said please occupy us. albia is radically pro-american and lots of ways. they named their kids george, when bill and hillary were in the white house demand their kids bill and hillary, popular names mlb -- albia. i don't know if there are a little barack now. lighthearted debate continues to be pro-soviet and then for a time they were associated with china and now america it seems really cute it's sort of like they are going back and forth between the partners. i have to give them credit to the love america and they want to be a state and it's a serious movement but obviously we don't think is serious in the united states. .. taiwan and others, who have said

they want to be part of the united states. in the case of albania, it is not likely. but one that might have happened was newfoundland, which was kind of separate from canada and they wanted to be part of america, and we probably could have worked bad deal out. but the united states at that time did not want to add in newfoundland as a state. texas was off for a nation that became part of america, -- was a foreign nation that became part of america, hawaii the same thing. host: "lost states" is the name appreciate your time this morning. at a lot of fun, a lot of interesting history there. thank you. >> guest: thank you very much. i am a big fan of c-span.

>> now the financial crisis inquiry commission. this government appointed committees investigating the causes behind the recent economic crisis. in this part of today's hearing members question former securities and exchange commission officials who were responsible for regulating equities markets. this is just under three hours. >> a meeting of the financial crisis inquiry commission will

come back into order. we are now on our third session of the day. it is the regulation of investment banks by commission. thank you very much for being here today gentlemen. as we do with all witnesses we are going to swear you before your testimony so would like to ask all of you to stand up and raise your right hand and be sworn. do you solemnly swear or affirm under the penalty of perjury that the testimony you are about to provide the commission will be the truth, the whole truth and nothing but the truth to the best of your knowledge? thank you. thank you. gentlemen, thank you for being here. we appreciate you having submitted written testimony to us. we also would now like to give you the opportunity to provide for both testimony of no more than five minutes and so with that, we are going to start with

you and we will go from my left to my right, so if you would please begin. thank you. >> thank you for the opportunity to testify today before this commission on the subject of the imitation of the securities and exchange commission consolidated supervised entity program and the adequacy of the oversight of bear stearns another cse program participants. i appreciate the interest of the ftc and the office of inspector general. my testament today i'm representing the office of the secretary-general and the views expressed are those of mine alone and do not reflect the views of the commission or any commission or. the office of inspector general's mission is to the critical programs and operations of the sec. this mission has become increasingly important in light of the current economic crisis facing our nation. are audit unit has issued numerous reports involving batters critical to the sec operations in the investing public. of the most significant audit

reports we we are prepared today was a comprehensive report issued september 2008 analyzing the commission's oversight of the sec cse program. we initiated this out of based on congressional requests received on april 22008 from charles grassley ranking member of the united states senate committee on finance. senator grassley requested review of the division of trading and marketing oversight of the cse firms with a special emphasis on bear stearns announced announced that we analyze how the cse program was run and the adequacy of the commission's monitoring of air stearns. the audit was not intended to be a complete assessment of the multitude of events that led to bear stearns's collapse and accordingly did not purport to demonstrate any direct connection between the failure of the program's oversight of bear stearns and air stearns's collapse. given the complexity of the subject matter he retained an expert to provide assistance with the other. professor kyle is a faculty member is a renowned expert on the aspect of caddell bull markets on numerous finance remitted manner.

this cse program or to improvement. to allow the commission to monitor for an act quickly and responsibly to financial operational weakness in the cse golding company or its unregulated affiliates that my place regulated entities including foreign registered banks and broker-dealers were the broader financial system had risk. are audit found the cse program failed to carry out its mission in his oversight of bear stearns because under the commission's cse program watch air stearns suffered financial weaknesses in the federal reserve bank of new york needed to intervene during the week of march 102008 to prevent significant harm to the broader financial system. overall are audit found there were significant questions about the adequacy of a number of cse program requirements given bear stearns was compliant with several other requirements but nonetheless collapse. and additionally i found prior to bear stearns collapse the

assisi became where potential red flags regarding bear stearns concentration of mortgage securities high leveraged shortcomings of risk management and mortgage based securities and the lack of compliance in the spirit of international spirit but did not take action to limit these factors. the audit found certain procedures and processes were not always strictly follow. for example the commission issued an order that approves bear stearns to become a cse prior to the completion of the inspection process. the sec authorize the cse audit staff to perform critical audit work involving risk management systems instead of its working for performed by the external auditor. further are audit found the division of corporation finance did not review bear stearns 10-k filing in a timely manner. the audit identified 26 recommendations intended to improve the commission's oversight of the cse firm. the recommendations included a reassessment of guidelines and rules regarding the cse like what do you programmer crime complaint to the existing rules that required external auditors to review the firm's risk

management control systems developing and automated process to ensure they are adequately resolved, improving collaboration efforts among the divisions of trading and market corporation finance and the office of compliance inspection and evaluation and the office of risk assessment. and tracking and monitoring compliance with its internal guidelines and the creation of a task force led by the office of risk assessment with staff and trading of markets division management to perform analysis of certain large firms. on september 26, 2008 a day after we issued a report on the oversight of bear stearns and related entities former sec chairman christopher cox announced they would end the program. notwithstanding the closer the program the sec has made efforts to implement the recommendations contained in our report and to improve its operations accordingly. as of march 31, 2002 management

completed 23 of the 26 recommendations contained in our audit report. in conclusion we appreciate the commission's interest in the sec in our office and in particular are audit report. i believe the commission's analysis of these matters is beneficial to strengthening the accountability and effectiveness of the sec. >> thank you or go mr. donaldson. >> turn your mic on please mr. donaldson. there should be a button and one thing i should ask of the witnesses is if the light will go to yellow, when there is one minute remaining on your time, and then a red when the time is up. >> thanks for inviting me to testify today. i particularly appreciate the opportunity to offer my views on the shadow banking system. is my long-standing interest to strengthen oversight of unregulated and opaque sectors of our financial market including during my tenure as chairman of the securities and exchange commission from

february 2003 until june 2005. you have asked me to discuss the origins of approval and structure of the sec consolidated supervised entity cse program and the impact of that program and the leverage of participants. we have also asked by comment on several additional issues. these issues include my understanding of the term shadow banking and second the ability of regulators to oversee the shadow banking system entered the sec's ability to oversee systemic risk and the wool over-the-counter derivatives played in the financial crisis. my remarks today i will summarize my views on these topics included in my written testimony. before discussed the topics i want to remind you that the views i express on my own and not necessarily the views of the sec in any current or former commissioners were commission staff. first i would like to discuss the cse program. public report mistakenly suggested that this step was the regulatory in nature, just the

opposite is the case. the program in fact extended sec oversight into new areas namely the activities of unregulated holding companies and other affiliations of u.s. broker-dealers. the sec does not have the legal authority to impose mandatory capital requirements on holding companies or large security firms. before 2004 the sec had required regulatory capital computations only for broker-dealer subsidiaries of such holding companies. the cse program established for the first time and sec history the framework for consolidated oversight of the capital liquidity and risk parameters of this holding company. the global activity carried out by those holding companies do their non-sec registered affiliates were of concern to regulators including regulators and certain non-us jurisdictions are going to thousand four during my tenure as chairman of the sec the commission adopted

the cse program by unanimous vote. under the cse program the holding company was hard to compete on a monthly basis risk-based consolidated holding company capital. the holding company was required to provide the sec with information concerning its activities and risk exposures on a consolidated basis and submit its nonregulated affiliates two examinations. the cse program relied on the existing authority over broker-dealer affiliates as the basis of an posing examination and driven story requirements on a parent holding company. the basel standard was generated through the efforts of bank regulators and financial markets and services of financial institutions. would use their internal mathematical models to calculate

the net capital requirements to the market risk of certain positions. which is how commercial banks and in market basis for their trading position since 1997. the commission recognized that utilizing these models might result in lower capital requirements that otherwise would be required under the net capital rule accordingly the commission decided to include a requirement that cse participants provided early morning to the commission that their net capital before utilizing the models total $5 billion. they also modified the rules to require cse companies to hold liquid assets. the rules did not contrary to the suggestions and some published reports eliminate leverage ratio restrictions on broker-dealers. large broker-dealers had not been subject to leverage ratio requirements under the capital standards in place since 1970 or over the net capital never

constrain leverage edna broker-dealer holding company or other regulated affiliate. as a result the many-- risky activities such as otc trading real estate loans were conducted outside the sec registered broker-dealer. additionally either the holding company level so simplistic and harrison of the leverage ratio to leverage ratio of banks is misleading. the product mix of securities differ significantly from that of banks. in particular security-- extensive holding of highly liquid assets and market books and limited exposure to off-balance vehicles. gse program represent a forward-looking effort to improve oversight of the unregulated affiliate of u.s. broker-dealers. it also requires--. >> how are you doing mr. donaldson? >> i'm going to start right now. >> i'm sorry.

>> i was going to go want to talk about shadow banking and a couple of other questions u.s. which i will be a glad to do at the end of the session. >> thank you very much. we have got many hard-working commissioners here. mr. cox. >> thank you very much. thank you for this opportunity to offer my views today. you asked me to overview the shadow crisis as well as the sec's experience for a program to regulate one portion of that system. the shadow banking system most often refers to borrowing and lending using nonmonetary instruments as well as money outside of the traditional banking system. includes money market mutual funds, insurance companies, securitization vehicles, hedge funds, and most significantly the gse's fannie mae and freddie mac which was roughly

$12 million. live in the commercial banks have been large elements in the shadow banking system are off-balance sheet entities and also through the investment banking subsidiaries. in the run-up to the financial crisis the abrupt devaluation of mortgage-backed securities and other credit risk transfer instruments led to many parts of the shadow banking system including investment banks facing a run on the bank. that said and evaluation of mortgage-backed securities was itself the result of an asset bubble, bubble in the housing market inflated with high risk mortgage products such as the notorious liar loans and that no money down financing. it is abundantly clear as the sec's former chief accountant lynn turner has testified that it's honest lending practices have been followed much of this crisis quite simply would not have occurred. most of this of course took place within the traditional banking system at the shadow banking system helped spread the

contagion to every sector. the failures of the bailout of so many regulated commercial banks as well as investment banks and non-banks highlighted the inadequacy of the capital of liquidity standards in both sectors. one might expect to see these problems in the unregulated part of the system but what about the failures to out the system. to answer this question the starting point is the capital standards for commercial banks which didn't provide an adequate early warning system. the standards which are still in place today assign a risk waste of bank assets to treat mortgages and in particular the securities of fannie mae and freddie mac as far less risky. even without the benefit of hindsight, commercial bank regulators have wrecked nice the problems with the basel standard they encourage people to put risk off-balance-sheet. that led to the basel ii standards which the sec incorporated into its voluntary program that chairman mcdonald described in 2004.

