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THE STATE OF THE BANKING INDUSTRY: 

PART II 

HEARING 

BEFORE THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED TENTH CONGRESS 

SECOND SESSION 

ON 

THE CURRENT STATE OF THE U.S. BANKING INDUSTRY 

THURSDAY, JUNE 5, 2008 

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

( 

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


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(II) 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

CHRISTOPHER J. DODD, Connecticut, Chairman 

TIM JOHNSON, South Dakota 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

EVAN BAYH, Indiana 

THOMAS R. CARPER, Delaware 

ROBERT MENENDEZ, New Jersey 

DANIEL K. AKAKA, Hawaii 

SHERROD BROWN, Ohio 

ROBERT P. CASEY, Pennsylvania 

JON TESTER, Montana 

RICHARD C. SHELBY, Alabama 

ROBERT F. BENNETT, Utah 

WAYNE ALLARD, Colorado 

MICHAEL B. ENZI, Wyoming 

CHUCK HAGEL, Nebraska 

JIM BUNNING, Kentucky 

MIKE CRAPO, Idaho 

ELIZABETH DOLE, North Carolina 

MEL MARTINEZ, Florida 

BOB CORKER, Tennessee 

SHAWN MAHER, Staff Director 

WILLIAM D. DUHNKE, Republican Staff Director and Counsel 

AMY S. FRIEND, Chief Counsel 

MARK OSTERLE, Republican Counsel 

DAWN RATLIFF, Chief Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor 


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(III) 

C O N T E N T S 

THURSDAY, JUNE 5, 2008 

Page 

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

Opening statements, comments, or prepared statements of: 

Senator Shelby .................................................................................................. 3 

Senator Reed ..................................................................................................... 4 

Senator Allard ................................................................................................... 4 

Senator Dole ...................................................................................................... 5 

Senator Corker .................................................................................................. 7 

Senator Bunning ............................................................................................... 7 

Senator Martinez .............................................................................................. 7 

WITNESSES 

Sheila C. Bair, Chairman, Federal Deposit Insurance Corporation .................... 8 

Prepared statement .......................................................................................... 33 

Response to written questions of: 

Senator Bunning ....................................................................................... 191 

Senator Dole .............................................................................................. 192 

John C. Dugan, Comptroller of the Currency, United States Treasury .............. 10 

Prepared statement .......................................................................................... 68 

Response to written questions of: 

Senator Bunning ....................................................................................... 196 

Senator Dole .............................................................................................. 198 

John M. Reich, Director, Office of Thrift Supervision .......................................... 12 

Prepared statement .......................................................................................... 89 

Response to written questions of: 

Senator Bunning ....................................................................................... 199 

Senator Dole .............................................................................................. 200 

Senator Corker .......................................................................................... 210 

JoAnn Johnson, Chairman, National Credit Union Administration ................... 14 

Prepared statement .......................................................................................... 109 

Response to written questions of: 

Senator Dole .............................................................................................. 210 

Donald L. Kohn, Vice Chairman, Board of Governors, Federal Reserve System ......................................................................................................................... 15

Prepared statement .......................................................................................... 125 

Response to written questions of: 

Senator Bunning ....................................................................................... 211 

Senator Dole .............................................................................................. 214 

Senator Corker .......................................................................................... 221 

Timothy J. Karsky, Commissioner, North Dakota Department of Financial 

Institutions, and Chairman, Conference of State Bank Supervisors ............... 17 

Prepared statement .......................................................................................... 139 


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(1) 

THE STATE OF THE BANKING INDUSTRY: 

PART II 

THURSDAY, JUNE 5, 2008 

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

The Committee met at 10:07 a.m., in room SD–538, Dirksen Senate Office Building, Hon. Christopher J. Dodd (Chairman of the 

Committee) presiding. 

OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD 

Chairman DODD. Good morning, everyone. The Committee will 

come to order. 

I thank all of our guests here this morning. I want to thank our 

witnesses for being back before the Committee. 

This morning the Committee convenes to examine the supervision and regulation of the banking industry, as a follow up hearing to the Committee hearing held on March 4th. At that hearing, 

Senator Shelby and I expressed, I think, in no uncertain terms our 

intention—indeed, our determination—to reconvene this panel of 

witnesses to assess the efforts and effectiveness of the agencies represented here during these extraordinary times for our economy 

and for the financial services sector in particular. 

I look forward, as all of us do this morning, to your testimony 

and hearing your views regarding the current condition of our 

banking industry and assessment of your supervision response to 

the recent and ongoing turmoil in the U.S. credit and mortgage 

markets, and your analysis of what lessons have been learned as 

a result. 

Perhaps most importantly, 3 months after your previous appearance before this Committee, I look forward to hearing about what 

each of you intend to do and hopefully have already begun to improve your regulatory oversight and address the issues of ongoing 

concern for the banking industry and in anticipation of future challenges. 

Recent history tells us that many banking officials, private sector 

CEOs, bank presidents and executives, and officials in the public 

sector including some of the regulatory institutions represented 

here this morning, expressed the opinion last year that the problems in the credit markets were contained and nearing an end. 

Those pronouncements were wrong, of course, the unjustified optimism that may have led to a complacency on the part of some that, 

at least in part, may have allowed problems that originated in the 

subprime mortgage market to evolve into a global credit crisis, a 


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crisis that crippled the balance sheets of some of the world’s largest 

banks and spread to non-mortgage related credit areas including 

student loans, credit cards, commercial real estate. And as Senator 

Reed and I were talking about recently, maybe into auto loans and 

the like. 

These concerns were not unknown. In fact, some of us had expressed the need for regulators to intervene to address the problems in the subprime market. 

A look at the transcript for the March 4th hearing reflects that 

many of you then, and I assume now, believe you could have and 

should have done more under the respective authorities of your 

agencies to address this crisis earlier on. I mention this not to engage in revisionist history—quite the contrary—or to assign blame, 

but rather to urge you to be vigilant and proactive in your regulatory and supervisory responsibilities moving forward. 

If my words are not enough to encourage your continued vigilance, then some of the data recently reported by the FDIC in its 

quarterly banking report certainly should be. The report includes 

some worrisome data suggesting that the banking industry continues to grapple with the fallout of the credit mortgage market 

turmoil and the effects of a weak economy. 

Among its findings are the following: ongoing problems in the 

real estate market continue to eat into bank profits. Commercial 

banks and thrifts reported a decline in profits of 50 percent in the 

first quarter of 2008, compared with the first quarter of 2007. Over 

half of the insured institutions reported lower net income in the 

first quarter. Bank earnings in the fourth quarter of 2007 were revised downward to their lowest levels in 18 years. An additional 

$26 billion in outstanding loans were delinquent—90 days or more 

past due is what we describe as being delinquent—from the previous quarter. And while much of that increase was mortgage related, credit card and auto loan delinquencies also increased, further proof that the ongoing credit mortgage market turmoil, coupled with the economic slowdown is destabilizing the economic condition of American families. 

The number of troubled U.S. banks grew, as well, with the FDIC 

now tracking 90 problem banks, the highest number in nearly 4 

years. This is a significant likelihood—there is a significant likelihood that that number will continue to grow and that even larger 

institutions may end up on the problem list. 

At the same time, the FDIC’s reserve fund is at its lowest level, 

1.19 percent of covered deposits, in more than a decade. These findings strongly suggest that our banks, their customers, and our 

economy will likely continue to grapple with the economic fallout 

of the meltdown in the credit mortgage markets for the foreseeable 

future, and perhaps well into 2009. 

So while I look forward to hearing your assessment of whether 

or not the worst is truly behind us, what is of greater interest to 

me, and I hope to my colleagues as well, and I imagine to other 

members of this Committee and others, is your outlook for what 

the future holds and what steps you have taken to ensure that 

there will be no more surprises for the members of this Committee 

and for our banking industry, which is so vital to our Nation’s economic well-being. 


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As I said in our very first hearing, the regulatory agencies that 

oversee our banking industry play an indispensable role, not only 

in the economic activities of the institutions that they regulate but 

the economic life of our Nation as a whole. You serve as the gatekeepers of the credit that fuels the world’s largest and most dynamic economy. And through your regulation of insured institutions, which holds in excess of $4 trillion in deposits, you serve as 

the guardians of the interest of the American taxpayers, who are 

ultimately liable when institutions fail. 

Yours is a Herculean mission and one that I know you and your 

dedicated colleagues strive to fulfill every single day. So I look forward to learning from each of you this morning not only your views 

regarding the current state of our banking industry, but also the 

concrete steps that you are taking to address the lessons learned 

in the recent market failures. 

With that, I thank you and I turn to Senator Shelby. 

STATEMENT OF SENATOR RICHARD C. SHELBY 

Senator SHELBY. Thank you, Mr. Chairman. 

There have been some significant developments in the banking 

sector since our last hearing, making this meeting I think both 

timely and very important. 

The most significant development has been the collapse of Bear 

Stearns, including the Federal Reserve’s efforts to intervene and its 

willingness to open the discount window to the 19 primary securities dealers. While this action provided a source of stability for the 

financial system, it also raised a number of policy questions which 

we can explore further today. 

Since March, the so-called problem bank list has also grown. As 

these numbers rise, I am concerned that the Deposit Insurance 

Fund reserve ratio is at its lowest level since 1996. I believe that 

it is critical to ensure that the fund remains healthy as we work 

through this period of stress. 

Finally, there has been a large number of earnings restatements 

in the banking industry for the fourth quarter of 2007. Earnings 

were originally reported at $5.8 billion but sizable restatements by 

a few large institutions caused fourth net income to decline significantly. 

If the credit crisis has demonstrated anything, I believe there is 

no substitute for sound risk management. In this time of turmoil, 

I think we must be confident that the Nation’s financial institutions are operating in a safe and sound manner. This requires vigilance and clear guidance from you, the regulators. 

As the credit crisis continues to affect many of our Nation’s financial institutions, I am also interested to hear today what you, 

as regulators, believe may be on the horizon. I am particularly interested to hear about the exposure of financial institutions to commercial real estate and the construction lending tied to the mortgage market. 

I would also like to hear how you are ensuring that banks operating in some of the most overheated markets are adequately prepared to deal with the stresses of the next several months which 

they will clearly face. 


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As we discussed in March, banks have been well capitalized coming into this period of stress, which is good news. But as we transition to new capital standards, however, I think we must continue 

to examine how Basel II will hold up in periods of stress because 

it has not been tested yet. 

I believe it is important to look at the number of facts, including 

general liquidity, the risk weighting of securitized assets, as well 

as a host of other factors. And with the list of troubled financial 

institutions growing, there is little doubt that bank failures will 

rise. 

The question for our witnesses, among others, is how do you intend to mitigate the fallout? 

I welcome all of our witnesses here today and I am sure we are 

going to be spending a lot of time together in the next year or so. 

Thank you, Mr. Chairman. 

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

Let me ask my colleagues, Senator Reed, any opening comments? 

STATEMENT OF SENATOR JACK REED 

Senator REED. Mr. Chairman, you and Senator Shelby have articulated very well the continuing challenge in the credit markets. 

Just yesterday Moody’s announced that MBIA and Ambac have 

been placed on the negative watch list. And after the Federal Reserve’s timely intervention with respect to Bear Stearns, they have 

now securities which I presume are rated by Ambac and MBIA. 

That goes to the question of the Federal Reserve’s position with respect to these securities. 

That is just one indication of the continuing significant difficulties in the credit markets. 

The housing market continues to deteriorate, as you have illustrated and indicated. Credit card problems, Sheila Bair has pointed 

out the correlation between housing problems and credit card defaults and delinquencies. 

All of this requires continued observation and scrutiny and I 

think this hearing is timely and extremely important. 

Thank you, Mr. Chairman. 

Chairman DODD. Thank you very much. 

Senator Allard. 

STATEMENT OF SENATOR WAYNE ALLARD 

Senator ALLARD. Thank you, Mr. Chairman. I want to thank you 

and Ranking Member Shelby again for convening this hearing. I 

think it is important that we have a thorough understanding of the 

dynamics that are going on out there in the banking and the various money markets and everything. And this will help. 

Also, today we continue to examine the state of the banking industry and the wide effects of housing and mortgage problems, 

what they have had on our entire financial system, and the continued deterioration in real estate and construction loans has put a 

persistent strain on the banking industry and there is a reason 

why industry earnings declined 49 percent from the previous year. 

There is also a contraction of the credit markets, and this has 

caused problems for consumers. I think it has had an impact on 

home loans. It has had an impact on auto loans and what not, and 


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I would like to hear some of your views as we move forward with 

that. So it has become much harder to borrow and obtain credit in 

many of these areas. 

If these lenders are not able to continue to lend or are unwilling 

to lend, it could have a huge impact on our economy and its ability 

to grow. So in time of record gas prices and higher food prices, the 

American consumer needs to be kept in mind, I think, as we move 

forward on these tough times. 

Now we are continuing to see a number of banks added to the 

problem list, which has been mentioned by my colleagues. But we 

also—I do not believe we have seen an increase in or experienced 

a spike in failed institutions. So I would like to have you comment 

a little bit about how that is happening and how we are moving 

forward and maybe we are not seeing a spike in failed institutions—I think in past times perhaps we would have seen a spike— 

and what we put in there that is acting as a cushion. 

So finally, I just think in this time of economic uncertainty we 

need to remain confident that our banking industry and economy 

as a whole will rebound and continue to foster growth, and so we 

are all eager to hear your assessment of the state of the banking 

industry and your insights, which I think will be helpful as we consider the various policy issues. 

Thank you. 

Chairman DODD. Thank you, Senator. 

Senator Dole, any comments? 

STATEMENT OF SENATOR ELIZABETH DOLE 

Senator DOLE. Yes. And again, I want to thank you for holding 

this hearing this morning, you and Ranking Member Shelby. 

First, there is no question, as you have already underscored, that 

the credit and housing crisis continues in earnest to this day. While 

this Committee has been active in looking into a number of the 

problems associated with the current crisis, for many Americans 

this issue came to the forefront after the near collapse of Bear 

Stearns, closely followed by the unprecedented Government-assisted sale of that firm to JPMorgan, an event that continues to be 

widely scrutinized. 

I believe that without the prompt action from the Federal Reserve and Treasury Department over those few days in March, our 

financial markets could have been exposed to systemic risk. While 

I remain concerned about the precedent this action sets for future 

crises, as well as the perceived exposure to the U.S. taxpayer as 

the ultimate backstop as part of the Federal Reserve/Treasury negotiated agreement, it appears that the regulators on the ground 

made the most of the situation at hand. 

Recently, there have been some encouraging signs. Confidence in 

the credit markets appears to have improved somewhat over the 

past 2 months, represented by the fact that the so-called yield 

spreads between bonds issued by securities firms and U.S. Treasuries have narrowed, which some economists would point to as a 

positive indicator. 

In addition, the IPO market appears to be showing some signs 

of life. As of the end of May, the Renaissance IPO Index had gained 


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nearly 17 percent over the past 3 months, albeit still well below 

comparable activity levels from 2007. 

Clearly, we are not out of the woods yet. Consumer confidence, 

as calculated by the University of Michigan, sank to a 28-year low 

last month. This comes on top of the widely followed Case-Shiller 

Housing Index which showed that home prices nationwide plunged 

14 percent in the first quarter. 

Finally, as the events of this week have already demonstrated, 

with the major investment banks slated to begin reporting second 

quarter earnings in the next few weeks, there is an ever-increasing 

likelihood that there will be additional losses and further asset 

write-downs at these institutions. 

