under which they can do that. that's where we're going to have to go. >> all right, well if there are no further questions, i want to say that again hearkening back to something susan said, which is that we don't really have a whole way of instructing people in the primary care site dirt and innovation, per se. fortunately, a lot of them did it anyway. and we heard some examples of that being discussed just now. i want to thank the final panel for a terrific set of presentations and once again say thank you to all of the authors who contributed to this issue of health affairs, all of the funders who helped make it possible and all of you, our readers and subscribers and others who keep us going and ready and revved up to continue to carry the message about the needed reforms in health care. so thank you to all of you. we enjoyed being with you today. [applause]

[inaudible conversations] [inaudible conversations] >> and current treasury secretary tim geithner on the governments actions taken during the 2008 financial crisis. congress established the 10 member bipartisan commission last year to look into the causes of the 2008 financial collapse. >> good morning. welcome to the second day of hearings by the financial crisis inquiry commission. as the members knowing that the

public know who has been watching us, we have been exploring the shadow banking system in this country and its effect on the financial and economic crisis, which has gripped this nation. we have been focusing on the growth and development of the system and the risk posed by. as we've said before, while there's significant interest obviously and what was done to rescue various financial and the two shines in the midst of financial crisis, the charge of this commission is to examine the causes of the crisis and to explore how risks to the system developed in the first place or could have been done, what should've been done to prevent those risks from coming into being. we have a full day of hearing again today. we are joined first of all this morning by former secretary of the treasury, henry paulson. and really with no further ado, we will begin this hearing, unless mr. vice chairman, and

would like to make an opening statement. >> no, i would like to say that yesterday was useful. today has a real opportunity to be useful. i cannot recall in my four decades in which we have two witnesses, both of whom were former secretaries of the treasury, one who had a background on wall street and one of the major firms in the other secretaries have any position in the federal reserve in new york, so that we get a full understanding based upon our ability to ask questions of both sides of the street, from two different perspired to over a period of time, which is obviously as we now know in retrospect very significant in the history of the united states. and so i look forward to the

testimony. thank you, mr. chairman. >> thank you, mr. vice chairman. and as the vice chairman indicated, will start figuring from former secretary paulson. we will then hear from secretary of the treasury, mr. baker and then we will have a panel later in the afternoon with participants in the shadow banking system from ge capital to timecode to state street bank. with no further ado, mr. paulson, thank you for being here this morning. i like to ask you to stand for what is a customary oath of office they were administered to everyone who appears before us. if you would please raise your hand if they administer the oath. do you solemnly swear or affirm under penalty and perjury that the testimony you're about to provide the commission will be the truth, the whole truth and nothing but the truth to the best of your knowledge? >> idea. >> thank you area much. mr. paulson, we have received your testimony and appreciate very much. a move like to ask you now to -- would like to give you the

opportunity and we'd like to obviously care and oral presentation by you. we passed in consideration of the time that you keep that presentation to no more than 10 minutes. i know you're familiar with testify and appear on the hill, so you probably know there's a light on the box that goes to yellow with one minute, to read when time is out. and if you make sure your microphone, you may commence. >> chairman angelides, vice-chairman thomas and members of the commission, thank you for the opportunity to testify today. i served as secretary of the treasury during the recent financial crisis. i am proud of the work we in government did to save a nation's financial system from collapse and chaos and our economy from disaster. even so, the crisis caused human suffering that simply cannot be measured. the american people deserve and policymakers will benefit from an understanding of the broad

and diverse causes of the crisis. the job of providing that explanation falls to this commission and it is an awesome responsibility. many mistakes were made by all market participants, including financial and diffusion, investors, regulators and the rating agencies as well as by policy makers. most of these are well and importantly policymakers are currently addressed in some major regulatory structure and authority issues that allowed the pre-2007 regulatory structure and authority issues that either, excuse me, policymakers are currently addressing this regulatory structures that either allowed the pre-2007 accesses in our system or made it difficult to address the crisis. nevertheless, a number of the root causes are not being addressed and remain sources of danger to our country. i fully support your important mission and i hope that my

testimony today can assist it. the roots of the financial crisis traced back to several factors, including housing policy to local capital flows, overleveraged financial and to tuitions, for consumer conception and are taken out voting financial regulatory system among many other causes. underlying the crisis was a housing bubble and it is clear that several policy decisions shaped the home mortgage market. access the number could eventually lead to a significant decline in home prices and a surge of loan defaults, which caused tremendous losses in the financial system, triggered a contraction of credit and put many americans quite literally out on the street. these were driven in large part by housing policy. from 1994 until 2006, home mortgage went from an already spectacular 64% of u.s. households to a staggering 69% due to the combined weight of a

number of government policies and programs. fannie mae and freddie mac, the government-sponsored enterprises comprised a central part of the u.s. housing policy. the gse is operated under inherently flawed model of private profit backed by public support, which encourage risky revenue ultimately led to taxpayer bosses. the united states has always encouraged homeownership and rightly so. adults will, stabilizes neighborhoods and creates jobs and promotes economic growth. but it must be pursued responsibly. the right person must be matched to the right house and consequently the right home loan. and in the years before the crisis, we lost that discipline. the overstimulation of the housing market caused by government policy is exacerbated by other problems of that market. subprime mortgages and from accounting for 5% of total mortgages in 1994 to 20% by 2006

tiered consumer protection, including state regulation of mortgage origination was spotty, inconsistent and in some cases nonexistent. speculation on rising home prices lead to increasingly risky loans, including far too many home loans made with no money down. securitization separated originators from the risk of the pocket they originated. they increased predatory lenders and scrupulous vendors pushed increasingly complex mortgages onto unsuspecting borrowers. the result was a housing bubble that eventually burst in a far more spectacular fashion than most previous bubbles. global forces also played a significant role in causing the crisis. imbalances in the world's economies led to massive and destabilizing cross-border capital flows. while other nations say it, americans spent her consumption

in this country is the norm spurred by low interest rates, aided by capital flowing from countries notably china and japan, which have high savings and low shares of domestic consumption. and further encouraged by u.s. tax laws that discourage savings, we are living beyond our means on burrowed money and borrowed time. consumers, businesses and financial institutions all over extended in overleveraged themselves with inevitably disastrous results while her federal and state governments continue to borrow heavily, jeopardizing their long-term fiscal flexibility. our financial institutions including commercial and investment tanks were notable examples of this overleveraged chain. in general, these institutions did not maintain sufficient high-quality capital, which left them unable to observe the significant losses they incurred as a housing bubble burst. many of them did not understand their liquidity position fully.

they held insufficient cash and cash equivalents and instead relied on short-term funding for sources that ran dry as the credit markets contracted. these leverage problems were further exacerbated by lack of transparency, which caused problems in subprime to affect other causes of assets. like a tainted food scare, relatively small batch of deadly products securitize the private mortgages, to fear and panic in the market for many mortgage securitization, driving down the price of assets, which triggered huge losses in severe liquidity problems. derivative contracts, including excessively complex financial products exacerbated the problems. these instruments embedded leverage in the institutions balance sheet along with risks which were so destroyed that at times they were not fully understood the investors, creditors, rating agencies regulators or the management

themselves. very importantly and other financial institutions have woefully liquidity management practices that allow these problems to grow and intensify in a number of cases reading to failure of his two shin. compounding the problems in these financial institutions was a financial regulatory system that was archaic and not loaded. our regulatory framework was built at a different time for a different system and it is not kept pace with the rapid changes. i noted during my time at treasury the enormous gaps in this authority duplication of responsibility and on healthy jurisdictional competition. no single regulator had responsibility for overseeing the stability of the system. the result was regulators were unable to supervise the firms they thought adequately could they do not see the impending systemic problems that progress during the crisis and they did not have the tools to contain all the harms that unfolded as

institutions began to collapse. in march of 2008, this led me to recommend a blueprint for the major reform of our financial regulatory system after a year-long comprehensive review. i will turn out to the specific topics at today's hearing, the shadow banking system from a term that refers to the large capital and credit market outside the traditional banking system to provide credit for municipal governments, corporations and individuals are short intermediate and long-term funding needs. before the crisis, these markets satisfy at least half of the consumer and business credit needs in one of the hallmarks of our advanced and highly developed capital markets. been greatly benefited our nation, spur growth and prosperity at all levels of our economy and they have enabled more people to receive higher education, more people to purchase homes, more people to start new businesses and more people to plan effectively for their children's future.

they have increased consumer choice, stimulated job creation in the latter system to diversify away from a large concentrated inks found in other capital market. but like all activities in the financial side are, these markets were filled by the global access such as regulatory fathers ever be discussed. when the crisis hit, the stresses placed on this expose many of these laws and these flaws turned extended an exasperated some of the effects of the crisis. these problems must be addressed. our financial system cannot move forward without fortifying the weak parts of it infrastructure. in my written testimony, i've address some specific areas of concern and my suggestions for reform. my list is not exhaustive and they're certainly other problem areas in need of scrutiny here at an these problems however, we must make sure that we retain the benefits of the underlying financial innovations.

in our haste to do with the flaws in the non-bank financial system, we should not move ourselves back to a system of consolidated monolithic commercial banks. i'm confident that we can achieve this. thank you and i'd be pleased to answer any questions. >> thank you very much, mr. secretary. we will now commence the questioning by members that we will start with me and the vice chair of the mouth of the members. and i might just say one thing i noted yesterday and that is commissioner born and commissioner holtz-eakin have served as commissioners have done a great job. mr. secretary, by the numbers of questions for you and they really focus on the run-up to the crisis. there's been as i said in my opening remarks about assassination of the bailout, how the financial system was stabilized, but for me and i suspect some other commissioners were the real question is, how

do we come to the point is the only options were either allow the financial system to collapse or to commit trillions of dollars of taxpayer dollars. what i'd like to do to start though this morning is ask you just a couple of questions, with respect to goldman before you became secretary treasury and the and the move on to your wallace treasury secretary. during the time you were the ceo of old men, from january 1, 2004 through june 1, 2006, goldman issued me team synthetic subprime ceos totaling about $8.4 billion. let me first ask you, because this goes to shut a big person goes to the system as a whole. what's your sense, if any -- what's your sense of the value if any of synthetic ceos in our financial system. do they provide any r. benefits for system or are they merely a

device for betting in terms of results of the system. are they backdoor they actually sources that provide capital liquidity to the real economy? >> mr. chairman, a number of times i have said that i believed that we had access to complexity and financial products. and not as i think about it, it's very hard to regulate against innovation. i think one of the things that i've recommended for a number of years now is when i look at some of these complex derivative products, some of these products that regulators make sure that we have a real substantial capital charges against these

products. now, in terms of the deals you are talking about, i don't remember the particulars of those particular products. >> do you think that they provide -- just the core issue, do you think they provide real benefit to the financial system into the economy? the real economy as a whole are they justified that that -- >> i would say that market-making because i think there's been a lot of discussion about market-making. and one of the things i saw. and again, i haven't been in the business for four years. but one of the things i saw was that clients increasingly were asking goldman sachs, other banks to provide capital and to help them manage risk.

