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S. HRG. 111–18 LEARNING FROM THE PAST: LESSONS FROM THE BANKING CRISES OF THE 20TH CENTURY HEARING BEFORE THE CONGRESSIONAL OVERSIGHT PANEL ONE HUNDRED ELEVENTH CONGRESS FIRST SESSION THURSDAY, MARCH 19, 2009 Printed for the use of the Congressional Oversight Panel rwilkins on PROD1PC63 with HEARING ( VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00001 Fmt 6011 Sfmt 6011 E:\HR\OC\A951.XXX A951 rwilkins on PROD1PC63 with HEARING VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00002 Fmt 6019 Sfmt 6019 E:\HR\OC\A951.XXX LEARNING FROM THE PAST: LESSONS FROM THE BANKING CRISES OF THE 20TH CENTURY A951 S. HRG. 111–18 LEARNING FROM THE PAST: LESSONS FROM THE BANKING CRISES OF THE 20TH CENTURY HEARING BEFORE THE CONGRESSIONAL OVERSIGHT PANEL ONE HUNDRED ELEVENTH CONGRESS FIRST SESSION THURSDAY, MARCH 19, 2009 Printed for the use of the Congressional Oversight Panel ( U.S. GOVERNMENT PRINTING OFFICE WASHINGTON 48–951 : 2009 rwilkins on PROD1PC63 with HEARING For sale by the Superintendent of Documents, U.S. Government Printing Office Internet: bookstore.gpo.gov Phone: toll free (866) 512–1800; DC area (202) 512–1800 Fax: (202) 512–2104 Mail: Stop IDCC, Washington, DC 20402–0001 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00003 Fmt 5011 Sfmt 5011 E:\HR\OC\A951.XXX A951 rwilkins on PROD1PC63 with HEARING VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00004 Fmt 5011 Sfmt 5011 E:\HR\OC\A951.XXX A951 CONTENTS Page rwilkins on PROD1PC63 with HEARING Opening Statement of Elizabeth Warren, Chair, Congressional Oversight Panel ..................................................................................................................... Statement of Damon Silvers, Deputy Chair, Congressional Oversight Panel .... Statement of Richard H. Neiman, Member, Congressional Oversight Panel ..... Statement of Bo Lundgren, Director General, Swedish National Debt Office ... Statement of Richard Katz, Editor-in-Chief, The Oriental Economist ................ Statement of David Cooke, Former Executive Director, Resolution Trust Corporation ................................................................................................................. Statement of Eugene White, Professor of Economics, Rutgers University, and Research Associate, National Bureau of Economic Research ........................... (III) VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00005 Fmt 5904 Sfmt 5904 E:\HR\OC\A951.XXX A951 4 6 27 28 37 65 81 rwilkins on PROD1PC63 with HEARING VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00006 Fmt 5904 Sfmt 5904 E:\HR\OC\A951.XXX A951 LEARNING FROM THE PAST: LESSONS OF THE BANKING CRISES OF THE 20TH CENTURY THURSDAY, MARCH 19, 2009 U.S. CONGRESS, CONGRESSIONAL OVERSIGHT PANEL, Washington, DC. The Panel met, pursuant to notice, at 10:01 a.m. in room 208– 209, U.S. Capitol Visitor Center, Elizabeth Warren, Chairman of the Panel, presiding. Attendance: Elizabeth Warren [presiding], Richard H. Neiman, Damon Silvers, Bo Lundgren, Richard Katz, David Cooke, and Eugene White. OPENING STATEMENT OF ELIZABETH WARREN, CHAIR, CONGRESSIONAL OVERSIGHT PANEL The CHAIRMAN. This hearing is called to order. Good morning. My name is Elizabeth Warren. I am the chair of the Congressional Oversight Panel. Last October, Congress established this Panel to oversee the expenditure of funds from the so-called Troubled Assets Relief Program. It is our duty to issue monthly reports and to evaluate Treasury’s administration of that program. In its first report, the Panel asked Treasury a series of fairly tough questions about TARP on behalf of the taxpayers. The very first question we asked consisted of only four words, but probably the most important four words in the report. What is Treasury’s strategy? The lack of a strategy from Treasury has never been clearer than it has been this week, as outrage has spread across the country over the millions of dollars awarded in bonuses to executives at AIG. This entire issue could have been avoided. If Treasury had developed and clearly articulated a comprehensive strategy to deal with this crisis from the beginning, rather than announcing and abandoning inconsistent plans, issues such as executive bonuses would have been addressed early on in the agreements with participating financial institutions. This lack of a clear strategy is also hampering our economic recovery. The markets need predictability. Investors are reluctant to take risks. Business people are hesitant to take on new obligations when no one is sure about our overall strategy. Certainly, the most important person—the most appropriate person to speak to Treasury’s strategy would be the Treasury Secrwilkins on PROD1PC63 with HEARING (1) VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 E:\HR\OC\A951.XXX A951 2 rwilkins on PROD1PC63 with HEARING retary, and it had been the strong hope of the Panel to have Secretary Geithner here today to testify. While we understand that he has many pressing concerns right now, it is very disappointing that Secretary Geithner did not make it a priority to be here. The development of a strategy requires an overview of the problems and of possible solutions. To advance that conversation, we believed that we could learn a great deal from prior financial crises. That is why we have called today’s hearing ‘‘Learning from the Past: Lessons of the Banking Crises of the 20th Century.’’ We understand that this crisis is different from past calamities. No examples will ever provide a perfect analogy. That said, while George Washington may not have known the difference between a credit default swap and a hybrid ARM—and I suspect he didn’t— he had a powerful learning experience with a bank crisis. In 1792, during his first term as President, our young Nation suffered a severe panic that froze credit. Subsequent Presidents faced similar challenges, as have leaders from across the globe. And so, it is important that we reflect on the efforts of policymakers who have steered their nations during some very dark hours. It is also important that we reflect on the efforts of other governments that have confronted similar circumstances but failed to restore the banking system and restart economic growth. We have invited four very thoughtful experts to join us here today in embarking on that reflection. Richard Katz is a veteran journalist, editor-in-chief of The Oriental Economist, and the author of two books on Japan’s banking crisis of the 1990s. Mr. Katz will testify about what has become known by policymakers as Japan’s ‘‘Lost Decade.’’ Bo Lundgren is the director general of the Swedish National Debt Office. As Minister for Fiscal and Financial Affairs, Director General Lundgren led the effort to steer Sweden out of a banking crisis in 1992. David C. Cooke is the former executive director of the Resolution Trust Corporation, which helped steer us out of the savings and loan crisis of the 1980s by taking over more than 700 financial institutions. And lastly, Eugene White is professor of economics at Rutgers University. Professor White has written widely about the Great Depression and will testify about how the lessons of the 1930s apply to today’s crisis. Welcome to all of you. There is no longer any question that we sit at a critical moment in history. The decisions made by our Government leaders today will have an impact for generations. While we cannot fix this crisis with one hand and prevent all future crises with the other, we must use all of the knowledge and lessons of the past to ensure that prior mistakes are not repeated and that success is not ignored. That is why we greatly appreciate that our distinguished witnesses have taken the time to be here with us today. We have your statements in full, and they will be made part of the record. But we will start with our conversation with you in just a few minutes. VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00008 Fmt 6633 Sfmt 6633 E:\HR\OC\A951.XXX A951 3 rwilkins on PROD1PC63 with HEARING In the meantime, I would like to recognize the Deputy Chair of the Panel, Damon Silvers, and ask Damon if he has opening remarks. Mr. Silvers. [The prepared statement of Ms. Warren follows:] VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00009 Fmt 6633 Sfmt 6633 E:\HR\OC\A951.XXX A951 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 E:\HR\OC\A951.XXX A951 Insert graphic folio 10 48951A.001 rwilkins on PROD1PC63 with HEARING 4 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00011 Fmt 6633 Sfmt 6633 E:\HR\OC\A951.XXX A951 Insert graphic folio 11 48951A.002 rwilkins on PROD1PC63 with HEARING 5 6 STATEMENT OF DAMON SILVERS, DEPUTY CHAIR, CONGRESSIONAL OVERSIGHT PANEL rwilkins on PROD1PC63 with HEARING Mr. SILVERS. Thank you, Madam Chair. Let me begin by expressing my profound appreciation to the witnesses for joining us here today, and particularly to Mr. Lundgren for traveling from Sweden to be with us for this hearing. Recently, Thomas Hoenig, the president of the Federal Reserve Bank of Kansas City, gave a speech in which he praised the work of Mr. Lundgren and his colleagues in addressing the Swedish banking crisis of the 1990s. This speech was called to my attention by Mr. Hoenig’s Senator, Senator Brownback of Kansas, and I ask that it be entered into the record of this hearing. [The information referred to follows:] VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00012 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00013 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert offset folio 13 here 48951A.003 rwilkins on PROD1PC63 with HEARING 7 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00014 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert offset folio 14 here 48951A.004 rwilkins on PROD1PC63 with HEARING 8 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00015 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert offset folio 15 here 48951A.005 rwilkins on PROD1PC63 with HEARING 9 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00016 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert offset folio 16 here 48951A.006 rwilkins on PROD1PC63 with HEARING 10 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00017 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert offset folio 17 here 48951A.007 rwilkins on PROD1PC63 with HEARING 11 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00018 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert offset folio 18 here 48951A.008 rwilkins on PROD1PC63 with HEARING 12 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00019 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert offset folio 19 here 48951A.009 rwilkins on PROD1PC63 with HEARING 13 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00020 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert offset folio 20 here 48951A.010 rwilkins on PROD1PC63 with HEARING 14 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00021 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert offset folio 21 here 48951A.011 rwilkins on PROD1PC63 with HEARING 15 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00022 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert offset folio 22 here 48951A.012 rwilkins on PROD1PC63 with HEARING 16 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00023 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert offset folio 23 here 48951A.013 rwilkins on PROD1PC63 with HEARING 17 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00024 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert offset folio 24 here 48951A.014 rwilkins on PROD1PC63 with HEARING 18 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00025 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert offset folio 25 here 48951A.015 rwilkins on PROD1PC63 with HEARING 19 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00026 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert offset folio 26 here 48951A.016 rwilkins on PROD1PC63 with HEARING 20 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00027 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert offset folio 27 here 48951A.017 rwilkins on PROD1PC63 with HEARING 21 22 rwilkins on PROD1PC63 with HEARING MR. SILVERS. In this Panel’s first report, our very first question was what is Treasury’s strategy? I hope that this hearing and the further work of the Panel and its staff will enable us to better understand what Treasury’s strategy is and how it measures up to the lessons of history. In the written testimony we have received from today’s witnesses, there were some distinct common points. Financial crises tend to follow asset bubbles. Two, financial institutions are reluctant to admit their true condition, and there is a tendency for regulators and other political bodies to indulge them in this wishful thinking. Three, financial institutions with weak balance sheets, large financial institutions, contribute to a downward economic spiral by pulling back on lending activity. The testimony suggests successful strategies for dealing with these common dynamics include, one, giving a Government agency clear authority to restructure the banks; two, being completely transparent about the strategy and operations of that agency; three, having that agency value bank assets on a realistic basis; four, holding bank executives accountable for their mistakes; five, being prepared to combine haircuts for bank investors with public funds to either, one, wind up truly failed institutions or, two, revive savable institutions with adequate capital; and six, above all, to move quickly to accomplish these tasks. It is noteworthy that in the three successful examples we are considering today, in no case did effective action result from trying to keep shareholders of zombie banks alive or from deferring to the incumbent management of those banks around key decisions such as asset evaluation or executive pay. On the positive side, the written testimony suggests that effective action often turns out to be less expensive than it appears at first, while delay in acting to restructure sick banks appears associated with increases in the ultimate cost to the public. This appears to be a striking feature of the testimony we have received on the most recent U.S. experience of financial institution failure, the S&L bailout. Of course, every country is unique. And while we in the United States benefit from the dollar’s status as reserve currency on the one hand, on the other hand, we cannot rely on someone else’s