martin and tom may have a lot more to say than i, i'm skeptical of that argument. i think that there is some amount of uncertainty that businesses have about the business environment. and there's some uncertainty that financial institutions have about the regulatory environment. but i think they're very different concerns so the uncertainty in the financial environment i don't think is inhibiting major financial firms from lending right now. >> they have huge sufficient capital cushions and sufficient funds to lend. i think the economic uncertainty for regular businesses is inhibiting their ability to hire workers. and i think that is harming the economy. >> martin, what do you have to say about this through mckinsey i'm sure you're in frequent contact with business executives? >> yes, i am, although mostly mckinsey to businesses and they

are not facing -- they are concerned about a lot of things including the future taxes, regulation, all that kind of stuff. but i don't think their borrowing costs are particularly a concern for them. i am aware of -- it's harder to get a reading on small business and one reads conflicting stories about it. i think there are small businesses who would like to expand, who are having difficulty getting funds. i think there are a couple of reasons for that. if you're talking about really small business or startups, i think that's because traditionally they have relied on family and friends and equity and homes which they don't have. so i think that's a fallout from the house crisis. >> credit cards? >> and credit cards, for that kind of borrowing. slightly larger businesses, i think there are a sum that would like to expand. i think many don't want to expand because they don't have the demand but some of them

would like to expand and are having difficulty. i think it's not so much because the banks can't lend to them as the -- you know, the risk premium has gone up, i even hear that bank regulators have become rather more cautious so they're looking over their shoulders of the banks and say, i'm not sure you should be making that loan. so i think we do have a problem. i'm not sure it's associated at this time with capital requirements. i want to make one quick comment on the earlier discussion. and while i think it's certainly true that the shadow banking system played a huge role in this crisis, i think there were plenty of regular banks that got into a lot of trouble, too, wamu, wachovia, citi and others and a lot of smaller banks, state-regulated banks that originated a lot of the bad loans so i think this really was a housing-related crisis, a lot of the moral hazard occurred

because of smaller banks that initiated loans and then sold them off to someone -- someone else. so i think it's a mixture of the nonbank and the banking sector in this crisis. >> i'd like to paint the scenario and hear how you all respond to this. imagine a moment which doesn't seem unmanageable to me in which european -- europe loses the political will to continue to fund greece's unbearable debts. greece defaults. this has a negative effect on european banks which remain undercapitalized. a big bank or two fail. this causes a run on american money market funds which have exposure of about a trillion dollars to european banks.

and we find ourselves very quickly back at a moment very much like 2008. do you find a scenario like this to be plausible? and if so, what has dodd-frank accomplished? >> maybe i can start and others can join in. first of all, i think it's a terrific and i think central important question. i do think there is real risk right now, as there has been for many months now, that crisis in europe hurts the -- not just the european banking sector but the u.s. banking sector and the u.s. financial sector. the money market fund system is still, i think, not fully resolved. that is i think the sec's changes under rule 287 that

improve the liquidity position of money market funds is good. the bazzel liquidity rules that will kick into place for the banking sector are good and will help. the capital margin and collateral requirements in the repo sector will also help significantly. and weaknesses -- i'm sorry, the last i would point out the significant capital cushion that's built up in the u.s. financial system, rather remarkably in the last -- in the last year will also help a lot. so in all those senses, the system is more resilient. and safer than it was just a short time ago. i do think we have not yet fully reformed, if you will, or fully solved the problem of the money market mutual fund system.

>> and you saw -- you've seen proposals across-the-board for different approaches to that including either private sector capitalization of a liquidity fund or floating requirements or split hybrid requirements of floating nav products. i think we're going to have to continue to make reform in that area, to bring more resilience into that aspect of the system. >> yeah, i think -- i agree with michael. i think that in the future, we're going to have to see some reform of the money market industry to bring it more under the regulatory umbrella. there are a lot of reforms being talked about and put in place. it seems to me they're not quite sufficient yet. although, i'm less worried about the effects of the scenario you described for just money market funds, per se.

i'm more concerned about what the contagion effects of such an event would be for the european economy because right now it's kind of a knife edge. and everybody has a view about greece and i don't know of any positive ones. there's slightly mixed opinions about portugal, they have a better program in place. >> but the big worry is spain. and then if spain comes under the microscope, then italy. and there's the potential for major sovereign debt crises. and those could easily trigger an event like the one we experienced a few years ago, so -- >> i agree with that. i don't think there's a prayer that greece can avoid some form of default and so there is a question of whether that triggers -- i think the greece

default by itself, if it stopped there, wouldn't be so bad. whatever we do in the united states, i think, germany and france bail out their banks. so they would bail them out. and prop them up. are they going to bail out greece which i think would be a bad idea or are they going to bail out the banks, i say it's a bad idea to bail out greece because i don't think greece can repay all this debt in order to service all this foreign debt, it has to become a net exporter and it's going to be a while before they get that part of the thing in shape. they're not competitive within the euro. but, yes, if the -- excuse me, if the other dominos start going down, then watch out. maybe a good time to put one's money under the mattress. [laughter] >> i got one more question and then we'll open it up. has everyone on the panel talked about the disparity between what

good policy looks like on paper and what policy constraints. i would like to hear from michael about what lessons you've learned about how to manage the political constraints that one faces when trying to construct new financial architecture. and i'm also interested in hearing from the panel -- this is, obviously, an age-old problem. but to what extent do you think our political system is more or less capable of producing good policy outcomes in this day and age? >> i don't know how to answer that, jon. i was laughing over at you. i was looking at amy friend who joined us and amy and i had lots of conversations that were about that very topic.

and amy was right more than i was about the answers to that question. but they were usually pretty pessimistic answers. so what do you do? i mean, it's like any other constraint. i mean, we live in the world we live in. and not in a different world. and the political system is no different than that. and it's much better to design good policy that works for the world you live in than to design policy that works for a world you don't live in. so i think not just being pig headed is the answer i would give. >> well, there is a moment in history when it's a little hard to be optimistic about policy. everything is so polarized.

my colleagues at brookings that congress is more polarized. that is to say the most liberal republican is more conservative than the most conservative democrat so working out agreements in that environment is pretty difficult. to take a slightly more positive turn, i think we do pass legislation. we find out how it works. there is then a process. it's not ideal. i mean, it's got a lot of lobbying in it but it's also got a lot of politics in it and hopefully things do get better. i'm a big fan of senator sarbanes. he helped me get confirmed twice. the first round at least of sarbanes-oxley was not great. i mean, it was extremely expensive to administer. and it wasn't -- it's not clear to me that it added to the safety or accounting practices of companies. but it's been modified and it's now much better than it was. i still don't think it's great

but i think it's better than it was. so i think we do have to rely on this process and hope that it gets us eventually we find out where the problems are in the legislation and then we make changes. >> well, i'm slightly more optimistic. i think -- in spite of my criticisms of the dodd-frank act, i think it really had its heart in the right place and it's got a lot of the important ingredients that we need to make the system sounder and safer. and i think it's -- >> i agree. >> it's structured in a way that is open to interpretation and improvement. i think it's a remarkable accomplishment. i mean, it took the -- it took a crisis of that magnitude and it really was a severe crisis to get this done. so let's hope that every positive piece of legislation

doesn't require such enormous costs to drive us forward. >> okay. we have about 20 minutes, i guess, for questions from the audience. does anybody want to -- alice? >> i agree there's a lot -- a lot of positive in dodd-frank. >> you got a mic? >> okay, yeah. >> let me make a general comment about dodd-frank, although there's much to admire in it. dodd-frank and this conversation and others about regulation are very focused on the end stage on the crisis itself and what do we do when we ever get in that situation again and that's admirable. but the fundamental problem was there was too much borrowing in the united states. and very lax lending standards and it wasn't just housing. it was credit cards.

it was auto loans. it was commercial real estate. it was everything. we were enormously overborrowed. and i'd like a little bit of analysis from michael and others about what -- what do we do to avoid that again without going to extremes? i mean, martin said one of the dangers of the consumer protection agency is that it might limit access to credit. well, for heaven's sakes we need to limit access to credit. that's the whole point. we don't need to overdo it and it isn't just a question of poor people as often the conversation is, well, not all poor people should own houses. well, of course. but it wasn't poor people who were doing most of the borrowing. it was everybody. so what are we going to do about that and how does dodd-frank help? >> so i think, alice, that the

dodd-frank act is quite focused on setting up a regulatory structure that reduces leverage in the system. >> and i guess i encompass in dodd-frank that is being accomplished through the basel process. on dodd-frank, looking across the financial system not just at banks on looking at improving the resiliency of the system through the use of central clearing parties in derivatives contracts. the imposition of margin and collateral requirements for rebill and derivatives trades. the ability to require risk retention and securitizations. they're all examples of that kind of focus. >> that's the top end. you wouldn't have all those derivatives if you didn't have the raw material going in at the bottom. >> yes, i'm working my way down the chain. [laughter] >> i'm starting with the big

numbers. and then if you look at -- similarly, if you look at the basel process looking at 11 in the system and liquidity requirements and capital requirements, are all building more resiliency. and one of those provisions which you would think would not be required, that instead we would use commonsense but there's a rule in there but the lenders have to look at the borrower's ability to repay. it is now a requirement of the dodd-frank act that you get documentation of loans and you have an assessment of the borrower's ability to repay. and you can't pay a loan broker more to put a borrower in a worse mortgage than a better mortgage. and a number of other changes like that that are designed to go to the very front end and

then there are a set of rules in between. and so i think the act does get at this very fundamental question. >> i agree with the basic sentiment that you expressed which is this problem was overborrowing which then led to a housing bubble which then got us into trouble and once housing prices fell, that much -- the whole system was extremely vulnerable. i'll stick by my statements saying i don't want to constrain lending too much to low-incomed folks precisely in a way the reason you gave which is they weren't the ones that were doing so much excess borrowing. obviously, there were some subprime loans that shouldn't have been made, but the big lending was not to them. it was to mortgage to families wanting second homes and getting equity out of their homes and buying cars and boats and all that kind of thing. so i do think we need a policy

that ramps back the amount of borrowing that we do as an economy. and i would think the obvious way to do that in our current situation would be to gradually limit the tax deductibility of interest and make borrowing less attractive because after all, that creates -- i don't know if it's exactly a subsidy but it creates a very favorable circumstance for upper incomed people to borrow and does nothing for low-incomed folks who buy houses and don't get much benefit from that deductibility. so i would do that -- that's in the dominici proposal? >> yeah. >> so then i got it right. >> yeah. >> hi, paul, president of the clearinghouse. a question for michael and the other panelists. we're already seeing perhaps the unintended consequence which is concentration within the banking

system in part driven by dodd-frank, they announced a shedding of many of-it branches. i guess with the theory of the real estate challenges and under the regulatory framework and expense reduction is a principal driver behind many of these excessive capital deployment of that capital were it to meet historical roe potentials and driving more risk into the system so could you address those two banks increasing their risk to get roe levels that have been chopped and secondly, concentration within the banking industry that perhaps is leading to the bigness that we're so eagerly willing to curtail. >> on the question of on capital requirements leading to greater risk-taking, i mean, there is this fundamentally different set

of views about how capital requirements work their way through the financial system and you have, i think, some very smart people on either side of this question. so let me just state the two views and i'll tell you which side i'm on. all right. view number 1 is that capital requirements increase the resiliency of the system and reduce risk-taking in the system by putting more of the firms on capital at risk and create a bigger buffer in the event of failure. the alternative view is that higher capital requirements just cause firms to only undertake risky projects in order to maintain the previous roe that they were able to maintain in the market. and so the people who have the second view say, roe's don't adjust and people with the first view implicitly are saying roe's adjust to the capital requirement. you know, this is an empirical

question that is tested over time. i think the somewhat better view but not -- not perfectly so is that capital requirement increases resilience in the system and i don't think the other is a trivial view and like i said, lot of smart people have it. i think the basic approach that we've taken in dodd-frank that basel has taken and that we're likely to take in the future and the view that i think is a better view suggests that roe in the sector will go down as a result. and that risk will go down as well. in terms of concentration, i would not have viewed that as a cause of -- sorry, as a consequence of dodd-frank. there was concentration built into the system as firms fell into each other's arms in the financial crisis. and now we're dealing with that. >> now we're pushed. >> yeah, i'm sorry. i didn't mean fall like it was an act of god. they fell when pushed into each

other. >> correct. >> i think the search for yield has something to do with that as well, so for the reasons you said. >> right here. >> i'm from the nyu school of business. this is a question for michael, so michael talked about the positives of dodd-frank. i was one of the faculty members involved in the book project where we try to herd all these other professors, 30 of them do an economic analysis of dodd-frank and one of the annoying things about the whole process was they kept on changing the act, you know, during 2009. so professor would write something and we would have to email them by the way that doesn't hold anymore so can you

rewrite it. >> might i suggest a little small violin for you? [laughter] >> i'm getting to my point. [laughter] >> so a lot changed in the act so my question for you is kind of during that process, what things were you sort of, you know, not so happy about being removed. and also not so happy about being put in? given that you were, you know, involved in them? >> you know, obviously, there's lots of moving pieces and the act could change over time. and i think at the end of the day, you know, i'd give us is solid a minus in terms of what came out in the final product. a bunch of things were added that were not really, i think, central to reform. some things got weakened around the edges. i'd say one of the things that surprised me about the process was that in the conference, when

we thought things were going to get much, much worse, they actually got much, much better. so at the very end of the process, i think the bill was strengthened in really, really important ways, especially, i'd say in the derivatives title, title 7, and in the repo title, title a. >> can you give me an example. >> that were really important. strengthening provisions for central clearing, for transparency, price transparency, for capital and margin rules, cleaning up some problems as it built up in title 7 along the way that were sort of knocked out and then the reintroduction of title 8, the basic backbone provision for repo markets which we had lost early in the process. we were able to get back in the end. so i think -- i mean, i could go through a list. i had gone through a list i was going to say with amy many times if the provisions that changed along the way.

but they're not -- they're not -- i think mostly not at the level of, you know, the top 30 things most people in the country would stay awake at night worrying about. they're things that kept me awake. >> why do you think things got better late in the process? obviously, we're seeing this now in the fiscal debate. a lot of policy gets made on the brink. and do you think it was luck that things got better at the end of the process or do you think there was something about the process that helped to make -- to make -- to get hard decisions made at the very end? >> well, first of all, i would say luck is always really important to have on your side. you can't do anything without it. you obviously can't plan for it. but you shouldn't underestimate the luck. or the roll of personality. i think we made a bunch of changes in the end because some senators and representatives bonded during the process that chairman frank and chairman dodd

had set up in ways that people were skeptical about that of which i would include myself, had not anticipated, so i think that helped. having a very good, open political process helped. the conference itself was an open conference. it was on c-span or c-span3 5 or something. or people could actually watch it. i think that happened a little bit. the mood of the country changes all the time. you may have noticed. and the mood of the country at that particular time was really focused on financial reform. and that helped, i think, having the sense that the country was watching improved things. we had a very -- i'm not only saying this to suck up to jon but we had a very educated press corps who were very focused on the details and writing about it all the time so it got a lot of

public attention and i think that -- that helped as well. and then, you know, as i mentioned at the outset, blind luck. >> well, just a quick comment. i do think the leadership, particularly, barney frank, ran a very strong conference. and, you know, you may agree or disagree with all of his policies but he's a very smart guy and he really understands the system and i think that made a huge difference. and i think the other thing i would mention is that they were trying really right up to the end to try to make it a bipartisan process. so i think there was an effort to really listen to all sides and pull it together and i think that was helpful, too. >> yeah, and just to highlight the point martin is making and this is what i was really alluding to before, on the senate side in particular, chairman dodd had a very tight bipartisan process for the entire -- for the entire time, and the way we fix the derivatives bill in the end was in a bipartisan bill, bipartisan

set of amendments. >> we have time for one or two more questions and then i think we might take a 5-minute break before we get started on the next panel. >> i'm at the peterson for international economic. one thing that hasn't been brought up in the discussion so far is implementation of the act and all the regulations that had been adopted or are in greater volume is being drafted, discussed and envisaged and my question is why is that? is the implementation regulation the second order concern compared to the act itself? or what are your concerns about this implementation phase of which a number of pieces have been delayed? >> you know, implementation is absolutely critical to the act working. there are an enormous number of

moving pieces. i think that by and large the process has gone better than would normally be expected. i just mean normally in our domestic implementation process. and i think the concerns i've had have been not maybe in the same direction as those expressed by the head of chase. they've been mostly in the opposite direction, that is to say, there's some concern that budget constraints imposed by the congress on the sec and cftc in particular have slowed the process of implementation of derivatives concern and some concerns that it will be hard to get the consumer agency off the ground when, you know, 44 senators won't confirm somebody to run that place unless they change the law.

so that's worrisome to me. .. worrisome to me. but, if you look at the overall picture, both on i would say the fossil process and on fee rule-writing it has gone faster and better than i would have anticipated. >> okay last question and then we will take a break. >> dennis kelleher from better markets. this may relate more to the next panel than this one but i wanted to ask kind of a macroquestion which is you bring up the limitations of the fed under 13.3 and how it air made him impair its ability to future. that really flowed from the feds lack of information to everybody including the congress. you have to remember the sanders amendment passed 96-0 the senate. unanimity is not common in the senate and bernie sanders will never in his lifetime get 96 posts in the senate i assume so it tells you the depth of which the lack of information and difficultly with that in terms

that's yesterday, but in the future, whether or not big parts of dodd-frank work depend on market discipline. market discipline depends on information. there's a view and bureaucracy surrounded by bank secrecy and not letting information out. dodd-frank went a long way in getting provisions to try to force that to happen, but in particular, i want to know what michael and the other panelists, how in future will dodd-frank work unless we have more information disclosed fry the fed, treasury, and other regulators who have a culture of not putting information out? >> i agree with most of what you said. i think there's historically been a problem with insufficient transparency by regulated entities and by regulators, and i do think dodd-frank moves the needle in the right direction on that. annual transparent stress tests

is, i think, a huge change for the financial industry and for regulators and will be a good thing in the future. similarly, the ability to gather and collect information and make it available through the office of financial research i think is a big change, and there's a number of others like that, but i do think that you are right that unless the regulators continue to have their feet held to the fire on being transparent, their tendency will not to be, and so i think it's good for -- good for the system for the public, for reporters, and the congress through oversight to insist on regular disclosure. >> how -- just -- >> go ahead. >> i was just going to say perhaps there has been a cost of exception in the past and what it reveals publicly, but it's

often been for very good reasons, and the other -- the other issue for them is the extent to which their independence as an institution gets challenged by this, and so they might have been excessively cautious for that reason, sort of fearful of the assaults on their independence and unwillingness to unvail a lot of data. i think what you'll see is a slightly more transparent fed as long as independence doesn't get threatened, and certainly the treasury i think that michael is right that the ofr is going to be a very positive addition to the institutional regulatory frame work in terms of improving transparency. >> i do think ben bernanke has

been fair in policy transparency and that's been one of his keystone things about reviewing the fed's views on monetary policy. having said that, i agree, you didn't get all the transparency at the time of the crisis, and i can see the problems with that and the reaction of congress which said, you know, hey, we control the strings. you guys are doing all this stuff, and we don't know about it. i understand that. i think there was a concern that revealing too much information at the wrong time might worsen the crisis or that congress would get in there and stop them from doing the things that they felt they needed to do so it is a question of how we structure our democracy. does everything go back to congress, or do we create institutions like the fed and give them independence and give them the authority to manage crisis when they happen? i mean, we don't go back and

say, you know, that general should have done the beach differently even though one can look back and say omaha beach was a disaster and thousands and because of troops die. you sort of say he got it done. it's a tricky tradeoff i think, but i do understand congress' concern that the fed had tremendous power over the purse and used it without always reviewing what was going on. >> just one additional point that in the heat of the crisis, the fed was engaged in what is arguably fiscal policy which is -- >> it was -- >> there's a lot of sensitivity about that, and i think probably an excess of caution of transparency precisely because they had to get through this period and deal with these assets even though that's not part of their normal agreement.

>> i'm going to make one final observation, and then we can take a break. i think it's important and instructive that the fed was forced to disclose the name of borrowers to its various facilities by not only the standards amendment, but also by the bloomberg lawsuit, and there's names and details have all come out, and the world did not end. you know, we know more about what happened during the financial crisis and the financial system is still functioning so i think that's instructive and helpful and hopefully help push the fed towards continuing to move towards more transparency, but we have a whole panel coming up on the fed so we can talk more about that. everyone please -- [applause] a round of applause. [applause] >> more now from this forum on the financial regulations law with the discussion on how the legislation impacts the federal

reserve. this is an hour and 15 minutes. >> more people will come into the room. the last question of the last panel was an excellent segue to this panel which is about the federal reserve and its role in implementing and carrying out its peace of the dodd-frank duties. our first speaker is patrick parkinson, the director of the fed's bank supervision and regulation division. he was also in the treasury department during the formulation of dodd-frank. he is unique insight in implementing and to the creation of the legislation. he's been at the fed -- let me see -- since 1986? >> 80. >> 1980, okay. without further adieu, patrick parkinson will give us a talk.

