>> too big to fail -- expectations and impact of extraordinary government intervention and the role of systemic risk in the financial crisis. good morning. i'm honored to welcome you as we open the last a year-long series of public hearings held in washington and new york examining the causes of the financial and economic crisis that has gripped our nation. if office fax in this -- while the facts in this crisis may appear clearer through our rear view mirror, the trauma is by no means behind us. our country continues to struggle. too many people are searching for jobs, trying to hold on to their homes, and praying they can salvage teetering businesses. as we wind up our investigation and assemble our findings, this commission is determined to peer behind these painful statistics and help the american people understand how this calamity came to be. beginning next week, we will hear from some of the people who have been most devastated by the crisis in communities around the

united states. we will hold a series of four field hearings in the home towns of some of the commissioners to learn more about how the seeds of this crisis were sown on the ground. if the commission will be in bakersfield, california on september 7. las vegas on september 8. miami on september 21. sacramento on september 23. we will be looking at a range of issues from mortgage fraud and predatory lending practices to the struggles of community banks and the fallout of this financial collapse on neighborhoods and small businesses. since our first public hearing, we have been on a journey together, following the evidence wherever it has taken us. we of puzzled over the same questions that many americans have asked, trying to figure out how a web of events that ensnared wall street came to strangle main street. today we're going to examine how a set of major financial institutions became too big to fail, and why the government decided to spend trillions of taxpayer dollars to salvage some of those institutions and the

financial system as a whole. what we know from history is that taxpayers should feel at risk when major financial firms veer towards collapse. for decades following the great depression, government average and was rare. but since the 1970's, bank bailouts have become more frequent and costlier. he began in 1974 with franklin national bank grew into a longer list of bank rescues through the 1980's and 1990's. first pennsylvania bank,, linda -- continental illinois, first city, first republicbank, in court -- mcorp, and the bank of new england. it all seems quaint that these institutions were once considered too big or too important to fail. today we have megabanks of a scale unimagined a generation ago. the combined assets of the five largest base in the country tripled in size between 1998 and

2007, leaping from $2.2 trillion to $6.8 trillion. the 10 largest banks expanded their shares of assets in the banking industry from 25% to 55% between 1990 and 2005. prior to their collapse, fannie mae and freddie mac held or guaranteed assets of a pop -- approximately $5 trillion. time and again we have watched as financial institutions of taken on more risk, used more leverage, and chased bigger profits. when things have unraveled, taxpayers have been handed the bill and warned that they must save the nation's financial system from perils created by the offending banks. to my mind, we have been living in a kind of financial groundhog day. if we've got a wake up and change course, and then we repeat what we have done before. many people as this commission whether the government during the most recent panic did the right thing to toss flotation devices to major financial firms while most of america took on water.

the real question before us is this -- how did we end up with only two choices? either bail out the banks or watch our world sink? many americans believe their reckless and institutions and greedy executives made appalling bets and came away not just unpunished but with a windfall of cheap capital. if they remain justifiably infuriated that top executives pocketed big bonuses with taxpayer money. if they rightly worry that the largest surviving financial firms are not just too big, but now are too big and too few to fail. if we will hear from witnesses about how these financial institutions were allowed to grow and take on so much risk. we're going to explore how the financial system became increasingly interdependent and interconnected. we will learn more about why the government grappled with the crisis in determined why certain banks and not others were deemed too big to fail. we will explore whether the expectation of bailouts at taxpayer expense served to encourage greater risk-taking by

the financial sector. the commission staff has produced another in a series of excellent background reports blood located at the website. the report dissects the governmental rescues of financial institutions during the decades leading up to the crisis that we are probing today. before i turn the microphone over to vice chairman bill thomas, let me thank him for all his hard work and cooperation on what has been a very long and hard journey in service to this country. let me also commend commissioners holtz-eakin and georgiou for taking the lead on this hearing. mr. vice chairman, the vice -- the microphone is yours. >> one of the things that this

commission does not have to do is recommend policy measures. on one hand, it is an easy job to do, and on another, almost impossible. when you bring a commission together, it is almost always the scene at which it rips apart. i think wisely, congress asked us to understand and explain the circumstances surrounding this. when i was hundred, in the early days of television, there was a program hosted on cbs by walter cronkite called "you were there." if we go back to periods in history -- it would go back periods in history. while that particular event was

evolving, there would be a reporter's approach to discussing that particular period in history. to a certain extent, that is what we are asking you folks and the other panelists, including the chairman of the federal reserve, ben bernanke, in assisting us in understanding what happened. the real difficulty is to deal something like too big to fail and a sense that it is something that you can define it in the abstract. it is really an adjective. what would not be of concern in a normal situation becomes one in a situation in which a series of events have occurred, almost an expectation that it is an action taken in anticipation of what might occur.

you hope to a series of non- events, and it invites everyone to play the hindsight monday morning quarterbacking game. it is clearly about the context in which decisions are made. that is the policymakers worst nightmare. i've often referred to the situation that justice potter stewart found himself in on the court when they were faced with the finding of scene. how you sit down and that kind of scene in a series of phrases or sentences? he gave the best answer that i think it ever be given. i know it when i see it. unfortunately many of the decisions that were made that brought about the determination to intervene or behind closed

doors, with some detail available to us, but not nearly enough to explain to the american people what happened. so we're asking you folks to do the best you can to provide us with a degree of understanding that our investigations have led us to believe that there were series of events that occurred that the american people will like to have a bit more knowledge about. this is the first time we have investigated this idea of too big or too important or to interconnected to fail in terms of institutions. and it is not going to be the last investigation that we have. but we do have the ability to focus on two case studies, wachovia and lehman brothers, as an example of decisions that were made that resulted in different outcomes.

our chairman comments about hearings in various regions of the country, we're not going to turn to what i think is one of the important incitements under the a statute, to hold field hearings, or informational or listening hearings, so that we can began talking to those folks who really represent the last domino. we've talked about a series of domino's falling on the other dominoes, and we're going to be looking at the last domino. many of them community banks, many of them people who were involved -- a longtime involvement in business activities, housing, various financial services -- who did not have another domino to fall against. this simply found downey. that is the and result.

-- they simply fell down. that is the end result. and it had six significant impact on the american people. i look forward to the questions as we continue to try to understand what people in particular context's came to determine was the criteria for too big to fail. >> thank you, mr. vice chairman. gentlemen, we will start our first panel of the vice-chairman indicated. we have two case studies will be examining wachovia as well as layman. tomorrow we will hear from chairman for 90 and chairman rnankechairman and chairman bair.

the solace where that you're going to be providing the truth to the rest of your knowledge? thank you very much. i think each of you for your recent testimony. we have asked each of you to give a five-minute oral presentation to the commission this morning. i am going to go to my left -- my right to start off today. alphabetically also, a logical order. we'll start with you, mr. alvarez. i am sure that you have been here before or in some room like this around the capital. i will indicate that one minute, there is a light and from the media goes from green to yellow. and then it will go to read when your time is up at 5 minutes. with that, mr. alvarez, if you begin your testimony. judy members of the commission,

i am pleased to testify about the acquisition of wachovia corp. by wells fargo in the fall of 2008. as an initial matter, the federal reserve was not requested to nor did in fact provide any assistance using its emergency lending authority under section 13-3 of the federal reserve act in connection with the acquisition of wachovia. nor did the fbi say provide any. the agencies were prepared to invoke the systemic risk exception to allow the fdic to provide extraordinary assistance if needed to reduce the provincial efforts of a face for wachovia failure on the economy. that party was not and faq's, and mccaw violist is all planned acquisition by wells fargo without extraordinary government assistance. to understand is, it is a born to understand the context. at the end of the second quarter 2008, wachovia was the fourth largest banking organization in the united states with assets of

approximately $812 billion. wachovia had experience significant losses during a period of extreme financial turbulence in distress. the nation's economy was in recession with housing prices declining and economic growth stalled. the financial system was also deteriorating quickly. within the four weeks leading up to the sale of wachovia, fannie mae and freddie mac were placed it to receive it -- to conservatorship, lehman brothers filed for bankruptcy, at efforts by private investors to provide liquidity to the aig failed, and the federal reserve provided it would temporarily if we using emergency lending authority. there was extensive withdrawal from a number of money-market funds. on september 25, 2008, the fdic seized and sold washington mutual bank, the largest thrift in the united states. the day after the failure of wamu, wachovia bank experience

significant withdrawal of funds by depositors. it appeared likely that wachovia would soon become unable to support its operations. on september 27 and 28, but citigroup and wells fargo began to do duke -- to do if diligence reviews and indicated to regulators that government assistance would be needed in each of their bids. the federal deposit insurance act includes concessions that allows the fdic to provide extraordinary assistance if the treasury secretary in consultation with the president and with the recommendation of the fdic and the federal reserve board determines that the assistance would avoid or mitigate adverse effects on economic conditions or economic stability. the federal reserve was concerned about the systemic complications for the failure of the fourth largest bank in the united states during this fragile economic period. markets were already under

considerable strain after the events involving the gsf -- fannie mae and freddie mac. it could lead investors to doubt the financial strength of other organizations that were seen a similarly situated. losses on debt issued by wachovia could lead creditors to stop funding other banking firms and cause more money and market firms to break the accelerating runs on these and other money funds. this could lead to extreme pressure in the fall of 2008 to virtually shut down. businesses and household confidence would be undermined by the worst bank financial market turmoil, and banking organizations would be less willing to lend. this would country to material weaker. for these reasons on september 28, the board unanimously recommended that the fdic be permitted to invoke the systemic risk inception in march to assist the resolution of

wachovia that would avert serious adverse effects on economic conditions and financial stability. for citigroup and then wells fargo bid for wachovia. and after a series of actions, wells fargo and ultimately acquire wachovia in a transaction did did not require use of the systemic risk exception. to better present -- prevented prepare for a situation like this, federal popples -- the federal reserve has already adopted things so that the federal reserve can understand linkages that could undermine the stability of the financial system. we're augmenting our traditional supervisory affect that focus on firm by firm examinations with greater methods to better identify common sources of risks and best practices for managing those risks. and with develop and enhance quantitative surveillance per graham's for large banking