consumer demand to rescue us, and to some extent, it seems both Japan and Sweden were able to rely on U.S. consumers to rescue them. Ironically, the United States has until very recently had a fairly decentralized banking system. But now our banking system looks more like Sweden’s and Japan’s than it does the U.S. system of the Depression era or even the late 1980s. And it seems that while we have many sick smaller banks, the FDIC is so far able to resolve them. It is the sick mega banks that are driving the crisis. While this Panel is awaiting a more detailed statement of the new administration’s strategy, I believe the unstated strategy pursued by the Bush administration in the 4 months following the passage of the Emergency Economic Stabilization Act of 2008 was essentially to offer a mix of implicit and explicit guarantees backed up by equity infusions in the hope of buying time for markets to become more rational and bank balance sheets to recover. The fun- VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00028 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 23 rwilkins on PROD1PC63 with HEARING damental assumption behind this strategy was that time was on our side. This Panel has held field hearings in Nevada and in Prince George’s County, Maryland, where we have heard firsthand from homeowners and seen the assets underlying at least the first rounds of our financial crisis. I am convinced that the fundamental assumption of the Bush administration’s approach—that time was on our side—was mistaken because the fall in asset prices at its heart was rational. Subprime loans and everything derivative upon them are not now and will never be worth their face value. The borrowers cannot pay their exploitative terms. The collateral is not worth and will never be worth on a present value basis anywhere near the value of the loans made on them. The reality of these losses, combined with the dramatic concentration in the financial sector that has left us with four mega banks, is a profound procyclical force, deepening the recession and worsening the bank crisis. Spoon feeding capital to broken institutions will not bring them back to life, nor will indulging in fantasies of reviving the real estate bubble. Having the Government buy bad assets will either fully reveal the weakness of bank balance sheets if done at fair prices, or if done at inflated prices will simply be a way of hiding the largest regressive wealth transfer in U.S. history, a wealth transfer that will still not be big enough to revive the sickest big banks. Most of all, the reality of losses and weak balance sheets is that time is not on our side, just as time was not the cure in any of the case studies. Time without action was not the cure in any of the case studies we are looking at today. The Obama administration now faces the choice of continuing a failed strategy based on mistaken assumptions or looking to the lessons of history to craft a new strategy consistent with the values of responsibility, transparency, and shared sacrifice that President Obama has rightly asked our nation to embrace. I look forward to hearing from our witnesses today on the lessons of history. [The prepared statement of Mr. Silvers follows:] VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00029 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00030 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert offset folio 33 here 48951A.018 rwilkins on PROD1PC63 with HEARING 24 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00031 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert offset folio 34 here 48951A.019 rwilkins on PROD1PC63 with HEARING 25 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00032 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert offset folio 35 here 48951A.020 rwilkins on PROD1PC63 with HEARING 26 27 The CHAIRMAN. Thank you very much, Mr. Silvers. Mr. Neiman. STATEMENT OF RICHARD H. NEIMAN, MEMBER, CONGRESSIONAL OVERSIGHT PANEL rwilkins on PROD1PC63 with HEARING Mr. NEIMAN. Thank you. Good morning, and thank you all for appearing here today. It is especially appropriate that we are meeting here to discuss the strategies that have been used successfully in past crises, both here in the U.S. and around the world. The current financial turmoil has demonstrated just how interconnected the global markets have become. What began as a wave of defaults in the subprime sector of the U.S. housing market was transmitted across the world, impacting seemingly unrelated products, distant markets, and billions of people. This is certainly not the first time that financial dislocations have occurred. But the increasing interconnectedness of the capital markets amplifies the shocks, which could, in turn, delay recovery unless all affected countries work together in a coordinated response. In developing that response, it is critical that we understand what strategies have worked in the past and what obstacles stand in the way of an effective solution. We can’t afford to overlook past lessons learned. As they say, those who cannot remember the past are condemned to repeat it. But, while there are similarities among all financial crises, no two are exactly the same. The prevailing conditions in the broader economy and the type of financial institutions involved provide a dynamic that makes every situation unique, requiring a unique solution. And there is no one regulatory approach that is immune from systemic shocks. The financial crisis has affected countries with diverse systems, including the UK with its more consolidated regulatory structure. However, understanding why certain strategies worked in other contexts can help us develop the right strategy in our own circumstances. And while there is no ready prescription for solving the crisis of today, there are time-tested principles that we can adapt to our present situation. One of the most important aspects of any successful strategy involves restoring consumer and investor confidence in the financial system. Instilling that confidence depends in part upon the Treasury Department articulating a clear strategy for moving forward and then clearly communicating the metrics to be used in measuring our progress in delivering on that strategy and in meeting our goals. Your testimony today will provide vital information for the Panel as we continue to advise Congress about the effectiveness of the Treasury’s strategy, and I look forward to your statements and the question and answer period. Thank you. The CHAIRMAN. Thank you. So let us get down to business. As we do, I want to thank Patrick McGreevy and Brian Phillips of the Oversight Panel for their hard VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00033 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 28 work in putting together this hearing. I don’t want to take the chance that I will forget at the end because we have gotten so engaged in this conversation. I would also like to pause to recognize His Excellency, the Swedish ambassador Jonas Hafstrom. Your Excellency, we are honored to have you here. And we appreciate the opportunity to learn from the challenges that your nation faced and how you dealt with them. We very much look forward to this. Thank you for joining us. So let us start with Director General Lundgren. I remind you all we have your statements, your written statements in full, and they will be made part of the official record. So if you could hold your oral comments to 5 minutes, that will give us a little time to be able to ask questions. Mr. Lundgren. STATEMENT OF BO LUNDGREN, DIRECTOR GENERAL, SWEDISH NATIONAL DEBT OFFICE rwilkins on PROD1PC63 with HEARING Mr. LUNDGREN. Thank you very much, and thank you for the invitation. Let me start with the differences between the Swedish banking crisis and what is happening now in the U.S. and, indeed, in the global context. Size, of course, Sweden being a small country. We had a regional crisis. This is a global crisis. This is a more complex crisis. We had a rather pure one with ordinary loans, not so much securitized. And we had another political situation. My advice is that if you have a banking crisis, please have it after elections, not before elections because after the election, it is much easier to build political consensus. We enjoyed that, and I would say that that is a very, very good situation to be in, listening to political debate in the U.S. There are, on the other hand, similarities as well. I mean, first of all, we are—both the U.S. and Sweden are market economies, even though I hear sometimes from commentators that we are a socialist country. The problem is that is not quite true. We have socialized, to a large extent, people’s incomes. But the business sector is very free and market oriented. We have the same challenges that we had in the ’90s and that the U.S. stands for today. One is to maintain liquidity in the financial system, and that, I would say, was taken care of then and is taken care of now. The second thing is to restore confidence in the financial sector, and that means that depositors and investors have to be feeling secure. And you have, thirdly, to restore the capital base. If you want to avoid or minimize credit crunch effects in the economy, of course, you need to have a capital base for lending. And if private sector investors don’t invest, then government has to invest. In Sweden, in the beginning of the ’90s, we had seven large and medium-sized banks that altogether had 90 percent of the markets, and then a couple of hundred smaller banks as well, mostly savings banks. The roots to the crisis was a speculation bubble in real estate mainly, same kind of roots as today. When I took office in October ’91, we already had the bubble bursting, and we had problems in one of the big banks, the partially already nationalized Nordbanken, and we got problems also VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00034 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 29 rwilkins on PROD1PC63 with HEARING in a big savings bank at that time. Initially, we worked case by case, but found out during spring ’92 that we were on the verge of having a systemic crisis. And in the autumn of ’92, we came to a situation close to the one that the U.S. experienced after Lehman’s when confidence was totally lost. We had prepared for that moment some months, and what we did then with the support of the opposition, since I talked about the political consensus being there, was to implement a package with two main ingredients. One was a blanket guarantee for depositors and creditors. Of course, not for shareholders. Shareholders have to pay first. That is a principle we used. We also had the right from parliament to be able to reconstruct and to restore the system, per se, by taking much different measures to unwind banks that should be liquidated, to capitalize banks that could be capitalized and then work again. We had a full assortment of tools to be able to use, and we had also a situation where we had an unlimited economic frame. We dared not to ask for a frame where we had to go back to parliament again because that would have increased the fright about the situation, and we didn’t want to take too much. So we got an unlimited frame, which was a good thing. We didn’t ask to own banks, which, being a center-right government and myself being market liberal, we wanted to avoid nationalization of banks. On the other hand, if you have to do it as part of a crisis management, so be it. Then you have to do it. Governments are not very good at running banks, but obviously, this time around, the former owners or the owners today hasn’t been very good either. And if you do it as a part of a crisis management in order to save all the taxpayers’ money, you should do it. We used the banks we took over, which was only two that were nationalized, the concept of a good bank/bad bank, in order to have management in the good banks being able to concentrate on the future and also to be able to get rid of or handle the bad loans, the nonperforming loans in a manner what we could recover as much as possible of the original loans. And it really worked quite well. We thought it could take up to 10, 15 years, but it took approximately 5 years before we could unwind these entities. We used transparency. Valuation was vital, of course. We had to have a situation where people trusted what we were doing and trusted, and the investors and others could trust that the estimates on the situation in the banks were correct as well, so we had rather tough mark-to-market valuation rules, which also helped us. Altogether, we got rather soon out of the crisis. Already in 1994, after 2 years, the bank system together was profitable once again. Thank you. [The prepared statement of Mr. Lundgren follows:] VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00035 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00036 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert offset folio 45 here 48951A.021 rwilkins on PROD1PC63 with HEARING 30 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00037 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert offset folio 46 here 48951A.022 rwilkins on PROD1PC63 with HEARING 31 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00038 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert offset folio 47 here 48951A.023 rwilkins on PROD1PC63 with HEARING 32 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00039 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert offset folio 48 here 48951A.024 rwilkins on PROD1PC63 with HEARING 33 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00040 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert offset folio 49 here 48951A.025 rwilkins on PROD1PC63 with HEARING 34 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00041 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert offset folio 50 here 48951A.026 rwilkins on PROD1PC63 with HEARING 35 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00042 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert offset folio 51 here 48951A.027 rwilkins on PROD1PC63 with HEARING 36 37 The CHAIRMAN. Thank you very much, Mr. Lundgren. I should point out the buzzing is nothing to be alarmed about. It indicates that there is a vote going on on the floor, to alert members that they need to be elsewhere, and that is one of the reasons we don’t have one of our members with us. Mr. Katz, could you speak to us of Japan? Mr. KATZ. Yes, and—— The CHAIRMAN. Push the little red button. STATEMENT OF