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S. HRG. 112–3

AN OVERALL ASSESSMENT OF TARP AND
FINANCIAL STABILITY

HEARING
BEFORE THE

CONGRESSIONAL OVERSIGHT PANEL
ONE HUNDRED TWELFTH CONGRESS
FIRST SESSION

MARCH 4, 2011

Printed for the use of the Congressional Oversight Panel

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AN OVERALL ASSESSMENT OF TARP AND FINANCIAL STABILITY

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S. HRG. 112–3

AN OVERALL ASSESSMENT OF TARP AND
FINANCIAL STABILITY

HEARING
BEFORE THE

CONGRESSIONAL OVERSIGHT PANEL
ONE HUNDRED TWELFTH CONGRESS
FIRST SESSION

MARCH 4, 2011

Printed for the use of the Congressional Oversight Panel

(

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WASHINGTON

65–276

:

2011

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CONGRESSIONAL OVERSIGHT PANEL
PANEL MEMBERS
THE HONORABLE TED KAUFMAN, Chair
KENNETH TROSKE
J. MARK MCWATTERS
RICHARD H. NEIMAN

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DAMON SILVERS

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CONTENTS
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Opening Statement of Hon. Ted Kaufman, U.S. Senator from Delaware ...
Statement of J. Mark McWatters, Attorney and Certified Public Accountant ..................................................................................................................
Statement of Damon Silvers, Director of Policy and Special Counsel,
AFL–CIO .......................................................................................................
Statement of Kenneth Troske, William B. Sturgill Professor of Economics,
University of Kentucky .................................................................................
Statement of Richard Neiman, Superintendent of Banks, New York State
Banking Department ....................................................................................
Statement of Timothy Massad, Acting Assistant Secretary for Office of
Financial Stability, U.S. Department of the Treasury ..............................
Statement of Jason Cave, Deputy Director for Complex Financial Institutions Monitoring, Federal Deposit Insurance Corporation ........................
Statement of Patrick Lawler, Chief Economist and Head of the Office
of Policy Analysis and Research, Federal Housing Finance Agency ........
Statement of William R. Nelson, Deputy Director, Division of Monetary
Affairs, Federal Reserve System ..................................................................
Statement of Joseph E. Stigliz, Nobel Laureate and University Professor,
Columbia Business School, Graduate School of Arts and Sciences (Department of Economics) and the School of International and Public
Affairs ............................................................................................................
Statement of Allan H. Meltzer, Allan H. Meltzer University Professor
of Political Economy at Carnegie Mellon University .................................
Statement of Simon H. Johnson, Ronald A. Kurtz (1954) Professor of
Entrepreneurship, MIT Sloan School of Management and Senior Fellow, Peterson Institute for International Economics .................................
Statement of Luigi Zingales, Robert C. McCormack Professor of Entrepreneurship and Finance and the David G. Booth Faculty Fellow, University of Chicago Booth School of Business ....................................................

(III)

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AN OVERALL ASSESSMENT OF TARP AND
FINANCIAL STABILITY
FRIDAY, MARCH 4, 2011

U.S. CONGRESS,
CONGRESSIONAL OVERSIGHT PANEL,
Washington, DC.
The panel met, pursuant to notice, at 10:00 a.m., in room D–538,
Dirksen Senate Office Building, Senator Ted Kaufman, chairman of
the panel, presiding.
Present: Senator Ted Kaufman (presiding), Richard H. Neiman,
Damon Silvers, J. Mark McWatters, and Kenneth R. Troske.

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OPENING STATEMENT OF HON. TED KAUFMAN, U.S. SENATOR
FROM DELAWARE

The CHAIRMAN. Good morning. As you can tell, this is our last
hearing and we took the ceremonial picture.
Good morning, Mr. Secretary. We appreciate your willingness to
join the final hearing of the Troubled Asset Relief Program.
There’s no question our economy faces real challenges today, but
let’s take a moment at the start of today’s hearing to imagine that
those challenges could be far, far worse and were far, far worse.
Let’s imagine that the S&P 500, which is risen by nearly 20 percent in the last year, had instead fallen by 30 percent in the last
month. Let’s imagine that our economy, which has added over a
million jobs in the last year, had instead lost that many jobs in just
two months. Let’s imagine that America’s oldest and most highly
regarded financial institutions were beginning to topple literally
like dominos.
I think it’s fair to describe this scenario as dire, even apocalyptic.
And yet that is precisely the scenario that faced our economy in
late 2008 around the time Congress passed the TARP into law.
Today the panic of 2008 is a slowly fading memory and the TARP
played a role in turning the page on that grim chapter in American
history. It did not rescue our economy on its own, nor were all of
its programs successful, not by a long shot. Even so, I believe that
any hearing on the TARP should begin by recognize its greatest
success, that in a moment of financial panic, panic, it helped to pull
our markets back from the abyss.
Despite this accomplishment the TARP remains deeply despised
among the Americans public. Most of the anger is eminently understandable, as the program is viewed as having done far more for
Wall Street than for every day Americans. It is only fair to note
that some of the TARP’s unpopularity is due to misunderstandings
about its track record. Disraeli said, ‘‘There’s three kinds of lies,
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lies, damn lies and statistics’’ and polls are the third kind, statistics. But a recent Bloomberg poll I think hits the point in terms
of anecdotal evidence, is exactly what I’ve found. It revealed that
60 percent of the Americans believe that most of the TARP money
provided to banks will be lost and we will not get that back. Only
33 percent believe that most of the money will be recovered.
Many of TARP’s greatest skeptics, I am sure, recall the frightening price tag first associated with the program, $700 billion, the
amount the Treasury requested and Congress approved to bail out
the financial system. What they may not know today is that the
Congressional Budget Office estimates that the TARP will lose $25
billion. Let me clear, $25 billion is a vast sum of money, yet it is
far less than anyone expected the TARP to cost when it was created.
Yet the news, unfortunately, is not all good. Most starkly, the
TARP has fallen far short in its effort to help owner—homeowners
stay in their homes. The President first announced the goal of
leveraging the TARP to prevent 3 to 4 million foreclosures. Today
the panel estimates it will prevent fewer than 800,000. It is no
wonder then that many Americans view the TARP as a program
designed and executed for the benefit of Wall Street CEOs rather
than Main Street homeowners.
Further, it would be grossly mistaken to account for the TARP
solely by the number of taxpayer dollars lost. The program has a
far greater and more noxious cost. Moral hazard. That lingering belief that America’s biggest banks are Too Big to Fail and the rules
that apply to everyone else in America do not apply to them. This
belief continues to distort our financial markets, advantaging the
largest banks on Wall Street, while disadvantaging every other
bank in the country. The cost of moral hazard is not easily quantifiable, but is real and it’s reprehensible.
Today’s hearing will consist of three panels of distinguished witnesses. First we are joined by Acting Assistant Secretary Timothy
Massad who currently manages all the TARP programs for the Department of the Treasury. Mr. Secretary, Mr. Massad, I particularly hope that you will share with us your lessons learned from
more than two years at work on the TARP.
If you were creating the TARP today what would you have done
differently? That’s what we’re focusing on, what would we have
done differently. What can our nation learn from this ugly experience and how can we prevent it from ever happening again?
Our second panel includes witnesses from FDIC, the FHFA and
the Federal Reserve. These offices played critical roles in responding to the financial crisis, often acting in coordination with addition
to TARP programs. I hope these witnesses will help us place the
TARP in its proper context among the full range of crisis response
programs.
Finally, we’ll be joined by four of this country’s leading economists who will bring decades of experience and exceptional credentials to the task of scrutinizing TARP and its effects. I look forward
to hearing their expert views on the financial crisis and its enduring impact.

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All of our witnesses’ testimony will provide material and support
for the panels 30th and final Oversight Hearing Report which will
be issued to Congress and the public later this month.
Before we proceed I’d like to hear from my colleagues. Mr.
McWatters.

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STATEMENT OF J. MARK McWATTERS, ATTORNEY AND
CERTIFIED PUBLIC ACCOUNTANT

Mr. MCWATTERS. Thank you, Senator Kaufman.
And welcome to our distinguished witnesses.
Although the Congressional Budget Office has recently estimated
that the subsidy cost of the TARP downward to only, only $25 billion, such metrics should not serve as the sole determinant of the
success or failure of the program. We should remain mindful that
the TARP’s overall contribution to the rescue of the U.S. economy
was relatively modest, when considered along with the multi-hundred billion dollar bailout of Fannie Mae and Freddie Mac, the
multi-hundred trillion dollar intervention of the Federal Reserve
and FDIC as well as the incalculable efforts of private sector capital market participants.
It is particularly difficult to label the TARP, or any other government sponsored program aimed at securing financial stability, an
unqualified successful when the unemployment rate hovers around
9 percent, the combined unemployment and under-employment
rate equals 16 percent and millions of American families are struggling to escape foreclosure. It is of cold comfort to these families
that the two big to fail financial institutions, aided by the TARP
and other generous, below market rate, government sponsored programs are recording near record earnings. That is, to this day that
TARP carries a substantial stigma with the residents of Main
Street should come as little surprise.
Professor Troske and I noted in our additional views of the Panel’s 2010 Oversight Report that the repayment by the TARP recipients of advances received under the program is a misleading measure of the effectiveness of the TARP and therefore should serve—
should not serve as the standard by which the TARP is judged.
The unlimited bailout of Fannie Mae and Freddie Mac, by Treasury, in the purchase of $1.25 trillion of GSE, guaranteed mortgage
backed securities, in the secondary market by the Federal Reserve,
under its quantitative—first quantitative easing program no doubt
materially benefited the TARP recipients and other financial institutions. These institutions were not required, however, to share the
costs incurred in the bailout of the GSEs.
In effect, the bailout of Fannie Mae and Freddie Mac permitted
the TARP recipients to monetize their GSE guaranteed MBS at
prices above what they would have received without the GSE guarantees and use the proceeds to repay their obligations outstanding
under the TARP, thereby, arguably shifting a greater portion of the
TARP from the TARP recipients themselves to the taxpayers. Costs
such as this should be thoughtfully considered when evaluating the
TARP.
After reflecting upon the analysis conducted by the panel, its individual members and panel staff over the past two years, it is all
but clear that the success or failure of the TARP remains an open
question in that neither a favorable adjustment to the CBO subsidy
rate, nor the repayment of the TARP funds by some recipients tells
the entire story. It is critical to note that although the TARP
played a meaningful role in the rescue of the U.S. economy during
the closing days of 2008, its enduring legacy may have been to all

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but codify the implicit guarantee of the ‘‘Too Big to Fails’’ notwithstanding the profound moral hazard risks arising from such action.
The TARP, in essence, reinforced the bubble/bailout cycle as the
government’s preferred business model. Along these lines, the
panel offered the following observations in its June, 2010 report on
the AIG bailout. And I quote, ‘‘The government’s actions in rescuing AIG continue to have a poisonous effect on the marketplace.
By providing a complete rescue that called for no shared sacrifice
among AIG’s creditors, the Federal Reserve and Treasury fundamentally changed the relationship between the government and
the country’s most sophisticated financial players. The AIG rescue
demonstrated that Treasury and the Federal Reserve would commit taxpayers to pay any price and bear any burden to prevent the
collapse of America’s largest financial institutions and to ensure repayment to the creditors doing business with them. So long as this
remains the worst effects of AIG’s rescue on the marketplace will
linger.’’
Likewise, in its January, 2011 report on the rescue of General
Motors and Chrysler, the panel noted, and again I quote, ‘‘Treasury
is now on course to recover the majority of its automotive investments within the—within the next few years. But the impact of the
actions will reverberate for much longer. Treasury’s rescue suggested that any sufficiently large American corporation, even if not
a bank, may be considered Too Big to Fail creating a risk that
moral hazard will infect the economy far beyond the financial system. Further, the fact that the government helped absorb the consequences of GM’s and Chrysler’s failure, has put more competently managed institutions at a disadvantage. For these reasons, the effects of Treasury’s interventions will linger long after
the taxpayers have sold their last shares of stock of the automotive
industry.’’
In closing, it is important to consider the reasons underlying the
distinct unpopularity of and the stigma associated with the TARP,
that the TARP helped to rescue the United States economy from
financial collapse in the closing days of 2008 should not have
served as a basis for the public outrage and scorn that shadows the
program to this day. From my perspective the public rejected the
program because hundreds of often profligate and ill-managed financial and other institutions, and their shareholders and officers
receive taxpayer funded bailouts as well as other subsidies from
the Treasury, the Federal Reserve and the FDIC on remarkably favorable terms. Many senior officers of these institutions retained
their lucrative employment and although they generally suffered
meaningful dilution, the shareholders and those TARP recipients
were not wiped out.
The publicly—public intuitively recognized that such policies
were an anathema in a market economy when entrepreneurs and
passive investors alike, retained their business investment profits
without question, but are accordingly expected to bear their full
losses with transparency and accountability and without subsidy.
Main Street quickly realized that the TARP was heavily tilted in
favor of Wall Street, while Main Street was stuck with dramatic
rates of unemployment, neighborhoods decimated by foreclosure,

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banks that refused to lend and the general sense that the residents
were left on their own.
Thank you. And I look forward to our discussion.
The CHAIRMAN. Mr. Silvers.

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STATEMENT OF DAMON SILVERS, DIRECTOR OF POLICY AND
SPECIAL COUNSEL, AFL–CIO

Mr. SILVERS. Thank you, Mr. Chairman.
Good morning. This is the last hearing of the Congressional
Oversight Panel. I would like to begin by expressing my gratitude
to Senate Majority Leader Harry Reid and to House Minority Leader Nancy Pelosi for giving me this opportunity to serve my country.
I would also like to express my profound gratitude to our chair
and his predecessor, my dear friend, Elizabeth Warren, for their
leadership of our panel.
And also our—my gratitude to our staff, in particular our staff
director, Naomi Baum, for all they have done over the last two and
a half years to make our panel a success.
Finally, I would like to thank my fellow panel members, Richard
Neiman, Mark McWatters and Ken Troske. We have worked together as a team in a manner that is tragically rare in our national
politics today and I’m honored to have been a part of that.
Now today we hear from Acting Assistant Secretary Timothy
Massad, from representatives of the key independent agencies that
work together with Treasury on restoring financial stability and
from some of the world’s leading economists and experts on financial crises. While I’m grateful to all of our witnesses for joining us
today, I want to note that we have, in many ways over the past
two and a half years, benefited from the advice and assistance of
Secretary Massad, of Professor Stiglitz and Professor Johnson. And
it is fitting that they should be with us today.
Before I conclude my opening remarks, I think it’s appropriate
for me to be clear what my final conclusions are about the TARP
program. One, I believe TARP, through the initial investments in
the large banks and in securitization markets primarily, was a substantial contributor to halting a global financial panic. It is, frankly, irresponsible, to suggest our nation would have been better off
had we taken no action.
Two, I believe, and there is overwhelming evidence to support my
position in our February, 2009 report, that at the time these initial
TARP investments were made, the public did not receive anything
like full value for our money. However, over time the management
of these assets and the execution of further transactions, by the
team at Treasury managing TARP, became systematically fairer to
the taxpayer. And the team at Treasury, Secretary Massad, his
predecessor, deserve a great deal of credit for that.
Three, the Paulson Treasury Department was not truthful with
the public when it said that the Capital Purchase Program funds
were only going to healthy institutions. And the Geithner Treasury
Department has compounded this lack of candor by refusing to
admit, in testimony before this panel, that Citigroup and Bank of
America were on the verge of collapse when they received additional TARP funds in November, 2008 and January, 2009, respectively.
Four, the failure to replace bank management, to do a rigorous
evaluation of the state of bank assets and to restructure bank balance sheets accordingly has left the United States with weak major
banks and a damaged sense of trust between the American public
and our nation’s elected leaders.

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Five, although more than half a million families have been
helped by tarps foreclosure prevention programs, foreclosure prevention has been subordinated to the needs of the banks. The truth
is that continued mass foreclosures of homeowners are a powerful
source of systemic risk and downward pressure on our economy
and on jobs.
In December, 2008 this panel held its first hearing in Clark
County, Nevada. We did so to make the point that the American
people would judge TARP based not on the wealth of bankers but
on the health of our communities. In December of 2008 unemployment in Southern Nevada was 9.1 percent. Today it is 14.9 percent.
In December, 2008, 6.58 percent of all home mortgages in Nevada
were delinquent. Today 10.06 percent are.
The most recent statement of the Federal Reserve’s Open Market
Committee states that quote, ‘‘The economic recovery is continuing,
though at a rate that has been insufficient to bring about a significant improvement in labor market conditions. Growth in household
spending picked up late last year but remains constrained by high
unemployment, modest income growth, lower housing wealth and
tight credit.’’ That is precisely the scenario that the majority of this
panel warned in our April, 2009 report, would be the likely consequence of failing to restructure the major banks.
Although this panel is going out of business, the task of managing TARP’s remaining programs, of regulating the banks, of overseeing systemic risk goes on. The mass foreclosures tragically continue, but it is never to late to act to make change.
Thank you.
The CHAIRMAN. Dr. Troske.

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STATEMENT OF KENNETH TROSKE, WILLIAM B. STURGILL
PROFESSOR OF ECONOMICS, UNIVERSITY OF KENTUCKY

Dr. TROSKE. Thank you, Senator Kaufman.
I would like to start by thanking the witnesses for appearing before the panel today. I recognize that all of you are very busy people with a number of other responsibilities, so I appreciate you taking time to come here and help us with our oversight responsibilities.
Given the focus of this, our last Oversight Panel Hearing, it
seems appropriate to comment on the overall impact of TARP and
the financial rescue efforts in general. I was recently asked by a
reporter whether my assessment of TARP would be different if
TARP had ended up costing $356 billion, as was originally estimated, instead of the current estimate of $25 billion, one of the
more creative questions I’ve gotten from a reporter. I answered
that any complete assessment of the success of TARP needed to
take into account a number of factors, such as the role TARP
played in preventing a financial collapse, the risk taxpayers were
exposed to at the time TARP was enacted, the long run impact
TARP had—has—will have on the market and TARP’s effect on the
likelihood of future financial crises.
So while the actual cost of TARP is an important component, it
is only one factor affecting ones evaluation of the success or failure
of TARP. So my answer to the reporter was, ‘‘Yes, I could still view
TARP as a success even if the program had cost taxpayers $356 billion.’’
Throughout the financial crisis the government’s actions were
circumscribed by the expectations of the market that in the event
of a financial crisis the government would bail out firms whose
bankruptcy threatened to increase systemic risk. These expectations, of course, were based on past government bailouts of large
financial firms. In fact, as I have argued previously, these expectations affected the severity of the financial crisis, since the market
responded to these expectations by encouraging firms to grow until
they became Too Big to Fail, thereby increasing the number and
size of systemically risky firms in the economy and in turn increasing the amount of money needed to stem the financial crisis. Also,
once they’d attained Too Big to Fail status, the bailout guarantee
provided these firms gave them the incentive to increase their risky
behavior, thus increasing the likelihood of a financial crisis.
Ultimately, in my mind, the success or failure of TARP in particular and the overall financial rescue in general will hinge on
whether we are able to eliminate the problem that caused the crisis, Too Big to Fail firms. Unfortunately, at least so far, it does not
appear that we have taken the necessary steps to end Too Big to
Fail.
In my opinion, the first step in fixing the problem of Too Big to
Fail firms is defining exactly what we mean by ‘‘systemically important firms’’ or ‘‘systemically important risks.’’ That way the market has a clear understanding of which firms will receive support
in the next financial crisis and which will not.
Then the government needs to start charging market based fees
to these firms for insurance provided to them, through substantially higher reserve requirements, which has been advocated by

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Professor Meltzer among others, by requiring firms to hold additional alternative reserves against their systemically risky holdings, as has been proposed by Professor Zingales, by charging firms
by the bailout insurance along the lines proposed by the president
of the Federal Reserve Bank of Minneapolis, or through some alternative mechanism which forces these firms to pay the cost of the
insurance that is currently being paid for by the American taxpayers.
Only by ending the taxpayer funded survival guarantee for large
firms, both domestic and foreign, will we return basic market discipline to Wall Street and ensure that large financial firms face the
same competitive pressures faced by firms operating on Main
Street. In turn, this will ensure that future financial crises will be
much less severe and the fixes to these crises will not involve putting trillions of taxpayer dollars at risk.
Since this is our last hearing, there are some people I would like
to note and thank for their work with the panel. First I would like
to thank the panel staff and especially our executive director,
Naomi Baum, for their work. Looking over the totality of the panel’s reports, one realizes this work will become one of the definitive
sources of information about the financial crisis and this is largely
due to the hard work, patience and dedication of our staff.
I would also like to thank my fellow panel member, Mark
McWatters for help—for the help he has provided me in becoming
familiar what the issues facing the panel. Mark was always available when I needed someone to bounce ideas off of, which helped
me develop and formulate my ideas about TARP.
I would like to thank Senator Kaufman for the leadership he has
provided over the last several months. Senator Kaufman’s guidance
was important in helping the panel continue to build on the bipartisan spirit of cooperation we first developed under the leadership
of former chair, Elizabeth Warren.
Finally, I would like to offer a special thanks to the longest serving panel members, Richard Neiman and Damon Silvers. Richard
has been part of 30 reports issued by the panel, while Damon has
participated in 27. As someone who is exhausted after having participated in a mere 10, I can honestly say I don’t know how they’ve
done it reading over and offering comments on three drafts of each
one of these reports. Based on my observations, both Richard and
Damon have performed these tasks while recognizing the important responsibility they had to represent and protect the interests
of the American taxpayers. So as one of these taxpayers, I would
like to say thank you.
And the—and I would also like, in conclusion, to thank the witnesses once again for joining us and helping us with our discussion
today.
The CHAIRMAN. Thank you.
Superintendent Neiman.

