>> interviews, pounds, and forms all free >> you will hear about the first meeting in nearly two years between the palestinian authority and israel. prime minister netanyahu and president abbas -- after that, george mitchell speaks with reporters after the meeting between the leaders. at 9:00 p.m., then bernanke testifies before the financial crisis and cory committee -- in greek committee. -- inquiry committee. >> you think about ponzi schemes -- the biggest ponzi scheme for

wall street is telling someone who has worked hard but cannot understand how that money will be invested. >> in 2007, meredith whitney word for citigroup. she is our guests sunday night. >> leaders of israel and the palestinian authority met today for the first time in nearly two years. prime minister benjamin netanyahu and palestinian authority leader abbas spoke. before the meeting, they were joined by secretary of state hillary clinton and george mitchell for a half-hour news conference. [applause]

>> good morning. i want to thank all of you for joining us today. we are here to launch negotiations to settle the israeli-palestinian conflict. i note that getting everyone at this table was not easy. we understand the suspicion and skepticism that so many feel, born out of years of conflict and frustrated and hope. a tragic act of terror on tuesday and the terrorist shooting yesterday or additional

reminders of the human cost of this conflict. but by being here today, you each have taken an important step towards freeing your people from the shackles of a history we cannot change. moving towards a future of peace and dignity that all you can create. so thank you. thank you for your courage and your commitment. i also want to recognize the support of egypt and jordan, which have long been crucial partners for peace. we appreciate the support of the arab league. i also wish to thank former

prime minister tony blair, the special representative of the quartet, for his leadership and ebert. mr. blair's work in support of the institutional and economic development of the palestinian people is critical to the success of these peace efforts. as we have said all along. -- as we have said all along, progress must go hand in hand with progress in negotiations. let me also, as represented by this overwhelming turnout of representatives from across the world, express our gratitude to many friends and allies who have worked so hard for progress towards our shared goals. to those who criticize this process, who stand on the sidelines and say "no," i asked

you to join us in this effort. as president obama said yesterday, we hear often from those voices in the region to insist that this is a top priority and, yet, do very little to support the work that would actually bring about a palestinian state. now is the opportunity to start contributing to progress. for our part, the united states has pledged its full support for these talks. we will be an active and sustained partner. we believe, prime minister and president, that you can succeed. we understand that this is in the national security interest of the united states that you do so. but we cannot and we will not impose a solution. only you can make the decisions

necessary to reach an agreement and secure a peaceful future for the israeli and palestinian people. now, for many of us in this room, this is not the first trip to the negotiating table. i look around and i see veterans from all three. we have been here before, and we know how difficult the road ahead will be. there undoubtedly will be obstacles and setbacks. those who opposed the cause of peace will try in every way possible to sabotage this process as we have already seen this week. but those of you here today, especially the veterans who are here today, you have returned because you have seen the cost of continued conflict. you know that your people

deserve the benefits of peace. the core issues at the center of these negotiations -- territory, security, jerusalem -- will get no easier if we wait, nor will the results themselves. success will take patience, persistence, and leadership. the true test of these negotiations will not see their first day and will not be their last day. it will be all of those long days in the middle when the past -- when the path towards peace seemed hidden and enemies helped to keep it obscured. we are convinced that if you move forward in good faith and do not wavered in your commitment to succeed on behalf of your people, we can resolve all of the core issues within one year.

you have taken the first step. you have both embraced the idea of a two-state solution, which is the only path towards a just, lasting peace that ensure security and dignity for both israelis and palestinians. i fervently believe that the two men sitting on either side of me, that you are the leaders who can make this long-cherished dream a reality. we will do everything possible to help you. this is a time for bold leadership and a time for statesmen who have the courage to make difficult decisions. mr. prime minister, mr. president, you have the opportunity to end this conflict and the decades of anger between your people once and for all.

i want to conclude by saying a few words directly to the people of the region. your leaders may be sitting at the negotiating table, but you are the ones who will ultimately decide the future. you hold the future of your families, your communities, and your people, this region in your hand. for the efforts here to succeed, we need your support and your patience. today, as ever, people have to rally to the cause of peace and peace needs champions on every street corner and around every kitchen table. i understand very well the disappointments of the past. i share them.

but i also know that we had it within our power today to move forward into a different kind of future and we cannot do this without you. so now let me turn to the prime minister to will make his remarks, paul led by the president. -- followed by the president. >> thank you, madam secretary. i want to thank you and president obama for the many efforts that you have invested to bring us to this moment. my friend, senator mitchell, thank you for your consistent efforts.

for bringing a lasting peace to our region. president abbas, as i said yesterday in our meeting at the white house with the president of the united states, the president of egypt, and the king of jordan, i see in you a partner for peace. together we can lead our people to a historic future that can put an end to claims and to conflict. this will not be easy. a true peace, a lasting peace would be achieved only with

mutual and painful concessions from both sides. from the israeli side, from the palestinian side, from my side, and from your side. but the people of israel and i as their prime minister are prepared to what this road and it to go a long way in a short time. we want to achieve a genuine peace that will bring our people security, prosperity, and good neighbors. good neighbors. we want to shape a different reality between us. this will involve serious

negotiations. there are many areas of contention. there are things we have disagreements on, but we have to get from this agreement to agreement. two years ago -- rather a year ago -- in a speech i gave at the university in israel, i tried to outline the two pillars of peace that i think will enable us to resolve all of the outstanding issues. these are legitimacy and security. just as you expect us to be ready to recognize a palestinian state as a nation-state of the palestinian people, we expect you to be prepared to recognize

israel as the nation-state of the jewish people. there are more than 1 million who have also rights in israel. there is no contradiction between a nation-state that guarantees civil rights and civil equality of the minority. i think this mutual recognition between us is indispensable to clarify to our two peoples that the conflict between us is over. i said to yesterday, a real peace must take into account the

genuine security needs of israel that have changed. they have changed sense -- last year we spoke about the veterans who were gathered here at this table. we have been here before. we-and the have run agreement -- we fashioned the hebron agreement. we have had the rise of iran and missile warfare. a peace agreement must take into account security arrangements against the real threats that have been directed against my country. 12,000 rockets had been fired on our territory and terrorist attacks go unabated. president abbas, i am fully

aware of your people's desire for sovereignty. i am convinced that it is possible to reconcile that desire with israel's need for security. we anticipate difficult days before we achieve the much desired peace. the last two days had been difficult. there were -- they were exceedingly difficult for my people and for me. blood has been shed. the blood of innocents has been shed. for innocent israelis were gunned down brutally -- four innocent israelis were gunned down brutally. two were wounded. there are seven new orphans.

president abbas, he condemned this killing. that is important. no less important than binding the killers. and equally, to make sure that we can't stop other killers. they seek to kill our people, kill our state, kill our peace. and, so achieving security is a must. security is the foundation of peace. without it, peace will unravel. with it, peace can be stable and indoor. -- peace can be stable and endure. president abbas has given us a rare opportunity to end the conflict between our people -- a

conflict that has been lasting more than a century. it is an unprecedented opportunity to end a century conflict. there have been some examples in history, but not many. we face such a task. to end the bloodshed and to secure a future of promise and hope for our children and grandchildren. in the first book of the bible, the book of genesis, there is a story of how two brothers in conflict -- brothers -- joined together to bury their father, abraham -- our father. the father of our two people.

i sit, the father of the hebrew aac, the father of the hebrew nation, and ishmail, the father of the muslim people. i can only pray -- and i know that millions around the world, millions of the israelis and millions of palestinians, and many other millions around the world prayed that the pain that we had experienced, you and us, in the last hundred years of conflict, will unite us, not only in a moment of peace around a table of peace here in washington, but will enable us

to leave from here and forge a durable, lasting peace for generations. shalom, salaam, peace. >> in the name of god, madam secretary hillary clinton, and prime minister netanyahu, ladies and gentlemen, let me once again extend my thanks to president barack obama and to

senator george mitchell and there came for the unrelenting effort they have exerted. the negotiations between the israeli government and the palestinians -- now that we are launching these negotiations, we know how hard it will be. these negotiations should, within a year, lead to an agreement of the legality

between our peoples. it is encouraging. what is giving us confidence is that the road is clear in front of us. the road is reckoned -- is represented by the national security council and the league of nations. ladies and gentlemen, because we have had many rounds of negotiations, we have studied all horizons and we also defined

all of the pending issues. the settlements, the borders, security, and detainees -- in order to create the state of palestine that rest side-by-side with israel. we want to bring peace and security to all the peoples of the region. once again, we want to state our commitment to security and ending the fighting. we call on the israeli government to go forward with this commitment to end all settlement activity and

completely lift the embargo of the gaza strip. also, with respect to security, we have -- we are doing everything expected from us. we did not only condemn the terrorist activity, but also followed the perpetrators and found the car that was used. we will continue all efforts to take security measures in order to find the perpetrators. we consider security important for both of us and we cannot

allow for anyone to do anything that would undermine your security and our security. we, therefore, not only condemn, but we keep on working fervently. ladies and gentlemen, once again, i want to state today what i said at the white house meeting yesterday in front of president mubarak. we believe their participation was very strong. these two states, along side with other arab states, do believe that peace is of vital

interest, not only for the palestinians and israelis, but also for all countries in the region and for the united states. president obama said the creation of a palestinian state is of vital national american interests. we are adamant about bringing peace, freedom, and independence to the palestinian people. a fair solution with the problem of the refugees, we have attached a resolution. we want to have a new era in our

region. an era that brings peace and justice to all. let me say, in 1993 on the night of september -- on september 9, we signed an agreement. it was a document of mutual recognition between palestinian -- between palestine and israel. this document was signed. in this document we showed that our intentions are good. our intentions are to recognize the state of israel. also, commitments were required

from us. we respect our commitments and our agreements. therefore, we start from here to reach a peace that will end the conflict. we will meet the demands and start a new era between the israelis and the palestinian people. thank you and make peace be among you. >> i want to thank both leaders for their statements. i also want to thank the members of their respective teams who are here in both delegations. the people sitting here have worked very hard, some for many years, and they have travelled a long way to be here. we are grateful for their commitment.

today, president obama and i, as senator mitchell, and our entire team are prepared to do what ever we can to help you succeed. we believe in you and we support you. again, let me thank you for being here. now it is time to get to work. thank you very much. [captioning performed by national captioning institute] [captions copyright national cable satellite corp. 2010]

[inaudible] >> after the meeting between the leaders, george mitchell said that palestinians in in -- palestinians in israel believe they can and that the talks in

one year. this is one half hour. >> good afternoon and welcome to the department of state in washington, d.c. today, we have successfully re- launched direct negotiations between the -- among the united states, israel, and the palestinian authority in pursuit of a final agreement, a final settlement and a just peace, two states living side by side. george mitchell will give a statement and answer a few of your questions, but we still have meetings going on with the parties and will have -- he'll have to return upstairs rather rapidly to rejoin the negotiations. but here's senator mitchell.

