[Senate Hearing 110-974]
[From the U.S. Government Publishing Office]
S. Hrg. 110-974
TURMOIL IN U.S. CREDIT MARKETS: EXAMINING THE RECENT ACTIONS OF FEDERAL
FINANCIAL REGULATORS
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED TENTH CONGRESS
SECOND SESSION
ON
EXAMINING THE RECENT ACTIONS OF FEDERAL FINANCIAL REGULATORS
----------
THURSDAY, APRIL 3, 2008
----------
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
Available at: http: //www.access.gpo.gov /congress /senate /
senate05sh.html
TURMOIL IN U.S. CREDIT MARKETS: EXAMINING THE RECENT ACTIONS OF FEDERAL
FINANCIAL REGULATORS
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED TENTH CONGRESS
SECOND SESSION
ON
EXAMINING THE RECENT ACTIONS OF FEDERAL FINANCIAL REGULATORS
__________
THURSDAY, APRIL 3, 2008
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
Available at: http: //www.access.gpo.gov /congress /senate /
senate05sh.html
U.S. GOVERNMENT PRINTING OFFICE
50-394 WASHINGTON : 2010
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20402-0001
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
CHRISTOPHER J. DODD, Connecticut, Chairman
TIM JOHNSON, South Dakota RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York WAYNE ALLARD, Colorado
EVAN BAYH, Indiana MICHAEL B. ENZI, Wyoming
THOMAS R. CARPER, Delaware CHUCK HAGEL, Nebraska
ROBERT MENENDEZ, New Jersey JIM BUNNING, Kentucky
DANIEL K. AKAKA, Hawaii MIKE CRAPO, Idaho
SHERROD BROWN, Ohio ELIZABETH DOLE, North Carolina
ROBERT P. CASEY, Pennsylvania MEL MARTINEZ, Florida
JON TESTER, Montana BOB CORKER, Tennessee
Shawn Maher, Staff Director
William D. Duhnke, Republican Staff Director and Counsel
Amy S. Friend, Chief Counsel
Roger M. Hollingsworth, Professional Staff
Dean V. Shahinian, Counsel
Julie Y. Chon, International Economic Policy Adviser
Drew Colbert, Legislative Assistant
Brian Filipowich, Legislative Assistant
Mark Osterle, Republican Counsel
Peggy R. Kuhn, Republican Senior Financial Economist
Brandon Barford, Republican Professional Staff Member
Jim Johnson, Republican Counsel
Andrew Olmem, Republican Counsel
Dawn Ratliff, Chief Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
C O N T E N T S
----------
THURSDAY, APRIL 3, 2008
Page
Opening statement of Chairman Dodd............................... 1
Opening statements, comments, or prepared statements of:
Senator Shelby............................................... 3
Senator Johnson.............................................. 4
Prepared statement....................................... 94
Senator Bennett.............................................. 5
Senator Reed................................................. 5
Senator Allard............................................... 6
Senator Schumer.............................................. 6
Senator Bunning.............................................. 7
Senator Carper............................................... 7
Senator Dole................................................. 8
Senator Menendez............................................. 8
Senator Tester............................................... 9
Senator Corker............................................... 9
Senator Crapo................................................ 9
WITNESSES
Ben S. Bernanke, Chairman, Board of Governors of the Federal
Reserve System................................................. 10
Prepared statement........................................... 95
Response to written questions of:
Chairman Dodd............................................ 163
Senator Shelby........................................... 163
Senator Bunning.......................................... 185
Christopher Cox, Chairman, Securities and Exchange Commission.... 12
Prepared statement........................................... 99
Response to written questions of:
Chairman Dodd............................................ 186
Senator Shelby........................................... 189
Senator Bunning.......................................... 195
Robert Steel, Under Secretary of Treasury for Domestic Finance,
Department of the Treasury..................................... 15
Prepared statement........................................... 103
Response to written questions of:
Chairman Dodd............................................ 199
Senator Shelby........................................... 199
Senator Bunning.......................................... 199
Timothy F. Geithner, President, Federal Reserve Bank of New York. 17
Prepared statement........................................... 105
Response to written questions of:
Chairman Dodd............................................ 200
Senator Shelby........................................... 200
Senator Bunning.......................................... 202
James Dimon, Chairman and Chief Executive Officer, JPMorgan Chase 71
Prepared statement........................................... 154
Alan D. Schwartz, President and Chief Executive Officer, The Bear
Stearns Companies, Inc......................................... 75
Prepared statement........................................... 159
TURMOIL IN U.S. CREDIT MARKETS: EXAMINING THE RECENT ACTIONS OF FEDERAL
FINANCIAL REGULATORS
----------
THURSDAY, APRIL 3, 2008
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:10 a.m., in room SD-G50, Dirksen
Senate Office Building, Senator Christopher J. Dodd (Chairman
of the Committee) presiding.
OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD
Chairman Dodd. Good morning. The Committee will please come
to order.
Again, let me thank all of our witnesses and my colleagues
and those of you gathered here this morning. We are not in our
traditional hearing room, and the size of the crowd in the room
is evidence of the reason why. So we thank all of you this
morning to participate one way or another in this gathering.
Today the Committee will carefully consider recent actions
taken by our Federal financial regulators in response to the
ongoing turmoil in our markets and our economy. Much of our
focus today will center on the period of 96 hours, mostly over
the weekend of March 15th and 16th. During this momentous 4-day
period, the Federal Reserve, the Federal Reserve Bank of New
York, and the Treasury Department took dramatic and
unprecedented action to stabilize our markets to infuse them
with liquidity and to prevent additional financial firms from
being swept under the riptide of panic that threatened to have
taken hold of our markets.
Among those actions was the decision by these entities to
support the acquisition of Bear Stearns by JPMorgan Chase. As
part of the acquisition, the Federal Reserve Bank of New York,
with the support and approval of the Federal Reserve Board of
Governors and the Treasury Department, committed some $30
billion in taxpayer money to help facilitate the sale of the
distressed company to JPMorgan Chase. And as part of its
broader efforts to provide stability to the markets, the Fed's
Board of Governors made a historic decision to allow primary
dealers, firms which include investment banks, to access
billions of dollars of liquidity on a daily basis.
The stunning fall of Bear Stearns, a Wall Street giant and
America's fifth largest investment bank, was matched only by
the swift and sweeping response to its collapse put together by
the New York Fed and the Federal Reserve Board of Governors,
which, with the support of the Treasury, exercised powers in
some instances that had not been used since the Great
Depression, and in others were unprecedented in nature.
There can be no doubt that these actions taken in order to
calm financial markets that appeared to be teetering on the
brink of panic have set off a firestorm of debate. They also
raise a number of important questions that warrant our
consideration. Was this a justified rescue to prevent a
systemic collapse of financial markets or a $30 billion
taxpayer bailout, as some have called it, for a Wall Street
firm while people on Main Street struggle to pay their
mortgages?
What was the role of the Federal Reserve, the Treasury, the
New York Fed, and the SEC in helping to facilitate a range and
set the terms, including the price of the original and amended
merger agreement between JPMorgan Chase and Bear Stearns?
While hindsight is invariably 20/20, it bears asking if
Bear Stearns would have survived if the Fed had opened the
discount window to investment banks earlier. And what led to
the sudden reversal on a policy that the Vice Chairman of the
Fed had openly rejected in response to a question that I asked
him before this very Committee only 2 weeks earlier?
What was the role of the SEC, the primary regulator of Bear
Stearns, during this critical 96 hours and in the weeks of
market turmoil leading up to that weekend of merger
negotiations? And why were they seemingly unaware of the
potential for market rumors to cause investors to suddenly stop
doing business with Bear Stearns until it was too late.
These questions, the series of events leading up to Bear
Stearns' rescue, the response by financial regulators, and the
implications of those actions will be discussed and debated for
years to come. It would be an overstatement to suggest that
what occurred during those fatal 96 hours may have
fundamentally altered our financial market landscape and our
system of financial market regulation.
Given these considerations and the highly unusual and
unprecedented actions taken by the Federal Reserve Board of
Governors, the Federal Reserve Bank of New York, and the
support of the Department of the Treasury, I believe it is
appropriate, indeed essential, that this Committee, the Banking
Committee, exercise its oversight and investigatory functions
to examine the authority, economic justification, and the
public policy implications of these extraordinary recent
actions by our Nation's Federal financial regulators.
As such, the Committee has convened today's hearing, the
first congressional analysis with all relevant parties to this
issue, to hear the testimony of the public and private
principals involved in this unprecedented series of events, and
to provide Committee Members and the American taxpayer with a
full, public, and thoughtful airing of these issues and their
implications. With $30 billion on the line, the public
deserves, of course, nothing less.
I want to thank all of the witnesses and my Committee
Members as well for their participation here this morning. We
look forward to the testimony of our witnesses.
Let me just say as well here that I want the witnesses to
know, and others, that as a bottom-line consideration, I happen
to believe that this was the right decision, considering
everything that was on the table in the closing hours on that
Sunday; that the alternative--and I do not think this is
hyperbole--could have been devastating, both at home and around
the world, for that matter. So I do not question that ultimate
decision, but I think it is appropriate that we look at the
rationale leading up to it, why decisions were made and not
made earlier and later during the process, what was a part of
that negotiation. Were there alternatives? Is this a model for
the future? If so, what are the implications? What did the
taxpayer get back from the $30 billion that we are putting on
the line, or the $29 billion here?
Those are the kinds of questions I think all of us are
interested in pursuing, and many, many more. But on the bottom-
line issue, at least to this Member, I think fundamentally the
decision was the right one in the final analysis. But I think
it is appropriate we look at what else went on here to
determine the wisdom of this step and what the implications
are.
With that, let me turn to my colleague from Alabama,
Senator Shelby.
STATEMENT OF SENATOR RICHARD C. SHELBY
Senator Shelby. Thank you, Mr. Chairman. Thank you for
calling today's hearing.
The collapse of Bear Stearns and the unprecedented
regulatory response led by the Federal Reserve call for a
thorough examination of this Committee, so I commend you, Mr.
Chairman, for bringing this Committee together today.
In deciding to commit $29 billion to help finance JPMorgan
Chase's takeover of Bear Stearns, the Fed has set a new
precedent on the type of response that the Federal Government
may provide during financial panics. It may be that the Fed's
actions were warranted by the unique financial conditions
prevailing in our markets. However, such policy decisions must
be fully considered by this Committee. After all, the ultimate
responsibility for financial regulations rests with this
Committee and the Congress.
In examining the events of the past few weeks, we must
certainly be mindful that regulators and market participants
had to make prompt decisions using available tools in the midst
of a financial storm. This will not be the last time that we
face financial upheavals in our history. However, I think it
would be unwise if we did not take this opportunity this
morning to thoroughly examine what transpired, including how
Bear Stearns was regulated, what caused its collapse, whether
any other institutions face similar risk, and if there are any
shortcomings in our regulatory structure.
Two aspects of the Fed's response deserve particular
attention.
First, for the first time since the Great Depression, the
Fed has funded a bailout of an investment bank. Previously,
assistance by the Fed had been extended to only FDIC-insured
depository institutions. But by extending the Federal safety
net to an institution not supported by an explicit Federal
guarantee, the Fed's actions may create expectations that any
major financial institution experiencing difficulties might be
eligible for a Federal bailout. I think we must guard against
creating a moral hazard that encourages firms to take excessive
risks based on the expectations that they will reap all the
profits while the Federal Government stands ready to cover any
losses if they fail.
A second point of concern is the legal authority for the
Fed's actions. The financial assistance extended by the Federal
Reserve was provided under the Federal Reserve's emergency
lending authority, which allows the Fed to lend to any entity,
not just banks, in, and I quote, ``unusual and exigent
circumstances'' with the approval of five members of the Board
of Governors. This unilateral regulatory authority is in sharp
contrast to the regulatory scheme set forth under FDICIA for
bank failures involving systemic risks, which includes roles
for the FDIC, the Fed, the Treasury Secretary, and the
President of the United States.
The Fed's recent actions may have been warranted.
Nonetheless, the Committee here today needs to address whether
the Fed or any set of policymakers should have such broad
emergency authority going forward. And if the evolution of our
markets leads to the Federal safety net being extended to non-
banks, attention should be given here, I believe, to ensure
that the proper decisionmaking process is here and safeguards
are in place.
I look forward to exploring these and other issues with our
witnesses today, and I appreciate again, Mr. Chairman, you
calling the hearing.
Chairman Dodd. Thank you very much, Senator Shelby.
Let me just say for the purposes of the Committee Members,
as you know, we have also got a major bill on the floor dealing
with the housing issue, so this is going to create somewhat of
an awkward moment or two here and there as we go back and
forth. What I would like to do, if I could at the outset--and
we want to get to our witnesses, but I also know that all of my
colleagues have some feelings about this matter, and so I am
going to take a step here and ask any Member that would like to
make an opening brief comment on this matter to be able to do
so before we get to our witnesses. And then we will hear from
the witnesses themselves and set up a question period as well.
But let me ask if anyone would like to be heard. I will
begin with Senator Johnson, if he has any brief comments. Or
anyone else who would like to be heard at the outset here, I
would like to give you that opportunity to be heard. Senator
Johnson.
STATEMENT OF SENATOR TIM JOHNSON
Senator Johnson. Thank you, Chairman Dodd, for holding this
hearing today.
There appears to be little consensus on the effects of the
recent Fed action in the purchase of Bear Stearns. There has
been criticism voiced from a large network of people. I have
received letters from my constituents with concerns that it is
a bailout of the big bank that creates a moral hazard. Others
wonder if it is appropriate to offer help to Wall Street firms
while insisting on market discipline for troubled homeowners.
There has also been applause for the situation from some
quarters. The U.S. markets responded favorably. Other
investment banks poised to be in trouble saw their stock rise.
Foreign governments applauded this as a positive move for
global markets, and other analysts suggested that the Fed
actions averted what could very well have been a modern-day run
on the bank.
The reality of the situation is probably somewhere near the
middle.
I thank you, Chairman Dodd, and I submit my whole statement
for the record.
Chairman Dodd. All statements, by the way, of Members and
any supporting data and information they would like to have
included will be included in the record during the entire
hearing.
Senator Bennett.
STATEMENT OF SENATOR ROBERT F. BENNETT
Senator Bennett. Thank you, Mr. Chairman. I agree with the
position you and the Ranking Member have taken. The only thing
I would quibble with in your statement is when you said,
``Hindsight is always 20/20.'' At this point hindsight has not
yet reached that level of accuracy because we are viewing these
events through the lenses of previously strongly held
ideological positions. And it is important for us to have this
hearing so that we can perhaps move away from some of those
strongly held ideological positions and find out what really
happened.
So I endorse what you have had to say and thank you for
calling the hearing.
Chairman Dodd. I will so modify my opening statement to
reduce the 20/20.
Senator Reed.
STATEMENT OF SENATOR JACK REED
Senator Reed. Well, thank you very much, Mr. Chairman, and
the dramatic intervention by the Federal Reserve with regard to
Bear Stearns raises significant questions.
What are the consequences of this implicit guarantee on
these institutions by the Federal Reserve and financial
markets? What regulatory authority should be exercised over
these institutions? What are the steps being taken to minimize
taxpayer exposure? And what are the steps being taken to ensure
that there is improved risk management both by the financial
institutions and regulators alike going forward?
I think all of these questions begin with a careful
analysis of what has happened, a sober and highly detailed
analysis of the actions of the agency, not just their
authorities, but also how they implemented their authorities,
how they cooperated and communicated with other regulatory
agencies. It is not finger pointing. It is the kind of after-
action report that is owed to the American public since you are
using their resources to stabilize this market.
We have, I think, an obligation to encourage you--in fact,
more than encourage you--to conduct this sober, no-holds-barred
analysis of what happened, because the bottom line is to
prevent a repetition and to strengthen our markets. I think the
greatest competitive factor in our financial markets is the
confidence that Americans and the world have that these markets
are well regulated and transparent. And if there is any
question about the regulatory sufficiency or transparency, that
makes us less competitive in the marketplace, and it does not
help us, it does not help the taxpayers that are supporting
these efforts.
Thank you, Mr. Chairman.
Chairman Dodd. Thank you, Senator Reed.
Senator Allard.
STATEMENT OF SENATOR WAYNE ALLARD
Senator Allard. Thank you, Mr. Chairman. I am anxious to
hear from the witnesses and get into the question period.
Chairman Dodd. Thank you.
Senator Schumer.
STATEMENT OF SENATOR CHARLES E. SCHUMER
Senator Schumer. Thank you for holding this hearing, Mr.
Chairman. I appreciate it. You can see by the fact that this
room is full that the economy has moved front and center when
even the behind-the-scenes moves of regulators and institutions
gets the attention it does.
My questions fall into three areas: the before, the after,
and the who. I think everyone agrees that the Fed had no choice
and the actions had to be done. But the question is first the
before. How long before this happened should the regulators
have known what happened? Bear Stearns had trouble. Two of
their hedge funds went under due to mortgages in the summer.
Where were the regulators? Was someone asleep at the switch, or
is it that our regulatory structure does not work? The SEC has
jurisdiction over Bear Stearns, but mainly looks at investor
protection and disclosure. The Fed has responsibility for
safety and soundness of the system, but no jurisdiction over
investment banks. I think that things fall between the cracks.
The after: What are we going to do now? How are we guarding
against the future Bear Stearns? And what rules are set in
place so that things are done in a fair way? The response to
Bear Stearns was necessary but ad hoc. If the Fed is going to
be a stabilizer of last resort, it would be best if the
stabilizing efforts were by the book instead of on the fly.
And, finally, the who: Everyone agrees that Bear Stearns
was staring into the abyss. What about homeowners who are also
staring into the abyss? It is true that a large institution
creates systemic risk problems. An individual homeowner does
not. As an aggregate, homeowners certainly do. Thousands and
thousands and thousands of foreclosures create as much systemic
risk as one investment bank. And I worry that as quickly as the
Federal Government moved to save Bear Stearns from complete
failure, it has moved at a snail's pace, if at all, to save
homeowners from foreclosures where the same types of moral
hazard like as not existed.
So I thank you for this hearing, Mr. Chairman. It is
necessary. It is the beginning of a long road we have to face
so that our system of regulation catches up to the financial
system that is on the ground today.
Chairman Dodd. Thank you, Senator Schumer.
Senator Bunning.
STATEMENT OF SENATOR JIM BUNNING
Senator Bunning. Thank you, Mr. Chairman. I will be brief.
First of all, I want to know, the first question: How big
do you have to be to be too big to fail? That is the question I
ask first.
I am very troubled by the failure of Bear Stearns, and I do
not like the idea of the Fed getting involved in a bailout of
that company. But before making a final judgment, I want to
hear from our witnesses why they thought it was necessary to
stop the invisible hand of the market from delivering
discipline. That is socialism. At least that is what I was
taught. And I would imagine everybody at that table was taught
the same thing. It must not happen again.
I am also troubled that the regulators who were supposed to
be watching the types of mortgages being written did not do
their job. Neither did the regulators who were supposed to make
sure one firm did not become exposed to too much risk.
Other questions need to be asked. Does anyone else think
they will get Fed intervention if they get into trouble? Who
let our financial system become so fragile that one failure
jeopardizes the health of the entire system?
I am sure many other questions will come up as well. I look
forward to the hearing and will follow up during the
questioning.
Chairman Dodd. Thank you, Senator Bunning.
Senator Carper.
STATEMENT OF SENATOR THOMAS R. CARPER
Senator Carper. Thank you, Mr. Chairman. Mr. Chairman,
thanks for pulling this together. I just want to say--just
start off by thanking you and Senator Shelby for the leadership
you have provided in recent days and weeks to try to make sure
that our action here in the U.S. Senate matches the action on
the part of the Federal Reserve and on the part of the Treasury
and others to try to restore confidence in our markets, to
restore liquidity as well.
We will be taking up when we leave here today--the Chairman
and Senator Shelby will be leading a debate, accepting
amendments, debating amendments, as to what our
responsibilities are to follow up on the actions that you take.
And I agree with Senator Dodd. At the end of the day, I think,
Chairman Bernanke, what the Fed has done will probably pass
muster, and we will end up thanking you for that.
I am going to ask you, when it comes time for me to ask
questions, I am going to be asking you to give us your advice,
your informed advice on the package that we are about to
consider, that we are going to debate. And we are taking on
ourselves the ability to criticize or comment on what you have
done, and I would welcome you to do the same in terms of what
we expect to do later today and maybe through tomorrow and next
week.
The other questions I am going to ask--and a bunch of my
colleagues have already indicated, telegraphed their pictures,
I will telegraph mine as well, in terms of looking and
reflecting on the steps you have taken. But among the questions
I want to ask, Chairman Bernanke, are: Why did the Fed take the
action that you have done? How did the Fed actually intervene?
Just sort of give us a glimpse behind the curtain as to how you
actually intervened. What are the probable repercussions of the
action? What are the possible repercussions if you had not
chosen to act? Could this intervention be seen as a model of
what to do or not to do in the future? And if it is maybe the
latter, what steps should be taken to reduce the likelihood
that similar interventions will not be needed in the future?
Those are the kinds of questions that I will be throwing
your way, but one of the first questions I will ask is: What
advice would you have for us as we take up our legislative
actions on the floor?
Thank you very much, Mr. Chairman.
Chairman Dodd. Thank you very much.
Senator Dole.
STATEMENT OF SENATOR ELIZABETH DOLE
Senator Dole. Thank you, Mr. Chairman. I am also anxious to
hear from the witnesses and get into the question period.
Chairman Dodd. Thank you very much.
Senator Menendez.
STATEMENT OF SENATOR ROBERT MENENDEZ
Senator Menendez. Thank you, Mr. Chairman. I appreciate you
calling this hearing, and certainly no one questions the
necessity of having acted to stop the Bear Stearns crisis. We
can only imagine what would have happened to our broader
economy at the end of the day. But the catch about this deal is
that much of it is riding on faith, as I see it, and our faith
cannot be blind, which means it is time to pull back the
curtains and examine the details.
If we do not learn from the chain of events that led to
Bear's demise, then we are doomed to see a repeat in the
future. I hope the answers we will hear today will provide
insight into some key questions, including how we ended up
blindsided by the sudden tanking of a firm as large as this one
on Wall Street; how the specifics of this unprecedented deal
were hammered out. What are the consequences of sticking
taxpayers with a $29 billion loan that could fail? And, last,
how do we continue to look at struggling homeowners in the eye
when we pull out all the stops to help a sinking ship on Wall
Street but homeowners are still adrift at sea, drowning in
foreclosure?
The Bear Stearns crisis reared its head, and it was solved
in a matter of days. The foreclosure crisis has been going on
for a year with no end in sight. And both pose, I think,
significant if not equal threats to our economy.
So I look forward to getting to the bottom of exactly how
the decision to rescue Bear Stearns came about and why their
crisis is so different from the crisis still raging in
neighborhoods across the country.
Thank you.
Chairman Dodd. Thank you very much.
Senator Martinez.
Senator Martinez. I will pass.
Chairman Dodd. You pass on that.
Senator Tester.
STATEMENT OF SENATOR JON TESTER
Senator Tester. Thank you, Mr. Chairman. Welcome, Committee
Members. You have got a lot of questions to answer, and I
appreciate you being here. This is a big issue.
You know, I had a hearing the day after this merger was
announced. I had a forum on financial investments. The first
question from the crowd did not go to the experts. It went to
me. And the question was: ``Why $30 billion? Why was it
invested? I am homeowner. I am in trouble. How come nobody
steps up to the plate to help me?'' Many of the same questions
that were asked here.
I guess if I was to add to this list of questions, Have we
set precedents? Is this going to be the policy from now on? Is
this the direction we are headed, and is the right direction to
be heading in?
With that, Mr. Chairman, I just want to thank you for the
hearing, and I do have many questions, more than that, when my
time comes.
Thank you.
Chairman Dodd. Thank you, Senator, very much.
Senator Corker.
STATEMENT OF SENATOR BOB CORKER
Senator Corker. Mr. Chairman, I do not have an opening
statement, and I hope that--you all have shown tremendous
leadership, especially over the last few days. I hope we can
move toward the leader and the Ranking Member only making
opening comments in the future somehow so we could get to the
witnesses, but I have been greatly illuminated and look forward
to certainly hearing our witnesses.
Chairman Dodd. We are glad you have a chair at the table
and not in the closet back there as well.
[Laughter.]
Chairman Dodd. We have all been in that seat at one point
or another.
Senator Bayh.
Senator Bayh. I will wait.
Chairman Dodd. Senator Crapo.
STATEMENT OF SENATOR MIKE CRAPO
Senator Crapo. Thank you, Mr. Chairman. I will be brief as
well. I believe that the Members of the panel who have spoken
already have already raised a number of critical issues. I
think there is one more that we need to pay attention to as we
look at this situation.
The Congress is--or the Senate literally today is looking
at issues relating to the housing market and the mortgage
industry, and we are going to today in this hearing be looking
very closely at what happened with the Bear Stearns situation
and how the Fed and the Treasury and the SEC responded there.
I think as we look at these issues and as the hearing moves
forward, we also need to look at our competitiveness, frankly,
in capital markets and whether we need to look at an entirely
new restructuring of how we regulate our financial markets in
this country. This issue has also been raised recently by
Secretary Paulson, and many others have raised it before he
did.
So I believe that what we are looking at in today's hearing
clearly brings forward the question of how is our regulatory
structure in the United States set up and how should it be set
up as we look forward to moving into this next century, and how
can we make ourselves as competitive as possible in today's
global economy.
With that, Mr. Chairman, I will stop.
Chairman Dodd. Thank you. Thank you very much, Senator.
And, again, I want to thank our witnesses for being here. We
have, of course, the Chairman of the Federal Reserve Ben
Bernanke; the Honorable Christopher Cox, the Chairman of the
Securities and Exchange Commission; the Honorable Robert Steel,
who is the Under Secretary for Domestic Finance at Treasury;
and Tim Geithner, who is the President of the Federal Reserve
Bank of New York. And we thank all four of you once again for
being here.
Chairman Bernanke, you have spent quite a bit of time in
Congress these last few days. I suggested in private before the
hearing that we might find an office up here for the Chairman,
he has been here so often over the last number of days.
We are grateful to you, all of you, for being here, as well
as our other witnesses who are here in the second panel. We
will begin with you, Mr. Chairman, and I would like you to take
5 or 6 minutes. I do not want to hold you to any specific time,
but if you would try and keep it in that framework. And also
any other information you think that would be valuable for the
Committee to have, we will, of course, agree to accept that
testimony, as well as the documentation.
With that, welcome to the Committee.
STATEMENT OF BEN S. BERNANKE, CHAIRMAN, BOARD OF GOVERNORS OF
THE FEDERAL RESERVE SYSTEM
Mr. Bernanke. Mr. Chairman, I do want to thank you for this
hearing, which I think is absolutely appropriate and necessary,
and we welcome your oversight.
Chairman Dodd----
Senator Bunning. Mr. Chairman, would you pull that mike
closer? Thank you.
Mr. Bernanke. How is that?
Senator Bunning. That is great.
Mr. Bernanke. Chairman Dodd, Senator Shelby, and other
Members of the Committee, I appreciate this opportunity to
discuss the economic and financial context and the actions the
Federal Reserve has taken to stabilize financial markets and
the economy.
Although the situation has recently improved somewhat,
financial markets remain under considerable stress. Pressures
in short-term bank funding markets, which had abated somewhat
beginning late last year, have increased once again. Many
lenders have been reluctant to provide credit to
counterparties, especially leveraged investors, and increased
the amount of collateral they required to back short-term
security financing agreements. To meet those demands, investors
have reduced their leverage and liquidated holdings of
securities, putting further downward pressure on security
prices. Credit availability has also been restricted because
some large financial institutions, including some commercial
and investment banks and the government-sponsored enterprises,
have reported substantial losses and writedowns, reducing the
capital they have to support new lending. Some key
securitization markets, including those for nonconforming
mortgages, continue to function poorly, if at all.
These developments in financial markets--which themselves
reflect, in part, greater concerns about housing and the
economic outlook more generally--have weighed on real economic
activity. Notably, in the housing market, sales of both new and
existing homes have generally continued weak, partly as a
result of the reduced availability of mortgage credit, and home
prices have continued to fall. Private payroll employment fell
substantially in February, after 2 months of smaller job
losses, with job cuts in construction and closely related
industries accounting for a significant share of the decline.
But the demand for labor has also moderated recently in other
industries. Overall, the near-term economic outlook has
weakened relative to the projections released by the Federal
Open Market Committee at the end of January. Inflation has also
been a source of concern. We expect inflation to moderate in
coming quarters, but it will be necessary to continue to
monitor inflation developments carefully.
Well-functioning financial markets are essential for the
efficacy of monetary policy and, indeed, for economic growth
and stability. Consistent with its role as the Nation's central
bank, the Federal Reserve has taken a number of steps in recent
weeks to improve market liquidity and market functioning. These
actions include reducing the cost and increasing the allowable
term of discount window credit to commercial banks; increasing
the size of our Term Auction Facility, through which credit is
auctioned to depository institutions; initiating a Term
Securities Lending Facility, which allows primary dealers to
swap less liquid mortgage backed securities for more liquid
Treasury securities; and creating the Primary Dealer Credit
Facility, which is similar to the discount window but
accessible to primary dealers. Although these facilities
operate through depository institutions and primary dealers,
they are designed to support the broader financial markets and
the economy by facilitating the provision of liquidity by those
institutions to their customers and counterparties. With
respect to monetary policy, at its March meeting the FOMC
reduced its target for the Federal funds rate by 75 basis
points to 2\1/4\ percent.
It was in this context of intensifying financial and
economic strains that, on March 13th, Bear Stearns advised the
Federal Reserve and other Government agencies that its
liquidity position had significantly deteriorated and that it
would have to file for bankruptcy the next day unless
alternative sources of funds became available.
This news raised difficult questions of public policy.
Normally, the market sorts out which companies survive and
which fail, and that is as it should be. However, the issues
raised here extended well beyond the fate of one company. Our
financial system is extremely complex and interconnected, and
Bear Stearns participated extensively in a range of critical
markets. The sudden failure of Bear Stearns likely would have
led to a chaotic unwinding of positions in those markets and
could have severely shaken confidence. The company's failure
could also have cast doubt on the financial positions of some
of Bear Stearns' thousands of counterparties and perhaps of
companies with similar businesses. Given the exceptional
pressures on the global economy and financial system, the
damage caused by a default by Bear Stearns could have been
severe and extremely difficult to contain. Moreover, and very
importantly, the adverse impact of a default would not have
been confined to the financial system but would have been felt
broadly in the real economy through its effects on asset values
and credit availability.
To prevent a disorderly failure of Bear Stearns and the
unpredictable but likely severe consequences for market
functioning and the broader economy, the Federal Reserve, in
close consultation with the Treasury Department, agreed to
provide funding to Bear Stearns through JPMorgan Chase. Over
the following weekend, JPMorgan Chase agreed to purchase Bear
Stearns and assumed Bear's financial obligations.
The purpose of our action, as with our other recent
actions--including our provision of liquidity to financial
firms and our reductions in the federal funds rate target--was,
as best as possible, to improve the functioning of financial
markets and to limit any adverse effects of financial turmoil
on the broader economy. We will remain focused on those
objectives.
Clearly, the U.S. economy is going through a very difficult
period. But among the great strengths of our economy is its
ability to adapt and to respond to diverse challenges. Much
necessary economic and financial adjustment has already taken
place, and monetary and fiscal policies are in train that
should support a return to growth in the second half of this
year and next year. I remain confident in our economy's long-
term prospects.
Thank you, and I would be pleased to take your questions.
Chairman Dodd. Thank you very much.
Chairman Cox.
STATEMENT OF CHRISTOPHER COX, CHAIRMAN, SECURITIES AND EXCHANGE
COMMISSION
Mr. Cox. Thank you, Chairman Dodd, Senator Shelby, and
members of the Committee, for inviting me to testify today on
behalf of the Securities and Exchange Commission about recent
events in the financial markets, and in particular the merger
agreement between JPMorgan and Bear Stearns.
The recent actions by the Federal Reserve, as Chairman
Bernanke has just described, are unprecedented and of
unquestioned significance. They include not only the extension
of guarantees and credit in connection with JPMorgan's
acquisition of Bear Stearns, but also the opening of the
discount window to every one of the major investment banks.
What happened to Bear Stearns during the week of March 10th
was likewise unprecedented. For the first time, a major
investment bank that was well-capitalized and apparently fully
liquid experienced a crisis of confidence that denied it not
only unsecured financing, but even short-term secured
financing. And even when the collateral consisted of Treasuries
and agency securities which had a market value in excess of the
funds to be borrowed.
Counterparties would not provide securities lending
services and clearing services. Prime brokerage clients moved
their cash balances elsewhere. These decisions, in turn,
influenced others to also reduce their exposure to Bear.
Over the weekend of March 15th and 16th, Bear Stearns faced
a choice between filing for bankruptcy on Monday morning, or
concluding an acquisition agreement with a larger partner.
In the cauldron of these events, the actions that the
Federal Reserve took--in particular extending access to the
discount window, not only to Bear Stearns but to the other
major investment banks--were addressed to preventing future
occurrences of the run-on-the-bank phenomenon that Bear
endured. It remains, however, for regulators and Congress to
consider what other steps, if any, are necessary to harmonize
this significant new safeguard with other aspects of the
existing legislative and regulatory structure.
The SEC, of course, does not have the function of extending
credit or liquidity facilities to investment banks or to any
regulated entity. Instead, through our consolidated supervised
entities program, the Commission exercises oversight of the
financial and operational condition of Bear Stearns, Goldman
Sachs, Lehman Brothers, Merrill Lynch, and Morgan Stanley at
both the holding company and the regulated entity levels. Our
oversight of the CSEs includes monitoring for firm-wide
financial and other risks that might threaten the regulated
entities within the CSEs, especially the U.S. regulated broker-
dealers and their customers.
In particular, the SEC requires that firms maintain an
overall Basel capital ratio at the consolidated holding company
level of not less than the Federal Reserve's 10 percent well-
capitalized standard for bank holding companies.
At all times during the week of March 10th through 17th, up
to and including the time of its agreement to be acquired by
JPMorgan, Bear Stearns had a capital cushion well above what is
required to meet the Basel standards. Specifically, even at the
time of its sale, Bear Stearns' consolidated capital and its
broker-dealers' net capital exceeded relevant supervisory
standards.
Even prior to the experience with Bear Stearns, the SEC's
supervision of investment bank holding companies has always
recognized that capital is not synonymous with liquidity. A
firm can be highly capitalized while also having liquidity
problems. So in addition to a healthy capital cushion, the firm
needs sufficient liquid assets in the form of cash and high
quality instruments such as U.S. Treasury securities that can
be used as collateral for loans in times of stress.
For this reason, the CSE requirements are designed to
ensure that an investment bank holding company can meet all of
its cash needs even in the face of a complete cutoff of
unsecured financing that lasts for a full year. In these ways,
the CSE supervisory model has focused on the importance of both
capital and liquidity.
What neither the CSE regulatory approach, nor any existing
regulatory model, has taken into account is the possibility
that secured funding, even if it is backed by high quality
collateral such as U.S. Treasury and Agency securities, could
become unavailable. The existing models for both commercial and
investment banks are premised on the expectancy that secured
financing would be available in any market environment, albeit
perhaps on less favorable terms than normal.
For this reason, the inability of Bear Stearns to borrow
against even high quality collateral on March 13th and 14th was
an unprecedented occurrence. And that is what has prompted the
Fed's action to open the discount window to investment banks.
Beyond this obviously powerful step that the Fed has taken,
the Bear Stearns' experience has challenged the measurement of
liquidity in every regulatory approach, not only here in the
United States but around the world. It was in this connection
that I conveyed to the Basel Committee my strong support for
extending their capital adequacy standards to deal with
liquidity risk of the kind that materialized for Bear Stearns.
The Fed's other important decision, to provide funding to
Bear Stearns through JPMorgan, was made because--as you have
heard Chairman Bernanke testify--Bear's extensive participation
in a range of critical markets meant that a chaotic unwinding
of its positions not only could have cast doubt on the
stability of thousands of the firm's counterparties, but also
created additional pressures well beyond the financial system
through the real economy. These are considerations of systemic
risk that extend far beyond the SEC's mandate to protect
investors, ensure orderly securities markets, and promote
capital formation through such means as the CSE program.
But it is important to observe nonetheless that the SEC's
statutory and regulatory framework, including not only our
broker-dealer net capital regime but also the protection
provided to investors through SIPC, and the requirement that
SEC-regulated broker-dealers segregate customer funds and fully
paid securities from those of the firm, worked in this case to
achieve the purpose for which it was designed.
