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REGULATORY RESTRUCTURING: BALANCING 

THE INDEPENDENCE OF THE FEDERAL 

RESERVE IN MONETARY POLICY WITH 

SYSTEMIC RISK REGULATION 

HEARING 

BEFORE THE

SUBCOMMITTEE ON 

DOMESTIC MONETARY POLICY 

AND TECHNOLOGY 

OF THE

COMMITTEE ON FINANCIAL SERVICES 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED ELEVENTH CONGRESS 

FIRST SESSION 

JULY 9, 2009 

Printed for the use of the Committee on Financial Services 

Serial No. 111–53 

( 

(II) 

HOUSE COMMITTEE ON FINANCIAL SERVICES 

BARNEY FRANK, Massachusetts, Chairman 

PAUL E. KANJORSKI, Pennsylvania 

MAXINE WATERS, California 

CAROLYN B. MALONEY, New York 

LUIS V. GUTIERREZ, Illinois 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

GARY L. ACKERMAN, New York 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

DENNIS MOORE, Kansas 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

MELISSA L. BEAN, Illinois 

GWEN MOORE, Wisconsin 

PAUL W. HODES, New Hampshire 

KEITH ELLISON, Minnesota 

RON KLEIN, Florida 

CHARLES A. WILSON, Ohio 

ED PERLMUTTER, Colorado 

JOE DONNELLY, Indiana 

BILL FOSTER, Illinois 

ANDRE ́ CARSON, Indiana 

JACKIE SPEIER, California 

TRAVIS CHILDERS, Mississippi 

WALT MINNICK, Idaho 

JOHN ADLER, New Jersey 

MARY JO KILROY, Ohio 

STEVE DRIEHAUS, Ohio 

SUZANNE KOSMAS, Florida 

ALAN GRAYSON, Florida 

JIM HIMES, Connecticut 

GARY PETERS, Michigan 

DAN MAFFEI, New York 

SPENCER BACHUS, Alabama 

MICHAEL N. CASTLE, Delaware 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

RON PAUL, Texas 

DONALD A. MANZULLO, Illinois 

WALTER B. JONES, JR., North Carolina 

JUDY BIGGERT, Illinois 

GARY G. MILLER, California 

SHELLEY MOORE CAPITO, West Virginia 

JEB HENSARLING, Texas 

SCOTT GARRETT, New Jersey 

J. GRESHAM BARRETT, South Carolina 

JIM GERLACH, Pennsylvania 

RANDY NEUGEBAUER, Texas 

TOM PRICE, Georgia 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

ADAM PUTNAM, Florida 

MICHELE BACHMANN, Minnesota 

KENNY MARCHANT, Texas 

THADDEUS G. McCOTTER, Michigan 

KEVIN McCARTHY, California 

BILL POSEY, Florida 

LYNN JENKINS, Kansas 

CHRISTOPHER LEE, New York 

ERIK PAULSEN, Minnesota 

LEONARD LANCE, New Jersey 

JEANNE M. ROSLANOWICK, Staff Director and Chief Counsel 

(III) 

SUBCOMMITTEE ON DOMESTIC MONETARY POLICY AND TECHNOLOGY

MELVIN L. WATT, North Carolina, Chairman 

CAROLYN B. MALONEY, New York 

GREGORY W. MEEKS, New York 

WM. LACY CLAY, Missouri 

BRAD SHERMAN, California 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

KEITH ELLISON, Minnesota 

JOHN ADLER, New Jersey 

SUZANNE KOSMAS, Florida 

RON PAUL, Texas 

MICHAEL N. CASTLE, Delaware 

FRANK D. LUCAS, Oklahoma 

JIM GERLACH, Pennsylvania 

TOM PRICE, Georgia 

BILL POSEY, Florida 

LEONARD LANCE, New Jersey 

(V) 

C O N T E N T S 

Page 

Hearing held on: 

July 9, 2009 ....................................................................................................... 1 

Appendix: 

July 9, 2009 ....................................................................................................... 45 

WITNESSES 

THURSDAY, JULY 9, 2009 

Berner, Dr. Richard, Chief Economist, Morgan Stanley ...................................... 29 

Galbraith, Dr. James K., Lloyd M. Bentsen, Jr., Chair in Government/Business Relations and Professor of Government, LBJ School of Public Affairs, 

University of Texas .............................................................................................. 28 

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

System ................................................................................................................... 6 

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

Economy, Tepper School of Business, Carnegie Mellon University ................. 33 

Meyer, Dr. Laurence H., Vice Chairman, Macroeconomic Advisers .................... 26 

Mishkin, Dr. Frederic S., Alfred Lerner Professor of Banking and Financial 

Institutions, Graduate School of Business, Columbia University .................... 24 

Taylor, Dr. John B., Mary and Robert Raymond Professor of Economics, 

Stanford University ............................................................................................. 32 

APPENDIX 

Prepared statements: 

Berner, Dr. Richard .......................................................................................... 46 

Galbraith, Dr. James K. ................................................................................... 50 

Kohn, Donald L. ................................................................................................ 57 

Meltzer, Dr. Allan H. ....................................................................................... 71 

Meyer, Dr. Laurence H. ................................................................................... 77 

Mishkin, Dr. Frederic S. .................................................................................. 83 

Taylor, Dr. John B. ........................................................................................... 86 

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Watt, Hon. Melvin: 

Written statement of Thomas F. Cooley, Professor of Economics, Stern 

School of Business, New York University ................................................... 90 

Written statement of the Financial Services Roundtable ............................. 96 

Responses to questions submitted to Donald Kohn ....................................... 106 

Responses to questions submitted to Dr. Allan Meltzer ............................... 108 

Responses to questions submitted to Dr. Laurence Meyer ........................... 109 

(1) 

REGULATORY RESTRUCTURING: 

BALANCING THE INDEPENDENCE 

OF THE FEDERAL RESERVE IN 

MONETARY POLICY WITH 

SYSTEMIC RISK REGULATION 

Thursday, July 9, 2009 

U.S. HOUSE OF REPRESENTATIVES, SUBCOMMITTEE ON DOMESTIC MONETARY

POLICY AND TECHNOLOGY, COMMITTEE ON FINANCIAL SERVICES, Washington, D.C. 

The subcommittee met, pursuant to notice, at 1:44 p.m., in room 

2128, Rayburn House Office Building, Hon. Melvin L. Watt [chairman of the subcommittee] presiding. 

Members present: Representatives Watt, Sherman, Green, Ellison, Adler; Paul, Castle, Gerlach, Posey, and Lance. 

Ex officio present: Representative Bachus. 

Also present: Representatives Perlmutter and Garrett. 

Chairman WATT. Unfortunately, we have been notified that we 

will have a series of votes, four or five votes pretty soon, so we are 

going to try to get as far as we can into the process. I am going 

to go ahead and get started. 

Let me call this hearing of the Subcommittee on Domestic Monetary Policy and Technology to order. Without objection, all members’ opening statements will be made a part of the record, and I 

will recognize myself for an opening statement, which I will try to 

get in before we get called for votes, and maybe we can get the 

opening statements in before we get the call to the Floor. 

This hearing is entitled, ‘‘Regulatory Restructuring: Balancing 

the Independence of the Federal Reserve in Monetary Policy With 

Systemic Risk Regulation.’’ 

Our current regulatory system, created largely as a response to 

the Great Depression in the 1930’s, has proven ineffective and outdated at preventing and addressing the financial crisis we are currently experiencing. Recognizing this, the President recently put 

forth a proposal for comprehensive financial regulatory reform. 

This hearing will examine one aspect of that proposal, the part 

that proposes to delegate to the Federal Reserve Board new powers, including the power to serve as the systemic risk regulator for 

all large, interconnected financial firms. 

As the systemic risk regulator, the Federal Reserve would be empowered to structure and implement a more robust supervisory regime for firms with a combination of size, leverage, and interVerDate Nov 24 2008 12:09 Dec 22, 2009 Jkt 053234 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 K:\DOCS\53234.TXT TERRIE
2 

connectedness that could pose a threat to financial stability. This 

hearing will examine whether and how the Fed could perform and 

balance the proposed new authority as systemic risk regulator with 

its current critical role as the independent authority on monetary 

policy. 

While recent events have caused many to reevaluate and question the role and the extent of independence accorded to the Federal Reserve, the Fed’s independence from political influence by the 

Legislative and Executive Branches of Government has long been 

viewed as necessary to allow the Fed to meet the long-term monetary policy goals of low inflation, price stability, maximum sustainable employment, and economic growth. Most central banks around 

the world, including the Federal Reserve, the Bank of England, the 

Bank of Japan, and the European Central Bank, have had a strong 

tradition of independence in executing monetary policy. Many 

scholars and commentators agree that an independent central bank 

that is free from short-term political influence and exhibits the indicia of independence, such as staggered terms for board members, 

exemption from the appropriations process, and no requirement to 

directly underwrite government debt, can better execute the longterm goals of monetary policy. 

The important question that our hearing today is focused upon 

is whether the Fed can maintain its current role as the independent authority on monetary policy, and take on a new role, a 

significantly new role, as the systemic risk regulator. 

Some scholars and commentators argue that the Fed is uniquely 

positioned to become the systemic regulator because it already supervises bank holding companies, and through its monetary policy 

function, helps manage microeconomic policy. Others argue that 

the Fed is already stretched too thin, and has strayed from its core 

monetary policy function, particularly by using its powers under 

section 13(3) of the Federal Reserve Act to purchase securities in 

distressed industries under existing emergency circumstances. 

As Congress and the President work to enact financial regulatory 

reform, it is critical for us to examine carefully the extent to which 

proposed new rules may conflict with existing roles and whether 

the Fed can effectively juggle all of these roles while performing its 

vital function as the Nation’s independent authority on monetary 

policy. 

For our economy to function effectively, the Fed’s monetary activities, such as open market operations, discount window lending, 

and setting bank reserve requirements must be independent and 

free from political influence. We need to get a clear handle on the 

extent to which the Administration’s proposals could compromise or 

interfere with what the Fed already is charged to do. 

I look forward to learning more about how and whether the Fed 

can effectively carry out additional regulatory responsibilities while 

maintaining its current role as the independent authority on monetary policy. I now recognize the ranking member of the full committee for 4 minutes, Mr. Bachus from Alabama. 

Mr. BACHUS. I thank the chairman. 

Mr. Chairman, I don’t think there is anything that is in such 

sharp contrast as the Administration’s proposal for the Fed’s role 

and that of the Republicans in the House. We particularly object 

3 

to what we see is allowing the Fed to become a permanent bailout 

agency. We believe that is most troubling, and we believe if that 

is allowed to happen, they will sacrifice their independence. It is 

absolutely impossible to make them an independent agency and 

allow them to function as they are and yet give them the opportunity to guarantee or loan billions of dollars without substantially 

increasing their accountability and transparency. 

But I do thank you for holding this hearing. Whether regulatory 

power and sweeping new powers really should be centralized and 

given to the Federal Reserve at a time when our country is facing 

unprecedented fiscal, economic, and monetary policy challenges, we 

believe, is very problematic. 

We have some foremost experts, Governor Kohn and our second 

panel, so we look forward to the testimony. 

During the past 2 years, we watched as the Federal Reserve has 

responded to dislocations in the financial markets with far-reaching interventions in virtually every corner of our economy. To confront the crisis, the Fed has used its emergency authority to bail 

out failing institutions—we believe, particularly with AIG and others, but particularly with AIG and with some of the auto companies, this was unwise—to provide loans and loan guarantees; to revive the credit markets, which I think has had success; and lowering the target Fed funds rate almost to zero; and more than doubling its balance sheet. Regardless of how one views these extraordinary Fed actions, I think we all agree that as we go forward, we 

do need a more transparent institution with a more clearly defined 

role. 

Republicans believe that the Fed’s core mission—and I stress 

this—is to conduct monetary policy and that mission will be seriously undermined if its supervisory responsibilities are dramatically expanded, as proposed in the Obama Administration’s White 

Paper. Indeed, the proper role of the Fed represents, as I said, the 

critical difference between the Administration’s proposal, which 

would statutorily bless what we consider an unwise cycle of bailouts, picking winners and losers, and obligating the taxpayers from 

our plan, which does none of those things. 

The Administration would reward past regulatory and monetary 

policy mistakes by giving the Fed the preeminent role in regulating 

the financial system and determining which financial institutions 

are ‘‘too big to fail.’’ This stretches the Fed’s resources; I think we 

all agree on that. It complicates its ability to carry out monetary 

policy functions at a time when our country faces crippling—well, 

let me say this: I believe if we continue to do these things, continue 

to have stimulus packages and deficits, we are going to have crippling inflation. And I think the Fed will have its hands full dealing 

with inflationary pressures without being distracted and overextended by these new powers. 

The Republican plan would therefore relieve the Fed of some of 

its current regulatory responsibilities and allow it to focus on monetary policy missions. 

So thank you very much, Mr. Chairman. But most importantly, 

I am going to close by saying we need to end the bailouts in which 

the Fed has been instrumental, I think, in carrying out over the 

4 

last 18 months, and I mean the ad hoc bailouts of individual institutions. Thank you. 

Chairman WATT. The ranking member of the subcommittee, the 

gentleman from Texas, Mr. Paul, is recognized for 4 minutes. 

Dr. PAUL. Okay. Thank you, Mr. Chairman. 

And welcome, Chairman Kohn. 

I am delighted you are holding this hearing today because it 

deals with a subject that I have talked about for many years, and— 

we have had earlier discussions, and the Fed’s position, of course, 

is that they do reveal a lot of information. And even in the testimony that we will hear today, they still argue their case for exceptions, the argument being that they don’t want the independence 

of the Fed threatened and they don’t want it to be politicized. 

Well, a lot of us think of independence—we put another word in 

there automatically, that means ‘‘secret’’ and ‘‘clandestine’’ and 

‘‘serving special interests.’’ It is a nice word—independence. But politicize, there is no goal, I don’t have a goal of making it political 

other than the fact that the whole system deserves political attention, and yet it gets so little attention; it has not had much attention over these many, many years. 

But there is good evidence that it has been politicized already. 

There have been journal articles written and books written about 

how the Fed has been influenced by the Presidents over time, and 

that when a reappointment time was coming up, policies were designed to serve certain Administrations. And so I would say that 

to argue the case that it should never be politicized is, you know, 

an argument against what we have, because it has been known to 

be politicized. 

