something other than that, then it's not. the question of portfolio hedging depends a lot on what you mean by portfolio hedging. if you're, quote/unquote, hedging some macro risk that is not related as the statute requires it to be to individual or aggregated positions and the risks that come from those, then it is not permissible under the statute, but, of course, in the end, the regulators, with our coordination, will have to work through exactly the technical issues of what that means, they put out a proposed rule, lots and lots, 18,000 or so comments came in. they are working through that right now, but i think the question's not whether it's portfolio hedging or not, because the statute doesn't talk about portfolio hedging. it talks about whether it's associated with individual or aggregate positions that the firm has taken and put on their books. >> and if you would as you go through, i assume that there's an order to have a political response to what's just happened

during this political season. we could end up making regulations on hedging that make some of the highly complex organizations, if we're going to keep them like they are, even more risky, is that correct? >> you know, i think the whole goal here is to allow hedging, that relates to risk with firm and in that respect it's risk reducing. what we don't want to have done and what the volcker rule is about, is not having activity with the firm's money that the rest of us, the taxpayers, are ultimately on the hook for making hold. >> that's what i thought you'd say, thank you. >> senator, at the last hearing, we had a discussion of did the distinction between proprietary trading and market making. and i think the difference between proprietary trading and

a hedging trade. when you ask what does that provision, which is basically taken from the statutory language and put in the regulation mean, at least with respect to hedging, what the proposed rule would do would be to put in place both some substantive guidelines for trying to distinguish between hedging of individual or aggregated positions on the one hand or proprietary trading on the other, and perhaps as importantly, put in place a set of risk management reporting and documentation requirements, so in essence, if a firm said we're doing this because it's a hedge, they would be required to explain to themselves, importantly as well as to the primary supervisor, what the hedging strategy was, how it was reasonably correlated with the positions that they were hedging, and how they would make sure they they didn't give rise

to new kinds of exposures, so i think you asked absolutely the right question, what does that mean, and that's the reason why in the proposed reg, there is an elaboration of both some substantiative guidelines but also some risk management documentation requirements. >> i would simply state, from a strictly supervisory standpoint, i think we expect all banks, large or small, to have robust and comprehensive asset liability management policies and practices in place. >> that includes portfolio hedging? >> it would depend on the risks in that particular institution that they are facing and could include that, but the issue, i think, as governor tarullo mentioned, is there robust risk management in place with controls and limits that allows these risks to be addressed and mitigated without introducing additional risk, and i think

that's the concern or issues the npr is trying to address. >> senator, i think the central issue here is hedging is a risk-management activity as opposed to a speculative nature where you're really trying to generate income, and i think the whole goal would be, and i think this has been the point that's been made, creating a set of controls which you can monitor the activities so that the legitimate and important hedging activity goes forward. if you're getting into riskier speculative activity, you want to be able to identify that. i think that's important for the institution to be able to recognize and important for the regulators to recognize. >> mr. chairman, i know my time's up and realize the consumer agency is not particularly involved in that aspect, but i thank you all, and i do hope that political

pressures of what has happened do not cause regulators to end up doing something different than they think is good for our banking system and i do hope down the road we'll look at some reforms that may work for us a little bit better and not put all the onus on having a regulator beside every banker. thank you. >> thank you. senator warner. >> thank you, mr. chairman. i want to pick up a little bit where my friend left off, one of the things you said was you were still here months after, at least looking into some of these jpmorgan accusations, at least trying to determine their strategy, and i believe governor tarullo said that one of the results of what you envision a

volcker rule being implemented might be is that determining this assessment of whether your hedging strategy would have to be laid out, in effect, ahead of time to make a determination of whether it was fit within the boundaries of appropriate hedging or bled into proprietary trading, do you think whether this particular morgan transactions fell in or out of the volcker restrictions or not, would the very nature of having this in effect, the sharing of strategy beforehand have perhaps given your office some more guidance and governor tarullo, if you want to comment on that as well? >> i think the point i would like to make in regards to the

discussion on the volcker rule and jpmorgan chase, we don't know all the facts, i think that's important before you make any judgments as to whether or not the rule if in effect would have been applicable on this particular instance, but the point i would like to emphasize is this was a risk-management issue whether or not the volcker rule was in place, and the issues are similar in the sense that, you know, were there appropriate management controls in place in advance of the strategy, were there procedures and reports that enabled management to assess the risks initially and as they may have developed in the course of the execution of that particular strategy, so i believe that, you know, in any event, it's still a risk-management issue regardless of the volcker rule. >> senator, i think the controller answering the

