MODERNIZING THE U.S. FINANCIAL REGULATORY SYSTEM 

S. HRG. 111–42 

MODERNIZING THE U.S. FINANCIAL 

REGULATORY SYSTEM 

HEARING 

BEFORE THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED ELEVENTH CONGRESS 

FIRST SESSION 

ON 

THE GOVERNMENT ACCOUNTABILITY OFFICE’S FRAMEWORK FOR ASSESSING PROPOSALS TO MODERNIZE THE U.S. FINANCIAL REGULATORY SYSTEM AND THE GROUP OF 30’s RECENT REPORT ON CREATING A FRAMEWORK FOR FINANCIAL STABILITY 

FEBRUARY 4, 2009 

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50–564 PDF 2009

S. HRG. 111–42 

MODERNIZING THE U.S. FINANCIAL 

REGULATORY SYSTEM 

HEARING 

BEFORE THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED ELEVENTH CONGRESS 

FIRST SESSION 

ON 

THE GOVERNMENT ACCOUNTABILITY OFFICE’S FRAMEWORK FOR ASSESSING PROPOSALS TO MODERNIZE THE U.S. FINANCIAL REGULATORY SYSTEM AND THE GROUP OF 30’s RECENT REPORT ON CREATING A FRAMEWORK FOR FINANCIAL STABILITY 

FEBRUARY 4, 2009 

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

( 

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

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

CHRISTOPHER J. DODD, Connecticut, Chairman 

TIM JOHNSON, South Dakota 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

EVAN BAYH, Indiana 

ROBERT MENENDEZ, New Jersey 

DANIEL K. AKAKA, Hawaii 

SHERROD BROWN, Ohio 

JON TESTER, Montana 

HERB KOHL, Wisconsin 

MARK R. WARNER, Virginia 

JEFF MERKLEY, Oregon 

MICHAEL F. BENNET, Colorado 

RICHARD C. SHELBY, Alabama 

ROBERT F. BENNETT, Utah 

JIM BUNNING, Kentucky 

MIKE CRAPO, Idaho 

MEL MARTINEZ, Florida 

BOB CORKER, Tennessee 

JIM DEMINT, South Carolina 

DAVID VITTER, Louisiana 

MIKE JOHANNS, Nebraska 

KAY BAILEY HUTCHISON, Texas 

COLIN MCGINNIS, Acting Staff Director 

WILLIAM D. DUHNKE, Republican Staff Director and Chief Counsel 

DEAN V. SHAHINIAN, Counsel 

JONATHAN MILLER, Committee Professional Staff 

DEBORAH KATZ, OCC Detailee 

JULIE CHON, Senior International Adviser 

LISA FRUMIN, Legislative Assistant 

DREW COLBERT, Legislative Assistant 

DIDEM NISANCI, Legislative Assistant 

ROBERT LEE, GAO Detailee 

DAVID STOOPLER, Legislative Assistant 

EMMA PALMER, Legislative Assistant 

MATTHEW PIPPIN, Legislative Assistant 

JONATHAN DAVIDSON, Legislative Assistant 

TAMARA FUCILE, Legislative Assistant 

MARY PERKO, Legislative Assistant 

MARK OESTERLE, Republican Deputy Staff Director 

ANDREW OLMEM, Republican Counsel 

MARK CALABRIA, Senior Professional Staff Member 

MIKE NIELSEN, Legislative Assistant 

GREGG RICHARD, Legislative Assistant 

SARAH NOVASCONE, Legislative Assistant 

DAWN RATLIFF, Chief Clerk 

DEVIN HARTLET, Hearing Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor 

(II)

C O N T E N T S 

WEDNESDAY, FEBRUARY 4, 2009 

Page 

Opening statement of Senator Dodd ...................................................................... 1 

Opening statements, comments, or prepared statements of: 

Senator Shelby .................................................................................................. 4 

Senator Schumer 

Prepared Statement .................................................................................. 48 

WITNESSES 

Paul A. Volcker, Chairman, Steering Committee of the Group of 30 ................. 7 

Prepared statement .......................................................................................... 49 

Response to written questions of Senator Johnson ....................................... 262 

Gene L. Dodaro, Acting Comptroller General, U.S. Government Accountability 

Office; accompanied by Orice M. Williams and Richard J. Hillman ................ 35 

Prepared statement .......................................................................................... 126 

Response to written questions of Senator Johnson ....................................... 263 

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

GAO Report to Congressional Requesters; Corporate Shareholder Meetings: 

Issues Relating to Firms That Advise Institutional Investors on Proxy 

Voting .................................................................................................................... 267 

GAO Report to the Ranking Minority Member, Committee on Health, Education, Labor, and Pensions, U.S. Senate; ‘‘Pension Plans: Additional Transparency and Other Actions Needed in Connection With Proxy Voting’’ .......... 295 

Testimony of Yvonne D. Jones, GAO, before the Subcommittee on Oversight 

of Government Management, the Federal Workforce, and the District of 

Columbia, Committee on Homeland Security and Governmental Affairs, 

U.S. Senate; ‘‘Financial Literacy and Education Commission: Further 

Progress Needed To Ensure an Effective National Strategy’’ .......................... 340 

Letter submitted by Derek B. Stewart, GAO, to the Subcommittee on Oversight of Government Management, the Federal Workforce, and the District 

of Columbia, Committee on Governmental Affairs; ‘‘Military Personnel: 

Bankruptcy Filings Among Active Duty Service Members’’ ............................. 360 

Testimony of Valerie C. Melvin, GAO, before the Subcommittee on Oversight 

and Investigations, Committee on Financial Services, House of Representatives; ‘‘Military Personnel: DOD Has Taken Steps To Address 

Servicemember’s Financial Needs, but Additional Effort Is Warranted’’ ........ 369 

(III)

(1) 

MODERNIZING THE U.S. FINANCIAL 

REGULATORY SYSTEM 

WEDNESDAY, FEBRUARY 4, 2009 

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

The Committee met at 3:05 p.m., in room SD–538, Dirksen Senate Office Building, Senator Christopher J. Dodd (Chairman of the 

Committee) presiding. 

OPENING STATEMENT OF CHAIRMAN DODD 

Chairman DODD. The Committee will come to order. 

Let me thank all of my colleagues, and I think you all understood 

we intended, obviously, at some time earlier to have this hearing 

a little earlier. But as I think all of you may know, we had an interesting session on our side of the aisle, gathering today to listen 

to some of our new economic team under President Obama, as well 

as the President himself and others, talk about many of the issues 

that are confronting the country, not the least of which was the 

issue of the subject matter of this hearing, the modernization of the 

U.S. financial regulatory system. I am particularly honored and delighted to have Paul Volcker here with us, who has been a friend 

for many years, someone I have admired immensely for his contribution to our country. 

How we will proceed is, because we are getting underway much 

later than normal for the conducting of Senate hearings, with the 

indulgence of my colleagues, I will make some opening comments 

myself, turn to Senator Shelby, and then we will go right to you, 

if we could, Chairman Volcker. Then I will invite my colleagues 

and tell them that any opening comments that they do not make 

for themselves, we will include them in the record as if given. And 

since there are not many of us here, we can move along pretty 

quickly, I hope, as well. So, with that understanding, we will get 

underway and, again, I thank all of you for joining us here today. 

Today, we continue the Senate Banking Committee’s examination of how to modernize our outdated financial regulatory system. 

We undertake this examination in the midst of a deepening recession and the worst financial crisis since the Great Depression in 

the 20th century. We must chart a course forward to restore confidence in our Nation’s financial system upon which our economy 

relies. 

Our mission is to craft a framework for 21st century financial 

regulation, informed by the lessons we have learned from the current crisis and designed to prevent the excesses that have wreaked 

2 

havoc with homeowners and consumers, felled financial giants, and 

plunged our economy into a recession. 

This will not be easy, as we all know. We must act deliberately 

and thoughtfully to get it right. We may have to act in phases 

given the current crisis. But inaction is not an option at all, and 

time is not neutral. We must move forcefully and aggressively to 

protect consumers, investors, and others within a revamped regulatory system. 

Last Congress, this Banking Committee built a solid foundation 

upon which we will base our work today, and I want to once again 

thank Dick Shelby, former Chairman of this Committee, and my 

colleagues, both Democrats and Republicans, who played a very, 

very constructive role in the conduct of this Committee that allowed us to proceed as we did. 

Subcommittees and Committees held 30 hearings to identify the 

causes and consequences of this crisis, from predatory lending and 

foreclosures, to the collapse of Bear Stearns, the role of the credit 

rating agencies, the risks of derivatives, the regulation of investment banks and the insurance industry, and the role and condition 

of banks and thrifts. 

The lessons we have learned thus far have been rather clear, and 

let me share some of them with you. 

Lesson number one: consumer protection matters. The current 

crisis started with brokers and lenders making subprime and exotic 

loans to borrowers unable to meet their terms. As a former bank 

regulator recently remarked to me, ‘‘Quite simply, consumers were 

cheated.’’ Some lenders were so quick to make a buck and so certain they could pass the risk on to the next guy, they ignored all 

standards of prudent underwriting. The consumer was the canary 

in the coal mine, but no one seemed to notice. 

Lesson number two: regulation is fundamental. Many of the 

predatory lenders were not regulated. No one was charged with 

minding the store. But soon the actions of these unregulated companies infected regulated institutions. Banks and their affiliates 

purchased loans made by mortgage brokers or the securities or derivatives backed by these loans, relying on credit ratings that 

turned out to be wildly optimistic. So we find that far from being 

the enemy of well-functioning markets, reasonable regulation is 

fundamental to sound and efficient markets, and necessary to restore the shaken confidence in our system at home and around the 

globe. 

Lesson number three: regulators must be focused, aggressive, 

and energetic cops on the beat. Although banks and thrifts made 

fewer subprime and exotic loans than their unregulated competitors, they did so with impunity. Their regulators were so focused 

on banks’ profitability, they failed to recognize that loans so clearly 

unsafe for consumers were also a threat to the banks’ bottom line. 

If any single regulator recognized the abusiveness of these loans, 

no one was willing to stand up and say so. And with the Fed choosing not to use its authority to ban abusive home mortgages, which 

some of us have been calling for, for years, the regulators were 

asleep at the switch. 

Lesson number four: risks must be understood in order to be 

managed. Complex instruments, collateralized debt obligations, 

3 

credit default swaps designed to manage the risks of the fault loans 

that backed them turned out to magnify that risk. The proliferation 

of these products spread the risk of subprime and Alt-A loans like 

an aggressive cancer through the financial system. Institutions and 

regulators alike failed to appreciate the hidden threat of these 

opaque instruments, and the current system of regulators acting in 

discrete silos did not equip any single regulator with the tools to 

identify or address enterprise or systemwide risks. On top of that, 

CEOs had little incentive to ferret out risks to the long-term health 

of their companies because too often they were compensated for 

short-term profits. 

I believe these lessons should form the foundation of our effort 

to shape a new, modernized, and, above all, transparent structure 

that recognizes consumer protection and the health of our financial 

system are inextricably linked. And so in our hearing today and 

those to come—and there will be many—I will be looking for answers to these questions. What structure best protects the consumer? What additional regulations are needed to protect consumers from abusive practices? We will explore whether to enhance 

the consumer protection mission of the prudential regulators or create a regulator whose sole job is protecting the American consumer. 

How do we identify and supervise the institutions and products 

on which the health of our financial system depends? Financial 

products must be more transparent for consumers and institutional 

investors alike. But heightened supervision must not stifle innovation of financial actors and markets. 

Third, how do we ensure that financial institution regulators are 

independent and effective? We cannot afford a system where regulators withhold bold and necessary action for fear that institutions 

will switch charters to avoid stricter supervision. We should consider whether a single prudential regulator is preferable to the alphabet soup of regulators that we have today. 

Fourth, how should we regulate companies that pose a risk to 

our system as a whole? Here we must consider whether to empower a single agency to be the systemic risk regulator. If that 

agency is the Federal Reserve Board, we must be mindful of ensuring the independence and integrity of the Fed’s monetary policy 

function. Some have expressed a concern—which I share, by the 

way—about overextending the Fed when they have not properly 

managed their existing authority, particularly in the area of protecting consumers. 

Fifth, how should we ensure that corporate governance fosters 

more responsible risk taking by employees? We will seek to ensure 

that executives’ incentives are better aligned with the long-term 

health of their companies, not simply short-term profits. 

Of course, my colleagues and our witnesses today may suggest 

other areas. I do not mean to suggest this is the beginning and 

end-all of the questions that need to be asked, and I welcome today’s witnesses’ as well as our colleagues’ contributions to this discussion and the questions that ought to be addressed. 

I look forward to moving forward collaboratively in this historic 

endeavor to create an enduring regulatory framework that builds 

on the lessons of the past, restores confidence in our financial system, and recognizes that our markets and our economy will only 

4 

be as strong as those who regulate them and the laws by which 

they abide. That is the responsibility of this Committee. It is the 

Republican of this Congress. It is the responsibility of the administration. 

I will recognize Senator Shelby for an opening comment and ask 

my colleagues if they might withhold statements, at least at the 

outset, so we can get to our witnesses. 

With that, I turn to Senator Shelby. 

STATEMENT OF SENATOR SHELBY 

Senator SHELBY. Thank you, Mr. Chairman. 

Today, the Committee will hear from one of this Nation’s most 

respected economists and veteran policymakers. Dr. Volcker is no 

stranger to this Committee. Senator Dodd and I remember many 

years ago when he would come here as Chairman of the Federal 

Reserve Board. During the financial crisis in the late 1970s, it was 

Paul Volcker who helped put our economic house back in order, 

and, Dr. Volcker, I welcome you back to the Committee again. 

While I am very interested in the views of our witnesses on regulatory modernization, I think the hearing could be a little bit premature. Let me explain. 

As I have said many times and will continue to say, I believe 

that before we discuss how to modernize our regulatory structure, 

or even before we consider how to address the current financial crisis, we need to first understand its underlying causes. If we do not 

have a comprehensive understanding of what went wrong, we will 

not be able to determine with any degree of certainty whether our 

regulatory structure was sufficient and failed or was insufficient 

and must change. 

I understand that next week Chairman Dodd plans to hold a 

hearing on the origins of the financial crisis, for which I commend 

him. I welcome that hearing, but I believe that one hearing, or 

even a handful of hearings, falls well short of what these exceptional times will demand. Instead, this Committee should, I believe, and must conduct a full and thorough investigation of the 

market practices, regulatory actions, and economic conditions that 

led to this crisis. 

The Committee should hear testimony from all relevant parties 

and produce a written report of its findings. This work is crucial, 

I believe, if we are to develop policies that will help end this crisis 

and prevent it from occurring again. 

While I understand many people have their own views of what 

happened, this Committee has yet to make that determination in 

a comprehensive and organized manner. As a result, nearly a year 

and a half later, we still have not documented what started the crisis and why it became so severe. The uncertainty about its origins 

has not only exacerbated our economic downturn by undermining 

confidence in our entire financial system, but it has left us without 

a clear understanding of what needs to be done. We need to remedy 

that. Thus far, the efforts of the Treasury Department and the 

Congress have been ad hoc at best. 

When this all began, I strongly opposed the TARP bailout legislation because I believed Congress jumped right to a legislative solution without first identifying the problem it was trying to solve. 

5 

Since we never developed a consensus about what caused this crisis, neither Congress nor the Treasury Department can devise a 

targeted solution. And as a result, TARP has drifted rudderless 

since it was passed 4 months ago, wasting taxpayer dollars while 

the crisis rages on without an end in sight. 

It is well past time that we investigate the origins of the financial crisis so that we can begin to lay the groundwork for a bipartisan, effective, and durable solution. In the absence of such effort, 

there is now talk of creating a commission to examine the origin 

of the financial crisis and to make recommendations for further action. At this time, I would oppose the creation of such a commission 

because a thorough investigation is something that this Committee 

can do and must do. The American people rightly expect their 

elects representatives, the Senators here, not unaccountable commissions to do the work necessary to solve the problems facing the 

country. 

This Committee is uniquely positioned to conduct a transparent 

investigation that could build the necessary political consensus 

around the appropriate legislative remedy that we must seek. This 

particular Committee has a long history of conducting such investigations. The best precedent, I believe, for this type of investigation that our current economic situation demands is the year-long 

investigation of stock market abuses the Committee conducted during the Great Depression. The so-called Pecora hearings produced 

a detailed report exposing a wide range of abuses on Wall Street. 

The Committee heard testimony from hundreds of witnesses, producing nearly 12,000 pages of transcripts from over 100 hearings. 

The investigative staff was made up of dozens of individuals and 

included attorneys, accountants, and statisticians. They conducted 

scores of interviews and sworn depositions. The Committee subpoenaed corporate records and heard testimony from the heads of Wall 

Street and industry, including 3 days of testimony, I have been 

told, from Mr. Morgan himself. The Committee’s investigative 

record comprises 171 boxes in the National Archives. 

The record that the Pecora hearings established ultimately laid 

the groundwork for the passage of the Securities Act and the creation of the Securities and Exchange Commission. Recently, renowned economic historian Ron Chernow wrote an editorial in the 

New York Times calling for Congress to initiate an investigation in 

the tradition of the Pecora hearings. He stated the importance of 

such an investigation to resolving the current crisis by pointing 

out, and I will quote him: 

If history is any guide, legislators can perform a signal service by moving 

beyond the myriad details of the rescue plans to provide a coherent account 

of the origins of the current crisis. The moment calls for nothing less than 

a sweeping inquest into the twin housing and stock market crashes to create both the intellectual context and the political constituency for change. 

I believe that he is correct. 

The hearings this Committee has held to date on the credit crisis 

have been helpful, but I think they have lacked the focus and purpose displayed during the Pecora hearings, partly due to the Committee’s lack of resources up to this time. To remedy this problem, 

Senator Dodd and I have already submitted an initial request for 

additional funding and office space for the Committee. We were reVerDate Nov 24 2008 11:07 Jul 15, 2009 Jkt 000000 PO 00000 Frm 00013 Fmt 6633 Sfmt 6601 S:\DOCS\50564.TXT SHERYL
6 

cently informed that the Committee is going to receive additional 

funding, although not what is necessary, I believe, to conduct a 

thorough and fair investigation. 

