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August 9, 2010
Phil Angelides
Cllflirman
Hon. Bill Thomas
Vice Chairman
Brooksley Born
Commissioner
Byron S. Georgiou
Commissioner
Via Email & Mail
Secretary Henry M. Paulson
c/o Kevin Downey
Williams & Connolly LLP
725 12th Street NW
Washington, DC 20005
Re:
Financial Crisis Inquiry Commission Hearing on May 6, 2010
Dear Secretary Paulson:
Thank you for testifying on May 6, 2010 in front of the Financial Crisis Inquiry
Commission and agreeing to provide additional assistance. Toward that end,
please provide written responses to the following additional questions and any
additional information by August 23,2010. 1
Senator Bob Graham
Commissioller
Keith Hennessey
Commissioner
1. In 2007 and 2008, how aware were you (and the United States Treasury) of
the fragile and precarious state of Fannie Mae, Freddie Mac and housing
markets in general? Did you make the full extent of your concerns known to
the public at that time? Did worry about inciting panic in housing and
mortgage-asset markets playa role in what you communicated to the public?
Douglas Holtz-Eakin
Commissioner
2. Please describe the role of over-the-counter derivatives in the financial crisis.
Heather H. Murren, CFA
3. Did any of the following factors create systemic risk and ifso, how?
a. The concentration of derivatives in the hands of the large derivatives
dealers;
b. The interconnections between those dealers and/or other large financial
institutions through derivatives contracts;
c. Lack of transparency in the derivatives market.
Commissioner
John W. Thompson
Commissioner
Peter J. Wallison
Commissiol1er
1 The answers you provide to the questions in this letter are a continuation of your
testimony and under the same oath you took before testifying on May 6,2010. Further, please
be advised that according to section 1001 of Title 18 of the United States Code, "Whoever, in
any matter within the jurisdiction of any department or agency often United States knowingly
and willfully falsifies, conceals or covers up by any trick, scheme, or device a material fact, or
makes any false, fictitious or fraudulent statements or representations, or makes or uses any
false writing or document knowing the same to contain any false, fictitious or fraudulent
statement or entry, shall be fined under this title or imprisoned not more than five years, or
both."
1717 Pennsylvania Avenue, NW, Suite 800 • Washington, DC 20006-4614
Wendy Edelberg
Executive Director
202.292.2799 • 202.632.1604 Fax
Mr. Henry Paulson
August 9, 2010
Page 2 of2
4. Were derivatives a factor in necessitating the rescue of a number of large
institutions? If so, which institutions?
5. Were credit derivatives a factor in fueling the securitization of mortgages and
other loans? If so, do you believe this in turn contributed to the housing and credit
bubbles?
6. Were credit derivatives the primary cause of AIG's failure and the government's
decision for its rescue?
7. Do you believe the structure of compensation packages in the financial system
played a role in the financial crisis? (For example, did the fact that investment
banks were not required to hold some of the securities they were underwriting
playa role in causing the financial crisis?) What role did the fact they were
allowed to hedge against these securities play in causing the crisis? Would this
role have been different if compensation to employees included some portion of
the securities that they participated in issuing or underwriting? Would this role
have been different if investment banks were required to hold some of the
securities they were issuing or underwriting (and prohibited from hedging this
risk)?
8. What role, if any, do you believe the all-cash compensation or bonus system (e.g.,
securities issued being part of the compensation to those who participated in the
deals) across investment banks played in causing the financial crisis?
The FCIC appreciates your cooperation in providing the infonnation requested. Please do
not hesitate to contact Sarah Knaus at (202) 292-1394 or sknaus@fcic.gov if you have any
questions or concerns.
Sincerely,
Wendy Edelberg
Executive Director, Financial Crisis Inquiry Commission
cc:
Phil Angelides, Chainnan, Financial Crisis Inquiry Commission
Bill Thomas, Vice Chainnan, Financial Crisis Inquiry Commission
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September 14,2010
Via E-mail (wedelberg@fcic.gov)
Wendy Edelberg
Executive Director
Financial Crisis Inquiry Commission
1717 Pennsylvania Avenue, N.W., Suite 800
Washington, DC 20006-5614
Dear Ms. Edelberg:
I write in response to your letter of August 9,2010, which asks Secretary Paulson
to answer a number of additional questions, following-up on his voluntary testimony before the
Financial Crisis Inquiry Commission ("the Commission").
Question 1 asks Secretary Paulson to explain any concerns he had about the GSEs
and the housing market in 2007 and 2008. In his public testimony before the Commission,
Secretary Paulson explained the concerns he had throughout his tenure at Treasury with respect
to the GSEs and the housing markets, including the actions he took to seek GSE reform. See
Testimony of Secretary Henry M. Paulson, Jr., Hearing ofthe Financial Crisis Inquiry
Commission (May 6,2010) ("Paulson Testimony") at 7:18-21; 21:9-22:20; 23:5-24:4; 24:1625:5; 51 :24-54:3; 65:11-66:18; 111 :12-22; 112:5-18. Secretary Paulson also addressed this topic
in his recent book. See Henry M. Paulson, Jr., On the Brink (2010) at 55-60.
Questions 2, 3, 4, and 5 ask Secretary Paulson for his views on the role credit
derivatives played in the financial crisis generally, as well as in the problems at AIG specifically.
In his public testimony before the Commission, Secretary Paulson explained his view on how
derivatives contributed to the financial crisis, including his opinion that these products did not
create the crisis but magnified and exacerbated it. See Paulson Testimony at 40:4-41 :8. In
general, Secretary Paulson's view is that the interconnectedness of financial institutions through,
among other things, derivative contracts was a cause of systemic risk, and the lack of
transparency in the market for thosv contracts vxacerbated that risk. With respect to AlG, the
systemic risk posed by the failure of that entity was due in part to the to the extent of its
WILLIAMS & CONNOLLY LLP
Wendy Edelberg
September 14,2010
Page 2
derivatives contracts and the market uncertainty occasioned by a lack of transparency regarding
the level of exposure an AIG failure would pose to its derivative counterparties. See Paulson
Testimony at 96:21-97: 18. Secretary Paulson addressed these issues in detail in his recent book.
See On the Brink, supra, at 200, 204-05, 217-18, 220-223, 229-230, 233, 236-237, 241.
Questions 6 and 7 ask Secretary Paulson about his views on compensation in the
financial services industry. Secretary Paulson has given his views on this subjects in his
testimony before the Commission and in other public venues. See Paulson Testimony at 87:2088: 11. Generally, Secretary Paulson's view is that it is important that compensation systems
create incentives that are consistent with the best long term interest of a company and its
shareholders and do not promote excessive risk taking. Regulators need to work with the
financial industry to set pay standards, but this can and should be done without regulators
determining specific compensation levels. Instead, pay should be aligned with shareholder
interests by ensuring that as an employee's total compensation grows, an increasing amount of it
is given out as equity that is deferred-vesting and paying out later-and subject to being clawed
back under certain circumstances. Senior executives should be prevented from selling most, if
not all, of the shares they are paid; when they retire or leave, their deferred share payments
should not be accelerated. Secretary Paulson discussed these views as well in his recent book.
See On the Brink, supra, at 444.
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