and there are just many examples of that. and you know, that business, i think, is a very legitimate business, a very beneficial business. and it needs to be done with very high standards, great integrity and in the way in which you're working for your clients interests. and i was thinking this morning about this hearing and thinking of all the situations were a client, you know, a major sovereign nation that was worried about the prices in oil rising would come to an investment banker look for a way they protect themselves against risk. our airline that was worried about, you know, the prices come in the oil price is going on a sovereign nation would be more concerned about oil prices going

down. so, there are many situations where customers want their investment banks to help them manage risk. and i ain't got a real legitimate function. >> you think it's legitimate that there's no underlying interest, like you mentioned the underlying interest him on this airline company with oil fuel, other entities that may have, you know, a commodity against which they may hedge because they utilize a? >> well, i would say this, i think of all of the times when i was in the business where we employed hedges, i actually think best practice in terms of prudent risk management is firms hedging securities that they have on their balance sheet. i think of underlines of securities where the investment

bankers or bankers needed to take a position which is quite the offering process to make sure there is a stable market. you know, there are -- and there's coming in now, and the housing, there's no reason why that someone who wants to put in a hedge in terms of protecting themselves against housing prices going one way or another shouldn't be able to do so. to me that's a very important function of a market maker. so i think what we want to do is we want to separate the function and the market-making, which needs to be done with a very high standards, not only in terms of compliance with the laws, but doing it in a way which it inspires and keeps client trust and separate that from, you know, from the deities that is not done properly.

and investment banks or banks can make mistakes, commit fraud in a whole variety of areas. but let's focus on the legitimate role that market-making place in the capital market. for that all right, let me ask you a quick question doesn't want to get to the meeting of this. but i want to ask you one quick question since you raised the standards of conduct. no address not so much in the market maker, but obviously i'm not going to refer to a specific case has been lodged by the sec since goldman, but do you get the appropriate when an entity is underwriting a security, that it would contemn earnestly that he can set security on issuance? is that appropriate and proper? >> i would just simply say that any transaction that is done in

a marketplace is got to be done with the highest standards come a fair dealing and disclosures here in now in terms of when you say betting against or shorting as i said i can think of when i was in the business and we sold to charities and the public market. he sold securities as part of an underwriting process. the syndicate or the underwriter had a short position. okay, so betting against the security? that was a legitimate function and it's done to make sure there's a stable market. frankly, everyone of these market-making transactions for many of them, the client or the customer expects the banker to take the other side of the trade and help them manage risk, commit capital. >> and so complete disclosure in your mind is what you think is the elemental. >> i said appropriate disclosure. >> i want to just ask about

this. let me talk about treasury secretary. obviously you know, but the treasury department and the website is responsible for quoted string the financial security of the united states. he rather the president cannot remark brought for the blueprint plan. one of the things i'm trying to get to is what didn't we know am looking forward to the risk of future crisis. we cannot organizational structures, but the real question is are we going to be able to pick up on the warning signs? you note in your bug that there at thursday august 17 meeting a couple months i phuket appointed, where you've indicated that in that meeting, august 17 that my number one concern voiced financial crisis. i was convinced we were due for another disruption. so here's what i want to ask you. soon enough position having come from wall street, by the end of 2006, the leverage ratios that bear stearns have hit 32 to one,

morgan stanley, 36 to one lehman brothers, 34 to one cannot come in for balance sheet management. in the spring of 07, which is obviously a little later than the day when you're at camp david or the ratio of level three assets, liquid assets, assets that are hard to price because there's no discernible market price. a bears fan, their 269% tangible , equity agreement to 43 at coleman 200, morgan stanley 266. the investment banks and just as they said they're not necessarily unique of been growing like weeds are goldman 26% a year compounded annual growth through morgan stanley about 15%, merrill lynch 18%. and as you point out in your testimony, there are warning signs that i found states all over the country trying to fight in early 2000 before you become treasury secretary deceptive and unfair lending. they were preempted by the occ

in 2004 the fbi warns about an epidemic of mortgage fraud. i held this up yesterday. the economist has an article cover called housing pris after the fall, which is sent 2005, the lead of the story says the day of reckoning is closer at hand. it's not going to be pretty. how the current housing boom could decide the course of the entire world economy over the next few years. housing prices are moving up in 2003 at 11% or 2004, 15%. 2005, 15%. you note in your testimony the subprime lending has exploded to be 20% of the market. and by 2006, mortgage debt between 2,002,006 has doubled in this country. we are part more in the six years in mortgage debt than the whole 225 years on this country's history. the assault of the opaque natures are are delivered for this. there's knowledge of a lot of

the events in the markets prefigures my fundamental question, what didn't you another policy make her snow when you came into office, guess my question is what was the missing information that would've allowed both policymakers and corporate leaders to begin to mitigate risk? >> well, mr. chairman, i think with all due respect, i began immediately to work to mitigate risk, that within the confines of the fact that treasury secretary has no direct responsibility for regulating entities for markets. i thought immediately of the huge dp holes and regulatory system. if i took several actions immediately. number one, regular quarterly meeting so regulators could immediately begin sharing information, figuring out how to work together to fill in the gaps. now, there was work done right

away on looking at the margin requirements and the amount of credit between for instance to regulated entities and hedge funds. i can come back to that more later. secondly, i immediately started working with congress to complete regular reform legislation for fannie and freddie, which had been stalled at politics for years. and then i commenced this review, this regulatory review and not of this came the blueprint. it came pressing institution, pressing market participants to strengthen their infrastructure in areas like otc derivatives in areas like that. and then ultimately, we came up with the blueprints. i think we were on it. now, in terms of the access as

you talked about, they are very. you couldn't push a button and have them go away. the battles have been made. we had -- >> was the toothpaste out of the tube at a time to write in your estimation? >> most of the toothpaste was out of the tube and there was -- there really wasn't the proper regulatory apparatus to deal with it. >> of my central question i understand i really had to when you really got to the second. but by the time you arrived, is the information that you need an essentially financial leaders on the table by 2006 because you know we've heard a lot in the series. we've heard a lot about -- we're shocked, were surprised at this

tsunami. it even when a tsunami can see a of time. >> to let me tell you what wasn't clear to me and i think it was clear to very many people, if any when i arrived. and that was the scale and the degree of the problem. and for instance, if you're referring to the book, the president said to me, what will cause the crisis. and i said, i wish i knew. it will be obvious after the fact that no one predicted the russian crisis. now we could see some of the problems and for instance subprime and housing. but no one, at least that i was talking to predicted this massive decline in housing prices throughout the united

states. and when i've asked myself why, why wouldn't people have predicted that? why wouldn't experts have predicted that? and i think it was because we were all looking through the paradigm that we have in this country since world war ii, where residential housing prices have essentially gone up, mortgages were safe investments. ..

people are concerned the levees were weak and hadn't been tested and that is it fair to say there wasn't a plan in place to deal with the crisis that was inevitable? >> it wasn't a plan in place when i arrived. i think we put a plan in place because the only plan on a note to put in place was to get the regulators to get their taking a different approach to the president's working group and with regular meetings we start working immediately and what we thought the issues were going to be and how to respond to them. and so, to get working on -- i believe to this day that the most effective thing anyone has

done either from the time i was there or since i left to deal with housing has been the actions taken with fannie and freddie has been the stem of the decline in the home prices and we started working on that right away. >> i'm going to stop right now. when i close up before you leave i have some very specific questions about fannie and freddie but i want to stop right now to get to the other commissioners. thank you, mr. secretary. >> thank you. that presented a bunch of questions i hadn't planned on in terms of that discussion. but i do want to start off, so with you, mr. psychiatry, at

goldman sachs not for any specific recollection of product, one of the things i am trying to better understand since i don't have any familiarity with the relationships in these institutions on wall street if you ask me about congress i could tell you a whole lot about things people don't normally appreciate resulting decisions including interpersonal relationships, the oil business who gets what and when and how long accommodations which are fundamental to any democracy in terms of quid pro quos and other structures that are there that make the system work. what i don't understand is the relationship between institutions especially in the

so-called shadow banking area because to me it is remarkable that there existed this healthy growing structure based upon very short term financing overnight, and number of institutions doing that so you were sharing the grazing in the pasture yet as it has been indicated in terms of old men with the current ceo and others that you would take opposite sides in terms of market making that was within the institution on a am trying to understand eight relationship between institutions not so much in an institution because clearly if you are the largest you can be on both sides and played various roles by virtue of this size but if you are smaller you may have to be more dependent on others

so it is a business of to what extent was there a symbiotic relationship with other firms not withstanding the are the competitor or was it pretty much predatory and that's one of the reasons the small ones went first? because the wind back to the congressional the simple, i could be fundamentally opposed to someone on one day on an issue and the issue is dispensed with and at the next day we wind up on the same side so one of the things you tell folks when they first come is you can be opposed to somebody but if you are locked in opposition to that individual you will miss a lot of opportunities to actually advance some of the things you are interested in. from your perspective, what was the culture predominantly rex it had to be symbiotic didn't it?

>> i think, mr. vice chairman what you're getting at when you're talking about infrastructure and to talk about secure lending was the repo market and secure lending and let me just talk cool odebolt but because i think it might help. many financial institutions largest traditional investment banks had to rely on wholesale funding for a big part of their funding. it wasn't all deposits. so you have this secure lending creepo market that grows up, which is a very healthy thing because you shouldn't -- you wouldn't want everyone to rely on the banks with wholesale funding. so repo is secure landing and the lender is partly protected during bankruptcy because they are -- their collateral was protected. i think the way you need to think about this and then there is a market where two parties could deal with each other.

there are many sophisticated institutions. some sophisticated, less because sums less sophisticated that want to invest money. some of them are pension funds, money market funds, government, they want to invest money and a safe way to do it would be entered into secure lending arrangements with a wall street firm. they could do that directly or through every custodian administer and handle the collateral and be a try party rico but that is the way that was done. what happened, and here is what i think it's to the question. what happened was this group very quickly. it was no single regulator having a purview of it and no one looking at it being able to get information on the whole thing so it grew topsy-turvy. there was a system that didn't keep up with it, infrastructure

didn't keep up with that, and the participants got sloppy on the credit decisions so it's one thing if i am a money-market fund lending to a bank taking the treasury as collateral. if i am taking mortgage security and i am asking for no margin hair cut that is a sloppy kind of provision. now what happens this says, through excesses' and i would say to the chairman this is something i was not aware of on the issue. i have seen it through one fact so this big market, no regulator looked at it so now when the crisis comes and investors are afraid, there were a number and so they are concerned about bear stearns. if they lose confidence.

