and arf thrilled to have her. we have added tony rogers who came from the state of arizona running their medicaid system and health strategy system. he will become head of the new center for medicare. peter will be focused on fraud and abuse and those are brand-new administrative positions and really will help us have a much more robust innovation strategy. enhanced effort on cracking down on fraud and abuse to deal with a lot of medicare challenges that the bill has presented. moving medicare to a much more valuable purchasing operation with $400 billion that we spend every year. we have an opportunity to help

change the delivery system in a pretty significant way to the benefit of beneficiaries and consumers. .. >> i don't think it bodes well for our future when we can't have a robust debate or some resolution our challenges in a bipartisan challenge. i am disappointed that from the

outset of this debate, a year ago before i was ever even appointed secretary, there were already sort of political battle lines being drawn and people saying we will never participate in this conversation, which i don't think is healthy going forward. i am also convinced that once we have an opportunity, not just the department of health and human services, but working with stake holder groups, working with consumer advocates, getting information out, when people understand what exactly is in the law, what isn't in the law, what it does, what kind of timetable the implementation strategy is taking, that there will be a lot of engagement and enthusiasm about it. will that help our next round of debates? i don't know. i hope so. i am a believer that finding some common ground is important

going forward. i was a, you know, democrat elected in an overwhelmingly republican state, and found building coalitions to be something that is critically important. we'll 50 right back to work -- go right back to work and try to do that. one of the things i think that got lost in the shuffle along the way, which is somewhat remarkable, is that there are groups and organizations, among them, the american medical association, representing the health care providers in this country, who have historically opposed any kind of health reform legislation, including medicare, vigorously opposed it, and yet they were at the table with this puzzle. there were lots of business groups, some definitely opposed, but some who came to the table, i think a recognition that we really had a broken system and we had an opportunity to make some significant changes and

people didn't want to lose that opportunity, so i think at the end of the day, that will be the common ground, that lost that opportunity and now we need to, you know, bring people back together about how we work together on implementation. >> we are almost out of time, bufore asking the last question, we have a couple important matters to take care of. first, to remind our members and guests of future speakers on april 12, dennis quaid will be discussing the potentially dangerous medical errors and janet napolitano will be here discussing the state of the nation's and the world's aviation system and on april 19th, congressman sandra levin will be speaking on financial reform and other topics. also would like to present today's speaker, thank you for very much for your time today. here is the legendary national press club mug. >> we leave this recorded program and take you live to the second round of the financial crisis inquiry commission hearings, first witness of the day is former federal reserve

chairman, alan greenspan. on the screen, phil angelides. >> i want to thank my fellow commissioners for all their hard work and dedication as we strive to fulfill our mission on behalf of the american people and i particularly want to thing commissioners murin, wallace who were the lead commissioners in preparation for this hearing and for hour investigation in to subprime lining practices -- lending practices. this hearing is one of a series that will focus on key p toics that this commission must consider as we examine the causes of the financial crisis. over the next several months, we will look at the role that, among other things, derivatives, credit rating agencies, the shadow banking system, too big to fail institutions, regulatory failure, and speculation played in bringing our financial system to its knees.

these hearings are just part of a research and investigation effort we are undertaking to conduct a full and fair inquiry that this nation deserves. in each of these hearings, we will examine the larger forces, policies and events that may have shaped the crisis. and we will also undertake a series of case studies of companies and government agencies so we can see what happened on wall street and in washington as the seeds of this crisis were sound and as the development spread across the nation and the globe. as we meet today, the mortgage and housing crisis is still very much with us. over two million american families have lost their homes to foreclosure. another two million homes are in the foreclosure process. and an additional 2.5 million households are more than 90 days behind on their home loans. one in four homeowners owe more on their mortgages than the value of their homes and american households have lost

almost $7 trillion in residential home value. over the next three days, we will look at how we got to where we are today. we will examine the role of the federal reserve in the mortgage crisis and in subprime lending. we will explore citigroup's activities and losses related to subprime loans and mortgage-related securities. we will probe the actions of the office of the controller of the currency as it oversaw citigroup and other financial institutions, engaged in the subprime market, and we will look at what happened at fannie mae and its regulator as the crisis unfolded. as we have noted before, this commission is a proxy for the american people. perhaps the only opportunity to have their questions asked and answered on their behalf, we hope to take stock of what happened, so we can learn from it and restore faith in hour economic system. as always, we welcome your thoughts and input. in that regard, we have posted on our web site, draft preliminary of staff reports for

review and comment. those can be found at fcic.gov. these reports have not been adopted by the commission and we invite you to submit your comments by may 15th. today's hearing is another step along the road in hour inquiry. we hope it will further our and the public's understanding of what has happened. we need candor about the past, so we can face the future. i'd now like to ask vice chairman thomas to make some opening reparks along with me this morning. thank you. >> thank you, mr. chairman. i too wanted to thank all of the participants in the hearing. i want to underscore the fact that everyone we have worked with have been extremely cooperative, and therefore none of the statutory tools that we have available, which will allow us even with uncooperative folks, to get the story, have been necessary. the people who are here before

us today have a story to tell. it isn't necessarily the exclusive story of those who are telling it, especially when we look at a corporation like citicorp. we're not singling out anyone, but as we examine the fundamental systemic crisis, we thought it was useful and valuable, frankly, to have examples so that we could, with the public in these public hearings, examine in some depth, the questions that we will be asking others, other corporations, other government agencies, other important players. a little bit like just showing the tip of the iceberg with 7 slashing 8 behind the scenes in terms of what we're doing. as we did in the first hearing, i'm going to ask each witness if they would voluntarily allow us to continue our communication with them in writing, since this

is a journey of education for us, as well as the american people. and at any one time, the questions we may think relevant of the various witnesses may very well be, but not the kind of followup questions that we would very much enjoy continuing to get answers to, which are impossible only in the setting of a hearing. so mr. chairman, it's a pleasure to be here. i thank the chairman for kicking this of off for us with the full understanding that we're just dealing with 1/8 of what it is that we're going to be looking at and 7/8 will go on behind the scenes, as it has for several months. thank you, mr. chairman. >> thank you, mr. vice chairman. now, chairman greenspan, as we have done with all witnesses, and we will do with all witnesses through the course of our hearings, i'm going to ask you to stand so i can administer the oath. to you.

do you solemnly swear or affirm under penalty of perjury that the system you are about to provide the commission will be the truth, the whole trout and nothing but the truth to the best of your knowledge? thank you very much. so mr. chairman, first of all, let me start by saying, thank you for being here, thank you for your extraordinary years of public service. and with that, i would -- i know you have submitted written system to us, and i would ask if you would like to make opening remarks of no greater than 10 minutes. in terms of oral testimony to us, if you would like to commence now. >> [inaudible] >> can you pull the microphone towards you? >> let's stop for a minute, see if we can pull that a little

closer. and it's not on. >> here comes our technician. good morning, sir. how are you doing? we don't want to strain your voice. tell us, sir, when we should roll. >> mr. chairman, in the interim, i do want to thank chairman

henry waxman, chairman of the energy and commerce committee, in whose meeting room we're meeting today. i noted to the chairman we've been in this relationship a number of times, but never in this particular room. i will not say that our first hearing in the ways and means committee had the microphones working. so i'm going to read the contract you have with the chairman in terms of what it is we get. >> here we go. no?

live television. all right. >> good morning. welcome to the meeting of the financial crisis inquiry commission. all right. thank you very much. andh that, chairman greenspan, of no more than 10 minutes and opening statement. >> thank you very much, mr. chairman. good morning to you, vice chairman thomas, and members of the commission. i want to thank you for the

opportunity to share my views on important issues raised in the commission's invitation to appear today. as i noted in my prepared remarks, while the roots of the crisis were global, it was securitized u.s. subprime mortgages that served as the crises' immediate trigger. the rate of global housing appreciation was particularly accelerated, beginning if late 2003, by the heavy securitization of american subprime mortgages, bonds that found willing buyers at home and abroad, many encouraged by grossly inflated credit ratings. the surge in demand for mortgage-backed securities was heavily driven by fannie mae and freddie mac, which were pressed by the department of housing and urban development and the congress to expand affordable

housing commitments. during 2003 and 2004, the firms purchased an estimated 40% of all private label, subprime mortgage securities, newly purchased and retained on investors' balance sheets. the enormity of these purchases was not revealed until fannie mae in september of 2009 reclassified a all right part of its mortgages portfolio as subprime and yet the effect of these gsc purchases was to preempt 40% of the market up front, leaving the remaining 60% to fill out domestic and foreign investor demand. as a consequence, mortgage yields fell relative to 10-year treasury notes, exacerbating the house price rise. which in those years, was driven

by interest rates on long-term mortgages. i warned the consequences of this situation in testimony before the senate banking committee in 2004 and specifically recommended that the gse's need to be limited in the issuance of gse debt and in the purchase of assets, both mortgages and non-mortgages, that they hold. i still hold that view. i u.s. subprime market grew rapidly in response to this demand, from global investor, gse's and others. for years, subprime mortgages in the united states had been a small but successful appendage to the broader u.s. home mortgage market, comprising less than 2 1/2% of total home mortgages serviced in the year 2000.

at that time almost 7 of subprime loans were fixed rate mortgages, fewer than half had been securitized, and few, if any, were held in portfolios outside the united states. by early 2007, virtually all subprime originations were being securitized and subprime mortgage securities outstanding totaled more than $900 billion, a more than sixfold rise since the end of 2001. the large imbalances of demand led mortgage originations to reach deeper into the limited potential subprime homeowner population by offering a wide variety of exotic products, products that lowered immediate monthly servicing requirements, thereby enabling previously untapped, high risk marginal borrowers who purchase a home.

-- to purchase a home. consequently, subprime mortgage underwriting standards deteriorated and subprime mortgage originations swelled in 2005 and 2006 to a bubbling 20% of all u.s. home mortgage originations, almost triple their share in 2002. the house price bubble was engendered by lower interest rates, but not the overnight rates of central banks. it was long-term mortgage rates that galvanized prices, and by 2002 and 2003, it had become apparent that individual country long-term rates were in effect, delinked from the historical tie to central bank overnight rates. in 2002, i expressed concern to the federal open market committee, noting that our extraordinary housing boom, financed by very large increases

in mortgage debt, cannot continue indefinitely. yet it did continue. despite the sends of i have two-yearlong tightening of monetary policy that began in mid 2004. in addition to tightening monetary policy and warning of gse risks, the federal reserve exercised oversight of consumer protection risks under the homeownership equity protection act and its general supervisory authority. in 2000, the board held hearings around the country on implementing its authority, focusing on expanding the scope of mortgage loans covered by hoepa on prohibiting specific practices, and of educating consumers. there after, we adopted rules that lowered the trigger for hoepa coverage and increased

consumer protections, including limitations on flipping, the use of balloon payments and the sale single he will premium credit insurance. more broadly, the federal reserve carefully monitored in the subprime market and adjusted supervisory policy to meet evolving marketplace challenges. in march 1999, the federal reserve issued its first interagency guidance on subprime lending, which addressed the variety of subprime mortgage risks, including the importance of reliable appraisals, and the need for income and other documents -- documentation. in october 1999, in 2001, and in 2004, the federal reserve issued detailed guidance addressing many of the loan features that have received recent attention, including prepayment penalties,

low introductory rates and low down payment loans, among others. a summary of these initiatives is included with my written testimony. the supervision of the fed banking agencies, including the federal reserve, is an important reason why banks and bank holding company affiliates were not a significant originators of the most controversial loan products as non-bank affiliated companies that operated outside the jurisdiction of federal bank regulators. the recent crisis reinforces some important messages about what supervision and examination can and cannot do. the forecasts of regulators have had a woeful record of chronic failure. history tells us regulators

cannot identify the timing of a crisis or anticipate exactly where it will be located or how large the losses and spill overs will be. regulators cannot successfully use the bully pulpit to manage asset prices and they cannot calibrate regulation and supervision in response to movements in asset prices. for examine regulators fully eliminate the possibility of few fewer crises. -- future crises. what regulation and examination can do is promulgate rates that are preventive and rules that are preventive and that make the financial system more resilient in the face of inherently unforeseeable shocks. such rules would protect automatically without relying on a fallible human regulator to predict the coming crisis.

concretely, i argue that the primary imperatives going forward have to be, one, increased risk based capital and liquidity requirements on banks, and two, significant increases in collateral requirements for globally traded financial products, irrespective of the financial institutionings making the trades. we will also need far greater enforcement of misrepresentation and fraud than has been the case for decades. if capital and collateral are adequate and enforcement against misrepresenting and fraud is -- misrepresentation and fraud is enhanced, losses will be restricted to equity shareholders, who seek abnormal returns, but in the process expose themselves to abnormal hall losses. >> mr. chairman, could you try to wrap up?