the program is voluntary as he mentioned because the commission lacked the statutory authority over almost all of the businesses within the investment bank holding company. this program a, the gse program is built on the sec's jurisdiction over the regulated broker-dealer of the investment bank holding company that bear stearns demonstrated this reliance on the internationally accepted waffles-- basel standards was a fundamental flaw. if the firms were even coming close to the 10% capital ratio of that the fed uses to determine a well-capitalized bank. yet at all times even during the weekend of the sale to jpmorgan chase dare stearns had a basel capital capital cushion well above that. that is why in march of 2008 i formally requested the basel committee to address the inadequacy of the standards in light of these experiences. since all of the world's major banking regulators rely on the basel standards this remained a

matter of the utmost urgency. while the sec and the fed and the treasury were surprised by the speed affairs run on the bank the decisions that week that bear stearns was too big to fail was even more surprising. the sec throughout its history had seen investment banks failed or be required to save themselves. e.f. hutton, salomon brothers and more involved a voluntary gse program and to give early warning of investment bank failures it was not capable of preventing them because no government regulation could do that. an important lesson from this is that the concept of too big to fail must be eliminated. along with regulatory and market uncertainty that follows from it and the freedom to fail which is the cornerstone of risk-taking has to be restored. i would add to this that transparency is a powerful antidote for much of what

happens in the financial crisis and that is nowhere more true than in the otc derivatives market. mr. chairman and the commission, thank you for your questions. >> thank you mr. cox. >> thank you for the invitation to testify at the sec regulation of investment banks in the shadow banking system. i am a professor of finance at bassman college in wellesley massachusetts. from september 2006 until april 2000 i was the director of the division of trading and market of the u.s. securities and exchange commission. the sec regulation of broker-dealer finances aims to ensure that in the event of a firm's failure, customers obtain the return their cash and securities held at the firm. some broker-dealers are subsidiaries of investment bank holding companies, complex firms with hundreds or even thousands of subsidiaries. the vast majorities of the subsidiaries as well as the holding companies of the entire investment bank lacks statutory regulation under the regulatory

regime laid out in the 1999 graham bleak graham-- of commercial bank holding companies but not for holding companies to investment banks. thus the u.s. regulatory system currently contains no statutory provision providing for substantive regulation of the investment bank holding companies including the setting of capital requirements. nor does the statute provide any regulator the authority to impose liquidity standards or other requirements intended to guard the financial or operational condition of the holding company. finally the law does not provide a consolidated supervisor that is knowledgeable in the course-- for security business of these firms and has the authority to impose requirements it would be recognized for this purpose by international regulators. following the demise in 1990 the sec realize they failure of the holding company for a nun broker-dealer subsidiary could cause problems for the regulated

broker-dealer. one of the measures taken by the sec to address the serious regulatory gap was a consolidated supervisory for u.s. investment banks in march of 2004. the program construct an alternative best capital regime for the broker-dealer subsidiary was carried as a condition the affiliated holding companies consent to groupwide supervision by the commission. this was a significant regulatory extrapolation that the commission believed in 2004 was necessary to fulfill a significant regulatory gap. with the five cse firms the commission oversaw not only the broker-dealer but also supervise holding companies and affiliates on a consolidated basis. the cse program is tailored to reflect to fundamental differences between investment banks and commercial bank holding companies. first the cse regime reflected the resilience of securities firms relying on security firms of daily mark-to-market accounting is a critical risk in

and governance control. second, the design of the regime reflected the critical importance of maintaining adequate liquidity for holding companies that did not have access to an external liquidity provider. it is important to note that the cse program was not the only oversight regime applicable to these firms. the broker-dealers within the holding companies were regulated and supervised by additional personnel and by a broker-dealer self-regulatory organization with extensive examination and enforcing staff and there were no regulators of other subsidiaries including foreign broker-dealers, insurance companies. the sec required to not less than 10% consistent with the federal reserve's well-capitalized standard for bank holding companies. there has been much confusion surrounding the commission's ultimate net capital rule for cse firms including the mistaken belief that the rule allowed the assessment bank holding company to increase their leverage.

this is not the case since prior to the cse regime there was absolutely no regulation either by statute or by rule over investment bank holding company capital for leverage. in addition to n. quincy the sec required each cse to adopt her seaters to ensure the hold and companies had standalone liquidity insufficient financial resources to meet expected cash flow in a stressed liquidity environment. abraxas was not available for a period of at least one year. alongside the capital standard to be critical to the effective supervision of the cse and the critical distinction between the supervisory regime for commercial and investment banks. the cse program adopted by the commission was developed to fulfill a serious regulatory gap to the graham leach lightly at the structured financial institutions. the remaining imperative is the need to express explicitly how

and by whom large financial firms with a primary security business should be regulated and supervised in the case of the financial distress. thank you for this opportunity to testify and i will answer any questions. >> thank you. will now go to commissioner questions and i will leadoff. mr. cox i want to start with you and i am going to focus my questions mostly on sec's specific supervision of bear stearns. i know other members will have comments generally or comments generally about the sec program so just a quick recounting of effects. my understanding is at dare enter the program in november of 05. as it happens, prior to completion of the interest exam that was required. in 2006, there is no on-site exam for books and records exam because there is a reorganization of staff at the sec. it turns out the close of the

firm's collapse in march of 2008 there is no exam for 07 which means essentially there is part of a regulatory program of which there is no on-site exam or examiners for the full length of time they are in the program. i do understand that there are monthly monitoring ports where the sec would talk to folks at all five investment banks and they do understand that there would present quarterly liquidity and funding reports and asset management, hedge funds blew up. they were either weekly or daily liquidity reports depending on the timeframe timeframe but all told, as i look at this, and i want to clarify them talking about on-site exams for the holding companies. but as a look at this, it doesn't seem to be a regulatory program as we would normally conceive conceived conceive of it and certainly not a regulatory program anything akin to the other supervisory programs, so i look at it to some extent, it looks like a

placebo, not to regulate our program and in what respect you think it was a credible regulatory program for holding companies? >> chairman angelides, as chairman donaldson just explain, this was additional regulation layered on top of what already existed for the regulated rocher dealers of each of the cse firms of which bear stearns was the first one. for the first time, as a result of the rules that the commission adopted in 2004, the sec was getting a look at all of the information at the consolidated level about risk management and so on from that standpoint verse might affect the regulated rocher dealer and second might affect the environment in which these firms and in particular their regular subsidiaries were operating so in those ways, this was a broad expansion of the

sec's vision. as you know, because you are looking at the whole picture, what was going on inside the sec's line of sight was only part of the whole picture. the bank holding company supervised by the federal reserve and other bank regulators as well as state regulators another figural-- federal regulators each have their own business so this question of systemic regulations , bore more to the point, systemic vision that is very much on everyone's mind these days back prior to the crisis, was a little bit closer to the blind man and the elephant. some people god bigger views of the elephant and some smaller. it is clear once the sec started saying this information that it had to be more closely coordinated with other regulators and that was the next that so it was even before bear stearns that i began talking about mou's with the federal

reserve and with the cftc and just the same way we have been concluding those mou's with foreign regulators. i did over a dozen of those while i was chairman. knitting this all together both domestically and internationally was vitally important because more than anything else, this is a question about being able to see beyond the narrow stovepipes is certainly the statute setup or any regulator. >> that is really my point. you are the consolidated supervisor overseeing the holding company therefore would be in a position not to be just one person touching the elephant. on reflection did you apply the resources and regulatory regime to this program that were warned? >> there are two ways. >> as i understand it, from the very onset and i know some other commissioners may want to talk about program designed so i will leave that to them but from the very onset the idea was that you have examiners on-site a couple

of weeks out of the air, kind of like swat teams but not of the nature of the normal regulatory program that is really going into the books and records particularly of the holding companies. >> i think that is exactly right. it wasn't built into the architecture that it would move in and actually redo or doublecheck all the work, but rather this was a program that was meant to review the information that was provided to the sec and then commence a dialogue about the reasonability of for example the metrics that were being used. each of the firms of course were using different metrics. although i was not there in 2004 at had the opportunity to listen to the commission meeting of which this rule was adopted. i've had the opportunity to read the release that was issued by the commission and the rules that were set out, and i was

about to say there are two ways to look at this, so i will describe the first in the second way. the first way is through the lens of the commission in 2004. i was not there so it is very easy for me to do. the commission believed it was taking a bold step forward into additional areas of regulation that were not open to it in the statute but that would give it a broader field of vision. it carved out of agency resources for the people to do that. to put this in perspective, the entire division of market regulation later renamed the division of trading and markets was less than 200 people, and they are responsible for overseeing 5000 broker-dealers, all the nation's markets and so on so inside this box now is the cse program that comes out of existing agency resources. nonetheless it was budgeted for and it grew and more than doubled during my chairmanship

and the architecture of the program made it clear that it had to be reliant upon information provided by the firm so it was different as you point out mr. chairman. other kinds of bank examiner programs where they have people on site in every firm and they are doing a very different job. this was a review function and it was a broader field of vision. >> it is fair to say really ended up being a review program, not a regulatory program. >> i don't think it is fair to say it was a regulatory program because clearly it was. it had rules and those rules said for example the centerpiece of it that you have got to retain it also ratio that meets the feds 10% well-capitalized requirement and you've got you have got to have liquidity and you have to configure but also ratio monthly. those were real rules and they were in force. in fact the programs

relentlessly worked against those metrics. one of my points today is that it is the wrong metric to go there are two ways of looking at this. >> just very quickly. >> the other way to look at it is from the standpoint of now or indeed the standpoint of post their 2008. the reason i shut down the program was what happened during 2008, so knowing what we know now or even what we knew then, it was manifest a program that limited itself to this even though this may have been ambitious given the lack of statutory authorization, was not all that was needed. we needed a lot more resources to do this. otherwise you couldn't muscle the banks around. you couldn't say you have got to change or business. you have got to do everything different even though your shareholders and your the one taking the risk, we are telling you you have got to do it

differently. you are going to tell goldman sachs until morgan stanley and everyone of these firms you don't understand your own risk models. we understand them better. if you are going to get to that point where you tell people how to run their business, you are going to need an army. >> let me ask weekly, did you ever ask for me -- mike more resources for this program? >> yes, literally days after. >> not prior to that time. >> bear stearns caught the world i think by surprise. the cse program at that point had been functioning as everyone expected it to. >> in fact i know right before bear stearns collapse i think on march 11 you said you had a good deal of comfort about the capital capital cushions of these firms what i want to go to this issue of leverage and in reviewing the information around the 2004 decision i don't find a direct cause between that decision and increase in leverage in the bank holding companies.

so, let me put that issue aside to let me go right to the facts, which is if you look at bear stearns, the tangible assets, the tangible equity ratio goes from 31% to 30% from 2,042,007. at goldman sachs from 26 to one to 30 two-to-one and morgan stanley goes from 29 to one to 40 to one. merrill lynch from 25 to one to 45 to one. 24521. lehman brothers, 30 four-to-one and then close to 421. also with respect to your comment mr. donaldson. if you look at all of these institutions by 07, they are level 3 assets and which is the ill liquid assets that are not, for which there is no discernible market, hard to price illiquid assets. greatly exceed their equity and bear stearns has 69% of tangible

common equity and lehman is 243 and goldman is 200%. morgan stanley is 266 in merrill lynch's 216. the fundamental question, did you ever look at that and say in terms of the business model these kinds of leverage ratios are just crazy. forget whether the 2004 decision triggered it. in the aggregate you have a 2% to 3% the munition after value and you avoid debt equity. to the sec under either of you look at these growing ratios and say this is a problem? >> i can only say this. >> turn your mic on mr. donaldson. >> during my tenure which ended in june of 2005 we only had to under the cse program and i go back to-- what i think cannot be emphasized enough, which is the reason for starting this program in the beginning, which was the leverage in the activities that

were going on at that period of time or beyond our purview. we needed to have more information and as a result of that, we felt that we should start the program. we recognize that using basel, there was going to be a different set of criteria. it never was leverage. i want to emphasize that again. there was never leverage restrictions on these firms. >> you have the ability to say you can't stand this program at this level of risk. you did have that ability and there would have been consequence for the firms. >> i'm not sure i understand. >> you have the ability to take action-- edmonds lease mr. halloran in interviews with our staff expressed that he you did have ample authority and ability to press the firms to reduce leverage, increase liquidity and of course the

ultimate sanction would have been to say you are out of this program. >> that was not the criteria prior to the program. the criteria was that capital. net capital had to do with your ability to discharge the obligations of the firm and it had nothing to do with leverage. we have that ability and we use that ability when the net capital wasn't adequate. >> i am kind of a simple guy. was this a safety and soundness regime and was it effectively implemented? >> i can't comment on what happened after i was there. i believe we effectively implemented the installation of the program, yes. >> let me do this. i know other commissioners have questions. let me reserve the balance of my time at this moment, and go to other commissioners. i will circle back after they have had a chance to answer their questions. >> mr. vice chairman. >> thank you. >> let me ask the question in a slightly different way.

because of the bear stearns panel we had just prior to you, looking back at what happened to them from their perspective going forward. this is both for mr. donaldson and mr. kotz. we were all aware of the contest that went on as the traditional banking system saw a significant shift from them to the so-called shadow banking or investment banks because of the ability to create more modern instruments or more creative or meet-- more peace brokered for what they want and it reached a point with gramm-leach-bliley passing in 99, which changed that traditional structure so that

traditional structure could plan , and the terms may not be technical, but could plan a little more into the activities of the investment bank. what was the mental set? i will start with you mr. donaldson because obviously the cse had no legislative structure and frankly, given the mental set that led to gramm-leach-bliley, it probably couldn't than put something else in place although there were some arguments at the time that we were going to get rid of yesterday and try to bring in tomorrow. i guess we are still working on tomorrow after what happened yesterday afternoon to all of us , and quite surprisingly. .com if you have this attempt to what? take the sec's given jurisdiction of regulatory power and see what you could do with it to solve or at least address

a blank in the regulatory structure because of what happened with the repeal of glass-steagall, or because you felt was necessary to deal with these people regardless of what happened in the old traditional statutory structure that was no longer there. am i making sense? >> was the cse the best thing that you could create given what you've created it out of, i.e. your regulatory powers that were there? >> yeah. speaking for the period of time that i was there, i think we were increasingly concerned. >> is your mic on? >> it is on. i'm just not speaking into it. sorry. we are increasingly concerned with what was going on in the shadow area, new instruments,

the activity of the holding companies. and i think that we felt that we had to do something about that, to at least gain access to what was going on. in addition to that, i think it is important to understand that the foreign non-us jurisdictions are putting pressure on the investment banks in the united states to be overseen at the holding company level. that is a very important thing to know. the investment banks were to be frozen out of doing business with one of their largest markets, the european union, unless we did something to make it possible for them to operate. >> the cse was created within and an extension of the regulatory powers that you already had? >> yes.

that is correct. >> and you could have used various criteria but you chose particular ones such as basel etc.? but may then shift over to mr. cox. where was the pressure coming from and i will transition over. my assumption is it wasn't coming from the industry, or was it? to create an oversight structure. >> have you gone to. >> not yet. i'm transferring from 04205. >> i think the pressure was induced upon the industry by specifically the european union, which said you are not going to be able to do business over here unless you are regulated under a holding company format.

we will do it for you if you don't do it for yourself. unless you are sec or somebody over there does something to put you inside of a holding company structure. that was where the real pressure came from. conversely, the pressure came from the industry wanting not to be frozen out of this market and also frankly i think wanting to be regulated by us, by an american regulator. >> so it has to be a voluntary system because you can impose it on them? >> right, yes. >> now, to your regime. bear stearns is one of the first ones then, the first one and? as a cse structure? >> yes, there were five total and bear stearns came in-- do you remember the date? >> in november of 05. >> they were the first 10 and then the others came in?

