there is complicated reasons i would be happy to discuss in part because we were operating within a set of existing capital requirements. this didn't adequately captured the risk the system had through the possibility of a deep recession. so i think the simplest way to answer the question about what do we not know -- what we did not know was the degree to which the system was reliant on ratings, ratings the did not capture with the falling house prices would do across the system. we did not know the extent to which the parallel financial system had built up leverage and exposure to liquidity risks that level then when it came crashing down would threaten the stability of the rest of the system. we did not know how vulnerable the money markets were to run and how unstable the basic funding structure was and i can go on. ..

you had this enormous growth and leverage, and liquidity risk in a large power for financial system. those were related, and people could not assess because they had no experience what would happen when you had a run on that system.

so the oversight system when they talked about-- as i said in my remarks, did not establish a set of classic restraints on leverage on what came to be a large part of the american financial system. and people tried with duct tape and string, like the ftc did in their regime, to take the authority to make the best of it and tried to get to a point where they were trying to put in place better constraints but that effort came too late and it was too weak and it was not grounded in law and it was fundamentally inadequate. >> so let me ask this, and that is, given you had spoken on this and you have actually identified what you sober levels of risk in some might say levels of the responsibility, you saw those two trains of risk in your responsibility going towards you, towards collision. do you believe that you are others in leadership sounded the

alarm early enough and loud enough? >> mr. chairman chairman i said this always. absolutely we could have done more. absolutely. and people ask, it is inevitable, were brief fundamentally powerless as a country to prevent this from building up? i do not believe we were powerless. i think it is unfair to say it is the benefit of hindsight, but i would say if the government of the united states had moved more quickly to put in place better designed risk-taking that captured where there was risk in the system, then this would have been less severe that the government had moved more quickly to contain the damage i think the crisis would have been less severe as well. >> let me talk about that in the last two days i cited a number of market warnings that i won't repeat today from the dramatic expansion of mortgage in this country to the explosion of sub-prime lending, the efforts of states that were printed by the occ to fight fair deceptive

lending, and just look him and i was a person in real estate investment on the ground, 50% annual increases in home prices so a lot of warning signs out there. clearly, one of the things you have identified is the lack of a structural barrel bureau plea to move on these problems but i want to assess and i really thought about it as we have gone through a set of hearings. do you also think that the system doesn't have enough iconoclast synod, that the decision-making process is unduly controlled but by people who were of the financial system and close to it and am able to step away from it in the way you need for true risk assessment? and of course i think there are variations of this all the way from people may be on wall street who can say what is happening in bakersfield and sacramento on the ground to families, to people who just don't have enough distance to make a critical analysis that you would want and expect? >> i think that is a very good question.

and i try always, i have always done this to my job and i tried it in the new york fed to make sure that we brought together people and advisory committees we established that represented a great diversity of views in these things from the academic community, from the broader business community and we put in place a series of advisory committees that try to capture that diversity of interests and perspectives, because they think what you said is so important. and i think it is very important for policymakers to make sure that they force themselves to be exposed to a wide diversity of views. fundamentally i don't think i was a problem. i think the problem was that you did not have a centralized accountability matched with authority anywhere in the government to look across the system, try to identify where we had a problem and have the

capacity to go in and act preemptively to try to put in place measures that might mitigate those risks. our system was fundamentally balkanized. you had people crawling over parts of the system, and parts that were very risky with nobody looking at it and nobody responsible and nobody in charge, and that was a tragic failure for the country as a whole. it was an avoidable failure believe. it is easy to say that in hindsight but it was true what you said come at the time anybody who was operating in that world could see that, you are seeing classic signs of an active price credit bubble that could prove very catastrophic, and the way i sought mr. chairman was that we have this huge wave of changes in finance capacity to hedge other things that helped disperse risk that look like they produced a more stable system. they look like they reduce the probability of the major financial crisis, but they also

comment this was essential to what happened, if we were to face a major financial crisis, it could be much more damaging and much harder to manage because it was likely to take place in starred as it did, in the parallel system where there was much more leverage and liquidity risk, derivative markets complicated it dramatically and you did not have in place tools they are to try to contain the damage earlier and that is really the story of the crisis. >> many of those signals i was talking about were not just market data by looking at leverage ratios, liquidity risk than those firms that were evident. two very quick, specific questions because i want to move onto other commissioners about point in time because one of the things i think we are trying to do is also measure what people saw at different points. so, very quickly in and i raised this with secretary paulson today. there was some engagement as you know between the secretary and

fannie, freddie, ofheo. i think the list of portfolio caps keep them in the marketplace as the part private market is totally withdrawn. the only reason i mention it is there is a reference and i don't expect you to know this e-mail but i'm looking for the bigger picture here of bob steele. he was involved in these negotiations. he says i leaned on very hard by bill dudley the hardened substantially guarantee. i do not like that. not the part of my conversation with anyone else in my view that is a significant move way above my pay grade to double size u.s. dead in one fell swoop. what i'm driving at is in march, that bear weekend were you worried about something of the magnitude that ultimately happened september happening in march? >> absolutely. i think we all were. i think secretary paulson was. at that time, as bear stearns fell off the cliff, we were deeply worried about what that would do to the broader

stability of the financial system and we knew at that point that fannie and freddie, like many other parts faced substantial losses on their particular their retained mortgage portfolio, and we worked very hard to encourage their relevant authority to encourage those firms to go out and raise a lot of capital. as we were doing in other parts of the system, and seemed the straightforward sensible thing. and, that was important because, as we saw fundamentally, short capital going to a storm like this was catastrophic and they were short capital. the problem with these crises is people tend to weight. if they wait too long it looks weak. the pricing is expensive. they don't want to dilute their shareholders so they keep the bass sick pay down-- basic

pattern that fannie and freddie had then we worked very hard to try to encourage people, to encourage them to raise capital. >> were you for hardening the guarantee at that point? >> i often use the argument that you need to make it more credible to the world. they are going to have the financial resources to meet their commitment. you can do that lots of different ways than one is by making sure they raise more capital and the other is to strength in what was an implicit commitment at that point for the government to stand behind them, and ultimately of course that was-- both were necessary and i was fully supportive of the judgment of the need to do that. >> the final question for you. later in the day we will have a panel of g. m. pimco recipients. it appears from documents that we have, that ge was able to keep its, going with this sichuan subs commercial paper throughout this crisis even though of course the general

spread over libor increase for all participants, but at some level, a disruption in the credit capacity of ge speaks volumes about the death of what we are seeing, so on september 29 and 30th, you had six telephone conversations. just to put that in context, you probably didn't get any sleep these days but the 27th and 20th was the day that goldman and morgan stanley became bank holding companies, that we can. on monday the 29th, that is the day the dow dropped 770-point. after the house voted down the financial bailout bill. was mr. al mao speaking to you about concerns about disruption in their ability to issue paper? >> at that point, after that famous mutual fund money market fund broke the buck in the wake of lehman's failure had abroad base run on money market funds and you had a broad base run on

commercial paper markets, so you take the prospect of some of the largest companies in the world, in the united states, losing the capacity to fund those commercial paper markets. so we were involved at that time in designing what ultimately became the commercial paper which was the backstop for the commercial paper market to complement the temporary guarantee for money market funds, so i was involved in a whole range of efforts to help decide that facility. and i was exposed to and had conversations with people across the financial market who depended on commercial paper markets, who were trying to make sure we were aware of what was happening and how perilous it was. you didn't need a phonecall to tell you that. all you needed to do was look at what was happening and it was developing it and self evident to all of us at the time. >> with the concerns

specifically about that and talk to you about that? >> i can go back and try to refresh my memory but what i'm sure they were about and making sure we were aware of how perilous they thought even a company that strong, how perilous those markets were at that time but as i said, that was self-evident. it was obvious conspicuous and you could see it in just looking at your screen. >> i don't expect you to carry your daily planner with you but if you would check on that because we are trying to get a measure of the intensity and direct concerns by different market persists as months. if you would check the 29th and the 30th. that is all of my questions at that point mr. vice chairman. >> thank you mr. chairman. mr. secretary, i do really appreciate your willingness to come before us, but the manner in which you have done so. i am very sensitive to structure and protocol, having been around a long time but our ability to

talk to secretary paulson and the value of his having been on wall street in the private sector, and then becoming secretary of the treasury, followed by your presence, which had you at the federal reserve just prior to coming to the secretary of the treasury, i noted also both of you went to dartmouth. i don't know what that means with all these harvard guys around, but i appreciate that. it gives us an opportunity to ask questions, which bridge that 2000-- 2000 to 22,003 to 2009 window in a way i don't think we have ever been able to do that. so, when i ask you this question, especially specially based upon your comments about what you did at the new york fed and bringing together experts for for the state of risk management and then running a global confab with the subject

matter. most people can't see this, and it is the only thing i have available right now but basically it is the access of selected financial sectors, and it shows the blue obviously are the deposits of the bank, and this is the shadow banking above it. and it is a federal reserve board of funds flow release, so it was around and people were aware of that. when you run the numbers, and this is all 2008, you have this, the commercial banks at about 7.3 trillion, the so-called shadow bank similar between 7.1 and 7.3. so i mean a 50/50 split right there. when you look at the residential mortgage-backed securities and 2008, about 6.7 trillion, then

you have got over-the-counter derivatives in the same timeframe of about 2008, gross market value, 20 trillion nominally, 684 trillion. and we all knew about the runs on a bank in the 30 and the located the problem. didn't anybody talk about the top-heavy aspect that somehow what works to keep conventional banks, and because of those restraints that they developed other approaches, but clearly, it was the same thing almost all over again except much more difficult to perceive because of the muddiness, the ratings and the rest, that never came up as the subject matter either with the experts at around and talked about, we are kind of concerned about the weight shifts into an area that could have liquidity problems, that could be

subjected to a run like we had in the 30s, and the global folks didn't talk about it either. i just don't get it, and they need to understand. now what we have heard from a lot of players in the market was that nobody had a model that, it in the pejorative sense, people said they never thought housing prices were going to go down. i think the correct answer is no one thought they were going to go down that far. and even given that, you have areas in the government that talk about disasters that no one likes to think about, because somebody has got to think about disasters that no one thinks about. i would think that the new york fed might he involved in that. looking at those markets, it may not have a direct power position, but you are the best person in my opinion to ask in that 03208 period.