One other point I want to strongly make is, the bill that I have 

offered, H.R. 1207, has been challenged at times, and I think it is 

justified to at least question; and that is, how much would my bill 

affect monetary policy? And it doesn’t. It doesn’t affect it in any 

way whatsoever. 

We are not looking for the Congress to run monetary policy. We 

just want to know what is going on and why and the discussions. 

Why wait 5 years to hear the debate? There is a strong argument 

made that the sooner the markets know what you are thinking and 

what you are doing and what the plans are, the better off you are. 

When I first came to Congress, we weren’t even allowed to know 

what the targets were going to be, and the markets—immediately 

after the meetings, they agitated, what are they doing? They figured it out, and all of a sudden they started announcing it. It 

wasn’t the end of the world, yet they argued, well, no, you are not 

allowed to know. 

There is a strong argument now that the more we know about 

what has been going on in this last year, the more it would have 

helped the markets. It is the unknown. And that is why we need 

a much more open Fed. 

And the people are demanding it. They want transparency. 

‘‘Transparency’’ is a good word, but to say that a little bit of transparency is good, but we can’t have a lot of it, there are certain 

things we don’t want you to know—what we are doing when we are 

talking to foreign central banks, foreign governments, international 

organizations; what kind of agreements do we have with the IMF? 

5 

We have an obligation, a moral obligation, here in the Congress 

to know exactly what the agreements are. And we are not doing 

this to preempt anything. This is the reason why the support for 

this bill that I have is now up to 255, and it is across-the-board— 

liberals, conservatives, progressives, populists, libertarians, they 

are supporting this because—and there is no agreement among 

those groups of what monetary policy ought to be. 

They don’t want to make it a political football. They are not asking for Congress to participate in FOMC meetings, but to know 

what the strategy is and what the plans are. That is legitimate information, and we shouldn’t be afraid of it. We shouldn’t be afraid 

of the truth. 

There have been arguments over the years made about transparency. And I can give quotes—and may later—quotes from Alan 

Greenspan, how important. And when you look at those quotes generically, they are very, very good. But when it comes down to the 

bottom line, they say, well, we want you to know what is going on 

on the unimportant things, but when it comes to the important 

things, we want secrecy. 

I yield back. 

Chairman WATT. I thank the gentleman for his opening statement. The gentleman from Delaware, Mr. Castle, is recognized for 

1 minute. 

Mr. CASTLE. Well, thank you, Mr. Chairman. I have sort of enjoyed these opening statements because I happen to agree with all 

sides and all positions being taken by everybody. 

And let me just say, Mr. Watt, that I agree with you. I think you 

have asked the basic, right question that a lot of us are concerned 

about, and that is, can the Federal Reserve maintain its role in 

shaping monetary policy at the same time that it is expanding 

itself is to cover systemic risk in this country? I think that is a very 

serious question that needs to be answered, and I certainly couldn’t 

answer it now. 

I don’t know if we can get that answer today, but we need to continue to work on that. 

But I would add another element to that, and that is all the bailouts, whatever you want to call them, that have been going on beyond just the monetary policy issue under Section 13(3). I mean, 

there is a lot of money that the Fed, without any constrictions from 

the Congress, has been putting forth to help these various entities. 

And I am not necessarily being critical of that, but I am very concerned about the role of the Fed and how it has expanded. 

I happen to agree with Mr. Paul. Mr. Paul and I don’t always 

agree, but I happen to agree with him with respect to his legislation and with the idea that we do need more transparency from the 

Fed. I think that would help a lot of us in terms of understanding 

and perhaps embracing some of this. I think his legislation, which 

I believe is H.R. 1207, is actually very positive legislation. 

I think it is interesting to see the number of cosponsors that he 

has. I think a lot of other people feel that perhaps the time has 

come for the Federal Reserve to be more transparent in terms of 

what it is doing. 

But I think we need a clear, coherent vision of exactly why the 

Federal Reserve would be the right choice if we are going to have 

6 

a systemic risk regulator, which I happen to believe in conceptually. But I am not 100 percent sure that the President and others 

who advocate this have targeted the right source to do it, and hopefully we can start to work that out today. 

Thank you, Mr. Chairman. I yield back. 

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

The rules provide for 10 minutes per side for opening statements. 

The Republican side has 1 more minute, so I am going to yield it 

to Mr. Paul. 

Dr. PAUL. Thank you, Mr. Chairman. I probably won’t use the 

entire minute, but it gives me my opportunity to quote Alan Greenspan. 

In a speech in 1996, Alan Greenspan was addressing this subject, 

and he said, ‘‘If we are to maintain the confidence of the American 

people, it is vitally important that the Fed must be as transparent 

as any agency of government. It cannot be acceptable in a democratic society that a group of unelected individuals are vested with 

important responsibilities without being open to full public scrutiny 

and accountability.’’ 

And I know those terms are general, and he probably might disagree with a little bit of my bill, but those are good words. And I 

am just carrying through on that because I think it is so important 

for the American people to know. 

I mean, the protectors of the value of our currency are all powerful, and we need to know everything conceivable about how that 

policy is designed. We don’t want to set the policy, but what we 

want to know is how it has been done and whose interests are 

being served. 

Chairman WATT. I thank the gentleman for his opening statement. I thank all parties for their opening statements. 

Mr. Perlmutter is here. He is not a member of the subcommittee. 

We welcome him. I haven’t recognized him for an opening statement, but we are going to proceed without recognizing him for an 

opening statement. 

We are delighted today to have on the first panel the only witness, Mr. Donald Kohn, the Vice Chairman of the Board of Governors of the Federal Reserve. 

Without objection, Vice Chairman Kohn, your written statement 

will be made a part of the record, and you will be recognized for 

5 minutes to summarize your testimony. I now recognize you for 

your statement. 

STATEMENT OF DONALD L. KOHN, VICE CHAIRMAN, BOARD 

OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM 

Mr. KOHN. Thank you, Chairman Watt, Ranking Member Paul, 

and members of the subcommittee. I do appreciate this opportunity 

to discuss with you the important public policy issues associated 

with the Congress’ grant to the Federal Reserve of a substantial 

degree of independence in the conduct of monetary policy and the 

interaction of this degree of independence with the possible enhancement of our responsibilities for financial stability. 

A well-designed framework for monetary policy includes a careful 

balance between independence and accountability. In 1977, the 

7 

Congress amended the Federal Reserve Act by establishing maximum employment and price stability as our monetary policy objectives. At the same time, the Congress has correctly, in my view, 

given the Federal Reserve considerable scope to design and implement the best approaches to achieving those statutory objectives, 

subject to a well-calibrated system of checks and balances in the 

form of transparency and accountability to the public and the Congress. 

Considerable experience shows that this approach tends to yield 

a monetary policy that best promotes economic growth and price 

stability. Operational independence, that is, independence to pursue legislative goals, reduces the odds on two types of policy errors 

that result in inflation and economic instability. First, it prevents 

governments from succumbing to the temptation to use the central 

bank to fund budget deficits; and second, it enables policymakers 

to look beyond the short term as they weigh the effects of their 

monetary policy actions on price stability and employment. 

The current financial crisis has clearly demonstrated the need for 

the United States to have a comprehensive and multifaceted approach to containing systemic risk. The Administration recently released a proposal for strengthening the financial system that would 

provide new or enhanced responsibilities to a number of Federal 

agencies, assigning to the Federal Reserve certain new responsibilities for overseeing systemically important financial institutions 

and payment clearing and settlement arrangements. These incremental new responsibilities are a natural outgrowth of the Federal 

Reserve’s existing supervisory and regulatory responsibilities. 

The Federal Reserve already regulates bank holding companies, 

which now include large investment banks, and we have been moving to incorporate a more macroprudential approach to our supervision and regulatory programs, as evidenced by the recently completed Supervisory Capital Assessment Program. 

The Federal Reserve has also long been a leader in the development of strong international risk management standards for payment clearing and settlement systems, and we have implemented 

these standards for the systems we supervise. In our supervision 

of bank holding companies, and our oversight of some payment systems, we already work closely with other Federal and State agencies. These responsibilities and close working relationships have 

not impinged on our monetary policy independence, and we do not 

believe that the enhancements to our existing supervisory and regulatory authority proposed by the Administration would undermine 

our ability to pursue our monetary policy objectives effectively and 

independently. Our independence in the conduct of monetary policy 

is accompanied by substantial accountability and transparency. 

For instance, the Federal Reserve reports on its efforts to achieve 

its statutory objectives in the semiannual monetary reports and associated testimony. The Federal Open Market Committee releases 

a statement immediately after each regularly scheduled meeting 

and detailed minutes of the meeting on a timely basis. We publish 

summaries of the economic forecasts of FOMC participants 4 times 

a year, and Federal Reserve officials frequently testify before the 

Congress. 

8 

In addition, the Federal Reserve provides the public and the Congress with detailed annual reports on the consolidated financial activities of the system. These are audited by an independent public 

accounting firm. We publish a detailed balance sheet on a weekly 

basis. 

This year, we expanded our Web site to include considerable 

background information on our financial condition and our policy 

programs. We recently initiated a monthly report to Congress on 

Federal Reserve liquidity programs that provides even more information on our lending, associated collateral, and other facets of the 

programs established to address the financial crisis. 

The Congress also recently clarified the GAO’s ability to audit 

the Term Asset-Backed Securities Loan Facility, a joint TreasuryFederal Reserve initiative, and it granted the GAO new authority 

to conduct audits of the credit facilities extended by the Federal 

Reserve to single and specific companies under the authority provided by Section 13(3) of the Federal Reserve Act. 

As this committee is aware, the Federal Reserve is already subject to frequent audits by the GAO on a broad range of our functions, including, for example, supervision and regulatory functions. 

The Congress, however, has purposefully and for good reason excluded monetary policy deliberations and operations from the scope 

of potential GAO audits. 

The Federal Reserve strongly believes that removing the statutory limits on GAO audits of monetary policy matters would be contrary to the public interest. Financial markets likely would see the 

grant of such authority as tending to undermine monetary independence, and this would have adverse consequences for interest 

rates and economic stability. 

An additional concern is that permitting GAO audits of the broad 

facilities the Federal Reserve uses to affect credit conditions could 

reduce the effectiveness of these facilities in helping promote financial stability, maximum employment, and price stability. 

Thank you, Mr. Chairman, for inviting me to present the Board’s 

views, and I look forward to answering your questions. 

[The prepared statement of Vice Chairman Kohn can be found on 

page 57 of the appendix.] 

Chairman WATT. I thank the gentleman for his testimony. 

The bad news is that we just got called for at least five votes on 

the Floor of the House. The good news is that once we get through 

this series of votes, we will probably be able to proceed uninterrupted through the balance of this witness and the next panel, we 

hope, although it is a little dicey on the Floor today. 

So I would at this point declare the subcommittee in recess, subject to the call of the Chair, and encourage the members to please 

return promptly after the last vote on the Floor in this series of 

votes. I hate to inconvenience all of the witnesses, but I guess you 

all have been through this before, so you know how it works. 

The committee stands in recess. 

[recess] 

Chairman WATT. We will reconvene now. I will recognize myself 

for 5 minutes to ask Mr. Kohn questions. 

I am interested in getting a better understanding of what your 

view is of what specific things a systemic risk regulator does, so let 

9 

me start there—or would do, I guess, to make it a theoretical question as opposed to a— 

Mr. KOHN. Chairman Bernanke has made a useful distinction between microprudential regulation and macroprudential regulation. 

And microprudential regulation is looking at each individual institution and making sure they are robust and resilient and safe. 

In a macroprudential context, you want to look at not only the 

individual institutions, but how they relate to each other and how 

they relate to the system as a whole. And sometimes it is not so 

much the size of the institution, but its interconnectedness—whether it is at the center of a web of relationships which, if disrupted, 

would have knock-on domino effects. 

So I think the job of the systemic risk regulator would be to take 

account of those interrelationships—the markets and how they are 

developing, and the institutions and how they fit into the markets—and look at the overall risk to the system as well as the risk 

of the individual institution, how that fits in. 

And I think the Federal Reserve is well positioned to play a role 

in that. We have not only our supervisory authority over bank 

holding companies, which now include all the major investment 

banks, but we have staff who are familiar with markets, the macro 

economy, and have responsibility for financial stability of the system through our lender-of-last-resort facilities. 

So I think it requires a little bit of a different perspective than 

we are used to exercising. And I think the Fed’s in good position 

to do that. 

Chairman WATT. Not unexpectedly, you focused on the synergies 

that exist between the two responsibilities. Let me ask you if you 

could candidly focus on the prospects or possibilities of conflicts. 

What are the areas in which those possibilities of conflicts might 

arise? 

Mr. KOHN. I think there are minimal possibilities. I think some 

people have asked whether, if we see a systemic risk from the individual institution, that would affect our monetary policy deliberations. But in my view, I think there really is a congruence between 

the stability of the financial system and monetary policy. We can 

achieve our objectives of maximum employment and stable prices 

much more readily in a stable financial system. So I just don’t see 

important instances in which there would be conflicts. 

Chairman WATT. What kind of staff would you anticipate would 

be necessary, additional staff would be necessary, to perform the 

systemic risk regulatory function versus what you are already 

doing? 

Mr. KOHN. Recalling that in our view, the systemic risk regulatory function that the Treasury has suggested for us is an incremental change to what we are doing now, it is not a big change, 

because we already have the systemically important institutions 

under our authority. 

I think it would require some more staffing, both on the side of 

the economists and the side of the supervisors, to evaluate systemic 

risk in a more systematic way, but I don’t think this is a major 

change in our responsibilities that would require a substantial increase in what we are doing. 

10 

Now, we have had to staff-up over the last year because we have 

several large investment banks, for example, that are now bank 

holding companies, and we have had to change and adapt to our 

new responsibilities. And we are doing that. 

Chairman WATT. My time is about to expire. Actually, it just did. 

But let me just squeeze in, because one comment you just made 

raised somewhat of an interesting question, because I had understood that a lot of the jurisdiction that you would be assuming for 

systemic risk regulation is not in existing entities that you already 

regulate. 

You said that you have all of these systemic risk regulators already under your supervision. Is that, in fact, the case? 

Mr. KOHN. I don’t know that we have all of them, Mr. Chairman. 

