Chairman Durbin, Ranking Member Collins, members of the Subcommittee, I appreciate the opportunity to testify before you for the first time as Treasury Secretary on the President’s Fiscal Year 2010 Budget request for the Department of the Treasury.

While we see some initial signs of economic improvement and the financial system is beginning to heal, our country faces very substantial economic and financial challenges.

President Obama and his Administration are working to meet these challenges by getting Americans back to work and getting our economy to grow again; by restoring fiscal discipline to ensure a sustained recovery, and by making the long-neglected investments in health care, energy and education needed to enhance America’s global competitiveness and produce more balanced, sustainable growth over the long-term.

Treasury’s Key Priorities

To achieve these goals, we are repairing and reforming our financial system so that it works for, not against, a recovery that serves all Americans.

To restore growth and meet our fiscal goals, we are redesigning and bolstering enforcement of our tax code so that it is both fairer and more efficient.

To advance our interests globally, we are working with other nations to promote economic recovery and financial repair, and to ensure more open markets for U.S. business.

And to protect the country, we are deploying all of the tools at our disposal to exclude terrorists, proliferators, and other illicit actors from the international financial stage, and thereby secure our financial system and combat threats to our security.

The Fiscal Year 2010 Budget that you have before you will allow Treasury to pursue these core missions assigned to the Department by the President and the Congress. The $13.4 billion request includes a $676 million, or 5.3 percent, increase over enacted 2009 levels.

Of this increase, $14 million would go to bolstering the staffs of our Domestic Finance and Tax Policy offices, which are at the epicenter of Administration efforts to support rigorous analysis and implementation of revenue policy and to redesign and improve our tax policies and tax code.

Some $137 million would be devoted to more than doubling our Community Development Financial Institutions (CDFI) Fund to ensure that the benefits of our financial repairs reach beyond our major banks and businesses to help economically distressed communities. These communities were underserved by our financial system even before the current crisis, and have been deeply hurt by the job losses and business failures that the crisis has spawned.

A total of $332 million would be devoted to new Internal Revenue Service (IRS) enforcement efforts, including $128.1 million to add nearly 800 new IRS employees to combat offshore tax evasion and improve compliance with U.S. international tax laws by businesses and high-income individuals. Another $130 million would go to bolster the security of the IRS information technology, improve the efficiency of its business systems and upgrade its fraud detection capabilities.

Although not directly under the jurisdiction of this Subcommittee, our Budget also includes funds to meet our international obligations to help us in mounting a global response to the crisis and in creating mutually reinforcing growth around the world.

As we seek these additional funds to respond to our nation’s troubles, we have cut back on some programs that are either ineffective or that we believe can be safely delayed.

For example, while the Earned Income Tax Credit (EITC) continues to be one of the most effective anti-poverty programs that the Federal government administers, the Advanced EITC, a related program which provides benefits in advance of filing a tax return, has been prone to exceptionally high levels of error and low use by those eligible for it. Accordingly, our Budget proposes to end this latter program for savings next fiscal year of $125 million.

Similarly, even as we seek to increase capital investment for the IRS, our Budget would reduce the Department-wide capital investment account by 65 percent for a savings of $17 million.

The Treasury Budget would reduce the number of international economic attachés from 20 to 16, saving $2 million next fiscal year. It would absorb a portion of our non-pay inflation through more efficient use of contracting and other cutbacks, saving $18 million. It would take advantage of the growth of efficient electronic filing of tax returns to reduce the IRS processing budget by $8 million next fiscal year.

Given we have had control over the budget for fewer than five months, the reductions that I have just described represent a first attempt to do more with less. As we begin work on the Budget for Fiscal Year 2011, Treasury has prepared itself for a more rigorous assessment of its spending.

I have already issued guidance to Treasury senior staff that says, in part: “To afford any new investments, we will have to take new approaches to solving old problems. I expect each bureau and policy office to identify opportunities for innovation that will transform how Treasury fulfills its missions in order to both improve performance and reduce cost.”

In addition, the President has announced his intention to nominate Dan Tangherlini to be our Assistant Secretary for Management and Budget. Consistent with the President’s mandate, I will look to Mr. Tangherlini to scour the Treasury’s budget for efficiencies and cost savings. He comes to the job with an impressive track record of working on budget, management and performance issues with District of Columbia Mayor Adrian Fenty, and I am convinced that he will bring the same results-oriented approach to the federal government.

Repairing and Reforming the Financial System

The President has assigned the Treasury to repair key sectors of our economy so that they help revive growth and produce broadly shared prosperity.

The Treasury has been working to repair and reform every major element of our financial system, and to fill gaps in the system so that it benefits all Americans.

Last month, federal banking supervisors announced results of the stress tests that we asked them to conduct on our 19 largest financial institutions. The aim of these assessments was to ensure that these institutions have sufficient capital buffers to absorb the losses that they could suffer under worse-than-expected economic conditions and continue to make the loans necessary to sustain recovery.

The clarity and transparency provided by the tests has helped improve market confidence in the banks, making it possible for them to collectively raise nearly $90 billion through private equity offerings, bond issuances without government guarantees and sales of business units.

On housing, Treasury is working with HUD to bolster our housing markets by helping to drive down mortgage interest rates and by assisting responsible homeowners to refinance into more affordable mortgages or modify their at-risk loans to avoid preventable foreclosures.

In terms of the non-bank financial sector, Treasury is working to revive critically important securitization markets for both new and old asset-backed securities.

We have begun to boost new consumer and business lending by re-starting the markets for asset-backed securities that financed almost half of all lending in this country before the crisis. There were more securities of this type issued the four months after we launched our effort than in the preceding nine.

Additionally, Treasury is about to join with private investors in seeking to restart the markets for legacy mortgage loans and securities that are now stuck on bank balance sheets, keeping these institutions from making new loans to families and businesses.

As we have made repairs to the financial system, we have understood that repair alone is not enough. We must also reform the system so that it is less prone to crises of the dimensions that we now face.

In the next few weeks, we will outline a comprehensive plan of reform that will include systemic risk regulations to ensure that no large and interconnected firm or market can take on so much risk that its failure could destabilize the entire financial system. The plan calls for bolstering consumer and investor protections. And it will streamline our out-of-date regulatory structure so that our regulatory system matches the size, shape and speed of our modern financial system. Together, these changes will help prevent another crisis of the magnitude that we have just lived through, and give the government new tools to better cope with similar problems should they occur in the future.

In addition to the financial system, Treasury is helping to ensure that the nation has a viable auto industry in the future. We are working with General Motors and Chrysler to make sure these companies make the changes necessary to again prosper. As President Obama has said “we cannot…must not…and will not let our auto industry simply vanish.”

The resources for administering key elements of both our financial and auto repair efforts were authorized by the Emergency Economic Stabilization Act.

These activities are being handled by our Office of Financial Stability (OFS), which is focused on ensuring that TARP funds serve the public purpose of economic and financial stabilization; that they are fulfilling this purpose in ways that protect taxpayers; and that we can provide a clear account to the Congress and the American people about the effectiveness of the funds’ use.

In order to administer TARP and ensure compliance by TARP recipients, OFS has had to quickly assemble a substantial staff. OFS staffing levels, which were at 88 when I arrived in office, had risen to approximately 165 by the end of last month and are expected to rise to 225 by next fiscal year. The office’s budget for next fiscal year will total $262 million, a 6 percent decline from the current fiscal year’s $279 million. The change is largely due to a decline in estimated spending on contracts as part of the program’s initial start-up.

While TARP is proving effective at improving the immediate stability of the financial system, the scope of the issues that this Administration and this Department face extend beyond TARP to include striking the delicate balance between intervention and allowing market participants latitude to operate; devising a new financial regulatory structure for the future; and working through the tough problems of what form our government-sponsored enterprises, Fannie Mae and Freddie Mac, should take as we emerge from this difficult period.

All of these issues fall to Treasury’s Office of Domestic Finance, which, together with OFS, is having to operate on new policy terrain, tackling problems that the country has not faced in generations and for which we have few guideposts in our immediate past.

That is why the workload of the Office Domestic Finance has already expanded greatly, and is all but certain to expand still further. And it is why we are seeking to modestly increase its size and bolster its expertise in several critical areas.

Our Budget requests an additional $8.7 million for the office to add 26 full-time equivalent (FTE) positions to the staff. This represents a 26 percent increase from the office’s current fiscal year staffing of 101.

The additional funds will be used to create two new Deputy Assistant Secretary positions, one for housing finance, small business and consumer issues, and a second for capital markets. These two new officials will lead teams that will perform the economic and institutional research necessary to ensure that we understand all of the policy options in each of these areas and choose the most effective ones for solving our problems.

As we seek additional funds for Treasury, we must also seek them for the front-line institutions that will sustain our economic recovery and ensure that its benefits are broadly shared.

Our Budget would more than double the resources of the Community Development Financial Institutions (CDFI) Fund to $243.6 million. The fund’s mandate is to help low-income, economically distressed communities that were poorly served by our financial system even in economic good times, and – although they had nothing to do with causing current conditions –have been significantly hurt by the economic and financial fallout of the crisis that we now face.

The $136.6 million, or 128 percent increase in funding, would allow this program to support financial institutions in making job-creating investments and in providing access to capital in communities that are often considered too risky for mainstream financial institutions to serve. By targeting lenders and borrowers in these communities, the Fund would help some of our most vulnerable populations weather the crisis and benefit once recovery is underway.

The aim of the fund is to make sure that we provide distressed communities with more than simply government grants and aid.  We must also build the capacity of their local financial institutions to ensure that capital is flowing to homebuyers and businesses so that they can finance their own economic futures. Since its inception in 1994, the fund has directed nearly $1 billion to distressed communities, and allocated $19.5 billion in tax credits through its New Markets Tax Credit program.

Financial institutions funded through the CDFI program make loans to small businesses and micro-enterprises and take equity positions in them.  They provide mortgages to low-income homebuyers, and finance developers of low-income housing and community facilities, such as charter schools, health clinics and child care centers.

One example can be seen right here in the Anacostia neighborhood of Washington, DC. City First Bank – a local CDFI – and Charter Schools Development Corporation partnered to provide a $13.3 million New Markets Tax Credit for the Thurgood Marshall Academy, the city’s first charter school focused on law, serving 360 students in grades nine through twelve and achieving a 100 percent college acceptance rate for its first three graduating classes.

Historically, the CDFI program has been heavily oversubscribed and has had to turn away qualified applicants. For example, in the current fiscal year, the program for CDFI financial and technical assistance awards is budgeted at $55 million, but it expects to receive applications for more than $500 million in funding.

Redesigning the Tax System for Fairness and Efficiency

The President has asked Treasury to redesign and bolster enforcement of our tax code so that it supports growth, sets the stage for our return to a sustainable fiscal path, and accomplishes these goals in a manner that is fair, efficient and supportive of our society’s broadest goals.

To make good on the President’s assignment, our Budget requests a modest increase in funding for Treasury’s Office of Tax Policy and more substantial increases to expand IRS enforcement activities and to improve its information technology.

Treasury has moved quickly in implementing the more than 30 tax provisions of the President’s economic recovery plan. Treasury also has played an integral role in designing the tax provisions of the President’s Fiscal 2010 Budget, and it will play a similar role in implementing these.

The President has made clear that he will not seek any major revenue increases until 2011 when the recovery should be firmly in place. He has, however, been equally clear that once recovery is underway, we must get our fiscal house in order or risk having government borrowing crowd out productive private investment. Treasury and the White House will work with Congress to make the tax changes that are necessary to reduce deficits and to do so in a manner that is fair to all Americans.

As part of our efforts to make sure that the tax system is working for recovery and is operating fairly, we have designed new policies to curb the use of off-shore tax havens, close the international tax gap, remove tax incentives for companies to shift jobs overseas, and replace these incentives with ones that encourage creation of jobs at home.

Our tax work on the recovery plan, the Fiscal Year 2010 Budget, and these international tax issues are just the beginning of an ambitious agenda for this Administration.

On health care, the President has made clear that the road to fiscal discipline and to solvency for Medicare and Social Security runs through overall health care reform. Although much of the cost of the President’s reform plan will be covered by savings from the system, we will need to design programs to cover some of the costs in ways that are fair to all Americans and do not harm the economy. Treasury is deeply involved in this effort and in the related work to expand coverage and improve our health care system in other important ways.

On retirement and economic security, Treasury and, in particular, the Office of Tax Policy, is taking the lead in developing and actively working with Congress to flesh out the initiatives proposed in the President’s budget to help enhance retirement security and savings for the half of working Americans who have no retirement provisions beyond Social Security. These proposals would make it easier for people to save for their own retirement, either through their workplaces or on their own, and would move us toward universal retirement savings coverage.

On climate change, Treasury is already working closely with Congress to design the auction mechanisms that will be needed to implement the Administration’s greenhouse gas cap-and-trade program.

Our Office of Tax Policy has been deeply involved in all of these issues from the outset of the Administration. Like our Office of Domestic Finance, its workload already has substantially increased and is certain to grow as the health reform, retirement security and climate change debates get underway in earnest.

At the moment, the Office of Tax Policy’s career staff includes 30 lawyers and 44 economists as well as support staff for an overall staffing level of 93. This is lower than its usual complement of over 100 professionals.

Our Fiscal Year 2010 Budget would increase the office budget by $4.9 million to add 15 full-time equivalent (FTE) positions in order to increase overall staffing to 108, and would therefore represent a return to historical norms. The additional staff is needed to perform analysis and revenue estimates for new policy proposals, conduct research for, among other things, congressionally mandated studies, and develop regulations and guidance for new legislation.

The vast majority of the new funds that we request in this Budget are for improving the enforcement efforts and the information technology of the IRS.

As I have said, $332 million would go to new IRS enforcement efforts, including $128.1 million to improve international tax compliance. The balance of these funds would be used to support three critical programs: 755 employees to increase examinations of tax returns for businesses and high-income individuals; 300 employees to expand the IRS document matching program, which compares tax returns to other forms such as W-2s and 1099s; and an additional 491 employees to improve collection operations and build two new IRS automated collection center sites.

Turning to IT, our Budget requests a $90 million increase in funding to protect taxpayers’ personal records from the increasing number and sophistication of Internet-based attacks. With these funds, the agency will deploy state-of-the-art, automated tools to improve record access management, risk assessment and system auditing. This effort would address concerns noted in the past by both the Government Accountability Office and the Treasury Inspector General for Tax Administration.

