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EXAMINING THE LINK BETWEEN FED BANK 

SUPERVISION AND MONETARY POLICY 

HEARING 

BEFORE THE

COMMITTEE ON FINANCIAL SERVICES 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED ELEVENTH CONGRESS 

SECOND SESSION 

MARCH 17, 2010 

Printed for the use of the Committee on Financial Services 

Serial No. 111–112 

( 

(II) 

HOUSE COMMITTEE ON FINANCIAL SERVICES 

BARNEY FRANK, Massachusetts, Chairman 

PAUL E. KANJORSKI, Pennsylvania 

MAXINE WATERS, California 

CAROLYN B. MALONEY, New York 

LUIS V. GUTIERREZ, Illinois 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

GARY L. ACKERMAN, New York 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

DENNIS MOORE, Kansas 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

MELISSA L. BEAN, Illinois 

GWEN MOORE, Wisconsin 

PAUL W. HODES, New Hampshire 

KEITH ELLISON, Minnesota 

RON KLEIN, Florida 

CHARLES A. WILSON, Ohio 

ED PERLMUTTER, Colorado 

JOE DONNELLY, Indiana 

BILL FOSTER, Illinois 

ANDRE ́ CARSON, Indiana 

JACKIE SPEIER, California 

TRAVIS CHILDERS, Mississippi 

WALT MINNICK, Idaho 

JOHN ADLER, New Jersey 

MARY JO KILROY, Ohio 

STEVE DRIEHAUS, Ohio 

SUZANNE KOSMAS, Florida 

ALAN GRAYSON, Florida 

JIM HIMES, Connecticut 

GARY PETERS, Michigan 

DAN MAFFEI, New York 

SPENCER BACHUS, Alabama 

MICHAEL N. CASTLE, Delaware 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

RON PAUL, Texas 

DONALD A. MANZULLO, Illinois 

WALTER B. JONES, JR., North Carolina 

JUDY BIGGERT, Illinois 

GARY G. MILLER, California 

SHELLEY MOORE CAPITO, West Virginia 

JEB HENSARLING, Texas 

SCOTT GARRETT, New Jersey 

J. GRESHAM BARRETT, South Carolina 

JIM GERLACH, Pennsylvania 

RANDY NEUGEBAUER, Texas 

TOM PRICE, Georgia 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

ADAM PUTNAM, Florida 

MICHELE BACHMANN, Minnesota 

KENNY MARCHANT, Texas 

THADDEUS G. McCOTTER, Michigan 

KEVIN McCARTHY, California 

BILL POSEY, Florida 

LYNN JENKINS, Kansas 

CHRISTOPHER LEE, New York 

ERIK PAULSEN, Minnesota 

LEONARD LANCE, New Jersey 

JEANNE M. ROSLANOWICK, Staff Director and Chief Counsel 

(III) 

C O N T E N T S 

Page 

Hearing held on: 

March 17, 2010 ................................................................................................. 1 

Appendix: 

March 17, 2010 ................................................................................................. 59 

WITNESSES 

WEDNESDAY, MARCH 17, 2010 

Bernanke, Hon. Ben S., Chairman, Board of Governors of the Federal Reserve ...................................................................................................................... 6 

Gerhart, Jeffrey L., President, Bank of Newman Grove, on behalf of the 

Independent Community Bankers of America (ICBA) ...................................... 51 

Kashyap, Anil K., Edward Eagle Brown Professor of Economics and Finance, 

and Richard N. Rosett Faculty Fellow, Booth School of Business, University 

of Chicago ............................................................................................................. 46 

Meltzer, Allan H., The Allan H. Meltzer University Professor of Political 

Economy, Tepper School of Business, Carnegie Mellon University ................. 43 

Nichols, Robert S., President and Chief Operating Officer, the Financial Services Forum ............................................................................................................ 49 

Volcker, Hon. Paul A., Chairman of the President’s Economic Recovery Advisory Board, and former Chairman of the Federal Reserve ............................... 10 

APPENDIX 

Prepared statements: 

Paul, Hon. Ron .................................................................................................. 60 

Watt, Hon. Melvin ............................................................................................ 61 

Bernanke, Hon. Ben S. ..................................................................................... 66 

Gerhart, Jeffrey L. ............................................................................................ 73 

Kashyap, Anil K. .............................................................................................. 80 

Meltzer, Allan H. .............................................................................................. 88 

Nichols, Robert S. ............................................................................................. 96 

Volcker, Hon. Paul A. ....................................................................................... 100 

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Watt, Hon. Melvin: 

Federal Reserve White Paper entitled, ‘‘The Public Policy Case for a 

Role for the Federal Reserve in Bank Supervision and Regulation,’’ 

dated January 13, 2010 ................................................................................ 114 

Bernanke, Hon. Ben S.: 

Written responses to questions submitted by Representative Baca ............ 125 

Written responses to questions submitted by Representative Cleaver ........ 127 

Written responses to questions submitted by Representative Foster .......... 129 

(1) 

EXAMINING THE LINK BETWEEN 

FED BANK SUPERVISION 

AND MONETARY POLICY 

Wednesday, March 17, 2010 

U.S. HOUSE OF REPRESENTATIVES, 

COMMITTEE ON FINANCIAL SERVICES, 

Washington, D.C. 

The committee met, pursuant to notice, at 2 p.m., in room 2128, 

Rayburn House Office Building, Hon. Barney Frank [chairman of 

the committee] presiding. 

Members present: Representatives Frank, Kanjorski, Waters, 

Maloney, Watt, Sherman, Meeks, Moore of Kansas, Hinojosa, 

McCarthy of New York, Baca, Miller of North Carolina, Scott, 

Green, Cleaver, Donnelly, Foster, Speier, Minnick, Kosmas, Himes; 

Bachus, Royce, Paul, Biggert, Hensarling, Garrett, Neugebauer, 

Price, Marchant, Jenkins, Lee, Paulsen, and Lance. 

The CHAIRMAN. Will the photographers please stand down? The 

only thing we could see was Mr. Volcker. Now, we can see everybody. 

This hearing will come to order. It is an important hearing that 

is relevant to the legislative task before us. 

As members know, the Senate had been considering very much 

the question of what the supervisory reach of the Federal Reserve 

should be. We obviously dealt with it in the bill that passed the 

House. 

We will, I believe, now be going to conference some time in April 

or early May, and one of the questions will be the appropriate role 

for the Federal Reserve. 

This is a subject which the chairman of the Subcommittee on Domestic Monetary Policy, the gentleman from North Carolina, has 

given a great deal of attention to. 

Obviously, it is clear to people that many of us felt that the Senate’s initial instincts here were insufficiently recognizing the importance of a role for the Federal Reserve. 

There has been some movement. The differences are less than 

they were. I now believe, as with the legislation in general, we are 

entering a range where the desire and the need for a bill will be 

greater than any individual differences. 

An important part of this will be how should the supervisory role 

of the Federal Reserve be structured, and that is why we are very 

pleased to have the Chairman and the past Chairman of the Federal Reserve with us to talk about this. 

2 

While I have the microphone, let me just say I want to make a 

couple of announcements that are relevant. This morning, I received letters, first from our colleague from Ohio, Ms. Kilroy, and 

then from Ranking Member Bachus asking for hearings into the information that was contained in the examiner’s report on Lehman 

Brothers, and that is obviously something we should do. 

It is something I believe we address in our legislation, this whole 

question of off balance sheet activity; that is important. 

We will have a hearing on that in April. Our hearing schedule 

has gotten pretty crowded. In April, as I told Ms. Kilroy and Mr. 

Bachus, we will be having a hearing. It will be a full committee 

hearing because the people involved include some people at the Department head levels and those have to be at the full committee. 

We will be having that hearing. 

We will proceed today with this hearing on the question of how 

to do the regulation. 

I am going to yield back the balance of my time so that it can 

be made available to the chairman of the subcommittee. 

I am going to now recognize the ranking member, but the driving 

force here, and the member who has put the most effort and considerable thought into this, is the gentleman from North Carolina. 

I am now going to turn the gavel over to the gentleman from 

North Carolina, and he has my remaining 3 minutes, plus his own 

time to allocate as he chooses, and the gentleman from Alabama 

is now recognized for 5 minutes. 

Mr. BACHUS. Thank you, Mr. Chairman. As Congress looks at 

ways to reform the country’s financial infrastructure, we need to 

ask whether bank supervision is central to central banking. 

It is worth examining whether the Federal Reserve should conduct monetary policy at the same time it regulates and supervises 

banks or whether it should concentrate exclusively on its microeconomic responsibilities. It is no exaggeration to say the health of 

our financial system depends on getting this answer right. 

Frankly, the Fed’s performance as a holding company supervisor 

has been inadequate. Despite its oversight, many of the large complex banking organizations were excessively leveraged and engaged 

in off balance sheet transactions that helped precipitate the financial crisis. 

Just this past week, Lehman Brothers’ court-appointed bankruptcy examiner report was made public. The report details how 

Lehman Brothers used accounting gimmicks to hide its debt and 

mask its insolvency. 

According to the New York Times, all this happened while a 

team of officials from the Securities and Exchange Commission and 

the Federal Reserve Bank of New York were resident examiners in 

the headquarters of Lehman Brothers. 

As many as a dozen government officials were provided desks, 

phones, computers, and access to all of Lehman’s books and 

records. Despite this intense on-site presence, the New York Fed 

and the SEC stood idle while the bank engaged in the balance 

sheet manipulations detailed in the report. 

This raises serious questions regarding the capability of the Fed 

to conduct bank supervision, yet even if supervision of its regulated 

3 

institutions improved, it is not clear that oversight really informs 

monetary policy. 

If supervision does not make monetary policy decisions better, 

then the two do not need to be coupled. 

Vince Reinhart, a former Director of the Fed’s Division of Monetary Affairs and now a resident scholar at the American Enterprise 

Institution, said that collecting diverse responsibilities in one institution is like asking a plumber to check the wiring in your basement. 

It seems that when the Fed is responsible for monetary policy 

and bank supervision, its performance in both suffers. Microeconomic issues cloud the supervisory judgments, therefore impairing safety and soundness. 

There are inherent conflicts of interest where the Fed might be 

tempted to conduct monetary policy in such a way that hides its 

mistakes by protecting the struggling banks it supervises. 

An additional problem arises when the supervision of large 

banks is separated from small institutions. Under Senator Dodd’s 

proposal, the Fed would supervise 40 or 50 large banks, and the 

other 7,500 or so banks would be under the regulatory purview of 

other Federal and State banking agencies. 

If this were to happen, the Fed’s focus on the mega banks will 

inevitably disadvantage the regional and community banks, and I 

think on this, Chairman Bernanke, you and I are in agreement, 

that there ought to be one regulator looking at all the institutions. 

H.R. 3311, the House Republican regulatory reform plan, would 

correct these problems. It would refocus the Fed on its monetary 

policy mandate by relieving it of its regulatory and supervisory responsibilities and reassign them to other agencies. By contrast, the 

regulatory reform legislation passed by the House in December represented a large expansion of the Fed’s regulatory role since its creation almost 100 years ago. 

Senator Dodd has strengthened the Fed even more. His regulatory reform bill empowers the Fed to regulate systemically significant financial institutions and to enforce strict standards for institutions as they grow larger and more complex, adopts the 

Volcker Rule to restrict proprietary trading and investment by 

banks, and creates a new consumer financial protection bureau to 

be housed and funded by the Fed. 

In my view, the Democrats are asking the Fed to do too much. 

Thank you again, Mr. Chairman, for holding this hearing. I look 

forward to the testimony. 

Mr. WATT. [presiding] I thank the gentleman for his opening 

statement. 

Let me see if I can try to use some of the chairman’s time and 

my time to kind of frame this hearing in a way that we will kind 

of get a balanced view of what folks are saying. 

The Federal Reserve currently has extensive authority to regulate and supervise bank holding companies and State banks that 

are members of the Federal Reserve System, and foreign branches 

of member banks, among others. 

Last year, the House passed our financial services reform legislation that substantially preserved the Fed’s power to supervise these 

financial institutions. The Senate bill recently introduced by SenVerDate Nov 24 2008 12:54 Aug 05, 2010 Jkt 056776 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 K:\DOCS\56776.TXT TERRIE
4 

ator Dodd, however, would strip the Fed’s authority to supervise all 

but approximately the 40 largest financial institutions. 

This hearing was called to examine the potential policy implications of stripping regulatory and supervisory powers over most 

banks from the Fed, especially the potential impact this could have 

on the Fed’s ability to conduct monetary policy effectively. 

Proponents of preserving robust Fed supervision authority cite 

three main points to support their position that the Fed should retain broad supervisory powers. 

First, they say that the Fed has built up over the years deep expertise in microeconomic forecasting of financial markets and payment systems which allows the effective consolidated supervision of 

financial institutions of all sizes and allows effective macro prudential supervision over the financial system. Proponents of retaining 

Fed supervision say this expertise would be costly and difficult if 

not impossible to replicate in other agencies. 

Second, the proponents say that the Fed’s oversight of the banking system improves this ability to carry out central banking responsibilities, including the responsibility for responding to financial crises and making informed decisions about banks seeking to 

use the Fed’s discount window and lender of last resort services. 

In particular, proponents say that knowledge gained from direct 

bank supervision enhances the safety and soundness of the financial system because the Fed can independently evaluate the financial condition of individual institutions seeking to borrow from the 

discount window, including the quality and value of these institutions’ collateral and their overall loan portfolio. 

Third, proponents say that the Fed’s supervisory activities provide the Fed information about the current state of the economy 

and the financial system that influences the FOMC in its execution 

of monetary policy, including interest rate setting. 

On the flip side, there obviously are many critics of the Fed’s role 

in bank supervision. Some of these critics blast the Fed for keeping 

interest rates too low for too long in the early 2000’s, which some 

say fueled an asset price bubble in the housing market and the resulting subprime mortgage crisis. 

Consumer advocates and others accuse the Fed of turning a blind 

eye to predatory lending throughout the 1990’s and 2000’s, reminding us that Congress passed the HOEPA legislation in 1994 to 

counteract predatory lending, but the Fed did not issue final rules 

until well after the subprime crisis was out of control. 

Other critics accuse the Fed of ignoring the consumer protection 

role during supervisory examinations of banks and financial institutions across a wide range of financial products, including overdraft fees and credit cards and other things. 

Perhaps the appropriate policy response lies somewhere between 

the proponents and critics of the Fed bank supervision. 

I have tried to keep an open mind about the role of the Fed going 

forward, and hope to use today’s hearing to get more information 

as we move forward to discussions with the Senate, if the Senate 

ever passes a bill. 

We are fortunate to have both the current Chairman and a 

former Chairman who are appearing today to inform us on these 

difficult issues, and with that, I will reserve the balance of our time 

5 

and recognize Dr. Paul, my counterpart, the ranking member of the 

subcommittee. 

Dr. PAUL. I thank the chairman for yielding. 

Yesterday was an important day because it was the day the 

FOMC met and the markets were hanging in there, finding out 

what will be said at 2:15, and practically, they were looking for two 

words, whether or not two words would exist: ‘‘extended period.’’ 

That is, whether this process will continue for an extended period. 

This, to me, demonstrates really the power and the control that 

a few people have over the entire economy. Virtually, the markets 

stand still and immediately after the announcement, billions of dollars can be shifted, some lost and some profits made. 

It is a system that I think does not have anything to do with free 

market capitalism. It has to do with a managed economy and central economic planning. It is a form of price fixing. Interest rates 

fixed by the Federal Reserve is price fixing, and it should have no 

part of a free market economy. It is the creation of credit and causing people to make mistakes, and also it facilitates the deficits 

here. 

Congress really does not want to challenge the Fed because they 

spend a lot. Without the Fed, interest rates would be very much 

higher. 

To me, it is a threat to those of us who believe in personal liberty 

and limited government. Hardly does the process help the average 

person. Unemployment rates stay up at 20 percent. The little guy 

cannot get a loan. Yet, Wall Street is doing quite well. 

Ultimately, with all its power, the Fed still is limited. It is limited by the marketplace, which can inflate like crazy. It can have 

financial bubbles. It can have housing bubbles. Eventually, the 

market says it is too big and it has to be corrected, but the mistakes have been made. 

They come in and the market demands deflation. Of course, Congress and the Fed do everything conceivable to maintain these bubbles. 

It is out of control. Once the change of attitude comes, when that 

inflated money supply decides to go into the market and prices are 

going up, once again the Fed will have difficulty handling that. 

The inflationary expectations and the velocity of money are subjectively determined, and no matter how objective you are about 

money supply, conditions, and computers, you cannot predict that. 

We do not know what tomorrow will bring or next year. All we 

know is that the engine is there, the machine is there, the high 

powered money is there, and of course, we will have to face up to 

that some day. 

The monetary system is what breeds the risky behavior. That is 

what we are dealing with today. Today, we are going to be talking 

about how we regulate this risky behavior, but you cannot touch 

that unless we deal with the subject of how the risky behavior 

comes from easy money, easy credit, artificially low interest rates, 

and the established principle from 1913 on that the Federal Reserve is there to be the lender of last resort. 

As long as the lender of last resort is there, all the regulations 

in the world will not touch it and solve that problem. 

I yield back. 

6 

Mr. WATT. I thank the gentleman for his opening statement. I 

think we have about 1 minute and 30 seconds left, which is yielded 

to Mr. Sherman. 

Mr. SHERMAN. Thank you, Mr. Chairman. ‘‘Too-big-to-fail’’ is 

‘‘too-big-to-exist.’’ As we examine the power of the Fed, it begs the 

question, what about the provisions that prevent an audit of the 

Fed? The Fed is exempted from audits, not only in the area of monetary policy but also foreign agreements. 

All of the efforts by the Fed to defend their exclusion from audit 

have focused on well, that could affect monetary policy, which begs 

the question, why is the Fed demanding an exemption or continuation of an exemption of its foreign agreements from the audit 

process? 

If supervision informs monetary policy, then we have to ask why 

the other bank supervisors are unwilling to share information with 

the Fed and why economic statistics are not being shared, not only 

with the Fed but with the American people. 

Finally, as the Supreme Court decides that corporations who 

hold government posts by spending unlimited amounts of money on 

campaigns, at least there in order to get a particular person selected for governmental authority, they have to convince humans to 

vote for them. 

The one exception to that is the Fed regional boards where corporations get to select who sits on these boards and who exercises 

governmental power without them being responsible to the voters 

at all. 

In a democracy, every agency of governmental power should be 

responsible for the electorate. 

I yield back. 

Mr. WATT. I thank the gentleman for his opening statement. 

We are fortunate to have the Chairman of the Board of Governors of the Federal Reserve, the Honorable Ben Bernanke, and 

the Chairman of the President’s Economic Recovery Advisory 

Board, and former Chairman of the Federal Reserve, the Honorable 

Paul Volcker. 

We will recognize the Chairman first, and then, Mr. Volcker. 

STATEMENT OF THE HONORABLE BEN S. BERNANKE, CHAIRMAN, BOARD OF GOVERNORS OF THE FEDERAL RESERVE 

Mr. BERNANKE. Thank you, Chairman Watt, Ranking Member 

Bachus, and other members of the committee. 

I am pleased to have the opportunity to discuss the Federal Reserve’s role in bank supervision and the actions that we are taking 

to strengthen our supervisory oversight. 