I think that would be something that in consultation with this 

council—remember that the Treasury is setting up a council of regulators to look at the systemic implications of the markets and the 

institutions. We would consult with them as to whether they saw 

some institutions that weren’t currently under our purview that 

were systemic. But at this point, I think that would be very, very 

few institutions. 

Chairman WATT. I thank you. My time has expired. 

And I will recognize the gentleman from Texas for 5 minutes. 

Dr. PAUL. Thank you, Mr. Chairman. 

Sometimes definitions of words are pretty important, and I alluded to that in my opening statement, about what ‘‘independent’’ 

might mean to others. 

For me, independent usually is a code word for ‘‘secret,’’ so we 

can’t get the information. But one of your arguments for the independence of the Fed or the secrecy of the Fed is that those central 

banks that do have independence—and they are less monitored in 

public, they tend to have lower and more stable rates of interest— 

but how can you compare that to what we have noticed under the 

Federal Reserve? 

You know, I remember when I first started looking at what the 

Federal Reserve was doing, we had 21 percent interest rates. That 

sort of got my attention. And today we have interest rates of less 

than 1 percent. 

So that is hardly stable. And to me, the real mischief comes not 

only because they are unstable and they fluctuate radically, but 

also the mischief it causes because these are artificial. 

I am a believer that interest rates, like prices, should be set by 

the marketplace. And control of prices and wages is the most serious abuse you can put onto an economy. And yet this fixing of 

prices seems to give us this trouble. And even the Secretary of the 

Treasury now, Mr. Geithner, you know, just a few months ago recognized that during the time he was in the Fed, the Fed kept the 

interest rates way too low for too long. 

So how can you defend the Fed’s maintaining independence or 

secrecy in order to maintain stable rates and to even try to achieve 

a stable economy which—obviously, nobody argues we have a stable economy? 

Mr. KOHN. So I do not equate independence to secrecy. In fact, 

I agree with the underlying premise, I think, of your question, 

which is independence and secrecy in a democratic society are antiVerDate Nov 24 2008 12:09 Dec 22, 2009 Jkt 053234 PO 00000 Frm 00016 Fmt 6633 Sfmt 6633 K:\DOCS\53234.TXT TERRIE
11 

thetical. And I think the Federal Reserve has been quite transparent and has become much more transparent under Chairman 

Bernanke about what we are doing and why we are doing it. And 

I think we can retain our independence and your ability to trust 

what we are doing only by explaining to you what we are doing and 

why we are doing it. 

We have not only the statements, which you mentioned in your 

opening statement, after every meeting explaining what we did and 

why we did it, but we also have minutes. You have hearings. There 

are Monetary Policy Reports. There are other hearings that you 

hold. 

So I think there are many, many opportunities for us to explain 

why we are doing what we are doing. And those opportunities and 

that transparency is absolutely essential for retaining our independence. 

Dr. PAUL. Okay. But I still think we can do better. Like I mentioned early on, there was a time when the Fed did not reveal immediately what their targets were. 

Mr. KOHN. That is right. 

Dr. PAUL. Why can’t we consider releasing the details, instead of 

in 5 years, why not in 5 weeks? What is the big deal that you have 

to have this information? 

And the other argument you use: It is in the public’s interest, 

that one really baffles me. The public is served by you having more 

information that we don’t have access to unless it is maybe 5 

years? It seems like there are other interests; it allows the suspicion to build. 

Whose interests are you really protecting? Because you say, it is 

the public’s interests, I don’t think reassures a lot of people, because all of a sudden we think, well, what are you doing? Are you 

protecting the bankers’ interests? Are you protecting some international—another government, another central bank or what? So I 

don’t see how you can protect the public’s interest. 

It seems like we in the Congress should have the responsibility 

for protecting the public interest by knowing more about what you 

are doing. 

Mr. KOHN. Within 3 weeks, Congressman, we release minutes of 

our meetings, which give detailed explanations of why we did what 

we did, including the arguments back and forth, the minority opinions if people disagree. 

I think you are talking about transcripts, which we release after 

5 years. I would be very concerned that releasing those transcripts 

earlier would inhibit debate. I think it is in the public interest that 

we have an unfettered debate within the Open Market Committee 

and that we are able to speculate among ourselves—what if we did 

this, what if we did that, where are things going—that there be no 

inhibition on the back-and-forth within the Open Market Committee. 

I have been at the Federal Reserve for several decades now, and 

in my view, publishing the transcripts themselves has had a somewhat inhibiting effect on the way the debate is carried out. There 

are many more prepared statements read at Open Market Committee meetings now than before the transcripts were published. 

12 

Participants would be very worried if their remarks were going 

to be made public very, very quickly. They would be very worried 

about what they would say, and they would be much more careful 

about what they are saying. And that is not in the public interest, 

provided we are willing to explain to you, as we are, why we did 

what we did and what the minority views are. And we do do that. 

Dr. PAUL. Of course, you know, without an audit we never know. 

It just seems that it would be of benefit to us to know what the 

detailed discussion is. Why is there any value? I just don’t quite 

agree with that, because it is really the discussion that we have. 

Like I made my point in the opening statement, this is after the 

fact. This is after you have had your meeting; it is after you have 

done something. 

And also, the more information the market gets, the better the 

market operates. And if they know what you are thinking about 

and what you are planning—you know, 5 years for the minutes is 

really way too long. 

Chairman WATT. The gentleman’s time has expired, but the witness may answer. 

Mr. KOHN. Well, I think we do explain what we are doing and 

why we are thinking what we are thinking within 3 weeks. And 

you have ample opportunity to question Chairman Bernanke when 

he comes up for hearings about why he is doing what he is doing. 

We would be glad to work with you on how your ideas about how 

we could be more transparent and more helpful. 

I agree with you that for the most part transparency, where it 

doesn’t inhibit debate and exchange of ideas, is better for the public. And we have taken huge steps in that direction over the past 

3 years. 

Chairman WATT. The other gentleman from Texas, Mr. Green, is 

recognized for 5 minutes. 

Mr. GREEN. When you say, ‘‘the gentleman from Texas’’ and don’t 

say which one, many microphones are opened up. Thank you, Mr. 

Chairman. 

I thank the witness for his testimony. And I apologize for not 

being here to hear you in your entirety in terms of your testimony. 

There are those who would like to have an independent Fed. Obviously, that has worked well. The autonomy of the Fed has inured 

to our benefit. And there are those who contend that if the Fed acquires these new powers and remains as independent as it has 

been, then the Fed becomes this awesome giant that would be beyond the control of Congress, of the Executive and Legislative 

Branches. 

How do you respond to those folks who conclude that this is 

risky, to give the Fed this much power? 

Mr. KOHN. I think there are two avenues for response, Congressman. One is the additional authority we are getting is incremental 

to what we already have, so it is not a huge increase in our authority. 

And the second is, for the authority we already have, we are held 

accountable. We work closely with other agencies, with the FFIEC, 

with the other regulatory agencies, on the President’s Working 

Group, with the Treasury. 

13 

The Government Accountability Office does audit our activities in 

the supervision and regulation area; they perform many audits like 

that. So we have been able to do that and be held accountable, 

work with other Agencies without sacrificing the independence that 

we need to exercise for monetary policy. 

So I think we are already doing it, and this wouldn’t be that big 

a change. 

Mr. GREEN. How would the H.R. 1207 audit differ from the GAO 

audit? 

Mr. KOHN. I am not sure. The H.R. 1207 would do what? That 

is Mr. Paul’s? 

Mr. GREEN. That is the audit bill that Mr. Paul— 

Mr. KOHN. As I understand it, and I don’t understand it perfectly, but I think it would make everything we do subject to GAO 

audit. 

Right now, since 1978, the GAO has been able to audit most of 

our activities except where they touch monetary policy and our 

interactions with foreign central banks and foreign authorities. And 

I think Mr. Paul’s bill would remove that exemption, so the GAO 

would be auditing our monetary policy as well as all the other 

things we would do. 

Our concern is that would be perceived as impinging to some extent on our independence to meet the objectives that you have 

given us for price stability and full employment. 

Mr. GREEN. And as a final question, how can Congress—if you 

have an opinion—be of assistance in making this transition if the 

transition is to take place? Is there something more that we need 

to do to help you transition to the regulatory reform side? 

Mr. KOHN. No. I think the hearings that you hold and mutual 

understanding of what is involved in this, with us and the Treasury and others who want to make this transition, you have every 

right, and you ought to be asking us, as the chairman did, what 

additional resources we would need in order to do this, how we 

would carry this out. 

So I think a dialogue between the Congress and the Federal Reserve is not only appropriate, but would be very useful to define 

what this is about. 

Mr. GREEN. Thank you. 

Thank you, Mr. Chairman. I will yield back. 

Chairman WATT. The gentleman yields back the balance of his 

time. 

Mr. Adler, the gentleman from New Jersey, is recognized for 5 

minutes. 

Mr. ADLER. Thank you, Mr. Chairman. 

Mr. Vice Chairman, you a moment ago articulated Congress’ 

mandate to the Federal Reserve with respect to maximum employment and to price stability. 

To what extent, if any, do you think additional responsibility as 

a systemic risk regulator would in any way distract the Federal Reserve from its 1977 congressional mission? 

Mr. KOHN. Congressman, I don’t think it would distract us at all. 

I see the two missions, the macroeconomic goals of price stability 

and maximum employment and systemic stability as being completely congruent. I think the more stable the financial system is, 

14 

the easier it will be for us to pursue successfully the goals of maximum employment and stable prices. 

Certainly we have seen a demonstration of that in the last 2 

years. The instability in the financial system has resulted in very 

high unemployment and has made it very difficult for the Federal 

Reserve to reach our objectives of maximum employment and stable prices. 

So I don’t see a conflict between those types of objectives. 

Mr. ADLER. You heard the gentleman a moment ago ask questions about the potential lack of accountability of the Federal Reserve as a sort of private entity, not completely under government 

control. Others have been concerned there is too much political interference with the Federal Reserve in the carrying out of its mission. 

I wonder if you could comment about what additional political interference you think the Federal Reserve might encounter if it undertakes this responsibility as a systemic risk regulator. 

Mr. KOHN. I think we can separate our accountability as a systemic risk regulator from our independence in carrying out your 

goals for monetary policy. So I don’t see additional political interference with the objectives that you gave us. 

We will be accountable as the systemic risk regulator. We will be 

accountable through the Government Accountability Office. We will 

be accountable to the Congress. We will be working closely with 

those other regulators in the financial system. 

And we have been successfully doing that for years, and this 

would sort of increase our interactions, but I don’t think there 

should be a risk that giving us this additional authority would impede our monetary policy independence. 

Mr. ADLER. Mr. Vice Chairman, I thank you. 

Mr. Chairman, I yield back the balance of my time. 

Chairman WATT. The gentleman yields back the balance of his 

time. 

We welcome Mr. Gerlach from Pennsylvania, and recognize him 

for questions, if he has any. 

Mr. GERLACH. None right now. Thank you. 

Chairman WATT. And we welcome the gentleman from California, Mr. Sherman, and recognize him for questions, if he has 

any. 

Mr. SHERMAN. I do. 

Chairman WATT. The gentleman is recognized for 5 minutes. 

Mr. SHERMAN. Mr. Vice Chairman, I think you are aware of 13(3) 

of the Federal Reserve Act. 

Mr. KOHN. I am. 

Mr. SHERMAN. It is breathtaking in its scope, but even more 

breathtaking in the amounts. 

I have talked to your Chairman. Almost facetiously, I asked him 

whether a $12 trillion limit on the total exposure under 13(3) 

would be acceptable to him, and believe it or not, he said yes. 

Chairman Bernanke has interpreted before this committee 13(3) 

as allowing the Fed only to take risks that are the equivalent of 

triple A, that is to say, only to extend the credit of the Federal Reserve under that section where there was the lowest risk that a 

credit rating agency would evaluate. 

15 

Do you agree with that constrained view of 13(3) or not? 

Mr. KOHN. Under section 13(3), the Reserve bank making the 

loan needs to be secured to its satisfaction. We have insisted on security on every loan that we have made. We have been releasing 

more and more information about those loans. 

I think, for the most part, those loans are safe. The credit risks— 

Mr. SHERMAN. I am asking you not for your prior practice but for 

your legal interpretation. 

Let’s say that the Secretary of the Treasury called you in the middle of the night and said, ‘‘By God, we need another $700 billion to shore up institutions on Wall Street. We need to do it right 

now or the entire world comes to an end; and those idiots in Congress, they won’t vote for another TARP. So the only way we are 

going to save civilization as we know it is for the Fed to take some 

substantial risks and become a general creditor of banks that 

would otherwise become insolvent and other financial institutions.’’ 

Do you believe that you or your successors have the legal right 

to say, ‘‘Yes, Mr. Secretary, we couldn’t agree with you more; we 

will have a vote on it and we will extend the credit?’’ 

Mr. KOHN. I think we need a new resolution authority through 

the Congress. 

Mr. SHERMAN. I am not asking you what new law should be 

passed. I am not asking you what your practice has been in the 

past. 

I am asking you what are the legal authorities you have under 

present law right now? 

Mr. KOHN. We need to be secured. 

I think one of the issues is— 

Mr. SHERMAN. So you can’t take a double A risk; you can only 

take a triple A risk? 

Mr. KOHN. We need to have enough security that we feel that the 

loan has good prospects of being repaid, that we are not taking fiscal risk. 

Mr. SHERMAN. Let’s say you were buying paper that if you 

worked for a credit rating agency, you would rate at single A. Is 

that the kind of risk that you are legally allowed to take under 

13(3)? 

Mr. KOHN. Only if it is discounted to an extent so that the collateral value would be less than the par value. 

And that is what we do. We take paper at the discount window 

that isn’t triple A, but we don’t give it full par value; we discount 

it. And I think we protect the public purse in that way. 

Mr. SHERMAN. It sounds like you have the power to do another 

TARP almost, but not quite. 

Shifting to another direction, in a democracy it is supposed to be 

one person, one vote. Every institution of the government is supposed to reflect the results of elections held in polling booths. Yet 

you have these—at least your regional Boards of Governors are selected on the basis of—I will call it ‘‘one bank, one vote,’’ to oversimplify. 