RICHARD KATZ, EDITOR-IN-CHIEF, THE ORIENTAL ECONOMIST rwilkins on PROD1PC63 with HEARING Mr. KATZ. First of all, thank you for having me. Japan is mostly lessons in mistakes to avoid. I very much agree with the comments made by members of the committee. The crisis is very, very different in the U.S. In Japan, there was a crisis in the real economy of goods and services that was reflected in the banking crisis, mostly about plain vanilla loans. Twenty percent of GDP was just bad debt. In the U.S., most of the nonfinancial sector outside of autos is actually quite healthy. The U.S. crisis is a problem in the shadow banking system of asset-backed securities and derivatives, not even so much the commercial banking system or the commercial banking part of the banking holding companies, but really the shadow banking system. So it is a more complicated problem, but not as deeply penetrating into the overall economy. So that is different, and that has pluses and minuses. Some lessons. One, the truth shall set you free. Japan hid from itself the depths of the problem, denied, covered up. I mean, criminal fraud cover-up. In the U.S., we created regulations that actually prevented us from even monitoring the size of credit default swaps or knowing the amount of counterparty risk. And the notion that we don’t sell financial derivatives on exchanges like we sell corn futures and stocks is just asking for trouble. So regulations requiring greater transparency, and putting derivatives on public exchanges, would certainly be a remedy. That would allow us to avoid the counterparty risk like AIG and allow us to just know what is going on as well as regulate it. Second, some people have got to go jail. Two reasons. One, they deserve to. When bank executives press loan officers to approve loans that they know are probably fraudulent and then they pass them on by securitizing them, that has got to be against the law. If it is not against the law, then the Congress has got to remedy that. The second reason is that the public will not approve spending hundreds of billions of dollars if they think you are bailing out banker crooks. That is one of the reasons it took Japan so long to inject public capital into the banks. In the U.S. S&L crisis, hundreds of U.S. banker crooks went to jail. In Japan, few, if any, went to jail. So to get public support for that kind of money, the public has to feel that they are the ones being bailed out, not the malefactors of great wealth. Thirdly, you do need a capital injection. Japan finally combined the capital injection with an upside for taxpayers, and the capital injection has got to be combined with insistence that that be used VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00043 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 38 rwilkins on PROD1PC63 with HEARING to write off the tax to toxic assets. In Japan, it took them about 6 or 7 years to finally inject some money. But initially, they injected the money so the banks could continue bailing out the zombie borrowers. When the Koizumi administration, after about a year in power, finally decided to go after the problem, they insisted that the toxic assets actually be written off the books. It took about 3 years to do it. The social dislocation was actually less than they had feared. So the U.S. needs to inject enough capital so that banks can afford to write off the bad loans—the Japanese banks were very, very thinly capitalized—but it also has to have the controls to make sure it is being used to get rid of toxic assets. The record on bank nationalization in Japan is actually a mixed record, which I can discuss in the Q&A, if you would like. Mark-to-market accounting is procyclical the way it is being used now. That needs to be adjusted. A large part of the capital losses of banking institutions is actually mark-to-myth writedowns because, in fact, capital markets have gotten panicked. So, there is irrationality in terms of these derivative prices relative to the level of the original asset. You could have the original loans being paid on time. And yet the securities based on them have lost a third of their value. Fiscal and monetary stimulus is absolutely essential. You cannot cure the crisis without it because you have to have a cushion underneath the economy to prop up the economy. It is inherently depressive to wipe out all of this wealth or to recognize the wealth that has already been written off. So you have to have that cushion. Japan did it in such a stopgo fashion that they gave fiscal stimulus a bad name, just as I fear some of the stuff we have done has given markets a bad name around the world. So you need fiscal and monetary stimulus, but you need it as anesthesia for the surgery of curing the banking problem of toxic assets. If you use it as heroin to dull the pain and avoid the surgery, as Japan did for 10 years, then you have bigger costs, more pain, more losses in the end. Japan needed regulatory institutional changes. We certainly do. I think the heart of the U.S. crisis was an orgy of deregulation, which basically gave financial executives incentives to act like buccaneers, creating loans they knew to be dubious, selling them off to pension funds of teachers and plumbers and bank tellers. And that, I believe, is the heart of the crisis. It is not excessive debt, per se. It is that the debt was used for worse than useless projects. I have figures here showing actually the debt level in the United States is not as bad as many people suppose. The problem is how the money was used and the fact that the shadow banking system is so obscure that the players don’t know what anything is worth. The markets are frozen. I will stop there. [The prepared statement of Mr. Katz follows:] VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00044 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00045 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert graphic folio 58 here 48951A.028 rwilkins on PROD1PC63 with HEARING 39 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00046 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert graphic folio 59 here 48951A.029 rwilkins on PROD1PC63 with HEARING 40 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00047 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert graphic folio 60 here 48951A.030 rwilkins on PROD1PC63 with HEARING 41 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00048 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert graphic folio 61 here 48951A.031 rwilkins on PROD1PC63 with HEARING 42 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00049 Fmt 6633 Sfmt 6602 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A951 Insert graphic folio 83 here 48951A.053 rwilkins on PROD1PC63 with HEARING 64 65 The CHAIRMAN. Thank you very much. I appreciate it. So we go from Sweden to Japan to the United States. Mr. Cooke. STATEMENT OF DAVID COOKE, FORMER EXECUTIVE DIRECTOR, RESOLUTION TRUST CORPORATION rwilkins on PROD1PC63 with HEARING Mr. COOKE. Hello. Thank you very much, Madam Chair and members of the Panel, for letting me be here today to talk a little bit about the RTC experience and what lessons may be relevant. What I will do pretty quickly is go back. The S&L crisis really started back in the late ’70s and early ’80s when interest rates were very high, and a lot of S&Ls got into deep trouble because they had made a lot of long-term, fixed-rate loans and depended on deposits. And depositors left, funding costs went up, and so then they started to lose money, and their capital accounts became very jeopardized. So you are dealing with—as rates are coming down, you are dealing with an industry that has already got weak capital, which is very important. During that time, a lot of the S&Ls that were mutuals converted to private stock ownership. They brought in new investors, and they started to use some of the expanded authority that Congress gave in ’80 and ’82 to basically allow the S&Ls to do more things so they wouldn’t be so dependent on residential mortgages. The S&Ls, what a lot of them did was they started making risky loans that they didn’t really understand, and the regulators really didn’t understand either. The S&L regulators at that time really were very good on understanding residential mortgages, but they didn’t understand a lot of this other stuff. So about around ’86, credit losses started to surface. Actually, they started to surface even earlier, and then it became pretty clear that a lot of the S&Ls were really in trouble and needed to be resolved. The regulators were really unprepared for what happened, in my view, over on the S&L side, of course. And already by the time ’88 ended, ’86 to ’88, there were like almost 300 failures and over $100 billion in assets of failed S&Ls that had been resolved either in some kind of assistance transactions, a lot of them were done in 1988. It got very controversial and political, and Congress got very outraged that the FSLIC, the insurer at that time, was bankrupt and it was making all these deals that it really didn’t have the authority or the funding to do. And things went pretty sour. So, at that time, you also had a very strong industry influence that didn’t want to acknowledge that the problems really existed. I mean, the S&L industry had a very powerful lobby, and they just disputed. And when the administration at that time did get some money in, back in those days, they didn’t get near enough. It had only gotten about 10 percent of what the costs ended up being. In 1988, in late 1988, the Treasury Department came over to the FDIC and asked if maybe we could provide some help in eventually running a temporary agency, the RTC, as well as taking over some of these failing thrifts that the FSLIC would say were no good. Take them over.’ We agreed. In August of ’89, FIRREA was passed, and that law was a fairly comprehensive law. As the executive director, my job VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00071 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 66 rwilkins on PROD1PC63 with HEARING was trying to ramp up operations and interact with the other agencies. So maybe I am a little influenced by that too much. But FIRREA did a major overhaul of the S&L regulatory system. At the same time, it was trying to have that system deal with the crisis, and that involves a certain amount of personal interaction and time that I don’t know yet is fully appreciated. FIRRA basically eliminated, abolished the Home Loan Bank Board, FSLIC, created OTS, created the Federal Housing Finance Board and created the RTC, transferred new functions to the FDIC. That takes time to do, but there was no time allowed to really do that. Maybe it is wrong, but at the FDIC side, we sort of kept an eye on it. But we didn’t do much until we knew there was going to be a law passed. And so, there really was not much preparing that I am aware of. The RTC was set up. I was the deputy to Chairman Bill Seidman at that time. He asked if I would go over to ramp it up, and I didn’t expect him to ask. And in hindsight, there were many times when I wish he had never asked. But in terms of the temporary agency, the RTC, first of all, it would avoid confusion in governance. If you are going to overhaul the regulatory system, don’t confuse people as to who is responsible for what. We had an oversight board that was created for the purpose of policy and had control of the budget. The oversight board consisted of Secretary of the Treasury, chairman of the Federal Reserve, the Secretary of HUD, and two private sector. A very, very high-level board. And the FDIC was responsible for putting someone in charge, trying to oversee the operations of the FDIC. There was a gap between the operation end and understanding the governance. And so, whatever is done, don’t put yourself in that same mess. On the operating side, we knew what we were supposed to do now. We didn’t realize how many there would be, but we knew we were supposed to take over these S&Ls and resolve them. That took a lot of time. Original loss etimates of $50 billion were way low. They were based on, maybe 400 failures and a couple hundred billion in assets. Ended up being like twice that, and that took a lot of time. I am trying to rush through here. About half of the assets were hard-to-sell assets. We had to come up with new ways to try to sell the assets and to value them. We came up with new valuation policies, and we came up with new disposition methods. We did not have to negotiate and buy. But we did have to come up with values because there were provisions of FIRREA not to sell any asset for less than 95 percent of fair value and no one really knew what was the fair value. Some of the markets in the Southwest, you know, Arizona, Texas, very hard hit during this, and people were concerned we would dump the assets. Interestingly, when I was in the chairman’s office, we had representatives from Arizona, as I recall, come in and ask that the RTC not dump assets and destroy the values that healthy banks had on their books. A year later, the same group came in and said you have got to start moving these assets because RTC was freezing up the market. VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00072 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 67 rwilkins on PROD1PC63 with HEARING So we started a much more aggressive approach. At the time, we went through a lot of times having to go back to Congress and say we don’t have enough money. We needed two types of money. We need money to pay for the losses in these institutions, but more money to get these institutions out of conservatorship. On the day that we opened our doors on August 9th, we had like 270 institutions in conservatorship, which meant that we were supposed to be somehow running them. There were no real guidelines on what meant. So when you nationalize an institution, at least know what you expect it to do, if that happens. The CHAIRMAN. Mr. Cooke, let me just stop you there. Mr. COOKE. Am I running over? I am sorry. The CHAIRMAN. Yes, that is all right. We are a couple of minutes over, but we will get back to more of this in the questions. Mr. COOKE. Okay. All right. Thank you. [The prepared statement of Mr. Cooke follows:] VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00073 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00074 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert graphic folio 91 here 48951A.054 rwilkins on PROD1PC63 with HEARING 68 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00075 