I am hoping that our colleagues on the Rules Committee would 

agree that this type of effort here in the Banking Committee right 

now is not only necessary but deserving of their support. I believe 

the investigation should start by calling before the Committee all 

of the regulators from the past decade or more who were appointed 

to make sure this crisis did not happen, but it did. 

The Committee has heard from regulators on their views on how 

to solve the crisis, but it has yet to hear from present and former 

regulators on what caused the crisis and whether steps could have 

been taken to prevent it. The Committee, I believe, should supplement this testimony with an exhaustive review of the records of the 

regulators from that period. Once again, there will be a time to discuss what needs to be done, but before we entrust any new or existing regulator with additional responsibilities or authorities, I believe we need to know if and how our present regulatory structure 

failed us. 

After we complete a thorough review of the role of the regulators, 

we should then call the CEOs of the largest banks, insurance companies, brokerage firms, home builders, realtors, and other financial services companies of the past 10 years to testify. This, of 

course, would be preceded by an extensive staff effort to examine 

the activities of each institution or industry. 

Since the crisis began, the Committee has not yet heard from 

Wall Street CEOs on their role in creating the toxic assets that 

have spread through our financial system like a cancer. Nor have 

they publicly explained why their risk management systems failed 

or why they operated with such dangerous levels of leverage. Because many of these firms have either failed, received public 

money, or sought some type of Federal assistance, I believe they 

owe it to the American people to explain how this crisis started and 

what role they played in it. 

Last year, I called for a hearing to examine the role of underwriters in spawning the crisis. The Committee announced that it 

would hold a hearing to examine underwriting practices, but it was 

postponed and is yet to be scheduled. That hearing could now be 

part of this effort. 

Mr. Chairman, I am willing to work with you, as I have, and I 

believe this Committee is uniquely positioned, as you do, to perform this important service at this time for the American people. 

I pledge my full support should you choose to undertake your own 

version of the Pecora hearings, as long as they are comprehensive. 

Chairman DODD. Well, I thank you, Senator, very, very much. I 

would just note for the record that there have already been some 

proposals, including one from Senator Isakson and Senator Conrad, 

for sort of a 9/11 Commission—some of my colleagues may be 

aware of this already—to be done outside of this Committee to go 

back and examine that, and that has, obviously, some appeal as 

well. Certainly we want to examine what happened, but also we 

need to go forward. 

With that, I thank you very much, Chairman Volcker, for being 

with us, and for those are unfamiliar with our first witness, ChairVerDate Nov 24 2008 11:07 Jul 15, 2009 Jkt 000000 PO 00000 Frm 00014 Fmt 6633 Sfmt 6601 S:\DOCS\50564.TXT SHERYL
7 

man Volcker is the Chair of the President’s Economic Recovery Advisory Board, Chairman of the Board of Trustees of the Group of 

30, and former Chairman of the Board of Governors of the Federal 

Reserve System. Chairman Volcker worked in the Federal Government for almost 30 years, including positions at the Federal Reserve Bank of New York, the Treasury Department, and Chase 

Manhattan—he has a wealth of experience. 

We thank you for coming and welcome you to the Committee. 

STATEMENT OF PAUL A. VOLCKER, CHAIRMAN, STEERING 

COMMITTEE OF THE GROUP OF 30 

Mr. VOLCKER. Thank you, Mr. Chairman, Mr. Shelby, Members 

of the Committee. I am delighted to be here. I want to make clear 

that I am appearing as Chairman of the Steering Committee of the 

Group of 30 and not as Chairman of the President’s Economic Recovery Advisory Board this morning. 

Chairman DODD. It is so noted. We will make that distinction 

here. 

Mr. VOLCKER. People accuse me of liking the title ‘‘Chairman,’’ 

but I want to make sure Chairman of what. 

[Laughter.] 

Mr. VOLCKER. The Group of 30 is a group of people drawn from 

the private and public sectors with experience in finance, and I emphasize that it is international, and this report was directed not 

just toward the United States, although it is perhaps most relevant 

to the United States. But it is directed toward authorities in any 

country that has extensive financial operations around the world. 

It does not discuss all the origins of the crisis. It does touch upon 

it, but that is not my purpose in appearing before you this morning. What is evident is, whatever the cause is—and we could go 

into that. What is evident is that we do meet at a time, as you 

have emphasized, of acute distress in financial markets. Strongly 

adverse effects on the economy more broadly are apparent. There 

is a clear need, I think, for early and effective governmental programs. They cannot wait a year for attacking the immediate problems to support economic activity and to ease the flow of credit. 

But I think it is also evident that more fundamental changes are 

needed in the financial system, and they will take some time to 

work out. 

But to the extent that we have some sense of the direction of 

those reform efforts, I think it will help the more immediate problem. The important thing is that we do not and should not want 

to contemplate a repetition of this experience, and that is what this 

report is aimed at, and I am sure will be your concerns over time. 

I understand that President Obama and his people are going to 

be placing before you some more immediate measures. They are 

not the subject of our report. But when we look further ahead, I 

do think the more we have a sense of the longer-term future, the 

better place you will be for appraising the immediate actions to 

make sure they are consistent with what we would like to see in 

the longer run. 

The basic thrust of the G–30 report is to distinguish among the 

basic functions of any financial system. First, there is a need for 

strong and stable institutions that serve the needs of individuals, 

8 

of businesses, of governments, and others for a safe and sound repository of funds, providing a reliable source of credit, and maintaining a robust financial infrastructure able to withstand and diffuse shocks and volatility that are inevitable in the future. I think 

of that as the service-oriented part of the financial system. It deals 

primarily with customer relationships. It is characterized mainly 

by commercial banks that have long been supported and protected 

by deposit insurance, by access to the Federal Reserve credit, and 

by other elements of the so-called Federal safety net. 

Now, what has become apparent during this period of crisis is increasing concentration in banking and the importance of official 

support for what is known as systemically important institutions 

when they become at risk of failure. What is apparent is that a 

sudden breakdown or discontinuity in the functioning of those institutions risks widespread repercussions on markets, on closely 

interconnected financial institutions, and at the end of the day, on 

the broader economy. 

The design of any financial system raises large questions about 

the appropriate criteria for, and the ways and means of, providing 

official support for these systemically important institutions. 

In common ground with virtually all official and private analysts, 

the G–30 Report calls for ‘‘particularly close regulation and supervision, meeting high and common international standards’’ for such 

institutions deemed systemically critical. It also explicitly calls for 

restrictions on ‘‘proprietary activities that present particularly high 

risks and serious conflicts of interest’’ deemed inconsistent with the 

primary responsibilities, I would say the primary fiduciary responsibilities, of those institutions to its customers. Of relevance in the 

light of recent efforts of some commercial enterprises to recast financial affiliates as bank holding companies, the report strongly 

urges continuing past U.S. practice of prohibiting ownership or control of Government-insured, deposit-taking institutions by non-financial firms. 

Second, the report implicitly assumes that while regulated banking institutions will be dominant providers of financial services, a 

variety of capital market institutions will remain active. Organized 

markets and private pools of capital will be engaging in trading, 

transformation of credit instruments, and developing derivatives 

and hedging strategies. They will take place in other innovative activities, potentially adding to market efficiency and flexibility. 

Now, these institutions do not directly serve the general public; 

individually, they are less likely to be of systemic significance. 

Nonetheless, experience strongly points to the need for greater 

transparency. Specifically beyond some minimum size, registration 

of hedge and equity funds should be required, and if substantial 

use of borrowed funds takes place, an appropriate regulator should 

be able to require periodic reporting and appropriate disclosure. 

Furthermore, in those exceptional cases when size, leverage, or 

other characteristics pose potential systemic concerns, the regulator should be able to establish appropriate standards for capital, 

liquidity, and risk management. 

Now, the report does not deal with important and sensitive questions of the appropriate administrative arrangements for the regulatory and supervisory functions, which agency will supervise 

9 

which institutions. These are in any case likely to be influenced by 

particular national traditions and concerns. What is emphasized is 

that the quality and effectiveness of prudential regulation and supervision must be improved. Insulation from political and private 

special interests is a key, along with adequate and highly competent staffing. That implies adequate funding. 

The precise role and extent of the central bank with respect to 

regulation and supervision is not defined in the report. It is likely 

to vary country by country. There is, however, a strong consensus 

that central banks should accept a continuing role in promoting 

and maintaining financial stability, not just in times of crisis, but 

in anticipating and dealing with points of vulnerability and risk. 

The report also deals with many more specific issues cutting 

across all institutions and financial markets. These include institutional and regulatory standards for governance and risk management, an appropriate accounting framework (including common 

international standards), reform of credit rating agencies, and appropriate disclosure and transparency standards for derivatives 

and securitized credits. Specifically, the report calls for ending the 

hybrid private/public nature of the two very large Governmentsponsored mortgage enterprises in the United States. Under the 

pressure of financial crisis, they have not been able to serve either 

their public purposes or their private stockholders successfully. To 

the extent that the Government wishes to provide support for the 

residential mortgage market, it should do so by means of clearly 

designated Government agencies. 

Finally, I want to emphasize that success in the reform effort, in 

the context of global markets and global institutions, will require 

consistency in approach among countries participating significantly 

in international markets. There are established fora for working toward such coordination. I also trust that the forthcoming G–20 

meeting, bringing together leaders of so many relevant nations, can 

provide impetus for thoughtful and lasting reform. 

Thank you, Mr. Chairman. I am delighted to have any comments 

or questions. 

Chairman DODD. Well, thank you very much, Mr. Chairman as 

well. And what I am going to do is ask the clerk here to put the 

clock on at 8 minutes, and we will try to adhere to that so we can 

get around to everybody, since we have not had opening statements 

be made. And I will begin, then turn to Senator Shelby. 

Let me, if I can, begin with a couple of—sort of a broad question, 

if I can. The GAO report states—and I am quoting it here. It says, 

‘‘Mechanisms should be included for identifying, monitoring, and 

managing risks to the financial system, regardless of the source of 

the risk.’’ 

What was the source of the risk in the current crisis, in your 

view? 

Mr. VOLCKER. Well, that is a complicated question that goes to 

some of Senator Shelby’s concerns about what caused the crisis. If 

I were analyzing this crisis in a substantial way, you have to go 

back to the imbalances in the economy, not just in financial markets. But as you know, the United States has been consuming more 

than it has been producing for some years, and its savings have 

practically disappeared, and that was made possible by, among 

10 

other things, a very fluid flow of savings from abroad, low interest 

rates—very easy market conditions, low interest rates, which in 

turn incited the great world of financial engineering to develop all 

kinds of complex instruments to afford a financing for businesses, 

and particularly in this case for individuals, homebuyers, that went 

on to exceed basically their capacity to pay. And it was all held up 

by rising house prices for a while, as you know, and everybody felt 

better when the house prices were rising, but that could not happen forever. And when house prices stopped rising, the basic fragility in that system was exposed. 

So you had an underlying economic problem, but on top of that, 

you had a very fragile, as it turned, highly engineered financial 

system that collapsed under the pressure. I think of it as we built 

up kind of a Potemkin Village with very fancy structures, but they 

were not very solid. 

Chairman DODD. Let me draw upon your experience as the 

Chairman of the Federal Reserve System, and you correct me if my 

facts are wrong about this thing. But as I understand it, there are 

about 1,800 economists that work for the various Federal Reserve 

banks across the country. 

Mr. VOLCKER. How many? 

Chairman DODD. I am told about 1,800. I do not know if that is 

true or not, but someone mentioned that number to me. But a very 

high number, whether it is 1,800 or not, but a significant number 

of people who do research all the time in the various banks. Can 

someone explain to me why there was not someone sounding the 

alarms out of the Federal Reserve System as people who monitor 

and watch what is happening economically that would have sent a 

signal to us back in the days of, I think, in 2005 or 2006 even, that 

this was a problem emerging in a glaring way? Why didn’t we 

hear? 

Mr. VOLCKER. Well, I have to say I do not think economists are 

very good at this kind of analysis. In a macro world, I am sorry 

to say that, but I am not sure there has been much improvement 

over the years. But I think if there are 1,800 economists, I am sure 

some of them were concerned and did in their own way raise some 

questions. 

But, you know, when things are going well—this is the bane of 

regulation. When things are going well, nobody wants to hear 

about regulation and restraints. 

Senator SHELBY. Absolutely right. 

Mr. VOLCKER. And so it is very hard to have your voice heard. 

When things are going poorly, everybody wants to regulate everything. And somehow we have to find a balance between too little 

and too much. 

This was an extreme case, but it is not unusual for imbalances 

to go along for a while without anybody really wanting to stand up 

and take strong action. 

Chairman DODD. Well, I would love to at some point further pursue the discussion about the Federal Reserve System and how it 

is working. 

Let me ask you, if I can as well, about the consumer protection 

issue. Your report describes the need to establish standards for 

capital liquidity and risk management for financial institutions. 

11 

But do you also believe that strong consumer protections play an 

integral part in financial stability? I am sure you do, by the way. 

And if so, what regulatory structure would best protect consumers? 

A separate consumer protection agency, as has been suggested by 

some? Elizabeth Warren, who will be before us tomorrow, has made 

a recommendation along those lines. Distinct consumer protection 

missions of the prudential regulator? Which of those two options do 

you find—— 

Mr. VOLCKER. Well, let me say, first of all, our report does not 

deal with that question. 

Chairman DODD. You do not. I realize that. 

Mr. VOLCKER. Quite deliberately. But there is—obviously, this 

administrative question you raise is relevant. We were dealing 

with what we think of as safety and soundness of the system. We 

were not dealing with protection of consumers, protection of investors, business practices—which are related but a different function. 

And one of the questions—which we did not deal with, but I think 

the Congress has to deal with it and the administration has to deal 

with it—do you adopt a separate agency and a separate administrative structure for what I will call ‘‘business practices,’’ including 

consumer protection, separate from the prudential regulator— 

which is a development which is true in some countries now, and 

it is along the lines that Secretary Paulson proposed in his thinking about the long run. 

I think that is a serious issue. I do not want to express an opinion now, but I have certain sympathy for exploring it, at least, personally. 

Chairman DODD. Well, I would welcome that as you give it more 

thought. 

Last, let me address the issue of systemic risk regulation again. 

And I realize I am not specifically referring to the report in some 

cases. I am drawing upon your knowledge and expertise in these 

areas. 

The G–30 report describes one of the lessons from the current 

crisis as follows, and let me quote it. It says: 

Unanticipated and unsustainably large losses in proprietary trading, heavy 

exposure to structured credit products and credit default swaps, and sponsorship of hedge funds have placed at risk the viability of the entire enterprise and its ability to meet its responsibilities to its clients, counterparties, 

and investors. 

Three questions: Should we allow financial institutions to become 

large and systemically significant? Should there be a single systemic risk regulator or should that substantial be shared among 

different agencies? Should the systemic risk responsibility be given 

to the Federal Reserve, in your view? And are you concerned that 

it would also be a burden on the Federal Reserve with numerous 

divergent tasks which you and I have discussed? And I will not 

elaborate here. You know the point I am trying to make. And, 

third, are you concerned that extensive involvement by the Fed in 

so many aspects of day-to-day operations of the economy and the 

financial system might jeopardize its independence? 

Mr. VOLCKER. Again, these are questions we did not deal with in 

the report. We dealt with the structural question that we felt these 

basic, systemically important institutions and banking institutions 

12 

that are protected by the Government and are dealing in a fiduciary way with customers should not engage in the kind of activities that you read from the report, these highly risky proprietary 

activities, because it undermines potentially their basic function. 

When it gets to who regulates it, it is just simply not in the report. But I tell you, the kind of considerations that you raise for 

the Federal Reserve, or without the Federal Reserve, I think are 

very relevant to that decision. You will have a different Federal Reserve if the Federal Reserve is going to do the main regulation or 

all the regulation from the prudential standpoint. And you have to 

consider whether that is a wise thing to do given their primary— 

what is considered now their primary responsibilities for monetary 

policy. 

They obviously have important regulatory functions now, and 

maybe those functions have not been pursued with sufficient avidity all the time. But if you are going to give them the whole responsibility, for which there are arguments, I do think you have to consider whether that is consistent with the degree of independence 

that they have and focus on monetary policy. 

Chairman DODD. I hope I am not over-reading you there. I hear 

that tone suggesting that that kind of a super-regulatory function 

would, I think, put into question the very issues that are raised by 

it. A systemic risk regulator might have less of a problem, in your 

view. 

Mr. VOLCKER. That is true. Then you have to consider how the 

systemic risk regulator matches up with the other prudential regulators. There are very interesting questions here. 

The G–30 issued a report, a rather detailed report, a year or so 

ago or 9 months ago, on different regulatory practices around the 

world, which raised the questions that you are raising, and almost 

all countries are struggling with these questions now. 

Chairman DODD. I thank you. 

Senator Shelby. 

Senator SHELBY. I want to pick up, Chairman Volcker, on some 

of the area that Senator Dodd is getting into. I think it is very important. 

Do you have any concerns, Dr. Volcker, that if the Fed assumes 

too many responsibilities, its ability to conduct monetary policy 

could be undermined? 

Mr. VOLCKER. Yes. 

Senator SHELBY. And what are your views on the separation of 

monetary policy from banking policy along the lines of the reforms 

that were enacted in the United Kingdom in the late 1990s that 

gave banking regulation to the FSA and monetary policy to the 

Bank of England? 

Mr. VOLCKER. Well, that is an interesting experience. That was 

rather widely acclaimed, and other countries attempted to or did 

follow that pattern. But then when they had a crisis, they found 

out it did not work so well. 

Senator SHELBY. It did not work. 

Mr. VOLCKER. And whether that was some idiosyncratic reasons 

in the U.K. or whether it is a more general reason, I do not know. 

But the underlying problem—— 

Senator SHELBY. Why didn’t it work, if you could—— 

13 

Mr. VOLCKER. Well, I—— 

Senator SHELBY. I know it did not work. 

Mr. VOLCKER. It seemed to be a lack of coordination between 

three agencies involved—the U.K. Treasury, the Bank of England, 

and the FSA, the regulatory agency—even though they had overlapping personnel to some extent. But it seems clear that coordination was not close enough. 

But I would make one point in connection with your observation. 

Supervision regulation has implications for the performance of the 

financial system and the economy, and it can work in support of 

monetary policy or it can work contrary to monetary policy. And 

that is one reason for giving the Federal Reserve responsibility for 

both. 