>> i will in just a moment. taxpayers will not be at risk and financial institutions will no longer be capable of privatizing profit and socializing loss les. -- losses. i thank the commission for the opportunity to submit these thoughts and look forward toupeetoanswering your question. >> good. thank you very much. so mr. chairman, i will start with a few questions and the vice chair and then we're going to go to the members, the lead members on this hearing. so let me pick up on some of your testimony, both your written testimony as well as what you have talked about today and i specifically want to focus on the area of subprime lending, which, as you know, and you've indicated exploded across this country from 2000 on, particularly in the later years. and in your testimony, you point to the fact that the securitization of toxic subprime mortgages was a key driver of the crisis and of course, that securitization could not have

occurred without the origination of those products. i want to focus very specifically on the actions of the federal reserve, could have taken, did or did not take with respect to regulating subprime mortgage products across this country, and specifically, i want to touch on something you mentioned, the homeownership and equity protection act and i have other questions about other areas in which you could have acted. so let melee this out for you. -- me lay this out for you. there was a whole set of regulations urging the public to act as well as information, which would have urged you to do the same. starting about 1999, a set of community groups began to visit with the federal reserve washing about predatory lending practices. in january of 2000, both hud and treasury urged the federal reserve to use its authority under hoepa to curb abusive

lending. the secretary of the treasury worked hard to put in place bet practices for subprime mortgage lending. in 2004, the f.b.i. warned that there was an epidemic of mortgage fraud, that if unchecked, could lead to losses greater than the s & l crisis. in 2005, the mortgage insurers wrote a letter to the federal reserve as well as other federal agencies warning that it is "deeply concerned about increased mortgage market fragility, combined with growing bank portfolios in high risk products poses serious potential problems that occur with dramatic suddenness." in addition to that, there were a number of internal actions, some of which you referred to. a staff memo in 1998 to the community and consumer affairs committee urging action in this area, a report by the staff, called the problem of predatory lending in november 2000, in which the staff wrote a proposal

urging that loans be prohibited to people that did not have the ability to pay and governor -- you did note that you issued guidance, not regulation, which showed an awareness of the subprime problem and in our interview, by our staff of you, you noted yourself that i sat through innumberble hearings on hoepa and you notedlet at another point -- noted at another point recently that we at the federal reserve were aware as early as 2000 of incidences of highly unregulated subprime mortgage underwriting practices. very simply, mr. chairman, why in the face of all of that did you not act to contain abusive, subprime lending, why did you allow it to become such an infection in the marketplace? >> first of all, mr. chairman, we did. there is a whole series of

actions that we take, which i've outlined in the appendix, which you have and which i repeated some early in my testimony, but let's remember, in a document that you sent to us, which is a federal reserve document, it says in july 1998, the federal reserve board and hud submitted a report to congress on mortgage reform, that report concluded that improved disclosures alone were unlikely to protect vulnerable consumers from unscrupulous creditors. the report recommended that congress consider the need for additional legislation, the report made several recommendations for possible amendments to hoepa, such as further restricting balloon notes, regulating the seal of single premium credit insurance, minimum standards for

foreclosure. now, i sat through innumberble meetings on the issue of hoepa, and we had, for example, detailed requests coming from a large group of representatives in 2000 and i think it was seven senators, about a month or so later, requesting that we do a series of things. including taking the hoepa triggered down from 10% to 8%, and a whole list of things, which i won't outline here, but they are in the appendix. we did do almost all of the things that you were raising. and the consequence of that is that i think things were better than they would have been, were they enough to stop the surge in subprime lending, they were not, and the reason for that is the

extraordinary changes that were going on in the marketplace and indeed, the actions of fanney and freddie, which we didn't know about until september 2009, which altered the structure of that market from what was in, say, prior to 2002, a small, well-functioning institution. >> i want to press on this, because you didn't have the ability to regulate fanney and freddie and by the way, i've seen your members and we're going of to a whole day on them and clearly things did not go well at those institutions an over 100 become dollars of taxpayer assistance to them but i do want to note that you cited the numbers from 2003 and 2004, they were 13% of the private label security market in 2005 and they were negligible in 2006, but what i really want to say, you did have the ability to regulate the products currently in the marketplace and so, you know, i do want to make sure

we're not rewriting or forgetting history here, and so i want to focus on what the result was of what the federal reserve did. you mentioned the guidance, and in fact, i know you issued guidance in 1999, 2001, 2004, 2006, 2007. of course, that was guidance to examiners, not binding, and most importantly, couldn't apply to the whole marketplace like hoepa could. it could only apply to those institutions you regulated and not all the independent mortgage lenders across the country. so it's good that you issued guidance, but i think that was more evidence that there was an awareness of the problem and a failure to act, but i want to specifically focus on the 2001 regulations, which you cited, and in fact, i think you said in your interview to our of staff, that "we developed a set of rulings that have held up to this day" but here are the facts. the facts are you adopted those rules in 2001, and at the time that they were adopted, they

were projected to cover 38% of the subprime lending activity in the country. when it was all said and done and an evaluation was done of those rules in 2006, not 2009, 2010, what in fact had happened is the rules you adopted covered just 1% of the market, so i return to you again, was there just a reluctance to regulate, was there just a belief that regulation was not the right tool to kind of con strain this level of abusive lending that ended up leading to the origination of product and then the mass securitization you talked about, because frankly without the origination, you couldn't have the securitization, but comment specifically on that 1%. are you aware that that finding was that the rules only covered 1%? >> well, look, mr. chairman, i just go back to what i said in my opening remarks. we at the board in 1998, were obviously aware of the nature of the problems. remember that the federal

reserve board is a rule-making, it is not an enforcement agency. we did not have the capacity to implement to the types of enforcement that the fdc has, hud has, the department of justice and what the rules should be and indeed, we covered as much as anyone could conceive of -- >> but if you had adopted those broader rules, the ftc could have enforced them and others could have adopted them. >> we did adopt a whole series of rules. >> but as i said, they only cover 1% of the activity. my view is and i want to move on to another issue, you of could, you should have and you didn't and i do think this is one area we have to explore, how this contagion could have been constrained. there was the issue of examination non-bank subsidiaries. in january 1998, you formalized

a policy not to conduct routine consumer compliance examines of the non-bank subsidiaries under your purview. the gao criticized that policy in november 1999. governor gram lick proposed that there should be examinations of consumer finance lenders, which would have covered, depending on the calculation, anywhere between another 12% to 18% of the subprime originations. it wouldn't have covered everyone by any extent. there was an august 2000 memo from dolores smith and glen loney of your staff, called compliance inspections of non-bank subsidiaries, of non-bank holding companies suggesting a pilot program. in 2004, the gao weighed in again, urging action, given the significant amount of subprime lending among holding company subsidiaries, but again, no action, no willingness to go in and examine a non-bank sub suddenry, even though after your

tenure in 2007, the federal reserve with the ftc and state regulators did launch a pilot and in 2009 began those examinations. why weren't you willing to go in and at least examine these institutions? >> well, first of all, let me just say with respect to 2009, regulation evolves over the years and i thought with the actions the fed took, in recent years, well after i have left, were appropriate, given the changing conditions, but let's take a second to give you a sense on how the decision-making operations at the fed took place. we have, of course, this 100 large, very sophisticated professional group in the division of consumer and community affairs, we have an outside consumer advisory group, we had 12 community groups

within each of the federal reserve banks, and we finally had the committee of the board which was pa committee on consumer and community affairs, which essentially oversaw the whole operation. that operation, as it worked its way through, would come to the board of governors with recommendations. now, all i am saying to you is that with respect to a number of the issues that, for example, governor gramlich, who i think is one of the best governors the board has ever had and a very close friend of mine, he was the chair of that committee and indeed, we always look to him to decide which we should be doing, which we shouldn't be doing, because he had the most knowledge. he chose not to bring those issues to the board, so i can't

say particularly why in individual cases, but frankly, i always thought his grasp of the situation was as good as anybody i have ever run into in the issue of consumer affairs. >> well, he was one person, but there were also others and there were staff reports. i mean, would you -- let me just ask you, would you put this under the category of oops? should have done it? >> i'm sorry, of what? >> would you put this under the category of oops, we should have done it? >> you know, when you've been in government for 20 up with years, as i have been, the issue of retrospective and figuring out what you should have done differently, is a really futile activity, because you can't in fact in the real world do it. i think -- i mean, my experience has been in the business i was in, i was right 70% of the time, but i was wrong 30% of the time, and there were an all lot of

mistakes in 21 years, so -- >> would this be one of them? would you put this in the 30% category? >> i'm sorry? >> would you put this in the 30? >> i don't know. certainly part of it i would. >> all right. let's do this then. i'm going to stop at this moment, i'll have additional questions, but what i'd like to do is now move to commissioner murin. >> oh, -- >> to my dear friend bill thomas. bill thomas. >> thanks to my dear friend, the chairman. you are in 21 -- i was in 21 from 1978 to january of 2007. i used to think timing was really important, now i think timing is everything. and so from your perspective and

my perspective, looking back at it, and in this particular instance, probably more so than anyone i can think of, there are enormous number of would have, could have, should have's, from an enormous number of institutions in government and in the private sector. one of the things -- and you've written a book, the recent paper in front of brookings, the crisis, and in your analysis here, does a pretty good job of pointing out problems in a number -- and you focus to a certain extent on government and not the private sector, but it's easy to do in terms of risk management decisions that were

made, i want to try to focus in a slightly different way on your role as the chairman of the federal reserve. during a period that you and i shared in terms of an economy that in your attempts to stimulate, you were beginning to run out of basis points in the cupboard and we were real close to job owning, because that was all we were going to have left. and always, when you approach a crisis, you approach it from today, looking at tomorrow. it's unfair, as you said, but i'd like you for just a little bit to turn around. because you've categorized concerns in the credit rating structure, the risk management structure, obviously the gses

and i'm not going to ask you to assign a waiting, but i do want to ask you, since we're not going to be able to accomplish everybody we want to accomplish in the time frame as i said in my opening statements, would you be willing to respond to written questions, in part, based upon this hearing, but any other information that we might need moving forward, understanding consideration of time, place, and manner? >> most certainly. i'd be delighted to do so. >> thank you very much. >> in your testimony, you point to a lot of the causes. none of them, not the subprime mortgage origination, for the housing bubble, for the prudent regulation of large entities, like cities that we'll hear from, are really the narrow focus, an even to a certain extent, broader focus of the fed.