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert graphic folio 92 here 48951A.055 rwilkins on PROD1PC63 with HEARING 69 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00076 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert graphic folio 93 here 48951A.056 rwilkins on PROD1PC63 with HEARING 70 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00077 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert graphic folio 94 here 48951A.057 rwilkins on PROD1PC63 with HEARING 71 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00078 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert graphic folio 95 here 48951A.058 rwilkins on PROD1PC63 with HEARING 72 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00079 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert graphic folio 96 here 48951A.059 rwilkins on PROD1PC63 with HEARING 73 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00080 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert graphic folio 97 here 48951A.060 rwilkins on PROD1PC63 with HEARING 74 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00081 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert graphic folio 98 here 48951A.061 rwilkins on PROD1PC63 with HEARING 75 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00082 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert graphic folio 99 here 48951A.062 rwilkins on PROD1PC63 with HEARING 76 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00083 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert graphic folio 100 here 48951A.063 rwilkins on PROD1PC63 with HEARING 77 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00084 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert graphic folio 101 here 48951A.064 rwilkins on PROD1PC63 with HEARING 78 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00085 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert graphic folio 102 here 48951A.065 rwilkins on PROD1PC63 with HEARING 79 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00086 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert graphic folio 103 here 48951A.066 rwilkins on PROD1PC63 with HEARING 80 81 The CHAIRMAN. Okay, thank you very much. And Dr. White. You will take us to the U.S., but further back. Please. STATEMENT OF EUGENE WHITE, PROFESSOR OF ECONOMICS, RUTGERS UNIVERSITY, AND RESEARCH ASSOCIATE, NATIONAL BUREAU OF ECONOMIC RESEARCH rwilkins on PROD1PC63 with HEARING Dr. WHITE. Yes. I would like first to thank the Panel for the invitation to provide testimony on the actions of the U.S. Government to stabilize the financial and housing sectors during the Great Depression. Although I devote equal time to these two questions in my written testimony, I understand the committee has requested that I focus on the operations of the Reconstruction Finance Corporation. At the beginning, I would like to point out that the financial system then was very different than today, and it is those differences which are instructive—principally, the absence of deposit insurance and the very high levels of capitalization. The Great Depression, as you know, we all know, was the most severe recession the U.S. has ever experienced. There is a general scholarly consensus that the primary driving force that transformed a relatively ordinary recession into the Depression was the failure of the Federal Reserve to pursue correct policies at several critical moments. The first question must always be why didn’t the Fed respond to the rising number of bank failures? That answer is fairly straightforward. Bank failures were a common feature of the financial landscape because of a structural weakness in the banking system. State and Federal regulations had a nearly universal prohibition on branching that created a system dominated by small, single office banks. Thus, in the 1920s, there were well over 20,000 banks. Failures of a few hundred a year were regarded by policymakers and most of the public as a normal winnowing of weak institutions with poor management. Shareholders lost their investment—in fact, more because there was double liability—and depositors faced a haircut. While this may sound severe, aggregate losses of the entire system were relatively modest. In the absence of Federal deposit insurance, bankers were aware that the public was attentive, withdrawing deposits if the banks appeared to be in trouble. Consequently, they maintained high levels of capital. For national banks of the 1920s, the capital asset ratio was about 12 percent, or approximately double what it is today. These bank failures did not present a systemic risk to the economy because they were relatively random and not part of a general economic decline. That changed in 1930, when the first panic began. The first major response to the massive bank failures was the creation of the Reconstruction Finance Corporation (RFC) in 1932. The Federal Reserve’s reluctance to provide additional liquidity to financial markets presented the Government with an unusual problem. The classic policy remedy in a banking crisis was for the central bank to lend freely from its discount window. This policy would VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00087 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 82 rwilkins on PROD1PC63 with HEARING enable banks that were illiquid but otherwise solvent to survive the crisis. The task of the RFC was to provide sterilized lending without a change in the monetary policy of the Fed to banks that were weak. In other words, a second-best policy. The RFC was an agency of the executive branch of the Government and granted extraordinary discretionary authority. The agency aimed to follow sound banking practices with advances being fully secured. Lending was through its field offices, and these had full authority to grant loans up to what are the equivalent today of $1.5 million. The management philosophy was to pick a man to be completely responsible for the operations in an office and let him succeed or fail on the basis of whether or not his office showed a profit. Loan evaluation was simple. Once an application was received, the agency evaluated whether an asset value was sufficient. There were three phases of the RFC’s operations—the first from February 1932 to July 1932, second from July 1932 to March 1933, and third after March 1933. The first program in 1932 was where the RFC made loans to banks and railroads. During this period, Eugene Meyer, chairman of the Federal Reserve Board, was also chairman of the RFC. Meyer kept the terms and collateral on loans at the RFC the same as those at the Federal Reserve. Consequently, what happened was that the Fed could only lend to member banks. So he essentially extended the policy to nonmember banks; and it is during this period that the RFC loans are generally seen to be ineffective in improving bank survivability. I should add parenthetically that the RFC also made loans, substantial loans to railroads. However, various studies have shown that these did not actually solve the problems of the railroads. In fact, they prolonged their distress. The second phase of the RFC began in July 1932, when lending rules were liberalized. However, at almost the same moment, the list of banks that had received aid had been kept secret, just as the Fed had kept the names of banks who came to the discount window secret were made public. Making these loans known to the public, banks became hesitant to go to the RFC to get loans, and the number of loans offered by the RFC rapidly dwindled. The last phase began in March of 1933, when the RFC began to offer its preferred stock purchase program. Unfortunately, this program occurred at just the same time as the banking system was collapsing and the bank holiday occurred. When the RFC failed to prevent bank failures and runs, the state turned to a widely used 19th century method, which was to restrict payments, and they began to announce bank holidays, which snowballed eventually into the bank holiday of March 1933. The bank holiday was a drastic remedy. Before the holiday, the public was prone to run on a bank because it had no means to assess its solvency. This information asymmetry had always been present, but it was heightened during the financial crisis. The Government now stepped in and erred on the side of caution. After examination, only those banks that were clearly solvent were reopened. Those banks whose condition was dubious would remain closed until the Government could ascertain their true condition. VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00088 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 83 rwilkins on PROD1PC63 with HEARING Thus, at the end of 1932, there were over 17,000 banks, but after the holiday, only about 11,000. The remaining 2,000 were either liquidated or merged. This had the effect of restoring public confidence in those banks which were open; and for those which were closed, depositors were not bailed out. Instead, all stakeholders in the failed institutions absorbed losses of $2.5 billion, or roughly equivalent today of $39 billion, about 2.4 percent of GDP. This burden was shared roughly between shareholders and depositors. To wind up, I will just offer you a rough comparison. If we compare the 1930s to the 1980s, the rough loss from the S&L and commercial banks was about $126 billion, about 3.4 percent of GDP. And if you believe that today’s crisis has losses of $1.7 trillion, that is 11.6 percent of GDP. So the cost of our crises seem to be spiraling upwards. [The prepared statement of Dr. White follows:] VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00089 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00090 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert graphic folio 111 here 48951A.067 rwilkins on PROD1PC63 with HEARING 84 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00091 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert graphic folio 112 here 48951A.068 rwilkins on PROD1PC63 with HEARING 85 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00092 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert graphic folio 113 here 48951A.069 rwilkins on PROD1PC63 with HEARING 86 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00093 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert graphic folio 114 here 48951A.070 rwilkins on PROD1PC63 with HEARING 87 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00094 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert graphic folio 115 here 48951A.071 rwilkins on PROD1PC63 with HEARING 88 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00095 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert graphic folio 116 here 48951A.072 rwilkins on PROD1PC63 with HEARING 89 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00096 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert graphic folio 117 here 48951A.073 rwilkins on PROD1PC63 with HEARING 90 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00097 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert graphic folio 118 here 48951A.074 rwilkins on PROD1PC63 with HEARING 91 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00098 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert graphic folio 119 here 48951A.075 rwilkins on PROD1PC63 with HEARING 92 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00099 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert graphic folio 120 here 48951A.076 rwilkins on PROD1PC63 with HEARING 93 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00100 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert graphic folio 121 here 48951A.077 rwilkins on PROD1PC63 with HEARING 94 VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00101 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 Insert graphic folio 122 here 48951A.078 rwilkins on PROD1PC63 with HEARING 95 96 rwilkins on PROD1PC63 with HEARING The CHAIRMAN. Thank you, I think. Thank you very much. Thank all of you. What we will do now is we just want to engage in some questions, if we can here. We limit ourselves as we ask questions to 5 minutes, but I think we will have enough time that we can go more than one round here. So we do want a chance to explore this while we have got everyone together. I get the privilege of asking the first. So let me tell you where I would like to start this. There has been much debate around the question of nationalization, and the argument back and forth about nothing is an appropriate analogy. Everything was different at every other point in time or every other place. And what I have tried to do as I have listened to this is I try to think, so what is it that people are concerned about with nationalization, other than it sounds like a scary word? And as best I can figure out, there are three things that seem to emerge each time, that sort of circle through this. One is that if we nationalize, there will be politics involved in lending. The notion that there will be folks from Congress who will call the local financial institution and lean on them to finance a constituent’s business or to—at a much larger level, to get involved in lending activities that they have no business getting involved in. The second is that it is simply too complicated. All well and good for those charming little banks of yesteryear, but that today we have mega institutions that are far too complex to be nationalized because, surely, no one in the public sector could run them. It takes the expertise of the private sector. And the third, and I think related to this, the argument runs there will be too many people who will have to be replaced. It is a sort of variation on the expertise argument. We will have to fire all the bank employees and put to work government employees who would then have to be retrained, who wouldn’t understand. That is the best I can figure it out from what I hear. And if I have left some out, you should feel free to add. But what I would like to do is I would like to start with you, Mr. Lundgren, if you could talk to us particularly about the political influence question. How did you deal with this problem in Sweden? How did you deal with the question of expertise, whether or not government officials could be expected to run these complex institutions? Mr. LUNDGREN. It has been fascinating to follow the debate in the U.S. regarding nationalization, which we didn’t use as a tool. That is not a tool. That is something that can come out of you handling a crisis. We had one bank that was partly nationalized, which we fully