then when you say that it's predatory, if someone is afraid and they are afraid about their own institution surviving, then they pull money out or they don't roll over their secure lending. why? because there are certain cash investors that don't know what to do with collateral if they got it. they are just looking at the underlying credit. so, again, this was a shadow market that is a very valuable market that should continue to be a valuable market and needs to be fixed. plaine needs to be fixed so there were mistakes made there by regulators, by a regulatory system, sloppy practices by practitioners and then the biggest sloppy practice of all or the banks and investment banks they didn't mean can add

liquidity cushions. everybody talks about capital. but to me, the biggest lesson i learned out of the crisis was the lack of focus by so many market participants and regulators, the importance of liquidity and you cannot place huge reliance on any short-term overnight market if you don't ask yourself what am i going to do with the market doesn't function as normal how much of the cushioned why have? >> wouldn't every of those institutions go to bed that might not only worrying about themselves but others because they depend upon a kind of short-term -- >> they didn't worry until they did. it's hard to explain this but -- >> i don't think it is all that hard if you use other examples. for example obviously bear stearns to the stuff was likely until they tried to put up the

assets. the only ones they felt comfortable or other people felt comfortable with what treasury. but the idea that an economic model in terms of mortgages in didn't anyone look at how much, what a mortgage was changed between the 50's, 60's and 70's, 80's and now the was significant erosion in any comfort level on how long a mortgage could last given the rules. let me get a quick example i represented a big area, a lot of desert and folks with fraud in the spring when there was enough glass in the desert. we began to see a fairly high less of desert tortoises sophie blm wanted to run an experiment and put styrofoam tortoises in the desert when the sheep were running on the grass to see what kind of introduction there was

so i told them my sheep men would be ready to put their styrofoam sheep out in the desert when the blm was ready to put the styrofoam tortoises so you don't get a decent understanding of relationship. when you rely -- atoll, rating agencies in a minute -- someone getting a aaa rating to a package who was so much different than an earlier package and you rely on that aaa rating at some point doesn't somebody look at the underlying problems? what happened frankly in the desert was the crows as population encroached the crows followed and they would flip them over in the morning and have a warm meal in the evening and until and unless you control the crows you are never going to solve the problem and you're flipping it over every one argues we didn't have a model

that could tell what was happening to the level at which people were operating which brings me to the question when he became secretary of treasury. looking at it from of the narrow perspective but the broad scope were you shocked at the amount of the weight placed on the portfolios on these risky mortgage packages? were you surprised? >> i tell you what surprised me, which is related to your question, that as you said, there was the rating, but a number of the firms, iowa and a number of people talked about it's important that those who underwrite securitizations have some skin in the game hold the some of the securities they underwrite. i think that is important, but where the big problems are more

in number of institutions, two or three institutions that not only did they have spoken in the game, they have half their body in the game because they had huge positions of these outsized positions that were overweighted so even if they were rated aaa. so one of the lessons of this that gets to your point is it is hard for experts, any expert to know anything with certainty. people could have been predicting this crisis for years and could have predicted themselves lost in a lot of money but it's just whole party to tie up a lot of any

institutions' balance sheet on any particular security matter how high the rating is unless it is a u.s. government securities. >> state what happened? the tight money in the mortgage market? because what i am trying to figure out is how could the weight of the securities that were created and supported by the mortgage markets hold on the commercial petrarchan, repo market, auction our securities market? was it that big? >> i was just -- >> i understand what -- >> they serve the paper but to get to doorplate what happened, i think the way to think about this is -- i think this is quite critical. the subprimal by itself was a relatively small relative to the u.s. economy or to the u.s. capital markets and the problem was much bigger.

there are excesses as we talked about in housing and across the markets more broadly. and you used an analogy of the desert i will give you an analogy used a lot there's a lot of dry tinder out there and the driest was subprimal, that is where the fire started but there is a lot of other excess. and that is really what happened and there are a whole lot of things coming together to create this crisis. >> in terms of the rating agencies we have legislation now from the house and senate. are you familiar with that legislation to have an opinion as to whether it is useful directed and effective in dealing with rating agencies? >> i would say in terms of the rating agency piece of this, i agree with one part of the

legislation i think it's controversial to certain people i think no matter how to regulate to the two agencies are regulated, and we need more regulation and disclosure around the rating agencies, i do not like the fact that we have several rating agencies that are enshrined in securities laws and regulatory manuals and so on to read and the ratings are referred to and so i think that's just in a dangerous crunch and i think too many investors and banks and three relied on a reading and i am all for the rating agencies. i think they should be independent rating agencies and should give their advice just

liked equity research houses and i think investors should look at those as one tool but i do not like the fact and i support the legislation that would take reference to the credit ratings of of the securities law. >> the senate would create an office within the sec to admit credit rating agencies' rules and practices. >> i think that is probably good enough. >> the house creates a seven member advisory board for credit rating agencies. >> i haven't really thought about it. >> you could get unanimous. both would require certification that due diligence has been done by someone, but neither one talks about who would pay for it in a structure so again it is going to involve outside of some

regulatory structure. >> i would say this, no matter how you rick healey this it needs more oversight and regulation a matter how you regulate them it will not be flawless. it's hard to believe that anyone in a rating agency is always going to be able to see the issues that others do not. >> i understand that. >> therefore that is what i want to get to that is much more basic than that. i don't want the rating agencies to be held up as a font of all truth and have the ratings be part of our security law. >> my only question left is just out of curiosity how come you didn't put more emphasis on the rating agencies in your testimony? i mean, you mentioned it. >> i thought that this was -- in terms of shadow banking --

>> when you gave an overview at the beginning of your testimony. >> i've written about it quite a bit so i do think the rating agencies made plenty of mistakes. i think they fell into the same paradigm so much of the rest of the world did. they used economic models that didn't foresee what might happen. >> but everybody has used that as an excuse in terms of not knowing the true value of what they held. >> so clearly the rating agencies in terms of -- and i made a number of strong recommendations even before bear stearns went down in the working group about the disclosures that you need to see from the rating agencies and the kind of process the need to run and the regulatory oversight. when i was just trying to get to something more fundamental than that, which as i don't want to

see a situation never again where a whole lot of sophisticated people can just turn and say it's not my fault it was the rating agencies. i want investors and big banks and regulators to be forced to use rating as one tool but to do some of their own work and do some thinking for themselves. >> thank you, mr. secretary. could i ask you would you be willing to respond in writing to other questions the commission might have as we go forward because frankly we are learning as we go. >> of course i just hope he will understand now my staff consists of one assistant. so why no longer have these -- i will respond. >> we will try to write questions that can be answered by one assistant. >> thank you. >> thank you >> thank you very much, chair

angelides and i want to thank you for helping in the investigation. the first area of i wanted to ask about is over-the-counter durham -- derivatives. i fully agree with you that the derivatives are extremely important instruments in managing and hedging risks and they play an invaluable role in that respect. nonetheless, the over-the-counter derivatives markets had grown to more than $680 trillion in fun notional amount by the time of the crisis in the summer of 2008 and it was virtually exempt from federal regulation and oversight because of a statute passed in 2000 the

commodity futures modernization act which have eliminated jurisdiction of the federal agencies over the market. i wanted to ask you whether in your view this regulatory gap played any role. use it in your testimony derivative contracts including excessively complex financial products exacerbated the problem during the financial crisis and i wondered if he would elaborate on that testimony. >> first i think your point is well taken and in a dutch after the german referred to in my book when we had the first conversation with the president about the potential of a credit

crisis and the topic i talked about then was over-the-counter derivatives and this had grown citing the same numbers you cited and i just talked about it being outside of the regulatory review and we just didn't even have at the time the right protocols how they would function in the crisis and, you know, the agreement and there were big backlog as of one book trade so there is a lot of work being done by the fed at that time and i was very supportive and pushing the industry. now, i think that these first of all these products didn't create the crisis but the magnified and exacerbated a and i think not only the way that has been written about a lot in terms of the interpol activity but in terms of masking the rest that is so opaque and complex and

difficult to understand i had certain regulators when my right saying that the system wasn't that leveraged because they were looking at the debt as opposed to what was indicted in the products. the products are hard to understand and so i -- that is why i so strongly believe that you want to press standardization is in all of our interest and so, the way you i think get the simplicity, the complexity just in general is our enemy. you can't -- it's hard to regulate against complexity and innovation. so i think the way you do this as you press everything that is standardized on to an exchange, and the over-the-counter you put through a central clearing house where you have got great oversight and then you have if it is complex you put big

capital charges so you penalize complexity that will help move towards greater standardization and i think that is the right way to deal with it and you are right on in terms of seeing that as a concern. but those people but to say it is a fundamental cause i think are wrong. it's not. it's just something that needs to be fixed and i am hopeful it looks like some of the legislation is on the way to fix it. >> with respect to the remaining over-the-counter markets, assuming regulations are applied that would put standardized contracts on exchange would you advocate more transparency for that market? >> yes. yes. that would solve so much and as you know regulators had no idea. industry participants didn't

know. taking general motors as an example. general motors are outstanding and no one had any idea. credit devah swaps contracts were on general motors funds. >> or who held them or what the exposure was. >> absolutely. so to me, i think fortunately this is now understood by just about everyone. >> let me ask you about the political influence and the power of the financial-services sector industry leading up to the crisis. there are some reports that indicate that the financial sector may have spent as much as $5 billion in lobbying expenses, federal lobbying expenses and campaign contributions and the

decade leading up to the crisis and that in 2007 there were almost 3,000 registered lobbyists and washington who had been hired by the financial sector. i wonder whether some of the regulatory gaps and weaknesses we saw a have been in part at least attributed to this effort to influence federal policy. >> it's interesting. i can't comment as to how it impacted congress. i do know that it is very, very difficult to get anything of that is fundamental, congress of a difficult done in congress without a crisis. but there are a lot of jurisdictional issues.

this is complex stuff. what i saw in terms of regulators by just saw regulators working to try to gather the information. if a man from mars when my right if i had to explain from a man from mars as to how this -- i see you laughing because you know, how this was regulated and why the ots regulated the institution and occ and why there wasn't any regulator that had access to all of the information in the shadow banking market i could have never explained it can't so i have no doubt that this lobbying has an impact but there you would have to talk to other members of the panel closer to the political process than i am. >> well, clearly there were

regulatory gaps or weaknesses in terms of the oversight of the shuttle banking areas don't you agree? >> yes. >> did you think that the effort by the sec to create a consolidated supervise the entity program for the investment bank holding company was a step in the right direction? >> at that time when i was on wall street i did and i thought that the people we worked with the sec were in the highest quality. and when i was in government working with them i thought that they were just some very strong professionals and working very hard and very diligently. so, it was -- i look at it from

that perspective and then i simply say if i get up to 100,000 feet in looking at it i just say we all made mistakes. when you get there are regulatory mistakes over periods of time and clearly from the bankers and the investors and all of the different participants, but i never doubted for a minute that the competence and the professionalism of the regulators and the sec who just in a very short time -- remember, this program for the council debate obligatory program had just recently evolved and then we had the tsunami. >> do you think that going forward it is important to try to eliminate regulatory gaps like those for the shettle

banking? >> here's what i think, i think these big complex financial institutions need to have a sort of uniform approach in having a tough consistent regulation without some being able to find the mix and crannies and then in terms of the château banking, a big reason why i recommended the system across regulator concept was someone needs the authority and the ability to gather all of the information necessary so you can look at these big systemic issues. i do think that a systemic risk regulator is had been in place would have more authority to deal with over-the-counter derivatives much earlier or would have had a curfew to deal with the authority with of the

repo markets. >> so institutions like aig, which was not really overseen effectively. >> at the holding company level that's right. that was an example of an institution that example arbitraged and built itself up by placing the gaps in the system rather than itself. >> well, one of the questions that i have is, and would be interested in your observations on this -- obviously there were problems in supervision, even with bankholding companies in terms of the biggest institutions and today some of those holding companies are even bigger than they were in 2008 because of consolidations and businesses have gone out of business and for other reasons.

are these institutions really capable of effective supervision by different regulators? indeed, are they capable of effective internal management probably your experience at goldman sachs confirm that issue >> i will say this to you. i think that the level of concentration where we have ten big institutions with 60% of the financial assets, this is a dangerous risk. i believe these institutions are necessary, they perform a valuable role. so the way i did ask your question is this. i say first of all we can have better regulation. absolutely no better more consistent, bigger capital

requirements, bigger liquidity requirements but then i come to the conclusion that regulation will never be perfect unless you hypothesize these institutions want to blow themselves up it is hard to believe that some -- the regulators are always going to be the problems they can't find themselves and so there will be -- there will continue to be failures. there have been since the beginning of time since the time we had capital markets institutions have failed. we have had financial crises. that is why i believe in addition to strengthening the regulatory system we need these resolution authorities so that the government has the authority that when a big institution fails to stick and outside of the bankruptcy process and wind it down and in a way you are not saving and propping it up in the current form. the expectation has got to be

that they are liquidated and i know that is complicated but you can train regulators to do that and that's why i am such a big proponent of this concept that these big institutions work with the regulators to create a road map for the liquidation if they do fail. so again, you will never get perfect regulation, but i just don't think the american people are ever going to again want to see if a taxpayer come in and bail out or save these institutions. so when they feel we need a way of liquidating them and in a way which they don't hurt the american people and take the system down. if that come to the -- you are right we can never -- regulation we should strive to make it as good and as effective as we can and to give the regulators the tools they need and the information they need is that they will be right more more

often but then there will be failure we have to figure out how to deal with them so it doesn't hurt everyone else. >> may i have another two minutes? i just want to follow-up with you on specific example. for example, goldman sachs. you are very familiar with what goldman sachs is like and what running it involved. do you think from your experience as the head of a big institution like goldman sachs that it is capable of an orderly wind down in case it gets into financial problems? >> i think that any institution can be wound down. it's complicated over a.