>> good afternoon, ladies and gentlemen. the parties have just concluded the first round of trilateral talks. the meeting lasted about an hour and a half. it began with a plenary session involving the full u.s., israeli, and palestinian delegations on the eighth floor of the state department and then broke to a smaller meeting in the secretary of state's personal office involving prime minister netanyahu, president abbas, secretary clinton, and myself. prime minister netanyahu and president abbas then went into a separate meeting for a direct discussion. that meeting is still going on right now.

in the trilateral meeting, there was a long and productive discussion on a range of issues. president abbas and prime minister netanyahu expressed their intent to approach these negotiations in good faith and with a seriousness of purpose. they also agreed that for these negotiations to succeed, they must be kept private and treated with the utmost sensitivity. so what i and they are able to disclose to you today and in the future will be limited, but i will now describe some of the key items that were addressed in the trilateral meeting. both prime minister netanyahu and president abbas condemned all forms of violence that

target innocent civilians and pledged to work together to maintain security. they reiterated their common goal of two states for two peoples and to a solution to the conflict that resolves all issues, ends all claims, and establishes a viable state of palestine alongside a secure state of israel. president abbas and prime minister netanyahu agreed that these negotiations can be completed within one year and that the aim of the negotiations is to resolve all core issues. the parties agreed that a logical next step would be to begin working on achieving a framework agreement for permanent status.

the purpose of a framework agreement will be to establish the fundamental compromises necessary to enable them to flesh out and complete a comprehensive treaty that will end the conflict and establish a lasting peace between israel and the palestinians. the parties agreed that in their actions and statements they will work to create an atmosphere of trust that will be conducive to reaching a final agreement. they agreed to meet again on september 14 and 15 in the region and roughly two weeks thereafter -- every two weeks thereafter. of course, continued interactions at other levels between the parties and also yet others involving the united states will take place between those meetings. in fact, a preparatory

trilateral meeting to plan for that second meeting in the region has already begun at another location in this building and will continue here and in the region between now and september 14th, as is necessary. as both president obama and secretary of state clinton have said, the united states pledges its full support to the parties in these talks. we will be an active and sustained partner throughout. we will put our full weight behind these negotiations and will stand by the parties as they make the difficult decisions necessary to secure a better future for their citizens. as we saw this week, there are those who will use violence to try to derail these talks.

there are going to be difficult days and many obstacles along the way. we recognize that this is not an easy task. but as the president told the leaders, we expect to continue until our job is complete and successful. and with that, i'll be pleased to take some of your questions. >> senator, i'm jeff napshin with cctv news out of asia. i would like to know what was their personal relationship. at times when you saw them next to each other, it seemed like they were kind of distant. did they seem to interact? did they seem to develop any kind of bond or relationship together? >> the relationship was cordial. as you know, these men have known each other for a long time. this is not the first meeting between them. they are not in any way

strangers politically or personally. and i felt that it was a very constructive and positive mood, both in terms of their personal interaction and in terms of the nature of the discussion that occurred. >> thank you. nadia bilbassy with mbc television. senator, president obama yesterday talked about some progress when asked, and i appreciate the fact that you do not want to divulge too many details, but today, prime minister netanyahu talk about the jewishness of the state, which is considered nonstarter issue for the palestinian. just generally, do you think that these issues can be -- can you bridge the gap considering there is obviously so many difficulties? but since re-launching the negotiation today, do you think this is -- could be an issue that could be an explosive for the whole issue -- for the peace process? >> first, i believe very strongly, deeply, and personally that this conflict can be resolved and that these negotiations can produce a

final agreement that enables the establishment of a palestinian state and peace and security for both peoples. secondly, it is, of course, self-evident that the reason for a negotiation is that there are differences. the differences are many, they are deep, they are serious, and it will take serious, good- faith negotiations, sincerity on both sides, a willingness to make difficult concessions on both sides if that agreement is to be reached. but i do not think that any human problem can be solved if one begins by viewing the problems as insurmountable, as

suggesting that the mountains are too high and the rivers are too wide, so let's not undertake the journey. there has to be a sincerity and a seriousness of purpose combined with a realistic appraisal and understanding of the difficulties, but a determination to overcome them. i believe that exists. i believe these two leaders, president abbas and prime minister netanyahu, are committed to doing what it takes to achieve the right result. >> major. >> hello, senator mitchell. major garrett, fox news. you remember well from your life on capitol hill the phrase, whenever a tough negotiation was going on, "nothing is agreed to until everything is agreed to." will that be the operative approach, you believe, for this

process? and as a result, will you be reluctant to talk about anything that's agreed upon until everything is agreed upon? that's one process question. the second one is you discussed the framework, is the deadline for the framework one year? or is the framework something we're likely to see much earlier and the one year still governs the entire solution to all remaining issues? >> in terms of process, that and other questions will be resolved by the parties. you cannot separate process from substance in these discussions. there is an interaction that affects both and we've made it clear that these issues are to be determined by the parties. we have had extensive discussions with them on that and many other issues, and those will continue. our goal is to resolve all of the frame -- all of the core issues within one year. and the parties themselves have

suggested and agreed that the logical way to proceed, to tackle them is to try to reach a framework agreement first. and as i said -- and i think this ought to meet clear because it is -- there has been a good a full meeting of minds publicly regarding a framework agreement. a framework agreement is not an interim agreement. it is more detailed than a declaration of principles, but it is less than a full-fledged treaty. its purpose is to establish the compromises necessary to enable the parties to then fleshed out and complete a comprehensive agreement that will end the

conflict and establish a lasting peace. >> thank you. you mentioned the number of issues talked about talks -- today, but can you mentioned that settlement was among them, and the plan to be in the region for the talks that will take place on the 14th and 15th? you said the u.s. will be a part of the talks. you plan to be there? can you tell us where they are going to be? >> as i said at the outset, wha i will be able to disclose to you and the parties will disclose will be limited, and so you have given me the first opportunity to invoke the principle with respect to the first part of your question, for which i thank you. [laughter] secondly but secretary clinton and i will be at the meeting in

the region on september 14 and 15, and one of the subjects now being discussed in the trilateral preparatory meeting that is ongoing in another room in this building, to which i must go in a few moments, is that subject. a determination has not yet been made. that will be mad i believe in the near future well in advance of the meeting. >> abc news. i would like to take another cracaddict. i understand and appreciate that you cannot get into specifics, but i'm curious whether you could say anything about the scope of today's talks, whether they involve any substantive discussions on any of the court issues or whether this is strictly to lay out a plan for the coming year. thank you. >> as i mentioned in my

response to major's questions, i cannot think one can neatly characterized process and substance as though they are two separate things in these matters. they do interact and relate to. you cannot discuss a process issue in any meaningful way without some relations to the substance that is being to be discussed -- that is ready toe discussed. that gives me a chance to say for the second time that i will not be able to get into the substance. but there were discussions that text on the subject of substance, although i do not want to suggest that the meeting was such that there was a detailed and extended discussion or debate on a specific substantive issue.

>> netanyahu talked-about recognizg a palestinian claim that the -- is that something that you have noticed? is that something thathe americans have been encouraging? >> we have encouraged the party ies tbe par rty' positive in our outlooks, other words, and their actions. any realistic appraisal of the situation,ncding the recent history, by which remain the

last two decades, makes clear that there are very serious differences between the parties. there are many difficulties that lie ahead. that is in terms of the substance of the issues, the impact on their domestic politics, the needs and interests of their societies. we have not, of course, attempted to prescribe what they can or should say about any issue. these are independent and extremely able leaders representing the interest of their societies. what we have sought to convey in a new role conversations that i have had -- in innumerable conversations that i have had with both leaders is president obama's conviction that, despite

all of the difficulties, near term, long term political substantive, personal and otherwise, the paramount goal of making the lives of their citizens more safe, more secure, more prosperous, more full can best be achieved by a meaningful and laing peace between the parties and in the region. the alternative to that poses difficulties and dangers far greater to the individuals, to the leaders, to their societies than those risks than they run in an effort to reach an agreement that brings about

their lasting peace. any realistic evaluation of the self-interest of the people of israel and the palace -- and the palestinn people must conclude that they are far better off living side-by-side as in two states in peace and security than in a continuation of the current situation >> prime minister netanyahu mentioned iran this morning. would that not make things more difficult to close the gap between the two parties? >> in every aspect of him a l, including your personal life and mine, the world is much different today than it was 10

years ago and vastly different than it was 20 years ago. that is certainly true of the middle east. it is an area of rapid change, of many conflicting currents that historians and analysts have described far better than i could in any change we have here. obviously, the actions and policies of the current government of iran have an effect in the region and in the wider world. they influence what is occurring here. in my judgment, they add another argument to those which i have already made and that many others have made as to why this conflict should be resolved.

it is in the interest of the people involved. in this respect, the worst comprehensive peace is direct. when president obama announced my appointment, he specifically identified comprehensive peace as the objective of u.s. policy in the region. israel and the palestinians, rael and syria, israel and lebanon, israel at peace with all of its neighbors in normal relation. obviously, one of the factors that makes that desirable, in my judgment, necessary for all of these parties is, in part, reactions and policies that have been taken. yes, it is a factor.

even if did not exist, there would be a compelling reason for peace between israelis and palestinians. but that is an additional factor. >> peace negotiations between the parties have taken place several times in the past. what is secretary clinton doing differently than her predecessors, including president clinton? >> although my comment on that is not constrained by the agreement which've earlier described, there are other constraining factors which come into play. [laughter] since i was not a part of the

immediately preceding administration -- although i did serve at the request of president clinton as chairman of an international commission in 2000-2001 following the eruption of the second fought, -- second fata, first, we cannot be deterred by the fact that negotiations did not succeed. it must continue with steny prior efforts of failure -- it must continue despite prior efforts. with respect to past efforts,

we think that the best approach is to carefully review them as we have done and to try to draw the best lessons out of each one, not be bound by any particular practice or process or procedure, and ways try to keep in mind the dynamic changes in the region that have occurred in what is, in historical terms, a very short time. our view is that this is an effort thatill try to learn from the lessons of the past, take the best and bring them forward,ut not be bound by any level or category or previous process. everything should be judged on the basis of what it will do to a dance -- to advance and

achieve the goal of peace in the region. one obvious difference is that president obama is the only president in recent times, to my knowledge, to have established this as a high priority. immediately upon taking office, to have acted immediately at that time -- there have been very well written books and it is clear in a couple of instances that time ran out. indeed, the authors of several of these books used exactly those words to describe it -- they ran out of time in the end. this president, i believe, will succeed. as he said yesrday, neither success failure is

predetermined or guaranteed. but it will not be because time ran out at the end. that is a vast difference. i have a highpinion of the men and women who served in these tasks in the past. i know most of them personally. i do not think you can attribute inability to achieve a result to their individual or collective feelings. they are the product of the difficulty and what many regard the impact ability of the problems and issues -- the impractability of the problems and issues. the most obvious difficulties that lie ahe for both sides

comes if they do not reach agreements. you have to remember that these leaders must weigh two things. the difficulties they face in getting the agreement and the difficulties they will face if they do not get an agreement. we believe it is a very powerful argument, a few subject these careful and reasoned analysis, the difficultiesill be much greater and have a much more profound impact on tir societie. thank you all very much. it has been a pleasure to see you. i look forward to reporting to you on a regular basis.

