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. we have that within our power today to move forward in a different kind of future. we cannot do this without you. now, let me turn to the prime minister who will make his remarks followed by the president.

>> thank you, madam secretary. i want to thank you and president obama with the many efforts he had invested to bring this to this moment. my friend, senator mitchell, thank you for your consistent effort for you and your staff's efforts to bring a lasting and durable peace to our region. president, as i said yesterday in our meeting at the white house with the president of the united states, the president of egypt, the king of jordan, i see in you its partner for peace. together we can believe our

people to a historic future that can put an end of to claims and to conflict. this will not be easy. a true peace, and 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, from your side. the people of israel, and i as their prime minister, are prepared to walk this road and to go a long way in a short

time to achieve a genuine peace that will bring our peoples security, prosperity, and good neighbors. we went to shape a different reality between s which will involve serious negotiations. there are many issues in contention, the four issues you outline, madam secretary, are things we have disagreements on. we need to get from this agreement to agreement, a big task. two years ago, -- or rather one year ago in a speech i gave 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 the 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 non-jews living in israel, the nation-state of the jewish people, who have a full civil rights. there's no contradiction between a nation-state that guarantees the national rights of the majority of about guaranteeing the civil rights, full 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 come yesterday that a real peace must take into account the genuine security of the individual that have changed since i was last year -- since i was last year at this table. we have been here before. refashioned those two agreements 12 years ago. in these 12 years, and new forces have arisen in our region and we have had the rise of miron and missile warfare.

-- iran and missile warfare. this must take into effect security agreements against the real threat against my country, threats that have been realized with 12,000 rockets fired in our territory and terrorist attacks. unabated -- and terrorist attacks that go unabated. president abbas, i respect 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 a much desired peace. the last two days have been difficult.

they were exceedingly difficult for my people and for me. blood has been shed. the blood of innocents. four innocent israelis were gone down brutally >> >> -- gunned down brutally. seven new or friends. president abbas, you condemned this. it is equally important to make sure we can stop other killers that seek to kill our people, kill our state, kill our peace. so, achieving security is a must. security is the foundation of

peace. without it, peace will unravel. with it, peace can be stable and enduring. president abbas, history has given us a rare opportunity to end the conflict between our peoples, a conflict that has been lasting for almost a century. it is an unprecedented opportunity to end this century- long conflict. there have been some examples in history, but not many. we face such a test, to end the bloodshed and to secure the 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 but have two brothers in the conflict, brothers isaac and fish mail -- ishmael, joined together to bury their father, abraham. he is the father of our two peoples. isaac, the father of the hebrew nation, ishmael, the father of the arab nation, joined together in a moment of the pain and mutual respect to very abraham -- bury abraham. i can only pray, and i know that millions around the world, millions of israelis and palestinians and many other millions around the world, pray

that the pain that we have experienced, you and us, in the last 100 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 it from here and to forge a durable lasting peace for generations. shalom, som -- salam, peace.

>> in the name of god, madam secretary, mr. prime minister and netanyahu, ladies and gentlemen, let me in the first place once again extend my thanks to president barack obama and secretary clinton and senator mitchell. i think him for the unrelenting efforts to have exerted here in the last month. ladies and gentleman, now that

we're launching these negotiations we do know how hard the options we are facing and we will face them during these negotiations that should, within one year, ease into the piece of international legality between our two people. what is encouraging as well and what is giving us confidence is that the road is clear in front of us. this is in order to reach peace. the national law is represented by the national security council and the general assembly of the united nations and the positions of the european union, the arab committee, and all of these positions clearly forrester present international unanimity

on the negotiations. ladies and gentlemen, we're not starting from scratch because we have had many round of negotiation between the plo and the israeli government. we have studied all of the horizons and we have also determined all of the pressing issues. we will work on the final status issues, the settlements, the borders, security, order, and also relieving the detainee's in order to end the occupation that started in 1967 of the palestinian territories in order to create the state of palestine side by side with the state of israel in order to end the historic events in the middle east and the to bring

peace and security for all of the peoples of the region. once again, we want to state our commitment on of our engagements including security and an. incitement. recalling the israeli government to come forward with its commitment to end all settlement activities and completely lift the embargo over the gaza strip. also, with respect to security, ladies and gentleman, you know that we have security that is still young. they are doing everything expected of them. yesterday, we condemn the the operations. we do not only condemn them, but we also followed the

perpetrators and we were able to find the car that was used and to a rest those who bought the car. we will continue all efforts to take security measures in order to find them. we've think security is vital for both of us. we cannot about for anyone to do anything that would undermine your security or our security. therefore, we do not only condemned but we keep working. ladies and gentlemen, once again, i want to stay today what i said at the white house meeting yesterday, we do

believe this represented the belief of jordan and egypt in peace. these two states along with other arab states do believe that peace is of vital interest that only for the palestinians and israelis but also for all in the region. president obama said that the creation of a palestinian state or the two state system is a of vital national american interest. the plo bridge is a break in these discussions with good intentions. we are anxious for the peace to

oversee independence for the palestinian people. we are attached to the international private solutions. we do not want anything less than. we want to have a new era in our region that brings peace, security, and prosperity. let me say that in 1993, on the ninth of september of this year we signed, mr. prime minister, what is called a document of mutual recognition between us and israel.

failing this document -- in this document, we share our intentions are good with respect to recognizing the state of israel. also, commitments were required. when we came back with president clinton, we carried on without of our commitments. we start from here to find a piece that will end the conflict, that will meet all of the demand in this new era between the israeli and palestinian people. thank you and peace be among you.

>> i want to thank the leaders for their statements. i 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. they have travelled a long way to be here. we are grateful for their commitment as well. today, president obama and die, senator mitchell, our entire team are prepared to do whatever we can to help you succeed. we believe in you. we support you. again, let me thank you for being here. now it is time to get to work. thank you all very much.

? good afternoon and welcome to the department of state. today, we have successfully relaunched direct negotiations among the united states, israel, and the palestinian authority in pursuit of a final agreement, a final settlement, and a just peace and two states living side-by-side. george mitchell will get a statement and answer a few of your questions. we still have meetings going on. you have to -- he will have to return upstairs rapidly to return to negotiations. here is senator mitchell. >> good afternoon, ladies and gentleman. the parties have just concluded the first round of trilateral talks.

it began with a session involving the full u.s.- israeli-palestinian delegation on the eighth floor of the state department. and then broke down into 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 before i direct -- 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 enter into the

discussion with a seriousness of purpose. they also agreed that for these negotiations to succeed that they must be kept private and treated with the utmost sensitivity. one eye and they are able to disclose to you today and in the future will be limited. i will now describes some of the key items that were addressed in the 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 people's and to a solution of the conflict that resolve all

issues and all claims to establish a viable state of palestine alongside a secure state of israel. presidents abbas and prime minister netanyahu you think these negotiations can be completed within one year and that the aim of the negotiations is to resolve all of these 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 the 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 lasting peace between israel and the palestinians.

the parties have agreed that in their actions and statements that have worked to create an atmosphere trust that will be conducive to reaching a final agreement. they have agreed to meet again on september 14th and 15th in their region and roughly two weeks thereafter -- every two weeks thereafter. continued interaction that other levels between the parties and others involved in the united states will take place between those meetings. a preparatory trilateral meeting to plan for that second meeting in the region has already begun in another location in this building and will continue here in the region as is necessary.

as both president obama and secretary of state clinton have said, the united states pledges their whole support to the parties in these talks. we will be enacted and sustained partner to route. 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 were those who have used violence to try and derail the talks. there will be difficult days. there will be many obstacles along the way. we recognize that this is not an easy task. as the president told the leaders, we expect to continue until our job is complete and successful.

with that, i will be pleased to take some of your questions. >> i would like to know what the personal relationship is. when you see the next to each other, they seem distant. did they seem to develop any kind of relationship together? >> the relationship was cordial. as you know, these men have known each other for a long time. this is not their first meeting. they are not in any way strangers, politically or personally. i felt that it was a very constructive and positive mood in terms of their personal interaction and of the interaction that occurred. >> nbc television. president obama yesterday talk

about progress. i appreciate the fact you do not want to advance to many details. today, prime minister netanyahu talk about the jewishness of the state. do you think you can bridge the gap given that there are so many difficulties? since launching the discussion today, do you think this could be an issue that could be explosive for the peace process starks -- peace process? >> i believe strongly 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. and secondly, it is, of course, self-evident that the reason for

the negotiation is that there are differences. the differences are many. they are deep and serious. it will take serious good-faith, negotiations, sincerity on both sides, willingness to make difficult concessions on both sides if the agreement is to be reached. i do not think that any human problem can be solved if one begins by reviewing the problems as insurmountable. that suggests the mountains are too high, the rivers are too wide, so let's not undertake the journey. there has to be a sincerity and seriousness of purpose combined

with a realistic appraisal and understanding of the difficulties. i believe that exists. i believe the two leaders, president abbas and prime minister netanyahu, are committed to doing what it takes to achieve the right results. >> hello, senator mitchell. fox news. you remember the days that nothing is agreed to until everything is agreed to. will that be the operative approach, you believe, for this process? will you be reluctant to talk about anything agreed upon until everything is agreed upon? my second question is that you discussed the framework. is the deadline for the framework one year or are we likely to see that much earlier and the one-year to govern 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. we have made it clear that these issues are to be determined by the parties. we have had extensive discussions on that and any other issues. those will continue. our goal is to resolve all of the core issues within one year. the parties themselves have suggested it and agree that the logical way to proceed, to tackle them is to try and reach a framework agreement first. as i said, and i think this ought to be made clear, because

there has been a good bit of misunderstanding or not a full meeting of minds publicly regarding a framework agreement. if framework agreement is not an interim agreement. it is more detail than a declaration of principles but it is less than a full-fledged treaty. its purpose is to establish the fundamental compromises necessary to enable the parties to than flesh out and complete a comprehensive agreement that will end the conflict and establish a lasting peace. >> i am with cbs news. you mentioned a number of issues talked about today. can you mention if the settlements were among them? do you plan to be in the region for the talks and at the table?

