U.S. GOVERNMENT PRINTING OFFICE

WASHINGTON : 

For sale by the Superintendent of Documents, U.S. Government Printing Office

Internet: bookstore.gpo.gov Phone: toll free (866) 512–1800; DC area (202) 512–1800

Fax: (202) 512–2104 Mail: Stop IDCC, Washington, DC 20402–0001

44–903 PDF 2008

SYSTEMIC RISK AND 

THE FINANCIAL MARKETS 

HEARING 

BEFORE THE

COMMITTEE ON FINANCIAL SERVICES 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED TENTH CONGRESS 

SECOND SESSION 

JULY 24, 2008 

Printed for the use of the Committee on Financial Services 

Serial No. 110–130 

( 

(II) 

HOUSE COMMITTEE ON FINANCIAL SERVICES 

BARNEY FRANK, Massachusetts, Chairman 

PAUL E. KANJORSKI, Pennsylvania 

MAXINE WATERS, California 

CAROLYN B. MALONEY, New York 

LUIS V. GUTIERREZ, Illinois 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

GARY L. ACKERMAN, New York 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

DENNIS MOORE, Kansas 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

MELISSA L. BEAN, Illinois 

GWEN MOORE, Wisconsin, 

LINCOLN DAVIS, Tennessee 

PAUL W. HODES, New Hampshire 

KEITH ELLISON, Minnesota 

RON KLEIN, Florida 

TIM MAHONEY, Florida 

CHARLES WILSON, Ohio 

ED PERLMUTTER, Colorado 

CHRISTOPHER S. MURPHY, Connecticut 

JOE DONNELLY, Indiana 

BILL FOSTER, Illinois 

ANDRE ́ CARSON, Indiana 

JACKIE SPEIER, California 

DON CAZAYOUX, Louisiana 

TRAVIS CHILDERS, Mississippi 

SPENCER BACHUS, Alabama 

DEBORAH PRYCE, Ohio 

MICHAEL N. CASTLE, Delaware 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

RON PAUL, Texas 

STEVEN C. LATOURETTE, Ohio 

DONALD A. MANZULLO, Illinois 

WALTER B. JONES, JR., North Carolina 

JUDY BIGGERT, Illinois 

CHRISTOPHER SHAYS, Connecticut 

GARY G. MILLER, California 

SHELLEY MOORE CAPITO, West Virginia 

TOM FEENEY, Florida 

JEB HENSARLING, Texas 

SCOTT GARRETT, New Jersey 

GINNY BROWN-WAITE, Florida 

J. GRESHAM BARRETT, South Carolina 

JIM GERLACH, Pennsylvania 

STEVAN PEARCE, New Mexico 

RANDY NEUGEBAUER, Texas 

TOM PRICE, Georgia 

GEOFF DAVIS, Kentucky 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

ADAM PUTNAM, Florida 

MICHELE BACHMANN, Minnesota 

PETER J. ROSKAM, Illinois 

KENNY MARCHANT, Texas 

THADDEUS G. McCOTTER, Michigan 

KEVIN McCARTHY, California 

DEAN HELLER, Nevada 

JEANNE M. ROSLANOWICK, Staff Director and Chief Counsel 

(III) 

C O N T E N T S 

Page 

Hearing held on: 

July 24, 2008 ..................................................................................................... 1 

Appendix: 

July 24, 2008 ..................................................................................................... 45 

WITNESSES 

THURSDAY, JULY 24, 2008 

Cox, Hon. Christopher, Chairman, U.S. Securities and Exchange Commission 6 

Geithner, Timothy F., President and Chief Executive Officer, Federal Reserve 

Bank of New York ................................................................................................ 9 

APPENDIX 

Prepared statements: 

Cox, Hon. Christopher ...................................................................................... 46 

Geithner, Timothy F. ........................................................................................ 55 

(1) 

SYSTEMIC RISK AND 

THE FINANCIAL MARKETS 

Thursday, July 24, 2008 

U.S. HOUSE OF REPRESENTATIVES, COMMITTEE ON FINANCIAL SERVICES, Washington, D.C. 

The committee met, pursuant to notice, at 10:06 a.m., in room 

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

Members present: Representatives Frank, Kanjorski, Waters, 

Maloney, Watt, Ackerman, Moore of Kansas, Capuano, Lynch, Miller of North Carolina, Scott, Green, Cleaver, Hodes, Klein, Wilson, 

Perlmutter, Murphy, Speier, Childers; Bachus, Royce, Manzullo, 

Jones, Biggert, Feeney, Hensarling, Garrett, Neugebauer, 

McHenry, Campbell, Putnam, Marchant, and Heller. 

The CHAIRMAN. The hearing will come to order. 

This is the second hearing we have had in a series that may continue in the fall and will certainly lead to action next year. 

What we are dealing with here is the action that we ought to be 

taking as a Congress and as a government to the events that manifested themselves in the reaction of the Department of the Treasury and the Federal Reserve to Bear Stearns. We are not here specifically to look at that, although that is obviously one of the subjects, given the centrality of the role of the New York Federal Reserve. It is a subject that was discussed before. But what we want 

to do is to look at that in the context of what do we do going forward? 

There is, I think, an increasing consensus that some extension of 

regulation is called for with regard to currently lightly-regulated 

aspects, lightly-regulated financial institutions. I say ‘‘lightly regulated’’ because we have represented here, our former colleague, the 

Chairman of the Securities and Exchange Commission. That institution has some responsibility, but I think it ought to be clear that 

Congress has never given the SEC the kind of full statutory mandate over systemic stability. They have a focus on investor protection and on keeping the markets functioning, and I don’t think 

there was any basis for any criticism of the SEC’s performance. 

Some, frankly, of what I have seen is based on a misunderstanding 

of their mandate. And the fact is that they have, I think, acted 

within their mandate. It is up to the Congress and the Executive 

Branch working together to decide whether that mandate should be 

expanded. And that is what we are talking about. 

We are talking about the extent to which regulatory authority 

over the activities of investment banks and others, particularly 

2 

since they may now be asking for access to various instruments in 

the Federal Reserve, to what extent should we deal with this? I 

think we have shown an ability as an economy and as a government to deal on an ad hoc basis with crises. 

It is important, however, that we do two things: First of all, examine what further instruments the regulators ought to have in 

dealing with the crisis; and even more important to me—because 

I do believe we can cobble together things in the short term, but 

that is not a very satisfactory long-term answer—what new regulatory approaches should we be taking to make the crises less likely? To what extent should we be giving some Federal entities in the 

regulatory field new powers over institutions that are not now 

heavily regulated, particularly from the standpoint of avoiding systemic risk? 

Then the related question is, there are different functions here. 

This is investor protection. And I know that the gentleman from 

Pennsylvania and I were just telling the Chairman of the SEC privately, but we both will say it publicly, that we are very pleased 

with the action he has taken regarding short selling, and we think 

that has been very helpful from the standpoint of protecting the integrity of the market. 

But there is a question as to what extent actions that are taken 

to protect the integrity of the market in the individual instance and 

the investor do or don’t conflict from time to time with questions 

of systemic stability? It is, in fact, we don’t want to take individual 

enforcement actions that, in a particular context—well, we may 

want to take them, but it is conceivable that individual enforcement actions, particularly against a number of institutions, could 

have some systemic impacts. How do we evaluate that? 

That also leads to the question of what is the institutional arrangement? I congratulate the Federal Reserve and the Securities 

and Exchange Commission for the memorandum of understanding 

they signed. That was a very good example of how we get cooperation. And the memorandum of understanding was useful. It does 

open the question that is, should there be some statutorization of 

that memorandum of understanding? Are there areas that should 

be approached in defining the relationship of these two important 

entities that could not be reached without some further legislation? 

How do we structure it? 

This is a noncrisis hearing. It is the second in our efforts to ask 

the responsible regulators here what their recommendations are to 

us for going forward. And of course, the goal I think we all share 

is very simple. We want to continue to reap the benefits of financial 

innovation, including securitization and the other creative ways of 

financial institutions serving the economy, while diminishing the 

risks. And you never hit 100 percent optimality there. But I do believe that there is room for us to take some action that will diminish risks without unduly impinging on the benefits we get from 

these operations. That is the purpose of this hearing. 

Let me say, under the rules, having the Department heads here, 

particularly the head of the SEC, we will just have the four opening statements, the two Chairs and the two ranking members. 

So the gentleman from Alabama is recognized for 5 minutes. 

3 

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

And I welcome our two witnesses to the hearing. Chairman Cox 

and President of the New York Fed Geithner, you have actually 

been at the center of the government’s response to recent turmoil 

in the financial markets. And I commend you both on the job you 

are doing. You are both very capable public servants, and I think 

the country is fortunate to have your expertise. We look forward to 

your perspectives as we go forward. 

Nothing I say today should be taken as a criticism of anything 

you have done, particularly in the Bear Stearns matter, because I 

realize that sometimes decisions are made, and we don’t know at 

the time whether they are the best, but we do the best we can. 

I think we were faced with that yesterday on the Floor. We had 

a difference of opinion. But we make a decision, and then we all 

come together and hope that decision is right when it is collectively 

made. 

I would say this to Chairman Frank, before we begin a serious 

discussion of greater government involvement in our capital markets, we need to have a clearer understanding of exactly where we 

are and how we got to where we are. I know the chairman has also 

said that. We need to know how we arrived at a system in which 

the issuers of credit default swaps are allowed to provide guarantees that far exceed their capital reserves and that there is virtually no possibility that they can pay in the defaults of the underlying obligations, commit themselves to obligations that they cannot possibly cover in worst-case scenarios. 

We need a better understanding of why our regulations allow 

credit default swaps to remain essentially under-regulated when 

they have such a profound effect and are so intertwined with our 

larger financial markets and even our economy. 

And in light of the Bear Stearns episode, and I think we all 

learned from that, we need to know whether the SEC’s current approach to the supervision of investment banks and their holding 

companies is sufficient to prevent further meltdowns in that sector 

of our financial services industry. Or even, you know, we need to 

ask ourselves, can regulators really prevent such meltdowns? What 

are our obligations? Sometimes, it may be to stand back and allow 

companies to fail. 

In this vein, and perhaps most critical of all, we need to know 

how we ended up with a financial system in which almost every 

primary dealer, at least on the surface, appears almost too big or 

too interconnected to fail or whether we have arrived at that point. 

If we accept that premise, that every primary dealer is too big to 

fail, then we also have to conclude that our financial markets are 

no longer capable of self-regulation and that government must exercise greater control, both as a regulator and as a lender, if not 

a buyer of last resort. 

As I indicated at our first hearing 2 weeks ago, that is a conclusion I am not prepared to accept. 

I think a far better approach is one that restores market discipline and discourages moral hazard. Does the Bear Stearns rescue and recent proposals to invest taxpayer dollars in the debt in 

equity of Fannie Mae and Freddie Mac, does that send a different 

4 

signal to the market, that taxpayers can be counted on, ultimately, 

to indemnify risk-taking that reaches levels sufficient to place the 

entire financial system in jeopardy? What we ultimately need is to 

ensure that our regulators maintain a framework in which individual firms can fail while the system continues to function. I think 

it has been referred to as an orderly liquidation. 

We know that sudden failures like Bear Stearns, if they are not 

orderly, can definitely have systemic risk. And I think we all appreciate that. 

We need to ensure that our firms strike the right balance between risk and leverage. Capital and credit must continue to flow 

where they are most needed, but our financial institutions should 

not be taking outsized risks that require repeated government 

interventions to save the system from recurring crisis. 

Chairman Cox, you have taken significant steps to protect the integrity of our capital markets during these turbulent times. I think 

your efforts have been underappreciated. 

One of your most important initiatives has been to help make 

sure investors have access to accurate and reliable information. In 

this regard, your credit rating agency reforms, your firm stance 

against the spreading of false information, and your emergency 

order to curb abusive short-selling practices in the securities of 17 

primary dealers and Fannie and Freddie were welcomed developments. And we have seen now that they have had a positive effect. 

On July 15th, the SEC also noted that it will undertake a rulemaking to address these issues across the entire market. I look forward to working with the Commission to ensure that a rulemaking 

recognizes the legitimate role of short selling and does not eliminate liquidity from the capital markets. 

I think we all appreciate that short selling is a valid, valuable 

process. It serves a useful purpose. What isn’t and what is presently prohibited is the spreading of false information to drive down 

the price of these stocks by some short sellers, not most, and that, 

you know, puts and calls, all those, are a valuable part of our market and indicate a sophisticated financial system. 

Mr. Chairman, I want to conclude by thanking you for holding 

this hearing. 

And my thanks to Chairman Cox and Mr. Geithner for being 

with us today. We look forward to your testimony. 

The CHAIRMAN. The gentleman from Pennsylvania, the Chair of 

the Subcommittee on Capital Markets, is recognized. 

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

Today we continue our review of a systemic risk in financial markets. Although we passed the housing reform package yesterday, 

tremendous economic anxiety and uncertainty remain. Finding an 

effective regulatory regime to keep pace with increasingly complex 

financial products and markets remains our goal. 

Striking an appropriate balance to enhance protection against 

systemic risk is also a difficult task. For just as the markets continually change and evolve, so must regulation. The explosive growth 

of complex financial instruments is well-documented. Credit default 

swaps and collateralized debt obligations are just two examples of 

comparatively new exotic products flooding our markets. 

5 

Warren Buffett famously labeled credit derivatives as ‘‘financial 

weapons of mass destruction.’’ Some may view his characterization 

as extreme. But allowing these risky creations to thrive in a thinly 

regulated or unregulated market is a recipe for disaster. So, in 

order to better understand these instruments, I sent 2 days ago a 

request to the Government Accountability Office that it begin a 

study on structured financial products. This study will examine the 

nature of these instruments and the degree of transparency and 

market regulation surrounding them. From this study, we should 

obtain a clearer picture of how to improve regulation in the sector 

of our financial system. 

