hold regulators accountable for carrying these out. they must accept the ethical restraints that would make them share this information is with the public. thank you, mr. chairman . >> thanks very much for having me here today. thank you for holding this hearing. the rest of the members of the committee can take pride in working hard with the rest of the challenges by the financial crisis. you brought an important congressional focus on the issue of financial stability and to the regulatory framework as a draw matter here today. he pursed landmark -- passed landmark legislation and engage in serious oversight. we must never lose sight the tremendous told the financial

crisis has taken on our country. many americans have lost jobs, homes, and it has hit our low or moderate income citizens with a terrible tragedy for many families across america. as we continue to recover from the financial crisis, our challenge is to successfully implement post-crisis reform. implemented correctly, these new rules will at markedly to financial stability. however, if they are implemented with out the cumulative impact on parental institutions and without a sense of balance and proportion, these rules will put a drag on the financial system, our economy, and job growth. if it is excessive, we can see a

decrease. i would like to take a moment to discuss capital requirements, which is of the much interest to this subcommittee. it is critical to a safe and sound relationship. the financial stability board recognizes the importance of capital and have acted forcefully. we have tough capital requirements and capital levels succeed previous requirements. under article 3, banks will have to hold 10.5% total capital and a 7% common equity. u.s. regulators may add an additional countercyclical offer of up to 2.5%. most of the financial institutions typically carry

above the required minimums. a minimum 300% increase in equity before additional offers are factored into the equation. 300%. a very significant addition. common equity is the highest capital. it is the most expensive for banks to raise. it is important to note that prior to the crisis, several of our largest non-banking institutions were suffering a critical regime. they had to designate non-bank financial institutions as systemically importance. there was more marked increase in capital requirements.

we are seeing an uptick in the amount of capital. while capital is an important tool in the supervisory tool kit, it is only one tool. we have achieved important reforms involving capital. i would not advise any further increases in capital requirements beyond the standards. critically important to safety in the sound is balance. how did you achieve the right balance and insure that regulations are serious and meaningful, but not so elaborate that they needed to weigh down the economy. there is no quick fix. i can provide some suggestions. congressional oversight,. id is enormously important to

the regulatory mechanism to performing correctly. support of the work of the financial research and its critical role in monitoring system of risk. i think this is one of the greatest steps forward in this piece of legislation. it creates a body of economists that were reached independently of the next financial bubble. it helps financial regulators to target their resources in the right direction. it ensures that moving forward is critical. our regulators need to be top professionals. it supports a prudent innovation and economic growth.

education in the regulatory field -- today, you can get a degree in almost everything in america. avoid waste and access at all costs. many of our procedures can be applied very well. this is critical. it missed target resources. periodically review regulatory rules to make sure that are reflective and cause the least burden possible. impose international capital and

liquidity rules for global banks on a level playing field basis. global standards must not put u.s. firms at a disadvantage. i think this is a very big issue. we have tough regulations. we need to impose these globally on a level playing field. properly regulate the shadow banking system, which currently oppose one-quarter of the united states financial sector. if you look at the pieces that triggered the crisis, the shadow banking sector is still loosely regulated. i think it is a genuine danger. i look forward to entering your questions. thanks for having me today.

>> just to make this salient, imagine a processing firm wants an to have a firm in a crowded residential area. some regulations would prohibit that. what if the government had a tax policy that encouraged the processing plant to locate in a crowded area? above that, it provided health benefits and insurance protection to help claims against the iranian processing plant, only if a look at it in a

crowded registered -- residential area. we have a policy when it comes to our banking sector. it subsidizes debt in makes equity expensive. the other subsidy is the one that is critical here. it is the too big to fail subsidy. there are guarantees given to the government safety net that subsidize firms and makes equity expensive. this creates huge distortions. if it affected only a few small banks, that could be one thing, but it makes the system

extraordinarily fragile. the evidence of what that can create, just a few years ago in a crisis, we have seen more of it play out in europe than here today. there are banks with too little equity create items that are negative, in that they create the possibility of a crisis. is there any social benefit? the answer is no. many claim that equity is expensive. that is based on a lot of the fallacies in the mistaken notions. the first is that this bank hold equity. banks hold assets. equity has to do with the right hand side of the balance sheet. the promise comes in two sets of forms.

