Senate Committee on Banking, Housing and Urban Affairs Holds Hearing on U.S. Credit Markets

CQ Transcripts Wire
Tuesday, September 23, 2008 2:38 PM







[*] DODD: Good morning, all of you. I thank my colleagues, thank our witnesses, those who are in attendance. This morning the committee will come to order.

And this morning we meet for a hearing on the turmoil of U.S. credit markets, recent actions regarding government-sponsored entities, investment banks and other financial institutions.

We want to welcome our distinguished witnesses here this morning. We thank the secretary of the treasury, Hank Paulson, who's here; the Honorable Ben Bernanke, of course, the chairman of the Federal Reserve; Christopher Cox, chairman of the Securities and Exchange Commission; and Jim Lockhart, the director of the Federal Housing Finance Agency.

The way we're going to proceed this morning is I'll make a brief opening statement, turn to my colleague from Alabama, Senator Shelby, a former chairman of the committee, to make his opening remarks.

And given the magnitude of this issue and the seriousness of it, I'm going to ask if my colleagues would like to make any brief opening comments quickly, and then we'll get to our witnesses.

My goal would be that we terminate the hearing sometime around noon, if we can. We all recognize the gravity of the situation, the importance of these witnesses to be able to get back and do the work they're doing.

So my hope would be that we try and move along. But, again, I want to give each of my colleagues a chance to at least say something at the outset of these remarks, but I -- I beseech you to try and keep them brief.

All of your full statements will be included in the record, and any supporting documents you care to include in the record will be there as well.

So with that admonition in mind, we'll try and make the opening rounds here about eight minutes apiece. That way we can get -- at least get a decent responses and time to ask questions.

And I'm not going to gavel down tightly, but try to keep it within that framework, if we can.

With that, let me share some opening thoughts this morning, and then I'll be turning to Senator Shelby.

The committee gathers this morning at an extraordinary and perilous moment in our nation's history. The landscape of our nation's economy has been radically reshaped by the United States government over the course of just a few days in a totally ad hoc manner, it would seem.

Companies that have formed the foundation of our financial markets are shrinking and disappearing practically overnight. Their insatiable appetite for risk in many cases has permeated all sectors of the financial services industry and has spread beyond our shores.

It has felled giants like Bear Stearns and Lehman Brothers, brought others to their knees like Merrill Lynch, AIG, Fannie Mae and Freddie Mac, prompted the largest, I might point out thrift failure in our nation's history, the Indymac bank, and eliminated the final two investment banks, Morgan Stanley and Goldman Sachs.

These drastic changes have reverberated far beyond the trading floors and boardrooms of corporate America. Across our great nation families are gathering around their kitchen tables each night, asking how they will weather this storm and how it will affect them very directly.

Hundreds of billions of dollars that Americans invested in retirement accounts and mutual funds have evaporated. Homeowners are watching the value of their homes plummet. Foreclosures are forcing 9,800 families from their homes each and every day in our country.

Families worry about how they will afford groceries and tax and gas -- gasoline. Six hundred thousand Americans have lost their jobs, while millions more have watched their paychecks shrink and their benefits wither away.

Perhaps the most dangerous consequence, the one that we don't speak enough about, in my view, of this economic maelstrom is that our collective confidence in our nation's future has been badly shaken. And that needs to be restored.

Less than six months ago our banking committee gathered in this very room to listen to the financial leaders of the Bush administration describe what at the time seemed an inconceivable event, the government's $30 billion intervention in the sale of Bear Stearns to JP Morgan.

Now, after spending hundreds of billions of dollars, more to prop up, bail out and wind down a multiple of -- multitude of institutions, the United States government effectively runs, supports or outright owns vast lots of the financial sector.

American taxpayers are angry, and they demand to know how we arrived at this moment and, more importantly, right now, how the architects of this economic landscape will put us back on a sound financial footing and restore American confidence and optimism.

As I and many members of this committee have argued for the past 17 months since I became chairman of this committee, the root cause of our economic crisis has been the collapse of a housing market triggered by what Secretary Paulson himself has called bad lending practices.

These are practices that no sensible banker should have engaged in -- and many did not, I might add -- reckless, careless and sometimes unscrupulous actors in the mortgage industry that allowed loans to be made that they knew hard-working, law-abiding borrowers would not be able to repay.

Financial regulators acted much too late and much too timidly. They failed to enforce the laws that Congress passed, requiring them to prohibit these bad lending practices.

What is tragic and lamentable is that the ensuing calamity was entirely foreseeable and preventable. This was no Act of God. It was not like Hurricane Hike -- Ike, rather.

It was created by a combustible combination of private greed and public regulatory neglect. And now we must confront the present crisis.

Barely 72 hours ago Secretary Paulson presented a proposal that he believes, and others do as well, is urgently needed to protect our economy.

This proposal is stunning and unprecedented in its scope and lack of detail, I might add. It would allow the secretary of the treasury to intervene in our economy by purchasing at least $700 billion of toxic assets.

It would allow the secretary to hold on to those assets for years and to pay millions of dollars to handpicked firms to manage those assets.

It would do nothing, in my view, to help a single family save a home, at least not up front. It would do nothing to stop even a single CEO from dumping billions of dollars of toxic assets on the backs of American taxpayers, but at the same time do nothing to stop the very authors of this calamity to walk away with bonuses and golden parachutes worth millions of dollars.

And it would allow the secretary and his successors to act with utter and absolute impunity without review by any agency or a court of law.

After reading this proposal, I can only conclude that it is not just our economy that is at risk, but our Constitution as well. Nevertheless, in our efforts to restore financial security to American families and stability to our markets, this Banking Committee has a responsibility to examine this proposal carefully and in a timely manner.

In my view, any plan to address this crisis must embody three principles. First, American taxpayers must have some assurance that their hard-earned money is being used correctly and responsibly.

Second, we must put in place proper oversight so that the executors of this plan are accountable and their actions are transparent.

And, finally, we must address the root cause of this crisis by putting an end to the rising number of foreclosures sweeping across our nation.

In the longer term it is clear that our economic circumstances demand that we rethink, reform and modernize supervision of the financial services industry. Certain basic principles should form the foundation for reform.

We need a leader in the White House who will ensure that regulators are strong cops on the beat and do not turn a blind eye to reckless lending practices.

We need to remove incentives for regulators to compete against each other for bank and thrift clients by weakening regulations. We need to ensure that all institutions pose a risk to our -- that pose a risk to our financial system and taxpayers are carefully and sensibly supervised.

And we need to accept the premise that consumer protection and economic growth are not in conflict with one another but inextricably linked.

If we learn nothing else from this crisis, it is that the failure to protect consumers can pause the collapse -- can cause collapse of our largest financial institutions, the loss of hundreds of thousands of jobs and the draining of hundreds of billions of dollars of wealth from hard-working Americans.

Today we're very fortunate to be joined, as I said at the outset, by Treasury Secretary Henry Paulson, Federal Reserve Chairman Ben Bernanke, S.E.C. Chairman Chris Cox and the director of the Federal Housing Finance Agency, James Lockhart. Regardless of how some may feel about the decisions these leaders have made and the impact they have had, we all ought to be able to agree they are good, talented, knowledgeable and experienced individuals, who I think want to do the best for our country.

And I agree as well that we need to move, and move quickly if we can, but I feel even more strongly that we need to move carefully and prudently and to make sure what we do is right.

I understand speed is important, but I'm far more interested in whether or not we get this right. There is no second act to this. There is no alternative idea out there with resources available if this does not work.

So it's critically important that we get it right. And the purpose of this hearing is to discuss whether or not this is the right approach and how we can prove it, if we need to.

Senator Shelby?

SHELBY: Thank you, Chairman Dodd.

This may be -- may be the most important hearing that this committee has conducted, at least in the 22 years I've been a member here.

SHELBY: Over the last 10 years, trillions of dollars were poured into our mortgage finance markets, often with the encouragement of well-intended government programs.

At first, the money backed conventional mortgages with standard down payments and properly verified incomes. Over time, however, the number of home buyers that met conventional loan requirements dwindled rapidly.

In order to fuel the upward spiral, mortgage products became more exotic, requiring less of borrowers and involving more risk.

Without regard for fiscal prudence and simple economics, bankers, investment bankers, mortgage brokers, realtors, home builders, mortgage bankers and home buyers created the conditions that helped inflate the housing bubble.

At the same time, Wall Street was developing ever more sophisticated financing vehicles to ensure that money continued to flow into the mortgage markets to meet the demand.

Mortgages were pooled, packaged and rated so-called investment grade by the credit rating agencies. They were then sold into a market eager to purchase securities with a wide range of risk and yields.

Many purchasers employed massive amounts of leverage, layering risk upon risk, in an effort to maximize return.

To cover their risk, many of the buyers also bought credit protection from one another, entering into derivatives contracts with nominal values in the hundreds of trillions of dollars.

All the while, our financial regulators appeared to be unaware as they sat on the sidelines.

As earlier as July of 2003, here at the Banking Committee, I asked Chairman Greenspan, then chairman of Federal Reserve, whether he was concerned about the growing number of loans to borrowers with weak credit histories and the number of homeowners who spent more than 50 percent of their income on housing.

I also asked him if he was concerned whether an economic downturn could lead to an increasing -- lead to increasing delinquencies and foreclosures. Chairman Greenspan, at this very committee, assured us that increasing home prices provided an equity cushion for mortgagors, and that lending to such borrowers would pose, quote, "a rather small risk to the mortgage market and the economy as a whole."

As recently as March of this year, Vice Chairman of the Federal Reserve Kohn, in testifying before this very committee, assured us that the banking system was, and I'll quote his words, "sound overall condition," and that losses, quote, "should not threaten their viability."

Now, we now know that was not the case. Eventually, economic reality caught up with our housing market, and housing prices stalled and then began falling. Many who bought homes with unconventional loans found that they were unable to afford their rising payments.

Because home values were dropping, they were unable to refinance and delinquency rates skyrocketed, as we all know.

Once homeowners began defaulting, the value of mortgage-backed securities plummeted. Collateralized debt obligations -- we call them CDOs -- that were comprised of the riskiest mortgage-backed securities became worthless.

As a result, financial institutions holding securitized assets have suffered enormous losses and have been desperately trying to raise new capital.

Of the five investment banks regulated at the beginning of the year by the Securities and Exchange Commission under its Consolidated Supervised Entities program, two have failed, one was forced to merge with a bank, and the remaining two have now left the program to become bank holding companies.

The recent demise of our investment banks lies in stark contrast to the vote of confidence we received in the Banking Committee from Chairman Cox in February of this year when he assured us that the CSE program was up to the task.

And I will now quote Chairman Cox. "The purpose," according to Chairman Cox, his words, "The purpose of the CSE program is to monitor for, and to act quickly in response to, financial or operational weakness in a CSE holding company that might place regulated entities or the broader financial system at risk. The commission," -- that is, the SEC, speaking of -- "seeks to ensure that the holding company has sufficient standalone liquidity and financial resources to meet its expected cash outflows in a stress liquidity environment for a period of at least one year." That was earlier this year.

In late 2007, Mr. Eric Sirri, head of market regulation for the Securities and Exchange Commission, described a consolidated, supervised -- supervision program that had, quote, "demonstrated its effectiveness during the current credit market difficulties." Nothing can be farther from the truth.

He likewise assured us that the SEC's consolidated supervision had achieved, quote, "the goal of reducing the likelihood that weakness within the holding company or an unregulated affiliate will place a regulated entity or the broader financial system at risk."

Notwithstanding assurances to the contrary, uncertainty about housing crisis and the value of mortgage-backed securities have brought our markets to a halt. We're now facing the most serious economic crisis, as Chairman Dodd said, in a generation.

So far, the Treasury Department and the Fed's response to the crisis has been a series of ad-hoc measures. First came the bailout of Bear Stearns, which we were told was unavoidable. Then came Lehman Brothers, which was allowed to fail. And then just last week, the Fed and Treasury organized the bailout of AIG.

I believe the absence of a clear and comprehensive plan for addressing this crisis has injected additional uncertainty into our markets and has undetermined (sic) the ability of our markets to tackle this crisis on their own.

Unfortunately, the Treasury Department's latest proposal continues, I believe, its ad-hoc approach, but on a much grander scale. The plan contemplates the purchase, as we know, of up to $700 billion in troubled, toxic mortgage-related assets from financial institutions that nobody would buy.

Treasury expects, but is not required, to purchase most assets through a type of reverse auction process. There are very few details in this legislation. In fact, Treasury officials admit that they will have to figure out the mechanics as they go along.

Rather than establishing a comprehensive, workable plan for resolving this crisis, I believe this legislation merely codifies Treasury's ad-hoc approach.

My hope is that this hearing will give us an opportunity to explore the parameters of the plan and why Secretary Paulson believes it will work.

I also hope to hear why the plan does nothing to address the root cause of the crisis, the rising default rate on mortgages.

While Wall Street banks get to sell their bad investments to the Treasury Department, homeowners will still be saddled with mortgages that they cannot afford.

My record is very clear on taxpayer-funded bailouts. I have long opposed government bailouts for individuals and corporate America alike. As a young congressman, I voted against the loan guarantees for Chrysler, I believe in '79 or '80.

However, if the government is going to get into the bailout business, shouldn't we also be focusing our resources on average Americans, the taxpayers, rather than sophisticated and well- compensated Wall Street bankers?

The Treasury's plan has little for those outside of the financial industry. It is aimed at rescuing the same financial institutions that created this crisis with the sloppy underwriting and reckless disregard for the risk they were creating, taking or passing on to others.

Wall Street bet that the government would rescue them if they got into trouble. It appears that bet may be the one that pays off.

Once again, what troubles me most is that we have been given no credible assurances that this plan will work. We could very well spend $700 billion or $1 trillion and not resolve the crisis.

Before I sign off on something of this magnitude, I would want to know that we have exhausted all reasonable alternatives. But I don't believe we can do that in a weekend.

Unfortunately, the incredibly accelerated process for considering this bill means that Congress does not have time to determine if there are better alternatives, or any alternatives, to the Treasury's plan.

I'm very concerned that the express need to pass something now may prevent us from devising a plan that would actually work. Without question, our markets and financial institutions need serious attention.

I do not believe, however, that we can solve this crisis by spending a massive amount of money on bad securities.

It is time for this administration and the Congress to do the work of devising, as quickly as possible, a comprehensive and workable plan for resolving the Congress -- this crisis, before we waste 700 to a billion dollars (sic) of taxpayers' money.

Thank you, Mr. Chairman.

DODD: Thank you, Senator Shelby.

Senator Johnson?

JOHNSON: Thank you, Senator Dodd.

This administration has asked Congress for the authority to buy up to $700 billion worth of residential and commercial mortgage- related assets from troubled Wall Street financial institutions. They are asking that this package have no strings.

In South Dakota, we believe strongly in personal responsibility. When you make mistakes, as many of these companies have, you should be held accountable for these decisions.

This package may be a necessary evil, but we cannot allow it to become a gift. It should have teeth with real oversight from -- from Congress. We should not use this package or American tax dollars to benefit foreign banks, and this package should contain limits on executive compensation.

People in South Dakota work hard for the taxes they send to Washington, and their earnings should not be wasted on the bloated compensation of a CEO.

Today, we need answers from the regulators as to how we got to this point and specifics about how our regulatory system failed us.

We also need to begin the dialogue between the regulators and this committee as to how to best change the regulatory structure so that this type of crisis does not happen again.

Our system needs good, effective regulation that balances consumer protection and allows for sustainable economic growth.

For years, many of these committees, and myself included, have been calling for just this sort of regulation. There should be no mistake that change is coming.

I look forward to working with the members of this committee to institute the changes needed to regulate and to guarantee responsible, modern regulatory system.

Please submit my full submit for the record.

DODD: Thank you, Senator.

Let me urge again, as I said at the outset, to try and keep these comments as brief as we can, so we can get to the -- the testimony.

I'm very grateful, by the way -- we've been working as a committee, by the way, many of us, over the weekend on a lot of this, and Senator Bennett and I have talked at length, and I thank him for those -- that participation.

Senator Bennett?

BENNETT: Thank you, Mr. Chairman.

We've had a housing bubble and the bubble has burst. And every time we have a bubble, whether it's housing or dot-com stocks, or anything else, when the bubble bursts, there is disaster.

And we will have bubbles in the future, because the human propensity to believe that the market will always go up is still there. Let's understand that.

The economy runs on credit. Credit is granted on confidence. And confidence is based on one of two assumptions -- the collateral is worth it, or the cash flow will be sufficient. One way or the other, the loan will be repaid.

What we're faced with now is finding a way to restore the confidence in the system so that credit can start to flow again. That's what we're here to try to do.

Thank you, Mr. Chairman.

DODD: Thank you, Senator.

Senator Reed?