>> there were others and already. >> you had five banks in there at one time and you shut it down in 08. were there any banks left? >> merrill had been by agreement acquired at that point. >> there weren't any banks in? >> it is close it is close to there after. >> what i am trying to do is remember and picture the environment at that time. was there in a push or pull him on the other regulatory instruments that oversee what used to be the old commercial banking system? was there a tug or a pulled that fdic may be could move in that direction or the fed should? did the sec take it upon themselves to do this or were they encouraged to do it by virtue of the appropriateness of what you could do?

>> questions going to the formation of the program i think need to go to chairman donaldson simply because i wasn't there for that part. the program was created before i got there but speaking for myself it was a freshly minted program when i arrived. it'd just been the subject of several years of consideration by the sec's top of the national staff that represented their best thinking. i've been developed by rule adopted unanimously by all of the commissioners. indeed when i became commissioner, i was in this room for my confirmation hearing sitting next to the director of the division of market regulation, erik's predecessor who became a member of the commission. so, she was extensive continuity for this program because she had been there when the thing was designed. so we had all the same people in

place who authored the program. the deputy director of the division who is a 30 year veteran of the sec and by the way all of these people seem to be connected to harvard university. >> wasn't as robust as he wanted it to be or as robust as it could be under your structure? >> since i was just getting to know the program all the people who were briefing me on for the architects of the program and that represented the agencies at the time so i had no reason out out-of-the-box. >> let me say mr. cox i know you outside of this and berman so if someone told me the way the world was you would necessarily accepted as the way it was. >> in addition to being natively critical also when i went to the sec i had a lot to learn all at once and this was one of those things and i was briefed about during the transition and i'm sure chairman donaldson and i spoke about it as well but the view of this program at least in the agency was that this was the best thinking of the agency

standard they use, the basel standards that were in use by banking regulators around the world. as former director explained it was pattern on the fed's program and that is where the 10% well-capitalized metric came from. the basel standards were used by banking regulators around the world and indeed the u.s. was on track to get these in 2000 lines of the program was buried dance in that sense. basel ii as you all know was constructed as it was because under basel i there were too many incentives to move risks off-balance-sheet and earlier today we have heard a lot about those problems, off-balance sheet risk even post basel two are going to be an issue in this is still something that needs to be worked on by taking a snapshot of the program pre-bear it was thought that this program was well constructed and a very aggressive use of the sec's

narrow statutory base which went only to the regulated broker-dealer. >> you have at some point all five investment banks and the cse program. and, bear stearns fails. is it conceivable that in your mind, looking at the structure and the environment at that time, that one of the investment banks could fail and in fact failed and that the other four could have remained standing without any extraordinary government support? i am kind of getting it too big to fail concept of. >> that it's certainly been the norm prior to bear stearns. as i mentioned, the sec's most prior experience has been what the sec set up to do and those instant, to be the regulator

during the liquidation of the regulated broker-dealer. even in the event of 2008 which were cataclysmic, what we saw that the customer protection rule worked. we saw that the segregation of assets and customer cash and securities worked, that what the sec by statute was supposed to do, which is to protect the investors and customers and those broker-dealers even if all around them is collapsing works. so the sec was fully prepared in the case of bear stearns to play that role again. as it was we played a different role and provide all sorts of regulatory approvals for weekend transactions involving jpmorgan chase. what i said at the time or at lease contemporaneously in the testimony before congress about that event, is that the way things happened we will now

never know. this commission may have the best opportunity to dig into it that we have seen thus far, but we will never know what would have happened if we played the game the other way. the social sciences unlike the physical science. once you run the experiment you can't re-create the conditions again and see what happened. >> i don't think any of us would want that as a model if in fact we have the chance. >> would be difficult to live through twice. speak and i just go back to 2004/05? there was considerable concern on our part as to what was going on outside our jurisdiction and we had the traditional turf battles if you will with other regulatory agencies as to whose jurisdiction it was. we were so concerned that we set up an internal risk department for the first time in the sec and the assignment there was to

look over the hill and around the corner and see if we couldn't identify risk. this was the beginning i think of a concern for the systemic problems. they were out there and they were falling through the cracks. >> it is really refreshing to note that in the most recent battle to try to create some structure of regulation that none of the regulatory agencies are in a contest with each other and the industry desires are not being reflected in any way as they attempt to move legislation through congress. we have apparently learned a lot. byron is getting to know me. could i ask all of you to say yes please to the offer that, as we continue to learn more, given the resources that you provide to us, that we can get to you with written statements and questions and you could respond to us with written statements. even so far as to what do you

think about where we are now and whether we are going in the right direction or not. because we are not supposed to talk about where people ought to be but it is very hard to figure out where you want to be if you don't have a full understanding of where you were. right now, we find that is actually a whole lot more difficult than some people would think you would be and i know you would from the position you are in that we need all the help we can get. would you be willing to respond in a written fashion to a written question? >> absolutely. >> yes. >> thank you very much. >> mr. boren one follow-up question to my earlier question and i think this goes to an issue that has been raised as to whether this was ever intended to be a true regulatory regime or whether was an accommodation for the investment banks face a problem with the european union. this is actually for you mr. cox i have read the work of our

staff. i've read the inspector general's report. we have looked at the monthly monitoring reports which we entered into the record earlier today. here is the one thing that strikes me, pulling away from all the detail. i don't see, and i noted earlier that there weren't any real on-site exams during a too flashy or period. just in very simple years i didn't see any action taken at any time by the sec to change the business practices act bayer, to change their risk profile or in any way alter the activities that might have given rise to their safety and soundness or the safety and soundness of the system. in the record-- am i wrong? i don't see anything of significance where there is a change made in any practice is. >> i think i would yield to director sirri on the details here but since you are addressing this in a general way i think the answer is that bear stearns changed rather dramatically in response to the

cse program and i can illustrate that in the following way. versus cse program set up a minimum 5 billion-dollar liquidity standard. that is something that by the way commercial bank holding companies don't have. they don't have a minimum liquidity number at all, so that was an additive metric that cse program. >> did i not made that noninterest interest? >> no they didn't. other cse supervision raise their liquidity to 12 billion by 2007 and ironically in march of 2008, the firm had reached his highest liquidity over of $21 billion. i think, if you consider the testimony you heard earlier, you would recognize that that was a change that was made also at the behest of the securities and exchange commission.

they force them to start looking at this on a firmwide basis so there were a lot of things about the way bear stearns was run that were changed by the program. let's take the even more broad. and on the details i would certainly defer to director sirri. >> i would just point out the inspector general found the activities were deficient on leverage and risk. they found they were deficient in mortgage concentration and they found there were no changes made by the sec with respect to bears risk-management. >> it is difficult to disagree with the conclusion that the ig report reaches. it says that the failure of the program is manifest in the failure of bear stearns itself since the main purpose of the program is was to provide an early warning system and it didn't. i've fundamentally agree with that and they also would point out that ig's for the federal reserve this last week found exactly the same things with respect to the same metrics, not

coincidently that would be used across the system. it wasn't just in the united states. it was around the world. with respect to the question of whether this was meant to be an accommodation of a regulatory program i can tell you since i wasn't there in 2004 when it was done i have every reason. i did listen to the meeting and i did look at the release and so on. i've every reason to believe that the story is exactly as i have heard it throughout my service at the sec and exactly as chairman chairman donaldson has explained it. the sec was very interested in gaining more information as much as it could in the cse program represented a much broader vision than it ever had before. >> i will stop at this point. >> thank you very much and thank you all of you for appearing here today. i am going to start off before we get to the consolidated supervised into the program,

just to ask mr. cox and mr. donaldson about a topic you both addressed in your written testimony and we haven't talked about yet this afternoon, which is the role that over-the-counter derivatives and the lack of transparency and oversight of them played in the financial crisis. and i wondered, mr. cox if you would comment on that. >> i would be happy to comment on that and i have to say on many occasions, i have been finding myself reviewing the debates that you had a very long time ago it seems now, certainly in another context. but when you are at the president's working group. when i served as a member of the president's working group, i

know how valuable that interchanges and how difficult it is sometimes to reconcile the difference he-- different agency pointed you in one of the things i recognized looking through the distance, the time in the fog of memory is that there were in addition to regulatory concerns and market concerns and so on, there seem to have been turf concerns and it seems that some of the recommendations that were provided load in addition to flowing from the good reasons that good recommendations flowed from and also flowed from the hour team is better sense that is the worst kind of rivalry when you have got the county sheriff over here and the city police over here and they are both chasing after the culprit. i think there was a pride of brand as both the sec and the cftc at that time, so even

though the sec's former recommendation was we should not regulate, i also got a sense that this was a blocking move as well and possibly the sec would have had a different view if they had had a regulatory program ready. i don't know if that is true or not and i am almost inviting questions from you instead of answering yours. ♪ ..

and chris was incapable of legislating on the subject and as we have seen when the regulatory system tries to work in this basis of law and the mall is to ancient then it comes up short as it did here. so, if we are going to fix this problem and the problem i don't want to assume everyone's definition is the same store i will state my view the problem with in particular cds but other synthetic products and derivatives during the financial crisis was largely a function of ignorance. people didn't know where the exposures were. it wasn't so much there was something inherently wrong with

a contract or concentrations or where they were so these things were so easily traded and the original authors substituted with new people and so on but it's difficult for people to put together a spreadsheet and say i know what's going to happen. i know what the second order effects are and so on. the kind of transparency we have in other markets were applied to the cbs market would have caused people to call number if you are looking at a notional value which even with the lower estimate rate and subsequently even the lower estimates we had in 2008 are with the notional value of contracts work was more than gross domestic product of every nation on earth and so if you have a lack of transparency and around that, then your going to have market problems and so when other parts of the financial system started showing signs of weakness there was a crisis in confidence and so on and this lack of transparency and on the certainty people served as a mother reason for investors to flee the market.

>> in your view what you think we should do going forward? >> i made very specific recommendations before i was broken and i stand by the recommendations now and i am happy to see two years later even when i testified about them it was a matter of urgency and this month and not later i'm glad i'm doing it now but what we are going to do as i understand is moves as much as possible of this market on exchange or something exchange like and we are we to have a central clearing house in the counterparty and we are going to have to the extent these are non-standardized contracts and can't be moved on on exchange have transparency because there will be dealer reporting and he will have a well functioning market because there will be transparency and so on. >> mr. donaldson do you think they played a role over-the-counter derivatives in the crisis?