Despite the run on the bank to which Bear Stearns was
subjected, its customers were fully protected. At no time
during the week of March 10th through 17th, up to and including
the date of the agreement with JPMorgan, were any of Bear
Stearns' broker-dealer customers at risk of losing their cash
or their securities.
The question has been asked what might have happened if,
notwithstanding the Fed's action, the transaction with JPMorgan
had not been agreed to before Monday, March 17th?
Unfortunately, unlike a laboratory in which conditions can be
held constant and variables changed while the experiment is
repeated, in the social science of the market the selection of
one course of action forever forecloses all other approaches
that might have been taken.
But there is one thing we know to a certainty. With or
without JPMorgan's acquisition of Bear and with or without a
bankruptcy, Bear Stearns' customers are and would have been
fully protected from any loss of cash or securities.
Beyond demonstrating the importance of short-term liquidity
in the form of available sources of secured funding, the Bear
Stearns' experience has highlighted the statutory supervisory
gap in this area. In 1991, when Congress enacted the Federal
Deposit Insurance Improvement Act, it recognized the importance
of having a framework for considering the resolution of
financial difficulties experienced by commercial banks, but not
unfortunately by investment banks.
FDICIA, together with the Federal Deposit Insurance Act,
reflect Congress' conviction that it is best not to improvise
the principles that will guide Federal intervention in
financial institutions. That is a point that is equally valid
not only for depository institutions but other systemically
important institutions, as well.
Now, as always, the SEC is working closely with our
regulatory counterparts to ensure that our regulatory actions
contribute to orderly and liquid markets. These recent events
have amply demonstrated that the SEC's mission to protect
investors, maintain orderly markets, and promote capital
formation is more important now than ever it has been.
Thank you again, Mr. Chairman, for the opportunity to
discuss these important issues and I look forward to taking
your questions.
Chairman Dodd. Thank you very much, Chairman Cox.
Secretary Steel.
STATEMENT OF ROBERT STEEL, UNDER SECRETARY OF TREASURY FOR
DOMESTIC FINANCE, DEPARTMENT OF THE TREASURY
Mr. Steel. Thank you. Chairman Dodd, Ranking Member Shelby,
members of the Committee, good morning. I very much appreciate
the opportunity to appear before you today to represent
Secretary Paulson and the United States Treasury Department,
and to join the independent regulators leading the Board of
Governors of the Federal Reserve System, the Securities and
Exchange Commission, the Federal Reserve Bank of New York. As
you know, Secretary Paulson is on a long-scheduled trip to
China today.
You invited Treasury here today to discuss the ongoing
challenges in our credit markets, and specifically, the
agreement between JPMorgan Chase and Company and the Bear
Stearns Companies, Inc.
The Treasury Department continues to closely monitor the
global capital markets and the past several months have
presented to us many important issues and situations to
evaluate and to address. As Secretary Paulson stated earlier
this week, a strong financial system is vitally important, not
only for Wall Street, not only for the bankers, but for all
Americans. When our markets work, people throughout our economy
benefit. Americans seeking to buy a car, a home, families
borrowing to pay for college, innovators borrowing on the
strength of a good idea for a new product or technology, and
business financing investments that create new jobs. When our
financial system is under stress, all Americans bear the
consequences.
Mr. Chairman, as you have appropriately noted in your
letter to Secretary Paulson, ``It is important to maintain
liquidity, stability, and investor confidence in the markets.''
The recent events in the credit and mortgage markets are of
considerable interest to this Committee, other Members of
Congress, and most importantly, all of the citizens of this
country. For several months, our financial markets have gone
through a period of turbulence followed by periods of
improvement. A great deal of deleveraging is occurring, which
has created liquidity challenges for financial institutions and
thereby compromised our credit markets' ability to be an engine
of economic growth.
It took a long time to build up the excesses in our markets
and we are now working through all of the varied consequences.
Market participants are adjusting, making disclosures, raising
capital, and repricing assets. We have continued to engage with
our fellow regulators and market participants so that
collectively we work through these challenges to limit the
spillover effects to our economy and make our markets even
stronger in the future.
During times of market stress, certain issues may hold the
potential to spill over to the broader markets and cause harm
to the American economy. This was the case, in our view, with
the events surrounding the funding capability of Bear Stearns
between March 13th, 2008 and March 24th. The funding condition
of Bear Stearns had deteriorated rapidly and by March 13th,
2008 had reached such a critical stage that the company would
have faced a bankruptcy filing on March 14th, 2008 absent an
extraordinary infusion of liquidity.
During this period, regulators were continually
communicating with one another, working collaboratively, and
keeping each other apprised of the changing circumstances. The
focus was not on the specific institution but on the more
important strategic concern of the implications of a
bankruptcy. The failure of a firm at that time that was so
connected to so many corners of our markets would have caused
financial disruptions beyond Wall Street.
We weighed the multiple risks, such as the potential
disruption to counterparties, other financial institutions, the
markets, and the market infrastructure. These risks warranted a
careful review and thorough considerations of potential
implications and responses.
Our role at the Treasury Department was to support the
independent regulators and their efforts with private parties
as credit markets were operating under considerable stress and
we believed that certain prudent actions could help to mitigate
systemic risk, enhance liquidity, facilitate more orderly
markets, and minimize the risk to the taxpayers.
The Treasury Department supports the actions taken by the
Federal Reserve Bank of New York and the Federal Reserve. We
believe the agreements reached were necessary and appropriate
to maintain stability in our financial system during this
critical time.
Obviously, each independent regulator had to make its own
individual assessment and determination as to what actions it
would or would not take. While the Treasury Department was not
a party to any agreements, we have a great deal of respect for
the leadership of each regulator and appreciate their efforts
during this extraordinary time.
Upon assessing the Bear Stearns situation, the Federal
Reserve decided to take the very important and consequential
action of authorizing the Federal Reserve Bank of New York to
institute a temporary program for providing liquidity to
primary dealers. Recent market turmoil has required the Federal
reserve to adjust some of the mechanisms by which it provides
liquidity to the financial system. Its response, in the face of
new challenges, deserves praise.
At the Treasury Department, we will continue to monitor
market developments. We remain focused on the issues
surrounding recent developments, including the important
responsibility of safeguarding Government funds.
Recent events underscore the need for strong market
discipline, prudent regulatory policies, and robust risk
management. The Treasury Department and our colleagues,
comprising the President's Working Group on Financial Markets,
are addressing the current and strategic challenges and doing
all that we can to ensure high quality, competitive, and
orderly capital markets. We seek to strengthen market
discipline, mitigate systemic risk, enhance investor confidence
and market stability, as well as facilitate stable economic
growth.
Thank you, and I look forward to your questions, sir.
Chairman Dodd. Thank you very much, Mr. Secretary.
Chairman Geithner.
STATEMENT OF TIMOTHY F. GEITHNER, PRESIDENT, FEDERAL RESERVE
BANK OF NEW YORK
Mr. Geithner. Thank you, Mr. Chairman, Senator Shelby,
members of the Committee. Thanks for giving me the chance to be
here today.
These are exceptional times. We have taken some very
consequential actions. They deserve and require very careful
analysis and reflection and oversight. And you are right to
begin that process now.
I have submitted a very extensive written testimony
describing in detail the events that began that evening of, I
think, March 13th. But I just want to limit my opening remarks
to three things.
One is I want to explain why we did what we did. I want to
talk a little bit about the policy challenges ahead and
continuing risks to the economy in this financial crisis. And I
want to set out some broad objectives for how we think about
the future.
Three weeks ago, on March 13th, we learned from the SEC
that Bear Stearns was facing imminent bankruptcy. This
presented us with some extraordinarily difficult policy
judgments. Bear Stearns occupies, occupied, a central position
in the very complex and intricate relationships that
characterize our financial system. And as important as that, it
reached the brink of insolvency at an exceptionally fragile
time in global financial markets.
In our judgment, an abrupt and disorderly unwinding of Bear
Stearns would have posed systemic risks to the financial system
and magnified the downside risk to economic growth in the
United States. A failure to act would have added to the risk
that Americans would face lower incomes, lower home values,
higher borrowing costs for housing, education, other living
expenses, lower retirement savings, and rising unemployment.
We acted to avert that risk in the classic tradition of
lenders of last resort, with the authority provided by the
Congress. We chose the best option available in the unique
circumstances that prevailed at that time.
The Federal Reserve has to strike a very careful balance
between actions to contain risk to the broader economy and
actions that might amplify the risk of future financial crises
by insulating investors from the consequences of imprudence.
In this context, though, let me just emphasize two things.
A failure to act would have imposed significant damage on those
households, on those companies, on those financial institutions
that had been comparatively prudent. And in this particular
case, no owner or executive or director of a financial
institution can look at the outcome for Bear Stearns and choose
to see their firm managed in such a way as to court a similar
fate.
The financial arrangement we reached to help avert defaults
was authorized by the Chairman of the Board of Governors, and
supported by the Secretary of the Treasury. It is very
carefully designed to provide a number of important protections
to reduce the risk of any loss. First, our loans are backed by
a substantial pool of collateral that will be professionally
managed. Second, JPMorgan Chase agreed to absorb the first $1
billion of any loss that might occur in connection with this
arrangement. And third, our long-term horizon for holding the
collateral will enable assets to be managed in an orderly
fashion to minimize the risk of any loss and minimize any
disruption to markets.
The risk in this arrangement--and there are risks in this
arrangement--are modest in comparison to the substantial losses
to the economy that could have accompanied Bear's insolvency.
I believe the actions taken by the Federal Reserve on a
number of fronts in recent months have reduced some of the
risks to the economy that is inherent in this adjustment
underway in financial markets. By reducing the probability of a
systemic financial crisis, the actions taken by the Fed on and
after March 14th have helped avert substantial damage to the
economy and they have brought a measure of tentative calm to
global financial markets.
Relative to the conditions that existed on March 14th, risk
premiums have narrowed, foreign exchange markets are somewhat
more stable, energy and commodity prices are somewhat lower,
perceptions of risk in the financial system have somewhat
diminished, and the flight to quality is less pronounced.
Nevertheless, and I want to emphasize nevertheless,
liquidity conditions in markets are still substantially
impaired and the process of deleveraging remains underway.
Financial market participants are still extraordinarily
cautious about assuming risk. And this will intensify, continue
to intensify, the headwinds facing the U.S. in the global
economy.
The causes of this crisis took a long time to build up and
they will take some time to work through. And in this context,
it is important to underscore the fact that policymakers and
financial market participants are going to need to continue to
act proactively, with actions that are proportionate to the
challenges ahead.
Let me just highlight three important areas for continued
focus on the policy front. First, it is very important that
financial institutions continue to improve the quality of
disclosure. And even the strongest institutions face compelling
incentives to raise new equity capital so that they can take
advantage of the opportunities ahead.
Second, alongside the broad policy actions, both monetary
policy and fiscal policy, that are already in place to contain
the downside risk to the economy, it is very important to
strengthen the capacity of the major government sponsored
enterprises, the Federal Home Loan Bank system, the Federal
Housing Administration, so that they can provide finance to the
mortgage market and help reduce the risk of avoidable
foreclosures.
Third, the Federal Reserve, working closely with other
major central banks, will continue to provide liquidity to
markets to help facilitate the process of financial repair.
Looking forward, and it is important to look forward, even
as we work to contain the risks in this financial crisis, we
need to begin to design a comprehensive set of reforms to the
financial system. In addition to the very important objective
of putting in place a stronger set of protections for
consumers, the overwhelming imperative of reform must be to put
in place a stronger framework for financial stability, both in
the United States and, I think, globally.
And our objective should be to create a system that
preserves the unique strength of our markets in providing
individuals and companies with innovative ways to access
capital and credit, but with a greater capacity to withstand
stress. And this is going to require significant changes to
regulatory policy and to the regulatory framework. And I think
the focus has to be on changing the incentives all financial
market participants face in managing risk and exposure to
adverse outcomes.
In my view, and this is my personal view, there are a set
of important objectives and principles that should guide this
effort. I am just going to list five quickly, before I
conclude.
First, we need to ensure there is a stronger set of shock
absorbers in terms of capital and liquidity in those
institutions, both banks and a limited number of the largest
investment banks, institutions that are critical to market
functioning. And they need to be under a stronger form of
consolidated supervision than exists today.
Second, we need to streamline and simplify our excessively
complex and segmented regulatory framework to reduce the
opportunity it creates for regulatory arbitrage, not just in
the mortgage market but more broadly.
Third, we need to make the financial infrastructure more
robust, particularly in the derivatives and repo markets, so
that the system can better withstand the effects of default by
a major participant.
Fourth, we need to redesign the set of liquidity facilities
that we maintain in normal times--we, at the Federal Reserve,
maintain in normal times--and in extremis, both in the United
States and across the other major central banks. And these
changes, as many of you have recognized, need to come with a
stronger set of requirements for the management of liquidity
risk by financial institutions that have access to central bank
liquidity.
And fifth, we need to make sure that the Federal Reserve
has the mix of authority and responsibility that is necessary
to enable it to respond with adequate speed and force to
systemic risk to financial stability.
Our system has many strengths, but to be direct about it, I
think we have suffered a very damaging blow to confidence and
the credibility of our financial system. One of the great
strengths of our system, though, is the speed with which we
adapt to change.
My colleagues at the Federal Reserve and I look forward to
working with this Committee, with the Congress, and with the
executive branch to try to think through the very important
task of how to put in place a stronger system for the future.
I just want to express, in closing, my admiration and
appreciation to the officers and staff of the Federal Reserve
Bank of New York and the Federal Reserve system. They have
performed with great skill and care under extreme pressure.
I also want to thank Chairman Bernanke, Secretary Paulson,
Chairman Cox, and Bob Steel, among many other colleagues in the
Fed and the supervisory community for really exceptional
leadership in a difficult time.
Thanks again for giving me the chance to appear today.
Chairman Dodd. Thank you very much, President Geithner.
Just a couple of quick points, if I can.
First of all, I just want to express once again to the
witnesses, I realize this was an extraordinary case in calling
this hearing, but with the exception of one witness we got
statements very late last evening. Again, I want to make this
appeal to people. You have got to let us know--my colleagues
here want to be able to read these statements, they want to
develop questions. We need to get these statements in a more
timely fashion under the rules of the Committee.
I would be remiss if I did not bring it up again. I do not
want to keep repeating it every hearing we go. So again, I
understand the timing of this Committee may have put some
additional pressures and I know others of you had to testify in
other hearings prior to this. But I want to make that case.
Second, what I would like to do here, why don't I try 7
minutes. That is not a lot of time, but there are a lot of
members here and I want to make sure everybody gets a chance to
raise questions. I am not going to bang down the gavel at
seven, but try and keep that in mind as you develop your
questions on the Committee.
I will begin, if I can, with a question for the Federal
regulators here. I guess going back, I was thinking this
morning, there was the question raised by Howard Baker years
ago, what did you know, and when did you know it? The kind of a
question that comes to mind when you look at this situation,
talking about the 96 hours. And what did our regulators know
and when did you know it, in terms of our response to the
situation with Bear Stearns.
Specifically, there have been some reports in the press
about the details of this negotiation. The Wall Street Journal
reported, and I quote them, it says ``This was no normal
negotiation. Instead of two parties, there were three, the
third being the Federal Government. It is unclear what the
explicit requests were made by the Fed or the Treasury.''
So I will begin with you, Chairman Bernanke, and also ask
Secretary Steel what, if any, interjections were there over
stock price of Bear Stearns? Specifically again, there are just
reports, and I want to share them with you, that they would
make an offer. That JPMorgan Chase would make an offer of $4 a
share. Subsequently it was conveyed to JPMorgan Chase by
someone in the Federal Government that the offer sounded too
high in terms of rewarding Bear Stearns' stockholders, given
the taxpayer funding that was involved.
Therefore, were you or any of your agencies aware at any
point that there was an offer of $4 a share made from JPMorgan
Chase? And second, did you or anyone in your agency provide
feedback to JPMorgan or Bear Stearns on the value of that
offer, in particular? And then last, given the specifics of the
situation, depending upon your answer, do you think it would be
improper or is it improper for any high-ranking Government
official to have given advice to the CEOs of companies
regarding what the appropriate stock price should be in
circumstances like this?
Mr. Bernanke. Mr. Chairman, the Federal Reserve's interest
in this negotiation was that Bear Stearns be assumed by a
strong firm so that its obligations would be met. I would
emphasize, in fact, that we were very careful to make sure that
there were multiple opportunities for different firms to talk
to Bear Stearns over that short period of time.
We had no interest or no concern about the stock price that
was evaluated. That was a secondary issue, as far as we were
concerned. We wanted to see Bear Stearns' liabilities assumed
in some way.
Chairman Dodd. So there was no interjection on the part of
the Fed at all in this area?
Mr. Bernanke. Not to my knowledge.
Chairman Dodd. Secretary Steel.
Mr. Steel. Well sir, the Secretary of the Treasury and
other members of Treasury were active participants during this
96 hours, as you describe. There were lots of discussions back
and forth. Also, in any combination of this type, there are
multiple terms and conditions.
I think the perspective of Treasury was really twofold.
One, was the idea that Chairman Bernanke suggested, that a
combination into safe hands would be constructive for the
overall marketplace. And No. 2, since there were Federal funds
or the Government's money involved, that that be taken into
account, and Secretary Paulson offered perspective on that.
There was a view that the price should not be very high or
should be toward the low end and that it should be, given the
Government's involvement, that was the perspective.
But regards to the specifics, the actual deal was
negotiated or the transaction was negotiated between the
Federal Reserve Bank of New York and the two parties.
Chairman Dodd. President Geithner, can you shed any light
on this at all, on these rumors that are going around about
Federal agencies recommending a lower price rather than one
that was being offered?
Mr. Geithner. Let me just echo what the Chairman and Bob
Steel said. Two objectives, very important for us. One was
there be an agreement reached that would avert the risk of
default because of the consequences for the economy as a whole.
The second was that the outcome, to the extent possible,
not add to the inherent moral hazard risk in this kind of
intervention.
From my perspective, the outcome reached that evening and
the subsequent agreement reached a week later, are fully
consistent with those two objectives.
Would there have been some outcomes that would have been
not consistent with other objectives? Possibly, but we were not
presented with those outcomes.
Chairman Dodd. The point I want to get at here is whether
or not our Federal agencies at all, including Treasury in this
case here, Secretary Steel, where one offer was made and the
Treasury recommended a lower--that a lower price be offered.
Was there any such intervention directly by the Treasury?
Mr. Steel. I cannot confirm that, sir. Secretary Paulson
and Treasury were active participants. But in the end, the
actual offer made and accepted was between the Federal Reserve
Bank of New York and the participants. As I said, there was a
perspective, as President Geithner suggested, that the outcome,
with all the different terms and conditions, would be
consistent with communicating and making clear moral hazard to
the least degree possible. And I think that is consistent with
how President Geithner and I describe it.
Chairman Dodd. I understand the motivation behind it. The
question is whether--I guess I maybe should ask the first
question. What would be your reaction to the question,
generally speaking, as to the propriety in this sort of
circumstance of the Treasury intervening with a specific
request that a certain price be offered where this kind of a
transaction is going forward?
Mr. Steel. I think that the Treasury was actively involved
and provided a perspective. The final terms and conditions were
settled by the Federal Reserve Bank of New York. It was our
perspective, as I said, that moral hazard wanted to be
protected as much as possible. And so therefore a lower price
was more appropriate. And there were lots of terms and
conditions.
The appropriateness, from my perspective, is that when
there is Federal money involved, as originally $30 billion and
then $29 billion, then there is a point of view that should be
offered to the principals, which in this case the Federal
Reserve Bank of New York, as to our perspective.
Chairman Dodd. Well, all right. Let me move on. I do not
want to dwell on it, but that is a question I am sure others
may pursue as well because it is a matter of concern.
I want to go back to the issue of the discount window, if I
could, Mr. Chairman, with you. As I mentioned in my opening
statement, in a hearing before this Committee a week or two
earlier than the events of March 13th and 14th, we had in fact
a panel of regulators before us. And I raised the issue as to
whether or not opening up the discount window to broker-dealers
would be a--how wise that would be. It was not just the Vice
Chairman of the Fed but, in fact, every regulator at the panel
that day rejected the idea. Obviously, people changed their
minds, apparently, over the next 10 days or 12 days.
The question I have for you is, one, what happened in that
10 days that caused the Fed to change its mind? Second, if you
had changed your mind, why didn't you change your mind on
Thursday night instead of Sunday night? And if you had changed
your mind on Thursday night instead of Sunday night, could Bear
Stearns have been saved, since Bear Stearns was not insolvent,
it was a liquidity issue. And if opening up that discount
window would have provided additional liquidity, could all of
this been avoided?
Mr. Bernanke. Mr. Chairman, it was a very substantial step
to do what we did, to open up the discount window. And we did
not take it lightly, as Vice Chairman Kohn indicated. We had,
in fact, earlier that week, on the Tuesday we had instituted
the Term Securities Lending Facility which was, in fact, open
to primary dealers. It was a source of liquidity and did
provide reassurance. The market responded very well to that.
But it was not available during that week.
It was precisely the set of conditions that we saw during
the week and that led to the Bear Stearns' situation that
caused us to reconsider our previously held position that it
would take a very high bar to open up the discount window. We
made the decision to do so on Sunday. At the time we did it, we
did not know whether the Bear Stearns' deal would be
consummated or not and we wanted to be prepared, in case it was
not consummated, that we would need to have this facility in
order to protect what we imagined would be pressure on the
other dealers subsequently to that.
Whether opening it up earlier would have helped or not is
very difficult to say. Perhaps President Geithner can add to
this, but Bear Stearns was losing customers and counterparties
very quickly. They were downgraded on Friday. We did lend them
money, of course, to keep them into the weekend. But it is not
at all obvious to me that it would have been sufficient to
prevent their bankruptcy.
Chairman Dodd. Before I turn to President Geithner on this
question, I want to ask you as well, as you pointed out and
others have, we are in the midst of considering legislation on
the floor dealing with the housing issue. And I have raised
this issue. Obviously, there are some serious regulatory
questions being raised now as a result of opening up the
discount window and expanding that opportunity.
Do you feel you have enough statutory authority to impose
regulations on broker-dealers? Or do you need additional
authority that we ought to be providing you? And since we are
on the floor dealing with a related matter, it seems to me it
is an important question to get to Senator Shelby and I and
others who would be interested in knowing whether or not we
ought to respond, rather than leaving this door open
potentially with exposure that could cost us dearly.
Mr. Bernanke. Mr. Chairman, for now we are working very
effectively with the SEC and with the firms. We have the
information we need. We believe that the lending we are doing
to the primary dealers is being done safely and soundly, so
there is not an immediate emergency there.
However, since our lending authority is only for
emergencies, we will have to take this window back. We will
have to close it when conditions normalize. So questions that
Congress will want to consider over time: Should we make this a
regular facility in the future? If so, presumably we will want
to think through the prudential regulation of the investment
banks to make sure that they are indeed safe and sound,
adequately safe and sound to receive this particular privilege.
And we would also need to think, I believe, about--the question
was raised about FDICIA. Do we need additional thinking on the
appropriate set of circumstances, the appropriate sequencing
under which an investment bank in trouble would be reorganized,
assisted, and so on?
So I think there are some very weighty issues, but let me
just emphasize for the time being that we are effectively
lending to investment banks. We are working very closely and
carefully with the SEC and with the firms, and we do not feel
that we are in any way lending improperly or unsafely at this
point.
Chairman Dodd. Let me ask the rest of you here the earlier
question I asked about whether or not, had this Sunday night
decision been made on Thursday or earlier--and others had
raised it earlier. This was not some new idea. People had been
talking about it, and it had been pretty widely rejected by the
regulatory community at large. But, President Geithner, what is
your reaction to that? What do you think might have happened on
Thursday night had the decision been made to open that up?
Would Bear Stearns have been in a different position?
Mr. Geithner. Very hard to know. Let me just make two
points.
In some sense, we had--you can think about that question by
thinking about what actually happened on Friday. So Friday
morning, we took the exceptional step with extreme reluctance,
with the support of the Board of Governors and the Treasury, to
structure a way to get them to the weekend so that we could buy
some time to explore whether there was a possible solution that
would have them acquired and guaranteed.
Chairman Dodd. Let me ask you something quickly on that
point. I have read the written statement of Alan Schwartz. I am
under the impression he thought that he got 28 days, not a day
or 2 days.
Mr. Geithner. Well, if you look carefully at the statement
that was made, the language said ``up to 28 days.'' But I think
I can answer your question if you will let me just continue
this one thing.
So we took that extraordinary step to buy time to get to
the weekend, and as you can hear from Alan later on, you can
see--if you ask about the details of what happened over the
course of that day, you can see a little bit about the scale of
the loss of confidence, because the dynamics that Chairman Cox
described accelerated over the course of the day. And the
number of customers and counterparties that sought to withdraw
funds, the actions by rating agencies on some Bear paper,
accelerated that dynamic, despite the access to liquidity and
despite the hope that that might buy some time. So I think that
does raise a lot of questions about whether this very
exceptional, temporary, carefully designed access to liquidity
we provided would have been sufficient.
One other point. The way the Federal Reserve Act is
designed and the way we think about the discount window for
banks is we only allow sound institutions to borrow against
collateral in that context. And I can only speak personally for
this, but I would think--I would have been very uncomfortable
lending to Bear given what we knew at that time if you could
walk back the clock and think about what had happened if that
facility had been in place before.
But, again, as everybody has emphasized, both these
facilities--the one the Chairman described was announced that
Tuesday, and the subsequent facility announced Sunday night--
these were exceptionally consequential acts, taken with extreme
reluctance and care, because of the substantial consequences it
would have for moral hazard in the financial system going
forward. And I do not believe it would have been appropriate
for us to take that action Sunday night if we had not been
faced with the dynamics that were precipitated by and
accelerated by the looming prospect of a Bear default.
Chairman Dodd. I have gone over my time, and I apologize to
my colleagues.
Senator Shelby.
Senator Shelby. Thank you, Chairman Dodd.
Chairman Cox, the Securities and Exchange Commission is the
primary regulator of Bear Stearns. Under the Commission's
Consolidated Supervised Entities Program, which you mentioned,
the SEC oversees certain investment banks, including Bear
Stearns, at the holding company level, focusing on the
financial condition of the entire company. Some people think
that the SEC missed the boat here, was asleep. You mentioned
earlier the difference between capital and liquidity, which is
a big thing.
When did the SEC first discover that Bear Stearns was
experiencing severe liquidity problems? And after learning of
Bear Stearns' problems, what steps did the Securities and
Exchange Commission take to address the situation? And did you
work with the Federal Reserve or anybody else in doing this?
And what impact did those actions or inactions by the SEC have
on protecting investors?
We all know that we had some warning about Bear Stearns
earlier as far as capital. There are some other firms that got
some capital problems and are out seeking capital to shore
themselves up. But let's go back to the SEC. Where was the SEC
on this? And were they on your kind of watchlist, if you want
to call it that? And if not, why not?
Mr. Cox. They were, going back to the summer of 2007,
because of the troubles of their two hedge funds. And while
some thought back in the summer of 2007 that because they did
not, those hedge funds, pose direct risk to the holding
company--they were separate--that that should not be of
material importance to an analysis of the Bear Stearns holding
company. The fact that for practical or commercial reasons Bear
decided to support one of those funds caused us to take a view
that we had to look at even outside the holding company at
Bear. The SEC at that time began to monitor both capital and
liquidity at Bear on a daily basis.
Fast forward to January of this year. As of January 31st,
the capital and liquidity at Bear were still above regulatory
thresholds and adequate for those purposes. The liquidity pool
was $8.4 billion----
Senator Shelby. Is that the last time you examined them?
Mr. Cox. No, this is now--I am speaking----
Senator Shelby. January 31st.
Mr. Cox. January 31st, $8.4 billion on that date. The
liquidity pool grew from January 31st to the first week in
March to $21 billion. So substantial additional liquidity was
being added, in part because of the pressure that the SEC as
their supervisor was placing on them.
In 1 day--take us now to this week of March 10th. In 1 day,
Thursday, March 13th, liquidity at Bear Stearns fell from $12.4
billion to $2 billion----
Senator Shelby. Why?
Mr. Cox [continuing]. And that is because of what we have
heard discussed here this morning: the complete evaporation of
confidence, the refusal of counterparties to deal with Bear.
Senator Shelby. Was there kind of a run on the place or
refusal to do business or what?
Mr. Cox. Even though we are not accustomed to using that
term in the investment banking sphere--that is a well-known
notion with depository institutions--the analogy is nearly
complete.
Now, to go to the rest of your question, our coordination
with the New York Federal Reserve, that was regular and
increasing since August of 2007 in the form of visits to their
offices in New York, regular conference calls, many e-mails and
so on. During that time we also worked together on a major
project led by the New York Fed, the paper produced under the
auspices of the senior supervisor group addressed to these
issues.
The week of Monday, March 10th, the SEC and the New York
Fed spoke by phone numerous times. Beginning on Monday, the Fed
provided us with extremely helpful information regarding market
rumors that they were hearing from a variety of market sources.
We shared with them what we were hearing and provided
information on Bear Stearns' operations and their finances. We
met in their offices in New York on Wednesday and discussed
Bear Stearns as well as the situation of other banks and
securities firms. That, of course, takes us to the 96-hour
period that everyone has already focused on.
Senator Shelby. Is there a gap in the regulation process
here between, say, the Federal Reserve's interest here, the
SEC's mandate, and so forth? Is there a gap there that
something fell through the cracks? Or is it just something that
is just already so fast, like the liquidity was gone?
Mr. Cox. Well, I think the speed with which this happened
is truly the distinguishing feature. But there are significant
differences between the charter and the mission of the SEC, on
the one hand, and the Fed on the other.
Senator Shelby. Absolutely.
Mr. Cox. It is very important--and the Treasury, I should
add, because the Fed is focused on safety and soundness and the
financial system. Treasury is concerned even beyond that with
systemic risk as it might pass over into the real economy and
affect things beyond the financial system. The SEC is focused
very particularly, first, under statute as it applies to these
broker-dealers, the investment banks, on their regulated
activities and on their customers and the protection of their
cash and their securities. We are also focused on orderliness
of markets and so on, but within the context of the securities
markets themselves.
So there is overlap between the SEC and the Fed's systemic
concerns, and certainly where we leave off, they pick up, and
where the Fed leaves off, the Treasury picks up.
Senator Shelby. Chairman Bernanke, are there some
comparisons between what happened at Bear Stearns and what
happened with the British bank Northern Rock? I know they are
different. Was there a liquidity problem there, too, and that
caused the bank to fail and the British Government to have to
step in or what?
Mr. Bernanke. There was a similarity. I agree with Chairman
Cox that there was a remarkable falling off of liquidity,
essentially a run on Bear Stearns----
Senator Shelby. A run on Bear Stearns.
Mr. Bernanke. That was analogous in some ways to what
happened to Northern Rock, although, of course, all the details
are quite different.
Senator Shelby. Secretary Steel, who first proposed using
taxpayer funds to help finance JPMorgan Chase's acquisition of
Bear Stearns? Secretary Paulson? Yourself? The Fed? Mr. Dimon?
Or who?
Mr. Steel. I will provide my perspective, Senator, and I
can be confirmed by others. But I believe that as the
negotiations proceeded through the weekend with the Federal
Reserve Bank of New York, with the direct principals, that as
we wore into the weekend and people took time, and there are
various terms to every transaction, that late Saturday evening
or early Sunday morning it was proposed by one of the
principals, JPMorgan, to President Geithner that so as to move
forward, that this would be a condition that seemed to be
appropriate to them. So answer your question specifically,
proposed by JPMorgan Chase to President Geithner.
Senator Shelby. And what kind of security, if any, did the
Fed get for this $29 billion?
Mr. Steel. Yes, sir----
Senator Shelby. Would you explain that? And what are the
chances of loss there?
Mr. Steel. Well, it is, as I said--excuse me.
Senator Shelby. Go ahead.
Mr. Steel. As I said earlier, I think that from the
Treasury's perspective, there were two concerns throughout all
of this process: No. 1 was the effect on the markets and the
marketplace and the stability of markets; and No. 2 was the
stewardship that we share--that we were sharing with others
with regard to U.S. taxpayers' funds. And the transaction as
developed was $30 billion, approximately, of collateral, all
investment grade securities, all of them current in interest
and principal. And those securities were transferred as the
collateral for the $30 billion loan.
Senator Shelby. What are the chances that this could happen
again, either in an investment bank or one of our large banks?
I know you are watching them. We see them, a lot of the banks,
trying to secure more capital and, of course, they are going to
have--as Chairman Cox said, they need liquidity with capital.
What are the chances there? And where are we today?
Mr. Steel. Well, I think our perspective is that this whole
situation took a very long time to build up, and it will take a
good while to work through.
Having said that, we think we are making progress. We can
cite increases in liquidity, as President Geithner said, and
things seem to be doing better. And there are signs of
improvement, and where I think the actions of the Federal
Reserve Board have been constructive to that end, we are doing
our best to be vigilant and to monitor the situation. And a cry
that Secretary Paulson has made all along has been for
financial institutions who believe they will be needing capital
to be on their front foot with regard to raising capital. From
our perspective, this is really about transparency, liquidity,
and capital--the trifecta of issues that will bring confidence
back to the market. People understand the assets. People begin
to price them and transactions occur, and institutions have the
strong capital position they need to work through the specific
situations.
Senator Shelby. But the Treasury and the Fed and the FDIC,
all the regulators, they have got to have some deep concern
about some of our big banks, commercial banks, and some of the
investment banks. You are not telling us that you have supreme
confidence that there is not going to be another problem? You
cannot say that, can you?
Mr. Steel. No, sir, I cannot. And so I think our goal is
to--as I said, I think this is about--and about 2\1/2\ weeks
ago my colleagues at this table, as members of the President's
Working Group, issued a report to focus on what we have learned
to date and what we can begin to do straightaway to make things
better. And I really think the three aspects are as I
described.
Senator Shelby. But we cannot send the signal out to the
marketplace that if you take the risk and you are too big to
fail, the Fed is going to come running, and the Treasury is
going to back it, and the taxpayer is going to be on the hook,
can we?
Mr. Steel. No, sir. Basically, my testimony made clear that
this was not a specific situation about an organization. This
was a decision made with regard to the markets itself, and
people should not draw a conclusion from this that there is a
message about a specific institution. This was an unusual time,
as all my colleagues have said, and a specific decision was
made with regard to market protection and to the effect on the
potential real economy. That was the nature of the decision.
Senator Shelby. If this is not a wakeup call to the Fed and
to Treasury and everybody else, as far as some of our banks and
the risks they take, I do not know what it would take, do you?
Mr. Steel. Sir.
Senator Shelby. Thank you.
Chairman Dodd. Senator Johnson.
Senator Johnson. Chairman Bernanke, on March 18th, the
Federal Reserve decreased the interest rate by another three-
quarters of a percent. This is the sixth scheduled emergency
cut in as many months. Are these cuts helping the economy or
will there be any need for further cuts?
Mr. Bernanke. Well, Senator, we do believe that these cuts
are justified by the slowdown in the economy. We believe they
are helping. The cuts in the federal funds rate both lower safe
interest rates, Treasury rates, and they contribute to a
reduction in spreads, which helps to offset--and it is true
that many, some rates at least, have not dropped very much
since we have begun cutting the federal funds rate, but I think
we have offset what might otherwise have been increases in the
cost of capital. So I believe we have helped to offset the
credit crunch to some extent, and, therefore, I think this is
constructive.
I would also point out, first, that we have been using our
liquidity measures, which have also helped to reduce spreads to
some extent, and I think they have been positive; and, second,
that the effects of monetary policy are felt over a period of
time, and we expect to see further positive effects of these
policies going forward.
Obviously, further actions will have to depend on how the
economy evolves, and we are looking, of course, at both sides
of our mandate--growth and inflation.
Senator Johnson. Are you concerned about inflation?
Mr. Bernanke. Of course we are concerned about inflation.
Inflation has been too high. Over the last year, it has been
about 3.5 percent instead of about a little over 2 percent in
the previous year. The primary reason for the high inflation is
rapid increases in prices of globally traded commodities,
including crude oil and food, among others.
It is our expectation, which is consistent with prices seen
in futures markets, that these prices will moderate during the
coming year and that, therefore, overall inflation will tend to
slow. However, we are aware of the uncertainties involved with
that, and we are obviously going to be watching the situation
very carefully.