Like many central banks around the world, the Federal Reserve 

cooperates with other agencies in regulating and supervising the 

banking system. 

Our specific responsibilities include the oversight of about 5,000 

bank holding companies, including the umbrella supervision of 

large complex financial firms, the supervision of about 850 banks 

nationwide that are both State chartered and members of the Federal Reserve System, so-called ‘‘State member banks,’’ and the 

oversight— 

7 

Mr. WATT. Will the gentleman pause for just a second? Ma’am, 

you are going to have to take that sign out of here. I am sorry. You 

are breaking the rules. You are either going to have to leave or we 

will have to have you removed or you will have to take the sign 

out. 

Any time today would be nice, ma’am. Thank you. 

Chairman Bernanke, you can resume. 

Mr. BERNANKE. The Federal Reserve’s involvement in regulation 

and supervision confers two broad sets of benefits to the country. 

First, because of its wide range of expertise, the Federal Reserve 

is uniquely suited to supervise large complex financial organizations and to address both safety and soundness risks and risks to 

the stability of the financial system as a whole. 

Second, the Federal Reserve’s participation in the oversight of 

banks of all sizes significantly improves its ability to carry out its 

central banking functions, including making monetary policy, lending through the discount window, and fostering financial stability. 

The financial crisis has made it clear that all financial institutions that are so large and interconnected that their failure could 

threaten the stability of the financial system and the economy 

must be subject to strong consolidated supervision. 

Promoting the soundness and safety of individual banking organizations requires the traditional skills of bank supervisors, such 

as expertise in examination of risk management practices. The 

Federal Reserve has developed such expertise in its long experience 

supervising banks of all sizes, including community banks and regional banks. 

The supervision of large complex financial institutions and the 

analysis of potential risks to the financial system as a whole requires not only traditional examination skills, but also a number 

of other forms of expertise, including: macroeconomic analysis and 

forecasting; insight into sectoral, regional, and global economic developments; knowledge of a range of domestic and international financial markets, including money markets, capital markets, and 

foreign exchange and derivatives markets; and a close working 

knowledge of the financial infrastructure, including payment systems and systems for clearing and settlement of financial instruments. 

In the course of carrying out its central banking duties, the Federal Reserve has developed extensive knowledge and experience in 

each of these areas critical for effective consolidated supervision. 

For example, Federal Reserve staff members have expertise in 

macroeconomic forecasting for the making of monetary policy, 

which is important for helping to identify economic risks to institutions and to markets. 

In addition, they acquire in-depth market knowledge through 

daily participation in financial markets to implement monetary policy and to execute financial transactions on behalf of the U.S. 

Treasury. 

Similarly, the Federal Reserve’s extensive knowledge of payment 

and settlement systems has been developed through its operation 

of some of the world’s largest such systems, its supervision of key 

providers of payment and settlement services, and its long-standing 

8 

leadership in the International Committee on Payment and Settlement Systems. 

No other agency can or is likely to be able to replicate the 

breadth and depth of relevant expertise that the Federal Reserve 

brings to the supervision of large complex banking organizations 

and the identification and analysis of systemic risks. 

Even as the Federal Reserve’s central banking functions enhance 

supervisory expertise, its involvement in supervising banks of all 

sizes across the country significantly improves the Federal Reserve’s ability to effectively carry out its central bank responsibilities. 

Perhaps most important, as this crisis has once again demonstrated, the Federal Reserve’s ability to identify and address diverse and hard-to-predict threats to financial stability depends 

critically on the information, expertise, and powers that it has as 

both a bank supervisor and a central bank, not only in this crisis, 

but also in episodes such as the 1987 stock market crash and the 

terrorist attacks of September 11, 2001. 

The Federal Reserve’s supervisory role was essential for it to contain threats to financial stability. 

The Federal Reserve making of monetary policy and its management of the discount window also benefit from its supervisory experience. 

Notably, the Federal Reserve’s role as the supervisor of State 

member banks of all sizes, including community banks, offers insights about conditions and prospects across the full range of financial institutions, not just the very largest, and provides useful information about the economy and financial conditions throughout 

the Nation. Such information greatly assists in the making of monetary policy. 

The legislation passed by the House last December would preserve the supervisory authority that the Federal Reserve needs to 

carry out its central banking functions effectively. 

The Federal Reserve strongly supports ongoing efforts in the 

Congress to reform financial regulation and to close existing gaps 

in the regulatory framework. While we await passage of comprehensive reform legislation, we have been conducting an intensive self-examination of our regulatory and supervisory performance and have been actively implementing improvements. 

On the regulatory side, we have played a key role in international efforts to ensure that systemically critical financial institutions hold more and higher quality capital, have enough liquidity 

to survive highly stressed conditions, and meet demanding standards for company wide risk management. 

We also have been taking the lead in addressing flawed compensation practices by issuing proposed guidance to help ensure 

that compensation structures at banking organizations provide appropriate incentives without encouraging excessive risk-taking. 

Less formally, but equally important, since 2005, the Federal Reserve has been leading cooperative efforts by market participants 

and regulators to strengthen the infrastructure of a number of key 

markets, including the markets for security repurchase agreements 

and the markets for credit derivatives and other over-the-counter 

derivative instruments. 

9 

To improve both our consolidated supervision and our ability to 

identify potential risks to the financial system, we have made substantial changes to our supervisory framework so that we can better understand the linkages among firms and markets that have 

the potential to undermine the stability of the financial system. 

We have adopted a more explicitly multi-disciplinary approach, 

making use of the Federal Reserve’s broad expertise in economics, 

financial markets, payment systems, and bank supervision, to 

which I alluded earlier. 

We are also augmenting our traditional supervisory approach 

that focuses on firm by firm examinations with greater use of horizontal reviews and to look across a group of firms to identify common sources of risks and best practices for managing those risks. 

To supplement information from examiners in the field, we are 

developing an off-site enhanced quantitative surveillance program 

for large bank holding companies that will use data analysis and 

formal modeling to help it identify vulnerabilities at both the firm 

level and for the financial sector as a whole. 

This analysis will be supported by the collection of more timely 

detailed and consistent data from regulated firms. 

Many of these changes draw on the successful experience of the 

Supervisory Capital Assessment Program (SCAP), also known as 

the ‘‘banking stress test,’’ which the Federal Reserve led last year. 

As in the SCAP, representatives of primary and functional supervisors will be fully integrated in the process, participating in the 

planning and execution of horizontal exams and consolidated supervisory activities. 

Improvements in the supervisory framework will lead to better 

outcomes only if day-to-day supervision is well executed, with risks 

identified early and promptly remediated. 

Our internal reviews have identified a number of directions for 

improvement. In the future, to facilitate swifter and more effective 

supervisory responses, the oversight and control of our supervisory 

function will be more centralized, with shared accountability by 

senior Board and Reserve Bank supervisory staff and active oversight by the Board of Governors. 

Supervisory concerns will be communicated to firms promptly 

and at a high level, with more frequent involvement of senior bank 

managers and boards of directors and senior Federal Reserve officials. 

Greater involvement of senior Federal Reserve officials and 

strong systematic follow-through will facilitate more vigorous remediation by firms. 

Where necessary, we will increase the use of formal and informal 

enforcement actions to ensure prompt and effective remediation of 

serious issues. 

In summary, the Federal Reserve’s wide range of expertise 

makes it uniquely suited to supervise large complex financial institutions and to help identify risks to the financial system as a 

whole. 

Moreover, the insights provided by our role in supervising a 

range of banks, including community banks, significantly increases 

our effectiveness in making monetary policy and fostering financial 

stability. 

10 

While we await enactment of comprehensive financial reform legislation, we have undertaken an intensive self-examination of our 

regulatory and supervisory performance. 

We are strengthening regulations and overhauling our supervisory framework to improve consolidated supervision as well as 

our ability to identify potential threats to the stability of the financial system. We are taking steps to strengthen the oversight and 

effectiveness of our supervisory activities. 

Thank you, and I would be pleased to respond to questions. 

[The prepared statement of Chairman Bernanke can be found on 

page 66 of the appendix.] 

Mr. WATT. We will now hear from the Honorable Paul Volcker, 

Chairman of the President’s Economic Recovery Advisory Board, 

and former Chairman of the Federal Reserve. 

STATEMENT OF THE HONORABLE PAUL A. VOLCKER, CHAIRMAN OF THE PRESIDENT’S ECONOMIC RECOVERY ADVISORY 

BOARD, AND FORMER CHAIRMAN OF THE FEDERAL RESERVE 

Mr. VOLCKER. I appreciate your invitation to address important 

questions concerning the link between monetary policy and Federal 

Reserve responsibilities for the supervision and regulation of financial institutions. 

Before addressing the specific questions you have posed, I would 

like to make clear my long-held view, a view developed and sustained by years of experience in the Treasury, the Federal Reserve, 

and in private finance. 

Monetary policy and concerns about the structure and condition 

of banks in the financial system more generally are inextricably 

intertwined, and if you need further proof of that proposition, just 

consider the events of the last couple of years. 

Other agencies, certainly including the Treasury, have legitimate 

interests in regulatory policy, but I do insist that neither monetary 

policy nor the financial system will be well served if our central 

bank is deprived from interest in and influence over the structure 

and performance of the financial system. 

Today, conceptual and practical concerns about the extent, the 

frequency, and the repercussions of economic and financial speculative excesses have come to occupy our attention. 

The so-called ‘‘bubbles’’ are indeed potentially disruptive of economic activity. Then important and interrelated questions arise for 

both monetary and supervisory policies. Judgment is required 

about if and when an official response, some form of intervention 

is warranted. If so, is there a role for monetary policy, for regulatory actions, or for both? 

How can those judgments and responses be coordinated and implemented in real time in the midst of crisis in a matter of days? 

The practical fact is the Federal Reserve must be involved in 

those judgments and that decision-making, beyond this broad responsibility for monetary policy and its influence on interest rates. 

It is the agency that has the relevant technical experience growing 

out of working in the financial markets virtually every day. 

As a potential lender of last resort, the Fed must be familiar 

with the condition of those to whom it lends. 

11 

It oversees and participates in the basic payment system, domestically and internationally. 

In sum, there is no other official institution that has the breadth 

of institutional knowledge, the expertise, and the experience to 

identify market and institutional vulnerabilities. 

It also has the capability to act on very short notice. The Federal 

Reserve, after all, is the only agency that has financial resources 

at hand in amounts capable of emergency response. 

More broadly, I believe the experience demonstrates conclusively 

that the responsibilities of the Federal Reserve with respect to 

maintaining economic and financial stability require close attention 

to manage beyond the specific confines of monetary policy, if we interpret monetary policy narrowly, as influencing monetary aggregates and short-term interest rates. 

For instance, one recurring challenge in the conduct of monetary 

policy is to take account of the attitudes and approaches of banking 

supervisors as they act to stimulate or to restrain bank lending, 

and as they act to adjust capital standards of financial institutions. 

The need to keep abreast of rapidly developing activity in other 

financial markets, certainly including the markets for mortgages 

and derivatives, has been driven home by the recent crisis. 

None of this to my mind suggests the need for regulatory and supervisory authority to lie exclusively in the Federal Reserve. In 

fact, there may be advantages in some division of responsibilities. 

A single regulator may be excessively rigid and insensitive to 

market developments, but equally clearly, we do not want competition and laxity among regulators aligning with particular constituencies or exposed to narrow political pressures. 

We are all familiar in the light of all that has happened with 

weaknesses in supervisory oversight, with failures to respond to financial excesses in a timely way and with gaps in authority. Those 

failings spread in one way or another among all the relevant agencies, not excepting the Federal Reserve. 

Both law and practice need reform. However these issues are resolved, I do believe the Federal Reserve, our central bank, with the 

broadest economic responsibility, with a perceived mandate for 

maintaining financial stability, with the strongest insulation 

against special political or industry pressures, must maintain a significant presence with real authority in regulatory and supervisory 

matters. 

Against that background, I respond to the particular points you 

raised in your invitation. 

I do believe it is apparent that regulatory arbitrage and the fragmentary nature of our regulatory system did contribute to the nature and extent of the financial crisis. That crisis exploded with a 

vengeance outside the banking system, involving investment banks, 

the world’s largest insurance company, and government-sponsored 

agencies. 

Regulatory and supervisory agencies were neither reasonably 

equipped nor conscious of the extent of their responsibilities. 

Money market funds growing over several decades were essentially 

a pure manifestation of regulatory arbitrage. 

Attracting little supervisory attention, they broke down under 

pressure, a point of significant systemic weakness, and the remarkVerDate Nov 24 2008 12:54 Aug 05, 2010 Jkt 056776 PO 00000 Frm 00015 Fmt 6633 Sfmt 6633 K:\DOCS\56776.TXT TERRIE
12 

able rise of the subprime mortgage market developed through a variety of channels, some without official oversight. 

There are large questions about the role and supervision of the 

two hybrid public/private organizations that came to dominate the 

largest of all our capital markets, that for residential mortgages. 

Undeniably, in hindsight, there were weaknesses and gaps in the 

supervision of well-established financial institutions, including 

banking institutions, major parts of which the Federal Reserve carries direct responsibility. 

Some of those weaknesses have been and should have been 

closed by more aggressive regulatory approaches, but some gaps 

and ineffective supervision of institutions owning individual banks 

and small thrifts were loopholed, expressly permitted by legislation. 

As implied by my earlier comments, the Federal Reserve, by the 

nature of its core responsibilities, is thrust into direct operational 

contact with financial institutions and markets. 

Beyond those contacts, the 12 Federal Reserve banks exercising 

supervisory responsibilities provide a window into both banking developments and economic tendencies in all regions of the country. 

In more ordinary circumstances, intelligence gleaned on the 

ground about banking attitudes and trends will supplement and 

color forecasts and judgments emerging from other indicators of 

economic activity. 

When the issue is timely identification of highly speculative and 

destabilizing bubbles, a matter that is both important and difficult, 

then there are implications for both monetary and supervisory policy. 

Finally, the committee has asked about the potential impact of 

stripping the Federal Reserve of direct supervisory and regulatory 

power over the banks and other financial institutions, and whether 

something can be learned about the practices of other nations. 

Those are not matters that permit categorical answers good for 

all time. International experience varies. Most countries maintain 

a position, often a strong position, and a typically strong position 

for central banks’ financial supervision. In some countries, there 

has been a formal separation. 

At the extreme, all form of supervisory regulatory authority over 

financial institutions was consolidated in the U.K. into one authority, with rather loose consultative links to the central bank. The 

approach was considered attractive as a more efficient arrangement, avoiding both agency rivalries and gaps or inconsistencies in 

approach. 

The sudden pressure of the developing crisis revealed a problem 

in coordinating between the agency responsible for the supervision, 

the central bank, which needed to take action, and the Treasury. 

The Bank of England had to consider intervention with financial 

support without close and confident appraisals of the vulnerability 

of affected institutions. As a result, I believe the U.K. itself is reviewing the need to modify their present arrangements. 

For reasons that I discussed earlier, I do believe it would be a 

really grievous mistake to insulate the Federal Reserve from direct 

supervision of systemically important financial institutions. 

13 

Something important but less obvious would also be lost if the 

present limited responsibilities for smaller member banks were to 

be ended. The Fed’s regional roots would be weaker and an useful 

source of information lost. 

I conclude with one further thought. In debating regulatory arrangements and responsibilities appropriate for our national markets, we should not lose sight of the implications for the role of the 

United States in what is in fact a global financial system. 

We necessarily must work with other nations and their financial 

authorities. The United States should and does still have substantial influence in those matters, including agreement on essential 

elements of regulatory and supervisory policies. 

It is the Federal Reserve as much as and sometimes more than 

the Treasury that carries a special weight in reaching the necessary understandings. That is a matter of tradition, experience, 

and of the perceived confidence in the authority of our central 

bank. 

There is a sense of respect and confidence around the world, matters that cannot be prescribed by law or easily replaced. 

Clearly, changes need to be made in the status quo. That is certainly true within the Federal Reserve. I believe regulatory responsibilities should be more clearly focused and supported. The crisis 

has revealed the need for change within other agencies as well. 

Consideration of broader reorganization of the regulatory and supervisory arrangements is timely. At the same time, I urge in your 

deliberations that you do recognize what would be lost, not just in 

the safety and soundness of our national financial system, but in 

influencing and shaping the global system, if the Federal Reserve 

were to be stripped of its regulatory and supervisory responsibilities, and no longer be recognized here and abroad as ‘‘primus inter 

pares’’ among the agencies concerned with the safety and soundness of our financial institutions. 

Let us instead strengthen what needs to be strengthened and demand high levels of competence and performance that for too long 

we have taken for granted. 

Thank you, ladies and gentlemen. 

[The prepared statement of Chairman Volcker can be found on 

page 100 of the appendix.] 

Mr. WATT. I thank both the Chair and former Chair for your 

statements. We will now recognize the members for 5 minutes of 

questions. I will remind the members that there is a second panel 

of witnesses, so we want to try to stick to the 5 minutes. 

I will recognize myself first for 5 minutes. 

Chairman Bernanke, the current system we have has a division 

of supervisory responsibilities between the Fed, the FDIC, the 

OCC, and I guess a fourth agency that would be consolidated under 

the House bill. How has that worked and how have you been able 

to compensate for the things that you say are so critical in that 

framework? 

Mr. BERNANKE. Mr. Chairman, I think there were some flaws at 

each level. There were flaws at the level of the legislative structure. There were flaws at the level of execution. I think we need 

to look at all of those. 

14 

I think there are two main lessons from the crisis. One is that 

every systemically critical large institution needs to have a consolidated supervisor that can look at the whole company and understand the risks that are faced by that company. 

Many of the worst problems in the investment banks and AIG 

and in other companies and markets were areas where there was 

no strong supervisor, where there was just a gap. We need to fix 

that as we go forward. 

We also, I think, need to strengthen the concept of consolidated 

supervision. We currently have a system where each supervisor is 

assumed to defer to the functional regulator of each subsidiary, and 

in some cases, that is not appropriate. When a consolidated supervisor sees a problem in a subsidiary, it needs the authority to go 

in and look at that. 

The other broad concern, the other thing we learned from the crisis at the very highest level, is the need to look at the system from 

a systemic perspective, not just look at each individual firm, but to 

look at broad risks to the whole system. 

I think that some of the ideas which have been advanced in the 

House bill and Senator Dodd’s proposal, such as creating a systemic risk council, and broadening the responsibilities of some of 

the regulators, would help address that problem, and together with 

tougher regulations like higher capital standards, I think that 

would improve our oversight considerably. 

Mr. WATT. The Dodd bill that was recently introduced sets a $50 

billion threshold for supervision of the Fed. Is there any rationale 

for either that $50 billion threshold or any other threshold? How 

does this cut in terms of actual need to be able to be involved in 

these things to determine or set monetary policy? 

Mr. BERNANKE. Mr. Chairman, we are quite concerned by proposals to make the Fed a regulator only of the biggest banks. It 

makes us essentially the ‘‘too-big-to-fail’’ regulator. We do not want 

that responsibility. 

We want to have a connection to Main Street as well as to Wall 

Street. We need to have insights into what is happening in the entire banking system to understand how regulation affects banks, to 

understand the status of the assets and credit problems of banks 

at all levels, all sizes, and smaller and medium-sized banks are 

very valuable to us and they provide irreplaceable information, 

both in terms of making monetary policy and in terms of us understanding the economy, but also in terms of financial stability. 