>> well, i'd like to thank the pew trust for the opportunity to provide my aspect on this important topic. the dodd-frank altered the federal reserve's authorities. given my current role, i plan to focus on the fed's responsibility for the supervision and regulation of banks, bank holding companies, and other financial institutions. i'll touch on the role regulatory agencies play going forward in the implication of the future management by the government. i will not address monetary policy, that can be directed by others more involved. the crisis that proceeded and generated strengthened the authorities in three principle ways. first, by expanding the population of firms subject to fed supervision, second, by expanding the fed's mandate to

include macrosupervision, and finally, by removing limitations on the authority the federal reserve to obtain information from and impose standards on subsidiaries of bank holding companies. the expansion of the range of firms and proportion of the u.s. financial sector subject to federal reserve oversight occurred in part de facto and in part dejury. at the height of the crisis, most of the stand alone banks that avoided fed supervision and regulation in the years leading up to the crisis suddenly were bank holding companies or were acquired by bank holding companies. many of the largest non-bank lending firms also thought supervisory comfort in the fed during the crisis including cit, amex, discover, and gmac. as a result of the changes, the complex institutions grew significantly and many of the firms find it hard to escape

that oversight going forward thanks to the hotel california provision of the dodd-frank act. dodd-frankfurt extended to reach the loan holding companies. on july 21, the fed inherits responsibility for roughly 400 savings and loan holding companies holding over $3 trillion in assets while the large majority of the companies are small and engage in activities that parallel those of traditional bank holding companies, the population also including 10 of the 25 largest insurance companies in the united states and 180 grandfathered unitary holding companies engaged in commercial activities. a few large insurance-based holding companies have already sold their thrift or announced plans to sell their thrift to escape oversight. others may follow as they are consulted with the full scope of the fed's consolidated supervision program, but many

are expected to retain their thrift. adapting the fed soup vise ri programs designed to address risk with the more traditional banks and holding companies to the large insurance companies and other nontraditional holding companies pose significant challenges in the coming months and years. in addition, dodd-frank gives the authority over any non-bank financial firms and financial market utilities designated as systemically important by the financial oversight counsel. the board will be the consolidated supervisor for any important institution designated by the council and we will need to adapt our consolidated supervision regulatory programs for systemic bank holding companies. dodd-frank gives the board new authority to participate in the examination of all market utilities and prescribe or recommend risk management standards for those designated

utilities. in addition to expanding the universe of firm subject defense supervision, this altered the focus of the holding company programs. prior to dodd-frank and the financial crisis, the feds consolidated supervision program ensured the safety and soundness of bank holding companies in minimizing the risk of deposits by institutions by the non-bank affiliates. dodd frank is the injunction of the fed and other other regulators to provide macro approaches. we are not just protecting the solvency of individual firms. i note that the fed already has begun to reorient supervision program towards the achievement of goals and included the 2009 scape program, the 2011

comprehensive capital analysis and review, and the formation internally of our large institutions supervision coordinating committee, but clearly, much work remains to be done to incorporate this macroprudential inspection. there's fed-light which limited the ability of the fed to examine, collect information from, and impose prudential standards on subsidiarybacks and other functional regulated companies. removal of the restrictions help improve the fed's visibility into subs of holding companies and give the fed a greater ability to address threats to a consolidated firm's safety and soundness or more broadly from wherever the threats emerge. dodd-frank specifically directs the fed going forward to examine non-functioning nonregulated banks and engage in banking activities in a manner consistent with the way that we, the occ and the fdic, examine

banks. not all elements of the dodd-frank act strengthen the role of the fed. like the fed is granted greater backup soup vise ri authority or the regulators of subsidiaries under the act, others have backup authorities where the fed traditionally stood alone. in line with responsibilities under title ii for resolving important financial firms, the fdiy has new authorities that are not generally in sound condition in order to protect deposit insurance fund and prepare for resolution. the fdic has joint responsibility for reviewing the so-called living wills or rev luxe plans under the act in determines jointly with the board if a sifi's plan is not credible or result in a liquidity. the derivatives gives the fcc

and tftc some authority on bank activities that have been the soul means of derivatives. there's recordkeeping and roforting standards for the intaps business of bank and non-banks, swap dealers and determines which swaps entered to by banks and non-banks should be cleared or traded. other banking agency maintain full soup vise ri authority over banks incoming setting capital and margin standards for unclear swaps entered into by banks, but the focus, the federal relation of derivatives 234 a post dodd-frank world is moving to the ftc and stc. the creation of the fsoc was to mitigate risk and monitor regulatory developments as a new layer of oversight sot regulatory activities of all the financial regulators including the fed. for example, the fsoc has

authority to make nonbinding recommendations to the board on enhanced prudential standards or sifis which dodd-frank requires and all regulator to promote financial stability goals. the last area i want to discuss is crisis management. dodd-frank removed a number of tools used by the government to manage the recent financial crisis. in particular, dodd-frank placed restrictions on the fed's lending authority in sexes 13.3, and not only has @ authority been restricted to broad-based facilities, but the secretary of the treasury can veto the establishment of the filths. while dodd-frank reigned in the tools, these constraints on the fed's authority in the context of other reforms is a positive step towards eliminating too big to fail. the narrow lending facilities at the fed employed during the crisis like bear stearns were created because there was no other authority at the time used to protect the financial system

for the disorderly failure for large interconnected financial institutions. in title ii, there's a set of tools to manage the resolution of a failing financial firm in crisis. i don't think we are shedding tears over the loss of the 133 authority. it will be managed by the fdic, but the fed has a role in the disci's makes process along with the treasury to consult with the president. in conclusion, i believe the faa strengthened the fed's role of soup viz ri on banks and other financial institutions, but strengthened the fdic and other arms of the federal government. now more than ever, our success in meeting safety and soundness and financial sable objectives is dependent on the ability to corroborate with others in the united states and regulators abroad. thank you. [applause]

>> okay. we have comments from vincent and reinhart. we'll lead off with vips who is the head of monetary affairs at the fed, and he is now writing a seers of papers -- series of papers with his wife. he is an interesting per spectsive on the economic backdrop today. >> that's right. i apologize at the outset to those who thought they would hear my wife speak. [laughter] it's not up common to hear a grown when they hear, oh, it's the other one. a year ago, president obama signed into wall the wall street reform and consumer protection act. appropriately enough, the traditional gift for a one year anniversary is paper. [laughter] legislation over 2,000 pages in

length surely consumes a lot of that. it's enact want to law changes the scope of financial firms, new responsibilities are given to old agencies, old functions given to a new agency, and a council of regulators sits a top it all. chief among the responsibilities of the oversight council is to determine the private firms that are more equal than others. being in the club of systemically important financial institutions comes with cost rolled into the category of enhance the prudential standards, but membership has its privileges. i'm going to discuss four issues. the first two relate to the misdiagnosis central to the legislation and the irrelevance of the wanted resolution powers at a time of crisis, the second to more narrowly concern the federal reserve. first, the agent focuses on -- the act focuses on activities

within the existing setup of the financial system. some formally done in banks have to be moved off the balance sheet, and more activities in more institutions are under the scrutiny of regulators, but the incentive to do most activities remains in tact. in a market economy, this means that those activities will continue to be done. financial institutions will spin off bits, rename other parts, and make their balance sheets further void of meaning. thus, the legislative response to the complexity of markets and institutions and related failures of regulation shown in the financial crisis we just lived there has been to make the system more complicated and rely more on regulation. indeed, a designed principle seems to be to preserve the status quo of a landscape dominated by large complex financial institutions. such complexity introduces three fundamental problems in

monitoring behavior. first, supervisors are at a decide the disadvantage in understanding risk taking and compliance at such firms, but if an institution is so difficult to understand from the outside, how can we expect market discipline to be effective? the second cost of complexity is the outside discipline of credit counterparties and equity owners if wanted. third, a complicated firm is almost impossible to manage. senior management cannot monitor employees, especially when staff on the ground have highly specialized expertise and law, finance, and accounting. employees who are difficult to monitor can want be expect -- cannot be expected to look to the long term interest of where they work. a second design failure is that relating to the key reason that financial firms strive to get big and complicated. financial officials will offer

them the protection of being too big to fail at a time of crisis. the privilege of sifi membership when markets are stressed, authorities almost surely convince themselves that a faltering firm would be the first domino to topple, that is the new resolution authority provided in the agent gives the authorities to act, but not increase willingness to do so in extrem. we have to remember that entered lexicon referring to banking's unwillingness. they had the authority, but not the will in the 1970s-80s. as for the federal reserve, authorities should have no regret that some of their lending powers have trimmed back. lending officialing should have to sign off when taxpayers' dollars are put to risk like lending to non-depository institutions. there's much to regret, however,

about the new responsibilities given to the fed. my third point is that monetary policymaking is already hard. adding an ambiguous mission regarding financial stability invites threats to the fed's reputation. the federal reserve is viewed by the public and elected firms in terms of all its responsibilities. multiple goals invite multiple opportunities for missteps to settle damages and reputations. missteps that are more likely when given a mission almost impossible to achieve. compounding the problem are the consequences for the communication of policy. public officials have to strike a balance between informing and reassuring the public. this sometimes leads them to shape public statements away from a description of the most likely outcome for events towards the most comfortable one. after all, what public official wants to be the one to trigger a

run? although in the q&a session, pat, you will have that opportunity. [laughter] thus, the wider scope of an agency, the more likely statements will be emptied of content to the detriment of its overall reputation. four, does the fed really need to be a supervisor to conduct mop tear policy? true, a central bank with no expertise about financial markets, institutions, and utilities would work at a clear disadvantage, but that would not be the feds stripped of regulatory powers. as the nation's central bank, the feds continue to operate the payments and book system. both systems record thousands of transactions each day measured in the trillions of dollars and working closely with key market utilities. moreover in performing these activities, the fed extends credit within the day to

financial institutions giving it leverage to pry open its balance sheet. these roles give the fed important insights about institutions, markets, and utilities. the fed's role as a provider of critical services and essential interday credit gives it the lever. with that as a base, the incremental benefit of supervision appears limited. my suggestion is that after the next financial crisis, and there will be a next one, legislation should eliminate the underline encouragements to complexity. the requirement of simpler and more transparent balance sheets restores supervision, market discipline, and tightened internal controls. it would also make officials competent that an individual firm could fail without bringing dop the entire financial system with it. finally, it would also let pat get to retire.

[laughter] >> okay. our next speaker is kermitt, known as kim, he was the chief economist from 1997 until 2005. >> thank you very much, john. pat, i think we'll keep you employed for awhile. i'm going to focus in the brief time on two simple questions. one, has dad-frank diminished the authority of the fed? a bit more, has dad-frank enhanced the fed's ability to handle or manage a future crisis? with regard to monetary independence, i doubt dodd-frank significantly compromises it in contrast to vince's suggestion. there's inevitable consequence of the extraordinary actions to contain the crisis. important concerns include the fed's interaction with treasury

during the crisis and the scale and composition of the balance sheet. dodd-frank, per se, is not a key driver of the concerns. earlier versions of dodd-frank, did threaten up dependence. for example, the house bill included provisions that could have fostered politically motivated scrutiny of monetary policy decisions and could have politicized senior appointments to the banks. fortunately, the final agent shed most expressions of revolt. by delaying the release of details about fed crisis operations, the final dodd-frank act achieved a better balance between the need of fed transparency and accountability and the need to ensure central bank effectiveness as a lender of last resort. even so, concerns linger whether intermediaries can participate in future liquidity operations

knowing their activities will be made public. how about the fed's ability to manage a future crisis? on balance, dodd-frank better equips the fed to prevent a crisis, but clips the authority to manage would be. -- manage one. this combined with the uncertainties of the complex untested rules for resolving failing sifis should further encourage policymakers to reduce the probability of the future crisis. how does dodd-frank better equip the fed to prevent one? dodd-frank highlights the importance of eliminating systemic risk and sur charges and regular stress test lay key foundations for a macroprudential frame work. the structural changes introduced by dodd-frank like the creation of a vice chair, a treasury oches of financial research, and the financial oversight com should help

institutionize and sustain the heightened attention to financial state. i am assuming or at least hoping that the new financial stability oversight counsel will identify any systemic nonbanks and police them under enhanced supervision by the fed in a timely fashion. no less heroically, i assume the fsoc prompts the fed and others to contain the systemic risk still inherent in key markets and institutions like the world of money market funds. ultimately, it will be up to the fsoc, fed, and other regulators to limit systemic risks in a world where manufacturing tail risk is profitable. the financial industry as a whole, its individual participants, and its political representatives will continue to resist rules that constrain profit. these rules include liquidity requirements. .. in dollar terms

rather than as a capital ratio. thus limiting the incentive to

deleverage. the successful test to mark the return of u.s. intermediaries to the capital markets in a wave of new private capital raising. in contrast, the method and outcome of the fed's second stress test completed this year posed some concerns. in particular, it is questionable that the u.s. financial system as a whole is sufficiently healthy to warrant the capital depletion that the fed authorized on the basis of the second stress test. if you're interested in seeing more details about why, i refer to this year's u.s. monetary policy forum report which i co-authored entitled stressed out, macro-prudential principles for stress testing. what if as seems virtually inevitable another crisis occurs. dodd-frank blesses the creation of fed broad access liquidity programs for nonbanks such as taff or pdcf during the crisis. the prior approval under dodd-frank would be a obstacle

but it would appear to formalize actual practice. with the fed undertaken in the crisis its extraordinary liquidity provisions in the face of treasury opposition, more important dodd-frank prevents the fed from lending to individual nonbanks outside of a program of broad access. in some instances, such regulation of form over function could be side-stepped. the crisis conversions into bank-holding companies of goldman and morgan stanley come to mind. yet the new dodd-frank rules seemed aimed at preventing a future fed intervention in a bare or aig -- bear or aig-like substance. it's to challenge nonbanks into the new fdic-led resolution process. on this front, i am meaningfully less optimistic than the fdic about limiting systemic disruptions if creditors face uncertain losses. in its recent assessment of how

the dodd-frank resolution mechanism might have worked in the case of lehman, the fdic estimated the creditors could have been quickly compensated and the healthy portions of lehman sustained only with small losses. however, this rosy scenario depends on several doubtful assumptions including a long period for assessing the condition of a fragile sifi, confidence of asset valuations during a crisis and lack of international jurisdictional bankruptcy complications. ultimately, policymakers can't have it both ways. enhancing market discipline by letting creditors take a hit in the crisis will raise the probability of a contagious run. the alternative of protecting creditors to keep a future lehman in operation foster's moral hazard. the worry is dodd-frank does both. uncertainty about the untested resolution process and the associated risk to creditors may encourage a run in an episode when the financial system's

capital has been depleted. conversely, the possible imp decision by the fed, by the fdic, of an ex post levy on survivor banks to fill a hole possibly nonintermediary encourages risk-taking and a race to the bottom. let me close then by endorsing the comments of fed governor trujillo. in his words, quote, the special resolution mechanism of dodd-frank and the enhanced capital requirements called for by that law should be regarded as complementary rather than substitutes. indeed, additional capital requirements would relieve some pressure on the insolvency regime, end quote. in those, the causality also goes in the other way. in my terms we need an array of matro-prudential policies to help avoid a tryout of the dodd-frank resolution regime. thank you.

>> before we get into questions i would like to give you an opportunity to respond to some of the comments you've heard from vince and ken. >> it's hard to know where to start. well, let's see. let's go back to vincent and the key point of financial responsibility. i think kim made a key point. while early versions of the administration's plans would have essentially given very substantial and sort of unique responsibility for financial stability to the federal reserve, as things came on, as i mentioned in my remarks, each and every federal prudential regulator has been given the macro-prudential objective and then importantly rather than the fed being given unique responsibilities for financial stability for the financial oversight council has been given that role with the treasury and the chair so i don't see that

particular compromising the fed's independence. i think, in fact, one of the respects in which we're much better under dodd-frank has been mentioned, we during the crisis, with respect to the single firm of 13-c facilities did as i said we only entered into those transactions because there was no other way to have a disorderly failure of those firms but wharf is comfortable with that understands it's a fiscal function and get get the consent or the agreement of the treasury before doing so. but i think there's no question given the aftermath and all the heat we took that having that kind of responsibility really did pose a risk to our independence so we're much better off post-dodd-frank with an arrangement with the fiscal policy authority with the consultation of the president is ultimately one making decisions of those sorts, not us. with respect to kim, maybe one

thing i'd like to address, he mentioned his concerns about the comprehensive capital analysis and review program that we completed earlier this year. and said that we were allowing capital depletion by at least some firms. i don't think that's exactly right. we did allow some firms to increase their capital distributions, either to increase their dividends or to increase their share buyback activity. but we did so only after going through an extensive analysis that convinced us that notwithstanding those increased capital distributions, they would continue to accrete substantial amounts of capital at least in the baseline economic scenario. and an important aspect and then someone might have asked, well, what if we don't end up with a baseline scenario, what if the economy weakens, what if we get a bad macroeconomic scenario, i think the answer to that is -- and it's been made quite clear

in a proposal rulemaking that we issued for public comment a couple of weeks ago is that we regard the exercise as a permanent part of supervision, an exercise that will be repeated at least annually in terms of requiring the firms to submit capital plans. and in some circumstances if their capital plan hasn't been approved, getting our prior approval to increase capital distribution. so that's going to be subject to routine oversight by the fed in a way that capital distributions regrettably were not subject to routine oversight in 2007 and 2008. and further, there's an expectation that's made clear in the proposed rulemaking that if either the firms risk pool changes or there's a change in the broad macroeconomic circumstances, that would have a material effect on the firm, that they're going to be expected to submit a new capital plan and we would have another

opportunity to object in particular, i think. it's relatively easy for these firms to turn on and off their share buyback programs and i think the first thing that would go if we had doubts about their ability to continue to accrete capital would be to share buyback programs and so i think, again, very thoughtful comments from both raised a lot of issues i might comment on but i'll just for now make comments on those two things and we'll leave it to the q & a to bring out the other points. >> well, i'd like to follow on a couple of things that vince and kim both raised. vince asked whether the fed needs to be a supervisor of banks and whether it could negatively affect their reputation. the fed has responded during the dodd-frank debate that its bank supervision responsibilities

inform its ability to carry out monetary policy functions and to act as a lender of last resort. could you explain to us the role that you play in forming monetary policy? and the role that you play in particular at fmoc policy meetings. >> well, let me rephrase those questions. [laughter] >> i think the question is -- number 1, if the bar is set what it needs to be, that there's no alternative way for the fed to meet its informational needs or that looking at it the other bay to be a bank supervisor i think that's a hard bar to meet. and i think the other question is and i think the argument we have been making is that first, our involvement in bank supervision does assist us significantly in undertaking our monetary policy responsibilities. and second, and what i can speak

to more directly i think the fact that a central bank has no monetary policy responsibilities but its responsibilities for monitoring markets, for being -- having expertise on payment and settlement systems all of that is enormously valuable to the supervision function in conducting bank supervision. and that is an argument i deeply believe in. with respect to my role at fomc meetings, i attend fomc meetings. i'm available to answer questions if any arise but it would be easy to overstate my role in the fomc policymaking process. on the other hand, i think especially of late, with a number of governors on the board and a number of reserve bank presidents who are deeply knowledgeable about and interesting in banking supervision, more and more the insights that are garnered through bank supervision are being shared with the fomc and, therefore, come in to play in making monetary policy decisions.

i think the way to rephrase the questions take it away from me to the supervision function as a whole where there's a much better case to be made. >> so there's a debate that's been going on inside the fed and out for some time about the role that monetary policy should play in preserving financial stability. should monetary policy lean against the wind when it says financial success, for instance, in housing enacts what would you advise the chairman of the fed or the fomc in a situation in which there were some question about whether financial stability was being threatened by some new -- some new area of excess. should monetary policy lean against the winds? >> maybe i'll sit back and see what they have to say about it. [laughter] >> at the outset i'm not the one the bored looks to for monetary policy and for good reason. >> okay. while he's throwing it to vince and kim, should monetary policy

lean against the wind? >> you can't have lived through the last couple of years without concluding that the prior companies that you trust to market and trust that you can cleaned up the failures worked. that there's got to be some failures for the volatility in the market decisions i think that has changed. i think it's just a couple of other points. one is, is if you looked at the transcripts of fomc meetings that are published, you will find very little evidence that it was informed by a discussion of supervision. maybe that was a problem and, therefore, you're headed in the right direction. but the evidence is not strongly

supportive. the second thing i just want to say they have to know the financial institutions it lends to. however, in every discussion of its lender of last resort function it invokes and say we always take good collateral. if it's collateral it contains risk it's not obvious why you need firsthand understanding of the institution if you've already gotten the signoff that it was a primary regulator. to the specific question, should bank supervision inform monetary policy, i think an understanding of the markets should inform monetary policy and the fed could get that even if it were not the supervisor. >> i think that question was about whether financial stability should influence monetary policy. >> uh-huh. >> and i think it would be hard to make the case against it these days. >> more specifically should monetary policy lean against the wind? in other words, should the fed raise interest rates when it's used in financial excess?