of time. it cannot immediately -- in the middle of a crisis there is no institution the matter with the capitol says if you have to liquidate it right away there is no institution i think the assets will be worth more than the liabilities. so, and again, mauney view is that with any institution there has got to be a way that if they fail you know and the expectation is you will not be propped up under the surgeon forum. they will be broken up and changed and they will be liquidated in a way. and so i believe that can be done. >> thank you. >> thank you, mr. chairman. i think you for joining and i appreciate your testimony. i want to go back to this observation in the book that the crisis was inevitable and ask you does that mean if there hadn't been a housing market crisis to trigger it something

else would have? >> when i said inevitable, what i said in the book is our history in this country and certainly in modern times is a 36, eight, ten years there has been some crisis. we could go starting with the s&l crisis and weekly -- i could just take you through the various, you know, 94, 98 win of the long term -- long-term capital -- russia and asia. so we've had these. so what i saw was excess building in the system. now i could have said the same

thing and in 2004 or 2005 and i would have been wrong in terms of the timing but ultimately you are going to have these. and what i saw and i didn't realize how true it was as if i said to people the difficulty with the interesting thing about the next crisis is we are going to be seen how these complex instruments and some of these private pools of capital and markets away from the traditional financial institutions perform for the first time under stress because there have been a lot of change and so we saw a lot of this perform under stress. so yes i think it is inevitable and as sure as we are sitting here today the next crisis is inevitable and i don't think it is going to happen right away that there will be stresses and

problems in the capitol markets sometime in the future and probably in our lifetimes again and so the key fame is how to have those be relatively small and manageable defense. they will never be small even to those in the middle of the markets dealing with them but so that they are small and manageable to the rest of us in the broader economy. sprick but the signature of this crisis that we have to report on is the housing market? >> yeah. >> you would agree with that? >> yes. >> in the testimony you said there were several policy decisions that shaped the home mortgage market. would be the policy decision? >> well, i think we would need to look at, you know, just look at the weight of the whole series of decisions we made.

you know, the various programs for housing. it's not just frannie and friday but it's fha and the various programs from state programs, it just takes something like the mortgage interest rate deduction. 1 million-dollar mortgage is deductible. is that fair relative to the renters were forgetting about fairness that i can't you have the sum total of so many things pushed housing layup. i would travel all around the world when i was in the capitol markets and other nations would look at us and all that we have homeownership above 60%. we were not satisfied with that. we got it up to 69%. so i just think you need to look at those policies as fundamental causes of the root causes of the crisis. >> and on that list would be the gse, fannie mae and freddie mac?

>> yes. >> in your would you also said after you arrived at the secretary treasury you receive a briefing about the gse and the quote is they were a disaster waiting to happen and that when our staff interviewed you use it to the business line was fundamentally flawed and could you just tell what the falls were in the gse business model and what you thought they were a disaster waiting to happen? >> i sure didn't prevent this is still happening the way it did so i will tell you that. that was a phrase but i used that turned out to be prophetic but i didn't see it quite as clearly as it can about. but in terms of the structure that first of all there were the ambiguities. there was the implicit government support, the congressional charter, and then

the private capital and private profit and the shareholders and compensation model so there was a contradiction there and secondly, this was a situation where the congress presumed to be the regulator. they defined capital. legislatively defined capital. not only the level of capital but what could count as capital. and some things i consider the yes capital, intangibles defined as capital so the regulator was set up to be weakened and not say anything negative about the people that held the job, but they were not given the authority is a normal regulators given, safety and soundness regulator to make judgments about capital. you had a -- dennett the elephant had gotten too big for the tent. it grew and grew and grew and so you had when you looked at all

of the -- it's just hard for people when we throw around these numbers to even comprehend. but you have $5.4 trillion when you look at the securities they ensured and the debt issued. so the danger when you look at the capitol markets, you know, the danger they pose are sort of the unimaginable. we can talk of the failure of any one institution, but the danger posed by lack of confidence and ability of these entities to repay the debt was much greater than that sophie's were big and then i think the part in the book you elude it to had to do with their portfolios. this was a big topic of debate because they would not only guarantee or ensure mortgage pools, they then would take

their funding and body in these mortgages and hold them and they said that this was necessary for the mission to support their market. but as people are explaining to me earnings were coming from that, so and their board had a fiduciary duty to their shareholders. we can talk about the public mission, they could talk about you know, they could testify on the hill about amazing to be committing their housing goals but degette public shareholders and that is where their duty was was to grow their profits, so as i look at that, i never saw much blame to the people that ran those organizations as those that designed the plane we asked them to fly before they fled into the side of the mountain. so it was the wrong structure. >> so, one of the things we heard yesterday was that during the early part of march as bear stearns kim under arrest, agency

securities were no longer accepted as collateral in the overnight repo market and indeed you look back at spreads of fannie and freddie during that period. they are spiking up and showing clear signs of market distrust, so i want you to walk me through that thinking then during the perot when fannie and freddie mac were actually committed to drop the lead from the portfolios and lose the capitol surcharge at a time the market is saying even with the capitol surcharge and when it is on the portfolio they are not very safe. >> it is exactly the opposite of what you said. i had my staff work with them to get them to raise capital, to increase their capital. and so as a result of what we did, fanny brenau and raised $7 billion of capital so there was a net increase in capital.

freddie mac committed to raise capital. it turns out they didn't. they didn't meet their commitment. but to step back that is the sort of specific question yes but to get back more broadly, what had happened was this: they had a credit crisis came mid 2007 and then most of the damage had been done by that point because after that time, mortgage lending virtually can to stop away from fannie and freddie and there was all kind of evidence of really very responsible borrowers and that wanted to buy homes and head of the economic wherewithal but we were having trouble getting mortgage lending and so now fannie and freddie are

essentially the only game in town and so i believe the problem was already baked. they owned the securities and portfolios and they had guaranteed what they guaranteed before the house in bubble had broken or burst and so what we were doing in march of 2008 at the time when we took the action we took with bear stearns we also were trying to increase confidence in these organizations and get them to increase their capital. so again i was pressing many institutions to raise capital. i was talking to the many ceos of institutions and saying i've never seen the ceo of a financial institution lose his job by having too much capital, you know? raise capital when you can raise capital. we press them as i said fannie

raised, but that their commitment and freddie mac didn't. specter got it from the treasury yesterday. if you run the clock forward than knowing what you know about the financial condition i believe you said something to the effect of ravee freddie mac -- fannie mae and freddie mac reform gave a bazooka and you would never have to use and then shortly thereafter they used it. >> i never said never. what i said was when i got this authority i said there was -- that i was asking for unlimited authority. it sounded out publicly to say on a limited so i said on a specified. i wanted to have the maximum amount of authority and i said to the extent of the more authority we have the more

confidence and that is the greatest and that will increase and reduce the likelihood we will have to use it and what happened was with fannie and freddie mac we went to the regulator and didn't have the authority or people to get in and look at it. so it wasn't until we actually got in, okay, and got the authority. we went up -- i was working very hard to get the emergency legislation from congress or get legislation from congress, reform legislation, and then confidence went in these entities and as i said it was a sort of unimaginable risk. so we went and got this emergency authority and then once we got it i was able to -- we had morgan stanley working with treasury as our adviser, we

had occ, we had the fed working with fha looking at these entities and it was only then we were able to get our arms around the scope and magnitude of the capitol problem and then the fact we had these authorities for the first time we could address the problem, we could do something about. we had the authority to put in the capitol and put them into conservatorship so that is sort of the story there. >> i don't know how much time that i wanted to go back and talk about the bear stearns episode itself. i wanted to get your views on whether bear stearns could have been allowed to fail. but we are yesterday -- >> could what? >> be allowed to fail. we heard yesterday -- fully convincing testimony that if the purchase said the expectation that other institutions would

get help and when lehman brothers did go down and that was a shock and surprise to the market so i was wondering if you could give your view particularly about the setting the precedent having seen the intervention with fannie and freddie how you felt about doing that with bear stearns. >> mr. chairman, i give the commissioner five additional minutes. >> okay, i would like to answer that question because in terms of convincing testimony you will never hear convincing testimony from anybody on this who was close to the markets in my judgment. >> i'm giving time to answer, so go. >> here's why would say. first let's look up the timing on this because their stearns was rescued in march, and we got the emergency legislation on fannie and freddie july and you're putting conservatorship in september.

i believe if bear stearns hadn't been rescued and it had failed, the meltdown we begin to see after lehman brothers had gone would have started months earlier and we would have really been in the soup because it would have started now that i look at it with hindsight before fannie and freddie were stabilized. could you just imagine the mess we would have had the? that if their stearns had, there were hundreds of thousands of counterparties that of grout to their collateral and start trying to solve their collateral, drove down prices, create even bigger losses. there was huge fear about the investment-banking model at that time because of the lack of the federal oversight and access to the discount window and so on. so, i think he would have seen other investment banks go very

quickly. now those that make that argument are missing, to me, one fundamental fact that as the chairman said using the expression once the toothpaste out of the tube, once the crisis had been going on for seven months the system was very fragile. you didn't see excessive risk-taking. you didn't see speculation. matter of fact there is a lot of prudent loans that were not being made. investors were even afraid to buy student loan securitizations where the government was behind it. sovereign wealth funds and other foreign buyers would come into morgan stanley, citigroup, merrill lynch but lost a lot of money. people were scared. so it wasn't like people said

they bailed out -- build of bear stearns, now we can go and let lehman brothers be profligate. but losses lehman brothers and a facade was in positions that were already on their balance sheets that were illiquid positions that just had to be marked down as the economy turned down and as home prices dropped. so again, i think he would have had a hard time finding any buyer for any institution if the government -- again, if their stearns failed. >> thank you. one last question. you talked about the investment bank model sort of being in trouble. what we heard yesterday from the sc -- sec is they brought

themselves to the capitol standards and have the liquidity requirements in excess of those required of commercial banks holding companies, that by the standards of regulation they were fine and so my question specifically is is there a real difference in the performance of commercial versus other entities during the crisis with failures across the board? >> i have a bit of a bye is given where i came from, but i will tell you this analytically that i think people from around the leverage ratios and if you had adjusted for accounting differences the fact that investment banks had the discipline of marking securities to market i think that they were at least as well-capitalized as the commercial banks. i believe that the issues that i

think this was a confidence issue. it started -- i think you have a couple of investment banks in barras terms and lehman brothers that had big exposure to the housing market and bear stearns in particular probably wasn't as diversified as some of the others and i think it really comes down to liquidity, management and of liquidity cushions and i think i saw the same lack of liquidity management -- i saw it across-the-board with banks and investment banks. but, so my comment didn't get to the relative strength or weakness. it really got to a concern and lack of confidence. and when the market closes confidence in an entity in the middle of the crisis, it's very hard for that company to continue to exist. >> thank you, mr. secretary.

