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1 UNITED STATES OF AMERICA 2 3 FINANCIAL CRISIS INQUIRY COMMISSION 4 5 Interview with Lawrence H, Summers, Phd 6 7 The commission met, pursuant to notice, at 8 2:07 p.m., 9 Office of 10 Friday, May 28, 2010, in the the Financial Crisis Inquiry Commission, when were present: 11 12 PHIL ANGELIDES, Chairman 13 CHRISTOPHER P. SEEFER, Esquire 14 BROOKSLEY BORN, Commissioner 15 WENDY EDELBERG, 16 DOUG HOLTZ-EAKIN, Commissioner 17 LAWRENCE H. SUMMERS, Phd 18 Director for the National 19 Economic Counsel, and Assistant 20 to the President, for Economic 21 Policy 22 DONALD VERRILLI, Esquire, 23 White House General Counsel. 24 ALSO ATTENDING, 25 Marne Levine 1 Veritext National Deposition & Litigation Services 866 299-5127 1 Roberto Gonzalez 2 George Manso 3 Michael Gordon 4 Gary Cohen 5 Greg Feldberg 6 Ron Borzekowski 7 Randall Dodd 8 Scott Ganz 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 2 Veritext National Deposition & Litigation Services 866 299-5127 PROCEEDINGS 1 (2:00 p.m.) 2 MR. SEEFER: 3 Dr. Summers, thank you very 4 much for coming in today. 5 of the Financial Crisis Inquiry Commission. 6 established by a statute called the Fraud 7 Enforcement and Recovery Act of 2009 last May, and 8 it tasks us with figuring out the various causes of 9 the financial crisis by the end of this year. 10 My name is Chris Seefer, We were In that regard, we are talking to many people 11 that we hope can help us understand various causes, 12 and of course we have identified you as i person to 13 talk to. Thank you very much for coming in. 14 As you can see, we do have a court reporter, so 15 you've probably been through this drill before, I'll 16 try not to speak over you and vice versa, so we can 17 get a clear record. 18 so and we'll take a break. 19 make a statement before you got started. 20 MR. VERRILLI: If you need a break, just say I know you wanted to Yes, thank you Chris. I'm Don 21 Verrilli, of the White House Counsel's Office, and 22 I'm here today representing the interests of the 23 White House. 24 white house official, and one of the President's 25 closest advisers. As you know, Dr. Summers is a senior 3 Veritext National Deposition & Litigation Services 866 299-5127 1 The White House has agreed to make Doctor 2 Summers available for the purpose of this interview 3 today in recognition of the commission's important 4 mission. 5 agreeing to a step like this interview is an 6 extraordinary accommodation for this or any White 7 House to make. 8 But we all need to recognize that even We have had what I think are very productive 9 discussions with commission staff, regarding the 10 interview, and based on those discussions we are 11 confident and we hope to share a sense with you that 12 the interview can go forward in a way that helps you 13 accomplish your important work, and that respects 14 the interest of the Presidency. 15 Specifically, it is our understanding, based on 16 those discussions, that the interview today will 17 focus on the historical record and not on current 18 administration policy or current events that the 19 administration is confronting or may have to 20 confront. We have an agreement about that? 21 MR. SEEFER: 22 MR. VERRILLI: 23 MR. SEEFER: Yes. All right then, thank you. So Doctor Summers, our 24 statute tells us to look at 22 different areas. 25 going to frankly ask you about several of those I'm 4 Veritext National Deposition & Litigation Services 866 299-5127 But before I do, I really just wanted to 1 areas. 2 broadly get your 3 were the primary causes of the financial crisis. 4 And then I'll ask more specific questions after we 5 hear that. opinions to start on what you feel DR. SUMMERS: 6 The beginning for me, the 7 right way to think about this financial crisis or 8 for that matter any major accident, to think in 9 terms of a number of factors which came together to In all likelihood, in the absence 10 cause the crisis. 11 of most of them, history would have plaid out quite 12 differently. 13 So I like to think of the factors in 4 broad The first is the macroeconomic 14 clusters. 15 environment. 16 by a period of low volatility. 17 very low interest rates, very substantial capital 18 inflows into the United States, relating to both 19 external economic conditions in the countries, and 20 to U.S. budget policy. 21 availability of credit contributed to a 22 macroeconomic environment that was prone to 23 speculative excess, broken asset and debt markets. A combination of overconfidence caused Low interest rates, The relatively easy 24 Second, obviously these are related, you had 25 quite a pervasive pattern of excessive leveraging 5 Veritext National Deposition & Litigation Services 866 299-5127 risk taking. At i level that's a reflection of 1 and 2 what's surely a factor in most human failure, greed, 3 irresponsibility, and cupidity. 4 it's a reflection of the incentive arrangements that 5 were poorly aligned, with respect to the 6 compensation of individuals, with respect to awards, 7 open to institutions. 8 reflects failures of regulation both gaps that 9 allowed leveraged decisions to be made without At another level At another level, it was 10 serious review or allowed commitments to be made, 11 where such an equivalent to leverage, guarantees and 12 the like, without serious regulatory review. 13 failures by regulators to fully assess risk in 14 situations where they were engaged in review. 15 situation speculative excess, combined with a 16 situation of excessive leverage created an 17 environment that was very easy for crisis to 18 develop. If you would like, a very, very dry 19 forest. The third factor was a set of evolutions 20 in our system that had made it more brittle, made it 21 brittle, and without the resilience that it had 22 earlier. It could be argued for some significant 23 interval, perhaps through the 1990s, that our 24 systems, the argument that Al Greenspan had made at 25 that time, had a resilience that came from credit And So a 6 Veritext National Deposition & Litigation Services 866 299-5127 1 being provided on the i hand by banks, and on the 2 other hand through the capital markets. 3 there was some tendency when the banking system got 4 in trouble as it did in the early '90's, for capital 5 markets to take up the slack. 6 markets got in trouble, for the banking system to 7 take up the slack. 8 9 And that And when capital The ways in which securitization evolved, the ways in which the shadow banking system evolved, 10 particularly as regards mortgages, ways in which the 11 derivatives markets evolve, created a system that 12 was very brittle, in the sense that there were a 13 large number of no's. 14 called the broad stability of the system into 15 question. 16 collapse came to be a much shorter one. 17 Failure at any i of which And so the jump from crisis to systemic A fourth factor was the lack of satisfactory 18 tools for crisis resolution that placed public 19 authorities in a situation where it was challenging 20 to act rapidly, decisively and legally. 21 faced them with, even if they were able to get the 22 legal authorities that they might wish, with 23 agonizing dilemmas's between on the i hand chaos, 24 confusion and potential collapse. 25 hand the indiscriminate infusion of large quantities And that And on the other 7 Veritext National Deposition & Litigation Services 866 299-5127 taxpayer money, with associated risks for 1 of 2 taxpayers and associated moral hazard consequences 3 down the road. 4 So while there are many, many aspects and 5 contributors, for me the broad list of the macro, 6 without a problematic macroeconomic environment, 7 likely would have survived many of the other 8 problems that we would've had with the problematic 9 macroeconomic environment, we but without excessive 10 leverage and failures of regulation consequences. 11 Quite likely it would have been less serious, even 12 with a flawed macroeconomic environment and 13 excessive leverage, without the degree of 14 brittleness and non-resilience that had emerged, we 15 would've had a better outcome. 16 of those, we might well have been in a much stronger 17 position if we had more satisfactory mechanisms for 18 containing failure. 19 And even with all 3 I might just finally emphasize, because I 20 realize that I didn't say it again. When I spoke of 21 excessive leverage, the examples I used in my tone, 22 emphasized in financial institutions. 23 excessive leverage by households, by businesses and 24 the decisions to extend excessive leverage to 25 households and to businesses are also part of the Of course 8 Veritext National Deposition & Litigation Services 866 299-5127 1 leverage story. MS. EDELBERG: 2 Can I just ask i follow up So what I keep coming back to is comments 3 question? 4 like Chairman Bernanke's. 5 when we said our housing market turned, the sub 6 prime crisis was contained. 7 that time, and what did we not know at that time? 8 And the reason I keep coming back to that is 9 that I can't help but think, given how many smart Where he said early on And what did we know at 10 people were, would have had every incentive to avoid 11 a financial crisis, that what led to the financial 12 crisis was things they didn't see, or connections 13 that they didn't see. 14 So with that in mind, I look at your list and 15 there are a number of these things that we knew in 16 2005. 17 macroenvironment, we arguably knew a huge amount 18 about leverage. 19 of leverage that we didn't understand, but we could 20 have understood them if we had looked in financial 21 institutions. 22 with undervalued ratios, and we understood what was 23 happening in the regulatory environment. 24 argue. 25 We knew what was happening in the It could be that there were parts We certainly saw what was happening I would The part that I see on your list that I don't 9 Veritext National Deposition & Litigation Services 866 299-5127 1 know that we appreciated in 2005, I'm trying to roll 2 back some time before the crisis, is the brittleness 3 of the system. Is that fair? Well I think it's, I made DR. SUMMERS: 4 First, the brittleness would have 5 or 3 points. 6 mattered less if the other factors that led the 7 resilience of the system to be tested, had not been 8 present. 9 right, it wouldn't follow that i should ascribe the 10 11 2 So even if your point was completely crisis only to the brittleness. Second, I think it's in some ways simpler to 12 think about the problem activities of investors 13 who's motivation wasn't to fix the situation, 14 only to evaluate it. 15 with fewer constraints. 16 of money were lost by people who had considerable 17 experience and considerable successful experience. 18 Hindsight is 20/20, and I think in retrospect but And who were therefore operate Obviously very large amount 19 it's clear that the macroeconomic environment was 20 highly suspect in the ways that I described. 21 actually was i who fairly early in this 2006/2007 22 gave some warning 23 macroenvironment, it corresponded to my judgment. 24 But it wasn't that it was an obvious judgment, a 25 completely obvious judgement. I about various aspects of the While it seems 10 Veritext National Deposition & Litigation Services 866 299-5127 1 obvious today, is I gave those warnings at that 2 time, 3 really very widely held view that when the Dow 4 reached the 6000 range in 1996 that it had a bubble 5 element as well. 6 appears not to have been the right one. I was aware that it was a quite common, and And ex post, that judgement So I think the judgment of when you have a 7 8 bubble, all these looks much easier ex post than it 9 does ex ante. Any moments in markets there are 10 bears and the ones who were bears at the moment the 11 ex posts were peaks, tend to look like they were 12 very wise. 13 somethings were out there is quite as definitive. So I don't think that the fact that I think an element, 14 I think a very, very 15 important element in understanding the crisis, and 16 it's somewhere between like the second and third 17 factors on my list, was that people who buy 18 investment grade credit or junk credit, believe it's 19 going to be credit worthy and believe it's going to 20 work out, or they wouldn't buy it. 21 with the understanding that failure is a 22 possibility, and based on a consideration of the 23 possibility of failure and the risks associated with 24 it. 25 securities, AAA tranches, in various kinds of low But they do so The investment in top grade securities, AAA 11 Veritext National Deposition & Litigation Services 866 299-5127 1 collateralized instruments, comes with relatively 2 little consideration of risk, because it's just 3 assumed to be safe. And so when the failure of what has previously 4 5 been assumed to be safe comes into doubt, you can 6 get a very substantial panic reaction. 