[Senate Hearing 111-18]
[From the U.S. Government Printing Office]


                                                         S. Hrg. 111-18

                  LEARNING FROM THE PAST: LESSONS FROM
                 THE BANKING CRISES OF THE 20TH CENTURY

=======================================================================

                                HEARING

                               before the

                     CONGRESSIONAL OVERSIGHT PANEL

                     ONE HUNDRED ELEVENTH CONGRESS

                             FIRST SESSION

                               ----------                              

                        THURSDAY, MARCH 19, 2009

                               ----------                              

        Printed for the use of the Congressional Oversight Panel




                                                         S. Hrg. 111-18

                  LEARNING FROM THE PAST: LESSONS FROM
                 THE BANKING CRISES OF THE 20TH CENTURY

=======================================================================

                                HEARING

                               before the

                     CONGRESSIONAL OVERSIGHT PANEL

                     ONE HUNDRED ELEVENTH CONGRESS

                             FIRST SESSION

                               __________

                        THURSDAY, MARCH 19, 2009

                               __________

        Printed for the use of the Congressional Oversight Panel







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                            C O N T E N T S

                              ----------                              
                                                                   Page
Opening Statement of Elizabeth Warren, Chair, Congressional 
  Oversight Panel................................................     4
Statement of Damon Silvers, Deputy Chair, Congressional Oversight 
  Panel..........................................................     6
Statement of Richard H. Neiman, Member, Congressional Oversight 
  Panel..........................................................    27
Statement of Bo Lundgren, Director General, Swedish National Debt 
  Office.........................................................    28
Statement of Richard Katz, Editor-in-Chief, The Oriental 
  Economist......................................................    37
Statement of David Cooke, Former Executive Director, Resolution 
  Trust Corporation..............................................    65
Statement of Eugene White, Professor of Economics, Rutgers 
  University, and Research Associate, National Bureau of Economic 
  Research.......................................................    81

 
   LEARNING FROM THE PAST: LESSONS OF THE BANKING CRISES OF THE 20TH 
                                CENTURY

                              ----------                              


                        THURSDAY, MARCH 19, 2009

                                     U.S. Congress,
                             Congressional Oversight Panel,
                                                    Washington, DC.
    The Panel met, pursuant to notice, at 10:01 a.m. in room 
208-209, U.S. Capitol Visitor Center, Elizabeth Warren, 
Chairman of the Panel, presiding.
    Attendance: Elizabeth Warren [presiding], Richard H. 
Neiman, Damon Silvers, Bo Lundgren, Richard Katz, David Cooke, 
and Eugene White.

  OPENING STATEMENT OF ELIZABETH WARREN, CHAIR, CONGRESSIONAL 
                        OVERSIGHT PANEL

    The Chairman. This hearing is called to order.
    Good morning. My name is Elizabeth Warren. I am the chair 
of the Congressional Oversight Panel.
    Last October, Congress established this Panel to oversee 
the expenditure of funds from the so-called Troubled Assets 
Relief Program. It is our duty to issue monthly reports and to 
evaluate Treasury's administration of that program.
    In its first report, the Panel asked Treasury a series of 
fairly tough questions about TARP on behalf of the taxpayers. 
The very first question we asked consisted of only four words, 
but probably the most important four words in the report. What 
is Treasury's strategy?
    The lack of a strategy from Treasury has never been clearer 
than it has been this week, as outrage has spread across the 
country over the millions of dollars awarded in bonuses to 
executives at AIG. This entire issue could have been avoided. 
If Treasury had developed and clearly articulated a 
comprehensive strategy to deal with this crisis from the 
beginning, rather than announcing and abandoning inconsistent 
plans, issues such as executive bonuses would have been 
addressed early on in the agreements with participating 
financial institutions.
    This lack of a clear strategy is also hampering our 
economic recovery. The markets need predictability. Investors 
are reluctant to take risks. Business people are hesitant to 
take on new obligations when no one is sure about our overall 
strategy.
    Certainly, the most important person--the most appropriate 
person to speak to Treasury's strategy would be the Treasury 
Secretary, and it had been the strong hope of the Panel to have 
Secretary Geithner here today to testify. While we understand 
that he has many pressing concerns right now, it is very 
disappointing that Secretary Geithner did not make it a 
priority to be here.
    The development of a strategy requires an overview of the 
problems and of possible solutions. To advance that 
conversation, we believed that we could learn a great deal from 
prior financial crises. That is why we have called today's 
hearing ``Learning from the Past: Lessons of the Banking Crises 
of the 20th Century.''
    We understand that this crisis is different from past 
calamities. No examples will ever provide a perfect analogy. 
That said, while George Washington may not have known the 
difference between a credit default swap and a hybrid ARM--and 
I suspect he didn't--he had a powerful learning experience with 
a bank crisis.
    In 1792, during his first term as President, our young 
Nation suffered a severe panic that froze credit. Subsequent 
Presidents faced similar challenges, as have leaders from 
across the globe. And so, it is important that we reflect on 
the efforts of policymakers who have steered their nations 
during some very dark hours.
    It is also important that we reflect on the efforts of 
other governments that have confronted similar circumstances 
but failed to restore the banking system and restart economic 
growth.
    We have invited four very thoughtful experts to join us 
here today in embarking on that reflection. Richard Katz is a 
veteran journalist, editor-in-chief of The Oriental Economist, 
and the author of two books on Japan's banking crisis of the 
1990s. Mr. Katz will testify about what has become known by 
policymakers as Japan's ``Lost Decade.''
    Bo Lundgren is the director general of the Swedish National 
Debt Office. As Minister for Fiscal and Financial Affairs, 
Director General Lundgren led the effort to steer Sweden out of 
a banking crisis in 1992.
    David C. Cooke is the former executive director of the 
Resolution Trust Corporation, which helped steer us out of the 
savings and loan crisis of the 1980s by taking over more than 
700 financial institutions.
    And lastly, Eugene White is professor of economics at 
Rutgers University. Professor White has written widely about 
the Great Depression and will testify about how the lessons of 
the 1930s apply to today's crisis.
    Welcome to all of you.
    There is no longer any question that we sit at a critical 
moment in history. The decisions made by our Government leaders 
today will have an impact for generations. While we cannot fix 
this crisis with one hand and prevent all future crises with 
the other, we must use all of the knowledge and lessons of the 
past to ensure that prior mistakes are not repeated and that 
success is not ignored.
    That is why we greatly appreciate that our distinguished 
witnesses have taken the time to be here with us today. We have 
your statements in full, and they will be made part of the 
record. But we will start with our conversation with you in 
just a few minutes.
    In the meantime, I would like to recognize the Deputy Chair 
of the Panel, Damon Silvers, and ask Damon if he has opening 
remarks. Mr. Silvers.
    [The prepared statement of Ms. Warren follows:]

    [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]


    
    STATEMENT OF DAMON SILVERS, DEPUTY CHAIR, CONGRESSIONAL 
                        OVERSIGHT PANEL

    Mr. Silvers. Thank you, Madam Chair.
    Let me begin by expressing my profound appreciation to the 
witnesses for joining us here today, and particularly to Mr. 
Lundgren for traveling from Sweden to be with us for this 
hearing.
    Recently, Thomas Hoenig, the president of the Federal 
Reserve Bank of Kansas City, gave a speech in which he praised 
the work of Mr. Lundgren and his colleagues in addressing the 
Swedish banking crisis of the 1990s. This speech was called to 
my attention by Mr. Hoenig's Senator, Senator Brownback of 
Kansas, and I ask that it be entered into the record of this 
hearing.
    [The information referred to follows:]

    [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    
    Mr. Silvers. In this Panel's first report, our very first 
question was what is Treasury's strategy? I hope that this 
hearing and the further work of the Panel and its staff will 
enable us to better understand what Treasury's strategy is and 
how it measures up to the lessons of history.
    In the written testimony we have received from today's 
witnesses, there were some distinct common points. Financial 
crises tend to follow asset bubbles. Two, financial 
institutions are reluctant to admit their true condition, and 
there is a tendency for regulators and other political bodies 
to indulge them in this wishful thinking. Three, financial 
institutions with weak balance sheets, large financial 
institutions, contribute to a downward economic spiral by 
pulling back on lending activity.
    The testimony suggests successful strategies for dealing 
with these common dynamics include, one, giving a Government 
agency clear authority to restructure the banks; two, being 
completely transparent about the strategy and operations of 
that agency; three, having that agency value bank assets on a 
realistic basis; four, holding bank executives accountable for 
their mistakes; five, being prepared to combine haircuts for 
bank investors with public funds to either, one, wind up truly 
failed institutions or, two, revive savable institutions with 
adequate capital; and six, above all, to move quickly to 
accomplish these tasks.
    It is noteworthy that in the three successful examples we 
are considering today, in no case did effective action result 
from trying to keep shareholders of zombie banks alive or from 
deferring to the incumbent management of those banks around key 
decisions such as asset evaluation or executive pay.
    On the positive side, the written testimony suggests that 
effective action often turns out to be less expensive than it 
appears at first, while delay in acting to restructure sick 
banks appears associated with increases in the ultimate cost to 
the public. This appears to be a striking feature of the 
testimony we have received on the most recent U.S. experience 
of financial institution failure, the S&L bailout.
    Of course, every country is unique. And while we in the 
United States benefit from the dollar's status as reserve 
currency on the one hand, on the other hand, we cannot rely on 
someone else's consumer demand to rescue us, and to some 
extent, it seems both Japan and Sweden were able to rely on 
U.S. consumers to rescue them.
    Ironically, the United States has until very recently had a 
fairly decentralized banking system. But now our banking system 
looks more like Sweden's and Japan's than it does the U.S. 
system of the Depression era or even the late 1980s. And it 
seems that while we have many sick smaller banks, the FDIC is 
so far able to resolve them. It is the sick mega banks that are 
driving the crisis.
    While this Panel is awaiting a more detailed statement of 
the new administration's strategy, I believe the unstated 
strategy pursued by the Bush administration in the 4 months 
following the passage of the Emergency Economic Stabilization 
Act of 2008 was essentially to offer a mix of implicit and 
explicit guarantees backed up by equity infusions in the hope 
of buying time for markets to become more rational and bank 
balance sheets to recover. The fundamental assumption behind 
this strategy was that time was on our side.
    This Panel has held field hearings in Nevada and in Prince 
George's County, Maryland, where we have heard firsthand from 
homeowners and seen the assets underlying at least the first 
rounds of our financial crisis. I am convinced that the 
fundamental assumption of the Bush administration's approach--
that time was on our side--was mistaken because the fall in 
asset prices at its heart was rational.
    Subprime loans and everything derivative upon them are not 
now and will never be worth their face value. The borrowers 
cannot pay their exploitative terms. The collateral is not 
worth and will never be worth on a present value basis anywhere 
near the value of the loans made on them.
    The reality of these losses, combined with the dramatic 
concentration in the financial sector that has left us with 
four mega banks, is a profound procyclical force, deepening the 
recession and worsening the bank crisis.
    Spoon feeding capital to broken institutions will not bring 
them back to life, nor will indulging in fantasies of reviving 
the real estate bubble. Having the Government buy bad assets 
will either fully reveal the weakness of bank balance sheets if 
done at fair prices, or if done at inflated prices will simply 
be a way of hiding the largest regressive wealth transfer in 
U.S. history, a wealth transfer that will still not be big 
enough to revive the sickest big banks.
    Most of all, the reality of losses and weak balance sheets 
is that time is not on our side, just as time was not the cure 
in any of the case studies. Time without action was not the 
cure in any of the case studies we are looking at today.
    The Obama administration now faces the choice of continuing 
a failed strategy based on mistaken assumptions or looking to 
the lessons of history to craft a new strategy consistent with 
the values of responsibility, transparency, and shared 
sacrifice that President Obama has rightly asked our nation to 
embrace.
    I look forward to hearing from our witnesses today on the 
lessons of history.
    [The prepared statement of Mr. Silvers follows:]

    [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    
    The Chairman. Thank you very much, Mr. Silvers.
    Mr. Neiman.