>> absolutely. i was just going to comment that i think there was an attitude toward derivatives in the early days, very positive one of risk dispersion. that was an attitude throughout many of our government agencies that the derivatives were a positive. as time went on and the derivatives got more exotic it became obvious there was increasing danger and i would agree totally with chris cox that we need to trade these things in a central location as much as we can and we need to know what's out there and we need to have a clearing arrangement that this makes sure that they are -- there is credit when the is things blow up. >> thank you. let's turn back to the csb program and as i understand the testimony, it was adopted

largely because the e.u. had taken the position in 2002 that our investment banks, our largest investment banks needed to demonstrate that they were receiving consolidated supervision in a meaningful way either here at home or they would be subject to regulation in the e.u. as a condition of their doing business there. and i wondered why what the motivation of the e.u. was in taking this position because of course at that time the united states did not have any requirement that investment banks or other financial institutions other than banks of

and their holding companies have to have consolidated regulation. >> it's hard to get into the head of the e.u.. >> what they explain it at all what their intentions were? >> i think there was a competitive situation going on where the e.u. wanted to become much more of a financial center if you will and wanted to outdo the regular -- regulatory on their part so it was to try to bring control to this new entity the e.u. financial market. but that's just supposition. >> so as i am to stand most of the impetus for this came from the industry itself who wanted to be able to continue their role in the e.u..

did they come to the sec with a proposal about consolidated regulation? >> i think it was a chicken and egg kind of things in other words the e.u. was saying you better get yourselves regulated in the the firm saying if we have to be regulated we would rather be regulating the sec and foreign regulators. >> as i understand the program, it was won a similar to what the banking regulators to or banking supervisors to in that it was designed to be provincial regulation with an eye to the safety and soundness of the institution rather than the traditional role that the sec and the cftc for that matter had played which focused on investor protection. is that right?

>> i think that's right. >> was this a rule that the sec had any experience with before? that is provincial regulation? >> obviously the focus of the sec was on investor protection and not provincial regulation. >> so this was something new that the sec was taking on the essentially in terms of the approach to the purpose of the regulation? >> yes. i would say so also we even in terms of just strictly a investor protection we needed to know more about what was going on in this market that we had no jurisdiction over which could have and investor protection implications to it. there was much more important than the provincial aspect. i don't think i can answer that

differently. >> mr. cox, do you agree? >> yes, in fact i think we have agreement even beyond this table with the current chairman of the sec the testified about this as well. this was an unusual step for the sec outside what normally was considered to be its core competency certainly outside its tradition. provincial regulation is different than the rule based regulation. to be very broad brush about the biggest difference is that individual based regulation there's a positive standard you can look at and, from your conduct to it and if you don't do it someone comes in and checks the box and rights you up. on the other hand if you are being supervised, you have a conversation about it, you might be required to do something a lot more than the rule. you might find the rule doesn't have an application and you're

not paying attention to it and you might have an ongoing dialogue where you revisit it regularly. there are important differences. the main 1i can point out is supervisors tend not to be enforcers. there's a good reason for that. if you're going to have this dialogue and that's been to be the nature of the supervision, you need to learn about. you need people to open up to you and tell you everything you need to know. but if you were going to be an enforcer people will have their lawyers with them when you talk to them. so, when i negotiated that great length in some detail it was very instructive and useful the memorandum of understanding between the sec and the federal reserve one of the sticking points about sharing information was if we get it to you you might give it to enforcement and we said if we see something that might be volatile of course we will. they said but if you do that and the supervised people know what

they won't tell you in the first place and both of those are useful commentaries but they tell you how it's very difficult to square the circle and so this was an interesting experiment for that reason ultimately i think however you have got to decide where you are going to be. and i noticed when chairman greenspan testified before this commission they took special care to point out that fed enforcement division that's not what they do and so supervision is very different. if i may parse this even more finely, safety and soundness is something that is a term for bank regulators and i don't believe that is in the charter of the sec program and the reason the matter some what is while it was a provincial supervisory program it had

specific aims preventing the failure of an institution wasn't one of them for the obvious reason that unlike the federal reserve there are no fiscal efforts, there is no money to rescue them with. >> you did testify the purpose of the program is to monitor for and act quickly in response to financial or operational weaknesses in the csce holding company or its own regulated affiliate's that might place regulated entities for the broad financial system at risk. >> yes i think that is right. i just want to distinguish between that and not to use a pejorative term bailout bill to the liquidity backstop the banking system provides are a big distinction between this program which was another way parallel and the federal regulatory system indeed some of

the state regulatory systems for banking. >> three minutes? >> please. >> did you feel -- and i can ask either of you this did you feel when you had the resources, the personnel, the experience to institute this kind of new regulatory program? >> well, back when this was first being formed the sec was tremendously understaffed and we got concurrent with my selection as chairman we got new budgets and to employment from 3,000 to close to 4,000 so all of a sudden overnight we had not only more bodies but more well-trained bodies so we thought we had a lot of adequate

resources to get this going. >> but obviously in in the end in 2008 all of the investment into the consolidated supervised entities that were in the program either failed or became something other than investment banks and i think mr. cox common use of the program was a failure and therefore you were terminating the project, right? >> i terminated the project. i don't believe i ever used those words to describe the program nor would i think even now that is an accurate assessment. i think rather as the general put it the program failed to achieve one of its architectural objectives which was to serve as an early-warning system. but with respect to the staff

that worked on this, something has been said about this and other forms so i just want to point out the stuff that was there when chairmen donaldson was there and i was there when i was there, highly expert people. the director was an addition to the team but had been the chief economist at the sec under german levin and like the other people in this program, distinguished ph.d. in economics at harvard in terms of understanding mathematical models that probably helps that he also has a ph.d. in astrophysics or a degree in astronomy it must have come in handy understanding some of those models. bob colby, the deputy who was there under bill and me 30 year veteran harvard lawyer of this

area understands it very well. and the head of the program, to harvard degrees and mit ph.d. in economics hired away by the federal reserve in the wake of all of this. these are good people and very smart people. one of the things that's always impressed me about the sec is how sharp the resources are and how the agency is able to attract the very best people so i think that is something of a kinard. but i do think is correct and something the inspector general has pointed out in other areas if not this one is that the hour skill sets that overweight the lawyers and that is probably something that is going to be continuing for the agency to try to diversify because even if it is going to be roel based and not provincial but still needs to have a variety of skills sets. >> perhaps you would like to -- >> [inaudible]

>> just one minute. perhaps this demonstrates as well as anything could help institutions that are too big and interconnected to fail may be too big to supervise as well. >> that is an outstanding observation with which i completely concur and i haven't heard it said at all. frankly i'm sure it must have been said by you or others somewhere but one of the lessons we have to infer from all of this is that if the market is going to be moving as fast as it is and people are going to be developing financial products in the future, sure we then will be a system of regulation that allows them to slow down and wait until we catch up isn't going to work. instead, you've got to make sure the subject of regulation is comprehensible to the regulator and that means perhaps rather dramatically changing the scope what it is that comes under

regulation. >> thank you. >> for the record before we move on to mr. holt's mr. donaldson you were talking about staffing and it's my understanding for the record the staffing level before your tenure were about 3,000 employees, give or take. jr tender it moved up to about 10,000 mr. cox it moved up to 3500. but even in that context the sec staff in 2004 had 12 to 15 folks dedicated to and in 2007, 24. so it was a thin slice of folks. i just thought i would make that observation. >> at the beginning? the mckeithen in 2007 it had 24 folks dedicated. >> thank you, mr. chairman and everyone for joining us. seems to me there are four areas worth pursuing.

one is structured and conduct of the program and isolation and the second would be experience at there stearns. how the sec look to other regulators where all regulated entities suffering discussed during the period and the fourth would be the traditional role of the sec investor protection and i want to pick up on what you just talked about, mr. cox on the traditional investor protection because one of the striking things to me in all of this is that the u.s. and the up with trillions of dollars of toxic securities and investors did not appear green protected when it all fell apart. i'm an economist recently that appears to be a good thing. not always. i didn't understand this but it looks like that the bulk was issued under these particular regulations and regulation deep

or will 144a and traditional sec oversight essentially was waived for large amounts of these so i guess i would like to hear the views of you, mr. donaldson and mr. cox was to the sec had the power to tighten the rules for the large sophisticated investors who ended up with these poorly understood complex problems during the crisis. >> i think there was a hole in the regulation of the dirt of its as the result of the law that was passed which to act authority away -- >> what about securitized mortgage assets and things like that, not just a derivatives? >> it was a commodity -- which was in effect opened up the gate in the derivatives market and took the effort ready away from

the cftc and the sec. and it is through that hole that the credit-default swaps and all these things went and nobody had jurisdiction over them. >> how about the cbo squared, mortgage-backed securities and staunches repackaged? booze aren't all through that. aren't some of those through your particular rules which allow sophisticated investors to have products which were not gone through the usual sec registration process? >> i'm talking about derivatives now. >> i'm not. >> okay. >> are there large amounts of securities which turned out in the end to be quite problematic which were never in any way but through the traditional fcc -- sec scrutiny because the existence of these exceptions for sophisticated investors who qualified institutional buyers.

sprick instrument or securities? >> my question is was there at any point in this did the sec have the power to increase the scrutiny of these instruments? >> to increase jurisdiction of the instruments for talking about? >> yes. >> i suspect it did unless it was prohibited by law from having jurisdiction which is what i was referring to on the derivatives issue. >> understand that. >> did you ever contemplate that? >> i am not exactly sure what instruments you're talking about that we didn't have jurisdiction over. >> not that i need to clarify mr. holtz-eakin but just as a listener i think that he's talking about an instrument that growth in the marketplace such

as the cbo is taking could the trenches of rmbs mortgage backed securities and creating new trenches cdo and in doing the cdo squares and then taking those and creating synthetic ceos. this will generation of products. >> i thought i said that. >> and by the way that was on my time. >> mr. cox? >> yes, i think i understand your question and you are asking in part about private placement as well as public offerings of securities. >> absolutely. >> i think the short answer is these securities were issued both ways. so it's not really the characteristics of the security that it operates under exception. it's rather a means, question of the way that it sold so that there are some statutory

exceptions that would override everything, commercial paper for example in a securities and what have you. so it depends on how people are structuring them. but the fact that some of these were large placements or otherwise is really much more an incident of how that particular transaction was structured than the issuance of securities themselves. the largest issuer of the kind of securities was of course the gse and they were very active in the public markets so there was a lot of requirement to come under the sec disclosure regime to the extent that securities were sold in public markets in terms of their own reporting fannie and freddie of course did not volunteer to be covered by

the 30 to react. i actually asked congress to do that. >> and they said no. >> even now it hasn't been done. they did it the 34 act in the fall of 2008. >> so in retrospect on the part of either of you should the sec have required some examination of the market innovations? >> certainly the sec was all for this in many ways both during the tenure and of mine but still to the extent that we are focused on securitizations and the use of the public market for this sort of thing the second thing i would say is that one of the biggest sources of private placement activity or unregistered activity hedge funds and there was a great deal focused on the hedge fund regulations right at that time that bill was chairman and i was chairman the sec enacted rules. i supported those rules and put them into effect.

we now have to put then attacked by statute because the court said that they didn't have that power. >> the affairs do refer to the -- cse and to the degree you have adequate staffing and this really was a safety and soundness regime. that is pretty clear. i guess i am interested in sort of how effective you were able to be an understanding of a risk profiles especially the dinkins up with, so in 2004 when the sec adopted the rule it did obtain the practice of the holding company, right, the risk manager practices? german donelson? >> your question is did we have the sophistication and of the knowledge? >> did you have the authority?