Senator SHELBY. Dr. Volcker, as you keep up with all this, and 

as a former Chairman of the Federal Reserve, you know the Fed 

has had a dramatic expansion of its liquidity facilities over the past 

year, and it has raised concerns that the Fed has moved out of the 

realm of monetary policy and into the realm of fiscal policy. 

The Group of 30 Report, as I understand it, recommends that 

central bank liquidity support operations should not involve lending against or outright purchases of high-risk assets. Instead, your 

report, as I understand it, recommends that those forms of support 

should be handled by directly accountable Government entities. 

In your view, what role should be given to the President or the 

Treasury Secretary in approving Government bailouts or other support for institutions that will likely involve taxpayer dollars? 

Mr. VOLCKER. Well, in cases where they do involve risk and the 

use of taxpayers’ dollars, we are pretty clear that the administration, particularly the Treasury, ought to be involved in that decision, and the Federal Reserve should not undertake those kinds of 

actions, if they do it at all, without the concurrence of the administration. 

Senator SHELBY. Is this in the line under our constitutional system that it would be inappropriate for unelected central bankers to 

determine whether a company or industry receives a taxpayerfunded bailout? Shouldn’t those decisions be made by the President 

and the Congress, who are accountable to the people? Is that—— 

Mr. VOLCKER. Well, Congress can provide a framework for making those decisions, but I think they do involve political questions 

that the President and the administration should be involved in. I 

think just to clarify, my own understanding from outside is when 

the Federal Reserve has done this recently, they have worked 

closely with the Treasury. They have not gone off on their own and 

undertaken these measures. 

Senator SHELBY. It seems like a new role for the Fed than when 

you were Chairman. 

Mr. VOLCKER. Yes, it is a non-traditional role. 

Senator SHELBY. Non-traditional role. You are very—— 

Mr. VOLCKER. The report takes a traditional view of the functions of the Federal Reserve. 

Senator SHELBY. Dr. Volcker, recently Stanford economist and, 

somebody you know, a former Under Secretary of the Treasury, 

John Taylor, argued that excessively loose monetary policy during 

the first part of this decade caused the financial crisis. 

14 

Mr. VOLCKER. Well, I do not think I am going to get into that 

question this afternoon. I do think that conditions in financial markets which were related to the large balance of payments deficit, 

large current account deficit, and the free flow of money from 

abroad laid the groundwork for many of the excesses in the market. 

Senator SHELBY. Now, this is in your report, as I understand it. 

One of the key recommendations of the G–30 Report is creating a 

failure resolution regime that imposes discipline—that is, actual 

losses—not only on managers and shareholders but also on sophisticated creditors. 

I believe one of the primary failings of the recent bailouts of the 

GSEs, AIG, and Bear Stearns was the intent of protecting any 

creditors from losses. 

Dr. Volcker, in terms of who qualifies as a ‘‘sophisticated creditor,’’ do you believe that both financial institutions such as investment banks and foreign central banks would count as sophisticated 

creditors? Or should? 

Mr. VOLCKER. Well, they individually are sophisticated, yes. 

Whether they need to be protected in some particular occasions is 

another question. 

Senator SHELBY. Given that the large creditors of the GSEs, AIG, 

and Bear had no legal claim to being bailed out—which they did 

not—what specific mechanisms would you suggest that we think up 

here to put in place to assure that such sophisticated creditors take 

losses in the future, which helps bring discipline to the market? 

Mr. VOLCKER. The premise of your question included the GSEs? 

Senator SHELBY. Yes. 

Mr. VOLCKER. Well, the GSEs, I think, if I may say so, with the 

connivance of the Congress, were considered to be something special and they would be protected. And there was a general understanding, rightly or wrongly, while officially they did not have the 

full legal requirement of a guarantee, through the years—— 

Senator SHELBY. But they had the implicit guarantee, didn’t 

they? 

Mr. VOLCKER. Pardon me? 

Senator SHELBY. The implicit guarantee. 

Mr. VOLCKER. Yes, they had an implicit guarantee and that 

was—— 

Senator SHELBY. Was that because they were hybrid—— 

Mr. VOLCKER.——I think, generally understood. 

Senator SHELBY.——you know, stock owned and Government 

sponsored? 

Mr. VOLCKER. We are very clear on one recommendation in this 

report. We should not have that kind of hybrid institution anymore. 

Senator SHELBY. I totally agree with you. 

Mr. VOLCKER. You know, you cannot change it overnight, but I 

think as we design a new financial system, we ought to avoid that 

kind of compromise that is going to get you in trouble. 

That does not mean that Congress or the Government cannot 

support the mortgage market if they want to. 

Senator SHELBY. Right. 

Mr. VOLCKER. But they ought to do it directly. 

15 

Senator SHELBY. Yes, sir. Thank you. 

Thank you, Chairman Dodd. 

Chairman DODD. Thank you very much. 

Senator Warner. 

Senator WARNER. Thank you, Mr. Chairman. 

Dr. Volcker, I have got three questions, and I think they follow 

up on both the Chairman’s and Senator Shelby’s approach. It 

seems from the report a clear understanding that there needs to 

be some level of regulation of some of these institutions that fell 

between the cracks. Yet it seems that even though major money 

center banks that clearly were regulated followed the market to 

start putting out these same kind of complex new instruments, 

your term of ‘‘over the top financial engineering.’’ 

I guess on a going-forward basis, as we move forward to some 

new structure, even with regulation and transparency, is that 

going to be enough or should there be some point of an evaluation, 

almost a societal value evaluation, of some of these instruments, 

whether the extra ability to price that risk down to the last decimal 

point is worth all of the side risks that we have seen taking place 

by some of these instruments? 

Mr. VOLCKER. Well, we do a lot of talking about the importance 

of risk management and so forth, but, in essence, the conclusion 

that we have is that some of these innovations and some of these 

very risky activities are almost inevitably going to get ahead of the 

regulators, and these basic institutions—the big commercial banks, 

in particular—are of systemic importance, therefore should not get 

involved in those activities. They are too risky, and I think it is 

clearly demonstrable they involve conflicts of interest that add to 

the uncertainty and risk. 

Senator WARNER. So you would see some system whereby there 

might be bright-line prohibitions—— 

Mr. VOLCKER. Yes, I see—we suggest some bright-line prohibitions for hedge funds and equity funds, and you asked me about 

proprietary trading—you did ask me about proprietary trading. I 

think these big financial institutions probably have to have some 

capacity, do need some capacity for trading. But if they have very 

aggressive trading in very large amounts, where it is not quite 

such a bright line, you probably need special attention, and we suggest special attention via special capital requirements if they are 

going to engage in those activities. 

Senator WARNER. And as you said, sometimes these instruments 

get ahead of the regulators, and how do you—— 

Mr. VOLCKER. No question about that. 

Senator WARNER. You do not want to stifle innovation, but it 

seems to me that some of these instruments recently were more 

about fee generation than they were about appropriately pricing 

risk? 

Mr. VOLCKER. Well, I think that is true, but there is plenty of 

room for innovation outside of the basic banking system, and that 

is a distinction we make. All kinds of sophisticated capital market 

techniques, a derivative explosion which may have gone too far, but 

the whole idea of securitization could be developed outside the 

banking system. To the extent it is inside the banking system, we 

say, well, the bank should hold onto what they securitize. That is 

16 

a traditional function. But outside, they can engage in all kinds of 

trading and—— 

Senator WARNER. But wouldn’t you say some of these outside 

functions now need to have some kind of regulatory—— 

Mr. VOLCKER. Yes, well, I guess we are trying to say we want 

to go relatively lightly, if they are relatively small institutions 

without systemic significance. But if they get big enough—and 

some of the hedge funds have, and we had the experience of Long 

Term Capital Management in the past where, rightly or wrongly, 

people thought it had systemic implications. Then you have to 

think about leverage requirements and capital requirements and liquidity requirements. 

I myself think that would just be a handful of those institutions, 

and most of them—we do call for reporting and registration, but I 

do not think they would take heavy regulation. 

Senator WARNER. Well, let me follow up on Chairman Dodd’s 

question as well, one of the points he raised. A lot of your focus 

is on systemic risk. We have heard the comment a lot in the popular press, you know, certainly these institutions are ‘‘too big to 

fail.’’ On a going-forward basis to try to alleviate that systemic risk, 

should there be some examination of sizing of some of these institutions? 

Mr. VOLCKER. Yes, well, we make a fleeting reference to that actually in the report. There is now more concentration than you ever 

had in the United States. The degree of concentration is not as 

great as many foreign countries have, but it is very large from our 

history. And I think that is a question you want to ponder. It has 

got political, obviously, as well as economic circumstances, whether 

there is such a thing as not only ‘‘too big to fail,’’ ‘‘too big to exist.’’ 

Senator WARNER. Right. 

Mr. VOLCKER. And it has got—we certainly have seen how difficult it is to manage these institutions given the variety of functions they have been performing. Now, we suggest that their functions be simplified. That would be easier to manage. But, still, 

there is in present law, as you know, a limit on deposit-taking. I 

think it is 10 percent. You cannot go beyond 10 percent. Back when 

I was Chairman, we once suggested 5 percent, which some people 

thought was too big. Now it is 10 percent. 

You know, it raises a question at some point. When is enough 

enough? 

Senator WARNER. Right. 

Mr. VOLCKER. And I think you ought to look at it. 

Senator WARNER. One last question. Over the last decade, as 

somebody who spent some time in the financial markets, there has 

always been the argument, oftentimes from our friends in the U.K., 

you know, to come over to their markets. Wall Street was complaining that if there was additional regulation, we would see a 

flight of all these firms abroad, development of new money centers 

all around the world with not as stringent a regulatory structure. 

In light of this complete worldwide collapse, do you think there 

will be an ability to come up with some strong international standards? Or are we going to be able to patch this over and still have 

a few 2-years later, 5-years later, a rush to the bottom as firms try 

to go around the world to find the least regulatory—— 

17 

Mr. VOLCKER. I think we have had a real wake-up call, here and 

elsewhere, in Europe, Japan, China. And this wake-up call I hope 

is strong enough so that we will emerge from this with consistency 

and the basic regulatory and supervisory framework. If it does not, 

I would still do what we think is appropriate here and let them go 

if they want to be in—— 

Senator WARNER. Even if we have a regulated system, you could 

make the argument that might be the safer system. 

Mr. VOLCKER. Yes, and I think in the long run—suppose we now 

had a strong regulatory system, and it was Europe and Japan and 

elsewhere that was in worse shape. All the money would be flowing 

into us because it was the strongest system. 

Now, unfortunately, that is not the case right now. But it should 

be the case. What should be the case is we have a high degree of 

uniformity. And I do not think that is impossible. You already have 

that pretty much in the capital area. Now, that is just one area. 

You have got a lot of other areas—the hedge fund regulation, rating agency regulation, accounting is one place where I am sure— 

I have a special background here, but I think we should have uniform accounting around the world. 

Senator WARNER. If I just follow where you are headed, you 

would actually say a strong regulatory system with appropriate 

oversight in this country would not be counterproductive to the 

continued growth of capital markets in the United States. It might 

still be a long-term benefit to our country. 

Mr. VOLCKER. Yes. That does not mean you want unproductive 

regulation. Good regulation we ought to have, regardless of what 

the rest of the world does. 

Senator WARNER. All right. Thank you, sir. 

Chairman DODD. Thank you very much, Senator. I asked someone once, ‘‘Why do you think it is that the world comes here?’’— 

talking about, obviously, not the present day, but a little time ago. 

‘‘Why does the world come here and bring its wealth?’’ The answer 

I was given, two reasons: one, we are very good at making money, 

and as importantly or more importantly, it was a safe place to be. 

You might make a bad bet, but you were not going to lose your 

money because the system was corrupt or did not work. And I 

think that is the point that Senator Warner is making, and I think 

if you have a strong, sensible, balanced regulatory system, the 

world could also follow us. They may not join us, but they will 

move in that direction. 

Mr. VOLCKER. I have hopes that, given what has happened, you 

will get some uniformity. You know, the argument always was we 

will lose all this business to London. Well, London has got the 

problem at least as much as we have, and I think that is generally 

recognized at this point. 

Chairman DODD. Senator Johanns. 

Senator JOHANNS. Thank you, Mr. Chairman. 

In reference to your last comment, I will offer an observation, 

and that is that the financial crisis is bad enough; where I do think 

there is a good chance of uniformity, just as you suggest, I think 

over time it is hard to sustain that. Why? Just simply because one 

country is going to look at this and, you know, when things stabilize—and hopefully they will stabilize—that country is going to 

18 

say, you know, we could get more banking business here if we 

tweaked this a little bit and tweaked that a little bit. So you almost 

need to think about what mechanism you have in place to deal 

with that economic phenomenon. Countries want business, and 

they are going to do things. Sometimes over time we see it is bad 

judgment, but I would just offer that observation. 

A couple more observations, and then I would like to ask you a 

question. It seems to me—and this is so complicated. It is hard to 

say there are a couple of reasons for what is going on, but it seems 

to me that there are two really, really important things that really 

have led in a substantial way to this financial crisis. 

Number one is whatever mechanism was in place to evaluate 

risk accurately just failed. Highly compensated, enormously bright 

people being advised by the best in the business simply lost their 

way when it came to evaluating risk. 

The second thing was that, for whatever reason, as regulatory 

agencies or departments tried to get a handle on this, it was very 

difficult for them or they dropped the ball, or whatever, in terms 

of themselves blowing the whistle on unreasonable risk being 

taken. 

Those two things strike me as really fundamental to what we are 

dealing with here. If you agree with that statement, I would really 

be interested, Dr. Volcker, in your educating us on how your recommendations would deal with that, number one, the failure to accurately evaluate risk and, number two, the failure, for whatever 

reason, to blow the whistle on that risk. 

Mr. VOLCKER. Well, we have got a lot of rhetoric in this report 

about the importance of risk management and trying to deal with 

the problem you have and the failures of risk management in our 

leading financial institutions—partly, and importantly, because the 

complexity became so great that we lost sight of how to measure 

the risk. 

Now, I have got a point of view on this, but the markets were 

taken over by financial engineers. They were mathematicians. They 

were not market people. They somehow thought that financial markets would follow the laws of physics or some natural law and everybody had a nice, normal distribution curve. And they kept being 

surprised by outlying events. Well, they seemed outlying if you 

thought of the world of a normal distribution curve, but that is not 

the world of finance that I know. Financial markets are affected 

today by what happened yesterday, and what is happening right 

now affects thinking and affects what happens tomorrow. So you 

get people going to extremes in both directions. And these financial 

engineers kind of thought that they had the answer to how to 

measure risk and take care of it. 

Things were very complex. When you mixed together these enormous compensation practices, the enormous gains possible, with 

obscure financial engineering, you had a recipe for extremes, I 

think, that kind of came back to haunt us. 

Senator JOHANNS. If I might just—— 

Mr. VOLCKER. That will be addressed by what is happening, but 

so much of the best talent in the United States is going off into financial markets. I wish more of it would go building bridges instead of financial markets. 

19 

Senator JOHANNS. If I might just offer another observation, and 

your thoughts on compensation, I think, really warrant this Committee kind of digging deep on that issue. But there is another 

piece to it, too. There was a point in time where someone was compensated based upon the quality of the loan that they wrote. You 

know, when I bought my first house, you didn’t get that loan unless 

you had a reasonable chance of continued employment, you had 20 

percent down in the bank, et cetera. However, the compensation 

structure turned to how many loans you could write and bundle 

and then sell, and like I said, nobody was figuring out how to 

evaluate the risk, or if they did, they threw all the rules out the 

window. 

Mr. VOLCKER. Well, I think that is a good example. In the old 

days, you had a customer. You evaluated his ability to pay, the 

value of the house, and so forth. But then they came along and 

said, well, look. If we put 80,000 of these loans together, our statistical analysis says 85 percent of them will be OK and the result 

was you put poorer and poorer loans in the package. It turned out 

that 85 percent were no longer good, and that is where we are. 

Senator JOHANNS. And the frustrating thing about that, and I 

will wrap this up, for the average citizen out there is that 15 percent now has been labeled toxic assets and somehow the taxpayer 

feels like they are being imposed upon to own that risk today and 

they are saying, ‘‘why me?’’ 

Mr. VOLCKER. I don’t know how you want me to respond to 

that—— 

Senator JOHANNS. You don’t have to respond, Doctor. You 

are—— 

Mr. VOLCKER. There comes a time when you have to support 

these institutions in the interest of the greater good and the stability of the markets. But one of the difficulties in this whole business is very much commented on today, is how you price those assets when the taxpayer takes them over. 

It is possible you could think of a scenario where if the taxpayer 

has to take them over and the markets are stabilized, the taxpayer 

may actually make money. But you certainly don’t want to go into 

it with the taxpayer unnecessarily losing a lot of money. But it is 

a very—this is all complex enough so it is very hard to unscramble 

all this stuff. 

Senator JOHANNS. Thank you very much. 

Chairman DODD. Thank you, Senator. Very good questions. 

Senator Reed? 

Senator REED. Thank you, Mr. Chairman, and thank you, Chairman Volcker, for not only your testimony, but for your service on 

this G–30 Commission as well as so many other commissions. 

We have been confronted with a long to-do list by the G–30 report, but our capacity is limited. I wonder, could you focus on what 

you consider to be the top two or three systemic risks that should 

be dealt with immediately? A sense of priority, I think, would 

help—I will speak for myself—would help. 

Mr. VOLCKER. Well, when you say immediately—— 

Senator REED. Well, immediately in the—— 

Mr. VOLCKER. First of all, we are going to have—I am not sure 

this is what you meant in asking the question—it is going to cost 

20 

more money to deal with this financial crisis. There shouldn’t be 

any mistake in your mind about that, that this has deteriorated to 

the point where it is going to take Government support in the interest of overall economic stability and recovery, and it is going to 

be lots more billions of dollars. I don’t know how many. But that 

is necessarily a priority, which I hope and believe the administration will face you with shortly. 

Now, looking ahead, I think we rather put the priority in what 

I put in my statement as our first point, that you have got to take 

these big protected institutions, particularly the large ones, but all 

the banks are going to be protected to some extent, and you have 

got to develop apparatus for protecting, but you have also got to 

limit what they can do, and you want to do that as intelligently as 

you can, because you want them to compete. You want them to be 

innovative in providing services. But you don’t want them taking 

a kind of risk that is inconsistent with the fact that at the end of 

the day, Government support is in the background. Now it is in the 

foreground. But ordinarily, it is in the background. And I think 

that is the, I think, the most fundamental thing. 

