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SYSTEMIC RISK: ARE SOME INSTITUTIONS 

TOO BIG TO FAIL AND IF SO, WHAT 

SHOULD WE DO ABOUT IT? 

HEARING 

BEFORE THE

COMMITTEE ON FINANCIAL SERVICES 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED ELEVENTH CONGRESS 

FIRST SESSION 

JULY 21, 2009 

Printed for the use of the Committee on Financial Services 

Serial No. 111–65 

( 

(II) 

HOUSE COMMITTEE ON FINANCIAL SERVICES 

BARNEY FRANK, Massachusetts, Chairman 

PAUL E. KANJORSKI, Pennsylvania 

MAXINE WATERS, California 

CAROLYN B. MALONEY, New York 

LUIS V. GUTIERREZ, Illinois 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

GARY L. ACKERMAN, New York 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

DENNIS MOORE, Kansas 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

MELISSA L. BEAN, Illinois 

GWEN MOORE, Wisconsin 

PAUL W. HODES, New Hampshire 

KEITH ELLISON, Minnesota 

RON KLEIN, Florida 

CHARLES A. WILSON, Ohio 

ED PERLMUTTER, Colorado 

JOE DONNELLY, Indiana 

BILL FOSTER, Illinois 

ANDRE ́ CARSON, Indiana 

JACKIE SPEIER, California 

TRAVIS CHILDERS, Mississippi 

WALT MINNICK, Idaho 

JOHN ADLER, New Jersey 

MARY JO KILROY, Ohio 

STEVE DRIEHAUS, Ohio 

SUZANNE KOSMAS, Florida 

ALAN GRAYSON, Florida 

JIM HIMES, Connecticut 

GARY PETERS, Michigan 

DAN MAFFEI, New York 

SPENCER BACHUS, Alabama 

MICHAEL N. CASTLE, Delaware 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

RON PAUL, Texas 

DONALD A. MANZULLO, Illinois 

WALTER B. JONES, JR., North Carolina 

JUDY BIGGERT, Illinois 

GARY G. MILLER, California 

SHELLEY MOORE CAPITO, West Virginia 

JEB HENSARLING, Texas 

SCOTT GARRETT, New Jersey 

J. GRESHAM BARRETT, South Carolina 

JIM GERLACH, Pennsylvania 

RANDY NEUGEBAUER, Texas 

TOM PRICE, Georgia 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

ADAM PUTNAM, Florida 

MICHELE BACHMANN, Minnesota 

KENNY MARCHANT, Texas 

THADDEUS G. McCOTTER, Michigan 

KEVIN McCARTHY, California 

BILL POSEY, Florida 

LYNN JENKINS, Kansas 

CHRISTOPHER LEE, New York 

ERIK PAULSEN, Minnesota 

LEONARD LANCE, New Jersey 

JEANNE M. ROSLANOWICK, Staff Director and Chief Counsel 

(III) 

C O N T E N T S 

Page 

Hearing held on: 

July 21, 2009 ..................................................................................................... 1 

Appendix: 

July 21, 2009 ..................................................................................................... 47 

WITNESSES 

TUESDAY, JULY 21, 2009 

Johnson, Simon, Professor, Massachusetts Institute of Technology ................... 9 

Mahoney, Paul G., Dean, University of Virginia School of Law .......................... 14 

Rivlin, Alice M., Senior Fellow, The Brookings Institution ................................. 5 

Wallison, Peter J., Arthur F. Burns Fellow in Financial Policy Studies, American Enterprise Institute ..................................................................................... 7 

Zandi, Mark, Chief Economist and Co-Founder, Moody’s Economy.com ............ 12 

APPENDIX 

Prepared statements: 

McCarthy, Hon. Carolyn .................................................................................. 48 

Johnson, Simon ................................................................................................. 49 

Mahoney, Paul G. ............................................................................................. 61 

Rivlin, Alice M. ................................................................................................. 68 

Wallison, Peter J. ............................................................................................. 79 

Zandi, Mark ...................................................................................................... 86 

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Frank, Hon. Barney: 

Written statement of the Property Casualty Insurers Association of 

America (PCI) ................................................................................................ 104 

(1) 

SYSTEMIC RISK: ARE SOME INSTITUTIONS 

TOO BIG TO FAIL AND IF SO, WHAT 

SHOULD WE DO ABOUT IT? 

Tuesday, July 21, 2009 

U.S. HOUSE OF REPRESENTATIVES, 

COMMITTEE ON FINANCIAL SERVICES, 

Washington, D.C. 

The committee met, pursuant to notice, at 2:03 p.m., in room 

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

Members present: Representatives Frank, Kanjorski, Maloney, 

Watt, Sherman, Moore of Kansas, Capuano, Clay, Green, Cleaver, 

Ellison, Perlmutter, Donnelly, Foster, Carson, Minnick, Kosmas, 

Himes, Peters; Bachus, Royce, Biggert, Capito, Hensarling, Garrett, 

Neugebauer, Bachmann, Marchant, McCarthy of California, Lee, 

Paulsen, and Lance. 

The CHAIRMAN. The hearing will come to order. 

Sometimes, we have hearings to find things out. That’s not the 

unvarying reason why we have hearings, but sometimes we actually have hearings because we want to learn things. For me, this 

is one of those times. 

There is a great disparity I have encountered between the overwhelming consensus that we do not like the effects of ‘‘too big to 

fail,’’ and what to do about it. 

It is a concept, it seems to me, more easily denounced than dismantled. And we, I think, have broad agreement in this committee 

that it’s not a good thing and it’s not helpful for a number of reasons. 

And, you know, we are open to ways to deal with it. There are 

ways to deal with it indirectly and directly, but this is legitimately 

and we have a panel today unlike many of our panels. 

It does not consist of practitioners, people in the financial industry, consumer advocates. It’s as near as we can see people with 

good analytical skills, and I mean this literally. I think there is a 

great eagerness on the part of my colleagues to figure out what’s 

the most appropriate way to deal with ‘‘too big to fail,’’ and we are 

here to listen. 

The gentleman from Texas. 

Mr. HENSARLING. Thank you, Mr. Chairman. 

I am curious, and I too want to listen to our witnesses very carefully. I’m not sure I have been convinced of the proposition of ‘‘too 

big to fail,’’ and if I have I haven’t quite convinced myself that the 

cure is not worse than the illness. I’m not completely convinced 

2 

we’re not kicking the economic calamity can down the road for future generations to deal with. 

Now, back in the circumstances of last September and October, 

I believe there was fairly universal thought that Congress needed 

to act. Clearly, we disagreed on the plan on how best to do that. 

Even as a fiscal conservative, I was willing to put the full faith and 

credit of the United States on the line in what I perceived to be 

one of the first truly emergency situations I had seen since coming 

to Congress, although I hear the phrase every single day that I 

serve. 

But as I look closely at firms that may be designated supposedly 

as too big to fail, the two that come to mind are certainly Fannie 

Mae and Freddie Mac. Again, these were creations not of a competitive market, but creations in a government laboratory that 

never would have existed in a competitive market. And so I guess 

I’m convinced that government can create firms that some may 

view as too big to fail, that can create systemic risk, but I’m more 

convinced that there aren’t more systemic events than there are 

systemic firms. And I’m not sure as this Nation has followed down 

the line of bailout mania that we necessarily have a whole lot to 

show for it. 

As we wake up today, we know since January that 21⁄2 million 

more Americans have lost their jobs. We have, I believe, 9.5 percent unemployment. We’re looking at the highest unemployment 

rate in a quarter of a century, and I feel that bailout begets bailout. Once we got away, for example, on TARP being about financial 

stability, bailing out Chrysler, bailing out GM, many of us said, 

we’re going to throw good money after bad. They’re going to end 

up in Chapter 11 anyway, and roughly $80 billion taxpayer dollars 

later, guess what? They did. 

You know, how is that fair to Ford who actually had to take on 

more debt to try to survive? And so, you know, to what extent is 

it even fair? To what extent is it even smart once you go down the 

road to start bailing out these firms? And so many of us fear, and 

I have introduced legislation, that TARP is now, regardless of its 

noble design back in September, October of last year, has morphed 

into a $700 billion revolving bailout slush fund that frankly is 

doing more harm to the economy than good. Now, I do want there 

to be an opportunity for large financial firms that fall into financial 

distress to be resolved and resolved quickly. 

That’s why in the Republican financial markets reform bill there 

is a provision that would create in the Bankruptcy Code a new 

Bankruptcy chapter to do just this. But, you know, you have to ask 

yourself the question: Should it be the policy of the Federal Government to necessarily reward bad business models at the expense 

of good business models? And, by the way, apparently CIT was not 

necessarily on the Administration’s list of ‘‘too big to fail’’ when apparently Uncle Sam wouldn’t give them a bailout. Lo and behold! 

Look what happens. The market comes through. 

Isn’t that interesting? You know, instead of CIT, maybe we 

should say see, I told you so. Maybe you ought to give private investment an opportunity to work. Again, bailout begets bailout. It 

keeps private investment on the sidelines. I’m convinced that it is 

hampering our economic growth. It’s hampering our job creation, 

3 

and I still look for the proof point that there are firms that are too 

big to fail, and that somehow by putting all this taxpayer liability 

exposure on the line, we’re going to end up doing ourselves more 

good than harm. 

I’m not convinced of it, I don’t think the American people are 

convinced of it, and so what do we have? We have a nation of bailout mania, trillions of dollars of debt. I think there’s a better way. 

I yield back the balance of my time. 

The CHAIRMAN. The gentleman from California is recognized for 

3 minutes. 

Mr. SHERMAN. Thank you, Mr. Chairman. 

Some say too big to fail, some say too interconnected to fail. 

Some of my constituents just think it’s too well-connected to fail. 

We need to design a system for the future that is bailout free. I 

was disappointed when the Secretary of the Treasury testifying 

about derivatives said in effect by not answering my question that 

we should continue to allow derivatives to be written today, that 

he reserves the right to seek to bail out tomorrow. 

We need to return to an economic system where bailout is not 

a possibility. We need to make sure that the resolution authority 

is extremely clear that it is not bailout authority. And we were still 

faced with this issue of what is too big to fail. Too big to fail means 

too big to exist. We cannot put the taxpayer in a position where 

entities are allowed to grow in their complexity or their size to the 

point where they can hold the American taxpayer hostage, and say, 

we’re going to take risks. And if these risks turn out badly, you 

have to bail us out or the entire economy will suffer. 

The solution is obvious: Prevent risks from being taken that endanger the entire economy. Now, we will be told that taking all 

these risks is somehow wonderful for the overall Wall Street system. I don’t think the American people want to hear it. They want 

no bailouts in the future; no possibility of bailouts in the future; 

and they want a system designed where everyone on Wall Street 

and everyone in Washington can say no bailouts ever. 

And if that means that our banks have to be smaller than their 

foreign competition, that is something I think the American people 

are ready to accept. So let us talk about breaking up those that are 

too big to fail before we talk about bailing them out, and hopefully 

we can, through better capital reserves and better regulation, 

eliminate both possibilities. 

Thank you. 

The CHAIRMAN. The gentleman from California for 21⁄2 minutes, 

Mr. Royce. 

Mr. ROYCE. Thank you, Mr. Chairman. 

I would like to thank the witnesses for coming here today to testify, and a special thanks to Peter Wallison from AEI who for years 

warned about the systemic threat posed by the Government-Sponsored Enterprises Fannie Mae and Freddie Mac. I got to know 

Peter back in the old days when he was raising these concerns. 

Eventually, the Federal Reserve itself became convinced that 

Peter was absolutely right, and in about 2004, they began to warn 

on what he was warning that this represented a systemic threat 

to the financial system, not just here in the United States, but 

worldwide at one point, the Fed Chairman said. 

4 

You know, for years there was this belief that should Fannie and 

Freddie run into trouble, the Federal Government would support 

them. After all, they had a line into the Treasury. They were Government-Sponsored Enterprises, and as Peter was warning, that 

perception allowed Fannie and Freddie to borrow at rates normally 

reserved for branches of the Federal Government, to take on excessive risk, and produce profits for shareholders and executives while 

they crowded out their competition. This was normally the result 

of when you have a government subsidy, this was the consequence. 

Well, the Federal Government had to step in to save Fannie and Freddie, and this could end up costing taxpayers $400 billion before 

it’s through, besides the effect that it had on the housing market, 

the collapse of the housing market. Additionally, the Federal Government is taking drastic steps using trillions of dollars to prop-up 

failed institutions because it was believed these institutions were 

too big to fail. One of the most unfortunate consequences of the 

massive move to provide public assistance is that moral hazard 

may become more deeply imbedded in our financial markets. 

We can and should take steps to eliminate the need and possibility of official bailouts in the future by avoiding labeling institutions as systematically important and providing an enhanced bankruptcy procedure to deal with non-bank financial institutions as an 

alternative to the course that we seem to be on. And this will provide clarity to the market. It will reduce the perceived government 

safety net, and lessen the moral hazard problem that has been created in recent months. In terms of the problems we’re going to deal 

with looming in the future, I think we have to take lessons from 

the mistakes made. And this panel here today I think will give us 

an opportunity to discuss just such issues. 

Thank you, Mr. Chairman. 

The CHAIRMAN. The Federal requests, we have a couple. And I 

just want to comment in the meantime that some of the members 

have a different view of this hearing than I do. 

We have heard very eloquent arguments against bailouts. Yes, 

that’s what this hearing is for, to see how we can avoid pressures 

to do them. This is not a case where it is an assumption that we’re 

going to have these large institutions and then figure out what we 

do if we get into trouble. Yes, precisely our role is to try to avoid 

the situation that the Bush Administration faced as it felt with regard to Bear Stearns and with regard to Lehman Brothers and 

Merrill Lynch and AIG. 

All those happened under the Bush Administration, committed to 

free enterprise, but they felt that the consequences of the failures 

there would be disastrous. They had four different ways of dealing 

with them, none of them satisfactory to a lot of people, including 

themselves. So that is precisely the point of this hearing, so that 

one, you make it much less likely that there will be institutions in 

that situation, because of capital requirements and other things. 

And, two, that if you do get to that, there are ways of putting them 

down much less disruptively and much less expensively. So, as I 

said, this is not a reply of last year. It’s enough to try and stop it. 

Mr. Garrett of New Jersey for 21⁄2 minutes. 

Mr. GARRETT. I thank the chairman. I thank all the members of 

the panel as well, and specifically Mr. Mahoney, because I’m just 

5 

going to steal a little of your thunder because I think you made a 

good point in your remarks. 

Mr. Mahoney is the dean of University of Virginia law school, 

and in your remarks of which you’ll go into more detail—but I just 

want to point this out—you say what approach that is used—I 

think which is a Republican approach—believes that it was a mistake to bail out creditors of failed institutions when Bankruptcy 

proceedings were a tried and true alternative option. And this 

school of thought believes that policymakers should make it clear 

going forward that these mistakes will not be repeated and take 

steps to limit Treasuries and the Federal Reserve’s ability to commit funds to failed institutions in the future. 

So, I would just say that I think this approach is basically in a 

nutshell what the Republican Financial Service Reform Plan is all 

about. The other approach is to concede that the government will 

not refuse to bail out certain large institutions and attempt to take 

steps to deal with their risky behavior, as the chairman just said. 