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STATEMENT OF RICHARD NEIMAN, SUPERINTENDENT OF
BANKS, NEW YORK STATE BANKING DEPARTMENT

Mr. NEIMAN. Thank you.
When the financial crisis hit in the fall of 2008, we had a Republican President and a Democratic Congress. This panel was created
by that Congress to help hold the administration accountable in
implementing the TARP program. There was no shortage of ideological objections from the Left and the Right when TARP was
passed and there are no fewer today. But the American public’s
concern, it seems to me, has been far less ideological or partisan.
Rather, they have retained the pragmatic focus asking the question, ‘‘Is the investment of our money serving the public well?’’
It would have been difficult for this panel to assist with answering that question if we ourselves got distracted from it. Congress
wisely placed both Democrats and Republicans on this panel to
force us to be as pragmatic as the people we were appointed to
serve. And our efforts toward that goal, over two years as the nation gained a new Democratic President and then gained a new Republican House of Representatives, remain the same.
Our five different perspectives and backgrounds could have led
to more disagreement than agreement and ultimately a failure to
shed light and create accountability regarding the most complex financial issues of the day. But one of the things that I will personally take away from this experience of the last two years is a renewed optimism that people can still work together for the public
good during increasingly partisan times.
Even in the beginning, when ideology was at its height, prior
panel members, Chair Warren, Congressman Hensarling and Senator Sununu who all had something important but different to contribute, found ways to come together. Elizabeth Warren deserves
great credit for her leadership in the early days of this panel.
We have not been perfect however, and our oversight was always
finite. So if someone asked me, ‘‘What is the single most important
public service we were able to provide,’’ I believe the answer could
really only be one, I believe we helped empower the American public to fulfill their critical role as the true watchdogs of government.
That’s why we consistently called for more public data and more
transparency. We demanded more information on TARP expenditures, HAMP mortgage modifications, non-HAMP mortgage modifications, bank health in lending and other TARP related areas.
Our goal was to attain information on a systematic basis communicated as clearly as possible.
With this, people can assess what is happening today and others
in the future can, with the benefit of time, truly assess what happened back in the first global financial crisis of the 21st century.
So our monthly reports and hearings come to a close this month,
but the end of TARP oversight does not. I would humbly encourage
our skillful fellow oversight body, SIGTARP and the GAO and the
many reporters and bloggers who so often got the facts right, to
continue to focus on ways to empower the public with clear information that provides opportunity to understand and have an impact.
The fact is that free markets work, but the other fact is, they
don’t work as well as we would always like. The reason for this ap-

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parent inconsistency is often the lack of broadly available information that allows market participants and consumers to create fully
functioning markets. We need continued light shedding oversight
and reforms to make free markets work, it’s simply good for the
housing market, the financial market and the greater economy.
I’d like to conclude by thanking today’s witnesses for their past
and current support of our work and by thanking all our earlier
witnesses. I feel particularly compelled to express great gratitude
to my colleagues, Ken, Mark, Chairman Kaufman and Vice-Chair
Silvers for solidifying a belief that people with different philosophies can still work together for greater good in Washington, D.C.
Thank you. I look forward to our questions.

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The CHAIRMAN. Thank you. I’m pleased to welcome Timothy
Massad, the acting assistant secretary of the Office of Financial
Stability and thank him for joining us. He was here at the beginning. It’s like bookends, it must be interesting to be at the beginning and the end.
We ask that you keep your oral testimony to five minutes, that
we will have adequate time for questions. Your complete written
statement will be printed in the official record of the hearing.
Please proceed with your testimony.

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STATEMENT OF TIMOTHY MASSAD, ACTING ASSISTANT SECRETARY FOR OFFICE OF FINANCIAL STABILITY, U.S. DEPARTMENT OF THE TREASURY

Mr. MASSAD. Thank you, Mr. Chairman.
Chairman Kaufman, Members McWatters, Neiman, Silvers and
Troske, thank you for the opportunity to testify today about the
continued progress of the Troubled Asset Relief Program.
As this is your last hearing, I want to begin by thanking you and
your staff for your hard work in overseeing TARP. Your reports
have provided useful insights and your suggestions and questions
have helped us refine and strengthen our programs. TARP is a success story today, and it was made possible by the tireless efforts
of countless people, not only at Treasury, but also at COP and the
other oversight bodies.
And as you noted, there is some irony or symmetry to this moment. I appear before you today as the Acting Assistant Secretary
for Financial Stability, but I began my work on TARP with you in
December, 2008, when I volunteered as your special legal advisory,
to help prepare the first of your nearly 30 reports. It has been an
interesting journey for all of us and I’m—think we can fairly conclude that the journey, the program, was successful by any objective measure.
First, TARP helped prevent a catastrophic collapse of our financial system and economy. In the fall of 2008 we were staring into
the abyss, now we are on the road to recovery. TARP was not a
solution to all of our economic problems, and there is still more
work ahead. Unemployment remains unacceptably high and the
housing market remains weak, but the worst of the storm has
passed.
Second, we accomplished all this using much less money than
Congress originally provided and we are unwinding TARP faster
than anyone thought possible. Congress authorized 700 billion, but
we will spend no more than 475 billion and we have already recouped two-thirds of what we have spent.
Third, the ultimate cost of TARP will be far less than anyone expected. The total cost was initially projected to be approximately
341 billion. According to the latest estimates, both from Treasury
and the Congressional Budget Office, the overall cost of TARP will
be between 25 and 50 billion and most of that will represent the
money we spend to help responsible American families keep their
homes.
Finally, our financial system is in far better shape today than before the crisis. It is stronger and on a path to recovery and Congress has adopted the most sweeping overhaul of our regulatory

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29
structure in generations, which will give us tools we did not have
in the fall of 2008. This work is not yet complete, but we have
made great progress since this panel held its first hearing.
TARP was a bipartisan success. The Bush Administration acted
quickly and decisively to stop the panic and when this Administration took office we adopted a broad strategy to restore economic
growth, free up credit and return private capital to the financial
system. Today people no longer fear that our financial system is
going to fail. Banks are much better capitalized and the weakest
parts of our financial system no longer exist. The credit markets,
on which small businesses and consumers depend, have reopened.
Businesses are able to raise capital and mortgage rates are at historic lows.
We have moved quickly to reduce the dependence of the financial
system on emergency support. We have already recovered almost
all of the funds invested in the banking system. And w this Administration provided funds to particular companies, we did so with
tough conditions. Those companies are stronger today and have already—and we have already begun to recoup those investments.
For example, the assistance we provided to AIG, one of the government’s most controversial actions, was necessary because the
failure of AIG, at that time, in those circumstances, would have
been catastrophic to our financial system and our economy. Now
barely two years later the company has been restructured and the
taxpayers are in a position, potentially, to recover every dollar invested, an outcome that many thought impossible back then.
Similarly, we’ve provided assistance to General Motors and
Chrysler on the condition that they fundamentally restructure
their businesses. Our actions helped prevent the loss of as many
as one million jobs and have helped restore the companies and the
industry to profitability. And we have completed a highly successful initial public offering of GM and we are working to exit our investments in Chrysler and Ally as well.
Finally, I want to address our efforts to help responsibility but
struggling American homeowners. By reducing mortgage rates and
providing sensible incentives to prevent avoidable foreclosures, our
policies have helped hundreds of thousands of families stay in their
homes and have helped to change the mortgage servicing industry
generally. We have not helped as many homeowners as we originally estimated, and much work remains to be done. But we remain committed to do so, to helping as many eligible homeowners
as possible in a manner that safeguards taxpayer resources and we
hope the panel will continue to support these efforts.
Mr. Chairman and panel members, TARP succeeded in what it
was designed to do. It brought stability to the financial system and
it laid the foundation for economic recovery. Our comprehensive
strategy and decisive action made our economy far stronger today
than it was two years ago. We are proud of our actions and we appreciate all the help you’ve provided along the way.
Thank you again for the opportunity to testimony and I welcome
your questions.
[The prepared statement of Mr. Massad follows:]

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The CHAIRMAN. Thank you, Mr. Secretary. There’s a lot of different reasons for this hearing and the last hearing and this report
we’re going to come out. And we’re going to go back in history and
what happened and the rest of it. What I’d like to focus today in
my questions, as I said in my opening statement, is kind of what
have we learned. What are the lessons learned? What—kind of—
you know, we get in this kind of situation again, coming back, what
did we learn?
Now this is difficult to do because when TARP was originally set
up, as I said in my opening statement, you—everybody at Treasury, everybody at the Fed was under incredible pressure. I mean
the place was going down and going down fast. A lot of decisions
were made. And I’m—this is not—I’m not here to be a Monday
morning quarterback and go back and look at those decisions, although I’m sure other panel members will ask that and it will be
in our report.
But in term of lessons learned, going forward, if in fact you were
summing up, we made some mistakes and things didn’t turn out
the way we wanted to, in the area of moral hazard, which everyone, I think, has referred to, what do you think? What does Treasury believe could have been done, would have been done or you
would do differently if, in fact, you were faced with this problem
again, to mitigate the moral hazard?
Mr. MASSAD. Mr. Chairman, that’s a very good question and
something we’ve thought a lot about. I think the main lesson we
learned is that we did not have the tools to deal with this crisis,
at the time. And that is what, unfortunately, necessitated this program, which no one really wanted to have to do but we had to do
it. We have now passed Dodd-Frank, the most comprehensive overhaul of our regulatory system, which I think gives us a variety of
tools that should enable us to minimize and prevent these sorts of
conditions again.
Now, much work remains to implement that. But to me that is
the principal lesson that we learned and that is the principal way
we are trying to address the moral hazard issue, which many of
you have, so rightly, noted.
The CHAIRMAN. I mean just for the record, specifically what in
Dodd-Frank do you think would reduce moral hazard?
Mr. MASSAD. Well, I think the fact today that we have resolution
authority, with respect to non-bank institutions, the fact that we
have a manner for regulating systematic risk, the fact that we have
the Office of Financial Research, Financial Stability Oversight
Council, we have higher capital standards. All of those measures,
I think, enable us to say that we now have the tools to try and prevent and minimize the effects of crises like this in the future. And
therefore, render the sort of assistance we had to provide under
TARP unnecessary.
The CHAIRMAN. How about the method of the assistance?
Mr. MASSAD. I’m sorry?
The CHAIRMAN. How about the method of the assistance, how
would that have changed with Dodd-Frank? How would you—
would you have done it differently?
Mr. MASSAD. Well, I think Dodd-Frank, for example, gives you
the tools to dismember a non-bank financial firm. We didn’t have

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that, that was one of the problems with the situation we confronted
with AIG. So I think now we have that authority.
The CHAIRMAN. And do you have any idea why most people believe, and you listen to economists talk about it of all parts and
spectrum believe that we still have banks that are Too Big to Fail,
that our major financial institutions that are Too Big to Fail?
Mr. MASSAD. I think obviously the moral hazard issue is a very
serious one and it’s one we have to continue to look at and address.
I think though, the focus should be now on implementing DoddFrank.
The CHAIRMAN. No, I got that. I’m just—and I understand that,
but I’m just trying to figure out what you learned, that specifically
you would do. And you’re saying essentially you have implemented—you have, in Dodd-Frank, all the things that Treasury
would like to have had that could have helped them resolve this
and eliminate——
Mr. MASSAD. I don’t know.
The CHAIRMAN [continuing]. Eliminate moral hazard or mitigate
moral hazard.
Mr. MASSAD. Mr. Chairman, I guess I would say we have all the
tools Congress decided to give us.
The CHAIRMAN. Yeah. Well that’s—this is your chance to tell—
to say—this is your chance to lay out everything that wasn’t included in that bill that you would have liked to have had, if in fact
we were moving forward with this.
Mr. MASSAD. Well, I don’t know that I want to re-litigate the battle over Dodd-Frank. I think the main thing is that we did achieve,
in a very short time, a dramatic overhaul and I think our focus
should be on implementing that. Now, we may, at a future date,
look at was that enough, do we need to do more. I think those are
very good questions and we’ll continue to address those.
The CHAIRMAN. How about—you know, one of the—and again, I
think most of the panelists mentioned this, there is a widespread
perception, not perception, I think it’s personally a reality, that
Main Street did a lot worse than Wall Street on this. Are there
some things that TARP, that Treasury could have done in the beginning of this program to kind of—more better balance between
what was going to Main Street, the benefits would accrue to Main
Street as opposed to Wall Street?
Mr. MASSAD. I guess I would say this, Mr. Chairman. I think the
main benefit to Main Street of this program was that we did stop
the panic. And again, when I say ‘‘this program’’ I should say in
conjunction with all the other actions that were taken, because it
wasn’t just TARP, but we did stop the panic and we did prevent
a second Great Depression, which could have resulted, as many
economists have estimated, of rates of unemployment of 16 percent,
20 percent possibly even higher. It also allowed us to start to get
credit flowing again. Those are the main benefits to Main Street.
Now obviously particular programs also had direct benefits.
Under the Capital Purchase Program we invested in 400 to 500
very small banks, banks that small businesses and communities
depend on.
I agree with you that the perception was that this program provided support to Wall Street and many people didn’t think it did

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much for them. I understand that. This is still a very tough economy and people that are unemployed or in danger of losing their
homes feel that way. We understand that and that’s why I say
there’s still a lot of work to be done.
The CHAIRMAN. I’ll revisit this, but it’s not a tough economy on
Wall Street. It’s a tough economy everywhere else, but it’s not a
tough economy on Wall Street.
Mr. McWatters.
Mr. MCWATTERS. Thank you, Senator. And welcome again, Mr.
Massad.
Following up on Dodd-Frank, if I may quote and I hope I’m not
quoting out of context, which is always a risk here, Professor
Stiglitz’s testimony. He says, ‘‘Resolution authority has made little
difference because few believe that the government will ever use
the authority at its disposal with these Too Big to Fail banks.’’
So we have Dodd-Frank, we have a blueprint to take down not
only financial institutions, which we had the authority under FDIC
to do before, but now AIG and others. Will there be the courage in
a time of panic to actually do this, to actually take them down, as
opposed to just simply writing a check with another bailout?
Mr. MASSAD. Mr. McWatters, I would certainly hope so. And I believe now that these tools are very good ones. But obviously it remains to execute on this, it remains to promulgate the regulations
necessary and to act. And it will require regulation that is nimble.
It will require regulation that is responsive to changes in the industry as we go forward. But I think we’ve come a long way and
I think we should give these tools a chance to work before we
judge.
Mr. MCWATTERS. And I know in one of the footnotes to my opening statement I make the observation that there was not the courage to take down some of the most insolvent financial institutions
in early to mid 2009. I don’t mean the last quarter of 2008 when
the markets were frozen, okay, that might unto itself have sent a
different message. But once the markets had stabilized in the last
quarter of 2008, begun to stabilize more in 2009 and certain institutions came back and said, ‘‘You know, oh by the way, we’re still
insolvent, we’re still insolvent by the tune of many billions of dollars,’’ at that point there were rules on the books of the FDIC to
take down these institutions and they were not.
So it really makes me question that now you have new rules for
new institutions, when it comes right down to it will this happen
or will simply more checks be written and as more questions are
written, more moral hazard will be created. Any thoughts on that?
Mr. MASSAD. Certainly. You refer to events in 2009, the Obama
Administration did not provide a single dollar to a large bank.
Most of the money provided to the banks was provided under the
Bush Administration, decisions with which I agree. I think they
made the right decisions under the circumstances, though I was
not involved in those. The Obama Administration provided $11 billion in additional funds to banks, most of that went to small banks.
Where we provided assistance to additional firms, we did so with
tough conditions. I think if you look at what we did with the auto
industry, we imposed some very tough conditions that required
them to restructure. Those companies—GM is now profitable, post-

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ed the first full year profit since 2004. Chrysler has an operating
profit.
So I don’t think there was a lack of courage. I think we acted
very forcefully and decisively.
Mr. MCWATTERS. Yeah, but there were other actions going on
underneath the surface, underneath TARP, which admittedly
TARP was grabbing most of the headlines, that the FDIC was taking certain actions, the Federal Reserve was taking certain actions.
Quantitative easing, one where the Federal Reserve purchased a
trillion plus dollars of mortgage-backed securities, governmentbacked, mortgage-backed securities which would not have been
purchased at a fair market value if Fannie and Freddie had been
permitted to fail. So the bailout of Fannie and Freddie seems to me
to have a direct correlation to the health of financial institutions
and their ability to pay back the funds. So I mean there were a
number of things going on here.
Mr. MASSAD. Be happy to respond to that. You’ve raised a number of interesting points. First of all, I agree with you and with
your opening comment that one must look at the cost of this, in
terms of all the government programs, not simply TARP. But when
you do that, the overall cost currently estimated is at about one
percent of GDP, which is far less than the cost, for example, to resolve the S&L crisis.
Secondly, you mentioned pricing of credit. In a crisis the government is acting because private capital isn’t flowing. So we are pricing that under what the market would otherwise charge, because
the market isn’t stepping up. The trick is to still price it properly
so that we don’t encourage excessive reliance on it, number one,
and to impose conditions so that we don’t create a bigger moral
hazard problem than is necessary. I agree that any government assistance comes with a moral hazard problem. But I think we did
that and I think, again particularly when the Obama Administration launched the stress tests and provided the Capital Assistance
Program, we said that is going to come with very tough conditions.
No one took the money.
Mr. MCWATTERS. My time is about up, but I’ll just leave it by
saying that I think that there were some private market participants. Mr. Buffett and another—among others who, you know, cut
better deals. So.
The CHAIRMAN. Thank you.
Mr. Silvers.
Mr. SILVERS. Mr. Secretary, first before I ask you any questions
I wanted to just expand a moment on my opening remarks in respect to your work and the work of your predecessor.
I think it’s no secret that I have been critical of the economics
of TARP transactions, but I want to, on the record, commend you
and your predecessor for the work you’ve done since the spring of
2009 in managing—in a.) in managing TARP’s—the TARP assets
that you, so to speak, inherited and in the execution of the transactions that occurred since you and your predecessor came to work
managing the TARP. I think particularly of the improvement in the
economics from the public’s perspective of the warrant repurchases
and the way in which both Citi and AIG’s investments have been
managed, as purely as investment assets. So I want to make clear

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that I think you all have done a fine job in that respect and the
overall cost numbers that you’ve been citing are substantially driven by that achievement.
Now I want to turn to I think the exchange you just had with
my colleague, Mr. McWatters, because I think that it’s important
in this final hearing to maybe shine a light on a couple of key moments in the history of the TARP. Do you agree that when the
Obama Admin—I take your point and I’ve noted it for a long time,
that under the Obama Administration there was not significant additional capital infused into large banks. Do you agree though, that
there was a set of decisions made by the Obama Administration
about what to do about the large banks and the government’s investments in TARP in the early months of the Obama Administration?
Mr. MASSAD. There were decisions made by Treasury and by the
regulators. But as you note, with respect to the Obama Administration and Treasury in particular, under TARP, we inherited those
investments and our focus was on managing those investments and
exiting them. The regulators really had the primary responsibility
to look at the health of those institutions and——
Mr. SILVERS. Mr. Secretary, that’s not exactly what I was asking
you.
Mr. MASSAD. Okay.
Mr. SILVERS. The Treasury Department released a plan in the
early spring of 2009, which included the stress tests, the stress
tests were the centerpiece of that plan.
Mr. MASSAD. Yes.
Mr. SILVERS. All right. The regulators executed that plan in substantial part, but it was an Administration and Treasury Department plan.
Mr. MASSAD. Absolutely.
Mr. SILVERS. Is that correct?
Mr. MASSAD. Yes, that’s correct.
Mr. SILVERS. Now, that plan appears to me to represent a key
strategic decision moment, right, for the Administration. Can you
explain a little bit about—can you amplify that a little bit if you
agree that that’s true, about what those strategic decisions were
that were made at that moment——
Mr. MASSAD. Certainly.
Mr. SILVERS [continuing]. By the current president’s administration?
Mr. MASSAD. Certainly. It’s a very good question. A central component of the financial stability plan was to recapitalize the financial system with private capital as efficiently as possible. And to do
that we worked with the regulators to formulate the stress test for
the largest 19 bank holding companies. And those tests were done
with extraordinary and unprecedented transparency, because without those tests the market was not willing to reinvest in these institutions.
I think the record of those stress tests and what followed is evidence of the success. Banks were able to raise a large amount of
private capital following the results of those tests. So I think it was
a very good strategy and executed successfully.