he said the u.s. would be a part of them, but do you plan to be there for those talks? can you tell us where they both be? >> as a said at the outset, what i will be able to disclose to you will be limited. you have given me the of first opportunity to invoke that principle with respect to the first part of your question, for which i think you. -- thank you. secondly, both secretary clinton and i will be at the meeting. one of the subjects now being discussed in the trilateral preparatory meeting going on in another room in this building, to which i must go to in a few moments, is that subject. a determination has not yet been

made. it will be made obviously in the near future and well in advance of the meeting. >> i am with abc news. i would like to take another crack at this. i appreciate you can i get into the specifics, but i'm curious if you can mention about today's talks if they did talk about some issues or whether this is strictly to that the plan for the coming year. thank you. >> as i mentioned in my response to the questions, i do not think one can neatly characterize process and substance as though there are two separate things in these matters. they do interact and relate. you cannot discuss the issue in any meaningful way without some

relations to the substance being discussed. i appreciate you taking another crack at his question. it gives me a chance to say for the second time that i will not be able to get into the substance. yes, there were discussions that touched on substance although i do not want to suggest to you that the meeting was such that there was a detailed and extensive discussion or debate on a specific substantive issue. >> it appears from this morning that obviously there were not concessions.al o dimension security. at the dinner they talked about recognizing the palestinian

claim. is that something you have noticed? have you played a role in getting the leaders to get out those statements? >> we have encouraged the parties to the positive in their outlook from in their words, and in their actions. any realistic appraisal of the situation including the recent history, by which remained the last two decades makes clear that there are very serious differences between the parties and that there are many difficulties which lay ahead both in terms of the substance of the issues, the impact on their domestic politics, the

needs and interests of their society. we have not, of course, attempted to prescribe what they can or should say about any issue. these are independent and extremely able issues representing the interests of their society. what we have sought today in innumerable conversations that i have personally but both leaders over many months is that president obama's conviction that despite all 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 lasting peace between the parties and in the region. the alternative to that poses difficulties and dangers for greater to the individuals come to the leaders come to their societies than those risks that they run in an effort to reach an agreement that brings about their lasting peace. any realistic evaluation of the interest of the people of israel and the palestinian people must come in our judgment, concluded that they are far better off living side by side in two

states in the peace and security than in a continuation of this situation. >> two last questions. >> senator, prime minister netanyahu mentioned iran this morning. would that make it more difficult for you to close the gaps between the parties? >> in every aspect of human life, 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 exchange we have here. obviously, the actions and policies of the current government of iran have in the region and in the world, the influence what is occurring here. in my judgment, they have another argument to those which i have already made and those have already made as to why this conflict should be resolved. it is in the interest of the people, and in this respect comprehensive peace is directly relevant. when president obama announced my point two days after taking office, he specifically identified comprehensive peace as the objective of u.s. policy

in the region. israel and palestinians, israel and syria, israel and 11 non -- lebanon. israel in peace with all of their neighbors with normal relations. obviously, one of the factors that makes that desirable, and in my judgment, and necessary for all of these parties is, in part, the actions and policies that have been and are now being taken for the government of iraq. yes it is a factor. even if it did not exist, there would be a compelling reason for peace between israelis and palestinians. >> last question. >> cnn. these negotiations between the parties have taken place obviously several times in the past.

what is secretary clinton doing differently than their predecessors including president clinton? >> although my comment on that is not constrained by the agreement which earlier described, there are other constraining factors which come into play that somehow come right into my head as you completed that question. [applause] -- [laughter] since i was not a part of the immediately preceding administration although i did serve at the request of president clinton and the president of the palestinian authority as the chairman of an international commission in the 2000 and 2001 following that, i will tell you my own belief.

first, we can now be deterred by the fact that previous efforts did not succeed. the cause of peace is so important, so just, and not trying to use the hyperbole, that must continue, notwithstanding our efforts, and an argument could be made to the reverse that prior failures create an even more compelling imperative to proceed. with respect to past efforts, as i said previously, not today but at an earlier briefing, we think the best approach is to carefully review them, as we have done, and to try and draw the best lesson that of each one and not be bound by any particular practice, process, or procedure and always keep in mind the dynamic changes in a

short period of time. i have been asked this often, is this a continuation of annapolis or some other process? our view is that this is an effort that will try and learn from the lessons of the past, bring them forward, and not be bound by any label, category, or previous process. everything should be judged on the basis of what it will do to advance to achieve the ultimate 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 and to have acted immediately at that time. there have been many very well written books on the history of the last 20 years. i think i have read most of them. it is very clear that at least in a couple of instances that time ran out. the author of several of these books used those exact words, they ran out of time at the end. well, this president, i believe, will succeed. as he said yesterday, neither success nor failure is predetermine the guaranteed but it will not be because time ran out at the end. that is a vast difference. i have a high opinion of the men and women who serve in these tasks in the past. i know most of them personally.

i do not think you can contribute to their individual and years. they have the difficulty and what many regard as the impact ability of the problems and issues. we believe that there are dynamic changes that occur. there are the more obvious difficulties that lie ahead for both sides. that name be even more obvious than they were five, eight, 12 years ago. you have to remember that these leaders must wait two things, the difficulties they face in getting an agreement and the difficulties they will face if they do not get an agreement. we believe it is a very powerful

argument that you subject these to careful reason and rational analysis to conclude that if they do not get an agreement, it will be much greater and have a much more profound impact on the society and as they face in trying to get an agreement. thank you all very much. it has been a pleasure to see you. i look forward to reporting to you on a regular basis. >> today on "newsmakers," the commandant of the u.s. coast guard talks about the budget

challenges of the coast guard. that is at 6:00 p.m. eastern here on c-span. >> the c-span network provide coverage of that work -- politics, public affairs, and non-fiction books all available to you on television, radio, on line, and of social media networking sites. i never content any time for our video library. we take c-span on the road with our mobile content vehicle, bringing resources to your community. washington your way -- the c- span network. now available in more than 100 million homes raided by cable and provided as a public service. >> in august, the unemployment rate rose to 9 1/6%. president obama spoke about the latest job numbers and call for passage of a series of tax breaks and other benefits. his remarks from friday are about five minutes. >> good morning, everybody. as we head into labor day

weekend, i know many people across the country are concerned about what the future holds for themselves, their families, and for the economy as a whole. as i have said from the start, there is no quick fix. this is the worst recession we have experienced since the great depression. it took years to create the current economic problems and it will take more time than any of us would like to repair the damage. millions of our neighbors are living with that painfully every day. i want all americans to remind themselves that there are better days ahead. even after this economic crisis, are markets remain the most dynamic in the world. our workers are still the most productive. we remain the global leader in innovation, discovery of, and in entrepreneurship. in the month by took office, we were losing 750,000 jobs per

month. this morning, the new figures show the economy produced 67,000 private-sector jobs in august, the eighth consecutive month of private job growth. additionally, the numbers for july were revised upward to 107,000. that is positive news. it reflects the steps we have already taken to break the back of this recession. it is not nearly good enough. that is why we need to take further steps to create jobs and keep the economy going including extending tax cuts for the middle-class and investing in the areas of our economy where the potential for job growth is greatest. in the weeks ahead, i will be discussing some of these ideas in more detail. one thing we also have to do right now, one thing we have a responsibility to do right now, is to lift up our small businesses which account for over 60% of the job losses in

the final months of last year. that is why, once again, i call on congress in passing a small business jobs bill as its first order of business when they come back into session later this month. here is why this is so important. up until this past may, we were not on the waiting fees for entrepreneurs who took out small business administration loans, but we were encouraging more banks to make loans to responsible business owners. the steps are part of the reason that about 70,000 new small-business administration wants have been approved. i think karen -- i thank karen for the job she has done for the small business administration. we want to extend this with a small business jobs bill which will more than double the amount mom? some small-business owners can get. it will completely eliminate

capital gains tax. it looks celebrate $55 billion in tax cuts for businesses, large and small, that make job- creating investments in the next 14 months. keep in mind that it is paid for. in a lot at one time to our deficit. -- it will not add one dime. this is good for workers, good for small business people, good for our economy. yet republicans in the senate have block this bill. needless delays that have led small business owners across this country to put off hiring, put off expanding, and put off plans to make our economy stronger. i have repeated this since i ran for office that there is no silver bullet that will solve all of our economic problems overnight. there are certain steps we know will make a meaningful difference for small businessmen

and women. they are the primary drivers of job creation. there are certain measures we know will the fans are recovering. this small business jobs bill is one of them. i'm confident that if we can put partisanship aside and leave the leaders the american people the best of a, if we're willing to do that is best for the next election but for the next generation that we will not only see american boxing hard-working families and small businesses bounceback that we will rebound america's economy stronger than it was before. thank you very much. i will be addressing a broader package of ideas next week. we are confident that we are moving in the right direction. we want to keep this recovery moving stronger and accelerate the job growth that is needed so

desperately all across the country. [inaudible] i do not regret the notion that removing forward because of the steps we have taken. i will have a press conference next year -- next month after you are able to hear where i am next month we will answer specific questions. the key point i am making right now is that the economy is moving in a positive direction. jobs are being created, just not as fast given the whole we have experienced. we will continue to work with republicans and democrats to come up with ideas to further accelerate job growth. i'm confident we can do that. the evidence we have seen over the summer and during the course of the last 18 months indicate

that we're moving in the right direction. we just have to speed it up, all right? >> president obama travels to milwaukee tomorrow to talk about the rest economy at the annual afl-cio labor day celebration. live coverage of the president's remarks begins at about 3:10 p.m. eastern on c-span. congress returns from break next week. here is a look at some of our

prime time programming right after president obama's speech on monday. watch town hall meetings with oklahoma senator tom coburn. >> i believe the plan is for this to fail. as a matter of fact, i know this plan will tell -- fail. this will create adverse selection. anyone young that is healthy, you will pay the fine in the 2014. it is smart. if you get sick, they have to cover you. it does not rise to $795 until 2016 as a fine. what will happen? the help the young people will not be in the insurance pool. what will happen to the people over 40 who are sick? what will happen to the cost of their insurance? that is why i think they have designed it to fail. ultimately they would like to revert and tell you that

insurance does not run because we need a government-run, government-mandated single health care. >> in my view, if we are serious about having a cost-effective high-quality health care system with a guaranteed coverage for every man, woman, and child is in medicare for all system. you are absolutely right. we are going to be delivers with lobbyists because it's the small state of vermont, if we can show that a medicare for all single payer system works then they are not far behind the new hampshire, calif., the rest of the country. >> we will show you both of these right after airing the president's speech sunday night here on c-span. now, a hearing with the commission looking into the 2008

financial crisis. in this portion, with the failure of lehman brothers with their former ceo and thomas baxter from the new york federal reserve. >> the meeting of the financial crisis inquiry committee will come to order. we will now start session two for today as a part of our hearing on institutions that are too big or too important to fail. in this afternoon's panel, it is about lehman brothers. i want to welcome the panel. thank you for coming here today. we will begin today's proceedings as we always do by asking of you to please stand and be sworn in.