>> that's a more specific question. i think -- i'm guessing that the three of us sitting here would now interpret monetary policy as going beyond interest rate policy; whereas, up until 2007, most people would not have thought of it that way. but the whole notion of creating a macro-prudential framework, of creating new tools for monetary policy outside of using interest rates, i think that's an important thrust of the thread. it's an important thrust of the chairman and i would expect that macro-prudential tools would be the first set of tools one would use to address the kinds of imbalances that you're worried about. i doubt that anyone today would say where they would rule out using interest rate policy to address financial stability issues. but they're still not likely to be the tools one would use in an early stage. >> one would only wonder what your headline would be when the federal reserve chairman says, he or she has raised the policy rate because house prices are going up too fast. >> it would certainly be on the front page, i would say that.

patrick, kim and vince both made the argument that there will be another financial crisis. i think everybody agrees with that. if you had to ask odds-makers what i would say this in vegas or on wall street you could have a hard time distinguishing between the two what is the most likely source of the next financial crisis today, i don't have people would say, it's in europe. the risk of a sovereign default affecting european banks and cockadine -- cascading through the financial system. what is your assessment of the resilience of the u.s. financial system to a shock from europe? and what is your assessment of the resilience of the european financial system to a shock in europe? >> i'll probably stick with answering your first question. but i think, obviously, we've been taking a long hard look at this. and the way it's usually framed

i think one has to make a distinction between direct exposures and indirect exposures through contagion facts. if one looks at the direct exposures of u.s. banks, particularly the peripheral europe, those exposures are not large. they're not a deep concern in and of themselves. i think the real concern is that if there were a default by one of the preferable countries, for example, that that could have much broader impact on financial markets and on the global economy. at a minimum it might lead to a widening of credit spreads within europe and undoubtedly to some extent it would lead to a widening of credit expresses globally. it would have an adverse effect on stock prices first on europe and to a lesser but still significant extent globally -- all of that would mean we direct economic activity. and that's, you know, the effects of that are much harder to gauge. they are exactly the kinds of

things we look at a stress test. in fact, one of the things i learned about stress tests is that in most cases whatever the initial shock is, that you're looking at, well, the banks tend to diminish their exposure to any particular sector really well where things can come or go awry is when, in fact, you have contagion effects that spread that well beyond that. so we look at these issues in the stress tests and again, we think when we look at it that most of our firms in the event are pretty well prepared to absorb a pretty broad shock but, obviously, in making that judgment you're making assumptions about just how large the shock is and there's always some shock that essentially for any finite amount of capital and earnings capacity, it wouldn't be enough. so it always bears watching and i think you're right the things

i would worry about most are the situation in europe and the potential for spillover effects to u.s. firms. and the recent news -- i don't know something was coming out today and i haven't had a chance to see it but certainly the recent news has been -- not been reassuring with respect to the u.s. housing sector. and to start with your first point i certainly would agree we've probably not seen our last financial crisis. >> kim or vince, do you have thoughts on the risk that europe poses to the u.s. financial system? >> i guess two points. the first is if you went back and read all the reports of the old financial stability forum, you would know that there was a palpable threat to global financial stability, namely, hedge funds. if you listen to economists, you knew there was a palpable threat

to global financial stability, it would be a massive depreciation of the dollar because of our large current account deficits. so the fact that people have identified one particular threat doesn't make me confident that will be the source of the next financial crisis. i think the second issue goes back to your previous question. you know, a lot of the discussions is old. that is with monetary policy taking into account financial stability. i think in any decade if the federal reserve was sitting there worried that there would be a default in europe, it would be very reluctant to change monetary policy and add to uncertainty. so i think these issues have been part of the monetary policy decision-making for a while. for a stretch, we got an unwanted confidence in the ability to market the function

and absorb risk but that confidence is long gone. >> john, i would just say thought your questions in the money market funds in the united states as a means is a good thing and i think it should be something we should be concerned about because the longer it takes in europe to address the problems, the greater the risk of some disruption. and it may simply be the decisions that are made independently of the managers of those funds. if the corporate treasurers in the united states decide they would rather not get an extra basis point being exposed to european banks, they may make their own decisions. >> so you actually anticipated my next question for patrick. i'm sorry for picking on you. but the chairman did raise the issue of money market funds in his press conference the other day. what's your assessment of the risk that financial contagion could spread through that particular sector? >> well, we saw in september of

2008, there was a run on the money market mutual fund sector which was staunched through an insurance program created by the treasury, by the way, they won't have any authority any longer to do. and by federal liquidity facilities which we still would have the authority to do but i think at least the particular facilities that we introduced back in 2008. i'm not sure they -- they would work so well in the current environment. so i think we still have a real vulnerability, if anything a greater vulnerability in that area and that's why it's absolutely essential that the public policymakers come to grips with this risk. there are a number of different proposals that are under debate. as far as i can tell there's not yet any consensus about which of those areas rose to take, whether it's attacking the constant nav or whether it's requiring capital by the parent

management companies or subjecting it to bank-like supervision or whatever it is, i think those are issues that deserve even greater attention than the beginning to this point because it is a vulnerability that nothing really -- i mean, the sec tightened up on the liquidity requirements or monetary funds but i don't think anybody thinks that the fundamental vulnerability has been addressed by those measures and most people think something more significant needs to be done but, unfortunately, to this point no consensus on what exactly that something is. but it is -- it is a vulnerability. >> let's open it up to some questions if anyone else wants to jump in. if not, i'll keep grilling patrick. >> please ask questions, especially to vincent and kim. >> we have one up front here and then after that another one in the back.

>> yes. a quick question, vince, and for the rest of the panel, really, about your point on complexity. it seems kind of a fundamental one. and one of the things in the act along with the orderly liquidation authority, was there's a requirement for living wills. and the way that's written suggests that the fed and the fdic -- if they had to dissolve could force the simplification of some institutions. are you guardedly optimistic center any potential for things to become more transparent and come forward. >> you said the clear phrase if they had the resolve. i think that would be extremely difficult to do so. and i think repeated has been the issue that if it's a

complicated institution, it will have a living will but it will be unforceable at the time of extremes. within the dodd-frank act i'm more optimistic about the potential for the office of financial research that could push on market utilities, could push on disclosure, basically solve the collective action problem that institutions find information very valuable to themselves and can pit each regulator against each other. the flf in principle could do tha that. >> morris goldstein, peters institute for international economics. like charles taylor, i was also interested by vincent's comments about complexity. i wanted to push him a little

bit, critical of dodd-frank. what is it that you would propose to reduce complexity? do you want to prohibit, for example, a large and complex financial institutions from having hundreds, sometimes thousands of majority-owned subsidiaries? if there's proposals for a charter that you would have to be a single entity with a home-based resolution? do you want to go back to glass-steagall. go beyond the volcker rule? do you want to go to narrow banking? do you want to go to your former boss' mantra about self-regulation? that would be simpler as well. you need to offer us what it is that is behind your conception of less complexity? >> yeah. self-regulation works as long as you don't pair that with too big to fail, morris and so i think the answer is, as i'd point you to the testimony i gave for chairman dodd before dodd-frank.

and argued among other things that you needed consolidation of supervisory agencies so you wouldn't get that sort of regulatory arbitrage. you need better accounting rules that don't allow basically the splintering of balance sheets. since harry potter is back in the news for the three people who will get the line, it's sivs that allow you to splinter your soul. and consolidation of regulators, simply indication of charters and accounting -- accounting rules, simplification of tax treatment go a long way but then if you are going to consolidate then i would have something like an office of financial research -- research have to report regularly on opportunities for market

utilities and simplification of contracts that would make living wills more credible. >> maybe i'll add something to that. i guess i would agree with vincent that resolution planning, the living wills exercise, is absolutely critical to fully addressing too big to fail. now, in one sense dodd-frank ends it clearly and cleanly by prohibiting any agency of government for engaging in open bank assistance. dodd-frank has the liquidation authority which is the only exist and it must go into receivership and it's going to fail and if it's going to fail there are also provisions that any holder of capital instrument simply can't benefit from any of the orderly liquidation parts. but yet you see the rating agencies still have ratings uplift in the credit ratings and they are not convinced and i

think the reason they're not convinced is that without extensive resolution planning we still, i think, if we had one of the very largest institutions approaching failure, the prospect of disorder. and i think when you talk to people in the marketplace, they understand what the law thinks. they think sometimes i or others in the government are going to violate. no, i'm not going to go to jail for financial stability but i think they think the congress will change the law. and i think what's essential, what resolution planning is essential is to convince them that, in fact, we can burn the creditors of the bank while preserving stability and i think that's only going to be the case if we have a clear plan essentially for moving the systemically critical function symbols a bridge institution. and i think when we start looking at how easy that's going to be in the short run not so easy. i don't think it really

requires, you know, getting in the subsidiaries to 1 or 2 and i don't think there are part of critical functions but -- the way banks manage themselves business wise don't easily map themselves into legal entities and as long as that's the case, i think it would be very hard to move the critical functions into a bridge without moving lots of other things. and eroding the disciplinary effects and so i think that really is the critical task for the fed and the fdic and yes it will take well and yes, it is critical to address too big to fail and i think in some instances it is going to impose significant costs on the banks if we -- if we exercise. we have the will to proceed along that path. >> you talk about punishing creditors. what will happen to creditors in particular short-term creditors and then other creditors in the event of the imminent failure of

a large institution? >> i think there is an issue, for example -- i think the fdic has proposed making a distuntion between creditors and senior creditors and i think there are problems that maybe irresolvable with respect to the short-term creditors in terms of disciplining them. and indeed, i'm not sure personally that much effective market discipline comes from those short-term creditors. i think history has taught us that they assume that they can get out in a hurry and indeed they do get out in a hurry and that doesn't contribute to stability. that contributes often to a disorderly unwinding. but i still think in the context to where there would be significant requirements, not only for capital but for long-term debt and indeed today, most of our large firms have very substantial amounts of long-term debt outstanding, there is the potential for powerful effective discipline from those long-term creditors even if there continue to be

problems credibly threatening to impose losses on creditors when that might lead to runs on all the other institutions. that is, a dilemma that one always faces in these situations. >> just add a note to thank our hosts in this regard because in your package i believe there's that was written by the pew reform project about how to address resolution in particular. it's a very thoughtful one. it actually highlights how remarkably complex it will be. so but it sets out the challenge in getting an enormous one. >> whenever i think of living wills and resolution authorities i think about the federal reserve's at least three decades-long anguish with the number of clearing banks for -- what would you do if one failed and the many, many meetings and

private sector groups and the answer was, always the clearing operations were woven so into the life blood of the institution that you couldn't lift it out without killing the body. that's the same sort of incentives going on in writing your living will, in getting complex. and so it's possible that dodd-frank can be used as the engine through very aggressive pursuit of living wills. but this was a very clear example of self-interest that couldn't be solved given -- given the industry pressures. >> i want to ask a question about disclosure and we'll get

back to some audience questions. the sanders amendment in the dodd-frank bill required the fed to disclose its emergency lending during the crisis in the bloomberg lawsuit has required additional disclosures. patrick, what is your assessment of the impact of those disclosures on net? has it been for the better? have there been costs to the disclosures as well? >> i think the question is, it's hard the disclosures were made after the crisis and no terrible things happened. i guess i'm not terribly surprised by that. the real issue and i think martin bailey hinted at it or addressed it in part in his remarks in the last panel is how it affect behavior during the crisis and there's a big distinction to be made between contemporaneous disclosure of information about who's borrowing from the fed and

disclosure after the fact has occurred and as required under dodd-frank. the concern with contemporaneous disclosures we already had problems during the crisis with so-called stigma even though there was no requirement for public disclosure of who was going to the window. firms reluctant to go to the window for fear that would get out and that they would come under funding pressures and the fact that firms were unwilling to borrow at the window meant that we were unable to as effectively as we might have counter the adverse effects on the financial system and the economy of the pull-back of lending by banks who were concerned about their ability to fund themselves. so to the extent that, say, there was a contemporaneous disclosure requirement and that indeed did make institutions reluctant to borrow from the window and in turn that meant them reluctant even more reluctant than they were to extend credit and meet the financial needs of the economy

that sounds like a procyclical implication of that and that would be a bad thing. but that's quite different it seems to me than disclosure ex post as to borrowed and i think in that instance that was an important distinction that congress obviously appreciated. >> just one thing to add there, it will matter how the recent disclosures affect future bank behavior in the next crisis. and if it turns out this increases stigma the next time around there may be costs that we didn't measure yet. >> didn't the fed charge a penalty rate when it makes loans through some of these 13-3 facilities? and isn't delayed disclosure just another version of a kind of penalty rate? if it doesn't -- if it doesn't require -- if it doesn't induce a short-term run, how is delayed

disclosure any different than a penalty -- >> the question is a large penalty, and it's a much more difficult to measure and it's difficult on lending rates and we don't know what private institutions to be the implicit shadow cost of future revelation of their borrowing behavior. >> but the other part is with penalty discount rate is, it may be a penalty in normal times but at a time of crisis when there's no access to funds it is a subsidy. >> i'd actually turn the issue around. i agree completely on contemporaneous disclosure, anything that adds to the stigma of the window would be unhelpful. but after the fact disclosure is something important for investor interest. if it was -- if the fed's lending to a particular institution was important for that institution's financial well-being, i kind of think that's material to invest

investor's decision-making and should be released. and i always wondered where the sec was in all of this. >> i think we have some more questions from the audience. we have one up here in the front her here. >> i wondered if pat or somebody would say a little bit more about the tools of macro-prudential regulation. as you might see them used in the run-up to a crisis in the housing bubble, for instance, it is as john pointed out hard to imagine the headline of fed raises interest rate in front of housing bubble but what is it not hard to imagine the headline with respect to your macro-prudential tools in that situation. >> well, i think the

macro-prudential tools that are most useable and perhaps most effective are simply making supervision and regulation more afford-looking. nowhere, in setting requirements for firms and asking, for example, in the case of our capital distribution policies whether they can afford to make those distributions to not be looking at simply the effects of those distributions might have on their current capital ratios but looking at what their capital ratios might be in a stressed scenario, where there's more adverse environment. and in general, there are any number of policies, whether it's, say, margin requirements, for example, where it's helpful in thinking about those margin requirements to set them in a way that's sustainable even in a crisis rather than setting them at a relatively low level and then when market volatility increases in a crisis saying oh, my god we have to raise the margin requirements in that effect has again this

procyclical limits. it's setting policies at a minimum that avoid exacerbating the inherent procyclicality of regulation priorities. >> we had that tool in the '90s and we didn't use it. >> well, we didn't use it in the '90s and maybe it's instructive in some ways. if you're referring to the run-up in stock prices, i don't think that was driven by leveraged borrowing and, therefore, raising margin requirements it, wouldn't have had the direct sort of mechanical effect people might have thought. not only because very many people were financing their acquisitions to stick with margin borrowing. it was mainly people pumping money into mutual funds and directly into stocks. but also i remember at the time if you looked at the amount of equity that people had in their margin accounts it was so far in

excess of the margin requirement that it wouldn't be much difference and the effect would have only been a psychological effect and troubled psychological effects is gauging just what effect the change in policy would have. and again at the time i remember the thinking being, well, there's a lot of efforts. there was a bubble. we'd like -- we'd like to let the air out of that balloon solely. but it wasn't clear that raising margin requirements wasn't a way to let it out correctly and it's the most dangerous thing for a financial system is not a large adjustment of asset prices over a long period of time but a sudden but the perspective from the payment and settlement systems, an abrupt decline in prices is the most dangerous thing and the thing to be avoided if one can. >> so if you have more missions, you definitely want more tools but i remember going to a lot of international meetings five years ago or so hearing about the -- the fact that the spanish have dynamic provisioning.

would help insulate their macroeconomy from asset market excesses. sometimes the wave is really, really high and the sorts of policies we are talking about only build the levee at a certain height. >> well, i don't think it doesn't mean you should build a levee. it is true. it goes back to the point someone made are we only going to eliminate crisis. that's not a realistic objective. i think the objective is to decreasing their frequency and severity and some of these tools may be helpful in that regard. >> jamie diamond argued to ben bernanke the other day that the cumulative effect of not only dodd-frank but also basel iii and new liquidity standards being approved globally is hurting the financial system and slowing the return of a fully

functioning banks and markets. i'd like to hear from everyone on the panel what they think of the cumulative effects of this regulatory reform? >> we do it every time, right? carmen and i wrote a paper called "after the fall" after the jackson hole symposium last august and the main regulator is if you looked at the 15 most severe crises in the second half of the 20th century, economies grow about 1.5 percentage points slower on average each year than in the decade before. and in 10 out of 15 cases, the unemployment rate never gets back to the precrisis level. and that really relates to three things. one is there's unfinished business. we don't deal with the problematic assets and that impairs the intermediation and households. the crisis was importantly about leverage. big buildup of leverage in advance of the leverage but

third we always make sure it will never happen again, whatever it was. and the problem is, it never happens again, something else does. but we add to the cost of intermediation. we raise capital. we create an environment of uncertainty. that has longer term prospects but it can be a head wind for a macroeconomy. i think the prayer financial regulators should say the saint augustin one lord make me virtuous but not too quickly. >> i'll remember that. [laughter] >> i didn't get that in my 13 years of catholic education. >> i'm 16. >> i didn't complete the jesuit schools. i guess i would just remind everyone of how we got here. we got here because we had a financial system that was highly efficient but not terribly stable. and i think inevitably the

policies that we're adopting which were designed to make the system more stable may make it somewhat less efficient. it may mean that the average growth rate is somewhat lower but ideally, achieving that, along with that coming to benefit that we avoid some of the tail events that we have been suffering from and this is challenging. there have been tail events for a long, long time. we have to be sober in assessing our ability to address that. in the particular context of the sifi surcharges, i can only say number 1 in terms of basel iii and the sifi surcharges an enormous amount has been engaging on what the macroeconomic impact are going to be and because our macroeconomic models and he knows more about this than i do and kim does are underdevelopment when it comes to the financial sector but nonetheless using the tools we have available, our estimates at least in the regulatory sector

are those effects won't be all that large. with respect to the sifi surcharges, i think the point has to be made that unlike basel iii, which will be broadly applicable, the sifi surcharges will be applied differentially to different firms and will apply only to a subset of the banks in the system so that whatever the effects will be for those firms, one can't extrapolate, though, automatically the effects on credit markets and the economy as a whole. in other words, i probably shouldn't say what may not -- it may be true that some of this is bad for the very largest banks in the country but what's bad for the very largest banks isn't necessarily bad for the united states. >> i guess let me put on the academic hat for just a moment and suggest that at least from the purest form, theory tells us that enhancing capital at a firm should not alter its ultimate value, in the absence of all

kinds of -- we are assuming that that a lot of variety, many important assumptions. however, if you make that assumption and why increasing capital at banks or particularly at a few large banks should do long-lasting to the economy especially if you do it over a long period of time. and i guess i would just endorse chairman bernanke's comments at his press conference recently and namely that it still seems that we're not on the side of capital requirements that is that they're too high. we're more likely to be on the side that they're too low. >> we have time for maybe one more question. if anyone wants to pose one. if not, we'll wrap up and take a break. thank you. [applause] >> this is a real break. [laughter]

>> a look now at how the financial regulations law deals with the concept of so-called too big to fail financial entities. we'll hear from a top advisor to treasury secretary timothy geithner. this is about an hour and 15 minutes. >> very good. we have -- i think i know for a fact we have all three panelists and i know for a fact we do not have our moderator , she's in d. she's going to be late and we're going to test her powers of quick thinking if she can march

into the role of moderator halfway through the presentations, that will be very impressive. but i think we should proceed and go straight to our first panel participant, matthew richardson, professor of applied economics. i think that probably covers a multitude of sins, doesn't it? [laughter] >> professor of interesting topics that have something to do with economics. and then we'll turn it over to nellie lainge whose role at the fed is basically i think to keep an eye on the ofc but i could be wrong on that and then comes dick banner whose role of treasury is to make it happen among other things i suspect. matt, to kick off. >> thank you, charles. you'll have to blame the typo to tom because when they gave the

chair that was available so academics works. at stern we've written sort of three books on the financial crisis over the last few years. you know, we've done a bunch of op-eds and a bunch of media stuff and when i tell my 7-year-old and show him the things and he doesn't show much interest much to my chagrin but i get to show siv's as hall cruxes i'm going to try that out tonight. i'm looking forward to that. so anyway, our panel is on systemic risk. and so i want to first start off saying that if you look -- think of the economic theory of regulation, it's very clear on the approach and that's you regulate where there's a market failure and i think it's a bit positive about the dodd-frank for the most part it does focus on the market failure that was in this crisis and that's

systemic risk. the net is associated with this risk is that private markets can't efficiently solve the problem. so a natural outcome is for some type of government intervention. and if you look at the act for the first time, really, we've got a focus on macro-prudential regulation so we're going to analyze and develop tools to measure in systemic risk so we have dick here who's going to talk about that. and then we've also given these -- this analysis we can then go ahead and think about how to designate which firms are systemic or which sectors are systemic. so that's a positive. and then from there we take those firms or those sectors like money market one, for example, and then we do enhanced regulation. and so i think that's all good about the act. obviously some of this stuff is always in the purview anyway of central banks and regulators but it's a pretty big deal that it's

written in the law, the biggest financial law over the last 75 years. and a testament to that is the fact that we have the top quality people like nellie running systemic risk group with the feds, dick setting up the office of financial research. that can't be underestimated 'cause i'm not sure that's what was being done two years, ago, five years ago, 10 years ago and you look several years from now and we will have much more better processes in dealing with systemic institutions and we'll have a much better understanding of how systemic risk emerges. so this is -- the cost of these activities are vastly outweighed by the benefits so dodd-frank deserve a big plus for that. that said i'm now going to put on my academic hat and be, you know, somewhat critical of dodd-frank and i'm going to focus on two particular aspects

of the law. the second one we'll talk about in a few minutes is on sort of the macro-prudential regulation and in particular the hot topic as of late in dealing with capital requirements. there's a handout in the middle of each table which is like a two-pager written by my colleague called "how to set cap requirements in a systemic risky world" not a particularly exciting title. but there's a few formulas so i'm going to refer to it i'm going to point in that direction. so let me put that aside for a second and now talk about one aspect of dodd-frank and systemic risk which is troublesome and it's actually going to mirror quite closely kim's comments that he gave before the break. so if you look at dodd-frank it puts a very heavy rolines on the orderly liquidation on

authority. but resolution by its nature is a balancing act between two forces that really work against each other. on the one hand you want to mitigate moral hazard, bring back market discipline but on the other hand you have to deal with monitoring systemic risk so you go ahead and do that so they generally move in opposite directions. [inaudible] >> those two aspects. i think from our perspective, or at least the perspective of the book, probably not that well. and the reason is it really seems to us that the focus of the dodd-frank act is really on the liquidation of the individual institutions and doesn't really deal with a system as a whole. so you think what's unique about a financial firm's failure? what's it's impact on the rest of the financial sector and the broader economy? so i like to give the following

analogy that chairman bernanke gave during the whole bailout period of the crisis. so he talked about living in a neighborhood and there's a guy in the neighborhood who's rude, obnoxious, no one likes him, big smoker and one day he's looking outside his kitchen window and he sees the guy drinking a beer, falls asleep holding a cigarette. the cigarette lights up the sofa, the fire spreads on the sofa and it starts to spread around the house and now he has to make a decision, do i have the house burn down which is what he really would like to do or do i call the fire company and put the house -- put the fire out? well, you got to call the fire company because the fire could spread to your house, the other neighbor's house, engulf the whole neighborhood and you call the fire company before it engulfs the neighborhoods. that's pre-dodd-frank. what would a balancing act would be? well, i think you should call the fire department but the fire

department will let the house burns down and it stands in protection of all the other houses in the neighborhood. and by the way, it's costly to pay for a fire department so you make all the smokers in the neighborhood pay for it fire department and over time, you'll end up finding that you'll have a lot less smokers in that neighborhood. that's the idea of sort of balancing between moral hazard and systemic risk. but that's not what dodd-frank does. i think it's being discussed already today but i think it's a little bit to letting the house burn down but not so much dealing with the managing the consequences of that. and here's one particular portion of the act that worries us quite a bit and i guess tom and michael got in a slight discussion about it earlier and kim brought it up again and that's really the incentives that are created about the act dealing with who pays for systemic risk. so the way it's sort of written is that if a bunch of firms fail and those monies can't be recovered from creditors and i

don't know how you would recover them from short-term creditors who already fled, the surviving systematically important financial institutions are going to make up the difference ex post. so what's the problem with this? well, it increases moral hazard because it creates a free rider problem. so that's not good. and it also increases systemic risk. why is that? because prudent firms are going to be charged more so they're going to be less likely to be prudent. you get firms hurting and you get this race to the bottom that kim talked about. plus, even moreover, it's highly procyclical. when the prudents the ones who are struggling for capital are now being asked to provide capital at the worst time. so that seems like a poor way to sort of manage the systemic risk and there are other examples, the 13-3 one at the fed is being mentioned already.

