1 1 2 3 FINANCIAL CRISIS INQUIRY COMMISSION 4 5 Official Transcript 6 Hearing on "The Shadow Banking System" 7 Thursday, May 6, 2010 8 Dirksen Senate Office Building, Room 538 9 Washington, D.C. 10 9:00 A.M. 11 12 COMMISSIONERS 13 PHIL ANGELIDES, Chairman 14 HON. BILL THOMAS, Vice Chairman 15 BROOKSLEY BORN, Commissioner 16 BYRON S. GEORGIOU, Commissioner 17 HON. BOB GRAHAM, Commissioner 18 KEITH HENNESSEY, Commissioner 19 DOUGLAS HOLTZ-EAKIN, Commissioner 20 HEATHER H. MURREN, Commissioner 21 JOHN W. THOMPSON, Commissioner 22 PETER J. WALLISON, Commissioner 23 24 Reported by: JANE W. BEACH 25 PAGES 1 - 329 2 1 Session I; Perspective of the Shadow Banking System 2 HENRY M. PAULSON, JR., Former Secretary 3 U.S. Department of the Treasury 4 Session II: Perspective on the Shadow Banking System 5 TIMOTHY F. GEITHNER, Secretary, 6 U.S. Department of the Treasury 7 Former President, Federal Reserve Bank 8 of New York 9 Session 3: Institutions Participating in the 10 Shadow Banking System: 11 MICHAEL A. NEAL, Vice Chairman, G.E. and 12 Chairman and CEO, G.E. Capital 13 MARK S. BARBER, Vice President and 14 Assistant Treasurer, G.E. Capital 15 PAUL A. McCULLEY, Managing Director 16 PIMCO 17 STEVEN R. MEIER, Chief Investment Officer 18 State Street 19 20 21 22 23 24 25 3 1 P R O C E E D I N G S 2 CHAIRMAN ANGELIDES: Good morning. Welcome to 3 the second day of hearings by the Financial Crisis Inquiry 4 Commission. 5 As the members know and as the public know who 6 have been watching us, we have been exploring the shadow 7 banking system in this country and its effect on the 8 financial and economic crisis which has gripped this nation. 9 We have been focusing on the growth, development of this 10 system and the risks posed by it. 11 As we've said before, while there's significant 12 interest, obviously, in what was done to rescue various 13 financial institutions in the midst of the financial crisis, 14 the charge of this Commission is to examine the causes of 15 the crisis and to explore how risks to the system developed 16 in the first place, what could have been done, what should 17 have been done to prevent those risks from coming into 18 being. 19 We have a full day of hearing again today. 20 We are joined first of all this morning by former 21 Secretary of the Treasury, Henry Paulson. And really, with 22 no further ado, we will begin this hearing. 23 Unless, Mr. Chairman, you'd like to make an 24 opening remark also. 25 VICE CHAIRMAN THOMAS: No. I would just like to 4 1 say that yesterday was useful. Today has a real opportunity 2 to be useful. 3 I cannot recall in my four decades in which we 4 have two witnesses, both of whom were former secretaries of 5 the Treasury, one who had a background on Wall Street in one 6 of the major firms and the other secretary having a position 7 in the Federal Reserve in New York, so that we get a full 8 understanding based upon our ability to ask questions of 9 both sides of the street from two different perspectives 10 over a period of time which is obviously, as we now know in 11 retrospect, very significant in the history of the United 12 States. And so I look forward to the testimony. 13 Thank you, Mr. Chairman. 14 CHAIRMAN ANGELIDES: Thank you, Mr. Vice 15 Chairman. 16 And as the Vice Chairman indicated, we will start 17 today hearing from former Secretary Paulson. We will then 18 hear from Secretary of the Treasury Mr. Geithner. And then 19 we will have a panel later in the afternoon with 20 participants in the shadow banking system from GE Capital to 21 PIMCO to State Street Bank. 22 With no further ado, Mr. Paulson, thank you for 23 being here this morning. I'd like to ask you to stand for 24 what is a customary oath of office that we administer to 25 everyone who appears before us. 5 1 If you would please raise your hand as I 2 administer the oath. 3 Do you solemnly swear or affirm under penalty of 4 perjury that the testimony you are about to provide the 5 Commission will be the truth, the whole truth, and nothing 6 but the truth to the best of your knowledge? 7 Mr. Paulson. I do. 8 (Witness sworn.) 9 CHAIRMAN ANGELIDES: Thank you very much. 10 Mr. Paulson, we have received your written 11 testimony, and we appreciate it very much. And we would 12 like to ask you now to--we'd like to give you the 13 opportunity, and we'd like to obviously hear an oral 14 presentation by you. We've asked in consideration of the 15 time that you keep that presentation to no more than ten 16 minutes. 