Our Budget also requests an additional $18 million for systems to help the IRS return review program detect noncompliance and fraudulent refunds, and a $22 million increase to continue modernizing the agency’s core taxpayer account database and modernized the e-File web-based platform.

Reengaging with the World on Economic Issues

The President assigned Treasury to ensure that this country reengages with the world, not just on issues of war and peace, but also on the current crisis, and on issues crucial to our common economic futures.

This is a global crisis. Recovery here depends on recovery abroad. We are working closely with other major economies to put in place the fiscal stimulus and make the financial repairs necessary to ensure U.S. and global recovery.

The U.S. is seeking to mobilize the financial resources of the better-off nations to help the emerging and developing economies that have been especially hard-hit by this crisis. We are doing this for more than simply humanitarian reasons; as recently as last fall, these economies accounted for fully 42 percent of all U.S. exports.

Last month, the President and leaders of the other G-20 nations agreed on the need to make more than $1 trillion in financial resources available to support global growth and trade.

Those funds include our commitment of up to $100 billion for an expanded New Arrangements to Borrow, a permanent back-up mechanism that provides the International Monetary Fund with supplemental resources to help emerging markets and developing nations weather the crisis.

As part of our effort to rekindle global growth for the sake of our own recovery, we are seeking to meet our past and present financial commitments to the multilateral development banks that help emerging and developing countries.

Although the funds to do this are not directly within the purview of your Subcommittee, I mention them to illustrate how Treasury’s entire budget is tailored to let us fulfill the missions that the President has set out for us. Our budget request includes $2.5 billion for international programs, most of which would serve to meet our past and present commitments to the multilateral development banks.

Our financial reform effort in the United States must be matched by similarly strong efforts elsewhere in order to succeed.

Conclusion

Before I end, let me say a word about the Department’s staff.  I have the honor of leading a team of smart and dedicated individuals who are working to make our government more effective and our society fairer, who are following a long tradition of debating policies fearlessly on their merits, doing what is right and not what is expedient, and drawing on the best ideas and expertise that are available. They are performing an incalculable service to our country in these challenging times, and I am immensely grateful to them.

The Department of the Treasury is responsible for promoting the nation’s economic prosperity and protecting its financial security. We advance our interests around the world through the strength not only of our economy but of our ideas.

This President and Treasury have already begun the hard work of recovery and reform. Our Fiscal Year 2010 Budget will allow us to pursue these critical goals, and deliver the balanced and sustainable growth that the American people seek and deserve.

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It is a pleasure to be back in China and to join you here today at this great university.

I first came to China, and to Peking University, in the summer of 1981 as a college student studying Mandarin. I was here with a small group of graduate and undergraduate students from across the United States. I returned the next summer to Beijing Normal University.

We studied reasonably hard, and had the privilege of working with many talented professors, some of whom are here today. As we explored this city and traveled through Eastern China, we had the chance not just to understand more about your history and your aspirations, but also to begin to see the United States through your eyes.

Over the decades since, we have seen the beginnings of one of the most extraordinary economic transformations in history. China is thriving. Economic reform has brought exceptionally rapid and sustained growth in incomes. China¡¯s emergence as a major economic force more fully integrated into the world economy has brought substantial benefits to the United States and to economies around the world.

In recognition of our mutual interest in a positive, cooperative, and comprehensive relationship, President Hu Jintao and President Obama agreed in April to establish the Strategic and Economic Dialogue. Secretary Clinton and I will host Vice Premier Wang and State Councilor Dai in Washington this summer for our first meeting. I have the privilege of beginning the economic discussions with a series of meetings in Beijing today and tomorrow.

These meetings will give us a chance to discuss the risks and challenges on the economic front, to examine some of the longer term challenges we both face in laying the foundation for a more balanced and sustainable recovery, and to explore our common interest in international financial reform.

Current Challenges and Risks

The world economy is going through the most challenging economic and financial stress in generations.

The International Monetary Fund predicts that the world economy will shrink this year for the first time in more than six decades. The collapse of world trade is likely to be the worst since the end of World War II. The lost output, compared to the world economy’s potential growth in a normal year, could be between three and four trillion dollars.

In the face of this challenge, China and the United States are working together to help shape a strong global strategy to contain the crisis and to lay the foundation for recovery. And these efforts, the combined effect of forceful policy actions here in China, in the United States, and in other major economies, have helped slow the pace of deterioration in growth, repair the financial system, and improve confidence.

In fact, what distinguishes the current crisis is not just its global scale and its acute severity, but the size and speed of the global response.

At the G-20 Leaders meeting in London in April, we agreed on an unprecedented program of coordinated policy actions to support growth, to stabilize and repair the financial system, to restore the flow of credit essential for trade and investment, to mobilize financial resources for emerging market economies through the international financial institutions, and to keep markets open for trade and investment.

That historic accord on a strategy for recovery was made possible in part by the policy actions already begun in China and the United States.

China moved quickly as the crisis intensified with a very forceful program of investments and financial measures to strengthen domestic demand.

In the United States, in the first weeks of the new Administration, we put in place a comprehensive program of tax incentives and investments ¨C the largest peace time recovery effort since World War II – to help arrest the sharp fall in private demand. Alongside these fiscal measures, we acted to ease the housing crisis. And we have put in place a series of initiatives to bring more capital into the banking system and to restart the credit markets.

These actions have been reinforced by similar actions in countries around the world.

In contrast to the global crisis of the 1930s and to the major economic crises of the postwar period, the leaders of the world acted together. They acted quickly. They took steps to provide assistance to the most vulnerable economies, even as they faced exceptional financial needs at home. They worked to keep their markets open, rather than retreating into self-defeating measures of discrimination and protection.

And they have committed to make sure this program of initiatives is sustained until the foundation for recovery is firmly established, a commitment the IMF will monitor closely, and that we will be able to evaluate together when the G-20 Leaders meet again in the United States this fall.

We are starting to see some initial signs of improvement. The global recession seems to be losing force. In the United States, the pace of decline in economic activity has slowed. Households are saving more, but consumer confidence has improved, and spending is starting to recover. House prices are falling at a slower pace and the inventory of unsold homes has come down significantly. Orders for goods and services are somewhat stronger. The pace of deterioration in the labor market has slowed, and new claims for unemployment insurance have started to come down a bit.

The financial system is starting to heal. The clarity and disclosure provided by our capital assessment of major U.S. banks has helped improve market confidence in them, making it possible for banks that needed capital to raise it from private investors and to borrow without guarantees. The securities markets, including the asset backed securities markets that essentially stopped functioning late last year, have started to come back. The cost of credit has fallen substantially for businesses and for families as spreads and risk premia have narrowed.

These are important signs of stability, and assurance that we will succeed in averting financial collapse and global deflation, but they represent only the first steps in laying the foundation for recovery. The process of repair and adjustment is going to take time.

China, despite your own manifest challenges as a developing country, you are in an enviably strong position. But in most economies, the recession is still powerful and dangerous. Business and households in the United States, as in many countries, are still experiencing the most challenging economic and financial pressures in decades.

The plant closures, and company restructurings that the recession is causing are painful, and this process is not yet over. The fallout from these events has been brutally indiscriminant, affecting those with little or no responsibility for the events that now buffet them, as well as on some who played key roles in bringing about our troubles.

The extent of the damage to financial systems entails significant risk that the supply of credit will be constrained for some time. The constraints on banks in many major economies will make it hard for them to compensate fully for the damage done to the basic machinery of the securitization markets, including the loss of confidence in credit ratings. After a long period where financial institutions took on too much risk, we still face the possibility that banks and investors may take too little risk, even as the underlying economic conditions start to improve.

And, after a long period of falling saving and substantial growth in household borrowing relative to GDP, consumer spending in the United States will be restrained for some time relative to what is typically the case in recoveries.

These are necessary adjustments. They will entail a longer, slower process of recovery, with a very different pattern of future growth across countries than we have seen in the past several recoveries.

Laying the Foundation for Future Growth

As we address this immediate financial and economic crisis, it is important that we also lay the foundations for more balanced, sustained growth of the global economy once this recovery is firmly established.

A successful transition to a more balanced and stable global economy will require very substantial changes to economic policy and financial regulation around the world. But some of the most important of those changes will have to come in the United States and China. How successful we are in Washington and Beijing will be critically important to the economic fortunes of the rest of the world. The effectiveness of U.S. policies will depend in part on China’s, and the effectiveness of yours on ours.

Although the United States and China start from very different positions, many of our domestic challenges are similar. In the United States, we are working to reform our health care system, to improve the quality of education, to rebuild our infrastructure, and to improve energy efficiency. These reforms are essential to boosting the productive capacity of our economy. These challenges are at the center of your reform priorities, too.

We are both working to reform our financial systems. In the United States, our challenge is to create a more stable and more resilient financial system, with stronger protections for consumer and investors. As we work to strengthen and redesign regulation to achieve these objectives, our challenge is to preserve the core strengths of our financial system, which are its exceptional capacity to adapt and innovate and to channel capital for investment in new technologies and innovative companies. You have the benefit of being able to learn from our shortcomings, which have proved so damaging in the present crisis, as well as from our strengths.

Our common challenge is to recognize that a more balanced and sustainable global recovery will require changes in the composition of growth in our two economies. Because of this, our policies have to be directed at very different outcomes.

In the United States, saving rates will have to increase, and the purchases of U.S. consumers cannot be as dominant a driver of growth as they have been in the past.

In China, as your leadership has recognized, growth that is sustainable growth will require a very substantial shift from external to domestic demand, from an investment and export intensive driven growth, to growth led by consumption. Strengthening domestic demand will also strengthen China’s ability to weather fluctuations in global supply and demand.

If we are successful on these respective paths, public and private saving in the United States will increase as recovery strengthens, and as this happens, our current account deficit will come down. And in China, domestic demand will rise at a faster rate than overall GDP, led by a gradual shift to higher rates of consumption.

Globally, recovery will have come more from a shift by high saving economies to stronger domestic demand and less from the American consumer.

The policy framework for a successful transition to this outcome is starting to take shape.

In the United States, we are putting in place the foundations for restoring fiscal sustainability.

The President in his initial budget to Congress made it clear that, as soon as recovery is firmly established, we are going to have to bring our fiscal deficit down to a level that is sustainable over the medium term. This will mean bringing the imbalance between our fiscal resources and expenditures down to the point – roughly three percent of GDP — where the overall level of public debt to GDP is definitively on a downward path. The temporary investments and tax incentives we put in place in the Recovery Act to strengthen private demand will have to expire, discretionary spending will have to fall back to a more modest level relative to GDP, and we will have to be very disciplined in limiting future commitments through the reintroduction of budget disciplines, such as pay-as-you go rules.

The President also looks forward to working with Congress to further reduce our long-run fiscal deficit.

And, critical to our long-term fiscal health, we have to put in place comprehensive health care reform that will bring down the growth in health care costs, costs that are the principal driver of our long run fiscal deficit.

The President has also proposed steps to encourage private saving, including through automatic enrollment in retirement savings accounts.

Alongside these fiscal actions, we have designed our policies to address the financial crisis to carefully minimize risk to the taxpayer and to allow for an orderly exit or unwinding as soon as conditions permit. Across the various financial facilities put in place by the Treasury, the Federal Reserve, and the FDIC, we have been careful to set the economic terms at a level so that demand for these facilities will fade as conditions normalize and risk premia recede. Banks have a strong incentive to replace public capital with private capital as soon as conditions permit.

Let me be clear – the United States is committed to a strong and stable international financial system. The Obama Administration fully recognizes that the United States has a special responsibility to play in this regard, and we fully appreciate that exercising this special responsibility begins at home. As we recover from this unprecedented crisis, we will cut our fiscal deficit, we will eliminate the extraordinary governmental support that we have put in place to overcome the crisis, we will continue to preserve the openness of our economy, and we will resolutely maintain the policy framework necessary for durable and lasting sustained non-inflationary growth.

In China, the challenge is fundamentally different, and at least as complex.

Critical to the success of your efforts to shift future growth to domestic demand are measures to raise household incomes and to reduce the need that households feel to save large amounts for precautionary reasons or to pay for major expenditures like education. This involves strengthening the social safety net with health care reform and more complete public retirement systems, enacting financial reforms to help expand access to credit for households, and providing products that allow households to insure against risk. These efforts can be funded through the increased collection of dividends from state-owned enterprises.

The structure of the Chinese economy will shift as domestic demand grows in importance, with a larger service sector, more emphasis on light industry, and less emphasis on heavy, capital intensive export and import-competing industries. The resulting growth will generate greater employment, and be less energy-intensive than the current structure of Chinese industry. Allowing the market, interest rates, and other prices to function to encourage the shift in production will be particularly important.

An important part of this strategy is the government’s commitment to continue progress toward a more flexible exchange rate regime. Greater exchange rate flexibility will help reinforce the shift in the composition of growth, encourage resource shifts to support domestic demand, and provide greater ability for monetary policy to achieve sustained growth with low inflation in the future.

International Financial Reform

These are some of the most important domestic economic challenge we face, and these issues will be at the core of our agenda for economic cooperation.

But I think it is important to underscore that we also have a very strong interest in working together to strengthen the framework for international economic and financial cooperation.

Let me highlight three important areas.

At the G-20 Leaders meeting, we committed to a series of actions to help reform and strengthen the international financial architecture.

As part of this, we agreed to put in place a stronger framework of standards for supervision and regulation of the financial system. We expanded and strengthened the Financial Stability Forum, now renamed the Financial Stability Board. China and other major emerging economies are now full participants, alongside the major financial centers, in this critical institution for cooperation. We will have the chance together to help redesign global standards for capital requirements, stronger oversight of global markets like derivatives, better tools for resolving future financial crises, and measures to reduce the opportunities for regulatory arbitrage.

We also committed to an ambitious program of reform of the IMF and other international financial institutions. Our common objective is to reform the governance of these institutions to make them more representative of the shifting balance of economic and financial activity in the world, to strengthen their capacity to prevent future crisis, with stronger surveillance of macroeconomic, exchange rate, and financial policies, and to equip them with a stronger financial capacity to respond to future crises. We also committed to mobilize $500 billion in additional finance through the enlargement and membership expansion of the IMF’s New Arrangements to Borrow in order to provide an insurance policy for the global financial system.

As part of this process of reform, the United States will fully support having China play a role in the principal cooperative arrangements that help shape the international system, a role that is commensurate with China’s importance in the global economy.

I believe that a greater role for China is necessary for China, for the effectiveness of the international financial institutions themselves, and for the world economy.

China is already too important to the global economy not to have a full seat at the international table, helping to define the policies that are critical to the effective functioning of the international financial system.

