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SYSTEMIC RISK AND 

THE FINANCIAL MARKETS 

HEARING 

BEFORE THE

COMMITTEE ON FINANCIAL SERVICES 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED TENTH CONGRESS 

SECOND SESSION 

JULY 10, 2008 

Printed for the use of the Committee on Financial Services 

Serial No. 110–127 

( 

(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, 

LINCOLN DAVIS, Tennessee 

PAUL W. HODES, New Hampshire 

KEITH ELLISON, Minnesota 

RON KLEIN, Florida 

TIM MAHONEY, Florida 

CHARLES WILSON, Ohio 

ED PERLMUTTER, Colorado 

CHRISTOPHER S. MURPHY, Connecticut 

JOE DONNELLY, Indiana 

BILL FOSTER, Illinois 

ANDRE ́ CARSON, Indiana 

JACKIE SPEIER, California 

DON CAZAYOUX, Louisiana 

TRAVIS CHILDERS, Mississippi 

SPENCER BACHUS, Alabama 

DEBORAH PRYCE, Ohio 

MICHAEL N. CASTLE, Delaware 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

RON PAUL, Texas 

STEVEN C. LATOURETTE, Ohio 

DONALD A. MANZULLO, Illinois 

WALTER B. JONES, JR., North Carolina 

JUDY BIGGERT, Illinois 

CHRISTOPHER SHAYS, Connecticut 

GARY G. MILLER, California 

SHELLEY MOORE CAPITO, West Virginia 

TOM FEENEY, Florida 

JEB HENSARLING, Texas 

SCOTT GARRETT, New Jersey 

GINNY BROWN-WAITE, Florida 

J. GRESHAM BARRETT, South Carolina 

JIM GERLACH, Pennsylvania 

STEVAN PEARCE, New Mexico 

RANDY NEUGEBAUER, Texas 

TOM PRICE, Georgia 

GEOFF DAVIS, Kentucky 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

ADAM PUTNAM, Florida 

MICHELE BACHMANN, Minnesota 

PETER J. ROSKAM, Illinois 

KENNY MARCHANT, Texas 

THADDEUS G. McCOTTER, Michigan 

KEVIN McCARTHY, California 

DEAN HELLER, Nevada 

JEANNE M. ROSLANOWICK, Staff Director and Chief Counsel 

(III) 

C O N T E N T S 

Page 

Hearing held on: 

July 10, 2008 ..................................................................................................... 1 

Appendix: 

July 10, 2008 ..................................................................................................... 57 

WITNESSES 

THURSDAY, JULY 10, 2008 

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

System ................................................................................................................... 10 

Paulson, Hon. Henry M., Jr., Secretary, U.S. Department of the Treasury ....... 7 

APPENDIX 

Prepared statements: 

Kanjorski, Hon. Paul E. ................................................................................... 58 

Neugebauer, Hon. Randy ................................................................................. 60 

Bernanke, Hon. Ben S. ..................................................................................... 61 

Paulson, Hon. Henry M., Jr. ............................................................................ 67 

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Bachus, Hon. Spencer: 

‘‘Remarks by U.S. Treasury Secretary Henry M. Paulson, Jr., on the 

U.S., the World Economy and Markets before the Chatham House,’’ 

dated July 2, 2008 ......................................................................................... 69 

Hinojosa, Hon. Ruben: 

‘‘Contents of Letter Sent to ED with Notice of Participation’’ ...................... 76 

‘‘On-going Barriers to Continued Participation in FFELP for Not-forProfit Lenders ............................................................................................... 78 

COSTEP Letter ................................................................................................. 80 

Memo to Texas Congressional Staff from Jimmy Parker, PPHEA, dated 

July 8, 2008 ................................................................................................... 81 

(1) 

SYSTEMIC RISK AND 

THE FINANCIAL MARKETS 

Thursday, July 10, 2008 

U.S. HOUSE OF REPRESENTATIVES, 

COMMITTEE ON FINANCIAL SERVICES, 

Washington, D.C. 

The committee met, pursuant to notice, at 10:05 a.m., in room 

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

Members present: Representatives Frank, Kanjorski, Waters, 

Maloney, Watt, Ackerman, Sherman, Moore of Kansas, Capuano, 

Hinojosa, McCarthy of New York, Lynch, Miller of North Carolina, 

Scott, Green, Cleaver, Davis, Hodes, Ellison, Perlmutter, Donnelly, 

Speier, Childers; Bachus, Castle, Royce, Paul, Manzullo, Biggert, 

Shays, Feeney, Hensarling, Garrett, Neugebauer, Campbell, 

Bachmann, Roskam, Marchant, and Heller. 

The CHAIRMAN. The hearing will begin. We have an overflow 

room, I believe. Is that true? 

The CLERK. Yes, sir. 

The CHAIRMAN. Okay, so there is an overflow room for people 

who can’t find seats. We have gotten the agreement of the Chairman and the Secretary, preliminary to any opening statements, to 

stay until 1 p.m. We will probably have some votes, so we will 

maximize our time. 

Let me remind the members that Chairman Bernanke will be before this committee next week for the Humphrey-Hawkins hearing 

on the economy. Members are obviously free to raise anything they 

want today, but it is my hope that we would focus on these very 

important questions of financial regulation. I know there are members who want to review what happened with Bear Stearns and 

then what we do going forward, but I personally believe the best 

use of the committee’s time today would be to focus on those structural questions and regulatory questions. 

We will have the Chairman before us for 3 more hours next week 

to talk about the economy and Humphrey-Hawkins; and, again, I 

would urge members to do that. All members are free, as we know, 

to bring up whatever they want, but that would be our hope, because I did note that some of the members of the committee had 

asked previously for a hearing to look into what happened with 

Bear Stearns. And I said at the time that I thought that was very 

important. I believed it was best to do that in this broader context. 

Members want to get a new context because the experience regarding Bear Stearns is clearly the context in which much of this hearVerDate Aug 31 2005 15:16 Nov 04, 2008 Jkt 044900 PO 00000 Frm 00005 Fmt 6633 Sfmt 6633 K:\DOCS\44900.TXT TERRIE
2 

ing is and much of what we will be talking about is what happens 

if that should occur. So those are the parameters. 

Given the importance of this, and given the interest of members 

in speaking, we are going to hold pretty firmly to the 5-minute 

rule. And, obviously, we are not going to completely finish in 5 

minutes, but no question can be asked after the 5 minutes have expired. We will allow the answers to conclude. But I am going to 

have to restrain myself and others from asking any questions after 

the 5 minutes. 

Under the rules that apply when we have cabinet and cabinetlevel officials, there are two opening statements on each side, the 

chairs and ranking members of the appropriate subcommittees. In 

this case, it seems clear to me that it is the Financial Institutions 

Subcommittee that is the developing subcommittee so that is how 

we will proceed. The official part of the hearing will now begin and 

I will recognize myself for a fairly strict 5 minutes. 

When I was about to become chairman of this committee in 2006, 

I was told by a wide range of people that our agenda should be that 

of further deregulating. I was told that the excess regulation in 

America from Sarbanes-Oxley and other acts was putting American 

investment companies and financial institutions at a competitive 

disadvantage and that people much prefer the softer touch of the 

financial services authority to the harshness of the American regulatory structure. Things have changed. 

Where there was a strong argument as recently as November of 

2006 that we had been over-regulating the financial system, I believe the evidence is now clear that we are in one of the most serious economic troubles that we have seen recently, in part because 

of an inadequacy of regulation. 

Clearly, that has been the case with regard to subprime mortgages, but what has been striking is not simply that we had the 

problems with subprime mortgages, but that those problems infected so much of the financial system, including, I must say, many 

in Europe. One of the things though that I do take away from that 

set of conversations, and then it’s a fairly clear one is that what 

we do, and I believe there is a consensus now among people in the 

Administration, among many of us in Congress, and among people 

in the financial industry, that an increase in regulation is required. 

It must be done sensibly. It must be market sensitive. 

But I believe we have seen a significant shift from the notion 

that the most important issue was to deregulate further to one recognizing the need for more sensible regulation, but more regulation. It is clear that this needs to be done in the context of international cooperation, and I am encouraged to believe, and the first 

trip this committee took when I became chairman was to Belgium 

and London to meet with people from the European Union and 

Great Britain in terms of their financial regulation. This needs to 

be done with international cooperation and I think the prospects of 

that are very good. I think there was a broad international recognition that some form of increased regulation was necessary. And the 

form we are talking about is regulation of risk-taking outside the 

very narrowly defined commercial banking. Innovation is very important, and an innovation that has brought a great deal of benefit 

during the last few decades is securitization. 

3 

Securitization replaces the lender-borrower relationship and the 

discipline that you have in the lender-borrower relationship. A very 

large part of our problem is that we have not yet found sufficient 

replacement for the discipline of a lender not lending to a borrower 

unless the lender is sure that the borrower will be able to repay. 

Something that simple causes problems in subprime, and it has 

caused problems elsewhere. 

We have had too many loans made without sufficient attention 

to whether or not the loans could be repaid. And, what we now 

have is a contagion, because people who bought loans in various 

forms that they shouldn’t have bought are now resistant to buying 

things that they should buy. 

That is why I believe regulation properly done, regulation of risk 

that is too unconstrained today, because the various risk management techniques that were supposed to replace the lender-borrower 

relationship have not been successful. Diversification and quantitative models and the rating agencies, we have not yet replaced 

them. Some form of regulatory authority is necessary. If properly 

done, a market sensitive regulatory authority not only prevents 

some of the problems, but is pro-market, because we have investors 

now who are unwilling to invest even in things they should. 

Many of our nonprofit institutions and our State and local governments have been the victims of this. So our job, I believe—and 

I congratulate the officials of this Administration for having done 

a good job in the current legal context of dealing with these problems—is to look at what happened, to look at what is now going 

on, and to decide what should be done to provide a better statutory 

framework for the increase in regulation that I believe people agree 

should happen. 

The gentleman from Alabama. 

Mr. BACHUS. I thank the chairman for holding this hearing on 

systemic risk and the appropriate regulatory responses to managing that risk and I know there will be short-term responses, and 

at some time in the future maybe a new regulatory structure which 

will take time. 

The two public servants before us today I think are eminently 

qualified to speak to these issues and we welcome Secretary 

Paulson and Chairman Bernanke. They had agencies whose mandates and responsibilities are broad and are deep, but the issue of 

systemic risk also requires the involvement of other significant and 

capable regulators, including particularly the SEC and the Federal 

banking regulators. 

It is my expectation that the leaders of these agencies will appear at a subsequent hearing with their comments and that will 

supplement our understanding and the testimony we gather today 

on this difficult issue, and I trust that Secretary Paulson and 

Chairman Bernanke agree that a collaborative effort that includes 

these agencies is going to be needed if we are to have a successful 

outcome. 

To say we are living through interesting times in our financial 

markets is to state the painfully obvious. We have seen a run on 

what was then the Nation’s 5th largest investment bank, Bear 

Stearns. We have seen the Federal Reserve intervene in order to 

avoid a cascading effect from Bear Stearns’s collapse that could 

4 

have spread throughout the financial system with what I believe 

would have been decidedly negative implications for the larger 

economy. 

And we have seen the Federal Reserve take steps or a series of 

steps that in the short term at least have brought a measure of 

confidence and stability to the financial markets. But now that the 

immediate crisis created by the run on Bear Stearns has passed, 

we face some difficult, long-term policy questions. 

Perhaps the most critical question is, have we arrived at the 

place where virtually every primary dealer is considered too big or 

too interconnected to fail? The logical extension of this too big to 

fail perception is that markets no longer work and that the government must not only exercise greater control of our capital markets, 

but also be the ultimate guarantor of financial solvency; that would 

be a conclusion I could not endorse. 

And in reading over the remarks of Secretary Paulson in London, 

I see that you did not endorse it, either. A far better alternative 

is to restore market discipline within appropriate regulatory 

bounds. I believe we have reached a consensus that we must establish a modern, regulatory structure to strengthen the safety and 

soundness of our institutions and discourage unsound practices and 

conduct. However, these regulations should not and cannot ensure 

that institutions will never fail. And if one does fail, we must ensure that taxpayers are not left holding the bag. 

Thanks to the fast action of the Federal Reserve in cooperation 

with the SEC and the Treasury, we dodged a bullet when Bear 

Stearns collapsed. We may not be so lucky next time. For that reason, I look forward to hearing from today’s witnesses about what 

we can do to provide for an orderly resolution in the event a large 

financial institution fails. 

The regulatory regime we establish and follow must accomplish 

three things: ensure market discipline; provide a shock absorber 

against systemic risk; and, first and foremost, protect the taxpayer. 

To preserve market discipline and discourage moral hazard, we 

must see to it that no firm should be considered too big or interconnected to fail. To protect against systemic risk, we must ensure 

that when a firm fails, it does not bring down the entire financial 

system with it, i.e., an orderly liquidation. And to protect the taxpayer, we have to make sure that the cost of that failure is borne 

by the firm’s shareholders and creditors, and not passed on to the 

taxpaying public. 

In conclusion, of necessity we have to plan for how to handle the 

failure of a major institution. It is important, however, that we create a system focused not on failure, but on success. In doing so, we 

must also resist the temptation to over-regulate in our zeal to discourage practices such as overleveraging an excessive risk-taking 

that put institutions at risk of failure. This is a tall order. 

Thank you, Mr. Chairman, for holding this hearing, and thank 

you to our witnesses. 

The CHAIRMAN. The gentleman from Pennsylvania is now recognized and will temporarily preside. 

Mr. KANJORSKI. Mr. Chairman, this hearing comes at a critical 

juncture. As the economy reels from a widespread, far-reaching financial crisis that continues to wreak havoc on everything from the 

5 

housing market to student loans, while we remain focused on many 

current economic difficulties average Americans face, we must simultaneously look to the future to determine how to prevent or at 

least mitigate future crises. 

Financial innovation and the proliferation of complex and exotic 

financial instruments are probably inevitably going to occur under 

our capitalist system. But we must develop innovative, regulatory 

and oversight responses to keep pace as these market transactions 

evolve. One such proposal worth considering is the Systemic Risk 

Reduction Act of 2008 put forth by the Financial Services Roundtable. 

This bill seeks to make regulation more efficient by closing gaps 

in our regulatory structure and by promoting consolidation and cooperation among regulatory agencies. Their proposal includes a 

provision of particular interest to me; namely, it proposes establishing a bureau similar in concept to the Office of Insurance Information which passed the Capital Markets Subcommittee yesterday. 

Without a Federal repository to collect and analyze information 

on insurance issues, we cannot fully understand and control systemic risk. The Roundtable proposal would also expand the authority of the Federal Reserve so that investment banks who borrow 

from the Fed’s discount window in various facilities do not get a 

free pass. 

No one else can borrow money without conditions, and the American people do not expect that the investment bank be allowed to 

do so. 

Chairman Bernanke spoke 2 days ago and raised many of these 

issues and offered ideas for consideration, noting that the financial 

turmoil since August underscores the need to find ways to make 

the financial system more resilient and more stable. I wholeheartedly agree. He further stated that the Fed’s powers and responsibilities should be commensurate. 

It is the job of Congress to strike that proper balance. While 

many concur that the Federal Reserve’s move to bail out Bear 

Stearns in March of this year was necessary to prevent a financial 

meltdown, most also agree that we should be concerned about setting precedents with broad ramifications down the road. Taxpayers 

cannot be asked to bail out financial institutions, and we should 

look for ways to prevent such dire situations from arising in the future. 

Another area germane to today’s discussion is speculation. Specifically, we must determine to what extent speculation in commodities futures has hurt American consumers by artificially inflating 

the price of oil, energy, and other goods. I appreciate the ongoing 

debate on speculation with economists, traders, pundits, and politicians staking out various positions on the issue. To the extent that 

we can glean further insight from our panelists today, that would 

be of tremendous help, for it is true that speculators bear blame. 

Then congressional action in the form of increased oversight in authority is warranted. 

on a related note, I am very interested in consolidating the regulation of our securities and commodities markets. While the CFTC 

currently has jurisdiction of this market, the Treasury’s recVerDate Aug 31 2005 15:16 Nov 04, 2008 Jkt 044900 PO 00000 Frm 00009 Fmt 6633 Sfmt 6633 K:\DOCS\44900.TXT TERRIE
6 

ommendation to merge SEC and FCTC seems a sensible course of 

action for Congress. 

We need to take this action now and I look forward to working 

with the Administration. 

The CHAIRMAN. The gentlewoman from Illinois. 

Mrs. BIGGERT. Thank you, Mr. Chairman, and thank you for 

holding today’s hearing on systemic risk. 

Your responsiveness to the letter submitted in April by Mr. Garrett, Ranking Member Bachus, and more than a dozen of us on this 

side of the aisle is very much appreciated, and I would also like to 

thank Congressman Garrett for his leadership on this issue. 

I welcome our distinguished witnesses today: Federal Reserve 

Chairman Bernanke; and Treasury Secretary Paulson. Your steady 

leadership is helping us weather the storm that our markets and 

our economy are experiencing. As a side, Secretary Paulson, I 

would like to specifically thank you and your staff, as well as the 

public and private sector partners for organizing the HOPE NOW 

Alliance, which has helped to keep hundreds of thousands of families in their homes. 

And Chairman Bernanke, the Federal Reserve’s actions continue 

to help preserve confidence and bring stability to our financial markets and institutions. Infusing liquidity into the marketplace has 

prevented the credit crunch from seizing the system, and facilitating the sale of Bear Stearns to J.P. Morgan is viewed by many 

as having been the lynchpin that prevented a run-on-the-bank type 

crises which could have spread throughout our financial system 

and caused irreparable harm. 

What brought us here today are these specifically and the latter 

actions on the part of the Fed, actions that begged the question, 

what can the Federal Government do to prevent future, similar 

bailouts that can put taxpayer dollars at risk? Is the Federal Government prepared for another Bear Stearns? Can a Federal regulator or regulators monitor specific indicators that will flag weaknesses within individual, financial institutions and prevent another 

Bear Stearns? And can they do so without unnecessarily increasing 

regulatory burdens that would diminish the competitiveness of the 

U.S. financial institutions in the global marketplace? 

