[House Hearing, 110 Congress]
[From the U.S. Government Publishing Office]
HEDGE FUNDS AND SYSTEMIC RISK:
PERSPECTIVES OF THE PRESIDENT'S
WORKING GROUP ON FINANCIAL MARKETS
=======================================================================
HEARING
BEFORE THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED TENTH CONGRESS
FIRST SESSION
__________
JULY 11, 2007
__________
Printed for the use of the Committee on Financial Services
Serial No. 110-48
U.S. GOVERNMENT PRINTING OFFICE
38-388 WASHINGTON : 2007
_____________________________________________________________________________
For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; (202) 512�091800
Fax: (202) 512�092104 Mail: Stop IDCC, Washington, DC 20402�090001
HOUSE COMMITTEE ON FINANCIAL SERVICES
BARNEY FRANK, Massachusetts, Chairman
PAUL E. KANJORSKI, Pennsylvania SPENCER BACHUS, Alabama
MAXINE WATERS, California RICHARD H. BAKER, Louisiana
CAROLYN B. MALONEY, New York DEBORAH PRYCE, Ohio
LUIS V. GUTIERREZ, Illinois MICHAEL N. CASTLE, Delaware
NYDIA M. VELAZQUEZ, New York PETER T. KING, New York
MELVIN L. WATT, North Carolina EDWARD R. ROYCE, California
GARY L. ACKERMAN, New York FRANK D. LUCAS, Oklahoma
JULIA CARSON, Indiana RON PAUL, Texas
BRAD SHERMAN, California PAUL E. GILLMOR, Ohio
GREGORY W. MEEKS, New York STEVEN C. LaTOURETTE, Ohio
DENNIS MOORE, Kansas DONALD A. MANZULLO, Illinois
MICHAEL E. CAPUANO, Massachusetts WALTER B. JONES, Jr., North
RUBEN HINOJOSA, Texas Carolina
WM. LACY CLAY, Missouri JUDY BIGGERT, Illinois
CAROLYN McCARTHY, New York CHRISTOPHER SHAYS, Connecticut
JOE BACA, California GARY G. MILLER, California
STEPHEN F. LYNCH, Massachusetts SHELLEY MOORE CAPITO, West
BRAD MILLER, North Carolina Virginia
DAVID SCOTT, Georgia TOM FEENEY, Florida
AL GREEN, Texas JEB HENSARLING, Texas
EMANUEL CLEAVER, Missouri SCOTT GARRETT, New Jersey
MELISSA L. BEAN, Illinois GINNY BROWN-WAITE, Florida
GWEN MOORE, Wisconsin, J. GRESHAM BARRETT, South Carolina
LINCOLN DAVIS, Tennessee JIM GERLACH, Pennsylvania
ALBIO SIRES, New Jersey STEVAN PEARCE, New Mexico
PAUL W. HODES, New Hampshire RANDY NEUGEBAUER, Texas
KEITH ELLISON, Minnesota TOM PRICE, Georgia
RON KLEIN, Florida GEOFF DAVIS, Kentucky
TIM MAHONEY, Florida PATRICK T. McHENRY, North Carolina
CHARLES WILSON, Ohio JOHN CAMPBELL, California
ED PERLMUTTER, Colorado ADAM PUTNAM, Florida
CHRISTOPHER S. MURPHY, Connecticut MICHELE BACHMANN, Minnesota
JOE DONNELLY, Indiana PETER J. ROSKAM, Illinois
ROBERT WEXLER, Florida KENNY MARCHANT, Texas
JIM MARSHALL, Georgia THADDEUS G. McCOTTER, Michigan
DAN BOREN, Oklahoma
Jeanne M. Roslanowick, Staff Director and Chief Counsel
C O N T E N T S
----------
Page
Hearing held on:
July 11, 2007................................................ 1
Appendix:
July 11, 2007................................................ 41
WITNESSES
Wednesday, July 11, 2007
Overdahl, James A., Chief Economist, U.S. Commodity Futures
Trading Commission............................................. 15
Sirri, Erik R., Director, Division of Market Regulation, U.S.
Securities and Exchange Commission............................. 17
Steel, Hon. Robert K., Under Secretary for Domestic Finance, U.S.