Second, we must cooperate to assure that the global trade and investment environment remains open, and that opportunities continue to expand. As economies have become more open and more closely integrated, global economic growth has been stronger and more broad-based, bringing increasing numbers out of poverty, and turning developing nations into major emerging markets. The global commitment to trade liberalization and increasingly open investment played a critical role in this process ¨C in the industrialized world, in East Asia, and, since 1978, in China. As we go through the severe stresses of this crisis, we must not turn our backs on open trade and investment – for ourselves and for those who have yet to experience the fruits of growth and development. The United States, China, and the other members of the G20 have committed to not resort to protectionist measures by raising trade and investment barriers and to work toward a successful conclusion to the Doha Development Round.

And third, one of the most critical long-term challenges that we both face is climate change. Individually and collectively, there is an urgent need to ensure that each and every country takes meaningful action to deal with this threat. Reducing land and forest degradation, conserving energy, and using clean technology are important objectives that complement both our efforts to achieve a new, sustainable pattern of growth and our goal of reducing greenhouse gas emissions. China and the United States already are working closely through the Strategic and Economic Dialogue in areas such as clean transportation, clean and efficient production of electricity, and the reduction of air and water pollution. We must continue these efforts for the sake of our natio ns and the planet.

Conclusion

In the last few years the frequency, intensity, and importance of U.S.-China economic engagements have multiplied. The U.S.-China Strategic and Economic Dialogue that President Obama and President Hu initiated in April is the next stage in that process. I look forward to welcoming Vice Premier Wang, State Councilor Dai and their colleagues to Washington to participate in the first meeting of the U.S.-China Strategic and Economic Dialogue.

Our engagement should be conducted with mutual respect for the traditions, values, and interests of China and the United States. We will make a joint effort in a concerted way “同心协力”. We should understand that we each have a very strong stake in the health and the success of each other’s economy.

China and the United States individually, and together, are so important in the global economy and financial system that what we do has a direct impact on the stability and strength of the international economic system. Other nations have a legitimate interest in our policies and the ways in which we work together, and we each have an obligation to ensure that our policies and actions promote the health and stability of the global economy and financial system.

We come together because we have shared interests and responsibilities. We also have our own national interests. I will be a strong advocate for U.S. interests, just as I expect my counterparts to represent China¡¯s. China has benefited hugely from open trade and investment, and the ability to greatly increase its exports to the rest of the world. In turn, we expect increased opportunities to export to and invest in the Chinese economy.

We want China to succeed and prosper. Chinese growth and expanding Chinese demand is a tremendous opportunity for U.S. firms and workers, just as it is in China and the rest of the world.

Global problems will not be solved without U.S.-China cooperation. That goes for the entire range of issues that face our world from economic recovery and financial repair to climate change and energy policy.

I look forward to working with you cooperatively, and in a spirit of mutual respect.

Introduction

Good morning.

Chairman Dodd, Ranking Member Shelby, members of the Senate Banking Committee, thank you for the opportunity to testify before you today.

On October 3, 2008, during a time of tremendous financial upheaval and economic uncertainty, Congress passed the Emergency Economic Stabilization Act (EESA) with the specific goal of stabilizing the nation’s financial system and preventing catastrophic collapse. Soon after taking office, this Administration rebuilt the EESA programs from the ground up with a new foundation. We also unveiled a financial stability plan to restore the flow of credit to consumers and businesses, tackle the foreclosure crisis in order to help millions of Americans stay in their homes, and comprehensively reform the nation’s financial regulatory system so that a crisis like this one never happens again.

Today, just four months into President Obama’s term of office, there are important indications that our financial system is starting to heal. For example, spreads for investment grade corporate bonds have fallen about 210 basis points and spreads on high yield corporate bonds are down about 770 basis points since the end of November. Spreads on AAA municipal bonds have come down 150 basis points since October. Risk premiums in short-term, inter-bank markets have fallen 280 basis points over roughly the same period and the cost of credit protection for the largest U.S. banks has fallen by about 180 basis points just since early April. Treasury is continuing to look into additional metrics that gauge the markets more broadly, as well as additional economic metrics, to determine the effectiveness of the current strategy and whether additional or different steps are needed.

With the help of our lending facility with the Federal Reserve, new securities issuance has started to revive. Spreads for AAA credit card receivables asset-backed securities (ABS) have fallen about 330 basis points from their peak. There has been more issuance of consumer ABS in the past two months than in the preceding five months combined. In our housing market, interest rates on 30-year mortgages have dropped to historic lows and refinancing has surged.

Finally, we have already seen a substantial amount of adjustment in our financial system. Leverage has declined, the most vulnerable parts of the non-bank financial system no longer pose the same risk, and banks are funding themselves more conservatively.

These are all welcome signs. However, the process of financial recovery and repair will take time.

The Conditions We Confronted Upon Taking Office

The challenges that our financial system confronts are complex, interrelated, and the result of developments over many years. Earlier this decade, a combination of factors generated unsustainable bubbles in many housing markets across the country. A protracted period of rapid innovation, excessive risk taking, and inadequate regulation produced a financial system that was far more fragile than was generally appreciated during the boom times.

Starting in 2007, unexpected losses experienced by major banks on mortgage-backed securities set off a vicious cycle. The losses reduced their capital, which forced them to pull back on lending. This put downward pressure on asset prices, which generated further losses for the banks and reduced wealth for millions of American families and businesses. Tightening financial conditions became a drag on the broader economy. As workers lost jobs and as prospects for businesses darkened, prospective losses on consumer and business loans increased. And as the scale of the potential financial losses increased, market concerns about the viability of individual institutions mounted, and as firms became reluctant to maintain even normal exposures to one another, the basic functioning of our financial markets was compromised.

In the fall of 2008, major policy intervention (including the EESA legislation) was, in the end, successful in achieving the vital but narrow objective of preventing a systemic financial meltdown. However, while those actions reduced overt concerns about systemic risk, as President-Elect Obama and his economic team prepared an economic program, the outlook for the economy was deteriorating rapidly. Economic data that became available in November and December pointed to a very sharp fall in economic activity. For example, the advanced data on orders for durable goods fell by 6.2 percent in October, the largest monthly decrease in two years. On December 4, it was reported that payroll employment had fallen by 533,000 in November.[1] This was the largest monthly decline since the deep recession of 1973-74. Quickly worsening prospects for the economy meant that likely losses for U.S. financial institutions were rising sharply as well, and this heightened concerns about the adequacy of their capital.

The disruptions to the financial system were a major factor undermining the economy. Liquidity in a broader range of securities markets, including the market for long-term Treasuries, fell sharply. Credit spreads for virtually all credit products reached historic highs in the fourth quarter. Loan growth and bond issuance slowed in the fourth quarter. In particular, the issuance of new ABS essentially came to a halt in October. Part of the decline in credit growth reflected falling demand for credit as consumers and businesses became more cautious. But a variety of factors pointed to meaningful constraints on the supply of credit. For example, a record number of banks reported tightening credit standards in the fourth quarter.

In addition, given the substantial burden placed upon the American taxpayers, there was deep public anger, skepticism about whether the government was using taxpayer money wisely, and a perceived lack of transparency, all of which led to eroding confidence.

Our Response

Leaving that situation unaddressed would have undoubtedly risked a deeper recession and more damage to the productive capacity of the American economy. It would have resulted in higher unemployment and greater failures of businesses.

The lesson of past economic crises is that early, forceful and sustained action is necessary to spur growth, repair the financial system and restore the flow of credit in order to sustain economic recovery.

Facing these extraordinary challenges, this Administration and the Congress responded with extraordinary action. Within weeks, we enacted the American Recovery and Reinvestment Act (ARRA) that is giving 95 percent of working Americans a tax cut, creating or saving 3.5 million jobs, providing nearly 4 million students with a new higher education tax cut and helping 1.4 million Americans purchase their first home by providing $6.5 billion in tax credits.

On February 10, the Administration outlined a series of proposals to stabilize the housing market; boost new consumer and business lending by re-starting the market for securities; increase transparency and new capital in the financial system by conducting an unprecedented regulatory review of our nation’s largest banks; and create a market for legacy real-estate related loans and securities that are clogging banks and making them reluctant to lend.

Reforming EESA

Upon taking office, this Administration reformed EESA in four concrete ways. First, we brought a new framework of transparency, accountability and oversight. Second, we redirected the program to get credit flowing again to the financial system. Third, we focused the program on the housing market, consumer business lending, small business lending, and efforts to help create a market for legacy loans and securities. Finally, we worked to ensure that our programs facilitated broader restructuring in the financial system by providing unprecedented transparency about the health of our major financial institutions, allowing investors to differentiate more clearly among banks and ultimately make it easier for banks to raise enough private capital to repay the money they have already received from the government. I would like to update the committee on each.

Transparency, Accountability and Oversight

A key element to our new approach came in March, when the Department of the Treasury launched a new website, www.financialstability.gov, that lists how taxpayer dollars are spent, what conditions are placed on institutions in exchange for government assistance, and provides an interactive map illustrating state-by-state bank and financial institution funding.

We have also taken a number of steps to better measure whether our programs are increasing the flow of credit through Monthly Lending and Intermediation Surveys. Treasury undertook this important initiative to better understand the effects the program is having and to help the public easily assess the lending and intermediation activities of banks participating in the Capital Purchase Program (CPP). The Surveys capture data from the 20 largest recipients of investments under the CPP, detailing quantitative information on three major categories of lending – consumer, commercial, and other financial activities – based on banks’ internal reporting, as well as commentary to explain changes in lending levels for each category. We are in the process of expanding our monthly survey to include all banks participating in the CPP, including more than 500 small and community banks across the country and are adding a metric to follow lending to small businesses. For institutions taking part in the Capital Assistance Program (CAP), which I will describe momentarily, Treasury is requiring recipients to detail in monthly reports their lending broken out by category.

In addition, on January 28, 2009, Treasury announced that it would begin posting all of its investment contracts online within five to ten business days of each transaction’s closing. Treasury is in the process of posting all the contracts signed prior to January 28 to the website as well. To date, Treasury has posted over 240 investment contracts on www.financialstability.gov, in addition to terms and program guidelines for all programs under the EESA.

Since taking office we have worked closely with the Government Accountability Office, the Congressional Oversight Panel, and the Special Inspector General for the Troubled Asset Relief Program, the three oversight bodies examining the implementation of EESA. We are continually reviewing their recommendations and are adapting our programs in response to their proposals.

Finally, on February 4, the President laid out a set of broad reforms for compensation packages for financial institutions that receive government assistance. Congress put in place additional reforms and currently Treasury is preparing an Interim Final Rule to implement the executive compensation and corporate governance provisions of the ARRA.

Housing

As we are all painfully aware, the collapse of the housing price bubble, and the sharp reversal in lending standards that helped fuel that bubble, have had a devastating effect on homeowners and the financial sector, with dire consequences for the economy overall. In addition to reducing household wealth across the country, and thereby further intensifying the economic contraction, falling home prices and extraordinarily tight lending standards have trapped homeowners in their old mortgages. Even many homeowners who made what seemed to be conservative financial decisions three, four, or five years ago find themselves unable to benefit from the low interest rates available to unencumbered borrowers today. At the same time, increases in unemployment and other recessionary pressures have continued to impair the ability of some otherwise responsible families to stay current on mortgage payments.

Since January, the Administration has spent considerable effort developing and implementing a comprehensive plan for stabilizing our housing market. Working with the Federal Reserve, along with enacting programs to help provide more financial strength to the GSEs, we helped bring overall mortgage interest rates down to historic lows.

We launched a new program called Making Home Affordable to make it possible for millions of American homeowners to refinance and take advantage of those lower interest rates.

And we put in place a program to reduce the monthly mortgage payments for eligible borrowers. This loan modification program ensures monthly mortgage payments are at most 31 percent of a person’s income for five years.

On April 6, building on MHA, Treasury announced a major inter-agency effort to combat mortgage rescue fraud and put scammers on notice that we will not stand by while they prey on homeowners seeking help to avoid foreclosure.

On April 28, Treasury announced a Second Lien Program so that, when a Home Affordable Modification is initiated on a first lien, servicers participating in the Second Lien Program will automatically reduce payments on the associated second lien according to a pre-set protocol. Servicers alternatively have the option to extinguish the second lien in return for a lump sum payment under a pre-set formula determined by Treasury, allowing servicers to target principal extinguishment to the borrowers where extinguishment is most appropriate. Treasury also announced steps to incorporate the Federal Housing Administration’s (FHA) Hope for Homeowners into MHA.

And on May 14, Treasury announced new details on Foreclosure Alternatives and Home Price Decline Payments. The Foreclosure Alternatives are meant to prevent costly foreclosures by providing incentives for servicers and borrowers to pursue short sales and deeds-in-lieu of foreclosure in cases where a borrower is eligible for a MHA modification but unable to complete the modification process. The Home Price Decline Protection Incentives will provide additional payments based on recent home price declines, and therefore will incentivize additional modifications in areas where home prices have been falling.

To date, MHA’s progress has been substantial. Fourteen servicers, including the five largest, have signed contracts and begun modifications under our program. Between loans covered by these servicers and loans owned or securitized by Fannie Mae or Freddie Mac, more than 75 percent of all loans in the country are now covered by MHA. The 14 participating servicers have extended offers on over 55,000 trial modifications and mailed out over 300,000 letters with information about trial modifications to borrowers and Fannie Mae and Freddie Mac have acquired thousands of refinancings for high loan-to-value (LTV) borrowers.

Since the launch of its new automated underwriting system on April 4, Fannie Mae has had over 233,000 eligible refinance applications through DU Refi Plus, with over 51,000 of these having LTVs between 80 and 105 percent. More than 3,650 Home Affordable Refinance loans have closed and been delivered to Fannie Mae and Freddie Mac already. These application volumes indicate the desire of homeowners to take advantage of the Administration’s program.

Since the Treasury released guidelines for servicers under MHA on March 4, close to 3 million borrowers have accessed Fannie Mae and Freddie Mac loan look-up tools online to see if they have a loan eligible for refinancing. Just two weeks after the guidelines were released Treasury also launched www.makinghomeaffordable.gov, a website dedicated to helping empowering homeowners with the tools to gather information about the program and determine whether they might be eligible. The site has received more than 17.7 million page views in less than two months.

Going forward, we will continue to explore additional ways to help the housing market and report on ongoing progress.