holding companies that use bank data analysis and formal modeling to help identified vulnerabilities. we're also working actively to implement the provisions of the dodd-frank act. we're developing enhanced capital risk management, liquidity, and other requirements that would be applicable to large systemically important financial organizations as well as developing resolution plans and other plants and the debt. >> can you wrapup place? >> i appreciate the opportunity to describe these events and i welcome your question. >> thank you very much, mr. alvarez. mr. corston. >> and i thank you very much and i appreciate the chance to be here. chairman angelides, vice chairman thomas, and commissioners, i appreciate the operative its test fight on the challenges faced by regulators in resolving its large financial

institution. the measures taken to improve the fdic supervision and processes. before i began, allow me to briefly introduce myself. i am john corston, acting deputy director of the complex financial institutions branch. part of my duties are to oversee large institution programs. the fbi statuette started to resolve depository a institution is governed by the improvement act of 1991. it requires the fdic is the least costly resolution method and to minimize expenditures from the depository insurance fund. the lease cost test ends all are examples that cost analysis based on the best available

information at the time. it includes an exemption to the least cost requirement for certain extraordinary circumstances under the systemic risk exception that was described by mr. alvarez. in the case of wachovia, a severe time constraints and limited available information significantly limited the ability of the fdic to develop resolution options. the ftse fell that a rapid failure of wachovia could have loss -- could have had losses for others and created significant adverse effects on economic conditions and the financial markets globally that was already experiencing severe market instability due to a succession of crises is a large institution. these factors led to unprecedented decisions to use systemic risk exception. following the lehman bankruptcy, wachovia experienced significant deposit outflows. liquidity pressures on wachovia

increased over the evening of september 12 when regular counterparties declined to lend to the firm. on the morning of friday, september 26, wachovia indicated to the fbi say that the institutions liquidity position remained manageable. but by the end of the day, the situation worsened and it faced a near-term liquidity crisis. there was a highly accelerated effort to find an institution that would provide protection of depositors and minimize damage to the wider financial system. as noted earlier, limited available information and the complexity led to the government approval of a systemic risk exception and the acquisition of wachovia by citigroup with government assistance. in the end, the citigroup transaction was superseded by a bid by wells fargo to acquire wachovia without government assistance.

if also tried to draw a parallel between wachovia and washington mutual, the situation for very difficult. having the ability to analyze the financial condition of stressed institutions critical in developing strategy in the case of wachovia -- washington mutual, the ftse had adequate time to develop strategies and understand the risks associated with a strategies. with wachovia, the fdic was not informed until the weekend before its collapse and had very limited information that could be used to understand the market implications, especially in a market extremely unstable. in response to the challenges during the financial crisis and aided by a new regulatory tools, we've taken a number steps to improve our supervisory and potential resolution responses for systemically important institutions. to address on the restrictions under the 2002 agreement, that govern our examination of

authority, the fdic and the board of directors approved a memorandum of understanding which provides the fdic a authority to conduct special examinations and is not limited and knowledge is the authority to direct them should circumstances warrant. furthermore, the dodd-frank act provides the fdic with broad new authority not available during the crisis to close and liquidate systemically imports and firms in an orderly manner. this includes the requirement to develop resolution plans knows as living wills. and a broader resolution of authority of systemically important institutions. in closing, the fdic has several trolls and on-site presence to better assess the information, broader resolution powers to successfully manage this. i would be please to answer any questions from the commission. >> thank you mr. corston.

mr. steele. >> i think your microphone. >> members of the commission, thank you for the opportunity to appear here " to proceed today before the inquiry commission. my name is robert steel and i served as ceo of wachovia from july 11, a 2008 until december 31, 2008. the commission has requested that i address a number of issues including deterioration of wachovia's credit portfolio in 2008 and the company's discussion for potential merger partners off in late september and early october of 2008. as the commissioner is aware, the housing market deteriorated throughout 2007 and 2008. in light of the worsening outlook for housing prices, changing borrow or behavior, and mark to market by u.s. and losses on the residential mortgage-backed securities and collateralized debt obligations and leverage lending portfolios,

wachovia reported a loss in the first quarter of 2008 of $707 million. if second quarter losses, like the first quarter, had been calculated prior to my arrival on july 11 and amounted to $9.1 billion, including all want -- all $1.6 billion loan provision. this reflected the worsening economic conditions, and anticipated future losses in the loan portfolio, prime morally but golden west portfolio. a series of unprecedented events occurred in the financial- services industry that increase the uncertainty and stress and the financial markets. these events include conservatorship of fannie mae and freddie mac on sunday, september 7, 2008. the bankruptcy of lehman brothers, and the acquisition of merrill lynch announced on monday september 16. and growing concerns about the viability of aig, which letter culminated in a transaction in which the federal reserve acquired most of aig's equity.

on thursday, september 25, in an unusual item, the seizure of the largest savings bank in the united states was announced, washington mutual bank. the subsequent place of washington mutual under fdic s receivership for possibly $1.9 billion. on september 25, a tentative agreement in the u.s. congress regarding the economic establishes a proposal collapse. the combination of these events from earlier in september, the seizure of washington mutual on thursday, the 25th, and the collapse of the congressional agreement precipitated a sharp downward turn in the financial markets. the cost to ensure wachovia is dead as evident by credit default swap for s -- credit default spreads. on friday the 26 there was significant downward pressure on the common stock and deposit base, and as the day

progressed, pressures intensified as financial institutions began declining normal transactions. in light of these deteriorating market conditions during the week of september 22, it appears as though f. wachovia was blogger in a position to engage in the public offering a pipe replacement transaction necessary to risk capital, if which was considered to be the best method short of selling the company for sustaining wachovia in this tumultuous environment. management advised the board of directors that in light of the bank's inability to access the capital markets, wachovia had begun discussions with but citicorp and wells fargo regarding a possible merger and that management intended to pursue both options during the weekend. the better of these negotiations could of resulted in wachovia filing for bankruptcy and a national bank being placed in a fdic receivership. it would of been a major impact on the creditors, counterparties, and the u.s. economy. on september 26, wachovia

entered into, fidelity agreement with citigroup and wells fargo, and initiated negotiations. wells fargo and city corp. conducted extensive due diligence on december 27 and december -- september 28. the chairman of wells fargo asked for a draft agreement and merger for the whole company representatives of citicorp indicated to me their interest were to acquire only banking subsidiaries, with an fdic guarantee an assistant. the transaction would create a residual entity with non-bank assets and other liabilities. the chairman of the f.d.i.c. contacted me by telephone and advised that no transaction with citicorp or wells fargo could be effective without government assistance. in the fdic's view, wachovia

pose a systemic risk to the banking system. she directed wachovia to commence negotiations with citicorp. we negotiated an agreement in principle with a sign. these negotiations began immediately and were conducted in earnest and in good faith by a team of wachovia advisers. these negotiations proved extremely difficult. on thursday, leaving and to negotiate the transaction in good faith. but then decided to pursue the transaction with wells fargo. wachovia board of directors approve the transaction later that evening. after receiving fairness opinions, the next day, wachovia and wells fargo and as the merger. naked, sir. >> thank you for your statement for your written testimony. we will proceed to commissioner

question. i will begin fallen by vice- chairman thomas and in the league commissioners on this. call like to talk a little bit of bell the matters about which i spoke in my opening statement, the key question in my mind or one of the key questions, how do we get to the point for the boys we chased across the system was either to let the financial system collapse or to move in and saved i have been reading the work of our staff. there was a pattern among many of these aestheticians that find themselves needing government assistance or being in the category of "too big to fail." the one thing i want to focus on

in my questions, with respect to the regulators, why were there not efforts taken to contain risk, to evaluate systemic rest until the very end. when i look at the documentation all the way through with respect to wachovia, i do not see either regulatory body -- i do not see evaluations of systemic risk. i do not see this until the weekend of september 27, 28, and 29. the ryan had begun in the wake by the fdic.zure that is what i would like to focus on. i would like to enter some documents into the record. they are the april 2007 report of examination to the federal reserve, the july 27 at, 2008,

examination to be a federal reserve, the august 4, 2008, examination of the office of comptroller of the currency, and with respect to the action taken by the fed, there are two memos from september 27 and another memo on september 27 -- documents concerning what wachovia's liability structure was as well as the recommendation of the year richmond said. that was september 29. i would also like to enter into the record the fdic resolution -- fdic resolution of september 29, the memo of recommendation on the same day and that the minutes said the fdic board. now i will go to my questioning.

, ai look at wachovia's gross dose from -- it goes to $782 billion in 2007. that is a great rate of 17.4%. by 2007, the tangible equity leverage ratio was 23.321. uninsured deposits climbed over $160 billion. mr. steele, you mentioned the acquisition of golden west lead to losses of more than $10 billion. as i look at what the regulatory bodies have done, as late as april 2007, the federal reserve in its report of examination is

awaiting wachovia and at a two, which is safe and sound. it is not until july 22, 2008, that the federal reserve downgrades wachovia 283. even at that point, -- to a 3. even at that point, there was only a remote threat to its continued viability. there were decentralized risk- management issues. he cited concerns about subprime concentration. the occ downgrades to a three on august 4. what strikes me is that all during this time as you look at the reports of examination, there is no report of systemic impact. mr. kohl, from the federal

reserve, does note that there were many constraints while the fed discussed internally the issues of significant growth, securing long-term funding, and acquiring more capital -- the fact is, when there are discussions about trying to get institutions to build some bulwark against those concerns, mr. kohl noticed a 2007 study that there was concern in the united states about losing out to london and other financial centers. there was the concern that there was too much regulatory oversight. we lose our competitive bid vintage. mr. kohl also said there was a

risk that risk management practices had improved and that the industry had matured. mr. kohl also said that at the federal reserve bank -- the focus was on a holding company and packs on suppositories. there was not a look at systemic risk. i would like to ask you to comment. was this a big hole? was there a hole in the system or the federal reserve did not look at the systemic and pac's? i did not see anyone -- systemic impacts? >> his points are correct. we operate under a statutory frankfurt -- statutory framework. the degree of our investigation is governed by statute.