It is vital that we closely examine the capacity of the Federal 

Government to monitor the large financial institutions like Bear 

Stearns, which represent not only American innovation and financial strength, but also our great vulnerability with respect to systematic risk in the financial system. 

I think without delay, we need to strike the right balance and 

create a simpler, stronger, regulatory system that preserves the resilience of our economy, protects taxpayers, and maintains the position of our financial system as the envy of the world. 

I look forward to the testimony and I yield back. 

The CHAIRMAN. I think the gentlewoman. 

We will now go to the opening statements, and a subject to which 

I sometimes pay insufficient attention is protocol. We don’t usually 

have two such distinguished witnesses. The question is, who goes 

first? 

I think the order, certainly, of succession to the Presidency is 

which Department was established first. And, I think, Mr. Paulson, 

7 

that you have about 125 years on Mr. Bernanke, so we will begin 

with you. 

STATEMENT OF THE HONORABLE HENRY M. PAULSON, JR., 

SECRETARY, U.S. DEPARTMENT OF THE TREASURY 

Secretary PAULSON. Mr. Chairman, Ranking Member Bachus, 

thank you very much for holding this hearing and for your leadership on these very important issues. 

As you know, our financial markets have been experiencing turmoil since last August. It will take additional time to work through 

these challenges. Progress has not come in a straight line, but 

much has been accomplished. Our financial institutions are repricing risk, de-leveraging, recognizing losses, raising capital, and improving their financial position. Their ability to raise capital even 

during times of stress is a testament to our financial institutions 

and to our financial system. 

Fannie Mae and Freddie Mac are also working through this challenging period. They play an important and vital role in our economy and housing markets today, and they need to continue to play 

an important role in the future. Their regulator has made clear 

that they are adequately capitalized. 

Market practices and discipline on the part of financial institutions and investors are also improving. Our regulators are shining 

a light on our challenges. Through the President’s Working Group 

on Financial Markets, we have issued a report analyzing the 

causes of the turmoil and recommending a comprehensive policy response, implementation of which is well underway. 

Regulators are enhancing guidance, issuing new rules, and communicating more effectively across agencies domestically and internationally. 

Although our regulatory architecture and authorities are outdated and less than optimal, we have been working together; while 

respecting our different authorities or responsibilities, we have 

been working together to ensure the stability of the financial system, because it is in the interest of the American people that we 

do so. 

Today this is by far our most important priority. And our seamless cooperation to achieve it is made possible by the leadership 

and support provided by this committee and by other leaders in 

Congress. I have confidence in our regulators and markets. We 

need to remain focused and continue to address challenges with 

your support and with your help. But we will ultimately emerge 

with strong capital markets, which will in turn enable our economy 

to continue to grow. 

Now looking beyond this period of market stress, which will 

eventually pass as these situations always do, I have presented my 

ideas for improving our regulatory structure and expanding our 

emergency powers. I look forward to discussing these ideas with 

you today, even as we continue our primary focus on confronting 

current challenges and maintaining stable, orderly financial markets. 

In March, I laid out a Blueprint for a Modernized Financial Regulatory Structure in which we recommended a U.S. regulatory 

model based on objectives that more closely link the regulatory 

8 

structure to the reasons why we regulate. Our model proposes 

three primary regulators: One focused on market stability across 

the entire financial sector; another focused on safety and soundness 

at institutions supported by a Federal guarantee; and the third focused on protecting consumers and investors. 

A major advantage of this structure is its timelessness and its 

flexibility, and that because it is organized by a regulatory objective rather than by financial institution category, it can more easily 

respond and adapt to the ever-changing marketplace. 

If implemented, these recommendations eliminate regulatory 

competition that creates inefficiencies and can engender a race to 

the bottom. The Blueprint also recommends a number of near-term 

steps. These include formalizing the current informal coordination 

among U.S. financial regulators by amending and enhancing the 

Executive Order which created the President’s Working Group on 

Financial Markets, and while retaining State level regulation of 

mortgage origination practices, creating a new Federal level commission, the Mortgage Origination Commission, to establish minimum standards for among other things personal conduct and disciplinary history, minimum educational requirements, testing criteria and procedures, and appropriate licensing revocation standards. 

The Blueprint includes recommendations on a number of intermediate steps as well, focusing on payment and settlement systems 

in areas such as futures and securities, where our regulatory structure severely inhibits our competitiveness. 

We recommended the creation of an optional Federal charter for 

insurance companies similar to the current dual charter system for 

banking, and that the thrift charter has run its course and should 

be phased out. We also recommend the creation of a Federal charter for systemically important payment and settlement systems, 

and that these systems should be overseen by the Federal Reserve 

in order to guarantee the integrity of this vital— 

The CHAIRMAN. Mr. Secretary, I don’t want you to feel constrained. Both you and the Chairman should ignore the time limits. 

We will be constrained by them, but this is too important for you 

to be, so please, both of you can ignore the red lights. 

Secretary PAULSON. Okay. I am just about finished. 

The CHAIRMAN. No, I didn’t mean to— 

Secretary PAULSON. Okay. 

The CHAIRMAN. Just the opposite. We have enough time to listen 

to this, so please don’t be constrained. 

Secretary PAULSON. When we released the Blueprint, I said that 

we were laying out a long-term vision that would not be implemented soon. Since then, the Bear Stearns episode and market turmoil more generally have placed in stark relief the outdated nature 

of our regulatory system and has convinced me that we must move 

much more quickly to update our regulatory structure and improve 

both market oversight and market discipline. 

Over the last several weeks, I have recommended important 

steps that the United States should take in the near term, all of 

which move us toward the optimal regulatory structure outlined in 

the Blueprint. I will summarize these briefly. 

9 

First, Americans have come to expect the Federal Reserve to step 

in to avert events that pose unacceptable systemic risk. But the 

Fed does not have the clear statutory authority, nor the mandate 

to do this. Therefore, we should consider how to most appropriately 

give the Federal Reserve the authority to access necessary information from complex financial institutions, whether it is a commercial 

bank, an investment bank, a hedge fund, or another type of financial institution, and the tools to intervene to mitigate systemic risk 

in advance of a crisis. 

The MOU recently finalized between the SEC and the Federal 

Reserve is consistent with this long-term vision of the Blueprint, 

and should help inform future decisions, as our Congress considers 

how to modernize and improve our regulatory structure. 

Market discipline is also critical to the health of our financial 

system, and must be reinforced, because regulation alone cannot 

eliminate all future bouts of market instability. For market discipline to be effective, market participants must not expect that 

lending from the Fed or any other government support is readily 

available. I know from firsthand experience that normal or even 

presumed access to a government backstop has the potential to 

change behavior within financial institutions with their creditors. 

It compromises market discipline and lowers risk premiums, ultimately putting the system at greater risk. 

For market discipline to effectively constrain risk, financial institutions must be allowed to fail. Today, two concerns underpin expectations of regulatory intervention to prevent a failure. They are 

that an institution may be too interconnected to fail or too big to 

fail. 

Steps are being taken to improve market infrastructure, especially where our financial firms are highly intertwined. The OTC 

Derivatives market and the triparty repurchase agreement market, 

which is the marketplace through which our financial institutions 

obtain large amounts of secured financing, must be improved. It is 

clear that some institutions, if they fail, can have a systemic impact. 

Looking beyond immediate market challenges, last week I laid 

out my proposals for creating a resolution process that ensures the 

financial system can withstand the failure of a large, complex financial firm. To do this, we will need to give our regulators additional emergency authority to limit temporary disruptions. These 

authorities should be flexible, and to reinforce market discipline, 

the trigger for invoking such authority should be very high, such 

as a bankruptcy filing. 

Any potential commitment of government support should be an 

extraordinary event that requires the engagement of the Treasury 

Department and contains sufficient criteria to prevent cost to the 

taxpayer to the greatest extent possible. 

This work will not be done easily. It must begin now and begin 

in earnest. Again, thank you for your leadership. 

[The prepared statement of Secretary Paulson can be found on 

page 67 of the appendix.] 

10 

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

SYSTEM 

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

Bachus, and other members of the committee, I am pleased to be 

here today to discuss financial regulation and financial stability. 

The financial turmoil that began last summer has impeded the 

ability of the financial system to perform its normal functions and 

has adversely affected the broader economy. This experience indicates a clear need for careful attention to financial regulation and 

financial stability by the Congress and other policymakers. 

Regulatory authorities have been actively considering the implications of the turmoil for regulatory policy and for private sector 

practices. In March, the President’s Working Group on Financial 

Markets issued a report and recommendations for addressing the 

weaknesses revealed by recent events. 

At the international level, the Financial Stability Forum has also 

issued a report and recommendations. Between them, the two reports focused on a number of specific problem areas, including 

mortgage lending practices and their oversight, risk measurement 

and management at large financial institutions, the performance of 

credit rating agencies, accounting and evaluation issues, and issues 

relating to the clearing and settlement of financial transactions. 

Many of the recommendations of these reports were directed at 

regulators in the private sector and are already being implemented. 

These reports complement the Blueprint for regulatory reform 

issued by the Treasury in March, which focused on broader questions of regulatory architecture. 

Work is also ongoing to strengthen the framework for prudential 

oversight of financial institutions. Notably, recent events have led 

the Basel Committee on Banking Supervision to consider higher 

capital charges for such items as certain complex structured credit 

products, assets and banks trading books, and liquidity guarantees 

provided to off-balance sheet vehicles. New guidelines for banks liquidity management are also being issued. 

Regarding implementation, the recent reports have stressed the 

need for supervisors to insist on strong risk measurement and risk 

management practices that allow managers to assess the risk that 

they face on a firm-wide basis. 

In the remainder of my remarks, I will comment briefly on three 

issues. The supervisory oversight of primary dealers, including the 

major investment banks, the need to strengthen the financial infrastructure, and the possible need for new tools for facilitating the 

orderly liquidation of a systemically important securities firm. 

Since the near collapse of the Bear Stearns companies in March, 

the Federal Reserve has been working closely with the Securities 

and Exchange Commission, which is the functional supervisor of 

each of the primary dealers and the consolidated supervisor of the 

four large investment banks, to help ensure that those firms have 

the financial strength needed to withstand conditions of extreme 

market stress. 

To formalize our effective working relationship, the SEC and the 

Federal Reserve this week agreed to a memorandum of understanding. Cooperation between the Fed and SEC is taking place 

11 

within the existing statutory framework, with the objective of addressing the near-term situation. 

In the longer term, however, legislation may be needed to provide a more robust framework for prudential supervision of investment banks and other securities dealers. In particular, under current arrangements, the SEC’s oversight of the holding companies 

of the major investment banks is based on a voluntary agreement 

between the SEC and those firms. Strong holding company oversight is essential, and thus in my view the Congress should consider requiring consolidated supervision of those firms and providing the regulator the authority to set standards for capital liquidity holdings and risk management. 

At the same time, reforms in the oversight of these firms must 

recognize the distinctive features of investment banking and take 

care neither to unduly inhibit innovation, nor to induce a migration 

of risk-taking activities to less-regulated or offshore institutions. 

The potential vulnerability of the financial system to the collapse 

of Bear Stearns was exacerbated by weaknesses in the infrastructure of financial markets, notably in the markets for over-thecounter derivatives and in short-term funding markets. 

The Federal Reserve together with other regulators in the private sector is engaged in a broad effort to strengthen the financial 

infrastructure. For example, since September 2005, the Federal Reserve Bank of New York has been leading a major joint initiative 

by both the public and private sectors to improve arrangements for 

clearing and settling credit default swaps and other OTC derivatives. 

The Federal Reserve and other authorities are also focusing on 

enhancing the resilience of the markets for triparty repurchase 

agreements, in which the primary dealers and other large banks 

and broker-dealers obtain very large amounts of secured financing 

from money funds and other short-term risk-averse investors. 

In these efforts we aim not only to make the financial system 

better able to withstand future shocks, but also to mitigate moral 

hazard and the problem of too big to fail by reducing the range of 

circumstances in which systemic stability concerns might prompt a 

government intervention. 

More generally, the stability of the broader financial system requires key payment and settlement systems to operate smoothly 

under stress and to effectively manage counterparty risk. Currently 

the Federal Reserve relies on a patchwork of authorities, largely 

derived from our role as a banking supervisor as well as on moral 

suasion to help ensure that the various payment and settlement 

systems have the necessary procedures and controls in place to 

manage the risks that they face. 

By contrast, many major central banks around the world have an 

explicit statutory basis for their oversight of payment and settlement systems. Because robust payment and settlement systems are 

vital for financial stability, the Congress should consider granting 

the Federal Reserve explicit oversight authority for systemically 

important payment and settlement systems. 

The financial turmoil is ongoing and our efforts today are concentrated on helping the financial system to return to more normal 

functioning. It is not too soon, however, to think about steps that 

12 

might be taken to reduce the incidence and severity of future financial crises. 

In particular, in light of the Bear Stearns episode, the Congress 

may wish to consider whether new tools are needed for ensuring 

an orderly liquidation of a systemically important securities firm 

that is on the verge of bankruptcy together with a more formal 

process for deciding when to use those tools. 

Because the resolution of a failing securities firm might have fiscal implications, it would be appropriate for the Treasury to take 

a leading role in any such process, in consultation with the firm’s 

regulator and other authorities. 

The details of any such tools and the associated decision-making 

process require more study. One possible model is the process currently in place under the Federal Deposit Insurance Corporation 

Improvement Act, or FDICIA, for dealing with insolvent commercial banks. The fiducial procedures give the FDIC the authority to 

act as a receiver for an insolvent bank and to set up a bridge bank 

to facilitate an orderly liquidation of that firm. The fiducial law 

also requires that failing banks be resolved in a way that imposes 

the least cost to the government, except when the authorities 

through a well-defined procedure determine that following the least 

cost route would entail significant systemic risk. 

To be sure, securities firms differ significantly from commercial 

banks in their financing, business models, and in other ways, so 

the fiducial rules are not directly applicable to these firms. 

Although designing a resolution regime appropriate for securities 

firms would be a complex undertaking, I believe it would be worth 

the effort. In particular, by setting a high bar for such actions, the 

adverse effects on market discipline could be minimized. 

Thank you. I would be pleased to take your questions. 

[The prepared statement of Chairman Bernanke can be found on 

page 61 of the appendix.] 

The CHAIRMAN. Thank you. Let me begin with the Secretary, because I was pleased to note in your statement that you understand 

that the regulator at OFHEO, of Fannie Mae and Freddie Mac, believe that they are now adequately capitalized. They were important institutions and I think that was—I’m pleased that you made 

that statement. I think that is important for people to understand. 

I said before that we are talking about more regulation done sensibly. Obviously there are still areas that the Secretary indicated 

where we could improve by simplifying regulation. That doesn’t 

mean that it means more regulation everywhere. But there does 

seem to me to be emerging a consensus that we need a regulator 

concerned with threats to the systemic stability of the economy, 

that come from unconstrained risk-taking in a group of financial 

institutions outside the commercial banking system. And I was 

pleased, Mr. Secretary, that you mentioned hedge funds and investment banks. I think it would be a great mistake to talk about type 

of institution. That would give people an incentive to change their 

hats. 

We are talking about the impact of the activity, and we are talking I think, and a consensus appears to be emerging that it is going 

to be the Federal Reserve. I have to say that there are people who 

say, well, either you create a brand new regulator, it seems to me, 

13 

which would be I think a mistake, or you give it to the Federal Reserve. And I agree with both of you, that in order to do that, the 

Federal Reserve needs more power. A situation in which the Federal Reserve is available and is under pressure to provide funding, 

but does not have the ability to act well before that time to diminish the need for that and to oppose conditions, that is unacceptable. 

We are talking, but we should be clear, about an increase in regulatory power. And let me say, you know, there was a time when 

the notion of requiring hedge funds to register was very controversial. It does seem to me that we have clearly gone beyond that. We 

are talking about giving the Federal Reserve the power to not just 

get information but to deal with various things which could include 

capital requirements and other factors. 

Now those are very important issues, and I think, as I said, there 

was a consensus emerging that it should be the Federal Reserve. 

And I have to say when people say, ‘‘Well,’’ they’ll have this or that 

question about whether the Federal Reserve should do it, I invoke, 

as people have heard me do, the wisdom of a great 20th Century 

philosopher, Henny Youngman. The maxim was, ‘‘How’s your wife? 

Compared to what?’’ And the Federal Reserve compared to what? 

I don’t see any alternative to the Federal Reserve. 

But my question is this. I think this is an important task, and 

there’s a great deal of agreement, that we should be moving to empower the Federal Reserve to have regulatory authority over a wide 

range of financial institutions in recognition in part of the fact that 

they have a systemic impact and that the current situation puts 

the Fed in an untenable position of being given a set of expectations to respond when it doesn’t have the full panoply of tools to 

respond. 

But here is the question: How soon? Now we are where we are. 

It is July of an election year. This is a very complex subject. We 

don’t want to do anything that would interfere with our wonderful 

financial system. And I mean our wonderful financial system, 

which has been so productive. We want to curb abuses without 

interfering with the productive function. 

Mr. Secretary, you said that they don’t now have that authority, 

and we all agree with that. Is it essential that we move now? My 

sense is this—and I applaud the signing of the memorandum of understanding between the SEC and the Fed. That kind of cooperation has been useful. The cooperation between your two entities 

has been useful. 

I guess there are two options. One is that we have to try and legislate something now. And let me say we should distinguish. Mr. 

Secretary, you had a broader set of recommendations involving 

thrift institutions and credit unions, and a whole lot of things that 

no one in this institution is eager to deal with. So nobody is in any 

hurry on those. But we have I think taken out of that—and you 

have elaborated with the resolution issue—the question of macrostability regulator, of the Federal Reserve being given powers to 

deal with the problems that could come to a system from someone 

too big or too unconnected to fail. 