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Mr. SILVERS. I would just observe that I think the nub of Mr.
McWatters’ dispute with you and perhaps another my—of my evaluation of TARP has to do with that moment and that set of decisions, in respect to the question of restructuring banks and the
like. I don’t want to spend what time we have arguing about that,
but I want to make clear on the record that that, I think, is the
key question.
Can I just ask you, before my time has expired, what are your,
going forward as this panel goes out of business, what are your
greatest concerns? What worries you, both about TARP and about
the issues TARP was designed to address, financial systemic stability?
Mr. MASSAD. I’m very focused on our housing programs. We have
not helped as many people as we would like. But I think the programs are very important and continuing to help tens of thousands,
and I’m very concerned about efforts to eliminate those. I think
without those programs many, many Americans who otherwise
could be helped into an affordable mortgage will not have that opportunity to do so.
Secondly, I’m very focused on managing and exiting our remaining investments as quickly as we can. I think it’s very important
to get the government out of the business of owning stakes in private companies. I think we’ve got a very good record there, we’ve
made a lot of progress, but we still have more work to do. And in
particular, with respect to our smaller banks, their path to recovery
has been a little harder and we need to continue to work with them
on that.
Mr. SILVERS. All right. Thank you. My time has expired.
The CHAIRMAN. Dr. Troske.
Dr. TROSKE. Thank you. I better turn on my mic. Thank you.
I want to come back to one—hopefully come back to some of Damon’s and Mark’s questions about stress tests, but I wanted to
start by talking more about TARP mandate.
As you know, in addition to the core goal of restoring stability
and liquidity to the financial system, the legislation directed Treasury to consider such goals as maximize overall returns and minimize the impact of the national debt, protect American jobs, savings and retirement security, help families keep their homes, stabilize communities, and on and on.
Do you think that TARP, the mission of TARP was too broad?
And do you think that this broad mandate clearly, I think a number of people have indicated, in terms of stemming the financial
crisis, many people would agree that it would be a success. We are
going to hear from some economists later. It’s these other things
that seem to be where the economy is still struggling. And by trying to throw all of that into a single piece of legislation, do you
think that in some sense that doomed TARP to get the stigma that
it has today?
Mr. MASSAD. That’s a very good question, Mr. Troske. We interpreted the considerations that you’ve referred to as things that we
should take into account in how we went about executing the authorities we were given. The authorities we were given were narrower than that. The authorities we were given were to purchase
troubled assets from financial institutions. We weren’t given $700

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billion and told—reduce the unemployment rate in any way you see
fit. We were given a specific mandate to promote the stability and
liquidity of the financial system. We were given the authority to do
that through the purchase of troubled assets. And in doing so we
were supposed to take those other considerations into account.
I agree with you though, that because of the breadth of those,
many people did feel it was up to TARP to resolve all of these economic problems, very important economic problems that we need to
resolve. But I don’t think it was the job of TARP to do that alone.
Dr. TROSKE. And I guess, I mean do you think Treasury has done
a good job of communicating its actions regarding TARP to the public? You know, are there areas or programs within TARP where
Treasury—you feel Treasury could have done a better job articulating its objectives, similar to what you just said to me?
Mr. MASSAD. Sure. Again, a very good question. I think we certainly could have done a better job explaining what we were doing,
explaining why we were doing it. I think there is a tendency, where
you’re very focused on a crisis like this and taking action, to assume that people know a lot about what you’re doing or know more
than they may know. You know, I recognize most people in this
country don’t follow what goes on in Washington day by day the
way many of us who live in Washington do. They’re focused on
their families, their homes, their jobs, keeping their homes, keeping
their jobs, getting their kids through school. And yeah, we certainly
could have done a better job communicating what we were doing.
Dr. TROSKE. I want to return to the questions about the stress
test. So I don’t know whether you saw there was a column in
Wednesday’s New York Times alleging that banks supplied the
measures that were used in the latest round of stress test, ensuring that they would look good and rendering the tests rather meaningless.
I think part of this comes from the fact that these latest rounds
of stress tests, the results have been kept somewhat private and
were not as public as the first time around. And I guess I want you
to maybe address why, and obviously this is the Fed’s decision, not
Treasury’s, but whether Treasury pushed the Fed to make them
public, what are the benefits and costs from making these results
public and do you have any idea why the Fed has tended to think
that the benefits were less than the costs in making the results
public.
Mr. MASSAD. Well as you know, the current round of stress tests
is being conducted by the Fed. It was designed by the Fed. I had
no involvement in it and Treasury generally did not, to my knowledge. So I can’t really answer why the Fed structured it the way
they have or their decisions about what they were going to publicize. Other than the fact that, I would note the following: Traditionally bank supervisory information and the testing that our regulators do, and they do it on an ongoing matter, is not made public.
The exception was the stress tests of the spring of 2009. And we
did that at that time, just given the gravity of the crisis.
Dr. TROSKE. But as you noted, you attributed a lot of success to
that. One would have thought we would want to follow up with
that success.

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Mr. MASSAD. Well, I think again, one has to do extraordinary actions in a crisis and I think in the crisis it was appropriate to conduct those stress tests with the transparency with which we did.
But I think there are good reasons why we have a model in this
country of bank regulation and supervision in which a lot of the detailed information is not made public, but certain conclusions and
other information is made public.
Dr. TROSKE. I’ll note that we—one of our later panelists is a
Nobel Prize winning economists who won his Nobel Prize for his
work on asymmetric information so I think it’s going to be interesting to hear his take on keeping information secret.
Mr. MASSAD. I look forward to that. Unfortunately I cannot stay,
but I look forward to reading the transcript later, of both the panels that follow.
The CHAIRMAN. We will send you the transcript.
Superintendent Neiman.
Mr. NEIMAN. Thank you.
Mr. Massad, thank you very much for your role. I was here when
you volunteered your work on the COP panel, which was very helpful at the time. I also very much appreciate the fact that you continued in that role when asked to serve by the Treasury Department. I also want to acknowledge the work of your predecessor,
Herb Allison for his efforts and his coordination with this committee.
I want to follow up with your answer to Damon’s question about
what worries you the most. The first point you mentioned was related to the housing programs and your concern that those could
be eliminated.
This is my area of interest because this week there were calls
from lawmakers to eliminate Treasury’s foreclosures mitigation
programs. Some have referred to the approximately $50 billion set
aside to American homeowners, as a waste of money. But few mention that very little of the money has actually been spent, and that
lack of spending frustrates those of us who believe that effective
government investment into the housing market is essential for
further financial stability and economic recovery.
But with only $1 billion spent on the HAMP so far, as estimated
by the CBO and nearly 600,000 mortgages permanently modified,
it’s difficult to conclude that HAMP has been a waste of money.
Even just as a back of the envelope estimate, that’s around $2,000
per permanent mod and we know that there are certainly other
more complicating factors, re-default rates and servicer incentives
and the role that the GSEs have played.
But, could you comment, from a cost benefit of analysis——
Mr. MASSAD. Sure.
Mr. NEIMAN [continuing]. As to the value of those dollars spent
on those 600,000 permanent mods?
Mr. MASSAD. Sure. I think it’s been dollars very well spent. First
of all, let me say that the money, as you know, is spent over time
for once there is a permanent modification of a mortgage, the payments are made over time as long as the homeowner continues to
make his or her payments. And you know, we estimate basically
that over time a permanent modification will cost the government
about $20,000. So we’ll see that number go up and as long as we

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can continue to roll out the program we expect that, you know,
more people will enter. We’re getting 25,000 to 30,000 additional
permanent modifications a month.
Keep in mind also that we have reallocated some of that $50 billion, it’s actually $46 billion total, but we reallocated some of that
to other programs, to the Hardest Hit Program, to the FHA Short
Refinance Program and there are other subprograms within Making Home Affordable. So we’re looking at the total cost that we
think will be spent, it will be below the $46 billion, but it will be
significantly higher than where we are today, of course.
Mr. NEIMAN. Could you talk to the benefits of those programs,
both to the borrowers, I think——
Mr. MASSAD. Sure.
Mr. NEIMAN [continuing]. Which are more obvious, but also to
the underlying economy?
Mr. MASSAD. Certainly. Certainly. You know, this is the worst
housing crisis that we’ve seen since the Great Depression and what
we’re trying to do through these programs is to help people modify
their mortgage where it makes economic sense to do so. And by
doing so you avert a lot of costs. A foreclosure, for any family that
goes through it, is obviously a terrible economic loss, it’s also a
great social and—or great psychological and emotional loss. It’s a
loss to the community, the community suffers from it because
neighboring house prices fall, particularly where you have a vacant
home that can be then subject to vandalism, that hurts the community.
So, you know, this situation is a drag on our economy as a whole.
So the more that we can help people get into sustainable modifications, which is the focus of our program, it’s not simply kicking the
can down the road, as some people have alleged, we’re helping people get into a sustainable situation, I think our country is much
better off.
Mr. NEIMAN. And before my time expires, could you comment on
the impact of ending those programs would have on the economy?
Mr. MASSAD. Certainly. I think it means that tens of thousands
of people that could otherwise get help directly will not get that
help. In fact more——
Mr. NEIMAN. And what of the impact on non-HAMP mods? Do
you see a direct correlation——
Mr. MASSAD. Absolutely.
Mr. NEIMAN [continuing]. If the HAMP program ended?
Mr. MASSAD. I think—excuse me. Absolutely. I think one of the
things that our program has done is it has set standards that have
now been followed by the industry widely. There were no modifications getting done prior to the launch of this program. We’ve set
standards, not only for how do you do a sustainable modification,
what should be its terms, but also standards for borrower protection. Dual track, for example, the procedure where some of the
servicers were talking to a homeowner about a modification at the
same time that they were foreclosing. It’s very, very confusing to
the homeowner and very frustrating.
Mr. NEIMAN. And the elimination of that program could certainly
jeopardize the standardization, the focus on those?
Mr. MASSAD. Absolutely. Absolutely.

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Mr. NEIMAN. Thank you. My time has expired.
The CHAIRMAN. Thank you.
Just to finish up on the moral hazard. I saw a quote, because as
you—as everybody’s pointed out, it’s really a government problem.
I saw a quote by Secretary Geithner and I just thought—right here
in Financial Times, on January 14th, he said, ‘‘In the future we
may have to do exceptional things again if we face a shock that
large. You just don’t know the systemic, not until you know the nature of the shock.’’
Is this kind of backing away from the fact, no time, no way, no
are we ever going to bail any bank out again?
Mr. MASSAD. Chairman, it’s a very good question. The Secretary—I’ve talked to the Secretary about that statement——
The CHAIRMAN. Yeah.
Mr. MASSAD. And he was referring to the use of the tools under
Dodd-Frank. I think it’s clear that we don’t know what the next
crisis will be. And as I said earlier, we believe that the tools that
we now have under Dodd-Frank give us the ability to minimize the
effects, but it requires, as I say, effective implementation and use
of those tools.
The CHAIRMAN. Is there any concern that—widespread belief
that there still are banks Too Big to Fail. The market seems to indicate by the spreads that they give to the larger banks, that
they’re Too Big to Fail, that people all over the world are trying
to figure out. I know there’s a new study going to come out on resolution authority across borders, which has not been dealt with in
Dodd-Frank and would be an incredible problem. Does any of that
kind of concern you in terms of moving forward, with moral hazard?
Mr. MASSAD. Certainly concerns me. I think the moral hazard
issue is obviously a very, very significant one. And as you all have
noted, it’s a very significant issue in light of what we had to do
under TARP. But, again I think it’s up to us now to take the tools
that Congress has given us and work to minimize that risk.
The CHAIRMAN. One of the frustrations I think that people—I
mean not just people, everyone has, it’s not just me, everyone, and
that is the fact that, you know, we went in, we helped out the
banks, we helped out the corporations and then the jobs just didn’t
come, the investment didn’t come, the banks held on to the money,
they’re still not investing the money, the corporations didn’t invest
the money. Is there some way that TARP could have been structured to—I mean it sounds an awful lot like trickle down to a
whole lot of people that didn’t trickle.
Mr. MASSAD. Um hmm.
The CHAIRMAN. And so is there any way that you think, looking
back on it, that TARP could have been structured so that it would
be a better chance that we’d actually get economic growth and jobs
for small business and for regular people?
Mr. MASSAD. I think that the key thing was that TARP alone
wasn’t enough.
The CHAIRMAN. No, I mean but again, we’re just focusing on
TARP.
Mr. MASSAD. Um hmm.

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The CHAIRMAN. Could TARP have been structured, do you think,
in some way so that we would have at least mitigated that if not
eliminated it?
Mr. MASSAD. Yeah. You know, I think policymakers, historians,
probably this panel will explore that issue. I think it’s one we
should explore. Sitting here today, you know, I’m very focused
on——
The CHAIRMAN. Right, I got it.
Mr. MASSAD [continuing]. Exiting the program and wrapping it
up.
The CHAIRMAN. One final thing. But one of the simple things was
the panel I know right in the beginning said that there should be
better support tracking of funds. And I know we’ve been concerned
about the transparency of tracking where the funds went. Do you
think, in retrospect, again the time, it was a tough time,
everybody’s running around. But now looking back in the calm of
two years, two and a half years later, do you think maybe it would
have been a better—good idea to track the funds better?
Mr. MASSAD. Well, you know, we implemented the recommendations of SIGTARP in this regard. It was done, you know, later after
a lot of the money went out the door.
You know, on the lending point though, I would simply note, as
I think this panel noted in a very excellent report, that the lending
issue is not simply a supply of capital issue, it’s also a demand
issue, it’s also a regulatory issue. In other words, the level of lending in this country and how you get that back up. And you’re going
to see that fall in a recession.
So these are complex problems and while it may be that we could
have done things differently under TARP, I think that, you know,
the focus now should be to work with the tools we have and try
to process——
The CHAIRMAN. No, I have that. What I’m trying to get at is kind
of a history so that if we go, start over again, god forbid anything
like it should ever happen again, we’re not starting without some
of the best suggestions. So my question—and you can think about
that, maybe you want to get back to me on that, kind of what are
some of the things that we could have done to have mitigated that.
Mr. McWatters.
Mr. MCWATTERS. Thank you, Senator.
If I may, I will go back to the written testimony of Professor
Stiglitz, first page, and I’ll read a quote and would like to hear
your comments. Towards the bottom of the first paragraph Professor says, ‘‘The normal laws of capitalism where investors must
bear responsibility for their decisions, were abrogated. A system
that socializes losses and privatize gains is neither fair nor efficient. Admittedly, the big banks were given money—were given
many enormous gifts,’’—and he uses the term gifts—‘‘of which
TARP was only one. The United States government provided
money to the biggest of the banks in their times of need, in generous amounts and on generous terms but have been forcing ordinary Americans to fend for themselves.’’
Would you care to comment on that?
Mr. MASSAD. Certainly. Well, first of all, I agree that we need to
have a financial system where firms can fail, regardless of how big

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they are. The question is, when you were in the midst of the crisis
that we faced, in the fall of 2008, what should we have done? And
again I think the actions taken were appropriate in light of the situation that we confronted and the tools we had. But we obviously
have to work toward a system where that never becomes necessary
again and where firms do fail if they have taken excessive risks.
Mr. MCWATTERS. Okay. Moving to the testimony of Professor
Zingales. Page 3, I read from the last full paragraph of the page,
‘‘TARP was the largest welfare program for corporations of its—and
their investors ever created in the history of humankind. That
some of the crumbs have been donated to auto worker unions does
not make it any better, it makes it worse. It shows that this redistribution was no accident, it was premeditated pillage of defenseless taxpayers by powerful lobbyists.’’
Do you agree with that or do you not agree with that?
Mr. MASSAD. I don’t agree with that.
Mr. MCWATTERS. Okay. On what basis?
Mr. MASSAD. Again, I think that we were confronted with an extraordinary situation in the fall of 2008 and we took actions that
were necessary to prevent the collapse of our financial system
which would have had terrible effects for everyone in this country.
And I think the actions we took succeeded in doing that.
Mr. MCWATTERS. You know, I don’t think—my time is up, but I
don’t think either one of these gentlemen is saying that in October
of 2008 the response by the United States Government was to do
nothing. Okay? But it’s more of a nuance issue as to, okay, once
the meltdown threat is over, just a few months later, which from
our recollection, then we need to be able to turn on a dime and
maybe apply the rules somewhat differently.
But, my time is up and I’ll end there.
The CHAIRMAN. Thank you. Mr. Silvers.
Mr. SILVERS. Mr. Secretary, we’ve had a lot of conversations in
this room and privately with the Treasury Department which kind
of end with the issue of, well, with the problem of, ‘‘Well that would
be a good idea to do but we don’t have the power to do it.’’ In that
vein, as you look at the powers you have and don’t have to manage
TARP going forward after this committee disbands, and with the
notion that Congress is listening, what powers would you like to
have that you don’t have?
Mr. MASSAD. Well, I guess I’ve assumed we’re not amending the
TARP at this juncture
Mr. SILVERS I assume we’re not either. I’m trying to build a
record. [Laughter.]
Mr. MASSAD. You know, I think the work that remains to be
done, particularly in the area of housing, is obviously critical.
Mr. SILVERS. Yes.
Mr. MASSAD. And as you know——
Mr. SILVERS. So let’s take housing. I mean I think we—I think
a lot of us agree on that and agree with, I think, the—I think the
sentiments you expressed a few minutes ago, which I hope that you
and your colleagues keep repeating.
So let’s take housing. You’ve got agreements, you’ve got a legal
structure with the HAMP participants. If you could rewrite those
agreements today, knowing what you know, what would you do?

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Mr. MASSAD. Well, if we were to rewrite the agreements, again
within the framework of the powers we have, we would have simply——
Mr. SILVERS. Assume someone gives you a magic wand, what
would you do with it? [Laughter.]
Mr. MASSAD. You know, it’s just difficult to answer the
hypotheticals in terms of rerunning the history. In terms of going
forward——
Mr. SILVERS. Going forward, yeah.
Mr. MASSAD [continuing]. I think there, you know, I will leave
it to the Congress. I don’t mean to dodge the question, but I think
there’s a variety of things that have been considered. They range
from the simple ones, which I know you’ve taken an interest in,
that we concluded we couldn’t even use TARP funds, for example,
to pay for legal aid and broad counseling in the housing program,
because——
Mr. SILVERS. But would it be a good idea to do that?
Mr. MASSAD. Yes.
Mr. SILVERS [continuing]. I mean I’m not—I know that——
Mr. MASSAD. We supported the legislation to do that. And it
didn’t go anywhere.
Mr. SILVERS. So that’s one that’s item one.
Mr. MASSAD. That’s a small one. That’s a small one. You know,
I think there are a range of things, such as cram down or reform
of the bankruptcy codes so that, you know, people could—that
judges could write down mortgages.
Mr. SILVERS. That would be item two then.
Mr. MASSAD. That could be item two, but you know, I think we
can certainly provide you potentially with others. I’m very focused,
obviously, on just executing the authorities we have.
Mr. SILVERS. Okay. I don’t know if I’m allowed to ask one more
question?
Several of the witnesses that we—in written testimony, have
suggested that we ought to have sliding scale capital requirements
for larger banks. That was in this panel’s regulatory reform report
at the beginning of our work. It is within the powers granted to the
bank regulators and the systemic risk regulator. What is your view
of that proposition?
Mr. MASSAD. I will leave that one to the regulators and the Financial Stability Oversight Council. I think it’s a very important
question but I would note simply that, you know, we have raised
the level of capital in the system significantly since where we were.
Our banks are better capitalized, far better capitalized today. But
as to the exact details of whether there should be a sliding scale
and what that sliding scale should look like, I would defer to those
who have that power.
Mr. SILVERS. Mr. Secretary, if the Treasury Department has a
view on that question, I know I sort of caught you by surprise on
that——
Mr. MASSAD. Certainly.
Mr. SILVERS [continuing]. If the Treasury Department has a view
in its role in the systemic risk process—management process, I
think we’d appreciate that in writing.

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Secondly and finally, we’ve had—a number of us have had a back
and forth with you about these fundamental strategic decisions
that were made in early 2009. Our expert witnesses have a lot to
say about that and a lot of it’s quite critical. I would offer you the
opportunity, in writing, to respond if you and the Treasury Department would wish, to make your view on those questions known.
Mr. MASSAD. Thank you.
The CHAIRMAN. Thank you.
Dr. Troske.
Dr. TROSKE. Thank you. I want to refer back to the quote that
Chairman Kaufman referred to and I know it’s always awkward to
put someone in the position of criticizing their boss, but Secretary
Geithner, Treasury Secretary Geithner did say, ‘‘You just don’t
know what’s systemic and what’s not, until you know the nature
of the shock.’’
The statement seems to be sort of in contrast to some of the calls
by many economists, including some of our next panel and of
course including myself in my opening statement, that the government needs to clearly define what they view as a systemically risky
firm or systemic risk so that the market has a very clear understanding of what that means and what we view that—what we
view is systemically risky.
Could you sort of tell me why you don’t think, or perhaps maybe
you do think, we can—why aren’t we defining what we mean by
systemically risky?
Mr. MASSAD. Well, I think there is a process going on to address
that. I think what the Secretary was referring to is that it’s not
simply a quantitative determination or a simple determination, it’s
also going to be a determination that changes over time. But I
think the Dodd-Frank legislation gives us the ability to do that. I
think the initial work in that area has indicated that there will be
a variety of criteria used that are both quantitative, qualitative,
that involve looking at capital levels, leverage, interconnectedness
and other factors.
So I think the meaning of the Secretary’s statement was simply
that it is a complex determination.
Dr. TROSKE. I mean—and I guess I want to push a little bit on
that. Do you view that at some point there’s going to be a clear
statement to the markets, very transparent statement, ‘‘This I
want we view as systemically risky,’’ so that someone from outside
looking in would come to approximately the same conclusion about
which firms are systemically risky as say a future Treasury secretary?
Mr. MASSAD. That is a subject that the Financial Stability Oversight Council and its various members will look at and consider,
and I’m sure they’ll have more to say about that in the future.
Dr. TROSKE. Going back to the original TARP legislation, one in
which was supposed to involve the purchasing of troubled assets,
you know, toxic assets of the books of banks. That’s not the way
it was implemented and, I guess in my opinion, rightfully so. But
I guess that—those troubled assets, presumably, are still sitting on
banks’ books. Do you have a sense of how big that—the problem
is today? Do you have a sense of the—and whether the Federal Reserve’s ultimate purchase of 1.2 trillion in residential mortgage-

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55
backed securities was, in addition to the other affects, a way of removing those troubled assets from banks’ books and shifting them
to the Feds books?
Mr. MASSAD. Well, I would say a couple of things. It’s a very good
question. I think what we’ve seen is we have seen substantial
write-offs by the industry, number one. Number two, I think we’ve
seen asset quality generally improve. Number three, I think we’ve
seen that the performance of the big banks at least has actually
been better than what the stress tests predicted. The stress tests
were designed to look at, you know, what was the riskiness of those
assets in the bank situation.
Is there more work to do? I would defer to the regulators on that,
about the principal responsibility for overseeing those banks. We’re
obviously still on the road to recovery.
Dr. TROSKE. Thank you.
The CHAIRMAN. Superintendent Neiman.
Mr. NEIMAN Thank you. I’d like to come back again to the foreclosure issues. And as I mentioned in my opening, I believe the
best thing this panel can do is to establish a precedent and a process to get good information to the public. And that’s why some of
our, I think greatest frustrations around the HAMP program have
been with respect to the release and obtaining of information.
The first being really around non-HAMP modifications. I think in
the defense of the HAMP program, you rightfully point to the fact
that not only did you create a system for modifications, but also
that it encouraged non-HAMP modifications outside of the HAMP
program, and I think they probably exceed three to one the number
of HAMP.
But despite our continued calls for information—and it’s been
supported by the Secretary himself—when Secretary Geithner was
here last December he acknowledged how important that kind of
information was. He pledged to us, ‘‘We are looking for ways we
can get better information out there to assess these programs.’’
What progress has been made since December in obtaining and
publicly releasing this data, regarding proprietary bonds?
Mr. MASSAD Thank you, Mr. NEIMAN. That’s a very good question and I know it’s been an issue that you’ve been very focused
on. And I agree with you, we need more data on those non-HAMP
modifications.
As you know, those are outside of our program and therefore outside of the system, the reporting system that we set up. There was
no reporting on any modifications in this country, prior to HAMP.
And we set up——
Mr. NEIMAN. Have servicers been asked to voluntarily submit
that?
Mr. MASSAD. We have suggested that to several of the servicers.
I know you’ve raised it with HOPE NOW in your conversations
with them and when they appeared before this panel. And I know
the regulators are also looking at that issue.
Mr. NEIMAN. So again, I think we would encourage you certainly
to put a process in place. This is something that certainly, if not
voluntarily submitted, should be a high priority to find a way to
require that information to be submitted and publicly released.