>> search the term "mideast peace" at the c-span and video library. interviews, panels, and forms all the way up to the middle east peace talks. >> in a few moments, federal reserve chairman ben bernanke testifies at the financial crisis commission. we will bring you coverage before and after the first meeting in nearly two years between israel and the palestinian authority. you'll hear from secretary of state clinton, palestinian authority president abbas, prime minister benjamin netanyahu, and george mitchell. on "washington journal" the

president of the national league of cities. he is the mayor of riverside california. lara brown will talk about her book. our series on politics concludes. our guest is alan abramowitz. "washington journal" is on every day. >> the making of the constitution. sunday, gordon wood on booktv. this is that 12:00 p.m. on c- span to. >> bin bernanke said today that regulators need to solve the

problem of financial firms that are considered "too big to fail." this commission is a bipartisan panel created by congress. they are due to report their findings of this december. this is a little more than 2.5 hours. >> good morning. welcome to the public hearing. this is our second day examining the issue of financial institutions that become too big, too important, to systemic to fail. yesterday we looked at two case studies -- wachovia corp. and

lehman brothers. this morning, we will be hearing from the chairman of the federal reserve, mr. bin bernanke, as well as the chair of the fdic, sheila of blair. i might note that this is the second time you have come before this commission. first, in our offices in a private session we first convened almost a year ago. today, in what will be our final hearing in washington, d.c., although after today we will head across the country to a number of communities in california, in nevada, and in florida to hold hearings in communities that are still gripped by high unemployment and high foreclosure rates. we will go to those communities to see how the seeds of the crisis were sewed on the ground. mr. chairman, as we have done

with all witnesses, we will ask you to stand so i can swear you as a witness. if he would stand and raise your right hand. do you solemnly swear and affirm under the penalty of perjury that the testimony will be the truth, the whole truth, and nothing but the truth to the best of your knowledge. >> i do. >> taking very much, mr. chairman. thank you very much for your extensive written ceremony -- written testimony. we would ask you to speak to us orally and take up to 10 minutes this morning to give your opening remarks. upon conclusion of your opening remarks, we would do questions from the commissioners. before issuers. >> i will not take a full 10 minutes. we will be submitting additional answers to your questions very shortly. chairman angelides, vice chairman thomas, and other members of the commission, your

-- this is indeed important. we have to guard against a repetition of this crisis. so call" too big to fail" institutions were a primary impediment to policymakers. in my view, this issue can only understood in the broader context of the crisis itself. in my testimony, i provided problems that complicated the management of the crisis. in understanding the causes of the crisis, the potential to distinguish between traders of a potential event and vulnerabilities that propagated and greatly amplified the initial shock. although a number of developments triggered the crisis, the prospect of

significant losses of subprime mortgage loans became apparent after housing prices began to decline. while potential subprime losses were large in absolute terms, judged in relation to global financial markets, they were not large enough to accounts for the magnitude of the crisis on their own. instead, the system's preexisting vulnerabilities, together with gaps in the government's crisis response tool kit are the primary explanation of why the crisis has had devastating effects on the global financial system and the broader economy. let me give you an you will striation of how as a result earlies in the financial system greatly increase the effects of the triggers of the crisis. in the years before the crisis, a system of so-called shadow banks, financial entities other than regulated depository institutions had come to play a major role in global finance. as it grew, the shadow banking system, including certain types of special purpose vehicles, such as those financed by asset backed commercial paper and some

investment banks, have become dependent on short-term wholesale funding. such reliance on short-term uninsured funds made shadow banks subject to runs, much like commercial banks had been prior to the creation of deposit insurance. when problems in the subprime mortgage market an other credit markets became known, the providers of short-term funding ran from the shadow banks, disrupting short-term money markets. thus, the vulnerability in this case, the excessive dependence of many financial institutions on unstable short-term fund, greatly amplified the effects of the trigger in this case, the prospective losses of the subprime mortgages. among of the consequences of the instability was sharp declines and high volatility in asset prices, widespread hoarding of liquidity by financial institutions and associated reductions in the availability of credit to support economic activity. many of the key vulnerabilities of the financial system were the product of private sector arrangements, including, as just

noted, overdependence of many financial institutions on unstable short-term fund, poor risk management, excessive leverage of some households and firms, misuse of certain types of derivative instruments, mismanagement of the mortgage securitization process an other problems. but important vulnerabilities also existed in the public sector, both in the united states and in other countries. these vulnerabilities including both gaps in the the statutory framework and flaws in the performance of regulators and supervisors. important examples of statutory gaps were the absence of effective authority to regular lay and supervise some important types of shadow banks, such as special purpose vehicles and broker dealer holding companies. the lack of authority or responsibility to take actions to limit systemic risks and the absence of a legal framework under which failing systematically critical, non-bank financial firms could be resolved in an orderly way. where appropriate authorities existed, financial regulators an supervisors, both in the united

states and abroad, not always used them effectively. for example, bank supervisors in many cases did not do enough to force financial institutions to strengthen their internal risk management systems and to curtail risky practices, and bank capital and liquidity standards were insufficiently stringent. the resents financial reform legislation addresses many of the statutory gaps i have mentioned, and the federal reserve and other agencies are taking strong steps to tighten the regulation of financial institutions, to give regulation and supervision a more systemic and multidiscipline orientation and to make supervision more effective. many of the vulnerabilities underlying the crisis were linked to the existence of so-called too big to fail firms. those whose size, interconnectivity and functions were such that their unspeck failure was likely to severely damage the financial system and the economy. because of the grave risks presented, too big to fail firm filed for bankruptcy protection, in the short run, governments have strong incentives to prevent such events from

occurring. hence, too big to fail. however, in the longer term, the existence of too big to fail firms creates severe moral hazard problems, which can lead to the buildup of risk and future financial instability, while complicating the resolution of financial crises. the existence of such firms also creates an uneven playing field between the largest firms and their smaller competitors. it is critical that the too big to fail problem be solved. an important components of the solution contained in the resents financial reform bill is the development of a resolution framework that allows the government to resolve a failing systematically important, non-bank financial firm in an orderly way, while imposing appropriate losses on creditors, protecting taxpayers, and limiting risks to the broader financial system. tougher regulation and supervision of systematically important firms and steps to increase the resilience of the financial system are also important if we are to bring a decisive end to too big to fail. the findings of this commission

will help us better understand the causes of the crisis, which in turn, should increase our ability to avoid future crises and to mitigate the effects of crises that should occur. we should not imagine though that it is possible to prevent all crises. a growing, dynamic economy requires a financial system that effectively allocates credit to households and business. the provision of credit inevitably involves risk taking. to achieve both sustained growth and stability, we must provide a framework which promotes the appropriate mix of prudence, risk taking, and innovation in hour financial system. thank you, mr. chairman. >> thank you very much, mr. chairman. we will now begin with questions. i will start the questioning and we'll go to vice chairman thomas and then to the balance of the members. so i'd like to talk to you for a few minutes about the runup to the crisis, because i believe, you know, a lot of the focus is always on did the government do

the right thing in the grips of the crisis, the real question for me has always been, how do we get in the position where we face such draconian choices an one of the things that struck me as we reviewed our case studies is the failure of regulator supervisors to identify and contain systemic risk in too big to fail institutions before the crisis hit. yesterday, we looked at wachovia, where assets grew from $250 billion to $7,802,000,000,000 by -- $782 billion and an aggressive growth rate of 17%, tangible asset to tangible equity ratio of 23-1. the acquisition of a big book of pay option arms from golden west, which in and of itself was three times tier one capital. but no progression by the fed or the occ of the systemic risk, in fact, no downgrading of the institution until july of 2008. similar fact pattern at lehman,

even though we realized the fedoras not the prudential supervisor, but again i'm talking in a larger sense, very aggressive growth, leverage of 39-1, let me just ask you, why such a bigamist and i want to put this in context, that some of your folks who have spoken to us here, like mr. alvarez and mr. cole, whom we interviewed, talked about how the fact is, well, gee, we had, and i think it was maybe mr. cole who used the word myopic, safety and soundness, but shouldn't have systemic risks been part of a safety and soundness regime even in the 2000 period? was this a substantial miss, how fundamental was the failure of proper supervision to the metastasizing of this problem? >> mr. chairman, first of all, it should be recognized that large complex international financial institutions do have an appropriate role. and the fact that you were

seeing growth and complexification of these institutions in a world of financial innovation, international capital flows, financial supermarkets and a whole variety of other innovations in itself should not be surprising. that was happening not only in the united states but happening globally, so there clearly was a reason for the growth and for the more complex institutions. now, that, said, it's certainly true that the system did not sufficiently anticipate the systemic risk associated with these institutions. that was frankly part my due to the regulatory structure that was given to us by congress, as you had mentioned, or charge was to focus on the safety and soundness of individual institutions. there was no provision, no authority to address systemic risk in an institution. in fact, when the fannie and freddie law was redone and there was additional regulation put on fannie and freddie, the congress

explicitly said you are not allowed to consider systemic risks when you're looking at the safety and soundness of this institution and furthermore, there was no -- no, that was part of the fannie and freddie's -- of the law that created the fhfa, the new institution. but -- and furthermore, there was no -- there was no collective assignment as there is under the more recent reform legislation, to look for systemic risks. many of the risks that occur obviously are interactions of the size and complexity of individual firms, but features of the entire system. they are emergent properties if you will of the overall system. having said all that, i must also agree, that supervisors in the united states and around the world underestimated the risks associated for example, with insufficientlinsufficient liqui.

a bank run essentially. we underestimated the stents to which risk remained concentrated within important financial firms, and so i'm not claiming that we found all those problems, but there was a combination of the structure of the system, the underlying trends toward greater and more complex firms, together with some mistakes and shortcomings on the part of regulators. [inaudible] >> thank you so much. it's early. it's been a long -- it's been a long journey for in commission and this is not a matter of political ideology, but there does seem to be within the financial markets, there was it appears to be a greater and greater reliance also on self-regulation. mr. alvarez in an interview he did with our staff, i believe in march, talked about the deregulatory environment in which policy decisions were made and again, without regard to party. i'm gogans say that -- going to say that very squarely here.