if you would please raise your right hand. i will read the oath. do you solemnly swear or affirm under the penalty of perjury that the testimony you are about to provide will be the truth, the whole truth, and nothing but the truth to the best of your knowledge? thank you very much, gentlemen. i will show the amazing non- partisan attitude of this

commission. >> mr. zubrow, will begin. >> my name is barry zubrow. and the chief risk officer of j.p. morgan chase. i have served in that role since i began working there in 2007. thank you for the invitation to appear today. you have asked me to address several topics, including our crapo program. -- repo program. j.p. morgan provides clearing services in the united states. reservist try party -- serve as triparty subsidiary. in process known as and wind, j.p. morgan -- these advances were entirely discretionary. they were meant to be fully

collateralized by the securities being repurchased. on a typical day during summer, 2008, these events is exceeded $100 billion daily. as of late 2007, j.p. morgan generally took no margin for hair cut on these large, discretionary loans we made to lehman each morning. this magnified the risk that j.p. morgan would be unable to recoup the full amount of our evinces if the collateral had to be liquidated. -- our advances had been liquidated. we begin taking margin on the intraday advances made to all of our broker clients. in addition, jp morgan executives held a high-level meeting with lehman in june, 2008 to discuss the unique risks we face from the on wind and the intraday extensions of credit to lehman -- unwind and the

intraday extensions of credit to lehman and identified a billion -- billions of dollars of shortfall. by late august and early september, 2008, lehman's deteriorating financial condition was becoming increasingly apparent. nevertheless, we were determined to support lehman by continuing to unwind the book each morning, otherwise acting on a business as usual basis. our growing exposure to lehman also included derivative transactions for prime brokerage clients and requests by counterparties for renovations. j.p. morgan understood that lehman's credibility and the markets could collapse instantly if j.p. morgan declined to take on this additional exposure. to protect ourselves, without triggering a run on lehman, we requested $5 billion in additional collateral -- an

amount which was far from sufficient to cover all of our potential exposure to lehman, but that we believe the lehman could reasonably provide appeared on some timber 9, lehman agreed to pledge additional -- provide. on september 9, lehman agreed to pledge additional collateral. analysis performed around of number 11, 2008 indicated that some of the largest pieces of collateral that lehman had pledged were illiquid, could not reasonably be valued, and were largely supported by lehman's own credit. this was inappropriate collateral because it was essentially claims against lehman pledged shoe secure other claims against lehman -- pledged to secure other claims against lehman. as the week progressed, we requested an additional $5

billion in cash collateral. this was still less than what we believed could be justified as a risk management matter. it was an amount that we also believed, based on their own statements, that lehman could handle. notwithstanding our efforts to provide support to lehman in the marketplace, and run on the bank eventually and sued for reasons wholly unrelated to j.p. morgan. we never turn our back on our clients. we continue to make enormous contributions. we accepted novations. even after lehman filed for bankruptcy, jp morgan extended tens of billions of dollars to credit to them on a daily basis, allowing them to stay afloat long enough to sell their business to barclays' capital and transfer more than 100,000 customer accounts. as a result of our continuing

support, jp morgan ended up with nearly $30 billion in claims against the bankruptcy. more than $25 billion arose out of exposure that j.p. morgan took on after the lehman bankruptcy filing as part of our efforts to support lehman in these increasingly distressed markets. i appreciate this opportunity to share my views and i look forward to your questions. >> thank you very much. mr. miller? >> microphone, please. >> thank you, mr. chairman. they appreciate the opportunity to testify. my name is harvey miller. i'm an attorney and partner in the firm of weil gotshal and manges, which is the major firm involved in the bankruptcy case of lehman brothers. my role is to provide the circumstances surrounding the background of this case. it would be virtually impossible to summarize in five minutes my

written testimony, but i will do the best i can. the commencement of a formal bankruptcy case was totally unplanned. a bankruptcy was never in contemplation by lehman as they struggled to the slowdown during 2008 and was subjected to the negative affects a bear stearns in march of that year. at the time of the bankruptcy filing, they were the fourth thus largest investment firm in united states. the consolidated enterprise had assets of over $6 billion and liabilities close to that amount. the lehman enterprise was global. it operated pursuant to a classic holding-company structure. lehman brothers holdings was the parent corporation. they managed and directed the subsidiaries and affiliates. they had over 8000 subsidiaries, with about 100 active. lehman's business included derivatives, commercial loans,

underwriting, real estate, bank ownership, and broker-dealer operations. at the time of the filing, they employed approximately 20,000 -- 26,000 people. over 10,000 employees were located in new york city. each day, they engage in thousands of transactions involving the movement of billions of dollars. the parent corporation was failing enterprise. generally, each night cash was swept into cash concentration accounts at the holding company. each morning, it was disbursed to various subsidiaries and affiliates as needed. lehman's cash needs were supported by substantial borrowings. a large portion of those were short-term, which negatively affected their ability to refinance as the economy slowed and was adversely affected by the subprime mortgage crisis. their liability was dependent on the confidence of the financial

markets and the public. any disclosure of bankruptcy consideration would have been disastrous to continued operation. public comments made after the collapse of bear stearns by various had one spokesman and others as to their legend insolvency -- their alleged insolvency had a negative effect. their condition deteriorated and was aggravated by the announcement of-quarterly earnings. as the week progressed, lehman situation became more precarious. there were bombarded by demands of clearing banks for additional collateral, security, and guarantees. lehman was confronting a major liquidity crisis. substantial pressure had been applied and was intensified to find a major partner -- merger partner or sale to resolve the financial distress. negotiations are ongoing as to a possible merger or sale involving bankamerica or

barclays. my involvement was during the week of september 8, 2008, when my firm was first contacted as to potential bankruptcy planning. at that time, almost all senior lien and personnel were involved in merger -- a senior lehman personnel were involved in merger discussions. the direct personal contact began during friday, september 12, when there was a meeting with representatives of the federal reserve bank of new york to get a determination as to the liquidity of lehman. that meeting was attended by large portion of the financial staff of lehman including the cfo. it was reported that lehman would not be able to give a complete picture on its liquidity until the close of all the markets and all the information came in from its

global offices. the conclusion would not be available until late at night or saturday morning. the events that followed after that were very dramatic, including meetings over the weekend at the federal reserve bank of new york to the net of those meetings was a decision that was made where lehman was told there would be no federal assistance. essentially, they were directed -- suggested that lehman representatives returned to the headquarters. a meeting of the board of directors convened. lehman should adopt a resolution to commence a bankruptcy filing before midnight. that was an impossible task. after consideration of the inevitability of bankruptcy because of a lack of liquidity, a bankruptcy petition was filed at 2:00 a.m., electronically with the united states bankruptcy court of the seventh district of new york. there were many evens and

factors that went into what occurred here the system the consequences that resulted during the following week -- i am happy to have opportunities to answer any questions the commission may have. i refer to my written testimony as to the circumstances which surrounded the filing of the bankruptcy petition. my conclusions and opinions are included as to why that decision was made by regulators. thank you, mr. chairman. >> thank you, mr. miller. mr. fuld. >> thank you for your invitation. lehman's demise was caused by uncontrollable market forces and the incorrect perception and accompanied rumors that lehman brothers did not have the capital to support its investments. it resulted in a loss of confidence which undermine the strength and soundness of the firm.

it threatened the stability of other banks, not just the women. lehman was the only firm that was mandated by government regulators to file for bankruptcy. the government was then forced to intervene. in march, 2008, bear stearns nearly failed. i believe then and still do now that, had the fed been opened the financing window to banks before that window, it might have provided the necessary liquidity to keep bear stearns operational and might have lessened the need for additional government intervention. with bear stearns gone, lehman was the next smallest investment bank and it became the focus of the marketplace which was subject to increase in-and inaccurate or -- increasingly negative and inaccurate rumors. we further strengthened our

capital and liquidity positions by raising 10 billion -- $10 billion of new equity and pursued a wide variety of new capital opportunities. during that time, clinton proposed a government regulators convert -- lehman proposed a government -- to government regulators several things, which were denied. on gun and rumors about lehman's continued -- an unfounded rumors continued -- and founded -- unfounded rumors continued. without confidence, no bank can function or continue to exist. the loss of confidence from women, although unjustified and irrational, -- from lehman, although unjustified and irrational, started a run. lehman was mandated by federal

regulators to file for bankruptcy. on that same day, the fed expanded the types of collateral that would qualify for borrowing from its primary dealer credit facility. only lehman was denied that expanded access. i submit that, had been in been granted that same access as its competitors, even that sunday evening, lehman would have had time for an orderly wind down or an acquisition, either of which would have alleviated the crisis that followed. there are a number of incorrect claims which have been held up as explanations for lehman brothers's de-. these could -- lehman brother's demise. these are still being made. they are still not true. i believe the committee needs to hear what is true. there was no capital hold.

we had $28.4 billion of equity capital. in contrast to the mark to market determinations, even the lehman bank examiner found in material differences in the firm's asset valuations ranging from all low of $500 million to a high of $1.7 billion. even assuming that full amount of write-downs, lehman still would have had $26.7 billion in equity capital. positive equity of $26.7 billion is very different from the -$30 billion --negative $30 billion perceived by some. lehman financed itself and did not need access to the fed. in addition on monday, september

15, the broker-dealer subsidiary borrowed billions of dollars from the fed, pledging no perceptible collateral. the fed was paid back 100 cents per dollar. what we needed was a liquidity bridge. we have the capital. in the indeed, lehman was forced into bankruptcy, not because it neglected to act responsibly or seek solutions to the crisis, but because of the decision based on flawed information not to provide women with the support given to each of its competitors. in retrospect, there is no question we made some poorly- time business decisions and investments, but we addressed those mistakes and got ourselves back to a strong equity position with a capital ratio of 11%. we had fun danceable collateral and had solidly- -- financeable collateral and had solid operations.

i have spent my entire -- i had spent my 40 years of business at lehman brothers. i was proud to be its chairman and ceo for its last 14 years. thank you for your time and i look forward to addressing your questions. >> thank you. mr. baxter? >> members of the commission, thank you for the opportunity to speak about the events that brought lehman brothers to bankruptcy. the events that occurred during 2008 when our nation was in the midst of the worst financial crisis it has experienced since the great depression. i would like to start with the question i am often asked about lehman. why did you allow lehman to fail? it is understandable, but it contains a false premise. the federal reserve did not allow lehman brothers to fail. instead, the federal reserve, the treasury department, the s.e.c. and others tried to avoid

this systemic consequences we have seen. in my written testimony, i discuss in greater detail the federal reserve actions. but now, given time limitations, i will focus on two matters. we needed a suitable merger partner for lehman. second, we needed that merger partner to provide a guarantee similar to the one that j.p. morgan chase provided in its acquisition of bear stearns. they agree to backstop nieman's trading obligations between the signing of the merger agreement and the merger closing. by sunday, september 14, a group of lehman creditors and counterparties had agreed to finance approximately $30 billion of lehman's the liquid assets to facilitate a lehman rescue. an indispensable element of the

plan, however, as secretary geithner and others have pointed out, was a willing and capable merger partner. as of friday, there were two candidates -- bankamerica and barclays. on saturday, september 13, bank of america reached an agreement to acquire merrill lynch, leaving barclays as the only potential acquirer with the resources and ability to merge with lehman. on sunday, september 14, with the consortium's financing committed, we learned for the first time that barclays could not deliver the needed guarantee without a shareholder vote bang, which could have taken months. there was no way to predict if the shareholders would even vote for the transaction to proceed. lehman simply did not have the luxury of that amount of time. i explored with counsel whether the u.k. government or the financial services authority

might waive this requirement so the guarantee could go forward and the rest you could proceed. i learned that the u.k. government was not amenable to a waiver. barclays cease to be the cable buyer that we needed to rescue lehman. -- ceased to be the capable buyer that we needed to rescue lehman. our experience with bear stearns is most instructive. ear, we had jp morgan chase, which guaranteed their operations from march, 2008, to the merger closing of june, 2008. this kept bear from being a growing concern and provided the necessary protection to dr. park res -- to counterparties.