one of our contractual obligations and equity holders to have some promises made by the banks. they get whatever is left. if you make too many promises to debt holders, you get into a situation such as what we had in 2008 where the system is teetering on the brink of and balance the end is insolvent. with little equity, we have a blocks that are centralize. in the capitalistic system, we want the latter not the former. one of the important things in this debate is to distinguish private from social costs. imagine that the processing firm is located close to a

highly populated residential area. the government says it must be moved. the owners of the plants could say it is costly, because we could use tax benefits and lose the insurance. you are providing in a highly populated area, if we move this iran in processing plant. you are taking away subsidies. the analogy is perfect. if we force the banks to move to a higher capital to safety, we are taking away subsidies that we had that encourages them to do better things. it is not costly from a social cost point of view. banks require a specific return on equity. it is somewhat independent of

how a bank is financed. they showed this is a basic fallacy. that is an argument that is based on wishful thinking about how the market may be fooled when you change risk exposures. a lot of compensation is based on roe, or you can go through a simple experiment. say we have a manager. the good manager has 10% equity. it manages the bank's assets very well and has a 3% return on it.

talk about a bad manager, who has a much less safe bank. manages the assets rather poorly, earning only 2.5% return on assets. that results in almost 19% r.o.e. if you are bad, you can make yourself look good by having good leverage. one of the questions alice's where does this come from? it does not require new savings, just that the banks changed the promises they have been making. it could prevent banks from paying dividends and other payouts to other shareholders.

they take away the subsidy and should be required to do that in the interests of social good. we should have a level playing field. if we are leveling airplane fields by mixing our bangs with taxpayers expense. it is no way to run our financial system. my analysis is quite simple. we need to get to the government less involved in the financial sector. we have to require that the private sector put out more equity and bear the risk the taxpayers are now bearing. >> i want to take another step.

the iranian plant analogy. nonfinancial companies typically hold more capital. and none financial firm -- why do we allow financial companies to hold so much money? that long-term, subsidizing in encouraging finance over other sectors. in our country, only 30 years

ago, we were 25% gdp manufacturing. that has flipped in the last few years. is that part of the reason we allow companies to hold less of their own money than we do other sectors of the economy? >> it comes about through several methods. some argued the banks should have 100% equity. some banks used to fund deposits and has social value. there are views that are used to get additional funding that exploits the government subsidies that i mentioned. one of the things that have been after 1970 is this notion

of too big to fail. it has created subsidies to the bank in that there is a backstop that encourages that. a lot of companies would love to have the government ensure their debt, because it would allow them to issue more debt and get a bigger tax advantage. the only sector that can do that is the financial sector. they have this implicit subsidy. what is easy to document is that it has created incentives for the financial sector to grow bigger more than is socially justified.

>> what are the effects of those distortions and implications for the economy? >> they are very severe. because of the implicit subsidy, the two big to fail banks can get assets to a lower cost. you can see it in their cost of funding. it leads them to expand. because of too big to fail banks have lower costs than community banks, and they often do not focus on lending past their means, we get a distorted economy.

there are relatively starved of funds relative to certain activities. the net result of this is that our economy is distorted in certain ways. we have been focusing on the size and the kinds of activities that they engaged in that get distorted. there are government guarantees, and more willing to undertake greater risk-taking. rather than lending on the basis of solid information on a smaller and medium enterprises, you go to non transparent cds's,

pa while. if you gamble big, and you win, you walk off with a profit. if you lose, the taxpayer suffers the losses. once the crisis happens, the economy beer's an enormous price. this is not capitalism. when you have to socialize in losses, you get a distorted market economy. this is undermining the function of an -- a market economy. >> his comments about a banks.ging differentn

talk about how large banks are highly more leveraged than other banks. one person talk about how they can borrow money at less cost than other entities. talk about the it pantages the larger banks enjoy the as a result of that. >> the larger institutions can hire better accountants and lawyers to see that the way in which risk is assessed in the system favors them.