Capital Assistance Program

Currently, the vast majority of banks have more capital than they need to be considered well capitalized by their regulators. However, concerns about economic conditions – combined with the destabilizing impact of distressed “legacy assets” – have created an environment under which uncertainty about the health of individual banks has sharply reduced lending across the financial system, working against economic recovery.

For every dollar that banks are short of the capital they need, they will be forced to shrink their lending by eight to twelve dollars. Conversely, every additional dollar of capital gives banks the capacity to expand lending by eight to twelve dollars. Providing confidence that banks have a sufficient level of capital even if the economic outlook deteriorates is a necessary step to restart lending, so that families have access to the credit they need to buy homes or pay for college, and businesses can get the loans they need to expand. Moreover, reassuring investors that banks have sufficient resources to weather even a very adverse economic scenario will make it possible for banks to raise additional private capital.

That is why a key component of any credible program to restore confidence to the financial system and get credit flowing again is to recapitalize the banking system, ensuring that the largest banks in the country have sufficient capital so they can support lending, even in a more severe economic scenario.

On May 7, Federal banking supervisors announced the results of the most extensive regulator review in our nation’s history of the biggest 19 banks. The forward-looking test provided unprecedented levels of transparency and clarity to address uncertainty in the banking system.

The results found that 9 of the 19 firms currently have capital buffers sufficient to get through the adverse scenario and that the remaining 10 firms collectively need to add $75 billion to their capital buffers to reach the target.

Any Bank Holding Company needing to augment its capital buffer is required to develop a detailed capital plan to be approved by its primary supervisor, after consultation with the FDIC and Treasury. These plans are due 30 days following the release of the results, on June 8th, and must be implemented within six months of the release of the results. Also, some firms may choose to apply to Treasury for Mandatory Convertible Preferred (MCP) under our program as a bridge to private capital.

This review is helping to increase confidence in the financial system. To date, more than $56 billion in funds have been raised or announced by the 19 banks, including $34 billion in common equity capital. Of the $56 billion, about $48 billion has been planned or executed by banks with a SCAP shortfall. Banks without a shortfall have signaled their intent to use funds to repay EESA capital if approved. One of the preconditions to repaying EESA capital is that banks must demonstrate financial strength by issuing senior unsecured debt for a term greater than five years not backed by FDIC guarantees. To date, banks have also raised $8 billion in non-FDIC guaranteed bonds.

Going forward, we plan to re-open the application window for banks with total assets under $500 million under the Capital Purchase Program, established last October by the previous Administration, and raise from 3 percent of risk-weighted assets to 5 percent the amount for which qualifying institutions can apply. This applies to all term sheets – public and private corporations, Subchapter S corporations, and mutual institutions. Current CPP participants will be allowed to reapply, and will have an expedited approval process.

In addition, we plan to extend the deadline for small banks to form a holding company for the purposes of CPP. Both the window to form a holding company and the window to apply or re-apply for CPP will be open for six months.

These are essential steps to ensuring that community banks, a source of strength and resilience for the U.S. financial system, continue to lend during this economic crisis. Community banks have accounted for more than one third of the dollar volume of loans to small businesses – the businesses which in turn have accounted for the majority of new jobs created annually over the past decade.

Consumer and Business Lending Initiative

Securitization has come to play a very important role in the U.S. financial system. Banks develop and maintain expertise in originating certain types of loans. This includes loans to individuals through credit cards, mortgages, student loans, and other forms of consumer credit as well as loans to businesses, particularly those that are not able to raise funds directly in securities markets. In recent years, an increasing portion of these loans have been aggregated into pools and sold as so-called Asset Backed Securities, or ABS. The rapid growth of the market for ABS in the years before the current crisis increased the supply of credit available to individuals and small businesses because once banks pool and sell loans to the securitization market, it opens up their balance sheet to create new loans.

As the economy deteriorated over the summer of 2008, credit spreads on ABS began to rise, and the disruptions that followed the failure of Lehman Brothers severely disrupted the market of newly issued ABS. Issuance of consumer ABS averaged $20 billion per month in 2007, and $18 billion per month during the first half of 2008. However, ABS issuance slowed sharply in the third quarter before coming to a virtual halt in October 2008. The closure of this market is a major constraint on the supply of new credit to individuals and businesses, particularly in an environment where banks have little scope to expand their balance sheets.

An important part of the FSP is a significant expansion of the Term Asset-Backed Securities Loan Facility (TALF) through the Consumer and Business Lending Initiative (CBLI). The TALF is designed to jumpstart the securitization markets, which in turn will increase lending throughout the economy. Under the TALF, the Federal Reserve extends loans to investors who purchased newly issued ABS. Treasury has committed funds under the EESA program to provide a degree of credit protection for the Federal Reserve’s TALF loans. The program was initially proposed in November 2008, with a focus on highly-rated ABS backed by student loans, auto loans, credit card loans, and loans guaranteed by the Small Business Administration (SBA). As part of our financial stability plan, we announced an expansion of the size and scope of the program, increasing the scale of potential ABS funding under TALF.

Recently, Treasury and the Federal Reserve expanded TALF to include newly or recently issued AAA-rated ABS backed by four additional types of consumer and business loans – mortgage servicing advances, loans or leases relating to business equipment, leases of vehicle fleets, and floor plan loans. Treasury and the Federal Reserve have expanded the 3-year TALF loans to include a 5-year term and just yesterday we announced extending certain legacy commercial mortgage backed securities as an eligible collateral for TALF loans. Addressing the dislocation in the commercial real estate market through this program is critical to restoring the flow of credit to owners of commercial real estate and preventing a damaging chain of events in this market.

The terms of the funding provided under TALF, including fees, are set in a way that is designed to limit the risks faced by U.S. taxpayers while still meeting the objective of encouraging lending to consumers and small businesses. The amount and cost of funding that is provided varies depending on the riskiness of the assets being financed. Treasury and the Federal Reserve used conservative assumptions when calibrating the limits on the funding provided given the uncertain economic environment.

To date there has been $24.8 billion in total new issuance under TALF, of which $17.2 billion was borrowed by investors using TALF loans. The three month average of TALF issuance was equivalent to 50 percent of the 2007 market volume. Spreads on ABS securities have narrowed between 40-60 percent from the peak in December 2008. Since the fourth quarter of 2008, 5-year fixed rate AAA credit cards tightened 300 basis points in four months. Finally, the commercial mortgage-backed securities spreads have narrowed by 800 basis points just from the presence of the TALF program.

Going forward, Treasury and the Federal Reserve will continue to monitor and enhance the ABS programs to bring in new, more niche asset classes and make sure that the number of eligible borrowers and issuers continues to increase.

Small Business Initiative

In recent years, securitization has supported over 40 percent of lending guaranteed by the Small Business Administration (SBA). As a result of the severe dislocations in the credit markets that began in October 2008, however, both lenders that originate loans under SBA programs and the “pool assemblers” that package such loans for securitization have experienced significant difficulty in selling those loans or securities in the secondary market. This, in turn, has significantly reduced the ability of lenders and pool assemblers to make new small business loans. While the SBA guarantees about $18 billion in new lending in 2008, new lending was trending below $10 billion earlier this year.

On March 16, 2009, Treasury announced a program to unlock credit for small businesses as part of the Consumer and Business Lending Initiative. As part of the program, Treasury will make up to $15 billion in EESA funds available to make direct purchases to unlock the secondary market for the government-guaranteed portion of SBA 7(a) loans as well as first-lien mortgages made through the 504 program. These purchases, combined with temporary benefits, including higher loan guarantees and reduced fees implemented under the American Recovery and Reinvestment Act of 2009, will help provide support to small business lending.

The announcement impact of this initiative – combined with the implementation of 90 percent guarantees and reduced fees – has helped raise weekly SBA loan volumes by over 25 percent since March 16. In addition, secondary market activity has picked up, with $185 million in total loan volume settled from lenders to brokers in April, the highest monthly total since September.

Going forward, Treasury expects to finalize details that will allow purchases to begin shortly.

Public Private Investment Program

A variety of troubled legacy assets are congesting the U.S. financial system. The vicious cycle of deleveraging has pushed some asset prices to extremely low levels, levels that are indicative of distressed sellers. The difficulty of obtaining private financing on reasonable terms to purchase these assets has reduced secondary market liquidity and disrupted normal price discovery. This constraint on capital reduces the ability of financial institutions to provide new credit and uncertainty about the value of legacy assets is constraining the ability of financial intuitions to raise private capital.

The Public Private Investment Program (PPIP) is intended to restart the market for these assets while also restoring bank balance sheets as these devalued loans and securities are sold. Using $75 to $100 billion in capital from EESA and capital from private investors – as well as funding enabled by the Federal Reserve and FDIC – PPIP will generate $500 billion in purchasing power to buy legacy assets, with the potential to expand to $1 trillion over time. By providing a market for these assets, PPIP will help improve asset values, increase lending capacity for banks, and reduce uncertainty about the scale of losses on bank balance sheets – making it easier for banks to raise private capital and replace the capital investments made by Treasury.

By following three basic principles, PPIP is designed as part of an overall strategy to resolve the crisis as quickly as possible with the least cost to the taxpayer. First, by partnering with the FDIC, the Federal Reserve, and private sector investors, we will make the most of taxpayer resources under EESA. Second, PPIP will ensure that private sector participants invest alongside the government, with the private sector investors standing to lose money in a downside scenario and the taxpayer sharing in profitable returns. Third, the program will use competing private sector investors to engage in price discovery, reducing the likelihood that the government will overpay for these assets. By contrast, if the government alone purchased these legacy assets from banks, it would assume the entire share of the losses and risk overpaying. Alternatively, if we simply hoped that banks would work off these assets over time, we would be prolonging the economic crisis, which in turn would cost more to the taxpayer over time. PPIP strikes the right balance, making the most of taxpayer dollars, sharing risk with the private sector, and taking advantage of private sector competition to set market prices for currently illiquid assets.

The program has two major components, one each for securities and loans. The Legacy Securities Program initially will target commercial mortgage-backed securities and residential mortgage-backed securities. Treasury will partner with approved asset managers. Pre-approved asset managers will have an opportunity to raise private capital for a public-private investment fund (“PPIF”). Treasury will invest equity capital from the EESA in the PPIF on a dollar-for-dollar basis with participating private investors. Additional funding will be available either directly from Treasury or through TALF. The program is designed to encourage participation by a wide range of investors, and we extended the application deadline to facilitate that objective.

The Legacy Loans Program is designed to attract private capital to purchase eligible legacy loans and other assets from participating banks through the availability of FDIC debt guarantees and Treasury equity co-investments. Under the program, PPIFs will be formed – with up to 50 percent equity participation by Treasury – to purchase and manage pools of legacy loans and other assets purchased from U.S. banks and savings associations. The FDIC will provide a guarantee of debts issued by PPIFs and collect a guarantee fee. The FDIC will be responsible for overseeing the formation, funding, and operation of legacy loan PPIFs and for overseeing and managing the debt guarantees it provides to the PPIFs.

The terms of the funding provided under both parts of PPIP, including fees, will be set in a way that is designed to limit the risks faced by U.S. taxpayers while still meeting the objective of generating new demand for legacy assets. In addition, those participating in the program will be subject to a significant degree of oversight to ensure that their actions are consistent with the objectives of the program.

To date, Treasury has received more than 100 unique fund manager applications representing various types and sizes of institutions, geographical diversity and including a significant number of women, minorities and veterans. Treasury is evaluating a select group of finalists and will inform applicants of their preliminary qualifications in the next several weeks.

Working with the Federal Reserve and the FDIC, we expect these programs to begin operating over the next six weeks.

Auto Task Force

On February 20, 2009, National Economic Council Director Larry Summers and I convened the official designees to the Presidential Task Force on Autos to analyze the February 17 restructuring plan submissions of Chrysler and General Motors and work toward a determination on the ability of the plans to yield long-term financial viability and competitiveness for these companies without taxpayer support. On March 30, the President laid out a new finite path forward for both companies to restructure and succeed; Chrysler would have until April 30 to reach a definitive deal with Fiat and secure the necessary support of stakeholders, and General Motors would have until June 1 to engage in more fundamental restructuring and develop a credible strategy for implementation.

In addition to supporting these companies with working capital during this restructuring period, the Administration took steps to ensure that consumers had confidence in the cars they buy and that suppliers that depend on viable auto companies had support to weather the storm. To this end, the President announced a warranty commitment program, which would guarantee the warranty of all new cars purchased from GM or Chrysler during the restructuring period, and a $5 billion Supplier Support Program to provide suppliers with the confidence they need to continue shipping their parts and the support they need to help access loans to pay their employees and continue their operations. In addition, the launch of the Term Asset-Backed Securities Loan facility (TALF) has expanded the funding available for retail auto loans.

On April 30, President Obama announced an agreement among Chrysler, Fiat and their key stakeholders that positions Chrysler for a viable future. As a result of the sacrifices by key stakeholders and a substantial commitment of U.S. government resources, Chrysler now has a new opportunity to thrive as a long-term viable 21st century company. We have been heartened by the steady progress that Chrysler has made through its bankruptcy proceeding and are confident that the new Chrysler-Fiat partnership will emerge from the court process shortly. A sale hearing on the transaction is scheduled for May 27 – less than a month after the company filed for Chapter 11.

As the President has made clear, this restructuring process will require sacrifice by all stakeholders in the auto industry, including auto workers, debt and equity investors, dealers, suppliers, and the communities in which they operate. Yet, the Administration’s commitment to the American automotive industry has given both GM and Chrysler a new lease on life, preventing plant and dealership closings on a massive scale and saving tens of thousands of jobs across the country. By helping these companies become more competitive, this process will result in more secure employment for tens of thousands of American workers and the best possible chance for the American auto industry to create more good jobs in the future.

Through the Task Force, we will continue to work with GM and its stakeholders in the lead up to the June 1 deadline. We will also continue our significant efforts to ensure that financing is available to creditworthy dealers and to pursue efforts to help boost domestic demand for cars.

EESA Funds

Some of the programs I have mentioned have required the Administration to use additional EESA funds and I would like to provide the latest estimate we have on how much remains. By the time President Obama was sworn in, over half of the $700 billion allocated to Treasury under the EESA had already been committed.

The new programs where we committed additional resources are our housing programs, consumer business lending, small business lending, the auto program and our program to create a market for legacy loans and securities. We’ve also had to make additional resources available to help stabilize AIG. An attached chart shows our latest accounting.

Today, Treasury estimates that there is at least $123.7 billion in resources authorized under EESA still available. The attached table provides a breakdown of our expenditures. This figure assumes that the projected amount committed to existing programs will be $601.3 billion (of which $355.4 billion was committed under the previous administration), but also anticipates that $25 billion will be paid back under the CPP over the next year and available for new assistance.