nationalized. And we had another one, which we nationalized because it was just a black hole and nothing else. What you have to do then is you replace top management because, obviously, those who led the bank into the black hole shouldn’t be there, and you have got to replace boards. And you don’t replace ordinary people in the banks. You don’t try to convince yourself that you are an expert in running banks because you are not. On the other hand, as I said, I mean, obviously, those people that have run the banks now and the shareholders that have been re- VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00102 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 97 rwilkins on PROD1PC63 with HEARING sponsible for them haven’t been very successful, to put it mildly. So government, could they do it worse? I don’t think so, to be honest. It is a crisis management question, and nothing else. Regarding political influence, it is not a tradition in Sweden. I wouldn’t see how local politicians here would be able to do that, but I couldn’t answer that question, of course. We didn’t have that problem at all. It wasn’t discussed at all. When it comes to the expertise, as I said, it can be solved. You have a lot of good people that were not responsible for what happened in the banks, and they could take over. So we took the one nationalized bank, put the viable parts into what was the government-owned, fully nationalized then, and now it is partly privatized. Only 19 percent is still in government, and that is Nordea, which is a very good bank today. The new management managed to restore the bank, per se. So I don’t really see there are any dangers because what you really need to do is if government goes in with capital, market economists say that if you take the responsibility of being an owner and you also take the advantages of being an owner, you should do it fully. You shouldn’t abstain from voting power. You shouldn’t be afraid of taking ownership. But you should, as soon as possible, try to get rid of it. The CHAIRMAN. That is very helpful. Mr. Cooke, was this an issue in the ’80s with the RTC? Mr. COOKE. Well, at the RTC, we had a lot of institutions in conservatorship, and we had to run them. The law that was passed creating the RTC, as I remember it, basically said to Congress, don’t get involved. But your three points—you know, politics, complication, and you need too many expert people—of those, politics was not as big an issue with us. But there was always a little bit. You can’t get away from it totally. As far as being complicated, I think that is the worst excuse to give because that is basically saying, as back in my examiner days, ‘‘It is too big to analyze. Pass it and watch it.’’ That is just going to be a problem. So you can’t—if it is too complicated to do something with, you have got to do something about that. And so, we had institutions that were complex, that were larger. But nothing like what people are talking about today. And as far as too many people to replace, you do have to get rid of the top management. You have got to do that. And you have got to get rid of probably the next line down before you start getting any objective analysis. Depending too heavily on the work of the guys in charge now, at least from my view, is a mistake that you will come to realize slowly. The CHAIRMAN. If my co-Panelists will indulge me, I just would like to follow by asking the question, in effect, in the reverse point. Mr. Katz, does the failure to nationalize take politics out of the relationship between the financial institutions and the government? Mr. KATZ. In Japan, it worked the other way around. There were some banks, about four, who were effectively nationalized. A couple actually had just simply gone bankrupt. Two were bailed out. VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00103 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 98 rwilkins on PROD1PC63 with HEARING In the first couple of cases, the stockholders were totally wiped out. In the last case, the stockholders were bailed out, and the stock market had a rally. S&P is about to come out with a study about the banks which were nationalized in Japan. Let me just preface this by saying I am not sure if nationalization is the right solution here or not, but let me discuss the track record in Japan. Those banks that were nationalized in Japan got rid of toxic assets much more thoroughly and much more quickly than those which were not nationalized. On the other hand, the ones that were nationalized got a much bigger capital injection from the government. So they could afford to do the writedown. And on the third hand, if you will allow me a third hand, the ones that were taken over were smaller. They weren’t the mega banks in Japan. On the politics. Politics actually really worked the other way around. In Japan, your social safety net is your job. So you can’t allow companies to fail, and you can’t allow banks to fail. They called it the convoy system. So the Diet members would actually call up banks and say, you are not making enough loans to Mr. Tanaka down the street, to mom-and-pop stores. So the political pressure on banks to lend was actually very, very great, having nothing to do with nationalization. It is just the way the system worked. Now what happened was the crisis was so bad that the Diet took the whole power over running the banks away from the finance ministry, which had been in cahoots with the bankers for mutual cover-up, and created an entirely new agency called the Financial Services Agency. One of my favorite bureaucrats there actually spent some time working in the National Police Agency, and had spent some time in London and in New York, and so seeing other things. So the politics actually worked fine, despite an awful lot of political pressure on the nationalized banks, one bought up by a U.S. hedge fund, to make these loans to weak zombie companies. That came out in public. It was a big brouhaha. But, in fact, the politics worked the other way. On the complexities of nationalization, I basically agree with the other people’s comments. Lop off the top management. But you are the shareholder. So you are the boss. You hire people, but you don’t get rid of everybody. The CHAIRMAN. Good. Thank you, Mr. Katz. And if I could just have a final comment from Dr. White. Just keep it short. Dr. WHITE. There is good news from the Great Depression—— The CHAIRMAN. Turn your—good news from the Great Depression. We are ready. Dr. WHITE [continuing]. On the issue of favoritism. The New Deal programs have been extensively studied, and almost all of them find extraordinary political favoritism, with the exception of the RTC. And the reason for that is there was a great deal of insulation by granting extraordinary executive authority to the President. So even though we know there are cases of congressmen and governors calling up the RTC, overall, it looks like a fairly clean pro- VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00104 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 99 rwilkins on PROD1PC63 with HEARING gram. It was easy to find plenty of people to staff both the RTC and the HLC, which had 20,000 people on its staff. The issue about the complexity of valuing a failed banks’ assets is kind of misleading because what happens is that at this point, the economy is in a terrible downturn. Markets have become very thin. Assets are harder to evaluate. And so, it is natural that it seems more complicated, but it is just requiring that people, the bank examiners and those others, to exercise a little more discretion. The CHAIRMAN. Good. Thank you all very much, and thank you, Panelists, for your indulgence on the time. Mr. SILVERS. Yes, first, just one quick thing. Mr. Lundgren, in your opening comments, you referred to yourself as a market liberal. That is a term that is not current in U.S. parlance. Am I right to assume that you represent the more conservative of the major Swedish parties and that you believe in free markets? Mr. LUNDGREN. Yes, we call it market liberal because liberal is something that is freedom. It is not the American way of political liberalism. I am a conservative in that respect. Market conservative you could say. Mr. SILVERS. Yes, just one of those things where we are separated by a common language. Secondly—first, Mr. Lundgren and then Mr. Cooke—could you talk about the treatment first of stockholders and elaborate on the reasons for the treatment of stockholders in the respective programs you ran. And then secondly, bondholders and how they were treated and why? And then I will have a follow-up question. Mr. LUNDGREN. If I would start out with the bondholders, I mean, they were creditors. They were investors, and you could argue that they should, of course, be evaluating their investment and suffer if they did wrong in their analysis. On the other hand, if you come to a systemic crisis, I think that you have a situation where nobody, depositor or creditor, can lose on a bank. You saw that after Lehman. Lehman was a mistake, obviously. So, first of all, all creditors were covered by this blanket guarantee. Secondly, if you have the blanket guarantee, then you have to, of course, handle the situation within the banks, and all banks except one applied for government support. We then told them that if you want capital injection from government, it is not soft money. We even had to change legislation one more time in order to try to convince them that we were superior when it comes to negotiations. It was not so much negotiations as it was an offer that you couldn’t refuse if you needed capital injection from the government. And that meant that you diluted the shareholders’ value, of course. And if we got majority in the government, so be it, then we took the majority in the banks. This helped us getting private equity because the owner families of the SEB, SE Banken, the Wallenberg family, of course, understood that it wasn’t very nice to have the bank taken over by government. So they found private equity. Of course, we were helped by the appreciation of the currency by the economy reviving and so forth. But still, it was a very tough handling. So it was an explicit message that there are no negotia- VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00105 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 100 rwilkins on PROD1PC63 with HEARING tions. If you need capital injection from government, we will take the same stakeholding in the bank as the amount of capital we put into the bank. Mr. SILVERS. Voting power? Mr. LUNDGREN. Voting power, of course. I mean, without voting power, you don’t have the influence. Mr. COOKE. With regard to RTC, it was all the deals, all the transactions were closed bank transactions, which basically meant the shareholders ended up being left behind in receivership. And if there were any collections when the day was done, they might get something. But they were pretty much removed from the picture as we removed senior management and all that. As far as bondholders, depending on the terms of the agreement, they may have been left behind in receivership, which is like the bankrupt estate. We would sell off the deposit franchise. If we can get money to sell it off before it evaporated. And we would sell off the assets, and they would just wait for the collections, their pro rata share of collections in the proceeds. So they would be a general creditor, most bondholders, unless they had some kind of security, they were secured. What may be more interesting, in the mid ’80s before they changed the law, a lot of big banks, not a lot, but big banks were coming to the FDIC, looking for what we called open bank assistance, which is where you are not closing the bank. You are not putting it through a receivership. You are going to provide assistance. And at that time, Chairman Seidman—there were getting to be a lot of people coming in, looking for money, saying, ‘‘Why don’t we get this?’’ And he established some ground rules that basically said to shareholders if you get Federal assistance, your interest, number one, is going to be substantially diluted. And if you want us to bring in new capital, we better have a situation where somebody else puts their money on the hook so we know that you are not the—someone else has said this is a viable assessment and also that top management prepare your travel plans. And as far as shareholders, one of the things that we did was go aggressively after management at the RTC, and if there are any shareholders, controlling shareholders for any issues that we felt contributed to because every time we had to go up for money, which we had to keep doing, it was good to have something good to tell Congress. And we would say, well, we didn’t do perp walks, but we would say this many people went to jail in the regular update. Mr. SILVERS. Second question. There has been a lot of debate in the United States about valuation issues, particularly about markto-market accounting. What is the experience—and any of you could answer. What is your view about the effectiveness of essentially an administrative valuation, which I think is a common theme across a number of your testimonies? And how does one understand it in relation to debates about mark-to-market accounting? Mr. LUNDGREN. If you start with Sweden, we had a simple situation. We had ordinary bank loans, plain vanilla, which was coupled with mainly real estate as collateral. So what we had to do, in ef- VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00106 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 101 rwilkins on PROD1PC63 with HEARING fect, was to try to get right values out of the collateral, which was real estate, commercial real estate mainly. What we did was opt for the mark-to-market valuation. Even if it could exaggerate in the long run the situation, I think that that gave us, due to the transparency it gave, gave us more credibility, restored confidence much easier. Because even if it seemed that the losses and the total losses in the bank would be greater than otherwise, it was mark-to-market is mark-to-market. Whatever other method you use, it is not a clean method. There is always an argument to what, how do you valuate? How do you really put a value on it? Of course, this situation with all these securitized instruments is much more difficult. On the other hand, what you need to do, I mean, you need to be able to show that all of the banks’ stress testing or whatever, you can have a real picture of what is the black hole