one of the gaps in the statute is one that is fixed by the "dodd-frank act" is on the individual safety and soundness of particular institutions, not on the system as a whole. there is no regulator in the banking area that is granted that kind of authority and oversight. that is one of the things that emerged in this crisis as a gap in the system. it is one of the things in that the "dodd-frank act addresses in a variety of ways. it encourages regulators to look at the systemic effect and the safety and soundness effect of particular institutions. it also establishes a council that brings together regulators of different markets ended institutions, so that gaps in

systemic problems can be monitored. where there are gaps, recommendations can be made to congress. park said it was the statutory framework we were operating under. we also, as mr. kohl mentioned, were limited to the institutions we could look at. we work required by law to defer to the primary regulator, institutions that are otherwise regulated, including the bank, the broker-dealer, and other regulated institutions. while we have a good relationship with those institutions, it is clear that the primary role belongs to somebody else. >> let me probe this a little more. we are in the high inside business. if you see an institution growing by 17% compounded annual growth rate, you see a tremendous wave of acquisitions and a fair amount of risk being taken. this has been a pattern over

time. the fed had the ability in the "good times" to make sure the boy works were there. -- make sure the bulwarks were there. having come from state government, i know that a lot of states have suffered. looking back on it, should the federal reserve or the jugular -- or the a regular -- or the other regulators have seen the growth rate? >> we did encourage a bulwark. that is what capital is for. the capital at wachovia, even at the time it failed, was sizable. it was well-capitalized by all definitions. when you are in a liquidity crisis, the capital may not be your saving grace.

indeed to be able to sell assets or be able to raise funding in some other way. that is what was happening in the fall of 2008. liquidity was drying up, so capital became less valuable as a bulwark. growth and size by themselves are not bad. growth of the banking system tends to mirror growth in the industrial and commercial entities in the united states. large, multi-national corporations, of which there are many of in the united states, find it helpful and very good for their business to have a large, american companies that can finance the growth of these commercial and industrial entities. >> i agree that growth is not in and of itself bad. when you see growth, you see a

wave of acquisitions. there's been a pattern. one thing that has struck me as you see the staff reports, over time there is a pattern of these institutions that do fall into trouble which is aggressive growth, high leverage, and increasing concentration in risky assets. i am probing, at any time did you say you had to look at the systemic risk implications and or that we should be concerned about the growth of these institutions and the risk profile they are taking? >> our ability to look at the systemic effects was limited. what we did was look at the institution's ability to look at the risk it was taking on. from the exam reports that you just released, the federal reserve was cognizant of the risks that wachovia was taking. they were urging wachovia to

address those rest and improve its risk-management systems as well as allies in its capital needs. we have a variety of efforts underway at wachovia at at other institutions to help them improve themselves said they will be in a better position individually to deal with their difficulties. unfortunately during the period of 2000 and eight -- 2008, institutions cannot address problems at their institutions. there was less funding available. there was less capital available. liquidity was scarce. we're stressing that companies deal with problems as those problems were becoming apparent. we were in a disadvantaged economic situation to adjust them. >> i want to ask you a couple of questions, mr. corston. it is my understanding that you had one examiner on site.

were you ever blocked from access to wachovia? i know in respect to washington mutual, it was blocked. are you familiar with that? >> i am familiar with that. >> but not in the essence of wachovia? >> correct. >> the one thing i want to ask you, in your role as the backup regulator with a significant amount of at-risk, did you ever look at the trail of the systemic risk implications for the system prior to the september 29 nemesis? is that an accurate characterization? >> the fdic was looking at our risk at the various institutions. we established what we refer to as date a"-- referred to as a "

national risk committee." it included directors of our insurance divisions and resolution divisions. it also has the chairman and vice-chairman of the fdic in attendance. what of the issues we became concerned about was the amount of liquidity in the markets and the amount of structured products and the complexity in the structure products and what we felt maybe insensitivity to credit risk in those products. we discussed that with our national risk committee and, in essentially, were involved in trying to get more information. wachovia was very involved in that area. we had our dedicated examiner

spent quite a bit of time working with the regulator and the federal reserve on getting information, background, and reporting for that committee. you mentioned the issue of growth and concern that we may have over growth. as mr. alvarez points out, growth is not always bad, but for the fdic, if growth results in a higher risk or more complexity, it becomes more of a challenge for the fdic. for example, when wachovia purchased golden west, golden west was what we would consider an institution having a single product, a mortgage portfolio that was largely collateral based. for the fdic to have that level of embedded risk in a single

institution is problematic. you can see that with the results of fannie mae, a freddie mac, and countrywide. this allowed a monoline institution go into a far larger institution that had diversified risk. the issue with wachovia is that it had a lot of other risks that exposed it to sensitivities in the market and liquidity in that market. one of the questions you had about whether we missed anything, the toughest thing as a supervisor and having to go to my board of directors, it is tough to not have a viable options for them. one of the things i do not think that we fully appreciated was

the sensitivity to the capital markets and the funding markets to the credit risks in some of these markets and how quickly that pull-back could be. with wachovia, you can see the rating was 3. we actually had in our lidi system, had wachovia-in march of 2008. that institution would be subject to a downgrade within the next 12 months. we had a discussion with the occ and they subsequently downgraded that institution. we did have concerns about it. the sensitivity to funding markets was something we did not have a pull the appreciation of. when the market became so displaced, this institution stood out as one that could not

weather that storm. >> it does seem to me that there is in assets -- in a since -- that it is like groundhog day. on the upside, we do not take the provincial steps that we take. do you believe in retrospect that that was a failure or a big gaping hole in the system? i do not see the systemic risk and liquidity prior to the weekend and this was done. >> i would agree it is a statutory gap because it was very critical for us. when we are dealing with the primary regulators, we were getting feedback that the rest were adequately managed. it is very difficult to say that the rest will and the growth in

itself was the problem. >> mr. alvarez? >> i reiterate what i said before. it was a gap that the "too big to fai -- it was a gap that the "dodd-frank act: was trying to close. >> some significant reservations had been addressed. in the transcript, acquiescence was discussed in the system. she was not completely comfortable with it. what was the core of this concern? >> she would be able to answer that question. the information that we presented to her prior to the board meeting and at the board meeting was an institution that was suffering extreme illiquidity stress and that

something had to be done. i am sure that board, including her, would have liked for more information and far more time to make a decision. i know that that was a concern. >> mr. alvarez, one last question for you. we are trying to examine it white some institutions where deemed "too big to fail" and others were not. we looked at the memos from the fed and from the fdic. i asked myself, "why did lehman not fit that criteria ?" they both seem to be in a position where they had systemic risk. one was in m1 was out. >> first of all, we do not have a list. i think as you will find in the discussion this afternoon, the difficulty with lehman was not that it would have had a systemic effect. it has been shown they did have

a systemic effect, but we did not have the tools to do anything other than what we did. lehman needed for more liquidity than the federal reserve could provide on a secured basis. without that security, we are not authorized to provide landing. we did not have the authority to provide capital. >> and me press you on that, mr. alvarez. he wrote a opinion on march 9 which i would like to enter into the record. you said at that time that the statutory "acts least the collateral within the reserve bank." you said that for the loss to be fully secured -- i am sorry. this is march 2009. he went on to say that requiring

most to be fully secured would "undermine the very purpose of the section." the other thing -- i would get into it more this afternoon -- was there ever an opinion rendered during the course of deliberations on women that credit could not be extended it legally -- lehman that credit could not be extended legally? the issue of a legal stopper never comes up as far as i can see. >> there was no time to write a legal opinion on lehman. everything happened incredibly quickly. we were dealing with the collapse of lehman. there was not time for that. on the other hand, if i could explain my legal opinion, the statute says that the federal reserve can land so long as the

reserve bank is secured to its satisfaction. the credit is either guaranteed by somebody else or secured to the satisfaction of the federal reserve bank. collateral is one way that eight reserve bank may find it secure. it may be the value of the collateral makes it feel it will be repaid. it has to be able to feel comfortable that it be repaid. going into that monday, there was not be believed that the federal reserve would be repaid because the collateral was inadequate. payment was a company that was failing. it did not have other sources of income to assure that they would repay the debt. there was no third party or the other source with funds to repay f. lehman did not. the federal reserve believed it would not recover the funds, debt for the credit was not

extended. >> i know that the private consortium went in and was trying to value the assets of lehman. i know that there was a valuation, but, of course, you can argue there was a motivation and a timeframe. did the fed ever do collateral analysis? did anyone in the federal government? >> a written report? no. >> there was time for extensive memos on wachovia. >> for lehman brothers, we were not the supervisors, and light wachovia. we did not have the access to information or the understanding of the company in the same way we do of wachovia. it is a different situation. >> thank you, mr. alvarez. >> thank you. >> vice-chairman? >> thank you, mr. chairman.

i think i have an extraordinary opportunity given the fact that mr. alvarez, you have been at the federal reserve, i believe, from 2004 until the present day. >> i was actually born at the federal reserve. [laughter] >> excuse me, the federal reserve notes. mr. corston, i understand that you were born at the fdic in 1987 and had been there ever since. >> that is correct. >> mr. steele, you were at the treasury for domestic affairs from 2006 to 2008, but moved from 2000 08 -- but moved in 2008 to wachovia.

you would be part of this string of decisions and results. so i will play walter cronkite, "and you are there." i am asking these questions as the chairman of the federal means and ways committee. all three of you gentlemen, when you were in government, are in article 2, the executive branch on the execution of the loss of the united states. when we talk about that -- and you were there, mr. corston, i understand on that meeting of the board of directors on

september 29 -- when you were looking at a potential decision to deal with wachovia, mr. alvarez, on page 10 of your testimony -- excuse me, on page 6 of your testimony, you emphasized in the observance of the behavior of the fdic meeting -- on september 28, the board by unanimous vote determine the compliance by the fdic met all of those requirements. it was a unanimous decision. >> yes. that was might board. i was not speaking about the fdic board. >> i apologize. what was the boat -- what was

the vote? >> if it was unanimous. >> it was a unanimous vote of the fdic. what it -- was it an easy unanimous vote? you know what i mean. just talk. >> i was a presenter. i did not get many questions. i think, though, it was not an easy decision. >> what was part of the concern about making that decision on the part of the board directors? >> that is easy to answer. it is the same problem i had. we had virtual time frames with a lot of gaps in information. while we had information regarding wachovia, we had very little information regarding the outside collateral impact

which we knew could be substantial. it was hard to calibrate a measure. when we presented our case, we knew this could be a very significant factor. decisions were going to be made upon, yet it was difficult to provide hard facts. i deal with institutions where i generally go up there for my --rd and present part that's present hard packs. i think this was the challenge we had that evening. >> as you indicated to the chairman, he liked to go into meetings with viable options. viable options are those based upon facts, that you had some certainty of presenting a course of action if that course of action was accepted. was their concern in the fdic about the potential of the fdic

holding the bag? that there would be some concern about costs to the fdic >> with regard to the case i presented and our analysis, the bid that was presented and the analysis we have from our field staff working with the federal reserve, it really showed that we had no loss exposure. now, we were given affect set that is not entirely 100% probability, but we were very comfortable that the actual dollar exposure was zero for the fdic. >> i your testimony, he said as a result, there is no expected loss of the fdic associated with the transaction. so you were home free.

mr. alvarez, in your testimony, on page 10, in terms of examining the arrangement, you say, "the federal reserve did not provide any emergency financial assistance in connection with the wells fargo- wachovia merger." in terms of taking care of your birth place, there was no risk, a financial obligation, or other financial world of the federal reserve -- financial role the federal reserve reply. >> that's right. so the federal reserve was home free? >> yes. i have to add a small footnote. >> small in size or importance?