REED: Thank you very much, Mr. Chairman. I have a written statement I'd like to submit for the record.

DODD: Included.

REED: I'd make several specific points.

The essence of the proposition that the administration is presenting to us today is that the taxpayers will assume the risk of disastrous investment decisions made by very highly compensated individuals and institutions on Wall Street.

I think the custom on Wall Street is when you assume the risk, it's because you get paid to do that. I believe it's essential that the taxpayers of this country are compensated for their assistance.

I think the only effective way to do that is a mandatory program of warrants, as a prerequisite to being -- participating in this assistance, for non-voting equity in the companies.

And as these companies improve, which is the hope and expectation of this program, the American taxpayers could also benefit from that improvement.

I think this also goes to a very difficult issue of pricing these securities -- that if the Treasury or its agents misprice the securities, and they overpay, presumably the benefits of that will flow to the companies and, frankly, with appreciated stock, again, I think taxpayers should benefit from that.

I think also, too, there's some discussion that if we do this, there'll be some limitation on participation, but I would suggest that might not be altogether a bad thing, that if this system could gain by people who are not desperately in need of government assistance that would be done.

REED: I think to present a company with a choice between surrendering warrants and participating or simply getting through on their own is not an unfair choice for sophisticated business manages who we presumably hope are dedicated to preserving their company and -- and benefiting their shareholders.

And, finally, I want to associate myself with the comments of the chairman and others, who say that we cannot simply assist Wall Street. We have to assist hundreds of thousands of homeowners, who are facing foreclosure.

With -- if we do not that -- don't do that, that will be, I think, unfair, and it will not result in a program that is legitimate I the eyes of the American people.

Thank you very much.

DODD: Very good. Thank you.

Senator Enzi?

ENZI: Thank you, Mr. Chairman.

In the past six months, our federal government has devised a dozen strategies to save America's financial markets. Each plan has been more costly, more risky, and less aligned with the principles of our country's free market economy than the last.

I am disappointed to say that this latest plan puts all the rest of them to shame. This proposal means a full-scale intervention of our country's free markets, with the Treasury buying every bad asset in sight with taxpayer money.

To make this point clear, if approved in its current form of $700 billion, this plan would cost every man, woman and child in this country approximately $2,300.

This plan will come with an enormous cost and enormous risk. Unfortunately, the only plan more costly would be doing nothing at all.

Last week I was given the legislative language for this proposal, and it was only three pages long -- $700 billion, three pages. I know that it's grown to six pages, and perhaps to 42 pages.

When I questioned Secretary Paulson and Chairman Bernanke about this plan on Sunday, they explained that flexible and broad authority was the only way the plan would work.

I was immediately reminded that the last time chairman and the secretary appeared before this committee and asked for such broad authority, it was to save Fannie Mae and Freddie Mac from insolvency this past summer.

I hope this time the plan is more successful. I have no illusions about the urgency of the problem our economy faces today, but Congress can't be expected to approve this bill without a guarantee of proper oversight and accountability for the taxpayer.

As I said before, we're talking about the equivalent of $2,300 from every U.S. citizen. This committee would not be doing its job, if that were allowed to happen.


Where is the accountability for these banks and their management? The Treasury and the Federal Reserve have asked us to cut them the biggest bailout check in history, and that money will be handed out to the same banks that put us in the mess to begin with.


Nowhere in the text of this bill do I see any equity sharing or loss mitigation that will protect taxpayers from unknown costs. It did make a difference to AIG stockholders, who are trying to pay off their loan already.

A treasury buy from our banks will be priced by the seller, not by the buyer. The federal government could end up owning mortgages that cost multiples of their resale value, and yet there's no recourse for our taxpayers.

It does not make any sense. It will reward the banks first, who got us in the financial mess, and the taxpayers second, many of whom were completely unaware that this kind of financial crisis was occurring...


DODD: I'm going to ask the audience. We'll have to clear this room. I don't want to do that. It's a public hearing. Let's have respect for the speakers, and there'll be no outbreak, applause or other comments. This is a serious hearing.


ENZI: I -- I have heard the argument that punitive or prescriptive measures could cause sellers to leave the market. I think that offends common sense. If banks can get a better price for their paper from someone other than Treasury, they shouldn't be bailed out in the first place.

If they choose to fail rather than sell their debt at its real market value and record the loss on the books, they should be free to take that option.

This legislation must be passed to help Main Street, not because the federal government is being held hostage by Wall Street.

I have some ideas. This committee must -- must find a way to make financial regulation more efficient, effective and accountable. I have some ideas, including a reevaluation of the market-to-market accounting. It's clear that such a method is not sustainable in a volatile market.

Providing some relief today could prevent firms from needing this expensive federal bailout. Reforms in the long term could prevent capitalization issues down the road.

Thank you, Mr. Chairman.

DODD: Thank you, Senator.

Senator Schumer?

SCHUMER: Thank you, Mr. Chairman. And thank you for holding this hearing.

My colleagues and fellow Americans, we live in amazing and dangerous times. Who would have thought that the lowly mortgage, long regarded as the safest of investments, could bring our financial system to its knees?

But that is where we are. And while we must look back and see what went so dramatically wrong, our immediate task is to look forward and to try and avoid a meltdown of the financial system.

And as we look forward in the week ahead, we face both a Scylla and a Charybdis, dangers on both sides. On the one hand, as we are reminded, there are real dangerous if we do not act.

The description Chairman Bernanke gave us when the leadership of the Democratic and Republican House and Senate met in Speaker Pelosi's conference room, the description Chairman Bernanke gave in quiet terms, without hyperbole, was astounding.

Chairman Bernanke told us that our American economy's arteries, our financial system, is clogged, and if we don't act, the patient will surely suffer a heart attack maybe next week, maybe in six months, but it will happen.

So we must act, and we must act soon. And make no mistake about it -- while Wall Street caused the problems we face, unfortunately, if we do nothing, Main Street will also pay a severe price.

Pension funds, money market mutual funds, 401-K plans will be negatively impacted. The lockdown in lending has widespread consequences.

I've heard from car companies that it's virtually impossible to get an auto loan right now unless you have a credit score over 720. And if that continues, the auto industry will sell six million fewer cars this year than it did in years past.

Even though the workers in Buffalo and Detroit and St. Louis are blameless, they will suffer. It's not fair. It's not right. But that's the world we live in.

So I want to assure the markets -- and I think I speak for all of us -- that we will not be dilatory. We will not Christmas tree this bill with extraneous amendments. And we will work in a bipartisan way to act, and to act soon.

But there is also the Charybdis, the other danger of acting so quickly that we choose a bad solution. The markets want action. We understand that.

But if we act so quickly that we create an ineffective solution without adequate safeguards, then we risk the plan failing, which would be an even worse outcome for the markets, for the economy, for our country.

Even on Wall Street, $700 billion is a lot of money. And none of the thousands of money managers would invest that sum without appropriate due diligence.

This hearing today and the discussions that will follow are is -- this hearing today and the discussions that will follow are our congressional due diligence. And we take that responsibility seriously and will make intelligent and relevant improvements.

Secretary Paulson has proposed his plan, the Troubled Asset Relief Program, or TARP, to Congress. And while I certainly recognize the need for action and want to move quickly, I think some changes are necessary.

To Secretary Paulson's TARP program, I need -- I believe we need to add THOR -- "T" for taxpayer protection, "H" for housing, "O" for oversight, and down the road, "R" for regulation.

I can talk about each of these at some length, but we don't have time, Mr. Chairman.

But on taxpayers we must put taxpayers first, should this program work. They must come ahead of bondholders, shareholders and executives, and we need to add to this legislation those types of protections, such as my colleague, Senator Reid, has spoken about in terms of warrants. That would be more of a mandatory than a optional nature.

Homeowners. Secretary Paulson has labored mightily to try to improve the homeowner problem. And Chairman Bernanke has said repeatedly until we find a floor to the housing market -- and foreclosures are directly related to the housing market -- we will not solve this problem.

And that effect -- not just those who made bad mortgages, or not this Joes who will lose their homes through no faults on their own, but every homeowner -- the number of foreclosures and the price of the average American's home is related and can't be separated.

Oversight. There have been lots of discussions of oversight led by Chairman Dodd, and there are excellent suggestions, and we must do them.

And "R" regulation. We must have a much better system of regulation, and many of us have begun thinking about this. It will probably have to wait till after we act here, but we must do it.

The bottom line, Mr. Chairman, is this. We do have to act, but we have to act smartly, wisely and relevantly. And I believe that's what this committee will do over the next few days.

DODD: Thank you very much, Senator.

Senator Hagel?

HAGEL: Thank you, Mr. Chairman.

The essence of our efforts and a final product is accountability, transparency and timeliness. We must define a rescue agreement based on the common interest of our country.

We have a responsibility to construct a program based on the general principles of agreement, not held hostages to the details of the differences.

We are in uncharted waters. We are living in a 21st century global marketplace. We are behind in not only understanding that, but regulating that. This is going to require a new 21st century regulatory regime.

But our current effort -- and we must stay focused on our current effort -- is a short-term rescue effort clearly in the interests of our country and the world. And it must be done. And it must be done with responsibility, but also with timeliness.

Mr. Chairman, thank you.

DODD: Thank you very much.

Senator Carper?

CARPER: Mr. Chairman, thank you.

Gentlemen, thank you very much for -- for joining us again here today.

I have a statement for -- for the record. What -- what I'd like to just mention -- I want to mention four things that I hope to take away from -- from this hearing today.

And the first of those is to better understand how we got into this mess. Chairman Cox and I were talking about short-selling yesterday. And I want to understand better the -- the role that the -- the debt played in getting us where we are today. I want to better understand how changing leverage ratios has gotten us to where we are today.

But I -- I want to know, when we walk out of here today, I want to have just a better understanding of how did we end up in this mess.

A second thing I hope to get out of this is -- is after understanding how we got into this mess, how do we get out of this mess, and how do we do so in a way that does not reward bad behavior from people who should not be rewarded for the bad behavior.

The third thing I'd like to take away with me today is to -- to have some assurance myself in the plan that we're discussing here or that -- that involves, that -- that we can make sure this kind of tragedy doesn't occur again in our lifetime and beyond.

And -- and finally, I -- I want to better understand how we maximize the chances that the Treasury will be made whole, or maybe even make a buck or two for the taxpayers at the end of -- of the day.

I mentioned in another meeting here on Capitol Hill this -- this morning -- I went back and recalled the bailout, at the time, of Chrysler, where the federal government did not provide loans to Chrysler, but provided loan guarantees issued in conjunction with warrants which were exercised.

We never had to -- to back up the loans, but we did have the opportunity to exercise the warrants. We made for the taxpayers on that deal.

When the S&L debacle occurred, we ended up with creating the Resolution Trust Corporation. The Resolution Trust Corporation, we will all recall, came in and bought not the -- the savings and loans, but what were deemed to be the bad assets of the savings and loans.

And as it turned out, a lot of them weren't bad assets. They were assets that -- whose value had diminished during that crisis, but assets that over the time appreciated in value. We were able to sell them and recover most of the taxpayers' money.

And my hope is as we go forward here, that we look to those two examples as a -- as a maybe a bit of a road map to enable us, while we find out how we got into this mess, how we get out of it, how we make sure it doesn't happen again, how we do all that without rewarding bad behavior, but at the end of the day, putting this much taxpayer money at risk -- at the end of the day, I'd feel a lot better if we had a pretty good -- pretty good assurance that when all is said and done, that we've actually recovered this money for our taxpayers.

And if we can make a buck or two at the end of the day, so be it. Thank you.

DODD: Thank you, Senator, very much.

DODD: I want to point out -- I turn to Senator Bunning -- it was two years ago that Senator Bunning, Senator Allard held a joint hearing on subprime mortgages, the conclusion of which Senator Schumer, Senator Reid, Senator Sarbanes, myself joined them in a letter to the regulators asking them what actions and steps they were going to take on the subprime mortgage problem.

Senator Bunning?

BUNNING: Thank you, Mr. Chairman.

So much has happened since the last time we had our witnesses before us that we could probably hold this hearing for a week and still have more to talk about. It's hard to even know where to begin.

Most pressing is the $700 billion Treasury proposal that is being negotiated with the chairman of the House Financial Services Committee. The Paulson proposal is an attempt to do what we so often do in Washington, D.C., throw money at a problem.

We cannot make bad mortgages go away. We cannot make the losses that our financial institutions are facing go away. Someone must take those losses.

We can either let the people who made the bad decisions bear the consequences of their actions, or we can spread that pain to others. And that is exactly what the secretary's proposal is to do, take Wall Street's pain and spread it to the taxpayers.

The plan has not even passed, and already Americans are paying for it because of the fall in the dollar as a result of all the new debt that we will be taking on.

I know there are problems in the financial markets, and I share a lot of the same concerns that other members and witnesses do. However, the Paulson plan will not fix those problems.

The Paulson plan will not help struggling homeowners pay their mortgages. The Paulson plan will not bring a stop to the slide in home prices. But the Paulson plan will spend $700 billion worth of taxpayers' money to prop up and clean up the balance sheets of Wall Street.

This massive bailout is not a solution. It is a financial socialism and it's un-American.

Thank you.

DODD: Good.

Senator Menendez?

MENENDEZ: Thank you, Mr. Chairman.

Certainly, in my 16 years in Congress, there hasn't been a more critical time for our economy and a more important Banking Committee hearing than this one.

The administration's economic and regulatory policy over the last seven years has led us to today. Now we have been told that we have less than seven days to make our choices and eight minutes to ask questions, so you'll forgive me if I'm not signing right away on the bottom line.

Unfortunately, the administration comes to the Congress at the final hour, instead of before, and in doing so leaves us with undesirable choices.

The credit crunch and the failing investment banks did not occur in a vacuum. At their core, they are about the housing foreclosure crisis, and that weakness was created by lax regulation, regulators asleep at the switch, and an unwillingness by many to acknowledge the direness of the situation early on.

In March of 2007, Mr. Chairman, in this committee, I raised the prospect of a tsunami of foreclosures in the Banking Committee, but the administration dismissed it.

A few months later, as foreclosures mounted, they assured us that the problems would be contained to the housing market.

And in July, we asked them about the prospect of a bailout of Fannie and Freddie, but they couldn't foresee it.

So how many times can the administration be wrong and still instill confidence?

This is why, while I need to know -- and I think we need to act, and I agree we need to act -- I am not going to be stampeded into rubber-stamping this proposal. There are serious questions that we need answers to before you have at least my vote.

Illiquid assets are illiquid either because they are non- performing, they are overvalued or, even worse, we don't even know what their true values are.

Questions range from are you intending to buy these bad loans at a significant discount, or will we be overpaying? If they are at a deep discount, how does that create the much-needed capital for their cash future and therefore solve the problem?

If Treasury is overpaying and working to create capital for the institutions, why aren't we getting equity, just as shareholders do, so that the taxpayers can recoup their money?

And as Treasury has amended their proposal for foreign entities to also be subject to this bailout, what are the central banks of those countries doing to establish and prop up their own institutions?

Why are we asked to put $700 billion to keep CEOs in their office while families get kicked out of their homes and the public gets the bill while this administration says it's all about Main Street?

We can't say that homeowners should bear all the consequences of bad decisions but that financial institutions get to share the pain of their bad decisions through public debt.

So, Mr. President, last -- Mr. Chairman, last week the president said, quote, "The risk of doing nothing far outweighs the risk of the package." But his statement inherently implies there is a risk involved, and with risk comes responsibility.

We need to quantify that risk. We need to limit taxpayer exposure. We need to work to keep families in their home as part of this effort. And therefore, I look forward to some honest answers here today.

The secretary's testimony, as seen -- as it's been presented to the committee, just reiterates the need.

Well, I hope we'll get to the answers as to how does he intend to have this work, and work in a way that limits the taxpayers' exposure, puts homeowners back in their home, and creates responsibilities by those who have -- believe that, you know, private risk can now become public debt.

DODD: Thank you, Senator.

Senator Crapo?

CRAPO: Thank you very much, Mr. Chairman.

I share many of the concerns and observations that have been made by my colleagues, so I won't restate all of them.

I do want to indicate, however, that I agree that this is probably the most critical threat to our economic circumstances in our country that we have faced since I've served in Congress, and one which has the type of urgency that requires us to take prompt action.

But I also share the sentiments that we must take the time to get it right. And I have a lot of the same concerns that others have shared about whether we have the right proposal or whether we need to continue to work through a refinement of it.

I have a number of questions. For example, as has been raised by some already today, how will these assets be priced?

If there is a market value that the holder or seller simply does not want to sell at, will the taxpayer be asked to buy them at a premium simply to help recapitalize those who are facing capital problems?

And if so, how will the taxpayer ever regain its investment in this circumstance if more than the assets are worth are paid for them?