so in your words, what exactly is the role and therefore the degree of fault that should fall on the federal reserve? >> well -- >> during that period. >> statutorily, we have a number -- we had a number and still do have a number of different authorities, fundamentally, it's monetarily policy, that's what a central bank does. we had supervision and regulation as a secondary but major issue. and we even, as we specify in the -- some of our written documents, the third one was systemic risk, so there's a very broad mandate that the federal reserve has and it's structured according to meet those particular mandates. we have an organization that is

the best in the business, as far as i'm concerned, in the issue of monetary policy. i know of no better supervision and regulatory operation than exists within the total federal reserve system. and we're dealing basically with problems, by its very nature, which are insoluble that require us to make decisions about what the future will hold and as i mentioned before, if we get it right 70% of the time, that is exceptionally good, and i think that we -- what we tried to do is the best we could, with the date that that we had and all i can say is -- data that we had and all i can say is did we make mistakes? of course we made mistakes. i know of no way that that can be altered under the existing

structure and i make a special point, as you know, of trying to emphasize that the only type of regulation that works and in fact, works sufficiently and adequately, is those that do not require forecasts. >> is it fair for me to indicate that the thrust of your testimony was that the crisis to a very great extent was caused by the demand for subprime securities? is that a fair -- >> well, fundamental cause of the crisis goes back to the end of the cold war, which is pretty object scour, but it's a global crisis. you cannot think of the united states' crisis in any form without looking at the global context. >> i'm going to get in to that as we go forward, but the narrow focus, and i do want to thank you for citing a book which i think is especially useful,

reinhardt and rogof, in getting us down the history of memory lane in terms of the bubbles, but if you were focusing on subprime securities, weren't they certainly predicated to a degree on rising housing prices? first of all, let's remember that the subprime mortgage market was actually a very effective market in its early years. it served a limited population, homeowner -- potential homeowner population, which couldn't afford the 20% down payment that prime mortgages pride. >> i agree with you in the early history. i've looked at statements from 1999, as they were moving into this area a number of people lauded it, isn't that the story of all bubbles, regardles regar,

whether they start of off with good intentions and somehow go awry and what we're trying to focus on in this particular bubble, what went awry? would you feel comfortable saying that at least some of the concern with the housing bubble was the fed's monetary policy or not hat all? >> i've tried to explain in some detail, in the brookings paper, i go through a lot of ec ecometrics, that a lot of things changed which made monetary policy ineffective in dealing with long-term asset prices, so you're asking -- >> i agree with you, i understand the argument, i'm just trying to move down a line and clearly, capital, the savings rate, the change in the

movement of money, and that had you -- it wasn't monetary policy in terms of your argument, because frankly, longer term yields would have been kept down by the inflow of capital, and long-term rates were kept below by international capital flows. but isn't it a minimally fair statement to at least say that if you had raised rates, wouldn't longer rates, albeit suppressed somewhat, still would have risen and slowed the growth of the housing bubble? >> i'm afraid that's precisely what we found didn't happen, and we -- >> and so even more capital would be flowing in, and it would have left basically long-term rates unchanged? >> well, you cannot explain -- >> that's your argument, isn't it? >> i'm saying basically that you cannot explain long-term rates in the united states other than what is being arbitraged in the

rest of the world as the paper in the brookings paper illustrates. in 2002 and 2005, the period when the bubble was emerging, that short-term rates, that is, the federal funds rate over which we had full chrome, did not affect long-term rates and that as a consequence of that, even though we tightened monetary policy starting in mid 2004, for a considerable period of time, we had very little to negligible effect on inflation in the home markets, which being is when the bubble is, so a simple answer to your question is -- >> give my self an additional five minutes, mr. chairman. >> simple answer to your question is the evidence does stipulate that it -- that we endeavor to tighten monetary

policy, did not affect long-term rates as it always had at the beginning of the tightening cycle earlier. >> ok. if the 10-year treasuries on which mortgages are based, don't react to short-term rates, what was the argument for keeping the funds rate low? wouldn't make any difference? was it for another reason? >> yes. the funds rate was kept low because even though monetary policy delinked from long-term interest rates in that period, it still had a significant impact on short-term rates, and short-term rates do have an impact on the economy. the reason we pushed rates down was in 2003, there was a very considerable concern that the type of deflationary processes which were underway looked very much like those that were

occurring in japan and indeed, similar to what's going on today and we decided that we needed insurance against that in the short end of the market. that was the reason we kept rates down, until mid 2004 that is. >> as we're looking at attempts, obviously, we're dealing with the situation in which a number of institutions fail, both in and out of government and we're asking ourselves questions, does it make sense to consolidate supervision, to try to make sure that the left hand knows what the right hand is doing, is it better to decentralize it. what about transparency. the whole question of the rating structure, third party analysis. in terms of looking at where

people in office and in positions of responsibility are going now, monetary policy, bubbles, making sure that certain things don't occur again, including, i think, the fed in terms of recent statements that are made, if they're moving toward regulatory instruments to target the bubble and interest rates to target economic activity, isn't that to a degree a -- maybe a repudiation is too strong a term, but isn't that different than the policy that you thought was appropriate or is it that they're looking at that period of history that they went through and are talking about where they need to go and what's your assessment of that? >> i think it's mainly the latter. it's difficult for me to know precisely what was going on in meetings, which i was not at,

but the markets are changing all the time. and it is critically important for the federal reserve to keep up with those changes and in many instances, they change in directions and require actions which previously would have been inappropriate. >> and then just let me say that in the last large paragraph of your testimony, are you really -- in my opinion, that pessimistic about our ability to deal with the conditions we find ourselves in, because inevitably, it will always be something else? but to a certain sent, i mean -- extent, i mean, when you have a river that overflows its banks, whether it's the nile or the kern river, building a dam seems to help by allowing a more regulated release? i got out of that last paragraph the only possible solution is

capital and collateral at an adequate rate, and i take that look at citibank and we'll be hearing from them recently, in that every turn they were, quote unquote, adequately capitalized in all the categories. so it's easy to say that, but what does adequately capitalized mean? and yes, we're in the human condition, and yes, i cited a book which kind of puts us in a historical perspective, at this time it's different, but it isn't, but i cannot believe that we can't get an understanding of how we can mitigate and to me, it's always transparency, it's always someone who is disinterested, slowing down the process and examining it to a certain extent. >> well, mr. thomas, you're raiding exactly what the be --

raising exactly what the issue is for regulators and that is raising adequate capital. i might just say parenthetically, that you're quite right, citi and everyone else was considered adequately capitalized. the major mistake in the system that adequate capitalization issue is a function of what your risk management system is, and as i mention in both the brookings paper and in the testimony, written testimony, what we discovered is that there was a fatal flaw in that system. we did not recognize it until we saw the outcome of what happened to the markets after lehman. the lehman bankruptcy. but the issue of adequate capital is important because just think for the minute, if we knew what the actual number should be, and of views as to what that number ought to be, it's higher obviously.

>> that will be a followup question in writing. if we had adequate capital and quid it's, whatever -- liquidity, whatever else we do would be adequate but not critical. if we had everything but but not adequate capital and liquidity, the system will fail to function. in short, i'm saying, we can solve this problem on the capital liquidity and collateral side as well as doing it in other areas like -- i say fraud and misrepresentation. in my judgment, over the last decades, has been inadequately enforced and that is a critical question. but how you structure regulation is interesting, important, but not critical to resolving this crisis and preventing the next one. >> i think we'll hear from a number of folks offering testimony that fraud or behavior should have consequences and if

it's illegal or criminal, something should result from it and it has been in my opinion, a failure from main street to wall street and here in the nation's capitol. thank you very much. >> all right, thank you, mr. vice chairman. now we are going to go to ms. murin. >> thank you, mr. chairman, and thank you, chairman greenspan. for your testimony. i enjoyed reading it. i'd like to know cuss specifically my line of questioning on the responsibilities of the federal reserve as it relates to ensuring the safety and soundness of the financial holding companies and the bank holdings company and their supervisory role. and in particular, go back to a time period that you mentioned, 2005, which was arguably the peak of the housing bubble and talk a little bit about the supervisory structure and examination staff of the federal reserve system. it's my understanding that there

were approximately 2600 people throughout the federal reserve system engaged in supervision and examination and during that time, approximately 12 of those people were allocated to examining citibank specifically and a similar number with allocated to examining the other major banks, which of course represent the major concentration of assets within the banking system. and i'm curious in retrospect, as to whether you would say that perhaps there could have been better resource allocation within that framework towards those larger banks, particularly in light of the fact that the federal reserve is not exon strained by the -- constrained by the appropriations process, as are some of the other agencies. >> let me go back to your original remarks. you were asking about the compensation issues that involved recently in history. i think it's important to -- >> mr. chairman, i'm sorry. i actually didn't mean compensation. but just the number of individuals that were assigned

to each enterprise. >> yes. i'll go to that. >> got it. >> the federal reserve and all the banking regulators have a fairly large cadre of permanent, on-site examiners in all of the big institutions and there is a very large contingent, not only obviously from the office of the controller of the currency, which of course regulates citibank, which is by far the largest institution in the citi holding company system, but we have the fed -- the federal reserve had a number of people involved. it's not an issue of resources, it's not an issue of people. it's an issue that it's an inherently rather difficult job and you're not going to get it done materially better by just resufficientlying the -- reshuffling the chairs. i think it requires a better

understanding of the type of problems that were to arise and most specifically, in my view, the necessity of -- the reason i raise the capital issue so often, is that in a sense, it solves every problem. now, banks don't like the issue of having to put up more capital, but if they didn't, and indeed, this last crisis exhibits this, they are getting a subsidy, unpaid for by the federal government, which has to bail out the banks at the tailend of crisis, and i think what the -- the critical question here is to focus on something we can do something about, control and generally have far greater effect than any changes we could make in supervision and regulation. >> well, to the extent that allocations of capital are similar in certain respects to the management of an agency or

business in terms of allocating resources that may be precious, personnel, time, energy, intellect, when you think about that, as an individual who is charged with ensuring safety and soundness for bank holding companies, in this case, citigroup, in concert with other agencies, even when you -- if you look back at some of the commentary from within the federal reserve system, there is a review of the operations of the federal reserve bank of new york as it relates to their supervision of citibank, which suggests that it was done in 2005. and i quote, that it had insufficient resources to conduct supervisory activities in a consistent manner. :