STATEMENT OF RICHARD H. NEIMAN, MEMBER, CONGRESSIONAL OVERSIGHT 
                             PANEL

    Mr. Neiman. Thank you.
    Good morning, and thank you all for appearing here today.
    It is especially appropriate that we are meeting here to 
discuss the strategies that have been used successfully in past 
crises, both here in the U.S. and around the world.
    The current financial turmoil has demonstrated just how 
interconnected the global markets have become. What began as a 
wave of defaults in the subprime sector of the U.S. housing 
market was transmitted across the world, impacting seemingly 
unrelated products, distant markets, and billions of people.
    This is certainly not the first time that financial 
dislocations have occurred. But the increasing 
interconnectedness of the capital markets amplifies the shocks, 
which could, in turn, delay recovery unless all affected 
countries work together in a coordinated response.
    In developing that response, it is critical that we 
understand what strategies have worked in the past and what 
obstacles stand in the way of an effective solution. We can't 
afford to overlook past lessons learned. As they say, those who 
cannot remember the past are condemned to repeat it.
    But, while there are similarities among all financial 
crises, no two are exactly the same. The prevailing conditions 
in the broader economy and the type of financial institutions 
involved provide a dynamic that makes every situation unique, 
requiring a unique solution.
    And there is no one regulatory approach that is immune from 
systemic shocks. The financial crisis has affected countries 
with diverse systems, including the UK with its more 
consolidated regulatory structure.
    However, understanding why certain strategies worked in 
other contexts can help us develop the right strategy in our 
own circumstances. And while there is no ready prescription for 
solving the crisis of today, there are time-tested principles 
that we can adapt to our present situation.
    One of the most important aspects of any successful 
strategy involves restoring consumer and investor confidence in 
the financial system. Instilling that confidence depends in 
part upon the Treasury Department articulating a clear strategy 
for moving forward and then clearly communicating the metrics 
to be used in measuring our progress in delivering on that 
strategy and in meeting our goals.
    Your testimony today will provide vital information for the 
Panel as we continue to advise Congress about the effectiveness 
of the Treasury's strategy, and I look forward to your 
statements and the question and answer period.
    Thank you.
    The Chairman. Thank you.
    So let us get down to business. As we do, I want to thank 
Patrick McGreevy and Brian Phillips of the Oversight Panel for 
their hard work in putting together this hearing. I don't want 
to take the chance that I will forget at the end because we 
have gotten so engaged in this conversation.
    I would also like to pause to recognize His Excellency, the 
Swedish ambassador Jonas Hafstrom. Your Excellency, we are 
honored to have you here. And we appreciate the opportunity to 
learn from the challenges that your nation faced and how you 
dealt with them. We very much look forward to this. Thank you 
for joining us.
    So let us start with Director General Lundgren. I remind 
you all we have your statements, your written statements in 
full, and they will be made part of the official record. So if 
you could hold your oral comments to 5 minutes, that will give 
us a little time to be able to ask questions.
    Mr. Lundgren.

 STATEMENT OF BO LUNDGREN, DIRECTOR GENERAL, SWEDISH NATIONAL 
                          DEBT OFFICE

    Mr. Lundgren. Thank you very much, and thank you for the 
invitation.
    Let me start with the differences between the Swedish 
banking crisis and what is happening now in the U.S. and, 
indeed, in the global context. Size, of course, Sweden being a 
small country. We had a regional crisis. This is a global 
crisis.
    This is a more complex crisis. We had a rather pure one 
with ordinary loans, not so much securitized. And we had 
another political situation. My advice is that if you have a 
banking crisis, please have it after elections, not before 
elections because after the election, it is much easier to 
build political consensus. We enjoyed that, and I would say 
that that is a very, very good situation to be in, listening to 
political debate in the U.S.
    There are, on the other hand, similarities as well. I mean, 
first of all, we are--both the U.S. and Sweden are market 
economies, even though I hear sometimes from commentators that 
we are a socialist country. The problem is that is not quite 
true. We have socialized, to a large extent, people's incomes. 
But the business sector is very free and market oriented.
    We have the same challenges that we had in the '90s and 
that the U.S. stands for today. One is to maintain liquidity in 
the financial system, and that, I would say, was taken care of 
then and is taken care of now.
    The second thing is to restore confidence in the financial 
sector, and that means that depositors and investors have to be 
feeling secure. And you have, thirdly, to restore the capital 
base. If you want to avoid or minimize credit crunch effects in 
the economy, of course, you need to have a capital base for 
lending. And if private sector investors don't invest, then 
government has to invest.
    In Sweden, in the beginning of the '90s, we had seven large 
and medium-sized banks that altogether had 90 percent of the 
markets, and then a couple of hundred smaller banks as well, 
mostly savings banks. The roots to the crisis was a speculation 
bubble in real estate mainly, same kind of roots as today.
    When I took office in October '91, we already had the 
bubble bursting, and we had problems in one of the big banks, 
the partially already nationalized Nordbanken, and we got 
problems also in a big savings bank at that time. Initially, we 
worked case by case, but found out during spring '92 that we 
were on the verge of having a systemic crisis. And in the 
autumn of '92, we came to a situation close to the one that the 
U.S. experienced after Lehman's when confidence was totally 
lost.
    We had prepared for that moment some months, and what we 
did then with the support of the opposition, since I talked 
about the political consensus being there, was to implement a 
package with two main ingredients. One was a blanket guarantee 
for depositors and creditors. Of course, not for shareholders. 
Shareholders have to pay first. That is a principle we used.
    We also had the right from parliament to be able to 
reconstruct and to restore the system, per se, by taking much 
different measures to unwind banks that should be liquidated, 
to capitalize banks that could be capitalized and then work 
again. We had a full assortment of tools to be able to use, and 
we had also a situation where we had an unlimited economic 
frame.
    We dared not to ask for a frame where we had to go back to 
parliament again because that would have increased the fright 
about the situation, and we didn't want to take too much. So we 
got an unlimited frame, which was a good thing.
    We didn't ask to own banks, which, being a center-right 
government and myself being market liberal, we wanted to avoid 
nationalization of banks. On the other hand, if you have to do 
it as part of a crisis management, so be it. Then you have to 
do it.
    Governments are not very good at running banks, but 
obviously, this time around, the former owners or the owners 
today hasn't been very good either. And if you do it as a part 
of a crisis management in order to save all the taxpayers' 
money, you should do it.
    We used the banks we took over, which was only two that 
were nationalized, the concept of a good bank/bad bank, in 
order to have management in the good banks being able to 
concentrate on the future and also to be able to get rid of or 
handle the bad loans, the nonperforming loans in a manner what 
we could recover as much as possible of the original loans. And 
it really worked quite well.
    We thought it could take up to 10, 15 years, but it took 
approximately 5 years before we could unwind these entities. We 
used transparency. Valuation was vital, of course. We had to 
have a situation where people trusted what we were doing and 
trusted, and the investors and others could trust that the 
estimates on the situation in the banks were correct as well, 
so we had rather tough mark-to-market valuation rules, which 
also helped us.
    Altogether, we got rather soon out of the crisis. Already 
in 1994, after 2 years, the bank system together was profitable 
once again.
    Thank you.
    [The prepared statement of Mr. Lundgren follows:]

    [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    The Chairman. Thank you very much, Mr. Lundgren.
    I should point out the buzzing is nothing to be alarmed 
about. It indicates that there is a vote going on on the floor, 
to alert members that they need to be elsewhere, and that is 
one of the reasons we don't have one of our members with us.
    Mr. Katz, could you speak to us of Japan?
    Mr. Katz. Yes, and----
    The Chairman. Push the little red button.