Does it make any sense to invest with the image of governmental 

power, and everybody—I mean, you can say there is a difference 

between the Fed and the branches of the Fed, although throughout 

business, ‘‘branch’’ means, in effect, another office, not even a sepaVerDate Nov 24 2008 12:09 Dec 22, 2009 Jkt 053234 PO 00000 Frm 00021 Fmt 6633 Sfmt 6633 K:\DOCS\53234.TXT TERRIE
16 

rately incorporated subsidiary, so most of the world is going to view 

your branches as part of your tree. 

Do you think it is appropriate to have privately elected Governors serve in what appears to everyone to be a governmental capacity? 

Mr. KOHN. The boards of directors of the Reserve banks have 

served a valuable function in the Federal Reserve. 

Mr. SHERMAN. Well, sir, in Germany before World War I, they 

had what many people thought was a very good government, but 

your voting power, your control over government agencies depended upon how rich you were. And you can argue it was a very 

good government that made very good decisions right up until Sarajevo. 

I am not asking you whether it is good government—whether you 

have made good decisions. What I am asking is, is it consistent 

with what we celebrated on the 4th of July to have such governmental power in the hands of those elected on the basis of one 

bank, one vote? 

Mr. KOHN. I think Congress, from 1913 on, has considered it consistent with its authorities and how it wished to carry them out. 

Mr. SHERMAN. That is before we gave you the enormous additional power we are considering. 

Chairman WATT. The gentleman’s time has expired. 

Mr. SHERMAN. I yield back. 

Chairman WATT. And while I would be a lot more generous, we 

have a little time bind that we are operating in. 

The gentleman from Delaware, Mr. Castle, is recognized. 

Mr. CASTLE. Thank you, Mr. Chairman. 

Mr. Kohn, I am concerned about conflicts here. As you deal with 

the 13(3) bailouts, or whatever you want to call them, and as you 

deal with monetary policy, and then you, the Fed, would get into 

the systemic risk regulator issue, do you at least see the potential 

for—and if you do, could you articulate what it would be—for conflicts of interest in terms of the different responsibilities the Federal Reserve would have if you had all those powers? 

Mr. KOHN. Congressman, no, I really don’t see the potential for 

major conflicts here. I think we carry out our monetary policy mission much more easily in a systemically sound financial system. 

We have seen the demonstration of that over the last 2 years, 

what happens when the system isn’t sound. It makes it very, very 

difficult for us. On the other hand, I don’t see us using our monetary policy authority in any way that wouldn’t be consistent with 

the objectives you gave us for macroeconomic stability and price 

stability. 

So I really think the two are congruent, not conflicting. 

Mr. CASTLE. I mean, I interpret from your opening statement, 

and what you have been saying is that the Board of Governors of 

the Fed welcome this responsibility—at least you seem to. 

Is there any conflict at all among the Board or discussion about, 

should we be doing this or is it better left to an independent agency 

or some other agency? 

Mr. KOHN. I think members of the Board have had different 

views about a broad grant of authority, but—I haven’t polled all 

the members of the Board. 

17 

Mr. CASTLE. I am not asking you to speak for them, just what 

you observed. 

Mr. KOHN. I see this as an incremental change from where we 

are right now, and, therefore, I am not aware of any dissent on the 

Board about the particular proposal that the Treasury has made. 

Before the Treasury made the proposal, there was a lot of discussion of some systemic risk regulator with unspecified authorities 

and unspecified responsibilities. I think there was concern on the 

Board, which I shared, that it was impossible to carry the responsibilities out because we didn’t have the authorities and because 

the expectations were way too high in terms of what was possible 

in a market economy that naturally has ups and downs. 

But I see the proposal on the table as more modest, which is taking what we currently do, but giving a little more macroprudential 

shape to it, thinking about the implications and being sure that the 

core institutions, the ones that have caused the problems that have 

given rise to what you call the ‘‘bailouts,’’ are safe and are not subject to the kinds of risks and the kinds of knock-on effects to the 

rest of the market that have caused us to intervene this time. 

Mr. CASTLE. How would you interact with other regulatory bodies that have jurisdiction over some of these entities, be it an SEC 

or whatever it may be? How do you think that would fundamentally work? 

Mr. KOHN. We would work closely with them. We already do 

work with the other banking regulators on FFIEC. We would be 

part of this council that the Treasury has looking at systemic risk 

and identifying systemic activities, systemic problems. 

We have close working relationships with the SEC, and I see 

that continuing. We basically rely on them for supervision of the 

individual institutions. But I think this would give us some authority to make sure not only that the individual institution is safe, but 

that the system is safe, too. 

Mr. CASTLE. What would be your responsibility with large insurers, hedge funds, and even private equity-type funds as you view 

it if you were to be under this legislation given that responsibility? 

Mr. KOHN. It would depend upon whether those entities were 

considered systemically important. And to the extent that they 

weren’t systemically important, we would have no particular authority over them. 

To the extent that they were, after consulting with the council, 

which would have the responsibility for identifying these issues, I 

think if we saw there was a gap in regulation that threatened the 

stability of the financial system, it would be up to us to try and 

fill that gap. 

Mr. CASTLE. I don’t know this, but I would assume, because insurance is generally regulated at the State level, that you get into 

that whole issue of State-Federal. I don’t know if you discussed 

that or not. 

Mr. KOHN. Right. But I think your proposal is to create a Federal 

entity, isn’t it? 

Mr. CASTLE. Well, it is being discussed. 

Mr. KOHN. I think the problem perhaps isn’t so much the insurance companies; at least thinking back to our very bad experience 

with AIG, it wasn’t the insurance companies, it was the stuff that 

18 

was going on next to the insurance companies. And I would hope 

if we saw something like that happening, we would find a way of 

containing that risk. 

Chairman WATT. The gentleman from Minnesota. 

Mr. ELLISON. Thank you, Mr. Chairman. And I thank the chairman for calling for this work. Do you believe it is appropriate for 

the Fed, particularly in light of the systemic risk? 

Mr. KOHN. I don’t think the fact that our power might be expanded is by itself a reason to relinquish the consumer authority. 

My personal view is that the Federal Reserve is well placed to do 

a good job in the public interest on consumer regulation. These are 

congruent, with good consumer regulation, give us a way of balancing issues having to do with consumer regulation. I think in the 

last years we have stepped up to the plate on high-cost mortgages, 

on consumer credit. We have revised truth in lending regulations 

coming out at the end of this month. I would hope that the Congress might think about whether there are ways of strengthening 

the Federal Reserve’s commitment to consumer regulation as an alternative to creating a new regulator. 

Mr. ELLISON. Would you allow, Mr. Vice Chairman, that the Fed 

was slow to the game in addressing some of these consumer issues 

you just pointed out, particularly in mortgages, credit cards? I 

mean, some of the issues that the more recent legislation addressed 

have been longstanding. 

Mr. KOHN. I agree that we did not see the abuses as widespread 

as they were, and we were slow to react to them. And I think if 

you kept consumer regulation in the Federal Reserve, if you were 

to decide to do that, you need to strengthen our commitment to 

that regulation. I agree. 

Mr. ELLISON. Do other central banks around the world have consumer protection as part of their mandate? 

Mr. KOHN. I don’t know. 

Mr. ELLISON. Is the Fed currently working on consumer concerns 

right now with regard to overdraft fees and things like that? 

Mr. KOHN. I am not sure, Congressman. 

Mr. ELLISON. Has the Fed addressed issues like among bank 

staff that—sort of like sales practices that would push products, 

push selling accounts, having quotas for selling a certain number 

of accounts on a given day or a given week without regard to the 

consumer’s best interest? So, for example, if a bank were to say to 

a personal banker staffer, you must produce 10 new savings accounts today, and then that staffer were to go try to get 2 and 3 

accounts from the same person in a day, is that something that the 

Fed has focused its attention on now? 

Mr. KOHN. I think our focus in that regard has been transparency, making sure that people knew what they were getting, the 

terms on what they were getting, and what the alternatives are. 

I know that we have focused on that in the mortgage area. 

Mr. ELLISON. Has the Fed focused on that issue? Particularly 

now, I mean, overdraft fees are a significant part of bank profit. 

Mr. KOHN. We have focused to some extent in the past. I don’t 

know whether we still are focused on that. 

Mr. ELLISON. And if I may be allowed a final question, I agree, 

I think that some of the work that Fed has done recently has been 

19 

very laudable, and I want to let you know that I feel that way. 

Some of the findings you made regarding credits cards and other 

things are just great. But I will say that given the Fed’s mandate 

of focusing on monetary policy, I wonder—and I wonder if you 

wouldn’t mind commenting—if there are not some occasions in 

which consumer protection takes a back seat to some of the other 

issues that the Fed is required to focus on. 

Mr. KOHN. I think that has happened in the past. I don’t think 

it has happened over the past 3 or 4 years. 

Mr. ELLISON. I will agree with that. 

Mr. KOHN. And I think there could be changes in our law making 

consumer protection explicitly a part of our mandate that would 

help to prevent that from happening in the future. But it has happened in the past, I agree. 

Mr. ELLISON. Thank you, Mr. Vice Chairman. 

Chairman WATT. The gentleman yields back the balance of his 

time. 

The gentleman from New Jersey. We welcome Mr. Lance. If the 

gentleman has questions, we will recognize him for 5 minutes. 

Mr. LANCE. Thank you, Mr. Chairman. Good afternoon. 

Regarding the powers of the Fed at the moment and then this 

huge debate regarding a systemic regulator, many of us on our side 

are concerned, Mr. Vice Chairman, with whether or not this should 

exist, and if it does exist, whether it should exist in the Federal 

Reserve Board, given your core mission as established, I gather, 

under Woodrow Wilson in 1913, perhaps. And perhaps you have 

answered this before I entered the room, and I apologize if you 

have, but if you could elaborate on your views personally, sir, regarding whether you believe a systemic regulator should be housed 

in the Fed. 

Mr. KOHN. I think the Federal Reserve is well positioned to carry 

that mission out in the public interest. I think we bring a variety 

of perspectives that are important to that. We have everyday contact with the markets, so we know what is going on there. We have 

supervision, so we have a view of what is happening within individual institutions. Our responsibilities for the macroeconomy give 

us a perspective on the intersection of financial markets in the 

macroeconomy. So I do think the Federal Reserve is well positioned 

to exercise some oversight in the systemic risk area. 

Mr. LANCE. Do you believe that there might be an inherent conflict given your responsibilities in managing the macroeconomy? 

Mr. KOHN. No, I don’t. Several of your colleagues have asked 

that question. I just don’t see the conflict. I see this as one of them 

supporting the other. I think macroeconomic stability will support 

financial stability, and financial stability will support macroeconomic stability. 

The Federal Reserve is inevitably involved in financial stability, 

because we are the lender of last resort and because we have the 

responsibilities that you gave us for macroeconomic stability. So it 

doesn’t matter in some sense who the financial stability regulator 

will be. In the end the Federal Reserve will have to be involved. 

And I think there are synergies for giving the Federal Reserve a 

little extra power to do that given our current authorities. 

Mr. LANCE. Thank you. 

20 

And in a completely unrelated area, I am personally concerned 

with the purchase by the Fed recently in an increasing amount of 

long-term T-bills, and I am not sure the American public is fully 

aware of this situation. It is obviously arcane and something that 

may not be on the front pages of newspapers. 

Could you update us on your recent purchases and where they 

are in relationship to where they might have been a year ago, sir? 

Mr. KOHN. In March, the Federal Open Market Committee decided to purchase up to $300 billion of Treasury—intermediate and 

long-term Treasury securities. We did that because we thought it 

would be helpful not for the Treasury per se, but because we 

thought it would push down interest rates for businesses and 

households at a time when the economy was falling very rapidly, 

very weak, and we needed to free up the credit markets so businesses and households would face lower charges and lower cost of 

capital, and then do some more spending. 

I am not exactly sure where we are in that process. I think we 

are about halfway through. We said, I think, it would be done by 

the end of September. At our last meeting we didn’t make any 

change in that plan. 

Mr. LANCE. So if I just might follow up, Mr. Vice Chairman. It 

is your expectation that you will not continue this beyond the September date, at least to the extent that you are currently involved 

in that area? 

Mr. KOHN. We have made no decision on that. That would be a 

decision the Open Market Committee would have to make. 

Mr. LANCE. Thank you. Obviously we on this committee would 

like to be apprised of that, and that is certainly an area of grave 

concern to me. 

Thank you very much, Mr. Vice Chairman. 

I yield back the balance of my time, Mr. Chairman. 

Chairman WATT. The gentleman yields back the balance of his 

time. 

We welcome the member of our full committee, Mr. Garrett, who 

is not a member of the subcommittee, but I would ask unanimous 

consent that he be given 3 minutes to ask questions. I would actually ask for longer, but we already displaced a meeting that was 

scheduled to start in this room at 4:00. There is another meeting 

that is scheduled to start in this room at 5:00, and we have another 

panel, but I would happily grant the gentleman 3 minutes, unless 

one of your members has an objection. 

Mr. GARRETT. I appreciate that. And, who knows, they might. 

But is there anything more important than this meeting and the 

Chairman that you are leading right now? But thank you, Mr. 

Chairman. 

Just a couple of questions. You know, you are familiar with the 

proposal the Administration has laid out, and I assume that you 

at least have the opportunity to know that the Minority party, the 

Republicans, have thrown out a proposal as well to deal with the 

situation. I don’t know whether you have gotten into the weeds of 

it at all. 

Mr. KOHN. I haven’t gotten into the weeds of the Republican alternatives. 

21 

Mr. GARRETT. Well, we will be certain to send you an annotated 

version. 

One of the provisions in it, in our plan, says, with regard to Section 13—and stop me if someone else threw this question out to 

you—that 13(3) should be reined in to some extent, the powers 

under 13(3), and one of the aspects of it to limit the ability for the 

Fed to actually pick, as it has in the past instance, particular institutions and proverbially bail them out as opposed to—prohibit that, 

but instead still allow them to use Section 13(3) in a larger, institutional-wide basis, if that is clear. 

Mr. KOHN. Yes. 

Mr. GARRETT. Comment? 

Mr. KOHN. So I think that is consistent, if I understand it correctly, Congressman, with our own position, which is with respect 

to the resolution of systemically important institutions, we don’t 

want to be involved in making those loans; that there needs to be 

some way of doing that. We need to have orderly resolution of these 

institutions, but that is not the job of the Federal Reserve. We 

would be consulting, we would be part of the process, but it ought 

to be a Treasury Department-led process. 