>> i think in both. while it was true we were not asked for emergency assistance, wachovia was barring the bank itself -- borrowing the bank itself. >> once you make that decision, that is part of your commitment, but it was not outside of that. the federal reserve was. have any kind of exposure. the reserve is home free. the fdic is home free. in your testimony, mr. steele, i found on page five that your information was kind of second- hand, for example, in the middle of the page, "chairman bair shortly thereafter provided details on the proposed transaction, including that it

would not require any government assistance." >> yes, sir. >> lower on the page, you were in flight, things were happening what you were moving. things -- this was at the time you're at what cobwachovia consistent with what she told them, chairman bair described it as providing no government support with no risk to the fdic fund. >> yes, sir. >> but the solution, notwithstanding the fact that the fdic took the unusual measures in its minutes to move to a citi-wachovia a structure was not talking about the arrangement, was she? >> no, certificsir.

she was speaking about the proposed transaction by wells fargo. >> and the proposed transaction came after the fdic had met and decided by unanimous vote that it was appropriate to go forward with the safeguards and the small risk of possibly having fdic funds expos. on the 29th? -- having fdic funds exposed. what happened on september 30? beckett year-old stomping ground, mr. steele, the department of treasury. there was at that time an irs notice, number 83, which changed a more than two-decade old

regulation dealing with the acquisition of companies. in terms of whether or not the acquisition focused on the acquisition for purposes of tax benefit rather than any of the other reasons that firms might want to merge. in fact, irs issued an opinion which turned the law on its head. it didn't provide -- we are familiar with it. the ways and means committee used to -- committee used to deal with that because it was a way to transfer previous losses to current situations and previous profits to current situations where you wanted to shift time to provide assistance. it was always on a fixed time that it was available, and it was always across the board available. that if you met the dollar amounts, you were able to

utilize them. you did not come at you did not. but in notice 83, the irs said it was available to banks only to shift. losses that would acrue to the acquiring company. so you were asked wachovia at the time, and subsequently with the acquisition of wells fargo, you moved them to a position on the board of wells fargo. >> after the closing of the merger, several former wachovia directors were invited to the wells fargo board. in january, 2009, i joined the board. >> i am trying to understand, as i am there and you folks are in

the positions you are, let me in on when treasury began looking at what you call, mr. corston, viable options, including a reversal of a regulation that significantly covered what you could or could not do in trying to salvage financial institutions that you might define as too big to fail. because suddenly laying on the table and ability to acquire a bank or financial institution in which the concern is failure, therefore, a significant losses, could actually be incorporated by the acquiring corporation and use to offset taxes. and that was the choice that was made, notwithstanding the fdic made the other choices. what was your reaction, mr. corston, to the september 30 announcement by the irs that

they were changing the fundamental rules of the game which would clearly change the potential relationship between these financial institutions that you folks were so concerned about the day before in your minutes? >> my reaction was more towards the wells fargo -- it was a viable bid as a result. that was far more palatable of an option. >> so the means justified the end. you were pleased the irs made the change in regulations, unilaterally, without consultation, with the legislative branch of that has the constitutional responsibility to change the law. in essence, they changed the law. but it was convenient, a brit, a better deal. on the previous deal, fdic was ok, the federal reserve was ok. why didn' t you look at

continuing the process and not leap at the opportunity to take this extreme, a fundamental change in the tax code brought about by an irs notice? >> the issue on a weekend rally was a liquidity issue. we did not know -- really was a liquidity issue. we did not know if they had enough liquidity to operate monday. and that was a concern, and a concern we presented to our board. the problem was we just did not know, but we did know that the implications of them not being able to operate and the resulting impact on counterparties and other institutions could be fairly significant. so are our decisions were made, as i said earlier, unfortunately very, very compressed time frames with really not a tremendous amount of

information. >> mr. steele, you were at treasury in an undersecretary position from 2004 -- 2006 to 2008. was there any discussion in terms of mr. corston's viable options of looking at this shift in the definition of what he could do under the irs? >> not that i'm aware of. >> was it brought up in any discussions when you were desperately looking for a solution? because i know treasury talks to fdic and the federal reserve, and you sit around and try to resolve problems collectively, making sure no one wind up holding the bag, certainly not the federal reserve or the fdic. would you characterize there would be no government exposure or cost? >> no, sir, no discussions of

this technique or issue. >> mr. corston? >> none at my level. >> none that i'm aware of. >> so this immaculate birth of an irs notice which fundamentally changed the way in which corporations could deal with the tax code on an acquired corporation's losses was so significant that it shifted your decisions to allow the wells fargo to go forward. citibank was little upset. didn't they take legal action? >> that's correct. >> you were probably supportive because it could have left a bit of exposure, notwithstanding the size of it, but exposure to the fdic. you were supportive of this utilization of the regulation change.

was there discussion in the fdic about this is a better way to go? >> the discussions i was involved with was analyzing the two transactions and the wells fargo transaction not requiring any assistance with the fdic was a far better proposal. >> right. you are home free. we knew the federal reserve was home free. mr. steele, how can you characterize, even a utilizating other people's characterization's because you include them in your testimony, that there would not be any government cost to the irs notice 83 solution? what it was was a significant loss of revenue to the treasury, unprecedented. so, how can you say there was no cost to the government? unless you saw the government as the executive branch. >> no, sir. i believe the way i would for in

this distinction is that drawing a distinction between specific government support for an instant transaction in one case versus a change in the irs tax code, which was available to all others who might be in addition to take advantage of it. >> all other corporations? >> all other institutions to fit the qualifications. >> which were financial banking institutions. >> yes. >> in the vernacular, we used to talk about it in terms of making these kinds of decisions -- it was a rifle shot. they changed the law for a specific group of institutions. did anybody think that was lawful? i understand it was convenient.

it certainly was a solution that was not available on the 29th when the fdic made its decision. became available on september 30, and while sharpening its pencil, a home by october 2 decided it was a good deal and they could do it without any government assistance. how can you not call changing the tax code to provide you with significant tax benefits doing it without government assistance? isn't taking money away from the taxpayers in the general fund through a change in the tax code government assistance? >> i understand your perspective. what i tried to describe was a distinction between support for a specific transaction and support for what you just

described as a group of people, meaning financial institutions, and that being a distinction in my mind with a different. >> this is not my characterization. a fellow it teaches at the university of virginia that i got to know very well, because we selected him as chief of staff of the joint committee on taxation said, "did the treasury department have the authority to do this? i think almost every tax expert would agree that the answer is no. they basically repealed a 22- year-old law that congress passed as a backdoor way of providing aid to banks." what happened once congress discovered what had been done by the irs? they immediately slammed the door on this provision, although i believe two other banking institutions got through before

the door was closed. i guess what just amazes me is looking at this tieme period, late september, early october, there was a focus on the fdic making sure they were hauled freight and the federal reserve making sure they were home free -- the ends justifying the means was quite all right for wells fargo and for the assumption by wells fargo of wachovia, because it made it government-assistance free. but it wasn't. it cost the taxpayers to utilize this. i guess what is so amazing to me when you begin to examine the options open to you that i think a lot of us have a concern about the kinds of discussions that went on behind closed doors, what the options were that were defined as a viable, including,

up to it changing the law of the internal revenue code to make it expedient to take a course of action that did not cost the fdic anything or the federal reserve anything. but to characterize it as no government assistance, no government cost is to tell me a whole lot more about those key decision makers' view of the world at that time they had to make decisions for the american taxpayers and for the american government. i nkoknow who you are looking ot for. i reserve my time. >> thank you. >> i would like to follow up

with mr. steele. do you still serve on the wells fargo board? >> no, i do not. >> do you know how much that tax code change benefited wells or whether it is still a continuing law? >> no, sir, i do not. >> does anybody hear know? anybody on our staff know? >> in an analysis provided, wells contended it -- contended they have not read any benefit to date, but i believe that is their statement, that they have not yet utilize or reap any benefits to date but there are projections ofor future use and

availability of the credit. >> and that is because they have not made enough money in the interim. but there was an estimate provided when the measure was repealed saying costs would be about $7 billion. that is my recollection. >> there is printed information that indicates that the difference between it september 29 and october 2 was a tenfold benefit to wells fargo and terms of the tax provisions. >> obviously, a tax loss carryforwards are valuable and that they shield a future income from taxation. at the end of the day, although the fdic did not have to impact the insurance fund, the fed did

not have to provide direct assistance, ultimately the taxpayers will be impacted by the diminution and -- in revenue that would otherwise have been collected from wells when and if they utilize these tax loss carry forwards. the point at the end of the day is not that that method was utilize but the characterization of it as not government assistance. it was a different form of government assistance, that's all. it was a delayed form of government assistance, but at the end of the day, the taxpayers will have less revenue, which is the same as expending the same amount of money effectively over time. i guess i was interested by some of the things mr. steele that you said to our staff in the