Here is the question: Working together as we have within existing authorities, with yourselves, with I hope cooperation—that you 

understand cooperation with us—can we get by until the end of the 

14 

year? We obviously will start working on this. Is it your view that 

immediate legislation is necessary? Or are we able to get by, given 

the cooperation we have had, given the kind of support we try to 

give you as much as possible, and begin working immediately together, so that early next year, one of the first items on the congressional agenda will be the legislation you talked about? Let me 

ask each of you to respond. 

Secretary PAULSON. Mr. Chairman, let me respond by saying 

first of all, the role of the Fed as a macro stability regulator will 

take time to think through. It’s a complex question. It’s an important question. The authorities that will go with that, how that will 

work. That will clearly take some time to consider and to get the 

legislation through. 

Even more pressing is—which is again a complex issue which 

will take time—is the issue of the resolution process and procedures for complex financial institutions that aren’t federally insured. We both talked about that. And so in terms of priorities, 

that should be even the higher priority in terms of time. But that 

will take some time. 

I think what you are getting at is even though our system may 

not optimal, the authorities may not be optimal, we have been able 

to work together to protect the system by communicating with Congress, and that’s our plan and our expectation that we are going 

to need to keep doing that, and we are going to work in that way, 

recognizing that the requests we have made are not things that can 

be implemented immediately. 

The CHAIRMAN. Mr. Chairman? 

Mr. BERNANKE. I would associate myself with Secretary 

Paulson’s remarks. We are working together extremely cooperatively, the Secretary and I, and the other agencies. Obviously, we’d 

like to have additional tools, but these are very complex matters, 

as the Secretary has indicated. So my hope would be that the Congress would begin soon to think hard about these issues, and we 

are happy of course to provide whatever support we can. But I 

think for the time being that the most likely outcome and the expectation is that we will continue to work in a creative way together to try to manage these ongoing situations. 

The CHAIRMAN. I’m going to break my own rule just to make one 

statement, because I gather what you’re saying is, it is better in 

this very complex and very important set of issues that we do it 

right and that we do it very quickly. 

Mr. BERNANKE. I would agree with that. 

The CHAIRMAN. The gentleman from Alabama. 

Mr. BACHUS. Thank you. I think there is a consensus that there 

needs to be a single regulator for market stability, and I think that 

is in the Treasury’s Blueprint. But short term, what are your 

present powers that you could bring to bear near term on risk management on containing risk, containing systemic risk, what are 

some things that you can do right now? 

Mr. BERNANKE. There were a number of recommendations in 

those reports I referred to. There are many steps that could be 

taken at the regulatory and supervisory level to strengthen the 

oversight of banks and other financial institutions. For example, I 

mentioned the Basel Accords which are strengthening liquidity reVerDate Aug 31 2005 15:16 Nov 04, 2008 Jkt 044900 PO 00000 Frm 00018 Fmt 6633 Sfmt 6633 K:\DOCS\44900.TXT TERRIE
15 

quirements, changing capital charges for different kinds of activities, making recommendations to the regulators about how to go 

about strengthening the risk management systems of these firms. 

We are paying very close attention to the system as a whole. We 

are looking at the payment systems and other parts. The Federal 

Reserve has after all acted as a de facto—along with the Treasury—crisis manager for many decades. So there are a number of 

things we can do to strengthen the oversight under existing statutes and to make sure that the infrastructure is working as well 

as possible. For example, I mentioned also the private-public cooperation that we are now having to strengthen the OTC derivatives infrastructure and the like. 

So there’s a lot that we can do, but we are doing—I just want 

to make very, very clear that what we are doing is, you know, 

working within the current statutory framework. The broader reforms that I believe are necessary are obviously the purview of 

Congress. And, you know, we hope that you’ll be addressing those 

issues in a timely way. 

Mr. BACHUS. Secretary Paulson? 

Secretary PAULSON. I agree very much with what Chairman 

Bernanke has said, and I would just simply say that even if the 

structure isn’t optimal and all of the authorities aren’t optimal, regulators are working together seamlessly to address some of the 

issues that have arisen, and I think progress has been made. 

Mr. BACHUS. You know, one thing I have noticed, I know the 

President’s Working Group, you know, as far back as say a year 

ago or I think as late as March, talked about the risk management 

practices of the investment banks as being faulty and that resulted 

in a lot of what we are seeing, market turmoil. 

I think the response I have seen from the Fed particularly has 

been that, you know, establishing risk management standards, 

which I certainly understand. You have also mentioned I think 

long term it’s necessary to establish capital standards and liquidity 

standards. But short term, I do worry about new capital requirements and liquidity standards as sort of precipitating and sort of 

a tension between that and the need for these institutions to raise 

more capital. So how do you balance that? 

And I know one thing that you have talked about, I think the 

Treasury has talked about, is giving these—a lot of the banks the 

right to increase borrowing from or raising capital from private equity. Would you like to address that? 

Secretary PAULSON. Yes, Congressman. We have encouraged, 

both of our organizations have encouraged financial institutions to 

recognize losses and to raise capital, because capital is available, 

and that is a much better alternative than shrinking their balance 

sheets and pulling back from the activities that are so necessary. 

And as it relates to raising capital, private equity is one source, 

and we very much endorse the Fed’s posture, which is being open 

to private equity investors and encouraging private equity investors. 

Mr. BERNANKE. Congressman, our first objective is to make sure 

that these firms are safe and able to withstand the current 

stresses. And so, for example, in our work with the SEC at the investment banks, we have urged them, and they have complied, in 

16 

raising capital and especially in raising liquidity, which was one of 

the key issues with Bear Stearns. So we want them to be safe and 

we want to do that immediately. 

In the longer term, there is this issue of ‘‘procyclicality,’’ the possibility that capital rules and reserving rules and so on, accounting 

rules, will tend to exacerbate the credit cycle. It is a very important 

issue. We have some elements of the Basel II Accords that address 

that. But I think it’s something that as we go forward, we will 

want to look at much harder to try to limit the regulatory impact 

on the procyclicality of credit. 

On private equity, I agree absolutely with the Secretary that we 

are looking for banks and other financial institutions to raise capital. Private equity is a very good source of capital. There are the 

issues relating to effective control as established by the Bank Holding Company Act, which has a statutory limit of 25 percent ownership. Below that, the Federal Reserve has to address what constitutes effective control. We are currently looking at that in the 

hope that we will make a clearer statement about when private equity can come in and add capital to the banking system. 

Mr. BACHUS. Thank you. 

The CHAIRMAN. The gentleman from Pennsylvania. 

Mr. KANJORSKI. Thank you, Mr. Chairman. Secretary Paulson, 

Chairman Bernanke, listening to your response to the chairman 

about timing, since last August of course all of us have examined 

and watched market failure occurring in various and sundry areas 

growing from subprime failure in August to what we call now a 

credit crisis. And the information that I am receiving from some 

entities is that the end is not here; there are other shoes to fall. 

And what occurs to me is that this gap we are talking about between now and when the new Congress convenes it could pass the 

emergency powers or extraordinary powers or change powers that 

are necessary to meet this crisis. It is probably for all intents and 

purposes 9 months at least. 

In the meantime, between now and March or April of next year, 

what type of anticipated problems could we be dealing with or 

could you be dealing with and the American economy be dealing 

with that we should take cognizance of now? And is there perhaps 

a need for extraordinary emergency legislation to empower either 

the Federal Reserve or Treasury to take certain actions to prevent 

systemic risk if over the next 9-month period the Congress is not 

able to act and you discern that the powers you have are not adequate to meet the challenges? That hiatus seems to me to be one 

that we have to address now. 

Mr. Secretary? 

Secretary PAULSON. Let me say that I have grown up in a world 

where you don’t always have all the tools you’d like to have, and 

I have very seldom seen a perfect hand that someone has to play. 

We are dealing in a financial market that has evolved greatly since 

the time that many of our rules were put in place, that many of 

the—that the regulatory structure was set. And so, realistically, I 

agree with the Chairman, that it will be difficult to get it done as 

quickly as we would like. 

The resolution powers for a large financial institution that is not 

a bank, it would be nice to be able to have that. But I will again 

17 

say to you, even though this is a difficult period we are going 

through, and we both said that it’s going to take some time to get 

through it, there will be some more bumps on the road, I really 

want to emphasize that you have seen the Federal Reserve, by 

opening up the discount window to the investment banks, through 

the Bear Stearns actions, to make a very strong statement about 

the importance of the stability of our financial system. And I have 

seen those investment banks working with the Fed and the SEC 

to strengthen their liquidity, strengthen their capital positions, and 

re-price risk. So we are making progress here. 

And, you know, I get reports all the time. Our regulators are 

very vigilant. I received a report about the banking industry and 

get it regularly. As of the end of March, even though the banks are 

going through some difficult problems, and their situation is evolving, the reports I got indicated that 99 percent of those institutions 

holding 99 percent of the assets fell into the highest capital category, well capitalized. So we are making progress. We don’t have 

everything we would like to have, but I think the right answer to 

our question, Congressman, which is a good question, is we have 

to—we always have to have contingency plans, be prepared for various eventualities. We plan, we work together. We have been doing 

that from before the turmoil started, from the day I set foot in 

Washington. And we are just going to have to work together, be 

creative and work with you. 

Mr. KANJORSKI. Mr. Secretary, my time is running out. This 

morning I spoke to a student loan group, and we worked for the 

last 4 or 5 months to try and resolve that pressing problem, the 

failure of the auction market. And even what I received from them 

is that sometimes the activities or willingness of our Departments, 

like the Department of Education and even your Department, are 

unwilling to take the risk of implying the authority to do things. 

I am just urging, either you recognize that now, and if you need 

emergency powers on some of these things you mentioned to us before we get to catastrophe. 

Secretary PAULSON. Well, let me mention the student loans, because here is a case where I think you have seen our department 

work creatively with the Department of Education to deal with a 

problem that’s here and now, and so we have a program in place 

which I think is going to be acceptable to most fellow lenders. I 

think it’s going to work. To the extent that we need something else, 

the Department of Education is ready with their direct lending, 

their lending of last resort. Meanwhile, we are working creatively 

at Treasury to come up with other market-based solutions to help 

this market. 

So we are working through this. We have a program that’s going 

to get us through this period, and we are working to do things to 

help that securitization market become more vital. 

The CHAIRMAN. The gentleman from Delaware. 

Mr. CASTLE. Thank you very much, Mr. Chairman. To the Chairman of the Federal Reserve and to Secretary Paulson, I would just 

like to thank them I think for what has been excellent work in very 

difficult circumstances, as well as the chairman and the ranking 

member of the committee. 

18 

My questions, I guess, are going to be more about timing than 

anything. We see the expressions ‘‘short term,’’ ‘‘intermediate 

term,’’ ‘‘long term,’’ expressions like that. I guess when you’re—we 

all look at our calendars differently. When you’re in Congress, you 

sort of think in terms of the next election or whatever it may be. 

We have a couple of more weeks in July. We have September, and 

then we have the election season coming up. And, Secretary 

Paulson, you mentioned that the financial institutions need to recognize their losses and raise capital, those kinds of things. 

But my question to you regarding the fluctuations in the various 

equity markets around the world, plus the housing market in the 

United States is this: Is the short term measurable, in a matter of 

months or whatever it may be, not years at this point? 

Furthermore, is there anything that we in Congress should be 

doing in the short time we have left that would be helpful with respect to the problems that exist right now in America? Is there 

anything—and you probably have identified this in your testimony, 

but I must admit it’s complicated enough for me to have trouble following. Are there things that you all should be doing on a shortterm basis that would be helpful that we should know about? 

Secretary PAULSON. Well, let me mention a couple of things right 

away. First of all, your committee has been out in front on this, but 

let’s get the GSE reform legislation done, to have a strong, independent regulator that will inject confidence into those institutions 

and into the markets, and that’s a very positive thing. 

And then secondly, we both haven’t said don’t work on this. I 

mean, work should begin immediately and urgently on these resolution authorities and these steps we have suggested. We are just 

telling you that realistically, because we have heard from you, and 

we know it to be the case, realistically, it’s going to be difficult to 

get things done this year. But this is going to take some time, so 

begin work urgently on that. But those are the two things that I 

would suggest. 

Mr. CASTLE. Chairman Bernanke? 

Mr. BERNANKE. Like Secretary Paulson, I have no objection 

whatsoever to early action and will continue to work with you 

closely in all directions. It’s just our sense, and of course you’re in 

a better place than we are to make the judgment, that the more 

complex issues like resolution or even financial regulatory restructuring are simply not likely to happen in a short term, and we need 

to take the time to make sure it’s done right and thoroughly 

worked through. 

So we will continue to think about what steps might be taken on 

a shorter-term basis and be in close touch with Congress. But, 

again, we are—I just want to be clear that, you know, it’s not that 

we don’t have any tools. We have plenty of tools, and we are working together very well I think to address a difficult situation. 

Mr. CASTLE. Well, I would agree with you. I think probably everyone in this room would agree with you on GSE reform. I hope 

you will carry that same message to the Senate, too. We think that 

is vitally important. And I would agree with you that we do need 

to work on some of these regulatory systems. But can you give me 

some sense of what you think the timing may be? I don’t see that 

happening this year, either in Congress or by outside regulatory 

19 

procedures. But do you have some sense of what the timing may 

be on the centralizing of regulation as encapsulated in what you 

have been stating? Is this something you would expect to happen 

next year, or would it take 3 to 5 years to do this? 

Secretary PAULSON. Well, yes. I think maybe I should have even 

been clearer on this. In terms of—when we started thinking about 

regulatory structure, we began the thinking before this period of 

market turmoil, well before this. And we started off saying, if we 

were beginning from scratch, which we obviously aren’t, how would 

you design a system? And that was more of a vision to start a discussion. And to me, to get to there, as the Chairman said, would 

take a good while. We are talking about multiple years. But if you 

don’t know which way you would like to head, you know, you have 

no chance of getting there. 

So we started with that vision, and then we came up with some 

immediate priorities and some other things that could be done in 

the intermediate term. And as I look at what can be done in terms 

of the timing the one thing we are not talking about a lot here, but 

I do believe we don’t want to forget, is the fact that a lot of this 

problem came about as a result of sloppy and lax mortgage origination procedures. These mortgages were originated, most—many 

cases at the State level with State regulation and supervision. We 

weren’t proposing doing away with this, but a mortgage origination 

commission to set standards at the Federal level and evaluate 

what’s going on, you know, at the States, I think is something you 

shouldn’t lose sight of. 

And then the things we have talked about here that can be done 

quickly are the resolution authorities for complex financial institutions that aren’t federally insured, giving the Federal Reserve authority and responsibility over the payment systems, which can be 

done very quickly; moving to have the Fed while retaining their responsibilities as a consolidated regulator, to give them the authorities they need to do the macro stability job, can be done. 

And then, looking out a little bit further, there is no doubt that 

we should have a merger, in my mind, with the SEC and the 

CFTC. And so that again is something that can be done in the intermediate term, as could an optional Federal charter for insurance. 

The CHAIRMAN. The gentlewoman from California. 

Ms. WATERS. Thank you very much, Mr. Chairman. I would like 

to thank you first for holding this very important hearing today, 

and I would like to thank both Secretary Paulson and Chairman 

Bernanke for being here today. 

Let me start by saying that which you have probably heard too 

often, how disappointed I am with all of us, Members of Congress, 

for what appears to have been weak oversight of our regulatory 

agencies, and our regulatory agencies for what appears to have 

been weak oversight of our financial institutions. 

I have to tell you, I have been holding hearings throughout the 

country on the subprime meltdown, and I’m absolutely stunned by 

the extent of the devastation to some of our families and communities caused by this subprime meltdown. I’m stunned when I hear 

about these exotic products and how they could ever have come 

into being without any oversight. 

20 

I’m really stunned about some of the ARMs and the way that 

they reset, and the fact that there’s something called a margin that 

I never knew about before, and that margin can be whatever the 

financial institution decides it should be, above and beyond the 

going interest rate. 

I came on this committee right after the S&L scandal, and I 

heard a lot about reform. And so while I suppose I should be impressed with the fact that there’s a President’s Working Group on 

Financial Markets and the reports that have been issued, I’m skeptical about what is being proposed. As it said in March, the President’s Working Group on Financial Markets issued a report and 

recommendations for addressing the weaknesses revealed by recent 

events, both at the international level—between the two reports— 

and at the domestic level, between the two reports, focused on a 

number of specific problems, including mortgage lending practices 

and their oversight, risk management and management at large financial institutions. 

And then there was, Mr. Bernanke, the Blueprint that you 

talked about for a modernized financial regulatory structure, and 

you proposed a new regulatory architecture, and the third regulatory agency would be focused on protecting consumers and investors. I have to tell you, I’m surprised, because I thought that our 

regulatory agencies, no matter how they were organized, whether 

it was by financial institution category or not, had as its prime objective, all of those things that you talk about doing now. 

So what I really want to know is not so much what you plan that 

may not be instituted for some time, because it takes some time 

to get this into practice, I want to know what you’re doing now. I 

want to know what you know about servicers. We have found that 

there’s little if any regulation of mortgage servicers. 

And I want to know if you have anything in your plans to deal 

with them, because after we get finished with all of the President’s 

HOPE NOW program and the money that we are giving to 

NeighborWorks and other organizations to do counseling, they can’t 

do very much good, because the servicers are the ones who make 

the decisions. 

They’re the ones that are in charge of these accounts. They decide to collect—well, they have to collect the fees, they have to collect the mortgage payment. They increase fees. They agree to extend or modify arrangement, but they can do practically whatever 

they want. I want to know what you know about them, what you’re 

doing about them. 

And secondly, I want to know and understand Mr. Bernanke, 

what you know about the sale of Countrywide to Bank of America. 

I understand that Bank of America bought these mortgages at 

quite a reduced rate. And I want to know what that rate was and 

whether or not these properties could go back on the market appraised at a higher rate than the bank purchased them for, and 

who gets the profit and the difference, and why can’t that go back 

to the homeowners who are losing their homes through foreclosure. 

First, I would like to hear from Secretary Paulson. 

Secretary PAULSON. Well, first of all, I understand your frustration, and I understand what’s going on right now in the marketVerDate Aug 31 2005 15:16 Nov 04, 2008 Jkt 044900 PO 00000 Frm 00024 Fmt 6633 Sfmt 6633 K:\DOCS\44900.TXT TERRIE
21 

place, how it’s affecting homeowners, and I feel your frustration 

and I understand it. 