so that's one aspect. what about the macro-prudential side of things? so even though we have all this firepower at this table and you're going to hear about some of the moral of it a little bit down the road, one fear is at the end of the day, what we're going to end up doing is something that's very basel-like and i don't mean that as a compliment. when you look the way they are designed, the when you look at the choice of what new level of capital is required, you look at the surcharges the systemic firms and how they're being set, if you think how the criteria they're choosing for which firms are systemic, you know, complexity, global activity, lack of substitutability, this

all seems to me somewhat arbitrary and not really based on objective criteria. and then for sure when you think about how its complimented, it's going to be implemented in a very coarse way not particularly fine. so it's going to be easily gained. you know, you're going to get half a percent of this, half a percent of this, half a percent of this. you add them together and you come up with a number. we sort of know that's what's going to end up -- how it's going to end up working. so to make the point of objectivity, i have a little handout here that some of you might have in front of you -- so point 2 of the handout sort of asks how should cap requirements be designed in good times to prevent systemic risk. so i think you need to set up some criteria and then you can debate what the right criteria to set up. here's just one example. i'm not saying this is the right criteria but it's fully reasonable. and that's that expectation of firm needs enough capital to

extend the full blown crisis. this came up in the last session about procyclicality and so this is in good times you want to make sure the firm has enough capital to withstand whatever crisis occurs down the load what that means is, it's expected equity capital needs to be above some minimum fraction of assets in this crisis. we do a little bit of math, a little bit of economics and you can get a current cap requirements a day and that's that point 3, that little equation. i was told to not have it out front because if you have a formula out front, no one will pick it up. that's why we -- [laughter] >> that's why we passed it out. so what is that formula? it says basically that you need an amount of equity that is equal to the minimum fraction of assets, scaled up by your expected percentage equity

losses in the crisis,, you know, as a function of those expected equity losses in a crisis. .. >> if you don't like statistics you don't have to use statistics. regulators estimate this quantity at least from now on their required by dodd-frank estimate it all the time. that's what a stress test does. it looks into your capital losses under adverse scenarios. so you can implement, you can

put those into a formula and you can see what happens. if you take actually this framework and took the 3% hard leverage that is now in basel iii, and we just use the estimates from nyu which range on losses across firms in the cross-section of large financial firms, we ended up with capital requirements from five to 11%. the point is they very with the objective criteria, one for one which is this particular measure. you could have another criteria. it's not willy-nilly. it's based on some kind of objectivity. i think that's what worries me a bit about max prudential regulation. in the end we are going to make a very discretionary, which tom talked about, and not sort of deal with harder facts.

>> thank you very much. that was fascinating. know that journalists are meant to be adverse to equations, but surprised that george bush was in a room like this, the croatians were dangerous. next we're going to hear from nellie liang. so get a perspective of how you're looking at this. >> thank you. i'm nellie liang at this it federal reserve board, director of the new office of financial stability policy and research, created recently in part response to the dodd-frank and in part recognizing the fine just the stability mandate the central bank. so, so i was asked to just speak on generally the approach we are taking at the fed. and no equations but i do have some pictures, and there was a handout on the front and i don't know if that's been distributed. okay, just so, some background.

thinking about systemic risk, so i think as we all realized, once we are starting to do with a complex financial system, where we link to each other for all kinds of reasons, to advantage their liquidity and credit risk exposure and it becomes easy to see how distressed a single from can be transmitted and amplified to other firms. we discover that policies designed to ensure the safety and soundness of individual institutions might be insufficient to enhance financial stability when you have these kinds of linkages. and so dodd-frank recognizes these interconnections, and requires a bunch of new rules and structures. to mitigate systemic risk. so that's sort of the way we're approaching it. we are defining systemic risk, and i think that's an important

thing to do to establish what your definition is so you can sort of build out the approach you're going to take. our definition of systemic risk is it arises when firms or markets have potential to promulgate shock. they can inflict significant damage on the broader economy. so there are a number of concepts here. it's firms and markets, it's not banking institution to much of the discussion of systemic risk surrounds individual institutions. it inflicted significant damage, so significant, and it is not about trying to regulate business cycles just per se. and it has effects on the broader economy. so we have -- i don't think this is just a central bank perspective. there's an issue about what affects would have on real activity output, and employment. so the counterpart, the goal of the financial stability

authority, is to improve the resilience of the financial system. its ability to absorb the shocks and continue for the financial system, to continue to allocate credit. so again we're not in the business of trying to prevent all crises. i think at best we can try to reduce the frequency and severity. so, systemic risk measures, the focus of difference of systemic risk measures, i think there are a couple that we try to keep in mind when we are developing our framework. one, is there structural risk that comes directly from all these links, direct and indirect linkages between institutes and markets. they are cyclical or other developing risks that might very with financial and economic conditions. these could build up over time. they can include the build up of leverage, it could be asset price misalignments that build up, and that could abruptly

unwind. it could reflect the development of new products. so we are trying to get a very broad scope. when we are thinking about financial stability. so the framework that we were incorporating at the board is pretty broad. somewhat eclectic, tries to capture shock and proper channels. in three steps, you know, a simple way to think about it in three steps, identify possible shocks, assessing the vulnerabilities that transmit and amplified these shocks, and three, evaluating how they can disrupt financial mediation and compare real economic activity. so basically one to three, it's very simple. in terms of laying out a framework. of course, the science of trying to measure all the concepts is where the challenges are.

so, i'm just going to skip two, and i don't know, this is where a picture might be dashed that what attracted you today is just present a couple measures. and again, just some examples and it's just to illustrate the breadth and scope of what kinds of measures could be useful here. it's going to reflect that we're not looking for a magic measure. you know, it doesn't exist, that our approach is very broad reaching, quantitative and -- that's a come on for the handout i highlight a few. first measures, systemic measures. these are measures that were built on the inside, that firms that have high covariates are likely to be the most systemically risky. three measures here.

maybe the authors of all three measures may be in this room. so the first one is the conditional value at risk. this is a measure based on stock prices, reflects the losses of the financial system, conditional of a specific firm. more technically it's an increase in the night of the risk of the financial system, conditional on sort of a bad tail event. conditional back at risk, and you can see a time series at the bottom of the chart by the green line. for example, of large institutions. the next two measures are conditional on the distress of the system. so rather than being conditional on the stress of a firm, matt and others are the authors of the first one, systemic

suspected shortfalls. conditional on a large bad tail for the broad equity market. and another measure similar concept, similar is the distress insurance premium. it's a hypothetical insurance premium against tail losses for a portfolio institutions. and the systemic importance of a firm is its marginal contribution to that aggregate premium. all three of these measures are plotted below again, just for a sample of large firms, you can see over time they suggest that the firms come if you look at the most recent observation, april 2011, these large firms now pose less systemic risk than in 2008 and 2009. but a bit more than before the crisis. i think, so criticism of these types of measures, they are based on market prices your question is, why do investors

know about these linkages? what is it that they know that we can infer? i think the answer, you know, while we can try to linkages, it has no sometimes market perceptions of how firms are links can be just as important as the actual linkages so i don't think this is a measure. i think these measures have quite a bit of value. the next page try to just illustrate something you might be able to get from, directly from linkages. and that's based on network analysis. and that estimates how the stress of a counterparty could directly affect other firms in the network. and then you can also do lots of simulations. these are kind of things that we think are fun. very limited data. that the constraint here is what kind of data are unavailable, detailed information about linkages to one another. so i illustrate one example, and

this is not from specific data. is the work being done at the bank of england and the working paper. they use the vis data, and they take country data. country banking group david your 21 countries. they met basically a capacity of these countries to transmit credit or funding stresses through the networks. sort of the idea is to identify clusters and to see if it's more than likely that one stress hit something, does it state in or does it go out? and you can come up with various measures. the chart at the bottom i just pulled from their most recent working paper. the chart at the left is 1989, what did the system look like in 1989? and the chart on the right is what the system looked like in 2008. there's a couple takeaways.

in 1989, the cluster in the middle is much bigger. that was u.s. and the cayman islands, u.k. and japan, which suggested that once you were in there, you tended to stay in the. the probability of moving out to the other modes were, you can see by the size of these arrows, you do move out. in 2008, the cluster in the middle is smaller. and the air was out our wider and fatter. and then there's lots of arrows between all those outside pieces. so this suggests that once something heads it moves around a lot. and that in some sense more contagion and also more systemically risky. one example is that if you have a crisis, in 2000 href have a lot more people in peru to have a discussion and you did in 1989.

that's a different way to characterize it. to more measures that i will just run through. the next line. so i think at the board we have not just again institutions in banking, but in market and macro issues. one example, the fed initiated in their survey a primary dealers last year to give qualitative information on the availability and terms of credit for securities financing and otc derivatives. this was to gain the window of leverage of the dealers outside of the banking system. i think over time this will be incredibly vital, just like the senior loan officer opinion survey. two other measures that i show here as i mentioned returning mismanagement short-term funding is a concern with a major issue in the last crisis.

one is the reports to look at how banking systems relies on such short term fund. another is to our full framework network anti-try to approximate a non-financial sector. this would be households and businesses. on short-term funding. for example, nonfinancial businesses to what extent are they relying on funding from cp, and even in the household sector. you can think about who holds the mortgage, how are they funded or who holds, if the mortgage, who holds that. so you can sort of map that short-term financing to the ultimate holder. that's the work we are doing. finally, i would just say on the real economy, this is a major research initiative as the federal reserve system. understand the effects of shocks and the availability and terms of credit to borrowers, and

adding richer financial sectors to structural models of economic activity. we have lots of macro models for various models. but adding a richer financial sector to those models is a key priority. okay. my last two things are just some quick organizational changes at the board. so pat parkinson was here earlier and he probably mentioned, i missed it, we have a new sort of overhaul, the way we supervise the largest most complex institutions, very much high level multidisciplinary group, greater focus on simultaneous horizontal reviews of the firms, greater use of quantitative methods, and centralizing it and employing lots of different, bringing a lot of resources to bear. we also created a new office of financial stability.

as a sort of mentioned the focus is on the comprehensive quantitative tool, quantitative analysis of risk that a violation of macroprudential tools. this office is working with the supervision group, the fsoc, international working group. would add, it's not a large increase in staffing. it's not like we're going out and building a new, you know, i don't, an lsr, how's that? we're really engaging the research economists and analysts around the system. there's quite a bit of work that is ongoing. it's all being organized through this group. and i guess i will finish this approach, and i think i started, it's really not based so much on sort of the unique ability to see the future, okay.

we recognize crises will happen. our goal is to reduce the frequency and severity. we are building on a lot of macroprudential tools, and structures that were created in dodd-frank. dodd-frank is not perfect, but it is a step forward. and, of course, i'll close with of course we need better data. and greater disclosure. i'm a firm believer in being transparent about how we're trying to measure things and engaging the academic and the market communities for that. so looking forward to working with you all. thank you. >> okay. thank you very much. i especially like learning that you guys have a lot of fun with your network analysis. it's good to know that it's not all nose to grindstone. next we'll hear from richard berner. he actually is someone who has

been accused of accurately predicting the future. he won a contest of private sector economists who most accurately predicted what was going to happen. so you're not safe from the sorts of caveats that nelly offer to your prediction. is someone who is building an office of financial research. and i hope we'll hear about that. and also, the perspective of being on wall street as well as now on the other side. >> nelly has made my job, and that has made my job easier. to talk about the office of financial research, goals and objectives and what we're trying to accomplish. and i can assure you that it's not just me alone here we have a number of people, not just in the treasury but in the financial stability oversight council including nellie who are contributing to that effort.

and as nellie said, we need your help. i'll talk about some of the partnerships that we want to try to forge to realize our objective. let me talk a little bit about some of the aspects of the macroprudential toolkit that i think are important that both matt and nellie alluded to. our criteria for success in big about macroprudential policy are much more diffuse than a offer monetary policy. monetary policy have the luxury of having some targets that are quantifiable. it's much more difficult as nellie implied to assess our criteria for success in macroprudential policy. over time, for example, we hope that we and our successors will put less money into banks. that's one criterion for success. over time, we and our successors hope for a more stable financial system. but hopefully not at the expense

of subpar growth. so there's a balancing act involved there that's much more difficult to calibrate. and that balancing act also is something that takes place over a much longer period of time than monetary policy. you're all familiar with the lack and implementation and recognition. in macroprudential policy we can really only assess our success over the credit cycle, and perhaps over more than one credit cycle. so we hope that our critics and the people who are assessing us will have the patience to look at that, that effort over time. many other issues in governance arise, but one of them that nellie alluded to, nellie talked about the efforts in the context of the fsoc, which is a council created among nine financial regulars and a representative and insurance specialist who

votes on the fsoc. and you can imagine that such a large committee which involves not only those 10 people but also five nonvoting members, can be a bit cumbersome. so there's a lot of collaboration and cooperation involves. and doing that is part and parcel of what we are trying to accomplish. specific responsibilities, have to be assigned. and, of course, the fed has the financial stability mandate, but that's going to be carried out in cooperation with other agencies, many of whom are represented in this room. dodd-frank mandated that the office of financial research would facilitate that process. it is a new entity that was established under the statute to help promote financial stability with four goals in mind. first, measuring and analyzing factors affecting a financial

stability. in collaboration with the other fsoc members. increasing the integrity, accuracy and transparency of information that we share, and that is reported to regulars and used by research communities. so there are partnerships implied there. reporting to congress and the public on the analysis and significant financial developments. again in collaboration with the fsoc. collaborating with foreign policymakers and regulators as well as multilateral organizations to establish global standards for data and policy to promote financial stability. so that all sounds like a big job, but when you stop to think about it, it's done and cooperation with the other members of the fsoc. if you want to think about it in these terms, while we are staffing up, and we are in the organization, we are trying to provide them a connective tissue among the members of the fsoc and a connective tissue where we think we have gaps in our data,

where we have gaps in our analysis, and where we can promote collaboration among all those nine members of the fsoc. our sole focus is to establish, to assess along with the other members, the risk of the financial system. and we have the authority in the statute to collect data from anywhere in that system. our mandate is to improve the quality of reporting, and we are accountable to the other members of the fsoc and to the congress. so you can think about as serving for different constituencies. the fsoc and its members, the congress and the public, and that service or the accountability goes in both directions. because we need to fsoc to provide us with direction for research and data collection. and similarly in the other direction we need to get help

direct the development risk monitoring tools and the data needed to facilitate the use of those tools and a technical analysis for members of the fsoc. the f. -- the data center which is primarily focus on the standardization of data, the production reference databases, and a collection of data and the warehouse and the appropriate safeguarding and distribution of them. then there's a second smaller part which is devoted to research and analysis, which will be devoted to risk assessment, forensics, looking at crises and why they occurred, what went wrong, financial innovation and how it is affecting the quality and character of our data, and the evolution of the financial system, and so on. it will have a to record and deputy directors who support

each of those two sides of the organization. so our goal in terms of research is to produce, promote and sponsor financial research, to publish nonconfidential financial data, reference data. and i'll tell you exactly what that means a just a moment. analytical tools. to establish fellowship and visiting scholarship programs for people who want to work on financial research. to collaborate with and provide data services for all the federal financial regulators and statistical agencies. and, finally, to promote best practices in risk management for financial firms. we have underway summer research projects in collaboration with other fsoc members their nellie alluded to some of those that were participating in. and on the data side of the house, we are most advanced in

our infrastructure because we think that is the most pressing need. hence the need which i think anybody in the fsoc recognizes, and what is perhaps some of the least overlap with other members of the fsoc. it may sound odd but our promise to the people with whom we want to form a partnership is were going to click more and better data, and actually reduce the reporting burden for the financial services industry. how are we going to do that? we are promoting a standardized set of reference data, one of which is called the kelly ayotte initiative, or the legal entity identification system. we go back, go to bedrock and identify the entities in the transactions that occur between them and among them. we don't currently have such a system. there's a multiplicity of identification systems. and those are going to exist in parallel with what we seek to

set up, but the unique and enduring transit system we hope will serve as a standard, set of standards which will enable researchers and regulators and financial firms to collect and report their data in a way that is transparent, in a way that reduces the burden of reporting, and that helps promote better risk management by enabling to devote resources to those other activities. and only the poor financial data in the most transparent streamlines way. so, in the data center we are building up an organization with strong data management. we are running the data center as a business driven technology enabled solution provider. we've hired people from private

industry, and information technology. the information technology industry, energy set up the data center, in order to begin cataloguing the data we already have in deciding with the other members of the fsoc, what data we need to make this happen. in our view, for partnerships are really critical for success. the financial institutions, the market data vendors and solutions providers who are out there who have a business model and providing and processing data, exchanges ccp is under the market data repositories who are now being set up which present us with unique opportunity to collect and refine those day. as well as the global regulatory community. and it's very important for us including those partnerships to set of procedures and protocols by which we can collect and share and safeguard those data so that they go to the right

people and so they don't go to the wrong people. so that they people who use and produces those data can trust the fact that they will end up in the right hands, not the wrong hands. and we'll have to negotiate every transmission on a case-by-case basis. that's extremely important when thinking about how we collect industry with the safeguards of that day. we've had many challenges. first we have to demonstrate our value to that broad array of constituents. we've got to work towards agreement on those global standards around the world. we are working hard on that. we are working to prioritize the data and research agenda with the other fsoc members. and ultimately we want to work to make the data that we have widely available to a variety of constituents, including research community so that we can develop better risk monitoring tools and have a much more transparent

financial system. >> thank you very much. i'm going to ask you guys questions for about 15 minutes, and then we'll have 10 or 15 minutes of questions from everybody else. so i wanted to start, matt, you have briefly disparaging remarks you made about basel. i wonder if you would like to elaborate on those a little bit and talk about the impact of the latest basel developments on the overall situation here in the united states? >> okay. perhaps the way to do that would be to maybe take a little too were back to what we just went through and kind of link some of the basel requirements to that. two examples. i would've can quickly. think of two of the largest financial services in this

crisis and you think of fannie mae, freddie mac, and you think of aig. and a large part of what they did was certainly exploiting the too big to fail guarantee with the implicit guarantee of the government for that. but they were really embedded in the financial system. it wasn't as if they were working in the shadows, so to speak. so the example of aig, i gave this analogy last night, we think of the aig financial products and you think of all the stories have been written about them. and they have that one picture of joseph appearing around the corner and that the only picture that existed. and we saw that again and again and again. and the inference was, here's a bunch of cowboys working outside the financial system, no one knows about them. acting like a hedge fund taking huge bets. the truth is, if you go to the quarterly report, the end of

2007, and i mentioned this again last night, page 122, we studied this, of the report, they describe the credit default swaps decisions of 530 billion them and data script 389 billion of that was both predatory capital release of financial institutions, primarily european but some broker-dealers as well. this is how it work. if you know the aaa security and you took out insurance from a aaa rated into the u.s. to hold no capital. so that's why aig wrote 389 billion of cds issue. it wasn't outside. it was part of the system and we can thank basel for that. go to fannie mae freddie mac. you're a bank. you write a portfolio of mortgage loans. you hold 4% of capital. use all those loans to fannie mae freddie mac and you buy them back exact same loans.