.. fannie and freddie were the game in town, they were the only game in town but it looks like what is happening here is the portfolio caps are going to be what? i think that happens february 28 so that fannie and freddie will keep lending now into a market

with big headwinds and the deal i think that you and your team are trying to broker, i don't know if that is an accurate characterization, but certainly involved in, involve them continuing to lend and, having their capital surcharge reduced some, in fact instantly reducing their capital by 10% on the promise to raise more capital. is that a fair assessment? >> i would say this. they made a commitment to raise more capital, and fannie. >> fannie and freddie did not live up to the commitment, so there was net more capital raised, and there was a deal, which the regulator and the gse's working with my staff broke heard broke heard, lifting the capital surcharge to raise

capital, and it was, and i just can't say strongly enough it was to raise capital. the other thing i will say, when you are saying blending into headwinds. i object. i think just the opposite. i think what you will find is that the markets-- the markets have declined dramatically in housing prices than they were continuing to decline, so everyone was aware of the issue, and so the losses they had didn't stem-- i am thinking you will find didn't stem from going ahead and doing risky things in here that have to do with what was going on in the housing market, and what had gone on and all of the, all of the loans that they guaranteed before that and put on their balance sheet. >> and, i think we are going to

have to look at this but here is what i wanted to get to the nub of. it is clear there is deep concerns. there is an e-mail march 16 in which ms. steele writes to mr. mud, they need to-- the regulator is not wild about this but interesting also he says i was leaned on very hard by teel-- bill dudley to harden the guarantee. i do not like that and it has not been part of my conversation with anyone else and they view it is a very significant move way above my pay grade. of the day or two before the transaction gets done, lockhart objects by saying this idea strikes me as perverse as i assumed it would seem perverse to the markets that are regulator would agree to eight regulate to increase its high mortgage credit risk, mortgage credit risk leverage without any new capital. i understand that part of this

was to raise more capital but here is my essential question. you have deep doubts and i'm just trying to get a sense of how you saw the markets in march bear had just been acquired that there was a rescue involved because the fed is involved. at this point, in a sense you are striking a deal that allows them to stay in the market. you have deep concerns about solvency. is there a view at that point that look, we are now in the business of a bailout. does the bailout started in march or do you generally believe things are going to write themselves? >> neither one. didn't believe things were going to write themselves in the bailout did not start in march. i just cannot say it clearer, and more definitively. this was about getting them to raise capital. that is what this was about. and guess what? it did. fannie made $7 billion in capital. freddie committed to me-- raise capital and later their lawyer said well we need to wait until

the second quarter numbers are out and buy the times the second quarter numbers are out, we had gone and gotten the emergency legislation, but this was solely about raising capital. because what we were dealing with, we were dealing with a situation where the markets are on the edge. they were the only game in town, and i was pressing-- this was not unique to them. we were pressing financial institutions to raise capital, and to me it was an unimaginable risk that these things closed. i had no idea that we would need to go at that time to congress and get these authorities, and i had no idea we could have gotten those authorities because remember, i had seen congress-- fannie and freddie were a political football like you

wouldn't believe. i had seen reform stymied for years and we were working to try to get the kind of authorities we needed. so i had no idea that we were going to need to get the authorities, get the authorities we got, which led is given with the real experts to get their arms around the problem, and then get the tools we needed to address the problem. so, working with the limited tools we had without being the regulator for fannie or freddie, we press them to raise capital and i think that was the right thing and i think it was a sign of confidence when they announced it and then when they went and fannie raise capital. >> at some point, given your one staff person, i would like to follow-up a little on this but i think there is a bigger objective here which is also trying to understand as markets are wobbling, this kind of dichotomy i think you faced and maybe, and i want to move on to

other members, between trying to stabilize the markets versus also acknowledging publicly the state in which they are in, but let me do this. >> well, obviously, it just simply say this. what you need to recognize, and i will say this been answered in writing an answer at the same way, that treasury is not the regulator. we didn't have the authority and we didn't have the people. we didn't have the capacity to really get in there. so, what we were doing was pressing them to raise capital. it was only when the markets lost confidence in we needed to get these authorities that we have the tools to get in there and get our arms around the problem. >> thank you. >> thank you mr. chairman and

thank you mr. secretary. i would like to ask three questions that relate to lessons learned, as you say, this is not going to be the final financial crisis that this country is going to have. one of those relates to a continuation of the bear stearns story and that is, when you face the issue of lehman brothers, you are in addition to dealing with lehman, you were establishing a principle which was that bear was not a precedent for all future similar circumstances, that you were not going to rally the federal government to the salvation of every institution. what were the factors that caused you to make a case-by-case decision that lehman was not worthy of a

federal assist the transition? >> thank you for asking that question, because despite the fact i have written a book and answer this hundreds of times, people tend still, despite the fact that we have had an in bernanke and tim geithner say the same things, people still question us on this a lot because it is hard to understand but, the fact is that bear faced a liquidity in the capital problem and we were very fortunate to have a buyer in jpmorgan to come in and solve the capital problem and be able to guarantee bear's trading books during the shareholder vote. so, and we learned there that the government limited our

authorities. no one have the authority to guarantee investment banks liabilities or two putting capital, and so we didn't have resolution authority. after that, i made a number of speeches where i talked about the need for this. lehman came along. we unfortunately were unable to get any bank to play the role of lehman that jpmorgan played on bear, and so we tried very hard to do that, and we were left frankly powerless. and, so they-- be prepared you know, for the bankruptcy. so this was not something we did intentionally. and it was just, we just had a

flawed regulatory system and powers. >> the second area is conditionality of funds to financial institutions through t.a.r.p. or other bailout practices. in contrast to what seems to be the perception of the u.s., where there were relatively few requirements in the united kingdom for instance, the royal bank of scotland was required to accept certain conditions as to what it's lending practices with the, limitations on dividends and compensation. why were there not similar conditions attached to the bailout of u.s. financial institutions? >> this is a totally different program. we did not want to be dealing with institutions as they

serially failed, as they did in the u.k.. we diagnose the problem of being a bid capital shortfall in the banking sector, and so we designed a program that would be attractive to healthy banks so that they would want to come in and voluntarily participate, and we put in preferred, which is passive. and designed so that the government would get the money back. and so, that was the whole purpose of the program and you know interestingly enough, i was hopeful when we announced it, we had a couple thousand banks that would participate, two or 3000, but right after we announced it,

and we had critics start saying you have got to force them to lend. they didn't say how much or how you are going to make them wonder what the government would do. you have to control their compensation understandably and then understandably another of the bank said wow i'm not sure we like this deal so we had a good number of banks apply for t.a.r.p., get accepted and then pull back, and we had about 700, not quite take the money and it was a big success because it prevented the collapse in the government is going to get their money back with a profit. but i think if it hadn't been stigmatized by all those that wanted to put the various controls on it, that we would have had two or 3000 banks that would have had the money for three to five years and that would have been far more than any stimulus could've gotten the economy going again, but again, i think some of those who say the program didn't work because

there wasn't enough landing where those people that stigmatized it. so, again we were trying to deal with healthy banks and make it voluntarily, and, so we weren't trying to nationalize banks like the british government had done, and we were tired of dealing with them serially when they failed. >> there was a public perception that one of the justifications of this was to stimulate the economy by making credit available. >> guest. >> and there was disappointment when there were perceptions that that wasn't happening. speak you are absolutely right. and of course that was our whole reason and i didn't make this point. i should have. the whole reason for designing the program was so many banks would take it, would have the capital and that would lead to lending. that was the whole purpose. but, in a funny way, as soon as

we announced it, before the first banks ever got the capital people were saying they can lend. why aren't they lending more? of course now if you are a bank, you really want this deal. how is big brother going to help you step in and tell you how to make these lending decisions? so, i think what happened was then, some banks were reticent to take the capital. now i think it did help in that did help lending but it could've been much more effective. >> is what you are saying that banks didn't want to take the capital which would put them in the position to be more effective contributing to the economy because they felt that they would be under external pressure to do that? >> that is right. i think a number of banks did so we had almost 700 banks take it, but i think even those banks

rush to pay it back. because of the extent to which they were stigmatized, and so i think banks were understandably concerned. so you have this paradox. people wanted them to lend more, but by clamoring for somehow or other there to be strings attached. i was never quite sure how much people wanted the banks to lend, more they would land in the middle of the crisis during the excesses, or you know, how much lending, what was the right level and how was the government going to determine that? clearly this was about landing and getting that banks the the capital they needed so that they could lend. speak that i have two minutes? the third question relates to a topic that you have alluded to and that is the role of congress

you said that congress had their ears such as its tendency to wait until the crisis had occurred before acting and then some of the jurisdictional restraints on dealing comprehensively with problems. from your experience in the executive branch, trying to influence congress to be more proactive and to be more comprehensive in its response, do you have any recommendations of what the executive branch could do to facilitate congress being a more effective partner or what congress ought to do within its own domain to enhance its contribution? >> i can say my own experience with congress was very positive, because twice i needed to go to congress with extraordinary request and twice they reacted before disaster struck.

and, democrats and republicans. guy, like a lot of a lot of people, i don't like partisanship, but i saw people on both sides of the aisle come together. i think in terms of how to solve the issue, you can get some experts appear that are more equipped than i am to deal with that question. >> thank you mr. chairman. >> thank you. senator wallison. >> it is good for you to be here. i appreciated very much. we all do. i would like to follow up on some of the questions my colleague, ms. holtz-eakin had talked about, the rescue of bear stearns, because to me this was one of the most consequential decisions that has ever been made by your government. i think there is a substantial

argument that gave rise to moral hazard that made lehman collapse much more significant than it otherwise would have been, if it would have occurred at all. and i want to point out that for example, once bear stearns was rescued, it certainly encouraged women to keep its price somewhat higher than it might otherwise have been in dealing with potential acquirers because on the other side, lehman had a reasonable expectation that it might also be rescued, and i think the chairman of lehman indicated that in some of the testimony he is given to congress in the past. in addition, creditors of lehman such as the reserve fund that caused so much difficulty would probably have rid themselves of the commercial paper that they were holding that would immediately have lost value if lehman had actually been allowed to fail, and so when lehman did

fail, they were stuck with this commercial paper and of course as you remember, that particular money market fund, reserve fund, actually broke the buck and there was a run on money market funds, so the consequences of rescuing lehman, in terms of its moral hazard were quite significant. so, i would like if i can, just to follow up your reasoning a little bit more carefully. if i may just make a couple of other points. yesterday we heard from offices and former offices of their stearns in from chairman cox of the sec, and we learned, i was surprised to learn, that bear stearns was actually solvent at the time that it was rescued. is it not actually be, insolvent , at least according to chairman cox and according to

those former officers of the company. and, so the first question i would like to ask you is whether you were aware that there was in fact a solvent company. now i understand it was a liquidity problem but were you aware that you were dealing, when you got bear to be rescued, that you are dealing with a solvent company? >> i think that is almost a ridiculous statement. we were told on thursday night that bear was going to file for bankruptcy friday morning if we did not act, so how does a solvent company filed for bankruptcy? when institutions, financial institutions die, they die quickly. it is a liquidity crisis. they die because the market loses confidence.

when they die, i don't care what someone has got on their books, okay? assets are not worth more than liabilities so make no mistake about it, we were told the jig is up, we are filing for bankruptcy tomorrow morning and do you know what? and at the time, we almost found out whether your hypothesis was right, because at jpmorgan and -- had emerged there was nothing that was going to be done here. that is your first question. >> now i would say that companies can file for bankruptcy even when they are solvent if they are illiquid because one of the definitions of bankruptcy is you cannot pay europe of nations as they come do. it not simply being legally insolvent. >> this is a.