Because the most relevant consideration is what funds will remain available for new programs, we believe that our estimates are conservative for two reasons. First, our estimates assume 100 percent take-up of the $220 billion made available for our housing and liquidity programs, which require significant voluntary participation from financial participants. If any of those programs experience less than full take-up, additional funds will be available. Secondly, our projections anticipate only $25 billion will be paid back under CPP over the next year, a figure lower than many private analysts expect.

Regulatory Reform

As we work to stabilize the financial system, we need to make sure we are also putting in place comprehensive reforms to ensure a crisis like this never happens again.

The rapid growth of the largest financial institutions and their increasing interconnections through securities markets have heightened systemic risk in the system. In response, we need to expand our capacity to contain systemic risk. This crisis – and the cases of firms like Bear Stearns, Lehman Brothers and AIG – has made clear that certain large, interconnected firms and markets need to be under a more consistent and more conservative regulatory regime. It is not enough to address the potential insolvency of individual institutions – we must also ensure the stability of the system itself.

Financial innovation has expanded the financial products and services that are available to consumers. These changes have brought many benefits. But we have to make sure that when households make choices to borrow, or to invest their savings, there are clear and fair rules of the road that prevent manipulation, deception, and abuse. Lax regulation has left too many households exposed to those risks. We need meaningful disclosures that actual consumers and investors can understand. We need to promote simplicity, so that financial choices offered to consumers are clear, reasonable, and appropriate. Furthermore, there must be clear accountability for protecting consumers and investors alike.

The rapid pace of development in the financial sector in recent decades has meant that gaps and inconsistencies in our regulatory system have become more meaningful and problematic. Financial activity has tended to gravitate towards the parts of the system that are regulated least effectively. Looking ahead, our regulatory structure must assign clear authority, resources, and accountability for each of its key functions.

The financial landscape has become ever more global in recent years. Advances in information technology have made it easier to invest abroad, which has expanded and accelerated cross-border capital flows. Greater global macroeconomic stability has also helped to accelerate financial development around the world. To keep pace with these trends, we must ensure that international rules for financial regulation are consistent with the high standards we will be implementing in the United States. Additionally, we must seek to materially improve prudential supervision, tax compliance, and restrictions on money laundering in weakly-regulated jurisdictions.

Finally, the recent financial crisis has shown that the largest financial institutions can pose special risks to the financial system as a whole. In addition to regulating these institutions differently, we must give the Federal government new tools for dealing with situations where the solvency of these institutions is called into question. Treasury has proposed legislation for a resolution authority that would grant additional tools to avoid the disorderly liquidation of systemically significant financial institutions that fall outside of the existing resolution regime for banks under the FDIC.

Conclusion

Let me conclude by saying that our central obligation is to ensure that the economy is able to recover as quickly as possible, and a prerequisite for that is a stable financial system that it is able to provide the credit necessary for economic recovery. Our work is not yet completed.

But, even then, stability is not enough. We need a financial system that is not deepening or lengthening the recession, and once the conditions for recovery are in place, we need a financial system that is able to provide credit on the scale that a growing economy requires.

Meeting this obligation requires early and aggressive action by the government to repair the financial system and promote the flow of credit. It requires governments to take risks. It also requires the financial system to support sustainable economic expansion. And it requires comprehensive regulatory reforms that deter fraud and abuse, protect American families when they buy a home or get a credit card, reward innovation and tie pay to job performance, and end past cycles of boom and bust.

This is our commitment. Thank you.

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Thank you, Mike and Cam Fine, for your leadership of the ICBA and for your work on behalf of community banks.

Everyone here should know that three days after I was sworn in as Treasury Secretary, Cam Fine was in my office talking about the ICBA.

Community banks play a vital role in our financial system and a central role in our economy.

Yours are the banks where children open their first savings accounts and then come back years later to get a small business loan or to get help buying their first home.

In a time when financial innovation has put more and more distance between borrower and ultimate lender or investor, yours are the banks where staff and customers greet each other by first name, and where relationships still define the business of banking.

Of the over 8,300 banks in America, 92% are small or mid-sized banks, with assets below $1 billion.

And as a group, you entered this crisis on average with strong capital positions, and that has allowed many of you to be a source of credit during a period of enormous challenge for businesses and families across America.

Lending by small banks held up better last year than lending did overall, or by large institutions.

Community banks have accounted for more than one third of the dollar volume of loans to small businesses – the businesses which in turn have accounted for the majority of new jobs created annually over the past decade.

And your banks provide financial services to communities that would otherwise not have them.  Of the 9,800 banking offices located in communities with populations under 10,000, more than two-thirds are community banks. In these markets, the local bank is the essential and the indispensible provider of banking services and credit.

At a time when many Americans have lost faith in the financial system as a whole, a Gallup poll conducted in just the past week found that 69% of customers have a lot of confidence in small and medium size banks.

Collectively, you are a source of strength and resilience for the U.S. financial system.  And you will play a critical role in laying the foundation for economic recovery.

When President Obama took office, the country was facing a deep recession and a damaged financial system.

In the months immediately preceding our arrival, American employers were shedding jobs at an average of 700,000 a month, auto sales were plunging at a 38% annual pace, and new single-family home sales had fallen from their 2005 peak by three-quarters.

Facing these extraordinary challenges, this Administration and the Congress responded with extraordinary action. We enacted a historic economic recovery plan that is giving 95% of American households a tax cut, creating or saving 3.5 million jobs, and helping 1.4 million Americans purchase their first home by providing $6.5 billion in tax credits.

We have taken action to stabilize our housing market and avoid foreclosures; to boost new consumer and business lending by re-starting the market for securities; and to create a market for old mortgage loans and securities that are keeping banks from lending by weighing down their finances.

And we just concluded an unprecedented regulatory review of the nation’s largest banks to bring greater transparency and new capital into the financial system.

On the strength of these efforts, the financial system is starting to heal.  Concern about systemic risk has diminished.  And overall lending conditions have started to improve.

• Spreads for investment grade corporate bonds have fallen about 210 basis points and spreads on high yield corporate bonds are down about 800 basis points since the end of November.
• Risk premiums in short-term inter-bank markets have fallen 275 basis points over roughly the same period, and the cost of credit protection for the largest U.S. banks has fallen by about 150 basis points just since early April.
• With the help of our lending facility with the Fed, new securities issuance has started to revive.  Spreads for AAA credit card receivables ABS have fallen about 300 basis points from their peak.
• There has been more issuance of consumer asset-backed securities in the past two months than in the preceding five months combined.
• In our housing market, interest rates on 30-year mortgages have dropped to an historic low of 4.8%, and refinancing has surged. These are all welcome signs, but the process of financial recovery and repair is going to take time.

We have already seen a substantial amount of adjustment in our financial system.  Leverage has declined.  The more vulnerable parts of the non-bank financial system no longer exist.  Banks are funding themselves more conservatively.  These are necessary changes, and there is more restructuring ahead for the financial industry as a whole.  But a substantial part of the adjustment process is now behind us.

This has been challenging period for community banks, even though, on average, you were better positioned to withstand the pressures of recession.

That is why Treasury, working closely with the FDIC and the Federal Reserve, has worked hard to provide support for community banks.

The Capital Purchase Program, established last October, provides viable financial institutions of all sizes an optional extra layer of capital for to help support lending.

These programs have benefitted communities across the country.  Treasury has invested capital in the form of preferred stock in 579 institutions, of which over 300 are small banks. We have made investments of $1 million or less in 17 banks, $5 million or less in 147 banks and $10 million or less in 258 banks. We have also invested in 15 community development financial institutions.

One example is Farmers National Bank in Emlenton, Pennsylvania. Farmers National has around $400 million in assets and 12 offices throughout rural Western Pennsylvania. In 4 of those locations, they are the only bank in town.

Bill Marsh, the President of Farmers National, told us that he took a Treasury investment last fall because he wanted to make his viable bank even stronger and ensure that it could lend more aggressively.

With the $7.5 million investment, he has been able to expand lending to small businesses in his area.  Since January Farmers National has provided $18.2 million in commercial and small business loans, an increase from the last quarter of 2008, despite a worsening economy.

The bank helped two real estate investors purchase older properties and turn them into affordable single family housing units. That means contractors, plumbers, electricians, and roofers are all getting work. And they helped an aspiring small business owner buy a small furniture store which he is now expanding. That means new hires.

Another example is the Bank of Commerce in Charlotte, North Carolina, which has around $170 million in assets.  As the economy started to contract, their president, Wes Sturgis, wanted to make sure he had enough capital to generate growth going forward and capital from the Treasury allowed him to do that.

The $3 million Treasury invested through CPP meant Mr. Sturgis could lend more actively.  In the 1^st quarter Bank of Commerce issued $5 million in loans helping an insurance agency purchase an office building and enabling a local printer to expand his business and workforce.

The Administration fully supports the FDIC’s request to increase its permanent statutory borrowing authority from $30 billion to $100 billion under its line of credit with the Treasury Department.  This could prove an important step towards decreasing the FDIC assessment fees that your banks now face and that we know you are deeply concerned about.

We have also sought to ensure that small businesses can continue to grow and borrow from small banks such as yours.  Beginning with our Recovery and Reinvestment Act we put in place a strategy for small businesses that increases loan guarantees and temporarily eliminates fees on SBA loans.

On March 16 the President, alongside Cynthia Blankenship and myself, announced a new $15 billion initiative of direct purchases to restart the secondary lending market.  Together these measures are designed to give banks the confidence to lend and since March 16^th, SBA weekly loan volume is up 25%.

And today I want to announce additional action we are taking to ensure your banks have the capital you need.

Using the proceeds of the repayments we expect to receive from some of the largest banks, we plan to re-open the application window for banks with total assets under $500 million under the Capital Purchase Program, and raise from 3% of risk-weighted assets to 5% the amount for which qualifying institutions can apply. This applies to all term sheets – public and private corporations, Subchapter S corporations, and mutual institutions. Current CPP participants will be allowed to reapply, and will have an expedited approval process.

In addition, we will extend the deadline for small banks to form a holding company for the purposes of CPP.  Both the window to form a holding company and the window to apply or re-apply for CPP will be open for six months.

I want to close with a look ahead to the comprehensive regulatory reform efforts this Administration will propose in the coming weeks.

We have focused initially on addressing systemic risk, making sure those risks that arise are less threatening to stability and that the government has tools necessary to contain the damage they pose to the American economy.  As in any financial crisis, this damage has been brutally indiscriminate.  Ordinary Americans, small business owners, and community banks who did the right thing and played by the rules are suffering from the actions of those who took on too much risk.

Our goal is to limit the extent to which community banks and tax payers are forced to bear the burden of those institutions that take irresponsible risks. Capital, liquidity and risk management requirements must be more exacting for the largest, most interconnected institutions. They must be applied with a view not just to ensure the soundness of the individual institution, but to maintain the stability of the system as a whole.  They need to be strong enough so that the system can withstand the impact of the failure of large institutions.  As part of this we need to bring the markets where institutions come together, such as the derivatives markets, under a strong framework of oversight.

These changes will help prevent future crises and limit their severity.  They will have to be accompanied by stronger tools for resolving crises when they happen, including the ability for the government to act more quickly to contain the potential damage cause by the potential failure of a large complex financial institution.

We have proposed resolution authority to help fill that gap.  The proposal is structured as an extraordinary mechanism for extraordinary situations, and will be kept strictly separate from the existing FDIC deposit insurance fund.  With this authority, the financial costs of intervention would no longer fall to those institutions that played by the rules and made conservative and prudent choices.

We believe that the combination of smarter, tougher regulatory standards to mitigate risks and resolution authority to manage risks when they arise will create a system that is more stable and resilient.

These steps will help level the playing field.  They will help ensure that we preserve one of the most important strengths of the U.S. financial system, the thousands of community banks.

Thank you.

This afternoon, the Federal Reserve and the national banking agencies released the results of the stress tests – the most comprehensive, forward looking review of our nation’s largest banks ever undertaken. These tests will help ensure that banks have a sufficient capital cushion to continue lending in a more adverse economic scenario. They will provide the transparency necessary for individuals and markets to judge the strength of the banking system.

This capital assessment is an important part, but just one part of the President’s comprehensive plan to stabilize and repair the financial system and help get credit flowing again. Over the last three months, we have put in place a series of programs to address the housing crisis, to help restart the securities markets that are critical to business and consumer lending, to catalyze small business lending in particular, and to help create a market for legacy real estate related loans and thereby help clean up bank balance sheets. 

Alongside these programs, we have worked to restore confidence in the banking system. The assessment announced today will help strengthen the lending capacity of banks, with greater transparency and actions to reinforce the amount of capital banks hold against the risk of future losses. Capital is critical to lending. Each dollar of capital generates up to 12 dollars of lending capacity. And each dollar of lending capacity helps businesses grow and reduces the cost of borrowing for firms and families.

• Greater disclosure will help improve confidence. Today’s results should make it easier for investors to evaluate risk and to differentiate across institutions. The stress test will help replace the cloud of uncertainty hanging over our banking system with an unprecedented level of transparency and clarity. This is important, as markets work best when they have full access to the information on which to make informed investment decisions. With better disclosure, private capital is more likely to flow into the financial system, which will accelerate the point at which banks can replace the government’s investments.
• Banks will be given a range of options to ensure they have a substantial capital cushion. Some institutions will be required to take steps to improve the quality and/or the quantity of their capital to give them a larger cushion to support future lending even if the economy performs worse than expected. These institutions have a range of options to raise capital in the private markets, including common equity offerings, asset sales and the conversion of other forms of capital into common equity. If these options are not sufficient, they can request additional capital from the government through Treasury’s Capital Assistance Program. Banks must submit a detailed capital plan to supervisors, who will consult with Treasury on the development and evaluation of the plan.
  
• Some banks will be able to begin to repay the government. Those institutions that do not need to raise additional capital will have the opportunity to repay the government’s existing capital investments. To do this, they will need to demonstrate that they are able to issue debt without FDIC guarantees, as some banks have already begun to do.

Going forward, in the event that financial institutions need significant government assistance in terms of the quantity or composition of capital, then in consultation with supervisors, Treasury will evaluate whether existing board and management are strong enough to restore the firm to viability without government assistance. Where Treasury does take common equity, we will seek to return the company to purely private ownership as quickly as possible, and will be guided by the basic principle that the best way to serve the interest of shareholders and taxpayers is to exert our influence only on core governance issues and not on day-by-day operations.