But, you know, if regulators fail to adequately limit their behavior, then a formal bailout framework would have to be set up in 

the meantime, and firms will be bailed out in a manner of course. 

So as I say, the Administration’s plan basically follows this blueprint. The Administration’s approach is premised on the anticipation that regulatory oversight would compensate for misaligned incentives. But we know time and time again, regulators have proved 

to be high on the curve and unable to keep up with the practices 

of companies that are tasked with regulating. 

So we don’t need to make their job any harder by encouraging 

destructive behavior to misaligned incentives. I do believe that the 

Republican plan is preferable, because it is based on a more sound 

premise. It would reduce moral hazard, because companies and 

creditors and counterparties would be responsible for the costs associated with their failures, not the taxpayers. And when companies and creditors have their own money on the line rather than 

other people’s money, sounder decisions are made benefiting the 

entire financial system. You saw what happened when Fannie and 

Freddie profits were privatized and risks were socialized. 

We don’t want to repeat those mistakes time and again by following the Administration’s proposal, which would create a whole 

privileged class of new Fannies and Freddie while institutionalizing an entire regime that would lead to expected and actual future bailouts. These would be bailouts that were paid for by the 

American taxpayer and smaller financial institutions, those that 

wouldn’t even benefit from the government’s ‘‘too big to fail’’ are 

premature in the first place. 

I thank you, and I thank Mr. Mahoney. 

The CHAIRMAN. We will now begin with Alice Rivlin. 

STATEMENT OF ALICE M. RIVLIN, SENIOR FELLOW, THE 

BROOKINGS INSTITUTION 

Ms. RIVLIN. Thank you, Mr. Chairman. 

I am really glad you’re holding this hearing to focus on the question of systemic risk and how do we avoid getting into this situation again; and, as you pointed out, I don’t think anybody wants 

6 

more bailouts ever if we can avoid it. I think that requires focusing 

on prevention. 

How do we fix the financial system so that we don’t have these 

perfect storms of a huge bubble that makes our system very prone 

to collapse? And then if this does happen, how do we make it less 

likely that we would have to resort to bailing out institutions? 

So I think the task before this committee is first to repair the 

regulatory gaps and change the perverse incentives and reduce the 

chances that we will get another pervasive bubble. But, however, 

hard we try to do this, we have to recognize that there’s no permanent fix. And I think one concept of systemic risk, what I call a 

macro system stabilizer that we need is an institution charged with 

looking continuously at the regulatory system at the markets and 

at perverse incentives that have crept into our system. 

Because whatever rules we adopt will become obsolete as financial innovation progresses, and market participants find around the 

rules. This macro system stabilizer, I think, should be constantly 

searching for gaps, weak links, perverse incentives, and so forth 

and should make views public and work with other regulators and 

Congress to mitigate the problem. Now, the Obama Administration 

makes a case for such an institution, for a regulator with a broad 

mandate to collect information from all financial institutions and 

identify emerging risk. It proposes putting this responsibility in a 

financial services oversight counsel, chaired by the Treasury with 

its own expert staff. 

That seems to me likely to be a cumbersome mechanism, and I 

would actually give this kind of responsibility to the Federal Reserve. I think the Fed should have the clear responsibility for spotting emerging risks, and trying to head them off before it has to 

pump trillions into the system to avert disaster. The Fed should 

make a periodic report to the Congress on the stability of the financial system and the possible threats to it, similar to the report you 

heard from Mr. Bernanke this morning about the economy. It 

should consult regularly with the Treasury and other regulators, 

but it should have the lead responsibility for monitoring systemic 

risk. 

Spotting emerging risk would fit naturally with the Fed’s efforts 

to monitor the state of the economy and the health of the financial 

sector in order to set and implement monetary policy. Having that 

explicit responsibility and more information on which to base it 

would enhance its effectiveness as a central bank. I would also suggest giving the Fed a new tool to control leverage across the financial system. 

While lower interest rates may have contributed to the bubble, 

monetary policy has multiple objectives, and the short-term interest rate is a poor tool for controlling bubbles. The Fed needs a 

stronger tool, a control of leverage more generally. But the second 

task is one you have emphasized in your title, how to make the 

system less vulnerable to cascading failures, domino effects, due to 

the presence of large interconnected financial firms whose failure 

could bring down other firms and markets. This view of what happened could lead to policies to restrain the growth of large interconnected financial firms or even break them up. 

7 

The CHAIRMAN. Could I get unanimous consent? I think it’s a 

complicated subject. We don’t have a lot of members here, so would 

there be any objection to going to 7 minutes for the witnesses? 

Hearing none, the witnesses get 7 minutes. It’s not a lot of time, 

but at least it is a little more, so please continue. 

Ms. RIVLIN. Okay. Thanks, Mr. Chairman. 

Some have argued for the creation of a single, consolidated regulator with responsibility for all systemically important financial institutions. The Obama Administration proposes making the Fed 

the consolidated regulator for Tier 1 financial institutions. I believe 

that would be a mistake. It would be a mistake to identify the specific institutions deemed ‘‘too big to fail,’’ and an even greater mistake to put this responsibility at the Federal Reserve. 

It’s hard to identify systemically important firms in advance. The 

attempt to do so and cordon them off might encourage risky behavior to move outside the cordon. Moreover, identifying systemically 

important institutions and giving them their own consolidated regulator tends to institutionalize too big to fail and create a new set 

of GSE-like institutions. 

Higher capital requirements and stricter regulation for large, 

interconnected institutions make sense, but I would favor a continuum rather than a defined list with its own special regulator. 

There is no obvious place to put responsibility for regulating financial institutions, but it seems to me a mistake to give the Federal 

Reserve responsibility for consolidated prudential regulation of big 

interconnected companies as proposed by the Obama Administration. The skills needed by a central bank are different from those 

needed to run an effective regulatory institution. 

The CHAIRMAN. Could you finish up if you have a last sentence 

or two? 

Ms. RIVLIN. Pardon? 

The CHAIRMAN. Do you have a last sentence or two? 

Ms. RIVLIN. Okay. Let me just conclude, Mr. Chairman. In short, 

I think the Obama Administration has it backwards, that the general spotter of financial risk should be the Fed and that it would 

be a mistake to have a consolidated regulator of ‘‘too big to fail’’ institutions. It’s a worse mistake to put at the Fed. 

[The prepared statement of Ms. Rivlin can be found on page 68 

of the appendix.] 

The CHAIRMAN. Mr. Wallison? 

STATEMENT OF PETER J. WALLISON, ARTHUR F. BURNS FELLOW IN FINANCIAL POLICY STUDIES, AMERICAN ENTERPRISE INSTITUTE 

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

Leaving aside Fannie Mae and Freddie Mac, which I think are 

a very special case, if there is such a thing as a firm that is too 

big to fail, it is only a large commercial bank. And we now have 

several of them that are enormous. 

When we say that a firm is too big to fail, we mean that its failure could have a major, adverse effect on the entire economy. This 

is not simply a mere disruption of the economy. It would have to 

be a systemic breakdown. We can’t define that very well, but it 

would have to be something greater than simply the kind of disrupVerDate Nov 24 2008 17:50 Dec 10, 2009 Jkt 053245 PO 00000 Frm 00011 Fmt 6633 Sfmt 6633 K:\DOCS\53245.TXT TERRIE
8 

tion that would occur from the failure of a firm. In my view, only 

a large commercial bank can create this kind of systemic breakdown. 

When a large bank fails, its depositors are immediately deprived 

of the funds they expected to have to meet payrolls and to pay their 

bills. Smaller banks are depositors in the larger banks, so the failure of a large bank can send a cascade of losses through the economy. If there is such a thing as a systemic breakdown, this would 

be it. For the same reasons, it is difficult to see how a large nonbank financial institution, that is, a bank holding company, a securities firm, a finance company, or a hedge fund can cause systemic 

risk. And thus it is difficult to see why a non-bank can ever be, in 

terms we are talking about today, too big to fail. 

Non-banks do not take deposits. They borrow for the short-, medium-, and long-term, but if they fail, their creditors don’t suffer 

any immediate cash losses that would make it difficult for them to 

pay their bills. No one deposits his payroll or the money he expects 

to use for doing business with a securities firm or a finance company. In addition, their creditors are likely to be diversified lenders, so all their eggs are not in the same basket. 

However, the freeze-up in lending that followed the collapse of 

Lehman Brothers has led some people to believe, and I think incorrectly, that Lehman caused that event. This is not accurate. They 

conclude that a non-bank financial firm can cause a systemic 

breakdown that it can thus be too big to fail. But Lehman’s failure 

caused what is called a common shock, where a market freezes up 

because new information has come to light. The new information 

that came to light with Lehman’s failure was that the government 

was not going to rescue every firm larger than Bear Stearns, which 

had been rescued 6 months before. 

In this new light, every market participant had to reevaluate the 

risks of lending to everyone else. No wonder lending ground to a 

halt. Common shocks don’t always cause a financial crisis. This one 

did, because virtually all large banks were thought at that time to 

be weak and unstable. They held large amounts of mortgage 

backed securities, later called toxic assets, that were of dubious 

value. 

If the banks had not been weakened by these assets, they would 

have continued to lend to each other. There would not have been 

a freeze-up in lending and the investor panic that followed. So if 

we want to avoid another crisis like that, we should focus solely on 

ensuring that the banks—we’re talking about commercial banks— 

are healthy. Other financial firms, no matter how large, are risk 

takers and should be allowed to fail. 

Accordingly, if we want to deal with the problem of too big to fail 

and systemic risk bank regulation should be significantly reformed. 

Capital requirements for large banks should be increased as those 

banks get larger, especially if their assets grow faster than asset 

values generally. Higher capital requirements for larger banks 

would cause them to reconsider whether growth for its own sense 

really makes sense. Bank regulators should develop metrics or indicators of risk taking that banks should be required to publish regularly. This will enhance market discipline, which is fundamentally 

the way we control risk taking in the financial field. 

9 

Most important of all, Congress should create a systemic risk 

council on the foundation of the Presidents Working Group, which 

would include all the bank supervisors and other financial regulators. The council should have its own staff and should be charged 

with spotting the development of conditions in the banking industry, like the acquisition by virtually all banks of large amounts of 

toxic assets, that might make all major banks weak or unstable 

and leave them vulnerable to a common shock. If we keep our 

banks stable, we’ll keep our financial system stable. 

Finally, as a member of the Financial Crisis Inquiry Commission, 

I urge this committee to await our report before adopting any legislation. 

Thank you. 

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

79 of the appendix.] 

STATEMENT OF SIMON JOHNSON, PROFESSOR, 

MASSACHUSETTS INSTITUTE OF TECHNOLOGY 

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

As you said at the beginning, the question, I think, is not controversial. The issue is to remove the possibility in the future that 

a large financial institution can come to the Executive Branch and 

say, ‘‘Either you bail us out, or there will be an enormous collapse 

in the financial system of this country and potentially globally.’’ 

And I think there are two broad responses to that, two ways of 

addressing that problem that are on the table. 

The first is what I would call relatively technocratic adjustments, 

changing the rules around regulation or changing the rules around 

bankruptcy procedure. 

I think there are some sensible ideas there, that are relatively 

small ideas. I don’t believe they will fundamentally solve this problem. 

The second approach is to reduce the size of these banks, and 

what we have learned, I think, over the past 9 months is a considerable amount about how small financial institutions can fail, and 

can fail without causing major systemic problems, both through an 

FDIC-type process, or through a market type process, as seen with 

the CIT Group. 

Let me emphasize or underline the difference between these two 

approaches, and why making them smaller is both attractive and 

feasible. 

I think that the key problem is this financial sector has become 

very persuasive. It has convinced itself, it has convinced its regulator, it has convinced many other people that it knows how to 

manage risks, that it understands what are large risks for itself. 

And of course this is what Mr. Greenspan now concedes was a 

mistake in his assessment of the situation during the boom. He 

thought that the large firms that had a great deal to lose if things 

went badly understood these risks and would control them and 

manage them. And they didn’t. 

It’s a massive failure of risk management and I see no indication 

either that the banks have improved this kind of risk management 

in the largest institutions, or that regulators are better able to spot 

this. 

10 

And while I agree with the idea we should have a systemic risk 

spotter of some kind, analytically and politically, it seems to me 

we’re a long way from ever achieving that. 

And if I may mention the lobbying of Fannie and Freddie on the 

one hand, and private banks on the other hand, it was just fantastic. These people are the best in the business, by all accounts, 

at speaking with many people, both with regard to legislation and 

of course detailed rules. 

Again, I see no reason to think that if you tweak the technocratic 

structures, you will remove this power and this ability that these 

large financial institutions have brought to bear. 

And it’s not just in the last 5 to 10 years; it’s historically in the 

United States and in many other countries, or perhaps most other 

countries the financial system has this kind of lobbying power, this 

kind of too-connected-to-fail issue raised by Mr. Sherman. 

Now I think, Mr. Chairman, if you put it in those terms and if 

you look hard at the technocratic adjustments, the most promising 

solution is to adjust the capital requirements of the firms, as Mr. 

Wallison said, in such as fashion as it becomes less attractive and 

less profitable to become a big financial firm. 

I also agree and would emphasize what Ms. Rivlin said, which 

is thinking about how to target leverage and control leverage, 

again through something akin to a modern version of margin requirements is very appealing in this situation. 

It’s about size. CIT Group was $80 billion in assets. Treasury 

and other—looked long and hard not at that before deciding not to 

bail it out. 

I think from what we see right now, that was a smart decision. 

I think the market can take care of it. 

The line they’re drawing seems to be around $100 billion in assets. Financial institutions above $500 billion in assets right now 

clearly benefit from some sort of implicit government guarantee, 

going forward. 

And that’s a problem, that distorts incentives, exactly as many 

members of the committee emphasized it at the beginning. 

So I think stronger capital requirements. You could also do this 

with a larger insurance premium for bigger banks. What have they 

cost? What has the failure of risk management at these major 

banks cost the United States? 

Well, I would estimate that our privately held government debt 

will rise from around 40 percent of GDP, where it was initially to 

around 80 percent of GDP as the result of all the measures, direct 

and indirect, taken to save the financial system and to prevent this 

from turning into another Great Depression. 

That’s a huge cost, and at the end of the day, you actually have 

more concentrated economic power, a more concentrated political 

access influence—call it what you want—in the financial system. 

So for 40 percent of GDP, we bought ourselves nothing in terms 

of reducing the level of system risk that we know now was very 

high, 2005–2007. 

I think it’s capital requirements and you can combine that with 

higher insurance premium, reflecting the system costs. That’s a lot 

of money. And include a tax on leverage. 

11 

Now I want to, in my remaining 2 minutes, emphasize some 

issues of implementation I think are very important. 

The first is in terms of timing. I think the capital requirements 

can be phased in over time. I think the advantage of an economy 

that’s bottoming out and starting to recover, you don’t have to do 

this right away. The firms will likely—not for sure—will likely not 

engage in the same kind of restless risk-taking in the next 2 to 3 

years. 