Mr. GARRETT. But there would be a distinction, though, to simply 

say that we should set up this wind-down authority as the Administration proposes. 

Mr. KOHN. Right. 

Mr. GARRETT. And not putting a limitation on the Fed, Federal 

Reserve; or, as we are suggesting if it goes through, that you actually have a wind-down authority as you suggest over in the Treasury, so you wind things down, but clearly in statute saying, going 

forward, Federal Reserve shall not have the authority to do so. 

Would you concur with that? 

Mr. KOHN. I would have to see the exact wording. Certainly, I 

agree with the idea. 

Mr. GARRETT. And I know the whole discussions with regard to 

moral hazard and what has occurred in the past has already been 

laid out here. 

One of the things—another issue that is totally unrelated that is 

in the news is with regard to the Fed Chairman and the allegations 

or the—with regard to pressure that has been put on certain institutions, what have you, in the past. And they only name specific 

institutions in those allegations, right? We are sending a letter to 

the White House just to try to get some more information on that, 

and so I will just throw the question to you right now. 

Are you familiar with any other institutions that the Fed or any 

officials at the Fed have exerted any pressure on in any way, 

shape, or form, or whether the Treasury has exerted any influence 

as those allegations are suggesting? 

Chairman WATT. The gentleman’s time has expired. And since 

that is really a subject that is not within the parameter of this 

hearing, I wish the gentleman would ask the question in writing, 

if he wouldn’t mind, since we are under some time pressure. 

Mr. GARRETT. Can you give me just a yes or no? 

Mr. KOHN. I would have to see the question in writing. We supervise lots of institutions, and in the process of supervising those institutions, we make lots of requests to them to change their pracVerDate Nov 24 2008 12:09 Dec 22, 2009 Jkt 053234 PO 00000 Frm 00027 Fmt 6633 Sfmt 6633 K:\DOCS\53234.TXT TERRIE
22 

tices. So I am not sure exactly what you are getting at. So perhaps 

the chairman’s suggestion of a written question would be best. 

Chairman WATT. The gentleman’s time has expired. 

The gentleman from Alabama, the ranking member of the full 

committee, is recognized for 5 minutes. 

Mr. BACHUS. Thank you. 

Governor, do we have an exit strategy from these ad hoc bailouts 

of failing institutions? 

Mr. KOHN. We have an exit strategy from the provision of reserves that we have made, the very high level of reserves that we 

now have in the system. We believe we have the tools to absorb 

those reserves, to raise interest rates when the time comes to do 

so. 

With respect to the individual institutions, I think each institution, like AIG, for example, is putting in place a business strategy 

to sell pieces of itself, repay the Federal loans and repay the U.S. 

taxpayer. So there are strategies being put in place for the individual institutions. 

Mr. BACHUS. To me, the Obama Administration proposal actually 

puts in place a permanent bailout agency, and that is the Federal 

Reserve. It empowers you to bail out through loans or guarantees 

failing institutions, does it not? 

Mr. KOHN. That is not my understanding, Congressman. 

Mr. BACHUS. Okay. 

Mr. KOHN. We are in agreement with the Administration that a 

separate resolution authority for failing systemic institutions needs 

to be established under the oversight of the Treasury, not the Federal Reserve. 

Mr. BACHUS. Would that include—would that be an enhanced 

bankruptcy proceeding? 

Mr. KOHN. It would be a substitute for bankruptcy procedure, 

just as we have today for banks and depository institutions under 

the FDIC. 

Mr. BACHUS. So the Federal Reserve as the systemic regulator 

would have no right to guarantee or loan money to an individual 

institution. 

Mr. KOHN. That wasn’t the process of failing. That would be the 

resolution of that institution, like Bear Stearns, AIG, would be the 

province of the Treasury Department. 

Mr. BACHUS. But the Fed over the past year has guaranteed 

some of the obligations and made loans; has it not? You participated— 

Mr. KOHN. We have been in a second and third guarantee position for some obligations of Citigroup. Is that what you are referring to? 

Mr. BACHUS. And AIG also. 

Mr. KOHN. And AIG. 

Mr. BACHUS. And what is the total obligation to AIG? 

Mr. KOHN. I think we have about $45 billion of loans outstanding 

to AIG, plus some special-purpose vehicles that have assets that 

they have taken over from AIG probably total about $40 billion or 

$45 billion. 

Mr. BACHUS. Do you anticipate or would you be opposed to a provision in any law that we pass to prohibit the Fed or the Treasury 

23 

from loaning billions of dollars of taxpayer money to these institutions or to guaranteeing their obligations? 

Mr. KOHN. I think somebody in the government, not the Federal 

Reserve, needs to have the authority to resolve systemically important institutions in an orderly way so they don’t threaten the jobs 

of Americans. 

Mr. BACHUS. I would agree with you that there needs to be an 

orderly resolution. 

Mr. KOHN. That is right. 

Mr. BACHUS. I would not agree with you that that would include 

taxpayer funding or—you know, either guarantees or loans, in the 

case of, as you say, Citi and AIG, was in the tens of billions of dollars, actually hundreds of billions of dollars. 

Do you believe that too big to fail—do you believe in that doctrine? Do you believe in the fairness of that doctrine? 

Mr. KOHN. I think too big to fail is a very difficult, troublesome 

issue. I agree with the thrust of your question that we need to deal 

with. I think there is a terrible moral hazard involved in that. And 

my thinking is that the Administration proposal, something like 

the Administration proposal is very helpful in that regard. It has 

two things. One is that the largest institutions that might be too 

big to fail face much tougher scrutiny, higher capital, greater liquidity, more robust risk management systems so that they won’t 

fail; and, secondly, that there be a resolution authority that would 

enable the government to resolve these in an orderly way, that 

might impose costs on the creditors, but in an orderly way outside 

of bankruptcy. 

Chairman WATT. The gentleman’s time has expired. 

The Chair notes that some members may have additional questions for this witness which they may wish to submit in writing. 

Without objection, the hearing record will remain open for 30 days 

for members to submit written questions to this witness and to 

place his responses in the record. 

We thank Vice Chairman Kohn for his patience and for his responses, and we will excuse this witness and call up the second 

panel. 

While the second panel is coming forward, I ask unanimous consent to enter into the record the following statements: The statement of Thomas F. Cooley, professor of economics, Stern School of 

Business, New York University, dated July 9, 2009; and the statement of the Financial Services Roundtable, dated July 9, 2009. 

Without objection, it is so ordered. 

The Chair will now briefly introduce the second panel, without 

giving them all of their glory in the introductions. We will put the 

full introductions into the record in the interest of time. But this 

panel includes Dr. Frederic Mishkin, Alfred Lerner Professor of 

Banking and Financial Institutions at the Graduate School of Business, Columbia University; Dr. Lawrence Meyer, vice chairman, 

Microeconomic Advisers; Dr. James K. Galbraith, Lloyd M. Bentsen, Jr., Chair in Government/Business Relations and professor of 

government, LBJ School of Public Affairs, University of Texas; Dr. 

Richard Berner, chief economist at Morgan Stanley; Dr. John B. 

Taylor, Mary and Robert Raymond Professor of Economics at Stanford University; and Dr. Allan Meltzer, The Allan H. Meltzer UniVerDate Nov 24 2008 12:09 Dec 22, 2009 Jkt 053234 PO 00000 Frm 00029 Fmt 6633 Sfmt 6633 K:\DOCS\53234.TXT TERRIE
24 

versity Professor of Political Economy, Tepper School of Business, 

Carnegie-Mellon University. 

We welcome each one of you, and we will recognize each of you. 

Your full statements will, of course, be made a part of the record, 

and each of you will be recognized for 5 minutes to summarize your 

statement. 

And I will start with Dr. Mishkin. 

STATEMENT OF DR. FREDERIC S. MISHKIN, ALFRED LERNER 

PROFESSOR OF BANKING AND FINANCIAL INSTITUTIONS, 

GRADUATE SCHOOL OF BUSINESS, COLUMBIA UNIVERSITY 

Mr. MISHKIN. It is a great pleasure to be here to discuss what 

is a very important issue, which is what role the Federal Reserve 

should have as a systemic risk regulator. 

I want to boil this down to three questions, even though we were 

asked four, but I think three that are quite relevant to these 

issues. And the first question is the essential one, which is, should 

the Fed be the systemic risk regulator? And I am going to answer 

yes to that question, and there are four reasons that I take that 

view. 

The first is that the Federal Reserve is involved in daily interaction with the market, and in terms of being a systemic risk regulator, that kind of information or that contact is extremely useful. 

The second is that there is a synergy between thinking about 

macroeconomic stability and financial stability, and that is, I think, 

extremely important in terms of performing the appropriate analysis to do systemic risk regulation in the best way possible. 

The third is that there is a synergy between the actions that are 

required in terms of promoting macroeconomic stability and financial stability. And so we have seen this, of course, in very major 

ways during this recent crisis. This involves the role of the Federal 

Reserve as a so-called lender of last resort, providing liquidity to 

the financial system to, in fact, make sure that macroeconomic stability is preserved. 

And, finally, the Federal Reserve is one of the most independent 

of government agencies. In order to be an effective systemic risk 

regulator, the kind of independence the Fed has had in the past 

and has used in the past would be also very helpful in this regard. 

So when I look at this issue of the Fed being a systemic risk regulator, I think that, from my viewpoint, it really is the appropriate 

logical choice when we think about the nature of this role. 

The second issue is should the Fed relinquish some of its other 

roles if it became the systemic risk regulator? And I think the answer here is yes. In particular, the Treasury plan has suggested 

that the Federal Reserve no longer be a consumer protection regulator, and I concur with this view. 

There are three reasons why I think that the Fed should no 

longer be involved in this activity if, in fact, it is handed these additional responsibilities. The first is that being a consumer protection regulator is not at the core mission of what the Federal Reserve does, where I actually do see macroeconomic stability and financial stability is part of that core mission. 

25 

The second is that it uses a very different skill set. And so in the 

context of thinking about the synergies, I do not see them to be 

nearly as relevant. 

And the third, I think, is really the most important, which is that 

consumer protection regulation is very political. Everybody cares 

about it. In the past I testified on credit cards. Everybody has 

issues in terms of their dealing with the credit card companies. In 

that context, the possibility of there being more pressure, political 

pressure, put on the Federal Reserve system is, in fact, greater. 

And so again I think that this is another reason why having something that is not in your core mission which is, in fact, something 

that tends to get more political could be harmful to the independence of the Fed, something that I am going to turn to later. 

The third question is, are there dangers from the Federal Reserve taking on this role of systemic risk regulator? And I think the 

answer is yes. There are three dangers that do particularly concern 

me. I will argue, however, that even though these dangers exist, 

that the Federal Reserve still should be the risk regulator, systemic 

risk regulator, and there are steps that the Congress can take to, 

in fact, ensure that the Federal Reserve can do its job adequately 

both in terms of monetary policy and in terms of promoting financial stability. 

So the first danger is that the Federal Reserve might lose its 

focus on price stability. Clearly there are concerns in the marketplace about this issue about the credibility of the Fed as an inflation fighter and steps that it needs to take in terms of making sure 

that inflation is not too high. And in this context I have argued 

elsewhere, both when I was a Governor at the Federal Reserve and 

also afterwards in op eds, that one way of dealing with this would 

be to have the Federal Reserve to have an explicit numerical objective in terms of inflation, something that it does not have at the 

current time. 

The second issue is, could systemic risk regulation interfere with 

the independence of the Fed? And I think there is some danger 

here. The danger, of course, is that systemic risk regulation, particularly in the context of having to deal with an institution which 

has to be reined in, could actually mean that there is some pressure put on the Federal Reserve in that context. And so I think 

that there is some danger here. 

But, again, I think that the issue here is that the Congress has 

to be aware that the independence of the Federal Reserve is very 

much in the national interest. Indeed, this is a very major concern 

that I have right now, given concerns about the Federal Reserve’s 

independence and people who have been saying the Federal Reserve needs to be reined in, I think it actually is something that 

can damage the Federal Reserve’s ability to maintain price stability and also macroeconomic stability. But, furthermore, I think 

that there is also an issue that—in that context that we could actually have even problems currently with concerns about Fed’s credibility, which is actually something that can raise interest rates, 

something that I think has indeed happened. 

The third issue is something that is not really discussed as much 

as I would like to see discussed, which is the Federal Reserve’s resources have been stretched to the limit by this crisis. And this is 

26 

particularly true of the Board of Governors. I saw this as a member 

of the Board of Governors where the staff was working extremely 

long hours and was exhausted. And I left in September of 2008, before the crisis really got bad. So there are issues in terms of the 

Fed having enough resources and the support of the Congress for 

the Fed to acquire the resources that it needs. And I think, again, 

that is something that is quite important. 

So the bottom line here for me is that one of the important lessons from this crisis is that we absolutely desperately need a systemic risk regulator. And then I look at the issue about who can 

do that the best, and my view is that the Federal Reserve is, in 

fact, best positioned to do so. 

On the other hand, there are some dangers here, but this is why 

I think the Congress needs to, in fact, support the Federal Reserve 

in its independence in terms of the resources that it needs to do 

this job. And as a result, I think that we would be better served 

having the Fed pursue this role. 

Thank you very much. 

[The prepared statement of Dr. Mishkin can be found on page 83 

of the appendix.] 

Chairman WATT. I thank you, Dr. Mishkin, for your testimony. 

And, Dr. Meyer, you are recognized for 5 minutes. 

STATEMENT OF DR. LAURENCE H. MEYER, VICE CHAIRMAN, 

MACROECONOMIC ADVISERS 

Mr. MEYER. Thank you very much. And thank you for giving me 

this opportunity to testify before you this afternoon. 

The independence of central banks with respect to monetary policy is absolutely essential. Policies that are focused on financial stability, on the other hand, require a more cooperative approach, including, in the United States, the central bank, functional regulators of banks and nonbank subsidiaries, and a clear role for the 

Treasury. But there needs to be a bright line between the more cooperative approach to financial stability policy and the independence of the Fed with respect to monetary policy. 

Supervising systemically important financial institutions is, of 

course, a central part of financial stability policy. I don’t believe 

there is a conflict between the current or newly proposed role for 

the Fed as systemic risk regulator and the traditional role as independent authority on monetary policy. But then, again, I do not see 

the Treasury proposal as conferring on the Fed vast new authority 

as systemic risk regulator. 