• This was a carefully designed, credible test. Banks supervisors applied a historically high set of loss estimates on securities and loans, as well as a conservative view towards potential earnings that could act as a buffer against those losses. Taking into account the banking system’s existing capital and reserves, the public now has a better idea of how much capital banks will need to ensure they have sufficient capacity to continue providing credit in a more adverse economic downturn. These are estimate of potential losses and earnings that could occur in the event of a more severe recession. They are not a prediction of where the economy is headed. The results are less acute than some had expected, in part because concern about the risk of a more severe recession have diminished, market have improved, and banks, in anticipation of the release of the stress test, have acted in the last few months to increased capital.
  
• The banks that did not undergo the stress test will have access to capital on the same terms as the largest banks. To this end, the deadline for access to the preferred stock issued under the existing CPP has been extended for an additional six months, and Treasury will continue to examine other ways to ensure that small banks across the country can access capital so that they can continue providing credit to their communities. Supervisors will not extend the stress test to the rest of the banking system.

Our government has taken extraordinary actions to ensure the stability of our banking system because this is essential to contain the risk of a worse recession and to lay the foundation for a sustainable recovery.

With this support, and with the clarity provided by today’s announcement, banks should be able to get back to the business of banking. Those in leadership positions in our banks are going to have to work hard to repair the loss of confidence in the financial system and regain the public’s trust. They can do this by expanding lending to creditworthy families and small businesses that we depend on to generate economic growth. And they need to demonstrate that they are reforming compensation practices to reinforce limits on future risk taking. And this responsibility must be felt by all banks, including those that hope to be in a position to repay the government’s capital investments. 

Today’s stress test results are an important step forward in the Administration’s plan to lead us on the path to economic recovery. Americans should know that the government stands behind the banking system and that their deposits are safe. The actions taken by Congress, the FDIC and the Federal Reserve have improved market confidence and reduced the threat of systemic risk. Mortgage rates have fallen to historic lows, home refinancing has increased significantly, credit spreads have narrowed and companies in recent weeks have found it easier to issue debt to finance new investments.

This is just a beginning, however. Even with the recent signs of stabilization in economic activity, the economic still faces significant risks and challenges. The cost of credit remains exceptionally high. We have more work to do, and recovery will take time. But we are starting to see some signs of progress toward financial repair, and we will continue to work to expand the availability of credit and improve the impact our new set of credit and lending programs. 

Krugman’s column today further adds to the case he’s been making all along during this financial crisis – Wall Street’s emperors have no clothes and taxpayers are footing the bill to rebuild their wardrobe.

So why did some bankers suddenly begin making vast fortunes? It was, we were told, a reward for their creativity — for financial innovation. At this point, however, it’s hard to think of any major recent financial innovations that actually aided society, as opposed to being new, improved ways to blow bubbles, evade regulations and implement de facto Ponzi schemes.

Consider a recent speech by Ben Bernanke, the Federal Reserve chairman, in which he tried to defend financial innovation. His examples of “good” financial innovations were (1) credit cards — not exactly a new idea; (2) overdraft protection; and (3) subprime mortgages. (I am not making this up.) These were the things for which bankers got paid the big bucks?

Here’s what I think is most disturbing about recent financial history and the Bush and Obama Administrations’ policies:

GDP, which I believe is due for an announcement this week, has generally grown but over the last two or three decades that growth has been in areas like financial services and based upon “paper value.”  In other words, where we used to count more tangible goods as product, and those goods were made in the U.S. and that economic activity supported a middle class.  The financial services’ contribution to the overall economy has become huge, but their numbers benefit very few – the investment class.  Both the Bush and Obama Administrations have so far let financial services off Scot-free and pushed trillions of dollars that industry’s way.  On the other hand, the nation’s Big Three automakers are being treated as one would expect failing companies to be treated – with healthy skepticism.

• New – or “re” – regulation in the financial services sector needs to be undertaken now.  Treasury Secretary Timothy Geithner and others in the Obama Administration have talked the regulation game, but there’s been no action.  The argument was for a time that we need to stabilize things then move on to resetting the rules.  Apparently, Wall Streeters are shifting comfortably back into business as usual.  The TARP and PPIP have not had the effect both administrations hoped for.  All of the other legislative priorities of the Obama Administration, from health care to energy policy will be derailed by a second wave of the financial crisis.  Regulate now.
• I’m begging on this one … Not One More Bailout.  As currently configured, nearly all the risk of saving the financial system is on the taxpayer.  Future bailouts or federal actions to prop up the system should be approached like the auto industry.  No more carrots without sticks.  It’s past time for accountability from bankers and brokers.
• Finally, for today, it’s astounding to me that revelations last week by New York Attorney General Andrew Cuomo that former Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke held a gun to Bank of America’s head to complete the Merrill-Lynch deal.  Furthermore, Paulson and Bernanke allegedly told BofA CEO Ken Lewis to not disclose his and management’s misgivings about the Merrill deal.  Why isn’t the media or Congress all over this?  When Wall Streeters like Geithner, Paulson and Summers are in charge only Wall Street benefits.  Were there SEC rules broken by Paulson and Summers?  Can the government intervene to stop the flow of information to corporate boards and shareholders?

Introduction

Good morning. Thank you for the opportunity to appear before you.

The challenges that our financial system faces are complex, interrelated, and the result of developments over many years. Earlier in this decade, a combination of fundamental factors and financial innovations generated unsustainable bubbles in many housing markets across the country. When those bubbles began to burst, starting in early 2006, housing price declines led to a sharp acceleration in mortgage delinquencies and charge-offs. Those unanticipated losses revealed deep-seated problems in our financial and economic systems. A protracted period of rapid innovation, excessive risk taking, and inadequate regulation produced a financial system that was far more fragile than was generally appreciated during the boom times.

In the years before the crisis, businesses, consumers, and importantly financial institutions had become increasingly complacent about risk. The volatility of the U.S. economy appeared to decline after the stabilization of inflation in the early 1980s. In recent years, savings outside the United States surged, generating strong global demand for financial assets, particularly U.S. financial assets. Nominal interest rates generally trended lower, and became less volatile, in the years before the current crisis.

The financial system itself was evolving at a rapid pace in the decades before the current crisis. Advances in information technology dramatically reduced transaction costs and made it possible for banks and other financial institutions to introduce a tremendous range of new products, including everything from ATMs to new complex financial contracts. In some areas, such as transaction services and credit cards, new technologies created economies of scale that favored large institutions. Just a few large firms are now responsible for processing the preponderance of credit card transactions. In other ways, advances in information technology favored markets over institutions. In recent decades, securities markets have grown more rapidly than financial institutions. For example, the share of securitized products in overall private financial intermediation grew from just 4 percent in 1980 to 26 percent in 2007. Over the same period, the share of banks and thrifts, which rely primarily on deposits, fell from 62 percent to 30 percent. The explosive growth of financial derivatives was also fueled by rapid advances in information technology. Given that much of this development occurred in a relatively stable macroeconomic environment, financial innovation in many cases increased complexity without sufficient concern for how new products would respond to shocks.

The combination of a stable macroeconomic environment, with strong risk appetite, and significant structural changes in the financial system, led to a buildup of leverage and risk throughout the system. That buildup was compounded by compensation systems that were not aligned with the long-term interests of shareholders, giving many managers and employees incentives to take excessive risks. Investors looked for higher returns by taking on greater exposure to the risk of infrequent but severe losses. At the same time, consumers, businesses, and a range of financial entities became too reliant on easy access to the credit that major financial institutions could readily provide. Misaligned incentives without transparency, market discipline, or appropriate regulation widened conflicts of interest throughout the financial system.

Our regulatory system did not respond adequately to the challenges inherent in this environment. Regulators did little to contain the risks posed by the growth in complex financial instruments. The structure of our regulatory system is unnecessarily complex and fragmented. It operates with large gaps in meaningful oversight. Investment banks, the holding companies and affiliates of large insurance companies, finance companies, and the government-sponsored enterprises were subject to only limited oversight. These highly leveraged institutions lacked strong, federal, prudential regulation and supervision, and they did not have established access to central bank liquidity. Moreover, they were permitted by law to choose among regulatory regimes, often allowing them to avoid a stronger regulatory authority that might have been applied if they had been supervised as bank holding companies.

Starting in 2007, unexpected losses experienced by major banks on mortgage-backed securities set off a vicious cycle. The losses reduced their capital, which forced them to pull back on lending. This put downward pressure on asset prices, which generated further losses for the banks. Tightening financial conditions became a drag on the broader economy. As workers lost jobs and as prospects for businesses darkened, prospective losses on consumer and business loans increased. As the scale of the potential financial losses increased, market concerns about the viability of individual institutions started to emerge.

In March of 2008, these pressures led to an acute funding crisis for the investment bank Bear Stearns. In an emergency operation, JP Morgan purchased Bear Stearns after the Federal Reserve agreed to effectively ring fence roughly $30 billion of Bear Sterns’ assets. Following the Bear Stearns rescue, pressures in financial markets eased for a time. But the economy continued to weaken, and alarm bells were sounded about the lack of tools available to the government to contain the emerging crisis.

Amidst rising unemployment and a significant correction in housing prices, delinquencies on conventional mortgages increased sharply. This was a significant challenge for Fannie Mae and Freddie Mac, government sponsored enterprises (GSEs) operating in the secondary market for home mortgages. Market pressures on the GSEs intensified over the summer as housing prices fell sharply and the performance of conventional mortgages deteriorated further. Moreover, the GSEs’ forays into investments in alternative mortgage products turned out to be a brutal mistake.  In early September, the decision was taken to put Freddie Mac and Fannie Mae into conservatorship. That decision had adverse consequences for the GSEs’ shareholders and this heightened pressures on other troubled financial intermediaries. After intense discussions with federal authorities and potential private investors, Lehman Brothers filed for bankruptcy protection less than a week after the GSEs were put into conservatorship. Because the government lacked the necessary tools to contain the fallout, the Lehman failure had an immediate impact on short-term money markets, particularly money market mutual funds and the market for commercial paper. A few days later, the Federal Reserve stepped in to provide substantial support to AIG because of the broad potential for contagion to many other financial institutions that would have followed its failure. These events significantly heightened market participants’ fears that rising losses might irreparably deplete the capital of major financial institutions. In this volatile environment, special guarantee programs for money market mutual funds and parts of the commercial paper market were established. Importantly, the U.S. Congress passed the Emergency Economic Stabilization Act of 2008 (EESA) establishing the Trouble Assets Relief Program (TARP). EESA also increased the limit on the Federal Deposit Insurance Corporation (FDIC) deposit insurance, and the FDIC established a new guarantee facility for medium-term bank borrowing.

Acute concerns about the viability of major U.S. financial institutions persisted, inducing a further retraction in the credit markets and a more severe economic contraction. As a result, the Department of the Treasury shifted the focus of TARP from purchasing “toxic” assets to providing new capital to banks. Treasury established the Capital Purchase Program (CPP) to provide capital support for U.S. banks using TARP funds with the goal of ensuring that they could continue to play their important role in the credit markets and maintain lending to consumers and businesses.

In early phases of the crisis, some financial institutions were able to raise significant amounts of private capital. But as the crisis deepened, and asset markets became more distressed, uncertainty about the value of bank assets became an obstacle to raising private capital. The initial thrust of CPP was to inject capital into all major institutions in an environment where systemic risk appeared significant.

The intense financial stresses generated by these developments in September and October of 2008 had a profound effect on the U.S. and global economies. U.S. consumers and businesses became much more cautious and cut back their spending as credit became scarce. The sharp fall in equity prices since the summer, in addition to falling house prices, generated significant declines in household wealth. Similar pressures emerged in other countries. The United Kingdom and Western Europe had been facing financial pressures similar to those in the United States since mid-2007. To some degree, this reflected the fact that European financial institutions held U.S. mortgage-backed securities. But it also reflected the fact that their financial systems suffered from many of the same problems as ours. Much of the global economy was already slowing over the summer of 2008, but acute financial stress in September and October also generated sharp declines in economic activity around the world. Domestic demand slowed in much of the world, particularly where financial stresses were acute, but there was an almost unprecedented collapse in global trade. Capital flows to emerging economies were also affected. The negative feedback between financial stress and collapsing economic activity had become global.

The Obama Administration’s Response

Policy interventions at the end of 2008 were, in the end, successful in achieving the vital, but narrow, objective of preventing a major systemic meltdown. Acute concerns about counterparty risk within the financial system that had peaked in the wake of the failure of Lehman Brothers eased towards the end of the year. For example, the spread between three-month interbank interest rates and the market’s expectation for short-term rates over the same period, a measure of distress in money markets, fell from a peak of 365 basis points in early October to about 100 basis points in early January. Even with that improvement, the spread remained high relative to the levels before the crisis; it averaged about 10 basis points in the first half of 2007.

While overt concerns about systemic risk had diminished since October, as President-Elect Obama and his economic team prepared their economic program, they faced a grave and rapidly evolving set of challenges in the financial sector.

The outlook for the economy was deteriorating rapidly and that had important implications for the financial sector. Economic data that became available in November and December pointed to a very sharp fall of in economic activity. For example, U.S. auto sales for October, which were released on November 3, were reported at a 10.6 million annual rate. This compares to an average level of 12.9 million in the third quarter. On December 4, it was reported that payroll employment had fallen by 533,000 in November.[1] This was the largest monthly decline since the deep recession of 1973-74. Quickly worsening prospects for the economy meant that likely losses for U.S. financial institutions were rising sharply as well, and this heightened concerns about the adequacy of their capital.

The disruptions to the financial system were the major factor undermining the economy. Liquidity in a broader range of securities markets, including the market for long-term Treasuries, fell sharply. Credit spreads for virtually all credit products reached historic highs in the fourth quarter. Loan growth and bond issuance slowed in the fourth quarter. In particular, the issuance of new asset-backed securities (ABS) essentially came to a halt in October. Part of the decline in credit growth reflected falling demand for credit as consumers and businesses became more cautious. But a variety of factors pointed to meaningful constraints on the supply of credit. For example, a record number of banks reported tightening credit standards in the fourth quarter.

In this context, doubts about the viability of major institutions persisted. Fannie Mae, Freddie Mac, AIG, Citigroup and Bank of America had all received substantial government support by mid-October. But these institutions had complex and opaque balance sheets that were heavily exposed to the deteriorating economy. Given the economic and financial environment, including illiquid markets and “fire sale” asset prices, investors were not convinced that the actions taken to that point were sufficient to ensure that the institutions were sound. Those doubts were reflected in pressure on equity prices and credit spreads. Further actions were ultimately necessary to shore up market confidence in these institutions.