if, during that critical time, a merger falls apart because of a failed shareholder vote, the counterparties will not be protected against the obvious risk of the target bankruptcy. many have asked why the federal reserve did not intervene and guarantee the trading obligations of lehman pending its merger with barclays. they observe that we lend approximately 20 billion -- $29 billion to facilitate the mortar -- the merger of j.p. morgan chase and bear stearns. they looked at our commitment to lend up to $85 billion to aig. under the law, the new york fed does not have the legal authority to provide what i would characterize as and a and naked -- a naked guaranteed.

lehman had no collateral to satisfactorily games such a guarantee. what without security, a guarantee of this kind would present enormous risk to the american taxpayer. upon default, the taxpayer would be liable for lehman's trading obligations. in end, no west was affected because we had no willing and capable merger -- rescue was affected because we had no willing and capable merger partner. thank you for this opportunity to speak to you today. i look forward to answering your questions. >> thank you, mr. baxter. we will now begin questioning. mr. fuld, i will start with you. you indicated that lehman's demise was a result of turbulent market conditions. would you stipulate, given the growth in your institution, the extraordinary leverage, the nature of the assets, the risks taken by the institution -- all

of that led to the demise? >> let me try to speak to that. you are asking me specifically how did we grow and what was the basis upon which we grew, thereby increasing risk? >> i am talking about your leverage ratios, which exceeded 30-to-one by 2007 -- 30-to-1 by 2007. the risk and the enormous growth of the company. you're aggressive risk posture -- your aggressive risk posture. >> i would say that aggressive risk posture is not an accurate depiction of how we ran lehman brothers.

our balance sheets certainly did grow. a group -- it grew as we regained and increased earnings which became net worth and equity capital. we did come in fact, in 2007, run a higher leverage ratio. at least half was our matchbooi. -- matchbook. we were one of the largest government dealers in the world. it was part of what brought to the government other securities. having said that, we did, in fact, have too much commercial real estate, as i have spoken about before. we had about $129 billion to $130 billion of less liquid assets, which included about $50

billion, maybe more, of commercial real estate. we brought that down to $30 billion. we had $45 billion of leveraged loans, which we brought down to about $9 billion. we had about $35 billion of residential mortgages, which we brought down to about $17 billion. $4 billion of that $17 billion was sold to black rock prior to our filing, which never got consummated. all in all, we had about $130 billion and we brought that down to about $69 billion. we brought our leverage down by increasing our capital, by taking $25 billion of write- downs, and by selling a lot of these less liquid assets. we de-risked our positions. by the time we got to the third

quarter, we had a tier 1 capital ratio that was close to 11%. but a number of standards, that is fairly solid. we had a strong liquidity pool, which unfortunately evaporated in three days after the run on the bank ensued. i believe, to this day, that our actions -- bringing down the balance sheet, raising capital, pursuing solutions with the regulators without asking for bank-holding company status, trying to pursue capital providers or actual buyers of the firm -- we pursued everything we possibly could to have prevented what occurred

september 15. >> let me ask you a couple of quick questions. yes or no or your best recollection. were you ever told by federal officials that there was no authority under 13-3 to lend to you or provide liquidity pre- bankruptcy? were you told that was the bar? >> i never had that conversation, to my recollection. rick are you aware of any collateral analysis that was done by the federal government or the federal reserve board of new york or by other federal entities in terms of the inadequacy of your collateral? were you ever presented with their assessment of your collateral? in the in -- and the insufficient heat thereof? >> not our collateral, is physically. we did have three meetings with the federal reserve bank of new york now reviewed -- not reviewed our funding

capabilities -- not -- backed -- that reviewed our funding capabilities. these were funding reduced. i actually participated in all three of them. there were different other people who participated. r c f zero, art treasurer, our senior officers -- our cfo, our treasurer, our senior officers. i never got any feedback, certainly no negative feedback. >> earlier into the day we entered into record a chronology from our staff based on supporting documents. i have a couple questions i would ask you and mr. baxter about. if you look at this chronology -- you live so that you do not have to every of -- have to

review -- it starts with the acquisition of bear stearns by j.p. morgan and concludes after the bankruptcy filing. here is what i take from it. we're looking back and trying to discern what happened. the federal reserve has said assistance was not extended -- what was the policy decision, the strategic decision, the why of not assisting lehman or not assisting in a way where there could be a more orderly wind down? when i look at the chronology, my first take away is that it seems to me that, over several months, what ends up being made is a conscious policy decision not to rescue the entity. that is my reading of the documents. it seems to me, during this time, there was financial assistance considered with no

legal bar being offered. in july, bill dudley talks about on may billing type of facility. -- and made in lane -- a maiden lane type of facility. there was -- there are a number of points along this chain. for example, heine as late as september 10, fed assistant general counsel and e-mails scott alvarez been saying that the working groups have been directed to flesh out how fed assistant be of the acquisition

transaction -- bankamerica acquisition transaction might look. he told the bankruptcy examiner that government assistance was possible as late as september 11. there's an e-mail from mr. parkinson that were first on september 11 to a federal court in new york financial commitment. -- that refers on some timber 11 to a pedro court -- on september 11 to a federal court in new york financial commitment. he said that he "cannot stomach us bailing out lehman." it would be horrible in the press. there is another e-mail on the 14 saying it does not seem like it is going to end pretty. no way government money is coming in. i am here writing the plan for an orderly winddown.

i also did a call with the white house. there is no money. no way in hell paulson could blink now. i see consideration of financial assistance and political considerations. there is a recognition of systemic problems, but there is no rescue in the end. do believe it was a conscious strategic and political decision? was it just the surprise of barclays not happening? what you think is the reason for the decision not to rescue or provide liquidity for an orderly winddown? >> i apologize. i thought you addressing that mr. tasker -- mr. baxter. that was a lot. i was not privy to that information that you just went through.

i was not part of the conversations over the weekend. for us, it was less about -- i understand the noise about crisis and bailout and moral hazard. lehman had the capital. we needed the liquidity. we went into the last week with over $40 billion of liquidity in lost close to $30 billion in three days in a classic run on the bank. we needed the liquidity. i really cannot answer you, sir, as to why may all chose not to not -- why they all chose not only to subside report --

provide support for liquidity, but also not to have opened the window to lehman that sunday night as they did to all of our competitors. i must tell you that when i first heard about the fact that the window was opened for expanded collateral, a number of my finance and treasury team came into my office and said, we are fine. we have the collateral. we can pledge it. we are fine. 45 minutes later, they came back and said that when all is not open to lehman brothers -- that window is not open to lehman brothers. regret that is in the chronology. -- >> that is in the chronology. mr. baxter.

i never see anyone say that we cannot do it because the condition of lehman will not allow it. i also see in this chronology that treasury -- someone at treasury action is says that the fed has plenty of legal authority to provide liquidity. he talks about the authority and there is also an assessment about impact, an acknowledgement that, for example, it would be much more -- there was a september 11 memo saying it would be much more complex to unwind in men's positions then -- lehman's positions then bear stearns because lehman has more. there is another study which said there would be a tremendous

impact. the size of the book was much larger, about $182 billion vs $50 billion to $80 billion. tell me about the policy considerations. were you saying it was never legally possible? it seems that there was a helluva lot of debate about whether or not to rescue. none of this was cut off by a legal opinion. we saw in the what cobia -- wachovia instance. you're saying there is no legal authority. i see no evidence of the inability to act illegally. >> let me see if i can clarify what happened from the week beginning september 8 until september 15. it is not true that no federal

assistance was provided to lehman. i'll explain that in a minute. >> are you talking about the lending post-bankruptcy? which was substantial. >> yes, sir. i will explain that. it is important to understand the experience we went with. our principal plan was to facilitate a merger between a strong merger partner and lehman. that was our first plan. rest assured, commissioners, we worked night and day to try to make that plan happen. it was not about politics. it was about getting to the right result. as i explained in my full statement and my oral statement this morning, we had a problem with the facilitated-merger and acquisition in that we could not get the guarantee that we needed. the first question was, we have

financing -- $30 billion from the private sector. reminiscent of 1998 with long- term capital management, i was there. we have the private-sector financing lined up, but it boiled down to the guarantee. there is a legal question. could the fed issue and the guaranteed -- a naked guarantee? the answer to that question is a matter of law. it cannot be done by the federal reserve. look at what happened in congress in october, 2008, when an express guarantee was conferred on the treasury. i am talking about section 102 of the emergency economic stabilization act. the fed has no such legal authority. the reason is that in section

13-3 of the federal reserve act, there is a requirement that we are secured to our satisfaction. a naked guarantee does not meet the statutory requirement. that plan could not be executed. secretary geithner or, when i worked for him, when he was president of the new york federal reserve bank, used to say to the staff plan beats no plan. he was not going to allow us to be in a position where we had no contingency plan. our contingency plan for the facilitated merger acquisition of lehman was the following. the parent would file a chapter 11 petition. the u.s.-brokered-dealer would stay in operation with the benefit of federal reserve liquidity until such time as a

proceeding could be commenced under the securities investor protection act. that was the contingency plan, if you will. let me give you a dimension. >> let me ask you a question. you have resumed this would be unsecured. -- presumed this would be unsecured. >> i am moving on to describe the secured facility. we had two widely-available programs. one was the primary dealer credit facility which mr. fuld mentioned. we also had one that we initiated before bear stearns. the third were routine, open market operations. those facilities were fully available to lehman. the question was would we continue those post-petition.

we decided the answer would be s. on monday, september 15, in the evening -- i am talking about the petition by the parent -- we extended credit to the broker- dealer in the amount -- this is apartment -- of $60 billion across a primary dealer credit facility and open market operations. it was all fully secured. but i have a question -- >> i have a question. why was it not extended prior to that? >> the facilities were available to lehman precondition and post addition -- pre-petition and post-petition. mr. fuld is incorrect. there is a letter statin gthat --stating that these were available. they were used.

