulation and guarantee the States’ 

ability to adopt and enforce stricter (more protective) laws for institutions of all types, regardless of charter. It also is proposed that 

the CFPA would have consumer protection examination and enforcement authority over all providers of consumer credit and other 

consumer products and services—banks and nonbanks. 

Giving the CFPA the regulatory and supervisory authority over 

nonbanks would fill in the existing regulatory and supervisory gaps 

between nonbanks and insured depository institutions and is key 

to addressing most of the abusive lending practices that occurred 

institutions and is key to addressing most of during the current crisis. In addition, the provision to give the CFPA sole rulewriting authority over consumer financial products and services would establish strong, consistent consumer protection standards among all 

providers of financial products and services and eliminate potential 

regulatory arbitrage that exists because of Federal preemption of 

certain State laws. 

However, the Treasury proposal could be made even more effective with a few targeted changes. As recent experience has shown, 

consumer protection issues and the safety and soundness of insured institutions go hand-in-hand and require a comprehensive, 

coordinated approach for effective examination and supervision. 

Separating Federal banking agency examination and supervision 

(including enforcement) from consumer protection examination and 

supervision could undermine the effectiveness of each with the unintended consequence of weakening bank oversight. 

As a Federal banking supervisor and the ultimate insurer of $6 

trillion in deposits, the FDIC has the responsibility and the need 

to ensure consumer protection and safety and soundness are properly integrated. The FDIC and other Federal banking agencies 

should retain their authority to examine and supervise insured depository institutions for consumer protection standards established 

by the CFPA. The CFPA should focus its examination and enforcement resources on nonbank providers of products and services that 

have not been previously subject to Federal examinations and 
81 

standards. The CFPA also should have back-up examination and 

enforcement authority to address situations where it determines 

the Federal banking agency supervision is deficient. 

Q.4. Since the two most recent banking meltdowns were caused by 

mortgage lending, do you think it is wise to have a charter focused 

on mortgage lending? In other words, why should we have a thrift 

charter? 

A.4. Over several decades, financial institutions with thrift charters have provided financing for home loans for many Americans. 

In recent years, Federal and State banking charters have expanded 

into more diversified, full service banking operations that include 

commercial and residential mortgage lending. However, it is understandable that the lack of diversification and exposure to the housing market could raise concerns about the thrift charter. Market 

forces have reduced the demand for thrift charters. Given the dwindling size of the Federal thrift industry, it makes sense to consider 

merging the Federal thrift charter into a single Federal depository 

institution charter. 

Q.5. Should banking regulators continue to be funded by fees on 

the regulated firms, or is there a better way? 

A.5. We believe the banking industry should pay for its supervision, but the Federal bank supervision funding process should 

not disadvantage State-chartered depository institutions and the 

dual banking system. State-chartered banks pay examination fees 

to State banking agencies. The Federal banking agencies are selffunded through assessments, exam fees, and other sources. This arrangement helps them remain independent of the political process 

and separates them from the Federal budget appropriations. 

Q.6. Why should we have a different regulator for holding companies than for the banks themselves? 

A.6. We do not believe it is always necessary to have a different 

regulator for the holding company and the bank. Numerous onebank holding companies exist where the bank is essentially the 

only asset owned by the holding company. In these cases, there is 

no reason why bank regulators could not also serve as holding company regulators as it is generally more efficient and prudent for 

one regulator to evaluate both entities. 

In the case of more complex multibank holding companies, one 

can argue it is more effective for the primary Federal regulators to 

examine the insured depository institutions while the Federal Reserve evaluates the parent (as a source of strength) and the financial condition of the nonbank subsidiaries. Yet even for a separate 

holding company regulator, the prudential standards it applies 

should be at least as strong as the standards applied to insured 

banks. 

Q.7. Assuming we keep thrifts and thrift holding companies, 

should thrift holding companies be regulated by the same regulator 

as bank holding companies? 

A.7. Similar to the answer to Question 6, it may not be necessary 

for small thrifts that are owned by what are essentially shell holding companies to have a separate holding company regulator. While 

one can argue that more complex organizations merit a separate 
82 

holding company regulator, even in this structure we believe prudential standards applied to a holding company should be at least 

as strong as those applied to an insured entity. 

Q.8. The proposed risk council is separate from the normal safety 

and soundness regulator of banks and other firms. The idea is that 

the council will set rules that the other regulators will enforce. 

That sounds a lot like the current system we have today, where different regulators read and enforce the same rules different ways. 

Under such a council, how would you make sure the rules were 

being enforced the same across the board? 

A.8. The proposed risk council would oversee systemic risk issues, 

develop needed prudential policies, and mitigate developing systemic risks. A primary responsibility of the council should be to 

harmonize prudential regulatory standards for financial institutions, products, and practices to assure market participants cannot 

arbitrage regulatory standards in ways that pose systemic risk. 

The council should evaluate different capital standards that apply 

to commercial banks, investment banks, investment funds, and others to determine the extent to which these standards circumvent 

regulatory efforts to contain excess leverage in the system. The 

council should ensure that prompt corrective action and capital 

standards are harmonized across firms. For example, large financial holding companies should be subject to tougher prompt corrective action standards under U.S. law and be subject to holding company capital requirements that are no less stringent than those for 

insured banks. The council also should undertake the harmonization of capital and margin requirements applicable to all OTC derivatives activities and facilitate interagency efforts to encourage 

greater standardization and transparency of derivatives activities 

and the migration of these activities onto exchanges or central 

counterparties. To be successful, the council must have sufficient 

authority to require some uniformity and standardization in those 

areas where appropriate. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR BUNNING 

FROM JOHN C. DUGAN 

Q.1. What is the best way to decrease concentration in the banking 

industry? Is it size limitations, rolling back State preemption, higher capital requirements, or something else? 

A.1. The financial crisis has highlighted the importance of interlinkages between the performance of systemically important banks, 

financial stability, and the real economy. It has also highlighted 

the risks of firms that are deemed ‘‘too big to fail.’’ There are a 

range of policy options that are under active consideration by U.S. 

and global supervisors to address these issues. Given the multifaceted nature of this problem, we believe that a combination of 

policy responses may be most appropriate. 

A crucial first step, we believe, is strengthening and raising the 

current capital standards for large banking organizations to ensure 

that these organizations maintain sufficient capital for the risks 

they take and pose to the financial system. Part of this effort is 

well underway through initiatives being taken by the Basel Com-
83 

mittee on Bank Supervision (the ‘‘Committee’’). As announced in 

July, the Committee has adopted a final package of measures that 

will strengthen and increase the capital required for trading book 

and certain securitization structures. The results of a recent quantitative analysis conducted by the Committee to assess the impact 

of the trading book rule changes suggest that these changes will increase average trading book capital requirements by two to three 

times their current levels, although the Committee noted significant dispersion around this average. 

The Committee has underway several other key initiatives that 

we believe are also critical to reduce the risks posed by large, internationally active banks. These include: 

• Strengthening the quality, international consistency, and 

transparency of a bank’s capital base; 

• Developing a uniform Pillar -1 based leverage ratio, which, 

among other requirements, would apply a 100 percent credit 

conversion factor to certain off-balance sheet credit exposures; 

• Introducing a minimum global standard for funding liquidity 

that includes a stressed liquidity coverage ratio requirement, 

underpinned by a longer-term structural liquidity ratio; and 

• Developing a framework for countercyclical capital buffers 

above the minimum requirement. The framework will include 

capital conservation measures such as constraints on capital 

distributions. The Basel Committee will review an appropriate 

set of indicators, such as earnings and credit-based variables, 

as a way to condition the build up and release of capital buffers. In addition, the Committee will promote more forwardlooking provisions based on expected losses. 

The OCC has been actively involved in, and strongly supports, 

these initiatives. In addition to these actions, there are other policy 

initiatives under consideration, including the development of incremental capital surcharges that would increase with the size and/ 

or risk of the institution, and measures to reduce the systemic impact of failure, such as reduced interconnectedness and resolution 

planning. 

As noted in my testimony, the OCC also endorses domestic proposals to establish a Financial Stability Oversight Council that 

would identify and monitor systemic risk, gather and share systemically significant information, and make recommendations to individual regulators. This council would consist of the Secretary of the 

Treasury and all of the Federal financial regulators, and would be 

supported by a permanent staff. We also endorse enhanced authority to resolve systemically significant financial firms. 

We believe that a multipronged approach, as outlined above; is 

far more appropriate than relying on a single measure, such as 

asset size, to address the risks posed by large institutions. We also 

believe that to ensure the competitiveness of U.S. financial institutions in today’s global economy, many of these policy initiatives 

need to be coordinated with, and implemented by, supervisors 

across the globe. 

Finally, we strongly disagree with any suggestion that Federal 

preemption was a root cause of the financial crisis or that rolling 

back preemption would be a solution. In this regard, we would 
84 

highlight that the systemic risk posed by companies such as AIG, 

Lehman Brothers, and Bear Stearns were outside of the OCC’s regulatory authority and thus not affected by the OCC’s application of 

Federal preemption decisions. 

Q.2. Treasury has proposed making the new banking regulator a 

bureau of the Treasury Department. Putting aside whether we 

should merge the current regulators, does placing the new regulator in Treasury rather than as a separate agency provide enough 

independence from political influence? 

A.2. It is critical that the new agency be independent from the 

Treasury Department and the Administration to the same extent 

that the OCC and OTS are currently independent. For example, 

current law provides the OCC with important independence from 

political interference in decision making in matters before the 

Comptroller, including enforcement proceedings; provides for funding independent of political control; enables the OCC to propose 

and promulgate regulations without approval by the Treasury; and 

permits the agency to testify before Congress without the need for 

the Administration’s clearance of the agency’s statements. It is crucial that these firewalls be maintained in a form that is at least 

as robust as current law provides with respect to the OCC and the 

OTS, to enable the new regulator to maintain comparable independence from political influence. In addition, consideration should 

be given to providing the new regulator the same independence 

from OMB review and clearance of its regulations as is currently 

provided for the FDIC and the Federal Reserve Board. This would 

further protect the new agency’s rulemaking process from political 

interference. 

Q.3. Given the damage caused by widespread use of subprime and 

nontraditional mortgages—particularly low documentation mortgages—it seems that products that are harmful to the consumer 

are also harmful to the banks that sell them. If bank regulators do 

their job and stop banks from selling products that are dangerous 

to the banks themselves, other than to set standards for currently 

unregulated firms, why do we need a separate consumer protection 

agency? 

A.3. In the ongoing debate about reforming the structure of financial services regulation to address the problems highlighted by the 

financial crisis, relatively little attention has been paid to the initial problem that sparked the crisis: the exceptionally weak, and 

ultimately disastrous, mortgage underwriting practices accepted by 

lenders and investors. The worst of these practices included: 

• The failure to verify borrower representations about income 

and financial assets (the low documentation loans mentioned 

in this question); 

• The failure to require meaningful borrower equity in the form 

of real down payments; 

• The acceptance of very high debt-to-income ratios; 

• The qualification of borrowers based on their ability to afford 

artificially low initial monthly payments rather than the much 

higher monthly payments that would come later; and 
85 

• The reliance on future house price appreciation as the primary 

source of repayment, either through refinancing or sale. 

The consequences of these practices were disastrous not just for 

borrowers and financial institutions in the United States, but also 

for investors all over the world due to the transmission mechanism 

of securitization. To prevent this from happening again, while still 

providing adequate mortgage credit to borrowers, regulators need 

to establish, with additional legislative authorization as necessary, 

at least three minimum underwriting standards for all home mortgages: 

• First, underwriters should verify income and assets. 

• Second, borrowers should be required to make meaningful 

down payments. 

• Third, a borrower should not be eligible for a mortgage where 

monthly payments increase over time unless the borrower can 

afford the later, high payments. 

It is critical that these requirements, and any new mortgage regulation that is adopted, apply to all credit providers to prevent the 

kind of competitive inequity and pressure on regulated lenders that 

eroded safe and sound lending practices in the past. Prudential 

bank supervisors, including the OCC, are best positioned to develop 

such new underwriting standards and would enforce them vigorously with respect to the banks they supervise. A separate regulatory mechanism would be required to ensure that such standards 

are implemented by nonbanks. While the proposed new Consumer 

Financial Protection Agency would have consumer protection regulatory authority with respect to nonbanks, they would not have— 

and they should not have—safety and soundness regulatory authority over underwriting standards. 

Q.4. Since the two most recent banking meltdowns were caused by 

mortgage lending, do you think it is wise to have a charter focused 

on mortgage lending? In other words, why should we have a thrift 

charter? 

A.4. When there are systemwide problems with residential mortgages, institutions that concentrate their activities in those instruments will sustain more losses and pose more risk to the deposit 

insurance fund than more diversified institutions. On the other 

hand, there are many thrifts that maintained conservative underwriting standards and have weathered the current crisis. The 

Treasury proposal would eliminate the Federal thrift charter—but 

not the State thrift charter—with all Federal thrifts required to 

convert to a national bank, State bank, or State thrift, over the 

course of a reasonable transition period. (State thrifts would then 

be treated as State ‘‘banks’’ under Federal law.) An alternative approach would be to preserve the Federal thrift charter, with Federal thrift regulation being conducted by a division of the merged 

agency. With the same deposit insurance fund, same prudential 

regulator, same holding company regulator, and a narrower charter 

(a national bank has all the powers of a Federal thrift plus many 

others), it is unclear whether institutions will choose to retain their 

thrift charters over the long term. 
86 

Q.5. Should banking regulators continue to be funded by fees on 

the regulated firms, or is there a better way? 

A.5. Funding bank regulation and supervision through fees imposed on the regulated firms is preferable to the alternative of providing funding through the appropriations process because it ensures the independence from political control that is essential to 

bank supervision. 

For this reason, fee-based funding is the norm in banking regulation. In the case of the OCC and OTS, Congress has determined 

that assessments and fees on national banks and thrifts, respectively, will fund supervisory activities, rather than appropriations 

from the United States Treasury. Since enactment of the National 

Bank Act in 1864, the OCC has been funded by various types of 

fees imposed on national banks, and over the more than 145 years 

that the OCC has regulated national banks, this funding mechanism has never caused the OCC to weaken or change its regulation 

or supervision of national banks, including with respect to national 

banks’ compliance with consumer protection laws. Neither the Federal Reserve Board nor the FDIC receives appropriations. State 

banking regulators typically also are funded by assessments on the 

entities they charter and supervise. 

Q.6. Why should we have a different regulator for holding companies than for the banks themselves? 

A.6. Combining the responsibilities for prudential bank supervision 

and holding company supervision in the same regulator would be 

a workable approach in the case of those holding companies whose 

business is comprised solely or overwhelmingly of one or more subsidiary banks. Elimination of a separate holding company regulator 

in these situations would remove duplication, promote simplicity 

and accountability, and reduce unnecessary compliance burden for 

institutions as well. 

Such a consolidated approach would be more challenging where 

the holding company has substantial nonbanking activities in other 

subsidiaries, such as complex capital markets activities, securities, 

and insurance. The focus of a dedicated, strong prudential banking 

supervisor could be significantly diluted by extending its focus to 

substantial nonbanking activities. The Federal Reserve has unique 

resources and expertise to bring to bear on supervision of these 

sorts of activities conducted by bank affiliates in a large, complex 

holding company. Therefore, a preferable approach would be to preserve such a role for the Federal Reserve Board, but to clearly delineate the respective roles of the Board and the prudential bank 

supervisors with respect to the holding company’s activities. 

Q.7. Assuming we keep thrifts and thrift holding companies, 

should thrift holding companies be regulated by the same regulator 

as bank holding companies? 

A.7. Yes. Thrift holding companies, unlike bank holding companies, 

currently are not subject to consolidated regulation; for example, no 

consolidated capital requirements apply at the holding company 

level. This difference between bank and thrift holding company regulation created arbitrage opportunities for companies that were 

able to take on greater risk under a less rigorous regulatory regime. Yet, as we have seen—AIG is the obvious example—large 
87 

1 Countrywide Financial Corporation 10-Q (Mar. 31, 2008). 

nonbank firms can present similar risks to the system as large 

banks. This regulatory gap should be closed, and these firms 

should be subject to the same type of oversight as bank holding 

companies. The Treasury Proposal would make these types of firms 

subject to the Bank Holding Company Act and supervision by the 

Federal Reserve Board. We support this approach, including a reasonable approach to grandfathering the activities of some thrift 

holding companies that may not conform to the activities limitations of the Bank Holding Company Act. 

Q.8. The proposed risk council is separate from the normal safety 

and soundness regulator of banks and other firms. The idea is that 

the council will set the rules that the other regulators will enforce. 

That sounds a lot like the current system we have today, where different regulators read and enforce the same rules different ways. 

Under such a council, how would you make sure the rules were 

being enforced the same across the board? 

A.8. The Treasury proposal establishes the Financial Services 

Oversight Council to identify potential threats to the stability of 

the U.S. financial system; to make recommendations to enhance 

the stability of the U.S. financial markets; and to provide a forum 

for discussion and analysis of emerging issues. Based on its monitoring of the U.S. financial services marketplace, the Council would 

also play an advisory role, making recommendations to, and consulting with, the Board of Governors of the Federal Reserve System. As I understand the Treasury proposal, however, the Council’s 

role is only advisory; it will not be setting any rules. Therefore, we 

do not anticipate any conflicting enforcement issues to arise from 

the Council’s role. 

Q.9. Mr. Dugan, in Mr. Bowman’s statement he says Countrywide 

converted to a thrift from a national bank after it had written most 

of the worst loans during the housing bubble. That means 

Countrywide’s problems were created under your watch, not his. 

How do you defend that charge and why should we believe your 

agency will be able to spot bad lending practices in the future? 

A.9. In evaluating the Countrywide situation, it is important to 

know all the facts. Both Countrywide Bank, N.A., and its finance 

company affiliate, Countrywide Home Loans, engaged in mortgage 

lending activities. While the national bank was subject to the supervision of the OCC, Countrywide Home Loans, as a bank holding 

company subsidiary, was subject to regulation by the Federal Reserve and the States in which it did business. 

Mortgage banking loan production occurred predominately at 

Countrywide Home Loans, 1 the holding company’s finance subsidiary, which was not subject to OCC oversight. Indeed, all 

subprime lending, as defined by the borrower’s FICO score, was 

conducted at Countrywide Home Loans and not subject to OCC 

oversight. The OCC simply did not allow Countrywide Bank, N.A., 

to engage in such subprime lending. 

When Countrywide Financial Corporation, the holding company, 

began to transition more of the mortgage lending business from 

Countrywide Home Loans to the national bank, the OCC started 
88 

2 Countrywide Financial Corporation 10-Q (Mar. 31, 2008). 

to raise a variety of supervisory concerns about the bank’s lending 

risk and control practices. Shortly thereafter, on December 6, 2006, 

Countrywide Bank applied to convert to a Federal savings bank 

charter. 

Countrywide Bank became a Federal savings bank on March 12, 

2007. Going forward, Countrywide Bank, FSB, was regulated by 

OTS, and Countrywide Home Loans was regulated by the OTS and 

the States in which it did business. Countrywide Financial Corporation continued to transition its mortgage loan production to the 

Countrywide Bank, FSB. By the end of the first quarter of 2008, 

over 96 percent of mortgage loan production of Countrywide Financial Corporation occurred at Countrywide Bank, FSB. 2

Bank of America completed its acquisition of Countrywide Financial Corporation on June 30, 2008. 

Countrywide Bank, N.A., was not the source of toxic subprime 

loans. The OCC raised concerns when Countrywide began 

transitioning more of its mortgage lending operations to its national bank charter. It was at that point that Countrywide flipped 

its national bank charter to a Federal thrift charter. The facts do 

not imply lax supervision by the OCC, but rather quite the opposite. 

The OCC continues to identify and warn about potentially risky 

lending practices. On other occasions, the OCC has taken enforcement actions and issued guidance to curtail abuses with subprime 

credit cards and payday loans. Likewise, the Federal banking agencies issued guidance to address emerging compliance risks with 

nontraditional mortgages, such as payment option ARMs, and the 

OCC took strong measures to ensure that that guidance was effectively implemented by national banks throughout the country. 

Q.10. All of the largest financial institutions have international 

ties, and money can flow across borders easily. AIG is probably the 

best known example of how problems can cross borders. How do we 

deal with the risks created in our country by actions somewhere 

else, as well as the impact of actions in the U.S. on foreign firms? 

A.10. As noted in our response to Question 1, the global nature of 

today’s financial institutions increasingly requires that supervisory 

policies and actions be coordinated and implemented on a global 

basis. The OCC is an active participant in various international supervisory groups whose goal is to coordinate supervisory policy responses, to share information, and to coordinate supervisory activities at individual institutions whose activities span national borders. These groups include the Basel Committee on Bank Supervision (BCBS), the Joint Forum, the Senior Supervisors Group 

(SSG), and the Financial Stability Board. In addition to coordinating capital and other supervisory standards, these groups promote information sharing across regulators. 

For example, the SSG recently released a report that evaluates 

how weaknesses in risk management and internal controls contributed to industry distress during the financial crisis. The observations and conclusions in the report reflect the results of two initiatives undertaken by the SSG. These initiatives involved a series of 

interviews with firms about funding and liquidity challenges and 
89 

a self-assessment exercise in which firms were asked to benchmark 

their risk management practices against recommendations and observations taken from industry and supervisory studies published 

in 2008. 

One of the challenges that arise in resolving a cross-border bank 

crisis is that crisis resolution frameworks are largely designed to 

deal with domestic failures and to minimize the losses incurred by 

domestic stakeholders. As such, the current frameworks are not 

well suited to dealing with serious cross-border problems. In addition to the fact that legal systems and the fiscal responsibility are 

national matters, a basic reason for the predominance of the territorial approach in resolving banking crises and insolvencies is the 

absence of a multinational framework for sharing the fiscal burdens for such crises or insolvencies. 

To help address these issues, the BCBS has established a Crossborder Bank Resolution Group to compare the national policies, 

legal frameworks and the allocation of responsibilities for the resolution of banks with significant cross-border operations. On September 17, 2009, the BCBS issued for comment a report prepared 

by this work group that sets out 10 recommendations that reflect 

the lessons from the recent financial crisis and are designed to improve the resolution of a failing financial institution that has crossborder activities. The report’s recommendations fall into three categories including: 

• The strengthening of national resolution powers and their 

cross-border implementation; 

• Ex ante action and institution-specific contingency planning, 

which involves the institutions themselves as well as critical 

home and host jurisdictions; and, 

• Reducing contagion and limiting the impact on the market of 

the failure of a financial firm by actions such as further 

strengthening of netting arrangements. 

We believe adoption of these recommendations will enhance supervisors’ ability to deal with many of the issues posed by resolving 

a cross-border bank. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR BUNNING 

FROM DANIEL K. TARULLO 

Q.1. What is the best way to decrease concentration in the banking 

industry? Is it size limitations, rolling back State preemption, higher capital requirements, or something else? 

A.1. Answer not received by time of publication. 

Q.2. Treasury has proposed making the new banking regulator a 

bureau of the Treasury Department. Putting aside whether we 

should merge the current regulators, does placing the new regulator in Treasury rather than as a separate agency provide enough 

independence from political influence? 

A.2. Answer not received by time of publication. 

Q.3. Given the damage caused by widespread use of subprime and 

nontraditional mortgages—particularly low documentation mortgages—it seems that products that are harmful to the consumer 
90 

are also harmful to the banks that sell them. If bank regulators do 

their job and stop banks from selling products that are dangerous 

to the banks themselves, other than to set standards for currently 

unregulated firms, why do we need a separate consumer protection 

agency? 

A.3. Answer not received by time of publication. 

Q.4. Since the two most recent banking meltdowns were caused by 

mortgage lending, do you think it is wise to have a charter focused 

on mortgage lending? In other words, why should we have a thrift 

charter? 

A.4. Answer not received by time of publication. 

Q.5. Should banking regulators continue to be funded by fees on 

the regulated firms, or is there a better way? 

A.5. Answer not received by time of publication. 

Q.6. Why should we have a different regulator for holding companies than for the banks themselves? 

A.6. Answer not received by time of publication. 

Q.7. Assuming we keep thrifts and thrift holding companies, 

should thrift holding companies be regulated by the same regulator 

as bank holding companies? 

A.7. Answer not received by time of publication. 

Q.8. The proposed risk council is separate from the normal safety 

and soundness regulator of banks and other firms. The idea is that 

the council will set rules that the other regulators will enforce. 

That sounds a lot like the current system we have today, where different regulators read and enforce the same rules different ways. 

Under such a council, how would you make sure the rules were 

being enforced the same across the board? 

A.8. Answer not received by time of publication. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR BUNNING 

FROM JOHN E. BOWMAN 

Q.1. What is the best way to decrease concentration in the banking 

industry? Is it size limitations, rolling back State preemption, higher capital requirements, or something else? 

A.1. There are several ways to decrease the concentration in the 

banking industry, including: 

1. Restricting further increases in concentrations. The largest 

banks in the U.S. have principally achieved their concentration dominance by mergers and acquisitions. Hence, slight 

changes to the current rules regarding the regulatory review 

and approval of mergers/acquisitions could play a large part 

in restricting further concentration. There could be modest 

changes made to the Herfindahl Hirschman Index (HHI) analysis when reviewing merger/acquisition applications of very 

large banks to restrict increases in concentrations. 

2. Reduce current concentrations. Options could range from severe, such as forced break-ups, to less severe such as requir-
91 

ing largest banks to increase their regulatory capital and/or 

tangible capital levels. 

3. Reduce the advantages of ‘‘Too Big To Fail’’ (TBTF). Having 

the U.S. Government as an implicit backstop for liquidity and 

capital reserves allowed the largest banks to raise capital at 

less expensive rates than could smaller, community banks. 

Large banks were able to use that capital to fund the acquisition of other banks. Removing the U.S. Government as a backstop by implementing explicit take over authority and procedures for TBTF institutions would help eliminate this moral 

hazard. 

4. Improve the outlook for community banks and thrifts. Efforts 

to make it easier to organize new or de novo banks and 

thrifts, as well as for smaller institutions to increase capital 

levels, would help level the playing field between community 

institutions and large banks. 

Q.2. Treasury has proposed making the new banking regulator a 

bureau of the Treasury Department. Putting aside whether we 

should merge the current regulators, does placing the new regulator in Treasury rather than as a separate agency provide enough 

independence from political influence? 

A.2. OTS has stated publicly that it does not support the elimination of the thrift charter or the Administration’s Proposal to establish a new agency, the National Bank Supervisor (NBS), by 

eliminating the Office of the Comptroller of the Currency, which 

charters and regulates national banks, and the OTS, which charters Federal thrifts and regulates thrifts and their holding companies. However, if a new NBS is established to be the Federal chartering and supervisory authority for Federal depository institutions, such new agency should be independent from the Department of Treasury rather than bureau of the Department. 

Among the Federal banking agencies, the Board of Governors of 

the Federal Reserve System and the Federal Deposit Insurance 

Corporation each are independent from Treasury for all purposes. 

A similar separation for any new banking regulator would assure 

that the agency would be free from any possible constraints on 

rulemaking, enforcement, or litigation matters. An example of recently established agency that is independent of the Department of 

Treasury or any other Department is the Federal Housing Finance 

Agency, which was created by the Housing and Economic Recovery 

Act in July 2008. 

To the extent that it is determined that the new NBS should be 

part of the Department of Treasury, if it is granted explicit independence in a number of areas, it would be insulated from political 

influence to the same degree that the OTS currently is. Examples 

of the type of activities of the new supervisor that must remain 

independent include the ability of the agency to testify and to make 

legislative recommendations. Another important area of independence is the agency’s authority to litigate. The current OTS authority provides that Secretary of Treasury may not intervene in any 

matter or proceeding before OTS, including enforcement matters, 

and not prevent the issuance of any rule or regulation by the agency. Any new agency should have the same authority that OTS cur-
92 

rently does. The operations of the NBS should be funded by assessments and not through the appropriations process. 

Q.3. Given the damage caused by widespread use of subprime and 

nontraditional mortgages particularly low documentation mortgages—it seems that products that are harmful to the consumer 

are also harmful to the banks that sell them. If bank regulators do 

their job and stop banks from selling products that are dangerous 

to the banks themselves, other than to set standards for currently 

unregulated firms, why we need a separate consumer protection 

agency? 