and what is the losses on the asset side and how much capital do you need to inject? Not only because Congress needs it to try to estimate what more funding might be needed, because probably more funding will be needed to handle the situation here, but also to convince investors that, okay, now you have a sizable—you have a picture of how big the size of losses are as well. So I would go for the mark to market, even if it is procyclical. I can see that there are those problems, but that is the one we would choose, and it helped us coming out quite good. Mr. KATZ. Could I make a very just quick comment on that? In Japan, there was, as far as the loans themselves, mark-to-market was less of an issue because they had preset sort of loan loss reserve ratios depending upon how much in arrears it was, how much loss. They began to develop an actual market in distress assets, both a government organization to create it and private markets. The real problem with their mark to market was that the banks were allowed to hold stocks as part of their capital. The stock market went down. That hurt them. The government tried what they call price-keeping operations, basically buying stocks. It didn’t work. This is the case where the patient has got a fever, so let us bribe the thermometer. But I would say the situation in the U.S. is different in the sense that mark to market is being used in cases where there is no market. So, for example, when Merrill Lynch has its fire sale of assets and 22 cents on the dollar to avoid bankruptcy, but there were so few actual deals in that particular instrument that everybody else had to mark it down to 22 cents to the dollar even though the underlying asset was actually good. Mr. SILVERS. Mr. Katz, I don’t mean to cut you off there. Keeping that in mind, I am curious about the effectiveness in the U.S. context in the past of essentially trying to get at real values through administrative processes rather than either through a frozen market or through pretending that they are worth more than they are. How good has that type of process been, and is it something that could be replicated in this situation? Mr. COOKE. In the case of the RTC, we had a lot of that. We had a lot of junk loans and construction development loans where there VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00107 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 102 rwilkins on PROD1PC63 with HEARING was no market for those assets. Now we were in the sell mode, not the buy mode, because we got it when the institution took them over, and that made a difference. And we were also required not to sell anything initially less than 95 percent of fair value in certain markets, which really created a problem. We updated appraisals, and appraisals were all revised, too, at that time because they were all—the practice was very flawed. We just couldn’t get a price we could sell the assets. So there was no market, but we worked with the private sector advisors as to what kind of reasonable returns would markets be looking for. Then we would take our assessment of the cash flows, and we would use that to establish what we called a derived investment value. We used that to sell the first pools of these structured assets, and we met what we thought was the fair market. And it definitely increased competition. Very quickly, everybody was in there because the market returns. All it takes is someone making on it to get somebody else to want to come in and do it. And the prices and the values went up. So it worked fairly well. But again, we were selling, not buying, and that is a little trickier. I would just say I agree. But I don’t know how you mark to market when there is no market. I just don’t know how you do that, and there has to be somewhat of a different model. Maybe the Government can come in and really assess cash flows, do something similar. I just don’t think you can price it. Dr. WHITE. Yes, just a bit of an historical comment on this. Given that commercial banks oftentimes specialize in lending to individuals who don’t have access to markets, it is hard to say that you mark to market a loan, particularly to small business or something like that. That being said, the bank examiners used to, before the Great Depression, basically mark to market, and it is only after the Depression comes when they gain the right to—because the markets, the values affecting it have tumbled so far—to make some judgments. And that is when we get forbearance at that point and that sticks, and we drift away from mark to market. The CHAIRMAN. Very helpful, thank you. Mr. Neiman. Mr. NEIMAN. Thank you. I would like a follow-on to Elizabeth’s first question, where she outlined three arguments against nationalization that are often used. I would like to add another one to the extent that nationalization could result in inhibiting factor for the attractiveness, attracting private capital into other institutions, particularly due to the risk of traders pushing down the price of the stock, shorting the stock in anticipation of which is the next bank to fall. This, I assume, is a relatively unique circumstance in our current events, but I would like your perspectives from whether it was a factor in your prior experiences and how it was significant. Is it a factor in the debate around nationalization? Mr. KATZ. In the case of Japan, it actually worked the opposite way. So the first couple of nationalizations, the companies actually went bankrupt. VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00108 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 103 rwilkins on PROD1PC63 with HEARING The government bought them and then fairly quickly sold them off to hedge funds, U.S.-based hedge funds actually in both cases. In the third case, which is the most interesting, the bank had not yet failed. It wasn’t a de jure nationalization, but de facto it was. They bought up controlling shares. They fired the top management. They injected lots of capital. They did not wipe out shareholders. And what happened was the stock market, which was at ridiculously low levels, suddenly recovered because other people felt, okay, they are not going to wipe out the shareholders in rescuing the bank, but they are going to fire top management and they are going to say you either get those loans off your books, or we are going to get them off for you. And what happened was then it concentrated minds in the other banks, which had not been getting the bad loans off the books. They started getting off the loans very quickly so they would not be taken over. And then they began to do all kinds of stock issuance. Some of it was pressuring their customers to send in stock. But the fact is that stocks, including bank stocks, did rally, and from that point on, it was about 2 to 3 years before the problem was really solved. It ended up attracting capital because it induced the management to finally step up and do the right thing. Mr. COOKE. Well, I just want to comment. In terms of the institutions—you are not going to attract investors until they are comfortable with the asset problems. I realize short sellers and hedge funds can try to drive prices down, but if you have a bank and you have isolated the problems and take it out, there are plenty of investors looking to buy banks. One comment about nationalization in terms of political interference. Some may disagree with me. Back when we had Continental Illinois, at the time it was the seventh largest bank. There is a tendency for regulators, when they are running a bank, to be overly risk averse, and that is probably not the right thing to say now. But, there is such a tendency to not be unfairly competing with other banks that are healthy or to take risks. And, I don’t think you can do that very long. So if the government nationalizes, it is best not to stay long. Get it out of government hands. Mr. LUNDGREN. Well, I have no further comment. I don’t think— I don’t see that as a problem. We didn’t experience it either. But a good thing, if you encounter a situation where you have to, due to crisis management, nationalize, not because you wish to nationalize, you get a better tool in order to get taxpayer money back. One of the reasons our 4 percent of GDP that the total outlays were in ’92 and ’93, of that, most of it came back. A lot of it due to value increase and later privatization of the bank or the banks, rather, that were nationalized. So that is a way also of getting back to having an upside for the taxpayer as well, I would say. Mr. NEIMAN. To include Dr. White in this discussion, am I correct that FDR imposed two rules in this respect? One eliminating mark-to-market for bank valuations and also under his first chairman of the SEC imposing the uptick rule to address the concerns around short selling? Dr. WHITE. Yes, that is correct. VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00109 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 104 rwilkins on PROD1PC63 with HEARING The CHAIRMAN. I think that you have all hit on this. I was really struck when I read the testimony that you all submitted in advance, which I appreciate. And it is certainly been a part of what we have been talking about today. But I want to give you an opportunity to draw a tighter line on the issue of honesty that I keep hearing in different incarnations. And if you can, I just want you to draw this line, if you can, as tightly as possible between what you learned from your experiences, what honesty meant in the context that you studied it or lived it and to how that affects or should be affecting what we are talking about today? Why this seems to be a live issue, if that would be appropriate? Could I start with you, Mr. Lundgren? Mr. LUNDGREN. It is a question of what you really mean with honesty. The CHAIRMAN. That is why I asked. Mr. LUNDGREN. It is vital that government is perceived as honest by the people. I mean, obviously, we had to be very, very straightforward, very open, very transparent. I went to Swedish parliament three or four times in order to be open about what we were doing and so forth. That is one thing. The second thing is that, obviously, a lot of bonuses we had at that time as well, or golden parachutes, you have to handle that. And you will be very strict in trying to reduce, get rid of, and so forth. And we also had—we sued boards of the two banks that were nationalized for compensation, since they obviously were not up to their responsibilities. There were breaking of bank rules and so forth. And we got some compensation out of that as well. So from a political point of view, you have to be very, very straight and very honest, and you have to try to see to it that people also understand that you shouldn’t be given gratification, bonuses or whatever, if you run something badly. And that is also a necessity to handle. The CHAIRMAN. I wonder if you had imagined that you would come here to testify to such points any time before the most recent past. Mr. Katz, you speak about this, and you speak about reluctance to acknowledge problems in Japan. Mr. KATZ. I think honesty is two levels. One is there was a theory in Japan that you would shatter confidence if you admitted the truth. So there was, on the instructions of the finance ministry, deliberate cooking of books. The problem is it destroys confidence because ultimately reality does come out. And certainly, if we don’t even know how big the derivative market is—we didn’t even know the size of the AIG exposure and all the links—then we cannot prepare for a crisis. So that is one level of honesty. The other level of honesty is what got us in the crisis in the first place. My belief is at the heart of the American crisis was a corrupt corporate governance system where CEOs were compensated in a way that they had to hit homeruns. If they hit homeruns, they got huge, huge bonuses. And if they struck out, there was no penalty. And should they actually get kicked out of the game, which is to say drive their company underground, they got $140 million sever- VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00110 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 105 rwilkins on PROD1PC63 with HEARING ance pay. So, naturally, you get people who should be hitting for singles and would be .300 batters who are instead always hitting for homeruns and striking out. And there is a huge difference between the performance of CEOs paid by stock options and those who were not. We also stopped applying rules that say when you lend to someone, they have to have a downpayment. When you lend to somebody, they have to be able to pay back. Also it would be preferable if they were alive. We have cases of banks lending to people who were dead. And so, these nonbanks originated these dubious mortgages and the nonbank portions of commercial banks could then unload these dubious loans, loans they knew to be probably fraudulent, on to other people through securitization. But executives made tons of money and faced no penalty. So we had an incentive system, which actually incentivized executives to do the wrong thing. That is a whole level of dishonesty that was not the case in Japan. It was much worse here. The CHAIRMAN. Thank you. Mr. Cooke. Mr. COOKE. I would just say, really, transparency is key. If you want honesty, the Government has to be honest. And I am pretty sure that the Government was not totally honest back in the S&L days. Everybody thought those problems were going to be more expensive, and they turned out to be so. So I think there was influences there. But honesty is important. You know, the Government has to be honest with the people, and they have to be—I mean, what is the situation right now? To me, the honest answer is the Government really doesn’t know. And what is worse, I don’t think the bankers know. I don’t think the heads of the major companies know any more than the regulators know about where the risks are. It is all over the place. So it is first try to feel, just tell the people that and say I am going to try to solve it. Maybe the stress test is the answer that they are doing. But it would be interesting to see exactly how that works, considering how global and complex these things are. Myself, I have great reservations. The CHAIRMAN. Thank you. Dr. White. Dr. WHITE. I would agree that it is transparency which is very important because if you have forbearance, then many things can happen. On the point actually of corporate governance, the reason why financial institutions are able to take these extraordinary risks is the fact