>> well, we did not have -- guinn forward after i was there we did not have the authority on the cdo, cmaa etc.. particularly the mortgage pool vehicles which began and fell in between the regulatory responsibility. >> my question is my understanding is when the broker dealers adopted the alternative that capital you had the authority to examine the risk practices and methodologies and what did you do to get comfortable with what they were practicing? >> i see we did have the authority -- >> and how did you use it? >> i'm not sure i understand your question i guess. >> the stress test that an investment bank might use, you examined them, become comfortable them and signed off on them? merrill lynch for a simple first into the program ultimately

fails and has to have a forced marriage. you're comfortable with the risk-management practices? >> you're talking about capital structure of the investment firms and stress testing? >> the risk management broadly defines the capitol they held, the portfolio's the invested, the hedging practices. >> well i think, again, with the eventual woody that came down the pipe we did not, nor did anybody i think realize what effect it would have been basically a run on the system and their refusal to finance the firm's buy their traditional suppliers of capital or withdrawal of capital. i think i was a circumstance that was not anticipated. it was a crisis and was not

anticipated. unexpected and unpredicted at least by our agency that that could happen. >> mr. cox, under your tenure, the other three investment banks entered the program and you took the image of the authority to examine and became comfortable with them? >> i think the answer is the agency did. the way that this works inside the agency of course is that the commission comprising five members who have brought a policy-making responsibility for all of physicians and offices and so on receive a recommendation at a meeting in a room something like this where the staff presents documentation for the recommendation and makes a recommendation so literally the vote is on whether to accept or reject the recommendation and

the means of pushing back on that your understanding is dialogue with the staff prior to the meeting and so on. and each of the commissioners has counseled that help them do this and so by the time one comes to a vote on this those questions have been answered. the source of information of course is the program itself and the professional staff who run it and to the extent they missed something or to the extent that there is a mistake inherent in the system than it probably wouldn't be uncovered in that way. >> mr. sirri, the inspector general has reported that the sec was aware of some sufficiency some risk-management practices of bear stearns concentration of mortgage things like that. do you think the sec could have prevented the failure at bear stearns? >> i think the distinction to be made here is the distinction

between understanding concentration and understanding what that means for the rest of the firm. we certainly were aware of concentrations of mortgage securities. bear stearns, the securities firm within that is substantial fixed-income business and nested within the fixed-income business that substantial mortgage business. so in that sense it was a business decision by the firm to be concentrated mortgage entity. the thing that we missed and i think most of the industry's best and most regulators missed is that the question of how volatile or what kind of prices are undermining the value changes you could see in the mortgage instruments. we didn't miss the concentration. the mistake was we felt that given that they were concentrated, given the rating of the paper that they were holding we thought that they could withstand the kind of shock we might reasonably expect for the mortgage instruments. it is in that sense that we

misjudged. >> one reason i was curious about this is that what we heard from bear stearns panel this morning was essentially the story that said well yes, we know there was a large decline in housing prices and there would be a great rest in mortgage finance. but we couldn't tell ran the risk. we looked at the counterparties and the investment banks and couldn't tell who had the risks we decided we were all safe. the market looked around and said we decided the same, too but they decided none of them were safe and we don't have them anymore. my question for you as could the sec distinguish among the five entities under the cse of the relative exposure and in the end of exposure to the risks of the decline housing markets which is a part of what went on? >> the answer is yes we could certainly distinguish the relative exposure is just as we could judge risk management capability and the degree that

they have hedged or otherwise managed their positions of that is a judgment that we could make. >> to push that a little bit one of the seminal moments that most people point to in the recovery was treasury stress test the distinguished relative financial health among entities within the t.a.r.p.. if he could reveal the financial health white was their none in the crisis? >> the german yields the gentleman additional five minutes. >> i would ask that of mr. cox as well. >> as i understand the stress tests, they were more rigorous, more substantial than the types of tests that we performed. notably they were performed to a uniform benchmarks across all firms so there were scenarios selected and they work run across the firm's and as a large undertaking. the types of work we did with respect to stress tests of the firm for example did not impose

a uniform standard on all of them and it's something that we discussed. the reason was well, we certainly could have done that. we effected not to because we wanted to let the firm managed risk with the way they thought was best managed given their business model. then we needed to build comfort in some cases we were comfortable and other cases we were not comfortable. we required change. >> what cases were those? >> we had a discussion earlier about asking questions like this about bear stearns. as they understand bear stearns came into the program before i was there. so i came in september of 06 so this will be before i got there but let me relate what my staff related to me. when bear stearns entered the program they did not at the holding company level have if all you would risk set of procedures or protocols. it was not the way they looked at risk at the bank. coming into the cse program we

were required to develop those types of quantitative models and to have those meet -- we had to approve them and say these met our standards. so they, because they wanted to come to the program develop those, got those the wing and came into the program. it would be one concrete example and if you will a quantitative fixable. there are other eight samples i think are important but have a different character that relate to the risk and governments. risk governments is important and these firms. the way the information flows and the way for ready flows within the integrated financial firm is important to our resolve disputes and three decisions, you what the appropriate decision makers to get information so for example of the internal audit function at bear stearns did their work but we found the information wasn't coming up to the audit committee appropriately. the quality of the information and the nature of the process wasn't good and it wasn't transparent and we expressed that view and we made sure the

quality of the interaction and the nature explicitly giving it more transparent flow of information from internal audits to the audit committee. >> thank you. >> mr. cox i guess i would close with the following question, which is there has been a lot of discussion about the staffing of this and i could approach a little bit on how the different entities were treated underneath the cse. but in the end, all of these investment banks are now gone. the field in one way or another. but that's not unique to the crisis. many institutions who were bank holding companies, who were fdic regulators, state regulators, there's a lot of failure so do you feel that it's inappropriate to single out the cse or you in particular for the failure of the investment bank's?

>> negative to our right to observe that this was something that affected all of the large banks and ultimately all of the large banks increasingly similar as they are faced the same fate or the same bailout and the large money-center banks with an investment bank subsidiaries or stand-alone investment banks fair the essentially the same way. i think the reason so much focus came on the sec in the midst of all of this was the sequence. bear stearns, which is the focus of this hearing happened in march of 2008. and that put a lot of the tension on first that institution and second that space in the financial-services as we now look back we can see that there's terms quantitatively a fleeced was very modest complement to what ultimately required $16 trillion

in order to restore confidence to the market. that is what the federal governor commit to in various forms. thank you. >> senator gramm i had a senior moment to read >> go ahead, senator. >> i would like to continue the line of questioning that was started. mr. sirri, relative to the information that is available and in particular i am asking the perspective of that investor who was trying to make sense of what the risks are and the options he or she has to invest in. much of our system is built upon in forming the investor and assuming they will use their good judgment to make decisions

that are best for them and best for the system. in our last panel, mr. schwartz, the last ceo of their stearns made the statement that from the outside you could not tell the exposure to the housing mortgage risk with the kind of information that was being made available to the investor community. my question is the shiastan inherent limitation of the accounting and of the literary professions to properly explain to the layperson what it is that is going on or is the structure of the information that we make available and adequate but susceptible to being made more informative so that prudent the person can make better

judgments? >> i think these are complicated instruments not designed to be understood with people who don't understand mathematical finance. as a result of that i think there was an over reliance on radiance. i think the individual investor looked at their ratings before they bought and that is one of the great weaknesses was the weakness of the ratings system. >> but my question -- you think that the instruments and process these are inherently so complex that they are not susceptible to more informative presentation to the prudent layperson who is looking to the information to make judgments? >> i think i can probably be better done by them and think it will ever be completely done

would be my judgment. >> mr. sirri? >> let me answer in two ways, with respect to the cse program and the more generally. to make clear the cse program was not about disclosure it was about the financial control of the firm so i just want to make sure to clarify that that there wasn't any misunderstanding. the question u.s. is a very good question as it goes to the opec news or the financial in the vehicle industry and the financial communities are wider nature very opaque by which i mean it's hard to tell what they are doing and in the case of the intermediaries with securities they hold. you don't have to go to an investment bank to get this resolved. you can think about a commercial bank that holds loans of the various types. well, there are loans and then there are loans yet when you think about the disclosure it's not generally sufficient to let you finally parts of the grindle level you might like to distinguish on the loan by loan basis what is going on. and that is not a theoretical

construct. that is reflected in the capitol markets as well if you take the financial intermediary and a corporate firm and look at say they're both double a. if you look at a yield of the senior debt, the financial will trade at a wider spread in part reflecting its capacity. so this is a way of saying i think is very difficult to get sufficiently granular exposure to the firms. general motors makes cars. they will get cars today tomorrow in a year from now for the financial intermediaries they have exposure long again tomorrow could have exposure short term goal substantially. it could make that kind of change because it is the only financial claims happening very quickly. the couple markets recognize that and discovered it because of it. hard to get periodic disclosure to reflect that. >> you think maybe the disclosure forms ought to contain something similar to what we require now on a package

of cigarettes that this is dangerous to your health and don't depend on what you're about to leave for any salvation? >> i wonder mr. kotz, which you have anything to add on that? >> one thing we did look at in our audit was this issue discussed previously about what was the information for so there were certain situations within the sec where other divisions perhaps corporation finance could have had access to some information from the trading and markets about what they were finding and what they were learning through their supervision that might have been used in a more disclosure process. and also there were 10k filings by corporation finance such as in this case we found the process too long and by the time the process was finished bear stearns have already collapsed so the investors were not able to have that information because

of the way the process worked. but part of the essentials all of the program i think was that it was meant to provide information to the folks and trading and markets not necessarily to be disclosed outside trading and markets so they would feel comfortable talking to them and then that would go against the other divisions within the sec chairman cox said enforcement as an example. having that information which then could be used to provide information to investors. ischemic my last question as relates to this room in which we are meeting, which is normally the house of this senate banking committee. to mr. donelson and mr. cox or their recommendations that were made during your leadership of the sec to the congress that were not adopted which would

relate to the crisis that we are now discussing not just merely to the shallow banking the to the broad financial industry that you think now what congress should reconsider as it moves forward in its reform efforts? >> one might think the congress should move forward on is the regulation of the so-called hedge funds. i think these are large pools of capital unregulated and we need legislation to regulate. we try to regulate them and it didn't get through the legal process. that would be number 1i think on my mind. >> mr. cox would be your priorities for with the congress should do in terms of reforming the financial-services system. >> i have a longer list even now that you asked what the congress

to adopt so what we and begin their. one of the things i recommended when we lost this in accordance with the chairman donaldson just described and that was starting at the sec were giving for the first time the opportunity to regulate hedge funds and register specifically their advisers. the second thing is i recommended urgently to the congress as i discussed with commissioner bourn the closing of the regulatory gap for credit defaults what specifically and that category more generally of derivatives and i think you heard me explain the ways in which i thought that that should be done. >> i went to yield two minutes if you can squeeze it in there. as we can go to the next commissioner. >> third i recommended to the congress it was repeatedly in many ways the sec be given the

authority to regulate in visible securities to the same extent we represent and regulate corporate securities and disclosure standpoint not in exactly the same way because they are different animals but because the multi trillion dollar market presents the same risks to investors, two-thirds of the more individual investors in that market as does the corporate market and as we have seen the economy has only put the stresses more seriously on municipal finance. california is now in a similar position to greece and this is when to be an enormous issue and disclosure transparency sunlight is the best anecdote. there's also other fancy things with regulation but the lead vehicle letting the markets understand what investors protect themselves. i also urge that we have legislation around the infrastructure for the credit-default swaps which i think is very important. i think we need to merge the

cftc and the cse. we are the only market on earth that does it this way. it's very stovepiped and the reason we don't do it as you know since we are sitting in this room is that there is a different jurisdiction. agriculture in the one hand and thinking on the other. we also need to rationalize more broadly the jurisdiction of the judiciary committee's with the banking committee because now we need to resolve these institutions and i made recommendations that had recommendations that may come back but the bankruptcy system needs to be tailored in order to resolve the large financial institutions and you can't do it if you've got to do it through the banking committee and house financial service committee and can do it either if you would only through the judiciary so i know that my two minutes to answer the question are up. please come back to me if you would like on that. >> thank you. >> thank you, mr. chairman.

mr. donaldson, let me start with you because you had something in your remarks i thought was quite why is to become -- why is. one of the things unique about one panel to see you have been in the investment bank. you ran a business in that area and so you have quite a lot of experience in how investment banks actually operate and what you said was simplistic comparison of cse leverage ratio to the leverage ratios of bank holding companies is misleading to the product mix of securities firms typically differ significantly from that of banks with relatively more expensive putting such highly liquid assets in market making books and more limited exposure to off-balance sheet funding vehicles. in other words, investment banks or a different business model entirely from commercial banks. in light of this comment, do you

think there is anything inherently wrong or inherently in opposite in the investment banking model, or can we expect that investment banks will return at one point as fully functioning members of the financial system? >> well, the investment banks have started from a base quite different than commercial banking system. there are a lot of different businesses. i don't think there is anything inherently wrong with that model accept i think as things have developed now i think it is questionable whether the investment bank's can continue to basically trade for their own

account, proprietary trading when they have a backstop now of all the investment banks that a bank holding companies the have a backstop with the federal reserve. i think i question some of the businesses that are in the investment bank mold right now and the top on the list would be proprietary trade. >> okay. but assuming they are not been called in companies or the have not submitted themselves to the regulation by the fed does bank holding companies, a stand-alone investment investment bank is not a business model we ought to consider on a suitable for our economy? >> no, i don't think it is. i think it is one that has to be regulated both in terms of

leverage and liquidity and all of the things we have been talking about but i don't think the model itself -- >> i'm going to ask your successor about the regulation issue because i'm interested in the spirit i asked the proceeding groups about the same thing and that is we have a strong system of regulation for banks. i have i guess what we would call much less robust systems of regulation for investment banks. at least you have all made a very strong presentation about how suitable and how effective in some respects investment bank regulation was, although we know that it's not as robust as the regulation of commercial banks. degette as you pointed out, german cox, both regulated commercial banks and investment

banks failed under their respective regulatory regimes at the same time during or proceeding were however we define the financial crisis. so, are we looking at something and i am asking you to speculate, are we looking at something that happened in the market during the financial crisis that no regulatory structure could cope with or are you saying that there is a way to make regulations so robust that it can withstand the kind of pressure that occurred in the financial crisis? >> let me answer the last part first and work backwards in that question. we now can quantify. we know how strong force wind was. and we know that it took