Senator Johnson. Did the Federal Reserve place any
conditions on JPMorgan Chase and Bear Stearns when it extended
the $29 billion line of credit?
Mr. Bernanke. We did that as part of an overall
negotiation, the point of which was to try to facilitate the
acquisition of Bear Stearns and the guarantee of its
liabilities by JPMorgan Chase. As President Geithner has
discussed, we have substantial protections. They include $30
billion of collateral as marked to market on March 14th; $1
billion first loss position by JPMorgan; professional
investment advice from an advisory company; and the luxury of
being able to dispose of these assets over a period of time,
not, therefore, have to sell them quickly into an illiquid
market.
Senator Johnson. Chairman Cox, is the SEC adequately
equipped to determine a holding company's liquidity risk? Did
the crisis at Bear Stearns bring to light any weaknesses in the
Consolidated Supervised Entities Program?
Mr. Cox. Senator, there is absolutely no question we have
learned much more than any of us would like in the caldron of
this experience. The liquidity measures that were thought to be
adequate were designed for a scenario in which all of the
firm's unsecured funding evaporates, and evaporates for a
period of a full year. The capital floor and the liquidity
floor, more to the point, that is required of firms to meet
that standard was more than met by Bear Stearns, and yet as we
described here earlier this morning, they ran through over $10
billion in liquidity in a day. So it is absolutely important
for us no longer to believe that that works. We have already,
with all of the firms that we supervise, gone back to work with
them to make sure that there is the kind of liquidity that is
needed to function in this stress scenario. And I have
communicated directly with the Basel Committee of Banking
Supervisors, who are preparing to take up this subject, to
encourage them because, of course, these standards for capital
that are used here in the United States in the commercial
banking sector and the investment banking sector are also used
around the world. They are considering addressing directly this
liquidity issue, and I think it would be very wise for them to
do so.
Senator Johnson. Chairman Bernanke, do you expect the Fed
to facilitate market arrangements like the JPMorgan Chase
purchase of Bear Stearns for other financial institutions? Does
this create a moral hazard for taxpayers?
Mr. Bernanke. We do not expect to have to do this, but we
are obviously going to be watching and monitoring the markets
very carefully, and institutions. I think this was a very
unusual situation. In particular, things happened very quickly
and left a very little time window. In most cases, when firms,
banks, have problems, they have a considerable amount of time
to take preemptive actions in terms of raising capital, finding
a partner, and taking other measures to avoid these problems.
I would like to make a comment on the idea that we bailed
out Bear Stearns. As President Geithner pointed out, Bear
Stearns did not fare very well in this operation. The
shareholders took very severe losses. The company lost its
independence. Many employees obviously are concerned about
their jobs. I do not think it is a situation that any firm
would willingly choose to endure.
What we had in mind here was the protection of the
financial system and the protection of the American economy.
And I believe that if the American people understand that we
were trying to protect the economy and not to protect anybody
on Wall Street, they would better appreciate why we took the
actions we did.
Senator Johnson. Thank you, Mr. Bernanke. No further
questions.
Chairman Dodd. Thank you, Senator Johnson.
Let me just say as well, I know there are a lot of
questions people would like to ask. We are going to leave the
record open as well, if you do not feel as though you have had
all your questions asked, to submit some from Committee Members
in writing, and we would ask you to respond as quickly as you
could to some of them.
Senator Bennett.
Senator Bennett. Thank you very much, Mr. Chairman, and
thanks to the panel. This has been very illuminating.
You used a phrase in the Federal Reserve Act, Chairman
Bernanke and President Geithner, that says you can do this ``in
unusual and exigent circumstances.'' And I think this
qualifies, very clearly as unusual and exigent circumstances.
But that is clearly not what the framers of the Federal Reserve
Act had in mind in 1913. We live in a very, very different
world than we did in 1913 when the Fed was created, and one of
the questions that I have as I look at this is whether or not
the members of the legal profession who are paying very close
attention to all of this--because they have great potential for
a great deal of income sorting all of this out--are going to
look at this event and say, well, this becomes the new standard
for an unusual and exigent circumstance and start to demand on
behalf of their clients that, well, while you did it that
circumstance, here is a similar circumstance, and you have a
requirement, therefore, to do it again.
And the circumstance that is very different now than it was
in 1913, of course, is the existence of derivatives--the
creation of hedge funds, people who use computers to slice and
dice various financial instruments and discover things that the
normal human being cannot discover without the ability of
computers to help them.
Looking ahead to all of this, what do we see in the
possibility of future circumstances not just here but
worldwide? You made, I think, the appropriate point, Chairman
Bernanke. This was not a bailout of Bear Stearns. And you did
not have the Bear Stearns shareholders in mind. Indeed, the
Bear Stearns shareholders are very upset, I think, about what
has happened. But I like the phrase that comes from a
specialist who looked at this. He said, ``Twenty years ago, the
Fed would have let Bear Stearns go bust. Today, it is too
interlinked to fail.'' Not ``too big to fail.'' ``Too
interlinked to fail.'' And that, again, is the world of
derivatives, the world of hedge funds, the world that we all
come together in.
I do not care who specifically responds because you are all
very knowledgeable in this area. But give me a response to this
future possibility, looking back on what I think we all agree
is a truly seminal, historic, and maybe pivotal event in the
way this international market is going to be dealt with from
now on. Anybody want to look into his crystal ball and help me
out on this.
Mr. Bernanke. Senator, if I just might reply quickly, we
have a very high bar for unusual and exigent, so this is twice
in 75 years that we have used this, that we have applied this
power. In thinking about it, we thought not only about the
interconnectedness of Bear Stearns and the issues we have
raised, but also about the situation in the financial markets
more generally. If the financial markets had been in a robust
and healthy condition, we might have taken a very different
view of the situation. But given the weakness and the fragility
of many markets, we thought the combination was indeed unusual
and exigent.
We will certainly be very diligent in resisting calls to
use this power in other less exigent situations. As I indicated
earlier, I do think this does raise important questions of
regulatory design. The world has changed a lot since the 1930s
when many of our regulations were put in place, and it will be
a challenge for all of us and the Congress to think through how
we might adapt to the way the world has changed, the way the
institutions have changed, the way the instruments have
changed, the way the markets have changed over 75 years.
Senator Bennett. Anyone else want to comment on this?
Mr. Geithner. Yes, sir. I just echo your formulation. What
was unique about this is not just Bear Stearns' role in this
interconnected, intricate, complex financial system where we
have such a large stock of outstanding derivatives, with repo
markets as large, but was the circumstances prevailing in
markets at the time. It is the combination of those two things
that made it so exceptionally risky for the U.S. economy.
But I would just echo something many of you have said, I
think, which is that the most important thing for us to do is
try to figure out how to make the system in the future less
vulnerable to these circumstances and make it strong enough to
be able to withstand the failure of a major institution even in
fragile conditions like these. That is a very hard thing to do,
requires a very careful set of judgments about regulation and
market discipline. But I think that is the dominant policy
challenge we face.
Senator Bennett. And we have the proposal from Secretary
Paulson before us as a Congress. We will look at it very
carefully.
Mr. Steel, you summarized it, I think, the best when you
talked about the need for transparency, capital, and
liquidity--all of which are leading to the one thing that is
essential here, and that is confidence. If we do not have
confidence in our ability to get our checks cashed, we produce
a run on the bank in the old model. Here, the international
system did not have confidence that there was anybody on the
other side of the deal if they were to cash in some of their
derivatives, and Bear Stearns stood in the middle of the deal
as the bank that would provide that confidence. So if Bear
Stearns goes down, that is, if the middle broker goes down, and
neither side has confidence that the paper they hold can be
redeemed, then the whole worldwide thing melts down. And I
think we need to keep that foremost in our minds in all of our
discussions.
All of the details are fine. All of the details are more
than fine. They are absolutely necessary. But the ultimate goal
to which we must constantly pay appropriate homage is
confidence that the system is going to work. And if I
understand what you have said here today, you were afraid that
that confidence was going to go out the window, and the whole
world losing confidence could ultimately come crashing down.
So for all of us, Mr. Chairman, this is, I think--the
ultimate goal is to see whatever we do, either you in your
regulatory actions or we in our policy actions, keep focus on
maintaining international confidence in the system of worldwide
credit.
Thank you.
Chairman Dodd. Thank you, Senator Bennett. I underscore the
point, and I have been using it over and over again.
Let me just say, I should have responded quickly to
President Geithner's comments earlier. This Committee's
intention is at the appropriate time to take a long look at
these various proposals regarding the reform measures to
reflect the 21st century world we are in, very different than
when a lot of these institutions were created, and that have
been amended over the years. So I welcome Secretary Paulson's
ideas in all of this.
I just want to quickly say, however, that the timing of all
of this--I mean, clearly we need to get to that, but I want to
make sure we are concentrating our attention on the crisis at
hand. And the crisis at hand is at its center a foreclosure
crisis. There is the contamination effect here. We need to
concentrate on that. But I do not want by that statement to
reflect any lack of interest in the broader subject matter,
which is an appropriate one. But I do not want to digress or
divert attention from the issue at hand. And so we will get to
that question, and this Committee will, and conduct a series of
hearings--I have talked to Senator Shelby about this already;
we will plan on that--to outline all of these ideas and
consider it thoughtfully and carefully.
Obviously, nothing will happen this year. We all know that.
It is going to take a new administration coming in. But
certainly we can set the table on these issues, and my
intention is in this Committee to try and do exactly that.
Senator Reed?
Senator Reed. Well, thank you very much, Mr. Chairman, and
thank you, gentlemen, not only for your testimony today but for
steering through a crisis which could have had catastrophic
consequences. That is an achievement in itself. As we go
forward, though, I think as I said initially, we have got to
look carefully at what was done. And let me raise a question
that was also raised by Chairman Dodd, that is, the discount
window facility.
Listening to Chairman Cox's analysis of the Bear Stearns
situation, it seemed to me the biggest failing was the lack of
access to secured funding. And yet the discount window facility
would have given that secured funding. But, President Geithner,
as the point on this effort, you indicated that you would not
have extended that facility to Bear Stearns because it was, in
your words, ``not a sound institution.'' That was a criteria--
you were applying criteria.
Can you tell us why it was not a sound institution? And
should the SEC have been aware of those shortcomings?
Mr. Geithner. Let me just say this as carefully as I can. I
was expressing my personal view. It is very hard to look back
and know. But all of these facilities, in all these facilities,
as you think--as you would expect, I think, we need to be very
confident that we are lending to sound, prudent institutions
that are designed to respond to liquidity problems, and it is
very hard to know, looking back, whether, given the way they
are designed, they would have been powerful enough to help Bear
navigate some of these challenges. And I just want to say that
it is not obvious to me--just my personal view--that lending
freely in the context of the accelerating pressures on Bear
would have been a prudent act by the Fed.
Senator Reed. Was that your conclusion--I know it is a
difficult one to make, and it is inherently subjective because
you have to weigh many factors. Was that a function of
management, a function of the balance sheet, a function of
market conditions beyond their responsibility? And, again,
should the regulator, primary regulator, the SEC, have been
aware of these faults that you at least recognized, or
potential faults?
Mr. Geithner. Again, very exceptional conditions we are
facing in markets, and everybody is rediscovering and
rethinking through what they think is adequate liquidity. And
any institution in these markets is discovering that if you
lose your unsecured, you may lose your secured. And independent
of the concerns that have been--we have been seeing throughout
the last 9 months about the strength of individual
institutions, we have seen a substantial withdrawal in the
willingness of markets to finance a range of different types of
collateral. So one thing that is unique about this is the
extent to which secured financing markets also became
vulnerable.
And a very important point Chairman Cox made several times
is--and Chairman Bernanke--that in these markets, these things
can happen incredibly quickly. Just incredibly quickly. What
you see in this context is a combination of two things. One is
these very powerful forces across all markets, impairing
liquidity for everybody. And you have a set of institutions
that were--some relatively more exposed to those risks, some
relatively less exposed. And with great respect to the people
and management employees of that institution, they were in a
position where they were more exposed to those risks.
Senator Reed. Let me follow up on another line of
questioning that the Chairman raised, and that is the price,
the initial stock price. You indicated--and Mr. Steel and
others--that there was no deliberate message from any Federal
official about the price. But did you, since I recall when I
was a young lawyer, went to closings, and there would be lots
of rules but the one rule was the Golden Rule: The person with
the gold made the rules.
You had all that, Mr. Geithner. Did you suggest a certain
range that you would not allow or any indication that your
agreement to the financing, taking the collateral and giving
JPMorgan the $30 billion was a function of a price that was, in
your view, appropriate?
Mr. Geithner. We did not set or negotiate the price.
Senator Reed. Did you suggest, if a price was raised, that
it was excessive or a deal would not close? Or did you in
general indicate to them that--and as I think you indicated in
your comments, the real issue of moral hazard, that you could
have said without stating a specific price that the price has
to reflect a steep discount from book value; otherwise, moral
hazard. Is that something you communicated?
Mr. Geithner. Well, just to repeat again, those two
objectives--finding a solution that would avert default in ways
that would make the system stronger, not weaker; not create
adverse incentives for future risk taking that would be a
problem for the system--were at the center of the judgments we
made. But I just want to underscore, both the agreement reached
between Bear and JPMorgan on that initial Sunday night, which I
think was the 16th, and the agreement reached a week later
were--just to speak for myself--in my judgment fully consistent
with those objectives.
Senator Reed. Chairman Cox, one of the points you raised
was this unusual and very rapid runoff of liquidity. Does that
suggest to you market activity which is more than unusual that
might be manipulative?
Mr. Cox. Senator, we do not know the answer to that, but,
of course, the Securities and Exchange Commission investigates
market manipulation and----
Senator Reed. Are you conducting an investigation now?
Mr. Cox. I am constrained, as you know, by the general
rules of discussion about civil law enforcement matters that
have not yet been filed in any court, so I cannot confirm or
deny the existence of any particular matter under
investigation. But suffice to say that the Securities and
Exchange Commission takes very seriously its responsibility to
investigate allegations of these kinds, and there have been
ample allegations made in this context.
Senator Reed. Thank you, Mr. Chairman.
Chairman Bernanke, you indicated that this was not a
bailout of Bear Stearns, and at $2, raised to roughly $10,
there is some persuasive force in your argument. But was it a
bailout of the surviving investment banks? Because with, I
think, the context of your discussions, your real fear was that
Bear could say, ``Oh, but that had to be the line of defense,''
that the others, if they fail, will be catastrophic, and that,
in fact, your action was very calculated and conscious to prop
up when remaining investment banks.
Mr. Bernanke. We were concerned about other institutions.
We were concerned about a variety of markets in which Bear
Stearns participated. We were concerned about the thousands of
counterparties whose positions would have become uncertain. So
we were--if you want to say we bailed out the market in
general, I guess that is true. But we felt that was necessary
in the interest of the American economy.
Senator Reed. I do not dispute you. I think that is the
role you had to assume. But I think--and many people,
homeowners that are looking at action that helps, you know, the
markets, helps them indirectly. But I think to say this was a
routine action that was not designed to save some institution
or prevent them from going into distress is not the most
accurate characterization. That is my point.
A final point, Chairman Bernanke. You have got about $30
billion of collateral, and some comments have been made that
you feel comfortable because it is highly rated. But a lot of
highly rated collateral these days is being subject to
questions about that.
Your comments on the quality of this collateral, will
eventually the taxpayers be on the hook for a significant
amount of that collateral?
Mr. Bernanke. Senator, as was mentioned, it is all
investment grade or current performing assets. The prices at
which we are booking them in terms of collateral are not the
face value but, rather, the prices to which Bear Stearns marked
those assets on March 14th. Therefore, they reflected current
market conditions, and they reflected, in addition, the
difficult liquidity situation that exists.
We do not know for sure what will transpire, but we have
engaged an independent investment advisory firm, who gives us
reasonable comfort that if we can sell these assets over a
period of time, we will recover principal and interest for the
American taxpayer. And certainly under no circumstances are the
risks to the taxpayer remotely close to $30 billion. There may
be some risk, but it is nothing close to the full amount. We do
have collateral, and I would say a good bit of it is very
highly rated.
Senator Reed. Thank you.
Thank you, Mr. Chairman.
Chairman Dodd. Thank you, Senator, and we may come back to
a couple of the questions that Senator Reed has properly raised
here, I think, as well.
Let me turn to Senator Allard.
Senator Allard. Thank you, Mr. Chairman.
We have had downturns in the economy and periods when it
has been rather prosperous, and at times they have involved the
banking institutions because of the amount of lending that goes
on in our economy to keep it going. And the thing that comes up
to me, when you take a lot of these instruments, like what we
have here, and you securitize them, you have got a big volume
of assets that are going in there.
How do you go about keeping track of those investments? And
how do you reach a point where you know that that becomes a
very risky security? And do we have the tools in place to make
those evaluations from the regulatory standpoint? Or do we just
rely on the common approach that, you know, if you get a
greater return, there is greater risk, and you ought to be
smart enough to balance your portfolio so you do not have that?
So I would like to have some discussion on how you arrive
at the creditworthiness of those assets that make up a total
security value. And I will open it up to anyone on the panel if
they want to address that question or that issue.
Mr. Bernanke. Are you referring to the collateral?
Senator Allard. Yes.
Mr. Bernanke. I would perhaps turn to President Geithner.
The investment firm, again, is doing its own evaluation, has
done an evaluation. The Bear Stearns marks I expect were based,
to the extent available, on market prices as available. To the
extent where market prices are not available, then the marks
are developed by a combination of market information and
various models that try to anticipate what the cash flows would
be for these various securities.
I do not know the specifics of the individual securities
and how they were marked.
Senator Allard. Yes. Mr. Geithner.
Mr. Geithner. Senator, I think you are raising a question
that is at the center of this financial crisis in the sense
that we have been through a period with extraordinarily rapid
innovation at a time where the world was growing, defaults were
very low, and a lot of leverage built up. And, therefore, it
was hard for anybody to know with confidence what the risk was
in a lot of those positions, how they would fare in a more
adverse world. And in a sense, you could say that is the
dominant lesson of financial crises, and people are learning
that lesson again.
And Chairman Cox referred to this comprehensive review of
risk management practices, weaknesses and strengths across the
major institutions, and I would say that the central lesson
from that review was the difficulty in thinking through how
much risk you might face in the extreme event and how best to
manage that risk, how much capital to hold against that risk,
how to make sure that your risk management structure, your
compensation incentives protected you from that risk
adequately. And because the future is inherently uncertain, it
takes experience with crises to learn more about how those
positions are going to respond. And I think that is also, I
mean, just another example of why this has been so powerful and
difficult to manage even for a set of very smart, competent
people.
Senator Allard. Any other comments? Yes.
Mr. Steel. I guess, Senator, I would concur with President
Geithner that I think your question leads us in a way back into
all the root causes of the situation we face.
Senator Allard. Correct.
Mr. Steel. And I am sure that is where you were taking us.
I would concur--agree with the observations by Chairman
Bernanke and President Geithner, and I think that when the
President's Working Group began their first efforts to try to
see what we have learned, that focus on transparency, better
risk management, and that all aspects--all of the actors in
this have to do a better job. And it is not--but it includes
credit rating agencies, issuers, investors, securitizers.
Everyone has to be focused more on these issues, and greater
transparency is really key, and people need to understand what
they are buying and selling is at the root of the issue. And
hopefully we have some ideas that can focus us in on this so
that things can be improved and lessons learned from the stress
that we have been through.
Chairman Dodd. Could I just interrupt one second, Senator?
I would like to maybe ask Chairman Bernanke, maybe it would be
helpful for this if the Fed could provide to the Committee in
writing the current value of these assets. If we could have
that available to the Committee, it would be helpful as well
for us. Whether that is to you, President Geithner, or whoever
could help us out on that, that would be helpful to the
Committee.
Senator Allard. Yes, and that was my question. What I am
getting into is do you have any concern about the reliability
of these ratings as it pertains to credit rating. You know,
that is a big part of this, it looks to me like, and credit
ratings can change pretty quickly. Sometimes they are under--
and there is a whole compilation. And do we have the capability
to say that what we have is pretty reliable?
Mr. Bernanke. I just want to reiterate that we are relying
on a well-known expert investment advisory company which
specializes in exactly these sorts of valuations, and we are
relying on their opinion.
Senator Allard. OK. Thank you.
Now, under the Bear Stearns agreement that was reached, one
thought that came to me is that the manager--who is going to be
the manager of the remaining assets, and it was determined that
Blackstone Group would be that. And so that is a key decision,
I think, in managing what is left. And how was that decision
arrived at? And how do you determine what they are--B, or
whatever would be determined to manage those assets?
Mr. Geithner. Thank you, Senator. That afternoon of Sunday,
March 16th, where we were exploring, again, whether there was a
way to make this work, we did a range of things to try to get
ourselves as comfortable as we could with the mix of assets
that we were willing to consider financing.
Now, the financial system holds typically several hundred
billion dollars of collateral at the New York Fed against the
possible need to borrow, and we have a team of people that
spend their lives thinking about how to value collateral and
look at that, and we had those people alongside us as we looked
at this portfolio. We established a set of very important
conditions described by the Chairman for what we would accept
in the portfolio. And we structured it, again, very carefully,
very, very carefully to minimize the risk of future loss.
But as part of that, we made the judgment, I made the
judgment, that we should have a world-class advisor sitting
there with us, and in that period of time, very little time. We
made the best judgment we could about what firm would have the
mix of expertise, knowledge, experience, and independence that
could best provide that judgment. I think they met that test.
I do not think there were any better options available at
that moment, and I think we are in a much better position now,
certainly than we were in the afternoon and going forward, to
have them at our side as we thought through those judgments.
And as the Chairman said and emphasized, part of the agreement
we worked out to limit risk to the taxpayer was to have them be
in a position to help manage these assets over time.
Mr. Steel. If I could just make a correction, sir?
Senator Allard. Yes.
Mr. Steel. In your question, the correct name is BlackRock.
Senator Allard. Oh, was it BlackRock?
Mr. Steel. BlackRock, not Blackstone.
Senator Allard. Well, whoever, yes. I appreciate that.
Thank you. That was an error that we had on my notes, and I
apologize for that. But just the same, I think the question
applies.
Mr. Chairman, I see that my time has expired. Thank you.
Chairman Dodd. Thank you very much.
Senator Schumer.
Senator Schumer. Well, thank you, Mr. Chairman. I hope next
time you do not need to bring in Black Boulder instead of
BlackRock or Blackstone.
When Chairman Bernanke came before us yesterday at the
Joint Economic Committee, I asked him when did he know that
Bear Stearns was in such serious trouble that they might go
under if nothing happened, and he said 24 hours before. Is that
true of you, Chairman Cox? Did you just know--did you just have
any idea that they would go under only 24 hours or so before?
Mr. Cox. Well, as I described earlier, the liquidity pool,
which had been $8.4 billion on the 31st of January, actually
grew in the first week of March to $21 billion. But in 1 day,
on Thursday, March 13th----
Senator Schumer. So is the answer yes?
Mr. Cox [continuing]. It dropped by $10 billion.
Senator Schumer. So is the answer yes? You did not know
until 24 hours before.
Mr. Cox. Well, we knew of the drop in the liquidity pool.
On the other hand, we had been focused, as had the New York Fed
working with us on these issues for some time, but this
precipitous drop occurred----
Senator Schumer. OK. I have limited time. I got a simple
yes or no from Chairman Bernanke. Did you have an idea that
they could go under almost immediately more than 24 hours
before it happened?
Mr. Cox. The drop occurred on the 13th of March.
Senator Schumer. How about you, sir?
Mr. Steel. No, sir.
Senator Schumer. No. How about you, Mr. Geithner?
Mr. Geithner. No.
Senator Schumer. OK. Thank you.
Now the question I have is: Should you have known? And it
relates to the future, not the past. Was it simply regulatory
mish-mash, if you will, that, in other words, safety and
soundness is lodged with Chairman Bernanke, oversight of the
SEC with Chairman Cox. We did have signs that Bear had some
trouble, obviously, with its hedge funds, et cetera. And as I
said, similar places--not similar places, but places that had a
lot of mortgage exposure, that had higher capital, even though
this was a liquidity crisis, higher capital seemed to be a
cushion against a liquidity run starting.
So the question, I guess I will ask you, Mr. Geithner:
Could a reasonable regulator have known and been ahead of the
curve here? Could someone have called Bear in and said, ``You
need more capital. You need to reduce your exposure to
mortgages''?
Mr. Geithner. Very hard to know. I want to underscore--I
will say it very quickly. These things can happen incredibly
quickly in markets like this. What the world is going through
and has gone through the last 9 months are truly extraordinary,
described by many as the worst in 50 years, worst in a
generation. So it is very important to underscore that because
it is easy to look back and say, ``But doesn't it look
obvious?'' And I think that is probably somewhat unfair to the
people at----
Senator Schumer. Mr. Undersecretary, do you agree with
that?
Mr. Steel. Yes, sir.
Senator Schumer. OK. And how about you, Chairman Bernanke?
Mr. Bernanke. Yes, I do.
Senator Schumer. OK. So clearly, then, something is wrong
with our regulatory structure unless we just think we should do
these things on an ad hoc basis. And so I would like to just
talk about going forward to prevent the next Bear Stearns
because our credit markets are still not the confidence--
confidence equals credit. Confidence is not all there. For all
we know, in some other--no one would have thought mortgages
would be the place where we would start doubting credit. It
should be a simple cut-and-dried thing. And if it happened in
mortgages, it could happen in some of these far more
complicated instruments, perhaps.
So my question is: What have we done to avoid this from
happening in the future, that the next warning signal, if, God
forbid, it happens in any of these places, would go off sooner
and we would not have to rush in at the last minute but could
make corrections before that? Do you have any tools to do that
other than the emergency power lodged in the Fed? And what new
tools do we need? Could you, again, Mr. Geithner, tell us what
is being done now after Bear Stearns that is different than
before that might avoid this from happening again if there were
another liquidity run on a company?
Mr. Geithner. First, we have at the SEC's invitation a team
of people in these institutions, the major investment banks,
looking carefully at their funding and how they are managing
their funding, how they are going to position themselves to be
stronger to withstand these kind of pressures.
Second, the Federal Reserve has put in place a very
powerful set of liquidity facilities to help mitigate the risks
that these things intensify going forward.
Third, we have been working very actively, alongside the
Treasury and others, to try to make sure that institutions take
steps to strengthen their capital positions so they are better
positioned to manage through this crisis.
Those are very important steps. I think we need to look
ahead, though, because those will not be enough, and we have to
think about--I mean, they will not be enough for the future.
Senator Schumer. Right. So there you need a change in
regulatory structure, which we have talked about.
Mr. Geithner. I believe you do. I think you need to look
comprehensively at a broad range of aspects of regulatory
policy and structure.
Senator Schumer. Right. Because if we do not, it is my
judgment--tell me what you think. If we do not change the
regulatory structure, given the inter-party risk you have
talked about, the quick moving of huge amounts of money, we are
going to be subject to these problems sooner or later somewhere
or other that we have not--that we might have been able to
prevent if we had a better regulatory structure. Is that fair
to say?
Mr. Geithner. Yes.
Senator Schumer. Do you agree with that, Secretary Steel?
Mr. Steel. Yes, sir.
Senator Schumer. You, too, Chairman?
Mr. Bernanke. It is partly structure, and it is partly
practice. Obviously, we have to, you know, understand better
how to deal with these risks and how to evaluate those risks,
as well as, you know, change the organization chart.
Senator Schumer. But right now, in an advisory way, Mr.
Geithner, you are looking at firms and seeing their capital and
seeing their exposure and giving them more early--more advice,
I guess is how I would put it, as to being careful. And are
they following you? I do not want to ask any specific names.
That would be very bad. But----
Mr. Geithner. We are doing everything sensible to----
Senator Schumer. And are they following your advice? Your
pause worries me.
Mr. Geithner. No. I am just trying to be careful. I would
say that we are doing everything we can sensibly to encourage
them to take steps that would put them in a stronger position,
and I think there is a lot of focus and attention across those
institutions in doing just that. No one is more worried about
them than they are in some sense, and as I said, you cannot
look at what happened over that weekend and look at the outcome
for that institution and take any comfort from it.
Senator Schumer. Correct. And, you know, right now they may
be careful, but all of these steps mean they reduce their
profits and the pressure on immediate profit and immediate
increase in share value will be back very soon if it is not
already.
What do you have to say about this, Mr. Secretary?
Mr. Steel. I think that you are on the right point, and
earlier I said I think there are three aspects to this:
transparency, liquidity, and capital. The Secretary and all of
us at Treasury have tried to be very strong on the idea of
capital increase so that firms have the right balance sheet.
You know, there are two ways this happens. One is that firms
can de-lever to improve their financial position or their
capital cushion, or the other is--and that has an unattractive
effect vis-a-vis contracting credit.
Senator Schumer. Right, and----
Mr. Steel. Our preference is that institutions raise more
capital so as to avoid the pro-cyclical effect of contraction.
And we have been adamant and will continue to be so.
Unfortunately, I cannot tell you that there is a red light/
green light, issue done. I think it is a progression, and we
will continue to be vigilant on this point.
Senator Schumer. Just one final question. Capital and
liquidity are related in some degree.
Mr. Steel. Absolutely.
Senator Schumer. And Mr. Geithner said yes, too.
Thank you, Mr. Chairman.
Chairman Dodd. Thank you, Senator, very much.
Senator Bunning.
Senator Bunning. Thank you, Mr. Chairman.
It is not unusual that Chairman Bernanke and I disagree on
certain things, but I would like for him to answer me this
question: Would Bear Stearns' stockholders have fared better in
bankruptcy than they did at $2 or $10 a share in what you call
not a bailout?
Mr. Bernanke. It is hard to know. And, besides, the
bankruptcy, they would have been facing probably a much worse
financial market condition as well. So I am--you know, the
shareholders certainly lost a huge amount relative to what they
had thought they owned earlier that week. Whether they would
have come out with zero or two or four, I don't know.
Senator Bunning. But the fact is that they are trading on
the New York Stock Exchange for over $10 a share today. Is that
accurate?
Mr. Bernanke. I believe so, yes.
Senator Bunning. If anybody can answer this question, I
would like it. How did we get to the point that the failure of
one firm can bring us to the edge of collapse, our whole
financial markets? We know the Fed and others did not do their
job in regulating lending practices and supervising the risk
banks were taking on. But how do you let the entire financial
system become so fragile that it cannot tolerate one failure?
Mr. Bernanke. Well, one response, Senator, is that this has
been a long time in the making. There was a substantial credit
boom that peaked last summer. That credit boom, which was
driven by international factors, which I could go into, if you
would like, involved a substantial increase in risk taking; a
lot of financial innovations, some of which turned out not to
work so well; deterioration in underwriting standards; and
essentially a letting down of the guard.
Supervisors made many efforts to address these problems. We
were not successful, obviously, in preventing the excesses.
Starting in August, triggered by but not, I would say,
fundamentally caused by the subprime crisis, there was a sudden
rethinking of the amount of risk that people were willing to
take. There was a major retrenchment in the markets.
Now, in contrast to last year when investors were willing
to lend against quite risky assets, now even the safest assets
find difficulty in getting financed. And so financial
conditions have become much more fragile, much more uncertain.
There is a great deal of distrust of counterparties, of the
valuation of assets, and a very strong aversion to taking risk,
of even liquidity risk, as opposed to credit risk.
As I mentioned earlier, under more robust conditions, under
more normal conditions, we might have come to a very different
decision with respect to Bear Stearns. We felt that given the
context, given the fact that financial conditions are already
creating a slowdown in our economy, that the risk was too
great.
Senator Bunning. Anybody else have a different opinion?
Mr. Geithner. Well, I do not have a different opinion,
Senator, but let me just underscore. In a market-oriented
financial system, where people are free to fail, make mistakes,
lose money----
Senator Bunning. I thought so.
Mr. Geithner [continuing]. Make imprudent choices, any
system designed that way is inherently vulnerable to the risk
that a sharp loss of confidence in economic activity induces a
dynamic like we are experiencing now. This happens rarely, but
it does happen. It happens across all different types of
financial systems over time.
But you are exactly right, and I think it is the critical
objective for policy. The challenge for policy is to try to
make the system strong enough so that it can withstand the
failure of even large institutions. But no system in a
situation this fragile economically is going to be able to
withstand such a failure easily, meaning withstand the risk of
default that easily, in conditions this fragile.
What produced this is a very complicated mix of factors. I
do not think anybody understands it yet. But we have to spend a
lot of time and effort trying to figure out how to get a better
handle on this set of stuff. And there are a lot of people that
are going to be part of that because it is very important that
we try to figure out a way to make the system less vulnerable
to this in the future.
Senator Bunning. There were an awful lot of red flags, not
just in the last 6 weeks, not just in the last month, but a
year or two before, that we were having some problems in our
mortgage markets, that we were having mortgages made that
should not be made, that the mortgage brokers were soliciting
people into mortgages that they could not afford, and finally
they knew were doomed to failure. Nobody was watching the
store. So it was eventually going to happen. It just happened
to be Bear Stearns who got a hold of all these things in one--
well, in 1 week, and the crisis occurred when everybody said,
``Watch out for Bear Stearns because they are not going to wind
up this week anywhere but in bankruptcy.''
I mean, that is what they came and told the Fed. Am I
wrong? Didn't they come and tell you that they were going to go
belly up and they asked for help?
Mr. Geithner. Senator, let me just step back for one
second. The people at this table and a bunch of other
supervising regulators took a lot of actions over the last
several years to try to make the system less vulnerable to this
kind of event----
Senator Bunning. I am sorry.
Mr. Geithner. I want to just----
Senator Bunning. I am sorry. I have been here too long to
try to convince me of that.
Mr. Geithner. Well, I am not trying to convince you, but I
just want to----
Senator Bunning. You are not going to be able to convince
me, because the red flags have been waving long before you
showed up at that table.
Mr. Geithner. Should I try to--can I just go through just a
few important things for the record?
Senator Bunning. Certainly. Go ahead.
Mr. Geithner. We did, working with the SEC, the other major
supervisors of the major institutions around the world, a
series of very important things, beginning in 2004 in
particular, focused on exactly the set of risks that are so
pronounced today. These things focused on strengthening the----
Senator Bunning. The problems come before 2004. It goes
back to 2000, 2002, and on down.
Mr. Geithner. I am not claiming that people were wise and
all-knowing or that we did everything that could have been
done. But I just want to underscore the fact that we took a
series of actions to try to make the system more resilient to
this kind of stress, and those things have made a lot of
difference. The system would have been more fragile without
those things. As the Chairman said, they did not achieve enough
traction in areas where we would have liked them to achieve
more. And we are going to be very focused on trying to figure
out how to deal with those things in the future, but it is
going to require a very comprehensive effort because we do not
have the incentives in the system aligned in----
Senator Bunning. You have talked me out of my time, but the
biggest problem with that is that I get the last say. And what
is going to happen if a Merrill or a Lehman or someone like
that is next?
Thank you, Mr. Chairman.
Chairman Dodd. Do you want to respond to that, Senator, or
do you----
Senator Bunning. No.
Chairman Dodd. All right. Senator Carper is not here. Let
me turn to--who is next? Senator Menendez is not here either.
Senator Tester.
Senator Tester. Thank you, Mr. Chairman. Thank God for
absences.
I want to ask a couple questions here. Chairman Cox, you
had mentioned some dates in answer to earlier questions about
the hedge fund in July of 2007 and adequate liquidity as of the
end of January and then it bounced up as of March 1st. I am
talking about Bear Stearns' liquidity. And I guess more
specific the question is: When did you know--and, Chairman
Bernanke, you are next. When did you know that we were in a
situation where one of the world's largest investment banks was
teetering on insolvency? Was that on the 14th? Or did you know
before that?
Mr. Cox. Bear Stearns approached the New York Fed on
Wednesday night to discuss, as I understand it, possible
accelerated access to something like the Term Lending Facility.
The following day, on Thursday, there was a precipitous
decline, a drop of over $10 billion in the liquidity pool of
Bear Stearns. And by Friday, we were in the midst of these
discussions, and in particular, the Fed----
Senator Tester. Sounds good.
Mr. Cox [continuing]. And the Treasury discussing with
JPMorgan and Bear Stearns.
Senator Tester. Thank you.
Mr. Bernanke.
Mr. Bernanke. Well, Senator, just to be clear, we are not
the supervisor of Bear Stearns.
Senator Tester. Just your perspective. When did you know?
Mr. Bernanke. We were simply--we are monitoring the
markets. We received, as was indicated, I think about 24 hours
in advance, a call that they were anticipating bankruptcy.