So there is some time to get ahead of this. But you really don’t 

want to run through anything like the kind of boom that we have 

seen before. And of course this will reduce the profitability in this 

sector. No question about it. 

And the industry will point this out. They will be very cross with 

you, and they will tell you that this undermines productivity 

growth, and job creation in the United States. 

I see no evidence that is the case. I see no evidence that having 

an overleveraged financial system with excessive risk-taking does 

anything at all for growth in the real non-financial part of the 

economy. 

Now I would emphasize, though, two important pieces of this 

that we should also consider and that are more tricky. 

The first is foreign banks. So if we reduce the size of our banks, 

relative to the size of foreign banks, I think that does not create 

a competitive disadvantage for our industry. But it does raise the 

question of, ‘‘How should you treat foreign banks operating in the 

United States?’’ 

For example, Deutsche Bank, or other big European banks, 

banks that are very big relative to the size of those economies in 

Europe, let alone the size of the banks that we may end up with. 

Those banks, to the extent they operate in the United States, 

should be treated in the same way as U.S. banks. The capital requirements have to be high based on where you operate. And if you 

want to operate in the U.S. financial markets, that will have to be 

a requirement. 

Otherwise, you get into a situation where the next bank that 

comes to the Treasury and says, you know, ‘‘It’s bailout or collapse,’’ will be a foreign bank, and that will be even more of a disaster than what we have faced recently. 

The second transactional issue, and my final point is with regards to the resolutional authority, I think Congress is rightly considering very carefully the resolutional authority requested by the 

Treasury, and I think that broadly speaking, that’s a good idea. 

But I would emphasize, it is not sufficient. It’s not a global 

resolutional authority. If a major multi-national bank comes to you 

with a problem and you know, you would like to say to them, ‘‘Go 

through bankruptcy,’’ but then when you look at the details of that, 

you see it will be a complete mess, because of the cross-border dimensions of that business. 

The same thing is true for a bailout. If you bail them out under 

your resolutional authority, it’s also going to be a disaster unless 

you have a global agreement at the level of the G–20. 

Thank you very much, Mr. Chairman. 

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

49 of the appendix.] 

12 

The CHAIRMAN. Mr. Zandi? 

STATEMENT OF MARK ZANDI, CHIEF ECONOMIST AND COFOUNDER, MOODY’S ECONOMY.COM 

Mr. ZANDI. Thank you, Mr. Chairman, and members of the committee for the opportunity to be here today. 

I am an employee of the Moody’s Corporation, but my remarks 

today reflect only my own personal views. I will make five points 

in my remarks. 

Point number one: I think the Administration’s proposed financial regulatory reforms are much needed and reasonably well designed. The panic that was washing over the financial system earlier this year has subsided, but the system remains in significant 

disrepair. Our credit remains severely impaired. 

By my own estimate, credit, household, and non-financial corporate debt outstanding fell in the second quarter. That would be 

the first time in the data that we have all the way back to World 

War II, and highlights the severity of the situation. 

I think regulatory reform is vital to reestablishing confidence in 

the financial system, and thus reviving it, and thus by extension 

reviving the economy. 

The Administration’s regulatory reform fills in most of the holes 

in the current system, and while it would not have forestalled the 

current crisis, it certainly would have made it much less severe. 

And most importantly, I think it will reduce the risks and severity 

of future financial crises. 

Point number two: A key aspect of the reform is establishing the 

Federal Reserve as a systemic risk regulator. I think that’s a good 

idea. I think they’re well suited for the task. They’re in the most 

central position in the financial system. They have a lot of financial 

and importantly intellectual resources, and they have what’s very 

key—a history of political independence. 

They can also address the age-old problem of the procyclicality 

of regulation; that is, regulators allow very aggressive lending in 

the good times, allowing the good times to get even better, and 

tighten up in the bad times, when credit conditions are tough. 

I also think as a systemic risk regulator, the Fed will have an 

opportunity to address asset bubbles. I think that’s very important 

for them to do. There’s a good reason for them to be reluctant to 

do so, but better ones for them to weigh against bubbles. 

They, as a systemic risk regulator, will have the ability to influence the amount of leverage and risk-taking in the financial system, and those are key ingredients into the making of any bubble. 

Point number three: I think establishing a consumer financial 

protection agency is a very good idea. It’s clear from the current 

crisis that households really had very little idea of what their financial obligations were when they took on many of these products, 

a number of very good studies done by the Federal Reserve showing a complete lack of understanding. And even I, looking through 

some of these products, option ARMs, couldn’t get through the 

spreadsheet. These are very, very difficult products. And I think 

it’s very important that consumers be protected from this. 

There is certainly going to be a lot of opposition to this. The financial services industry will claim that this will stifle innovation 

13 

and lead to higher costs. And it’s true this agency probably won’t 

get it right all the time, but I think it is important that they do 

get involved and make sure that households get what they pay for. 

The Federal Reserve also seems to be a bit reluctant to give up 

some of its policy sway in this area. I’m a little bit confused by 

that. You know, I think they showed a lack of interest in this area 

in the boom and bubble. They have a lot of things on their plate. 

They’ll have even more things on their plate if this reform goes 

through. As a systemic risk regulator, I think it makes a lot of 

sense to organize all of these responsibilities in one agency, so that 

they can focus on it and make sure that it works right. 

Point number four: The reform proposal does have some serious 

limitations, in my view. The first limitation is it doesn’t rationalize 

the current alphabet soup of regulators at the Federal and State 

level. That’s a mistake. The one thing it does do is combine the 

OCC with the OTS. That’s a reasonable thing to do, but that’s it. 

And so we now have the same Byzantine structure in place, and 

there will be regulatory arbitrage, and that ultimately will lead to 

future problems. I can understand the political problems in trying 

to combine these agencies, but I think that would be well worth the 

effort. 

The second limitation is the reform does not adequately identify 

the lines of authority among regulators and the mechanisms for resolving difference. The new Financial Services Oversight Council, 

you know, it doesn’t seem to me like it’s that much different than 

these interagency meetings that are in place now, where the regulators get together and decide, you know, how they’re going to address certain topics. 

They can’t agree, and it takes time for them to gain consensus. 

They couldn’t gain consensus on stating simply that you can’t make 

a mortgage loan to someone who can’t pay you back. That didn’t 

happen until well after the crisis was underway. So I’m not sure 

that solves the problem. I think the lines of authority need to be 

ironed out and articulated more clearly. 

The third limitation is the reform proposal puts the Federal Reserve’s political independence at greater risk, given its larger role 

in the financial system. Ensuring its independence is vital to the 

appropriate conduct of monetary policy. That’s absolutely key; I 

wouldn’t give that up for anything. 

And the fourth limitation is the crisis has shown an uncomfortably large number of financial institutions are too big to fail. And 

that is they are failure risks undermining the system, giving policy 

makers little choice but to intervene. 

The desire to break up these institutions is understandable, but 

ultimately it is feudal. There is no going back to the era of GlassSteagall. Breaking up the banking system’s mammoth institutions 

would be too wrenching and would put U.S. institutions at a distinct competitive disadvantage, vis-a-vis their large global competitors. 

Large financial institutions are also needed to back-stop and finance the rest of the financial system. It is more efficient and practical for regulators to watch over these large institutions, and by 

extension, the rest of the system. 

14 

With the Fed as the systemic risk regulator, more effective oversight of too-big-to-fail institutions is possible. These large institutions should also be required to hold more capital, satisfy stiffer liquidity requirements, have greater disclosure requirements, and to 

pay deposit and perhaps other insurance premiums, commensurate 

with the risk they take and the risks that they pose to the entire 

financial system. 

Finally, let me just say I think the proposed financial system regulatory reforms are as wide-ranging as anything that has been implemented since the 1930’s Great Depression. The reforms are, in 

my view, generally well balanced, and if largely implemented, will 

result in a more steadfast, albeit slower-paced, financial system 

and it will have economic implications. 

And I think that’s important to realize, but I think necessary to 

take. 

The Administration’s reform proposal does not address a wide 

range of vital questions, but it is only appropriate that these questions be answered by legislators and regulators after careful deliberation. How these are answered will ultimately determine how 

well this reform effort will succeed. 

Thank you. 

[The prepared statement of Mr. Zandi can be found on page 86 

of the appendix.] 

The CHAIRMAN. Mr. Mahoney? 

STATEMENT OF PAUL G. MAHONEY, DEAN, UNIVERSITY OF 

VIRGINIA SCHOOL OF LAW 

Mr. MAHONEY. Thank you, Mr. Chairman, Ranking Member 

Bachus, and members of the committee. I appreciate the opportunity to present my views here today. 

I will discuss those portions of the Administration’s regulatory 

reform proposals that deal with the largest financial institutions, 

the so-called Tier 1 financial holding companies. 

The Administration proposes a special resolution regime for financial holding companies outside the normal bankruptcy process, 

that would be triggered when the stability of the financial system 

is at risk. 

And when the Treasury triggers the special resolution regime, it 

will have the authority to lend the institution money, purchase its 

assets, guarantee its liabilities, or provide equity capital with funds 

to be recaptured in the future from healthy institutions. 

I think it is fair to use the term, ‘‘bailout’’ to describe that system. 

There are two general schools of thought on how best to avoid 

future financial crises leading to widespread bailouts. The first 

holds that it was an error in the recent crisis to help creditors of 

failed institutions avoid losses that they would have realized in a 

normal bankruptcy proceeding, and that the focus of policy going 

forward should be to make it clear that the mistake will not be repeated. 

The alternative is to concede that the government will ordinarily 

bail out large and systemically important financial institutions. 

15 

Under this approach, Congress should focus on limiting the risks 

that those institutions can take, in order to minimize the likelihood 

that they will become financially distressed. 

Buy if those efforts fail, and a systemically important institution 

becomes financially distressed, a bailout will follow as a matter of 

course. 

The Administration’s financial reform blueprint takes this approach. 

I think the first approach will produce a healthier financial services industry that will make fewer claims on taxpayer dollars going 

forward. It is based on a sounder premise—that the best way to reduce moral hazard is to ensure that economic agents bear the costs 

of their own mistakes. 

The Administration’s plan is premised on the view that regulatory oversight will compensate for misaligned incentives. 

The central argument for trying to avoid bailouts through regulatory oversight rather than insisting that financial institutions 

bear the cost of their mistakes is that some institutions are too big 

to fail. 

Putting those institutions through bankruptcy could spread contagion, meaning that other banks or financial institutions may also 

fail as a consequence. 

Widespread bank failures in turn may reduce the availability of 

credit to the real economy, causing or exacerbating a recession. 

There is debate over that analysis. But in any event, it is not 

clear that the magnitude of the problem is sufficient to justify the 

scale of government intervention that we have seen in the past 

year. 

It is important to note that the loss of capital in the banking system in the recent crisis was not just the result of a temporary liquidity problem. It was the consequence of sharp declines in real 

estate and other asset values. A bailout can redistribute those 

losses to taxpayers, but it cannot avoid them. 

The bankruptcy process is itself a means of recapitalizing an insolvent institution. Bankruptcy does not imply or require that the 

firm’s assets, employees, and know-how disappear. Instead, it rearranges the external claims on the firm’s assets and cash flows. The 

holders of the firm’s equity may be wiped out entirely while unsecured creditors may have to substitute part or all of their debt 

claims for equity claims, thereby reestablishing a sound capital 

structure. 

If the insolvent institution still has the skill and experience to 

facilitate credit formation, it will continue to do so under new ownership, management, and capital structure. 

Of course, the bankruptcy process is subject to inefficiencies and 

delays, and those should be addressed. A more streamlined process 

may be appropriate for financial institutions, because they do have 

short-term creditors. 

But this does not require an alternative regime of institutionalized bailouts. A bailout regime, unlike a bankruptcy regime, creates moral hazard problems that impose costs on the banking sector continuously and not just during crises. 

Because creditors of too-big-to-fail financial institutions anticipate that they will be able to shift some or all of their losses to taxVerDate Nov 24 2008 17:50 Dec 10, 2009 Jkt 053245 PO 00000 Frm 00019 Fmt 6633 Sfmt 6633 K:\DOCS\53245.TXT TERRIE
16 

payers, they do not charge enough for the capital they provide. The 

financial institution in turn does not pay a sufficient price for taking risk. 

The result is a dangerous feedback loop. Large banks have access 

to cheap capital, which causes them to grow even larger and more 

systemically important, while taking excessive risks—all of which 

increase the probability of a crisis. 

Thus, a bailout regime leads to more frequent crises, even as it 

attempts to insulate creditors from them. 

The Administration believes its proposal will alleviate moral hazard and decrease the concentration of risk in too-big-to-fail institutions. The idea is that these Tier 1 financial holding companies will 

be subject to more stringent capital rules that will reduce the 

amount of risk they can take and create a disincentive to become 

a Tier 1 financial holding company in the first place. 

I think these disincentives are insufficient and implementation of 

the plan would increase and not decrease the concentration of risk. 

Once a firm has been designated a Tier 1 FHC, other financial institutions will view it as having an implicit government guarantee. 

The theory behind the proposal is that this advantage will be offset by stricter capital requirements and other regulatory costs, 

which will on balance make the cost of capital higher for Tier 1 

FHCs. 

That analysis strikes me as wildly optimistic. Having an implicit 

government guarantee, Tier 1 financial holding companies will be 

extremely attractive counterparties, because risk transferred to 

them will in effect be transferred to the Federal Government. 

Tier 1 financial holding companies will have a valuable asset in 

the form of the implicit guarantee that they will be able to sell in 

quantities limited only by the Fed’s oversight. They will have powerful incentives to find mechanisms—new financial products, or 

creative off-balance sheet devices—to evade any limits on the risks 

they can purchase from the rest of the financial sector. And banks 

that are not already Tier 1 financial holding companies will have 

strong incentives to grow to the point that they become Tier FHCs 

in order to guarantee access to bailout money. 

The fastest way to grow larger is to take bigger risks. An institution that can keep its gains while transferring losses to the government will engage in excessive risk-taking and excessive expansion, 

and the financial system as a whole will suffer more frequent crises. 

Thank you, and I look forward to your questions. 

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

61 of the appendix.] 

The CHAIRMAN. Thank you, Mr. Mahoney. 

Let me save some discussion about perhaps—a number of you 

have talked about this idea in the Administration of the list of Tier 

1 companies. And I understand the Administration understood that 

to mean that this would be a terrible—this would be a kind of probation for them. 

It does seem very clear that most people think that the reaction 

of these companies to being on that list would be that of Brer Rabbit to the briar patch. 

17 

And I’m going to suggest then they substitute a different model. 

I think with regard to identifying the companies that might be particularly a systemic risk, the Administration is going to have to 

adopt the approach of Potter Stewart to pornography. They will be 

able to know it when they see it, but they’re not going to have a 

pre-existing list. I think that idea is pretty much gone. 

Now, Mr. Johnson, one interesting issue that you referred to that 

has been suggested to us is to vary the bank insurance fund according to the riskiness of the venture. Am I correct in that? Is that 

something that could be conceptualized, measured with some degree of appropriate specificity? 