Mr. Chairman, when this Committee examined the Government’s 

facilitated buy-out of Bear Stearns in early April, I brought up the 

issue of credit defaults swaps and the role they could have played 

in its demise. As I mentioned, as I understand it, this market has 

exploded in size, from an estimated $1 trillion in 2000 to $62 trillion in market exposure this year. This dwarfs the size of the underlying bond issuances and has the potential to unwind the credit 

markets by exposing counterparty risk. 

While the regulator aspect of credit default swaps might seem like an esoteric issue for some, although $62 trillion can hardly be 

considered esoteric, I think it underscores an important point. 

These instruments, like so many other structured products and derivatives, operate in an environment where there is no formal 

clearing process or minimal public reporting regarding the true 

value of these assets. 

While I do not question that the creation of these structured 

products has delivered a measurable benefit to the American consumer by lowering borrowing costs, it is becoming clear that a lack 

of transparency in the pricing and trading of these instruments has 

contributed to the credit crisis. 

I challenge Federal regulators to begin more closely monitoring 

these effects and to seek ways to improve transparency regarding 

the pricing and trading of these instruments across the financial 

marketplace. 

Last week, the FDIC published its quarterly banking profile for 

the first quarter of 2008, which provides insight about the stability 

of the U.S. banking industry. Several items caught my eye. Industry earnings declined 46 percent from last year. Loan loss reserves 

now absorb a higher share of revenues, which eclipsed $37.1 billion 

in the first quarter. And problem loans continue to rise across 

many banks’ real estate portfolios. 

In addition, the FDIC reported that the number of so-called troubled institutions increased from 76 to 90 in the first quarter, with 

no end in sight. This marks the sixth consecutive quarter that the 

number of problem institutions has increased and reflects the largest number of institutions on this list since the 3rd quarter of 2004. 

Clearly, these are not promising developments and I hope that 

Congress has empowered the FDIC—which I believe is responding 

to this crisis to the best of—its ability, with the necessary tools and 

resources to handle the new realities facing the banking industry. 

Thank you, Mr. Chairman. 

Chairman DODD. Thank you, Senator, very much. 


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Senator Corker, any comments? 

STATEMENT OF SENATOR BOB CORKER 

Senator CORKER. Mr. Chairman, as usual, I look forward to hearing from the witnesses. 

Thank you. 

Chairman DODD. Thank you very much, Senator. 

I do not know whether Senator Martinez or Senator Bunning, I 

am not sure what order they came in. I apologize. 

Senator MARTINEZ. Mr. Chairman, I will defer to my senior colleague from Kentucky. 

[Laughter.] 

Senator BUNNING. Senior colleague, thank you very much. 

Chairman DODD. It is been amazing how you have grown, Mel, 

in understanding. 

Senator BUNNING. I deeply appreciate that, and I think Senator—— 

Chairman DODD. He offered his—he did not defer to Senator 

Hagel, who is leaving, of course. He is deferring to you. 

Senator BUNNING. I know, because I got here just a little ahead 

of Senator Hagel. 

STATEMENT OF SENATOR JIM BUNNING 

Senator BUNNING. Mr. Chairman, I want to thank you for holding this second hearing on this critical issue. 

After all the problems in the financial system over the last year, 

we would all like to think our banks are out of the woods, but they 

are not. Hopefully, we are getting closer to the end than we are to 

the beginning. 

Home prices are continuing to fall and problems still exist in the 

credit markets. Unfortunately, it appears that troubles at banks 

around the country are on the rise. The FDIC problem list is getting longer. Four banks have already been closed this year, and it 

seems like there is speculation every day about the health of the 

major banks. I think we are all worried about that. 

I hope to hear from our regulators today that they are closely 

monitoring the health of the banks and are ready and able to respond even if a major bank fails. I also hope to hear that they do 

not expect that to happen. 

Thank you, Mr. Chairman. 

Chairman DODD. Thank you very much, Senator Bunning. 

Senator Hagel? Senator Martinez? 

STATEMENT OF SENATOR MEL MARTINEZ 

Senator MARTINEZ. I will be very brief. Thank you, Mr. Chairman. 

I appreciate this hearing and I am glad that we are keeping a 

close eye on our banking industry, which is so important to our Nation. 

Chairman Bernanke, in speaking to the International Monetary 

Conference yesterday, noted that although we may see somewhat 

better economic conditions during the second half of 2008, until the 

housing market—and particularly housing prices—show clear signs 

of stabilization, downward growth risk will remain. 


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On that note, I would like to sound a note of cautious optimism 

that in the real estate market in Florida, it appears that we are 

heading in a better direction. Florida Realtors recently reported an 

upswing in existing home and condominium sales from March to 

April of 2008. And Realtors around my State are reporting an increase in phone calls, home showings, and buyer activity. The market appears to be stabilizing and we are working through the huge 

backlog of inventory that exists. 

Economists at the National Association of Realtors predict that 

home sales and prices throughout most of the Nation will improve 

in the second half of the year, especially if access to mortgage 

backed by the Federal Housing Administration, Fannie Mae, and 

Freddie Mac increases. 

So I believe we are witnessing, in many ways, the market’s reaction to various steps Congress has taken to help alleviate the current housing crisis. Congress has much to finish on this front, including finalizing the pending legislation. As we work toward that 

end, we should be moving simultaneously to ensure we do not ever 

find ourselves back in the kind of situation we are in today to the 

extent possible. 

I continue to be concerned about the availability of credit and the 

condition of our banking system as we work through the crisis. 

Some of my friends in the industry in Florida complain about excessive regulation, the increase in reserves to a point where they 

now are constraining their ability to continue to be a resource to 

those who would create the conditions for the market to come back. 

So I hope we will continue to shed light on this situation through 

today’s hearing and look forward to hearing from the witnesses. 

Thank you, Mr. Chairman. 

Chairman DODD. Thank you very much, Senator. 

And again, welcome to our witnesses this morning. We have six 

very distinguished witnesses this morning, and I am going to ask 

all of you, if you would, to try and keep your remarks to around 

5 to 6 or 7 minutes, if you could. Obviously, all of your full statements and any supporting documentation you think would be valuable for the Committee will be included in the record. 

I will ask you to proceed in the order that you are sitting, Sheila 

beginning with you and ending up here at the other end of the 

table. Good to have you with us here this morning, as well. Mr. 

Karsky, is that how you pronounce it? 

Mr. KARSKY. Sure. 

Chairman DODD. And we will proceed along those lines, and then 

we will get to some questions. But we thank all of you for being 

here and coming back to the Committee. 

Sheila Bair. 

STATEMENT OF SHEILA BAIR, CHAIRMAN, FEDERAL DEPOSIT 

INSURANCE CORPORATION 

Ms. BAIR. Thank you, Chairman Dodd, Senator Shelby, and 

members of the Committee. 

I appreciate the opportunity to testify on behalf of the FDIC regarding the condition of the banking industry. 

Uncertainties in today’s economic environment continue to pose 

significant challenges for banks, households, and bank regulators. 


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As I said before, I believe that the distress in the housing market 

is the key to our broader economic problems. In order to return stability to the credit markets, we must ensure that future mortgage 

lending is properly underwritten and results in loans that are sustainable over the long term for borrowers. 

In addition, we must deploy multiple tools to combat unnecessary 

foreclosures that create a self-reinforcing downward spiral for housing prices. 

Last week, the FDIC released its quarterly banking profile, a 

comprehensive summary of financial results for all FDIC-insured 

institutions for the first quarter of 2008. Although the industry reported earnings of $19.3 billion, the data showed financial performance that was significantly lower than in past years. The economic 

slowdown brought on by the disruptions in credit availability is expected to exert continuing downward pressure on industry earnings 

over the coming quarters. 

The construction and development segment of commercial real 

estate lending stands out as the most important short-term credit 

quality issue. Loss rates have risen dramatically on C&D loans 

through the first quarter of 2008 and likely will increase because 

of the current oversupply of new housing units. 

The FDIC is taking aggressive steps to work with our supervised 

institutions. Examiners have conducted targeted visits in institutions with C&D lending concentrations in former high growth markets and determined that a rapid increase in problem loans may 

translate into significant further losses this year. As a result, we 

are intensifying our supervision of these institutions and we are accelerating onsite reviews and expanding examination tools to deal 

with these developments. 

In addition, we are taking steps to improve our capability to handle future bank failures. So far this year, four institutions have 

failed, with total assets of $2.2 billion and estimated losses of $225 

million to the Deposit Insurance Fund. The number of failures in 

recent years has been unusually low by historic standards and we 

expect that bank failure activity in the near term will be higher. 

As we reported last week, there were 90 institutions with total 

assets of $26.3 billion on the FDIC’s problem bank list at the end 

of the first quarter, up from 76 with total assets of $22.2 billion at 

the end of 2007. Nevertheless, about 99 percent of all insured institutions, representing over 99 percent of industry assets, met or exceeded the minimum regulatory capital standard for well capitalized status under PCA. 

As of March 31st, the balance in the Deposit Insurance Fund 

stood at $52.8 billion. The strong growth in insured deposits, together with the increase in loss provisions, pushed down the DIF 

reserve ratio to 1.19 percent from 1.22 percent at year-end 2007. 

As insurance losses increase due to failures, combined with strong 

deposit growth, the fund could drop below the 1.15 percent minimum of the statutory range. I can assure this Committee that the 

FDIC Board will act as necessary under the statutory requirements 

of the Reform Act to maintain the integrity of the DIF. 

Because the rate of bank failures is expected to return to a level 

above that of recent years, and with the current uncertainties in 

the banking industry, the FDIC is actively ensuring that we have 


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the capacity and appropriate skills to address the resolution of 

failed institutions. With the significant consolidation in the banking industry, we are focusing particularly on unique issues associated with large financial institutions. 

Even though the probability of such a failure is extremely unlikely, the development of mega-institutions means that the FDIC 

must ensure that its processes and systems are capable of handling 

the complex issues such a failure would pose. For example, some 

institutions may have millions of deposit accounts. The ability to 

determine their insured status quickly is essential to a successful 

resolution of a large failed bank. 

After 2 years of study and public input, the FDIC Board will be 

considering at our next meeting a new regulation to require certain 

large banks to modify their deposit systems to facilitate deposit insurance determinations. 

The FDIC also is working to improve our ability to respond effectively to larger and more complex portfolios of qualified financial 

contracts held by banks. The new rule will ensure that critical information about these complex financial relationships is available 

to the FDIC under the very tight timeframes necessary to achieve 

an orderly resolution of a failed bank. 

As part of our contingency planning for increased bank failures, 

we have beefed up our resolution and receivership staff and crosstrained over 1,200 existing staff who can help with various aspects 

of the resolution process. We have also been running bank failure 

readiness exercises to test our preparedness for the resolution of 

larger, more complex institutions. We are taking these measures as 

a precaution. We feel we must be prepared for any contingency. 

Finally and most importantly, I commend the Committee on 

passing legislation to expand eligibility for loans guaranteed by the 

FHA, combined with GSE modernization and regulatory reform. 

This legislation is laudable and will help many borrowers. 

We have also welcomed the opportunity to discuss with Committee members individually our suggestions for additional tools to 

combat escalating foreclosures. My written statement includes a 

description of the Home Ownership Preservation loan proposal that 

would provide loans to pay down distressed mortgages to an affordable level with repayment costs shared by borrowers and mortgage 

investors. We believe this proposal could be a valuable compliment 

to the current FHA proposals recently approved by this Committee. 

This concludes my testimony. Thank you very much. 

Chairman DODD. Thank you very much, Ms. Bair. 

John Dugan, thank you. 

STATEMENT OF JOHN C. DUGAN, COMPTROLLER OF THE 

CURRENCY, UNITED STATES TREASURY 

Mr. DUGAN. Chairman Dodd, Senator Shelby, and Members of 

the Committee, I am pleased to be here today to update the Committee on recent events in the financial markets and the condition 

of the national banking system. 

When I testified before this Committee in March, I reported that 

two powerful and related forces were exerting real stress on banks 

of all sizes and in many different parts of the country. One was the 

unprecedented series of credit market disruptions precipitated by 


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declining house prices and severe problems with subprime mortgages. The other was the slowdown in the economy which had 

begun to generate a noticeable decline in credit quality in a number of asset classes. 

As we assess the impact of these forces today, I would say this: 

Credit markets are somewhat better, while credit quality, meaning 

the performance of loans and other credit extensions to which 

banks are exposed, is worse. 

On the first point, we are beginning to see improvements in several key segments of the credit markets. In particular, there is significantly more liquidity in money markets, and spreads on credit 

default swaps have narrowed. Financial institutions have raised 

unprecedented amounts of capital since October 1st of last year, 

over $100 billion by national banking organizations alone. And this 

shoring up of their balance sheets has helped restore confidence 

and liquidity in the interbank market. In addition, the pipeline of 

hung leveraged loan deals has slowly begun the clearing process. 

While these are all good signs of progress, we clearly are not out 

of the woods. There continues to be considerable uncertainty among 

market participants about the underlying strength of the economy 

and the ongoing effects the recent market disruption and economic 

downturn are having on financial counterparties, consumers, and 

commercial borrowers. This uncertainty may lead to continued volatility in the financial markets that we and the institutions that 

we supervise will need to monitor carefully. Moreover, securitization channels for residential mortgages remain largely closed, except for conforming mortgages sold to the GSEs and FHA. Although banks and other portfolio lenders have taken up some of 

this slack, they cannot provide the same level of credit to this important part of the mortgage market as was previously provided by 

securitization markets. 

In addition, the number of homes in foreclosure continues to rise. 

In this regard, we support the significant new options provided in 

this Committee’s recent legislation that would help borrowers refinance their homes rather than face foreclosure. 

On the second point, credit quality, the downturn in housing and 

the broader economy is indeed continuing to have an adverse effect 

on national banks’ loan portfolios. The level of nonperforming and 

past-due loans is increasing. Not surprisingly, housing-related credit is of particular concern, including home equity loans, lower-quality first mortgages, and commercial real estate related to residential construction. 

But credit quality is also declining in credit card loans, auto 

loans, small business loans, and, to a lesser extent, commercial and 

industrial loans and commercial real estate unrelated to housing. 

There are, however, two important caveats: 

First, this upward trend in losses starts from a very low base of 

exceptionally benign credit conditions. 

Second, banks in some parts of the country where regional economies are stronger have simply not experienced the same increases 

in problem loans. 

Nevertheless, given the clear trend lines in most banks, responding to deteriorating credit quality will continue to be a major focal 

point for supervisors and bankers in the months ahead. In light of 


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these conditions, we believe the substantial increases that banks 

have made both to loan loss reserves and to capital in recent quarters are both prudent and warranted. Indeed, should credit performance continue to worsen, as we expect, additional loan loss reserves will be needed and, in some cases, additional capital. As always, we support maintaining strong conservative reserves, and we 

will continue to underscore this message to bankers, the accounting 

standards setters, and bank auditors. 

Likewise, both on our own and in cooperation with other supervisors, we continue to identify and implement lessons learned from 

the recent market turmoil, especially for our larger institutions. 

These efforts focus on improvements to risk management, including 

addressing new types of liquidity risk, appropriately identifying 

and managing off-balance-sheet exposures, managing concentrations, and significantly enhanced metrics for aggregating risks to 

particular counterparties. Each of these areas is described in more 

detail in my written statement, and I would be pleased to address 

questions about any of them. 

Thank you very much. 

Chairman DODD. Thank you very much. 

John Reich, thank you for being here. 

STATEMENT OF JOHN M. REICH, DIRECTOR, OFFICE OF 

THRIFT SUPERVISION 

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

Shelby, and Members of the Committee. I appreciate the opportunity to return today to give you an update on the financial condition and performance of the thrifts industry. 