   STATEMENT OF RICHARD KATZ, EDITOR-IN-CHIEF, THE ORIENTAL 
                           ECONOMIST

    Mr. Katz. First of all, thank you for having me.
    Japan is mostly lessons in mistakes to avoid. I very much 
agree with the comments made by members of the committee. The 
crisis is very, very different in the U.S. In Japan, there was 
a crisis in the real economy of goods and services that was 
reflected in the banking crisis, mostly about plain vanilla 
loans. Twenty percent of GDP was just bad debt.
    In the U.S., most of the nonfinancial sector outside of 
autos is actually quite healthy. The U.S. crisis is a problem 
in the shadow banking system of asset-backed securities and 
derivatives, not even so much the commercial banking system or 
the commercial banking part of the banking holding companies, 
but really the shadow banking system. So it is a more 
complicated problem, but not as deeply penetrating into the 
overall economy. So that is different, and that has pluses and 
minuses.
    Some lessons. One, the truth shall set you free. Japan hid 
from itself the depths of the problem, denied, covered up. I 
mean, criminal fraud cover-up. In the U.S., we created 
regulations that actually prevented us from even monitoring the 
size of credit default swaps or knowing the amount of 
counterparty risk. And the notion that we don't sell financial 
derivatives on exchanges like we sell corn futures and stocks 
is just asking for trouble.
    So regulations requiring greater transparency, and putting 
derivatives on public exchanges, would certainly be a remedy. 
That would allow us to avoid the counterparty risk like AIG and 
allow us to just know what is going on as well as regulate it.
    Second, some people have got to go jail. Two reasons. One, 
they deserve to. When bank executives press loan officers to 
approve loans that they know are probably fraudulent and then 
they pass them on by securitizing them, that has got to be 
against the law. If it is not against the law, then the 
Congress has got to remedy that.
    The second reason is that the public will not approve 
spending hundreds of billions of dollars if they think you are 
bailing out banker crooks. That is one of the reasons it took 
Japan so long to inject public capital into the banks.
    In the U.S. S&L crisis, hundreds of U.S. banker crooks went 
to jail. In Japan, few, if any, went to jail. So to get public 
support for that kind of money, the public has to feel that 
they are the ones being bailed out, not the malefactors of 
great wealth.
    Thirdly, you do need a capital injection. Japan finally 
combined the capital injection with an upside for taxpayers, 
and the capital injection has got to be combined with 
insistence that that be used to write off the tax to toxic 
assets. In Japan, it took them about 6 or 7 years to finally 
inject some money. But initially, they injected the money so 
the banks could continue bailing out the zombie borrowers.
    When the Koizumi administration, after about a year in 
power, finally decided to go after the problem, they insisted 
that the toxic assets actually be written off the books. It 
took about 3 years to do it. The social dislocation was 
actually less than they had feared.
    So the U.S. needs to inject enough capital so that banks 
can afford to write off the bad loans--the Japanese banks were 
very, very thinly capitalized--but it also has to have the 
controls to make sure it is being used to get rid of toxic 
assets. The record on bank nationalization in Japan is actually 
a mixed record, which I can discuss in the Q&A, if you would 
like.
    Mark-to-market accounting is procyclical the way it is 
being used now. That needs to be adjusted. A large part of the 
capital losses of banking institutions is actually mark-to-myth 
writedowns because, in fact, capital markets have gotten 
panicked. So, there is irrationality in terms of these 
derivative prices relative to the level of the original asset. 
You could have the original loans being paid on time. And yet 
the securities based on them have lost a third of their value.
    Fiscal and monetary stimulus is absolutely essential. You 
cannot cure the crisis without it because you have to have a 
cushion underneath the economy to prop up the economy. It is 
inherently depressive to wipe out all of this wealth or to 
recognize the wealth that has already been written off.
    So you have to have that cushion. Japan did it in such a 
stop-go fashion that they gave fiscal stimulus a bad name, just 
as I fear some of the stuff we have done has given markets a 
bad name around the world.
    So you need fiscal and monetary stimulus, but you need it 
as anesthesia for the surgery of curing the banking problem of 
toxic assets. If you use it as heroin to dull the pain and 
avoid the surgery, as Japan did for 10 years, then you have 
bigger costs, more pain, more losses in the end.
    Japan needed regulatory institutional changes. We certainly 
do. I think the heart of the U.S. crisis was an orgy of 
deregulation, which basically gave financial executives 
incentives to act like buccaneers, creating loans they knew to 
be dubious, selling them off to pension funds of teachers and 
plumbers and bank tellers. And that, I believe, is the heart of 
the crisis.
    It is not excessive debt, per se. It is that the debt was 
used for worse than useless projects. I have figures here 
showing actually the debt level in the United States is not as 
bad as many people suppose. The problem is how the money was 
used and the fact that the shadow banking system is so obscure 
that the players don't know what anything is worth. The markets 
are frozen.
    I will stop there.
    [The prepared statement of Mr. Katz follows:] 

    [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    
    The Chairman. Thank you very much. I appreciate it.
    So we go from Sweden to Japan to the United States. Mr. 
Cooke.

STATEMENT OF DAVID COOKE, FORMER EXECUTIVE DIRECTOR, RESOLUTION 
                       TRUST CORPORATION

    Mr. Cooke. Hello. Thank you very much, Madam Chair and 
members of the Panel, for letting me be here today to talk a 
little bit about the RTC experience and what lessons may be 
relevant.
    What I will do pretty quickly is go back. The S&L crisis 
really started back in the late '70s and early '80s when 
interest rates were very high, and a lot of S&Ls got into deep 
trouble because they had made a lot of long-term, fixed-rate 
loans and depended on deposits. And depositors left, funding 
costs went up, and so then they started to lose money, and 
their capital accounts became very jeopardized.
    So you are dealing with--as rates are coming down, you are 
dealing with an industry that has already got weak capital, 
which is very important. During that time, a lot of the S&Ls 
that were mutuals converted to private stock ownership. They 
brought in new investors, and they started to use some of the 
expanded authority that Congress gave in '80 and '82 to 
basically allow the S&Ls to do more things so they wouldn't be 
so dependent on residential mortgages.
    The S&Ls, what a lot of them did was they started making 
risky loans that they didn't really understand, and the 
regulators really didn't understand either. The S&L regulators 
at that time really were very good on understanding residential 
mortgages, but they didn't understand a lot of this other 
stuff.
    So about around '86, credit losses started to surface. 
Actually, they started to surface even earlier, and then it 
became pretty clear that a lot of the S&Ls were really in 
trouble and needed to be resolved. The regulators were really 
unprepared for what happened, in my view, over on the S&L side, 
of course.
    And already by the time '88 ended, '86 to '88, there were 
like almost 300 failures and over $100 billion in assets of 
failed S&Ls that had been resolved either in some kind of 
assistance transactions, a lot of them were done in 1988. It 
got very controversial and political, and Congress got very 
outraged that the FSLIC, the insurer at that time, was bankrupt 
and it was making all these deals that it really didn't have 
the authority or the funding to do. And things went pretty 
sour.
    So, at that time, you also had a very strong industry 
influence that didn't want to acknowledge that the problems 
really existed. I mean, the S&L industry had a very powerful 
lobby, and they just disputed. And when the administration at 
that time did get some money in, back in those days, they 
didn't get near enough. It had only gotten about 10 percent of 
what the costs ended up being.
    In 1988, in late 1988, the Treasury Department came over to 
the FDIC and asked if maybe we could provide some help in 
eventually running a temporary agency, the RTC, as well as 
taking over some of these failing thrifts that the FSLIC would 
say were no good. Take them over.'
    We agreed. In August of '89, FIRREA was passed, and that 
law was a fairly comprehensive law. As the executive director, 
my job was trying to ramp up operations and interact with the 
other agencies. So maybe I am a little influenced by that too 
much.
    But FIRREA did a major overhaul of the S&L regulatory 
system. At the same time, it was trying to have that system 
deal with the crisis, and that involves a certain amount of 
personal interaction and time that I don't know yet is fully 
appreciated. FIRRA basically eliminated, abolished the Home 
Loan Bank Board, FSLIC, created OTS, created the Federal 
Housing Finance Board and created the RTC, transferred new 
functions to the FDIC.
    That takes time to do, but there was no time allowed to 
really do that. Maybe it is wrong, but at the FDIC side, we 
sort of kept an eye on it. But we didn't do much until we knew 
there was going to be a law passed. And so, there really was 
not much preparing that I am aware of.
    The RTC was set up. I was the deputy to Chairman Bill 
Seidman at that time. He asked if I would go over to ramp it 
up, and I didn't expect him to ask. And in hindsight, there 
were many times when I wish he had never asked.
    But in terms of the temporary agency, the RTC, first of 
all, it would avoid confusion in governance. If you are going 
to overhaul the regulatory system, don't confuse people as to 
who is responsible for what.
    We had an oversight board that was created for the purpose 
of policy and had control of the budget. The oversight board 
consisted of Secretary of the Treasury, chairman of the Federal 
Reserve, the Secretary of HUD, and two private sector. A very, 
very high-level board.
    And the FDIC was responsible for putting someone in charge, 
trying to oversee the operations of the FDIC. There was a gap 
between the operation end and understanding the governance. And 
so, whatever is done, don't put yourself in that same mess.
    On the operating side, we knew what we were supposed to do 
now. We didn't realize how many there would be, but we knew we 
were supposed to take over these S&Ls and resolve them. That 
took a lot of time. Original loss etimates of $50 billion were 
way low. They were based on, maybe 400 failures and a couple 
hundred billion in assets. Ended up being like twice that, and 
that took a lot of time.
    I am trying to rush through here. About half of the assets 
were hard-to-sell assets. We had to come up with new ways to 
try to sell the assets and to value them. We came up with new 
valuation policies, and we came up with new disposition 
methods.
    We did not have to negotiate and buy. But we did have to 
come up with values because there were provisions of FIRREA not 
to sell any asset for less than 95 percent of fair value and no 
one really knew what was the fair value. Some of the markets in 
the Southwest, you know, Arizona, Texas, very hard hit during 
this, and people were concerned we would dump the assets.
    Interestingly, when I was in the chairman's office, we had 
representatives from Arizona, as I recall, come in and ask that 
the RTC not dump assets and destroy the values that healthy 
banks had on their books. A year later, the same group came in 
and said you have got to start moving these assets because RTC 
was freezing up the market.
    So we started a much more aggressive approach. At the time, 
we went through a lot of times having to go back to Congress 
and say we don't have enough money. We needed two types of 
money. We need money to pay for the losses in these 
institutions, but more money to get these institutions out of 
conservatorship. On the day that we opened our doors on August 
9th, we had like 270 institutions in conservatorship, which 
meant that we were supposed to be somehow running them.
    There were no real guidelines on what meant. So when you 
nationalize an institution, at least know what you expect it to 
do, if that happens.
    The Chairman. Mr. Cooke, let me just stop you there.
    Mr. Cooke. Am I running over? I am sorry.
    The Chairman. Yes, that is all right. We are a couple of 
minutes over, but we will get back to more of this in the 
questions.
    Mr. Cooke. Okay. All right. Thank you.
    [The prepared statement of Mr. Cooke follows:]

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    The Chairman. Okay, thank you very much.
    And Dr. White. You will take us to the U.S., but further 
back. Please.