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56
The other area has been around the web portal. And we’ve been
talking about this web portal to allow not only housing counselors
and borrowers to submit data directly through a web based system
to their servicers, but even more importantly, to allow them to assess the status of their modification.
Mr. MASSAD. Um hmm.
Mr. NEIMAN. We continue to read and hear about the slow implementation and even the slow pick up on usage. Can you give us an
update as to how frequently and the volume of usage on that system?
Mr. MASSAD. Let me get back to you on that. I don’t have those
figures at my fingertips or the status of that. I know it has taken
a lot of work to get to where we want to be. There are issues of,
you know, making sure that it not only works, but that it protects
privacy. But I’d be happy to get back to you on that.
Mr. NEIMAN. Okay. And the last, if you bear with me, is something I’ve asked at our last hearing. I’ve asked Ms. Caldwell and
I’ve asked the Secretary himself regarding the need for a national
foreclosure database. And I’ve been given polite noncommittal responses each time. So I wouldn’t want you to feel that you were
left out today. [Laughter.]
So, well what is it? What do you think would be the reluctance
for starting a program that would provide mortgage performance
data across the board, across state, across national, across all lines,
for banks and nonbanks?
Mr. MASSAD. Again, a very good question, Mr. Neiman. I think
we’re at a point in time where we’re going to see very dramatic
change, overall, in the mortgage servicing industry which will lead
to things like national servicing standards and presumably a national database on a number of these issues. It’s been clear
throughout this crisis that we didn’t have data, we didn’t have
standards and that’s been a large part of the problem.
So I think there is a lot of work going on on a number of fronts
to look at those. I can’t give you a specific prediction as to where
we’ll be when, but I think we will see some significant change
there.
Mr. NEIMAN Thank you. I look forward to your follow-up response on the web portal. Thank you.
The CHAIRMAN. Thank you, Acting Assistant Secretary Massad.
Thank you for being here today, but thank you so much for your
public service.
Mr. MASSAD. Thank you for having me.
The CHAIRMAN. It’s a real—it really is—appreciate it.
One thing, one question I have is you said that you’ve raised
bank capital requirements significantly. I don’t want to ask that
question now, if you could just submit in writing kind of what you
did to raise bank capital requirements significantly.
Mr. MASSAD. Yeah. Certainly. It wasn’t us, but just generally
what I meant was that bank capital levels have increased.
The CHAIRMAN. Okay. I’d just like some details on that.
Thank you very, very much.
And the next panel come forward, please.
Welcome. I am generally pleased to welcome our second panel.
We’re joined by Jason Cave, deputy director of the Office of Com-

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plex Financial Institutions Monitoring at the FDIC; Patrick
Lawler, chief economist and associate director for Policy Analysis
and Research at FHFA; and William R. Nelson, deputy director, Division of Monetary Affairs, Federal Reserve.
Thank you all for joining us. Please keep your oral testimony to
five minutes so that we will have ample time for questions. Your
complete written statement will be printed in the official record of
the hearing.
We’ll begin with Mr. Cave.

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STATEMENT OF JASON CAVE, DEPUTY DIRECTOR FOR COMPLEX FINANCIAL INSTITUTIONS MONITORING, FEDERAL DEPOSIT INSURANCE CORPORATION

Mr. CAVE. Chairman Kaufman and members of the panel, I appreciate the opportunity to testify on behalf of the FDIC concerning
the Temporary Liquidity Guarantee Program or TLGP.
A significant contributor to the financial crisis was a disruption
in credit markets, which significantly impaired the ability of even
credit-worthy companies to refinance their commercial paper and
long term debt.
The FDIC’s TLGP was one of several extraordinary measures
taken by the U.S. Government, in the fall of 2008, to address the
crisis in the financial markets and bolster public confidence. The
FDIC TLGP helped to unlock the credit markets, calm market
fears and encourage lending during these unprecedented disruptions.
The TLGP provided a guarantee, for a limited period of time, for
certain new senior unsecured debt issued by financial institutions.
We designed this program to be as inclusive as necessary to ensure
that credit—particularly between banks—began to flow again. This
calmed what was becoming ‘‘the perfect storm,’’ whereby creditors
refused to roll their debt beyond weeks or even overnight and demanded more collateral at the exact time that banks needed these
funds to continue to finance their operations.
Additionally, the TLGP fully guaranteed certain non-interest
bearing transaction deposit accounts. This provided stability to insured banks, particularly smaller ones, enabling their commercial
customers to continue to do business without disruption. The creation of this aspect of the program was necessary because we were
seeing that smaller, healthy banks were losing these accounts to
their much larger competitors because of uncertainties in the financial system.
At its peak, the FDIC guaranteed almost $350 billion of debt outstanding. As of December 31, 2010 the total amount of remaining
FDIC guaranteed debt was $267 billion. Of that amount, $100 billion, or 37 percent will mature in 2011, and the remaining $167 billion will mature in 2012.
The TLGP has worked as it was intended to. Credit markets
have returned to some level of normalcy, and private investors
have resumed their roles as credit providers at market terms. Financial institutions are in the process of repairing their balance
sheets, increasing cash positions and reducing their alliance upon
short term debt.
The FDIC as deposit insurer and as guarantor of TLGP supports
these needed improvements. Given that $267 billion in TLGP remains outstanding, it is important that financial institutions continue to replace government guaranteed debt with private funds.
The FDIC is closely monitoring the funding plans that institutions
have developed to ensure that TLGP can be fully repaid through
the private credit markets. The next two years will be important,
given the significant amount of debt that is coming due.
The financial system benefited from a prompt, coordinated response across regulatory agencies. The FDIC believes it is just as

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important to have that same level of coordination in evaluating the
health of these large financial institutions coming out of the crisis.
Currently we are working with the Federal Reserve to review the
dividend plans at the large banking organizations. We believe that
a comprehensive review of dividend and capital repayment plans
across large firms is critical since these payments were a large
drain on cash reserves prior to the crisis, leaving financial institutions more vulnerable to the disruptions that followed.
This is why the dividend plan review and TLGP repayment plans
are intertwined. The regulators should not approve dividend and
capital repurchases which involve significant cash outlays by financial firms until we are all fully confident that these firms will have
the financial resources, under both normal and stressed conditions,
to repay debt guaranteed by the FDIC.
In conclusion, while the measures taken by the FDIC and other
governmental agencies to address the financial crisis were unprecedented in nature, these measures were successful at stabilizing the
credit markets and creating an environment that allowed for economic recovery. Now we are actively working to ensure that the
program winds down in an orderly fashion by the end of 2012.
Thank you. I will be pleased to answer any questions from members of the panel.
[The prepared statement of Mr. Cave follows:]

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74
The CHAIRMAN. Thank you.
Mr. Lawler.

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STATEMENT OF PATRICK LAWLER, CHIEF ECONOMIST AND
HEAD OF THE OFFICE OF POLICY ANALYSIS AND RESEARCH,
FEDERAL HOUSING FINANCE AGENCY

Mr. LAWLER. Thank you. Chairman Kaufman, members of the
panel, thank you for the invitation to present FHFA’s perspective
on the impact of TARP on the economy and the financial sector.
I’m going to be referring to some charts in the back of my testimony, if you’ve got that handy.
TARP was created when financial markets were in the midst of
a crisis. Collectively, TARP programs made important contributions
to reestablishing financial stability by increasing confidence and
adding liquidity to financial markets. The oversight board, on
which FHFA’s director sits, concluded that without TARP the severity of the crisis and its impact on the economy would have been
materially greater.
Given the origins of the crisis and housing financial markets, the
conservatorships of Fannie Mae and Freddie Mac were designed
from the start to maintain access to funds for sound, new mortgages. To assist borrowers who were struggling to make payments
on poorly structured and unaffordable loans, FHFA worked with
the Treasury, HUD and others to develop a series of programs, including the Home Affordable Modification Program, which used
TARP funds for non-GSE loans to enhance incentives for borrowers
and servicers.
In all cases, FHFA has been guided by its responsibilities as conservator of each enterprise to limit activities to those that make
business sense, are safe and sound and are consistent with the enterprises’ charters and the goals of conservatorship. These programs have benefited the enterprises by mitigating risks and reducing both direct losses on loans where foreclosure is avoided, and
indirect losses on properties where housing markets are stabilized,
which reduces defaults on other loans.
As shown in Figure 1, with these and other programs, including
notably the Federal Reserves large program for purchasing mortgage securities, the cost of mortgage borrowing declined, both absolutely and relative to yields on reference Treasury securities.
In Figure 2, cheaper financing and foreclosure prevention programs helped stabilize house prices, as measured by FHFA, almost
immediately and by other measures within a few months.
In Figure 3, serious delinquencies continued to rise sharply in
2009 as the recession worsened, but they have since eased somewhat. Inventories of houses currently or potentially for sale are
very high in portions of the country, so significant risks remain, despite recent price stability and lower delinquency rates.
The enterprises have significant responsibilities with respect to
TARP through their implementation of Making Home Affordable
programs for mortgages on their own books as well as through
their roles as Treasury’s financial agents.
Turning to Figure 4, in 2010 the enterprises completed nearly a
million foreclosure prevention workouts. More than double 2009
total and nearly two and a half times the number of foreclosure

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sales in 2010. Most workouts are home retention actions intended
to keep borrowers in their homes.
While HAMP has not produced the volume of loan modifications
the Treasury Department initially hoped for, we believe it has been
instrumental in standardizing and streamlining the industry’s
modification process. And in that way it has contributed greatly to
the sharp rise in non-HAMP modifications that has taken place
over the past two years.
The quality of the modifications also appears to have improved,
as indicated in Figure 5. Although it is still too soon to judge how
successful recent modifications will ultimately prove to be, re-defaults of loans modified by the enterprises have been much lower
since the implementation of HAMP than previously.
In addition to foreclosure prevention programs, the enterprises
used the Home Affordable Refinance Program, HARP, to help
homeowners whose property values has fallen to take advantage of
historically low interest rates by refinancing their mortgages which
can help them avoid future default. In Figure 6, the volume of
HARP refinances has also been much less than Treasury—the
Treasury Department anticipated, but refinances outside HARP,
many with a similar streamlined structure, have been ten times as
large with Fannie Mae and Freddie Mac mortgages.
FHFA has worked closely with the Treasury Department on critical issues brought on by the housing crisis and general financial
and economic disruptions over the past few years. The interactions
have been frequent and professional, respectful of our differing
roles and legal responsibilities but collaborative toward our common goal to bring stability and liquidity to housing markets and
seek foreclosure alternatives whenever feasible.
Thank you. I’ll be happy to answer questions.
[The prepared statement of Mr. Lawler follows:]

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The CHAIRMAN. Thank you.
Mr. Nelson.

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STATEMENT OF WILLIAM R. NELSON, DEPUTY DIRECTOR, DIVISION OF MONETARY AFFAIRS, FEDERAL RESERVE SYSTEM

Mr. NELSON. Chairman Kaufman and members of the Congressional Oversight Council. Thank you for the opportunity to testify
about the Term Asset Backed Securities Loan Facility, TALF,
which was established by the Federal Reserve and Treasury Department during the financial crisis to increase the availability of
credit to households small businesses. Treasury provided credit
protection for the TALF under the Troubled Asset Relief Program,
TARP.
When the financial crisis intensified in the fall of 2008 investor
demand for highly rated asset-backed securities, or ABS, evaporated. Spreads on ABS widened dramatically and issuance of new
ABS dwindled to near zero. In response, lenders that relied on
securitization for funding pulled back on the credit they provided
to households and businesses contributing to the severe contraction
in the economy that followed.
Among the many actions taken by the Federal Reserve and the
Treasury in response to these events, was the creation of the
TALF, which was designed to encourage renewed issuance of ABS.
Under the TALF the Federal Reserve Bank of New York provided
loans to investors for the purchase of certain ABS backed by consumer and business loans. TALF loans had maturities ranging
from three to five years. The interest rate spreads on TALF loans
were set below spreads on highly rated ABS prevailing during the
financial crisis, but well above spreads in more normal market conditions, providing investors an incentive to repay the loans as financial conditions normalized.
To protect the Federal Reserve and the Treasury, several layers
of risk controls were built into the TALF program and are detailed
in my prepared remarks.
The TALF contributed importantly to a revival of ABS markets
and a renewed flow of credit to households and businesses.
Issuance of non-mortgage ABS jumped to $35 billion over the first
three months of TALF lending in 2009 after having slowed to less
than $1 billion per month in 2008.
During its initial months of operation the TALF financed about
half of the issuance in the ABS market. Over the life of the program the TALF supported nearly 3 million auto loans, more than
1 million student loans, nearly 900,000 loans to small businesses,
150,000 other business loans and millions of credit card loans.
When the program closed in June, 2010, $43 billion was outstanding. As a result, in July, 2010 the Federal Reserve Board and
the Treasury agreed that it was appropriate for the Treasury to reduce the credit protection provided by the TALF under the TARP,
from $20 billion, ten percent of the authorized size of the program,
to $4.3 billion, ten percent of the loans outstanding when the program closed.
As I noted, the TALF loan interest rates were set at spreads chosen to be well above those that prevailed in more normal financial
conditions, yet below those at the height of the crisis. The TALF

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has earned nearly $600 million of net interest income to date. If
there were to be any losses on TALF loans, the losses would first
be absorbed by the accumulated net interest income. The TARP
funds would absorb any losses that exceeded the accumulated net
interest income, up to the commitment provided by the Treasury.
The experience to date suggests that the multiple risk controls
built into the TALF program have been effective and losses appear
unlikely. Because market conditions have improved, TALF loans
now appear expensive, as intended, and more than two-thirds of
the loans have been repaid early. All the remaining TALF loans
are current regarding payments of interest and principal. All of the
collateral backing the outstanding loans have retained their AAA
ratings and the market value of the collateral backing each of the
loans has remained well above the loan amount.
As a result, we see it as highly likely that the accumulated interest will be sufficient to cover any loan losses that may occur without drawing on the dedicated TARP funds.
In conclusion, we believe that the TALF program represents a
highly successful use of TARP funds. The TALF program helped restart the ABS markets at a critical time, thereby subording the
provision of credit to millions of American households and businesses. Moreover, its careful design has protected the taxpayer and
in the end the program almost certainly will remit a net profit to
the Treasury.
Thank you for the opportunity to discuss the TALF program
today. I would be pleased to take any questions that you have.
[The prepared statement of Mr. Nelson follows:]

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The CHAIRMAN. Thank you very much.
And we’ll start—we’ll have one round of questions.
Mr. Cave, can you talk a little bit about the plans of the—that
you mentioned in your testimony about plans for large banking organizations to increase dividends and how you think that works
and why you think that works and what has to be done before that
should go forward?
Mr. CAVE. Yes, thank you. I’d be happy to answer that question.
The Federal Reserve is the lead agency with responsibility for
administering the stress tests and the review of the dividend plans.
We are involved as well. We think that this is a positive program.
Before the crisis you had institutions that paid out significant
amounts of cash in dividends and in capital repurchases, leaving
them more vulnerable when the crisis did hit. So the process that’s
being used—before institutions can begin to increase dividends and
capital repayments—is a programmatic approach that we view as
an improvement over the past. And we are very much involved in
that as well.
The CHAIRMAN. Do you have any thoughts about the timing of
this at this particular time?
Mr. CAVE. The staffs are working presently on this. It’s a priority. There is interest in having responses to institutions for the
first quarter of 2011, so this is a very important time where a lot
of work is going into this as well.
The CHAIRMAN. Mr. Nelson, do you have any comments on that,
the dividends plans of large banks?
Mr. NELSON. No, I do not.
The CHAIRMAN. Okay. Mr. Lawler, what’s your view about
Fannie Mae and Freddie Mac having conflicts as their roles as investors in residential mortgages and their roles as Treasury agents
with respect to HAMP?
Mr. LAWLER. I don’t think it creates important conflicts. They are
investors. They do have an interest in trying to reduce foreclosures
to the maximum extent possible. I think it’s very consistent with
the Treasury Department’s goals with these programs. They’re
working together to try and create programs that will work to keep
people in homes and reduce costs to taxpayers.
The CHAIRMAN. But the—one of the problems is, is there are conflicts involved throughout the whole process, with the servicers. Do
you agree? And as Fannie Mae and Freddie Mac, you don’t see
they—where they have any conflict?
Mr. LAWLER. With servicers?
The CHAIRMAN. Yeah.
Mr. LAWLER. Servicers have some conflicts in some parts of the
process. For example, if they hold a second lien——
The CHAIRMAN. Right.
Mr. LAWLER [continuing]. On a property where they’re also servicing the first lien, that’s a conflict and that’s certainly an issue.
The CHAIRMAN. Fine. Mr. Nelson, did TALF work, in your opinion?
Mr. NELSON. Yes, sir, it was very effective. For example, in research that was just released on the Federal Reserve’s website yesterday, my colleagues and I at the Federal Reserve have found that
the TALF had a very consequential affect on lowering ABS spreads,

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99
both for consumer ABS and in commercial mortgage-backed securities.
In other research, my colleagues have found a link between the
issuance of TALF ABS and lower loan rates extended by the lenders that funded themselves with TALF ABS.
And finally, I’d add that we talked to issuers when the program
was in operation and in subsequent surveys and asked them what
the effects of the program were for them and they indicated that
the program helped them to lower rates and that without the program they would have lent less and there conceivably been a much
more severe contraction of credit.
The CHAIRMAN. Great. Follow on Dr. Troske’s question, Mr.
Cave. Are you concerned about how we get troubled assets off the
balance sheets of banks?
Mr. CAVE. I think that what we are seeing are some improvements in troubled asset levels compared to what we saw during the
crisis. Our latest review, the Quarterly Banking Profile that we released last week, showed that we’re seeing some improvements in
delinquencies and net charge-offs from the crisis levels. But again,
levels are elevated compared to historical averages and there still
remains work to be done to continue the process of balance sheet
repair.
The CHAIRMAN. Thank you very much.
Mr. McWatters.
Mr. MCWATTERS. Thank you. Following up on that. Do these
troubled assets, which are estimated at around a trillion dollars, as
presently constituted, do they pose a systemic risk to the economy?
Mr. Cave?
Mr. CAVE. Compared to where we were with troubled assets during the crisis, we are at a point where levels have receded. It is
still very much something the FDIC monitors closely. Also, we look
to ensure that institutions have proper reserves and capital and liquidity to be able to deal with their problem assets. Something
that, again, we look at very closely.
Mr. MCWATTERS. Okay. And I’m putting words in your mouth
and saying that sounds like a no to me. I mean it sounds like a
no answer. It’s not that these troubled assets, a trillion dollars on
the books, do not pose a systemic risk today. Is that a fair statement or?
Mr. CAVE. I would need to get additional information to you on
that.
Mr. MCWATTERS. Okay. Fair enough.
Mr. Lawler or Mr. Nelson, do you have any thoughts on that?
Mr. NELSON. No, sir.
Mr. MCWATTERS. Okay.
Mr. LAWLER. At Fannie Mae and Freddie Mac and the home loan
banks there are troubled assets, but because Fannie Mae and
Freddie Mac are currently under conservatorship and backed by
the Treasury, they’re not currently creating a systemic risk.
Mr. MCWATTERS. But if the bailout of Fannie Mae and Freddie
Mac somehow went away, then the answer could be different?
Mr. LAWLER. Yeah, that’s a hypothetical, so.
Mr. MCWATTERS. Okay. Okay.