interview they conducted with you. one of the things he said was the resolution process, you believe, should be mean-spirited with all parties playing a price as a pedagogy or methodology for resolution. i think people should not be too big to fail, but given the concentration issue, how should people fail in a way that does not have a ripple effects? could you elaborate on that? >> surely. i think i would start with what i believe are the right principles and then i would talk about preventative perspectives and then the right approach once events develop. as you recounted from my interview, my personal belief is that no institution should be too big to fail, but we do have a reality and that is that the

nature of that government involvement, in particular with depository institutions, set up a situation that is complex with regard to moral hazard and the relationship between these institutions. where we have a complicated crystal that wer are not clear on. so that is the reality, but my belief is that no institution should be 20 big to fail. so what to do about that? i believe that there are certain things we do in advance and some of them mr. alvarez described, whether it is a living wills, more effective regulation and supervision, and efforts to understand systemic risk as the chairman discussed in great detail. those are examples of things we can do in advance. then i think you get to the complex issue of when institutions run into trouble,

what is the method by which, if you adopt my perspective that no institution it should be too big to fail, why do you think should be the methods by which institutions are wound down o r have the as to least effect on other parties? they're my view is that we have processes for bankruptcy and that we should use as much of the processes available by bankruptcy as we possibly can before we get to the issue of thinking about government support. that is the philosophical perspective i would bring to the second part of the discussion. >> a lot of us on this commission share that view. but one thing that is in our charge is to attempt to evaluate and elucidate for the american people how it is that we got to the point where so many institutions were provided with

extraordinary governmental assistance. and, of course, they -- the policymakers only faced the choice of whether to save an institution when they are on the verge of failure, which, of course, customarily occurs not in an isolated manner, when one particular institution fails and a time when it is generally of rosy economic circumstance. if that occurs, quite often we allow them to fail because it is not going to impact anyone else. the problem is when circumstances present themselves, as they did in 2007 and 2008, when liquidity was being withdrawn from the marketplace. as we look at those issues, we are doing so with the hope that we will learn something about it that might enable us to address these matters differently.

one concern i have is that it appears that just the top six largest banking organizations in america, that would be bank of america, j.p. morgan chase, citigroup, wells fargo, goldman sachs, and morgan stanley, their assets were -- grew from 17% in 1995 to 58% of gdp in 2007 as we approached the high point of the financial crisis, but they are 63% as of the end of 2009. they are not any smaller. those six banks are 5% or to have a 5% greater size relative to gdp now than they did during the crisis. so my question to you, and i guess i will start with you, mr. steele, because you have a lot of experience in the private as

well as public sectors, then i will turn to the other two of you -- are we really any less likely to be compelled to save one of these six very large and very interconnected financial institutions in the event that we have a liquidity crisis anywhere near as severe as we had before? and i raise this because it seems to me that there are conceivable circumstances in the future that could lead there. we, obviously, commercial real- estate loans are not as large in number as residential real- estate loans, but if we all can see that the loss of value in the residential real-estate market place was a significant factor as a trigger of the crisis, you know, could we face a similar one as the commercial real a state losses have to be absorbed in these institutions over the next few years? and are we better position today

than we were two years ago to avoid the need to provide extraordinary government assistance to these institutions? >> i will revert back to the methodology of was describing. i think first is are we building or in the process of building better capabilities for thinking ahead, thinking systemically as the chairman suggested, having a more robust perspective from supervisors and regulators, and are we building tools so we are more aware and have a better line of sight on these institutions? i think that is in the process of happening. then you get to the second part of the question. and here, i think we have to be a very disciplined about setting into process now methods by which we do with this before we get into this situation. as you said quite correctly, when you have a situation like

we had in 2008, where several institutions are being stressed at the same time, then you need to know in advance what you are going to do. that is why i have liked, preferred some of the perspectives of recognizing we have to say in advance we will move in this direction and be more tough-minded with regard to potential bankruptcy. >> how do you do that? you have to do it well in advance of the crisis? the think we are doing that now? >> i think this is all yet to be determined. they are going to be writing 50 rules in the next 18 months. it will be in the work of implementing this legislation that we will see how people do. >> mr. corston? >> i think we certainly have an opportunity to address these issues that we face in the past.

ints youhe pooint raise, under our current process for resolutions, you will notice that to resolve all large institution it generally is absorbed by another institution. so, given the example of washington mutual bank gets absorbed by j.p. morgan chase, and now we have j.p. morgan chase. the solution for wachovia is absorption by wells fargo. those statistics you mentioned, i think if you look at each crisis, the concentration of assets afterwards, we see more and more concentration in banking assets in larger institutions. frankly, under the dodd-frank that was our only way of for a large institution, to have

absorbed by another institution. one of the things, the fdic looking to resolve an institution, you need time, information, and you need to understand structures. the bill will provide that information. one of the keey pieces is that when institutions make decisions right now, they make them with the sole focus on the bottom line. so if you are sitting at citigroup, j.p. morgan chase, you are not concerned with your structure unnecessarily if it had to be wound down in an orderly manner. that does not cross your mind set. that is not a business decision. with dodd-frank that becomes a business decision. for the fdic that is crucial. in many of these structures, whether legal or informations systems, the structure of some of their products, if you make

simple decisions at the beginning, at the outset, we understand some of the decisions they are making at the outset, not under a compressed time frame, in a weekend, but going back when institutions are making decisions, we will buy wachovia. we look at the structure and we are able to work with the institution to make it more palatable. >> let me focus on that for a second. obviously, wachovia bought golden-west. they had these pick your payment mortgages that we know people picked -- when given the option to pick a payment, they generally pick a lower one and a lot of people would like. sometimes they even picked ones that resulted in negative amortization that did not even meet the interest, let alone of

the reduction in principle, so their loans kept ballooning. these are the kinds of loans that cause problems not just at wachovia but at many institutions. does anybody have the authority now to address a similar type acquisition that will create within one of these larger financial conglomerates that kind of focused risk that helped to bring down wachovia dodd-ee of the keys in frank is when institutions have mergers, we can look at those structures, see it through a living will process, is it something with which our corporation can deal? ultimately, if we cannot, we have the ability to force the best your. there are steps along the way,

but at least it provides the ability to influence some of these structures to get the complexity iand size to a manageable size for our corporation to deal. and ultimately, under the bankruptcy code, is the goal. >> two minutes. thank you. i want to highlight one point and that is that some of the most astonishing testimony we have heard over the last many months was testimony from the leadership, the ceo, the chief risk officer and chief financial officer of citigroup testified that they did not know that within their sold investment banking subsidiaries had a liquidity provision that required them to buy them back, which they ultimately exercised. there was $25 billion, which

was 1/3 of the $75 billion of capital that city book had on its books. aig's leadership testified that they did not know that there were collateral calls associated with the credit defaults what they sold. their required when those tranche as were downgraded, required collateral to be put up. this led to the demise or would have been the demise of one of the oldest and best capitalized insurance companies in the history of the world. are we presenting a problem now that it will be exceedingly difficult in the future to resolve with the bailing out institutions by creating institutions that have so many diverse product lines and so forth within them that they are exceedingly difficult to manage it? or are those just al

outliers? citibank and aig were central to our financial system for a long time. is part of the problem, when these large institutions are created, they are difficult to manage and to supervise as well from the regulatory perspective, and is that just setting this up for a difficulty that is going to be a problem in the future? if youhairman angelides ifmr. , could respond to that. >> that is an incredibly difficult question and problem. but one way to think about it is dodd-frank puts more responsibility on agencies to ensure that large organizations have been has requirements to deal with risk management. there have been accounting changes that will help with a citibank problem. aig fell in a gap in regulation.

there was no one is supervising the top of the organization, which does not relieve management from its responsibility, but may explain why there was not more government pressure for the management to know what was going on. those things have been attempted to be addressed in dodd-frank. going forward, the tools we have to deal with the crisis are different than what they're were up to 2009. the federal reserve will no longer have the ability to make loans to individual institutions like aig. in its place is put a requirement that we resolve these institutions by wiping out the management and the shareholders and assessing losses across the creditors and closing down the institution. so the approach of going forward will have to be different -- more regulation on the front side to prevent the problem and

more drastic solutions in the event someone gets into trouble. >> we wish you godspeed in your work, because this is important work for the american people. i would urge you in your analysis to try to bring in your analysis all the off-balance sheet exposures that all these institutions have that render them incapable and their capital and adequate when crunch time came. so really you have to look at them holistic way with in the institution. and to the extent to have been given that authority by the new legislation, i urge you to use it. >> mr. vice chair? >> 30 seconds to mr. corston in terms of your answer, about corporations looking to their bottom line, did the fdic do exactly that, when on the 29th,

you unanimously accepted a shared relationship with citibank in the acquisition of wachovia, and two days later, when you were let off the hook by virtue of an unprecedented executive branch usurpation of tax law, provided and all that really was a solution the better protected your bottom line? >> when i % my analysis to our board of directors, i present analysis -- when i present my analysis to the board of directors, i present analysis that when we gotd the wells offer that the exposure to deposit insurance fund was less than that of citigroup so it would be better for us, less risky. >> so if i line up your loyalty responsibility, it is to the fdic first and to the american tax payer second. that is just what he said.