  STATEMENT OF EUGENE WHITE, PROFESSOR OF ECONOMICS, RUTGERS 
UNIVERSITY, AND RESEARCH ASSOCIATE, NATIONAL BUREAU OF ECONOMIC 
                            RESEARCH

    Dr. White. Yes. I would like first to thank the Panel for 
the invitation to provide testimony on the actions of the U.S. 
Government to stabilize the financial and housing sectors 
during the Great Depression. Although I devote equal time to 
these two questions in my written testimony, I understand the 
committee has requested that I focus on the operations of the 
Reconstruction Finance Corporation.
    At the beginning, I would like to point out that the 
financial system then was very different than today, and it is 
those differences which are instructive--principally, the 
absence of deposit insurance and the very high levels of 
capitalization.
    The Great Depression, as you know, we all know, was the 
most severe recession the U.S. has ever experienced. There is a 
general scholarly consensus that the primary driving force that 
transformed a relatively ordinary recession into the Depression 
was the failure of the Federal Reserve to pursue correct 
policies at several critical moments.
    The first question must always be why didn't the Fed 
respond to the rising number of bank failures? That answer is 
fairly straightforward. Bank failures were a common feature of 
the financial landscape because of a structural weakness in the 
banking system. State and Federal regulations had a nearly 
universal prohibition on branching that created a system 
dominated by small, single office banks.
    Thus, in the 1920s, there were well over 20,000 banks. 
Failures of a few hundred a year were regarded by policymakers 
and most of the public as a normal winnowing of weak 
institutions with poor management. Shareholders lost their 
investment--in fact, more because there was double liability--
and depositors faced a haircut. While this may sound severe, 
aggregate losses of the entire system were relatively modest.
    In the absence of Federal deposit insurance, bankers were 
aware that the public was attentive, withdrawing deposits if 
the banks appeared to be in trouble. Consequently, they 
maintained high levels of capital. For national banks of the 
1920s, the capital asset ratio was about 12 percent, or 
approximately double what it is today.
    These bank failures did not present a systemic risk to the 
economy because they were relatively random and not part of a 
general economic decline. That changed in 1930, when the first 
panic began.
    The first major response to the massive bank failures was 
the creation of the Reconstruction Finance Corporation (RFC) in 
1932. The Federal Reserve's reluctance to provide additional 
liquidity to financial markets presented the Government with an 
unusual problem. The classic policy remedy in a banking crisis 
was for the central bank to lend freely from its discount 
window. This policy would enable banks that were illiquid but 
otherwise solvent to survive the crisis.
    The task of the RFC was to provide sterilized lending 
without a change in the monetary policy of the Fed to banks 
that were weak. In other words, a second-best policy. The RFC 
was an agency of the executive branch of the Government and 
granted extraordinary discretionary authority. The agency aimed 
to follow sound banking practices with advances being fully 
secured. Lending was through its field offices, and these had 
full authority to grant loans up to what are the equivalent 
today of $1.5 million.
    The management philosophy was to pick a man to be 
completely responsible for the operations in an office and let 
him succeed or fail on the basis of whether or not his office 
showed a profit. Loan evaluation was simple. Once an 
application was received, the agency evaluated whether an asset 
value was sufficient.
    There were three phases of the RFC's operations--the first 
from February 1932 to July 1932, second from July 1932 to March 
1933, and third after March 1933. The first program in 1932 was 
where the RFC made loans to banks and railroads. During this 
period, Eugene Meyer, chairman of the Federal Reserve Board, 
was also chairman of the RFC.
    Meyer kept the terms and collateral on loans at the RFC the 
same as those at the Federal Reserve. Consequently, what 
happened was that the Fed could only lend to member banks. So 
he essentially extended the policy to nonmember banks; and it 
is during this period that the RFC loans are generally seen to 
be ineffective in improving bank survivability.
    I should add parenthetically that the RFC also made loans, 
substantial loans to railroads. However, various studies have 
shown that these did not actually solve the problems of the 
railroads. In fact, they prolonged their distress.
    The second phase of the RFC began in July 1932, when 
lending rules were liberalized. However, at almost the same 
moment, the list of banks that had received aid had been kept 
secret, just as the Fed had kept the names of banks who came to 
the discount window secret were made public. Making these loans 
known to the public, banks became hesitant to go to the RFC to 
get loans, and the number of loans offered by the RFC rapidly 
dwindled.
    The last phase began in March of 1933, when the RFC began 
to offer its preferred stock purchase program. Unfortunately, 
this program occurred at just the same time as the banking 
system was collapsing and the bank holiday occurred.
    When the RFC failed to prevent bank failures and runs, the 
state turned to a widely used 19th century method, which was to 
restrict payments, and they began to announce bank holidays, 
which snowballed eventually into the bank holiday of March 
1933.
    The bank holiday was a drastic remedy. Before the holiday, 
the public was prone to run on a bank because it had no means 
to assess its solvency. This information asymmetry had always 
been present, but it was heightened during the financial 
crisis.
    The Government now stepped in and erred on the side of 
caution. After examination, only those banks that were clearly 
solvent were reopened. Those banks whose condition was dubious 
would remain closed until the Government could ascertain their 
true condition.
    Thus, at the end of 1932, there were over 17,000 banks, but 
after the holiday, only about 11,000. The remaining 2,000 were 
either liquidated or merged. This had the effect of restoring 
public confidence in those banks which were open; and for those 
which were closed, depositors were not bailed out. Instead, all 
stakeholders in the failed institutions absorbed losses of $2.5 
billion, or roughly equivalent today of $39 billion, about 2.4 
percent of GDP. This burden was shared roughly between 
shareholders and depositors.
    To wind up, I will just offer you a rough comparison. If we 
compare the 1930s to the 1980s, the rough loss from the S&L and 
commercial banks was about $126 billion, about 3.4 percent of 
GDP. And if you believe that today's crisis has losses of $1.7 
trillion, that is 11.6 percent of GDP. So the cost of our 
crises seem to be spiraling upwards.
    [The prepared statement of Dr. White follows:]