we have seen a number of institutions around the world fail, even though they meet the capital requirements, because the risk rates were all wrong. certain assets were not being counted in the system. the industry is always here before congress. they say how devastating they would be. most the polls, from non transparency. it is almost a little bit like a black jack, where you have a fixed strategy on the part of the dealer. if the player place -- [unintelligible]

>> can i make one more example of the nature of the difficulty? one of the issues that is debated before they died franc bill was passed is what -- adodd passed is bill was proper whether institutions should be allowed to write cds's. none transparent over the counter gambles. whether insurance or gambling, they are not a lending activity. what about a government insured

depositories solution? once you had it, with the government backing them, they have incentive to engage in this kind of practice. most of the profits they were making was due to trading not lending. the american people were told that the reason for the tar bailout was to get lending started. that never happened. they used that basis that the zero interest rates to undertake a high leverage and highly risky trading activity, which they generated higher returns.

>> one of the questions that comes up about the safety net that nobody seems to lose money but is making money. this money is extracted from the taxpayer in advance. it hurt not help anyone. >> i want to read the sentence, britain bought a finance professor. she said there is no credible way to get rid of bailouts. do you agree with that? >> i think the regulator would recognize that as an unimportant tool. the high leverage, which has been rightly criticized, the

excessive 40 to one, outside of the commercial banking system, it is excessive. it should not exist. you and the rest of congress has put a lot of that to rest, in terms of the banking system with very strong capital requirements. the capital is only one tool. it is almost impossible to have some much capital did you can prevent failures of financial institutions. commercial banks typically failed not because of a lack of capital, but liquidity and adequacy. it is the nature of the fragile banking system. many have been focusing attention over the last year or plus on liquidity ratio that banks maintain. it is another tool in the toolbox. what we lack in the last decade

is the utilization of those tools. they are being used vigorously now. our issue going forward is striking a balance, so that we have a stable financial system and that can support the economy of the united states. the danger we face is losing that balance and becoming excessive in the way we implement dodd thank -- frank. >> he said earlier in your testimony that we have seven standards. tell me what you think the feds should do -- i assume you are

saying -- what should the fed imposed on the banks and financial companies? >> it gives the national regulator a cushion on top. i think it makes sense. i would not go beyond that. the capital increases have been so significant. we are in new territory now. they have been impact on these institutions to support the economy. we have multiple other tools. before we take additional steps, we want the implementation of those tools. we want to support the economy of the united states.

>> the push back that i hear in ohio against higher capital requirements were a couple of things. one was the competitive disadvantage with european banks. the other would cause banks not to lend if we required higher equity standards. would the other three panelists comment about the push back that higher capital standards would mean u.s. banks to lend to the degree that we would like them to. >> liquidity is always a

problem. it is only a problem when there is a problem with insolvency. it has a lot of equity. there is no problem with going to the fed and pledging assets, getting liquidity. it does not put the tax payer at risk. it is not just a liquidity issue, but one that is insolvency, understanding that a party may be below water. competitiveness with european banks, cutting back on lending. we do not want to be competitive if it requires that we put our economy in jeopardy.

banks -- if they require a subsidy, we and giving it away that it does not require high leverage. if we decide banks in need to be subsidized, because they are doing something, we need to get the subsidies in a way that does not create a fragile banking system. just to tell us where we are right now with respect to these types of requirements, a few weeks ago, moody's announced that the support rating that it gave to bank of america was five notches above government support. it indicates that looking forward, the government support

is moving the bank of america debt to what would be minimum investment-grade to very high quality. how much capital do we need? one monitor for that would be players in the economy do not seek government support in there. >> does it bother you that someone wrote that european banks have fought against capital requirements. what does it mean for banks and our competitiveness and behavior? >> it bothers me that we live in a economy and we cannot insulate ourselves from mistakes made in europe. we have an integrated economy.

there is no doubt that problems that are there can spill over in our economy. the goal is to race to the top. we need global standards that are much higher. we should sink to the low standards and not put our jeopardy -- put ourselves in jeopardy. -- it is a proposition that i do not think has been demonstrated if banks need subsidies. >> comments? >> what has happened in europe has affected the credibility of sovereignty in the report.