A.3. The OTS examines institutions to ensure that they are operating in a safe and sound manner. OTS does not believe that Federal regulators should dictate the types of products that lenders 

must offer. Although we believe strongly that Government regulators should prohibit products or practices that are unfair to consumers, the Government should not be overly prescriptive in defining lenders’ business plans or mandating that certain products be 

offered to consumers. 

Defining standards for financial products would put a Government seal of approval on certain favored products and would effectively steer lenders toward products. It could have the unintended 

consequence of fewer choices for consumers by stifling innovation 

and inhibiting the creation of products that could benefit consumers and financial institutions. We are concerned about the consumer protection agency defining standards for financial products 

and services that would require institutions to offer certain products (e.g., 30-year fixed rate mortgages). The imposition of such a 

requirement could result in safety and soundness concerns and stifle credit availability and innovation. 

The OTS supports consolidating rulemaking authority over all 

consumer protection regulation in one Federal regulator such as 

the proposed consumer protection agency. This regulator should be 

responsible for promulgating all consumer protection regulations 

that would apply uniformly to all entities that offer financial products, whether an insured depository institution, State-licensed 

mortgage broker or mortgage company. Any new framework should 

be to ensure that similar bank or bank-like products, services, and 

activities are treated in the same way in a regulation, whether 

they are offered by a chartered depository institution, or an unregulated financial services provider. The product should receive 

the same review, oversight, and scrutiny regardless of the entity offering the product. 

To balance the safety and soundness requirements of depository 

institutions with these important functions of the consumer protection agency, the OTS recommends retaining primary consumer-protection-related examination and supervision authority for insured 

depository institutions with the FBAs and the NCUA. The OTS believes that the CFPA should have primary examination and enforcement power over entities engaged in consumer lending that 

are not under the jurisdiction of the FBAs. 

Safety and soundness and consumer protection examination and 

enforcement powers should not be separated for insured depository 

institutions because safety-and-soundness examinations com-
93 

plement and strengthen consumer protection. By separating safetyand-soundness functions from consumer protection, the CFPA and 

an FBA could each have gaps in their information concerning an 

institution. 

Q.4. Since the two most recent banking meltdowns were caused by 

mortgage lending, do you think it is wise to have a charter focused 

on mortgage lending? In other words, why should we have a thrift 

charter? 

A.4. Beginning with the enactment of the Home Owners Loan Act. 

Congress has several times acted to reinforce a national housing 

policy. Over the years, Congress has taken steps to ensure that a 

specialized housing lender is retained among the charter options 

available tor insured institutions. The causes of any banking crisis 

are difficult to identify because of the interconnected nature of financial services. The crisis that we currently are working through 

is different in several important ways from the banking crisis of 

the 1980s and early 1990s. In the early months of the current crisis, there appeared to be similarities in its origins to the crisis of 

the 1980s and appeared to have been caused by mortgage lending. 

Even if the early obvious causes of the current crisis are found in 

the mortgage market, the industry has evolved and changed since 

the earlier crisis. The elimination of a dedicated mortgage lending 

charter would not have eliminated the current crisis. 

In the 1980s, the thrift industry was more limited in the activities in which it could engage and in the loan products institutions 

could offer to consumers. In a period of rapidly rising interest 

rates, many thrift institutions held long term fixed rate mortgages 

on their books while at the same time paying high rates on deposits to meet competition. The mortgage banking industry was not 

mature and the use of the secondary mortgage market was not 

widespread, therefore the long term fixed rate assets originated by 

thrifts created an interest rate mismatch on the books of the institutions. As a result of the earlier crisis, the OTS developed a proprietary interest rate risk model and expertise in supervision of institutions likely to have interest rate risk concerns. Throughout 

varied interest rate environments, the industry has not experienced 

the problems of the 1980s. 

However, interest rate risk was not a primary cause of the current crisis and the mortgage related causes of the current crisis are 

already the subject of revised guidance at the OTS and the other 

Federal banking agencies. Unlike the problems of the 1980s, there 

are a number of causes of the mortgage related problems that surfaced in the current crisis. 

First, during the recent housing boom, credit was extended to too 

many borrowers who lacked the ability to repay their loans when 

interest rates rose on the adjustable rate loans. For home mortgages, some consumers received loans based on their ability to pay 

introductory teaser rates, an unfounded expectation that home 

prices would continue to rise, inflated income figures, or other underwriting practices that were not as prudent as they should have 

been. 

In addition, mortgage related problems are in part the result of 

inadequate supervision of State entities that had no Federal over-
94 

sight. Another factor was the growth of the secondary market and 

the ability of lenders of any charter type or organizational form to 

fund lending activities with sales of originated loans. Whether it 

was the entities that originated the loans or the numerous entities 

that packaged the loans and sold them as part of securities, the entities involved were not always supervised by Federal banking regulators and that lack of supervision is a more direct contributor to 

the crisis than the existence of a charter that focuses on mortgage 

lending. 

There are many lessons learned from the current crisis, but one 

of them is not that Congress should eliminate the thrift charter or 

a charter that focuses on housing finance. Homeownership continues to be an important policy objective for Congress. Consumers 

deserve to have the option of obtaining a loan from a dedicated 

home and consumer lender that is able to offer products that meet 

that consumer’s needs. 

Q.5. Should banking regulators continue to be funded by fees on 

the regulated firms, or is there a better way? 

A.5. As a general matter, we believe that bank regulatory agencies 

(agencies) be funded by the institutions that they regulate. The alternative, funding the agencies with tax payer dollars through the 

appropriations process, is inherently problematic. Funding the 

agencies in this manner creates a taxpayer subsidy for the institutions. Moreover, subjecting the agencies to the appropriations process will make the agencies more vulnerable to political influence. 

Now more than ever it is critical that the agencies be independent and free of political influence. However, funding the agencies through appropriations will do just the opposite. The Office of 

Federal Housing Enterprise Oversight (OFHEO) was subject to the 

appropriations process and as such was very vulnerable to political 

influence. For example, in 2004 OFHEO investigated accounting 

improprieties at Fannie Mae and that entity used the appropriations process to hinder the agency, portraying it as over its head 

on complex financial matters. This resulted in the Senate Appropriations Committee voting to hold back $10 million of a proposed 

funding increase until OFHEO got a new director. (S. Rep. No. 108- 

353, at 71.) 

It is critical that the agencies have the resources necessary to effectively regulate institutions. As was the case with OFHEO, Congress can withhold or threaten to withhold such funds. Even in the 

absence of such actions, Continuing Resolutions (CR) and other appropriations law requirements may hinder the agencies in achieving their mission. Beginning in October of every year and until a 

yearly appropriations bill is passed, agencies under the appropriations process are typically under a hiring freeze and are severely 

restricted in their expenditures under a CR. On January 21, 2004, 

Annando Falcon, then Director of OFHEO testified that Congress’ 

protracted FY04 appropriations process placed ‘‘severe constraints’’ 

on OFHEO’s capacity to implement reforms at Freddie Mac and 

carry out other oversight responsibilities. Director Falcon told the 

House Financial Services Capital Markets Subcommittee that 

‘‘[t]he short-term continuing resolutions we are operating under 

prevent us from hiring the additional examiners, accountants and 
95 

analysts we need to strengthen our oversight. In addition, we are 

unable to hire the help we need to conduct our review of Fannie 

Mae. If the long term [continuing resolution] is enacted which 

freezes our budget at 2003 levels, we will need to scale back oversight at a time when greater oversight has never been more urgent.’’ (Special Examination of Freddie Mac: Hearing Before the 

Subcommittee on Capital Markets, Insurance and Government 

Sponsored Enterprises of the H. Comm. on Financial Services, 

108th Cong. 8-9 (January 21, 2004) (statement of Armando Falcon, 

Director of Office of Federal Housing Enterprise Oversight.)) 

Some believe that a banking agency may supervise an institution 

less vigorously if it fears that the institution will switch charters 

and the agency will lose a funding source. 

However, there is no evidence that this is the case and we 

strongly disagree with this suggestion. 

Q.6. Why should we have a different regulator for holding companies than for the banks themselves? 

A.6. Since the establishment of the savings and loan holding company, the OTS and its predecessor have regulated savings associations and their holding companies. Regulators have greater oversight into an institution and the holding company if they have the 

same supervisor. OTS disagrees that the institution and the holding company should have a different regulator. An exception to this 

general statement is if the holding company is so large or interconnected with other financial services companies that a systemic 

regulator also will provide oversight. 

OTS has long had authority to charter and regulate thrift institutions and the companies that own or control them. The agency 

has a comprehensive program for assessing and rating the overall 

enterprise as well as the adequacy of capital, the effectiveness of 

the organizational structure, the effectiveness of the risk management framework for the firm and the strength and sustainability 

of earnings. OTS performs capital adequacy assessments on an individualized basis for the firms under our purview with requirements as necessary, depending on the company’s risk profile, its 

unique circumstances and its financial condition. 

The net effect of this approach has been a strong capital cushion 

for the holding companies OTS supervises and the ability for the 

firms under our purview to support the insured depositories within 

their corporate structures. It is because the agency supervises the 

institution and the holding company that the impact of the holding 

company activities on the institution can be assessed on a regular 

basis. 

Q.7. Assuming we keep thrifts and thrift holding companies, 

should thrift holding companies be regulated by the same regulator 

as bank holding companies? 

A.7. As explained more fully in the answer above, thrifts and thrift 

holding companies should continue to have the same supervisor. 

The regulatory framework that has been developed for the institution and its holding company provides a seamless supervisory process for savings associations and their holding companies. The benefits of having the same regulator for the institution and the holding 

company include the supervisor’s ability to view the institution and 
96 

the holding company as a whole and judgments based on all of the 

information. 

Q.8. The proposed risk council is separate from the normal safety 

and soundness regulator of banks and other firms. The idea is that 

the council will set rules that the other regulators will enforce. 

That sounds a lot like the current system we have today, where different regulators read and enforce the same rules different ways. 

Under such a council, how would you make sure the rules were 

being enforced the same across the board? 

A.8. The Administration has proposed the creation of the Financial 

Services Oversight Council (Council) to be chaired by the Secretary 

of the Treasury and to include the heads of the Federal banking 

agencies and other agencies involved in the regulation of financial 

services. The Council will make recommendations to the Board of 

Governors of the Federal Reserve System (FRB) concerning entities 

that should be designated as systemically significant (Tier 1 FHCs). 

The FRB will consult the Council in setting material prudential 

standards for Tier 1 FHCs and in setting risk management standards for systemically important payment, clearing, and settlement 

systems and activities. The Council will also facilitate information 

sharing, provide a forum for discussion of cross-cutting issues and 

prepare an annual report to Congress on market developments and 

emerging risks. Under the Administration’s proposal, the Council 

would not be authorized to promulgate rules. 

Q.9. Mr. Bowman, in your statement you defend your agency’s regulation of thrifts and thrift holding companies, however you never 

mention AIG. How do you defend your agency’s performance with 

that company? 

A.9. Commencing in 2005, OTS actions demonstrated a progressive 

level of supervisory criticism of AIG’s corporate governance culminating in a communication to the company in 2008 which discussed 

the supervisory rating downgrade and a requirement to provide 

OTS with a remediation plan to address the risk management failures. OTS criticisms addressed AIG’s risk management, corporate 

oversight, and financial reporting. 

It is critically important to note that AIG’s crisis was caused by 

liquidity problems, not capital inadequacy. AIG’s liquidity was impaired as a result of two of AIG’s business lines: (1) AIGFP’s ‘‘super 

senior’’ credit default swaps (CDS) associated with collateralized 

debt obligations (CDO), backed primarily by U.S. subprime mortgage securities and (2) AIG’s securities lending commitments. 

While much of AIG’s liquidity problems were the result of the collateral call requirements on the CDS transactions, the cash requirements of the company’s securities lending program also were 

a significant factor. 

AIG’s securities lending activities began prior to 2000. Its securities lending portfolio is owned pro rata by its participating, regulated insurance companies. At its highest point, the portfolio’s $90 

billion in assets comprised approximately 9 percent of the group’s 

total assets. AIG Securities Lending Corp, a registered broker-dealer in the U.S., managed a much larger, domestic securities lending 

program as agent for the insurance companies in accordance with 
97 

investment agreements approved by the insurance companies and 

their functional regulators. 

The securities lending program was designed to provide the opportunity to earn an incremental yield on the securities housed in 

the investment portfolios of AIG’s insurance entities. These entities 

loaned their securities to various third parties, in return for cash 

collateral, most of which AIG was obligated to repay or roll over 

every 2 weeks, on average. While a typical securities lending program reinvests its cash in short duration investments, such as 

treasuries and commercial paper, AIG’s insurance entities invested 

much of their cash collateral in AAA-rated residential mortgagebacked securities with longer durations. 

Similar to the declines in market value of AIGFP’s credit default 

swaps, AIG’s residential mortgage investments declined sharply 

with the turmoil in the housing and mortgage markets. Eventually, 

this created a tremendous shortfall in the program’s assets relative 

to its liabilities. Requirements by the securities lending program’s 

counterparties to meet margin requirements and return the cash 

AIG had received as collateral then placed tremendous stress on 

AIG’s liquidity. 

Q.10. I asked Chairman Bair this question a few weeks ago, so this 

is for the rest of you. All of the largest financial institutions have 

international ties, and money can flow across borders easily. AIG 

is probably the best known example of how problems can cross borders. How do we deal with the risks created in our country by actions somewhere else, as well as the impact of actions in the U.S. 

on foreign firms? 

A.10. OTS exercises its supervisory responsibilities with respect to 

complex holding companies by communicating with other functional regulators and supervisors who share jurisdiction over portions of these entities and through our own set of specialized procedures. With respect to communication, OTS is committed to the 

framework of functional supervision Congress established in 

Gramm-Leach-Bliley. Under Gramm-Leach-Bliley, the consolidated 

supervisors are required to consult on an ongoing basis with other 

functional regulators to ensure those findings and competencies are 

appropriately integrated into the assessment of the consolidated 

enterprise and, by extension, the insured depository institution. 

As a consolidated supervisor, OTS relies on effective communication and strong cooperative relationships with the relevant primary 

supervisors and functional regulators. Exchanging information is 

one of the primary regulatory tools to analyze a holding company 

and to ensure that global activities are supervised on a consolidated basis. Approximately 85 percent of AIG, as measured by allocated capital, is contained within entities regulated or licensed by 

other supervisors. AIG had a multitude of regulators in over 100 

countries involved in supervising pieces of the AIG corporate family. OTS established relationships with these regulators, executed 

information sharing agreements where appropriate, and obtained 

these regulators’ assessments and concerns for the segment of the 

organization regulated. 

As part of our supervisory program for AIG, OTS began in 2005 

to convene annual supervisory college meetings. Key foreign super-
98 

visory agencies, as well as U.S. State insurance regulators, participated in these conferences. Part of the meetings was devoted to 

presentations from the company. In this portion, supervisors had 

an opportunity to question the company about any supervisory or 

risk issues. Another part of the meeting included a ‘‘supervisorsonly’’ session, which provides a venue for participants to ask questions of each other and to discuss issues of common concern regarding AIG. OTS also used the occasion of the college meetings to arrange one-on-one side meetings with foreign regulators to discuss 

in more depth significant risk in their home jurisdictions. 

This notion of consolidated supervision in a cross-border context 

is a widely accepted global standard implemented by most prudential supervisors. The key concepts of cross-border consolidated supervision have been supported by the Basel Committee on Banking 

and reflected in numerous publications. This framework has been 

embraced by the International Monetary Fund and World Bank 

and utilized in connection with their Financial Sector Assessment 

Program (FSAP) which is an assessment of countries’ financial supervisory regimes. 
(99) 

STRENGTHENING AND STREAMLINING 

PRUDENTIAL BANK SUPERVISION 

TUESDAY, SEPTEMBER 29, 2009 

U.S. SENATE, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, Washington, DC. 

The Committee met at 2 p.m. in room SD–538, Dirksen Senate 

Office Building, Senator Christopher J. Dodd (Chairman of the 

Committee) presiding. 

OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD 

Chairman DODD. The Committee will come to order. 

Let me inform my colleagues here, my good friend, Richard Shelby, is stuck in an airport in Birmingham trying to get back, and 

so I left a message for him that when he arrives about 10 or 11 

this evening, that Senator Corker will call him and read him the 

entire testimony today. He would like that. He would appreciate 

that. 

[Laughter.] 

Chairman DODD. So what we will do here is I will make a few 

opening comments and I will ask if either of my colleagues would 

like to be heard at all and we will get right to our witnesses. We 

thank them for joining us here today in this hearing on ‘‘Prudential 

Bank Regulation: Should There Be Further Consolidation?’’ 

I know we have had a lot of informal conversations with each 

other over many, many months on this subject and many others related to the reform of the financial regulatory structure. As I have 

said over and over again, while I think some of us are getting closer to firmer ideas, I believe most of us here are still very anxious 

to hear from people who bring a particular knowledge and expertise, as our witnesses do here today, on this subject matter. So we 

are interested in your thoughts. 

We all understand here how important this subject matter is. We 

also understand how important it is that we do it right and that 

we realize we are doing things here that have not been done in 

years, and so as we chart forward, we want to make sure that we 

are doing so carefully and thoughtfully. So while I know there are 

those who are impatient, that while we haven’t answered all the 

questions, even though the problems that emerged a year ago have 

not been entirely solved, I think it is important that we do it carefully and right, and that is our determination on this Committee. 

This afternoon, we will have a chance to hear from four very 

knowledgeable witnesses on the subject matter. I have read all of 

your testimony. I think it has been tremendously helpful. I think 
100 

you go beyond, in some cases, talking about the single prudential 

regulator or the consolidation of regulation to other areas, as well, 

so while we are talking about that subject matter, certainly my colleagues don’t need any advice from me on the subject matter, but 

clearly, the expertise is at this table. We would invite questions regarding a wide subject matter, in addition to the one that is the 

title of the hearing today. 

So with that, this afternoon we examine how best to ensure the 

strength and security of our banking system. I would like to thank 

our witnesses again for returning to share your expertise after the 

last hearing was postponed. 

Today, we have a convoluted system of bank regulators created 

by an almost historical accident. I think most experts would agree 

that no one would have designed a system that worked like this. 

For over 60 years, Administrations of both political parties, Members of Congress across the political spectrum, commissions, and 

scholars have proposed streamlining this irrational system. 

Last week, I suggested further consolidation of bank regulators 

would make a lot of sense. We could combine the Office of the 

Comptroller of the Currency and the Office of Thrift Supervision 

while transferring bank supervision authorities from the Federal 

Deposit Insurance Corporation and the Federal Reserve and leaving them to focus on their core functions. 

Since that time, I have heard from many who have argued that 

I should not push for a single bank regulator. The most common 

argument is not that it is a bad idea, but rather, consolidation is 

too politically difficult to achieve. That argument doesn’t work terribly well with me, nor, I suspect, with many, if not most, of my 

colleagues. 

Just look what the status quo has given us. In the last year, 

some of our largest banks needed billions of dollars of taxpayer 

money to prop them up and dozens of smaller banks have failed 

outright. It is clear that we need to end charter shopping, where 

institutions look around for the regulator that will go easiest on 

them. It is clear that we must eliminate the overlaps, 

redundancies, and additional red tape created by the current alphabet soup of regulators. We don’t need a super-regulator with 

many missions, but a single Federal bank regulator whose sole 

focus is the safe and sound operation of our Nation’s banks. A single operator would ensure accountability and end, I think, the frustrating ‘‘pass the bucket’’ excuses that we have been faced with 

over these many, many months. 

We need to preserve our dual banking system, and I feel just as 

strongly about that point as I do the earlier point. State banks 

have been a source of innovation and a source of strength, tremendous strength, in our communities. A single bank regulator can 

work, I think, with the 50 State bank regulators. Any plan to consolidate bank regulations would have to ensure community banks 

are created appropriately. Community banks did not cause the crisis and they should not have to bear the cost or burden of increased regulation necessitated by others. Regulation should be 

based on risk. Community banks do not present the same type of 

supervisory challenges that large counterparts do. 
101 

But we need to get this right, as I said a moment ago, which is 

why you are all here today. I am working again with Senator Shelby and other Members of the Committee and colleagues here to 

find a consensus that we can craft on this incredibly important bill. 

So with that, unless one of my other colleagues wants to be 

heard for a few minutes on opening up, I will turn to our witnesses. 

Our first witness—and I will introduce all of them briefly here— 

Eugene Ludwig, is the Chief Executive Officer of the Promontory 

Financial Group. Before assuming that responsibility, Gene served 

as the Vice Chairman and Senior Control Officer of Bankers Trust 

Corporation, which he joined in 1998. He served as the Comptroller 

of the Currency from 1993 to 1998, and prior to joining the OCC, 

was a partner in the law firm of Covington and Burling. 

Martin Baily is a Senior Fellow for Economics at the Brookings 

Institution. Dr. Baily also serves as the Cochair of the Pew Task 

Force on Financial Sector Reform and is a senior advisor to 

McKinsey and Company. He served as Chairman of the Council of 

Economic Advisors under the Clinton administration from 1999 to 

2001, and prior to that was a member of the same Council from 

1994 to 1996. 

Richard Carnell is an Associate Professor at the Fordham University School of Law. He previously served as the Assistant Secretary for Financial Institutions at the Treasury from 1993 to 1999. 

And prior to that, Mr. Carnell was also a Senior Counsel to this 

very Committee, from 1989 to 1993. 

Richard Hillman is the Managing Director of the Financial Markets and Community Investment Team of the U.S. Government Accountability Office. He has been with GAO for 31 years and his 

team looks at the effectiveness of regulatory oversight in the financial and housing markets and the management of community development programs. 

We are honored that all four of you are with us today. We thank 

you for your service, your past service, and your willingness to participate in today’s conversation. 

All of you have been before this Committee many times in the 

past and I will not limit you in a strict fashion to the time, but if 

you would try to keep it in that 5 to 7 minutes—and I know your 

testimony goes on longer than that, and the testimony, the full testimony and comments and supporting data, we will include as part 

of the record, as well. 

Gene, we welcome you back to this Committee. 

STATEMENT OF EUGENE A. LUDWIG, CHIEF EXECUTIVE 

OFFICER, PROMONTORY FINANCIAL GROUP, LLC 

Mr. LUDWIG. Chairman Dodd, and to Ranking Member Shelby, 

who is not here, and other distinguished Members of this Committee, I am honored to be here today and I want to commend you 

and the staff for the thoughtful way in which you have examined 

the causes of the financial crisis and the need for reform in this 

area. Under your leadership, Chairman Dodd and Ranking Member 

Shelby, the bipartisan and productive traditions of the Senate 

Banking Committee have continued. 

In this regard, it should be noted that the need for an end-to-end 

independent consolidated banking regulator, the subject you have 
102 

asked me to address today, has been championed over the years by 

Members of the Senate Banking Committee, including its Chairman, as well as Treasury Secretaries from both sides of the aisle. 

Consistent with this tradition, the Administration’s white paper 

is directionally helpful and commendable. While refinements to the 

white paper are needed, this is an inevitable part of the policymaking process. 

I also want to commend the Treasury Department of former Secretary Henry Paulson for having developed its so-called ‘‘Blueprint,’’ which also has added important and positive developments 

to the debate in this area. 

Lamentably, the financial regulatory problem we face is not just 

the current crisis. Over the past 20-plus years, we have witnessed 

the failure of hundreds of U.S. banks and bank holding companies, 

supervised by every one of our regulatory agencies. By the end of 

this year alone, well over 100 U.S. banks will have failed, costing 

the Deposit Insurance Fund tens of billions of dollars. Before this 

crisis is over, we will witness the failure of hundreds more. 

In the face of this irrefutable evidence, it is impossible to say 

there is not a very serious problem with our regulation of financial 

services organizations. There are three things, however, this problem is not. It is not about the lack of talented people in our regulatory agencies. It is not about weak regulation or weaker bankers. 

The problem is in large part—the problem stems from a dysfunctional regulatory structure, a structure that exists nowhere else in 

the world and no one wants to copy, a structure that reflects history, not deliberation. 

The recent financial crisis has accentuated many of the shortcomings of the current regulatory system. Needless burdens that 

weaken safety and soundness focus, lack of scale needed to address 

problems in technical areas, regulatory arbitrage where the ability 

to select or threaten to select a weaker supervisor tears at the fabric of solid regulation, delayed rulemaking, regulatory gaps, limitations on investigations, where one agency cannot seamlessly examine and resolve a problem from a bank to its nonbank affiliate, and 

diminished international leadership. What is needed and what 

would resolve these problems is an end-to-end independent consolidated banking supervisor. 

Now, there have been a number of misconceptions about what a 

consolidated end-to-end institutional bank regulator is and what it 

is not. First, an end-to-end supervisor is not a super-regulator 

along the lines of Britain’s FSA. The end-to-end consolidated institutional supervisor would not regulate financial markets like the 

FSA, would not establish consumer protection rules like the FSA, 

would not have resolution authority, would not have deposit insurance authority or any central banking functions. 

The consolidated end-to-end institutional regulator would focus 

only on the prudential issues applicable to financial institutions, 

and this model has been quite successful elsewhere in the world. 

I think this is really quite important. 

For example, the Office of the Superintendent of Financial Institutions, OSFI, in Canada, and the Australian Prudential Regulatory Authority, called APRA, in Australia have been quite successful consolidated supervisors even in the current crisis, where 
103 

Canadian and Australian banks have fared much better than our 

own. 

There has been a second misconception that a consolidated regulator that regulates enterprises chartered at the national level cannot fairly supervise smaller community organizations and that it 

would do violence to our dual banking system. I might say as an 

aside, I, like the Chairman, believe the dual banking system is 

alive and well and an important fabric of our banking system and 

this would not do violence to it. 

In fact, interesting enough, even today, the OCC supervises well 

over a thousand community banking organizations whose businesses are local in character. That is, the national supervisor supervises over a thousand small banks. In fact, it is the majority of 

the banks it supervises, the vast majority, and they choose that as 

a matter of their own predilection, not by rule. Indeed, today, all 

our Federal regulators regulate large institutions and smaller institutions. A new consolidated supervisor at the Federal level would 

merely pick up the FDIC and Federal Reserve examination and supervisory authorities. 

To emphasize, all the consolidated supervisor would do is take 

the Federal component and move it to another Federal box. It 

would not change the regulation or the fabric of that supervision. 

Third, some have claimed that a consolidated institutional supervisor would not have the benefit of other regulatory voices. This 

would clearly not be the case, as a consolidated institutional supervisor would fulfill only one piece of the regulatory landscape. The 

Federal Reserve, Treasury, SEC, FDIC, CFTC, FINRA, FINCEN, 

OFAC, and the FHFA would continue to have important responsibilities with respect to the financial sector. 

In addition, proposals are being made to add additional elements 

to the U.S. financial regulatory landscape, the Systemic Risk Council and a new financial consumer agency. This would leave multiple 

financial regulators at the Federal level and 50 bank regulators, 50 

insurance regulators, and 50 securities regulators at the State 

level. It seems to me that is a lot of voices. 

Fourth, some have also claimed that the primary work of the 

Federal Reserve—monetary policy, payment system, and acting as 

the bank of last resort—and the FDIC—deposit insurance—would 

be seriously hampered if they did not have supervisory responsibility. The evidence does not support these claims. 

One, a review of FOMC minutes does not suggest much, if any, 

use is made of supervisory data in monetary policy activities. In 

the case of the FDIC, it has long relied on a combination of publicly 

available data and examination data from the other agencies. 

Two, there are not now, to my knowledge, any limitations on the 

ability of the Federal Reserve or the FDIC to collect any bank supervisory data. Indeed, if need be, the Federal Reserve or the FDIC 

can accompany another agency’s examination team to obtain relevant data or review relevant practices. 

Three, if the FDIC or the Federal Reserve does not have adequate cooperation on gathering information, Congress can make 

clear by statute that this must be the case. 

And four, even if the FDIC were not the supervisor of State chartered banking entities, the FDIC would continue to have back-up 
104 

supervisory authority and be able to be resident—resident—in any 

bank it chose. 