>> to do the jobs it's required to do, that the president of the federal reserve bank would have been on the phone with me, very quickly, and complained. no such telephone call, or any of the king indication ever existed. notion of an adequacy, not verifiable. i do think there are always problems of turnover and i think

the bank had a significant amount of turnover, which does create managerial problems. it's not a resource problem, although it's not a lack of funds as you correctly point out. the federal reserve is not subject to, i should say the federal reserve uses its own funds and does not require funds appropriated by congress. so we are not limited ourselves, even though we kind of restrict what we spend on, because we don't have appropriated funds. >> may i continue on this discussion of the supervisory responsibilities, and perhaps in this instance working with other agencies. some of the safety and soundness the terminations for the holding companies, who were the result of a dependence on the conclusions of other agencies. for example, the security

dealers, broker-dealers, or some of these major institutions would be covered by the fcc. if i'm not mistaken, and legislative language and suggest that the federal reserve should rely on the result of their supervision, their examinations. and i wonder in some respects if this doesn't in some ways mirror a dependent, say, on a rating agency. i mean, essentially you are depending on the work of others to determine the safety sounds and dignity of an underlying asset. >> yeah, that's a very tough question to answer. the reason basically is that this gets to the issue of centralization and to the extent the pros and cons of having, for example, as we do now, a number of different regulatory operations within banking. since i came to the federal reserve, there have been all sorts of discussions about should we have a single consolidated regulator, including the sec, the occ, et

cetera. and their argument i think, effective arguing on both sides of the argument. i think the current system has worked as well as it can. i'm not sure that centralization, per se, moving chairs around will alter its effectiveness. >> could you comment briefly on the composition of the board of the new york federal reserve bank? and your feeling about the constitution, if you have six of nine members who are themselves subject to the supervision of the entity itself, do you think that influences in any way the outcomes of their decision-making? and i would note that the lehman brothers, was one of the members of the board. do you think it makes them too close to the companies that they regulate? >> theoretically i would say that's an issue that has to be thought through. i personally have seen no

evidence that members of the board at the new york bank had any influence on policy, other than giving us advice. there were an extraordinarily vital source of information, because of their scope, but the notion that we in any way favored any of them, are basically were influenced with respect to policy by what they said, other than the facts they gave us, which we always evaluated. i saw no evidence of that in my tenure. >> and just a final question. back to subprime origination that occurred outside of entities that were supervised by the federal reserve, is it your opinion that this indicates should be supervised by the federal reserve now? >> well, first of all, remember we have yet to distinguish between supervision and

enforcement. a lot of the problems which we had any independent issue of subprime and other such mortgages, the basic problem there is that, if you don't have enforcement, and a love that stuff was just plain fraud. you're not coming to grips with the issue. the federal reserve, remember, is not an enforcement agency. we don't have or didn't have the types of personnel which that the sec, department of justice has to do that. so i can't answer that question fully because i can't say -- is fully cognizant. >> do you think then you should have those types of enforcement

authorities? >> it would require a very significant set of revisions with respect to how or supervision and examination forced would be. because remember, that was the federal reserve examines are largely experts and examining concentration assets, bookkeeping, a whole set of issues which relate to how banks work and how banks work in an effective manner. it's not a group who can ferret out investment, fraud, misrepresentation. and indeed when you get such examples, what we tend to do is recognize that we don't have the facilities, and we refer to the department of justice. which we did on innumerable occasions, and a lot of issues. in other words, we were requesting other enforcement

agencies to rectify the problems that we, in our examinations, work on merit. >> thank you. when you look forward, one of the comments that you made in the past is that future supervision, mr. sassi will have to rely far more on a banks risk management information systems to protect against loss. and then further, technology and innovation, the developers of sophisticated market structures and responses, do you still feel that is the direction that supervision and regulation should go? or do you think there should be some balance between bad and what would perhaps be viewed as more of old fashion auditing of the various assets that why within our organization? >> well, we are still working with the supervision structure and philosophy that existed 100

years ago. that is, back say, the year 1900, the examiners for the comptroller of the currency would go into a bank and be able to actually see the individual loan documents and review them in the usual manner. the system has become so complex that there is no longer the capacity, except in very small community banks, to still do it that way. which incidentally, is the ideal way to actually to supervision and regulation. so we are confronted with a problem that, in order to prevent the individual counterparties of various banks which we supervise and oversee, we are reaching far beyond our capacities. so that you have to rely, because there is no other real

alternative, to a sound risk management system on the part of individual institutions who, in my experience, know far more about the people to whom they lend then we at the federal reserve would know. so that they have to be the first line of defense. if they fail, and they did, in this instance. it's not a simple issue. let's regulate better. the old fashion regulation to which you refer, what i'm to -- was the best. it has been largely a victim of the degree of complexity, current, complex division of labor, society, requires and the financial institutions that are required to support so that you can't turn the clock back. this is all interrelated, and

it's a different world. the standard of living's are much our. the complexity is awesome, and i wish i knew a simple action to this problem, but i do know that if you cannot depend on the counterparties for balance of the individual banks which we regulate, our ability as regulators would be far less effective to the extent that it is. >> thank you. >> thank you, ms. murren. let's now go to mr. wallison. you have 15 minutes, mr. wallison. >> thank you, mr. chairman. mr. chairman, it is good to have you here. and i look forward to the opportunity to talk with you today. as you know, we are in the business of trying to find out what actually caused the financial crisis.

and you mentioned in your opening statement and in a written statement subprime and alt-a mortgages. and i wanted to follow-up a little bit on that. it's not in the material that the commission has put out, but it appears that there were as many as 27 million subprime and alt-a, in other words, week loans. in the u.s. financial system, which 12 million, according to the information that fannie and so put out, as you mentioned, and 2009, 12 million were held and guaranteed by fannie mae and freddie mac. and about 5 million guaranteed by fha. so that would be made the 17 million out of the total of 27 million that were on the books of government agencies. now, what we have forgotten a little bit in this is that we were very happy during the late '90s and the early 2000s

with the fact that these mortgages were increasing homeownership in the united states. something that it's very important. and we understood that these mortgages were subprime and otherwise we'd. but the whole objective was to increase ownership among groups that had previously been underserved. and, in fact, the homeownership in the united states increased from about 64% in 1992-93, to about 69% by the 2003-2004. this is a very significant thing in the minds of most people. now, these mortgages, however, as you pointed out, drove a bubble come a very significant bubble. and when that bubble deflated they began to, deflate themselves, to default themselves in unprecedented numbers.

and in 2007, as you are aware, the entire asset-backed market for mortgage-backed securities simply disappeared. as far as i know, this is an unprecedented event in financial history where markets simply disappears. and as a result of that, a large number of financial institutions were simply unable to market or even value the assets they were holding. now, i'd like to give you a chance to expand on what might have -- what this whole series of events might have meant as a cause for the financial crisis here and particularly, what was the fatal flaw you spoke about after lehman brothers failed? and i'd like you also to focus in your remarks, perhaps, on the

role of government policy in creating, or at least demanding, the creation of all of these weak and high risk mortgages. you've got a very broad express in markets, worldwide markets, the exactly the kind of problem we have been looking at. the collapse of worldwide market, and, in fact, a worldwide financial crisis. and to me, your experience there would be in doubt able to us in understanding the connections between government policy, on home ownership, and that crisis. >> well, mr. wallison, as i mentioned in my prepared remarks, government policy as such was very strongly related to the issue of enhancing

homeownership for lower and middle income groups. the way i put it, when honda was a major issue early on to federal reserve, and they were beginning to observe the extent of discrimination, that was involved in a lot of mortgage making, the thrust of policies were all acutely aware, was very strongly, to move towards increasing homeownership. a policy which i supported, because i think in a market oriented capitalist economy, the greater degree of ownership of property, the greater the participation of all people in that type of economy. the trouble, unfortunately, is that if you now go back and track a policy, we started off from the point where redlining

was the real concern. and indeed what that implied was there were a lot of banks which were leaving potentially profitable loans on the table. and so we at the fed were pushing for them to evaluate these loans in a more objective way, and they were doing that. the evolution of the subprime market goes over the years, and then begins to accelerate. because it was the broad thrust of this government to expand homeownership, especially amongst lower and middle income groups. it was a policy officially of and which gave standards to fannie and freddie, to significantly increase their participation in those types of

loans. and we look back now at the numbers, as you point out correctly, that is as often the case we go from one extreme to the other. and if you take the extent of fannie and freddie participation in and every to meet the hud goals, the numbers are extraordinarily large and very -- so large in fact, that they are preempting a major part of the market. and that, which we learned only in retrospect start in september 2009, was a major factor in producing the bubble. >> let me follow up a little on that. and i'm delighted to have the time to do that. because i've wanted for a while, i want to get a little bit more of the failure unfair flavor for what it was like to have sat in

your seat for many years during this period. in 2003-2004, maybe even 2005, if the federal reserve had tried to clamp down on subprime lending, when homeownership was increasing in the united states, what would you imagine would have happened? >> well, at that time foreclosures were low. home ownership was expanding. the delinquencies and subprime markets were remarkably small. if the fed as a regulator tried to thwart what everyone perceived in, i would say, fairly broad consensus, that the trend was in the right direction. home ownership was rising.

that was an unmitigated good. that congress would have clamped down on us. there's a presumption there that the federal reserve is an independent agency. and it is up to a point. but we are a creature of the congress. and if in the midst of period of expanding homeownership, no problems perceived in the subprime market, had we said we're running into a level and we would have to start to retrench. congress would say we haven't a clue what you are talking about. and i can virtually guarantee, indeed, if you want to go back and look at what various members, the house and senate, said during these periods on the subject, i would suggest the staff do a little run and you will be fascinated by how different it sounded back then

than the way the retrospective view of history has evolved. i mean, i sat through meeting after meeting in which the pressure is on for the federal reserve, and on i might add all of the other regulatory agencies, to enhance lending were remarkable. right now we have, as you point out, a nonexistent subprime market. it is also nonexistent alt-a market as well. and we have a lot of regulations for subprime, especially hoepa, so there is no monitor. i certainly trust it comes back, but the private subprime market shows no signs of moving. and it's not self-evident to me that it is coming back. so we could argue what the rule should be. the rules over what? there's nothing left.

i am merely saying that having to 18 and a half years before the congress, there was a lot of amnesia that is emerging currently. >> let me follow up a little more also on another part of this whole process. when the market collapsed, it was impossible, as i said, for financial institutions that were holding these instruments to value them or to sell them. in other words, this had a major event on their liquidity, but also on their financial statements. and i'd like your views on the significance of the elimination, the end of this asset-backed market for mortgage-backed securities, on the accounting of that financial institutions were required to pursue the rules of mark to market, or fair value accounting, and what effect those might have had on the

financial crisis. >> this is a major dispute within the accounting profession, and in odyssey the banking industry as well. i have always held a few that fundamental straight loans, commercial loans, which you do not expect to sell prior to maturity, that book valuation with amortization is usually, is the probably sensible thing to do. but there are an awful lot of instances out there, which fluctuate in value. and we do sell them. and the accounting profession says those definitely have to be marked to market. now, this is a dispute which will take two hours. i don't want to get involved and specifically.