In this context, President Obama decided that a new approach was needed.  Leaving that situation unaddressed would have undoubtedly risked a deeper recession and more damage to the productive capacity of the American economy. It would have resulted in higher unemployment and greater failures of businesses, and it would have greatly undermined the substantial spending and tax incentives in the American Recovery and Reinvestment Act (ARRA). In addition, given the substantial burden placed upon the American taxpayers, there was deep public anger, skepticism about whether the government was using taxpayer money wisely, and a perceived lack of transparency, all of which led to eroding confidence.

In response to this inheritance, President Obama, upon taking office, outlined a series of changes designed to improve transparency, accountability, and oversight. This included a number of new online resources so that Americans could see exactly how their money was being spent; a

[1] The estimated change in payroll employment in November was later revised to a decline of 597,000.

monthly lending and intermediation survey to better gauge, in ways readily accessible to the public, the performance of banks participating in the CPP; and strong taxpayer protections to ensure that Americans receive a return on these long term investments, and are not rewarding failure, including with respect to executive compensation.

Alongside the reforms, earlier this year we laid out a broad strategy designed to address the five major challenges facing the financial system.

First, since the onset of the crisis, major financial institutions have reported unprecedented losses. Looking ahead, substantial additional shortfalls are all but certain. Uncertainty about the real value of distressed assets and the ability of borrowers to repay loans has contributed to a decline in the confidence required for the private sector to make much needed equity investments in our major financial institutions. We must ensure that individual banks have sufficient capital to absorb future losses, even under adverse circumstances, and still be able to provide the credit the economy needs. Moreover, we cannot allow doubts about the viability of major institutions to undermine the financial system as a whole. The U.S. government must continue those policies critical to sustaining confidence in the core of the system.

Second, the breakdown of key markets for new securities has constrained the ability of even creditworthy small businesses and families to get the loans they need. In today’s financial system, markets for asset-backed securities, as opposed to just deposit-taking banks and thrifts, raise a substantial portion of the funds that ultimately support new credit creation. It is essential that we get these markets working again so that families and businesses can have access to credit on reasonable terms.

Third, a range of legacy assets remain on the books of major banks. Pressure on banks to shrink their balance sheets has depressed the prices of these assets to “fire sale” levels and liquidity for these assets is limited. Uncertainty about the value of legacy assets is undermining confidence in major banks and impairing their ability to raise capital. We need to increase liquidity for legacy assets, break the cycle of deleveraging, and improve price discovery.

Fourth, the ongoing adjustment in the housing market remains at the center of the economic and financial crises. Falling home prices are a major financial challenge for many families. At the same time, financial losses related to the housing sector adjustment continue to be a significant headwind for banks and other financial institutions. Foreclosures are particularly problematic because they not only impose significant financial and emotional burdens on families, they are also costly for communities and banks. For all these reasons, addressing the housing crisis and reducing foreclosures is an important objective.

Finally, the lack of a modern regulatory regime and resolution authority helped create the current crisis, and it will limit our ability to address future crises until we put in place fundamental reforms. We need to expand our capacity to contain systemic risk. We have to make sure that when households make the choice to borrow, or to invest their savings, there are clear and fair rules of the road that prevent manipulation, deception, and abuse. Our regulatory structure must assign clear authority, resources, and accountability for each of its key functions. We must also seek to ensure that international rules for financial regulation are consistent with the high standards we will be implementing in the United States. The Federal government needs new tools for dealing with situations where the solvency of major financial institutions is called into question.

Capital Assistance Program

Currently, the vast majority of banks have more capital than they need to be considered well capitalized by their regulators. However, concerns about economic conditions – combined with the destabilizing impact of distressed “legacy assets” – have created an environment under which uncertainty about the health of individual banks has sharply reduced lending across the financial system, working against economic recovery. For every dollar that banks are short of the capital they need, they will be forced to shrink their lending by eight to twelve dollars. Conversely, every additional dollar of capital gives banks the capacity to expand lending by eight to twelve dollars. Providing confidence that banks have a sufficient level of capital even if the economic outlook deteriorates is a necessary step to restart lending so that families have access to the credit they need to buy homes or pay for college, and businesses can get the loans they need to expand. Moreover, reassuring investors that banks have sufficient resources to weather even a very adverse economic scenario will make it possible for banks to raise additional private capital.

One of the major components of the Administration’s Financial Stability Plan (FSP) is the Capital Assistance Program (CAP). The CAP is designed to ensure that individual banks have sufficient capital even in adverse circumstances. This strategy begins with the idea that in order to ensure our largest banks have adequate capital to weather a more severe economic scenario and continue to lend, we must first accurately diagnose their problems. Federal banking agencies will soon complete a forward looking assessment or “stress test” for the 19 largest banks. The stress tests will determine the capital needs of these banks by estimating losses that they might face if economic conditions were to deteriorate more than expected over the next two years, as well as the appropriate level for loss loan reserves at the end of the period. The analysis will take into account the likely path of earnings for individual banks over the same period. By focusing on individual banks, this approach allows the analysis to take into account the unique exposures that individual banks face as well their individual prospects for generating earnings.

If a judgment is made, in consultation with management, that a bank needs additional capital, it will be encouraged to raise that capital from private sources. Where needed, the CAP will provide additional capital in the form of convertible preferred stock as a backstop until private capital becomes available. Furthermore, all eligible banking organizations, not just the 19 organizations undergoing the stress test, will be able to apply to issue to Treasury convertible preferred stock equal to between one and two percent of their risk-weighted assets.

Because today’s financial system is highly interconnected, a failure of a major financial institution can create severe challenges for the financial system and the wider economy. The events of last September and October are a concrete reminder of this very real threat. Maintaining confidence in key financial institutions, particularly as they raise new capital and restructure, has to remain a central objective of financial policy.

On February 10, Treasury, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Office of Thrift Supervision, and the Federal Reserve clearly stated their commitment to ensuring that confidence is maintained in the core of the financial system.[2] These institutions put in place a range of programs over the last year and are committed to continuing these programs to help reinforce confidence in core institutions, including a variety of guarantee programs, to ensure that key institutions continue to have access to stable funding. In March, the FDIC extended its Temporary Liquidity Guarantee Program (TLGP).[3] Under this program banks and other eligible financial institutions can issue medium-term debt that carries an FDIC guarantee. This program was an important factor in helping to stabilize the banking system in the wake of the failure of Lehman Brothers. Treasury has also recently extended its Money Market Funds Guarantee Program through September 18, 2009.[4]

Consumer and Business Lending Initiative

Securitization has come to play a very important role in the U.S. financial system. Banks develop and maintain expertise in originating certain types of loans. This includes loans to individuals through credit cards, mortgages, student loans, and other forms of consumer credit as well as loans to businesses, particularly those that are not able to raise funds directly in securities markets. In recent years, an increasing portion of these loans have been aggregated into pools and sold as so-called ABS. The rapid growth of the market for ABS in the years before the current crisis increased the supply of credit available to individuals and small businesses because once banks pool and sell loans to the securitization market, it opens up their balance sheet to create new loans.

An important part of the Obama Administration’s FSP is a significant expansion of the Term Asset-Backed Securities Loan Facility (TALF) through the Consumer Business Lending Initiative. The TALF is designed to jumpstart the securitization markets, which in turn will increase lending throughout the economy.  Under the TALF, the Federal Reserve extends loans to investors who purchased newly issued ABS. Treasury has committed funds under the TARP program to provide a degree of credit protection for the Federal Reserve’s TALF loans. The program was initially proposed in November 2008, with a focus on highly-rated ABS backed by student loans, auto loans, credit card loans, and loans guaranteed by the Small Business Administration (SBA). As part of President Obama’s FSP, we announced an expansion of the size and scope of the program, increasing the scale of potential ABS funding under TALF.

In March, the first transactions – Four deals, including three auto securitizations and one credit card securitization, were brought to the market. These transactions totaled approximately $8.5 billion, with just under $5 billion financed through TALF.  Recently, Treasury and the Federal Reserve expanded TALF to include newly or recently issued AAA-rated ABS backed by four additional types of consumer and business loans – mortgage servicing advances, loans or leases relating to business equipment, leases of vehicle fleets, and floor plan loans.

The terms of the funding provided under TALF, including fees, are set in a way that is designed to limit the risks faced by U.S. taxpayers while still meeting the objective of encouraging lending to consumers and small businesses. The amount and cost of funding that is provided varies depending on the perceived riskiness of the assets being financed. Treasury and the Federal Reserve used conservative assumptions when calibrating the limits on the funding provided given the uncertain economic environment.

In recent years, securitization has supported over 40 percent of lending guaranteed by the Small Business Administration. As a result of the severe dislocations in the credit markets that began in October 2008, however, both lenders that originate loans under SBA programs and the “pool assemblers” that package such loans for securitization have experienced significant difficulty in selling those loans or securities in the secondary market. This, in turn, has significantly reduced the ability of lenders and pool assemblers to make new small business loans. As a result, while the SBA typically guarantees about $20 billion in loans annually, new lending was trending below $10 billion earlier this year.

On March 16, 2009, Treasury announced a program to unlock credit for small businesses as part of the Consumer and Business Lending Initiative. As part of the program, Treasury will make up to $15 billion in TARP funds available to make direct purchases to unlock the secondary market for the government-guaranteed portion of SBA 7(a) loans as well as first-lien mortgages made through the 504 program. These purchases, combined with higher loan guarantees and reduced fees implemented under the American Recovery and Reinvestment Act of 2009, will help provide lenders with the confidence that they need to extend credit, knowing that if they make an SBA loan, they will be able to sell it and access the liquidity necessary to do further lending.

Public Private Investment Program

A variety of troubled legacy assets is congesting the U.S. financial system. The vicious cycle of deleveraging has pushed some asset prices to low levels. The difficulty of obtaining private financing on reasonable terms to purchase these assets has reduced secondary market liquidity and disrupted normal price discovery. While economic fundamentals have deteriorated substantially in this crisis, there is ample evidence that current market prices for many legacy assets include substantial liquidity discounts.[5] Such discounts constrain the economic capital of U.S. financial institutions, reducing their ability to provide new credit. Moreover, uncertainty about the value of legacy assets is constraining the ability of financial intuitions to raise private capital.

The Public Private Investment Program (PPIP) is intended to restart the market for these assets while also restoring bank balance sheets as these devalued loans and securities are sold. Using $75 to $100 billion in capital from EESA and capital from private investors – as well as funding enabled by the Federal Reserve and FDIC – PPIP will generate $500 billion in purchasing power to buy legacy assets, with the potential to expand to $1 trillion over time. By providing a market for these assets, PPIP will help improve asset values, increase lending capacity for banks, and reduce uncertainty about the scale of losses on bank balance sheets – making it easier for banks to raise private capital and replace the capital investments made by Treasury.

By following three basic principles, PPIP is designed as part of an overall strategy to resolve the crisis as quickly as possible with the least cost to the taxpayer. First, by partnering with the FDIC, the Federal Reserve, and private sector investors, we will make the most of taxpayer resources under TARP. Second, PPIP will ensure that private sector participants invest alongside the government, with the private sector investors standing to lose their entire investment in a downside scenario and the taxpayer sharing in profitable returns. Third, the program will use competing private sector investors to engage in price discovery, reducing the likelihood that the

government will overpay for these assets. By contrast, if the government alone purchased these legacy assets from banks, it would assume the entire share of the losses and risk overpaying. Alternatively, if we simply hoped that banks would work off these assets over time, we would be prolonging the economic crisis, which in turn would cost more to the taxpayer over time. PPIP strikes the right balance, making the most of taxpayer dollars, sharing risk with the private sector, and taking advantage of private sector competition to set market prices for currently illiquid assets.

The program has two major components, one each for securities and loans. The Legacy Securities Program initially will target commercial mortgage-backed securities and residential mortgage-backed securities. Treasury will partner with approved asset managers. Pre-approved asset managers will have an opportunity to raise private capital for a public-private investment fund (“PPIF”). Treasury will invest equity capital from the TARP in the PPIF on a dollar-for-dollar basis with participating private investors.[1] Additional funding will be available either directly from Treasury or through TALF. The program is designed to encourage participation by a wide range of investors, and we extended the application deadline to facilitate that objective.

The Legacy Loans Program is designed to attract private capital to purchase eligible legacy loans and other assets from participating banks through the availability of FDIC debt guarantees and Treasury equity co-investments. Under the program, PPIFs will be formed – with up to 50 percent equity participation by Treasury – to purchase and manage pools of legacy loans and other assets purchased from U.S. banks and savings associations. The FDIC will provide a guarantee of debts issued by PPIFs and collect a guarantee fee. The FDIC will be responsible for overseeing the formation, funding, and operation of legacy loan PPIFs and for overseeing and managing the debt guarantees it provides to the PPIFs.[2]

The terms of the funding provided under both parts of PPIP, including fees, will be set in a way that is designed to limit the risks faced by U.S. taxpayers while still meeting the objective of generating new demand for legacy assets. In addition, those participating in the program will be subject to a significant degree of oversight to ensure that their actions are consistent with the objectives of the program.

Housing

[1] Additional information on the terms and conditions of the Legacy Securities Program are available at: http://www.treas.gov/press/releases/reports/legacy_securities_terms.pdf

[2] Additional information on the Legacy Loans Program is available at: http://www.treas.gov/press/releases/reports/legacy_loans_terms.pdf

As we are all painfully aware, the collapse of the housing price bubble, and the sharp reversal in lending standards that helped fuel that bubble, has had a devastating effect on the financial sector and on homeowners alike, with dire consequences for the economy overall. In addition to reducing household wealth across the country, and thereby further intensifying the economic contraction, falling home prices and extraordinarily tight lending standards have trapped homeowners in their old mortgages. Even many homeowners who made what seemed to be conservative financial decisions three, four, or five years ago find themselves unable to benefit from the low interest rates available to unencumbered borrowers today. At the same time, increases in unemployment and other recessionary pressures have continued to impair the ability of some otherwise responsible families to stay current on mortgage payments.

As a result, as many as 6 million families are expected to face foreclosure in the next several years. Foreclosures have massive negative externalities – such as reducing surrounding home values, and increasing vacancies, homelessness, and violent crime. In some studies, foreclosure on a home has been found to reduce the prices of nearby homes by as much as 9 percent.

