produce and bottled water from a local economy? @@@@ it is sort of emotionally reassuring to see pop tarts and everything else. on the other hand, afghan farmers are looking for markets. the afghan economy is something we need to prop up in order for them to be successful. the alternative is to grow opiate.

if you can buy more produce from the afghan economy, it makes a lot of sense. obviously, you have to take security measures. our soldiers are walking the streets every day in afghanistan. i think they can afford to eat a afghan tomato. propping up the economy is one of our best ways to succeed and give the afghan people some hope. that is just one example. on the economy, we have about 50 or 60 donor countries doing their own thing in afghanistan today. they all do a little bit in one part of the country for another. we need a stronger overall strategy. we now have general microscope back up by general rodriguez -- general mcchrystal.

i would suggest we ask the european to take the lead. and have a strong international aid coordinator. host: you mentioned in this article it could be european or japanese officials. guest: i think that makes sense, partly as a gesture of solidarity. the brits have now taken 175 fatalities. we have seen incredible efforts out of some of our partners. they deserve a little more appreciation. we do need a strong central command on the military side. that has to come from the united states. on the economic side, the europeans are good that this sort of thing. i would submit that we might ask them to take a stronger coordination role. host: on the republicans line, charles from richmond, va.

let's go to carol on the independent line from georgia. guestcaller: good morning. thank you for c-span. we have no business being in afghanistan in the way we're doing it. if we want to win the minds and hearts of the afghan people, we do need to give them food and shelter and stop bombing the schools for the children. we will have a great loss of our men and women in afghanistan. we are taking the wrong approach. do you know the reason why they will back the taliban? that is because it is the only choice. i have watched programs on free- speech tv and link tv. we have bombed innocent people,

innocent women, and children. the steeple are suffering. when is the war going to stop? -- these people are suffering. when are we going to look at ourselves as american people and decide we will not put our tax dollars into killing people? we can win the world economy if we can help other nations instead of killing them. guest: thank you for the powerful point. there have been big mistakes made in this war, no doubt. if you add up all the afghans that have been killed by accidental nato air strikes in the entire war, it may be a couple thousand people. that is a couple thousand too many, but there are 7 million kids in school in afghanistan who were not in school under the taliban. under the television, there were less than 1 million kids in school at any time -- under the taliban. that is a bit of congress would because of the change of regime that has occurred -- that is a

big change because of the change in regime that has occurred. i think we need to protect the schools and these health clinics well enough so that more afghans can make use of them, that they will not be destroyed by the taliban. i do not think the afghan people want the taliban back. they bought new strategies -- they want new strategies. they are angry when we do not do enough. they assume we are all-powerful. i think we have to prove that we are committed, we will help them protect the schools and health clinics, complete the big road projects. i think we're at the verge of turning this thing in a positive way. 7 million kids in school is a huge accomplishment. 1/3 of them are now growthirls.

i do not think it is a hard comparison to realize that things have gotten better in afghanistan. unfortunately, it is not stable and not good enough. host: the article in "financial times." how much does poppy and opium, and to play? guest: a huge part. the police in afghanistan are very corrupt. a big part of why they're corrupt is because they're involved in the drug trade. the police are not dependable, the local population do not believe in the strategy. they see the taliban as the only alternative. i do not think too many view the taliban as for jews, but they might feel like they're getting a straight deal -- i do not think too many people view the taliban as virtuous, but they

might feel that they're getting a trade deal. and working to moves with drug dealers and allow those people to get through. this is probably the most important way in which the drug trade is competing our effort by corrupting a lot of the institutions, including the police. if we can build up the afghan army and the legal system, we can basically leave. they will have strong enough state control of their own territory that they can probably win this thing on their own over time. if we cannot build up strong and dependable organizations, then we are in trouble. host: we have a comment from twitter. let's go to our next caller, bob

on the democrats' line from texas. caller: good morning. i it to me with the gentleman totally. we are used to instant gratification. we want a microwave solution to everything including more. in reality, i think it will take 20 years before we see the progress of cabalism type of -- capitalism type of paradigm in afghanistan. there's also the problem of the islamic hurdle. as people get educated and realize they do not have to rely on drug money to get an education. some of the things we have lost track of -- i think we will see a change there. we just have to be patient.

we have to stick to our resolve. the reason why we see the world we see it today is because we had strong religious reform and also, industrial growth. it is a battle of philosophy. you cannot win that with bullets. some people are willing to die for their rigid beliefs. guest: i think it is well said. the taliban does have an extreme distorted view of islam. there were elements of the taliban philosophy in the 1990's that appealed to afghans because they sensed a certain sincerity and a certain commitment and a certain devotion. it became quickly apparent -- there was also this brutality, this cruelty, and this wanting to go back to the seventh

century. this very rigorous fundamental form of islam. then the taliban became cruel and ruthless. the afghan people are a devout people and very committed. they do not want this extreme distorted view of his loislam. the only way the taliban can be successful is if the state is so weak that there is no alternative. there's a vacuum. and then create a minimal level of support in that way. we need to give the mainstream afghan people the tools to be able to take that on. that means a strong government

and strong security institutions. host: what effect does the capture and video release of the private from idaho -- what affect is that going to have now? we have not seen this from afghanistan lately. do you think this will have an affect on the public opinion of the war? guest: to be direct, no. we all feel for this captured soldier. capturing hostages and using them to try to distort the public view, that is something we were much more vulnerable to in the 1970's, 1980's, and 1990's. after 9/11, something changed. americans realized that if we gave in in order to free this one hostage, that would trivialize the casualties of the

war, and it would impede the war effort. more lives would be lost in the end. because we did not take the risk of may be losing a few dozen people. americans have learned that if you take the easy way out in the short term, sometimes to pay a much higher price of a longer- term. i hear no debate proposing that somehow we deal with the captors of this hostage and given to their demands. no one has said that. we're all preaying for this soldier. host: michael joins us on the republicans line from pennsylvania. good morning. caller: good morning.

i'm very glad to hear you talking about infrastructure. it is my belief and my experience that as we provide infrastructure and education, we're giving the afghans eighta chance to become a country. this is rice flatly disagree with you. at this point in time, there's a substructure were afghans -- this is where i slightly disagree with you. you have a group of very independent, strong minded tribes. hopefully we can work to make the different tribal groupings understand that there is an advantage to working together in afghanistan. i wonder if you could talk for a bit about whether we're having any success in combining the

different ethnic subgroups and or tribal groups. guest: thank you. i cannot really disagree with you. you are right. you are emphasizing the strength of the tribes historically. both realities are in afghanistan. you have already seen president karzai tried to build this multi-ethnic group of leaders and his government. sometimes we do not like what he does in the process. we think one of those guys may have been implicated in some atrocities were implicated in the drug trade. i think president karzai does make some mistakes. he is trying to avoid the kind of sectarian divisions that we

saw in iraq@@ bosnia. that gives me some hope as well. you do not have to contend with this incredible hatred that we've seen in other countries around world. host: on the democrats' line, alfred from santa monica,

monicca. guestcaller: in regards to the captured soldiers, we all wish him to return to us. when you consider that president obama, my hero, is trying to release the prisoners who have here based on some liberal agenda of freedom of will over enemies into the world -- i think it is sending the wrong message. we are holding our captured enemies because they were captured on a battlefield trying to destroy us. irish soldier was fighting a just war based on -- our soldier was fighting a just war based on his decision to go into the army.

he knew the risk. i believe our brave soldier is prepared to die for our country. it is important that america does not capitulate to the demands of a small group of individuals. i do not believe afghanistan has an organized army. these are small pockets of resistance. you would be hard pressed to suggest the taliban is willing to be capable of rising up in the story on us from where they are. guest: i think tennis general legal said -- i think that is generally well said. there is not the answer of the united states capitulating over the hostage situation. we're all very aware of his

fplight. i'm sure there are thoughts and ideas percolating above will leave my people to do to secure his safe release. the negotiating with the resistance will not be one of the options. the idea of calling of military operations to give the release of one person with even more lives at risk over the longer term. i am quite confident we will not do that. host: from shreveport, shelton on the independent line. caller: we went into afghanistan because of al-qaeda. we overthrew the taliban, which was the government there, which was totally wrong. the thing of trying to establish some form of government does not

come from outside forces. i do not know where it has been done. it comes from the people themselves. the people have to have the will in terms of the direction and the form of government they want to have. it cannot be imposed. it is a -- it might not be the same as the drougiraq. the mixture is going to be the same case. it is one to be a quagmire. guest: afghanistan might do fine if it had a chance to run its own affairs, but it has not had that chance for the last 30 years. in the 1970's, the soviets did not like the afghan leader.

they overthrew him and debated. they dropped all sorts of bombs on the country. they probably killed 1 million afghans in the process. after we worked with pakistan to drive the soviets, we said, okay, we have given you all these alarms and advice, so now we will leave you to your own devices. good luck forming an umbrella government. of course, it did not work. then the taliban came to power. and they brutalized their own people. some people were grateful at first because there was not this chaos that the outside people that brought to afghanistan. we're normally choosing between and afghanistan left to its own devices and -- we have had nothing but outside intervention for 30 years. it has been malicious. it has been done with a certain type of indifference at best and

cruelty at first in the case of the soviets. i think we owe afghanistan the chance to give them some tools to try to build their own country. you are right. in the end, they have to do it on their own. we can only go so far. we're having outside powers -- i believe we have to give them one serious fair chance to have the tools they need to build the country themselves. i believe there's a decent chance that we finally do this mission the way it's supposed to be done that the afghan people will grab that opportunity. host: from charleston, south carolina, on the republicans line. caller: good morning. i appreciate what you just said. another should assess -- not

allowing the country to become a base for al-qaeda. it does not relate directly to we were talking about. you seem to have different knowledge about the area. people call in all the time and say things like there were no weapons of mass-traction found -- mass destruction found in iraq. the reports i heard is that we were finding elements of tools of mass destruction on a daily basis. i wondered whether you could comment on that. guest: thank you. in iraq, the overall verdict is that we did not really find in the advanced weapons of mass destruction. on the other hand, saddam had such things in the past, so it was reasonable to believe he would have them again.

most of us were of the opinion that he at least had chemical and biological. . -- chemical and biological weapons. there was no reason to think he had not had them. he had brutalized the shia and the kurds. he was a stream dictator. -- he was an extreme dictator. the idea that he would not have those weapons of mass destruction is not something that most of us think about as a plausible possibility. i was wrong, like many others. the most unfortunate conversation was about the potential for him to have a nuclear weapon in short order. he was not close to that. we knew he was not close to that. also the implication that he had ties to al-qaeda by some in the bush administration. there has never been any serious evidence to back that up. on chemical and biological

weapons, most of us felt that he probably had them, and i have to administration give the to some leeway -- i have to give the bush administration wwwwwwwwwwwwwwwwwwwwwwwwwwwwwwww regulator.

barney frank of massachusetts chairs the committee. live coverage on c-span 3. >> -- on how best to do that, even as a fiscal conservative, i was willing to put full faith and credit of the united states on the line in what i perceived to be one of the first truly emergency situations i had seen since coming to congress,

although i hear the phrase every single day that i serve. but as i look closely at firms that may be designated supposedly as too big to fail, the two that come to mind are certainly fannie and freddie. again, these were creations not of a competitive market, but creations in a government laboratory that never would have existed in a competitive market. so i guess i'm convinced that government can create firms that some may view as too big to fail, that can create systemic risk, but i'm not convinced that there aren't more systemic events than there are systemic firms. and i'm not sure as this nation has followed down the line of bailout mania that we necessarily have a whole lot to show for it. as we wake up today, we know since january that 2.5 million

more americans have lost their jobs. we know that i believe it's 9.5% unemployment, we're looking at the highest unemployment rate in a quarter of a century. and i feel that bailout begets bailouts. once we got away, for example, on t.a.r.p. being about financial stability, bailing out chrysler, bailing out gm, many of us said we're going to throw good money after bad. they're going to end up in chapter 11 anyway and roughly $80 billion taxpayer dollars later, they did. how is that fair to ford, who actually had to take on more debt to try to survive. so you know, to what extent is it even fair, to what extent is it even smart, once you go down the road to start bailing out these firms? so many of us fear, i have introduced legislation that would end t.a.r.p., that t.a.r.p. is now, regardless of its noble design back in september, october of last year,

has morphed into a $700 billion revolving bailout slush fund that frankly is doing more harm to the economy than good. now, i do want there to be an opportunity for large financial firms that fall into financial distress to be resolved, resolved quickly. that's why in the republican financial markets reform bill, there is provision that would create in the bankruptcy code a new bankruptcy chapter to do just this. but you know, you got to ask yourself the question, should it be the policy of the federal government to necessarily reward bad business models at the expense of good business models. by the way, apparently c.i.t. was not necessarily on the administration's list of too big to fail, but when apparently uncle sam wouldn't give him a bailout, lo and behold, look what happens. the market comes through. isn't that interesting.