Let’s not forget that small institutions have been part of financial 

crises in the past, including in the 1930’s, in the thrift crisis, and 

other examples. 

We think it is very important for the Federal Reserve not to be 

just the big institution regulator. We need to have exposure to the 

entire economy and to the broad financial system. 

Mr. WATT. Chairman Volcker, you indicated that some division 

of supervisory and regulatory responsibility is appropriate. I am 

trying to get a better view of what you think that division should 

be if neither the Senate bill nor the House bill is necessarily ideal. 

Mr. VOLCKER. If you are going to have more than one regulatory 

agency, and I have some sympathy for that, you have to have some 

division of responsibility. 

15 

Just where you place that, I do not know. I do not know the im- plications of the $50 billion. I do not know how many banks are 

below $50 billion offhand, and if the Federal Reserve maintained 

a small number of member bank supervision, what the FDIC would 

have and what the OCC would have. I think that is a practical and 

maybe pretty arbitrary matter in the last judgment. 

I do think we do not want to signal out some institutions as ‘‘toobig-to-fail.’’ I think we want a system in which particularly nonbanking institutions can fail. That brings up many other issues in 

financial reform that do not rest significantly on precise quantitative amounts. 

Mr. WATT. My time has expired. I will recognize the gentleman, 

Mr. Bachus. 

Mr. BACHUS. Thank you. Chairman Bernanke, was the New York 

Fed aware that Lehman Brothers was using an accounting gimmick, repo 105? 

Mr. BERNANKE. Congressman, first of all, the Federal Reserve 

was not the supervisor of Lehman Brothers, and indeed, one of the 

issues I was talking about was that under the existing system, an 

investment bank like Lehman Brothers would not have a consolidated supervisor. We did not have that information. 

We had only a couple of people in the company whose primary 

objective was to make sure we got paid back the money we were 

lending to Lehman through our primary lender credit facility. We 

were not the supervisor, and in any case, we would not have had 

the authority to address accounting and disclosure issues in that 

context. 

Mr. BACHUS. The Federal Reserve had run three stress tests on 

Lehman and in the course of those stress tests, would you not have 

found out they were using this accounting gimmick? 

Mr. BERNANKE. No, sir. These were liquidity stress tests. The objective was to discover whether they had enough liquidity to deal 

with a stressed situation, and they failed all three tests. That was 

information we shared with the SEC and with Lehman Brothers. 

Mr. BACHUS. The argument that you and former Chairman 

Volcker have used is as the lender of last resort, you must have 

direct access to bank data to assess the creditworthiness and collateral of a would-be borrower, but the New York Fed made the discount window available for cheap money with this going on. 

I will ask Chairman Volcker, does that not trouble you? Then, I 

will ask Chairman Bernanke. 

Mr. BERNANKE. We assess the value of the collateral. We put in 

an extra haircut because we were concerned about the solvency of 

the company, and we were repaid fully. That part of it worked fine. 

Again, we were not charged with supervising the company. 

Clearly, it was a very troubled company. If we had some kind of 

provision to take a non-bank into receivership, we would have applied that in the case of Lehman. 

Mr. BACHUS. All right. Thank you. Chairman Volcker? 

Mr. VOLCKER. I think this is an example of why we need some 

pretty thorough reform, so that an institution of that size would 

have some official oversight. 

I would also hope that if we have the kind of reform that is being 

talked about, the issue of the Federal Reserve lending to those inVerDate Nov 24 2008 12:54 Aug 05, 2010 Jkt 056776 PO 00000 Frm 00019 Fmt 6633 Sfmt 6633 K:\DOCS\56776.TXT TERRIE
16 

stitutions, non-bank institutions, would not be relevant because if 

push came to shove and they were failing, it would come under the 

so-called ‘‘resolution authority’’ that would have the power and resources to provide a suitable liquidation or merger of that institution. 

The Federal Reserve would not have to get directly involved as 

a lending organization. 

Mr. BACHUS. They should not be lending money to failing institutions? 

Mr. VOLCKER. Not ordinarily. 

Mr. BACHUS. Through the discount lending window. 

Mr. VOLCKER. Quite true. We want a system so they would not 

be put in that dilemma, to save the rest of the market, so to speak. 

We want to have a system that can provide— 

Mr. BACHUS. Do you support our efforts to not allow under Section 13(3), the bailouts that you have seen in the last year? Senator 

Dodd says 13(3) cannot be used, and the House Republicans also 

had a provision saying 13(3) cannot be used for an ad hoc bailout 

of a non-bank financial institution. Do you agree? 

Mr. VOLCKER. If you had the resolution authority, you would not 

need 13(3). 

Mr. BACHUS. Let me ask you, you said in your testimony in debating regulatory arrangements and responsibilities appropriate for 

our national markets, we should not lose sight of the implications 

for the role of the United States in what is in fact a global economy. We necessarily must work with other nations and their financial authorities. 

How about the Volcker Rule? What if the proposed limitations on 

proprietary trading—what if other countries do not adopt that? 

Would that put us at a disadvantage, and could we instead use sort 

of capital requirements and maybe restrictions on leveraging or restrictions on coming to the discount window for cheap money? 

Mr. VOLCKER. I think that question is a little premature. The 

first thing we ought to do is get other countries to go along, and 

then we would not face that kind of a problem. I am hopeful that 

will be the result. 

Mr. BACHUS. If they do not? 

Mr. VOLCKER. If they do not, I think we should still apply it in 

the United States, but in American institutions, I think it would 

present relatively minor problems. 

Mr. BACHUS. All right. 

Mr. VOLCKER. These activities we are talking about, just so I am 

clear, are a small part of the activity of very few American banks. 

Mr. BACHUS. Thank you. 

Mr. WATT. The gentleman’s time has expired. The gentleman 

from Pennsylvania, Mr. Kanjorski, is recognized for 5 minutes. 

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

Chairman Bernanke, if I may ask, I heard you refer to some 

loopholes and legislative holes in things you can or cannot do. 

It brought to mind, has the Federal Reserve done a critique of 

the legislation put together by this committee and passed in the 

House, and a critique of the Dodd bill, so that we can have a criticism as to whether or not any loopholes exist that should be covered or if not covered, what the impact will be? 

17 

Mr. BERNANKE. No, sir. We do not have a specific critique of 

these individual bills. We have been pretty clear about what we 

think is the right approach. I would be happy to discuss any specific item. 

Mr. KANJORSKI. Could I make the request of you, and I appreciate the discussion and having an open discussion like that, but 

could I ask you if you could have your experts really make those 

thorough reviews so that if there are any loopholes that have to be 

closed or considered or at least identified—there are many members of the committee, including myself, who would not recognize 

a loophole if we walked into it. 

I am sure the expertise of the Federal Reserve sees them and 

sees the tilt light go off that they are there. I would like to be informed about it. 

If you could have your experts at the Federal Reserve review our 

piece of legislation that passed the House and the Dodd bill and 

any other bill that ultimately comes out of the Senate, to give us 

that critique so that we may use that critique when we go to the 

conference committee to address those loopholes? 

Mr. BERNANKE. Congressman, what we have been doing is trying 

to provide technical assistance on each issue. We do not want to 

overstep our bounds and say, this is good and that is bad. We like 

to help wherever we can. 

Mr. KANJORSKI. That is part of the legislation I am responsible 

for. Do not worry about overstepping bounds. 

Mr. BERNANKE. Okay. 

Mr. KANJORSKI. Mr. Volcker, unfortunately, we did not have the 

Volcker Rule before us when we went through the House side of 

regulatory reform, but now obviously, it is included in the Dodd 

bill. 

I guess I have two questions: one, did the Dodd bill include the 

entire Volcker Rule or are there important portions of it that have 

been left out that you think we should look at or address if we go 

to conference; and two, if you could for the record indicate why you 

think it is so important that we have mandatory provisions such 

as the Volcker Rule? 

Mr. VOLCKER. The first part of your question, I do think the 

Dodd bill makes a big step forward. There may be a few areas 

where I think maybe additional clarification would be desirable. 

I am out of office so I have no reluctance to overstate my ability 

to make comments. 

Mr. KANJORSKI. I am inviting you to. 

Mr. VOLCKER. I do think it has to be mandatory because I have 

been a regulator, I have been a supervisor, and I have observed 

regulators and supervisors. It is very hard to take tough restrictive 

measures before the crisis, and after the crisis, of course, it is too 

late. 

I really think in an area like this where the rationale to me at 

least is quite clear, the law should say as specifically and as 

mandatorily as possible, and I think the Dodd bill, as I understand 

it, goes considerably in that direction. 

Mr. KANJORSKI. Very good. In view of the fact that there are so 

many members, Mr. Chairman, I will yield back what balance of 

time I have. 

18 

Mr. WATT. I thank the gentleman. The gentleman from Texas, 

Dr. Paul, the ranking member of the subcommittee. 

Dr. PAUL. Thank you, Mr. Chairman. I have a question for 

Chairman Bernanke. 

During the early part of the decade, a lot of the free market 

economists keet saying, well, interest rates have been too low for 

too long, and there was a financial bubble and a housing bubble, 

and there had to be a correction. 

Of course, we did in 2008. Since 2008, many of the mainstream 

economists have more or less agreed with that assessment because 

frequently we will hear them say interest rates were held too low 

for too long, and I think even Secretary Geithner has made that 

statement. 

Where do you come down on that perception? Do you think interest rates were held too low for too long? 

Mr. BERNANKE. Congressman, I have given a speech on this. I 

think the bottom line is, nobody really knows for sure, but that the 

evidence is really quite mixed. 

I would say even if they were too low for too long, the magnitude 

of the error was not big enough to account for the huge crisis we 

had. I think what caused the crisis were the failures of regulation. 

I would fault the Fed here, too, because some of those failures were 

ours in the sense that we did not do enough, and I have admitted 

this and acknowledged this many times, we did not do enough on 

mortgage regulation. 

I think it was the weakness of the regulatory system, not monetary policy, that was most important here. 

Dr. PAUL. Of course, I do not agree with that, but if you assume 

for a minute that it was too low for too long, and you had perfect 

regulations, what is the harm done by interest rates being too low 

for too long? Do you see any damage by interest rates being artificially low for a long period of time? Let’s sort that away from regulations for a second. 

Mr. BERNANKE. Certainly, one possibility which my colleagues to 

the left know a lot about is that if you keep rates too low for too 

long, you get inflation. Every central banker wants to be sure that 

the price level remains stable. That is an important consideration. 

Dr. PAUL. Do you think the investor, the businessman, makes 

mistakes if interest rates are lower than say the market? Are not 

low interest rates an indication there are savings and if there are 

no savings but the interest rates are low because of newly created 

credit by the Fed, does that not send a false signal to some investors and to some business people? 

Mr. BERNANKE. If interest rates are below their normal levels, it 

is because the economy is operating at a very low level. Currently, 

we are not in anything an economist would call optimum equilibrium or anything like that. 

We certainly are in a situation where a lot of people are out of 

work and consumption is well below its normal levels and low interest rates serve the function of increasing demand and putting 

people back to work. 

Dr. PAUL. You do not think that if interest rates are 2 and 3 percent instead of 6 percent, without artificially low interest rates, 

there would not be a temptation for people to build too many 

19 

houses or people to try to capitalize on the fact they are anticipating price inflation and in the bubble? 

Mr. BERNANKE. Congressman, interest rates are very low right 

now, and I do not think building too many houses is really a problem. 

Dr. PAUL. That makes a very important point. In the boom part 

of the cycle, the low interest rates cause people to do things that 

might not be proper and best for the economy, and then when the 

bust comes, we resort to the same policy of keeping interest rates 

extremely low for too long. 

What are the chances—do you think there is any chance in a 

year or two or three from now we will look back and say well, not 

only were they too low for too long in the early part of the decade, 

they were too low for too long in the latter part of the decade? 

When the prices start to go up, it is sort of a little bit too late, 

and then you have the job of reigning that all in. 

Mr. BERNANKE. It is a difficult—central banking is an art and we 

need to balance our dual mandate. Our dual mandate is to maximize employment and price stability. We need to try to find an appropriate policy that gets us as close as we can to both sides of that 

mandate. 

Dr. PAUL. The free market people say the dependency on regulation is just imaginary because the fault is all these mistakes being 

made because they have false information. 

Price fixing, nobody is advocating wage and price controls because of all the false information. You cannot run the economy with 

price fixing. That is why socialism fails. 

If you fix the price with interest rates, it is one-half of the economy because you are messing around with the monetary system, 

and then all of a sudden instead of dealing with that, we say we 

just need more and smarter regulations and we are going to solve 

all these problems. 

That does not concern you at all? 

Mr. BERNANKE. You need some system to set the money supply. 

I guess you are a gold standard supporter. 

Dr. PAUL. I am for the Constitution. 

Mr. BERNANKE. Every major country currently in the world uses 

a central bank which must make some decision about the money 

supply, whether it is to keep it stable or to move it around. Nevertheless, it is a choice that is made. 

Dr. PAUL. Then there is no good information for the investor, unfortunately. 

Mr. WATT. The gentleman’s time has expired. The gentleman 

from California, Mr. Sherman, is recognized for 5 minutes. 

Mr. SHERMAN. Thank you, Mr. Chairman. 

I do not think the folks in the financial world understand the 

permanent damage done to our social and political institutions, 

done to the social contract by the Wall Street bailouts and the prospect of future bailouts which exist as long as we allow to exist institutions that we brand as ‘‘too-big-to-fail.’’ 

Chairman Volcker, with three Federal prudential supervisors 

plus various States, how can we in the future get consistent, comprehensive, and effective regulation and supervision of all banks 

and similar institutions? 

20 

Should there not be a single body for setting out one set of rules 

that all the supervisors would comply consistently? 

Mr. VOLCKER. Conceptually, there could be one supervisor. I 

think that is the way to go. Many countries have it that way. We 

have a particularly big and complex country and financial markets 

with their own traditions. That has led to a multiplicity of regulatory agencies, and I think it is fair to say, a certain amount of 

confusion. We have to do better in coordinating what they do. We 

have been left with extremely weak supervision outside the banking system as a matter of historic development. 

Let me say on the other side as I said in my statement, and this 

is basically a political decision, there are some advantages in having more than one regulator. In many instances, I think, countries 

find a single regulator gets pretty rigid in its bureaucracy and 

there are legitimate complaints by the financial institutions that 

there is too little room for innovation and flexibility and freedom. 

On the other hand, I do not want regulatory agencies competing 

with each other in liberalism. 

Mr. SHERMAN. I can agree with you on that. 

Mr. VOLCKER. I think what this comes down to— 

Mr. SHERMAN. I need to interrupt you, because I have two other 

questions to squeeze in. 

Chairman Bernanke, you have outlined the advantages of mixing 

monetary policy and bank supervision. I want to address one of the 

perceived disadvantages. I will ask you not to just offset it by saying, well, here are all the advantages, but rather address the disadvantages. 

Bureaucracies hate bad headlines. They will often do desperate 

things behind the scenes to avoid that big headline from breaking. 

Prudential regulators are going to get bad headlines if a big institution fails, particularly under some circumstances, and they can 

prevent that failure if they can just put it off for 6 months. Their 

reputations and careers can be saved. 

Monetary policy, just cutting the interest rate by a quarter of a 

point, can save a troubled institution. How can we be sure that 

monetary policy is not influenced by the natural human desire of 

bank supervisors to save one or two institutions for at least long 

enough for them to move over to another department? How do we 

make sure monetary policy does not meet the career needs of bank 

supervisors? 

Mr. BERNANKE. I do not think that is a very realistic scenario. 

If a bank was really that sick, I do not think a quarter point interest rate change would help it very much and the consequences— 

Mr. SHERMAN. Every dying patient is on the borderline at some 

point. Yes, there can be circumstances where it is touch and go. 

Mr. BERNANKE. Again, I do not think that is an efficient way or 

effective way even to achieve that objective. The central bank 

chairman would nevertheless still be presumably around and concerned about his or her reputation when the economy has excessive 

inflation or whatever problem might arise from that interest rate 

policy. 

I do not think there is much evidence for that particular issue. 

Mr. SHERMAN. I am going to squeeze in one more question. You 

may have to respond for the record. 

21 

Why should our statutes exempt the Fed from audits of—I will 

quote the statute—‘‘Transactions for or with a foreign central bank, 

government of a foreign country, or a non-profit international financial organization,’’ and are you willing to provide for the record 

a description of all such transactions from the 1990’s, where they 

are old and gold, so we can get an idea of what the bank was doing 

internationally? 

Mr. BERNANKE. We have told you— 

Mr. WATT. You have been invited to submit your answer for the 

record. 

Mr. BERNANKE. Okay. Thank you. 

Mr. WATT. I think you have already done it on several occasions, 

but do it again. 

Mr. VOLCKER. Can I make just a brief comment on the previous 

question? I think you put your finger on what is sometimes called 

the ‘‘not on my watch syndrome’’ and it does not have to be by 

monetary policy. It could be a direct rescue of an institution. 

That is why it is so important to get this resolution authority enacted into law in a rigorous way, so that the policymaker is not 

faced with what seems to me to be an awful dilemma of letting the 

institution fail in a messy kind of way or rescuing it and contributing— 

Mr. SHERMAN. I sure hope that resolution authority is not just 

a TARP bailout. 

Mr. WATT. The gentleman’s time has expired. 

Mr. SHERMAN. I thank the chairman. 

Mr. WATT. The gentleman from Texas, Mr. Neugebauer, is recognized for 5 minutes. 

Mr. NEUGEBAUER. Thank you, Mr. Chairman. 

Chairmen, I want to go to this process of the Fed being a prudential regulator. I go to this point. We have had a lot of people coming in here. 

For the last 18 months, we have been trying to find out who the 

bogeyman was in all of the calamity that has happened in the financial markets. Everybody who comes in says well, it was not my 

fault. 

I think the bottom line here is under the proposed structure by 

the House version or the Senate version, basically in many cases, 

the Fed had regulatory authority over many of these entities that 

people are saying was part of the problem. 

I guess the question I have is, if it did not work before, how does 

it work now? The second part of that is these very large financial 

institutions, if you had gone into them, let’s say 18 months ago, 

and said, we are a little concerned about what is going on here, 

and they said well, we have record earnings, we are making lots 

of money, we have good liquidity, we have good balance sheets, our 

ratios are in place. What do you mean you want us to stop originating more mortgages? What do you mean you want us to slow 

down our securitization activity? What do you mean you want us 

to get out of the credit default swap business? 

How did you miss it and how would you have done it differently? 

If you are not going to do it differently, then we are moving in the 

wrong direction here. 

I will start off with Chairman Bernanke. 

22 

Mr. BERNANKE. That is the $64 billion question you just asked. 

Mr. NEUGEBAUER. No, it is the trillion dollar question. 

Mr. BERNANKE. There were mistakes and problems throughout 

the system. Regulators, the Federal Reserve, the private sector, 

and even Congress made mistakes in this crisis. The only thing we 

can do is go forward and fix the mistakes. 

We are working at every level. We, of course, are recommending 

changes to the overall statutory structure to address gaps and 

other problems in the system, but we are also taking actions ourselves. 

We are strengthening our capital requirements, for example. Liquidity turned out to be a big issue in this crisis. We have been 

working internationally to strengthen that substantially. 