In fact, that raises another very interesting question, and that is should the plan, if it -- if it does require a significant infusion of capital, should the plan be -- having the taxpayers purchase distressed assets, or should the plan involve the taxpayers gaining some type of ownership interest or some type of ability to come ahead of the shareholders in terms of the losses that are taken in the operations of the firms?

The question as to what type of investment or what type of -- of capitalization should take place is critical.

And I think that the basic bottom line here is that we must protect the taxpayers so that as losses must be taken, those losses are taken not by the American taxpayer but they are taken by those who have the ownership interests in the firms involved.

I have many, many other questions. But again, the bottom line to me is how do we make sure that the connection between Main Street and Wall Street is understood not only by America but by the policy makers here in this committee and in this Congress so that we address the issue in such a way that we make sure that the taxpayer is protected and that the markets are strengthened and reassured.

I think that Senator Schumer's comment about assuring the markets that we are going to be diligent and careful and prudent as we move forward is very helpful. I think the markets need to know that.

We also need to make sure that the markets know that we will be efficient and -- and careful and prudent in making sure that the solution we get is the right solution.

Thank you, Mr. Chairman.

DODD: Thank you, Senator, very much.

Senator Brown?

BROWN: Thank you, Senator Dodd, for calling today's hearing.

Thanks to the witnesses for joining us. They've had many long nights lately, and this may be a long morning. I make no apologies for that. I doubt they seek any.

Like my colleagues', my phones have been ringing off the hook. The sentiment from Ohioans about this proposal is universally negative. I count myself among the Ohioans who are angry. Had the federal government acted to contain the epidemic in subprime lending, I don't think we'd be sitting there today.

The time we spend this morning will be time well spent not just for our own benefit but for the benefit of the people we represent. I'm not sure they will be convinced, but they sure deserve a better explanation than they have received to date.

A man from Westerville, Ohio was so concerned he took a day off work and drove to Washington this week, a seven-hour drive, to share his views with me. He quite rightly asked why we're rushing to bail out companies whose leaders got rich by gambling with other people's money.

Here's another communication, and I quote, "The federal government must not prolong necessary corrections in the housing market, bail out lenders or subsidize irresponsible borrowing and lending at the expense of hard-working people who have played by the rules," unquote, except that statement didn't come from Ohio. It came from the Office of Management and Budget three short months ago.

Throughout this sorry chapter in our nation's financial history, the administration has shown extraordinary attention to the problems of Wall Street while, at times, showing hostility to rebuilding Main Streets across the country.

The statement I quoted above was from the administration's veto threat of the housing bill. Congress had the audacity to include $4 billion to rebuild neighborhoods devastated by the foreclosure crisis, but the administration didn't want to reward irresponsible borrowing and lending. Now it does.

But before we agree, there are many, many unanswered questions that Congress and the American people have a right to ask and that the administration needs to answer.

As Chairman Bernanke knows, the bank panic of 1933 started in Detroit and, in two weeks, spread to Cleveland. Two of the city's largest banks were shuttered and never reopened.

One had ties to my predecessor in this seat, Republican Marcus Hanna. Rumors flew that the bank's closure was a political decision. If we don't know the rules now, these types of rumors will be reborn.

Secretary Paulson, as much as I respect your judgment, you'll not be making the hundreds of individual decisions that this effort will require. As your colleague, Senator Kempthorne, has found, a lack of close supervision and adherence to rules can lead to disastrous results.

Many of the people who will be making these decisions as to the purchase of these troubled assets have come from Wall Street, and they may be returning to Wall Street. The notion that they can operate without clear guidelines is not just unfair to taxpayers, I think it's unfair to them.

So I hope this morning we go into considerably greater detail. I hope we can give Main Street a good bit more help and attention than we have to date. I think the taxpayers need to be protected.

And I think the leadership of these companies have to be held accountable. If any CEO hesitates to participate because of his or her narrow self-interest, his or her compensation, I'd say it's time to get a new CEO.

It's fine to say that people's 401(k) accounts may be affected. They will be if we do not act. But for most people, their home is their 401(k). WE need to help them as well.

Mr. Chairman, gas is expensive. I want that man from Westerville, Ohio to know that his time and his money were well spent.

DODD: Thank you very much, Senator.

Senator Dole?

DOLE: Mr. Chairman, I have very strong concerns that this rescue proposal will unfairly hold taxpayers responsible for the costly and reckless decisions of investment bankers on Wall Street.

I, like the North Carolinians I'm hearing from, am very skeptical of this proposal. And frankly, I'm extremely frustrated that we find ourselves in this position.

So much of what is happening with regard to the credit crisis, the housing slump, the bankruptcy and dissolving of major financial institutions can be linked to the mismanagement of Fannie Mae and Freddie Mac, which was made possible by weak oversight and little accountability.

Since arriving in the Senate, I have been one of a handful of members pushing for stronger oversight of Fannie Mae and Freddie Mac. I've helped introduce, as have Senators Chuck Hagel, John Sununu, Mel Martinez and Richard Shelby, legislation to strengthen oversight, and I've raised the issue in the Banking Committee hearings time and time again.

Unfortunately, Fannie and Freddie dispatched an army of lobbyists, reportedly spending more than $100 million, to gain protection in Congress and this committee to oppose our legislation.

As we know, one of my committee colleagues proclaimed in April 2005 that Fannie and Freddie have done, and I quote, "a very, very good job." It was only two months ago that our bill was finally included in the housing stimulus package, so it took five years to finally get appropriate action. This problem could have been resolved years ago.

DOLE: It is astounding that despite the years of widely publicized mismanagement at Fannie and Freddie, despite our group of United States senators sounding the alarm about the lack of oversight, despite Alan Greenspan in 2005 urging Congress to act, warning that we are placing the total financial system of the future at a substantial risk, despite the preponderance of red flags, it took, of all things, the investment banking division of Morgan Stanley hired by the Treasury Department to uncover that Fannie and Freddie were still using overly aggressive accounting techniques to inflate their capital adequacy positions.

Now my constituents and, indeed, taxpayers across the nation are asking how we arrived at this crisis. It is infuriating. We need to end the existing structure of an implied government guarantee. We need to end the practice of private rewards at public risk.

I fully support the mission of affordable housing and believe the government will continue to play an important role in this area. That said, it is abundantly clear that Fannie and Freddie have utterly failed to deliver on their intended purpose.

In fact, because of their congressional apologists, Fannie and Freddie have effectively done just the opposite. They have put us on the brink of a situation in which almost no one can obtain financing for a home.

One of the big casualties in all this mess is AIG. As we know, Treasury had to swoop in with an $85 billion loan to prevent the largest company failure in history. The AIG downfall was caused, in large part, by the hemorrhaging credit default swaps on mortgage- backed securities.

Consistently throughout the year, I've been one of the few members who called for more oversight and tougher reporting requirements for the $60 trillion credit default swaps market, which we now know also played a significant role in the collapse of Lehman Brothers.

I reference this as yet another example of what is now painfully obvious -- the federal government's oversight structure for the financial sector is fatally flawed, and I am not at all convinced that this bailout plan, which appears incredibly expensive and hastily concocted, is the answer.

I welcome today's hearing not only for us lawmakers to get answers, but for the taxpayers who need to understand in no uncertain terms why they are being asked to foot this bill.

Thank you, Mr. Chairman.

DODD: Thank you, Senator.

Senator Casey?

CASEY: Mr. Chairman, thank you very much.

I want to thank Secretary Paulson, Chairman Bernanke, and Chairman Cox and Director Lockhart for your presence here today.

I think my reaction to the proposal that was sent by the administration this weekend was similar to not just members of this committee and others, but I think the American people, in a couple of ways.

One was I thought it was far too broad a grant of authority to the Treasury Department, and I know we'll -- we'll talk more about that.

But I think the -- in terms of what was missing from it were a couple of -- of basic features.

First of all, I think it missed completely the idea of addressing directly the root cause of this problem, which you know started with foreclosures. And I know there's been -- been work done this weekend to try to fill in that -- that hole, fill in that blank.

On Friday, I sent a letter both to you, Secretary Paulson, and -- and Chairman Bernanke, outlining a couple of things on housing.

First of all, Hope for Homeowners is a way to -- to further amplify or expand our -- our efforts in that area, the -- the moratorium issue that Senator Brown, Senator Menendez and Senator Schumer and I proposed, and also an innovative way in the city of Philadelphia, where the -- literally the -- the city government -- the court system intervened to try to prevent foreclosures. And it's a -- it's a very successful model.

And I think there are other ideas that we'll hear. I know that Chairman Dodd has made a series of proposals just in the last couple of days that I think are very instructive here and very helpful on transparency and accountability, the idea of oversight, certainly in the area of -- of assistance for -- for homeowners. So we're going to have a chance to review those today and in the next couple of days.

I think overall, people are looking for -- taxpayers and families are looking for a couple of things. They're looking for more oversight.

They want to know that if a department of their federal government is given the opportunity to exercise power, which involves the expenditure of maybe $700 billion, that there's some oversight by the elected officials and -- and others who are charged with that responsibility. I think taxpayers have a real concern, obviously, a deep, abiding concern about their own savings. What -- what will this mean to their own livelihood, any kind of a -- any kind of short-term livelihood, but especially long-term, in terms of their own personal savings?

I think they know that we need more performing loans, not loans that are -- that are headed to foreclosure. And I think the bankruptcy strategy here in terms of that enhancing our ability to modify loans is central to achieving that kind of result where you have more performing loans instead of loans headed to foreclosure.

But I think in the end, what people are -- are most concerned about is -- is staying in their homes. We've got to do everything possible -- with limited time, I realize, and under -- under duress and urgency -- to do everything possible to keep people in their homes.

And I think that's, in the end, what -- what most Americans are concerned about. They're concerned about not just their own family, but their -- their own neighborhoods. And it really comes down to peace of mind in so many ways.

And I think that I -- I would hope that in your efforts -- and I know you're -- you're -- you're trying to do this, but in your efforts to explain what has to happen to support financial institutions and other entities which will, in turn, strengthen our economy and help -- help on Main Street, that you keep in mind what individual families are up against.

In my home state of Pennsylvania, which has been spared somewhat in a relative sense what other states have gone through, the foreclosure crisis got a lot worse in August of 2008 compared to August of 2007, up 60 percent, a much higher rate than -- than the rest of the country.

And then when you look at -- if you add to the foreclosure problem in a state like Pennsylvania -- and add the other challenges that people have with gas prices, health care costs, the cost of education -- one -- one that stood out for me is child care.

If you're a family in Pennsylvania, you got two kids, your monthly cost for child care is $1,311. That's weighing on people as they worry about making the house payment this month and next month and all these months ahead of us.

So I would urge you, as we -- as we finalize the proposal -- and I know we're trying to work together to make this -- make this happen -- that we keep in mind those families and their peace of mind and their economic security.

Thank you very much.

DODD: Thank you, Senator.

Senator Martinez?

MARTINEZ: Thank you, Mr. Chairman.

I look forward to hearing from the witnesses, and I'll be very, very brief. But I do think it merits for us to look for a moment to how we -- we got here, because a lot can be said about the lack of regulation.

And I want to associate myself with the comments, excellent comments, from Senator Dole. I can't help but have a sense that a lot of what has transpired here, a lot of what we're dealing with today, has its origins in Fannie Mae and Freddie Mac.

And as we look at that and we try to deal with the current problem, we cannot help but also look back. We have not looked back enough to know how Fannie Mae and Freddie Mac got the entire financial world in the mess that we're in today.

One of the problems is that it did not have a world-class regulator. And I know it's real popular today and easy to do -- you just beat up on the administration and -- and blame everything from tsunamis to hurricanes on them.

But having been a part of this administration, and having come to this Congress and before this very committee to testify in 2003, along with then Secretary of Treasury Snow, to ask for stronger regulation over Fannie and Freddie, to have a world-class regulator, I find it just a little troubling to -- to just exactly overlook and -- and -- and not pay some attention to how we got here.

And I do want to recall also Chairman Greenspan's comments in 2005 before this committee, where he said that if Fannie and Freddie continue to grow, continue to have the low capital that they have, continue to engage in the dynamic hedging of their portfolio, which they need to do for interest rate aversion, they potentially create ever-growing potential systemic risk down the road.

And that is where we are today, systemic risk, so that is just a little bit on how we got here. Where I think we need to -- Director Lockhart, I hope we're going to drill down and find out a lot more about how Fannie and Freddie got us here.

But beyond that, we need to do what we need to do now. We need in the long term to also deal with a -- a -- a complete revamping of our regulatory scheme of our financial institutions. But that will come in the future.

For now, I believe we're saddled with a problem that needs and requires action. That action needs to be thoughtful but timely. We need to talk about oversight. We need to talk about the size of this fund and whether it will work or not.

But it does appear to me that there are also some questions that we need to have answered, which is if the underlying problem regarding this entire matter has to do with the ever-declining home values, what are we doing here that will help to stem that decline in home values.

It seems to me, when we look at the state of Florida, that it's about a tremendous inventory of unsold properties as well as the availability of credit. Hopefully what we're doing here may help with the availability of credit, but certainly the tremendous inventory is something that I think we also need to address.

So I look forward to hearing the testimony from the witnesses, having many questions answered. But at the end of the day, I do believe that it is our responsibility to ask -- to -- to act, to act timely, and to act responsibly but yet to act.

Thank you, Mr. Chairman.

DODD: Senator Bayh?

Thank you, Senator.

Senator Bayh?

BAYH: Thank you, Mr. -- thank you, Mr. Chairman.

And thank you, gentlemen, for your public service. We may not agree on everything, but we're all grateful for your efforts to try and deal with this important moment for our nation.

Mr. Chairman, we gather here today at a time of the most palpable sense of national crisis since we gathered here in this building immediately following the 9/11 attacks.

It's been less than 72 hours since we listed to the chairman of the Federal Reserve tell us that we were only a matter of perhaps days from the beginning of a major economic collapse, the free fall of our financial markets, and the beginnings of a severe and protracted recession that could cost businesses going out of business, many jobs being lost, savings being wiped out, people losing their homes, real distress for our country.

And coming from a man who I think, Mr. Chairman, it's safe to say is not known for engaging in hyperbole, this tended to focus the mind. So the sense of urgency is palpable.

And yet we also have to focus on getting it right. I'm going to focus my questions on what alternatives have been considered. Why are we convinced that this is the right path?

Were there no private sector solutions available that would perhaps lead to better outcomes than the ones that have been proposed?

If it takes us a couple of extra days to increase the likelihood that this will work and work well, well, it's worth -- worth working through the weekend. It may be worth postponing going home to campaign for. I mean, this is important enough that we take the time to get it right.

And so I'm going to focus my questions first on what other alternatives were considered and why do we think this is the optimal solution to the problem. Several of my colleagues, including Senator Menendez, have mentioned, you know, is our purpose here to protect the taxpayers by buying these instruments at market prices. If that's the case, how does it help solve the problem by recapitalizing these institutions?

If we're paying above market prices, well, what do the taxpayers receive in return? If equity is the answer, that's one thing. If it's not equity, then we have to ask why not.

And if it's not equity, we have to ask why do we encourage or at least permit sovereign wealth funds to invest in our companies and markets but perhaps not allow the American taxpayers to take a similar interest in our own companies and markets. So I'll be asking about that as well.

Finally, and perhaps my greatest concern, Mr. Chairman -- and you and I have discussed this -- we have to act, but we also have to be willing to take the steps to make sure that this situation does not reoccur.

As my colleagues have indicated, there is a sense of outrage on the part of ordinary taxpayers. I hear from my citizens all the time, people who behaved prudently, who did not take inordinate risks, who saved their money, who did not get in over their heads, who did not participate in highly leveraged instruments that have now come back to haunt them.

What about them? Who speaks for them? Who will protect them? We owe it to them to make sure that we learn the lessons from this so that it does not happen again.

And the way Washington works -- and I must say, I am -- I'm not a cynic, but I am a skeptic. We'll act in this moment of crisis. But once the crisis is abated, the sense of urgency will dissipate. The forces of reform will not have the energy they have today.

All the interests will circle this place like hungry birds looking at carrion to prevent us from taking the steps that are necessary, and we must not let that happen.

So I understand we cannot make the long-term reforms in this vehicle. It is not possible in the time frame that is our -- that is at our disposal.

But I'm going to be looking for some incentive, Mr. Chairman, some mechanism, that will force us to revisit this issue, because if we do not revisit the issue of long-term reform to keep this from happening again, it will happen again.

And history will judge us poorly, and our children and grandchildren will not forgive us, nor should they.

DODD: Thank you, Senator.

Senator Corker?

CORKER: Senator Bayh makes some good -- some good comments.

I want to say to all of you that I thank you for coming.

I think it's absolutely reprehensible that, in the biggest financial crisis in modern history, our timeline is to get out of here on Friday so we can adjourn for the year in September.