>> the point is, i just want to be sure that we are talking about the possibility that we could rescue firms that are in fact insolvent. now, the officers of bear stearns we talked to an chairman cox, although chairman cox was not speaking as chairman of the sec, both said they did not think that bear stearns was too big to fail, and if it had failed, it would have caused-- they did not believe it would have caused the kind of disruption that we normally consider is necessary to rescue an institution that is too big to fail. why did you think that there bear was too big to fail? >> first first of all i don't take moral hazard lightly. if bear stearns, if this had happened at a time-- this

occurred at a time when the credit crisis had been underway for seven months and the system was very fragile. secondly, we didn't have the tools as i said, to wind down outside of a bankruptcy process. so, what i saw in the marketplace was a market gripped with fear and that bear was not the cause, that bear was a symptom of a fear and panic in the market and of this broader problem of illiquidity. so, as they said to you, i believe that, if bear had failed, that there were all sorts of counterparties which would have grabbed their

collateral, sold it, would have led to bigger losses and the bigger write-downs. for instance, your comment about a reserve fund holding lehman papers, yeah, darned right. if bear had gone down the reserve fund would not have held the lehman paper and neither would have any other fund or many of them. so, just would have triggered it quicker. you would have had lehman going i think almost immediately if bear had gone, the whole process would have started earlier. >> if that is true, then how could you not have rescued lehman under those circumstances, because what you are saying is that you had implied that you were going to rescue everybody else for the same reason. there was fear in the market. >> we looked at every one of these in their own circumstances but we tried hard to come up

with a solution for lehman, very hard. again, if there had been a buyer for lehman like there was for bear, we would have done the same thing. >> let me just turn the questioning to one other.if i can ask you a question on a different subject. you said that the sub-prime mortgages were relatively a small part of the problem, although they were a triggering element i think in your view of this. are you aware that there are views that the number of sub-prime and all day mortgages are let-- much more than the 20%. as much as half of all mortgages by 2008, as much as half for sub-prime and thus were ready to fail, when the bubble that we

were experiencing began to flatten out. >> if you had known that at the time, would your view about what was likely to happen or the importance of sub-prime mortgages have been different? >> first of all, i don't know that but i don't-- i think the big question and i think where you and i agree is that housing policy and housing was a big issue here that we dealt with. as i look at the problem, there were excesses throughout the market but it was housing policy and mortgages more generally. so i am not as focused on-- i think sub-prime was, was obviously one of the most egregious excesses that took

place and i have no doubt. people use this e. coli example or mad cow disease that first came for me and treasury and we used it in the book. i do think that it is a good example, because there was so much uncertainty about that. it infected securitizations in terms of the way investors were concerned. it was a big concern but i'm not sure that that would have made a big difference. >> let me tell you why i think it is significant to think about it in these terms and that is why we have had questions here. yesterday and we might have some further wants to be. that is, both regulated banks, which are heavily regulated, as you know, and investment banks failed and roughly the same circumstances. there were runs an effect on both confidence was lost in

both. so the question really is, if there were circumstances that were so severe coming out of some event, which seems unprecedented, at least in the last 70 years, wasn't it a significant fact that there was no way that our regulatory system could have prevented or did prevent the loss of not only among banks, but also among regulated real banks? >> i take your point. the fact is, this event is-- it is hard i think to, to go back in history and find any event

that was more extraordinary in terms of the extent of the crisis, the magnitude of some of the things that were witnessed here. and so, i think your thesis is, has got a lot of truth to it. >> thank you. >> mr. georgiou. >> thank you mr. chairman and thank you mr. paulson for joining us here today. i want to turn to a portion of your testimony with which i agree, and i would like to highlighted if i could. go on page 4 of your testimony on securitization, you say, because securitization separated mortgage originators and underwriters from holding the risk of the loan they originate it enabled sub-prime lenders to stop focusing on the

creditworthiness of the loans they made and instead focus solely on their ability to focus on those upstream to underwriters. underwriters in terms relax their reliability to sell their securities into a booming market. you want to save reforms are in reforms are in question will be required. better disclosure is necessary, underwriters and originator should be required to retain some portion of what they sell requiring underwriters to keep some skin in the game will properly aligned their incentives with those of investors who end up holding the bulk of the risk. ..

amount of money in light of the capitalization of a lot of the institutions that had to write down this paper. and yesterday wind james kaine and alan schwartz, the last two ceos of bear stearns testified, i asked them when they fall of the idea of requiring investment bankers to hold, take some of their fees and at show securities they create what it that might enhance the diligence and align the interests of the investors more closely with those of the underwriters. and of course they both said the sound like a great idea but

mr. kaine said, you know, they are not going to like it. [laughter] about the investment bankers. so, and i just want to hearken back to your successor at goldman sachs who i asked a similar question of back at the first hearing in january and he said well we could take those securities that then we would do ase hedge them and essentially not, you know, not effectively have the exposure to lead and of course i said well, the whole idea would be to be long, so that in your underwriting obligations when you are representing to investors these would be sound investments you would actually be side-by-side with them in the long haul. so, all of which is to lead me to a question which i really think there's more on your experience at goldman sachs and on the street generally them at the treasury of the secretary. how could such a motion be implemented in light of the

different responsibilities that investment banks have enough least three of their rolls? one is an underwriter in which they undertake to have a fiduciary duty to investors and represent that a security they are selling is not just the right to sell that to our actually represent it will perform as represented. member to come as a market maker which is essentially what mr. mr. blank line was asking for a long or short or hedge their positions in various respects and third, as proprietary traders investing for their own account. and the reason i say that, and i would like your thoughts on this regard, is if people were required to hold those securities, number-one, how would you enforce them holding them and staying long on not hedging them, and is that

realistic in light of the differential obligations of these investment banks? >> that's a very good question. and a lot of people have recommended what i recommend and its recommendation is short of the policy and short on how you would implement it, and i will tell you it is difficult to implement for the reasons you suggested. but on what -- and i think your question has got the way the you need to think about it because i think a market making function is not really what we are talking about here. if the bank is in the marketplace and it has a client that wants to sell or once a banker that can be capital and help manage risk that's one

situation. so it is an underwriter and i don't know that i even have a problem and i probably need to think about this some more, but even as an underwriter, putting a hid john, again, the hedge if it is structured probably you could have a hedge against for instance mortgage market of all so this particular security you're going to perform better, right? because you had such a good due diligence and so i -- the only caveat is you would want some skin in the game and i made the comment earlier but you don't want to much because actually those firms, some of them that got in the most problem were those that kept an extraordinary amount of the paper they had

underwritten which was the aaa and we were hoping to the cold and so much of the balance sheet they almost killed because of it. islamic that is what jon said. i asked him what they ought to eat their own cooking and he said they choked on the own cookie is what he said and they got stock on those security books but that wasn't his intention, his intention was to originated and distribute them but he wasn't able to sell them all. >> that's right. so what we are talking about here, i'm not talking about some of the different prudent risk management. i don't think we ever want to ask financially institutions to do things that is not going to end of prudent risk management, but there has got to be a way as you underwrite separate from that there is some piece of what

you have under it tend to continue to have to live with and on. >> live with even as long as the securities intended to produce. and maybe the bonus is paid to the people who did the deal with and were responsible for the diligence ought to be part of the securities they created. one of the thoughts is many people suggested here the fact that underwriters were paid exclusively in cash, the credit rating agencies were paid exclusively in cash, mortgage brokers exclusively in cash when the issue was sold and it didn't have any -- didn't retain any risk for the failure to perform as projected was the problem -- i'm sorry could i have two minutes more? thank you. >> i would think the formulaic compensation just in general is

a problem and particularly paying any cash makes the problem greater -- >> not saying to the eckert paying in cash. sprick formulaic and then paying in cash is another problem because again, i strongly believe women looking at compensation it's important to wine in interest and for there to be a long tail on that compensation so as you say those that underwrite the securities, however it is done is an important part of the compensation should be how well they do their job and how well they do their job is going to be the quality of the job not just a short-term profit. >> and i think it also has a beneficial one pact of aligning their interest with investors to

purchase it and avoiding, being on the opposite side. i wonder if i could ask you in the last few seconds i have here to reflect a little upon this question and maybe you could respond in writing if you come up with any thoughts from your longtime experience of the street how this might work because this might be an element i think that many people are looking for a solution to that could improve diligence and improve the quality of the paper sold which could avoid the problem going on for work in the future. >> wixom ratings it is easier to discuss in 100,000 feet and figured out how to implement. i will give it more thought. >> thank you mr. psychiatry and for your service. >> we will keep that assistant of yours busy. [laughter] >> can i have just a minute? i give myself a minute of my own

time. there are some of us on this commission who are admitted mauney economists said there is a jargon that is used which we sometimes have to translate. >> i will join you in that. >> i'm also an admitted non-attorney so there is a whole lot of things i'm admitted on but in trying to understand both in terms of the château banking system and the point that mr. wallsten makes so about the supply and alt-a mortgage packages, i think most people would understand interconnectedness that you have five men claiming a mountain road together and one falls and pulls the other forward with him but conti agenda and colman shock that our terms being used

for a little more for me difficult to sparse. when you use the e coli example, my argument is coming from the agriculture background that if you told me that the package of spending which was an actual case you would go ahead and eat lettuce and don't have to worry about getting e coli because it is this the message and then the common shock would be that everybody had it, so where do you place the mortgage packages? did sifry buddy have them and that pulled everybody down and then all of the other assets became devalued? >> here's what happened and i will try to explain this in simple terms. >> i can usually handle complex terms. >> this will be you can handle very complex terms. anybody that has led the tax

code knows. but what happened was there are these very complicated securities that are hard to understand. people bought them on a reading and so they knew there were problems in the subprimal and so once the problem occurred, then there was anything that even looks like securitization in the mortgage area or complexity caused people to pull back because they said -- and wasn't a matter of pricing, it became illiquid that is why the people like, if it was reduced -- if there was a big concern about these and was reduced to the price of hamburger or people wouldn't buy it if they were scared. >> but what about the plea for a simple? of bear stearns could say and we were not very begin subprimal

then they were not big in alt-a. >> what happens then is people said investors became concerned even if there was a likelihood. so what happened is when one asset class becomes a liquid no one can sell it. then what happens people run to sell another asset class and so they go to to sell the mortgages that are saleable and pretty soon those become illiquid because everyone is trying to sell them and everyone is sitting around the same risk control table to solve the same thing and all of the buyers are in the hospital, so -- -- it is contingent robert and common stock. >> because illiquid, you try to sell something that becomes a liquid because it can't be sold so then securities that shouldn't be related, you know, they are not supposed to be correlated become correlate it because they are what everyone

else tries to sell. >> bear stearns of the and said the only thing they could deal with treasurys. >> well, i would just simply say that counterparties in the repo market lost confidence in bear stearns and they are unable to borrow against certain securities. >> notwithstanding the fact others had the same? >> there were others and this was a loss of confidence. others were experiencing similar problems but not nearly the same extent. this was focused on bear stearns. but let me also say to you that lending practices were sloppy in the borrowing practices. it's one thing if i want to repo a treasury. if i am repo a mortgage security

and you are giving me 100% of the value of lending not asking for a hair cut that is sloppy and so what happened was there was the assumption you could keep borrowing at full value on these securities when they were dropping in value. >> i have to ask my colleague and add to the economist and sloppy is a term. >> mr. hennessy. >> thank you, mr. chairman. well i would like to ask you to do is focus on three specific failures. i guess for if we package fannie together. we were talking about why they failed but instead what i would like to ask is for you to explain your thinking about scenarios you feel might happen if they were not built or rescued. so bear stearns, freddie and fanny and aig.