but there is no simple solution. if you don't have a market value, as part of it may be, how else do you evaluate these things? you really have it a fundamental book or market. there's nothing in between. >> what about cash flow violation? many institutions attempted to use discounted cash flow because many of these assets, i understand, we will talk about this later when we get to see, we're continuing to flow cash. is that not a valid way to do it? >> well, as i said, there are, there are pros and cons to all of this. and there is no general agreement within the accounting professions, or in the banking professions. and i think it's a very important and useful discussion because it points out the fact that our books of accounting, not necessarily sacrosanct

merely because they are printed and published. we do not know exactly what the consequences of mark to market was, although remember, immediately following the lehman default, there were very major arguments that the accounting process of requiring mark to market was a factor in exacerbating price declines. that's a hard argument to make. it sounds plausible, but the question is always relative to what. and so i'm not -- i have not taken a position that i feel truly comfortable with in this issue. i am still learning. >> i have one more question, my final question, and that is a national community reinvestment coalition reported in its annual

report in 2007 that banks have made over $4.5 trillion in cra loan commitments in connection with the paving of approvals for mergers, principally by the federal reserve. and that is because banks had to meet certain standards in their cra committee we investment act to lending. do you recall these commitments in connection with approvals of mergers by the fed? and which you refer to that and ascribe that to us, if you do. >> mr. chairman, i would yield commissioner wallison three minutes. >> so done. >> i've got three more minutes so you have three more minutes. >> all mergers and acquisitions that are under the auspices of

federal reserve, that is the holding company act, require us to evaluate cra in conjunction with coming to the decision. it can only be made by the full board. cannot be done in any other place in the fed. so with every merger that we authorized was always accompanied by an evaluation of cra, the degree of meeting the cra requirements. the lowest -- law is pretty specific on that, and i think there are innumerable cases which will turn down mergers and acquisitions, but are far greater in which the staff initially said the board would

not in its existing various procedures, it's not likely to agree with this merger, unless you alter your cra commitments. and so most of the mergers that occurred, i would say probably had some cra adjustment either directly be threatening to say no to the merger, or indirectly by anticipating that we would say no, and therefore changed. so i think it was a fairly heavy cra commitment in the banking insist passionate industry. and it's working because you don't hear about it. >> thank you. thank you, mr. walston. now we will go to mr. georgiou. 15 minutes. >> thank you, doctor greenspan. let me just follow-up on 11 thing commissioner wallison began on. at page 12 of your prepared

testimony, you state that in my judgment the origination of subprime mortgages as opposed to the rising global demand for securitize subprime mortgage interest was not a significant cause of the financial crisis. could you elaborate on that briefly, please? >> i'm sorry, which you repeat that? >> let me respectfully reiterate that in my judgment the origination of subprime mortgages was not a significant cause of the financial crisis, as opposed to the rise in global demand for securitize subprime mortgage interest. the bottom of page 12. >> the actual originations of subprime mortgages, when the subprime mortgage were evolving from early 1990s through, say, the year 2002, was a contained market, largely fixed rate, and

that mortgage, that market worked well. it in another itself was not the problem and would not have been the problem, because it's only when we went to adjustable rates, sometimes, deep into the potential of home ownership, that the problems began to emerge, because the defaults, foreclosures were not the major problem early on. it's the securitization, which in turn is a consequence of the demand coming largely from europe. there was a remarkably large demand, the collateralized debt obligations in europe, which were funded by subprime mortgages. and the reason the demand was so

large is the prices -- i mean the yields were high, and the credit rating agencies were in the traunches of these various ceos triple-a. >> you term it directly to where i want to move to. one of the things that you said at the end of your repair testimony again is that you have a number of suggestions. to ensure that financial institutions will no longer be capable of privatizing profit and socializing losses. and those a just and are largely in the area of increased capital requirements and liquidity requirements, which you suggest might have avoided some of the most significant problems that we have had. you know, you serve the better part of two decades as the most important bank in the world. which is 20% of the time the federal reserve has been in existence, and ultimately the federal reserve is the ultimate

potential regular responsible for the safety and soundness of all of our financial institutions, all the principal bank holding companies and financial holding companies in the united states, what are some of the most important financial institutions in the world. i would ask you if your suggestions that more capital and more focus on liquidity could have been implemented during your tenure in a way that could have uploaded the financial crisis? >> not by the federal reserve itself, because remember, that where most of the problems existed is in the so-called shadow banking area here that is investment banks and others, not directly supervise and regular by the federal reserve. >> except the capital requirements frequentlfrequently were established by the federal reserve here. >> only for bank holding companies and banks. we did not have capital

requirements which we could enforce on the investment banks. that's an sbc -- >> understood, but, of course, in many instances the banks that you supervise were facilitating the creation of securitize assets by the investment banks that were within their groups. let me just give you an example here. the securitization row in 2001, which addressed early forms of the capital arbitrage through securitization established risk weightings. as you may recall based on the credit weightings at each charge of the secret secure session. and soon after regulars allowed liquidity puts out asset backed commercial paper traunches to give 10% with waiting a capital charge of only eight tenths of 1% in liquidity puts. and one of the citi executives have told our staff the citi

made its decision to support their growing ceo business with its own capital because of the regular capital associate with the super senior aaa traunches was close to zero. how did your supervisor, if at all about identifying and addressing the problems of capital arbitrage in the marketplace? >> remember that the so-called basel accord which was the consolidated international system of determining, for example, what risk weights to put on various assets and the various other issues which determined risk adjusted capit capital. i -- it's not clear to me what that has got to do with, for example, any of the large investment banks, whether it the bear stearns, lehman, others. it's not clear to me how we

could have regulated specifically their capital. remember, there tangible capital got two levels well below that requires, that is required by banks. we have no capability. >> but some of the activities of the investment bankers affiliates that were within the financial holding companies and within the bank open companies were impacted. the bank itself was significantly impacted by the commitments that they made. let me just give you an example here again. we found from our investigation of the citi that these credit default, credit debt obligations were ultimately citi, the bank itself have to come up with $25 billion on liquidity puts that they had committed to bring

these assets back onto their balance sheet, when the crisis hit. and they were basically illiquid and unable to deal with them. now, that had a significant impact. that was roughly 30% or more of the capital that was being held at that time by citi. and certainly, that even sure the is something that as a prudent safety and soundness regular at the federal reserve, somebody out to have known about it and had some impact on. >> no, i think you're raising a legitimate question in the sense that while we didn't have any control of the capital of investment banks, hedge funds, insurance companies, to the extent that banks lend to those entities, obviously, that is an issue which does impact on the overall financial markets. but that is a question of

supervision and regulation on -- it's even, i would say, the old fashion regulation, are the loans that you are making sound and do they have the capacity of being repaid. >> well, but again hear what we had is the bank -- the ultimate bank holding company backstabbing and taking, undertaking effectively the risk of the securitized -- the securitize, in this case, collateralized debt obligations of the investment bank. because, you know, this is, i mean, it strikes me frankly as i studied these things, you know, i consider myself a recently intelligent person. it takes considerable study. i am not a trained economist, to understand these extraordinary exotic financial structures. and you pointed out in your testimony that we run real risks in that frequently they are

misunderstood and exceedingly difficult to value. and just to take this one example, it seems to me that they were essentially engaged in something akin to the medieval or the mythical medieval, and that they were claiming the ability to turn triple be mortgage-backed securities into ineffectively aaa plus senior prime securities through the collateralized debt obligations. and, in fact, as it turns out, they were able to sell these to anybody. to help them on their trading books and part of the reason we are told by people within the fed and within citigroup, are that they help help them on the trading books because on the trading block, the capital requirements, the leverage was essentially 700 or 800 to one, because there was essentially no capital required while they were held on the trading book.

of the liquidity puts themselves were only rated at 10%. so what effectively is going on, it seems to me, is a capital arbitrage which puts the safety and soundness of the ultimate bank in jeopardy in order to support, in order to support exotic financial instruments which we now know didn't deserve the rating that the ultimately received an odd not to have been regarded as so risk-free. and should have been very significantly greater capitalize. and i guess i'm just pointing out to you really want of the consequences of your own testimony, which isn't that i think that is true that the fed could have and should have understood these languages better and required greater capital on the part of all the bank and financial holding counties in order to avoid the crisis that we face speak was

obvious he i can't speak in specific detail, but i know what the problem is. the problem is the bank supervisors and examiners would be looking at the aaa ratings that they see in a lot of these have securities. and we have a fundamental problem that the credit rating agencies gave aaa valuations to certain tranches, collateralized debt obligations, which in retrospect were nonsense. as you point out they couldn't sell them. and my impression is, but i don't know because i wasn't there and i don't know what was going on specifically, in certain areas, at a bank examiner would be looking at whether or not a loan was being made which was backed up in some form or another by an inappropriate credit rating agency. because when you're dealing with

the size and complexity of the types of things that people have to evaluate, there is a tendency, especially of an average pension fund manager, to seek the safety -- >> the safety of the credit rating agency. understood. we have a hold of the hearing will be done in the future with regard to credit rating agencies, but the occ examiners that we talked to suggested to us that they regarded these liquidity puts as essentially outside of their purview. because there are supposed to be looking at the, you know, this was a principal business that was existing within the investment bank. and they regarded that as something that wasn't their responsibility come a century, to -- not only was it the responsibly, they were precluded from examining it. so i think some of these linkages, as you look at the fragmentation of the regulation,

these linkages between the various units within the holding companies, but the banks safety and soundness at significant risk. and that seems to me to be an area where the federal reserve could do a much better job in its role as the ultimate credential regulate any systemic risk of regular. >> let me just say this. not knowing the details of the particular transactions that you're working on, i certainly agree with you in principle. that they have been failures because you can't account for what happened, how supervision failure occurring as part of the problem. but not no -- >> the specific detail basically at the citi's case is that they had to come up with $25 billion. they came up with $25 billion for the liquidity puts. to bring back, to buy back essentially these assets that

were standing behind the commercial paper. and rather than having issued a strict bank a guarantee which would because mary any commercial paper asset bank bank transaction, which you have to provide capital to, in this instance they honored the liquidity put to the tune of $25 billion, and that was roughly 30% of their capital at the time. the bank in. >> what year is this? >> 2007. >> see, -- >> it was after you were gone, but is just emblematic that i'm not trying to focus exclusively on citi. i just like to say this isn't emblematic structure of the collateralized debt obligations, which were these exotic instruments that really didn't justify the ratings that they had. and cause additional risk to the system which might have been

uploaded by the capital. but i will yield an additional three minutes. >> thank you. i guess my point really, and, you know, i'm sorry that i have run close out of time, but my point is to focus again on your fundamental obligation to enforce adequate safety and soundness of the institutions. and at the end of the day, really i understand your suggestion, and i think you're suggesting is a sound one, that at this point we need to additional capital and liquidity requirements on all of these financial intermediaries in order to avoid a crisis in the future. because none of us can predict precisely what exotic financial instruments that's next devised will fail, and not perform as represented by the originators. i mean, i note and one thing you testified in front of the waxman

committee back in october of 2008, and one thing i noticed that you said was as much as i would prefer otherwise in this financial environment, i see no choice but to require that all security measures retain a meaningful part of the securities they issue. this will offset in part marketing efficiencies stemming from the feathers of counterparty surveillance. i take it by that you mean that that would be -- that would provide confidence to the market if they were to retain a portion of the securities, those securities that deeply the securities actually would be sound, and worthy of investment there was that dewpoint? >> that's correct. >> and isn't that the case really with regard to part of our focus is on securitization, and isn't the case, we've created a situation in which a number of the parties involved in the origination of these securities are all paid in cash as of the securities are issued,

and retain no ultimate interest in the ultimate success or failure of the security, ranging all the way, if you count, the originators of the mortgages, the mortgage brokers, the investment bankers, the lawyers to write the prospectuses, the auditors who audit the books, the credit rating agencies that rate the agent, that rate the securities, and at the end of the day they have left all -- they have no skin in the game. they have no obligation to have a financial consequence to their creation. and isn't that a problem that needs to be addressed? >> yes, and i agree with you. in that regard. a major source of that problem was that because of the complexity of the types of products that were being issued, that otherwise sensible people in despair we lied on the credit

rating agencies issued by the issue. and if they were otherwise, in other words, instead of giving aaa designations to a lot of these things, they gave them be or triple b., which many of them were. there was a problem that you're raising would have happened. >> and they would have bought them because many of them were prohibited by the statute or their own requirements for not buying them. and, of course, the problem further is that the credit rating agencies frequently only paid if the securities were sold. they were paid a portion of the issue, so they had an incentive to create a aaa rating which might not otherwise have been justified. thank you. >> let's do this. we will take -- mr. kempe, please let me for the record, mr. chairman, i noticed you were nodding your head at the final statement that the gentleman made.