c.i.t., maybe we should say see, i told you so. maybe you ought to give private investment an opportunity to work. again, bailout begets bailout. it keeps private investment on the sidelines. i'm convinced that it is hampering our economic growth, hampering our job creation, and i still look for the proof point that there are firms that are too big to fail and that somehow by putting all this taxpayer liability exposure on the line, we will end up doing ourselves more good than harm. ip not convinced of it. i don't think the american people are convinced of it. so what do we have, we have a nation of bailout mania, trillions of dollars of debt. i think there's a better way. i yield back the balance of my time. >> the gentleman from california is recognized for three minutes. >> thank you, mr. chairman. some say too big to fail. some say too interconnected to fail. some of my constituents just think it's too well-connected to fail.

we need to design a system for the future that is bailout-free. i was disappointed when the secretary of the treasury in testifying about derivatives said in effect by not answering my question that we should continue to allow derivatives to be written today that he reserves the right to seek to bail out tomorrow. we need to return to an economic system where bailout is not a possibility. we need to make sure that the resolution authority is extremely clear that it is not bailout authority. and we are still faced with this issue of what is too big to fail. too big to fail means too big to exist. we cannot put the taxpayer in a position where entities are allowed to grow in their complexity or their size to the point where they can hold the american taxpayer hostage, and say we're going to take risks and if these risks turn out badly, you have to bail us out or the entire economy will suffer. the solution is obvious.

prevent risks from being taken that endanger the entire economy. now, we will be told that taking all these risks is somehow wonderful for the overall wall street system. i don't think the american people want to hear it. they want no bailouts in the future, no possibility of bailouts in the future and they want a system designed where everyone on wall street and everyone in washington can say no bailouts, ever, and if that means that our banks have to be smaller than their foreign competition, that is something i think the american people are ready to accept. so let us talk about breaking up those that are too big to fail before we talk about bailing them out, and hopefully, we can through better capital reserves, better regulation, eliminate both possibilities. thank you. >> the gentleman from california for two and a half minutes. >> thank you, mr. chairman. i would like to thank the witnesses for coming here today to testify and a special thanks

to peter wallison from aei, who for years warned about the systemic threat posed by government-sponsored enterprises, fannie mae and freddie mac. i got to know peter back in the old days, when he was raising these concerns. eventually, the federal reserve itself became convinced that peter was absolutely right and in about 2004, they began to warn on what he was warning, that this represented a systemic threat to the financial system, not just here in the united states but worldwide at one point, the fed chairman said. you know, for years, there was this belief that should fannie and freddie run into trouble, the federal government would support them. after all, they had a line to the treasury. they were a government-sponsored enterprise, and as peter was warning that perception allowed fannie and freddie to borrow at

rates normally reserved for branches of the federal government, to take on excessive risk and produce profits for shareholders and executives while they crowded out their competition. this is normally the result of when you have a government subsidy. this is the consequence. well, the federal government had to step in to save fannie and freddie and this could end up costing taxpayers $400 billion before it's through. besides the effect that it had on the housing market, the collapse of the housing market. additionally, the federal government has taken drastic steps using trillions of dollars to prop up failed institutions because it was believed these institutions were too big to fail. one of the most unfortunate consequences of the massive move to provide public assistance is that moral hazard may become more deeply imbedded in our financial markets. we can and should take steps to eliminate the need and possibility of official bailouts in the future by avoiding labeling institutions as

systematiccally important and instituting a procedure to deal with these institutions as an alternative to the course we seem to be on. this will provide clarity to the market that will reduce the perceived government safety net and lessen the moral hazard problem that has been created in recent months. in terms of the problems we're going to deal with, looming in the future, i think we have to take lessons from the mistakes made and this panel here today, i think, will give us an opportunity to discuss just such issues. thank you, mr. chairman. >> i just want to comment in the remaining time that some of the members have a different view of the hearing than i do. we have heard eloquent arguments against bailout. that's what this hearing is for, to see how we can avoid pressures to do them. this is not a case where it is an assumption that we are going

to have these large institutions and then figure out what we do if they get in trouble. precisely our role is to try to avoid the decision that the bush administration faced as it felt with regard to bear stearns and lehman brothers and merrill lynch. all those happened to the bush administration committed to free enterprise but they felt the consequences of the failures there would be disastrous. they had four different ways of dealing with them, none of them satisfactory to a lot of people, including themselves. so that is precisely the point of this hearing, so that one, you make it much less likely that there will be institutions in that situation because of capital requirements and other things, and secondly, that if you do get to that, there are ways of putting them down much less disruptively and much less expensively. as i said, this is not a replay of last year. it's an effort to try and stop it.

mr. garrett of new jersey for two and a half minutes. >> i thank the chairman. i thank all the members of the panel as well. and specifically mr. mahoney, because i'm going to steal your thunder because i think you made a good point in your remarks. mr. mahoney is the dean of the university of virginia law school and in your remarks, which you will go into more detail, you say that one approach that is used i think which is a republican -- believes it was a mistake to bail out creditors of failed institutions when bankruptcy proceedings were a tried and true alternative option. this school of thought believes policy makers should make it clear going forward that these mistakes will not be repeated and take steps to limit treasuries and the federal reserve's ability to commit funds to failed institutions in the future. i will just say i think this approach is basically in a nutshell what the republican financial service reform plan is all about. the other approach is to concede that the government will not refuse to bail out certain large institutions and attempt to take

steps to deal with the risky behavior. as the chairman just said. but if regulators fail to adequately limit their behavior, then a formal bailout framework will have to be set up in the meantime and firms will be bailed out in a matter of course. so the administration's plan basically is -- follows this blueprint. the administration's approach is premised on the anticipation that regulatory oversight will compensate for misaligned incentives but we know time and time again, regulators have proved behind the curve and unable to keep up with the practices of companies that are tasked with regulating. we don't need to make their job any harder by encouraging destructive behavior through misaligned incentives. i do believe the republican plan is preferable because it is based on a more sound premise. it would reduce moral hazard because companies and their creditors and counterparties would be responsible for the costs associated with their failures, not the taxpayers. and when companies and creditors have their own money on the line, rather than other people's money, sounder decisions are made benefiting the entire financial system. you saw what happened when

fannie and freddie profits were privateized and risks were socialized. we don't want to repeat those mistakes by following the administration's proposal which would create a whole privileged class of new fannie and fred aus while@@@@'$$#rr"dgibrrrrgrr fail imprimatur in the first place. i thank you. i thank from mahoney. >> we will now begin. >> thank you, mr. chairman. i'm really glad you're holding this hearing to focus on the question of systemic risk and how do we avoid getting into this situation again. as you pointed out, i don't think anybody wants more bailouts ever, if we can avoid it.

i think that requires focusing on prevention, how do we fix the financial system, so that we don't have these perfect storms of a huge bubble that makes our system very prone to collapse, and then if this does happen, how do we make it less likely that we will have to resort to bailing out institutions. so i think the task before this committee is first to repair the regulatory gaps and change the incentives and reduce the chances that we will get another pervasive bubble, but however hard we try to do this, we have to recognize that there's no permanent fix, and i think one

concept of systemic risk, what i call macro system stabilizer that we need is an institution charged with looking continuously at the regulatory system, at the markets and at perverse incentives that have crept into our system because whatever rules we adopt will become obsolete as financial innovation progresses and market participants find around the rules. this macro system stabilizer i think should be constantly searching for gaps, weak links, perverse incentives and so forth, and should make views public and work with other regulators and congress to mitigate the problem. now, the obama administration makes a case for such an

institution, for a regulator with broad mandate to collect information from all financial institutions and identify emerging risk. it proposes putting this responsibility in the financial services oversight council, shared by the treasury, with its own expert staff. that seems to me likely to be a cumbersome mechanism and i would actually give this kind of responsibility to the federal reserve. i think the fed should have clear responsibility for spotting emerging risks, trying to head them off before it has to pump trillions into the system to avert disaster. the fed should make a periodic report to the congress on the stability of the financial system and the possible threats to it, similar to the report you heard from mr. bernanke this morning about the economy. it should consult regularly with the treasury and other

regulators but it should have the lead responsibility for monitoring systemic risk. spotting emerging risk would fit naturally with the fed's efforts to monitor the state of the economy and the health of the financial sector in order to set and implement monetary policy. having that explicit responsibility and more information on which to base it would enhance its effectiveness as a central bank. i would also suggest giving the fed a new tool to control leverage across the financial system, while lower interest rates may have contributed to the bubble, monetary policy has multiple objectives and the short term interest rate is a poor tool for controlling leverage -- for controlling

bubbles. the fed needs a stronger tool control of leverage more generally. but the second task is the one you have emphasized in your title, how to make the system less vulnerable to cascading failures, domino effects due to the presence of large interconnected financial firms whose failure could bring down other firms and markets. this view of what happened could lead to policies to restrain the growth of large interconnected financial firms or even break them up -- >> hold on for a second. i get unanimous consent. it's a complicated subject. we don't have a lot of members here. would there be any objection to going to seven minutes for the witnesses? hearing none, the witness gets seven minutes. it's not a lot of time but -- so please continue. >> okay. thanks, mr. chairman.

some have argued for the creation of a single consolidated regulator with responsibility for all systemically important financial institutions. the obama administration proposes making the fed the consolidated regulator for tier one financial institutions. i believe that would be a mistake. it would be a mistake to identify the specific institutions deemed too big to fail and an even greater mistake to put this responsibility at the federal reserve. it's hard to identify systemically important firms in advance. the attempt to do so and cordon them off might encourage risky behavior to move outside the cordon. moreover, identifying systemically important institutions and giving them their own consolidated regulator tends to institutionalize too

big to fail and create a new set of gse-like institutions. higher capital requirements and stricter regulation for large interconnected institutions makes sense, but i would favor a continuum rather than a defined list with its own special regulator. there's no obvious place to put responsibility for regulating financial institutions, but it seems to me a mistake to give the federal reserve responsibility for consolidated prudential regulation of big interconnected companies as proposed by the obama administration. the skills needed by a central bank are different from those needed to run an effective regulatory institution. >> can you finish up if you have a last sentence or two? >> pardon? >> do you have a last sentence or two?