$60 billion, then another $45 billion. there is a misunderstanding about what happened here. there is lending to the broker- dealer after the petition was filed and it was fully secured. that distinguishes this situation from the naked guarantee which was not secured and not limited and not within the authority of the federal reserve. >> i will return for more questions. first, the vice chair. >> thank you, mr. chairman. for those of us who reside in the second half of the alphabet, we appreciate your courtesy in starting with z and working over to b. you are not familiar with how rarely we get that kind of an offer. i would ask each of you to verbally respond to our request

that, as in the case with every panel, we wind up with questions after the panel is over. if we can submit written questions to you, would you give us a timely written response? >> yes. >> thank you. ds.is hard to record head nonc i am willing to admit that i have never had an interest in or followed -- although i had to -- all the intricacies that we're trying to discuss. i will ask some questions that are just kind of questions that most anyone would ask. we focused on bear stearns. we understand j.p. morgan was willing to take on that relationship. this was in march, right?

to designate. -- 2008. even its continued on for five months, going on 26, by the time we got to september. could any of you getting on -- give me an understanding on folks who saw what happened to bear and you are looking -- did not somebody start looking around and beginning to assume if what happened to them -- there but for the grace of god -- not in maybe me -- now it may be me. was there any concern about looking for potential connections?

was there discussion on the street or behind closed doors? at the fed, were you talking about hooking up other marriages? what was going on during that time. -- time period? >> at the time of bear stearns, the record book, as i understand, speaks to j.p. morgan's first, second come and third cut -- second, and third cut at acquiring bear stearns was negative. the fed continued to give comfort to consummate the transaction. when that transaction was finished, it set two precedents. one -- very difficult for new

capital providers to understand where the government was in their position, to either be part of it or not part of it, to provide liquidity. the fed did open the window after bear stearns, which was a very positive move. that did answer the question of liquidity. to a number of other investors and counterparties, that did mean that the fed was there to provide liquidity for noncommercial banking entities, meaning investment banks. it also set another president -- precedent. the terms bailout and crisis -- had the fed provided liquidity prior to the bare problem, those

words would never have been used -- the bear problem, those words would never have been used. it would have alleviated the problem. i cannot talk about what would be in their book. i do not know. it would be inappropriate. their stock dropped. you correctly said earlier -- i do not know how those assets changed so quickly. there was a time of a loss of confidence. stock prices were going down. investors were saying -- if there continue to be asset sales, will these firms have enough capital to support those losses? that was the beginning. during that entire time, all the banks, not just lehman,

derisked and raised capital. lehman raised $10 billion of new equity capital. if you look at our total net losses, we raised close to -- i think it was $37 billion or $38 billion than we lost net. with all of our capital raises and all of our net losses, we came out close to $4 billion of additional capital then when we started. i do not want to take you through the whole litany again. >> that is ok. i want to make sure i understood you correctly. you said that lehman did not have the collateral to back a sufficiently large bridge loan.

is that correct? >> no. i was talking about the naked guarantee of the treaty obligation -- trading obligation. if you look at the transaction between bear stearns and j.p. morgan chase, you will see a guarantee without limit and that was not secured. we were working off that model. the fed has no authority to issue that kind of guarantee. >> i understand that. what i hear nieman's saying is that they needed some assistance -- lehman saying is that they needed some assistance on liquidity, a liquidity bridge if not a collateral bridge. why was barclays the only one who stepped up? were there others? >> in the period leading up to that weekend, from mid-march,

2008, to september, 2008, on what i read in mr. valukas's report, mr. fuld was trying very hard to find a merger partner for lehman. mr. fuld did not succeed. the government was trying to facilitate a merger of lehman by coming up with a private-sector group who would finance the liquid assets and make lehman more amenable to an acquiring institution like merrill lynch or barclays, which were the two institutions that were into -- that were interested in a possible merger at the time. the really important thing to focus on is that we had committed financing. we had gotten to that by

september 14. $30 billion was going to be provided by these private- sector institutions to take the a liquid assets out of lehman and facilitate the merger. that is really important. even with that, we could not get the deal done. the problem -- >> barclays was a foreign bank? >> they could not provide a timeline guarantee. bank of america decided to merge with merrill lynch on saturday, september 13. so we could not get the merger done via the question then became, what is the best alternative plan? in our view and the view of our advisers, the best plan was to put the parent into the chapter 11 proceedings and keep the u.s. broker-dealer alive with bridge financing of the fed, not waiting for some other hypothetical merger partner to arrive, because we did not think

that would ever happen, but alive long enough to conduct an orderly winddown until we could do the proceedings. that was the contingency plan. >> on page 9 of your testimony, and this is where i need you to explain, you say detect in this case, lehman had no ability to pledge the amount of collateral required to secure a fed guarantee -- one large enough to credibly withstand a run by lehman's creditors and counterparties. how short were they? >> let's imagine an unlimited guarantee of the trading obligations of lehman which was $600 billion in assets size. how much collateral would you need for a guarantee of that kind? you can imagine that happening under the new authority in the

emergency economic stabilization act. how would used for that for purposes of the authorization? would wipe out the entire authorization? perhaps. that is the point i was trying to make, perhaps in elegantly -- inelegantly on page 7. women did not have the hundreds of billions of dollars -- lehman did not have the hundreds of billions of dollars of collateral. >> they did not have that and they went into bankruptcy. in hindsight, was that an indication that they were too big to fail? was it evidence that you could go to -- you went fairly close to the border and that they were not too close to fail -- too big to fail?

the consequences of them failing were expected? what would have happened post- lehman had there been abridged sufficient -- a bridge sufficient, although i do not understand what it was a bridge to if there was no one to acquire them? we thought it -- >> we thought it was a bridge to nowhere at that time. i do believe lehman was systemic. i do not believe lehman was the only systemic trigger during this incredible month of september, 2008. lehman was not our only problem. the day after they filed their petition, we had aig, then wamu at tehe end of the month. this was an extraordinary public in the crisis -- point in the

crisis. >> had lehman failed in may, it might have been a different circumstance prior to this extremely confusing month of september? >> it would have been systemic in may, march, and it was in september. >> i want to reserve my time. i know there are others who have questions to ask. i took more than my usual time in the first panel. >> more coverage now from the financial crisis inquiry commission. federal reserve chairman ben bernanke talks about what happened in 2008 and financial regulations that have been put in place. this is a little over two and a half hours. >> good morning.

welcome to the public hearing of the financial crisis in greek commission. this is our second day examining -- inquiry commission. this is our second day examining institutions which have become too big, too important, to systemic to fail. we looked at a good case studies -- at two case studies yesterday. this morning, we will hear from the chairman of the federal reserve, ben bernanke, as well as the chair of the f.d.i.c., mr. liber -- ms. sheila bair. thank you. this is the second time you have come before this commission. first in our offices for private session when we first convened. i believe that was almost a year ago. today, in what will be our final hearing in washington, d.c.,

although we will then head across the country to a number of communities in california, nevada, and florida to hold hearings in communities that are still gripped by high unemployment, high foreclosure rates. we will go there to see how this crisis was sown and what its consequences are today. we'll ask you to stand so i can swear you in as a witness. raise your right hand. do you solemnly swear or affirm under penalty of perjury that the testimony you are about to provide will be the truth, the whole truth, and nothing but the truth to the best of your knowledge? thank you very much, mr. chairman. thank you for your extensive written testimony. we would like to ask you to speak to us orally and take up to 10 minutes to give your

opening remarks. upon conclusion of your opening remarks, we will move to questions from commissioners. mr. chairman, the floor is yours. >> thank you. i will not take the full 10 minutes. we will submit additional answers to your questions very shortly. members of the commission, you are charged to examine the causes of the recent financial and economic crisis. that is important. by understanding the factors that led to an amplified cresses, we can hope to guard against -- crisis, we can hope to guard against usual -- future situations. in my view, the too big to fail issue can only be understood in the broader context of the financial crisis itself. in my full written testimony, i provide an overview of the factors underlying the crisis

and the problems that complicated the management of the crisis. understanding the causes -- in understanding, it is essential to distinguish the triggers that touched off the crisis and the structural weaknesses in the financial system and in the regular edition -- and in the regulation that amplified ocks. although a number of developments help to trigger the crisis, the most prominent was the prospect of significant losses of subprime mortgage decline whileame potential subprime losses were larger in absolute terms, a judge in relations to global financial markets, or not large enough to account for the crisis on their own. instead, the assistant pre- existing vulnerabilities -- the system's pre-existing vulnerabilities are the primary explanation for why it crisis had such devastating effects on the financial system in the broader economy. let me give an illustration of how vulnerabilities greatly

increase the effects of the 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 bad scenarios

the total losses in some prime mortgages were unlikely to be $300 billion which is a lot of money when compared to global financial markets. it was just a 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 another risk as well. i don't think we have the nuclear power type of model at this point.

>> can i have two additional minutes? >> i can't say no to you. >> two minutes for the senator. >> i was intrigued by your statement that there were some indicators, some markers of whether this more rigorous supervision is accomplishing its objective. in the vertical column, what are those indicators particularly that have some capacity to be quantified to answer the question is the tougher regulation working? >> one importance of indicators relates to the cost of capital to these 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 intensification of the general run on the international banking institution. that is a significant concern. as i talked to the commission when we met a year ago there were a number of other features of aig that were also concerned but that was an important one. >> so in other words, in addition to the real credit exposures and financial difficulties that might have been expected there was

uncertainty about what the exposures were and what institutions had them, how much they were, lack of transparency in this market, in essence fueled the panic. >> absolutely. >> you quite appropriately in your testimony distinguish between derivatives transactions themselves and the infrastructure for trading clearing, settlement of those instruments. ..

so in your review, was the trading of derivatives over-the-counter as opposed to exchange trading and derivatives a problem i posed some risk because of the lack of transparency, because of the existence of counterparty risk in the over-the-counter arena. >> yes, certainly. and ahg is the poster child for that. it was not so much the loss of their counterparties experienced under themselves, but rather the counterparty risk that was the

problem. i'm sure you know that the fed was quite concerned about teer one settlement arrangements in the federal bank of new york and a lot of work to try to improve arrangements for credit derivatives and also some other types of derivatives. and we were very supportive of the provisions in the recent financial reform legislation to standardize derivatives and put the month until counterparties and the lake. the point that should be making a know you fully recognize if you're going to concentrate counterparty risk in central counterparties, that they must be saved. and for that recently that it was important to entitle the fed and other agencies work together to make sure that potential standards for a post on this counterpart -- central counterparties as well. but i agree with what you just said. one final comment is that another area where the are active in strengthening the

trading boat in the capital requirements for banks, which essentially will make it more costly to the extent that things still use over-the-counter true for days the capital costs will be higher, reflecting the underlying risks, both counterparty and fundamental risks. so that's another incentive to put these instruments on exchanges. >> we have heard from the fed -- the federal reserve staff yesterday about interconnectivity of large financial institutions through their counterparty exposures and oct derivatives, contracts and that the relevance of that in assessing systemic risk of those institutions. and i wanted to ask you about

lehman brothers, for example. and you have said if it had been -- you knew before it was allowed to fail as this failure would be catastrophic. in mr. baxter said yesterday that there was a significant concern beside it the otc derivatives market would be severely impact to pay the failure. was this a concern of yours with respect to lehman brothers? didn't also enter into your concerns about bear stearns and wachovia and other large institutions with concentrated derivatives positions?