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    The Chairman. Thank you, I think. Thank you very much. 
Thank all of you.
    What we will do now is we just want to engage in some 
questions, if we can here. We limit ourselves as we ask 
questions to 5 minutes, but I think we will have enough time 
that we can go more than one round here. So we do want a chance 
to explore this while we have got everyone together.
    I get the privilege of asking the first. So let me tell you 
where I would like to start this. There has been much debate 
around the question of nationalization, and the argument back 
and forth about nothing is an appropriate analogy. Everything 
was different at every other point in time or every other 
place.
    And what I have tried to do as I have listened to this is I 
try to think, so what is it that people are concerned about 
with nationalization, other than it sounds like a scary word? 
And as best I can figure out, there are three things that seem 
to emerge each time, that sort of circle through this.
    One is that if we nationalize, there will be politics 
involved in lending. The notion that there will be folks from 
Congress who will call the local financial institution and lean 
on them to finance a constituent's business or to--at a much 
larger level, to get involved in lending activities that they 
have no business getting involved in.
    The second is that it is simply too complicated. All well 
and good for those charming little banks of yesteryear, but 
that today we have mega institutions that are far too complex 
to be nationalized because, surely, no one in the public sector 
could run them. It takes the expertise of the private sector.
    And the third, and I think related to this, the argument 
runs there will be too many people who will have to be 
replaced. It is a sort of variation on the expertise argument. 
We will have to fire all the bank employees and put to work 
government employees who would then have to be retrained, who 
wouldn't understand.
    That is the best I can figure it out from what I hear. And 
if I have left some out, you should feel free to add. But what 
I would like to do is I would like to start with you, Mr. 
Lundgren, if you could talk to us particularly about the 
political influence question. How did you deal with this 
problem in Sweden? How did you deal with the question of 
expertise, whether or not government officials could be 
expected to run these complex institutions?
    Mr. Lundgren. It has been fascinating to follow the debate 
in the U.S. regarding nationalization, which we didn't use as a 
tool. That is not a tool. That is something that can come out 
of you handling a crisis.
    We had one bank that was partly nationalized, which we 
fully nationalized. And we had another one, which we 
nationalized because it was just a black hole and nothing else.
    What you have to do then is you replace top management 
because, obviously, those who led the bank into the black hole 
shouldn't be there, and you have got to replace boards. And you 
don't replace ordinary people in the banks. You don't try to 
convince yourself that you are an expert in running banks 
because you are not.
    On the other hand, as I said, I mean, obviously, those 
people that have run the banks now and the shareholders that 
have been responsible for them haven't been very successful, to 
put it mildly. So government, could they do it worse? I don't 
think so, to be honest. It is a crisis management question, and 
nothing else.
    Regarding political influence, it is not a tradition in 
Sweden. I wouldn't see how local politicians here would be able 
to do that, but I couldn't answer that question, of course. We 
didn't have that problem at all. It wasn't discussed at all.
    When it comes to the expertise, as I said, it can be 
solved. You have a lot of good people that were not responsible 
for what happened in the banks, and they could take over.
    So we took the one nationalized bank, put the viable parts 
into what was the government-owned, fully nationalized then, 
and now it is partly privatized. Only 19 percent is still in 
government, and that is Nordea, which is a very good bank 
today. The new management managed to restore the bank, per se.
    So I don't really see there are any dangers because what 
you really need to do is if government goes in with capital, 
market economists say that if you take the responsibility of 
being an owner and you also take the advantages of being an 
owner, you should do it fully. You shouldn't abstain from 
voting power. You shouldn't be afraid of taking ownership. But 
you should, as soon as possible, try to get rid of it.
    The Chairman. That is very helpful.
    Mr. Cooke, was this an issue in the '80s with the RTC?
    Mr. Cooke. Well, at the RTC, we had a lot of institutions 
in conservatorship, and we had to run them. The law that was 
passed creating the RTC, as I remember it, basically said to 
Congress, don't get involved.
    But your three points--you know, politics, complication, 
and you need too many expert people--of those, politics was not 
as big an issue with us. But there was always a little bit. You 
can't get away from it totally.
    As far as being complicated, I think that is the worst 
excuse to give because that is basically saying, as back in my 
examiner days, ``It is too big to analyze. Pass it and watch 
it.'' That is just going to be a problem. So you can't--if it 
is too complicated to do something with, you have got to do 
something about that.
    And so, we had institutions that were complex, that were 
larger. But nothing like what people are talking about today. 
And as far as too many people to replace, you do have to get 
rid of the top management. You have got to do that. And you 
have got to get rid of probably the next line down before you 
start getting any objective analysis. Depending too heavily on 
the work of the guys in charge now, at least from my view, is a 
mistake that you will come to realize slowly.
    The Chairman. If my co-Panelists will indulge me, I just 
would like to follow by asking the question, in effect, in the 
reverse point. Mr. Katz, does the failure to nationalize take 
politics out of the relationship between the financial 
institutions and the government?
    Mr. Katz. In Japan, it worked the other way around. There 
were some banks, about four, who were effectively nationalized. 
A couple actually had just simply gone bankrupt. Two were 
bailed out.
    In the first couple of cases, the stockholders were totally 
wiped out. In the last case, the stockholders were bailed out, 
and the stock market had a rally.
    S&P is about to come out with a study about the banks which 
were nationalized in Japan. Let me just preface this by saying 
I am not sure if nationalization is the right solution here or 
not, but let me discuss the track record in Japan. Those banks 
that were nationalized in Japan got rid of toxic assets much 
more thoroughly and much more quickly than those which were not 
nationalized.
    On the other hand, the ones that were nationalized got a 
much bigger capital injection from the government. So they 
could afford to do the writedown. And on the third hand, if you 
will allow me a third hand, the ones that were taken over were 
smaller. They weren't the mega banks in Japan.
    On the politics. Politics actually really worked the other 
way around. In Japan, your social safety net is your job. So 
you can't allow companies to fail, and you can't allow banks to 
fail. They called it the convoy system. So the Diet members 
would actually call up banks and say, you are not making enough 
loans to Mr. Tanaka down the street, to mom-and-pop stores.
    So the political pressure on banks to lend was actually 
very, very great, having nothing to do with nationalization. It 
is just the way the system worked.
    Now what happened was the crisis was so bad that the Diet 
took the whole power over running the banks away from the 
finance ministry, which had been in cahoots with the bankers 
for mutual cover-up, and created an entirely new agency called 
the Financial Services Agency. One of my favorite bureaucrats 
there actually spent some time working in the National Police 
Agency, and had spent some time in London and in New York, and 
so seeing other things.
    So the politics actually worked fine, despite an awful lot 
of political pressure on the nationalized banks, one bought up 
by a U.S. hedge fund, to make these loans to weak zombie 
companies. That came out in public. It was a big brouhaha. But, 
in fact, the politics worked the other way.
    On the complexities of nationalization, I basically agree 
with the other people's comments. Lop off the top management. 
But you are the shareholder. So you are the boss. You hire 
people, but you don't get rid of everybody.
    The Chairman. Good. Thank you, Mr. Katz.
    And if I could just have a final comment from Dr. White. 
Just keep it short.
    Dr. White. There is good news from the Great Depression----
    The Chairman. Turn your--good news from the Great 
Depression. We are ready.
    Dr. White [continuing]. On the issue of favoritism. The New 
Deal programs have been extensively studied, and almost all of 
them find extraordinary political favoritism, with the 
exception of the RTC. And the reason for that is there was a 
great deal of insulation by granting extraordinary executive 
authority to the President.
    So even though we know there are cases of congressmen and 
governors calling up the RTC, overall, it looks like a fairly 
clean program. It was easy to find plenty of people to staff 
both the RTC and the HLC, which had 20,000 people on its staff.
    The issue about the complexity of valuing a failed banks' 
assets is kind of misleading because what happens is that at 
this point, the economy is in a terrible downturn. Markets have 
become very thin. Assets are harder to evaluate. And so, it is 
natural that it seems more complicated, but it is just 
requiring that people, the bank examiners and those others, to 
exercise a little more discretion.
    The Chairman. Good. Thank you all very much, and thank you, 
Panelists, for your indulgence on the time.
    Mr. Silvers. Yes, first, just one quick thing. Mr. 
Lundgren, in your opening comments, you referred to yourself as 
a market liberal. That is a term that is not current in U.S. 
parlance. Am I right to assume that you represent the more 
conservative of the major Swedish parties and that you believe 
in free markets?
    Mr. Lundgren. Yes, we call it market liberal because 
liberal is something that is freedom. It is not the American 
way of political liberalism. I am a conservative in that 
respect. Market conservative you could say.
    Mr. Silvers. Yes, just one of those things where we are 
separated by a common language.
    Secondly--first, Mr. Lundgren and then Mr. Cooke--could you 
talk about the treatment first of stockholders and elaborate on 
the reasons for the treatment of stockholders in the respective 
programs you ran. And then secondly, bondholders and how they 
were treated and why? And then I will have a follow-up 
question.
    Mr. Lundgren. If I would start out with the bondholders, I 
mean, they were creditors. They were investors, and you could 
argue that they should, of course, be evaluating their 
investment and suffer if they did wrong in their analysis.
    On the other hand, if you come to a systemic crisis, I 
think that you have a situation where nobody, depositor or 
creditor, can lose on a bank. You saw that after Lehman. Lehman 
was a mistake, obviously. So, first of all, all creditors were 
covered by this blanket guarantee.
    Secondly, if you have the blanket guarantee, then you have 
to, of course, handle the situation within the banks, and all 
banks except one applied for government support. We then told 
them that if you want capital injection from government, it is 
not soft money. We even had to change legislation one more time 
in order to try to convince them that we were superior when it 
comes to negotiations. It was not so much negotiations as it 
was an offer that you couldn't refuse if you needed capital 
injection from the government.
    And that meant that you diluted the shareholders' value, of 
course. And if we got majority in the government, so be it, 
then we took the majority in the banks. This helped us getting 
private equity because the owner families of the SEB, SE 
Banken, the Wallenberg family, of course, understood that it 
wasn't very nice to have the bank taken over by government. So 
they found private equity.
    Of course, we were helped by the appreciation of the 
currency by the economy reviving and so forth. But still, it 
was a very tough handling. So it was an explicit message that 
there are no negotiations. If you need capital injection from 
government, we will take the same stakeholding in the bank as 
the amount of capital we put into the bank.
    Mr. Silvers. Voting power?
    Mr. Lundgren. Voting power, of course. I mean, without 
voting power, you don't have the influence.
    Mr. Cooke. With regard to RTC, it was all the deals, all 
the transactions were closed bank transactions, which basically 
meant the shareholders ended up being left behind in 
receivership. And if there were any collections when the day 
was done, they might get something. But they were pretty much 
removed from the picture as we removed senior management and 
all that.
    As far as bondholders, depending on the terms of the 
agreement, they may have been left behind in receivership, 
which is like the bankrupt estate. We would sell off the 
deposit franchise. If we can get money to sell it off before it 
evaporated. And we would sell off the assets, and they would 
just wait for the collections, their pro rata share of 
collections in the proceeds. So they would be a general 
creditor, most bondholders, unless they had some kind of 
security, they were secured.
    What may be more interesting, in the mid '80s before they 
changed the law, a lot of big banks, not a lot, but big banks 
were coming to the FDIC, looking for what we called open bank 
assistance, which is where you are not closing the bank. You 
are not putting it through a receivership. You are going to 
provide assistance.
    And at that time, Chairman Seidman--there were getting to 
be a lot of people coming in, looking for money, saying, ``Why 
don't we get this?'' And he established some ground rules that 
basically said to shareholders if you get Federal assistance, 
your interest, number one, is going to be substantially 
diluted. And if you want us to bring in new capital, we better 
have a situation where somebody else puts their money on the 
hook so we know that you are not the--someone else has said 
this is a viable assessment and also that top management 
prepare your travel plans.
    And as far as shareholders, one of the things that we did 