The Fed is already bank holding company or consolidated supervisor for all financial institutions that have a bank. Of the systemically important financial institutions today, most are already bank 

holding companies. Other institutions that might be designated 

systemically important could be a couple of insurance companies, 

a few other large financial firms that are not supervised today, 

and, in principle but not likely in practice initially, very large and 

highly leveraged hedge funds. 

It also should be recognized that there are functional supervisors 

of the bank and the investment banking and insurance subsidiaries 

of bank holding companies, and they do much of the heavy lifting 

27 

in overseeing the risks in their respective parts of the bank holding 

company. 

There has always been a debate about whether the Fed’s role in 

bank and bank holding company supervision complements or conflicts with its role in monetary policy. One of the cases for a complementary role is that the Fed’s responsibility as hands-on supervisor of some banks and all bank holding companies provides firsthand information about the state of the banking sector, which can 

be a valuable input into the assessment of the economic outlook, 

especially in periods of extreme stress like today. 

The counterargument is that the Fed’s concern for the health of 

the banking system, derived from its role as bank and bank holding company supervisor, can encourage the Fed at times to sacrifice 

its macro-objectives in order to help the banking system when it is 

ailing. When I was on the Board, I never witnessed any conflict in 

practice between these two roles. I don’t see why the debate should 

change as a result of the marginal increase in supervisory reach 

under the Treasury proposal. 

A basic premise for my view is that a central bank should always 

have a hands-on role in bank supervision. First, central banks always have at least an informal responsibility for monitoring systemic risk, and the banking system is a major source of such risk. 

Second, the central bank is always a source of liquidity to and lending to banks, and must therefore have firsthand knowledge of their 

creditworthiness, and this is especially true at times of stress. Finally, the central bank will always be called upon to cooperate with 

Treasury at times of interventions in particular institutions where 

the Fed will sometimes provide the liquidity, and Treasury should 

take all the credit risk. 

Given the Fed’s role already as consolidated supervisor of most 

systemically important financial institutions, the choice may be 

whether to remove the Fed from its role in banking supervision altogether, or expand its role modestly to cover all systemically important financial institutions. This seems like an obvious choice for 

me. I also don’t see the need to isolate these two functions from 

each other within the Federal Reserve, at least more than they are 

today. 

Now, if the Fed were getting substantial new powers as systemic 

regulator and had to devote considerable new resources to this new 

responsibility, then it seems reasonable that it should give up some 

of its current responsibilities. If something is to be given up, the 

most obvious choice is consumer protection and community affairs. 

These are not seen around the world as core responsibilities of central banks. In addition, the case for giving up consumer protection 

and community affairs is strengthened by the Treasury proposal to 

unify these responsibilities in a single agency. 

The bottom line is that the Fed is the best choice for consolidated 

supervision of systemically important financial institutions in addition to its role as independent authority on monetary policy, and 

these joint roles are much more complementary than they are conflicting. Indeed, there is a very natural fit between these two roles. 

Thank you. 

[The prepared statement of Dr. Meyer can be found on page 77 

of the appendix.] 

28 

Chairman WATT. Thank you, Dr. Meyer. 

Dr. Galbraith, you are recognized for 5 minutes. 

STATEMENT OF DR. JAMES K. GALBRAITH, LLOYD M. BENTSEN, JR., CHAIR IN GOVERNMENT/BUSINESS RELATIONS 

AND PROFESSOR OF GOVERNMENT, LBJ SCHOOL OF PUBLIC 

AFFAIRS, UNIVERSITY OF TEXAS 

Mr. GALBRAITH. Thank you very much, Mr. Chairman. And as a 

member or an alumnus of this committee staff, it is again a pleasure and privilege to be here. 

I want to begin with a comment on this question of independence 

which has been touched on repeatedly. Vice Chairman Kohn said, 

and I think with very carefully chosen words, that the Congress 

granted a substantial degree of independence to the Federal Reserve. That independence is, of course, independence from the Executive Branch. It is not and cannot be independence from the Congress itself. The Federal Reserve may be delegated certain functions by the Congress, but the Congress can always choose to hold 

it accountable, and this committee, of course, has the responsibility 

of oversight precisely for that reason. So I think we should be very 

clear that, when speaking of the independence of the Federal Reserve, it is a legal independence of a kind that other regulatory institutions have had over the course of our history. It is not an independence which is specific to monetary policy per se. 

The question before us is whether the Federal Reserve is the best 

agency to take on the responsibility for regulating systemic risk, 

and I have some reservations about that, and I would classify them 

in three broad categories. The first one we might call constitutional, and I would pick up the point that was already made this 

afternoon by Congressman Sherman, concerning the fact that the 

Federal Reserve is constituted in part of regional Federal Reserve, 

of Federal Reserve district banks, who have boards of directors who 

are formed from the member banks themselves. And it is, of course, 

true that the district banks are represented on the Federal Open 

Market Committee with a voting power whose constitutionality, incidentally, was challenged in court by the chairman of this committee back in the 1970’s when I was serving here on the staff. The 

issue was never resolved on the legal merits. 

It is also the case, as I understand it, that the examiners under 

a systemic risk supervision regime would actually reside in the district banks rather than at the Federal Reserve Board, and it seems 

to me this does raise a question at least of perception; that is to 

say, whether it is appropriate to have systemic risk regulators who 

are part of institutions that report in part and are accountable in 

part to boards of directors consisting in part of the member banks 

of those institutions for two reasons. One, there may be a systematic conflict between the interests of the member banks and the interests of system stability. And, secondly, there may be conflicts between the interests of member banks and the interests of other 

Tier I financial holding companies who are not member banks. So 

it seems to me that is at least a question which is worth considering as you think about the architecture of this particular system. 

The second concern that I would have is institutional. It is 

whether, in an agency whose primary functions are macroeconomic, 

29 

one would ever have a commitment to the systemic risk regulation, 

to the supervisory responsibilities that are commensurate with the 

importance of that particular function. It seems to me worth pointing out that there is in the Treasury proposal basically a two-stage 

process, one of which is analytical, and the other one has more of 

an enforcement character. 

The analytical question is to determine what is a systemically 

dangerous institution to be classified as a Tier I financial holding 

company. That, it seems to me, would be an appropriate function 

to vest in the Federal Reserve Board, where an office that is incremental in the sense that Vice Chairman Kohn stipulated could decide amongst the relatively small number of large institutions who 

is and who is not in that category. The enforcement, the supervision, and the regulation of the behavior of the institutions, it 

seems to me, naturally would be more appropriately placed in an 

agency for whom that is the primary priority, an agency such as 

the FDIC. 

The third concern that I have is a question of really the leadership of the Federal Reserve. Historically this is—the chairmanship 

of the Board of Governors of the Federal Reserve is an extremely 

high-profile appointment. It is an individual who tends to be close 

to and to need the confidence of the financial markets, and there 

is a real question as to whether there is any record in the history 

of the Federal Reserve of effective response to systemic risk in advance of crisis. 

This was not the case of Benjamin Strong of the 1920’s, who was 

the leading figure at the time, although not the Chairman of the 

Board. It was not the case of Alan Greenspan in the run-up to the 

latest crisis. We had a doctrine which, in effect, denied that systemic risk could, in fact, bring down the system. That doctrine was 

articulated at the peak of the Federal Reserve, and it seems to me 

that we had a test of that proposition, and it came up wanting. So 

it does seem to me that there are reasons to be worried about investing the authority for systemic risk in the Federal Reserve. 

Thank you very much. 

[The prepared statement of Dr. Galbraith can be found on page 

50 of the appendix.] 

Chairman WATT. I thank you for your testimony. 

And, Dr. Berner, you are recognized for 5 minutes. 

STATEMENT OF DR. RICHARD BERNER, CHIEF ECONOMIST, 

MORGAN STANLEY 

Mr. BERNER. Thank you, Mr. Chairman, Ranking Member Paul, 

and other members of the committee. Thanks for inviting me to 

this hearing to address this important question, the role of the Federal Reserve in systemic risk regulation. 

I think the broader question here is how should we address the 

significant weaknesses in our financial system and our financial 

regulatory structure that the current financial crisis has exposed? 

Among market participants, and I talk to many of them, I think 

there are two policy changes that are needed that are well recognized: first, strengthen our regulatory infrastructure; and second, 

adopt appropriate regulation oversight to mitigate systemwide 

risks across financial market instruments, markets, and instituVerDate Nov 24 2008 12:09 Dec 22, 2009 Jkt 053234 PO 00000 Frm 00035 Fmt 6633 Sfmt 6633 K:\DOCS\53234.TXT TERRIE
30 

tions. In addition, I believe that macroeconomic policy should lean 

against asset and credit booms, which create financial instability. 

In my view, the Federal Reserve is best equipped to take the lead 

on systemic risk regulation and oversight. Like others, I think this 

function is an essential and natural extension of the Fed’s traditional monetary policy role and of its responsibilities as lender of 

last resort. 

Three factors support that claim: First, the Fed is the ultimate 

guardian of our financial markets, and so it should be the agency 

that ensures the safety and soundness of the most important financial institutions operating in those markets. 

Second, the process of intermediation through traditional lenders 

in the capital markets has become increasingly complex. Supervision of the institutions involved will enhance the Fed’s ability to 

make the right monetary policy decisions. 

And, finally, the Fed’s expertise in financial markets and institutions makes it the natural choice for this role. The Fed’s leadership 

in the Supervisory Capital Assessment Program demonstrated that 

expertise. 

In short, good monetary policy and financial stability, in my 

view, are complementary. Asset booms and busts destabilized the 

economy and financial system at great cost. A financial stability 

mandate for the Fed requires that focus on asset and credit booms 

as well as systemic regulation and oversight. And the policy tools 

required for each overlap substantially. 

That may explain why the other countries that separate such responsibilities from the traditional role of the central bank have 

fared no better than we did in this crisis. The U.K. is a good example. While the Bank of England and the Financial Services Authority clearly have collaborated in the recent crisis, their separation 

of powers did not help manage the current crisis more successfully 

than U.S. regulators. 

However, naming the Fed to this role won’t solve all of our problems that I just enumerated. To see why, in the rest of my time, 

I outline some related remedies. I will conclude by answering the 

four questions you posed. 

In my view, our regulatory system has three major shortcomings: 

First, we supervise institutions rather than financial activities, 

which allows some firms to take on risky activities with inadequate 

oversight. A focus on systemic risk is one remedy for that problem. 

Designating the Fed to take the lead will limit risky activities and 

important market information slipping through the cracks, and it 

will promote supervisory accountability. 

Second, our regulatory safety net is excessively prone to moral 

hazard, encouraging inappropriate risk-taking. Concentration, as 

you have all alluded to in this hearing, in our financial services industry has created institutions that are too big to fail. 

Remedies needed should include: more extensive oversight and 

supervision of large, complex financial institutions; an explicit regulatory charge on such institutions to help us offset the moral hazard created by an implicit guarantee; and a strong resolution 

framework that is understood by all before crisis hits. An ad hoc 

approach creates uncertainty and reduces the credibility of policy. 

31 

The third problem is procyclicality. Our regulatory infrastructure 

encourages excessive leverage, which magnifies financial market 

volatility. Three remedies needed here are: First, we need a stronger system of capital regulation that should improve financial stability and help monetary policy lean against the wind of asset 

booms. We must resolve the tension between accountants who want 

to limit reserves and regulators who want to build them—in favor 

of the regulators. Second, securities must be more transparent and 

homogeneous and less reliant on credit ratings. And third, to reduce settlement and payment system risk, we need greater use of 

central counterparties for over-the-counter derivatives. 

I want to conclude by answering your four questions. Are there 

conflicts with the Fed’s traditional role here? Yes, there can be. In 

a crisis, decisions about particular firms likely would involve the 

Fed in inherently political considerations and the use of taxpayer 

funds that could compromise its independence. 

We should insulate the Fed’s independence with two firewalls. 

First, the resolution of troubled financial institutions should fall to 

the FDIC; and, second, and globally, we must change institutions 

now too big to fail into being too strong to fail. Remedies will include many of the options I just discussed. Both firewalls should 

strengthen the Fed’s role as lender of last resort by reducing moral 

hazard, especially by reducing the chance that we will keep nonviable institutions alive, a concern you have expressed. 

What are the policy pros and cons here? In my view, the pros 

outweigh the cons. Interconnectedness means that supervision 

must look horizontally across instruments, markets, institutions, 

and regions rather than in vertical silos. In my view, the Fed has 

the most expertise and reach to provide that. The Fed is also best 

positioned to prescribe and enforce remedies to procyclicality and 

to build financial shock absorbers. 

Now, I hasten to state the obvious: The Fed is imperfect. As the 

guardian of our financial system, the Fed in the past has come up 

short in a number of ways. I would only say that while we consider 

making the Fed the lead systemic regulator, the Fed and we must 

examine how it can improve its functioning to take on these new 

duties. 

What about the arguments against? Well, ensuring financial stability may be too big a job for just one regulator. Even if the Fed 

takes the lead, coordination with other regulators will be essential 

for success. Coordination with regulators and central banks abroad 

may be even more critical than being in sync with regulators at 

home. Our markets and institutions are global, but our regulation 

is largely local. So I like the President’s recommendations for the 

Financial Services Oversight Council and international cooperation 

and coordination especially. 

Last, what about reassigning some Federal responsibilities to 

other agencies? Regulators should do what they do best. And, for 

example, as others have said, consumer protection and promotion 

of financial literacy could go to another agency, but I think that the 

Fed may still play a useful role in supporting these areas. 

Mr. Chairman, let me add that these views are mine and not 

necessarily those of my employer, Morgan Stanley, or its staff. I 

32 

want to thank you for your attention. I am happy to answer any 

questions. 

[The prepared statement of Dr. Berner can be found on page 46 

of the appendix.] 

Chairman WATT. Thank you for your testimony. 

Dr. Taylor, you are recognized for 5 minutes. 

STATEMENT OF DR. JOHN B. TAYLOR, MARY AND ROBERT 

RAYMOND PROFESSOR OF ECONOMICS, STANFORD UNIVERSITY 

Mr. TAYLOR. Thank you, Mr. Chairman, Ranking Member Paul, 

and members of this subcommittee, for inviting me to testify on 

this important subject. 

In my view, the Administration’s plan would grant to the Fed 

significant new powers, more powers than it has ever had before. 