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How about the robo-signing problems and the breech of representations that we read about a lot a couple months ago? Did those
create a systemic risk in the opinion——
Mr. LAWLER. If the foreclosure process were to stop functioning
entirely that would create some significant problems. Most of the—
my understanding of those issues were that the processes were not
followed correctly, but if they can be created, so that they do work
properly, then that’s not a systemic risk. If we simply were unable
to foreclose on properties then that could create more serious problems.
Mr. MCWATTERS. Well, what about a systemic risk that could develop when financial institutions, the servicers, the originators, the
securitizers are sued, particularly the financial institutions are
sued and wearing any of those hats, perhaps multiple hats of the—
being the securitizer and the originator? I mean there are claims
now before the courts that investors were materially misled and
they’re asking for a significant amount of damages. I understand
lawsuits, they happen all the time, but is the cumulative effect of
these lawsuits, do they present a systemic risk to these financial
institutions?
Mr. LAWLER. Again, not to Fannie Mae and Freddie Mac, because
they’re not——
Mr. MCWATTERS. Okay.
Mr. LAWLER [continuing]. The ones being sued.
Mr. MCWATTERS. Mr. Cave, what do you think?
Mr. CAVE. I think that in our view this is very much a question
for the Financial Stability Oversight Council. As you have noted,
this situation involves various financial market participants as well
as regulators and we believe that this is something that should be
a question for the FSOC.
Mr. MCWATTERS. Mr. Nelson, the Fed, what’s the Fed’s view of
this?
Mr. NELSON. I’m sorry, sir, this is not an area of my expertise.
Mr. MCWATTERS. Okay. Okay. Fair enough.
So it sounds like no one is saying, well, with the exception of Mr.
Lawler, because his client is—has an unlimited check from Treasury, that the answer is simply uncertain.
Let me ask one final question in the few seconds I have. If you
had to do this all over again and you were back in 2008 and you
were gearing up, would you do anything differently? Would you
have different programs? Would you have the programs that you
have now but would you tweak them some way?
Mr. Cave.
Mr. CAVE. Thank you for the question. From our perspective, the
TLGP program, so far, has been a success and has done what it
was intended to do, unlock the credit markets and allow institutions to extend their liabilities. We think that’s very important.
What was happening prior to the crisis was that institutions’ balance sheet liabilities were getting shorter and funding was getting
more complicated. So again, we think that the TLGP was successful in addressing that issue. There is still more time to go. We still
have exposure and we are monitoring that very closely. So I think
that is working as expected.

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101
The Dodd-Frank Act has provided us with greater authorities to
do things that we could not do prior to the crisis. And we view,
very much, the proper implementation of the Dodd-Frank Act as a
key thing to do as we move forward.
Mr. MCWATTERS. Okay. Thank you, Mr. Cave.
Mr. Lawler, Mr. Nelson, any thoughts?
Mr. LAWLER. Putting Fannie Mae and Freddie Mac into conservatorship was the right thing to do and that helped provide
funding, continued funding for housing markets. We did not, at
that time, appreciate, when we put them into—first put them into
conservatorship, how serious the recession would be and how bad
unemployment would be and what the implications would be for
the housing market from that point forward.
We did move with the Bush Administration to start the streamline mortgage modification program, but as we did that and as we
moved into HAMP we learned a lot of lessons about how to institute such a program. We’d never done anything remotely like this
before, trying to get all large servicers in the country working on
a single program, doing things the same ways with systems that
were entirely different. So we learned a lot as we implemented that
and as we shifted from SMP to HAMP that had we gone through
the experience before we would have been able to do faster.
Mr. MCWATTERS. Okay. Thank you. My time is up. Sorry.
The CHAIRMAN. Mr. Silvers.
Mr. SILVERS. So this hearing and the wind up of our work is really focused, I think on two really major issues that I want to address with you all. One—and the relevance of your testimony to
these two issues. One is the question of the stability, the health of
the banking system and the other is the question of the housing
market and the continuing foreclosure crisis.
Let me start with the housing market. Mr. Lawler, let me make
sure I have—I understand the GSE’s position here correctly in
terms of their exposure to the housing market and the foreclosure
crisis. The GSEs have obligations to their—to the holders of GSE
issued securities. And the GSEs bought some stuff during the run
up to the financial collapse. It turns out probably to have been a
mistake.
Am I right in understanding that, and as a general matter, the
more foreclosures there are, the more housing prices fall, the more
the value—the more GSEs have difficulty meeting their obligations
to their security holders and the lower the value of those assets
they purchased fall, is that basically right?
Mr. LAWLER. Right. If they can prevent unnecessary foreclosures
then that will help the market and makes their securities more valuable.
Mr. SILVERS. So if housing prices fall secularly across our economy, the losses the GSEs will suffer and that—the money that will
be paid out per the guarantee Mr. McWatters was talking at, will
increase, right?
Mr. LAWLER. Right.
Mr. SILVERS. So from the perspective of the interests of the GSEs
as at least nominally independent firms, the fiduciary duties of the
trusteeship over those entities, there seems like a compelling rea-

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102
son to try to do everything you can to keep housing prices from falling further. Is that right?
Mr. LAWLER. Right.
Mr. SILVERS. Okay. Now, the GSEs are today the, as far as I understand it, the really the only providers of a secondary market of
any consequence, for mortgages in the United States. Is that true?
Mr. LAWLER. Conventional mortgages. Ginnie Mae handles——
Mr. SILVERS. Yes, there’s Ginnie Mae and FHA, but there’s not
a private label mortgage market of any consequence today?
Mr. LAWLER. That’s right.
Mr. SILVERS. Right? So you—so the GSEs really are—the GSEs
have, shall we say, a fair amount of market power right now?
Mr. LAWLER. Okay.
Mr. SILVERS. Right? Would you agree that’s true?
Mr. LAWLER. Yes.
Mr. SILVERS. All right. Does it make—isn’t it—is it consistent
with the GSEs business purposes, right and the duties owed to the
GSEs by the governance of the GSEs, is it consistent with that to
use that market power to ensure that the housing market doesn’t
fall further, all right, to—and to thus minimize the losses the GSEs
are going to incur in the future? Does that make sense?
Mr. LAWLER. Well it does, except that the prices they charge directly affect what their earnings or losses are as well, so there’s a
balance that——
Mr. SILVERS. Right. No, I’m saying in totality the GSEs should
be managing their business to minimize the losses they’re going to
incur. And this has everything to do with the broad movements of
housing prices and stability in the housing market. Am I right?
Mr. LAWLER. That’s right.
Mr. SILVERS. Okay. So would you agree then that to the—that
because foreclosures, as a general matter, all right, some foreclosures are unavoidable, but that foreclosures as a general matter
contribute to falling housing prices and greater losses to the GSEs,
as a pure business matter the GSEs ought to use every instrument
and every power in their disposal to ensure that no unnecessary
foreclosure occurs?
Mr. LAWLER. And ‘‘unnecessary’’ is an important word there.
Mr. SILVERS. But you agree with that, as a business matter?
Mr. LAWLER. Their program——
Mr. SILVERS. I said as a business matter——
Mr. LAWLER. Right.
Mr. SILVERS [continuing]. Not as a public policy matter, not as
a matter of social do-gooderism, but as a pure business matter for
the GSEs, you agree that that’s true?
Mr. LAWLER. That’s what their programs are designed to do.
Mr. SILVERS. Okay. Excellent. Thank you.
Mr. Cave, your testimony, which I found very interesting expresses some concerns about dividends. And not surprisingly, the
FDIC appears concerned that the—loans which the FDIC has guaranteed be paid first before any dividends get issued. I am concerned further beyond that about the quality of earnings at the
large banks that are proposing paying dividends. Do you have—
does the FDIC share my concern?

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Mr. CAVE. Thank you. Based on our recent Quarterly Banking
Profile report, the earnings and the state of the industry have improved. We saw 2010 as a turnaround year with stronger earnings.
But, a portion of that was due to reductions in loan loss provisions,
which had a benefit for earnings. Revenues did not see as much improvement. That’s an area we are looking at very closely to ensure
that those reductions in provisions are appropriate given the current risk of the assets. I think that’s an area that——
Mr. SILVERS. Right.
Mr. CAVE [continuing]. Further work is needed. But we are looking at that very closely.
Mr. SILVERS. Now my time is expired, but if I can ask the Chairman’s indulgence. I just want to clarify that for the non-bank regulators who might be listening. What we’re talking about here, and
you tell me if I’m wrong, all right, is that a fair amount of the
earnings of the large banks does not reflect actual cash that has
gone into those banks. It reflects changes in assumptions about future losses. The dividends that would be paid would involve actual
money, not assumptions or promises or other things, but actual
money so that on the one hand you have no money coming in for
that part of those earnings and on the other hand dividends would
involve real money coming out. Is that, in a sort of simple-minded
way, is that what we were just discussing?
Mr. CAVE. I think that would be a fair representation. Dividends
would be cash coming out and there are various attributes of the
earnings stream that have various levels of quality.
Mr. SILVERS. All right. I’m concerned about that. Thank you.
The CHAIRMAN. Dr. Troske.
Dr. TROSKE. Thank you. So I’ll start with you, Mr. Nelson. In a
recent paper Professor Zingales and a co-author estimated that the
CPP program, along with the FDIC’s Temporary Liquidity Guarantee Program increased the value of banks participating in these
two programs by approximately $130 billion, of which 40 billion
represented a direct taxpayer subsidy to banks, it seems clear that
many of the programs implemented by the Federal Reserve’s including its purchase of mortgage-backed securities and the Primary
Dealer Credit Facility also provided significant financial assistance
to banks. Do you think the assistance from these other programs
and other agencies enabled large banks to repay their TARP funds
more quickly?
I know that these efforts were coordinated between Treasury and
the Fed and the FDIC. Was there some discussion about this and
if so, do you think that these other programs allowed some of the
shifts—some of the costs of TARP to be shifted to these other what
I would call less scrutinized programs? Do you have any thoughts
on that?
Mr. NELSON. The Federal Reserve’s response to the financial crisis could be divided up into two broad categories. One would be
their provision of liquidity through the discount window, a traditional lender of last resort response, their liquidity facilities of
which TALF was one. Those facilities were intended to increase the
liquidity of financial markets and ultimately allow for greater credit to flow to consumers and businesses as I discussed.

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The purchases of agency mortgage-backed securities, something
you mentioned before all of the Federal Reserve’s purchases of securities were government guaranteed securities. Those were designed to act very much like traditional monetary policy, by lowering interest rates, encouraging spending, bringing down unemployment and achieving the macroeconomic objectives that the Congress gave to the FOMC.
I don’t know anything about any additional objectives along the
lines of what you just described.
Dr. TROSKE. But I mean it certainly is the case that they entered
into a market in which the mortgage-backed security market was
close to not functioning and they dumped $1.2 trillion into that
market. And I’m not arguing with—that that was not part of an
active monetary policy and that that was not the right policy to
adopt. But clearly that had to have some affect on the mortgages
that were, you know, the liquidity that banks had with these mortgages and allowed them to move them off their balance sheets. Is
that correct?
Mr. NELSON. Well, Dr. Troske, I’d respectfully disagree. The government guaranteed mortgage-backed securities market functioned
very well throughout the financial crisis. And the liquidity of those
assets was very well maintained. They were government guaranteed assets. And during the financial crisis there was quite a bit
of demand for the safety and security of government guaranteed
assets.
So it is true that by the nature of the actions, lowering interest
rates raises the prices of securities, that’s how it works. So, by lowering interest rates anyone who was holding those securities would
have had an asset that went up in value, but that was not the objective of the programs.
Dr. TROSKE. Mr. Cave, I guess I’d direct the same question to
you. Do you think that the FDIC’s actions sort of benefited large
banks and in some sense allowed them or enabled them to be more
quickly pay back their TARP funds? I mean and I’m not arguing
that that was the main purpose but was that one of the consequences of this action?
Mr. CAVE. I don’t believe that that was a consequence. The TLGP
was very much a programmatic—systematic—approach that provided help to the markets, not just for large institutions.
There were two parts to the program. It’s important to know
with the TLGP debt guarantee program that the main purpose
there was to address the situation where money was coming due
very quickly and debt was getting shorter. The TLGP allowed institutions to refinance as institutions were becoming less liquid. So it
was very important.
There was also the Transaction Account Guarantee program that
benefited large banks, but also very much benefited small banks as
well, because we were seeing issues there with these accounts.
That provided some stability, not just to large institutions, but
small institutions as well. We were taking a combined approach.
These were broad programs with broad participation that provided
the improvements to the situations that we were seeing at that
time.

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Dr. TROSKE. Okay. And Mr. Nelson, let me ask you one more
question. I guess throughout this crisis it seems as if, and perhaps
rightfully so, there was a blurring in distinction of the Fed is traditionally the agency that conducts monetary policy, Treasury is traditionally the—one of the agencies that conducts fiscal policy. Many
of the programs of the Fed looked a lot like fiscal policy, lending
money to AIG, Primary Dealer Credit Facilities that I mentioned
before. Financial stability program of the Treasury looked a lot like
monetary policy, an effort to remove liquidity from the market to
tamp down inflationary expectation.
Does that concern you about this blurring of the distinction between who does monetary policy and who does fiscal policy? Perhaps it was necessary and I guess—do we think that at some point
we can put the genie back in the bottle and get back to more traditional roles?
Mr. NELSON. Dr. Troske, I agree. This is a very good question
and it’s very important that the independence of the Federal Reserve and the separation of monetary policy from fiscal policy be
maintained. Being a lender of last resort is a very traditional role
of a central bank and of the Federal Reserve. It’s part of the reason
why the Federal Reserve was created.
You mentioned the Primary Dealer Credit Facility, that was a facility that was created using our emergency authority. But it
looked like a traditional discount window facility rather than lending to depository institutions, in the case of the Primary Dealer
Credit Facility, we lent to primary dealers who are generally large
investment banks, for very short terms with very good collateral.
And all of the Federal Reserve’s interventions were against very
good collateral. And all of the Federal Reserve’s credit facility
loans, apart from the TALF loans, which I’ve discussed, have all
been repaid with no cost to taxpayers. So, I would argue that the
Federal Reserve’s actions during the crisis have been consistent
with the traditional role of a central bank, as a lender of last resort, as a liquidity provider.
In the case of the TARP and the TALF, which we’re discussing
today, that was a very important role of the TARP in allowing the
Federal Reserve to participate in the TALF with the Treasury and
yet maintain its position as a liquidity provider by having the credit protection provided by that program.
Dr. TROSKE. Thank you.
The CHAIRMAN. Superintendent Neiman.
Mr. NEIMAN. Thank you.
I’d like to shift to another area, probably one that you’re not expecting, and that’s the critical lesson that we learned from the financial crisis on the inextricable link between safety and soundness and consumer protection and the fact that loans that are
made to individuals—either on onerous terms or loans that cannot
be paid back—have a clear impact on financial stability.
One of the most prominent steps to fix this problem, in DoddFrank, was the establishment of the Consumer Financial Protection Bureau. But regulators, particularly some of the witnesses
here today, clearly are not off the hook when it comes to consumer
protection. Certainly regular institutions below the $10 billion level

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continue to be reviewed for compliance by their existing federal
regulators.
But what I’m interested in, and maybe we could start with Mr.
Cave as deputy director of the Complex Institution Unit at the
FDIC, is how do you incorporate consumer protection into your risk
assessment at these large institutions, particularly those over 10
billion, where you no longer have responsibility for direct consumer
compliance examination that will be shifted to the CFPD?
Mr. CAVE. I’d be happy to answer that question. First off, at the
FDIC we view safety and soundness and consumer protection as
going hand-in-hand. We have made some changes in our structure
at the FDIC recently, creating a new Division of Consumer Protection to continue to give that very much the focus that’s necessary.
That group will work very closely with our supervision group.
But, it’s a very important issue. I think that the recent foreclosure situation highlights the fact that what can happen on the
consumer issues can have an impact for the large institutions. And
it goes to show the importance of having the structures and controls in place to deal with those issues. Regulators very much look
at those structures and controls to ensure that those are in place
because consumer issues could create risks to these institutions.
Mr. NEIMAN. So how will the actual supervision process change
going forward? So I assume there will be a formal process for sharing exam information with the CFPB when they take on that responsibility. But the risk—you’re still responsible for assessing risk
within those institutions, assessment management. So how will you
be able to assess management, assign ratings without having a
clear understanding of the processes and controls around risk? Will
it be beyond simply relying on the information from the CFPB?
Mr. CAVE. For the large institutions, our role will continue to be
in a back up capacity. So we’re used to being in that role, of having
to work with other regulators to ensure that we have the information we need to assist. From that standpoint, for the large institutions, we have some experience there. We’ve made some improvements to where things weren’t as enhanced, I think we would continue to work along those lines.
Mr. NEIMAN. Thank you. I don’t want to exclude other witnesses.
And you know, when blame is assessed there’s often fingers being
pointed across the board with respect to institutions and credit rating agencies, and regulators are certainly not left out of that list.
One of the issues that comes up frequently is the ability of regulators and examination personnel to stay current and have the expertise to understand the complexity of transactions at some of the
largest most sophisticated financial institutions in the world.
I’d like to get your sense of if this is an issue. How do you change
or are you changing, either the incentives or the hiring? What are
the issues around of being able to stay ahead and on top of these
complex transactions at some of the most sophisticated institutions
in the world?
Mr. LAWLER. We are indeed trying to develop a new program of
examiner training, internally, to address just those kind of problems.
Mr. NEIMAN. Mr. Cave.

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Mr. CAVE. At FDIC we recently created the Office of Complex Financial Institutions. I’m the Deputy Director of the monitoring section. There’s a few things going on there that are important to
note. We’ll have a group that is responsible for having onsite presence in the largest institutions. So we will have teams that will
look at specific institutions and look at all of the risks associated
with those. In addition, we’ll be creating a systemic risk branch
that will look at institutions horizontally—across institutions—to
see where there might be outliers, where there might be areas of
risk, and where there might be certain portfolios that require our
onsite teams to devote more attention.
So by covering the waterfront, both looking vertically at the institution and horizontally, we believe that we’ll get a better picture
of what’s going on. And that will feed very much into our resolutions group that will also be part of the Office of Complex Financial
Institutions and be responsible for the resolution plans. This will
provide information to say, ‘‘We’re seeing some things here that
concern us, I think we need to look further into the resolution
plans, see how the institutions are dealing with it.’’ So, we have
that hand-in-hand.
The other area we have is an international section. Because, as
it was noted in the earlier panel, having the coordination for these
large institutions beyond the U.S. borders is essential to ensure
that we will have plans that actually mean something when they’re
needed. So we will have a group that will be dedicated to working
with the international regulators to make sure we’re talking the
same language.
Mr. NEIMAN. Thank you. So there is no doubt, the fact that I am
a current regulator, I am totally confident that regulators have the
ability, that the types of people they are attracting have the ability
and experience to stay current in order to provide that kind of oversight role. This is something that we should never lose sight of and
though it will continue to be a challenge, it will certainly be a top
priority.
So thank you all.
Mr. LAWLER. And I should have added, as Jason and also the Fed
and the FDIC and all of the regulators that are part of FSOC have
developing units to address systemic risk issues that go across institutions.
Mr. NEIMAN. Thank you.
The CHAIRMAN. And thank you very much. Thank you for being
witnesses. Thank you for your public service.
I think as Superintendent Neiman said, it goes without saying
that one of the features of our democracy is that we have regulators that have to work. And it only works because we have good
people in regulatory agencies. And the sacrifices made by people in
the regulatory agencies and people in public service and especially
people in the federal service is something I’ve always been amazed
at.
So I just want to thank you again. And we’ll bring up the next
panel.
I am very pleased now to welcome our third panel of distinguished economists. Joseph Stiglitz, a Nobel Laureate, University
Professor at Columbia University; Allan Metzger—Meltzer, the

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Allan H. Meltzer University Professor of Political Economy at Carnegie Mellon; Simon Johnson, the Ronald A. Kurtz Professor of Entrepreneurship at MIT Sloan School of Management and a senior
fellow at the Peterson Institute for International Economics and
Luigi Zingales, the Robert C. McCormack Professor of Entrepreneurship and Finance and the David G. Booth Faculty Fellow at
the University of Chicago Booth School of Business. Thank you
very much for coming. I want to thank you all.
Please keep your oral testimony to five minutes so we can have
ample time for questions. Your complete written statement will be
printed in the record.
We’ll begin with Mr. Stiglitz.

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STATEMENT OF JOSEPH E. STIGLIZ, NOBEL LAUREATE AND
UNIVERSITY PROFESSOR, COLUMBIA BUSINESS SCHOOL,
GRADUATE SCHOOL OF ARTS AND SCIENCES (DEPARTMENT
OF ECONOMICS) AND THE SCHOOL OF INTERNATIONAL AND
PUBLIC AFFAIRS

Dr. STIGLITZ. Well thank you very much for this opportunity to
share with you my views about the success and failures of TARP.
TARP and the recovery of troubled assets were not ends in themselves, but means to an end, namely the recovery of the economy.
TARP was justified to the American people as necessary to maintain the flow of credit. It was hoped that it would provide—play a
pivotal role in dealing with the flood of mortgage foreclosures and
the collapse of the real estate market that led to the financial crisis.
In these ultimate objectives TARP has been a dismal failure.
Four years after the bursting of the real estate bubble and three
years after the onset of recession, unemployment remains unacceptably high, foreclosures continue almost unabated and our economy is running far below its potential, a waste of resources in the
trillions of dollars. Lending, especially to small- and medium-size
enterprises, is still constrained. While the big banks were saved,
large numbers of the smaller community and regional banks that
are responsibility for much of the lending to SMEs are in trouble.
The mortgage market is still on life support.
But TARP has not just failed in its explicit objectives, I believe
the way the program was managed has, in fact, contributed to the
economy’s problems. The normal laws of capitalism where investors
must bear responsibility for their decisions were abrogated. A system that socializes losses and privatizes gains is neither fair nor
efficient. TARP has led to a banking system that is even less competitive, where the problem of Too Big to Fail institutions is even
worse.
There were six critical failings of TARP. First, it did not demand
anything in return for the provision of funds. It neither restrained
the unconscionable bonuses or payouts and dividends, it put no demands that they lend the money that they were given to them, it
didn’t even restrain their predatory, speculative practices. Secondly, in giving money to the banks it should have demanded appropriate compensation for the risk borne. It is not good enough to
say that we were repaid or we will be repaid or we will be almost
repaid.