And I agree with those who think we ought to get this right. I'll focus these comments to Chairman Paulson and -- Secretary Paulson -- and Chairman Bernanke.

I can't imagine two people that have a better background to deal with this, nor people that I respect more from the standpoint of that and their perspective.

I did not support the rebate stimulus, and I did not rebate the bazooka in the pocket theory. And history will judge whether that was a good decision or not.

But in both cases, you came to us with strength of commitment and telling us that absolutely was the right thing to do. I disagreed.

In this case what bothers me is that each of you -- and I realize you're trying to solve a problem, and I truly believe you're trying to do it in a way that you think is best for the country. I believe that with all of my heart.

But I get a sense that's more of a deer in the headlights mentality. This is a much bigger undertaking -- this bailout. And I don't, by the way, criticize you for not knowing exactly what to do, but this is being done on the fly.

If this $700 billion were to be extended, per Bloomberg data today, it would have -- add up to $1.8 trillion that we've -- that we've extended to the markets, not counting the rebate checks that -- that went away at $168 billion or somewhere thereof.

So I just have to tell you that I hope today that what you will do in questions and answering is talk about some of the options that you thought about, as Senator Bayh brought forth, and I hope you'll be able to convince us that this solves the problems that we're dealing with.

I'm getting letters from bankers throughout the state of Tennessee that were not involved in this, and yet they have severe issues that are caused by some of the things that have happened on Wall Street.

So I hope this meeting will be full, Mr. Chairman. I -- I did the math for you. I hope you don't object, but 21 times 8 is 168 minutes. I know no one will stay within that eight minutes, and I do hope that this hearing will last long enough so that we leave here fully understanding what it is we're talking about.

DODD: I appreciate that very much.

And I again thank my colleagues. And there are a couple more members who want to be heard from, but this, as many have pointed out, probably the single most important hearing this committee has held -- certainly in my time.

And, therefore, having the opportunity for members to be heard on this I think is particularly important. And it's important I think that our witnesses have the opportunity as well. They're reflecting the views of their constituents about these matters, and it's clearly important that we be working together on this.

So I apologize for the length of it, and I'll try and make sure we move along here, recognizing our witnesses have work to do as well. But it's a critical moment in our system, so we need to hear from members. So I thank my colleagues for their comments as well.

Let me turn to Senator Akaka, and then Senator Allard, and we'll begin to go to our witnesses.

Senator Akaka?

AKAKA: Thank you very much, Mr. Chairman. I appreciate your -- your conducting this hearing today.

And I want to add my welcome and thanks to the witnesses, who are here today.

Mr. Chairman, I understand the -- the need to act to stabilize the markets. However, we must not give the secretary of treasury of blank check with no accountability or oversight.

We must deliberate and provide a solution that protects taxpayers as much as possible and limits the potential for this new authority to be abused.

$700 billion is a huge sum of money. I know the president has said that the whole world is watching Congress now. I remind all of you that the members of this committee and the rest of the taxpayers will be closely watching the development of the Troubled Assets program.

The purchase and sale of assets has great potential to be abused and lead to corruption. Members of Congress and the GAO, the Treasury inspector general and the public must review the activities of Treasury authorized by this proposed act.

We must make sure that this situation, which has been caused partially by greed, will not be exploited to enrich individuals and corporations.

In addition to stabilizing the markets, we must do more to help working families. We need to help those who have already suffered the consequences of the current economic downturn. We must do to try and keep people in their homes.

Consumer protection -- protections must be improved to better protect families from being exploited by predatory lenders.

Mr. Chairman, we're here today due to a massive market failure. In addition to this emergency legislation, we need a complete reexamination of our financial services oversight system in order to strengthen regulation and prevent the need for future bailouts.

While most of those issues will be considered in the next session of Congress, I look forward with working with all of you to bring together a fair proposal to stabilize the markets, improve the lives of working families, and overhaul the financial services regulatory system.

Thank you very much, Mr. Chairman.

DODD: Thank you, Senator.

Senator Allard?

ALLARD: Thank you, Mr. Chairman.

I want to thank the panel for being here with us today. This is a critical time in our nation and in our economy, and we must move forward from here. I hope to get more details on how we do that.

We need to act on solid facts so that we can act in the interests of the taxpayer of this country. I wish the administration to be more forthcoming with facts in this -- on their plan, their cost estimates and implementation.

Telling Congress to give full discretion in implementing the bailout program is not the way to go.

Congress needs to be involved, and I urge more cooperation and sharing with the Congress in the hope that we can act in a limited way and avoid going behind what is necessary to stabilize the markets.

This committee, this Congress must act to preserve our free market tradition. We've tried to avoid propping up failed businesses on Main Street. We should not prop up failure, malfeasance and avarice on Wall Street.

Second, we not -- cannot do so successfully, even if we wanted to. The history of government's ineptitude at running business is known now the world over.

And third, we must prevent panic both in the market and in the government. Overreaction will in the long run be worse for our freedom and our economy. We must remember the long run.

Mr. Chairman, I have a complete statement that I'd like to put in the record. And in the interest of being able to move forward so we can hear from this panel, I'm going to cease my comments and thank you.

DODD: I -- I thank the senator very much.

And before turning to Secretary Paulson, let me just say for the purpose of my -- benefit of my colleagues and others, our -- our intention had been quite frankly, barring the events of the last few days, to actually use this month and next month to have some hearings and informal conversations on exactly the issue of long-term restructuring of our financial service regulatory system.

My intention is at some point to do this. In fact, Senator -- Chairman Bernanke and I had been chatting about this yesterday as well, and -- and we hope to get to that, to be able to start that process before the inauguration of a new president in January, to be able to present some ideas.

It's impossible this week to do that, but I want my colleagues to know it's our intention. I know certainly members -- Senator Allard, Senator (inaudible) have worked on regulatory reform for a long time.

And so I want to be calling upon us as a -- as a committee, informally or formally, to actually have those conversations in the coming weeks, even before we commence our work in -- in January, to actually consider ideas to allow for the restructuring of that.

So I want the witnesses, as well as our colleagues, to know that.

With that, Secretary Paulson, let me underscore what's been said by others here. We admire immensely your willingness to serve our country.

And that goes for all of you that are at the table.

There are obviously concerns that have been expressed here strongly this morning. I hope it's been valuable for you to hear from across the country how our colleagues are hearing from their constituents and their own concerns about these issues.

In no way should this be an interpretation of our lack of respect and admiration for those who are willing to serve our country. And we appreciate immensely your willingness to do it. We admire as well your background experience you bring to this issue.

So with that, we thank you for being here this morning, anxious to receive your testimony, and answer some questions.

PAULSON: Thank you very much, Chairman Dodd, Senator Shelby, members of the committee. Thank you very much for the opportunity to appear before you today.

I very much appreciate the comments you made, and I -- I understand them, and I appreciate them. I also...

DODD: Pull that mike a little closer.

PAULSON: I also share the comments that you -- that you all made about the importance of the situation and the importance of this hearing.

This is a difficult period for the American people. I very much appreciate the fact that congressional leaders and the administration are working closely together so that we can help the American people by quickly enacting a program to stabilize our financial system.

We must do so in order to avoid a continuing series of financial institution failures and frozen credit markets that threaten American families' financial well-being, the viability of businesses both small and large, and the very health of our economy.

The events leading us here begin many years ago, starting with bad lending practices by banks and financial institutions and by borrowers taking out mortgages they couldn't afford.

We've seen the results on homeowners, higher foreclosure rates affecting individuals and neighborhoods, and now we're seeing impact on financial institutions.

These loans have created a chain reaction, and last weeks our -- our credit markets froze. Even some Main Street non-financial institutions -- or, excuse me, some non-financial companies have trouble financing their normal business operations.

If that situation were to persist, it would threaten all parts of our economy. Every American business depends on money flowing through our system every day, not only to expand their business and create jobs, but to maintain normal business operations and to sustain jobs.

As we've worked through this period of market turmoil, we've acted on a case-by-case basis, addressing problems at Fannie Mae and Freddie Mac, working with market participants to prepare for the failure of Lehman Brothers, and lending to AIG so it can sell some of its assets in an orderly manner.

And here I would make the comment -- you know I've heard your comments on executive compensation. I share your frustrations. I feel those frustrations. Practices throughout America also upset me.

Let me just say that with regard to Freddie and Fannie and AIG, in case you or your constituents don't know, in those cases CEOs were replaced. The government got warrants for 79.9 percent of the equity. Golden parachutes were eliminated. Strong action was taken.

I will also say to the comments made about Freddie and Fannie and the bazooka -- you all can be darned glad you gave us the bazooka, because we needed it. Let me tell you something. Those -- the root of that problem was in congressional charters started many, many years ago. We are living up to our obligations here. There are -- there are ambiguities. There were obligations around those charters.

And what we did is we came in, we stabilized the market, mortgage rates went down so that capital could flow through our system.

And I can just say I for one -- and I know that the other witnesses feel very glad about this -- thank goodness that was done, and they were stabilized before we had some investment banks report their earnings, or let me tell you this would be a much more serious situation than it is today.

So there was an example of broad authorities working the way they were supposed to work to stabilize our system.

Now -- sorry for that ad hoc response, but we've also taken a number of powerful tactical steps to increase confidence in the system, including a temporary guarantee program for the U.S. money market mutual fund industry.

These steps have been necessary, but not sufficient. More is needed. We saw market turmoil reach a new level last week and spill over into the rest of the economy.

We must now take further decisive action to fundamentally and comprehensively address the root cause of this turmoil. And the root cause is the housing correction, as you've all pointed out, which has resulted in illiquid mortgage assets that are choking off the flow of credit, which is so vitally important to our economy.

We must address this problem and this underlying problem and restore confidence in our financial markets, in our financial institutions, so they can perform their mission of supporting future prosperity and growth.

PAULSON: We have proposed a program to remove troubled assets from the system. We would do this through market mechanisms available to thousands of financial institutions throughout America -- big banks, small banks, savings and loans, credit unions -- to help set values of complex, illiquid mortgage and mortgage-related securities, to unclog our credit and capital markets and make it easier for private investors to purchase these securities and for the financial institutions to raise more capital after the market learns more about the underlying value of these hard-to-value, complicated mortgage- related securities on their balance sheets.

This troubled asset relief program has to be properly designed for immediate implementation and be sufficiently large to have maximum impact and restore market confidence.

It must also protect the taxpayer to the maximum extent possible and include provisions that ensure transparency and oversight while also ensuring the program can be implemented quickly and effectively.

And let me give you another ad-hoc comment there. When we all met Thursday night, as you'll recall, Chairman, with -- with the leaders of Congress, you all said to us, "Don't give us a fait accompli. Come in and work with us."

We gave you a simple, three-page legislative outline, and I thought it would have been presumptuous for us, on that outline, to come up with an oversight mechanism. That's the role of Congress. That's something we're going to work on together.

So if any of you felt that I didn't believe that we needed oversight -- I believe we need oversight. We need oversight. We need protection. We need transparency. I want it. We all want it.

And we need to do that in a way that lets this system -- lets this program work effectively, quickly, because it needs to work effectively and quickly, and it needs to -- and it needs to -- to get the job done.

Now, the market turmoil we are experiencing today poses great risk to U.S. taxpayers. When the financial system doesn't work as it should, Americans' personal savings and the abilities of consumers and businesses to finance spending, investment and job creation are threatened.

The ultimate taxpayer protection will be the market stability provided as we remove the troubled assets from our financial system. Don't forget that. If this system has to work, it has to work right, and that will be the ultimate market protection.

I am convinced that this bold approach will cost American families far less than the alternative, a continuing series of financial institution failures and frozen credit markets unable to fund everyday needs and economic expansion.

Again, I'm frustrated. The taxpayer is on the hook -- the taxpayer's already on the hook. The taxpayer already is going to suffer the consequences if things don't work the way they should work.

And so the best protection for the taxpayer, and the first protection for the taxpayer, is to have this work.

Over these past days, it has become clear that there is a bipartisan consensus for an urgent legislative solution. We need to build upon this spirit and enact this bill -- enact this bill quickly and cleanly and avoid slowing it down with provisions that are unrelated or don't have broad support.

This troubled asset purchase program on its own is the single most effective thing we can do to help homeowners, the American people and to stimulate our economy.

Earlier this year, Congress and the administration came together quickly and effectively to enact a stimulus package that has helped hard-working Americans and boosted our economy. We acted cooperatively and faster than anyone thought possible.

Today, we face a much more challenging situation that requires bipartisan discipline and urgency. When we get through this difficult period, which we will, our next task must be to address the problems in our financial system through something you all talked about. We need reform that fixes this outdated financial regulatory structure. You've all heard me talk about that a lot.

And we need other strong measures to address other flaws and excesses in the system. And there are plenty, and we've all talked about them, and they can't be addressed this week. We're going to take a -- we need to take time to address these.

I've already put forward my recommendations on this subject. Many of you have strong views based on your expertise. We must have that critical debate, but we must get through this period first.

Right now, all of us are focused on the immediate need to stabilize our financial system. And I believe we share the conviction that this is in the best interest of all Americans.

Now let's work together to get it done. Thank you.

DODD: Thank you very much, Mr. Secretary.

I'd be remiss if I didn't just point out and thank you, by the way -- but for the cooperation of Senator Shelby and the overwhelming majority of members of this committee, we were able to enact that legislation in July that you've referenced. And it doesn't mean that everybody was supportive of every detail of it, but it was an example of coming together and getting a job done. It took some time, but we got it done. And I thank you for your comments about it.

And I thank Senator Shelby and members of this committee, Democrats and Republicans, who worked with us to get that done.

Chairman Bernanke?

BERNANKE: Mr. Chairman, Senator Shelby, I have submitted formal written testimony for the record. With your permission, I'd like to speak just a few minutes about the Treasury proposal.

The Fed supports the Treasury initiative. We believe that strong and timely action -- we believe that strong and timely action is urgently needed to stabilize our markets and our economy.

But I believe some clarification is needed about why this proposal could make a positive difference, and I'd like to offer a few thoughts on that subject.

Let me start with the question, why are financial markets not working. Financial institutions and others hold billions in complex securities, including many that are mortgage-related. I'd like to ask you for a moment to think of these securities as having two different prices.

The first of these is the fire-sale price. That's the price a security would fetch today if sold quickly into an illiquid market. The second price is the hold-to-maturity price. That's what the security would be worth eventually when the income from the security was received over time.

Because of the complexity of these securities and the serious uncertainties about the economy and the housing market, there is no active market for many of these securities, and thus today the fire- sale price may be much less than the hold-to-maturity price.

This creates something of a vicious circle. Accounting rules require banks to value many assets at something close to a very low fire-sale price rather than the hold-to-maturity price, which is not unreasonable in itself, given their illiquidity.

However, this leads to big write-downs and reductions in capital, which in turn forces additional sales that send the fire-sale price down further, adding to pressure.

Meanwhile, private capital is unwilling to come in because of uncertainty about the value of institutions and because of the prospect of more write-downs.

One suggestion that's been made is to suspect mark-to-market accounting and use banks' estimates of hold-to-maturity prices. Many banks support this. But doing this would only hurt investor confidence because nobody knows what the true mark -- true hold-to-maturity price is. Without a market to determine that price, investors would have to trust the internal estimates of banks.

So let me come to the critical point. I believe that under the Treasury program auctions and other mechanisms could be designed that will give the market good information on what the hold-to-maturity price is for a large class of mortgage-related assets.

If the Treasury bids for and then buys assets at a price close to the hold-to-maturity price, there will be substantial benefits. First, banks will have a basis for valuing those assets and will not have to use fire-sale prices. Their capital will not be unreasonably marked down.

Second, liquidity should begin to come back to these markets.

Third, removal of these assets from balance sheets and better information on value should reduce uncertainty and allow the banks to attract new private capital.

Fourth, credit markets should start to unfreeze. New credit will become available to support our economy.

And fifth, taxpayers should own assets at prices close to hold- to-maturity values, which minimizes their risk.

Now, how to make this work? To make this work, we do need flexibility in design of mechanisms for buying assets and from whom to buy. We do not know exactly what the best design is. That will require a consultation with experts and experience with alternative approaches.

Second, understanding the concerns and the -- and the worries of the committee, we cannot impose punitive measures on the institutions that choose to sell assets. That would eliminate or strongly reduce participation and cause the program to fail.

Remember, the beneficiaries of this program are not just those who sell the asset but all market participants and the economy as a whole.

But finally, and very importantly, this is not to say that the financial industry should not be reformed. It should be. It's critical. I agree with the Treasury secretary. The Federal Reserve will give full support to fundamental reform of the financial industry.

But whatever reforms the Congress makes should apply to the whole industry, whether they participate in this program or not.

So in summary, I believe that under the Treasury authority being requested, a problem can be undertaken that will help establish reasonable hold-to-maturity prices for these assets. Doing that will restore confidence and liquidity to financial markets and help the economy recover without an unreasonable fiscal burden on taxpayers.