As I reported to the Committee in March, thrift institutions are 

continuing to face significant challenges from the downturn in the 

housing sector and general economic weakness. But despite these 

challenges, the industry generally is continuing to hold up remarkably well. Capital is down slightly, but it remains solid. Managers 

of OTS-regulated institutions are showing that they take the challenges seriously by adding a record amount to their loan loss provisions in the first quarter of this year, $7.6 billion. And I have encouraged institutions’ CEOs to be aggressive in adding to their loan 

loss reserves. Setting aside this money has decreased earnings, but 

the rise in troubled assets indicates that higher provisions are necessary. 

When I talk with the news media about the performance of the 

thrift industry, I am often asked how the current climate compares 

with the climate that existed in the 1980s and 1990s. One illustration I can provide is to point out the number of problem thrifts, 

which stood at 12 at the end of March, the end of the first quarter, 

and stands at 17 today, that figure compared to 1992, for example, 

when more than 200 thrifts were in troubled condition. During that 

time, industry capital was not in the solid condition that it is 

today. Although we anticipate the possibility of a few smaller institutions may fail in coming quarters, there is no comparison to the 

late 1980s and the early 1990s, when hundreds of thrift institutions failed and were closed. 

My written testimony describes how OTS is emphasizing to thrift 

institution management the lessons learned from the current crisis 


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as both examiners and institution executives assess their management of risk. Bank management is largely about managing risks, 

and risk management in the financial services industry was clearly 

inadequate in anticipating the approach of the current crisis and 

in accurately assessing its potential impact. 

Learning lessons from these inadequacies, doing a better job of 

identifying and measuring risks, and thereby preventing a recurrence are essential to the safety and soundness of our financial system. An attachment to my testimony is a March letter we sent to 

thrift CEOs describing specific areas where they should be focusing 

their attention in managing risks. We are continuing to emphasize 

these points during examinations and regular town meetings that 

we hold with thrift executives around the country. 

I might say that I have boosted the number of outreach events 

that I have had done since our March hearing with institutions 

around the country, and I have asked all members of my senior 

management in Washington, D.C., and in our regional offices 

around the country to go out on an examination this year to get 

a firsthand feel. Many of our senior management has not been out 

on examination for 5, 10, 15 years, and it is time that they reacquainted themselves with how things really are. 

Perhaps the most important lesson that we have learned from 

this crisis is that all of the players in the home mortgage market 

need to play by the same rules. There is a corrosive effect on the 

entire system when certain segments of the market can cut corners, unsound loan underwriting, and evade serious scrutiny. 

The OTS and the other Federal banking regulators have issued 

guidance and focused our supervisor attention on ensuring sound 

underwriting for nontraditional mortgage products and subprime 

loans. Many States have adopted this guidance, but others have 

not. So uniform nationwide protections do not exist for consumers 

making what is probably the largest investment of their lives. 

These regulatory gaps have a real impact on families across 

America, and in my opinion, we should make closing the gaps an 

urgent priority. 

For home mortgages, consistent regulation is essential for the 

brokers who originate home mortgages and for the mortgage companies, including mortgage banks. I believe the OTS is in a unique 

position to work with States to close the gaps in regulation, because our agency has nearly two decades of experience in supervising financial institutions engaged primarily in home mortgage 

lending and in other consumer-related lines of business. 

For the originators, we need nationwide registration and licensing, financial obligation, demonstration of some financial capacity, 

such as a net worth requirement or a bond, and a change in compensation structure so that brokers have a stake in the long-term 

viability of every loan that they originate. The OTS would work 

with State regulators to establish such a system and monitor its effectiveness. 

For mortgage companies, we recommend following the model 

used by the FDIC and States in examining State-chartered banks, 

alternating examinations, or conducting joint examinations. The 

OTS would work with the Conference of State Bank Supervisors 

and other State regulatory groups to develop these partnerships, to 


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ensure accountability, consistency, and transparency throughout 

the mortgage lending process. 

Thank you, Mr. Chairman, and I look forward to your questions. 

Chairman DODD. Thank you very, very much as well. 

JoAnn Johnson from the National Credit Union Administration, 

we thank you. 

STATEMENT OF JOANN JOHNSON, CHAIRMAN, NATIONAL 

CREDIT UNION ADMINISTRATION 

Ms. JOHNSON. Thank you, Chairman Dodd, Senator Shelby, and 

Members of the Committee. Thank you for the opportunity to update the Committee regarding the state of the credit union industry in the context of your broader review of how financial institutions are performing during the recent turbulence. 

The overall financial state of the credit union industry remains 

strong and healthy, with financial trends indicating a safe and 

sound industry. We do note, however, isolated but not systemic 

problems. I will outline key data which supports this conclusion 

and also underscore NCUA’s belief that the industry has implemented our regulatory guidance regarding the need for increased 

vigilance and more careful management of credit union balance 

sheets. 

Federally insured credit unions are well capitalized. Net worth 

stands at 11.1 percent, and over 99 percent are at least adequately 

capitalized. Total assets are at $792 billion, and aggregate net 

worth is $87.87 billion, the highest dollar amount in history. The 

Share Insurance Fund is strong, with a current 1.31 equity level. 

While we have increased our loss reserves, we expect the year-end 

equity level to be a 1.30 percent with the ability to withstand any 

projected potential losses. 

Lending continues to be a main focus of credit union service to 

members. As of the end of 2007, loans represented just over 67 percent of credit union assets. Within that figure real estate loans 

comprise over 52 percent of total loans. Credit union mortgage 

lending is primarily of the traditional variety. Nearly 60 percent of 

credit union mortgage loans are fixed rate. Only 2.4 percent are interest-only or optional-payment loans that have garnered much of 

the recent attention on Capitol Hill and made this hearing, unfortunately, necessary. 

Overall, loan delinquencies have decreased slightly since the last 

time we met to discuss this important issue from 0.93 to 0.91 percent. And real estate delinquencies now stand at 0.7 percent. Aggregate net charge-offs for all loans have increased from 0.5 percent to 0.67 percent, with real estate net charge-offs currently at 

0.19 percent. 

Those relatively low numbers indicate that credit unions have 

positioned themselves to withstand the current economic uncertainty and related mortgage problems. To make certain that continues, NCUA has played a proactive and aggressive role in issuing 

supervisory guidance regarding lending. 

Since 1995, NCUA has issued guidance on risk-based lending 

and specific mortgage lending guidance that has identified potential problem areas, particularly regarding subprime lending, credit 

risk management, due diligence, and stringent evaluation of thirdVerDate Nov 24 2008 02:09 Apr 02, 2010 Jkt 050405 PO 00000 Frm 00018 Fmt 6633 Sfmt 6602 E:\HR\OC\A405.XXX A405

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party relationships. Home equity lines of credit and so-called exotic 

mortgage products, such as the interest-only and payment-optional, 

were also covered by this guidance. 

Last year, in concert with my fellow regulators, joint guidance regarding workout arrangements, subprime lending, and loss mitigation was issued. All of this was aimed at increasing credit union 

awareness of the potential pitfalls inherent in a rapidly changing 

and complex lending landscape. It also serves as a constant reminder to the industry of NCUA’s vigilant posture when it comes 

to identifying and managing risk. While NCUA appreciates the desire of credit unions to serve their members as fully as possible, we 

recognize that there is no substitute for strong supervision that enhances safe and sound operations. 

Federally insured credit unions remain financially strong. They 

have implemented NCUA guidance related to real estate and other 

lending and as a result are positioned to weather the current economic turbulence. While data shows that the industry is not entirely insulated from the adverse impact of the mortgage situation, 

it also supports the conclusion that strong risk management and 

prudent standards, hopefully supervised by an engaged regulator, 

will ensure continued success. 

Thank you, and I look forward to your questions. 

Chairman DODD. Thank you very, very much. 

Donald Kohn—Donald, thank you very much—Vice Chairman of 

the Federal Reserve. 

STATEMENT OF DONALD L. KOHN, VICE CHAIRMAN, BOARD 

OF GOVERNORS, FEDERAL RESERVE SYSTEM 

Mr. KOHN. Thank you, Mr. Chairman, Ranking Member Shelby, 

and Members of the Committee. I appreciate this opportunity to 

appear today to discuss the condition of the U.S. banking system 

as a follow-up on our previous hearing in March. 

The U.S. banking system, while still in overall safe and sound 

condition, continues to face challenges. As the U.S. housing market 

has weakened and the economy has slowed over the past year, 

banking organizations have recognized significant losses. These 

losses stem from higher credit charges against residential mortgage-related loans held on their books and from sharp asset value 

write-downs of securitized mortgage-related positions and of leveraged loans. The largest bank holding companies performed better 

in the first quarter of 2008, but softening economic conditions have 

caused continued problems in mortgage loan portfolios, particularly 

home equity lines of credit, and in loans to real estate developers. 

Nonperforming assets of bank holding companies more than doubled over the past year, and loan loss provisions have also risen 

sharply, partly as institutions build their loan loss reserves in advance of expected further deterioration in loan quality. Bankers 

and their supervisors have increasing concerns about the potential 

for more losses from traditional lending activities, such as credit 

card loans, auto loans, home equity lines of credit, and loans to 

businesses. 

U.S. bank holding companies have raised more than $80 billion 

in capital so far in 2008, and some have reduced dividend payouts. 

We support such efforts by institutions to improve their capital 


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bases. Stronger capital positions will allow a banking institution to 

participate in and support the rebound in lending that will accompany the strengthening of the U.S. economy. Banking institutions 

must also continue to strengthen their liquidity positions, and we 

are highly supportive of those efforts as well. 

We see a similar overall outlook for State member banks and anticipate that the number of banks with less than satisfactory supervisory ratings will continue to increase from the relatively low levels that have existed in recent years. 

As recently documented in a series of public reports, the market 

events of the past year point to a number of risk management lessons for financial institutions. Bankers need to properly identify 

and measure and understand risks. They need to understand their 

liquidity risk on an enterprise-wide level and exercise strong management oversight to independent risk management functions. 

Overconfidence and complacency need to be continually battled, especially during an extended period of good times. 

On the supervisory side, we are improving our supervisory processes and supervisory guidance on liquidity risk management, compliance risk management, and other relevant areas. We are acting 

to ensure that banks improve their forward-looking risk identification processes, which should include a more comprehensive understanding of their main and emerging business lines and the full 

range of risks they generate. We are also counseling institutions to 

understand the limits of their more traditional risk identification 

processes, emphasizing the importance of stress testing and scenario analyses. Better risk management at banking organizations 

must also be accompanied by more robust liquidity and capital 

cushions. 

As you know, the Federal Reserve is a consolidated umbrella supervisor of large bank holding companies in the U.S. The process 

of consolidated supervision generally works well with strong, cooperative relationships between the Federal Reserve and other relevant bank supervisors and functional regulators. Recent events 

have highlighted the fundamental importance of enterprise-wise 

risk management, and we need to ensure that our system of consolidated supervision keeps pace. 

The Federal Reserve is enhancing its guidance on consolidated 

supervision to provide greater clarity for our examination staff as 

they deal with the challenges of supervising increasingly complex 

organizations. The enhancements will provide greater consistency 

in the Federal Reserve’s consolidated supervision process, as well 

as improve our ability to look at risks across an entire organization 

regardless of the legal entities in which those risks reside. 

In this manner, the enhancements will assist us considerably in 

our broader financial stability rule. Naturally, under the upgraded 

guidance, we will continue to coordinate closely with other relevant 

supervisors and functional regulators. 

Going forward, we must continue to send strong supervisory messages to senior management at financial institutions, perhaps with 

more force and frequency than in the recent past, to ensure that 

institutions retain their focus on sound risk management in good 

times and bad. We continue to review our supervision practices to 

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cent events. More generally, the Federal Reserve will continue to 

work with other banking agencies, foreign supervisors, and the 

Congress to help ensure that bank safety and soundness is maintained. 

Thank you, Mr. Chairman. 

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

Mr. Karsky. 

STATEMENT OF TIMOTHY J. KARSKY, COMMISSIONER, NORTH 

DAKOTA DEPARTMENT OF FINANCIAL INSTITUTIONS, AND 

CHAIRMAN, CONFERENCE OF STATE BANK SUPERVISORS 

Mr. KARSKY. Good morning, Chairman Dodd, Ranking Member—— 

Chairman DODD. Mr. Karsky, let me introduce you. He is the 

Commissioner of the North Dakota Department of Financial Institutions and Chairman of the Conference of State Bank Supervisors, 

and we thank you very much for joining us. 

Mr. KARSKY. Thank you, Mr. Chairman. Good morning Chairman 

Dodd, Ranking Member Shelby, and Members of the Committee, 

my name, again, for the record is Tim Karsky, and I am the Commissioner for the North Dakota Department of Financial Institutions. I also serve as Chairman of the Conference of State Bank Supervisors, and we thank you for giving us the opportunity to discuss the state of the Nation’s banking industry. 

As we reported to the Committee in March, our Nation’s banks 

are operating in a challenging economy. Unfortunately, we are seeing and will continue to see some banks fail. Based on current conditions and trends, State banking regulators do not expect these 

failures to be widespread or beyond our capacity to manage. 

As the recent failures have demonstrated, the banking industry 

is strong enough to absorb failed institutions, providing stability to 

the local market. This was most recently illustrated by last Friday’s bank failure in Minnesota, which was then acquired by a 

State-chartered bank in North Dakota. This largely market-based 

solution can be managed with limited losses to the Deposit Insurance Fund and without the Government having to provide direct 

support to provide market stability. We have the tools to handle 

this. 

If we are to look for ‘‘lessons learned’’ from the housing and capital markets crisis and the ongoing economic downturn, I believe 

that ‘‘strength through diversity’’ should be at the top of that list. 

‘‘Diversity’’ does not just refer to variation within an institution’s 

lending portfolio or lines of business. It is also diversity in the 

number and size of institutions. It is not an accident, but rather 

conscious policy decisions that have fostered the breadth of banks 

in the United States, which now stands at about 8,500. 

In my home State of North Dakota, community banking is a pillar of economic development. For this reason, I am concerned about 

the mission creep of the Farm Credit System and its direct competition with community banks. The preferential status of Farm 

Credit banks creates an unlevel playing field for community banks. 

This disparity could eventually result in safety and soundness 

issues for the banking system in my and other States. 


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Since this Committee’s hearing in early March, the Treasury Department released its blueprint for financial regulatory modernization and the failure of Bear Stearns prompted historic action from 

the Federal Reserve. We must acknowledge that failures and resolutions take on a variety of forms based upon the type of institution 

and its impact upon the financial system as a whole. Legislative 

and regulatory decisions that alter our financial regulatory structure or financial incentives should be carefully considered against 

how those decisions affect the competitive landscape for institutions of all sizes. 

We recognize that extraordinary events require extraordinary actions. To provide market stability, the Federal Reserve has provided a tremendous amount of liquidity through various lending facilities and access to the discount window by investment banks. As 

we evaluate our regulatory structure, we must examine the linkage 

between the capital markets and the traditional banking sector. 

Depository institutions are heavily regulated. Going forward, we 

believe that the capital markets, and investment banks in particular, require enhanced regulatory scrutiny. 

While State supervisors are leery of a complete overhaul of the 

banking system, we have long recognized the need for changes to 

residential mortgage regulation. As a result, CSBS has been working diligently to improve cooperation and coordination among State 

regulators and between State and Federal authorities. CSBS contends that an enhanced regulatory regime for the residential mortgage industry is necessary to ensure legitimate lending practices, 

provide adequate consumer protections, and to once again instill 

both consumer and investor confidence in the housing markets. 

We congratulate this Committee on the passage of the S.A.F.E. 