Finally, I would note that it is important that the new consolidated supervisor be an independent agency for at least three reasons. First, banking supervision should not be subject to political 

influence. 

Second, the agency and the agency head needs the stature of the 

Federal Reserve, SEC, or FDIC to attract talented people and to be 

taken seriously by the other agencies. 

Third, and this, I think, is critically important, Congress, in fulfilling its oversight function—its critical oversight function—must 

hear the unfettered truth about the banking system from the head 

of its supervisory agency, not views filtered through another department or agency. And indeed, I would go further. I think it is 

incredibly difficult for you to fulfill your oversight responsibilities 

with an alphabet soup of regulators. Indeed, having regulators that 

have clear missions, it seems to me, makes it possible for you to 

exercise your critical function in a more effective way. If one 

pushed these together even more, as has been suggested by some, 

I think it becomes almost unmanageable for Congress. 

In sum, our country greatly needs a consolidated independent 

end-to-end institutional regulator. Without one, we will not have financial stability, in my view, and we will continue to be victimized 

by periods of bank failures and follow-on credit crunches that deteriorate our economy. 

Thank you very much. 

Chairman DODD. Thank you very much, Gene Ludwig. We appreciate it very much. 

Dr. Baily, we thank you, as well, for being with us. 

STATEMENT OF MARTIN N. BAILY, SENIOR FELLOW, 

ECONOMIC STUDIES, THE BROOKINGS INSTITUTION 

Mr. BAILY. Well, thank you, Chairman Dodd and Members of the 

Committee, to give me a chance to talk about this issue. 

The summary of my testimony is, number one, I think that the 

best guide to financial reform is the objectives approach, which divides up regulation into microprudential, macroprudential, and 

conduct of business regulation. So we have to make sure that all 

parts of the financial sector are adequately supervised, we don’t 

have gaps in regulation. We also want to make sure we don’t have 

duplicative agencies. After all, there were plenty of regulators. 

There were rooms full of regulators. They didn’t prevent this crisis. 

My second point is that the quality of regulation must be improved regardless of where it is done, and I don’t want to denigrate 

anybody in the regulatory agencies, but I do think there is a problem that they may not always be well enough paid, have enough 

experience, or have the kind of stature that they need to deal with 

our very complex financial sector, particularly the large global 

banks. I don’t think we want a situation where people are in Government jobs for a while and then they move over to the financial 

sector, viewing that as sort of where they are going to make their 

money. I think we want the regulatory jobs to be desirable and stable jobs and get the best people we can. 
105 

I agree with the Chairman and very much with Gene Ludwig 

that we need a single Federal microprudential regulator, combining 

the supervisory functions currently carried out at the Fed, the 

OCC, the OTS, the SEC, and the FDIC. I think this regulator 

should partner closely with State regulators. You mentioned the 

importance of the community banks, and I agree with you on that. 

I would say, however, that some of the State chartered nonfinancial 

institutions were a source of a lot of the bad mortgages that were 

made, so I think having the right partnership between the Federal 

regulator and the State chartered enterprises is important. I think 

there should be a sharing of information there and perhaps of 

standards and appropriate methods and data. 

I do think, and this is going a little beyond the immediate discussion of this hearing, but I do think the U.S. does need an effective 

conduct of business regulator. That is an important part. As Gene 

said, that has been combined in the U.K., where the FSA was both 

the prudential regulator and the conduct of business regulator, and 

cobbling it all, the whole lot that was done there, I think that is 

a mistake. I think having a separate conduct of business regulator 

is a good idea. 

My own view is it would be nice to have that in a single agency, 

and I think the SEC is probably the place to put it, although the 

SEC, I must say, did not do a very good job in this crisis. But I 

think potentially the SEC should be the place that looks after 

small shareholders and also looks after consumers, so it would 

have a CFPA division within the SEC. Now, I know there is a case 

for having a separate consumer agency and I am not diametrically 

opposed to that. I think there are some advantages to the consolidation of having conduct of business regulation in one place, but 

a good CFPA on its own would be fine. 

Now, this structure that we are describing takes away from the 

Fed an important part of its existing power, which is what has 

been to supervise the bank holding companies, most of the large 

banks and a number of the smaller banks. I think that is the right 

thing to do. I agree with Gene. I don’t think this is something that 

the Fed has done particularly well. They are obviously paying a lot 

more attention to it now than they used to, but historically, I don’t 

think that is something that they have done very well. 

I share that view with my colleague, Alice Rivlin, who I think 

has testified to this Committee, and she was there and saw the 

point that Gene Ludwig made, which is that the prudential people 

haven’t typically had a lot of say on Open Market Committee meetings. That hasn’t been a main thing. 

I do think it is very important that the Fed, as the lender of last 

resort to the financial sector, does have to have information about 

what is going on in the banks. I think that was a significant failure 

in the U.K., where the FSA and the Bank of England were so separate and were not talking to each other, and I think Mervyn King, 

the head of the Bank of England, thought it was inappropriate for 

him to talk too much to the FSA. He wanted the independence of 

the Bank of England when they were making monetary policy. You 

know, I see his argument, but I think that was a big mistake and 

one of the things that got them into trouble. 
106 

So I think we should have a lot of lines of communication shared 

between the regulators and the Federal Reserve so that they can 

set monetary policy with the adequate amount of information and 

that they are aware of what is going on in the banks, and if they 

need to be a lender of last resort, that is not suddenly sprung on 

them. But I think they don’t have to be the people that are doing 

the day-to-day supervision. 

Another point I would like to make in this regard is that the big 

bank holding companies, or the big banks, as we know, both investment banks or the traditional commercial banks, are run as single 

entities. So the idea that you had a bank holding company which 

was sort of a separate entity from the bank itself really is not the 

way things operate. These were run from the top and these banks 

would sort of come up with a new line of business, something that 

was going to be profitable, and they would discuss it, and then as 

someone was walking about the door, they would sort of say, well, 

which legal entity shall we put this in, and the answer to that was 

typically, well, where would they get the most favorable tax treatment? Where would they get the most favorable regulatory treatment? It is not as if these things were really different entities. 

So I think another advantage of having a single prudential regulator is that they would regulate these businesses top to bottom as 

single companies, which is what they are. 

I have used up my time. The last thing I want to say is to reinforce the point that Gene made. I think we both had the same reaction when we attended the hearing in August. You know, it is natural for regulators to say, well, don’t close my agency. Mine is all 

right. When you came back and some of the other Members of the 

Committee came back and said, well, shouldn’t we consolidate, 

shouldn’t we make this a more rationally organized regulatory 

structure, the answer came back, well, the U.K. had trouble and 

they had this single regulator, so we don’t see why that should do 

any good. 

That prompted, I think, both of us to go take a look—Gene probably knew already, but I actually went to take a look at regulation 

around the world, not covering every country, but trying to cover 

several countries, and particularly the English-speaking countries 

which tend to have some similarity of their institutions, and you 

are right. 

Canada, I think, did a much better job. They do actually have 

quite a few different agencies, so they weren’t my ideal. I think 

Australia, which actually the Paulson Blueprint pointed to, is to be 

commended. They took quite a while. They decided, what is the 

best way to regulate. They took their time in doing it. They consolidated in an appropriate way. 

What happened in the U.K.—and I grew up in the U.K., I am 

fond of the U.K., but they didn’t do this very well—Gordon Brown 

came in as Chancellor of the Exchequer and he said, it is crazy to 

have all these agencies. I think he was right about that. That the 

functions that these different companies are performing are crossing boundaries and we want to have a single agency. But they 

hadn’t made any preparation. They hadn’t really laid the groundwork for doing it. They hadn’t figured out how to do it well. And, 

in fact, the FSA remained really quite divided. There were a lot of 
107 

different subagencies within that, so they weren’t communicating 

well, and as I said earlier, they weren’t communicating with the 

Bank of England. 

So I think the examples that were given last time to say, oh, 

other countries—a single agency doesn’t work in other countries, I 

think that is wrong. I think if you look in the right place, you will 

find that having a single prudential regulator is pretty much what 

is the right choice to make, based on international experience. 

Let me stop there. Thank you. 

Chairman DODD. Thank you very much, Dr. Baily. 

Dr. Carnell? Thank you very much, Doctor, for being with us. 

STATEMENT OF RICHARD S. CARNELL, ASSOCIATE 

PROFESSOR, FORDHAM UNIVERSITY SCHOOL OF LAW 

Mr. CARNELL. Mr. Chairman and Members of the Committee, our 

current bank regulatory structure is and remains a source of serious problems. Its defects are significant and longstanding. The system is needlessly complex, needlessly expensive, and imposes needless compliance burdens on banks. It impedes—it blunts regulators’ 

accountability with a tangled web of overlapping jurisdictions and 

responsibilities, and it gives credence to the old saying, when everyone is responsible, no one is responsible. 

The system wastes time, wastes energy. It hinders timely action 

by regulators. It brings policy down to the lowest common denominator that four agencies can agree on. And it takes a particular toll 

on far-sighted action, action aimed at preventing future problems. 

That is because so often in policymaking, there is someone who 

says, if it ain’t broke, don’t fix it. So it is a lot easier to get agreement when you wait until you are confronted with a problem than 

when you are trying to look ahead and head off problems to begin 

with. 

Now, there is a straightforward solution to the problems we see 

from our fragmented regulatory system, and that solution is to 

unify the supervision of FDIC-insured depository institutions, 

banks and thrifts, in a single agency. Treasury Department Lloyd 

Bentsen offered that solution here in this room 15 years ago and 

it made sense at the time. I worked with him in preparing that 

proposal, and I think the events of the last 15 years bear out the 

wisdom of that approach. 

This new agency would take on the existing bank regulatory responsibilities of the OCC, OTS, Federal Reserve, and FDIC. The 

Federal Reserve would retain all its existing central banking functions, including monetary policy, the discount window, and the payment system. The FDIC would retain all its deposit insurance powers and responsibilities, including back-up examination and enforcement authority. 

On top of that, under the approach I propose, the Fed and the 

FDIC would be on the board of the new agency, let us say a fiveor seven-member board with those two agencies represented. The 

Fed and FDIC could have their examiners participate in examinations conducted by the new agency, and they would have full access 

to supervisory information. So the Fed and FDIC would get all the 

information they get now and their examiners could be part of 
108 

teams in all FDIC-insured banks, which is more access than they 

customarily enjoy now. 

This straightforward structure would be a major improvement 

over the current fragmented structure. It would promote clarity, efficiency, accountability, and timely action. Equally important, it 

would give the bank regulator greater independence from special 

interest pressure. That is, this new agency would regulate the full 

spectrum of FDIC-insured institutions. There wouldn’t be the sort 

of subspecialization category like we see with thrift institutions. 

Now, if you look at the thrift debacle, for example, you see that 

thrift regulation was better when it was done by agencies that had 

a broad jurisdiction than when it was done by specialized thriftonly regulators. So, for example, at the Federal level, we had 

thrifts regulated by both the FDIC, which regulated the traditional 

savings banks, and we had thrifts regulated by the specialized Federal Home Loan Bank Board. FDIC-regulated thrifts were much 

less likely to fail and, if they did fail, caused smaller losses than 

the Home Loan Bank Board-regulate thrifts, and we see the same 

thing at the State level. 

At the State level, in about two-thirds, three-quarters of the 

States, the State Banking Commissioners supervise thrifts, and in 

those States, the losses to the insurance fund were much lower 

than we saw in States with specialized thrift regulators, and that 

is basically because the thrift regulators had no reason for being 

if there wasn’t a thrift industry, and so they looked for every way 

to keep thrift institutions going, even when, in fact, it was unrealistic at that point. The result was a failure to deal effectively with 

troubled thrifts, much larger losses to the Deposit Insurance Fund. 

A unified structure would have another major advantage. It 

would recognize the reality of how banking organizations actually 

operate, and Dr. Baily already touched on this, as well. Under the 

existing system, each agency looks at only part of the organization. 

But in these organizations, you may, in fact, have the various parts 

doing business with each other extensively, and to evaluate risk, 

you need to look at the whole, think about the whole, and it sure 

helps in doing that to be responsible for the whole. 

So the fragmented system hinders the agency from getting the 

full picture. Here is how Secretary Bentsen described the problem. 

Under our current system, any one regulator may see only a limited piece of a dynamic, integrated banking organization when a 

larger perspective is crucial, both for effective supervision of the 

particular organization and for an understanding of broader industry conditions and interests. 

Mr. Chairman, if I could, I wanted to speak a bit to the question 

of holding company regulation, which came up earlier. First, I want 

to note something that may not be widely appreciated, and that is 

that holding companies as a major subject of regulation, that thing 

is unique to the United States. In other countries, the regulation 

focuses on the bank. Regulators look out, reach out, but it is not 

like we have got people devoting their careers to the Bank Holding 

Company Act. 

And here is what two of the leading experts, Pauline Heller and 

Melanie Fein, say. Bank holding companies have no inherent necessity in a banking system. They developed in the United States 
109 

only because of our unique banking laws which historically limited 

geographic location and activities of banks. Their only material 

purpose has been to serve as vehicles for getting into things banks 

couldn’t get into directly. 

So this puts it into perspective. There is nothing magical. There 

is nothing high priestly about bank holding company regulation. 

There is no need for a separate holding company regulator. A bank 

regulator can fully handle all the functions of a holding company 

regulator, policing the banks’ transactions with the banks and looking at overall risk. 

In conclusion, Secretary Bentsen, speaking from this table in 

1994, underscored the risk of continuing to rely on what he called 

‘‘a dilapidated regulatory system that is ill-defined to prevent future banking crises and ill-equipped to cope with crises when they 

occur.’’ He observed in words eerily applicable to the present that 

our country had just emerged from its worst financial crisis since 

the Great Depression, a crisis that our bank regulatory system did 

not adequately anticipate or resolve. 

And he issued this warning, which we would yet do well to heed. 

If we fail to fix the system now, the next financial crisis we face 

will again reveal its flaws, and who suffers then? Our banking industry, our economy, and potentially the taxpayers. You have the 

chance to help prevent that result. 

Thank you, Mr. Chairman. 

Chairman DODD. Thank you very much for your testimony. I was 

very fond of Lloyd Bentsen, served with him here. He was a wonderful Member of the Senate and a very good Secretary of the 

Treasury as well. So thank you for being with us. 

Welcome, Mr. Hillman. Nice to see you, and thank you for being 

here. Thank you for your service to the GAO, 31 years. Congratulations on that contribution. 

STATEMENT OF RICHARD J. HILLMAN, MANAGING DIRECTOR, 

FINANCIAL MARKETS AND COMMUNITY INVESTMENT TEAM, 

GOVERNMENT ACCOUNTABILITY OFFICE 

Mr. HILLMAN. Thank you very much. Mr. Chairman and Members of the Committee, I am pleased to be here today to discuss 

issues relating to efforts to reform the regulatory structure of our 

Nation’s financial system. 

In January 2009, we reported on gaps and limitations in our current structure, and we presented a framework for evaluating proposals to modernize the U.S. financial regulatory system. Given the 

importance of the U.S. financial sector to the domestic and international economies, we also added modernization of the outdated 

regulatory structure as a new area to our high-risk list because the 

fragmented and outdated regulatory structure was ill-suited to 

meeting the challenges of the 21st century. 

My statement today, which is based on prior reports that we 

have completed, focuses on how regulation has evolved and recent 

work that further illustrates the significant limitations and gaps in 

the existing regulatory structure, the experiences of countries with 

other types of varying regulatory structures and how they fared 

during the financial crisis, and our reviews on certain aspects and 

proposals to reform the regulatory system. 
110 

I would like to make the following points: 

First, the current U.S. financial regulatory system is a fragmented and complex arrangement of Federal and State regulation 

that has been put into place over the past 150 years but has not 

kept pace with major developments in financial markets and products in recent decades. My prepared statement details numerous 

examples from our prior work identifying major limitations of the 

Nation’s fragmented banking regulatory structure. For example, in 

July, we reported that less comprehensive oversight by various regulators responsible for overseeing fair lending laws intended to prevent lending discrimination may allow many violations by independent mortgage lenders to go undetected. That same month, we 

also reported that regulatory capital measures did not always fully 

capture certain risks and that none of the multiple regulators responsible for individual markets or institutions had clear responsibility to assess the potential effects or the build-up of systemwide 

leverage. 

Recent proposals to reform the U.S. financial regulatory system 

include some elements that would likely improve oversight of the 

financial markets and make the system more sound, stable, and 

safer for consumers and investors. For example, under proposals 

under the Administration and others, new regulatory bodies would 

be created that would be responsible for assessing threats that 

could pose systemic risks. Our past work has clearly identified the 

need for a greater focus on systemwide risks in the regulatory system. 

In addition, the Administration and others are proposing to create a new entity that would be responsible for ensuring that consumers of financial services are adequately protected. Our past 

work has found that consumers often struggled to understand complex financial products, and the various regulators responsible for 

protecting them have not always performed effectively. As a result, 

the creation of a separate consumer protection regulator is one 

sound way for ensuring that consumers are better protected from 

unscrupulous sales practices and inappropriate financial products. 

However, our analysis indicates that additional opportunities for 

further consolidating the number of Federal regulators exist that 

would decrease fragmentation, reduce the potential for differing 

regulatory treatment, and improve regulatory independence. For 

example, the Administration’s proposal would only combine the 

current regulators for national banks and thrifts into one agency 

while leaving the three other depository institution regulators—the 

Federal Reserve, FDIC, and the regulator for credit unions, 

NCUA—intact. Our work has revealed that multiple regulators 

who perform similar functions can be problematic. When multiple 

regulators exist, variations in their resources and expertise can 

limit their effectiveness. 

The need to coordinate their actions can hamper their ability to 

quickly respond to market events, and institutions engaging in regulatory arbitrage by changing regulators through reduced scrutiny 

or their activities or to threaten to change regulators in order to 

weaken regulatory actions against them. 

Having various regulators that are funded by assessments from 

the institutions they regulate can also in such regulators become 
111 

overly dependent on individual large institutions for funding, which 

could compromise their independence in overseeing such firms. As 

a result, we would urge the Congress to consider additional opportunities to consolidate regulators as it deliberates reform of our 

regulatory system. 

Finally, regardless of any regulatory reforms that are adopted, 

we urge the Congress to continue to actively monitor the progress 

of such implementation and be prepared to make legislative adjustments to ensure that any changes in the U.S. financial regulatory 

system are as effective as possible. In addition, we believe that it 

is important that Congress provide for appropriate GAO oversight 

of any regulatory reforms to ensure accountability and transparency in any new regulatory system, and GAO stands ready to 

assist the Congress in its oversight capacity and evaluate the 

progress agencies are making implementing any changes. 

Mr. Chairman and Members of the Committee, I appreciate the 

opportunity to discuss these critical issues and would be happy to 

respond to any questions at the appropriate time. 

Chairman DODD. Thank you very, very much. Let me thank all 

of you on behalf of the Committee for your testimony and your observations. They have been very, very helpful this afternoon. 

Let me pick up on the issue of the community banks and the 

issue of a single regulator, because I think this is where maybe the 

most contentious political problems arise. I want to underscore the 

point—I think, Gene, you made it, others may have made it as 

well—that we have a lot of community banks that are operating 

under Federal charters and, in fact, are regulated at the Federal 

level. I think you mentioned 1,000 or a number like that. And at 

a time, obviously, when they could have easily, under the present 

system, decided to migrate from that to a State charter—they may 

have had their own reasons for not doing so, but the fact that so 

many have stayed with a Federal regulator indicates a relatively 

high degree of satisfaction in terms of how they were being handled, in the midst of that same institution handling the Chases, the 

JPMorgans, and Bank of America and other large institutions. So 

you have the largest number of community banks in many ways 

maintaining a regulatory structure where there is duality. But it 

is of concern, and I think we need to address it in ways that are 

practical. 

There have been some suggestions, something along this line, 

and I would like to maybe get a little more in the weeds on this. 

How do you envision, if we had a single regulator, a division within 

that regulator to be able to handle the concerns of the community 

banks, particularly ones that would be State chartered, how they 

would handle that in a way that would give them some degree of 

satisfaction that they are not going to be lumped together in a way 

that would diminish their capacity to be able to function and get 

lost in the shuffle? How do you do that? 

I would ask all of you, and if you have got any ideas on that, I 

would be interested in your thoughts. 

Mr. LUDWIG. Well, Mr. Chairman, I think that it is important for 

the new regulatory agency to have departments that are specialized in dealing with institutions of a particular size. The Comptroller’s office currently has three segments: one deals with small 
112 

banks, one midsized, one large. I think that there are specialized 

techniques, ability to simplify supervision for community banks, 

and I think it is important. 

In that regard, I think the same kind of sensitivity to small bank 

supervision can be found both at the Federal Reserve and the 

FDIC. Remember, the only thing that one would do in terms of this 

new agency would be to move the Federal component of the supervisory authority to the new agency. It would not change the component. But I think one can have a separate division that focuses on 

simplifying it. I think that Congress, in writing these rules itself, 

ought to mandate that simplified treatment—that one of the responsibilities of the new agency is to reduce burden wherever possible, particularly in terms of community and regional financial institutions. 

Chairman DODD. Dr. Baily. 

Mr. BAILY. Yes, I agree very much with what Gene said. I think 

that can be handled within a single regulator. The Federal Reserve 

currently supervises the bank holding companies, and you think of 

them as the big ones. But, actually, some of them are pretty small. 

They have got quite a range. So they have been supervising both 

big and small banks. 

So I think it is certainly possible to have a separate division 

within the prudential regulator that looks to the needs of community banks, and I think it is very important that small banks not 

be overburdened with regulation. One wants different requirements, perhaps, different capital requirements for a bank that has 

large overseas operations, subsidiaries. That has become—it seems 

too big to fail, although I hope we can overcome that problem. The 

needs there are very different than the community banks, and I 

think that should be part of the legislation taking account of that. 

Chairman DODD. I should have asked this of Gene as well. In 

your examination of global examples, you mentioned Australia and 

Canada, and I do not know this, so I apologize for my ignorance 

on this. I do not know what the Australian banking system looks 

like. Is there duality there at all? Or is this all one system? Is 

there any place you looked at that has a comparable duality of systems that would—— 

Mr. BAILY. Well, there certainly are countries that have small 

banks. Germany has a lot of small banks, actually many of them 

State-owned banks that ended up buying quite a bit of CDOs as a 

matter of fact. So they did not always make good decisions. 

Typically, in Canada, you have some small banks, but really the 

market is dominated by about five or half a dozen very large 

banks. So I do not think they are quite comparable to the U.S., 

which, as you say, or somebody said earlier, grew up because of 

geographical limitations. 

I do not know whether you want to add to it. 

Chairman DODD. Do you have anything on that, Gene? 

Mr. LUDWIG. First, Canada does have a Federal system, and 

there are some smaller institutions. But there is no place on Earth 

that really quite has the number of commercial banking institutions that we do. 

Having said that, the point is well taken that Germany does 

have a good many landesbanks, and I think a survey of the world 
113 

would reveal other consolidated supervisory mechanisms that deal 

with small banks and large banks and do it effectively. And I think 

Canada is probably a pretty good example, actually, though they 

are not as numerous. 

Chairman DODD. Well, Germany is sort of the antithesis of ours. 

That is a highly decentralized system in many ways in Germany. 

Dr. Carnell. 

Mr. CARNELL. Yes, three things. First, Secretary Bentsen’s legislative proposal included a statutory requirement establishing a 

community banking division within the agency seeking to institutionalize a sensitivity to the ways community banks are different 

and the ways they should not be treated just the same as larger 

institutions. 

And I think—and this is my second point—that something like 

that, even though in a sense it is just an outline of an idea, it sends 

a signal that Congress cares about it, that it is something that 

needs to be done. I think that is a signal that the agency will clearly hear. 

And then, third, in any event the new agency would have every 

incentive to foster a healthy community banking system. The agency has no reason to favor large over small, and there are advantages to the agency when bankers come in, for example, to talk to 

Members of Congress, that people are having a positive experience 

with the new agency. 

So there is absolutely no reason for the regulator to hold back 

from doing the best job it can. There is no reason why a unified 

regulator would do any less of a good job than what we see now 

where an agency like the OCC regulates from the largest banks 

down to some of the smallest. 

Finally, you mentioned duality, and in case you were asking 

about a dual banking system, that is not something that you see 

abroad. That is, to my knowledge, a quirk of U.S. regulation having 

to do basically with some developments in the 1860s and 1870s. 

Chairman DODD. Thank you very much. 

Mr. Hillman. 

Mr. HILLMAN. There clearly are ways to provide a voice for State 

banks or community banks and still achieve great consolidation of 

the banking regulatory structure. I agree with Rick that one of the 

ways in which you could achieve that would be to establish a division within that prudential regulator to serve the needs of community and State member institutions. 

Another way of achieving that goal would also be, like the FDIC 

currently has with its board structure, to ensure that membership 

of that board might include members that have a background or 

might have been a prior community banker in the past. That would 

give that regulator the opportunity to have that voice heard at the 

highest levels of the institution. 

Chairman DODD. Good idea. Good suggestion. 

Senator Corker. 

Senator CORKER. Thank you, Mr. Chairman, and I thank each of 

you for your testimony. I know Gene and Marty we have talked 

with—a great deal about this and certainly appreciate the two of 

you coming in. 
114 

I am going to ask some questions that do not necessarily reflect 

my point of view but just to probe. I am open on all of these issues 

and am still, like many Members on this Committee, trying to figure out what is the best route or have you all propose something, 

and maybe a hybrid of that is best, who knows? But hopefully we 

will get to that—I know we will—before we regulate. 

You mentioned the issue of having an alphabet soup of people 

coming to talk to us, and it is not unlike having witnesses come 

before our Committee with differing points of views in many ways. 

I have to tell you, I have enjoyed that. Each of the regulators, 

sometimes gleefully, sometimes not, points out the deficiencies of 

the other regulator. And I have to tell you, there is some merit in 

that. Just for what it is worth, you know, to have a captive regulator, much like we have with the GSEs, which would be the case 

with all banks, to me, could be very problematic. I think having 

feet on the ground sometimes gives you a sense—I know in my 

business it was very important to be in various States where we 

were building. As Senators, we go back home to our States to not 

be Washingtonized, and there is just some benefit of having feet on 

the ground, as the FDIC has argued and as the Fed has argued. 

And then the OCC to me is the most procyclical—which what we 

are talking about is a super OCC. Let us face it. They are the most 

procyclical organization that we have. They move quickly in a direction that creates bubbles, and now they are out throughout the 

country. Anybody that has got a commercial real estate loan or 

anything like it is being criticized, and so they are creating, I think 

strongly creating a self-fulfilling prophecy. 

So I would love to hear your comments about the RUBs being 

helpful in some cases and the competition being helpful, but also 

what would be in this to keep the OCC—super OCC, if you will— 

from being so procyclical as they are now. 

Mr. LUDWIG. Well, Senator, a couple of comments. I agree with 

your comment that if one were to homogenize the entire regulatory 

system down to one, there would be something that would be lost. 

But we are not homogenizing it down to one. 

First, the FDIC itself has back-up supervisory authority, which 

means the FDIC would have on-site continued responsibilities. 

Second, as I mentioned, both the FDIC and the Fed would have 

serious information gathering and review authorities. 

Senator CORKER. But that does not happen now. I mean, they do 

not share information now. I know you said we could put that in 

law, but that is problematic. 

Mr. LUDWIG. Well, I am not honestly sure that is the case. There 

are certainly claims that that is the case. If it is the case, it is 

heart-stopping because in the midst of this crisis, one would assume that the information the Fed and the FDIC and other agencies need to do the job would be forthcoming or they would be 

squawking, I mean big time, to you and others. 

In addition, we are talking about a systemic regulator. There is 

the SEC, the CFTC, FINRA. There are all these other agencies, 

and in terms of giving you the kind of diversity you need to hear 

other points of view, you will still have the 50 State bank supervisors that can be called up. So you get quite a—even with a sim-
115 

plified Federal regulatory mechanism, you get quite a cacophony of 

other voices that I think is available. 