But there are so many things that need attention that it is hard 

for me to rank them in priority. The accounting problem is a real 

one. And apart from the fact of the desirability of uniformity, and 

there has been a lot of progress in that area. That is one area I 

think we are going to get uniformity, and we should get uniformity. 

But then uniformity is one thing, but uniformity according to what 

standard? And there, there is a problem with all this mark to market business and fair value accounting. When should that be applied? When should it not be applied? If it is not mark to market, 

what else do you do? 

My own feeling is that is something that has to be thought about 

by the regulators themselves and they ought to have a voice in the 

accounting for the basics, banking anyway, banking, insurance 

companies. But intellectually, that is a very tough problem. 

Senator REED. Let me ask this related question. We are debating 

a significant recovery package at the moment. That, I would think, 

would complement any efforts we make to further aid the financial 

institutions, because without this recovery package, then the potential hole has got to be much bigger. Is that your view, also? 

Mr. VOLCKER. That is right. No, you have got kind of a threelegged stool. You have got the stimulus package to help provide direct support to the economy. You have got to have the financial 

package to unleash the flow of credit. And then related to both 

those things, I think you have got the individual mortgage problem, 

which nobody has figured out how to deal with very effectively, but 

it is an important part of the problem. So you have got to advance 

on all those fronts. 

Senator REED. Let me—— 

Mr. VOLCKER. Let me just point out—— 

Senator REED. Yes, sir? 

Mr. VOLCKER.——the obvious. If you didn’t have the stimulus 

package, let us say, the worse the economy gets, the more problems 

you are going to have in the banking system. That is obvious. 

Senator REED. And the bigger the hole that has to be filled. 

Mr. VOLCKER. The hole gets bigger. 

21 

Senator REED. In the G–30 report, the reported noted that credit 

rating agencies are not held legally accountable for their ratings. 

Do you believe that has to change? 

Mr. VOLCKER. I believe this is an area that has to be reviewed. 

We made a few suggestions in the report, including the one that 

you mentioned. I don’t feel that that is the last word, frankly, what 

we say in this report. The whole compensation structure is important and we allude to it, but we don’t say what the answer is. I 

am not prepared now to say I think I know the answer to that, but 

it is not an unimportant question, obviously. 

Senator REED. Let me ask you a final sort of set of questions. 

The Chairman raised the issue of 1,800 economists at the Federal 

Reserve. Did anyone sort of notice the implications of the housing 

bubble building up and other problems? The Ranking Member has 

talked about sort of looking into the regulatory practices of the 

Federal Reserve, particularly regulating these large institutions. 

My assumption is that on a daily basis, the Federal Reserve 

would have hundreds, perhaps, of examiners within these institutions. Why wasn’t anyone aware of some of these off-balance sheet 

devices, liquidity puts? Was it an area of concern? Was this an 

issue they were aware or, or were they completely blindsided? I 

think it goes to the point of trying to discover who knew what 

when so we have an idea of how we can restructure the—— 

Mr. VOLCKER. I do not know the answer to your question. A perfectly reasonable question. I was not there. I can’t answer the question. 

Senator REED. That is a perfectly reasonable response. 

Thank you, Mr. Chairman. 

Chairman DODD. Thank you. 

Senator Bennett? 

Senator BENNETT. Thank you, Mr. Chairman. 

Dr. Volcker, welcome. We have had three simultaneous bubbles. 

They haven’t burst simultaneously, but they were going on simultaneously. We have had the housing bubble. We had the oil bubble. 

And then we had a credit bubble. The oil bubble, everyone who 

pumps gas is delighted that it has burst. Everyone who produces 

gas and oil is probably a little sorry that it has burst. But all of 

the dire consequences that we heard predicted with respect to the 

oil bubble are now no longer on the front page and we no longer 

talk about the oil shock and its impact on the economy and the rest 

of us because the price—— 

Mr. VOLCKER. What about the opposite? The price isn’t high 

enough to stimulate the—— 

Senator BENNETT. That is right. It has gone from $145 a barrel 

to $35 a barrel and then bounced around. But that is a bubble that 

burst and a collapse that happened very rapidly and the American 

motorist is delighted. 

The housing bubble has burst and we don’t know where the bottom is. It is uneven across the country, and that is why I am a little suspect of the Case-Shiller number, because that takes the 

worst parts. There are some places in the country where housing 

prices have actually risen, but the mortgage problem remains very 

much a difficulty because nobody knows what the securities are 

22 

worth. They don’t know how much toxic paper they have, and so 

on. 

Let us talk about the credit bubble. It is different from the classic bubbles of the housing bubble and the oil bubble, but we still 

don’t have a firm handle on what is happening with respect to 

credit. We don’t have any kind of normalcy. There was a time when 

credit was enormously available. Now, it is almost not available at 

all, except again, like the housing thing, there are some parts of 

the country where it is available, or there are some markets where 

it is available and others where it is not. 

Look into your crystal ball and tell me, or tell us what it is going 

to take for the credit bubble to resolve itself and how long you 

think that might be. 

Mr. VOLCKER. Well, I won’t profess to know the answer to that 

question with any reliability. It is going to take some time. We are 

not at the end of this business. And I think the immediate challenge is to provide some basis for greater confidence in the banking 

system and in lending. You know, it is kind of a spiraling process. 

The worse the economy gets, the less confidence there is, and the 

less confidence there is, the more difficult creditors and the worse 

the economy gets. 

So we have got to break into that cycle, and I think that is why 

I emphasized earlier the importance of dealing with the banking 

situation. It is going to cost some money. And if we do that effectively, then I think we could begin seeing the end of this. But it 

is, I don’t know how many months, but it is not going to be overnight. 

Senator BENNETT. It is not going to be soon—— 

Mr. VOLCKER. We have had a great shock to confidence and trust 

in markets and these markets depend upon confidence and trust 

and it is going to take a while to restore that. 

Senator BENNETT. It is not going to be soon and it is not going 

to be cheap. 

Mr. VOLCKER. And it is not going to be cheap. 

Senator BENNETT. Now, since you have put your finger, I think, 

on the real core of all of this, which is confidence, you talk about 

a three-legged stool, a stimulus package, something, for want of a 

better summary term, I will call more TARP to deal with the financial institutions, and then resolving the mortgage crisis. I am perfectly willing to go down all three roads, but what happens if we 

pass a stimulus package that is not stimulative? Doesn’t that 

produce a greater hit to the confidence circumstance than if we did 

nothing? 

That is what I think the debate is all about. I don’t subscribe to 

those who say, well, we want the economy to fail because then 

Obama will fail and then the Republicans will come back. This is 

one Republican who rejects that, absolutely, and for the good of the 

country. 

But it is one thing to say, let us pass a stimulus package. It is 

another to be sure it is going to be stimulative. It is one thing to 

say, well, let us shore up the financial institutions. Then it is another thing to be sure that the way we do that is going to be helpful, and so on. Can you give us your advice as an economist as to 

what you think is the most stimulative? 

23 

Mr. VOLCKER. Well, I want a stimulus package that stimulates. 

Senator BENNETT. Well, we all stipulate to that. 

Mr. VOLCKER. To the extent—you know the dilemma here—to 

the extent you can take action that not only stimulates but is in 

accordance with some longer-term needs of the economy, obviously 

you are sympathetic toward that. I am sympathetic toward that, 

and that, among other things, leads you to infrastructure. 

Senator BENNETT. Right. 

Mr. VOLCKER. The problem is, that takes time. So what do you 

do in the immediate future? There are things that are very compelling in the short run in terms of helping people that are out of 

work in terms of unemployment compensation and other things 

where there is the pressure of immediate money in their hands. 

But when you take those two different kind of extremes, both useful, put it together in as good a package as you can and get it 

passed, would be my advice. I am not an expert on all the particulars of this program. I haven’t looked at it. But I am aware of the 

debate. But I hope that gets resolved in a constructive way as 

quick as you can. 

Senator BENNETT. I have talked to some bankers who say, well, 

the injection of capital that has come as a result of TARP is not 

only welcome, but essential, but we still do not have sufficient capital to make any loans. We have sufficient capital to sustain our 

present balance sheet, which we didn’t have before. But we are unable to attract any private capital and we are unlikely to get any 

more public capital. Do you have any prescription for us as to what 

we should be doing there with respect to—— 

Mr. VOLCKER. Well, I don’t know what the administration is 

going to propose, but I suspect there is going to need to be some 

public capital—— 

Senator BENNETT. And then—— 

Mr. VOLCKER.——maybe quite a lot of it. 

Senator BENNETT. Then the question arises, in what form? The 

first TARP, for which I voted, contrary to my friend, Senator 

Shelby, was sold to us on the basis that it was going to acquire the 

toxic assets and clean up the balance sheets of the bank, and then 

it changed toward a program of buying preferred stock or making 

some other kinds of loans, warrants, and so on. Along with Senator 

Dodd, I agreed we ought to give the Secretary of the Treasury full 

authority to do whatever he thought was best, but the track record, 

at least coming from somebody’s analysis, has been a little bit spotty as to whether that is—— 

Mr. VOLCKER. Well, I think it is fair to say, if you look back over 

the last 6 months or so, that they were kind of repeatedly firefighting, on some crucial weekends in particular, and it may have 

been successful or unsuccessful in particular cases, I think mostly 

successful in putting out a particular fire, but it didn’t come across 

as being very consistent and very credible in terms of what comes 

next and I think we have suffered from that. And what we need 

now is, I think, a kind of comprehensive program that recognizes 

the breadth of the problem—it is not just one or two institutions— 

and provides a framework for dealing with this in a consistent way. 

I think that is essential to get confidence back in this situation. I 

hope that is what is going to happen in the next couple of weeks. 

24 

Senator BENNETT. Thank you very much. 

Chairman DODD. Thank you, Senator Bennett. 

Just a quick question before I turn to Senator Schumer. In your 

view, Doctor, looking back, did we do the right thing in early October in supporting that TARP program or not? 

Mr. VOLCKER. You know, it is very hard to sit on the outside and 

say what should have been done in particular circumstances. All I 

know is something had to be done. Whether it was perfect foresight 

or whatever, we could have done it differently, you mentioned the 

TARP program, which was designed in the first instance—I had actually written something about it before it happened and suggested 

that we get rid of some—buy up some of these so-called toxic assets, and that was the original intention and then they switched, 

maybe for good reason. But the whole thing wasn’t as persuasive 

as it might have been. 

Now understand, as time goes past, these loans are getting 

worse. They are not getting better because the economy is worse, 

so that makes it more difficult. 

Chairman DODD. So the answer—— 

Mr. VOLCKER. Well, the answer, as I say, I think you need, apart 

from the stimulus program, you need a program that looks big 

enough, powerful enough, across the board enough, not that it necessarily has to be applied, but you have something there that can 

be applied in terms of further deterioration of the market or individual institutions. You hope that by the mere fact of being there, 

confidence might begin to be restored. The better looking the program, the less you have to use it. 

Chairman DODD. So I think I hear you saying, yes, you agree 

that it should have been done. How it was executed is another matter. Is that a fair characterization? 

Mr. VOLCKER. I think—yes, I think so. 

Chairman DODD. Senator Schumer? 

Senator SCHUMER. Thank you, Mr. Chairman, and thank you, 

Mr. Chairman. It is good to see you. I have been on Banking Committees for 28 years and I think you have been testifying before 

them for about 28 years. 

Mr. VOLCKER. Just about. 

Senator SCHUMER. So it is good to see you. I have an opening 

statement, Mr. Chairman. I am going to forego reading it. It outlines my general views on regulatory reform, including a much 

more unitary—well, controlling systematic risk, ensuring stability—I have always thought all holding companies should be regulated by one regulator, maybe the Fed, maybe not, but one regulator, and I know you have been asked about that—unifying our 

regulatory structure—we have too many regulators, too many holes 

between the cracks, too many conflicting organizations. Third, regulating the currently unregulated part of the markets, both instruments and entities, hedge funds and others. We need to do that. 

Fourth, to recognize that we are in a global financial world, global 

solutions, and increase transparency. Those have been my five 

principles. I wrote an op-ed about this about a year ago and I have 

been sticking with them. It hasn’t changed. So I ask unanimous 

consent that that be put in the record. 

25 

Senator SCHUMER. I would like to focus on the international part 

first, because to me, the biggest challenge we face when we set up 

a new system of regulation is not what we do here. I think there 

is sort of a consensus. I mean, I have heard Chairman Dodd has 

said, Chairman Frank, the administration, they are very similar to 

the five things that I have outlined here. But how in this international financial world, with a national system of regulation, don’t 

you always flee—doesn’t money always flee to the lowest common 

denominator? And if we regulate swaps here or regulate hedge 

funds here, they just migrate to a place where they are not regulated because the individual operators, regulation is a common 

good. 

Mr. VOLCKER. Well, I expressed some optimism on this point earlier, before you came in—— 

Senator SCHUMER. Good. Well, I welcome hearing again, because 

there isn’t much—— 

Mr. VOLCKER. I have optimism only because this crisis is so serious. We here in this country, in the U.K., in Japan, potentially in 

China, have never seen anything like this, and so this kind of focuses the mind. I think the leaders in Europe and the United 

States, Canada, Latin America, they are all interested in this subject. 

You have a forum in the G–30. I don’t think it is an ideal forum 

for this purpose, frankly, for getting into the detail, but it is a good 

forum for making sure that somebody else does it. And we do have 

some international bodies that are making progress. 

In many of the areas that you would be concerned with, take 

hedge funds, the Europeans are more concerned about regulating 

hedge funds than we are. 

Senator SCHUMER. You know, I am not so worried—I mean, although the details, look how long it took to get some agreement on 

Basel and the capital accords. 

Mr. VOLCKER. Right. 

Senator SCHUMER. Everyone had general agreement and it took 

five or 10 years to get this done. 

Mr. VOLCKER. Now wait a minute, I was largely, or importantly 

responsible for the first so-called Basel Agreement. It only took 2 

years. 

Senator SCHUMER. Right, but Basel II took much longer. 

Mr. VOLCKER. The revision took much longer because we did 

such a good job the first time. 

[Laughter.] 

Senator SCHUMER. But, you know, in this new global world, Hong 

Kong could decide that they don’t want the Western consensus. 

They will go for the short-term hit of having—— 

Mr. VOLCKER. I—— 

Senator SCHUMER. You know, it is just difficult. 

Mr. VOLCKER. Look, one area where this is front and center is 

in accounting—— 

Senator SCHUMER. Yes. 

Mr. VOLCKER. and I have a special interest in this because I used 

to be the Chairman of the International Accounting Standards 

Committee. 

Senator SCHUMER. Right. 

26 

Mr. VOLCKER. And there, the suspicion in the United States has 

been our U.S. GAAP is better than anything else and that we have 

international accounting standards and we ought to adopt U.S. 

GAAP. Well, I think that has been proven to be a bit of an illusion. 

U.S. GAAP is not God, either—— 

Senator SCHUMER. Right. 

Mr. VOLCKER. and there are lots of problems, and I see no reason—I do not believe that the international standards are in any 

sense weaker than GAAP. They are more principle-based—— 

Senator SCHUMER. Yes. 

Mr. VOLCKER.——but in terms of the substance, they are no 

weaker, and there has been a lot of progress. 

Now, there are political pressures on the international standard 

setters and we ought to be alert to that and those pressures, frankly, are—well, they are in the United States, too, but they are particularly strong in Europe, and I think we all have an interest in 

maintaining the independence of the standard setters and we want 

to put pressure on them to do a good job. 

Senator SCHUMER. Yes. 

Mr. VOLCKER. But I think that is a promising area and a very 

difficult area. 

Senator SCHUMER. Yes, it has been difficult, the most difficult. 

My worry is a year from now, when we begin to see the light at 

the end of the tunnel here, say China will decide they want to gain 

the immediate advantage and just set up rather sophisticated—— 

Mr. VOLCKER. No, but we—— 

Senator SCHUMER.——trading operations, and it just—— 

Mr. VOLCKER. We said—— 

Senator SCHUMER. My experience—— 

Mr. VOLCKER. We said earlier, if we have got good regulation, 

and good is not synonymous with a lot of regulation necessarily, 

but if we have intelligent regulation and the rest of the world 

doesn’t follow us, well, that is too bad, because I think in the end, 

it will be recognized that we have the best and the business will 

come here. 

I am tempted to say, because this is not the first time I have 

been before this Committee and this problem arising in the United 

States, where when you talk about—the Senator talked about everybody wants to tweak the regulation to their advantage. 

Senator SCHUMER. Yes. 

Mr. VOLCKER. That is true of American States. They are always 

trying to tweak—— 

Senator SCHUMER. Of course. 

Mr. VOLCKER.——financial regulation to the advantage of particular States. So we have had a certain experience there. 

But all I can say is if we can’t deal with this now, given the extent of the problem not just in the United States—— 

Senator SCHUMER. Around the world. 

Mr. VOLCKER.——but around the world, we have an opportunity 

to do it. 

Senator SCHUMER. Yes. I agree, it is a unique opportunity. It is 

just my experience has shown everyone agrees 10,000 feet up, and 

you start getting into the details and they don’t, and then there are 

new instruments that come along and new opportunities for one 

27 

country to gain on the other and they trade that short-term benefit 

to everyone’s long-term detriment. But good. I am glad you are optimistic. 

Mr. VOLCKER. One thing I would say in that connection, maybe 

I am optimistic and out of it and don’t know what is going on, but 

there are bodies—— 

Senator SCHUMER. I doubt that. 

Mr. VOLCKER.——internationally to deal with this, and to the extent it can be left to these more or less expert bodies, and accounting is one example, but the Basel Committee is another example—— 

Senator SCHUMER. Yes. 

Mr. VOLCKER.——and there are several other examples, the political leaders ought to put pressure on those expert groups. When 

they try to do it themselves—— 

Senator SCHUMER. I understand. 

Mr. VOLCKER.——I think you get a problem. 

Senator SCHUMER. All you need is one significant outlier to throw 

off the—to toss up the apple cart. 

One other question, because my time is running out, credit rating agencies, where there has been real trouble. Do you think the 

model ought to change, that we ought to—— 

Mr. VOLCKER. I mean, I can answer that question yes. But if you 

ask the next question, how—— 

Senator SCHUMER. Yes. 