Mortgage Licensing Act of 2008. As recognized in the bill, the cornerstone of the State initiatives to improve mortgage supervision 

is the development of the CSBS–AARMR Nationwide Mortgage Licensing System. Since our last appearance before this Committee, 

the State Foreclosure Prevention Working Group, of which CSBS 

is a member, released its second data report, which is attached to 

my written testimony. This report contains important findings on 

loss mitigation efforts of mortgage servicers. 

I thank you for the opportunity to testify today and look forward 

to any questions you may have. 

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

appreciate your being with us this morning. 

Let me ask the clerk to put that clock on us here at 5 or 6 minutes, if we can, and try to get around. We have had a good number 

turn out here this morning, and I want to give everyone a chance 

to engage in the discussion. So we will begin, and I will try and 

keep an eye on this clock myself. 

What I will suggest in advance, I suggest there will probably be 

a lot of questions, and we may not get to all of them. So I am going 

to leave that record open for several days so that if we don’t get 

all of our questions asked, we will submit them to you quickly and 

ask for a quick response, if we can, as well. 

Sheila Bair, let me begin with you, if I can, and your testimony 

warns us of more bank failures to come this morning and says that 

these failures may not be confined to the smaller institutions. What 


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specific factors do you believe lead these banks to be in that condition? And do you expect that this round of failures will pose different challenges to your agency or the agencies represented at the 

table than the failures did in the 1990s? And, last, are you concerned about the Deposit Insurance Fund reserve ratio? 

Ms. BAIR. Thank you, Mr. Chairman. I think in terms of risk exposure, obviously those institutions that had monoline business 

models and were heavily involved in nontraditional subprime mortgage lending are of concern. Those institutions that have high CRE 

concentrations, particularly combined with rapid growth, are of 

concern. 

Within the CRE category, we are particularly focused on residential construction and development. That is where we are really seeing the delinquencies spike. And within that category, institutions 

with assets between $1 to $10 billion we think warrant a particular 

focus. 

Chairman DODD. I am sorry. Would you repeat that? 

Ms. BAIR. For mid-sized institutions with assets between $1 and 

$10 billion with high CRE concentrations, we’re seeing a significant 

increase in delinquencies especially for that category of assets. 

In terms of the resolution activity, so far, I am very proud of the 

way we have handled it. We perhaps were a little rusty. We went 

21⁄2 years without any bank failures. We had three last year, four 

this year. The number will go up. I think we have been working 

very hard to prepare, to staff up. There is a broad range of institutions that we need to keep a close eye on, but I do think we are 

taking all the steps that we can take. 

Again in terms of a very large institution failure, I don’t see that 

happening. I would be very surprised if that happened. But we feel 

like we have to prepare for all contingencies. 

So we have been really going on two fronts—dealing with the 

more traditional resolution activity for the smaller institutions, 

where we know we have increases, and then trying to prepare 

through additional staffing and conducting simulation exercises for 

the larger, more complex institutions, as well as finalizing this 

rulemaking to get large institutions to update their deposit systems 

so we could very quickly make an insured deposit determination if 

the worst happens that we would have to close one. 

Chairman DODD. And the ratios? 

Ms. BAIR. The coverage ratio is a particular concern, and other 

regulators have mentioned that as well. The coverage ratio is a 

ratio of loan loss reserves to non-current loans. It has been slipping. It is down to 89 cents. We would like to keep it to about a 

dollar. That is a conservative range, but we would like to keep it 

there. So it has been slipping and, again, it appears that the institutions with large CRE concentrations, especially mid-sized institutions, is where we have seen a lot of slippage. So we are very, very 

focused, as are all the regulators, on getting those loan loss reserves up. 

I am sorry, the ratio on the Deposit Insurance Fund. 

Chairman DODD. Yes. 

Ms. BAIR. Yes. We are down to 1.19, mainly because of very robust deposit growth in the first quarter. But we also had an inVerDate Nov 24 2008 02:09 Apr 02, 2010 Jkt 050405 PO 00000 Frm 00023 Fmt 6633 Sfmt 6602 E:\HR\OC\A405.XXX A405

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crease in our contingent loss reserve which has to be removed from 

the account balance that we use to determine the reserve ratio. 

So, as you know, Mr. Chairman, we are at 1.19 now. If it drops 

to 1.15, the Reform Act requires us to implement a 5-year restoration plan in a very quick time period. So, again, I think probably 

in mid-August we will have a better sense of how close we will be 

to that, but we will act very quickly. 

Chairman DODD. But you are prepared to respond to that. 

Ms. BAIR. Absolutely. Absolutely. 

Chairman DODD. Do you anticipate that is going to happen? 

Ms. BAIR. I am trying not to make predictions, Mr. Chairman, 

because there are a lot of uncertainties out there. So we are trying 

to prepare for all contingencies. It is certainly within the realm of 

possibility. I do not discount it, which is one of the reasons why I 

wanted to raise it at this hearing, so you would know and not be 

surprised. 

Chairman DODD. Well, I appreciate that. 

Let me move quickly, if I can, to—one of the fundamental questions is whether we should be relying on models in setting bank 

capital, which is one of the components of Basel II, as you know. 

Don Kohn, my friend over here, argued that the Basel Committee 

will, and I quote him here, ‘‘adjust the Basel II capital requirements in light of recent market events.’’ 

Ms. Bair, you have raised some concerns in your response by 

pointing out, and I quote your testimony, that the ‘‘unprecedented 

downgrades and massive losses incurred by banks on AAA-rated 

structured securities such as CDOs and asset-backed securities are 

a prime example of why models cannot be relied upon to set capital 

requirements and are meant to protect and preserve the solvency 

of our Nation’s financial institutions.’’ 

Mr. Kohn, let me ask you, how would you respond to Ms. Bair’s 

concerns about whether or not we should be relying on these models, in light of her statements about the recent evidence that indicates that that is a dangerous precedent to be engaging in. 

Mr. KOHN. Well, I certainly agree with Chairman Bair that we 

should not rely exclusively on models to gauge the capital adequacy 

of risk-based capital. Models are one input. They didn’t do very 

well in a number of respects, in a number of types of assets, and 

the most recent market turmoil. We are engaged with other supervisors in looking at the implications of that for the Basel capital 

requirements themselves. But I would also add there is a Pillar 2 

to Basel, so that the banking regulators need to be confident that 

the numbers coming out of Pillar 1, based in part on model simulations, are adequate. And if we think they are not, we will insist 

that the banks hold more capital. 

So this is not—Basel II is not just relying on some mathematical 

formula. There is quite a bit of regulatory oversight of how those 

formulas are done and adjustments of the regulation and supplements to that. 

Chairman DODD. Well, I know there is a lot of interest on that. 

Senator Reed has raised these issues before in previous hearings 

we have had, so we will be following it very closely. 

Let me move, if I can, to the issue of credit cycle and some of 

the write-offs, potential write-offs. As I mentioned in my opening 


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statement, some people now believe that the worse is behind us in 

the current credit crisis, while others believe that there are still 

some large potential pitfalls in our path. And we do know that we 

have witnesses—we have witnessed an unprecedented amount of 

write-downs by banks, which have led them to raise additional capital. By one account, banks throughout the world have had to raise 

over $200 billion in additional capital to confront these write-downs 

and losses. So I have two questions for the panel, if you would 

quickly respond to them. 

First, is the cycle of mortgage-related write-downs nearing an 

end in your view? And, John Dugan, I will begin with you on this 

one. 

And, second, discuss the risks to financial institutions from additional credit exposures, including loans and securitizations from 

credit cards, commercial real estate, or other areas of lending that 

will need to be addressed in the coming period. Somebody mentioned auto loan issues, for instance, which are showing some 

stress, to put it mildly. I would like you to just quickly comment 

on this, if you could. 

Mr. DUGAN. Well, if I may, on the first question about are we 

past the period of most significant write-downs, if you look at the 

things that caused the really huge losses—the CDOs that were on 

the biggest firms’ balance sheets where they have taken very large 

write-downs already, in some cases 50 percent of the value of the 

asset, even though the asset continues to pay, it is a liquidity kind 

of write-down. We think that the pace of those write-downs has already slowed and was nearing a place where we do not think it is 

likely to go down too much farther, which is a good thing. 

If you ask about the particular loan level things like mortgages, 

home equity loans, et cetera, we expect that to continue to decline 

in almost all asset classes, as I have described. You mentioned 

auto. I would say home equity is a place that because it stands behind first mortgages, takes the first loss. We have seen very significant upturns in losses in that asset class, and unlike a lot of first 

mortgages which are sold off to third parties, those are pretty 

much all on the balance sheets of the institutions that originate 

them. We are still starting from a very low level of delinquency, so 

the fact that it has gone up is a concern, but not one that we would 

describe as a capital event, more an earnings event. 

But across all these asset classes, whether it is consumer or commercial, we are seeing an uptick—and more than an uptick in some 

places—of criticized and classified assets. 

The one thing I would like to emphasize, though—and you mentioned this—is institutions have been able to tap the capital markets and raise a tremendous amount of capital, and they did not 

do that in the 1980s. Not only did they not start with as much capital, but they were not able to access and replenish it. And that has 

been a difference, and a very significant, very healthy, difference 

this time around. And we expect to see more of that. 

Chairman DODD. John Reich, do you have any comment? 

Mr. REICH. I think one of our biggest concerns today is housing 

prices and the growing inventory of housing that is for sale, to the 

point today where there is about an 11-month inventory of homes 

for sale today. The longer that continues to be the case, the more 


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downward pressure that puts on housing prices today. And that 

will have an impact on our institutions, particularly on—HELOCs 

have been referred to today, home equity lines of credit that stand 

behind, generally, first mortgages. Thrift institutions have about 

$1.5 trillion in total assets. About 7.8 percent of their assets are 

in home equity lines of credit, about $118 billion. 

As I mentioned in my opening statement, we have been encouraging them to add to their reserves. A year ago, reserves for future 

loan losses stood at about a half of 1 percent. Today they are over 

11⁄2 of 1 percent. They have provisioned aggressively in the fourth 

quarter of last year and the first quarter of this year. 

We are seeing some positive signs. Net interest margin is showing some sign of improvement. There has actually been some improvement in the delinquency ratios for residential mortgages in 

the months of April and May of this year, during the second quarter of the year. 

But I am not really wanting to make any predictions either as 

far as what inning we are in or whether we are out of the woods. 

I think our institutions are—I think they have geared up. I think 

we are dealing with a situation as it stands today, and I have some 

degree of optimism. But I would hate to characterize that too clearly. 

Chairman DODD. Ms. Johnson. 

Ms. JOHNSON. When you consider the charge-offs, the overall delinquency rate has ticked up, and the losses as well. But it is not 

an alarming figure. The credit unions are very well capitalized, and 

we feel it is a manageable situation. 

Chairman DODD. OK. Don. 

Mr. KOHN. I agree with my colleagues, Mr. Chairman. I think as 

John Reich said, the housing market bottom is not here yet. Prices 

are continuing to fall in many localities. I was encouraged by Senator Martinez’s comments that he was beginning to see a little bit 

of a bottom in Florida. I would like to see that in the data as well. 

So house prices are continuing to fall, but it is also the case that 

expected declines in house prices have been built into many of the 

prices of the securities that are driving the kinds of write-downs 

that John Dugan was talking about. So the market expects this to 

happen. They have built it in, and they have written down the 

price of the securities. So to that extent, I think both Johns are 

right. 

Still, as long as the housing market is on a downward path, as 

long as those prices continue to fall, I think there is a risk that the 

losses could continue to mount on a variety of loans. 

It is also the case that consumers, with a soft economy, a little 

bit of an increase in the unemployment rate we have seen so far— 

we have seen consumer spendable incomes pinched by rising energy prices, and we have seen upticks in problems in various consumer loan categories. And it would be surprising if that did not 

continue to rise for a while. Banks need to be prepared. I think by 

and large they are prepared. They are well capitalized. They have 

good capital cushions, and they have begun to build their reserves. 

But I also believe that they can use more, particularly against 

downside risk. So I would encourage them to continue the capitalVerDate Nov 24 2008 02:09 Apr 02, 2010 Jkt 050405 PO 00000 Frm 00026 Fmt 6633 Sfmt 6602 E:\HR\OC\A405.XXX A405

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raising path that they have been on to protect themselves against 

the potential that things turn out to be worse than people expect. 

Chairman DODD. Mr. Karsky. 

Mr. KARSKY. Thank you, Mr. Chairman. I would say that I think 

for State-chartered banks as a whole, we have come through a 

pretty good economic time where our banks have a history of high 

capital ratios and we have had some good periods of earnings. We 

have some concerns going forward. We will not make predictions, 

but I think our banks are in good shape to handle the future crises. 

Speaking for North Dakota, if I have a risk or a concern out 

there, it is just that we do not run into an agricultural crisis with 

overlending on land values and we continue to lend on cash-flow. 

We have learned some pretty valuable lessons from the 1980s and 

1990s, and as long as we stick to what we have learned, I think 

we are going to be OK. But our land prices have gone up substantially, I think, in the Midwest due to those high commodity prices. 

If those commodity prices drop, land values are going to drop. If 

our banks overlend, we are going to have some problems. 

Chairman DODD. Yes. Well, thank you. And I have some additional questions. I wanted to get to this discount window issue, but 

I will reserve that until I get around. I went over my time, as I 

promised I would not, with these questions, but there are so many 

panelists here. 

Let me turn to Senator Shelby. 

Senator SHELBY. Governor Kohn, I want to pick up on some of 

the areas that Senator Dodd was into. As a lot of the subprime 

loans are reset, which they are being reset now, a lot of people in 

the financial markets are really concerned since this will have an 

impact not only on the price of housing but on the whole housing 

sector and financial sector. How do you see that? Is that already 

priced in? Or can it be priced in by the market? Because these are 

huge amounts of money we are talking about. 

Mr. KOHN. I think it is priced in to a certain extent. A couple 

of comments, Senator. 

One is I think because of our monetary policy actions, the threat 

from resets looks less dire than it did a year ago, because interest 

rates have come down, so they are not resetting to quite as high 

a rate as they were before. But they are still resetting, and many 

borrowers will—— 

Senator SHELBY. But there have got to be still concerns there 

for—— 

Mr. KOHN. There are lots of concerns, and the concerns actually 

perhaps are more focused on this price issue, that the price of collateral, the price of the houses going down, and people are in the 

so-called negative equity position, and what will they do in those 

situations, and how can we help them stay in their homes, prevent 

foreclosures. I do think that there is still mounting stress in the 

mortgage markets, and foreclosures are increasing, and those foreclosures will, as I think Chairman Bair said, add to the pressure 

on prices. So—— 

Senator SHELBY. Is this more regionalized or is it across the 

board? 

Mr. KOHN. Well, it is true in a lot of places, but it is most evident 

in those areas that had very rapid run-up in prices, and so CaliVerDate Nov 24 2008 02:09 Apr 02, 2010 Jkt 050405 PO 00000 Frm 00027 Fmt 6633 Sfmt 6602 E:\HR\OC\A405.XXX A405

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fornia, Arizona, Nevada, Florida, I think were the—but those 

places are really stretched. They had very rapid run-up in prices, 

and a lot of lending to the full value of the collateral, and sometimes beyond that, on the assumption that the value of the collateral would rise and bail people out of all their problems. And now 

the collateral is falling very markedly. 

The other stretch, geographical stretch of problems is in the 

upper Midwest where the industrial economy is in such bad shape. 

Senator SHELBY. Ms. Bair, do you agree with his testimony? Is 

that some of your concerns as Chairman of the FDIC? 

Ms. BAIR. I do, yes. We continue to be very, very focused on the 

housing market and this self-reinforcing cycle of foreclosures putting more pressure on home prices, resulting in more defaults and 

foreclosures. 