Another area of regulation we should consider is the consolidation of regulation of our securities and commodities markets. The 

Treasury’s recommendation to merge the Securities Exchange Commission and the Commodity Futures Trading Commission is something that ought to be discussed today. Such a merger illustrates 

the kind of streamlined regulatory system to which we should aspire. 

Additionally, last week’s emergency order on naked short selling 

has received much attention. This committee is due an explanation 

as to the reason for the order, the effect to date on the market, its 

possible extension, and whether it will be expanded to broader 

market segments. I dare say it is something that the Commission 

should be commended for. I have seen the results and they seem 

to be quite clear that they aid the free flow of the market. 

Even to those of us who view short selling as a necessary provider of liquidity and market efficiency, naked short selling is worthy of closer scrutiny. People enter into trades with the expectation 

to complete them. 

In closing, both the Commission and the New York Federal Reserve have played crucial roles throughout the current financial crisis. I very much appreciate Chairman Cox and Mr. Geithner being 

here today, and I look forward to their testimony. 

The CHAIRMAN. On instruction from the gentleman from Alabama, I now recognize the gentleman from California, Mr. Royce, 

for 1 minute. 

Mr. ROYCE. Thank you, Mr. Chairman. 

I would like to thank you for your continued attention on this 

issue. I think it is important to be fully vetted. 

I would also just like to briefly welcome my good friend and our 

former colleague here, Chairman Cox. 

And just to say, Chairman Cox, while your leadership and insight while you were a Member here are missed, we do appreciate 

your hard work at the Commission, especially on behalf of investors and the securities industry during these rather difficult and 

challenging times with our capital markets. 

And so, welcome back. 

The CHAIRMAN. In the interest of bipartisanship, we will start 

Mr. Royce’s minute now. We won’t charge him for being nice. That 

is not necessarily a precedent around here, but we will do it today. 

So, Mr. Royce. 

Mr. ROYCE. I will yield back, Mr. Chairman. 

The CHAIRMAN. Then we have 2 minutes for the gentleman from 

Texas, Mr. Hensarling. 

6 

Mr. HENSARLING. Thank you, Mr. Chairman. 

I find it somewhat ironic that we would be holding this hearing 

24 hours after we gave the Secretary of Treasury a blank check to 

help bail out Fannie and Freddie. It seems that we took a huge 

step in the wrong direction with respect to systemic risk. 

Moral hazard leads to more systemic risk. And I fear yesterday 

a very strong message was sent to every investment bank in America that if you are large enough, if you get interconnected, if you 

get well-connected in the halls of Congress, you can indeed figure 

out a way to privatize your profits and socialize your losses. 

And just in case somebody missed the message, we are having 

a serious discussion now about giving the Federal Reserve increased responsibility and ultimate authority for financial stability 

in our markets. This may be a good thing. It may be a bad thing. 

But it is also a very risky thing. And I fear that the markets will 

interpret this as meaning, again, that potential Fed backing is 

around the corner if investment banks get in trouble. 

I fear that, as we continue to lose market discipline, we substantially increase the chances of having yet another Fannie and 

Freddie debacle, perhaps another S & L debacle. 

I am very concerned also about where we find the role of the 

Federal Reserve today in all the different directions they are 

pulled, starting with price stability and monetary policy, minimizing unemployment. On top of that, we add a healthy dose of 

consumer protection. Now we are about to add potential financial 

stability, and oh, I at least heard the chairman say once that he 

cared about taxpayer protection as well. That is pulling the Fed in 

a lot of different directions. 

I do know that some believe that the ultimate answer is more 

regulation. I certainly believe we could have better regulation. We 

may need smarter regulation. I don’t know if we necessarily need 

more regulation. And I do know that an overly restrictive regulatory regime will kill innovation and chase our capital overseas, 

something I do not want to see. 

With that, Mr. Chairman, I thank you, and I yield back the balance of my time. 

The CHAIRMAN. I thank the gentleman. 

We will now proceed with the statements. And we will begin with 

the Chairman of the Securities and Exchange Commission, our 

former colleague. 

STATEMENT OF THE HONORABLE CHRISTOPHER COX, 

CHAIRMAN, U.S. SECURITIES AND EXCHANGE COMMISSION 

Mr. COX. Thank you very much, Chairman Frank, Ranking 

Member Bachus, and members of the committee. 

It is a pleasure to appear on this panel with my regulatory colleague, Tim Geithner. Under his leadership at the New York Fed, 

the SEC and the New York Fed have established a very strong and 

positive working relationship. 

I want to thank this committee for inviting me to testify on behalf of the SEC about reform of the U.S. financial regulatory system. 

There is no question, as several of you have just pointed out, that 

the financial regulatory structure that was forged in the Great DeVerDate Aug 31 2005 16:25 Nov 12, 2008 Jkt 044903 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 K:\DOCS\44903.TXT TERRIE
7 

pression has served this Nation well over the intervening 8 decades. Even today in the midst of current strains on the financial 

sector, the U.S. capital market is larger, deeper, and more liquid 

than any other market in the world. In large measure, that is due 

to the world-class protections that investors enjoy in the United 

States, and those are protections that we should secure. 

In the decade since our regulatory agencies were chartered, the 

capital markets and the broader economy have undergone profound 

changes. The regulatory system in the main has adapted well to 

some of these changes, but other changes have presented new challenges that are rightly the subject of this committee’s review as you 

consider legislative solutions. 

I hasten to add that, given the many strengths of the current 

regulatory system, we don’t need to start from scratch. Instead, we 

can build on what we know has worked. At the same time, we can 

take lessons from what has not worked and modernize, rather than 

replace, the current system. 

One thing that has worked exceptionally well is the regulatory 

concept of an agency chartered to protect investors, to maintain 

fair, orderly markets, and to promote capital formation. If the SEC 

didn’t already exist, Congress would have to invent it. 

Each of the elements of the SEC’s mission is mutually reinforcing of the others. The Commission’s work to protect investors 

through our enforcement program has been greatly benefited by 

the expertise of the SEC staff who specialize in the regulation and 

supervision of broker dealers and investment advisors. The Commission’s regulatory program, including our commitment to ensuring full disclosure of information about public companies, has been 

informed by the experience, in turn, of the enforcement and examination staffs. 

But I hasten to add that, given these many strengths, there are 

many problems as well in the current system. Today when derivatives compete with securities and futures, and insurance products 

are sold for their investment features, it is no longer true that we 

can stovepipe regulation. 

As we approach the end of the first decade of the 21st Century, 

the growing gaps and crevices in our regulatory system are beginning to show. We all know that the current market crisis began 

with the deterioration of mortgage origination standards. As a result, it could have been contained to banking and real estate if only 

our markets weren’t so interconnected. 

But in today’s world, these problems quickly spread throughout 

the capital markets through securitization, and at the same time, 

the explosive growth of the over-the-counter derivatives markets 

have drawn the world’s major financial institutions into a tangled 

web of deeper interconnections. This has led to the realization that 

when a major commercial or investment bank is threatened, so, 

too, may be the entire marketplace. And it has cast a spotlight on 

the significant regulatory gap that currently exists when it comes 

to the regulation of investment banks. 

When this committee devised the Gramm-Leach-Bliley Act in 

1999, you—or perhaps I should say ‘‘I’’ because, along with many 

of you, I served on the conference committee that wrote the legislation—decided that the SEC would serve as the functional regulator 

8 

with responsibility over broker dealers, investment advisors, and 

mutual funds. And we decided that the Federal banking regulators 

similarly would be functional regulators for banking activities. 

Under this approach, the securities-related activities would be regulated by the SEC, which would also continue to be responsible for 

regulating broker dealers that are the central entities in investment banks. The Fed would be given consolidated oversight of holding companies that contain broker dealers and also most types of 

insured depository institutions. And finally, the SEC would retain 

the authority to regulate that net capital of broker dealers within 

the financial holding companies. 

But no explicit arrangement was established for the regular 

sharing of information between the Fed and the SEC in order to 

take into account the need to view capital and liquidity on an entity-wide basis. And that is what the memorandum of understanding 

between the Federal Reserve Board and the SEC is accomplishing 

today. 

Likewise, neither the Commission nor the Fed was authorized to 

exercise mandatory consolidated supervision over investment bank 

holding companies. As a result, today there is simply no provision 

in law that requires investment bank holding companies to compute capital measures and maintain liquidity on a consolidated 

basis. 

In 2004, the Commission adopted our voluntary program, called 

the Consolidated Supervised Entities Program, to fill this regulatory gap. But now, recent events have highlighted the need for 

legislative improvements as well. We need to fill the GrammLeach-Bliley regulatory gap by amending the existing statutory authorization for voluntary SEC supervision of investment bank holding companies to make it mandatory for all firms that today are 

regulated as CSEs. 

The Commission should be given a statutory mandate to perform 

this function at the holding company level along with the authority 

to require compliance. In addition, legislation should prescribe explicitly how the resolution of financial difficulties at investment 

bank holding companies will be organized and funded. Any regulatory reform that you undertake should recognize the very fundamental business, accounting, and regulatory differences between 

investment banks and commercial banks. Rather than extend the 

current approach of commercial bank regulation to investment 

banks, I believe Congress and regulators must recognize that different regulatory structures are needed for oversight of these industries and, in particular, that investment banks should not be 

treated like commercial banks by providing them with permanent 

access to government-provided backstopped liquidity. The added 

regulation that this would necessitate, following the commercial 

bank model, would fundamentally alter the role that investment 

banks play in the economy. 

In addition, as you weigh other possible reforms, there are five 

points that should be carefully considered: 

First, were the Congress to consider addressing the potential for 

future Bear Stearns-like rescues in statute, any such authority 

should be reserved for exceptionally rare cases. 

9 

Second, the securities and bankruptcy laws currently provide an 

explicit statutory framework for liquidating a failed securities brokerage firm and for protecting customer cash and securities. This 

framework generally works as well, even in instances of fraud. I 

would not recommend changing the system. 

Third, for banks and thrifts, the FDIC has long served as the receiver for failed banks. The FDIC Improvement Act, FDICIA, mandates a least-cost resolution analysis and imposes intentionally onerous restrictions on a bank’s ability to receive lender-of-last-resort 

funding. This is a useful model for resolving investment banks as 

well. 

Fourth, FDICIA prescribes a detailed process involving supermajority approvals by the interested regulators and formal approval of the Secretary of the Treasury after consultation with the 

President. It also requires detailed findings of serious adverse effects on economic conditions or financial stability and a finding 

that the proposed action would mitigate any adverse effects. These, 

too, are important constraints. 

Fifth and finally, OTC derivatives receive special treatment in 

bankruptcy proceedings. In particular, in the event of insolvency, 

counterparties can immediately terminate their contracts and seize 

any collateral related to OTC derivatives. As a result, today, 

unwinding a significant portfolio in bankruptcy can threaten market disruptions and raise systemic issues. To remedy this problem, 

the SEC should be given explicit authority to control the liquidation of investment bank holding companies or their unregulated affiliates that generally hold most of the derivative positions. 

Mr. Chairman, I hope that these observations from the SEC will 

be of assistance to you and to the committee as you consider the 

broad questions of whether and, if so, how to reform the existing 

Federal regulatory system for financial services. 

Thank you, again, for this opportunity to discuss these important 

issues. I look forward to taking your questions. 

[The prepared statement of Chairman Cox can be found on page 

46 of the appendix.] 

The CHAIRMAN. Thank you, Mr. Chairman. 

You really did engage exactly what we were hoping to engage. 

And now, Mr. Geithner. 

STATEMENT OF TIMOTHY F. GEITHNER, PRESIDENT AND 

CHIEF EXECUTIVE OFFICER, FEDERAL RESERVE BANK OF 

NEW YORK 

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

Bachus, and other members of the committee. I appreciate the opportunity to be here with you today. 

We are dealing with some very consequential issues, and I think 

as a country we are going to face some very important questions 

going forward. 

I am particularly pleased to be here with Chairman Cox from the 

SEC. We are working very, very closely together in navigating 

through the present challenges. And I want to express appreciation 

for his support and cooperation. 

The U.S. and the global financial systems are going through a 

very challenging period of adjustment, an exceptionally challenging 

10 

period of adjustment. And this process is going to take some time. 

A lot of adjustment has already happened, but this process will 

necessarily take time. And the critical imperative of the policymakers today is to help ease that process of adjustment and cushion its impact on the broader economy, first stability and repair 

and then reform. 

Looking forward though, the United States will look to undertake 

substantial reforms to our financial system. There was a strong 

case for reform before this crisis. Our system was designed in a different era for a different set of challenges. But the case for reform, 

of course, is stronger today. Reform is important, of course, because 

a strong and resilient financial system is integral to the economic 

performance of any economy. 

My written testimony outlines some of the changes to the financial system that motivate the case for reform. These changes include, of course, a dramatic decline in the share of financial assets 

held by traditional banks; a corresponding increase in the share of 

financial assets held by nonbank financial institutions, funds, and 

complex financial structures; a gradual blurring of the line between 

banks and nonbanks, as well as between institutions and markets; 

extensive rapid innovation in derivatives that have made it easier 

to trade and hedge credit risk; and a dramatic growth in the extension of credit, particularly for less creditworthy borrowers. 

As a consequence of these changes and other changes to our financial system, a larger share of financial assets ended up in institutions and vehicles with substantial leverage, and in many cases, 

these assets were financed with short-term obligations. And just as 

banks are vulnerable to a sudden withdrawal of deposits, these 

nonbanks and funding vehicles are vulnerable to an erosion in market liquidity when confidence deteriorates. 

The large share of financial assets held in institutions without 

direct access to the Fed’s traditional lending facilities complicated 

our ability as a central bank, the ability of our traditional policy 

instruments to help contain the damage to the financial system 

and their broader economy presented by this crisis. 

I want to outline a core set of principles, objectives that I believe 

should guide reform. I offer these from my perspective at the Federal Reserve Bank of New York. The critical imperative is to build 

a system that is a financial—that is more robust to shocks. 

This is not the only challenge facing reform. We face a broad set 

of changes in how to better protect consumers, how the mortgage 

market should evolve, the appropriate role of the GSEs and others, 

and how to think about market integrity and investor protection 

going forward. 