As to your comment on procyclicality, I think that there is the 

nature of all regulators, and I think that actually if you looked at 

all the agencies, both at the Federal and State level, you would 

find that in times of stress they become tougher. You see the calls 

at the G–20 and others for more capital right now, sort of in a crisis. 

Senator CORKER. Which creates a bigger crisis. 

Mr. LUDWIG. Which has a tendency to be procyclical, which is not 

desirable. The Spanish had it right in terms of their—through their 

cycle provisioning and through their cycle capital rules, which I am 

very hopeful that will be adopted in this country. 

But I do not think that is limited just to the OCC. It is something, I agree with you, that deserves criticism because an evenhanded effort and a push to an evenhanded effort is highly desirable. 

Senator CORKER. And let me just—I know my time is about up. 

The clock must have been on 2 minutes today. 

Chairman DODD. Your questions are so eloquent. 

Senator CORKER. OK. There you go. 

If you would—and I know Marty is getting—and this is my last, 

just to advance this a little bit, the procyclical piece to me is a huge 

problem that you do not necessarily create by your formula, but it 

is something that has not served us well. The same thing happens 

in 1990 and 1991, and we just do a really poor job of it. 

There is nothing in your proposal that, for instance, changes— 

I mean, much of this is about rearranging the deck chairs and just 

getting different people—it is almost a family squabble. We sometimes refer to the insurance industry’s issue the same way. But 

what they do is also very important, and, you know, the—for instance, the counterparty risk, I mean, is this—is there anything 

about any of this that changes their ability to really look to those 

deficiencies that really are the heart of the problem here, that really are causing us right now to be doing what we are doing? And, 

Marty, you may answer that, and I will stop. 

Mr. BAILY. Well, I agree with you very much, Senator, that simply creating a single prudential regulator is not going to solve all 

our problems. The deficiencies of our system are greater than that, 

and there were a lot of private failures. We need to try to improve 

private incentives so that people do not get to play with other people’s money and they take on the risk if the risk is there. 

So I agree with you completely. This is not by any means going 

to solve all our problems. I think it does help, though, because it 

allows for the kind of consolidated regulation that can, if necessary, 

stand up to the big banks and make sure that they are following 

the right rules. It can respond, it has got the resources and the 

stature to respond to innovation because one of the problems with 

regulation is you are always sort of one step behind what the private market is trying to do. And we want to encourage that innovation, but at the same time, we do not want it to be in the direction 

of making things less safe. 

So on the procyclicality side, we need to get rid of that. First of 

all, I think we need higher capital requirements so that in good 
116 

times there is plenty of capital, and in bad times we can sort of 

cushion that shock. So that needs to be part of the reform, too, is 

how we deal with cyclicality, and there are some proposals there 

for so-called ‘‘contingent capital’’ or ‘‘convertible capital’’ that allow 

you to do that. So I think that should be an important part of the 

regulatory changes. 

I just think also on the diversity of views, the way I would put 

it is that we need to make sure that our prudential regulator is accountable. I mean, there are a lot of people—again, I do not want 

to impugn anybody in particular, but some regulators made some 

very bad decisions in this process. And, you know, do they still 

have jobs? Maybe they should not. 

We need to set up this structure in a way that preserves accountability whether it is a single prudential regulator or more than one. 

Mr. CARNELL. Mr. Chairman, could I just add two quick points 

here? 

Chairman DODD. Yes, certainly. 

Mr. CARNELL. First, that the agency, Senator Corker, would incorporate a diversity of views because under what I am proposing 

it would have the Fed and the FDIC on its board. They would 

share in making policy. But even so, they are likely to have some 

disagreement with what comes out, and they will let you know 

about the disagreement. You would have more diversity within 

such a board than you would at most any independent agency and 

the rest of the Government. 

Second, it is key in preventing crisis to look ahead and fix the 

roof while the sky is still blue, not to wait until the thunderstorm 

is brewing up. 

Now, as for being procyclical—and I am building on that point— 

the Federal Reserve has actually tried to get rid of one of the existing two capital standards: the leverage limit. It has tried at least 

twice in the past 15 years. The existing capital standards were set 

in 1986 and 1992. We had years of enormous, unprecedented prosperity, record profits, and nothing was done to raise capital standards that had been set as the second best during a crisis. 

So I think the existing system, including the Fed’s role in it, does 

not look good at all there. 

Senator CORKER. Chairman Dodd, Senator Warner and I had a 

summit last night down at Johnny’s Half Shell, and—— 

Chairman DODD. Why weren’t we invited? 

Senator CORKER. This whole issue, I think, of leverage is one 

that certainly we need to look at. You know, we actually urge people in this country to use leverage, but we penalize equity. And I 

hope that as we move through this, that is something that we will 

look at more closely. 

I am sorry to take so much time. 

Chairman DODD. Not at all. 

Senator Reed. 

Senator REED. Thank you, Mr. Chairman. Thank you, gentlemen, 

very much for your testimony. 

It seems that you are coalescing around the advice of the single 

consolidated regulator, and I just want to understand what the 

landscape will look like afterwards in simple terms. 
117 

There will be essentially two banking regulators—the FDIC and 

the Federal regulator. Is that your approach, Mr. Ludwig, focused 

on—— 

Mr. LUDWIG. Well, first there would be an—— 

Senator REED. No, I know the SEC is there and other things. 

Mr. LUDWIG. But in terms of bank lending, you would have a 

highly professionalized institutional regulator, and to Senator 

Corker’s concerns about procyclicality and also—I do not think it 

would be a super OCC. 

One of the problems with the current alphabet soup is nobody is 

large enough, professional enough that there is really the kind of 

study, focus, or stature for these supervisors to be able to go head 

to head adequately on things like derivatives, emerging new capital 

structures, et cetera. 

So I think that you would have two that would be at the Federal 

level close to supervision, but the Federal Reserve by nature, with 

its information gathering, study, and concern would be actively involved in thinking about these issues and prescribing solutions. 

And the new systemic council or systemic enterprise would also be 

very much a backstop to the banking supervision, as it would be 

a backstop to other regulatory issues throughout the Federal and 

State systems. 

Senator REED. Well, let me just take a step further and focus on 

the point that Professor Baily made about the top-to-bottom bank 

holding company regulation. Would that be the Federal Reserve, or 

would that be the new—— 

Mr. LUDWIG. Oh, no, that absolutely has to be the new institutional supervisor. The notion, the stopping at the border, I think 

Mr. Baily said it really quite eloquently. Stopping at the border is 

absolutely pernicious, because if you have an examination issue 

and you really want to follow that through, you cannot basically 

have a situation where it migrates to another enterprise and the 

investigator cannot get to it, cannot see it, cannot enforce it. It 

must be holistic. 

Senator REED. No, I accept that, but typically bank holding companies today are deposit-taking institutions, investment banks, proprietary traders, wealth management, et cetera. SEC has a responsibility, the CFTC. So just give me an idea of how this new Federal 

regulator who has got top-to-bottom responsibilities interacts with 

SEC, CFTC, and everybody else. That would have to be done, correct? 

Mr. LUDWIG. Yes, it would, and to the point that there would not 

only be one. It would have the ability to investigate in detail and 

would have the responsibility to be an expert in all the financial 

issues that are important to the institution. But it would have, if 

you will, a colook, a coexamination, coconcerns from these other 

agencies. 

Senator REED. You know, it goes to the point that was made, 

which is that when everyone is in charge, who is in charge? And 

we saw that so many times. 

Mr. LUDWIG. But it would be primarily in charge, Senator. 

Senator REED. So it would be very clear that this regulator would 

be the primary regulator of all these functions, even if they feel 

under the range of CFTC or SEC. 
118 

Mr. LUDWIG. In my view, yes. 

Senator REED. OK. 

Mr. BAILY. Yes, in my view, also. 

Now, I do think the systemic regulator, whether it is a council 

or whether it is the Federal Reserve—I think myself I would prefer 

it to be the Federal Reserve, but whichever—does have, I think, the 

need to look across our whole financial sector because the prudential regulator is basically saying, Is this institution safe and sound? 

And we then have a consumer protection agency that is saying, ‘‘Is 

it behaving itself with respect to the consumer?’’ But we need to 

have a systemic regulator that says, ‘‘Do we have within our financial system a buildup of risky assets? Are we seeing a huge rise in 

risks being taken?’’ 

Paul Volcker remarked that one of the clearest signs that a financial institution was going to get into trouble was that it was 

building a fancy new headquarters. 

So I think, you know, if you see somebody making lots of money 

doing something that—that may be because they are very good, or 

it may be because they are taking a lot of risk. 

Senator REED. Just a quick question. The FDIC is supported by 

its own fundraising activities, to put it mildly. One of our problems, 

frankly, is that we have underresourced at critical moments our 

bank regulators, our SEC. It goes to the point that you have all 

made. Where is the expertise? Where are the computer systems? 

How can you keep up with five Ph.D.s when you are, you know, 

a recent law school graduate? 

So should we have this agency dedicated funding, not through 

the appropriations process? 

Mr. LUDWIG. It should be dedicated funding by the industry. I do 

not think it needs to cost the taxpayer a nickel, and it ought to 

have, as is true today with the Federal Reserve, plenty of deep 

pockets to be able to do its job correctly. 

Senator REED. If I may, one final question. We have talked about 

one Federal regulator for Federal institutions. Should there be one 

Federal charter? Should we eliminate the Federal thrift charter, 

the Federal savings bank charter, et cetera? 

Mr. LUDWIG. I do not think you need to do that. I think the issue 

of the Federal thrift charter is an issue that is fundamentally 

steeped in the housing policy of the United States. That is, do we 

want to foster housing as a special goal. That decision need not be 

made if you have a single consolidated institutional supervisor. 

Senator REED. Thank you, gentlemen. 

Mr. BAILY. My inclination might be to create a single charter for 

these Federal institutions. I do not think I will fall on my sword 

on that one, but that would be my inclination. 

And to go back to Senator Corker’s point, we do have a lot of provisions in our tax law and our laws to promote homeownership, 

and I think that is a good idea. I think homeownership is a good 

thing. But as part of that, we also promote borrowing. I mean, we 

really do, and maybe we have gone too far in that direction. 

Senator REED. Just one final point. Professor Baily, you made, I 

think, a very cute observation. Most of the decisions where to stick 

these functions were a function of regulatory preference and tax 
119 

law. And as we sort of look at reforming our regulatory system, I 

do not think we can be sort of oblivious to tax provisions that—— 

Mr. BAILY. Absolutely. 

Senator REED. ——can form behavior more than our regulators. 

And as we go forward systematically, I think we really have to look 

at the Tax Code as well as the Federal regulations and Federal 

banking law. 

Mr. BAILY. Absolutely. 

Chairman DODD. That is very good. And good suggestions, by the 

way. 

Senator Warner. 

Senator WARNER. Thank you, Mr. Chairman. I appreciate the 

panel. It is a little challenging. You have raised a lot of the issues 

I was hoping to. I guess that is the challenge of being far down the 

table here. But I will try to re-ask the same questions perhaps. 

As somebody who has been an advocate, as I think some of the 

panel knows, of a single end-to-end regulator, you know, I want to 

go back to what the Chairman raised around some of the, I think, 

legitimate concerns that the community banks and smaller banks 

have offered, and I would be happy to have any member of the 

panel comment on this. 

I do think there is—the notion of a separate division makes some 

sense, but in any large organization is not the bias going to be toward the larger institutions? Is the best personnel going to want 

to seek out serving the larger institutions? And could you—what 

other protections could we ensure to make sure that the smaller 

banks do not get the short end of the stick? And I believe a couple 

of you mentioned—Martin, you mentioned as well that you could 

have different regulatory standards. And I guess I would like you 

to touch a little bit on that. How do we make sure that if we were 

to go with the single end-to-end regulator you would not be imposing the same overly burdensome set of regulations on a very small 

community-based bank that you might be on a major bank holding 

company? 

Mr. LUDWIG. First, I would say—— 

Mr. BAILY. Go ahead. 

Mr. LUDWIG. Oh, I am sorry, Martin. 

Mr. BAILY. No, no. Go ahead. No, please, you start, and it gives 

me more time to think. 

Mr. LUDWIG. First, I would say, Senator, that I do think that it 

makes sense to enact protections so that community banks—one, it 

is a comfort that they are protected in terms of having a simplified, 

specialized regulatory approach that best suits their needs. 

Having said that, my own experience at the OCC, where there 

are—in my day, I think over 2,000 community banks. It may be actually true today. I used the word a thousand—is that you do have 

the quality people at the agency devoting their attention to the 

community banking sector. Indeed, one of the advantages of having 

a consolidated regulator is, as people come up, you have similar talent available for both sides of the aisle, and you find—today, for 

example, the gentleman in charge of small bank supervision at the 

OCC was a large bank supervisor during his time, and he is one 

of the most talented people there. I think you will find that interplay. 
120 

The danger, I think, works the other way, that if you separate 

the two, you will only have second-class supervisors at the smaller 

institutions as opposed to having the cross-fertilization you do with 

the larger institutions. 

The other thing I think worth pointing out is just because you 

are smaller or larger does not necessarily mean you are more complex or less complex. Some of the smaller institutions by choice get 

involved in fairly complex issues, and there is going to be a tendency as we go into the future, because of the Internet, because of 

technology, because of the structured products available, that 

smaller institutions will indeed get involved with these more complex activities, and the supervisor not only needs to supervise that 

adequately, A, but it also needs to have the sophistication to help 

the small bank with these products. I think it is perfect doable, and 

I think you will just have a higher-quality supervision generally. 

One cannot also overstate in this whole discussion the pernicious 

nature of regulatory arbitrage. I know that is not your question. 

But both having—— 

Senator WARNER. That was my next question. 

Mr. LUDWIG. As a supervisor, whether it is your examiners that 

get threatened by the offhand, intended remark of some bad actor 

banks saying, look, we do not have to put up with this, we can 

move to another regulator, and how that—even if you are being 

tough at headquarters to do the right thing, how that can degrade 

the quality of supervision generally. That is not just theoretical, 

but if you have to do it every day, it is real. 

Senator WARNER. Before Marty answers, I do think that is a 

valid point, that we sometimes look at the arbitrage in terms of 

banks that have actually switched charters and some of those that 

were very much engaged in the crisis, but I think that is a very 

important point you raised, that if simply the implied threat of 

switching may end up utilizing that regulatory arbitrage and consequently not having the—— 

Mr. LUDWIG. When I was Comptroller, Senator, I had bankers in 

my office when they were unhappy threaten me, and my examiners, I know, had to live it in the field during their time, and I 

think most folks who have experienced that would have that, and 

that is really—it degrades the quality of supervision. 

Mr. BAILY. I would like to reinforce that view, and I think it is 

why—you know, in general, I am a big fan of competition as a 

means of making things more efficient and creating diversity, but 

competition among regulators can have this downside of regulatory 

arbitrage. 

Let me comment on the point about maybe different requirements. You know, Senator Dodd mentioned that it may be difficult 

politically. That shouldn’t govern what decision is made. It may be 

difficult politically to do consolidation, so I think one thing that 

needs to be sure to be in the legislation is that we satisfy the community banks that we are looking after them, because otherwise, 

there is going to be a lot of resistance to this legislation. 

And obviously, as individuals, we all like the devil we know, so 

to speak, and people want to hold on to the regulator they have, 

and that is another reason they are resistant to this consolidation. 

So I think it is very important that we carve out for the community 
121 

banks a sense that they will be looked after, they won’t be subject 

to burdensome regulations. 

On the other end of the scale, for the—— 

Senator WARNER. Can you speak to that for a moment? 

Mr. BAILY. Yes—— 

Senator WARNER. I know my time is running out, but just how 

could we put in place, or what kind of guidelines so that you 

wouldn’t perhaps have the same level of burdensome regulation for 

a small community bank versus a major bank holding company? 

Mr. BAILY. Well, I think I would defer to my colleagues on the 

details. The part of it that I think I would like to comment on is 

the capital requirements. I actually don’t like the idea of designating Tier 1 institutions. I don’t like the idea of trying to cap the 

size of institutions. But clearly, we need to do something so that 

we don’t end up bailing out these great big institutions. 

So having a sort of sliding scale, that the bigger you are or the 

more interconnected you are or depending on the kind of activity 

you do, that the capital requirements and potentially the extent of 

supervision—how often, the nature, the information you have to report, how frequently you have to report it—those kinds of things 

could increase as an institution becomes larger or more important 

to the system, and I think that is also a way of taking some of the 

burden off of the community banks. 

Mr. LUDWIG. If I might, Senator, I would reserve the right to 

come back to the Committee with a list of suggestions, because I 

come from a small town myself, and I am a huge believer in community banks. I think it is one of the great benefits here in the 

United States, one of the great forces for good and innovation, and 

I think the consolidated supervisor at the end of the day will do 

more to support community banking than the current system. 

Senator WARNER. And it may even get down to not simply capital 

requirements, but literally forms and volume of forms they have 

to—— 

Mr. LUDWIG. Right. Right. 

Senator WARNER. I know my time is expiring. One final point, 

Mr. Chairman. I won’t ask the question, but I just want to follow 

up on Senator Reed’s comments, and again, it is part of what the 

panel has made mention of. When we have seen these kind of 

closed doors take place that you have had before this panel, clearly 

the most visible example of that with the enormous scandal of Mr. 

Madoff and the fact that regulators were not able to go beyond 

their prescribed jurisdiction, and that clearly—thank goodness we 

have not had that same kind of travesty take place in the banking 

system, but this fact that we have got one focus looking at the 

bank holding company level, another looking at the bank depository piece, could create that same kind of—and as Senator Reed 

mentioned, the securities piece—failing to have that single end-toend regulator that can look at the whole bank holding company 

and all of its operations would prevent that. 

Chairman DODD. Let me just, before I turn to Senator Merkley, 

it is a related question. Maybe Mark asked this in a way. Maybe 

he addressed it when I stepped out for a second, and that is on the 

issue of assessments, for instance. I don’t know if you raised that 

or not, but do you see some? Because, clearly, if I am sitting back 
122 

as a community banker, I am going, well, wait, yes, it is nice to 

have the division in all of this, but am I going to be assessed? I 

presume you wouldn’t be, but I wonder if you would address that 

question, because clearly it is one of the concerns I would have. 

Could you address the issue of assessments? 

Mr. BAILY. I think you must have a system that is countercyclical, while our current system is procyclical, and one that 

doesn’t penalize the best community banks, which the current system does, and pay for the sins of the bad ones. So the system of 

assessments that funds this agency has to be one that takes into 

account not increasing the assessment for community banks and 

certainly not increasing the assessment for any banks in the storm, 

and I think that is achievable in terms of the way the institution 

is funded. 

Chairman DODD. Legislatively, in some way, though, right? 

Mr. BAILY. Yes, sir. So, for example, the reserves on deposit at 

the Fed are currently used to fund the Federal Reserve’s regulatory 

activities, I believe. One could use the reserves similarly to fund 

the regulatory activities of the new consolidated supervisor, if that 

was Congress’s predilection, or part of it could be used to make 

sure that the community banks had a particularly fair opportunity 

to pay what was appropriate for them. I think there is a lot of plasticity in the way one could construct this to be fair and countercyclical in terms of the funding mechanism. 

Chairman DODD. Thank you very much. 

Senator Merkley. 

Senator MERKLEY. Thank you very much, Mr. Chair, and thank 

you all for your testimony. 

When Mr. Bernanke was before us, he made an argument that 

the Fed should be the principal entity both for monetary policy, 

prudential policy, consumer policy, and systemic risk—everything—— 

[Laughter.] 

Senator MERKLEY. and I raised my concern that some of these 

would be in conflict with each other and he made the best case he 

could that they fit very well together. 

I think the article that was in the Washington Post on Sunday 

that pointed out some of the failure to address consumer issues 

over a significant period of time in many ways goes to my concerns. 

I believe that what I am hearing from you all is summed up in part 

by what is in the GAO report, that the twin peaks model is viewed 

as advantageous by some because the two principle objectives of financial regulation, systemic protection and consumer protection, 

are fundamentally in conflict, and putting these objectives in different agencies institutionalizes the distinction and ensures that 

each agency focuses on a particular objective. It goes on. But does 

that fundamentally underlie the perspective that all four of you are 

bringing to the table? 

Mr. BAILY. Well, I think—I am an admirer of Ben Bernanke. I 

am not a close friend of his, but I have known him for a long time 

and I admire the way he handled this crisis. As I said in my testimony, I don’t think the Fed—I am also an admirer of Alan Greenspan, who is a friend of mine, and I don’t think—leading up to this 

crisis, I think they made some very substantial mistakes when they 
123 

didn’t give enough consumer protection and they didn’t react to 

some of the bad lending that was going on. So I think there were 

certainly a lot of mistakes that were made prior to this crisis that 

would have mitigated it. 

So, you know, I understand why, obviously, the Fed wants to 

hold on to the authorities it has, but I think what we are suggesting is that you take away the prudential regulation part, because that may be in conflict. You make sure that it still has access 

to the information it needs, but it is no longer the prudential regulator. 

I think the thing that the Federal Reserve has done well is monetary policy, not that they haven’t made any mistakes, but if you 

look over the last, oh, 20, 30 years, I think they have done a good 

job, and typically when you pick people to serve on the Fed, you 

tend to pick economists or people with expertise in monetary policy, 

and that is the thing they should do, and I think they should also, 

since monetary policy is key to the stability of the economy, I think 

they should also be concerned with systemic stability. 

But I don’t see why—they certainly haven’t done a great job on 

prudential regulation and I don’t see—what is the point of the 

Chairman of the Federal Reserve sitting around worrying about details of credit card regulation? That is what he is doing right now, 

and I think that is a mistake and not a good use of his time. 

Senator MERKLEY. Does anyone else want to comment? 

Mr. CARNELL. Yes. A couple of things, Senator Merkley, if I 

could. First, the Federal Reserve argument that it needs to be a 

primary Federal bank regulator to do its monetary policy responsibilities are just not credible, based on facts at several levels. 

First, right now, the Federal Reserve only has supervisory responsibility for 13 percent of FDIC-insured assets and 10 percent of 

FDIC-insured institutions, so it is not a significant proportion at 

all. 

And then on top of that, our whole commercial banking system 

only accounts for 18 percent of credit market assets. Gone are the 

days when banks held 50 percent of those assets, as would have 

been true when I was born. There is just a big change in the 

growth of other financial markets and it is just out of touch with 

reality for someone to suggest that that Fed connection to being a 

primary Federal bank regulator is essential. 

Senator MERKLEY. I want to get into some other questions before 

I run out of time here, but Mr. Carnell, to follow up, you made a 

comment in regard to bank holding companies, that they exist to 

allow banks to get into businesses that are, and I am not sure if 

I caught this quite right, but incompatible with banking or very 

distinct from banking. Should we be eliminating bank holding companies? I mean, do they serve a—what purpose do they serve—— 

Mr. CARNELL. Well, just so—— 

Senator MERKLEY. ——more risk than value? 

Mr. CARNELL. I don’t think we need to eliminate them, but I do 

think our system has put much too much emphasis on them. I 

think our focus in banking policy should be on what can banks do 

and how should they go about doing it. 

I wouldn’t want to leave the impression that bank holding companies had this role as letting do something nefarious. I mean, we 
124 

are talking about things like opening an office in the next county, 

opening a bank in the next State. These were things that restrictive laws of 50 years ago didn’t allow. And then getting into nonbanking activities, many of which are not allowed in the bank or 

Congress has passed a law saying they could be in the same corporate family. 

So it is not that the activities were inherently problematic, but 

it is that we have this enormous growth of holding company regulation that is really unrelated to any real need other than the fact 

that we sort of built it up in these loophole-based ways. 

Mr. LUDWIG. If I might, Senator, go a little farther, I would say 

that the comment—I forget whether it was Senator Corker or 

someone made, that, in fact, what happens when you have to make 

a decision at the corporate level, you ultimately decide what box to 

put it in for capital reasons or tax reasons, et cetera, and what happens then at the supervisory level—so I find something wrong in 

the bank. I can’t go to that other entity. That other entity is not 

being supervised, and in fact, if you look at this current debacle, 

a great deal of the problem in the larger financial institutions was 

not in the technical bank. The bank was infected by it. It was actually in the nonbank affiliates that were hard to get to and it was 

hard to look at the animal as a whole. And if you are really going 

to be an effective supervisor—after all, everybody has the same interest, a healthier institution—you have got to do the whole piece. 

Senator MERKLEY. Thank you all. I am over my time. I will just 

close by echoing concerns about the community banks and also 

about our credit union system, where they have rules that have 

constrained their risk, not using prepayment penalties, having interest rate caps, and so forth. They are a little nervous about being 

rolled into a system with an unfamiliar regulator and perhaps paying fees disproportionate to the risk they impose on the system, 

and so our community banks and our credit unions may—are a little disturbed that they might not have been so much of the problem but may get rolled into a disadvantageous set of rules, and so 

of great interest. Thank you. 

Chairman DODD. One of these things that is going to be important for us, this is not being punitive. I think that is one of the 

things we are getting into, this notion that because some have been 

good actors and bad actors, I think we have some history of that. 

So I think it is really important as we look at all of this, this is 

not to punish some or discipline some, but rather to try to think 

in 21st century architectural terms. How do we create an architecture and a structure that makes sense in all of this? 

And the only thing I was getting at on the assessment issue, because I think putting aside the question of who was responsible for 

what, just given the magnitude and size and complexity of institutions, I mean, the idea that you would level sort of the same assessments across the board because you have one regulator, to me 

would be offensive. I mean, you have got to clearly make some distinguishing features. But I hope we can stay away from the punitive quality here as we look at all of this. 

We can go back and examine, how did we get here and what we 

are trying to do, and I think all of us agree that, in part, it was 

this patchwork out there that contributed, certainly, among other 
125 

things. It is not the only thing. I think somebody made that point, 

that there are a lot of issues we need to look at. This is one of one. 

And it isn’t going to solve everything, either. I think Bob Corker 

made the point, and I agree with him on this, is the assumption 

that if you solve this, you would solve the problem, I think would 

be false. 

But clearly I want to get away—because I think you can see that 

developing, that argument that somehow we are laying—we are 

blaming institutions by putting them in this. That is not the argument at all. The question is whether or not this makes sense. 

Let me raise one other question I have for you, and then I will 

see if anyone has interest in a second round. I wonder if you agree 

with the Administration’s proposal regarding the systemically important financial companies that have a parent or significant affiliate engaged in commercial activities, whether they should be regulated as a bank holding company and forced to divest commercial 

activities. This is a big issue that is going to be before us. It sort 

of follows on with Jeff’s question, I think, that he raised. Does anyone want to jump into this one? Professor, you sound like you have 

got some strong views on this, so—— 

Mr. CARNELL. I do. I think this is a very troublesome aspect of 

the Administration’s proposal. I should emphasize that I am troubled mainly on its use of political capital. I don’t know that—I don’t 

think the substantive stakes are very large here. I will make that 

more clear in a moment. 

Go back to the point I made earlier about how bank holding company regulation as a really big deal is unique to the United States. 

It is a historical quirk of our system. It is something the Federal 

Reserve got hold of in a context where the Congressional objectives 

were completely different from what we have now and the Fed was 

able to expand its authority and make it into a very big deal. 

Let me actually just make that a bit more clear. The bank holding—there is something in my written statement about this, but 

the Bank Holding Company Act was passed in 1956 in a populist 

effort to limit bigness and also to split up some affiliations, like 

Bank of America and TransAmerica were affiliated at the time. But 

basically we had—Chairman Wright Patman of the House Banking 

Committee believed that everything was too big, including $100 

million banks, and so he responded with the Bank Holding Company Act. He got trade association support for people who were 

concerned about banks getting into their business. 

We are not talking about something that was a safety and soundness statute in its origin. It was a kind of populist antimonopoly 

statute in its origin. We see safety and soundness come in as a criterion in 1970 as a basis for exceptions on some things. But this 

was not originally a safety and soundness statute. It was not a 

statute relating to bank policy. And yet it becomes what my old 

boss, Jerry Hawk, Under Secretary of the Treasury, said, a matter 

of theology, where there are people invested in a certain kind of 

outcome here. 