>> yes, it's not the only aspect of interconnectedness. there's a lot of a lot of funny relationships on so on. but it certainly is an important one. it's very difficult to unwind these positions and when you lose a counterparty, then you have to replace your protection. and so, it was a significant concern and one indication of our concern about lehman was we took a lot of steps to try to put foam on the runway so to speak is the expression went. and one of those things is to work with otc markets to get them to address these concerns. another dimension of this, by the way, what are the things we got to work out very quickly with the credit default swap's in lehman that others were trading and trying to range for settlements of those as efficiently as possible to get into problems with counterparties and ambiguity

security that itself is a fairly complex process. so the short answer to your question was this was an important aspect certainly for the investment they, lehman, bear stearns and a certain extent to the other institutions that have broker-dealers in this kind of exposures. >> and i just have time for one last -- >> two minutes at >> that would be fine. with respect to these concerns, i assume that the concerns went beyond credit default swap's two-out over-the-counter derivatives. as you know, credit default swaps were relatively small amount of the over-the-counter world of two rivet is at that point. and there were massive connections with other kinds of over-the-counter derivatives between the big dealers like the

investment banks and their counterparties. and that the same problems of potential credit exposure, lack of transparency, potential, concerns about what the exposures were applied generally to the whole over-the-counter derivatives market. >> yes, there is some types like equity trivet is that shared some of the problems, operational problems they had in terms of clearing the settlement. the more generally, when they spoke derivatives, for example, you had both counterparty risk and he also had the complexity of trying to value the positions and that becomes serious when you're trying to come in a crisis, trying to figure out what exposures are and whether a company can solve it or not. so, yes.

>> thank you. >> mr. hennessy. >> thank you. thank you, mr. chairman. yesterday mr. fuld argued it was unsupported by the reality of the day. we heard the same thing from bear stearns that there found was financially healthy and they're what down by whispers and rumors and unsubstantiated fun. i believe i heard you just say it that lehman is probably insolvent. in your view, did lehman and they are fail all my because of unjustified the quiddity runs or were there also general solvency problems that arose? >> so as i said before, one of the reasons the ceos also coincided with there is a general planet. it was obviously general financial crisis that will put the companies under extraordinary strain. that being said, there were

certainly a hierarchy and weaker companies were certainly the first to feel pressure. the bear stearns is widely viewed to be the weakest of the investment banks and lehman was widely viewed to be the second weakest and so on. and they were clearly lost his in the quiddity issues that those companies. in particular, in the case of lehman, they had raised some capital and the spring, but they have not succeeded in spinning off a substantial position that a lot of embedded buses and they've not succeeded in raising additional capital that they were able to persuade new investors to come in. and so it was a combination of general feel, certainly, but also some legitimate concerns about both the asset position of the company. you know, its balance sheet, but also i think some concerns about

the longer-term viability of the firm, business model and other issues that are concerning hoax as well. and it's the nature of financial institutions that they live on compliments on their counterparties and customers and predators don't believe there is sustainable, then the pressure amount greatly. >> i hear a lot more discussion on how to present prevent failure and what will happen and what failure occurs. now the government has a new resolution authority at one point these large non-bank financial firms will have living wills. but those mechanisms are not yet in place. it takes time to implement them. we were discussing force of the international aspects of resolution authority which i imagine our nightmarishly complex. and at the same time, you're 13 authorities are curtailed and they won't be t.a.r.p. around. are you confident that the

government, including the fed has the tools and means to deal with a failure of a too big to fail for if and when they should next occur? >> while i prefer that to be tested in the next few days if you wouldn't mind. that being said -- >> i hope i won't be the case. >> that being said, the fdic has embarked on this at admiral urgency at chairman bair will tell you in a little while and then moving to set up the rules which we needed to implement this and it's not only a question of implementation, but i think the benefit of this and i'm sure mr. wallison would agree to have been certainty in advance about how the process will be run and what the effect will be on predators and so on a firm. so it is a work in progress

right now for sure. but we're working very quickly to try to put it into operation. >> if i could come is it just a timing thing of getting his mechanisms up and running. if you don't have the ability to provide a firm number anymore and the t.a.r.p. isn't there to provide capital injections, is there a scenario which you might meet the money into a firm where there is or is not a tool to actually do that? >> remember the treasury can provide the loan as long as it's repaid, either from the company in receivership or if necessary from an assessment of the financial industry. so if money is needed to prevent the disorderly failure or to facilitate the bridging process, et cetera, then the government can provide that. and the fed meanwhile is of

course limited in our ability to go beyond just our normal lending to a sound company. but that was a change we were comfortable with as long as these alternative authorities were provided. systemic risk. i hear a lot of people talk about it. i haven't heard a precise definition other than people usually say it means risk to the system, which doesn't -- [laughter] and i understand there's always going to be discretion involved in than it's been much more of an art than a science. are there efforts underway or is anyone dead in the good work in trying to turn this from an art to science to eventually some sort of engineering where you can measure this and analyze systemic risk? >> yes, there is right now and academic research literature looking at some of these things, trying to identify, for example, with some of the material are,

how big, how connected, those sorts of things. or some criteria involving things like correlation, how correlated it is a stock of company acts with other shares of other companies and what does that say about it systemic importance? dearth of academic literature under way. the federal reserve has to set up a set of rules that will govern how we recommend to the oversight council which companies are to be treated as systemically critical for the purposes of oversight. and so we're going to have to read which puts down on paper, in a way that is likably sensible what are the criteria were looking at. so to some extent, it also remains subjective and the criticality of the firm depends on the environment. so our decisions vis-à-vis his own firms redress in a calm

environment. for the overall economic and financial betterment matters, not just the firm. but we are cognizant we need to be more specific. as i said there was literature to draw and we have a project in the fed right now trying to write this ruled that will govern our recommendations. >> good. i'll end with an easy one. other then your speech is, what do you think are the most important writings on the crisis of the whole? if you could recommend that people read two or three really good speeches, books, papers, whatever they happen to be. what are the most important are underappreciated work? by the way that pre-pre-13 when i book comes out. >> i think there's a lot of interesting work. i know you're familiar with sort of the narrative histories and so on and i won't bother to go

over those, but i cannot stand to profit cereal, there's an interesting academic work already looking at these issues and i even made reference in a testimony to carry gordon's work, where he is pretty clear to identify the analogies between what happened to the shadow banking system and classic tinkerings, 19th 19th century style bank runs. i think those are interesting. there's also quite a bit of interesting work, people like marcus britton meyer at princeton, which looks at the turning max of a panic in the repo market and how the cycle of increasing haircuts and margin were. and he and others have also done the the work or for trade moment ago in trying to identify critical firms are looking at their characteristics. maybe i could come up with a few other things given it a little bit of time. but there is some interesting work underway in this area.

>> could you provide is chairman bernanke's fall pretty messed? >> only if you take a test on it. last night we're taking a test. >> all do that. >> and we may post this on the website feature benefit day. all kidding aside, there would be great if there were few pieces. >> if you understand the lord a finance book which was pulitzer prize of the history of the great depression and you feel sometimes this seems awfully familiar. >> ms. marin. >> thank you. and thank you, mr. chaiman for your time today. my question begins actually in your written testimony for you referenced the glamour each bliley act by having limited to regulators to get any enterprise of risk in financial position and activities. and i was wondering if when you think to back to how the crisis

unfolded, part of our churches determine what caused it. in your mind, does the fact rise to the level of causation or isn't simply one of many fact there is were part of the whole unfolding of the crisis? >> i think it was one of many factors. and you could point to specific examples where cost problems. for example, the fed was somewhat reluctant to examine nonbank subsidiaries, bank holding companies, feeling that the sense of the love we needed to do for whoever was nominally the regulator. and so, for that reason, we were probably not as aggressive as we should have been in identifying some of these were issues that arose from mortgage companies and other nonbank lenders. for that would be one example.

another example, which is more complex, has to do with the role of off-balance-sheet vehicles. and this turned out to be a big problem and not under the existing accounting -- under the existing accounting rules at the time, but the bank did not have a majority ownership of an off-balance-sheet vehicle, it didn't have to consolidate that vehicle and its capital charges were limited only to explicit commitments of liquidity or capital to the vehicle. and so, in actuality, it turned out the exposures of the vehicles were much greater than understood because the banks themselves to have monitoring systems and also because in the event for reputational reasons they often came to rest you these few clothes as i got into trouble, even though they weren't contractually obliged to not cost them money as well.