I want to focus on the systemic dimensions of reform and regulatory restructure. First on capital, the shock absorbers for financial institutions, the critical shock absorbers are about capital and 

reserves, about margin and collateral, about liquidity resources, 

and about the broad risk management and control regime. We need 

to ensure that, in periods of expansion, in periods of relative stability, financial institutions and the centralized infrastructure of 

the system hold adequate resources against the losses and liquidity 

pressures that can emerge in economic downturns. This is important both in the institutions and the infrastructure. 

11 

And the best way I think that we know how to limit pro-cyclicality and severity of financial crises is to try to ensure that those 

cushions are designed in a way that provides adequate protection 

against extreme events. 

A few points on regulatory simplification and consolidation. It is 

very important, I believe, that central banks and supervisors and 

market regulators together move to adopt a more integrated approach to the design and enforcement of these capital standards 

and other prudential regulations that are critical to financial stability. We need a more consistent set of rules, more consistently applied, that substantially reduce the opportunities for arbitrage that 

exist in our current very segmented, fragmented system. 

Reducing moral hazard is critical. As we change the framework 

of regulation oversight, we need to do so in a way that strengthens 

market discipline over financial institutions and limits the moral 

hazard risk that is present in any regulated financial system. The 

liquidity tools of central banks and, to some extent, the emergency 

powers of other public authorities were created in the recognition 

of the fact of the basic reality that individual financial institutions 

cannot protect themselves fully from an abrupt evaporation in market liquidity or the ability to liquify their assets. 

Now the moral hazard that is associated with these lender-oflast-resort tools needs to be mitigated by strong supervisory authority over the consolidated financial entities that are critical to 

the financial system. 

On crisis management, the Congress gave the Federal Reserve 

very substantial tools, very substantial powers to mitigate the risk 

to the economy in any financial crisis. But I think, going forward, 

there are things we could put in place that would help strengthen 

the capacity of governments to respond to crises. As Secretary 

Paulson, Chairman Bernanke, and Chairman Cox have all recognized, we need a companion framework to what exists now in 

FDICIA for facilitating the orderly liquidation of financial institutions where failure may pose risks to the stability of the financial 

system or where the disorderly unwinding or the abrupt risk of default of an institution may pose risk to the stability of the financial 

system. 

Finally, we need a clearer structure of responsibility and authority over the payment systems. These payment systems, settlement 

systems, play a very important role in financial stability. And our 

current system is overseen by a patchwork of authorities with responsibilities diffused across several different agencies with significant gaps. 

It is very important to underscore that, as we move to adapt the 

U.S. framework, we have to work to bring a consensus among the 

major economies about complementary changes in the global framework. 

Moving forward will require a very complicated set of policy 

choices, including determining what level of conservatism should be 

built into future prudential regulations and capital requirements; 

what institutions should be subject to that framework of constraints or protections; which institutions should have access to 

central bank liquidity under what conditions; and many other questions. 

12 

A few points, finally, about how to think about the role of the 

Federal Reserve in promoting financial stability. 

First, the Federal Reserve has a very important role today, working in cooperation with bank supervisors and the SEC in establishing the capital and other prudential safeguards that are applied 

on a consolidated basis to institutions that are critical to the proper 

functioning of markets. 

Second, the Federal Reserve, as the financial system’s lender of 

last resort, should play an important role in the consolidated supervision of those institutions that have access to central bank liquidity and play a critical role in market functioning. The judgments 

we are required to make about liquidity and solvency of institutions in the system requires the knowledge that can only come 

from a direct, established, ongoing role in prudential supervision. 

Third, the Federal Reserve should be granted clear authority 

over systemically important payments or settlement systems. 

Fourth, the Federal Reserve Board should have an important 

consultative role in judgment about official intervention in crises 

where there is potential for systemic risk as is currently the case 

for bank resolutions under FDICIA. 

And finally, the Federal Reserve’s approach to supervision and to 

market oversight will need to look beyond the stability just of individual banks to market developments more broadly, to the infrastructure that is critical to market functioning, and the role played 

by other leveraged financial institutions. 

I want to emphasize in conclusion that we are working very actively now today in close cooperation with the SEC and other bank 

supervisors and with our international counterparts to put in place 

steps now that offer the prospect of improving the capacity of the 

financial system to withstand stress. We are doing this in the derivative markets. We are doing it in secure funding markets, and 

we are doing it with respect to the centralized infrastructure. 

I very much look forward to working with you and your colleagues as we move ahead in working to build a more effective financial regulatory framework in this country. 

Thank you very much. 

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

55 of the appendix.] 

The CHAIRMAN. Thank you, Mr. Geithner, and also for directly 

addressing our—there are a couple of empty chairs here. We have 

two very well-prepared witnesses, so their revenues are smaller. 

They didn’t need quite as many helpers, so there are a couple of 

empty chairs over there. People should fill themselves in. And 

there are some staff chairs; people shouldn’t have to stand if there 

are chairs. 

I am going to hold off on my questions for a while. I want to give 

members a chance. So I am going to begin the questioning with the 

chairman of the Capital Markets Subcommittee, not the Financial 

Institutions Subcommittee. I incorrectly designated the committee. 

The gentleman from Pennsylvania. 

Mr. KANJORSKI. Thank you, Mr. Chairman. 

Mr. Geithner, I am trying to discern the bottom line of just how 

thorough a reform you are talking about, or reorganization, of our 

regulatory system. It sounds to me that you are going down to the 

13 

rudimentary rules and approach it perhaps even from a whole new 

philosophical view. Is that correct? Or am I overreacting to what 

you are saying? 

Mr. GEITHNER. I think you have to look at everything. 

You have to be prepared to look at everything. Our system has 

many strengths. But I think the challenges we have seen in this 

crisis justify a very broad-based fundamental look. 

Mr. KANJORSKI. I agree with that proposition, and I think it 

would take a number of Congresses to succeed along those lines. 

We are particularly acutely aware of the international accounting 

standards that are going to come into play about 2012. And it 

seems to me we ought to coordinate our regulatory reform in this 

country to be consistent with that. 

But then I anticipate a problem that prior to this immediate 

credit crisis that we ran into, the situation that people will argue 

that we ought to prevent the race to the bottom in reform shopping. And I see that as if we—you know, we could write great regulatory reform here and have all our companies go to Bermuda, if 

you will. So how do we prevent the two? And how do we get adequate and good responsible reform and, on the other hand, don’t 

run into the escape psychology of companies that can do better in 

another jurisdiction? 

Mr. GEITHNER. I think you are absolutely right. As we think 

about what makes sense for us, we have to figure out ways to get 

the world to move with us. And I don’t believe it is possible, given 

how integrated our markets are, for us moving alone to adequately 

address the challenges we face here. So a critical part of everything 

we do will be to try to improve the odds that we get a more resilient system in place in the United States and get the primary supervisors of other major global financial institutions and the other 

major financial centers to move with us. And we have a very active 

cooperative effort now underway, including with Chairman Cox and 

his colleagues today. I believe we have a reasonable prospect, if we 

identify sensible things here, of bringing the major financial centers along with us. 

Mr. KANJORSKI. Do you perhaps suggest that we could use an 

international conference or a summit with all the leading industrial nations of the world to establish international standards of 

regulations? 

Mr. GEITHNER. Well, our predecessors built a very elaborate network of consultative bodies, the Basel Committee on Banking Supervision. I chaired something called the Committee on Payments 

and Settlement Systems. There is a group called the Financial Stability Forum, established in the late 1990’s, that brings together 

central banks, market supervisors, market regulators, and supervisors. I believe that framework provides a lot of opportunity for us 

to build consensus. 

But I just want to underscore your point. I think you are exactly 

right that we can’t achieve what we need in this country that is 

in the interest of the United States without achieving progress outside of the United States, at least in the major financial centers. 

Mr. KANJORSKI. I guess—and just before I lose my time here— 

Chairman Cox, how can we get the CFTC and your organization 

14 

merged so that we do not have this conflict? Or is that a hope that 

defies political solution? 

Mr. COX. Well, obviously, the answer is through legislation. 

Short of that, and we are far short of that, what the SEC and the 

CFTC have undertaken under our existing regulatory authorities— 

and we administer statutory regimes that in some respects are significantly different—is to execute a memorandum of understanding 

so that we work together as closely as possible. 

In some respects, I have observed over a period of many years, 

including when I first worked in the Executive Branch in the 

1980’s, that the SEC and the CFTC can be, for turf reasons, natural enemies. The chairs of the CFTC with whom I have worked 

have very much wished that this was not the case. And we have 

worked, I think, in the best interests of investors in the marketplace to make sure that, for example, new product approvals are 

done in a consultative way, not serially by the CFTC and by the 

SEC. This kind of deepened personal and organizational cooperation and collaboration between regulators is something that I think 

works very well. It typifies what we are doing with the Fed. 

We have also had a great deal of experience in the last few years 

doing this with international regulators, I should say, with foreign 

regulators as well in the international context. That was necessitated by such market occurrences as the NYSE Euronext merger 

and by the NASDAQ OMX combination. We are working with regulators in those countries of necessity, and we have deepened our 

collaboration also on the enforcement front. 

So, in all of these ways, I think that, starting with the SEC and 

the CFTC, the question you put about collaboration among regulators, generally we can do a lot even if it is difficult to rationalize 

the whole thing with an entirely new statutory regime. 

Mr. KANJORSKI. Let me ask you, on our committee right now, we 

are working on consideration providing legislation to have an optional Federal charter insurance. And of course, we were considerably along that line when the credit crisis occurred. I would like 

your honest opinion, both of you, actually, is this something that 

should be delayed on our part because of this tendency to confuse 

and complicate the existing crisis? Or is it something we should 

move forward with? Is it a tool that could be utilized to standardize 

regulatory reform within the system? 

Mr. COX. Well, I think I will defer, only in part, to Tim on the 

subject of the across-the-board economic-wide systemic issues that 

you inquire about. 

I will say, on the merits, I think it is a good idea. It is certainly 

important in any case for this committee to be considering it in a 

very serious way. There are obviously some significant issues to be 

worked out with the States. The background of State regulation in 

this area is rich with history, and people understand it. This is an 

optional charter that we are talking about. It is not unduly intrusive in that sense. But that kind of very close working relationship 

with the States as you consider this legislation, I think would serve 

the subject matter well. 

Mr. GEITHNER. On the question of whether you need to do it now, 

I think that, in general, across the set of issues, I think it is going 

to be hard to get the ideal balance and mix until we are through 

15 

this crisis. And so I think most of the big questions need to be 

thought of in an overall context once we get to the other side of 

this downturn. 

But I think, right now, there needs to be a spirit, and I think 

there is, a spirit of pragmatism at the State level among those insurance supervisors so that if capital can come into the parts of the 

system now where capital is necessary, that is able to happen with 

the necessary speed. 

The CHAIRMAN. The gentleman from Alabama. 

Mr. BACHUS. Thank you, Mr. Chairman. 

Mr. Chairman, before I ask questions of these two witnesses, I 

would like to make a statement that I think is very important. 

There is an article in the American Banker today where Ralph 

Nader talks about the Deposit Insurance Fund. I won’t criticize 

anyone. But let me say this, during the height of the Savings and 

Loan debacle, there were 1,800 financial institutions on the trouble 

list, and 800 or 900 of them failed. People are comparing the financial services banking industry, that to now. And it is not a valid 

comparison. 

We only have 90 banks that are even on the troubled list. If we 

have a situation like Savings and Loan, as far as the number, then 

40 percent of those may fail. And so you are talking 40 or 50 banks 

out of a large universe. Our banks are well capitalized. Our Deposit 

Insurance Fund is sound. There is absolutely no factual basis for 

saying that there is not money there to pay. 

There is a crisis in confidence. There are a lot of people saying 

things that may be panicking the general public. But factually, it 

is irresponsible to say that. And I wanted to say that because I 

think it is very important—we have talked about short sellers, people spreading mischief, and whether it is for sensationalism, to sell 

magazines, or to grab attention, it is just not true. And we as 

Americans ought to all be concerned about that, not to say things 

which cause people— 

The CHAIRMAN. Would the gentleman yield to me for just a second? 

Two questions that have to be kept separate. One, the question 

of how at the Federal level we would finance any need to respond. 

Two, are the insured deposits safe? The answer to two is, absolutely, completely, without question. 

We will be dealing with question number one as it comes up. But 

nobody ought to think that there is any linkage between those two 

questions. Insured deposits are 100 percent safe. 

Mr. BACHUS. Thank you. 

I associate myself with those remarks. And I just hope the general public—I hope in our writing, we don’t repeat rumors that are 

totally sensational without any basis. 

And I think the story that the American people need to hear is 

that our banking system is sound. It is well capitalized, and their 

deposit—I wouldn’t say that. As a politician, the worst thing I 

could say is that there is a problem with the solvency of that. I 

would never want to say that if I didn’t believe it 100 percent. 

Chairman Cox, in your June 19th editorial, you asked a question 

that I think this committee has to answer. And that is, should the 

extensive system of commercial banking supervision and regulation 

16 

developed in large measure to counter the problem of moral hazard 

be extended to investment banks? And if so, who should be responsible? 

How would you answer your own question? And in doing so, are 

there characteristics that distinguish investment banks from commercial banks and argue for a different treatment, different regulatory treatment? 

Mr. COX. I think that there are. And I think that the object of 

reform in this area should be to create the conditions in the marketplace that first give a lot of transparency to investors so they 

can see where the risk lies. We have had shortcomings that have 

been clearly identified in that respect of late. In addition, that can 

make it possible for interconnectedness, which can be a good thing, 

to be only a good thing and not also a bad thing with a dark side 

because we don’t know where risk lies. So that when a firm is mismanaged, it can fail, as in a free enterprise economy it should, 

without threatening the entire financial system. 

