The Treasury Secretary Geithner, and Fed Chairman, Bernanke, were grilled during Congressional testimony Tuesday. Also includes comments by CNN pundits and reporters. Read the transcript. Excerpt below:
GEITHNER: Thank you, Mr. Chairman.
As we've seen with AIG, the stress at large complex financial institutions can pose risks as dangerous as those that led the United States to establish a full framework of tools for dealing with banks.
We need to extend those protections and authorities to cover the risks posed by our more diverse and complicated financial system today. And we are proposing legislation the provide those tools and look forward to working with this committee and the Congress to pass such legislation as quickly as possible.
The proposed resolution authority would allow the government to provide financial assistance to make loans to an institution, to purchase its obligations or assets, to assume or guarantee its liabilities, and purchase an equity interest.
U.S. government as conservator or receiver would have additional powers to sell or transfer the assets or liabilities of the institution in question, to renegotiate or repudiate the institution's contracts, and prevent certain financial contracts with the institution from being terminated on account of conservatorship or receivership.
This proposed legislation would fill a significant void in the current financial services regulatory restructure in respect to these large complex institutions, and implementation would be modeled on the resolution authority that the FDIC has under current law with respect to banks.
This is an extraordinary time for our country, and your government has been forced to take extraordinary measures. We will do what is necessary to stabilize our financial system and, with the help of the Congress, develop the tools we need to make our economy more resistant -- more resilient and our financial system more stable and more just.
We need to work together to create an environment where it's safe to save and invest and where all Americans can trust the rules governing their financial decisions.
Thank you, Mr. Chairman.
FRANK: Mr. Bernanke?
BEN BERNANKE, CHAIRMAN, FEDERAL RESERVE SYSTEM BOARD OF GOVERNORS: Thank you.
Chairman Frank, Ranking Member Bachus and other members of the committee, I appreciate having this opportunity to discuss the Federal Reserve's involvement with AIG.
In my testimony, I will describe why supporting AIG was a difficult but necessary step to protect our economy and stabilize our financial system. I will also discuss issues related to compensation. I know of two matters raised by this experience that merit congressional attention.
We at the Federal Reserve, working closely with the Treasury, made our decision to lend to AIG on September 16th of last year. It was an extraordinary time. Global financial markets were experiencing unprecedented strains and a worldwide loss of confidence.
Fannie Mae and Freddie Mac had been placed into conservatorship only two weeks earlier, and Lehman Brothers had filed for bankruptcy the day before. We were very concerned about a number of other major firms that were under intense stress.
AIG's financial condition had been deteriorating for some time, caused by actual and expected losses on subprime mortgage-backed securities and on credit default swaps that AIG's financial products unit, AIG-FP had written on mortgage-related securities.
As confidence in the firm declined and with efforts to find a private sector solution unsuccessful, AIG faced severe liquidity pressures that threatened to force it imminently into bankruptcy. The Federal Reserve and the Treasury agreed that AIG's failure under the conditions set for failing...
FRANK: Please, with all -- no, you understood. You had the sign up. The next one that holds a sign -- it is distracting to people. I understand that there are some people for whom rational discussion is not an appropriate means of expressing themselves.
You are entitled to do that in general, but not in a way that interrupts those of us who are trying to have rational discussions. So the next one that holds a sign will be ejected.
I do not know how you think you advance any cause to which you might be attached by this kind of silliness.
Mr. Bernanke, please proceed.
BERNANKE: Thank you, Mr. Chairman.
The Federal Reserve and the Treasury agreed that AIG's failure under the conditions then prevailing would have posed unacceptable risks for the global financial system and for our economy.
Some of AIG's insurance subsidiaries, which are among the largest in the United States and in the world, would have likely been put rehabilitation by their regulators, leaving policy holders facing considerable uncertainty about the status of their claims.
State and local government entities that had lent more than $10 billion to AIG would have suffered losses. Workers whose 401(k) plans had been purchased -- had purchased $40 billion of insurance from AIG against the risk that their stable value funds would decline in value would have seen that insurance disappear.