was go aggressively after management at the RTC, and if there 
are any shareholders, controlling shareholders for any issues 
that we felt contributed to because every time we had to go up 
for money, which we had to keep doing, it was good to have 
something good to tell Congress. And we would say, well, we 
didn't do perp walks, but we would say this many people went to 
jail in the regular update.
    Mr. Silvers. Second question. There has been a lot of 
debate in the United States about valuation issues, 
particularly about mark-to-market accounting. What is the 
experience--and any of you could answer. What is your view 
about the effectiveness of essentially an administrative 
valuation, which I think is a common theme across a number of 
your testimonies? And how does one understand it in relation to 
debates about mark-to-market accounting?
    Mr. Lundgren. If you start with Sweden, we had a simple 
situation. We had ordinary bank loans, plain vanilla, which was 
coupled with mainly real estate as collateral. So what we had 
to do, in effect, was to try to get right values out of the 
collateral, which was real estate, commercial real estate 
mainly.
    What we did was opt for the mark-to-market valuation. Even 
if it could exaggerate in the long run the situation, I think 
that that gave us, due to the transparency it gave, gave us 
more credibility, restored confidence much easier. Because even 
if it seemed that the losses and the total losses in the bank 
would be greater than otherwise, it was mark-to-market is mark-
to-market. Whatever other method you use, it is not a clean 
method. There is always an argument to what, how do you 
valuate? How do you really put a value on it?
    Of course, this situation with all these securitized 
instruments is much more difficult. On the other hand, what you 
need to do, I mean, you need to be able to show that all of the 
banks' stress testing or whatever, you can have a real picture 
of what is the black hole and what is the losses on the asset 
side and how much capital do you need to inject?
    Not only because Congress needs it to try to estimate what 
more funding might be needed, because probably more funding 
will be needed to handle the situation here, but also to 
convince investors that, okay, now you have a sizable--you have 
a picture of how big the size of losses are as well. So I would 
go for the mark to market, even if it is procyclical. I can see 
that there are those problems, but that is the one we would 
choose, and it helped us coming out quite good.
    Mr. Katz. Could I make a very just quick comment on that? 
In Japan, there was, as far as the loans themselves, mark-to-
market was less of an issue because they had preset sort of 
loan loss reserve ratios depending upon how much in arrears it 
was, how much loss. They began to develop an actual market in 
distress assets, both a government organization to create it 
and private markets.
    The real problem with their mark to market was that the 
banks were allowed to hold stocks as part of their capital. The 
stock market went down. That hurt them. The government tried 
what they call price-keeping operations, basically buying 
stocks. It didn't work. This is the case where the patient has 
got a fever, so let us bribe the thermometer.
    But I would say the situation in the U.S. is different in 
the sense that mark to market is being used in cases where 
there is no market. So, for example, when Merrill Lynch has its 
fire sale of assets and 22 cents on the dollar to avoid 
bankruptcy, but there were so few actual deals in that 
particular instrument that everybody else had to mark it down 
to 22 cents to the dollar even though the underlying asset was 
actually good.
    Mr. Silvers. Mr. Katz, I don't mean to cut you off there. 
Keeping that in mind, I am curious about the effectiveness in 
the U.S. context in the past of essentially trying to get at 
real values through administrative processes rather than either 
through a frozen market or through pretending that they are 
worth more than they are.
    How good has that type of process been, and is it something 
that could be replicated in this situation?
    Mr. Cooke. In the case of the RTC, we had a lot of that. We 
had a lot of junk loans and construction development loans 
where there was no market for those assets. Now we were in the 
sell mode, not the buy mode, because we got it when the 
institution took them over, and that made a difference.
    And we were also required not to sell anything initially 
less than 95 percent of fair value in certain markets, which 
really created a problem. We updated appraisals, and appraisals 
were all revised, too, at that time because they were all--the 
practice was very flawed. We just couldn't get a price we could 
sell the assets.
    So there was no market, but we worked with the private 
sector advisors as to what kind of reasonable returns would 
markets be looking for. Then we would take our assessment of 
the cash flows, and we would use that to establish what we 
called a derived investment value. We used that to sell the 
first pools of these structured assets, and we met what we 
thought was the fair market. And it definitely increased 
competition.
    Very quickly, everybody was in there because the market 
returns. All it takes is someone making on it to get somebody 
else to want to come in and do it. And the prices and the 
values went up. So it worked fairly well.
    But again, we were selling, not buying, and that is a 
little trickier. I would just say I agree. But I don't know how 
you mark to market when there is no market. I just don't know 
how you do that, and there has to be somewhat of a different 
model.
    Maybe the Government can come in and really assess cash 
flows, do something similar. I just don't think you can price 
it.
    Dr. White. Yes, just a bit of an historical comment on 
this. Given that commercial banks oftentimes specialize in 
lending to individuals who don't have access to markets, it is 
hard to say that you mark to market a loan, particularly to 
small business or something like that.
    That being said, the bank examiners used to, before the 
Great Depression, basically mark to market, and it is only 
after the Depression comes when they gain the right to--because 
the markets, the values affecting it have tumbled so far--to 
make some judgments. And that is when we get forbearance at 
that point and that sticks, and we drift away from mark to 
market.
    The Chairman. Very helpful, thank you.
    Mr. Neiman.
    Mr. Neiman. Thank you.
    I would like a follow-on to Elizabeth's first question, 
where she outlined three arguments against nationalization that 
are often used. I would like to add another one to the extent 
that nationalization could result in inhibiting factor for the 
attractiveness, attracting private capital into other 
institutions, particularly due to the risk of traders pushing 
down the price of the stock, shorting the stock in anticipation 
of which is the next bank to fall.
    This, I assume, is a relatively unique circumstance in our 
current events, but I would like your perspectives from whether 
it was a factor in your prior experiences and how it was 
significant. Is it a factor in the debate around 
nationalization?
    Mr. Katz. In the case of Japan, it actually worked the 
opposite way. So the first couple of nationalizations, the 
companies actually went bankrupt.
    The government bought them and then fairly quickly sold 
them off to hedge funds, U.S.-based hedge funds actually in 
both cases. In the third case, which is the most interesting, 
the bank had not yet failed. It wasn't a de jure 
nationalization, but de facto it was. They bought up 
controlling shares. They fired the top management. They 
injected lots of capital. They did not wipe out shareholders.
    And what happened was the stock market, which was at 
ridiculously low levels, suddenly recovered because other 
people felt, okay, they are not going to wipe out the 
shareholders in rescuing the bank, but they are going to fire 
top management and they are going to say you either get those 
loans off your books, or we are going to get them off for you.
    And what happened was then it concentrated minds in the 
other banks, which had not been getting the bad loans off the 
books. They started getting off the loans very quickly so they 
would not be taken over. And then they began to do all kinds of 
stock issuance. Some of it was pressuring their customers to 
send in stock. But the fact is that stocks, including bank 
stocks, did rally, and from that point on, it was about 2 to 3 
years before the problem was really solved.
    It ended up attracting capital because it induced the 
management to finally step up and do the right thing.
    Mr. Cooke. Well, I just want to comment. In terms of the 
institutions--you are not going to attract investors until they 
are comfortable with the asset problems. I realize short 
sellers and hedge funds can try to drive prices down, but if 
you have a bank and you have isolated the problems and take it 
out, there are plenty of investors looking to buy banks.
    One comment about nationalization in terms of political 
interference. Some may disagree with me. Back when we had 
Continental Illinois, at the time it was the seventh largest 
bank. There is a tendency for regulators, when they are running 
a bank, to be overly risk averse, and that is probably not the 
right thing to say now. But, there is such a tendency to not be 
unfairly competing with other banks that are healthy or to take 
risks.
    And, I don't think you can do that very long. So if the 
government nationalizes, it is best not to stay long. Get it 
out of government hands.
    Mr. Lundgren. Well, I have no further comment. I don't 
think--I don't see that as a problem. We didn't experience it 
either. But a good thing, if you encounter a situation where 
you have to, due to crisis management, nationalize, not because 
you wish to nationalize, you get a better tool in order to get 
taxpayer money back.
    One of the reasons our 4 percent of GDP that the total 
outlays were in '92 and '93, of that, most of it came back. A 
lot of it due to value increase and later privatization of the 
bank or the banks, rather, that were nationalized. So that is a 
way also of getting back to having an upside for the taxpayer 
as well, I would say.
    Mr. Neiman. To include Dr. White in this discussion, am I 
correct that FDR imposed two rules in this respect? One 
eliminating mark-to-market for bank valuations and also under 
his first chairman of the SEC imposing the uptick rule to 
address the concerns around short selling?
    Dr. White. Yes, that is correct.
    The Chairman. I think that you have all hit on this. I was 
really struck when I read the testimony that you all submitted 
in advance, which I appreciate. And it is certainly been a part 
of what we have been talking about today. But I want to give 
you an opportunity to draw a tighter line on the issue of 
honesty that I keep hearing in different incarnations.
    And if you can, I just want you to draw this line, if you 
can, as tightly as possible between what you learned from your 
experiences, what honesty meant in the context that you studied 
it or lived it and to how that affects or should be affecting 
what we are talking about today? Why this seems to be a live 
issue, if that would be appropriate?
    Could I start with you, Mr. Lundgren?
    Mr. Lundgren. It is a question of what you really mean with 
honesty.
    The Chairman. That is why I asked.
    Mr. Lundgren. It is vital that government is perceived as 
honest by the people. I mean, obviously, we had to be very, 
very straightforward, very open, very transparent. I went to 
Swedish parliament three or four times in order to be open 
about what we were doing and so forth. That is one thing.
    The second thing is that, obviously, a lot of bonuses we 
had at that time as well, or golden parachutes, you have to 
handle that. And you will be very strict in trying to reduce, 
get rid of, and so forth. And we also had--we sued boards of 
the two banks that were nationalized for compensation, since 
they obviously were not up to their responsibilities. There 
were breaking of bank rules and so forth. And we got some 
compensation out of that as well.
    So from a political point of view, you have to be very, 
very straight and very honest, and you have to try to see to it 
that people also understand that you shouldn't be given 
gratification, bonuses or whatever, if you run something badly. 
And that is also a necessity to handle.
    The Chairman. I wonder if you had imagined that you would 
come here to testify to such points any time before the most 
recent past.
    Mr. Katz, you speak about this, and you speak about 
reluctance to acknowledge problems in Japan.
    Mr. Katz. I think honesty is two levels. One is there was a 
theory in Japan that you would shatter confidence if you 
admitted the truth. So there was, on the instructions of the 
finance ministry, deliberate cooking of books. The problem is 
it destroys confidence because ultimately reality does come 
out.
    And certainly, if we don't even know how big the derivative 
market is--we didn't even know the size of the AIG exposure and 
all the links--then we cannot prepare for a crisis. So that is 
one level of honesty.
    The other level of honesty is what got us in the crisis in 
the first place. My belief is at the heart of the American 
crisis was a corrupt corporate governance system where CEOs 
were compensated in a way that they had to hit homeruns. If 
they hit homeruns, they got huge, huge bonuses. And if they 
struck out, there was no penalty.
    And should they actually get kicked out of the game, which 
is to say drive their company underground, they got $140 
million severance pay. So, naturally, you get people who should 
be hitting for singles and would be .300 batters who are 
instead always hitting for homeruns and striking out.
    And there is a huge difference between the performance of 
CEOs paid by stock options and those who were not. We also 
stopped applying rules that say when you lend to someone, they 
have to have a downpayment. When you lend to somebody, they 
have to be able to pay back. Also it would be preferable if 
they were alive. We have cases of banks lending to people who 
were dead.
    And so, these nonbanks originated these dubious mortgages 
and the nonbank portions of commercial banks could then unload 
these dubious loans, loans they knew to be probably fraudulent, 
on to other people through securitization. But executives made 
tons of money and faced no penalty.
    So we had an incentive system, which actually incentivized 
executives to do the wrong thing. That is a whole level of 
dishonesty that was not the case in Japan. It was much worse 