were you in agreement with his assessment in terms of the behavior of the credit rating agencies to a certain degree of? >> credit rating agencies as such as well all i can say for myself is the rating, the ratings that were developed by the credit rating agencies were a major factor in the cost of the problem. >> thank you. >> will take a five minute break. let's be back here in five. thank you. [inaudible conversations] [inaudible conversations] [inaudible conversations] [inaudible conversations]

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[inaudible conversations] >> as you can see who we are in a break right now, awaiting the second panel of today's financial crisis inquiry commission hearing. the first witness of the day was former federal reserve chairman alan greenspan. the commission has six members, appointed by democrats, and for republican appointees. it is scheduled to deliver a report to congress by the sender 15th of this year. former california treasurer phil angelides chairs the commission. former house ways and means committee chairman bill thomas of california is cochairman.

[inaudible conversations] [inaudible conversations] [inaudible conversations] >> we are still in a short break right now. awaiting the return of former federal reserve chairman alan greenspan, testifying before the financial crisis inquiry commission. this is the first of three days of hearings. we will have more from a financial crisis inquiry

commission thursday and friday. tomorrow the focus will be on former citigroup executives who will testify about risky mortgage lending. and on friday, commission members will hear from former fannie mae executives. you can watch it live both days starting at 9 a.m. eastern here on c-span2. [inaudible conversations] [inaudible conversations]

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[inaudible conversations] >> the financial crisis inquiry hearing is in a brief break right now. the first witness of the day was former federal reserve chairman alan greenspan. we are awaiting h return. and while we wait, this when we talk to a journalist about fcc regulation. >> the headline reads court backs contest over at cc. the subhead, growing deals blo to propose to the author amy shots who joins us on the phone right now. if you could, kennedy was a little back story on this decision and for those who may not be falling on a day-to-day

basis. >> guest: sure. so basically a couple of years ago comcast was accused of preventing some of its subscribers from downloading large video files on these file sharing. and essentially comcast didn't tell people they were doing this. they were telling their subscribers did all of sudden these subscribers can download these files. so they complained. the fcc start investigating in 2008, and concluded that yes in fact comcast was blocking this and that was a violation of these for net neutrality principles that they had come up with a few years ago. and the principles basically where consumer protections for people on internet. things like you should be allowed to look at any website you want to look at, and you should be able to connect any device to the internet that is not going to affect the internet or other people are using it. and so it's a century the fcc said you just can't do that. and they sanctioned comcast and said that you violated the

principles. comcast then change its practices so that they stopped blocking traffic that way. they started using different ways of managing your network. but they challenge the fcc's decision and said the fcc doesn't have the authority to just enforce principles. if you want to enforcement, you have to go through things like rule makings and go through a lot more legal hoops than the fcc had done. and yesterday the court basically said just comcast is right that the fcc had not gone through the hoops. but then the court went further and said in fact the fcc doesn't have the authority to do this post on because congress never intended for the fcc to regulate internet lines. and if they have they would've put something in the 96 telecom act. >> host: if the fcc can regulate things and such as television and radio and things along that, why doesn't have authority over the internet? >> guest: it comes back to congress. congress never passed a law the

fcc has authority to do this. and if congress did pass that law, or if congress came back and said we really think net neutrality is a problem, and the fcc should be the policeman, there wouldn't be any problem. the problem is that telecom is really hard and congress does a lot of other things. these things are pretty competent or. so they just haven't passed any laws like that. the last three laws we had back in 1986 they haven't changed since then. so the agency has been using this really old law to try to apply to these new lines. and it just hasn't been going very well. >> host: some of the stories this morning talk about efforts that the fcc is doing of something called a national broadband plan. some are saying there are problems with this decision. yesterday and the fcc efforts going forward. could you explain that? >> guest: basically the fcc was using, in the national planning, they say because we are the placement for the internet and we think everybody should have internet, we are going to change

some of the things that we do so that we can assure universal broadband to the problem is that legal authority that they were putting some of that stuff on just sort of collapsed yesterday under the d.c. circuit decision. and so it's sort of not clear that they can kind of go forward with some of these things, like one of them is to ensure that consumers have a better sense of what kind of speed of broadband they will get. it's not clear they can enforce companies to do that now. or it's not really clear that you could change the federal subsidies fund to spend money on broadband lines instead of phone lines. the way it is set up now it goes for phone. it is not real clear now that they can change that. >> host: what options are left for the fcc now in light of this decision? >> guest: they can kind of go three rounds. they can try to ignore and say we are going to keep going forward and say that we've got the authority and we think we have the authority. . .

>> guest: probably the third. because congress isn't only going to be in for so much longer to go back to start campaigning. so it's kind of unlikely that the agency would say we're going to try to go with the dicey authority that we have. it seems like the most obviously choice it to say we made a mistake. let's go back to reregulate. the problem is that photo and cable companies are really

against this proposal. there's going to be a huge fight over that. they don't want the regulation coming back down the road. >> host: fcc has a story in today's marketplace session. amy, as always, thanks for your time. >> guest: thank you. >> just a reminder, you can watch washington journal in its entirety on our web site, c-span.org. we'll take you back live now to the financial crisis inquiry commission. their witness is former federal reserve chairman alan greenspan. this is live coverage here on c-span2. [inaudible conversations]

[inaudible conversations] [gavel] [inaudible] >> let's start again. we are going to start with mr. cannacy37 >> thank you, mr. chairman. i want to focus on creating or exacerbating the explosion of bad subprime knowledges and specifically on their portfolios. you, it's possible that not everyone watching has read your written testimony. i want to if i can try to summarize how i understand that part of your testimony.

and i want to ask about a specific house action from 2007 which i think contributes to this. as i understand it, fannie mae and freddie mac held huge port foalons on $6 or $700 billion each. they were undercapitalized and they ultimately led to fannie and freddie's collapse. the department of urban development significantly raised the affordable housing goals they set. fannie and freddie chose to meet those new goals by dramatically increasing their purchases and holding of securities backed by subprime adjustable rate mortgages. your testimony says in 2003 and 2004 they bought about 40% of this market, five times more than they did in 2002. and at the time, fannie classified the mortgages at prime in september of '09 they reclassified much of that portfolio to be subprime.

now, as i understand it, the huge increase from 2003 and 2004 contributed to the decline in long-term mortgage rates relative to treasuries. that decline in long-term mortgage rates helped fuel the rise in housing prices. when the housing price bubbles hurt not only people who owned adjustable rate, but fixed rate mortgages as well. now in february 2004, what we're talking about here is we're both talking about the gse holding huge portfolios, in effect, multihundred billion hedge funds on top of their guarantee business, combined with new housing goals set in the fall of 2000. now in february 2004, you testified that quote gse need to be limited in the issuance of gse debt and in the purchase of asset, both mortgages and nonmortgages that they hold. that was in the 2004. in 2007, the congress considered

the housing finance reform act. and the bill that came out of chairman frank's committee gave the new housing finance regulator certain authorities. and because it's important, i want to read the language. what a language said is that the director shall consider any potential risks posed by the nature of the portfolio holdings. that's it. okay. so the new regulator should consider the risk of these multihundred billion dollar portfolios when she was evaluating fannie mae and freddie mac. it was house amendment 207. it passed on may 22, 2007, on a 383-36 vote. that is overwhelming bipartisan vote. what that amendment did is it limited the new housing regulators authorities.

it said that the new housing regulator can only consider the risk that these portfolios place to the safety and soundness of fannie mae and freddie mac, not to the financial system as a whole. what i want to do is rad to you language from the sponsor of the amendment, he said, this legislation clarifies that when the regulator looks at regulating this entity, that he looks at the safety and soundness of that that entity and not external factors. he later says we shouldn't put things out there that the regulators is not able to quite honestly articulate. because what is a systemic risk. sometimes the regulator cannot explain exactly the systemic risk as they believe it is. it is a way to limit their portfolios. so in effect, 221 house democrats and 162 house republicans voted to preclude the regulator from being able to

consider systemic risk with the gse portfolios. this is districtly contradicting your recommendation of february 2004. suppose it had gone the other way. suppose that housing regulator had had the authority to limit the gse portfolios in 2007 and had exercised that authority. what effect do you think that might have had on the crisis? >> well, let's go back a number of years because the original mandate of fannie and freddie was read as securitization solely. and that the accumulation of portfolios of assets was not in their business plan. with the onset of, i guess, the

cynical view of the market the presumption that fanny -- fannie and freddie were not backed but the full faith of the united states government and that cynicism led to 20 to 40 basis points subsidy if their deventures in short-term debt which for a financial institution is huge. and so the procedure that is were involved with fannie and freddie were largely to build up the asset side of the portfolios. it didn't -- it almost didn't matter what they held. just as long as they harvested the subsidy. that creates huge profits, huge rates of return on equity, and set into place a very large component of potentially tockic

assets. and the failure of fannie and freddie was a major factor in the crisis remembering it occurs prior to the lehman default. as a result is that is that the combination of the system breaking down had extraordinarily large effects which had difficult to judge because you only have a single incident. you can't say what would have happened if, but there is no doubt in my mind that if fannie and freddie had held only those mortgages in its portfolio which were required to make securitization easiable, you have to hold a certain amount of inventory, which is a very small fraction to what they actually held. if that didn't happen, they would not have failed.

and the lack of that particular event which is a very important event in the evolution of the crisis may have headed it off. i don't frankly know. i don't know how one would know. but that would have been far better off, in my judge, is unquestionable. >> thank you. and a secondary point, as i understand your testimony, part of what you're suggesting is that to meet the higher affordable housing goals set in october 2000, fannie and freddie increased their purchase of specifically subprime a.r. -- --a.r.m.s, what would you record we ask them about the interactions of these housing goals and the actions that they took in 2003 and 2004? >> well, i would ask them other

than making profit for the corporation, what was purpose of accumulating the assets in their portfolio, the reason i raise the issue is i never got a straight answer in the early years that i was involved with them. and i think this is an unfortunate event which as far as i'm concerned, had it not occurred namely the huge accumulation of assets for a lot of different reasons, including potential distortions in the marketplace, we would not have had incidentally, the big affordable housing purchases by fannie and freddie, because it's based on volumes. and the amount of fannie and freddie as it turns out a.r.m.s that they bought, would have been very much less

and that would have been removed a very substantial amount of weight on the subprime market. because remember, that mandated demand, it's mandated, remember, that mandated demand took out effectively as a first tranche, 40% of a market. when you do that to any market, it has extraordinarily major impacts. and i cannot but believe that even with the affordable housing goals with a far smaller fannie and freddie portfolio, that would have been ran into the extent of the types of problems we were to run in 2008, for example. >> thank you. thank you very much.