mr. cole talks about recognizing some of the problems in the institutions and the ride up the rollercoaster but the push back from financial institutions, so how much of this was also a function of a shift away from an aggressive regulatory regime to frankly, just a common view that we should be more reliant on self-regulation, internal risk management by the institutions and replacements of regulation? >> well, i think there's some truth to that. it was -- there was some change in i think in overall velocity, as firms became more complicated, there was a greater and greater understanding that regulators could not replicate all the risk assessments that the firms themselves could do, and we had to rely more on their own assessments or instead, instead of looking at the risks themselves, making sure they had good systems in place and they were taking appropriate steps to address those risks, so that's certainly a problem and it was exacerbated i think by the fact that there's always i am police italian international competition before the crisis,

one of our main concerns was london and tokyo, where they, you know -- were they taking away the financial industry from the u.s. and was excessive regulation doing that, so those are some of the concerns. that being said, i think that innovation in of the financial system, partly to avoid regulation, but also in part, to respond to the legitimate changes in the economy, i refer to the shadow banking system a moment ago. the development of new types of financial institutions off-balance sheet vehicles, non-bank mortgage lenders, much bigger investment banking activities and so on, our bank regulatory system was designed for a bank centric financial system and that's where it came from and as always these non-bank activities grew, we were not -- we, the country, were not sufficiently proactive in establishing a regulatory framework to encompass all of those aspects. >> all right. thank you. but it does seem to be particularly for entrepreneurering into an era of

larger and larger banks that if we're going to have banks that are too big to fail, it would mrs. seem to me that we need regulators that are too tough to fold. this is going to be a particularly challenging environment, with a set of even larger banks, fewer of them. would you agree with that, that the challenge going forward is even more dramatic? >> i think it's very, very important. as i said before, the most important lesson of this crisis is we have to end too big to fail and i believe that we, in a much different way than we did before the crisis, we now have the tools to address that. in particular, tougher regulation and oversight will reduce the risks. the existence of a resolution regime will increase market discipline, because creditors will know that they can lose money and strengthening the resilience of the financial system itself will reduce its incentive of the government to i want convenient in these situations. my projection is even without direct intervention by the government, over time, we'll see some breakups and some reduction if size an complexity of some of

these terms as they respond to the in 10 cyst created by -- incentives created by market pressures and regulatory pressures as well. >> so, our staff prepared for us what i thought was an excellent -- all the information you already know, by virtue of being chairman of the fed and your background, but it was striking that our staff did for us, and it's posted on our web site, essentially a history of too big to fail, also, governmental rescues from franklin national to continental illinois through the multiple rescues in 2008 and as i look at it, you almost can take the view that wall street seems to believe that a financial sucker is born every crisis, and so i think one of the biggest questions that americans have is how do we break the cycle? what is the singlemost important thing that should have been done and can be done in the future to break the cycle? the singlemost important policy action that we can take. >> there has to be a credible way to let firms fail, in fact, require that they nail.

i think it's striking that the new rules do not permit discretion. they do not allow so-called open bank assistance, which allows the government to assist a firm to continue to exist, rather, what it does is provide a system for trying to take a firm into receivership in a way that does minimal damage to the system. it's not going to be easy. let me just be clear. this is not going to be easy to implement, because these are large, complex firms, with multinational presence. >> and significant power. >> and significant power. but is -- a very important step to take away the discretion. if i might have just cite the examples of the law passed in the early 1990's, which created a set of well specified triggers under which the fdic has to come in and close a bank, except under extreme circumstances, systemic risk exception. there is no systemic risk exception for the resolution regime in the dodd-frank bill. that has worked very well, and the analogy to using that,

applying that to large firms, i think it's very important, so i can -- i could hardly agree with you more, mr. chairman, that this was a catastrophe, and it's bad in the long rupp, as well as in the crisis, and we must address it. >> all right. let me talk for a moment about failed institutions. as you know, we had mr. fuld here from lehman yesterday, mr. baxter from the federal reserve bank of new york. you stated on many occasions that the failure of lehman had consequences. in the role as commissioner doing our level best to understand the history of this crisis, we're trying to -- at least i am, trying to unfurl the set of decisions, the why's, the wherefores. when you first testified to congress after the failure of leave man, you had essentially said in your testimony and i'm shortening this up that lehman was not rescued, essentially because the market, the

participants had had time to prepare in the wake of market developments. and i say this as i said yesterday, it seems to me that the decision to allow lehman to nail was pa conscious policy decision, and -- to fail was a conscious policy decision and not implying people said let them just go down, but like any other policymakers, you were weighing a whole set of factors. now, since early on, it seems as though the fed and other officials have indicated that it was solely due to a lack of legal authority, the inability to make the loan under 133, the lack of sufficient collateral, but when i at least look at the chronology, it seems to me you were trying to deal with a whole set of complex factors. we released yesterday a chronology of different events along the way and it seems to me that, you know, there was serious consideration of financial assistance, the fed stepping into the shoes of the clearing banks, if that was necessary, you know, mr. did you doily, for example, i think in july proposed a maden lane type

of solution. mr. geithner told the fsa as late as a few days before the failure that government system was possible and as late as the last few days, there's a federal reserve board in new york, of new york, document i think mr. parkinson circulates, we should find a maximum number of how much we are willing to finance before the meeting starts, but not divulge our willingness to do so to the consortium. in terms of any liquidity, support should be long enough to guard against a fire sale, but a short enough fuse to encourage a buyer of lehman assets to come forward, two months to two years in duration. question mark. lehman seems to be bigger than bear. there certainly seem to be political considerations and i don't necessarily mean at the fed, but among treasury, white house, which is legitimate.

people are trying to weigh the mood of the country, how policy makers are going to view this. there's an awareness of impacts, larger triparty book than bear. a bigger and more complex institution to unwind. i don't see any documents or discussion along the wave about legal bars or government analysis of a shortage of collateral and i see mr. alvarez's position in march of 2009, saying the fed has wide latitude in terms of how it defines collateral. my real question for you, what was the mix of policy considerations? i understand because i've been in transactions on the private side and the public side, that there will shall legal barriers, obstacles that have to be respected, but it doesn't look as though that cut this discussion off. what were the biggest considerations, would you have saved lehman, if you had the legal authority, but in rolling up to that decision, trying to determine were they too big to fail, not too big to fail, you've already said that you thought it had significant

disasterrous consequences, what were the things you were trying to weigh, the decision-making factors. >> i can only speak for myself. i don't know everybody's review on that. first of all, there was, of course, we were trying to arrange a private takeover, over the weekend, and we wanted that to be done on the best possible terms that we could and for that reason, there was some benefit i think in the week prior to lehman to keep our hands, you know, a little bit up to the vest in terms of what we were willing and able to do, so there was some of that going on in the week prior to the lehman weekend. that being said, let me just state this as unequivocally as i can, before i came to the fed chairmanship and i studied the financial crisis, and this is my bread and butter, and i believe deeply, that if lehman was allowed to fail or did fail, that the consequences to the u.s. financial system and the u.s. economy would be catastrophic, and i never at any

time waivered in my view that we should do absolutely everything possible to prevent the failure of lehman. now, on sunday night of that weekend, what was told to me was that, and i have every reason to believe, was that there was a run preceding on lehman, that is, people were essentially demanding liquidity from lehman, lehman did not have enough collateral to allow the fed to lend it enough to meet that run, therefore, if we lent the money to lehman, all that would happen would be the run would succeed, the firm would fame, and not only would we be unsuccessful, but we would have saddled the taxpayer with tens of billions of dollars of losses. so it was both a legal consideration, but also a practical consideration. legally speaking, we are not allowed to lend without a reasonable expectation of

repayment. the loan has to be secured to the satisfaction of the reserve bank. remember, this is before t.a.r.p. we had no ability to inject capital or make guarantees. the unanimous opinion that i was told and i heard from both the lawyers and from the leadership of the federal reserve bank of morning, lehman did not have sufficient collateral to borrow enough to save itself, and therefore, any attempt to lend to lehman within the law would be futile and only result in a loss of cash. in some cases, you can take the going concern value of the firm into consideration, but in this case, lehman was under a run, its going concern value was melting away, because its customers, counterparties, employees and so on were not going to be sticking with this firm, so i believed as of sunday night, it wasn't just a question of legality, it was a question of whether we could conceivably do that would prevent the failure of the firm and therefore, it was with great reluctance and sadness that i

conceded that there was no other option, there was never any -- there was never any discussion which says, here's how we can save lehman, should we do it or not. we never had a discussion like that. the discussion was, there is no way, and that was my belief and that's how i proceeded, because as i said, if i could have done anything to save it, i would have saved it. now you asked appropriately about the -- >> can i ask one question on that. you said you represented your own views. there were differential views expressed, i've seen in the e-mails, concern about the politics, bear has been bailed out, the gsc's, there seems to be some political reluctance, mr. wilkinson is writing e-mails, can't stomach a bailout. >> well, it's certainly understandable that people would have those concerns, but i must say in my own case and as far as i know, in the cases of the other principals, the primary consideration was the knowledge that the failure of lehman would have catastrophic consequences. met me just say one word about the testimony you referred to, which has gotten -- has

supported this myth that we did have a way of saving lehman. this is my own fault in a sense, but the reason we didn't make the statement in that testimony, which was only a few days after the failure of lehman, that we were unable to save it, was because it was a judgment at that moment, with the system in tremendous stress and with other financial institutions, under threat of run, or panic, that making that statement might have even reduced confidence further and led to further pressure. that being said, i regret not being more straightforward there, because clearly, it has supported the mistaken impression that in fact, we could have done something. we could not have done anything. >> one last question on the subject. that is a loan was made under the pdcf to the broker dealer i believe in the amount -- i guess authorized $50 billion, but i think daily amounts were 29, $30 billion and of i don't the

numbers with me exactly. you were able to do that because -- >> because they had sufficient collateral to support the loan. >> that was not available on the night before at the holding company level? >> correct. >> because the holding company had a capital hold in your judgment? >> i believe it had a capital hold, but in any case, the calculations were that the liquidity demands on the holding company were much greater than the collateral they had available to meet the demands and moreover, by the way, we didn't do anything to prevent the broke are dealer from lending to his own holding company and it didn't seem to decide that was a smart thing to do either. >> of course at that point they had filed bankruptcy and i'm not going to take your time with yesterday's dialogue with mr. baxter about what i preferred to as the smoking letter about whether in fact, the holding company had the ability sunny. we'll tip to look at that matter. matter. and what transpired. >> i can only tell you what i knew at the time and what i knew at the time and what i was informed and what i believed was that there was no capacity for

them to borrow sufficiently, have enough collateral to borrow sufficiently to meet their obligations. >> was that based on an analysis or the private consortium's analysis. >> why that was based on analysis at the federal reserve bank of new york, going on through the week and before that we had done a lot of analysis based on our presence atley man -- at lehman during the summer. >> one final question, i'm exhausting my time, very quickly, i want to ask you, as we look at the genesis of this crisis, it's hard not to look at the actions of the fed prefer and i know mr. thompson is going to want to talk about this all. when you look at the opportunity to regulate subprime lending, rules were adopted in 2001 that ended up covering only 1% of the loans, when you look at the referral of unfair and deceptive lending practices to justice, only two institutions, i think the desert community bank in victorville california and the first american bank in illinois,

only two referrals in six years, a decision not to examine non-bank subsidiaries, was this a very significant failure in your looking back in retrofit fro expect. >> i think it was indeed, a most severe failure of the fed in this particular episode. >> i think mr. thompson will want to ask some more about that. i'm defer the rest of my questions if i have any, to mr. thomas. thank you very much, mr. chairman. >> thank you, mr. chairman. and thank you, mr. chairman. nice to see you again. let me say first of all, for those of us who have been around for a while, some folks might move us in the category of mr. senator, having been around forever. and you look at the political situation, just in terms of coordination and ability to move quickly. which is always difficult in a political body. in the fall -- well, decembe

december 2007, fall of 2008, spring of 2009 and of course now today, historically, when you look back, that actually was a presidential election period. there was a change in government and for those of us who have been actually involved in these kinds of processes, i want to thank you, and i want to thank the others who were involved, because it took, in my opinion, a degree of aggressiveness that had you not been bold enough to carry out, circumstances might have been significantly different, so thank you. after the fact, you get people who may have been pretty upset. some behind closed doors, some in open doors, now beginning to take a look at really where we were.