>> okay. let me just conclude, mr. chairman, in short, in short, i think the obama administration has it backwards, that the general spotter of financial risk should be the fed and that it would be a mistake to have a consolidated regulator of too big to fail institutions. it's a worse mistake to put it at the fed. >> mr. wallison? >> thank you very much, mr. chairman. leaving aside fannie mae and freddie mac, which i think are a very special case, if there is such a thing as a firm that is too big to fail, it is only a large commercial bank and we now have several of them that are enormous. when we say that a firm is too big to fail, it means its failure to have a major adverse

effect on the entire economy. this is not simply a mere disruption of the economy. it would have to be a systemic breakdown. we can't define that very well, but it would have to be something greater than simply the kind of disruption that would occur from the failure of a firm. in my view, the only -- only a large commercial bank can create this kind of systemic breakdown. when a large bank fails, its depositors are immediately deprived of the funds they expected to have to meet payrolls and to pay their bills. smaller banks are depositors in the larger banks so the failure of a large bank can send a cascade of losses through the economy and if there is such a thing as systemic breakdown, this would be it. for the same reasons, it is difficult to see how a large nonbank financial institution, that is a bank holding company, a securities firm, a finance company, a hedge fund, can cause

systemic risk, and thus, it is difficult to see why a nonbank can ever be in terms we are talking about today, too big to fail. nonbanks do not take deposits. they borrow for short, medium and long term, but if they fail, their creditors don't suffer any immediate cash losses that would make it difficult for them to pay their bills. no one deposits his payroll or his -- the money he expects to use for doing business with a securities firm or a finance company. in addition, their creditors are likely to be diversified lenders so all their eggs are not in the same basket. however, the freeze-up in lending that followed the collapse of lehman brothers has led some people to believe, and i think incorrectly, that lehman caused that event. this is not accurate.

they conclude that a nonbank financial firm can cause a systemic breakdown, that it can thus be too big to fail. but lehman's failure caused what is called a common shock, where a market freezes up because new information has come to light. the new information that came with lehman's failure was that the government was not going to rescue every firm larger than bear stearns, which had been rescued six months before. in this new light, every market participant had to re-evaluate the risks of lending to everyone else. no wonder lending ground to a halt. common shocks don't always cause a financial crisis. this one did because virtually all large banks were thought at that time to be weak and unstable. they had large amounts of mortgage-backed securities, later called toxic assets, that

were dubious value. if the banks had not been weakened by these assets, they would have continued to lend to each other. they would not have been a freeze-up in lending and the investor panic that followed. so if we want to avoid another crisis like that, we should focus solely on ensuring that the banks, we're talking about commercial banks, are healthy. other financial firms, no matter how large, are risk takers and should be allowed to fail. accordingly, if we want to deal with the problem of too big to fail and systemic risk bank regulation should be significantly reformed. capital requirements for large banks should be increased, as those banks get larger, especially if their assets grow faster than asset values generally. higher capital requirements for larger banks will cause them to reconsider whether growth for its own sake really makes sense. bank regulators should develop matrix or indicators of risk

taking that should have to be published regularly. this will enhance market discipline which is fundamentally the way we control risk taking in the financial field. most important of all, congress should create a systemic risk council on the foundation of the president's working group which would include all the bank supervisors and other financial regulators. the council should have its own staff and should be charged with spotting the development of conditions in the banking industry like the acquisition by virtually all banks of large amounts of toxic assets that might make all major banks weak or unstable and leave them vulnerable to a common shock. if we keep our banks stable, we will keep our financial system stable. finally, as a member of the financial crisis inquiry commission, i urge this committee to await our report before adopting legislation. thank you. >> mr. johnson?

>> thank you very much, mr. chairman. as you said at the beginning, the question i think is not controversial. the issue is to remove the possibility in the future that a large financial institution can come to the executive branch and say either you bail us out or there will be an enormous collapse in the financial system of this country and potentially globally. i think there are two broad responses to that, two ways of addressing that problem that are on the table. the first is what i would call relatively technocratic adjustment. i think there are sensible ideas there, relatively small ideas. i don't believe they will fundamentally solve this problem. the second approach is to reduce the size of these banks, and what we've learned i think over the past nine months is a considerable amount about how small financial institutions can fail and can fail without

causing major systemic problems, both through an fdic type process or through a market type process as seen with the c.i.t. group.@@@@@@@ @ @ @ @ $@ @ @ r convinced many other people that it knows how to manage risks, that it understands what are large risks for itself and of course, this is what mr. greenspan now concedes was a mistake. in his assessment of the situation during the boom, he thought the large firms that had a great deal to lose if things went badly understood these risks and would control them and manage them, and they didn't. it was a massive failure of risk management and i see no indication either that the banks have improved this kind of risk management in the largest institutions or that regulators

are better able to spot this and while i agree with the idea we should have a systemic risk spotter of some kind, analytically and politically, seems to me we're a long way from ever achieving that. and if i may mention the lobbying of fannie and freddie on the one hand and private banks on the other hand, it was fantastic. these people are the best in the business by all accounts at speaking with many people, both with regard to legislation and of course, detailed rules, again, i see no reason to think that if you tweak the technocratic structures, you will remove this power and this ability that these large institutions have brought to bear. it's not just in the last five or ten years. it's historically in the united states and in many other countries or perhaps most other countries. the financial system has this kind of lobbying power, this kind of too connected to fail issue raised by mr. schouman. i think if you put it in those terms and look hard at the

adjustments, the most promising solution is to adjust the capital requirements of the firms in such a fashion as it becomes less attractive and less profitable to become a big financial firm. i also agree, would emphasize what miss rivlin said, which is thinking about how to target leverage or control leverage, again, through something akin to a modern version of margin requirements is very appealing in this situation. it's about size. c.i.t. group is $80 billion in assets. treasury and others looked long and hard at that before deciding not to bail it out. from what we see right now, that was a smart decision. the market can take care of it. the line, that drawing seems to be around $100 billion in assets. financial institutions above $500 billion in assets right now clearly benefit from some sort of government guarantee going forward and that's a problem. that distorts incentives, exactly as many members of the committee emphasized at the beginning. so i think stronger capital requirements, you could also do this with a larger insurance premium for bigger banks.

what have they cost, what has the failure of risk management at these major banks cost the united states? i would estimate that our privately held government debt will rise from around 40% of gdp, where it was initially, to around 80% of gdp as a result of all the measures direct and indirect taken to save the financial system and to prevent this from turning into another great depression. that's a huge cost and at the end of the day, you actually have more concentrated economic power, more concentrated political access, influence, call it what you want, in the financial system. so for 40% of gdp, we bought ourselves nothing in terms of reducing the level of system risk that we know now was very high, 2005, 2007. so i think it's capital requirements and you can combine that with higher insurance premium reflecting the system costs. that's a lot of money. include a tax on leverage. i would want to, my remaining two minutes, emphasize some issues of implementation are very important. the first is in terms of timing. i think the capital requirements

can be phased in over time. i think the advantage of an economy that's bottoming out and starting to recover, you don't have to do this right away. the firms will likely, not for sure, would likely not engage in the same kind of reckless risk taking in the next two to three years so there is some time to get ahead of this. but you really don't want to run through anything like the kind of boom that we have seen before and of course, this will reduce the profitability in this sector. no question about it. the industry will point this out, they will be very cross with you and they will tell you this undermines productivity growth and job creation in the united states. i see no evidence that that is the case. i see no evidence that having an overleveraged financial system with excessive risk taking does anything at all for growth in the real nonfinancial part of the economy. i would emphasize, though, two important pieces of this that we should also consider and are more tricky. the first is foreign banks. so if we reduce the size size of our banks relative to the size of foreign banks, i think that does not create a competitive disadvantage for our industry but it does raise the question

of how should you treat foreign banks operating in the united states. for example, deutsch bank or big european banks, banks that are very big relative to the size of the economies in europe, let alone the size of the banks that we may end up with, those banks to the extent they operate in the united states should be treated in the same way as u.s. banks. capital requirements have to be high based on where you operate and if you want to operate in u.s. financial markets, that will have to be a requirement. otherwise, you get no a situation where the next bank that comes to treasury and says it's bailout or collapse, will be a foreign bank. that will be even more of a disaster than what we faced recently. the second transitional issue and my final point is in regard to the resolution authority. i think congress is rightly considering very carefully the resolution authority requested by the treasury and i think broadly speaking that's a good idea. but it is not, i would emphasize it is not sufficient. it's not a global resolution authority. if a major multi national bank comes to you with a problem and you would like to say to them go through bankruptcy but when you look at the details of that, you

see it would be a complete mess because of the cross-border dimensions of that business, the same thing is true for a bailout. if you bail them out, under your resolution authority, it's also going to be a disaster unless you have a global agreement at the level of the g-20. thank you very much, mr. chairman. >> sir? >> thank you, mr. chairman, members of the committee, the opportunity to be here today. i am an employee of the moody's corporation but my remarks today reflect only my own personal views. i will make five points in my remarks. first, i think the administration's proposed financial regulatory reform are much needed and reasonably well designed. the panic that was washing over the financial system earlier this year has subsided, but the system remains in significant disrepair. credit remains severely impaired. my own -- by my own estimate, credit, household and nonfinancial corporate debt outstanding fell in the second quarter, that would be the first

time in the data that we have all the way back to world war ii and highlights the severity of the situation. i think regulatory reform is vital to reestablishing confidence in the financial system and thus reviving it and thus by extension, reviving the economy. the administration's regulatory reform fills in most of the holes in the current system and while it would not have forestalled the current crisis, it certainly would have made it much less severe and most importantly, i think it will reduce the risks and severity of future financial crises. point number two, a key aspect of the reform is establishing the federal reserve as a systemic risk regulator. i think that's a good idea. i think they're well suited for the task. they are the most central position in the financial system. they have a lot of financial and importantly intellectual resources and they have what's very key, a history of political independence. they can also address the age-old problem of the regulation, regulators allow

very aggressive lending in good times, allowing the good times to get even better and don't weigh against -- and tighten up in the bad times when credit conditions are tough. i also think the systemic risk regulator, the fed will have an opportunity to address asset bubbles. i think that's very important for them to do. there's good reasons for them to be reluctant to do so but better ones for them to weigh against bubbles. they as a systemic risk regulator will have the ability to influence the amount of leverage and risk taking in the financial system and those are key ingredients into the making of any bubble. point number three, i think establishing a consumer financial protection agency is a very good idea. it's clear from the current crisis that households really had very little idea of what their financial obligations were when they took on many of these products. a number of very good studies done by the federal reserve showing a complete lack of understanding and even i, looking through some of these

products, option a.r.m.s, couldn't get through the spreadsheet. very, very difficult products. i think it's very important that consumers be protected. there is certainly going to be a lot of opposition to this. financial services industry will claim that this will stifle innovation and lead to higher costs and it's true, the industry probably won't get it right all the time. but i think it is important that they do get involved and make sure that households get what they pay for. federal reserve also seems to be a bit reluctant to give up some of its policy sway in this area. i'm a little confused by that. i think they showed a lack of interest in this area in the boom and bubble. they've got a lot of things on their plate. they will have even more things on their plate if this reform goes through. as a systemic risk regulator, i think it makes a lot of sense to organize all of these responsibilities in one agency so they can focus on it and make sure that it works right. point number four, the reform proposal does have some serious

limitations in my view. the first is it doesn't rationalize the current alphabet soup of regulators at the federal and state level. that's a mistake. the one thing it does do is combine the occ with the ots. that's a reasonable thing to do but that's it. so we now have the same byzantine structure in place and there will be regulatory arbitrage and that ultimately will lead to future problems. i can understand the political problems in trying to combine these agencies but i think that would be well worth the effort. second, the reform does not adequately identify the lines of authority among regulators and the mechanisms for resolving differences. the new financial services oversight council, you know, it doesn't seem to me like it's that much different than these interagency meetings that were in place, that are in place now, where the regulators get together and decide, you know, how they're going to address certain topics. they can't agree and it takes time for them to gain consensus. they couldn't gain consensus on

stating simply that you can't make a mortgage loan to someone who can't pay you back. that didn't happen until well after the crisis was under way. so i'm not sure that that solves the problem. i think the lines of authority need to be ironed out and articulated more clearly. third, the reform proposal puts the federal reserve's political independence at greater risk, given its larger role in the financial system, ensuring its independence is vital to the appropriate conduct of monetary policy. that's absolutely key. i wouldn't give that up for anything. finally, point number five, the crisis has shown an uncomfortably large number of financial institutions are too big to fail. that is, their failure risks undermining the system, giving policy makers little choice but to intervene. the desire to break up these institutions is understandable but ultimately, it is futile. there is no going back to the era of glass-steagall. breaking up the banking system mammoth institutions would put institutions at a distinct competitive disadvantage vis a

vis their large global competitors. large financial institutions are also needed to backstop and finance the rest of the financial system. it is more efficient and practical for regulators to watch over these large institutions and by extension, the rest of the system. with the fed as systemic risk regulator more effective oversight of too big to fail institutions is possible. these large institutions should also be required to hold more capital, satisfy stiffer liquidity requirements, have greater disclosure requirements and to pay deposit and perhaps other insurance premiums, commensurate with the risks they take and the risks they pose to the entire financial system. finally, let me just say i think the proposed financial system regulatory reforms are as wide-ranging as anything that's been implemented since the 1930s great depression. the reforms are in my view generally well-balanced and if largely implemented, will result in a more steadfast, albeit slower-paced financial system, and it will have economic implications.