Mr. JOHNSON. Yes, Mr. Chairman. That is an idea that technical 

people, experts on the banking system, are working on. And the 

people I know who have made the most progress have work that’s 

not yet public, but I would be happy to— 

The CHAIRMAN. But if we had reached the level of reality that 

could be used as a basis for— 

Mr. JOHNSON. It will be a paper by one of my colleagues at Jackson Hole this summer, so— 

The CHAIRMAN. Okay. And you think that would have the effect 

of discouraging risk taking or penalizing those who took it? 

Mr. JOHNSON. Yes, sir. 

The CHAIRMAN. All right. That’s a very important issue. By the 

way, it divides the banking community up. You see the smaller 

banks, the community banks who feel they have been victimized by 

the trash talking—the American Banking Association not so much. 

Mr. Wallison, on the Systemic Risk Council that you talk about? 

Mr. WALLISON. Yes? 

The CHAIRMAN. That would be statutory, because the President’s 

Working Group is just— 

Mr. WALLISON. Yes— 

The CHAIRMAN. You know, five people get together and hang 

out—so you would make that statutory— 

Mr. WALLISON. Pursuant to an Executive Order, right. 

The CHAIRMAN. All right. By Executive Order. 

And then, I’m interested as to its powers. I do note you talk 

about the countercyclical macro potential that it could limit growth. 

When you say limit growth and you say by imposing higher capital—I assume by the way, there did seem to be an agreement here 

that as somebody imposed higher capital limits on institutions that 

grow, we don’t mean simply proportional, we mean disproportionate. That is, its— 

Mr. WALLISON. Yes— 

The CHAIRMAN. You don’t have a constant percentage, but that 

the bigger you are, the higher the percentage. 

Mr. WALLISON. That’s right. 

The CHAIRMAN. And would you go beyond that to put actual limits on it? I mean, we have, for instance, the 10 percent deposit 

limit. That doesn’t seem to me to do a great deal, but would you 

give the Systemic Risk Council the ability to, in establishing and 

enforcing a level of bank growth, could they do an absolute limit, 

so you can’t get any bigger? Or would it only be through the capital 

requirements in other ways? 

18 

Mr. WALLISON. First of all, Mr. Chairman, I want to be sure 

we’re talking—the term, ‘‘bank’’ is used very loosely. I am talking 

here about a commercial bank. 

The CHAIRMAN. Yes. 

Mr. WALLISON. Okay. 

The CHAIRMAN. The way you’re using it—depository— 

Mr. WALLISON. Okay. Yes. And in that case, I don’t believe that 

there should be any limits placed on the size of the institutions. 

But as capital rises, I think the institutions will be required themselves to limit their growth— 

The CHAIRMAN. But you say here, ‘‘The Systemic Risk Council 

could be authorized to establish an acceptable limit of bank growth 

and impose appropriate limits on growth that are not consistent 

with the limits.’’ 

By that, do you mean capital requirements? There’s no actual 

limit? 

Mr. WALLISON. No, there’s no actual limit on the size of the institution. But as the capital increases the institution will decide to 

put some sort of cap— 

The CHAIRMAN. But— 

Mr. WALLISON. I’m not for caps in general. 

The CHAIRMAN. All right. The language frankly could have supported that. So you’re not quoted in opposition to something—you 

are talking about strict capital— 

What else would the Systemic Risk Council do—because you say 

here—and obviously I think this is an important possible area of 

some common ground—you say, ‘‘The Systemic Risk Council would 

be authorized then to monitor the worldwide financial system, report to Congress and the public on the possible growth of systemic 

risk, or the factors that might produce a serious common shock.’’ 

Would they have any more power than just to report it to us? Do 

they just drop it in our laps? Or would you give them any power 

to do anything other than limiting the capital limits on banks? 

Mr. WALLISON. Well, I outlined in my prepared testimony some 

things in addition that they might do. 

The CHAIRMAN. I didn’t find any formal things. Help me with it, 

because I couldn’t find any, other than there was a metrics of risktaking. 

But the Systemic Risk Council identifies, as you say, the growth 

of systemic risk factors that might produce a serious common 

shock—would they be empowered to do anything about that? 

Mr. WALLISON. The most important thing that the Systemic Risk 

Council would do, Mr. Chairman, is to identify areas that were not 

identified before the current crisis— 

The CHAIRMAN. And would they be empowered to act on that, 

once they had identified it? 

Mr. WALLISON. I think the way it would work is that they would 

instruct the supervisors of the particular institutions. The members 

of the Council would be the Federal Reserve, of course, the OCC, 

the FDIC, and so forth. And when the Council saw that there was 

developing the kind of systemic risks that we have had up to now, 

which is all— 

19 

The CHAIRMAN. Let’s talk about what they would do. They give 

instructions to the regulators. Would they be binding on the regulators? 

Mr. WALLISON. I would expect that the regulators would take 

those actions— 

The CHAIRMAN. Well, then we have to write laws. We can’t do attitudes. I don’t mean to be, you know, pressuring you too much. 

But I have to write a law here. 

Would the Systemic Risk Council have the power to order the 

regulators to act, once they have discovered something? Or would 

they not? 

Mr. WALLISON. Well, I don’t think it’s possible to order regulators 

to do anything— 

The CHAIRMAN. By statue— 

Mr. WALLISON. But if they have agreed to the Council’s policies— 

The CHAIRMAN. I’m going to stop you here. You could statutorily 

say that the Systemic Risk Council had the statutory authority to 

require action. Of course you could. It’s a question of whether you 

want to or not. 

Mr. WALLISON. Well, the regulators are part of the Council, Mr. 

Chairman. I don’t understand how— 

The CHAIRMAN. Does the Council have to vote by unanimous— 

Mr. WALLISON. What the Council decides to do— 

The CHAIRMAN. Does the vote have to be unanimous on the 

Council? No. 

Mr. WALLISON. I think that’s the sort of thing a Council can decide on its own. I haven’t run into those kinds of questions— 

The CHAIRMAN. Well, I’m going to say I’m disappointed, because 

you’re leaving ambiguities here that are not—I’m sorry, Mr. 

Wallison, I’m going to finish—that are not appropriate to a statute. 

So can the fact that one member, one entity as a member of the 

Council doesn’t mean that it might not be in disagreement. And I 

think you’ll leave yourself hanging here when you say we have this 

Systemic Risk Council and they can report, monitor the growth of 

systemic risk or the factors that might produce common shock. And 

then you leave me hanging as to what they do about it. 

The gentleman from Texas? 

Mr. HENSARLING. Thank you, Mr. Chairman. 

My first question for anybody on the panel who would care to 

take it is as you analyze the root causes of the economic turmoil 

we find ourselves in today, I am curious what aspects of the turmoil you can cite as resulting from a lack of regulatory authority 

as opposed to perhaps mistakes, malfeasance on the part of regulators. 

Clearly, we have a very large capital markets reform bill in front 

of us. Some have opined that we had a lack of regulatory authority. 

I am not sure with the exception of Fannie and Freddie, we have 

covered that history and battle before, but with that possible exception, I know for example we had testimony from the head of OTS 

that he had the resources, the financial expertise, the regulatory 

authority to regulate the credit default swaps of AIG, they just 

missed it. 

As we analyze the legislation before us, is it more regulatory authority that we need? Do we need to make sense of the regulatory 

20 

regime we have before us, or do we just need to figure out a way 

to get regulators to act smarter and perhaps focus on systemic 

events that previously they have not focused on? 

Whomever might want to take that first. Mr. Johnson? 

Mr. JOHNSON. Mr. Hensarling, I think I completely agree with 

you on the safety and soundness point, which is that the regulators 

did have the ability, did have the statutory authority to reign in 

many of the excesses, including to prevent the abuses of consumers 

that we have seen, and they did not exercise those powers. 

That is part of the reason, I think, we should actually reinforce 

the protection of consumers through a new safety agency, focused 

just on consumers. 

I think with regard to banking safety and soundness, on derivatives, perhaps the regulators could have found the authority, but 

I think they were correctly interpreting the legislators’ intent with 

regard to not regulating many derivatives’ transactions, and I 

think that was a very conscious decision made at the end of the 

1990’s, which should be re-visited. I think putting that in the legislation makes sense. 

Mr. ZANDI. Can I take a crack at it? 

Mr. HENSARLING. Sure, Mr. Zandi. 

Mr. ZANDI. I think that the reason why this financial crisis 

evolved into a financial panic last September—I think it was a 

manageable, albeit greater than garden variety crisis prior to September, it turned into a panic in September because policy makers, 

including the regulators, the Federal Reserve, the Administration, 

did not have a clear understanding of what their authority was and 

how they should use it. 

That begins with Fannie Mae and Freddie Mac in early September. That extends to Lehman Brothers. That extends to AIG. 

That extends to Citigroup. 

I think that goes to a key failing of the current regulatory structure. 

Mr. HENSARLING. I have limited time. Let me move onto another 

line of questioning here. To me, a very fundamental question that 

we have to examine here is if we either implicitly or explicitly designate firms as being systemically significant, do we not have a self 

fulfilling prophecy? 

I am trying to figure out how does one avoid that. If you set up 

criteria for bank holding companies, there is so much public information there, if you attempt to keep these firms confidential, their 

names, sooner or later, the market is going to figure out which 

firms have the implicit guarantee and which do not. 

We know with Fannie and Freddie how implicit becomes explicit 

at the snap of a finger and hundreds of billions of dollars of taxpayer exposure/liability later. 

I just do not understand any mechanism that one steps up, and 

I appreciate the argument that regulators need to look at individual firms and that through capital and liquidity requirements, 

maybe there is much they can do to reduce the systemic risk, but 

once you set up a criteria, I do not know how you do not have a 

self-fulfilling prophecy and everybody is waiting in line wanting to 

be the next systemically significant firm. I just do not see how you 

avoid it. 

21 

Mr. Wallison? 

Mr. WALLISON. It seems to me if we focus solely on the banking 

industry, we do not have that problem because all banks are regulated. Right now, the largest banks are regulated much more fully 

than the smaller institutions. 

One can assume that a large bank is too big to fail, but it does 

not have to be true. There is a certain amount of ambiguity when 

you come to a line between the very largest and the less large institutions. 

We have no idea what systemic risk is. That is one of the major 

faults in this legislation. 

What we ought to do is simply make sure that the banking industry is safe and sound and then we do not have to worry about 

any of the others. 

The main fault with what the Administration is doing is attempting to extend regulation which did not work for the banking industry across a broader range of our financial system. There is no need 

to do that. If we focus solely on banks, we can solve almost all of 

the problems that we encountered in 2007 and 2008. 

Mr. HENSARLING. Thank you. It is up to the chairman. I see I 

am out of time, Ms. Rivlin. 

The CHAIRMAN. The gentleman from Pennsylvania. 

Mr. KANJORSKI. Thank you, Mr. Chairman. 

Ms. Rivlin, in your testimony, I am not sure I understood whether or not you were indicating that the Federal Reserve should not 

be designated as the systemic risk regulator or that it was in fact 

well qualified to be the gatherer of information and data for the 

systemic risk regulator. 

Ms. RIVLIN. I was trying to distinguish two concepts of systemic 

risk agencies. One is monitor and gatherer of information for which 

I think the Fed is very well qualified and should be doing it anyway and it is coordinate with its responsibilities on the economy. 

I would put that responsibility there. 

I do not think that it should be the systemic risk regulator in the 

sense of regulator of systemically important institutions, regulator 

supervisor of systemically important institutions, because (a) I do 

not think there should be such a designated responsibility for the 

reasons we have been talking about. I do not think you should have 

a list. 

Second, if you did do that, I sure would not put it at the Fed. 

I think it would dilute their monetary policy responsibilities and 

they would not be very good at it. 

Mr. KANJORSKI. I agree with you, but I wanted to perhaps attack 

part of your premise there. I recall very clearly in 2005, the Chairman of the Federal Reserve was testifying before this committee. 

I specifically asked him a question, whether or not there was a 

real estate bubble in his opinion, and he said he thought there was, 

and that the price of real estate was ever increasing, but it was 

perfectly manageable and it did not constitute a risk to the system. 

If he in fact were the gatherer of that information and the analyzer of that information, we would have missed the opportunity to 

have found systemic risk. 

What is your answer to Mr. Greenspan’s lack of perceiving that 

difficulty? 

22 

Ms. RIVLIN. I think he was just wrong. He said that himself. He 

did not see this one. I think we have learned a lot about bubbles. 

One thing we have learned is that interest rates is not a perfect 

tool for controlling them, which is why I would give them more leverage control as well. 

Mr. KANJORSKI. I understand that. Let me move to Mr. Wallison 

because you seem to be talking about that our only problem here 

in regard to systemic risk exists in financial institutions. 

Mr. WALLISON. No. I think the only real problem exists with 

banks, commercial banks. 

Mr. KANJORSKI. Just banks, nothing else? 

Mr. WALLISON. Just banks. 

Mr. KANJORSKI. Mr. Wallison, testimony before this committee 

not too many months ago was heard from General Motors, Ford 

and Chrysler. They appeared together, their CEOs, and I think the 

CFOs of those three corporations. 

Their testimony was quite clear that it was their opinion that the 

failure of any one of them, and particularly Chrysler, who only entertained 7 percent of the car market in the United States, would 

cause systemic risk if they were allowed to fail, and that was their 

opinion as to why the Congress should marshal the assets necessary to ‘‘bail’’ the three companies out if they needed it, but most 

particularly Chrysler and General Motors, who at the time did recognize the fact that they needed it. 

Their total argument was that they both feed off the same dealer 

base and supplier base. Just the loss of Chrysler Corporation’s 7 

percent penetration of the market and the use of the dealers and 

suppliers would bring down all of the suppliers and all of the dealers, and therefore bring down the entire industry. 

Just recently, on Friday, you probably have read the paper, the 

question that I would pose to you, I want your idea on the General 

Motors’ problem, but then CIT, most of our regulators concluded 

that did not constitute systemic risk, I think that is the conclusion. 

Luckily, they did not need help from the Government ultimately. 

As I understand the problem, as it was explained to me on Friday, if it had been allowed to fail, that is the factory business that 

CIT was involved in, that it would have brought down 70 percent 

of the apparel suppliers in the country, to the extent that the department stores and specialty stores in the retail business in the 

United States would not have had the inventory to continue their 

practices. 

Hundreds of thousands if not several million jobs would be lost 

in the supplier trade manufacturing and in the retail businesses 

throughout the country. 

That came to my attention through a department store owner 

who called those facts to my attention. 

Would you not feel that perhaps is a systemic risk and it is not 

a financial institution— 

Mr. WALLISON. In my testimony, Congressman, I looked very 

carefully at this question of the difference between a systemic risk 

and mere disruption. 

We really do not understand what systemic risk is or how it 

would be created or what kinds of institutions would create it. This 

23 

is one of the fundamental problems with what the Administration 

is talking about. 

In the case of General Motors or Chrysler or Ford, for that matter, or CIT, yes, there would certainly be disruption if a large firm 

fell. I think the same thing is going to be true of financial institutions other than very large banks. 

That is why it is such a bad idea to provide to the government 

the authority to bail out or take control of any kind of institution, 

because the institutions will always come in and argue that their 

failure will cause some sort of huge loss in our economy, whereas 

in fact companies fail all the time. But they don’t create a systemic 

event, just disruption. They get worked out in bankruptcy. Sometimes, they return to full activity. Other times, they are completely 

unwound. 