Mr. VOLCKER.——I will tell you, I am not ready to make a pronouncement. I think that—— 

Senator SCHUMER. Well, what about the old model, where instead of the issuer paying for it, it was the investor that did? 

Mr. VOLCKER. Well, I was surprised to learn, or I had forgotten, 

because ever since I have been compos mentis and an adult, I think 

the AAA ratings or AA or whatever they were, but 20 or 30 years 

ago, they were paid by the investor. 

Senator SCHUMER. Exactly. Yes, and it worked. 

Mr. VOLCKER. And it worked. It seemed to work. So why can’t 

it work again? I don’t know the answer. 

Senator SCHUMER. The one—and this will be my last, because 

my time is expiring—the one thing people say is that when the investor pays, the investor doesn’t want to make it public and there 

is sort of a public good. 

Mr. VOLCKER. Yes. 

Senator SCHUMER. What would you think of some quasi-governmental intervention here? 

Mr. VOLCKER. I can’t see the governmental agency making the 

credit rating. The potential political pressures that will come on, 

everybody—— 

Senator SCHUMER. Well, that is why I said quasi. Don’t you think 

the Fed is pretty well removed from political pressures? 

Mr. VOLCKER. Well, I think the Fed is more removed, properly 

so—— 

Senator SCHUMER. Yes, it should be. 

Mr. VOLCKER.——than any other agency, and I like to think it 

has earned that in part over time by competence in the way it acts. 

28 

But I don’t think you just want to pile everything on the Federal 

Reserve. At some point—— 

Senator SCHUMER. Yes. 

Mr. VOLCKER.——it breaks. 

Senator SCHUMER. Well, to clarify, my view would be to go back 

to the investor-paid initially. We have got to do something to 

change it. 

Mr. VOLCKER. Well, I agree with that. 

Senator SCHUMER. Thank you. Thank you, Mr. Chairman. 

Chairman DODD. I won’t ask you to comment on this, but since 

your knowledge and background in accounting, the FASB model, 

and I realize they are very different functions we are talking about 

here, but a FASB model has worked fairly well in accounting 

standards, particularly when we got away from the industry supporting it and financially underwriting it. 

Mr. VOLCKER. Well, that is—the IASB is the FASB model writ 

large internationally. 

Chairman DODD. So there is a value in maybe talking about that 

model, as well. 

Senator Crapo has been, of all the members of this Committee, 

probably has worked as hard on Government regulation, reform 

regulation as any member, so we welcome your continuing participation in the Committee, Mike. Thank you. 

Senator CRAPO. Thank you, Mr. Chairman. 

Chairman Volcker, I want to go back to the Group of 30 report 

just to kind of try to understand maybe in a little more detail with 

you what was intended by it. I am going to first focus on one of 

the concepts that Senator Schumer mentioned—I apologize for my 

voice, I might lose it during the questions—and that is the principle of unifying our regulatory system. 

For some time even before we ran into this crisis, I have been 

arguing that we need to unify our regulatory system and really 

make sure that we had the right regulatory system for our financial system and for our capital markets. In that context, as I look 

at what we have today, it seems to me we have a lot of overlap 

that is unnecessary. We have gaps where there is no regulation 

where there should be. And we have weaknesses in some parts of 

our system. And what we need to do, as I think you said earlier, 

we need to get good regulation, not necessarily a lot of it. We have 

got to be thorough. We have got to cover everything, and in my 

opinion, eliminate overlaps. 

As I look at the first principle of the Group of 30’s report, it talks 

about dealing with gaps and weaknesses and so forth in the system. But one of your first points is that the activities of banks 

should be subject to prudential regulation and supervision by a single consolidated regulator. Do I understand you or the report at 

that point to be talking about something like merging the functions 

of the OCC and the OTS and perhaps other regulators? 

Mr. VOLCKER. Well, we deliberately did not get into the specifics. 

We were at a high level of generality when it came to the administrative arrangements. But we do recognize the problem that you 

just described and that you had to have some kind of a unified system, at least for banks. 

29 

Senator CRAPO. And when you say at least for banks, I noticed 

one of your other points was that the activities of large insurance, 

investment banks and broker dealers require consolidated supervision. Are you not saying essentially the same thing there in other 

contexts? 

Mr. VOLCKER. Well, I can’t say, speaking in the report, we were 

saying the same thing, because we deliberately didn’t want to get 

into the detail. I think it is an important subject, but we were concentrating on what the substance of the regulation should be. At 

some points, we said it should be consistent. But we didn’t opine 

about who should do what. 

Senator CRAPO. Well, let me try to take you there, and you don’t 

have to speak for the report right now. A lot of discussion has been 

made about whether we should have a single regulator like they 

have in England, whether we should have three regulators, one for 

the systemic, one prudential, and one consumer protection—— 

Mr. VOLCKER. Well, one of—— 

Senator CRAPO. Do you agree with those approaches or that idea 

of consolidating? 

Mr. VOLCKER. I think you should at least explore the idea of two 

regulators, which was raised by Secretary Paulson’s report a year 

or so ago, that you have one on so-called business practices and 

consumer protection and investor protection and one on prudential 

safety and soundness concerns. They overlap. They are not entirely 

separate, but there is substantial difference between those two approaches. In fact, there is enough difference in approaches you will 

get a clash between those agencies. But maybe that is healthy—— 

Senator CRAPO. Right. 

Mr. VOLCKER.——instead of just having one. Now, you take the 

English pattern, they went all one way and away from the Central 

Bank. Now, that didn’t work so well in terms of crisis. So how do 

you get——what we did say very clearly is whatever system you 

have, you had better get the Central Bank involved enough so they 

can respond effectively to a crisis. 

Senator CRAPO. And that is consistent also with Secretary 

Paulson’s blueprint—— 

Mr. VOLCKER. Yes. 

Senator CRAPO.——in terms of the suggestions made there? 

Mr. VOLCKER. Yes. 

Senator CRAPO. One other point that was made in the report is 

that the money market mutual funds that were wanting to continue to offer bank-like services should be required to be reorganized as special purpose banks. Could you expand on that a little 

bit? What was intended by that? 

Mr. VOLCKER. Well, what was intended by that—you go back in 

history a little bit. Money market funds developed because—to escape regulation, effectively. This is a way to provide a banking 

service outside of banks, and they had some competitive advantages because they weren’t banks and they didn’t subject to banking regulations. So when a crisis came along, the framework was 

not adequate. In some cases, they were owned by rich parents and 

it was OK. When they weren’t owned by a rich parent, you had a 

collapse with widespread repercussions. 

30 

We said, you should not essentially say we should not have institutions out there that promise to act like a bank, but they are not 

regulated and protected like a bank. And if they are going to be 

protected de facto, which is what happened here, in effect, they got 

a free ride, and they shouldn’t have gotten a free ride. So if they 

are going to act—if they are going to talk like a bank and squawk 

like a bank, they ought to be regulated like a bank. 

Senator CRAPO. Well, one of the principles that I tend to follow 

as I approach this issue is that similar products or similar functions should be regulated with the same rules or by the same regulators. Would you agree with that principle? 

Mr. VOLCKER. Well, I think if you adopted that regulation on 

money market mutual funds, the natural thing would be to have 

the same regulator as the banking regulator. 

Senator CRAPO. Thank you. One more thing I would like to ask 

a little clarification on and that is your comment and the report’s 

comments about the way we should handle our GSEs, Fannie and 

Freddie. You indicate that a clear separation of Government financial support from the private profit-seeking sector of this should be 

done. It is not clear again whether you are saying that we should 

nationalize the Fannie and Freddie functions or whether we should 

withdraw the Federal guarantees or accomplish the Federal guarantees in some other way. What exactly are you saying? 

Mr. VOLCKER. We are saying that is your choice. You ought to 

do one or the other. 

[Laughter.] 

Senator CRAPO. All right. 

Mr. VOLCKER. You shouldn’t leave them hung up in between, because it is confusing and when you got into trouble, were they public agencies or were they not? And if they were acting in the public 

interest, were they doing right for their fiduciary responsibility to 

the stockholder? I think they got placed in an impossible position. 

They were supposed to be important constructive factors in the 

mortgage market. The crisis came along and they were so over-extended in pursuit of their stockholder interests that they couldn’t 

perform the public function. And if they performed the public function, their stockholders would squawk. And you shouldn’t permit 

that to happen. 

Senator CRAPO. Thank you very much. Just one last question, 

and really, this is sort of a summary to go back to what we have 

already talked about and that you have already expressed a comment on, but I would just like to explore it a little further with you, 

and that is it seems to me that right now, depending on whether 

you count the FDIC, there are six or seven Federal regulators with 

overlapping responsibilities in some cases, and as I said earlier, 

gaps in some places and so forth. 

It seems to me that regardless of the specifics, that Secretary 

Paulson’s blueprint, the Group of 30 report, even though it didn’t 

get into the details, and a number of the other reports that have 

dealt with this same issue have all concluded that we have too 

complex a system that needs unifying and simplification. Now, 

whether we go to a single regulator or whether we go to a smaller 

number than the seven that we have now, that we need to simplify 

and reduce the number of regulators and clearly identify the funcVerDate Nov 24 2008 11:07 Jul 15, 2009 Jkt 000000 PO 00000 Frm 00038 Fmt 6633 Sfmt 6601 S:\DOCS\50564.TXT SHERYL
31 

tions they are regulating and then move forward from there. Is 

that general statement something you could agree with? 

Mr. VOLCKER. Yes, I agree with that, but I guess what I would 

say is when you get to that stage, that stage ought to be second. 

I don’t mean it should be way off, but you ought to have some feeling about the substance of the regulation and then decide who 

should do it rather than decide who should do it and worry about 

the substance afterwards. 

Senator CRAPO. Agreed, and in that context, just to help me in 

my mind, I am starting to think of that substance part of it as 

something focusing on systemic risk, prudential regulation, and 

then consumer protection, and there may have to be some other insurance aspects or whatever. 

Mr. VOLCKER. Yes. 

Senator CRAPO. But would that tend to be the kind of thing you 

were talking about? 

Mr. VOLCKER. I think it is one of the possibilities, yes. A good 

possibility. 

Senator CRAPO. Thank you very much. 

Mr. VOLCKER. The report doesn’t say so, but—— 

Senator CRAPO. I understand. I understand. 

Chairman DODD. No, and let me just say, too, I appreciate Senator Crapo’s longstanding involvement in this and I think we are 

sort of heading in the same direction on a lot of this. Obviously, 

the devil is in the details, a lot of it, but you are getting sort of 

a consensus emerging up here and some ideas and thoughts in this 

direction. That is why your testimony is so tremendously helpful. 

I can’t—first of all, I don’t disagree at all about the conflicting 

missions of the GSEs of protecting your shareholder interests and 

the public policy notion of housing. I am struck by the notion that 

we are sort of doing—aren’t we doing the same thing now? When 

I look at Citi and Bank of America and Goldman Sachs and the infusions of massive amounts of taxpayer money, once again, now 

you have got the exact same situation we talked about with the 

GSEs. In effect, we have a massive amount of public money going 

in, so that we are setting public criteria on private institutions. 

What is the difference? 

Mr. VOLCKER. Well, the difference, I hope, is that this is a reaction to a particular emergency and it is transitional and nobody is 

thinking you are keeping it that way. 

Chairman DODD. All right. I hope so. 

Senator CRAPO. You are right, and I hope so, too. 

Chairman DODD. Let me just also, and Senator Shelby had to go 

on to another meeting, let me just in a sense respond and ask, as 

well. I mean, look, we obviously know that we have got to go back. 

We are reviewing all the time how we get here. We are asking everyone what their thoughts were on how this happened and it is 

a very important question. None of us disagree with it. 

As the Chairman of a committee here, and all my members serve 

on other committees, as well, and we have obviously got a very important agenda to deal with, not the least of which is the modernization of the regulatory structure and some sense of urgency, 

I happen to believe, and I think you have implied this, if there is 

any silver lining in all of this right now, it is that I think there 

32 

is a willingness and an understanding that we have to move. In the 

absence of this moment, if this were, quote, ‘‘normal’’ times, I think 

we would have a hard time engaging in this debate and discussion 

because of the vested interests that don’t want anything to change 

at all. So we have been given a moment, unfortunately, here, tragically, I might add. But it is a moment. 

Now, what do we do with the moment, and my fear is that if I 

end up squandering a year going back and reviewing for the next 

number of months how we got here—not an illegitimate question— 

that I may miss the moment, and I will look back and this Committee will look back and say, we had an opportunity. Recognizing 

the moment, we need to do something about this. 

And so I respect immensely the idea that we ought to spend 

time, and I want to move carefully, obviously, and deliberately. But 

my concern is if we miss the moment, we will find ourselves in a 

deeper hole for a good many years to come. 

So let me ask you, Doctor, if I can, do you sense that, as well? 

Should this Committee and the others responsible, obviously the 

House and the President, the executive branch, move? And again, 

as I sensed it, your priority would be to deal with systemic risk up 

front and soon. Is that correct? 

Mr. VOLCKER. Yes, you know, with all deliberate speed. 

Chairman DODD. I agree. 

Mr. VOLCKER. I am not enchanted by, you know, talking about 

combining the SEC and the CFTC. It is an important issue, but do 

that as part of the whole thing. Just don’t pick out particular 

issues like that, in my view, but I—— 

Chairman DODD. Deal with the totality of it. And an issue that 

Senator Crapo brought, and I care about, as well, is sort of the 

forum shopping that went on by the major interests that restructure themselves in order to pick out a regulator. It is all backwards, in a sense. We should be determining who is going to be 

regulated, not you choosing who you are going to be regulated by, 

and that has been a constant problem, as well. 

So as I hear you say it, the systemic risk would be the area you 

think we ought to be aggressively pursuing, carefully but aggressively pursuing. Am I correct? 

Mr. VOLCKER. Yes. 

Chairman DODD. Do my colleagues have any additional questions? Senator Warner? 

Senator WARNER. One quick question. Thank you, Mr. Chairman, 

and I had to step out for a moment, so if Senator Crapo asked this 

question, I apologize. 

One of my questions earlier was about the argument over the 

last decade, if we added more regulation, how the capital markets 

would migrate elsewhere, and it seemed like, and I was one of 

those folks who held up what looked like the model in the U.K. as 

maybe one to go after. Clearly, it has not proven to be all it was 

made out to be. Is there some other—as we think through this, is 

there some other nation around the world that has got a regulatory 

structure that you say, hey, as you think through this in America, 

look at country X or country Y? 

Mr. VOLCKER. I hate to make an advertisement for the Group of 

30, but we just issued a big report on that subject. We described, 

33 

I don’t know, what, two dozen countries, different systems. We refrained from saying which is best, but we did pronounce a lot of 

pros and cons, what looked more promising and the advantages, 

disadvantages of different systems. 

There seems to be some intellectual and other movement toward 

what the Senator was describing of two agencies, one for business 

practices and one for prudential. I can’t claim that that is widespread, but there are two or three countries, or four or five countries that now follow that. For a while, this business of putting everything in one agency seemed to attract a following. That enthusiasm has been a bit dampened by the fact it didn’t solve all the 

problems in the U.K. 

But those are the two alternatives that need to be looked at. The 

United States is big enough and complicated enough, we may have 

a system like nobody else’s, but I don’t think anybody is very happy 

with the system we have and it takes this kind of a crisis to change 

it. 

Senator WARNER. Well, you could, Dr. Volcker, maybe you could 

share with the Chairman at some point which of those countries 

you think might be models or might give us some guidelines or lessons we could learn from. 

Mr. VOLCKER. We do have—your staff can, I am sure, look at the 

report we have on that subject because it does try to describe the 

strengths and weakness of different approaches. And there is a 

pretty strong feeling, which is not the case in the United States 

historically, that similar functions should be subject to the same 

regulator and the same regulations, which is—— 

Senator WARNER. So focused on function rather than on institution? 

Mr. VOLCKER. Than by institution, yes. 

Senator WARNER. Thank you, Dr. Volcker. 

Thank you, Mr. Chairman. 

Chairman DODD. Thank you very much, and Doctor, we thank 

you immensely. Let me just recommend, as well, and I am sure you 

will agree based on your last comment, why don’t we make available the staff of the Group of 30, and for any interested members 

and their staffs, we will try and set something up and have a session where they can go through and do exactly that, get into more 

details and the questions back and forth as part of our ongoing effort here. It might be very worthwhile and we will arrange that to 

occur, as well. 

And I should have said at the outset, by the way, and I apologize, Doctor, you and the Group of 30, the people who are involved 

in this, I know the names are listed in the report itself, but I want 

the record to reflect how much we appreciate that effort. This was 

a very comprehensive effort made to examine this—— 

Mr. VOLCKER. Thank you. 

Chairman DODD.——and it is appropriate that our first witness 

in a series of hearings we are going to be having on this subject 

matter comes from this very group that brings a wealth of knowledge and expertise to this subject matter. We are going to hear 

from the GAO and staff, who have also been involved in this. I am 

going to bring them up here shortly, but I want the record to reflect how much we appreciate that effort. 

34 

You have begun a very important discussion, obviously not a 

completely comprehensive one, but one that touches on the very 

major issues we will have to address in the coming days if we are 

going to effectively respond to the challenge of modernizing our 

regulatory structure, so I thank you. 

Mr. VOLCKER. Well, I think I can speak for my colleagues that 

engaged in the study that we appreciate your interest. We feel it 

was worthwhile, so—— 

Chairman DODD. Well, this is the moment. This is the moment. 

We have been given, unfortunately, a moment. 

Mr. VOLCKER. And just in terms of all this competition between 

countries and so forth, this is an international report. 

Chairman DODD. I know that. 

Mr. VOLCKER. There is no sharp cleavage between people from 

different nationalities. 

Chairman DODD. Thank you very much. 

We will leave the record open a little bit. There may be others 

who couldn’t be here today who would like to maybe submit some 

ideas and questions to you, as well, and if you have a chance to 

respond to those. We thank you. 

Mr. VOLCKER. Thank you. 

Chairman DODD. I will invite our second witness up, our second 

panel. Welcome to Dr. Gene Dodaro, who is the Acting Comptroller 

General of the U.S. Government Accountability Office, the GAO. 

Mr. Dodaro has worked for over 30 years in a number of key positions at GAO, including Chief Operating Officer. He will also be 

testifying tomorrow before the Committee on the Troubled Asset 

Relief Program, so he is a busy man with being here today and tomorrow. 