And so what they are wanting to do, then, is to conform the existing nonfinancial owners of financial institutions to sort of a very 

pure version of how they would like things to come out. Now, in 

fact, nonfinancial institution ownership has saved the taxpayers 
126 

money. Ford Motor Company put about $1 billion, as I recall, into 

a thrift institution that had acquired trouble. So there has been 

positive results. I don’t think there have been significant negative 

results. And this ownership, like General Electric and so forth, was 

not a source of the current crisis. 

So the idea of making a big deal out of this is sort of like, as we 

have seen from some quarters, is sort of like trying to protect us 

from the Mexican mafia by building a wall on the Canadian border. 

It is just not related to the major problems. 

Chairman DODD. Well, thank you for that observation. I want to 

make the point, I just mentioned to Senator Merkley as he was 

walking out, I heard him say credit unions. Credit unions are not 

part of this consideration at all. We are talking about banks. And 

before we start getting inundated with e-mails and messages from 

across the country, credit unions, you are OK on this. 

[Laughter.] 

Chairman DODD. Let the word go forth from all of this. 

Senator Corker, any—— 

Senator CORKER. No. I think you have just given evidence as to 

where the real political clout is. 

[Laughter.] 

Senator CORKER. I referred earlier to sot of a super-OCC, and I 

realize it is sort of that, what you are proposing. As we have looked 

at the resolution mechanisms that need to be in place so that we 

don’t have the same kind of problem, I think we all understand 

part of the reason we had the problems we had was there was no 

resolution mechanism for highly complex bank holding entities and 

one of the only solutions was to prop them up artificially. 

So the OCC has argued strongly to keep in place the ability to 

use taxpayer monies to prop up institutions that fail. The FDIC, on 

the other hand, has argued strongly against that. I happen to have 

fallen on their side of the equation and think that having any institution that is too big to fail creates tremendous problems, and I 

really appreciate what Paul Volcker has said about that recently. 

But hand-in-hand with this is the notion of how we resolve—in 

other words, we have the regulator—how we resolve that. You all 

have already made a great case for this type of arrangement that 

you want to have. I don’t think there is any point in going down 

that path anymore. I understand what it is you would like to see 

happen. But what should we do as a it relates to a resolution mechanism and how should that be set up? 

Mr. LUDWIG. Well, Senator Corker, I couldn’t agree with you 

more that resolving the largest institutions is a critical issue and 

I am not in favor of propping them up. That is, if we don’t resolve 

them, we basically create two problems. One is we have public utilities if we don’t have an ability to resolve them. And we also disadvantage the community and regional institutions. 

Rather, this whole structure ought to be one that creates sufficient stability and focuses in a professional way on proper supervision so as to minimize burden and increase the ability of all these 

institutions to support the economy of the United States. And 

where one of these institutions is not doing its job correctly and it 

gets into problems, we have to have a private sector component 

here—this is really a private sector activity—where it fails, and we 
127 

have to have the ability to fail it without creating a systemic crisis. 

If we don’t have that, I think we also have the danger that these 

largest institutions end up controlling the economy and the Governmental mechanism, not vice-versa. 

Mr. BAILY. Can I throw in a comment? I think Gene is absolutely 

right and you are right. We don’t want to have institutions that are 

too big to fail. We want to be able to have a mechanism by which 

they can go bankrupt when they make bad decisions. Otherwise, 

this is not a good system at all. But realistically, I mean, if an airline goes into bankruptcy, you can still have the planes fly, or if 

a railroad goes into bankruptcy, you can still have the trains go on 

the tracks. The trouble with a financial institution is that it may 

get to a certain point where it really can’t function without some 

kind of funding or some kind of support to keep it going. 

Now, to some extent, that was the justification for giving money 

to General Motors. You needed money for the suppliers, and I don’t 

want to get into that case which I don’t know the ins and outs of. 

But clearly, we need a mechanism, whether it is a bankruptcy 

or a resolution mechanism, that has a certain amount of money 

available to make sure that you don’t just close the doors and people can’t get at their money. Now, what is in the Treasury proposal 

is a sort of open-ended checkbook that somebody can write a check 

for any amount to prop up an institution. So I think that is—I 

don’t agree with that. I think that Treasury proposal is too openended, and I think the House and the Senate need to make sure 

taxpayers are protected and that they have a control over the 

purse. 

But I don’t think we can, at the same time, just say, no, we are 

never going to put taxpayer money in again, because the fact of the 

matter is we will come into another financial crisis and we will end 

up putting in a lot of money, and it is better to have a resolution 

mechanism or a special bankruptcy court that has the resources to 

let this thing down gently, although letting it down. 

Mr. CARNELL. Senator, be wary of anyone who puts a lot of stress 

on the notion that we need a new resolution mechanism. By and 

large, we had the resolution mechanisms that we needed. I could 

be a little more specific about that, but just to put it in the perspective. 

There certainly are some things that could be helpful here, but 

basically, we had the mechanisms. There were two problems. First, 

the system had been allowed to go in the direction of internal 

weakness to such a degree that problems piled up and happened 

quickly. But mainly—— 

Senator CORKER. And how did that happen, by the way? 

Mr. CARNELL. Well, I mean, we are talking about a decade in 

which—or more specifically, from about 2002 to 2007 in which market participants became increasingly complacent about credit risk 

and where regulators were not taking the opportunity to strengthen things like capital standards while the sky was blue and the 

sun was shining, take advantage of that time to build bank capital 

up. Those would be some examples of things that could have been 

done in the context. 

But the key thing is that most of the laws we needed were already in place, and in the case of something that is a bank or 
128 

thrift, the Federal Deposit Insurance Act is the model for the world 

in terms of doing resolution, and—— 

Senator CORKER. And we used it, but what about in the other examples of how they kind of—I won’t name the entities, but our 

largest entities in the country, what about in those cases? 

Mr. CARNELL. Well, if you—— 

Senator CORKER. What type of mechanisms existed that we 

didn’t use? 

Mr. CARNELL. Well, I should emphasize that many of the largest 

entities in the country are bank holding companies where the biggest part of the firm is the bank. So the law was there available 

for that. Now, with a bank holding company—— 

Senator CORKER. Or the FDIC to come into the bank component 

itself. 

Mr. CARNELL. That is correct, and let me just emphasize that 

this does not require—it certainly doesn’t require a pot of taxpayer 

money and it doesn’t necessarily—FDIC money is not the only 

thing that is available, because you can—the FDIC needs to satisfy 

insured deposits. But other creditors can have a haircut applied to 

their claims and you close the bank one day and it opens the next 

business day with a new charter, but the same tellers and so forth 

there. 

Now, as for the nonbank part of organizations, we do have the 

bankruptcy courts. There are some changes that would make sense 

for bankruptcy courts dealing with nonbank financial institutions, 

for example, to make sure that you can’t shop for the court that 

you think is best, say shop between New York and Delaware or 

something like that, to make sure that these cases go to judges who 

have some expertise and some other things to expedite that. But 

basically, the law is there. 

Senator CORKER. I would like for you, if you would, to schedule 

some time to come in and talk about some of the tweaks on the 

bankruptcy side. And again, I just want to point out that in many 

ways on this regulatory piece, we are looking at sort of rearranging 

the deck chairs, and I think the suggestions that each of you have 

made have been very helpful, but even after you make those 

changes, it is that lack of—it is that procyclical thinking that drove 

us to where we were. The sun was shining and so we were continuing to do more and more instead of reserving up more. And I 

still haven’t heard of a way—it seems like to me that what we are 

going to do is create sort of a super-regulatory entity, but we still 

haven’t yet figured out a way to cause them to actually not be 

procyclical. So again—— 

Mr. CARNELL. If I could come back to you on that one, Senator, 

it is a very difficult challenge, and I do not mean to suggest that 

there is any simple solution to the problem that you—the challenge 

you pose there. 

I do emphasize in my testimony the importance of looking at the 

incentives that regulators have, because the fact is: bank regulators had the tools that they needed, but they did not take action 

that they could have here. Part of it is a foresight problem, but 

part of it is also an incentive problem. That is, if you look at it from 

the standpoint of the particular people making the decisions, what 

makes sense from their standpoint? 
129 

Now, in a four-regulator system where there is squabbling over 

turf, where there is competition for regulatory clientele, it is tougher to look ahead—if you are the person who is looking ahead and 

said—to take the example—let us go for higher capital standards 

now, let us raise the standard in terms of your exposure to systemic risk from other institutions. If you look ahead and you are 

doing the thing that is not considered obvious at the time, you are 

more open to criticism. And in a multiregulator system, the friction 

among regulators provides something of a disincentive there. On 

top of that, where you need to do joint rulemaking with regulators—and that is a requirement under various laws—you know, 

you run into other ones who say, ‘‘If it ain’t broke, don’t fix it.’’ 

Mr. BAILY. Since you want people to be wary of folks like me that 

think—— 

Mr. CARNELL. I do not mean you. 

Mr. BAILY. Well, you should, because I think you need to have 

a certain amount of money available. However good a system you 

set up, a big financial institution is going to get into trouble at 

some point in the future. That has always been true, and I suspect 

it is going to be true again. We can improve regulation as much 

as we like, but somewhere somebody is going to get into trouble 

again. And I think we need to make sure that we have a mechanism, whether it is—I think it should be a special bankruptcy 

court. I do not think you can just pick any judge. I mean, this has 

to be a judge with special expertise. Or you have a resolution mechanism, and there has to be a way—you know, this is not just FDIC, 

because this is not just banks. It is financial institutions more generally. And we have to have a way in which we can keep them operating and that they do not bring the rest of the system down 

while we are doing it. And if we do not set up that now, then you 

are going to end up—taxpayers are going to cost a lot of money 

down the road. 

Mr. LUDWIG. Two points, Senator. One is that these systemic 

problems are really, by and large, governmental problems. They 

are not institutional problems. So when you say who is going to be 

looking out, one of the reasons you want to have somebody with a 

systemic responsibility for looking for systemic problems—i.e., bubbles—that is independent is because if you look historically, it has 

really been governmental problems into which institutions are 

dragged, by and large. 

The second thing is the point you made and the point that Rick 

made about a single consolidated regulator being less given to arbitrage and, therefore, more likely to be conservative. To some degree, the proof of the pudding is in Canada and Australia. In both 

those systems, they are both English-speaking countries with consolidated prudential supervisors, and that is all they did. And in 

both systems, they were quite conservative as regulators in terms 

of their institutions. 

Now, I just came back from Canada. I was up a couple weeks ago 

and spent some time with their finance minister and their head of 

the central bank and their bankers. And they will all say that their 

supervisor was a restraining force on them getting into a lot of the 

problems that our institutions got into. 

Senator REED [presiding]. Senator Warner. 
130 

Senator WARNER. Mr. Chairman, I will not ask a question. I 

would just like to make a request to the panel, because it is clear 

that the panel has got a lot of ideas here. 

As I think I said earlier, I would love to see more specificity 

about how we can ensure community banks, smaller banks, are inside a single end-to-end regulator, from assessments to less regulatory, less paperwork. What are the protections we could give beyond division, number one? 

Number two, Senator Corker and I believe that there needs to 

be expanded resolution authority at least to bank holding companies, with the FDIC, and the FDIC has raised—and I know you 

have addressed today, but has raised the concern that if they 

were—if we took away their prudential supervision, would back-up 

supervision be enough to have them have their pulse on the status 

of all of the institutions that they might cover in this expanded jurisdiction. So I would love to have some specific suggestions on how 

we could address that concern. 

And then, third, obviously, you know, the Federal Reserve will 

make the point that, as lender of last resort, they still need to keep 

their hands in this pie in terms of at least with these larger institutions on the bank holding companies. And I think you have made 

some very—the whole panel has made a number of valid points 

about the bank holding companies, but I would love—and, again, 

Martin, you made the comment about the fact that FDIC and the 

Fed would be on the board. But what are other ways that we could 

ensure that the Fed, as lender of last resort, would not lose the expertise that they have? 

Thank you, Mr. Chairman. 

Senator REED. Thank you very much, gentlemen. I just have one 

or two quick questions since I have got the opportunity with this 

panel, which is rare. 

Going back to the landscape after we adopt a single regulator, at 

least hypothetically, should the Federal Reserve continue to have 

any regulatory authority with respect to State member banks if 

that is all they are doing in the regulatory sphere? Mr. Ludwig. 

Mr. LUDWIG. I would not think so, Senator. I think there is huge 

advantage to having, just like companies, entities that do things 

that they do well and focus on them. I think it is better for oversight for the Congress. I think it is better for the agencies themselves. And I think to Martin Baily’s excellent point, monetary policy is so essential in central banking functions. Do we really want 

our Chairman of the Federal Reserve sitting around thinking about 

either consumer rules or bank supervision rules? Which are not unimportant, but how much can you do in a day? 

I think one of the problems we have with CEOs generally is how 

much can you actually accomplish in a day, and I think that is an 

enterprise that they should give up. 

Senator REED. Another general question is that this is an opportunity, obviously, and a necessity to look across the board in terms 

of the Federal regulatory structure, and I think not just in concept 

of how you regulate banks, but the structure itself of the Federal 

Reserve. As we cut back, presumably, some of their responsibilities, 

does their present structure still need to remain the same with re-
131 

gional banks located sort of because the way America was in 1930, 

not 2010? Does anyone have any comments? 

Mr. CARNELL. I would not try to defend the location of Federal 

Reserve banks, including, you know, the old thing about why are 

there two in Missouri. But I do think the Federal Reserve banks 

play a valuable role in Federal Reserve policymaking. That is, they 

are not just regional offices that receive top–down directives from 

Washington. And I think in monetary policy and in a great many 

other things, they provide a diversity of perspective that is desirable. 

I would note, by the way, that where a significant proportion of 

supervisory personnel are currently located in Reserve banks, that 

same space could be used, if desired, by employees of the new agency, and you would still have, you know, interaction of proximity 

there. So I would keep the Reserve banks. I would encourage crossfertilization like that. I do not think—— 

Mr. LUDWIG. I think that is an excellent—I mean, a consolidated 

supervisor does not mean that everything should be in Washington. 

And, indeed, with the majority of the banks being located everywhere, you would assume there would be substantial regional offices and duty stations really all over the place. But the advantage 

of being able to filter it back and have cross-fertilization I think is 

huge. 

Mr. BAILY. I agree. 

Senator REED. Let me ask you if there is a final comment by any 

of the panelists that you would like to make before I thank you 

very much and—yes? 

Mr. CARNELL. Actually, I would like to say, if I could, some words 

in favor of a consumer financial protection agency. I support creating a new independent agency. As I would propose, it would have 

full responsibility for writing rules implementing consumer protection legislation, financial consumer legislation. And I would also 

agree with the Administration that it should have primary enforcement authority over nonbank lenders. 

Now, I differ with the Administration on a couple of points. I 

think it should have only back-up enforcement authority over 

FDIC-insured banks and their affiliates. I think that is enough. I 

think that will do the job. And I also do not support slashing the 

preemptive effect of the National Bank Act. The State regulators 

had primary responsibility for dealing with nonbank lenders that 

were the epicenter of predatory lending. They did a poor job, and 

yet what they talk about is national bank preemption, which was 

not the practical problem there. 

On top of that, I point out that the Supreme Court issued a 

major decision earlier this year, Cuomo v. Clearing House, that cut 

back on some of the preemptive claims made for the National Bank 

Act. So I do not think there is a need for action in the preemption 

area, certainly not what the Administration has proposed. But the 

agency is a good idea. 

Senator REED. Thank you, gentlemen, very much for this excellent testimony, and thank you very much. 

Mr. BAILY. Thank you for having us. 

[Whereupon, at 3:55 p.m., the hearing was adjourned.] 

[Prepared statements supplied for the record follow:] 
132 

PREPARED STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD 

This afternoon, we will examine how best to ensure the strength and security of 

our banking system. I would like to thank our witnesses for returning to share your 

expertise after the last hearing was postponed. 

Today, we have a convoluted system of bank regulators created by historical accident. Experts agree that nobody would have designed a system that worked like 

this. For over 60 years, Administrations of both parties, members of Congress, commissions, and scholars have proposed streamlining this irrational system. 

Last week I suggested further consolidation of bank regulators would make a lot 

of sense. We could combine the Office of the Comptroller of the Currency and the 

Office of Thrift Supervision while transferring bank supervision authorities from the 

Federal Deposit Insurance Corporation and the Federal Reserve, leaving them to 

focus on their core functions. 

Since that time, I have heard from many who have argued that I should not push 

for a single bank regulator. The most common argument is not that it’s a bad idea— 

it’s that consolidation is too politically difficult. That argument doesn’t work for me. 

Just look what the status quo has given us. In the last year some of our biggest 

banks needed billions of dollars of taxpayer money to prop them up, and dozens of 

smaller banks have failed outright. 

It’s clear that we need to end charter shopping, where institutions look around 

for the regulator that will go easiest on them. 

It’s clear that we must eliminate the overlaps, redundancies, and additional red 

tape created by the current alphabet soup of regulators. 

We don’t need a super-regulator with many missions, but a single Federal bank 

regulator whose sole focus is the safe and sound operation of the Nation’s banks. 

A single operator would ensure accountability and end the frustrating pass the buck 

excuses we’ve been faced with. 

We need to preserve our dual banking system. State banks have been a source 

of innovation and a source of strength in their communities. A single Federal bank 

regulator can work with the 50 State bank regulators. 

Any plan to consolidate bank regulators would have to ensure community banks 

are treated appropriately. Community banks did not cause this crisis and they 

should not have to bear the cost or burden of increased regulation necessitated by 

others. 

Regulation should be based on risk—community banks do not present the same 

type of supervisory challenges their large counterparts do. 

But we need to get this right, which is why you are all here today. I am working 

with Senator Shelby and my colleagues on the Committee to find consensus as we 

craft this incredibly important bill. 

PREPARED STATEMENT OF EUGENE A. LUDWIG 

CHIEF EXECUTIVE OFFICER, PROMONTORY FINANCIAL GROUP, LLC 

SEPTEMBER 29, 2009 

Introduction 

Chairman Dodd, Ranking Member Shelby, and other distinguished Members of 

the Senate Banking Committee; I am honored to be here today to address the important subject of financial services regulatory reform. I want to commend you and 

the other Members of the Committee and staff for the serious, thoughtful, and productive way in which you have examined the causes of the financial crisis and the 

need for reform in this area. 

Today, there are few subjects more important than reform of the financial services 

regulatory mechanism. Notwithstanding the fine men and women who work tirelessly at our financial regulatory agencies, the current outdated structure of the system has failed America. At this time last year, we were living through a near meltdown of the world’s financial system, triggered by weaknesses generated here in the 

United States. Two of our largest investment banks and our largest insurance company failed. Our two giant GSE’s failed. Three of our largest banking organizations 

were merged out of existence to prevent them from failing. 

But the problem is not just about an isolated incident of 1 year’s duration. Over 

the past 20-plus years we have witnessed the failure of hundreds of U.S. banks and 

bank holding companies. The failures have included national banks, State member 

banks, State nonmember banks and savings banks, big banks and small banks, dozens if not hundreds of banks supervised by every one of our regulatory agencies. 

By the end of this year alone, I believe over 100 U.S. banks will have failed, costing 
133 

the deposit insurance fund tens of billions of dollars. And, I judge that before this 

crisis is over we will witness the failures of hundreds more. In the face of this irrefutable evidence, it is impossible to say something is not seriously wrong. 

Now is the time to act boldly and bring American leadership back to this system. 

A failure to act boldly and wisely will condemn America either to a loss of leadership in this critical area of our economy and/or additional instances of the kinds of 

financial system failures that we have been living through increasingly over the 

past several decades, the most pronounced instance of which is currently upon us. 

No one should underestimate the complexity of accomplishing the needed reforms, 

though in truth the changes that are needed are surprisingly straightforward from 

a conceptual perspective. The Administration’s financial services regulation White 

Paper is commendable and directionally correct. It identifies the major issues in this 

area and provides momentum for reform. In my view, certain essential refinements 

to the plan laid out in the White Paper are needed; the need for revisions and refinements is an inevitable part of the policymaking process. I also want to commend 

the Treasury Department of former Secretary Henry Paulson for having developed 

its so-called ‘‘blueprint,’’ which also has added important and positive elements to 

the debate in this area. 

Financial services regulatory reform is not fundamentally a partisan issue. It is 

fundamentally a professional issue. And, under the leadership of you and your staffs 

Chairman Dodd and former Ranking Member Shelby the traditions of the Senate 

Banking Committee, which for decades has prided itself on a balanced bipartisan 

look at the facts and the needs of the country has continued. In this regard, it 

should be noted that many of the matters I cover below, including importantly the 

need for an end-to-end consolidated banking regulator, have been championed over 

the years by Members of the Senate Banking Committee, including its Chairmen, 

from both sides of the aisle. Similarly, many of these concepts, including the need 

for an end-to-end consolidated institutional supervisor, have been championed by 

Treasury Secretaries over the years from both political parties. 

I have set out below the seven critical steps that are needed to fix the American 

Financial Regulatory system and to refine the approaches put forth by both the current and previous Treasury Departments. Being so direct is no doubt somewhat presumptuous on my part, but I have been fortunate in my career to have worked in 

multiple capacities with the financial services industry and consumer organizations 

in this country and abroad, including as a regulator, money-center bank executive, 

board member, major investor in community banks, and chairman and board member of community development and consumer-related organizations. 

So what has gone so wrong? Let me begin by saying what the problem is not. 

• First, the problem is not the failure to have thousands of talented people working in bank and bank holding company supervision. I can testify from personal 

experience that we do indeed have exceptionally fine and able men and women 

in all our regulatory agencies. 

• Second, our banks and bank holding companies are not subject to weak regulations. On the contrary, though not without flaws, our codes of banking regulations are no less stringent than those in countries that have weathered the current and past crises well. 

• Third, it is not because America has weaker bankers than in the countries that 

have been more successful at dealing with the current crisis. On the contrary, 

we have a right to take pride in America’s banks and bankers many of whom 

work harder than their peers abroad, have higher standards than their peers 

abroad and contribute more to their communities in civic projects than their 

peers abroad. 

Of course, we have had isolated cases of regulators and bankers that failed in 

their duties. However, 20-plus years with hundreds of bank failures through multiple economic cycles is not the result of a few misguided souls. 

So what is the problem with financial institution safety and soundness in the 

United States and how can we fix it? To my mind, the answer is relatively straightforward, and I have outlined it in the seven areas I cover below. 

Needed Reforms 

1. Streamline the current ‘‘alphabet soup’’ of regulators by creating a single world 

class financial institution specific, end to end, regulator at the Federal level 

while retaining the dual banking system. 

a. Introduction. We must dramatically streamline the current alphabet soup of 

regulators. The regulatory sprawl that exists today is, as this Committee well 
134 

knows, a product of history, not deliberation. The recent financial crisis has accentuated many of the shortcomings of the current regulatory system. 

Indeed, it is worth noting that our dysfunctional regulatory structure exists virtually nowhere else. And, I am not aware of any scholar or any country that believes 

it is the paradigm of financial regulatory structuring; nor am I aware of one country 

anywhere that wants to copy it. 

b. How Our Regulatory Structure Fails: There are at least seven ways in which 

our current regulatory structure fails: 

• Needless Burdens That Weaken Safety and Soundness Focus. First, a profusion 

of regulators, such as we have in the United States, adds too much needless 

burden to the financial services system. Additional burdens where they do not 

add value are not neutral. They actually diminish safety and soundness. Many 

banking organizations today have several regulatory agencies to contend with 

and dozens—in a few cases—hundreds of annual regulatory examinations with 

which to cope. At the same time, top management’s time is not infinite. It is 

important to streamline and target regulatory oversight, and accordingly top 

management talent’s focus to address those issues that most threaten safety 

and soundness. 

• Lack of Scale Needed To Address Problems in Technical Areas. Second, under 

our current regulatory structure, not one of the institutional regulators is sufficiently large or comprehensive enough in their supervisory coverage to adequately ensure institutional safety and soundness. Typically, no regulator today 

engages in end-to-end supervision as different parts of the larger financial organizations are supervised by different regulatory entities. And gaining scale in 

regulatory specialties of importance, for example, risk metrics, or capital markets activities, is severely hampered by the too small and fractured nature of 

supervision today in America. 

• Regulatory Arbitrage. Third, the existence of multiple regulatory agencies is fertile ground for regulatory arbitrage, thereby seriously undercutting strong prudential regulation and supervision. 

• Delayed Rulemaking. Fourth, rulemaking while often harmonized at least 

among the banking supervisors is slow to advance because of squabbles among 

the financial services regulators that can last for years at a time. 

• Regulatory Gaps. Fifth, because our regulatory structure is a hodgepodge, for 

all its multiple regulators and inefficiencies, it is not truly ‘‘end-to-end’’ and has 

been prone to serious gaps between regulatory agency responsibilities where 

there is little or no supervision. And these gaps are often exploited by financial 

institutions, overburdened by too much regulation in other areas—weeds take 

root and flourish in the cracks of the sidewalk. 

• Limitations on Investigations. Sixth, where an experienced and talented bank 

regulator believes he or she has found a problem in the bank, that individual 

or his or her regulatory agency cannot follow the danger beyond the legalistic 

confines of the chartered bank itself. ‘‘Hot pursuit’’ is not allowed in bank regulation today. We count on our bank examiners to function as a police force of 

sorts. But even when our bank detectives and cops sniff out trouble, they may 

have to quit following the trail when they hit ‘‘the county line’’ where another 

agency’s jurisdiction begins. Like county sheriffs, examiners sometimes can do 

little more than plead with the examiners in the neighboring jurisdiction to follow up on the matter. 

• Diminished International Leadership. Seventh, our hydra-headed regulatory 

system, with periodic squabbles among its various components, increasingly undercuts our moral force around the world, leading to a more fractured and less 

hospitable regulatory environment for U.S.-based financial services providers. 

Let me elaborate on two of these points—the counterproductive nature of excess 

burdens and regulatory arbitrage: 

• Counterproductive Burdens. Today, a large financial institution that has a bank 

in its chain is in almost all cases subject to regulation by a bank regulator, the 

Federal bank regulator, (the Federal component of which will be the Office of 

the Comptroller of the Currency, the Federal Reserve Board, the Federal Deposit Insurance Corporation, or the Office of Thrift Supervision) and in many 

cases by a State bank regulator. Many banking organizations have national 

banks, State banks and savings banks in their chains, so they are subject to 

all these bank supervisors. 
135 

In addition, every institution with a bank in its chain must have either the Federal Reserve or the OTS as its bank holding company and nonbank affiliate regulator. 

In all cases, financial services companies with bank affiliates are subject to the 

FDIC as an additional supervisor. 

But the list does not stop there. Additional supervision may be performed by 

the State Attorneys General, the Securities and Exchange Commission, and the 

Financial Industry Regulatory Authority. For Bank Secrecy Act, Foreign Corrupt Practices Act, and anti-money-laundering matters there is a supervisory 

role for the Financial Crimes Enforcement Network and Office of Foreign Asset 

Control. Also, the insurance company subsidiaries of bank holding companies 

may be subject to regulation by State insurance regulators in each of the States. 

In addition, at times, even the Federal Trade Commission serves as a supervisor. And, the Justice Department sometimes becomes involved in what historically might have been considered civil infractions of various rules. Even the accounting standard setting agencies directly or through the SEC, get into the act. 

This alphabet soup of regulators results in multiple enforcement actions, often 

for the same wrong, and dozens of examinations, which as I have noted for our 

largest institutions may literally total in the hundreds in a year. There are so 

many needless burdens caused by this cacophony of regulators, rules, examinations and enforcement activities that many financial services companies shift 

their business outside the United States whenever possible. 

But the burden is not in and of itself what is most concerning. The worst feature of our current system is that for all the different regulators, the back-up 

supervision and the volumes of regulation has not produced superior safety and 

soundness results. On the contrary, based on the track record of at least the 

last 20-plus years, it has produced less safety and soundness than some simplified foreign systems. As the current crisis and the past several debacles have 

shown, our current expensive and burdensome system does not work. 

• Regulatory Arbitrage. Financial institutions that believe their current regulator 

is too tough can change regulatory regimes by simply flipping charters and thus 

avoid strong medicine prescribed by the previous prudential supervisor. Indeed, 

even where charter flipping does not actually occur, the threat of it has pernicious implications. Sometimes stated directly, sometimes indirectly, often by 

the least well-run banking organization, the threat of charter flipping eats away 

at the ability of examiners and ultimately the regulatory agency to be the cleareyed referee that the system needs them to be. 