and situations that would have occurred. obviously, you talk about gaps, the reason we talked about gaps is because we now know there were gaps. before we knew they were gaps, it's always hard to find the gap. one of my worries now becoming more acquainted with the complexity, the failure of transparency, what people thought was adequate capital, carrying out various kinds of behaviors and the complexity that is now present, not just nationally, but internationally, one of the concerns i have is while -- well, your final statement about obvious needs in terms of the structure that we have on a flexibility of movement, that when you try to look at dealing with too big to fail and so we aren't going to let that happen again and you set up a structure, is there any concern about some of these

structures might be too complex to unravel in a time period that is meaningful, given the circumstances? because at some point, what high heard from virtually everyone, we just heard the testimony yesterday some of the derivatives products, they're still trying to unwind them in the lehman bankruptcy. what concerns can you share with us in terms of -- i mean, i often think, you know, you've got the cartoon of the child who is going to go out in the snow, so the mother puts on one layer, two layers, three layers and it finally then is allowed to go outside and play, and it can barely move getting outside. you can set up a structure to make sure that it doesn't happen, but how do you keep the flexibility to allow this system

to function? where are we in terms of your concerns, dodd-frank legislation, providing some additional tools, comfort level and now understanding better and more importantly, if we are now not going to have these crisis interventions when we do fail, unwinding structures in a reasonable way. >> that's an absolutely central question. of course, as you know, chairman bair has written testimony which addresses this issue in some detail. >> as we say, she's next. >> she's next on the program, i understand. it's a very difficult problem. certainly, the kind of firms we're talking about are much more complicated than the small and medium sized banks, which are the typical companies that are unwound through the fdicia process, so this is not at all an easy process, however, i think we'll be much better off,

if you think about -- one thing i feel people don't always appreciate is we try to do these very complex operations, you know, within hours, within a weekend, and certainly we'll be much better off if we have extended amount of time to understand and study and prepare and make plans, and that is an important part of what the fdic's new division on complex firms is about. they will be aided, as will we, at the federal reserve, by living wills, that is, by a required document that firms will provide, which will explain how they would be wound down and if those living wills are not satisfactory, we have the authority to require them to simplify their legal and organizational structure as necessary to make it feasible, so it's going to be very difficult, but certainly, we'll be much better placed than we were prior to this crisis. i think the one area where it's going to take a lot of effort is the international element.

because these firms, one of the banks that we supervise has offices in 109 countries, each one with its own bankruptcy code and its own rules and so on beings an we're going to need to develop sort of the moral equivalent of tax treaties with other jurisdictions, whereby we have rough agreements on how we would cooperate and work together, so unwind a firm, and that will be very challenging, but it's something that's currently being heavily investigated by international bodies like the financial stability board and i any it should be a top priority. >> and where are we in terms of those discussions, because that was definitely one of the concerns that i had. we could resolve our problems and if we can't get an international agreement, given the complexity and the multinational nature of today's financial structure, and of course, the farther you get away from the cliff, the less you want to kind of make the sacrifices that allow for that international stability.

what's your comfort level and where we're going on that. >> the fdic is well advanced in developing rules to explain how they will invoke these powers an we are working with the fdic to develop more knowledge to go about unwinding u.s. firms. as you agreed, the international aspect is very difficult, but there is a very concerted effort, as i mentioned, the financial stability board and the bank's international settlement and other international bodies are looking at this very seriously. i think what we will have to do is work primarily with the principal countries although this bank is in 109 countries, there are four or five countries, which are the most important that we have to work with, which has the largest banks and bank presence, so it's going to require some, again, some agreements, some mou's, some work together, some ideas about how to divide assets, how

to reconcile different bankruptcy codes and the like, so it's a lot of work to be done. and i -- you know, i think we have a way to go still, but obviously, we're very focused on doing that and we have a lot of cooperation and goodwill from our international partners. >> and mr. chairman, you indicated, i think the phrase was, the regulations given to us by congress, you know, and we always looked for the ability to structure legislation with the flexibility under regulation, did not put any to a statutory straitjacket, but i had some concerns yesterday in testimony. when you look at that period in late september-early october, in attempting to deal with wachovia, and in the minutes of the fdic discussions, they take

the very extraordinary step of accepting the concept of hopefully no dollar exposure, but responsibility for backup, on the city wachovia structure. that's put to bed. and then literally, the very next day, i.r.s. issues 20883, fundamentally changing a two-decade old tax code provision and you may recall some of us from the article i part of government being fairly sensitive, because there's a difference between needed and desirable. and it concerns me very much that whoever was meeting came up with an idea that could solve the problem. but didn't fully appreciate the

consequences of inventing solutions when you're charged with not carrying out activities and the argument, we weren't given the power by congress, but where you came up with an idea that could be inventive, you go ahead and do it. the real difficulty for me in the long run, in these kinds of situations, is whether the executive branch is a demand center, or whether it's a command center, and clearly, there are times when it has to be a command center, both domestically and internationally, but more often, the argument that we had to be a command center is used to do what you want to do, rather than not. did you have any behind the scenes knowledge of i.r.s. and treasury deciding to create what we call in the business, a rifle shot? in terms of picking up losses of a company that they could

arequire, which this kind of fundamentally violated a portion of the tax code as i said that had been honored for a couple of decades, which actually changed the result of what happened to wachovia in finding a home, in my opinion. and others may argue. any reaction to what i just said? >> i have all i can say is, i just don't know the facts monday that, but i can say that i have no knowledge, i have no inside knowledge or any other kind of knowledge of this fact before it occurred. from my perspective, putting aside the very important procedural and legal issues that you raised, it was inconsequencial, because one way or another, wachovia was going to get protected and that was the thing i was concerned about. i did not advocate or get involved in the the tax decision. >> well, our concern is that in a crisis, which we went through, necessity can be the mother of invention, but you better come up with a solution, coming out

the other end, that doesn't provide you or embolden you with the opportunity to do what happened again. i know, some of my colleagues got pretty frightened when they were presented with the option that you must pass what's on this piece of paper, before tomorrow morning or the world, as you know it, is going to end. you bet away with that once, and i'm hopeful that as we continue to move forward, you spend a lot of time consulting with those who actually believe they have some role to play, not after the fact. but during it. is there a comfort level now in terms of your ability to communicate with the legislative branch, that perhaps you couldn't do in that crunch time frame? >> yes, certainly with the benefit of time, clearly, these activities were not things that i wanted to do. the fed presever took an enormous amount of heat for them and came under a lot of pressure

politically and legislative because of those actions, so i would much rather would not have had to do them and i'm very happy to see that we're moving towards a system where there is a well designed framework for addressing these problems and i hope that we can mask it workable so that -- make it workable so that we can avoid any such freelancing in the future. >> let me say, mr. chairman, you have taken a lot of heat, but in the final legislative battle in terms of legislative product, i think you did pretty well defending your position in the way the final legislation was written. one last question in terms of comparisons, which are always questions that we wind up trying to examine, because we don't know what happened behind closed doors. now of how was lehman different from aig? if there was a run on aig, capital was locked up in insurance subacid can i ry, what was the difference? >> there was a fundamental

difference. again, the issue was, could we make a loan that was adequately secured, that was reasonably likely to be paid back. the -- unlike lehman, which was a financial concern and whose entire going concern value was in its operations, aig was the largest insurance company in america, and the financial products division, which got in to the trouble was just one outpost of this very large and valuable insurance company. and therefore, -- and in fact, that's why they created this, because they wanted to ride on the coat that's of the aaa rating of aig, so unlike lehman, which didn't have any going concern value or not very much, aig had a very substantial business, huge business, more than a trillion dollars in hey sets, and a large insurance business that could be used as collateral to borrow the cash needed to meet financial products liquidity demand. so that's a very big difference and indeed, the federal reserve

will absolutely be paid back by aig. >> thank you, mr. chairman. i just want to thank you once again for, in political terms, your bravery and willingness to move in the way that you did. thank you very much. >> thank you for joining us today, mr. bernanke. after reading and re-reading your prepared testimony, with all respect, i find a less than thorough discussion of one area that i think is exceedingly important, which is the erosion of market discipline associated with the creation of the engineered financial instruments that became toxic assets on the balance sheets of our financial institutions. these assets became a significant cause of the liquidity crisis, based by these institutions, when they couldn't meet their obligations, either because they couldn't so many the assets without a steep discount, an ever increasing discount and couldn't borrow against the assets as collateral, except with a large and increasing haircut and of

course, when they faced the last, they turned to the american taxpayer and the federal reserve and others to essentially rescue them from their excesses. you've spoken to the deterioration and mortgage originallation standards, they were problematic to be sure, caused in many institutions by differential awards to financial regulators, who were paid more to steer borrowers that produced greater returns to the mortgage holders and greater costs to the borrower, which resulted in a higher likelihood of default by the bore would youer. without regard to its success or failure to perform as represented to the investor owners. the underwriting investment banks legally responsible for the exercise of due diligence on the products, the lawyers who drafted the prospectuses, the

accountants who created the accompanying financial statements, the credit rating agencies that rated these securities, all received their fees in cash when the securities were sold and only if they were sold. so is it any surprise that every participant in the chain opined that everything was in order, when we know that it was not? some 92 to 94% of the mortgage-backed securities and thyratron muchs that were created that were rated aaa have been downgraded and many of them exceedingly severely and we're not speaking here simply of mortgage-backed securities, but collateralized debt obligation, in which miraculously they take the trip b tronchs of mortgage backed securities and miraculously put them altogether and make a security that's not rated just aaa, but a product

that can fail and fail they did. then we go to synthetic cdo's, which are creations which are essentially bets on the success or failure of the underlying other securities. when they didn't have other things to sell. so the financial reform legislation attempts to address some of these problems by prohibiting differential compensation to mortgage originators, for steering borrowers to riskier products and requiring issuers to hold 5% of the product they created. since it seems to me that nothing focuses the mind of wall street bankers more than having their own money at rings an their own skin in the game, it is hoped that greater discipline and diligence will be exercised when the the creator knows that their own financial future depends on the performance of their creation, so i apologize for such a long introduction, dr. bernanke, but i wonder, would ask you to comment on the initiatives put in place by the federal reserve in exercising its responsibility to be the

safeguard of the safety and soundness of america's financial institutions to address some of these issues. >> sure. i did refer in my testimony to the problems with the originate to distribute model, which goes all the way from the initial mortgage loan to securitization and there were clearly a lot of problems there. we are trying to address them, although as i said earlier, we were late in developing mortgage underwriting standards under hoepa. we did in 2007-2008 did establish some very strong standards and i'm sure they'll be maintained by the new consumer protection agency. we also have put out -- we also have banned, the fed presever has banned yield spread premiums, which allow lenders to be compensated on the basis of the type of mortgage that they provide, and so we've tried to address the front end of origination to distribute. on skin in the game, i think we all agree that we want to create good incentives, and that is one