7 somebody has said, somebody has used the analogy, it 8 would take a very little bit of botulism, the 9 smallest risks to change life quite profoundly if It's as if 10 people wondered about the integrity of the water 11 supply which they had previously completely relied 12 on as being safe. 13 the brittleness, and that brittleness has elements 14 in the structure of the financial system. So that was in part a source of But it also has elements in what the size of 15 It also has elements 16 the bubble turned out to be. 17 in how much leverage there was, because if there had 18 been less leverage, even with the bursting of a 19 bubble, the previously safe securities wouldn't 20 have. 21 question of brittleness, but at least in my view, to 22 really trace it through, and to capture this aspect 23 of the previously safe not being the gestalt 24 changing, with respect to the previously safe. 25 You'd have to look to all 4 of the factors that I So I understand why you are going to the 12 Veritext National Deposition & Litigation Services 866 299-5127 1 talked about. MR. SEEFER: 2 Understanding your point 3 about folks that invest in AAA's and perhaps don't 4 consider losing anything to panic, one of the 5 factors in our statute is looking at the credit 6 rating agencies, and in fact our next hearing is 7 going to be on credit agencies. What are your 8 opinions about the role they plaid in the crisis? DR. SUMMERS: 9 There are aspects that I 10 know more about, there are aspects that I know less 11 about. 12 enough about. 13 that I know less about. 14 There are probably no aspects that I know Credit ratings would be an aspect There is no question that the credit rating 15 agencies made huge errors, and that uncritical 16 reliance on the credit rating agencies, while credit 17 rating agencies were making huge errors, was an 18 important aspect of the problem. 19 credit rating agencies and those who in regulation 20 make use of their product, I'm talking about this, 21 phrases like investment grade, have a lot of 22 soul-searching to do. 23 And obviously the I would make 2 other remarks. The first is 24 that I think they sort of go in opposite directions. 25 The first is that, and again, I think you will find 13 Veritext National Deposition & Litigation Services 866 299-5127 1 people who can speak to this, speak to what I am 2 about to say much in much more nuance than I can. 3 You'll find that there was some activity of the 4 credit rating agencies which is like what most 5 people's image of what a credit rating agency does. 6 i issued a bond, you rate the bond, and after I've 7 issued the bond you evaluate the bond. There came to be at least a substantial amount 8 9 of activity, particularly in the synthetics area, 10 where it is at least frequently alleged that the 11 rating agency was a partner or at a minimum a close 12 advisor, or was more actively involved and rather 13 more extensively compensated in the design and the 14 rating process. 15 serious kinds of questions. And that obviously raises more At i level, you know the distinction can't be 16 17 drawn with precision. 18 If 19 this way, how would you rate it? Suppose I issue it 20 that way, how would you rate it? How does iterative 21 question asking differ from cooperating in the 22 design? 23 distinctions in that area. 24 think that where there is more extensive 25 involvement, that's an area that requires I think If I evaluate and you rate, I issue and then you rate. Suppose I issue it There are clearly some difficult But I think one has to 14 Veritext National Deposition & Litigation Services 866 299-5127 I think it receives particular i particular scrutiny, 2 scrutiny at least in some versions of the financial 3 legislation now under consideration. 4 The other point I would make though, goes in a 5 somewhat different direction, just in assessing 6 credit rating agencies. 7 of specialized entities concerning credit risk and i 8 is the credit rating agencies. 9 difficulties also have contributed in a non-trivial Is that you have a number Another who's 10 way to the crisis is the bond insurance agencies. 11 And the bond insurance agencies did dismally in many 12 cases. 13 bond insurance agency is that their failure was not 14 due to the incentive problem that the credit 15 agencies had. 16 were on the hook if a bond they insured failed. 17 they had massive incentives to avoid it, and made 18 many of the errors that the credit agencies made. 19 And the i thing that you can say about the They were in a position where they So So my instincts would be that it may slightly 20 oversimplify what I think is a very deep problem to 21 attribute it in a dominant way to incentive 22 problems, rather than to intellectual problems, 23 given the pervasiveness of the problem, even where 24 there were very strong incentives to avoid. 25 Now again, particularly in the synthetics 15 Veritext National Deposition & Litigation Services 866 299-5127 I think there were real questions 1 cooperative area, 2 that can be asked about the arrangement. 3 are a place where I have had a little bit of an 4 occasion to think about these issues. 5 there are some similarities with the set of issues 6 involved in the work of accountants auditing, 7 designing tax policies, doing consulting business, 8 how one draws lines. 9 things have been fairly substantially considered. 10 The issues Similarly, There is a place where these MR. SEEFER: So am I understanding you 11 correctly that when it comes to the Ambacs and the 12 MBIA5 and I guess we can throw AIG in there when we 13 talk about the bond insurers, that there was more a 14 function of I guess a lack of intellectual 15 firepower, so to speak? 16 DR. SUMMERS: Intellectual firepower, I 17 think I would rather make the slightly more narrow 18 statement that corresponds to what I have some 19 chance of knowing. 20 problem, in the sense that they have very strong 21 incentives to do right. 22 whether the judgment has to do with the 23 unsatisfactory quality of information they received, 24 or the intellectual judgments they made about that 25 information, Which is it wasn't an incentive It was a judgment error, I don't have a basis for making any 16 Veritext National Deposition & Litigation Services 866 299-5127 1 judgment at all about that question. MR. SEEFER: 2 I understand that, another 3 area that we're looking at, another area that the 4 statute tells us to look at, is the role of 5 executive compensation and compensation packages in 6 general. 7 other company, there are still compensation 8 incentive structures where the managers incentives 9 may not necessarily be aligned with the company. And whether it's Ambac, MBIA or AIG or any 10 mean have you thought about it at all, for the 11 Ambac's and the MBIA's and the AIG's? Let me go back to your 4 factors, and ask you 12 13 about what you wrote, what you said in a speech 14 before the Brookings Institution on March 13th of 15 2009. 16 there's 2 kinds of economic downturns. 17 know, monetary policy and rising inflation, and then 18 of course the financial crisis, the spontaneous 19 correction of financial excess, as you said. 20 talked about how we get 2 or 3 of these a century, 21 and I'm wondering if you just think, given these 4 22 factors, that if you had the fourth factor, if you 23 did have satisfactory tools for regulation by 24 government, could we avoid these financial crises s 25 2 or 3 times a century? And in there you were talking about how One, you You 17 Veritext National Deposition & Litigation Services 866 299-5127 DR. SUMMERS: 1 In my tone, as I spoke to 2 the 4 factors, was to suggest that I thought that 3 with any one of them fixed you would make the 4 situation substantially better, and that would be my 5 belief. 6 vastly, vastly, vastly better to have an effective 7 fire department than not to have an effective fire 8 department. 9 just have an effective fire department it's okay to 10 If you're going to have fires, it is But it doesn't quite follow, if you have fires. So I don't want to be heard as suggesting that 11 12 with satisfactory resolution authority everything 13 else can be allowed to rip, and that you won't have 14 serious problems. 15 kinds of resolution authority the risk of a crisis 16 becoming systemic and coming to the brink of 17 bringing the system 18 be quite significantly attenuated. I do think that with the right to the brink of breakdown could MR. SEEFER: 19 Let me ask you some follow Several of them are in our 20 ups on your 4 factors. 21 statute, not surprisingly are within your 4 factors 22 50 far. In the article that you and Mr. Geithner 23 wrote in the Washington Post on June 15th of last 24 year, 25 And 1 of the first things you talked about in terms VA New Financial Foundationv it was called. 18 Veritext National Deposition & Litigation Services 866 299-5127 1 of the macroenvironment was the global imbalance of 2 savings, which is i of the first things we are 3 supposed to look at in the statue. 4 Any further comment on how that contributed to 5 the financial crisis, other than the way you 6 explained and described in the first factor? DR. SUMMERS: 7 I think you have 2 or 3 There is an aspect which is that when 8 aspects. 9 money is cheap it's more attractive to borrowers. 10 And the very substantial availability of funds from 11 countries that for a variety of reasons were seeking 12 to accumulate liquid reserves, and the posture of 13 monetary policy reflecting concerns about deflation 14 led to money being cheap, which in turn encouraged 15 borrowing to buy, which in turn encouraged higher 16 asset prices. I think that's i aspect. 17 A second, and I think logically not completely 18 independent, but somewhat separate aspect is that a 19 very large demand for safe assets called forth a 20 desire to supply them, which in turn drove the 21 creation of the apparently safe assets, which were 22 subject to the gestalt changes that I described, and 23 also drove the rather large and substantial 24 activities around tranching, and the creation of 25 synthetic securities, which may, given the absence 19 Veritext National Deposition & Litigation Services 866 299-5127 1 of transparency and with problems in regulation, 2 contributed to the brittleness of the system. CHAIRMAN ANGELIDES: 3 4 Can I just ask a question? 5 MR. SEEFER: 6 CHAIRMAN ANGELIDES: Of course. Can I probe this for Which is obviously you've identified that 7 a minute? 8 there is a demand for the safe assets, perhaps i and 9 that's spurred the creation of a whole set of 10 products to satisfy that demand. 11 thinking about the other end of the chain. 12 at the other end of the chain, at least the first 13 set of products, before you got into the synthetics 14 and mezzanine CEO's. 15 consumers to borrow so substantially? 16 driving factors there? 17 but obviously if someone is offering you cheap money 18 for the option, 19 that people were over their skis, in terms of being 20 able to meet their needs, wages were flat, money was 21 cheap. 22 assets that they thought had appreciation? 23 were the driving factors at the other end? 24 25 But I keep Which is What is it that drove American money, What were the Now, not to give the answer, I can see that. But was it People saw the ability to borrow to buy DR. SUMMERS: What I'm not sure that I can articulate them neatly into categories, but I guess 20 Veritext National Deposition & Litigation Services 866 299-5127 First, there was optimism i I could suggest several. 2 founded on recent experience. 3 that matter car prices, had been robust for a 4 substantial period of time. The set of phenomena 5 the economists were calling, vThe great moderationv 6 had led households to a sense that their incomes 7 would be relatively robust. 