Global banks and investment banks would have suffered losses on loans and lines of credit to AIG and on derivatives with AIG-FP The banks' combined exposure exceeded $50 billion. Money market mutual funds and others that held AIG's roughly $20 billion of commercial paper would also have taken losses.
In addition, AIG's insurance subsidiaries had substantial derivatives exposure to AIG-FP that could have weakened them in the event of the parent company's failure.
Moreover, as the Lehman case clearly demonstrates, focusing on the direct effects of a default on AIG's counterparties understates the risk to the financial system as a whole. Once begun, a financial crisis can spread unpredictably.
For example, Lehman's default on its commercial paper caused a prominent money market mutual fund to break the buck and suspend withdrawals, which in turn ignited a general run on prime money market mutual funds with resulting severe stresses in the commercial paper market.
As I mentioned, AIG had about $20 billion in commercial paper outstanding, so its failure would have exacerbated the problems of the money market mutual funds.
Another worrisome possibility was that uncertainties about the safety of insurance products could have led to a run on the broader insurance industry by policy holders and creditors.
Moreover, it was well known in the market that many major financial institutions had large exposures to AIG. Its failure would likely have led financial market participants to pull back even more from commercial and investment banks and those institutions perceived as weaker would have faced escalating pressure.
Recall that these events took place before the passage of the Emergency Economic Stabilization Act which provided the funds that the Treasury used to help stem a global banking panic in October.
Consequently, it is unlikely that the failure of additional major firms could have been prevented in the wake of a failure of AIG. At best, the consequences of AIG's failure would have been a significant intensification of an already severe financial crisis and a further worsening of global economic conditions.
Conceivably, its failure could have resulted in a 1930-style global financial and economic meltdown with catastrophic implications for production, income and jobs.
The decision by the Federal Reserve on September 16th, 2008 with the full support of the Treasury to lend up to $85 billion to AIG should be viewed with this background in mind.
At that time, no federal entity could provide capital to stabilize AIG and no federal or state entity outside of a bankruptcy court could wind down AIG.
Unfortunately, federal bankruptcy laws do not sufficiently protect the public's strong interest in ensuring the orderly resolution of non-depository financial institutions when a failure could pose substantial systemic risks, which is why I have called on the Congress to develop new emergency resolution procedures.
However, the Federal Reserve did have the authority to lend on a fully secured basis, consistent with our emergency lending authority provided by the Congress and our responsibility as the central bank to maintain financial stability.
We took as collateral for our loan AIG's pledge of a substantial portion of its assets, including its ownership in its domestic and foreign insurance subsidiaries.
This decision bought time for subsequent actions by the Congress, the Treasury, the FDIC and the Federal Reserve that have avoided further failures of systemically important institutions and have supported improvements in key credit markets.
Having lent AIG money to avert the risk of a global financial meltdown, we found ourselves in the uncomfortable situation of overseeing both the preservation of its value and its dismantling, a role quite different from our usual activities.
We have devoted considerable resources to this effort and have engaged outside advisers.
Using our rights as creditor, we have worked with AIG's new management team to begin the difficult process of winding down AIG-FP and to oversee the company's restructuring and divestiture strategy.
Progress is being made on both fronts. However, financial turmoil and a worsening economy since September have contributed to large losses at the company, and the Federal Reserve has found it necessary to restructure and extend our support. In addition, under its troubled asset relief program, the Treasury injected capital into AIG in both November and March. Throughout this difficult period, our goals have remained unchanged -- to protect our economy and preserve financial stability and to position AIG to repay the Federal Reserve and return the Treasury's investment as quickly as possible.
In our role as creditor, we have made clear to AIG's management, beginning last fall, our deep concern surrounding compensation issues at AIG. We believe it is in the taxpayers' interest for AIG to retain qualified staff, to maintain the value of the businesses that must be sold to repay the government's assistance.
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