Senator Tester. Chairman Cox, I want to come back to you on
that issue. Has anyone brought to your attention or do you know
of the possibility of short selling that helped bring down Bear
Stearns?
Mr. Cox. I want to be careful in the way that I respond to
your question. It is a perfectly appropriate question. It
deserves a straight up and factual answer. I am a little bit
constrained because the SEC is in the law enforcement business,
and I tried delicately to answer that question before.
The SEC very aggressively pursues insider trading, market
manipulation, and the kinds of illegal naked short-selling that
have been very publicly alleged in this case.
Senator Tester. OK. Thanks. I will interpret that answer
the way I think everybody else in the room interprets it.
The question I had goes also back to Mr. Bernanke. It deals
with the $30 billion that has been talked about a lot here
today. And I think initially you said it was $30 billion market
value, and then with another question, I think it was Senator
Allard, you said it was a model--it was a market to model value
on it. Who set the value?
Mr. Bernanke. Bear Stearns.
Senator Tester. Bear Stearns set the value. You had also
mentioned, I think--and if it was not you, you can forward this
question to Chairman Cox--that for the most part, these were
pretty good collateral.
Mr. Bernanke. Yes. They were all investment grade and----
Senator Tester. Why didn't JP Chase take them?
Mr. Bernanke. I can ask President Geithner to elaborate,
but they were swallowing a pretty big chunk. They were
concerned about the implications for their capital, for their
risk profile, and particularly for the liquidity. One advantage
that we have over market participants--the Federal Reserve,
that is--is that we do not have any problem in financing the
assets, and we could afford to hold them for a period and
dispose of them in a more orderly way.
Senator Tester. OK. So it was a liquidity issue, and you
are nodding your head so you must agree. The reason JP did not
take them is because it is a liquidity issue for their firm?
That is what I heard Mr. Bernanke just say. You can say no. You
can disagree. It does not matter.
Mr. Geithner. I would just echo what he said, which is that
you will have a chance to ask JPMorgan this, but Bear is a very
large and complicated institution, a lot of risk. JPMorgan was
not prepared to assume the full risk in that, and for reasons
that I think were very carefully thought through. So to help
make it happen, we agreed to assume some of that risk.
Senator Tester. Would it be fair to say that the $30
billion in collateral we got was probably the least secure?
Mr. Geithner. No.
Senator Tester. So it was just an arbitrary one--just an
arbitrarily cutoff, just you arbitrarily took all the
investments from A to D, went to the Federal Reserve, and the
rest? How was it determined?
Mr. Geithner. Very carefully. It was a negotiation. We set
a set of parameters for things we would accept and what we
would not accept. And that is how we got to the outcome we got
to.
Senator Tester. You do not have to do it now, but could I
get a list of those parameters?
Mr. Geithner. Absolutely.
Senator Tester. OK.
Senator Tester. Chairman Cox, or whoever is most applicable
to answer this question, how much is BlackRock charging for
managing the $29 billion?
Mr. Geithner. Senator, we have not yet completed our
negotiations on the fee. It will be a commercially reasonable
fee. We will be very careful in setting it so that we are
getting something--or we are paying something that matches the
complexity of the responsibilities and the importance to us
that it get managed in a way to minimize the risk.
Senator Tester. Well, I will ask this to the next panel,
but is that typically how things are done? You enter into an
agreement and set the fees later?
Mr. Geithner. Almost nothing is typical about the
arrangement that we reached in this context. And as I said, we
tried to be very careful to make sure we designed this in a way
to minimize any risk to the taxpayer, and part of that was
having them there with us.
Senator Tester. OK. Senator Bunning brought up some good
points in his opening statement that talked about how big is
too big. Senator Bennett talked about it being intertwined. I
am curious, and I think the bigger you are, the more
intertwined you are. So I think both points apply.
The question is: Would the Federal Reserve have agreed to
this situation if it would have cost $50 billion or $100
billion? And I know you said it was based on markets, and it
was said earlier here today that $29 billion--I believe this is
a quote--not from you guys but from somebody on this panel--$29
billion, the whole world could have come crashing down if we
did not do this. Is that accurate? And at what point do you say
no?
Mr. Bernanke. Well, Senator, it was a negotiation. We think
we got a good deal. We did not spend $29 billion. We lent it
against collateral. We believe we will recover most or all of
it, probably all of it. It was, again, a very important
consideration to try to make sure that this failure did not
occur. And I would reiterate that, you know, the moral hazard
questions that Senator Bunning appropriately pointed to, I
think the moral hazard was minimized by the costs borne by Bear
Stearns. And in the future, I think, however, we should take
actions to make sure that, you know, these problems don't arise
again.
Senator Tester. If another investment bank of similar size
were in the same situation tomorrow, would you duplicate your
effort?
Mr. Bernanke. Well, the situation has, I believe, improved
now, and we have put in place these liquidity facilities, and
we are monitoring, as SEC is doing, the condition of these
banks. It was a very unusual situation. Don't expect it to
happen again. But if any situation arises which threatens the
integrity of the U.S. financial system, we would have to try to
address it the best we could.
Senator Tester. Thank you very much. Seven minutes goes by
way too fast.
Thank you.
Chairman Dodd. Very good questions, Senator. Thank you very
much.
Senator Dole.
Senator Dole. Chairman Cox, in a recent interview with
Barron's, Laurence Fink, the chief executive of asset manager
BlackRock, suggested that both hedge funds and the credit
rating agencies may have played a role in the downfall of Bear
Stearns, and he further calls on the SEC to investigate.
Given BlackRock's own involvement in the JPMorgan-Fed deal,
what do you think of Mr. Fink's appraisal?
Mr. Cox. When I saw the remarks that he made with respect
to credit rating agencies, the downgrade that occurred was on
Friday when I think it perhaps was too late to have a different
outcome, Thursday having been, as I described, the truly
cataclysmic day in that week. I do not know whether it is the
responsibility of a credit rating agency which has its own
responsibilities, both contractually and legally, to forbear in
downgrading in the face of that kind of a situation in
collaboration with regulators, which was the suggestion that
was made.
It would be an interesting fact pattern in a different set
of circumstances, but as I say, it occurred so late on Friday
of that week that I do not think it was the proximate cause of
what occurred in this case.
Senator Dole. Let me ask Chairman Bernanke and Secretary
Steel: On Tuesday of this week, an article in the Wall Street
Journal highlighted the market impact of so-called credit
default swaps and estimated these swaps were written against
$45 trillion of underlying debt in the first half of 2007.
Given these credit default swaps were a contributing factor
regarding the recent troubles at Bear Stearns, as well as the
concern about whether or not Federal securities laws actually
apply, what are the Fed and Treasury doing to make sure that
these financial instruments are better understood and accounted
for?
Mr. Bernanke. Senator, first, to the extent that the credit
default swaps were involved in any market manipulation, to
which I have no knowledge that is the case, that would
obviously be an issue for the Securities and Exchange
Commission to be looking at in the course of their duties. So
that would not be our particular province.
We are interested in credit default swaps in a number of
contexts. First of all, through our regulation of supervised
institutions, we want to make sure that they understand and
they properly manage the risks associated with their credit
default swaps, the counterparty risk, the credit risk and so
on. And, second, President Geithner of the Federal Reserve Bank
of New York has led a very substantial effort working with
private participants, private market participants, to improve
the clearing and settlement process for credit default swaps to
eliminate or reduce the risk that uncertainties about who owns
what that might arise in a period of rapid changes in prices or
changes in conditions would be an issue. And that, I would want
to commend President Geithner for his work on that front, and
we have not seen clearing and settlement issues play a very
important role at all in any of these recent financial problems
that we have had.
Mr. Steel. Senator, I think that Chairman Bernanke has
pointed to the right issue, and the whole area of the over-the-
counter derivatives market is quite complex. It has grown a
lot, and it is very, very large and important. When the
President's Working Group recently issued a report of issues to
be focused on in the near term, we specifically highlighted the
area of over-the-counter derivatives as something where
policies and procedures need to be enhanced, and President
Geithner has been a lead person on that. And so we think you
are on exactly the right track, and we are committed to doing
that.
Senator Dole. Let me ask one somewhat tangential question,
Secretary Steel. I have, along with Senators Martinez and Hagel
and Sununu, been a strong advocate of GSE reform, and our
legislation would create, as you know, an independent world-
class regulator to oversee the safety and soundness of Fannie
and Freddie, which earlier this decade had significant
accounting problems.
Last month, OFHEO announced that it was lowering the
capital requirements for both Freddie and Fannie, which comes
on the heels of the temporary increase of the GSEs' conforming
loan limits.
Secretary Steel, in light of this most recent action, is it
not now all the more urgent that comprehensive GSE reform be
enacted to ease the turmoil in our credit markets and to
further ensure that GSEs do not pose more of a systemic risk?
Mr. Steel. Senator, I think that several of the other
Senators now, including you, have raised this issue of what
have we learned about regulation and our regulatory regime in
general. And I think the importance of clear responsibilities
and the ability to have the tools to deal with challenging
times is really the note that everyone is singing to.
I believe that comprehensive GSE reform is completely on
key with that issue, and the Treasury would be a strong
proponent of a comprehensive GSE reform bill.
Senator Dole. Thank you.
Thank you, Mr. Chairman.
Chairman Dodd. Thank you very much, Senator.
At that point we turn now to Senator Carper.
Senator Carper. Thank you, Mr. Chairman. And you all are
holding up well. Thank you for your patience and for dealing
with us for all this time.
I indicated when I made my brief opening statement earlier
that we were going to be asking you to sort of explain what you
have done, why you have done it, and what you think the
implications are, the lessons learned. We are about to
undertake some actions here in the Senate under the leadership
of Senators Dodd and Shelby to take up what I call ``the
housing recovery package.'' The elements of it include--and you
may have heard some of them, but the elements include FHA
modernization, trying to bring FHA into the 21st century to
make it relevant in the lives of a lot of people; providing the
ability to use the proceeds from mortgage revenue bonds to help
out in refinancing some subprime mortgages; some extra money
for community development block grants to enable State and
local governments to work with distressed housing in some of
their communities; some extra money for housing counselors to
try to steer people into Project Hope Now so they can take
advantage of that. The net operating loss carryback for home
builders I think goes back about 4 years, and Senator Isakson
proposed a tax credit to go to people who actually move into a
home, buy a home that has been foreclosed, and agree to stay
there for an extended period of time.
Those are all ideas that are included in the bill. There
are a few others, but those are the ones that are there.
Senator Dole has just asked you about GSE regulatory
reform, and we have debated that this Congress, last Congress,
and Chairman Dodd has indicated a strong desire to move us to
that legislation quickly and to get--put in place a strong
independent regulator for our GSEs, for Fannie and Freddie and
for the home loan banks. I applaud that and look forward to
that. That is not part of this package, but my hope is that it
is something that is going to be acted on real soon, and the
Chairman has indicated that is his full intent.
Among the amendments that are going to be offered to the
bill, this housing recovery bill on the floor--if not today,
then in the next couple of days--is one that would empower a
judge in bankruptcy to not only modify the interest parameters
with respect to a primary home mortgage, much as they can now
with a second home, but to enable them to not only work down or
modify the interest parameters of the first mortgage, the
primary mortgage, but to also work on the principal itself. And
there are some who think that is a good idea, some who are
concerned about it.
I just would ask, since this is something we are likely to
vote on in the next day or two, I would just ask you what you
think is good about that proposal, what is not, or is there a
better option out there for us.
Mr. Bernanke. Well, Senator, first of all, I think you are
absolutely right to be focusing on housing. Housing is very
central to the current situation. It is affecting both the
broad economy as well as borrowers, lenders, and communities.
So I compliment you on that focus.
I think some of the areas that I have advocated and I think
are productive, one is the FHA modernization, the general idea
of letting the FHA, which has seen its market share shrink to a
very small amount, ironically displaced to a large extent by
subprime lending, to increase its ability, its flexibility, its
budget in order to both finance more new purchases and also to
be able to refinance people out of troubled mortgages.
A second area that I would mention again is--Secretary
Steel mentioned government-sponsored enterprises. They are
supposed to be stabilizing the market. To do that, they need
both good oversight, and they need to raise more capital so
that they can expand their activities and substitute for the
weaknesses in the remainder of the housing market.
I would like to mention counseling, which I believe is a
very high bang for buck activity. The Federal Reserve at the
reserve bank level has worked extensively with NeighborWorks
and other community organizations on counseling activities, and
I think that is very productive.
On bankruptcy, I think there are arguments on both sides.
Some argue that a bankruptcy judge could take a more
comprehensive view of a borrower's situation and make a better
overall determination. Opponents note the length of time that
it might take, the delays that might occur, and argue that it
would lead eventually to higher costs of borrowing in the
future.
The Federal Reserve did not take a position on the earlier
bankruptcy bill, and we are not taking a position on this one.
And I think it is a very substantive decision that the Congress
will have to face on that one.
Senator Carper. All right. Thank you very much.
Others, please? Chairman Cox, you may or may not want to
comment on this. It is your call.
Mr. Cox. Well, I think as the Chairman of the SEC it is
difficult for me to comment on this particular piece of
legislation. As a former Member of the Congress, it is really
easy, but I think I will forbear in the interest of----
Senator Carper. I will ask you to keep your current hat on
rather than put on a new one.
Secretary Steel.
Mr. Steel. Senator Carper, thank you for the question. A
couple of things, and I think that Chairman Bernanke did a good
job of kind of walking through the issues.
As you went down the list of all the various components and
issues, we have not seen the specifics of this, and some of the
things you alluded to are not part of the bill. But I think our
position is pretty clear. FHA modernization is important and
can allow the FHA to do more right away. FHA has been a force
for good throughout this process. They can do more.
Modernization is something we support and look forward to
doing. We can be helpful for that going through.
I think that also the GSEs, as Senator Dole first raised,
consistent with prudent operations if something--it is a time
where they can be stepping in and doing more, and we would
encourage that. Counseling also.
I think on the issue of bankruptcy, as you said there are
arguments on both sides. I think from our perspective, it does
not seem to be the right tool for the task, that there are lots
of public policies that suggest that there was a very
purposeful decision when this was--the process was described
this way, and that should you allow bankruptcy to be organized
in the same way with regard to single-family residences, it
would have a chilling effect. It basically would reduce the
amount of capital and raise the price of capital. And I think
that has been the public policy perspective, and I think that
we need to be very careful to consider anything other than
that.
I think the idea that--and also, too, I think something
that Chairman Dodd said, that we are working now in real time
and it does not seem to me that when we need a fast solution,
that heading to the courts is our logical first idea. So I
think that given those perspectives, that would not be
something we would view as a key tool.
Senator Carper. All right. Thank you.
Mr. Geithner.
Mr. Geithner. I do not have anything to add.
Senator Carper. All right. Fair enough. Well, thank you
very much.
Chairman Dodd. Thank you very much, Senator.
Senator Carper. Mr. Chairman, if I could, I know the
Chairman has been working with, I think, his counterparts,
Congressman Frank, the Chairman of the House Banking Committee,
on a different approach that helps to address the situation
where folks have their mortgages underwater, where the amount
of money that is owed is significantly worth more than the
value of the property, the kind of situation where a lot of
people are thinking--are walking away or thinking about walking
away.
Some have suggested that that might be actually a better
approach than working on the bankruptcy side, and I think that
is a question that----
Chairman Dodd. Well, you would like to avoid it if you can.
Once you are into bankruptcy, you have got another whole set of
issues. If you can avoid that situation, obviously--and the
value, I have tried to explain all of this, while there is
clearly value, obviously, in trying to keep people in their
homes, all the residual effects of that, the larger value to me
is that you are establishing a floor. You are getting to the
bottom of this. And unless you get to the bottom of this, you
are not going to see capital begin to flow. That to me is the
greatest asset, potentially, of a plan like this.
We are spending a lot of time talking about it and getting
other people's advice and opinion on this, and I am anxious--
and Senator Shelby and I have talked about it. I am not going
to make it a part of this particular bill we have on the floor
right now because it is controversial, and I do not want to end
up having a lot of people vote against something that I think
they might be inclined to vote for if we can frame it right. So
we are going to be having some hearings on it, and I am going
to be soliciting the opinions of many of you here as to how we
do this.
But in my view, in the absence of doing that or something
like that, all we are doing is dealing with the effects of all
of this rather than dealing with the problem. And the problem
is to get capital to flow. So that is another--that is what we
are trying to drive at in all this.
With that, Senator Martinez.
Senator Martinez. Thank you, Mr. Chairman.
I want to pursue a little more on the inquiries that
Senator Dole raised regarding the Government-sponsored
enterprises, Fannie Mae and Freddie Mac, and from two aspects:
No. 1, Mr. Chairman, I would like to know your thoughts on
whether a failure of one of these enterprises would pose a
systemic risk to the system. And, obviously, I think I know the
answer to that, but I would like to be sure I understand your
position on that.
Mr. Bernanke. I think it would. It would be sort of two
options. One would be significant systemic risk or Government
guarantees. So either way it would be not a good outcome,
obviously. So for that reason, I certainly support both good
oversight and that the GSEs should continue to raise capital.
The recent evidence is that financial firms can raise capital.
They can do so, and they can do so profitably, given the
opportunities they have right now in the housing market. So I
would strongly urge them to do that.
Senator Martinez. In order to raise capital, would it be
helpful--do you anticipate that the investor would have a high
level of confidence and would bring new money into the market
for mortgages if there was a world-class regulator that would
give investor confidence at a time like this when there is such
fragility and where we have seen a huge failure of one of the
investment banks?
Mr. Bernanke. I think that is an excellent point, Senator.
It would assure investors that the GSEs were safe and sound and
that they had adequate capital to conduct profitable
operations.
Senator Martinez. Secretary Steel, could I get your
comments on both of those issues?
Mr. Steel. I think that the two questions, one, is the
size, scale, scope of these GSEs, is there the potential for
systemic risk, the answer is yes, period.
I think with regard to the second question, I would concur
with Chairman Bernanke that anyone who would consider investing
in these entities would have to view the establishment of a
clear, strong, appropriately empowered regulator as a positive.
And so, therefore, the answer to the question is yes.
Senator Martinez. So it seems to me that based on the fact
that we have seen accounting irregularities in the recent past,
that they have worked out of, and this is good, with the need
for them to play an increasing role with higher conforming
limits, with us empowering them to lend more money by reducing
their capital requirements, and all of us knowing that OFHEO
today does not represent that kind of world-class regulator
that Senator Dole was talking about, then maybe the time is now
for us to give the investor confidence that is needed as well
as provide the kind of security to our taxpayers, because make
no mistake about it, these entities cannot be allowed to fail,
and there is an implied guarantee of the Federal Government.
So rather than us be here Monday morning quarterbacking
sometime down the road, it sure would seem to me to be a good
idea for the Congress to get about the business of something I
have been advocating even before I was in the Congress, and
that is, a world-class regulator. Kind of a long question.
On the current issue, which is the Bear Stearns situation,
and I guess this might be to you, Mr. Geithner. One of the
issues that has concerned me as it relates to the shareholder
is whether there were other suitors, whether there were options
available that might have provided a better outcome to the
shareholders. Could you comment on that?
Mr. Geithner. Absolutely, and I do say quite a bit about
this in my written testimony, and, of course, you will have a
chance to hear later today their perspective on this.
Bear Stearns began approaching people right away, very
quickly, and they, of course, had a very strong incentive in
trying to get as many people as possible looking at ways to
provide financing. And we encouraged that. It was very
important to us, too, that we maximize the chance there be an
outcome that was going to be, you know, good for the system as
a whole. Ultimately, though, only one institution was willing--
had the ability, the will, willing to move that quickly.
Was there a better option available at the time? No, I do
not believe so. And I think everything was done to maximize the
chance that there would be a set, a range of choices available,
but I do not believe there was a better option available.
Senator Martinez. And the governmental entities involved
did not presume or select JPMorgan in this instance?
Mr. Geithner. Absolutely not. It was Bear's decision who
they initially approached, and our interest was only in--and it
was very important to us that they open up and allow a range of
institutions to do due diligence, which they did.
Senator Martinez. Thank you.
Chairman Cox, a couple of questions more related to the
shareholders. One has to do with the value of the $2, which I
know there was a financial advisor that provided an opinion of
fairness at the $2 level. I guess when the transaction was up
significantly, it raises in my mind the question of whether, in
fact, the financial advisor's advice was appropriate, adequate,
or was it just a better deal when it became $10, the $2 value.
Do you have any concern from the shareholder standpoint about
the appropriateness of the financial advisor's role in this
transaction?
Mr. Cox. Well, the Commission's concern is that the
shareholders get all of the information that they need to
evaluate that for themselves. There are many things about this
transaction that are unusual and that have broken the mold, but
one thing that is not different is that this is ultimately a
transaction between JPMorgan Chase and Bear Stearns. There is a
merger. There is going to be a proxy. There are going to be
shareholder votes and so on. And all of those decisions have to
be understood and approved by shareholders. The SEC has never
in its history intervened to determine the price of a
transaction, and we would not in this case.
Senator Martinez. Will there be a shareholder vote in this
transaction?
Mr. Cox. Now, if you are getting into the terms of the
transaction and the what-ifs, I think I might better yield to
the people that are directly involved in it.
Senator Martinez. Fair enough. Maybe we can get----
Mr. Cox. I mean other witnesses as well as the next panel,
but----
Senator Martinez. Mr. Geithner.
Mr. Geithner. I do not think I am the one in the best
position to talk about the way forward in terms of the legal
issues around consummating this agreement. But I think you will
have the opportunity later today to have them----
Senator Martinez. Maybe I should pursue the question later.
Mr. Cox. I will say that just as a generic matter--and
under the terms of the merger agreement, which is not unusual
in this respect--there is to be a shareholder vote.
Senator Martinez. But is it not a stock exchange?
Mr. Cox. It must be approved. It is a stock-for-stock
transaction, must be approved by the shareholders.
Senator Martinez. OK. Good enough. Thank you very much.
Thank you, Mr. Chairman.
Chairman Dodd. Thank you very much, Senator.
Senator Menendez.
Senator Menendez. Thank you, Mr. Chairman.
Chairman Bernanke, I am trying to get a sense here of the
risk for the taxpayers, and I heard some or was informed of
some of your answers to Senator Reed before. You know, a letter
from the Treasury indicates that these are largely mortgage-
based securities and related hedge investments.
Now, I have heard this panel testify in your opening
statements that, you know, in essence, what happened here was a
lack of confidence. Well, a lack of confidence happens because
of underpinnings. I would hate to believe that simply the rumor
mill can bring down one of the largest investment banks in the
Nation, because then we are really in trouble.
So there had to be some underpinnings of what created that
lack of confidence, and that is what I am concerned about, is
what is the confidence that we have in where the taxpayers are
out there on liability.
Now, I know that you said that you are reasonably
comfortable that the risks are not remotely close to the full
amount. Well, what are they remotely close to? Because we have
seen reports that Bear Stearns was leveraged 30 to 1, in some
cases 100 to 1. I mean, what--we have heard other financial
institutions say that they, in fact, cannot truly verify the
full value of their securities.
So if we do not have a valuation of these securities, how
are we so confident--I know that the first billion of loss goes
to JPMorgan, but they would not get involved with this
transaction unless the Fed came forth. That is still $29
billion. So what is the response to where the risks lie here
for the taxpayers as a whole?
Mr. Bernanke. Well, Senator, first of all, Bear's overall
condition or its leverage is irrelevant here because we are
only looking at a set of assets. These were assets, as
President Geithner mentioned, that we negotiated to get. They
are not in any way the residual or the worst assets or anything
like that. They are representative assets.
Senator Menendez. Are they worth $29 billion?
Mr. Bernanke. We have several sources of information. We
have Bear's own marks. But, in addition to that, we have the
valuation of our own experts. As President Geithner mentioned,
we do value assets for the purpose of lending at the discount
window. And we have the advice of a well-respected, independent
advisory firm that takes the view that if we sell these assets
over time--and we have allowed ourselves up to 10 years,
although we can sell them any time we would like--and,
therefore, avoid the need to sell into a distressed market,
that we will recover the full amount, and that, in addition, if
we are fortunate, we may turn a profit beyond that. But I think
we have a very good chance of recovering the full amount.
Senator Menendez. If that is true, why did JPMorgan say
they would never have gotten involved in this but for your
guarantee?
Mr. Bernanke. Well, again, it was an issue of how much they
could swallow, how much total risk they could take on, how much
capital they have, and just the shortness of time from their
perspective.
Senator Menendez. So you are telling the Committee that, as
far as you are concerned, the American taxpayer has no
liability here.
Mr. Bernanke. I am not saying that. There is----
Senator Menendez. Well, what is--I am trying to quantify
the liability. Give the Committee a sense of what the liability
is for the American taxpayer in this regard.
Mr. Bernanke. I do not know the exact number. I think----
Senator Menendez. And that is my concern.
Mr. Bernanke. Well, again, our advisor suggests that we
have collateral that is worth as much or more as our loan.
Senator, I would just simply like to point out that this cost,
if it turns out to be a cost--which is by no means obvious--
must be weighed against the effects on the American economy and
the American financial system of allowing this firm to collapse
and all the consequences that would have had for the markets
and for the economy.
Senator Menendez. Well, listen, I realize that. I said that
in my opening statement. I also realize that a year ago, when I
said we were going to have a tsunami of foreclosures, you all
downplayed it, and we have not even seen the crest of that
tsunami. And I believe that that consequence to the economy is
equally consequential.
As a matter of fact, if, in fact, these securities are
mortgage-backed residential and commercial securities, I am not
sure of the value.
What does ``highly rates''--you have mentioned several
times ``highly rated securities.'' What does ``highly rated''
mean in a time where so many highly rated securities have
absolutely plummeted?
Mr. Bernanke. Senator, all I can say is that we are not
basing our evaluations on face values. We are basing them on
market values from several different sources. I cannot give any
firmer guarantees than that. I don't know, President Geithner,
if you want to add to this, but we believe based on independent
professional advice and our own evaluation that we have an
excellent chance of recovering the full amount, as well as
interest.
Senator Menendez. Well, I have to be honest with you.
Haven't you gone beyond a--it seems to me--as I understand the
process that you set up, what the Fed is getting in exchange is
a question. That is a bit surprising because the deal is far
from a standard loan. That money goes to JPMorgan. The firm is
not the borrower. The Fed cannot demand repayment from JPMorgan
if the Bear assets turn out to be worth less than what has been
promised. And what is odd is that if there is any money left
over--which hopefully there will be, but I am not so sure. I am
really concerned that it is not. The Fed gets to keep the
residual value for itself. That seems to be more of an
investment than a collateral loan. You have really stretched
the limits of what this is all about.
Chairman Cox, you know, what are you all doing at the SEC?
I mean, it seems to me that we always say, oh, we have learned
all these things. We can never have the foresight to look ahead
and say, you know, we need to change the regulatory system to
ensure that in the dynamics of all of these instruments that
are being used that we have the appropriate regulation and we
are looking for the right standards to ensure that this does
not happen. You know, when a JPMorgan analyst says that, in
fact, it is not indisputable that rumor and innuendo can bring
down a firm, and quickly, you know, that is troubling,
particularly at a time when shorting of stocks as a core
investment style becomes so widespread.
What are we doing? What are we doing to ensure that that
just cannot happen? And to put the taxpayers at the risk--at
the risk--because I have not heard anything here that gives me
a sense that we are whole by any stretch of the imagination.
Mr. Cox. Senator, the fact that unsecured funding might not
be available in times of stress is baked into all the
regulatory models that are used for both commercial banks and
investment banks in this country and around the world. The idea
that secured funding, even for good collateral, would be
unavailable and in such breathtaking fashion as occurred in
this case was indeed a revelation. And everyone has inferred
that lesson since the time. As a result, not waiting for new
legislation or even new regulation, the SEC and the Fed are in
all five of these firms, working with those firms to make sure
that they do things such as, first, increase their liquidity
pools; second, lengthen the term of their financing; third,
redouble their focus on their own risk practices and models.
And beyond that, the act that the Fed has taken in opening the
discount window to all of the firms has dramatically changed
the risk landscape.
So much has changed since this happened, but you are
absolutely right that we are living in very different times.
Senator Menendez. Mr. Chairman, I will not belabor it. I
just want to make one last point. There are all series of new
financial instruments which we have not kept up with in a
regulatory context. I urge those of you who have not to read
the book ``Trillion Dollar Meltdown.'' I think he does a very
good job of describing what we are facing and what we are
headed toward. And I have to be honest with you. I am looking
for our regulators to be protectors, not following the
aftermath, the cleanup brigade. And I do not think that what we
have had here--what we have here is a cleanup brigade, not a
protector of the very institutions that we need to have
protected for the well-being of all Americans.
Thank you, Mr. Chairman.
Chairman Dodd. I thank the Senator. I do not know if you
were here in the room or not, Senator, when I mentioned earlier
that the issue right now, in fact, is there some additional
authority that the regulators need that they do not have, since
we have now expanded the opportunity to investment banks and
broker-dealers at a discount window here where capital
requirements and other regulatory sanctions at least exist on
the member banks here, should we be doing something.
The Chairman is going to let me know whether or not we need
to be giving them some authority in this window. Again, it is a
limited period of time, but, nonetheless, that is an important
consideration so we do not look back and say why didn't we do
something in the middle of all of this. And they are very
legitimate questions that you and Senator Tester have raised
and were raised as well as to--I look back on some of these
other arrangements, to be looking back on the situation at
Chrysler or others. You know, to what extent was there some
assets that were coming back to cover the very exposure that
potentially we have. So a very good set of questions.
Senator Corker.
Senator Corker. Mr. Chairman, thank you. I think this has
been an outstanding hearing, and to all of you for your
patience. I know I am one of the few things that separates you
from leaving the building and having lunch and doing something
maybe more productive. But I want to generally say that there
is going to be all kind of postmortems, I know, on this deal,
and that you all had to make decisions in a vortex of a short
amount of time and a lot happening and a lot at stake. And I am
sure there are even decisions that you can think back upon that
you might have made a little bit differently. But, generally
speaking, I think that you acted in the best interest of the
financial markets and our country, and I want to thank you for
that. I think it has been a good thing.
And I would actually say that I know a lot of people are
asking, you know, what ``too big to fail'' is. My guess is any
of the institutions today, because of where we are liquidity-
wise, they are so intertwined, would have been dealt with in
this manner, any of them. And, anyway, again, I think it was
probably prudent.
I have read the testimony of the witnesses coming after
you, and I know that Alan Schwartz--who I know has not had a
good life over the last several weeks, nor have his
stockholders--talked a great deal about the rumors and how in
essence--I mean, it was just laced--I mean, in essence, if you
read his testimony, it almost solely occurred because of rumors
and the ability of those rumors to move quickly with
telecommunications the way they do today.
On the other hand, President Geithner, you were asked the
question about, you know, would it have made sense to open up
the Fed window, and I think I heard you say that you did not
think that was prudent, that you would have, if I heard you
correctly, opened the window to other comparatively well-
managed firms, but you would not have done so to Bear Stearns,
which gives me an indication that it was more than rumors, that
you actually felt like the firm was not well managed. And I
just would like for you to square that up, if you will, with
Mr. Schwartz's testimony.
Mr. Geithner. This is a very difficult question, and,
again, I cannot--I do not think anybody can say with confidence
what would have happened if we had done this, what would have
been possible. But just to go back to what I said to Senator
Dodd on this, it is not clear to me, it is far from clear to me
that the facilities we designed carefully to try to mitigate
these market pressures would themselves have been powerful
enough, sufficient to insulate Bear from the position they
found themselves in at that time.
I do not think I can say it any differently. It is just not
clear to me, it is very hard to know--I may be wrong, but I
just--it seems to me that the combination of the unique
pressures on markets and the specific position Bear was in
makes it hard to reach the judgment that would have delivered a
different outcome.
Senator Corker. I would just make the observation, based on
the testimony today and other written statements recently, that
it appears to me there is a tremendous difference--I know one
of the other Senators talked about the relationship between
capital and liquidity. There is a relationship, no question,
but there is a vast, vast difference. And I do wonder whether
any of the firms, any of the major firms that we all know
today, any of them could survive, period, with a run on their
particular facility. And I would love to have any--it seems to
me that none of them could with the liquidity change that
Secretary Cox referred to earlier with the run, that we have no
firms in our country today that could stand a run on their
particular institution.
Mr. Geithner. I think you are right that financial systems
rely on confidence. Confidence can go quickly. Without
liquidity, no leveraged financial institution can survive. And
the system as a whole depends on the ability of institutions
individually to convince their creditors and people who fund
them that they should continue funding them. And every system
relies on that.
What is unique about our system is that we put in place
almost a century ago a set of protections to reduce the risks
to the economy that come from runs on banks. But the system has
changed a lot since then, and those protections do not extend
to a set of institutions who are also vulnerable to liquidity
pressures, who also play a very important role in the economy.
And we have been trying to adapt our system to compensate for
that change, but we are going to have to think through very
carefully a set of other changes in the future to get ourselves
a better balance.
But you are absolutely right that every system depends on
confidence, and no leveraged financial institution can
withstand the abrupt cliff of unwillingness of people to fund
it.
Senator Corker. It just seems to me that in the future, as
we look at what might happen over the next couple of years--and
I know that is not the focus of our meeting--that really
liquidity should be our focus and not capital. Capital I know
is important, but at a time like this, liquidity is certainly
much more that way. And I know of the things you recommended
was shock absorbers, and I think that in essence may be what
you are referring to, but I look forward to expanding that
discussion a little bit later. I only have 7 minutes here.
Secretary Steel, I know that Secretary Paulson and you both
were involved in the negotiations in, it seems to me, a fairly
big way. I am not criticizing that in any way. And I am sure
that Secretary Paulson was focusing with the Fed Chairman on
the fact that the price needed to be low because of the moral
hazard issue, that if there were, in fact, going to be a
transaction, the share price needed to be very, very low.
I guess I am a Bear Stearns person, or a former Bear
Stearns--I guess a present Bear Stearns stockholder. Where are
we as a country, as a Federal Government, as it relates to
shareholder suits and those kinds of things? What kind of--I
know you all thought about that as you were moving through the
process, but where does that put the Federal Government as it
relates to shareholder suits?
Mr. Steel. Well, I am not an expert in this area, and maybe
someone else here will be, but I will do my best. I think that
this was a transaction that was agreed upon between JPMorgan
Chase and Bear Stearns. On behalf of the Government, the
Federal Reserve Bank of New York was at the table because----
Senator Corker. But let me just add something to that. The
fact is that my sense is Chairman Bernanke wanted buy-in by
Treasury. In other words, they did not want a $29 billion
guarantee without the Treasury saying good things about what
they had done. I am sure there was--and I mean that in a
positive way. I think that is healthy that you all were talking
with each other. The fact that Secretary Paulson was saying low
price I am sure affected the whole transaction. It is kind of
like, look, there needs to be a low price or maybe we will not
say good things about what happened.
And so I am just putting in that context. It seemed to me
that that does affect, if you will, the terms of the
transaction. I am just wondering, again, if you could in that
context talk to me.
Mr. Steel. I will try, and then I would invite Chairman
Bernanke to speak. I think that Secretary Paulson and others at
Treasury were active participants. I think that this twin
responsibility of wanting to be sensitive to the state of the
markets and what the situation could cause balanced with also
wanting to not encourage a sense of moral hazard. And
consistent with that is a price that seems to be appropriate.
And I guess the answer to that is low, and I am sure that the
Secretary provided that perspective to Chairman Bernanke and
President Geithner.
I just would add, though, sir, that throughout this
process, I can report to all of you that there was good
collaboration, and I view that as a good thing, that people
were helping each other, trying to think about various issues,
and the 96 hours was fairly fraught. And the Secretary was in
constant communication and trying to be helpful to Chairman
Bernanke and President Geithner as they came to work through
this and offered his perspective.
Senator Corker. I will ask one last question. It seems to
me that the amount of taxpayer liability that the Fed was
willing to put up actually determines the value of the stock.
In other words, if it had been willing to guarantee $100
million, the stock price might have been $20 or maybe $30. Who
knows?
So I know there is going to be a debate that ensues over
the next couple of years, a debate as to whether the Fed acting
alone can risk taxpayer dollars on its own or whether the Fed
needs to seek the approval of other people in political
positions. And, by the way, I do not have a position. I am
looking forward to learning.
But I wonder if you might comment on that. I know this
transaction had to happen in a hurry, and it seems to me there
was healthy collaboration between all departments when this
occurred. But should, in fact, the Fed need the approval of the
Treasury Secretary or somebody else in a ``political position''
that is looking in a different way at taxpayer funds when
something like this is done?