8 had borrowed had 9 well for a quite long period of time. . . . House prices, for By and large those who it had turned out reasonably And in 10 general, this is a sort of nonscientific 11 generalization, but financial messes, both for 12 individuals and firms and for countries tend to made 13 when there's a ton of behavior that takes the form 14 of doing today what you wish you had done yesterday. 15 When people buy things that have just gone up, 16 because they've just went up, that's what causes 17 bubbles. 18 borrowed a decade ago and it ended up working out 19 well for them, that tends to be when you get 20 over-leveraging. 21 the household system. 22 When people borrow, because people who So I think there was an element in Second, we had the innovativeness and to some 23 extent the greed and irresponsibility of lending 24 institutions combined with inadequate regulation. 25 In the spring of the year 2000, Andrew Cuomo and I 21 Veritext National Deposition & Litigation Services 866 299-5127 1 issued a report on predatory and subprime lending 2 practices, that talked about no doc loans, talked 3 about loans with adjustable rates with inadequate 4 disclosure of the adjustment. 5 variety of the other practices that became famous. 6 So it had to do with household decisions, but you 7 know there is a saying about life insurance, that 8 it's sold, not bought. 9 said about a fair amount of It talked about a And something similar can be lending activity. So 10 the absence of satisfactory consumer financial 11 regulation, coupled with a plausible story as to why 12 consumers were better off borrowing created strong 13 incentives for the excess borrowing on the consumer 14 side. 15 16 17 I want to ask a quick MS. EDELBERG: question on global imbalances. CHAIRMAN ANGELIDES: Just i small point. 18 So how much of any of it was driven by flat wages, 19 need to borrow 20 had done yesterday what you're about to do now, the 21 availability of product? versus the optimism, the wishing you You know it's- 22 DR. SUMMERS: 23 CHAIRMAN ANGELIDES: And I don't know if 24 there is any, I have asked the staff whether that 25 can really be quantified. 22 Veritext National Deposition & Litigation Services 866 299-5127 DR. SUMMERS: 1 Here is why I am having It's a terrific question, but 2 trouble answering. 3 I'm having a little trouble answering. 4 hand if wages had risen, if you had a period when 5 real wages were rising significantly, I'm sure there 6 would've been less need for borrowing and there 7 would have been more wherewithal to repay. 8 the way, if the environment with rising wages and 9 higher incomes, there would have been more upwards On the i And by 10 pressure on housing prices, which would have also 11 averted some of the problems. So at i level I agree with you, and I should 12 13 say- 14 CHAIRMAN ANGELIDES: 15 DR. SUMMERS: I don't know- The reason why I didn't put is because it related to the 16 more emphasis on it, 17 arguument that was made a little bit earlier. 18 type of argument that was made a little bit earlier. 19 Wages were, wages have been relatively stagnant for 20 middle-class families for a long time. 21 not sure that wages that were stagnant and had been 22 stagnant are so much a cause of the problem. 23 other hand you can argue that in a period when 24 investment was particularly strong, federal budget 25 position was better in the 1990s, You did see some The And so I'm On the 23 Veritext National Deposition & Litigation Services 866 299-5127 Perhaps if that whole 1 significant wage growth. 2 pattern had continued, that too would have 3 contributed to reducing these problems. MS. EDELBERG: 4 So on global imbalances, 5 global imbalance confuses me for a couple of 6 different reasons. 7 to get clarity from. 8 monetary policy would've made it cheap to borrow in 9 the U.S. Short-term, and Vince Rinehart has this And you seem like a good person So I can understand why 10 argument, that it's actually the steepness of the 11 yield curve that matters, and that makes some sense 12 to me. 13 or really even certain parts of the world economy 14 saving a lot of money means that they have to bring 15 that money into the U.S, and invest it in assets 16 that are part of an asset bubble. 17 I'm looking at there, is I'm looking at the gross 18 flows, which is the net flows. 19 lot this way, money has gone a lot that way. 20 doesn't seem like it's an inevitability. 21 global imbalances create an asset bubble within the 22 U.S. 23 partly. 24 25 But I don't understand why monetary policy And part of what And money has gone a This That the And that it's monetary policy to blame, DR. SUMMERS: Well again, I think it was the nature of the way I laid out the factors to 24 Veritext National Deposition & Litigation Services 866 299-5127 1 suggest that it was the 4 of them coming together 2 that caused the crisis. 3 of them made the crisis inevitable. 4 MS. EDELBERG: 5 DR. 6 MS. EDELBERG: 7 Right. So in that senseI'm sorry, I meant the asset bubble. DR. SUMMERS: 8 9 SUMMERS: Which is to say that no i -I relate to what you are saying, if you, and I don't doubt that with nothing 10 different in the rest of the world, if there had 11 been 12 systems, stronger regulation, that led to less 13 leverage and better judgments by financial 14 intermediaries, that it would've had a significant 15 effect on the pattern that emerged in asset prices. 16 So that's certainly right as well. 17 more responsibility and better risk management If the question is though why is large 18 accumulation of reserves by China for example, 19 relevant to this whole phenomenon, I'd come back to 20 2 factors, to the 2 things that I tried to get at 21 before. 22 there's higher, it's a higher level of savings in 23 the world, and there is a tendency for real interest 24 rates to be equalized around the world, you'll have 25 lower real interest rates, which contribute to more That ceteris parabus, other things equal, 25 Veritext National Deposition & Litigation Services 866 299-5127 1 mortgages, and that many of the savers, to use, 2 don't know who's phrase it was, first Keynes I think 3 and then Frank Amagliani's phrase. 4 habitat. 5 saving on the part of those who had a preferred 6 habitat, in safe liquid securities, then that's 7 going to affect the relative pricing of safe liquid 8 securities, which in turn is going to influence the 9 incentive to create them, which in turn is going to I Preferred If you had a substantial increase in 10 influence the EPG, Treasury Bills, AAA tranches. 11 Which in turn is going to influence the demand for 12 the assets with which they can be attached, 13 mortgages and ultimately housing. 14 MR. SEEFER: You mentioned the paper that 15 you and Mr. Cuomo came out with in the spring of 16 2000, when you were talking about irresponsible 17 lending practices and predatory lending, and you and 18 Mr. Geitner mentioned the same thing, in the June 19 15th, 2009 Post article, and surprise, surprise, our 20 statute tells us to look at the role of fraud and 21 abuse in the financial crisis. 22 23 24 25 CHAIRMAN ANGELIDES: Is there a statute that they tell us not to look at? MR. SEEFER: record as saying, And I believe that you are also on V1f we would've had a Consumer 26 Veritext National Deposition & Litigation Services 866 299-5127 1 Protection Agency it would've been able to protect 2 against these subprime abuses.v 3 So I guess I have a two-part question. One, 4 generally do you have opinions on the role of fraud 5 and abuse, in particular predatory lending in the 6 crisis, and why do you think having a Consumer 7 Protection Agency will help, since I think we've had 8 some failures in regulation which contributed to the 9 crisis too? 10 11 12 13 14 15 16 CHAIRMAN ANGELIDES: Or maybe the question is why it might have helped- MR. VERRILLI: I prefer the Chairman's formulation of the question. CHAIRMAN ANGELIDES: That's fine, that's fine. It was inadvertently effective. DR. SUMMERS: If you look at certain areas 17 where you see the greatest problems emerge in the 18 housing market, you also see the highest fraction of 19 mortgage activity that would fall within the kinds 20 of categories that Secretary Cuomo and I had 21 identified in our predatory loans document, you 22 would have no down payment loans without documented 23 income, substantial adjustability in rates, that was 24 poorly disclosed, inadequate appraisal practices, 25 questionable compensation arrangements, involving 27 Veritext National Deposition & Litigation Services 866 299-5127 1 2 all participants, the realtors and so forth. So I think the nexus between some of the most 3 problematic elements of the housing market in the 4 lending practices suggested by the pervasiveness of 5 the lending practices, and their particular 6 pervasiveness in the places where the housing market 7 was most serious. 8 9 With respect to the question consumer financial regulators, I think there are probably 3 arguments. 10 First, when you have consumer responsibility in the 11 agencies, whose 12 success is safety and soundness, inevitably there 13 will be some tendency to prefer things that 14 contribute to profitability to things that might 15 interfere with profitability. 16 motives and judgment. primary mission and criteria for Even with the best 17 Second, you have a substantial amount of 18 consumer lending activity, an activity that placed 19 substantial pressure also on activity in banks took 20 place outside the banking system. 21 expected that activities placed in banking agencies 22 can place consumer lending and banking agencies, 23 however you define those agencies, more attention 24 would be paid to banks then will be paid to 25 non-banks, as in fact proved to be the case. And it is to be 28 Veritext National Deposition & Litigation Services 866 299-5127 1 Third, there is just a cultural if you like, 2 feature around those who are appointed to the 3 positions and those who are at political level 4 decisions, and those who choose to spend their 5 career in the civil service positions, that when the 6 primary mission is around monetary policy, or when 7 the primary mission is around safety and soundness, 8 those who will end up with the responsibility will 9 be people who have more experience in and more 10 11 passion for what is the primary mission. That's why over time we as a country have come 12 to have large numbers of independent regulatory 13 agencies, rather than place all the responsibility 14 with some focus in the mission. 15 to be the reasons why one would expect that 16 established in December, the Occupational Health and 17 Safety Administration will lead to more focus on 18 occupational health and safety than placing the 19 responsibility of the Commerce Department whose 20 mission is to promote America and economic growth, 21 one can give a large number of similar examples. So those seem to me 22 So those are the judgements that have lead me 23 for quite some time to favor a Consumer Protection 24 Agency. 25 MS. EDELBERG: I'm sorry, I just want to 29 Veritext National Deposition & Litigation Services 866 299-5127 And I'm not talking about 1 make sure I understand. 2 any of the legislation that's being proposed, just 3 thinking backwards. 4 said monetary policy, my ears perked up. 5 saying, does that even include the Federal Reserve? 6 Right? 7 goal of monetary policy, then the people who are 8 rising up through those ranks were most focused on 9 that primary mission, and not on regulation, and Would you include, so when you Are you That the Federal Reserve with its primary 10 perhaps that was true at Treasury, perhaps that was 11 true at other? 12 DR. SUMMERS: Well I think that was, I 13 mean my comments really went, the Federal Reserve, 14 and there are people in this room that probably know 15 more about the structure from year 1. 16 more about the details of the structure of the 17 Federal Reserve than I do. 18 fair to say that the Federal Reserve employs a 19 substantial number of people whose mission is around 20 helping to calibrate and set monetary policy, 21 including monetary policy with a view towards 22 financial stability. 23 number of people whose work is focused on various 24 aspects of financial market conditions and financial 25 suitability, including in particular the supervision Probably know But I think it would be It employs a substantial 30 Veritext National Deposition & Litigation Services 866 299-5127 And it employs a 1 of financial institutions. 