i think that's important to realize. but i think necessary to take. the administration's reform proposal does not address a wide range of vital questions, but is only appropriate that these questions be answered by legislators and regulators after careful deliberation. how these are answered will ultimately determine how well this reform effort will succeed. thank you. >> mr. mahoney? >> thank you, mr. chairman. ranking member baucus and members of the committee. i appreciate the opportunity to present my views here today. i will discuss those portions of the administration's regulatory reform proposals that deal with the largest financial institutions, the so-called tier one financial holding companies. the administration proposes a special resolution regime for financial holding companies outside the normal bankruptcy process that would be triggered when the stability of the financial system is at risk. when the treasury triggers the special resolution regime, it will have the authority to lend the institution money, purchase

its assets, guarantee its liabilities, or provide equity capital with funds to be recaptured in the future from healthy institutions. i think it is fair to use the term bailout to describe that system. there are two general schools of thought on how best to avoid future financial crises leading to widespread bailouts. the first holds that it was an error in the recent crisis to help creditors of failed institutions avoid losses that they would have realized in a normal bankruptcy proceeding and that the focus of policy going forward should be to make it clear that the mistake will not be repeated. the alternative is to concede that the government will ordinarily bail out large and systemically important financial institutions. under this approach, congress should focus on limiting the risks that those institutions can take in order to minimize the likelihood that they will become financially distressed. but if those efforts fail, and a

systemically important institution becomes financially distressed, a bailout will follow as a matter of course. the administration's financial reform blueprint takes this approach. i think the first approach will produce a healthier financial services industry that will make fewer claims on taxpayer dollars going forward. it is based on a sounder premise, that the best way to reduce moral hazard is to ensure that economic agents bear the costs of their own mistakes. the administration's plan is premised on the view that regulatory oversight will compensate for misaligned incentives. the central argument for trying to avoid bailouts through regulatory oversight rather than insisting that financial institutions bear the cost of their mistakes is that some institutions are too big to fail. putting those institutions through bankruptcy could spread contagion, meaning other banks and financial institutions could fail as a consequence. widespread bank failures in term

may reduce the availability of credit to the real economy, causing or exacerbating a recession. there's debate over that analysis, but in any event, it is not clear that the magnitude of the problem is sufficient to justify the scale of government intervention that we have seen in the past year. it is important to note that the loss of capital in the banking system in the recent crisis just the result of a temporary liquidity problem. it was a consequence of sharp des in real estate and other asset values. a billout can redistribute those losses to taxpayers, but it cannot avoid them. the bankruptcy process is itself a means of recapitalizing an insoler vent institution. it does not require that assets, employees and know-how disappear. instead, it rearranges the external claims and cash flows. unsecured creditors may have to

substitute part or all of their debt claims for equity claims thereby re-establishing a capital sound structure. if the insolvent institution still has the skill and experience to facilitate credit formation, it will continue to do so under new ownership management and capital structure. of course, the bankruptcy process is subject to inefficiencies and delays and those shob addressed. a more streamlined process may be appropriate for financial institutions because they do have short-term credit forps but this does not require an alternative regime of institutionalized fail yuts. a bailout regime, unlike a bankruptcy regime creates more problems that imposes costs on the banking sector continuously and not just during crises. because creditors of too big to fail financial institutions anticipate that they will be able to shift some or all of their losses to taxpayers, they do not charge enough for the

capital they provide. the financial institution in turn does not pay a sufficient price for taking risk. the result is a dangerous feedback loop. large banks have access to cheap capital, which causes them to grow even larger and more systemically important while taking excessive risks. all of which increase the probability of a crisis. thus a bailout regime leads to more frequent crisis, even as it attempts to insulate creditors from them. the administration believes its proposal will alleviate moral hazard and decrease ris income too big to fail institutions. the idea is these tier one financial holding companies will be subject to more stringent capital rules that will reduce the amount of risk they can take and create a disincentive to become a tier one financial holding company in the first place. i think these disincentives are insufficient and it would increase not decrease the concentration of risk.

once a firm has been designated a tier one fhc, other financial institutions will view it as having an implicit government guarantee. the theer vi this advantage will be offset by stricter capital requirements and other regulatory cost which is will on balance make the cost of capital higher for tier one fhcs. that analysis strikes me as wildly optimistic. having an implicit government guarantee, tier one financial holding companies will be extremely attractive counterparties because risk transferred to them will be in effect transferred to the federal government. tier one financial holding companies will have a valuable asset that they will be able to sell in quantifies limited only by the fed's oversight. they'll have powerful incentives to find mechanisms, new financial products or creative off balance sheet devices to evade any limits on the risks they can purchase from the rest of the financial sector. and thanks that are not already

tier one financial holding companies will have strong incentives to grow to the point that they become tier one fhcs in order to guarantee access to bailout money. the fastest way to grow larger is to take bigger risks. an institution that can keep its gains while transferring losses to the government will engage in excessive risk taking and excessive expansion and the financial system as a whole will suffer more frequent crises. thank you and i look forward to your questions. >> let me save some discussions. a number of you have talked about this idea, the administration -- the list of tier one companies. i understand the administration understood that to mean that this would be a terrible -- this would be a kind of probation for them. it does seem very clear that most people think that the reaction of these companies to being on that list will be compared to the briar patch. i'm going to suggest they

substitute a different model. i think with regard to identifying the companies that might be particularly systemic risk, the administration is going to relate it topography. they tier going to know it when they see it but they're not going to have a pre-existing list. i think that idea is pretty much gone. one interesting thing that's been suggested to us is to vary the bank insurance fund according to the rigskiness of the venture. am i correct? is that something that could be measured with some degree of appropriate specificity? >> yes, mr. chairman. that is an idea that technical people, experts on the bank system are working on, and the people who i know who made most progress have work that's not yet public but i would be glad to share with you. >> would it reach the level of reality that it could be used as a basis for --

>> it will be a paper by one of my colleagues in jackson hole this summer. >> and you think that that would have the effect of discouraging risk taking or penalizing those who took it? >> yes, sir. >> that's very important. by the way, it divides the banking community. i see the smaller banks, the community banks who think they've been victimized by the trash talking for it. the american banking association, not so much. on the systemic risk council that you talk about, that would be statutory? the president's working group is just, you know, five people get together and hang out. >> executive order, right. >> all right, by executive order. i'm interested as to its power. i do note that you talk about the countercyclical mack kro prudential that it could limit growth. when you say limit growth, and you say by imposing higher capital limitations. there did seem to be an agreement here as somebody imposed higher capital limits on

institutions that grow, we don't mean simply pro-potional with we mean disproportionate. you don't have a constant percenta percentage, but the bigger you are, the higher the percentage? >> that's right. >> and would you go beyond that? put actual limits on. we have the 10% deposit limit. doesn't seem to do a great deal. would you give the systemic risk council the ability to, in establishing and enforcing a level of -- could they do an bs absolute limit it co-can't get my limit or would it be only through the capital requirements? >> first of all, the term bank is used very loosely. a commercial bank? >> another way you're using it. >> in that case, i don't believe that there should be any limits placed on the size of the institutions, but as capital rises, i think the institutions will be required themselves to limit their growth. >> the systemic risk council could be authorized to establish

an acceptable limit. by that you mean capital requirements, there's no actual limit? >> there's no actual limit on the size of the institution burke as the capital increase, the institution will decide to some sort of cap. i'm not for caps in general. >> the language frankly could have supported that. so you're talking about strict capital requirements. i think this is an important possible area of common ground. the systemic risk council would be authorized to monitor the worldwide financial system, report to congress and the public on the possible growth of systemic risk or factors that might produce a serious -- would they have any more power than to just drop it in our laps? or would you allow them to do anything other than limit the

capital limits on banks? >> well, i outline in my prepared testimony some things in addition what they might do. >> the systemic risk council identifies again the growth of systemic risk, would they be empowered to do anything about that. >> it is to identify areas that were not identified in the current problem. >> would they be empowered to act on that once they identified it. >> i think the way it would work is that they would instruct the supervisors of the particular institutions. the members of the council would be the federal reserve, of course, the occ, the fdic and so forth.

when the council sow up until now, all institutions -- >> they would give instructions -- would they be binding on the regulators? >> i would expect the regulators would take those actions. >> we have to write laws. we can't do attitudes. i've got to write a law here. would they have the power to order the regulators to act or would they not? >> well, i don't think it's possible to order regulators to do anything. if they have agreed to the council's policy. >> you could statutorily say they had the requirement, you could. >> i don't understand how they will -- >> unanimous -- >> what the council decides to do. >> does a vote have to be unanimous on a council? no. >> i think that's the sort of thing a council can decide on

its own. >> i'm going to say i'm disappointed. you're leaving ambiguities -- i'm sorry, let me finish. that are not appropriate to a statute. the fact that one member of a -- one city a member of council doesn't mean it might not be in disagreement. you leave yourself hanging when you say we have this systemic risk council and they can report, monitor the growth of systemic risk and the factors, then you leave me hanging with what they do about it. the gentleman from alabama. >> thank you, mr. chairman. my first question on the panel for anybody who would care to take it, as you analyze but for the root causes of the economic turmoil we find ourselves in today. i'm curious what aspects of the turmoil you can cite as resulting from a lack of

regulatory authority as opposed to perhaps mistakes, malfeasance on the part of regulators. clearly we have a very large capital markets reform bill in front of us. some have opined that we had a lack of regulatory authority. i'm not sure with the exception of fannie and freddie. we've covered that history and battle before. but with that possible exception, i know for example we had testimony from the head of ots that he had the financial expertise and the regulatory authority to regulate the financial kpret swamps but he just miss it. is it more regulatory authority that we need? do we need to make sense of the regulatory regime we have before us, or do we just need to figure out a way to get regulators to

act smarter and perhaps focus on systemic events that previously they haven't focused on, whoever might want to take that first, mr. johnson? >> agree on the safety and soundness point. the regulators did have the statutory authority to rein in many of the excesses, including prevent the abuses of consumers we' seen and they didn't exercise those powers. that's part of the reason we should actually reinforce the protection of the consumers through new safety agency focused just on consumers. i think, though, with regard to banking safety and soundness. i think on derivatives, though, perhaps the regular tai tors could have found the authority. they're correctly interpreting the intent with regard to not regulating many derivatives tans actions, and i think that that was a conscious decision made at the end of the 1990s, which we

should be revisited and putting that in legislation makes sense. >> can i take a crack at it? >> sure. i think that the reason why this finan#,@@ @ $rr a"rr ing of how to use it. that includes to fannie and freddie, aig and citigroup. i think that goes to a key failing of the current regulatory structure. >> i have limited time, so let me move on to another line of questioning here. to me a very fund. al question we have to examine

here is if we either implicitly or explicitly designate firms as to being systemically significant, do we not have a self-fulfilling prophesy, period, paragraph. how does one avoid that? if we set up a criteria for bank holding companies, there's so much public information there, if you attempt to keep these firms confidential, soon eor later, the market is going to figure out which firms have the implicit guarantee, which don't. the hundred of billions of dollars of taxpayer exposure, liability later. so i just don't understand any mechanism that one sets up. i appreciate the argument that regulators need to look at

individual firms and that through capital and liquidity requirements there's much they can do to reduce systemic risk. i don't know how you don't have a self-fulfilling prophesy and everybody is waiting in line wanting to be the next systemically significant firm. i just don't see how you avoid it. >> it seems to me if we focus solely on the banking industry, we don't have that problem. because all banks are regulated. right now, the largest banks are regulated much more fully than the smaller institutions. one can assume that a large bank is too big to fail but it doesn't have to be true. there's a certain amount of ambiguity when you come to a line between the very largest and the less large institutions. we have no idea what systemic risk is. and that's one of the major faults in this legislation.