question to whether this is a proprietary trade and i think he's saying he doesn't have information right now that would allow him to say whether, if in effect, it would have been a proprietary trade. my point is, though, regardless of what we conclude about the actual nature of this particular set of transactions, if this proposed rule had been in place, if the hedging exception were to be invoked by a firm, they would have had to ensure that the kinds of risk management that tom speaks of would have been in place and they would have been required to document it, and i suspect we're going to find, in this case, that there was an absence of documentation both within the firm and in reporting to supervisors. >> you would have perhaps a little more guidance on aggregate hedging. clearly, i think there's a value on aggregate hedging. instead of hedging each individual trade, but you would

have had a little clearer guidance? >> i think that's the intention of these additional provisions in the regulation, and then, of course, the ongoing supervisory challenge is to make sure the information that is received is scanned and reviewed properly. >> let me move to a different subject, because my time's running out. both again, governor tarullo, one of the new tools we tried to put in place, that we worked on, is these living wills. and as we move down that path, i'd like both your comments in terms of have you had the tools you need to kind of evaluate these back and forth on creation living wills and to what standard are you going to hold the institution in a sense this living will will demonstrate how they would unwind themselves, are you looking at it in a blue skies

environment? are you looking at it in the potential real environment we may have with a break up of the euro, love to just get some comments on that. >> senator, the statute itself establishes the standard for evaluating the plans, and that standard is the bankruptcy code, and the requirement is that you have to make adjustment as to whether the plan could credibly result in an unwinding of the institutions under the standards of the bankruptcy code and that's sort of the operating premise for the development of the resolution plans. as i indicated previously, the fed and the fdic issued a joint rule last year establishing the criteria for the plans. we've been working with the institutions on their development. under the rule, the first round of plans will be for the largest institutions, those with assets

of over $250 billion will be in july. so we've been engaged in a process with those companies and the initial development of those plans, we're going to get the initial submissions in july, then there's going to be a process of review of those plans following the submissions. >> only thing i'd add to that, senator, is that, obviously, it's not possible to tailor a lot of different resolution plans to a lot of potential adverse scenarios, and i think that's why our review of the plans that are submitted is going to need to include basic questions about the ongoing structure of the firm, that is we're not just going to be able to say, gee, if something bad happens on thursday, will they be able to resolve by monday morning? i think we're going to need to ask ourselves whether the drafting and review of the resolution plans shows us that

there are structural elements or features of the organization that could be an impediment to achieving that end and thus as a matter of current supervisory policy, we need to adjust, and that kind of exercise should help provide some more suppleness in response to whatever the risk is that could eventually lead to the firm's problems. >> thank you. senator cordray? >> thank you, mr. chairman. i want to first indicate that i strongly agree with the tenor of the questions that we heard from senator corker and senator warner with regard to the volcker rule and those aspects. i think we covered that thoroughly, but i want to indicate i would have had we not had a full discussion on that, and i encourage you to take their comments to heart as we

move forward. i'm very concerned about how we're moving forward in the regulatory climate with the response to things like the jpmorgan issues and others. i want to just shift the focus for a minute and mr. cordray, i want to talk to you first. the housing credit market continues to be very tight, and i'm hearing a lot of concern about how dodd-frank will reduce credit availability through the proposed rules through qualified mortgage that increases liability and qualified residential mortgage that requires a 20% down payment. i know that last week the cfpb reopened the comment period for the qualified mortgage proposal until july 9th. seeking comments about data that can be used to model the relationship between the borrower's ability to repay and the consumer's ratio to debt -- of debt to income. is it your opinion to discuss

this rule? >> so thank you, senator, for the question about the qualified mortgage ability to repay rule. one of the reasons we did reopen the comment period is that we have recently been able to obtain significant amount of data from fhfa that gives us a better window into the mortgage market. we're all, i think, quite concerned and i know all of you are as well about the direction and trajectory of that market, and this is an important rule in helping shape the pugh tour of that market. we want to be clear that we craft a rule that is based on sound data and that does not unduly restrict access to credit, which i think is something we have been hearing consistently from small banks, large banks, community, and consumer groups across the country. even after the feds comment period had closed on this proposed rule, we continued to