We need to get to a better place in that respect than where we 

are. I think it is for that reason that the authorities, the emergency 

authorities, that regulators have exercised in these circumstances 

are temporary. But the object should be to let market discipline 

govern risk and investment in risk and not to have the Federal 

Government have to step in in each of these cases. 

Mr. BACHUS. Thank you. 

And President Geithner, one of the particular, I guess, sources of 

systemic risk could be the credit default swaps. I know the credit 

default (CDS) market has grown over the past decade to more than 

$45 trillion, which is roughly twice the size of the stock market. 

And I know you have made efforts to create a central clearinghouse 

for these derivatives and to automate their trading and settlement. 

Those are welcomed initiatives. 

How have credit default swap issuers been able to provide guarantees that vastly exceed their capital reserves to the point where 

there is virtually no possibility that they can pay in the event of 

a default on the underlying obligations? And in answering that 

question, how can we contain that systemic risk posed by CDSs but 

at the same time preserve the beneficial uses of CDSs as a valuable 

risk-management tool for these firms, because they are a valuable 

financial instrument? 

Mr. GEITHNER. I completely agree. They do bring very important 

benefits to the financial system that we do want to retain, but they 

come with a lot of challenges. 

So I think the two really critical things are that the institutions, 

the dealers that are at the center of this market, carefully manage 

their exposures in this area relative to their capital. So the first 

most important thing is to make sure that these institutions—and 

this is largely a group of 12 to 18 of the largest financial institutions of the world, banks, investment banks—carefully manage 

those exposures. 

The second thing, as you noted, is to try to make sure that the 

trade processing infrastructure that supports what is now a bilateral market is modernized to the point that it offers a level of automation, a reduction in operational risk, a capacity for dealing with 

17 

defaults in the underlying, that is more appropriate to the centrality of these instruments and this market. 

You can’t say another way, but that infrastructure substantially 

lagged development of that market. We are working very hard at 

trying to close that gap. And that requires not just moving the 

standardized part of this market onto a central clearinghouse and 

moving to greater automation but a range of other things that are 

critically important. 

You are going to see in the public domain in the next couple of 

weeks another set of clear objectives and targets and commitments 

from those dealers. 

Mr. BACHUS. Thank you, Chairman Cox, and Mr. Geithner. 

I appreciate you both. 

The CHAIRMAN. I am now going to proceed. As I announced at 

the last hearing where we had Mr. Bernanke and Mr. Paulson, we 

are going to now go to the people who didn’t get to ask questions 

there first, and then come back. The order, by the way, will be Mr. 

Ackerman, Mr. Scott, Mr. Perlmutter, and Mr. Wilson. And then 

we will get back to the regular order. 

So Mr. Ackerman will begin. 

Mr. ACKERMAN. Thank you. Thank you very much. 

I would like to know why, at a time when we see a lot of abusive 

and manipulative short selling, especially in an economic climate 

where people are very mistrustful and lack confidence, that we 

would not reinstate the uptick rule. 

Mr. COX. The uptick rule— 

Mr. ACKERMAN. I have introduced legislation that would mandate that it be reinstated. It seemed to work very, very well when 

we had it for all of those years, and we seem to have all of these 

problems now. 

Mr. COX. The uptick rule, as you know, went into effect in 1938 

when a tick was a tick. It meant something. 

We went to decimalization in relatively recent history, and a tick 

became a penny. There has never been an SEC action more carefully studied by economists both within and without the Agency. 

Indeed, in order to study this issue, which commenced under my 

predecessor, one third of the stocks on the Russell 3000 Index were 

put into a pilot; half of them had a tick test, half of them didn’t 

have a tick test, and the effects on a number of parameters, including volatility, were studied. 

What was discovered was that the tick test no longer had any effect. It wasn’t effective in achieving its original purpose. The question that you raise, however, is a very good one; should there be 

a test that does work, should there be something that is meaningful? If it can’t be a tick because a tick is now just a penny, and 

even when the stock is dropping like a stone it tends to drop with 

penny upticks along the way, is there a price test that could work 

with an increment of a nickel or dime or what have you? And the 

SEC is carefully studying this even now. 

Mr. ACKERMAN. Maybe a tick is just a tick, but I think we are 

suffering from Lyme disease right now. In the movie The Producers, and the play, which is very successful, the hustlers in that 

game would go out and sell 150 percent or 500 percent, 1,000 perVerDate Aug 31 2005 16:25 Nov 12, 2008 Jkt 044903 PO 00000 Frm 00021 Fmt 6633 Sfmt 6633 K:\DOCS\44903.TXT TERRIE
18 

cent of this play and try to make it bad enough that it would definitely lose so that they could make money when it lost. 

I think we are dealing with a market that is very, very rumor 

sensitive, especially in this day and age. And while betting on 

something going down is a legitimate game, I think that pounding 

it down and hammering it down is something that is disastrous, 

and a game that we should be protecting against, so that there is 

transparency and people understand what they are investing in; 

and at the same time, tie this in with the issue of naked short selling, where people can actually sell 150 percent because they are 

not really borrowing the stock. If you combine that with the tick 

rule or the lack of such, I think we are heading for an absolute 

total disaster. I would like to know why the change in rules has 

basically given a cloak of protection and security to 19 firms instead of protecting all of the banking institutions on naked short 

selling. Who are we protecting if we are not protecting everybody? 

Mr. COX. Well, there is a regulation recently put into effect and 

recently tightened even further called Regulation SHO that targets 

naked short selling. It applies across the entire market. And so the 

norm, that you need to borrow a stock or you need to have a contract to borrow that stock or you have to have a reasonable expectation that you can— 

Mr. ACKERMAN. But you have two different standards, one for 19 

companies and one for everybody else as to what the standard of 

showing is. 

Mr. COX. The difference between Reg SHO, which applies across 

the market, and our emergency order is that one of the three 

prongs of the test has been removed, so that now you have to either 

borrow or have a contract to borrow. Having a reasonable expectation that you can do so is no longer sufficient. And the universe of 

entities to which this emergency order applies is precisely the universe that the Federal Reserve has drawn. 

Mr. ACKERMAN. And with the 19 to whom the full test applies, 

it seems to be very effective. If something is very effective, why not 

use that as a template and apply it to everybody, so that everybody 

has the same sense of confidence in the playing field? 

Mr. COX. When the Commission issued its order, I made it very 

clear that is our intent; that we are going to propose a rulemaking 

that will put in operational protections for the entire market beyond even those in Reg SHO that presently exist. 

The CHAIRMAN. The gentleman from California, Mr. Royce. 

Mr. ROYCE. Thank you, Mr. Chairman. 

Chairman Cox, we had a previous hearing here in the committee 

on systemic risk, and we had the Chairman of the Federal Reserve 

here at that time and the Treasury Secretary. I mentioned a quote 

by former Chairman Alan Greenspan, and in that quote, Mr. 

Greenspan expressed his belief that private counterparty regulation or monitoring basically through market discipline generally 

has proved better at constraining excessive risk taking than has 

government regulation, in his view. I mention this quote again because as we look to potentially increase the regulatory authority of 

the Fed over investment banks and large broker dealers, I think 

it is critical that we preserve the rule of market discipline among 

19 

these institutions. We have to keep an eye, I think, on what happens when we lose that market discipline. 

And I was going to ask you, Mr. Chairman, are you concerned 

that the potential increase in regulatory authority and overall regulation may in fact weaken the effectiveness of market discipline 

among these firms? 

Mr. COX. Of course. I think the goal of our supervision of the 

firms and of any financial regulatory regime restructuring should 

be to eliminate the need for continued access to the Fed’s liquidity 

facilities. No one more than the Federal Reserve appreciates the 

connection between the provision of government backstop liquidity 

on the one hand and moral hazard on the other. It gives rise in 

turn to the need then for more regulation and supervision. And ultimately, if one takes that to the logical extreme, the requirement 

would be for the government to have to supplant the wisdom of the 

entire market, and to do everything through regulation supervision 

clearly is not possible. So it is the wrong model. It is not what we 

should be building towards. 

These are exigencies, as Chairman Frank noted and others noted 

in your statements. We are doing a good job of dealing with problems as they come up. But this hearing is about restructuring the 

thing so that you don’t have to do this. And our objective should 

be—whether or not mankind can be perfect in this respect is perhaps another question. But there is no question what we should be 

trying to build, and what we should be trying to build is something 

in which the Federal Government isn’t in this business. 

Mr. ROYCE. It has been reported recently that many of the investment banks have scaled back their usage of the primary dealer 

credit facility that we established in March that was—in fact I 

think the window has gone unused, the discount window has gone 

unused for the past 3 weeks by these institutions. What should we 

make of this pullback? If there isn’t this borrowing going on now 

through the discount window, is this a reflection of the health now 

of these institutions? Or is this a statement to regulators and lawmakers that these investment banks are not prepared to trade access to the discount window in exchange for the burdens of increased regulation? I was just wondering what your take is on that. 

Mr. COX. I think you probably want to hear from both of us on 

this. 

From the point of view of the SEC, I don’t think it is the latter. 

I do think that it is a reflection of what Secretary Paulson has said 

on many occasions: It is much better to not use authority that people know exists, to not have to rely on backing that people know 

exists because it does its job better that way. I think that is a bit 

of what is going on here. 

Mr. ROYCE. Let me ask then the President of the Federal Reserve Bank of New York. Mr. Geithner, what is your observation 

on that? 

Mr. GEITHNER. It is hard to know. But my sense is that these 

facilities, all of them, are still providing a very important role in 

confidence as a backstop source of liquidity in extremis. And I don’t 

think you can really judge the value today to the firms themselves 

or to the people who fund them from looking at use day-by-day. So 

20 

my own sense is that there is still plenty of kind of an important 

role, even though use has declined progressively over time. 

Just to underscore one important point, we have been very careful from the beginning, along with the SEC, to try to make sure 

that while these facilities are in place the major investment banks 

move to adopt a more conservative mix of leverage and funding 

than they had on the eve of the Bear Stearns thing. And I think 

it is important to note, and I think Chairman Cox has said this, 

too, that they have made substantial progress in moving towards 

an appropriately more conservative mix, as I said, of the leverage 

and funding risk. 

Mr. ROYCE. Thank you. Thank you, Chairman Cox. 

The CHAIRMAN. The gentleman from Georgia. 

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

Let me ask, do each of you believe that the action that has been 

taken by the Fed, the Treasury, and other central banks has done 

a good job in helping reduce risk, raise capital, and build liquidity? 

How can we improve upon this? And as the Fed is beginning to 

face added pressures from some regional Federal bank presidents 

regarding starting to raise the cost of credit to curb expectation of 

higher inflation, in your minds, is inflation indeed of greater concern right now? 

Mr. GEITHNER. Congressman, it shouldn’t surprise you to hear 

me say that I believe that what the Fed has done with other central banks to help ease the liquidity pressures in markets has been 

necessary and appropriate. And we try to be careful to underscore 

a commitment to continue to do things, as I said, to, ‘‘help ease this 

process of adjustment.’’ That is important, and not just because the 

financial institution is still facing some pretty substantial pressures and we want to mitigate the risk that those pressures increase overall headwinds to the economy as a whole. But it is important to make monetary policy more able to deal with the full 

range of challenges we face as a central banker. 

Mr. COX. I would be happy to address your question as well. As 

you know, the SEC is not responsible for monetary policy, but inflation is something about which investors—whom we look after— 

care a great deal. One of the things that the SEC concerns itself 

with every day is making investors comfortable, taking their money 

and putting it into investments where it can be productive in our 

economy, what you on this committee call intermediation. We want 

to make sure that can happen. And that is one of the best ways 

for investors to protect themselves against inflation if they think 

that is a risk or if in fact it is a risk. 

So creating and maintaining market confidence is vitally important in this respect as well as in others. That is what we are focused upon. 

Mr. SCOTT. Another part of my question is yesterday, we made 

a very bold and I think a very, very, very good and substantial 

move with our housing package. And given the fact that now we 

have addressed our housing package, let me ask you, do you believe 

that a second round of stimulus package is necessary? Would you 

support a second round of stimulus in the face of what people are 

saying and economists, that we still expect sustained economic 

weakness to last, many say, for the next 2 or 3 years? 

21 

So my point is, given the housing package, given the earlier stimulus, do you foresee down the road a necessity to move with a second stimulus package? And what do you think the first stimulus 

package has done? 

Mr. COX. I think economists will have to tell us what are the actual effects based on empirical data that even now they are collecting of the stimulus package that has already been put into effect. 

Complementary to the SEC’s role in instilling and maintaining 

market confidence is the policy that the Federal Government and 

that the Congress enacts, including fiscal policy, that stimulates 

economic activity and that promotes economic growth. 

I would say, as the investors advocate, that investors rather obviously look for after-tax rates of return. And that when they are facing, as they are now, scheduled increases in taxes on dividends, 

capital gains, ordinary income, that there is probably a lot of room 

there to create positive incentives for people to put their money in 

the market that will also be consistent with promoting growth in 

the economy, and that for Congress to be examining those things. 

Mr. SCOTT. My time is about up. So what you are saying then 

is that you believe that we have moved sufficiently with the housing, we have moved sufficiently with the economic stimulus package. Is that enough right now? Or where do you see us in terms 

of calming the jitters within the markets? 

Mr. COX. I think we are far from achieving our potential as an 

economy, as a Nation, and that there is a great deal more that 

sound policy, promoting economic growth, can accomplish. 

Mr. SCOTT. Thank you, Mr. Chairman. 

The CHAIRMAN. The gentlewoman from Illinois. 

Mrs. BIGGERT. Thank you, Mr. Chairman. And I would like to 

welcome you to this hearing. My first year here was 1999, which 

was a very interesting year, of course, when Gramm-Leach-Bliley 

passed. And I thought that we did it rather quickly, until I realized 

that most of my colleagues on this committee had spent their entire congressional career working on that. I guess I was fortunate 

just to have 1 year of hearings. 