Now— 

Ms. WATERS. Mortgage servicers. 

Secretary PAULSON. In terms of market servicers, the HOPE 

NOW Alliance is, I believe, making a big difference and making a 

difference every single month. It is helping 200,000 people a 

month. And it is getting to those people, and as far as I can see, 

Congresswoman Waters, and I look at this data all the time, and 

the standard I use is this: Are there people who can afford to stay 

in their homes, who want to stay in their homes but are being 

forced into foreclosure? 

Very sadly, there have been people who have been put in homes 

who didn’t have the ability to stay in the homes and to afford to 

stay in the homes, and there are others who were speculators and 

walked away from mortgages. So what we have done, this HOPE 

NOW Alliance is again focused on getting to people and making a 

difference. And I think the servicers are making a difference. 

Ms. WATERS. I’m sorry. I really do need to ask a question about 

mortgage servicers. 

The CHAIRMAN. We can’t ask another question. We are over time. 

We have a time problem. Mr. Chairman, do you want to answer? 

Mr. BERNANKE. I would like to briefly answer, yes. I said a few 

things. On consumer protection, about a year ago I testified before 

this committee and said that the Federal Reserve was going to take 

significant action on protection for high-cost loans. On Monday we 

will announce the final rules, and I think they will be very effective 

in addressing some of these issues. 

Admittedly, it would be better if it had been earlier, but we have 

responded and you’ll soon see the proposal or the rules that we are 

going to be issuing with respect to consumer protection. We are 

also of course working on rules with respect to credit cards as well. 

On foreclosure avoidance, again, HOPE NOW has been taking a 

leadership role. The Federal Reserve has been supporting that in 

various ways, including urging banks to work with customers in 

trouble and through a variety of neighborhood activities through 

our reserve banks around the country, which I would be happy to 

provide more information about. 

And finally, on Countrywide, of course that was a market transaction. The Fed had nothing to do with it, and the discounts related to the probability that some of those loans would go into default. I do think that in a sense some of those savings ought to pass 

through to the ultimate borrowers. And in a sense, when there’s a 

principal writedown or other loan modification that is essentially 

what is happening, that you’re giving a break to the borrower so 

the borrower can stay in the home, and I think that’s a good thing 

to do. 

The CHAIRMAN. Let me ask, Mr. Secretary, that you respond in 

writing, particularly because of our time constraints, on the 

servicer issue. 

Secretary PAULSON. Yes, I look forward to doing that. 

The CHAIRMAN. So I would ask that you respond in writing to the 

servicer part of the question. The gentleman from California. 

22 

Mr. ROYCE. Thank you, Mr. Chairman. I want to thank you, Secretary Paulson and Chairman Bernanke, for being with us, and I 

want to begin with a question to Secretary Paulson. And Chairman 

Bernanke, you might want to comment on this, too. 

There was a speech delivered by the Federal Reserve Chairman, 

former Fed Chairman Alan Greenspan, to the Federal Reserve 

Bank of Chicago in May of 2005. And he said, ‘‘Market participants 

usually have strong incentives to monitor and control the risks 

they assume in choosing to deal with particular counterparties. In 

essence, prudential regulation is supplied by the market through 

counterparty evaluation and monitoring rather than by the authorities. Such private prudential regulation can be impaired, indeed even displaced,’’ said Greenspan, ‘‘if some counterparties assume that government regulators obviate private prudence. We 

regulators are often perceived as constraining excessive risk-taking 

more effectively than is demonstrably possible in practice, except 

where market discipline is undermined by moral hazard, for example, because of federal guarantees of private debt, private regulation generally has proved far better at constraining excessive risk 

taking than has government regulation.’’ 

And more recently, Jeffrey Lacker, the president of the Federal 

Reserve Bank of Richmond, and he said—he got into details about 

the need for regulators to distinguish between fundamental and 

nonfundamental runs on financial institutions when considering 

intervention by the regulators. And he said, ‘‘There are models in 

which runs are self-fulfilling prophesies, are costly, and could be 

avoided perhaps through central bank intervention. Other runs 

arise from fundamental developments, and for these, central bank 

intervention interference with market discipline distorts market 

prices.’’ 

And so I would ask you both if it is possible to establish a regulatory model that can provide a sense of security to prevent selffulfilling prophesies, to use, you know, Jeffrey Lacker’s words, with 

respect to runs on our financial institutions, and at the same time 

avoid interfering with the type of market discipline that Mr. Greenspan believes is so critical to the health of our capital markets. 

And if I could start with you, Secretary Paulson. 

Secretary PAULSON. I believe that is really the trick. That’s what 

needs to be done, to have the right balance between market stability, you know, the regulatory piece, and market discipline. That 

is critical. And a well-balanced, healthy system over time is going 

to need that. 

And what I have said, and what I tried to say today is that right 

now we are going through a period of unusual turmoil. The focus 

on all of our parts is on market stability. That’s what the focus is. 

But our system will never be what it should be unless we can get 

to the point where market discipline plays its necessary role. And 

in order to get there, I want to emphasize what Ben Bernanke said. 

We need to do some things to strengthen the infrastructure we 

have, the over-the-counter derivative market, the tri-party repossession market, and that which is secured financing between institutions, and we need to do that so that the appearance and the reality that institutions are too interconnected to fail no longer exists, and we are going to need broader emergency authorities for 

23 

the resolution or wind-down of complex financial institutions that 

don’t have Federal deposit insurance. 

But that’s where we need to get. That is what we have to drive 

toward, but let’s not forget today our institutions have been doing 

the things they need to do, shoring up their liquidity, their capital, 

and our emphasis is on stability today. 

Mr. ROYCE. Thank you, Secretary Paulson. Chairman Bernanke, 

if you could respond. 

Mr. BERNANKE. I would like to. Thank you. First of all, I agree 

absolutely that market discipline is the heart of our system. Avoiding the moral hazard, having strong market discipline makes the 

system work better, and an example would be the counterparty discipline between the banks, investment banks, and the hedge funds, 

has protected the banks and the banks and the investment banks 

from any losses from hedge funds. There have been no material 

losses to banks or investment banks because of failing hedge funds, 

and because the banks have been doing due diligence, and that’s 

what we want to see. 

Now in my view, our action to address the Bear Stearns situation 

was necessary, given the financial conditions at the time, but it’s 

absolutely correct, as President Lacker has pointed out, it does 

raise moral hazard concerns going forward, and then the question 

is how do you address those. 

In my remarks today, I listed three possible approaches or complementary approaches. The first is supervisory oversight of those 

institutions to make sure that they are in fact doing what they 

need to do to be safe and sound, are not taking advantage of the 

implicit backstop. So since we have gone into the investment 

banks, they have all raised their liquidity, not reduced it. So that 

is one way to ensure that the moral hazard is minimized. 

Second, as Secretary Paulson mentioned, if we can strengthen 

our infrastructure sufficiently so that it could absorb the failure of 

a large firm—we felt it wasn’t able to do so in March. But if it were 

clearer that the system could withstand the failure of a firm of 

Bear Stearns’ size, then we would be much more comfortable letting it happen, because we would think the system would be preserved. 

And finally, I think that, as has happened in the commercial 

banking world, we do have stronger resolution procedures that 

would allow us to intervene in an early stage perhaps and to try 

to create an orderly process that doesn’t create the market 

externalities at the same time it would avoid moral hazard because 

the equity holders, the management and subordinate debt holders 

would all be subjected to losses in that process. 

The CHAIRMAN. The gentleman from Alabama had a unanimous 

consent request. 

Mr. BACHUS. Thank you. Mr. Chairman, I would like to ask for 

unanimous consent to submit for the record Secretary Paulson’s 

speech in London on July 2nd on market discipline. 

The CHAIRMAN. Without objection, the speech will be made a part 

of the record, and the gentlewoman from New York is recognized 

for 5 minutes. 

Mrs. MALONEY. Welcome, and thank you for your service. I want 

to give a very special welcome to Secretary Paulson who previously 

24 

was a business and civic leader in the great City of New York, and 

it is reassuring to me and many Americans that someone who has 

deep experience in the day-to-day operation of financial markets is 

at the helm of Treasury and really initiating this conversation and 

discussion today. 

I also want to welcome Chairman Bernanke, who has brought 

the Fed to fully realize its role, not only managing monetary policy 

and guarding the safety and soundness of our financial institutions, 

but also focusing on curbing unfair and deceptive practices that 

have hurt working Americans and our overall economy. Next week 

we look forward and congratulate you on your new regulations to 

shore up mortgage lending, and I enthusiastically support your proposed role to eliminate abusive practices in credit cards. 

I would like to follow up on my colleague’s questioning on market 

discipline and ask Secretary Paulson, who has a great deal of experience in this area. It’s clear from recent events that many expected synergies of financial service activities, whatever benefits 

that they gave during times of economic prosperity, gave rise to 

conflicts and excessive risk taking. It appears that many firms are 

in so many lines of businesses that conflicts and excessive risk 

arise. 

Huge trading operations have also put more mundane activities 

of financial institutions at risk. For example, some have said Bear 

Stearns’ trading operation may have caused risk to its clearing operations. And in view of these recent events and challenges, some 

have said that the repeal and deregulation of Glass-Steagal may 

have gone too far. 

And I would like to ask, would a financial service industry where 

banks, hedge funds, investment banks, and other entities were 

more limited to the array of business they are in help the situation 

by providing competitive and arm’s-length checks and balances on 

financial activities through the marketplace? And would a more diversified financial service industry that had more specialization 

and less concentration offer any benefits in reducing risk and the 

need for regulation? 

Secretary PAULSON. Congresswoman Maloney, that’s an important question. There is no doubt that our financial system has 

grown. It has become much more complex. We have seen a complexity of financial instruments, and a lot has taken place between 

the last stress we had in the market in 1998 and this current period. And so we are seeing how a number of these institutions and 

securities are performing under stress for the first time. 

I do agree with you that large, complex financial institutions are 

difficult to manage. So I agree with you there. I would also say, 

though, that a lot of the diversity in our financial system, and 

Chairman Bernanke commented about it, you know, the so-called 

hedge funds where people were saying is that going to be a major 

problem? And yet those risks, so far we have managed through 

those pretty well. 

I believe that the biggest problems we are dealing with is not the 

diversification of these organizations but it is the amount of risk 

that was taken on, and the amount of leverage, much greater than 

was understood, because a lot of it was taken on through complex 

25 

products that were difficult to understand. And that’s why it’s taking so long to work through this. 

So I believe the big part of the answer here is going to be the 

de-leveraging and going forward enhancing liquidity practices, risk 

management practices, and getting our arms around some of these 

complex products. 

Mrs. MALONEY. Thank you. My time has expired. Unless you 

would like to— 

The CHAIRMAN. You cut yourself off, but did you want a response 

from the Chairman? 

Mrs. MALONEY. Absolutely, if time permits. If time permits, Mr. 

Chairman. 

The CHAIRMAN. Well, the rule is that no member can ask questions after their 5 minutes is up, but if there is a question pending, 

we will take it. 

Mr. BERNANKE. Just very quickly, Congresswoman. I think 

Gramm-Leach-Bliley has some definite positives in terms of diversification, complementary services and the like has created very, 

very big firms. One of the things that the various reports from the 

PWG and the FSF have highlighted is that firms did not do a good 

enough job of firmwide risk management. They looked at individual 

business lines and not the firm as a whole. That’s a critical step 

for them to be doing. We are encouraging that. And we are also trying to do a better job of our consolidated supervision whereby we 

focus not just on the holding company but we make sure that we 

interact more intensively with the functional regulators of the subsidiaries or the affiliates. 

So I don’t think the system is broken, but it does need some improvement in execution. 

Mrs. MALONEY. Thank you very much. 

The CHAIRMAN. The gentleman from Texas. 

Dr. PAUL. Thank you, Mr. Chairman. And welcome, Secretary 

Paulson and Chairman Bernanke. I’m delighted the two of you are 

here today because I might just get to the bottom of the question 

I have been asking for many years, which is, who is in charge of 

the dollar? Because sometimes when I ask the Fed, I get referred 

to the Treasury and vice versa, but maybe I can get a better answer today. 

I do want to acknowledge the gentleman from New Jersey, Mr. 

Garrett, for playing a part in bringing these hearings about, and 

also Chairman Frank for having these hearings because I deeply 

appreciate it. 

But I would like to take a minute to just challenge something he 

said during his questioning, because he made the flat statement 

that there was no alternative to the Federal Reserve system. I 

don’t want to take my time to explain the alternative, but maybe 

later on, Chairman Frank and I can talk and I can explain to him 

what an alternative might be. 

The CHAIRMAN. That’s not very likely. 

[Laughter] 

Dr. PAUL. But anyway, I would like to pursue the theme of the 

day, and that has to do with systemic risk. And there’s a lot of talk 

about systemic risk and also taken in the context of market discipline. But, you know—and we are talking so much about more 

26 

regulations. And quite frankly, I think we should have a lot more 

regulations, but I think we should have market regulations. 

I would like to see a lot more regulations on the government and 

on the Federal Reserve, because I think it’s the ability of the government, through regulatory agencies as well as the Federal Reserve, to disrupt markets and destroy market discipline. That is 

where I think our problem lies. 

When Enron failed, we immediately said, well, it must have happened because we didn’t have enough regulation, so Congress immediately responded by passing Sarbanes-Oxley. It hasn’t exactly 

helped our markets. You know, our markets today, almost every 

index of the market today is where it was 8 to 9 years ago, and 

that’s not taking into consideration inflation, the devaluation of the 

dollar. So the markets are in severe trouble. They are very dysfunctional. 

But the real question is, why are they in such disarray? And of 

course I maintain that they’re in disarray because our monetary 

policy disrupts the markets because we create interest rates below 

market rates. Right now the money is free to the banks. They can 

borrow money at 2 percent. Real inflation is 10 or 12 percent. 

And we wonder why there are disruptions when you have artificially low interest rates, you cause the malinvestment, you cause 

excessive debt to accumulate, and you cause the bubbles to burst. 

And then when they burst, the only thing we can come back for is 

more regulations and more inflation, we need lower interest rates, 

we need to print more money. 

But it is back to this basic fundamental problem that we think 

that we can compensate for lack of savings by creating money out 

of thin air, and it doesn’t work. It has never worked throughout 

history, it’s not going to work this time, and we can’t bail ourselves 

out by more regulations and more monetary inflation. And that is 

where we are today. 

I think the IMF is correct in this circumstance. They say we are 

in worse shape than since the Depression. And yet our government 

tells us there’s not even a recession. This is utterly amazing. Ask 

the American people. Our government tells us inflation is 4 percent. Nobody believes that. I mean, just look at the cost of energy. 

So we have to someday get back to the fundamentals of what is a 

dollar, where do they come from, and who’s in charge of the dollar. 

So my question is directed to Secretary Paulson dealing with the 

dollar, because evidently he is the spokesman and he is the champion of the dollar, and all public statements are that the dollar is 

to be strong. Well, the dollar lost 20 percent in the last 2 years. 

In the last 3 years, we have created $4 trillion of new dollars. But 

when we go to China, we tell the Chinese we want a weak dollar. 

I would like to see if I can get the Secretary of the Treasury to 

explain this to me. Do we want a weak dollar or a strong dollar, 

and why don’t we worry about the value of our dollar? 

Secretary PAULSON. Congressman, we want a strong dollar. And 

what I have said is, a strong dollar is in our Nation’s interest, and 

I think you and I agree on that, at least I think we do. And I have 

had a career in the financial markets, and that has taught me that 

a strong dollar is in our Nation’s interest. 

27 

Now as I look at what’s going on in our economy, and we are 

going to have some ups and downs. Every economy does. We are 

going through a tough period right now. But I travel around the 

world, and I don’t see a major industrial nation that has better 

long-term fundamentals than we do. I don’t see a major industrial 

nation that I believe is going to perform better over the long term 

in their economy than ours will. 

And so what I say is, I believe these long-term fundamentals are 

going to be reflected in the value of our currency. And what we 

need to do is to have policies that are going to enhance confidence 

in our economy. And to me, those polices are pro-growth policies, 

they are continuing to advocate for trade, for open investment. 

Now in terms of China and the renminbi, what I believe in, Congressman, are markets, and I think it is a—there are many countries around the world that don’t have market-determined currencies. There’s no country as big as China and as integrated as 

they are into the global economy in terms of goods and services. 

And so in some ways, it’s an unnatural act. 

And they are not ready yet to have a market-determined currency, but we are encouraging them to move in that direction and 

move more quickly in that direction, because that will be a key also 

to their continued development and economic progress, which is important to all of us. Because contrary to what some people may believe, we will benefit if China continues to grow and has a healthy 

economy. 

The CHAIRMAN. Mr. Secretary, I’m going to cut you off because 

I received a letter, let me just say, from the ranking member of the 

full committee and the ranking member of the Domestic and International Monetary Policy Subcommittee asking for a hearing on 

what is being done by you two gentleman—the letter suggested not 

enough—to protect our currency, and particularly to focus on its relationship to oil prices. I have instructed the staff to schedule such 

a hearing. 

So the request that the minority has made for that hearing is 

going to go forward. We hope to have it—you know, we will have 

it before we break in August, and we can get further conversations 

on that. 

Dr. PAUL. I appreciate that very much. 

The CHAIRMAN. The gentleman from North Carolina. 

Mr. WATT. I want to get back to the framework, the model that 

Secretary Paulson—I’m over here, I know you are looking for me— 

has outlined, the three primary regulators. And you—I don’t understand it, or I have some concerns about it. 

Maybe you can help me understand it. And maybe that will address my concerns. But three areas you outlined: A regulator focused on market stability across the entire financial sector; another 

focused on safety and soundness of institutions supported by Federal guarantee; and a third focused on protecting consumers and 

investors. 

The first concern I have is that the third one, the one focused on 

consumers and investors, will be the redheaded stepchild. And the 

discussions, all of the discussions we have had this morning suggest that because there had been very little discussion of the consumer and investor side. 