and so, there were some -- i think a little bit of uncertainty about giving it thought she vehicles might have been sponsored by the bank, which therefore would make them responsibility some sense of the providers like the occ, but they were obviously also part of the overall holding company. you think there was a little bit of uncertainty of whose responsibility these were immediate was not sufficiently aggressive potential paid to those off-balance-sheet. i'm sure there was not attention paid to the saatchi balance. i think there were some things that fell between the cracks. i wouldn't want to elevate it to the principal cause of the crisis, but it was one of the reasons that some of the risks that face the overthrow overall companies were not appreciated. >> in a bind with the new legislation is recently passed,

had that been in place at the time, but actions would've been taken that might have been different or what would've been different about the body of knowledge that you another regulators might have had that would've allowed you to act perhaps more preemptively? >> well, i think the clearest cases the nonbank subsidiaries were we, for example, did not -- we only began a pilot program to look at nonbank wending subs in 2007 or so, working with the other regulators of the substring to identify consumer protection issues. in the absence of the gop i think we would've been earlier looking at some of those problem areas and less reticence going into those. again, the issue of off-balance-sheet vehicles is more complicated, but i think that the situation in the legislation now, rather than letting these issues fall

between the cracks, especially gives multiple responsibility that says you have to post look at this is more likely to identify those problems in the future. >> thank you. another question just to touch back on something earlier which was the housing bubble. could you talk about your feeling as to the relationship between securitization of the housing bubble? the america think there was a relationship. so securitization was the other end of the originate distributed model. and there's a big sea paradise project that came from foreign investors, but not entirely of course, to create the wrong material for security is a tax, you had to have lots of mortgages be made. and as a result, to expand the number of potential homebuyers come you had to lower the standards. so you got increasingly weak underwriting and more and more exotic mortgage instruments being used to expand the number

of people who could get mortgages and therefore buy houses. and what this did was -- i don't member the exact number, but this is very substantial action of the mortgages issued in 05 come a 06 were released nonprime mortgages and that obviously increased the overall demand for houses. so you see a chain going from the demand for securities products, the demand for material to pressure to weaken underwriting standards to expansion of a number of people borrowing to increase house prices. another was a circle because again as house prices rose, lenders became more comfortable making more risky loans. and not just was a self-fulfilling prophecy of this until prices cut to the point where they can be sustained any further. so there was indeed a connection there. >> for your feeling is really where the demand of us driving the process as opposed to the push from the originators who stood obviously to do rather

well in that environment where they could continue to originate mortgages? or do you think it's both clacks >> so, i figure there's a push would've come not so much from the ultimate mortgage makers who themselves are agents of the bank for investment banks. there was probably some push coming from the folks who were creating the securities products, the salesman going out and saying he's an attractive investment vehicle. it's rated aaa. so there certainly was some pressure coming from outside. but clearly there was an awful strong demand is domestically and abroad for given how low, in particular, you know, given the treasury yields are pretty low and given the demand for longer-term states fixed income assets. that demand, hardly from abroad, drove wall street to come and you know, to create these

products, to satisfy that demand. >> teeny mac. >> you're welcome. >> all right, mr. chairman, just a couple of quick wrapups items i know very quickly member giorgio and also senator graham have a couple of quick questions. and i want to ask you about historically and going forward, we talked about the challenge of the factory is too big to fail institution and going forward we have institutions that may be not only to date, but too few to fail. fewer institutions, larger scale. and there be a challenge of political will for regulators to be as tough as they need to be. it seems to me there was and is in the company in question and that is one of resources. and adjusting resources in sheer numbers. i mean, let's be blunt about it. a lot of the wall street guys are likely spades. they're hard to catch. and you know, there's many new products. sometimes even call it

innovation. as you noted, that may be a kind word in many respects. and i guess my question as to what extent was the kind of mismatch here a problem and both will be the future? and i don't just mean come you know, there's been a damning nation of the ethos of public service. it's been growing compensation deaths. in the public arena as we all know it's no picnic. and i guess my question is, what is your confidence level that we can chart resources. i saw almost no debate during dodd-frank of the talent level you need to be able to have effect of oversight. and to what extent was not a problem and will it be a problem? >> no, it's a very good question. and you're right that we can't outspend wall street in terms of hiring people, obviously. i'm a very strong incentives to evade regulation in certain circumstances. just a couple of comments.

one is that this is one of the reasons why haven't the market discipline both be very helpful. we need to have the additional set of eyes that comes from investors and what we see spread open enough for stock prices going down, that's a signal we should pay attention to because clearly have very talented people who are in the markets and are assessing these firms. and their information is transmitted to prices we should pay close attention to that. the other comments and i think one of the things we learned from her stress testing this in other areas is that we willingly choose all our resources geared so it's one thing to have experienced supervisors and collectively among us and the fdic and the occ we have a cadre of experienced supervisors, but given the institutions and global capital flows and like a movie to bring another expertise as well. and so we have come at the side,

we have -- as i said come with taking a rumbled to disciplinary and buy him some financial and other experts to support the supervisor for. so i think i will be helpful. and mr. thomas mentioned how the fed had come to know, retained a lot of supervisory authority. i think one of the reasons for that was because we have a lot of those skills, which are going to be necessary to make this work. all that being said, you know, it's just simply never going to be the case that the government can pay willful streak and pay and we're going to have to work very hard and watch very carefully to make sure, you know, that we are successful in oversight. again, we don't have to replicate every business decision or evaluate every asset. we can't do that. so we can try to do was make them convince us that we have

systems and management in place of a plausibly deliver the right answers and give us confidence to do in the right thing. but you're absolutely right this is a poor issue of practical matters is we try to implement this fall. >> final question for me and it's something we've talked about and we've talked about internally. i know my friend john thompson and i have wrestled with this a little. he talked about the magnitude of sometime monday. ..

i'm going to ask it. what was the dominant phenomenon here -- the toxicity or the fragility of the system? the infection or the weakness of the body? >> the theme of my -- testimony was triggers vs vulnerabilities. we had a healthy, strong, stable financial system -- if we had had that, it could have accepted this problem without creating such a major crisis. i believe very strongly that it was not subprime lending, perse, although it caused -- per se, although it did cause severe and problems. the system had sigma begin weaknesses. the equal like -- nikolai -- the e. coli got into the system.

>> the middle-class -- it was the biggest asset. the fact that the e. coli got into the most widely-eaten food product -- did that exacerbate it or was it the nature of the securitization? could this have happened with other asset classes? what were the unique features that allowed this to metastasize? >> if you were to do a macro economic model and look at the effect of the housing prices going up and down and ignored the financial crisis effects, you would not find anything like the crisis we have seen. this magnitude would not be big enough. what caused the crisis was, essentially -- there are many things, but it is the e. coli effect. there was an awful lot of dependence on short-term, and stable funding, which is analogous to the deposits in

banks before the period of deposit insurance. since they were not insured, they were prone to runs. e not insured, they were prone to run. and when people think there's something wrong with the assets, even if it's only 1% or 2%, they say what the hell, i'm going to be my money out. why should i lend against this potentially risky product? that panic was a very, in turn force people to sell assets into a liquid assets, created more problems for other firms. it was that dynamic that was a very important part of this. i still think of this as more of a trigger the e. coli than the fact is that itself would have system to seize up. >> chairman georgiou, for your remaining -- >> thank you. to follow-up on that, dr. bernanke, another problem what a great deal about in our hearings was this notion of regulatory

arbitrage and capital arbitrage, where institution held assets off-balance-sheet to avoid capital requirements. in some cases mischaracterize assets to put them into categories that require them to hold less capital under the rules. you know, we talked about safety at its peak, if you brought on in all the dispersed assets had some 3.3 trillion in assets with roughly $75 billion in capital, which is a little only over 2%. the third of that got used in one liquidity put on one set of cdos. obviously, in hindsight almost everyone agrees including her predecessor as fed chair that more capital less leverage would have been media rated the financial crisis. it may be facile to say the system would've been safer, been required to raise and hold more capital but the mere fact it's facile is not astounding make it untrue. i wondered if he details what the feds use are going forward regarding capital requirements

and what particular provisions to put in place to insure that the financial institutions that have grown so large and are prone to be rescued are well capitalized on a go forward basis? >> thank you. i think it's important when you think about the situation going forward is recognize that there are two big things happening. one is the financial reform legislation recently passed in the u.s. congress and signed by the president. the other is a substantial reform of international capital standards which is currently going on and i will be attending the basel meeting next week in switzerland. so the united states agrees, secretary geithner is talked about this, we agree, secretary chairman bair, that stronger capital standards are essential as one of the key components going forward to ensure the safety of the system. and so what we're talking that with their international

colleagues in basel now is first having more capital, having higher quality capital, that is not using intangible assets and other things that are not loss of serving as capital, making capital for risk sensitive so that it responds more to losses and absorbs losses more effectively, creating some counter cyclicality in capitals, capital can be built up in good times and run down in bad times. and, finally, we are working with the accounts and others, you know, we've gone beyond the situation you talked about, where citi had always off-balance-sheet assets which were not consolidate has been very largely changed now by new accounting rules. which will require consolidation where there is substantial ownership of those assets. on top of that we are looking for international leverage standards and international liquidity standards. we expect of some very substantial improvements in

those regulations. internationally create a level playing field and i do believe as we go forward those rules and their implementation will be the same order of magnitude and importance of ensuring a safe financial system going forward as the changes, very important changes, been made in the recent legislation. >> thank you, dr. bernanke. >> senator graham, a quick closing question? >> yes. chairman -- [inaudible] spent the chairman answered the question i was going to ask, which related to what is the status of off-balance-sheet items. but i cited earlier a report that there seems to be a weakening of resolve i a basil group in terms of liquidity and capital standards. does that coincide with what you're hearing, and if so, do

you think that we can participate adequate resolve at the international level to get the standards where they need to be? >> so when you're developing complex and capital standards, it's important to consult with the banks to understand, make sure you understand what indications are for how much capital they hold and how it will affect their business and so. it's important understand that you're not making good policy if you don't understand the implications of your decisions. that being said, that's not the same thing as weakening standards. we want to make sure the standards are rational and effective. and we are committed to very strong standards, and i think you will see when they come out that they will be substantial improvement over the standards that we've had the last few years. >> thank you. >> just one question. bank regulars have for many years been concerned about fair value accounting, mark to market accounting.

and some have said that have something significant to do with what happened in the financial crisis. what's your view of that? >> well, i think that mark to market accounting at times increased the procyclicality of the system there were times when markets were highly illiquid and it was very hard to value assets. that being said i think we should do our best to get appropriate market values of assets that do not market prices. this is a somewhat different issue when you're dealing with long-term credit in the banking book. where there is no secondary market and appropriate valuation requires, yeah, a model are some assumptions. i'm in favor of accurate accounting. i think that there are sometimes problems when markets are very illiquid and the fasb tried to move in the direction of

clarifying how to deal with so-called level three assets and illiquid markets. but i'm also very cautious about mark to market accounting to the long-term loans, the bank loans, the banking loans of the banks. if i could say one quick thing about a question you asked me before. i would just point out that the decisions there, the interventions are there were fdic decisions. they must've made, i'm sure they make independent judgment about the best way forward. they're concerned about protecting the deposit insurance fund. i'm sure they're trying to find the least cost solution to that. >> my question, thank you for that, but my question really was what importance do you think market to market accounting might have had in the financial crisis as we understand, that is, this huge decline in asset values? >> i think it exacerbated it somewhat, the nature of

financial markets that asset prices move up in booms and down in crashes. that is an exacerbating factor, but, you know, we don't want to sacrifice accurate valuations to eliminate the issue. i don't think you could. so it was an issue, but i don't think we should abandon mark to market accounting. >> mr. chairman, thank you very much for this second appearance before us. during our deliberations i also want to reiterate something that the vice-chairman and others have said. douglas holtz-eakin i know mentioned specifically, you understand and the federal reserve have been very forthcoming, very cooperative in terms of providing documents information, we appreciate the way in which you have helped conduct, us conduct our investigation, our inquiry for the benefit of the american people and for history. you have been very good in this regard and we look forward to continue to work together as we

do our final report. thank you very much for being here this morning. >> thank you, mr. chairman,. >> will now take a 10 minute break, members. and then chairman bair will be before us. [inaudible conversations] [inaudible conversations] >> today on "newsmakers," the commandant of the coast guard admiral robert papp talks about the impact of the gulf oil spill and the coast guard budget.