what happened? >> i will begin by saying financial crises are caused by unwillingness of people to think the unthinkable and that seems unlikely so we are not going to worry about that. that is the fundamental mistake that underpins most financial crises in our system was-- that mistake was pervasive across the system. complete, whichever phrase you want to use. >> even the watchers watching-- apparently thought the same thing. >> know no i wouldn't say that. the initiative that i describe, that we were engaged in, we didn't call it, we didn't really talk it back in 04 and 05 about the shadow banking system, but we were deeply focused on exactly this risk. when i say, when i first came into that job, i said let's look at the system today. it is true we have these major banks, but what about the

investment banks? who is watching them? what about aig? what about the gse's? what about the hundreds of finance companies that else up not as banks that's doing banking. so that basic concerned about the vulnerability of the financial system to systemic risk in those institutions was central to the efforts that i described that we initiated. now you are right to say that those were outside of our-- outside of our formal legal authority and outside of our mandate in some sense but we knew the horror of the system we were responsible was made more risky and we knew we were in the classic position where in effect, we were the only station in town you could turn to when things fell apart for liquidity but we had no capacity to constrain risk outside of that regulated core. but when none of us anticipated i think was, and i certainly did not understand fully was what

produced that finance and how vulnerable it was to run, how you could have had a system where these people again they were operating in public markets issuing public debt under the disclosures of the laws of the united states united states funded by institutional investors. market discipline and all the checks and balances we rely on in that area would have proved so inadequate to contain leverage earlier. fannie and freddie you can understand because it was essentially a moral hazard. i guess i would say, that set of concerns was central to the efforts we began, but fundamentally what we learned when we discovered and this is an important lesson for us that underpins our reform efforts is that you can't run a stable system with one part under-- and one part without andy's constraints on leverage, capital

requirements were not conservative enough. where they exist in and they were not designed in a way given the accounting disclosures that allow them to fully capture the risks in an extreme event. partly because of their reliance on ratings, partly because of a long history before the stability so it wasn't in the memory, and that left the whole system more vulnerable. >> given those areas that you did have responsibility over, the old-fashioned commercial banks, bank of america, morgan chase and citibank, the one thing that strikes most people when they talk about it is that they are really really upset about what happened in the residential mortgage area because it affects them directly. what scares them more was the fact that there were no firewalls anywhere and that what started as an area that you could say wasn't regulated by

the definition of shadow banking and the rest of it, but it also affected the structure that was designed after the initial failure not to fail again. >> exactly. >> okay, so i got a right but how come we didn't get it right? >> again, another tragic failure of the crisis was that we designed a system with deposit insurance around banks, basic protections designed to prevent a fire caused by the failure of a single bank to inspect and jeopardize the stability of banks. system long texted overtime comes with moral hazard risks. not perfect. the s&l crisis being at a good example but the other systems had none of those protections, no fire breaks and no firewalls. the executive branch of the united states, the largest

financial system in the planet came into the crisis with the president having on the emergency authority limited to the act of closing financial markets are declaring a bank holiday. actions in a crisis which are largely panic increasing, not panic containing. so you are exactly right, we didn't have the tools to prevent the fire from breaking in the system and these reform proposals, congress was debating on the subject of the hearing are designed to provide exactly those tools. to make sure that large complexes like aig manage itself so that you could put them out of their misery safely in prevent the fire from breaking apart, from jumping the firebreak. >> one last question, which again amazes me in terms of how many people have used it as an answer in terms of the assets that they held in the potential liquidity especially in the shadow banking area.

they were aaa rated. at one point, when you look at the kind of residential mortgage products that was bungled, everybody knew-- people that you never thought could get into a house that got into a house but something had happened to deal 20% down and all the other arguments that gave you some comfort. why would anyone think a package of the 08 staff would have the same aaa rating as the package of the 2000 or 1990 ratings? was it because they wanted to believe it did? i mean how could anybody think that an especially this group of experts and others? >> when things are going well and people are making money, they tend to think they are smart and not lucky and they think it validates wisdom. >> mr. secretary i just have to tell you that when things are going well and people are making money, no one thinks about making the amount of money that was being made.

that is not money. >> i completely agree and to reinforce, given this basic collective sentiment that we had somehow produced a perfectly stable system and into shock, things couldn't go bad and you are right in many ways, what happened to compensation and a whole range of incentive structures fed the evolution. >> thank you or go somewhere i remember reading something about pride going before-- thank you very much mr. secretary. >> ms. born. born. >> thank you very much, and thank you mr. secretary for being willing to join us and help us in our investigation. your testimony i think demonstrates how there were regulatory weaknesses, regulatory gaps that tied the hands of the regulators and financial supervisors during the

crisis, and i take it that you feel that lack of regulatory powers in some areas was an important aspect of the problem. >> absolutely. as i they said my written testimony it is quite literally an example of authority that was not used early enough and forcefully enough, but in the subject of your hearing and this is true for shadow banking, power banking derivative markets generally, i would say the oversight failure was a, was a gap, a gulf and accountability and legal authority that prevented people come, even people who had perfect foresight from acting preemptively to continue those risks. >> let me just ask you briefly first about the over-the-counter derivatives market, and enormous and unregulated market as of the time of the crisis, where there were tens of thousands of

contracts out there, creating counterparty credit risk and virtually no transparency. you said in your testimony, these markets have proved to be a measure of force of uncertainty and risk during periods of financial disruption. do you feel that they lack of regulation, the lack of transparency, the enormous size of the market played a role in exacerbating the financial crisis? >> i do. i would emphasize two things though. the first is that, and this is anything fundamental. you had very large institutions writing hundreds and hundreds of billions of dollars worth of commitment and derivatives without capital to back them up. this is obviously true for aig but it was true for a whole industry of insurance companies and of course it was true for many other financial

institutions. and the mentally what happened was when they had to meet those commitments they didn't have enough resources to do it and of course that brought them to the edge of collapse. but i think the other problem was in this world of billions of bilateral contracts, it was like spaghetti, putting spaghetti together and when the crisis hit and you had to untangle those and try to figure out what was my exposure to default risk across the system, it was very hard for people to know and they reacted as people do in facing fierce. they decided, i'm going to withdraw and pull back the risk wherever i can. that in a crisis tends to-- like margin spirals and that tends to emphasize the crisis of the inability that those tens of thousands of millions of contracts provided for people to assess quickly what my exposure was to the risk of default by a major institution was a

substantial factor exacerbating the panic and made the crisis harder to manage and of course the paradox is that those were markets designed to people-- help people hedge risks and that gave people the capacity to hedge risk but it also gave the much more risk of exposure to panics when things fell apart. >> so, i believe they are very useful instruments, and essential to managing risk, but that they also magnify risk greatly in this disruption. >> i agree with that or go. >> is this why the administration is proposing regulatory oversight over the market? >> absolutely and again, these markets grew up, grew dramatically in the decades. you of course know this very well. the risks were apparent to many earlier but they grew dramatically over that period of time and it it was fundamentally, people were doing this thing by spreadsheet in

fact. people did not have electronically sensible records of what their exposure was. there were huge backlogs of transactions not captured, so when i came to the new york fed and we started the effort to clean that up and produce it, it put us in the position where we couldn't could and finally propose reforms that would bring the standardized part of the market onto clearinghouses and make sure that clear stuff would be traded on trading platforms and the reforms also of course as i said give people the authority to make sure that major institutions writing these commitments, that margins are conservative mouth and the ftc and cftc have the tools they need to better police fraud and manipulation to deter fraud and manipulation earlier. those are the reforms working their way through the congress and they are a very strong package of reforms. >> you essentially indicated

that the lack of regulation or the lower level of regulation and shadow banking made the shadow banking sector more vulnerable to the financial problems that we experienced in 2007 in 2008. and, i wanted to ask about kind of the flip side of the, which is whether the growth and competition of the shadow banking system impacted subtly or at all on banking regulation, because this was a less regulated system. i think the banks did suffer competitively with various

aspects of the shadow banking system. they lost deposits to the money market funds. they lost potential commercial loans to commercial paper and repo, and i can imagine that commercial banks having felt this competitive pressure would have wanted to be able to engage in broader activities and with less constraints from banking regulators. we have been told during our investigation that by the time glass-steagall was altered by gramm-leach-bliley, there was not a great deal of separation in fact between the activities commercial banks could engage in

and investment banks. so, i wanted to ask you whether, as a banking regulator yousaf pressures to soften constrained on the commercial banking your because of the growth of shadow banking? >> i did not feel those constraints but when he described what was happening and you gave all the right examples, but let it may provide a few more. we created a system that allowed institutions to an effect choose their regulator. the best examples of that were banks that chose to become thrifts. countrywide seems the best example. a lot of people thought regulatory competition was a virtue and would produce better regulation, but if you allow people to move risks to where they are the weakest and they

operate with leverage and risk to the system, that is just a catastrophic choice. besought definitely across banking regulators and in fact you know countrywide is an example where countrywide was able to evade the tougher restrictions of the fed regime and choose a softer regime which is an ots regime, that is a good example. overwhelmingly you saw people pressured, pressured to follow the market down. what happened in mortgage underwriting is another great example. i think he was true in the early part of the decade, probably up until 2004 most of the mortgage and were still underwritten by banks and by thrifts over time of course most of the mortgages migrated to other parts of the system outside the banking, promotes the banking system for the same basic reason so again, a mistake is to permit that and what these reforms did was recognize the basic principle that if you are doing banking,

we regulate u.s. banks so we can better protect the system. doesn't mean everybody has to be exactly the same in their financial structure but the leverage requirements they operate with, the requirements on funding should be economically similar that we produce a level of stability that is more tolerable to the country. >> when you are were at the federal reserve bank of new york , you and your staff had the role of overseeing some of the biggest bank holding companies in the world. and those were also institutions that suffered adversely during the financial crisis that we have experience. i wonder if you would comment on the ability of the supervisors to effectively oversee institutions that are that

large, and that complex, and whether you felt that you and your staff braley had the capability to do the kind of jobs you would have wanted to do. >> i believe we did, and i think that we have examples that work quite well at examples where was just fundamentally inadequate. it was absolutely made difficult by the fact we were operating in a system where the checks and balances that we all rely on, which are internal controls, good out of control in firms, risk management that look across the entire entity in capture those risks and bring them together so we can look at them, those things were fundamentally weak and it inadequate. we were vulnerable to the fact that under gramm-leach-bliley, we are, we rely on functions of

supervisors to supervise for safety at the underlying banks or in the case of the ftc in this case, the broker-dealer and each firm operates across the world and were able to push risk into other jurisdictions to make it harder to captured and we were vulnerable to those as a whole. and of course as we have learned, the capital requirements and the accounting requirements in the exposure requirements did not do a good enough job of giving us a good picture of what capital really was relative to risk. that is why the big lesson i take from this, among the many lessons are to make sure that we forced the system to run with more conservative requirement some leverage because i do not believe you can design a system that depends on a community of regulators always been wise and

tough and smart and have the foresight imperfect foresight to preemptively, preempt pockets of risk and bubbles of leverage. we will do our best and people will do their best but they will be imperfect and in the best sense that potential problem is, it forces the system to run with the stronger shock absorbers to observe losses across the system and begin that is the lesson we are trying to bring about with these forms so it is not just the institutions that the markets like repo or secured funding markets, security funding markets etc., derivatives markets coming together also run with much more conservative cushions against the uncertain come against the possibility that the next shot could be beyond our imagination and could be very damaging. that is the central light lesson we try to take. >> what about the need for

systemic view, which is very hard for any of our existing regulators to have, because of their silo jurisdictions. >> i think that is very important. there are two ways to do it. one is to take all the regulatory responsibilities relevant to systemic risk, put them in one place like maybe the british did in some ways, and have a single point of accountability for measuring and managing all those basic risks. i don't think that system works. i don't think it is feasible. we are proposing a different model which is to create a council which brings those firms, those entities together with their functional specialization for market integrity, for resolution for safety and soundness, for the payment system etc. and put them into a place where they have to sit around the table with the secretary of the treasury, too,

because we are the custodians of the taxpayers money and fundamentally responsible for the financial security of the country have to be in a position to be accountable to the congress for making sure that complement of regulators is running the system sufficiently and conservatively. there or not against. it is not lagging behind the growth of these markets. that is not going to force-- but i think it offers a better chance of someone being accountable and making sure we don't re-create again huge gaps, opportunities for arbitrage where the rules leg with a heightened risk in the they did. >> let me ask you one last thing there became prevalent a view among economists, a view among

some regulators during the last 10 or 20 years, that financial markets were essentially self-regulatory, and government supervision, government regulation of markets was either unnecessary or actually counterproductive. do you think that played a role in the regulatory weaknesses and the regulatory gaps that you have described in your testimony? >> it is hard to know. i find it hard to imagine that anybody who lives in the financial system believes fundamentally they are self-regulating just because the history of financial systems is a history of recurrent crises, some devastating like this one, and some more mild, but all consequential. and we learned those lessons painfully of course, but i think the lesson of the behavior and

experience in history is that if you allow institutions to take deposits that can be withdrawn on demand and make loans, they can be called on demand, then you create a risk of runs and that is consequential to the economy as a whole so we built up a set of protections not just to counteract the moral hazards caused by the perception that these firms are important and consequential but to make sure that you protect the economy from thing is getting out of whack. our system, like any country, among its strengths, and has a lot of people with diverse perspectives making decisions in the congress and the regulatory community. i think the real problem was that that long period of stability allowed all views to prevail. some people could say that proves that all these innovations reduce risk. that they prove that the markets are working well.