here.
    The Chairman. Thank you. Mr. Cooke.
    Mr. Cooke. I would just say, really, transparency is key. 
If you want honesty, the Government has to be honest. And I am 
pretty sure that the Government was not totally honest back in 
the S&L days. Everybody thought those problems were going to be 
more expensive, and they turned out to be so. So I think there 
was influences there.
    But honesty is important. You know, the Government has to 
be honest with the people, and they have to be--I mean, what is 
the situation right now? To me, the honest answer is the 
Government really doesn't know. And what is worse, I don't 
think the bankers know. I don't think the heads of the major 
companies know any more than the regulators know about where 
the risks are. It is all over the place.
    So it is first try to feel, just tell the people that and 
say I am going to try to solve it. Maybe the stress test is the 
answer that they are doing. But it would be interesting to see 
exactly how that works, considering how global and complex 
these things are. Myself, I have great reservations.
    The Chairman. Thank you. Dr. White.
    Dr. White. I would agree that it is transparency which is 
very important because if you have forbearance, then many 
things can happen.
    On the point actually of corporate governance, the reason 
why financial institutions are able to take these extraordinary 
risks is the fact that you have insured many of these 
institutions. That is the other side of the balance sheet, so 
to speak, so that that is one of the underlying, I think, 
problems is that there is such an extraordinary ability to take 
risks. And there is no risk essentially that a run will 
materialize or any sort of penalty will be imposed except from 
the oversight of the agencies.
    The Chairman. Thank you very much.
    Mr. Silvers, last question. We are going to--no, I mean 
down the line. [Laughter.]
    Mr. Silvers. First, in preparing for this hearing, I had a 
look at a report done by the Norwegian bank authorities, 
looking comparatively at the Scandinavian experience during 
what you described, Mr. Lundgren, as the regional crisis. Could 
you comment on the role played in terms of the net cost to the 
public in each country that faced this crisis? The role played 
by how aggressive they were in terms of taking upside?
    Mr. Lundgren. To be honest, I haven't studied that. We 
studied, before taking to work with our crisis, the savings and 
loan crisis. We went back to 1933. We studied what happened in 
Norway some years before Sweden. They were nationalizing quite 
a lot, and we didn't really like to do that, if we could.
    I haven't followed up to what extent their initial outlays 
have been repaid. What I know about is our own, which was, as I 
said, 4 percent of GDP, of which most is back, due to bad 
banks' handling of the bad assets and so forth as well. But I 
have no comparison with Norway.
    Mr. Silvers. They concluded that--and again, I don't wish 
to spark any sort of rivalries here. But they concluded that 
essentially in those circumstances in which very aggressive 
positions were taken in terms of taking equity upside that it 
was directly correlated to the net final cost to the taxpayer.
    Mr. Lundgren. I mean, obviously, if you go in as owner, you 
get the upside, the whole upside in the bank. So, obviously, 
then it is a question, if you want to do it or use it as a 
tool, the first tool if you want to do it otherwise. It would 
be better if banks managed to get equity on their own, but 
still we managed to get most of the money we spent back.
    Otherwise, the main problem for us with Norway is all their 
gold medals. [Laughter.]
    Mr. Silvers. You know, Mr. Lundgren and other witnesses 
have been very kind to be with us. And obviously, these issues 
are front and center not just for the United States, but on a 
global basis, as my colleague Mr. Neiman stated in his opening 
remarks.
    I would like to use the rest of my time to give Mr. 
Lundgren in particular, but any of you, the opportunity to 
comment further about the particular situation of today, and 
what, in your view, would be helpful policy for the United 
States to pursue in relation to what is obviously a global 
crisis.
    Mr. Lundgren. I mean, being a small country representative, 
I shouldn't say so much. But on the other hand, what obviously 
is needed is some kind of--I mean, you have to restore 
confidence. And if stress tests will do that or not, it is 
difficult.
    But you have to have a way of getting people, investors, 
ordinary people understanding that you have--you are 
comfortable with handling the situation. You can tell about the 
size of the problems and so forth.
    We did a blanket guarantee for creditors and depositors. 
That restored confidence immediately. I see the problems with 
that. On the other hand, I mean, some kind of guarantee can 
help out, especially if it is difficult to value assets without 
having to buy them or try to make as you said an administrative 
pricing of that, which is very difficult to do that.
    In 1933, the Roosevelt administration did close the banks 
and restored confidence by that way. It is not very 
recommendable to do it, of course, in modern times.
    But to find the size of the problems in one way or another 
also guarantees that you can restore both confidence by showing 
the size of the problems, by guaranteeing or whatever, and then 
also being able to do the capital injections, having the frame, 
the economic frame to be able to convince people that the 
capital base will be restored. So lending will take place in 
the same amount as before the crisis as well.
    Mr. Silvers. Can I just stop for just one second on capital 
base? It seems to me that we have shifted from a moment in 
which sort of systemic confidence was the main issue, which was 
clearly the case in October, to a situation in which we have 
large, a handful of very large, systemically significant 
institutions with no capital base or an unknown capital base, I 
think, to Mr. Cooke's comment.
    Does that strike you as the right--and I would welcome 
anyone, but since Mr. Lundgren was talking, does that strike 
you as the right description of where we sit today?
    Mr. Lundgren. I mean, obviously, there is a lot of 
uncertainty. I mean, exactly how certain it is for different 
institutions. But all around for the banking sector as a whole 
in the U.S., both in the U.S. and abroad, obviously nobody 
knows how the situation is. And that is something that you have 
to make clear.
    Restore confidence and restore capital base. That is a 
necessity, either by Government or by private capital, if 
possible.
    Mr. Silvers. Now you can't have a living bank without an 
adequate capital base, can you?
    Mr. Lundgren. No, no. I agree with you, and then perhaps 
government has to inject that capital, and then as I said, I 
think that for the taxpayers' sake--and being a market 
conservative--working with market economy, you should also have 
the ownership.
    Mr. Silvers. Radical notion.
    The Chairman. Thank you.
    Superintendent Neiman.
    Mr. Neiman. I am interested in your views, based on lessons 
learned as well as your current thinking, on how to structure 
these asset purchases by the Government of these toxic assets 
in a way to best protect the taxpayers. Are there other means, 
both in terms of valuing the assets or structuring, so that 
government is not paying all cash up front, giving it a right 
to recover a part of the losses suffered based on a later 
disposition of those assets?
    I would be interested in your thoughts, starting with David 
Cooke.
    Mr. Cooke. If you are providing assistance to a bank, then, 
yes, I think you should have some protection. If you are going 
to basically help them out with the assets and it turns out 
things turn out better, the Government should have something.
    That potential drain, though, it is going to discourage 
investors. If you want to bring new capital into the 
institution, depending on what you want. That doesn't make 
sense if you ended up effectively paying too much for the 
asset, then, sure, it would make sense that the Government 
would share, would get something because the bank is better off 
than it would have been. But if it gets too much, the bank is 
back where it was.
    So it is a difficult thing to structure, but you probably 
can create some kind of reverse sale or something, as long as 
you have competition. And you can certainly price any asset. 
These are complex assets, but you can price them because 
underneath them somewhere there is an asset. There is a loan. 
There is a house. So you can do it. It is not going to be easy.
    So you can figure out a standardized approach to set your 
price, and then just get yourself some upside if you end up 
paying effectively too much.
    Mr. Katz. Could I add here? In the private market, 
basically, you have an awful lot of debt-for-equity swaps. I 
don't see why, if the Government wants to inject the money, it 
cannot do a similar thing. So there is an upside there.
    I look at the situation a little bit differently than Mr. 
Silvers. If you look at the figures, the banks, despite much 
more aggressive writing off of bad assets than in Japan, have 
an asset-to-liability ratio that is fairly high relative to 
current assets. It is just low relative to the future because 
they are going to have still more to write off.
    But I don't see the problem in terms of the actual normal, 
plain vanilla lending. The problem is that the securitization 
market is so frozen that a bank which makes a car loan can't 
then securitize it today, use the proceeds to make yet another 
loan, yet another loan. So even though the bank portfolio is 
going up, the actual net credit in the economy is going down.
    I think Bernanke's measures of guaranteeing certain things, 
backstopping certain things is immensely helpful. Whether you 
use a good bank/bad bank technique or nationalization, you have 
to find some way to separate the good assets from the bad. I 
think pricing is difficult because in the shadow banking 
system, so much is obscure and unknown. It is not like pricing 
a loan for a house, where there is a relationship between the 
value of the instrument and the value of the underlying asset.
    The shadow banking system is so obscure, and that is why 
markets are frozen. That is what makes this difficult, in my 
view.
    The Chairman. Do you want to say something else?
    Mr. Neiman. No, go ahead.
    Mr. Silvers. I read this part of your testimony, Mr. Katz, 
in relationship to this question. And it seems--and I was 
trying to reconcile your data with what we know about 
conditions in credit markets right now in the United States and 
what everyone tells us in field hearings and so forth. And I 
want to test something by you on this.
    If you look, we have four very large institutions now. Two 
of those institutions come back, have been coming back on a 
repeated basis to the Government for more capital. And it 
appears to me as though their capital ratios in some sort of 
real sense--although again there is a real question of what 
reality is here at all--are significantly lower than the 
averages you have, all right?
    You have a third, Wells Fargo, where I would say it is a 
little thin, although they haven't come back for more money. 
These are sort of keystone institutions with a major presence 
in secondary markets, and it strikes me that that may explain 
this kind of paradox of the data you have versus people's 
experience in the credit markets today.
    And it also, again, focuses the problem that we face on 
what to do about these very large institutions, not the banking 
sector as a whole. And I wondered if does that make sense to 
you, or do you have another explanation?
    Mr. Katz. Well, you know what? It puzzles me also because 
of these things. Here is my sense of it.
    First of all, some of the capital the banks raised, was 
raised in the first three quarters of the year before TARP. But 
there was this huge jump in the fourth quarter, so part of what 
we are calling the capital is, in fact, the result of the 
injection that has already occurred.
    And there will need to be further injections. I said you 
have to look at the capital ratio not only to their existing 
assets, but since we don't really know the value of those 
assets, they are going to lose more capital going forward, 
certainly in the next few quarters. So in relationship to that, 
they are going to need more capital.
    But the fact is they have been aggressive about writing 
down. The real problem here is that I think you have to 
distinguish the writedowns of actual loans on real homes, cars, 
whatever, and the default rate there versus this mark-to-market 
writedown on securities, some of which is justified and some of 
which is not. And just the level of uncertainty is causing 
derivative levels to be lower than perhaps they ought to be.
    And that is why I think you need to separate the shadow 
stuff and dubious assets as well as outright toxic assets from 
the good assets. You have to do some sort of separation. In all 
of the examples that worked, there was a separation.
    In terms of the experience of borrowers, it is the fact 
that the bank cannot use the same dollar four or five or six 
times by securitizing the loan. So that is how I reconcile the 
fact that the outstanding loans on the books of the banks are 
going up, but people are not getting the money because the 
asset-backed securities market is going down.
    Mr. Silvers. Our metrics for understanding credit markets 
don't take into account how important the shadow credit markets 
have become and are not capturing the reality of what 
constitutes bank activity in this area anymore.
    Mr. Katz. Because laws were passed that prevented us from 
knowing that under the theory of deregulation.
    Mr. Neiman. Yes, and I have confirmed that through 
conversations with the Fed economists. And, it is very 
revealing because they, in looking back at past recessions over 
the last 30 years, where bank lending has declined over that 
period of recession. This is a period when you look at that 
bank lending and it has actually increased from the start.
    Mr. Silvers. It is misleading.
    Mr. Neiman. But it goes to the exact point I think that Mr. 
Katz is making about being able to securitize those loans and 
not making up for the difference in the lack of a 
securitization market.
    Any other follow-ups on the pricing of toxic assets if we 
were to create a bad bank or in the Treasury's implementation 
of its private-public fund?
    Mr. Cooke. I would just make the comment that I agree that 
what the Fed is doing now to try to restore some liquidity to 
the more easily quantifiable assets, the loans, makes a lot of 
sense. But I am pretty familiar with how securitization works 