Mr. Dodaro will be accompanied by two GAO staff members, Rick 

Hillman and Ms. Orice Williams. We thank you for joining us, as 

well. 

Why don’t you come on up and sit with—have both of you come 

up and sit there, because I know you worked very closely on the 

details of all of this and I know Mr. Dodaro would appreciate having you sit there with him, as well, and respond to some of this. 

Again, we thank you very, very much. I am sorry about the 

delay, but obviously a lot of questions for Dr. Volcker. So we welcome your comments, and again, congratulations on this. All of us 

have great respect for the GAO and the work you do, but this is 

a very important effort you have put forward and sort of a template 

for us to begin this very important discussion of regulation modernization. 

35 

STATEMENT OF GENE L. DODARO, ACTING COMPTROLLER 

GENERAL, U.S. GOVERNMENT ACCOUNTABILITY OFFICE 

ACCOMPANIED BY RICHARD J. HILLMAN, U.S. GOVERNMENT 

ACCOUNTABILITY OFFICE; AND ORICE M. WILLIAMS, U.S. 

GOVERNMENT ACCOUNTABILITY OFFICE 

Mr. DODARO. Thank you very much, Mr. Chairman. I appreciate 

the opportunity to appear before you and the members of the Committee this afternoon to assist your deliberations on the financial 

regulatory system. 

As you mentioned, we in this report embarked on an effort to assist this Committee and the Congress in tracing the evolution of 

the financial regulatory system over the last 150 years, how it has 

evolved; to talk, second, about some of the developments in the 

market that has really challenged that regulatory system; and to 

put forth a framework to help guide decisions on how to craft and 

evaluate proposals to change the system going forward. 

Our bottom line conclusion is that the current system is outdated, it is fragmented, and it is ill suited to meet the 21st century 

needs of our nation. There are many reasons for this. Three I 

would point out, trends that we identified in the report. 

First is that the regulators have struggled and often failed to 

mitigate the systemic risks of large interconnected financial conglomerates or to adequately ensure that they have managed their 

own risks. There is no one single regulator charged with looking at 

risk across the financial system. This, as mentioned in the earlier 

discussions today, is a problem that needs to be addressed. 

Second, regulators have been confronted with some large market 

participants that are less regulated. Non-bank mortgage lenders, 

credit rating agencies have been mentioned here. They are two that 

we point out in our report, as well. 

Third, both the regulators, consumers, investors have all been 

challenged by the emergence and growth of complex financial instruments, whether it is collateralized debt obligations, credit default swaps, over-the-counter derivatives. All these products have 

really evolved and introduced new dimensions into the system that 

really outpace the regulators’ ability to be able to handle that. 

Now, going forward, we think that action needs to be taken. It 

needs to be deliberative, as pointed out here in the discussion so 

far. And in order to assist this, we outline nine characteristics in 

our report which we think are good touchstones. 

First is that the regulatory goals need to be clear and articulated 

in statute, and the goals really ought to drive the substance of the 

organization, as Dr. Volcker mentioned earlier, and they ought to 

be in statute so that they can be used to hold the regulators accountable going forward and can provide consistency over a period 

of time and ensure that there is consistency in the regulation going 

forward. 

Next, it has to be—reform has to be comprehensive. The current 

institutions and products that, where there are gaps, the gaps need 

to be closed and it needs to be looked at in an interrelated set of, 

as has been mentioned, in a unified basis going forward. 

36 

System-wide risk needs to be addressed. Somebody needs to be 

in charge of making sure that the system-wide risks are monitored 

going forward. 

It needs to be flexible and adaptable, and by that we mean it has 

to allow for innovation, but somebody has to be staying abreast of 

risks that are emerging going forward. We know where the risks 

are now. What shape they will take in the future is really anybody’s guess at this point, but we need to have a monitoring system 

in place that can triage those risks, make determination, not be totally reactive to the situations going forward. 

It needs to be efficient and effective. By this we mean there is 

overlapping jurisdictions right now that can be consolidated or 

looked to to consolidate so we have an efficient system going forward. 

Consumer protection has to be also a paramount consideration 

here. Every time we have evaluated an activity for this Committee 

or another committee in Congress in terms of whether it is credit 

card fees or whether it is mutual fund fees, the disclosures invariably aren’t adequate enough going forward, and I believe there also 

needs to be more attention to financial literacy concerns. The Federal Government has a commission on this, but it hasn’t been—had 

a strategic plan, been resourced properly. That needs to be part of 

the package, as well. 

The regulators have to have the right authorities. They have to 

have proper independence, and that involves the funding sources 

that they draw upon to ensure that independence going forward. 

And last, taxpayer exposure has to be minimized. We believe 

that whatever structure is put in place, that future failures are 

borne by the cost of the market participants and not by taxpayers 

going forward. An example here is what is set up currently in the 

Bank Insurance Fund, where fees are paid and then institutions, 

if they fail or are taken over, then the fund is recapitalized by the 

participants in the fund and not by taxpayers going forward. 

Now, to your point about seizing the moment, one of the things 

that we did in order to highlight attention to dealing with this 

issue was add the need to modernize the financial regulatory system to our most recent update for the High-Risk List that we keep 

for the Congress and unveil at the beginning of each new Congress, 

and this is important because we have added areas in need of 

broad-based transformation as one of the criteria to be put on the 

High-Risk List. We think it was important to do that, to feature 

this as the attention of need of change both by the executive 

branch and importantly by the Congress, in this case, through legislative initiatives. 

So that sort of concludes my opening statement. My colleagues 

and I would be happy to answer any questions that you have. 

Chairman DODD. I must say, you are always a spectacular witness. That was his testimony given without reading, and your comprehensive knowledge of your own report is pretty impressive. You 

have testified before us on numerous occasions and you always do 

an excellent, excellent job, and so I command you and your staff 

for your depth of understanding and appreciation of the issue. 

Am I to understand, by the way, when you listed the list, the list 

is not necessarily in the order of importance, because consumer 

37 

protection comes sort of at the mid-point in that list and I don’t interpret that to mean that that is less important than the first issue 

you raised. 

Mr. DODARO. That is correct. Basically, these nine characteristics 

all have equal value. The only thing I would say is we list the regulatory goals articulation up front, which could include—and should 

include—consumer protection as sort of an overarching starting 

point. But other than that, they are all of equal importance. 

Chairman DODD. And the last comment you made is I understand to be that you believe this ought to be a high-priority item 

for this Congress, the 111th Congress. 

Mr. DODARO. Definitely. 

Chairman DODD. Yes. Let me, if I can, begin with the first question I asked Dr. Volcker, because again, while obviously we are 

looking forward here, Senator Shelby’s point, whether you want to 

have this Committee do it or someone else do it or however, and 

I think you can walk and chew gum, that we can actually do both 

functions maybe simultaneously, that is analyze how we got here 

as we decide what steps to take going forward, is an important 

question. 

And so the question I asked Dr. Volcker was, I will repeat, and 

that is your, in fact, the report here states, and I quote here: 

Mechanisms should be included for identifying, monitoring, and managing 

risk to the financial system regardless of the source of the risk. 

What was the source of the risk? 

Mr. DODARO. I think, you know, basically the three areas that I 

pointed out in terms of these developments that have occurred that 

have outpaced the ability of the financial regulatory system. It depends on how you want to frame it. Our report frames it in terms 

of market developments compared with the regulatory system. Our 

report is not a comprehensive inventory of every, perhaps, poor decision that was made by individual regulators or by companies or 

by other institutions going forward. Clearly, that is worthy of investigation. 

But our point was that there are these broad trends, and these 

trends, you know, we have seen emerge over a period of time. In 

1994, we issued a report on the problems that were emerging in 

derivatives. In 2004, at the request of this Committee, we issued 

a report talking about the need to modernize the financial regulatory system. So a lot of the need to change the system, I believe 

has been emerging over a period of time. It was definitely brought 

to the forefront over this past year in the scope and dimensions of 

the problem. But I think there is enough basis of study being done 

that could begin to build the record that Senator Shelby was talking about. 

But until action is taken, we continue to have these exposures 

and vulnerabilities, and I don’t think, you know, some of this can 

proceed on a parallel path. 

Chairman DODD. I agree with you, as well. 

Let me—the structure of the financial regulation. Again, we have 

heard a lot of different ideas today. I keep sensing some commonality among members up here and I would like to raise, if I 

can, in order to address the problem, should we consolidate regulatory agencies? If so, which agencies should be consolidated and 

38 

what public policy goals would such consolidation achieve? Is there 

a role for maintaining a State-Federal system of optional bank 

charters, for instance, in your view? What are the advantages and 

disadvantages of creating a Federal insurance regulator? 

We are debating up here, and this subject has been before us, on 

the Optional Federal Charter. A lot of people think there is not 

much debate over life issues. There is a significant debate over 

property casualty issues of how we go. What are your thoughts on 

those questions? 

Mr. DODARO. I will ask Mr. Hillman to comment on the insurance industry. He has done a lot of work on that area. But in terms 

of your first question about consolidation, some of our work in the 

past, in the banking regulators agency, we raised the issue of the 

potential benefits of merging OTS and OCC and perhaps the supervisory responsibilities of the FDIC as a potential area that ought 

to be examined going forward. Obviously, many people have mentioned the SEC-CFTC potential issue going forward. 

But my point would be, at this juncture, those decisions need to 

be made in concert with identifying who the systemic regulator 

would be, because the relationship between that regulator and the 

other regulators that may have more specific prudential responsibilities, I think needs to be thought of in a holistic fashion. Otherwise, we are going to put in place another potentially fragmented 

system to replace a fragmented system that we already have. 

Chairman DODD. So get to the systemic risk issue first? 

Mr. DODARO. First, and then in parallel with that decide how to 

make the other system support that, and it will also help the systemic risk regulator because they won’t be having to deal with as 

many other entities going forward and it does address the issue of 

regulatory arbitrage that you mentioned earlier, Mr. Chairman. 

But Rick can comment on the insurance area. 

Chairman DODD. Yes. 

Mr. HILLMAN. The notion of an alternative national insurance 

regulator is something that is deserving of significant merit, that 

we need to best understand the tradeoffs associated with that. But 

in recent years, the preponderance of evidence, particularly 

amongst the larger insurance companies, suggests that they are at 

a disadvantage compared to the banking and security sectors in 

that the banking and security sectors can bring new products to 

the market more swiftly that are similar to products that are also 

being sold by the insurance industry. However, the insurance industry, rather than having one or a small number of regulators to 

get product approval, has 54 separate regulators from the 50 different States and four different Territories. So the idea of having 

some commonality associated with the introduction of products of 

similar nature in the marketplace is something that deserves close 

attention. 

Chairman DODD. Yes. Well, it does and this Committee cares a 

lot about it. What about the State-chartered versus federally chartered institutions? 

Mr. DODARO. I think what we have seen and observed over time, 

the State function, particularly as it relates to consumer protection, 

has provided an important safeguard and we think the benefits of 

that need to be preserved going forward. There needs to be obvious 

39 

coordination in this area. There are—it is important always to have 

some checks and balances in the system, and I think the FederalState issue is one of the important checks and balances that needs 

to be maintained in a revised system. Most of our work is focused 

on the Federal level, of course. 

Chairman DODD. Let me jump, if I can, to the issue of failing institutions. The GAO report suggests that a regulatory system 

should have adequate safeguards that allow financial institution 

failures to occur while limiting taxpayers’ exposure. Can you give 

us an example of some of those safeguards? 

Mr. DODARO. I mentioned, alluded to one in my opening statement. The Bank Insurance Fund, I think, is the model that we 

have in mind going forward here extended across the system 

whereby the banks pay fees into the system. The fund is then capitalized. There is a statutory ratio that is set, and if the fund falls 

below that ratio, FDIC has a number of years in order to recapitalize the fund—— 

Chairman DODD. Right. 

Mr. DODARO.——but that is done by the financial institutions in 

the system and not supported by taxpayer funds. I mean, that was 

something that was modernized during the savings and loan and 

banking crisis we had in the 1990s. 

Chairman DODD. Yes. 

Mr. DODARO. We think there ought to be something like that 

more broadly speaking in this system so that the taxpayers aren’t 

turned to to provide anywhere near the level of investment that we 

are being asked to provide today. 

Chairman DODD. The former SEC Chairman, Bill Donaldson, 

once warned against executive compensation plans that emphasized rewards for short-term financial targets, and I quote him 

here. He says, ‘‘People with targets and jobs dependent on meeting 

them will probably meet the targets, even if they have to destroy 

the enterprise to do it,’’ end of quote. 

I wonder if you might explain the relationship of compensation 

to risk taking, particularly when oriented toward short-term goals 

and discuss how they should be addressed. 

Mr. DODARO. This is an area that we haven’t studied extensively 

going forward, but clearly the role of incentives here are important 

going forward and you are seeing some of that. We point some of 

that out in our report in terms of the number of mortgages lent, 

for example, and the incentives systems build into it. So I think 

that is an area that needs a lot more study and attention, but 

clearly, the incentives in the corporate governance aspects of this 

can’t be overlooked going forward. 

Chairman DODD. So the issue of proxy voting and so forth on 

compensation issues, it has been discussed a little bit in the past, 

but to what extent shareholders at what level have a right to participate in making—first of all, they find out invariably a lot of 

these contracts are entered into and you don’t discover all the details of them until someone is leaving. 

Mr. DODARO. Mr. Chairman, let me go back and look at what we 

have done in the past. I don’t have a ready answer for you on that 

today and we will provide one. 

40 

Chairman DODD. I appreciate it. I thought you might, but it was 

one I wanted to raise. 

Let me turn to Senator Johanns. 

Senator JOHANNS. Thank you, Mr. Chairman. 

A couple of thoughts. Having run a State government from the 

Governor’s office and having a Director of Insurance which I appointed and regulating insurance at the State level, I will tell you, 

and we were a fairly small State population-wise, at least, that 

there was a closeness of regulation there that never got very far 

away from you. 

Now, I compare that with having run a Federal department, very 

large, 110,000 employees in 75 foreign countries. We regulated a 

whole bunch of things. These regulatory enterprises can be so big 

and the diversity so enormous around the country that what happens is exactly what your report points out. It just breaks down. 

And so when you start comparing State charter versus Federal 

charter, et cetera, I think we have to keep that in mind. I really 

do. Having run both, I can tell you, a department that regulates 

on a national basis is always going to fight that battle. That is my 

observation. 

My question, though, deals with kind of a follow-up on this whole 

issue of risk analysis. How do you figure out that this basketful of 

assets has value and what is its value and what exposure do you 

want to take to that risk? I would like to hear your thoughts on 

that. Is this something where you would suggest that our regulatory framework have kind of a pre-approval feature to it, because 

once the investments are made, the horse has pretty well galloped 

out of the barn, if you know what I am saying. I would just like 

to hear your thoughts about that. 

Mr. DODARO. Yes. Clearly, the risk management failed at several 

levels in this situation. It failed at an institution level. It failed at 

an industry level. It failed at the national level and at an international level. I think the breadth in which this moved across the 

globe, I think really surprised a lot of people. 

At the request of Senator Reed, in his capacity as a Chair of one 

of the subcommittees of this Committee, we are looking at risk 

management practices going forward and I will ask Ms. Williams 

to give you a little bit of an outline on what he has asked us to 

do, and we will be reporting on that shortly. 

But this is an area that I think is really in need of attention 

going forward. This is the role that we would see the systemic risk 

regulatory playing, to monitor the developments and to make that 

decision. And I think you are going to have to rely on the regulators to make the decision as to whether to intervene or not. There 

is the possibility perhaps of allowing pilots to go forward without 

it being system-wide. There are other cases where you may want 

to be watching it, monitoring it for a while very closely. But this 

risk management that we have in mind needs to be an active risk 

manager, not over-reactive, but not under-reactive, as well. 

Orice? 

Ms. WILLIAMS. Basically, what we are going to do on this engagement, we are looking at risk management oversight. We are specifically interested in what the Federal regulators do when they look 

at risk management at an institution, how they actually go about 

41 

examining that particular aspect of a financial institution, and 

then we are looking at how the regulators identify risk that they 

are going to focus on in an examination, because they do risk-based 

examinations, to see how often risk management bubbled up in the 

past several years up to the current point. And then finally, we are 

looking at the resources that are dedicated to the examination 

function across the banking regulators, as well as the SEC. 

Senator JOHANNS. One other thing I wanted to ask you about as 

you start to look at this is the whole issue of offloading risk, and 

maybe there is no solution to that, but it seemed to me this system 

got created in such a way that the premium for me as the broker 

was to write the loan at all costs, whatever I could do to get that 

person to sign on the dotted line, then it is packaged and it is sold 

off and the risk goes to somebody else and somebody else or whatever. 

I would really like to hear your thoughts on how to deal with 

that, because—and maybe that gets back to the issue of valuation 

again. But to me, that seems to be an important element as we 

think about what we want to do with the regulatory system. 

Mr. HILLMAN. When you go back a decade or more, the process 

that depository institutions typically followed in funding mortgages 

is they would have their own underwriters review the competency 

of individuals to pay those loans and they would go through a detailed process before making a decision to provide a loan to an individual. Once that decision was made, they would hold that risk or 

hold that loan on their books themselves. 

Today, most oftentimes that is not the case. The case is a model 

of originate to distribute, where institutions are making decisions 

and receiving a fee for that service and passing that risk on to others. This originate to distribute model is one of the reasons why we 

have resulted in the crisis that we are in today and some say that 

additional attention is going to be needed in the future to help to 

ensure that at least some responsibilities are being held by each of 

the individual parties along the way to ensure the appropriateness 

of decisionmaking at each of those levels. 

Senator JOHANNS. Can I often one last piece to this? That piece 

would be the thought of rating the risk. Is that an appropriate governmental function? For example, if my bank wants to go out and 

originate junk in the hopes of marketing it, we should call it that. 

If, on the other hand, they are following a model of caution and due 

diligence and doing the very best they can to make sure that those 

loans are going to be repaid, that should be viewed differently. 

But the important thing is, how do we let the consumer know 

that? How do I, Mike Johanns, going in to make my deposit, how 

do I know that those practices have been employed, so if I buy their 

stock or invest my money in that stock or whatever, I am an informed consumer? These are complicated issues, but I think that 

is what we are trying to get to here, is to protect the consumer. 