that capital requirements are strong. and that long period where risk seems permanently reduced allow people to not confront i think what worked fundamental vulnerabilities. that is the way i would try to answer that question. >> thank you. >> thank you mr. chairman and thank you as her secretary for coming today. one of the things that is to live full about your testimony is you actually are clear about what you think and don't think of what went on and that is not in the typical performance by someone at the table so thank you. let me ask you a few questions about that. one thing you said is that a root cause of the crisis is uneven regulation or absence of regulation. yesterday we were-- learned that under the csa program the sec felt that all of the five major investment banks have adequate capital. they met the standards. bid 10% capital the fed would

have required. they had more than adequate liquidity because they had gone above the standard set of bank holding companies. what difference would having it eat a legal requirement make it even if they were in compliance with the standards? >> i want to answer that question carefully because as you know i was not the supervisor and have no underlying knowledge of their financial quest-- condition. >> since they were in compliance with the regulation what this making it legal to? >> i think would actually be very hard to justify a judgment that those firms were operating with a level of leverage and they sufficiently conservative funding structure that made them equivalent, certainly three of them, equivalent in terms of stability to those firms that were operating under the constraints of the leverage ratio and the broader banks advisory regime. i would not agree with that judgment and of course i'm limited by the fact that i'm even know what happened after,

after the storm engulfed many of them and had no direct knowledge before that. but i think it's fair to say, looked but dead in the appropriate way, economically they were allowed to run with more leverage, much more exposure to run the risk that was true for a classic bank subject to a leverage ratio and the other requirements that came. >> i guess that was my second question which was the assertion that this was a fundamentally more fragile structure. in the aftermath, it appears that regulated banks, commercial banks and the shadow, whatever you want to call them, failed in a comparable way. >> wing of the banking systems are fundamentally fragile. most financial crises are classic failures of traditional banking. banks lending too much for too long without risk etc. so you are exactly right in this crisis shows you both examples. but, it begins and was much more severe in my view and this

parallel banking system, and i think the crisis would have been much easier to manage if it was simply eight classic yanking crisis, which are slower moving by design because liquidity risk is more contained, but i think you are right to say traditional banking and in parts of the shadow you call -- maxell people making too much risk and against the possibility, the remote possibility they thought of a deep recession. i think you are right and is a set of my remarks i absolutely believe that the leverage constraints, the capital requirements that were put in place in the traditional banking system were not conservative enough and i think they were not conservative enough in two respects. one is it didn't give enough weight to the possibility we have a huge shock like this and they also didn't capture the exposure banks had to the pressures that would come when

that parallel banking system did not collapse that parts of its collapse under enormous stress, so those were a failure and design of capital requirements to traditional banks as will. >> just a point of clarification, you don't want to college shadow or traditional banking of institutions but there was a set of activities located in traditional banking and seen by the regulators that were the activities that were the same as in the shadow banks. >> i think that is fair to say, and if you want to try to say what is the one cause that was common to everything. >> a i would love to hear that because i disagree with the cause is so far. which causes are the most important? >> i was going to say, i think if you look at a single factor that underpins the risk management failures, there is the ratings failure etc. was the failure to anticipate the possibility of how prices would

fall as much as they did, and what effects that would have on the ability. that failure is the same failure that caused millions of families to borrow more than the value of their home and was likely to be orphan as well as more prudent. that would be one-- what was not a cause of the crisis? which things people have put forward you think ought to be crossed off our list? >> why don't you give me her candidates and i will respond. global capital flows. i believe along period of very low at just rates around the world absolutely contributed to the crisis. i think that created an enormous force of money looking for a return. i would say it was a factor. i mean, this is a deeper conversation of course but there are people who believe that at

the root of everything was again a fine moral hazard risk which is a set is more complicated than that. i don't believe the existence of the fire station caused a financial crisis so i would not put that high on the list. but you should probably test me on the others. >> we will come back to this. i don't want to lose all my time but another thing you said in your diagnosis of the problem was the absence of a systemic regulator, and i was instantly going to point out the fsa in that england had a financial crisis and you have dismissed them as a preferred model but to what extent did we not already have it president financial market to have the capacity to do exactly what you are suggesting, sit down a look at risk and we got a financial crisis crisis anyway? >> excellent question and i agree and i think that body did not provide its important function, and you are also right to say that it is establishing an instead see that it is now

over the full mandate won't necessarily make sure people use that with that effect but i think it is important difference in the sense of the way the reforms are designed now, there really is an explicit mandate with the ability to in effect, deter weakening of let's say prudential requirements and to recommend they be higher and the existing much more informal structure that is the president's working group does not come with that responsibility so i think that would help again as you know i think from what i said, i i don't think committees prevent financial crises and i don't think committees all financial crises, but on the other hand, you do need to invest people with a direct response but you want people to wake up everyday with a a sense of obligation not just to look across a system where risks are but given some authority to act in that case and we did not establish an executive branch of the united states, that set of obligations

are quite that the capacity for leverage. >> i want to go back now to your time as residents of the new york fed, and during that period, the board of governors came to the conclusion that the risks and sub-prime housing could be contained and he made a statement. did you agree with that? >> i never made that statement. i was not part of making it. >> did you agree with that? >> i would not have said it that way. i believe i try to say this, that i think we face growing risk across this financial system of exposure to a very dramatic crisis, and part of it of course what was happening in real estate markets. it was not principally because of what was happening and sub-prime. it was a much harder wider phenomenon that produce this mix of leverage across a system. when i talked about it, i try to

cast it as facing significant risk that risk from a much broader and i think more dangerous constellation of forces than simply what was happening with sub-prime. >> what would, beyond that list and that constellation. >> you had people taking huge leveraged bets on the possibility, on a world which is -- falling sharply or growth falling off the cliff or go. bad was the unifying mistake that so many people in a forest management investors, borrowers made. >> were you surprised by the concentration of mortgage exposures on the balance sheet sheets of for example the regulated tanks, city matt? >> no. i think that banks lend money. banks always hold exposure to real estate risks as you have seen across the country. the story of community bank failures across the country is concentrated to the commercial

real estate relative to capital. capital. what was surprising was that a huge part of that risk was held in these financing vehicles that came with very high ratings. the instructions came with very high ratings and as they said the capital requirements were that they were not-- they were designed in a way that made them much more while mobile to those failures and did not protect against those failures so people everywhere took false comfort from the fact that exposures to real estate risks were in securities that were rated aaa. >> were you surprised by the large amounts of hedging that was done through aig and other monoline insurers, the cd's? >> of course i was up to my eyeballs in the growth in the tbs market and what that meant for the system, but we had no window and no capacity to said

set you would-- who had written huge commitments relative to capital because as you know, the things we could see were only in those institutions we could regulate and as i said, even those metrics we use were flawed. but we were not able to see where you have those huge pockets of risk and institutions outside the banking system that wrote those huge commitments and derivatives. >> when he attacked mr. corrigan to assess risk management and develop-- best practices, how did they do? you never said. >> the institutions did not do well but the recommendations i think if you look back in retrospect have them were quite good. as i said, the lesson i take from this is that we did not have sufficient traction to use those recommendations to induce

enough changes in behaviors earlier largely because we were still operating within the existing capital requirements, and i think the only way i can think of preventing that from happening in the future again is to make this simple capital requirements in a leverage ratio and the other one, conservative enough so you can rely on them, not rely on all of these other things you try to do. remember all of these firms when you look at their stated ratios, they gave you some convert that they held a fair amount of capital against their risk. that was false comfort. a simple lesson i think is just to say you have got to run the system with more conservative shock absorbers. speak and you need more capital. i don't want to look like i was contesting that. i was just trying to get a sense for even what the perceived best

practice might be, what your assessment of their actual practice was and whether they improved it in response to this. >> i think some did improve. you look at the corrigan report, and you compare it against this thing we organize called the senior supervisors group, a report on actual practices across those firms that i think was published in the fall of zero wait? 07? i am not sure. and you could see and they are a pretty historic criticism of what was the state of actual practice and i think we have significant effect in changing practice, but obviously not enough. the numbers were inadequate. >> before i run out of time, two more questions. number one, you said in your statement that among the things that cause the crisis was the government not moving quickly

enough. when should it have moved in what should it have done and what did you mean by that? >> again, i am a king things more simple then they obviously could be, but to say historically, i would say we did not move early enough to contain the emerging risk across the system. >> preemptively. >> preemptively and when things started to fall apart, and i think this is true for governments around the world, did not move quickly enough and forcefully enough to try to contain the damage. i think the federal reserve was exceptionally aggressive, took a huge amount of criticism and did things we hadn't contemplated ever before with the authority congress gave us but in the end he canceled his financial crises with tools that are about liquidity. they require ultimately as we saw, the full financial force of the government in terms of

fiscal policies to support demand and ultimately capital in the system and broad-based guarantees to contain panics, and they believed that have been deployed more quickly and many of us of course were strong advocates of early action, i think this would have been a less damaging crisis. >> i yield the judgment to additional minutes. >> in particular-- indeed many of these banks. a question that immediately comes up then is should the fed has moved more quickly to provide discount window access to people outside a bank holding companies and as you know, there is lots of interesting decision-making that went into that and i would love to hear your views. >> we were extraordinarily reluctant, i think appropriately reluctant to take that exceptional step. it had not been taken since the great depression ben, to provide traditional lending against collateral to institutions we

were not supervising and regulating because we knew in doing that, you would be creating enormous moral hazard risk for the future and i think we were appropriately reluctant until we believed and we came to believe of course that that fateful week in march, that the system was at the edge of collapse. now those facilities of course are not designed to protect individual failures. they are designed to protect the system from broad-based runs and prevent solvent institutions from becoming illiquid and they can only achieve so much, as you kept seeing. we were very reluctant until we were at the point where we thought there was a substantial possibility of systemic collapse and at that point it was absolutely necessary in my judgment essential we do it, and i fundamentally believe we do did that at the right time. >> thank you. thank you mr. chairman. >> the former chairman of bear stearns yesterday said you did it 45 minutes too late.

if you could do would an hour earlier, do you think the end result would have been significantly different, different or ultimately no different? ..

