Treasury Secretary Timothy Geithner says a root cause of the financial crisis was Congress' failure to give regulators authority to curb risk in a system of institutions operating outside rules for traditional banks.
Geithner is testifying at a hearing Thursday of a special panel investigating the crisis and this so-called "shadow" banking system. As president of the New York Federal Reserve in 2008, he was one of the key architects of the government's response to the crisis and the federal bailout.
Geithner says in his prepared testimony that the financial overhaul legislation now before Congress would close the gaps to give regulators needed powers to restrain risk in the "shadow" system.
The testimony was given before the Financial Crisis Inquiry Commission, a bipartisan panel established by Congress to probe the roots of the financial crisis. It is the first time the panel has heard from either of the men who called the shots in late 2008 as the global financial system nearly collapsed.
The panel is looking at nonbank financial companies such as PIMCO and GE Capital that provide capital for loans to consumers and small businesses. When rumors spread in 2008 that Bear Stearns was teetering, these companies started what former Bear Stearns executives described Wednesday as a "run on the bank," drawing so much of its capital that it could not survive.
Then-Treasury Secretary Paulson and Geithner, as president of the Federal Reserve Bank of New York, engineered Bear's rescue. The New York Fed put up a $29 billion federal backstop to limit JPMorgan's future losses on Bear Stearns' bad investments.
Bear Stearns was the first Wall Street bank to blow up. Its demise foreshadowed the cascading financial meltdown in the fall of that year.
The panel is investigating the roots of the crisis that plunged the country into the most severe recession since the 1930s and brought losses of jobs and homes for millions of Americans.
In earlier testimony before the House Committee on Oversight and Government Reform, Paulson defended his response to the economic crisis as an imperfect but necessary rescue that spared the U.S. financial market from total collapse.
"Many more Americans would be without their homes, their jobs, their businesses, their savings and their way of life," he said in testimony prepared for that hearing.
While losses have been staggering, "that suffering would have been far more profound and disturbing" had the government not intervened, Paulson said.
In addition to Geithner and Paulson, the meltdown probe will hear Thursday from leaders of key players in the shadow banking system including senior executives from GE Capital and asset managers PIMCO and State Street.
In its first day of hearings on shadow banking Wednesday, the FCIC dissected Bear Stearns as a case study, and heard from former CEOs James Cayne and Alan Schwartz.
The commissioners challenged them and other former Bear Stearns' executives on what caused Bear Stearns to collapse.
The executives testified that they did all they could to keep Bear Stearns afloat before it fell victim to an unstoppable run on the bank. Its business strategy of borrowing funds from rival firms was sound under the crimped credit market conditions at the time, they said.
The role of federal regulators also is key in the panel's autopsy of the financial disaster and the huge Wall Street investment banks. The Securities and Exchange Commission's oversight of the firms — some rotting from within from piled-up securities tied to subprime mortgages — was criticized by lawmakers and investor advocates both during and after the crisis.
Wednesday's hearing marked Cayne's first public appearance in the aftermath of the crisis. Cayne was a flamboyant character who led Bear Stearns — a firm known for its go-against-the-grain scrappiness — for 15 years.
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