2 significant, but I suspect quite a bit smaller 3 number of people whose mission is around consumer 4 protection or the enforcement of anti-discrimination 5 statutes and the like. My comment was to suggest that the orientation 6 7 of the institution was heavily enough to the first 8 2, 9 you may have been seeking to see whether I was to make you wonder about the third. But I think 10 expressing a view about the second, relative to the 11 first. 12 anything And I was quite consciously not saying about that. MR. SEEFER: 13 Obviously i area we're 14 looking at was the growth in subprime loans and 15 broader non-traditional mortgage loans over time, 16 and the reasons for that growth. 17 we've been looking at include the originate to 18 distribute models, securitization, whether that was 19 creating demand for all the GSE5, and other things 20 that escape my mind right now. 21 opinions on the causes of the growth of the non 22 traditional mortgage product in the decade of the 23 2000s? 24 25 DR. SUMMERS: And areas that But do you have any As you noted, a great deal of the growth took place in the 2000s, took place in 31 Veritext National Deposition & Litigation Services 866 299-5127 1 particular over a period when I wasn't in 2 government, wasn't in the financial markets and 3 wasn't especially watching. 4 to the people with a keener sense than I. So you'll have access My impression is that in a period of quite 5 6 robust housing price performance, default rates on 7 almost every kind of loan had been very low for a 8 long time. 9 the experience of the previous period continued to And therefore it appeared profitable if To make loans, even loans underwritten to 10 hold. 11 less rigid criteria than had been the case 12 previously. 13 Entrepreneurs sought to do that. The 14 additional public policy, subsidy to the activity 15 that was provided by the fact that the GSE's were at 16 a certain point significantly encouraged by being 17 given low income credit, or credit towards their 18 affordability goals, to hold these loans was 19 obviously a reinforcement, both in a direct 20 financial sense, and probably a broader moral sense 21 to this kind of activity. 22 What fraction of the. . . to what extent they 23 bear responsibility, that the GSE extension in, to 24 what extent that's responsible for a large part of 25 the growth in subprime predatory, or small part of 32 Veritext National Deposition & Litigation Services 866 299-5127 1 the growth in subprime predatory is a question in 2 your place. 3 not i where I know enough to presume to venture a 4 view. I would think was an important one, but I think it is legitimate to explore the extent 5 6 to which we may, there are other aspects that are 7 appropriate to explore here. 8 questions during the time I was at the Treasury 9 about the magnitude of the implicit subsidy through I have raised 10 the aura of government credit support, and how large 11 a subsidy that was to the GSE5. 12 to their shareholders, but some of which flowed to 13 the nation's housing market, and flowed therefore 14 into housing. 15 increased, both as their activities expanded quite 16 substantially, and as their leverage increased. 17 There were efforts I made some, Chairman Greenspan 18 made some in the very late '90's and the early 2000s 19 to address the questions that were raised by the 20 GSE. 21 Some of which flow And the magnitude of that all There is a broader question to be asked which 22 goes to the very substantial benefits that our 23 society generates from being a society in which 24 families are enabled in many circumstances 25 encouraged to own their own homes on the i hand. 33 Veritext National Deposition & Litigation Services 866 299-5127 1 But on the other hand homes are large, permanent 2 rather illiquid assets, and home ownership may not 3 be appropriate as an objective for people in all 4 circumstances. 5 made, in so far as it caused gazes to be averted 6 from some of the more egregious subprime practices, 7 so far as to cause some lack of scrutiny of the GSE5 8 at a certain point I think it was problematic around 9 the approach we as a country take, in terms of the 10 Certainly, the suggestion has been degree of encouragement of home ownership. But the other hand we have derived enormous 11 12 benefit as a country from home ownership. 13 all kinds of evidence on the benefits for children, 14 and families that own their own homes and so forth. 15 So I think it is an area that needs very 16 considerable thought and there obviously were some 17 excesses in the kinds of ways credit was provided, 18 but I wouldn't presume to judge where the right 19 balances were. MS. EDELBERG: 20 There's Should we be thinking of 21 putting the subsidy to the GSE5 in the same category 22 as all of the subsidies to home ownership in the tax 23 code? 24 homeowners, 25 write off mortgage interest? Whether it's the relative tax rates for versus renters, the fact that you can 34 Veritext National Deposition & Litigation Services 866 299-5127 Just so we're all clear 1 DR. SUMMERS: 2 MR. VERRILLI: That would be great. 3 MS. EDELBERG: My question was totally 4 theoretical. DR. SUMMERS: 5 Just so I'm not being The GSE5 currently are in 6 misunderstood. 7 conservatorship, so you are in a rather different 8 framework than we were previously. 9 With respect to the previous question, there 10 are sort of 2 questions, to analyze the GSE5, and I 11 don't know whether i was written while 12 CBN director or not, Commissioner Holtz-Eakin, but 13 CEO has periodically written reports that say in 14 careful ways what I am about to say. 15 you were the To reach the question you first have to decide 16 how large the subsidy was to the GSE5, which depends 17 on the judgment of what their creditworthiness is, 18 and how to think about their creditworthiness in the 19 absence. 20 Second, in so far as you have formed views on 21 how large the subsidy is, 22 what extent it's being passed on to homeowners, and 23 to what extent its sticking to their shareowners. 24 My suspicion is that analysts would tend to judge 25 that the GSE subsidy, while important in a number of you need to decide to 35 Veritext National Deposition & Litigation Services 866 299-5127 1 respects, was probably not huge, relative to the tax 2 subsidy. 3 the aspects associated with the deductibility of 4 property taxes. Or to take another issue that is vexed, You found stickiness though? 5 MR. SEEFER: 6 CHAIRMAN ANGELIDES: Yet the bulk of the 7 subsidy went to the shareholders, a de minimis base 8 point reduction,in Morgan Chase. MR. SEEFER: 9 Turning back to causes for 10 the increase in non-traditional mortgage products. 11 Another thing we've looked at since we first asked 12 you this question. 13 boom, and then after that the feds started to 14 tighten. 15 home purchase loans that you did refis. 16 opinion did monetary policy and other factors in 17 that part of the decade contribute to the increase 18 in non-traditional mortgage loans? 19 had any role? 20 In 2003, you saw the big refi I think you saw, DR. SUMMERS: I think relatively more In your Do you think it Monetary policy was itself 21 responsible to a whole range of macroeconomic 22 conditions, including a set of issues associated 23 with the pressure of capital inflows, in intervals 24 when short-term interest rates rose for some time. 25 But there was less impact on long-term rates than 36 Veritext National Deposition & Litigation Services 866 299-5127 But I was not watching markets 1 many expected. 2 closely enough for me to have an opinion that would 3 be particularly helpful for you. MR. SEEFER: 4 According to a transcript 5 that I saw at least of an April 22nd 2010 PBS news 6 hour, it was about you. 7 there was no question, you know, that things had 8 happened on Wall Street, where the reason we had 9 this financial crisis and you mentioned a couple of You know that you said that Mistakes on Wall Street, the mortgage area, 10 things. 11 the subprime bubble, house price appreciation, loans 12 that borrowers could not afford, and you said that 13 credit errors on Wall Street brought financial 14 institutions to the brink of insolvency. 15 Can you maybe give us a little more color on 16 the mistakes that were made in the mortgage area, 17 and then in credit errors that were made on Wall 18 Street? 19 (Laughter.) 20 Or was the transcript wrong? DR. SUMMERS: No, the transcript was I That always makes me nervous when 21 assume right. 22 people read back things I've said. 23 actually felt fine. 24 (Laughter.) 25 But that one As you were reading it back, no, I'm just not 37 Veritext National Deposition & Litigation Services 866 299-5127 1 sure that I've got a lot to add to what I've been 2 saying. 3 misjudgments of the risks associated with 4 mortgage-backed securities that were made by many 5 financial institutions to purchase those securities, 6 and as a consequence lost very large amounts of 7 money. 8 have been averted by, if the houses on which 9 mortgage were written had not collapsed in value, 10 11 There were obviously very substantial And those errors, as a matter of logic could then there couldn't have been those errors. If there had been limits on the leverage, and 12 the initial equity in those houses, then even if the 13 houses had collapsed, there would have been much 14 less money lost, if the guys who held 15 mortgage-backed securities or contemplated holding 16 mortgage-backed securities, had foreseen the risks 17 associated with them, and paid appropriate prices, 18 they wouldn't have lost large volumes of money that 19 would've been a major source of risk associated with 20 the system. 21 diversification and in the extent of their 22 risk-taking, the magnitude of the consequences of 23 their errors on the first 3 points would have been 24 less serious for the health of the financial system. 25 And if they have been prudent in their MR. SEEFER: Obviously it's always hard to 38 Veritext National Deposition & Litigation Services 866 299-5127 1 call a peak, and you know very few people are 2 successfully calling peaks and troughs, but I really 3 want to ask though, why were there such serious 4 errors in judgement given the underlying quality of 5 the collateral, I mean you had 6 a lot of, it seems to me, yellow and red lights 7 going off. 8 a year. I think certainly a level of knowledge about 9 the type of instruments in the market, no doc loans, and there were Home prices rising at 10, 11, 15 percent 10 very high debt to income ratios, extraordinary, no 11 proven ability, no respective ability to pay. 12 loans really made on rapidly escalating collateral 13 prices, without ability to service the loans. 14 So Knowledge which I guess to many people wasn't 15 available, that we really did have a. 16 hear no one could have anticipated a 30% decline in 17 national house prices. 18 securities become impaired by 19 prices have dropped off 1 or 2%, and we had a 2% 20 drop in the '90 to '93 21 driven by regional drops. 22 . . you now Of course many of these area. mid 2007, when house Of course mostly i guess just fundamentally, if you step back, 23 why was there such, do you think, a lack of 24 understanding, a lack of due diligence, the 25 magnitude of error about the underlying 39 Veritext National Deposition & Litigation Services 866 299-5127 1 collateral? Dr. SUMMERS: 2 I think you would be much 3 better advised to ask those who made these errors. 4 To ask those who made these errors what they're 5 thinking and their judgments on that question would 6 be much, much more valuable than my judgment. 7 think it seems incredible in retrospect, but much 8 always seems incredible in retrospect. 9 that something that was very commonly said in those I The fact 10 days on a national basis, house prices had never 11 come down. 12 period, and people thought therefore that meant that 13 it wouldn't happen. 14 contributor. 15 knew, and 16 dynamics of the pricing of these securities. 17 suspect that when they failed in 2007, even if house 18 prices had not fallen much yet, the decline in 19 mortgage-backed securities reflected what was at 20 that point a reasonable expectation that there would 21 be significant declines in housing prices. 22 not that they were so leveraged that they were 23 vulnerable, that they were that incredibly 24 vulnerable to a period of stagnant house prices. 