[inaudible conversations] >> i would like to put our crisis into a broad perspective. i have seen some foreign ministers of finance and others who had been at least socially critical that we may be moving too rapidly therefore not properly integrating our reforms with what will happen on a broad multinational basis. could you comment s to is this crisis if you give a diagnosis without result in a sufficiently

similar determination of causation to than lead to an essentially similar prescriptions being written for a variety of countries? >> center that me say two things in response. there are a lot of people and we debated this who made the argument a year ago that we should wait until the crisis was definitively past. we are going to take a longer reflection of how best to fix it before we begin the process of broad reform and we made the different ways. we decided this with countries around the world that we were better able to get consensus quickly on a stronger set of reforms if we were acting when people were deeply aware of the scars of the crisis and the damage, the memory haven't faded and, you know, i think we know what we need to know about the choices in revolving the system and we've done this in close

cooperation and in parallel with other major economies so it was april of last year we were laying out our initial set of proposals we also negotiated with of the g20 and the new financial stability board of a complementary set of proposals we hope would be enacted globally. there are core elements of the reforms that to be effective have to be done multilaterally. the best example of that is capital and we are in the process of negotiating new international capital accord to limit risk taking but there are some things that are a problem unique to the market that have to be done differently and our responsibility of course is to make sure we are fixing those things, too. the world i believe generally was very much to see the united states act to fix the things we got wrong in the country and depending on us to do it and i've never heard any of them suggest to us that we shouldn't slow the pace of reform down.

they want to make sure we are doing this in ways that globally would be not punitive on them and there's a lot of concern outside of the united states some of the proposals we've been promoting on capital for example are going to be a big burden for other countries and that is the source of some tension as inevitable it shouldn't be but it is a sign of you should view it as a sign of health that we are being ambitious and what we are trying to achieve. >> if i could pick up on that issue of capital i was surprised to learn that under the basil ii that the value of securitized mortgages is higher for purposes of capital purposes than the underlying mortgages of themselves. is that a correct statement? >> i do not know whether that exact point is correct. i would say one of the things important to note is basil ii wasn't in effect for u.s. banks.

it's still not in effect for u.s. banks and was essentially irrelevant to the cause of the crisis. all u.s. firms are operating under basil i designed back in 1990 with a set of leverage requirements, and those set of risks waves did laundry good job of capturing the broad set of risks firms and they were involved in a very important process in the united states to try to change those to make them better reflect risk. >> you sort of anticipated my question as if the statement i made and maybe i had of the wrong basil is correct, and my colleague thinks it is correct, does this indicate that the international financial community was falling victim to the same mistake that we made which was to put on boreman to

dalia behind a certain set of instruments largely because they had a high credit rating without any requirement that they be some greater due diligence as to just what was the composition of the structure instruments. >> absolutely, absolutely and the system was riddled with that basic vulnerability which is too dependent on ratings that were too vulnerable to the mistakes and firms as a result how old was couple than they should have. >> and do you believe that the international financial community is moving to correct those errors? >> absolutely. the way the system works as we don't turn this over to the international community for us. what we do is we figured out what makes sense to the united states and we try to build consensus internationally to pull other firms to that level and we preserve the authority to be more conservative to differ

if we need to do it differently. one example in the system but we were fortunate in many ways because we had a leverage ratio in place for the banks and bank holding company's many companies did not and as a result of were firms were forced to run with more capital and have less leverage, less vulnerable to crisis than for other countries and as many people of pointed out, our banks although they look large because they are a large country were much smaller as a share of the economy than was true for the major countries to reduce our banks work at the peak even with investment banks now called banks are about one time gdp comparable numbers in switzerland and the peak were almost eight times gdp and the u.k. almost five times gdp and europe, almost two times gdp so our banks were less leveraged than the whole system as a whole was much schaller dee dee to smaller as a share of our economy and hard to imagine because our crisis was severe but we were in a better position

to withstand the shock that was true for other countries. >> spread the leverage ratios the you just cited are so extreme as that indicate a higher proportion of the financial business in a place like switzerland is run through traditional banks as opposed to what we are studying on the shadow system? >> you are right. the shuttle's systems are would recall universal banking models and they combine one entity, legal entity the span of the financial activities their capital security markets are less important source of credit and our country. our country is still half of the credit comes through what we call banks and roughly half of credit comes through the security markets both simple bond markets as well as asset backed securities markets. >> i am almost out of time. >> a couple of minutes?

>> a couple of additional minutes to ask a different question and that is you talk a lot about your efforts in new york and now here to look over the horizon and try to have a better idea of what is coming at us. do you -- what degree will the reform that you are advocating increase our capability to be more anticipatory there for proactive rather than just reactive? >> i think it will help. it will help a lot and ideally of course what you want is a system that is able to move more preemptively that is more agile that can stay close to the frontier of innovation and we hope to produce that there is no guarantee we can and that is what fundamentally i keep coming back saying you need to do your best and design a system that creates the possibility that compare for the possibility it won't be perfect and therefore you want the system to have better cushion against the inevitable uncertainty we all

live with because we want to know with confidence where the next shocks are going to come from. we just make sure it will be less damaging when it happens. >> thank you. >> thank you. mr. wilson. >> thank you, mr. chairman. and thank you, mr. secretary to spend some time with us today. it's been very informative i would like to follow-up on what my colleague, douglas, was talking about before because i think these are very important questions, and particularly the question of whether you and what you are proposing four and reform is to solve the root problem because i think you would agree that we don't want to solve the wrong problem and one of the things we are in is figuring out what the problem really was. now in the hearings we told so far it seems very clear it did

not really matter whether you were a regulated bank or less regulated investment bank in terms of what happened to that institution in the financial crisis. would you agree with that? >> i wouldn't agree with that. i would say that in the -- let's think of it this way. you have a world where you have to institutions. classic banks that take deposits and make loans and u.s. banks that we call them banks for the minute but they are funded a very short, no deposit insurance. money can leave in an instant and they are able to take on more leverage than banks. >> the assets are different than banks. in the bank assets team to be causing to be long-term and investment banks tend to have very short term assets easily sold. >> a little less short and many

people thought. a very substantial portion of their asset were quite illiquid in the crisis and they could not sell them actually that quickly which was a fundamental difference and so the level -- i'm not an economist of the level of transformation that risks run in many of those institutions was very, very large. i think in many ways as large as banks but the difference is that when the liquidity dries up in the parallel system, the assets were not liquid enough in the panic to be able to sell them and meet the demand for the margin it's a bird or for the margin of withdraw so that stuff came crashing down and the enormous pressure -- it was only -- we did only what mistakes banks made over centuries. it would have been a slow moving crisis because liquidity would have been more stable because most of it was deposit funded and it would have been an easy courses to manage. it would have been a serious recession still, an easier

crisis to manage so i think it was a different consequence. >> okay. now waiting to raised exactly the point i was trying to get to. thank you very much. and the point was in 2007 as you recall, the mortgage-backed securities market simply came to a halt, completely unprecedented and that meant that these investment banks that you are talking about here turned out to have an affect long-term assets when they were intended to be short-term assets so the question really is is the right question the investment banks or is it what caused the short-term assets of a thought they had to become the long-term assets that made them look a little bit like regulated commercial banks? so i am going to pause it to you the possibility that because of

this crash in the mortgage-backed securities market that short-term assets were turned into long-term assets, no regulatory system could have survived this. because we took about $2 trillion in assets that was on the banks of financial institutions on the balance sheets of financial institutions all over the world also particularly in the united states but all over the world and we made them illiquid. they couldn't be sold. isn't that a major effect that no regulatory system could have anticipated and shouldn't we be thinking about what caused that to happen rather than imposing more regulation. islamic i'm not quite sure where you are going with that but that is an interesting question. i guess i would try to look at it this week. if you are going to take on a lot of risk but it looks short

term or long term with everything that the assets, but you know that there is risk in those assets and you are going to fund them with money that can leave and a heart beat and you don't hold much capital against the risk of losses then you will have a problem. and that, i believe, is a problem that is mitigated if you get capital regulation right over institutions that are in the business of making the markets where companies barrault. but i completely agree there are other things that happened in our financial markets that made us more vulnerable to the abrupt loss of confidence of anybody holding securities backed by real estate in the united states. >> all i am saying is simply this, and we had an abrupt, and

shot to the entire system coming from the fact that a very large number and size of assets simply disappeared as salable assets on the balance sheet to banks and investment banks and that changed the condition of those institutions very materially from a capital and liquidity standpoint. i would like your reaction to that. >> that is what happens in any crisis. the positions are tested. one is the proposition that you are funded stable in a lot of people made a lot of judgment on the expectation that would be seamless permanent uninterrupted never disappeared it would be they're cheap and available. that assumption is of a crisis and a mother is you hold a bunch of assets and think you know what you might lose in those assets to sell them or hold them over time and it takes both of those mistakes to cause a crisis

and we had both at the same time and they were related. people ran because they solve all. they couldn't tell what it was. >> this wasn't any crisis. this was larger than anything we've experienced before and i think the reason is we are talking about an asset size larger than anything we've ever experienced before. about $2 trillion in mortgage-backed securities and related securities scattered throughout the financial world and have a suddenly becoming not worthless but very difficult to sell except the most distressful circumstances. this isn't a problem rather than have sufficient regulation. >> no, i don't think so because again like almost every financial crisis it has real estate at the scene of the crime. it doesn't really matter how fancy the products are or what you call them, cbo's or asset

backed securities, they have real estate central to the crime, and nothing unique in that and again what we do is we protect ourselves from that risk by making sure the institutions that are necessary to make the markets function to make economies work and enough capital to cover the losses and are not liable to run and again, i don't think that the regulation can solve all problems. it can solve lots of damage and has done poorly it's damaging. regulation creates incentives for asian, but capital leverage with a test to be at the center of any diagnosis and the problem and the reforms. >> i have a little bit of additional time, so i will go on. spinet three minutes. >> here's the issue. you suggest that capital regulation would be a solution to this problem but if we are talking about a 70 year study

that is we haven't had anything like this for instead -- since the depression to talk about imposing so much in capital requirements and fine arts, banking system on investment banking systems they will no longer be able to offer a reasonably priced credit to those who needed? >> no but you are asking the right question i believe. when i first came to the new york fed and was understanding the system in which banks were operating i asked my colleague how do we know what is enough capital? how do we choose what is the net and my colleagues is this an example which is to say we think it is enough to cover a 30 year flood but not 100 year flood. government's gauge place about what level of insurance you force to run against what probably of the flood and i agree we cannot and should not try to design the system that

makes filling your impossible to recover because that would impose excessive costs on businesses and would not be efficient for the country as a whole but i can say with a lot of confidence that our requirements were too thin and too modest and would be better for the credit generally, better for the economy and allocation of capital cost chaim if those requirements more conservative but i agree you can't design the mendicant try to to protect against all sorts of shocks and we have to have a system that allows for failure. you don't want to fill the air as damaging as it was in this crisis. >> one last question then. >> you see in your prepared testimony that the financial system i think i'm quoting here out grew the protections created in the depression. now, wouldn't it be fair to say that the system group outside the banking system not to avoid

regulation so to speak but because banks were in effect unable to participate in the securities market which was a very efficient market for financing business and financing consumers. this is the securitization market. banks were effectively prevented from participating in that because of class people and not advocating them certainly but isn't that why we developed this shadow banking system if we want to call without? >> the capitol requirements of the paradoxical feature there was strong enough to encourage a lot of the funding to shift outside for with a there was no capital regulation but they were not strong enough to protect the system when that system came crashing down so i don't think they were right in the sense that the banks were allowed to

help companies raised debt and equity and they were about to participate actively in these other secured funding markets for credit card receivables for automobile receivables on just real-estate asset backed so they were able to participate in a lot of them did of course in ways that left them in the panicky referred to so i don't quite agree with that part of your question. >> that is all the time i have. thank you. >> mr. giorgio. >> thank you. mr. secretary, you said something to the effect that all this stuff started to crash down and crashed on quickly. i guess i would like to explore whether the stuff deserved to crash down and was created in such a way that anybody other than right in the center of it and not looking at it ought to

have known it had the strong possibility of crashing down. yesterday we had testimony from former sec chairman cox who said of the practices had been followed the crisis simply would not have occurred. the nearly complete collapse of lending standards by banks and other mortgage originators to the creation of worthless or near worthless mortgage perez of september 2008 banks reportedly for one half trillion dollars of losses on u.s. subprime mortgages and related exposure, and the creation of those mortgages plus exacerbated by then turning to those in in in in in a end to residential mortgage-backed securities and into collateralized debt obligations in the process that the last hearing by likened to something like alchemy where you're took the trouble be rated trauner gist of the residential