I noticed the Mortgage Bankers Association came out with their 

most recent data. I think it just confirms what Don indicated. Foreclosures again were up. California, Florida, Nevada, and Arizona 

accounted for 93 percent of the increase in foreclosures among 

subprime ARMs. So particularly with those states where there was 

a big boom, there is a big bust now. We are getting into this dynamic where it is not just affordability of the mortgage, it is a combination of affordability plus being underwater, and at what point 

do more and more borrowers just give up and walk. 

Senator SHELBY. Are those the areas that Governor Kohn was 

talking about in the country, are those where you are most concerned about bank failures? 

Ms. BAIR. Well, that is a very—— 

Senator SHELBY. Where there is big exposure to real estate? 

Ms. BAIR. Some of our more recent closings were banks who have 

done lending in those areas. These banks were not based in those 

states, but they were doing lending in those states. They were 

doing out-of-area lending. So that is another risk factor that we are 

taking a close look at. 

Senator SHELBY. What is the value roughly of the FDIC fund 

today? 

Ms. BAIR. It is $52.8 billion. 

Senator SHELBY. $52 billion—— 

Ms. BAIR. $52.8 billion. 

Senator SHELBY. Billion. And that is a lot of money, but considering the risk, you don’t know as Chairman if that will be adequate 

down the road, do you? 

Ms. BAIR. Well, our target is 1.25, which is where it has been for 

many years. We are at 1.19, as I indicated, and it is declining primarily because of deposit growth, but also because of increased 

losses due to bank failures. We do have back-up liquidity lines with 

Treasury. We are guaranteed by the full faith and credit of the 

U.S. Government. So, I think it is very important for depositors to 

understand absolutely the resources are there to back all insured 

deposits. 

But I think we are fine. I think we are, even though there is an 

uptick in resolution activity, the number of failures is still low, certainly very low, compared to what was going on during the S&L 

days. So at this point, I think we are well prepared to handle it. 


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Senator SHELBY. Governor Kohn, I want to address another question to you, if I could. You are the Vice Chairman of the Federal 

Reserve. Current law, as I understand it, permits only entities that 

qualify as thrift, bank, or financial holding companies to exercise 

control over thrifts and banks. These laws were designed to protect 

the banking sector and have done so for about 75 years. At the 

same time, these restrictions limit many non-banking entities from 

providing capital to the banking system. 

In light of the legal reality and the ongoing volatility of the financial markets—you are the Vice Chairman of the Fed—do you 

have any questions or concerns about the pool of capital available 

to banks and thrifts in today’s markets? 

Mr. KOHN. I think banks and thrifts have done a very good job 

in tapping a variety of capital in today’s market, and they seem to 

have found ready sources of capital from a number of sources, including private equity, sovereign wealth funds, their own shareholders. I think so far there is ample capital out there if you are 

willing to pay for it, and they can do that. 

I think the restrictions that Congress has put in place, basically 

in Gramm-Leach-Bliley, trying to separate banking from commerce, 

is what is, I think, underlying your question about what kinds of 

companies—— 

Senator SHELBY. Absolutely. 

Mr. KOHN [continuing]. Should be allowed to buy banking companies. And I think if we broaden this out beyond financial holding 

companies, which we have now, I think that would be a very major 

step. I am not saying it should not necessarily be taken, but I think 

it would require a lot of discussion by the Congress as to whether 

they wanted to cross this boundary which they had drawn—— 

Senator SHELBY. It would be a big change from where we are 

today, would it? 

Mr. KOHN. It would be a huge change from where we are today, 

and I am not sure it is necessary in order to get capital. 

Senator SHELBY. But you do anticipate some of our banks—I 

know we do—are going to have to seek additional capital to meet 

what you as regulators say they need—is that correct?—considering the risk. 

Mr. KOHN. I think they do. I do not think it is a risk because 

I think they do, they will be raising capital, and they will find that 

capital—— 

Senator SHELBY. Well, the capital is to cover the risk, isn’t it? 

Mr. KOHN. Yes, right. Right, they need the capital to cover particularly the downside risk in case things do not go very well. 

Senator SHELBY. Governor Kohn—and I will address this to you 

and Chairman Bair—since the JPMorgan Chase takeover of Bear 

Stearns, there has been much discussion on the topic of a financial 

institution being too interconnected to fail, in addition to the older 

notion of too big to fail. The extension of the Federal Reserve discount window to securities firms, unprecedented, has now put Government funds at the disposal of these firms for the first time in 

our history, I believe. 

I have concerns, and other people do, about the processes in 

place should another large and interconnected firm face financial 

troubles, which some people think will happen. How do you believe 


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a potential failure at a large and systemically important financial 

institution should be handled going forward? Same way you did 

with Bear Stearns? Which some people thought was stretching 

your legal authority and getting into some unknown territory. 

Mr. KOHN. As you know, in order to provide liquidity support for 

that transaction, we, the Federal Reserve Board, had to vote that 

circumstances were unusual and exigent, and we did that, I did 

that readily in the circumstances then prevailing. The situation in 

the second week of March in financial markets was very, very 

stressed and deteriorating very badly. There was a flight to liquidity and safety. That flight caught Bear Stearns—who was probably 

the least strong of the major investment banks. Our judgment was 

that had Bear Stearns been allowed to walk into bankruptcy court, 

that would have disrupted the financial system and had very serious effects on the economy. And we would be—I would—if something like this were coming again, I would have to make the same 

kinds of judgments. My judgments are balancing the costs and benefits of any action we take—— 

Senator SHELBY. Continue to bail them out, in other words, is 

that what you are saying? 

Mr. KOHN. I don’t know what we would do. We would try to 

maintain the stability of—— 

Senator SHELBY. But you have set the precedent. 

Mr. KOHN. We would try to maintain the stability of the financial 

system. 

Senator SHELBY. But you have set the precedent by Bear 

Stearns. 

Mr. KOHN. I agree. 

Senator SHELBY. So some people believe that there are at least 

one or two more houses that if they don’t fail, are going to come 

close to it. I hope not. 

Mr. KOHN. I don’t want to comment on—— 

Senator SHELBY. I know that. 

Mr. KOHN [continuing]. The financial stability of these houses. I 

think that the investment banks in general have taken lessons 

from what happened in the first 2 weeks of March. They are building their liquidity. They are reducing their leverage. They are protecting themselves against downside risk. So I think we have a 

stronger set of investment banks than we had a month and a half 

ago. 

Senator SHELBY. You really believe that now? You believe that 

we have a stronger set of investment banks, with all the stress and 

all the exposure, and most of them out looking for capital, than we 

did, say, a year ago? You think they are stronger? 

Mr. KOHN. I said ‘‘than a month and a half ago.’’ 

Senator SHELBY. A month and a half ago. All right. 

Mr. KOHN. I think they recognize the risks and they are taking 

steps to deal with the risks in a much more proactive way than 

was occurring before the middle of March. 

Senator SHELBY. And a lot of that is because it is necessary to 

survive, is it not? 

Mr. KOHN. That is right. There are very—as we were talking 

about the banking system, the same is true of the investment 

banks. There are a lot of risks out there, much of it priced into the 


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market, but not all of it. People are still very concerned about the 

liquidity and safety of where they have invested their money, and 

our major financial institutions need to make very sure that they 

understand the risks, they have got liquidity backstops to protect 

them against some very dire circumstances, and they have got adequate capital so that people will have no doubt about their viability. 

Senator SHELBY. Have you ever seen this much stress in our financial system in your lifetime? You haven’t, I know. I will answer 

that. 

[Laughter.] 

Senator SHELBY. Chairman Bair, the FDIC’s bridge bank model, 

should it be employed in areas like this? Do you want to comment 

on that? 

Ms. BAIR. Well, I do think it is something Congress should consider, and I would hasten to say that we fully support what the 

Fed did with Bear Stearns. They had a very short timeframe, and 

they had no playbook for the situation. I think they were very creative in how they dealt with it. 

That said, I think that this does present an issue of lack of parity 

between how commercial banks—insured depository institutions 

that get in trouble—are treated if they are systemically significant, 

versus investment banks. The FDIC, as you know, must follow 

least-cost resolution, and plus make a systemic risk determination. 

Generally that means the bank has to be closed. It has to be put 

out for bid to multiple bidders. It means that equity shareholders 

and general creditors have to take full haircuts before we would experience losses in the DIF. 

So there are very elaborate procedures. I think they are good procedures. But I think Congress should consider whether perhaps a 

similar set of procedures should be established for a troubled investment bank situation. We cannot deviate from least cost unless 

a supermajority of my board and the Federal Reserve decide that 

we should deviate from least cost. And, the Secretary of the Treasury has to approve it in consultation with the President. So it is 

a fairly elaborate procedure. 

Senator SHELBY. If the Chairman will indulge me, I have got one 

other question. 

Hedge funds and private equity firms have become, as all of you 

know, increasingly large participants in many sectors of the world 

economy. As of now, it is my understanding that these entities are 

only allowed to hold non-controlling stakes in banks and thrifts. 

Governor Kohn, for the record, what constitutes control for each 

type of financial institution that you regulate? And I would also 

like to ask Chairman Reich this. And would you discuss the role 

you see private equity and hedge funds playing as large stakeholders in our financial markets as other traditional funding 

sources may either be strained or unavailable? And what are your 

thoughts about potential changes to investment limits on the harmonization of these rules? 

Governor Kohn? I know that is a big question. 

Mr. KOHN. Senator Shelby, I am not familiar with all of the specifics of all of our regulations, but let me give you a general answer 

here. 


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So you are right, that if you want to control a bank or a bank 

holding company or a financial holding company, you must be a financial institution. And furthermore, under the laws that you have 

passed, you must be ready to support the bank, the depository institution. 

Senator SHELBY. Right. 

Mr. KOHN. You must be a source of strength to that institution. 

So any organization that wants to conform to those rules that 

Congress has established is welcome to apply to become a financial 

holding company to own a bank. I think there is an upper limit of 

24.9 percent in the law of the shares. But even below that, obviously you could have a lower stake in a bank—— 

Senator SHELBY. 24 percent could be working control. 

Mr. KOHN. Exactly. Exactly. And so we have put other metrics 

in place to ensure that Congress’ intention about who controls a financial holding company is in place. So we have looked at whether 

the new equity owners, how many seats do they have on the board? 

What say do they have over the control? Do they have over the 

business strategy of the organization? What control do they have 

over hiring and firing the CEO? So we look at a number of metrics 

of control. 

I think these are things we are looking at all the time. There are 

elements of flexibility there and we have those under continuous 

consideration because, like you, we share the desire to have as 

much capital as possible in this—— 

Senator SHELBY. Chairman Reich, quickly. 

Chairman DODD. Very quickly. 

Senator SHELBY. The Chairman has been very indulgent. 

Chairman DODD. I know, but I have other members here. 

Mr. REICH. We have two primary metrics that are involved here. 

One is 9.9 percent. If a private equity fund were to have 9.9 or 

greater percent, they would have to rebut a presumption of control. 

And 24.9 percent, also the same as the Federal Reserve. 

We have had a number of conversations with private equity 

funds in the last several months. They have shown increasing interest in financial services. Most of them do not want to make an 

investment that would put them in the category of being a financial services holding company. 

Senator SHELBY. Thank you. 

Chairman DODD. Thank you very much. 

And let me just quickly say and move along to other members, 

I happen to be in support of what the Fed did with the Bear 

Stearns JPMorgan Chase issue. I have questions about why we did 

not do something earlier, maybe to avoid the issue. But I think, 

given the time and framework, it was the right thing to have done. 

And I think it is appropriate that there is an improvement, in my 

view, that things have improved since a month-and-a-half ago. 

And there are some additional questions I want to address on 

why it happened the way it did and what steps are being taken to 

make sure that those that are accessing that window are fulfilling 

some of these requirements. But we will get to that when I get 

back to my questioning. 

Senator Reed. 

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


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Governor Kohn, I mentioned in my opening statements, both 

Ambac and MBIA have been placed on a watch list by Moody’s. Do 

you have a general notion of how much exposure that they are insuring against? Is this in the trillions of dollars? 

Mr. KOHN. I do not know the dollar amounts that they are insuring against. 

Senator REED. But it is significant? 

Mr. KOHN. It is significant. That is correct. And many banks 

have bought insurance from these institutions. I think, in many 

cases, the banks have written down the value of the insurance that 

they have bought from them. So they have been anticipating this 

weakness. 

Senator REED. Let me—specifically with the Fed, the collateral 

that you assumed in the Bear Stearns, to what extent are those 

products enhanced by insurance? And to what extend that you 

have to take similar steps? Do you have a notion about that? 

Mr. KOHN. I do not know to what extent the financial guarantors 

are involved. I do know that, for the most part, as was in the appendix to President Geithner’s testimony, for the most part, these 

are mortgage, mortgage-related assets. They do have some hedges 

on them, which we are also taking. But I do not know the specifics 

of whether any of this is guaranteed by the financial guarantors. 

Senator REED. It goes, I think, to the line of questioning that 

Senator Shelby was addressing, this interrelatedness which pops 

up in so many different ways, not so much—in this case, it is an 

insurance entity that insures some of these financial instruments 

that banks are holding as capital, that could become problematic. 

Mr. KOHN. I think that is an excellent point. So banks thought 

they had protection against a risk in the mortgage markets, in the 

housing markets. But the people they were buying the protection 

from themselves had a big exposure in those housing markets so 

their protection was worth less than they thought. 

Senator REED. And this goes beyond just the mortgage part now 

because credit defaults swamps, collateralized obligations, credit 

cards, home loans, car loans, et cetera. 

Mr. KOHN. Right. 

Senator REED. Let me ask Chairman Bair, in your capital discussions, which you say is adequate, are there instruments like this 

in that capital that you have been discussing with financial institutions about downgrading? Are you concerned about this issue that 

Governor Kohn illustrated? 

Ms. BAIR. Yes, we are watching it very carefully. I think you 

need to separate their guarantee function on the structured financing versus their muni bond business. I think the muni bonds are 

safe with or without insurance. But there is bank exposure there, 

as well, particularly with the smaller banks. 

A lot of these instruments have been written down significantly 

already. It is difficult to gauge what the impact would be, whatever 

the future Ambac and MBIA ratings may be. The best we can do 

is closely monitor it, especially individual institutions that have 

significant exposure or are relying on the existence of insurance to 

not take a write-down. That is something that needs to be vigorously addressed on an institution-by-institution basis. 

Senator REED. Mr. Dugan, please. 


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Mr. DUGAN. Yes, most of these exposures are by the large national banks that we regulate and they have to reserve against the 

likelihood or unlikelihood that the protection that they have bought 

would not be there when they needed it and make an adjustment 

accordingly. We monitor that quite closely. 

What Governor Kohn said about it is absolutely right, it turned 

out to be not as much protection as they thought they had. But in 

terms of national banks accounting for that in an appropriate way 

so that it shows up on their balance sheet, we absolutely monitor 

that. 

Senator REED. Are you as satisfied of the structure that they are 

adequately monitoring for that and reserving for that risk? 

Mr. DUGAN. Yes, but that is not the same as saying that the risk 

could not increase over time and might result in additional losses. 

I think they are accurately capturing what the risk is. 

Senator REED. Mr. Reich, your comments? 

Mr. REICH. I believe that there is not serious exposure in the 

thrift industry here. 

Senator REED. Thank you. 

Ms. Johnson, the same thing with respect to the credit union industry, not a serious exposure? 

Ms. JOHNSON. That would be accurate, there are not significant 

volumes. 