But in looking at what you both have presented as outlines in 

what should be accomplished, and I know that the centerpiece of 

the Treasury Blueprint is the reorganization of regulators and the 

regulatory authorities along functional lines, is what you are proposing in line with that? They say it says to do a consumer protection regulator and insured institutions regulator and a systems 

risk regulator. And I must say, I haven’t had time to really study 

what you both have proposed. But is this in keeping with the 

Treasury? Or is this a different way to do this? And most of all I 

am concerned about, how long will this take, what has to be legislated, and what can be done now? 

Mr. Geithner or Chairman Cox, whomever would like to go first. 

Mr. GEITHNER. The Secretary of the Treasury, I think, deserves 

a lot of credit for putting out a very comprehensive set of reforms 

with a very, I think, sensible set of objectives for those reforms. 

I did not address in my written testimony the full range of issues 

that will be raised by that, including those that affect the specific 

rules of the Fed. But I think the basic idea of modernizing the 

22 

framework, of having a more clearly established, appropriately assigned set of rules more consistently applied is very important. I 

think the call for very substantial consolidation simplification is 

very important. I think the emphasis in trying to make sure that 

there is authority commensurate with the responsibility where that 

rests for financial stability, I think those are all absolutely sensible 

objectives, and probably should guide any framework of reforms 

going forward. 

There are a lot of complicated things about how to do that that 

have to be thought through carefully, but I think at that basic level 

it is a very well-designed, comprehensive set of proposals. 

Mrs. BIGGERT. Thank you. Chairman Cox? 

Mr. COX. The Treasury Blueprint was a ‘‘big think’’ exercise 

going way outside the box and the boxes. We had a brief exchange 

here during this hearing about just what would be involved if one 

were to consider only the piece involving the CFTC and the SEC. 

Obviously, we would have to get the Agriculture Committee in this 

room and likewise on the Senate side. 

While I think those exercises, those big think exercises are useful 

in many respects to challenge orthodoxy and to get us imagining 

all the possibilities, what I am here to testify about today is very 

focused and very different and, I think, much more tractable in 

real time even if real time is measured as next year or the year 

after. We are asking first that we plug the Gramm-Leach-Bliley 

regulatory hole concerning the lack of consolidated supervision for 

investment bank holding companies, and we are saying that the 

SEC should be given explicit authority to control liquidation of investment bank holding companies or their unregulated affiliates 

that generally hold most of the derivative positions. 

I think those are things that this committee could do in something like real time. 

Mrs. BIGGERT. So do you think then that you will be working 

with the Treasury after the real-time considerations that you have 

and then move on? Is there a move to really look at that, or was 

it just a think exercise? 

Mr. COX. No, I don’t think that this is merely an exercise. It is 

certainly big think. But I think the Treasury in issuing it, and you 

should all be aware as I am sure you are, that this was a Treasury 

product, not a Fed product, not an SEC product. It was meant by 

being purposefully nonconsultative to be internally logically consistent. And it is that. Whether or not it has the approval of every 

other regulator in every other respect, I think you can imagine it 

does not. But the Treasury acknowledged when they issued it that 

this wasn’t going to happen right away. It might not ever happen, 

that this is a process that is getting underway. 

We then had Bear Stearns. We had other events in the marketplace that have accelerated the pace of the people’s thinking here. 

I think that has focused us much more on what can be done realistically, measured in terms of months. The Treasury, the SEC, the 

Federal Reserve, and the CFTC, through the President’s Working 

Group are very focused on these and related questions on a regular 

basis. There will obviously be a change of Administrations before 

I think any thorough legislation is passed. So these are institutional questions. It is not so much a question of whether Chris Cox 

23 

is working with Hank Paulson or Tim Geithner or Ben Bernanke 

as it is that Congress is focused institutionally on these things and 

has a path and a way forward. I think this hearing is a wonderful 

way to institutionalize that process here in the House. 

The CHAIRMAN. The gentleman from Colorado. The order now 

will be the gentleman from Colorado, the gentleman from Connecticut, and the gentleman from Ohio. Then, we will go back to 

the regular order. The gentleman from Colorado. 

Mr. PERLMUTTER. Thank you, Mr. Chairman. Just a quick question back on that uptick rule. And the reason I am interested in 

it is that I am walking precincts on Saturday. As Chairman, you 

have had to walk plenty of precincts. A guy says, why did they 

eliminate the uptick rule? And you said it is because of the 

decimalization and the fact that a penny isn’t worth very much 

anymore. But shouldn’t there be some sort of stop in this system? 

Because when you look at Bear Stearns, when you take a look at 

what I think happened to Freddie Mac and Fannie Mae 2 or 3 

weeks ago, these guys are betting against the house; they are betting in a big way. I think you used the words ‘‘distort’’ and ‘‘short.’’ 

And something isn’t right about all of that. So shouldn’t there be 

an automatic stop? 

Mr. COX. There are several questions I think that you have 

touched on in your comment, and I will try and address each of 

them. 

First, the most virulent combination from a regulator’s standpoint is intentionally false information being inserted into the marketplace by people who are then manipulating the stock and using 

short selling as a means to turbo charge the effect of it. It is that 

combination that we really need to be worried about, because that 

goes directly towards the credibility and integrity of the information in the marketplace that everybody depends upon. And particularly when markets are moving as fast as they do today, there is 

not a lot of time to get it right a week later. We want information 

to be right in real time, and we are focused a lot on real-time disclosure for public companies. 

Second, the uptick rule itself was the subject of, as I mentioned 

earlier, a very elaborate pilot study in which essentially the provisions of the rule were suspended for one group of stocks and they 

were comparable stocks, so within the Russell 3000 they were studied not only by the Office of Economic Analysis within the SEC 

over a period of a year, but also by academics outside who replicated this and got similar results. And the findings were that 

there was no significant effect on market quality or on volatility. 

We were then able in the subsequent more volatile markets to 

compare the effects on volatility, on the U.S. economy, with effects 

and changes in volatility in other countries, some of which had an 

uptick rule, some of which didn’t. And there was found to be no correlation. So if one is focused on empirical results, we have a lot of 

them here, and that is generally the basis on which you want your 

regulators to make decisions. 

But then the third question that you raised is whether or not you 

want something that does work. And I think that is very much 

under Commission consideration right now. The trade-off there, 

rather obviously, is a circuit breaker or something that can protect 

24 

investors from things running away on the one hand, and making 

sure that you don’t interfere with liquidity and efficiency on the 

other hand. 

Mr. PERLMUTTER. I appreciate that. And I guess I am more for 

putting a stop in there, because information does flow so quickly 

that for you to be able to catch up even a day or two later may 

be too late. And so we have seen huge swings in these organizations and their stock prices. And I think in one of your articles we 

talk about if you pump the stock up based on false information, you 

get jail time. And hopefully the same thing applies, if you drive the 

stock down based on false information, you get jail time. That is 

what I am feeling. Because a lot of people lost a heck of a lot of 

money in the last 3 or 4 weeks in some very significant stocks to 

this country, and we had to take some emergency steps yesterday 

to remedy that. 

Now, I do want to get to the bigger question, which is GrammLeach-Bliley and Glass-Steagall. In my opinion, investment banks 

and commercial banks are very different animals and have very 

different purposes, equity side, debt side. And in one of your comments in your paper, you say: ‘‘Rather than extend the current approach of commercial bank regulation to investment banks, I believe Congress and regulators must recognize that different regulatory structures are needed for oversight of these industries.’’ 

My question is, shouldn’t we separate these things again? There 

was an erosion of the separation between the two types of banks, 

the investment banks and the commercial banks, from 1980 to 

today. Has that been good for us? And shouldn’t we separate them 

again? 

And then I am done. Thank you. 

Mr. COX. I think that the Gramm-Leach-Bliley essence of eliminating the Glass-Steagall in a wall of separation was a good thing 

and can be distinguished from what I am trying to point out here, 

which are the essential differences even in today’s world that characterize investment banks on the one hand and commercial banks 

on the other. Some of those differences are regulatory, some of 

them are accounting, some of them are the nature of the business. 

The approach to leverage and risk is very different in investment 

banks than it is for commercial banks. For accounting reasons, investment banks have to daily mark to market everything they 

have. Commercial banks don’t often have to do that. 

If we don’t appreciate these distinctions and appreciate the different roles that these institutions play, then I think we will find 

that applying the commercial bank model of regulation to investment banks will so restrain the role that they play in the economy 

that somebody else then in the marketplace is going to rush in to 

do that, likely an unregulated entity, hedge funds and others private pools of capital. Then we will have the same set of questions 

to ask all over again but now with a new set of entities, and we 

haven’t really solved that problem. 

The CHAIRMAN. I want to say to my friend from Colorado, I did 

a quick survey of some of my colleagues here, and we want to congratulate you on the financial sophistication of your district. None 

of us going door-to-door have ever been asked about the uptick 

rule. So we did want to either congratulate or console you on that. 

25 

The gentleman from Texas. 

Mr. HENSARLING. Thank you, Mr. Chairman. 

Mr. Geithner, in my opening comments I asked a rhetorical question; now I would like to ask a direct question. And that is, just 

how will the Federal Reserve think about the balance between 

price stability, financial stability, consumer protection, full employment, and taxpayer protection? I am curious about how you, as 

head of at least the New York Fed, would think about this balance. 

And what would be the risk associated with increasing the charge 

to the Fed with more responsibilities, particularly at a time when 

at least many of our constituents, when they look at price stability, 

might not give you an A-plus? 

Mr. GEITHNER. I think you are raising exactly the right question. 

I think that it is very important that we are not given responsibilities for which we do not have authority, and it is very important 

we are not given responsibilities which would conflict fundamentally with the basic obligations that the Congress gave us in the 

Federal Reserve Act. 

It is important, though, to recognize that all central banks in any 

serious economy are given a set of mandates that require a balance 

between price stability and some mix of sustainable long-term 

growth objectives. That mix differs. But also financial stability. 

And in any central bank, the basic lender of last resort instruments 

that are given to prevent liquidity problems from becoming solvency problems along with some broader financial stability are inherent to the functions of modern central banks. 

It is very important, though, to recognize that those instruments’ 

responsibilities come with and have implications for moral hazard; 

and, therefore, it is very important they be complemented by a set 

of constraints on risk-taking and a framework for dealing with 

problems that can help limit and offset that moral hazard risk. But 

that basic framework of responsibilities, from price stability to financial stability, are integral to what all central banks live with 

every day, and those objectives do not need to conflict. 

Mr. HENSARLING. As we seemingly have the Fed go down this 

road of taking on increasing responsibilities for financial stability, 

I believe it is now twice in 60 years that the Fed has chosen to 

open a discount window to nondepository institutions, those two occasions being within the last 4 months. I asked Chairman 

Bernanke the same question. I didn’t leave with an answer that I 

felt necessarily was the model of clarity, and maybe that was on 

purpose. But I would like to know, in your opinion, who is this window open to? What is the criteria? Who is eligible? Why are they 

eligible? Is it simply bigness? Is it simply interconnectedness? 

What is the criteria? Who qualifies? And if that is difficult to answer, who doesn’t qualify? 

Mr. GEITHNER. Today, under the current facilities, two types of 

institutions qualify: Institutions that are what we call depository 

institutions, institutions that take deposits like banks; and institutions that we call primary dealers. Primary dealers come now in 

essentially two forms. They are affiliated with banks and those 

that are independent. The four large investment banks are examples of the latter. 

26 

The reason why they have access to those facilities now is because those institutions play critical and unique roles in market 

functioning. And in order to help facilitate this adjustment the 

economy is going through, they need to have the ability to finance 

less liquid assets with the central bank, but those are the institutions and that is where the line now exists. 

Now, the Federal Reserve Act did give us the ability to go broader if we believe circumstances require that, but at the moment we 

have drawn the line there, I think appropriately. 

Mr. HENSARLING. I see I am soon to run out of time. From the 

perspective of just dealing with systemic risk, notwithstanding 

what took place on the House Floor yesterday vis-a-vis Fannie and 

Freddie, but looking forward and not looking backwards since I assume ultimately the bill will become law, if in an orderly fashion, 

and your one goal was to reduce systemic risk, would you believe 

that a system where you had broken up Fannie and Freddie into 

a more atomistic market, lowered their conforming loan limits, and 

minimized their portfolio holdings, or, in the alternative, totally 

privatized them over, say, a 5- to 7-year basis, would you believe 

that would lead to less systemic risk in the economy? 

Mr. GEITHNER. I believe that there is going to have to be some 

very fundamental rethinking of the future of these institutions 

going forward. It is hard, though, to say today with confidence 

what the optimal role will be in the future. But for the reasons you 

have said and many others, the current balance is probably untenable over the longer term. 

Mr. HENSARLING. Thank you. 

The CHAIRMAN. The gentleman from Connecticut, Mr. Murphy. 

Mr. MURPHY. Thank you, Mr. Chairman. 

Mr. Cox, I wanted to get specifically at the emergency order relevant to pre-borrow requirements for short selling. And I for one 

appreciate the SEC’s action in this regard, but I have maybe a twofold question. 

You have limited the order to 19 specific stocks. There are those 

of us in correspondence with your office who have been advocating 

for a pre-borrow requirement industrywide, and I appreciate the 

fact that you have recognized that at least for these particular companies, this is an immediate problem that necessitated the emergency order. 

But I guess the two parts to my question are: First, why not 

apply this industrywide? You have had a regulatory process that 

has been ongoing for some time looking at this issue which has 

now been I think going forward for about a year, and I am interested to know why, if it makes sense for these 19 companies, it 

doesn’t make sense for the entire industry? And second, what hazard do you potentially see with selecting only these companies and 

not others? We have seen just in the 2 days after the emergency 

order was put into effect, I think for all but two or three of those 

companies, a double digit percentage increase in the value of their 

stocks. I think across-the-board, I am looking at a 21 percent increase in their value in the 2 days after that order was put into 

place. 

So the twofold question is: First, why not do it for the entirety 

of the industry? And, second, do you foresee any problems in pickVerDate Aug 31 2005 16:25 Nov 12, 2008 Jkt 044903 PO 00000 Frm 00030 Fmt 6633 Sfmt 6633 K:\DOCS\44903.TXT TERRIE
27 

ing only these 19, and leaving other companies then potentially 

with even greater exposure to short sales? 