Department of the Treasury..................................... 12
Warsh, Hon. Kevin M., Member, Board of Governors of the Federal
Reserve System................................................. 14
APPENDIX
Prepared statements:
Overdahl, James A............................................ 42
Sirri, Erik R................................................ 49
Steel, Hon. Robert K......................................... 61
Warsh, Hon. Kevin M.......................................... 67
Additional Material Submitted for the Record
Frank, Hon. Barney:
Financial Times article, dated July 10, 2007................. 80
Article from Moody's Investors Service....................... 81
Bean, Hon. Melissa:
Responses to questions submitted to Erik Sirri............... 85
Responses to questions submitted to Hon. Robert K. Steel..... 88
Responses to questions submitted to Hon. Kevin M. Warsh...... 90
Responses to questions submitted to James A. Overdahl........ 93
HEDGE FUNDS AND SYSTEMIC RISK:
PERSPECTIVES OF THE PRESIDENT'S
WORKING GROUP ON FINANCIAL MARKETS
----------
Wednesday, July 11, 2007
U.S. House of Representatives,
Committee on Financial Services,
Washington, D.C.
The committee met, pursuant to notice, at 10:04 a.m., in
room 2128, Rayburn House Office Building, Hon. Barney Frank
[chairman of the committee] presiding.
Members present: Representatives Frank, Kanjorski, Waters,
Maloney, Watt, Meeks, Capuano, Clay, McCarthy, Baca, Lynch,
Scott, Green, Cleaver, Sires, Hodes, Klein, Mahoney, Boren;
Bachus, Baker, Pryce, Castle, Royce, Shays, Capito, Feeney,
Hensarling, Garrett, Brown-Waite, Neugebauer, McHenry,
Campbell, Bachmann, and Marchant.
The Chairman. The hearing will begin. This is a hearing of
the Financial Services Committee with the members of the
President's Working Group, which I guess is about 20 years old.
And it is part of a series of hearings we are having on the
issue of hedge funds and private equity, the increase in the
amount of financial activity that goes through.
We had a hearing earlier with some of the representatives
of hedge funds themselves. We will continue to deal with this
and we are pleased to have the President's Working Group before
us.
I think, as I read the testimony, we have a kind of uneasy
consensus that there is a potential problem here that we wish
we were more sure about how to approach. I, for instance, read
with great interest the speech by Assistant Secretary Ryan of
the Treasury a couple of weeks ago. I don't think anybody can
be confident that all is entirely well here, but neither is
there any obvious thing we ought to be doing.
This is a matter for concern. It is an interesting issue in
that it's a challenge to our regulatory system both within the
United States and internationally. I mean the fact that we have
a wide range of entities here, we have two quasi-independent
commissions, and we have the Treasury and the Federal Reserve
all with pieces of this.
We have obviously a very important interface with the
international community, and I know that people don't generally
believe this, but it is the case that sometimes, not often, I
acknowledge, but sometimes, congressional committees have
hearings because they want to know things. That's not the norm,
but it is true today.
This is a subject of great importance and considerable
uncertainty. There is obvious value to the activity of these
entities. The market is not irrational. People profit because
they are doing things that are ultimately beneficial, but there
are also potential dangers.
In particular from this community standpoint I think, not
all of us but most of us, is the potential for systemic risk.
We are not here largely in an investor protection capacity.
Particularly after what the SEC has done, we are not talking
about small investors.
There is one exception to that. There is a great deal of
concern about the potential for pension funds to get involved
beyond what they should be doing. And I've talked to the
chairman of the Committee on Education and Labor, Mr. Miller,
who has jurisdiction there. We are going to be working at--one
of the things we have to address is whether or not there should
be some special rules regarding pension funds.
But beyond that, the question is systemic risk. The
question is whether, given the proliferation of forms of
investment that have high leverage, whether or not if there is
a rapid change in the basic financial environment, people will
be able to deal with the consequences. So far, there have been
some good signs.
The Amaranth situation was a problem for people for whom it
should have been a problem but it did not have broader systemic
problems. It does not appear so now, but we'll be interested in
people's sense of whether the Bear Stearns issue is going to be
something that causes broader problems. But those have happened
within a stable financial context.
The question, I guess, is what happens if the current
financial context regarding international liquidity and
interest rates were to change. And I don't think anyone thinks
that's going to remain forever in both contexts. So what we are
talking about is, are we now ready to deal with a potential
problem, and if so, what should we be able to do about it and
how do we get ready to do that without causing some damage?