Senator REED. Let me turn quickly, Chairman Bair, to another 

issue. And that is the issue of credit card delinquencies, which significantly are becoming, I think, very problematic. Not only delinquencies, but defaults and also bankruptcy filings in which the individual borrower is now essentially writing off the entire credit 

card debt, or at least the companies are until they can recover it 

through legal proceedings. 

Is this a significant issue that you are watching? 

Ms. BAIR. Yes, credit card delinquencies are up. They are still 

relatively low but they are going up. As you indicated earlier, we 

are learning there is a clear interrelationship between mortgage 

distress and a consumer’s ability to meet other types of consumer 

debt obligations, including credit cards. 

So we are watching it carefully. It is going up. It is still relatively 

low but it is an area of increased concern. 

And, because this is unsecured credit, the charge-offs come much 

more quickly than they would with other types of secured lending. 

Senator REED. Mr. Dugan, please. 

Mr. DUGAN. Yes, the national banks have about roughly about 80 

percent of the credit card market. And if you look at an average 

charge-off rate, it is about 5.5 percent over time. 

Frankly, it has been a little lower going into this and below that 

than we would have seen by this point. As Sheila just said, it has 

ticked up to that level. I think credit card providers have been 

more aggressive about managing credit lines and that kind of risk, 

and we are still at that average. It is not like what we are seeing 

in some of the other portfolios like home equity where the losses 

are way higher than historical averages. Here we come back up to 

historical averages, where the trend line is going up. Particularly 

in areas of the country where we have had bad housing market situations, we are seeing it even higher. 


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Senator REED. Thank you. Thank you, Mr. Chairman. 

Chairman DODD. Thank you very much, Senator Reed. 

Senator Allard. 

Senator ALLARD. Mr. Chairman, I just have one question for each 

member of the panel. I guess you could take 20 minutes to answer 

it, but I have got 5 minutes of time. 

My question is this: in regard to the recent events in the markets, from your perspective, would you comment on those areas you 

think where adequacy has done well and areas where you think 

there has been some shortfalls in our current system? And maybe 

comment a little bit about Secretary Paulson’s fairly substantial reform for the Federal Reserve and banking regulatory systems? 

Ms. BAIR. I think our strong supervisory function and strong capital standards have served us well going into this. I think where 

we did not do as well as we should have was with monitoring underwriting standards. We let it get out of control. It was being driven heavily by the non-bank sector, but banks were involved, too. 

So I think we need to get back—and we are getting back—to basics with banks and our supervisors, making sure people make responsibly underwritten loans. 

Senator ALLARD. Do you need legislation to deal with the underwriting? 

Ms. BAIR. Well, I think there was a lot of regulatory arbitrage 

going on, and there are different ways to address it. But one of the 

aspects of the Paulson plan would be to create a prudential supervisor and a business conduct regulator for all financial institutions, 

so we do not have this more Balkanized system that we have now, 

yes. 

Mr. DUGAN. I agree that the underwriting standards, in the 

subprime market in particular, declined obviously dramatically. 

But I think we did have a problem of uneven regulation. And I 

think the problems were way more pronounced outside of the insured depository institution framework. We need to have a system 

that evens out that regulation, so that basically the same rules 

apply to anybody who originates a mortgage loan. We do not really 

have that now. We have made progress toward that goal, but we 

do not have that. And that is a single area where I think we need 

to improve. 

Secondly, I agree that we had good capital coming into recent 

events. I think that is a positive sign. I think we, and everyone, 

relied too heavily on high credit ratings from the credit rating 

agencies. And I think that that created a false sense of security, 

both for institutions and for regulators. There is a lot of work being 

done now to examine that and reexamine not only what rules 

should apply to get those ratings, but also how much regulators 

should rely on them in the first instance. And I think this is very 

much worthy of review. 

Mr. REICH. I agree with Comptroller Dugan. It is a cliche to say 

that we have had an unlevel playing field with regard to supervision, but it is true. And it is gaps in supervision that really initiated the problems that escalated to a broader area in our portfolios. 

I think everyone agrees that housing and mortgage finance are 

major components of our economy that need continuing attention. 

And we need even level supervision among those areas. And I adVerDate Nov 24 2008 02:09 Apr 02, 2010 Jkt 050405 PO 00000 Frm 00035 Fmt 6633 Sfmt 6602 E:\HR\OC\A405.XXX A405

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32 

dressed in my opening statement that I thought that the Office of 

Thrift Supervision could be a part of the solution in leveling the 

playing field in that regard. 

Ms. JOHNSON. Thank you. Yes, I believe that the early vigilance 

and the early guidance that NCUA provided to the credit unions, 

particularly in these lending areas, have certainly paid off, in addition to the robust exams that we performed. 

We also have—credit unions are limited with more narrowly 

drawn investment opportunities and they have not been involved 

in most of this type—this part of the market. 

As far as the Treasury proposal, I believe that there is strong 

evidence that there is a need for an independent regulator for credit unions because of the nuances of the difference between the notfor-profit cooperatives and the banking sector. And I think the success that we have had during this time of turbulence stands to support that. 

Senator ALLARD. Yes. 

Mr. KOHN. I think the successes include the fact that we came 

into this with a very, very well capitalized banking system, so that 

the shock—which has been tremendous, as Senator Shelby was 

saying—has increased failures, it has caused a lot of stress. But in 

the commercial banking system and in the thrift system, I think 

the amount of fallout, while substantial, is certainly less than it 

would have been if we had entered this situation with much less 

robust capital. 

So I think the system learned a lot in the early 1990s and it has 

made it more robust in the mid-2000s. 

I think another thing that has worked reasonably well is—— 

Chairman DODD. Mr. Kohn, excuse me, if I can, just a moment. 

We have been—I wanted to complete this, if I could, but we have 

been notified that there is an objection been filed on the floor of 

the Senate to any committees meeting. I do not know what levity 

or discretion I have here to continue and finish the line of questioning, but I think under the rules of the Senate if an objection 

is filed, then you cannot continue to meet. I regret that deeply, this 

is a very important hearing. 

I apologize to our colleagues who have been here all morning 

waiting to ask questions. So we will leave the record open for the 

questions. But under the rules of the Senate, I think I am obligated 

to terminate the hearing. And I regret having to do that. 

Senator ALLARD. Those of you who did not answer my question, 

maybe you can get a written answer. 

Chairman DODD. We will get a written statement for you. And 

any other questions we will have submitted and ask you to respond 

to our colleagues. 

But this Committee stands adjourned. 

[Whereupon, at 11:48 a.m., the hearing was adjourned.] 

[Prepared statements and responses to written questions supplied for the record follow:] 


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RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING 

FROM SHEILA C. BAIR 

There was an article in the June 4, 2008, Financial Times that 

said banks could be forced to bring up to 5 trillion of assets currently held off their books onto their balance sheets. This raises 

many questions, but I will start with three. 

Q.1. First, in the current markets can the banks raise the capital 

they need to hold against these assets? 

A.1. The June 4, 2008 Financial Times article addresses lingering 

concerns with off-balance sheet exposures. Firms have used loopholes in off-balance sheet accounting for years in order to enhance 

their financial statements without shedding risk. Capital and accounting rules need to reflect the economic reality of the transactions that our large financial institutions engage in on a daily 

basis. 

Financial institutions have shown a remarkable ability to raise 

capital even in this stressed market, which I view as a positive reflection on the long-term prospects for the U.S. banking system. 

Bloomberg reports that the ten U.S. bank holding companies with 

the largest write-downs and credit losses since second quarter 2007 

raised $114.5 billion in capital during this same time period. This 

amount more than offsets the $100.2 billion in write-downs and 

losses that these institutions reported. To shore up their capital 

bases, institutions have reduced and in some cases eliminated cash 

dividends and have raised common stock and preferred shares from 

a wide range of sources. 

While their ability to continue to access the capital markets for 

funding is not assured, institutions have taken the right steps to 

adequately plan for their capital needs. However, several market 

participants have indicated that continued losses are expected as 

we work through the credit market turmoil, which could place additional pressure on bank capital levels. 

We are continuing to evaluate the potential impact of any FASB 

action on off-balance sheet accounting on regulatory capital and on 

the securitization business in general, and will be in a better position to consider changes once the FASB proposals are issued for 

public comment. 

Q.2. Second, since you are their regulators, do you know and have 

you known all along what those assets are? 

A.2. U.S. regulators have three important tools at our disposal for 

identifying and evaluating the risk present in bank operations: onsite examination, off-site surveillance, and public disclosures. While 

these tools provide us with a significant amount of information necessary to assess the safety and soundness of our banks, the financial innovations that have transpired over the past several years 

have made it more difficult to fully understand the risks present 

in off-balance sheet structures such as securitized investment vehicles (SIVs) and collateralized debt obligations (CDOs). These vehicles were used to transfer a wide variety of exposures to investors 

without a sufficient degree of transparency and disclosures. However, the opacity in these structures served to exacerbate problems 

since investors and, in some instances, regulators were not able to 

quickly identify the assets placed in these vehicles. 


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The work underway in the Basel Committee to improve the disclosures governing off-balance sheet vehicles should address many 

of these concerns. In addition, I have been a strong advocate of requiring banks that invest and manage securitization exposures to 

fully understand the risk characteristics present in the 

securitization vehicles and the underlying collateral supporting 

these structures before they can take any capital relief from external ratings. These are bare minimum due diligence standards that 

serve as the foundation of prudent investment management. 

Q.3. And third, why were they allowed to move trillions of dollars 

of what turned out to be the riskiest assets off their books to avoid 

capital charges? 

A.3. The accounting and capital rules have provided banks with the 

ability and incentive to remove assets from their balance sheet. I 

believe that the accounting standards and the capital rules need to 

be reassessed in order to ensure that they provide the right incentives for managing risks at our largest financial institutions. 

Securitization in general has provided several benefits to the financial markets—it has enhanced credit availability and has provided 

market participants with another asset class in which to invest. At 

the same time, the off-balance sheet rules were abused in some 

cases. I am pleased to see that the Financial Accounting Standards 

Board is reviewing their off-balance sheet accounting standards 

with an eye towards eliminating any loopholes. The Basel Committee and U.S. regulators need to consider these issues as well in 

conjunction with any revisions to our capital rules. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR DOLE 

FROM SHEILA C. BAIR 

Q.1. In March, the Attorney General of New York, OFHEO, and 

the GSE’s entered into an agreement creating new appraiser requirements that are inconsistent with existing practices. Last 

month, I introduced an amendment to the Federal Housing Finance Regulatory Reform Act of 2008 that would require the Director of OFHEO to issue a regulation establishing appraisal standards for mortgages purchased or guaranteed by Fannie and 

Freddie. It would establish a common set of appraisal standards 

governing mortgage lenders that are federally supervised and regulated. In your opinion, would this amendment strengthen the appraisal standards of federally regulated mortgages? 

A.1. The New York Attorney General, Fannie Mae, Freddie Mac, 

and the Office of Federal Housing Enterprise Oversight (OFHEO) 

have proposed a Home Valuation Code of Conduct that would overlay the long-standing set of federal banking agency appraisal regulations and Uniform Standards of Professional Appraisal Practice 

(USPAP) guidelines. The FDIC provided a comment to OFHEO on 

the proposal on June 20, 2008, which is attached. Our comment letter strongly supports the concept of appraiser independence and 

USPAP standards, but articulates our belief that the use of inhouse or affiliated appraisers may be appropriate if managed prudently. 


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The Dole amendment would direct OFHEO to devise appraisal 

rules for mortgages purchased or guaranteed by government-sponsored enterprises in a way that is consistent with appraisal regulations issued by the federal banking agencies. This would have the 

advantage of establishing a common set of appraisal standards for 

insured depository institutions and other mortgage lenders nationwide. As indicated in our comment letter, the FDIC supports an 

interagency rulemaking process to establish comprehensive appraisal and appraiser standards. 


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RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING 

FROM JOHN C. DUGAN 

Q.1. There was an article in the June 4, 2008, Financial Times 

that said banks could be forced to bring up to 5 trillion dollars of 

assets currently held off their books onto their balance sheets. This 

raises many questions, but I will start with three. First, in the current markets can the banks raise the capital they need to hold 

against these assets? 

A.1. The accounting changes referenced in the article relate to 

work of the Financial Accounting Standards Board (FASB) to revise two accounting pronouncements. One is FAS 140, Accounting 

for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, which is the primary accounting standard for 

securitization transactions. The other is FIN 46(R), Consolidation 

of Variable Interest Entities, which is the primary accounting guidance for the consolidation of special purpose entities. FIN 46(R) 

often affects whether banks have to consolidate asset-backed commercial paper conduit programs including structured investment 

vehicles. While proceeding separately, the International Accounting 

Standards Board (IASB) is also undertaking work to enhance the 

accounting and disclosure standards for off-balance sheet entities. While the article you cited claims that $5 trillion could be 

brought onto bank balance sheets as a result of FASB’s actions, the 

precise amount is difficult to gauge. A major reason for the uncertainty is that the proposed accounting changes have yet to be fully 

articulated and subjected to public comment. We understand that 

the FASB intends to issue the proposed FAS 140 and FIN 46(R) 

amendments contemporaneously in the coming weeks, for formal 

public comment prior to a final standard being released and becoming effective. While we do not know for certain which current offbalance sheet entities would be consolidated under revised accounting standards, many people following the FASB project believe that 

certain structured finance entities (e.g., ABCP conduits) and revolving securitization trusts (e.g., credit card receivables) will be required to be consolidated by the sponsoring entities. It is less certain whether securitized residential mortgages and money market 

funds would be affected significantly by the proposal. 

In relation to your first question, while investors have shown 

strong willingness to provide capital to U.S. banks, a change in 

generally accepted accounting principles (GAAP) that would add a 

large amount of assets onto bank balance sheets and a related increase in the need for regulatory capital would place additional 

strain on the banking system. As I noted in my written testimony, 

the OCC believes policy makers and accounting standard setters 

need to carefully evaluate how these proposed accounting changes 

may affect markets and institutions and ensure that appropriate 

transition periods are provided if significant changes are adopted. 

Specifically, we believe any effective date and transition period 

should provide time for financial institutions to review their existing transactions and respond to the final FAS 140 and FIN 46(R) 

amendments. This would allow U.S. banks an opportunity to raise 

capital, shed assets, or make other adjustments to their balance 

sheets to prepare for the influx of off-balance sheet exposures. 

Moreover, enhanced coordination between FASB and IASB could 


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minimize international competitive issues resulting from differing 

accounting standards governing these activities. 

We are considering the extent to which these accounting changes 

should flow through to regulatory capital requirements, which 

would also affect whether banks need to raise more capital. As is 

discussed in more detail below, our regulatory capital rules already 

require capital against many off-balance sheet exposures. Once the 

details of the proposed accounting changes are available, we will 

evaluate how our capital requirements might need to be altered. 

Q.2. Second, since you are their regulators, do you know and have 

you known all along what those assets are? 

A.2. As touched on above, off-balance sheet exposures that might 

be affected by the accounting changes include a wide array of assets, including residential mortgage loans, auto loans, and credit 

card receivables that have been sold through securitization transactions. The accounting changes might also affect asset-backed 

commercial paper programs used by banks to provide financing to 

bank customers for assets such as trade receivables. As part of our 

supervisory process, we are actively engaged in evaluating our 

banks’ activities and risk exposures, including an in-depth understanding of bank exposures not shown on the balance sheet. 

Q.3. And third, why were they allowed to move trillions of dollars 

of what turned out to be the riskiest assets off their books to avoid 

capital charges? 