Mr. COX. Well, thank you for the opportunity to expand on this, 

because I think it is an important and a good question. 

Our emergency authority is limited, as you can imagine. Our 

rulemakings are generally governed by the Administrative Procedure Act, which requires an elaborate process of notice and comment; it requires economic justification; it requires a fair amount 

of empirical analysis, historical analysis, and so on. 

Our emergency order was tailored precisely to the emergency orders that the Federal Reserve had issued. We issued it in close consultation with the Treasury and the Fed as an ancillary, as a support for those actions. And so the universe of firms that are covered 

by the emergency extension of credit facilities by the Federal Reserve is the same universe of firms that the SEC order covers. And 

I think because of the nature of our emergency authority we are 

constrained in that respect. 

However, it is vitally important for us to look after fraud in the 

entire market, and we are doing so in real time. This isn’t the only 

initiative that we have announced. As you know, we have a sweep 

examination that we have undertaken with FINRA and also with 

other regulators, and that covers the intentional spread of false information in the marketplace that is generally part of this witch’s 

brew of distort and short, to which you alluded. 

In addition, beyond that we have immediately pivoted to a broader rulemaking so that we can use the APA process to extend this 

kind of procedural protection to the entire marketplace. I think 

that very soon we will be in a position to issue a proposal on that. 

Mr. MURPHY. And let me ask again the second part of that question: Do you have concerns? And Mr. Geithner, you can answer this 

as well. Do you have concerns as has been expressed, for instance, 

by some of the banking organizations in letters to your office, that 

by limiting this order to a small set of stocks, you are creating 

greater exposure for those that weren’t included in this order? And, 

again, I think this has been expressed to you at the very least by 

some community banking organizations that believe this might be 

the case. 

Mr. COX. I think the concerns in the marketplace are chiefly focused on the potential for illegal manipulation through the insertion in the marketplace of false information. And that is something 

that we are policing across the entire market. 

I think it is important to note that our emergency order concerning naked short selling was not based on an analysis of a big 

problem in this area that exists currently. It is prophylactic. It is 

preventative. It is designed to shore up confidence. But because 

there was not an epidemic in the first place, I don’t think that 

there is a risk that the epidemic that didn’t exist is going to be 

moved to somewhere else. 

We also have Reg SHO. We have the opportunity because of the 

step-up in enforcement that we are doing in this area, we have the 

opportunity to enforce it across-the-board. So I think any financial 

institution, and indeed any public company, can expect much greater protection and confidence for their investors that the marketplace is operating on the level as a result. 

28 

The CHAIRMAN. The gentleman from New Jersey. 

Mr. GARRETT. Thank you, Mr. Chairman. And good morning, 

gentlemen. 

We are here for a hearing on systemic risk in the financial markets. And I guess it is typical of the way government and Congress 

works that we are doing this today, only the day after we voted in 

Congress on perhaps one of the most significant changes to our financial marketplace and the taxpayers with the potential for a $5 

trillion impact upon the taxpayer and extension of authority to the 

Treasury Secretary. But perhaps that is just the way Congress 

works; we do the hearings following the action. But I do appreciate 

your coming here today to talk about some of these actions, and I 

will begin with what we did yesterday with regard to the GSEs and 

Fannie Mae and Freddie Mac. 

Secretary Paulson, prior to us taking this action, was sort of in 

the marketplace trying to calm it down, if you will, trying to facilitate the debt sales and that sort of thing. But Chairman Cox, during that period of time, if you were a trader in Fannie or Freddie, 

in their equities, if you were long on their positions, was everyone’s 

ability still in margin accounts? Or were there some of the brokers 

requiring cash accounts basically for Fannie or Freddie during that 

period of time and even today as well? 

Mr. COX. I am not sure— 

Mr. GARRETT. Were the brokers requiring marginal—raising the 

margin requirements on the trades? 

Mr. COX. No. 

Mr. GARRETT. So there were none of them out there asking for, 

basically treating it as a cash transaction, to your knowledge? 

Mr. COX. I think the answer to that is ‘‘no.’’ 

Mr. GARRETT. My understanding is that perhaps that is not the 

case, and that some of them were looking at it, trading it as a cash 

requirement. Maybe I am wrong. I will ask you to get back to me 

to clarify to assure me that is not the case. 

If that was the case, that they were in essence raising the margin requirements at the same time that the Secretary was out 

there trying to smooth things over, calm the marketplace, then that 

would be going exactly in the opposite direction. Wouldn’t that be? 

Mr. COX. I think that is right. 

Mr. GARRETT. And is that the SEC’s responsibility to be looking 

at that sort of thing? 

Mr. COX. Obviously our concern is that, first, the information in 

the marketplace on which investment decisions are being made is 

accurate. And then, second, in terms of maintaining orderly markets, to make sure that the trading itself is disciplined. 

Mr. GARRETT. The other thing, this is a general question, this is 

a step back, is looking for stability in the marketplace, is stability 

with all you folks. Where are you guys going to be? I know where 

I hope to be a year from now if everything works out well in November. Where will you both be a year from now? 

Mr. COX. A fascinating question. 

The CHAIRMAN. Chairman, your wife may be watching television. 

Mr. COX. I hope that at least the market environment in which 

I am operating at that time will be a positive one and a strong one. 

That is what we are working on building here. 

29 

Mr. GARRETT. And you will still be with the Bank? 

Mr. GEITHNER. Life is uncertain, but I certainly expect to be. 

Mr. GARRETT. I say that in jest in some sense, but also in the 

sense that it is reassuring that the players who are here today will 

be the players who will be here a year from now, all present company included up here on the panel as well. 

Back with the SEC and the Bear Stearns situation, was it your 

responsibility or were you engaged in the process of looking at Bear 

Stearns, their situation, their liquidity, and their management at 

the time prior to the ‘‘collapse?’’ If you were, what were your findings? And did you feel that there were any shortcomings in what 

you were doing? 

Mr. COX. The SEC through our consolidated and supervised entity program was monitoring capital and liquidity at Bear Stearns. 

And in fact, on a daily basis in January, February, and March, the 

liquidity position of Bear Stearns as a result of that interaction 

more than doubled between January and February. They were in 

a position of, going into March, having between $18 billion and $20 

billion of liquidity. The CSE program, managed rigorously against 

the standards that it had been set up with for liquidity to ensure 

that— 

Mr. GARRETT. I only have about 10 seconds, sir. I will put my 

question out again, sir. Should there have been any other red flags 

that you should have seen going up to that time? Because other 

people on the street were not seeing them as well, should the SEC 

have seen the red flags prior to obviously what just happened? 

Mr. COX. Beginning with the failure of Bear Stearns hedge 

funds, there were market rumors in Europe about loss of secured 

funding sources that caused us to take a look at all of their secured 

funding sources. We found out, in fact, that their secured funding 

had increased. 

Using the capital and liquidity standards that the SEC program 

put in place, including the Basel II standards, including liquidity 

standards that require that you be able to go a full year without 

access to unsecured funding, the capital and liquidity cushions for 

Bear Stearns going into the week of March 10th were above regulatory requirements. But what we discovered during that week, 

and what banking regulators of all kinds in the United States and 

in other countries have not seen up to that point was that there 

could be this run on the bank phenomenon, where customers withdraw their free cash balances, where people novate their contracts 

and so on. The result in the Bear Stearns case was that it lost 89 

percent of its liquidity in 3 days. 

Mr. GARRETT. Thank you. 

The CHAIRMAN. The gentleman from Ohio. 

Mr. WILSON. Thank you, Mr. Chairman. 

Gentlemen, I would like to address my question to both of you, 

if I may. One of the concerns I have had through this whole process 

has been the oversight and the lack of connection or the not having 

connection among the oversight groups. So I have two questions. 

One is, how important is it that the central banks, governments, 

and supervisors look more carefully at the interaction between accounting, tax, and disclosure, and capital requirements and their 

effect on the overall leverage and risks across the financial system? 

30 

Mr. GEITHNER. Very important. There has not been enough attention paid to that interaction in the past, largely set by entities 

with independent authority and responsibility. And so I think it is 

a central imperative going forward. 

Mr. WILSON. Mr. Cox? 

Mr. COX. I strongly agree with that. And because of the nature 

of these different responsibilities, the fact that they of necessity fall 

in the hands of different regulators, some of what in the past has 

been ad hoc’ery and is now increasingly formalized, the cooperation 

through a memorandum of understanding, for example, is absolutely vital. 

Mr. WILSON. As we look and move forward to work on this, I 

think it is very important that be one of the primary goals that we 

have. And sometimes it surprises me how much we get off of the 

real issue we are trying to accomplish. 

As Congress considers the Fed’s bid to expand authority over the 

financial services industry, what do you believe is fair regarding 

additional powers for what you will do to help with the oversight 

and the stability of the financial services market? 

Mr. COX. I am sorry, is your question directed to the SEC? 

Mr. WILSON. I was basically addressing it to both of you. I can 

specifically make it to you, Mr. Cox. 

Mr. COX. All right. To begin with, the SEC. First, the SEC already has in statute the authority to run a voluntary program of 

consolidated supervision with respect to an oddly defined category 

of investment bank holding companies. We need to strengthen that 

legislation so that the program is not voluntary, it is mandatory, 

so that the SEC has the authority to mandate compliance, and also 

so that each of the CSE firms that presently today are regulated 

under that program are covered. 

Second, we have asked to be given explicit authority to control 

the liquidation of investment bank holding companies and their unregulated affiliates, particularly with respect to derivative positions 

that they hold. 

Mr. WILSON. Mr. Geithner. 

Mr. GEITHNER. I don’t believe that we need a dramatic expansion 

or redefinition or change of our rule. As I laid out in my testimony, 

I think there are some areas which represent continuity where 

there are additional responsibilities, where I think you need to 

tighten up responsibility and authority and give us a better balance 

of ability to compensate for the moral hazard that is created by 

things we have to do in crisis. 

So I would say, just to repeat them, it is very important that we 

have, as we do now, a rule in thinking about and setting the capital requirements and other prudential requirements that apply to 

core institutions. It is very important that we have a rule in consolidated supervision of those institutions, because you will not 

have good judgments made by this Bank, this Federal Reserve in 

the future unless we have the direct knowledge that comes with supervision. 

It is very important in crises that central banks are able to move 

with force and speed when circumstances require it, and that won’t 

happen unless you have a tighter match between that responsibility for lender of last resort functions and the knowledge that can 

31 

only come for some role going forward. It is very important in the 

payments area, where we have substantial responsibilities now, 

that you have a little more clarity about who is accountable for a 

level playing field and a broader systemic stability. And it is very 

important in crises that have systemic implications that we have 

a consolidated framework. 

That basic framework is very consistent with the responsibilities 

we have now, but our system has changed a lot since that was designed, and so we just need to look at how to make sure we get 

a better match between responsibility and authority. 

Mr. WILSON. Thank you. We will certainly try to do that. 

Thank you, Mr. Chairman. 

Mr. COX. Mr. Chairman, if I might, just before this next round 

of questions, clarify my response to Congressman Garrett. I was 

not sure in his question whether he was asking about brokers’ individual or required margins. The question that I answered concerned required margins. Required margins did not change. But it 

is also the case that brokers can raise their own marginal requirements. We don’t have data about that at this hearing, but if Congressman Garrett would like that for the record, we would be 

happy to provide it. 

The CHAIRMAN. Thank you. 

Mr. McHenry. 

Mr. MCHENRY. Thank you, Mr. Chairman. This question is to 

Chairman Cox. 

There is wide agreement that the credit rating agencies need to 

be reformed, and there needs to be reform instituted by them as 

well. Your rulemaking goes a long way towards that end to resolve 

some conflicts of interest and create some greater transparency 

within the credit rating agencies so the market can truly know 

what is happening. And I believe we need to ensure that issuers 

and originators are providing credit rating agencies with adequate 

information on assets underlying a structured security. 

So does the SEC currently have the authority to ensure that 

originators and issuers are providing NRSROs the information they 

need to rate structured securities? 

Mr. COX. Our authority under the Credit Rating Agency Reform 

Act runs to the rating agencies. But we certainly have authority 

concerning their disclosure of the information upon which they rely 

and their internal procedures for using that information. We don’t 

have the authority in statute to regulate precisely how they come 

up with their ratings, nor do I think that you want the Federal 

Government to regulate that. We want to deal with that through 

competition and disclosure. But the net result of this, which will 

be covered amply in our very sweeping set of rule proposals, is that 

we will get directly at this problem. 

Mr. MCHENRY. Can the SEC intervene when NRSROs, basically 

if the credit rating agency fails to advise the investing public of 

material information? 

Mr. COX. Absolutely. That authority is clearly given to the SEC 

under the credit rating agency format. By the way, these authorities just kicked in last fall. We have been aggressively using them 

since that time. But there has been a great deal of change in that 

industry in just a few months. 

32 

Mr. MCHENRY. I have legislation, H.R. 6230, which would clarify 

the intent of Congress that the SEC has this authority and the 

prudential steps thereafter to take action here to further clarify 

that. 

Mr. COX. I have not reviewed that legislation, but I think we 

would welcome that authority, because it is consistent with the authority I believe that Congress meant us to have. 

Mr. MCHENRY. Because in terms of material information, I think 

that has to be clarified so that you can take those actions and steps 

necessary. Because, after all, part of the credit challenges that we 

are facing currently are because the credit rating agencies did not 

accurately detail the risks in the marketplace and actually rate 

products effectively. 

And another question for both of you, but starting with you, 

Chairman Cox, is the SEC—and to you, Mr. Geither. Are you all 

studying the implications of the FASB fast tracking and elimination of the qualified special purpose entities? Basically, what allows for securitization in the marketplace. Are you studying the effects that this rulemaking—because they are trying to push it and 

have it implemented by the end of the year—could have in the 

marketplace? 