25 It had never happened over a 50 year It is a substantial I'm not able, I don't think I ever certainly don't know now the precise I So it's There are a set of questions about mortgages. 40 Veritext National Deposition & Litigation Services 866 299-5127 1 There are then a set of questions that I don't feel 2 at all authoritative on. 3 relevant to your broader inquiry, having to do with 4 how these judgements were made. 5 risk made by the people who were doing the trading? 6 Were the judgments made independently? 7 process of coming to judgment supervised? 8 all questions in terms of, there is an element of 9 understanding the cognitive aspect of why an error But I think are perhaps Judgements about How is the These are 10 was made, and then one has an explanation of what 11 the cognitive pattern is. 12 question of what kinds of scrutiny were applied to 13 the judgments when they were made. 14 question of what kind of conviction, how much was 15 put at risk around this. 16 There's still the And there is the And then I think there's also an aspect which I 17 touched on earlier, which goes to the question of 18 resilience. 19 system of i financial institution making mistakes 20 alone is very different than the consequences for 21 the system of multiple financial institutions making 22 the same mistakes. 23 to unwind, everybody is unwinding in the same 24 direction. 25 Keynes wrote famously about it being better to be Which is the consequences for the Because then when it comes time That goes to various incentive problems. 41 Veritext National Deposition & Litigation Services 866 299-5127 i wrong conventionally, than right unconventionally. 2 I'm not sure whether that's right or not, but I'm 3 sure if you are going to be wrong, 4 be wrong conventionally, then to be wrong 5 unconventionally. 6 7 That leads to a fair amount of band-wagoning. MS. EDELBERG: So now is the perfect time We have been struggling with 8 for this question. 9 common shock versus liquidity shock? 10 there's 2 different shocks. 11 question of- 12 13 14 15 it's better to MR. VERRILLI: Well no, So there is the I'm sorry, I'm just asking Dr. Summers whether he wants a break. No, I'm okay. DR. SUMMERS: I can go for the whole session. 16 MR. VERRILLI: Just let us know. 17 MS. EDELBERG: Okay. So i of the things 18 that we're struggling with is that a lot of 19 financial institutions get in trouble all at once, 20 and there's a question as to whether that's in 21 trouble all at once. 22 hypothesis, that they got in trouble all at once. 23 And part of this hypothesis is, they got in trouble 24 all at once because they were all basically exposed 25 to either the same asset, which was the mortgage I guess that's part of the 42 Veritext National Deposition & Litigation Services 866 299-5127 1 shock, or actually they were all exposed 2 same utter dependence on liquidity and they were 3 basically just all exposed to a liquidity shock. to the Or there was some shock, there was little bit 4 5 of E coli in the system, and we actually had 6 contagion and it spread through, due to 7 interconnectedness. 8 yes? 9 those 3 stories. Does that seem like a fair, So we are trying to differentiate between DR. SUMMERS: 10 I know this sounds like a 11 wiseguy answer, I don't mean to give a wiseguy 12 answer. 13 without both my right shoe and my left shoe, and so 14 i don't quite know how to answer. 15 shoe that causes me to walk across the street, well 16 yes. 17 street? 18 answer is that all of those were present. 19 it is certainly the case that many of the same 20 judgments were reached in many financial 21 institutions. 22 be problematic, the problems were common to many 23 institutions. 24 25 I can't really walk across the street Is it my right Does my left shoe cause me to walk across the Yes. Is it both my shoes? So I think the I think And so when those judgments proved to Second, when the errors were propagated, the fact that the institute judgments were common to 43 Veritext National Deposition & Litigation Services 866 299-5127 1 many institutions meant that it was difficult to 2 unwind the securities. 3 referred to earlier, I spoke about a variety of 4 different vicious cycles that kicked in 5 times a century. 6 de-leveraging, leading to Sally, leading to more 7 de-leveraging. 8 that comes from that, reinforced by losses make 9 lending more difficult, make losses on other capital 10 11 In the speech that you 2 or 3 The first of those was And so you have a kind of contagion assets. And then you have the elements of illiquidity 12 that clearly were coming from rising credit spreads 13 coming from changing macroeconomic conditions. 14 don't know that you can 15 and all 3 were importantly, at least to my mind, 16 interconnected and I don't know that you can 17 precisely say what their relative importance was. . . . So I if all 3 were important 18 CHAIRMAN. ANGELIDES: 19 MS. EDELBERG: 20 CHAIRMAN ALGELIDES: Can I? Yes. Another question that The dot com bubble was 21 is related in a way is this. 22 about a 5 or 6 trillion dollar shock, the housing 23 bubble was about a 5 to 6 trillion dollar real 24 shock, the latter appears to have cruised to 25 financial crisis, the former did not, why? 44 Veritext National Deposition & Litigation Services 866 299-5127 1 2 3 DR. SUMMERS: The largest simple explanation of itCHAIRMAN ANGELIDES: We're doing our dirty 4 laundry, these are the debates we've been having. 5 We're letting you adjudicate all of them. 6 MR. SEEFER: 7 DR. SUMMERS: Or suck you in, i of the 2. In many ways it's an 8 incomplete answer, but I think the first sentence 9 is that if Larry Summers loses a dollar then he's a As a consequence, he will spend 10 dollar poorer. 11 less, maybe he'll spend a nickel less, that way 12 he'll lose the dollar over his life. 13 just feel he's got to get it back this year, and 14 he'll spend a dollar less. 15 Maybe he'll If a bank that has a tier i capital ratio of 5% 16 feels a need to maintain that 5% tier i capital 17 ratio loses a dollar, then they have to rein in $20 18 of balance sheet activity, and so it's the 19 difference between the nickel when the assets sit 20 proximately within an individual who is going to 21 spread it over time, and the $20 when the assets are 22 sitting heavily at a levered financial institution 23 that I think is the beginning of understanding why 24 it's so much more serious. 25 COMMISSIONER HOLTZ-EAKIN: So that was my 45 Veritext National Deposition & Litigation Services 866 299-5127 1 first answer too, 2 next question is, why? 3 of derivatives and financial innovation against the 4 dot corn stock bubble that we saw against the housing 5 bubble? DR. SUMMERS: 6 7 i was leveraged, i wasn't. So rny Why didn't we see this sort Can I ask for clarification here? 8 COMMISSIONER HOLTZ-EAKIN: 9 DR. SUMMERS: Sure thing. I guess the leverage was 10 inherent in the nature of, of course sorne of that 11 stock would have been leveraged, correct? 12 nearly to the sarne extent. COMMISSIONER HOLTZ-EAKIN: 13 14 DR. SUMMERS: Okay. I think that would It's been a while since I was a rnore pure 16 be. 17 acadernic, and thought about- COMMISSIONER HOLTZ-EAKIN: 18 20 That's where I'rn going next. 15 19 Not Welcorne to rny club. DR. SUMMERS: Thought about these kinds 21 of questions Doug, but I think 2 aspects that i 22 rnight want to think about are the volatility, at 23 least as it was judged as of that tirne, associated 24 with stocks, was very substantially greater than the 25 volatility associated, I rnean any theory of leverage 46 Veritext National Deposition & Litigation Services 866 299-5127 1 would emphasize that you lever more that which is 2 less volatile. 3 quite different. 4 And the volatility of stocks was Second, the leverage associated with commercial I think that's probably the most 5 real estate. 6 important thing. 7 live in their homes. 8 their homes that they are going to own at a 9 relatively young age, before they have accumulated Second thing is people like to People like to begin living in And therefore the 10 sufficient assets to buy it. 11 substantial leverage derives from the desire to live 12 in a house before one is in a position to buy the 13 house for cash. 14 the dominant role of housing is to be lived in. 15 dominant role ultimately is of stocks, is to prepare 16 for one's retirement or to save. 17 the leverage of stocks in the United States, 18 feasible amount of leverage is much less than it 19 would be on houses. 20 their stocks, because of the different volatility, 21 but for the most part, stocks are not levered to the 22 extent that they could. 23 could be levered, reflecting judgements about risk 24 and return and savings for retirement, and the 25 degree of volatility that would be associated with a In contrast, the dominant, sort of A So if you look at the Nobody can borrow 80 percent on Io the extent that they 47 Veritext National Deposition & Litigation Services 866 299-5127 1 levered portfolio isn't something that most people 2 would be likely to want. 3 leverage in the small business area, and you've seen 4 some of the kinds of adverse developments, vicious 5 cycles in community banks and the like. MS. EDELBERG: 6 You do see substantial But that gets us into 7 foreclosure crisis, some part of our foreclosure 8 crisis. 9 effect from the economy tanking. At least the i before you get the feedback But that doesn't so I can understand 10 necessarily get us 11 households leveraging, typically leveraging their 12 home gets us maybe more foreclosures. 13 doesn't get us why the financial system didn't 14 figure out how to leverage the dot com bubble. 15 certainly at the time there was lots of rhetoric 16 about how we're in a new economy, stock prices are 17 never going to come down, it's a brave new world. 18 So why didn't the financial system figure out how to 19 do this? 20 that it? 21 22 . . . And Why did they only do this with housing? Is Dr. SUMMERS: Well I think part of the answer to that, partly volatility- 23 MS. EDELBERG: 24 DR. SUMMERS: 25 But it You said volatilityVolatility. You know I think relative to what's actual volatility. It's 48 Veritext National Deposition & Litigation Services 866 299-5127 1 often said that people have a tendency to confuse 2 price discovery with price volatility. 3 see in the stock market a price every day, 4 up loo points or it goes down. 5 price of your house everyday. 6 to market 7 appear quite volatile. 8 probably think of the differences in volatility as 9 being rather less than. 10 And so you it goes You don't see the If there was a mark price for your house everyday, it would Not seeing that price, you . . think of the difference in volatility as being even greater than it in fact is. CHAIRMAN ANGELIDES: 11 Can I ask one last 12 question, and then I will leave all of you to finish 13 this up, and then I will eagerly await reading the 14 whole transcript. 15 question. 16 hindsight is 20/20. 17 calling things, right time, right place. 18 were to look back at your service during the Clinton 19 Administration and you were to look at frankly 20 mistakes or errors or things you would have done 21 differently that may have been foundational. 22 causing the crisis, but may have been contributors 23 to. 24 look back on? 25 personally,it's not a gee, would I Larry, if you But I would like to ask you 1 So looking back, as we all know, Very few of us are perfect at If you Not to What do you think are the biggest markers you And I say that not just 49 Veritext National Deposition & Litigation Services 866 299-5127 1 look back in terms of policies undertaken in the 2 late 90's, were there policies undertaken that may 3 have accelerated, exacerbated, sewn the seeds in 4 some way of this that, on reflection, part of this 5 process is to reflect back at what we did and should 6 have done differently. 7 making different judgements in the future. 8 9 DR. SUMMERS: Hopefully with the mind of Well I think the financial reform bill, without getting into its details, that 10 is under discussion today reflects something that is 11 fairly close to my thinking, and I suspect the 12 thinking of many of us who served in the Clinton 13 administration. 