These powers would include determining whether a financial firm 

is a threat to financial stability. These designated firms by the Fed 

would then be put in a special group called Tier I FHCs, financial 

holding companies. The Fed would then have the power to supervise and regulate this newly defined group. And the firms in this 

group would be subject to this new resolution regime chosen by the 

Fed. 

Taken as a whole, these powers mean that the Fed would be a 

systemic risk regulator. Though that term is not defined in the documents, I take it as a definition these new powers. In my view, 

these new powers will negatively affect the Fed’s role as an independent monetary authority. I have four main concerns. 

First, it seems to me that the additional powers and responsibilities would dilute the key mission of the Federal Reserve, which is 

to maintain overall economic and price stability by controlling the 

growth of the money supply and thereby influencing the overall 

level of interest rates in the economy. My experience in government, including the U.S. Treasury and elsewhere, is that institutions work best when they focus on a limited set of understandable 

goals and are held accountable to the public for achieving these 

goals. As the number of goals and the lack of clarity increases, the 

effectiveness and the performance generally decline. 

My second concern is that responsibility for these new Tier I financial holding companies would reduce credibility of the Federal 

Reserve by involving it directly in potentially controversial decisions. In fact, it seems to me the experience of the last few months 

illustrates this problem. The Fed’s credibility is an extraordinarily 

valuable asset, and it would be terrible to lose that asset. 

My third concern is that the plan would create a conflict of interest. Indeed, this has been discussed widely already at this hearing 

with the Vice Chairman and others. In my view, firms in the Tier 

I financial holding company category would be perceived as too big 

to fail and perhaps even too big to resolve to go through that complicated process that is being proposed. In my view, there will 

therefore be a temptation to adjust the instruments of monetary 

policy, the money supply or the interest rates to help protect these 

institutions. It is a natural evolution. Lower interest rates, whether 

or not appropriate, will be harmful to the economy, and a larger 

33 

Fed’s balance sheet when not appropriate would be harmful to the 

economy. 

My fourth concern is that by giving so much new power to the 

Federal Reserve, that the plan would actually threaten the Fed’s 

independence regarding monetary policy. Why would this be the 

case? In my view, sooner or later the increased power will result 

in checks and limits on it, perhaps through micromanaged political 

interference or perhaps through legislative change. It would be impossible, as some have suggested, in practice to prevent such interference from spreading from the new regulatory powers and supervisory powers to the traditional monetary function of the Fed. After 

all, they are in the same institution, and they are run by the same 

CEO. 

I think this loss of Federal Reserve independence is a serious 

issue, especially at this time of rapidly growing Federal debt and 

greatly expanded Federal Reserve balance sheet. Actually, I could 

not do any better than to quote a former Secretary of the Treasury, 

also former Secretary of State, Secretary of Labor, and Director of 

the Budget, Secretary George Shultz, who, after studying carefully 

the events of the last few months, came up with the following 

statement. And I quote Secretary Shultz: 

‘‘Observing this process, the question comes forcefully at you, has 

the accord gone down the drain?’’ 

The Secretary, of course, is referring to the 1951 accord where 

the Fed regained its independence from the Treasury, which it had 

lost during World War II, and was committed to pegging Treasury 

interest rates. And then he goes on to say: 

And remember how difficult it was for the Fed to disentangle 

itself from the Treasury in the post-World War II period. 

So these are very serious concerns, my four concerns, and I 

would be happy to answer any questions you have about them. 

Thank you, Mr. Chairman. 

[The prepared statement of Dr. Taylor can be found on page 86 

of the appendix.] 

Chairman. WATT. Thank you, Dr. Taylor. 

Dr. Meltzer, you are recognized for 5 minutes. 

STATEMENT OF DR. ALLAN H. MELTZER, THE ALLAN H. 

MELTZER UNIVERSITY PROFESSOR OF POLITICAL ECONOMY, TEPPER SCHOOL OF BUSINESS, CARNEGIE MELLON 

UNIVERSITY 

Mr. MELTZER. Thank you, Chairman Watt. And greetings to my 

old friend, Congressman Ron Paul, and to the members. Thank you 

for the opportunity to present my appraisal of the Administration’s 

proposal for regulatory changes. I will confine most of my comments to the role of the Federal Reserve as a systemic regulator, 

and will offer an alternative proposal much closer to the Republican proposal. 

I share the belief that change is needed and long delayed, but appropriate change must protect the public, not the bankers. 

During much of the past 15 years, I have written three volumes 

entitled, ‘‘A History of the Federal Reserve.’’ Working with two assistants, we have read virtually all of the of the minutes of the 

Board of Governors, the Federal Open Market Committee, and the 

34 

Directors of the New York Federal Reserve Bank. We have also 

read many of the staff papers and the internal memos supporting 

decisions. I speak from that perspective. 

Two findings are very relevant for the role of the Federal Reserve. First, I do not know of any single clear example in which the 

Federal Reserve acted in advance to head off a crisis or a series of 

banking and financial failures. We all know of several where it 

failed to act in advance. 

Members of Congress should ask themselves this question: Can 

you expect the Federal Reserve or anyone else as systemic regulators to close Fannie Mae and Freddie Mac after Congress has decided that it declined to act? What kind of a conflict is that going 

to pose? And how is it going to be resolved? 

Second, in its 96-year history, the Federal Reserve has never announced a lender of last resort policy. It has discussed internally 

the content of such a policy several times, but it rarely announced 

what it would do. And the announcements that it made, as in 1987, 

were limited to the circumstances of that time. 

Announcing and following a policy would alert financial institutions to the Fed’s expected actions and might reduce pressures on 

Congress to aid failing entities. Following the rule in a crisis, the 

lender-of-last-resort rule in a crisis would change bankers’ incentives and reduce moral hazard. 

A crisis policy rule is long overdue. The Administration proposal 

recognizes the need, but doesn’t propose the rule. Experiences in 

the past from the history suggest three main lessons: 

First, we cannot avoid banking failures, but we can keep them 

from spreading and creating crises; 

Second, neither the Federal Reserve nor any other Agency has 

succeeded in predicting crises or anticipating systemic failure. It is 

hard to do, in part because systemic risk is not well defined. Reasonable people will differ, and since much is often at stake, some 

will fight hard to deny that there is a systemic risk. 

One of the main reasons that Congress in 1991 passed FDICIA, 

the Federal Deposit Insurance Corporation Improvement Act, was 

to prevent the Federal Reserve from delaying closure of failing 

banks, increasing losses, and weakening the FDIC fund. The Federal Reserve and the FDIC have not used FDICIA against large 

banks in this crisis. That should change. 

The third lesson is that a successful policy will alter bankers’ incentives and avoid moral hazard. Bankers must know that risktaking brings both rewards and costs, including failure, loss of 

managerial position and equity, followed by sale of continuing operations. 

Several reforms are needed to reduce or eliminate the cost of financial failure to the taxpayers. Members of Congress should ask 

themselves and each other, is the banker or the regulator more 

likely to know about the risks on the bank’s balance sheet? Of 

course, it is the banker, and especially so if the banker is taking 

large risks that he wants to hide. To me, that means the reform 

should start by increasing the banker’s responsibility for losses. 

The Administration proposal does the opposite, by making the 

Federal Reserve responsible for systemic risk. Systemic risk is a 

term of art; I doubt that it can be defined in a way that satisfies 

35 

the many parties involved in regulation. Members of Congress will 

properly urge that any large failure in their district is systemic. 

Administrations and regulators will have other objectives. Without 

a clear definition, the proposal will bring frequent controversy, and 

without a clear definition, the proposal is incomplete. 

Resolving the conflicting interests is unlikely to protect the general public. More likely, regulators will claim that they protect the 

public by protecting the banks. 

I think that is wrong. I believe there are better alternatives than 

the Administration’s proposal. First step, end ‘‘too big to fail.’’ Require all financial institutions to increase capital more than in proportion to the increase in the size of their assets. ‘‘Too big to fail’’ 

is perverse; it allows banks to profit in good times and shifts the 

losses to the taxpayers when crises or failures occur. 

Second step, require the Federal Reserve to announce a rule for 

‘‘lender of last resort.’’ Congress should adopt a rule that they are 

willing to sustain. The rule should give banks an incentive to hold 

collateral to be used in a crisis period. Bagehot’s Rule from the 

19th Century Bank of England is a great place to start. 

Third step, recognize that regulation is an ineffective way to 

change behavior. My first rule of regulation states that lawyers 

regulate, but markets circumvent burdensome regulation. The 

Basel Accord is a current example. It told banks to hold more reserves if they held more risky assets. So they put the assets off 

their balance sheets. Later, after the fact, they had to take them 

back, but that was after the fact. 

Fourth step, recognize that regulators do not allow for the incentives induced by their regulations. In the dynamic financial markets, it is difficult, perhaps impossible, to anticipate how clever 

market participants will circumvent the rules without violating 

them. 

The fifth step, either extend FDICIA to include holding companies or subject financial holding companies to bankruptcy law. 

Make the holding company subject to early intervention either 

under FDICIA or under bankruptcy law. That not only reduces or 

eliminates taxpayer losses, but it also encourages prudential behavior. 

Other important changes should be made. Congress should close 

Fannie Mae and Freddie Mac and put any subsidy for low-income 

housing on the budget. The same should be done to other credit 

market subsidies. The budget is the proper place for subsidies. 

Three principles should be borne in mind: 

First, banks borrow short and lend long. Unanticipated large 

changes can and will cause failures. Our problem is to minimize 

the costs of failures to society. 

Second, remember that capitalism without failure is like religion 

without sin. It removes incentives for prudent behavior. 

Third, those that rely on regulation to reduce risks should recall 

that this is the age of Madoff. The Fed, too, lacks a record of success in managing large risks to the financial system, the economy, 

and the public. Incentives for fraud, evasion, and circumvention of 

regulation often have been more powerful than incentives to enforce regulation that protects the public. 

Thank you, sir. 

36 

[The prepared statement of Dr. Meltzer can be found on page 71 

of the appendix.] 

Chairman WATT. I thank the gentleman for his extensive statement. I am going to recognize the members for questions, and I will 

just reserve my questions until last if we have time, because we 

have to be out of here by 5 o’clock. There is another meeting. 

I recognize the gentleman from Texas, Mr. Paul, for 5 minutes. 

Dr. PAUL. I thank you, Mr. Chairman, and I welcome the panel. 

It is especially nice to see Dr. Meltzer here. 

I would like to start with a question of Dr. Meltzer because I 

wanted to follow up on his testimony about the Latin America crisis, where you mention that the Federal Reserve went to the IMF 

and instructed the IMF to pay interest to those banks that were 

exposed. And, of course, that was without congressional permission, 

and I think it makes a point, one of the points I have been trying 

to make, and that is transparency of the Federal Reserve. 

Now it sounded to me like the majority here is for independence, 

which is a code word for secrecy and in opposition to transparency. 

And it is always used for the public interest. Of course, I think the 

public interest is served by exposure and knowing what is going on 

and whose interests are being served, and that is why I would like 

to see a lot more transparency. 

But the question I have for Dr. Meltzer is, since he is aware of 

this, he has published this, is this a good reason for us to know 

a lot more about the agreements that the Federal Reserve makes? 

Because they can make agreements with international banking institutions, and we have no right—we may have a right under the 

Constitution that we should, but we don’t—and we have given up 

that right, we have given up that privilege. 

Would this be a good example of why we need to know more of 

what exactly the Federal Reserve is doing? 

Mr. MELTZER. Yes. 

Let me begin by saying independence, to me and, I believe, to 

many of the members of the panel, does not mean lack of transparency. It means protection. The reason we have independent central banks is so that they don’t expand under pressure from Congress, from the Administration, from the banking community, and 

from others. We want them to be independent, to make their judgments without—because they are obligated by law to maintain high 

employment and low inflation. 

Now, that law doesn’t work very well, at least in my opinion, but 

that is why we want independence. 

So transparency, how can you be against transparency? But I believe the Congress would be more effective in its oversight of the 

Federal Reserve if it concentrated much more on outcomes and 

much less on process. Let them make their decisions the way they 

want to make them and monitor the process. They are not living 

up to the mandate to maintain full employment or high employment and low inflation, and that is what we should be concerned 

about. 

Dr. PAUL. I thank you. And I am going to hurry along because 

our 5 minutes runs out rather quickly. 

But I wanted to ask Dr. Galbraith a question, because he has 

worked here and he knows the system, so I have been rather 

37 

shocked at what you presented here. You actually talked about the 

Constitution. Didn’t you find out that we are not supposed to do 

that around here? We don’t have that much concern about it. 

So I was delighted, from my viewpoint, that you brought this up 

and reminded us about Henry Ruess’s concern about the constitutionality of the FOMC. And, of course, I agree with that. 

But I wanted to see if there was a little bit more that you might 

agree with, because there are some who believe that we shouldn’t 

be doing anything unless it is explicitly authorized. And, of course, 

the central bank is not authorized. It has been ordained by the 

courts and the Congress, but it was never explicitly authorized. 

But the point, the more practical point that I might be able to 

get you to comment on is the concept of the budget. I mean, the 

Fed is a government unto itself. You know, they hire and make 

their wages and it doesn’t go through the ordinary process. The 

Constitution says it should all go through the constitutional process. 

And also maybe you could comment on these foreign agreements. 

These are like treaties. The Federal Reserve goes and makes these 

agreements, and they pass out money. 

Does this strike you as maybe that too might be challenged if you 

happen to come at this from a constitutional viewpoint? 

Mr. GALBRAITH. Well, I think under the Constitution, the Congress has every right for whatever information it seeks from the 

Federal Reserve. And if the Congress were to decide to change the 

way the Federal Reserve is funded, it would also have the right to 

do that. It seems to me it would be an appropriate decision for Congress to make. 

Dr. PAUL. So they would then have a right—so my proposal that 

we find out more, you would say that would be right and proper 

to find out what type of agreements they have made with other 

governments, other central banks, international banking organizations? 

Mr. GALBRAITH. My own view on this is that as a Member of 

Congress, you are entitled to that information. That would be the 

position I would have understood to be the case when I was working here 30 years ago. 

Dr. PAUL. Thank you. 

Chairman WATT. The time of the gentleman has expired. 

The gentleman from Delaware, Mr. Castle, is recognized for 5 

minutes. 