After all, in my opinion, the Federal Reserve, but more importantly the Treasury, stepped in on Fannie Mae and Freddie Mac 

because of a report, a Lehman Brothers report, that explained the 

risks going forward with the FASB rule the possibility that they 

might need $75 billion in capital. And that was just based on an 

assumption that the rule would go into place. 

So this FASB rule about qualified special purpose entities, if you 

could discuss that. 

Mr. COX. I think it is wrong to say that this is being fast tracked. 

I think the likely scenario is that there will be a period for public 

comment, consideration, and that— 

Mr. MCHENRY. They have said publicly they want to have it done 

by the end of the year. 

Mr. COX. And in terms of effective dates that they are considering in their proposals, we are talking years into the future. 

Mr. GEITHNER. Could I have— 

Mr. MCHENRY. So is that, no, you are not studying it? 

Mr. COX. Well, the answer to your—I am sorry, if you asked a 

yes or no question, the answer is yes. We are not just studying it, 

but we have discussed it extensively with the FASB. We have also 

discussed it with the Federal Reserve Bank of New York. And just 

yesterday I discussed this with Chairman Bernanke. So we are 

very, very focused on this, and we understand precisely the environment in which we are operating. 

So on the one hand we have the important question of reforming 

accounting in this area, something the President’s Working Group 

asked the FASB to do in March of this year. On the other hand, 

we want to make sure that the discussion of this and the implementation of this is conducted in such a fashion that the market 

can absorb it and it doesn’t create any unnecessary shocks. 

Mr. MCHENRY. Mr. Geithner. 

Mr. GEITHNER. I just want to reinforce exactly what Chairman 

Cox said. Of course we are studying this carefully. And you are 

33 

right to point out this has very substantial implications to the dynamics of this crisis. 

There are a range of issues in the accounting area, not just the 

treatment about balance sheet commitments, enterprises, that need 

to be thought through. And there are implication with changes in 

the capital regime, too. I think it is important that those be done 

thoughtfully and carefully, and be done in a way that doesn’t add 

to uncertainty and risk, amplifying what is still a pretty special set 

of tensions in the markets today. And I welcome Chris’s careful attention to those issues and willingness to consult more broadly 

with the Fed and others about those implications. 

The CHAIRMAN. I will recognize myself. 

First, there was a reference previously to one of the great fantasy 

figures that is now circulating, and that was the $5 trillion obligation that theoretically just passed the vote yesterday. Nonsense 

rarely gets so graphic—$5 trillion is the total value of all the mortgages held by Fannie Mae and Freddie Mac. If none of them ever 

paid a penny, presumably there would be a $5 trillion loss. No one 

thinks that is remotely realistic in any case. Nothing that the 

House did yesterday or that the Senate will do or that the President will sign, misguided though some consider him to be in this 

regard, will obligate us to anything if those mortgages don’t pay. 

But, again, we ought to be clear about the $5 trillion figure. It 

is based on an assumption apparently that there would be a liability because all of the mortgages they hold would fall to zero, that 

none of the houses behind them would be worth anything. Not a 

serious figure. 

I want to talk about one potential conflict we have had and it affects both of your organizations. We have to think about this going 

forward. Between actions that protect investors and the integrity 

of the market and systemic stability, and there are times when 

those two could theoretically fall in different directions, and we obviously want to make sure we can reconcile those. And then that 

has implications for, are there two organizations or one organization? In terms of one specific example, mark to market; clearly investors are entitled to know what is the real value of whatever it 

is they are asked to buy into. It is also the case—and I thought Mr. 

Cox’s phrase, warning us against hard wiring consequences, here 

was a useful one. 

It is also the case that going not simply to a mark to market requirement, but insisting that various consequences immediately 

follow on the mark to market could have a procyclical effect, and 

that our interest in fully informing the investor by mark to market, 

if we are not careful, could generate negative consequences. No one 

is, I think, suggesting or should expect to be able to suggest that 

we back off mark to market. But I thought Mr. Cox would take 

some unusual steps. This is an example of how we could combine 

investor protection, which is part of what mark to market is, but 

also with some concern for the stability of the system by having 

some flexibility in the consequences as to how much capital has to 

be raised and how quickly, as to whether or not other entities have 

to divest. 

There is a question about mark to market. I will take my own 

case, my investment is largely in Massachusetts municipal bonds 

34 

because that is the only investment I can make without members 

of the media harassing me any more than they already do, because 

I presume people would think it is in my interest as a Member of 

Congress to support the financial structure of Massachusetts even 

though I wasn’t helping. In fact, I work against interest because I 

think the municipalities pay an unfairly high-risk premium from 

which I benefit. And I wish that I was getting less interest because 

I wish people weren’t being overcharged. 

But the point I want to make is this: I don’t plan to trade those 

things. I plan to hold them for my retirement. Marking them to 

market is really irrelevant to me to some extent because I am looking at the interest going forward. So I guess—let me just put the 

question now: Generally, what guidance can you give us and will 

you be giving us on how you reconcile those two, and particularly 

if you take sort of investor protection actions at a time like now 

when there is weakness, can you avoid procyclicality and is mark 

to market an example of this? How can we handle it? Let me begin 

with Mr. Geithner. 

Mr. GEITHNER. Those are deep existential fundamental theological questions for people involved in the central bank and supervision. And I personally don’t know how we get a better balance 

between the accounting regimes that now apply, particularly to 

those institutions that exist to quota the system. But I would just 

say one basic point is that what you want to assist is have a system where you have a level of cushion in terms of capital reserves, 

liquidity, etc., in the good times that you can allow so that when 

things change, confidence erodes, risk goes up, that those cushions 

are stabilizing rather than destabilizing. 

If you run a system where people hold cushions that are too thin 

against plausible states of the world because they expect to be able 

to catch up and raise those in extremis, then you risk amplifying 

the crisis. And what you need to do is make sure you look at the 

interaction between the incentives we create for capital and those 

created through accounting regimes to make sure that they reinforce that basic objective. But this basic issue of procyclicality, very 

complicated, and you have very thoughtful people spend a lifetime 

advocating the benefits of both those regimes, and we live now in 

a somewhat uncomfortable middle. 

The CHAIRMAN. Mr. Cox. 

Mr. COX. I think, first of all, you are absolutely right about the 

general perspective of investors when it comes to fair value accounting. Investors appreciate it. On July 9th of this year, the SEC 

hosted a roundtable, it is what we call our hearings, on this topic; 

and we heard from a wide variety of participants in the marketplace. The general consensus was that fair value has been a help 

to investors in these difficult circumstances. They want more of it, 

not less of it, and that it has not been the cause of volatility in the 

markets or other problems that we have seen in the current market turmoil. 

We, also at that same roundtable, got into the kinds of issues 

that Tim is talking about. There are, particularly in Europe as they 

consider fair value, existential questions about fair value or not. I 

don’t think we are having that debate just now in the United 

States. The real question is, you know, at the margin when you are 

35 

away from instruments that the market generates prices for and 

you have a model that is trying to generate your price, but at the 

same time that asset is throwing off some cash, do you have to 

value it at zero? There are practical questions that people want answers to, and we are hoping that we can provide those answers in 

something like real time in the form of guidance. I don’t think that 

there is, when it comes to fair value, necessarily a conflict between 

the investor protection mission and the systemic risk mission. I 

think fair value, properly used, can be very helpful. 

The CHAIRMAN. Let me ask you, you did talk though, about the 

danger of hard wiring, when you say—and I agree, I don’t think 

anybody should be backing away from the fair value. And it is a 

good way to call it that. But there has been a set of rules in place 

that have had some consequences automatically flow from a downward valuation. And the question is whether we should explore 

flexibility there. 

Mr. COX. I think there is a lot of need for people to be able to 

understand what fair value accounting is all about. And depending 

on which investors you are talking about and in which country, 

sometimes those questions are very acute. There are some significantly counterintuitive results from fair value accounting that can 

startle some investors. For example, when fair value accounting is 

applied to your own debt on your own balance sheet when your 

debt becomes less valuable, it runs—in other words, your firm is 

doing worse, that generates income that you then run through the 

income statement. 

So I think there is a lot of work that we can do in terms of investor education so that people understand how to use these accounting tools. And those are all legitimate questions when it comes to 

fair value. 

The CHAIRMAN. We are going to have votes soon. We can say stay 

until the votes come. Let me ask my colleagues to each ask one 

question, the three who remain. Would that be fair? The gentlewoman from New York. 

Mrs. MALONEY. First, I want to welcome all of our witnesses, 

particularly Tim Geithner from New York. So I have to put that 

in. 

Chairman Cox, in your recent op-ed in The Wall Street Journal, 

you wrote that for financial institutions whose lifeblood is trading, 

not lending, there is yet no agreement upon apples to apples, comparison of balance sheets and leverage metrics. Regulators must 

determine whether the different kinds of risks both types of institutions bear within the context of their business models are appropriate for our financial system as a whole. 

And one of the concerns that I have had that many people have 

expressed since the collapse of Bear Stearns is that certain entities 

have become overleveraged. How much is overleveraged? How do 

you determine to balance that in the future? And as you pointed 

out in your comments, it is hard to have an apples-to-apples comparison of balance sheets and leverage metrics. Do you think that 

we need to have a mechanism that allows for an apples-to-apples 

comparison? And if so, how would you suggest that we do this? 

Another question connected to this is, as we move forward with 

reorganization, many of my constituents have expressed concerns 

36 

of putting too much power into the Federal Reserve, whose primary 

focus is monetary policy. Will that diminish their ability to be effective on monetary policy and are we putting too much in one area? 

Thank you. 

Mr. COX. The apples to apples comparison is emerging day by 

day. It is really one of the things that we are focused on in our collaboration, the SEC’s collaboration with the New York Fed, and 

with the Federal Reserve Board. Obviously, for some of the very accounting reasons we were just discussing, there are significant differences between the way commercial banks, investment banks report for financial reporting purposes. There are, though, sometimes 

translate into differences in the way regulatory capital is computed. But as we are now getting information from the Federal Reserve about financial holding companies so that we can look at 

what had been, you know, treated as banking regulatory beasts for 

regulatory purposes up until now in a more holistic way and they 

are getting from us investment bank holding company information 

so that they can take a look at things in a more systematic way 

as well. 

That is generating the need to be able to compare all this and 

analyze it under some if not common metrics then at least common 

principles. So this is a work in progress and we are very, very busy 

at it. Ultimately what accounting regulators do also matters here. 

The CHAIRMAN. Mr. Geithner. 

Mr. GEITHNER. Just two quick things. The Federal Reserve cannot bear the sole responsibility for responding to the kind of challenges that the United States is going through. I think that the 

Fed has an important role but I think as the Congress has recognized, the Administration has recognized and it is truly in all financial crises. You need a set of policy measures to be responsive 

to these challenges. And monetary policy cannot bear the sole burden of responding to those challenges. We have been very careful 

to make that line there. 

On the broad question about scope of authority, what I want to 

underscore again is how important it is not to give us broader responsibility without authority, that we cannot compensate for— 

without basic authority. If you gave us more responsibility, that 

would probably come with a broader increase in moral hazard, with 

less capacity to mitigate that risk. And getting that balance right 

is very important. 

Mrs. MALONEY. Thank you. 

The CHAIRMAN. The gentleman from North Carolina. 

Mr. WATT. Thank you, Mr. Chairman. Let me start with the assumption that we are not going to do anything else this year after 

yesterday. It took us forever to get the Senate to do what we did 

yesterday. So in this discussion, I am really more looking at the 

longer-term reform issues. And it seems to me that the only person 

who has really done any creative proposals and suggestions about 

that has been Secretary Paulson. 

I was pretty aggressive with him because he left some gaps in 

what he proposed. But at least he came out with a proposal that 

is a real reform proposal under which he suggested a regulator that 

deals with market stability across the entire financial sector, a second regulator that focused on safety and soundness of institutions 

37 

supported by Federal guarantee, and a third regulator focused on 

protecting consumers and investors. Everybody else who has been 

here, including, with all due respect, all of you today, has been tinkering around the edges of the existing structure rather than looking creatively at a more comprehensive reform of the regulatory 

structure. 

And it is the third of those really that captures my attention 

more than anything else, which is the protecting consumers and investors regulator, which I think the markets, the economy, everything you all have talked about will always get taken care of based 

on my experiences. It is the consumers and the investors that I always worry about. 

The proposal that I have heard that—not in this room but off the 

record—is that since most of what consumers and investors are 

buying now are products, financial products, that we ought to be 

creating something like a consumer protection agency or an Environmental Protection Agency or some kind of agency that protects 

people against bad toys or you know that kind of thing. And so I 

want to ask your opinion about two things, and you probably won’t 

be able to do it in answers. Just give me the—and particularly, 

Chairman Cox, give me your—if you would—your suggestions 

about responses to Secretary Paulson’s overall proposal, these three 

different areas of regulation. 

And number two, what is your reaction to a really robust protector of consumer and investor interest patterned on somebody 

who is really going to look out for how do you give them the authority they need to do that? I know they can’t do that. 

The CHAIRMAN. Let him start with the second because they did 

touch, to some extent, on the first before. I would ask that they hit 

the consumer product safety piece, because we did get some response earlier on the broader plan. But if we could get that. 

Mr. COX. In financial services, consumers are investors indeed. 

And the investors’ advocate is the Securities and Exchange Commission. I think when one looks at the Treasury Blueprint, it is a 

little bit difficult to find precisely where existing regulatory functions fall, in which box, and whether—some people have inferred 

from this report that it would enlarge the responsibilities of the 

SEC, and others that it would substantially diminish them. The 

point of my testimony today is that we don’t need to remake the 

world. We have a lot that works and what works in particular is 

the idea of a regulator whose foremost responsibilities are investor 

protection, making sure that we have orderly markets and making 

sure that we promote capital formation. The mutual reinforcing aspects of the different responsibilities of what the SEC does, for example, understanding the business of investment advisors, understanding the business of mutual funds, understanding the business 

of investment banks and broker dealers, regulating public companies, and getting honest disclosure to the market, all of that is vitally important to our enforcement function and vice versa. 