get immense amounts of comment from different groups, and we thought that we would open up a comment period again to make sure everybody had an even chance on commenting on those issues, including data issues that we have identified in the re-comment proposal, because this rule was originally proposed by the fed, the small business panel does not -- is not implicated, and if we were to try to convene a whole process, we'd miss the deadline congress has set for us, which is january 2013, which we fully intend to comply with. so that is our approach at the moment. we encourage any small provider that wants to take advantage of the renewed comment period, and this is part of the reason why we did it, those outside the beltway often do not understand ways that they can access the agency, and we want them to have full access and full voice in our rule making to make sure we're reflecting the entire market. >> thank you, and to mr. gruenberg, curry, and tarullo,

it would seem to me because the mortgage is supposed to be more broadly defined than the qualify mortgage, would it be correct to say that the banking regulators should wait for the cfpb to finish its rules before they move ahead with their risk retention rules? >> i don't know that a formal -- senator, i don't know that a judgment's been made on that. i think as a general matter, we thought there was a logic in having the qrm follow the qm, so we'll have to see, but there is a logic to that. >> mr. curry, do you agree? >> i think that's a necessary component to the entire package of rule making, the qrm and the qm. >> mr. tarullo? >> it's an interagency process, senator, if people want to wait, we will wait too. >> all right, i encourage you to do that. mr. tarullo, recent events have highlighted the difficulty in modeling risk. my understanding is that federal

reserve is following or utilizing the current exposure method and that there has been quite a bit of concern about whether that is an accurate method of risk modeling. are you -- are you considering other models or are you focussed on simply staying with the current exposure method? >> senator, in what context, in the stress test context? >> that's my understanding, yes. >> so with respect to -- with respect to stress testing, and what we're trying to do in stress tests is make our best judgment as to what kinds of losses would be entailed across the industry. >> let me interrupt -- >> i was mistaken. i was more focussed on the -- single counterpart -- >> that is a different issue. that's a calibration issue with respect to the

determination of the exposure of a large institution to another institution for purposes of the limits that we'll be promulgating, so that will be -- that's one of the topics that's being commented on in the consideration of changes to or potential modifications to the proposed rule on 165, 166. there have been -- there have been a number of alternatives suggested. i think the challenge, without trying to signal where we'd go, because we haven't seen all the comments yet, and i certainly haven't had a briefing on it, but i think the challenge is going to be on the one hand wanting to have a methodology that tries genuinely to track actual risk exposure while on the other not becoming dependent on modeling within firms, because as we've seen in a number of other contexts,

dependence sole ly upon the modeling firms can lead you astray particularly because firms in our observation tend to be much more at modeling associated kinds of risk assessments for more or less normal times as opposed to the tale events we're trying to guard against, so in thinking about the comments on the proposed rule, we'll have to keep both those issues in mind, trying to hue towards what really are the risks associated with the positions on the one hand, and on the other hand, wanting to make sure we're not totally dependent on some internal model. >> it's another example if we model too aggressively one way or another, we'll get it wrong and create unintended consequences, so i encourage you to get it right and focus on the concerns about the current accuracy of the current exposure method. thank you, mr. chairman. >> senator merkley. >> thank you very much, mr. chair. does anyone on this panel think

that bruno exo, the london whale, woke up each day trying to mitigate the risk from excess deposits existing between loans and bonds? >> that is a related area of inquiry at the occ. >> so you're inquiring, but you wouldn't argue that case? >> not necessarily. >> no, i wouldn't think anyone would, because he woke up each day as head of the strategic investment unit trying to make money for the bank, and so it's kind of a basic observation. small business across america and comptroller curry, i'll address this to you and try to ask you to keep your responses crisp so i can try to get through a series of questions,

but across america, small businesses are trying to get access to credit, they are highly frustrated. the ability for them to access credit is essential to the recovery of our economy. does it do damage to have our banks diverting taxpayer deposits into hedge fund investments rather than making loans to families and small businesses? >> we at the occ, senator, are very supportive of small business lending by the entire spectrum of national banks that we supervise -- >> that wasn't the question, the question is diverting deposits into hedge fund investing rather than making loans damaging to our economy? >> i would hope not. i hope that was not the case, would not be the case. >> but it would be if deposits were diverted into hedge fund investing rather than making loans to small businesses? you're hoping it wasn't the case, but you're saying it would be if that's what happened?