And, regulatory arbitrage is greatly increased by the funding disequilibrium in 

our system whereby the Comptroller’s office must charge its banks more since 

State-chartered banks are in effect subsidized by the FDIC or the Fed. The 

practical significance of this disequilibrium cannot be overstated. 

c. Misconceptions. There have been a number of misconceptions about what a consolidated end-to-end institutional supervisor is and what it is not, as well as the history of this kind of prudential regulator. 

• Not a Super Regulator. First, an end-to-end consolidated institutional supervisor is not a ‘‘super regulator’’ along the lines of Britain’s FSA. A consolidated 

institutional prudential regulator does not regulate financial markets like the 

FSA. The SEC and the CFTC do that. A consolidated institutional regulator 

does not establish consumer protection rules like the FSA. A new consumer 

agency or the Federal Reserve does that. A consolidated institutional supervisor 

does not itself have resolution authority or authority with respect to the financial system as a whole. The FDIC does, and perhaps the Fed, the Treasury and 

a new systemic council would also do that. The consolidate institutional regulator would focus only on the prudential issues applicable to financial institutions like The Office of the Superintendent of Financial Institutions (OSFI) in 

Canada and the Australian Prudential Regulatory Authority (APRA), both of 

which have been successful regulators, including during this time of crisis, 

something I discuss in greater detail below. 

• An Agency That Charters and Supervises National Entities Cannot Regulate 

Smaller Institutions. Second, there has been a misconception that a consolidated 

regulator that regulates enterprises chartered at the national level cannot fairly 

supervise smaller community organizations. In fact, even today the OCC currently supervises well over 1,000 community-banking organizations whose businesses are local in character. And, it is worth adding that these small, community organizations that are supervised by the OCC, choose this supervision 
136 

when they clearly have the right to select a State charter with a different supervisory mechanism. The OCC, it must also be noted, supervises some of the largest banks in the United States. If the OCC unfairly tilted supervision toward 

the largest institutions or otherwise, it is hard to imagine that it would have 

smaller institutions volunteer for its supervision. 

• Entity That Regulates Larger Institutions Cannot Regulate Smaller Institutions. 

Third, there is a misconception that a consolidated regulator that regulates 

larger enterprises cannot regulate smaller enterprises or will tilt the agency’s 

focus in favor of larger enterprises. In fact, whether consolidated or not, all our 

current financial regulators regulate financial institutions with huge size disparities. Today, all our Federal regulators make meaningful accommodations so 

that they can regulate large institutions and smaller institutions, recognizing 

that often the business models are different. In fact, as will be discussed in 

greater detail, it is important to regulate across the size perspective for several 

reasons. It means the little firms are not second-class citizens with second-class 

regulation. It means that the agency has regulators sufficiently sophisticated 

who can supervise complex products that can exist in some smaller institutions 

as well as larger institutions. 

• Checks and Balances. Fourth, some have worried that a consolidated institutional supervisor would not have the benefit of other regulatory voices. This 

would clearly not be the case as a consolidate institutional supervisor would fulfill only one piece of the regulatory landscape. The Federal Reserve, Treasury, 

SEC, FDIC, CFTC, FINRA, FINCEN, OFAC, and FHFA would continue to have 

important responsibilities with respect to the financial sector. In addition, proposals are being made to add additional elements to the U.S. financial regulatory landscape, the Systemic Risk Council and a new Financial Consumer 

agency. This would leave 8 financial regulators at the Federal level and 50 bank 

regulators, 50 insurance regulators and 50 securities regulators at the State 

level. I would think that this is a sufficient number of voices to ensure that the 

consolidated institutional supervisor is not a lone voice on regulatory matters. 

• Need To Supervise for Monetary Authority and Insurance Obligations. Fifth, 

some have also claimed that the primary work of the Federal Reserve (monetary policy, payments system and acting as the bank of last resort) and the 

FDIC (insurance) would be seriously hampered if they did not have supervisory 

responsibilities. The evidence does not support these claims. 

1. A review of FOMC minutes does not suggest much if any use is made of supervisory data in monetary policy activities. In the case of the FDIC, it has 

long relied on a combination of publicly available data and examination data 

from other agencies. 

2. There are not now to my knowledge any limitations on the ability of the Federal Reserve or the FDIC to collect any and all information from the organizations they are now supervising, whether or not they are supervising them. 

3. And whether or not the Federal Reserve or the FDIC is supervising an entity, it can accompany another agency’s examination team to obtain relevant 

data or review relevant practices. 

4. If the FDIC or the Federal Reserve does not have adequate cooperation on 

gathering information, Congress can make clear by statute that this must be 

the case. 

5. The Federal Reserve’s need for data goes well beyond the entities it supervises and indeed where the majority of the financial assets have been located. Hedge funds, private equity funds, insurance companies, mortgage 

brokers, etc., etc., are important areas of the financial economy where the 

Fed has not gathered data to date and yet these were important areas of the 

economy to understand in the just ended crisis. Should not these be areas 

where Federal Reserve Data gathering power are enhanced? Is this not the 

first order of business? Does the Federal Reserve need to supervise all of 

these institutions to gather data? 

6. Even if the FDIC were not the supervisor of State chartered banking entities, the FDIC would have backup supervisory authority and be able to be 

resident in any bank it chose. 

7. There is scant information that suggests the Federal Reserve or FDIC’s onsite activities, were instrumental in stemming the current crises or bank failures. Again, it is important to emphasize, this is not a reflection on these 

two exceptional agencies or their extraordinarily able and dedicated profes-
137 

sionals. It is a reflection of our dysfunctional, alphabet soup supervisory 

structure. 

• No Evidence That Consolidated Supervision Works. Sixth, some have claimed 

that because the U.K.’s FSA has had bank failures on its watch, a consolidated 

institutional regulator does not work and would not work in the U.S. As noted 

above, the U.K. FSA is a species of super-regulator with much broader authorities than a mere consolidated regulator. It is also worth noting that neither in 

the U.K. nor elsewhere is the debate over supervision one that extols the U.S. 

model. Rather, the debate tends to be simply over whether the consolidated supervisor should be placed within the central bank or elsewhere. 

More importantly, it should be emphasized that there are regulatory models 

around the world that have been extremely successful using a consolidated institutional regulator model. Indeed, two countries with the most successful 

track record through the past crisis, Canada and Australia, have end-to-end, 

consolidate regulators. In Canada the entity is OSFI and in Australia APRA. 

Both entities perform essentially the same consolidated institutional prudential 

supervisory function in their home countries. In both cases they exist in governmental structures where there are also strong central banks, deposit insurance, 

consumer protections, separate securities regulators and strong Treasury Departments. Canada and Australia’s regulatory systems work very well and indeed, that they have not just a successful consolidated end-to-end supervisor 

but a periodic meeting of governmental financial leaders that has many of the 

attributes systemic risk council, discussed below. 

• Would It Do Damage To The Dual Banking System? Seventh, there was considerable concern in the 1860s and 1870s that a national charter and national supervision would do away with the State banking system. It did not. Similar 

fears arose when the Federal Reserve and FDIC became a Federal examination 

supervisory component of State-chartered banking. These fears were also unfounded. Both the Federal Reserve and the FDIC are national instrumentalities 

that provide national examination every other year and more frequently when 

an institution is troubled. A new consolidated supervisor at the Federal level 

would merely pick up the FDIC and Federal Reserve examination and supervisory authorities. 

d. Proposal. Accordingly, I strongly urge the Congress to create one financial services institutional regulator. In urging the Congress to take this step, I believe that 

several matters should be clarified: 

• Institutional Not Market Regulator. I am not suggesting that we merge the market regulators—the Commodities Futures Trading Commission, the SEC, and 

FINRA—into this new institutional regulatory mechanism. The market regulators should be allowed to continue to regulate markets—as a distinct functional task with unique demands and delicate consequences. Rather, I am suggesting that all examination, regulation, and enforcement that focus on individual, prudential financial regulation of financial institutions should be part of 

one highly professionalized agency. 

• Issue Is Structure Not People. As a former U.S. Comptroller of the Currency, 

who would see his former agency and position disappear into a new consolidated 

agency, the creation of this new regulator is not a proposition I offer lightly. 

I fully understand the pride each of our Federal financial regulatory agencies 

takes in its unique history and responsibility. As I have said elsewhere in this 

testimony, I have nothing but the highest regard for the professionalism and 

dedication the hard-working men and women who make up these agencies bring 

to their jobs every day. The issue is not about individuals, nor is it about historic agency successes. Rather, it is all about a system of regulation that has 

outlived the period where it can be sufficiently effective. Indeed, perpetuating 

the current antiquated system makes it harder for the fine men and women of 

our regulatory agencies to fully demonstrate their talents and to advance as far 

professionally as they are capable of advancing. 

• Retention of Dual Banking System. In proposing a consolidated regulatory agency, I am not suggesting that we should do harm to our dual banking system 

as noted above. Chartering authority is one thing; supervision and regulation 

are quite another matter. The State charter can and should be retained; the 

power of the States to confer charters is deeply imbedded in our federalist system. There is nothing to prevent States from examining the institutions subject 

to their charters. On the contrary, one would expect the States to perform the 

same regulatory and supervisory functions in which they engage today. As 
138 

noted, the new consolidated regulatory agency would simply pick up the Federal 

component of the State examination and regulation, currently performed by the 

Federal Reserve and the FDIC. 

• Funding. This new consolidated financial institutional regulatory agency should 

be funded by all firms that it examines, eliminating arbitrage, which often masquerades as attempts to save examination fees. 

• Importance of Independence. Importantly, this new consolidated supervisory 

agency needs to be independent. It needs to be a trusted, impartial, professional 

referee. This is important for several reasons. It is absolutely essential for the 

agency to be taken seriously that it be free from the possible taint of the political process. It must not be possible for politically elected leader to decide how 

banking organizations are supervised because of political considerations. Time 

and again, when the issue of bank supervision and the political process has 

been considered by Congress, Congress has opted to keep the regulatory mechanisms independent. 

Independence also bespeaks of attracting top talent to head the agency, and this 

is of considerable importance. If the head of the agency is not someone who is 

as distinguished and experienced as the head of the SEC, Treasury Secretary 

or Chairman of the Federal Reserve, if it is not someone with this level of Government seniority and distinction, the agency will not function at the level it 

needs to function to do the kind of job we need in a complex world. 

e. Architecture of Reform Proposals/Congressional Oversight. Enterprises perform 

best where they have clear missions, and there are not other missions to add confusion. The consolidated end-to-end supervisor would have a clear mission and would 

fit nicely with the proposals below where the roles and responsibilities of all parts 

of our regulatory system would be simplified and targeted. The Federal Reserve 

would be in charge of monetary policy, back-stop bank and payments system activities. The FDIC would continue to be the deposit insurer. The SEC and CFTC market regulators. The Systemic Council would identify and seek to mitigate potential 

systemic events. And a consumer organization would be responsible for consumer 

issue rule setting. 

This allows for much more effective Congressional oversight. Congress will be able 

to focus on each agency’s responsibilities with greater effectiveness when one agency 

engages in a disparate set of activities. 

2. Avoid a two-tier regulatory system that elevates the largest ‘‘too-big-to-fail’’ institutions over smaller institutions. 

Eliminating the alphabet soup of regulators should not give rise to a two-class 

system where our largest banking organizations, deemed ‘‘too big to fail,’’ are regulated separately from the rest. To do that has several deleterious outcomes: 

a. Public Utilities or Favored Club. A two-class system means either the largest 

institutions become, in essence, public utilities subject to rules—such as higher 

capital charges, inflexible product and service limitations, and compensation 

straitjackets—or, they become a special favored club that siphons off the blue 

chip credits, the best depositors, the safest business, the best examiners and 

supervisory service whereby the community banking sector has to settle for the 

leftovers. Both outcomes are highly undesirable. 

b. Smaller Institutions Should Not Be Second Class Citizens. I can assure you 

that over time, condemning community banking to the leftovers will make 

them less safe, less vibrant and less innovative. Even today, tens, indeed hundreds of billions of dollars have been used to save larger institutions, even 

nonbanks, and yet we think nothing of failing dozens of community banks. 

Over 90 banks have failed since the beginning of 2009, and they were overwhelmingly community banks; the number is likely to be in the hundreds before this crisis is over. 

c. Two-Tier Supervisory System Exacerbates ‘‘Too-Big-To-Fail’’ Problem. Creating 

a two tier supervisory system and designating some institutions, as ‘‘too big to 

fail’’ is a capitulation to the notion that some institutions should indeed be allowed to function in that category. To me, this is a terrible mistake. We are 

enshrining some institutions with such importance due to their size and interconnected characteristics that we are implicitly accepting the notion that our 

Nation’s economic well-being is in their hands, not in the hands of the people 

and their elected officials. 

d. Danger of Second Class Supervisory System for Smaller Organizations. As a 

practical matter, a two-tier system makes it less likely that top talent will be 

available to supervise smaller institutions. At the end of the day, who wants 
139 

to work for the second regulator that has no ability to ever regulate the institutions that are essentially defined as mattering most to the Nation? 

e. Size Is Not the Only Differentiating Characteristic. Finally, just because we 

might have one prudentially oriented financial services supervisor does not 

mean that we should not differentiate supervision to fit the size and other 

characteristics of the institutions being supervised. On the contrary, we should 

tailor the supervision so that community banks and other kinds of organizations—for example, trust banks or credit card banks—are getting the kind of 

professional supervision they need, no more and no less. But such an avoidance 

of a one-size-fits-all supervisory model is far from elevating a class of financial 

institution into the ‘‘too-big-to-fail’’ pantheon. 

In sum, I urge the Congress not to create a ‘‘too-big-to-fail’’ category of financial 

institutions, directly or indirectly, either through the regulatory mechanism or by 

rule. On the contrary, I urge the Congress to take steps to avoid the perpetuation 

of such a bias in our system. 

3. It is essential to have a resolution mechanism that can resolve entities, however 

large and interconnected. 

Essential Nature of the Problem. It cannot be overstressed just how important it 

is to develop a mechanism to safely resolve the largest and most interconnected financial institutions. If we do not have such a mechanism in place and functioning, 

we either condemn our largest institutions to become a species of public utility, less 

innovative and less competitive globally, or we have to create artificial measures to 

limit size, diversity, and perhaps product offerings. If we choose the first alternative 

and go the public utility route, we are in effect admitting that some institutions are 

‘‘too big to fail,’’ and thus unbalancing the rest of our financial services sector. Moreover, adopting either alternative would change not only the fabric of our financial 

system, but the free-market nature of finance and the economy in the United States. 

Complexity of the Undertaking. An essential aspect to eliminating the perception 

and reality of institutions that are ‘‘too big to fail’’ is to ensure that we have a resolution mechanism that can handle the failure of very large and/or very connected 

institutions without taking the chance of creating a systemic event. However, it is 

worth emphasizing that creating such a resolution mechanism will require careful 

legislative and regulatory efforts. Resolving institutions is not easy. 

To step back for a moment, it is quite striking that the seizure of even a relatively 

small bank, (e.g., a bank with $60 million in assets) is a very substantial undertaking. With the precision of a SWAT team, dozens of bank examiners and resolutions experts descend on even a small institution that is to be resolved, and they 

work nearly around the clock for 48 hours, turning the bank inside out as they comb 

through books and records and catalogue everything from cash to customer files. 

Imagine magnifying that task to resolve a bank that is 10 times, 100 times, or 1,000 

times larger than my community bank example. 

A Resolution Mechanism Can Be Created To Resolve the Problem. The FDIC has 

capably discharged its duties as the receiver of even some very large banks, but significantly revised processes and procedures will have to be created to deal with the 

largest, most interconnected and geographically diverse institutions with broad 

ranges of product offerings. With that said, having worked both as a director of the 

FDIC and in the private sector as a lawyer with some bankruptcy experience, I am 

reasonably confident that we can create the necessary resolution mechanism. 

Several aspects to creating a resolution mechanism for the largest banks that deserve particular attention are enumerated below: 

a. Costs Should Not Be Borne By Smaller Institutions. We have to be careful that 

the costs of resolution of such institutions are not borne by smaller or healthier 

institutions, particularly at the time of failure when markets generally may be 

disrupted. This means all large institutions that might avail themselves of 

such a mechanism should be paying some fees into a fund that should be available when resolution is needed. 

b. Treasury Backstop. Furthermore, such a fund should be backstopped by the 

Treasury as is the FDIC Deposit Insurance Fund (DIF). We should not be calling on healthy companies to fill up the fund quickly, particularly during periods of financial turmoil. An unintended consequence of current law is that we 

have been requiring healthy community banks to replenish the deposit insurance fund during the banking crisis, making matters worse by making the good 

institutions weaker and less able to lend. We should change current law so 

that this is no longer the case with respect to the DIF, and this certainly 

should not be the case with a new fund set up to deal with larger bank and 

nonbank failures. 
140 

c. Resolution Decisions. The ultimate decision to resolve at least the largest financial institutions should be the province of a systemic council, which I will discuss in greater detail shortly. The decision should take into account both individual institutional concerns and systemic concerns. Our current legal requirements for resolving the troubled financial system is flawed in that it is onedimensional, causing the FDIC to make the call on the basis of what would 

pose the ‘‘least cost to the DIF,’’ not on the basis of the least cost to the economy, or to the financial system. I emphasize that this is not a criticism of the 

FDIC; that agency is doing what it has to do under current law. My criticism 

is of the narrowness of the law itself. 

d. Resolution Mechanics. In terms of which agency should be in charge of the mechanics of resolution itself, there are a number of ways the Congress could 

come out on this question, all of which have pluses and minuses. Giving the 

responsibility to the FDIC makes sense in that the FDIC has been engaged 

successfully in resolving banking organizations and so has important resolutions expertise. One could also argue that the primary regulator that knows 

the institution best should be in charge of the resolution, calling upon the DIF 

for money and back up. The primary regulators do in fact have some useful 

resolutions and conservatorship experiences, though they have not typically 

been active in the area, in part due to the lack of a dedicated fund for such 

purposes. Or one could argue for a special agency, like the RTC, perhaps under 

the control of the new systemic risk council. 

I have not settled in my own mind which of these models works best, except to 

be certain that the institution in charge of resolutions has to be highly professional 

and that a special process must be in place to deal with the extraordinary issues 

presented by the failure of an extremely large and interconnected financial institution. 

In sum, I urge Congress to create a new function that can require the resolution 

of a large, complex financial institution. This new function can be handled as part 

of the responsibilities of the Systemic Risk Council discussed below. The mechanism 

that calls for resolution of a large troubled financial institution need not be the 

same institution that actually engages in the resolution activity itself. Any of the 

FDIC, the primary regulator and/or a new resolution mechanism could do the job 

of actually resolving a large troubled institution if properly organized for the purpose, though certainly much can be said for the FDIC’s handling of this important 

mechanical function, given its expertise in the area generally. Even more important, 

it is absolutely key that we clarify existing law so that the decision—and the mechanics—to resolve a troubled institution is a question first of financial stability for 

the system and then a question of least-cost resolution. 

4. A new systemic risk identification and mitigation mechanism must be created by 

the Federal Government; A financial council is best suited to be responsible for 

this important function. 

Nature of the Problem. The financial crisis we have been living through makes 

clear beyond a doubt that systemic risk is no abstraction. Starting in the summer 

of 2007, we experienced just how the rumblings of a breakdown in the U.S. 

subprime housing market could ripple out to Germany and Australia and beyond. 

Last year, we witnessed the devastating effects the demise of Lehman Brothers, a 

complex and interconnected financial company, could have on the financial system 

and the economy as a whole. The entire international financial system almost came 

to a standstill post Lehman Brothers failure. 

Notwithstanding the magnitude of the problem and the possible outcomes of a 

Lehman Brothers failure, our financial regulatory mechanism was caught relatively 

unaware. For more than a year preceding the Lehman Brothers catastrophe our regulatory mechanism was in denial, considering the problem to be a relatively isolated 

subprime housing problem. 

The same failure to recognize the signs of an impending crisis can be laid at the 

feet of the regulatory mechanism prior to the S&L crisis, the 1987 stock market 

meltdown, the banking crisis of the early 1990s, the emerging market meltdown of 

1998, and the technology crisis of 2000–2001. No agency of Government has functioned as an early warning mechanism, nor adequately mitigated systemic problems 

as they were emerging. 

Only after the systemic problem was relatively full blown have forceful steps been 

taken to quell the crisis. In some cases the delay in taking action and initial governmental mistakes in dealing with the crisis have cost the Nation dearly—as was true 

in the S&L crisis. The same can be said of the other crises of the preceding century 

where for example in the case of the Great Depression, steps taken by the Govern-
141 

ment after the problem arose—to withdraw liquidity from the market—actually 

made the problem markedly worse. 

Admittedly, identifying potential systemic problems is hard. It involves identifying 

financial ‘‘bubbles,’’ unsustainable periods of excess. However, though difficult, 

economists outside of Government have identified emerging bubbles, including the 

past one. Furthermore, there are steps that can be taken to mitigate such emerging 

problems, for example, increasing stock margin requirements or tightening lending 

standards or liquefying the markets early in the crisis. 

The Need To Create a New Governmental Mechanism. This Committee is wisely 

contemplating the creation of a Systemic Risk Council as a new mechanism to deal 

with questions of systemic risk. There is general agreement that some new mechanism is needed for identifying and mitigating systemic problems as none exists at 

the moment. 

Indeed, the current Treasury Department has also wisely highlighted the importance of considering systemic risk as one of the issues on which to focus as a central 

part of financial regulatory modernization. Former Treasury Secretary Paulson, too, 

who spearheaded Treasury’s ‘‘blueprint,’’ focused on this important issue. There is 

now a reasonable consensus that there are times when financial issues go beyond 

the regulation and supervision of individual financial institutions. 

Why a Council in Particular Makes the Most Sense. There are a number of reasons 

why no current agency of Government is suited to be in charge of the systemic risk 

issue, and why a council with its own staff is the best approach for dealing with 

this problem. 

1. Systemic Risk: A Product of Governmental Action or Inaction. It is essential to 

emphasize that historically, virtually all systemic crises are at their root 

caused by Government action or inaction. Though individual institutional 

weakness or failure may be the product of these troubled times and may add 

to the conflagration, the conditions and often even the triggering mechanisms 

for a systemic crisis are in the Government’s control. 

i. For example, the decision to withdraw liquidity from the marketplace in the 

1930s and the Smoot-Hawley tariffs were important causes of the Great Depression; 

ii. The decision to raise interest rates in the 1980s coupled with a weak regulatory mechanism and expansion of S&L powers led to the S&L failures of 

the 1980s; 

iii. The decision to produce an extended period of low interest rates, the unwillingness to rein in an over-levered consumer—indeed quite the contrary— 

and high liquidity coupled with a de-emphasis of prudential regulation is at 

the root of the current crisis. 

2. No Current Regulatory Agency Is Well Suited for the Task. Our existing regulators are not well suited, acting alone, to identify and/or mitigate systemic 

problems. There are a variety of reasons for this. 

a. Substantial Existing Duties. First, each of our existing institutions already 

has substantial responsibilities. 

b. Systemic Events Cross Existing Jurisdictional Lines. Second, systemic events 

often cross the jurisdictional lines of responsibilities of individual regulators, 

involving markets, sector concentrations, monetary policy considerations, 

housing policies, etc. 

c. Conflicts of Interest. Third, the responsibilities of individual regulators can 

create built-in conflicts of interest, biases that make it harder to identify and 

deal with a systemic event. 

d. Systemic Risk Not Fundamentally About Individual Private Sector Institution 

Supervision. Fourth, as noted above, it bears emphasis that the actions needed to deal with systemic issues (identification of an emerging systemic crisis, 

or the conditions for such a crisis, and then action to deal with the impending crisis) are largely not about supervising individual private-sector institutions. 

e. Systemic Events May Involve Any One Agency’s Policies. Systemic crises may 

emanate from the polices of an individual financial agency. That has been 

true in the past. It is hard to have confidence that the same agency involved 

in making the policy decisions that may bring on a systemic crises will not 

be somewhat myopic when it comes to identifying the policy law or how to 

deal with it. 
142 

f. Too Many Duties and Difficulties In Oversight. There is a legitimate concern 

that adding a systemic risk function to the already daunting functions of any 

of our existing financial agencies will simply create a situation where the 

agency will be unable to perform any one function as well as it would otherwise. Furthermore, Congressional oversight is made considerably more difficult where an agency has multiple responsibilities. 

g. Too Much Concentrated Power. Giving one agency systemic risk authority 

coupled with other regulatory authorities moves away from a situation of 

checks and balances to one of concentrated financial power. This is particularly true where systemic risk authority is incorporated in an agency with 

central banking powers. Any entity this powerful goes precisely against the 

wisdom of our founding fathers, who again and again opposed the centralization of economic power represented by the establishment of the First and 

Second Banks of the United States, and instead repeatedly insisted upon a 

system of checks and balances. They were wary, and I believe the current 

Congress should likewise be wary, of any one institution that does not have 

clear, simple functional responsibilities, or that is so large and sprawling in 

its mission and authority that the Congress cannot exercise adequate oversight. 

3. Multiple Viewpoints With Focused Professional Staff. A Systemic Risk Council 

of the type contemplated by Committee has the virtue of combining the wisdom 

and differing viewpoints of all the current financial agencies. Each of these 

agencies sees the financial world from a different perspective. Each has its own 

expertise. Combined they will have a more fulsome appreciation of a larger 

more systemic problem. 

Of course, a council alone without a leader and staff will be less effective. To 

be a major factor in identifying and mitigating a systemic issue, the council will 

need a strong and thoughtful leader appointed by the President and confirmed 

by the Senate. That leader will need to have a staff of top economists and other 

professionals, though the staff can be modest in size and draw on the collective 

expertise of the staffs of the members of the council. 

Accordingly, I urge Congress to adopt a system whereby the Federal Reserve 

along with its fellow financial regulators and supervisors should form a council, the 

board of directors, if you will, of a new systemic risk agency. The agency should 

have a Chairman and CEO who is chosen by the President and confirmed by the 

Senate. The Chairman should have a staff: 

• The function of the systemic risk council’s staff should be to identify potential 

systemic events; take actions to avoid such events; and/or to take actions to 

mitigate systemic events in times of a crisis. 

• Where the Chairman of the systemic council believes he or she needs to take 

steps to prevent or mitigate a systemic crisis, he or she may take such actions 

irrespective of the views of the agencies that make up the council, provided a 

majority of the council agrees. 

5. Taking additional steps to enhance the professionalization of America’s financial 

services regulatory mechanism should be a top priority. 

America is blessed with an extremely strong group of dedicated regulators at our 

current financial services regulatory agencies. However, we must do much more to 

provide professional opportunities for our fine supervisory people: 

a. As I have said many times before, many colleges and universities in America 

today offer every conceivable degree except a degree in regulation, supervision, 

financial institution safety and soundness—let alone the most basic components of the same. Even individual courses in these disciplines are hard to 

come by. 

b. We should encourage chaired professors in these prudential disciplines. 

c. What I hope would be our new institutional regulatory agency should have the 

economic wherewithal to provide not just training but genuine, graduate 

school-level courses in these important disciplines. 

In sum, we need to further professionalize our regulatory, examination and supervision services, including by way of enhancing university and agency professional 

programs of study. 
143 

6. Regulate all financial institutions, not just banks. All financial institutions engaged in the same activities at the same size levels should be similarly regulated. 

We cannot have a safe and sound financial services regulatory system that has 

to compete with un-regulated and under-regulated entities that are engaged in virtually identical activities: 

a. It simply does not work to have a large portion of our financial services system 

heavily regulated with specific capital charges and limits on product innovation, while we allow the remainder of the system to play by different rules. For 

America to have a safe and sound financial system, it needs to have a level 

regulatory playing field; otherwise the regulated sector will have a cost base 

that is different from the unregulated sector, which will drive the heavily regulated sector to go further out on the risk curve to earn the hurdle rates of return needed to attract much needed capital. 

b. In this regard, I want to emphasize that good regulation does not mean a lot 

of regulation. More is not better; bigger is not better; better is better. Sound 

regulation does not mean heaping burdens upon currently regulated or unregulated financial players—quite the contrary. I have come to learn after a lifetime of working with the regulatory services agencies that some regulations 

work well, others do not work and perhaps even more importantly many banks 

and other organizations are made markedly less safe where the regulator 

causes them to focus on the wrong item and/or piles on more and more regulation. Regulators too often forget that a financial services executive has only so 

many hours in a day. Targeting that time on key safety and soundness matters 

is critical to achieving a safer institution. 