mortgage backed securities 90% of the charges for high earmarks and this was the bottom of 5% of the 7%. there was 2% of equity below and then you took that staunch low-rated from a whole bunch of mortgage-backed securities and created something called the collateralized debt obligation. somehow slicing and dicing ending up with a security that had it was super senior tonsures ostensibly but of course we now know that all that was essentially fictitious and that when he lost a very modest amount when these mortgages begin not to perform in some modest amount three, 5% you impact all of that to launch and then he essentially rendered the cd a worthless and it was exacerbated i think it's

important to note it was exacerbated by the shadow banking system in a couple of ways. we had another $120 billion of those who were essentially in short by aig by selling credits default insurance against which they were not capitalized for and they were essentially spreading their aaa ratings like holy water over the cdo is that did deserved to be great in that way and another 60 million sold to the paper, wood, so you took these fundamentally forecasters securitized products and concentrated risk eckert we as taxpayers have to bail out, city dee dee to a citibank which took $25 billion liquidity put on the cdos off of their balance sheet which was essentially one-third of the capitol which nobody seems to have noticed anything about and i guess all

of this goes to sit at -- say that it seems to me we need to have people prepare to recognize the emperor had no clothes their need to be people who saw the possibility of this collapse of these securities was much higher than anybody gave them credit for and i wonder if you can speak to that. >> i agree with much of what you said and i think you are right that modest losses would been

deeply into those kysa torch ron gist you describe to -- you have to emphasize it wasn't just in those complex structures -- lacrosse the system and countrywide was an example would and banks across the country that did suggest current real-estate as a whole when and

i don't know that in this regulatory reform that's going on how much how much there will be with remedial, how much remedial measures will be in it you like to say these reforms will solve all the problems but then we won't know for sure which ones they are doing an adequate job but they do some very important things. they do get fundamentally add some of the complex agencies. they will force the risks

exposed they will force firms that write these commitments to hold more capital against the commitments. some limited intellect -- one these things are i think you can say they are necessary quote hot of course of the time people will find a way around them and have another period you create great incentives for people who take great risk they will do it again. our job is to make sure those mistakes when they happen or not as damaging to the system. >> and i guess the other things that we looked at the last hearing i would like your comment is this capital arbitrage where institutions ha like citibank were putting things off balance sheet or into different elements putting them into the trading but donato avoided people recognizing

different regulatory entities recognizing recognizing there's ultimately address in this particular instance of liquidity of $25 billion almost one-third of their capital. if one set of ceo's sale. >> again the system who did not capture the economic exposure many firms had to the funding vehicles. the crisis began in july of 2007 when a french bank that of a money-market fund closed the gates of the withdrawal because the fund had funded a bunch of risk in a structured investment vehicles, these off balance sheets of german banks that had brought a huge amount of mortgage risks so the bank it happens across the system and the accounting ration, the disclosure regime, the ratings regime, the cattle rations and

did an adequate job of capturing the exposure and that is a fixable problem and it will be fixed perfectly and you want to make sure that is overtime better and i think that is a problem we can do a much better job of presenting in the future by again making sure that accounting conventions capture the exposure to the exposure is better. ratings less vulnerable to the conflict, capital provides a bigger cushion against uncertain of loss. it won't solve all problems but it is a good place to start. >> very good. thank you. >> mr. secretary i want to make an observation picking up early on mr. wallison and mr. george yo and one of the things that struck me when i heard the discussion is the people who've come before us have talked about how nothing could have been done to avert the crisis but at least

is clear to me as i read more and hear more there is a lot that should never have been done at the outset and you were talking about in this discussion what kind of regulation on securitized products are on capitol is it fair to say some for it to look at the point of origin and other words there was a situation here i am not saying it was the whole of the problem but the fact was poisonous subprimal loans were permitted to enter the system in the first place and an exotic financial instruments were treated that helped carry the poison throughout the system. ..

>> but the job of government is to make those failures less damaging. they don't cause damages and consequences for the economy, and i believe we can do a better job. and i think to provide a very good framework for fixing not just the direct cause of the crisis, but making us much less vulnerable in the future. crises will happen. what policies should do is make them less damaging. >> would you agree that the problem in prime mortgages may have been exacerbated which in part may have been fueled by the

availability of the no down payment to a whole set of consumers that wouldn't have been able to enter that market. >> i do agree with that. >> okay. this is the way of clean up. i had earlier abouts you about conversations. i've assume you've had a lot of conversations with him because he was on your board. but i know that october 7 of 2008, you announced a commercial paper, october 27, you began buying commercial paper. i believe there are talking about that being only asset-backed and not unsecured. i know it was shifted. we started a facility called the asset-backed had some accra anymore. it was about asset-backed commercial paper, then we put in place a broader commercial paper back. >> when i asked you about the

conversation and being able to issue commercial paper by ge, i'd like to expand did conversations about being able to enter those programs because of the programs to support their issue or the market as a whole. >> got the best of my recollection, mr. chairman, those conversation that i had with a variety of people in the market, money investors and people relying on cp markets, they were about making sure we understand how broad the problems were. people had lots of ideas about how we should solve them. >> we were going to check. i don't expect you to -- like i said carry your daily plans. >> like the asset-backed questions -- >> the a-issue in the time b and b-their participation in the programs. okay? >> i'll be happy to go back and

check. my recollection is almost certainly they were about making sure we understood how broad the potential financing stress was. and like we heard from across the system, across the economy, encouragement for us to do something about it. >> all right. double check. we can swing back. mr. hennessey. and thank you for coming together. i am a little concerned about one the biggest challenges that we have here. two the biggest challenges. they are the advantage of hindsight and the dangerous of selection bias. we know now what happened when policymakers and supervisor its did not know what was going to happen. you can find someone predicting any outcomes. we've had people points to the a in the past and say why weren't those paid attention to. with respect to senator graham,

i can tell you with certainty that devastating hurricanes will hit florida. but that is different than suggesting that i should know when a specific hurricane is going to hit miami, and even if i know that houses are being built that are too big on the shoring of florida, that's different than saying i should have known about this hurricane or some have been suggesting that i knew that a particular situation was going to occur and that someone did nothing about it. since you were running the new york fed, that argument would apply to you. i don't buy the argument. but i want to ask you about it. with respect to housing and how the housing problems translated into the financial sector. i think it was generally known for years if not decades that u.s. policy subsidizes housing. i know a lot of my economist friends would say

oversubsidizes. i know that i did not know until the fall of 2007 that there were specific severe problems in an element of the housing finance market. can you comment on the argument that policymakers should have seen well before the summer or fall of 2007 those housing problems? do you believe that's a valid argument? >> i -- basically agree with where you begin. i say most -- i usually say exactly the same thing to you. which is be weary of the benefits of hindsight. and be skeptical of the capacity of the foresight. i completely agree with that. i can told tell you what i thought at the time. which is that i was very worried

about the possibility that this whole set of forces you saw in the long period arising house prices, huge increase in leverage, growth in these risky funding structures. i was very worried those risk would be substantial for the system. and that did not know what the possibility was of a big shock. where it would come from. where it would happen. how damaging it would be. i thought there was a risk it would be quite damaging and harder to manage for the reasons that i said before. but i would not claim, and having said that, that i thought at the time where i spent time. i spent a lot of time with people in the markets, of course. i did not find people at the time who were particularly compelling about exactly putting these things together and seeing how exactly what's happening in no doc loanses, ninja loans, et

cetera, it was actually producing huge exposures that looked triple a or supersenior. be wary of the benefits of hindsight. and -- but i think on these basic, the reason i think it's important to come back to the simple risk in leverage is that leverage is hard to capture. you could observe at that time, there was leverage in the system that made us vulnerable to a shock when it was going to happen. nobody had the capacity to predict the timing nature, magnitude of that shock. the lesson that i would take is design system that recognized. don't deny a system that trying to depend on people that sits in the job. we're going to hope those people in washington step in with perfect wisdom in the future and deprive people of boring too much. i think that would not be a good way to run a system.

run a system that has more skepticism about the capacity of individuals to act preemptively. i think that's the forms try to do. >> thank you. second part of that, same sort of question. i could characterize it as were you generally surprised by the bayer and subsequent events. by 2009, everyone knew there were problems in financing. taking that specific failures in specific institutions. some have been suggesting you and others should have seen that was going to happen or some are even implying that people did see that was going to happen and didn't do something about it. >> as i try to explain, we did a lot of things starting to 2004 which were designed to make the system more resilient. reduce the risk that whatever

happened, it would be less damaging. i think the steps had the right objectives. they were very effective in many areas. i think, for example, what happened to the how little event hedge fund failures had on the system as a whole. a lot of examples of things that those results that were helpful to the system. but absolutely did not do enough soon enough to make the system strong enough to withstand that. for us, in my view, this crisis started in the middle of 2007. and as, you know, the fed moved very aggressively doing things we had never done before. no road map ahead of over countries to help to put some foam on the run away and sort of contain the risk that would estimate other institutions. but ultimately, of course, you don't solve the problems by using liquidity. you have to solve them with more force. >> good. i want to praise you for the

work you have been doing on dealing with the resolutions issues, having to do with credit derivatives. and i strongly support the arguments that you are making about in effect hardening the system so that even if all of the over sight and all of the supervision failed that was system is more robust to withstand that shock. we heard from bayer, they said, look, we were profitable. solvent. just in irrational run occurred. after bayer, there was the among ridgety facility of the fed, which as i understand it, as since expired. so let's imagine that another profitable solvent firm faces an irrational run. isn't there the same risk, isn't the system not hard enough in that particular area. >> two additional minutes. >> i would not characterize what happened on the case on a run on

a solvent institution. but if you -- if we don't reform the system, absolutely. we're still living the vulnerability today. without the full set of protections, preventive and better tool for crises, we've been living with a more vulnerable system. they add to moral hazard. sit here and do nothing. the system would be more vulnerable and more stable in the past. even solvent firms are vulnerable. you saw a lot of institutions that were strong come under pressure because the world went into panic. again, i think the best defense against that is to make sure that the entire system, firms and these funding markets, derivatives markets, et cetera, are run with thicker cushions against loss. that will make everything less

frank jill will somebody makes huge mistakes. but also makes sure when people make mistakes, you can put them out of the misery, because the taxpayer be exposed to loss and you can draw a fire break so the fire doesn't jump to the rest of the system. that's the basic simple theory under the reforms. i think those are achievable reforms. they don't be designed to prevent fuel from making mistake. p we just want the mistakes to be less damaging. >> so that's the resolution authority. and then a whole set of requirements to reduce the probability that any one particular firm gets himself in the situation where investors will lose confidence. we saw this with wachovia and wamu, even insured institutions can face runs. even if the pending legislation becomes law, you are still at a greater risk for one the

noninsured firmed of the irrational liquidity just because it doesn't exist. you can have an solvent firm saying we are running out of liquid. >> that's right. the question you have to ask is that desirable. will that produce more conservative behavior. there's the safety net. it should induce caution. it didn't work hawaii coming into the crisis. so again, i think the lesson we try to take is to say there's a function called banking. which about helping companies raise capital, helping people borrow, you want that to be stable in crises. other economies can't function well. that requires restraints on risk taking and better fire fighting capacity. you can't make the system stable

if it only exist on fundamentally half of the system. >> thank you. ms. murren. >> thank you. thank you, mr. secretary, for being here to talk to us about this. i'd like to follow up on a nuts-and-bolts question that came up in the last hearing on citi. we had the opportunity to question former chairman greenspan. we were able to look at the bank supervisor group in new york. this one is dated may 9 to may 27th of 2005. i'd like to enter that into the record. it is conducted by examiners from other federal reserve banks. and it is my understanding that each reserve bank is reviewed every four years. and that in this particular report, there was commentary made that related to the citigroup team.

that was the team's time and energy is absorbed by hot topic supervisory issue which is compliance, governance, information request, that keeps the team from continuing its supervision objectives. the result is there are insufficient resources in a consistent manner. we recommend that management review the sufficiently of staff across the lcdo portfolio. there's also another report which is the same year on the same topic which is titled draft close out, which also mentioned not having sufficient staff to sustain continuous supervision which may result in late reaction to address emerging risk areas. i'm curious about when you look back on this, and recognizing the benefits of hindsight, do you agree with the findings of this report. that there were resources to citigroup and other large complex banking organizations?