ms. born. >> thank you. mr. chairman, you long championed the growth of the over-the-counter derivative market. >> could you put your microphone closer? >> is your mike on ms. born? >> it is on, yes. >> now we hear you. >> you've long championed the growth of the over-the-counter derivative markets because of the shifting of the opportunities that it provides. you've also taken the position that over-the-counter derivatives market should not be regulated. as chair of the federal reserve board, you endorsed the president's working group report in 1999, calling on congress to eliminate regulation of the otc derivatives market. you then welcomed the adoption of the commodity futures modernization act of 2000 which eliminated virtually all federal

government regulation of the otc derivatives market and also preempted certain state laws relating to it. so as a result, otc derivatives have been trading with virtually no regulation for a decade and the market grew to exceed 800 -- $680 trillion by the summer of 2008. in your view did credit default swaps, which are a type of over over-the-counter derivatives contract, play any roll in causing or exacerbating the financial crisis? >> well, first let's remember that in the early years, credit default swaps were an extremely small part of the total notional value. and indeed, the arbator didn't

find credit default swaps to sufficient volume to show them as a separate category until the end of 2004. and if you separate credit default swaps from the rest of the market and look at the rest of the market essentially as interest rate derivatives and foreign exchange derivatives, which is still is, you have the remarkable phenomenon of these unregulated derivatives having the most extraordinary stress test in 2008, 2009 with no evidence of which i am aware that they didn't work is exactly as they were going to. it is certainly the case that credit default swaps did create problems and indeed the federal reserve bank of new york was probably the very first group to

really come to grips with the problems in 2005. so if you go back to the earlier periods, credit default swaps were never discussed in the president's working group to my knowledge. when we talked about derivatives, we were talking about essentially interest rate derivatives and foreign exchange derivatives. and they have been unregulated to be sure and no problems have emerged as a consequence of that. credit default swaps are a more complex issue but they were not on the agenda in the early years when we had these discussions that the presidents working group. >> well, they certainly existed as of that time. i think there is a august 12, 1996 supervisory guidance that

was issued by the federal reserve board on the -- to the banking committee -- community, about the use of credit default swaps and other credit derivatives. and certainly if you've read jillian tet's book called "fools gold" it talked about the derivatives in some very creative things that jpmorgan did in 1997. are you aware that the collapse of aig was caused by its commitments under credit default swaps that it had issued? the taxpayers had to bail out aig because of its exposure on credit default swaps to the tune of more than $180 billion. >> well, first let me respond to

your 1997 reference. i can't give you an exact number. but my recollection was that there were credit default swaps something like 1% of the total notional value of all derivatives. the mere fact that it was being discussed is something which is to be expected. but if you're a evaluating their impact on the economy, and on the financial system, 1% or less in notional value is not a big factor in anything. with respect to aig, it is credit that their offering and selling vast amounts of credit default swaps was the proximate cause of their problem. if they were selling insurance,

they could have just as easily sold and gotten into the same trouble by issues insurance instruments rather than default swaps. my understanding is there was a differential capital requirements, that is not an issue of the credit default swaps per se, the issue was the extraordinary behavior of investment officers at aig who took unbelievable risks with essentially very little capital. there is a difference between credit default swaps and, for example, interest rate derivatives in the sense that credit default swaps ensure the principal as well as the interest. interest rate derivatives, for example, only deal with interest. and they are therefore far less subject to the problems that exist when you are insuring the

level of principal as well as interest. >> mr. chairman, the market for credit default swaps had risen to $60 trillion in notional amount equal to the gross national -- the gross domestic product of all of the countries in the world by 2008. also let me point out that had these been being sold as insurance products, they would have been regulateed by insurance regulators and supervisors, there would have been a requirement of capital reserves, there would have been a requirement that these contracts could only have been sold to entities that had an insurable interest that is held the bonds for securities that

were being insured against. there was no such regulation in the otc derivatives market thanks to the action of the president's working group and congress in 2000. let me go on to another subject. in your recent book, you described yourself as an outlier in your libertarian ideology. like the derivative markets are self-regulatory and the government -- and that government regulation is either unnecessary or harmful. you've also stated that as a result of the financial crisis, you have now found a flaw in

that ideology. you served as chairman of the federal reserve board for more than 18 years, retiring in 2000, and became, during that period, the most respected sage on the financial markets in the world. i wonder if you're belief and deregulation had any impact on the level of regulation over the financial markets in the united states and in the world. you said that the mandates of the federal reserve were monetary a policy supervision and regulation of banks and bank holding companies and systemic risk. you appropriately argue that the roll of regulation is preventive. but the fed utterly failed to

prevent the financial crisis. they failed to prevent the housing bubble, they failed to prevent the predatory lending scandal, they failed to prevent our biggest banks and bank holding companies from engaging in activities that would bring them to the verge of collapse without massive taxpayers bailouts. they failed to recognize the systemic risk posed by an unregulated over the counter derivatives market and they permitted the economy to reach the brink of disaster. you also failed to prevent many of our banks from consolidating and growing into gigantic solutions that are now too big and or too interconnected to fail. didn't the federal reserve system fail to meet its responsibilities?

fail to carry its mandates? >> and by the way on this, i'm going to yield two minutes for the response. we're over time. >> first of all, the flaw in the system that i acknowledged was the inability to fully understood the -- understand the state and potential of the risk that were yet untested. we didn't see what those risk were until they unwound at the end of the lehman brothers bankruptcy. i had always presumed, as did everyone in academia, regulatory areas, banks, presumed that risk potential was. having failed there mean that is we were undercapitalizing probably for 40 or 50 years. and that has to be exhausted.

but the notion that somehow my views on regulation were predominant and effective as influencing the congress is something you may have perceived. it didn't look that way from my point of view. first of all, i took an oath of office to support the laws of the land. i don't have the discretion to use my own ideology to effect my judgments as to what the congress is requiring the federal reserve and others to do. as far as i'm concerned, if somebody asked me my view on a particular subject, i would give it to them. i expressed them in the book that you are referring to. but that is not the way i ran my

office. i ran my office as required by law. and it's an awful lot of laws that i would not have constructed in the way that they were constructed. but i enforced them nevertheless because that was my job. that was built into my oath of office when i took over the feds chairmanship in 1987. >> thank you. >> so i know my time has run out. but i really fundamentally disagree with your point of view. >> all right. okay. good. thank you, mr. thompson. >> microphone, mr. thompson. >> thank you, mr. chairman. dr. greenspan, thank you for joining us this morning. i'd like to go back to the line of questioning raised regarding regular regulatory arbitrage. you said the complex affiliate and structure who's sole purpose

is tax avoidance or regulatory arbitrage. it's clear from our view of citi that that was, in fact, part of what drove some of their decisions as they looked at opportunities. so how should supervisors have prevented this regulatory arbitrage from occurring prior to the financial crisis? >> well, it's -- to a large extent it's caused by the legal structure of these organizations. one of the problems that exist is that people concerned about off balance sheet accounting. that's not what bothers me. what bothers me is if you take something off of your balance sheet, it should be prohibitive from bringing it back. i cannot believe that people secondarily thought that representation risk all of the sudden emerged, they didn't know about it.

so i think there's a bit of dubious bookkeeping going on at that particular point. but if -- if the regulators can determine what type of subsidiary structures you can have in the large organization, you can eliminate a fairly significant amount of the regulatory arbitrage. and it's not an economic issue, it's basically a means by looking at what the capital requirements or other requirements are and figure out how you would structure the various subsidiaries of your organization to avoid that. that is in nobody's interest. >> so financial innovation has been an important component of what's driven the contribution to gdp growth from the financial services sector over the last 20 years or so. if you were to think about other

industries that have significant societal impact, pharmaceuticals, transportation, a range of others, they are required to test those products and have those products certified before they release them into the marketplace. so if we were to now think about the societal impact of financial services, and in your views around collateral and capital, should there be a different scheme for new product introduction in this industry that would mitigate, perhaps, the societal impact that some of the risk we're taking really represent today? >> well, that's a good question. i think you first have to start off with the function with a question of what's the function of our financial system? and basically, it's to supply financial services to the nonfinancial sector main street so to speak which facilitates the production and standards of living that emerge as a

consequence of that. when you -- for example, we have an extraordinary rise in the share of national income going to finance starting in 1947 year after year after year. and so we are dealing with is a major problem in how to make judgments of what is innovation that works and what is it that doesn't work. but that's your median ovation to essentially keep up with these complexity of the nonfinancial economy because it goes without saying. all innovation by its nature is unforecastable with respect to how it will come out. so i think what we find in finance as well as in the

nonfinancial area is that a large number of innovations fail. but fortunately, that caused progress and productivity that is more innovations are positive than otherwise. you cannot tell in advance which is which. so my judgment is the only way to solve that problem is to have enough capital that will absorb x percent of innovations failing. we will never see sids, or synthetic cdos for the -- as far as in the future i can imagine. they are gone. the critical issue here is investors who determine what products fail and what succeed. it's not the banking system. the banking system can offer them, but they don't buy them there's no use.

so the nonfinancial part of our economy is the arbator of what products fail. >> would you be in favor of putting aa head of the release of these critical innovations? >> as a general rule, i'm not comfortable with variable capital changes, you know, whether it's for -- the main argument is usually that there's adjusted capital requirements. that would have been fine if we would forecast where in the business cycle we were in real time. we're always very thoughtful on the issue of where we were in the business cycle. but it's another -- it's a holy different issue when you're in

real time and saying are we in the beginning of the cycle or closer to the end? i think to -- >> well, for new producting, we would clearly be at the beginning of the cycle. >> i'm sorry. >> for a new product innovation, we would clearly be at the beginning of the cycle. >> i'm referring to the business cycle in general. but i agree with you. every innovation always starts at the beginning. and you don't really know where it's going to come up. and the nonfinancial system will tell you whether it's valuable to them. i would just assume not try incremental, i have nothing in principal against it, it's just i feel it's not easy to implement. >> well, you cented this morning that -- commented the morning this issue of the consolidated regulatory scheme amongst the peer agent sis. and it's your opinion that the change that -- that there's not evidence that would suggest the

change to consolidating the regulatory scheme would in fact help. therefore, should i conclude from that comment that you as someone who sat over and was the standard bearer, if you will, for your financial system for almost 20 years believes that no meaningful change is necessary now? >> i don't know the answer to that question. because we've got so many overlapping jurisdictions and the like. that frankly, they are kept that way for political not economic or financial reasons. and i have no doubt -- >> put politics aside. >> i'm sorry. >> politics aside. >> politics aside, yeah, i've always thought that the there are differing things that could have been done. but i want to emphasize that it's not the particular agency which does the things, but more

importantly, what is done than who does it? >> so you strongly believe that incremental capital and incremental collateral would help? i interpret that from your comments. >> i would say i'd be more incline to set levels. there is a problem with changing capital requirements, largely because it creates an element of uncertainty in the marketplace which probably i have no idea how big it would be. but it's certainly negative. i think that you are far better off fixing capital requirements at levels and just holding them there. it's permanent requirements. i think that would address in my judgment most of the problems that i see that are out there. >> well, i would tend to agree with that, it would also seem to