$16 trillion to restore market confidence once that approach was desired upon and once you decided what to backfire the system as opposed to let things fail. as a result, it is easy to see that no and out of liquidity would be enough to withstand a run on the bank because at some point cash runs out. these are fractional reserve systems. the investment banks are delivered and the banks are delivered themselves just at a distance from investment banks that people put up the money they collapse. that's what happens to the banks and why there can be a run on the banks. so once you are in a run on the banks' base where fear is driving and people are putting out their money than capital liquidity standards cannot be enough. but the next part of your question is is this system that we've got, the market such as it

is today susceptible some form of regulation that will stand between us and what happened or is this inherently of control? and what i would say is as long as you are willing to let institutions fail, then you really don't have to worry too much about how much it is going to cost the taxpayer because the losses fall on the people who take the risks. the problem that we have had that got us to this discussion is that the government decided the people's representatives ultimately decided that these institutions could not fail and that makes it very direct intersection with the system of taxation and representation by goes with that. if the federal government is going to be involved and the taxpayer is going to be involved in paying for these things than it seems to me you cannot have -- i think that commissioner or

whoever it was that said this earlier had a vote right label, which is too big to manage -- >> royte let me stop you there because -- let me stop you there because this is the fundamental question and you touched on it and that is bear stearns as we have said that 10% capital of the officials of bear stearns told us they were expecting in fact to be profitable in the first quarter of the new year just before they were taken over. yet, they're stearns was rescued. in other words, it was treated as though it was too big to fail. now in the past in the securities business as you have mentioned drexer, solomon, they all failed, no particular disaster in the market as a result of all of those failures and people learned lessons. bear stearns was the first time

the u.s. government had ever stepped in to rescue a security firm as distinguished from the bank. so in your view and let me add one more point is that is the officials of bear stearns who were here before us, just before you said they didn't think that bear stearns was too big to fail. do you think their stearns to big to fail? did you participate in a recommendation of concerning bear stearns this position that week? and i don't want to mess with your recommendation was because the executive privilege but if you choose to imply what you said and what you thought we would like to hear it. >> mr. chairman, i yield an additional five minutes. >> thank you. >> yes, i heard the testimony earlier today on that subject. i thought it was eliminating to learn that there was not an

expectancy on bear stearns of the ground rescue. that contrasts with what we heard from richard told testifying recently before the house of presentive sue said he expected a liquid the bridge so i do think something changed in march. >> the was moral hazard, wasn't it? >> morrill hazards certainly but i think that understates it given the scope of what was going on. moral hazard is a sort of vague thing. this is specific. beginning in march every one first of the investment banking but possibly through the side of banking as we have been referring to it loosely came to the view they would be too big to fail. if you were a larger investment bank how could you not be? >> swain asking is what is your view about the policy of

rescuing bear stearns in light of the moral hazard as vague as that might be that it created and clearly fould's remarks suggested that moral hazard was operating here because he expected that his firm would be protected in some way and so probably they didn't take many actions they would otherwise take to protect themselves and many others probably didn't take action with respect to lehman brothers if that were necessary to protect themselves so what is your view of the policy of that? was it a good idea to rescue bear stearns or not? >> well, this is as i said the ultimate bill that can't be unrung. the satisfaction would be to one round the table and do it the other way. we can't do that so there are two explanations. one is the world would have been a lot worse if we hadn't done these things. the other is that there runs on the bangerter evan bayh panic

and fear and what the government did make that worse. we have heard all of this before and i honestly don't know how to sort that out. to go back in a real time which is what you acquired about i was of course skeptical an ounce commissioner thomas mengin volume native lee skeptical, period, about all of these things and so i was skeptical about the long-term consequences of the bailout. i thought that the short-run effects were clear enough and the purpose was to restore the system but not only was a called morrill hazard but where do you go from here needed to be thoroughly considered. i was very satisfied that these questions were thoroughly considered by both tim geithner and hank paulson what was in discussion with in those days. after discussing the moral

hazard and other questions, i remembered secretary paulson said he never thought he would ever see the day when bear stearns would be deemed to big to fail. but once the decision was made by the federal reserve about what they needed to do to protect the system for which they are responsible and the money for which they are responsible, the sec, and i personally acquiesced on the decision and agreed to do everything possible to help facilitate -- >> mia lee internet because i am running out of time and i think that -- understand that the ruminations that went through your mind. what i am asking you is no link now what he knew what happened in the market after bear stearns , do you believe that it was a good policy to rescue bear stearns? was there any indication you have as the chairman of the sec that the failure of bear stearns would have affected other

institutions? .. >> i would not have, as a member of congress voted for a policy

of burying out financial institutions outside the traditional banking system. >> thank you. >> mr. georgiou. >> thank you mr. chairman and thank you gentlemen for joining us this afternoon. mr. cox, you stayed and i poe, above all the sec as a law enforcement agency. and our role on the commission here is to turn determine whether that performance or failure of the sec in this law enforcement function played a role in the local financial crisis? as the top cop in the u.s. sec, you worked for almost four years as the most important person in the world responsible for policing the global securities market. as they look back on your tenure everyone knows of the two large ponzi schemes that were missed by the sec by bernie madoff in

stanford, and of course although these conmen cost investors tens of millions of dollars few would argue that they were the cause of the global financial crisis in neither what i. on page 3 of her testimony, if i could direct you to it, you stated that the mbs devaluation was itself the result of an asset bubble in the residential mortgage market exacerbated by the rise in the use of high risk mortgage products including the liar loans and no money down financing. is abundantly clear as the former chief testified in congress on the failure of aig that wrote making fun is lending practices have been followed, much of this crisis quite simply would not have occurred. the nearly complete collapse of lending standards by banks and originators led to the creation of so much worthless or near worthless mortgage paper that as of september 2008 thanked reported over -1/2 trillion

dollars in losses on u.s. sub-prime mortgages and related exposures. again, we have heard at other hearings about an fbi report in 2004 issuing a warning about the extraordinary amount of fraud in mortgage origination market. i guess i would ask you in light of the fact that these underlying mortgages became part of these residential mortgage-backed securities, which as you stated became worthless or near worthless mortgage paper and then of course they in turn were sliced and diced into collateralized debt obligations and other securities. what did the sec do to investigate the underwriting of the so-called aaa securities that were created from this quote of worthless or near worthless mortgage paper? >> one of the reasons i pointed this out in my written testimony

is to knit together what is a rather long narrative of all of the things that went wrong in the financial crisis and certainly the failure of underwriting standards in the mortgage business is one of them. the sec is obviously not the regulator of mortgage lending nor the enforcer of the standards, but if it is not the case that the collapse of those standards was the cause of the financial crisis, it is certainly must closer to the beginning and i think it is very important that we keep our eye on that ball because even today, albeit the gse's are now under government management, the standards that seem to be extent are very loose and that hazard is still being created. the sec's enforcement role is focused, as you pointed out, in the securities market. and there, the sec has been very active. in 2007 we formed a task force

that at the time that i left the following year we had over 50 active sub-prime investigations going. some of those have resulted in actions last year that are quite well-known. some of them were now while i was chairman. i think it is very very important that the sec continue in this because as we all no, market confidence is in some ways very closely connected to law enforcement. furthermore, as the sec has over half of his people devoted to law enforcement, you can expect that. >> on my time, can i just follow-up and then returned to you on my time? were those enforcement actions against sub-prime originators, who were those? >> they wouldn't be against lenders for lending.

they would be against people from committing securities fraud. >> by any measure, let me be blunt to kind of cut through it. to the sec succeed in this regard are not? >> i think so. >> do you think the fcc succeeded? the securitization market went hog wild then it was underpinned by mortgages that you said in your testimony were inherently flawed. this became a business of hundreds of billions of dollars, trillions of dollars and to suggest that the sec was effective enough that that meant is ludicrous. at a certain point, long answers do not suffice for direct and effective action. >> i think i answered a different question than the one you put because i wouldn't disagree with your assessment that law enforcement generally is not effective to stop the abuses in mortgage lending and the lack of underwriting standards. i simply meant to separate the

sec's role, which is to go after securities fraud and all the rest of law enforcement which includes in some cases banking regulators that are responsible for mortgage lending and enforcing those underwriting standards. the liar loans in all that sort of thing. >> but back on your time, let me take a back. you also have a law-enforcement function. as you said your responsibility was to ascertain whether the securities that were created from these flawed mortgage products were-- met the standards of the securities and exchange commission to the extent that they work rooted in the public marketplace or whatever other authorities you had as the regulator, and it seems to me that that was a complete failure during those years. the fact that you may have started in 06 at 07 and maybe something came out in 08, by that time everything was all over. their head are collapse in

lehman was about to go out the door and everything else was in trouble. >> if i may, just to disagree rather strongly with that. in real time, as you remember the credit markets froze up and that affected him in his old bull markets and auction rate securities. and the fastest action i've ever seen the sec bring we also got the largest settlement by far in the sec history. normally those are measured in millions. these settlements were over $55 billion, money returned to investors in the form of settlements and that is to this day the record for the sec and it was a very significant real-time action that the sec took for the profession -- my protection of bank's. >> taking back of the securities by the underwriting, i understand that and that was good but the mortgages themselves come the residential securities that were created from these loans which you characterize as becoming later

worthless or near worthless, it seems to me those proliferated during many years. without anybody effectively acting against them and i'm not going to just point to you. i think the private sector people who originated them also had responsibility for them. >> i think we are coming to an agreement here because it wasn't obviously securities fraud that cost all of this and to the extent that these were securitized, the disclosure system didn't work. it wasn't sufficiently transparent. i think the sec rules provided a whole lot of information about the securities that the underlying instruments were so complex that the marketplace was unable to effectively appraise the risk of. >> they all appraised at aaa. and they relied on. >> basically they were rated as extraordinarily high levels and of course everybody now knows that they didn't deserve

anywhere near that perception in the marketplace. we just heard from the people at their learned that when they could roll over their money, they could finance it with anything approaching the par they were holding on their books and ultimately that caused enormous liquidity problems and put them out of business and put a number of other people out of business as well. there was a discussion this morning about bear in particular that had to do with naked short selling and i hate to admit that i from time to time actually read rolling stone but there was an article about a month ago now that called into question a particular trade that was placed on bear in which bear was i think at that time trading at something like $60 a share and somebody brought a put $1.7 million to put the shares at $25 or thereabouts, which was

a very unusual trait and then of course there was quite a lot of shortselling in the next 10 days and there was enormous volume in the marketplace and at least i say mr. kaine, if not mr. schwartz suspected that there was some potential nefarious collusion on the part of a the number of people to do it bear if you will on bear stearns. so we had a little discussion about that and of course it turns out that apparently you testified before this committee here in this room regarding that subject that was raised to you at some point and i wonder if you might comment on what the sec did to look into that because so far at least, it appears that is not in resolve. >> 's b.s., as i mention we had many investigations well over 50 of them at the time that i left focused on these related areas and one of the areas that was of great significance was market

manipulation. when i was chairman we set the record for the highest number of market manipulation enforcement actions. this is a big area of focus in one of the pathbreaking actions we brought involved intentional spreading of false rumors. in the market crisis, given the scale of it, it was so large obviously that is an environment that is ripe for that kind of fraud and manipulation. it could potentially spread a false rumor that someone might believe it so investigating at least as many as was humanly possible of those claims in real time was a very important focus for the sec. i know that the way that those investigations work, ultimately you have to prove your case in court, so it takes a while to develop the evidence and i can't as a former chairman to tell you what the inventory is at the sec right now but i would not be sent prized if there were not ongoing investigations even now in those areas.