A.3. It is important to note that the assets that might be brought 

onto bank balance sheets if accounting changes are enacted can 

often be of relatively high credit quality. The fact that assets are 

off-balance sheet does not imply that those assets are riskier than 

assets kept on the balance sheet. For example, credit card receivables and prime mortgage loans that have been securitized and 

sold to third-party investors generally do not appear on bank balance sheets but could be brought on as a result of accounting 

changes. Although the loss rates on these types of exposures are increasing due to the effects of the housing and economic downturn, 

we do not expect the losses to approach those experienced in the 

collateralized debt obligation (CDO) market. Similarly, we anticipate that loss rates for home equity loans, which typically are not 

securitized, will be substantially higher than loss rates for 

securitized prime mortgages. 

The ability to move assets off the balance sheet is dictated by 

GAAP, which are governed in the United States by FASB. While 

the regulatory capital rules build off of the accounting framework, 

bank regulatory capital requirements take into account exposures 

beyond just the assets appearing on the balance sheet. In particular, the agencies’ risk-based capital rules include charges for 

off-balance sheet risks. These risk-based capital requirements attempt to look at the economic risks of a given transaction, as opposed to being driven solely by the accounting decision of whether 

the assets can be removed from the balance sheet. For example, 

unfunded portions of liquidity facilities, as well as credit guarantees that banks provide to asset-backed commercial paper programs, are generally off-balance sheet, but they are captured under 

the risk-based capital rules. 


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With that said, the banking agencies readily acknowledge that 

our existing regulatory capital rules warrant review and enhancement. Recent events have revealed some shortcomings in our capital rules, and we are considering changes to these rules to better 

reflect risks. One of the motivations of developing the recently finalized Basel II-based capital rules was to further enhance risk 

sensitivity of the regulatory capital framework. We believe that, 

once implemented, the Basel II-based rules will better reflect 

risks—both on and off the balance sheet. 

Furthermore, we have not stopped considering how to improve 

the rules with the adoption of Basel II. Recent events have led the 

Basel Committee on Banking Supervision to examine making refinements to various aspects of the securitization framework of the 

international Basel II Accord. Changes to the Accord could affect 

the minimum regulatory capital required for off-balance sheet exposures, such as bank exposures to asset-backed commercial paper 

conduits. Changes could also affect on-balance sheet exposures, 

such as certain CDOs and other structured finance transactions 

that have contributed significantly to large losses at banks in recent months. We will consider the changes to the Accord developed 

by the Basel Committee for adoption by U.S. banks through our notice and comment process. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR DOLE 

FROM JOHN C. DUGAN 

Q.1. In March, the Attorney General of New York, OFHEO, and 

the GSE’s entered into an agreement creating new appraiser requirements that are inconsistent with existing practices. Last 

month, I introduced an amendment to the Federal Housing Finance Regulatory Reform Act of 2008 that would require the Director of OFHEO to issue a regulation establishing appraisal standards for mortgages purchased or guaranteed by Fannie and 

Freddie. It would establish a common set of appraisal standards 

governing mortgage lenders that are federally supervised and regulated. In your opinion, would this amendment strengthen the appraisal standards of federally regulated mortgages? 

A.1. As we understood Senator Dole’s amendment, it would require 

the Director of OFHEO to issue a final regulation establishing appraisal standards for mortgages purchased or guaranteed by 

Fannie Mae and Freddie Mac. In doing so, the Director would be 

required to ensure that the regulation is consistent and does not 

conflict with the regulations and guidelines issued by the Federal 

banking agencies and the NCUA. Finally, the regulation would supersede the terms of ‘‘any agreement relating to appraisal standards’’ (including the agreement with the New York Attorney General (NYAG) referred to in this question) to the extent of any inconsistency between the regulation and any such agreement. The Director would have the authority to determine whether or not such 

an inconsistency exists. (‘‘Consistent’’ provisions of any such agreement would not take effect until one year after issuance of the Director’s final regulation.) 

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1See Letter from John C. Dugan to James B. Lockhart III (May 27, 2008) (OCC Letter); Letter 

from Randall S. Kroszner, John C. Dugan, John M. Reich, and JoAnn M. Johnson to James B. 

Lockhart III (June 19, 2008) (Interagency Letter). 

plicable to the GSEs do not run counter to the standards that already have been established by the Federal banking agencies and 

the NCUA to implement the framework for appraisal regulation 

that Congress provided in the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA). The FIRREA appraisal provisions provided the foundation upon which an extensive regulatory 

scheme for appraisal standards and oversight for appraisers and 

depository institutions has been built. The imposition of new and 

inconsistent standards on mortgages purchased by the GSEs is unnecessary and could add additional, unwarranted impediments to 

the availability of mortgage credit and an unnecessary new and potentially disruptive factor in the mortgage marketplace. In two recent letters to the Director of OFHEO, the OCC has described its 

serious concerns in these respects.1 If enacted, the Dole amendment would prevent these problems. The OCC supports that result. 

Two modifications to the Dole amendment would further promote 

consistency in the appraisal standards that apply to federally supervised lenders and to the GSEs. (1) The Director of OFHEO 

should be required to consult with the Federal banking agencies 

and the NCUA in two instances to ensure such consistency: first, 

consultation should occur prior to the Director’s promulgation of 

the regulation required by the amendment; second, consultation 

should occur when the Director determines whether there is inconsistency between the regulation and any agreement relating to appraisal standards. (2) The provision at the end of the amendment 

that makes ‘‘consistent’’ agreement provisions effective one year 

after the Director issues the regulation can be eliminated. To the 

extent the OFHEO regulation is ‘‘consistent’’ with an agreement, it 

would be unnecessary for the agreement to continue in effect at all. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING 

FROM JOHN M. REICH 

Q.1. There was an article in the June 4, 2008, Financial Times (attached) that said banks could be forced to bring up to 5 trillion dollars of assets currently held off their books onto their balance 

sheets. This raises many questions, but I will start with three. 

First, in the current markets can the banks raise the capital they 

need to hold against these assets? Second, since you are their regulators, do you know and have you known all along what those assets are? And third, why were they allowed to move trillions of dollars of what turned out to be the riskiest assets off their books to 

avoid capital charges? 

A.1. The Financial Times article was referring to structured investment vehicles (SIVs). SIVs were primarily an off-balance sheet financing tool or arrangement used by large money center banks. 

Typically a large bank utilizing a SIV would also provide a line 

of credit to the investor/lender that was used to help guarantee the 

credit rating of the underlying collateral. Only the largest banks 

have both the wherewithal and credit rating necessary to provide 

these guarantees that would be acceptable to investors/lenders. 


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1OTS issued the attached comment letters concerning the legal and policy issues presented 

by the Code and Agreements. See letter dated April 30, 2008, from T. Ward, Deputy Director 

for OTS, and the joint letter dated June 19, 2008 from Randall Krozner, Governor, Board of 

Governors of the Federal Reserve System, John M. Reich, Director for OTS, John C. Dugan, 

Thrifts did not utilize this type of financing. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR DOLE 

FROM JOHN M. REICH 

Q.1. In March, the Attorney General of New York, OFHEO, and 

the GSE’s entered into an agreement creating new appraiser requirements that are inconsistent with existing practices. Last 

month, I introduced an amendment to the Federal Housing Finance Regulatory Reform Act of 2008 that would require the Director of OFHEO to issue a regulation establishing appraisal standards for mortgages purchased or guaranteed by Fannie and 

Freddie. It would establish a common set of appraisal standards 

governing mortgage lenders that are federally supervised and regulated. In your opinion, would this amendment strengthen the appraisal standards of federally regulated mortgages? 

A.1. The Office of Thrift Supervision (OTS) welcomes congressional 

efforts to promote quality appraisals and appraiser independence 

for secondary mortgage market transactions. OTS is very interested in this amendment because of the potential effect of any new 

appraisal requirements on federal housing and mortgage markets 

and the institutions we regulate. OTS supervises an industry 

whose primary activity is mortgage lending. 

We support requiring, among other provisions, that the Office of 

Federal Housing Enterprise Oversight (OFHEO) issue a regulation 

establishing appraisal standards for mortgage transactions that are 

guaranteed or purchased by the Federal Home Loan Mortgage Corporation or Federal National Mortgage Association (collectively, the 

GSEs). This provision would ensure that appraisal requirements 

adopted by the GSEs are established through a process that follows 

procedural and other laws applicable to a federal agency rulemaking. 

This open and public process would provide federally regulated 

institutions and other interested parties the opportunity to provide 

meaningful input and to question the assumptions upon which proposed requirements are based. In contrast, the requirements imposed by the Home Valuation Code of Conduct and the Home Valuation Protection Program and Cooperation Agreements (the Code 

and Agreements), as executed by OFHEO, the Attorney General of 

the State of New York (NYAG), and the GSEs, are not the result 

of a federal agency rulemaking. In our view, the Code and Agreements are the products of a flawed process that would implement 

sweeping changes in the industry without adequate notice and public comment. 

More importantly, we are very concerned that certain requirements imposed by the Code and Agreements would unnecessarily 

undermine the safe and sound extension of credit, reduce the availability of mortgage credit to many consumers, and ultimately lead 

to less reliability and accuracy in appraisals as explained in our attached correspondence.1 Such requirements would conflict with the 


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Comptroller of the Currency, and JoAnn M. Johnson, Chairman for the National Credit Union 

Administration. 

existing regulatory framework for appraisal standards and appraiser oversight that implements the Financial Institutions Reform Recovery and Enforcement Act of 1989 and other legislation. 

To address these concerns, the amendment ensures that OFHEO’s 

appraisal regulation would supersede any agreement entered into 

by OFHEO or the GSEs to the extent that any such agreement is 

inconsistent with the regulation. 

Finally, the amendment directs OFHEO to issue an appraisal 

regulation that (i) would be consistent with appraisal regulations 

and guidelines issued by OTS and other federal banking agencies, 

including regulations related to the independence and accuracy of 

appraisals and (ii) would not conflict with any other banking regulations. While we support this provision, it is important that 

OFHEO’s appraisal regulation not create unnecessary regulatory 

burden for federally regulated institutions or otherwise adversely 

affect mortgage credit availability. Our concern is that a new set 

of appraisal requirements could be ‘‘consistent’’ and yet impose additional standards already addressed by our current regulations. If 

this were to occur, we would address the specific requirement with 

OFHEO well in advance of a final regulation. 


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RESPONSE TO WRITTEN QUESTIONS OF SENATOR CORKER 

FROM JOHN M. REICH 

Q.1. In an earlier hearing in front of this committee, an OTS plan 

was outlined which would have created negative equity certificates 

for 2nd lienholders in refinancing troubled or underwater mortgages. This was of particular interest to me because I believed that 

the incentive for 2nd lienholders to work out their obligations with 

servicers and borrowers was not there if they would be required to 

forfeit the entire lien at a loss. However, I am told, that this would 

actually have cost the U.S. government and the taxpayers a great 

deal more than the plan we recently passed out of committee because the uptake would have been higher. I am also told that we 

will have a better picture of what our housing situation looks like 

in September when we are able to see how much of the inventory 

was ‘‘cleared’’ during the typically busy spring and summer 

months. In the state foreclosure working group report that was just 

released on seriously delinquent loans, it indicates that 2nd liens 

are a growing problem and a tremendous obstacle in getting 

servicers to do what needs to be done in refinancing. Do you think 

that the Banking Committee’s passed legislation strikes the right 

balance between market based solutions and government intervention in this unprecedented housing situation? 

A.1. The OTS proposal includes the idea of creating a certificate in 

which the borrower, servicer and perhaps the second lien holder 

may be entitled to some percentage ownership. This proposal is 

based on our belief that the servicer needs an incentive to aggressively seek modifications of troubled loans. The cost of a loan modification can run as high as $500 per loan and takes considerable 

time to negotiate. The negative equity certificate gives the servicer 

some potential upside in a loan modification, should there be any 

proceeds available from the eventual sale of the home. By offering 

a percentage ownership of the certificate to the homeowner, it is 

our hope that this will give the owner an incentive to maintain the 

home and seek to get the highest price for the home in a sale. Finally, if desired, the second lien holder may be offered a share of 

the certificate to provide an incentive for the holder to agree to the 

loan modification. We too, understand that second lien holders may 

stand in the way of a modification and may require an incentive 

to consent to a modification. 

The Committee’s legislation addresses many issues that plague 

our housing market and we believe many participants will take the 

necessary measures to do their part to correct the problem. However, voluntary efforts to address troubled loans may delay the necessary and immediate action required to help these homeowners 

stay in their homes. We continue to believe that an incentive for 

those most intimately involved to execute the modification will expedite the process and help move the U.S. housing market back to 

health. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR DOLE 

FROM JOANN JOHNSON 

Q.1. In March, the Attorney General of New York, OFHEO, and 

the GSE’s entered into an agreement creating new appraiser reVerDate Nov 24 2008 02:09 Apr 02, 2010 Jkt 050405 PO 00000 Frm 00214 Fmt 6633 Sfmt 6602 E:\HR\OC\A405.XXX A405

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quirements that are inconsistent with existing practices. Last 

month, I introduced an amendment to the Federal Housing Finance Regulatory Reform Act of 2008 that would require the Director of OFHEO to issue a regulation establishing appraisal standards for mortgages purchased or guaranteed by Fannie and 

Freddie. It would establish a common set of appraisal standards 

governing mortgage lenders that are federally supervised and regulated. In your opinion, would this amendment strengthen the appraisal standards of federally regulated mortgages? 

A.1. Senator Dole’s proposed amendment to the Federal Housing 

Finance Regulatory Reform Act of 2008 would strengthen the 

standards used for federally regulated mortgages in that it would 

supersede the agreement the government sponsored enterprises 

(GSEs) entered into with the Office of Federal Housing Enterprise 

Oversight (OFHEO) and the New York State Attorney General. As 

a result, Senator Dole’s amendment would avert the unintended 

consequences stemming from the agreement. 

As currently drafted, by virtue of the agreement, lenders desiring 

to sell mortgages to the GSEs after December 31, 2008 must comply with appraisal standards that are not entirely consistent with 

existing federal regulations. If the agreement between the New 

York State Attorney General, OFHEO, and the GSEs goes into effect, lenders face an unfortunate choice of either incurring excessive costs to comply with the agreement or losing a significant 

source of liquidity by discontinuing their relationships with the 

GSEs. 

While the goals of the agreement may be laudable, it unduly emphasizes structural issues, as opposed to internal controls, without 

the support of essential and important empirical data. Moreover, 

the provisions of the agreement, which affect all lenders selling to 

the GSEs, were not put into place through an appropriate rulemaking process. 

In contrast, the existing federal regulatory structure for appraisals was developed over time and encompasses public comments 

that considered the views of all stakeholders. Existing guidance 

also provides appropriate deference to agency supervision of individual lenders and sound risk management practices. 

Senator Dole’s proposed amendment would improve standards by 

restoring the credibility of the existing federal regulatory structure 

and superseding any prior agreements OFHEO and the GSEs have 

entered into that contradict existing federal standards and regulations. Moreover, Senator Dole’s proposed amendment would require 

OFHEO to consult with appropriate FFIEC regulators to ensure 

any future regulations affecting the GSEs are consistent with federal regulations and guidelines. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING 

FROM DONALD L. KOHN 

There was an article in the June 4, 2008, Financial Times that 

said banks could be forced to bring up to 5 trillion dollars of assets 

currently held off their books onto their balance sheets. This raises 

many questions, but I will start with three. 


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Q.1.a. First, in the current markets can the banks raise the capital 

they need to hold against these assets? 

A.1.a. The Financial Accounting Standards Board (FASB) has not 

yet made public the proposed changes to accounting standards that 

would require consolidation of certain off-balance sheet 

securitization exposures; however, it is expected that the initial 

proposal would be subject to a period of public comment. It is difficult to estimate with any degree of certainty which structures 

would be consolidated and the associated impact on bank balance 

sheets and capital requirements. The basis for the $5 trillion estimate in the Financial Times article was not disclosed, so we are 

unable to verify that number. In addition, it is unknown whether 

the accounting change will include a grandfathering or transition 

provision, which would make the potential impact of consolidation 

more gradual. 