So I urge you to act as soon as possible. Thank you.

DODD: Thank you. Thank you, Mr. Chairman. Thank you, Mr. Chairman, for that -- that testimony.

Christopher Cox?

COX: Thank you, Chairman Dodd, Ranking Member Shelby, members of the committee, for inviting me here today to discuss the current turmoil in our markets and our policy responses to it.

The extraordinary nature of recent events has required an extraordinary response from both policy makers and regulators.

Last week, by unanimous decision of the commission, and with the support of the secretary of the Treasury and the Federal Reserve, as well as close coordination with regulators around the world, the SEC took emergency action to ban short selling in financial securities to stabilize markets as you consider this legislation.

At the same time, the commission unanimously approved two additional measures to ease the crisis of confidence in the markets. One makes it easier for issues to purchase their own shares on the open market, thus providing additional liquidity.

The second requires weekly reporting to the Securities and Exchange Commission by large investment managers of their daily short positions.

In addition, the SEC recently issued new rules that more strictly enforce the ban on abusive naked short selling under our Regulation SHO.

Beyond these immediate steps, the SEC is vigorously investigating how illegal activities may have contributed to this subprime crisis and the recent instability in our markets.

First and foremost, the SEC is a law enforcement agency, and we already have over 50 ongoing investigations in the subprime area alone. The Division of Enforcement has undertaken a sweeping investigation into market manipulation of financial institutions, including through the use of credit default swaps, a multi-trillion- dollar market which is completely lacking in transparency and is completely unregulated.

Last month, the Enforcement Division, working with state regulators, entered into agreements that will be the largest settlements in SEC history.

On behalf of investors who bought auction rate securities from Merrill Lynch, Wachovia, UBS and Citigroup. Happily, the terms of these agreements would provide complete recovery for individual investors.

The commission also recently brought enforcement actions against portfolio managers at Bear Stearns Asset Management for deceiving investors about the hedge funds' overexposure to subprime mortgages.

The commission is using its regulatory authority simultaneously to ensure that the market continues to function. Last week, the commission's Office of Chief Accountant provided guidance to clarify the accounting treatment of banks' efforts to support their money market mutual funds. This will help protect investors in those funds.

And our examinations of the major credit rating agencies for mortgage-backed securities exposed weaknesses in their ratings processes and led to our sweeping new rules to regulate this industry under the new authority that this committee and the Congress have given us.

We are also moving quickly to mitigate the impact of recent events. In the past week, the SEC oversaw the sale of substantially all of the assets of Lehman Brothers Incorporated to Barclays Capital.

Hundreds of thousands of Lehman's customer accounts, with over $1 billion in assets, can now be transferred in a matter of days instead of going through a lengthy brokerage liquidation process.

With all that has happened, it is important to keep in mind how we got here. The problems that each of these actions has addressed have their roots in the subprime mortgage crisis, which itself was caused by a failure of lending standards.

The complete and total mortgage market meltdown that led to the taxpayer rescue of Fannie Mae and Freddie Mac was not built into the stress scenarios and the capital and liquidity standards of any financial institution.

Bank risk models in every regulated sector, for better or for worse, failed to incorporate this scenario that has caused so much damage in financial services firms of all kinds.

The SEC's own program of voluntary supervision for investment bank holding companies, the Consolidated Supervised Entity program, put in place in 2004, was fundamentally flawed because it adopted these same bank capital and liquidity standards, and because it was purely voluntary.

It became abundantly clear with the near collapse of Bear Stearns that this sort of voluntary regulation doesn't work.

Working with the Federal Reserve, the Division of Trading and Markets moved quickly last spring to strengthen capital and liquidity at investment bank holding companies far beyond what the banking standards require, and we immediately entered into a formal memorandum of understanding with the Fed to share both information and expertise.

COX: But the fact remains that no law authorizes the SEC to supervise investment bank holding companies, let alone to monitor the broader financial system for risk.

For the moment this regulatory hole in the statutory scheme is being addressed in the market by the conversion of investment banks to bank holding companies.

But the basic problem must still be addressed in statute by sealing that regulatory hole, as I have reported to Congress on previous occasions.

I will conclude, Mr. Chairman, by warning of another similar regulatory hole in the statute that must immediately be addressed, or we will have similar consequences.

The $58 trillion notional market and credit default swaps, to which several of you have referred in your opening comments, that is double the amount that was outstanding in 2006, is regulated by absolutely no one.

Neither the SEC nor any regulator has authority over the CDS market, even to require minimum disclosure to the market.

This market is ripe for fraud and manipulation, and indeed, we are using the full extent of our anti-fraud authority, our law enforcement authority, right now to investigate this market.

Because CDS buyers don't have to own the bond or the debt instrument upon which the contract is based, they can effectively naked short the debt of companies without -- without any restriction, potentially causing market disruption and destabilizing the companies themselves.

As the Congress considers reform of the financial system in the current crisis, I urge you to provide in statute for regulatory authority over the CDS market. This is vitally important to enhance investor protection and to ensure the continued operation of fair and orderly markets.

Mr. Chairman, I appreciate the opportunity to discuss this current market turmoil, and I look forward to answering your questions.

DODD: Well, thank you, Mr. Chairman. Let me just very briefly -- we received your -- your testimony about 20 minutes before the hearing began today. Other chairmen over the years have talked about it, and again I just raise it briefly here with you.

We need to get the testimony -- and I appreciate the fact we did from other witnesses last evening -- we need to get it from the SEC earlier than 20 minutes before a hearing.

Mr. Lockhart?

LOCKHART: Chairman Dodd, Senator Shelby and members of the committee, thank you for the opportunity to testify on the Federal Housing Finance Agency's decision to place Fannie Mae and Freddie Mac into conservatorship.

Fannie Mae and Freddie Mac share the critical mission of providing stability, liquidity and affordable to the nation's housing market.

Between them these enterprises have $5.3 trillion of guaranteed mortgage-backed securities and debt outstanding, which is equal to the total debt of -- publicly held debt of the United States.

Their market share earlier this year reached 80 percent of all new mortgages made.

During the turmoil that started last year, they had played a very important role in providing liquidity to the conforming mortgage market. They required capital to support a very careful and delicate balance between safety and soundness of mission.

That balance was upset as house prices, earnings and capital have continued to deteriorate. In particular, the capacity to raise capital without Treasury Department support vanished.

That left both enterprises unable to fulfill their mission. Worse, it threatened to further damage the mortgage and housing markets if they had to sell their assets.

Rather than letting those conditions worsen and put the financial markets in further jeopardy, FHFA decided to take action.

The goal of these dual conservatorships is to help restore confidence in Fannie Mae and Freddie Mac, enhance their capacity to fulfill their mission, reduce systemic risk, and make mortgages -- and this is the most important -- make mortgages available at lower cost for the American people.

FHFA based its determination on five key areas, each of which worsened significantly over the last several months.

First, there was accelerating safety and soundness weaknesses.

Second, there was a continued and substantial deterioration in equity, debt and MBS market conditions.

Third, the current and projected financial performance and condition of each company, as reflected in its second quarter financial reports and on -- and our ongoing examination. Fourth, the inability of the companies to raise capital or to issue debt according to normal practices and prices.

And lastly, the critical importance of each company in supporting the country's residential mortgage market.

I shared our growing concern with Federal Reserve Chairman Bernanke, who was made our consultant in the law you passed in July, and with Secretary Paulson. They agreed that a conservatorship was necessary, as did the boards of both firms.

A detailed list of events leading to our conclusion to appoint a conservator is provided in my written statement. I'll just highlight a few.

It became apparent, during this intense supervisory review that began in July, that market conditions were deteriorating much more rapidly than anybody expected.

We had supplemented our examination team with senior examiners from the fed and OCC. All three sets of examiners corroborated that the -- that there was a significant deterioration in the credit environment, and it was a threat to the capital of these two companies.

We also finished our semi-annual examination ratings of the companies, and across the board the ratings were significant and critical weaknesses.

The companies themselves disclosed in their second quarter filings how rapidly the environment had deteriorated and was negatively affecting their outlook and their ability to raise capital.

Freddie Mac reported losses of $4.7 billion over the last year. Fannie Mae reported losses of $9.7 billion.

Now, let me turn to the conservatorships. First signs are that the conservatorships are positive. The enterprise funding costs and the spreads on MBS have declined. This lower cost has been passed on to homebuyers with 30-year mortgage rates well below six percent for the first time since January.

On the first day, business opened as normal, but with stronger backing with -- for the holders of their mortgage-backed securities, their debt and their subordinated debt.

Over the next 15 months, they will allow to increase their portfolios to provide support to the housing market. They will also be able to continue to grow their guaranteed MBS books.

As the conservator, FHFA assumed the power of the board and management. Highly qualified new chief executive officers and non- executive chairmen have been appointed. They will be delegated significant powers.

In order to conserve over $2 billion in annual capital, the common stock and preferred dividends were eliminated. The U.S. Treasury financing facilities, which were critical to this conservatorship, are all in place and will provide the -- the needed support to Fannie Mae and Freddie Mac to fulfill their mission over the long term, while giving upside potential for taxpayers.

FHA will continue to work expeditiously on the many regulations needed to implement the new law. The new legislation adds importantly affordable housing, a trust fund and mission enforcement to the responsibilities of the safety and soundness regulator.

We are also continuing to work with the enterprises on loan modifications, foreclosure preventions, pricing and credit issues. The decision to appoint a conservator for each enterprise was a tough, but necessary one. They can now become part of the solution.

Unfortunately, all the good and hard work put in by the FHFA and the enterprises was not sufficient to offset the consequences of the antiquated regulatory structure, which was overwhelmed by the turmoil in the housing markets.

Conservatorship will give the enterprises the time to restore the down -- balances between safety and soundness and their mission.

Working together with the enterprises, Congress and the administration and other regulators, I believe we can restore confidence in the enterprises, and with the new legislation that you passed, build a stronger and safer future for the mortgage markets, homeowners and renters in America.

Thank you. I'd be pleased to answer questions.

DODD: Thank you very much, Mr. Lockhart.

Senator Tester was presiding over the Senate when we were gathering here, and everyone else had a chance to make a brief comment.

And, Senator Tester, you have a brief comment you'd like to make.

TESTER: I do. Thank you, Mr. Chairman. And -- and thank you for allowing me to just ask a few questions.

Ten years ago I got involved in politics because of electrical deregulation in the state of Montana. It was a total disaster. I've got plenty of questions to ask about the plan, and I will as they come forth.

But I guess my concern is this. Six months ago we -- we heard about Bear Stearns. And then we've had Fannie and Freddie, and we've had some other ones come down the pipe.

A week ago you came forth with a $700 billion bailout plan -- $700 billion -- and -- and it was made clear that -- that this was going to be -- there was going to be nothing added on to it -- accountability, demanding of reregulation was not going to be accounted. And my question -- and -- and this is the concern I have. You guys are a lot smarter in financials than I am. I'm a dirt farmer. You guys have been in the business -- the former chairman of Goldman Sachs.

Why do we have one week to determine $700 billion that has to be appropriated, or this country's financial systems go down the pipes?

Wasn't there some opportunity sometime down the line where we could have been informed of how serious this crisis was so we could take some preventative steps before this got to this point?

That's it. Thank you, Mr. Chairman.

DODD: Thank you, Senator, very much.

Well, let's -- again, we'll turn the clock on here and try -- and try and move along.

And let me pick up sort of on -- on that question. I appreciate, Chairman Bernanke, your -- your laying out why you think this particular plan will work. But I'd like, if you could, to step back. And in addition to laying out why you think the plan would work, tell us it again.

As Senator Schumer mentioned the other evening when we sat on Thursday night, the -- the reason why we have to act. And put aside whether or not we're going to act this week or next week.

But for a minute tell us why you believe it's critically important, one, that we act. What are the circumstances out there that warrant us responding as quickly as we're being asked to?

And secondly, do you believe that the amount being asked for is going to adequately address the issue, particularly if you adopt -- if we adopt the plan as suggested by the secretary?

BERNANKE: Mr. Chairman, the -- the financial markets are in a quite fragile condition, and I think absent a plan they will certainly get worse.

But even at the current state, they are not serving the necessary function to support the economy. Credit is not being provided. As Secretary Paulson mentioned, non-financial companies are not able to finance themselves overnight.

Credit is just not going to be available. It's going to also affect savers because of the value of their assets that they have.

So even in the current condition, even if things don't get severely worse -- but I think they would get worse without some kind of action -- this would be a major drag on the U.S. economy and will greatly impede the ability of the economy to recover in a -- in a healthy way.

The amounts involved are -- are intended to be enough, adequate. We don't want to go in and underwhelm the situation. That might be to suggest more problems down the road.

There have been some ways of looking at it. This is about five percent of all the mortgages outstanding, for example -- $700 billion. But it certainly illustrates the size of these markets and the size of the problem.

I think it is important to state, as I mentioned before, that this is not an expenditure of $700 billion. This is a purchase of assets. And if auctions are done properly, if the evaluations are done properly, the American taxpayer will get a good value for his -- his or her money.

And as the economy recovers, most, all or perhaps more than all of the -- of the value will be recovered over time, as was the case in other similar situations in the past.

DODD: Let me ask you this. Again, and we've heard our colleagues here and across the spectrum here, both politically and geographically, talk about the -- the impact this is having beyond, obviously, the -- the information we're aware of in terms of form -- firms that either disappeared or been consolidated, and the concerns about what's happening to people in the country -- their homes being lost and the like.

Explain, if you would, what is your concern as chairman of the Federal Reserve if we were not to act? Give us some idea of what you think the implications would be if we did not respond in one way or another to the situation that you just described?

BERNANKE: Well, again, I think the...

DODD: In terms of what happens outside of the financial services sector...

BERNANKE: Of course.

DODD: ... what happens to people out there, who have a job, getting ready to retire, worried about their kids education. These are matters which are going to be directly affected, I presume. That's the argument you're making.

Give us some sense, as chairman of the Federal Reserve, why those people's concerns are going to be in even more dire straits than they would be if -- if we did not act?

BERNANKE: Senator, you made my -- my point for me. I'm a college professor. I was criticized for taking the job without having been working on Wall Street. I never worked in Wall Street. I don't have those -- those interests or those connections.

My interest is solely for the strength and the recovery of the U.S. economy. I believe if the credit markets are not functioning, that jobs will be lost, the unemployment rate will rise, more houses will be foreclosed upon, GDP will contract, that the economy will just not be able to recover in a normal, healthy way, no matter what other policies are taken. I therefore think this is a pre-condition for a good, healthy recovery by our economy. It -- the -- these institutions provide credit for homeowners. They provide credit for businesses. They create jobs.

It's about the people who need that -- those services and that credit. It's about people retiring, who need to have assurances about the value of their investments and their assets.

Again, I think if this is not done, that it will be of significant adverse consequences for the average person in the United States.

DODD: And that's your recommendation as chairman of the Federal Reserve.

BERNANKE: Yes, sir, it is. I do believe we need to act to -- to stabilize the situation, which is continuing to be very unpredictable and very worrisome.

DODD: Let me, if I can, look at the -- just quickly at the foreclosure mitigation issue. I think there's general consensus here about oversight, accountability. We may argue about specifics, but I think every one of us here feel very strongly there's got to be strong areas now.

I think we all sort of agree as well on the issue of -- of taxpayer protection -- one way or the other, how the taxpayers are going to be covered in this -- in this proposal.

There's I think a greater debate probably about foreclosure mitigation. But let me run back if I can, and -- and remind you in May what you told this committee.

You said, "High rates of delinquency and foreclosure can have substantial spillover effects on the housing market, the financial markets and the broader economy. Therefore, doing what we can to avoid preventable foreclosures are not just in the interest of lenders and borrowers. It's in everyone's interest."

DODD: That was the chairman -- the Federal Reserve chairman, Bernanke.

Would -- would policies that help American families keep their homes and prevent closures (sic) help address the root cause, in your view, of the present crisis?

BERNANKE: Well, foreclosures are not all of it, but it's an important part. The housing market is very central to this whole issue, and I support and I have supported efforts to avoid preventable foreclosures. I have spoken about this on a number of occasions. And I think it would be helpful to the economy.

I would note that steps have been taken. The GSE conservatorship, for example, has already lowered interest rates and helped to stabilize the mortgage market, which will be supportive of house prices, and therefore reducing foreclosures.

The Federal Reserve is on the board of the Hope for Homeowners bill that was just passed by this Congress that involves $300 billion of -- of -- of purchases of mortgages to be refinanced into the -- to the FHA. I'm sure much more could be done. I will support further action.

I would note one -- two things. First, as a minor point, that one of the things that this program being discussed could do would be to purchase second liens, which have proved to be a very significant barrier to the resolution of -- of foreclosures.