Mr. DODARO. I think basically the answer to that question, Senator, I think involves safeguards at various levels. You need to 

have the regulators in the examination be clear that the institutions are following due diligence, good practices; second, there is 

proper disclosure; and then third, there is education, and then a 

consumer protection safeguard in place. 

42 

So it is a very important question. It runs—the threat of it runs 

through all these various areas that we are talking about. I don’t 

think there is one solution to it, but it is something that needs to 

be looked at on a comprehensive basis because it is pivotal to the 

decisionmaking that takes place within all these various levels of 

institutions and products. 

Senator JOHANNS. We have run out of time, but my final 

thought, Mr. Chairman, is this. If we don’t figure this piece out, the 

mechanism won’t make a bit of difference. We can create this. We 

can put it under the Fed. We can do whatever, whatever, but if you 

don’t solve that piece of it, then they are almost guaranteed to fail 

as a regulator and we will be back to reports like you just wrote. 

Mr. DODARO. Yes, and basically, that is why we set out those 

characteristics, because if you address all the characteristics, we 

believe you will get at this issue. This isn’t just the question of 

moving boxes around and solving a problem. It is not anywhere 

near that simple. 

Senator JOHANNS. I went over my time, so thank you. 

Chairman DODD. No, you didn’t, Senator. You just made a very, 

very valuable point to me, because if there is that common denominator, as Mr. Dodaro just described that thread, I believe it is consumer protection. I think we have operated for far too long, over 

the last number of years, where there has been a notion that consumer protection was antithetical to economic growth, that if you 

were talking consumer protection, you were creating hurdles, barriers to economic growth. 

And the painful lesson we have all learned in these last number 

of months, several years now, is that when consumer protection is 

foremost in your minds, what happens to that investor, what happens to that customer who walks in, if you are guarding and 

watching out for them, that you can avoid the very problems we 

got into. 

We didn’t watch out, that is we, the regulators, the Government 

itself, was not watching out for what happened to that purchaser 

of that mortgage. We were assuming somehow that the system was 

taking care of them, and they weren’t, and so they got cheated in 

the process. When you abandon the consumer in your analysis of 

all of this, you put economic growth at risk, and I think your question is right at the heart of it. 

We just move boxes around here and create different structures 

and make it look more simple, but without providing that kind of 

protection, coming back to the notion that protecting the consumer 

is absolutely essential for economic growth and the avoidance of 

the very situation we find ourselves in today, I think is an excellent point. Thank you for it. 

Senator Warner? 

Senator WARNER. Thank you, Mr. Chairman. 

Mr. Dodaro, nice to see you again and, again, compliments on 

initiating this report and listing it as a top priority for the Congress to take on and the country to take on. 

I want to follow up on Senator Johanns’ point. One of the areas 

that has been suggested—and I do not know if you all have 

weighed in—is if you are originator of one of these mortgages or 

43 

one of these loans, you keep a stake in the game, that you cannot 

sell off 100 percent of that risk. 

Have you taken a position or do you have a comment on that 

‘‘stake in the game’’ notion? 

Mr. DODARO. Now, we have not looked at that particular issue, 

Senator. 

Senator WARNER. Mr. Chairman, that is one way, if you are not 

taking the whole—selling off 100 percent of the risk, as Mr. 

Hillman mentioned earlier. A decade ago the bank, the originator 

of the loan, would keep that loan on its books and have a long-term 

obligation. As they have been securitized and sliced and diced, that 

connection and bond between the lender and the lendee has disappeared. And one proposal is reconnection and making sure that 

if you originate, you keep some skin in the game. 

Chairman DODD. Absolutely. 

Senator WARNER. But let me also follow up on, I think, your appropriate point about protecting the consumer, and it is kind of, 

again, from a—I keep coming back to, you know, this kind of way 

we approach this. My concern is, Mr. Chairman, that we clearly 

need to do a better job of protecting the consumer, but I think we 

have operated on the premise that transparency and disclosure 

alone would be enough to protect the consumer. And it seems like 

we have had two contradictory policy goals. On one level, we want 

to protect the consumer. On the other level, as we push out these 

more challenging mortgages or credit cards, the population that we 

are dealing with are oftentimes the least financially literate. 

So what I question, even with more focus on financial literacy 

programs, is whether disclosure alone is going to get us there and, 

you know, will there need to be some type of restrictions—again, 

I come back to my bright lines—on certain products that if you are 

not, for example, a qualified investor—I spent 20 years in the venture capital business. You know, to invest in my venture capital 

funds, which were high risk, you had to be a qualified investor. 

Do we need to have, in addition to—if we are going to truly protect the consumer, in addition to disclosure and transportation, are 

we going to need actually some bright-line prohibitions? 

Mr. DODARO. I definitely think that the systemic regulator that 

we are talking about would fulfill that function, or at least that 

could be one of the functions they fulfill, is to assess the risk level, 

and there have to be tolerances put in place and balances and decisions made on a case-by-case basis as to whether the risk—you 

know, assuming you have these clear goals of consumer protection 

as one of your goals, along with, you know, allowing innovation and 

capital formation. But, I mean, all those things have to be balanced. But I think you definitely need that in place. 

I agree with what you are saying, that, you know, disclosure, 

transparency alone are not going to be enough. I think you need 

to have it sort of from one end to the other. One is the regulators 

need to be protecting the consumers as well as allowing for innovation, all the way through transparency, disclosure, down to educating people more to make them more financially literate. 

Senator WARNER. I had a family member who I warned time and 

again do not get into this adjustable rate mortgage. All the warnings in the world, all the transparency in the world, would not 

44 

have precluded her from taking a bad long-term action. I was able 

to bail her out, but now we are looking to a national Uncle Sam 

bailing everybody out because at some point people with information may still not be making good financial judgments here. 

Mr. DODARO. I agree completely. 

Senator WARNER. So there has to be some protection component. 

Mr. DODARO. Right. 

Senator WARNER. I know our time is getting short, but one last 

question. We have spent a lot of time, again, about all these new 

financial tools and the over-financial engineering that is taking 

place. How do we make sure that the regulators stay abreast of 

these tools and have the skills and the technology and the competency to make sure that they actually understand these new 

products as they emerge? 

Mr. DODARO. Well, I clearly think—and I will ask Ms. Williams 

to comment on this because she has been doing a lot of our work 

on these instruments. But, first, clearly the goal has to be set for 

them to do that. And I think if the Congress sets a statutory—as 

part of the regulatory goal, an expectation that occur, that is there, 

I think they need to be given then the authorities to be able to hire 

the necessary people and compensate them appropriately for doing 

that. And I do think they would have the capability to be able to 

do it. 

There is no doubt in my mind that you have some very talented 

people in the regulatory system right now that, given the proper 

goals and expectations, can, you know, develop in that area. It will 

not be easy because of the ingenuity of many of the market participants, but I think it is achievable. 

Orice, do you have anything? 

Ms. WILLIAMS. The only thing that I would add is that this is an 

area that the regulators are always going to be at a disadvantage 

in dealing with because the markets are always looking to come up 

with new and innovative products. But I think one of the things 

that would really help—and we tried to speak to this with our principal, focused on having, you know, a flexible, nimble process for 

regulators to be able to adjust, is to get beyond the type of product 

and the label that is attached to a particular product and really be 

able to focus on the risk that that product may pose to the system 

and making that the focus and the driver for whether or not products need to be brought under a regulatory umbrella. 

Senator WARNER. So actually making a risk assessment of the 

product, and then if the assessment was the product was too risky, 

then perhaps saying some universes of consumers might not be eligible to—— 

Ms. WILLIAMS. Or that it needs to be, you know, regulated or 

looked at from a regulatory perspective and not just focus specifically on it meets this statutory definition so, therefore, it falls out 

of a regulatory jurisdiction versus it poses this particular risk to 

the system, therefore, it needs to be subject to some level of regulation and oversight. 

Senator WARNER. We had that situation last week in the Madoff 

hearing where we had both SEC and FINRA here, and, you know, 

asked very much suddenly, you know, on broker-dealers, if somebody says they were an investment adviser and FINRA is looking, 

45 

they are going to suddenly stop and not turn over that information. 

These regulatory lines clearly in that case might have precluded 

exposing a real financial scam. 

Ms. WILLIAMS. Exactly. And one example, we have worked looking at credit default swaps, and that is another example of a product that meets a definition and, therefore, there is—— 

Senator WARNER. No examination beyond meeting the definition. 

Ms. WILLIAMS. Exactly. 

Senator WARNER. Amen. Thank you very much. 

Ms. WILLIAMS. You are welcome. 

Senator Akaka. 

[Presiding.] Thank you very much, Senator Warner. 

Mr. Dodaro, it is good to see you again, and our panel. I am so 

glad that we have a new team that is addressing the problems that 

we are facing immediately. And I think you know the history of the 

so-called Financial Literacy and Education Commission. That is 

chaired by the Secretary of Treasury, and it has a mission that has 

really not been carried out. And I think that is an answer to some 

of the problems that have been mentioned here. 

Previously, I heard about protecting the consumers. Well before 

the current economic crisis that we are facing at this time, financial regulatory systems were failing—failing to adequately protect 

working families from predatory practices and exploitation. And 

this Commission was really put in place to try to prepare strategies 

that would deal with the problems that people in the country would 

have. 

I would tell you that one of the huge problems that this country 

has is that this country is financially illiterate. And so these financial literacy programs fill that void, and we need to really, I feel, 

try to bring that back to life and to help the causes here. 

Families have been pushed into mortgage products with associated risks and costs that they could not afford. And instead of utilizing affordable, low-cost financial services found at regulated 

banks and credit unions, too many working families have been exploited by the high cost of fringe financial service providers such 

as payday lenders and check cashers. I would tell you—and I am 

sure it is not only in Hawaii—that you find offices like these outside of our bases, and so our military personnel really suffer on 

this. 

So my question to you, Mr. Dodaro, is: How do we create a regulatory structure that better protects working families against predatory practices? 

Mr. DODARO. I will ask Rick to elaborate on the Financial Literacy Commission, Senator Akaka, but first, it is a pleasure to see 

you again as well. 

We have studied the Financial Literacy Commission. We have 

also studied issues relating to information being provided to our 

military families to educate them. Ms. Williams was involved in 

that, and we can provide that information for the record as well. 

But I think, clearly, the issue first has to be a clear articulation 

of consumer protection being a clear goal of the regulatory system, 

to have it organized properly, resourced properly, and there needs 

to be continual congressional oversight. I think this is an area that 

the whole financial regulatory system needs to have some ongoing 

46 

oversight activities. Even if the Congress makes the determination 

that the system is going to be modernized and a new system is put 

in place, the idea that that would operate effectively from day one 

without continual refinement and oversight I think is an unrealistic goal. 

And so I would say there needs to be a proper transition and it 

needs to be followed through on oversight. But let me have Rick 

talk about the Financial Literacy Commission, because I could not 

agree with you more about its importance. 

Senator AKAKA. Thank you. 

Mr. HILLMAN. We recently completed a report assessing the Financial Literacy Commission at the Department of Treasury. Exactly as you have said, this Commission was established to help to 

promote financial literacy on a nationwide level. It brought together over 20 departments and agencies who had financial literacy 

programs with the hope of consolidating those efforts and distributing those out to the nations in need. What we have found, however, though, is that the Commission itself is well understaffed and 

unable to achieve the mission which it was set up to accomplish. 

For example, one of the activities that the Commission undertook 

was to ask each of these agencies to determine the extent to which 

they had any overlap or duplication in the individual financial literacy initiatives that they had undertaken. And due to a lack of resources, they asked each of the agencies to themselves make that 

assessment as opposed to having some sort of expert assessment 

done by an outside party. 

That internal assessment came up with very limited suggestions 

as to how the financial literacy programs could be improved, and 

we made a recommendation that they seek additional expertise to 

assess the effectiveness of those programs. 

Regarding the notion on the military bases, we have done significant work and we have work ongoing now that is looking at the 

extent to which sales of financial products to the military, particularly egregious insurance products, are continuing to cause havoc 

on bases. Sadly, we are finding that that continues to be the case. 

One of the major limitations associated with the oversight of payday lenders and other types of establishments that you mentioned 

in your State that is rampant across all States has to do with the 

fact that those types of associations that fall outside of the reach 

of a financial services regulator are under the regulatory authority 

of the Federal Trade Commission. The Federal Trade Commission 

is largely an enforcement agency, not an oversight agency. It is a 

small organization with significant responsibilities, and currently 

configured, it is simply unable to achieve the level of oversight that 

most would like to have. 

Senator AKAKA. Yes, and I also understand that the Commission, 

as you said, has been understaffed. Also, they are having problems 

trying to come to some consensus among themselves, the 20 Federal agencies, and simply because they have different missions and 

perspectives. But I hope that we can look at these missions and 

perspectives as a means of bringing a solution to this particular 

problem. And part of the mission, of course, is education, and this 

is one thing that we really need to press across the country. And 

I feel that if more of the citizens of this country were better eduVerDate Nov 24 2008 11:07 Jul 15, 2009 Jkt 000000 PO 00000 Frm 00054 Fmt 6633 Sfmt 6601 S:\DOCS\50564.TXT SHERYL
47 

cated financially, some of the problems we are facing now may not 

have been as large as this. 

But I think we need to, Mr. Dodaro, work on this Commission 

to make it more effective and to use its efforts to deal with financial literacy in the country. 

Mr. DODARO. I agree, Mr. Chairman, and we would be happy to 

follow up on our report and provide a follow-up activity report on 

how well they have implemented the recommendations to the Committee. 

Senator AKAKA. Well, let me thank you for your January 2009 

report, and I have seen parts of it, and your report states that: 

New and more complex products raise challenges for regulators in addressing financial literacy. Without sufficient financial literacy, individuals will 

not be able to effectively evaluate credit and investing opportunities or be 

able to cope with difficult economic situations. 

And we agree with that. 

My question to you is: How can we ensure that in a new regulatory structure financial literacy is effectively addressed? 

Mr. DODARO. I think in the characteristics that we point out in 

our January report, Senator, we point out a couple things, characteristics that are pivotal to this issue. One is clear articulation in 

statute of a regulatory goal. So this needs to be clearly articulated. 

Someone has to be given the responsibility for doing it, proper resources, proper accountability back to the Congress, and I think 

that there needs to just be follow-up. 

This is not a hugely difficult task in the sense if we make a priority and then we apply the proper resources and we ensure people 

are following through on this initiative. Plus I think this is one 

that if there is work to be done with our education system, there 

needs to be an integrated fashion, you know, put in place to be able 

to do this. 

One of the things that I almost did rather than come to GAO 

many, many years ago is I had an idea to start a class to be taught 

in high schools on this very issue at that point in time because I 

think it is very important. It has got to start early with people and 

be built into the education system, and then it has to be reinforced 

on a more sophisticated level as people take on additional responsibilities and begin working and making larger purchases going forward. 

Senator AKAKA. Well, I want to thank our witnesses today for appearing here, and I apologize for Chairman Dodd, who was called 

away. That is why he is not here. And I want to thank you again 

for your responses. 

The hearing record will remain open for additional statements 

and questions, and, again, I thank you for your responses and look 

forward to having you in hearings in the future. 

This hearing is adjourned. 

[Whereupon, at 5:36 p.m., the hearing was adjourned.] 

[Prepared statements, responses to written questions, and additional material supplied for the record follow:] 

48 

STATEMENT OF SENATOR CHARLES SCHUMER 

First, I’d like to thank Chairman Dodd for holding the first of what I’m sure will 

be many hearings on financial regulatory reform. For decades, America generally, 

and New York in particular, have been the financial capitals of the world. Our markets have been the deepest, most liquid and safest. Our dominant position was built 

not only on our talent, ingenuity and expertise, but also on a foundation of strong 

but efficient regulation, and a reputation for fairness, that demonstrated to investors that they would be protected from fraud and financial recklessness here. The 

events of past 24 months have destroyed our reputation as the system has been 

gripped by a financial crisis that resulted from years of regulatory neglect at all levels. 

Eight years of the Bush Administration’s one-sided, laissez-faire, deregulatory ideology have helped cripple our financial system, and an outdated and overmatched 

regulatory system in this country compounded their failure. Even former Federal 

Reserve Chairman Alan Greenspan, once an ardent defender of deregulation and 

the free market, recently acknowledged that there was a ‘‘flaw’’ in his belief that 

markets could and would regulate themselves. I hope that we’ve learned that as appealing as deregulation may seem in good times, the price we ultimately pay will 

be far higher than had we exercised the good judgment and restraint imposed by 

responsible regulation. 

Designing a regulatory system is a complicated and difficult task. Regulation 

must strike a delicate balance—providing a sense of safety and security for investors, without snuffing out the flame of entrepreneurial vigor and financial innovation that drives economic growth. 

It’s easy, and even tempting, to go to the ideological extremes on either end of 

the spectrum. But threading this needle correctly is an essential component of restoring confidence and long-term stability to the financial system. 

For many years, the United States had struck that balance very well. However, 

new factors, including technology, globalization, and industry consolidation and evolution have left our regulatory infrastructure too far behind the reality of today’s 

global financial system. 

Where does this leave us? Well, it leaves us needing significant reform. As we go 

forward, I believe there are a number of clear principles that we must adhere to. 

I’ve discussed these principles before, but I think they’re worth repeating now as 

we begin the discussion of regulatory reform under a new Administration. 

1.) We must focus on controlling systemic risk and ensuring stability. 

In increasingly complex markets, even the most sophisticated financial institutions don’t always understand the risks their decisions involve. Smaller institutions 

like some hedge funds and private equity firms, can also create systemic risk in today’s world and cannot escape regulation, particularly when it comes to transparency. We need regulation that looks at risk systemically and above all, we need 

to ensure that whatever may happen to any individual financial actor, we can be 

confident that the financial system itself will remain strong and stable. 

2.) We need to look closely at unifying and simplifying our regulatory structure. 

In this era of global markets and global actors, we cannot maintain the older 

model of separate businesses with separate regulators. Right now there are too 

many regulators at the Federal level with overlapping authority. This creates a regulatory ‘‘race to the bottom’’ as less responsible firms are able to play the regulators 

off one another in their efforts to operate with as little oversight and as few restrictions as possible. 

3.) It is clear that we must figure out how to regulate currently unregulated parts 

of the financial markets and opaque and complex financial instruments. 