because as i understand, the scenarios that might have happened if the firms had failed or somewhat different and particularly thinking about counterparties. with the bear stearns it is like what you're describing was if there was the slowest stealing and the lions got it than they might fall prey to the lions whereas there were other scenarios that stood for what would happen to the system if fannie and freddie happened or if aig have been periods can you compare and contrast? >> i have to really be very careful here because with what i know today in terms of what i knew then. so with bear stearns what i knew then i wasn't -- i knew enough to know the system was fragile

and that there were so many unknowns in terms of the counterparties that this was a very dangerous risk and prudent risk to take to have them go down. but i know today is that what was waiting for us in terms of fannie and freddie, which i did not know then, and how severe the overall situation was, so but there is no doubt that -- bear stearns was the kind of firm i believe it had gone down like a directional during a more normal market as opposed to one where there is a huge stress and fragility and what i saw beneath the surface throughout the institutions of europe and the u.s. caused me concern.

you mentioned fannie and freddie. that is a different order of magnitude because i said that is an unimaginable risk to me and if there had been a loss of confidence that they didn't have the ability to pay back their securities and there was 3.7 trillion held in the u.s. and 1.7 trillion of side of the u.s. and they just float through the financial markets almost like water. liquid securities considered to be. so that was -- a big disruption there. the world wouldn't have confidence and ability to deal with this. >> what you are describing are two different things. with a bear stearns if they feel it's not other people would be holding the securities and that would push them under. it's that the same problem that affected bear stearns might affect another firm. estimate it started a chain

reaction. >> but fannie and freddie what you are describing is there were actual firms that held the debt on the balance sheet and fannie and freddie's collapse would have caused problems -- >> yes, but it's more than that. it is the whole felt that something of this magnitude that was chartered by the united states of america would be in the housing bauble but we were not going to stand behind that. why would any institution be safe? and then you talk about lehman brothers -- minnick actually it was about aig. >> aig, okay. well, aig's is an order of

magnitude because of obviously lehman brothers or bear stearns. it was one that we knew the least about because there was no one regulator that had a clear line of sight so we knew the least about it. we knew that it was huge in terms of the size and interconnectedness' and the swaps were counterparties. it is an example of reading. i have a, you know, the danger of the triple a rating and again, liquidity. many people injured in contracts with them without getting normal margin because they were aaa. they entered into contracts where they would have to post collateral of there was a

downgrade. how we make sure we have the liquidity to deal. and then of course you touch so many individuals because they guarantee to get contracts and other retirement plans for teachers and the health care workers and others so you get tons of millions of americans there and, you know the insurance. so again, you know, it is like lehman brothers squared. >> yesterday, a different topic, yesterday, consistently from the bear stearns executives we heard non-specific hypothesis that was in citing the panic that there were -- there were actors out

there who were actively trying to bring bear stearns down to make money. you hear this crop up all lot but you never hear anyone actually name the names and say here is why i think it is the hitting strategically. i will not ask you to name names but do you think that there were persons out there who were trying to bring down their restaurants or any of these other firms. >> i do. i think that where there is smoke there is fire, number one and it was among the loss of confidence i believe in short-selling as essential for the price process in the u.s. but i don't use the word close of because it has a legal connotation. but i would say that when ucc real attacks largest industry

overall but serial attacks and of the easiest trade to short the stock and credit to be false swaps to do that and to see it go from wolfpack trying to pull down to a dealer. so i'm not saying that there is behavior that was illegal that it was something i wanted and i sure that they were to investigate if they found something that was illegally collusive for manipulative they would have acted or they would have acted. but i do think that like so many things we had wolf's that were there to service between the which at times like this we need to take actions with regard to

short selling and i think those are the thinking about circuit breakers or ways of addressing short selling during times of crisis or a stock moves too far or best things to do and i do think there are -- it sure looked to me like some kind of coordinated action. >> thank you. >> thank you. ms. murren. >> thank you, mr. secretary for spending so much time talking about these important issues. i would like to talk to you actually about a fundamental assumption people seem to have and i would like to challenge you and get your response. people often say that financial innovation is a great thing. it's important, it is necessary and service important purpose but when i think about innovation i think about cancer research, technology, and it seems to me that when you look at financial innovation over the

last decade you have in bs, indios that all of these seem to have led to a common lack of understanding about the instruments themselves both on the selling side of it on the buying side of it it could extend all the dumb to mortgage products that have become increasingly complex yet they don't seem to protect the people that would use these kind of innovations to protect themselves against the natural business exposure. they do not seem to have strengthened the u.s. economy and help the real economy at all. but really what it served to do is enrich the intermediaries throughout this process to create a lot of unpredictability and volatility which leads us to where we are. so i guess if that do you believe that financial innovation beyond a certain point is a positive thing? >> no, i don't. but here's the problem. we get to the problem we were talking about earlier is how to

deal with this because there is no doubt in my mind that a lot of innovation has been good. the fact that we have strong markets, efficient markets away from the banks that i think the concept of securitization is a good one and when used properly it is great. i think the repo markets are but they have had excessive innovation and complexity and i think particularly excess of complexity is a problem in a lot of places even with companies bringing up new products you learn you can only -- you are bound to have mistakes that are more difficult or complex and of course the kind of complexity these financial products it is a

real problem and the only way i can think to practically deal with that it is a very difficult to write the rules that say you can do this and you can't do that so i think the regulators should be pushing towards the standardization and i think the right way to deal with it is with capital charges and big capital charges. if something is and, you know, transparency. a sliding toward transparency disclosure, capital and penalized complexity with capital churches. >> thank you. i will want to follow on that issue of transparency in particular looking at a conversation we were just having about indirectly about hedge funds and their behavior within the market and one of the salient moments for bear stearns was when the hedge fund

operations declared they were insolvent i guess. when you think about the hedge fund surrounding the crisis there was a fair degree of lack of transparency in that regard. do you think these are entities should be included in what you describe which is the regime that more adequately discloses not only the positions but also perhaps the motivation of the various players in the markets? >> it's interesting as we focus on hedge funds early on in the president's working group and one of the first things we did was all but the relationships between the prime brokers and the big banks and the hedge funds and make sure the regulated institutions had capital on margin and as it turns out this wasn't where the problem occurred. i think the work was good because it didn't have the problem the problem was under our nose and the regulated

entities and we were focused on the citizen conduct. we were focused on the hedge funds. but having said that, i recommended that in the print we put out that the hedge funds that were big and complex enough to be systemically important and chartered and have that regulation and i am all for that. so i do think that is important. >> thank you. one final question, one of the things striking to me talking to everyone we talked to so far is there haven't been any one yet his admitted they've made mistakes and the whole thing they would do differently i know that you've said that from 10,000 or 100,000 feet everybody makes a mistake. i would wonder if he would like to be the first to that reflect what mistakes you would have

made in the crisis? >> there's a good number of mistakes because the -- i think my mistakes were primarily communication mistakes and i hardly know where to begin their because let's start with of the t.a.r.p. because when we send the out plan to congress which should have had a press conference that said this is not take it or leave it or complete, this is a starting place for negotiations. i was never able to explain the american people in a way in which they understood why these rescues were for them and for their benefit not for wall street, never, ever to make that connection and the rescue today remains very unpopular. i think the things that are

generally pointed out as mistakes that we made our in most cases situations like lehman brothers where we didn't have the authority and in looking for 100,000 feet i think the major decisions we made 2020 hindsight it's easy to say this working with the in perfect tools and authorities or the right ones. i look back on those and i think they were the right ones but along the way, there were plenty of mistakes made by everyone and i wish i communicated better a lot of the time. >> when you look around the other people involved in this could you give me the the top two or three mistakes made it that might have made a difference in this? >> i think the understanding of liquidity. i can't say that over and over

enough's. it's so easy to look at the capitol. capital is a number and it is, you know whether it is 8% or 10%, you have to look at that in relation to the overall balance sheet and so when you find a bank taking a prime brokerage account taking of the securities and using them to finance itself overnight but then making 30 day or 60 day loan to the prime brokers of the prime broker sticks securities out you can't finance yourself overnight but you still got the 30 day loan. i wonder how people do those things and so i think those liquidity and understanding of liquidity and then other than that i really believe despite we could talk about all the

mistakes the bankers made and rating agencies make and i think this committee if you don't get the root causes of these we will be sitting down with some other committee in years and will be worse because they will still be those mistakes and different market participants but still have a root cause, which is we better change the housing policy and we better restructure and scale back and shrink the mission of fannie and freddie at the minimum and we better do some things with five tax policy and some discourage over borrowing. so again, that would be my two cents' worth. >> thank you. >> mr. secretary, thank you. one technical matter. i'm sorry, two minutes? benign have a very click close. spread i wanted to follow on something important that vice

chairman thomas talked about issue of common shock and liquidity. this seems to me the significant fact is that because the big losses on the sub prime and the alt-a loans as you know the mortgage securities market came to a halt basically in 2007. that is they couldn't buy a or sell the mortgage backed securities, ceos and so forth but they basically this meant it seems to me the the national institutions couldn't sell a substantial portion of their assets and they can largely illiquid and in fact they had to lay down some of their assets because the rules for accounting for that reason the institutions look like they were on unstable or insolvent. they were certainly illiquid and it's in important as you point also the regulation of banks and investment banks simply couldn't cope with that.

this is the disappearance of another asset class it was no longer there. there was no market and i would like your reaction as a person familiar with markets. islamic there was no real liquidity problems. that makes it hard to value assets. i know the view of the mark to market accounting and i know there are a number of thoughtful people that blame the market economy, fair value accounting. i am not one of them. in other words i believe the problems would have been worse without it. i believe if more financial institutions had the mark to market accounting they wouldn't have built up to the point they built up. it would have been more apparent. and i frankly don't know how you run an institution if you don't have the discipline of having to

mark the assets and put a value on them rather than the historical value continually. so again i am a proponent and i think -- and i had people during the crisis say i've got an idea. let's stop the mark to market accounting and the problem will go away and of course that would have scared investors. interested wanted visibility and transparency that again i understand your view and i spent a lot of time talking about this with thoughtful people and there is no doubt that during the crisis, marked to market accounting extention we did the issues. >> i shouldn't have mentioned mark to market accounting. i just wanted to clarify i was talking about the lack of liquidity that came from the fact people couldn't value their assets any more. there was no market for their assets. >> there was not a market or a market they wanted to accept.