But more importantly, the housing market is not going to recover if the economy is -- is declining, if jobs are being lost, if credit is not available. And so I do think you cannot separate these as two completely separate issues.

You need to have financial stability and financial markets working properly for the economy and the housing market to have a chance to recover.

DODD: Well, my -- my quick follow-on question, then, to Secretary Paulson is -- and I understand why you've been reluctant to get into the oversight and accountability questions.

But -- but given the fact that this is not just a cosmetic issue and a feel-good issue, but it goes to the very core of why we're here today, and if that's the core reason -- and you've said it over and over again, and I've quoted you; it's the bad lending practices that went on -- why didn't we include some mitigation for foreclosure as part of this, not because we want to send a message that we care about Main Street, but because if we don't address that, bad mortgages out there are still going to be a lingering problem, and our ability to address this is going to be -- is going to be less?

PAULSON: Mr. Chairman, thank you very much. As we thought about what is the best thing we could do to minimize foreclosures and deal with this problem, we thought, first of all, stabilizing Fannie and Freddie.

Secondly, Treasury has a program where -- where we're going to be buying and holding agency securities, and now that the government is -- is really behind them -- is, I think, a good use of -- of -- of taxpayer money, and it will help get -- it will help the market.

And then, of course, we all believe that the very best thing we can do is make sure that the capital markets are open and that lenders are continuing to lend, and so that's what this overall program does, is -- is deals with that.

Now, as the chairman said, we've both been very involved in working with services and others in avoiding preventable foreclosures. And there's no doubt that this program will give us more leverage in doing that, given the securities that will be owned, the second lien mortgages and so on.

So that was a way we looked at it, and we looked at it -- let's -- let's address the root cause through this -- through these authorities we're asking for.

DODD: Senator Shelby?

SHELBY: Thank you, Mr. Chairman.

I'd like to address this to -- my first question to Secretary Paulson and Chairman Bernanke. I assume that during your deliberations dealing with this crisis that you must have considered a range of proposals before you decided on the one that you proposed to us. Is that correct? Is that right? You -- you considered other proposals.



SHELBY: Could you just in a few minutes describe several of the proposals that you considered, telling us in detail the specific -- in specific terms why those proposals were deemed inadequate by both the Treasury and the Fed?

PAULSON: OK, I'll go first. We have, as you know, Senator, been talking with Congress and talking among ourselves for some time about what's going on in the -- in the housing area.

And we've worked very hard together to approach the foreclosure issue. And so there's a lot of work that was done in dealing with foreclosures, number one.

Number two, as you yourself have said, there was -- you saw some case-by-case approaches, and you know, I would argue that every one of those was absolutely essential and was necessary.

And as we -- as -- as we looked at this situation, we said the root cause of this is housing. The root cause is housing and the housing correction, and until we get at that, we're not going to solve it.

And as we looked at the -- how we get at that, there were some that said we should just go and stick capital in the banks, put preferred stocks, stick capital in the banks.

And that's what you do when you have failures, you know? That's what happened in Japan. That's what happened in other spots.

And we have -- we've dealt with some failures, and we've dealt with them where there's capital, and we -- but we said the right way to do this is not going around and using guarantees or injecting capital, and there's been -- been various proposals to do that, but to use market mechanisms.

And again, I think that some of the questions here and some of the frustration here I share, you know, on compensation and so on.

And when you deal with ad-hoc situations, when you deal with an institution that is failing or about to fail, and you have to buy mortgages or securities at well above value, or you need to put capital in, then you take tough compensation measures.

But as we looked at it and thought about this -- and -- and -- and we consulted together about this, you know, for a long time, and said ultimately -- and we hope we don't get there. We hope that this decline will -- can be arrested.

But we both have said that until the biggest part of the correction in the housing -- in housing prices is over, there's no way to -- to really have a stable financial system, so we decided that this market mechanism, and going out very broadly -- this is broadly to financial institutions all over and -- and working on the asset prices and -- and helping develop value that the market can build around.

SHELBY: Do you agree with that, Chairman Bernanke?

BERNANKE: I do, Senator, but let me just add a couple of comments. As you know, I'm a student of financial crisis and financial history, and we've looked at past experiences in the United States and other countries, like the Home Owners' Loan Corporation, the RTC, the RFC, Japan, other situations.

Those were all situations where -- again, as the secretary said, where you were dealing with failed institutions and having to dispose of relatively simple assets that were taken over by the government. That works in that context, and there are ways to do that. The situation we have now is unique and new. It involves not failing institutions, although we've had a few failures, but we've dealt -- where we had failures, we've dealt with them in a very tough way. You know, we -- we -- we've insisted on -- on, you know, bringing the shareholder value down close to zero, imposing tough terms and so on.

But the firms we're dealing with now are not necessarily failing, but they are contracting. They are de-leveraging. They're pulling back. And they will be unwilling to make credit available as long as these market conditions are in the condition they are.

So in order to address the illiquidity of the market and how to deal with these complex securities in the hands of going concerns, the -- the -- the methods used to resolve failed institutions in other contexts are not really appropriate, because that would involve -- it would involve, I think, a great deal of concern on the part of other potential investors that if -- if they invest in a bank that the government's going to come in and -- and take away their -- their value.

So I think that we're better off trying to address the root cause of the problem.

SHELBY: What banks would be eligible to participate in this plan, assuming Congress adopted it as you proposed it, in selling their non-performing assets to the Treasury or to an entity, and what size banks would be eligible to participate in that crowd?

PAULSON: Senator, thank you for that question, because that's where I think there have been broad misunderstandings, and maybe we did not communicate this properly.

But what we are seeking to address with this is we are seeking to address -- first of all, we're dealing with complicated securities, mortgage and mortgage-related, and we've got various asset classes here, and we need different approaches for different asset classes.

But when we use the market mechanisms, we want -- we're looking at thousands, you know, of institutions, because to make this run properly, we need to deal with big banks, small banks, S&Ls, credit unions, because what we're trying to do here -- and I think we'll be successful -- is to -- to develop mechanisms where we -- where we get values out there.

And where there's some value that the market can look at, then private capital will come in.

SHELBY: Are -- are you planning to buy assets of foreign banks doing business in the United States? And -- and if so, why, and how do you rationalize that to the American taxpayer?

PAULSON: Yeah, it's -- the answer is yes, and it's very easy to rationalize it to the American taxpayer.

SHELBY: Well, I -- I need your help here. PAULSON: OK. OK. Here's -- here's -- here's how I want to -- this is all about the American taxpayer. That's all we care about. And so -- so any -- any business -- any banking operation in the United States that is doing business here and dealing with the American public is important.

They're all important to keeping our markets open, keeping credit flowing. They're -- the American public, when they're dealing with the financial system, doesn't know who owns that -- that -- that bank. What they care about is how is this system working.

So we're doing this to protect the system, and it's about keeping credit flowing, protecting savings, making it possible to have car loans, student loans, mortgages.

And again, if you have operations in the United States and you're doing business with the American people -- that's what we're focused on, but let me also say to you we have a global financial system.

And when -- when I was on the phone a number of times, and -- and most recently Monday morning, talking with central bankers and finance ministers around the world, I urged them all to put in place, where it's necessary, similar programs or programs with similar -- similar objectives.

SHELBY: What do you say to people that ask us, or at least ask me, and I'm sure others, how do you rationalize or justify bailing out banks and so forth that cause -- are the root cause of a lot of this problem, where they will be made whole with capital -- at least, it will strengthen them?

And I understand that strengthens the economy, but they will profit dearly from this, more than likely.

PAULSON: Senator Shelby, I share your frustration, so I hate to be on this side of the table, because this is not something that I ever wanted to ask for.

SHELBY: I know.

PAULSON: But it's much better than the alternative. So what I do is I start off saying I -- I am not only concerned, I'm angry by the things that got us here, OK?

But the greatest protection for the American taxpayer, by far the greatest protection, is having this program work and having it be effective, because the consequences if it doesn't are worse.

When the credit markets -- you asked Chairman Bernanke about what would happen if it didn't work. When I look at the...

SHELBY: What's the worst...


SHELBY: ... worst case scenario under your plan? What if it doesn't work? You know, you assume it will work, but you can't assure us that you know it's going to work, because you thought some of the other plans would work.

PAULSON: Well, let...

SHELBY: And they haven't.

PAULSON: ... let me say this, with all due respect, Senator. I believe that Freddie and Fannie worked the way it was supposed to work. We stabilized that.

And in terms of the other actions, I will -- I would very respectfully submit if the Federal Reserve hadn't stepped in on AIG, we would have been facing a major calamity.

So again, I don't think any -- this -- this -- this problem has been growing for a long time. But to get to your question about this plan working, it gets to the root cause, housing; deals with illiquid assets.

It's going to free up balance sheets, let -- let capital flow, and it will lead to price discovery, private capital coming in, and injecting confidence in the -- in -- in the markets.

SHELBY: What does it do to the homeowner who's losing their home?

PAULSON: Well, I would say, regrettably, there's not every homeowner that's going to save their home. As -- as you well know, even in normal times, in good times, there are many foreclosures. There's some people that can't afford to stay in their home.

But there is a huge effort being made so that everyone that can afford to stay in the home and want to stay in the home stays in the home.

But what this plan will do is make financing available. And I don't think there's anything more important. Lenders have got to keep lending. If they're not lending and there's not capital available, homeowners aren't going to be able to stay in the home.

DODD: Thank you very much.

Senator Johnson?

And let me just remind my colleagues, we're going to try and keep you to this time now. We're going over, and I want to give everybody a chance to -- to ask some questions, so...

JOHNSON: Secretary Paulson, the Treasury, it seems to me, proposal rewards the bad actors, those financial institutions that engaged in irresponsible lending, have bad assets on their books, and needs help from the government to stay afloat.

What punitive actions are being taken against these companies and their CEOs?

PAULSON: Senator, thank you for the comment. The first thing I wanted to -- to say is this plan is broad-based, and it is dealing with the root cause.

And when we have needed to come in and do something to -- to save a failing institution, there have been very harsh consequences. And when we deal with one-off situations, I think there always should be very significant consequences. That's number one.

Number two, in terms of what needs to be done to fix the system, we could have a long conversation about that, and you're going to be busy for a long time, and you're going to be busy after I'm gone doing that.

I've given you my suggestions, and they are suggestions that have to do with a totally outmoded and insufficient regulatory structure.

When I got down there, and after about several months on the job, I was shocked, absolutely shocked, to find it wasn't deregulation, or too much regulation or too little regulation. It was a just flawed regulatory structure.

It was build for a different model, for a different financial system. The financial system changed. The regulatory system didn't change. And so that clearly has to be -- it clearly has to be corrected.

When you look at these mortgages, the vast majority of the mortgages that were -- that were -- that were originated with very, very shoddy procedures were regulated at the state level, OK? You can't come down here, come down to Washington as Treasury secretary and fix all that.

We made a proposal that I think is the right proposal for this mortgage origination commission, which would be a federal commission not to invalidate state regulation but to make sure there's common standards, enforcement. So there is -- there's a lot of things that need to be done.

And in terms of the compensation issue, there's a lot of things that need to be done there, but I would respectfully submit that we can't do those as quickly as it takes to get this system up and running, because that's what you care about.

You care about the constituents in your state, the average people, and Americans, in terms of what the impact is going to be on them. And unfortunately, and it may make you angry -- it makes me angry -- when you ask about the taxpayers being on the hook, guess what? They're already on the hook, OK?

They got put on the hook by the system we have, the system we all let happen, the system that Congress, the administration, future administrations let exist, and that -- and so if this system is not stabilized, they're going to bear the costs. The chairman explained that. I've explained it.

So the best thing we can do for all of them is to stabilize the financial markets so that people can continue to get loans, small businesses can get loans, small farmers in your states can get loans, big farmers in your states can get loans, and then go to work to -- to make sure that this doesn't happen again.

And that's going to take a longer period of time.

JOHNSON: Given what occurred with AIG, should the federal government regulate some or all insurance companies? Would an optional federal charter model be appropriate?

PAULSON: Well, in the regulatory blueprint that we put forward at Treasury, and we put forward well before we were in the midst of this crisis -- and it's something we've been working on for a long time -- there were a series of -- of -- of recommendations.

One was the Federal Reserve play the role of macro stability regulator to look for excesses and problems throughout the economy.

Another was there should be a federal charter for insurance companies. I strongly believe that. There's a lot of debate on both sides of the aisle here. That will take, in my judgment, a good deal of time to sort out. But that would be -- that would be my judgment on that one.

JOHNSON: Chairman Cox, last week you issued several emergency orders regarding short selling. How did the SEC determine which firms to include, and what happens when the orders' (inaudible) period expires?

COX: Senator, this is not a step that we took lightly. With the support of the Federal Reserve and the Treasury, and a unanimous commission, we took temporary emergency action directed at financial stocks for the purpose of stabilizing the market at a time when Congress is considering important legislation that may deal in a broader way with these problems.

The financial sector is defined according to standards that the SEC has provided to the exchanges. The exchanges themselves are making the particular determinations of whether their listed companies fall within those categories.

When the order expires, which it will because it's an emergency order, we will segue into sturdy protections against naked short selling. We already have permanent rule changes that have just taken place in the last week to make even stronger the existing ban against naked short selling.

JOHNSON: Mr. Lockhart, what will the GSEs look like when they come out of conservatorship, and how long do you plan on (inaudible) them in conservatorship?

LOCKHART: We -- we will certainly be working with the two companies and their new management teams to rehabilitate themselves and -- and work through the issues.

I think the time period will depend a lot on what's happening in the housing market and their ability to raise capital in the future. That may take a year or even longer.

But how they will look, I think, to a large extent may depend on where Congress wants to go.

Certainly, the legislation that was passed in July -- and I thank you for -- for -- for passing that legislation -- does create a much stronger regulator with the kinds of tools that would be needed to -- to regulate these companies going forward.

DODD: Thank you, Senator.

Senator Bennett?

BENNETT: Thank you, Mr. Chairman.

Chairman Cox, I'd like to spend time with you on the short selling issue. As you know, I've spent a lot of effort pursuing that, and I want to thank you for the diligence with which you have pursued that.

Having said that, I'm driven by the conversation to concentrate on Secretary Paulson and Mr. Bernanke, so don't take my passing over it as a symbol that I'm not still intensely interested, because I am, and that I'm not supportive of what you've done, because I am. I think you've done an excellent job, and I -- I appreciate that.

Chairman Bernanke, you -- you ran us through a tutorial, true to your college professor background, which I found very helpful, talking about the difference in hold-to-maturity prices and fire-sale prices. And there's going to be an auction, presumably, to determine what the fire-sale price is or what the hold-to-maturity price is. What are people going to be bidding on, do you think?

BERNANKE: Well, we know, more or less, what the fire-sale prices are. Those are the marks that a lot of... BENNETT: Right.

BERNANKE: ... companies have. You know, there are a lot of different ways -- auctions, auctions combined with expert evaluations and so on, to try to determine the -- the hold-to-maturity price.

So for example, if the government tries to acquire a substantial portion of a security, the marginal seller would be somebody who has a hold-to-maturity interest in it, for example, so...


BERNANKE: ... I think there are methods to -- to determine that hold-to-maturity price.

BENNETT: OK. Well, the best place to determine a price, obviously, is willing buyer and willing seller. But this is not going to be your ordinary auction, because the Treasury is going to be there with a $700 billion checkbook.

And the question that arises in my mind is who's going to bid against the Treasury? Against whom is the Treasury bidding? And what will affect -- what effect will that have on the price?

BERNANKE: It's a reverse auction, which means that there would be many bidders holding these securities who'll be bidding the lowest price in order to sell them to the Treasury, which is a reason why you don't want to limit participation...

BENNETT: So that's an offer, not a bid.


BENNETT: That's an offer price, not a bid.

BERNANKE: Well, it's a reverse auction, so that people are...


BERNANKE: ... bidding in order to...

BENNETT: All right.

BERNANKE: ... sell rather than to buy.


So will -- Secretary Paulson, do you anticipate that this might attract some outside capital into this auction and say that looks like a pretty good price, and -- and I'd like to own it at that price? PAULSON: Not exactly that way, but here's -- and again, let me come back and -- and -- and say to you, the reason we asked for broad flexibilities -- and the -- the chairman said it earlier -- is we're dealing with complex securities.

We're dealing with many classes of securities. We're going to need to use different approaches in different situations. So the reason we've been general and talked about market mechanisms -- we're going to have to involve experts. We're going to have to use different approaches.

The chairman said, you know, Treasury, we're going to -- we're going to need to get some really good asset managers. We're -- we're going to -- we'll do a certain amount of experimentation.

But if this works the way it -- it should work -- that once there is a, you know, bid from Treasury, and -- and there's more learned about these securities, the -- the thought would be that then it's easier for private capital to come into the market...