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If we had demanded arm’s length terms, terms such as those
that Warren Buffett got when he provided funds to Goldman Sachs,
our national debt would be lower and our capacity to deal with the
problems we had would be stronger. The fairness of the terms is
to be judged ex ante, not ex post, taking into account the risks at
the time.
Thirdly, there was a lack of transparency. Fourthly, there was a
lack of concern for what kind of financial sector should emerge
after the crisis. There was no vision of what a financial sector
should do. And not surprisingly, what has emerged has not been
serving the economy well.
Fifthly, from the very beginning TARP was based on a false
premise, that the real estate markets were temporarily depressed.
The reality was that there had been an enormous bubble for which
the financial sector was largely responsible. It was inevitable that
the breaking of that bubble, especially given the kinds of mortgages
that had been issued, would have enormous consequences that had
to be dealt with. Many of the false starts, both in asset recovery
and homeowner programs, have been a result of building on that
false premise.
Particularly flawed was the PPIP, a joint public/private program
designed to have the government bear a disproportionate share of
the losses, the private sector, while putting up minimal money,
would receive a disproportionate share of the gains. It was sold as
helping the market re-price but the prices that were—that would
emerge would be prices of options, not of underlying assets. The
standard wisdom in such a situation is summarized in a single
word, ‘‘restructure.’’ But TARP, combined with accounting rules
changes, made things worse.
The sixth critical failure of TARP was that some of the money
went to restructuring securitization under the TALF program,
without an understanding of the deeper reasons for the failure of
mortgage securitization. These attempts to revive the market have
failed, and to me this is not a surprise.
There were alternative approaches, evident at the time of the crisis and even more so as time went on, that I describe more fully
in my written testimony. These approaches, had they been taken,
would have led not only to a strong economy today but would have
led to our government being in a stronger fiscal position.
We might say, ‘‘Oh, this is water over the dam,’’ but it’s not. We
have not repaired our banking system and indeed, with the enhanced moral hazard and concentration in the financial sector, the
economy remains very much at risk, in spite of Dodd-Frank. Our
economy is not back to health and will not be until and unless
lending can be restored, especially to small- and medium-size enterprises. This means that we need a more competitive financial
sector and one more focused on its core mission of lending.
A wide—there is a wide array of important activities performed
by the financial sector, but not all of them should be undertaken
by government-insured banks. Banks won’t focus on lending if they
can continue to make more money by publicly underwritten speculation and trading or by exploiting market power in the credit and
debit card markets. Moreover, Too Big to Fail institutions, whether
they be mortgage companies, insurance houses or commercial in-

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vestment banks, pose an ongoing risk to our economy and the
soundness of government finances.
I want to conclude with two more general comments. First, we
should not forget the process by which TARP and this oversight
panel were created. That political process does not represent one
of the country’s finest moments. At first a short three-page bill was
presented giving enormous discretion to the Secretary of Treasury
and without congressional oversight and judicial review. Given the
lack of transparency and potential abuses to which I have already
referred, which occurred even with full knowledge that there was
to be oversight, one could only imagine what might have occurred
had the original bill been passed.
Fortunately, Congress decided that such a delegation of responsibility was incompatible with democratic processes. On the other
hand, the political deals required to get TARP passed, with an estimated $150 billion in largely unjustified and unjustifiable tax
breaks, do not speak well for our democracy. When we think of the
cost of TARP, surely the price tag associated with those tax breaks
should be included in the tally.
Nor should we underestimate the damage of the correct perception that those who were responsible for creating the crisis were
the recipients of the Government’s munificence. And the lack of
transparency that permeated this and other government rescue efforts has only reinforced public perceptions that something untoward has occurred.
For these and the other failings of TARP, our economy and our
society have paid and will continue to pay a very high price.
[The prepared statement of Dr. Stiglitz follows:]

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The CHAIRMAN. Thank you.
Mr. Meltzer.

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STATEMENT OF ALLAN H. MELTZER, ALLAN H. MELTZER UNIVERSITY PROFESSOR OF POLITICAL ECONOMY AT CARNEGIE MELLON UNIVERSITY

Dr. MELTZER. Mr. Chairman, members, gentlemen.
The invitation to this hearing, like most discussions of the TARP
program asked whether TARP succeeded in preventing major financial failures. My answer is yes, TARP avoided a potential financial disaster.
My concern is with a question. Congress should not start with a
crisis that followed Lehman Brother’s failure, instead it must ask
and demand answers to some other questions. Why was it necessary to issue about a trillion dollars of public money to prevent
financial collapse? What, if anything, has been done to reduce to
insignificance the prospect that another TARP will follow at some
unknown time in the future?
Like many other bad decisions, the use of public funds to prevent
failures began small. In the 1970’s the Federal Reserve began the
policy that became Too Big to Fail, by preventing the failure of
First Pennsylvania Bank. That was followed by other bailouts.
Soon bankers and financial firms recognized that becoming large
was a way to reduce risk. Some recognized that they could take
more risk. This is known as moral hazard.
The process works like this. I’ve been present for some of these.
Bankers and Treasury or Federal Reserve staff warn the principal
policymaker that the failure invites a domestic or world financial
crisis. Sometimes they say, ‘‘Mr. Secretary, your name will be on
that crisis in the history books.’’ I’ve never found any way of overcoming that warning when the crisis occurs or seems imminent.
It doesn’t help to point out that on the few occasions when there
was no bailout, financial failures occurred but no crisis followed.
One example is the failure of Penn Central Railroad in June, 1970.
Penn Central Railroad was a major issuer of commercial paper.
The commercial paper market closed to most issuers. Federal Reserve Chairman Arthur Burns was anxious to protect the commercial paper market by bailing out Penn Central. Budget Director
George Schultz opposed. President Nixon made the mistake of appointing an outside counsel from his old Nixon law firm. Congressional leaders, led by Congressman Wright Patman, viewed that as
an effort to assist the Republican Party. That ended the bailout.
The taxpayers were lucky that time, there was no crisis. The
commercial paper market declined but borrowers got the accommodation at banks. No crisis occurred. After a few months the commercial paper revived—market revived.
Drexel Burnham Lambert, the major issuer of non-investment
grade debt at the time, went bankrupt. No bailout and no crisis.
Other financial firms took over the business that Drexel had done
and Drexel went into bankruptcy.
The main reason that policymakers resort to Too Big to Fail in
ever larger amounts is regulatory failure. Regulators do not require
financial firms to hold enough capital. In the 1920’s large banks
had capital—held capital equal to 15 to 20 percent of their assets.

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119
Many small banks, but no large banks, failed. Even in the early
years of the Great Depression, very few large banks failed. Stockholders, not the general public, bore those losses. That is as it
should be, in my opinion.
After the recent crisis Congress passed the Dodd-Frank bill.
Dodd-Frank did nothing to increase capital requirements. The
international regulators at Basel did better, but did not increase
capital enough. Further, Dodd-Frank put the Secretary of the
Treasury at the head of the committee to decide on Too Big to Fail.
That decision embeds two errors in the law. First, the time to prevent bailouts is not when the crisis occurs, it has to be established
policy, not a judgment made when failure threatens the international financial market. We profess to believe in the rule of law,
we need a law that embeds a rule and a policy that applies it.
Second, the Secretary of the Treasury is very often the principal
person who favors Too Big to Fail. Nothing in Dodd-Frank changes
these incentives, it continues bailouts, it even provides money for
them.
I will repeat the proposal I’ve made in several previous hearings,
that some minimum size to protect community banks, Congress
should require banks to increase capital relative to their assets as
asset size increases. Instead of subsidizing large banks we should
make them pay for the cost that they impose. If a bank increases
assets by ten percent, capital must increase by more than ten percent.
The proposal has three major benefits. First, stockholders and
managers bear the losses, not the taxpayers and the public. Second, the rule encourages prudence and eliminates the imprudent
by replacing owners of failed banks. Third, Congress can eliminate
many of the regulations included in Dodd-Frank. Regulation will
not strengthen financial institutions, more capital will.
In the most recent crisis Bear Stearns was the first big failure.
Instead of letting it fail the Federal Reserve took some of the worst
assets on to its balance sheet, shifting many losses to the public.
The market read the decision as a sign that Too Big to Fail remained the policy. They got a big shock when without much warning, in the midst of a recession, Lehman Brothers was allowed to
fail. This sudden policy change without warning in the midst of a
recession created massive uncertainty. I believe Secretary Paulson
and Chairman Bernanke were wrong to change policy without
warning, but I praise the prompt response called TARP that provided liquidity to all parts of the market after making a huge error.
TARP avoided compounding the error.
Notice, however, what has happened. Chairman Bernanke told
us that the top funds were short term, they would run off in due
course, thereby shrinking the Federal Reserve balance sheet. But
instead of shrinking the Fed, at the pressure from the Treasury,
bought mortgages more than offsetting the original TARP funds.
Again, Chairman Bernanke told us that the mortgages would
start—would be repaid so the balance sheet would shrink. Again,
that didn’t happen. QE–2 purchased more than—purchases more
than offset the reduction in mortgages.

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I don’t believe that the Federal Reserve has a credible strategy
to reduce its balance sheet. We face the prospect, in future years,
of high inflation.
Three last remarks. First, how can Congress continue to justify
a system that makes the public pay for bankers’ mistakes? Second,
remember that capitalism without failure is like religion without
sin, it doesn’t work. Third, Congress should demand a detailed
statement of how the Federal Reserve plans to shrink its balance
sheet, including an estimate of how high market interest rates will
have to rise.
[The prepared statement of Dr. Meltzer follows:]

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124
The CHAIRMAN. Thank you.
Mr. Johnson.

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STATEMENT OF SIMON H. JOHNSON, RONALD A. KURTZ (1954)
PROFESSOR OF ENTREPRENEURSHIP, MIT SLOAN SCHOOL
OF MANAGEMENT AND SENIOR FELLOW, PETERSON INSTITUTE FOR INTERNATIONAL ECONOMICS

Dr. JOHNSON. Thank you, Senator Kaufman.
I completely agree with and would like to endorse the views of
both Professor Stiglitz and Professor Meltzer. And let me frame my
agreement in the form of the following question. Does anyone here
think that Goldman Sachs could fail? If Goldman Sachs hits a rock,
a hypothetical rock, I’m not saying they have and I’m not saying
they will, but if they were to hit a rock, does anybody here believe
that it would be allowed to collapse, fail, go bankrupt,
unencumbered by any kind of bailout now or in the near future?
I’ve asked this question around the country and across the world
for the past two years, I’ve yet to find anyone who realistic thinks
it could fail. I found some people who wish it could fail, but that’s
a different question.
Goldman Sachs is too big. Goldman Sachs has a balance sheet
around $900 billion in the latest data. It was a $1.1 trillion bank
when it came close to failing in September 2008 and it was rescued
by being allowed to convert into a bank holding company. It is too
highly leveraged. Those debts are held in a complex manner
around the world, including through its derivative positions. And
it is too inherently cross border. We—I would remind you, and I
would ask you to reinforce with everyone you meet, we do not have
a cross border resolution authority. Whatever you think of DoddFrank, and I share many of the reservations already expressed,
there is, there can be no cross border resolution authority in U.S.
legislation. You need a cross border agreement.
Among other things, I’m the former chief economist of the International Monetary Fund, I know well the technical people, the G20,
the G10, various bodies responsible in the alphabet soup of international regulation and macro-prudential supervision, I know these
people, I talk to them, there will not be a cross border resolution
in our lifetimes. No mechanism, no authority. You cannot handle,
in an orderly fashion, the failure of a bank like Goldman Sachs or
JP Morgan Chase or Citigroup which operate in 50, 100, 120 countries. You can let them collapse but then you face another Lehman,
or you can bail them out with some form of conservatorship where
you protect the credit, and that’s the key point, and then you have
all of the complications Professor Stiglitz and Professor Meltzer put
forward.
Or it gets worse. You enter another phase of what the Bank of
England now calls a ‘‘doom loop’’ where repeated boom, bust, bailout cycles lead you not just to some unfortunate situation where
there’s always a transfer from the public to the bankers, it leads
you to fiscal ruin. And if you don’t believe me look carefully at the
experience of Ireland, where three big banks became two times the
size of the Irish economy and they blew themselves up at enormous
cost. That is where this leads. It leads to fiscal ruin.

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What we should have done along with TARP or in addition to it,
quickly on its heels, is implement a form of size cap, a form of leverage cap relative to GDP, just as was proposed in the BrownKaufman Amendment to Dodd-Frank, which unfortunately failed
on the floor of the Senate, I believe 33 to 61.
We should also have implemented a cross border resolution
framework, although as I said, that will always prove elusive.
Given that those measures have failed and that water is now under
the bridge, we should do exactly what Professor Meltzer and Professor Stiglitz have suggested. We should have much higher capital
in these banks.
It is astonishing, but unfortunately true, that Basel III supplemented with all the supplementary cushions and all of the implementation that we will see for systemically important financial institutions, the so-called SIFIs, will I believe leave us with a Tier
I capital requirement below that which Lehman Brothers had the
day before it failed. Lehman Brothers had 11.6 percent Tier 1 capital. We will end up between 10 and 11 percent.
How can this make any sense? The Swiss national bank is requiring 19 percent capital requirements, although I would suggest
they go with pure equity for all 19 percent. The Bank of England
is actively pursuing and trying to implement capital requirements
closer to 20 percent.
Raising capital requirements in this form is not socially costly.
I know that the bankers claim vehemently to the contrary, but they
are wrong. And if you don’t believe me you should consult the research of Anat Admati and her colleagues at Stanford and other
leading universities. These are the top people in finance who are
not captured by the financial industry and they say we need more
capital, it’s not costly and we need a version, I would suggest, of
exactly what Professor Meltzer just laid out for you most
articulately. We are not going to do it.
In conclusion, let me quote Larry Summers. His 2000 Ely Lecture to the American Economic Association where he reviewed the
experience of financial crisis around the world to that point, particularly in the 1990s when he was at the U.S. Treasury. And Mr.
Summers said, ‘‘It is certain that a healthy financial system cannot
be built on the expectation of bailouts.’’
[The prepared statement of Dr. Johnson follows:]

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131
The CHAIRMAN. Mr. Zingales.

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STATEMENT OF LUIGI ZINGALES, ROBERT C. MCCORMACK
PROFESSOR OF ENTREPRENEURSHIP AND FINANCE AND
THE DAVID G. BOOTH FACULTY FELLOW, UNIVERSITY OF
CHICAGO BOOTH SCHOOL OF BUSINESS

Dr. ZINGALES. Thank you, Chairman Kaufman and members of
the Congressional Oversight Panel. Thank you for inviting me.
In providing—TARP and the financial sector economy it’s important to establish what is a counter factor, what will happen in the
absence of TARP. Chairman Bernanke and then Treasury Secretary Paulson repeatedly presented their choice as an alternative
between TARP and the collapse of the entire financial system. If
the alternative was indeed the abyss, TARP is clearly an unqualified success. We have escaped the abyss.
Even if the alternative was between TARP and some chance of
falling into the abyss, we have to conclude that TARP was a success. The cost of TARP, however big, is small with comparison to
the possibility of a second Great Depression.
Pietro Veronesi and I estimated the bankruptcy of the ten largest
banks would have wiped out 22 percent of their value for a total
of 2.4 trillion, a number that doesn’t consider the cost imposed on
the rest of the U.S. economy which could be a multiple of that. The
financial system was at risk and some intervention was needed.
Yet, it is both false and misleading to say there were no other alternatives. False because there were feasible and in fact superior
alternatives. Misleading because it made TARP appear inevitable
forcing people not to question its cost.
By stating clearly why an intervention was needed, ie. where the
market failed, it would have been possible to design plans more effective and less expensive. This is not just hindsight. On September
19, 2008 I wrote a proposal to address the instability of the financial system through an emergency reform of the bankruptcy code
that could have transformed the long term debt of shaking financial institutions into equity. The feasibility of this idea is proven
by the fact that the Credit Suisse has not advanced a similar proposal to deal with future bailouts. The same is true for alternative
plan to deal with home foreclosure and with the bankruptcy of GM
and Chrysler.
I didn’t write a plan for AIG because I never understood what
the real goal of bailing out AIG was, to save European banks, Goldman Sachs or the policyholder. We have to rely on Wall Street for
claims that the failure would have completely roiled markets.
If we agree that other feasible alternatives did exist, then we
have to consider the cost and benefits of TARP, vis a vis these alternatives. Veronesi and I estimated that the capital purchase program increased the value of banks’ debt by 120 billion at a cost of
32 billion for the taxpayers. Though in spite of the enormous value
created by the government intervention, taxpayers ended up with
a large loss. In the auto companies’ case, creditor were now the
winner, the autoworkers union was with a gain of 16 billion. There
is, however, a consistent lower, the taxpayers who lost 59 billion
in the rescue.

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TARP was the largest welfare program for corporations and their
investors ever created in the history of humankind. That some of
the crumbs have been donated to the autoworkers unions doesn’t
make it any better. It makes it worse. It shows that that redistribution was no accident, it was a premeditated pillage of defenseless taxpayers by powerful lobbyists. TARP is not just a triumph
of Wall Street over Main Street, it is the triumph of K Street over
the rest of America.
Yet, the worst long term effect of TARP is not the burden imposed on taxpayers but the distortion to incentives it generated.
First, its excessively lenient terms of the bailout ensure that the
legitimate assistance recapitalized in smaller banks and at market
terms became more difficult.
Second, the way subsidies were distributed under TARP show
that the enormous return to lobby. A member of the Bush Treasury
admitted that during the summer of 2008 any phone call from the
212 area code had one message, ‘‘Have the government buy the
toxic assets.’’ Eventually this constant request became government
policy.
Third, the way the bailout was conducted destroyed the faith
that the Americans have in the financial system and in the government. In a survey they conducted in 2008, 80 percent of the American people stated that the government intervention made them
less confident to invest in the financial market.
Last but not least, it entrenched the view the large financial institutions cannot fail and their creditors cannot lose. This expectation leads investors, such as a CFO I know, to invest their money
in the banks most politically collected, not in the most financially
sound.
This is the end of the credit analysis and the beginning of political analysis.
[The prepared statement of Dr. Zingales follows:]

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The CHAIRMAN. Thank you.
Now we’ll begin the questions. And the first question I have is
moral hazard. The panel, one of the things that has been incredible
about the way this panel’s functioned since I’ve been here is, and
not because of me, because of the other panelists, is how bipartisan, non-partisan things have been. And I think moral hazard
has been raised in every one of our discussions, just about everything that TARP’s done and our concerns about that.
Could each one kind of—this is kind of the history of TARP. Can
each one kind of talk about how you think TARP impacted on
moral hazard?
Mr. Stiglitz.
Dr. STIGLITZ. You know, I think the point has been made by all
four of us, and we didn’t coordinate our testimony.
The CHAIRMAN. Right.
Dr. STIGLITZ. And I think this is reflecting where the broad span
of the economics profession is from a whole spectrum. We don’t
agree about a lot of things, but one of the things we do agree is,
incentives matter. And that if you know that you’re going to get
bailed out no matter what your losses are, then you have an incentive to take on more risk. The market gets distorted because the
Too Big to Fail banks get capital at a lower cost. So that money
doesn’t flow on the basis of efficiency, but on the basis of this connectedness, is the way Professor Zingales put it.
So it’s manifested in absolutely every way. It also gets manifested at a higher level, it’s not quite moral hazard in the usual
way, but the banks have gotten much higher returns out of their
political investments than any other form of investment. And you
might say, from the point of view of a firm obligated to maximize
your returns to your shareholders, ‘‘Where is the best place to put
your money? It’s on K Street.’’
The CHAIRMAN. Mr. Meltzer.
Dr. MELTZER. I agree completely with Joe. [Laughter.]
He’s absolutely right. There has to be incentive. Those incentives
will never come if you say to the Secretary of the Treasury, ‘‘Look,
there’s this crisis and we have to do something about it now. We
have to do something about it before. We have to have capital in
the banks. We have to give an incentive to the bankers to be prudent in the risks that they take.’’ No set of regulations is going to
do that.
You know, I’ve given this talk to lots of places, including the
Council on Foreign Relations, where I said regulations are made by
bureaucrats and regulators and is circumvented by lawyers and
markets. First question was a man got up and said, a large Wall
Street audience, first question came from a man who said, ‘‘I’m a
Wall Street lawyer, who do you think shows them how to circumvent them?’’ [Laughter.]
We need to have capital so that the incentives are on the banker
and stockholders to avoid TARP. We started small with First Pennsylvania. Before the 1970’s we didn’t bailout large banks. It’s only
something that has been growing and growing and growing. And
it’s time for Congress to put an end to it.
The CHAIRMAN. Mr. Johnson.