28 

But I want to set that one aside, because I don’t want to spend 

my 5 minutes talking about my concern about it. I do have that 

concern and I want you to know it. 

If we had a regulator that is solely focusing on consumers and 

investors, I think it will be so marginalized that it will—it will in 

effect, be a third powerful regulator rather than a one or two, or 

equivalent—equal player in the process. But let me make sure I 

understand the other two, because I don’t understand what falls 

into the second category for example, the one focused on safety and 

soundness of institutions supported by a Federal guarantee. 

Either you are acknowledging the implicit guarantee that we 

apply to Fannie and Freddie, or you are talking about something 

else. What are the institutions that would fall, in your model, 

under that second regulator, the current institutions that you are 

talking about? 

Secretary PAULSON. Yes, Congressman, those are institutions 

that have Federal insurance or guaranteed insurance. 

Mr. WATT. Okay. You are talking about—are you talking about 

flood insurance, for example? 

Secretary PAULSON. Well, it could be. You could have an insurance— 

Mr. WATT. Okay. Just give me a couple of examples of who you 

are talking about. 

Secretary PAULSON. The banks. The depository insurance. 

Mr. WATT. Okay. 

Secretary PAULSON. But again, I want to say something— 

Mr. WATT. So that—would that take the portfolio of the OCC? 

Secretary PAULSON. Yes, exactly. 

Mr. WATT. The credit union regulator. 

Secretary PAULSON. Right. 

Mr. WATT. So that would be a conglomerate of the existing regulators— 

Secretary PAULSON. Right. 

Mr. WATT. —but we don’t provide a guarantee to credit unions, 

do we? 

Secretary PAULSON. Well, whether there is—what this would 

do—this would be a charter that would go for every banking institution where there is any kind of Federal deposit insurance, where 

the depositors have insurance. 

Mr. WATT. Okay. But you still have a bunch of entities, financial 

entities that are left out of that category. And I didn’t see them 

pick up in the first category, because when you all started talking 

about market stability across the entire financial sector, I assumed 

that is an expansion of the Federal Reserve’s authority now. 

But there are some institutions here that are still left out of this 

equation. And I don’t know where they go in these three tranches 

that you are giving us in this model. 

Secretary PAULSON. Are you—let me begin by saying this model 

is sort of an optimum long-term model to start the discussion. Now 

I am going to start for the life of me— 

Mr. WATT. But you have to get all of your— 

Secretary PAULSON. I will— 

Mr. WATT. —institutions into the model. 

Secretary PAULSON. You are right. 

29 

Mr. WATT. Okay. 

Secretary PAULSON. Here is what we will do. And let me begin 

by saying in terms of regulation by objectives, it escapes my imagination how anyone could believe if you—if you had an institution 

just focused, not divided—just focused on protecting investors and 

investor protection how somehow whether that would be a weaker 

institution—one misguided, divided focus. 

So again, I believe if you have to have a focus, that would be 

very strong. Secondly, what we do is in the optimum model—what 

we do is we say we are not going to have regulatory competition. 

We will have one charter. 

So there will be a charter for every institution, whether it’s—I 

think you are driving at credit unions, whatever it is. And we say 

specifically, we would not get into business model. 

So if there is a cooperative that would be fine. I very much appreciate what credit unions do. If they are community-based, they 

would have a tax-exempt status. 

So again, in the optimum model, and that would be a long time 

before you get there, we wouldn’t do anything in the immediate 

term. But in the optimum model, you would have one charter for 

institutions that do the same thing. 

You wouldn’t have regulatory competition. There would be a level 

playing field in terms of that. But we wouldn’t pre-judge ownership. You could still have cooperative, community-based. 

And you could still have tax exemptions that went along with 

that ownership model. So again, this was—and in the intermediate 

term, there would be a number of things we would do. But again, 

it wouldn’t impact their credit unions. 

The CHAIRMAN. The gentlewoman from Illinois. 

Mrs. BIGGERT. Thank you, Mr. Chairman. Chairman Bernanke, 

I think that you announced on July 8th, this past Tuesday, that 

you were considering extending the term of the primary dealer 

credit facility. 

I think that Federal Reserve Governor Kevin Warsh has said 

that the Federal supplied liquidity is a poor substitute for a private 

sector supplied liquidity. And that the Fed-provided liquidity 

should not be mistaken for capital. 

Do you think that extending the term of the PDCF would make 

the credit markets even more dependent on continued support from 

the Federal Reserve? 

Mr. BERNANKE. Congresswoman, you are correct. We are considering extending the PDCF. If we extend it, it will be based on the 

judgement that unusual and exigent circumstances still prevail in 

financial markets. 

And that by withdrawing that facility, we might evoke a severe 

reaction in the markets. It’s true that—I mean two comments 

about dependency: One is, of course, that barring any change in 

rules, that this is a self-limiting facility, because it’s only legally allowed so long as there is a set of unusual and exigent circumstances. 

So at some point we would have to phase it out when we felt that 

the system had sufficiently recovered. The other point I would 

make is that even as we take steps like this to support the financial markets and help improve their functioning, we are simultaVerDate Aug 31 2005 15:16 Nov 04, 2008 Jkt 044900 PO 00000 Frm 00033 Fmt 6633 Sfmt 6633 K:\DOCS\44900.TXT TERRIE
30 

neously on a track to try to strengthen the financial system and reduce the need for these kinds of facilities. 

So I mentioned again in my testimony, the necessary supervision, the strength in the infrastructure, the resolution regime. 

Those are the kinds of things—improved oversight. Those are the 

kinds of things that would make the PDCF less necessary over 

time. 

And therefore I think those two things should go together to support the improved function of financial markets and to make such 

facilities less and less necessary. 

Mrs. BIGGERT. I guess I was concerned because you said that if 

current unusual circumstances continue to prevail. So did you 

think that if it were right now that you would want to extend 

that—condition such? 

Mr. BERNANKE. Well, we have already—in March, when we instituted this, we set a target essentially of 6 months into September. 

And I don’t think there is justification at this point for removing 

it. 

The markets remain quite strained, particularly the dealer funding markets and other markets where this was particularly focused. So I don’t think that moving at this point would be a good 

idea. 

What we are considering in this issue is—at this juncture is 

whether the circumstances warrant an extension. And how to 

structure that. 

Mrs. BIGGERT. Thank you. Secretary Paulson, we have been talking about all the things that need to be done. What is the most 

pressing priority that needs to be addressed to ensure that our 

markets remain stable? 

Secretary PAULSON. I wish I could tell you one thing, but there 

isn’t a silver bullet. If there was, and we knew how to address it 

right now, we would. And what is going on now as I said earlier, 

is it’s just taking us a good while because there is much more leverage than was—what was once healthier—much more leverage 

than was perceived to be the case. 

And it was in the form of financial products. And then many of 

which were complex. There has been recorded progress made. It 

hasn’t been in a straight line, but the progress I would site has 

been the risk reduction, the de-leveraging, the things that the 

Chairman has cited, in terms of increased liquidity and management, funding management by the investment banks, the capital 

that has been raised, being raised. 

But I believe part of this of course, is confidence. And having 

been through periods like this, they always are the worst until they 

are resolved. And before they are resolved, you wonder how they 

ever are going to be resolved. 

But confidence has a way of returning to the markets. And over 

time there have been many investors, wise investors, that have 

come in during times of great risk, adversity, and made investments and have made money on those investments. 

I think one of the key things is going to be when you start to 

see, and we are seeing some, more of these hard-to-sell assets 

changing hands and private money coming into the markets. But 

meanwhile, we have, all of us, some real work to do. 

31 

The CHAIRMAN. The gentleman from Kansas. 

Mr. MOORE OF KANSAS. Thank you Mr. Chairman, for having 

this meeting. My questions are for both Secretary Paulson and 

Chairman Bernanke. 

For the past several years, the Treasury and the Federal Reserve 

have argued that the housing GSE’s pose systemic risk to the financial system, and that they were a likely source of the next financial crisis. I agree that we should pass legislation that will give 

the GSE’s a strong, new independent regulator. 

Do you agree that the GSE’s have played a constructive role in 

trying to stabilize the markets? 

Secretary PAULSON. As I said, I believe that GSE’s have played 

a constructive role, and that they are playing a very important and 

vital role right now. They touch 70 percent of the mortgages that 

are made in this country. 

And so they are a very important part of our economy, a very important part of our housing market. And they are an important 

part now, and they are going to be an important part in the future. 

Mr. MOORE OF KANSAS. Thank you, Mr. Chairman. 

Mr. BERNANKE. I agree that the GSE’s are playing a critical role 

there at this point, a very big part of the existing mortgage market. 

I think they could do an even better job if they were better supervised and better capitalized. With respect to supervision, I support the call for a GSE reform that has been discussed. 

With respect to capitalization, I believe that they are well capitalized now in the sense of—in an inventory sense. But I think as 

we have called upon all financial institutions to expand their capital bases so that they can be even more proactive in providing 

credit and support for the economy. 

So I would include the GSE’s in that broad call for increased capital. 

Mr. MOORE OF KANSAS. Thank you, and one follow-up question: 

Do you still believe the GSE’s pose a systemic risk to the economy? 

And if so, how does that risk compare with the risks that have 

come to light with our current gaps in regulatory oversight that 

have in part led to the current crisis? 

Secretary PAULSON. I would say Congressman, in today’s world 

I don’t think it is helpful to speculate about any financial institution and systemic risk. I am dealing with the here and now, and 

the important role that they are playing, and other financial institutions are playing. 

Mr. MOORE OF KANSAS. Thank you, sir. Mr. Chairman, do you 

have anything to add to that? 

Mr. BERNANKE. No. 

Mr. MOORE OF KANSAS. Thank you. 

The CHAIRMAN. The gentleman from Connecticut. 

Mr. SHAYS. Thank you both for being here and for your service. 

And I want to say before I ask a question that I am very proud 

of being on this committee and I appreciate the work that our 

chairman does and our ranking member. 

This is the one area in Congress, where I think surprisingly we 

see less politics and a real interest in trying to do what is right for 

our country. I am deeply concerned obviously, as everyone else is, 

about energy and the incredibly high cost of oil. 

32 

I am surprised that it has only resulted in a 4-percent increase 

in inflation. And I want to know if there is just a lag, and if next 

we are going to see inflation at 5, 6, or 7 percent. 

It is hard for me to imagine that we won’t. I also have found myself altering what I say. I say we need to be energy independent, 

and we are. And I was rightfully correct in we are energy independent as it relates to natural gases, it relates to hydropower and 

coal in a sense. 

These are homegrown. And Europe doesn’t have these resources. 

We have a competitive advantage as it relates to energy, ironically 

in spite of our big gap in oil. And I am being told that because energy is becoming such a high price—in other words, our electric 

power is much less—our production costs are much less as it relates to energy. 

That energy is now beginning to trump labor costs. And that we 

have reason to believe that we might see a renewal in manufacturing, because of the advantage that we have over many countries 

over energy. 

So one, I would like to know about the impact of energy on inflation, not just this year but the next. And I would like you to comment on do we have a comparative advantage on the energy sector 

that we could start to see benefiting this country. 

Also related to obviously, the value of the dollar and what exports advantage—the advantage we have on exporting. I would like 

both of you to answer. 

Mr. BERNANKE. Let me start, Congressman. First of all, it does 

take a bit of time for the oil price increases to feed through to the 

consumer. So when oil prices go up, it takes a bit of time before 

it shows up at the pump. 

And so over the next couple of months, we would expect to see 

the headline inflation rate rising, reflecting that. Once that impulse 

has passed through, if oil prices stabilize, even at the current level, 

then you would expect to see inflation come back down. 

But of course, that is an uncertainty at this juncture. I don’t 

think we have a strong comparative advantage. We have been—in 

energy—we do produce certain kinds of energy. But we are less energy efficient than some countries. 

We have less alternatives than some countries. So I think it’s 

very important—one of the benefits of a high price of oil—the—cost 

of course, but there is at least one benefit, which is it generates incentives for development of alternative forms of energy for conservation, and even for exploration and development of oil. 

So we need to allow that process to work. I think it will help us 

develop the energy, not necessarily independence, but less vulnerability to energy prices than we currently have. 

Secretary PAULSON. I don’t, Congressman, have much to add to 

that. There are some parts of our economy where we are maybe 

more efficient than some others when it comes to using oil, like for 

instance— 

Mr. SHAYS. We are not talking about oil, that is the difference. 

Our electric generation is coal, hydro— 

Secretary PAULSON. Right. 

Mr. SHAYS. —it’s nuclear. And it’s homegrown. And it’s less expensive than in almost any other part of the world. And there are 

33 

people coming to me now saying that we have this competitive advantage, now that you see energy costs continue to climb. 

So the bottom line is this is not something you all have thought 

about, I am gathering. 

Secretary PAULSON. Well, I would say this, I have thought about 

it. And as I look at energy and power around the world, there are 

obviously some countries that aren’t nearly as efficient as we are, 

in some of the developing countries aren’t nearly as efficient. 

Although I can tell you—in our automotive sector, you know 

that’s oil, we rank up there with the inefficient. But the—we are— 

I again believe that the challenge here for us is going to be continued investment in new technologies and alternative sources of— 

Mr. SHAYS. Before the red right light goes on, let me just say I 

believe absolutely that there are going to be alternative sources of 

energy that are going to move us along in the long term. But we 

have short-term needs. Thank you. 

Secretary PAULSON. Yes, I agree with that. 

The CHAIRMAN. The gentleman from Texas. 

Mr. HINOJOSA. Thank you, Mr. Chairman. I also want to thank 

both of you for coming to our committee, and giving us an opportunity to better understand the problems that we are facing in financial markets. 

My first question is directed to Secretary Paulson. And I want 

to say that there are people coming to my office, as the chairman 

of the Higher Education Subcommittee, and expressing their problems about accessibility and affordability of higher education. And 

they go directly into asking for relief to college student loan providers. 

They talked to us about 3 or 4 months ago about lacking liquidity. And so the Committee on Education went on and passed some 

legislation that would give them some relief, as you mentioned earlier in your comments about your Department being a lender of 

last resort. 

Secretary PAULSON. The Department of Education is a lender of 

last resort. 

Mr. HINOJOSA. We talked about both the Treasury being involved,— 

Secretary PAULSON. Right. 

Mr. HINOJOSA. —and that the—as secretary— 

Secretary PAULSON. Right. 

Mr. HINOJOSA. —be that lender of last resort. But it’s not working. And this week, we have had representatives of companies, entities that are not-for-profit, including COSTEP of South Texas and 

the Panhandle Plains Higher Education Authority. The third one 

was the Razos Higher Education Service Corporation, all saying 

that they need for us to be aware that some of their lenders are 

no longer wanting to participate. 

And an example is this COSTEP memorandum that says, ‘‘It is 

with the deepest regret that I have to announce that effective July 

1, 2008, Texas State Bank Trustees for COSTEP will suspend making new Federal Family Education Loan Program loans.’’ And they 

go on to explain why. 

Secretary PAULSON. Let me first of all say that this is a very important area. It is critically important that students receive loans. 

34 

And that the Treasury Department is doing everything we can to 

work with the Department of Education to address the need. That’s 

the first thing. 

The second thing I will say is let’s make a distinction between 

certain lenders that don’t participate and whether or not students 

are getting loans, because I think the key question for all of us is 

are the students going to get the loans they need to attend college? 

And what the program, and we very much appreciate in that 

Congress gave to the Department of Education and the programs 

that have been put in place to get us through this period. The first 

part of the program was government buying loans you know, that 

originated by these—by these financial services firms. 

And most of the failed lenders are participating in that program. 

Some aren’t, but most are. And most are participating at a level 

where they will be able to make money and students will have 

loans. And as I have said, if to the extent that just to be sure the 

Department of Education has greatly expanded it’s resources, ready 

to do—get involved with direct loans, lender of last resort. 

And the other thing we are doing at Treasury is working to develop market-based solutions to help further make this market 

more robust, because it’s not ideal but I think the thing that will 

really get my attention is if you come to me and say, ‘‘Here is a 

student who qualifies and can’t get a loan.’’ 

I think that is our first priority, to make sure students get loans, 

and do what we can to get this market up and going again. 

Mr. HINOJOSA. All I can tell you is that when you get—the university is also coming in to see me and talking about the barriers 

such as the one that is explained in this note here. In order to participate in the Loan Participation Purchase Program, the eligible 

lender must certify they—participation interest in front loans to 

the Department of Education with an aggregate balance of not less 

than $50 million. 

And so that eliminates companies like these three that I have 

mentioned, which by the way Mr. Chairman, I ask unanimous consent that they be included in today’s— 

The CHAIRMAN. Without objection, and the witnesses will respond. 

Secretary PAULSON. Yes. And I will—I am sure that Secretary 

Spellings will be very happy to get back to you with the details 

with that. But again, and it’s regrettable when any of these lenders 

don’t participate. 

The program that was designed—hopefully they all would have 

participated, but some didn’t. But again, the key thing is, are students getting the loans? I believe students are going to get loans 

and attend college, and we are going to meet that need and we are 

going to keep working on strengthening the market. 

The CHAIRMAN. The gentleman from Texas, Mr. Hensarling. 

Mr. HENSARLING. Thank you, Mr. Chairman. I appreciate you 

calling this hearing and I appreciate the gentleman from New Jersey for his leadership in calling for this hearing as well. 

Chairman Bernanke, I believe the central question really before 

the committee is should the Federal Government really become the 

guarantor of last resort, or the lender of last resort to investment 

banks, not unlike they are commercial banks for the purpose of creVerDate Aug 31 2005 15:16 Nov 04, 2008 Jkt 044900 PO 00000 Frm 00038 Fmt 6633 Sfmt 6633 K:\DOCS\44900.TXT TERRIE
35 

ating financial stability within our markets, obviously doing this 

with taxpayer dollars, given the recent intervention of the Fed by 

facilitating the Bear Stearns sale, which I am led to believe is the 

first time in 70 years that the Fed has opened up a discount window to a non-depository institution. 

My question is, have investment banks become so big and so 

interconnected that their bigness and interconnectedness alone now 

defines systemic risk? 