we just now holliday mortgage-backed security. no risk. the risk in the system is identical. now the bank has told 1.6%. so my seven year old who i told about at the beginning the thing today, he's not doing decibels yet but if i asked him what would fannie mae-freddie mac have to hold, he probably would guess 2.4%. it was 45 basis points. that's half the amount, have to leverage. so double leverage. they were part of the financial system. no wonder they dominated. again we can thank basel for that. you can just go down the line and just see how, when things are relatively arbitrary and relatively coarse and set out without really a system criteria, how they can begin. a simple criteria, is not easy to implement with the fact that

you have two identical worlds. they should have roughly similar requirement. and if one is less than the other, not surprisingly everyone is going to go as well. that's not written down anywhere as the gore into the and that's not in dodd-frank either. so when they look at what's going on right now, with the basel, the strong are you for having high capital requirements, the miller story in our classes, but i do know what the economic analysis providing that goes from 4.5, to seven our graduate from seven to 7.5 to eight to 8.5 tonight. achieve things a little bit arbitrary. and there are tools being developed, you know, by nellie and central bankers elsewhere. and also there's data about leverage being developed eventually at the office of financial research that could

really help pinpoint descent. i've got a feeling it's going to be basel four, people older sitting around saying conference room, you know, in switzerland, making kind of similar kind of negotiated decisions which i'm not sure is the right approach for these issues. >> richard, are they right? >> i think matt makes a valid point that anytime you try to read it one part of the financial system and another part of it is slightly red live in financial activities will go in a lightly regulate part of the system. and i think what we are trying to do in developing macroprudential tools is to recognize that and to create more holistic set of tools that look at not just capital, not just liquidity requirements, but tools that also enable us to reduce regulatory arbitrage, and

to reduce the implicit or explicit buildup of leverage in other parts of the financial system. so, the use of appropriate margins and haircuts in financial markets, financial instance, the collection of data and swap data repositories and other parts of the system will help us in doing that. we are at the very early stages i would say in the department of those tools but we recognize fully the need to do it in a holistic way that looks at the financial system as a whole. and how evolving in response to financial regulation. >> matt, just a moment ago referred to and gives a great example of the gaming of the system. you, richard, were talking about how the need to have buy-in from the private sector participants. how do you guys strike that

balance? there was a really interesting essay by tyler cowen at the beginning of you which was mostly about inequality in america, but one of his sort of final observations what he thinks inequality is bound to increase because the financial and intellectual firepower in financial services just sell out guns you poor underfunded, understaffed regulators, that they are always going to run circles around you and you can devise the best metrics you want, the best data, they'll always find ways around it. are your systems vulnerable to that? are you finding ways around it? >> i will start on that one. i think that's clearly a recognition of all regulators. in fact, there's a fabulous research paper written that looked at the actual education levels of the financial institutions versus the regulars

which is pretty eye-opening. the gap between has opened up a lot since the '60s. i think that's also one of the main reasons why we think this has to be a pretty open, transparent process. that it isn't about the regulars sitting in around and trying to figure this out and not engaging the whole academic and market community in a. so having data, making it available to others to use, promoting development different meshes, i think that's all part of a strategy. >> you know, that's absolutely right. and when we talk about buy-in and the proposition that we're going to collect more and better data but reduce the regulatory burden, i think that's essential for the data collection process. >> have to persuade europe wall street counterparties that you're going to do that?

>> we have tremendous buy-in from the industry. and sifma and others around the world in the industry are leading the charge. in fact, i think they are somewhat inpatient we are not going faster in the process into the identification and the process of other things that will facilitate reporting of data in an easy way and facilitates their own business models, their mis in management information systems, in the way they report dated. so if anything, i think they are trying to get us to go more quickly. >> if i could just add to that. systemic risk, it's the public thought, so it's not necessarily -- it's within the incentive structure, anyways the financial industry to actually support this. i think the problem is when the regulatory environment, the

government gets the popular, populous, whatever, gets to punitive towards the banking sector. getting a buy-in, it's in their interest because the race to the bottom, just because that's the nature of the analogy. i think everyone would prefer a little bit less systemic risk in the system but you have to do it in a way where you are not picking favorites. i think that's what you have to deal with. >> how about getting the right people? never referred to this on paper. you are trying to attract people, also with the kind of data skills which are very valuable, not just on wall street but in silicon valley right now. how's that going? >> well, frankly it's not easy because we are looking for a very talented people, and we are being kind of picky about it. but we have really started stepping up any variety of ways.

and so, i think, you know, the other is we have a historic opportunity to get the financial system and the regulatory architecture right, to build institutions that are going to be lasting. like the ofr. and like what's happening at the fed. so i think there are tremendous opportunities. and one way to do that is to make sure that we provide opportunities at every level of career development so that people who are just coming out of grad school can participate. people who are about to go into teaching can postpone that for a year. and come into the ofr, go to the fed, go to the new york fed and other places, and participate in the process of discovery which we think is so exciting. >> so as i mentioned, we are not by design looking to build up a

huge community. the ofr -- [inaudible] we are drawing on the whole reserve bank system. we have 12 reserve banks. we have economic research divisions and supervisors and other analysts at these institutions. those are critically important to how we function, just like in monetary policy. they are all engaged in there. we're trying to bring them all into the financial stability. we are making an active effort to get to the academic community. we engage the academic community monetary policy all the time. and the outside on the. we get criticism. we get suggestions. we did everything. i think in the area of financial stability we can aim to do the same. >> shall we take questions?

please. >> bob feinberg with risk management community.com. it seems like the problem you face is your credibility is just long since shot and you can look at last week's roundtable at the fdic where simon johnson, whose credentials are impeccable, expressed frustration that he sees the prospect of two and a half trillion banks being combined into 5 trillion banks. and he tries to bring those directly to the attention of secretary geithner, whom he has access. and he got nowhere. he was told that this is a

problem for the e.u. so, i would ask you how you overcome that, but it's not something that you can really answer because people are not going to believe what you say. >> okay, well, there's your answer. [laughter] >> nellie, dick, do you care to address, elaborate on? how to work when you have no credibility. [laughter] >> we do it all the time as academics. >> journalists also, so there you go. >> so i will just -- you know, in the crisis, i mean, we've been subject to the criticism of why, why couldn't they do something now that it clearly missed in the last crisis. i think this view is, you know, there are quite a few causes.

it wasn't a simple cause for the crisis, the recent crisis. there were lots of blame, so to speak, to go around. they were institutions, regulators, consumers, governments. i think dodd-frank does try to address some of those issues, and one of the main features to define clear authorities and to try to close some regulatory and information gaps. you know, there's a long implementation process, and the data, the council and sharing a better information are all challenges, but i think that's just the road forward. >> please, sir. >> hi, dave, with credit site.

the phasing periods for both groups and any timelines for different things coming about, when do you have to have a director, according to dodd-frank, things of that nature? >> i assume you're asking that about the ofr? we don't have any particular time frame obviously. it's the one year anniversary of dodd-frank that comes up in mid-july. there are a number of things that are supposed to be done by that time. the statute doesn't specify that we need to have staffing, but we are very much aware of the need to have our staffing in place. and that's an extremely high priority for us and we're working aggressively to try to implement that specter critical mass output. i mean, when do you expect that? another year from now? >> you know, but now he talked about not building up a huge

infrastructure is actually also actor for the ofr because we're trying to create a virtual research community that includes all the members of the fsoc. and as i said to create a connected tissue among the members of the fsoc and to reach out to partners in the financial services industry and the research community. so that the output is already beginning, and with a very small number of staffers. on the data side, we are making a lot of progress and cataloging the data that we have and assessing the data that we need. that's part and parcel of the process that we are going through to implement other parts of dodd-frank such as the designation process that matt referred to. and that is teaching us a lot about the data that we need and need to collect. and we are making progress on that as well. so, i think drawing o on the

resources that we already have, you're going to see in very short order a lot of progress that's been made on both those fronts. >> and do you have any timeline questions for nellie? now. >> i have to referee reports due on wednesday. [laughter] >> the thing about the timeline is it's important of timelines and deadlines for implementation. but i think you all need to recognize that just as monetary policy is an ongoing process, so the implication of a macroprudential policy is going to be ongoing and we're trying to build the institutions and frameworks to do that. the bad news if you want to put on those terms is that, you know, in monetary policy analysis is far more advanced than what we are talking about here. the good news is that there's a

lot of opportunity to discover and to move the ball up the field very quickly. we think we're doing that. >> i'm from the university of maryland. not only the three of you but earlier comments were made, remarks today to check stub which the regulatory arbitrage, but i put forth maybe the proposition, just to be discussed is to maybe from the point of view systemic risk is good in the sense that what you can do with it is by birding, and this is dodd-frank is this a bit with a capital requirements, by burdening larger institutions, you ask we create pressures for those people to go to smaller institutions. and more smaller institutions is not only far less systemically risky, but it's probably also a

better market and would ultimately drive a better economy, a healthier economy. by the way, the benefits we haven't discussed at all partly because we can't quantify it yet i think, so i put forth the proposition we shouldn't be wringing our hands about regular arbitrage. that's an ally from the point of view of managing systemic risk. >> i think you make an important point, and the important point is that we want to create a regulatory structure that also in bodies markets and the and a discipline and market incentives. and i think that there are a number of ways we can do that. you referred to so-called sifi surcharge or sifi buffer. one thing that might help do that. there are others that i alluded to, and that are extremely important in promoting transparency, better place discovery and markets that have

been opiate. better data so that we can all analyze that. when i say we all, not just numbers were genuity, but the resource communicate market participants themselves. all those i think are important ingredient. in having market discipline act as our ally. >> i would tend to agree. i think an important issue is worth that activity migrates to. surcharge on to large institutions, you know, lending activity migrates to the next tranche of firms and stays in regulate banking sector that's one area that moves out to areas that may have, it's not clear what the backstop is, i mean, -- [inaudible] >> yes. >> and where do you think it's likely to move?

>> the capital surcharges. solving activity -- so i think it's early to tell with the capital surcharges. the function is an entirely made explicit get. the analysis hasn't been thought of for the macro, how the effects on the economy that i think pat alluded to earlier have been thinking about it moving, lending activity staying within the banking sector, largely -- i -- it's hard to tell at this point. it's too early. >> i understand your point but i don't quite agree with it. i think wha what you wanted, you want the charge, the systemically risky activities, you know, some kind of, whether it's systemic tax or whether it's a capital surcharge were some other line to move it out of this systemic part of the financial sector to a less systemic part. i don't think size is the right country. you think of the monoline insurance industry. you think of money market funds,

lots of examples where things are being shifted to smaller entities that actually produce lots of systemic risk. but i agree with the general principle that you can use systemic risk management to sort of push stuff away from risky part. after all, our whole model of securitization, in academia, not to be implement it that way. so basically to take a liquid assets, create gold out of them, make them look good and get them out of the risky part of the financial sector to less systemically risky areas. and, of course, it was the opposite. they were bought on the risky part of the capital arbitrage. i think you have to be careful, but i think the overall idea behind it is right. >> and what is your prediction on how things are likely to go? >> you know, i'm not that confident because again, i look

at the basel approach, and i do think that dodd-frank has the opportunity to maybe take a different view. i'm worried at the end of the day people sitting around peru are just going to relate back to the previous system, even though nellie and dick are going to be producing all these wonderful things for us where they'll be acted on by fsoc or whoever it was in the room deciding on the final decision-making. >> are you guys worried about that? you have great data but no one will pay attention to it. >> we'll have lots of great data but we also have lots of great analysis. nellie dr. potter criticism that the fed gets from a variety of constituents about monetary policy. we are all going to get a lot of racism from all the people in this room about macroprudential policy, and we welcome that because that's absolutely

necessary to improve the kinds of policies that we implement. >> i do think as i mentioned in my opening remark, i do think five years from now these activities are at the same level, we're going to be much, much better understanding of what's going on, much better data to answer these questions. >> any other questions? >> a two-pronged question. one is, the minute we are doing two things come were trying to get a handle on systemic risk with the data we have the common and we're trying to develop new data for a future vision of how we might understand measure going forward. against both those things, the first case, are we at a riskier world than we were? is risky generally trending down? do you think dodd-frank is actually reducing systemic risk at the stage or do we have to wait for implementation? and secondly, measures of

systemic risk. what's your initial thinking about how we could measure it, not for institutions and a contribution to systemic risk which were address, nellie, i think, but more the state of the financial system as a whole. how do you expect to -- you have any hypotheses how you'll measure that as opposed to just collecting data? >> okay, to easy questions. nellie, do you want to go first? >> i think in terms of whether you can see dodd-frank has contributed to less systemic risk, boy, that's a hard question. taking it out of the context of a financial sector and an economy where everybody's inclination now is we are still cleaning up the past, there's caution in terms of leverage and risk-taking on the parts of all participants now. how much of that is dodd-frank,

i just don't see that, we're in any position to answer that now. or maybe later. it's always this question of you see quantity and you see prices and you don't know, you know, the supply and demand shift. in terms of measuring over all systemic risk, you know, there are some attempts to try to get a bigger handle on all the different handsets and get them all together. i think our approach is, we're not trying trying to achieve a single measure. [inaudible] >> yeah, so i think it's a pretty broad scope. i mean, you've got, you've got firms. you've got markets. you've got leverage. there's just so many concepts

trying to convey that it would be very difficult to come up with a single measure. on the other hand, i would say i think the attitude, the risk, you know, in terms of pricing and the potential for systemic risk, there's less leverage, less short-term fun and less maturity mismatch and there's less innovations that are getting around our ability to understand. there's less of that and it was a while ago, and it was just a couple of years ago. >> agreed. and i think as we look at the agenda going forward, what we learn about how the financial system evolves will, you know, will drive the way that we collect data. and we need to be alert to the fact that it will evolve. and financial innovation has subsided somewhat, is going to continue to evolve. and one of the shortcomings of what we did in the past love to

overlook that innovation. which was partly driven by regulation and partly driven by economic and financial opportunity. we will continue to be driven by those factors. .. we are working on indicators. >> okay, if there is one secret. >> he comment if you have a super. >> he final question?

>> my. >> he question is -- you can look on the web site and see for systemic risk to be across five firms and that will cover europe as well and you know there will be a lot more details. at what point is the bow as far or fsoc going to have similar public transparent of systemic risk concerns to the market available so that everyone can see it? >> that is why it may not be soon. certainly we are going to use the analysis that we are developing and at other places as well. and that we develop ourselves. within the members of the fsoc. how much of it be published

remains to be seen. but, you know there is always the question of if you identify a problem, or an emerging threat or vulnerability to the financial system then you have to say what you are going to do about it. so, that is, that is really incumbent on us as policymakers and i think that's too close that loop, it is going to be very important for people to understand what you might describe as the macroprudential policy reaction, which has as many dimensions as there are sources of systemic risk so to just add complexity to the problem. it is not going to be sufficient for us to talk about where the risks are. it is going going to be incumbent on us to talk about what they plan to do about it. >> okay i think our time is run out and i would just make it quick final lightning round for the three of you. at dawn and frank what is the single best thing that is done

from your perspective, your one favorite change? >> introducing macroprudential regulations to the market. >> nellie. >> that is interesting. all those great things. in some sense, the council to -- with solid shortcomings of trying to coordinates among 15 or tend to address if you have an information exchange and closed regulatory gap. >> i think the single most important thing is the dodd-frank has made people aware of all those gaps and it has made people aware that we have got a very complex and evolving financial system, and that we need to pay a lot of attention to the unintended consequences of regulation and to thinking about regulation across the

entire financial system, not just for depository institutions or for one set of financial players. >> okay, thank you to the three of you for a rich and positive discussion and some really great questions. [applause] >> thank you. now we have an hour and a half for lunch. of that time, half an hour is to do whatever you want to do, bring your food in here, settle down and start to eat quietly. and then, at half an hour in, we will be asking our lunchtime speaker to step up. it is an hour and a half a or an hour and a quarter for lunch? in any event, back here and a half an hour. thank you. [inaudible conversations]

[inaudible conversations] [inaudible conversations]

>> the there are three days of booktv programming this holiday weekend on c-span2. ñ?(

>> at the political level we we are more divided if you look at partisan polarization at any point since the civil war and reconstruction. >> the end the dalai lama talks about religion, violence and the death penalty and later nixon white house insiders discuss his presidency's foreign-policy. this monday july 4 beginning at 10:00 a.m. eastern on c-span. for the complete schedule go to c-span.org. a house financial services subcommittee recently looked at the stability of money market mutual funds in the wake of the financial crisis including how to new financial regulations might impact the industry. witnesses include officials from vanguard and fidelity, to the largest mutual fund companies. new jersey republican scott garrett chairs this to our infinite t. minute hearing.

>> i recognize myself to opening statements. let me welcome the panel. and say a couple of housekeeping things. so, we are going going to do opening statements and then of course we will roll to the witnesses statements. we understand either at top of the hour or so more and there we will be called for votes, and so we don't know how many votes but if it is only one vote, then what we will probably do is just rotate through and just keep you all, keep on testifying as i pop in and out in that sort of thing. we hope it goes that way. if it is to post unfortunately we will probably have to take a brief 15 or 20 minute recess to allow ourselves to go vote. so that is where we are. i recognize myself now for four

minutes, and again as i said many welcome everyone to the hearing. we are here to explore a series of issues impacting the mutual fund industry. as you may notice that more than six years since this committee last held the hearing focused on mutual funds. this new republican majority has made it a priority to focus on oversight and a lonely of government regulators but also industries under its purview so given that it has been over six years this is a good opportunity now to reappoint this committee with issues affecting this industry. there has been some attention in the media this week regarding how the greek debt crisis may affect money market mutual funds and while this is not why this hearing was scheduled, certainly it will be a topic worthy to explore to some extent. more broadly though there was the intent to focus today on different efforts of proposals to provide more certainty to policymakers along with stability of the money market mutual funds. i do think the fcc's recent set

of reforms have made significant process in quelling systemic concerns about money market funds but i also think it is worthy and discussing different ideas regarding potential so-called buffers for money funds. as safe as money markets generally have been unfortunately the proverbial genie was allowed out of the bottle back in 2008 when treasury and the fed stepped in to provide a temporary guarantee program for money market funds potentially at the time putting taxpayers at risk. this type of action definitely needs to be avoided in the future and i think representatives of the industry and the panel today would agree with that point of view. as i said i'm interested in having a good discussion on some of what is hearty been done by the fcc in the past and what further could potentially be done going forward. with all that being said i have not been convinced that the nav is a proper avenue to go down in order to address the perception by some that the money funds represents a systemic risk. for one i am not convinced that

replacing a stable nav with a floating one solves the worry that runs on the bank money market funds. additionally policymakers must take into account the impact a floating n.a.b. would have on corporate and governmental issuers of debt and our broader economy as well. so there is compelling evidence that such an action would lead to a loss of access to a significant source of short-term funding. floating nav would type investors of all shapes and sizes and while i can understand some of what concerned about money market funds we can also ignore the concerns of our banks which is likely where much of that money would now invested in money market funds would migrate over to if you institute a floating nav. while on the one hand their money market funds was a source of undeniable problems back in 2008, hundreds of banks that failed in the last few years and the t.a.r.p. program pumped literally hundreds of billions of dollars into banks during the death of a crisis that we can't

look at potential victims of a floating an idea in a vacuum. that would be i think at considerable cost. another issue i hope the subcommittee can explore today's the potential for the fsoc asset management firms such as mutual fund companies and systemically significant financial institutions. with the way that dodd-frank required regulators to regulate there is some, a lot of questions as have mutual funds would be regulated under a regime largely set up the same regime as the banks. for the more today's hearing may also touch on issues such as the 12 b-1 fees, the dodd-frank at rome a king issue and its impact on mutual funds, fiduciary standard proposals as well as proposed amendments to cftc rule 4.5. more than anything else that of today's hearing affords us an opportunity to have a good and robust discussion on many of the issues affecting the mutual fund industry today so i very much appreciate the panel being with us and with that i turn to

mr. green for two minutes. >> thank you mr. chairman gareth and i also:the full committee chairman who is not with us, but thank him as well and of course the honorable maxine waters. mr. chairman i would like to commend you for holding this hearing. it is an important hearing and i think of the witnesses for participating. you have indicated it's been six years since we examined this topic in the committee and i agree and concur that it is time for us to have another opportunity to visit these issues. i am eager to understand how we can adapt regulatory framework and governing through mutual money market funds such that we can avoid a run similar to the one that we experienced in the fall of 2008. i understand my constituents and our constituents hold a lot of savings and retirement funds and

accounts heavily invested in money markets ritual funds because of their safety, and i want to ensure that future generations can continue to depend on these financial instruments. they are important to our economic stability and they have been of great benefit to us. i am also interested in exploring the various options are witnesses bring to the table today, including industry funded research offers, a liquidity bank and two-tiered net asset value for money market funds. additionally, the recent economic climate in europe has raised some concerns over risks to u.s. money market funds. with the knowledge that millions of americans depend on stable savings and retirement accounts, i am concerned about the ramifications of a greek debt crisis with regard to these mutual funds.