somebody is going to have to a resort the costs. europe will learn that subsidizing their banks could ruin the economy for a while. the notion that because they are subsidizing in the past will take away from the lesson of this crisis. >> the primary lesson is higher capital requirements. >> you have to deal with average versus marginal requirements. we are not subsidizing a foolish risk taking. we can have lots of differences in the system. we want to make sure that we are

not encouraging people to find ways to hide their capital. >> would banks not lend? i want to address that question. i want to go back to my first remark, which is that a change in the debt equity, a change in the financial structure of banks, does not really increase their costs. to the extent that we can put aside the subsidy, the fact that there would not be higher costs and no reason for u.s. lending. >> do you agree with that that ?a

>> it is a practical matter. raising capital is so costly, particularly at this time. they have raised so much to increase their capital positions that a number of banks will consider that instead of raising additional capital, they are shrinking their balance sheets to accommodate higher capital charges. >> dividends have been restrained. >> they were distributed and there was some thought from others that the banks, because of equity issues, they are saying that they could not attract enough equity and would hold on to their profits for a number of time for reasons. >> they can issue reasonable dividends to make it harder to attract capital.

it undercuts the confidence the public has. if they're not willing to pay a reasonable dividend, -- it is a matter of balance and proportion. >> if they have more capital, would be more confident in the public. as i said in my testimony, there is a problem with transition. if there is a problem in transition, they not pay out dividends or excessive bonuses, and it would allow them to recapitalize the banks and put it on a safer basis, so that we would not have the taxpayer under writing them.

equity is not costly. when you have higher leverage, you are increasing the risk of that equity. that is the fundamental flaw in those dealing with the high cost of equity. you are driving up the cost of equity and a shifting risk. >> this discussion about to the debate of liquidity risks versus sovereignty risks. when there is a lower equity base, there is a higher probability of a bankruptcy in or problem, and therefore a higher likelihood that no one will give money to the banks.

that is the cause of the liquidity crisis. if the banks were solvent, there would be no liquidity problem. there are two issues that are intertwined. the risk of a liquidity crisis would shrink lending and undermines the economy and is related to capital. on the issue a competitive disadvantage, of what to agree with what is said. there are two other points. the framework regulation -- if we have financial institutions coming into the united states, they ought to be incorporated

into have a subsidiary, not a branch. the basic principle means that the united states is a large market. banks will want to operate in the united states. we can set regulations to protect the american economy. protect our job, and our own society. the issue, can our banks compete abroad. i am not worried about that. if it were the case, in terms of our national economy, how many jobs were created in america by the bank's operating in europe or latin america? this is not a major industry for the rest of our society.

in my view, we should focus on the united states and protecting it, not on creating jobs in europe. there is a little bit of a profit that goes into the american banking firms, but it is a minor issue for our economy. we should not have a set of regulations dictated by the worst banking regulator in the world. we do not want iceland and ireland to dictate the terms of american banking regulations. bangs will say there is some country that is blocked by the banks. it is going to have low regulation and can do things that we cannot do.

we need to focus on what is could for the american economy. >> i could not agree with you more. we do not need to fight the whole war. we have much higher capital standards. we do not want to have a race to the bottom. what we want to do it is used our clout to ensure that regulations supervision abroad, with respect to capital are applied fairly. the issue in terms of competitiveness and meeting our high standards is important.

when a panic in serious comet in respect of of the amount of capital, if people get panicked enough, they withdraw funds. it is in part to the genius of banking. one is the maturity transformation ability of the banks. people deposit attacks, checking accounts, and they lend it for longer time frames. the genius of the banking system is the maturing transformation. it is a matter of confidence. capitalist a certain important.

the public having enough confidence that the regulatory mechanism is functioning correctly. >> if some set higher capital requirements would reduce the amount of lending, why not have no capital requirements? would that mean no landing? would the economy get back on its feet? >> of the art of of finance is about balance and proportion. no capital would say, -- the

practical problem is to raise capital so significantly in that you get to a point in which only in the transition time, and we are in a delicate economic time now that banks faced with additional capital requirements will start saving their balance sheets. lending is a risky business. they take excess risks. >> we do not have higher capital requirements now.

we have a capital shortage banking system today. >> he is talking about future numbers, not today. >> the market anticipated those requirements and it puts pressure on the institutions to raise capital in short term. so it is raising capital in advance of the requirement. >> they were trying to pay those dividends and had to be restrained. we are seeing a lot of pressure coming into the implementation of the daughter of frank rejectdodd frank. i do not think we have to worry about the u.s. banking system

being overregulated. where do we have the runs in this class crisis? they were put back on structured investment vehicles. that is when the banking system began to be terribly weak. one industry shows us that you have to regulate maturity transformation. interest rates will go up again in this country. we have to be very concerned with institutions.