what we ought to do is simply make sure that the banking industry is safe and sound and then we don't have to worry about any of the others. the main fault with what the administration is doing is attempting to extend regulation, which didn't work for the banking industry across a broader range of our financial system. and there isn't any need to do that. and if we focus solely on banks, we can solve almost all of the problem that we encountered in 2007 and 2008. >> it's up to the chairman. i see i'm out of time. >> gentleman from pennsylvania. >> thank you, mr. chairman. >> in your testimony, i'm not sure i understood whether or not you were indicating that the federal reserve should not be designated as the systemic risk regulator or that it was, in fact, well qualified to be the

gatherer of information and data for the systemic risk regulator. >> i was trying to distinguish two concepts of systemic risk person -- or agency. one is monitor and gatherer of information, for which i think the fed is very well qualified and should be doing it anyway and is coordinating with its responsibilities on the economy. so i would put that responsibility there. i do not think that it should be the systemic risk regulator in the sense of regulator of systemically important institutions, regulated supervisor of systemically important institutions because k, i don't think there should be such a designated responsibility for the reasons we've been talking about. i don't think you should have a list. and second, if you did do that, i certainly wouldn't put it at the fed because i think it would dilute their monetary policy

responsibilities and that they wouldn't be very good at it. >> i agree with you, but i wanted to perhaps attack part of your premise there. i recall very clearly in 2005, the chairman of the federal reserve was testifying before this committee and i specifically asked him a question whether or not there was a real estate bubble in his opinion and he said he thought there was and the price of real estate was ever increasing, but it was perfectly manageable and it did not constitute a risk to the system. so that if he, in fact, were the gatherer of that information and the analyzer of that information, we would have missed the opportunity to find systemic risk. what would your answer to mr. greenspan's lack of perceiving that difficulty? >> i think he was just wrong. he said that himself. he didn't see this one.

but i think we've learned a lot about publics. but one thing we have learned is that the short-run interest rate is not a perfect tool for controlling them, which is why i would give them more rench control as well. >> you seem to talk that our only problem here with regard to systemic risk exists in financial institutions? >> no, i think the only real problem exists with banks, commercial banks. >> just banks? nothing else? >> just before this committee not too many months ago general motors, ford and chrysler, they appeared together, the ceos and cfos of those corporations. and their testimony was quite clear that it was their opinion that the failure of any one of them and particularly chrysler

who only entertained 7% of the car market in the united states would cause systemic risk if they were allowed to fail. and it was their opinion as to why congress should marshall the assets to bail the three companies out if they need it. most particularly chrysler and general motors at the time did recognize the fact that they deed kneaded it. and their total argument was that they both feed off the same dealer base, and supplier base. and just the loss of chrysler corporation's 7% penetration of the market and the use of the dealers and the suppliers would bring down all of the suppliers and all of the dealers and therefore bring down the entire industry. just recently on friday, you probably read the paper. the question i would pose to you, i want your idea on the

general motors problem. but then c.it, most of our regulators concluded that did not constitute systemic risk. i think that's their conclusion. luckily they didn't need help from the government ultimately. but as i understand the problem, as it was explained to me on friday, is that if it had been allowed to fail, that is the factor business that cit was involved in, that it would have brought down 70% of the apparel suppliers in the country. to the extent that the department store and specialty stores in the retail business in the united states would not have had the inventory to continue their practices. and hundreds of thousands, if not several million jobs would be lost in the supplier trade, manufacturing and in rhett tail businesses throughout the country. that came to my attention

through a department store owner who called those facts to my attention. wouldn't you feel that that perhaps is systemic risk, and it's not a financial institution? >> in my testimony, congressman, i look very carefully at this question of the difference between a systemic risk and a mere disruption. we really don't understand what systemic risk is or how it would create it or what kind of institutions would create it. this is one of the fundamental problems which the administration is talking about. in the case of general motors or chrysler or ford for that matter or cit, yes there would certainly be disruption if a large firm fell. and i think the same thing is going to be true of financial institutions other than very large banks. that's why it's such a bad idea to provide to the government the authority to bail out or take control of any kind of institution because the

institutions will always come in and argue that their failure will cause some sort of huge loss in our economy. whereas, in fact, companies fail all the time. they get worked out in bankruptcy, sometimes they return to activity. other times, they are completely unwound. but we have to make sure that we know the difference between a mere disruption which they will claim and systemic risk, and we don't know that distinction. >> gentleman from alabama? >> thank you. i read something here and i agree with it. it's from mr. johnson who was actually called by the democratic majority to testify, but what he says is that short-term measures taken by the u.s. government since the fall of 2008, particularly under the obama administration have helped stabilize financial markets.

primarily by providing unprecedented levels of direct and indirect support to the large banks. but these same measures have not removed the long-run causes of systemic ins stability. in fact, as a result of supporting these leading institutions on generous terms, systemic risk has likely been exacerbat exacerbated. in other words, the bailouts have actually increased the danger. >> that's similar -- you have said that on a different way, have you not? we're actually creating a more dangerous environment. >> every time we bailout one institution, we create the belief that other institutions of a similar size or maybe even smaller also be bailed out.

out's been creates as professor mahoney made clear in his system. >> plm kanjorski and i were in a meeting request own of the leading hedge fund managers. the financial times said he was the smartest billionaire in the world. and he said what you said about lehman in your testimony. the problem was that they were -- markets were shock ed they thought they were going to bail out lehman. which is exactly what you said. this gentleman is a private, very private individual. you all come to the same conclusion. now, mr. johnson goes on to say. i believe this is absolutely true. some of our largest financial firms have actually become bigger reltive to the system and stronger politically because of

a crisis. the competition has been eliminated. and do you agree with that, mr. johnson? >> yes, sir. >> executives of the surviving large firms have every reason to believe they're too big to fail. they have no incentive to help bring system risk down to acceptable level. that's exactly the problem we have today. responsible official thinking shifts to failout at any dos. we certainly have seen that over the past six months. and here's where i think we maybe can all come again. the treasury and fed were

seemingly confused whether they had the authority to intervene the broker-dealer failure. mr. mahoney has said give them that procedure. give them a procedure. isn't that right? >> that's right. i think the idea of adding another chapter to the bankruptcy code makes perfect sense. it is probably the case that the amount of agenda control that debtors have in the standard chapter 11 bankruptcy proceeding could be disruptive in the case of a large financial institution where you're dealing with some short-term creditors who need to know what's the value of this obligation that i'm holding sooner rather than later. so i think you could create a

quicker more streamlined procedure. i would draw a sharp restriction through the procedure from which through the procedure from which it happens and theká@ @ @ @ @ @ substantive rules that we use lehman, you know, ultimately, you would -- you would clear out the confusion. you would have certainty and the certainty would be that they would only go into -- you would have an expedited procedure. you can call it expedited bankruptcy, but it really needs

to be there, in my opinion. >> i think the bankruptcy koetd probably would be inadequate for purposes of these kinds of failures. >> but if we made -- if we changed the procedure. >> i don't think the courts would be viable for the kind of decision making that needs to be done as quickly as needs to be done. >> it also goes to the collective confidence we have in our system. if you go into a bankruptcy proceeding, you may be able to solve the interconnectedness problems, but competence would still be an issue. >> you said we all know the regulators had a complete lack of understanding. >> and that needs to be changed. >> but i don't know how you give understanding -- you know, i think that you, you know, that's

actually worse than the bankruptcy courts to me. if you gave them a procedure, you give them the rights, how we could amend that code and use the basics of it. >> the gentlemjgentleman of new. i did want to respond. reading the point here, i'm not going to tell you what he means. i do want to be very clear. every single activity now characterized as a bailout going on in the united states was initiated by the bush administration by mr. bernanke and mr. paulson. that's aig, that was bear stea ra ns, that was merrill lynch an the bank of america, that was a kind of bailout. that was general motor, that was chrysler. every single one of them. the first proposal for a bailout that came to the obama administration with cit and they said no. now i don't think it ought to be part stan. one administration carried on

from the other, but literally every single bailout now going on was initiated in the bush administrati administration. secondly, yes, it is true. i think we all agree as a result of a need for bailouts has made us more vulnerable. that's why our agenda does something about it. sure we need to do something. but there's not a bailout under way that wasn't initiated by the bush administration. it's the gentlewoman's time. this is the second time the gent theman has done that. i asked other members to yield. i would ask the gentleman to pay attention. >> i will be less disruptive in the future.

>> thank you, mr. chairman. i truly believe that our government was at its best following the 9/11 crisis when we came together and created a bipartisan professional commission to study what went wrong. they came forward with a professional report that sold more copies than "harry potter." and it pointed out 53 direct areas that they thought needed to be corrected. we proceeded to react to their recommendations and this congress passed 47 of their recommendations. and i don't believe we were aware of what the true problems were until we got that report. i would like to see a report come back from the bipartisan commission on what caused this crisis and their ideas of what we need to do to reform our system and to go through that

proce process. we now have a blueprint that in many ways looks like the problems that we confronted. many people say fannie and freddie with their implicit government guarantee caused many of the problems. so what are we going to come back with? an implicit guarantee that tier one too big to fail banks are going to be guaranteed. therefore everyone is going to want to do business with a guaranteed bank. every bank is going to want to be a tier one in order to have that implicit guarantee that gives them an advantage in business. lower rates, more prestigious. i'm not sure that's the direction we want to go in. the other big idea is that we have a systemic risk regulator under a federal reserve. >> i argue we have a regulator under the federal reserve.

they have tremendous power to look wherever they want. the prior administration for mr. bernanke was criticized for never having their step on the sub crime crisis with the directive, never pointing out what needed to be done. and i'm not so sure what the systemic regulator that was systemic on the ability and drive of the person in the position was exactly the answer to our problems. the only thing we seem to agree on is the regulation failed. yet the regulation they're proposing is similar to the regulation we have right now. to build on a question the chairman brought up earlier, what happens when you disagree. when we have this council of regulators and they disagree. how do you come to the conclusion. many people say lehman brought

down the stability of our financial sector in many ways. where was the way to counterthe decision of whomever made that decision. how do you agree if they der -- how would you agree with these councils? and you have to have a specific way you agree. you know they're going to disagree. there was a disagreement as to how to respond to other challenges with various businesses. that was played out in the press. my time has expired. >> a brief response? >> i agree completely. i think you have to assume that regulators will fail in the future as they've failed in the past and you have to assume that extending any kind of implicit guarantee is going to create the same stort of distortions and problems as in the past. i think you need to design the system around those assumptions. and to my mind, making the

largest institutions, financial institutions smaller is not a guarantee by any means against future problems. but it means when the problems occur, they should be more manageable. you should be able to more easily push them down to the bankruptcy courts. but still, sometimes it's going to be hard tor predict. sometimes the government may need to take action and you need to make sure they have the proper authority to do that. >> let me associate myself with the words from the gentlelady from new york on just about everything that she said. that may be a first, but i do. mr. zandy, if we need a systemic risk regulator and we need it -- and you advise it to be in the federal reserve, you need to address the situations as to future asset publics for dealing

with being countersicyclical as opposed to being pro cyclical and to address maybe the regulatory side, capital requirements as well. is that correct? >> yeah. they would have authority there as well. >> you have to raise the point on the asset bubble with regard to the housing bubble that we have. i'm going back further with the tech bubble. alan greenspan said maybe i missed that one and he maybe sort of rewrote history as far as the review of whether he knew it or not. but if you look at the minutes of the federal reserve, they all missed that and there was no discussion whatsoever with regard to an asset bubble during the entire time. they were looking at that purely as an increase in productivity. the federal reserve is out front

for a long time. which would go in the wrong direction with regard to that. and as far as the regulation, or the capital lierequirements, dit they have an ability for cit, with citi waen bank of america? did they do anything? the answer is no, with regarding to raising capital requirements. so here's an entity that you're nodding your head to that has -- i'll use the word -- dismal track record. and each one of those, but you, sir, would suggest they' the ones we're going to give the authority to. >> if i were king for the day, i would design it differently. i would think a model where the regulatory function was in a separate entity a systemic risk regulator separate from the federal reserve would make the most sense. but ning the context of where we're starting from and just the practicality of the situation, i think the most logical place for that to reside the federal reserve. >> of all the bad choices out there, they're the best one?