>> i -- we expect national banks and federal thrifts to meet the credit needs of their communities, including small business lending. we don't direct exactly how they do that. we assess it from the cra -- >> i'll continue then, thank you, does it increase systemic risk to have banks diverting taxpayer deposits into hedge fund investments? >> i believe that's the intent of the volcker provisions of the dodd-frank act. >> certainly, it is the intent, but in your opinion, does it increase systemic risk? >> unrestrained financial risk taking outside of legitimate risk framework is something that we'd be very concerned about as a supervisor at the occ. >> from a common citizen's point

of view, when they look at a host of institutions that survived only because we bailed them out, i think the case is fairly clear that if you are in the hedge fund business, you increase systemic risk, and if you're in the banking world doing hedge funds, you'd increase systemic risk. is that fair, am i way off base here? >> again, senator, we would look to the banks engaging in safe and sound lending within the context of the banking to the extent that it was undue risk taking that was occurred. we would hope to either have a statutory or regulatory restraint. >> let me explore from this angle. do bank-hosted hedge fund investment units have a competitive advantage because the bank-hosted funds have access to the discount window and insmurd deposits. do they have a competitive advantage over non-bank hedge funds? >> i would have to look at the available research to come to a conclusion. >> of course, they have an

advantage. they have packs pair-insured deposits and access to a discounted window. is that way off mainstream common sense? >> i would like to be able to research that subject further. >> okay, okay. in terms of proprietary trading being disguised as risk mitigation, seems there are basic things that kind of create red flags. if a company says it's mitigating risk on a long position that is investments in credit and corporate bonds, by essentially taking a long position by selling insurance, is that a red flag that maybe this isn't risk mitigation after all? >> that is something that we would raise red flags and would have to look at. >> how about if they are investing in hedge funds, private equity funds. would that be a red flag? that had is an investment operation, a proprietary trading operation?

>> that would be another area under general risk management at a minimum that we'd be looking at. >> so a potential red flag that would draw attention. if a risk mitigation operation is making massive trades not identified from specific risks from specific assets, would that be a red flag? >> we would look at that and the other examples you've given very closely. >> okay, if they are not tight correlated, a red flag. are you going to support closing the loopholes so they can continue hedge-fund style operations or are you going to support closing those loopholes or keeping those loopholes? >> that's one of the issues the banking agencies and other agencies are looking at. i would add i think our experience here, as it unfolds with jpmorgan chase would help inform our views in the final

rule making. >> thank you very much. thanks. >> thank you. >> senator toomey. >> thank you, mr. chairman. i'd like to start by also acknowledging mr. tarullo's comment about the importance of capital, and i know you've given a great deal of thought to this for a very long period of time and have considered this in a very sophisticated way, and i just maybe many things you and i may or may not agree on, but i think the emphasis on capital in a general matter is the direction we ought to be heading in, and i fear that dodd-frank is a profoundly misguided effort to do many, many other things. i have to respectfully disagree with our chairman, who in his opening comments, i think, tends to disagree with the characterization of dodd-frank,

as i have characterized it, as a very explicit attempt to require the regulators micromanage banks. i do believe very much it is exactly that and it is guaranteed to fail in that respect, but i want to touch on another topic, if i could, and mr. gruenberg, i observed in a recent speech that you stated, among other things, that the quote, and i think this is within context, that the typical path toward the failure of an insured bank starts with bad loans. my understanding is according to the fdic's website over the course of 2009 and 2010, there were almost 300 banks that failed, about 297. that's actually quite a high rate of failure, the highest since the early 1990s. 95% of these failures were banks with assets of less than $1 billion. and i would just ask you, to

your knowledge, how many of them failed because of their prop trading activities? >> well, to my knowledge, senator, none of them. >> not one. did they fail because they had loans that went bad? >> as a general characterization, yes. >> virtually 100% of the cases it was because of bad loans. would it be fair to say that historically, and including to the present day that the biggest risk of banking is the lending activity that is inherent to the banking process. >> yes. >> do you regulate that at all, and does the occ or anybody have any regulatory authority over the lending process? >> yes. >> it is a considerable focus of the examination of supervision. >> lots of regulation, right? documentation. >> and on site -- >> and concentration requirements and supervision of the activity, and yet, despite

that, 100% of the failures of banks in america in the last two years are attributed to bad loans. this is not my, and i'm not criticizing the regulatory process, and it seems to me that if we have a banking activity, the very nature of which is to take risks in extending credit, some of the banks in the tough economic times are going to fail. and that is unfortunate, but it is acceptable, and it is unavoidable, and the real goal of the regulatory regime it seems to me ought to be to just ensure that you don't have systemic risks or the failure of one or more institutions taking down the rest. and this is why i go back to mr. tarullo's point that if you have less capital, you have less leverage if you have more capital and greater ability, of course, to absorb whatever losses might occur. but, instead, we're