17 I know you're familiar with testifying up here on 18 the Hill so you probably know there's a light on that box 19 that goes to yellow with one minute, to red when time is up. 20 And if you'd make sure your mike is on, you may commence. 21 WITNESS PAULSON: Chairman Angelides, Vice 22 Chairman Thomas, and members of the Commission, thank you 23 for the opportunity to testify today. 24 I served as Secretary of the Treasury during the 25 recent financial crisis. I am proud of the work we in 6 1 government did to save our nation's financial system from 2 collapse and chaos and our economy from disaster. Even so, 3 the crisis caused human suffering that simply cannot be 4 measured. 5 The American people deserve, and policy makers 6 will benefit from, an understanding of the broad and diverse 7 causes of the crisis. The job of providing that explanation 8 falls to this Commission, and it is an awesome 9 responsibility. 10 Many mistakes were made by all market 11 participants, including financial institutions, investors, 12 regulators and the rating agencies, as well as by policy 13 makers. Most of these are well understood. And 14 importantly, policy makers are currently addressing some 15 major regulatory structure and authority issues that allow 16 the pre-2007 regulatory structure and authority issues that 17 either--excuse me. 18 Policy makers are currently addressing these 19 regulatory structures that either allowed the pre-2007 20 excesses in our system or made it difficult to address the 21 crisis. Nevertheless, a number of the root causes are not 22 being addressed and remain sources of danger to our country. 23 I fully support your important mission and I hope 24 that my testimony today can assist it. 25 The roots of the financial crisis trace back to 7 1 several factors, including housing policy, global capital 2 flows, over-leveraged financial institutions, poor consumer 3 protection, and an archaic and outmoded financial regulatory 4 system, among many other causes. Underlying the crisis was 5 a housing bubble. And it is clear that several policy 6 decisions shaped the home mortgage market. 7 Excesses in that market eventually led to a 8 significant decline in home prices and a surge of loan 9 defaults, which caused tremendous losses in the financial 10 system, triggered a contraction of credit, and put many 11 Americans quite literally out on the street. These excesses 12 were driven in large part by housing policy. 13 From 1994 to 2006 home ownership soared from an 14 already spectacular 64 percent of U.S. households to a 15 staggering 69 percent, due to the combined weight of a 16 number of government policies and programs. Fannie Mae and 17 Freddie Mac, the government sponsored enterprises, comprised 18 a central part of the U.S. housing policy. The GSEs 19 operated under an inherently flawed model of private profit 20 backed by public support, which encouraged risky revenue 21 seeking and ultimately led to significant taxpayer losses. 22 The United States has always encouraged home 23 ownership, and rightfully so. Home ownership builds wealth, 24 stabilizes neighborhoods, creates jobs, and promotes 25 economic growth. But it must be pursued responsibly. The 8 1 right person must be matched to the right house and 2 consequently the right home loan. And in the years before 3 the crisis we lost that discipline. 4 The over-stimulation of the housing market caused 5 by government policy was exacerbated by other problems of 6 that market. Subprime mortgages went from accounting for 7 five percent of total mortgages in 1994 to twenty percent by 8 2006. 9 Consumer protection, including state regulation 10 of mortgage origination, was spotty, inconsistent, and in 11 some cases non-existent. Speculation on rising home prices 12 led to increasingly risky loans, including far too many home 13 loans made with no money down. 14 Securitization separated originators from the 15 risk of the products they originated. Mortgage fraud 16 increased and predatory lenders and unscrupulous brokers 17 pushed increasingly complex mortgages to unsuspecting 18 borrowers. 19 The result was a housing bubble that eventually 20 burst in a far more spectacular fashion than most previous 21 bubbles. 22 Global forces also played a significant role in 23 causing the crisis. Imbalances in the world's economies led 24 to massive and destabilizing cross-border capital flows. 25 While other nations save, Americans spend.