S. HRG. 111–179 REGULATION AND RESOLVING INSTITUTIONS CONSIDERED ‘‘TOO BIG TO FAIL’’ HEARING BEFORE THE COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS UNITED STATES SENATE ONE HUNDRED ELEVENTH CONGRESS FIRST SESSION ON REGULATING AND RESOLVING INSTITUTIONS WHOSE FAILURE WOULD POSE A RISK TO THE FINANCIAL SECTOR AND UNDERLYING ECON- OMY IN THE UNITED STATES MAY 6, 2009 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 53–822 PDF WASHINGTON : 2010 For sale by the Superintendent of Documents, U.S. Government Printing Office Internet: bookstore.gpo.gov Phone: toll free (866) 512–1800; DC area (202) 512–1800 Fax: (202) 512–2104 Mail: Stop IDCC, Washington, DC 20402–0001 VerDate Nov 24 2008 11:07 Jan 19, 2010 Jkt 000000 PO 00000 Frm 00001 Fmt 5011 Sfmt 5011 S:\DOCS\53822.TXT SHERYL 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 JIM BUNNING, Kentucky EVAN BAYH, Indiana MIKE CRAPO, Idaho ROBERT MENENDEZ, New Jersey MEL MARTINEZ, Florida DANIEL K. AKAKA, Hawaii BOB CORKER, Tennessee SHERROD BROWN, Ohio JIM DEMINT, South Carolina JON TESTER, Montana DAVID VITTER, Louisiana HERB KOHL, Wisconsin MIKE JOHANNS, Nebraska MARK R. WARNER, Virginia KAY BAILEY HUTCHISON, Texas JEFF MERKLEY, Oregon MICHAEL F. BENNET, Colorado EDWARD SILVERMAN, Staff Director WILLIAM D. DUHNKE, Republican Staff Director and Counsel AMY FRIEND, Chief Counsel DEAN SHAHINIAN, Senior Counsel MARK OESTERLE, Republican Chief Counsel DAWN RATLIFF, Chief Clerk DEVIN HARTLEY, Hearing Clerk SHELVIN SIMMONS, IT Director JIM CROWELL, Editor (II) VerDate Nov 24 2008 11:07 Jan 19, 2010 Jkt 000000 PO 00000 Frm 00002 Fmt 0486 Sfmt 0486 S:\DOCS\53822.TXT SHERYL C O N T E N T S WEDNESDAY, MAY 6, 2009 Page Opening statement of Senator Dodd ...................................................................... 1 WITNESSES Sheila C. Bair, Chairman, Federal Deposit Insurance Corporation .................... 3 Prepared statement .......................................................................................... 48 Response to written questions of: .................................................................... Senator Vitter ............................................................................................ 108 Gary H. Stern, President and Chief Executive Officer, Federal Reserve Bank of Minneapolis ...................................................................................................... 5 Prepared statement .......................................................................................... 56 Response to written questions of: .................................................................... Senator Vitter ............................................................................................ 112 Peter J. Wallison, Arthur F. Burns Fellow in Financial Policy Studies, Amer- ican Enterprise Institute ..................................................................................... 32 Prepared statement .......................................................................................... 80 Response to written questions of: .................................................................... Senator Vitter ............................................................................................ 114 Martin Neil Baily, Senior Fellow, Economic Studies Program, the Brookings Institution ............................................................................................................. 33 Prepared statement .......................................................................................... 91 Response to written questions of: .................................................................... Senator Vitter ............................................................................................ 116 Raghuram G. Rajan, Eric J. Gleacher Distinguished Service Professor of Finance, University of Chicago, Booth School of Business ............................... 35 Prepared statement .......................................................................................... 