14 As to what type of structure best reduces the 15 risk of financial crisis, if we had been more 16 successful in calling, in recognizing the need for, 17 foreseeing the need for, applying political pressure 18 for and in legislating the kinds of measures that we 19 have now judged and we now see as essential, 20 that would have put the country in a better position 21 than it was, coming into this crisis. I think 22 i say that with the recognition of on i hand 23 this bill proved to be not perfect, that's always 24 the case, and with 25 changed very, very dramatically during the 2000 and the recognition that markets 50 Veritext National Deposition & Litigation Services 866 299-5127 So it would in some areas probably 1 after period. 2 have required great foresight. 3 knowledge that the political constellation, in terms 4 of the appetite of Congress for regulation in 5 various areas was quite different in the 1990's. 6 And with the But I guess when I asked myself what I would 7 have wished, it goes back to the kinds of proposals 8 that we are now putting forward. MR. ANGELIDES: 9 Well sir, just to probe So the vShadow Banking 10 that, just a little. 11 Systemv, a system of relatively unregulated or 12 lightly regulated institution, many depend on short 13 term money. 14 risks inherent in that system or just not identify 15 with that point? 16 that there wouldn't be the kind of growth in the 17 marketplace? 18 prescient. 19 risks, or that the political calculus just isn't 20 there to move on risks unless they become wholly 21 evident? 22 Did people see that there would be The calculation on derivatives was And again, it's very hard to be Was it mostly that they were unseen DR. SUMMERS: I think others would have to 23 sort of go back and try to. 24 useful to do this kind of thing to think of risks 25 that were present but not recognized. . . I think it may be Risks that 51 Veritext National Deposition & Litigation Services 866 299-5127 1 could clearly have been foreseen and risks that 2 really substantially emerged after 2000. And I think, 3 I don't doubt that there were I'm not sure that I could 4 elements of all 3. 5 distinguish in a careful way what the proportions of 6 those 3 categories of risk were. CHAIRMAN ANGELIDES: 7 Okay, i last one on In terms of, for example, risks recognized 8 this. 9 and not acted upon, can you identify any of those '90s and i other, looking back, the most 10 from the 11 substantial risk present, but not fully recognized? DR. SUMMERS: 12 Well I think the risks that 13 were probably recognized, I'm not sure that I 14 understand the 2 parts. 15 recognized and not fully acted on. 16 second? Well the first was What was the CHAIRMAN ANGELIDES: And that was present, 17 18 but at the time not recognized, but looking back and 19 saying, okay, that's the i where winding this clock 20 back, that was a ticking time bomb? DR. SUMMERS: 21 You know, I think that with 22 respect to risks that were recognized but not fully 23 acted on, 24 the mortgage market and housing finance were 25 recognized by many, and not.., the system didn't act I think the sets of risks associated with 52 Veritext National Deposition & Litigation Services 866 299-5127 1 as fully on them as we would have liked, or than 2 many would have wished. 3 I'm not sure that I can give an answer, in 4 terms of risks that were recognized 5 at the time, but not recognized. 6 a set of issues around derivatives, where it's very 7 clear that by 2008 our regulatory frame work with 8 respect to derivatives was manifestly inadequate. 9 that were there There are clearly It's clear that there were derivatives extant It's clear that the derivatives that 10 in the 1990s. 11 proved to be by far the most serious, those 12 associated with credit default swaps increased 100 13 fold between 2000 and 2008, and it's clear that 14 some, including Commissioner Born warned about 15 derivatives very strongly in the 1990s. 16 whether derivatives constituted an area where the 17 situation evolved very substantially, the warnings 18 that we gave this area needed to be continually 19 watched, weren't heeded as credit default swaps 20 rose, or whether an alternative way to think about 21 it would be that there was a risk there that was 22 foreseen at the time, that was not adequately 23 perceived at the time. 24 25 And so A question of interpretation on which different people will take different views. 53 Veritext National Deposition & Litigation Services 866 299-5127 CHAIRMAN ANGELIDES: 1 I appreciate it very 2 much. Thank you, and I'm sorry for having to exit, 3 but as I 4 ask better questions than me, and I look forward to 5 seeing the transcript. 6 DR. SUMMERS: 7 CHAIRMAN ANGELIDES: 8 MS. EDELBERG: 9 14 Thank you very much. Thank you, Mr. Chairman. Thank you. Do you have any questions MR. SEEFER: That's actually, I was going to say a perfect segway. CHAIRMAN ANGELIDES: 12 13 I know that my colleagues here will on derivatives? This seems like a good time. 10 11 said, I wandered it in for you. MR. SEEFER: One of the things that we're 15 asking everybody on derivatives is just their 16 general opinion of what role do you think, if any, 17 derivatives played in the financial crisis? 18 there as a cause, whether as a problem or anything? 19 And then not just predatory derivatives, but any 20 kind of derivatives. 21 DR. SUMMERS: Whether You know I think the 22 overwhelmingly, clearly the events at AIG and AIG's 23 use of credit default swaps to take on a set of 24 risks that then proved to threaten its viability, 25 which, given it's interconnection, threatened major 54 Veritext National Deposition & Litigation Services 866 299-5127 1 systemic risk, was obviously a critical aspect of 2 understanding the crisis. 3 There are issues it seems to me a variety of 4 issues to explore there, where I'm just not into - 5 what my duties have been for the last 18 months - 6 into the details enough to make judgments. 7 Clearly if their unregulated derivatives 8 affiliate had been extensively regulated in the way 9 proposed in 1999, but was never something Congress 10 was prepared to act on, that might have offered the 11 prospect of reducing the risks. 12 There are many who argue that the real source 13 of the problem was AIG's desire to take risk and the 14 lack of comprehensive risk regulation of AIG. 15 so even if somehow there hadn't been derivatives, 16 they would've taken the risk, and if their overall 17 risk taking had been regulated, it would have worked 18 their way into the problem. And 19 There are others who argue that if their 20 derivatives activities had been non-bilateral, had 21 been through appropriate clearing arrangements, that 22 involved the appropriate posting of margin, it would 23 not have been possible to build up the risk 24 positions that were built up. 25 positions have a certain logic to them, and the And I think all those 55 Veritext National Deposition & Litigation Services 866 299-5127 1 approach that we've taken with respect to 2 derivatives in the legislation, that many people 3 have taken, since they are a matter of public 4 record, is really to address all the possibilities. 5 To insist on comprehensive regulation of AIG, 6 and others systemically important financial 7 institutions, which should independent of any 8 regulation of particular instruments have offered 9 the prospect of eliminating or attenuating that And also to require any major financial 10 problem. 11 participants, the use of substantially enhanced 12 transparency, and the use of appropriate clearing 13 arrangements. 14 historical question, there is an element of belt and 15 suspenders in the regulatory approach of this 16 proceeding. 17 So that however i judges that There is an important set of issues which I 18 don't have a clear set of views on. 19 with, aside from the situation at AIG, what were the 20 roles of derivatives activity, both in leading to 21 runs of various kinds on major financial 22 institutions at difficult moments in complicating 23 the process of workout in leading to market 24 breakdowns. 25 least feel that in terms of the continued operating Having to do My impression is that many people at 56 Veritext National Deposition & Litigation Services 866 299-5127 1 and functioning of derivatives, markets, that was 2 less of a major problem that many people would've 3 expected, given the magnitude of all of the other 4 problems. 5 But no doubt, derivatives issues played an 6 important role in the thinking with respect to many 7 different aspects of the work out of the crisis. 8 And as 9 sort of belt and suspenders approach, that gets at I say, the judgment we've come to is that a 10 derivatives is part of risk regulation of 11 institutions, and gets at derivatives markets per 12 se, offers the best prospect of success, and clearly 13 for some variety of reasons, 14 sense that the, that credit default swaps in 15 particular raised questions. 16 I think there is a There are questions that I think are very 17 important for financial regulation that are not just 18 systemic risks questions. 19 transparency, in their execution, issues with 20 respect to manipulation and market integrity. 21 there are a set of 22 time, with respect to, in the equity area that with 23 the rise of credit default swaps, now exist in the 24 credit default swap area of control rights divorced 25 from economic or their non-coincident with economic Issues going into And issues that have arisen for some 57 Veritext National Deposition & Litigation Services 866 299-5127 1 2 interests. ALl of those require, and I believe are 3 receiving regulatory attention. 4 all of this has arisen really over quite a 5 remarkable developments, in terms of these markets 6 where some of these instruments, particularly credit 7 default swaps just about doubled every single year 8 from 2000 on. 9 MR. SEEFER: Let me ask you, in terms of AIGFP would have been 10 what you said about if 11 regulated as proposed in '99. 12 and that wasn't the case. 13 DR. SUMMERS: 14 MR. SEEFER: 15 DR. SUMMERS: As a consequence, Well the CFMA passed Excuse me. Sure. You didn't mishear me, but I 16 think you may have misunderstood CFMA. 17 that I referred to is a proposal that would have 18 regulated the risk taking capital adequacy and the 19 like, with respect to derivatives affiliates. 20 The proposal CFMA went in various ways to the ability to the market and the process of 21 regulate the market, 22 trading on derivatives, as distinct from the 23 financial position of affiliates or the entities 24 that traded derivatives. 25 MR. SEEFER: Thank you. What I wanted to 58 Veritext National Deposition & Litigation Services 866 299-5127 1 ask you, in terms of the regulation not of the 2 market but of the entity. 3 OIS was it's consolidated regulator. 4 regulation and I believe they had jurisdiction, 5 since they were a consolidated operator, to look at 6 FP. AIG was regulated, the So there was Any opinion on the role of regulation in AIG? DR. SUMMERS: 7 Well I think it's, again 8 there are various aspects of macro and the financial 9 markets have been professional preoccupations of Structure of financial regulation has not 10 mine. 11 historically been so. 12 with much greater expertise than I have. 13 think it's fair to say that it is very widely felt 14 that the regulation of AIG on a consolidated basis 15 by its consolidated supervisor, DOIS, was manifestly 16 inadequate. 17 of form, the extent of scrutiny, extent of analysis 18 and reporting. 19 although I'm not the one that's informed enough to 20 do it. 21 My You'll be able to find people But I In addition to the results on evidence One could buttress that conclusion, impression is that the view is quite widely 22 held that the regulation was inadequate, if you 23 believed that systemic regulation of such 24 institutions was appropriate. 25 was inadequate, even without reaching the judgment Ihat the regulation 59 Veritext National Deposition & Litigation Services 866 299-5127 1 2 about the results of the regulation. COMMISSIONER BORN: May I ask a couple of 3 follow-up questions on things that Larry has already 4 talked about a little bit. 5 swap funds, some of the issues we're looking at, and 6 I wondered if you had thought about these things and 7 had an opinion on them. 8 9 On the credit default One, whether credit default swaps tended to fuel or accelerate the securitization process, 10 because AIG was insuring through CDS the top AAA 11 tranches, and thereby allowing them to be AAA rated 12 and to seem like very secure investments? 13 DR. SUMMERS: I don't have expertise to 14 make that judgment, either in terms of detailed 15 knowledge of what it was that AIG was insuring. 