this issue comes after particularly troubling times when retirement savings have already been severely diminished by the recent economic crisis. further, i am -- i would like to examine the potential for individual mutual funds or their managers to be considered systemic important. i am very interested to explore the arguments for or against designating mutual funds as systemically important, along with what they potential impacts would be for both retail and institutional investors. so with all these issues, and they are all important to us and i'm looking forward to this hearing mr. chairman, i thank you and i yield back the balance of my time. >> the gentleman yields back in i understand mr. capuano and mr. carney would like to participate in the hearing today and without objection -- at this time i i will yield a minute and a half to the gentleman from

california. >> thank you mr. chairman, garrett. you know when we look back at 08, we have very little exposure to lehman throughout the industry, but when reserve funds broke that dollar, broke the buck, we had a massive run on prime money market funds and it really took some extraordinary steps by the government to put a hault to that run. and i think we have got some questions here, whether the events in 08 proved that the structure of money market funds makes the industry today susceptible to that kind of a run. that is up for interpretation. what isn't subject to interpretation though is that we are now left with an industry that is at least implicitly government-backed. and given recent headlines noting the potential exposure of the european bank debt crisis, there are the questions that are

going to have to be kicked around in this committee. you know we are going to have to ask, has the industry fundamentally changed since then? is it in a better position to prevent and industrywide run this time? will the government be forced to intervene again in such a circumstance? but i hope that the hearing not only answers those questions at the end of the day. i think we have got to remove the perception that money market funds are risk-free or government-backed, and i think reducing investors incentives to redeem shares from distressed funds is going to result in more stable funds and a more stable financial system. how that is achieved is subject of this hearing. we have various competing ideas here that are going to be presented to us in terms of the best way forward. i:the chairman for holding this timely hearing and i think that these are subjects that need to be resolved and i appreciate his

leadership in trying to kick this off. thank you. >> i thank the gentleman. the gentleman from massachusetts for two minutes. >> thank you mr. chairman. i want to thank the witnesses for appearing before this committee today in helping us with our work. as of april of this year the combined assets of the mutual fund has totaled about $12.5 trillion. from a systemic risk perspective it is important regulation maintain proper oversight of this industry. it is also important to recognize that the money market funds that have been noted in earlier remarks have been the most stable sector of the mutual fund industry and represent about $2.7 trillion within the industry however everyone does remember, as the gentleman from california mentioned, we remember the event with a reserve fund breaking the buck back in 2008. but since that event, the sec and other market participants

have studied the mutual fund industry and significant forms of party been implemented in response to the reserve fund event. one of these measures, rule to a imposes a requirement for asset quality and liquidity. the commission is also reduce the amount of money that market funds can invest in lower-quality and illiquid securities from 5% of a fund's assets to 3% and the presidents working group on money market has proposed requiring money market funds to allow their net asset value to float. above or below a share. the goal, the stated goal it least of the proposal would be to help remove the perception of money market funds are risk-free and reducing investors incentives to redeem shares from so-called distressed funds that break the buck. however there is also countervailing evidence that allowing them to float would

also undermine the value of those assets so i would like to hear the panel's opinions on that toy and, how all of these reforms have affected the money market industry and particularly how glowing n.a.b. proposal might affect this financial tool, whether would make it more less attractive to investors and how to improve safety and soundness. i want to thank you mr. chairman for your courtesy and i look forward to the testimony from our witnesses and i yield back. >> one and a half minutes mr. dold. >> we combined assets now exceeding $12 billion, millions of americans rely on the mutual fund industry or retirement funding, for college tuition funding and for growing personal resources. despite mutual fund industries vital importance to so many americans, into our economy is as a whole this committee has not held an oversight hearing since 2005.

since that last oversight hearing we have seen the 2008 financial crisis, the dodd-frank regulation, the resulting rulemaking process and continuing dramatic industry growth in so many other developments that impact the industry. today's hearing is timely and important i want to thank the chairman for calling it. i also look forward to hearing from our witnesses about several specific topics including reforms, potential fsoc designations corporate governance reforms in the sec's effectiveness regulating the industry. most important i'm interested in how we might improve the safety and stability of money market funds which now contain assets approaching $3 trillion. as we learn from the research primary funds during the 2008 financial crisis. there can be some risk to investors and money market funds. in that case the administration decided to expose taxpayers to trillions of dollars of potential liability by guaranteeing certain money market fund investments. fortunately in that case and other guaranteed money market

funds actually failed but we must ensure that taxpayers are never again so badly exposed to such enormous potential losses. we all want smart and cost effective regulation of the mutual fund industry and i look forward to hearing from the witnesses about how we can get closer to that objective and i yield back or goes be the gentleman yield back. >> thank you mr. chair. our to thank the chair and ranking member for holding this hearing. as the state of our financial markets and the economy intended to be of utmost concern is we will be specifically focusing on money market mutual funds today i'm very hopeful our witnesses will explain why or why not these funds are good or monies to be invested in. i understand these funds to provide for short-term financing for businesses, banks and governments at all levels. there is a certain stability as well as convenience these funds bring to the table. while a few money market funds have broken the buck or have gone below 1 dollar, the fund company or sponsor has stepped in to absorb the losses.

i do however have concerns. i have some questions regarding their net asset value and your opinions on money market funds assuming they floated in a v structure. i'm interested in learning about what this change could do to not only the nature of a single investment vehicle but also what further implications and consequences these would have for the entire system. i also have some questions on whether or not these funds could potentially be under some scrutiny for holding any greek debt or other eurozone investments. i'm also curious as to how the faltering million-dollar greek financial bailout threatens the industry. the money market fund industry has indeed as you well know, under heightened scrutiny in the wake of the financial crisis. it has brought to my concerns for both the funds and systemic risk associated with these funds. we are curious as to how we can distinguish these different

vehicles from our distinguished panelists and really getting your insights, and thoughts on initiatives within the radio story system, really explaining systemic risk without damaging money market mutual funds important role as a source of value to investors and funding to the short-term capital markets. thank you mr. chairman and i yield back. >> the gentleman yields back and i believe that is all the opening statements that we have up here so now we turn to our esteemed panel. as you know, you are a full written testimony has been already delivered to the committee. you are now ready nice for five minutes to summarize your statements. mr. stevens. pull it up close. >> chairman garrett, congressman green and members of the subcommittee we welcome today's hearing because of the central role that mutual funds and other registered investment companies play in helping some 91 million americans achieve their most

important long-term financial goals. today the assets of these funds actually total sum or team $.8 trillion representing nearly one quarter of the financial assets to u.s. households. as these figures suggest, the fund market is vibrant and highly competitive. one leading indicator of that competition is the cost of fund investing. since 1990, average fees and expenses paid by mutual fund shareholders have decreased by more than half as a percentage of assets for both stock and bond funds. over the same period the range of services investors received has increased just as dramatically. the key to the industry's success is the comprehensive framework of regulation in which funds operate. that framework grew out of the great financial crisis of the 1930s and has proven its worth for over seven decades. its distinctive features include market valuation of fund assets each day, and tight limits on

leverage, unruffled transparency, strict custody of fund assets, detailed prohibitions on transactions with affiliated parties and strong governance overseen by independent fund directors. fund regulation and our fiduciary culture helped assure that funds were not at the center of the latest crisis nor were funds the focus of the dodd-frank asked. nonetheless funds and their visors remain concerned about how the financial stability oversight council will exercise its authority under dodd-frank to designate non-bank financial institutions as systemically important and subject them to heighten bank type regulation. as we explained in detail in a written statement, funds are already among the most highly regulated and transparent financial companies in the country. they simply don't present the kind or extent of risks to financial stability that would merit designation.

moreover quite apart from designation there is ample regulatory power in dodd-frank and under other existing laws to address risks identified by the fsoc or other regulators and regulators in our view should use those tools first. money market funds are a good case in.. regulators not only have authority they need over these funds. they have already put that authority to use. after the financial crisis our industry supported and the securities and exchange commission adopted comprehensive amendments to its rules governing money market funds. those amendments raised standards or credit quality. they shorten maturities. they improve disclosure and for the first time they implode -- imposed explicit minimum daily and weekly liquidity requirements. as a result, time funds or they have a minimum of $660 billion in highly liquid assets available to meet redemptions on a daily and weekly basis.

this far exceeds the $370 billion in outflows we saw during the week of the lehman brothers failure. in short we have come a long way in making money market funds more resilient and the industry remains open to ideas to strengthen these funds further including ways to enhance liquidity and in the mice the risk of the fun breaking a dollar. any further proposals however must preserve the utility of money market funds to investors. they also must avoid imposing cost that would make large numbers of additional advisers unwilling or unable to continue to sponsor these funds. y. lading either of those two principles will undercut the important role that money market funds play in our economy. bear in mind that these funds hold more than one third of all commercial paper issued by american companies and ore than half of all the short-term municipal debt outstanding. the funding they provide is part of the lifeblood of jobs and communities and in today's

economy especially we can ill afford to disrupt it. one disruptive ideas the notion of floating the value of in the market funds shares, forcing these funds to abandon their stable 1 dollar per share price. our investors and institutions and individuals alike have stated clearly that they cannot or will not use funds that fluctuate in value for cash management purposes. and a secretary timothy geithner recently noted, any further changes to money market funds must be made quote without depriving the economy of the broader benefits that those funds provide. leah greve. lastly let me know their concerns about conflicts and duplications that can arise when multiple regulators oversee the same entities. one compelling example is the cftc's sweeping proposal to amend rule 4.5 and subject many hundreds of mutual funds potentially to regulations that duplicate or even directly

conflict with those of the fcc. why this is necessary the cst -- cftc is not ethically explained in our judgment nor is it clear where the cftc wants to so dramatically expand its regulatory reach now when it says to congress it doesn't have enough resources to do its basic job on dodd-frank. this committee has addressed the need to promote regulatory coordination and avoid market disruption by passing h.r. 1573. iti supports the policy goals. mr. chairman my written testimony touches on a wide variety of other issues any of which i will be happy to discuss with you and her colleagues during the question and answer session. thank you. >> thank you very much. from the university of mississippi. >> thank you chairman garrett. congressman green and members of the subcommittee. thank you or the opportunity to appear before you today. respect and to provide useful lessons in the management of systemic risks, prudential

regulation and protection of the mutual fund industry. performs a stock and bond mutual funds for example is demonstrated a remarkable resiliency over the radio to restructure in times of extreme stress. a share values of plummeted mow shareholders and mutual funds have stood their ground. this confidence and investment company structure reduces the likelihood of the kind of panic selling that contributes to systemic risk. this is one of the reasons true mutual funds that price their shares based on net asset value did not impose material systemic risk and should not be treated for example as systemically important financial institutions. another reason is that there are conference of the regulated under the federal securities laws and the fcc, by the fcc. in contrast money market funds are not true mutual funds. they are not required to redeem their shares at the current net asset value or more precisely they are permitted to round their net asset value to the nearest dollar. money market fund staple acid --

asset value in the wake of the 2008 run on money market funds. they can be no dispute this risk is real. the question before regulators is what steps if any should be taken to address the systemic risk. money market fund portfolios are safer than they were before the crisis. they are better able to handle operational and liquidity stress and they are subject to improved regulatory oversight. but they were safe before the crisis. the 2008 run did not result from shareholders judgments about the safety of individual funds in which they were invested. they made an undiscriminating judgment about the safety of time money market funds as cash management vehicles. any regulatory form needs to address the systemic fund risk. therefore it must and outside of the system for which the reforms intended to provide a backstop. in other words it must retain the face of the system that supports has lost. for example kratovil requirements would operate within the very system in which shareholders have lost faith.

when there's a system that shareholders doubt safety mechanisms that are viewed as operating within that system will not prevent a run. the only meaningful preventive mechanism for systemic run risks is a guarantee like the treasuries temporary guarantee program that shareholders believed to be derived from external sources. the strongest sources is the full faith and credit of the united states reflected by the deposit insurance. is my view that the deposit insurance extended to money market funds in conjunction with banks from investing insured deposits in anything other than short-term assets. however, deposit insurance is not necessarily the only external guarantee that could provide an adequate source of independent confidence. for example liquidity banquet access to the fed's discount window might be sufficient to quell the doubts of institutional money market fund shareholders who are likely to leave any market money fund in a crisis such as that experienced

in 2008. in contrast, requiring money market funds to affect transactions of so-called floating nav proposal would not negate systemic risk. this would however overruled the market preferences of tens of millions of money market fund shareholders. if the fcc money market fund roundtable is any indication however the preferences of these millions of small investors and money market funds appear to be an afterthought. in conclusion i'm also concerned regarding the sec's approach to being a prudential regulator. in january 2008, i thought the room a king petition with the group of similarly concerned organizations to require money market funds to file their portfolios with the sec on a monthly basis to enable detailed monitoring of their portfolios. this is what we wrote in that letter. nine months before the reserve funds broke a dollar. no retail fund has broken a dollar. we believe that it may be inevitable that a money manager will one day decline to bail out

its money market fund. to prepare for this eventuality the commission should take steps to ensure that the damage to faith and money market funds is minimized. the commission adopted this proposal years after we submitted our petition. i am concerned it is not doing what should be doing with that data. in the last week we have seen headlines claiming money market funds are vulnerable to european exposure. i read in wednesday's l.a. time that federal reserve chairman bernanke said that he is keeping a quote close eye on money market funds. i found no public statements from the sec on what it has found within the rest of us -- leaving the rest of us to wonder whether banking regulators announcements are at risk may actually be true. the prudential regulator means proactively, directly, aggressively addressing concerns regarding the stability of money market funds. i hope that the sec will set the record straight. thank you. >> thank you.

>> thank you chairman garrett and members of the subcommittee for permitting me to testify before you. my name is andrew donohue and was the director of the extent -- exchange commission from a 2006 until november 2010. party joining the sec i held senior positions in the investment company industry, most recently as global general counsel for merrill lynch investment managers. i've been associated with investment company industry since 1975 and i've recently been elected to the board of mutual fund directors forum, nonprofit organization of independent fund or actors. the views i express today are my own and should not represent those of my firm, my firm's clients or any other organization. funds are subject to a conference of regulatory regime that has served funds invested well and played a significant role in the success of the one industry. with a critical role that funds

play on our economy and an investment of american people's hard-earned money for savings and retirement, it is essential that this regulatory regime urban comprehensive yet flexible enough to meet changing market and investor needs as well as to enable product innovation. during the financial crisis, funds and their investors receptor to many the the of the same challenges as other financial institutions. funds perform quite well during this period with but a few exceptions. a few short-term bond funds had exposures to mortgage-backed securities that cause them to suffer unexpected losses. a number of closed end funds had in preferred securities that suffered auction failures in early 2008 resulting in those securities becoming illiquid and losing value. money market funds have liquidity pricing and credit issues that affected them during this reid. the industry was quite

supportive of their money market funds with over 25 advisers providing liquidity and other financial support to over 100 money market funds. while only one money market fund broke the buck, some extraordinary steps are taken by the treasury and the federal reserve to stabilize this area. since then the fcc has adopted amendments to its rules significantly strengthening the regulatory regime for money market funds and is currently considering additional measures. i am confident that the sec and industry participants will be able to craft an approach that lessens the likelihood of a run on money market funds or money market fund breaking the buck. while still preserving the benefits money market funds have historically provided to investors and the markets. while mutual funds in mutual fund complexes are important participants in the u.s. financial system, and provide many benefits to their investors, i believe that the nature of mutual funds, their

operations and a conference of regulatory regime within which they operate argue quite forcefully for them not being considered systemically important financial institutions. mutual funds have predatory requirements on the degree of leverage they can employ, the diversity patient of their portfolios, where and under what circumstances their assets are held, the valuation of their assets on a daily basis at market value, the requisite liquidity of their investments and limits on transactions with affiliates. these and other requirements are provided to some structure for the funds to operate in and in a manner that does not expose the u.s. financial system to the types of risks that dodd-frank act was concerned with. for somewhat different reasons i did not believe asset managers should be designated as significantly important financial institutions. the asset management industry is quite different from that of other financial institutions and

those differences should militate against them being considered significantly important financial institutions. asset managers do not put their balances at risk to not balance the returns on their clients bear the risk of the investment. the asset management industry is not concentrated and is quite competitive and assets can be moved quite freely from manager to manager. the sec has played a critical role in the comprehensive regulatory regime for the funds. it is used the flexibility provided in the investment company act to adapt a the 7-year-old statue to changing markets and investor needs and to facilitate innovation in the fund industry such as money market funds and exchange traded funds. it is also used to permit funds to engage in activities otherwise prohibited by fashioning alternative means of achieving the safeguards intended the statute. i want to thank you for the

opportunity to testify today and i welcome any questions that you might have. >> thank you and before you go mr. gopal i i will to syndicate to the panel and the rest of the members we are just -- it is only one boat so members are encouraged to -- to the boat so we will proceed as you go boating. mr. goebel for five minutes. >> chairman garrett, members of the subcommittee, thank you for the opportunity to testify today. my name is scott goebel and i'm senior vice president and general counsel are up fidelity research company. in this role i'm responsible for legal matters pertaining to fidelity's investment advisory businesses including the fidelity mutual funds. fidelity investments are one of the world's largest providers of financial services with assets under administration of $3.7 trillion including managed assets of more than $1.6 trillion. we manage over 400 mutual funds across a wide range.

as you might of assembly are strong advocates for the mutual fund model and benefits of mutual funds provide to individual investors. mutual funds allow shareholders at a low cost for small minimum investment to obtain a professionally managed, liquid, diversified portfolio of securities with the added safeguards of a robust regulatory regime and independent ward oversight. for example mutual funds operate under strict statutory borrowing limits and as a result the vast majority of mutual funds do not use leverage to generate investment returns. today there are more than 7500 funds moving over 12.5 trillion in assets offered by a host of financial services companies. we believe that these numbers illustrate the intense competition and low barriers to entry that up in the hallmarks of the mutual fund industry forces that continue to drive mutual funds to innovate and improve product offerings. the assets in mutual funds belong to our shareholders and are not for pride terry assets and not fidelity investments.

our mission he stays to put the interests of our shareholders first as we manage the assets of these funds. i want to focus today in my oral testimony on money market mutual funds. money market funds are a convenient way for millions of investors and institutions to invest short-term cash. for 40 years they have offered stability equity in income at a reasonable cost and today provide an important source of funding for state and federal governments and corporations. in 2008 during the worst economic crisis since the great depression, the credit arts became stressed as uncertainty ripple through the financial markets. as part of a broad range of efforts by the u.s. and foreign governments to stabilize the markets, the u.s. treasury established a limited insurance program to support money market funds. the federal government actually earned $1.2 billion in fees. at the height of the crisis in 2081 money market fund that reserve my merry funds dip below the stable 1 dollar per share price that money market strive

to maintain. in the aftermath of this financial meltdown the sec adopted a comprehensive set of amendments to rule 287 which have dramatically enhanced the resiliency of money market funds. to take one example the sec rules now require that each money fund be able to liquidate 10% of its assets in one day and 30% in seven days. this change alone is created by one estimate more than $800 billion of new liquidity and money market funds. the question is what comes next? are there additional money market fund reforms that are necessary or appropriate? some reform options under consideration such as the floating nav would cause shareholders to leave money market funds and large numbers. based on client service we believe the shareholders would shift to other investment options including banks, offer products and unregistered institutional investment options all of which pose greater systemic risk than to money market funds. however fidelity and her stances on federal financial regulators

and others believe that more needs to be done to increase the resiliency of money market funds. therefore we are working with others in the industry on a proposal that would strengthen money market funds by creating a buffer within each fund. it is worth noting that this is a private market solution and does not rely on any government support. the idea is pretty simple. each fund would be required to hold back a portion of the yield shareholders would otherwise receive and this amount would throw over time to create a buffer or cushion that would help absorb any potential losses and help ensure liquidity by enabling money market funds to sell securities at a loss to meet large redemptions. show shell show holders were content to buy and share shares of the 1 dollar price but he sure would represent assets of slightly more than 1 dollar. we arrived at the solution by asking ourselves what is the problem regulators are trying to solve? by and large we believe the issue is that some shareholders have or think they have an incentive to redeem first in order to avoid paying for a portion of the potential loss in

the money market fund. ben affleck buffer concept eliminates this because they shareholders redeem the buffer amount is spread over a smaller investor base. in other words a shareholder redeems 1 dollar leaves the value of the buffer behind in the fund which helps protect the remaining shareholders. as regulators in the industry consider additional possible reforms, we submit that the question should not need how do we prevent the next money market funds from making a buck? rather the question should be sent so much as already been done to improve the resiliency of money market funds, how can we alter shareholder incentives to ensure that if a money market fund breaks a buck in the future shareholders and other funds are not affected. i would like to thank the subcommittee and staff for their work on these issues that are important to mutual funds and our investors and for holding this hearing. i would be happy to answer any questions. >> thank you. ms. stam for five minutes.