Mr. Bernanke. Well, Senator, first of all, there was
excellent collaboration, and we very much valued not only the
Treasury's support as a Department but the market knowledge and
insight of Secretary Paulson and Under Secretary Steel. So that
was a very useful collaboration, much of it taking place at the
wee hours of the morning.
In terms of legal authorities, you should recognize that we
loan money against collateral all the time. We do not do it
usually in quite these unusual circumstances, but we do have
the authority to do it. But certainly given the unusual
circumstances, it was helpful for us to have--to consult with
the Treasury to make sure that they were comfortable with what
we were doing, and it was very helpful that they were.
You also raise a good point, which is that, as I said
earlier, my main concern was that this deal happen so that
there not be the implications for the market of a Bear default.
And I did not personally have a strong view on the share price,
but it is true that to the extent that the Fed was facilitating
the transaction, it would clearly have been--you would have
questioned it I think even more if the price had been very
high. You would have asked the question: Why didn't the
Government, you know, strike a better deal? So that certainly
is a relevant consideration. And, indeed, when JPMorgan raised
its offer for Bear based on a number of considerations over the
next week, the Government renegotiated and approved our
situation as well. So those two things were linked in that
respect, certainly.
Senator Corker. I know my time is up. I would love to ask
some more questions, but thank you, Mr. Chairman.
Chairman Dodd. Well, you are going to be able to submit
them if you want. I realize we have such a heavy participation
by members in the second round that it is probably not going to
be possible, but we can submit questions, and I would urge you
to do so. They are good questions.
Senator Corker. Thank you.
Chairman Dodd. Senator Bayh.
Senator Bayh. Thank you, Mr. Chairman, and thank you to our
panelists. I am grateful for your dealing with these very
complex, very significant challenges that arose in these
circumstances, and I think a fair amount of modesty is in order
for those of us who were not there in the room trying to deal
with this. And yet I think you understand we need to try for
the purposes of going forward to prevent situations like this
from recurring as best we can.
Chairman Bernanke, I would like to begin with you. How
much, as we gather here today, has been lent through the
discount window to investment banks?
Mr. Bernanke. Well, the amount differs day by day. I
think--and, President Geithner, correct me if I am wrong--I
think a recent number was on the order of $35 to $40 billion.
Senator Bayh. How long do you anticipate this continuing?
Mr. Bernanke. Well, we are going to keep the Primary Dealer
Credit Facility open so long as conditions remain stressed and
these liquidity issues that we have been talking about are
still prevalent. We want to make sure that conditions have
improved, so we are not going to be precipitate in closing that
window. But our legal authority requires, you know, exigent
circumstances, and so at some point we would have to close it.
Senator Bayh. I thought Mr. Geithner went through a list of
several advisory or supervisory activities that you have been
trying to counsel people about how to improve their condition.
Is there a requirement on behalf of these investment banks that
have used the discount window that they listen to Mr. Geithner
and follow up on his recommendations? Or can they just
disregard him at their pleasure?
Mr. Bernanke. Well, first of all, we are cooperating very
closely with the primary supervisor, the SEC, and the firms are
also providing excellent cooperation both in information and in
conduct.
We have a very strong tool. We do not have to lend to them.
We can deny anyone who wants to come to the window if we do not
feel that they are safe and sound and do not present adequate
collateral.
Senator Bayh. I am interested just as a shadow banking
system seems to have arisen, perhaps we have the seeds of a
shadow supervisory or regulatory structure in nascent form
here. But, in any event, I am glad to know that they are aware
of your ability to lend or not lend, and perhaps that does lead
to them taking suggestions to heart when we do that. Thank you,
Mr. Chairman.
Mr. Geithner, to you, second, I think the Chairman was
right, and as many, including my colleague Senator Corker,
pointed out, we did not bail out, at least in substantial
regard, the shareholders of Bear Stearns. But we did ride to
the rescue of the credit holders. I think that is fair to say.
And the counterparties certainly were rescued in this
situation.
Do you have any plans to identify who these counterparties
were, what kind of risks they had run, so that we can evaluate
whether they had engaged in reasonable behavior or not since we
have, you know, provided a substantial service to them?
Mr. Geithner. Well, I guess I would just step back and
begin by saying that you cannot protect the system against the
risks of this type of systemic crisis without some----
Senator Bayh. Well, the reason I ask, Mr. Geithner, I
suppose the failure of Bear Stearns, while tragic in and of
itself, did not really pose a systemic risk. It was the
counterparties, it was the ripple effect from that, correct?
So----
Mr. Geithner. Yes. I would say they are inseparable.
Senator Bayh. And somebody mentioned a thousand
counterparties or thereabouts. I guess in order to keep this
from reoccurring and to really understand what was going on
here, we need to understand, you know, what was the magnitude
of the counterparty risk.
Mr. Geithner. Well, I agree. I think that the--I would say
anybody in this world today is spending a huge amount of time
trying to figure out what their exposure is directly and
indirectly, not just the first round but the second round,
third round, fourth round effects of this kind of thing. Very
hard to do that. But in some sense, what you are seeing in
markets--the reason markets are so fragile now is partly the
symptom of people preparing for and buying more insurance
against those very difficult to measure effects as these things
ripple through the system.
But, one, I would say I would put on the top of the agenda
for how you think about risk management improvements and reform
just the point you made, which is how to make sure people can
do a better job of figuring out what that exposure is in
extreme events better ahead of the boom.
Senator Bayh. If I could get your reaction to a couple of
suggestions that have been made for our consideration going
forward, some of these special-purpose, off-balance-sheet
vehicles are pretty exotic. Obviously, they had a tremendous
impact here, and yet there were no minimum capital
requirements, and the holders of these were not really required
to report their results. Do you think there should be minimum
capital requirements? And in the off-balance-sheet world,
should the results be required to be reporter?
Mr. Geithner. Bob, Secretary Steel, I cannot remember which
part of the President's Working Group report addresses this
question, but a lot of issues around accounting treatment, the
disclosure, the capital treatment, and how liquidity puts are
regulated in that context, which a lot of people thought, you
know, are going to be working through. I agree with you it is
an important question. We have got to get it right. I do not
think we have got it right at the moment.
Mr. Steel. And it will be a combination of market
discipline, which transparency will make clear. Sometimes
people did not recognize what was going on, so the combination
of transparency with better risk management from financial
institutions----
Senator Bayh. We have really got to look at the accounting
standards with regard to some of this off-balance-sheet stuff--
--
Mr. Steel. Yes, sir.
Senator Bayh [continuing]. And the appropriateness of
capital requirements and margin requirements and all that kind
of thing.
I just have--oh, I have got a whole minute left. How about
that? Two more questions. Chairman Bernanke, to you, and back
to your point again, we did not--the equity holders in Bear
took a huge hit here. The holders of the bonds, I do not follow
the value of their credit instruments, but I suppose they have
performed much better. Is that a fair guess on my part,
following the government's intervention?
Mr. Bernanke. That is correct, but you had many short-term
lenders, including----
Senator Bayh. Well, here is my question. If going forward
the lesson--and perhaps, Secretary Steel, this gets to you a
little bit--is that the lenders of equity need to be more
prudent in the risks they take. What lesson are we sending to
the providers of credit and the kind of risks that they take?
And might this not skew the market toward greater risk taking
in the credit arena than the equity arena? And what are the
consequences of that?
Mr. Bernanke. You raised an excellent question, Senator. It
is hardly the case, though, that the debt spreads for other
companies have shrunken to zero, you know, that lenders believe
now that they are completely safe. There is still quite a bit
of concern about counterparty and credit risk. So it is hardly
the case that we have, you know, persuaded the market that debt
instruments are entirely safe. But you are absolutely right,
there is a bit of an asymmetry there.
Senator Bayh. My final question, Mr. Chairman, and it has
been touched upon by a number of others, and I just throw it
out for any of you. Obviously, the public is following this,
and there are a variety of perspectives. People who have made
prudent decisions--I am talking about homeowners here who have
made prudent decisions, who are paying their mortgages. You
know, they wonder, well, you know, those who did not make
prudent decisions, they are receiving some assistance. What
about me? And yet at the same time, if we allow some of those
to go down, it does have an impact on them. And you had to make
a decision here about the systemic risks with a large Wall
Street bank and were providing up to $29 million in credit. We
have made a--going back to the 1930s, you know, opening up the
discount window, again to try and at the top level provide
systemic risk.
When constituents of mine ask me about all this, what would
you say to them and the appearance of, well, when it comes to
large Wall Street institutions, we ride to the rescue, and yet
for the little guy--and I think Senator Schumer mentioned this.
In the aggregate, which could be just as important, it was at
the genesis of all this, there is a greater degree of
indifference with regard to them. What would you say to people
who raise that concern?
Mr. Bernanke. Well, I think the key point to make--and I
realize it is not an easy sell sometimes, but the truth is that
the benefits of our actions were not Bear Stearns' and not even
principally, you know, Wall Street. It was Main Street. It was
the fact that the financial system has been under a lot of
stress, and that has affected our ability to grow. It has
affected employment. It has affected credit availability. And I
think people are sophisticated enough to understand that if the
financial system crashes or at least is severely hobbled, the
economy cannot grow in a healthy way either. And that is why we
did what we did.
On the other hand, it is also important to address the
problem you are referring to, which is the housing issue. I
would say that the Fed is trying to help on that dimension as
well. By cutting interest rates, for example, we have reduced
the pressure of resets, for example. And by improving liquidity
in the market, we have helped to reduce mortgage rates. So we
are doing our part in that respect. We are also working with
communities on the local level through our reserve banks.
So we are trying to address both issues, but our ultimate
concern is the health of the American economy and of the
average person.
As I said before, I think one of the key issues here is
housing, though, and I commend the Congress for focusing on
that issue, which I believe is crucial both to the financial
situation and to the economic situation.
Senator Bayh. My time has expired, and I do not expect any
of you to comment further, unless you want to. But I would just
conclude, Mr. Chairman, by saying that the reason for my--and I
appreciated your answer very much, Chairman Bernanke. The
reason for my question is that it seems to me that in trying to
strike the balance between systemic risk and moral hazard, in
the moment you made the right decision. And yet I have been
somewhat disappointed, Mr. Chairman. You and Senator Shelby
have done a great job, but some of the things that would go to
the sort of little guy, for lack of a better term, are still
out there to be addressed. And I think it is important we send
a message to them that we are going to take their concerns to
heart as well as those that present systemic risk from the top;
those that present in the aggregate systemic risk at the bottom
also need to be addressed in a real way so that the reality and
perception of fairness in our system is maintained for all the
participants.
Chairman Dodd. Well, it could not have been said better,
and obviously, the point of today, in fact, is to contribute to
that sense of confidence that people need to feel. And the
perception is--and I appreciate the answer of the Chairman as
well. The perception is--and I think all of us are aware of
this; I hope we are, anyway--that it seems to be lacking
balance, that we are not addressing as directly as we could the
problem of those individuals who are at 7,000 or 8,000 a day
running the risk of losing the most important investment in
their life. Most of them will never own a stock or a bond or
anything else, more than likely. They will count on that home,
that equity in that home for their retirement, for a health
crisis, for their kids' education, for all of these things that
can happen. That is the great asset, the great wealth creator
for them. And it has been put at great jeopardy and great risk.
And so we need to do a far better job, and my hope is in the
coming days we are going to. But you have articulated it very,
very well, Senator.
Senator Casey.
Senator Casey. Mr. Chairman, thank you very much. I may be
last. Is that correct? I just want the panel to know that,
unless someone else walks in.
Thank you for your testimony and your presence here. I want
to focus my questions principally, I think initially, to
Chairman Bernanke and to President Geithner on a couple of
areas. One in particular is this question of collateral, the
valuation of the collateral. And I think for purposes of my
questions, we could probably establish a couple of things.
First of all, pursuant to a question by Chairman Dodd I
guess we are going to get a report as part of this record about
that valuation. Is that correct?
Mr. Bernanke. You will receive certainly a list of the
major categories and the valuations.
Senator Casey. OK. And we can also establish for the record
that the valuation of the collateral in this arrangement was
established by Bear Stearns. Is that correct?
Mr. Bernanke. That is correct, but in our accepting it, we
had the advice both of our own experts and also the investment
advisory firm.
Senator Casey. And something that, Chairman Bernanke, you
know from our Joint Economic Committee hearing from yesterday,
I asked you about the question of if there was a shortfall from
the valuation placed upon the collateral and then what happens
to be something less than $30 billion, if that were to occur,
that that differential, that shortfall, the taxpayers would not
be able to go back then to JPMorgan to make that up. Is that
correct?
Mr. Bernanke. That is correct.
Senator Casey. So I wanted to ask and turn my attention, I
think, to President Geithner and Chairman Bernanke. Looking at
both sets of testimony, you outlined a lot of the detail of
what happened here, especially, Mr. Geithner, your fairly
exhaustive review of what happened here day by day and
sometimes hour by hour.
The one thing I thought was missing--and I want to explore
it--or a couple things. First of all, I did not get any sense
of--first of all, BlackRock was not mentioned, as far as I
could tell by reading it. I am not saying that they necessarily
had to be mentioned, but I think there is a missing piece there
in terms of the role of BlackRock. You had said that their fee
would be--is still being negotiated or the payment terms. But I
think what I want to know, in the context of what happened
here, this was obviously very complicated. The time pressures
were excruciating, and I recognize that. But I want you to fill
in some blanks for me and for the Committee members. In terms
of just generically, were there steps taken here as it pertains
to the particular question of valuation of collateral, concern
about taxpayer interest here, all of those basic concerns, were
there steps that you took here because of the exigent
circumstances that you would not take if you had more time?
That is No. 1.
And, No. 2, walk us through the process that you undertook
or, Chairman Bernanke, that you and your team undertook to do
the due diligence to make sure that we were doing everything
possible to make sure that the valuation of the collateral that
Bear Stearns provided was adequate for you to go forward? Do
you get my sense of what--I am concerned about the process
here, even though you had tremendous time pressures. I just
want to walk through that with you.
Mr. Geithner. Again, it is hard to know what would have
been possible, but I think if we had had more time, we would
have done exactly the same thing in the sense that we would
have had a mix of our own people looking at the collateral and
its value; we would have had--we tried to get the best
expertise in the world to give us a second opinion on that. We
would have had more time certainly to go through the details.
But I think the fundamental parameters we established for what
we would accept and what we would not accept and the design of
the structure to mitigate the risk of any loss are things that
we would have done, I think come to, even if we had a lot more
time.
But as we have been clear, there is risk in this
transaction. There is no doubt about it.
Senator Casey. Sure.
Mr. Geithner. But I think we have been very exceptionally
careful to limit that risk, and we have tried to provide as
much detail as possible as to how we limited that risk, but
there is risk in this. But, of course, the judgment we were
making is the comparison between that modest risk and the
certainty of very substantial losses across the financial--
including to the comparatively prudent.
Senator Casey. OK. I just want to know more about the role
of BlackRock in this. In other words, what did they contribute
in this window of time? If you can summarize the due diligence,
the analysis.
Mr. Geithner. You know, more eyes are better than one, one
pair, so there is value in that. They have got a set of
expertise that is really exceptional, and they were able to
help us get as much confidence as we could in that period of
time, that we had some sense of the overall risk we were
taking.
So I do not know how else to say it beyond that.
Senator Casey. But was part of that--was BlackRock charged
with the responsibility of providing--well, two questions: one,
charged with the responsibility of providing a valuation of the
collateral. Were they asked to do that? And I realize the time
was short, but were they asked to do that?
Mr. Geithner. Well, let me come back to----
Senator Casey. Or were they asked to do something in
substitution of that?
Mr. Geithner. No. Let me come back. We reached a decision
to finance in a carefully designed structure a portfolio of
securities that would be valued at Bear Stearns' marks on March
14th. A lot of uncertainty in how conservative those marks
were. Some may have been more conservative than others; as a
matter of fact, some less conservative. Very hard to know. But
there was uncertainty around what those things were actually
worth.
That uncertainty exists today, of course, because these are
very complicated markets. It is very unclear over time what the
value of those things were likely to be.
What BlackRock did is help us make some judgments, I think
good judgments, about what we should take and what level of
risk was that going to be leaving us with.
Senator Casey. But that did not include a valuation.
Mr. Geithner. Well, of course. Part of what they are going
to be doing in sort of how to think about managing this
portfolio with us will be a bunch of judgments about valuation.
And as I said in my written testimony, we will disclose
quarterly our fair value estimate of this portfolio through the
life of this transaction that is outstanding. So that will give
people a reasonable picture, a reasonable frequency, about what
is happening in terms of best estimate of value over time.
Senator Casey. Chairman Bernanke, do you want to add
anything to that?
Mr. Bernanke. No. I think that given the remarkable time
pressure, President Geithner and his team did a good job of
getting a good estimate of the--and a good level of confidence
in the quality of the assets, which, again, we had a great deal
to do in choosing. They were not some residual.
Senator Casey. In terms of the question overall of due
diligence, not just as it pertains to the valuation of the
collateral but just generally, when you are facing this kind of
decision, you are making determinations rather quickly. What is
the process you undertake on due diligence? In other words, I
know you said in your testimony that you dispatched a team of
examiners to Bear Stearns; you spoke to due diligence later in
the testimony. You go on to talk about the lending against the
collateral and the authority or that. But describe for us in
summary what that means in terms of----
Mr. Geithner. I think the best way to say it is----
Senator Casey. Is there a checklist of due diligence that
you undertake?
Mr. Geithner. I would say as much as we can, as carefully
as we can in the time allotted, with the best resources
available. But we had not faced and hope to not face again
quite this level of challenge in terms of complexity in
reaching those judgments. But I would be happy to walk you or
your staff through in more detail all the things we did.
Senator Casey. If you could provide that for the record, we
would appreciate that.
I think this is the last question. On the question of
interest payments, Mr. Geithner, is it correct that your new
partner in this received an agreement that they would receive
interest payments at a rate 4.5 percent greater than what the
Fed would receive?
Mr. Geithner. That is correct.
Senator Casey. And when it comes to the question of
arriving at an interest payment, how did you arrive at that
determination?
Mr. Geithner. That is an interest they are taking on a
subordinated note, which has a lot of risk in it. Remember,
they are going to absorb the first losses, the first billion of
any losses on this. That interest rate, if you look at similar
structures in the market, is way, way below what would normally
have accompanied that type of position. But, like anything, it
was a negotiation.
Senator Casey. But that interest rate is higher than what--
--
Mr. Geithner. That is right, higher, but----
Senator Casey [continuing]. Taxpayers will get.
Mr. Geithner. But that makes sense given the nature of the
risk. And it really should be just relative to the risk and the
different funding situation of us and them in that context. And
I think in light of that, it is an economically very sensible
arrangement for the taxpayer.
Senator Casey. When you make that determination, are you
evaluating risk in the transaction itself plus greater risk to
the credit markets in the economy? Or how do you----
Mr. Geithner. No, I think in the--well, of course, overall
in reaching these judgments, we were trying to find a balance
between what was best for the system and what was possible. But
in this case, it was just--I think, again, the relative
economics of the different risks in the structure we designed
support a different interest rate, although if this had been
done in a different context, if you look at a similar structure
in the market, that interest rate, which, as you said
correctly, is 450 basis points above ours, would have been
multiples and multiples higher.
Senator Casey. Thank you, Mr. Chairman.
Chairman Dodd. Thank you very much----
Mr. Bernanke. Senator Casey, could I----
Senator Casey. Certainly.
Chairman Dodd. Sure.
Mr. Bernanke. I just want to add one point on the interest
payments, which is that we, the taxpayers, the Federal Reserve,
get paid all our principal and all our interest before JPMorgan
gets a penny. So they do not get paid interest until we are
fully made whole.
Senator Casey. Thank you.
Chairman Dodd. Thank you, Mr. Chairman.
Let me, because I made the request and Senator Casey raised
it again earlier, and that is the requirement or the request by
the Committee here to have, if we can, I would say to Chairman
Bernanke, the marked-to-market value at the close of business
yesterday of these assets. The Committee would like to--I don't
know whether that should be addressed to you, Mr. President, or
you, Mr. Chairman, but to whomever it should be addressed, it
would be helpful to the Committee, I think, to get that.
Mr. Geithner. I apologize, Senator. I was just talking to
my chief of staff.
Chairman Dodd. It was a request I made earlier about the
valuation----
Mr. Geithner. About the valuation.
Chairman Dodd. Yes.
Mr. Geithner. Well, we laid out in my written testimony a
description of the collateral in broad terms----
Chairman Dodd. No, I just want to know the value of it.
Mr. Geithner. No, I understand that. And we will--we would
like to work out some arrangement with your staff so they could
come and confidentially review the portfolio, and in that
context, as I said, we will go forward. We will provide a
quarterly valuation on fair value--quarterly estimate of the
fair value over time.
Chairman Dodd. Well, again, this is a very important point,
obviously considering the potential exposure----
Mr. Geithner. Exactly, precisely.
Chairman Dodd. It is important to this Committee that we be
able to have access to that. It is going to be very, very
important.
Mr. Geithner. I understand that.
Chairman Dodd. Let me just--a couple of quick points, if I
may, and try to raise--one, and it has been raised by some
already. I will make this quick if I can. But I was struck. I
went back and looked at the volume of transactions. I guess,
Chairman Cox, I would like to address this to you, if I can. I
was looking at the volume of transactions. It looks like
historic volume. I am looking at the amount of transactions
that occurred daily, weekly. Transactions on a daily basis, the
numbers run at Bear Stearns, running up to this week, 3
million, 5 million, 6 million, 8 million, 7 million, 2 million.
She has roughly those numbers.
You get into the week of March 10th through the 14th, and
the volume jumps to 32 million, 54 million, 26 million; on
Friday, March 14th, 186 million. A substantial jump in volume.
I am also intrigued about the 30-day puts--the 30-dollar
puts, excuse me, over 10 days. There seems to have been a
rather significant--in fact, someone ran the math on it for me,
and if you made a $600 investment on Thursday in Bear Stearns,
on Monday that was worth about $37,000. Not a bad deal to make.
To what extent is the Fed looking at this--excuse me, not
the Fed. The SEC. And I understand you answered the question
earlier you cannot comment on investigations. Let me put it
this way to you, I guess, Chairman. I mean, I would hope that
you are looking at this, and to the extent this kind of spike
that occurred here, it would seem to me must have triggered
some sort of bells and whistles at the SEC here. This goes
beyond rumors. There is no violation in law about rumors. There
is about collusion. And when I look at a 10-day on 30-day puts,
I wonder what is going on here, and when I see the spike, it at
least raises bells and whistles in my mind what is going on.
I guess I can ask you this: Did your agency react to this
at all? Was there a reaction going on that week to these
activities?
Mr. Cox. Yes, Mr. Chairman. Your hopes will be, I think,
met and exceeded with respect to the agency's response to these
concerns. There has been some discussion here today about the
concept of ``too big to fail.'' The rumors surrounding the
activity you describe are too big to miss, and our Enforcement
Division is very active for a number of reasons, including the
fact that a well-policed market is essential to market
confidence. This is all about market confidence.
Chairman Dodd. Well, I appreciate that.
Let me, if I can, jump to one other issue. Again, this has
been a subject--Senator Menendez, Senator Tester, many people
have raised the issue.
Let me frame, if I can, this issue. Again, I want to say
what I did at the outset here. I agree with those who said
look, we are going back and reviewing this more for future
benefit, I sense. At least I am. I obviously want to know what
happened, but there are some precedents we may be setting here
that I want to make sure we do not necessary duplicate. Or if
we are, to understand why we are going to do it in the context
of sound policy and prudent judgment.
And it goes to this. If I am incorrect at all in framing
this in terms of the transaction, you correct me. I want to
focus on the $30 billion worth of assets involved here. As I
understand it, Bear Stearns will sell $30 billion worth of its
assets to this new LLC which is funded by a $29 billion loan
from the Federal Reserve Bank of New York and a $1 billion loan
from JPMorgan Chase. Bear then receives $30 billion in cash
from this LLC. The deal is contingent and contemporaneous with
the merger. So that the $30 billion in cash then goes to
JPMorgan Chase.
In effect, JPMorgan Chase will lend $1 billion to buy
assets and then get $1 billion back immediately once it buys
Bear Stearns, which now has the $30 billion in cash on its
balance sheet.
Is that a correct characterization? Is that what this is?
Does that describe it?
Mr. Bernanke. JPMorgan is certainly taking $1 billion of
risk on this position. They are not somehow avoiding that risk.
Chairman Dodd. But then when they acquire Bear Stearns they
get the money back, they get the cash.
Mr. Bernanke. Right, but they have the $1 billion note
financing the LLC which they will not get repaid if the----
Chairman Dodd. OK, I understand.
Let me ask you a couple of questions. One is was this--you
mentioned earlier that there were a number of other people who
expressed an interest in being involved, that you reached out
to a number of other people. Were they aware--were all the
other potential purchasers aware of this particular offer?
Mr. Geithner. Let me just clarify one thing. Bear reached
out to a number of different people.
Chairman Dodd. Right, and you talked to--you encouraged it.
Mr. Geithner. We encouraged them to reach out to as many
people as possible.
Chairman Dodd. Right.
Mr. Geithner. But I think it was pretty clear to me, at
least, I think, that at the time when we were contemplating
things we could do to facilitate this, there was no other
institution that was going to be in a position to make a
binding commitment to acquire them and, critically, guarantee
their obligations.
Now if--again, it is very hard to know if it would have
been possible. If, at that moment, there were more than one
institution in that position, would we have done the same
thing? Of course, we would have had to have been prepared to do
that. It would be in our interest, in some sense, because then
we could have had a bit more of a sense of what a feasible set
was.
But we made the judgment, which I think is right--and I
think it was clearly true late Friday night that that was
necessary--that we had to maximize the chance something was in
place before Asian markets opened because of the chain of
events set in place by the events of late Friday.
Chairman Dodd. Which was Sunday night?
Mr. Geithner. Yes, that is right. I am sorry, Sunday night.
I apologize.
But of course, if we had been in the situation where there
were a range of institutions at that point who were really
committed to doing this and had the ability to do it and could
have stood behind Bear, would we have made a similar
arrangement with them? Of course, we would have considered
that. And it would have been in our interest, if we had gotten
to that point, that would have been better for us.
Chairman Dodd. Again, I appreciate that. It is an important
point.
I also, and this goes to the issue--and I again, listen,
again, the time constraints in dealing with all of this, I
think those are very valid points you've made here.
But in terms of any precedent setting nature of this, what
it looks like to many of us up here--and we are all, listen,
hoping and relying that these assets are going to turn out to
be worth more than, in fact, the numbers we are talking about.
We hope that is the case. But again, the issues that Senator
Menendez raised and others raised obvious questions about it.
What it looks like, if I had to try and frame this to
people, is that we have socialized risk and we have privatized
reward. We are on the hook--hopefully it does not happen, but
we are on the hook. Why didn't we try to take some of those
assets and at least cover to some degree the potential, merely
the potential, of the liability of the American taxpayer as we
have done in other examples--totally different, in many ways,
than what we are talking about here. But in the past warrants,
for instance, were a part of that risk. That we could bring
back at least potentially covering the potential of possible
losses to the American taxpayer.
Mr. Geithner. I think, Senator, we have actually designed
it with that in mind and with that objective and reach, in the
sense that if these assets are managed over time--and it is
perfectly possible they will be--that there is a positive
return to them, then that return is captured for the American
taxpayer.
Chairman Dodd. I understand that, again, but--you've heard,
I made my point on this and I've kept you a long time.
Let me turn to Senator Shelby.
Senator Shelby. I will try to be quick, just a few
observations.
Everybody here knows, banking is managing risk or trying to
manage risk. We have extraordinary stress, it seems, in the
marketplace today, financial markets. A lack of confidence in
the market. A lot of exotic products that probably a lot of us
certainly do not understand. I hope you do, as regulators, but
I am not sure.
Liquidity, a lot of capital, lack of liquidity. Too much
leverage. But we know banking is leverage, to some extent, and
managing risk.
I fear, and I feared this for a long time when I was
Chairman of the Committee, that the market might be running
ahead of the regulators with products and so forth. And if you
continue as regulators, whether you are the Fed Chairman, the
SEC Chairman, at Treasury, or the New York Fed, which is a very
important part of the Fed system, to continue to react to
situations after they happen, where are we going to be?
And my last observation would be is this an unusual era we
are going into now? Or is this an intervention by the Fed and
Treasury and others? Is this a one-time deal? I do not believe
you know the answer to that. We certainly do not know the
answer to that. We hope. But we had better, I believe, from
this point up here on the Banking Committee, and you as
regulators, had better be concerned.
And I hope, and Senator Dodd and I have been on this
committee a long time together, more than anybody, more on this
side or that. But we have seen stress, we have been through the
thrift bailout.
I hope--this $29 billion is not peanuts, it is not a few
dollars. It is a lot of money. And I hope that the Fed manages
that risk. And I hope that they get this money back by managing
it.
But we have got some investment banks that you all know
here, and some commercial banks, that are dying for capital and
probably liquidity. So I hope this is one heck of a wakeup call
to you as regulators.
Thank you, Mr. Chairman.
Chairman Dodd. Thank you very much.
By the way, I mentioned earlier the fact that there are a
lot of people in this country owning stock. I should have made
that point. My point is, in terms of great value, it is the
home that is the substantial value for people.
You have been incredibly patient. There are probably some
additional questions from members on writing, and I will ask
them to submit them quickly to you. And if you could respond as
quickly, I would appreciate it very, very much.
This has been very helpful to us. I know it is a lot of
time to take but this transaction has obviously provoked
serious questions from all of us and constituents across the
country. So we are very grateful to all of you for taking the
time in being here, and we thank you very, very much.
I am sorry, Senator Corker, do you have----
Senator Corker. I know everybody wants to leave and I know
you have got people--if you could just give us, while we have
this panel together, which is a unique group--the sense of what
inning we are in not as it relates to the economy but just the
issue of liquidity itself and sort of getting back to norms, if
you will? Chairman Bernanke, and not everybody has to respond
if one is sufficient, but I wonder if you would just give us a
sense of that today?
Mr. Bernanke. Well, a lot of losses have been taken and I
think a lot of the adjustment in house prices, for example, has
taken place. But we have to remain agnostic and see how the
economy evolves.
We remain ready to respond to whatever situation evolves
and that is, I think, part of the value of having the Federal
Reserve and the Treasury have this flexibility to respond to
different conditions.
Senator Corker. But any sense of where we are from the
standpoint of liquidity and getting back to norms?
Mr. Bernanke. I think we have seen some improvement
recently, but you know, we have to see if it persists. I cannot
guarantee that it will persist.
Senator Corker. Thank you, sir.
Chairman Dodd. Thank you. Thank you all very, very much. We
appreciate you being here.
We will take just a couple of minutes of break while we
bring in our second panel and we express our gratitude to them,
as well.
[Recess.]
Senator Reed [presiding]. I would like to, on behalf of
Senator Dodd, welcome the second panel. He is taking a
momentary break.
I would recognize on this panel James Dimon, the Chairman
and Chief Executive Officer of JPMorgan Chase, and Mr. Alan D.
Schwartz, the President and Chief Executive Officer of the Bear
Stearns Companies, Incorporated.
Gentlemen, thank you. Mr. Dimon, if you are ready, we would
be pleased to accept your testimony.
STATEMENT OF JAMES DIMON, CHAIRMAN AND CHIEF EXECUTIVE OFFICER,
JPMORGAN CHASE
Mr. Dimon. Thank you very much.
Senator Reed. If you could just bring that forward and make
sure the microphone is on.
Mr. Dimon. Can you hear me now?
Senator Reed. Yes, sir.
Mr. Dimon. Thank you.
Good afternoon, Chairman Dodd, Senator Reed, Ranking Member
Shelby, and members of the Committee. My name is Jamie Dimon. I
am the Chairman and Chief Executive Officer of JPMorgan Chase.
I appreciate the invitation to appear before you today.
Mr. Chairman, your letter inviting me to testify asked me
to address a number of issues relating to the JPMorgan-Bear
Stearns merger. At the outset, I want to underscore a few key
points about the transaction.
First, we got involved in this matter because we were asked
to help prevent a Bear Stearns collapse that had the potential
to cause serious damage to the financial system and the broader
economy.
Second, we could not and would not have assumed the
substantial risks of acquiring Bear Stearns without the $30
billion facility provided by the Fed. While we wanted to help,
and I believe we were the only firm ultimately in the position
to help, we had to protect the interests of our shareholders.
Third, this transaction is not without risk for JPMorgan.
We are acquiring some $360 billion of Bear Stearns assets and
liabilities. The notion that Bear Stearns' riskiest assets have
been placed in the $30 billion Fed facility is simply not true.
And if there is ever a loss on the assets pledged to the Fed,
the first $1 billion of that loss will be borne by JPMorgan
alone.
Let me turn now to how we became involved in the effort to
rescue Bear Stearns and avoid a financial crisis. On Thursday
evening, March 13th, Bear Stearns called to tell us that it
might not have enough cash to meet obligations coming due the
next day and that it needed emergency help. We contacted the
New York Fed and learned that they were aware of the situation
and that they recognized that a Bear Stearns bankruptcy posed a
serious risk to the financial system.
Working through the night and into Friday morning, the New
York Fed agreed to establish a secured lending facility for the
company using JPMorgan as a conduit. But it became clear by the
end of Friday that a comprehensive solution would be needed
before the markets reopened in Asia on Sunday evening.
We had teams of people working around the clock that
weekend in an effort to determine what we could do to help. My
perspective from the start was that we could not do anything
that would jeopardize the health of JPMorgan. That would not be
good for our shareholders and it would not be good for the
financial system.
But I also felt that to the extent it was consistent with
the best interest of shareholders, we would do everything we
reasonably could to try to prevent the systematic damage that
the Bear Stearns' failure would cause. We, the management team
and the whole board of the company, viewed that as an
obligation of JPMorgan as a responsible corporate citizen.
By Sunday morning we had concluded the risks were too great
for us to buy the company entirely on our own. We informed the
New York Fed, Treasury, and Bear Stearns of our conclusion.
This was not a negotiating posture, it was the plain truth.
The New York Fed encouraged us to consider what kind of
assistance would allow us to do a transaction. That is what we
did. Finally, on Sunday evening, the private and Government
parties announced a plan with three core elements.
First, JPMorgan would acquire Bear Stearns in a binding
stock deal worth $2 per share to Bear's shareholders.
Second, the Fed would provide the merged company with a $30
billion non-recourse loan, collateralized by a pool of Bear
Stearns assets valued on Bear Stearns' books at the same
amount.
Third, JPMorgan would provide an unprecedented guaranty on
hundreds of billions of Bear Stearns' trading obligations. This
was done to assure the market that it could continue to do
business with Bear and prevent a further run on the bank.
We hoped that the initial plan would save Bear Stearns and
reassure the market that Bear Stearns would survive, but we
also understood that we had to monitor the situation very
closely. It soon became clear that we had not done enough.
Customers and counterparties continued to flee for two reasons:
the market perceived our guaranty as too narrow; and it doubted
that the $2 offer price would be enough to get Bear Stearns'
shareholders to approve the transaction.
Discussions with Bear Stearns and the Federal Government in
the week following the initial merger led to a revised rescue
plan with a package of five critical new elements designed to
address these real concerns. First, we strengthened our
guaranty to cover virtually all of Bear Stearns products,
customer relationships, and subsidiaries.
Second, in a response to a request from the Fed, we gave it
a separate guaranty on its existing loans to Bear Stearns.
Third, we agreed to take the first $1 billion of losses
that might ultimately flow from the Fed's $30 billion non-
recourse funding.
Fourth, Bear agreed to sell $95 million newly issued shares
to us, representing 39.5 percent of its voting stock.
And fifth, to help achieve finality, we increased our offer
to $10 per share.
The amended plan seems to have worked. In the week
following its announcement, the liquidity situation at Bear has
stabilized. And that day Standard & Poor's raised Bear Stearns'
credit ratings.
Let me say a word also about the $30 billion of collateral
for the Fed. We are subject to a confidentiality agreement with
the Fed in relation to those assets, so I am constrained in
what I can say. But I can make a few general points.
The assets taken by the Fed consist entirely of loans that
are current and rated investment grade. We kept the riskier and
more complex securities in the Bear Stearns' portfolio for our
own account. We did not cherry pick the assets in the
collateral pool. The process of designating what collateral
would be pledged was overseen by the New York Fed's advisor,
BlackRock, a recognized expert in the field.