>> to you need more time? >> just a moment or so. >> thank you. this was with regard to the particular allegation of naked short selling at bear and lehman. i don't know if you had any recollection of that because i know you gave assurances that that would be looked into. >> esn i can give you assurances that immediately it was set upon by the enforcement at the securities and exchange commission. beyond that it would not be appropriate for me to say, if i did no, i don't know the answer to where it stands at the moment. >> that is fine. i guess i did have one quick question to mr. cox and that was one of the things that struck me about your testimony is you are pointing out that bear was permitted to allow internal auditors to audit the risk management system rather than

external auditors which struck me was a major deficiency in the process, and i wondered if you could elaborate just very briefly on that? >> sure. we found in fact that the procedures of the program requires that it be done by external auditors but rather the decision was made to have internal auditors do it and there were questions about how that work was performed. so we recommended that matter be looked at and also be assured that if there is a decision like that that was made to have internal auditors and set of external auditors do the work but at least it would be run by the commission because strictly speaking under the rules we found that it was prohibitive to do it that way. >> of core status sort of follows on to the backs that the cse permitted this supposedly regulated entities to essentially establish their own parameters for capital and liquidity associated with the risk that they perceive so if

they were then also investigating--. >> let's wrap this up because of time. if you request time we will see a few we can do it. mr. hennessey. >> thank you. we heard this morning from the bear executives that bear failed basically because of an act of god or nature and that the firm was solvent and profitable and what brought the firm down was a nun substantiated run which was either a panic or maybe it was caused by nefarious actors out there. what i thought i heard from you and your testimony was that part of the reason why bear failed was because the cse program was not effectively enough implemented and that there actually were problems that-- at bear. my question is not specifically about the cse program that was the run on bear unsubstantiated? was everybody either irrational or nefarious and withdrawing

either their money of customers from bear or their willingness to offer liquidity to bear or where their substantive problems with bear that justified some of the people pulling out? do you pride the executives argument that there was no reason for their firm, no rational reason for their firm to periods rounds? i have one other topic so if you could keep your answers brief. >> we didn't look specifically at that issue but i can say we certainly looked at in hindsight issues that arose that perhaps trading markets could good at st. edward deficiencies and those deficiencies would go against the very of the bear stearns executives that was run by rumors. >> chairman cox. >> picking up where david is leaving off, his report to the

agency, which i was very grateful for and accepted all 26 recommendations from and put into effect immediately was very clear that there was no evidence of any connection between the significant deficiencies that he found in his examination and the cause bear stearns collapse. so the question is a live one, just as you put it. whether or not this is some irrational manifestation of something or why bear? and i think there are several reasons. first, it was the smallest of the investment banks, so if there were going to be a run on one of these firms, it would take place, and if the run were going to be occasioned not only

by people withdrawing their funds but also marketplace activity that would incense that, such as a tax on the firm by people betting against it, it would be easiest to accomplish that in the marketplace with the smallest of the firms so i think that is why bear was first and i think everyone understood after bear that you just go next on the pecking order. even in an efficient market where ripping is rationally priced with business models and so on there was nonetheless, a hornets nest around one firm at a time and i think people understood by the time it all culminated in september that all of them in the end, given that i'll all meant and that was building up, would be vulnerable in that same way. >> let me move on to the other topic. the title of this hearing is about the shadow banking system and there is an implication from that that if only there were

more sunlight, if only people had more information and if only there were tougher regulations none of these problems would have happened. we have heard a lot of specific questions about the cse program, and arguments that affect the cse program needed to be legislatively strengthened. i happen to believe there should be leveraged requirements that are imposed so i buy some of those arguments, but what i am having a tough time and the point that has been raised by others, which is singling out the particular aspect of the cse program as being primary contributing factors to these failures, given that over 200 commercial banks had also failed. so i have no doubt that a stronger cse program or even a more effectively implemented the cse program could have helped. what i am trying to figure out is how does the difference between the cse program and for instance the fdic's greater amount of information and

greater regulatory oversight of the commercial banks help us understand that two of the five investment banks failed and 200 commercial banks failed. it seems to me what we should be thinking about is not just why did bear fail, why did lehman fail and what does that teach us about the cse program but in addition why did washington mutual, wachovia and indymac and 200 other banks fail and is there in some fact some underlying common aspect that is more important between the fdic regime and the cse regime? maybe start with dr. sirri. >> it is the lack of permanency of the operating capital that forced the investment banking firms to fail, with the withdrawal of the funds they need you to the business. it had nothing to do with the cse program in my view. >> okay. dr. sirri?

>> i think the observation you make in the observation wallison made is a good one and that is that it is hard to strike causality to the former the regulation, the implementation of the regulatory oversight. i just think the ancillary comment that it is hard to describe the problem to the institutional forum because you saw investment banks, commercial banks, insurance companies, non-bank mortgage originators, all sorts of entities failed. what is common in this case are the instruments. the answer mentor tied tightly to mortgages in some cases to mortgage real estate. that seems to be what was common. i think especially in the regulated entities, the commercial banks and the cse firms in the sense that they were regulated, and maybe a couple of other places, people understood the exposures. they understood the concentrations, talking specifically about their stearns but that was harder to

appreciate was justifying, reconciling with the market was telling you and remember markets aggregate information and the market was sending a particular signal is something that happened that was really outside of what people expected. in this case the movement of those prices. there were a number things like that that happened. we spend a lot of time here talking about the disappearance of security funding. these were scenarios we just didn't plan far. had we gone back in time four years ago, and i said and directed my staff to say we need to run an evaporation of secured funding-- one week of managing firms to that. i think that would have been a a very difficult thing to happen. ex-post, it happened but to go back four years ago and say-- disappears in a week. in all honesty people would have come back and said what are you talking about?

they would not say that today. >> chairman cox. >> i think first, to answer the cse part of your question, that general kotz couldn't have been more clear that the sufficient deficiencies, there was no evidence of. >> mr. chairman i yield the commission or three additional minutes. >> just enough time to hear the answers. >> there was no evidence that caused the crisis so we would then left to answer your question, as you put it, what is it that all of these things have in common, all the commercial banks that you mention that had to be rescued that failed and investment banks and the one thing that they all have in common is that they all used the same regulatory standards. the basel standards in use not only here in the united states the fed and other bank regulators that by bank regulators around the world heavily discount mortgages from

a risk standpoint and a deeply discounted fannie mae and freddie mac paper. and so, to the extent you are worried about mortgage concentration, concentration is baked into the standards and those were the standards, not coincidentally that the sec started has started to put into it cse program and put it in the center of it and it became the background of the cse program. therein lies an explanation not only of what happened to the investment banks but also what happened to all these commercial banks. >> chairman donaldson do you have anything else to add? >> i would just add that in the discussion today about how it seems to look right after bear stearns collapse and how things look now of course we did a report right after bear stearns collapse but we were appropriately judicious in what we said, as chairman cox noted, that we didn't find a specific connection between the failures of the cse program and the

collapse of bear stearns. but to also echo what chairman cox said and one other feature which is in addition to the standards being inappropriate and not useful, what we found in this case was the lack of influence, and the lack of regulatory effect, that it was not aggressive enough oversight that was conducted here in perhaps if one were to look at other situations that they might find that this same lack of aggressive oversight could have been a cause of perhaps more than just matters involving cse and the fcc. >> thank you. ms. murren. >> thank you also being here and i want to pursue that exact line of questioning mr. cox and that is, when you think about the cse program do you think the voluntary nature of the program did not allow the sec to pursue things as aggressively as they might have? >> i think that was a big

factor. today we have heard a lot about how the program was described. dialogue, conversation. we are trying to learn a lot from them, the business decisions that were up to them. at the firm's manager is the way they want to. those were all qualities of the voluntary program. while in our report we did find there were instances where certainly the sec could have been more aggressive in saying as suggested by the chairman earlier, you you were out of the program or to threaten them to be out of the program. nevertheless i do think the voluntary nature of the program is something that was in the minds of all the oversight folks and that had a great effect on how the program was implemented. >> your comments and also your written testimony suggested he felt that there might have been some culture of inaction at the sec and i'm not sure what timeframe you were looking at when he suggests that. do you think that that is still present now because mr. cox would describe a different picture?

how would you assess a two-day? >> we were talking about it in terms of the cse program. so that lack of aggressive oversight may have been reflected in the fact that it was considered a voluntary program. i don't think we would have that same view with respect to other aspects of the sec the chairman cox described nor when he was there, nor now under chairman schapiro. >> if i could, thank you. mr. sirri could you talk a little bit about some technical aspects. i have heard a number of people who have talked to me about a couple of things in a related transparency and disclosure. are there differences in the disclosure requirements for long positions versus short positions and also specifically mutual funds birches-- versus hedge funds and do you think if there are differences, do you think they play a role in some of what has been talked about today with regard to market activities and potential manipulation?

>> let me see if i can be helpful. let's start with hedge funds versus mutual funds. the regime for reporting for mutual funds is very particular because mutual funds are regulated investment companies. there is a particular regime for disclosure about those administered by the investment management. you can find out information about every security that they hold, a listing that will be provided periodically. that kind of information is provided to you at the division of investment management regulatory regime and that is because mutual funds are constantly individual investor products so disclosure is aimed at that. hedge funds are different. hedge funds are not regulated. they are exempt under particular portions of the investment company act. an adviser could be registered and generally is not so there is no regime for disclosure about those positions. they are not required to

periodically report a table saying look here is what we bought and sold. that just doesn't happen so that mutual fund versus hedge funds. you also asked about long and short position. i think it is a good question than the one that we were asked a lot during the time of the 2000 a crisis, something the commission dealt with directly disclosure around especially sure position. i think it depends what instruments you are talking about. i'm going to presume you are talking about equities. your question may have been broader than that to other kinds of instruments. if you were asking about equities than the dominant disclosure is disclosure about during the time the crisis was building up in the disclosure was about long positions, the same periodic reporting regime. short position disclosure or something that the commission is dealt with. it is something that the u.k. is dealing with and something i think there's still a topic of debate.

in the last person of your question as i understood it, did the disclosure regime figure importantly into what we saw happen? i think with respect to this equity disclosure for the mutual funds or here, i am going to say i don't think they were the key issues that were the disclosure this equity positions because what we saw here were issues around fixed income. mortgage instruments or loans of various types that weren't securities. so i don't think they related to that, those types of disclosure issues. >> if i could stop you there because i want to follow-up on that. there a number of companies, whether just constellation energy that would come to mind if you look at what the executives at bear stearns said about the financial sector. there are instances where it appears that because of pressure

on the equity securities and potentially some other debt instruments to that puts companies in in a position where they might go south perhaps not necessarily directly because of the fundamentals and i guess my question is when you have mutual funds you are required to have a certain level of disclosure but you have hedge funds you are not required to disclose at all and furthermore not required to disclose your positions the way you might long positions. does that add to the desire to have a whisper or chatter or manipulation that you might not otherwise have if you were to have those disclosure requirements in place? in other words, why would you not do it? >> it is an issue that we regularly discuss amongst ourselves because it is something you have to think about. and, i think it may be under consideration still by the commission. i have been gone for a bit. look,.

>> aren't the principles the same? >> many of them are but there is a slightly different side. when you have mutual fund disclosures for the benefit of the shareholders who owned a mutual fund, the disclosure you are talking about say for constellation energy is for constellation energy's benefit. if there are a hedge fund holding long compote-- constellation energy or short constellation energy, the concern with respect to mutual funds was for the benefit of the mutual fund shareholders. i spank-- constellation energy was the one example but if i wish to invest in a stock i could very easily go on at grand total up what kind of company i'm keeping so i do think to the extent that part of the job and the mission of the sec is to create a fair marmot where people are able to easily assess the investment they are going to make knowing who is going to sure position on would be an important part of making that investment decision in the same

manner that knowing who has a long position would be. >> i take your point. is good.. the only additional point i would observe about the short positions is they are not held long-term so they may be very short-term but if your point is look, there might be a well-known investor who has a short position and they have had it for nine months or year that might be relevant information to an investor who might like to know that when you made your purchase decision. i take the appoint. >> is a follow-on to the specific example because it has come up several different times. >> do you need more time? >> maybe a minute. is that something that you yourself have had an opportunity to explore is that something that is still in discussion? did you see the previous testimony? the executives from bear stearns talk a lot about a. >> i am sorry. i didn't see that but i caused a sense of it but i can't really-- if you want to explain it to me

i'm happy to answer. >> it is just their particular take on this was there was about market manipulation that was the work and they were naked decision except for the fact that they ended up with a liquidity run. >> i would answer this way. over the period of time we are talking about, 2008, number of senior executive from wall street firms felt there was manipulation often through shortselling. they would say the short sellers have ganged up on us and my response to these people when they called us to say please give specificity, give us a trade, give us a name, something that i would have turned over to so they could pursue it. i had countless conversations and that was the information i relayed straight away to those people and i will tell you not one single time did anything come back to me with enough specificity that i could pass on to a colleague at the commission. >> that is helpful. thank you. >> is born bourne you had a