thank you, mr. chairman. >> thank you, mr. chairman, and thank you, a gentleman, to help us today think about this issue. i think it goes almost without saying that the nature of government intervention to financial institutions to -- and markets is the signature of this particular era and one of the most controversial aspects of public policies you can imagine. it does raise questions we have to somehow answer. in particular, did the intervention or the expectation of intervention cause or exacerbate the crisis that we have lived through it? for institutions that received a, what were the criteria that were applied? who gets the help, how much do they get, what form does it take? in terms of thinking about the notion of identifying those that

intervention, what are the dimensions policy makers are looking at? is it scale, large institutions get attention? is it interconnectedness? the fact that many counterparties may be deeply affected due to the failure of an institution? is it the business of being a similarly situated, allowing one institution to fail sends signals about others that are similarly situated? or is it just the nature of market conditions that dictates the need to intervene? these are all dimensions of the problem that have been bandied about in our discussions in preparation for this hearing. i think i was asked to lead this preparation in part because i approve and i do not understand how to think about this problem. i want to start with you, mr. steele, and ask you, during your tenure at treasury, as we saw

financial market conditions evolved in the fall, 2007 and into 2008, what institutions was the treasury surveiling? what criteria were you looking at? were you looking at the largest, counterparty exposures and measuring them? how was the the treasury thinking about this problem and the fallout from individual institution failure? >> well, when i reflect back at treasury, and i was there from 2006 to 2008, it really was in the summer, 2007, when you saw the first cracks start to appear. and basically, what began with housing-related issues spread into securities markets and then

began to have the reverberations into specific institutions, is how i think about the process developing. and everyone has their own image of this, but that is mine. i believe there is no question that it was tough to keep up with this situation as it was developing, challenging. and that i think that our focus rolled along with the phenomenon that i just described, where there was our original focus on the challenges of housing and foreclosures and what could we do to understand and tried to be constructive toward housing and focus on foreclosures. roman number ii, was as the spreads into securities markets,

it was a matter of things like the commercial paper market, and asset backed commercial paper markets. then you saw, overarching this period, was concer n about gse's. i think that was leading up to the institutions. first with security firms and then into commercial banks. that was a transition of how we monitor it and try to follow the different things, just from a time frame of the lends and how things lined up, sir. >> is it fair to say that you were then looking at firms that were similarly situated as specific markets became more impaired? >> i think we did our best to think about the interconnectedness, too, because when you look at the effects on the model line industry as it spreads out to other areas and what it means for securities on the balance sheets of lots of other institutions, all kinds,

insurance companies, commercial banks, securities firms -- so i think it was trying to understand the interconnectedness' and the institutions affected by the situation we are examining as we worked for those challenges. >> but scale, per se, did not appear to be important. when i hear you say, it is not the size that matters. his other characteristics. >> all kinds of things. this began at the grass-roots level of trying to understand the effect on foreclosures and homeowners. that was really the first. from there, you have the ripples. where does adcp lie? if general electric has a problem, that affects credit cards, it affects student loans, and it affects all types of securitized credit. so this was a phenomenon that when in lots of directions.

>> so my understanding of the dodd-frank legislation is that the nature of the interventions changes. the fed will not be permitted to provide liquidity to individual firms, but it will and should stand up like it did in this crisis -- there would be brought eligibility for liquidity systems. if that kind of facility is in place, commercial paper assets, does that change the way we will have to worry about the supervision of institutions and their systemic implications or have we taken care of that by providing broadbased liquidity to those markets? >> i am not sure i have a perspective on that, to be honest. >> not even a guess? i guess all the time. to return to you, mr. corston. you have been at the fdic for a long time, long enough to have

lived through -- the law that was supposed to rain in the fdic's ability to assist large banks when they are in trouble. in your career, was there a sense that the 1991 law put handcuffs on you and raised the borrower in terms of your ability to provide fdic assistance to troubled institutions. >> it narrowed the options. i think with prompt, corrective action is davis the structure to work in. -- it gave us the structure to work in. as an examiner, it made things easier to implement. but with that structure, there were some constraints, also. >> so, the decision to provide the systemic risk exemption in the wachovia case was a very important decision? >> absolutely.

it was a very unique situation. obviously a difficult one for our board to make progress can you tell me a little bit about the process for making that decision and what you looked at to identified as systemically important? >> at my level, i deal with the examiners at the ground level and those -- am responsible for producing information and analysis. so, executives or directors can make decisions. with regard to wachovia, we knew it had credit exposure, certainly with the golden-west portfolio, provided unique risk, because it is difficult to calculate the embedded risk in a typical portfolio when you cannot tell what is really a non-performing loan. >> were there any wachovia- specific risks desk what were

the systemic dimensions? via,s we worked with wachoiva and we got to the weekend of the 25th, we had a situation in a market that was very unstable. we had an institution that had of funding structure that was a very sensitive to the types of displacements that were taking place in the market. and we knew that it had this exposure. what we were not clear on was to the degree it could impact the outside markets and other institutions. we were certain -- >> but that is the nature of systemic. >> our analysis showed that there definitely would be an impact. and the impact would be significant. >> and what would those impacts be and how large would they be and how would you measure them? >> as mentioned before, these were difficult to measure, and we were dealing in compressed time frames. we were dealing with limited

information, but we did know we had very large institutions also funded in a similar manner to wachovia. we knew the market was concerned about some of these institutions, and we knew that if something happened to disturb or give less confidence to various counterparties at wachovia, it could impact other large institutions with which we may have to deal right after a situation at wachovia, and ultimately, it frees up the funding markets. >> so, you saw wachovia as being indicative. there were others out there that looked like it. >> they had similar circumstances. >> you did not make the same decision with washington mutual. why not?

>> with washington mutual, the structure and the liability structure was quite different than that of wachovia. they did not have the same for a deposit exposure, the same wholesale funding exposure, the sizable broker-dealer, the holding company, they did not deal in complex, structured products. so to measure the impact at washington mutual, which while large, was really a large thrift that had a simple funding structure and it was a far easier to calibrate the collateral impact of that institution. >> and you did not feel the same concern that there were the other large thrifts structured like washington mutual that would come under attack? >> no, because essentially it was the largest, and we had dealt with some of the weakest ones already.

and again, because of the structure of their funding, they are not as sensitive to the funding market that wachoivvia was. >> mr. alvarez, the federal reserve to do the same conclusion for the same reasons? >> for the same reasons. many of the things you outlined. i presented it in more detail in my testimony. i believe the commission has the memo we used to analyze the wachovia situation. it was the context. the economic situation was important to making judgments about systemic risk of individual institutions, the scale. wachovia was the third largest institution by deposit, so incredibly large and interconnected. we looked at measures of the interconnectedness, how -- to the extent we could, where the commercial paper was placed and the effect of not being able to

pay might have on other institutions. some of its other large exposures to different markets and a different institutions. the fact that it was well- capitalized, considered well- capitalized. the market did not seem to see the failure of it coming. unlike wamu where the market saw it that they died over a period of time. a lot of folks prepared for that. >> so do you agree that there should have been no intervention with wamu? >> yes we agree. >> there are some who assert that the failure of wamu triggered a run on wachovia? >> the day after wamu failed, two events occurred. that was also the date the legislation failed. both of those things had a

pretty dramatic effect on wachovia. the question is not so much whether it had a bad effect on wachovia, but if we had aided in wamu, would that have changed circumstances with wachovia? it is not clear that if we provided assistance to washington mutual, that would prevent the problems at wachovia. >> i will reserve the balance of my time. i will come back later. >> mr. chairman? >> i want to follow up on that one comment. it does strike me dead in this crisis, -- it does strike me in this crisis that intervention by the government's is so big into the system that the two systems that were not saved, lehman and mau

wamu, triggered panic in the system. in this instance, wamu is not saved and the run begins a that afternoon, the next day on washington mutual. which brings me back to my original point which is it seems to meet that is so big into the system that the focus should have bent, in the past and in the future, on as the problem is growing, the risks are growing, the scale is growing, that is where the focus needs to be. because when you get to the tail end and there is panic, there appears to be no viable response by rescue. >> yes, sir, the more challenging situation, the fewer options you have. another way to think about it which is constant with the situation at wachovia was that

as things became more challenging, some of the planned alternatives became more difficult to execute. so, yes, sir, i think that prevention and a more better diagnostic approach in the advanced certainly gives you more option melody on choices. >> it seems to me that if you are going to have banks that are too big to fail, you need regulators that are tough enough to handle those banks of enormous scale. >next would be senator graham. >> thank you, mr. chairman. it seems to me the key question is will there continue to be the political support to do what has been done in the past few months, which is to intervene at the time of all to the crisis? second, if that is suspect, that

continuing political support, what are the fundamental ways it to avoid reaching that point of extremist? there are many candidates this fall for congress who are running on a platform of no more bailouts. not to support programs like tarp, should they be elected to congress. whether there will be a majority for us or not is unknown, but that voice is certainly going to be louder in the next congress than it has been in the present congress. so, if you assume that it is going to be more difficult to come to the assistance, and if the consequences of not coming to the assistance are as catastrophic as we have described, then it seems to me it puts a particular premium on figuring out how to avoid getting to that extreme.

there are at least a couple of options. one is that those institutions that have the characteristics, whether they are size, complexity, interconnectedness, similarity, the herd effect, should they be restrained, somewhat like the sherman antitrust act was used to restrain the growth of large industrial conglomerates at the end of the 19th and throughout the 20's century? or can we have a regulatory system that will be engaged at an early end of stage with these large, complex institutions to avoid them getting into extrem ist? what is your sense as it is it possible to control these organizations of this size and

complexity in their current form or will necessitate fundamentally changing the system which has allowed these enormous institutions to revolve? i will start with mr. steele. >> thank you, senator. i think you provided two choices. and i believe that my perspective would be to support the second one. and that is that we can develop the right tools, capabilities so as to do a better job of regulating, managing these important institutions. i believe that the idea of a size limitation or an interconnected limitation or in importance limitation is less

realistic. there are benefits that come from having larger institutions in terms of product offerings, economies of scale and things like that. and the global nature of the world is such that many of the competitors have these characteristics. so my view would be to favor the second of the alternatives you suggested. i alluded earlier to whether it is a systemic perspective with regard to all of these institutions or whether it is the idea of living wills or planning in advance with the regulators, how to wind down would occur and what are the stress points. whether it is a matter of regulators having learned from the past and doing a better job going forward. that would be my instinct, sir, to the question. >> mr. alvarez? >> i agree with mr. steele. in one of your early points, it will take regulators with strong backbone going for. we are not going to be able to

stop crises from occurring. on the other hand, we can prepare ourselves better for it and lessen the impact, hopefully, and one of the ways to deal with that is by having strong regulation of the large institutions that are complex to make sure they assess the risk and do with the risk, they are prepared for the risk and a better way than they have been in the past. also, we are going to try an experiment now. i think the federal reserve has not bend itself happy with being in the middle of providing assistance with large institutions. my chairman has said that providing alone to aig was one of the worst experiences of his life. congress has reassessed the tools. we will not be providing that kind of assistance any more. that sends a message to the industry itself that the idea that the federal reserve will be able to stand behind you and provide liquidity if you get

into trouble is no longer present. now you have to confront, as management, you have to confront the likelihood expectation, a new resolution will be in your future. it does require a lot of strong work on the front end and a different look on the back end. . .