way to do it, and the fed is also involved in making sure that incentive compensation contracts for both executives and other employees of financial firms reflect appropriately the long run returns of their activities and not the short run returns as you were describing. the only thing -- >> if i could just probe you on that. how would you propose to rejigger those compensation incentives to reflect the long-term performance? >> well, we're asking the -- since the nature of the business differs across institutions, we're asking for proposals, we're asking for companies to show us what they're going to do and we work with them and make sure we're satisfied. the basic principle is that return should depend, first of all, they jobberies being adjusted, so if you take a riskier action, that should be taken into account and secondly, a longer horizon, not just whether you made the sale or made the deal, but rather, how did it work out over a number of

years an things like non-vested stock and things of that sort are ways to achieve that, so that's another step. >> and some have suggested a basket, an index based on a basket of the securities created, so that you can actually track over time the success or failure of those securities and compensate people more or less depending on how they perform. >> for capitalism to work, you have to have incentives tied to performance and i think one of the things people are very upset about is the fact it seems like a lot of people who drove their companies into the ditch walked move with lots of money and that's not good capitalism and it's not good for -- it's not a good ethical outcome either. the only comment i would make, one thing which is puzzling in a way, is that these firms that package securities, whether it's by mistake or not, ended up being pretty exposed to them and they took a lot of losses in many cases, and so we have to figure out why, even though they were still exposed to these securitized products, they

weren't more careful, but that's clearly a key issue. >> thank you. and i think the answer at the end there is sometimes they just got caught without being able to sell them hall. i mean, you know, it is a game to some extent, when there's musical chairs, the music stops and you're not necessarily finding a seat, and i think that to some extent happened to some of these institutions. let me turn -- i appreciate your considerations, and i encourage you, as you look at these institutions, on a go forward basis, you consider that kind of -- those kinds of thoughts as you evaluate their soundness. >> there's some data that we've seen that suggests that the sixth largest u.s. banking organizations, b of a, jp morgan chase, citigroup, wells fargo, goldman sachs and stanley, now are actually larger as a result of mergers and the elimination of other institutions, than they were even in 2007, just before

the height of the crisis. that apparently, they were 58% of g.d.p. in 2007, something like 68% of g.d.p. in 2009, which had gone up from 17% of g.d.p. in 1995, so there's been a consolidation and a growth, and i guess, my question to you, would be, given their increasing size, do you really believe that these institutions wouldn't be allowed -- would or would not be allowed to fail by the fed if they got into financial trouble today? i mean, i hope it doesn't happen, but let's just say for the sake of argument, that a diminution in some other asset class results in serious stress to both the balance sheet and the liquidity needs of these institutions. are we really in any better shape today to avoid the bailouts that have been so criticized in the last few years? >> the federal reserve was created, but we were always well within the law and we always did -- only exerted our legal powers

and the changes in the bell, that was just passed, has, for example, eliminated the ability of the fed receiver to lend to -- federal reserve to lend to a financial institution and it has spes need how we must deal with a stemically critical firm, so you know, borrowing some midnight session of congress, which rewrites the law, i don't see any way that it would be feasible. for the government to bail out a firm in the same way that happened during the crisis. so it's very important that we make sure that our methods that we do have, the resolution regime, etc., that they work. and that's something we're very much engaged on. i think it's also very important that we make sure the firms, we're always going to have big and complicated firms, we want to make sure they're big and complicated for the right reasons, good economic reasons and not because they're simply trying to hide behind too big to fail and my believe is that again, the combination of tougher oversight, additional capital required for systematically critical firms, tougher resolution regime and those things are going to take

away some of the attractiveness to firms of being too big and will, i think, help us over time, and with market discipline, reduce the size and complexity of some of these firms. >> i noted on page 17 of your prepared testimony, you did speak to the size of the firms and the, in certain respects, its unmanageability and unmanageability with regard to risk of some of the institutio institutions. i wonder if some have suggested that they've simply gotten too large. i'm not sure i agree. i understand the notion that we need large institutions to compete in a global marketplace, and to meet the financing needs of large -- our own large corporations and other borrowers, but it's not inconceivable and commonly utilized that when a large credit facility is necessary, people enter into syndicates, if the one bank isn't big enough, somebody or one or two of them

take a lead and bring others in, and so you still end up pulling together the resources necessary. you know, we've had some extraordinarily startling testimony in the course of hour eight months or so of hearings. we heard from the c.e.o., the chief financial officer and the chief risk officer of aig that they did not know that the products sold by the financial products division, had provisions in them, that if the aig's ratings wept down or the tronchs that they had insured against the credit default swaps, the credit they insured against went down, that they had collateral calls, which were ultimately what brought aig to the brink of insolvency, and the same, similar kind of astonishing testimony from citigroup's then c.e.o., chief financial officer and keefe risk officer that they did not know,

that their banking subsidiary had sold collateralized obligations with a liquidity put that if they were downgraded permitted the holders to essentially put them back to citibank, to the main holding company and they did so, one day, they took $25 billion and bought this stuff back, which was a third of their then capital, of $75 billion on some 3.3 trillion of assets. these were astonishing risk management failures and some have even speculated that really, they couldn't possibly have meant it when they testified here that they didn't know, but assuming for the sake of argument that they did not know, that really can't -- ought not to occur on a go forward basis, so are these institutions so complex, and so diverse, in their product mix, that they've become too large to manage, and if that's the problem, then how do we address that from the fed presever's perspective -- fe

federal reserve's perspective. >> it's our responsibility and the other regulators to make sure that their management is effective and they have good risk management systems and if we are persuaded that they cannot manage the risks of the corporation, because it's too large or complex, we are able, we have the ability to make them distributiodivest or change thee and that's even accounting the new authority, if a firm is viewed as being systematically risky that it can be broken up on those grounds as well, so we do have authority there, and in the case of citigroup, they have put a substantial portion of their company, put it into a separate structure, which is being sold off, so i agree with you, that where there is failure of risk management or business macment, because of size or complexity, it's very important that the firm and the regulators work to address the problem, and i assure you that we will.

>> thank you very much. if i might, could i reserve two minutes of my time? >> you have 1:17, but we will graciously grants you the 44 seconds. >> thank you very much. >> thank you, mr. chairman. and thank you, mr. chairman, for spending this time with us today, and i guess i'd like to follow the -- those who are preceding me in thanking you for your service in this difficult period and for the fed receiver into this -- federal reserve for this inquiry. it's been very helpful. i don't have a particularly systemic set of questions. i have a couple of things i'm curious about. i want to go back to the trigger, the housing bubble subprime crisis. you touched on this in your testimony. could you walk us through your view of the causes of the housing bubble and i'm interested in the points of

recognition within the federal reserve when we had a housing bubble and sort of what your policy options were in light of that. >> so bubbles by their very nature are difficult to understand, even after of the fact. the house prices began to increase fairly rapidly in the middle to late 1990's, and then of course, they accelerated to some extent in the early 2000's and peaked in 2005, 2006. my only view is that there are many actors con -- many factors contributed to that. in my testimony, i discussed two that was important. one was the interaction of expectation optimism on the one hand and innovation and mortgage instruments on the other, and what you saw was hand increased willingness on the part of lenders to make loans to people who were really not qualified on the expectation that appreciation in the value of their homes would allow them, by giving them more equity, would allow them to refinance into

more standard instruments and what we saw as the crisis progressed, was increasingly sketchy instruments, that had -- if they had even existed prior had been reserved only to very limited groups of customers, but now you had people who had not bought a house before, using option arms and interest only and other complex mortgage instruments, whose primary purpose was to bring the monthly payment to as low a level as possible. and again, that worked okay, as long as prices were rising, but of course, prices couldn't rise forever and once they stopped rising, the whole process unwound, so i think that was very important, and people like bob schiller have been pioneers in identifying those issues. another ac factor, which i have talked about since 2005, is so-called global saving glut. all that really means is for a variety of reasons and the

timing here works well, going back into the 1990's, its u.s. has been a major recipient of global capital flows and lot of those capital flows have gone into relatively safe fixed income instruments like mortgage backed securities or securitized credit products and that includes not only the excess savings from asia and emerging markets but also the gross savings from markets like europe and asia looking for those type of instruments, so that demand both reduced mortgage rates and reduced spreads and gave investment houses in the u.s. and elsewhere an incentive to create these new products, the alchemy, making uncertain mortgages and by restructuring them, creating the tronchs of so-called super a. the controversial issues, because it matters so much for the future, how monetary policy is conduct, what role the monetary policy played and there's a lot of conventional

wisdom about this and i think the only honest answer is we really don't know exactly how big the role was, but i've tried to give some arguments, why i think the view that monetary policy was a principal cause is not supported by the evidence, and i can repeat that if you'd like, but very briefly, there was the fact that the previous relationships, between monetary policy and housing prices, don't look remotely like they would have had to have been in order to account for the increasing house prices in the recent episode. cross country, we don't see issue between monetary policy and housing prices, and finally, i think, even if there had been some relationship, it would have been very questionable that we should have, you know, substantially raised interest rates in the situation of 2003 2003-2004, given what was happening in the macro economy as an attempt to try to close off the housing bubble. my strong preference and i said

this in my very first speech as a governor in 2002, that we should use supervision and regulation to approach bubbles. we didn't do that. >> thank you. >> going forward, we need to be able to do that and that's very important. on the fed's views, the fed is taking criticism for not, quote, recognizing the obvious etc. we knew that house prices were rising quickly, but as of 2003-2004, there really was quite a bit of disagreement among economists about whether there was a bubble, how big it was, whether it was just a local or a national bubble. so we were certainly aware of that risk factor, but you know, frankly, we by time, it was evident that it was a bubble and it was going to create rusk to the financial system, it was rather late to address it through a monetary policy. :

even under very 60 trillion dollars of equity value in markets around the world. it is a small amount of money. small amount of money. the loss of $400 billion of equity is nothing to the

regulatory economy. what happened is the financial system had these fulmer abilities which i talked about in my long her testimony and what was relatively small factor in the scheme of things triggered these weaknesses that led to a much bigger crisis. so what i did not recognize and i thought said price was contained -- the system had flaws that would amplify the initial shock from sub prime to make it a much bigger crisis. >> i want to talk a little bit about the institutions of we investigate going forward. has it bleeds into the broader financial markets, what

institutions are you watching carefully and by what criteria are you selecting the ones you are really worried about? >> you mean today? >> at the time. what was the nature of the fed's criteria for identifying institutions they need to be on watch for? >> to begin with, is important to remember that the fed was not a systemic regulator at the time. we had some specific responsibilities for bankholding companies principally. we did not have responsibilities for aig or invested banks or fannie and freddie or mortgage bankers. many of the areas where there were problems we simply did not have ongoing authority or supervisory presence. and so we did not get heavily involved in those situations until well into the crisis. around the time of bear stearns when it was evidence that some

financial institutions were under a lot of stress. the treasury and to some extent the fdic and other agencies were coming together to address them. we came rather late. that was simply the nature of our responsibilities. in terms of which firms to pay attention to, there are multiple criteria. size is important. but it is not the only criteria. for example bear stearns was not that much larger but bear stearns was a much more complex firm. it had large presence in the try party money market and in securities lending and other short-term financing. ahead large derivatives so it was very interconnected. a very important aspect of the prices was a rolling panic. the notion that if confidence