I think execution is very important. Within our own supervisory 

system, we have been doing a lot of soul searching and a lot of 

changes and those changes are both at the level of the framework 

for supervision, which we believe needs to be more systemic, more 

so-called ‘‘macro-prudential,’’ but also in terms of execution. 

We have found situations just like you described, where we were 

not fast enough, we were not forceful enough. We need to change 

our culture, our structure, and our instructions to examiners and 

so on to make sure we do a better job next time. 

Everyone has to do a better job. We are working to do a better 

job. We think there are structural reasons that the central bank 

needs to be involved in this process. 

Mr. NEUGEBAUER. Chairman Volcker? 

Mr. VOLCKER. Let me make a general point. We have a lot of discussion about supervision and gaps and supervisory policies. Supervision is a tough job. 

You are dealing with a very complex situation with some known 

and some unknown factors in a political world where your tools are 

limited and you have to be able to explain what you are doing, 

which is very hard to take restrictive rules when things are going 

well. 

Do not put more burdens on the supervisors than are necessary. 

If there are some structural factors in the market that you want 

to promote or eliminate, do it by legislation and do not leave everything up to the supervisor, or give the supervisor a very clear 

framework within which to work. The more you do that, I think the 

better off we will be in terms of supervision. 

Mr. NEUGEBAUER. I do not disagree with that, Chairman 

Volcker. I am a ‘‘less regulation’’ person but I think the point is we 

actually had regulation in place. We had regulators in place. I 

think there is an unreasonable expectation here that somehow we 

are going to fix this. 

We have bank regulators today and we have over 100-some 

banks fail, and the question is, I think some people think well, by 

expanding or reshuffling the deck that we are going to have a better outcome. I think we would have had a much better outcome if 

we had people who were doing the job they were already supposed 

to be doing. 

Mr. VOLCKER. I cannot deny that. There were gaps in regulations, gaps in authority. One was large gaps in the investment 

banking area, in my opinion, where a lot of the crisis arose. 

23 

You had gaps in the subprime mortgage. You had some regulatory authority over some parts of it, but none over other parts of 

it. 

You had a big gap given what we know now, and I keep coming 

back to it because I think it is important, in the resolution authority. There was no resolution authority that gave the supervisors a 

reasonably effective and efficient way of closing down a non-bank 

institution with minimal damage. 

That is something you have to legislate. 

Mr. WATT. The gentleman’s time has expired. The gentleman 

from New York, Mr. Meeks. 

Mr. MEEKS. Thank you, Mr. Chairman. Thank you, Chairman 

Bernanke, and former Chairman Volcker, for your testimony. 

Let me ask Chairman Bernanke first, we have this language in 

the House bill empowering regulators to deal with systemic risk. 

My question to you is, do you think the language that we have in 

the House bill is strong enough to expedite a removal of systemic 

risk or do we need—there was a question, do we need something 

mandatory like the Volcker Rule? 

Mr. Volcker, I would like to get your response on that, too. 

Mr. BERNANKE. I would like to maybe answer you in writing on 

that because it is a very complicated bill. I think the general direction is good, but there are some areas where we think if we had 

our preference, we would make some changes. It is a complicated 

bill. 

Mr. NEUGEBAUER. I would gladly wait for you to give us a response in writing, because I want to see if you think you have the 

authority from what we put in there or do not. 

Mr. Volcker? 

Mr. VOLCKER. I will give you a particular example of what I am 

concerned about and responsive to the previous comment. 

On the so-called ‘‘Volcker Rule,’’ a prohibition of proprietary trading and hedge funds and equity funds, the House bill has a provision and it is kind of voluntary, just turns it over to the regulators 

and the supervisors. In my opinion, it is very unlikely that the regulators and supervisors would invoke a strict prohibition until a 

crisis came and then it is too late. That is why you want it in legislation. 

Mr. MEEKS. The question, I guess, or part of it, and I will wait 

for Chairman Bernanke’s response in writing, is would the Volcker 

Rule at least set a floor from which to work? 

I know you said it will be in writing, so I look forward to hearing 

that. 

Let me ask you, Chairman Bernanke, if you added up the cumulative working hours at the Fed, could you tell me about what percentage of work is spent on bank oversight, on consumer protection, on monetary policy, and on monetary systemic risk? Is there 

any way you could tell us how much time is spent there? 

Mr. BERNANKE. We have separate divisions that work on each of 

those areas to some extent. We are also doing a lot of cross disciplinary/multi-disciplinary work. Once again, if I could send you data 

on the number of people in each area, that would be more exact 

than just taking a guess off the top of my head, if that would be 

okay. 

24 

Mr. MEEKS. That would be great. Mr. Volcker, from your experience when you were Chair of the Fed, could you tell me at that 

time if you know how the Fed spent the majority of its time? Was 

it on bank oversight, bank regulation, or whatever, from your experience? 

Mr. VOLCKER. I must say, through history, I think the Federal 

Reserve activities in this area have varied quite a lot, depending 

upon the leadership in the place. 

Specifically, during my term in office when we had some big 

problems, we were fortunate at one point in having an extremely 

effective head of the supervision area and the regulation area. 

That made a big difference in the effectiveness of the way we 

went about our work, which I think emphasizes the importance of 

having effective people on the job and effective leadership in the organization. 

I have been an advocate of something that is in the Dodd bill, 

of having a new position in the Federal Reserve or new in the 

sense of one of the Governors designated as Vice Chairman for Supervision. 

I think you need that continuing focus and clear sense of responsibility so that the attention that the Federal Reserve pays is less 

subject to ups and downs over time. 

Let’s build it into the organization in a way that it has not been 

built, and as conclusively as it should have been, in the past. 

Mr. MEEKS. I basically agree. Sometimes, and I know in our congressional offices, for example, sometimes you have to prioritize. An 

office might prioritize something as being more important than others, and those priorities, sometimes in my office, that means something else might be subordinate. Generally, that is the way things 

work. 

I am concerned about that but I will wait to see what the Chairman sends back. I do have some concerns there. That is just generally what people do in offices. 

Mr. VOLCKER. I think that is why you need this vice chairman, 

to give continuity. It is his priority by law to pay attention to this 

and report to the Congress as appropriate and be designated and 

confirmed on the basis that he had a particular responsibility for 

overseeing the Federal Reserve’s efforts in that area. 

Mr. MEEKS. Thank you. 

Mr. WATT. The gentleman’s time has expired. The gentleman 

from California, Mr. Royce, is recognized for 5 minutes. 

Mr. ROYCE. Thank you, Mr. Chairman. 

Chairman Bernanke, watching the trends in the market for 

Treasuries, it appears as though the two major creditors, which 

would be Japan and China, have begun to scale back their purchases of U.S. Government securities. 

Filling the void in demand have been other foreign governments 

or other foreigners, as they say, and I would assume that would be 

foreign banks and hedge funds, and then also U.S.-based financial 

institutions. 

Clearly, there is market play here, the carry trade is in effect 

here by these banks, which essentially amounts to borrowing at 

next to nothing from central banks and lending it back to the U.S. 

25 

Government at 1 or 2 percent, depending on how far out they go 

on the yield curve. 

Have we backed ourselves into a corner here? Essentially, if you 

raise interest rates, the carry trade evaporates, as does the demand 

in the Treasury market, and our ability to finance the $1.5 trillion 

deficit this year. 

Who is going to lend to us if we do that? If foreign governments 

are scaling back and financial institutions can no longer make 

money in this market, where will the demand for Treasuries come 

from? 

Mr. BERNANKE. This is a very large and deep market. Indeed, 

when you see stress in other areas around the world, perhaps in 

other countries’ fiscal positions, for example, the dollar tends to 

strengthen because money flows into U.S. Treasuries. 

I have not seen any reduction in demand for U.S. Treasuries. 

The foreign demand remains quite strong. I do not anticipate any 

problem. 

I guess there is always the question of price. There, the question 

is, will all our creditors, including domestic creditors, remain confident in the long-run fiscal stability of the United States, and 

there, I think it is very, very important for the Congress to be devising a plan to create a trajectory whereby we have a more stable 

debt position going forward. That is very important. 

Mr. ROYCE. I concur on the points you have made on that publicly. Getting back to the question of the extent that we are dependent upon the carry trade to finance our debt, do you think 

there is an element of truth to that point? 

Mr. BERNANKE. Sometimes, there is a misunderstanding that the 

carry trade is an arbitrage for pure profit opportunity. It is not. 

When you borrow to buy a long-term security, you are taking on 

considerable risk associated with the longer-term life of the security. 

I think what will happen is if short-term interest rates go up because the economy strengthens, then long-term rates might go up 

as well. That would affect our cost of financing our deficit, another 

reason to get the deficit under good control. 

The interest rate will do what is necessary to attract the demand 

for our securities. Again, I do not see any reason to think there will 

not be demand for those securities. 

Mr. ROYCE. Let me ask a question of Mr. Volcker, too. With the 

introduction of Mr. Dodd’s legislation in the Senate, we now have 

regulatory reform bills in each chamber that institutionalize rather 

than eliminate this ‘‘too-big-to-fail’’ concept. 

The ultimate cost of ‘‘too-big-to-fail’’ will be borne by our capital 

markets and the broader economy. 

The approach put forward in these bills essentially bifurcates our 

financial system and those institutions that will be labeled systemically significant will likely see lower borrowing costs and greater 

access to capital compared to their smaller competitors. 

That would give these firms a significant competitive advantage. 

This is what happened with Fannie Mae and Freddie Mac. They 

wiped out the competition and they formed a duopoly over the 

prime secondary mortgage market because they were perceived to 

be government-backed. 

26 

Mr. Volcker, are we recreating the moral hazard problem found 

at Fannie and Freddie by labeling these institutions ‘‘too-big-tofail?’’ How would you expect creditors and counterparties of these 

institutions to react to this label or even make the label official? 

Mr. Volcker? 

Mr. VOLCKER. When you talk about Fannie and Freddie in particular, and the moral hazard in the mortgage market, the moral 

hazard with respect to those institutions, I think it is very real and 

it will be a real challenge to change that in the future. You are not 

going to do it right now. 

The mortgage market is wholly dependent or mostly dependent 

on government participation, including support for Fannie Mae and 

Freddie Mac. You are stuck with it. 

I do not think we want to get ourselves in that position in the 

future. I hope that is on your agenda next year, and we reorganize 

the mortgage market. 

So far as other financial institutions are concerned, I hope your 

opening comment that both bills institutionalize ‘‘too-big-to-fail’’ is 

not correct. I understand your concern about labeling an institution 

implicitly as ‘‘too-big-to-fail.’’ I do not want to do that, which is part 

of the reason hiding behind or in the forefront of the kind of proposal I like, I do not want that presumption to exist particularly 

for non-banks. I want it to exist for banks as little as possible but 

banks do have access to the Federal Reserve. I do not think we are 

going to change that. They do have deposit insurance. They also 

are heavily regulated, and that is the balance. They do not have 

that much competitive advantage. 

The other ones, I do not want to have any competitive advantage. 

If they are extremely vulnerable, they will get some regulation, but 

they should not have any expectation they are going to be bailed 

out. 

Mr. WATT. The gentleman’s time has expired. 

Mr. ROYCE. Thank you, Mr. Volcker. 

Mr. VOLCKER. That is the point behind my concerns. 

Mr. ROYCE. I understand. 

Mr. WATT. The gentleman’s time has expired. The gentlelady 

from New York, Ms. Maloney. 

Mrs. MALONEY. Thank you. Welcome, particularly to Paul 

Volcker, who is a proud resident of the great State of New York, 

and we are very proud of your many years of contributions to our 

country and your public service. 

There is a great deal of concern about the proposal in the Dodd 

bill in the Senate regulatory reform proposal that limits the Fed’s 

banking supervision to banks that are larger than $50 billion. First 

of all, do you see a need to make the distinction between large and 

small banks? 

I would specifically like to comment on the Federal Reserve’s interest rate setting body, the Federal Open Market Committee, 

which met yesterday. It is comprised of Federal Reserve Governors, 

the President of the New York Fed, and on a rotating basis, the 

presidents of five of the 11 regional Reserve Banks. 

Would reducing the number of institutions supervised by the 

Federal Reserve have an impact on the FOMC’s activities? First, 

Mr. Bernanke, and then Mr. Volcker. 

27 

Mr. BERNANKE. Yes, we are very concerned about being the regulator of only the big banks. We think that is a bad idea. We need 

to see the broad financial system. We need to have the information 

about the broader economy. We need to know what is going on 

across the country, not just in the great State of New York, for example. 

There is a close connection between the need for the Federal Reserve to look at banks of all sizes and our regional structure. It is 

exactly why we have a regional structure. We have policymakers 

drawn from 12 districts around the country who speak to local people, including local bankers, and get information about what is 

happening in their part of the country. 

Both the regional structure of the Federal Reserve and the supervision of small and medium-sized banks, 5,000 holding companies, 850 State member banks across the country, both of those 

things together provide us with information, qualitative information, which cannot be obtained really any other way. 

Mrs. MALONEY. You would say it is important to monetary policy 

to have supervision over all the banks? 

Mr. BERNANKE. Both to monetary policy, but also to financial stability because we need to see what is happening in the entire banking system, and indeed, small banks can be part of a financial crisis. 

Mrs. MALONEY. Mr. Volcker, do you have a position on this? 

Mr. VOLCKER. I think I have similar views to Chairman 

Bernanke, which should not surprise you. 

Let me make one comment again on this ‘‘too-big-to-fail.’’ There 

was a $50 billion limit. I would not interpret that as $50 billion is 

a limit between who will be saved and who will not be saved. From 

that criteria, $50 billion is much too low in my opinion. 

It is a difficult and rather arbitrary decision as to which size 

banks would be regulated by the Federal Reserve apart from losing 

the contact through the Federal Reserve of the smaller banks. 

Mrs. MALONEY. It is interesting. I have received a number of 

calls today on this proposal, many from small banks who are concerned that they would not be part of the Federal Reserve supervisory system, that they want to be a part of it. 

Mr. Bernanke, could you comment on the Federal Reserve’s supervisory powers over your member institutions on various financial activities in which they operate? What is your role with derivatives, lending and custodial services? 

Why is it important that you have a supervisory or role over 

these particular activities and what is your role in those activities? 

Mr. BERNANKE. We operate the way all the bank regulators do, 

which is we want to make sure the banks are safe and sound, so 

to the extent they are taking derivative positions or hedging their 

risk, we want to make sure they are doing so in a way that is safe, 

that takes into account counterparty risk, takes into account the 

full range of risks they face. 

Clearly, safety and soundness is a big part of our mission. We 

want to make sure those banks are safe. 

At the same time, the stability of the entire system depends on 

the operation of derivatives markets, for example. We saw in the 

28 

crisis how problems with credit default swaps and other types of 

derivatives caused broader issues in the economy. 

As a regulator of the banking system, we will be able to see what 

is happening and be able to make better decisions about how to address any potential risks to the broad system that those kinds of 

products might pose. 

Mrs. MALONEY. Mr. Volcker, any comments? 

Mr. VOLCKER. No, I do not think I have anything to add to that. 

Mr. WATT. The gentlelady’s time has expired. 

Mrs. MALONEY. Thank you. 

Mr. WATT. The gentleman from Texas, Mr. Hensarling, is recognized for 5 minutes. 

Mr. HENSARLING. Thank you, Mr. Chairman. Chairman 

Bernanke, welcome. Chairman Volcker, welcome. 

Chairman Bernanke, I have been an outspoken proponent for 

having a Federal Reserve that restricts itself to conduct monetary 

policy tied to specific inflation targets. 

In your testimony, you posit that it is a critical element of conducting monetary policy to have the prudential regulator role. I 

certainly have an open mind to that argument. Is not our own historical evidence and international examples—is not the empirical 

evidence kind of murky, if you look at the U.K., if you look at 

Japan, and if you look at Germany, clearly they did de-couple the 

two. They had similar economic challenges that we had. We did not 

de-couple. 

Can you please elaborate on the evidence that is out there that 

might be convincing to members of this committee? 

Mr. BERNANKE. Congressman, those three examples are quite interesting because, as you point out, in each case there was a decoupling, to some extent, of the regulatory function and the central 

banking function. 

I believe in all three—certainly in Germany and the UK—the 

current trend is very strongly towards giving supervisory authority 

back to the central bank. And, indeed, in Europe the ECB, the European Central Bank, is being made, essentially, also the financial 

stability regulator for the entire continent. 

I think the perception was in each of those countries that moving 

the central bank out of regulation deprived it of information it 

needed to be effective in the financial crisis, including executing its 

lender of last resort function. 

Mr. HENSARLING. But, Mr. Chairman, we— 

Mr. BERNANKE. So, again, in each case the tendency is to go back 

towards— 

Mr. HENSARLING. But clearly, we have not decoupled here. And 

yet, we did not avoid the panic. We did not avoid the recession. 

Mr. BERNANKE. That’s absolutely right. And— 

Mr. HENSARLING. So what should I derive from that? 

Mr. BERNANKE. Well, the question is, can we identify problems? 

I have already tried to identify some. I think there are some in the 

structure of our regulatory system, and there are some in the execution. Certainly there were problems. And I’m not saying this is 

the one and only issue. But I think the lessons of history are generally on the side of having integration of monetary and supervisory functions. 

29 

Mr. HENSARLING. On the next panel we are going to hear from 

Dr. Meltzer, who is sitting over your left shoulder there. I notice 

he was kind enough to quote me in his testimony, so I’m going to 

return the favor. I have looked through his testimony. 

He says, ‘‘Setting up an agency to prevent systemic risk without 

a precise operational definition is just another way to pick the 

public’s purse. Systemic risk will forever remain in the eye of the 

viewer. Instead of shifting losses onto those that caused them, systemic risk regulation will continue to transfer costs to the taxpayer,’’ which clearly, again, takes us back to the whole question 

of ‘‘too-big-to-fail.’’ 

So, I guess I have a two-part question here, and that is, is the 

concept of a systemically significant firm really in the eye of the 

beholder? 

And if so, in order for you to execute your charge of maximum 

employment and price stability, is it not counterproductive to have 

any type of designation of a fund that creates the impression, 

again, that there are firms that are ‘‘too-big-to-fail?’’ 

Is there not another method—a resolution authority, as you have 

argued for—that would avoid creation of an explicit fund? And 

would there not be—could not the proper application of capital and 

liquidity standards be used in order to avoid the designation of ‘‘too 

big-to-fail,’’ but essentially solve the problem? 

Mr. BERNANKE. I think what you just said was very, very cogent. 

I agree with most of it. I think the fund could very well be exposed, 

which would mean that the industry, not the taxpayer, would bear 

any cost. 

I think it’s very important to have tough ex-ante regulation on 

capital and liquidity and other aspects, to make sure that if an institution threatens the institution if it fails, we need to be especially careful with it, and make sure that it’s as safe as possible. 

But in particular, going back to a question that was raised earlier, we really have to address ‘‘too-big-to-fail,’’ and that means that 

the resolution regime that we devise has to be one that makes sure 

that all the providers of capital, including subordinated debt and 

convertible capital and so on, will be wiped out, that they will not 

be protected, and that the authorities have the ability to go further 

up the obligations to the extent that it’s consistent with stability. 

So, we need to create market discipline. We can only do that if 

people actually believe they’re going to take losses. We didn’t have 

the flexibility in 2008, when we were dealing with these crises— 

we didn’t have the flexibility, in many cases, to impose losses without creating the bankruptcy that we were trying to avoid. 