We have to make sure that we know the difference between a 

mere disruption, which they will claim, and a systemic risk. We do 

not know how to make that distinction. 

The CHAIRMAN. The gentleman from Alabama. 

Mr. BACHUS. Thank you. I read something here for the first time. 

I agree with it. I have thought it. It is from Mr. Johnson, who actually was called by the Democratic Majority to testify. 

What he says are short-term measures taken by the U.S. Government since the Fall of 2008, particularly under the Obama Administration, have helped stabilize financial markets, primarily by providing unprecedented levels of direct and indirect support to the 

large banks. 

But these same measures have not removed the long run causes 

of systemic instability. In fact, as a result of supporting these leading institutions on generous terms, systemic risk has widely been 

exacerbated. 

In other words, the bailouts have actually increased the danger. 

Mr. Wallison, that is similar—you have said that in a different 

way, have you not? That we actually are creating a more dangerous 

environment? 

Mr. WALLISON. Yes, of course. Every time we bail out one institution, we create the belief on the part of people in the markets that 

other institutions that have a similar size or maybe even smaller 

will also be bailed out, and as a result, great moral hazard is created, as Professor Mahoney made so clear in his testimony. 

Mr. BACHUS. Mr. Kanjorski and I were at a meeting with one of 

the leading hedge fund managers. I will not name his name. The 

Financial Times said he was the smartest billionaire in the world. 

He said the same thing you said about Lehman in your testimony. 

The problem was the markets were shocked. They thought they 

were going to bail them out because they had bailed out Lehman, 

which is exactly what you said. I am not sure if you were aware. 

This gentleman is a very private individual. You all came to the 

same conclusion. 

Mr. Johnson goes on to say, and I believe this is absolutely true, 

some of our largest financial firms have actually become bigger relative to the system and stronger politically as a result of the crisis. 

The competition has been eliminated. 

Do you agree with that, Mr. Johnson? 

Mr. JOHNSON. Yes, sir. 

24 

Mr. BACHUS. Executives of the surviving large firms have every 

reason to believe they are too big to fail. They have no incentive 

to help bring system risk down to an acceptable level. That is exactly the problem we have today. 

Mr. Johnson goes on to say that when you have a situation like 

this, it is either bailout or collapse, but as it begins to affect other 

institutions, responsible official thinking shifts to bailout at any 

cost. We certainly have seen that over the past 6 months. 

Mr. Zandi says, and here is where I think we maybe can all come 

to a consensus, he said the Treasury and the Fed were seemingly 

confused as to whether they had the authority or ability to intervene to forestall a Lehman bankruptcy and ensure an orderly resolution of the broker-dealer’s failure. The procedure was not in 

place. 

Mr. Mahoney today has said give them that procedure, as I understand it. Give them a procedure, but in bankruptcy. 

Is that right, Mr. Mahoney? 

Mr. MAHONEY. That is right. I think the idea of adding another 

chapter to the Bankruptcy Code makes perfect sense. It is probably 

the case that the amount of agenda control that debtors have in the 

standard Chapter 11 bankruptcy proceeding could be disruptive in 

the case of a large financial institution where you are dealing with 

some short-term creditors who need to know what is the value of 

this obligation that I am holding sooner rather than later. 

I think you could create a quicker, more streamlined procedure. 

I would draw a sharp distinction between the procedure through 

which this happens and the substantive rules that will govern it. 

I think it is important that the substantive rules be the same as 

they would be for anyone else, which is to say the creditors take 

their losses in the order of their contractual priority so it is predictable. There is a set of rules that is known in advance, and everyone 

will understand where they are in the pecking order. 

Mr. BACHUS. Mr. Zandi, you said the confusion is the big problem, but if we had the substantive rules that we used in dreadful 

WorldCom and Lehman, ultimately, you would clear up the confusion. You would have certainty, and the certainty would be that 

they would go into—you would have an expedited procedure, and 

you can call that expedited bankruptcy, but it really needs to be 

there, in my opinion. 

Mr. ZANDI. I think the Bankruptcy Code probably would be inadequate for purposes of these kinds of failures. 

Mr. BACHUS. If we made the procedure, if we changed the procedure— 

Mr. ZANDI. I do not think the courts would be viable for the kind 

of decision-making that needs to be done as quickly as needs to be 

done. 

Mr. BACHUS. We had a small bank in Washington fail and the 

FDIC put 400 people on it. Obviously, they would need help from 

the regulators. I would agree with that. 

Mr. ZANDI. To me, too big to fail is more than the interconnectedness of the institutions, it also goes to the confidence we have in 

our system. You would get bank runs, and if you go into a bankruptcy proceeding, you may be able to solve the interconnectedness 

problems, but confidence would still be an issue. 

25 

Mr. BACHUS. Of course, you said about the regulators that we all 

know they had a complete lack of understanding. 

Mr. ZANDI. And that needs to be changed, but I do not think the 

Bankruptcy Code is the way. 

Mr. BACHUS. I do not know how you give understanding. That is 

worse than the bankruptcy courts to me. If you gave them the procedure, you gave them a right to do things, and you establish a procedure, maybe we can work together on some things, how we could 

amend that Code and use the basics. 

The CHAIRMAN. The gentlewoman from New York. May I ask the 

gentlewoman to yield me 1 minute? I did want to respond. 

Reading Mr. Johnson’s point here that short-term measures, particularly under the Obama Administration, I am not sure entirely 

what he means. I do want to be very clear. 

Every single activity now characterized as a bailout that is going 

on in the United States was initiated by the Bush Administration, 

by Mr. Bernanke and Mr. Paulsen. That is AIG, Bear Stearns, 

Merrill Lynch, and Bank of America, which was kind of a bailout. 

That was General Motors, Chrysler. Every single one of them. 

The first proposal for a bailout that came to the Obama Administration was CIT, and they said no. Literally, every single bailout 

now going on was initiated in the Bush Administration for the 

Obama Administration to carry out. 

Yes, it is true, I agree, I think we all agree that where we are 

today is a result of the need for the bailouts and then the bailouts 

have made us more vulnerable. That is why our agenda is to try 

to do something about it. That is no great point. 

Sure, we need to do something, but again, there is not a bailout 

underway today that was not initiated by the Bush Administration. 

I thank the gentlewoman. The gentlewoman from New York. 

Mr. BACHUS. Mr. Chairman— 

The CHAIRMAN. It is the gentlewoman from New York’s time. 

Mr. BACHUS. You took the extra time. 

The CHAIRMAN. I asked the gentlewoman to yield. This is the second time the gentleman has done that. I have asked other members to yield. It is disruptive. I have asked members to yield. I 

would ask the gentleman to pay attention. 

Mr. BACHUS. I will be less disruptive in the future. 

[laughter] 

The CHAIRMAN. The gentlewoman from New York. 

Mrs. MALONEY. Thank you, Mr. Chairman. I truly believe that 

our government was at its best following the 9/11 crisis, when we 

came together and created a bipartisan professional commission to 

study exactly what went wrong. 

They came forward with a professional report that sold more copies than Harry Potter. It pointed out 53 direct areas that they 

thought needed to be corrected. 

We then proceeded to react to their recommendations, and this 

Congress passed 47 of their recommendations. 

I do not believe that we were aware of what the true problems 

were until we got that report. 

I for one would like to see the report coming back from the bipartisan commission on what really caused this crisis, and their ideas 

26 

of what we need to do to reform our system and to go through that 

process. 

We now have a blueprint that in many ways looks like the problems that we confronted. Many people say Fannie and Freddie with 

their implicit government guarantee caused many of the problems. 

What are we going to come back with? An implicit guarantee 

that tier one too-big-to-fail banks are going to be guaranteed. 

Therefore, everyone is going to want to do business with the guaranteed bank, and every bank is going to want to be a tier one in 

order to have that implicit guarantee that gives them an advantage 

in business, lower rates, more prestige. 

I am not so sure that is the direction we want to go in. Then the 

other idea is that we have a systemic risk regulator under the Federal Reserve. I would argue we have a systemic risk regulator now 

under the Federal Reserve. They have tremendous power to look 

anywhere they want. 

The prior Administration before Mr. Bernanke was criticized for 

never having taken a step on the subprime crisis, never coming forward with a directive, never pointing out what needed to be done. 

I am not so sure a systemic regulator, which is very much dependent on the ability and drive of the person in the position, is the 

exact answer to our problem. 

The only thing that we seem to totally agree on is that regulation 

failed, yet the regulation they are proposing is very similar to the 

regulation we already have right now. 

I would build on really a question the chairman brought up earlier, what happens when you disagree? When we have this council 

of regulators and they disagree, how do you come to the conclusion? 

Many people say Lehman brought down the stability of our financial sector in many ways. Where was the way to counter the 

decision of whomever made that decision? How would you agree 

with these councils? 

You have to have a specific way that you agree because you know 

they are going to disagree. I see it every day. There was tremendous disagreement recently over how to respond to other challenges 

in the private sector with various businesses that was played out 

in the press. 

My time has expired. 

The CHAIRMAN. Brief response? Mr. Johnson? 

Mr. JOHNSON. I agree completely with Mrs. Maloney. I think you 

have to assume that regulators will fail in the future as they have 

failed in the past, and you have to assume that extending any kind 

of implicit guarantee is going to create the same sort of distortions 

and problems as in the past. 

I think you need to design the system around those assumptions, 

and to my mind, making the largest institutions, financial institutions, smaller, is not a guarantee by any means against future 

problems, but it means when the problems occur, they should be 

more manageable. You should be more able to push them down to 

the bankruptcy courts. 

Still, sometimes it is going to be very hard to predict. Sometimes 

government may need to take actions. You need to make sure they 

have the appropriate authority to do that. 

The CHAIRMAN. The gentleman from New Jersey. 

27 

Mr. GARRETT. Thank you, Mr. Chairman. Before I begin, let me 

associate myself with the words of the gentlelady from New York 

on just about everything she said. That may be a first, but I do. 

Mr. Zandi, if I heard you correctly, and correct me if I am wrong, 

we need a systemic risk regulator and you advise it to be in the 

Federal Reserve? 

Mr. ZANDI. Yes. 

Mr. GARRETT. You need someone to address situations, future 

asset bubbles, for dealing with being countercyclical as opposed to 

being procyclical? 

Mr. ZANDI. Right. 

Mr. GARRETT. Also, someone who can address maybe on the regulatory side, capital requirements as well; is that correct? 

Mr. ZANDI. Yes, they would have authority there as well. 

Mr. GARRETT. You would put it in the Federal Reserve. The reason why I want to clarify that is if you look at the history of the 

Federal Reserve on each one of those points, you have to raise the 

question, why them? On the asset bubbles, someone else raised a 

question to Ms. Rivlin with regard to the housing bubble that we 

had, I am going back even further than that with the tech bubble. 

Alan Greenspan later on said maybe I missed that one and he 

sort of re-wrote history, some would say, as far as his review, 

whether he knew about that or not, but if you look at the minutes 

of the Federal Reserve, not just him but the entire Federal Reserve, they all missed that. There was no discussion whatsoever 

with regard to an asset bubble during the entire time. They were 

looking at it purely as an increase in productivity. 

On the countercylical aspect of it, the Federal Reserve was out 

front for a long time on Basel II; were they not? Which would go 

in the wrong direction with regard to that. 

As far as on the capital requirements, did not the Federal Reserve have the ability with regard to institutions under them, Citi 

and Bank of America, and did they do anything? The answer is no, 

regarding raising capital requirements. 

Here is an entity that you are nodding your head to, with a ‘‘dismal’’ track record in each one of those, but you, sir, would suggest 

they are the ones we are going to give the authority to. 

Mr. ZANDI. Right. If I were king for the day, I would design it 

differently. I would think that a model where the regulatory function was in a separate entity, that was a systemic risk regulator 

that was separate from the Federal Reserve would make the most 

sense. 

I think in the context of where we are starting from and just the 

practicality of the situation, I think the most logical place for that 

to reside is the Federal Reserve. 

Mr. GARRETT. Of all the bad choices that are out there, they are 

the best one? 

Mr. ZANDI. Exactly; right. I do think there was a general philosophy, maybe even to this day, that the Federal Reserve should not 

weigh against asset bubbles, that is not in their job description, so 

to speak. I think that is inappropriate. 

I think that it should be something they should do and the tool 

that they need to implement that— 

28 

Mr. GARRETT. It is not in their rules that they should be weighing in with regard to asset bubbles? 

Mr. ZANDI. No. There is a reluctance to weigh against asset bubbles, yes, at the Federal Reserve. 

Mr. GARRETT. Before you can even weigh into them, you first of 

all have to see them. 

Mr. ZANDI. That is probably why they have a reluctance to do 

that. 

Mr. GARRETT. And they did not see them. 

Mr. ZANDI. My view is bubbles are created largely by leverage, 

that if they have a very clear ability to control or manage leverage 

throughout the entire financial system, which they would have as 

the systemic risk regulator, then they would have the tool they 

need to be able to manage that aspect of monetary policy. 

Ms. RIVLIN. May I? 

Mr. GARRETT. Sure. You are where I was going next. 

Ms. RIVLIN. I think there is a difference between the bubble in 

the 1990’s in the stock market and the housing market bubble. 

I was at the Fed in the 1990’s. We did not miss the stock market 

bubble. We knew it was there. We talked about it. Mr. Greenspan 

made the speech. We did not do enough about it, in my opinion. 

We could have raised margin requirements. It would have been 

largely symbolic, but we should have done it. 

We did not have the right tool. Raising the short-term interest 

rate in the middle of the bubble, we also had the Asian financial 

crisis and a lot of other things going on, so you do not have the 

right tool if you are relying entirely on the short-term interest rate. 

Mr. GARRETT. Mr. Wallison, I thought you were going to say a 

quick no to the chairman’s question in regard to the policy, this 

council being able to tell the regulators what to do. I thought you 

were saying no, they cannot do that. 

Do you have another comment to make? 

Mr. WALLISON. Yes. I have a comment on the question of bubbles. I think we have to distinguish this bubble from every other 

bubble. We will always have them. We are human beings. We tend 

to believe that when things are going in one direction, they will 

continue to go in one direction. That is both up and down. 

This bubble was completely different. In this bubble, we had 25 

million subprime and non-traditional loans that are failing at rates 

that we have never seen before. The question we have to answer 

is, why did that happen? That is one of the major reasons that this 

particular bubble turned into a worldwide financial crisis. 

Mr. GARRETT. Thank you. 

The CHAIRMAN. The gentleman from North Carolina. 

Mr. WATT. Thank you, Mr. Chairman. Ms. Rivlin, I confess I am 

having a little trouble understanding what you would do. You talk 

about a ‘‘macro system stabilizer’’ and then you talk about a ‘‘systemically important’’ or somebody who is over—I thought that what 

you were proposing was akin to what the Obama Administration 

has proposed, that the Fed be put in charge of the kinds of things 

that you indicate a ‘‘macro system stabilizer’’ would do, but you 

seem to have some concerns about that. Can you clarify what it is 

you are proposing? 