>> here's how i think about it again and colored a little bit by hindsight. i was very concerned in looking at our mix of responsibles in those bank holding companies. about the burden imposed by a range of what you might call compliance obligations, consumer protection, cra, bank secrecy act. very important policy instruments, policy requirements that we were charged with enforcing through regulation. and the burden those imposed, relative to the resources that we had to also do what you might call a much more difficult task. also important task of judging whether a firm had a risk management capacity to manage the risk, whether the safety and soundness obligations they faced were adequately met. when the liquidity was managed. whether the firm had adequate stress testing what might happen if all of those securities had

held and turned to mud. and i felt -- and again this lesson helped shape what we know of financial reform. we did propose to take the fed out of consumer protection and have it focus in its supervisory on a narrower range of requirements. i still believe that's right and appropriate. in part, it helps make sure these people are focused on a more single mission. which is safety and soundness. which has we discovered is so important to the system as a whole. >> i guess the question then would also be have we had an opportunity to be able to address that or have you? if you look also particular operation review. this one is dated december of '09. there are still references here to the timlyness of the supervisory products being a concern. and that it is in fact a repeat

findings from the 2005 operations review. and their further citations that relate to supervisory ratings not being updated on an ongoing basis to effect to the financial condition to the organization. do you feel like the responsiveness at the supervisors at the federal reserve bank in new york was swift enough to the circumstances? do you think they should have been more aggressive in the ratings and reportings of the condition of citigroup. >> i believe these are the most capable, most talented, public servants i've ever worked with. but i absolutely agree. i've said that many times. i do not think we did enough as the institution with the authority that we had to help contain the risk that ultimately emerged in that institution. and i think a lot about what we could have done differently.

maybe part of is it about resources. i think it's more fundamental. i think the system again we were operating with a set of rules that did not compel firms to hold enough capitol against the risk they were taking. they did not capture them. that's why i believe it's so important in the reform process that we rely not so much on the discretion of supervisors to force more than the framework, try to get the rules better. and so that firms can live with the set of measurable objective rules. you not forced with the risk that these very capable people because of other preoccupation that are burdens were insufficient leverage and traction. you don't want the system to rely on their ability to force terms in conservative in the rules. i got to make sure the rules adapt and force more themselves. >> do you think there should have been more examination of

the off blast sheet of sit tough group, specifically the underlying assets. is that something you think would be beneficial? >> a lot of this has happened. you need to make sure they come on balance were or stay off, you force people in the exposures, just one note though. one risk themselves did not in the end prove that large in that particular case. but it was a particular across the system. and it made it much harder for people to understand what fundamentally might be the ultimate measure of losses in a lot of institutions that took too much risk for the real estate losses they had. >> thank you. and i think i need to enter these two reports that i sited into the record.

do you need information on that? >> i'll note the 2005 operation report and 2009 operation report; correct? can i quickly though, i want to prez one last point. in the federal reserve banking, we did not citi's off balance sheet, in the end as we understand, what happened is they have been reporting the $13 billion subprime exposure. as you know, i'm sure you're quite aware in a matter of weeks leading up to mr. prince's resignation, that was revised upward $55 billion. they took that $25 back on to their balance sheet even though they weren't legally required. we can at least say it was terrible. the other thing that was pointed out to us, the examiners complained about the provisions

of graham-leach-bliley and kept them blind to some of the asset quality problems. it sounds to me like there was a whole here. the offbalance seat endties, vehicles, and no one is looking at them. so they did pose a risk or at least certainly a potential. >> absolutely. i agree they were material in the sense. this system, this system of a whole bunch of different regulators looking at pieces of the entity. the fed is supposed to be looking at whole thing. accounting regime. capital that didn't capture the risk. internal checks and balances that failed to transfer. that system did not work. >> by the way, i should add the scc toll. they really fell, it seems to us, at least my reading of into a black hole of shorts. >> right. >> or a gray hole.

>> many problems with the problem with the hole is it looked like it was called aaa or supersenior. and people didn't say how big is a cushion of loss source is underpinning that. that's why all of the sudden stuff that looked like was risk free had a lot of embedded. >> they were cdos. with that, i want to thank you all. thank you about all of the commissions were coming here today for your time and answers to our question, mr. vice chairman. >> ms. -- mr. secretary, we're going to be sending you a list of causes. probably more fundamental than that. as one the architects of the financial regulatory reform that's currently being examined by congress, would you provide a 30 second or 1 minute pep talk to the commission as we're going forward, attempting to find the causes of the financial crisis

while you and others have already decided what it was? [laughter] >> and you can take a minute. >> you are doing such a terrific job of exposing the full range of fundamental causes that you are helping the cause of reform. because we can match very closely the causes that you've exposed with the core of the reforms that the senate is now considering. you are giving great energy and urgency to the task. even if the senate enacting, don't stop your exercise. because that's just the first stage. we are still going to have to be not deal with the gse and housing finance markets. we're still going to have to process that you are

undertaking. it'll be the prosses that was formed and the work you had ahead. not sure you wanted this, mr. thomas. please encourage our leaders in the senate to act on reform. so we can get on. >> i'm trying to explain to them the institution and the fact that the committees have jurisdictions which don't necessarily cover everything that needs to be done. by the leadership in congress but the fellowship sometimes doesn't get there. >> i'm learning that myself too. but i think we're close now. and i hope they move quickly. i think there will be an enormous amount of work that we have to shape. and the process of inquiry that you've laid out will be enormously important to the work. >> final work. we have to quit talking about it as history.

it's here still. >> the vulnerability, absolutely. we're living through the system that caused the worst financial crisis since the great depression. and it's worse than that. because we had to do things no one should have to do that create the risk of moral hazard. if we don't act to fix those problems, we'll be more vulnerable. my compliments to what you are trying to do. keep at it. don't stop because we're going to get the bill done. >> thank you very much. we got out of that question and answer unscathed. we will take, commissioners, a 15 minute break. we will recommence at 2:35 -- actually -- 2:30. we'll take a 12 minute break. thank you very much, mr. secretary. [inaudible conversations]

>> we'll begin with the commerce department lawyer, gary. this is an hour and 20 minutes. >> welcome back. ladies and gentlemen, as you all can tell, these things run their course and we'll full in the

morning and laggers after lunch. but i think if you look at the agenda, you'll see that the afternoon promises to be just as substantive, just as engaging and to kick that off, we have some opening remarks from our general council, cam carey. just a couple of thoughts before cam comes up here. at commerce, we've kicked off the internet policy task force. the executive sponsorship for that really comes from cam and my boss, travis sullivan, the director of strategy in the secretary's office. it's been a pleasure to get to know cam. to put it into context, i think you saw this morning, the type of leadership that we have both within the commerce department on this issue with michelle o'neil guiden one panel and

larry guiding another and the support we have for the rest of the administration. one of my pleasures at being at the commerce department is i get to see others a spents of it as well. most people don't know it, but the commerce department is very sprawling in its composition and in its mandate. to the south we have the cap and trademark office. we've actually got an incredible leader down there. we have our headquarters across the street. up in the north we have nist. which is led by pat gallagher. somebody at a senior staff level, it's a pleasure of mine to be able to work with a very, very strong suite of executives going from the pto through commercial department headquarters and out to nist. one of those strong executives is cam carey our general

council. cam has spent years in private practice. many years as a senior partner at the law firm of mince levin. cam was the lead of the group up in the boston off until he was on the counsel. but he's transported himself down here to work for the administration. again, he provides great leadership and great wisdom on e-commerce issues for us. he's just a great guy to work with. thanks. [applause] >> well, mark, thank you. good afternoon. i think this is -- builds on the program as afternoon remarks. i thought we might sell more seats and bring in some of the lunch time laggers if we build

it as afternoon delight. but i didn't win that fight. boy, i see what secretary locke was talking about this morning. i feel like i'm the umpire in the tennis match in this room. this morning, secretary locke highlighted some of the astonishing statistics about the growth of e-persian and our reliance on e-commerce and on the internet. among other statistics noted that online transactions today are are estimated to total $10 trillion annually. and expected to pass $24 trillion by the year 2020. but these remarkable statistics actually understate the impact of the internet and the digit

tat -- digital economy in this ere ere -- era. they don't measure the massive amounts of data that are moved across the internet. mind, by academics, and by corporations for research. taking advantage of vast increases in computer power. they don't pressure -- measure the efficiency gain for business that is use b to b techniques for inventory management. they don't measure the welfare games for consumers from increased choice and competition globally. as the previous panel discussed, during -- during the discussion of innovative with personal

information. increasingly, data is being used personalize online experiences to make product recommend and to connect people with many different kinds of communities across the the globe. nor do these statistics measure the full impact of the internet on our society today. it's not only a vehicle for internet -- economic transactions, it's the backbone by which we communicate today. it flattens organizations. it decentralized politics. and it changes the way we communicate with family, friends, and with colleagues. i've watched this unfold as a communication lawyer going back to the days of the computer

inquiry. and as a consumer back to the days of a text-baseed delphi internet account. when it came to the department of commerce, i knew and came there with a sense that we have a special responsibility of stewardship for the internet and for e-commerce. i recall that in 19 e79d, the department of commerce was a leader in establishing the global framework for e-commerce. and it's with that role in mind that we have launched the internet task force and launched this privacy inquiry and other inquiries to follow. and in doing that, i've headed mine the role of one of my

predecessorred, andy. andy was a leader in formlating some of the best thinking around a range of internet issues. along with our morning pannist, larry irving, when he was the assistant, he knew if we were going to build the internet to its potential, the united states government needed the right touch in the process. so it's an honor to pick up that manner of leadership. and as one simple message that i want to leave you with today. and that is that in this field, the department of commerce is

back. we are back to lead. it's a model that we want to carry forward as we update the framework for global, digital -- for the global digital economy in the 21st century. and we're back because our continued economic recovery and tomorrow's pros -- prosperity that's able to innovative and expand. we're back because the internet and e-commerce depend on trust to flourish. we're back because the government has an important but delicate role to play in preserving trust and enabling this digital fabric across our society to flourish.

trust and privacy are central to the mission of this effort, central to the mission of the department of commerce. earlier this year, secretary locke established within the department a department wide internal facing privacy council which i chair. one of our first acts was to adopt a privacy mission statement for the department of commerce. it says that the department of commerce is committed to safeguarding personal privacy. individual trust in the privacy and security of identifying information is a foundation of trust in government and commerce in the 21st century. as an employer, as a collector of data on millions of individuals and companies, the

developer of information management standards, and the federal advisor on information management policy, the department strives to be a leader in best practices and privacy policy. to further these goals, the department assigns a high priority to privacy considerations in all systems, programs, and policyies. to lead on the external privacy facing issues, we are committed to ensuring that we serve as a leader in an example for the u.s. government in best privacy practices, facing inward. hundreds of millions of americans in trust in the department of commercial with protected and sensitive census information. corporation trust us with trade secrets. applicants to our many grant

programs trust us with their dreams and with their plans to the future. with this privacy symposium today, we are stepping up our outward facing work. our objective in these forums is clear. we want to ensure that we preserve and we protect everyone's access to an open global internet. and where innovation and privacy can flourish side by side. as we begin the public conversation, i want to tell you about an asset institute conference that larry strikeling and i attended last summer in colds. our assignment there was to look at four different scenarios for the development of broadband. we were joined by leaders from the public sector, from

congressional staffs from the fcc from private industry, carriers, programming providers, nonprofit leader, from public knowledge and free press and academics from across the country. we were divided into four groups. each group analyzed a different scenario. and all four groups independly, these were people who are not shy about disagreeing with one another. they highlighted one driver or one risk in common for the continued development of the digit stall society. every one of them framed it in exactly the same terms, trust. trust. so for me, this striking convergence, consensus, validated a guiding principal

for our work as we embark on this new framework. it's working for trust. government has a vital roll. a vital role to play in bringing together many stakeholders like you today to ensure a foundation of trust that can be adriver for a security and sustainable, digital economy. as evidenced by today's symposium, we're proud to be at the -- and to serve as a leader within the executive branch in the continuing interagency conversation on these issues. we look forward to working with our colleagues at the ftc, at osdp, the state department, and across the country.