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Dr. JOHNSON. Gene Farmer, the father of the efficient markets
view of finance, said on CNBC recently, ‘‘Too Big to Fail is not a
market, it’s a government subsidy scheme.’’ And it’s an abomination and it should end. The new GSEs, the government sponsored
enterprises of today are—include, most prominently, the largest six
bank holding companies in the country: Bank of America, JP Morgan Chase, Citigroup, Wells Fargo, Goldman Sachs and Morgan
Stanley. These firms can borrow more cheaply because they are
backed by the government.
The estimates—responsible, realistic estimates are they have a
funding advantage about 50 basis points, .5 of a percentage point.
They can get bigger, they want to get bigger, they want to become
more global. These are all exactly the things we can’t deal with
when they fail. It’s all the things that make it harder for any secretary of the Treasury to refuse them a bailout.
Gene Farmer suggests, and I actually agree with him, we should
be looking at capital requirements closer to 40 or 50 percent. This
isn’t—this is just the percent of their assets financed with equity.
I know it’s anathema to the modern bankers, because they’re excessively focused on return on equity.
And also they’re not doing the analysis right. They’re not following the principles of basic finance.
And again, I refer you to the website of the analysis of Anat
Admati and her colleagues who have written extensively about this
for a broad audience and explained it to the newspapers repeatedly
in op eds and letters. The technical people get this, the bankers
refuse because they want to be paid on a risk—on a return on equity basis that’s not risk adjusted. That way they can get a lot of
cash out in the boom and they walk away a long time before society
bears these horrible ultimate costs.
The CHAIRMAN. Mr. Johnson, let me just follow up on that and
then I’ll get to Mr. Zingales.
The plan of major banks to increase their dividends. How does
that fit into capital requirements and stockholders’ equity?
Dr. JOHNSON. Senator Kaufman, it makes no sense at all. The
Federal Reserve and the other responsible authorities have not yet
determined—you know, so even within their own framework it
makes no sense. They’ve not yet determined what a systemically
important financial institution should hold. There are exactly the
issues you were discussing with the previous panel, in terms of additional losses coming through from major lawsuits, various kinds
of put-backs and so on. We don’t know how much capital they’re
going to need to weather the next stage of the global cycle. And the
Federal Reserve has not yet determined that. So why you would
allow them to pay out any of this capital as dividends? This is just
reducing their equity, it is allowing them to have more leverage in
their business.
The bankers, again, want it because they get paid on a return
on equity basis. But this is just letting them leverage up. And
there’s a put option. We write the put option, we bear the cost of
that. You’re increasing the put option, which is not scored in anyone’s budget, by allowing them to pay these dividends. It’s unconscionable, it’s irresponsible and the Federal Reserve should back off

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from allowing this increase in dividends, which is apparently where
they’re currently headed.
The CHAIRMAN. Thank you. And I’ll take this time off my next
thing, Mr. Zingales, so we can have everyone comment.
Dr. ZINGALES. Thank you.
In terms of—I agree with most of—what everybody else has said.
Let me point out one aspect of moral hazard that people generally
don’t think of, because they always think about sort of shareholders doing crazy stuff.
But moral hazard arises also on the size of investors. What I was
mentioning in my testimony is during the crisis I was talking with
a CFO who had to park his liquidity, it was in Europe. And he had
like very large liquidity in this company and was worried and he
said, ‘‘I need to invest in a safe place. Where is a safe place, and
not the banks with more capital, other banks who are more politically connected.’’
And so this creates the incentives for lenders to actually lend
more to the banks that are politically connected, independently of
their safety. And bankers who find this—that extremely cheap, find
it irresistible to take back. And sometimes they take back because
they really sort of want to speculate, sometimes it’s because they
just don’t see the end in sight. I think that in the case of Lehman,
probably at the end, Dick Fuld was a fool, was not excited playing
on some strategic risk taking, was simply not seeing that—the mistakes he was doing. But the credit market was not there to stop
him because the credit market felt ensured by the Too Big to Fail
policy.
Let me add another couple things that are slightly different to
my colleagues here. Number one, I would like, like Professor
Meltzer, stop the Too Big to Fail by legislation. I don’t think this
is feasible. I think that it’s like trying to stop a parent from saving
a child when the child is in danger. I think that we should not bailout our children, it’s not educationally good, but when their life is
in danger we can’t resist. And even if we promise before not to do
it, eventually we’re going to do it.
So the very way to address sort of this problem is not by legislating out an intervention, it is by adding a system of intervention
in place. Because the real problem of the regulator is they intervene too late. It’s not that they don’t have the instruments.
Let’s take a case where they did have the instrument, like in
savings and loans or in the case of Washington Mutual, the regulator had the—all the instruments to intervene. You know when
they intervene? When the credit default swap price was 3,305. It
means 33 percent spread over the risk free rate.
And in spite of this, if you Googled Washington Mutual and
shareholders, you find that there are some shareholders sued because the shareholders are complaining that the regulators are—
intervene too early. I always say, if you are a turkey Thanksgiving
always comes too early. And if you are sort of a shareholder of a
bank that is really out of the money, the regulator always intervenes too early and you exert an enormous political pressure for
them to intervene.
So we need to have the market-based signal to force the regulator to intervene early on and give a choice, either you recapitalize

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or you are liquidated. And in a sense, what the gentleman earlier
was saying, from the Treasury, the stress test was exactly that,
was an out and out choice. Either you sort of recapitalize or we
take you over. And all of a sudden all the problems in raising capital disappeared.
The CHAIRMAN. Thank you very much. I just lost my second
round.
Mr. McWatters.
Mr. MCWATTERS. Thank you. That’s a hard act to follow.
When I read your testimony last evening, it was well after midnight, I’d just flow in and I was thumbing through the pages and
I thought, ‘‘Okay, there’s four minds here thinking pretty much the
same way.’’ And I happen to agree with most everything I was
reading, which was delightful.
It raises a question though. If we go back to September of 2008,
okay, September, 2008 if President Bush and Secretary Paulson
had called you and said, ‘‘We’re in a jam, we’re in a really bad jam
here. What should we do,’’ what would you have said?
Mr. Stiglitz.
Dr. STIGLITZ. Well, I think it is clear that there had to be some
government action. I think it’s also clear that we’ve all said the
real mistake was letting things get to that position and also the
case that given what we know now, the Fed knew that there was
a lot of turmoil in the financial markets well before. Everybody
knew; the Financial Inquiry Commission pointed this out, that
after Bear Stearns it was known that Lehman Brothers was very
likely—this argument that they didn’t have authority is a little bit
nonsense, because if they really believed that, they should have
gone and asked for the authority. So they needed to do something.
The real problem that I had, and I tried to emphasize in my remarks, was the way they gave money to the banks was wrong.
Now, interesting, when TARP was passed, they said they were
going to buy the troubled assets. Everybody pointed out that that
was a flawed approach and to their credit Paulson changed the
strategy after several weeks. And it would have been an even
worse disaster had he not changed that strategy. But the way the
money was put in, as I said before, without conditions, without
thinking about the structure of where you wanted to go, and most
importantly without thinking about the mortgage market which
was the source of the—the underlying source of the problem. It
seemed to me that they went in without any vision, without any
understanding of how to get re-lending started, what to do with the
mortgage market. And they’d had plenty of time to think about
that. So it’s not the intervention, it’s how the intervention was
done.
Mr. MCWATTERS. Okay. Mr. Meltzer.
Dr. MELTZER. I’m in a good position to answer your question, Mr.
McWatters, because I appeared on the Lehrer Program when the
program was first announced and I said, ‘‘I’m against it. He hasn’t
explained how it’s going to work, he hasn’t explained why it should
work, he doesn’t have a coherent plan. We need a coherent plan.’’
I’ve got—I’ve been on TV, such programs, many times. I received
an overwhelming response from the public. Nobody that I knew, it
went 149 to 1 on my side.

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I got a call from the Treasury, they said, not in so many words,
but the message was clear, the message was, ‘‘Okay, wise guy,
what would you do?’’ So I went to the Treasury and I told them
what I would do. I said, ‘‘Call the banks in, raise capital in the
market. If you can raise—if you need $20 billion, raise $10 billion
in the marketplace and we’ll give you $10 billion at subsidized
rates. If they can’t do that they’re done.’’ The Treasury eventually
did something like that, close to that but at the time they didn’t
want to hear it.
Capital, that’s spelled in capital letters, is what protects the public and incentivizes the management and the stockholders.
Mr. MCWATTERS. Okay. Thank you.
Mr. Johnson.
Dr. JOHNSON. If you give me the choice between global calamity
and unsavory bailout, I’m going to suggest unsavory bailout, along
the lines of Mr. Meltzer recommending the capital injection, that
is best practice if you find yourself with that choice.
But I think all of the suggestions we’re making are with regard
to how do you learn the lesson and reduce the chance of a global
calamity scenario going forward. And I completely agree, that given
the options now on the table, capital is the answer. We need a lot
more capital and it needs to be pure capital, real capital, not funky
capital, not hybrid capital, not contingent capital. It needs to be
real equity capital in our financial system.
This is not costly, from a social point of view. The bankers don’t
want it. They hate it. They’re fighting against it. All the arguments
they brought forward against it are pure lobbying. They have no
research on their side. They have no analysis on their side. It is
complete public relations exercise. We need a lot more capital in
the financial system here. And we need to persuade anybody who
wants to do banking business or financial sector related business
in the United States from another country needs to have, whatever
they do in the United States be just as well capitalized as our financial institutions. And hopefully that will be a lot more capital
than we have today.
Dr. ZINGALES. Also in my case the question is not so hypothetical. I am a member of the Committee on Capital Market Regulation and while I didn’t speak directly to Treasury, I did speak
with the chairman of our committee who spoke with Paulson. And
I had a very clear proposal that I articulated in two pieces that I
reference in my testimony.
One with a very subtle title, ‘‘Why Paulson is Wrong’’ and the
second, ‘‘Plan B’’ where I would say it’s very simple, you basically
require a bank to do a debt for equity swap. There is enough long
term debt that can absorb those losses. And if you think that this
requirement is coercive, you give the option to shareholders to buy
back their shares through a scheme that is known in the literature
as a batch scheme, which is very fair.
So it would not have been coercive at all, it would have been immediate. And even—the only objection that people could raise to
the Meltzer idea, which is a very good idea, is the market is not
ready to provide that capital. In that particular case there wasn’t
even that objection. So the plan was feasible.

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And, as I said in my testimony, now the Credit Suisse is proposing it as the law of the land in Switzerland. Why? Because
banks in Switzerland know that they are too big to be saved. And
so they are concerned about what is going to happen in the future.
In the United States they’re not concerned about that so they lobby
in a different direction.
Mr. MCWATTERS. Okay. Thank you.
I’ll ask one more question. This will be my second round. If you
fast forward to today and look at the other end of the bookend,
March 4, 2011, you’ve all described problems we have now. The
chair has described moral hazard and the like, we’ve all written
and talked about moral hazard. What do you do today? I can anticipate your answers as I think you’ve given them, but just to make
it very clear on the record, what would your recommendation be on
March 4, 2011?
Dr. STIGLITZ. Okay, very briefly. You know, first I want to emphasize the two things that we’ve already said. One, that you need
more capital and that you need—the magnitude of more—increasing capital has to be commensurate with the size of the banks, the
risk of the Too Big to Fail distortion has to be eliminated.
But secondly, if you have a problem, I think Professor Zingales
is right, you ought to play by the ordinary rules of capitalism which
says when you go into bankruptcy you convert debt to equity. I
mean it’s really just a version of the standard rules of capitalism.
And you look at the numbers, say back in Citibank, they had
enough long-term capital that it was more than enough to manage
them, it was actually more than we actually put in. So the answer,
you know, that we need to have the resolution authority, ought to
be nothing more than basically the rules of capitalism.
But I do feel that because there are what we call agency problems, that the owners of the bank—the managers of the banks do
not necessarily act in the interest of the owners. This is, you know,
we have a kind of managerial capitalism, that you have to go beyond that to have regulations and restrictions on risk-taking. And
in particular, for instance, that it should not be allowed for government-insured institutions or very large institutions to be writing
these kinds of risky derivatives and under other very high risk activities.
So I think we do need additional regulations and more transparency that would circumscribe excessive risk taking by either
government insured institutions or large institutions, because
they’re implicitly government-insured, because I don’t think the
capital is enough, is a full solution.
Mr. MCWATTERS. Thank you.
Dr. MELTZER. At the risk of sounding as though Simon Johnson
and I collaborated, I would say, I’ll change the word capital to equity and picking up what he had said. And what would I would do?
I would raise the requirement to say that for every—that after a
minimum size, to protect community banks, you start to phase in
capital requirements which start at 10, 10 percent and increase as
the size of the bank increases so that it’s 11, 12, 13 going up toward 20. So that the largest banks will be paying what they were
paying in the 1920’s.

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And I would phase that in beginning now, because the big banks
are reporting substantial profits. And I would give them three
years to get to the required capital.
And as far as other regulation is concerned, I’m a believer that
regulation only works when it incentivizes the regulated. That is,
if you compare drug regulation where you say, ‘‘Well, we’ll give you
a monopoly and you produce this drug,’’ then you have someone
who wants to protect his right. We have to go the same thing. Capital is one way to do it. There are other ways to incentivize the
bankers. If we just give them prohibitions what we’ll get, you can
see it happening, you can see the number of lobbyists, bankers that
are in Washington every day trying to write the rules that were
passed in Dodd-Frank. That isn’t the way we’re going to restrict future risks.
Mr. MCWATTERS. Okay. Thank you.
Dr. JOHNSON. Don’t allow them to pay dividends today. Nobody
knows—we’re all agreeing you need more capital. Nobody knows
how much capital is necessary. The—even the bankers will concede
that the easiest way to increase equity in the business is to retain
earnings. They have profits now. That money stays in the bank, it
belongs to the shareholders.
Paying out equity under these circumstances makes no sense in
economic terms. It’s irresponsible. It encourages risk taking of
these banks, high leverage bets and it’s completely contrary to the
state of policy, both in the broad of the administration, Mr.
Geithner says, ‘‘We need capital, capital, capital,’’ that’s what he
says all the time. But they’re not pushing for enough capital.
And it’s completely against the process. The federal Reserve process stress test and the determination of how Basel III will apply
to systemically important financial institutions is not done, so why
would you let them pay capital under these circumstances? It
makes no sense and they shouldn’t do it.
Mr. MCWATTERS. Okay. Thank you.
Dr. ZINGALES. I agree with most of what has been said, with one
qualification. I think the definition of capital, especially if it is done
in accounting terms, is not particularly useful because Washington
Mutual did not violate any capital requirement before it failed. As
was reminded earlier, Lehman at 11 percent of capital just the day
before it went bust. So I don’t think that this accounting based
measure of capital are particularly useful.
What we need to do is a market base. And Oliver Hart and I
have a proposal based on credit default swap, you can have other
proposals based on other indicators.
But I think the notion is we don’t want to treat everybody the
same, because there are virtuous banks, there are sort of people
who behaved properly. Why should they be subject to the same
rules? I think that the rule should be if your CDS is above a certain level you cannot pay dividends and you cannot pay cash
bonus. You have to transform all the bonus you want into equity
and that will likely play a bigger role in recapitalizing banks than
even stopping dividends.
Mr. MCWATTERS. Thank you gentlemen.
The CHAIRMAN. Mr. Silvers.

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Mr. SILVERS. Well, if I’ve learned one thing from this panel, it’s
not to ask all of you the same question. [Laughter.]
Actually I have several questions I would like to get answered,
and so although I enjoyed listening to you I’m going to be specific
in whom I’m asking.
First, when Secretary Massad spoke one of the things that I took
away from his testimony was the argument that while we have a
lot of problems in our economy, those problems aren’t really related
to TARP. Unemployment, foreclosures, so forth, that they didn’t
really—perhaps even in credit provision are not really the fault of
TARP or shouldn’t be—TARP shouldn’t be held responsible for it.
Professor Stiglitz, I think I take your testimony to be of the view
that you don’t agree with that. Can you explain what it is, in relation to those macroeconomic matters, that are related to TARP?
Dr. STIGLITZ. Well, they’re related in the short run and in the
long run. In the short run what I was trying to argue is that if
you—they had given money to the banks in ways—in other ways,
they could have induced more lending and induced more restructuring. So for instance, by the time we bailed out Citibank and
Bank America, we were very large shareholders. We could have
been even larger shareholders if we got shares——
Mr. SILVERS. If we got the value for the money, so to speak?
Dr. STIGLITZ. Yeah, if we had gotten voice relative to the money
we put in. If we used that shareholder voice to say, you can’t go
make your profits out of speculation, you can’t go paying these bonuses, this goes back to the point paying out bonuses and dividends
is decapitalizing the banks and what was needed was recapitalization. And we allowed the decapitalization of the banks through the
payouts of bonuses and dividends. We didn’t put any pressure, any
constraints on the behavior of the banks, so there were—including
the restructuring of the mortgages.
So given the amount of money that, you know you’re putting in—
if you’re putting in hundreds of billions of dollars you should have
some voice in what happens. And the result of that is that we
didn’t get what we wanted, which was a restarting of the economy.
The long run are the more—are the even worse problems, because we have a more concentrated banking system, that means interest rates will be higher, spreads will be higher. And the result
of that is not only are there the long risks that we’ve been talking
about but in the short run the—because the market is less competitive the flow of money will, in the long run, not be what it should
be.
Mr. SILVERS. Okay. Professor Johnson, Treasury seems convinced
that the banks are healthy, sound or something like that. I wonder
if you would comment on two things. One is, is that right? And
two, how can anyone know that’s right and given the state—we’ve
talked a lot about the capital side of the balance sheet, the liability
side, given the state of what we know or don’t know about the
asset side of the balance sheet.
Dr. JOHNSON. Yes, that’s exactly right. There’s a great deal of uncertainty around asset values. And of course, the correct way to assess the state of any banks is to do the stress test. Now there needs
to be tough stress tests, the downside scenario needs to be much
more rigorous or negative, pessimistic than the one they used in

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2009. And I fear that the stress tests that they’re doing now, although they haven’t disclosed anything really about them, I fear
that those tests are even more gentle.
So my answer is, we don’t know. There’s a lot of bad things that
can happen. We’re certainly not out of the recession, as my colleagues have mentioned, in many dimensions, and you have emphasized. So the sensible, prudent thing to do is to require that the
banks retain the earnings and build up bigger equity buffers
against potential future losses.
And that’s irrespective of whether or not you accept my view;
Gene Farmer’s view; Professor Meltzer’s view and Admati’s view
that going forward we should have 20, 30, 40, Adair Turner’s view
from the UK, the FSA there, Financial Supervisors; Mervyn King’s
view, the head of the Bank of England; Philipp Hildebrand’s view,
the head of the Swiss National Bank, even if you don’t agree with
the views of those people, just today, and if you’re just in learning
Basel III the only thing that makes sense is to have them retain
the earnings right now and not pay out dividends, given what we
know and the many things we don’t know, many things we fear
about the economy going forward.
Mr. SILVERS. Professor Meltzer, your suggestion that we have
size adjusted capital requirements is, as I noted in the prior panel,
it was one of the recommendations of this panel, in our regulatory
reform report to Congress.
Dr. MELTZER. Good for you. [Laughter.]
Mr. SILVERS. Thank you.
It seems to me, just the most sort of obvious idea and I’m heartened to see some one of your experience having recommended it.
Dr. MELTZER. Senator Vitter introduced a bill to do it.
Mr. SILVERS. Now I’ve also been involved in the arguments on
The Hill that essentially prevented it from being mandated in
Dodd-Frank and I find that in general it is treated as though you
were suggesting the creation of a perpetual motion machine or
something of that nature in our politic processes. Can you explain
to me why something so sort of straightforward can’t seem to be
taken seriously?
Dr. MELTZER. Yes. The bankers don’t want it and they come
down with their lobbyists in hordes to tell them—tell the congressmen, you know, ‘‘That’s just disaster. You’re facing disaster. There
won’t be loans for the public. There won’t be capital to build industry,’’ all that stuff.
Mr. SILVERS. Can I just ask and then I’m going to stop.
Dr. MELTZER. We got through the 1920’s with capital requirements.
Mr. SILVERS. But since we’re talking about size-weighted capital
requirements, would that not just mean that it would be a powerful
incentive for institutions to be smaller and then they would lend
more when they were smaller? I mean would not rational actors
move to basically step away from the Too Big to Fail structures
and the amount of credit provision would not be affected.
Dr. MELTZER. We would remove the incentive which pushes them
to be bigger and bigger all the time. And that would be good. I
don’t think they would be small, but I do think they were be smaller.