There are too many vital players and products in the financial markets that operate beyond the scope of Federal regulators, yet have the ability to put the system 

at risk. We must create an effective regulatory framework for those actors and for 

more exotic financial instruments like complex derivatives and even the relatively 

plain vanilla credit-default swaps, which have grown into a multi-trillion dollar part 

of the financial system. 

4.) We must recognize that a global financial world requires global solutions. 

In this era of global finance, while we have international markets, we still have 

national regulations. The danger is that there is often a rush to the place where 

regulation is lightest and least effective. This may be our toughest challenge. 

5.) Increased transparency must be a central goal. 

49 

We must continue to emphasize transparency among all market participants. The 

ability of investors, lenders and especially regulators to evaluate the quality of holdings and borrowings is essential for restoring confidence. 

A complete overhaul of this nation’s financial regulatory system will be difficult, 

complex and time consuming. I look forward to working with President Obama, and 

under the leadership of Chairman Dodd to advance this process so that as we begin 

to recover from the current financial crisis in the coming months, we have a system 

in place to prevent its repetition. 

PREPARED STATEMENT OF PAUL A. VOLCKER 

CHAIRMAN, STEERING COMMITTEE OF THE GROUP OF 30 

FEBRUARY 4, 2009 

Mr. Chairman and Members of the Senate Banking Committee: 

I appreciate your invitation to discuss the recent Report on Financial Reform 

issued by the ‘‘Group of 30’’. I remind you that the Group is international, bringing 

together members with broad financial experience from both the private and public 

sectors and drawn from both highly developed and emerging economies. While certainly relevant to the United States, most of the recommendations are generally applicable among globally active financial markets. 

I understand that the text of the Report has been distributed to you and your 

staff and will be included in the Committee record. Accordingly, my statement will 

be short. 

What is evident is that we meet at a time of acute distress in financial markets 

with strongly adverse effects on the economy more broadly. There is a clear need 

for early and effective governmental programs both to support economic activity and 

to ease the flow of credit. It is also evident that fundamental changes and reform 

of the financial system will be required to assure that strong, competitive and innovative private financial markets can in the future again support economic growth 

without risk of a systemic financial breakdown. 

It is that latter challenge to which the G–30 Report is addressed. I understand 

that President Obama and his administration will soon place before you a specific 

program for dealing with the banking crisis. Such emergency measures are not the 

subject of our Report. However, I do believe that the implementation of the more 

immediate measures will be facilitated by an agreed sense of the essential elements 

of a reformed financial system. 

In that respect, the basic thrust of the G–30 Report is to distinguish among the 

basic functions of any financial system. First, there is a need for strong and stable 

institutions serving the needs of individuals, businesses, governments, and others 

for a safe and sound repository of funds, as a reliable source of credit, and for a 

robust financial infrastructure able to withstand and diffuse shocks and volatility. 

I think of this as the service-oriented part of the financial system dealing with customer relationships. It is characterized mainly by commercial banks that have long 

been supported and protected by deposit insurance, access to Federal Reserve credit, 

and other elements of the Federal safety net. 

What has become apparent during this period of crisis is increasing concentration 

in banking and the importance of official support for systemically important institutions at risk of failure. What is apparent is that a sudden breakdown or discontinuity in the functioning of such institutions risks widespread repercussions on markets, on closely interconnected financial institutions, and on the broader economy. 

The design of any financial system raises large questions about the appropriate 

criteria for, and the ways and means of, providing official support for these systemically important institutions. 

In common ground with virtually all official and private analysts, the Report calls 

for ‘‘particularly close regulation and supervision, meeting high and common international standards’’ for institutions deemed systemically critical. It also explicitly 

calls for restrictions on ‘‘proprietary activities that present particularly high risks 

and serious conflicts of interest’’ deemed inconsistent with the primary responsibilities of those institutions. Of relevance in the light of recent efforts of some commercial enterprises to recast financial affiliates as bank holding companies, the Report 

strongly urges continuing past U.S. practice of prohibiting ownership or control of 

Government-insured, deposit-taking institutions by non-financial firms. 

Secondly, the Report implicitly assumes that, while regulated banking institutions 

will be dominant providers of financial services, a variety of capital market institutions will remain active. Organized markets and private pools of capital will be engaging in trading, transformation of credit instruments, and developing derivatives 

50 

and hedging strategies, and other innovative activities, potentially adding to market 

efficiency and flexibility. 

These institutions do not directly serve the general public and individually are 

less likely to be of systemic significance. Nonetheless, experience strongly points to 

the need for greater transparency. Specifically beyond some minimum size, registration of hedge and equity funds, should be required, and if substantial use of borrowed funds takes place, an appropriate regulator should be able to require periodic 

reporting and appropriate disclosure. Furthermore, in those exceptional cases when 

size, leverage, or other characteristics pose potential systemic concerns, the regulator should be able to establish appropriate standards for capital, liquidity and risk 

management. 

The Report does not deal with important and sensitive questions of the appropriate administrative arrangements for the regulatory and supervisory functions. 

These are in any case likely to be influenced by particular national traditions and 

concerns. What is emphasized is that the quality and effectiveness of prudential regulation and supervision must be improved. Insulation from political and private special interests is a key, along with adequate and highly competent staffing. That implies adequate funding. 

The precise role and extent of the central bank with respect to regulation and supervision is not defined, and is likely to vary country by country. There is, however, 

a strong consensus that central banks should accept a continuing role in promoting 

and maintaining financial stability, not just in times of crisis, but in anticipating 

and dealing with points of vulnerability and risk. 

The Report deals with many more specific issues cutting across all institutions 

and financial markets. These include institutional and regulatory standards for governance and risk management, an appropriate accounting framework (including 

common international standards), reform of credit rating agencies, and appropriate 

disclosure and transparency standards for derivatives and securitized credits. Specifically, the Report calls for ending the hybrid private/public nature of the two very 

large Government-sponsored mortgage enterprises in the United States. Under the 

pressure of financial crisis, they have not been able to serve either their public purposes or private stockholders successfully. To the extent the Government wishes to 

provide support for the residential mortgage market, it should do so by means of 

clearly designated Government agencies. 

Finally, I want to emphasize that success in the reform effort, in the context of 

global markets and global institutions, will require consistency in approach among 

countries participating significantly in international markets. There are established 

fora for working toward such coordination. I trust the forthcoming G–20 meeting, 

bringing together leaders of so many relevant nations, can provide impetus for 

thoughtful and lasting reform. 

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PREPARED STATEMENT OF GENE L. DODARO 

ACTING COMPTROLLER GENERAL, U.S. GOVERNMENT ACCOUNTABILITY OFFICE

FEBRUARY 4, 2009 


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262 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR JOHNSON 

FROM PAUL A. VOLCKER 

Q.1. There is pressure to move quickly and reform our financial 

regulatory structure. What areas should we address in the near future and which areas should we set aside until we realize the full 

cost of the economic fallout we are currently experiencing? 

A.1. I recognize the desire to move quickly to reform the financial 

regulators structure, but more important is to get it right. Speed 

should not become the enemy of the good, and a piece-meal approach may inadvertently prejudice the thoroughgoing comprehensive measures we need. There may be a few measures—such as the 

proposed new crisis resolution procedure—that may be usefully enacted promptly, but we still have much to learn from unfolding experience and about the need to achieve international consistency. 

Q.2. The largest individual corporate bailout to date has not been 

a commercial bank, but an insurance company. Given the critical 

role of insurers in enabling credit transactions and insuring 

against every kind of potential loss, and the size and complexity of 

many insurance companies, do you believe that we can undertake 

serious market reform without establishing Federal regulation of 

the insurance industry? 

A.2. Consideration of Federal regulation of insurance companies 

and their holding companies is an example of the need for a comprehensive approach. A feasible starting point should be the availability of a Federal charter, at least for large institutions operating 

inter-state and internationally, with the implication of Federal supervision. 

Q.3. As Chairman of the G–30, can you go into greater detail 

about the report’s recommended reestablishment of a framework 

for supervision over large international insurers? Particularly, cm 

you provide some further details or thoughts on how this recommendation could be developed here in the United States? Can 

you comment on the advantages of creating a Federal insurance 

regulator in the United States? 

A.3. As indicated, the absence of a Federal charter and supervision for insurance companies is a gap in our current regulatory 

framework. I am not prepared now to opine whether the Federal 

regulator should be separate from other supervisory agencies but 

some means of encouraging alignment is necessary. Again, I’d prefer to see the issue resolved in the context of a more comprehensive 

approach; in this case including consideration of appropriate and 

feasible international standards. 

Q.4. How should the Government and regulators look to mitigate 

the systemic risks posed by large interconnected financial companies? Do we risk distorting the market by identifying certain institutions as systemically important? How do foreign countries identify and regulate systemically critical institutions? 

A.4. The question of mitigating systemic risks is a key issue in 

financial reform, and can be approached in different ways. Specifically identifying particular institutions as systemically important, 

with the implication of special supervisory attention and support, 

has important adverse implications in terms of competitive balance 

263 

1 GAO, Financial Regulation: A Framework for Crafting and Assessing Proposals to Modernize 

the Outdated U.S. Financial Regulatory System, GAO–09–216 (Washington, D.C.: Jan. 8, 2009.) 

and moral hazard. I am not aware of any foreign country that explicitly identifies and regulates particular systemically critical institutions, but in practice sizable banking institutions have been 

protected. 

An alternative approach toward systemic risk would be to provide a designated regulatory agency with authority to oversee 

banks and other institutions, with a mandate to identify financial 

practices (e.g., weak credit practices, speculative trading excesses, 

emerging ‘‘bubbles’’, capital weaknesses) that create systemic risk 

and need regulatory supervision. Particular institutions need not 

be identified for special attention. 

Q.5. In your testimony you say that you support continuing past 

U.S. practice of prohibiting ownership or control of Government-insured, deposit-taking institutions by non-financial firms. What are 

your thoughts on the commercial industrial loan company (ILC) 

charter? Should this continue to exist? 

A.5. I do believe recent experience only reinforces long-standing 

American aversion to mixtures of banking and commerce. The commercial industrial loan companies and other devices to blur the distinction should be guarded against, severely limited if not prohibited. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR JOHNSON 

FROM GENE L. DODARO 

Q.1. There is pressure to move quickly and reform our financial 

regulatory structure. What areas should we address in the near future and which areas should we set aside until we realize the full 

cost of the economic fallout we are currently experiencing? 

A.1. As we noted in our January 2009 report, financial regulators 

have been appropriately focused on limiting the damage from the 

current crisis to the United States economy and its financial system.1 Given the experiences of other countries, particularly Japan 

that suffered stagnation for a decade likely as a result of its ineffective attempts to address its financial crisis in the 1990s, Congress and regulators should likely continue to address in the near 

term efforts to further stem the crisis and restore our financial institutions to more normal operating conditions, including finding 

an appropriate and effective solution to the issue of troubled assets 

being held by so many institutions. 

However, directing actions more to the current crisis should not 

preclude Congress from exploring with regulators plans for modernizing the United States financial regulatory system. As we 

pointed out, taking piecemeal actions and creating new regulations 

and regulatory bodies in the aftermath of past financial turmoil is 

one reason why our current structure is so fragmented and has the 

gaps and inconsistencies in oversight that have contributed to the 

current crisis. As a result, careful consideration of how best to develop a structure and financial regulatory bodies within it that 

more holistically embodies aspects like the nine elements of an effective regulatory system that we described in our report is imporVerDate Nov 24 2008 11:07 Jul 15, 2009 Jkt 000000 PO 00000 Frm 00271 Fmt 6602 Sfmt 6602 S:\DOCS\50564.TXT SHERYL
264 

tant. Taking adequate time to consider and complete this critical 

task is more advisable than taking quick actions that could lead to 

gaps or inconsistencies later. 

Q.2. The largest individual corporate bailout to date has not been 

a commercial bank, but an insurance company. Given the critical 

role of insurers in enabling credit transactions and insuring 

against every kind of potential loss, and the size and complexity of 

many insurance companies, do you believe that we can undertake 

serious market reform without establishing Federal regulation of 

the insurance industry? 

A.2. Over the years, GAO has reported on the inconsistency and 

lack of uniformity of regulation that insurance companies receive 

across states. This lack of consistency can lead to uneven protections for consumers across states as well as inefficiencies for insurers that could lead to higher premiums. We currently have a study 

under way looking at reciprocity and uniformity of State insurance 

regulation in three key areas: product approval, producer licensing, 

and market conduct regulation. The study will touch on issues of 

consistent oversight across states. Having an optional Federal charter for insurance would be one way to potentially increase the consistency of oversight of insurance companies. 

Although the problems experienced by AIG and the subsequent 

action by the Government to address them demonstrates that the 

United States has significant gaps in its oversight of significant financial institutions, the extent to which this case demonstrates the 

need for Federal insurance oversight is unclear. Although some of 

AIG’s financial difficulties arose from the securities lending activities engaged in by its life insurance companies, and some of the 

Federal assistance went toward unwinding those transactions, the 

insurance company operations were, and have remained, stable. 

Those companies have been negatively affected by the damage to 

the parent company’s reputation, and may no longer benefit to the 

same extent from the parent company’s financial strength, but they 

appear to be financially sound. While it’s possible closer review by 

State insurance regulators may have more quickly identified the 

risk associated with the life insurance companies’ securities lending 

operations, the primary problems appear to have originated in one 

of AIG’s non-insurance subsidiaries. In addition, State insurance 

laws require State insurance regulators to approve any significant 

transactions between an insurance company and its parent company or other subsidiaries, and, according to State regulatory officials and AIG securities filings, some State regulators did not allow 

transactions that would have transferred capital from AIG’s insurance companies to the parent company. 

Q.3. The GAO recommends consistent financial oversight—to ensure that similar institutions, products, risk and services are subject to consistent regulation oversight and transparency. In the 

case of insurance, the regulation and oversight is not consistent. 

Shouldn’t insurance receive the same consistent financial oversight 

that is desperately needed for other financial institutions? 

A.3. In our January 2009 report on the need for regulatory reform, we noted that the United States needs a financial regulatory 

system that is appropriately comprehensive and provides consistent 

265 

2GAO–09–216. 

oversight of institutions engaging in similar activities and risks. In 

addition, we advocated that consumer protections be similarly consistent across institutions and products. As a result, to the extent 

that insurance companies conduct activities, such as over-thecounter derivatives trading or market products as investment alternatives to securities or bank saving products, we advocated that 

they be overseen with similar risk management, capital, and consumer disclosure requirements. 

In general, the operations of most insurance companies themselves do not appear to have given rise to the complexities that 

made regulation difficult in the case of AIG. For entities that just 

engage in insurance activities, having Federal oversight could be 

one way that more uniformity of oversight is achieved. However, 

our report also noted that State regulators, including those for insurance, have played important roles in identifying and taking actions to address problems for consumers. As noted above, we have 

a study under way looking at reciprocity and uniformity of State 

insurance regulation that will touch on issues of consistent oversight across States. 

Q.4. The GAO’s report suggests that Congress should consider 

establishing a Federal insurance regulator; can you comment on 

the advantages of creating a Federal insurance regulator in the 

United States? 

A.4. As we noted above, a Federal insurance charter could have 

the potential to alleviate some of the challenges in harmonizing insurance regulation across States. However, we also note that such 

an approach could have various disadvantages. Currently, property 

and casualty insurance activities are heavily influenced by State 

laws—including those relating to insurance, torts, and business operations—and having Federal oversight of such varying requirements could be very challenging. In addition, State regulators assert that because of their greater familiarity with the particular demographics of their jurisdictions, they are in a better position to 

protect consumers. Another issue that would have to be addressed 

in implementing a Federal insurance charter would be the loss of 

income to states from taxes paid on insurance premiums by consumers. These taxes generally provide funds beyond what is required to fund the regulation of insurance. 

Q.5. How should the Government and regulators look to mitigate 

the systemic risks posed by large interconnected financial companies? Do we risk distorting the market by identifying certain institutions as systemically important? How do foreign countries identify and regulate systemically critical institutions? 

A.5. Various options exist for addressing the systemic risk posed 

by large interconnected financial institutions. As we advocated in 

our January 2009 report, such institutions should receive comprehensive and consistent regulation from both a prudential and 

consumer protection standpoints.2 Having such oversight should reduce the potential for such institutions to experience problems that 

threaten the stability and soundness of other institutions and the 

overall financial system itself. In addition, we advocated that our 

266 

regulatory system needs a systemwide focus to address the potential threats to system stability that can arise from institutions, 

products, and markets. Such a focus could be achieved by designating an existing regulator or creating a new entity to be tasked 

with overseeing systemic risk in the United States. Such an entity 

could also be tasked with prudential oversight of the large interconnected financial institutions or their primary oversight could remain the responsibility of another regulator with the systemic risk 

regulator supplementing this oversight by collecting information, 

examining operations, and directing changes from the large institutions as needed. 

While one obvious way of ensuring that these large institutions 

are all subject to similar regulatory requirements and oversight 

would be to designate them as systemically important and place 

them under the regulation of a single regulatory body, such an approach also has disadvantages. Some market observers have expressed concerns that designating certain institutions as systemically important could distort competition in the financial market 

sectors in which these entities operate by providing the designated 

institutions with funding advantages and reducing market discipline of the firms that do business with them because of the belief 

that the Government will not allow such institutions to fail. In 

light of the experience of the housing Government-sponsored enterprises recently, such concerns should be taken seriously. 

However, the more extensive oversight that systemically important financial institutions would likely receive could offset some of 

the competitive advantage they receive from being designated as 

so. Given such institutions greater potential than other institutions 

to create systemic problems, they should appropriately be subject 

to higher prudential standards for capital, liquidity, and counterparty risk management, etc. So although their status as systemically important institutions could possibly create competitive distortions or moral hazard, increased prudential standards would 

seek to mitigate that (and any systemic risks they might pose). 

Other countries have not generally had to face the issue of 

whether their systemically important institutions should be supervised separately because of the differences in the regulatory and 

market structures outside the United States. In many countries, 

the primary financial institutions are universal banks that offer a 

range of services across sectors, including banking, securities, and 

insurance activities, and that are overseen by a single regulatory 

body, which reduces the potential for inconsistent oversight. In addition, the number of financial institutions in many countries is 

relatively small, which also reduces the potential for less consistent 

oversight across institutions that might provide a competitive advantage for those designated as systemically important. 

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