i want to recognize some of those colleagues who are here today or who have been here today. in the department of commerce and the federal trade commission have had a productive partnership on privacy issue for many years. it's a relationship that we look forward to continuing for many more. we are fortunate to have here, jessica rich, the ftc's deputy director of consumer protection. she's going to appear on the next panel. and i want to extend a special thanks both to the ftc and to jessica. we have worked closely with the ftc on many issues. globe trade and privacy issues, as many of you know. the european safe framework, the

asia-pacific commerce, the oecd working party, the trilateral committee on transborder data flows. so as general council, i look forward to the job of bringing the insights that you offer today, that you offer in response to our notice of inquiry to the ftc, to the fcc and across the government. the also want to recognize for their participation today ambassador phil ve -- revere and u.s. coordinators for communications and information policy. also andrew mclaughlin, the

deputy chief technology officer. i thank you them for their leadership and for their support on these important issues. and we are truly fortunate at the department of commerce to have with us the kind of recognized experts in quality thinkers and leaders in mark and in danny. i want to thank mark -- not just for his kinds words of introduction, but for importantly for his leadership, his vision, within the office of secretary. and i want to thank dany. -- danny. not just for his work on this

symposium, but for his brilliant work on the day-to-day leader of the department of commerce effort this -- in this arena. while there are too many here to acknowledge individually, i do want to acknowledge the many staff from ntia, ita, from nift, and across the department of commerce who have worked hard on this issue and in preparation for this symposium. if you are here, would you please stand up and be recognized? [applause] >> but finally, i want to thank all of you. you're participation this this symposium here today starts a

new focus in our conversation. if you haven't done so yet, please submit comments on our noa for comments. we need to hear your thoughts and give us your insights as we grapple with the many difficult issues discussed today. and outlined in the privacy notice inquiry. i said to somebody earlier, one the striking things in this field, and i'm sure you've seen it today, you can put together people with extraordinary intelligence and command of public policy, and familiarity with this area. and have a discussion with many thoughtful questions. but, you know, still struggling to find answers. so our task is certainly not an easy one.

this is nothing less than a comprehensive review of the access between privacy and innovation in the internet economy. we're dealing with technology that moves faster than government policy can adapt. with changing consumer expectations, multiplying global marks and regulatory regimes. we need to hear from you how the u.s. government can strike the right balance between privacy and innovation. we can't address these issues without your help. so thank you for your participation in today's symposium. we look forward to continuing this partnership as we move into this next chapter of the internet age. thank you. [applause]

>> if the panelist for the next session wouldn't mind coming up and populating the seats. i want to come back to a point that i raised earlier. before taking this job we worked in corporate america for 20 years. and 12 of those years with one particular company, and i've worked on many, many public policy initiatives. and public policy initiatives succeeded when we had support as follow si advocates from the executive sweep -- policy advocates from the executive suite. i saw another indication of the strength of the support that we have as policy staff at commerce department from our executive suite. cam carey couldn't have been

more articulate in showing the high level of support for this initiative across the executive tier at department. with that, we'll return to geek and wonk speak. we have pretty much a continuation of the conversation that we had before lunch. although, this panel has more folks from the business side than the earlier conversation. and what we'll be able to drill into brass tax issues more. we'll also not be endeavoring to do live demos. we will be throwing up a few screen shots so people with see what some of the developments have been occurring in the arena. before we move on to the brief demos and the conversation, just a few framing remarks.

i'm one of those people who enjoys looking at the internet economy and the internet as a whole through an evolutionary lens. that we see piecuation on the internet. we see new ways of doing things that people couldn't have foreseen or predicted five years, 10 years ago. one the things that paleontologist will tell you that human and animal evolution never occurred really at a continuous rate. rather there were periods of instability andic lib yums. the pace of evolution speeds up dramatically. and the out comes are highly unpredictable. and what we've got, i think, in

the internet area, we are fortunate to be living through this is that type of rapid evolution, but in the commercial separation and in the development of social technologies. communications technologies, for example. and this brings, you know, tremendous benefit. cam went through them. we all know them. but also policy changes. i think one the biggest is that we see the pace of innovation in products and services moving out so fast. we know the legislation and policy development moves at the tortoise speed by comparison. what do you do about that difference in time scale? we also in this space, in the privacy space we know that corporate leaders, innovators are constantly developing privacy enhancing technologies. i think we need to be honest that the development of privacy enhancing technologies is not quite yet at the same pace as

development of internet technologies and services. so we have racing out ahead of us the development of new services and new technologies. we have at a slightly different pace the development of privacy enhancing technology and lagging far behind in legislation and development. all of these three things are in play and hewing at different time scales. i don't have the answer. i don't know if any of us do. that's one the purposes of the inquiry that i hope our panel can focus on. with that let me pass it over to a handful of folks who have been in the midst of developing these prior si -- privacy enhancing technologies. mike zanes will lead off and

then reed taylor. if that's even a word bbb, bricks and motar company or organization representing 10 years ago recognized internet was a new thing. they were a leader then and they have continue the to adapt it. we have representatives from yahoo! and at&t who are also leaders in the space. once we get through a few of their presentations, we'll discuss what people think about them. so with that, mike? do you want to -- >> thanks, mark. i appreciate it. i think i would like to kind of reconfirm about the statement.

i think there's no better question. that's the point as an industry. we are looking to activate. i think i probably have the best job here today. i get to stand up and represent the collective wisdom and work of hundreds of company that is have come together to push the envelope on new innovative ways in pushing consumers notice and empowering consumers choice. specifically in the online space. i don't want to spend a lot of time with the history and the process, suffice to say, we took a lot of cues from the federal trade commission hi when they put out the principal for self-regulation. it's been a long process. it's been an inclusionive process. really resulting in last july, the set of oba privacy principals that really seven principals. i'm going to talk about the choice and transparency principals today. that's what we're here to focus on. but these principals truly are

revolutionizing the way cob assumers get information about howdah that is collected and used -- how data is collected and used online. it's also revolutionizing the scope in which they are empowered to opt out of that and say no, i don't want to be targeted. so, you know, just a little bit about the scope. when all is said and done, when you look at the steering committee made up of our partners with the protect marketing association, the council of better business bureaus, the association of national advertisers and the american association of national advertising agency, when that grew to trade associations and literally hundreds of companies that come together to consider the principals at the board level and unanimously approve these and move towards implementation. i just want to point out because principals are great. until you see it in the marketplace, you don't have a whole lot to stand on. so you look at the collective

membership of these trade associations. you are talking about 5,000 leading companies. advertisers, agencies, marketers, publishers, ad networks, portal search engines. i'd also commend the direct marketing. they've already incorporated into the member code of conduct. so their members are already beginning to come into compliance as some of the other trade organization. let's really look at what we're talking about. because fundamentally, there are two ways to deliver notice to consumers. you can do it through the web site. the first party publishers. or you can do it through a third party. i want to focus on an example. this is live this week on publishers clearinghouse, powered by the trustee, whoever everybody knows as the enforcement compliance, third party program across the industry. if you look at the ads, you can

see it targeted. they know i live in vienna, virginia, probably throughhe i.p. address. if you look in the ad itself, you'll see the icon and a notice. :

and innovative and that is the key today. so treatment that was locked up by a company called utter advertising that is a compliance program that helps people come into compliance and live up to the privacy principles and if you look you have the notice within the and nothing could be more easily discoverable by consumers than the notice of data collection within the targeted amount itself and so as you go through, consumers want to find more information and you click on it on the ad you get an over lake, it takes over the air.

from member this is different from the first publisher notice because the third party doesn't have access to the entire website said the have to respect the territory but it takes over the ad is false and there is a meaningless information how the data is collected and you can see right there if they want to -- if they keep going forward and if they want to opt out of the data collection and hour of the targeting it is very easy for them to do and as we go to the next slide you will see how easy it is to opt out of the targeting. so this is the landing page. i just want to show to representations of innovative, creative ways the industry is implementing new types of notice, and the key of choice is to make sure for the first time everybody in the ecosystem is complying and participating and respecting consumers' privacy expectations. that is the real evolution. there's nothing new about the opt out but to have everybody doing it even people that are not front or consumer facing is

the key so, principles are great. we are seeing notice and twice that in the and we also need accountability and i want to highlight, lee is going to talk to the council of better business bureaus been a partner from day one and bigotry program but i also highlight v dma ray the trey program that has a long history in this area and the trusty we showed the treatment from trustee and the service so there's a commitment to enforcement and compliance and with that i think i will let lee takeover. >> am i on? how about now? [inaudible] and an as mark said. the process of adapting.

we will be 100-years-old next year. i wasn't there when it started of course. [laughter] what i want to do today is talk about how self regulation can fit in with the problem of commerce overall work at privacy principles because one of the themes from this morning was what this space needs more than anything else is standard of flexibility and one of the hallmarks of any self-regulatory approach is flexibility. the probe into the eckert problem is when you go out and do your basic google search on the self regulation you come up with pretty pejorative widely misconceptions about the self regulation is. my favorite was an article in the newspaper the describes self regulation as an oxymoron. i don't think it can get worse than that. but there's a different view of

self regulation. we are trying to develop in this process mike was talking about and that is to basically make third-party accountability program and up principles adopted both we and the direct marketing association has undertaken to construct just that and the idea is you have a third party either as a bbb or marketing conducting oversight, compliance with the principles and that is a very remarkable but in addition we have committed we will be transparent about the trading that if we find a violation we will report them publicly and if they are not corrected we will refer them to the government. now, there is a track record here that shows that approach could work. we have administered for years and organizing and called the children's advertising review unit that looks at all

advertising directed at children in any media and has a specific set of principles on privacy and those principles both parallel and the privacy protection act and some instances go beyond this. these are standards developed by the industry. they are applied across the board to every industry member whether or not the industry member has said they agreed to comply with them. the children's advertising review unit monitors that space. they have in the last two years more than 50 reported positions in that area. they have 100% compliance. what we have 100% compliance is because we get great wonderful support and back up from the federal trade commission and certainly that is one version of self regulation, the self regulation is something that supports regulation. there's another version of self

regulation that is in lieu of regulation or goes beyond regulation and in fact most of the self regulatory activities for children online privacy do involve provisions that go beyond the basic provisions of the privacy act and require screening by sides of that may be attracted to a significant number of children so going back to where i started, i took one of the things the department of commerce could be doing is trying to develop an intellectual basis and support for the process of self regulation as part of the privacy protections and i can from a meeting at the ftc, the international consumer protection enforcement network which is a ground-breaking organization the ftc put together to bring together consumer protection officials from all over the world to talk about court made it standards and coordinated consumer protection. i can tell you the concept of using self regulation in many

countries is not as well developed as it is in this country and even in this country it could be better developed. that is an explicit goal of the program we've undertaken with the support of the company's and the room and all of the advertising trade associations. thank you. >> [inaudible] [laughter] >> so those on the panel can see the slides we are kind of reaching -- i wanted to talk and get examples how we are dealing with notice and twice today. i've been to a lot of panels like this and it starts off with five conversation of the notice and choice are dead. they are old antiquated ideas and i think what nicole said this morning was instructive