in 2006, the rate of accelerations started to slow and by the end, there was evidence of declining home prices. several loan originators went bankrupt. those would seem to be early morning systems that some saw

debs needed to be taken pretty soon. >> two minutes to wrap up. >> in hindsight, there were signs that housing was having unusual activity and we were having challenges start to appear. i can tell you at that time, in 2006 and in early 2007, it was not our opinion that the prices would fall as much as they did. it was the significant decline in the asset prices which was the fuel to this situation.

maybe we should of seen more things coming but it did not seem to have the trajectory that would take it as far as it did. >> no more bailouts, will this cause the treasury and other regulatory and supervisory groups to take a look at what is going on in order to reduce the chances? >> i hope this would be the case. a day think that we have some

some other perspectives on what those preventive steps would be. there are positions by regulators, a systemic regulation in regards to wisc, those are all the right types of things that i think it be beneficial. >> thank you. >> my questions are about to the other firm we are talking about in the next panel. i was very interested. i would like to ask you about this situation. your explanation before was there helpful about secure vs unsecured loan. collateral is one form of security.

the difference between the bear stearns situation is that there were as buyers available and security. i have heard numerous people say that the fed chose not to act in the case of lehman brothers. there is an implication halt and that there was an option for the fed to go into bankruptcy and they chose not to do this. in your opinion, was there a viable legal option? >> there was no merger partner that came forward to acquire the men as there had been in bear

stearns. there was a very big difference. if the federal reserve was linked to lehman without adequate collateral and other security, this hearing and all others would have been about how we wasted taxpayers' money. i don't think that we would have been repaid. from my perspective, there was not a legal option. >> when you said the chairman, you were referring to the chairman of the federal reserve >> in his written testimony, a couple of things stand down.

he said that lehman had adequate collateral. could you give your opinion or your understanding on these points? >> quite frankly believe on that monday, let me separate the two things. there is a broker dealer. this was a sizable portion. we did in fact lend to the broker dealer for the week afterwards as it was going towards bankruptcy and the bankruptcy court sold the dealer. we only needed a small amount of funding. the parent of lehman brothers in order to operate needs a guarantee of all of its obligations going forward.

it's liquidity had tremendously diminished. it might have had capital but to the assets was declining rapidly. there were a few people willing to deal with the company on any basis that did not involve massive amounts of collateral. the third parties for not finding the institution. i can understand that management would have a different point of view. they had a plan to save the company and wanted additional capital. we could not take that risk. >> i want to follow up on the distinction between whether or not they were solvent or liquid. i interest and that everyone is

losing confidence. people had been that information -- people had a lot of information. where their assets greater than the value of their liabilities? everyone talks about everyone else losing confidence. when you look at the balance sheet, where they softened? >> i am a lawyer as opposed to an accountant. >> can you give us something in writing that describes what the fed was thinking in regards to

the solvency? can you asked -- tell us what lehman brother asked the government to do that they did not do? they are granting an exemption over section 23 of the federal reserve act. the third is a ban on naked short-selling. >> the notion of lehman becoming a bank holding company in is something explored to the early part of the summer. it has benefits and costs. one of them is a provision by the federal reserve and all of the regulatory burden by that.

lehman brothers was not certain of the benefits. they were afraid that it would look like a gimmick. in fact, the substance of the change to becoming a bank holding company are very different. they gain no additional access. what today to -- this is similar to bank holding companies that are around today. this was not enough of a benefit to. >> you are saying that they decided not to pursue it because their testimony says

they were not permitted to become a bank holding company. >> there was never an application filed by lehman brothers. there were preliminary talks. they would not be able to pass muster. this is clearly a judgment. management has to look at the cost. lehman brothers is able to transfer some assets into the bank. they had an industrial loan company.

one of the issues around 23 a are the quality of the assets being transferred to the bank, will they put the bank at risk? this is a direct taxpayer exposure. the agencies were very careful about allowing institutions to transfer risky assets into the bank. it is hard to believe that they would have gained enough liquidity from lehman brothers into the bank to have prevented the failure of lehman brothers. >> the conclusion is in the end lehman brothers was forced into bankruptcy not because they neglected to act responsibly or seek solutions to the crisis but because of a decision based on flawed information not to provide them with the support

given to each of their competitors and other non- financial firms in the ensuing days. >> i think i can agree with the first half but not the second half. they try to very hard to save the company. they have a plan that they were in the process of implementing that failed which would have downsized the company selling off a bunch of assets and raising more capital. management was trying very hard. i think they failed not because the government was not willing to help them but because they were a victim of the circumstances and the economy and some bad decisions that they had made and they did not have time to get out of these.

>> because of a decision based on flawed information, i believe that is a decision by the government, d you agree with that? >> i'm not sure what he is referring to. >> mr. chairman. >> if you provided you with lunch, would that be enough inducement to stay around for the second panel? you don't have to answer the one but it is obvious that we will not be able to ask for follow-up on any number of questions. what all of you be willing to respond back to us in writing if we send you some questions that we arrive at in writing after

this hearing? >> almost certainly. >> thank you. >> one of the things that was raised, what i want to do at this point is it will be the subject of a subsequent panel. this is a chronology that has been selected by our staff. you can enter this into the record. i think it shows a relatively complex picture. a legal opinion was offered through financial assistance.

what you see in this chronology is say recognition of the problems that arise if it were to go bankrupt. there are tools and authorities available. you also see political concerns about the bailout. this is a complex situation we are trying to deal with. it looks as though there were a number of considerations -- political, financial. is that a fair statement? i never see consideration, for example, and never see the fed

is saying that they cannot do it. >> you have experts this afternoon and i will defer to them. we were doing contingency planning all through to thousand 8 and all kinds of institutions and learn how to think about these problems. we very seldom had much time to act could tel. many times, the scenarios that you have dreamt up in the summer are not available and don't work. so, we had a few of those. it is not surprising to me as

the person who has to write memos that on a weekend like lehman, we would not have been able to write the credit memos that you would like to see. h>> i am not sure what your question this. hwe have heard there are other options. it was a busy weekend. >> we can do it deceptive but i did not see in the course of two-three months any expression about any legal bar. >> is there a question about the legality or the analysis of the fed of whether or not there was sufficient collateral?

>> or whether this was a more complex decision. >> i did not mean to leave the impression that this was not a complex decision. >> there are questions why we cannot do this, legal authority. what we see an absence in this chronology is any focus on the legal bar and the inadequacy of the collateral. maybe that came over the weekend? >> i am not sure i understand the other variables because at least my experiences if you don't have a legal option, you don't worry about the other consequences, that is not legal, what else can we do? >> whether the legal constraint was the bar here or a number of

considerations that went from political to financial to strategic. >> we are hearing from the general counsel that it was his judgment that it was illegal. are you judging whether this was right at the time? >> i think i'm questioning whether this is the totality of the decision. in the 2009 decision seems to give the fed enormous latitude. what were all the factors that went into that decision. i want to put a timely

statement. a investigation and the action that was taken by treasury, it was concluded that there was legitimate argument that this constitutes overstepping by the ministry of action. i consider those pretty strong terms. some folk were considering going on some of the box. >> i have a series of questions to ask what can get some clarity. it appears as though there is not list of rules or criteria if

you determine whether aid firm will pose a risk to the system if they fell. that is not only based on the intrinsic characteristics but also the environment. would that be fair? also the ability to be able to govern situations where firms may fail. volume curious what would have been different if you apply the rules that we had today when we're looking at situations like wachovia. how would your body of knowledge

be different? >> of one important piece is for our corporation to reach in the institution to be able to address them accountable. a lot of institutions have risky business activities that take place across multiple entities. this is broker-dealer operations. the ability to address an entity in total is from a practical standpoint something you can actually implement far easier in a complex institution than dealing with a specific entity which is very difficult to

decouple from a holding company structure. there are pieces having to deal with the ability of having -- produced by an entity to understand how they can be broken up. also for us to be able to set up some resolution planning behind a living will that provide a few things such as up-front time information and some influence over these structures. >> how would this have been different? >> we had a brokerage dealer

outside of wachovia. tsk the ability to understand the interconnectedness and the insurer institution and to the various counterparties. under our qualified financial contract, we would be able to get an understanding of all of the relationships and the financial contracts ahead of time and understand the magnitude of these various contracts which would be a tremendous help. also looking at the structure and understanding the ability to work the holding company through the bankruptcy code as well as the insured in to entit.

>> it would have been easier as you would along? >> i think we would have made much more informed decisions. >> thank you. >> some of the handcuffs would have been taken off on our supervision and we would have had more enhanced capital risk and management and this is something that we would explore and this is something which we hope to be a useful tool. i think the greater effect would be in the other institutions that we have been mentioning today. those institutions would have been subject to higher capital requirements, or liquidity, and better supervision.

hopefully, we would not have gotten into this cycle that some of the commissioners have been worried about and starting to help an institution such as bear stearns and create a moral hazard that goes along with providing government assistance and the expectations that the craze for other institutions. if we can break that cycle, we will end the too big to fail. this is more natural to deal with it wachovia and hopefully last stress. >> some of the other firms would have been in a better financial position or what have not failed? >> if not, they would have been put into liquidation. >> can you talk up by that

situation at wachovia? with the company's situation have been dramatically different from what you can see? rol>> if we take the prism thats been suggested as part of a new regulation certain some parts would have been constructed on how they run their business. in particular, those things i prescribed as good health type activities -- stronger regulation, more engage regulators and supervisors, living will for planning for resolution. it is very difficult and early to say with specificity what differences might have been given the fact us of any of the

world's related to this legislation had not yet been written. i find that a bit of a leap that is uncomfortable but there's no question that a more robust supervisory regime and a tighter lands on capital would be useful. >> thank you. >> we have heard a great deal about how interconnections among financial institutions played a role in the government's decision to rescue institutions or provide extraordinary

government assistance. all of our largest commercial bank holding companies and investment banks were among the world's largest over the derivatives. at the time, they received extraordinary government assistance. there were millions and millions of these transactions in existence in may 2008. they had over 680 trillion dollars.

what we wanted to know if the juror dispositions played any role in your agencies consideration of whether they should be rescued. maybe we should start with mr. alvarez. >> most certainly, aig, the derivative suit were a key factor in measuring the risks to the institution and the interconnectedness of the institution. this is one of the things that we looked at to understand their exposure and whether their failure would have ramifications broadly in the system.

with a i.t. in particular, they had a sizable but of all unhedged exposure which pose a tremendous risk to them. this was one of the sources of their financial difficulties. there was interconnections throughout the world. this is a big indicator of the risks. >> did they have information on the inner connectivity of all of these institutions? >> they will make great strides

to remedy. >> how will they do this? >> they will create a 40 in the federal reserve to collect information about derivatives exposures. this also requires more clearing of the derivatives of the central counterparties and strongly organized strongl counterparties. bac>> is this an issue that the

fdic looks to and considering systemic risk but secondly in the process of resolution of a failing institution? >> this is extremely important. hwhat most important parts is the predisposition and the contracts. we need to know the risk characteristics very quickly. that is important. >> how does the fdic handled the derivatives portfolio of a commercial bank when it fails?