16 suppose the question would arise, would there have 17 been other ways. 18 have written a letter of guarantee on them. 19 would have been tantamount to insuring them. I Without insuring them, they could Which 20 So whether one should think of that in terms of 21 a credit default instrument or not, I think it is at 22 least something one would want to study. 23 don't know enough about it to have a view. 24 that's part of it. 25 COMMISSIONER BORN: But I I think Well the second 60 Veritext National Deposition & Litigation Services 866 299-5127 1 hypothesis we're looking at is, there were 2 instruments called synthetic CDO's, which were 3 composed either entirely or partly of credit default 4 swaps, rather than mortgage-backed securities. 5 were in essence credit default swaps on existing 6 mortgages or existing mortgage-backed securities or 7 existing CDO5. 8 amplified the market for securitization and thereby 9 made it a larger market, and continued it for a They And we are looking at whether that 10 longer period of time, after the mortgage market was 11 really shutting down, so there weren't 12 mortgage-backed securities available to fund these 13 things? 14 DR. SUMMERS: I don't have enough granular 15 knowledge of the quarter by quarter evolution of the 16 market to be helpful. 17 needs to always ask the question, if a financial 18 market participant has for whatever reason, bad 19 judgment in grade, misaligned incentives and 20 intellectual misunderstanding of how the world is 21 working, has decided to take on a certain risk, 22 whether by regulating instruments rather than by 23 regulating that financial institution, one is going 24 to succeed in getting them not to take on that risk 25 and how that's going to happen, is a question that I I think in general, I think i 61 Veritext National Deposition & Litigation Services 866 299-5127 1 think one always has to keep in mind in designing 2 regulatory regimes. 3 The orientation that runs through the financial 4 regulation bill is towards a belt and suspenders 5 approach, as you force a lot, you regulate capital 6 if you're systemically important, you regulate 7 transparency in general so that people can see 8 what's going on and see instruments where there are 9 particular problems, you also regulate there. 10 But I would worry a little bit about the hope 11 that by regulating instruments in a world where 12 people can innovate, you will succeed in controlling 13 overall risk taking. 14 COMMISSIONER BORN: Another thing that 15 we're looking at is the need to rescue AIG. 16 it's potential interconnectedness with other 17 counterparties through the credit default swaps, 18 through other kinds of mechanisms. 19 your views are on that? 20 DR. SUMMERS: And I wonder what There are certainly 2 sets 21 of questions that are implicit in that, in the 22 issues that you raise, and I can distinguish between 23 them, but I can't say a great deal about either. 24 a general matter, my view having been in government, 25 having been out of government, is that when you're As 62 Veritext National Deposition & Litigation Services 866 299-5127 1 out of government is very difficult to know all of 2 the information, all the pressures, all the 3 constraints, and all the opportunities on those that 4 are making the decisions. 5 difficult to second guess or ask questions. 6 wasn't in government at the time. 7 So it's very, very I I would find it very surprising if a compelling 8 argument could be made that simply allowing AIG to 9 file for bankruptcy and letting the chips fall where 10 they would, in a way that was done at Lehman would 11 have been an availing strategy at that moment. 12 With respect, that would have seemed quite hard to 13 believe to me that, that would have been a viable 14 option. 15 With respect to the way in which transactions 16 were handled, and then respective decisions that 17 were made, 18 who were in authority at that time, and the sense of 19 the fog of war that would've surrounded the 20 decision-making at points like that. 21 have nuanced opinions on the ways in which decisions 22 were made or the particular structures that were 23 adopted, or the ways in which dealings were made. 24 25 I have enormous respect for the people COMMISSIONER BORN: But I don't One last question. In terms of the runs on investment banks, other 63 Veritext National Deposition & Litigation Services 866 299-5127 1 institutions, do you think that there was any role 2 played by with respect to derivatives in those runs? 3 Do you have any views on that? 4 DR. SUMMERS: I alluded to that 5 possibility, to say that I didn't know enough to say 6 to be confident either yes or no. 7 that there were probably issues involving the 8 posting of margin bilaterally, and concern about 9 margin being lost in the event of failure that led My impression is 10 to runs, and contributed to the pressure on 11 institutions, which in turn contributed to their 12 desire to hoard cash, which contributed to the 13 freezing of the system. 14 my impression, not my firm knowledge, is that there 15 were behaviors that served to strike for the case 16 for more multilateral, joint and severally liable 17 kinds of clearing arrangements, so the kind that are 18 contemplated in this legislation, that I might say 19 is the kind that in the 90's, mid 90's were 20 essentially prohibited by law. 21 including in the CFMA to establish permissive 22 frameworks that enabled the clearing houses to 23 engage in a certain amount of suasion. 24 course, is a step significantly short of the step 25 that's contemplated in the current legislation. And that there was, again, And where we worked, Which is of 64 Veritext National Deposition & Litigation Services 866 299-5127 1 Which is essentially to mandate for a wide swaths of 2 these 3 clearing arrangements. transactions, the use of clearinghouse house MS. EDELBERG: 4 So going to an earlier 5 government intervention when the market was in 6 trouble, long term capital management. 7 talk about your role in that? 8 not you think that any of the government response to 9 long-term capital management created any moral 10 So can you And then whether or hazard that had an affect? MR. VERRILLI: 11 Just in terms of the Of course Doctor Summers will answer the 12 answer. 13 question. 14 ability to answer during that period of time, to the 15 extent that you're asking about his communications 16 with President Clinton, or deliberations. 17 would be. 18 Clinton's lawyer here. 19 for the same reasons as the current situation. 20 with that constraint- 21 22 There is a parallel constraint on his . . That I think we would have to have President MS. EDELBERG: That would be off limits, But I'll happily defer to whatever you think is, 23 MR. VERRILLI: We'll carve that part out. 24 MS. EDELBERG: Yes. 25 DR. SUMMERS: My personal role as things 65 Veritext National Deposition & Litigation Services 866 299-5127 1 happened was not large, because my preoccupation was 2 on the international area, where there was plenty 3 going on at that time. 4 probably pretty familiar with 5 very important to distinguish between what went on 6 in the LTCM context and in a variety of other 7 contexts. 8 Fed, no taxpayer money was involved in the LTCM 9 case. I would say that I am . . . I think it's Other than sandwich money at the New York The role that was played by the official sector 10 11 was a coordination role in brokering what was a 12 mutually advantageous set of arrangements for the 13 various participants. 14 various events that were generating of moral hazard, 15 i wouldn't be inclined to put great weight on LTCM. 16 A degree of financial cost, subsequent litigation 17 and such on those at LTCM was perhaps not as large 18 as it could imaginably have been, but was large 19 enough that I think any operator would be at very 20 substantial pains to avoid the fate that befell 21 LTCM. 22 issues around transparency, around regulation of 23 prime brokers. 24 time, some of which are addressed in this 25 legislation. So if I were to think about I think LTCM did point out a variety of Some of which we pursued at that 66 Veritext National Deposition & Litigation Services 866 299-5127 1 I also think i has to be slightly careful in Moral hazard is a bad 2 thinking about moral hazard. 3 thing, confidence is a good thing. 4 anything that is successful in reducing run risks, 5 is that the provision of confidence, or is that the 6 establishment of moral hazard? 7 these are such complex subjects. MS. EDELBERG: 8 9 And in a sense That's part of why Well that's fair enough. But certainly market participants, and certainly in 10 retrospect, market participants viewed what the 11 government did with LTCM as extraordinary government 12 involvement. 13 step over and above what they typically do, and did 14 it because they thought that LTCM 15 systemic role in the economy, or in the financial 16 system? 17 stake. 18 associated with government actions. 19 thing and not another. 20 DR. SUMMERS: That the government took an unusual had some sort of Whether or not there was taxpayer money at I mean there is an opportunity cost They may do i They chose to go in andNo, I don't.., we may have 21 different readings of the views about the 22 participants. 23 It was an extraordinary circumstance, and in 24 that extraordinary circumstance government did 25 something that was extraordinary. Perhaps not 67 Veritext National Deposition & Litigation Services 866 299-5127 1 surprisingly in an extraordinary circumstance 2 government would do something that was 3 extraordinary. We were busy, we had a lot to do, I suppose. 4 5 But I'm not sure the opportunity cost of a week of 6 the Federal Reserve President and New York's time is 7 a factor, that would loom enormously. MS. EDELBERG: 8 9 No, I meant the government could actually be going around brokering deals that 10 it thought were to the good of the economy. 11 Elsewhere, the government chooses not to get 12 involved in that 13 other things, with it's political capital. activity, because it chooses to do DR. SUMMERS: 14 I suppose, I think that's 15 fair, and I think that i of the reasons for the 16 effort, rather substantial efforts involving both 17 the 18 LICM, was to contemplate rather more satisfactory 19 legal frameworks for the self executing failure of 20 hedge funds, which were a test. 21 were a number of failures of reasonable sized 22 financial institutions that didn't have the same, 23 the systemic consequences, in part because of a 24 variety of things that were put in trade after LICM 25 changed settlement private and the public sector in the wake of Amaranth, there procedures, changed margin 68 Veritext National Deposition & Litigation Services 866 299-5127 1 procedures and the like. 2 There were a variety of special factors that 3 mostly went to urgency, immediacy and externality 4 that lead to the judgements that were made during 5 LTCM. 6 in financial markets, I think it's, at least I have 7 not heard the case convincingly made that some 8 aspect of what happened at LTCM 9 precedent that led to a variety of misguided And while there's much that one can question either set a 10 government interventions, or lead to a set of 11 expectations that somehow contributed to problems 12 down the road. 13 other arguments with respect to the LTCM experience. But you know, perhaps there are MR. VERRILLI: 14 Just, if you could hang on It's about 3:15, I just want to 15 for i second. 16 make sure that we know that we are coming up on our 17 2 18 needs to get done, and I know you've got another 19 that has to get done. 20 1/2 hour limit here. MS. EDELBERG: SO So we have a report that Sorry, I'll ask you a 21 question on a different front. 22 want to know what you think about what those factors 23 were, but I will put that aside, in leading to one 24 of the extraordinary involvements of LTCM. 25 Though I do really Shadow banking system versus traditional 69 Veritext National Deposition & Litigation Services 866 299-5127 1 banking system. There is a question, 2 things we're wrestling with is, did different things 3 happen to 2 different financial sectors, or did the 4 same thing happen to both of these financial 5 sectors? 