Panel I of a Hearing of the Senate Banking, Housing and Urban Affairs Committee; Subject: Turmoil in U.S. Credit Markets: Examining the Recent Actions of Federal Financial Regulators

Statement

Panel I of a Hearing of the Senate Banking, Housing and Urban Affairs Committee; Subject: Turmoil in U.S. Credit Markets: Examining the Recent Actions of Federal Financial Regulators.

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SEN. JACK REED (D-RI): 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 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's not finger-pointing. It is the kind of after-action report that is owed to the American public since you're using their resources to stabilize this market.

We have, I think, a(n) 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 has that these markets are well-regulated and transparent. And if there's any question about the regulatory sufficiency or transparency, that makes us less competitive in the marketplace, and it doesn't help us -- doesn't help the taxpayers that are supporting these efforts.

Thank you, Mr. Chairman.

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SEN. JACK REED (D-RI): 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's an achievement in itself. And 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 be the biggest failing was a 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 the criteria you were applying -- criterion. Can you tell us why it was not a sound institution? And should the SEC have been aware of the shortcomings?

MR. GEITHNER: Let me just say it as carefully as I can. I was expressing my personal view. It's very hard to look back and know.

But all these facilities -- in all these facilities, as you think -- as you would expect, I think, we need to be very confident that we're lending to sound, prudent institutions. They're designed to respond to liquidity problems. And it's very hard to know, looking back, whether, given the way they're designed, they would have been powerful enough to help Bear navigate through these challenges. And I just want to say that it's not obvious to me -- and just my personal view -- that lending freely into the context of the accelerating pressures on Bear wouldn't have -- would have been a prudent act by the Fed.

SEN. REED: Was that, your conclusion --- I know it's a difficult one to make and it's 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, the primary regulator -- the SEC -- have been aware of these faults that you at least recognized, or potential faults?

MR. GEITHNER: Again, very exceptional conditions were facing markets, and everybody's 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 might lose your secured. And independent of the concerns that we've been seeing throughout the last nine months about the strength of individual institutions, we've seen a substantial withdrawal in the willingness of markets to finance -- arrange different types of collateral. So one thing that's 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 -- which is that in these markets, these things can happen incredibly quickly, just incredibly quickly. What you see in this is there was 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 and employees of that institution, they were in a position where they were more exposed to those risks.

SEN. REED: Let me follow up on another line of questioning the chairman raised, and that's the price, the initial stock price. And you indicated that -- 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, to taking the collateral and giving JPMorgan the $30 billion, was the function of a price that was, in your view, appropriate?

MR. GEITHNER: We did not set or negotiate the price.

SEN. REED: Did you suggest, if a price was raised, that it was excessive or the deal would not close, or did you in general indicate to them that -- 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 that initial Sunday night, which I think was the 16th, and the agreement reached a week later were in -- just to speak for myself -- in my judgment, fully consistent with those objectives.

SEN. REED: Let me -- Chairman Cox, one of the points you raised was this unusual and very rapid run-off of liquidity. Does that suggest to you market activity which was more than unusual, that might be manipulative?

MR. COX: Senator, we don't know the answer to that, but of course the Securities and Exchange Commission investigates market manipulation and we have --

SEN. REED: Are you conducting investigation now?

MR. COX: We have -- I'm 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 can't 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.

SEN. REED: Thank you, Mr. Chairman.

Chairman Bernanke, you indicated that this was not a bail-out of Bear Stearns, and at $2 rates of roughly $10, there's some persuasive force in your argument. But wasn't it a bail-out of the surviving investment banks? Because with -- I think the context of your discussions, your real fear was that -- Bear could fail, but that had to be the line of defense, that the others, if they fail, would be catastrophic, and that in fact your action was very calculated and conscious to prop up 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's true. But we felt that was necessary in the interest of the American economy.

SEN. REED: I don't dispute you. I think that's 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 not a -- this was routine action that wasn't designed to save some institution or prevent them from going in distress is not the most accurate characterization, that's my point.

Final point, Chairman Bernanke: You've got about $30 billion of collateral. And some comments have been made that you feel comfortable because it's 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, that 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's nothing close to the full amount. We do have collateral, and I would say a good bit of it is very highly rated.

SEN. REED: Thank you.

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