While no one can predict how the portfolio will ultimately
perform--and, of course, it could actually increase in value--
if the portfolio declines in value, the first $1 billion of
that loss will be borne solely by JPMorgan.
Finally, let me turn to the Committee's interest in the
implications of this rescue for American taxpayers. The key
point, in my view, is this: Bear Stearns would have failed
without this effort, and the consequences could have been
disastrous. The idea that a Bear Stearns fallout would have
been limited to a few Wall Street firms just is not so. People
all over America, union members, retirees, small business
owners, and our parents and children, are now invested in the
financial system through pensions, 401(k)s, mutual funds, and
the like.
A Bear Stearns bankruptcy could well have touched off a
chain reaction of defaults at other major financial
institutions. That would have shaken confidence in the credit
markets that have already been battered and it could have made
it harder for home buyers to get mortgages, harder for
municipalities to get the funds they need to build schools and
hospitals, and harder for students who need loans to pay
tuition.
Moreover, such a cascade of trouble could have further
depressed consumer confidence and consumer spending, resulting
in widespread job losses, and accelerated the ultimate
downturn.
Mr. Chairman, the events of the past 3 weeks have been
extraordinary. I commend you and your colleagues for examining
their implications for the future. One thing I can say with
confidence: if the public and private parties before you today
had not acted in a remarkable collaboration to prevent the fall
of Bear Stearns, we would all be facing a far more dire set of
challenges.
Thank you, and I look forward to answering your questions.
Chairman Dodd [presiding]. Thank you very, very much.
Mr. Schwartz, we thank you.
By the way, let me--I was out of the room for 30 seconds
before you came in and I apologize that I was not here
personally to welcome both of you. Let me extend that welcome
and thank you. You have been here a long time already this
morning. But having the benefit of hearing a wonderful
distinguished panel of regulators here is certainly--having
spent some time with them.
I should have said, by the way, and I want to note this.
While I did not speak with either of these two gentlemen over
the weekend, Chairman Bernanke and Secretary Paulson called
periodically over that weekend to sort of at least keep me
posted on generally what was going on. And so I was very
grateful they have taken time out at least to generally keep me
informed. I was not aware of any of the details of this, I must
say.
I will also tell you that I spent 72 hours at the end of
that, leaving in fact on Sunday evening, to meet with the
Economic Ministers of the European Union in Brussels on Monday
morning, having flown all night, leaving without knowing the
outcome and fearful that I was going to have to get on a plane
and come right back again in the morning.
The press has already reported this, but the reception of
the conclusion was warmly received. That is not to suggest they
were not understanding of the difficulties, Mr. Schwartz, that
you and the employees of Bear Stearns and others and
shareholders faced, but going to the point earlier about
whether or not this was a better outcome, the reaction was
such.
With that, Mr. Schwartz, thank you.
STATEMENT OF ALAN D. SCHWARTZ, PRESIDENT AND CHIEF EXECUTIVE
OFFICER, THE BEAR STEARNS COMPANIES, INC.
Mr. Schwartz. Thank you, Chairman Dodd, Ranking Member
Shelby, Senator Reed.
My name is Alan Schwartz. I am the President and Chief
Executive Officer of the Bear Stearns Companies. Bear Stearns
and its 14,000 employees provide global investment banking
services, securities and derivatives trading, clearance and
brokerage services, and asset management services worldwide. I
have been part of and have grown with, the Bear Stearns family
for over 32 years. I am saddened by the fast-moving events of
the past several weeks that bring me here today.
During the week of March 10th, even though the firm was
adequately capitalized and had a substantial liquidity cushion,
unfounded rumors and attendant speculation began circulating in
the market that Bear Stearns was in the midst of a liquidity
crisis. The company assured the public that our balance sheet,
liquidity, and capital were strong but the rumors and
conjecture persisted.
Due to the stressed condition of the credit market as a
whole and the unprecedented speed at which rumors and
speculation travel and echo through the modern financial media
environment, the rumors and speculation ultimately became a
self-fulfilling prophecy. Because of the rumors and conjecture,
customers, counterparties, and lenders began exercising caution
in their dealings with us, and during the latter part of the
week outright refused to do business with Bear Stearns.
Even if these counterparties and institutional investors
believed, as we did, that we were stable, it appears that these
parties were faced with the dilemma that if the rumors proved
to be true they could be in the difficult position of having to
explain to their clients and others why they continued to do
business with Bear Stearns.
As the week progressed, unfounded rumors grew into fear and
our liquidity cushion dropped precipitously on Thursday, as
customers withdrew cash and repo counterparties increasingly
refused to lend against even high-quality collateral. There
was, simply put, a run on the bank.
I want to emphasize that the impetus for the run on Bear
Stearns was in the first instance the result of a lack of
confidence, not a lack of capital or liquidity. Throughout this
period, Bear Stearns had a capital cushion well above what was
required to meet regulatory standards. However, by Thursday of
that week, a tipping point was reached on liquidity. The market
rumors became self-fulfilling and Bear Stearns' liquidity pool
began to fall sharply.
At that point, we needed to find a source of emergency
financing to stabilize the situation and calm our clients and
counterparties. On Thursday, we reached out to JPMorgan, among
others, in part because JPMorgan served as our clearing agent
and was therefore already familiar with our collateral
position. We also informed the SEC and the Federal Reserve as
to what was happening.
We worked through the night and on Friday morning, March
14th, JPMorgan agreed to make a short-term loan available to
Bear Stearns, supported by a back-to-back loan from the New
York Federal Reserve Bank. We believed at the time that the
loan, and the corresponding backstop from the New York Fed,
would be available for 28 days. We hoped this period would be
sufficient to bring order to the chaos and allow us to secure
more permanent funding or an orderly disposition of assets to
raise cash if that became necessary.
However, despite the announcement of the JPMorgan facility,
market forces continued to drive and accelerate our precipitous
liquidity decline. Also, that Friday afternoon, all three major
rating agencies lowered Bear Stearns' long-term and short-term
credit ratings. Finally, on Friday night, we learned that the
JPMorgan credit facility would not be available beyond Sunday
night.
The choices we faced that Friday night were stark: find a
party willing to acquire Bear Stearns by Sunday night, or face
what my advisors were telling me could be a bankruptcy filing
on Monday morning which could likely wipe out our shareholders
and cause losses for certain of our creditors and all of our
employees.
Therefore, we set out to find a potential purchaser to
acquire Bear Stearns that had the wherewithal to provide the
backing we needed, an arrangement we hoped would reassure our
constituencies and curtail the flight of our clients and
counterparties. And we needed to find and reach agreement with
such a party over the weekend.
On Sunday, March 16th, after an intense effort to find the
best transaction possible, we reached the first agreement with
JPMorgan which has been much discussed in the press. JPMorgan
would acquire Bear Stearns for $236 million, or $2 a share.
Significantly, JPMorgan also agreed immediately to guarantee
the trading obligations of Bear Stearns and its subsidiaries.
As part of this deal, as has been noted, JPMorgan obtained
an agreement from the New York Fed to loan up to $30 billion to
JPMorgan, secured by certain of Bear Stearns' assets. While we
at Bear Stearns had some understanding that JPMorgan was
seeking this commitment, we were not directly involved in the
negotiations between JPMorgan and the Government.
The following week, due to market uncertainty about the
guarantees and the successful completion of the deal, the
agreement between Bear Stearns and JPMorgan was renegotiated.
In the end, JPMorgan agreed to pay $10 a share for Bear Stearns
in a stock-for-stock merger. Enhancements were made to
JPMorgan's guarantee of our operating and certain other
obligations, and a number of other changes were made to give
greater certainty of closing.
At the same time, we understand that JPMorgan's agreement
with the New York Fed was modified to make the terms more
favorable to the New York Fed.
In sum, before unfounded rumors began circulating in an
already precarious credit market, leading to the run on Bear
Stearns, the company had adequate capital and liquidity, and a
book value of approximately $12 billion. Facing the dire choice
of bankruptcy or a forced sale under exigent circumstances, we
salvaged what we could to avoid wiping out our shareholders,
bondholders, and 14,000 employees.
Federal officials that you talked to today and JPMorgan are
in a better position than I to discuss their rationale and
motives for participating in this transaction. I can only say
that as devastating as these events have been for the Bear
Stearns family, the failure of Bear Stearns could have had an
even more extensive, devastating impact on the stability of the
financial markets as a whole and it may have triggered a run on
other investment banks with potentially disastrous effects on
the Nation's overall economy.
Like many of us, I am certainly glad such a disaster did
not occur.
Thank you for your time. I am prepared to answer any
questions that you might have.
Chairman Dodd. Thank you very, very much. It was well said,
Mr. Schwartz.
On behalf of all of us here on this dais, our sympathies go
out to your employees. I have just read story after story about
long-standing employees, having spent careers at Bear Stearns,
who watched assets go from a Friday to a Monday that literally
were devastating for them. There is no adequate way we can
express our sorrow to them what happened.
Obviously, the shareholders have the same sort of feelings,
but obviously the employees particularly, it is a particularly
hard blow.
You know, you and I chatted some months ago and you raised
with me this whole idea of the discount window. I am going back
to now--I don't know whether it was last spring. I've forgot
exactly when I stopped by and chatted with you at Bear Stearns
about the various ideas and you raised this issue.
And I raised the issue, and I do not know if you were in
the room or not when I raised the issue this morning, when I
had a hearing a couple of weeks ago and raised with, in fact, a
panel of regulators including the Vice Chairman of the Federal
Reserve Bank about the possibility of opening the discount
window. And it was widely rejected out of hand as something
that would just be inadvisable.
Then, of course, you had the events on Thursday night and
then again on Sunday night. And I raised the question, had that
decision been reached earlier--whether on Thursday night or
even before--whether or not this might have salvaged the
situation and avoided this 96 hours that you and Mr. Dimon and
others went through.
You heard earlier, in response I think to Jack Reed's
question, it may have been, the question to President Geithner
about whether or not, in fact, had this window been opened
whether or not Bear Stearns would have qualified for them as a
prudent risk.
Would you respond to that, as well?
Mr. Schwartz. I certainly would, Senator. I think what I
conveyed to you, if I remember correctly, when we spoke was
that it was my view--and I think shared by some others in the
investment banking community--that this was the first major
credit crisis that we had experienced since there had been an
elimination of some of the Glass-Steagall restrictions against
the competition or the participation in investment banking by
commercial banks.
And that it felt to me that, as this environment unfolded,
having direct competition, people being in the same exact
businesses between commercial banks and investment banks, and
the commercial banks having a known access to a liquidity
source for all of their high-quality collateral and the
investment banks not having that, that created a situation that
I thought was precarious for the whole financial system.
Now getting directly to the point about what might have
happened if action had been taken more quickly, I will just
parse it in two ways because I remember there were two
questions about it: what happened if they had just opened that
window on Thursday night? Or what if they had done it sooner?
On Thursday night, I think, as Mr. Geithner pointed out,
there was already a run going on--But--when he said that, the
experience on Friday that showed that even the facility they
came up with did not stop the run, as we know, on Friday
afternoon--I think the problem with that analogy is when you
make an emergency situation available for one particular bank,
that does not shore up the confidence in that particular bank.
I think that is different than if you make a facility available
for all investment banks as a precautionary note. I think the
situation could be different.
Having said that, I do not know whether Thursday night
would have been too late, since the run on the bank and the
crisis of confidence was occurring Thursday afternoon. It is my
strong belief that by every measure that I can think of that
our balance sheet, our capital ratios, our risk profile lined
up well with all of our leading competitors. So I do believe
that if, as a policy measure, the discount window had been
opened to investment banks for their high-quality collateral, I
think it is highly, highly unlikely, in my personal opinion,
that we would be in the situation we find ourselves in today.
Chairman Dodd. Let me, getting down to the weeds a bit on
this, but I had read your testimony, and you just made the
point again here this afternoon, that you were working on an
assumption that that extension was going to be good for 28
days. President Geithner said, as I recall his language, it was
up to 28 days, which is kind of a different reaction here.
Take me through that a little bit. I presume someone, at
some point, raised the question that this was going to be more
than 2 days?
Mr. Schwartz. I want to start by saying that everything
happened in a very, very short period of time on Monday
morning, when we put this together. So we first got a draft of
what we were going to be putting out that referenced an
agreement between JPMorgan and the New York Fed, and then
referenced JPMorgan's facility to us. And I believe the
language said that there would be an interim period of up to 28
days.
When we, our advisors, and others read that, I think we
interpreted it--just the language--that the initial period
would be 28 days, unless we could stabilize the situation in a
shorter period of time.
As it turns out, and maybe exacerbated by the situation
with the run that continued on Friday, and since this was not
stabilizing the situation, we were informed that their view of
the language was no, it could be up to 28 days but could be
removed.
And so I think there was just an honest different reading
of the same words.
Chairman Dodd. Let me, if I can, I raised sort of at the
end of the appearance by the panel of Federal regulators--
again, and you both have forgotten more in the next 10 minutes
than I will ever probably understand about all of this. But
this question of what happens--when I looked at the volume, and
this was just getting up on Yahoo, in fact, I looked at the
volume of trades with Bear Stearns historically. I do not know
if that was just that month or so, but the numbers are--I do
not know if that has been true throughout the last year or so,
but that 3 million, 2 million, 5 million, 6 million, 7 million.
And then jumping to that Friday of 156 million, not to mention
the $30 puts for 10 day, that truncated period that went on
here.
Share with the Committee here your own thoughts and
observations. It sounds like more than just rumors to me that
were contributing to this.
Mr. Schwartz. Well, point No. 1, I do not have any specific
facts and I hope some facts will emerge over time. Given what I
have been through in the last few weeks, I do not want to
encourage too much rumor speculation. I would like the people
to find the facts.
But I would say that the nature and the pattern of the
rumors--I mean, one of the things we were trying to do was get
facts out that discounted the rumors that were out there. And
the minute we got a fact out, more rumors started or a
different set of rumors. So you could never get facts out as
fast as the rumors.
I would just say that as an observer of the markets, that
looked like more than just fear. It looked like there were
people that wanted to induce a panic. There are lots and lots
of reasons why people could have a financial motivation to
induce a panic. There is a lot of the trading that would point
to that.
I can only hope--there are laws against manipulating the
market. There used to be laws in this country against spreading
rumors about banks because they could cause a run on the bank.
There are no such laws on investment banks, but there are laws
against manipulating the markets.
If facts can come to light, I think that would be very
appropriate to go after.
Chairman Dodd. Mr. Dimon, welcome, and thank you for being
here, as well. Appreciate it very, very much.
In your testimony, you said that the--and I quote here--
``The New York Fed encouraged us to consider what kind of
assistance would allow us to do a transaction.''
Mr. Steel, the Secretary, in his testimony said that
JPMorgan first approached the New York Fed asking for
Government assistance.
Can you help us out as to which of these versions is----
Mr. Dimon. Mr. Chairman, I think lots of things took place
in a very brief period. When we had the conversation that we
would be unable to do the loan, we had a quick conversation
what would it take if you got help to do it?
So I do not actually remember who suggested it or not
suggested it, but it was the only way that we could have done
it.
Chairman Dodd. Let me just ask you the question here, if I
can. Did you or any of the senior management at JPMorgan Chase
ever have a conversation with anyone in the Federal Government
about the price that you were going to offer for Bear? And if
so, who did you talk to and what did they say?
Mr. Dimon. With President Geithner, the answer is he knew
the price but he always said that it was a decision of JPMorgan
Chase. And at one point with Secretary of Treasury Paulson, he
also knew the price. We had spoken several times. He also made
it very clear that that was the decision of JPMorgan Chase but
did express the point of view, which was held by a lot of
people including on the JPMorgan Chase side that the higher the
price, the more the so-called moral hazard. So that was simply
taken into consideration among all the other factors in what
the price would be.
Chairman Dodd. So the stories that have gone around and
been circulating about your willingness to pay $4 a share, and
that that was rejected flatly in a very direct way by the
Treasury are not true?
Mr. Dimon. Right. And I think another fact that can answer
that, Mr. Chairman, is that soon thereafter we were willing to
pay more. And we felt completely free to make such a
suggestion.
Chairman Dodd. I understand that came, but I am looking at
that 96 hour period, in that window.
Mr. Schwartz, let me ask you, were you ever offered $4 a
share?
Mr. Schwartz. No. We were, at differing times during the
negotiation, different prices were discussed as potential
prices. But the only actual offer we ever received was $2 a
share.
Chairman Dodd. Senator Shelby.
Senator Shelby. Mr. Dimon, you are the CEO of one of our
largest banks. Do you believe that most of our bigger banks are
well capitalized and have enough liquidity today? Or do you not
know?
Speak of your own bank first. I know you know where you
are.
Mr. Dimon. We have always believed in being extremely well
capitalized, conservative accounting, filling loss reserves,
and being prepared for what we call bad weather, which happens
when you do not really expect it.
I really cannot speak about all the other financial
institutions in the country.
Senator Shelby. Do you believe, do you have any inkling
that the Fed might have to go to intervene again--we keep
bringing this up--if another house failed?
Mr. Dimon. Senator, I do not know the answer to that but I
think they have done an awful lot of powerful financing that
hopefully will either eliminate or greatly reduce the chance of
having that happen again.
Senator Shelby. Mr. Schwartz, do you believe that your
management team at Bear Stearns has any responsibility for the
company's collapse?
Mr. Schwartz. Well, Senator, I do not think a management
team can ever say it bears no responsibility for anything that
happens.
Senator Shelby. Sure, because the buck stops with you,
basically.
Mr. Schwartz. Yes, the buck stops here and we, and our
shareholders, pay the price.
Senator Shelby. Sure.
Mr. Schwartz. I can just tell you that--I can guarantee you
it is a subject I have thought about a lot. Looking backwards,
and with hindsight, saying if I had known exactly the forces
that were coming, what actions could we have taken beforehand
to have avoided the situation. And I just simply have not been
able to come up with anything, even with the benefit of
hindsight, that would have made a difference to the situation
that we faced.
Senator Shelby. Did you believe at Bear Stearns, when the
week began, that you had adequate capital and liquidity to
carry on business? By Thursday you had problems. On Monday, how
were you on Monday?
Mr. Schwartz. Well, I certainly believed on Monday that we
had adequate capital and liquidity. They were in our normal
ranges. And by most measures, I believe our capital was
measured as being above standard.
I always had a concern. I never dreamed it would be as
rapid as things happened here, but I always had a concern that
the lack of a known liquidity facility for your collateral is
something that can cause a problem with the lenders against
that collateral. All of us, as investment banks, lend against
high-quality collateral and we turn around and use that
collateral. We never believed we could rely on unsecured
financing. We always felt like we needed a collateral pool.
And I did worry that there was an environment that could
happen that if we did not have--if the market could not see
that we had some place to go and borrow against that
collateral, then the fears could start. I just never, frankly,
understood or dreamed that it could happen as rapidly as it
did.
Senator Shelby. Do you believe that a lot of the value of
the collateral just collapsed?
Mr. Schwartz. No, I do not think----
Senator Shelby. Caused by rumors and other things?
Mr. Schwartz. I do not think the value of the collateral
collapsed. The willingness of people to lend against it----
Senator Shelby. Dissipated.
Mr. Schwartz [continuing]. On our behalf just dissipated
because of fear.
Senator Shelby. Mr. Dimon, for some time, JPMorgan Chase
has acted as the clearinghouse for Bear Stearns. I believe that
JPMorgan Chase also has extensive OTC derivative contracts with
Bear Stearns. What was the extent, sir, of JPMorgan Chase's
interconnectedness with Bear Stearns prior to Bear's
announcement of their intention to file for bankruptcy? And
what would have been the impact on your company's balance sheet
if Bear Stearns had been liquidated? Were these considerations
that went through your mind? Because you were connected. You
were the banker, basically, the commercial banker for the
investments.
Mr. Dimon. Senator, yes. We were one of their bankers and
one of their main clearinghouses. So we had obviously extensive
relationships and exposures.
But the answer to the question, our direct exposure on that
day was approximately zero. And where we did have exposure, it
was fully and totally collateralized.
Our real exposure would have been if Bear Stearns went
bankrupt, the impact it would have had on the financial system.
We probably would have lost money, but we still would have been
in fine shape.
So it really was not one of the reasons we went ahead and
did this transaction.
Senator Shelby. Mr. Dimon, in your testimony, you also
point out that the assets securing the Fed's loan, and I will
quote your words, ``consist entirely of loans that are current
and domestic securities rated investment grade'' and that
JPMorgan Chase is retaining ``the riskier and more complex
securities in the Bear Stearns' portfolio.''
Since your company, and you gave us an amount earlier of
$300-something billion----
Mr. Dimon. $300 billion was the amount of assets we are
buying from Bear Stearns; right.
Senator Shelby. OK. Since your company will be purchasing,
according to your testimony, the riskiest assets of Bear, why
did you opt not to purchase Bear without Federal assistance? If
the Fed is truly getting good assets--and we hope and pray they
are and they work out--why does JPMorgan Chase not want to
purchase those assets, or why did you not? Want some
assistance?
Mr. Dimon. Senator, one of the concerns we had was how much
exposure can we take on top of our other exposures. So we
already had plenty of mortgage exposures and risky security
exposures and we could do nothing that would leave JPMorgan in
the precarious position--like you have seen happen to lots of
other institutions.
Senator Shelby. You could not jeopardize your bank----
Mr. Dimon. You have to look at how many straws can you put
on the camel's back. And we are fairly conservative and we went
as absolutely far as we could go, both in terms of taking risky
assets, taking more mortgage assets, and having to borrow
another $30 billion.
Senator Shelby. Thank you, Mr. Chairman.
Chairman Dodd. Senator Reed.
Senator Reed. Thanks very much, Mr. Chairman. Thank you,
gentlemen.
I just want to clarify, Mr. Dimon, the guarantee that you
have, that you mentioned in your testimony. The loan is for $30
billion which was extended by the Fed. You are guaranteeing the
first $1 billion of that?
Mr. Dimon. Yes, so the $30 billion special facility,
Senator, we are going to take the first $1 billion of loss. The
Fed has also lent $25 billion to Bear Stearns under the primary
facility, another $25 billion, which exists today. And we have
also guaranteed that.
Senator Reed. So you are guaranteeing the $25 billion total
facility, the first facility, and $1 billion of the second
facility?
Mr. Dimon. That is correct.
Senator Reed. Thank you very much.
Mr. Schwartz, you have said, and I think Chairman Cox also
said, that your capital ratios were adequate as far as the
supervisors were concerned. Many things seemed to be in order
just several days before this transaction was entered into. But
others have raised the issue of your leverage, the fact that
you might have been more highly leveraged than other
competitive institutions. Can you comment on that leverage
issue?
Mr. Schwartz. Yes, I can.
I think that when people examined our balance sheet, a lot
of people examined it very carefully and got very comfortable
with it. There is one measure of leverage, which is total
assets to equity, which I do not think that any sophisticated
analysis of a balance sheet says that one measure is a sign of
leverage. It depends on what kinds of assets with what kinds of
risk.
The way capital cushions are monitored is you look at all
of the liabilities that you have or all of the assets that you
have, and you take a haircut based on the risk of those assets.
And those are basically across the board, across the industry,
the same.
And so when you looked at our capital versus the perception
of risk by those measures compared to other people, our capital
looked very adequate for the risk that we had on our balance
sheet.
Senator Reed. The other issue that is raised is that a lot
of your funding was very short-term funding and that you left
yourself exposed to a sudden seize up of the market, as
happened. Could you comment on that?
Mr. Schwartz. I could, and it is a good question because I
think some of the testimony you have heard today said that this
credit problem has been intensifying for many, many, many
months. Coming into it, we had made a decision to reduce our
reliance on unsecured financing at all and get all of our high-
quality collateral out, and as much as we could get it out on
longer term lines. We also borrowed in the long-term markets
when we could.
As this credit environment has frozen, it became very, very
hard to continue to borrow in the long-term market and the
facilities that one had against secured collateral that were
term, as they termed out people did not want to lend for a
longer period of time and they started shortening.
Having said that, we worked as hard as we could against
that and we actually had a bigger liquidity cushion than we
have had in a long, long time from the actions that we took.
Senator Reed. Let me ask you another question. You had two
funds that failed, basically, and mortgage securities were
principal items in the funds. And it caused concern not only
here but in Wall Street. And your response to the failure of
those funds, did that dramatically alter your behavior? Or can
you comment about how you reacted to those fund failures?
Mr. Schwartz. I am not sure I understand the question.
Senator Reed. Well, some would suggest that that was a
strong wakeup call about the overall condition. Also, it
alerted to many people in the market the potential for further
disruption at your firm and raised, I think, in my mind the
obvious question of how do you not only compensate but perhaps
even overcompensate for that, not only the economic effect but
the psychological effect? I mean, you are a major firm, one of
the premier firms. You have had two funds that you have backed
your reputation with, and they have totally failed.
Mr. Schwartz. Correct. Well, there is no question that
those funds that had our reputation, they were not our economic
exposure. But they were our reputation and we took a
significant reputational hit because of that. We were extremely
aware of that.
We did an awful lot of things. And the thing that we could
do the most was just put our heads down and perform as we went
forward because we could not set the clock back.
We also, we did step in. We had no obligation to make a
loan to those funds, but we decided to make a loan to one of
those funds in an attempt to try and save investors money, if
we could liquidate the collateral in an orderly basis. The
markets continued to go down, we were not able to accomplish
that, and then we did take some losses on that loan.
But we ended up with a loss for the quarter. I think if
somebody puts in context the losses that we took relative to
many, many financial institutions, they actually were not
particularly large.
And once again, if you took a look at our balance sheet, as
many people did, we had recovered. Our capital ratios were
strong. Our liquidity was strong. We were back to earning
money. And our business was actually moving along at a nice
pace.
Senator Reed. I have one more question.
After your experience with these funds, and I think also
with the growing economic situation that all of your
competitors were facing, there was a need to raise additional
capital even though you might technically be well capitalized.
I think you had attempted to enter into a transaction with
China's CITIC Securities in October and that transaction did
not close. Was there any particular significance to the failure
to close that transaction or to raise capital by other ways?
Mr. Schwartz. No, there are two parts to that question, if
I could. First, in terms of raising capital, it is my
understanding that if you looked at the capital raising that
went on at other financial institutions, it was often--it was
always accompanied by a very significant loss that was
reported, and that that loss had brought their capital down.
And it is my understanding that the capital they raised brought
their capital ratios back up to acceptable levels. So that is a
different situation than anticipatory.
The transaction with CITIC Securities, the largest
securities firm in China, was a transaction that we thought had
tremendous strategic value to the firm. And as part of the
transaction, we were raising $1 billion in capital. They did
extensive due diligence on us. They agreed to go forward with
the transaction. We needed to get approvals from the various
regulatory authorities in the United States. We had just gotten
those approvals. They were about to go and get the same
approvals from the CSRC when all of the events of the week we
described happened.
Senator Reed. Thank you very much, Mr. Chairman. Thank you,
gentlemen.
Chairman Dodd. Thank you, Senator, very much.
Senator Corker.
Senator Corker. Mr. Chairman, thank you, and thank both of
you for being here today. I know that this is kind of a
bittersweet situation with stockholders of one company feeling
good and the others not. But I thank you both for being here. I
know you have had both distinguished careers.
From the standpoint of JPMorgan, I know there has been
comments. Our Chairman mentioned the large amount of options,
trading that took place, toward the end of the week on the
downside. I know that Mr. Schwartz has talked about things
stronger than rumors, if you will, driving that. You obviously
had this relationship and were obviously paying attention to
what was happening. I wonder if you have any editorial comments
regarding what was actually happening, whether it was actually
driven by people who had nefarious kind of thoughts and
actions, or whether it was just in fact rumors from your
standpoint?
Mr. Dimon. Senator, I do not know what the real facts are
here, but I think there is enough smoke around the issue that
it is a proper thing for the regulators to look at what
actually happened. And I personally think that if people
knowingly created or passed on false rumors, they should be
punished under the law.
Senator Corker. The negotiation that took place at the end
of the day, I mean, it was either not be in business or sell.
So it really was not much of a negotiation. It sounds to me--
which I understand under the circumstances. It seems to me that
actually the pricing of the stock was based more upon making
sure there was not, in essence, some kind of moral hazard.
I wonder if you could speak to that just for a moment?
Mr. Dimon. I think, Senator, the price of the stock was not
really based on the value of the company. It was really based
upon protecting the downside of JPMorgan. I told you buying a
house is not the same as buying a house on fire. While some
people look at the upside, and we hope there is upside for our
shareholders, we were far more focused on the downside. Other
people were there and could not do it at all, probably at any
price.
And then obviously during the next week we did recognize
there was more value there. And I think it ended up for a fair
play for the Bear Stearns' shareholder, too.
Senator Corker. From your side, Mr. Schwartz, in essence it
was just whatever the price was, it was; right? I mean, at that
point, there was no negotiation. It was, in essence, what was
JP willing to do. It does not seem like there was much
leverage, from your standpoint?
Mr. Schwartz. Well, I think all the leverage went out the
window when a deal had to happen over the weekend. I think that
we had another party who had started doing due diligence on
Friday, a sophisticated party who after doing due diligence was
prepared to write a multi-billion dollar check to invest into
equity at Bear Stearns. But he was going to require some
significant financial institutions that he had relationships
with to provide a funding facility.
That is one example of a type of party that we could have
talked to. I think there could have been other large financial
institutions that would have liked to, including JPMorgan might
have wanted to pay a higher price if they had a chance to do
the kind of due diligence that normally goes with a large
acquisition.
But I think to go to a board of directors on a weekend and
say that we are stepping into the shoes in this credit
environment of another financial institution, and say we are
going to do that on a basis where we have to commit firmly to
the transaction, we understood in those circumstances there
were very, very few entities, and we thought maybe if any.
So we understood that JPMorgan was stepping up to doing
that, and the price, we had no leverage at all.
Senator Corker. Mr. Dimon, you obviously are highly
heralded and should be, and I am sincerely happy for you and
the stockholders of your company.
What is it that you and your colleagues now, in this
environment, are doing, if you will? I mean, people are looking
at liquidity issue of having short-term debt against longer
term obligations.
What is it that, just as a group your colleagues are doing
to make sure that you stay strong and that these types of
issues do not occur with other institutions?
Mr. Dimon. Senator, I appreciate the nice comment about
JPMorgan. I should point out, we have made plenty of mistakes
ourselves. So we do not stand in front of you as if we made
none.
Senator Corker. Sure.
Mr. Dimon. And we are always looking at capital measures,
risk measures, accounting, loss reserves. How bad can it get?
How bad can the storm be? Stress testing, and there are
multiple other measures we look at, including just plain old
common sense. What happens if you are wrong? Because very often
you are wrong.
So we try to maintain as firm a balance sheet and finance
the company way ahead of time so that we do not ever get in a
position where we can find ourselves in financing difficulty.
Senator Corker. But are you and your colleagues even
changing the way you are doing business right now based on the
circumstances of the last 30 days? Are more proactive steps
being taken by other colleagues?
Mr. Dimon. I believe the answer is yes a little bit but not
in a material way. But we, like everybody else, when events
like the past few weeks happen, hopefully we learn from them.
So we analyze them to death and then we go through all the
facts and we look at what we can do better. And we are in the
process of doing that today.
But we feel we are completely properly capitalized and
funded.
Senator Corker. And just the last question. I know when
people began accessing the Fed window they realized that right
behind that regulatory issues were going to come. I wonder if
you might give some editorial comments about some notions in
that regard knowing that that has to be coming with access to
Fed funds?
Mr. Dimon. Right, so Senator, many people commented this
morning about the need for change in the regulatory system and
that some of the things we all live under were--those laws were
passed, and they are closer to the Civil War than they are
today. We all acknowledge we need streamlining, modernization.
And I think opening up the primary window to investment banks
does have policy ramifications. And I hope the regulators and
the Congress spends a good amount of time to come up with good
policies and rules that prevent at least this kind of accident
from happening again.
Senator Corker. Thank you, Mr. Chairman.
Mr. Dimon. Thank you very much, Senator.
Senator Carper.
Senator Carper. Thanks, Mr. Chairman.
Gentlemen, thank you for being here. Thank you for your
extraordinary patience and for standing up during a really
difficult period of time, for not just your shareholders and
your institutions but I think for our country.
I was Treasurer of Delaware a number of years ago when the
folks at Chrysler just about went belly up. There was a bailout
faction here, an assistance plan faction here in Congress to
help save Chrysler. We participated in our State, along with a
number of other states that had Chrysler facilities.
There was a bit of a hue and cry about taxpayer bailout at
the time. And it turned out the U.S. Treasury made money off
the deal. And we in Delaware did, too. And Chrysler has had
some ups and downs since. We are hopeful that they are going to
survive, but knock on wood they will be around for a lot
longer.
But there have been concerns raised in this instance that
potentially some taxpayer exposure, Treasury exposure. I do not
know that the taxpayers are going to walk away, as we did with
Chrysler, actually being better off and being able to show a
profit for our intervention. But in terms of whether or not it
was worth it for the taxpayers, was it for our country, what
comments would you have there for us?
Mr. Dimon. Well, Senator Carper----
Senator Carper. What would be the upside for----
Mr. Dimon [continuing]. I think the first comment is this
would have been far more, in my opinion, expensive for
taxpayers had Bear Stearns gone bankrupt and it added to the
financial crisis we have today. It would not even have been
close.
I think the Fed has protected itself with the expected loss
note and the collateral, the long-term funding, the
professional management, and we will hopefully get back all
this money and possibly more.
And we did have a conversation at one point with the Fed
that we could have done it differently, share upside and
downside. But I was not aware of all of the regulatory
statutory issues they have in doing something like that. I
think they have certain constraints they live under by law.
Plus, we did not have a lot of time. We had literally 48
hours to do what normally takes a month.
Senator Carper. Mr. Schwartz, Senator Corker over there
asked you a question I was planning to ask myself. The question
is if you go back in time, I do not think the Congress had to
pass a law to say to the Federal Reserve, you can open a
discount window to investment banks. I believe they did that,
they took that step under a law that may have been passed in
the Great Depression if I am not mistaken. I do not know that
it was ever exercised until now. It may have been exercised
prior to now but it has not been exercised often.
The question that Senator Corker has asked is what are the
ramifications in terms of regulation, presumably regulation
from the Fed. I just want to go back to that and say if this is
the kind of thing that is going to happen with more frequency,
again what are the ramifications for regulations from the Fed
for--JPMorgan Chase already has to deal with that. But Bear
Stearns and other investment banks do not.
Mr. Schwartz. Right. So I do think that look, it is a well-
established precedent under regulation that financial
institutions that rely on confidence, that knowing that there
is liquidity for their assets actually inspires that
confidence. And so it is much harder to start rumors that they
have no place to go with their collateral if there is an
identifiable place at the Government where they could take that
collateral.
So the rumors and the fear become deflated by the fact that
people know that they have a liquidity source. And therefore,
you have to find some other thing.
So I believe that going forward, I think everybody had to
move here in a very, very, very rapid basis. I think when
people sit down, all of the people in Government, and look at
this I think they are going to say we need a new system. And I
think that one of the elements of that system I am convinced of
will be that the major investment banks--I was very glad to see
Sunday night that the window was open to those investment
banks. I was very, very glad to see that.
I think that some sort of facility will be made available
to keep a run on the bank from starting or happening. I think
that it is very appropriate to ask if that is going to be part
of a new regime of some kind then what are the other oversights
and regulatory reviews that have to occur to make sure it is
done on a sound basis? And I think that process will begin and
I hope it moves in a positive direction.
Senator Carper. Thank you.
The last question I have deals really with us and our
action. We have been sort of observers, to some extent,
watching the Federal Reserve be involved in a variety of ways,
extraordinary ways, in the last couple of months, and to watch
Treasury being involved in setting up Project Hope now, and a
number of other things to try to help the situation.
It is our turn now. And it is our turn now, and the
leadership Senators Dodd and Shelby bring to the floor today--
literally today--for debate and vote legislation that is
designed to deal with the situation, again restore some
additional liquidity, deal with the homes that are foreclosed
on.
What advice would you have for us as to one or two elements
that, if we do nothing else in the context of legislative
action this week or next week, what would be some of the things
on the must do list?
Mr. Dimon. Senator, I think I can do the pretty long to do
list. And most people that you speak to, it is kind of non-
partisan. We want to get it done. We know we need to make
changes. There will be a lot of debate about those changes.
I would say we should do it in due haste. You should get
all the help you can get. And obviously JPMorgan, in any way,
shape or form they can help would be happy to do so.