6 different happened to these 2 different sectors, was 7 it because of the different regulatory environments 8 that these 2 different sectors were in, or is that 9 actually a red herring, and in fact you know, you i of the And you know, to the extent that something 10 had talked a little bit earlier about the interplay 11 between the banking sector and capital sector, and i 12 used to save the other, etc. 13 the interplay? DR. SUMMERS: 14 How do we think about You had a set of problems in 15 the mortgage company sector for example that were 16 not heavily caused by or causal to the banking 17 system. 18 could probably think of the 2 systems with some 19 degree of separateness. So far as those were important issues, one 20 You had a set of issues arising out of 21 securitization, where the 2 systems proved to be 22 auction rate securities, where the 2 systems proved 23 to be rather more closely linked than many had 24 supposed. 25 both aspects of your question. So I think there were elements in this of 70 Veritext National Deposition & Litigation Services 866 299-5127 MR. SEEFER: 1 So as we wind down; too big What are your opinions on what makes an 2 to fail. 3 institution too big to fail, and how did it 4 contribute to the financial crisis? 5 forward, not looking forward, and do you avoid it? 6 Is the answer simply more capital, more liquidity, 7 or is the answer something else? 8 DR. SUMMERS: 9 In looking Too big to fail refers to a situation where an institution, at least for me, 10 refers to a situation where an institution derives a 11 significant benefit from what the market sees as a 12 government provided put, caused by the fact that its 13 failure would have catastrophic consequences. 14 if you accept that definition, there are several 15 ways, there's 3 broad categories of approach and to 16 constraining too big to fail. 17 And The first is by making failure less likely. So 18 even if there is a perception that the government 19 will come in and will support it if it fails, that's 20 kind of not a relevant factor, because an assumption 21 even ex governments support is that it won't fail. 22 And the agenda for doing that is sort of broadly the 23 regulatory agenda towards the institution, with at 24 least 3 specific elements. 25 standards, liquidity standards, and restrictions Capital leverage 71 Veritext National Deposition & Litigation Services 866 299-5127 1 which go to riskiness, which goes into everything 2 from compensation arrangements to limitations on 3 proprietary trade or the like. Second category measures systemic measures that 4 5 make failure more acceptable, clearing for 6 derivatives, multilateral clearing for depravities 7 is 8 to survive the failure of the institution. 9 i such example. Measures which enable the system And the third is managers, is what I call or 10 think of as local measures, can make failure a 11 viable option. 12 which provide for a framework for going through a 13 bankruptcy type of procedure rapidly and with a 14 minimum of uncertainty. 15 arrangements, is a kinder vision in this build. 16 And that is resolution frameworks Plan your own funeral type I don't think there's any single silver bullet 17 with respect to, too big to fail. 18 it can be quite substantially curtailed in the ways 19 that I just described. 20 MR. SEEFER: But I think that We are almost out of time, so 21 i of the things I definitely want to ask you is what 22 haven't you told us, that you think is important for 23 us to know? 24 25 I know we've asked you a lot. DR. SUMMERS: You gave me a pretty open first question, where I had a chance to touch on 72 Veritext National Deposition & Litigation Services 866 299-5127 The only thing I would say in 1 every aspect. 2 conclusion I guess, is something that I've said in a 3 number of my speeches on this, if you'll permit me 4 on that. 5 and oversimplified analogy. 6 If you'll permit the somewhat overdrawn If you look at the history of automobile safety 7 in the United States, it was dismal, it was 8 terrible. 9 young Daniel Patrick Moynihan made to public policy And the first major contribution that the 10 was an essay he wrote on automobile safety. 11 basically said in that essay was that the then 12 prevalent approach, which was based on lots of 13 drivers had, and lots of criminality for reckless 14 driving. 15 drive safely, then we would have fewer automobile 16 accidents. 17 What it Because if we could only get people to It was basically a terrible failure. And he basically felt that we should move from 18 an approach that was based on human betterment, 19 making people better, to an approach that was 20 directed at making the system better for people who 21 were as they were. 22 I think with respect to the financial system, 23 people are going to be avaricious, people are going 24 to extrapolate from the recent past, people are 25 going take advantage of gambles that are favorable 73 Veritext National Deposition & Litigation Services 866 299-5127 People, whether in the private sector or 1 to them. 2 the public sector, are going to have highly 3 imperfect foresight. 4 system needs to be safe for ignorance, and safe for 5 human fallibility. 6 characteristics, that's why some of the themes that 7 i kept coming back to were capital and leverage. 8 Why in a number of different contexts I used the 9 phrase belt and suspenders, why I wanted to allow So the lesson is that the And the system that has those 10 some overlap in regulatory functions with some 11 separateness of the consumer. 12 And I guess as you think about causes, I would 13 resist the temptation to take a list of causes and 14 make judgments about their relative importance, in 15 favor of thinking about the multiple stages at which 16 an accident might have been avoided. 17 Was World War I caused by the assassination of 18 the Archduke, or was World War I caused by the 19 ascension of Germany and the difficulty of the 20 international system to accommodate the ascension of 21 Germany? 22 agenda to try to distinguish the respective roles of 23 those 2 factors, rather than recognizing that a 24 strategy for maintaining peace can usefully address 25 the events pointed out by both of those things. I kind of think it's a somewhat sterile 74 Veritext National Deposition & Litigation Services 866 299-5127 1 And I guess my thought would be that if I have 2 not been entirely definitive in answering some of 3 your questions, part of the reflection of the vast 4 amounts that I don't know, and it's in part a 5 reflection of a judgment that there are these 6 multiple levels of causation associated with 7 different levels of solution, that you have to think 8 about with respect to a crisis like this. 9 MR. SEEFER: I certainly don't think it's 10 the plan to look at the 22 sections and assign 11 percentages at the end of the year. 12 DR. SUMMERS: 13 MR. SEEFER: 14 MS. EDELBERG: Right. So thank you very much But on the flip side, the 15 perfect storm is something I think worth resisting. 16 It suggests that it just happened. 17 so many factors, who could 18 need to find something in between. 19 DR. SUMMERS: . . . That there were you know. I think we I'm sure I've been unclear, 20 but I didn't think that I had been that unclear. 21 Nothing in what I've tried to say this afternoon, 22 and certainly nothing in my last thought should have 23 been interpreted as any excuse for fatalism. 24 Indeed, the notion of causation at multiple levels 25 actually has as it's implication that there are 75 Veritext National Deposition & Litigation Services 866 299-5127 1 multiple independent strategies, the success of only 2 1 of which would have been sufficient. 3 seems to me to suggest that this was a perfect storm 4 is in some ways, it's sometimes invoked. 5 recognize that the notions of a perfect storm are 6 invoked to suggest a DSX Mac and so that there can 7 be avoidance of responsibility on anyone's part. 8 I've got a rather different view, which is that it 9 requires many contributing elements. And so it I 10 And if the navigation system had been better on 11 the ship, if the systems for keeping the ship stable 12 in waves had been better. 13 in which the accident could have been averted. 14 i think the more one sees it in that way, the more 15 different avenues one is lead to pursue and the 16 greater the prospect of doing it. 17 In contrast, There are multiple ways And I think if you take more, and no 18 one here is doing it, the morality play view of a 19 crisis, you are then left with the aspect, can you 20 change the aspects of human nature that Aristophanes 21 and Shakespeare wrote about. 22 more daunting challenge than establishing 23 multilateral clearing mechanisms. 24 it in the way that I did. 25 COMMISSIONER BORN: And that's probably a That's why I put May I just ask 1 final 76 Veritext National Deposition & Litigation Services 866 299-5127 I'm taking from everything that you are 1 thing? 2 saying that you would not attribute the financial 3 crisis to the sole factor of a housing problem? 4 That it may have been 1 of the issues, but 5 obviously it came in the context of all the rest of 6 the activities? 7 DR. SUMMERS: I like to use the metaphor 8 when thinking about the financial crisis of a very, 9 very, very dry forest, into which someone throws a And then the question is did the 10 cigarette butt. 11 cigarette butt cause the fire? 12 Well there is a sense in which the answer to 13 that question is clearly, yes. But there is also a 14 sense in which, I think this is your point, 15 Commissioner. 16 if it was a very, very, dry forest, there likely 17 would have been a fire in any event. 18 a question that, and again I'm just quoting myself 19 from things I've said in the past. 20 generation, we've seen the 1987 crisis, the stock 21 market crash, the S 22 Russia, the NASDAQ bubble, Enron, now this. 23 what you probably think of this, this financial 24 crisis is much more profound in some ways, but comes 25 off a background of a financial system that has been If that cigarette butt hadn't arisen, & Look, I think That the last L debacle, Mexico, LTCM, Asia, And so 77 Veritext National Deposition & Litigation Services 866 299-5127 1 too often a source of too much instability, and I 2 think that perspective has to inform how we think 3 about its regulation. 4 MR. BARKER: 5 Thank you very much Dr. Summers, for your time. 6 DR. SUMMERS: 7 MR. VARRILLI: Thank you. Thank you. And before we just want to say for the larger 8 go off the record, 9 group, about 2 things first. I That we appreciate 10 very much that you were able to structure this 11 interview in a way that worked for you and for us as 12 well. 13 Second that Chris and I discussed the rules of 14 confidentiality applying to your Treasury Department 15 interviews that we all agree apply here. 16 that means as far as we're concerned, is that we are 17 going to review the transcript, decide whether 18 anything is confidential from our point of view. 19 Don't know whether we'll conclude that anything is. 20 But our understanding is, until we have had the 21 opportunity to do that, the contents of this 22 interview and transcript, both will remain 23 confidential. 24 MR. SEEFER: 25 everybody is copying? And what Does the record reflect that Very good. 78 Veritext National Deposition & Litigation Services 866 299-5127 1 MR. VARRILLI: That's on the record. 2 MR. SEEFER: 3 MR. VARRILLI: 5 MR. SEEFER: 7 I guess that's correct. 4 6 Okay, That's correct. Thank you very much. (WHEREUPON, the proceedings were concluded at 4:30 p.m.) 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 79 Veritext National Deposition & Litigation Services 866 299-5127 1 I, Charles Hoffman, do hereby certify: 2 3 4 That the foregoing proceedings were taken 5 before me at the time and place herein set forth; that 6 any witnesses in the foregoing proceedings, prior to 7 testifying, were placed under oath; that a verbatim 8 record of the proceedings was made by me using machine 9 shorthand which was thereafter transcribed under my 10 direction; further, that the foregoing is an accurate 11 transcription thereof. 12 I further certify that I am neither 13 financially interested in the action nor a relative or 14 employee of any attorney of any of the parties. 15 16 IN WITNESS WHEREOF, I have this date subscribed my name. 17 18 Dated: June 8, 2010 19 20 21 CHARLES HOFFMAN 22 23 24 25 Veritext National Deposition & Litigation Services 866 299-5127
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