that is at 6:30 -- 6:00 p.m. here on c-span. >> president obama travels to milwaukee tomorrow to talk about the u.s. economy at the annual afl-cio labor celebration. our live coverage begins at about 3:10 p.m. eastern on c- span. now, a look at a recent report on the decrease of illegal immigration to the u.s. here is a 15-minute portion. host: paul taylor is the director of the pew hispanic center. here to talk about the drop in immigrants. 1 million, about 8%. guest: it is a dramatic decrease in the inflows of authorized immigrants. we estimate these numbers annually. we have been able to do this for the last decade. we are able to do an annl

estimatef inflows. there the drop is even more dramatic. from 2000-2005, annually on average, about 850,000 on authorize migrants came to the country. now in the last two real years, 2007-2009, it's down to 300,000. this is not a static population. as a population that comes and goes, but the net result of the dramatic decreasen inflow is that the the first time in 20 years, we see a decrease in un immigrants. host: were you able to find out the reasons why is? guest: we do not have the tools or the skills to say that will with quantifiable -- say that

with quantifiable expertise. a couple of things have happened over the last five years. the economy has gone sour and the jo are are the magnet that draws immigrants. enforcement along the border has stepped up. there is a border fence being built. enforcement is much tougher at the worksite. so the more deep -- there are more deportations. both of those factors are moving in the same direction and will tend to decrease the inflow. there is a third factor, which we know from reading news accounts, it is more dangerous to get across the border illegally than it used to be. you read accounts of people lose their lives. this is something that happened to the years, but the drug war in mexico, the lack of law enforcement in mexico, makes it a more dangerous journey. host: talk about the inflows of unauthorized immigrants and

which countries they are coming from and where you saw the decreases. guest: we estimate that of the current on all the rest immigrant population, about 60% are from mexico. another 20% are from the rest of whether america other than mexico. and the other 20% are from asia, africa, and other countries. in terms of the decrease in inflows, the most dramatic decrease has been from mexico. in terms of the decrease in stock, we see a bigger decrease in the stock of current authorized immigrants here from the rest of latin america other than that mexico. this suggests that there may have then a greater immigratiem. unauthorized immigrants return. a lot of journalists and others have speculated that that is something that is likely to have happened because of the sour economy.

we do not see a great deal of that. there is always circular flow. we do not see an uptick in return flow to mexico, but we can surmise from these numbers that there may have been an uptick in the return flow from other countries in latin america. so the stock of authorized immigrants, but now we are talking about south, central america and the caribbean, we estimate is down by 22%. host: let's talk about states with the largest on authorize immigration population. california, texas, florida, new york, illinois, new jersey, arizona. some may be surprised arizona is that far down on the list. guest: if you start with the biggest states, these are not only large states, but these are historic and treat poientry poi. if you compare the share of

those top five states and their share of unauthorid immigrants 20 years ago, they accounted for roughly 80% of all authorized immigrants. now they account for slightly more than fivhalf. what we saw last 20 years is a dramatic increase in this population and its geographic dispersion of this population. arizona is a border state, along the southern border. it has always had some flow. in some ways, the more dramatic change over the last decade has been in the south east of the united states, the carolinas and georgia which had very little hispanic population to speak of and a little on authorize population. that has grown pretty sharply. some states in the midwest, where again, no history of hispanic immigration, that began to change. these are now some of the states where we see this inmigration

leveling off. there are a few states were able to stay with some certainty, in florida, nevada is one and virginia is one where the stock of unauthorized immigrants has come down and the past year. host: i want to ask you first, how do you come up with your terminology? like unauthorized immigrants. you hear a lot of different labeling with this issue. guest: the pew hispanice center as part of the pew research center. we don't have a dog in any fight. we are nonpartisan. if you choose what label or another, you are seen as being on one side of the issue or the other. we are not on any side. we chose the term the government uses. whetr it works for some people or does not, it is the closest thing, we think, to the initial term. ho: how did you do this

study? how you calculate it is coming in and he is leaving? guest: i urge your viewers to go to our website. it includes a seven-page methodology section that describes how we do it. i will try to give you a brief summary. our website is www.pewhispanic.org. does is iswho rey purcell. he worked for the census bureau of some 20 years ago. he has been with us for the last five years. he is the originator of this methodology. it is called the residual estimation methodology. in so many words, it starts with census data, but now the census

put sell lots of product every year, where they are updating numbers -- the census puts out lots of product every year. what share are u.s.-born and hare arerahre immigrant. do they have green card? ock that iss a blc residual, that is step one. we can look at mexican census data. mexico does aood joof tracking its immigrants and emigrants, and we can compare our data about the inflows and outflows with their data to make sure our estimation is in the right ballpark. i emphasize, however, that these are estimates. they are subject to ranges of

errors, margins of error and we make that clear in our report. host: caroline is joining us on the independent line in caldwell, texas. caller: how can you say there are fewer illegals? you cannot prove it in my neighborhood, because there are more and more daily. we live out int h the country on small lakes. they're here everywhere. more and more daily. and they respect nothing, you know. no laws of any kind. we have to help pull drunk illegals, who cannot speak english, tearing up your hard, driving off.

they are putting illegal septic tanks in. we paid a fortune to have hours put in. host: where is caldwell? texas a &m,twest of college station. host: do youssume that they're illegal? how do you know this? nobody: well, let's see, speaks english, number one. number two, is when a policeman comes around, they are like a bunch of roaches that run and hide. perception. guest: as of 2009, there were

11.1 authorize immigrants in this country. if you go back a decade, there were only about 8 million there is no question that there has been a genetic increase in this population over the last few decades -- a dramatic increase in this population over the last few decades. that increase peaked about three years ago, has leveled off, and has declined slightly, which is the first decline were able to measure in more than two decades. these are estimates, but we believe that is possible. what we have done with these estimates as we applied the same methodology to data year in and year out. whenever the strengths or weaknesses of the method is, they are consistent from one year to the next, giving us confidence that the overall trend we are reporting on is accurate. host: california. the democratic line.

good morning. caller: i think what he is saying is untrue. i live in a community of predominately hispanics, from within 10 miles. the men hang out. they bring cars across the board appeared they take their drugs out. gangbangers. i have a town house. i cannot let my 11-year-old daughter go outside. the gangbangers. the men are here. the women here. it tears down our neighborhood. the school, i cannot take my daughter there. they spend so much money on esol to teach them english. they come home and speak nothing but spash. and i know they are not citizens. they are not ahorized workers.

host: where's hayward located? caller: hayward, california. san francisco, oakland area. oakland police station has the map of all of the gangbangers north and south. so much of violence. host: paul taylor, anything there? guest: it's hard to comment on all of that. you kno one of the things we did about 8 months ago is we did a major survey of latinos coming of age, 16-25. we tried to understand how they're were doing in this country, how they were assimilating, becoming american, if you will.

this population of latino youth is not primarily immigrant the latino immigration wave for this country, which really began about four years ago, is mature enough that it is generating a ry large second generation, children of immigrants. that is where most of the growth is. so, on some of the things u mentioned, what we find and we find that the census finds that other efforts, other scholars find that in terms of english acquisition, immigrants tend to be predominantly spanish- speaking, but very dramatically, children and grandchildren of immigrants pick up english. 95% plus become english speakers because they realize what every immigrant has to realize -- if you want to make here, you need to acquire english skills. you mentioned gangbanging.

we tried to get this inur survey. it is not easy to ask -- are you a member of a gang? you may not get a straight answer we ask, do you know somebody who is a member of a gang? a little bit surprising, but when you think about it not all that much, it is not the immigrant kids who are most likely to say, i know somebody. it is the children or grandchildren of immigrants to say that. again, these are young adults who are u.s. citizens by virtue of having been born here. the gang phenomenon seems more prevalent in the second and third generations. host: "does the pew hispanic center promote for or against any policy regarding amnestyi?" guest: we do not promote any policy for or against anything.

our mission is to provide good information toward public policy issues. we do this with a generating numbers. we say, we hope this informs the debate. it is up to the policy makers to figure out what to do with it. host: ohi al on the republican line. caller: good morning, paul. i have a question and a statement. the way the economy is in t dumps, did you mention that? it does that have a lot to do with that? guest: absolutely. caller: now, do they slowdown on letting illegals -- on documented workers come in for visas? did they cut down on tha host: actually, you found an

increase of that. is that right? guest: the share of immigrants that are authorized versus those who are here legally has shifted. if you go back to the middle of the decade, about 31% of all immigrants in this country were unauthorized. that is down to 28%. there was another important change. today, we estimate, based on this methodology, that the unemployment rate of authozed immigrants is higher than the unemployment rate of legal immigrants or u.s.-foreign citizens. this is a change. if you go back to pre-recession. housing boom. construction was a big industry that employs a large amount of unauthorized

immigrants. the unemployment for of the rise is 10.4%. u.s. data is is 9.1%. -- the unemployment rate of unauthorized is 10.4%. the risk of getting across the border is higher than it used to be. there is more workplace enforcement then there used to be. if they have someone in custody for one reason or another, looki at their immigration status, and setting them out of the country, i think the >> tomorrow on "washington journal," the discussion on the latest unemployment numbers. we will hear about security

preparations or afghanistan's upcoming elections. then, the discussion of "rethinking homeownership." that is like a 7:00 a.m. eastern here on c-span. -- live at 7:00 p.m. eastern here on c-span. >> president obama travels to milwaukee to market talk about the economy at the annual afl- cio labor day celebration. online coverage begins -- our live coverage begins at about 3:10 p.m. eastern here on c- span. congress returns from break next week. here is a look at some of our prime time programming. watch town hall meetings with republican oklahoma senator tom coburn and independent vermont senator bernie sanders as they both talk about health care. >> i believe the plan is for this to fail. i know this plan will fail. health insurance is going to be way too high. you're going to create what is

called adverse selection. anybody young that is healthy -- you will pay the fine in 2014 rather than spend thousands of dollars on health insurance. it is smart. if you get sick, they have to cover you. it does not rise to $795 until 2016 as a fine. healthy, young people will not be in the insurance pool. what will happen to the people over 40 who are sick? what will happen to the cost of their insurance? that is why i think they have designed this to fail. they wanted to revert back -- want it to revert back. we need a government-controlled, single-payer system. >> in my view, if we're serious about having a cost-effective, high-quality health care system which guarantees health care to every man, woman, child --