that its notice and to place ten years ago was a two dimensional thing. interestingly enough when i was looking for the agenda i did a search on the ntia privacy and came up with an event held in 2000. a lot of the same topics being discussed. eight, ten, 12 years ago but i feel this different is the way we are approaching them so when we think about the notice and twice today we are thinking about it in a different kind of world than notice and choice ten years ago. when i first started at dahuk we'd adopted a policy and put links on every single page and thought that was kind evolutionary a company would tell consumers what we collect and how we use it and it's an important thing to have but we have tools today we didn't have a favorable ten years ago because we have evolved. the web is a different place. if we were talking about this two years ago we wouldn't have been talking about facebook or rhetoric. we would be talking about different wed experiences so

what we have done on yahoo! if you go back i missed my clicker, i miss the country. we implemented an icon on the front page and on the male page with the ads we show. those are the most heavily trafficked pages on the internet today. we have been thinking about how we provide context will privacy notices to consumers because what it's about today is not in a document or a number of choices you tell consumers find it, read it, manager of them some place. it's about giving users the choice of information they need in the context of their experiences and advertising and privacy in that context is one way that we are doing that and this is an example of that so when we started thinking about this actually it was three years ago when yahoo! entered into the third party advertising space. donner who has been serving ads on yahoo!'s site for 15 years but the idea serving ads off the site put us into the new camp of

being a third party ad network and we worked with a number of partners including ebay and wal-mart and we spent time talking with them how do you provide privacy notices so that consumers know yahoo! is involved in the transaction we are providing some customized services and adding services for two so what we came up with is an idea of information and the note this context we. the challenge to bring this from the publishers' standpoint is every publisher has to make changes on their site, on their templates. that is a rather difficult problem from the skillet of the stand with. on the internet we are thinking in terms of scale because this is a fast-moving medium. the partnerships and arrangements are changing daily and the advertising ecosystem has gotten -- it is different than it was ten years ago and an ad network in the contract and the entities work together and they were shown by one network or two. today you have a lot of players

and the ecosystem is more complicated so we were trying to figure out how to make it scaled and we thought we could do it better from the ad network perspective they necessarily the publisher perspective so we have been testing a couple of different models. this is one we are working on the ninth choice label appears next to the little circle. joel is a free with the privacy forum and a number of other companies work together to test this out. i think what's important is to go to the next clich you will see a blow up here represented on the front page, the idea was to give consumers a meaningful marker that would let them know here's where you would find more information about privacy. there are ways to convey the information that isn't helpful. i'm sure everyone has a credit card and have gotten in your statement a privacy notice. am i right? how many of you read them?

that is still not very many. even this audience. so many have lost their lives. many billions of dollars are spent in compliance and i am not sure the consumers are better off. one of the things we were keen on doing is to test this out with consumers and find out whether it is helpful to them and i know that jewel can speak more to that. click again and this is a clean the page that shows more information. some educational information. the goal in the future is to baliles this down and right now we are not using -- we are testing for later this year this idea of transmitting with the ed data about the ad and its referred to as many of the doubt. the idea is when we serve an ad with an icon we can convey information about who the advertiser was, for the ad network and where you can go to opt out specifically of the ad network information's of this is web 1.0 but we will be giving a lot more of this in the next

year. one more time. this is where it takes you today. this is where you would go to express choices with yahoo!. we launched the ad in december of next year and the goal, this was a long time in the works was too feeble to convey to the consumer the information we are using as part of the customization process and let them exercise their choice. it simply and you can opt out by exercising the one yellow button but we are giving more information to consumers about what information we hold and how we are using it. a few years ago there was concern of showing as much information to consumers but what we find is that by being this transparent giving consumers disinformation it's incredibly in power in and did demystifies the process to a large degree when you talk to the consumer about what information is collected and used there is a sense and i got this message and click on this link it was a porn site. i didn't want to go to a porn

site. and it is not as being used to customize advertising and we show you what we are using and to give control over it and it is allowing the consumer to engage with that and we are finding that it's demystified and giving people more comfort how this whole process works so this is the clear process what we have launched. i encourage you to take a look at it. it is at privacy.yahoo.aim. there's been conversation about op can and ought not and how to wheel for discussion on to the by mary set of choices. a lot of people in the industry would say it's a spectrum of trace. it's not -- there's not one way to read or another way to do it. we tend to think of our model has more of an opt out model but we are doing that of adult model with exceedingly clear notice to consumers with this kind of transparency control. i think it's actually a very

good way to go. i want to look and see what it is we are seeing. ann mentioned the industry is getting challenging because you have a web publishers on the networks, isp and al qaeda factors in the ecosystem. i would tell you my company is highly challenging because we are all of those. so within one company trying to manage the different business interests as we talk about privacy has been produced pretty good results and with our partnership and yahoo!, in fact

att.net is powered by dahuk. we get the benefit and all the innovation mike is talking about with the iab, we are good partners with mp3 really want to point out a couple things in practice because we are the living laboratory of this is a large brand name is an advertiser on line, the top five advertisers on 90 we are also the number one isp. and we of the top 50 web sites so we do play all of these roles. how does one navigate through them in the era of privacy with the notices are sufficient one feature. we collapsed or privacy policy a year and have to go from 17 policies into one. we did a huge redraft and created one-stop shops for privacy for all the businesses, wireless, isp, publishing all included and by drastically reducing the number of words but

i can't talk about putting video up and one feature i would highlight for this audience we have not talked about is the intentional intent to engage the customers in the privacy policy and we did that by will win out the new privacy policy with a 45 day preview per group. we spent over 100 million, that's over 100 million notices through their bill inserts and the web can pay to say check out the new privacy policy. the drive them to the site and on the site of the site where you first got on to the single unified privacy policy we said tell us what you think and by the way the policy is not going to be effective for 45 days so if you want to tell boy you think we will in fact week to hear what you have to say and listen. we answered every one of our customer inquiries and 45 days later when we need the privacy

policy effective we did in fact change the policy reflecting some of the concerns about language that wasn't clear despite the fact we had focused groups in the early previews of all of this. we found in fact the customers made really good points about the clear language and we changed and they created worry with our lawyers and internal to the business you are letting the customers tell you how to write a policy but it turned out to be a tremendously effective tool. it was well received and as we all know it is as privacy provisionals changing terms of service on the privacy policy is a flash point in any event and the fact we use the customers as our own kind of laboratory with highly effective and i would encourage everyone to do so in part of this process for us internally is recognizing engagement is the key to be an

effective advocate for the customers. so, flipping i don't know where we are on this. a couple other things. yellowpages.com, is that where we are? another interesting thing, our major publisher as i mentioned and is a publisher beyond our att.net we also have yellowpages thought, and now it is yp.com we are looking to the customers and we realize in that context we need to be even clearer so we added a link at the bottom of the page that says advertising choices. you click on that blanket and you can turn and in fact as others subscribe, as ann described a comes the ability to do two things. one, opt out if you not want to be part of any kind of collection of data and links them to the opt out and brings you very quickly. but it also tells you the

advertising policies are separate from the privacy policies. if you want to understand that we try to do it very clearly in addition to that you can click we also worked with our friends at blue car to create eight manager. we are talking about a very different skills and yahoo! publishing site but in fact we ended reading the customer preference is allowing the customers to find out what was being collected, how we were making the advertising and in fact allows manipulation of the interest categories depending upon what the customer felt they wanted including not being a part of the interest category. in addition to that, we also -- we are not the delivering of of order. we took the icon and whether that makes a difference not just advertising on the bottom page but let's take an icon. working with joel in the privacy forum we picked one of the top

three that had been tested, the icons had been tested well sadly for us it is not agree to be the times man. it will be the eye. we like the times man because it looks like that guy. [laughter] like ann we've been testing it in the human factors context where we see people where do their eyes going and where they drop on the page. or the understanding that, does coverage help? so we have been trying to be a living example of industry innovation anytime there is one we jump in and say we will tested and tried to the contrary it. i was going to add yellow p gistel, is a local search engine very popular local search engine in addition to that we have gone beta on a bus product, not the others, this is a recommend

terse site that allows our customers when they're looking for a local search engine entry to actually say i want to go the recommendations do you want to participate in a recommendation from your family and friends on the best for it civil you were looking for a souci restaurant in san francisco and want to send the question out to your group of friends or family you can send that out and expect answers to come back so the local search is enhanced by your recommendations of people that you know. go on. i should say if you go back for one more slight. at the bottom a couple of things we did hear which ads to the discussions again we wanted to engage the customer in the actual privacy designs of this. we first fall at the bottom we don't say link to the privacy policy. we say very clearly here is how we are going to share information on the site and we

make it very clear and identify it for what it is, the sharing of information of the protection of privacy. then go next if you click on that and you understand it come part of the future of the product when you are engaged -- when you go to the recommend terse site a feature is identifying who are and who you are reflects how you want your privacy settings to be. so as a part of the actual product, you have to identify at the outset are you shy or outgoing? we use words people understand, not tricky words that shoddy or outgoing. then we explain what we mean by shy or of doing by identifying what in fact that means for the customer. shy, more protective of information come out during you want everybody to see what your recommendations are. in addition the final feature of this is we say by the way,

shoddy is anonymous but it may not be anonymous because if you are asking for the best sushi restaurant in madison, wisconsin, and you have for friends and you are anonymous but are the only one living in madison, wisconsin, people might figure out who you are from the context of that even though it is synonymous. so we made clear in the statement very upfront by the we don't send sensitive information thinking it's anonymous because it might not be. we want people to use the service but by the way let's be aware anonymous doesn't necessarily mean private. it means donato must unless the context suggests otherwise. so it is an early on site. we try to build in the privacy features as an element of privacy, an element of and working with our business we didn't go out and say let's figure out whether this sort and pull it back.

the industry is really to side on that point. some people go out and make mistakes and come back and we are all there because we've made mistakes in the corporate setting as well but in this context we deliberately try to go forward and create the right privacy changing of the outset. we will see if it works and people like it. thanks. >> jessica, would you like to rejoin us? [laughter] jules doesn't have slides. getting back to where i start to think i see an extraordinary amount of adaptation and the privacy told of a lot of space and last time i engaged in this

actually was when it danny and i first met and we were working on the platform for privacy preferences and whether we were giving people too much risk, too much granularity etc and we will also working with bbb on the seal and trustee on the seal and its easy to say back in the world was two dimensional and now we have lots of examples of more sophisticated privacy enhancing technology and i think what i would like to hear the panel discussed and started off with jessica and then jules is how far does this get us? there are a number of issues. ann mengin the importance of scale. it's important for one company but also important for the entire ecosystem. one of the things that lee mentioned that might have been passed over people's heads is that it's going to go out and they are going to probe the

sites that haven't signed up for some of these processes so just like in the cairo example somebody could be sitting out there if there is any business that doesn't have a privacy policy and can get a note from the bbb saying guess what you are expired and you are not following the practices. the other interesting thing is we see a lot of experimentation in different companies approaches which is great but confusion on the part of the consumer, when do we get toward something that is more standardized it's important to press the standardization and then i think the big question is we see that this is effective for our i assume people think the tools will be effective for u.s. consumers in the u.s.

context. people noted overseas are of little development and adoption and self regulation isn't there so where does this get us in terms of the global tunnell? these are the pressing questions. t want to take a few of those? >> [inaudible] >> i think we need a microphone. >> i will start with the middle question and see if i can meander to some of the others. i think it spoke to me to say is this going to be confusing for consumers? just to start off everything everyone described here today is with the federal trade commission called for when it asked for self regulation of asked for greater transparency in the july advertising in