Mr. BERNANKE. There were really three reasons why we took the 

action we did. One was the actual size of the firm and its implications for the broad financial markets. The second one was the fact 

that the infrastructure was not strong enough to deal with the implications of the failures in the derivatives markets in triparty repo 

markets and other areas. And the third was that the existing financial conditions were extremely fragile at the time that we made 

that decision. 

So I think we made the right choice in the sense that it was necessary at that time and in those circumstances to prevent much 

wider prices in financial markets and I was reminded of the gentleman from Texas asking about student loans. The problem with 

student loans came directly from the option rate securities market 

which fell apart because of the financial stresses. 

These things directly impact Americans. It is not just a question 

of Wall Street, it really affects broad based welfare and the economy. So I believe we did the right thing. I would do it again. I 

think it was necessary to protect the financial system. 

I don’t want to do it again, and so to avoid doing it again, we 

want to have things in place that will make it unnecessary, and 

that includes good supervision and includes strengthening the infrastructure, and it includes other measures to make the financial 

markets more stable. If we do those things, I hope that such events 

will be extraordinarily rare, as they have been historically. 

Mr. HENSARLING. Mr. Chairman, in another speech, you were 

quoted as saying, ‘‘Under more robust conditions we might have 

come to a different decision about Bear Stearns.’’ Again, you 

haven’t been at the Fed for 70 years, but this is the most extraordinary remedy. 

Looking in the rear view mirror, were there other circumstances 

that you believe that the Fed should have opened the discount window to non-depository institutions in the past, and by what criteria, 

what extraordinary criteria will be used under your current authority to do it in the future? 

Mr. BERNANKE. Well, there have been many financial crises 

going back to the 1930’s, which was of course was probably the 

worst of the 20th Century. Each one is different— 

Involves, in some way or another, with most of these financial 

crises, either through, as oversight, as moral exhortation, it is convening power, and we have a wide variety of episodes where the 

Fed has been involved in trying to mitigate a potential financial 

crisis. 

The Fed always has to make the choice whether or not it needs 

to intervene to protect the system or whether the system is strong 

enough to accept a failure, and in some cases the failure shows in 

the latter. For example, Drexel was allowed to fail because it was 

36 

viewed at the time that it would not bring down the whole system 

and that was the correct assessment. 

So I think it is a very rare thing to do. This particular confluence 

of circumstances has not occurred in the past and these were the 

powers that we had available to try and address this problem. 

Again, I share your concerns. This is not something I want to do 

again, it is not something I really wanted to do in the first place, 

and I hope that the Congress can work with us to develop a set 

of regulations and rules that will make this unnecessary in the future. 

Mr. HENSARLING. Mr. Chairman, you alluded to the 1930’s and 

obviously the Great Depression. Now those who seem to have an 

abiding faith in regulators and regulation, I know you have studied 

the Great Depression, can not a case be made that frankly we had 

very bad regulation that helped turn a garden variety recession 

into the Great Depression, including the Fed allowing the money 

supply to contract dramatically, protectionism in a trade war 

brought about by Taft/Hartley and the prohibition of nationwide 

branch banking? 

Mr. BERNANKE. All those things were relevant but another thing 

that was quite relevant was that the Federal Reserve did not follow 

through on its responsibility to try to stem the bank failures, and 

the continuation of bank failures over a number of years contributed to the decline in the money supply and to the contraction of 

credit and was a major source of the Depression. So it was exactly 

the failure of the Fed to act in the early 1930’s that made the situation as bad as it was. 

Mr. HENSARLING. Thank you, Mr. Chairman. 

The CHAIRMAN. The gentleman from Massachusetts. 

Mr. LYNCH. Thank you Mr. Chairman. Mr. Chairman I appreciate you holding this hearing and I want to thank the ranking 

member as well. I want to thank the Secretary and the Chairman 

for appearing before us and helping the committee with its work. 

I want to go back to a point that was raised earlier, Mr. Secretary, in your response to Ms. Maloney and also I think, Mr. 

Chairman, you address it at page three of your remarks. 

And basically my question is this. A lot of the lack of confidence, 

I think, in some aspects of our market come from the complexity 

and the opaqueness of some of these derivatives that we have actually gone back and tried to drill down into the models on which 

some of these derivatives are actually based. And in some cases 

they probably stretch from myself to Mr. Hensarling down there. 

I am just wondering, is there anything in your proposed reforms 

that might get at this issue? I mean, some of these derivatives I 

have to admit, it is just very, very tough to value them or mark 

them to book as some of my friends in the industry have described 

it. The credit default swaps that are a huge, huge part of the market out there, these collateral debt obligations, the failure of these 

risk and recovery models to really predict or to ascertain the value 

of these things, they are so complex, I honestly believe if we adopted a simple rule that said an investor had to understand these 

things before they bought them, that this whole market would 

come to a screeching halt. I honestly believe that, and I am only 

half joking. 

37 

But is there anything that you have proposed that would get at 

that opaqueness and lack of transparency and complexity? Something that would allow investors to have more confidence? I mean, 

in some of these cases, and synthetic CDOs, we don’t even know 

where the actual ownership lies. So it is just very, very tough for 

an investor, especially in difficult times to have confidence in their 

investment when they can’t really determine that on their own. 

Secretary PAULSON. I think Congressman, both the Chairman 

and I spoke about how important it was to make enhancements in 

the infrastructure and the transparency around credit default 

swaps and other over the counter derivatives. And I think you 

heard him say that the New York Fed is driving an effort, or we 

need to have a clearinghouse, we need more transparency, we need 

better protocols, I think more standardization. So there is a lot of 

work being done. 

Now I want to also say to you that there is—these contracts have 

done a lot to make the markets more efficient, and we have gone 

through periods of time where we have had some major failures, 

at the time of Enron and so on, and the markets were able to 

weather it because of the efficiency of these markets. But they 

clearly need more discipline and stronger infrastructure. 

Now there were other things that have been suggested and are 

being pursued really quite aggressively to deal with this. One is, 

as you have made the point, investors need to do their work and 

make sure they understand, and if they don’t, then they shouldn’t 

be investing. 

And there is a lot of work being done on the part of the rating 

agencies and Chairman Cox has spoken to that and he has done 

a lot of good work there in terms of reforming those practices. We 

at the President’s Working Group have suggested that when the 

rating agencies make their ratings, that they make a differentiation between a rating that goes to a standard corporation or a municipality and one that is a structured, highly structured financial 

product, maybe they should get a different designation. 

So there have been a number of suggestions that have been 

made, and they are all being pursued. Now it is going to take some 

time to work through this, but progress is being made here. 

Mr. LYNCH. Okay. Mr. Chairman? 

The CHAIRMAN. Quickly, Mr. Chairman. 

Mr. BERNANKE. I would just say that the Federal Reserve is very 

much involved in this process to make the post-trade clearing and 

settlement process, the management of the risks associated with 

this, the transparency, the standardization, these are all things we 

are working on, and I elaborated a bit on that in the speech I gave 

earlier this week, and this is a very high priority for us. 

Mr. LYNCH. I look for it. Thank you. 

The CHAIRMAN. The gentleman from New Jersey. 

Mr. GARRETT. Thank you, Mr. Chairman, and thank you, Chairman Bernanke and Secretary Paulson for your service to the country. 

Secretary Paulson, I was very pleased to see your comments on 

Tuesday regarding covered bonds and how there can be maybe another way to increase the availability and lower the cost of mortgage financing to hopefully get us back to normal home buying in 

38 

this country. I agree that covered bonds both in the commercial 

area and in residential area present a great way to provide more 

liquidity to the U.S. housing market during this credit crunch. 

I have spoken to Chairwoman Baer directly about cover bonds 

and I know my staff has been in touch over the weeks with your 

colleagues at the Treasury. And over the last 3 months, I have 

been working with outside interested parties to see whether we can 

work together on coming up with legislation to help facilitate covered bonds. 

Chairman Bernanke, on this topic I have not heard, maybe you 

have made a statement, but I have not heard it, do you have position, are you generally in favor or support of Secretary Paulson 

with regard to helping address the mortgage situation? 

Mr. BERNANKE. I do. Like you Congressman, I think it is very 

important for us to be—here we mean both the regulatory community but also the private sector—looking for new ways to get financing. 

Covered bonds are a very successful financing vehicle in Europe, 

and therefore it is an attractive thing for us to look at here. The 

FDIC has a rule that is about worked out that will clarify some of 

the issues associated with the priority of covered bond collateral 

versus deposit insurance fund. I’m in favor of working in this direction. 

I wonder, I think it is not yet known, whether this can be successful without legislation. I think that is a question we want to 

look into. 

Mr. HENSARLING. I look forward to working on this legislation. 

Turning now to the issue that most of us have talked about so far, 

the Bear Stearns situation. I had a chart, but I know the numbers 

are pretty small, but you should be familiar with it because it 

comes from your own folks on your Web site, it is the Federal Reserve balance sheet as of June 25, 2008. 

As I read and others explain, it indicates that there is only 

roughly $22 billion, generally speaking, of Treasury bills remaining, and the Fed has already exchanged $255 billion, roughly, for 

a variety of types of private debt, some of which you could question 

the quality. 

Now today the Secretary has made remarks to the need for a 

new statutory framework and the deal with the unwinding of the 

situation. I am sure you have seen a number of the articles that 

talk about this, and the press indicate there are several other brokers out there that might be facing significant problems as well 

going forward, and you have already indicated you would hate to 

have to deal with this situation as you had with Bear Stearns in 

the past. 

So, Mr. Chairman, it appears to me that if one of these highly 

interconnected investment banks were to fail in the near future, 

the Fed’s balance sheet then has limited or no room left on it coupled with there being no legislative framework in place going into 

this, would the Fed, in essence, have to monetize the situation to 

bail them out? Would the Fed have to deal with new Treasury 

paper to bail out the bondholders, which is what really occurred 

with the Bear Stearns situation, if another situation came? 

39 

I have three questions. First, can you assure, and I think I know 

the answer to this question, but can you assure us that you will 

not conduct any similar Bear Stearns transaction if another investment bank or a GSE gets in trouble without the prior explicit authorization of Congress via some sort of enabling legislation? 

Second, if you decide that there is no alternative than to conduct 

another bail out or support, however you want to call it, to one of 

these troubled organizations, will you be willing to monetize the 

debt to finance such a transaction due to the current limitations on 

your balance sheet? 

And third, your claim that your actions with the Bear Stearns 

transactions are granted to you under section 13 of the Federal Reserve Act, are there any limitations within that section or elsewhere as to your abilities going forward to deal with these situations? 

Mr. BERNANKE. Well, to try to address that range of questions, 

over the weekend where we were working on the Bear Stearns 

issue, I was in touch with congressional leaders, kept them informed, and the sense I got was that there was not an objection 

to pursuing it. I also of course worked very closely with the Treasury and with the SEC and other authorities to develop a consensus 

for the actions we took, and as I have argued before, they were necessary. 

So I don’t want to make any commitments. I don’t think a situation like this is at all likely, but unless I hear from Congress that 

I should not be responding to a crisis situation, I think that it is 

a longstanding role of the central bank to use its lender of last resort facilities to address— 

Mr. HENSARLING. The first answer is ‘‘yes.’’ The second question 

then is would you essentially monetize the situation at the— 

Mr. BERNANKE. There is not monetization. This is a sterilized operation; there is no effect on the money supply. 

And in addition, I would add that our lending, not only to Bear 

Stearns but more generally to the banks and so on, is not only 

collateralized with good hair cuts, it is also a recourse to the banks 

themselves. We have not lost a penny on any of this lending, and 

it is just lending, we are not purchasing any of it, it goes back to 

the bank when the term of the loan is over. 

Mr. HENSARLING. So there is no limit to the amount. 

The CHAIRMAN. No, I’m sorry, no further questions. We were over 

the 5 minute— 

Mr. HENSARLING. Can I get an answer to my last question? 

The CHAIRMAN. He can answer, but no further questions from us. 

Mr. BERNANKE. It does not affect the money supply. We have 

plenty of balance sheet room left, so I don’t visualize that as a constraint in the near term. 

The CHAIRMAN. The gentleman from North Carolina. 

Mr. MILLER. Thank you. I have served on this committee for almost 6 years, and I remember the testimony pretty well on mortgage lending, but I have recently gone back and reviewed some of 

it to see what the lending industry was saying at the time about 

the kind of mortgage practices that have led to the problem. 

And what they have always said was that the provisions of the 

mortgages that may seem to be a problem, they seem unfavorable 

40 

to consumers, actually were risk based, they were responding to a 

greater risk by certain borrowers, and that without those provisions they would not be able to lend to those borrowers, and those 

borrowers would be denied credit, would be unable to buy a home, 

and be unable to borrow against their homes to provide for life’s 

rainy days. 

Looking back on the practices that actually led to the problem, 

the subprime mortgages made in 2005 and 2006, it is pretty clear 

that those provisions had nothing to do with risk and nothing to 

do with benefiting consumers or making credit available to them 

that would otherwise not have been available. It was a fundamental change in consumer lending from making an honest living 

off the spread to trying to trap consumers, homeowners into a cycle 

of having to borrow repeatedly and paying penalties and fees when 

they did, and that the loans were intended to become unpayable for 

the borrowers, so the borrower would have to borrow again. 

Insurance regulation at the State level generally requires that 

policy forms provisions and policies and premiums be approved in 

advance by the State regulator, and that the insurer has to justify 

those provisions. So the kinds of arguments that we heard in this 

committee that we were not really in a position to judge on a provision by provision basis, a reasonably competent regulator could 

judge and determine whether that really was related to the risk, 

whether it really was to the advantage of the consumer, and 

whether it also presented a solvency issue for an insurer. 

Secretary Paulson, the proposed regulator to protect consumers, 

will that regulator have the authority, should it have the authority, 

to review consumer lending products in advance to see if the practices can be justified both for what it might do to the solvency of 

the institution and also what it does to the consumer? 

Secretary PAULSON. Well, I would say this, whether it reviews in 

advance or not, I believe that if we had a regulator that was focused solely, completely on consumer protection and investor protection, it is difficult to imagine we would have had some of the 

abuses that we have had today. 

In terms of, we did not intend when we set out this Blueprint 

to get involved in exactly what this regulator would do and how it 

would do it, but if that was the pure focus, there is no doubt that 

it would be involved there. 

I think in the meantime, because that is a long-term vision, the 

things that we are seeing done by the Fed right now in terms of 

the HOPE NOW Alliance and in terms of looking at unfair lending 

practices, it is very, very essential. 

And again, in the meantime, I do hope, because I think it is unlikely that anytime soon we are going to supplant the State regulation of mortgage origination, I do encourage you, even if it is in the 

next Congress, to pick up the idea of this mortgage origination 

commission which will be able to work with States and evaluate 

the State programs and do it in a very transparent way, and I 

think that may help. 

Mr. MILLER. Chairman Bernanke, do you think there should be 

some way to review in advance before they go into widespread use, 

consumer financial products, to make sure that they are not rapacious to the consumer? 

41 

Mr. BERNANKE. Well, to some extent that is happening, in the 

following sense that first, as Secretary Paulson mentioned, the Federal Reserve is releasing on Monday a new set of rules which will 

limit the parameters, essentially, of how the mortgage can be constructed, and will eliminate certain kinds of confusing and other 

practices from the possible contracts. 

Second, we are continuing—as we have recently done in credit 

cards—a very sensitive set of disclosure reviews so that the lender 

will be required to explain and provide essential information to the 

borrower. I think we are going to go a long way towards reducing 

both the predatory aspects of the lending that you were referring 

to and also what I would just call the bad lending which ended up 

being losses for the lenders themselves because they had insufficient oversight and care when they made the loans. 

In terms of creating a standardized project in advance, I think 

it is an interesting idea. It would simplify things in some ways, but 

on the other hand, there are some benefits to having flexibility and 

innovation in the mortgage market to have different types of mortgages available like shared appreciation mortgages or variable maturity mortgages and so on, so I wouldn’t want to take government 

action to eliminate the possibility of innovation in that market. 

The CHAIRMAN. The gentleman from California. 

Mr. CAMPBELL. Thank you, Mr. Chairman. 

There seems to be general agreement—with which I concur—that 

we need regulatory restructuring, regulatory reform, and that we 

want to do it right rather than quickly. However, markets don’t 

wait. If we are waiting until next year, which is I think the implication here in the next Congress, the next President, three-quarters are going to pass at least before we have something in place. 

So my question to both of you is, if there were a financial institution that, to use your terms, Secretary Paulson, is either too big or 

too connected, that we are approaching some failure, some major 

difficulty, do you currently have the transparency to know in time 

and the tools to deal with that and/or is there anything we can give 

you quickly to help with that? 

Secretary PAULSON. Let me say what history shows us is that it 

is very difficulty to predict in advance, and I don’t think you’re 

going to be able to reasonably give us any tool right now. So I’m 

going to just tell you that there is an urgent need. We are not saying take your time, wait. There is an urgent need to get more tools. 

But I also will tell you that I believe that the focus on market stability and the actions that the Fed has taken, not just in the Bear 

Stearns episode, but in the follow-up in opening the PDCF to the 

opening of the diskette window to the investment banks has sent 

a very strong signal. And the work that the Fed and the SEC has 

done with these good institutions is a strength in their liquidity 

management, is, I think, very important. So neither of us are predicting another incident and we are looking at the progress that 

has been made. 

We both would like additional tools. We are not saying take forever, but we recognize the fact that the regulatory structure hasn’t 

been changed in a long time and the fact that we don’t have these 

tools mean that it’s not going to be easy. It’s going to need to be 

thought through and the sooner the better, but we are prepared to 

42 

work together, work with you to deal with the situation on the interim. 

Mr. CAMPBELL. You do believe, and then a question for you 

Chairman, you do believe you could deal with a too big or too connected failure to prevent the systemic damage? 