that you have insured many of these institutions. That is the other side of the balance sheet, so to speak, so that that is one of the underlying, I think, problems is that there is such an extraordinary ability to take risks. And there is no risk essentially that a run will materialize or any sort of penalty will be imposed except from the oversight of the agencies. The CHAIRMAN. Thank you very much. Mr. Silvers, last question. We are going to—no, I mean down the line. [Laughter.] Mr. SILVERS. First, in preparing for this hearing, I had a look at a report done by the Norwegian bank authorities, looking comparatively at the Scandinavian experience during what you described, VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00111 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 106 rwilkins on PROD1PC63 with HEARING Mr. Lundgren, as the regional crisis. Could you comment on the role played in terms of the net cost to the public in each country that faced this crisis? The role played by how aggressive they were in terms of taking upside? Mr. LUNDGREN. To be honest, I haven’t studied that. We studied, before taking to work with our crisis, the savings and loan crisis. We went back to 1933. We studied what happened in Norway some years before Sweden. They were nationalizing quite a lot, and we didn’t really like to do that, if we could. I haven’t followed up to what extent their initial outlays have been repaid. What I know about is our own, which was, as I said, 4 percent of GDP, of which most is back, due to bad banks’ handling of the bad assets and so forth as well. But I have no comparison with Norway. Mr. SILVERS. They concluded that—and again, I don’t wish to spark any sort of rivalries here. But they concluded that essentially in those circumstances in which very aggressive positions were taken in terms of taking equity upside that it was directly correlated to the net final cost to the taxpayer. Mr. LUNDGREN. I mean, obviously, if you go in as owner, you get the upside, the whole upside in the bank. So, obviously, then it is a question, if you want to do it or use it as a tool, the first tool if you want to do it otherwise. It would be better if banks managed to get equity on their own, but still we managed to get most of the money we spent back. Otherwise, the main problem for us with Norway is all their gold medals. [Laughter.] Mr. SILVERS. You know, Mr. Lundgren and other witnesses have been very kind to be with us. And obviously, these issues are front and center not just for the United States, but on a global basis, as my colleague Mr. Neiman stated in his opening remarks. I would like to use the rest of my time to give Mr. Lundgren in particular, but any of you, the opportunity to comment further about the particular situation of today, and what, in your view, would be helpful policy for the United States to pursue in relation to what is obviously a global crisis. Mr. LUNDGREN. I mean, being a small country representative, I shouldn’t say so much. But on the other hand, what obviously is needed is some kind of—I mean, you have to restore confidence. And if stress tests will do that or not, it is difficult. But you have to have a way of getting people, investors, ordinary people understanding that you have—you are comfortable with handling the situation. You can tell about the size of the problems and so forth. We did a blanket guarantee for creditors and depositors. That restored confidence immediately. I see the problems with that. On the other hand, I mean, some kind of guarantee can help out, especially if it is difficult to value assets without having to buy them or try to make as you said an administrative pricing of that, which is very difficult to do that. In 1933, the Roosevelt administration did close the banks and restored confidence by that way. It is not very recommendable to do it, of course, in modern times. VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00112 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 107 rwilkins on PROD1PC63 with HEARING But to find the size of the problems in one way or another also guarantees that you can restore both confidence by showing the size of the problems, by guaranteeing or whatever, and then also being able to do the capital injections, having the frame, the economic frame to be able to convince people that the capital base will be restored. So lending will take place in the same amount as before the crisis as well. Mr. SILVERS. Can I just stop for just one second on capital base? It seems to me that we have shifted from a moment in which sort of systemic confidence was the main issue, which was clearly the case in October, to a situation in which we have large, a handful of very large, systemically significant institutions with no capital base or an unknown capital base, I think, to Mr. Cooke’s comment. Does that strike you as the right—and I would welcome anyone, but since Mr. Lundgren was talking, does that strike you as the right description of where we sit today? Mr. LUNDGREN. I mean, obviously, there is a lot of uncertainty. I mean, exactly how certain it is for different institutions. But all around for the banking sector as a whole in the U.S., both in the U.S. and abroad, obviously nobody knows how the situation is. And that is something that you have to make clear. Restore confidence and restore capital base. That is a necessity, either by Government or by private capital, if possible. Mr. SILVERS. Now you can’t have a living bank without an adequate capital base, can you? Mr. LUNDGREN. No, no. I agree with you, and then perhaps government has to inject that capital, and then as I said, I think that for the taxpayers’ sake—and being a market conservative—working with market economy, you should also have the ownership. Mr. SILVERS. Radical notion. The CHAIRMAN. Thank you. Superintendent Neiman. Mr. NEIMAN. I am interested in your views, based on lessons learned as well as your current thinking, on how to structure these asset purchases by the Government of these toxic assets in a way to best protect the taxpayers. Are there other means, both in terms of valuing the assets or structuring, so that government is not paying all cash up front, giving it a right to recover a part of the losses suffered based on a later disposition of those assets? I would be interested in your thoughts, starting with David Cooke. Mr. COOKE. If you are providing assistance to a bank, then, yes, I think you should have some protection. If you are going to basically help them out with the assets and it turns out things turn out better, the Government should have something. That potential drain, though, it is going to discourage investors. If you want to bring new capital into the institution, depending on what you want. That doesn’t make sense if you ended up effectively paying too much for the asset, then, sure, it would make sense that the Government would share, would get something because the bank is better off than it would have been. But if it gets too much, the bank is back where it was. So it is a difficult thing to structure, but you probably can create some kind of reverse sale or something, as long as you have com- VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00113 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 108 rwilkins on PROD1PC63 with HEARING petition. And you can certainly price any asset. These are complex assets, but you can price them because underneath them somewhere there is an asset. There is a loan. There is a house. So you can do it. It is not going to be easy. So you can figure out a standardized approach to set your price, and then just get yourself some upside if you end up paying effectively too much. Mr. KATZ. Could I add here? In the private market, basically, you have an awful lot of debt-for-equity swaps. I don’t see why, if the Government wants to inject the money, it cannot do a similar thing. So there is an upside there. I look at the situation a little bit differently than Mr. Silvers. If you look at the figures, the banks, despite much more aggressive writing off of bad assets than in Japan, have an asset-to-liability ratio that is fairly high relative to current assets. It is just low relative to the future because they are going to have still more to write off. But I don’t see the problem in terms of the actual normal, plain vanilla lending. The problem is that the securitization market is so frozen that a bank which makes a car loan can’t then securitize it today, use the proceeds to make yet another loan, yet another loan. So even though the bank portfolio is going up, the actual net credit in the economy is going down. I think Bernanke’s measures of guaranteeing certain things, backstopping certain things is immensely helpful. Whether you use a good bank/bad bank technique or nationalization, you have to find some way to separate the good assets from the bad. I think pricing is difficult because in the shadow banking system, so much is obscure and unknown. It is not like pricing a loan for a house, where there is a relationship between the value of the instrument and the value of the underlying asset. The shadow banking system is so obscure, and that is why markets are frozen. That is what makes this difficult, in my view. The CHAIRMAN. Do you want to say something else? Mr. NEIMAN. No, go ahead. Mr. SILVERS. I read this part of your testimony, Mr. Katz, in relationship to this question. And it seems—and I was trying to reconcile your data with what we know about conditions in credit markets right now in the United States and what everyone tells us in field hearings and so forth. And I want to test something by you on this. If you look, we have four very large institutions now. Two of those institutions come back, have been coming back on a repeated basis to the Government for more capital. And it appears to me as though their capital ratios in some sort of real sense—although again there is a real question of what reality is here at all—are significantly lower than the averages you have, all right? You have a third, Wells Fargo, where I would say it is a little thin, although they haven’t come back for more money. These are sort of keystone institutions with a major presence in secondary markets, and it strikes me that that may explain this kind of paradox of the data you have versus people’s experience in the credit markets today. VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00114 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 109 rwilkins on PROD1PC63 with HEARING And it also, again, focuses the problem that we face on what to do about these very large institutions, not the banking sector as a whole. And I wondered if does that make sense to you, or do you have another explanation? Mr. KATZ. Well, you know what? It puzzles me also because of these things. Here is my sense of it. First of all, some of the capital the banks raised, was raised in the first three quarters of the year before TARP. But there was this huge jump in the fourth quarter, so part of what we are calling the capital is, in fact, the result of the injection that has already occurred. And there will need to be further injections. I said you have to look at the capital ratio not only to their existing assets, but since we don’t really know the value of those assets, they are going to lose more capital going forward, certainly in the next few quarters. So in relationship to that, they are going to need more capital. But the fact is they have been aggressive about writing down. The real problem here is that I think you have to distinguish the writedowns of actual loans on real homes, cars, whatever, and the default rate there versus this mark-to-market writedown on securities, some of which is justified and some of which is not. And just the level of uncertainty is causing derivative levels to be lower than perhaps they ought to be. And that is why I think you need to separate the shadow stuff and dubious assets as well as outright toxic assets from the good assets. You have to do some sort of separation. In all of the examples that worked, there was a separation. In terms of the experience of borrowers, it is the fact that the bank cannot use the same dollar four or five or six times by securitizing the loan. So that is how I reconcile the fact that the outstanding loans on the books of the banks are going up, but people are not getting the money because the asset-backed securities market is going down. Mr. SILVERS. Our metrics for understanding credit markets don’t take into account how important the shadow credit markets have become and are not capturing the reality of what constitutes bank activity in this area anymore. Mr. KATZ. Because laws were passed that prevented us from knowing that under the theory of deregulation. Mr. NEIMAN. Yes, and I have confirmed that through conversations with the Fed economists. And, it is very revealing because they, in looking back at past recessions over the last 30 years, where bank lending has declined over that period of recession. This is a period when you look at that bank lending and it has actually increased from the start. Mr. SILVERS. It is misleading. Mr. NEIMAN. But it goes to the exact point I think that Mr. Katz is making about being able to securitize those loans and not making up for the difference in the lack of a securitization market. Any other follow-ups on the pricing of toxic assets if we were to create a bad bank or in the Treasury’s implementation of its private-public fund? Mr. COOKE. I would just make the comment that I agree that what the Fed is doing now to try to restore some liquidity to the VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00115 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 110 rwilkins on PROD1PC63 with HEARING more easily quantifiable assets, the loans, makes a lot of sense. But I am pretty familiar with how securitization works and you can value those assets based on the underlying cash flows. It is not easy. You have got to get a lot of information you may not have access to. You need to get that information. But there is a way to approach it, and then to establish, if you are going to be on the buy mode, on the buy side, some value. But some of this, some of these derivatives and all are very, very complex. But they are solvable. Mr. KATZ. The Government may have to go in and create a market by buying some toxic assets. When somebody actually goes and create a market, that is a price. If it is the wrong price, the market will either push it up or push it down. But at least