>> exactly. right. and i think there's a general philosophy that the federal reserve should not weigh the asset bubbles. that's not in their job description so to speak. i think that's inappropriate. i think it should be something they should do and the tool that they need to implement that -- >> it's not in their rules that they should be weighing in with regards to ss s asset bubbles? >> no. there's a reluctance to weigh in on asset bubbles at the federal reserve. >> before you can weigh into them, you have to first see them. >> that's part of the reason they have a reluctance to do that. >> they didn't see them. >> bubbles are created largely by leverage. if they have a very clear ability to control or manage leverage throughout the entire financial system then they would be able -- they would have the tool they need to be able to manage that aspect of monetary policy. yes.

>> could i -- >> sure. >> i think there's a difference between the bubble in the '90s in the stock market and the housing market bubble. we didn't miss the stock market bubble. we knew it was there. we talked about it. greenspan made the irrational exuberance speech. we didn't do enough about it. we could have raised margin riern requirements. it would have been largely symbolic but we didn't do it. but we didn't have the right tool. raising the interest rate in the middle of the bubble, we also had the asian financial crisis and a lot of other things going on. you don't have the right tool if you're relying entirely on the short-term interest rate. >> i thought tuyou were going t say, a quick note with regard to the policy, being able to tell this council, being able to tell the regulators what they do.

you're saying no, they can't do that, but you have another comment? >> i have a comment on the question of bubbles. we have to distinguish this bubble from every other bubble. we will always have them. we are human beings. we tend to believe when things are going in one direction they will continue to go in one direction. and that's broet up and down. this bubble was completely different. in this bubble, we have 25 million sub prime and nontraditional loans that are fails at rates that we have never seen before. the question we have to answer is why did that happen? because that is one of the major reasons that this particular bubble turned into a worldwide financial crisis. >> thank you. >> the gentleman from north carolina? >> thank you, mr. chairman. ms. rivlin, i confess i'm having a little trouble understand iin where -- what you would do.

. you talk about a macrosystem stabilizer, and then you talk about a systemically important -- somebody that is over -- i thought that what you were proposing was akin to what the obama administration has proposed that the fed be put in charge of the kinds of things that you indicate a macrosystem stabilizer would do. can you clarify what it is that you're proposing. >> yes. i'm proposing exact opposite of

what the odam ma administration is proposing. we're both recognizing that there are two kinds of tasks here. one is spotting problems in the system that might lead to excessive boom boom or crash? >> the administration proposed to give that to the feds? >> they proposed to give that to a council. i would give it to the fed. i think it's similar to the kind of responsibility that the fed has already to spot problems in the economy. >> and to spot problem, one of these institutions interconnected is an issue. would you not give the fed the authority to deal with that? >> i would not. >> who would you give the authority to deal with that? >> i think we need a new regular tear institution to be the

consolidated regulator of financial institutions. i would not separate out the too big to fail ones and give them a special regulator. >> but that shouldn't be the fed is what you're saying. >> so you would create a new agency for that purpose? >> i deally i would. >> we're getting quite a bit of pushback from the proposal to create a new agency for consumer protecti protection. would you create a new agency for consumer protection, too? >> i would. let me explain what i meant the first time. i would consolidate regulation of institutions, financial institutions into a single regulator, ideally. i wouldn't separate out the too big to fail ones from the other one.

>> so they would have the ability from all the existing regulators from some others? >> yeah. you would unmake a bunch of agencies. >> what i wanted to stress was not doing the too big to fail institutions separately and not putting that in the fed. >> would this new big agency have the responsibility for the institutions that would be too big to fail? >> among others. >> so you would put that under their jurisdiction, too? >> but i wouldn't have a separate list. >> oh, yeah. okay. >> you didn't tell me what your opinion was on the consumer protection agency. you did, i guess, but you didn't tell me why? >> i think a new consumer protection agency would be a good idea, because the existing agencies did not perform its functions well.

and you can either make sure that they perform it well. the fed did not. for example. or you can put it in a new agency. at the moment, i think i would opt for a new agency. >> i thank you, mr. chairman. i yield back. i just wanted to get -- >> will the gentleman give me 30 seconds? how much time when you were at the fed did you spend on consumer issues? >> depends on what you mean by that. we spent quite a lot of time on -- there were consumer councils who were advised on whether -- >> credit cards, home mortgages, unfair and deceptive practices. >> not very much. i don't think the fed did that well. >> thank you. i didn't mean you personally. >> the gentleman from texas. >> thank you, mr. chairman. >> mr. wallaceson i saw you on a

tv program this morning and you made a comment that i would like you to follow up on little bit about. you said that aig actually was not too big to fail. >> no, that's right. >> and there was no actual default there? >> well, i think we were talking about credit default swaps. and a credit default swap is, short hand it's kind of like an insurance policy. you're insuring someone against a loss. my point was simply that when aig failed, it did not cause any losses to any of the people who were its counterparties. it's just exactly like you had an insurance policy on your home and your insurer failed, you would go out and get another insurer. but unless you already had a fire, you hadn't suffered a loss. and that's exactly the case with

credit default swaps. there is in my view a lot of misinformation around about credit default swaps suggesting they are very dangerous. i don't believe they're dangerous and i don't believe in the case of aig, there was any need to bail out aig. aig had one major counterparty of a lot of others. the biggest one was goldman sachs. $12.9 billion in credit default swaps protecting goldman sachs. when it was learned that goldman sachs was the major counterparty, the press went to them and said what would have happened if the government allowed aig to fail and goldman sachs said nothing, we were fully protected. we had collateral from aig and in addition we had bought other protection against a possible failure by aig so it would not have been a problem for us. that's how we have to look at

the aig question. it was large, it was engaged and interconnected as all financial institutions are always interconnected. but the possibility of loss from aig was very small. >> mr. zandy, would you comment on the fact that this last bubble was created in large part by financial ins instruments that did not exist maybe 20 years ago, and especially the derivative part of the mortgage part of it and how it sustained a bubble in the housing market, which really sustained the mortgage market which continued to sustain the housing market. >> well, i think the -- one of the root causes in the bubble housing market is the process of

securitization was fundamentally broken. no one in the chain of the process had a clear understanding of all the risks in its entirety. the investment banks package got the rating. the rate agencies put their stamp on it and sold it to goldman investors. no one was looking at the entire system making sure that the structure was properly working. that the loans that were ultimately being made were good loans. so the process of securitization fell apart. it just was not functioning well because in my view there was not a systemic risk regulator looking at it holistically looking at it saying does this make sense? >> and it was a product that really was unfamiliar to anyone that was looking at it. even a lot of the regulators. >> i don't think anyone truly understood the entire process altogether.

i think it has economic value and it makes sense under certain circumstances, but that got abused and the economic value got lost and the profit making going on during the period. let me just say, i don't agree with aig. i think it's very clear that if aig failed, it would have been a very substantive risk to the entire financial system and economy. and this goes to an important point. we talk about too big to fail in the context of relationships, but it also goes to confidence. you have to remember back confidence was completely eviscerated. if that institution failed a lot would have come to a grinding halt. i don't agree with that assessment.

>> votes will probably be 35 to 40 minutes then we're taking our picture. i plan to come back. i'm going to skip the picture. and if other members want to come back we'll start again. if you can stay, we would appreciate it. obviously you have a right to leave. but if anyone can stay, i plan to be back in about half an hour and we'll do some more questioning for another 45 minutes or so after that, financial

firms and massachusetts congressman barney frank is the chair. this is live coverage on c-span3. >> one of the things i want to be clear. several of you have said there are ways to restrain growth by a higher capital charge that's disproportionate. by insurance levees. so we understand that. and i think there was a general consensus that things that would restrain growth could be very helpful. does anyone on the panel favor either an absolute limit on growth or even beyond that, reducing the size of existing institutions. and i ask you that because it's a very important view that's

there. and when people say, gee, you don't want it to be too big to fail. make it small. keep it small. let me go down the line. what's your response to people who say, hey, if it's too big, make it smaller or keep it small. >> i don't think there's a feasible, defensible way to break up institutions. so my answer to that would be no. but discourage growth. >> but you wouldn't put a legal cap on it going forward? >> no. >> and mr. walton, we've already discussed that. mr. johnson? >> i would favor a cap, assuming the interim until you feel these restraining measures have bite. as you point out, mr. chairman in the beginning. we have a cap. exactly. and now the rationale behind that presumably is, it's not antitrust because we have a different mechanism for looking at that. it's a backup. it's a fail safe. >> i don't know of an antitrust regime in which 10% gets you into the anti-competitive

situation. except the way some of us feel about people who run against us. but what would the cap be? what could you cap as an interim thing? >> we don't have information perfect on this, but i think that the treasury itself identified 19 institutions they sthaut was systemically important. on the other hand we see the experience of cit group, but it's extremely informative. in terms of the arguments they were making about being interconnected, their importance to the real economy. all kinds of arguments about how they are widely cited and synthetic ceos. that all turns out to be baloney. you can let them fail through bankruptcy or renegotiation with the creditors. that's between $100 billion total assets and $500 billion total assets, subject to a leverage caveat of ms. rivlin, right? >> but is that -- is assets -- what's the cap? we know we have one on deposits and that's a percentage one. of course, what would be --

would it be assets? >> yeah, well, its assets. it's either total dollar assets or as a percent of gdp. i'm saying 1% of gdp total assets would be the cit threshold. >> wachovia failed. countrywide failed. they were pretty big. it did not cause -- we had a regime. what is your sense of this? >> i think it would be difficult and counterproductive to try to break up private institutions. i don't think that makes a lot of sense. it makes a lot of sense to raise the cost of being large and larger and i don't think there needs to be any cap at all. you get larger. you pay more because you are relying on the system in a more significant way. >> and i assume the rationale for that is that if you raise capital, reduce leverage, particularly in a kind of -- you are making failure less likely and less costly if it happens. >> and in a sense, and also, i

think you might want to also in addition to capital ratios or leverage ratios, the deposit insurance fee or another insurance premium. >> self-insured. >> mr. mahoney? >> i wouldn't agree with a cap. i think there are ample small and medium sized banks that could compete effectively with the large banks. if they are on a level playing field and the problem is they are not currently on a level playing field because there's one group that has this implicit guarantee. >> i appreciate that. as an economic historian, as to the level playing field, no entity in the economic history of america has ever been on the high end of the level playing field. i know economists have concepts about constantly downward sloping things. we have a constantly downward sloping playing field. i have been doing this for many, many years. and i have heard the playing field invoked several times and never has anyone ever been at

the top of it. it is an extraordinary playing field in which everybody is at the bottom. it's the reverse of lake woe-be-gone. t@ important to have all of this out.t to have all of would it be the prudential regulator of each institution. mr. walton always talks about banks. others didn't think -- who would invoke. who would say when the time would come to put the cap on? would it be the counselor or the individual regulator? ms. johnson, you really wanted the cap, so --