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

Let me just say, I thought this was a very good panel. I think 

you had some good ideas. Whether one agrees or not with the concept of where we are going to go, I would hope that staff and all 

of us will take note of what you stated here today. I think it makes 

a difference. 

I might start with you, Dr. Meyer. You basically indicated that 

in going to systemic risk regulation, it wouldn’t be a great change 

as far as the Fed is concerned. I don’t mean to put words in your 

mouth, but that was my impression of what you stated. 

And if that is the case—and others have indicated that the Fed 

did not anticipate particularly well the problems which have arisen 

in the banking industry in the last year or two, but if that is the 

38 

case, is it arguable that the Fed had some of this power and did 

not succeed in carrying out the responsibility of dealing with systemic risk to the limits they had before, and therefore we should 

question whether they should expand or not? 

Mr. MEYER. First, let me reiterate what I said before, and I agree 

with Vice Chairman Kohn here, that what the Treasury proposal 

does is very incremental and not very dramatic, not a vast expansion of powers—basically asking the Fed to do what it has been 

doing as bank holding company supervisor and extending that 

reach to a modest degree over systemically important financial institutions that don’t have a bank. 

I think it is clear that the Federal Reserve didn’t distinguish 

itself in carrying out its responsibilities as supervisor and regulator 

of banks and bank holding companies. This is an extraordinary period; it is the first financial crisis since the Great Depression, and 

I don’t believe any other financial supervisor or regulator carried 

out its responsibilities to protect the safety and soundness of the 

banks and institutions under their control in this circumstance either. 

So I think what we need to do is not only ask the Fed to carry 

out its responsibilities, but to encourage it to do what I think it 

would otherwise do, to change capital standards that make them 

more onerous for systemically important institutions, carry out 

more macroprudential supervision than it has done before, although, let me say, the Treasury proposal separates that out and 

gives that responsibility mainly to Treasury—well, mainly to the 

risk council that is staffed by Treasury and chaired by the Secretary. 

Mr. CASTLE. Thank you. I am not sure I understand all that 

quite yet, but I will try to absorb it. But I appreciate your answer. 

Dr. Berner, you indicated that coordination with other regulators 

will be essential on this. Can you be more explicit about that? 

What other regulators? I assume the FDIC and others. And exactly what that coordination would be? Would this be something 

that the Federal Reserve would do on its own, or should there be 

some sort of a council in which they would meet on a regular basis? 

How would that coordination occur, in your mind at least? 

Mr. BERNER. Well, I mentioned that there are probably two aspects to that coordination. One is within our own boundaries in the 

United States and for U.S. financial institutions. But I also think 

that we need to coordinate globally, since our markets and institutions are global as well. 

As far as the United States is concerned, you know, we have a 

multiplicity of regulators. And even in the sweeping proposal from 

the Treasury or in other regulatory proposals, I haven’t heard any 

move to, you know, to consolidate them all into one. And as I indicated, it is not clear to me that doing so would produce a better 

outcome. 

So the coordination would have to take place among the various 

regulators that we have, however we reshape them, so that information doesn’t slip through the cracks, so that we don’t miss the 

activities of institutions who are regulated by one group or one regulator, but who are engaged in activities that are properly the responsibility of—if you will, collectively all the regulators. 

39 

That extends, I think, across borders because markets are global. 

And so we need to coordinate, or the Federal Reserve and other 

regulators will need to coordinate across borders with their counterparts overseas, taking into account what institutions are doing 

either to, as Dr. Meltzer indicated, avoid regulation by doing things 

in one place rather than in another, so that they are aware of what 

is going on and so that they can appropriately safeguard markets 

and institutions. 

Mr. CASTLE. I think what you have just discussed is vitally important. And I hope everybody gives a lot of thought to exactly how 

that would be done, because I think ultimately that is something 

that is going to have to happen no matter which way we go. 

Dr. Galbraith, you indicated, I thought— 

Chairman WATT. The gentleman’s time has expired. 

Mr. CASTLE. I am sorry. I yield back. I may write to you about 

that question. 

Chairman WATT. The gentleman from New Jersey, Mr. Lance, is 

recognized for 5 minutes. 

Mr. LANCE. Thank you, Mr. Chairman. Let me agree with my 

colleagues that I believe this is an extremely distinguished panel, 

and it is my privilege to participate this afternoon. 

Dr. Galbraith, to follow up on some of the questioning of Ranking 

Member Paul, you indicated one way out of the difficulty might be 

the elimination of the boards of directors of the regional Federal 

Reserve Banks, or alternatively, to remove the voting power of the 

regional bank presidents on the FOMC. 

Realistically, is that likely to occur? 

Mr. GALBRAITH. As a witness, it is not my responsibility to be the 

most realistic person. 

Mr. LANCE. We do rely on your expertise, however. 

Mr. GALBRAITH. I do think that one has to look at this question 

of the perception of a privileged position to whom the presidents of 

the regional districts are responsible. 

Mr. LANCE. Absolutely. 

Mr. GALBRAITH. An alternative, of course, is not to put the examining power in the regional Federal Reserve Banks, to leave it in 

the hands of a tough cop who is entirely autonomous. 

Mr. LANCE. Yes. I think on our side of the aisle we have great 

difficulty with reposing these powers in the Federal Reserve Board 

at all. 

To Dr. Taylor and Dr. Meltzer, regarding the establishing of Tier 

I financial holding companies, I think many of us have a concern 

that if that were to occur, there would be some sort of assumption 

that they would have the backing of the Federal Government. We 

already may be in that place in some areas, and certainly we were 

in that place regarding Fannie Mae and Freddie Mac. 

Your comments, both of you as distinguished persons regarding 

this area of your expertise, could you elaborate on that a little bit 

for me? 

Mr. TAYLOR. Yes. I think the reason why I would characterize 

this proposal as giving significant, not incremental powers to the 

Federal Reserve, largely lies in this ability to distinguish certain 

institutions as a threat to the financial system as defined by the 

Treasury. And so once an institution—we don’t know, quite frankVerDate Nov 24 2008 12:09 Dec 22, 2009 Jkt 053234 PO 00000 Frm 00045 Fmt 6633 Sfmt 6633 K:\DOCS\53234.TXT TERRIE
40 

ly, how many there will be; it is not clear. I think that would be 

a good question to ask Treasury or the Fed, but it could be quite 

large. 

Mr. LANCE. In your opinion, could you give us an estimate as to 

how many you think it might be? 

Mr. TAYLOR. I have no idea. That is one of the problems. 

Mr. LANCE. Yes, sir. 

Mr. TAYLOR. Operationally, there is no definition of ‘‘systemic 

risk’’ here, and so it could be quite large. 

It might not be, by the way, this Federal Reserve, these people, 

who make the decision; it could be their successors. 

Mr. LANCE. Yes, sir. 

Mr. TAYLOR. And so I think the danger is, just as you say, once 

these institutions are in this group, then they do become too big 

to fail, certainly—in fact, probably too big to resolve because it will 

look like a black mark. And so they could become Fannie Maes and 

Freddie Macs of the future. 

Mr. LANCE. Yes. Thank you. 

Dr. Meltzer? 

Mr. MELTZER. Yes, I like your emphasis on realism. That is— 

Mr. LANCE. I am new here, so I am sure I will get over it. 

Mr. MELTZER. Try hard not to. The realism, to me, says what 

would the systemic risk regulator do with the Tier I holding companies? In my opinion, it would be Fannie Mae and Freddie Mac, writ 

large. 

Mr. LANCE. That is my concern. 

Mr. MELTZER. These are going to be banks or institutions that 

are going to have branches all over the country. Every Member will 

feel an obligation to say, we can’t let that happen in our district 

and in our districts. And so too big to fail will really become an 

even greater problem now. 

How can you limit the risks that bankers, some bankers, are 

going to take? Make them bear the risk. 

Mr. LANCE. Thank you. Thank you very much. 

I yield back the balance of my time, Mr. Chairman. Thank you. 

Chairman WATT. The gentleman yields back. 

The gentleman from Alabama, Mr. Bachus, is recognized for 5 

minutes. 

Mr. BACHUS. Thank you, Mr. Chairman. 

Mr. Meyer, you described the proposed changes as incremental to 

the Federal Reserve? 

Mr. MEYER. Right. 

Mr. BACHUS. Reading the Treasury proposal on what they say 

about it, they say this report proposes a number of major changes 

to the formal powers and duties of the Federal Reserve, including 

the addition of several new financial stability responsibilities. 

These proposals would put into effect the biggest changes to the 

Federal Reserve’s authority in years—or decades. 

Mr. MEYER. I think you have to read the rest of the report and 

see whether you agree with that. 

I read the rest of the report, and I don’t see that there is this 

vast new power. The Administration possibly wants to look at this 

as a more sweeping set of proposals than perhaps it is. 

Mr. BACHUS. Okay. 

41 

Mr. MEYER. But as Vice Chairman Kohn said, that is just not the 

case. 

Mr. BACHUS. Okay. So actually, you don’t agree with their description of— 

Mr. MEYER. Absolutely not. 

Mr. BACHUS. —their own plan? Okay. 

Let me ask the panelists, can you function as a systemic risk regulator of significant institutions without a robust examination and 

supervision authority? Can you do that? 

Mr. MEYER. Impossible. 

Mr. BACHUS. Impossible? 

Mr. GALBRAITH. I agree. 

Mr. MISHKIN. I completely agree here that clearly part of this 

issue of being a systemic risk regulator is that you have to go in 

and know what is going on in the institutions that you are regulating. And so I think it is essential that this be part of the role. 

And I think clearly that there is already an element of this, a 

very strong element in what the Federal Reserve does now with the 

bank holding companies. 

Mr. BACHUS. Do you think the Federal Reserve had a robust supervision and examination of those institutions that failed, including AIG? 

Mr. MISHKIN. Well, certainly the Federal Reserve did not have 

this responsibility for AIG. 

Mr. BACHUS. Well, they were a holding company, were they not? 

Mr. MEYER. Not a bank holding company. 

Mr. MISHKIN. Not a bank holding company. 

Mr. BACHUS. How about Citi? 

Mr. MELTZER. But they have people monitoring Citigroup and all 

from the New York Fed every day. Did they find anything at 

Citigroup? Nothing that they were willing to do anything about. 

Mr. BACHUS. And I guess Wachovia was a bank holding company. 

Does the Fed—do they have, you think, the robust examination 

or supervision, or is that something that the OCC or the FDIC does 

on a day-to-day basis? 

Mr. MEYER. The OCC and the FDIC have never been responsible 

for consolidated supervision. They have no history of doing that. 

The FDIC does not have a supervisory staff that has any expertise 

in the complex banking situation of the institutions we are talking 

about. The OCC is already involved and was the bank supervisor 

of many of the institutions that have gotten into trouble. And in 

most of the large institutions, OCC is the bank supervisor and the 

Fed is the holding company supervisor, and they both have to work 

together. 

Mr. BACHUS. Yes. And they didn’t do that in the last— 

Mr. MEYER. Well, I think—let’s say, neither distinguished themselves. 

Mr. BACHUS. Okay. I agree. 

Do we need to determine the causes of the present financial crisis before we start legislating a fix? And have we done that? 

Mr. GALBRAITH. It would be very helpful, in my view, to conduct 

a full and independent investigation into the cause of the financial 

42 

crisis, similar to the Pecora Committee investigations of the early 

1930’s. 

Mr. BACHUS. How about Dr. Mishkin? Do you agree? 

Mr. MISHKIN. Well, I think that clearly we do have to think more 

about these issues and that, in particular, the rush to do regulatory 

reform is something that I have been concerned about. 

I do actually think, however, that the need for a resolution authority is absolutely critical. And so— 

Mr. BACHUS. And I don’t disagree. 

Mr. MISHKIN. And I think that one of my concerns has been that 

if we go down the route of worrying about the big picture and then 

don’t do anything, that we are actually in a situation which not 

only means institutions can get in trouble, and we can’t do anything about them, but also we are in a very weak position to get 

them to fix things because we have no ammunition. 

Mr. BACHUS. Let me say this. The Republican proposal is for an 

enhanced resolution, a bankruptcy-like proceeding for nonbank financial companies. 

I don’t know. Have you all looked at the Republican proposal? 

Mr. TAYLOR. Not in detail. 

Chairman WATT. The gentleman’s time has expired. And I would 

encourage him to send each of these witnesses the Republican proposal. 

Mr. BACHUS. How about a second round of questions? 

Chairman WATT. Unfortunately, there is another meeting scheduled, as I had previously announced, in this room at 5 o’clock. If 

we had been more expeditious on the Floor, perhaps we could have 

had more time to do what we do in committee. 

And I am not trying to be mean about it. I just— 

Mr. BACHUS. I don’t think you are being mean. 

Chairman WATT. I can’t give more time than the room allows me 

to give. The gentleman’s time has expired. 

Dr. Galbraith, let me just ask one question. You distinguished 

between the two responsibilities on the bottom of page 2 and top 

of page 3 of your testimony. One was to identify as Tier I financial 

holding companies considered to be so large and interconnected; 

and then the second was the institution of a regime of examination 

and regulation. 

If the first part of that—the first one of those, I take it you concluded, was not constitutionally suspect to be done by the Fed? 

Mr. GALBRAITH. It could be done in the Federal Reserve Board, 

and it would be an incremental responsibility of the kind that Vice 

Chairman Kohn described, yes. 

Chairman WATT. And then I take it that you are recommending 

that the second part of that be undertaken by the FDIC. 

Mr. GALBRAITH. By an agency for whom it is the highest priority 

and for whom it is a major mission, yes. 

Chairman WATT. Even for institutions that are not federally insured. What about— 

Mr. GALBRAITH. Yes. 

Chairman WATT. Okay. The Chair notes that members may have 

additional questions for this panel which they may wish to submit 

in writing. Without objection, the hearing record will remain open 

43 

for 30 days for members to submit written questions to these witnesses and to place their responses in the record. 

I thank the witnesses for their unending patience throughout the 

afternoon, and regret that we have to rush out of the room. Otherwise, we would be happy to go another round. But I am sure the 

members will follow up with vigorous written questions, and I encourage you to answer them as expeditiously as you can so that we 

can continue the process moving along. I thank you for coming. 

And the hearing is adjourned. 

[Whereupon, at 5:06 p.m., the hearing was adjourned.] 

(45) 

A P P E N D I X 

July 9, 2009 

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