Mr. BERNANKE. What distinguishes the situation today from 

where it was before Bear Stearns is we have taken additional steps 

to try to prevent such a contingency in the first place. So, in particular, in conjunction with the SEC, we have pushed the investment banks to increase their capital and particularly liquidity, 

which they have been doing. We have opened up the window to 

provide a backstop source of liquidity so that reduces the chance 

of a run. So those things, I hope and expect, will make this contingency much less likely, and should it arise, we would have to deal 

with it in real time with what tools we have. 

With respect to timeframe, you know, again, it’s really Congress’s 

judgment about what is possible and in what period of time, if 

there is an appetite in Congress to work in some of the things for 

example that we have outlined in our various proposals. I’m sure 

we will be more than happy to facilitate that in any way possible, 

but it has just been our sense that given the complexity of these 

issues, it’s probably going to take longer rather than what could be 

done in this year. 

Mr. CAMPBELL. Okay, and my final as we expire question is relative to this, but also to the GSEs, to Fannie and Freddie. If there 

were issues and so forth there, you have the tools you need there. 

Secretary PAULSON. Well, I don’t think we should be speculating 

or talking about what-ifs with any particular institutions. And so 

with Fannie or Freddie, what I’m emphasizing is the tool that I 

want is the reform, and the reform legislation that will inject a confidence into the marketplace. And we have a situation here where 

the independent regulator said as adequate capital and where we 

both know this is a very important institutions that have an important role to play in their economy. 

Mr. CAMPBELL. Thank you. 

The CHAIRMAN. The gentleman from Texas. 

Mr. GREEN. Thank you, Mr. Chairman. 

I think this is a most important hearing and I am greatly appreciative that you decided to have it. 

Chairman Bernanke, I want to thank you. I think it took great 

courage to do some of what you have done. You are in a tough position and you have made some very difficult choices. And, you have 

done it, I think, with the notion that you were doing it in the best 

interest of the country. 

I thank you, Secretary Paulson, for some of the things that you 

have done. I have read some of your messages at home and abroad 

and I think that the two of you understand that it is time for us 

to act, and I greatly appreciate it. 

Mr. Chairman, you indicated that because you did not have and 

I’m paraphrasing, ‘‘restraints,’’ imposed upon you, you felt it appropriate to move forward with the Bear Stearns, for want of better 

terminology, ‘‘deal.’’ Given that these things are always going to be 

different, there probably will not be a cookie cutter approach to 

dealing with a Bear Stearns scenario. 

43 

Given this and given that you have to act sometimes expeditiously because you have exigent circumstances, systemic problems, 

systemic failures that may erupt, do we need to clarify this area 

of law, if you will, such that there won’t be any question as to 

whether you can act. And you indicated that unless Congress said 

no, you would move forward. But is there a need for some clarity 

in this area so that you can act without reservation or hesitation? 

Mr. BERNANKE. Well, the two that we used was our 13(3) authority, which allows us to lend to individuals, partnerships, and corporations, so long as there are not other credit accommodations 

available. That was set up by Congress with the intention of creating a very flexible instrument that could be used in a variety of 

situations, and it allowed us to address a situation in which we did 

not anticipate and which had not been seen before. And so in that 

respect, having that flexibility, I think, was very valuable. 

That being said, both in the short term, I think it would be entirely appropriate for us to have discussions. And as I have discussed personally with congressional leadership about what the 

will of the Congress is and how we should be approaching these 

types of situations; and, in the longer term, as Secretary Paulson 

has proposed, it would be better if we had a more formal mechanism that created some hurdles from decisionmaking that set a 

high bar in terms of when these kinds of power would be invoked 

and provided more than this lending tool, which was really not 

well-suited in some cases to address systemically important failures. 

So I think the IPC authority is an important authority and it has 

important flexibility, but I certainly agree that ultimately it is the 

decision of Congress about, you know, in terms of advice and in 

terms of legislation about how they want the authorities addressing 

these kinds of situations. 

Mr. GREEN. For the short term, you are comfortable with the 

13(3) authority? 

Mr. BERNANKE. Well, we have needed it. We have used it in several contexts, and it does give us a lot of flexibility. I think prior 

to putting any constraints on that it would be important to provide 

some substitutes, some alternative methods or approaches for dealing with systemically relevant failures. 

Mr. GREEN. Thank you. 

I appreciate the way you have approached dealing with some of 

these large, financial institutions in terms of commenting on their 

strength or lack thereof, because perception has a lot to do with reality and we don’t want to create perceptions that can infringe 

upon reality. 

With this understanding, as we approach trying to draft and 

craft the regulations that can have the positive impact we desire, 

we, I think, have to be very careful that we don’t create the perception with the institutions that there is something imminent about 

to occur, and I quite frankly don’t know all of what we can do to 

prevent that perception from developing. Just know how important 

it is to prevent it. 

Your comments, please? 

Mr. BERNANKE. Well, that is one advantage of having a deliberate process. If you take time to do it right and then take some 

44 

time to get this done it will be evident to the market that you’re 

not addressing some immediate crisis, but rather, thinking about 

the next set of issues. 

Mr. GREEN. Thank you, Mr. Chairman. I will yield back the balance of my time. 

The CHAIRMAN. The gentleman from Illinois. 

Mr. ROSKAM. Thank you, Mr. Chairman. 

Mr. Chairman, I was involved in a meeting with you and other 

members a couple of weeks ago where you kind of walked through 

the decisionmaking that you and your leadership went through in 

the Bear Stearns situation and kind of in a nutshell, I don’t want 

to over-characterize this, but you’re the umpire. You’re calling balls 

and strikes. You called it a strike, did what you felt like you had 

to do. Others called it a ball. 

But you made it very clear that you weren’t happy about that situation and you made it clear that there’s a plan moving forward. 

In your testimony today, you outlined three points. I just would 

like you to focus in, and I don’t think this will take all 5 minutes, 

and I’ll give you all the time. 

Could you focus in particularly on the supervision piece as it relates to investment banks, and could you comment on the interplay 

between statutory change that you might think necessary, the regulatory piece that are rules that you can promulgate in relationship 

with the Securities and Exchange Commission. 

But also, could you please comment on the attitude of the investment banks and kind of what is the backdrop of the conversation? 

Because basically dad came home, right? I mean, at the party, and 

looked around, and what is the look in their eye as they’re interacting with you and the demeanor going forward? 

Mr. BERNANKE. Well, on the last point, our presence in the investment banks is based on agreement and coordination with both 

the SEC and with the firms. We have had a good working relationship with the firms. They have not resisted our interest. Your 

broader question, I think, where the statutory authority is needed 

in clarifying that the investment banks require consolidated supervision, and what the powers of that consolidated supervisor should 

be. 

Currently, the SEC’s authority is based on essentially a voluntary agreement between the companies and the SEC. I think it 

ought to be made more explicit and required. In terms of the actual, regulatory practice I started off my testimony by referring to 

some reports and activities by the committee and others. There 

really is a remarkably globally-integrated response to this set of 

issues, and many of them bear on supervisory practice and supervisory expectations. 

The triumvirate, which is always critical, is capital liquidity and 

risk management, and in all those areas, the regulators around the 

world are talking about ways in which we need to strengthen financial institutions on those three dimensions. I think one concern 

the investment banks might have, and I’m putting words in their 

mouths, they would say our business model and our financing is 

not the same as a commercial bank. Therefore, we wouldn’t be comfortable having the exact rules used in a commercial bank context 

45 

applied without modification to us. And I think that’s a legitimate 

concern. 

Again, as long as we stick to the basic principles of capital liquidity risk management the details could be different from a regulatory perspective for investment banks because of the differences 

in their business models and their financing. So I am very much 

in favor of differentiating between different types of firms in our 

regulatory approach. 

The CHAIRMAN. The gentleman from California. 

Mr. SHERMAN. Thank you, Mr. Chairman. 

Mr. Bernanke, we see what happens when there’s a lot of risk 

to financial institutions. We would all want to reduce that risk. 

Would allowing financial institutions, including commercial 

banks, go into real estate brokerage or other lines of commerce, increase the financial risks they bear? 

Mr. BERNANKE. Well, the issue you’re referring to is of course 

under Gramm-Leach-Bliley. The Treasury and the Fed are in 

power to allow banks or bank holding companies to enter activities 

that are incidental to financial activities. The law will require us 

to make a determination as to whether that’s incidental or not. But 

the Congress, obviously, had some concerns about this; and, therefore, Congress has essentially prevented us from even making that 

determination. We have not attempted to determine whether it 

meets the statutory test, nor have we done extensive analysis of 

the systemic implications of such a move, so, for the time being, it 

seems to be pretty much a moot question. 

Mr. SHERMAN. So with Congress taking the stance, you haven’t 

even investigated whether you have the legal right to let that happen and then having not determined the legal right, you haven’t 

done the economic analysis to see whether it would be a wise move. 

But, in general, I would think that the greater you expand the 

rights of banks to engage in all kinds of non-financial commerce, 

the greater the risks that they face, my other question is Black 

Rock gets the contract to administer this portfolio. It was a no-bid 

contract. 

Will you provide us with a copy of that contract? And, now that 

the immediate crisis has passed, will you put asset management 

out to bid, or will Black Rock receive a long-term, no-bid contract 

that would last until the portfolio is disposed of? 

Mr. BERNANKE. We will certainly provide you with all the important information, the relevant information, associated with our contract with Black Rock. They are one of our relatively few number 

of firms that could address the needs that we have; and, given the 

exigencies of the weekend, it was obviously beneficial that we could 

get their services in a very short-term notice. 

We will be reviewing these conditions and terms and try to ascertain whether any additional steps are necessary. I can’t at this 

point, I guess at this point, it’s not an immediate plan to change 

the company as they have been working very effectively for us. We 

think that it has been a good arrangement with them at this point. 

Mr. SHERMAN. Well, now that there’s not a crisis situation, 

wouldn’t you want competitive bidding on such an important contract? 

Mr. BERNANKE. We will look into it. 

46 

Mr. SHERMAN. Okay. I now have quite a number of questions for 

the record, because I realize my time is limited and I look forward 

to getting responses. The first is whether off-balance sheet financially engineered instruments oppose a risk to the major corporations of this country. The second is whether we have moved to a 

system of capitalism for the poor and socialism for the rich. The 

pizzeria in my district that goes out of business, they’re not going 

to get any kind of bailout from the Fed. And, the subordinated 

debt-holder, namely the guy’s uncle who lent him money to start 

the place, he isn’t going to get anything either. 

I understand why the Fed acted in an emergency situation, but 

now we are no longer in an emergency situation, and the question 

is what are we doing to make sure that those who should have 

borne the risk, the shareholders, the subordinated creditors, who 

are going to come out of this thing whole, even though they bought 

subordinated debt, and the regular debtors of Bear Stearns are not 

contributing and paying for this $30 billion worth of risk that the 

taxpayers have borne. 

Should we, and I would like both Treasury and the Fed to respond to this, be looking to impose a tax on the subordinated creditors, on the shareholders, to recapture for the Federal Government 

a fair fee for the incredible risk that the Federal Government is assuming, or should we just make this huge gift that no private sector company would ever engage in to those who are thought on 

Wall Street to be so important, something we would never consider 

doing for a pizzeria in my district. 

The CHAIRMAN. The gentleman’s time has expired. 

Mr. SHERMAN. Thank you. 

The CHAIRMAN. We will get, as the gentleman requested, responses in writing. 

The gentleman from Missouri. 

Mr. CLEAVER. There are those who suggest that had Congress 

not approved the stimulus package when it did, the current crisis 

would probably be worse. There’s no way to tell for sure whether 

they are accurate or not. 

But I’m curious about your position on the talk now about stimulus package no. 2, which might include an extension of employment insurance and perhaps even deal with some of the issues that 

we failed to deal with in the first stimulus package, like infrastructure construction, where the Federal Government funds infrastructure projects and the local communities are able to go out and hire. 

And in addition to that, also predicting that the 4th quarter will 

look very, very bleak, and that the positive benefits from stimulus 

no. 1 are fading. So they would suggest that there is a need for 

stimulus no. 2. Do you agree with those who are encouraging stimulus no. 2? 

Mr. BERNANKE. Well, it’s a preliminary matter of fact. I think UI 

extension was in fact—is that passed, or is that— 

The CHAIRMAN. It has been signed; it is part of the supplemental. 

Mr. BERNANKE. Yes. So that part has been— 

The CHAIRMAN. That was signed, not cheerfully, but it was 

signed. 

Mr. BERNANKE. That has been done. I think it’s just a bit early. 

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47 

ning to feed into consumer incomes. Our sense is that it is being 

helpful. We have seen consumer spending hold up, despite a lot of 

other concerns. But I guess my inclination would be to wait a bit 

longer to see: (a) if the economy begins to strengthen on its own; 

and (b) to assess the effects of the stimulus that has already been 

put into the system. 

Mr. CLEAVER. Well, as we talk about systemic action, I mean do 

we wait until we get into the 4th quarter and realize— 

The CHAIRMAN. Could I say again that we are going to have the 

Chairman back next week on Humphrey-Hawkins, when this will 

be very much the center of the discussion. 

Mr. CLEAVER. Yes. This will be more appropriate at that time. 

Thank you, Mr. Chairman. 

The CHAIRMAN. Mr. Ellison, I’m going to miss the previous question on the Washington Rochambeau myself. I think my constituents will forgive me. We are going to end soon. You know, members, that the vote is about to end. It is the previous question on 

the rule for the Washington Rochambeau or whatever it is. I’m 

going to stay here, so anyone who wants to stay and ask questions 

can do that. 

The gentleman from Minnesota? 

Mr. ELLISON. Mr. Chairman, a lot of my questions do have to do 

with Humphrey-Hawkins— 

The CHAIRMAN. Well, then we will take it back. The gentleman 

from Indiana? 

Mr. DONNELLY. Thank you very much, and thank you both for 

being here. 

I’ll ask a question real quick, because I do have to vote. Do you 

think that the immense amount of monies being sent overseas for 

energy purchases weakens the dollar? And that it almost becomes 

a vicious cycle that we are defunding ourselves, the dollar weakens, 

oil increases even more because the dollar weakens, and then it 

just keeps going around? 

Secretary PAULSON. You know, that’s interesting. I have heard a 

number of people say that one of the reasons the price of oil has 

gone up so much is the dollar has depreciated. And yet when you 

look at the statistics, look at what has really happened, if you go 

back to February of 2002, the dollar has declined in value 24 percent, the price of oil gone up over 500 percent. And so again, I really think the price of oil is being driven by supply-and-demand factors, and the real solution here is to address both. There is not an 

easy, short-term solution, but there is a lot that has to be done. 

Mr. DONNELLY. And if I could just ask you real quick, do you 

think it’s dangerous that there has been such a transfer of wealth 

for energy purchases to our country? 

Secretary PAULSON. Well, I would say this: If you’re asking me 

whether we should have greater energy security in this country, 

the answer is, you betcha. And we have a lot to do. And there are 

things, this is subject to self-help. There are things we can do ourselves right now in this country in terms of development of oil resources and things we can on the conservation and efficiency side 

and alternative sources of energy. 

Mr. DONNELLY. Okay. Thank you. 

The CHAIRMAN. The gentlewoman from California? 

48 

Ms. SPEIER. Thank you, Mr. Chairman. Thank you, Secretary 

Paulson and Chairman Bernanke, for your service during this particularly difficult time in our country’s financial history. I’m one of 

the newer members, as you can tell by my seating here, so maybe 

I have a little license to ask some dumb questions. 

I guess to you, Mr. Chairman, the investment banks are now eligible to access money through the discount window. Unlike the 

commercial banks that are subject to much regulation, they are 

not. And I want to know if you intend to put any regulations on 

the investment banks that the commercial banks presently have. 

Mr. BERNANKE. Congresswoman, we are already doing that. The 

SEC has been their oversight regulator for some time, and they 

have tried to apply rules very similar to the ones that are applied 

to commercial banks, in particular the Basel II Capital Rules. Since 

we began lending to the investment banks, the Federal Reserve has 

also had people onsite, collaborating with the firms and with the 

SEC to make sure that those firms do meet safety and soundness 

standards. 

So in fact we are doing that now, and in my statement I do 

think, though, that it is something of an ad hoc arrangement, and 

I do think that the Congress ought at some point to clarify what 

the supervisory regulatory responsibilities are with respect to the 

investment banks. 

But we are already doing most of what you’re suggesting in that 

we are onsite in those firms, working with the SEC to make sure 

that the investment banks meet the appropriate standards of safety and soundness. 

Ms. SPEIER. Well, the Washington Post editorial today would 

suggest that is not the case. And in fact, it was entitled ‘‘Bail Out 

Ben,’’ which I guess is attributed to you. But the point being made 

in the editorial was that there is money being made available without strings attached to investment banks. And you’re saying that 

is not the case. 

Mr. BERNANKE. No, it’s not the case. We are there and we have 

expectations for their capital liquidity and risk management. I 

think the way I would have interpreted some of the concerns is 

that, as I said, this is sort of an ad hoc arrangement. You know, 

we have joined the SEC in looking at these firms because we made 

the loans. No one intends us to be the long-term, permanent arrangement. And I think what the thrust of that editorial was that 

Congress needs to begin to clarify its views on how they would like 

to see these firms supervised, going forward. 

Ms. SPEIER. So how do we make sure that investment banks 

don’t continue to take undue risk, because we now have a history 

where the U.S. Government has bailed them out? 

Mr. BERNANKE. Well, again, there are several ways of doing that. 

The first is prudential supervision, a consolidated supervision, 

where you’re there and you make sure that they meet the appropriate standards. If the capital regulations tie the amount of capital they hold to the risk that they take, so if they want to take 

bigger risk, they have to hold more capital. So by ensuring through 

prudential supervision on capital and liquidity and risk management, we can ensure—well not ensure, but at least make much 

49 

more likely that those firms won’t get into trouble or take excessive 

risks in the future. 

Secondly, I suggested in my testimony a few other steps we can 

take to make the system as a whole stronger, so that should the 

time come, if a Bear Stearns were to ever happen again, unlike in 

March, when we just felt that the system was not strong enough, 

resilient enough to suffer the consequences of that, we might be 

able to make a different decision in the future, because we would 

say this is something that the system can absorb. 