me that combining the motion of supervisory as well as enforcement would also help. because you indicated that in many instances, while the federal reserve-supervisory responsibility, you really did not have enforcement. so i'm not sure how the system works and improves without us making some changes. not just in capital and collateral, but in how we execute on the rules and laws that we have in place. >> well, i think in order to do that, if the federal reserve were required to enforce the rules and regulations that it promulgates, i think the staff would have to be vastly larger. >> but some other part of government would also have to shrink. >> well, there's a -- right now there's a great deal of discussion that's going on with

respect to who should have been supervising what? and the problems that -- i'm not sure that we solve any of the problems that have been properly identified in this crisis by moving the chairs around. i do not deny that if you ask me, starting from scratch, what i have a different type of regulatory systems focused on the areas where i think they can be most effective, the answer is i've suggested that in the brookings panel piece where i went through the reasons why what regulations can do and what they can't do and if we emphasize what we can do, which can be very effective, and in my judgment, determinative, what you tend to do is to cause the losses to be concentrated in the common shareholders of

institutions. and if capital is large enough, all of the losses acue to them and not to the debt holders and definitely the do not default. therefore, you don't have serial con they gent which is caused by the senior debt mainly, but debt in general. >> unfortunately, we don't have the luxury of being able to start over from scratch. we're going to have to increment changes and your knowledge of what changes would be beneficial to the american public would be very helpful. >> thank you. >> all right. now mr. thomas, you and i have some remains time. should i go ahead and take my clean up items and turn to you? >> i would advice you that setting politics aside as chairman you should let me go first. >> you go ahead. >> and begin to close.

although i'm very tempted by that invitation. >> go ahead, mr. thomas. >> thank you. i would just tell my friend that setting politics aside is a sure invitation for politicos to tell you that you can't. we've seen that over and over again. just the way the system works. if you are going to start with a clean sheet of paper, it means you have it turned over. you really need to turn it over. there is no such thing as a clean sheet of paper. mr. chairman, this is a question that i will ask you that i don't need you to answer now. you might want to do it on paper to me. if you don't and you can offer a responsibly short version that's perfectly acceptable. and i reason i put it in that context is that your mention of the book reinhart and rogoff, i

serve at aie with a colleague who's the husband of professor reinhart, vince reinhart, and in discussions that we've had, he's indicated in his position and i should give a bit of background, he's the head of the monetary affairs at the fed from '01 to '09. and he's talked about the fact that he thinks based on his knowledge and experience, that the fed made a mistake signally to the market that it was going to slowly raise short-term rates. and the argument goes that this created a steep yield curve because the market as we saw over and over again quickly adjusted to where they knew the rates would go. the steep yield curve led to novel ways for firms to take advantage of boring very short-term and lending long-term. do you agree with that analysis

in retrospect was the fed's strategy the right one to take or is the usual argument given the information and circumstances? >> well, vincent reinhart is a first-rate economist who's judgment i have for many years relied on. let me answer that question in writing after i go over the particular details of the position i know he's taken. >> and i wanted to offer that to you because i am interested in a more fundamental answer. because it'll lead to other questions as we go forward. so thank you. and we'll submit it to you in writing. >> additional questions, mr. thomas? >> none at this time, mr. chair. >> all right. a couple of items, just first of all, a couple of clarifications. because i want to make sure we have the facts for the record. even by your own stipulation, let me stipulate that fannie mae

and freddie mac were disasters, you keep referring to 40% of the market. if you look at the 2002 to 2005 period, the private market, wall street was anywhere from 59 to 92% of the security market. that's just a fact. secondly, i wanted to follow up on ms. morin's question of earlier. i wanted to point out because when she referred to the view of the federal review bank, i don't think you would have seen the review from 2005. there was not some third-party wild-eyed critic, this 2005 review which ms. morin referenced was a peer review by other banks and there was a second review in december 2009 where again the peer other federal reserves commented on the supervision of citi bank by the federal reserve bank in new york and they said it was less

than effected although the team is well qualified and generally has sound knowledge of the organization, there has been significant weaknesses in the execution of the program. i just wanted to point out these were internal reviews as the iny of supervision. you indicated what was important to go after fraud, embezzlement, inlegal activities, and you've been clear on that. very quickly, the warning in 2004, there was an increase in the number of suspicious activity reports from 2003 to 2006, your own federal reserve in 2005 put out a white paper on the detection investigation deterrence of mortgage loan fraud. just quickly, what was the single most important thing that the fed did in light of the

evidence to prevent fraud in mortgage? >> well, first of all, enforcement against fraud and misrepresentation is one of the key elements in any market society. you cannot have an effective market society if counterparties cannot trust individuals with whom they are dealing, wholly independent of what that contractual relationships and enforcement is. the fbi's i believe they had 22,000 cases in 2005, that's important and critical. one issue of fraud is enough. but 22,000 when you have 55 million total mortgages outstanding residential only, home mortgages, as well as a lot of commercial mortgages, it's

not a systemic problem. >> but did you then make any actions? i could only count two referral under fair lending laws from 2000 to 2006 by the fed to justice. just two. one more first american frank in illinois and one from carpenter bank in victorville. it seems firm. >> the issue is that the staff in evaluating what was going on -- the goodly part of supervision and regulation is to get things solved so that if somebody is in violation of something and you can get them to adjust so that the regulators are satisfied, it never gets to the point where it's a referral for enforcement of some form or another. i agree with you in the sense that the number of actual referrals that were made to the department of justice were small. and i believe a good reason for

that is we've been able to get compliance without doing that. >> all right. well i wanted -- here's my final observation. it really follows up on mr. the questions. i think it's something significant around which i think a lot of americans have questions. -- no audio] >> we have a problem with over live coverage. we are working on it and plan to return to the event shortly. [silence]

[silence] [silence] >> as you can see, there have

>> for 50 years -- >> again back in the room where power is out. the shades are opened to shed a little light on the financial crisis inquiry commission. continuing its work now through its power outage. alan green span, -- greenspan, the former chair is testifying. >> by no means because it's not the conceptual framework of how to regulate, but the actual application of it. we did not have enough capital in the system to obtain the type of crisis which in my judgment happens once in 100 years. this financial crisis is best i can judge. it's the most severe in history. it's not the same thing as saying that the severe economic crisis. that was the great depression.

but there is no examples that i've been able to find of a breakdown in short-term financial availability which is the critical issue in a financial crisis. and in any history that i can see as on a global scale that occurred within days following the lehman brothers bankruptcy. >> mr. vice chair, on that statement, mr. chairman, i would ask you a follow-up question. and that was quite a contextual position for your statement that you do not given your background, understanding, history, see any comparable collapse. in that regard, i'd have to say notwithstanding the difficulties we're still in, the experiences that we had previously in my opinion, i want your reaction allowed us to take some actions

which mitigateed notwithstanding all of the damage that have been done and even greater crisis. is that accurate? >> i'm sorry. may i answer that for the record? if you don't mind. >> i think at some point the whole concept of bubbles is -- you didn't know, you didn't anticipate, this time is different. if this is not magnitude that you indicated different than any past, notwithstanding the damage all of the understanding of what we need to lead to, it could have been worse. >> well, this is the critical period that we're going to have to -- we're going to have to

look at how this thing ultimately evolves before we fully understand what the consequences are. but let me respond to your question in more detail on the record. >> certainly. commissioner? >> just one question i would ask you. i'd ask you to respond to it if you could in writing. the capital, i think we've all come to the conclusion and your advice have been that the capital and the liquidity requirements historically haven't really -- weren't adequate to avoid the consequences of the crisis. i take it it that mean that is we ought to implement some more significant capital requirements on a go forward basis. would that be fair to say? >> mr. chairman, these questions can be recorded, but i think

they ought to be answered in writing given the current circumstances. >> i understand. but i thought he nodded his head yes, is that correct? >> no. we had the hard stop. >> i believe there's a question for the record. we'll submit it in writing. if you can phrase it. >> and my question is this: the unprecedented thing about our current situation the total number, it seems to me, of subprime and alt-a projects -- mortgages in our economy. it's about half of our mortgages in our economy. when you have responding in writing, to the question of what caused this financial crisis, i would like you also to consider whether in addition to what was

required, what effect this substantial number of bad mortgages might have had. >> so those will be submitted in writing to mr. greenspan. look, i just want to say, mr. greenspan, you gave a lights-out performance. [laughter] >> i want to thank you very much for your time. thank you very much for coming before us. thank you for your service to the country. and we're going to adjourn for 30 minutes and hopefully we will have lights and power when we return. thank you all very much. >> thank you very much. [inaudible conversations]

>> you're watching the first of several days with the financial crisis inquiry commission as it focuses on subprime mortgages. former chair alan greenspan testifying this morning. lights on for most of the morning, but a power outage for the last few minutes or so. a lunch break now. still to come in a half hour or so, a panel on how subprime loans were originated and packaged for sale on the market. that'll be followed by a panel of former citigroup risk managers on their company's subprime product. all of that coming up this afternoon. we'll have live coverage here on c-span2. and our coverage continues tomorrow with former citigroup executives and on friday former

fannie mae executives will appear as well. it starts 9 a.m. eastern time thursday and friday here on c-span2. the associated press said that alan greenspan defended the fed's failure to police the most risky mortgage failing this morning. while we wait for started, we'll reair a portion of mr. greenspan's testimony. we'll start with his opening statement. >> thank you very much, mr. chairman. good morning to you, vice chairman thomas and members of the commission. i want to thank you for the opportunity to share my views on important issues raised in the commissions invitation to appear today. as i noted in my prepared remarks while the roots of the crisis were global, it was securitized u.s. subprime mortgages that served as the crises immediate trigger.

the rate of global housing appreciation was particularly accelerated beginning in late 2003 by the heavy securitization of heavy prime and mortgages, bonds that found willing buyers at home and abroad. many encouraged by crossly inflated credit ratings. the surge and demand for mortgage-backed security was heavily driven by fannie mae and freddie mac which repressed by the department of housing and urban development and the congress to expand affordable housing commitments. during 2003 and 2004, the firms purchased an estimated 40% of all private label, subprime mortgaged securities, knewly purchased and retained on investors balance sheets. the enormity of these purchased was not revealed until fannie

mae in september 2009 reclassified a large part of its prime mortgages security portfolio as subprime. and yet the effect of these gse purchase was to preempt 40% of the market up front leaveing the remaining 60% to fill over domestic and foreign investor demand. as a consequence, mortgage yields fell relative to ten year treasury notes, exacerbating the house price rise. which in those years was driven by interest rates on long-term mortgages. i warned of the consequences of this circumstances in testimony in 2004 to the senate banking committee and specifically recorded to the gses need to be limited in the debt and

purchase of assets, both mortgages and nonmortgages that they hold. i still hold that view. the u.s. subprime mortgage grew rapidly in response to this demand from global investors, gse and others. the years subprime mortgages in the united states had been a small but successful appendage to the broader u.s. home mortgage market comprising less than 2.5% of total home mortgages serviced in the year 2000. at that time, almost 70% of subprime loans were fixed rate mortgages, fewer than half had been securitized, and few, if any, were held in port yellow -- portfolios outside the united states. virtually all subprime