So, with a well-designed resolution regime, we can impose losses, 

and that will bring market discipline back to the system. 

Mr. WATT. The gentleman’s time has expired. The gentlelady 

from New York—I’m sorry, the gentlelady from California, Ms. 

Waters, is recognized for 5 minutes. 

Ms. WATERS. Thank you very much, Mr. Chairman. I would like 

to thank both Mr. Volcker and Chairman Bernanke for being here 

today. And while we are not going to get into the Volcker Rule 

today, I understand that we are going to hold a hearing to talk 

about it more. I understand the President is very interested in 

30 

what he calls the Volcker Rule. And I want to learn a lot more 

about it, too. 

But we are very pleased that you are here. We have respected 

your work for so many years. And I am looking forward to having 

you back with us again, so we can talk about the Volcker Rule. 

Having said that, I want to go to Chairman Bernanke. It was not 

until 2008, well after the predatory mortgage loan products had 

done their damage, that the Fed finalized its rule-making for the 

Home Ownership and Equity Protection Act, which Congress 

passed in 1994, mandating that the Federal Reserve prohibit unfair, deceptive, or abusive acts or practices in mortgage lending. 

I know the work that you have done, and you mentioned the intensive self-examination that the Federal Reserve has taken of its 

regulatory and supervisory performance, and I really do appreciate 

that. I am not going to get deeply into the consumer financial protection agency that has been talked about so much, and what’s 

happening with the Dodd bill. 

But here is what I really wanted to try and focus on. I have this 

notion that there are some products that are so bad, that are so 

predatory, that they should never have been on the market, should 

not be on the market. It seems to me that flies in the face of what 

those of you in the industry think about, the ways that you think 

about it. 

You feel that in a free market society, businesses are able to 

come up with all kinds of ideas about how they want to provide 

products or services or what have you, and it’s up to you to regulate them, not to prohibit them and say, ‘‘You can’t do that.’’ 

I don’t understand why a regulator can’t take a look at a product 

and say, ‘‘This is so bad, this is so predatory, that it shouldn’t be 

on the market, and we’re not going to allow it to be on the market,’’ 

or, ‘‘We’re going to discourage it from being on the market.’’ And 

that’s one of the reasons I am so interested in the Consumer Financial Protection Agency, because I think they can start to see 

these things in different ways than they have been seen in the 

past. 

Do you feel that, as a regulator, you should have the ability to 

say, ‘‘No, you can’t put that product on the market. It is just too 

bad. It is too predatory.’’ 

Mr. BERNANKE. Absolutely, and we have done it. 

Ms. WATERS. Really? 

Mr. BERNANKE. Credit cards, for example. We have banned a 

number of practices, like double-cycle billing, for example. If there 

are practices which serve no good business purpose, and which the 

consumer cannot understand, there is no reason to allow them. 

Ms. WATERS. Yes. 

Mr. BERNANKE. And we have banned them. 

Ms. WATERS. But if I may, Mr. Chairman, those were banned, I 

think, after they had been so abusive and out in the market for 

such a long period of time. We don’t get to see these mortgage 

products, for example. 

They are calling my office every day—and I am looking at an elderly couple who took out an interest-only loan and, after 5 years, 

that loan adjusts. They had something called a 30-year adjustable 

31 

rate, which is kind of a contradiction in the way that they showed 

that loan to work. 

And what happens is that loan that they took out was at about 

4.5 percent a few years ago. And that loan could go up to 9 percent 

in this 30-year adjustable after it resets. The couple was over 65, 

and in the next 5 to 10 years, it could go up to 9 percent. We don’t 

know what the interest rates are going to be. And they said that 

they didn’t have that when they first took out the loan, but that 

an amendment was slipped in somewhere into this package of papers, and they signed off on it. 

What can we do about that kind of thing? 

Mr. BERNANKE. Well, the Federal Reserve, or whoever is in 

charge of consumer protection, needs to make sure that the products are safe for people to use. And we have done—you are right 

to criticize the Federal Reserve for being late in doing the mortgage 

regulation. You are correct about that. We did do some things, but 

we didn’t do enough. 

But once we did it—and under my chairmanship, we have 

worked hard in these areas—we banned a lot of bad practices. You 

can’t offer a mortgage that has those practices any more, like a prepayment penalty for a short ARM, for example. 

I don’t know about this particular case you’re talking about, we 

would have to look at it, but we are looking at features of mortgages and other financial instruments. And some of them we just 

ban, because we don’t think they serve any purpose, and they’re 

not—the public can’t understand what they’re about. 

Ms. WATERS. Thank you, Mr. Chairman. 

Mr. WATT. The gentlelady’s time has expired. The gentleman 

from New Jersey, Mr. Garrett, is recognized for 5 minutes. 

Mr. GARRETT. Thank you, Mr. Chairman. Thank you, both of you 

Chairmen. 

A quick question off point in all this. I have a bill in that deals 

with the GSEs, that suggested the GSEs should be on budget by 

the OMB, the same way the CBO does it. So, a quick question to 

you is, do the GSE’s obligations—are they sovereign debt? 

Mr. BERNANKE. The government has been pretty vague about 

that, and your chairman says— 

Mr. GARRETT. I thought I knew where the chairman stood, but 

now I don’t know where the chairman stands, after his first comment and after his second comment. Where do you stand? 

Mr. BERNANKE. Well, it’s my interpretation that the government 

is standing behind the— 

Mr. GARRETT. We’re paying it, but do you think it is sovereign 

debt? 

Mr. BERNANKE. Whether it’s legally sovereign debt or not, I am 

not equipped to tell you. I don’t know. 

Mr. GARRETT. Okay. Mr. Volcker, Chairman? 

Mr. VOLCKER. I agree with— 

Mr. GARRETT. You agree that it’s—you’re not equipped to tell. 

Okay. 

Mr. VOLCKER. The government is standing behind it, and it’s a 

bad arrangement, where you have this— 

Mr. GARRETT. Right. 

32 

Mr. VOLCKER. —quasi-private organization and the government— 

Mr. GARRETT. Right. 

Mr. VOLCKER. —stands behind it. 

Mr. GARRETT. Well then, let’s move back to the other questions. 

The report in the paper, with regard to the Lehman situation. I 

heard the question earlier and your answer to that. It seems as 

though the answer you gave—and I was outside, listening to that— 

was you were not the primary regulator in that case. 

But let me just ask it this way. The Fed was there on scene. The 

paper reports your folks being over at Lehman’s, embedded, as they 

say, over there. Was the Fed aware of the 105 repo situation, and 

the accounting irregularities going on? 

Mr. BERNANKE. No. 

Mr. GARRETT. So you were not? 

Mr. BERNANKE. No. 

Mr. GARRETT. And the reason that you were not aware of them 

was? 

Mr. BERNANKE. They were hidden. We are currently the principal 

regulator of Goldman Sachs, and we have about a dozen people onsite, and another dozen people who are looking at the company. We 

had, in this case, I think two people assigned to Lehman. And their 

main obligation was to make sure we got paid back our loans. 

So, it was not our responsibility, or our capacity, in the middle 

of the crisis, to look at that. 

Mr. GARRETT. So when the paper reports—all I know is what I 

read in the paper on this one—what the paper reports is that there 

were a dozen people over there. Only a couple of them, two, were 

yours? 

Mr. BERNANKE. I don’t think—yes. 

Mr. GARRETT. The rest of them were the SEC’s? 

Mr. BERNANKE. That’s my information, yes. 

Mr. GARRETT. And should there have been more, and as much 

as—before, Lehman would not have had access to the discount window up until this period of time. Correct? 

Mr. BERNANKE. Well, again, our objective was to make sure our 

loan was safe, and they were safe. We got paid back. 

Mr. GARRETT. Well, you did get paid back, but is that because 

the collateral was adequate? And how would you know that, if not 

an adequate investigation was going as far as their accounting was 

being done? 

Mr. BERNANKE. Well, it was largely the collateral. Also, the loan 

we made was to the brokerage, and not to the holding company. 

So that was a bit of a distinction, as well. But we took collateral, 

and we took extra large haircuts, to make sure that it was safe. 

Mr. GARRETT. You intrigue me when you say that you only have 

a couple of folks over at Goldman—and I guess that’s as we speak. 

Mr. BERNANKE. There about a dozen folks who come— 

Mr. GARRETT. A dozen folks over there? 

Mr. BERNANKE. I got that number this morning. 

Mr. GARRETT. Okay, all right. 

Mr. BERNANKE. About a dozen folks who go to work at Goldman 

every day. 

33 

Mr. GARRETT. Okay, and I’m not going to hold you to the number 

on that. 

In light of these reports, is that something that we should be 

concerned about, activity of these other houses, as well? Is that 

something that we should be concerned about? Is that something 

the Fed should be concerned about? 

Mr. BERNANKE. Well— 

Mr. GARRETT. And are you looking into it? 

Mr. BERNANKE. Lehman, of course, obviously is no longer in existence. But Goldman and Morgan Stanley and Merrill, etc., are 

now under the Fed’s consolidated supervision. And so now it’s our 

responsibility, and we are paying attention to these issues. 

Mr. GARRETT. And so you are—are you specifically looking at 

their accounting procedures, to see whether this same sort of activity is going on now, or was it going on at that time, as well? 

Mr. BERNANKE. I don’t know. I would have to check and see 

whether we have been looking at that. This report just came out 

this week. 

Mr. GARRETT. Right. Would that be one of the gaps, then, that 

we should be concerned about, going forward? 

Mr. BERNANKE. If we are the consolidated supervisor, then it’s 

our responsibility, and we need to do a good job to do that. But, 

of course, there are lots of things to look at. 

I have to say, in the case of Lehman, it was pretty clear that 

they were in weak condition, independent of this particular piece 

of accounting. 

Mr. GARRETT. Well, that’s interesting that you say that, because 

the New York Fed did not one, not two, but three actual stress 

tests, right? 

Mr. BERNANKE. Liquidity stress tests. 

Mr. GARRETT. Liquidity stress tests. And each time, they came 

back as they failed those stress tests, correct? 

Mr. BERNANKE. Right. 

Mr. GARRETT. Right. Were any recommendations then made to 

Lehman before additional funds were lent to them? 

Mr. BERNANKE. We pushed them, and Secretary Paulson pushed 

them, and I’m sure the SEC pushed them to improve their financial position and to raise capital, if at all possible. But they were 

unable to raise sufficient capital. 

Mr. GARRETT. Well, my understanding is, according to the examiner’s report, the New York Fed required no action from Lehman 

in response to the stress test. Is that an incorrect understanding? 

Mr. BERNANKE. The key word there is ‘‘required.’’ We have no authority to require them to do anything. 

Mr. GARRETT. And did you indicate this to their regulator, that 

their regulator should require that, then, of them? 

Mr. WATT. The gentleman’s time has expired. 

Mr. BERNANKE. I don’t have the exact information that you’re 

asking. 

Mr. GARRETT. If you could, get back to me on that last point. 

Mr. WATT. The gentleman’s time has expired. 

Mr. GARRETT. Thank you. 

Mr. WATT. The gentleman from Kansas, Mr. Moore, is recognized 

for 5 minutes. 

34 

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

Bernanke and former Chairman Volcker, thank you both for your 

testimony this afternoon. And thank you for your public service. 

You both have had to take some very unpopular actions during economic downturns. But I believe without your efforts, which I approve and applaud, and without an independent Fed, I don’t think 

we would be where we are today in our recovery from the financial 

crisis. 

Last year, this committee and the House approved a strong bill 

creating an independent consumer financial protection agency. And 

Senator Dodd’s recent proposal has a truly independent consumer 

financial protection bureau located in the Fed. 

Chairman Volcker, would you support separating safety and 

soundness regulations from consumer protection, so that each can 

focus on one mission and do their job better? Is that something you 

can support, sir? 

Mr. VOLCKER. I think you can separate consumer protection from 

safety and soundness. I think there is some overlap, because some 

of the consumer protection has implications for safety and soundness. But, by and large, I think they are distinct enough so that 

you can separate them, yes. 

Mr. MOORE OF KANSAS. Thank you. And with respect to the Fed’s 

bank supervision powers contained in the Senate’s recent proposal, 

I am concerned that it will turn the Fed’s focus away from smaller 

financial institutions, and focus it only on the largest banks and institutions on Wall Street. Do you share this concern, Chairman 

Bernanke? 

Mr. BERNANKE. Very much so. We value very greatly our connections to small and medium-sized banks. We learn a lot from them. 

We learn a lot about the economy. It keeps us in contact with the 

country, as a whole, and not just Wall Street. And we hope very 

much to retain those connections. 

Mr. MOORE OF KANSAS. Okay, thank you. And if the Senate’s 

proposal became law, what would that mean for community banks, 

smaller financial institutions, and our local economy back in Kansas? Any thoughts there, sir? 

Mr. BERNANKE. The law would give the oversight to the FDIC for 

State member banks, or State banks. But what it would do, from 

our perspective, besides being quite disruptive for both the banks 

and the regulators, what it would do from our perspective is close 

off an important source of information and connection to the broader economy. 

Mr. MOORE OF KANSAS. Thank you. Any thoughts, sir? Mr. 

Volcker? 

Mr. VOLCKER. This is one area where the discussion came up 

earlier as to whether you have one regulator, or there is some 

value in having a variety of regulators. 

There are a lot of small banks. And we now have divided direct 

supervisor authority over them. I think this is one area where it 

is possible to argue that having more than one supervisor is not a 

bad thing. It doesn’t pose the same kind of systemic risk that the 

big institutions do, but there is value to the Federal Reserve, and 

maybe some value in having more than one agency concern there. 

Because the FDIC has a legitimate interest in knowing what’s 

35 

going on among a lot of institutions that it may have to—does provide insurance for. 

Mr. MOORE OF KANSAS. Thank you. Another issue I’m interested 

in is in looking at how we become dependent on debt across the 

board: corporations; consumers; governments; and especially financial firms. 

In a letter to Senators, Tom Hoenig, the president of the Kansas 

City Fed, wrote last month, ‘‘This financial crisis has shown the 

levels to which risk-taking and leveraging can go when our largest 

institutions are protected from failure by public authorities. A stable and robust financial industry will be more, not less, competitive 

in the global economy. Equitable treatment of financial institutions 

will end the enormous taxpayer-funded competitive advantage that 

the largest banks enjoy over the regional and community banks all 

over the country.’’ 

As we think of how overleveraged the largest financial firms became leading up to the crisis that we have experienced, if the Fed 

is disconnected from smaller financial institutions who were not 

overleveraged, and leaving the Fed with nothing to compare to, 

would that hinder the Fed’s supervision of the largest institutions? 

Any thoughts there, Chairman Bernanke? 

Mr. BERNANKE. I think it’s helpful to know what’s going on in 

the whole banking system, because you can learn about the asset 

quality. You can learn about the impact of regulation. And small 

banks can be involved in financial crises, as well. So I think there 

is a lot to be learned from not restricting yourself narrowly to one 

class of institutions. 

And I agree with his basic point, that we have to get rid of ‘‘toobig-to-fail,’’ and that theme has come up today quite a few times. 

We have to have a system where the creditors of—and shareholders of a large organization can take losses when the firm can’t 

meet its obligations. 

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

thanks to both of you for your service to our country. 

Mr. WATT. The gentleman’s time has expired. The gentleman 

from Minnesota, Mr. Paulsen, is recognized for 5 minutes. 

Mr. PAULSEN. Thank you, Mr. Chairman. And I want to thank 

both of you for taking the time to testify here again today. 

Chairman Bernanke, a document that you sent to the Senate 

Banking Committee contains the statement, ‘‘We recognize, of 

course, that bank supervision, including ours, needs to be more effective than in the past. And we have reviewed our performance, 

and are making improvements at multiple levels.’’ 

I just came from a meeting with a bunch of local bankers from 

Minnesota, and they talked about how they have money to provide 

for credit, and they want to lend it out into the market. And their 

overwhelming concern was in regards to the uncertainty or the inconsistency that is being created by the regulators: the OCC, and 

the FDIC. These regulators are being inconsistent in the sense that 

when they come in and visit with the banks, from visit to visit, 

their demands essentially are changing, and they’re preventing 

good loans from being continued or from even being made in the 

first place. 

36 

I know we had a hearing in this committee, along with the Small 

Business Committee just a few weeks back. And I think every single member—nearly every single member—of this committee raised 

this issue. And the FDIC and the OCC responded essentially by 

saying they have told their people in the field to kind of take a step 

back in regard to what is actually happening. But I think there is 

still a disconnect that’s going on. 

And so, I am just wondering, knowing that I met with 30-some 

bankers, and it seems like nothing has really changed in recent 

times regarding the examinations that are going on with the 

banks, what can the Federal Reserve do better to handle this issue 

and create some consistency for the bankers so more credit is available to be put out into the market? 

Mr. BERNANKE. This has been one of our top priorities. It’s very, 

very important. What you need to do here is get an appropriate 

balance, on the one hand, between making sure the banks are safe 

and sound, making good loans. On the other hand, making sure 

that credit-worthy borrowers can get credit, and that the economy 

can grow. 

So we need to find the appropriate balance there, and we have 

done that in a number of ways. We have taken the lead on issuing 

guidance to our examiners and to the banks on small business 

lending, on commercial real estate lending, where the emphasis is 

on finding that appropriate balance. And it’s giving lots of examples to the banks and the examiners, where you can look at the example and it gives you some insight into what criteria to apply 

when you’re looking at a loan. 

And, in particular, one point that we have made repeatedly is 

that just because the asset value underlying a loan, the collateral 

of the loan has gone down, doesn’t mean that it’s a bad loan. Because as long as the borrower can make the payments, that still 

can be a good loan, and we shouldn’t penalize the banks for making 

those loans. 

So, we have issued those guidances, and we have done an enormous amount of training with our examiners to make sure they understand it. We have been gathering information and feedback 

from the field, including asking for more data and more information, but at each of the reserve banks around the country, having 

meetings that bring in small businesses, banks, and community 

leaders, to try and get into the details of what’s going on. 

We have also tried to support the small business lending market 

with our TALF program, which has helped bring money from the 

securities markets into the small business lending arena. So it is 

a very important priority for us. 

We were asked before about the interaction between being responsible for the macro-economy and being a supervisor. Well, here 

is one case where knowing what’s going on in the banking system 

is extremely important for understanding what’s going on in the 

economy broadly. And we take that very seriously. 

So, I realize it’s still an issue. It’s going to be a concern, because 

certainly standards have tightened up. Certainly some people who 

were credit-eligible before are no longer eligible, because their financial conditions are worse. But we really think it’s very imporVerDate Nov 24 2008 12:54 Aug 05, 2010 Jkt 056776 PO 00000 Frm 00040 Fmt 6633 Sfmt 6633 K:\DOCS\56776.TXT TERRIE
37 

tant that credit-worthy borrowers be able to get credit, and we are 

working really hard on that. 

Mr. PAULSEN. Okay. Mr. Volcker, can you add some comments on 

that, based on your history? 

Mr. VOLCKER. I would be glad to add a comment, because I think 

this is an old problem. 

I remember when I was a young fellow writing about the Federal 

Reserve. And the long-standing chairman of the Federal Reserve in 

the 1930’s was one Marriner Eccles, who repeatedly complained in 

the 1930’s, in the midst of the recession, that the other banking— 

the sole responsibility for banking supervision and other agencies— 

they were being too tough because they had had a lot of losses on 

their watch, and they were overreacting, in terms of strict regulations at a time when it was inappropriate, because the economy 

was mired in recession. 