PAULSON: ... and that there'll be some price discovery mechanism.

Now, again, the -- the...

BENNETT: Let -- let me just comment on that. The price discovery mechanism in a simple world -- and you're describing a very complex, un-simple world -- has to do with the cash flow the underlying asset will produce.

And I would think the problem here is determining what that cash flow is, and is that what you're bringing all these experts to determine, what -- what this is going to be?

PAULSON: I wish it were that simple, because -- and even that would not be easy. What -- what the chairman said -- and when -- when he presented, he said no one's been faced with this situation before.

We spent a lot of time thinking about it, and there are different types of assets classes -- mortgage derivatives. There's mortgage- backed securities. There's -- there are different -- whole loans.

And so when you look at dealing with this, we're going to have to use different approaches in different situations, and there'll be market-based approaches, and that's all -- you and I can't sit here and figure out what the auction technique should be, and how to use it, and -- and in what situations to use it.

So what we -- we asked for was broad-based authority to use -- to use a series of market-based approaches, and we'll be dealing in different -- different approaches in different situations.

We can't sit here and say, "Here is -- here is the reverse auction we're going to use in every situation." So we need... BENNETT: Well, my -- my time is up.

PAULSON: We need flexibility.

BENNETT: Yeah. I understand that.

My time is up. I just want to -- to leave this -- this last comment. This is the -- the whole core of what you're trying to accomplish, and this is the whole problem with our giving you...


BENNETT: ... blank check authority to accomplish it, because in theory, it's easy to describe and it will work, but if you end up paying too little to these institutions, which mark-to-market accounting might drive you to, you're not giving them the support that they need.

If you end up paying too much, then there's no upside potential for the -- the taxpayer when the time comes for you to liquidate these.

And the details of how you find the right balance here are the ones that all of us need -- you, certainly, as much as we -- all of us need to understand better as we -- we make our determination of whether or not to support your proposal.

PAULSON: You're right, and you -- you have defined the problem, and the problem is easier to define than to solve.

And we believe that we're going to get the right group of experts, and we're going to -- we are going to come up with a solution, and it will be different with different asset classes and in different situations.

And as I said, this should not be confused -- because some people have confused it -- for instances where you need to go in and, you know, do things that are extraordinary things to save an institution. So those are -- those are two different -- two different -- two different actions.

But for this system to work the way it needs to work, we need a broad group of -- of institutions, banks and S&Ls, to want to participate, and we need them to participate, not just those that are under immediate pressure.

And so that's -- for this to be effective, it's got to be designed to have it work that way.

BENNETT: Thank you, Mr. Chairman.

DODD: Thank you very much.

Senator Reed?

REED: Thank you very much, Mr. Chairman. Chairman Bernanke, the equity participation rights which were a central part of the AIG arrangement -- were they punitive in nature?

BERNANKE: Well, they're -- they're 80 percent...

REED: Well, no, I...

BERNANKE: ... participation.

REED: Was that a -- was that a...

PAULSON: Seventy-nine nine.

BERNANKE: Seventy-nine point nine percent.

REED: You specifically wanted to punish AIG?

BERNANKE: Our terms included, besides 79.9 percent, an interest rate which is currently over 11 percent, and essentially a super lien on most of the assets of the company. So I think that it's a very tough deal that we struck.

We did that because we wanted to protect the taxpayer. At the same time, we were concerned about the implications for the markets of the failure of this large -- large company.

I'd like to say I think we do have a serious too big to fail problem in this -- in this economy. It's much worse than we thought it was coming into this crisis, and as we go forward, we need to develop methodologies to reduce that too big to fail issue, and this is what happened.

REID: Why wouldn't equity participation rights work in this arrangement to protect the taxpayers and reimburse the taxpayers, particularly with the difficult problems of pricing these securities, the different arrangements that Secretary Paulson suggested that might be undertaken, and the need really to assure the public that this not a one-way salvation for Wall Street at the expense of taxpayers?

BERNANKE: The reason it's that -- is that when we dealt with Bear Stearns or AIG or Fannie and Freddie, those were situations where the company was about to fail, had no option.

We came in to prevent failure for systemic reasons. In those situations, it's appropriate to knock the share values down low as -- as -- reduce the moral hazard for subsequent events.

But if we're dealing with going concerns, companies that can -- you know are -- are still operating and have reasonable business prospects, we don't want to threaten the companies with -- with reducing their share value to zero, because that will obviously...

REID: Well, no one was suggesting that you reduce the share value to zero, but I think in that context of going companies, this program will be strictly voluntary.

There will have to be a business judgment made by the managers of that company whether it is worth it to them to enter into this transaction to rid their balance sheets of toxic assets.

Right now the price of admission is zero. I think it's not inconceivable or inappropriate to demand in that calculation they recognize if they benefit from this transaction in the future -- and that's the notion of a warrant or a participation in the future -- that they will share that benefit with the taxpayers who have made the benefits possible.

BERNANKE: Well, just -- I just would note that if you -- if you leave the risk on the balance sheet in that way, you really haven't accomplished anything.

REID: Well, if a company is willing to accept those risks, manage those risks themselves, they don't need a bailout.

If they're unwilling to do that or cannot do that, then they should pay for it -- at least in a contingent fashion, which is the essence of this whole issue of participation rights or warrants or whatever you'd like to call it.

PAULSON: Let me approach it this way. This is a huge...

REID: Do you want to turn that on a minute so we can hear you, Mr. Secretary?

PAULSON: OK. Approach it this way. This is -- when you talk about what the companies need, this is not about the companies. This is about the American people. We need something to work.

And for something to work here, rather going to a group of troubled institutions that need to sell and say, "Here we are. Sell to us. You know here's all the things we want from you in -- in turn for that," we need and we want for this to work -- a broad range of institutions to willingly -- not -- not that we have to go and sign them up -- but to willingly participate, because we're trying to find value.

And we're trying to get markets working, because we don't want to have to deal with a failure. RTC is about failure. Putting capital in institutions about failure. This is about success.

REID: Mr. Secretary, you are suggesting that these very brilliant financial people, who are running these companies, would risk the failure of their enterprise by not participating in this function, because now we've imposed a contingent reimbursement to taxpayers.

PAULSON: Let me just say one more time. I am as frustrated as you are about compensation.

REID: This is not about compensation, Mr. Secretary. This is not about what they get paid. This is about when they do well, and if they don't well, the value of the warrants are not -- are zero.

PAULSON: Here -- here's what I'm saying, and we will -- that if -- if this -- when we protect the taxpayer, the right way is to have the program work and have the assets appreciate the economy appreciates.

I'm saying that the model you are looking at is the model where we go to people that absolutely need to sell and say, "If you want to sell, give us something."

The model we're looking at is -- and -- and what we believe it takes to be successful here -- is to go to a broad group of institutions, and a very, very wide range of institutions that own these assets, and have them participate.

And if we deal with selectively -- or as we deal with situations where there's -- where there's serious trouble, to use a different approach. But anyway, I -- I appreciate your comments.

REID: Mr. Secretary, one other way to describe what you just said is to go to some institutions that don't need help, and we give them help for free.

But let me change the subject, if I may -- and I'm -- I'm indulging the chairman's time.

In this reverse action, it's very difficult to set the price, but one of the principles -- would one of the principles be that someone cannot sell to you or bid to you at a price higher than what they paid for? Because today there are funds that are collecting distressed assets at discount prices.

If you don't have some protection like that, they will walk in, and they could -- could very well sell you something that they paid much less for.

PAULSON: Yes, well, first of all, Senator, we are going to be dealing, and our intent is to be dealing with regulated financial institutions, OK? That's number one.

And number two, the reason we want to deal with it on a broader basis is -- is so we don't get into that situation.

But thirdly, it won't be -- let's not focus on one reverse auction. That's one way of doing it. There will be a number of market mechanisms. I think a reverse auction is -- and there's different forms of that.

UNKNOWN: It's not regulating them.

REID: Mr. Secretary, then you would not oppose language in legislation that will restrict this to regulated financial institutions?

PAULSON: I would -- what I would like, whether in the negotiating language here -- what I would like is I would like as much flexibility, but the intent would be to deal with regulated financial institutions with business operations in the United States.

REID: Thank you.

DODD: That's a very important point -- what is the definition of a financial institution and whether or not you're limiting it to regulated financial institutions.

Senator Enzi?

ENZI: Thank you, Mr. Chairman.

And I appreciate the questions that Senator Reid had. I had a number of those, too, on equity sharing and future assessments.

Actually, all the questions that I have I'd -- I'd like everybody to answer them, but we don't have time to do that, so I'll ask them of -- of one person, and I would hope that you would have your staffs get together and answer for -- for me later, but not very late.

One of the things that follows up on Senator Reid's question is what happens if Treasury can't price the assets accurately? This is for Secretary Paulson. Shouldn't we have the process designed before we do $700 billion in -- in an experiment?

Treasury has to set the perfect market for the assets, and I'm not sure that I have faith in the ability of the federal government to emulate the free market.

How can an artificial market drive a real market for these assets?

PAULSON: In terms of that, I would say you pointed to the complexity and the difficulty.

I would very respectfully say that if the federal government tried to legislate a proscriptive solution, it almost certainly wouldn't work when you're -- when you're getting into the -- to the market mechanisms.

Again, you're asking me about free markets and how the government's going to work better than free markets. And listen, I -- I have never been a proponent of intervention.

And I just think we have an unprecedented situation here, and it calls for unprecedented action. And there is no way to stabilize the markets and deal with the situation other than through government intervention.

And so what we're going to do -- we put forward something we thought about for a long time in terms of the issue and different ways of dealing with the issue.

And so what we're asking for is -- is some broad powers with some -- with some good, strong oversight. And -- and we think that's the best way to protect the taxpayer. That's -- that's our view.

ENZI: I want to get into something a bit more specific on that, because I'm -- I'm concerned about the -- the small banks in this reverse auction situation, because a lot of the details are left out. As you say, you don't want it to be proscriptive.

But the reverse auction that you -- you described in your testimony...

PAULSON: We're not -- we're not just recommending reverse auction. It would be one -- one way of handling it.

ENZI: OK. But just on the reverse auction part of this, I mean we're going to have questions on -- on all parts of it, but I think it will help the big banks to sell their toxic debt.

But what about the smaller banks? How are we going to be able to compete with the Citigroups and the world to sell their assets?

Economies of scale suggest to me that the plan will bail out the big banks, and our community institutions might be left holding the bag. What kind of consideration has been given to that?

PAULSON: Well, that's -- we are very focused on that, very focused, because to have this work right, we're going to have to go broadly, because only by going broadly in a number of these asset classes and these securities are we able to -- to really deal with the market.

And so that -- that's something that we -- we have very much in mind. And if this -- if this were just about going to -- to a few big banks, we would have designed an entirely different program with a -- with a different structure.

ENZI: Thank you.

Chairman Cox, I'm always interested in the accounting aspects of all of these things and the effect that they can have on it -- and been looking at getting some authority to spend the -- suspend the market-to-market accounting.

I -- I know that writing regulations takes a long time, but sometimes if it's included in congressional language, it can short circuit that and -- and make it possible.

Another -- another area that I've gotten a lot of comment from -- the small banks that hold the GSE stock -- they'd prefer that that be considered a loss to the bank rather than -- a loan loss, rather than a stock loss. Some implications like that I'd -- I hope that you're taking a look at them.

I know that we have talked about this being a fire and wanting to put the fire out before we address the fire code, but I'm -- I'm hoping that we'll take a look at all tools and make sure that this -- this proposal has all the tools possible so that we're not throwing water on an electrical fire.

Have -- have you given consideration to whether Congress would need to act on some of these accounting things, or whether you have enough authority to do that?

COX: Senator, both the United States and international accounting standard setters are very focused on the need to provide timely guidance on the fair value issues that several of you have raised here this morning and this afternoon.

In fact, today the FASB's valuation resource group is meeting to address these very application issues in the context of U.S. generally accepted accounting principles with a goal of providing timely guidance to companies.

ENZI: Thank you. My time's expired. I'll have additional questions.

DODD: Thank you very much, Senator.

Senator Schumer?

SCHUMER: Thank you, Mr. Chairman.

Thank all the witnesses. This is not a easy day.

One of the things, as I mentioned, I want to focus on is taxpayers. And so I have a couple of questions in that regard, first to Chairman -- Secretary Paulson.

One of the things I've thought about is whether we shouldn't create an insurance fund similar to the FDIC for the whole financial system.

All firms over a certain size would pay -- not small little community banks, but everything else. They would pay a fee, not too onerous or too large, but over time it could help defray the -- the costs of any losses we might suffer.

Actually, it's the financial system that has the trouble, and the taxpayers are bailing it out, as you say, in part because it will help the taxpayers. But why does the -- why do the taxpayers have to hold -- do the whole thing?

What would be your initial reaction -- I'm not asking for a commitment here -- of some kind of a broad FDIC that would help pay for some of these losses from financial institutions, as I said, above a certain size, whether they participate in the program or not?

PAULSON: Well, one thing that both the chairman and I have talked about a lot, have spoken with -- with the chairman and Senator Shelby about, is that we were not left with the authorities we needed fully to protect the system and the taxpayer, because we have wind down authorities, where the insurance or you know savings depositors, FDIC insurance -- in 75 years you know we haven't had a saver with FDI insurance lose a penny.

SCHUMER: Yes. So it works.

PAULSON: For a hundred thousand.


PAULSON: So what -- what you need is if a -- but if a non-bank, or for someone without deposit insurance, fails, in many cases there's just bankruptcy, and that throws the system into disarray. So...

SCHUMER: But this would be different than FDIC. PAULSON: That's right. So -- so that's right. And so I'm saying so if you had wind down authority, then you've got to say, "OK, how do you pay for it?"

And there's various ways to pay for it, and one way, as you've mentioned, would be some kind of -- of broader industry-wide tax.


PAULSON: And that -- that -- but that is something we -- we didn't have, so we have to use...

SCHUMER: OK. Good. You would be open to it, in other words.

PAULSON: Yes, right.

SCHUMER: And would you think it might be a good -- might be a good idea, Mr. Chairman?

BERNANKE: Potentially, yes, but I think it's more important...

SCHUMER: Well, I think I'm going to cut you off right there.

BERNANKE: ... it's more important to...


It's very important to try to address this "too big to fail" problem.

SCHUMER: Yeah. Understood.

BERNANKE: It's a real problem.

SCHUMER: Understood.

But I think this -- on the second question, again, about protecting the taxpayers, I think in some of our informal discussions, when we asked why $700 billion, and over how long a period of time, one of you -- I think somebody mentioned it would cost about -- probably use about $50 billion a month.

If that's the case, and you're certainly not going to use all $700 billion immediately -- and, as you can see, there are a lot of questions about whether this would work.

We understand you've done your best. You think this would work best. But clearly, we're in uncharted waters with Scylla and Charybdis around.

What about doing this in tranches? Why couldn't you ask us for $150 billion and, on January 15th or January 20th, we would come back, we'd assess how this worked, and grant some more money if it's really working? Maybe, you know, the markets will have stabilized and you actually will have made money. Why ask for the full $700 billion? I never thought I'd think that $150 billion is a low sum of money, but compared to $700 billion it is, and I think it would make people sit not easily, but at least a little easier.

PAULSON: I'll give you my answer, Senator. I think you got at it when you said "when we come back in January," because what we need to do is we need to stabilize the system, and we need to -- this is on market -- based on market -- we need market confidence, and we need the tools to work with.

Now, of course, we plan to do this in tranches. And again, as a number of people have said, this is not an expenditure -- I know that this doesn't fit into your -- your outlay system in Congress. The taxpayer is on the hook.

SCHUMER: Yes. Yes.

PAULSON: But again...


... it's purchasing assets. They'll be held. They'll be resold. Money will come back...

SCHUMER: Understood.

PAULSON: ... come back in.

But to your basic question, we think we need the full authority for that size to do the job and stabilize the market.

SCHUMER: But could you -- could you live with less?

PAULSON: That doesn't mean -- that does not mean that it's going to be invested -- be spent between now and January. We're going to...

SCHUMER: Could you live with less? I think people would feel better if it were -- if we did this and could come back and reassess it. As I said, it's uncharted waters, so I'm not asking you to support it now.

But again, could the system work if we put in the legislation, say, this is the first tranche, and by January 15th, say -- just pick a date -- Congress will come back and reexamine?

PAULSON: I think that would be a grave mistake.

SCHUMER: And why?

PAULSON: Because I think what this is about -- it is about market confidence and having the -- the tools to do the job.

SCHUMER: Well...

PAULSON: We're -- we're going to do this in tranches, but I -- I'm wondering, when Congress is gone, and if -- if we need -- if -- if we need this, what it is we do.

And so again...

SCHUMER: Well, the president -- if there's an emergency in any -- of any type...

PAULSON: Well...