102 (III) VerDate Nov 24 2008 11:07 Jan 19, 2010 Jkt 000000 PO 00000 Frm 00003 Fmt 5904 Sfmt 5904 S:\DOCS\53822.TXT SHERYL VerDate Nov 24 2008 11:07 Jan 19, 2010 Jkt 000000 PO 00000 Frm 00004 Fmt 5904 Sfmt 5904 S:\DOCS\53822.TXT SHERYL REGULATION AND RESOLVING INSTITUTIONS CONSIDERED ‘‘TOO BIG TO FAIL’’ WEDNESDAY, MAY 6, 2009 UNITED STATES SENATE, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, Washington, D.C. The Committee met, pursuant to notice, at 9:05 a.m., in room SD–538, Dirksen Senate Office Building, Senator Christopher J. Dodd (Chairman of the Committee) presiding. OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD Chairman DODD. The Committee will come to order. Let me apologize to my colleagues and the witnesses as well. It was a late hour last night when we changed the schedule, but as I am sure my colleagues are aware, anyway, we are going to have about six votes beginning around 10:30 to try and finish up the housing bill. And, therefore, I thought we would try to move this up a half an hour so we could have at least a good hour and a half with you. I am going to ask my colleagues to restrain themselves, if they can, in opening statements so we can get right to the witnesses and hear their thoughts. Sheila, welcome. Nice to have you back before the Committee. Let me just share some opening comments. Senator Shelby has a meeting. He will be here shortly. He had something around 9:10, so he will be coming along. I am going to begin. Normally, of course, I would wait for my colleague from Alabama, but in light of the fact of the change in the time here, we are going to begin, anyway, on this. So let me share some opening thoughts on this subject matter, and then we will go right to the witnesses. This morning is the 13th in a series of hearings since January to identify causes of the financial crisis and specific responses that will guide the Committee’s formulation of the new architecture for 21st century financial services regulation. I welcome all of our wit- nesses. This morning, we are going to discuss regulating and resolving institutions whose failure would pose a risk to the financial sector and our underlying economy. To be sure, we meet at a moment when many of these so-called ‘‘too-big-to-fail’’ institutions are under a microscope, and for good reason. Consider for a moment the fol- lowing financial institutions: Bear Stearns, Fannie and Freddie, Lehman Brothers, AIG, Washington Mutual, Wachovia, Citigroup, Bank of America. Inside of 14 months, every one of these institu- tions either failed or posed a risk of failing absent Government (1) VerDate Nov 24 2008 11:07 Jan 19, 2010 Jkt 000000 PO 00000 Frm 00005 Fmt 6633 Sfmt 6633 S:\DOCS\53822.TXT SHERYL 2 intervention. Some were sold under duress; others failed outright. Many were saved because the Government resorted to an array of loans, guarantees, and capital injections to keep these large, com- plex financial firms afloat. But, regardless, the result of this turmoil is clear, with 20,000 layoffs and 10,000 homeowners entering into foreclosure each and every day. As this Committee works to modernize our financial ar- chitecture, I believe it is essential that we identify ways to give the Government the tools it needs to unwind troubled, systemically im- portant institutions in an orderly way that will put adequate safe- guards in place to prevent unwarranted risky behavior on the part of the largest market actors and puts our economy at risk. And I would commend the administration again for sharing my belief that the resolution authority be given to the FDIC, with whom the expertise of unwinding failed institutions clearly lies. To be sure, we have seen unprecedented consolidation in the banking industry over the last few decades. In 1992, the 25 largest insured depository institutions accounted for a quarter of banking industry assets. As of 2008, the top 25 held over 60 percent of in- dustry assets. Four U.S. bank holding companies now have over $1 trillion each in banking assets. At the same time the industry became increasingly consolidated, the institutions themselves became more interconnected, and as many of these failures have illustrated, their relationships with one another even more complex. The growth of the largely unregulated credit derivatives market and the ability to process transactions with increasing speed added to the unprecedented level of com- plexity as well. But it was the performance of our regulators, in my view, that spun this all out of control, allowing these financial institutions to take on more and more risk, more and more leverage, with far too much autonomy and far too little accountability. Essentially, regu- lators took our largest financial institutions at their word that they understood what they were doing, and clearly they did not. In fact, some had no idea at all. The question before this Committee today is how to prevent this from happening again and how do we create an architecture to allow for wealth creation and for productivity to be restored. Some have looked at the failure of many large, complex financial firms to manage their risks and the failure of regulators to ade- quately supervise them. They concluded that we