There have been other times when, if you’re just looking at banking regulation, that’s your only responsibility, maybe you’re going 

to be too easy when things are going very well, and the economy 

is on the verge of—you know, the party is getting a little too ebullient. 

I think, really, that the Federal Reserve is in a better position 

to get a balanced regulatory position, regulatory approach, simply 

because they are responsible for monetary policy and responsible 

for business activity, too. That is one of the strengths in keeping 

the Federal Reserve in the regulatory business, in my view. 

Mr. WATT. The gentleman’s time has expired. The gentleman 

from Georgia, Mr. Scott, is recognized. 

Mr. SCOTT. Thank you very much, Mr. Chairman. And welcome 

to both Chairman Bernanke and Chairman Volcker. 

Let me ask you, Chairman Bernanke, as we grapple with this 

whole issue of stripping the Fed of its supervisory authority and 

concentrating on the larger banks only—and I must admit, you 

make a good argument, but I’m torn for this one reason. Let me 

give you an example where there has been a massive failure on the 

part of the Fed, in my opinion, to be able to handle both the big 

banks and the smaller banks. 

I represent the State of Georgia. And in the State of Georgia, 

over the last 36 months, there have been 27 bank failures of these 

smaller banks. And that accounted for 26 percent of all of the bank 

failures in this country, 1 State. 

The issue becomes, where was the Fed in this? Is this not a sign 

of a realization as to why maybe we’re asking too much of the Fed, 

as we move into this new economic climate? And I’m wondering, 

where was the Fed? How did this happen under your watch, where 

1 State accounted for 26 percent of all the bank failures, and over 

a short period of just 36 months, 27 banks failed in 1 State? 

Mr. BERNANKE. Well, I would make two points. The first is, of 

course, that there are multiple regulators. And the question you 

have to ask is where—did the Fed do as good a job as everybody 

else? And I think the answer is, on a national basis, that we have 

done a good job with small and medium-sized banks. 

But we have been actually leaders in this area. Because one of 

the key issues—and particularly in Georgia, particularly for small 

and medium-sized banks, has been commercial real estate. The 

38 

Federal Reserve, back in 2000, took lead in developing some guidance on commercial real estate about not having too much, about 

managing the risk better, about not having too much geographic 

concentration—which has been an issue, I know, in the southeast. 

We got resistance on that, and it took longer to do, and the banks 

resisted. It took longer to get done than it should have taken. 

But that was something that we pushed, and we thought was 

very important. And banks that were particularly careful about 

managing their commercial real estate have done better because 

that has been one of the main risk areas. So, I would say that we 

took those issues into consideration, and did a good job, at least in 

trying to address them. 

Mr. SCOTT. How can you say you did a good job, when the Fed’s 

policy became—made a decision not to examine the books, but to 

allow the banks to examine themselves? That—not to examine 

their portfolios, when we saw that some of these banks had a 78 

percent portfolio just in this real estate? 

So, if there is a problem area here that I have been able to detect, it was in the Fed’s failure to—or willingness, or laxity, whichever, to allow these banks to self-examine, to assess themselves. 

And do you think that, going forward, should continue? Or do you 

not agree that might have been an area where the Fed fell down? 

Mr. BERNANKE. No, I don’t agree with that. We examined the 

banks, and we made sure that they met appropriate capital and liquidity standards. 

Now, it turns out that they should have been tougher. And we 

have done a lot of work, internationally, to strengthen those standards. 

Mr. SCOTT. I have here where—and it might not be with you— 

but the Fed announced that the Fed would no longer directly examine banks’ portfolios, but would instead rely on bank self-examination and self-assessments. 

Mr. BERNANKE. That’s not our policy. 

Mr. SCOTT. So that policy has changed, and this is inaccurate? 

Mr. BERNANKE. It probably relates to the notion of Basel II, and 

the structure of banks using proprietary models as a way of evaluating the risks of some of their positions. Basel II was never implemented, and clearly, it’s very important that whenever models are 

used, that they be closely vetted and closely evaluated. This is 

what we do. 

And again, we are going to be very careful to make sure that 

banks are meeting the appropriate standards. 

Mr. SCOTT. And so, you were aware—or were you not aware— 

that the portfolios of these banks were averaging between 75 and 

80 percent total concentration in real estate? 

Mr. WATT. The gentleman’s time has expired. And I am kind of 

being tough on him, because we have just been called for votes. I 

would like to try to get the other three members who are here, who 

have been here for a while, in. So, if you can respond to that in 

writing, that might be helpful to us. 

The gentleman’s time has expired. And I will now recognize the 

gentleman from Texas, Mr. Marchant, for 5 minutes, and I encourage the members to exercise as much restraint as they can, in an 

effort to get all three members in who are still here, allow us to 

39 

release this panel, and be set to go with the next panel immediately after this series of votes is over. Mr. Marchant? 

Mr. MARCHANT. Thank you, Mr. Chairman. Chairman Bernanke, 

I would like to ask you about the inter-connectedness of Fannie 

Mae, which is owned—the largest shareholder is the United States 

Government in conservatorship. And, arguably, every loan that is 

originated today in Fannie Mae is explicitly guaranteed by the 

Treasury. 

When the mortgage-backed security—when Fannie Mae packages 

the mortgage-backed securities, the Fed is a principal holder of 

mortgage-backed securities. You have $1 trillion with authority, I 

think, to go to $1.25 trillion. 

Fannie Mae, every month, is accruing a loss on the loan that the 

Treasury is making it. And the Treasury is assessing Fannie Mae 

at a rate of 11 percent every month. This loan—and they’re loaning 

Fannie Mae the money to make the interest payment. 

At what point—who exits first? Does Fannie Mae slow its lending 

down, so that the flow of the mortgage-backed securities slows? 

Does the Treasury lower the interest rate to Fannie Mae, so that 

the losses are less? Or does the Fed exit the mortgage-backed security—its holdings in mortgage-backed securities? Which will move 

first? Which part will move first? 

Mr. BERNANKE. First, just very quickly, as Chairman Volcker indicated, the Federal Reserve was very concerned about Fannie and 

Freddie for many, many years. This was an issue that we pointed 

out and noted the moral hazard with the implicit government guarantee. 

My assumption is that sometime soon, the Congress will reform 

Fannie and Freddie, perhaps break them up, perhaps make them 

officially governmental. At that point, then there will have to be 

decisions made about whether the government is going to stand behind their securities and, if so, in what way. 

My assumption is that the mortgage-backed securities, which are 

already outstanding, will be grandfathered, and will retain the U.S. 

Government backing that they currently have. 

So, at some point there will be a change in the structure, and 

there will be no more of the current type of MBS created. But the 

existing MBS, I assume, will be protected until such time as they 

either expire or are purchased back. 

Mr. MARCHANT. A couple of weeks ago, I read that the Treasury 

had sold $200 billion worth of notes, paper, and had deposited that 

with the Fed. And the explanation for that was to provide a liquidity for the Fed, if the Fed decided to begin to liquidate its position 

in mortgage-backed securities. Is that correct? 

Mr. BERNANKE. The Treasury has restored what it had last year, 

which was a $200 billion account at the Fed. We pay interest on 

that account— 

Mr. MARCHANT. Right. 

Mr. BERNANKE. —so that the taxpayer is not losing any money. 

And it has the advantage that it reduces the amount of reserves 

in the banking system for the given amount of mortgage-backed securities that we hold. And that gives us more flexibility as we manage policy, going forward. 

40 

Mr. MARCHANT. And my last question, how does the Fed acquire 

the mortgage-backed securities? Does it acquire them directly from 

the agencies’ auctions? Or do they acquire them as collateral from 

banks that are borrowing against them? 

Mr. BERNANKE. We buy them in the open market. 

Mr. MARCHANT. Okay. Thank you, Mr. Chairman. 

Mr. WATT. The gentleman’s time has expired. The gentleman 

from Kansas City, Mr. Cleaver, is recognized. 

Mr. CLEAVER. I will do this quickly. Thank you very much for 

being here. My district office is 3 blocks from the Kansas City Fed. 

I have gotten to know Tom Hoenig very well. In fact, we flew in 

together on Monday. So I am concerned about some of the regional 

issues. 

And first, Chairman Volcker, here in this post-economic crisis, 

how should the Fed and the regional banks relate? Right now, it 

appears we have two seats of power: the one you lead, Mr. 

Bernanke; and the one in New York. And so, I am concerned about 

what happens to the regional banks. Are we going to emasculate 

them any further? 

How should we, in this moment of reorganization, create the relationship between the Federal Board and the regional banks? 

Mr. VOLCKER. Well, I take off on a basic point that Chairman 

Bernanke has been emphasizing about the importance of the regional banks, in terms not just of information, but in terms of contact with regional financial institutions and regional publics right 

around the United States. It has been a great strength of the Federal Reserve. 

That is anchored, to some extent, in their supervisor responsibilities. Supervisory responsibilities are shared between the Board in 

Washington and the banks. But it’s fundamentally, in the end, the 

responsibility of the Board of Governors in Washington. But it is 

delegated, in substantial part, to the banks. And I think that works 

out to the mutual interest. 

And what you do in terms of parceling out these regulatory responsibilities, supervisory responsibilities, will inevitably bear on 

the point of the organization of the Federal Reserve, if not immediately, over time. And I think it’s something you ought to take 

into account. 

Because for who knows how many years now—95 years almost— 

I think this kind of regional system is clearly controlled at the center here in Washington, but nonetheless has regional participation, 

and has served the country well. It served the independence of the 

Federal Reserve and the credibility of the Federal Reserve, I think, 

through many decades. 

Mr. CLEAVER. So it should remain the way it is now? 

Mr. VOLCKER. Pardon me? 

Mr. CLEAVER. It should remain the way it is now? 

Mr. VOLCKER. Yes. 

Mr. CLEAVER. The relationship. Mr. Hoenig would probably consider this heresy, what I’m about to ask you, Mr. Bernanke. He 

may even jump out of the window if he just knew I asked this 

question. But the regional bank presidents and regional boards 

could be viewed as captive, somewhat as captives, of the regional 

banks industry, since the presidents are chosen by the member 

41 

banks’ directors in the regions. And to break it down, three of the 

regional bank board directors are chosen by the Fed in D.C., and 

three are chosen by regional bank members. 

What would you think of having the three who are chosen by the 

region, chosen by the Federal Board? 

Mr. BERNANKE. To begin with, I just want to make clear that the 

perception of a conflict is more perception than reality. The members of the boards are completely insulated from supervisory decisions, and the presidents are all approved by the Board of Governors in Washington. So the conflict isn’t quite as great as is 

sometimes made out to be. 

That being said, I think we would be open to discussing changes 

of that type that you just described, to try to make sure that everybody understands that the role of those boards, regionally, is to 

represent their area, their broad public, and to give us the feedback 

and information that is provided by banks, but is also provided by 

other folks: community development people; business leaders; and 

so on. And we want a broad representation on those boards. 

Mr. CLEAVER. Really quickly? 

Mr. WATT. You have 5 seconds. 

Mr. CLEAVER. Then, I surrender. 

Mr. WATT. Which you have just lost. The gentleman’s time has 

expired, and I have to go to Mr. Foster from Illinois, as the last 

questioner. 

Mr. FOSTER. Thank you both for waiting around to the end here. 

In the Wall Street Journal’s list of the recommendations for what 

should be done to reform the financial system, the number one recommendation was to improve capital standards, including the incorporation of contingent capital, into the capital structure of large 

financial firms. 

I was the author of the amendment that passed out of this committee, authorizing contingent capital requirements. And I understand it’s being dealt favorably in the Senate proposal, as well. 

So, what I was interested in was what—do you view the role of 

the Fed in administering standards for contingent capital, and possibly administering the stress test that’s often talked about as the 

trigger mechanism for the debt conversion? Do you think that’s an 

appropriate Federal—one that’s likely to happen? 

Mr. BERNANKE. We have a couple of roles. One is the international agreements discussions that take place in developing 

international capital standards, and we have put the contingent 

capital idea on the table, internationally. 

Then, assuming we maintain our consolidated supervision and 

oversight of holding companies, we would be working with the 

functional regulators to develop stress tests at that level. So we 

would be, obviously, very much involved in both the setting of the 

standards, and analyzing whether or not the contingent capital 

should be converted or not. 

We think that’s a very intriguing idea. There are some issues to 

be resolved, and some details to be worked out, but we are looking 

at it pretty actively at the Federal Reserve. 

Mr. FOSTER. Thank you. And, let’s see, countercyclical mortgage 

underwriting standards are being implemented at various levels in 

different countries around the world. And, simply put, what this 

42 

means, when a housing bubble begins to develop, you turn up the 

downpayment that’s required. 

And I guess my first question to Chairman Bernanke is that had 

these type of policies been in place in the previous decade, how effect would they have been at damping down the housing bubble, 

even in the presence of very loose monetary policy? 

And more—and secondly, in respect to the subject of this hearing, would countercyclical underwriting requirements be easier to 

implement in the context of consolidated Fed supervision? 

Mr. BERNANKE. It’s a somewhat speculative question. I can’t give 

you a precise answer. But there are some countries where they are 

using variable LTVs. And I think we have discussed this before. I 

think that’s an interesting idea. And it’s clear that because of piggyback mortgages and other kinds of instruments, loan-to-value ratios got way too high in the United States and, going forward, the 

financial system and the regulators were being much more conservative. 

I think that’s another interesting idea to look at. 

Mr. FOSTER. Yes. I have a concrete proposal that I will get to you 

in writing. I would like your reaction, if possible, in writing afterwards. 

Thank you. I yield back. 

Mr. WATT. The gentleman yields back. I ask unanimous consent 

to insert into the record the Fed’s policy statement entitled, ‘‘The 

Public Policy Case for a Role for the Federal Reserve in Bank Supervision and Regulation.’’ 

Hearing no objection, is is so ordered. 

Mr. WATT. I ask unanimous consent to submit for the record my 

full opening statement. 

Mr. WATT. Hearing no objection—nobody else is here to object— 

it is so ordered. 

We thank both of these distinguished gentlemen for their patience and their time. We will release them, and I will announce 

that as soon as the votes are concluded, we will convene the second 

panel, and we will be back promptly. 

We stand in recess until after the votes. 

[Recess.] 

Mr. WATT. The hearing will reconvene, and I will introduce the 

witnesses. I’m told that Mr. Meltzer has a time constraint in that 

he needs to be on a plane at 6:30. 

Mr. MELTZER. My plane is at 6:30. 

Mr. WATT. Your plane is at 6:30. Okay. So I’m totally happy to 

have you testify first and allow you to leave, if it’s all right, because otherwise, you are not going to make it. So let me quickly 

introduce the witnesses. I will not elaborate on bios so as to save 

time. Our panel consists of: Mr. Anil Kashyap, Edward Eagle 

Brown professor of economics and finance, and Richard N. Rosett 

faculty fellow at the Booth School of Business, University of Chicago; Mr. Allan Meltzer, the Allan H. Meltzer university professor 

of political economy, Tepper School of Business, Carnegie Mellon 

University; Mr. Rob Nichols, president and chief operating officer 

of the Financial Services Forum, which I have had some dealings 

with; and Mr. Jeffrey L. Gerhart, president, Bank of Newman 

43 

Grove, on behalf of the Independent Community Bankers of America. 

And with everyone’s consent, we will allow Mr. Meltzer to go 

first, so he can scoot out the door and catch his flight. Your full 

statements will be made a part of the record, so please summarize 

in 5 minutes, if you can. 

STATEMENT OF ALLAN H. MELTZER, THE ALLAN H. MELTZER 

UNIVERSITY PROFESSOR OF POLITICAL ECONOMY, TEPPER 

SCHOOL OF BUSINESS, CARNEGIE MELLON UNIVERSITY 

Mr. MELTZER. Thank you, Mr. Chairman. Happy St. Patrick’s 

Day. It’s a pleasure to be here again. Both Houses of Congress 

have worked hard to develop means of reducing greatly the risk of 

future financial crises. I believe they have neglected to remove 

completely the two most important causes of the recent crisis. 

First, in my opinion, the disastrous mortgage and housing problem, especially the rules as followed by Fannie Mae and Freddie 

Mac and all recent Administrations. If they had not existed, the 

crisis would not have happened. 

Second, without advance warning, the Treasury and the Federal 

Reserve ended a 30-year policy of ‘‘too-big-to-fail’’ in the midst of 

a recession by letting Lehman fail. 

The first reform, the one that is ignored most is, I believe you 

need to put Fannie Mae and Freddie Mac on the budget the way— 

with a subsidy on the budget. It’s not a question of whether there 

should be a housing and mortgage policy; it’s where it should be 

located. It should not be located as a subsidy through the financial 

markets, subsidies in a well-run democratic country are on the 

budget. 

After the failure, after the mistake of allowing Lehman to fail, 

the Fed acted forcefully, directly, aggressively, and intelligently to 

prevent the failure from spreading. What we want to consider is 

what might be done to avoid a repeat of government policy failure. 

‘‘Too-big-to-fail’’ encouraged some large bankers, to use the word of 

the then-chairman of Citigroup, ‘‘to get up to dance when the music 

was playing.’’ That was a mistake. That mistake, I believe, would 

not have happened if there were not—if he didn’t believe that he 

could take the risks and allow the taxpayers to pay the losses. The 

taxpayers, indeed, paid for the losses. So did he. 

We need a system that protects the public. The current system 

leans toward protecting the banks. It’s important, most important, 

to end ‘‘too-big-to-fail’’ in a way that will work in crises. Regulation 

often fails. We have the examples of Madoff, Stanford, the structured—the SIVs that circumvented the Basel Accord Basel regulated risks. The markets circumvented it. Ask yourselves what happened to FDICIA. This committee, in 1991, passed a rule that said 

we’re going to try to do early intervention before companies fail, before banks fail. It didn’t happen. FDICIA has been missing. Is that 

unusual? No. It’s the common effect of regulation. 

The first law of regulation, my first law of regulation is that bureaucrats, lawyers make regulations. Markets learn to circumvent 

the costly ones. The second law of regulation is regulation is static; 

markets are dynamic. If they don’t figure out how to circumvent 

44 

them at first, they will after a while. That’s what has happened 

very often in the case of regulation. 

So you need to do something. You must regulate, but you have 

to regulate in ways that rely on incentives that affect the way the 

bankers behave. And my proposal is, you want to tie the capital 

standards to the size of the bank. Let the banks choose their size. 

Beyond some minimum size, say $10 billion, for every 1 percent 

they increase their assets, they have to increase their capital by 1.2 

percent. That way, the capital ratio will go up and up and up with 

the size of the bank and that will limit the size of the bank and 

it will put the stockholders and the management at risk. That’s the 

way to prevent failures. 

One other step: If failures occur, markets require something to 

be done about the counterparties. In the 96 years of its history, the 

Fed has never announced or followed a consistent lender of last resort policy. Never. They have never announced it. They have discussed it internally many times. They have never had a consistent 

policy. Congress should insist on a lender of last resort policy and 

it has to be one that the Congress will honor in a crisis. So it 

should negotiate with the management of the Fed to choose a lender of last resort strategy that the Congress is willing to honor. 