>> thank you chairman garrett and members of the subcommittee. i appreciate being here today. my name heidi stam and i'm a managing director of vanguard and angered mutual funds. vanguard is one of the largest will -- world's largest funds. we serve nearly 10 million shareholders. about 95% of the assets we oversee our own by individuals whether they invest directly with vanguard or incorrectly through financial advisers or as participants in retirement plans. in short we are at a company that serves many many small investors. we appreciate your interest in vanguard's piece about the current state of the mutual fund industry and we hope to learn through this hearing the perspective of the average investor from main street, not wall street. during the financial crisis the trust and confidence in the global financial system was severely damaged. investor trust and confidence in mutual funds however was not and this is a very important

distinction. indeed, assets in mutual funds reached an all-time high of nearly $13 trillion at the end of last year. this is a tremendous testament to the trust of millions of investors placed and have placed over many decades in mutual funds. mutual funds are resilient and they have weathered every crisis from the great depression of yesteryear to the great procession of yesterday. mutual funds are the most efficient effective and intelligent way to invest in the securities market. compared to other financial products they provide superior liquidity, transparency, professional management and diversification all at a reasonable cost. we believe that strict regulatory oversight of mutual funds has played a vital role in their success. mutual funds are subject to a comprehensive regulatory regime and for more than 70 years the sec and the industry have shared an obligation to serve and protect the interest of investors. it is an obligation we do not take lightly.

the shared obligation came to reform in 2008 when the money markets were rattled by the most significant liquidity crisis in our history. the industry and the sec move to solve the problem quickly and thoughtfully. the industry formed a working group which began a thorough review of whose governing market funds and they developed a series of measures to address the fund's ability to withstand the extremely unusual market conditions that existed at the time. shortly thereafter the sec adopted enhancements to rule to a seven which include the liquidity credit quality maturity and transparency of money market funds. we believe that these enhancements address the need for greater liquidity and money market funds and significantly reduce the risk that a future systemic architect of disruption with threatened the liquidity of these funds. if the sec determined however that additional measures are needed, then we would encourage a solution that is tailored to address the remaining concerns.

specifically more liquidity may be required for institutional money market funds that have demonstrated a heightened need to make large same-day redemptions and we think this could be achieved quite simply by increasing the liquidity requirements for these funds. this approach or other recent proposals discussed here today are simply not required for mom and pop money market funds. the cost, complexity and description additional changes may cause small retail investors are not -- given away these money market funds are used, paid the mortgage, send a tuition check or save for a rainy day. if we have money market funds are well-regulated and should remain solely under the sec's jurisdiction. that said vanguard understands the need for the financial stability oversight council to monitor risk across markets constitution since segments. it is important to emphasize though none of the reckless

lending leveraging our financial engineering that led to the creation of fsoc related to mutual funds. mutual funds do not have leverage exposures or off-balance sheet liabilities. they mark their asset value to market every day. their portfolio holdings are transparent and reported regularly. mutual funds don't engage in proprietary trading. they do not pose systemic risk to. they do not have the attributes of systemically important financial institutions based on the fsoc factors and they should not the designated as such. vanguard has always been willing to discuss the interest of mutual fund investors with legislators and regulators. we respectfully caution against duplicative regulation that has the potential to limit innovation, raise the cost of investing, stretch the resources time of fiscal constraint unless there are clear benefits to investors. we believe that mutual funds are already banned from investor

protection in the form of strong security laws and effective regulatory agencies, a keenly competitive industry and educated consumer and a vigilant news media. thank you very much for this opportunity to share our views and we would be happy to answer the questions. >> thank you is stam. professor. >> mr. chairman and members of the subcommittee, i thank you are giving me the opportunity to testify at this hearing. my name is rene stulz and i am a professor at the college of business at ohio state university. systemic risk is used everywhere within the regulatory community. at the same time it is rarely defined on almost never quantified which makes possible a lot of mischief. my definition of systemic risk is that it is a risk that the financial system becomes incapable of performing one or more of its key functions in a way that prevents normal economic activity.

regulation in the name of preventing systemic risk it is important on the benefits of that regulation. any systemic designation should be based on objective, unquantifiable criteria. on economic grounds there is no reason to believe a specific mutual funds, mutual fund complexes or management company should be designated and systemically important. the asset management industry plays a critical role in our economy by managing the funds of investors. the failure of the industry in performing its role does not create a systemic risk. if one is in trouble another player can take its place. there is no evidence that the asset enrichment industry created systemic risks during the recent crisis except in one segment, the money market fund segment. rather than designating money market funds of systemically important it would make more sense to eliminate the features of money market funds that

create systemic risk. by their very nature money market funds are prone to runs. when investors run from funds, it tends to sell assets and disrupts the provision of short-term funding in the financial system. in 2008 the run was started by losses on lehman investments at one fund, the reserve primary fund which was shares at less than 1 dollar. in the two weeks following the bankruptcy of lehman, more than $400 billion left money market funds. further, money market funds sold assets to become more liquid to cope with further redemptions. runs on anticipated redemptions lead to chaos in the commercial paper market as well as the repo market. the point of reform of money market funds is not therefore to make investors in these funds safer. it has to be to make the financial system safer. some might argue that reforms

that the party taken place would eliminate the problem. this is not correct. money market funds are still vulnerable to runs. further, the last position of the funds in european banks are a source of risk for these funds as well as for the financial system. a recent study finds that the top 18 largest prime funds have more than 50% of their assets invested in foreign banks. the lion's share of these investments in european banks. the key reason by money market funds are prone to runs is that they are investors at 1 dollar the market value of the fund's assets is worth less than 1 dollar. if the market value of the fund's assets is worth less than 1 dollar a share they can become rationale for investors to runs since they receive 1 dollar by redeeming immediately instead of possibly receiving less if they do not. to make friends much less likely

a group of 14 economists of which i am a member has proposed that money market funds either should have a floating nav or should have a offer that could be used to prevent the nav from falling below 1 dollar a share. via buffer we mean resources by the management company or by third parties that absorb losses so that the fund can keep redeeming shares at 1 dollar, even if it is made. the use of a buffer makes it possible to keep a stable value nav mechanism but largely eliminates the incentives for investors to run since the buffer ensures that the mark-to-market value of the shares does not fall below 1 dollar as long as the buffer is large enough to cover losses. we propose several mechanisms to create a buffer. irrespective of of the buffer implemented we recommend that any buffer mechanism should have three important characteristics.

first, the mechanism should be such that in the presence of losses the buffer should be replenished quickly. second, as stable value funds should immediately convert to a floating nav fund, if the butter is depleted so that it's value is below the minimum threshold. third, once losses have been made the offer should be replenished within a short period of time and if not the fund should convert to a floating nav fund. thank you again mr. chairman and committee members for letting me testify. i would be happy to answer any questions. >> thank you mr. stulz. you are all very impressive and it is amazing how close you came to hitting the exact five minutes. a couple of odds and ends. one i just finished early this morning reading something from the federated investors. i would like to actually put that into the record. and the chair yields himself five minutes. i would like to actually continue where you were going

professor stulz. as you call it a buffer, if an account or a fund puts that offer, what has it done to its yield? >> in the swan lake proposal which is in my written testimony, we try to estimate the impact on the yield. our conclusion is that the impact would be minimal. what would happen is that the funds would be very transparent about their holdings. >> my concern was actually, i was actually going for your proposal this morning and i was trying to get some understanding particularly -- i come from having once been an institutional investor in these types of accounts and just managing lots and lots of cash, sometimes i could only hold it for 45 days until i had to pay teacher salaries or sheriffs

deputies. but that yield sometimes with the salary for another teacher. and so i am always very yield centric if that offer does much damage on that greater return? >> our conclusion is that it would not do much damage to the rate of return. >> okay. professor bullard it almost -- almost the same question and he said something interesting in your testimony but access to the window. could you expand, first the question and then expand on that? ..

>> that kind of change in attitude of institutional investors who are really the only ones who would lead a run. i think retail investors would have followed in september, but they're the only ones who would lead a run, and they're the ones we should focus on. but we can't know that, and not being an economist i'm not willing to say that i do know the answer to that. i do know the answer that full faith and credit solves the problem, but i think a liquidity window, certainly, has a high enough possibility of changing their attitude that it would actually present precisely the kind of run a buffer would fail to prevent. >> don't harbor not being an economist. >> i think it's a badge of honor. >> mr. stevens. give me pros and cons on floating up and down over the net asset value. >> um, i'm harder pressed to do the pros than the cons. i think many of the people who

have suggested floating the nav understand implicitly that as a result of that we won't have money funds as we know them any longer. and that would be just fine with them. so if that's a pro, that's, i think, what they have in their minds. the con is that as has been observed already, the money will go into, from institutions, into unregulated parts of the financial system, and we'll be replicating the same risks that are perceived here, we'll just be doing it elsewhere where the sec is not overseeing it, and it's not as transparent. much more importantly, though, we'll put at risk the whole mechanism that funds corporations, state and local governments, individuals who are accessing the credit markets. for that matter, even the treasury's auctions depend very substantially on money market mutual funds participation. so it would be a real shock to the current funding model, a

real shock to those people who depend upon money market mutual funds for critically important financing. and it will not solve the systemic risk issue. >> okay. we probably barely have time to touch this one. is it ms. stam? >> yeah. >> in today's world with one of these funds, what do you think your regulatory cost is compared to what it may expand to with some of the discussions? >> with well, you know, i have to say interestingly enough the funds have been operating under very conservative money market regulations for some time, so the enhancements to rule 207 that were adopted recently are very consistent with the way we've managed these funds historically. so there's been not much of an incremental cost to those changes. when we think about the other suggestions that have been put on the table, buffers of different types and so on, there are certainly costs associated with them, and that's something that we'll have to evaluate as

to whether these are workable solutions. we would hate to burden, um, the money market fund investors with costs that would, essentially, make the process unusable. >> and i'm over my time. you'll have to forgive me, i was always, safety principal return was always number one, but that little bit of yield is what, you know, helped employ that, you know, next teacher. so five minutes to mr. green. >> thank you. i will yield to mr. lynch, and then i'll proceed next in the rotation. >> mr. lynch. >> thank you, mr. chairman. thank you, mr. green. first of all, i want to agree heartily with the testimony of mr. stevens and mr. goebel in terms of the value and opportunity that mutual funds have created for working class families that i represent in my district. you know, i have companies like procter & gamble, gillette, where -- and i came out of the iron worker industry myself, the building trade, and i know there

are a lot of hard working families out there that at a very low cost are now able to invest and over their working lives accumulate, you know, significant wealth because of the structure and stability of mutual funds. so there's great support here for that. i do want to talk about, you know, most of the controversy here has been focusing on the reserve fund and breaking the buck. and i just know that there's, there's, there's less and less support in this body and in the senate for government guarantees where the good faith and credit of the american taxpayers is at risk. and that's what intrigues me about, mr. goebel, your testimony regarding this buffer for the money market mutual funds as a private sector

response to this where the taxpayer is not at risk and that over time, incrementally, a buffer would be created. could you, could you go over that? i know that's an industry response. i think it's, i think it's thoughtful, i think it's responsible, i think it could work. i just need to hear a little bit more about it, and if you would. >> sure. thank you, congressman. the fundamental premise that we have is that to the extent there is additional residual risk in the product that has not been resolved -- and i should pause and say that's still an if for us -- the significant liquidity, one of the issues in lehman and the post, the crisis that followed from lehman was that institutional investors did not know what was inside our portfolios. they did not have the visibility into what the actual holdings were. it's very common in the institutions to disclose full

holdings within a day or two. so there is much greater transparency. if there's an institutional investor who has questions or concerns about what is inside one of our funds, they can find out very quickly and very easily. so the liquidity changes, the transparency changes have been significant. the idea of the buffer is to say we don't think that the government should be standing behind these products. we recognize there is some risk in them. they're an investment product. shareholders are putting their dollars with us, and our job is to return stability of the principal, liquidity and yield in that order. so what we have, what our approach is to say that yield, a piece of that yield over timeshare holders, we think, will accept a reduction in that yield in order to enhance the stability of the product. so the question that was asked earlier of the panel was how much of the yield, how much of a cost is this gonna be. and the answer is, the answer to

that question is you tell me how quickly you want to get to the buffer, and i'll tell you how much it's going to cost. because if it's 30 basis points and you take five basis points a year, that's a six-year issue. so one of the questions we have with all of the issues with basel iii and banks increasing capital liquidities is how quickly we can get to the level of protection. and we submit this product is very safe and secure today, but the idea of taking a little bit of the yield from time to time out of what shareholders would otherwise receive fully disclosed, so shareholders can understand what they're getting, is a pretty elegant solution. and the reason for that, the reason why we think it works in the marketplace is that a shareholder can make a decision about the yield that it or he or she is receiverring on that product. and if they don't like the yield, they can go to another product. so over the last 20 years roughly, taxable money market funds have returned 150 basis points more than banks. we believe in a normal rate environment taking five, six,

seven basis points of that yield and diverting it into this buffer idea is a reasonable trade-off, and shareholders will continue to invest. >> okay. thank you. well, i do agree that the situation with lehman, the death knell there was really the lack of transparency, the uncertainty. no one knew what counterparty exposure was, and that's a much different situation than what we have here today. i know i'm short on time. but, mr. stevens, do you have anything you want to add to that? >> i think it's an idea that is worth very serious consideration, and i think it's a number that the institute has developed. and i would just reiterate the points that i made. as we consider these things, i think they need to be held up to two standards; do they maintain the utility of the product to the investor, number one, and number two, are they going to still be consistent with maintaining a robust array of advisers who want to be in this market and to provide these

funds? i think that's, those are the two criteria appropriate to begin thinking about what additional reforms should be. >> thank you. thank you, mr. chairman. i yield back. >> thank you. mr. dole, five minutes. >> thank you, mr. chairman. professor stulz, question for you. in your testimony you urged regulators to refrain from designating financial firms as systemically important until they can be accurately set forth an objective and quantifiable criteria to define the term. can you give me some examples of some quantifiable criteria congress and the regulators can use to define a systemically important fund? >> well, financial economies have developed models that look at the impact of a shock to one firm on the rest of the financial system. so the use of models of that kind would provide an objective benchmark for whether an institution is systemically important or not. so you would want to see based

on historical evidence or based on simulations what would happen to the financial system if a product or institution runs in trouble. if such models were used, it's inconceivable to me that the asset management industry would show that it has a systemic impact. >> can you give me just some sort of an idea how many firms out there right now would get the s irk fi designation? -- sifi designation? do you believe they're systemically important financial institutions? do you have a number? >> i don't have a number, but i believe that the number would not be in the hundreds, would not be in the, i mean, more than 50. i think we should be very careful in giving the definition, and we should make absolutely sure that there's an objective evidence that the failure of the institution would have systemic consequences. >> okay. thank you so much. so you're, basically, at about 50.

i've heard a couple of dozen would be the most. mr. donohue, what is your assessment? how many firms do you think would qualify for a sifi designation or should be qualified? >> i'm not sure i'm well informed enough to make that judgment. i would say, as i said in my testimony, that i, absent extraordinary circumstances, i don't see asset managers, traditional asset managers or mutual funds being within that class. >> just continuing to follow up with you, sir, in your opinion is the sec oversight of mutual funds, has it worked in the past, and what can be improved internally within the sec to better regulate those funds? >> i'm a strong supporter of the sec's role in regulating mutual funds. i had an interesting seat during the financial crisis heading up the division of investment management. the expertise that exists inside the sec the understanding of the mutual fund industry and how it operates, um, and the way that,

in fact, the sec is operating with regard to mutual funds over the years, i think, is a testament to the right regulation of an industry. and i think the growth of the industry during the period is testament to that. that doesn't mean that there aren't challenges. it's a 70-plus-year-old statute that the commission has to, that they have a tool in order to adjust the statute, the ability to do exemptive and other type relief. but that is time consuming and does take resources that the, that the commission then has to have in order to adapt. i think they've done it well. i think if they don't have adequate resources in order to do it well, then i think that the robust regulatory regime that funds have had, um, may be compromised. >> thank you. professor bullard, if i can ask you in the absence of the

government bailout under t.a.r.p., how many money market funds do you think would have failed? >> i'm not sure there's any evidence that suggests that the t.a.r.p. bailout had an impact on the survivability of any particular money market fund. and that was, you know, that was quite a different kind of exercise in the socialization of risk that we see banking regulators engaged in. so i would say i don't think anyone can know the answer to that, but my guess is close to zero. >> okay. in light of that, do you think it's necessary that the government be a backstop to money market funds? >> well, there are a couple of different levels in which to answer that question. as an overall systemic regulation question, money market funds should be regulated considering the context in which all short-term cash is regulated which my recommendation of deposit insurance necessarily

with weaning banks from be their overreliance. within the context of money market funds, i would probably say, no. i have a somewhat akon dallasic view of -- iconoclastic view of what happened. i would not have supported any of the improvements the sec has made to the safety of the objective portfolios that have been done to date. i support the operational changes, the liquidity changes, the concurrence of whether the product itself has become meaningfully safer. i think that is simply an incorrect assumption and has, essentially, been giving in to political pressure. and what you're going to find in a few years is the ici's going to tell us how many basis points that shareholders and money market funds have lost because of it without any real, meaningful change in safety. on the other hand, systemic risk is a different thing. there's a good argument that there should be some kind of systemic risk management put into place, and for that purpose, as i said, it needs to be something that will force money market fund shareholders to think differently about money

market funds as a structure. and the only way you can actually do that is not a buffer, is not capital requirements, is not increased liquidity, is not greater safety. there's only one thing out there, and that is some kind of federal guarantee. and the discount window probably by itself would be sufficient to bring about that change of perception in money market funds while costing the government as little as possible as a general matter. >> thank you so much. mr.mr. chairman, i yield back. >> thank you. mr. green? >> thank you, mr. chairman. and to the witnesses, thank you again for appearing. the financial system depends greatly on confidence, and confidence depends greatly on transparency. with reference to the money market system, is there sufficient transparency, is there more that we can do to enhance transparency such that we enhance the confidence of the

system as a whole? so let me just ask, i don't need to go down to every person. if you think there's more you can do in the area of transparency, would you kindly extend a hand into the air? anyone? yes, sir, mr. stevens. >> i would say in the dialogue around this issue there's, um, a sense that some believe that shareholders don't understand the risks of money market mutual funds enough. you know, we're almost victims of our own success here. our track record in maintaining that stable nav per share is really quite extraordinary. it's gone on for 30 years. only two money market funds have ever broken a dollar. in the case of the reserve primary fund, shareholders lost a penny on the dollar where many other investors would have thought that was a great day in the market for them. so to the extent that they don't understand it, even despite the

fact that the prospectuses say these funds are not guaranteed, they're not insured by the fdic or by the united states government, we can try to make sure in blaring headlines we communicate that to people. so that might be a useful thing to remind everyone that these are investment products. they have risks that are quite minimal, and people need to understand that as they invest in them. um, i'd like, also, just to mention something about, about the systemic risk issue. and you have to think about money market funds in september of 2008 in coon text. in a context. the context was, essentially, a paralysis in the short-term fixed-income markets that affected every market participant. not money market municipal funds uniquely by any means. it was a crisis in the banking system that paralyzed the markets in which we invest. what we needed then, congressman, was not a federal

guarantee. in fact, we never asked secretary paulson for a guarantee. we were kind of appalled because we knew the consequences when it was extended. what we wanted was liquidity in the markets, particularly the commercial paper market. and we may have another crisis one day in that market, and fixing money market mutual funds is fine and we think that's important, but we also ought to attend to the reality that we're going to need to have liquidity provisions in that market as well. and there's no possibility of that at the moment. >> well, as we review and reflect, obviously, lehman comes to mind and the cascading impact that it had on the entire system, economic system. um, how, how do you avoid that given that it was, it generated a run? and once you get a run, sometimes difficult to stop the run.

so how do you do that under those economic circumstances? i understand the liquidity argument, but how do you present, how do you stop the run or prevent it? >> we spent as a result of the treasury department white paper and the president's working group report suggesting the desirability of exploring a liquidity facility, the institute and its members spent almost two years putting together a very detailed model of how such a facility might work. formed as a commercial bank, capitalized by sponsors of prime money market funds and by shareholders in prime money market funds. and as a commercial bank regulated by the fed and overseen as a bank, but available as a dedicated market maker in commercial paper should there be a liquidity crisis this that market, it would be able to make a market for money market funds, prime money market funds. and in the worst circumstances -- >> i'm going to let you continue, but let me intercede for just a quick second. is it anticipated that in the

shadows there will be the hidden hand of the government? >> i was going to say the only hand of government here other than overseeing the institution would be that it would, just as every other commercial bank, have access to the fed's discount window in the worst kind of circumstances. but it would do it with a haircut and at the expense of the institution and its participants just as would be the case with every other commercial bank. no different than others. >> thank you, mr. chair. >> thank you. i'll recognize myself. so along those lines, first of all, as far as the blaring statements as to evidence that these things are not guaranteed by the government, of course, that was the case. i mean, i have a little bit in a fund, and anytime you call up to make, have a transaction or find out what's going on, the recorded message there is exactly that, right? telling you that this is not guaranteed by the federal government until after the fact you found out that it really was. >> and, mr. chairman, that's a

circumstance we would very much like to avoid ever again in the future. as an industry, we are not seeking -- we are not seeking a guarantee of any kind from the government. >> right. and just elaborate a little bit as to what your protestation was at the time when this was going on as far as to the secretary. were you saying that we don't want this? >> no. we thought the problem was liquidity. and if markets in which we invest could be jump-started -- as eventually they were through the fed's facilities -- then that would solve the problem. the guarantee was, perhaps, an appropriate response to an extraordinary crisis, and it certainly did bolster confidence. i think most people didn't understand how limited the guarantee was. what the guarantee was if a fund is at risk of breaking a dollar, it would have to immediately suspend redemptions and liquidate its shares. the level of risk to the treasury was very, intentionally very small.