29 

Ms. RIVLIN. Yes. I am proposing the exact opposite of what the 

Obama Administration is proposing. We both recognize that there 

are two kinds of tasks here. One is spotting problems in the system 

that might lead to excessive boom or a crash. 

Mr. WATT. Okay, and they propose, the Administration proposed 

to give that to the Fed? 

Ms. RIVLIN. They propose to give that to a council. I would give 

it to the Fed because I think it is very similar to the kind of responsibility that the Fed has already to spot problems in the economy. 

Mr. WATT. And if one of those spot problems was that one of 

these institutions’ interconnectedness is an issue, would you not 

give the Fed the authority to deal with that? 

Ms. RIVLIN. I would not. 

Mr. WATT. Who would you give the authority to deal with that? 

Ms. RIVLIN. I think we need a new regulatory institution to be 

the consolidated regulated of financial institutions. I would not separate out the too-big-to-fail ones and give them a special regulator. 

Mr. WATT. But that should not be the Fed, is what you are saying? 

Ms. RIVLIN. And I certainly would not have the Fed do that. I 

do not think they do— 

Mr. WATT. So you would create a new agency for that purpose? 

Ms. RIVLIN. Ideally, I would. And I think that that— 

Mr. WATT. We are getting quite a bit of push back from the proposal to create a new agency for consumer protection. Would you 

create a new agency for consumer protection too? 

Ms. RIVLIN. I would let, but let me explain what I meant on the 

first time. I would consolidate regulation of institutions, financial 

institutions, into a single regulator, ideally. I would not separate 

out the too-big-to-fail ones from the other ones. 

Mr. WATT. So this new agency would be—would have the responsibilities of all of the existing regulators plus some others? 

Ms. RIVLIN. Yes, so you would un-make a bunch of agencies. I did 

not stress that in my testimony because what I wanted to stress 

was not doing the too-big-to-fail institutions separately and not 

putting that at the Fed. 

Mr. WATT. Would this big new agency have responsibility for the 

institutions that might be too big to fail? 

Ms. RIVLIN. Among others. 

Mr. WATT. So you would put that under their jurisdiction? 

Ms. RIVLIN. Well, but I would not have a separate list. 

Mr. WATT. Oh, yes, okay. You did not tell me what your opinion 

was on the consumer protection agency. You did I guess, but you 

did not tell me why? 

Ms. RIVLIN. I think a new consumer protection agency would be 

a good idea because the existing agencies have not performed this 

function well. And you can either make sure that they perform it 

well, the Fed did not, for example. Or you can put it in a new agency. At the moment, I think I would opt for a new agency. 

Mr. WATT. All right, I thank you, Mr. Chairman. I yield back. I 

just wanted to get clarification. 

30 

The CHAIRMAN. Will the gentleman give me 30 seconds? Ms. 

Rivlin, how much time when you were at the Fed did you spend 

on consumer issues? 

Ms. RIVLIN. It depends on what you mean by that. We spent 

quite a lot of time on—there were consumer councils who advised 

on whether TILA and so forth were being— 

The CHAIRMAN. Credit cards, home mortgages, unfair and deceptive practices? 

Ms. RIVLIN. Yes, not very much. I do not think the Fed did that 

well. 

The CHAIRMAN. Yes, thank you. No, I did not mean you personally. The gentleman from Texas? 

Mr. MARCHANT. Thank you, Mr. Chairman. Mr. Wallison, I saw 

you on a TV program this morning, and you made a comment that 

I would like you to follow-up a little bit about. You said that AIG 

actually was not too big to fail. Am I misinterpreting that? 

Mr. WALLISON. No, that is right. 

Mr. MARCHANT. And that there was actually no default there, no 

actual default on the part of AIG? 

Mr. WALLISON. I think we were talking at that time about credit 

default swaps. 

Mr. MARCHANT. Yes. 

Mr. WALLISON. And a credit default swap is, in shorthand, like 

an insurance policy. You are insuring someone against a loss. My 

point was simply that when AIG failed, it did not cause any losses 

to any of the people who were its counterparties. It is just exactly 

like you have an insurance policy on your home, and your insurer 

fails. You would go out and get another insurer, but unless you had 

already had a fire, you had not suffered a loss. 

And that is exactly the case with credit default swaps. There is 

in my view a lot of misinformation around about credit default 

swaps, suggesting that they are very dangerous. I do not believe 

they are dangerous. And I do not believe in the case of AIG there 

was any need to bail out AIG. AIG had one major counterparty, 

and a lot of others, but the biggest one was Goldman Sachs, $12.9 

billion in credit default swaps, with which AIG was protecting 

Goldman Sachs. When it was learned that Goldman Sachs was in 

fact the major counterparty, the press went to them and said, 

‘‘What would have happened if the government had allowed AIG to 

fail?’’ And Goldman Sachs said, ‘‘Nothing, we were fully protected. 

We had collateral from AIG. And, in addition, we had bought other 

protection against a possible failure by AIG. So it would not have 

been a problem for us.’’ And that I think is how we have to look 

at the AIG question. It was large. It was engaged. It was interconnected, as all financial institutions are always interconnected, 

but the possibility of loss from AIG was very small. 

Mr. MARCHANT. Mr. Zandi, would you comment on the fact that 

this last bubble was created in large part by financial instruments 

that did not exist maybe 20 years ago, and especially the derivative 

part of the mortgage part of it, and how it sustained a bubble in 

the housing market, which really sustained the mortgage market, 

which continued to sustain the housing market? 

Mr. ZANDI. Well, I think one of the root causes of the bubble in 

the housing market was that the process of securitization was funVerDate Nov 24 2008 17:50 Dec 10, 2009 Jkt 053245 PO 00000 Frm 00034 Fmt 6633 Sfmt 6633 K:\DOCS\53245.TXT TERRIE
31 

damentally broken, that no one in the chain of the process had a 

clear understanding of all the risks in its entirety. The lenders 

made the loan. They sold it to the investment banks. The investment bank’s package got the rating. The rating agencies then put 

their stamp on it. And then it was sold to Goldman investors. And 

no one was really looking at the entire system, making sure that 

the structure was properly working, that the loans that were ultimately being made were good loans. So the process of securitization 

fell apart. It just was not functioning well because in my view 

there was not a systemic risk regulator looking at it holistically 

and saying, does this make sense, and will it work if it is stressed 

under a bad economy, under a bad housing market? 

Mr. MARCHANT. And it was a product that really was unfamiliar 

to anyone who was looking at it, even its regulator, even a lot of 

the regulators? 

Mr. ZANDI. I do not think anyone truly understood the entire 

process altogether. I think the process of securitization I should say 

has economic value and it makes sense under certain circumstances, but that got abused and the economic value got lost 

in the profit-making that was going on during the period. 

Let me just say I do not agree with AIG. I think it is very clear 

that if AIG failed, it would have been a very substantive risk to 

the entire financial system and the economy. And this goes to an 

important point. We talk about too-big-to-fail in the context of relationships, in the case of AIG, credit default swaps, but it also goes 

to confidence. That you have to remember back to that day in midSeptember when AIG was about ready to go under, confidence was 

completely eviscerated, and if that institution failed, a lot of other 

institutions in the entire system and the economy would come to 

a grinding halt. So I do not agree with that assessment. 

Mr. MARCHANT. Thank you, Mr. Chairman. 

The CHAIRMAN. We are going to break now. And let me say this, 

votes will probably take 35 to 40 minutes, and then we are taking 

our picture. I plan to come back. I am going to skip the picture. 

And if other members want to come back, we will start again. I do 

not want to impose—if you can stay, we would appreciate it. Obviously, you have a right to leave. But if anybody can stay, I plan 

to be back in about a half-hour and any other members who are 

here, and we will do some more questioning for another 45 minutes 

or so after that if that is acceptable. Again, I will understand if you 

have obligations and do not want to sit around while we have our 

picture taken. We are in recess. 

[recess] 

The CHAIRMAN. I am going to recognize myself for another round, 

and I will recognize other members. But this has been very useful. 

One important question, and I must tell you this is partly a hearing, as I said, to learn things, but it is partly to refute things. 

There is out in the country a frustration about the fact there were 

bailouts and anger about too-big-to-fail. I think there are some people who think it is easier to do than others. Of course, one obvious 

answer that you get from some people is, if something is too big, 

what do you do? You make it smaller. And one of the things I want 

to be clear about, and Mr. Wallison, although he is not with us, already made this clear, several of you said there were ways to reVerDate Nov 24 2008 17:50 Dec 10, 2009 Jkt 053245 PO 00000 Frm 00035 Fmt 6633 Sfmt 6633 K:\DOCS\53245.TXT TERRIE
32 

strain growth by a higher capital charge that is disproportionate by 

insurance levies. So we understand that. And I think there was a 

general consensus that things that would restrain growth could be 

very helpful. Does anyone on the panel favor either an absolute 

limit on growth or even beyond that, reducing the size of existing 

institutions? And I ask you that because that is a very important 

view that is there. And when people say, ‘‘Gee, you do not want it 

too-big-to-fail, make it smaller, keep it small,’’ let me go down the 

line, what is your response to people who say, ‘‘Hey, if it is too big, 

make it smaller or keep it small?’’ Ms. Rivlin? 

Ms. RIVLIN. I do not think there is a feasible, defensible way to 

break up institutions, so my answer to that would be no, but discourage growth. 

The CHAIRMAN. Right, but you would not put a cap, a legal cap 

on it going forward? 

Ms. RIVLIN. No. 

The CHAIRMAN. I know, Mr. Wallison, that we have already discussed that. Mr. Johnson? 

Mr. JOHNSON. I would favor a cap certainly in the interim until 

you feel that these restraining measures have bite. As you pointed 

out, Mr. Chairman, at the beginning, we would have a cap I guess 

on the books. 

The CHAIRMAN. At 10 percent. 

Mr. JOHNSON. Yes, exactly. And the rationale behind that presumably is it is not antitrust because we have a different mechanism looking at that, it is sort of a back-up, it is a fail safe. 

The CHAIRMAN. You are right because I do not know of an antitrust regime in which 10 percent gets you into the anti-competitive 

situation. 

Mr. JOHNSON. Not usually. 

The CHAIRMAN. Except the way some of us feel about people who 

run against us but other than that. What would the cap be, what 

could you cap as an interim? 

Mr. JOHNSON. Well, I think—we do not have perfect information 

on this, but I think that the Treasury itself identified 19 institutions that they thought were systemically important and therefore 

subject to stress tests. That is on the one hand. On the other hand, 

we see the experience of CIT Group, which is just one data point 

but it is extremely informative because in terms of the arguments 

they were making about being interconnected, their importance to 

the real economy, there were all kinds of arguments about how 

they are widely cited synthetic CDOs, I think that all turns out to 

be baloney. They are not that systemically important. You can let 

them fail through bankruptcy or renegotiating with their creditors. 

So that says the threshold is somewhere between $100 billion total 

assets and $500 billion total assets, subject to a leverage caveat, 

Ms. Rivlin, right? You have to— 

The CHAIRMAN. But that is assets? What is the cap? We know 

we have one on deposits and that is a percentage one. What would 

be—the metric be, would it be assets? 

Mr. JOHNSON. Yes, well, it is assets, it is either total dollar assets or it is assets as a percentage of GDP. So I am saying 1 percent of GDP total assets would be the CIT threshold. 

33 

The CHAIRMAN. Wachovia failed, Countrywide failed. They were 

pretty big. It did not cause the skies to drop because we had a regime. Mr. Zandi, what is your sense of this? 

Mr. ZANDI. I think it would be very difficult and counterproductive to try to break up private institutions. I do not think 

that makes a lot of sense. I think it makes a lot of sense to raise 

the cost of being large and larger, and I do not think there needs 

to be any cap at all. As you get larger, you pay more because you 

are relying on the system in a more significant way. 

The CHAIRMAN. And I assume the rationale for that is that if you 

raise capital, reduce leverage, particularly in a kind of disproportionate way, you are making failure both less likely and less costly 

if it happens? 

Mr. ZANDI. Exactly, also I think you might want to also in addition to capital ratios or leverage ratios, the deposit insurance fee 

or another insurance premium so that you are self-insured. 

The CHAIRMAN. Mr. Mahoney? 

Mr. MAHONEY. I would not agree with a cap. I think there are 

ample small- and medium-sized banks that could compete effectively with the large banks if they are on a level playing field. And 

the problem is they are not currently on a level playing field because there is one group that has this implicit guarantee and there 

is another that does not. You would do away with that. 

The CHAIRMAN. I appreciate that. Let me tell you as an economic 

historian, as to the level playing field, no entity in the economic 

history of America has ever been on the high end of the level playing field. I know economists have concepts about constantly downward sloping things, we have a constantly downward sloping playing field. I have been doing this for many, many years, and I have 

heard the playing field invoked several times and never has anyone 

ever been at the top of it. It is an extraordinary playing field in 

which everybody is at the bottom. It is the reverse of Lake 

Wobegon. Everybody is way below average. 

But I appreciate that. And I guess what I am saying is to the 

extent that it is a too-big-to-fail issue, it is not anti-competitive, 

and so that is why antitrust—people raise about antitrust. The 

problem is not anti-competitive; it is the negative impact of failure. 

Let me just ask Mr. Johnson, it is important to sort this out, 

would it be the prudential regulator of each institution? I know Mr. 

Wallison only talks about banks. Others I think did not think it 

would be limited to banks. Who would say when the time had come 

to put the cap on? Would it be the council or the individual regulator? Mr. Johnson, you are the only one who wanted a cap so I 

ask you? 

Mr. JOHNSON. I am not a big council fan myself and not really 

endorsing that, but I think it has to rest with whomever has the 

authority to do the bailouts. Who makes the bailout versus collapse 

decision? It is Treasury under our system. I think it remains Treasury because they write the checks. 

The CHAIRMAN. I think that is a good point. And I know your 

prior history at the IMF. I understand your aversion to the conciliatory form of governance. I am sure it was a trial from time to 

time. 

Mr. Royce? 

34 

Mr. ROYCE. Thank you, Mr. Chairman. I would ask a question 

of Mr. Mahoney and Mr. Zandi for their opinion on this. For many 

years I was concerned about the perceived government-backing of 

Fannie Mae and Freddie Mac and about the ability of these firms 

to borrow at interest rates that were a lot lower. They were near 

governmental rates. And most private companies of course because 

of perceived investment risk associated with Fannie and Freddie 

being so much lower, most of their competitors were at a disadvantage. At the same time, they were allowed to involve themselves in 

arbitrage. I think the leverage was 100 to one. 

I think that one of the main problems that we had was legitimizing the idea that subprime loans were safe. And I think the fact 

that the Government-Sponsored Enterprises went out and purchased for their portfolios a half trillion of these, directed by the 

government to do so, by the way; and one of the comments made 

by one of the GSE officials was that we sought to indicate to the 

market the safety of mortgage-backed securities that were 

subprime. 

And I do think that that entire process, and the way in which 

they became a duopoly, forced their competitors out, became too big 

to fail, there is a probably a lesson we should learn out of that. And 

I think it would be very dangerous for Congress to move to set up 

a regulatory structure that separates these institutions that are 

deemed systemically significant from the other institutions, whether you do that de facto or de juri, whether you name them or you 

do not name them. The result I suspect is likely to be the same. 