Let me say a few other things in my remaining 10 seconds. First, 

the regulators talk about systemic risk, and there’s a systemic risk 

council. No one can define systemic risk in an operational way. You 

and your colleagues will properly say there is a large failure in 

your district. It’s a responsibility to do something about it. That’s 

a systemic risk as far as you’re concerned. Who will decide on systemic risk? The Secretary of the Treasury. Who has been the person most active in bailouts? The Secretary of the Treasury. Therefore, moving to a systemic risk council with the Secretary of the 

Treasury as its chairman is an invitation to continue to do the 

things we have been doing: bailing them out. 

Mr. WATT. Mr. Meltzer, you are putting yourself in systemic risk 

of missing your flight. 

Mr. MELTZER. My time is up. 

[The prepared statement of Professor Meltzer can be found on 

page 88 of the appendix.] 

Mr. WATT. Your time is up, and at least one of our members— 

I don’t have any questions for you, but at least one member has 

a question, maybe two. 

So, Dr. Paul? 

Dr. PAUL. Thank you, Mr. Chairman. And welcome, Dr. Meltzer. 

It’s good to see you. I have a very brief question and I don’t think 

it will take 5 minutes, but I want to follow up on a question I 

asked earlier in the day, and that is, dealing with the flaws of monetary policy and whether or not all we have to do is write regulations to take care of it. 

Most of us recognize the fact that rising prices is a monetary 

phenomenon. Price inflation comes from monetary policy so—but 

not many people, anyway there are not that many economists 

around now who say the solution to price inflation is wage and 

price controls. Most people would say correct the monetary policy. 

But there are other problems with monetary policy, other types of 

consequences from a flawed monetary policy. When that happens, 

45 

is it wise to believe that we can compensate by just having more 

regulators and more regulations to compensate for bad monetary 

policy? 

Mr. MELTZER. No. I mean, monetary policy—I have just completed 15 years of working on the history of monetary policy. If you 

listen—if you ask yourself what are the good years, what are the 

years in which the congressional mandate, which came later, but 

the congressional mandate, which said let’s have low unemployment and low inflation. Well, there’s 1923 to 1928, there are a few 

years in the 1950’s and early 1960’s, and then there’s a period that 

we just went through when they were following, more or less following, the Taylor Rule, and we had for about 15 years, we had low 

inflation and low unemployment. 

The rest of the time, we haven’t had that. So it hasn’t been a 

very successful enterprise, and it needs to be changed. Independence of the Fed began under the gold standard. When the gold 

standard came off, so did the limits on what the Fed could do. Congress needs to do something to replace those standards. It needs 

to legislate something which would say, look, we have told you to 

have low inflation and low unemployment. Now what we want you 

to do is announce and agree with us, or with the Secretary of the 

Treasury or with the President, what you’re going to do over the 

next 2 to 3 years. Tell us what you are going to do, what you are 

going to achieve. If you achieve it, fine. If you don’t achieve it, you 

can offer—you should offer your resignations and an explanation. 

There are lots of valid reasons why you might not achieve it. 

There may be an oil shock, there may be a devaluation of the dollar. A lot of things can happen. The weather may be bad. So then 

Congress can accept the regulation, can accept the explanation, or 

they can accept the resignation, but we need to discipline the Fed. 

Dr. PAUL. Thank you. 

Mr. WATT. Mr. Hensarling is recognized for one question. 

Mr. HENSARLING. Thank you, Mr. Chairman, and I understand, 

Dr. Meltzer, you have to run. Your testimony was very helpful, and 

I certainly could not agree with you more that but for Fannie and 

Freddie and misguided housing policies, this—I believe you said, 

‘‘These actions converted a garden variety recession into worldwide 

crises.’’ And I could not agree with you more. 

My precise question, before you have to leave, is I’m a little uncertain as to precisely what type of lender of last resort policy you 

may be advocating for the Federal Reserve. You state that 13(3) 

should be removed because, I believe, it was used in the AIG case, 

which was institution-specific. So are you advocating a policy of 

clearly articulated standards that would open the discount window 

to non-depository institutions on a pre-stated basis that Congress 

would agree to, or could you elaborate on what you are advocating, 

sir. 

Mr. MELTZER. Yes. First, let me just say about 13(3); 13(3) was 

passed in the Great Depression. It was there to help small and medium-sized borrowers who couldn’t get accommodation, very much 

like some of them now. That was the idea of 13(3). It never was 

very important. The Fed made some loans under 13(3), but not 

very much. It was never intended to be used to bail out something 

46 

like AIG. That’s a complete perversion of the spirit of that legislation. 

What do I mean by a lender of last resort agreed to by the Congress? Well, if you don’t agree to it, it won’t—if Congress doesn’t 

agree to it, it won’t work. That is because you—the pressures on 

the Fed will be just too great. So you have to agree to it, what 

should you agree to. 

There was something called Bagehot’s Rule, which the Bank of 

England used. The Bank of England was an international lender, 

similar to what the United States is now. It had loans all over the 

world. It said, look, if you have good collateral, you can borrow. If 

you don’t, goodbye. They had bank failures, big ones in some cases, 

but no crises. Why? Because the borrowers knew that they had to 

come with collateral and they held collateral. 

We have to go back to a system in which the responsibility is on 

the banker. I want a system where the chairman of the bank goes 

in every morning and says to his number two guy, ‘‘How the devil 

did we get that junk on our balance sheet? Get rid of it at once.’’ 

That way, we’ll have safety and soundness. 

Mr. HENSARLING. Dr. Meltzer, I think the chairman is trying to 

do you a favor. The 5:00 traffic— 

Mr. WATT. I have been trying to do him a favor, and he seems 

to be resisting me doing him a favor. 

Mr. MELTZER. Mr. Chairman, I thank you. 

Mr. WATT. Before you do that, Mr. Meltzer, I do need to make 

you aware that some members may have additional questions for 

you, and other members of this panel, that they may wish to submit in writing. Without objection, the hearing record will remain 

open for 30 days for members to submit written questions to these 

witnesses and to place their responses in the record. So we may be 

following up with you with written questions. 

Mr. MELTZER. Of course. 

Mr. WATT. You are excused unless you have something else. 

Mr. MELTZER. No. I just want to thank you for your forbearance. 

Mr. WATT. Okay. Well, I hope you make your flight. 

Now, we will recognize Professor Kashyap. 

STATEMENT OF ANIL K. KASHYAP, EDWARD EAGLE BROWN 

PROFESSOR OF ECONOMICS AND FINANCE, AND RICHARD N. 

ROSETT FACULTY FELLOW, BOOTH SCHOOL OF BUSINESS, 

UNIVERSITY OF CHICAGO 

Mr. KASHYAP. Thank you, Chairman Watt, and members of the 

committee. Besides my affiliation at Chicago Booth, I want to mention I’m also a member of the Squam Lake Group, since I’m going 

to tout a couple of their recommendations. Today, I’m going to consider whether and how the Fed supervisory role should change by 

considering three specific questions. 

First, I want to ask how the most costly mistakes in the United 

States regarding individual institutions might have differed if the 

Fed had been stripped of its supervisory powers; second, I want to 

review the U.K. evidence where the Central Bank was not involved 

in bank supervision and ask if those outcomes were particularly 

good; and third, time permitting, I’ll look at the overall financial 

system and ask what might have been done to protect the whole 

47 

system better. I’m going to skip large parts of my written testimony, but I would be happy to take up questions about that. 

So let’s look at the biggest individual supervisory failures. As has 

already been mentioned here today, by far the most expensive rescue was for Fannie and Freddie. CBO’s latest estimates put the 

costs to the taxpayer at over $200 billion and the problems of these 

institutions were well known, and as Chairman Bernanke indicated, the Fed was testifying as early as 2004 about the risks that 

they posed. So it seems hard to put the blame for these two on the 

Fed. 

The next most expensive rescue was for AIG. The cost of this intervention was estimated at probably upwards of $30 billion. In 

this case, the Fed wrote the check for the rescue, and the Fed actions, particularly regarding the transparency around the transaction, have been legitimately and heavily criticized. AIG’s primary 

regulator was the Office of Thrift Supervision, which had absolutely no experience in understanding what was happening inside 

AIG Financial Products. 

So when the decisions that had to be made about AIG were 

taken, the Fed was flying blind. Chairman Bernanke has said the 

AIG case causes him the most trouble of anything that happened 

in the crisis, and I think it also provides the best example of why 

stripping the Central Bank of its supervisory authority would likely 

make problems, such as AIG, more probable in the future. 

No one thinks it’s possible to have a modern financial economy 

without a lender of last resort facility. So let me offer an analogy. 

As a lender of last resort, you’re never sure who is going to come 

through the door and ask for a date. When your date shows up on 

Friday night and it’s AIG, the question at hand is, would you like 

to know something about them or would you rather have to pay 

$85 billion to buy them dinner. If we mandate that the Fed is not 

involved in supervision, then we make hasty, uninformed decisions 

inevitable whenever the lender of last resort has to act. 

The third most expensive rescue is likely to turn out to be Bear 

Stearns. Here again the primary regulator, in this case the SEC, 

was clueless about what was going on as Bear’s demise approached. The Fed crossed the rubicon in this rescue, but as with 

AIG, it was forced to act on short notice with very imperfect information about Bear’s condition and with no supervisory authority to 

shape the outcome. 

Whatever the criticisms one wants to make about the Fed’s actions regarding Bear Stearns, the problems didn’t come because of 

incompetent Fed supervision of Bear. If anybody wants to ask 

about Citigroup, we could talk about that as well. That is a case 

where the Fed had direct responsibility. 

My point in reviewing these cases is not to absolve the Fed. As 

we say in this town, plenty of mistakes were made. But I think this 

quick summary shows that if another supervisor had taken over 

the Fed’s responsibilities, the U.S. taxpayer still would be on the 

hook for billions of dollars. 

One obvious objection to the way I have been reasoning is that 

I took the rest of the environment as given in contemplating a supervisory system without the Central Bank. Perhaps if the Fed had 

been out of the picture, other supervisors would have stepped in 

48 

and built a better system. Here the lessons of the United Kingdom 

are particularly informative. 

The U.K. has deep financial markets with many large financial 

institutions and London is a financial center. The U.K. separated 

the Central Bank from supervision in the 1990’s and set up a separate organization—the Financial Services Agency—to focus on bank 

supervision. The agreement that was reached required the treasury, the Central Bank, and the FSA to agree on any rescues. 

The first real test of this system came when Northern Rock got 

into trouble. The management of Northern Rock notified the FSA 

of its problems on August 13, 2007; the Bank of England found out 

the next day. It took over a month of haggling between the Bank 

of England, the treasury, and the FSA to decide what to do before 

the Bank of England eventually announced its support for Northern Rock. Even that support was not enough to prevent a run, and 

the first failure related to a run in the U.K. since 1866. 

While the distribution of blame is debated, there is complete 

agreement that the situation was mismanaged and the lack of coordination was important. Besides Northern Rock, several other 

large British banks, including Lloyd’s and Royal Bank of Scotland, 

required government assistance in the United Kingdom. The total 

taxpayer burden from these interventions is guesstimated as being 

about 20 to 50 billion pounds. 

I expect that if we formed a council to oversee the U.S. financial 

system, we would arrive at the same arrangement as in the U.K. 

In particular, it would rely on consensus, and information sharing 

amongst the different agencies would be poor. The events in the 

U.K. suggest when this system was actually adopted, it didn’t 

work. And I see no reason to expect it would work in the United 

States. 

So, what should we do? Well, the problems with the existing regulatory structure go far beyond the question of which organizations 

do the supervision of individual institutions. The gaps in supervisory coverage were critical. The fact that institutions could 

change regulators if the regulator became too tough is appalling, 

and that let the risks in the system grow for no good reason. 

But the crisis has also shown us that while there were many 

sources of fragility, nobody was watching the whole financial system. And when individual regulators did see problems, they were 

often powerless to do anything about them. Thus, a critical step in 

reforming regulation must be the creation of a systemic risk regulator that is charged with monitoring the whole financial system. 

The regulator must have the authority and tools to intervene to 

preserve the stability of the system. 

I know Mr. Watt’s subcommittee held some very nice hearings in 

July on exactly this issue, and the lack of progress on this front 

is disappointing. But even with a vigilant systemic risk regulator, 

it seems likely that most of the problems in the crisis would have 

appeared anyway. 

The Squam Lake Group has argued that the cost of the AIG rescue could have been substantially reduced if we had a package of 

reforms. And this package would have included: one, just designating the Fed as systemic risk regulator; two, increasing the use 

of centralized clearing of derivatives; three, creating mandatory livVerDate Nov 24 2008 12:54 Aug 05, 2010 Jkt 056776 PO 00000 Frm 00052 Fmt 6633 Sfmt 6633 K:\DOCS\56776.TXT TERRIE
49 

ing wills for financial institutions and bolstering resolution authority; four, changing capital rules for systemically important institutions; five, improving the disclosure of trading positions; and six, 

holding back pay at systemically relevant institutions. I would be 

glad to discuss this in the question-and-answer period. 

I just want to close with one last thought, which is I don’t want 

to sound like I think that the Fed has a role or comparative advantage in all types of financial regulation, and I want to reiterate the 

Squam Lake Group’s recommendation to get the Fed out of the 

business of consumer protection regulation. This is a case where 

there are very few synergies between the staffing requirements of 

consumer protection and other essential Central Bank duties. The 

Fed would be far better off handing off these duties to another regulator. Thank you. 

[The prepared statement of Professor Kashyap can be found on 

page 80 of the appendix.] 

Mr. WATT. Thank you very much for your testimony. 

Next, Mr. Nichols of the Financial Services Forum. 

STATEMENT OF ROBERT S. NICHOLS, PRESIDENT AND CHIEF 

OPERATING OFFICER, THE FINANCIAL SERVICES FORUM 

Mr. NICHOLS. Chairman Watt, Ranking Member Paul, thank you 

for the opportunity to participate in today’s hearing, to share our 

views regarding the Federal Reserve, and specifically, the relationship of supervisory authority to the Central Bank’s effective discharge of its duties as our Nation’s monetary authority. 

By way of background, the Financial Services Forum is a nonpartisan financial and economic policy organization comprised of 

the chief executives of 18 of the largest and most diversified financial institutions doing business in the United States. Our aim is to 

promote policies that enhance savings investment in a sound, open, 

competitive financial services marketplace. Reform and modernization of our Nation’s framework of financial supervision is critically 

important. We thank you, Mr. Chairman, Ranking Member Paul, 

and all the members of this committee for all of your tireless work 

over the past 15 months. 

To reclaim our position of financial and economic leadership, the 

United States needs a 21st Century supervisory framework that is 

effective and efficient, ensures institutional safety and soundness, 

as well as systemic stability, promotes the competitive and innovative capacity of our capital markets, and protects the interests of 

depositors, consumers, investors, and policyholders. 

In our view, the essential elements of such a meaningful reform 

are enhanced consumer protections, including strong national 

standards, systemic supervision ending once and for all ‘‘too-big-tofail,’’ by establishing the authority and procedural framework from 

winding down any financial institution in an orderly non-chaotic 

way in a strong, effective, and credible Central Bank, which in our 

view requires supervisory authority. 

On the 11th of December, your committee passed a reform bill 

that would preserve the Federal Reserve’s role as a supervisor of 

financial institutions. On Monday of this week, Chairman Dodd of 

the Senate Banking Committee released a draft bill that would asVerDate Nov 24 2008 12:54 Aug 05, 2010 Jkt 056776 PO 00000 Frm 00053 Fmt 6633 Sfmt 6633 K:\DOCS\56776.TXT TERRIE
50 

sign supervision of bank and thrift holding companies with assets 

of greater than $50 billion to the Fed. 

While we think that it is sensible that the Fed retains meaningful supervisory authority in that bill, we also believe the Fed and 

the U.S. financial system would benefit from the Fed also having 

a supervisory dialogue with small and medium-sized institutions, a 

point which is well articulated by Jeff Gerhart in his testimony. 

You will hear from him in a moment. 

As this 15-month debate regarding the modernization of our supervisory architecture has unfolded, some have held the view that 

the Fed should be stripped of all supervisory powers, duties which 

some view as a burden to the Fed and distract the Central Bank 

from its core responsibility as the monetary authority and lender 

of last resort. Mr. Chairman, we do not share that view. Far from 

a distraction, supervision is altogether consistent with and supportive of the Fed’s critical role as the monetary authority and 

lender of last resort for the very simple and straightforward reason 

that financial institutions are the transmission belt of monetary 

policy. 

Firsthand knowledge and understanding of the activities, condition and risk profiles of the financial institutions through which it 

conducts open market operations, or to which it might extend discount window lending, is critical to the Fed’s effectiveness as the 

monetary authority and lender of last resort. It must be kept in 

mind that the banking system is the mechanical gearing that connects the lever of monetary policy to the wheels of economic activity. If that critical gearing is broken or defective, monetary policy 

changes by the Fed will have little, or even none, of the intended 

impact on the broader economy. 

In addition, in order for the Federal Reserve to look across financial institutions and the interaction between them and the markets 

for emerging risks, as it currently does, it is vital that the Fed have 

an accurate picture of circumstances within banks. By playing a 

supervisory role during crises, the Fed has a firsthand view of 

banks, is a provider of short-term liquidity support, and oversees 

vital clearing and settlement systems. 

As former Fed Chairman Paul Volcker observed earlier this 

afternoon, monetary policy and concerns about the structure and 

condition of banks and the financial system, more generally, are inextricably intertwined. While we don’t see eye-to-eye with former 

Chairman Volcker on everything, we sure do agree with him on 

that. 

As Anil Kashyap noted, U.S. policymakers should also be mindful 

of international trends in the wake of financial crisis. In the United 

Kingdom—I’ll point to the same example as Anil—serious consideration is being given to shifting bank supervision back to the Bank 

of England, which had been stripped of such powers when the FSA 

was created in 2001. It has been acknowledged that the lack of supervisory authority and the detailed knowledge and information derived from such authority likely undermined the Bank of England’s 

ability to swiftly and effectively respond to the recent crisis. 

Thank you for the opportunity to appear before you today. 

[The prepared statement of Mr. Nichols can be found on page 96 

of the appendix.] 

51 

Mr. WATT. Thank you for your testimony. 

Finally, Mr. Gerhart is recognized. 

STATEMENT OF JEFFREY L. GERHART, PRESIDENT, BANK OF 

NEWMAN GROVE, ON BEHALF OF THE INDEPENDENT COMMUNITY BANKERS OF AMERICA (ICBA) 

Mr. GERHART. Chairman Watt and members of the committee, I 

am Jeff Gerhart, president of the Bank of Newman Grove in Newman Grove, Nebraska. I’m also a former director of the Federal Reserve Bank of Kansas City. The Bank of Newman Grove is a State 

member bank supervised by the Federal Reserve with $32 million—that’s ‘‘M’’ in million, not ‘‘B’’ in billion—in assets. Our bank 

was founded in 1891, and I’m the fourth generation of my family 

to serve as the bank’s president. 

Newman Grove is an agricultural community of 800 in the rolling hills of northeast Nebraska. Our bank works hard to ensure 

Newman Grove is a vibrant community through loans to our local 

farmers, small businesses, and consumers. I am pleased to testify 

on behalf of the Independent Community Bankers of America and 

its 5,000 community bank members nationwide at this important 

hearing to link the Fed’s examination—or supervision of monetary 

policy. 