And then have a regulatory system which adjusts very
quickly after that because I do think that the regulatory
authorities need to move very quickly in this new world. And
they do not have the luxury to do some of the things you might
have wanted them to do.
For example, the Fed might have acted very differently that
weekend had they other statutory authorities.
Senator Carper. Mr. Schwartz, any advice for us as we turn
to our legislative responsibilities?
Mr. Schwartz. Not a lot. I do think that raising the limits
on the conforming mortgages could be helpful to supply some
liquidity to housing. I think expanding the authority of FHA to
step back into a market that it was created for would make
sense.
I think those are short-term and I think helping homeowners
stay in their homes is not only the right thing to do but it is
good economic policy.
I think longer term we have to look at the whole way that
mortgages get underwritten because there has to be some
liability for the people who underwrite the mortgages to make
sure that they are applying standards appropriately.
Senator Carper. Thank you very much. Thank you.
Chairman Dodd. Thank you, Senator.
We have been joined by Senator Menendez, who I believe has
some questions, as well.
Senator Menendez. Thank you, Mr. Chairman. Thank you,
gentlemen.
Let me ask you, Mr. Dimon, with reference to the securities
that are backing this transaction that the Fed has done, my
understanding is they are largely mortgage-backed securities
and related hedge investments. Is that a fair statement?
Mr. Dimon. Yes, Senator.
Senator Menendez. Do you know what the valuation of those
assets are?
Mr. Dimon. The valuation at which the Fed has taken them
into the books is at the same valuation that Bear Stearns had
them marked on March 14th. It is the same valuation that
JPMorgan has taken the other $300 billion at as of March 14th.
Senator Menendez. And what is that?
Mr. Dimon. Whatever is on their books for.
Senator Menendez. But in reality, that is not the valuation
of them, are they? Is that the real value of it in the
marketplace at this moment?
Mr. Dimon. Well, Senator, I think you could have a big
debate on what the value is. But I think that Bear Stearns--I
believe BlackRock also has looked at it--believes those values
are approximately appropriate.
Senator Menendez. Why do you think that there was this
first panel testified--I assume you agree with them--that there
was a crisis of confidence and a set of rumors. Why do you
think an institution of yours, with such reputation, such
standing, could simply fall on a series of rumors if it is not
a question of valuation at the end of the day?
Mr. Schwartz. I think that, as I said in the earlier
testimony or opening statement rather, I think that it is well
established in financial history that institutions that lend
money against assets, if people are concerned that there is a
liquidity crisis or if there are rumors that their money is not
going to be there after everybody else withdraws their money,
there is a rush to the exit.
In my mind that is what happened this week.
Senator Menendez. Well, let me ask you, do you really know
what the value is of the securities that you have?
Mr. Schwartz. I think that when you ask do we know the
value of the securities, I think that when you get into--I
think Chairman Bernanke testified that if you look at
securities that become highly, highly illiquid, if you have to
sell them overnight then you will have a much, much lower value
than if you look at what is a required return and how you value
that return over a reasonable period of time.
So do I think there are some assets on our balance sheet
that may turn out to be worth less than what we are carrying
them for? Yes. We have some significant hedges against a number
of those assets that tend to move in the other direction where
we are short.
I also think there are a number of assets on our balance
sheet that could be worth a lot more than what they are carried
at. One example of that was highlighted in the transaction with
JPMorgan where they asked for an agreement to be able to buy
our headquarters building for $1 billion. It is not carried on
our books at anywhere near that.
Senator Menendez. Well, the problem is that Chairman
Bernanke also testified in response to my questions that he
cannot tell us what the liability of the American taxpayer is
here. So if your valuations are equal to or greater, then we
have no problem. If your valuations are less than, we have a
problem even over the long term.
And I think that I have seen some statements in some
reports that, going back in time, say that when we had analysts
doing this home mortgage crisis situation, there were
analysts--and I do not know, Mr. Dimon, if your institution was
one of them--who said we cannot really tell you the totality of
the challenge that we might have.
So I do not particularly think that you all know what the
value of the instruments that you have really is. And that is
part of our challenge here.
Mr. Dimon, is it wrong to have said that you would not
have, on behalf of your institution, entered into this
agreement without the Fed's position?
Mr. Dimon. Senator, that is correct.
Senator Menendez. And as such, the reason you took that
position is why?
Mr. Dimon. Because, remember JPMorgan was buying another
$300 billion of assets, some of which were far riskier than the
$30 billion. And we analyzed this from our downside that we can
only put on so much debt, so much risky asset, so much risky
assets we already had. And we could not leave JPMorgan, for any
reason, under any circumstances, in a predicament where we
could jeopardize our financial health. And that is a judgment
call we made, how many straws can you put on that camel's back?
And that is all we could do. And we would have and could have
done no more.
Senator Menendez. And so you looked at the transaction and
you looked at the assets that would be acquired and you said
there are more straws there that might break the camel's back
than we can afford?
Mr. Dimon. I think the way we analyze it is what is the
chance that things can go wrong or get worse? We do not live in
a static world. So while we know that things can get better,
the question I had to answer for my board is what if things get
worse? Are we in good enough position? And it was plain simple,
and we needed the capital and the funding ability so that
JPMorgan remained a strong healthy institution after the
transaction.
Senator Menendez. And hopefully the Federal Exchange, on
behalf of the American taxpayer, asked the same question.
Thank you, Mr. Chairman.
Chairman Dodd. It is a great question and I tried to frame
it, Bob, after you had left. I do not want to over-simplify it,
but the concerns I think on this aspect--and again, all the
time constraints and everything else, we are very conscious
of--but what I called the socialization of risk and the
privatization of reward and that we are all hoping that the
case will be that this will turn out well. There is that
question mark there, that we have.
If that is a precedent-setting decision, it has incredible
implications. And so I think it is important to identify it for
what it is and recognize that we all hope this one works out.
But as others have suggested, in the absence of several
changes, we could be looking at other situations that come down
the pike here, maybe at far greater risk than the ones we are
talking about here. And to the extent we want to socialize
risk, in a sense, the socialization of it, is going to raise
some very serious questions here as well.
But it is an excellent set of questions and I appreciate
that.
Senator Menendez. Mr. Chairman, I would just make a note,
if we went to socialize risk, then we should look at
socializing the risk of mortgage foreclosures in this country.
Chairman Dodd. That is a wonderful lead-in to my next
question. In the sense that, to digress for a minute, because I
do not want to miss the opportunity of having two very talented
people here.
And let me say, Mr. Schwartz, as well, when you and I had
that conversation--however many months ago--about the discount
window, I want to just say in this hearing room I regret that
others did not listen to you at the time. I think it might have
made a big difference.
You had to have commensurate quality assets and collateral
and regulatory framework for all of it. But I think
unfortunately at the time there was a failure to understand the
gravity of the problem. We kept on hearing the language, the
problem is contained, that things are rosy, that things are
getting better.
It could not have been more wrong in their analysis of the
situation. And had there been people listening and willing to
utilize some of these vehicles earlier on at a time when I
think we might have had a better response, we might be avoiding
the kind of hearing we are having today.
I want to ask you about this issue that--utilizing your
talents here and background. Obviously, the points you have
made in the absence of this decision, this merger. And I agree
with this, I think most of us do here, that we would be looking
at a very different situation having come Monday morning. And
that is in no way to minimize the impact on employees and
shareholders and the like. But I think you have framed it both
well in terms of what was involved here.
There are those, and Senator Menendez just raised the issue
here. And I have been trying to come up with some ideas, again
not new ideas. In fact, in the previous years the idea of
trying to figure out a way to keep people in their homes, but
also find that bottom here that will unleash capital and begin
to move us out of this problem.
I have raised this issue before, and Senator Shelby has
been gracious enough to say let us hold some hearings to take a
good hard look at it. There is a lot of potential exposure but
there is some tremendous benefit as well.
I do not know if you have had a chance to take a look at
this idea--and I am not asking you to endorse a specific idea,
but just to comment generally on this question of whether or
not we can do something.
In the past, actually the Federal Government bought these
mortgages at highly discounted value and kept people in their
homes for a period of time, and actually made money, I think
some $14 million decades ago.
What I am talking about here is ensuring through FHA,
obviously getting a write down of the overall value of it, but
keeping people in, a voluntary program over an extended period
of time. And then have enough transactions occur so that you
can help identify that floor.
And if that is the case, then I am told by those who
believe this could work, you then begin to see capital begin to
move. Could you comment on that idea generally, as to the value
of it, or what you----
Mr. Schwartz. Well, I think there are a lot of pieces to
the puzzle. I do think that in our own mortgage servicing over
the years, we think that it is economically appropriate--
getting away from the social side of it for a second--that
there are times when it is better to modify a loan, even cut
the principal that somebody owes so they have an incentive to
continue making their payments and those payments become easier
to make.
Because large numbers of people being taken out of their
homes, as difficult as it is for those homeowners, also creates
additional supply on the market which keeps affecting supply
and demand for housing.
So it is a very complicated set of facts and I think that
an intersection of seeing where the appropriate modifications
to give people a real chance to stay in their homes would help
on the supply and demand side to stabilize the housing market
which is, underneath all of this, a point I think you are
making, Mr. Senator, is until we can stabilize the housing
market, it is really hard to say what is going to happen to a
lot of securities that relate to the value of homes in the
United States.
Chairman Dodd. Jamie?
Mr. Dimon. Yes, sir. Senator, I agree--first of all, I
think the legislation has moved rather quickly on Fannie Mae
and Freddie Mac and changing things to make it more easy to get
capital the borrower, the person who actually wants to buy the
home.
I think when you are in a crisis like this, you should not
stand on ceremony. You should fight the crisis. And those
things will all have ramifications for future policy.
I think using FHA to have people take haircuts on their
mortgages--which would be the banks. I want to make sure that
people understand, we are not looking for any sympathy in this.
We are obviously--I think JPMorgan Chase had among the best
underwriting standards but we also made mistakes and would like
to be very helpful.
I think a program and a policy like that could actually
work quite well and we would love to get engaged and to see if
we can help come up with something that makes sense for the
homeowner and for the American public.
Chairman Dodd. Thanks very, very much. I appreciate that.
Senator Shelby, any closing comments?
Senator Shelby. No, thank you.
Chairman Dodd. I thank both of you. You have been very
gracious and spent a lot of time here today. The first panel
took a little longer than anticipated with the interest,
obviously, by my colleagues here as well. But it has been very,
very helpful.
And I would like to leave the record open for a few days
for members to submit some questions possibly to you that they
did not get a chance to raise this afternoon.
But we wish you well and this has been helpful to help
clarify a lot of questions people have had out here.
I thank you both.
The Committee will stand adjourned.
[Whereupon, at 2:59 p.m., the hearing was adjourned.]
[Prepared statements and responses to written questions
supplied for the record follow:]
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RESPONSE TO WRITTEN QUESTIONS OF CHAIRMAN DODD FROM BEN S.
BERNANKE
Q.1. Does the Fed intend to conduct a study of what happened at
Bear Stearns, with lessons learned?
A.1. The SEC, which was Bear Steams' prudential regulator, is
conducting an in-depth study of the events that precipitated
the firm's liquidity crisis. The SEC has promised to share the
results of its study with us. We will assess the results of the
SEC's review and then consider whether further study of what
happened to Bear Stearns is necessary. In terms of lessons
learned, one lesson that is already clear is that asset and
funding liquidity can evaporate suddenly, even for very high
quality assets. Both leveraged financial intermediaries and
their prudential regulators must think through carefully the
implications for prudent capital and liquidity buffers.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM BEN S.
BERNANKE
PRIMARY DEALER CREDIT FACILITY
Chairman Bernanke, the Federal Reserve is now lending
regularly to securities firms under its Primary Dealer Credit
Facility. It has been suggested that if the Fed is going to
open its discount window to securities firms, additional
regulation of securities firms may be needed.
Q.1. How do we balance the need to have appropriate supervision
of securities firms, especially now that they can receive
Federal loans through the Fed, against the need to preserve the
competitiveness of our financial services sector and avoid
over-regulation?
A.1. All the primary dealers eligible to borrow from the
Federal Reserve under the Primary Dealer Credit Facility (PDCF)
are subject to supervision and regulation by the SEC. In
addition, the parent companies of nearly all of these primary
dealers are subject to consolidated supervision--either by the
Federal Reserve in the case of dealers that are owned by a U.S.
bank holding company, a foreign bank supervisory agency in the
case of dealers that are owned by a foreign bank, or the SEC or
OTS in the case of dealers that are not affiliated with banks.
The Federal Reserve is working closely with the SEC to
ensure that we have access to necessary financial, risk
management, and other information about primary dealers--
including information about their capital and liquidity
positions--and this coordination has been very useful to date.
In the near term, the Federal Reserve does not see a need for
any additional supervisory authorities with respect to primary
dealers.
Over the longer term, the Federal Reserve is analyzing the
costs and benefits of possible changes in the supervision and
regulation of securities firms and their parent holding
companies (particularly as regards their capital adequacy and
liquidity). Upon completion of this review, we would be pleased
to discuss these issues with you.
REGULATORY RELIEF
It has been reported that as a condition for purchasing
Bear Stearns, regulators promised JPMC certain regulatory
relief, including SEC no-action letters and forbearance on
capital requirements.
Q.2. Would you please list any and all regulatory relief your
agency or department has agreed to provide JPMC in connection
with its merger with Bear Stearns?
A.2. The Board provided two regulatory exemptions requested by
JPMC in connection with its proposed acquisition of Bear
Stearns.
First, the Board provided JPMC with a temporary (18-month)
exemption from the risk-based and leverage capital requirements
for bank holding companies. The exemption allowed JPMC
initially to (i) reduce its risk-weighted assets by the total
arnount of risk-weighted assets of Bear Stearns for purposes of
the Board's risk-based capital adequacy guidelines for bank
holding companies; and (ii) reduce its balance-sheet assets by
the total balance-sheet assets of Bear Stearns for purposes of
the Board's leverage capital guidelines for bank holding
companies. The amount of the exemption going forward will
shrink by one-sixth during each succeeding quarter until the
exemption expires on October 1, 2009. JPMC has committed that
it will remain well capitalized during this period, both with
and without the exemption.
Second, the Board provided JPMC with a temporary (18-month)
exemption from section 23A of the Federal Reserve Act and the
Board's Regulation W. The exemption allows JPMorgan Chase Bank
to extend credit to Bear Stearns and issue guarantees on behalf
of Bear Steams so long as the transactions are (i) fully
collateralized; (ii) subject to daily mark-to-market and
remargining requirements; and (iii) guaranteed by JPMC. The
initial amount of the exemption was 50 percent of the bank's
regulatory capital. The amount of the exemption going forward
will shrink by one-sixth during each succeeding quarter until
the exemption expires on October 1, 2009. All transactions
between JPMorgan Chase Bank and Bear Stearns would continue to
be subject to section 23B of the Federal Reserve Act, which
requires financial transactions between a bank and an affiliate
to be conducted on market terms.
A copy of the Board's regulatory capital and section 23A
exemption letter is attached.
Although not a regulatory relief matter, the Board also
approved the acquisition of Bear Stearns Bank & Trust by JPMC
on April 1, 2008, on an expedited basis as provided in the Bank
Holding Company Act. A copy of the Board's order approving the
acquisition is attached.
EMERGENCY LENDING AUTHORITY
Chairman Bernanke, in my opening statement I mentioned the
Federal Reserve's emergency lending authority. The Federal
Reserve Act does not clearly specify the goals or purposes for
which the Fed should exercise this authority. It only provides
that lending to corporations should occur in unusual or exigent
circumstances and when a corporation is unable to secure credit
from other banking institutions. These relatively simple
conditions effectively give the Fed broad discretion on when to
exercise its emergency lending authority. You have written
widely about the importance of inflation targeting, arguing
that inflation-targeting provides ``discipline and
accountability in the making of monetary policy.''
Q.3. If monetary policy benefits from a framework that provides
discipline and accountability, would not the Fed's emergency
lending authority also benefit from having clearer objectives
and conditions provided by Congress?
A.3. In my view, the Congress has achieved an appropriate
balance between the needs for discipline and accountability, on
the one hand, and flexibility and judgment, on the other, in
the statutory frameworks that it has established for both
monetary policy and emergency lending.
With regard to monetary policy, the Congress has
established the goals of maximum employment, stable prices, and
moderate long-term interest rates, and it has set a framework
for monetary policy accountability, partly through semiannual
reports and testimony on monetary policy. The Congress has left
the specific interpretation of the statutory goals for monetary
policy to the judgment of the Board of Governors and the
Federal Open Market Committee; for example, the Congress has
wisely Chosen not to quantify three goals of policy. Similarly,
the Congress has provided only general guidance regarding the
Federal Reserve's semiannual reports on monetary policy,
leaving the specific content of such reports and the
accompanying testimony to the judgment of the Federal Reserve.
The Congress has chosen an analogous approach for the
conditions and accountability for emergency lending. With
regard to the conditions for emergency lending, the Congress
has established a clear framework that sets a high hurdle for
undertaking such activities: Emergency lending can be done only
in unusual and exigent circumstances, only when the borrower
cannot otherwise secure adequate credit accommodations, and
only with the approval of at least five members of the Federal
Reserve Board. However, the Congress left the specific
interpretation of the first two conditions to the Board. In my
view, this was a wise decision by the Congress: Financial
crises tend to be unique events, making it very difficult to
set in advance an appropriate set of specific conditions that
would have to be met for emergency lending. Moreover, the
Congress has established an ongoing framework for the
accountability of the Federal Reserve's financial operations by
requiring that the Board publish on a regular basis statements
of conditions for the Reserve Banks and for the System as a
whole. Within this reporting framework, the Board has provided
detail on the amounts outstanding under its various credit
programs both in routine circumstances and in the current
period of financial stress. In addition, the Federal Reserve
recognizes that when it undertakes emergency lending it has an
obligation to explain why it believes the conditions for such
lending have been met. Congress has the authority to review the
Federal Reserve's explanations, as it did at the hearing on
April 3.
Chairman Bernanke, the Federal Reserve Act grants the Board
of Governors broad emergency lending authority. It enables the
Fed to extend the Federal safety net to corporations, such as
investment banks, that otherwise are not guaranteed by the
Federal government.
Q.4. Since taxpayers bear any losses on any emergency loans the
Fed extends, should there be limits on the amount of lending
the Fed can conduct under its emergency lending authority? And
given budgetary implications of such lending, should the
Treasury Secretary also have to formally approve these loans?
A.4. When Congress established the Federal Reserve as the
nation's central bank, Congress considered it important that an
independent agency be created to help maintain the stability of
the U.S. financial system. Financial crises can develop quickly
and with considerable intensity, and it is crucial that the
Federal Reserve have authority to respond rapidly and
powerfully to a severe crisis by, if necessary and appropriate,
providing liquidity to the financial system.
It is important to note that the Federal Reserve's
emergency lending authorities are subject to a number of
important qualitative limits. Most notably, the Federal Reserve
generally has authority to lend to non-banks only in unusual
and exigent circumstances, and when the borrower is unable to
obtain adequate credit accommodations from other banking
institutions. Moreover, these emergency credits must be secured
to the satisfaction of the lending Federal Reserve Bank and
approved by a super-majority of the Board of Governors of the
Federal Reserve System. Consistent with the spirit of the
Federal Reserve Act, we have only used our power to make
emergency loans to non-depository institutions on a small
number of occasions in the 75 years since Congress granted this
authority to the Federal Reserve.
The Federal Reserve also has been very careful in its
recent actions to minimize any potential losses to taxpayers.
All credit extended to primary dealers under the PDCF and all
transactions with primary dealers under the term securities
lending facility (TSLF) are fully secured by investment-grade
securities with appropriate haircuts. In addition, the March 14
loan to Bear Steams was repaid on March 17 without loss to the
taxpayer. There are also substantial protections for taxpayers
associated with the prospective $29 billion extension of credit
by the Federal Reserve to be made in connection with the
acquisition of Bear Stearns by JPMC. The collateral for the
loan will be in the form of investment-grade securities and
performing credit facilities, JPMC will bear the first $1
billion of losses on the collateral pool, the Federal Reserve
will be able to liquidate the collateral over a long-term
horizon of at least ten years, and we have hired a professional
independent investment adviser to manage the collateral pool.
The Federal Reserve has never incurred any losses in
extending credit through the discount window, and we will take
every precaution to ensure that that remains the case.
In light of the strict qualitative limits on Federal
Reserve emergency lending, the Federal Reserve's practice of
using this authority judiciously and safely, and the need for
the Federal Reserve to be able to act in a financial crisis
with maximum alacrity and independence of judgment, we do not
think it would be necessary or appropriate to require the
Secretary of the Treasury to approve Federal Reserve emergency
loans.
Q.5. Also, does the Fed's mere possession of such broad lending
authority create expectations that the Fed will not permit
major financial institutions to fail?
A.5. Investors in and creditors of major financial institutions
undoubtedly are now more aware of the Federal Reserve's broad
emergency lending authority. There are substantial constraints
on the Federal Reserve's authority, however, that should help
promote continued market discipline. Specifically, in contrast
to the FDIC's broad authority to resolve and/or liquidate
insured depository institutions, the Federal Reserve does not
have authority to acquire or otherwise resolve financial firms.
The Federal Reserve may only address the liquidity needs of
solvent non-depository companies in unusual and exigent
circumstances. In this regard, the Federal Reserve did not
prevent the demise of Bear Stearns. The resolution of Bear
Stearns relied on a private sector acquisition.
The inability of the Federal Reserve to acquire or
otherwise provide a solvency backstop to financial institutions
is reflected in the market prices of obligations of financial
institutions and derivative instruments based on obligations of
financial institutions. Prices of these financial assets imply
that market participants are far from certain that the Federal
Reserve would prevent major financial institutions from
failing. In particular, market participants continue to pay
substantial premiums for protection against losses from failure
of most major U.S. financial institutions.
Moreover, any incidental costs associated with the Federal
Reserve's lending authority must be compared against the
substantial benefits that accrue to the financial markets--and
ultimately to taxpayers and homeowners--by allowing the central
bank to respond quickly in emergency situations as a lender of
last resort. Congress created the Federal Reserve in part to
serve the traditional central bank function as lender of last
resort and thereby to reduce in emergency situations the
potential adverse effects of illiquidity on either an
individual firm or on the financial system more broadly. The
fact that the Federal Reserve has exercised this authority to
extend credit to non-depository institutions on only a small
number of occasions in the past 75 years underscores the high
hurdle that Congress and the Federal Reserve have set for such
lending.
MORAL HAZARD
Q.6. Chairman Bernanke, would you please address the extent to
which the Fed's actions in this case have increased the risk of
moral hazard?
A.6. Access to the federal safety net, including access to
central bank credit, necessarily entails a degree of moral
hazard. Thus, granting primary dealers access to Federal
Reserve credit has increased moral hazard to some degree.
Although the potential for moral hazard should be carefully
analyzed and considered by policymakers, it seems more likely
that the example of Bear Stearns--in which shareholders and
management suffered considerable losses--and the broader
distress in financial markets will serve as a potent reminder
to primary dealers and other leveraged financial firms about
the importance of prudent liquidity risk management. In
particular, in developing their liquidity management plans,
primary dealers and others must now attach considerable weight
to scenarios in which their access to funding in the repo
market is sharply curtailed. Of course, the Federal Reserve,
the SEC, and other regulatory agencies will be working to
reinforce that message.
The adverse effects of moral hazard must and can be
mitigated through prudential supervision and regulation. The
SEC and the Federal Reserve have been monitoring the leverage
and liquidity of the primary dealers. Going forward, the SEC
and the Federal Reserve will assess what changes in prudential
supervision and regulation of primary dealers (such as
increased capital or liquidity requirements) are needed to
mitigate moral hazard and ensure that the dealers manage their
risks appropriately.
The adverse effects of moral hazard from use of the Federal
Reserve's emergency lending powers also must and can be
mitigated through judicious, sparing, and disciplined use by
the Federal Reserve of these powers. In this regard, as noted
above, the Federal Reserve generally has authority to lend to
non-depository institutions only in unusual and exigent
circumstances and has very rarely exercised this authority.
The Federal Reserve's actions with respect to Bear Stearns
are instructive in this regard. The Federal Reserve facilitated
the acquisition of Bear Stearns by JPMC because the substantial
involvement of Bear Stearns in many important financial
markets--at a time when the credit markets were particularly
vulnerable--was such that a sudden failure by Bear Stearns
would likely have led to a chaotic unwinding of positions in
already severely strained circumstances. Moreover, a failure by
Bear Stearns to meet its obligations would have cast doubt on
the financial strength of other financial firms whose
operations bore superficial similarity to that of Bear Stearns,
without due regard to the fundamental soundness of those firms.
The Federal Reserve judged that a sudden failure of Bear
Stearns under these unusually fragile circumstances would have
been extremely disorderly and would have risked unpredictable
but severe consequences for many sound financial firms and for
the functioning of the broader financial system and the
economy.
Moreover, as discussed in my answer to the previous
question, any incidental costs associated with the Federal
Reserve's lending authority--such as increased moral hazard--
must be weighed against the substantial benefits that accrue to
the financial markets by allowing the central bank to serve as
lender of last resort. The Federal Reserve's recent actions
under its emergency lending authorities--the establishment of
the PDCF and TSLF and the proposed financing of the JPMC
acquisition of Bear Stearns--were essential to avert a
financial crisis that likely would have had serious
repercussions for the U.S. economy.
LESSONS LEARNED AND TOO BIG TO FAIL
We have heard the argument that Bear was ``too
interconnected to allow to liquidate quickly''. This would
appear to be the case for a number of financial entities,
including both banks and non-banks.
Q.7. What changes in financial surveillance and reporting could
the regulators use to make such a situation of
``interconnectedness'' less likely to trigger the type of
resolution the Fed entered into with Bear?
A.7. As noted in our answer to the previous question, although
the interconnectedness of Bear Stearns was a consideration in
the Federal Reserve's decision to facilitate the acquisition of
Bear Stearns by JPMC, it was not a sufficient condition for the
Federal Reserve's actions. Other important causes of the
Federal Reserve's actions with respect to Bear Stearns were the
suddenness of the collapse of the liquidity position of Bear
Stearns and the unusually fragile conditions in the financial
markets.
Regulators have for some time been paying considerable
attention to the extent and nature of commercial and investment
banks' credit exposures to other large financial institutions,
including exposures arising from OTC derivatives. But clearly
this is an issue that deserves further attention. In
particular, regulators need to understand and evaluate the
effectiveness of the stress tests that these firms use to
assess and limit the potential for exposures to increase
significantly in stressed market conditions. Regulators also
need to take a hard look at the firms' liquidity risk
management practices, including their reliance on common
sources of funding their vulnerabilities to sudden reductions
in the availability of those types of funding.
Q.8. Given that the Fed has pursued this transaction, how can
the Fed and perhaps the Congress now convince market
participants that something similar will not happen again? And
if we cannot convince market participants that is the case,
what is the implication for risk-taking behavior in the future?
A.8. As discussed above, it seems likely that the considerable
losses suffered by shareholders and management of Bear Stearns
should serve to check and possibly diminish incentives for
undue risk-taking by the owners and managers of large financial
institutions. Moreover, as discussed above, the adverse effects
of moral hazard from use of the Federal Reserve's emergency
lending powers are mitigated by the sparing and disciplined use
by the Federal Reserve of these powers. As noted above, the
Federal Reserve generally has authority to lend to non-
depository institutions only in unusual and exigent
circumstances, when the borrower is unable to obtain credit
accommodations from other banking institutions, when the loans
are secured to the satisfaction of the Federal Reserve, and
when at least five members of the Board of Governors of the
Federal Reserve System approve the transaction. The Federal
Reserve's decision to extend credit in support of IPMC's
acquisition of Bear Stearns was based on a highly unusual
confluence of events, including the suddenness of the collapse
of the liquidity position of Bear Stearns and the highly
fragile state of the financial Markets at the time.
As noted above, the Federal Reserve is currently analyzing
whether changes in the supervision and regulation of securities
firms and their patent holding companies (particularly as
regards their capital adequacy and liquidity) would be
appropriate to mitigate potential residual adverse effects of
actions such as the Federal Reserve's recent emergency
liquidity facilities.
Attachments (2).
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING FROM BEN S.
BERNANCE
Q.1. If Bear Stearns, which was only the 5th largest dealer,
was prevented by the Fed from failing, will you allow anyone to
fail?
A.1. As a threshold matter, it is important to note that the
Federal Reserve's authority to provide emergency support to
non-depository institutions is limited to lending. In contrast
to the FDIC's broad authority to resolve and/or liquidate
insured depository institutions, the Federal Reserve does not
have authority to acquire or otherwise resolve financial firms.
We may only address the liquidity needs of solvent companies in
unusual and exigent circumstances. The resolution of Bear
Stearns relied on a private sector acquisition.
The Federal Reserve's actions with respect to Bear Stearns
are instructive in this regard. The Federal Reserve facilitated
the acquisition of Bear Stearns by JPMorgan Chase because the
substantial involvement of Bear Stearns in many important
financial markets--at a time when the credit markets were
particularly vulnerable--was such that a sudden failure by Bear
Stearns would likely have led to a chaotic unwinding of
positions in already severely strained circumstances. Moreover,
a failure by Bear Stearns to meet its obligations would have
cast doubt on the financial strength of other financial firms
whose operations bore superficial similarity to that of Bear
Stearns, without due regard to the fundamental soundness of
those firms. The Federal Reserve judged that a sudden failure
of Bear Stearns under these unusually fragile circumstances
would have been extremely disorderly and would have risked
unpredictable but severe consequences for many sound financial
firms and for the functioning of the broader financial system
and the economy.
The inability and unwillingness of the Federal Reserve to
acquire or otherwise provide a solvency backstop to financial
institutions is reflected in the market prices of obligations
of financial institutions and derivative instruments based on
obligations of financial institutions. Prices of these
financial assets imply that market participants are far from
certain that the Federal Reserve would prevent major financial
institutions from failing. In particular, market participants
continue to pay substantial premiums for protection against
losses from failure of most major U.S. financial institutions.
Q.2. Are there functions or transactions that have developed in
our financial system today that are so essential that we need
to update regulations or protections to ensure they do not
fail?
A.2. A number of important financial markets have developed or
gown considerably in the past decade. These include the markets
for mortgage-backed securities and other asset-backed
securities, over-the-counter derivatives (including in
particular credit derivatives), securities lending and
borrowing transactions, and repurchase and reverse repurchase
agreements. Significant progress has already been made to
improve the clearing and settlement of over-the-counter credit
and equity derivatives, but more work needs to be done. The
Federal Reserve and other financial regulators continue to
review the resiliency of, and the adequacy of the
infrastructure surrounding, these markets and are reviewing the
supervision and regulation of the financial institutions that
participate meaningfully in these markets.
Q.3. Chairman Bernanke, as recently as last February I asked
you if you thought the inverted yield curve was signaling
trouble ahead. Your answer was that you did not think the yield
curve was a good indicator anymore. Do you still agree with
that?
A.3. My views on this issue have not changed. I continue to
believe that the slope of the yield curve, taken on its own, is
not a particularly useful indicator about future economic
conditions. As I noted in my response to your question in
February 2007, a flat or inverted yield curve that results from
a decline in long-term interest rates need not signal a slowing
of economic activity; instead, the lower long-term rates act to
reduce financing, costs for businesses and households and
encourage spending. In addition, recent empirical work has
highlighted that a number of other financial indicators help
predict future activity. These indicators include credit risk
spreads on corporate bonds, measures of market liquidity, and
lending policies at banks. Please be assured that we at the
Federal Reserve are monitoring a wide range of indicators, both
financial and nonfinancial, to assess the current state of the
economy and to inform our forecasts of its path over time.
------
RESPONSE TO WRITTEN QUESTIONS OF CHAIRMAN DODD FROM CHRISTOPHER
COX
Q.1. The SEC as a consolidated regulator differs from the Fed
because it does not have the ability to make loans to the
entities under its jurisdiction. Is this a flaw in the SEC's
ability to effectively regulate an investment bank? Or can the
SEC work cooperatively and effectively with the Fed as the
central bank to effectively address liquidity crises that may
arise in the future? Does the SEC need any additional
legislative authority?
A.1. The supervision of the CSE firms and the function of
providing a back stop liquidity facility are separate
activities, although they should be coordinated. There are
other holding company supervisors in the U.S. and abroad that
are not back stop liquidity providers. By way of analogy, a
lender typically does not regulate, supervise, or manage a loan
recipient, although it has a significant interest in monitoring
the health of the borrower to protect its investment.
The SEC should not be able to make loans to the entities
under its jurisdiction, and the fact that it is not a lender is
not a flaw in the regulatory approach. The CSE firms are
fundamentally securities firms, and SEC is the most
knowledgeable financial regulator in overseeing these complex
trading operations. The Commission has a long history of
cooperation and coordination with other domestic and
international supervisors, including particularly the Federal
Reserve, which quite properly does have lending authority.
During the events at Bear, the SEC worked exceptionally closely
with the Federal Reserve, as well as the Department of the
Treasury, and we are continuing to work together to ensure that
our regulatory actions contribute to orderly and liquid
markets. We are currently formalizing our coordination in an
information sharing arrangement with the Federal Reserve, so
that processes are in place and a common set of data is
understood by the interested supervisors.
With regard to legislation, I believe Congress should
establish a statutory framework for the mandatory consolidated
supervision of systemically important investment banks and
adopt, where appropriate, the applicable concepts from the
Federal Deposit Insurance Corporation Improvement Act to govern
the resolution of any future financial difficulties at a
systemically important investment bank. Should Congress enact
legislation to provide access to an external liquidity provider
under exigent conditions in the future, the cooperative sharing
of information and collaborative assessment of capital and
liquidity that the SEC and the Federal Reserve are currently
formalizing would provide the basis for making such an
arrangement work.
Q.2. The Wall Street Journal wrote that the SEC ``is debating
whether it would have been useful to have data about short-
term, or repo, financing from the banks that clear trades and
hold collateral for the securities firms under the agency's
review . . . It . . . could have been useful in identifying the
problems at Bear. Currently, the Fed has access to the
information, but the SEC doesn't.'' [``SEC Role is Scrutinized
in Light of Bear Woes,'' March 27, 2008.] How would you respond
to this?
A.2. Understanding the functioning of the interbank funding
market is critical to understanding the process by which Bear
Stearns came to face a liquidity crisis. Prior to March 13,
Commission staff were in close contact with the Federal Reserve
Bank of New York, which provided information on developments
affecting not only Bear Stearns' ability to access this market,
but also overall market conditions. In light of the importance
of this information, the SEC and the Federal Reserve are
currently formalizing an agreement to share this information.
Q.3. Do you believe that certain investment banks should be
``too big to fail'' or that are, as Chairman Bernanke said,
``too intertwined to fail,'' and, if so, under what
circumstances? Do you feel that investment banks under certain
circumstance should have access to the discount window?
A.3. The reality of the modern financial system is that there
are a relatively small number of interconnected financial
institutions--commercial banks, investment banks, and insurance
companies both in the U.S. and globally--that are systemically
important. Having a comprehensive and effective financial
markets supervision regime--including established plans for the
resolution of financial difficulties at one or more of these
institutions--is critical to the stability of today's financial
markets and by extension the broader economy. This does not
mean that any insolvent bank is categorically ``too big'' or
``too interconnected'' to fail, but rather that under certain
circumstances its orderly resolution might prevent broader
market problems.
With regard to access to a backstop liquidity provider,
current law provides for predictable access to the Federal
Reserve 's liquidity facilities for certain financial
institutions, but presently provides for access only under
limited circumstances for other financial institutions that are
arguably of equal systemic importance. This disparity presents
a challenge for Congress and regulators for coping with the
changing nature of the financial markets and the increasingly
similar activities undertaken by the major financial firms
regardless of whether they are labeled as commercial banks,
investment banks, or with some other title.
The PDCF facility is providing the investment banks and
their supervisors invaluable tune and breathing room to analyze
the events that led to the collapse of Bear Stearns, and to
take steps to make investment bank funding plans more
resilient. Whether such a facility should be available in the
future depends on a number of factors, including the state of
the supervision regime for the institutions that would be
eligible to participate, the nature of the business in which
these institutions are engaged, and the level of risk
associated with those business activities.
Q.4. Investor confidence in Bear Stearns eroded sharply leading
to its serious financial problems in the days leading up to its
collapse. In its regulatory oversight, does the Commission
assess the confidence that the markets have in securities firms
in order to anticipate future problems?
A.4. Yes. In the course of its supervision, the CSE staff
reviews and considers a wide array of information, including
information from other regulators, market participants, analyst
reports, and the financial press on market sentiment.