7. Protecting consumer interests and making sure that we extend financial services 

fairly to all Americans must be a key element of any regulatory reform. We cannot have a safe and sound financial system without it. 

We cannot have a safe and sound financial regulatory system that does not protect the consumer, particularly the unsophisticated, nor can we have a safe and 

sound financial system that does not extend services fairly and appropriately to all 

Americans. 

The Administration has in this regard come out with a bold proposal to have an 

independent financial services consumer regulator. There is much to commend this 

proposal. However, this concept has been quite controversial not only among bankers but even among financial services regulators. Why? I think at the center of what 

gives serious heartburn to the detractors of this concept are three matters that deserve the attention of Congress: 

a. First, critics are concerned about the burdens that such a mechanism would 

create. These burdens are particularly pronounced without a single prudential 

regulator like the one I have proposed, because without such a change, we 

would again be adding to our alphabet soup of regulators. 

b. Second, I believe critics are justifiably concerned that the new agency would 

at the end of the day be all about examining and regulating banking organizations and bank-related organizations but not the un- and under-regulated financial services companies, many of which are heavily implicated as causes of 

the current crisis. 

c. Third, there is a concern that the new mechanism will not give rise to national 

standards but rather, by only setting a national standards floor, will give rise 

to 50 additional sets of consumer rules, making the operation of a retail banking organization a nightmare. 

For myself, I feel strongly that an independent consumer regulatory agency can 

only work if these three problems are solved. And I believe they can be solved in 

a way that improves upon the current situation for all stakeholders. My recommendations follow: 

• Focus On Un- and Under-regulated Institutions. First, I would focus a new independent consumer financial regulatory agency primarily on the un- and underregulated financial services companies. These companies have historically 

caused most of the problems for consumers. Many operate within well-known 

categories—check cashers, mortgage brokers, pay-day-lenders, loan sharks, 

pawn brokers—so they are not hard to find. It is here that we need to expend 

the lion’s share of examination and supervisory efforts. 

• Minimize Burden. Second, consistent with my comments on prudential supervision, I would work to have maximum effectiveness for the new agency with 

minimum burden. In this regard, it is hard to judge such burden unless and 
144 

1Martin Neil Baily is the Bernard L. Schwartz Senior Fellow in the Economic Studies Program at the Brookings Institutions, the cochair of the Pew Working Group on Financial Sector 

Reform and a member of the Squam Lake group of academics studying financial reform. He was 

Chairman of the Council of Economic Advisers under President Clinton. The opinions expressed 

are his own but he would like to thank Charles Taylor, Alice Rivlin, Doug Elliott, and many 

other colleagues for helpful comments. 

until we can see all the financial services regulatory modernization measures. 

Chairman Dodd and Ranking Committee Member Shelby, you along with many 

of your fellow Committee Members should be commended for waiting to act on 

any piece of financial services regulatory modernization until we can see the entire package—for precisely these reasons. 

• National Standards for Nationally Chartered Entities. Third, we need to establish uniform national standards for nationally chartered financial organizations. 

We are one Nation. One of our key competitive advantages as a Nation is our 

large market. We take a big step toward ruining that market for retail finance 

when we allow every State to set its own standards with its own enforcement 

mechanism or entities that have been nationally chartered and are nationally 

supervised. Do we really want to be a step behind the European Union and its 

common market? Do we really want to cut up our country so that we are less 

competitive vis-a-vis other large national marketplaces like China, Canada, and 

Australia? I hope not. I do not think many of the detractors of the current independent consumer agency proposal would continue to oppose the legislation— 

irrespective of how high the standards are—if the standards are uniform nationally and uniformly examined and enforced. 

• Utilization of Existing Supervisory Teams. It is worth noting that one way to 

deal with the burden question that has been suggested by Ellen Seidman, 

former Deputy to the National Economic Council and former Director of the 

OTS, is to allow the new agency to set rules and allow the banking agencies 

to continue to be in charge of examination and enforcement. There is a great 

deal to say for this approach. However, I am reserving my own views until I 

see the entire package evolve, absolute musts being for me the three items just 

mentioned: strict burden reduction, true national standards, and a focus on the 

unregulated and under-regulated financial services entities. 

Conclusion 

In conclusion, Mr. Chairman, I again want to commend you, your colleagues, and 

the Committee staff for the serious way in which you have attacked this national 

problem. The financial crisis has laid bare the underbelly of our economic system 

and made clear that system’s serious vulnerabilities. We are at a crossroads. Either 

we act boldly along the lines I have suggested or generations of Americans will, I 

believe, pay a very steep price and our international leadership in financial services 

will be shattered. 

Thank you. I would be pleased to answer any questions you may have. 

PREPARED STATEMENT OF MARTIN N. BAILY 

SENIOR FELLOW, ECONOMIC STUDIES, THE BROOKINGS INSTITUTION

SEPTEMBER 29, 2009 

Thank you Chairman Dodd, Ranking Member Shelby, and Members of the Committee for asking me to discuss with you the reform of Federal regulation of financial institutions. 1

I would like to share with the Committee my thoughts on consolidation of the 

Federal financial regulatory agencies and what it would take to make them successful in the future. However, this is part of a larger puzzle—the reorganization of Federal financial regulation generally and, in some respects, it is difficult to discuss the 

narrower topic without examining the broader context. I will therefore also say 

something about possible complementary changes in the roles of the Federal Reserve, the SEC and the proposed CFPA. 

A summary of my testimony today is as follows: 

• The best framework to guide current reform efforts is an objectives approach 

that divides regulation up into microprudential, macroprudential, and conduct 

of business regulation. 

• The quality of regulation must be improved regardless of where it is done. Regulatory and supervisory agencies must have better qualified, better trained and 
145 

2See, ‘‘Pew Financial Reform Project Note #2: Choosing Agency Mandates’’, by Charles Taylor. 

better paid staff with clear objectives to improve safety and soundness and encourage innovation. Regulatory personnel must be accountable for their actions. 

• A single Federal microprudential regulator should be created combining the regulatory and supervisory functions currently carried out at the Fed, the OCC, 

the OTS, the SEC, and the FDIC. This regulator should partner closely with 

State regulators to ensure the safety and soundness of State chartered financial 

institutions, sharing supervisory authority. 

• The U.S. needs effective conduct of business regulation. The SEC is currently 

charged with protecting shareholders and the integrity of markets and must improve its performance in this area. In my judgment, the SEC should also create 

a new division within the agency to protect consumers, that is to say, it would 

add a CFPA division and become the consolidated conduct of business regulator. 

Although my first choice is for a single conduct of business regulator, a welldesigned standalone CFPA could also be effective. 

• The Fed should be the systemic risk monitor with some additional regulatory 

power to adjust lending standards. In this it should work with a Financial Services Oversight Council, as has been proposed by the Treasury. 

The Objectives Approach to Regulation 

I support an objectives-based approach to regulation. 

The Blueprint for financial reform prepared by the Paulson Treasury proposed a 

system of objectives-based regulation, an approach that is the basis for successful 

regulation in Australia and other countries overseas. The White Paper prepared by 

the Geithner Treasury did not use the same terminology, but it is clear from the 

structure of the paper that their framework is an objectives-based one, as they lay 

out the different elements of regulatory reform that should be covered. However, 

they do not follow through the logic of this approach to suggest a major reorganization of regulatory responsibilities. 

There are three major objectives of regulation: 

• First is the microprudential objective of making sure that individual institutions are safe and sound. That requires the traditional kind of regulation and 

supervision—albeit of improved quality. 

• Second is the macroprudential objective of making sure that whole financial sector retains its balance and does not become unstable. That means someone has 

to warn about the build up of risk across several institutions and take regulatory actions to restrain lending used to purchase assets whose prices are creating a speculative bubble. 

• Third is the conduct of business objective. That means watching out for the interests of consumers and investors, whether they are small shareholders in public companies or households deciding whether to take out a mortgage or use a 

credit card. 

An objectives-based approach to regulation assigns responsibilities for these three 

objectives to different agencies. The result is clear accountability, concentration of 

expertise, and no gaps in coverage of the financial services industry—even as its 

structure changes and new products, processes and institutional types emerge. No 

other way of organizing regulation meets these important criteria while avoiding an 

undue concentration of power that a single overarching financial services regulator 

would involve. 2 The main focus of this testimony will be to make the case for a single microprudential regulator, something I believe would enhance the stability of 

the financial sector. Having a single microprudential regulator is not a new idea. 

In 1993, the Clinton Administration and the Paulson Blueprint in 2008 proposed the 

same thing. 

It is important to remember that how we organize regulation is not an end in 

itself. Our plan must meet the three objectives efficiently and effectively, while 

avoiding over-regulation. In addition for objectives-based regulation to work, it is essential to use the power of the market to enhance stability. Many of the problems 

behind the recent crisis—executive and trader compensation, excessive risk taking, 

obscure transaction terms, poor methodologies, and conflicts of interest—could have 

been caught by the market with clearer, more timely and more complete disclosures. 

It will never be possible to have enough smart regulators in place that can outwit 

private sector participants who really want to get around regulations. An essential 

part of improving regulation is to improve transparency, so the market can exert 

its discipline effectively. 
146 

The Independence of the Federal Reserve 

In applying this approach, it is vital for both the economy and the financial sector 

is that the Federal Reserve has independence as it makes monetary policy. Experience in the U.S. and around the world supports the view that an independent central bank results in better macroeconomic performance and restrains inflationary 

expectations. An independent Fed setting monetary policy is essential. 

The Main Regulators and Lessons From the Crisis 

The main Federal microprudential regulators had mixed performance at best during the recent crisis. 

OTS did worst, losing its most important institutions—WaMu, IndyMac, and 

AIG—to sale and outright failure. Without any economies of scale in regulation, 

OTS suffered from a small staff in relation to their supervisory responsibilities. Its 

revenue was dominated by fees on a very small number of institutions, leading to 

regulatory capture. And, as many have observed, OTS lax standards attracted institutions to a thrift charter and it because the weakest link in the Federal financial 

depository regulatory chain. The lessons were: regulatory competition can create a 

de facto race to the bottom; and large institutions cannot be supervised and regulated effectively by small regulators—not only because of the complexity of the task 

but also because of capture. 

The Office of the Comptroller of the Currency (OCC) fared only somewhat better. 

Their responsibilities were far wider and their resources were far greater. Nevertheless, several of their larger institutions failed and had to be rescued or absorbed. 

While an element of the problem was that there were parts of these institutions 

where their writ did not reach—OCC-regulated banks bought billions of dollars of 

CDOs, putting many of them into off-balance-sheet entities—it was not the only 

problem. Somehow, even this relative powerhouse failed to see the crisis coming. 

The lessons were: even the best of the Federal regulators may not have been up 

to the demanding task of overseeing highly complex financial institutions; and balkanized and incomplete coverage by microprudential regulators can be fatal. 

The FDIC is rightly given credit for having championed the leverage ratio as an 

important tool of policy. While the Fed and the OCC became increasingly enamored 

of Basel II over the past 10 years, the FDIC suffered repeated criticism for their 

stick-in-the-mud insistence on the leverage ratio. On that issue, they have been vindicated not only here in the U.S., but internationally. But they did not do so well 

in prompt corrective actions during this crisis. Their insurance fund dropped from 

$45bn to $10bn in 12 months. Several of the firms that failed were well capitalized 

just days beforehand. The lesson is that liquidity and maturity transformation can 

matter as much as leverage in a crisis. Prompt corrective action focused on capital 

ratios alone is not enough. 

While some State regulators have a fine record, nonbank financial institutions, 

largely overseen at the State level, were a major source of trouble in the recent financial crisis. Often working with brokers, these institutions originated many of the 

subprime, prime, and jumbo mortgages that have subsequently defaulted. They provided the initial funding for mortgages, but then quickly sold them to other entities 

to be packaged and securitized into the CDOs that were sliced and diced and resold 

with high credit ratings of dubious quality. They made money by pushing mortgages 

through the system and did not carry risk when these mortgages defaulted. Many 

State regulators failed to control bad lending practices. The main lessons: skin in 

the game is needed to keep the ‘‘handlers’’ of securitizations honest; and any reform 

of financial regulation has to somehow strengthen State regulation as well as Federal. 

Perhaps the most difficult regulator to assess in the current crisis is the Federal 

Reserve. 

More than any other institution, it has prevented the financial system from falling 

off a cliff through often brilliant and unprecedented interventions during the worst 

days of the crisis. I have expressed publicly my admiration for the job that Ben 

Bernanke has done in managing this crisis with Secretary Geithner and others. 

Taxpayers are understandably angry because of the funds that have been spent or 

put at risk in order to preserve the financial sector, but the alternative of a more 

serious collapse would have been much worse. The historical experience of financial 

crises here in the United States and around the world is that a banking collapse 

causes terrible hardship to the economy, even worse than the current recession. 

Bernanke and Geithner have helped avoid that disaster scenario. 

However, the Fed did nothing at all for 14 years to prevent the deterioration in 

mortgage lending practices, even though Congress had given it the authority to do 

so in 1994 under HOEPA. Several of the bank holding companies under Fed supervision faced severe problems in the crisis—its microprudential regulation was inef-
147 

fective. And, while the Fed has repeatedly claimed that systemic risk management 

was their responsibility, they failed to anticipate, or even prepare for, the crisis in 

any meaningful way. 

In short, in its role as a regulator of bank holding companies, the record of the 

Fed is not good. Bank regulation has been something of a poor relation at the Fed 

compared to the making of monetary policy. The Fed as an institution has more 

stature and standing than any other Federal financial institution, but this stature 

comes from its control over monetary policy, not on its role in bank supervision and 

regulation. In addition, the Fed’s powers were limited. It could not gain access to 

key information from many large financial institutions and had no power to regulate 

them. Lehman and Bear Stearns are two examples. 

While, the Fed has increased its knowledge and understanding of the large banks 

as a result of managing the crisis and conducting the stress tests, the lessons are: 

having an institution with a secondary mandate for consumer protection (under 

HOEPA) does not work well; and the Fed’s focus on monetary policy also makes it 

difficult to direct enough institutional focus on supervision. 

Finally, there is the Securities and Exchange Commission which did an abysmal 

job in this crisis. It told the public that Bear Stearns was in fine shape shortly before the company failed; in fact it failed to supervise effectively any of the bulge 

bracket firms, Merrill Lynch, Bear Stearns, Goldman Sachs, Morgan Stanley, and 

Lehman). It did nothing to restrain the credit agencies from hyping the ratings of 

CDOs. And it did not stop Madoff and others from defrauding investors. However, 

the leadership has changed at the SEC and I believe it has learned important lessons from the crisis: its strong suit is not microprudential regulation of institutions; 

it must focus on investor protection and the integrity of the markets—not only the 

traditional ones like the stock and bond markets, but also the securitization market—including the development and implementation of policies to revamp 

securitization credit ratings. 

One vital issue to recognize in regulating the large financial institutions is that 

they are run as single businesses. They decide what their business strategies will 

be and how to execute them most effectively. The specific legal forms they choose 

for their different divisions is determined by what they think will work best to 

achieve their strategic goals, given the tax, regulatory and legal environment that 

policymakers have set up. Under the current regulatory system, the Fed supervises 

and regulates the bank holding company while, for example, the OCC supervises the 

U.S. banks that are the subsidiaries of the holding company. Most of the large financial institutions are in several lines of business and, at present, are regulated 

by more than one agency. Inevitably, this encourages them to shift activities to the 

subsidiary and hence the regulator that is most tolerant of the activity they want 

to pursue. Balkanized regulation is unlikely to stop the next crisis. 

This short review is not inclusive. There are credit unions that have a separate 

regulator and there are important issues around the GSE’s and their regulation and 

around derivatives and their regulation that I will not tackle in this testimony. This 

review has been critical of the regulatory agencies but I want to note that there are 

many people to blame for the financial crisis, including bankers who took excessive 

risks and failed to do due diligence on the assets they purchased. Economists generally did not predict that such a severe crisis was possible. Very few people saw 

the possibility of a 20 percent or more decline in the price of housing and almost 

nobody saw the depth of problems that have resulted from the sharp declines in 

house prices. 

What Structure Best Meets the Objectives of Financial Regulation? 

Regulatory Performance Must Be Improved Regardless of Where It Is Done 

There must be improved performance in the supervision and regulation of financial institutions regardless of who is doing it. There were rooms full of regulators 

sitting in all of the large regulated financial institutions prior to the crisis and they 

failed to stop the crisis. This means there should be more accountability for regulators, so that they are censured or removed if they do not perform the role they 

were hired to do. It means they should be better paid. It seems paradoxical to reward a group that did not do so well historically, but if we want better regulators 

then they must receive salaries that make their jobs attractive to high quality people, those who can understand complex institutions and products and who may have 

the option of earning high incomes in the private sector. Adequate training must 

be available. Better quality regulation is a ‘‘must-have’’ of financial reform and must 

be part of the legislation now being considered. A lot of improvement can be made 

even under existing legislation if regulators have the incentives and abilities to do 

their jobs. 
148 

Some people argue that regulation has been the cause of the problem and that 

if the Government were removed from the equation then the financial sector would 

regulate itself, with weak companies failing and the strong companies surviving. 

Overall, I am a strong supporter of letting markets work and letting companies fail 

if they cannot be efficient or innovative. This includes financial institutions that 

should be allowed to fail if they do make bad decisions and fail to meet the market 

test. The financial sector has unique features that make it different from most other 

industries, however. Failure in one institution can spill over to others and problems 

in the financial sector can rock the whole economy, as we have seen in this crisis. 

Regardless of one’s perspective on this issue, however, it is clearly a mistake to create worst of both worlds. If the Government provides a safety net for consumer deposits and props up financial institutions in a crisis, then there must be effective 

high quality regulation that will protect the interests of taxpayers. 

The Case for a Consolidated Microprudential Regulator for the Financial Sector 

A single prudential regulator would become a powerful institution with stature in 

the policy community that could hire talented staff and attract strong and able leadership. It would be formed by drawing together the best people from the existing 

supervisors and regulators in the OCC, the OTS, the SEC, the FDIC, and the Federal Reserve, it would hire financial experts in areas where more expertise was 

needed, and it would be the primary supervisor of the institutions that make up the 

financial sector of the United States. The head of the organization would be chosen 

by the President with the consent of the Senate and would serve for a term of several years. It would be worth considering a structure like that of the Federal Reserve, with a board that served staggered 16 year terms. Thus constituted, the financial regulator would have the standing and capability to stand up to the heads 

of leading financial institutions and to be an independent arbiter. It would be a 

partner with and advisor to the Administration, Congress and the Federal Reserve. 

The financial sector does not stand still. It evolves and innovates and new institutions and products are born. A single prudential regulator with the necessary staff 

and skills would be best positioned to evolve along with the industry and adapt regulation to a changing world. Having a single prudential regulator would make it 

much easier to avoid gaps in regulation and discourage the kind of regulatory evasion that contributed to the crisis. It would also reduce the regulatory burden on 

financial institutions because it would avoid much of the duplication that now exists. 

A single prudential regulator would supervise and regulate large institutions and 

small and be able to maintain a level playing field for competition. It would be able 

to examine all of the activities of the large global banks and make sure they were 

not accumulating excessive risks through a combination of activities in different 

parts of their business. 

There is a great deal to be said for competition in our economy. Ultimately, competition in the private sector drives innovation and growth and provides choices to 

consumers. It is the lifeblood of our economy. It is not clear, however, that competition among regulators a good thing. The serious danger in regulatory competition 

is that it allows a race to the bottom as financial institutions seek out the most lenient regulator that will let them do the risky things they want to try, betting with 

other people’s money. One possible advantage of regulatory competition is that it 

could make it easier for companies to innovate whereas a single regulator might become excessively conservative and discourage new products even if these would 

bring substantial benefits. However, given the experience of the recent crisis, the 

dangers created by multiple regulators, including a race to the bottom, are greater 

and outweigh the possible advantages of competition among regulators. 

An effective single prudential regulator acting as a cop on the beat could actually 

increase the level of effective competition among private companies in the financial 

sector, thus making the private market work better. In addition, it would be very 

important that the mandate of the single prudential regulator include the promotion 

of innovation and economic growth. The U.S. financial sector has been one of the 

strongest in the world and has been one of our major exporters. Prior to the crisis 

there was great concern that the New York financial markets were losing their global competitive position—See, for example the Bloomberg-Schumer report. The goal 

of sustaining a dynamic and competitive sector remains vital. 

Another advantage of creating a single Federal prudential regulator is that it 

would enhance the independence of the Federal Reserve in making monetary policy. 

It gets the Fed out of the regulatory business and lets it concentrate on its main 

tasks. 
149 

3 I have testified to this Committee before on the dangers of ‘‘too big to fail’’ or ‘‘too interconnected to fail.’’ An important aspect of regulatory reform is to make sure badly run financial 

companies are allowed to fail in a way that does not imperil the whole system, either through 

a resolution mechanism or through a special bankruptcy court. The FDIC would play an important role with either system. 4The Federal Reserve did not do a good job in protecting consumers in the period leading 

up to this crisis, nor did it stop the erosion of mortgage lending standards that contributed to 

build up of toxic assets in the financial system. Since the crisis, however, the consumer protection division within the FED has been strengthened and is now an effective force with strong 

leadership. The personnel from the consumer protection division of the FED, together with the 

best personnel in this function in other agencies, could be moved into the new CFPA division. 

The Role of the FDIC 

With a single microprudential regulator, the FDIC would lose the supervisory and 

regulatory authority it has now. Staff from the FDIC that have performed well in 

this crisis would move to the new prudential regulator, so there would not be a loss 

of knowledge or expertise. The role of the FDIC as manager and supervisor of the 

deposit insurance fund would continue. In this position, it would also be able to 

sound warnings about depository institutions in difficulties, acting as a backup for 

the new unified prudential regulator. Another possibility is that the FDIC would become the principle agency dealing with the resolution of failing institutions. 3

The SEC as the Conduct of Business Regulator 

Under the single prudential regulator described above, the SEC would lose its authority to supervise nonbank financial institutions, which would reside instead with 

the prudential regulator. The SEC would continue to have a very important role as 

a protector of the interests of shareholders, a bulwark against insider trading, market manipulation, misselling and other practices that can undermine our capital 

markets. There is a case for giving the SEC additional authority to provide consumers protection against financial products that are deceptive or fraudulent. 

The Treasury White Paper proposed establishing a new standalone agency, the 

CFPA, to provide consumer protection and it is understandable that such a proposal 

is made given what has happened. There were a lot of bad lending practices that 

contributed to the financial crisis. As noted earlier, many brokers and banks originated mortgages that had little chance of being repaid and that pushed families 

onto the street, having lost their savings. There was also misbehavior by borrowers, 

some of whom did not accurately report their income or debts or manipulated their 

credit scores. I agree with the Administration and many in Congress—notably 

Chairman Dodd—on the importance of protecting families against a repetition of the 

bad behavior that proliferated in recent years. 

My first choice would be to place the responsibility for consumer protection in a 

new division within the SEC rather than creating a separate agency. The proliferation of regulators was a contributory factor in the crisis, so that adding a new agency is something that should be done reluctantly. While the SEC did badly in the 

crisis, there has been an important change in leadership and the new head of the 

agency is clearly someone of strength and talent who has pledged reform in the operations of the agency. Congress should ask the SEC to form a new CFPA division 

within its ranks charged specifically with consumer protection. 4

Placing the tasks of the CFPA into the SEC would create a single strong conduct 

of business regulator with divisions specifically tasked to protect both consumers 

and small and minority shareholders. It would also make it easier to gain acceptance for greater consumer protection from the financial industry. The CFPA has become a lightning rod for opposition to regulatory reform. Given that the financial 

sector is largely responsible for the crisis, it is surprising that this sector is now 

lobbying so hard against greater consumer protection. Greater protection for consumers is needed and that would also provide greater protection for taxpayers. However, having the CFPA functions as a division within the SEC would accomplish 

that goal while calming industry fears. 

Having the CFPA functions within the SEC is my first choice, but if Congress decides against this approach, I could support a standalone agency. The Treasury 

White Paper does a good deal to allay the fears that the new agency would stifle 

innovation, including: the overall focus on unfair, deceptive, and dangerous practices, rather than risk, per se; the instruction to weigh economic costs and benefits; 

the instruction to place a significant value on access to financial products by traditionally underserved consumers; the prohibition against establishing usury limits 

and; the option to consider previous practice in regard to financial products. The 
150 

5See, additional discussion of these issues by Douglas Elliott of Brookings and also by the 

current author posted on the Brookings Web site. The financial reform project of the Pew Charitable trusts has also posted material on the topic. 

Treasury recognizes the dangers of having an agency that would overreach and its 

proposed structure would avoid that possibility. 5

One final issue with the CFPA is preemption. The Treasury proposal indicates 

that State regulators would have the power to enact consumer protection legislation 

that was stronger than that in the Federal statute. I understand the case for States’ 

rights in this arena, but the prospect of a myriad of different State rules is daunting 

and has the potential to reduce the efficiency of the massive U.S. marketplace. 

There has been enormous progress towards a single market in financial products, 

leveling the playing field for businesses and consumers, so that the terms of loans 

or other financial activities are the same in all States. Whether or not Federal consumer protection rules preempt State rules is not a major issue for safety and 

soundness, but having single set of consumer rule uniform in all States would improve economic efficiency. As a result, I support the view that Federal rules should 

preempt State rules in this area. 

Regulating State Chartered Financial Institutions 

Starting with a clean sheet of paper, I would prefer to see all banks and relevant 

nonbank financial institutions have Federal charters and be supervised by the unified prudential regulator. However, that is not the situation we are in and I recognize the importance of States’ rights and the desire to have local institutions that 

can help local businesses by using the power of personal knowledge and relationships. It is a fact of life that there will continue to be State chartered banks subject 

to State supervision. 

In the short run, it is unlikely that we will see again State chartered nondepository institutions that are originating and selling bad mortgages. The markets have 

been burned and will remember for a while that such institutions may not be selling 

quality products. Over the years, however, memories will fade and regulatory reform 

enacted today should avoid problems in the future as far as possible. I urge Congress to require State regulators to partner with the Federal prudential regulator 

in order to harmonize safety and soundness standards and to exchange information 

for State chartered banks and nonbanks. The Federal prudential regulator should 

set out minimum standards that it would like to see in State run financial institutions. And State regulators should be required to exchange data with the Federal 

regulator and work in cooperation with them. This is already how things work for 

most banks and it is important that we do not see in the future a situation where 

State charters are exploited by nonbank financial institutions to undercut the safety 

of the financial system. 

The Federal Reserve as Systemic Risk Monitor or Regulator 

The Treasury White Paper has proposed that there be a council, an extension of 

the President’s Working Group on financial stability to coordinate information and 

assess systemic risk. The Working Group has played a valuable role in the past and 

I support its extension to include the leaders of all institutions with power to regulate the financial sector. As others have said, however, committee meetings do not 

solve crises. 

The proposal outlined earlier in this testimony is for a single microprudential regulator, which would deprive the Fed of all its microprudential functions. However, 

I propose that monitoring and managing systemic stability and responding to increased exposure to systemic risks formally be added to the Fed’s responsibilities. 

The strong performance of the Fed in managing this crisis strongly suggests that 

this institution should be the primary systemic risk monitor/regulator. Moreover, 

this role is a natural extension of monetary policy, which can be thought of as the 

monitoring of, and response to, macroeconomic developments. It fits with the dominant culture of economists and the Fed’s strong tradition of independence, which are 

both needed for systemic risk management to be effective. It would slightly cut into 

the role you have proposed for the Financial Services Oversight Council, but not 

much. 