There will be the perception that these particular institutions are 

going to be covered. So how will the market perceive these companies, and are you concerned that counterparties will then perceive 

their investment risk in these institutions would be a lot lower and 

therefore it starts the process of being able to overleverage. It 

starts the process certainly of having a lower cost of capital, which 

will force your competitors out of the market. What will this mean 

for institutions competing against these now government-backed 

companies that in essence become too big to fail and GovernmentSponsored Enterprises in a way. That would be the result I fear 

out of it? 

Mr. MAHONEY. Well, I agree with that point entirely. I think that 

the counterparties of that entity are going to—all other things 

being equal, want to deal with a so-called tier one entity because 

they will see that it has the implicit guarantee. Whether you call 

that a competitive advantage or simply point out the fact that 

those entities are likely to increase in size, I think they will increase in size because they will be the most attractive entities to 

do business with. So if your objective is to limit size, I think this 

is exactly the wrong way to go. 

I also think that it is probably not a solution to just say we will 

not identify the entities that are too big to fail. Part of the problem 

that arose, particularly after Lehman Brothers, was the fear that 

we could not really predict what the government would do next and 

what it was going to do was going to be quite ad hoc, and this in 

some sense enshrines an ad hoc and unpredictable process. 

Mr. ROYCE. Let me ask Mr. Zandi for his observations on those 

two questions? 

35 

Mr. ZANDI. Yes, I sympathize with the concern. I think that at 

the very least we cannot identify any institution as so-called tier 

one institutions, too big to fail, because it would lead to some of the 

concerns that you have enumerated and it would lead to the same 

kind of problems we have had with Fannie Mae and Freddie Mac. 

I do think though, unlike Mr. Mahoney, I think if we do not identify those institutions, and we treat all institutions the same, we 

say these are the rules, as you grow in size in terms of your asset 

base and your deposit base, as the composition of your asset base 

shifts to more riskier assets, than you have to put up more capital, 

you have to pay higher deposit insurance, you have perhaps another insurance premium to pay in case you do fail, I think that 

would work reasonably well. 

And it is important to remember that Fannie Mae and Freddie 

Mac were born out of the government and did have a guarantee. 

They had a line to the Treasury, and none of these institutions that 

we are discussing today have that similar kind of heritage or that 

similar kind of backing. 

Mr. ROYCE. I will ask one quick last question and that is on subordinated debt, we have talked before, Mr. Zandi, about how we 

might have avoided this in the past, but what do you think of Mr. 

Wallison’s concept of structuring that subordinated debt, if I could 

ask you? I do not know if you had a chance to see his paper on 

that? 

Mr. ZANDI. Yes, I read his paper. I do not know it well enough 

to really comment. I do not have an opinion. I thought it was an 

interesting idea, but I have not thought it through well enough to 

really comment. 

Mr. ROYCE. Okay, thanks. Yes? 

Mr. JOHNSON. Sir, if I could on the subordinated debt and the 

more general idea that the market can pick up the risk, I would 

point out that the evidence says the market pricing of risk, for example look at the CDS for Citigroup prior to the crisis, was going 

the wrong way. They thought Citigroup was becoming less and less 

risky. As we know, looking back, it was actually becoming more 

and more risky. So I am afraid, as one thing to look at, it is okay, 

but as a panacea or something to put a lot of weight on, I would 

do that with hesitation. 

Mr. ROYCE. But basically the way it would work is that the largest banks would be required to issue the subordinated debt, and it 

could not be bailed out. And so if the interest rate on these instruments were to rise above the rate on Treasury, substantially above 

the rate on Treasury securities, it certainly would be one signal to 

regulators that the market perceives excessive risk taking by that 

bank, and it would then—you could set up a structure so at least 

there would be an objective way to monitor this, and at the same 

time you would have the advantage of the subordinated debt out 

there. 

Mr. ZANDI. But why wouldn’t you pick up that information in the 

CDS mark or credit spreads on bonds or even in the equity premium? I am not sure why there is any additional—I do not know. 

Mr. ROYCE. But it has the additional benefit at least of having 

a subordinated debt there that by definition cannot be bailed out. 

36 

So it is one more indicator but it is an indicator combined with 

something that is going to reduce the incentive. 

The CHAIRMAN. The gentleman from California? 

Mr. SHERMAN. Thank you, Mr. Chairman. Mr. Mahoney, thank 

you for focusing on the portion of the White Paper dealing with resolution authority. It is being sold as if it is just a tweaking of the 

Bankruptcy Code, but as you illustrate it is permanent TARP and 

not limited to $700 billion. It is unlimited TARP. Wall Street will 

love the money. Treasury will love the power. It has absolutely no 

chance in that form of passing the House of Representatives on a 

fair up or down vote. So the question really is whether my party 

will fall in love of the idea to the point where we try to force Members to vote on it in the dead of night or as part of some major appropriations bill because I think the only thing less popular than 

TARP in an emergency is unlimited permanent TARP. 

The economists here have asked us to design a system that implies the possibility of bailouts, at least as a possibility. And I 

would hope that whether that is great economics or not, you would 

recognize the political situation and help us design whatever the 

best economic regulatory system is that absolutely shuts the door 

permanently and absolutely on bailouts. I do not think there are 

many Members of the House who do not want to shut that door. 

The idea of hiding which companies are tier one seems absurd. 

First, we are in favor of transparency. Second, everybody will know 

anyway. And, third, I think if we are going to require additional 

capital of certain companies, that will identify who is tier one. If 

we do not require additional capital of tier one companies, then we 

are going to give them the possibility of being bailed out and being 

a systemic risk without even requiring additional capital. 

Professor Johnson, you put forward an interesting idea of trying 

to limit size but pointed out how do we apply this to foreign-based 

banks? One idea would be to say that no financial institution could 

have actual or contingent liabilities to Americans in excess of $100 

billion or $200 billion or whatever the figure is. So that Deutsche 

Bank or Bank of America could pose the same level of risk to the 

United States economy. If the German government wants Deutsche 

Bank to have liabilities to Germans of a couple of trillion, that is 

up to them, but if a bailout is necessary, it will be because of the 

effect its collapse could have on the German economy and presumably that money would come from Berlin. Could you comment on 

the idea of setting an absolute limit on the size that a financial institution could be in the American economy measured by its actual 

or contingent liabilities to Americans? 

Mr. JOHNSON. Certainly, and obviously this raises complications 

in terms of international agreements. It is not something you 

would necessarily do unilaterally, but I think that is why you need 

the G–20 to be brought with you. 

Mr. SHERMAN. The G–20 will never do this. We have a right to 

say that you cannot borrow more than a certain amount from 

Americans as a single financial institution. 

Mr. JOHNSON. No, I agree completely. 

Mr. SHERMAN. And if we were to do it and they were to disagree, 

what are they going to do to us? Go on. 

37 

Mr. JOHNSON. I completely agree with you. I was just talking 

about process. Look, I think you do this in terms of anybody who 

is deposit taking. So if you look at what went wrong with Icelandic 

banks in the UK, for example, at the retail level, they participated 

in the deposit insurance scheme of the UK and that took care of 

people with deposits below the UK limit. The issue was the other 

liabilities to UK citizens. And they obviously got into a very nasty 

fight with the British government about what assets all of those 

Icelandic banks would be used to settle up those debts. And I think 

what you are pointing to is exactly what implicitly came out of this, 

which is the British government felt that they could claim a lot of 

these Icelandic assets in the UK, that was supposedly in the UK. 

They even threatened to use anti-terrorist legislation to do that. 

That is where this thing is heading unless and until the United 

States impose these kinds of limits. 

Mr. SHERMAN. Would we, if we are going to limit too big to fail 

means too big to exist, can we do that just for depository institutions and/or their holding companies? Or if we are going to protect 

the American people from both systemic risk and the risk of having 

being called upon to make a bailout, do we need to apply it to entities other than banks? 

Mr. JOHNSON. I think you have to apply it to entities other than 

banks. I realize that I am quite far from the consensus view on 

this, but I think that it is really very important. When we are talking about all financial institutions, I think we have not talked 

enough about insurance companies today actually. The conversation has tended to gravitate towards commercial banks. I would not 

assume that the next financial crisis is going to be just like this 

financial crisis. They tend to mutate. They tend to involve other 

kinds of risk-taking institutions where we do not fully understand 

to measure the risk. So I think your point is very important, it has 

to be broad and it has to be across a lot of financial institutions. 

Mr. SHERMAN. Ms. Rivlin, I wonder—you seem to have a comment? 

Ms. RIVLIN. No, I agree with that, and I was glad to get a chance 

to counteract the absent Mr. Wallison who thinks we only need to 

worry about banks. I think the lesson of this crisis is we need to 

worry about the whole financial sector and a lot of the trouble 

came from outside the banking system. 

The CHAIRMAN. I am going to recognize myself, and I will give 

myself one more round, having to come back to this for about 2 

minutes, and that is I want to deal with this notion that we are 

somehow—it seems to me people have gotten attached to a whipping boy and unwilling to be torn away from it, the whipping boy 

with the name tier one companies. We have said we are not going 

to name tier one companies, and some people are reluctant to move 

on. And they say, ‘‘Oh, well, you will have secret tier one companies.’’ No, there will not be any tier ones in the legislation we are 

dealing with. And you say, ‘‘Well, but if you are raising capital,’’ 

well, the requirement that people raise capital will not only apply 

to the largest. There will be a general thing. So, again, I think people have decided this is a nice thing to attack. I want to make it 

very clear, there is no tier one. 

38 

There was a great Marx Brothers movie in which Chico is negotiating a contract with Groucho and Chico keeps objecting to this 

cause and that cause, and they keep tearing up the causes. And, 

finally, Chico says, ‘‘What’s this?’’ And Groucho says, ‘‘Well, you 

cannot object to that. That is the sanity clause.’’ And Chico rips 

that up and says, ‘‘Hey, you cannot kid me. There ain’t no sanity 

clause.’’ Well, there ain’t no tier one either. It is just not there, so 

people have to let that whipping boy and strawman go. 

Mr. SHERMAN. If the chairman will yield? Whether tier one are 

identified or not identified, as long as companies are eligible for 

bailouts, the ones most eligible will be the biggest. 

The CHAIRMAN. No question about it, but that is your argument, 

what you are saying is anything big. So I understand the gentleman’s position is a law, which of course would not be persuasive, 

by the way, you are arguing against yourself, because all you could 

pass would be a statute that said there could never be a bailout. 

And what can you do to a statute? 

Mr. SHERMAN. You could repeal it. 

The CHAIRMAN. I will yield again to the gentleman. In fact, the 

TARP was a statute. So if there had been a law on the books that 

said you can never have a bailout, it would have been amended by 

the TARP. There was no way under the Constitution. So if you 

posit that at some point people are going to say, ‘‘Oh, I have to 

have a bailout. You cannot stop me, I am jonesin’ to do a bailout,’’ 

then there is no way around that. I do believe there are structural 

things you can do but let’s not have the strawman of the tier one 

or the company. If you say, ‘‘As long as they are a big company, 

then people will think there could be a bailout,’’ even if there is a 

statute that says no bailout, it is not binding against the present 

statute. 

I yield to the gentleman. 

Mr. SHERMAN. I would think that there is a huge difference between adopting the President’s proposal, which is permanent power 

for bailouts, and saying, ‘‘Yes, there could be a bailout if you can 

pass it on the Floor at some other time.’’ 

The CHAIRMAN. I will take my time back to say that I do not 

know where the gentleman thinks he is. We are not confined to 

picking Plan A or Plan B. We are going to write the bill, and it is 

not necessarily what the President does. We are going to deviate 

from what the President does in a number of cases, as witness to 

the fact that they have these tier one companies. And I understand 

it is a lot easier to beat up the tier one companies, but that fight 

is over. There are not going to be any inside, outside. And the fact 

that capital requirements are increased will not be a tip off because 

all manner of institutions will be told, small banks will be told by 

the FDIC, others will be told, to increase capital. 

So if you are convinced, I think probably the only way you could 

break the habit is there would be a couple of people who fail. So 

I would differ with the gentleman in this sense, I think the likelihood of this society holding to an absolute 100 percent hard and 

fast never a bailout is less likely than a resolving regime that 

would say you have to fire the CEO, that you have to fire the board 

of directors, that you have to impose other penalties. You have to 

make it really unpleasant. And that rule out in the course of that, 

39 

as sometimes happens in a bankruptcy, some payment. Those are 

the two choices but it is not the strawman that people wanted. 

The gentleman from Colorado? 

Mr. PERLMUTTER. Thank you, Mr. Chairman. And I think I agree 

with the chairman on increasing capitalization for all institutions, 

and especially in good times increase the capital, in bad times, give 

them a little bit of a break. But I guess sort of as a philosophical 

economic question to the panel, whether we are better off or worse 

off having over the years slowly eroded and chipped away at GlassSteagall and unit banking so that we have separated the investment side, the stock traders from the bankers and the insurance 

company, and we have made banks stand—every bank stand on its 

own capital? So that would be my first question to the panel. Are 

we better off by having a more efficient system or were we better 

off by having every bank stood on its own merits, and we kept the 

investment side separate from the banking side? 

Ms. RIVLIN. In other words, should we never have passed 

Gramm-Leach-Bliley? 

Mr. PERLMUTTER. And Garn-St. Germain and start of national 

banking and branch banking. We cannot ‘‘unring’’ this bell but just 

as a general principle, do we want a really efficient system, which 

is where we headed, and then it all collapsed very quickly, or do 

we want to put some brakes in the system that do not exist right 

now? 

Ms. RIVLIN. I think we want as efficient a system as we can get 

consistent with reasonable stability. And I realize that is kind of 

gobbledygook, but it is a trade off. And if we were to go back to 

no-branch banking and so forth, I do not think that is either feasible or sensible. But we may have gone too far in allowing growth, 

and maybe not even for efficiency reasons. And so we need to revisit this question and see where we want the trade off to be. 

Mr. PERLMUTTER. Mr. Johnson? 

Mr. JOHNSON. Do we really have an efficient system at this 

point? Mr. Bernanke gave a speech recently where he talked about 

financial innovation and the value of it, he did not name a single 

innovation since the 1970’s in the financial system, okay. We did 

not get that much efficiency, I think we need to apply the brakes. 

I do not think you can go back to where we were before. You cannot ‘‘unring’’ the bell as you said, but I think applying the brakes 

is absolutely critical. 

Mr. PERLMUTTER. And how would you do that? 

Mr. JOHNSON. The main thing, the main proposal I put forward, 

as we have been discussing, is to reduce the size of the largest financial institutions so that when you find yourself in a collapse or 

bailout situation, you can say, ‘‘No, that is okay, you go to bankruptcy. You sort it out with your creditors.’’ You are more like CIT 

Group last week than Citibank over the past 6 or 9 months. 

Mr. PERLMUTTER. Or could you demand sort of as a compromise 

to that that you do not break up the bank or reduce their size and 

make them spin something off but you say, as to the Northeast, 

you have to show capital for Massachusetts, Connecticut, Maine, 

New York, whatever, so that you have a version of unit banking, 

that your bank has to stand on capital based on a section of the 

country? There are a lot of ways to deal with this. The chairman 

40 

and I have been in a disagreement. I think that really you have 

to look at both the size of the institutions as well as their product 

mix, not just markets—not just capitalization, but I am trying to 

find something that maybe I can get him to bite on. 