Since January, the Administration has made significant progress in developing and implementing a comprehensive plan for stabilizing our housing market, the centerpiece of which is the Making Home Affordable Program (MHA). By reducing foreclosures around the country, the average homeowner could see their house price bolstered by as much as $6,000 as a result of this plan, and up to 9 million homeowners may increase the affordability of their mortgages and avoid preventable foreclosures.

MHA targets the root causes of the foreclosure crisis directly.  First, the refinancing program expands access to refinancing for families whose homes have lost value. Second, the modification plan commits $75 billion to loan modifications that will provide sustainably affordable mortgage payments for borrowers.  The focus of the plan is affordability because providing borrowers with payments they can afford, including those with negative equity, will keep millions from being foreclosed on in a way that is most effective for taxpayers. A third part of the plan supports refinancing more generally by increasing confidence in the GSEs.

MHA’s design centers on two key ideas. First, MHA creates detailed standard industry guidelines for loan modifications, with the goal of helping to transform the industry standard to a product better for all borrowers, both within and outside of MHA. In the past, a lack of common standards has limited loan modifications, even when they are likely to both reduce the chance of foreclosure and raise the value of the securities owned by investors. Second, the innovative pay for success structure of the program aligns the incentives of servicers, investors, and borrowers to voluntarily modify mortgages in a way that will be affordable for borrowers in the long-term, cost-effective for taxpayers, and profitable for lenders. In addition, when Hope for Homeowners has been expanded and improved, we also intend to position this program as a critical part of MHA.

Our progress in implementing MHA to date has been substantial. We have introduced detailed guidelines for loan modifications which will establish a new standard practice for affordable modifications in the industry. We have already signed contracts with the top servicers covering a majority of loans nationwide for our loan modification program. Servicers have begun executing refinancings and modifications under our program, and our program has helped push interest rates to historic lows, increasing refinancing nationwide. For example, Fannie Mae did $77 billion in refinancings in March, its largest one-month volume since 2003.

We have launched MakingHomeAffordable.gov, a consumer website for the program, which has had 11.2 million page views in less than a month. These are just a few of the many steps that have been taken to implement these programs.

We have also expanded the efforts of the federal government to combat mortgage rescue fraud and put scammers on notice that we will not stand by while they prey on homeowners seeking help under our program.

We are also supporting or are working on additional measures to stabilize housing, all of which are aimed at supporting the success of MHA in keeping homeowners in their homes or in finding alternative and less damaging “exit strategies” for borrowers who own homes that they are clearly unable to afford, even under favorable mortgage terms. These measures include reform of the bankruptcy code to allow judicial modifications of home mortgages, a second lien program under MHA, further details on a short sales and deeds-in-lieu program, and, as noted, the strengthening of Hope for Homeowners.

We will continue to explore additional ways to help the housing market and report on ongoing progress as we push forward.

Regulatory Reform

The programs outlined above are designed to help rehabilitate our financial sector and, as quickly as possible, turn it into a source of support for our economy rather than a drag on it. But this effort will not be fully successful unless a broader set of reforms is put in place. Our regulatory and market infrastructure has to catch up to significant changes that have occurred in our financial sector in recent decades.

The rapid growth of the largest financial institutions, and their increasing interconnections through securities markets, have heightened systemic risk in the system. In response, we need to expand our capacity to contain systemic risk. This crisis – and the cases of firms like Lehman Brothers and AIG – has made clear that certain large, interconnected firms and markets need to be under a more consistent and more conservative regulatory regime. It is not enough to address the potential insolvency of individual institutions – we must also ensure the stability of the system itself.

Financial innovation has expanded the financial products and services that are available to consumers. These changes have brought many benefits. But we have to make sure that when households make choices to borrow, or to invest their savings, there are clear and fair rules of the road that prevent manipulation, deception, and abuse. Lax regulation has left too many households exposed to deception and abuse. While outright fraud like that perpetrated by Bernie Madoff is already illegal, these cases highlight the need to strengthen supervision and enforcement across the financial sector. We need meaningful disclosures that actual consumers and investors can understand. We need to promote simplicity, so that financial choices offered to consumers are clear, reasonable, and appropriate. Further, there needs to be clear accountability for protecting consumers and investors alike.

The rapid pace of development in the financial sector in recent decades has meant that gaps and inconsistencies in our regulatory system have become more meaningful and problematic. Financial activity has tended to gravitate to parts of the system that are regulated least effectively. Looking ahead, our regulatory structure must assign clear authority, resources, and accountability for each of its key functions.

The financial landscape has become ever more global in recent years. Advances in information technology have made it easier to invest abroad, which has expanded and accelerated cross-border capital flows. Greater global macroeconomic stability has also helped to accelerate financial development around the world. To keep pace with these trends, we must ensure that international rules for financial regulation are consistent with the high standards we will be implementing in the United States. Additionally, we must seek to materially improve prudential supervision, tax compliance, and restrictions on money laundering in weakly-regulated jurisdictions.

Finally, the recent financial crisis has shown that the largest financial institutions can pose special risks to the financial system as a whole. In addition to regulating these institutions differently, we must give the Federal government new tools for dealing with situations where their solvency is called into question. Treasury has proposed legislation for a resolution authority that would grant additional tools to avoid the disorderly liquidation of systemically significant financial institutions that fall outside of the existing resolution regime for banks under the FDIC.

Status of TARP

TARP, established under EESA, has been a vital part of our efforts to rehabilitate the financial sector. Since the Congress released the second half of the $700 billion allocated to Treasury through EESA, we have unveiled our FSP in an effort to use the full range of tools at our disposal to create the foundations for an economic recovery. Table 1 below summarizes current projections concerning the remaining funds available as part of the FSP.

When President Obama took office, Treasury had already committed over half of the funds allocated for the Troubled Assets Relief Program. Today, Treasury estimates that there is at least $134.6 billion in resources authorized under EESA still available. This figure assumes – as reported by the Government Accountability Office – that the projected amount committed to existing programs will be $590.4 billion (of which $355.4 billion was committed under the previous administration), but also anticipates that $25 billion will be paid back under the CPP over the next year. Because the most relevant consideration is what funds will remain available for new programs, we believe that our estimates are conservative for two reasons. First, our estimates assume 100 percent take-up of the $220 billion made available for our housing and liquidity programs, which require significant voluntary participation from financial participants. If any of those programs experience less than full take-up, additional funds will be available. Secondly, our projections anticipate only $25 billion will be paid back under CPP over the next year, a figure lower than many private analysts expect.
In the attached table, we have broken down our commitment of EESA funds under four categories:

• Exceptional Relief: Funds committed for exceptional relief to specific financial institutions and the auto industry.
• Capital Purchase Program.
• Housing and Liquidity Initiatives: New initiatives directed towards addressing weaknesses in the housing and credit markets.
• Paybacks.

In addition to the programs discussed above, Treasury has stated its intention to provide additional support to the auto industry – contingent on an acceptable restructuring – as well as capital under the Capital Assistance Program. We believe that even under the conservative estimate of available funds described here, we have the resources to move forward in implementing all aspects of our FSP.

Indicators on interbank lending, corporate issuance, and credit spreads generally suggest that credit conditions have improved significantly in the past few months. The LIBOR-OIS spread, an indicator of major banks’ willingness to lend, has fallen to about 90 basis points, down from its October peak of 365. Additionally, corporate bond issuance and issuance of asset back securities both rose in March after grinding to a halt in October and November.

However, reports on bank lending show significant declines in consumer loans, including credit card loans, and commercial and industrial loans. It is also important to point out that the cost of credit and terms of credit, even where they have recently declined, are still elevated.

Transparency

Upon taking office, President Obama committed to increased transparency, accountability, and oversight in our government’s approach to stabilizing the financial system. Treasury is committed to an open and transparent program with appropriate oversight.

We have launched a reinvigorated public communications initiative designed to more directly communicate how our policies will stabilize the financial system and restore the flow of credit to consumers and businesses. A key element to this enhanced public outreach effort is providing user-friendly resources online. Last month, Treasury launched a new website, FinancialStability.gov, that details financial stability programs in a simplified format. In addition, Treasury has taken a number of steps to better measure whether financial stability programs are increasing the flow of credit to consumers and businesses. In January, we launched a monthly lending and intermediation survey to better gauge, in a way readily accessible to the public, the performance of banks participating in the CPP. The most recent results, covering February 2009, demonstrate that the largest CPP banks continue to lend and refinance despite the increasingly severe headwinds posed by this economic downturn. Absent Treasury capital provided through the CPP, lending levels would likely have been substantially lower.

Treasury announced on January 28, 2009, that it would begin posting all of its investment contracts on our website within ten business days of each transaction’s closing. Treasury is in the process of posting all the contracts signed prior to January 28 to the website as well.

Treasury looks forward to continuing to work with our four oversight bodies – the Financial Stability Oversight Board, the Inspector General, the Comptroller General, and the Congressional Oversight Panel. Transparency will not only give the American people comfort in our stewardship of these funds, it will give the markets confidence that we are stabilizing and strengthening the financial system.

Executive Compensation

Compensation systems in many financial institutions played a material role in creating this financial crisis. They gave individuals incentives to focus on short-term profits at the expense of long-term value. In many institutions they did not reward sound risk management. Going forward, it is important that everyone in financial institutions – from traders to executives – have compensation that is closely and tightly aligned with sound risk management and long-term value for their financial institution and the economy as a whole. We have to be careful, however, not to destroy beneficial forms of incentive compensation or to restrict financial firm compensation packages so severely as to drive the most talented people out of the U.S. financial sector. We will engage in a thorough review of this issue, and we want to hear the ideas and analysis of experts throughout the country. I anticipate that we will look for ways to orient compensation towards long-term performance. Had this been done earlier, I think a certain amount of the pain caused by this financial crisis and the resulting loss of public trust that has resulted could have been mitigated.

In accordance with ARRA provisions, Treasury will be conducting a review of TARP recipient compensation for the 25 most highly-compensated employees. In addition, the Administration is currently working to develop an Interim Final Rule (IFR) that will set clear standards of acceptable compensation for recipients of federal assistance under EESA. While the IFR will be effective immediately upon publication, Treasury will invite public comment during a sixty-day period and will consider all comments in developing a final rule.

Major Initiatives

February 10, 2009: Treasury Introduced the Financial Stability Plan (FSP)

To address the financial crisis – a crisis of confidence, of capital, of credit, and of consumer and business demand -  FSP is designed to attack the credit crisis on all fronts. Restarting our economy and creating jobs requires ensuring that businesses with good ideas have the credit to grow and expand, and working families can get the affordable loans they need to meet their economic needs. To protect taxpayers and ensure that every dollar is directed toward lending and economic revitalization, FSP will institute a new era of accountability, transparency and conditions on the financial institutions receiving funds.

February 18, 2009: Treasury Introduced the Making Home Affordable Plan (MHA)

The collapse in home prices served as the catalyst for the current financial crisis, harming both household balance sheets as well as much of the financial sector. MHA includes a refinancing program that provides the opportunity for 4 to 5 million homeowners to refinance their mortgages and reduce their monthly payments, a $75 billion loan modification program that keeps 3 to 4 million families in their homes, and provides support for low mortgage rates by strengthening confidence in Fannie Mae and Freddie Mac.

Since the introduction of MHA, consumers have seen record low interest rates helping to alleviate pressure on homeowners. Also, the first loan modification contracts have already been signed in an effort to bring monthly payments to sustainable levels.

February 25, 2009: Treasury Introduced the Capital Assistance Program (CAP) and Measuring Capital Needs

Treasury launched CAP in order to ensure that institutions have enough capital to lend – even during tougher economic times. CAP requires that banks maintain a capital buffer as an insurance policy against worse-than-expected economic conditions. The country’s largest banks are undergoing a forward looking “stress test” designed to determine how large a capital buffer is necessary to ensure that those banks would be well capitalized in even a severe economic scenario.  The results of this exercise are expected to be released during the first week of May. Many banks will not need additional capital, but in cases where an additional buffer is needed, Treasury is making government capital available as a bridge to private capital through CAP. In order to ensure transparency, over the last several months bank supervisors have been conducting forward looking assessments of the balance sheets of the 19 largest banks to determine the strength of their capital and capital needs.

March 3, 2009: Treasury Introduced the Consumer and Business Lending Initiative

Treasury announced the Consumer and Business Lending Initiative (CBLI) including a significant expansion of the Term Asset Backed Securities Loan Facility (TALF) – a program developed to help improve credit market conditions by addressing the securitization markets. TALF was expanded in collaboration with the Federal Reserve to ease the pressure on credit markets. New asset classes expanded from credit cards, auto loans, student loans, and SBA loans to rental, commercial and governmental vehicle fleet leases, small ticket equipment and heavy equipment leases, agricultural equipment loans and leases and commercial mortgage backed and older securities.

March 16, 2009: Treasury Introduced the SBA Loan Purchase Program

Treasury announced a program to unlock credit for small businesses as part of the Consumer and Business Lending Initiative. As part of the program, Treasury will make up to $15 billion in TARP funds available to make direct purchases to unlock the secondary market for the government-guaranteed portion of SBA 7(a) loans as well as first-lien mortgages made through the 504 program. These purchases, combined with higher loan guarantees and reduced fees implemented under the American Recovery and Reinvestment Act of 2009, will help provide lenders with the confidence that they need to extend credit, knowing that if they make an SBA loan, they will be able to sell it and access the liquidity necessary to do further lending.

March 23, 2009: Treasury Introduced the Public-Private Investment Program (PPIP)

Treasury introduced PPIP in order to address the vicious market cycle and troubled assets clogging the balance sheets of financial institutions. By using government financing in partnership with the FDIC and the Federal Reserve and co-investment with private sector investors, PPIP will create substantial purchasing power to create a new market for legacy assets and make the most of taxpayer resources. PPIP ensures that private sector participants invest alongside the taxpayer, with the private sector investors standing to lose their entire investment in a downside scenario and the taxpayer sharing in profitable returns. To reduce the likelihood that the government will overpay for these assets, private sector investors competing with one another will establish the price of the loans and securities purchased under the program.

In order to accommodate increased participation in the Legacy Securities Program, the deadline for asset manager applications was extended to Friday April 24th, 2009.

March 31, 2009: Treasury Extended the Federal Guarantee of Money Fund Assets

Treasury extended the money market fund guarantee in order to support ongoing stability in financial markets. As a result of this extension, the temporary guarantee program will continue to provide coverage to shareholders up to the amount held in participating money market funds as of the close of business on September 19, 2008. All money market funds that currently participate in the Program and meet the extension requirements under the Guarantee Agreements are eligible to continue to participate in the program.

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