Some in Congress have proposed that the Federal Reserve’s supervision of State member banks be eliminated and that a supervision over holding companies be eliminated or limited to the very 

largest companies. Although the primary responsibility of the Federal Reserve is to conduct monetary policy, the ICBA opposes separating the Federal Reserve’s monetary policy role from its role as 

financial supervisor. For decades, the Federal Reserve has played 

a critical role in the banking regulatory system as a supervisor of 

State member banks and holding companies. 

ICBA believes the local nature of the regional Federal Reserve 

banks, working in harmony with State bank regulators, gives them 

a unique ability to serve as a primary regulator for State member 

banks, the vast majority of which are community banks serving 

consumers and small businesses. This, in turn, gives the Federal 

Reserve an efficient means for gauging the soundness of the banking sector, information that is critical to developing and implementing sound monetary policy. 

Federal Reserve Chairman Bernanke recently testified that the 

Federal Reserve’s supervision of community banks gives the Fed 

insight into what has happened at the grass roots level to lending 

and to the economy. This is particularly true with respect to the 

vital small business sector. While community banks represent 

about 12 percent of all bank assets, they make 40 percent of the 

dollar amount of all bank small business loans under a million dollars. The Federal Reserve monetary policy is to promote this important sector of the economy. The Federal Reserve’s supervision of 

community banks must be maintained. 

In addition, regulation of community banks gives the Federal Reserve a window on the vast array of local economies served by community banks, many of which are not served by any larger institutions at all. The inside gain from the supervision of State member 

banks and holding companies, both large and small, allows the 

52 

Federal Reserve to identify disruptions in all sectors of the financial system in order to meet its statutory goal of ensuring stability 

of the financial system. 

The record shows the Federal Reserve has been a very effective 

regulator of community banks, and this role should be preserved. 

ICBA is very concerned that limiting the Federal Reserve’s oversight to only the largest or systemically dangerous holding companies could lead to a bias and favor the largest financial institutions. 

This is a risky approach to financial reorganization and a path that 

the United States should not go down. 

The Federal Reserve Bank of Kansas City, the Federal supervisor of my bank, brings to its bank supervisory role a highly regarded expertise in the agricultural economy. The Federal Reserve’s expertise in agriculture enhances its ability to supervise 

Midwestern community banks like mine with a significant ag loan 

portfolio. It would be a mistake to remove the Federal Reserve’s 

economic expertise from the country’s financial supervisory structure. 

Having multiple Federal agencies supervising depository institutions provides valuable regulatory checks and balances and promotes best practices among those agencies. The contributions and 

views of the Federal Reserve have been an important part of this 

regulatory diversity, which would significantly be diminished if the 

Federal Reserve were stripped of all or most of its supervisory authority. 

I want to thank you for inviting me here today, and I would be 

glad to answer any questions. 

[The prepared statement of Mr. Gerhart can be found on page 73 

of the appendix.] 

Mr. WATT. Thank you for your testimony. 

Mr. Foster has been so patient and diligent. He has been here 

the whole time. I think I’m going to reward him by recognizing him 

first for 5 minutes to ask questions. 

Mr. FOSTER. Well, thank you. Let’s see. My first question, briefly, 

if you could all three comment on where you are on the discussion 

that was touched on with Chairman Bernanke about whether it 

was monetary policy or regulatory failure that was responsible for 

the crisis we have just gone through. So just go down in order, if 

you could. 

Mr. KASHYAP. Many more regulatory problems, I mean, the 

banks ate their own cooking. You have to remember the most financially sophisticated banks ended up sitting on these AAA subprime securities that ended up coming back to haunt them. And I 

think if we had somebody looking out across the system seeing 

those concentrations of risks and being able to adjust things like 

loan to value ratios in the housing market and also haircuts and 

margins on those securities, you would not have the deleveraging 

that I think was so dangerous. 

Mr. FOSTER. Thank you. 

Mr. NICHOLS. Congressman Foster, I think it was a perfect storm 

of activities, activities, conditions, behaviors, failures, in a lot of 

places. So like Chairman Bernanke pointed to two or three different factors, I even think it’s broader than that. Certainly, the industry played a role in terms of internal controls and risk manageVerDate Nov 24 2008 12:54 Aug 05, 2010 Jkt 056776 PO 00000 Frm 00056 Fmt 6633 Sfmt 6633 K:\DOCS\56776.TXT TERRIE
53 

ment; lack of mortgage origination standards; the role of credit rating agencies; even our trade imbalance, a lot of money coming in 

for yield, interest rate policy. There was a perfect storm of failures. 

People were overleveraged. Some Americans bit off more than they 

could chew. It was really—I don’t think you could just point to one 

thing that led to the housing bubble. There were a lot of accelerates and a lot of contributors to it, but it’s a dozen different factors 

all intertwined, in my humble opinion. 

Mr. FOSTER. Thank you. 

Mr. GERHART. Would you be kind enough to repeat the question? 

Mr. FOSTER. Where are you on the debate over the extent to 

which monetary policy was responsible for the crisis we just went 

through versus regulatory failure? 

Mr. GERHART. Honestly, that is not an area as a day-to-day 

banker that I dwell on very often. So I would respectfully take a 

pass on that. Thank you. 

Mr. FOSTER. Okay. Let’s see. I guess I would like to first make 

a couple comments on the Squam Lake Group, which actually led 

me to discover the concept of contingent capital, which I thought 

was one of the really positive lessons that I think we’re going to 

carry out of this. And I was wondering what the status of work in 

the academic sector is on contingent capital or on the commercial 

sector. Is there a baseline implementation that people are talking 

about? Are there ongoing series of conferences? What is the actual 

status of that concept besides sort of secret deliberations in the 

Federal Reserve? 

Mr. KASHYAP. Well, I pointed a member of your staff earlier 

today towards one working paper I know that has been written on 

this, but I think there is still active discussion over what the trigger should be. I understood your question to Chairman Bernanke 

to be asking whether or not should there be a regulatory trigger 

that would convert the debt. Was the Fed to be the regulator to 

pull the trigger? I don’t think that’s the way he answered it, but 

that’s what I thought you were asking. 

I know that the rating agencies have said that if that trigger is 

enacted, they may not be willing to rate the debt. So there has 

been some discussion about what other triggers could be used with 

convertible debt that would still preserve the features that would 

add to the loss bearing capacity of the debt, but maybe not prevent 

rating agencies from being able to assess the risk. So that’s one 

area. But generally, I think, there’s a holding pattern until some 

of the regulatory bodies, namely the Financial Stability Board in 

Basel, come out with their assessments, which I understand to be 

coming soon. 

Mr. FOSTER. And I understand a couple of European banks have 

actually issued some of those what they call CoCo securities? 

Mr. KASHYAP. Yes. Well, the first issue was a U.K. bank, but 

that was a bank that was under the control of the British government. And so there was some skepticism as to whether those terms 

were indicative and informative. I’m not sure if any continental 

banks have issued any in the last month or two, but— 

Mr. FOSTER. Okay. So as of yet, you don’t think there is any relevant market experience with them. 

54 

Mr. KASHYAP. No. There were actually some issued in Canada in 

around 1999, but ironically, the Canadian regulators decided it 

shouldn’t count as capital. So it was done on a small scale and they 

were ready to issue it en masse, and they couldn’t get the regulatory treatment they needed. 

Mr. FOSTER. Okay. Thank you. I yield back. 

Mr. WATT. I thank the gentleman for being here all day, and for 

his good questions. 

I recognize myself for 5 minutes. I have to apologize for Mr. Paul 

having to leave. He had another commitment. 

Mr. Gerhart, I know the hearing today is about the Fed’s supervisory role and the impact it has on monetary policy, but from your 

perspective as the supervised bank, could you tell me how your life 

would change if your supervisor were the FDIC or the OCC or 

somebody other than the Fed, as you perceive it? 

Mr. GERHART. I have been a national bank. So I have been examined and supervised by the Comptroller of the Currency. We converted to a State charter in 2005, made the choice that we would 

like to remain a Fed member bank, so we applied with the Nebraska Department of Banking and Finance, along with the Federal Reserve Bank of Kansas City, and that is who our regulators 

are. What it does is it takes away from the dual banking system 

if you remove the Federal Reserve system from regulating us. They 

are— 

Mr. WATT. I understand that from— 

Mr. GERHART. Okay. 

Mr. WATT. —the bank’s—from the Fed’s side. But from your perspective, what difference would it make? 

Mr. GERHART. Well, it takes away choice because right now, I 

have a choice. Do I want to have the FDIC? Do I want to have the 

Federal Reserve Bank? I can pick one of the two, which both do a 

good job. A State member bank either has a choice of remaining 

with just the FDIC as their other Fed regulator or they can choose 

the Federal Reserve. So taking away choices is very important. Or 

I could go back to being a national bank and apply for a national 

bank charter. 

So that’s extremely important. I can tell you, honestly, in fact, 

we just had an examination last week. The Fed is extremely thorough, the State is extremely thorough, and the OCC was extremely 

thorough. They look under every rock, and we are very well supervised in my book. 

Mr. WATT. I don’t have any question about that. I’m just trying 

to figure out what, I mean, what difference would it make to you, 

other than you wouldn’t have a choice between the Fed and some 

other regulator. Would the level of regulation and supervision be 

any different as you perceive it? 

Mr. GERHART. Well, taking away choices is a pretty big— 

Mr. WATT. I understand that. 

Mr. GERHART. Okay. 

Mr. WATT. But would the level of supervision and regulation be 

any different if you had a different regulator? 

Mr. GERHART. I think it could be. 

Mr. WATT. How so? 

55 

Mr. GERHART. If I go back to my days as a national bank, those 

folks, the Comptroller’s office, did a good job, but having the State 

as our—one of our regulators allows me to have somebody that is 

a little bit better fit, a little bit more in tune with rural agricultural economy. And I think that goes along with our choice for the 

Federal Reserve Bank of Kansas City. Their tenth district encompasses a lot of agriculture. And again, it was an option, and it gives 

us a good choice, and I think that needs to remain out there. I 

don’t— 

Mr. WATT. Do you have a particular position on the consumer financial protection agency, whether it should exist, and if so, where 

it should exist. 

Mr. GERHART. We would like to see that at $10 billion or above, 

and if there’s a cutoff for the community banks, we feel like we’re 

very well taken care of protecting consumers for all the products 

that come out. And for the most part, it wasn’t community banks 

that had products to their consumers that people got in trouble 

with. 

Mr. WATT. You’re nicely avoiding my question. Do you have an 

opinion of whether it should exist? 

Mr. GERHART. It could exist. 

Mr. WATT. Regardless of who—I mean, I assume you’re saying it 

doesn’t—it really wouldn’t have any impact on your bank because 

you wouldn’t be under the House bill; we exempted you. But— 

Mr. GERHART. We may be exempt, but I think in the end, yes, 

it will have some impact as far as that goes. And we’re certainly 

comfortable— 

Mr. WATT. I need your opinion on whether it should exist, and 

if so, where it should exist. 

Mr. GERHART. In the Fed. 

Mr. WATT. And if now, why it shouldn’t exist. 

Mr. GERHART. In the Fed or the FDIC, but it should—it needs 

to be fair to everybody. 

Mr. WATT. But you do think there is a need for a consumer financial protection agency somewhere. 

Mr. GERHART. Somewhere. 

Mr. WATT. Okay. All right. 

Mr. Nichols, what’s your opinion on the CFPA and where it 

should exist, whether it should exist? 

Mr. NICHOLS. Sure, Mr. Chairman. We are—as we have discussed before—in heated agreement with you that we need to enhance consumer protections. I think among the many, many, many 

lessons learned from the crisis, that’s certainly one of them. 

We are—I mean, our view, candidly, is that probably tethering 

the enhanced consumer protections with the safety and soundness 

a prudential regulator does—is sensible. We’re interested to learn 

more about the proposal that’s being—that was unveiled a couple 

of days ago. So but with regard to the overall goal of enhancing 

consumer protections, as identified in this testimony, that’s a critical, critical issue that we think absolutely has to happen. 

Mr. WATT. You haven’t—you are giving me trouble getting you 

pinned down on this issue. 

You have been pretty direct about this, Professor. In your oral 

testimony, you said that you did not really think it had any parVerDate Nov 24 2008 12:54 Aug 05, 2010 Jkt 056776 PO 00000 Frm 00059 Fmt 6633 Sfmt 6633 K:\DOCS\56776.TXT TERRIE
56 

ticular reason that it needed to be in the Fed and they ought to 

jettison it. Elaborate on your position on that, if you would. 

Mr. KASHYAP. Well, first of all, I think some aspects of it are inherently politicized. And the Fed has enough political troubles, as 

we have seen from the questions and answers today, I don’t see 

why they need to be borrowing other issues to be testifying about 

and arguing with when it’s not central to being the Central Bank. 

There is no synergy between deciding whether or not a mortgage 

is abusive or a credit card shouldn’t be able to have certain addon fees and deciding anything about monetary policy or deciding 

anything, frankly, about the stability of the financial system. 

Mr. WATT. Where would you put it and what authority would you 

give it? 

Mr. KASHYAP. I don’t have a strong view as to whether it needs 

to be completely independent or it could go into another agency. I 

think whoever is supervising that staff has to be accountable to 

Congress and should be a specialist. Like Chairman Volcker said, 

maybe the Fed should have a vice chairman for financial stability. 

If this was to go into another organization, I think there should be 

a special designee to sit on top of it and have to come to talk to 

you. But whether it should be set up from scratch, I don’t know. 

I think the staff would largely be lawyers. And that’s another 

reason why the culture of the Fed is more one of economists. There 

is no reason to put the two together. So I would house it in an organization where you can get the right staff and where they are 

going to be suitably accountable. 

Mr. WATT. Mr. Nichols, if you tethered it, as you said, with the 

supervisory agency, how would you avoid the potential of three inconsistent consumer protection attitudes if you had three different 

supervisory agencies? 

Mr. NICHOLS. Well, that’s the key question. One of the things 

that policymakers have been grappling with, and we are grappling 

with ourselves, is how do you deal with, if there is a—how do you 

come up with a reconciliation mechanism between the safety and 

soundness regulator and the consumer protections? So I don’t know 

today precisely how— 

Mr. WATT. I’m dwelling on how you reconcile the three consumer 

protection agencies now, not even the safety and soundness part of 

it, if you have three different consumer protection agencies: one at 

FDIC; one at the Fed; and one at the OCC. How would you avoid 

having three different consumer protection standards, aside from 

the safety and soundness aspects of it? 

Mr. NICHOLS. Right. Well, we think—well, with regard to—first, 

one thing. With regard to national standards, we actually think we 

should come up with—during this policymaking process, it’s probably a sensible thing to come up with a strong national standard 

with regard to consumer protection. So that is one—that is a side 

issue, but one that is probably worth sharing. 

But I do think part of it, when—your specific question with regard to the individual regulators and the consumer protections 

housed within them, you know, obviously, for example, what is 

happening at the SEC, the products that are overseen by the SEC 

are a little different at times and within the banking regulator. So 

I think the fact that you do have— 

57 

Mr. WATT. Now Mr. Gerhart just told me, you know, yes, but supervisors are a little bit different for financial institutions. You 

have banks and you have banks. They are not securities. Why 

would you have three different consumer protection agencies? 

Mr. NICHOLS. Well, I wouldn’t propose having three different 

agencies. I’m just thinking—I’m suggesting just tethering them, if 

that makes sense. 

Mr. WATT. I don’t know what you mean by tethering. That is 

why I asked the question. I thought you were saying if you needed 

to tether them to their—to the particular regulator, which would 

mean to me, if I’m reading what you say correctly or if I’m understanding what you say correctly, you would have one tethered to 

the FDIC, one tethered to the Fed, and one tethered to the OCC. 

That is three different regulators. How would—maybe I don’t understand the word ‘‘tethered.’’ 

Mr. NICHOLS. I’m sorry. I’m doing my best to answer your question. I do think pairing them makes sense. And so is your question 

to me is, will you have inconsistent standards if you have different 

groups of different regulators? 

Mr. WATT. Yes. How can you avoid that if you have three different tethered— 

Mr. NICHOLS. Right. One idea— 

Mr. WATT. —consumer protection? 

Mr. NICHOLS. One idea that was explored in this body is to have 

a council of, you know, an office—a council of consumer protection 

offices within the different regulatory bodies that would perhaps 

report to Congress, directly to you, that they would share best 

practices, that they would gather together and talk about and communicate and coordinate and consult with one another to see 

what’s happening. 

Walt Minnick from Idaho had a concept that was obviously debated before this body—and I think there was some merit to that— 

which would get directly to your question. Sorry I didn’t hit on it 

earlier. 

Mr. WATT. Why would you do that with consumer protection and 

not do it with safety and soundness? You have the FDIC. You have 

the Fed responsible for safety and soundness of Mr. Gerhart’s 

bank, the FDIC dibbling and dabbling in safety and soundness 

with respect to his bank. The OCC is not dibbling and dabbling in 

safety and soundness with respect to his bank. Why would you 

want two different agencies dibbling and dabbling in the consumer 

protection part of it? 

Mr. NICHOLS. Well, to some extent, on safety and soundness, that 

proposal is being considered. Both this—both your body, as well as 

the Senate, are talking about proposing the creation, which I think 

is a sensible idea, of a systemic stability council. 

Mr. WATT. That’s the great big guys. I’m talking about the smaller banks. For systemic people, you are looking across a whole array 

of financial institutions. You are big enough to have a significant 

adverse systemic impact on the whole economy. I have jumped 

across that hurdle. I’m talking about the guys that don’t fall into 

the systemic risk category. Why would you set up a different standard when it comes to consumer protection than the standard you 

would apply to safety and soundness? 

58 

Mr. NICHOLS. I take your question, Congressman, and I would be 

glad to get back to you on a further answer. I just— 

Mr. WATT. Okay. I mean, these are not trick questions. 

Mr. NICHOLS. Sure. 

Mr. WATT. At every hearing, I have been very transparent in 

what I have said. I want a consumer protection agency that is just 

as robust, just as independent as the safety and soundness people. 

I think that is what the consumers deserve. And if you are going 

to make compromises on consumer protection, then those same 

compromises ought to be considered for the safety and soundness. 

I’m not suggesting that, but I think it’s the—you know, I’m good 

with Mr. Gerhart having only one safety and soundness regulator, 

but I don’t know why we would set up a three-party consumer protection agency, if we’re not setting up a three-party safety and 

soundness person. It seems to me that would just signal to the public that we are treating consumer interest as second-class, and I 

think it sends the wrong signal. 

Mr. NICHOLS. I do agree with you that we cannot send a signal 

that consumer protections are not utterly, utterly important. 

Mr. WATT. Think about it. I’m well over my time. Of course, nobody is objecting, except the staff who want to go home. So I’m delighted to have all of you here. I really apologize that we got caught 

in a bind and you had to be here all day and—but that is the cost 

of doing business, or whatever it is called. 

The Chair notes that some members may have additional questions for this panel, which they may wish to submit in writing. 

Without objection, the hearing record will remain open for 30 days 

for you to respond to in writing, if you would like, to this question 

that I posed to you, and for other members to submit written questions to these witnesses and to place their responses in the record. 

I thank you all so much for your patience and for your persistence and for being here, and the hearing is adjourned. 

[Whereupon, at 5:55 p.m., the hearing was adjourned.] 

(59) 

A P P E N D I X 

March 17, 2010 

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