So, as I have noted earlier, along with our lending decisions, we 

have also been looking at ways in which we and the Congress can 

move forward to make sure that there’s a commensurate supervision that balances out whatever lending privileges the investment banks get. 

Ms. SPEIER. Mr. Chairman, I would like to just point out that 

there probably is some action that we should take as the committee 

sooner than later, as it relates to the authority of the Fed over investment banking institutions, because another Bear Stearns can 

happen, it could happen in the course of 6 months while we are 

campaigning for re-election. And if it’s as important as you say it 

is to get some authority in place, so it’s very clear, I would think 

that would be one priority— 

The CHAIRMAN. Well, if the gentlewoman would yield, I would 

disagree with her. And I think frankly it’s a disservice to suggest 

that they don’t have the authority. They had it under Bear 

Stearns, and I don’t think we should be suggesting—in fact I think 

there is an agreement here that they do have the authority—it’s 

not as perfect in many ways as they want it to be, but they did 

for Bear Stearns. I have talked to the agencies, and people have 

talked about this, but I haven’t seen anybody draft anything. There 

are a whole lot of people ready to write, but they are in favor apparently of somebody else drafting this legislation. 

Anybody is free, of course, to introduce a bill or do whatever they 

want. But I do think it’s a disservice to suggest that there’s a 

shortfall in authority now. I believe that with the memorandum 

and with the work we have done together, and with the support 

that they would get from us, so that no one would think they could 

end run things, that we are capable of getting through this. And 

if someone things he or she can write a bill that we can pass that 

quickly, obviously, everybody has that right. 

I am very skeptical, and I think beginning a process and getting 

it bogged down in the Senate or elsewhere is more likely to cause 

uncertainty than saying, ‘‘Look, we have gotten this far, we will 

continue to work this way together.’’ 

Other members are free, if they want to write up something and 

try to offer it. The Departments are free to do it. The Fed is free 

to do it. I think the fact that no one has done it is a recognition 

of reality. 

Ms. SPEIER. Mr. Chairman, I recognize that I have very little expertise in this area at this point. But I do sense from our two 

speakers that there is a sense of urgency that we need to act. And 

I just want to make sure that we are not in a situation in a few 

months where there is a need to act— 

50 

The CHAIRMAN. Well, I want to respond. I very much disagree 

with gentlewoman’s statement. As we made clear at the beginning—I don’t know if the gentlewoman was here for the whole 

hearing. 

Ms. SPEIER. I was— 

The CHAIRMAN. We addressed that early on, and they said—and 

I don’t think that should be undercut—that the authority that we 

have had so far is still there. I think it is a mistake to suggest that 

there is a lack of authority, and yes, we all agree that there is an 

urgency. The Treasury has not and the Federal Reserve has not 

asked us specifically to do something. And I think that is in recognition that it is best for everybody out there to understand that 

we are going to continue as we have been, pending this situation 

until we can do new legislation. 

And the likelihood of being able to do this very complicated subject—and I would say this: Doing it and then redoing it would be, 

I think, a very bad idea. I think the instability that would be there 

would be a mistake. 

So as I listen to our two witnesses, their view is that in an ideal 

world, we would have more authority, but that we are able to continue working together as we have been, with the SEC, with them 

and with us. And as I said, I think it’s a great mistake to suggest 

that there is going to be some crisis we can’t handle. We did handle 

Bear Stearns, and I think we will be able to deal with others. 

Ms. SPEIER. I yield back. 

The CHAIRMAN. The gentleman from Massachusetts? 

Mr. CAPUANO. Thank you, Mr. Chairman. 

Mr. Secretary and Mr. Chairman, first of all, thank you for coming. And I apologize. My plan today was to be here for the entire 

hearing. Unfortunately, I had to go to the— 

The CHAIRMAN. No. It was at my request. The gentleman from 

Massachusetts was accommodating my request to handle bills on 

the Floor. It was not his fault. 

Mr. CAPUANO. I don’t mind, and it has nothing to do with the 

chairman. It got embroiled in some political chicanery and I got 

stuck. So I apologize. 

But I do want to ask—first of all I want to make it very, very 

clear that I support almost everything you have done and are discussing doing. Both of you I think are doing a great job. I think 

both of you are talking about the things you need to talk about. I 

think both of you are on the right path to where we need to go. 

I know how difficult it’s going to be to get there. I know now controversial it is to some. I’m not so sure we are all going to agree 

on every detail, but that’s not important. 

The concepts you are talking about, in my opinion, are exactly 

the right concepts that we should be talking about. I personally 

think we should have been talking about them years ago, but we 

will let that dog lie for a while, and we will just move forward. 

So I’m looking forward to getting us from where we are now to 

where we need to be. 

I do want to talk about a couple of specific items, though, that 

have been concerning me—especially relative to the Fed. I believe—I agree with the chairman—I believe that you have the authority to have done what you have done thus far. Under the unVerDate Aug 31 2005 15:16 Nov 04, 2008 Jkt 044900 PO 00000 Frm 00054 Fmt 6633 Sfmt 6633 K:\DOCS\44900.TXT TERRIE
51 

usual and exigent circumstances language, I believe that. I agree 

with what you have done; I think it’s fine. 

However, it does raise serious questions. I think you know that. 

And I believe that moving forward, we will try to address those on 

a more permanent basis. 

My concern is in the meantime—you have seen this today, and 

I haven’t seen the debate here today, but I have heard it a thousand times—there are a lot of people here that every time you hint 

at this much more oversight or regulation, they go absolutely berserk and somehow that’s anti-American, and it’s going kill the entire capitalist system, and the world will go to hell in a hand basket. I’m not like that; I believe that reasonable, fair, clear regulation actually helps the capitalistic society, and I think it’s a good 

thing 

Between now and there, I’m deeply concerned of what we are 

going to do and what we have, and I am particularly concerned 

with the—it’s not the amount, but the amount combined with what 

I see is the lack of requirements that the Fed is putting on those 

people who are coming to all the different windows that you have 

created. They are huge amounts of money. 

In the last 6 months, by my figures, the Fed has, all totalled, loaned out, give or take, over $3 trillion, which is more than 100 

times more than you loaned out the previous 6 months. I’m not 

complaining about it. I think it’s necessary. I think it’s fine. I don’t 

think it’s unstable. I think it’s the right way to go. But it’s a huge 

amount of money. And almost all of that money has gone out with 

virtually, in my opinion, minimal at best, if any, requirements. 

I would argue—and I would ask your opinion—I would suggest 

that since you have the power to loan the money—you do not have 

the power, and I agree, to impose regulations on people before they 

get to the window—but I do believe that as a condition of the loan, 

you do have the ability to impose, not regulation but conditions of 

the loan that may look like regulations to some, that simply allows 

those people who come to the window to say, ‘‘Hey, if I want the 

money, I will meet these requirements,’’ whatever they might be. 

Capital requirements—and I trust your judgment as to what they 

might be; I know you would do it in conjunction with the Secretary 

and others—and I’m just curious, do you believe, do you agree or 

disagree that you currently have the authority, if you chose to use 

it, to put very clear, very concise conditions—not regulations, but 

conditions—on the loan that hopefully would lead us and my colleagues to know where you might want to go, if we gave you the 

authority—which I would be happy to do—if we gave you the authority to have those regulations before they got to the window? 

Mr. BERNANKE. Well, Congressman, there are two classes of 

firms that are borrowing from us. There are the commercial 

banks— 

Mr. CAPUANO. Right. 

Mr. BERNANKE. —which already have a well-established regulatory structure and a set of regulators. And we are, of course, 

along with our fellow regulators, working hard to make sure that 

they have adequate capital and that they are taking all the steps 

necessary. 

Mr. CAPUANO. Right. 

52 

Mr. BERNANKE. The investment banks have had a more ad hoc 

relationship because we have been working with the SEC, as you 

know. But as I have mentioned, between us we have made strong 

demands on the firms. We have insisted that they raise their liquidity holding in particular, because that turned out to the major 

point of vulnerability for Bear Stearns. And we have also asked 

them to raise their capital, to improve the practices of risk management, and so on. 

So we are doing very much the same kind of thing between the 

Fed and the SEC in the investment banks that we and other regulators already do in the commercial banks. So there is a quid pro 

quo that if we are going to lend to you, you have to take steps to— 

The CHAIRMAN. The gentleman from Massachusetts earned a 

waiver of the 5-minute rule. So if he has any further questions— 

Mr. CAPUANO. Thank you, Mr. Chairman. 

I’m glad to hear that. I agree with it. I would personally like to 

see it in a more organized fashion as opposed to—and I understand 

that you’re still running quickly to get where you want to go. 

And Mr. Secretary, I would ask you—I mean I know you’re very 

familiar with what the Fed is doing—do you agree with what the 

Chairman has said, and do you agree with the general format that 

they’re operating under? 

Secretary PAULSON. I couldn’t agree more. I agree totally. This 

is an example of regulators coming together to transcend some of 

the issues in the regulatory system. And again, the emphasis that 

the Fed and the SEC are placing on the investment banks is one 

that is different from commercial banks, because the issues here 

are different and the focus has been more on funding and liquidity. 

I strongly agree with that, and I have been gratified to see some 

of the improvements that are resulting. 

Mr. CAPUANO. One of the reasons I ask—actually the main reason—I believe that if these requirements were put in a more formalized fashion, there would be more uniform, as opposed to each 

time you come to the window—I actually—maybe I’m wrong—but 

I think it would actually help the market, it would help some of 

my friends who might have some concerns about the concept of regulation. And I think it would actually help some of the stabilization. 

I know you have addressed some of the issues, some of the socalled rumors about Fannie and Freddie today, and as I understand it, you have addressed those issues that, you know, some 

people are concerned that capital requirements are going to go 

through the roof, and they’re going to get shaky. It’s my understanding that has been addressed and clarified. 

At the same time I think that if there were formalized regulations across the board—not regulations, I shouldn’t use the word— 

formalized requirements for a loan, then I would argue that they 

would help stabilize the market. 

And the other question I want to ask—and again I apologize— 

but just a few days ago there was a story in the paper that concerned me deeply. I raised it yesterday, and I’m going to raise it 

again today with you. I read—again, it’s only on the basis of news 

reports, I have not yet had an opportunity to get beyond the news 

reports, so forgive me if anything I say is wrong—but I read that 

53 

the SEC is considering basically for all intents and purposes adopting international accounting standards—a little overstatement, 

maybe a little overreaching for that—but going much further along 

that way, doing it relatively quickly, hopefully I guess theoretically 

before the term ends or the current chairman. 

My concern with that is, I’m not opposed to moving thoughtfully 

and steadily towards international accounting standards, but I am 

deeply concerned that to simply say American regulators no longer 

have authority here, and the American regulations, just in yesterday’s news, were going to international regulations like this, that 

it would undermine many of things you are currently doing to try 

to stabilize the market. 

It raises questions on how do we make the transition. It raises 

questions on transparency. It raises questions on investor protections. And I think it raises questions on whether we have the ability or the authority to somehow regulate our own financial markets. 

I know it’s not directly what you’re doing, but I ask: Are you familiar with what the SEC is doing on this issue? And if you are 

familiar, I would like to know what your initial opinion is of the 

matter. 

Secretary PAULSON. Yes. I would say I’m familiar and I’m supportive of it. And I thought that statement was—I read the same 

press report, and I didn’t agree with the way it was slanted—that 

what the SEC is doing is moving toward greater convergence in accounting and acceptance, and they’re concentrating on those accounting regimes where the standards and the qualities are very 

similar to what we see in the United States and in the principals. 

So I’m supportive. 

Mr. CAPUANO. Mr. Chairman? 

Mr. BERNANKE. Well, there are two elements. One is that FASB 

and the International Regulatory Accounting Board are on a convergence path already. They’ve set goals to essentially be the same 

or very similar within a couple of years. And so that process is useful and taking place. 

As I understand it, the SEC’s action is to give internationally active companies a choice—this doesn’t apply to all U.S. firms but to 

companies that already have to do the international standards, can 

they avoid having a duplicate set of books, essentially, using the 

FASB standards? And that seems to make sense in terms of giving, 

you know, more incentive for foreign companies to operate in the 

United States, for example. 

So long as the system that we are looking at is one that we are 

comfortable with and is very similar to FASB, I don’t think it creates necessarily any major problems with either accounting system 

or our regulatory system. 

The CHAIRMAN. Can I—let me just speak. The Secretary referred 

to some, I thought, questionable things in the article. Nothing in 

that, as you have described it, Mr. Chairman, to allow either set 

to be done would, for instance, waive any part of the SarbanesOxley or non-account or any other regulation. I don’t think that 

was clear from the article. So is that correct? 

Secretary PAULSON. I didn’t mean to cast aspersions on the article. I’m just saying I read the article quickly— 

54 

The CHAIRMAN. It’s okay to cast aspersions on articles. Free 

speech works both ways. 

Secretary PAULSON. And again, as I look at accounting, we have 

by industry different accounting standards. We have different accounting standards for different financial institutions. It’s hard to 

say there is one— 

The CHAIRMAN. But it does not—that decision about mutual recognition would not relax any other regulatory standards. 

Secretary PAULSON. No. 

Mr. CAPUANO. Let me just say—Mr. Chairman, if I might. 

The CHAIRMAN. Yes. 

Mr. CAPUANO. I actually have the article. And I would suggest 

it didn’t imply anything. Again it’s an article, but it’s an article 

from a reputable source. It says very clearly—and again, it’s an article, and that’s why I caveat it right up front and I haven’t had 

a chance to talk to the SEC about it—but it says it would ‘‘permit 

American companies to shift the international rules which are set 

by foreign organizations and give companies greater latitude in reporting earnings.’’ 

Now that alone right there—greater latitude in reporting earnings after our Enron mess and all the mess that we have right 

now—if that doesn’t raise hackles on the back of your neck, I don’t 

know what does. After all the work that you have done to try to 

stabilize the books and stabilize—and again I’m not saying the article is right, I’m simply saying if that is correct. 

And it goes on to say that it enabled companies, for example, to 

provide fewer details about mortgage-backed securities. Now if 

that’s correct—I don’t know yet—I hope that raises concerns, if it’s 

correct. If it’s not correct, so be it. Again, I agree with the Chairman. I don’t necessarily accept anything wholehearted, no matter 

how good the source. 

But those lines just in and of themselves in a relatively short article raised major questions in my mind that with all the problems 

we have in mortgage-backed securities right now, to then go into 

a regime now—I’m not saying that we shouldn’t do it over time, 

thoughtfully one step at a time—as you stabilize things, we can 

head towards convergence, I’m all for it—but if this is correct, and 

they do it like this, I will tell you that I for one will have some 

major concerns, because I want you two to be able to finish what 

you’re doing to get us to a more stable ground, so that we can then 

look to continue to progress in our economic status. 

Secretary PAULSON. Yes. I totally—you should definitely talk to 

Chairman Cox about this. 

But the only thing I will say is that there are different accounting regimes that have different standards and different requirements that doesn’t make them worse than ours. We have had plenty of issues in our markets, in our system, with our accounting regime. And so again, I think that the Chairman’s approach is to 

take other countries where they have accounting systems and regimes, which he thinks have standards that are very similar to 

ours, the highest standards, and then allowing for this— 

The CHAIRMAN. Let me say—and I have to wind this up. I am 

very appreciative of the witnesses’ time; they have stayed over time 

and it has been helpful. We have a hearing in 2 weeks with ChairVerDate Aug 31 2005 15:16 Nov 04, 2008 Jkt 044900 PO 00000 Frm 00058 Fmt 6633 Sfmt 6633 K:\DOCS\44900.TXT TERRIE
55 

man Cox and the President of the New York Federal Reserve, Mr. 

Geithner, to go over many of these same issues, and that obviously 

will be something that we will expect Mr. Cox to be addressing. 

I would just say for the purposes of the members on the Democratic side of the aisle, or others listening, we will begin the questioning there with those who didn’t get to ask a question today, as 

we will next week on Humphrey-Hawkins begin the questioning 

with those who didn’t have a chance. 

Some other substantive points I wanted to make: One, I disagree 

with the gentleman from California, Mr. Sherman. Obviously we 

have a different view here. I do not think that competitive bidding 

would have made any sense in the crisis atmosphere regarding 

Bear Stearns with Black Rock. Two, I don’t think that people 

thought this was the most desirable assignment ever set up. And 

three, to now disrupt what Black Rock is doing and put it out to 

bid, I think, would be very disruptive. So I think—I would also add 

that the Government Operations Committee had requested some 

information about this, and the Chairman of the Federal Reserve 

did respond very appropriately to their inquiries. 

I understand that there are questions about urgency. I guess a 

lot of people believe in urgency in principle, but not on paper. And 

you can’t be urgent in theory. You have to be urgent with very specific legislation. I do not believe that it is either necessary or possible to deal with this complex set of issues with the appropriate 

degree of certainty or at least assuredness, and to do it and then 

have to re-do it or amend it a few months later, I think would be 

a terrible idea. 

But this is what I want to make very clear. No one should think 

that we here in the Congress are available for end-runs. We have 

a situation where the SEC and the Federal Reserve and the Treasury and other regulators will be putting together their various powers, so that if crises arise they can be met. I believe we have sufficient power now to get through the crisis. We don’t have sufficient 

power, frankly, to avoid some of the crises. And that, I think, is a 

distinction. 

We have the power to respond if there are crises. What we are 

looking for are rules that will make the crises less likely. And I 

think that is a very high priority. We will begin working on this. 

Work we begin now—frankly if we were to decide to do it now, I 

don’t think we could get it finished just in terms of the complexity 

of the issues and the hearings and the bills in both Houses. 

But we are going to start now, and I hope that early next year 

we will able to complete it. But I don’t want anyone to think that 

there are somehow loopholes that they can run through, and that 

they might get some cooperation here. I think we have all worked 

together very cooperatively when it comes to the crisis situation, 

and I believe that we will be able to continue to do that. 

I thank the Chairman and the Secretary, and the hearing is now 

adjourned. 

[Whereupon, at 1:17 p.m., the hearing was adjourned.] 

(57) 

A P P E N D I X 

July 10, 2008 

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