all of our funds participated and paid a billion and a quarter in premiums. there were no claims against the guarantee. >> so one of the solutions is the floating nav. so let's say we did that, would that preclude -- i'll open this to anyone -- would that absolutely preclude a next run on the bank, so to speaksome. >> i'd like to take a crack at that. >> sure. >> the floating idea, we don't think it works for several reasons. one is we know shareholders don't want it. depending on the segment between 70 and 90% prefer the stable nav. the tax and accounting issue is more complicated. so if you believe that a floating nav means the product will go away, if that's the goal, then floating may not be a bad policy choice. but if you believe money market funds are a necessity to funding municipalities, then that's a

bad idea. >> so part of the answer why they don't want it is because of that dependency for short-term financing by corporations. is part of the problem then, maybe, that there's too much reliance? you said municipalities, but others on these fund for short-term financing? is. >> i think, well, first of all, the business model that was the poster child for overreliance on short-term funding no longer exists. so there have been significant changes in the marketplace. i know we're going to talk a little bit about european banks later, but as we get into that conversation, the lessons of overreliance on short-term funding have been learned by participants in the marketplace as well. so there are very different approaches to liquidity, very different understanding of how much short-term funding ought to be used by particular entity. so money market funds are investors investing in the very shortest part of the market trying to get our money back. and we do, like other very short-term investors, see the problems that occur in the marketplace and react quickly

enough to protect our shareholders. that's an element of how these products work. >> okay. so, professor stulz, there seems to be not much love for the floating nav. >> well, i still think that it should be pursued and that we should study it very carefully. the great advantage of floating nav is full transparency. the investors know exactly what the value of their investment is. currently, they really don't. they can withdraw their money at one dollar, but that's not the value of the shares. it's not the fair value of the shares. so the floating nav has the advantage of the transparency. it has the advantage of removing the free option that investors have under the current system that leads to runs. so the floating nav is very, i mean, has some advantages. i agree that it has operational difficulties, and i think the

ici report describes them extremely well. >> and i apologize, but i want to quickly get to you with regard to sifis and your comment the regulators shouldn't be declaring some of these financial institutions as sifi until they can accurately define what a systemically important institution is. are you able to help set forth what that criteria should be? >> well, financial economies have come up with a number of models that are helpful in answering that question. and so, yes, the answer is that i could help. >> okay. because we -- that's been one question that we've grappled with here from the day that chairman, former-chairman frank raised the issue that we need to go after these systemically important institutions to the time that we had secretary geithner here and ben bernanke. we could never quite get anyone to actually define exactly what we're talking about in this situation. but i appreciate your answer.

gentleman's recognized. >> thank you, mr. chairman. one striking he is son from the -- lesson from the financial crisis is that there were enormous aspects of the financial system that no one knew anything about. americans in general didn't know anything about it and, really, no one in congress knew anything about it. i don't think including members of this committee, including me. and i don't think it was because we lacked diligence -- well, not in every case. it was because there was nothing to call our attention to some of what was going on, some of the changes in the market, in the financial system. and those who really did know about it, didn't see any percentage at all in calling our attention to it. one of which was the repurchase market, the repo market. at the time of the crisis, that was described as a freeze in be

interbank -- as a freeze in interbank lending. but it really was a traditional run. the only proposal that seems to -- and as i understand it, the repo market, um, was approximately the same size every night in daily lending as all deposits. so it was enormous. and no one knew the first thing about it, and this was no regulator even breathing on it. and the run in the repo market around the time of lehman and really, before that, bear stearns is what precipitated most immediately the crisis. has anything changed? there's certainly been no regulatory change, but is there any reason to think that the repo market is less vulnerable to a run, is there any more market discipline in who financial institutions will lend to through the repo market?

um, well, professor, bullard -- professor bullard, you talked about the possibility of run in money market, money market funds. have you given any thought to that? >> >> i don't, i don't follow the repo market as such, but the problem with the repo market is it gives a superficial sense of confidence in that it looks like something that's almost immediate cash. t easy to forget that what stand behind it is a single counterparty which presents issuer risk. rule 207 has long regulated repos in, i think, the right way by understanding you have an issuer standing behind that repo. and i'm not aware of any problems in the money market world that have stemmed from repo liquidity or value as butch. >> if i could jump in, actually. when 207 was amended, actually, the repo positions positioned in 207 which is the rule that

governs money market funds was strengthened with regard to what's called the look-through rule and whether or not you had to look just to the counterparty, or whether we could look through for the underlying collateral. and you can only look through the underlying collateral if it's government securities now. i think it's been strengthened not because money market funds had issues, but rather looking forward to insure that money market funds don't have issues going forward with regard to having to liquidate the collateral on repos. >> well, not all the -- money market funds may have been participants in the market, but mutual funds were participants beyond the money markets, isn't that correct? >> yes, that's correct. >> mr. goebel? >> that is correct. the new york fed's got a tri-party repo commission. there was an understanding that there's a concentration of risk at certain aspects of the structure. the way repos are actually

affected over the course of the day. of so there's a group that's been working on greater transparency, removing that intraday risk, understanding how the confirmation process works so there's better understand anything the tri-party repo market. there's also work to create different liquidity sources in the case there are issues within the repo market. so there's definitely work on the way to strengthen the way the repo market operates. if your observation is that there is an investment decision made every day by money market funds and others to participate in the repo market, that's certainly true. cash that needs to be invested overnight, there are securities available for this market. and that is something that is important to the way the markets operate today. >> well, i think, actually, the concern by the critics of the repo market is that they were not decisions being made every day. it really was reflexive until it got to point where bear stearnss or lehman brothers got to.

sheila bair's concern at the fdic is that instead of identifying a firm that was in trouble earlier when the resolution of that firm would not be quite so expensive or complicated. the run on the repos left the collateral required and all the rest left firms in a crater. they would hit earth and leave a large crater which made it very hard, much more expensive, much more complicated, much more systemic risk resulting from that. >> can i just say that when we think about repo, we ignore the collateral. we receive full collateral for the investments, but we assume that we have to look to that counterparty to make that investment good. so we're very careful to evaluate the risk of every trade we enter into. >> my anytime's expired. >> thank you. chairman neugebauer.

>> thank you very much. i want to associate myself with some of my colleagues who have spoken earlier about the fact that we've almost made an implied guarantee of money market funds by the fact that the government stepped in. and, you know, that's something we've got to fix because we can't let companies pick up the profits and the taxpayers pick up the losses. and so i think this is a healthy discussion. i think one of the things that -- and i'm not necessarily associating myself with the floating asset value concept at this particular point in time, but i do have to, we have to think about if you are going to classify yourself as an asset manager, at that point where the value of the underlying securities is less than what you are obligated to pay, you're moving away from an asset manager to you have created a security that comes with a

obligation to the firm managing those assets. and so i guess one of the questions i would have for the panel is if, where am i missing the fact that that, creating that additional liability then brings into question, you know, why wouldn't if taxpayers eventually pick that up, wouldn't that have some systemic implications to that? >> congressman, may i try to provide one part of the answer? >> sure. >> we, actually, have looked very carefully at a group of money market funds and how the pricing of their portfolios has been done over time. they also mark their portfolios to market and carefully examine the extent to which the market value deviates from that one dollar above or below. now, if we actually issued a paper which i'd be pleased to submit for the record here, and

what we find historically is that the deeuation up or down is extraordinarily minuscule. i mean, even if you bring several places to the right of the decimal. and the reason for that is because the securities in which the fund is investing are very short dated so they don't have much interest rate risk, they're extraordinarily high quality so they don't have much credit risk. if they are expected to be held to maturity and, therefore, can be valued at their amortized cost, and that's the accounting treatment that allows them to maintain that one dollar per-share value. >> let me stop you there just a second. so you talk about maturity and credit -- how about concentration? >> yes. the concentration is limited under the role as well so you don't have overexposure in the fund to an individual name. there's new rules with respect

to the weighted average maturity of the portfolio as a whole, the weighted afternoon life of instruments in the portfolio. so the the experience of the industry under 2a7 over time has been with the exception of glaring circumstances of the sort that the reserve fund found itself in with the credit difficulties that lehman brothers presented has been the transacting at a dollar really does represent from a shareholder perspective the value of its or his or her interest in the portfolio. and the degree of success that we've had is remarkable. there's actually been a third of a quadrillion dollars -- and we don't think much about a quadrillion dollars even in the congress -- but that's gone in and out of money market funds over their history without the

loss of principal to the shareholder. it shows you the level of success that these rules have had in the industry for over 30 years. >> we don't want the congress to know there's something after a trillion. [laughter] >> that's a how trillion. >> yeah, i know. what about the capital that an entity whole versus the amount of issue that has the ability to maintain that commitment if you're going to continue, if one of the other panelists want to dive into that. >> are you -- just to clarify the question, are you asking about the size of capital that might be required to support any one of these ideas? >> yes. >> with so what you -- there are a couple of different theories. one you've heard was there needs to be enough money to set aside

to avoid any fund never breaking the buck again. in 2008 it was three cents on lehman. in the primary reserve fund, excuse me. and even though eventually shareholders received 99 cents. our approach is different. our approach is to say that there is a cushion, there's an amount of money that's appropriate to set aside, and it is enough to, for shareholders to understand what's happening, it's enough to over a period of a ten-day crisis, we've got a chart in our attachment that explains what happens over a ten-day crisis assuming underlying securities, and 60% of the fund leaves, you still have a dollar left for your shareholders. so with a relatively small buffer, what you really do is buy time, you buy a chance for the markets to resettle, for investors to really understand what's happening. and, ultimately, if a board, a mutual fund board and the adviser conclude that they've got a product that's no longer

viable, it should be okay again for a money market fund to shutter its doors and say we're going to return our money to you, and the rest of the system can continue to operate. >> if i could just add one point to that. >> you'll forgive me. any objections to another 30 seconds, please? >> i just wanted to add that thanks to recent innovation, a really brilliant invitation that we have mr. donohue to thank for is you can go online and look historically at the nav of these money market funds. i've done that. 1.000, first one, second one too. i guarantee the first one started showing up at .9999 is going to start losing asset, and that is, in some ways, the best answer to the point that mr. stevens is making. this is now very transparent, very obvious. if you took bank balance sheets and started forcing them to do that, we'd see very different behavior in banks as well. >> so you believe there is market discipline concepts built

into the system? >> yes. enterprising financial journalists cannot wait to write the article about the money market fund that is routinely falling under that 1.0000 number. >> thank you, chairman. [inaudible] >> thank you, mr. chairman. welcome to all the panelists. i'd like to ask mr. stevens, you may recall during the dodd-frank markup that i offered an amendment which was accepted to include leverage as part of the criteria for deciding whether a nonbank should be designated a sifi, a systemically important financial institution. as major financial firms were failing during this crisis, it seemed that one of the main problems was the degree to which they were leveraged to really outrageous levels. mutual funds and their advisers

are not highly leveraged, and i'm wondering if you believe that the regulators are devoting enough attention to leverage. >> congresswoman, i do recall the efforts that you made in dodd-frank, and we appreciated them. and i think your insight was exactly correct. excessive leverage in the system was one of the fundamental problems that visited upon us the financial crisis. and one of the reasons that funds came through it so well is that our portfolios don't reflect any leverage of that kind. our maximum leverage ratio is 1.5 to 1. and any borrowing that a fund does has to be covered by, by assets, um, so that its indebtedness would be, if you will, secured. that's been in our dna, if you will, um, since the investment company act of 1940 was passed.

and i think it's a fundamental strength of our institutions. i hope, frankly, that it will, um, be among many factors that would persuade the fsoc that sifi designation is not appropriate in our case. >> okay. well, i'd also like to ask you and professor bullard. as an economist and former mutual fund executive who is now a professor at harvard university, and i request unanimous consent to place this article in the record. so granted? may i put it -- thank you. pozen wrote that money market mutual funds that invest in short-term tax-exempt instruments issued by states and

municipalities offer investors an opportunity to invest in tax-exempt securities that banks cannot offer. if regulators decide that money market funds can't maintain a stable net asset value of a dollar, what would the impact be on the availability of these types of investments for consumers? >> when we've talked to investors about this issue, they've told us, in essence, if it's not a dollar in and a dollar out, you don't get my dollar. that's true across the board, but this is a particularly compelling case that you cite because in the municipal finance area there's -- it's not apparent who could pick up the shortfall in funding if you didn't have tax-exempt money market funds available. um, there was a question earlier, why do people finance in the short term end of the spectrum, and they do it because in many instances it's lower cost. and because they're refinancing on a regular basis, they can

keep a current rate of interest, um, in many instances lower than if they're borrowing on a longer term basis. so for america's communities around the country, access to that financing is extraordinarily important, and i think bob pozen's piece -- which i did read -- is exactly right about what's at risk if we, if we remove that funding from our state and local governments. >> thank you. professor? >> i agree 100% with those comments. mr. pozen is one of the smartest guys in the fund industry, so i'd listen to what he has to say. we're talking about people that are relying on income for retirement that would be nettenned by removing that product from the marketplace, especially we know that so clearly just having been taken away from d.c. residents just in the last month. >> ms. stam, in if your testimony -- in your testimony

you noted the se yes,c's money t rules have improved the fund's safety, liquidity and resiliency under extreme market conditions. do you believe that these recent reforms constitute a sufficient amount of reform to the money market fund industry, or should the sec pursue additional activities? and i ask you and if professor bullard, if you would respond too. >> yes, thank you. i believe that the enhancement has gone an extremely long way to addressing many of the concerns mentioned by a number of the members commenting. i mean, the amount of increased liquidity, improvements to credit quality, the transparency that a number of members talked about being so important to making sure that the marketplace understands the value of the money market funds investments. we think, really, it has addressed in the large measure the concerns that were faced in 2008.

to the extent that something is left yet to be done, and i think there are proposals worth considering and we should consider them thoughtfully, but the problems that occurred in 2008 were really focused on the movement of large institutional investor who had a need for intradaily quiddity of their assets. and the run that precipitated the reserve fund came from those investors. so to the extent we look to put further constraints on this product, we ought to think about tailoring the response to that market. >> thank you. youmay i have 30 seconds -- >> without objection, 30 seconds. >> as i noted before, i agree to the operational liquidity reforms, but i disagree for the need to those to go to the specific quality of the assets were held with the possible exception of the treatment of

auction rate securities. >> thank you. chairman royce. >> yes. let me ask a quick question to mr. bullard. you view the assertions as overstated in terms of the threat of a european debt problem reaching the point where it impacts money market funds here in the united states. in your report. could you, could you walk us through that in terms of -- i might agree with you, but i just want to hear your thoughts on that. you think it's overstated, and there isn't that amount of debt in the money market fund system. >> um, what is misleading about the representations we've been seeing this week is the characterization of those holdings that simply european

bank exposure. if you look at 2a7 and the nature of the instruments that they would be allowed to hold, they would be, essentially, is safest, shortest term obligations issued by those banks. i think part of it is driven by a cheaf fistic attitude driven by anything offshore, repeatedly making assertions about the quality of money market fund assets with respect to european banks while statement their banks hold long-term obligations of those same european banks. what we need, i think, is the sec to come out and do what prudential regulators do and do best which is to say we have looked at what they hold, and this is what we can tell you about them. they are safe, they are extremely short term, and money market funds are not vulnerable. >> let me go to a question where i disagree with you, and that is your proposal for federal

insurance from money market funds. it seems to me that that moves in exactly the wrong direction. i mean, to do that explicit federal backstop, to try to regulate these like a bank when they're not in that category, they don't have the leverage, they don't have the -- they've had very different terms of operation. it just seems to me that you put that backstop in, what it's going to do is end courage a whole lot of -- encourage a whole lot of additional short-term financing which is the opposite of what we want. and so, you know, when economists talk about this moral hazard problem, why would we want to go down that path? >> i agree, i would not go down it alone. what i would do is go down it on a path that as i described in an article i wrote more fully about this issue, down the path of what i call least insurance. we need to look at the entire market and look at the total picture of distortions caused by

insurance. while there is a distortive effect of short-term lending, nothing compares to the systemic risks created by insuring long-term obligations which is the foundation of the insurance that we provide for deposits held by banks. so i agree with you, i would not do that by itself. i think we need to move down a path where we're reducing the overall socialization of risk in the system and that any insuring of money market funds and other short-term assets should be combined with a long-term attempt to reduce the scope of government insurance of private sector activity. and what's happened in the last three years is the opposite of that. i think that we need to look at the big picture. of but i agree completely with your point as to just money market funds. >> with yeah. i think the problem we have there is you're explicitly expanding the safety net in one more area, and if it's 60% of the financial economy now, you're just ratcheting it up. but i think, mr. donohue --

>> i wanted to respond to a couple points. one is i think that the debate that's going on about the european exposure money market funds is precisely because of the transparency that money market funds have about their portfolio holdings that may not exist inside other areas of the financial system. i think it's a healthy debate. one of the things that gives me a degree of comfort is that many institutional managers, many institutions that are very highly qualified get to see those exposures on a frequent basis. and as my co-panelist had mentioned, you know, in many cases daily they have not moved their money. they're comfortable with those exposures, they've kept them there. >> let me go to mr. goebel for a question. >> yes. >> mr. goebel, you mentioned that the net asset value buffer funded by the money market funds as an alternative would mitigate the potential for runs without, of course, increasing taxpayer

exposure. and what i wanted to ask of you, professor bullard doesn't believe this is enough to prevent a run. what do you think? if explain that argument, if you will. >> >> excuse me. i differ with the professor. what we're trying to do is create an appropriate signal to shareholders that they don't need to leave. so if you imagine you've got 30 basis points of extra benefit, extra buffer in a fund, a shareholder has a decision. if he or she believes that there's a risk in the fund that they want to get out of before that share price drops, they can go. but by going they leave behind a bigger buffer for those who stay. so it's both an incentive not to leaf because you can see every day that your share is worth more than a dollar. and if you choose to leave anyway, those who don't are protected. now, over time you could imagine a massive credit problem, a significant crisis in europe or some region of the world that swamps the buffer.

and so we concede that this is not a solution that solves every issue. but we think that the buffer coupled with an understanding by shareholders that the federal government is not a backstop, not a guarantee -- this is a private order solution, and you need to decide where your dollar's going. not all money market funds are equal. we believe we've got a very talented group of people who spend all day long, resources that are devoted to making sure the credit is correct, that we're doing the trading appropriately, that the portfolio management is working, and we think that people invest with the name of fidelity not just because there's a rule out there that says you get a dollar back, but because of what we offer. and we think that's appropriate in the marketplace for shareholders to be able to make differentiations, and really -- >> and you think there's enough time to ramp up with that -- >> and that'll be your last question because we do have votes after this. i mean, i want to get all the questions in, but the next vote's here. >> sure. so, briefly, we don't think

that -- we need some time to build the buffer just like we would need any sort of capital support, just like the banks need to get to basel iii. so we recognize that this is a, um, an approach that will take some time to build up, but we think that's appropriate. we don't want to do something that's so precipitous that the product becomes uneconomical or shareholders decide they don't want it. so one has to strike a balance as to what the path is and how you get this. >> gentleman from colorado. >> i want to thank the panel. this is a very interesting conversation that we're having. and, you know, several of us having lived through this as did you, you know, the 2008 collapse, experienced a little posttraumatic stress syndrome. and to be two, two and a half years out now, to look back, try to be objective, professor stulz says -- as objective as we can be -- in determining, you know, what are realistic, reasonable

precautions to take to avoid something like this happening again. but i guess, um when this all occurred and was starting to occur, terms came up that i'd never heard of before. and i'd been a litigator sort of in the financial arena for a long time. so when you said we need to have objective, defined terms for what systemic is -- and i agree with you except that's easier said than done. and it made me think of do any of you know what the gastroc nemius? it's a tearing of the calf. i never knew what it was until i did it a couple of days ago. i had no clue what auction rate securities were or collateralized default swaps. you never know where it's going to come from. that's all i'm saying.

and so as you try to come up with your objective criteria, you know, be a little more expansive than narrow. just, that's all i wanted to say on that. it's -- this is about confidence, and it's about fear. and when there is confidence -- and secretary paulson, you know, did that overnight guarantee, in effect, to bring confidence to this system where there was a run on the system. that was my experience of that day or those, those weeks. fdr did a banking holiday. so now we're back to normal, as normal, i hope, as we can get and continue to develop confidence in the system. so what i really want to understand because people do look at this as cash. i mean, out there on the street it's cash. so explain to me the difference, really, so i can understand it between the buffer and the

liquidity bank if you would, mr. goebel and mr. stevens. >> sure. so the idea of the buffer is actual dollars that sit in the fund that shareholders can see that's subject to board oversight that does not involve the federal government. to insure that people understand that the incentive to leave does not need to be there if there is one in a stable -- >> is this a fund-by-fund-by-fund buffer? >> yes. every fund would have a buffer and be mandated. >> all right. >> you can imagine different kinds of funds might have a different buffer, there are a lot of details to be worked out, but in essence, yes, every fund would have a buffer. the real risk we talk about is this con contagion effect where i have to worry about what my money looks like over here. the idea is there's no collective socialization of the risk. every mutual fund in every

complex has its own buffer. >> all right. so let me stop you because mr. . >> week earth -- mr. . >> week earth talked about being a treasurer, and a lot of them in colorado were in the primary fund, okay? and we had to deal with the bankruptcy and all of that stuff. how -- is the liquidity bank different? is it a general backstop, mr. stephens? >> yes. and you can think about it this way. one is designed to make sure that there's not the first fund that wreaks the dollar. -- breaks the dollar. the liquidity facility is designed to if fund breaks a dollar for credit reasons to make sure it does not have a knock-on effect by making the markets in which other funds invest illiquid as a result of massive defections. it socializes not credit risk by any means, it socializes liquidity available to the industry, building it up over

time and, essentially, dedicating it as a market maker particularly in the commercial paper markets where there's no one else who serves that function. that, it seems to me, was part of the lesson of the crisis that we need to make sure those markets function well because they're so essential for american businesses. and so the liquidity facility would allow a, if you will, money market funds to have an opportunity to exchange money good commercial paper for u.s. treasury obligations or cash that they then could, in turn, meet redemptions with and would be put together as a commercial bank under the normal supervisory arrangements with the banking relators -- regulators. >> would the gentleman yield back? >> i was just going to thank the panel. >> no, you've got it. >> because this is a very good conversation, and i think we've got to continue it because now we can look back properly on what happened without just, you know, some knee jerk reaction and really do this, i think, in a good way. and i appreciate the teston