follow-up question and then mr. taken. >> i wanted to ask about a slightly different topic. during the decade leading up to the financial crisis in 2008, securities firms broadly defined , spent $1.1 billion in federal lobbying expenses and campaign contributions according to data from the center for responsive politics. the financial sector as a whole reportedly spent more than $5 billion for lobbying and campaign contributions during the same. not. i wanted to ask mr. cox and mr. donaldson whether you were aware while you were at the sec of these efforts to exert political influence in washington and whether the

financial services industry was actively lobbying congress concerning the regulatory powers at the sec? mr. donaldson? >> is certainly one is aware of lobbying going on but in terms of the lobbying, if your question is did it affect the operations of the sec, did it affect the decisions that were made, did it affect any of the things that we are supposed to be doing in terms of protecting investors? no. >> that is a law that is applicable to you. whether any changes in the law during your period bear? >> certainly, a perfect example would be the lobbying on hedge funds. the massive lobbying effort going on and it is equally didn't have any affect on the

decision of the commission to both to regulate hedge funds. that was thrown out of a court decision but as far as influencing anybody within the commission or on the commission, i don't think there was any influence coming from that. >> and there were no legislative changes resulting from industry lobbying that you were aware of relating to the fcc. >> in terms of functioning inside the sec? >> or your jurisdiction. >> not that i was aware of. >> mr.. >> i obviously have the unique opportunity to have seen this from three vantage point in washington, from the white house first, then from congress and then from an independent agency. my assessment first is that

there is an enormous amount of lobbying that goes on and because this is all about money, even more so. second, the lobbying almost always takes the form of stopping things from happening when it comes to the sec rather than trying to reverse engineer the whole system and make the sec into something. and so, when i got to be the chairman of the sec and i was in a position to make legislative recommendations such as the ones i outlined earlier concerning ces, concerning the municipal market for example, there was an immediate pushback and a lot of it from the industry that likes things the way it is. i mentioned the municipal market is a multibillion dollar market. there are firms that underwrite all of this debt that like things exactly the way they are now and they don't want to have prospectuses and they don't want to disclose to retail investors as if they were buying a regular

bond, so they will try to stop the. >> thank you. >> i want to thank you everyone on the panel for helping us piece together this very complicated narrative we are going to have to eventually agree on. one of the things that really stands out about today is that again, the bear panel basically said if we look around the investment bank world in particular "wall street journal," we all look the same. we couldn't tell risk differences, couldn't tell where the risks were so when bear went down because of unfounded rumors , where is you mr. sirri said we can clearly identify the concentrations and wrists and expos certainly independent of organizational form, regulatory environments, those exposed to residential and some commercial and cement are the ones who failed and i would suggest that markets really were disciplining bear in particular when things started to happen.

but there is one more piece of interference in the market discipline that came up this morning and i want to get your reactions. yours mr. sirri and mr. as well. mr. schwartz suggested that there was an indirect lender of last resort that would appear before the investment banks have that was commercial banks borrowing from the discount window to the fed in handing the funds over. this was a traditional rural commercial banks played and his role was trying to engineer this and i was wondering if you would comment on whether you felt that that was an expectation on the part of investment banks are whether indeed there was an effort of that type? >> to take your second question first, i have no knowledge that there were sufficient effort in place so i absolutely can't comment on that. to the first part of your question, i think there have been times in the past were commercial banks were used as conduits to address certain

parts of the financial system that had gotten in trouble. for instance the stock market crash of 1987, that was a mechanism that was used in a proportion of the financial. >> your oversight of their liquidity risk in particular, was there an expectation this would be part of the risk? these guys did not show of. >> absolutely not. the mechanism you mentioned, i never once had that discussion with my staff as being part of the management scenario. >> mr. thomas? one quick wrapup question to bring us back home at least to the discussion about the csa program which, i am picking up on things mr. hennessey said. i do think one of the things we will have to consider is the relative performance of different institutions engaged in either similar or diverse practices. at the end of the day the csa program on an objective basis fail because all five institutions either were gobbled up, converted to bank holding

companies or failed. i think i want to ask a specific question because it really does go to the nature of what it was constructed to be, whether was constructed to be an accommodation to the e.u. and the financial institutions or a true regulatory program. in when the program was adopted in the open session, mr. donaldson is that if anything goes wrong it is going to be a big mess. net nazareth who i think she was then director of trading and market assured the commission we have broad discretion and the ability to constrict activity we believe is problematic. i guess this is probably for you mr. sirri as head of that department and i had the opportunity to review what the other commissioners the monthly monitoring reports which i believe when to you, correct? >> vs. >> obviously they identify further discussions and number of risk areas that are occurring at these institutions and

particularly bear. i guess the simple question it is all hindsight that should there have been certain activities that bear that you should have constrained? spiel let me start. i will directly answer your question. one thing that i want to make sure that hasn't come out that much today as something, you asked about why was the program there. an important part of the program was the regulated entities, the broker-dealer. in the drexel burnham world what happened was the regulated and to me -- back mag entity, capital was downstream to the broker-dealer. in the holding company in other parts got in trouble it took down the broker-dealer so the point there is that given we are charged with watching the broker-dealer, comprehensive information about the broker-dealer was not enough. you are not going to do it that way so we needed other information. >> very basically looking at the

whole elephant, whether activities that should have been constrained? >> to have done that-- let's take concentration of mortgages as an example because it seems to be the key issue here. i think what you are asking me is shouldn't we have looked at that mortgage concentration and said, it is too much. rachet babette. i think the answer is, when you asked the question, when you ask a question in august of 2007 are in that timeframe when it just starts to bubble up or maybe a little earlier. at that point it is probably too late. the reason it is too late is the market has started to seize up by then so when you start to see the problem slightly after the fall of the bear stearns hedge funds it is probably too late to shed those positions holy without taking a pretty serious capital hit so you then have to move back in time to ask the question.

let's suppose we move back in time to 2005 perhaps. >> or 2006. whatever time period, was there a time that he saw a serious problem? if you identify them you should have pushed him. >> the october 2006 report that came to me about that highlighted the concentration. the point is though that the thing you have to deal with is, you would have to have a few that was contrary to the view of the entire market. that is, a small group of folks who were smart people doing diligent work. you would have had to take a position i was contrary to the firm, the street on the market. we did not have that level of confidence that we were right. if we did have the level of confidence that we were right, that they knew the mortgage market was going to go down, then we would have taken the position. we would have rounded up the flagpole within the building. that is what i am telling you, as a staff who identified the

concentration, we saw what happened. we didn't sit there and say oh my gosh, these markets are going to head down. it is a bobo. therefore we should do something. we didn't believe that that was the case. >> this raises a very significant-- the corollary to that and them that i will go to the the vice chair. would raise a very significant issue which was what we have heard in a series of hearings and our best investigative work is this is what everyone believe. of course it is not what everyone believe because there were many voices out there saying there is a bubble underway. there are a tremendous amount of sub-prime lending going on in their race to the system but it does seem to me that the people in the system itself didn't have critical eyes. there were are many aconda class around either at the investment banks were at the regulatory entities. there weren't many outside critical voices saying hey, wait a minute. this is a structural issue that

everyone go new" all the people of knowledge were part of a system in which they shared value in information and it turned out to be very limited. >> i think i would answer that in two parts. the first is to say at any moment there are people on both sides of the beat. there are people, there is no question that people at the view that we were in a bubble and these were going to decline. the same time you people who said this is still a strong market. the signs were good and you should concentrate in mortgages. the market bring those two people together at a particular price. what i take away from this is actually when you are regulator needs it in the middle and you look at that it is very hard to second-guess the market. that is a tough judgment to make. if you design a regulatory system that hinges critically upon that, that hinges on the regulator second-guessing market prices, that is a tough thing to do. >> in calibrating the levelers

of risk and the overall-- i agree. very hard to call the top and very hard to call the bottom and i'm generally not good at it. having said all that you can also decide you need to put parameter to round certain activities because the consequences of not doing so, mr. thomas. >> have only just come full circle? that is the brown bag on the table, as it were something? how much is it worth? you have people that are going to be all over the lot. i love it when people say that someone predicted something and they got it right. what about the 872 times they predicted and didn't get it right? at some point the concept of market is the collective wisdom but how can you have wisdom about what is in the brown bag when you can't look in the brown bag to make the decision, which is the whole business about the way in which you handle these new instruments, cdo's, you have to have a structure in exchange so you have some concept. at least other people can look at what is in the brown bag and

come to a conclusion. i just would like to get it out of of the brown bag and on the table so people can make those assumptions. to say there were some people who said that it was going to be bad is not going going to be enough people lined up to offset the people who said it was going to be good so how can you expect the referee to make that kind of a decision? i think it was a lot of people who thought they were smarter than they were dealing with products they had no idea what they were, created by folks in mr. wallison's position who didn't fully understand that they were doing except this was something that was very useful for their particular purposes and there was another agency pushing it for the societal betterment in terms of making sure that everybody was able to possess something which was them mortgage regardless of what conditions there were. speak and i just make one comment?

>> very quick and then we want to adjourn. >> yes, it seems to me that what you are saying is absolutely correct. it seems to me that one solution to that which has been tossed around is, independent systemic risk oversight. somebody who is not in the channels of looking at things from the point of view of their agency and the normal way of looking at it. somebody that has the right to go anywhere. an agency that has the right to to go anywhere and can put two and two together. >> why do you need someone above the fray? by you just get it above the brown bag and set up there and say what it is worth. to me, is the failure of transparency and and the ability to communicate in a market that prices based upon what other people think it is worth. that has been my biggest problem. how in the world that people figure out what they had when they didn't know what it was?

>> thank you very much. anything else from commissioners? thank you all very much for your time. thank you commissioners were hard they work to curb we will be back in this room tomorrow at 9:00 a.m. with secretary paulson. thank you all very much. and current secretary geithner to follow. [inaudible conversations] [inaudible conversations]

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a billion dollars more than this year's budget. next, a senate panel hears from the nih director about that budget request as well as some of the ongoing research at the institute. iowa senator tom harkin shares this 90 minute hearing. >> the senate subcommittee on labor, health and human services appropriations will come to order. i want to start first by welcoming dr. francis collins who of course has appeared before the subcommittee many times over the past 20 years. until now he testified as the director of the national human genome research institute. today, wearing a much different

and bigger hat as director of the entire national institute of health. the fiscal year 10 budget for the genome institute is $516 million. the budget budget for nih as a whole is $31 billion. at least that is where it is right now anyway. we are looking at dad and of course the portfolio as nih director is much larger than the one that dr. collins had at the ng hra are institute. have been known to dr. collins for all these years i can't help proud i am of-- i remember when you first took over at the genome, the genome project. i think it was called the project at that time. 92? 93. i knew i was close. and, and to take data from the project to the complete sequence

he of the human genome was a singular accomplishment and as i said, watching it during that whole time and watching your shepherd that thing through, i tell you, you were in the right place at the right time right now as is director of nih. one of the things, when you think about the issues that confront nih today, what role does biomedical research play in health care reform? how can we capitalize on the human genome project that we completed? how can we do a better job of translating basic research in the field? how can we encourage some of our brightest young minds to enter this field when we have got tight budgets? so we need someone who thinks big to head up nih and that is why we have dr. collins here, because he does think big and he accomplishes big things. so the president's budget for

nih for 2011 calls for a 1 billion-dollar increase over 2010 level for a total of $32 billion. it is about a 3.2% increase which i'm told is the same as the biomedical inflation rate. the fiscal year 2000 level will bring with it a special set of challenges namely how to achieve the softest possible landing for nih after the $10.4 billion appropriated in number cover he acts. that is one area that i hope to explore with dr. collins in our question-and-answer period. i also want to spend some time discussing one of the questions i raised earlier, how we can more effectively translate a six science into treatment and practices that actually improve people's health? i know you have heard me say this many times before dr. collins, that they are is a reason it's called the national institutes of health, not the national institute of basic research. but before we hear from dr. collins i would yield to senator cochran for his opening

statement. >> mr. chairman thank you for conducting this hearing and looking at the budget request for the next fiscal year. that is the national institute of health specifically under the generalship of dr. collins. we appreciate very much your fine leadership and good work not only as a researcher but also to manage and help identify priorities that help this committee decide how much funding we need to place in the different accounts in this bill. it is a very large bill. wish it could be larger but the budget constrains us. within that budget framework we have two identified the highest priorities and your testimony will help us to a better job of that so we appreciate your assistance to the committee and your leadership and your role. thank you. >> thank you senator cochran. i didn't read that before i sat