lost firms that were vulnerable from a liquidity point of view came under attack. stock market reduced confidence as well. it was our view that the failure of bear stearns would lead to the same effect we saw with lehman brothers six months later. huge stresses in the repo markets and other money markets. those short-term liquidity stresses would feed into other firms even the ones without direct counterparty relationships. those criteria, size, interconnectedness, complexity and performance of critical functions. so for example, banks like j.p. morgan and wachovia had very

important roles in various payments and settlements and infrastructure type aspect in the financial system and that was additional considerations. >> i don't want to put words in your mouth but when we talked to former undersecretary steal it really appeared that what mattered most was interconnectedness and complexity but which markets were showing signs of distress and panic and that was the criteria for intervention and the reason i want to push this is in the sort of new legislation there is a lot of thinking about who is going to be a systemically important institution which doesn't appear you could anticipate because you don't know the market -- is that a fair concern? >> it is a fair concern. the legislation requires us to identify systemically important institutions for the purposes of oversight but i don't need you

to be identified for the resolution to apply it to the firm. that is a decision that is made at the time. >> how could they prepare a living will if they have not been identified as someone who should be resolved? >> for firms that are on the cost if you will, prudence might have as work with them on these issues in any case. that would be important for complex for is but you raise an important point. >> the second question, on the living will, by wonder how you think about this, we relied on the past of systems of internal risk assessment as a substitute for direct measurement of the risk exposure to firms because of the assessment of risks. firms are too difficult to resolve rely on their plans for

resolving themselves if we don't understand how to do it? >> it sounds like the same thing. they have to come up with the plan. they are better placed than we are to figure out the best way to unwind the firm but we have to take responsibility with their cooperation and assuring ourselves that is a workable plan and responsibility for that is the fed and the fdic and other regulators relevant so we put together a lot of expertise to figure that out. at the fed, the lesson we took from the crisis is we really need to take a much broader, mulford disciplinary approach. we need more economists, more payment people, more accountants to supervise the supervisory activities to make sure we have the perspective we need to get this done.

>> going back to as the crisis unfolded and the fed's decisions about where to intervene with institutions. i want to ask again about lehman brothers versus a ig, thinking of the criteria for intervention. i'm not sure i understand what you said about a ig making a loan in that case. i want to walk through the logic of that because you said you didn't want to loan to lehman brothers because they didn't have sufficient assets and it wouldn't get repaid. aig had no buyer. there was clearly a liquidity run. you do is ultimately lind into it and had to go back and lend a lot more in short order so it didn't look like you stop it. it looked like it continued. what i am confused about is your

assessment of the ability to repay because lot of the assets were not available as collateral for -- the insurance division's in the firm. what is the difference in the thinking of lehman brothers versus aig. >> two additional minutes. >> both of them met the criteria for trying to save them a federal possible and were systemically critical. aig had a completely separate ongoing business that had growing concern value, a lot of shareholder equity, subsidiaries that are trying to sell off substantial value. it was our assessment they had plenty of collateral to repay the loan because it was a

separate business that didn't have a lot of our value or assets. it is true that in the fourth quarter, they lost more money than any country in history, $62 billion. that made things more difficult and required additional help from the treasury in terms of capital. when we made the decision, the problems at aig didn't relate to weaknesses in the insurance business. it related specifically to the losses of the financial products division. the rest of the company was a sound company with a lot of foul you. >> so you can stop it eventually. >> as long as they have collateral. >> the same is not true for lehman brothers. >> they did not have collateral in terms of financial assets. was tied into financial operations. they didn't have a separate

business that provided additional value. >> last question briefly, what would be different now? with the new authorities of the fed how would it have played out if you had the authority you have now? >> remember bear stearns was acquired by j. p. morgan. >> it was a subsidized acquisition. >> the existence of this resolution may have changed the bargaining position somehow. if we could have gotten required -- without any kind of subsidy. barring that, in all three cases they would have been appropriate candidate for application of this regime. >> in particular a ig -- aig had held the ongoing concern that

would have been resolved. >> i don't see what the alternative would have been unless we stopped for run through keywords of some kind. i don't know how to do that. if you figure that out let me know. >> senator graham? >> thank you, mr. chairman, for your excellent insights today. it seems to me we sort of have three options in looking at this issue of what to do when the too big to fail institutions get in trouble. the legislation has provided some what neater and cleaner funeral of circumstances to bury the body. the others are steps that might be taken to keep the institution healthy, such as the kind of

more rigorous oversight regulation you have discussed. or the other option might be the option of the late 19 food and early 20th-century to try to change the basic structure of the too big to fail. after the civil war the growth of the commercial and industrial trust became the source of concern in the federal and state level with efforts made to try to contain more predatory policies. finally people despaired and they moved towards breaking up of the trust to keep them from fundamentally damaging our capitalist system.

this legislation, the option that these institutions, growing rapidly. a dominant force within the economy. indicated some optimism about the ability to supervise these institutions and you stated there would be indicators that would indicate that would be indicative of this more strenuous regulation is accomplishing its intended purpose. i would have to say i am not that optimistic. i am not optimistic domestically for the last three decades, american people have elected governments, both republican and democratic which tended to support looser and looser

standards of regulation. some of the most significant occurred during democratic administrations. at the international level, we see the influence of the largest institutions. it has been reported currently is at the committee is under a great deal of pressure to weaken the standards that basel for collateral and liquidity that had originally had been proposed. what is the basis of your optimism that domestically there is the political will sustain stronger supervision and there will be international support for that kind of effort so that it is stronger supervision at home that is not seen as a means of neutering our ability to be

an effective competitor in the global financial markets? >> you raise some good issues. it is lack of political will. there is no solution that is sustainable. the combination as i said before, ideally we would like to see firms restructured in a way that makes economic consensus consistent with markets. the best way to do that would be to combine tough oversight regulation including such things as surcharges for firms that are systemically critical which would make them safer but also more onerous to be sustainably critical complaint with the resolution regime or similar things that create more market discipline. in principle, i recognize this may not happen but we should work to make it happen. in principle that would give firms the incentives to

restructure and change their form in ways that will respond to market, the size and complexity that is really needed that becomes too big to fail. the bill doesn't give us the authority but it does give us the authority if we despair of these other methods that we believe the firm in size and complexity is dangerous we have both of the living will requirement but also the authority regulators collectively to break up firms. i don't know the answer to that question. that is the charge congress has been -- given the regulators and we take seriously that charge. we put in place some reasonable approaches, but i appreciate your historical perspective

which says over the long run you have to take into account the political influence of these large institutions. >> in terms of the will of the institutions themselves, there is a division in american industry. some industries have adopted levels of self regulation, in depth, an acceptable behavior for instance nuclear power industry has developed impressive processes. best practice and enforcement, on the other hand. they had just seen one of the

manifestations. the financial community or nuclear power industry or more like deepwater drilling. defense in depth for his own actions. >> going back to historical analogies, there was a time when the principal regulatory or clearing house in the banks themselves. if they recognize if one bank failed they were

i think it is the nuclear power. >> can i have two additional minutes for questioning? >> >> how can i say no to you? there is no time limit. >> salisbury in treated years statement that there would be some indicators and more farquhar's of whether this rigorous supervision is accomplishing its objective. what would you put down in the vertical column? ipowhat are the indicators that

have some capacity to be quantified that you will be looking at him into the question, is the tougher regulation worth it? >> certainly, one important indicator rebates to the cost of capital. if they are not too big to fail, an important source of their market advantage will be eliminated. firms. if they are not too big to fail, then an important source of their market advantage would be eliminated. you would expect to see wider risk spreads reflecting the increased conviction of the market that they could fail. those could be more responsive to market developments. that would be one set of things and also look at things like

return on equity which should not be artificially increased by too big to fail characteristics of the firm. >> do you see the fed developing this report card of indicators and periodically making it available to the public so there will be a capacity for continued public monitoring of how well the supervisory system is functioning? >> some of the indicators are public when you look at them. we are well along in developing a quantitative surveillance mechanism which will be looking at a whole variety of financial and other indicators of individual firms and using them as a supplement to the on-site supervision that supervisors do. i am not sure what form you will communicate this to the public but we want to make sure the

public is confident that firms are safe and sound. we will try to find ways to communicate that effectively. >> to conclude going back to the importance of the public seeing that this is not only their individual interests but also the broader societal interest to have effective regulation, we reduced the likelihood of firms getting into the extreme situation where you have to plant the cleaned up funeral. i believe that keeping the public informed is a critical element of building that support so i would urge you to make this as communicative and publicly available as possible.

>> thank you, senator. mr. thompson? >> thank you, mr. chairman. it is out of order. >> that little switch from last session. >> keep us on our toes. thank you for joining us. while this hearing is about too big to fail i would like to go back to the broader issue of the crisis if i might. would you describe for us the role that the federal reserve place in monitoring or managing credit standards in our country? >> as i mentioned earlier, the federal reserve has had a role in consumer protection, so we have created rules for example on requiring documentation, escrow accounts and other

standards of underwriting that apply to mortgages. the other main area i can think of is like other bank regulators we want to make sure banks -- is their decision what risks to take and what loans to make, that they are adequately capitalized to deal with any losses that might occur. so we are pressing on the one hand for stronger sensitive capital standards to tie the amount of capital banks have to hold to the risk of the loans that they make and therefore if they make a riskier loans they need to hold more capital and judge for themselves if it makes sense to do that and we want to continue to work with the accountants and the sec and others to make sure banks have adequate reserves against losses. by providing adequate capital

reserves, banks have the right incentives to make adequate loans. some countries, it is an interesting idea, some countries the authority is in loan to value ratios. we haven't done that in this country. but i think we ought to look broadly at how we might in short we don't have a system where credit gets too easy. and too tough in the downturn. >> you commented about the innovation that occurred in the market primarily around the distribute model and what have you which clearly was facilitated by lax lending standards. could the federal reserve not have stepped in as its of this model being developed in this innovation, really putting the

economy at risk? >> as i said, we bear some responsibility. primarily in two areas. the first was in the underwriting standards and application of the regulations. the problem, acknowledging the concern. one of the problems is although the federal reserve had the authority to write rules, we would have had to rely on state and other regulators to enforce those rules and it was partly because we weren't supervising these firms we didn't see what was going on as clearly that we didn't respond as quickly as we should have. that was an important failure has a i agreed many times. the other area where we and other bank supervisors should have been more effective in risk-management more generally. the firms did not have enough information about what the

brokers were doing on their behalf or what standards they were applying. they didn't know their own exposures to sub prime and other types of mortgages as was pointed out. they rely too heavily on credit rating agencies who themselves had flawed models that ignored risks of housing across the country. those were the two areas where the fed and other bankers could have done more. was at the underwriting level, in general risk-management to understand their exposures both in terms of their own losses but also their operational risks they were taking and they were packaging these mortgages. >> my background in the technology business, i have an appreciation for the value of innovation and stronger appreciation for the role

