March 11, 2009
TG-52

Interim Assistant Secretary for Financial Stability Neel Kashkari
Testimony before the House Committee on Oversight and Government Reform,
Subcommittee on Domestic Policy – As Prepared for Delivery

Good morning. Mr. Chairman, Ranking Member Jordan, and Members of the Subcommittee, thank you for asking me to testify before you today. As you know, I was appointed by the prior Administration. The Obama Administration asked me to remain at Treasury for a brief period to help with the transition. I am honored to provide whatever help I can to the new Administration.

The American people provided Treasury with broad authorities under the Emergency Economic Stabilization Act (EESA) to stabilize the financial system and it is essential we communicate our actions in a clear and transparent manner to maintain their trust. Today, I will briefly review the actions Treasury has taken to stabilize the financial system and describe the steps we are taking to monitor the lending activities of the recipients of government capital.

Many years in the making, the credit crisis erupted during the summer of 2007. Last year, the crisis intensified and our major financial institutions came under severe pressure from deteriorating market conditions and the loss of confidence.  In a short period of time several of our largest financial institutions failed.  In March - Bear Stearns.  In July - IndyMac.  In September, we witnessed the conservatorship of Fannie Mae and Freddie Mac, the bankruptcy of Lehman Brothers, the rescue of AIG, the distressed sale of Wachovia, and the failure of Washington Mutual. Eight major U.S. financial institutions effectively failed in 6 months – six of them in September alone.

This stress is reflected in the LIBOR-OIS spread, which is a key measure of risk in the financial system.  Typically, 5 – 10 basis points, on September 1, 2008 the one month spread was 47 basis points.  By the 18th, when Treasury and the Fed first went to Congress, the spread had climbed to 135 basis points. By the time the bill passed, just two week later on October 3, the spread had nearly doubled to 263 basis points.  Credit markets continued to deteriorate and, just one week later, the spread had spiked to 338 basis points – almost 50 times normal levels.  Our Nation was faced with the potential imminent collapse of our financial system.

What if the financial system had collapsed? Businesses of all sizes might not have been able to access funds to pay their employees, who then wouldn't have money to pay their bills. Families might not have been able to access their retirement funds. Basic financial services could have been disrupted. The severe economic contraction and large job losses we are now experiencing were triggered by the credit crisis. However, had the financial system collapsed, this recession, including terrible job losses and numerous foreclosures, could have been far, far more severe.

A program as large and complex as the TARP would normally take many months or years to establish.  But, we didn't have months or years.  We moved as quickly as possible to implement programs that would rapidly stabilize the system and prevent collapse.  In the 159 days since Congress passed the EESA, we have successfully implemented the Capital Purchase Program (CPP), having now invested in 489 banks of all sizes in 47 states and Puerto Rico, with approximately 30 new investments per week. The median investment is $16 million.  Treasury also helped the Federal Reserve establish a lending program to reduce borrowing costs for consumers, including auto loans, student loans, small business loans and credit cards, which will begin funding this month.  We are planning to expand this lending initiative to include other asset classes, such as commercial mortgage-backed securities. Under the new Financial Stability Plan, Treasury also announced a new Capital Assistance Program (CAP) and launched a multi-part housing program to reduce borrowing costs and encourage long-term sustainable loan modifications.  Finally, we are developing a public-private investment fund to purchase illiquid assets from banks to support new lending.

During this time, Treasury has unfortunately had to step in to stabilize several large institutions whose failures would pose a systemic risk to our financial system and economy.  We regretted having to take these actions – to put so many taxpayer dollars at risk to support firms that had made bad decisions.  But the choice was clear when the consequences of inaction were so severe – and the potential cost to taxpayers of inaction so much greater than the cost of intervention.

Today, the LIBOR-OIS spread has fallen from a peak of 338 basis points to 34 basis points. We believe the combined actions of Treasury, the Federal Reserve and FDIC have prevented a financial collapse, but we still have much more work to do to get credit flowing to our communities.

Monitoring Lending

In January, Treasury began collecting data from the twenty largest recipients of capital under the CPP, representing almost 90% of CPP capital investments. We published our first monthly lending survey in February. This survey shows, bank by bank, the lending and intermediation activities of institutions by category, such as consumer, commercial and real estate loans. This survey is published monthly on Treasury's website.  In recessions, credit levels typically fall as both borrowers and lenders become more cautious. The first survey shows that lending held-up remarkably well despite one of the most severe quarterly economic contractions in decades. Without capital from Treasury, lending levels would likely have been much lower.  We are also developing a narrower survey for smaller institutions that receive government capital to monitor their lending monthly.  And the new CAP program will require institutions to indicate their expected use of funds and track lending against a baseline.

With investments in almost 500 institutions, and hundreds more in the pipeline, we must ensure that our investments are targeted at stabilizing the economy but we must also take great care not to try to micromanage recipient institutions.  However well-intended, government officials are not positioned to make better commercial decisions than lenders in our communities.  The government must not attempt to force banks to make loans whose risks they are not comfortable with or attempt to direct lending from Washington.  Bad lending practices were at the root cause of this crisis.  Returning to those practices will not help end this financial turmoil. 

Conclusion

The EESA was one of several initiatives taken by the Federal government to stabilize the financial system – a necessary precondition to economic recovery. We believe the combined actions of Treasury, the Federal Reserve and FDIC have helped prevent a financial collapse. Nonetheless, the current crisis took years to build up and will take time to work through, and we still face real economic challenges. There is no single action the Federal government can take to end the financial market turmoil and the economic downturn, but the authorities Congress provided last fall dramatically expanded the tools available to address the needs of our system.

Thank you.

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