SCHUMER: ... if this doesn't work over the next two months, and the cataclysm that Chairman Bernanke has talked about -- you're going to have to call us back into session if you need some other type of authority.

I -- I -- I have to tell you, I -- I'd ask you to think about this. I know ideally you'd like to just have as much as possible, but you're not going to use $700 billion in these three months. It's a huge sum of money, even $150 billion.

And the confidence in the markets will be determined how -- by how well it works initially, not by how much money you have in your pocket next to your bazooka.

PAULSON: Well, I would say -- I would say, with all due respect, Senator, you're going to have to decide -- we -- we've -- the -- the two of us...


PAULSON: ... have made the recommendation of what is -- what is required. As you said, this will not be spent or invested right away. It's going to be done in tranches.

And all we're doing is giving you -- again, I don't like to be in this position asking for things and -- and you know, answering to the American taxpayer on this. I think this is -- but it's -- it's...


PAULSON: ... a sad story, but the American taxpayer, as I said, is already on the hook.

And you know, here's the other thing I want to say to you, because it's so important. This is not about big financial institutions.

Every American employer depends on money flowing through our financial system every day, not just to -- to create new jobs, but to sustain and keep existing jobs. What we're playing with here is very important.

And again, give us the tools we need to -- to make this work.

DODD: Thank you...

SCHUMER: Thank you, Mr. Chairman.

DODD: ... Senator Schumer, very much.

Senator Hagel?

HAGEL: Thank you, Mr. Chairman.

Secretary Paulson, you have addressed a number of questions regarding reverse auction elements and how it would work.

If you could explain to the committee your concept of the implementation of the plan, focusing first on a framework of oversight, which -- you noted in your remarks why that was important.

How do you conceptualize this working? Who would be the oversight? How would it work? I know Chairman Dodd has laid some ideas down.

And then let -- let -- and then take us down from that, the oversight structure, and then -- and then the implementation of the plan. You have noted, I think, in your words, the right group of experts that you'd bring in on...


HAGEL: ... evaluating equities and so on. Walk us through that.

PAULSON: First of all, in terms of -- and this is what we're -- we're working through right now with -- with your committee and with others. We need to have -- we need to have transparency here. We clearly need protections.

There -- there has to be oversight, and we're -- we're going to work with you on that group, but -- and we have to be effective and efficient, and we can't get slowed down to the point we can't do the job.

And so this is a balance we're -- we're -- we're all going to need to work on together. And again, as I said, in terms of the -- of the market mechanisms, we can spend a fair -- and I know our staffs will spend time together on this.

But again, there are so many different asset classes, some held by a very broad range of institutions, that what we're going to do is look to use market mechanisms and bringing in some of the -- the very best asset managers and others to work with our people, getting -- getting help from within the government, help from obviously the Fed, other talent we have here, to -- to make this -- to make this work.

But there's -- there -- there's not -- this is not a situation where we can come up and say here's what we want to do, here's how we want to price it, here's the -- here's exactly how the reverse auctions will work.

HAGEL: I understand that, but that's not really the question. You understand, as does everyone on this panel, why these hearings are so valuable. They're valuable, in my opinion, first because they allow you to educate and inform the American people and the committee as to how these kinds of things work.

And there's a tremendous amount of misunderstanding, as you know, and it's been reflected by comments this morning, misunderstanding of how does this work. Are we just putting $700 billion of taxpayers' money out here with no oversight, with no structure?

So what I want to bring you back to is are you envisioning an oversight board, once-a-month meetings, or how -- just walk me through in very layman's terms so someone could understand how are you going to do this. How are you going to implement it?

Also, does the Treasury have the capacity, the capability, to administer something this big?

PAULSON: Well, those are very good questions. Let me answer them.

First of all, we need an oversight board, OK? We need and we want it, OK? And -- and so what -- and the way I envision this working is with great transparency so that the board clearly knows what we're doing, we can explain this to the American people, as complicated as it is.

And the -- again, the -- the process which we're looking at doing, which I think has been misunderstood, is something that would be broad-based. If it is -- and to a large extent broad-based.

There may be some parts of it that need to be more narrowly focused, and then we will deal with that, use different -- different methodologies and different approaches to deal with that.

And so it would be something that, as we went along, and as we started -- and we would probably start with a simpler set of securities, something simple like mortgage-backed securities, as -- as opposed to something more complicated.

And we would go out and we would do -- the first tranche would be, obviously, a smaller tranche, not a -- not a significant part of the -- the $700 billion, and we would get out quickly into the market.

And we would -- we would be very clear to me what it is we've done, and so that -- that is the -- really, the -- you know, as -- as much right now as I can say to the American people, other than that the key thing for the American people is that the -- if this works the way it should work, the assets -- this is not an expenditure. This is an investment.

And as the economy grows, as housing corrects, these assets should appreciate in value. The cost to the taxpayer will be far below what is invested in -- in the assets. Some people have mentioned that under certain circumstances you could actually make money. We're not committing that. We're saying the taxpayer is at risk.

And we're -- we've also said, very up front, that we're going -- there's going to need to be some experimentation, because we're dealing with things that have -- haven't -- have not been dealt with before. And so there will be experimentation.

In terms of experts, we're able to attract, and we have attracted, a variety of experts, and we're going to continue to bring them in. We want best and brightest working with us as we go through this.

HAGEL: Thank you.

Mr. Chairman, thank you.

DODD: Thank you, Senator Hagel. Thank you, Senator. Thank you, Senator Hagel, very much.

(OFF-MIKE) turn now to (OFF-MIKE)

(UNKNOWN): Thanks. Thank you -- thank you very much.

I -- first of all, a question for -- for Chairman Cox, if -- if I could. I -- I -- I've been in -- out of the -- out of the hearing for a while, chairing a hearing on the census. The census has had its share of problems in the last year or two as well, and I think we're getting that one resolved.

And I totally -- the director of the census, if -- when he finishes getting the census ready to roll, we might bring him in and help address this -- this issue. He offered -- he offered his -- his -- his -- his -- his assistance.

A question for -- for -- for Chairman Cox. We talked a -- a little bit earlier this week about short selling, and the role that that has played in getting us into the jam that we're in today, and I know you've -- have not just some thoughts, but have taken a number of steps.

Just a little bit of a -- of a short selling 201 for -- 101, short selling 101, for us, and what role do you believe it is playing and it has played in -- in getting us to where we are today.

COX: Senator, the decision to intervene in market rules in this way was highly unusual and a very difficult one for the commission. It's not a step that was taken lightly.

It was taken with the support of and in coordination with the secretary of the Treasury, the chairman of the Federal Reserve, but also, importantly, international regulators. As you noticed, the U.K. took this step, and we worked very closely to coordinate our actions with them.

We have been in contact with our counterpart regulators around the world, who are taking related actions in the current circumstances, narrowly focused on financial stocks.

And the reason is based on the connection between the share price, which we have seen, and confidence in the institution itself.

We have got healthy institutions, or -- or at least all institutions -- perhaps there are none healthy anywhere, but if that's the case, we have the kind of problem that the Congress is here to address -- that are put at risk if there is a downward spiral based not on normal information but on fear.

And so in this climate, we want to make sure that decisions in the market are going to be made in a way that protects the overall market and investors in it, but we also want to get out as quickly as possible. That's why this is an emergency order. It's very narrowly tailored, and it is time-limited.

(UNKNOWN): All right, thank you.

I -- I don't know if you all have gotten into this today. Let me just ask this -- but I think the proposal offered by Senator Dodd includes the creation of a special inspector general.

I believe the -- the -- and my understanding from the House bill is they -- they don't create an inspector general, but they -- they do call on the General Accounting Office, the comptroller general, to play a -- a role with respect to -- to accountability going forward.

And my -- my -- my question is for -- for each of you. I'm going to start with -- with Mr. Lockhart. I don't know if you've fielded a lot of questions today, but we're going to make -- make sure you earn your keep here.

And we'll just turn to you first. What -- what are your thoughts on the creation of an inspector general to oversee this program?

I'm just going to come right down the -- right down the -- the line, if you will.

LOCKHART: Thank you, Senator. Our view is actually we are getting an inspector general as part of the new legislation that was just passed.

LOCKHART: Inspector generals are a useful part of the government process. I have found them useful. And I've certainly found working with GAO useful in my career, as well.

(UNKNOWN): All right. Thank you.

Mr. Cox, Chairman Cox?

COX: I would support it.

(UNKNOWN): All right.

Mr. Chairman, Chairman Bernanke?

BERNANKE: I think you need to have rigorous oversight, and -- and OIGs are a -- the Federal Reserve has an OIG, as do many other agencies, and they're very effective.

(UNKNOWN): All right. Thank you.

Secretary Paulson?

PAULSON: I would say the same thing, but I -- I don't think we can sort of design it here today, but we clearly want -- for -- for -- to protect the American taxpayer and for all of our protections, we want -- we want oversight.

(UNKNOWN): And another question that kind of relates to the one I've just asked, but in -- -- in -- with respect to conflicts of interest or the potential for conflicts of interest going forward, the Treasury plan calls for -- as I understand, for -- for private sector portfolio managers to basically run the day-to-day management of -- of the -- the assets that would be purchased by the -- the Treasury.

And while this may be more efficient than creating a -- a government entity -- and my -- my first thought is to -- to be supportive of what you're asking for, but it also does create some possible -- possibilities for -- for conflicts of interest.

Let me just ask, what safeguards need to be put in place to minimize, in your view, any potential conflicts of -- of -- of interest?

PAULSON: Well, I would say we're -- we -- we can't design these here, but we're -- we've been very conscious of this, and when we've dealt with advisers before, we've been very careful about how we do it.

But I -- I just can't emphasize enough to you how important it is that we have experts available to begin working quickly, because this is about market confidence, effectiveness, and so we need to balance, OK -- we -- we need to balance the -- the need to go quickly with -- with the protections we build in.

And I want strong oversight, strong protections, great transparency, and as this develops, I'm -- I'm sure it will evolve, and it will -- it may evolve in various different ways.

But right now, we need to get up and running and deal with the market as it exists.

(UNKNOWN): Thank -- thank you for that response.

I -- my -- my time's expired, and I'm not going to ask another question, but I do want to make a statement to -- just to follow up on what others have said, Mr. Chairman, and what I said earlier during my opening statement.

I went back in time and I -- I asked us to recall the -- the Chrysler bailout, where the federal government did not take an equity position in Chrysler. The federal government did not actually make a loan to Chrysler. The federal government actually guaranteed loans.

And ultimately, our guarantee was never exercised. We didn't actually have to -- to use the -- the guarantee, although there was -- it was out there. But at the end of the day, we made money. The federal government, the taxpayers, made money, recovered money, on behalf of -- of -- of our citizens.

And the -- and the Resolution Trust Corporation, when it was established, my recollection -- Resolution Trust Corp didn't go in there and take an equity position in -- in savings and loans.

The Resolution Trust Corporation took off the hands of the S&Ls the non-performing loans, and a lot of them were actually good -- good -- good investments -- shopping centers, apartment complexes, and on and on.

And they had -- because of the condition of the market, they -- they had fallen in value. They were actually taken off the books of the -- the S&Ls, held for a period of time, and all -- as the economy recovered and as values -- property values recovered, the -- the Resolution Trust Corporation was actually able to -- to recover a fair amount of money for the Treasury.

We need that kind of thinking. We need to be entrepreneurial. We need to be -- and I don't know at the end of the day of the federal government ought to have an equity position in these -- in these companies.

But at the -- the end of the day, I don't -- I don't want to go home unless we can say to the -- the taxpayers in my state we've come -- we've come as far as we can, as close as we can, to recovering every dime we put into these companies, and lastly, to be able to look them in the eye and say, "We have made, to the best we can, every effort to ensure that no bad behavior is being rewarded," and the people who should not be rewarded when there's financial -- they're not going to get -- they're not going to get rewarded.

Thank you very much.

DODD: Thank you, Senator, very much.

I just briefly wanted to make a point, because I think this is something we've missed a little bit. If we were to move forward with this, the idea of giving the -- the Treasury, with all of the oversight and -- and accountability built in -- is the authority to deal with this.

What I think needs to be said, Mr. Secretary -- unless you're going to tell me I'm -- this would not be allowed under your plan -- is that if you discover along the way that there's some better idea or some variations of these ideas that would work better -- and there are a lot of -- number of ideas we're all hearing about from people from the world in which you come.

But there's nothing in here that would prohibit you from -- from using the flexible notions and thoughts out there on how a better approach might work -- an equity infusion, for instance.

PAULSON: Mr. Chairman, you said it better than I did. And this is -- I am not looking -- and I did not want to find myself in this position.

I didn't want to find myself in the position of being here asking for these authorities. But under the circumstances, I think they're better than the alternative.

This is something we will work on together. And if -- if -- as we -- if -- as we learn, if there are better ways of doing things, we -- clearly, as we get into the markets, we are going to learn. And our whole objective here is going to be to minimize the -- the ultimate cost to the taxpayer.

DODD: Senator -- Senator Dole?

DOLE: I'd like to ask Secretary Paulson, Chairman Bernanke and Chairman Cox the following question. According to the Wall Street Journal, the market for credit default swaps has reached $62 trillion, up from $144 billion, as of 10 years ago.

The issue of credit default swaps, as I mentioned earlier in my opening comments, is one that I've consistently raised throughout the year, beginning with Bear Stearns in March -- the transparency of this market and what regulators have been doing to improve oversight of these securities.

Chris Cox has spoken today to the regulatory issue. At the time, though, the Treasury Department, Federal Reserve and SEC all testified that these CDS securities did not play a major role in the situation at Bear Stearns.

Now, Americans come to learn that these same securities, credit default swaps, played a role in the collapse at Lehman Brothers and the government intervention of AIG.

Simply put, what has changed? And given that we now know they played a significant role in the demise of AIG and Lehman Brothers, will the Treasury Department plan on purchasing some of these illiquid CDSs?

PAULSON: There -- there's some confusion here. Let me -- let me explain. This is a huge market, and we have all, from the day I came down here, my very first meeting -- as a matter of fact, my first meeting with the president -- talked about these issues.

And we've all -- we've been working with the Fed, because there -- there's this huge market, and the most important thing that needed to be done was to build the protocols, to build the -- the infrastructure, to -- to handle this. And so we've all known the risks.

As a matter of fact, the -- the fact is that the reason -- one of the major reasons that the government helped out in the Bear Stearns situation was to avoid throwing it into bankruptcy with all the credit default swaps, and not having the infrastructure.

One of the reasons the chairman has said to Senator Schumer even more important than the wind-down in the insurance, is the "too big to fail," and part of the reasons for the "too big to fail" is the lack of all the infrastructure and protocols and discipline around the over-the-counter derivatives market.

But it's not as simple as to just say let's just regulate it. The -- there -- it's -- this is a market that regulators, led by the New York Fed, have been making huge inroads in with the industry, and there's a lot more that needs to be done on this market.

So it's a big problem. We've been focused on it for a long time. How it got here is another story. But we -- we would -- we've been dealing with it.

BERNANKE: Senator Dole, this -- this is a -- an instrument that's grown extraordinarily rapidly, as you point out, more -- more quickly than the infrastructure that supports it.

And the Federal Reserve, particularly the New York Federal Reserve Bank, have been extremely active in working with market participants to improve the transparency, the clarity, of those trades, to develop protocols in case the -- case there's a failure, how to deal with that, and to move toward a central clearing -- a central counterparty that will help, you know, make these a safer -- make this a safer market.

So we're -- we're working on that and making a lot of progress. It's part of a broader plan to try to make the system more resilient, more transparent, so that when we have crisis conditions that, you know, those problems will be much less severe.

So we understand your concern, and we've been working very hard to try to make that market better.

DOLE: Yes?

COX: Senator, I think that there are several issues here. One is the infrastructure issue that the SEC is working on with the Fed, and the Treasury, of course, and the President's Working Group are very aware of this, and this has been a leadership effort for some time.

It is important to have an OTC derivatives clearance and settlement infrastructure that works much better. It is important to have a central counterparty.

It's also important to note that legislation has expressly excluded CDS from regulation even of the most modest kind, such as disclosure, and the lack of disclosure, the lack of transparency, around this market is one of the reasons that we as a law enforcement agency, but also market participants, are very, very concerned about this.

We have seen what happens with these regulatory holes. We had a big regulatory hole around investment supervision. We now have right in focus -- and we can see how this works -- a big regulatory hole around CDS.

Holding a credit default swap is, you know, effectively or nearly effectively taking a short position in the underlying. But CDS buyers don't have to own the underlying.

They don't have to own the bond or the debt instrument upon which the credit default swap is based. So they can effectively naked short it.

This is a problem that we've been dealing with, with our international regulatory counterparts around the world, with straight equities. And it's a big problem in a market that has no transparency, and people don't know where the risk lies.

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