and you can value those assets based on the underlying cash 
flows. It is not easy. You have got to get a lot of information 
you may not have access to. You need to get that information. 
But there is a way to approach it, and then to establish, if 
you are going to be on the buy mode, on the buy side, some 
value. But some of this, some of these derivatives and all are 
very, very complex. But they are solvable.
    Mr. Katz. The Government may have to go in and create a 
market by buying some toxic assets. When somebody actually goes 
and create a market, that is a price. If it is the wrong price, 
the market will either push it up or push it down. But at least 
you started something as opposed to when there is no activity, 
then nobody else can make a decision.
    So make a market. And if you have made a mistake, it is a 
lot better than doing nothing and having the whole thing 
frozen. It will adjust.
    The government needs to create a debt-for-equity situation. 
So even if taxpayers lose on the downside, when the upside does 
occur, the taxpayer will get some of that back. And then you 
have created a market. You can begin unfreezing things.
    The Chairman. Let me ask on the question about markets 
because this is the one that puzzles me. So if the Government 
comes in, let us just say, hypothetically, and it buys at a 
highly inflated price because its ultimate goal is to make the 
banks look better, to make the financial institutions look 
better, how does that start a market?
    It says, hey, any time the Government will come in and pin 
$20 to it and sell it, someone will buy it. But why does that 
start a market by itself if you use a highly inflated price? 
How does it produce the next purchase once the Government is 
not in it?
    Mr. Cooke. No, I think if the Government pays too high, it 
is going to be stuck with the assets, unless it turns out to be 
right, sometimes, a miracle happens. If it pays too low, it 
will be a difficult problem for the Government. But it has to 
have a rational basis for establishing those prices. If it pays 
too low, it is going to bring down other banks.
    The Chairman. So your real point about it is not just that 
someone will come in and make a purchase, it is that someone 
will come in and make a purchase that at least starts close 
enough that you are talking about markets. You are not talking 
about subsidization----
    Mr. Katz. No, no, no. I am not talking about going crazy.
    The Chairman [continuing]. Through the back door?
    Mr. Katz. I am saying do your best possible estimate.
    The Chairman. Fair enough.
    Mr. Katz. In a market that is just so crazy, if you are 10 
or 20 percent too high or 10 or 20 percent too low, that is 
something you can adjust to. If you are paying twice as much, 
well, then your markets can't clear.
    The Chairman. But then what you are really saying is the 
only thing you can be driven by is trying to get an accurate 
market price because that is the only thing that runs at least 
the opportunity for starting a market, as you put it.
    Of course, go ahead. Mr. Silvers.
    Mr. Silvers. Yes, I am struck in this conversation by what 
I think was a model more or less in common of the RTC and the 
Swedish experience, which was to--and you all tell me if I have 
this wrong--which was, in the case of the RTC, you simply took 
the assets in a receivership mode, and I think, Mr. Cooke, your 
testimony was that you sold low in many cases?
    Mr. Cooke. We had to start to gin the market up, get it 
motivated in some areas. Yes.
    Mr. Silvers. Right, and then, effectively, the Government 
only insured depositors. Whatever the hit was as a result of 
that was eaten by bondholders, effectively. Is that right?
    Mr. Cooke. Right. But let me just qualify that. We ended up 
with very conservative valuation assumptions that we were 
pretty convinced, advised by the advisors, if we could show the 
cash flow and we use the market discount rate, we would be able 
to move these assets. We didn't sell them lower than what we 
thought was a fair price, but at what we thought was a market 
based, more realistic price. So we weren't trying to sell low.
    Mr. Silvers. No, I understand that.
    Mr. Cooke. Market competition came in, and prices went up.
    Mr. Silvers. Right, but the key feature of what you did was 
is that you looked, and the process of doing that, which 
obviously did create markets for real estate in some places. In 
the course of doing that, your basic receivership was 
structured so that the losses that were going to happen versus 
the books at these banks was in the first instance absorbed by 
bondholders, right? And in the second instance absorbed by the 
taxpayer?
    Mr. Cooke. Yes, anybody that had any claim against the 
receivership, they suffered the loss first. I mean, 
shareholders would take the first----
    Mr. Silvers. Shareholders took first. Bondholders took 
second.
    Mr. Cooke. Well, it depends. Bondholders may share--at that 
time, and I think it is still the case, pro rata with general 
creditors. We didn't have a preference. Then later, somewhere 
in there, I forget when, they give a depositor preference. 
Congress passed that.
    Before then, we were just like any other general creditor. 
So if the bondholder lost, we lost. The Government lost. Its 
agency lost.
    Mr. Silvers. So the depositors were made whole in a context 
in which the Government as deposit insurer was pari passu. It 
was on par with the bondholder in the losses. Is that right?
    Mr. Cooke. At that time, yes.
    Mr. Silvers. Right. Now, in the Swedish case, you all, as 
you said, Mr. Lundgren, you marked down very aggressively the 
assets when you took control of banks. That is correct?
    Mr. Lundgren. Only a couple of banks marked down, and we 
tried to find a mark-to-market valuation with a valuation board 
with a lot of experts on. We did, I think, 30,000 valuations or 
something like that for different real estate.
    But aggressive or not, we tried to find the right at that 
time mark to market, but only for the assets in the banks that 
we took over. So we only formed bad banks for those. We didn't 
have one bad bank and bought other assets as well because--and 
that is why we didn't have a no valuation problem. If we were 
wrong, in a way, it was just in our own bank.
    And bad banks were formed also by the private banks that 
survived. They also did, and they formed their own bad banks.
    Mr. Silvers. Let me just clarify also one thing while the 
chair is kind enough to give me the floor. Some people have 
asserted in U.S. debates that should the Government impose a 
receivership on one bank, it would have to do so on all, 
particularly in relationship to major institutions. That was 
not your experience, I gather?
    Mr. Lundgren. No, it was not. I mean, it depended on if the 
bank needed huge capital injections, which made government 
forced to take over the bank or get the majority anyhow. And 
that was only for these two banks. The others had a threat of 
having it coming into that situation, but they managed on their 
own.
    But what we are talking about here is, of course--I mean, 
we had, as the RTC, rather plain vanilla situation. Today, it 
is much more complicated, and I have all respect for that, and 
that is why I am thinking from my experience some kind of 
guarantee. Without buying assets, finding a situation where you 
really can't find the right price, where you have a possible 
upside, you need to have it for the taxpayer.
    I mean, to use some kind of guarantees instead to restore 
confidence might be a possibility instead of a long, drawn-out 
process of trying to value unvaluable assets.
    Mr. Katz. Could I make a comment from the Japanese 
experience? You know, if you had all these bad debts in 
Japanese banks, and again, there really is a difference between 
if it was an underlying asset, you would need to have a market-
clearing price. But if there is no market, then there is no 
market-clearing price.
    Okay, so you had these assets the banks didn't want to get 
rid of, couldn't get rid of, whatever. And Lehman, of all 
people went out to the banks and started buying their bad 
loans. The banks couldn't get rid of them because foreclosure 
laws in Japan are so cumbersome, they really couldn't 
foreclose. And Lehman and others started buying them on, say, 
20 cents, 30 cents to the dollar.
    And then they would sell the loans back to the borrower for 
40 cents, 50 cents on the dollar. So the bank got rid of some 
stuff at a very low price. Lehman made oodles of money. And the 
borrower had their debt cut in half. Now which price was right? 
The 20 percent that Lehman paid or the 40 percent that the 
borrower paid back to Lehman?
    Well, the point is a market was created. And over time, 
things began to coalesce. Once you have a market, then you 
could have a market-clearing price.
    My concern is in this area of these derivatives where the 
market is frozen, and there is no market--and I think Ben 
Bernanke is doing a superb job at trying to unfreeze that. That 
is why I am saying if you have a rational estimate of the right 
neighborhood, then you go about doing things to de-stress asset 
markets, resell them to other people. Prices will begin to be 
created, and they will go up or down, and we will find a price.
    Mr. Silvers. Can I just comment on this that it seems to me 
that it is not possible to have that sort of effect if your 
primary objective in setting the price that you sell assets or 
that you buy assets because I think that is what we are talking 
about--buying, not selling--what Mr. Cooke was doing.
    If the Government's primary purpose in buying assets is to 
prop up stockholders in the banks, then the prices that the 
Government will put out there to buy will always be prices that 
are not--they don't have any credibility in the marketplace 
because any price that comes anywhere near where shall we say 
self-protective actors in the market are willing to operate at 
will be one that will reveal the capital inadequacy of the 
banks.
    Mr. Cooke. Could I just make a comment on one thing? Just 
on one bank's failure bringing down other banks. That may be a 
reference to the cross-guarantee provision. Are you familiar 
with that?
    Mr. Silvers. No, it was a reference to the argument, Mr. 
Cooke, that--and I think Richard alluded to it a moment ago--
that once you start, that in modern market conditions, once you 
start stepping forward and forcing dramatic dilution of equity 
holders, that you will set off some sort of dynamic of lack of 
confidence in the equity markets that otherwise healthy banks 
would have be taken over through a bear raid or panic of some 
sort in the equity markets. That was, I think, the position 
certainly held by Paulson's team.
    Mr. Cooke. I don't know. I don't know if that would happen 
or not. As far as guarantees, one thing, some of the solutions 
the FDIC did when we were at the RTC, they found sometimes they 
would package up a failing bank. They would turn it over to 
another healthy bank, and they would have them isolate the bad 
assets, and they would get a stop-loss protection, but it 
wasn't to the same owners and the same people. It was outside 
that.
    The Chairman. Thank you.
    Mr. Neiman, I want to make sure you complete your 
questions. I am afraid Mr. Silvers and I----
    Mr. Neiman. No, this is a very good discussion. If I had a 
little time, I would go back to Mr. Lundgren and spend a little 
time on the disposition side.
    From what I read in your Swedish resolution process, there 
is an indication that had you had more time to sell those 
assets, you may have been able to increase your return. And, I 
know that there are issues around the RTC selling too quickly 
and the impact it has on the market. So I would be curious 
about the disposition period of assets.
    The Chairman. Please, go ahead, Mr. Lundgren.
    Mr. Lundgren. Thank you.
    The law in Sweden said that banks had to disperse of these 
kind of assets within 3 years. That was, of course, a short 
period of time. So we wanted to increase that time. They could 
hold somewhat longer.
    And when we formed these two bad banks for the two 
nationalized banks, my belief at that time was that we should 
give them about 10 to 15 years at least, but it was upon what 
they themselves experienced, that they found that after 5 
years, in 1997, they could wind up the operations. They have 
been quite successful.
    You can always argue that they could have recovered even 
more if they stayed on for 5 more years. But I think myself 
that it was a good decision to wind up at that time. 
Altogether, as I said, with the shares increasing in value and 
privatizations, we recovered most of the money anyhow. So you 
can always discuss the length of it.
    The Chairman. Good. I want to thank everyone. Thank you, 
Your Excellency, Ambassador Hafstrom, for being with us today. 
Director General Lundgren, we really appreciate your coming. 
And Mr. Katz, Mr. Cooke, Dr. White, this is what it should be 
about.
    I have to say I was very much struck by your comment before 
and that you alluded to in your testimony that as Sweden worked 
through its difficulties, that you had turned to the 
experiences of the RTC and our efforts during the Great 
Depression in part to help inform the next iteration of how to 
deal with these problems, and that makes me doubly grateful 
that you would travel to the United States and bring us your 
experiences that we might bring them together here.
    I want to say that this Panel reminds me of the importance 
of our having an overall strategy to deal with this problem. It 
is enormously valuable to hear from four different sets of 
experiences and to hear common themes that run through them, 
some of which we have already begun to heed, some of which we 
clearly have not.
    It is also very interesting to hear the much more shall I 
say muscular approach taken toward management and investors and 
on behalf of the taxpayers whose money is being used to try to 
rescue these organizations and to put the economy back on a 
sound footing. But ultimately, the idea of developing and 
executing a plan in order to be able to preserve the financial 
institutions and restart the economy is deeply underscored by 
the testimony of all four of you.
    I very much appreciate your taking the time to be with us 
today. The record will be held open if anyone wishes to add 
additional questions.
    I am sorry that our colleagues were not able to be with us. 
I know the press of other business has kept them elsewhere. We 
may have additional questions that we would like to send to you 
and ask for your remarks in writing so that they might be made 
part of the formal record.
    With that, this stands adjourned. Thank you.
    [Whereupon, at 11:40 a.m., the hearing was adjourned.]