>> i'm not a big counsel fan myself, and not really endorsing that. but i think it has to rest with whoever has the authority to do the bailouts. who makes the bailout versus collapse decision? i think it's treas because they write the checks. >> i know your prior history at the imf. mr. royce? >> thank you, mr. chairman. i would ask a question of mr. mahoney and mr. zandy for their opinion on this. but for many years, i was concerned about the perceived government backing of fannie mae and freddie mac. and about the ability of these firms to borrow at interest rates that were a lot lower. they were near governmental rates. and most private companies, of course, because of perceived investment rink associateded with fannie and freddie being so

much lower, most competitors were at a disadvantage. at the same time, they were allowed to involve themselves in arbitrage. i think the leverage was 100 to 1. i think that one of the main problems that we had was legitimizing the idea that subprime loans were safe. and i think the fact that the government sponsored enterprises witness out and purchased for their portfolios a half trillion of these directed by the government to do so, by the way. and one of the comments made by one of the gses officials was that we sought to indicate to the market the safety of mortgage backed securities that were subprime. and i do think that that entire process and the way in which they became a duopoly, forced their competitors out, became too big to fail. there's probably a lesson we should learn out of that that. and i think it would be dangerous for congress to move

to set up a regulatory structure that separates these institutions that are deemed systemically significant from all the other institutions. whether you do that defact or or de jury. whether you name them or don't name them. the result, i suspect, is likely to be the same. there will be the perception that these particular institutions are going to be covered. so how will the market perceive these companies and are you concerned that counterparties will then perceive their investment risk in these institutions would be a lot lower and, therefore, it starts the process of being able to over leverage. it starts the process, certainly, of having a lower cost of capital, which will force your competitors out of the market. what will this mean for

institutions competing against these now government-backed companies that, in essence, become too big to fail and government-sponsored enterprises in a way. that would be the result, i fear, out of it. >> well, i agree with that point entirely. i think that the counterparties of that entity are going to, all other things being equal, want to deal with a so-called tier one entity because they'll see that it has the implicit guarantee. whether you call that a competitive advantage or simply i point out the fact that those entities are likely to increase in size. i think they will increase in size because they'll be the most attractive eptities to do business with. if your object sieve to limit size, i think this is exactly the wrong way to go. i also think that it is probably

not a solution to just say we won't identify the entities that are too big to fail. part of the problem that arose, particularly after lehman brothers, was the fear that we couldn't really predict what the government would do next and what it was going to do was going to be quite ad hoc in this in some sense enshrines an ad hoc and unpredictable process. >> let me ask mr. zandy for his observations on those two questions. >> yeah, i sympathize with the concern. i think that at the very least, we can't identify any institution as so-called tier one institutions, too big to fail, because it would lead to some of the concerns that you've enumerated. and it would lead to the same kind of problems we've had with fannie mae and freddie mac. i do think, though, unlike mr. mahoney. i think if we don't identify those institutions and treat all institutions the same, we say these are the rules, you know,

you, as you grow in size in terms of your asset base and depoits base, as the composite shifts, then you have to put up more capital. you have to pay higher deposit insurance. you have perhaps another insurance premium to pay in case you do fail. i think that would work reasonably well. it's important to remember that fannie mae and freddie mac were born out of the government and did have a guarantee. they had a line to the treasury. and none of these institutions that we're discussing today have that similar kind of heritage or similar kind of backing. >> i'll ask one quick last question, and that is on subordinated debt. we've talked before, mr. zandi, about how we might avoid this in the past. but what do you think of mr. wallison's concept of strubturing that subordinated debt. i don't know if you had a chance to see his paper on that. >> i don't know it well enough

to comment. i thought it was an interesting idea but haven't thought it through well enough to really comment. >> thanks. >> sir, if i could -- on the subordinated debt. the more general idea the market can pick up the risk, i would point out, the market pricing risk, look at the -- for citigroup prior to the crisis. they thought citigroup was becoming less and less risky. as we look back, it was becoming more and more risky. as one thing to look at, it's okay. as a panacea or something to put a lot of weight on, i would -- >> basically, the way it would work, the largest banks would be required to issue the subordinated debt, and it could not be bailed out. and so if the interest rate on these instruments were to rise above the rate on treasury, substantially above the rate on treasury securities, it certainly would be one signal to regulators that the market

perceives excessive risk-taking by that bank, and it would then, you know, you could set up a structure so at least there would be an objective way to monitor this and you'd have the advantage of the subordinated debt out there. >> why wouldn't you pick up that information in the credit spread on bonds or unit equity premium? i'm not sure why there's -- >> it has the additional benefit at least of having the subordinated debt there that, by definition, cannot be bailed out. so, you know, it's one more indicator but it's an indicator combined with something that's going to reduce the incentive. >> gentleman from california. >> thank you mr. chairman. mr. mahoney, thank you for focusing on the portion of the white paper dealing with resolution authority. it's being sold as if it's just a tweaking of the bankruptcy code. but as you illustrate, it is permanent t.a.r.p., and not limited to $700 billion. it's unlimited t.a.r.p. wall street will love the money.

treasury will love the power. it's got absolutely no chance in that form of passing the house of representatives on a fair up or down vote. so the question really is whether my party will fall in love with the idea to the point where we try to force members to vote on it as in the dead of night or as part of some major appropriations bill because i think the only thing less popular than t.a.r.p. in an emergency is unlimited permanent t.a.r.p. our -- the economists here have asked us to design a system that implies the possibility of bailouts. at least as a possibility. and i hope that whether that's great economics or not, you'd recognize the political situation and help us design whatever the best economic regulatory system is that absolutely shuts the door

permanently and absolutely on bailouts. i don't think there are many members of the house that don't want to shut that door. the idea of hiding which companies are tier one seems absurd. first word favor transparency. second, everybody will know anyway. and, third, i think if we -- if we're going to require additional capital of certain companies, that will identify who is tier one. if we don't require additional capital of tier one companies, then we're going to give them the possibility of being bailed out and being a systemic risk without even doing -- requiring additional capital. professor johnson, you put forward the -- an interesting idea of trying to limit size, but pointed out, how do we apply this to foreign-based banks. one idea would be to say that no

financial institution could have actual or contingent liabilities to americans in excess of $100 billion or $200 billion or whatever the figure is. so that deutsche bank or bank of america could pose the same level of risk to the united states economy if the german government wants deutsche bank to have liabilities to germans of a couple of trillion. that's up to them. but if a bailout is necessary it will be because of the effect its collapse could have on the german economy and presumably that money would come from berlin. could you comment on the idea of setting an absolute limit on the size that a financial institution could be in the american economy measured by its actual or contingent liabilities to americans. >> certainly. and, obviously, this raises complications in terms of

international agreements. it's not something you would necessarily do unilaterally. that's why you need the g-20 to be brought with you. >> the g-20 will never do this. we have a right to say that you can't borrow more than a certain amount from americans as a single financial institution. >> i agree completely with that. >> and if we were to do it and they were to disagree, what are they going to do to us? go on. >> i completely agree with you. i was just talking about process. i think we -- you do this in terms of -- anybody who is deposit taking. so if you look at what went wrong with icelandic banks in the uk, for example. at the retail level, they participated in the deposit insurance scheme of the uk and that fook care of people with deposits below the uk limit. the problem is other uk citizens and they obviously got into a nasty fight with the british government about what assets all of those icelandic banks will be used to settle up those debts.

what you are pointing to is what implicitly came out of this, which is the accomplish government felt they had -- they could claim a lot of these icelandic assets. they threatened to use antiterrorism legislation to do it. that's where this is heading unless and until the united states impose these limits. >> if we're going to limit too big to fail, means too big to exist, can we do that just for depository institutions and/or their holding companies, or do -- if we're going to protect the american people from both systemic risk and the risk of being called upon to make a bailout, do we need to apply it to entities other than banks? >> i think you have to apply to entities other than banks. i'm quite far from the consensus view on this. i think it's really very important. i think we're talking about all financial institutions. we haven't talked enough about insurance companies today. conversations tended to gravitate towards commercial banks. i wouldn't assume the next financial crisis will be just like this.

they tend to mutate and involve other risk-taking institutions where we don't fully understand the measure of the risk. your point is very important. it's got to be broad and across a lot of financial institutions. >> ms. rivlin, you seem to have a comment or i may be -- >> no, i agree with that, and i was glad to get a chance to counteract the absence mr. wallison who thinks we only need to worry about banks. the lesson of this crisis is we need to worry about the whole financial sector and a lot of the trouble came from outside the banking system. >> i'll give myself one more round. for about two minutes. i want to deal with this notion that we're somehow -- people have gotten attached to a whipping boy and are unwilling to be torn away from it. the whipping boy with a name tier one companies. we have said we're not going to name tier one companies and people seem reluctant to move on. and they -- we'll have secret

tier one companies. no, there won't be any tier one in the legislation we are dealing with. and you say, well, but if you're raising capital. well, the requirement that people raise capital will not only apply to the largest. there will be a gener@@@ iúx x r well, there's no tier one. so people have to let that whipping boy and straw man go. >> if the chairman will yield. >> whether tier one are identified or not identified, as

long as companies are eligible for bailout, the ones most eligible will be the biggest and -- >> no question about it. what you are saying is anything big. so i understand the gentleman's position is a law which, of course, would not be persuasive. you are arguing against yourself. because all you can pass would be a statute that said there can never be a bailout. what can you do to a statute? >> you could repeal it. >> i will yield again to the gentleman. if there had been a law on the books that said you cannot have a bailout, it would have been amended by the t.a.r.p. at some point people are going to say i have to have a bail out. i'm jonesing it do a bailout, there's no way around it. i do believe there are structural things you can do. let's not have the strong arm of the tier one or the big companies. people will think there can be a bailout. it's not binding to a further statute. >> i would think there's a huge

difference between adopting the president's proposal, which is permanent power for bailouts and saying, yes, there could be a bailout if you can pass it on the floor. >> i'll take my time back to say idon't know where the gentleman thinks he is. we're not confined to picking plan "a" or plan "b." we're going to write the bill. we'll deviate from what the president does in a number of cases. i understand it's easier to beat up the tier one companies but that fight is over. there won't be any inside, outside and the fact that capital requirements are increased will be a tip-off because all manner of institutions will be told, small banks will be told by the fdic to increase capital. so if you are convinced -- i think probably the only way to break the habit would be a couple people who fail. i differ with the gentleman in this sense. i think the likelihood of the society holding to an absolute 100% hard and fast never a

bailout is less likely than a resolving regime that would say you've got to fire the ceo, you have to fire the board of directors, you have to impose other penalties. you have to make it really unpleasant and that would not rule out in the course of that, ad sometimes happens in a bankruptcy, some payment. those are the two choices but it's not the strong arm that most people wanted. the gentleman from colorado. >> thank you, mr. chairman. and i think i agree with the chairman on increasing capitalization for all institutions and especially in good times, increase the capital, in bad times give them a little bit of a break. but i guess sort of as the philosophical economic question to the panel, whether we're better off or worse off having over the years slowly eroded and

chipped away at glass stiegel and banking so that we've separated, you know, the investment side, the stock traders from the banke erers ane insurance company and we've made banks stand each street -- every bank stand on its own capital. so that would be my first question to the panel. so are we better off by having a more efficient system or were we better off by having every bank stood on its own merits and we capital the investment side separate from the banking side? >> in other words, should we never have pass ed and gard-st. jermaine and started national banking and branch banking. we can't unring this bell. but just as a general principle, do we want a really efficient system, which is where we headed, and then it all collapsed very quickly, or do we

want to put some brakes in the system that don't exist right now? >> i think we want as efficient a system as we can get consistent with reasonable stability. and i realize that's kind of gobbledy gook but it's a trade-off. and if we were to go back to no branch banking and so forth, i don't think that's either feasible or sensible, but we may have gone too far in allowing growth. and maybe not even for efficiency reasons. and so we need to revisit this question and see where we want the trade-off to be. >> mr. johnson? >> do we really have an efficient system at this point? mr. bernanke gave a speech where he talked about financial innovation. he didn't name a single innovation since the 1970s in the financial system. it's clear to me we've got that much efficiency.

i think we need to apply the brakes. i don't think you can go back to where we were before. you can't unring the bell as you said. but applying the brakes is absolutely critical. >> how would you do that? >> the main thing -- the main proposal is to reduce the size of the largest financial institutions so when you find yourself in a collapsable bailout situation you can say that's okay. we go to bankruptcy. you are more like cit group last week than citibank over the past, six, nine months. >> or could you demand as a compromise to that that you don't break up the banks or reduce their size and make them spin something off but you say as to the northeast, you've got to show capital for massachusetts, connecticut, maine, new york, whatever. so that you have a version of unit banking, that your bank has to stand on capital based on a section of the country or -- i mean, there are a lot of ways to deal with this. the chairman and i have been in a disagreement.