>> that is not an area that i deal with but the fdic has to look at financial contracts and determine within a short window, 24 hours, whether they want to keep the contract or not. our ability to understand the position on the contract and whether this is advantageous to the receiver is very important. >> over-the-counter derivatives were deregulated in 2000 with the commodity futures. i am sure that that made it more difficult for the agencies to have an understanding of the marketplace and to have the information about exposures of various institutions.

mr. alvarez, in your discussions with the commission's staff, you talked about the role that the regulation played in the marketplace ended perhaps making the marketplace more fragile and exposed to the kind of crisis that we have. do you think that the regulation was a factor? >> well, i do. there was a strong press for the regulation through the late 90's. this weakened the resolve of the regulator and the attention paid by institutions to the risk management that the institution should have had.

the regulatory burden is important to watch. this is something that agencies need to be mindful of, particularly as it relates to a small institution. i think that our resolve was weakened at other institutions which was a mistake. >> i would like to place in the record the transcript of the interview with our staff from mr. alvarez on march 23rd, 2010. >> thank you. >> thank you for coming in and thank you for your service to our country over many years, especially through the difficult times.

we have not discussed the decision to rescue bear stearns. this was the original sin because everything changed after they were rescued. another thing is, participants in the market thought that all large firms would be rescued. hough companies probably did not believe they had to raise as much capital as they might need it because they probably did not have to dilute their shareholders because the government would rescue them hom. to the reserve fund did not think they had to eliminate the commercial paper that they held in lehman brothers because lehman brothers would be rescued

and they would not have to suffer that loss. buyers probably thought that they weren't title to get some government support. foit was thought that lehman brothers would be rescued and they were likely to drive a harder bargain. the decision on bear stearns was exceedingly important in analyzing this entire process. mr. alvarez, mr. steele, you were probably involved in that. i would like to get your socks. one of the things that flows from bear stearns is the question of moral hazard. for when you are giving consideration on whether to

rescue bear stearns, was any thought given to the question of moral hazard and what that would do to the market in the future? since now regulators are expected to consider systemic issues when they examine or are otherwise supervising financial institutions, i would like you to give us some indication of what you think a systemic risk is and how apart from the circumstances at the moment you would be able to define systemic risk. if i may, can i start with you, mr. alvarez. fo>> yes, there was some consideration. there are some things that made the decision at bear stearns and

each of the decisions. this is very difficult for the governors and the board. they wanted to be a support for everyone. that is one of the reasons that you can see. secretary paulson said there would be no government assistance in part trying to negate the moral hazard. this is one of the reasons that the chairman of the fed, chairman bernanke, began calling for a resolution regime. he needed and felt that we needed a more certain way to pass on losses to the

shareholders to replace management and to try a different avenue. moral hazard is something that we are worried about in all of our situations. >> if i can interrupt, why did you decide given the consequences for moral hazard to which you were so sensitive to rescue bear stearns? >> we thought that if we did not provide assistance to allow a merger, we look at that a little bit differently than a rescue. if bear stearns had failed, the cost to the system would have been much greater than the cost of the moral hazard. >> how did you make that decision?

what costs were you considering and how can you add up all of those costs? >> there is no serious number that you can add up and be certain about it. in early 2008, the financial system was under severe stress. there was the various indicators of market activity. they were showing that markets were closing. funding was becoming shorter and shorter. chairman cox testified that while the rules are based on the idea of liquidity based on collateralized borrowing, it never occurred that there could be borrowing or even collateral not be sufficient. that is the problem that the

broker dealers found themselves in. we were worried about a collapse of lehman, goldman, merrill lynch, all white in a row and the consequences. >> you were able to assess those as very likely to occur? >> we were very worried that they would occur, we thought that the loan that we provided in connection with an acquisition of bear stearns would be repaid so the taxpayer would not actually take any losses. it was a tool that congress gave us to deal with these situations. we had a tool and we did not use it and there was a horrible effect and the federal reserve stood by. we decided to provide the credit. >> mr. steele, can you provide any further information about what was in your mind?

? well, i think you are correct to suggest as you did in your opening comments that this in a way set us on a path that became increasingly challenging to manage their had been introduced earlier that year for the government to get involved with weaker financial institutions which we had chosen not to respond to. the markets work and they recapitalize the themselves. this was difficult for me, as you suggest, i had spent almost

three decades in the securities industry and i viewed that the firms were different then depository institutions and that over my career i had seen people be successful and people be unsuccessful and the freedom to fail was part of the dynamic that characterize this segment of the financial-services industry. i think we drew a distinction again, maybe this is too fine but this is with a different service that facilitating a merger with a loan that we fully expected to be repaid, the fed fully expected to be repaid was appropriate given the dynamics and if my memory is correct, the

price was 126 cents 3/8. the idea that this was done without any pain, the company would change management and management from bear stearns would leave, the shareholders would pay a significant price. so, the bridging to bear stearns with this loan seemed to be appropriate. >> with all respect, the issue is not money, this is the moral hazard consequences going ahead with bear stearns. the government was going to be paid back. this is not as significant as the fact that the creditors were actually rescued and would from that point not have a completely different attitude towards what the government was going to do in the future. >> there's no question at that

point is correct and fair and i did not say in my answer, certainly we discussed this issue, given the benefit of hindsight and all of the other things that happen, then you have to progress this perspective to think about this. >> we appreciate all of what you do for our country. what is clear is that there appears to be nor formulaic approach in dealing with too big to fail. there is no standard approach by which you can calculate or determine whether an entity faulted in that category. this is very judgmental. this is also clear from not just comments made by you but by chairmen shapiro was that this was in fact a huge failure and

supervision where in fact had some things been done on the front end, we might have mitigated the crisis we are suffering through as a country yet at least two of you have said that the dodd frank act has the potential to change the world. this will make things much better for our country the next time around, so why in our we as the commissioners or american people to believe that supervisory failures will not occur the next time around if the bill may set some foundation for what regulations will be put in place but we will fail once again to implement those regulations in practice. there are those failures which

are the result of regulators not doing their job well enough and and there is all of us to realize that we could do our job better and you want to do our job better but there are also supervisor regulatory and statutory caps, there are things that we could do -- there are things that we could not do no matter how much we wanted to do them. this plus a bunch of holds. this authorizes the regulators to look at all systemically important institutions, that authority did not exist for, this authorizes us to take a systemic approach to supervision before we were constrained to taking a mike review of the safety and soundness of a particular institution so it takes off some handcuffs that were put on during the the period of

regulatory burden reduction to keep them from doing too much. all of those are important improvements to our ability to do a better job on a supervisory front. i agree that there's no way to be certain that the regulators will get everything right or do our jobs perfectly going forward so there has to be changes in management of the institutions, they are focused on their own risk management and how they deal with it. they will have to deal with the better. investors have to do a better job of paying attention of what they invest in there is blame to go all the way around and while we deserve our part and will deal with our part, for us to deal with the crisis more successfully going forward, everyone will have to do a better job than we did leading

up to 2007. >> there are systemic issues in which the individual agency did not necessarily have a clear perspective. this recognizes that as they got more large and complex, this is not just an insured institution but you are looking at having to address this and it addresses the issue of the fact that given the size of these institutions, there is upfront work that needs to be done with regard to establishing a living will process. >> no one would like to be the person who turned the lights out on the party and there was a big party going on here and what changes have to happen in the management of the regulatory organization such that they're

willing to step up and turn the lights on. >> it is very hard to identified bobbles when they are happening. there was a debate about whether there had been a repeal of the business cycle or whether there was an increase for some amount of time or whether there was an end. given the difficulty in identifying when the punch bowl needs to be pulled away, the most important thing we can do is to try not to set the conditions for the creations of a bubble.

we want institutions to understand how to reduce risks and making sure that they understand not just how the risk affects them that how this affects others in the market that they are dealing with. as an example, the origination and distribution model was from a very narrow point of view. the bank supervisor was looking at safety and soundness of a very good approach because they were originating mortgages but they were not taken on the risks of those mortgages and their son them to investors who understood the risk and dealt with the risk. as it turned out, they did not understand the risk. while the institution originated was not taken on risks directly, they were creating weakness in the system that reverberated back in the institution itself.

being able to have a system queue up risk allows us to take steps to address those types of models and hopefully identify them in advance and have underwriting standards in this case improved and perhaps take steps for investors to pay more attention to the risk. this allows a different perspective and hopefully this allows us to reduce the conditions for baubles so they will not be as large. there's not anything we can do to identify everything or prevent them all for to prevent a crisis but we can certainly do more than we could before. >> i don't think i have anything ad. i think would be on optimistic that we would have regulation that would be perfect and that we will not catch anything.

the idea of planning in advance and then to do as much as you can do have the institutions take on more responsibility you have lots of responsibility by lots of different parties that was not discharged as we would wish. basically, this goes with regulators, management, individuals and with congress. they are all examples where everyone could have been more perceptive and more honest and more for thinking about these things. things.