>> we are going to conclude. i will give you a moment to think about it. one or two significant improvements that you might suggest. give me one or two thoughts. the former attorney general of ohio came this week. i have known him for many years. this confirmation is probably in some doubt. there was an article about competitive advantages in the shadow banking sector. he said it does not have a senate approved a leader. it says the consequence kicks

in and they will examine and take action with banks, but not against their non-bank competitors. are you saying that traditional banks are heard by efforts? >> yes, they are. i am a huge supporter and it is important that we have a functioning agency. there will be in position of the banking sector, not a bad thing. i think we should get out moving forward. >> what are the improvements he would make to it? >> [unintelligible]

i think most of us are concerned about too big to fail banks. an amendment should have been included. the second one is, much higher capital requirements along the lines that most of us have been talking about. i do not think it goes far enough. third is cds exemplifying

excessive risk-taking. it makes no sense, the fact that a fraction of them continue to be over the counter and non transparent. there is a risk that if they change goes out, there should be some liability of all those in exchange said that the taxpayer does not have to accept that up. and the practices of the banking sector, the credit cards, are outraged. a major source of revenue distort our economy.

it hurts ordinary retail merchants throughout our country. small businesses. cery stores.e why there are some cases where homicide 50% of their profits are given to the banks. that is when they are paid for by credit card. it seems disproportionate to the services provided. >> i can reduce mine. financial research is one of the great innovations potentially of dodd frank. it has been placed under a bit complicated committing.

we have to address the need to publicize what taxpayers and her. this will be the job of financial research. to help authorities do this skillfully is change the way regulators are trained and incentivized. i think we can help with these tips. >> i lament the fact that we do not have a single credential supervisor. we advocated for that early on during the clinton administration. the country could have done better in australia, japan, during the crisis, had there been a single focus.

it is critical. -- [unintelligible] i think it is essential that we implement this with prudence and care. there are only so many hours in the day and we want our financial institutors and regulators not on those days that are extraneous. >> i probably do not have much to add. in some ways, just reinforced.

i made the analogy that we are trying to regulate cards that are speeding down the road at 100 miles an hour and are only 5 feet apart and it requires very careful brick relation to make sure they do not hit each other. the obvious solution is to have them have a greater buffer between them and follow each other at much greater links. that is capital. it does not solve everything here. it is about putting in a much more privatisation than of the socialization of loss that we have now. i have not got a very much about having a single regulator. this idea makes a lot of sense to me. it puts us in the direction of

taking care of a lot of the presentations that we have now. and getting the opposite end of research up. in next crisis may not happen in the way the last one did. we need to constantly be vigilant and be ahead of this rather than behind it. it will be useful. getting it up and running is important. >> thanks for the spirit of discussion in your public service. it was very helpful today. i appreciate all of this. [captioning performed by national captioning institute] [captions copyright national cable satellite corp. 2010] --2011. [unintelligible]

>> several live events to tell you about today here on c-span. a subcommittee will look at violence along the border between sudan and the new country of south sudan. that is at 10:00 a.m. eastern.

and the center for american congress will hold a forum on security along the border between u.s. and mexico. the commissioner of border protection will be speaking. in a few moments, this morning's headlines and your calls, live on "washington journal." at 10:00 eastern, the history of violent along the border between sudan and the south sudan. and the center for american progress will hold a forum on the security around the border between the u.s. and mexico. the panelists include alan bersin. that is at noon eastern. we will focus on a group of lawmakers that are pushing for additional budget cuts of $1.50 trillion as part of the debt ceiling deal. our guests are from