i think that there really -- you've got to look at both the size of the institutions as well as their product mix. not just markets -- not just capitalization. but i'm trying to find something that maybe i can get him to bite on. >> if the gentleman would yield. >> i certainly would yield. by my disagreement sican't get the gentleman to tell me what he proposes. he referred to a disagreement. the only disagreement is i can't understand what you're talking about. i've asked you to tell me what it is you want to do. >> i know what i want to do. i want to reduce the size of some of the big -- >> with regard to -- are you asking we repeal -- what would the gentleman do to restore it? >> mr. johnson, please help me here. >> perhaps the chairman would consider a graduated capital requirement. so this is not the 0, 1 tier. but capital that increases quite sharply because we know the system risk and the amount of

extra debt to gdp that's taken on. so this is a very sharply increasing curve. >> yes, that's what eye when i said a disproportionate increase in capital. >> the question is in the numbers. how fast has it increased? how big is the disadvantage to size? >> i don't think you want to go ba to any kind of regional criteria. if you remember back historically, we had vicious regional economic cycles in large part because of unit banking. because the bank was stuck to its region and exacerbated the do downturn in those regions. we had severe regional psycheles in large part because of the unit banking system we had. so i think that would be very counterproductive. >> thank you. >> i completely agree with that point and would also just note that in the crisis, what you saw is that institutions that had a lot of exposure to subprime did very badly. some of those were stand-alone investment banks like lehman.

some of them were more or less stand-alone commercial banks like countrywide. some were combined investment and commercial banks like citigroup. so i don't think that that's a strong piece of evidence that we need to re-establish glass-stiegel. >> thank you, and i lead back. >> i am going to take time. the gentleman raised it. i frankly didn't recognize my views as he characterized them. my conversation with him, he said i'd like to -- i still don't understand what the proposal. yes, in terms of capital requirements, i very much agree. but the gentleman hasn't given me any ideas with which i could disagree. >> the gentleman is work on it and he's asking the panel for some assistance. if i can't come up with an answer that satisfies you then i can't coming up with an answer. >> characterizing it as disagreement is sort of puzzling. >> if the gentleman will yield. i did put forward an idea, not based on whether you are mixing

investment banking with insurance and the glass/stiegel idea but a dollar limit. you can't have debts to americans in excess $1600 billion c of $200 billion. >> is it too big to fail? is it one of the arguments has boon. >> would the gentleman yield? >> i just want -- if that's what people want, that's your proposal is very different. >> mine is like a glass/stiegal. i don't believe -- i think that the investment banking community is all about risk. and i think they should be allowed to do whatever derivatives they want to do. subject to disclosing to their investors in an open fashion. and they're over in this part of the investment or in the financial community, and the banking system, which i believe is like a public which is why we pumped in $700 billion because we had to keep the

lights on, and we intervened in substantial way through the fed, that's, in my opinion, what we had to do last fall, which was a radicalizing moment for me. so i just believe that they really look at the world differently. >> first of all, that doesn't account for aig. aig was not a bank. it was doing derivatives and the federal reserve intervened without us. people should remember that the federal reserve are, the approval of the treasury, came to us and announced that they were intervening. it it wasn't part of the t.a.r.p. initially. they just did it on their own. it wasn't because they were a bank. my other point, gentlemen, is you say -- we've been talking about this for months and i still don't know what it is you're proposing. >> i'm proposing one, one, to limit the amount of deposits a single institution can make. >> that's not what we were talking about. >> i'm talking about size and

product mix. so i'm also saying that insurance companies cannot be part -- insurance companies, stock trading companies and banks should be separate, as they were under glass/teague elle. i believe the roosevelt administration did the right thing when its first act was glass/beagle -- >> are you -- that's the first i heard that you're proposing that as a solution. >> that's the best way i can articulate what it is that i believe. so with that i yield back. >> gentleman from indiana. >> thank you, mr. chairman. we've been talking about too big to fail, and there's another area and that is too big of an effect on the entire market. and mr. zandy, i want to ask you -- i read your statement where it talked about emerging market investors did little or no research of their own and that the credit could not -- this could not have occurred

without someone providing the credit. but didn't the aaa ratie inings kbichb by moody, isn't that how the credit floweded, if you give me aaa the credit will come from that? so we had a large investor who talked to us and said, if the credit rating agencies had not done that, this never would have started in the first place. >> let me reiterate i'm an employee of the moody's organization, but these are my own personal -- >> no. i understand. >> and i think there's plenty of blame to go around in that chain of securitization from the lender to the investment bank to the rating agency to the investor. all of them were culpable. all of them made mistakes. all of them were wrong. so i don't -- if you read through the entire statement, i go through that chain. >> and i did. i guess what i'm asking is, we've been talking about solutions to this, and so with

the credit rating agencies, the question is, what keeps the moo moodys from being in their same position with their aaa ratings again? and that's what we've been looking at. we've talked about cutting the cord or the apparent conflict of interest of the person who is asking you to rate these securities being the same one who pays the fees. there's been a couple of things offered and i guess i wanted to get your opinion. is it something that, like they do in the legal world when you go to file a case, that the judge is pulled out of a hat so you can't pick your judge? is this, in effect, a number of these ogss are put organizatio in a hat and you can't say i want moodys because they'll give me a aaa? >> i think that's worth in my view an xpeemt. i don't know if that works

better or not. but i think it probably is an idea that is worth@@@@@@@ @ rr@r monitoring and evaluating what the rating agencies are doing p much like banking regulators do with credit risk officers of major commercial banks. they look at the model, say, does this make sense, and should we be doing this? i think it should be required that the data that the rating agencies use and the ratings should be vetted in some a.

one of the biggest problems in my view was that the rating agencies would say, you give me the data. i don't reunderwrite the line. i take it as given and then i rate. they said it to everybody, the investor, the bank. that's the way we do it since we started business. but that makes no sense to me. there should be a third-party firm that's the data, samples the data, makes sure it's okay. so i think all of these things could be -- should be implemented and tried. let me say one thing and this is " a no-win to me. >> no. that's not true. i read your book and everything. >> bottom line, i don't believe that this conflict of interest -- and there is one -- is fundamentally why they screw up, why they made a mistake in the ratings. i don't believe that. i think it's these other issues we've discussed. and i don't think i would experiment with the approach you

just articulated but fundamentally you're going to ha have conflicts no matter what. it's a matter of managing the conflicts the best you can. >> one of the other things the investor, this fellow, talked about was -- and he talked to all of us -- maybe what we ought to do is throw a couple of cents on everybody trade and have a quasi -public rating system so we don't have to speculate on the opinion of mood kmoody's or effect become like a public utility, that it's too important getting this right to our economy, to the global economy. we had fed chairman in today who said if we had let this get out of hand the whole global economy would have collapsed. and so much of it was tied into these incorrect ratings given by hoodie's and others. >> let me say one thing. i think a transaction fee is a

good way to raise revenue. the only brob you have to do is globally. you can't just do it here. >> then you're noncompetitive. >> it's just not going to work. talk about g-20. >> what we're trying to do is we're throwing out ideas of how we can fix this. anything from any of you -- >> in a financial transaction, it may be a good way to raise revenue to self-finance too big to fail. there's a way to generate revenue, you put it into a fund. but you can't do it unless it's a global process. >> mr. johnson wanted to say something. >> and i think there's an implicit assumption here that we'll get it right next time. >> that's why i said, why can we assume that next time we'll do it any better? >> i'm not opposed to these ideas. let's try them. but fundamental lly we'll get i wrong again. we haven't changed the politics of the entire process and the powerful people in the system.

a quasi-public system will be wrong also. we should design something that will withstand the failure of that. i think the way to do that is make sure when things fail they're not so big relative to the economy. >> one point mr. zandi made, we all make progress in reaching consensus such as with the tier one companies, i think it's overwhelmingly likely that we will repeal all statutory mandates to rely on rating agencies and that we will instruct the regulatory agencies to examine theirs. so that is one way to deal with it. that one i guarantee you will be in the final bill, that all of those -- there are two forms. in some cases people aren't allowed to do certain things unless they get a certain rating. people can't invest many other entities unless they have a certain rating. we're combing the statutes now. that's something that the republican plan and our plan that will half happen.

i thank -- >> mr. chairman? i thought we were doing another round. i wonder if i could -- >> we've got to -- >> i wonder if i could have one minute. >> sure. >> i would just say that i we're trying to minute the mreef on wall street that particular companies have somehow a federal guarantee. the best way to do that is to have no bailout authority vested in treasury unless and until some future statute is passed. t.a.r.p. will expire, and then wall street would have to recognize that it would be very difficult under any circumstances to pass t.a.r.p. again. the way to maximize the belief on wall street that those companies that they identify as systemically important are going to get a federal bailout and, therefore, are entitled to lower cost capital is to vest in treasury the right to bail out companies. and the fact that the management of that company might lose its job is of little interest to the

counterparties. what we're trying to do is make sure that the cost of capital does not reflect the belief that there may be a bailout of the institution and whether management comes or goes doesn't really matter to the creditors. i yield. >> would the gentleman identify for me, where do you find this bailout authority? >> the bailout authority i think was well summarized by mr. -- >> i'm asking you where you found it in the administration's position? i think you've overstated it significantly. where in the administration's position are they asking for money -- >> they don't ask for an appropriation. i don't have a copy of the proposal. i do have mr. mahoney's testimony and my statements are fully consistent with the second page of his testimony. >> do you have the reference? what is it that you think constitutes bailout authority? >> well, i think it is the -- there's a statement that in the

special resolution procedure there are all of these authorities given to spend money. now, the white paper doesn't say where the money comes from. i believe db. >> the question wouldn't be where it came from but where it went to. is the authorization to bail out creditors? >> the authorization is to recapitalize, to purchase assets from, to make loans to, and that would go directly from treasury into the -- >> my understanding it was more analogous to the bankruptcy situation where you are not paying off old debts but trying to get things going forward. but we'll look at that. >> if that's all that is being talked about, then that's great. but i certainly didn't read it that way. >> in the white paper. >> yes. >> that's not our impression, but, again, we know that will be

our position. the hearing is adjourned. oh, i apologize. the property casualty associatr8 portion

begins with the opening statement by house financial-services chairman barney frank. >> i will now begin reviewing on substance. ausley welcome the chairman and i think it's very important and i was pleased to see his article in "the wall street journal" about a question very much on people's minds. the united states government according to the federal

reserve, the federal reserve for a variety of reasons mostly bought of its choosing the federal government was deeply engaged and increasing liquidity putting money out into the economy particularly to a constriction of credit and they want people who are concerned that this will be inflationary. i think the chairman has shown consistently has of secretaries of treasury paulson and geithner aware of this but when you were talking about inflation you talking not just about a reality that perception. if people think there's going to be inflation that's inflationary and it's very important the chairman address as he has been doing in a very straightforward way these concerns. i am persuaded by the chairman and others that we are able in an orderly way to undo what we had to do so that there wouldn't be that inflationary impact.

i hope we believe the inflationary danger is not the current most important one, but it is i think a very good opportunity for the chairman to address but i also want to talk about another matter and want to make a confession apparently of the leverage is of apparently my vision is deteriorated more rapidly than i hope to would be. i have looked carefully at deliberations we have seen about the bank of america merrill lynch issue and our colleagues on the government committee have had a number of hearings on that. i must say one of the interesting and potentially constructive things that cannot was secretary paulson's explaining that he couldn't because he has never sent them. that is a practice of i recommend to many others will follow myself, but as i studied

all of this here is my problem. i cannot find the villain. many of my colleagues have found various fillings. they tend to be private sector or public sector depending on the ideology of the founder. but as i look at what happened, what i see is a very difficult situation that threatened further severe damage to an economy already damaged. a repetition of the attack on the credits issue which is central to the functioning of our economy which we have seen in earlier failures, and i believe we had people faced with a difficult situation to say to some of my democratic friends have been critical of the bank of america as i have been and other areas they've not done what they should in modifying mortgages. i would have plenty of criticism to make in the financial but people health said well, why was

he not focused entirely on the shareholders? many of my colleagues who have made the criticism said they don't want private-sector people looking up the narrow interest of the shareholders but they do want them to take into account the broad impact of what they do. possibly terrible credit crunch would hurt their shareholders. as to the federal reserve and the treasury, i think they had a very important responsibilities not to see a repetition of the collapse of merrill lynch by bank of america they would have had very negative consequences. i think there was one thing people need to remember. solutions cannot be more elegant than the problems they seek to resolve. brandt you have a terrible mess it is unlikely those who try to immediate danger of that mess will come out looking clean. not for the first time as an elective officials on a and the