>> thank you. i just wanted to dig down and the weeds into failures and or your opinion on what happened. the rebel market failed dramatically and we talked about that. but something that also failed was the sort of traditional role of the commercial banks as a conduit to investment banks in particular bear stearns went for $30 billion to jpmorgan who knew them and knew their collateral and was not able in the crisis to have that loan and take place and this is related to the remarks made by the officers of bear stearns who said that one of the things that went on in the past is when things got bad ticket go to the commercial banks who had a lender of last resort and the mechanism was available to the in elyria the difficulties. what went wrong in this crisis if that didn't happen? >> i think you need to expect any crisis if it is fair enough that an institution is going to do what it takes to preserve

itself and not overexposed to credit risk. and i think that, you know, tim geithner her you will be talking about plater can tell you more than i can about the try party repo market. but remember how that works. you've got the custodian banks and after there's a big time during the day when they almost administered convenience for collateral during the crisis they were the ones that handled all of the -- they own the rest and there was an uncomfortable spot for them to be in and an uncomfortable spot for an institution on the other side to be so dependent on one or another institution but i don't -- i can't comment beyond that

simply saying that it is difficult at the time when everyone is worried about markets to asked the institutions to extend a line of credit when the confidence koza i ron started. >> thank you. >> just one technical matter. i referenced might begin the questioning from documents provided us by goldman sachs with respect to the cbo's. i would like to enter to pages from goldman sachs and one from the senate subcommittee on the investigations and the page compiled by amoore own staff from the author goldman documents just for clarity. just very quickly mr. secretary because it has been mauling at me. when paul revere solve a lantern one of by land to a spicy he jumped on the course and said the british are coming and i

referred earlier to this kind of dilemma you may have faced. why is it that in 2007 no one from the public and financial leadership settled up like paul revere and warned about the coming crisis? >> in 2007 my no one -- i think a lot of people's all excess. but remember we had a the markets for some time and why is it that almost any bubble becomes obvious after the fact and they all have certain things in common when you look at them they all have -- usually of the

nine markets, there is almost always excess risk taking not a lot of transparency but here i think that many people knew there excesses' and i think that there were few of us. i certainly didn't but saul something of the magnitude we saw. it's pretty hard to predict the 800 years storm. >> even as late as 2007? you were worried -- were you worried about shaking the market? >> i would say in late 2007i think we do the markets for fragile but in late 2007i think

that on, and i've said this a number of times before, on a was concerned as anyone out around me and i underestimated in of late 2007 and in the early 2008 by ander estimated. i underestimated the magnitude and the scale of what we are dealing with. it is just so big. really almost every step of the week. now i look back and i see what i would have done different, but this was -- as i think that today it is hard to imagine what we are going through. it keeps me -- i don't like to think about it. >> i know the vice chair would like to make a comment but i am going to put him close. i want to thank you for coming today. we probably could ask you more questions but we are going to take 15 minutes for lunch after the vice chair makes his closing

remarks. thank you mr. secretary. >> i think some of the problem might have been you were flying at 100,000 feet. edwards air force base was in my district the entire time i was in congress and when pilots got into the exodus scheme and flew above 50,000 feet thick of astronaut wings. so i suggest you are right about 50,000 then you have to have a little better picture of what was going on. >> good point. >> thank you for a much for coming. we really, really appreciate the ability to cross sections with one person and trying to get a better understanding of what happened. both government and private sector. thank you. >> thank you. >> thank you. we will to a 15 minute recess, commission members. so we have got to move fast. [inaudible conversations]

>> the meeting of the financial crisis team commission will come back to order. welcome, mr. secretary. thank you for joining today. we appreciate you joining us midway into days of hearing about the shettle banking system. but joseph starts as we do with all witnesses. i'm going to ask if he would stand to be sworn for the oath. if you please stand and raise your right hand. do you solemnly swear or affirm under penalty of perjury the testimony you're about to provide the commission will be the truth, the whole truth and nothing but the truth to the best of your knowledge? >> [inaudible] >> good. i know you've been to the hill a few times and no the microphones and lights mean that in this instance we appreciate having received your written testimony,

and we would like to afford you the opportunity and we would like the benefit of an oral presentation by you this morning at one minute the yellow light will go on and at the time up, the red light we would like to ask you to give the presentation of up to ten minutes and then we will move to the commissioner questions. thank you. >> thank you mr. chairman, mr. vice chairman and members of the commission. thanks for me to be a good chance of having to do. during the job of sifting through the wreckage of the crisis so that we can better understand the cause and how to present a recurrence and i recognize the chance to be part of that effort. the senate took an important step yesterday passing with overwhelming bipartisan support reform to prevent future financial bailout. this is a necessary but not sufficient steps to make the financial system more stable. as the debate now shifts the design of the consumer protection oversight of the

derivatives markets and other issues, the votes ahead are very important. and within the context of this hearing i want to emphasize a central tragic lesson of the crisis. we cannot create a more stable financial system by carving out certain types of financial institutions or activities from these reforms. if we do we will only make the system less stable. if we do, we will only allow once again burns in the business of providing credit to ease keep the necessary protection that we need for consumers and businesses against predation abuse and excessive risk. we have to create a strong set of rules that no institution can he state. in the aftermath of the great persian the united states put in place broad protections over the financial systems that laid the foundation for a more stable banking industry for several decades. but over time this financial system and outgrew those protections. over time the constraints imposed by banking regulations

encouraged activity to move away from the banking sector in search of weak regulation and the promise of the returns. and over time a large parallel banking system took root out side of the regulatory banks. in the parallel system a diverse group of financial institutions were allowed to engage and the business of banking providing financial services to individuals and companies without being regulated as banks. at the peak this financial system financed about $8 trillion in assets, becoming almost as large as the traditional banking system. and much of the system used the substantial leverage with relatively thin cushions against the possibility of loss. the parallel financial system operating with much real protections proved exceptionally vulnerable to the loss of confidence as the crisis intensified investors began to pull back and demand more collateral in the system to sell

assets to meet the demand for cash pushing the price of assets down leading to a vicious cycle of panic. that brought was a classic run on the financial system brought us to the brink of collapse and the economy faced a credible risk of injuring a second great depression. now, many people call the parallel system in shadow banking system but it wasn't hidden away. it operated in broad daylight financed by institutional investors with the history, system with no history or reasonable expectations of governor support in a crisis. instead in many ways the system of secure failure of market discipline. so why did protection put in place following the great russian protect us against the growth of risk in the system? first i what is it possible is we entered a long period by relative economic financial

stability during which the investors took on more and more risk. trillions of dollars of the financial decisions were made in the u.s. and around the world all the expectations that house prices would never fall. the rescissions would be short and shallow and systemic financial crises in the developed markets were a thing of the past and the world economy would continue to grow. those judgments proved tragically optimistic and ultimately the protections put in place about the traditional banking system didn't provide sufficient shock absorbers to have a deep recession and a substantial fall in the real-estate values. but part of the cause lies in the bullpen last fragmented regulatory system designed in a different era that lags far behind changes in the financial markets. the government's system of the financial oversight was simply not designed to constrain the risk-taking in this parallel financial system. credential regulations were

limited to the banks. the federal reserve had no legal authority to set and enforce capital requirements on a major institutions to operate essentially banking businesses outside of the bank holding companies. the fed also had no legal authority over the investment bank's diversified institutions like the aig for hundreds of small and big financial finance companies. yet as you know no legal authority to set and forced capital requirements on a consolidated basis across the full range of activities across investment banks. more broadly this is more critical no regulator or supervisor of the core system taking action to prevent the diversion of activity away from the protections regulations designed to provide. the result was a system of the applied a safety and soundness regulation only to the banks was unable to protect the safety and the civility of the broad financial system.

addressing these failures is the essentials part of the comprehensive reform now being considered by congress. these reforms would require enforcement of tough constraints on leverage and risk-taking across the major institutions that played a critical part in causing the crisis. financial institutions will no longer be able to ease keep these limits. large and complex global financial institutions will be forced to operate with higher capital and more stable funding reflecting the greater risk they pose to the economy as a whole. these reforms will bring derivative markets out of the dark and provide transparency and disclosure and comprehensive oversight over all derivatives markets and all participants in those markets. and we will bring standardized data to disk into the central clearing houses and stock trading facilities reducing the risk that the derivative market could again threaten the system. these reforms will provide more stability and funding markets to reform the funds to make them less vulnerable to run and take

the repo markets more resilient. the reforms will help improve the disclosure and accounting requirements reducing opportunities for each asian and giving investors better tools for the rest. they will address the rating agencies and reducible our ability of the systems to the future mistakes in the credit ratings and they will provide a carefully designed type of bankruptcy process for large financial institutions so that we can break them up with no risk of loss to the tax payer and less risk to the economy as a whole. i know when people look back at the crisis and a look at the excess of risks we are taking by large institutions, there is a natural inclination to want to move the risky activities elsewhere. to create stability, some argue, we should simply separate banks from prescott. but important ways dreading risk-taking into areas with less regulation that is exactly what caused this crisis. the fundamental lesson of the parallel financial system is

that we cannot make the economy safe by taking functions the central to the business of banking. functions necessary to help create capital for businesses and help businesses hedge risks and move them outside of the bank's outside of the strong regulations. mr. chairman of the close by thanking the commission for your work in drawing public attention to one of what i think was the key factors in this crisis and one of the most important objectives of financial reform. thank you. >> thank you, secretary geithner tebeau we will begin the questioning. what we start with to stick to questions and as i said to former secretary paulson today at least in my instance while there has been a lot of fascination generally with the bailout and how the financial system was stabilized i think the questions i want to focus on today is how do we come to the point where it seems like the only two options were either to allow the collapse of the financial system or to commit

substantial trillions of dollars of taxpayers' money to save it and i do want to talk to you in your was the president of the federal reserve board of new york recognizing you had direct supervising responsibilities of the bank holding companies but beyond that in many respects to the eyes and ears of the federal reserve on wall street. you were in constant contact with primary dealers who had a board that did have linkages, to the financial community and that you would play a special role in the monitoring system crist infected had undertaken efforts of respect to cleaning up the backlog and trade confirmations in the otc derivatives market. one of the things i noted in preparing the last month for our look at the shadow bank system and that in the period of 2004, 2005, 2006 you actually made a number of speeches about risks that were expanded under the sand contagions, shadow banking. i will notice you made to different speeches on the same

day. may 19th must have been a busy day talking about risk. about concentration risk posed by the cbo's and creditor of this and leverage in the system. and it seems to me that you were in a place where you had extraordinary access to information not just market data that primary dealers are telling you information on the repo market so this is a pretty fundamental question i have particularly as we look forward trying to assess the impact what didn't you know. and this doesn't need to just be at home and in but what did you and other key policymakers know and have before you to understand the magnitude of what might hit us? microphone on. spec what we start by saying i have spent my previous 15 years in public service dealing with a series of incredibly damaging emerging-market financial crises and financial crisis in japan. when i went to the new york fed,

i've been blessed or scarred by the experience of watching the country's management mismanaged the development of risk and systems and how to clean up and contain the damage in the aftermath and when i went to the new york fed, early in the process beginning in 2004, we began a series of three important initiatives to try to contain donald back reduced we saw growing in the system and reduce the odds that if the conditions change with a shock recession the the system was going to be stronger and the position withstand the shock. let me mention the three most important things we did in that context. the first was to bring a serious of experts in market and risk management led by debate could together to a comprehensive examination of the state of risk management practice managing the things that have been the subject of this crisis. risk in derivatives, exposure to

hedge funds, complex financial products, help liquidity is manage and stress testing is conducted and using a model of a process pretty much like you are doing which is a sort of post mortem process after the failure of long-term capital management. we brought the group together at my initiative and asked them to do a comprehensive evaluation and provide recommendations to get it and we took the recommendations and we asked the major firms in the world to undertake this assessment of how they were doing against those recommendations. second, very important thing we did is to bring financial supervisors of all of the major defeat to major global firms. the ftc, the british fsa, their counterparts together to conduct a series what we call horizontal review to try to assess limitations and risk-management and try to encourage people to fix the problems of risk-management early and those

targeted very much like what i began with risks and derivatives in the lending to hedge funds and management of liquidity conducting stress testing. and those efforts were designed to assess what was the practice where there were gaps and try to bring all of them to get around the world to encourage beginning at that point and 05, 06, 07 to try to get firms that buy all that the reason they were taking and to mention the one thing you mentioned we need and a similar effort to start to clean up the derivatives markets and standardization of a automation pave the way to achieving these reforms to bring this out of the dark on to the clearinghouses so we can manage the risk better. now, as you know, those efforts were in the end fundamentally inadequate. they did not do enough's enough and they d