For monitoring the economy and for making monetary policy the Fed needs, 

among other things, quick access to a broad base of financial information. Currently, 

the regulatory reporting is primitive. More complete, relevant and real time data 

should be available to all Federal financial regulators. A coordinated information 

strategy for the Federal financial regulatory agencies ought to be one of the first 

tasks of the FSOC. The Fed as systemic regulator would need to work closely with 

the prudential regulator so that it knows what is going on inside the big institu-
151 

tions, and the small ones. It would also need to work closely with the Treasury and 

the FSOC, exchanging information with all members that could help it see dangerous trends as they emerge. 

To respond to specific systemic risks, the Fed needs another instrument in addition to its control over short term interest rates and I suggest that Congress should 

grant the Fed the power to adjust minimum capital, leverage, collateral and margin 

requirements generally in response to changing systemic risks, in addition to the 

specific power it has had to adjust margin requirements in stock trading since the 

Great Depression. The microprudential regulator would set basic minimum standards. The Fed would adjust a ‘‘multiplier’’ up or down as systemic circumstances required. This additional power should be used rarely and in small increments; recall 

how the Volcker-Carter credit restrictions stopped the U.S. economy on a dime in 

1980. 

No one can guarantee that a systemic regulator will be able to foresee the next 

bubble or crisis, but it is definitely worth the effort to spot trouble forming. In particular, the Fed may be able to spot a concentration of purchases of risky assets 

made with borrowed funds. A systemic regulator could have seen that many banks 

had lent large sums to LTCM to speculate in Russian bonds or other risky assets. 

It should have been able to spot the build up of risky CDOs in SIVs that were affiliated with the banks. It could potentially see if large hedge funds or private equity 

companies were using borrowed funds and concentrating on a particularly risk class 

of assets. Analysts who were studying the real estate market prior saw signs of 

trouble well before the crisis started. 

Conclusions 

A single strong agency would meet the objective of microprudential regulation of 

all financial institutions that were subject to regulation and supervision. It would 

work with State regulators, especially to make sure the abuses that contributed to 

the crisis could not be repeated. It would work closely with the conduct of business 

regulator(s) (the SEC and the CFPA) and the Federal Reserve to ensure that consumer protection is adequate, that monetary policymakers are well informed and 

that all these institutions and the Treasury would work together effectively to deal 

with a new crisis should it occur in the future. 

The Federal Reserve has shown its mettle in managing the crisis and should be 

given the role of principle systemic regulator or monitor. It would work closely with 

the members of the risk council in performing this task. It should have the power 

to adjust borrowing rules prudently if it sees a bubble developing driven by excessive leverage. 

The SEC is the natural institution to become the conduct of business regulator 

with a mandate to protect small and minority shareholders and, with a CFPA division, also to protect consumers in financial markets. A single prudential regulator 

plus a single conduct of business regulator would constitute the so-called ‘‘twin 

peaks’’ approach to regulation that many experts around the world see as the best 

regulatory structure. However, a well-designed standalone CFPA could also be an 

effective protector of consumers and taxpayers. 

Appendix: Lessons From the U.K. and Australia 

Opponents of regulatory consolidation in the United States frequently cite the experience of the United Kingdom, which has a consolidated regulator, the Financial 

Services Authority (FSA) but did not escape the crisis, indeed it has suffered perhaps even worse than the United States. Given London’s status as a global financial 

center it was to be expected that the U.K. would face problems in the global crisis, 

but it is surprising that the extensive regulatory reforms undertaken in the late 

1990s did not better insulate the country from the effects of the financial crisis. 

In 1997 the U.K. overhauled its financial regulatory system, combining a myriad 

of independent regulatory authorities (including the regulatory functions of the 

Bank of England, the Securities Investment Board, and the Securities Futures 

Board, among nine total) into a single entity. Then Chancellor of the Exchequer 

Gordon Brown argued that the distinctions between banks, securities firms and insurance companies had broken down, and that in this new era of more fluid and 

interchangeable institutional definitions, the old regulatory divisions no longer made 

sense. The FSA’s statutory objectives are to maintain market confidence, to promote 

public awareness on financial matters, to protect consumers, and to reduce financial 

crime. To achieve those ends, the FSA employs broad investigatory, enforcement, 

and prosecutorial powers. 

Although the external structure of regulation in the U.K. may appear simple 

enough, there is a great deal of internal complexity. There are two main branches 

within the FSA; one branch which deals with retail markets and another branch, 
152 

6 Hughes, 2008. 

7 Ellis, 2009. 

which focuses on wholesale and institutional markets. Within each branch, there are 

further divisions based on specific financial activities and institutional design, including insurance, banking and mortgages, asset management, and credit unions. 

There also exist some internal groups which look at specific financial activities in 

each of the retail and wholesale sectors. Therefore, in practice the FSA did not create an effective single prudential regulator. Instead it preserved some of its older 

agency divisions, albeit under a single umbrella. Critics of the FSA have pointed to 

the haste with which the FSA was formed and the failure of the new integrated regulator to fully overcome the old institutional divisions of its former approach to regulation. 

The FSA has admitted on its own to significant failings over Northern Rock. An 

internal FSA report cited inadequate resources devoted to overseeing the institution, 

including high personnel turnover and limited direct contact with the institution (no 

one had visited the bank for 3 years), and a failure to push management at the 

bank to modify an eventually disastrous business model. 6 The U.K. Government 

was determined to develop London as the key financial center in Europe and that 

London could compete effectively with New York. As part of this strategy, they instituted ‘‘light touch’’ regulation, in which financial institutions were given the goals 

or principles that they should follow but were given considerable leeway to determine how the goals should be met. While there is some merit in this approach, it 

created significant danger and it meant in practice that U.K. financial institutions 

took on excessive risks. Some U.K. banks developed a reputation around the world 

for lending money to companies that local banks would not touch and the regulators 

were not stopping them from taking these bad risks. 

Another problem is that there was totally inadequate communication between the 

FSA and the Bank of England. The Bank of England was intent on maintaining its 

independence and focused on its mission of fighting inflation. When the crisis 

struck, the Bank was unwilling to step in quickly to support troubled institutions 

and markets because it had not been kept up to date about the condition of the 

banks and had not been tasked with the job of maintaining system stability. 

In summary, the U.K. experience does not provide an appropriate counter example for the regulatory model proposed in this testimony. They did not create an effective, strong single prudential regulator. They did not make the Bank of England 

responsible for systemic stability, nor did they ensure that the Bank of England was 

informed about the condition of the U.K. banks. 

Australia does not have a major financial center serving the global market and 

so it cannot provide an ideal example for the United States to copy. Nevertheless, 

the Australian regulatory reforms seem to have been well designed and well-executed and there are some lessons to be learned. 

Australia determined that the ‘‘twin peaks’’ model was the right one and they created the Australian Prudential Regulatory Authority (APRA), which is responsible 

for prudential regulation while the Australian Securities and Investment Commission (ASIC) oversees conduct-of-business regulation. A cross-agency commission 

seeks to resolve conflicts of overlap and facilitate communication between the two 

agencies. 

The Australian economy weathered the financial crisis better than many other developed countries, and its experience owes much of its better-than-average performance during the financial crisis to sound policy choices and the effectiveness of its 

financial regulation. There was not a housing bubble and there was not the same 

erosion in lending standards as had occurred in the U.S. This was in part due to 

stricter regulation of mortgage lending. Australia’s prudential regulator had raised 

capital requirements for banks investing in riskier mortgage products. 7 Consumer 

protection laws and foreclosure laws also discouraged borrowers from taking out 

mortgages that they could not afford. 

Until 1998 Australian financial regulation resided with the country’s Central 

Bank and took an institutional approach. Following a review of the country’s overall 

financial system, the twin peaks approach was put into place. As in the U.K., 

APRA’s regulation is a largely a principles-based approach, relying heavily on dialogue between the regulators and the regulated institutions, but with a considerably 

heavier touch by the regulators to guard against excessive risk taking. 

The ASIC oversees securities market and financial services providers. ASIC has 

the power to impose criminal or civil sanctions against financial firms or individuals. As a corporate regulator, ASIC oversees company directors and officers, capital 

raising, takeovers, financial reporting, etc. It also provides licensing and monitoring 
153 

for financial services firms. In addition, ASIC has been tasked to protect consumers 

against misleading or deceptive conduct related to financial products and services. 

The Australian approach is cited as a model for other countries, for example in 

the Paulson Treasury’s blueprint, in part because it allows flexibility and innovation, while maintaining protections. The regulatory structure is not the only reason 

for the fact that their economy avoided the worst of the financial crisis, but it seems 

to have helped. One aspect of the Australian regulatory approach that could serve 

as a model is the process by which it arrived at reform. Where the road to reform 

in the U.K. was hasty and lacked adequate consideration, the Australian reform 

process began with the Wallis Inquiry in 1996 to review how financial system reform could be structured in Australia. The inquiry looked specifically at how prior 

attempts at deregulation had affected the Australian financial system, what forces 

were at work changing the system further, and what would provide the most efficient, effective and competitive regulatory structure for the country going forward. 

In summary, Australia provides a good positive example where a single prudential 

regulator has worked well. 

PREPARED STATEMENT OF RICHARD S. CARNELL 

ASSOCIATE PROFESSOR, FORDHAM UNIVERSITY SCHOOL OF LAW

SEPTEMBER 29, 2009 

Mr. Chairman, Senator Shelby, Members of the Committee: You hold these hearings in response to an extraordinary financial debacle, costly and far-reaching: a debacle that has caused worldwide pain and will saddle our children with an oversized 

public debt. ‘‘And yet,’’ to echo President Franklin D. Roosevelt’s inaugural address, 

‘‘our distress comes from no failure of substance. We are stricken by no plague of 

locusts. . . . Plenty is at our doorstep.’’ Our financial system got into extraordinary 

trouble—trouble not seen since the Great Depression—during a time of record profits and great prosperity. 

This disaster had many causes, including irrational exuberance, poorly understood 

financial innovation, loose fiscal and monetary policy, market flaws, regulatory gaps, 

and the complacency that comes with a long economic boom. But our focus here is 

on banking, where the debacle was above all a regulatory failure. Banking is one 

of our most heavily regulated industries. Bank regulators had ample powers to constrain and correct unsound banking practices. Had regulators adequately used those 

powers, they could have made banking a bulwark for our financial system instead 

of a source of weakness. In banking, as in the system as a whole, we have witnessed 

the greatest regulatory failure in history. Our fragmented bank regulatory structure 

contributed to the debacle by impairing regulators’ ability and incentive to take 

timely preventive action. Reform of that structure is long overdue. 

In my testimony today, I will: 

1. Note how regulatory fragmentation has grave defects, arose by happenstance, 

and persists not on its merits but through special-interest politics and bureaucratic obduracy; 

2. Recommend that Congress unify banking supervision in a new independent 

agency; and 

3. Reinforce the case for reform by explaining how regulatory fragmentation helps 

give regulators an unhealthy set of incentives—incentives that hinder efforts 

to protect bank soundness, the Federal deposit insurance fund, and the taxpayers. 

I. Fragmentation Impedes Effective Supervision 

Fragmentation Is Dysfunctional 

Our fragmented bank regulatory structure is needlessly complex, needlessly expensive, and imposes needless compliance costs on banks. It ‘‘requires too many 

banking organizations to deal with too many regulators, each of which has overlapping, and too often maddeningly different, regulations and interpretations,’’ according to Federal Reserve Governor John LaWare. It engenders infighting and impedes 

prudent regulatory action. FDIC Chairman William Seidman deplored the stubbornness too often evident in interagency negotiations: ‘‘There is no power on earth that 

can make them agree—not the President, not the Pope, not anybody. The only 

power that can make them agree is the Congress of the United States by changing 

the structure so that the present setup does not continue.’’ The current structure 

promotes unsound laxity by setting up interagency competition for bank clientele. 

It also blunts regulators’ accountability with a tangled web of overlapping jurisdic-
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tions and responsibilities. Comptroller Eugene Ludwig remarked that ‘‘it is never 

entirely clear which agency is responsible for problems created by a faulty, or overly 

burdensome, or late regulation. That means that the Congress, the public, and depository institutions themselves can never be certain which agency to contact to address problems created by a particular regulation.’’ 

Senator William Proxmire, longtime Chairman of this Committee, called this 

structure ‘‘the most bizarre and tangled financial regulatory system in the world.’’ 

Treasury Secretary Lloyd Bentsen branded it ‘‘a spider’s web of overlapping jurisdictions that represents a drag on our economy, a headache for our financial services 

industry, and a source of friction within our Government.’’ Chairman Seidman derided it as ‘‘complex, inefficient, outmoded, and archaic.’’ The Federal Reserve Board 

declared it ‘‘a crazy quilt of conflicting powers and jurisdictions, of overlapping authorities, and gaps in authority’’ (and that was in 1938, when the system was simpler than now). Federal Reserve Vice Chairman J.L. Robertson went further: 

The nub of the problem . . . is the simple fact that we are looking for, talking about, and relying upon a system where no system exists. . . . Our 

present arrangement is a happenstance and not a system. In origin, function, and effect, it is an amalgam of coincidence and inadvertence. 

Opponents of reform portray a unified supervisory agency as ominous and unnatural. Yet although the Federal Government regulates a wide array of financial 

institutions, no other type of institution has competing Federal regulators. Not mutual funds, exchange-traded funds, or other regulated investment companies. Not securities broker-dealers. Not investment advisers. Not futures dealers. Not Government-sponsored enterprises. Not credit unions. Not pension funds. Not any other financial institution. A single Federal regulator is the norm; competition among Federal regulators is an aberration of banking. 

Nor do we see competition among Federal regulators when we look beyond financial services—and for good reason. Senator Proxmire observed: 

Imagine for a moment that we had seven separate and distinct Federal 

agencies for regulating airline safety. Imagine further the public outcry 

that would arise following a series of spectacular air crashes while the 

seven regulators bickered among themselves on who was to blame and what 

was the best way to prevent future crashes. 

There is no doubt in my mind that the public would demand and get a single regulator. There is a growing consensus among experts that our divided 

regulatory system is a major part of the problem. There are many reasons 

for consolidating financial regulations, but most of them boil down to getting better performance. 

Fragmentation Is the Product of Happenstance 

Two forces long shaped American banking policy: distrust of banks, particularly 

large banks; and crises that necessitated a stronger banking system. Our fragmented regulatory structure reflects the interplay between these forces. As FDIC 

Chairman Irvine H. Sprague noted, this structure ‘‘had to be created piecemeal, and 

each piece had to be wrested from an economic crisis serious enough to muster the 

support for enactment.’’ 
155 

1Mark J. Roe, ‘‘Strong Managers, Weak Owners: The Political Roots of American Corporate 

Finance’’, 99–100 (1994). 

Distrust of banking ran deep from the beginning of the Republic. John Adams, 

sober and pro-business, declared that ‘‘banks have done more injury to the religion, 

morality, tranquility, prosperity, and even wealth of the Nation than they have done 

or ever will do good.’’ Thomas Jefferson asserted that states ‘‘may exclude [bankers] 

from our territory, as we do persons afflicted with disease.’’ Andrew Jackson won 

reelection pledging to destroy the Nation’s central bank, which he likened to a malicious monster. This powerful, longstanding distrust of banking shaped U.S. law in 

ways that, until recent decades, kept U.S. banks smaller and weaker (relative to the 

size of our economy) than their counterparts in other developed countries. 

Yet banking proved too useful to ignore or suppress. To cope with financial emergencies, Congress acted to strengthen the banking system. It created: 

• National banks to finance the Civil War and the OCC to supervise national 

banks; 

• The Federal Reserve in response to the Panic of 1907; 

• The FDIC, its thrift-institution counterpart, and the Federal thrift charter to 

help stabilize the financial system during the Great Depression; and 

• The Office of Thrift Supervision in response to the thrift debacle of the 1980s. 

These and other ad hoc actions gave us a hodgepodge of bank regulatory agencies 

unparalleled in the world. Each agency, charter type, and regulatory subcategory 

developed a political constituency resistant to reform. 

The Bank Holding Company Act, another product of happenstance, exacerbated 

this complexity. It ultimately gave most banking organizations of any size a second 

Federal regulator: the Federal Reserve Board. As enacted in 1956, the Act sought 

to prevent ‘‘undue concentration of economic power’’ by limiting banks’ use of holding companies to enter additional businesses and expand across State lines. The Act 

reflected a confluence of three disparate forces: populist suspicion of bigness in 

banking; special-interest politics; and the Federal Reserve Board’s desire to bolster 

its jurisdiction. Representative Wright Patman, populist chairman of the House 

Banking Committee, sought to prevent increased concentration in banking and the 

broader economy. Small banks sought to keep large banks from expanding into new 

products and territory. A variety of other firms sought to keep banks out of their 

businesses. The Fed gained both expanded jurisdiction and a respite from Chairman 

Patman’s attempts to curtail its independence in monetary policy. 1 The Act originally applied only to companies owning two or more banks. But in 1970 Congress 

extended the Act to companies owning a single bank. 

Special-Interest Politics Perpetuate Fragmentation 

Regulatory fragmentation leaves individual agencies smaller, weaker, and more 

vulnerable to pressure than a unified agency would be. It can also undercut their 

objectivity. Fragmentation played a pivotal role in the thrift debacle. Specialized 

thrift regulators balked at taking strong, timely action against insolvent thrifts. 

Regulators identified with the industry and feared that stern action would sharply 

shrink the industry and jeopardize their agencies’ reason for being. In seeking to 

help thrifts survive, the regulators multiplied the ultimate losses to the deposit insurance fund and the taxpayers. For example, they granted sick thrifts new lending 

and investment powers for which the thrifts lacked the requisite competence (e.g., 

real estate development and commercial real estate lending). 

By contrast, bank regulators who also regulated thrifts took firmer, more appropriate action (e.g., limiting troubled institutions’ growth and closing deeply insolvent 

institutions). These policies bore fruit in lower deposit insurance losses. State-chartered thrifts regulated by State banking commissioners were less likely to fail—and 

caused smaller insurance losses—than thrifts with a specialized, thrift-only regulator. Likewise, thrifts regulated by the FDIC fared far better than those regulated 

by the thrift-only Federal Home Loan Bank Board. 

II. Unifying Federal Bank Supervision 

Fragmentation problems have a straightforward, common-sense solution: unifying 

Federal bank regulation. Treasury Secretary Lloyd Bentsen offered that solution 

here in this room 15 years ago. As Assistant Secretary of the Treasury for Financial 

Institutions, I worked with him in preparing that proposal. He made a cogent case 

then, and I’ll draw on it in my testimony now. 

Secretary Bentsen proposed that we unify the supervision of banks, thrifts, and 

their parent companies in a new independent agency, the Federal Banking Commis-
156 

sion. The agency would have a five-member board, with one member representing 

the Treasury, one member representing the Federal Reserve, and three independent 

members appointed by the President and confirmed by the Senate. The President 

would designate and the Senate confirm one of the independent members to head 

the agency. 

The commission would assume all the existing bank regulatory responsibilities of 

the Comptroller of the Currency, Federal Reserve Board, FDIC, and Office of Thrift 

Supervision. The Federal Reserve would retain all its other responsibilities, including monetary policy, the discount window, and the payment system. The FDIC 

would retain all its powers and responsibilities as deposit insurer, including its 

power to conduct special examinations, terminate insurance, and take back-up enforcement action. The three agencies’ primary responsibilities would correspond to 

the agencies’ core functions: bank supervision, central banking, and deposit insurance. This structure would promote clarity, efficiency, accountability, and timely action. 

It would also help the new agency maintain its independence from special-interest 

pressure. The agency would be larger and more prominent than its regulatory predecessors and would supervise a broader range of banking organizations. It would 

thus be less beholden to a particular industry clientele—and more able to carry out 

appropriate preventive and corrective action. Moreover, a unified agency could do 

a better job of supervising integrated banking organizations—corporate families in 

which banks extensively interact with their bank and nonbank affiliates. The agency would look at the whole organization, not just some parts. Secretary Bentsen put 

the point this way: 

Under today’s bank regulatory system, any one regulator may see only a 

limited piece of a dynamic, integrated banking organization, when a larger 

perspective is crucial both for effective supervision of the particular organization and for an understanding of broader industry conditions and trends. 

Having the same agency oversee banks and their affiliates both simplifies compliance and makes supervision more effective. We have no need for a separate holding 

company regulator. 

Under the Bentsen proposal, the Fed and FDIC would have full access to supervisory information about depository institutions and their affiliates. Their examiners 

could participate regularly in examinations conducted by the commission and maintain their expertise in sizing up banks. As members of a Federal Banking Commission-led team, Fed and FDIC examiners could scrutinize the full spectrum of FDICinsured depository institutions, including national banks. The two agencies would 

have all the information, access, and experience needed to carry out their responsibilities. 

The Treasury consulted closely with the FDIC in developing its 1994 reform proposal. The FDIC supported regulatory consolidation in testimony before this Committee on March 2, 1994. It stressed that in the context of consolidation it had five 

basic needs. First, to remain independent. Second, to retain authority to set insurance premiums and determine its own budget. Third, to have ‘‘timely access’’ to information needed to ‘‘understand and stay abreast of the changing nature of the 

risks facing the banking industry . . . and to conduct corrective resolution and liquidation activities.’’ Fourth, to retain power to grant and terminate insurance, assure prompt corrective action, and take back-up enforcement action. Fifth, to retain 

its authority to resolve failed and failing banks. 

A regulatory unification proposal can readily meet all five of those needs. Indeed, 

Secretary Bentsen’s proposal dealt with most of them in a manner satisfactory to 

the FDIC. The Treasury and FDIC did disagree about FDIC membership on the 

Federal Banking Commission. The FDIC regarded membership as an important assurance of obtaining timely information. The Treasury proposal did not provide for 

an FDIC seat, partly out of concern that it would entail expanding the commission 

to seven members. Now as then, I believe that the agency’s board should include 

an FDIC representative. 

The Federal Reserve and FDIC complain that they cannot properly do their jobs 

unless they remain the primary Federal regulator of some fraction of the banking 

industry. These complaints ignore the sort of safeguards in Secretary Bentsen’s proposal. They also exaggerate the significance of the two agencies’ current supervisory 

responsibilities. FDIC-supervised banks hold only 17 percent of all FDIC-insured institutions’ aggregate assets; Fed-supervised banks, only 13 percent. Nor does the 

Fed’s bank holding jurisdiction fundamentally alter the picture: the Fed as holding 

company regulator neither examines nor supervises other FDIC-insured institutions. 

The Fed and FDIC, in carrying out their core responsibilities, already rely primarily 

on supervisory information provided by others. 
157 

Thus it strains credulity to suggest that the FDIC cannot properly carry out its 

insurance and receivership functions unless it remains the primary Federal regulator of State nonmember banks. These banks, currently numbering 5,040, average 

$460 million in total assets. How many community banks must the FDIC supervise 

to remain abreast of industry trends and remember how to resolve a community 

bank? Likewise, the Fed cannot plausibly maintain that its ability to conduct monetary policy, operate the discount window, and gauge systemic risk appreciably depends on remaining the primary Federal regulator of 860 State member banks (only 

10 percent of FDIC-insured institutions), particularly when those banks average less 

than $2 billion in total assets. Moreover, according to the most recent Federal Reserve Flow of Funds accounts, the entire commercial banking industry (including 

U.S.-chartered commercial banks, foreign banks’ U.S. offices, and bank holding companies) holds only some 18 percent of our Nation’s credit-market assets. In sum, the 

two agencies’ objections to reform ring false. They are akin to saying, ‘‘I can’t do 

my job right without being the supreme Federal regulator for some portion of the 

banking industry, small though that portion may be. Nothing else will do.’’ 

Nor do regulatory checks and balances depend on perpetuating our multiregulator 

jumble. ‘‘Regulatory power is not restrained by creating additional agencies to perform duplicate functions,’’ Secretary Bentsen rightly declared. A unified banking supervisor would face more meaningful constraints from ‘‘congressional oversight, the 

courts, the press, and market pressures.’’ Its decision making would also, under my 

recommendations, include the insights, expertise, and constant participation of the 

Federal Reserve Board and FDIC. 

III. Regulatory Fragmentation Promotes Unsound Laxity 

Most debate about banking regulation pays little heed to bank regulators’ incentives. That’s a serious mistake, all the more so given the recent debacle. As noted 

at the outset, regulators had ample powers to keep banks safe but failed to do so. 

This failure partly involved imperfect foresight (an ailment common to us all). But 

it also reflected an unhealthy set of incentives—incentives that tend to promote unsound laxity. These incentives discouraged regulators from taking adequate steps to 

protect bank soundness, the Federal deposit insurance fund, and the taxpayers. 

Economists refer to such incentives as ‘‘perverse’’ because they work against the 

very goals of banking regulation. These incentives represent the regulatory counterpart of moral hazard. Just as moral hazard encourages financial institutions to take 

excessive risks, these incentives discourage regulators from taking adequate precautions. To improve regulation, we need to give regulators a better set of incentives—incentives more compatible with protecting the FDIC and the taxpayers. 

Several key factors create perverse incentives for bank regulators. First, we have 

difficulty telling good regulation from bad—until it’s too late. Second, lax regulation 

is more popular than stringent regulation—until it’s too late. Third, regulators’ reputations suffer less from what goes wrong on their watch than from what comes to 

light on their watch. This is the upshot: 

Bank Soundness Regulation Has No Political Constituency—Until It’s Too 

Late. 

To make the incentive problem more concrete, put yourself in the position of a 

regulator who, during a long economic boom and a possible real estate bubble, sees 

a need to raise capital standards. The increase will have short-term, readily identifiable consequences. To comply with the new standards, banks may need to constrain 

their lending and reduce their dividends. Prospective borrowers will complain. 

Banks’ return on equity will decline because banks will need more equity per dollar 

of deposits. Hence bankers will complain. You’ll feel immediate political pain. Yet 

the benefits of higher capital standards, although very real, will occur over the long 

run and be less obvious than the costs. Raising capital levels will help protect the 

taxpayers, but the taxpayers won’t know it. Moreover, in pressing weaker banks to 

shape up and in limiting the flow of credit to real estate, you may get blamed for 

causing problems that already existed. From the standpoint of your own self-interest, you’re better off not raising capital standards. You can leave office popular. By 

the time banks get into trouble, you’ll have a new job and your successor will have 

to shoulder the problem. 

Similar incentives encourage too-big-to-fail treatment. Bailouts confer immediate, 

readily identifiable benefits. By contrast, the costs of intervention (such as increased 

moral hazard and potential for future instability) are long-term, diffuse, and less obvious. But you can leave those problems for another day and another regulator. You 

risk criticism whether or not you intervene. But on balance you run a greater risk 

of destroying your reputation if you let market discipline take its course. Unwar-
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ranted intervention may singe your career; a seemingly culpable failure to intervene 

will incinerate it. 

Bank regulators need better incentives far more than they need new regulatory 

powers. Creating a unified regulator will make for a healthier set of incentives. 

Conclusion 

Now is the right time to fix the bank regulatory structure: now, while we’re still 

keenly aware of the financial debacle; now, while special-interest pressure and bureaucratic turf struggles are less respectable than usual. Reform should promote efficiency, sharpen accountability, and help regulators withstand special-interest pressure. 

Speaking from this table in 1994, Secretary Bentsen underscored the risk of relying on ‘‘a dilapidated regulatory system that is ill-designed to prevent future banking crises and ill-equipped to cope with crises when they occur.’’ He observed, in 

words eerily applicable to the present, that our country had ‘‘just emerged from its 

worst financial crisis since the Great Depression,’’ a crisis that our cumbersome 

bank regulatory system ‘‘did not adequately anticipate or help resolve.’’ He also 

issued this warning, which we would yet do well to heed: ‘‘If we fail to fix [the system] now, the next financial crisis we face will again reveal its flaws. And who suffers then? Our banking industry, our economy, and, potentially, the taxpayers. You 

have the chance to help prevent that result.’’ 
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PREPARED STATEMENT OF RICHARD J. HILLMAN 

MANAGING DIRECTOR, FINANCIAL MARKETS AND COMMUNITY INVESTMENT TEAM, 

GOVERNMENT ACCOUNTABILITY OFFICE

SEPTEMBER 29, 2009 
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