technology place in the financial services sector, largest consumer technology as a sector in the economy. getting the role of innovation in that sector, what more should be done to manage the innovation process within of a financial services sector in such a way that someone creates a systemic risk to the economy? >> one of the lessons of the crisis is innovation is not always a good thing. there are innovations that have consequences, there are innovations whose primary purpose is to take unfair advantage rather than create a more efficient market and there are innovation that can create systemic risks even from the perspective of the individual firm. that this is not evident. i am not sure i would go so far as to say we need a new product approvals safety commission or

something like that although the cfpv will to some of that. the we ought to pay close attention to financial innovations and regulators as we look at the risk-management and systemic consequences of these decisions need to be assertive if there are developments we find counterproductive from consumer protection or systemically risky. we ought to intervene there. >> you made a comment in your opening statement about your longstanding background as a student of financial markets and financial crisis and often in a crisis leaders are asked to do things they never had to do before, often times that means asking for forgiveness as

opposed to permission. in hindsight, would you have preferred to ask for forgiveness and done something to save lehman brothers in such a way that this crisis would not have unfolded the way it did in our economy and our country? >> it is hard to know what would have happened. one possible scenario is -- the only way we could have saved it was by breaking the law. i am not sure i am willing to accept those consequences from the federal reserve and for our system of laws. i don't think that would be appropriate. i wish we had saved lehman brothers, we tried very hard to do so but it was beyond our ingenuity or capacity to do it. [talking over each other] >> willing to be creative -- >> you did see it coming. >> we saw a lot of risks in

lehman brothers and other companies as well but the actual failure was not preordained. we were hopeful even up to the last day that we had -- >> my reference was to the consequences of their failure. you predicted that. >> i was personally convinced. i guess i would add in our decision to rescue aig, i was taking a risk that it could have happened that after a few days of market upset the market would have digested the lehman event and people would have said what were you doing with aig? i was very confident that lehman's devise would be a catastrophe and i thought aig would be a catastrophe so i did everything i could to prevent that. >> no way in our system that someone with your perspective and insight could have

influenced the white house to say we cannot let this happen? >> the white house was well informed and very supportive. the previous administration and the new administration were very supportive. we've of all kinds of creative things but could not find a way to do it. i am not prepared to go beyond by legal authorities. that is appropriate. >> thank you, mr. thompson. mr. wallace? >> i am full of surprises today. >> it is called chairman discipline. >> something simpler working from the outside. [talking over each other] >> thank you, mr. chairman. thank you for coming. i would like to explore

something called the discount window a little bit. my understanding of the purpose of the discount window for banks is it is an opportunity for a bank to take assets that are not liquid and provide them as collateral to the fed and the fed in turn monetizes them and use that cash to meet its obligations. one of the purposes of that is to address runs. when a bank is facing runs, assuming it is solvent, it can present collateral, including loans, which are liquid, to the fed and if the fed judges those loans have some value given an appropriate discount, it provides cash to the bank to meet the loans, to meet the

obligations. the fact that the fed is doing that is very influential with the market. people say as long as i can make these withdrawals, that is in a run and the cash is always there, and the fed, lending the money, the fed must think they are solvent and that is only the circumstance under which you would do that, then it is supposed to come to an end. that is kafiri. the market is quite satisfied that the cash is always going in there. wachovia is different. i can understand the only thing that was considered for wachovia, i would like your judgment on this, the only thing that was considered for wachovia was an acquisition.

whereas wachovia, at least as far as we understand it, was solvent but subject to liquidity problems. there were runs. why was it then that as an alternative, wachovia was not able to use the discount? >> they were allowed to use the discount window. perhaps i could come back with more information subsequent to this hearing, but their liquidity range was quite serious. it was their judgment they were not going to be able to open up in a day or two. they fought liquidity rates for such they could not meet them even with the discount window. >> wachovia's judgment? they were the ones who said we can survive this? >> considered by the richmond

federal reserve bank. >> it wasn't that anyone considered them to be insolvent. it was simply a matter of their view, wachovia's view that they could not survive this even if they were able to provide collateral to the fed. >> i think there was uncertainty as to whether if they were solvent or not. even if they had regulatory capital, that capital was not very risk sensitive. more. s that were similar and what wachovia had -- part of my problem is i don't recall the discussion and i would like to get back to you on that. >> the lehman case is slightly

different. although the media had said that the fed had given access banks to the discount window that was not exactly true. what was done was under 13-3 or special powers to deal with serious financial consequences, enable you to make available to investment banks funds from the fed for which you would be getting some kind of collateral. we were told by mr. fuller yesterday and no one disagreed with this that lehman brothers was solvent. it had plenty of assets and subject to a run. my question to him. i am hesitant to put words in his mouth when he responded, my

question to him was what could the fed did the same thing with the discount window for banks as a matter of law? we will take all of your liquid assets as far as we put a value on them and we will monetize, provide the cash. so you can meet this run. mr. baxter said to me there is a way for the fed to do that but only if the fed board adopts a resolution of some kind which changes the nature of what they normally do under 13-3 to make it more like the discount window. they can take assets that are not liquid and use them for the purpose of making a loan to the institution that is suffering a run.

you said you are willing to do anything to save lehman. is mr. baxter correct? could the fed board have adopted a resolution that will take any good assets and monetize them? provide the liquidity so that lehman can continue to meet withdrawals or the run that people are referring to? so lehman brothers had a holding company and a rubber deal. i'm talking about only the holding company. >> for everyone's information, the appropriate dealer was eligible to bar from the primary dealers facility and was allowed to do so so the question was should we create a new lending provisions to allow loans to folding company? >> yes. >> we were able to do so so long as we had sufficient collateral

and we were prepared to do that. i was ready to call the board together to do that if that was going to be helpful. when i was informed by those working on lehman's finances, it was far too literal collateral available to come to the window to get enough cash to meet what would be the immediate liquidity runs on the company. if we were to land, what would happen would be a continual run. not nearly enough collateral to provide liquidity to meet the run. the company would fail anyway and the federal reserve would be left holding this billliquid collateral, very large amount of it. it was our view we could not lend enough to save the company and do the restriction we could only lend against collateral. >> you were saying even if the collateral was illiquid, you

concluded that there wasn't enough of such even illiquid assets? >> that is correct. >> did you do a study of the collateral? does new york fed have a study of the collateral that was available? >> i refer you to them. we were working with the sec to do these stress tests we did over the summer and over the weekend, there was 24-hour analysis that included not only the staff of the new york fed but also assistance from the private sector companies that were gathered there. i don't have to my knowledge any study to hand you but it was the

judgment made of -- by the leadership of the new york fed and people charged with the books that there was not enough cash to meet the run. that was the judgment given to me. that was my understanding. >> since i have a minute i will ask another question. a somewhat different subject. wachovia failed or didn't fail, apparently in the view of the fed it was not viable and had to be combined with some other institution. one of the things you said in your testimony was there were vulnerability is and weaknesses in the system and one of those vulnerabilities you identified was the fact that the investment bank's would likely regulated or

not sufficiently regulated. investment banks were in fact lightly regulated but banks like wachovia and wamu were heavily regulated by the fed at least in the case of wachovia -- i & wamu was regulated differently. but what about when the outcomes seemed to be the same? the banks got into the same kinds of trouble the investment banks get into? what does that say about the idea of providing yet more regulatory power? >> wachovia was a national bank regulated by the holding company

supervisor. part of what was happening, frankly, which is why some of the ceos feel they were blindsided by a truck is there were systemic problems and individual institutional problems. there was a panic that went across a variety of firms. one of the sources of the panic was the sub prime lending which was done by banks and nonbanks and we all share some responsibility for that. another set of problems had to do with this high reliance on unstable short-term funding. that was much more a situation in investment banks and other shadow banks. that is why if you look at the chronology of the crisis, what you see is the firms that were hit first were not banks, they were bear stearns which was under pressure in march of 2008.

they were fannie and freddie which had separate issues. they were essentially all the investment bank's, came under very large stress early on. it was only when market conditions got a very severe that banks began to face liquidity problems and banks like liquid -- wachovia and city which had some substantial reliance on non core deposits that the liquidity source came directly under pressure. we had to improve on all dimensions. i would say the sub prime lending in particular was done more outside regulated banks sector than within it. certainly i don't claim there were stakes in that as well. >> you have a quick follow-up?

>> here is what i don't understand. mr. fuld said all he needed was a liquidity breach and he had collateral. if he were to give you the collateral, you are protected. why replace his judgment with the fed's judgment? >> when we make these discount window loans we have two sources of production. one is the collateral itself which we really don't want to own. the second is the signature of the firm. we don't generally loan in the banking sector. we don't make loans to failing banks even against collateral because we want to have the

double protection of the firm quality and the collateral itself. it was our sense based on the information developed in new york that lehman was far short of the collateral they would need, they were essentially making a hail mary pass at that juncture and so what was going to happen was we would lend to them on illiquid collateral. they would certainly fail anyway but the other consequence would be that the fed would have a large amount of illiquid collateral which would be risky at least for the taxpayer. that was the reason. it was our view that they did

not have enough collateral and the run is based on a variety of short-term funding obligations got downgraded, there would be more collateral calls and there was not adequate collateral to meet the run and it would only be exposing the fed and taxpayer to make those loans. >> that taxpayer risk was larger than your perceived catastrophe? why not try the hail mary pass? >> the view that the failure was certainly the case. >> you had a quick -- >> just 30 seconds. we may be pounding this nail but based upon yesterday and ongoing discussion, final point you responded to was where i want to focus a little bit more.

if there wasn't sufficient collateral, the other thing i want to add to it that it wasn't sufficient collateral by an inch, by a mile, because you were looking at an ongoing process that you essentially decided wouldn't be worth starting, so that there was just no question about the shortfall, that it would have been ongoing -- >> my general tone and attitude was is there anything we can do? i believe that that goal was shared by the other principals. by timothy geithner and secretary paulson and chairman cox. none of those folks were known for timidity in previous episodes in terms of finding

ways to prevent a worsening of the financial crisis. what are heard from them was this sense of defeat. it is too big a hole. my own view is the company was insolvent, not just illiquid. >> thank you, mr. chairman, for being willing to appear before us today. you previously said that over the counter derivatives were a mechanism that transmitted shock during the financial crisis. i would like to explore with you some of the ways that they did so and their relevance to systemic risk. as you said today, the potential failure of aig was caused by aig

financial products divisions enormous sale of credit default swaps without sufficient resources to boast collateral as required by their contracts. was aig considered to be of importance because many of the girl's largest and most important financial firms were aig's counterparties and could have been impacted with aig's failure? >> it is a subtle point but i will distinguish from the actual financial exposure and the fact that the world knew that aig was the counterparty of many global financial firms. in some cases those exposures were manageable. in some cases they would have been more substantive.

at the time, we were at the brink of a global run on all financial institutions. the progenitor of runs is uncertainty. people don't know whether a bank or a company is sound and that is when they take their money out. two years later we are not entirely sure what the net exposure was. certainly on the day that aig failed if it had failed, investors are around the world would not have known what the net exposure of a given bank was to aig. my sense was over and above the direct losses that it the capital that would have experienced not only through these derivative counterparty agreements but also straight commercial corporate bonds and other vehicles that this would have triggered an