And so to have a strong consumer protection regulator, you need 

these supporting buttresses. I don’t think one can imagine a design, a mission for a regulatory agency that has investor protection 

more clearly at heart than does the existing charge for the SEC. 

So I don’t think that we need to remake that in any respect. 

38 

Mr. GEITHNER. Could I just add one thing? 

The CHAIRMAN. Yes. 

Mr. GEITHNER. It is very important to focus not just on the 

standards and the rules, but also on improving the consistency and 

enforcement of those rules. Because you can very carefully design 

rules with appropriate protection for consumers, but if you allow 

vast disparities in how they are enforced across different institutions, what you have just created is incentive for that to move 

where enforcement is weaker. 

So as part of thinking through this, you want to make sure not 

just that you get the broth standards right with the appropriate 

balance between consumer protection and other objectives, but that 

you have oversight enforcement incentives for complying that are 

more even. And that is a complicated thing to do in a country designed as ours is with a Federal structure and a lot of competing 

authorities. 

The CHAIRMAN. The gentleman from Massachusetts. 

Mr. LYNCH. Thank you, Mr. Chairman. Let me go one step further, and this is sort of related to the chairman’s question about 

investor protection. 

I agree that we need a strong regulator. But I also believe that 

some of these instruments, as you said in your opening statement, 

Mr. Geithner, that our current laws and regulations were put in 

place when we had a much different market. And they don’t necessarily address the situation we have today. 

I think one of the fundamental needs of our reform system, and 

I wish it was in one of your lists, is basic understanding within the 

market, by the market, by the individual investor. And it is great 

to have a policeman in the background of a strong regulator. But 

the best protection would be allowing the investor to protect themselves. And I have to tell you, I think Warren Buffett was right. 

He calls some of these complex derivatives the financial weapons 

of mass destruction, and he predicted this whole fallout. 

These complex instruments, the CDOs, the credit default swaps, 

these complex derivatives, based on models are so complex, our 

own rating agencies couldn’t figure out who owned what or how to 

value them. And when I asked Mr. Bernanke at our most recent 

hearing who was addressing this, he indicated that you were, Mr. 

Geithner. So I hope he wasn’t throwing you under the bus. Can you 

tell me what we are doing to just equip the investor with the ability to make those smart determinations on their own? 

Mr. GEITHNER. I wish we had the power to do that. I completely 

agree with you, that people who take risks should understand the 

risks they are taking and make sure they are not taking risks they 

cannot handle and absorb. That is a very hard thing to do with regulation. What you want to do is to design a system that doesn’t 

prevent people from losing money and making mistakes because 

that is inevitable. What you want to do is make sure you run a system where the consequences of those mistakes are less damaging 

and consequential for the more prudent and for the economy as a 

whole. And that balance is very hard. I think, again, the fundamental objective is to try to make sure that the institutions at the 

center of this system are run with a set of shock absorbers against 

all the risks they assume, in derivatives and elsewhere, so they can 

39 

withstand pretty bad outcomes. And you want to make sure that 

the infrastructure is able to better deal with the consequences of 

default by major institutions. 

Mr. LYNCH. I am talking something much more basic. I am just 

talking about price, putting the right price on this product, how do 

you do that? 

Mr. GEITHNER. I think you can’t do that with regulation because 

fundamentally that price is set by the people who are on both sides 

of that— 

Mr. LYNCH. What about a clearinghouse or something of that nature that could vet some of these derivatives? 

Mr. GEITHNER. Absolutely. So for the standardized part of the 

credit default market, which is very large now, there is a very 

broad basis support in the dealer community to move that into a 

central clearinghouse over the next 6, 12, 18 months. And they are 

likely, I believe, to move quite quickly to take the standardized 

piece into that structure with appropriate risk management framework so the system stays safer. That is a very valuable thing. 

There are other things you can do in terms of disclosure that would 

also help that broad outcome which we are, along with Chris Cox 

and a whole bunch of others, are working very hard to advance. 

And I completely agree with you. Fundamentally what you want 

is people to better understand the risks they are taking and not 

take risks that are going to threaten their viability if that is going 

to have consequences for the system as a whole. 

Mr. LYNCH. I yield back, thank you. 

The CHAIRMAN. The gentleman from Missouri. 

Mr. CLEAVER. Thank you, Mr. Chairman. Mr. Cox, during my 

term as Mayor of Kansas City, there was a vicious rumor put out 

about our police chief and what he did was—I didn’t think it was 

possible—he put some detectives on it. And they just went from 

person to person to person, who told you, who told you, who told 

you? It eventually landed on the desk of a secretary who confessed 

that she was just joking. Of course she wasn’t. And she was fired. 

And so I know it is possible to track down a rumor. And the rumors 

that caused the collapse of Bear Stearns is more than just some little harmless rumor about sex. It is a rumor that has done devastation to our economy. 

I know that you have said that you are interested in this rumormongering. But does the SEC investigating unit deal with this? Or 

is there a financial purgatory section existing out here where we 

have no one that deals with that? Or do we need a rumormongering monitor with some teeth so that when people spread 

these rumors, they pay? Bear Stearns was the smallest, most vulnerable of the big five. Now Lehman Brothers is. I mean, what can 

you say that would cause the people who do this on Wall Street to 

tremble? 

Mr. COX. Well, first of all, you are right, that in the circumstance 

that you outlined or in any market circumstance, it is possible for 

people to believe false information and make decisions based upon 

it. We have to make sure that this variant of false or misleading 

information, which is really what our whole honest public disclosure mission is all about, gets interdicted as early as possible. PreVerDate Aug 31 2005 16:25 Nov 12, 2008 Jkt 044903 PO 00000 Frm 00043 Fmt 6633 Sfmt 6633 K:\DOCS\44903.TXT TERRIE
40 

vented if at all possible, which we can do through the public example of our ongoing enforcement examinations. 

That is why this year we have been very high profile in what we 

have been doing in this area. As you know, we brought the firstever case in the Agency’s history this April where because of technology, we were able to do what you did in a different environment, 

in the market context. The individual who had manufactured very 

specific information about price, time and so on, board action of a 

prospective merger and put it in the marketplace so that he could 

trade on the false information was tracked down through his instant messages. 

So the same technology that is spreading these rumors around 

the world faster than ever is also now the friend of law enforcement. We have also announced a very significant sweep examination. The former case that I talked to you about was from our division enforcement. But our Office of Compliance Inspection Examination has also now joined with FINRA, the New York Stock Exchange regulation, to do a sweep examination of broker deals and 

hedge fund advisors to make sure that the existing rules, because 

there are rules, very specific rules against spreading these kinds of 

rumors, are being enforced, that there are programs in place so 

that there has to be compliance. Because sometimes it can be someone who is just working at a desk. And the firms that employ these 

people have to be responsible for implementing compliance control. 

So we are going at it that way as well. Enforcement and examination. 

Mr. CLEAVER. We don’t need any new laws? 

Mr. COX. I think we have a lot of laws. We also have a lot of law 

enforcement and regulatory attention. Best of all, we have some 

technology now that is helping us in an area that in the past has 

been very difficult. Because what you described was parsing the 

difference between the person who started it and then mere intermediaries who were passing it along. Passing around what you 

heard is not a problem. Markets thrive on information. Markets 

have to evaluate whether it is true or false. But the people who are 

deliberately putting false into information into the mix, those are 

the people you want to go after. 

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

The CHAIRMAN. The gentlewoman from California will finish. 

Ms. WATERS. Thank you very much, Mr. Chairman. I came in at 

a time when Congressman Watt was raising some questions about 

protection for consumers. And my staff had talked with me about 

the notion of suitability in the lending and broader financial services industry. It gets down to a discussion that was, I guess, led 

by Harvard law professor Elizabeth Warren’s notion of the financial product safety commission as analogous to the Consumer Product Safety Commission. 

Have you been involved in any extended discussion or given any 

thought to this idea of a Consumer Product Safety Commission 

that would be for either—well let’s start with Chairman Cox. 

Mr. COX. I think the idea of taking a look at insurance products, 

at derivatives products, at securities, at all financial products, 

which presently fall within the rubric of—and the jurisdiction of a 

41 

variety of regulators has a certain appeal. It also has a certain danger, and that is, that it might be so ambitious as to fail of its own 

weight. Because, as you know—I was just talking with Secretary 

Chertoff about this because during my 4 years chairing the Homeland Security Committee and the work we have spent here in Congress trying to do something similar in the homeland security area 

caused me to ask the basic question, what is the line, where are 

you better off merging things? And where are you better off sharing 

with existing structures? That is an issue that Secretary Chertoff 

is still managing within the Department and outside of it. 

I think it is vitally important to recognize the connection between the sophistication of law enforcement. President Geithner 

was talking about the enforcement piece and how important it is. 

The sophistication of that enforcement is really what makes the 

difference. If it weren’t necessary, we would just have the NYPD 

or the Los Angeles Police Department go after this as a matter of 

routine law enforcement. But the cops on the beat really have to 

understand these markets. The products are very sophisticated. 

The trading techniques are very sophisticated. They are global 

markets. There is a lot of complexity here. Indeed I would go so 

far as to say that in all the major market disruptions and frauds 

that we have had, complexity has been a significant ally of the 

fraudsters because they kick a lot of dust up in the air, and they 

get away with things because people don’t understand at first what 

they are doing. 

So there is a trade-off that has to be made. I like the idea of knitting this together as much as we possibly can. The question of 

whether you actually try and merge functions all into one agency 

gets a little harder because, you know, mergers present management difficulties. There are other organic statutes that are administered that might not fit together. There are a lot of complexities 

there as well. 

Ms. WATERS. President Geithner, I am very concerned about 

what we are experiencing in the subprime meltdown. What disturbs me is, there were so many products that were introduced into 

the market. And it appears that there was no oversight responsibility for the no doc loans. They are not sophisticated ARMs. They 

are just trickery ARMs. The ARMs that have the teaser rates at 

the beginning, that are very low and then the resets quadruple. I 

mean, there is nothing sophisticated about that. Rather, it is organized in such a way that it entices, it encourages, and it supports 

people getting into situations that they cannot control and they 

cannot afford. And there are those who say, well, the consumer 

should know better. It is their responsibility. I take a little bit different approach. 

The average working man or woman who goes to work every day, 

who may be very well-educated, who is raising their family, who 

is trying to make the best use of their dollar, paying their bills, 

they don’t know about these trickery products. Most of the Members of Congress didn’t know about these products. Nobody reviewed these products and said to the initiators, I don’t know. This 

looks a little bit difficult. I think this is going to create some problems in the market. And that is what I am talking about. I am 

talking about a kind of consumer protection that does not assume 

42 

that the consumer is just a little bit too dumb, a little bit too stupid 

to understand these sophisticated products. What do you think 

about this Consumer Product Safety Commission idea? 

Mr. GEITHNER. I haven’t looked at that specific proposal, but I 

want to underscore the point that the Federal Reserve Board did 

put out for public comment some pretty comprehensive changes to 

underwriting standards last week, I believe. And I think they 

would go some direction to meeting many of the concerns you laid 

out. The challenge, of course, is to make sure that they are evenly 

enforced. And you want to really make sure you are careful not to 

make sure that working family you described is unable to borrow, 

to meet the needs of health care or to finance education or to help 

create a business. 

And finally getting that balance right is important. I don’t think 

we have that balance right today. I don’t think anybody can say 

that. And it is going to require things like what the Federal Reserve Board laid out last week as well as a broader improvement 

in the sophistication and quality of supervision oversight and enforcement of the full range of institutions that are engaged in making those kind of loans. 

Ms. WATERS. Thank you. If I may, there is just one other question that I have. I have gotten a partial answer from some of the 

staff members back here. I had an opportunity to meet with minority bankers. Some of them were from the Gulf Coast area, New Orleans in particular, who had experienced considerable destruction 

during Hurricane Katrina. And they were complaining about not 

getting a lot of support, a lot of help from anybody. Of course, they 

brought up Bear Stearns, look at what happens when Bear Stearns 

gets in trouble, but nobody is there for us. I don’t know a lot about 

the use of the Federal Reserve discount window. Is this available 

to these bankers? 

Mr. GEITHNER. If they are banks, they have access to that window. 

Ms. WATERS. How does it work? 

Mr. GEITHNER. You have the ability to come and borrow from the 

Fed under a set of conditions. And that privilege existed before 

Katrina, before Bear Stearns. It exists today. 

Ms. WATERS. Did any of the banks who had been impacted by 

Katrina take advantage of the opportunity to borrow from the discount window? 

Mr. GEITHNER. I would have to consult with my colleagues in the 

Fed and get back with you in writing on that specific question. 

Ms. WATERS. But you don’t remember any discussion that you 

were involved with anyone? 

Mr. GEITHNER. Well, I am responsible for the institutions of New 

York and can’t speak to the others. 

Ms. WATERS. Okay. 

Mr. GEITHNER. What we do disclose once a week is broad use of 

our facilities. We never disclose individual institutions for a bunch 

of understandable reasons. But yes, they have access to those facilities today and have had for some time. 

Ms. WATERS. Thank you very much. I think I am the only one 

left, so there can’t be any other questions. I was not given permisVerDate Aug 31 2005 16:25 Nov 12, 2008 Jkt 044903 PO 00000 Frm 00046 Fmt 6633 Sfmt 6633 K:\DOCS\44903.TXT TERRIE
43 

sion, but I am going to adjourn this hearing. Such is the order. 

Thank you. 

[Whereupon, at 12:39 p.m., the hearing was adjourned.] 

(45) 

A P P E N D I X 

July 24, 2008 

46 


44903.001
47 


44903.002
48 


44903.003
49 


44903.004
50 


44903.005
51 


44903.006
52 


44903.007
53 


44903.008
54 


44903.009
55 


44903.010
56 


44903.011
57 


44903.012
58 


44903.013
59 


44903.014
60 


44903.015
61 


44903.016
62 


44903.017
63 


44903.018
64 


44903.019
65 


44903.020
66 


44903.021
67 


44903.022