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Mr. SILVERS. Smaller, right.
Dr. MELTZER. There isn’t any evidence that I know that says that
there are economies of scale at that size which makes them want
to be bigger.
Mr. SILVERS. Yeah.
Dr. MELTZER. And I would like to add one other thing. In 1991
I believe Congress passed FDICIA. Are you familiar with FDICIA?
Yes. Did they use it at all? No, they didn’t use it at all. What did
it call for? It called for early intervention. Just completely ignored.
And they gave reasons. They said it didn’t apply to holding companies, such things as that. You know, given all the things that they
were doing they could have made FDICIA work and closed them
down early or make them raise more capital. They didn’t do that.
So we have to legislate it.
Mr. SILVERS. Thank you. I’m allowed to keep going, I’m told.
Various people want to speak. Mr. Johnson?
Dr. JOHNSON. My understanding of the literature, just to reinforce Professor Meltzer’s point, is there’s no economies—no evidence for economies of scale or scope in banking over about $50 billion in total assets. You might see $100 billion dollars if you wanted to be generous. All the benefits above that are private benefits,
not social benefits.
Mr. SILVERS. I guess one——
Dr. STIGLITZ. Can I just make one more point——
Mr. SILVERS. Yeah, sure.
Dr. STIGLITZ [continuing]. Just to emphasize the theoretical point
here, that the requirements of leverage, there’s a basic idea in economics called the Modigliani-Miller Theorem——
Mr. SILVERS. Yes.
Dr. STIGLITZ [continuing]. That says that leverage doesn’t buy
you anything except higher probabilities of default. And that—and
so that the argument that they’re making that it would interfere
with the efficiency of the economy has no support in the economics
profession.
Mr. SILVERS. But there is one more argument I’d like to dispose
of, because there is this—there is the notion that—I mean you all
suggested various levels of capital be required. But setting the
question of how much capital should be required at any given size,
just the notion of a sliding—the notion of a sliding scale, right, does
not—is there any basis for the argument that a sliding scale would
bring on a credit crunch?
Dr. MELTZER. No.
Dr. STIGLITZ. No.
Dr. ZINGALES. Can I dissent on this? I think that——
Mr. SILVERS. I’ve found a point of agreement. I feel proud.
[Laughter.]
Dr. ZINGALES. I have to say I have great respect for Professor
Stiglitz. I think that since Modigliani and Miller we have a large
literature in corporate finance saying that actually it’s sort of—the
level of that is not irrelevant. And actually he contributed in part
to that literature. So I’m surprised to say—to see now that he says
that it’s completely irrelevant. I don’t think it’s irrelevant, I think
that there are some costs of having too much or too little debt depending on the situation. And I think that in the current situation,

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if you were to dabble in the capital requirement to banks tomorrow, you will have a credit crunch. I think that it will definitely
be a consequence.
Why? Because the managers don’t want to raise more equity, regardless of whether this is in the interest or not of the shareholders, but they don’t want to raise more equity. And so the alternative of raising more equity is to lend less. So I think there will
be consequences and I think that the argument they’re going to use
to say why the sliding scale is bad is that it’s going to unfairly affect the large banks. I completely disagree with this argument. I
think that now we unfairly favor large banks so the sliding scale
will only bring sort of a level playing field, but that’s how to argument they would make.
Mr. SILVERS. Right. Your point about the credit crunch is kind
of an institutionalist argument.
Dr. MELTZER. But, the main change would be——
Dr. ZINGALES. Why institutional? I’m sorry.
Dr. MELTZER [continuing]. You get more collective form of lending. That is if a bank—one argument that’s made is that the corporations are so big that they need to have——
Mr. SILVERS. Big banks, right.
Dr. MELTZER [continuing]. Big banks. But they can syndicate the
loans, they’ve done that for hundreds of years. They can syndicate
the loans and service the banks—the customers.
Dr. JOHNSON. Sorry, I see a straw man slipping into the conversation. And no one is proposing that you immediately double
capital requirements and tell them to hit that number tomorrow.
Yes, the one way you could achieve that is by dumping assets or
reducing loans as Luigi said. But, if you can look, for example, at
the plans brought forward by or proposed by Jeremy Stein and
David Scharfstein, for example, who are both very experienced,
both worked in the Treasury under this administration, and now
have proposals out there for ways in which you can time the shift
in capital requirements to phase in these kinds of either a higher
level overall or a step level as Professor Meltzer’s suggesting. This,
if implemented properly, would not be contractionary.
Dr. STIGLITZ. Let me just go back to——
Mr. SILVERS. I don’t think—my chair has told me that this must
come to an end. [Laughter.]
The CHAIRMAN. Dr. Troske.
Dr. TROSKE. Thank you. This has been a fascinating conversation
and I’m certainly not going to try to compete with you on your
field, so I’m going to pull you over to mine as a mere labor economist and start talking about executive compensation, which is—has
received a certain amount of attention.
But my own view of this issue and combined with the current crisis sort of has evolved over time and to one in which it seems to
me that when you have a Too Big to Fail financial institution it’s
the case that shareholders very much value risk and are going to
move towards more leverage. And they’re actually going to compensate executives in a way that would have them shift the risk
profile of the investments that they make out to a more risky environment. So you don’t need to take a very strong stand, in terms
of whether you think, you know, executive pay is set, you know, op-

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timally or not, but in the presence of Too Big to Fail, both shareholders and executives are willing to move towards more risky
forms of investment and are going to be compensated in that fashion.
I guess I’d like your thoughts on my hypothesis. And I’ll start
with you, Professor Stiglitz.
Dr. STIGLITZ. Well, let me just say, the important point that
you’re emphasizing is that the decisions made by the banks are
made by managers, not by the shareholders, and that there can
often be misalignment of interest between the two. And that’s why
I remarked before, I think that there need to be regulations affecting shareholder compensation, regulations in general, including
regulations affecting shareholder incentives. Because those incentive structures can lead them to want to undertake excessive risk
and there may be limited ability of shareholders to constrain the
ability of managers in that way.
So—and there’s a second problem in managerial compensation
that you didn’t mention that I think is important to realize. That
when you get shareholder stock option kind of compensation, it provides an incentive for you to distort the information that you’re
providing. So it encourages nontransparent accounting and there’s
always going to be a lot of discretion. A lot of the issues that—
we’ve ignored the mistakes that have been associated with the ability to not—to keep on bad mortgages at full value and that whole
distortion in the assessing of the asset structure. But the point is
that if you have compensation that is related to the seeming performance of the share market, you—sharers, you have an incentive
to distort the information provided by the market and to the regulators.
Dr. TROSKE. Does anybody have anything different to add?
Dr. JOHNSON. Yes.
Dr. TROSKE. Okay.
Dr. JOHNSON. If I may. I agree with you that theoretically if the
Too Big to Fail guarantee holds, then the interest of the investor
and interest of management, in this regard, are—can be aligned.
So the investors want the management to leverage up, they want
them to take a lot of risk. However, as a practical matter, I think
the kinds of concerns Professor Stiglitz was mentioning come into
play.
And I would refer you to a paper by Sanjai Bhagat and Brian
Bolton who went carefully through the compensation received by
the top 14—by executives of the top 14 financial institutions in the
United States between 2000 and 2008. They found that those executives took out, in cash bonus and through stock sales, $2.6 billion in cash. In fact the top five executives took out around $2 billion in cash. And the shareholders, at the same time, if you were
a buy and hold shareholder over that period, you did pretty badly.
So that suggests that as a practical matter, maybe it’s because
of misrepresentation, actually I think that’s quite a plausible explanation, or maybe it’s for some other reason, the shareholders do not
do well when the managers leverage up, take a great deal of risk
and get paid on a more or less immediate return basis, which is
linked to your return on equity basis, not properly risk adjusted.
Dr. TROSKE. Yeah. Thanks. Can I——

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Dr. MELTZER. Dr. Troske, I worried about this program a lot as
a practical thing because I was a chairman of an audit and compensation committee for a Fortune 500 company. And so I faced the
problem of how do you reward the chief executive and subsidiary
executives. I don’t think there’s an easy answer to this problem.
Dodd-Frank came up with a proposal which says that you have a
nonbinding vote of the shareholders. So far I believe the evidence
is the shareholders don’t care much. That should be evidence that,
leave it alone.
Dr. TROSKE. Professor Zingales——
Dr. MELTZER. Except in the case where you’re failing.
Dr. TROSKE [continuing]. I’d like to ask you a little, somewhat
different question more related to your recent paper, ‘‘Paulson’s
Gift,’’ and I like your title. I wish I were that creative, or editors
let me be that creative in my titles.
You estimate that TARP preferred equity infusions and the FDIC
debt guarantee cost taxpayers between 21 and 44 billion. You talk
about an alternative plan. The government could have charged
more for both the equity infusion and the debt guarantee, as Warren Buffett did when he invested in Goldman Sachs three weeks
before the Paulson plan. Could you kind of—could you elaborate on
the difference between private party transactions undertaken at
the time of TARP on the one hand and the actual TARP transactions as well as the FDIC’s extension of deposit insurance?
Dr. ZINGALES. Yes. I think that there are two aspects. First of
all, the capital infusion that was done was done, not in market
terms by any stretch of the imagination, was definitely worse than
the one that Warren Buffett got in terms of return. And the same
is true for the debt guarantee. Now, what is interesting is we observe when this debt guarantee was the standard that the overall
cost of insuring these institutions dropped.
So—but even if we take the value of this cost after the announcement, so let’s think about there is a systemic effect and there is an
individual effect, even if we sort of take anyway the systemic effect,
the cost of insuring this institution was too cheap and that was not
really varying according to the type of institution. So for JP Morgan this was not very convenient, for Citigroup or Goldman was
tremendously convenient.
So what the accurate number you reported doesn’t give a good
sort of picture of is sort of the cross section. There was an important redistribution also within banks. JP Morgan was heavily penalized by the plan, probably because the market expected them to
buy on the cheap the assets the other people were selling. And
Citigroup was—Citigroup, Morgan Stanley and Goldman were tremendously helped by the plan.
So there is sort of also this cross sectional aspect which I think
is important because it distorts the market incentives. By treating
everybody the same the good managers are not rewarded and the
bad managers are not penalized.
Dr. TROSKE. So let me ask one final question. As a profession
we’re often characterized as unable to reach consensus on any
issue. And I would argue that the five independent PhD economists
in the room, and I’m going to be arrogant enough to put myself in
your group, agree about the importance of incentives and the ef-

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fects that these distorted incentives had throughout this problem
and continue to have today. This is a point I’ve made repeatedly
since being on this panel.
I can understand why folks ignore me, but I struggle to understand why they ignore you. And I guess I’m kind of curious on your
thoughts, what are we doing wrong as a profession because I do
think these issues are something that economists do agree about.
And so I guess I’d like your thoughts on, you know, on—because
I’m kind of tired of shouting into the wind. I don’t know about you.
[Laughter.]
Professor Stiglitz, I’ll let you lead off.
Dr. STIGLITZ. Okay. Well, I think the—what is interesting about
this particular case is that there is a broad spectrum of support
from the Left and the Right in the economics profession. But this
goes back to the particular groups who are big beneficiaries of this
particular system. And they have a lot of money to invest in both
trying to shape public opinion and to get what they want.
So I don’t find it that mysterious in a way, that there is a lot
of money at stake. I mean he’s talked about some of it, but a lot
of money and that the money on the other side of trying to create
a more efficient, fairer system, the point that a number of people
have always made, Becker, for instance, that those are lots of people. And you have concentrated beneficiaries and the alternatives
are much more diffuse. It’s very hard to get a fair battle when you
have that—this much money at stake.
Dr. TROSKE. Professor Meltzer, you’ve been doing this for a long
time. What are your thoughts?
Dr. MELTZER. Well, I’m a strong believer in what is now called
‘‘political economy,’’ that is making policy; the first four letters of
policy and politics are the same and the money is very important.
So you know, we’re fighting a battle that I—well, I agree with my
old friend, the late Milton Friedman who said, ‘‘Our job as economists is to come up with proposals and when the crisis comes it
will be better than the proposals that will occur at that time.’’ And
he and we have had a record of getting things done that way in
crises.
In the ordinary course of events you’re fighting a tough political
battle in which, as Joe just said, there’s much at stake and there’s
a lot of money that goes into campaigns coming from Wall Street
and that makes, you know, a big, big hurdle to get over. So when
Senator Vitter introduced my bill to scale up the thing, you know,
there just wasn’t a lot of support in the Senate Banking Committee
for it.
Dr. JOHNSON. It’s a fascinating question that the bankers, when
confronted by these proposals in the United States say, ‘‘We’re
going to move to the UK,’’ and when confronted by these proposals
in the UK they say, ‘‘Well, we’re going to move to New York.’’ You
don’t have to get the G20 together on this, you need to have the
world’s leading financials and New York and London would span
most of it. And the Swiss are already pointing in exactly the same
direction.
And there are people within the Federal Reserve system, for example, Thomas Hoenig, within the other regulatory agencies, including Sheila Bair, who I think totally get this. I’m not saying

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that we convinced them, I think that they figured this out by themselves.
There are other people, such as Treasury and important elements within the New York Fed and within the Board of Governors
of the Fed who are absolutely adamantly opposed to applying the
logic that we’ve been discussing here today. They say—well, I don’t
know what they say. They don’t come out and discuss it enough
and clearly enough and I think, you know, ultimately a lot of the
reasons they put forward make no sense at all.
And I think it was Mark Hanna, the legendary Republican Senator at the turn of the—beginning of the 20th century, the organizer of the Republican Party in the Senate around the country
who said, ‘‘There are two things that matter in American politics.
The first is money and I don’t remember what the second one is.’’
Dr. TROSKE. Mr. Zingales.
Dr. ZINGALES. I think there are a couple of reasons. First of all,
I think we know, as Stiglitz reminded, that there is a capture by
the sort of people who are well organized and have a lot of money
at stake. I actually believe in democracy enough that I think that
on some topics this sort of strength can be overcome, but it requires that the topic is sufficiently interesting and sufficiently sort
of easy to explain in the media that it generates sort of a public
outrage.
So I think that in terms of environmental issues, people are
much more sensitive because you can explain that more easily to
the ordinary human being. I think that excessive compensation
really attracts the interest of voters. When it comes to how to properly regulate capital requirements, I think that would put asleep
like 99.9 percent of the people. And so it’s very hard to be successful in explaining or pushing on—with the political agenda, against
the entrenched interest.
But I have to say that there is also a responsibility of the economic profession in that. I think that you preach to the choir and
it says, here this is not a selected sample, I think there are people
that have been actively engaged in public speaking and I don’t
think that you can say the thing about most economists. I think
that most economists don’t write in newspapers, don’t sort of actively sort of take their positions, they’re not public figures. It’s not
what you are awarded for academically. The type of policy advice
you give is not sort of very strong in your vitae and I think that
they don’t care.
Dr. TROSKE. Thank you.
The CHAIRMAN. Thank you.
Superintendent Neiman.
Mr. NEIMAN. Thank you.
The CHAIRMAN. We saved the best for last.
Mr. NEIMAN. Oh, okay. Thank you.
You know, in addition to the global calls and efforts to increase
bank capital, we also know that liquidity is a driver to a firm’s failure. Lehman is a good example with reference to the capital position at the time, the impact of short sellers, and of the fact that
short term funding can dry up at any point in time.
I’d be interested in your views on the relationship between capital and liquidity. And also your views on the proposals out there,

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particularly Basel III; the proposals with respect to increases in liquidity practices and requirements.
Dr. ZINGALES. Can I start?
Mr. NEIMAN. Sure.
Dr. ZINGALES. I think that the risk that short term debt presents
is very large because short term debt can run very quickly. If I
lend somebody overnight, I don’t want to take any risk that the
counterparty will fail overnight. Whatever high interest rate you
offer over a day is not large enough to compensate for the risk. And
that’s the reason why when the market sentiment shifts and when
there is a fear that the counterparty is insolvent or—then the short
term lenders stops lending.
So that’s the reason why I think it’s important to have a cushion
of long term debt. And so the Basel requirement for having a significant amount of long term debt I think is important. And paradoxically I think that part of what made the crisis worse are two
pieces of—two facts. One is the Fed policy that kept sort of interest
rates, especially short term on the curve, very low favored people—
favored the short term borrowing by part of financial institutions,
made it very convenient. And of course they don’t internalize this
externality of sort of the systemic aspect.
The second paradoxically is sort of the bankruptcy reform done
in 2005. By making sort of—by exempting derivative and repurchase agreements from bankruptcy, they made them much cheaper
than everything else, basically inducing institutions to take more
of it and then making them more fragile. So, I’m definitely in favor
for some sort of requirement in terms of compositional liabilities.
Mr. NEIMAN. Any other?
Dr. STIGLITZ. The—I think the issue that you raise focuses particularly on the question of the shadow banking system and that
this is a really very serious problem that a lot of the discussion will
be focusing on in the banking system. But you know, the point
where Lehman Brothers really showed up was the collapse of reserve—the reserve fund. And people thought that they could use
the shadow banking system as a substitute for the banking system.
I think what we now know we have to regulate both the shadow
and the regular banking system. We have to see them as an integrated whole and that we shouldn’t view the shadow banking system as a way of circumventing the banking system. So I think that
is one of the important aspects.
I do want to agree with Professor Zingales that the incentive
structures that are often built very subtly into the whole structure,
like the bankruptcy provision, is really an example of something
that’s a major distortion that got very little attention at the time
that it was adopted, but is obviously—it is an example of the kind
of concern.
Another example is when you have incentives where some of the
things are—some of the CDSs are done in a transparent market
and some are done over the counter. That is an incentive to move
things into the dark areas and to engage in things where nobody—
it’s difficult to regulate.
So, we are now, in the way we’re going forward right now are
creating new opportunities and new incentives to move things
away from where we can see what’s going on and to where we can’t

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and where these kinds of liquidity issues become all the more important.
Mr. NEIMAN. I’m glad you raised the issue of shadow banking because I did want to ask about the regulatory reform efforts about
riskier activities, proprietary trading, swap activities and different
proposals. For example, the Volcker Rule requires moving those activities, the proprietary trading, hedge fund activities out of the
holding company all together as opposed to certain swap activities
being moved out of the bank into the holding company.
I’d be interested in your views as are you shifting those activities
into a less regulated area or would you prefer to see them within
the bank holding company structure with a higher level of oversight and capital requirement?
Dr. STIGLITZ. Well, my view, there are two separate issues. I
think we have to deal with very strongly with the Too Big to Fail
banks and financial institutions, whether they’re banks or nonbanks and with the Too Correlated. We haven’t talked about the
Too Correlated to Fail, because that’s another set of problems that
represent systemic risk. But—so that’s one set of issues. And when
you have them still connected in a holding company you haven’t
really solved the Too Big to Fail.
But the other issue is, wherever they are there needs to be transparency. And the movements to allowing large segments of transactions to be in a nontransparent venue seems to me a real invitation to problems.
Mr. NEIMAN. Any other?
Dr. MELTZER. Yes. I’d like to say that on the money market
funds, the biggest part of the off banking system, how did that crisis come about? Well, they got a rule, they had to mark their markets—their assets to market until they got to the point where they
no longer could do that and pay a dollar or pay their face value.
So they got the SEC to change the rule so they didn’t have to mark
their market—their assets to market. And when there was a run,
after Lehman, that caused them. If they had been forced to mark
their market—their assets to market that would have been the normal course of events. That was just a bad ruling.
We ought to reverse that ruling and say that when your liabilities are only worth 95 cents, they’re worth 95 cents.
Mr. NEIMAN. Thank you, Mr. Meltzer.
Dr. MELTZER. That was a mistake. I agree with a comment that
you made quickly and I think it is a major problem that you have
to think about. If we regulate too much, and we may well be doing
that, we’re just going to shift—somebody has to bear the risks of
the forward movement of the American economy. If we shift those
risks out of the banks, the most regulated part of the system, and
into other agencies, perhaps some not yet born, that’s not going to
be in the public interest or in the long run interest of the country.
So we have to be concerned with what we do to keep the risks
where we can at least see them.
Mr. NEIMAN. Well the most descriptive is to avoid playing
‘‘whack-a-mole’’ I live near an amusement park and——
Dr. MELTZER. Right. So that’s another reason why capital requirements are much more desirable than regulation.
Mr. NEIMAN. Appreciate that.

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Mr. Johnson.
Dr. JOHNSON. I agree completely. The—many of these shadow
structures were constructed as a way to get around capital requirements, to so called economize on capital which means to take more
highly leveraged bets and to take on more risk. And while I recognize your points about liquidity, and I agree that we have constructed incentives for too much short term funding of longer term
assets and assets that should be actually funded with equity, because of the nature of the risks there, I would emphasize we need
high capital requirements across the board.
We can’t rely on the market to do this by itself, because as we’ve
discussed it’s an incentive for the management, for sure, and in
many cases management and shareholders to get big enough so
they can fail.
And I would end by quoting somebody I know in the hedge fund
sector, in a very large hedge fund, household name. He said to me,
‘‘Simon, let’s face it, on the Too Big to Fail debate you lost. And
now our question is, or what we’re working on in the hedge fund
is, how do we become Too Big to Fail.’’
Dr. ZINGALES. Can I sort of endorse strongly what Professor
Meltzer said? I think that the single most evil rule that is still in
place is exactly that one of the SEC that provides an appearance
of safety on money market funds and help them market themself
as complete substantive deposits when they are not. And it’s ironic
that we had 2,000 pages of legislation and we could have changed
that rule sort of very easily, I don’t think it’s subject to congressional approval, it’s just a rule of the SEC, but nobody wants to do
it and nobody even is discussing doing it.
Mr. NEIMAN. All right. Thank you.
The CHAIRMAN. Well, I’ve been around this place for almost 40
years, I’ve never seen a panel and a group of witnesses more in
agreement in my entire life. [Laughter.]
So I—and let me tell you something, I know you know about the
disparity in the political ideas of the witness, let me tell you,
there’s some pretty different views about just about everything up
here on the panel, but I think there’s one thing that we’re all in
agreement on and I think that Dr. Troske raised a good point, that
I have felt the—I have the scars from, and that is the difficulty,
of not just economists of trying to get some of these ideas that have
been raised here that seem to be pretty simple, pretty straightforward and pretty widely held by people that have spent time
thinking about it, to get it into legislation and get it into the Securities Exchange Commission and get it into CFTC.
So anyway, I really, really want to thank you all for taking time
out of your day to come down here and do this. We really do appreciate it.
The record for the hearing will be kept open for one week so the
panel may submit questions to the record of witnesses.
I want to finally say, just thank some folks. And I want to thank
my fellow panelists. I mean you know, I came into this late and
the welcomeness, the ability, the—I’ve never seen a group that is
so easy to get along with and are so interested in trying to come
to a common ground, even though there are very basic differences
on the issues. So I really want to help my fellow panelists.

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The other thing, having been a staff person, when you show up
at this point with a staff that’s in existence, you show up and
you’re a little scared because you know what you want in a staff
and the rest of it. And I want to tell you, this has been a—absolutely—this COP staff is absolutely incredible and Naomi Baum
does an incredible job to monitor the—Elizabeth and the whole
group has just done an incredible job and I think the record shows
that.
So I want to thank everybody from here. And with that we will
close the hearing.
[Whereupon, at 1:44 p.m., the hearing was adjourned.]

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Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102