The CHAIRMAN. If the gentleman will yield? 

Mr. PERLMUTTER. Yes, I certainly would yield to the chairman. 

The CHAIRMAN. My disagreement is I cannot get the gentleman 

to tell me what he proposes? 

Mr. PERLMUTTER. Well, I am asking the experts. 

The CHAIRMAN. Well, the gentleman referred to a disagreement. 

The only disagreement is I cannot understand what you are talking 

about. I have asked you to tell me what it is you want to do. 

Mr. PERLMUTTER. I know what I want to do. I want to reduce the 

size of some of the biggest institutions. 

The CHAIRMAN. With regard to Glass-Steagall, are you proposing 

we repeal Gramm-Leach-Bliley? I keep asking the gentleman because he made it public, what would the gentleman do to restore 

it? 

Mr. PERLMUTTER. Mr. Johnson, please help me here? 

Mr. JOHNSON. If I could make a suggestion, I would not go on 

the—perhaps the chairman would consider a graduated capital requirement so that it is not the zero one, tier one or not, but a capital requirement that increases quite sharply, because we know the 

system risk, an amount of extra GDP that is taken on when these 

big guys fail is enormous, so this is a very sharply increasing 

curve. 

The CHAIRMAN. When I said a disproportionate increase in capital, that is what I meant. 

Mr. JOHNSON. The question is in the numbers then. I think the 

question is, how fast does it increase? How big is the disincentive 

to size? 

Mr. ZANDI. I do not think you want to go back to any kind of regional kind of criteria. If you remember back historically, we had 

vicious regional economic cycles in large part because of unit banking, because the bank was stuck to its region and exacerbated the 

downturn in those regions. And so we had very severe regional economic cycles in large part because of the unit banking system that 

we had, so I think that would be very counterproductive, very counterproductive. 

Mr. MAHONEY. I completely agree with that point. I would also 

just note that in the crisis, what you saw is that institutions that 

had a lot of exposure to subprime did very badly. Some of those 

were stand-alone investment banks like Lehman. Some of them 

were more or less stand-alone commercial banks like Countrywide. 

Some were combined investment and commercial banks like 

Citigroup. So I do not think that that is a strong piece of evidence 

that we need to reestablish Glass-Steagall. 

Mr. PERLMUTTER. Thank you, and I yield back. 

The CHAIRMAN. I am going to just take time, since the gentleman 

raised it, I frankly did not recognize my views as he characterized 

them. I still do not understand what the proposal—yes, in terms 

of capital requirements, I very much agree but the gentleman has 

not given me any idea with which I could disagree. 

41 

Mr. PERLMUTTER. The gentleman is working on it, and that is 

why he was asking the panel for some assistance. And if I cannot 

come up with an answer that satisfies you, then I cannot come up 

with an answer. 

The CHAIRMAN. But characterizing it as disagreement is sort of 

puzzling. 

Mr. SHERMAN. If the gentleman will yield? I did put forward an 

idea, not based on whether you are mixing investment banking 

with insurance and the Glass-Steagall idea, but just a dollar limit. 

You cannot have debts to Americans in excess of $100 billion. 

The CHAIRMAN. Well, I agree, but that is not the specific point. 

The gentleman from Colorado was specifically referencing GlassSteagall. Part of this hearing is to get out on the table vague ideas. 

Is it too big to fail? One of the arguments— 

Mr. PERLMUTTER. Would the gentleman yield? 

The CHAIRMAN. —would be bring back Glass-Steagall? If that is 

what people want, discuss it. Your proposal— 

Mr. PERLMUTTER. Mine is certainly like a Glass-Steagall. I do not 

believe that, and I think that the investment banking community 

is all about risk, and I think they should be allowed to do whatever 

derivatives they want to do, subject to disclosing to their investors 

in an open fashion. And they are over in this part of the investment or in the financial community. And the banking system, 

which I believe is like a public utility, which is why we pumped in 

$700 billion because we had to keep the lights on, and we intervened in substantial ways through the Fed, that is in my opinion 

what we had to do last fall, which was a radicalizing moment for 

me. So I just believe that they really look at the world differently. 

The CHAIRMAN. I understand that but does the gentleman—first 

of all, that does not account for AIG. AIG was not a bank. AIG was 

doing derivatives and the Federal Reserve intervened without us. 

People should remember that the Federal Reserve with the approval of Treasury came to us and announced that they were intervening. It was not part of the TARP initially, they just did that on 

their own. Mr. Wallison said it was not necessary but it was not 

because they were banks. 

But my other point to the gentleman is you say that, what is it— 

we have been talking about this for months, and I still do not know 

what is it you are proposing? 

Mr. PERLMUTTER. I am proposing, one, to limit the amount of deposits a single institution can take, which right now is 10 percent. 

The CHAIRMAN. That is not what we are talking about. 

Mr. PERLMUTTER. I am talking about size and product mix. So 

I am also saying that insurance companies cannot be part—insurance companies, stock trading companies and banks should be separate, as they were Glass-Steagall. I believe that the Roosevelt Administration did the right thing when its first act was GlassSteagall to separate those— 

The CHAIRMAN. Are you proposing that we be imposing GlassSteagall? That is the first I have heard of your proposing that as 

a solution. 

Mr. PERLMUTTER. That is the best way I can articulate what it 

is that I believe. So with that, I yield back. 

The CHAIRMAN. The gentleman from Indiana? 

42 

Mr. DONNELLY. Thank you, Mr. Chairman. We have been talking 

about too big to fail, and there is another area and that is too big 

of an effect on the entire market. And, Mr. Zandi, I want to ask 

you, and I read your statement where it talked about emerging 

market investors did little or no research of their own and that the 

credit—this could not have occurred without someone providing the 

credit. But did not the triple A ratings given by Moody, is not that 

how the credit flowed was if you give me triple A, the credit will 

come from that? And so we had a large investor who talked to us 

and said if the credit rating agencies had not done that, this never 

would have started in the first place? 

Mr. ZANDI. Well, let me just reiterate, I am an employee of the 

Moody’s organization but these are my own personal views. 

Mr. DONNELLY. No, I understand. 

Mr. ZANDI. And I think there is plenty of blame to go around in 

that chain of securitization, from the lender to the investment 

bank, to the rating agency, to the investor, all of them were culpable, all of them made mistakes, all of them were wrong. And if 

you read through the entire statement, I go through that chain. 

Mr. DONNELLY. Right, and I did. And I guess what I am asking 

is we have been talking about solutions to this. 

Mr. ZANDI. Yes. 

Mr. DONNELLY. And so with the credit rating agencies, the question is what keeps a Moody’s from being in the same position with 

their triple A ratings again? 

Mr. ZANDI. Right. 

Mr. DONNELLY. And that is what we have been looking at. And 

we have talked about cutting the cord or the apparent conflict of 

interest of the person who is asking you to rate these securities 

being the same one who pays the fees. And there have been a couple of things offered, and I guess I wanted to get your opinion, is 

it something that, like they do in the legal world when you go to 

file a case, that the judge is pulled out of a hat so you cannot pick 

your judge. And so is this in effect a number of these organizations 

are put in a hat and that you cannot say, ‘‘I want Moody’s because 

they will give me a triple A?’’ 

Mr. ZANDI. Right. And I think that in my own personal view is 

worth an experiment. I do not know if that works better or not, but 

I think it probably is an idea that is worth some experimentation. 

There are a number of things though that I think should be 

done. I think the reliance on ratings in regulatory requirements is 

inappropriate. Right now, if you are a money market fund, it can 

say I can only invest in securities with a rating of above a certain 

amount, I think that is inappropriate. Regulators are outsourcing 

their function to the rating agencies, and they should not do that. 

I think the SEC, as the regulator of the rating agencies, should 

be more active in monitoring and evaluating what the rating agencies are doing, much like banking regulators do with credit risk officers of major commercial banks. They look at the model. They say 

does this make sense and should it be doing this? 

I think it should be required that the data that the rating agencies use in the ratings should be vetted in some way. One of the 

biggest problems, in my view, was that the rating agencies would 

say, ‘‘You give me the data, I do not re-underwrite the loan, I take 

43 

it as given and then I rate.’’ And they say that to everybody, the 

investment bank and the investor, ‘‘That is not what we do, and 

that is the way it has been since we started our business 100 years 

ago,’’ but that makes no sense to me. There should be a third party 

firm that vets the data, samples the data, and makes sure it is 

okay. 

So, I think all these things could be—should be implemented and 

tried. But let me say one thing, and this is no win for me, right, 

because you are not going to believe me anyway? 

Mr. DONNELLY. No, no, that is not true. I read your book and everything. 

Mr. ZANDI. Okay. But bottom line, I do not believe that this conflict of interest, and there is one, is fundamentally why they 

screwed up, why they made a mistake in the ratings. I do not believe that is it. I think it is these other issues that we have discussed. And I do not think, I would experiment with the approach 

you just articulated, but fundamentally you are going to have conflicts no matter what you do and no matter how you design it and 

it is a matter of managing the conflicts as best you can. 

Mr. DONNELLY. One of the other things the investor, this fellow, 

talked about was, and he talked to all of us, was maybe what we 

ought to do is just throw a couple of cents on every tray and have 

in effect a quasi-public rating system so that we do not have to 

speculate on the opinion of Moody’s or that they be part of in effect 

almost become like a public utility, that it is too important getting 

this right to our economy, to the global economy. We had the Fed 

chairman in today who said if we had let this get out of hand, the 

whole global economy would have collapsed. And so much of it was 

tied in to these incorrect ratings given by Moody’s and others. 

Mr. ZANDI. Well, let me just say two things. One, I think a fee, 

a transaction fee, is a good way to raise revenue, the only problem 

is you have to do it globally. 

Mr. DONNELLY. Right. 

Mr. ZANDI. You cannot just do it here because it is— 

Mr. DONNELLY. Then you are not non-competitive. 

Mr. ZANDI. —just not going to work. 

Mr. DONNELLY. Right. 

Mr. ZANDI. And talk about G–20— 

Mr. DONNELLY. But what we are trying to do is we are throwing 

out ideas of how we can fix this. 

Mr. ZANDI. Yes. 

Mr. DONNELLY. Anything from any of you. 

Mr. ZANDI. In a financial transaction, it might be a good way to 

raise revenue to self-finance too-big-to-fail, right? It is a way to 

generate revenue, you put in the fund so that might be a way to 

do it, but you cannot do it unless it is a global process. 

The CHAIRMAN. Mr. Johnson wanted to say something, I think. 

Mr. JOHNSON. I think there is an assumption here, which is that 

we will get it right next time. The analytics will be better, the politics will be better. 

Mr. DONNELLY. And that is why I said, why can we assume that 

next time we will do it any better? 

Mr. JOHNSON. I am not opposed to these ideas, let’s try them, but 

fundamentally we will get it wrong again. We have every reason 

44 

to think we just have not changed the nature of human society and 

human judgment and the politics of the entire process and the 

power of the most powerful people in the system, so a quasi-public 

rating system will get it wrong also. And you should plan, we 

should design something that can withstand the failure of that. It 

may be a good idea to tweak it, I am not opposed to that. But I 

think we should design something that—and the only way I think 

to do that is to make sure that when things fail, they are not so 

big relative to the economy. 

The CHAIRMAN. Let me at this point because I want to close it 

out, but one point Mr. Zandi makes, we are making progress in 

reaching consensus, such as with the tier one companies. I think 

that it is overwhelmingly likely that we will repeal all statutory 

mandates to rely on rating agencies, and that we will instruct the 

regulatory agencies to examine theirs. So that is one way to deal 

with. That one I can guarantee you will be in the final bill, that 

all those—there are two forms. In some cases, people are not allowed to do certain things unless they get a certain rating. In other 

cases, people cannot invest in other entities unless they have certain rating. We are combing the statutes now. There is agreement, 

that is something that was independently come up with in the Republican plan and our plan. That will happen. 

Mr. SHERMAN. Mr. Chairman? 

The CHAIRMAN. Sure. 

Mr. SHERMAN. I thought we were going to do another round. I 

wonder if I could have 1 minute then? 

The CHAIRMAN. Sure. 

Mr. SHERMAN. I would just say that we are trying to minimize 

the belief on Wall Street that particular companies have somehow 

a Federal guarantee. The best way to do that is to have no bailout 

authority vested in Treasury unless and until some future statute 

is passed. TARP will expire, and then Wall Street would have to 

recognize that it would be very difficult under any circumstances 

to pass TARP again. The way to maximize the belief on Wall Street 

that those companies that they identify as systemically important 

are going to get a Federal bailout, and therefore are entitled to 

lower-cost capital is to vest in Treasury the right to bail out companies. And the fact that the management of that company might 

lose its job is of little interest to the counterparties. What we are 

trying to do is make sure that the cost of capital does not reflect 

the belief that there may be a bailout of the institution. And 

whether management comes or goes, it does not really matter to 

the rating institution. 

The CHAIRMAN. Will the gentleman yield? 

Mr. SHERMAN. I yield. 

The CHAIRMAN. Would the gentleman identify to me, because we 

obviously have not done it yet, but what in the—is it in the resolving authority, where do you find this bail-out authority? 

Mr. SHERMAN. The bail-out authority, I think, was well-summarized by Mr. Mahoney. 

The CHAIRMAN. No, but I am asking you where you found it in 

the Administration’s position because I think you have overstated 

it significantly? Where in the Administration’s position are they 

asking for money to be able to give out? 

45 

Mr. SHERMAN. I do not have—they do not ask for an appropriation. I do not have a copy of the proposal. I do have Mr. Mahoney’s 

testimony, and my statements are fully consistent with the second 

page of his testimony. 

The CHAIRMAN. Mr. Mahoney, do you have the reference? What 

is it that you think constitutes bail-out authority? 

Mr. MAHONEY. Well, I think it is the—there is a statement that 

in the special resolution procedure, there are all these authorities 

given to spend money. Now, the White Paper does not say where 

the money comes from. I believe there was— 

The CHAIRMAN. The question would not be where it came from, 

but where it went to. Is the authorization to bail out creditors? 

Mr. MAHONEY. The authorization is to re-capitalize, to purchase 

assets from, to make loans to, and that would go directly from 

Treasury into the— 

The CHAIRMAN. My understanding of it was regarding the bankruptcy situation, where you were not paying off old debts but trying to get things going forward, but we will look at that. 

Mr. MAHONEY. If that is all that is being talked about, then that 

is great, but I certainly did not read it that way. 

The CHAIRMAN. It is in the White Paper? 

Mr. MAHONEY. That is right. 

The CHAIRMAN. That is not our impression but, again, that will 

be our decision. The hearing is adjourned. 

I apologize, the Property and Casualty Insurance Association 

asked that we submit a statement. Any member who wishes to submit any information, including any of the witnesses, without objection, the hearing record will be open for 30 days. 

[Whereupon, at 5 p.m., the hearing was adjourned.] 

(47) 

A P P E N D I X 

July 21, 2009 

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