The effect of the accounting change, whatever its final details, 

will depend on each individual bank’s activities. The vast majority 

of banking organizations do not engage in material securitization 

activities; however, there could potentially be a material impact for 

those institutions, primarily the largest U.S. banking organizations, with significant securitization activities. With respect to 

those banks affected by the proposed accounting change, some may 

already have sufficient capital cushions to support the newly consolidated assets. Others may need to raise capital. During the current market turmoil, banks have been able to raise capital when 

needed. It is likely some banks will need to raise more capital to 

cover losses and position themselves to lend in the future. In that 

regard, a requirement to raise substantial amounts of new capital 

to accommodate the addition of securitized assets will put pressure 

on the cost of capital for all banks. I would urge FASB to allow 

banks a considerable period of time to prepare before any new consolidation requirement became effective. 

Q.1.b. Second, since you are their regulators, do you know and 

have you known all along what those assets are? 

A.1.b. We have a good understanding of bank asset securitization 

processes and firms’ explicit exposures arising from securitizations 

based on both supervisory activities and information collected 

through regulatory reports. The Federal Reserve, the Office of the 

Comptroller of the Currency, and the Federal Deposit Insurance 

Corporation collect information on the outstanding principal balance of assets sold and securitized by a bank with servicing retained or with seller-provided credit enhancements, as well as on 

the bank’s maximum amount of retained credit exposure to the 

securitizations. They also collect information on unused commitments to provide liquidity to securitization structures. The agencies 

began collecting detailed data on securitization activities in 2001. 

Q.1.c. And third, why were they allowed to move trillions of dollars 

of what turned out to be the riskiest assets off their books to avoid 

capital charges? 

A.1.c. Accounting rules, set by the FASB, prescribe which assets 

must be consolidated on a banking organization’s balance sheet. 

The U.S. banking agencies’ risk-based capital requirements do not 

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sures to off-balance sheet securitization transactions. We have in 

place capital requirements on securitization exposures. Together 

with other supervisors, we are taking a hard look at the requirements for these exposures under Basel II to ensure they are appropriate. 

Securitization provides banks with several important benefits. 

The securitization process offers banks alternative sources of funding and liquidity, and provides an opportunity to reallocate some 

of the risk of securitized assets (for a price) to investors. The funding costs associated with asset securitization maybe lower than the 

cost of direct borrowing. Moreover, the reduced risk and leverage 

created by securitization allows banks to redeploy capital efficiently 

to support other banking activities. Although regulatory capital 

considerations influence some securitization activity, they are not 

necessarily the driving force; asset securitization provides a critical 

source of funding for certain banks and, consequently, increases the 

availability of credit for borrowers. 

The U.S. federal banking agencies have worked for many years 

to reduce opportunities for regulatory capital arbitrage associated 

with securitization activities. Importantly, in 2001, the agencies 

published a final rule directly addressing the regulatory capital 

treatment of securitization exposures. In many cases, a sponsoring 

bank is required to hold dollar-for-dollar capital against the risk it 

retains in association with a securitization. Capital is also required 

for other securitization exposures, such as investments in assetbacked securities and liquidity facilities provided to asset-backed 

commercial paper conduits. The new Basel II-based risk-based capital rules, which the agencies currently are in the process of implementing, provide an even more risk-sensitive approach to banks’ 

securitization exposures. In addition, banks are required to conduct 

an internal assessment of the capital needed to support 

securitization activities. 

Q.2. On June 4, 2008, Moody’s placed two of the largest bond insurers (MBIA and Ambac) on watch for downgrade, and S&P lowered their rating the following day. Is any collateral pledged at the 

various facilities or in the Fed’s assets from the Bear Stearns deal 

insured by those insurers? What impact does the downgrade, and 

the potential for further downgrades, have on the value of collateral the Fed has been taking at the various facilities and on the 

Fed’s assets from the Bear Stearns deal? What will the Fed do 

about any pledged securities that are downgraded? Is the Fed continuing to rely on ratings from the rating agencies in assessing the 

risk and value of pledged collateral, and if so, why given the 

unreliability of those ratings? Beyond using ratings from ratings 

agencies, what is the Fed doing to verify the quality of the collateral it is getting? 

A.2. The Federal Reserve accepts a wide range of collateral under 

its standing liquidity facilities for depository institutions and primary dealers. It is important to note that, for all of the Federal Reserve’s existing liquidity facilities, the Federal Reserve has recourse to the borrowing institution beyond the specific collateral 

pledged. Although the collateral requirements for the various liquidity programs vary somewhat, credit ratings are used in some 


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cases as a screen to eliminate assets of poor quality. Assets that 

pass this screen are then assigned market values based on market 

pricing sources, and haircuts are then applied to these market values to determine the final collateral value of the pledged collateral. 

For those assets without available market prices, substantially 

larger haircuts are applied to the outstanding principal balance to 

determine the final collateral value. Market prices are updated regularly and haircuts are set to provide a significant measure of protection against market, credit and liquidity risk. In addition, the 

credit ratings of the assets pledged as collateral are monitored on 

an ongoing basis. Finally, the Federal Reserve independently reviews assets pledged as collateral to ensure that acceptability criteria are met and that all necessary legal documentation is in 

place. 

A downgrade of the bond insurers could result in a corresponding 

downgrade of an asset that is pledged as collateral at the Federal 

Reserve. If the downgrade of Federal Reserve collateral meant that 

it no longer met basic eligibility criteria, the collateral would be returned to the borrower and the institution would be required to 

provide alternative collateral of sufficient quality. Of course, even 

if the collateral pledged at the Federal Reserve is not downgraded, 

the troubles at bond insurers could affect the market value of the 

Federal Reserve’s collateral. In this case, changes in market valuation would be captured through our regular pricing updates, and 

the final value of the collateral pledged would decline. The Federal 

Reserve closely monitors the value of collateral pledged to ensure 

that it exceeds the value of credit extended at all times. 

Regarding the special financing arrangement in the case of Bear 

Stearns, the Federal Reserve and JP Morgan Chase extended credit to finance a pool of about $30 billion in assets. As described in 

the Federal Reserve’s public announcements, the Federal Reserve 

extended about $29 billion of senior financing under this arrangement, and JPMorgan extended about $1 billion of financing 

through a first loss position. The asset portfolio is professionally 

managed by an independent portfolio management firm and will be 

marked to market values on a quarterly basis; those values will reflect the effects, if any, of the downgrades of the guarantors. Details regarding the value of these assets and the outstanding balance on the credit extension are published weekly on the Federal 

Reserve’s H.4.1. statistical release. The Federal Reserve determined to enter into this special financing arrangement because a 

disorderly failure of Bear Stearns would have posed a serious 

threat to overall financial stability and would most likely have had 

significant adverse implications for the U.S. economy. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR DOLE 

FROM DONALD L. KOHN 

Q.1. In March, the Attorney General of New York, OFHEO, and 

the GSE’s entered into an agreement creating new appraiser requirements that are inconsistent with existing practices. Last 

month, I introduced an amendment to the Federal Housing Finance Regulatory Reform Act of 2008 that would require the Director of OFHEO to issue a regulation establishing appraisal standVerDate Nov 24 2008 02:09 Apr 02, 2010 Jkt 050405 PO 00000 Frm 00218 Fmt 6633 Sfmt 6602 E:\HR\OC\A405.XXX A405

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1See the attached letter dated June 19, 2008, from Randall S. Kroszner, Governor, Board of 

Governors of the Federal Reserve; John C. Dugan, Comptroller of the Currency; John M. Reich, 

Director, Office of Thrift Supervision; and JoAnn M. Johnson, Chairman, National Credit Union 

Administration, to James B. Lockhart, Director, OFHEO. 

ards for mortgages purchased or guaranteed by Fannie and 

Freddie. It would establish a common set of appraisal standards 

governing mortgage lenders that are federally supervised and regulated. In your opinion, would this amendment strengthen the appraisal standards of federally regulated mortgages? 

A.1. The Federal Reserve is supportive of promoting sound appraisal practices in residential mortgage lending that ensure lenders use independent, quality appraisals and that protect appraisers 

from inappropriate influence by the loan production staff, borrowers, or other third parties. In fact, these important principles 

are embodied in the existing appraisal regulations and guidance of 

the Board and other federal financial regulatory agencies, which 

have been in place since the early 1990s. 

Your proposed amendment would acknowledge that federally regulated institutions and their affiliates are already subject to an appraisal regulatory framework and would address potential confusion on the part of those entities as to the appraisal standards for 

which they will be held accountable. 

Q.2. Vice Chairman Kohn, would you review this technical issue 

with the other Members at the Federal Reserve Board? Could the 

Board please get back to us in writing with a detailed letter articulating all the inconsistencies and conflicts of this agreement with 

current banking law, and the corresponding risks associated therein? I would ask that this letter not only articulate the inconsistencies and conflicts with current banking law, but also the potential risks to safety and soundness, as well as the expected impact 

on consumers as it relates to the costs and availability of mortgage 

credit. 

A.2. The Federal Reserve has reviewed the agreement and the accompanying Home Valuation Code of Conduct and provided written 

comment to the Office of Federal Housing Enterprise Oversight.1

Our letter to OFHEO should provide sufficient information to respond to your request for explanation on the inconsistencies and 

conflicts of the agreement with current banking laws and regulations. Further, the letter outlines our most significant concerns 

with the agreement and code, and explains how the agencies’ existing appraisal regulatory framework promotes appraiser independence and reliable valuations of real estate collateral in mortgage 

lending by federally regulated institutions. 


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RESPONSE TO WRITTEN QUESTIONS OF SENATOR CORKER 

FROM DONALD L. KOHN 

Q.1.a. What is the banking system’s exposure to the monoline insurers? 

A.1.a. Banks have two basic types of exposures to monoline financial guarantors: 

Direct exposures stemming from lending transactions as well as 

from purchasing credit derivatives protection from guarantors as 

hedges against a variety of structured credit products, which generates counterparty credit exposures. 

Indirect exposures, which are exposures to assets that are 

‘‘wrapped’’ (i.e., guaranteed) by the guarantors, may reside on 

banks’ balance sheets or in off-balance-sheet vehicles that are sponsored by banks or to which banks have extended some form of support. 

Direct Exposures 

Exposures from lending facilities to monoline guarantors are generally not a significant share of banks’ capital or of total credit exposures at banking organizations. 

More importantly, financial guarantors have reported selling over $500 billion in notional value of credit derivatives-based protection to financial institutions, with roughly $125 billion of that 

protection sold on so-called CDOs of ABS that contain subprime 

mortgage-related collateral in the asset pool. Some of that protection was purchased by large domestic bank holding companies. The 

current counterparty credit exposures generated by these hedges 

are a function of the market value of the positions being hedged, 

and are not the same as the notional values. 

Given the deterioration in the positions hedged by banks using 

these credit derivatives, particularly with respect to the CDOs of 

ABS, banks’ direct counterparty credit exposures to financial guarantors from these hedges have grown significantly over the past 

year. Nonetheless, for domestic bank holding companies, these exposures are equivalent to only a moderate share of the firms’ capital and are a relatively small share of total credit exposures across 

the firms. 

As has been noted in the press and in some firms’ publicly reported statements of financial condition, many financial institutions, both foreign and domestic, have begun to take markdowns 

and/or reserves—generally in the form of a ‘‘credit valuation adjustment’’—against the value of these exposures, with over $20 billion 

of write-downs reported through end-March 2008. If deterioration 

in credit markets continues, banks’ exposures will grow further 

and, given the associated deterioration seen in the financial guarantor sector, they will likely take further write-downs and/or reserves against their counterparty credit exposures to the financial 

guarantors. 

Indirect Exposures 

A substantial majority of wrapped cash assets are municipal 

bonds, which are generally solid credit risks even without the guarantees provided by the monolines. There are also a variety of other 

types of credit assets that are guaranteed, including asset-backed 


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and mortgage-backed securities. Most of these wrapped assets have 

seen market price declines over the past year as the value of the 

guarantees have been discounted, and banks have seen some losses 

from marking to market these assets over that time period. Given 

the ongoing marking down of the value of these assets over time, 

significant future losses on these assets resulting from the deterioration of the guarantors appears unlikely, as market participants 

are generally now looking directly at the underlying assets and 

have already discounted the value of the guarantees. 

Q.1.b. Likewise, what is the banking system’s exposure to the 

mortgage insurance companies? 

A.1.b. The banking system’s exposure to the mortgage insurance 

companies comprises two categories: direct loans to mortgage insurers and exposure to mortgage insurers as providers of insurance 

on mortgages underwritten by the banks. As to the first category, 

as of May 2008, syndicated loans to mortgage insurers extended by 

federally regulated institutions totaled $3.9 billion. As to the second category, we estimate that banks’ exposure to mortgage insurers as of March 2008 was approximately $37 billion. 

Q.1.c. In light of the exposure of counterparty risk related to the 

monolines and mortgage insurers, how do you quantify the safety 

and soundness of these counterparties and what do the regulators 

need to do to understand and monitor the risk going forward? 

A.1.c. Monoline financial guarantors and mortgage insurers are 

regulated by state insurance regulators. 

The Federal Reserve has been very closely monitoring developments in the financial guarantor sector and has engaged in a number of discussions with supervised firms regarding their exposures 

to guarantors and the implications of continued deterioration in the 

condition of the guarantors. We will continue to closely monitor the 

monolines’ financial condition as well as the size and performance 

of the various exposures that exist at supervised banking organizations. 

As to mortgage insurers, we monitor the health of this segment 

continuously, by studying the industry, gathering publicly available 

data, and meeting with state insurance regulators. In addition, we 

are in contact with the banks that are the largest beneficiaries of 

mortgage insurance and are obtaining detailed information on their 

exposure to this industry. Supervised banks’ exposures to the mortgage insurers are relatively small relative to their exposures to 

other industries and relative to their capital (and balance sheet 

size), and are generally well distributed across those banks that 

have exposure to mortgage insurers. 

I appreciate the Federal Reserve’s efforts to address unfair and 

deceptive practices in the credit card industry. I am pleased that 

the Federal Reserve has solicited public comments on the proposal 

from consumers, credit card issuers and other interested parties to 

fully understand the impact these new rules will have on the marketplace. 

Q.2. In that regard, has the Fed considered the impact these rules 

will have on consumers who pay their bills on time? Could timelypaying consumers see an increase in the cost of credit as a result 


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of this rule due to the fact that the Fed would restrict, in a fairly 

significant way, the ability for banks to adjust prices for those consumers who demonstrate a higher risk? 

A.2. In proposing restrictions on credit card issuers’ ability to increase rates on existing balances, the Board carefully considered 

the potential costs and benefits for all consumers. The proposal 

seeks to balance issuers’ need to price for risk with consumers’ 

need to have greater transparency so they can better predict how 

their decisions and actions will affect their costs. The proposed 

rules would not affect card issuers’ ability to price for risk when 

setting rates at account opening. Although ‘‘hair trigger’’ repricings for existing balances would be prohibited (for example, 

when a payment arrives one day late), issuers could re-price existing balances for a serious delinquency when the account is 30 days 

past due. In addition, after providing 45 days’ advance notice, 

issuers could increase the rate on new transactions. As new business models emerge, consumers might see some costs decline while 

other costs might potentially increase, but the intent is to increase 

transparency and fairness in how credit card accounts operate, 

which should enhance competition and benefit consumers as a 

whole. 


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