Q.5. Chairman Cox, you said in your letter to the Basel
Committee that ``the fate of Bear Stearns was the result of a
lack of confidence, not a lack of capital'' and cited ``rumors
spread about liquidity problems at Bear Stearns, which eroded
investor confidence in the firm.'' Should, or can, the
Government address false rumors circulating in the market?
A.5. The SEC has broad enforcement authority to sanction rumors
that constitute fraud. For example, the Commission recently
filed an enforcement action against a Wall Street trader for
spreading false rumors. In the context of the CSEs, I believe
maintaining strong liquidity and capital positions at the CSE
holding companies, improving transparency, and the current
access to the PDCF go far to tempering the contagion that may
result from false rumors. I also believe improving the
clearance and settlement of OTC derivatives and addressing
operational issues that arose when counterparties novated large
volumes of OTC derivatives contracts away from Bear would
assist in this effort.
Q.6. Some observers have alleged that during the week of March
10 there was a great deal of improper short selling of Bear
Stearns stock by investors who were spreading false rumors
about problems at Bear Stearns. As a result, significant
investors stopped doing business with Bear which caused a
liquidity crisis that drove the stock price lower.
In light of the discussion in recent years about short
selling, will the Commission review whether it would be
beneficial to impose greater sanctions for market participants
who fail to deliver shares to cover on settlement dates or to
reinstitute an uptick rule, perhaps with a larger increment?
A.6. Economic studies have shown that short selling is higher
when there is a greater degree of uncertainty, and the period
prior to and since the financial difficulties at Bear Stearns
was associated with a high degree of uncertainty. If we uncover
traders who attempted to make profitable trades by selling
short and intentionally propagating false rumors, we will
pursue those individuals in the enforcement context. With
respect to Bear Stearns, specifically, we have yet to find any
evidence that the lack of an uptick rule contributed to its
collapse.
Q.7. Does the SEC intend to conduct a study of what happened at
Bear Stearns, with lessons learned?
A.7. Yes. Commission staff are currently undertaking a granular
review of the loss of secured funding and its impact on the
operations and liquidity of Bear Stearns.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM
CHRISTOPHER COX
FDICIA PRECEDENT
Chairman Cox, in your testimony you point out that FDICIA
established a framework for resolving difficulties experienced
by commercial banks where systemic risk is involved. Because
investment banks are not part of the deposit insurance system,
the FDICIA process does not cover their failure even where
systemic risk may be involved. The purpose of FDICIA, you note,
is to ensure that Federal intervention involving systemic risk
is guided by clear principles rather than improvised in the
midst of a crisis.
Q.1. Do you believe that the regulatory response to the
collapse of Bear Stearns was done on an ad hoc or improvised
fashion due to the lack of clear statutory guidelines?
What principles should guide Federal intervention involving
institutions, other than depository institutions?
A.1. Yes, I do. The principles we should now follow should be
informed by the experience of dealing with ``lender of last
resort'' issues, including moral hazard, in the commercial bank
regulatory context. In 1991, after experiencing record bank
failures and with the FDIC deposit insurance fund at a record
low level, Congress eliminated much of the FDIC's discretion in
resolving troubled commercial banks by adopting the ``least
cost test.'' At that time, Congress also recognized the
importance of having a mechanism in place for senior government
officials considering the resolution of difficulties at
systemically important commercial banks. However, Congress has
not provided for analogous provisions relating to investment
banks, which meant that there was a sparse statutory framework
within which regulators were operating during the difficulties
with Bear Stearns.
The Federal Reserve Board judged that it was appropriate to
use its emergency lending authorities under the Federal Reserve
Act to avoid a disorderly closure of Bear Stearns. The existing
authority in the Federal Reserve Act gives the Federal Reserve
broad authority to lend to many kinds of entities. In
appropriate circumstances, that flexibility provides an
important safety valve as is illustrated by Bear Stearns'
financial crisis.
Although there is not a specific framework in place that
governed resolution of a systemically important investment bank
not affiliated with a commercial bank during a financial
crisis, the agencies worked together well and in a coordinated
fashion that could only be enhanced by adopting a statutory
framework. This statutory framework should provide for a
mandatory consolidated supervision regime, borrowing where
appropriate from applicable concepts in the Federal Deposit
Insurance Corporation Improvement Act (``FDICIA '').
Legislation to enhance the Commission's authority over
consolidated supervised entities (``CSEs') should strengthen
the oversight regime by providing the Commission statutory
examination authority, capital setting and monitoring
authority, and specific authority to impose progressive
restrictions on activities and capital. This authority could be
modeled on the Federal Reserve's authority over bank holding
companies under the Bank Holding Company Act.
Second, any such legislation should include requirements
for a minimum frequency of examinations, for certain types of
examinations (such as internal control examinations), and for
the Commission to apply progressively more significant
restrictions on an institution's operations as its capital
adequacy falls.
The FDICIA ``prompt corrective action'' capital categories
would not be appropriate for CSEs in their precise form because
the businesses of a broker-dealer and a bank differ in ways
that make it inappropriate to impose exactly the same capital
requirements. For example, a bank uses insured deposits from
customers to make illiquid loans. A commercial bank's capital
requirement is based on a percentage of the bank's assets,
which includes those loans. In contrast, a broker-dealer must
reserve 100% of customer cash at a bank and also supplement the
reserve account with its own cash. A broker-dealer cannot use
customer cash to fund its business. Only with appropriate
consent from customers can either a bank or a broker-dealer
lend customer securities.
Similarly, the ``least cost resolution'' requirement in
FDICIA would not be appropriate for a broker-dealer, or
bankruptcy-eligible institution such as a bank holding company
or an investment bank holding company. The ``least cost
resolution'' requirement is directed at constructing an FDIC-
managed resolution of a failed bank in a manner that will be
least costly to the FDIC's deposit insurance fund and
potentially to taxpayers. The analogous regulated affiliate of
an investment bank holding company, the registered broker-
dealer, is already covered by a statutory regime, the
Securities Investor Protection Act, which addresses the
financial failure of broker dealers, and protects customers
whose money, stocks, and other securities are either stolen by
a broker or put at risk when a brokerage fails for other
reasons.
A statutory mechanism for the resolution of systemically
important institutions would be valuable and would provide
predictability and certainty to the markets. FDICIA also
provides an exception to the restrictions on federal
intervention for situations involving systemic risk affecting
the financial marketplace. Under FDICIA, such a finding
requires a two-thirds vote of the FDIC's and the Federal
Reserve 's boards of directors and concurrence by the Secretary
of the Treasury after consultation with the President. A
similar framework (involving the relevant investment bank
regulators) would be necessary to prevent a systemically
important institution from declaring bankruptcy.
IMPACT OF BANKRUPTCY FILING BY BEAR STEARNS
Chairman Cox, it has been suggested that allowing Bear
Stearns to file for bankruptcy could have triggered a much
larger and more severe financial crisis. Since bankruptcy was
not an option, and no firm was willing to buy Bear Stearns on
its own, a Federal bailout was the only viable alternative left
to regulators. The purpose of the bankruptcy code, however, is
to provide an orderly process for the liquidation of firms.
Q.2. Would you please explain what would have happened if Bear
Stearns had filed for bankruptcy and whether you believe a
bankruptcy filing would have triggered a larger crisis? Would
the same outcome occur today if another major investment bank
filed for bankruptcy?
Does the Bear Stearns example mean that a major investment
firm cannot file for bankruptcy without triggering a financial
panic? If so, do we need consider whether a specialized process
is needed for the liquidation of such firms?
A.2. Unfortunately, unlike a laboratory in which conditions can
be held constant and variables changed while the experiment is
repeated, in the social science of the market the selection of
one course of action forever forecloses all other approaches
that might have been taken. To better understand the potential
effect of the operation of the bankruptcy laws with respect to
a complex financial institution such as Bear Stearns, it is
important to highlight the different types of entities included
in the Bear Stearns conglomerate.
The Bear Stearns Companies, Inc., the publicly-traded
holding company registered with the Commission, has over 350
subsidiaries. These subsidiaries include broker-dealers
registered with the Commission, futures commission merchants
registered with the CFTC, foreign regulated financial firms,
and unregistered U.S. and foreign entities including
unregistered over-the-counter derivative trading entities. An
entity such as Bear Stearns that decides to file for bankruptcy
protection has numerous options concerning which entities may
be included in the bankruptcy petition. For example, the
holding company and certain unregistered affiliates may file
for bankruptcy under Chapter 11. However, a registered broker-
dealer with customers is not eligible to file under Chapter 11
but rather is governed by other statutory provisions (e.g. the
Securities Investor Protection Act).
A bankruptcy filing by one or more of the Bear Stearns
entities would have triggered immediate action by Bear's
counterparties in securities and financial transactions. While
a bankruptcy filing generally is designed to maintain the
status quo by imposing an automatic stay on all efforts by
creditors to recover their claims against the debtor to give
the debtor time to resolve its financial difficulties, the
Bankruptcy Code excepts commodity, forward, and securities
contracts; repurchase agreements; swap agreements; and master
netting agreements from the operation of the automatic stay.
Consequently, Bear Stearns holding company counterparties could
have exercised their rights with respect to any collateral
securing their transactions if Bear Stearns had failed to
satisfy its obligations to those counterparties.
In addition, in the case of these financial transactions
and agreements, the Bankruptcy Code permits enforcement of
contractual provisions that are triggered by an insolvency or
bankruptcy filing (so-called ``ipso facto'' clauses),
immediately permitting any counterparty to liquidate,
terminate, or accelerate securities and financial transactions.
If Bear Stearns filed for bankruptcy, its counterparties likely
would have begun liquidating repurchase agreements and other
collateral held to securitize those open positions, leading to
further difficulties for the markets and possible liquidity
problems for other firms.
These consequences are not limited to broker-dealers, but
would affect any large financial institution dealing in these
types of contracts, including banks.
This is not to say, however, that under no circumstances
could a major investment firm use the bankruptcy laws without
triggering a crisis. The events at Bear Stearns occurred during
a time of pre-existing widespread market stress. Any future
circumstance in which a major financial firm were to face
bankruptcy would have to be judged in the context of then-
current market conditions. Moreover, since the Bear Stearns
sale, the SEC and other financial markets supervisors in the
U.S. and around the world have already taken steps to modify
their approach to investment bank liquidity risk management, as
well as broader problems in the credit markets that were
understood to have contributed to the subprime crisis.
CSE PROGRAM
Q.3. Chairman Cox, would you please provide an overview of the
nature and scope of your oversight of investment banks under
the SEC's Consolidated Supervised Entities program? How many
regulators do you have assigned to monitoring each investment
bank? What type of financial reporting do you require?
A.3. Since 2004, through our voluntary consolidated supervised
entities (CSE) program, the Securities and Exchange Commission
has supervised Bear Stearns, Goldman Sachs, Lehman Brothers,
Merrill Lynch, and Morgan Stanley at both the holding company
and regulated entity levels. The program entails monitoring for
firm-wide financial and other risks that might threaten the
regulated entities within the CSE, especially the US. regulated
broker-dealer and their customers and other regulated entities,
here and abroad. Prior to the Bear Stearns sale, the SEC
required that firms maintain an overall Basel capital ratio at
the consolidated holding company level of not less than the
Federal Reserve 's 10% ``well-capitalized'' standard for bank
holding companies. Since that time we have further tightened
both capital and liquidity standards. CSE firms provide monthly
Basel capital computations to the SEC. The CSE rules also
provide that an ``early warning'' notice must be filed with the
SEC in the event that certain minimum thresholds are breached
or are likely to be breached.
Even prior to the experience with Bear Stearns, the SEC's
supervision of investment bank holding companies has always
recognized that capital is not synonymous with liquidity--and
that more is required to determine a firm's financial health.
For this reason, the CSE program requires substantial liquidity
pools to allow firms to continue to operate normally in such
environments. Prior to the Bear Stearns sale, CSEs were
required to maintain funding procedures designed to ensure that
the holding company has sufficient stand-alone liquidity to
meet its expected cash outflows in a stressed liquidity
environment where access to unsecured funding is not available
for a period of at least one year. Since then, the SEC has
further strengthened the liquidity requirements based on
scenarios that contemplate significant impairment of access to
secured funding as well.
The Commission's CSE program supervises holding companies
in a manner similar to the ``Federal Reserve 's oversight of
bank holding companies. In addition to monthly computation of a
capital adequacy measure consistent with the Basel II Standard
and maintenance of substantial amounts of liquidity at the
holding company, CSEs are required to document a comprehensive
system of internal controls which are subject to Commission
inspection. Further, the holding company must provide the
Commission on a regular basis with extensive information
regarding its capital and risk exposures, including market and
credit risk exposures.
The CSE program provides prudential holding company
supervision that augments the oversight of regulated
affiliates. Specifically, regulated broker-dealers are
supervised both by the SEC and the primary self-regulatory
organization, FINRA, which devotes a large amount of resources
to overseeing the broker-dealers that are the core regulated
entities within the CSE groups. This extensive supervision of
the regulated entities in addition to the holding company is
akin to bank supervision at the depository institution level as
well as the holding company level. That is, the oversight of
the registered broker-dealer is based on regulation at the SEC
and SRO (such as FINRA) level, backed by examinations and
enforcement. The oversight of the CSEs at the holding company
level is similarly based on rules that incorporate principles
of prudential oversight, backed by ongoing monitoring and
examinations. Similarly, bank and insurance company affiliates
are subject to functional regulation by the respective
supervisors.
The specific elements of this supervision include:
At least monthly review of:
Consolidated capital adequacy measures
computed under the Basel Accord;
Liquidity measures computed under liquidity
guidelines developed by the firm and approved by the
Commission; and
Credit and market risk measures computed using
methods developed by the firm and approved by the Commission.
At least quarterly review of consolidating
financial statements that provide insight into the activities,
measured by balance sheet usage and revenue production,
conducted in unregulated affiliates.
At least quarterly meetings with corporate
treasury to monitor, inter alia:
The liquid assets available to the holding
company, namely those held at the parent and not in regulated
entities, and the nature of the funding supporting the assets;
The funding model used to determine the amount of
long-term debt and equity necessary to support the balance
sheet, including the schedule of ``haircuts'' for different
types of balance sheet assets; and
The impact on the firm of a liquidity stress
scenario, intended to reflect the impact of both firm-specific
and market events on the liquidity of the holding company.
At least quarterly meetings with financial
controllers at each firm to monitor, inter alia:
Significant profit and loss (P&L) events at the
desk level, including large losses, large gains, and large
variances with prior quarters;
P&L for non-trading businesses such as investment
banking and retail brokerage;
Significant accounting policy changes, especially
those related to mark-to-market accounting; and
The mark-to-market review process.
At least monthly meetings with market and credit
risk managers at each firm to monitor, inter alia:
The firm's market risk profile, as reflected by
VaR and other market risk measures;
Validation of exposure measures through
comparison of ex ante risk measures with realized profit and
loss;
Risk limits, usage of limits, and related
governance issues;
Concentrated credit risk exposures, and related
governance issues; and
Analysis of historical and theoretical scenarios
intended to capture the impact of low-probability but severe
events.
At least quarterly meetings with the internal
auditors at each firm to monitor, inter alia:
Evolution of the audit plan throughout the year
as projects are added or deferred;
Resolution, or escalation to the Audit Committee
of the board, of significant audit findings; and
Detailed discussions of selected audits,
typically those with implications for risk governance.
Targeted on-site inspections to test whether the
firm robustly implements its documented policies and procedures
with respect to, inter alia:
Operational controls, including transaction
processing and risk measurement systems, applicable to
products booked in unregulated legal entities;
Marking to market of complex and less-liquid
positions;
Consolidated capital computations; and
Anti-money laundering.
Topical reviews of businesses, activities, risk
models, products and other topical issues as warranted by
market developments, corporate acquisitions, and regulatory
initiatives.
The SEC has 25 staff persons in the CSE program with a
range of backgrounds including financial analysts,
statisticians, economists and lawyers. The size of the program
has risen as the complexity and range of supervisory activities
has grown, and further expansion is currently underway. As part
of the Commission's FY 2009 budget request, the Commission is
on the path to increasing by 60 percent the number of staff
assigned to the CSE program.
REGULATORY RELIEF
It has been reported that as a condition for purchasing
Bear Stearns, regulators promised JPMC certain regulatory
relief, including SEC no-action letters and forbearance on
capital requirements.
Q.4. Would you please list any and all regulatory relief your
agency or department has agreed to provide JPMC in connection
with its merger with Bear Stearns?
A.4. On Sunday, March 16, 2008, JPMorgan Chase contacted SEC
staff about relief and guidance that they sought in furtherance
of a possible deal. To assist in advancing a possible
transaction, the SEC staff was able to provide several letters
clarifying the staffs position on certain matters connected
with the merger.
Specifically, the Division of Trading and Markets wrote a
letter addressing the timing of JPMorgan 's filing of a Form BD
with the SEC. The Division of Investment Management wrote two
letters concerning issues under the Investment Company Act and
Investment Advisers Act arising out of the change in control of
investment advisers affiliated with Bear Stearns. The Division
of Corporation Finance wrote a letter addressing sales by
client accounts managed by JPMorgan and Bear Stearns of the
other firm's securities, in view of the control relationship
created by the merger agreement. The Division of Enforcement
wrote a letter concerning investigations and potential future
inquiries into conduct and statements by Bear Stearns before
the public announcement of the transaction with JPMorgan. The
staff declined to provide assurances about possible future
enforcement actions, or to provide relief on capital
requirements.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING FROM
CHRISTOPHER COX
Q.1. Are there functions or transactions that have developed in
our financial system today that are so essential that we need
to update regulations or protections to ensure they do not
fail?
A.1. The complexity and interconnectedness of financial markets
is both a source of strength and an area of concern. It is
therefore a key responsibility of the SEC and every regulator
to update regulations and protections to keep pace with changes
in the marketplace. Doing so is a process and not a result, so
at all times the Commission and other financial regulators must
review our existing statutes and rules to determine how well
the existing framework applies in the current financial
marketplace.
One recent example where financial supervisors have been
concerned is the proliferation of over-the-counter derivatives
and their potential destabilizing effect on the markets and
market participants. The SEC and the Federal Reserve Bank of
New York are cooperating on an initiative to improve the
clearance and settlement processes as well as documentation of
OTC derivatives. Improvement in these areas is an important
first step in reducing risk in this space.
Q.2. Chairman Cox, can you elaborate on the point in your
testimony that we need to put in place methods for resolving
problems in troubled investment banks?
A.2. I believe that a statutory mechanism for the resolution of
systemically important institutions would be valuable and would
provide predictability and certainty to the markets. Such a
statutory framework should provide for a mandatory consolidated
supervision regime for investment banks and adopt, where
appropriate, applicable concepts from Federal Deposit Insurance
Corporation Improvement Act (``FDICIA'') to govern the
resolution of any future financial problems at an investment
bank holding company.
Legislation to explicitly authorize the Commission's
authority current voluntary program for supervision of
consolidated supervised entities (``CSEs'') should strengthen
the oversight regime by providing the Commission statutory
examination authority, capital setting and monitoring
authority, and specific authority to impose progressive
restrictions on activities and capital. This authority could be
modeled on the Federal Reserve's authority over bank holding
companies under the Bank Holding Company Act.
Second, any such legislation should also borrow certain
applicable elements from FDICIA. These could include
requirements for a minimum frequency of examinations, for
certain types of examinations (such as internal control
examinations), and for the Commission to apply progressively
more significant restrictions on an institution's operations as
its capital adequacy falls.
Q.3. What role do you think elimination of the ``uptick'' rule
played in the demise of Bear Stearns, and in market turmoil
generally? Are you reevaluating that rule change in light of
recent events?
A.3. With respect to Bear Stearns, specifically, we have yet to
find any evidence that the lack of an uptick rule contributed
to its collapse. A high level of short selling in Bear Stearns
was likely even if the uptick rule was in place.
By way of background, last year the SEC repealed Rule 10a-
1, the rule that required that short sales on exchanges occur
in an upward market. Before we made this change, the Commission
engaged in a multi-year pilot program to test the effects of
the uptick rule, in which the rule was lifted for all trades in
about 1,000 stocks. The results of a study of this pilot
conducted by SEC economists, as well as studies conducted by
several academics, showed that removal of the uptick rule did
not significantly affect market quality.
A number of observers have subsequently called for
reinstatement of the short sale rule because they believe that
its repeal has contributed to increased market volatility.
Others have cited its repeal as a contributing factor to the
trouble facing securities firms. These concerns are misplaced
for at least two reasons. First, volatility has increased in
foreign markets as well as domestic. These foreign markets did
not see a change in their short-selling rules, suggesting the
increase in market volatility has causes unrelated to the
elimination of the uptick rule. Second, the uptick rule was not
an effective barrier to short selling, even when the price of a
security was declining, because today's equity markets trade in
pennies.
Questions regarding the 2004 ``Alternative Net Capital
Requirements for Broker-Dealers That Are Part Consolidated
Supervised Entities'':
Q.4. Please evaluate what impact the 2004 rule change had on
the collapse of Bear Stearns. In that evaluation, please
compare and contrast how Bear Stearns would meet regulatory
capital requirements under the alternative method and the
traditional method. If possible, please provide the data
quarterly since the rule was implemented, as well as a similar
comparison for the other four large investment banks.
A.4. The simple answer is that The Bear Stearns Companies, Inc.
was not subject to any consolidated capital requirement. Prior
to 2005, the Commission supervised the capital of only the
registered broker-dealer affiliates of The Bear Stearns
Companies Inc, and did not supervise the capital of the entity
as a whole. When Bear Stearns' application to become a
consolidated supervised entity (CSE) was approved by the
Commission in 2005, the holding company was for the first time
required to compute capital based on the Basel Standard and to
maintain a ratio of regulatory capital to risk-weighted assets
of no less than 10 percent. Thus the Alternative Net Capital
rule resulted in the imposition of a new capital requirement,
and the imposition of a significant monitoring regime
administered by the Commission that had never before existed.
For Bear Stearns' regulated broker-dealers, the alternative
net capital calculation did not reduce the actual amount of
capital. The same is true for the other CSE firms. In fact,
tentative net capital at many firms rose as a result of the new
requirements. While as a general matter, the alternative method
could reduce the position-based charges for market risk and
counterparty credit exposures as implicit recognition is given
for diversification effects, these potential reductions are
coupled with new requirements on liquid capital. Under the
alternative method, broker-dealers are required to hold a
minimum of $1 billion in tentative net capital, defined as
capital less deductions for illiquid assets. They are similarly
required to formally notify the Commission in the event that
tentative net capital falls below a $5 billion early warning
threshold, imposing a de facto $5 billion standard. Finally,
for practical purposes, the minimum net capital requirement for
the CSE broker-dealers using the alternative method of
computing net capital is 2% of aggregate debit items. As a
result of this balance of requirements, the minimum required
capital of the major broker-dealers was not reduced when they
joined the CSE program.
Q.5. Please explain why in the cost benefit analysis of
adopting the rule, the Commission considered the benefit the
broker-dealers would receive from lower capital charges, but in
the cost analysis the Commission failed to consider any
possible cost for the increased systemic-risk from reducing the
capital requirements for the large broker-dealers.
A.5. As stated above, the rule did not reduce the minimum
required capital.
The risks to the broader market in connection with Bear
Stearns arose not from the alternative method for calculating
net capital at the regulated broker-dealer, but from the loss
of access by the parent firm, The Bear Stearns Companies, Inc.,
to the secured financing market. This sudden loss of liquidity
by a major financial firm posed potential risks to Bear
Stearns' counterparties and threatened to more broadly shake
market confidence in the overall U.S. financial system.
It should be added that the net capital rules are designed
to preserve investors' funds and securities in times of market
stress, and they served that purpose in this case. This
investor protection objective was fully met by the current net
capital regime, which--together with the protection provided by
the Securities Investor Protection Corporation (SIPC) and the
requirement that SEC-regulated broker-dealers segregate
customer funds and fully-paid securities from those of the
firm--fully protected Bear Stearns' customers without creating
any new systemic risks.
Q.6. Please explain why the Commission amended the definition
of Tentative Net Capital to include securities for which no
ready market existed. Please evaluate what impact that decision
had in causing Bear Stearns to fail.
A.6. In 2004, the Commission promulgated rules to implement its
alternative net capital requirements for broker-dealers that
are part of consolidated supervised entities \1\ to allow
certain broker-dealer \2\ to include as part of their tentative
net capital certain securities that have no ``ready market.''
The amendments allow broker-dealer subsidiaries of CSE firms to
calculate market and credit risk charges using internal models,
such as value-at-risk (``VaR'') for market risk and potential
future exposure for credit risk. These amendments also modified
the definition of tentative net capital for the broker-dealers
that are part of a consolidated supervised entity to allow them
to use a different methodology to determine whether a security
has a ``ready market'' for purposes of the net capital rule.
---------------------------------------------------------------------------
\1\ See Exchange Act Release No. 49830, Jun. 8, 2004 (69 FR 34428,
Jun. 21, 2004).
\2\ This treatment is open only to those broker-dealers that apply,
and are approved, to calculate net capital in accordance with Appendix
E to the Net Capital Rule. As of May 15, 2008, there are six broker-
dealers approved to calculate net capital in accordance with Appendix E
to the Net Capital Rule. Broker-dealers approved to calculate net
capital in accordance with Appendix E must maintain at least $1 billion
in tentative net capital, and must immediately notify the Commission if
their tentative net capital falls below $5 billion.
---------------------------------------------------------------------------
The 2004 amendments did not eliminate the ``ready market''
test for allowable assets. Rather, they subjected less liquid
positions included in tentative net capital to market and
credit risk charges, as well as to additional market risk
charges above and beyond value-at-risk where warranted. Only if
the broker-dealer is able to demonstrate to the staff that its
models adequately capture the material risks associated with
those positions may the broker-dealer include a portion of
those positions after appropriate charges. If a broker-dealer
is unable to make such a demonstration, it cannot include those
securities as part of its tentative net capital.
The staff of the Division of Trading & Markets believes
that the run on Bear Stearns was unconnected to the nature of
assets held in the broker-dealer, and that the changes to the
broker-dealer net capital standards permitted by the 2004 rule
changes played no role in Bear Stearns' financial distress.
------
RESPONSE TO WRITTEN QUESTIONS OF CHAIRMAN DODD FROM ROBERT
STEEL
Q.1. Does the Treasury intend to conduct a study of what
happened at Bear Stearns, with lessons learned?
A.1. In March, members of the President's Working Group on
Financial Markets (``PWG'') issued a comprehensive review of
policy issues related to recent financial market turmoil. The
PWG recommended measures to reform mortgage origination,
strengthen risk management, enhance disclosure and improve
market discipline in the securitization process, and reform
disclosure and use of credit ratings. When implemented, these
recommendations will change behavior and strengthen our markets
through greater risk awareness, enhanced risk management,
strong capital positions, prudent regulatory policies, and
greater transparency. The PWG has committed to measuring
progress by the end of this year, so as to ensure the
implementation of these recommendations.
Treasury remains prepared to work with you or your staff on
specific questions related to the Bear Stearns acquisition.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM ROBERT
STEEL
REGULATORY RELIEF
It has been reported that as a condition for purchasing
Bear Stearns, regulators promised JPMC certain regulatory
relief, including SEC no-action letters and forbearance on
capital requirements.
Q.1. Would you please list any and all regulatory relief your
agency or department has agreed to provide JPMC in connection
with its merger with Bear Stearns?
A.1. The Treasury Department has not agreed to provide
regulatory relief to JPMC in connection with its acquisition of
Bear Stearns. We understand that the independent bank
regulators, including the Office of the Comptroller of the
Currency, have provided such relief, but we cannot speak on
their behalf.
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RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING FROM ROBERT
STEEL
Q.1. If Bear Stearns, which was only the 5th largest dealer,
was prevented by the Fed from failing, will anyone be allowed
to fail?
A.1. It is not accurate to say that Bear Stearns was prevented
from failure. Bear Stearns shareholders experienced significant
losses, many Bear Stearns' employees will have to find other
jobs, and a company that has survived for 85 years will no
longer exist. Instead, the Federal Reserve's actions
facilitated the orderly acquisition of Bear Stearns so as to
promote more stable markets and minimize financial disruptions
beyond Wall Street. Our role at the Treasury Department was,
and continues to be, to minimize any impact on the real economy
and to support the independent regulators and their efforts to
enhance risk management practices for our financial
institutions and ensure our financial institutions are well-
capitalized.
Q.2. Are there functions or transactions that have developed in
our financial system today that arc so essential that we need
to update regulations or protections to ensure they do not
fail?
A.2. The current regulatory framework for financial
institutions is based on a structure that has been largely knit
together over the past 75 years. Moreover, it has evolved in
response to problems without any real focus on overall mission.
In order to address these shortcomings, Secretary Paulson
introduced Treasury's Blueprint for a Modernized Financial
Regulatory Structure on March 31st. This report outlines a
number of short, intermediate, and long-term improvements that
can strengthen the U.S. financial system. We at the Treasury
look forward to engaging with Congress on these
recommendations.
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RESPONSE TO WRITTEN QUESTIONS OF CHAIRMAN DODD FROM TIMOTHY F.
GEITHNER
Q.1. President Geithner, you testified that the New York
Federal Reserve Bank, ``began to explore ways in which [it]
could help facilitate a more orderly solution to the Bear
situation. [It] did not have the authority to acquire an equity
interest in either Bear or JPMorgan Chase.'' Do you feel that
the Federal Reserve Bank should have the authority to acquire
equity interests in private companies?
A.1. The potential benefits of providing the Federal Reserve
with explicit authority to acquire equity interests in
financial institutions would have to be balanced against the
potential risk that such authority could raise expectations
about the probability of future intervention, thereby
contributing to moral hazard. We are in the process of
examining the adequacy of our existing authority and
instruments and are working closely with other supervisors to
examine the lessons we should draw from this episode. This
includes giving careful consideration to how best to adapt
supervisory policies and the overall supervisory and regulatory
framework, as well as the legal framework for insolvency and
liquidation of financial institutions, to address the
challenges we face going forward.
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RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM TIMOTHY F.
GEITHNER
SYSTEMIC RISK AFTER MERGER
Q.1. President Geithner, what impact will JPMC's merger with
Bear Stearns have on its capital levels and are you confident
that the merger will not expose JPMC to any liabilities that
could threaten its solvency? In other words, what assurance can
you provide that this merger will not produce a much larger
systemic risk by undermining the financial position of one of
the nation's largest banks?
A.1. JPMC remained well-capitalized (as defined in section
225.2 of the Board of Governors Regulation Y) following its
acquisition of Bear Stearns. Although there are significant
risks in this transaction, we believe that JPMC has the
capacity to manage those risks and to absorb any potential
losses that may result from the merger.
LESSONS LEARNED AND TOO BIG TO FAIL
We have heard the argument that Bear was ``too inter-
connected to allow to liquidate quickly''. This would appear to
be the case for a number of financial entities, including both
banks and non-banks.
Q.2. What changes in supervision or financial surveillance and
reporting could the regulators use to make such a situation of
``interconnectedness'' less likely to trigger the type of
resolution the Fed entered into with Bear?
A.2. The The President's Working Group on Financial Markets,
the Senior Supervisors Group and the Financial Stability Forum
have each recently issued reports aimed at identifying some of
the critical weaknesses in the system that were revealed by
this crisis. These reports also outline a range of
recommendations for making the global financial system more
resilient in the future. Included among those recommendations
are the following:
Strengthen the capacity of the core financial
institutions to withstand periods of severe stress by
increasing the size of the capital and liquidity buffers they
hold even during periods of robust growth and highly liquid
markets;
Strengthen risk management practices by enhancing
oversight and creating better incentives for firms to manage
their risk in a forward-looking manner that incorporates both
on and off-balance sheet exposures as well as the potential for
distress to be firm-specific or system-wide;
Improve the capacity of the system to absorb a
default by a major market participant by enhancing the
robustness of the market infrastructure, particularly in the
over-the-counter derivatives and repo markets; and
Increase the effectiveness of market discipline
by improving the disclosure practices of sponsors,
underwriters, and investors with respect to a range of
instruments including securitized and structured credit
products.
Our first and most--important priority continues to be
helping the economy and the financial system get through the
present crisis. Longer term, we will be working closely with
financial supervisors in the U.S. and abroad to advance the
objectives described above and strengthen the resiliency of our
financial system.
Q.3. Given that the Fed has pursued this transaction, how can
the Fed and perhaps the Congress now convince market
participants that something similar will not happen again? And
if we cannot convince market participants that is the case,
what is the implication for risk-taking behavior in the future?
A.3. Congress gave the Federal Reserve the responsibility and
the authority to act to promote financial stability. The
particular legal authority used to facilitate the Bear Steams
transaction has been used very sparingly by the Federal Reserve
over the last 75 years, and its use in this context was
motivated by the specific--and extraordinary--circumstances
that prevailed at that time. The fact that we found ourselves
in those extraordinary circumstances makes a compelling case
for undertaking a comprehensive reassessment of how we use
regulation to strike an appropriate balance between the
efficiency and dynamism of the financial system on the one hand
and resiliency and stability of the system on the other.
Achieving this balance will entail a mix of changes to our
regulatory policies--some of which are described above in my
response to your previous question as well as to our broader
regulatory structure and to certain aspects of our crisis
management framework. Policymakers in the U.S. and around the
world are actively engaged in the process of identifying and
implementing the necessary changes.
It is important to note that the actions we took in the
context of these extraordinary circumstances were designed to
protect the system in a way that minimized the ``moral hazard''
consequences of providing that protection. No owner or
executive or director of a financial institution would look at
the outcome for Bear Stearns and choose to see their firm
managed in such a way as to court a similar outcome.
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RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING FROM TIMOTHY
F. GEITHNER
Q.1. If Bear Stearns, which was only the 5th largest dealer,
was prevented by the Fed from failing, will you allow anyone to
fail?
A.1. Our decision to lend in connection with the acquisition of
Bear Stearns by JPMC was based on the systemic risk generated
by the confluence of a number of extraordinary factors,
including the rapidity with which Bear Steams' funding capacity
had eroded and the exceptionally fragile conditions that
prevailed in short-term funding markets at that time. Bear
Stearns, although smaller than the other major investment
banks, was a significant counterparty in these and other
critical markets. In our view, these extraordinary
circumstances meant that the disorderly unwinding of a major
market participant could likely trigger contagion and transmit
distress to a much wider range of markets and market
participants than just those directly connected to that firm.
The combination of the fragile state of markets and Bear's role
as counterparty in derivatives and secured funding markets
meant that a default would likely have caused very substantial
damage to the financial system and to the economy as a whole.
Substantial changes to our regulatory policies and
regulatory structure are needed. The Federal Reserve is working
in concert with the U.S. Treasury Department and supervisors
and regulators from around the world to improve the capacity of
our financial system to withstand stress, including the stress
that would occur in the wake of the failure of a major
institution. A description of some of the key elements that
should guide this process is provided in the response to your
second question below.
Q.2. Are there functions or transactions that have developed in
our financial system today that are so essential that we need
to update regulations or protections to ensure they do not
fail?
A.2. The U.S. financial system has long been one of the most
dynamic and innovative systems in the world. It is an ongoing
challenge for regulators and supervisors to keep abreast of the
innovation taking place, and to devise and adopt the right mix
of incentives and constraints to keep the system stable without
reducing that dynamism. As has been the case in past crises,
this episode has highlighted a number of areas in which
innovation outpaced market participants' understanding of the
risks, and the system became less transparent and more
vulnerable to acute instability. We have begun the process of
considering what set of changes to our regulatory and
supervisory framework are needed to enhance financial
stability. Our objective should be to preserve the dynamism of
our markets while also strengthening their capacity to
withstand stress. This will require changes to our regulatory
policies and our regulatory structure, as well as a careful
look at the set of crisis management tools at our disposal.
Among the changes that will be needed are: (1) a stronger set
of capital and liquidity ``shock absorbers'' in those
institutions that are critical to market functioning and the
overall health of the economy, with a stronger form of
consolidated supervision over those same institutions; (2) a
more robust financial infrastructure, especially in the
derivatives and repo markets; (3) a more effective mix of tools
to manage crises; and (4) a more streamlined regulatory
framework that provides the Federal Reserve System with the
right mix of authority and responsibility for promoting
financial stability and responding to systemic threats when
they arise.
Our first and most important priority continues to be
helping the economy and the financial system get through the
present crisis. In the longer term, we will be working to
advance the objectives described above, with the goal of
strengthening the resiliency of our financial system.