you started something as opposed to when there is no activity, then nobody else can make a decision. So make a market. And if you have made a mistake, it is a lot better than doing nothing and having the whole thing frozen. It will adjust. The government needs to create a debt-for-equity situation. So even if taxpayers lose on the downside, when the upside does occur, the taxpayer will get some of that back. And then you have created a market. You can begin unfreezing things. The CHAIRMAN. Let me ask on the question about markets because this is the one that puzzles me. So if the Government comes in, let us just say, hypothetically, and it buys at a highly inflated price because its ultimate goal is to make the banks look better, to make the financial institutions look better, how does that start a market? It says, hey, any time the Government will come in and pin $20 to it and sell it, someone will buy it. But why does that start a market by itself if you use a highly inflated price? How does it produce the next purchase once the Government is not in it? Mr. COOKE. No, I think if the Government pays too high, it is going to be stuck with the assets, unless it turns out to be right, sometimes, a miracle happens. If it pays too low, it will be a difficult problem for the Government. But it has to have a rational basis for establishing those prices. If it pays too low, it is going to bring down other banks. The CHAIRMAN. So your real point about it is not just that someone will come in and make a purchase, it is that someone will come in and make a purchase that at least starts close enough that you are talking about markets. You are not talking about subsidization—— Mr. KATZ. No, no, no. I am not talking about going crazy. The CHAIRMAN [continuing]. Through the back door? Mr. KATZ. I am saying do your best possible estimate. The CHAIRMAN. Fair enough. Mr. KATZ. In a market that is just so crazy, if you are 10 or 20 percent too high or 10 or 20 percent too low, that is something you can adjust to. If you are paying twice as much, well, then your markets can’t clear. The CHAIRMAN. But then what you are really saying is the only thing you can be driven by is trying to get an accurate market price because that is the only thing that runs at least the opportunity for starting a market, as you put it. VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00116 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 111 rwilkins on PROD1PC63 with HEARING Of course, go ahead. Mr. Silvers. Mr. SILVERS. Yes, I am struck in this conversation by what I think was a model more or less in common of the RTC and the Swedish experience, which was to—and you all tell me if I have this wrong—which was, in the case of the RTC, you simply took the assets in a receivership mode, and I think, Mr. Cooke, your testimony was that you sold low in many cases? Mr. COOKE. We had to start to gin the market up, get it motivated in some areas. Yes. Mr. SILVERS. Right, and then, effectively, the Government only insured depositors. Whatever the hit was as a result of that was eaten by bondholders, effectively. Is that right? Mr. COOKE. Right. But let me just qualify that. We ended up with very conservative valuation assumptions that we were pretty convinced, advised by the advisors, if we could show the cash flow and we use the market discount rate, we would be able to move these assets. We didn’t sell them lower than what we thought was a fair price, but at what we thought was a market based, more realistic price. So we weren’t trying to sell low. Mr. SILVERS. No, I understand that. Mr. COOKE. Market competition came in, and prices went up. Mr. SILVERS. Right, but the key feature of what you did was is that you looked, and the process of doing that, which obviously did create markets for real estate in some places. In the course of doing that, your basic receivership was structured so that the losses that were going to happen versus the books at these banks was in the first instance absorbed by bondholders, right? And in the second instance absorbed by the taxpayer? Mr. COOKE. Yes, anybody that had any claim against the receivership, they suffered the loss first. I mean, shareholders would take the first—— Mr. SILVERS. Shareholders took first. Bondholders took second. Mr. COOKE. Well, it depends. Bondholders may share—at that time, and I think it is still the case, pro rata with general creditors. We didn’t have a preference. Then later, somewhere in there, I forget when, they give a depositor preference. Congress passed that. Before then, we were just like any other general creditor. So if the bondholder lost, we lost. The Government lost. Its agency lost. Mr. SILVERS. So the depositors were made whole in a context in which the Government as deposit insurer was pari passu. It was on par with the bondholder in the losses. Is that right? Mr. COOKE. At that time, yes. Mr. SILVERS. Right. Now, in the Swedish case, you all, as you said, Mr. Lundgren, you marked down very aggressively the assets when you took control of banks. That is correct? Mr. LUNDGREN. Only a couple of banks marked down, and we tried to find a mark-to-market valuation with a valuation board with a lot of experts on. We did, I think, 30,000 valuations or something like that for different real estate. But aggressive or not, we tried to find the right at that time mark to market, but only for the assets in the banks that we took over. So we only formed bad banks for those. We didn’t have one bad bank and bought other assets as well because—and that is why VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00117 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 112 rwilkins on PROD1PC63 with HEARING we didn’t have a no valuation problem. If we were wrong, in a way, it was just in our own bank. And bad banks were formed also by the private banks that survived. They also did, and they formed their own bad banks. Mr. SILVERS. Let me just clarify also one thing while the chair is kind enough to give me the floor. Some people have asserted in U.S. debates that should the Government impose a receivership on one bank, it would have to do so on all, particularly in relationship to major institutions. That was not your experience, I gather? Mr. LUNDGREN. No, it was not. I mean, it depended on if the bank needed huge capital injections, which made government forced to take over the bank or get the majority anyhow. And that was only for these two banks. The others had a threat of having it coming into that situation, but they managed on their own. But what we are talking about here is, of course—I mean, we had, as the RTC, rather plain vanilla situation. Today, it is much more complicated, and I have all respect for that, and that is why I am thinking from my experience some kind of guarantee. Without buying assets, finding a situation where you really can’t find the right price, where you have a possible upside, you need to have it for the taxpayer. I mean, to use some kind of guarantees instead to restore confidence might be a possibility instead of a long, drawn-out process of trying to value unvaluable assets. Mr. KATZ. Could I make a comment from the Japanese experience? You know, if you had all these bad debts in Japanese banks, and again, there really is a difference between if it was an underlying asset, you would need to have a market-clearing price. But if there is no market, then there is no market-clearing price. Okay, so you had these assets the banks didn’t want to get rid of, couldn’t get rid of, whatever. And Lehman, of all people went out to the banks and started buying their bad loans. The banks couldn’t get rid of them because foreclosure laws in Japan are so cumbersome, they really couldn’t foreclose. And Lehman and others started buying them on, say, 20 cents, 30 cents to the dollar. And then they would sell the loans back to the borrower for 40 cents, 50 cents on the dollar. So the bank got rid of some stuff at a very low price. Lehman made oodles of money. And the borrower had their debt cut in half. Now which price was right? The 20 percent that Lehman paid or the 40 percent that the borrower paid back to Lehman? Well, the point is a market was created. And over time, things began to coalesce. Once you have a market, then you could have a market-clearing price. My concern is in this area of these derivatives where the market is frozen, and there is no market—and I think Ben Bernanke is doing a superb job at trying to unfreeze that. That is why I am saying if you have a rational estimate of the right neighborhood, then you go about doing things to de-stress asset markets, resell them to other people. Prices will begin to be created, and they will go up or down, and we will find a price. Mr. SILVERS. Can I just comment on this that it seems to me that it is not possible to have that sort of effect if your primary objective in setting the price that you sell assets or that you buy as- VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00118 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 113 rwilkins on PROD1PC63 with HEARING sets because I think that is what we are talking about—buying, not selling—what Mr. Cooke was doing. If the Government’s primary purpose in buying assets is to prop up stockholders in the banks, then the prices that the Government will put out there to buy will always be prices that are not—they don’t have any credibility in the marketplace because any price that comes anywhere near where shall we say self-protective actors in the market are willing to operate at will be one that will reveal the capital inadequacy of the banks. Mr. COOKE. Could I just make a comment on one thing? Just on one bank’s failure bringing down other banks. That may be a reference to the cross-guarantee provision. Are you familiar with that? Mr. SILVERS. No, it was a reference to the argument, Mr. Cooke, that—and I think Richard alluded to it a moment ago—that once you start, that in modern market conditions, once you start stepping forward and forcing dramatic dilution of equity holders, that you will set off some sort of dynamic of lack of confidence in the equity markets that otherwise healthy banks would have be taken over through a bear raid or panic of some sort in the equity markets. That was, I think, the position certainly held by Paulson’s team. Mr. COOKE. I don’t know. I don’t know if that would happen or not. As far as guarantees, one thing, some of the solutions the FDIC did when we were at the RTC, they found sometimes they would package up a failing bank. They would turn it over to another healthy bank, and they would have them isolate the bad assets, and they would get a stop-loss protection, but it wasn’t to the same owners and the same people. It was outside that. The CHAIRMAN. Thank you. Mr. Neiman, I want to make sure you complete your questions. I am afraid Mr. Silvers and I—— Mr. NEIMAN. No, this is a very good discussion. If I had a little time, I would go back to Mr. Lundgren and spend a little time on the disposition side. From what I read in your Swedish resolution process, there is an indication that had you had more time to sell those assets, you may have been able to increase your return. And, I know that there are issues around the RTC selling too quickly and the impact it has on the market. So I would be curious about the disposition period of assets. The CHAIRMAN. Please, go ahead, Mr. Lundgren. Mr. LUNDGREN. Thank you. The law in Sweden said that banks had to disperse of these kind of assets within 3 years. That was, of course, a short period of time. So we wanted to increase that time. They could hold somewhat longer. And when we formed these two bad banks for the two nationalized banks, my belief at that time was that we should give them about 10 to 15 years at least, but it was upon what they themselves experienced, that they found that after 5 years, in 1997, they could wind up the operations. They have been quite successful. You can always argue that they could have recovered even more if they stayed on for 5 more years. But I think myself that it was a good decision to wind up at that time. Altogether, as I said, with VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00119 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951 114 rwilkins on PROD1PC63 with HEARING the shares increasing in value and privatizations, we recovered most of the money anyhow. So you can always discuss the length of it. The CHAIRMAN. Good. I want to thank everyone. Thank you, Your Excellency, Ambassador Hafstrom, for being with us today. Director General Lundgren, we really appreciate your coming. And Mr. Katz, Mr. Cooke, Dr. White, this is what it should be about. I have to say I was very much struck by your comment before and that you alluded to in your testimony that as Sweden worked through its difficulties, that you had turned to the experiences of the RTC and our efforts during the Great Depression in part to help inform the next iteration of how to deal with these problems, and that makes me doubly grateful that you would travel to the United States and bring us your experiences that we might bring them together here. I want to say that this Panel reminds me of the importance of our having an overall strategy to deal with this problem. It is enormously valuable to hear from four different sets of experiences and to hear common themes that run through them, some of which we have already begun to heed, some of which we clearly have not. It is also very interesting to hear the much more shall I say muscular approach taken toward management and investors and on behalf of the taxpayers whose money is being used to try to rescue these organizations and to put the economy back on a sound footing. But ultimately, the idea of developing and executing a plan in order to be able to preserve the financial institutions and restart the economy is deeply underscored by the testimony of all four of you. I very much appreciate your taking the time to be with us today. The record will be held open if anyone wishes to add additional questions. I am sorry that our colleagues were not able to be with us. I know the press of other business has kept them elsewhere. We may have additional questions that we would like to send to you and ask for your remarks in writing so that they might be made part of the formal record. With that, this stands adjourned. Thank you. [Whereupon, at 11:40 a.m., the hearing was adjourned.] VerDate Nov 24 2008 22:38 May 07, 2009 Jkt 048951 PO 00000 Frm 00120 Fmt 6633 Sfmt 6602 E:\HR\OC\A951.XXX A951