So as I said, I regard this as a study that's ongoing, and
I'm glad to say that it has been a collaborative one between
the Congress and the various regulators and it's good to see
them working together on this. And as I said, we are here to
learn some things and to talk about things in general, and this
is part of a continuing inquiry into this problem which is we
have quantitatively, and as Marx said, ``Changes in quantity
can become changes in quality.'' We have what could be a
qualitative change in the extent to which investment is carried
on.
Our question is, does that pose potential problems, and is
the regulatory structure adequate to this new set of issues.
That's what we will be dealing with. I'll now recognize for 5
minutes the ranking member of the committee, the gentleman from
Alabama.
Mr. Bachus. I thank the chairman. I thank you for holding
this hearing.
This is the third hearing we've held on the rapid growth of
private pools of capital including hedge funds and private
equity funds. I'd also like to associate myself with the
remarks of the chairman when he said that we're unsure about
what to do, and we're not confident about any action that we
may take at this time.
So that is, as he said, a clear indication that we ought to
be listening, we ought to be learning, but we should not be
taking legislative action. What we are doing, I think, is very
appropriate. We're talking with each of you, your agencies, and
we're confident that the regulators appreciate the problems and
we're also confident that you know more about it than we do.
We're really fortunate to have with us our four witnesses
today. They are distinguished representatives of the
Presidential Working Group on Financial Markets.
And the President's Working Group, as you all know, but the
audience may not know, was formed in the wake of the 1987 stock
market crash. It is chaired by the Treasury Secretary, and it
is made up of the Chairmen of the Federal Reserve, the
Securities and Exchange Commission, and the Commodity Futures
Trading Commission. It was formed to promote integrity,
efficiency, orderliness, and competitiveness in our financial
markets.
Since then, it has issued periodic reports on these issues
affecting the U.S. markets including the 1999 report on Long
Term Capital Management.
Earlier this year the President's Working Group endorsed an
approach to hedge fund regulation that relies primarily on
market pressures and incentives to contain risks. The group
concluded, correctly in my opinion, that market discipline
together with statutory limits restricting access to hedge
funds to wealthy investors can sufficiently mitigate industry
risk.
By emphasizing the importance of free market forces, rather
than the hand of excessive government regulation, I believe
that the President's Working Group struck the right balance in
regulating and overseeing the activities of these highly
innovative investment vehicles.
Hedge funds and private equity funds have in recent days,
as we all know, become convenient targets for those favoring
higher taxes and more government intervention in our capital
markets. While this is certainly a debate worth having, I hope
that it will be an informed debate, informed by the
appreciation for the vital role that these private pools of
capital play in an efficiently functioning market and their
importance in maintaining America's competitive standing in the
global economy.
Hedge funds actively pursue arbitrage opportunities across
markets, and in the process often reduce or eliminate
mispricing of financial assets. That actually can bring
stability to a market.
As former Federal Reserve Chairman Alan Greenspan said,
``Their willingness to take short positions can act as an
antidote to the sometimes excessive enthusiasm of long-term
investors. Perhaps more importantly, they often provide
valuable liquidity to financial markets both in normal market
conditions and especially during periods of stress.
``They can ordinarily perform these functions more
effectively than other types of financial intermedia because
their investors often have a greater appreciation for risk and
because they are largely free from regulatory constraints on
investment strategies.''
Private equity funds offer tools for providing capital and
expertise to underperforming companies and companies struggling
with the tremendous pressure of the public markets to meet
quarterly earnings expectations in order to improve corporate
performance. Private equity funds recruit top managers and
directly tie compensation to long-term performance and growth.
They develop strategic business plans and implement operational
improvements to revitalize these companies in a manner that can
only be achieved when the firm's owners are directly and
actively engaged in its management.
Let me conclude by saying that hearings like the one we're
having today are important because they allow Members of
Congress to better understand the industries and markets we
oversee. If Congress attempts to regulate or tax any specific
sector of the financial services industry without a thorough
understanding of the role it plays in our financial system the
risk of unintended, unnecessary, burdensome and harmful
regulation is real. The last thing we want to do is drive
investment--whether it's hedge funds or private equity funds--
and their capital offshore.
So I again commend Chairman Frank for his attention to this
issue, and I welcome our distinguished guests.
The Chairman. Next, the gentleman from Louisiana, Mr.
Baker, is recognized for 4 minutes.
Mr. Baker. Thank you, Mr. Chairman, and thank you, Ranking
Member Bachus, for the time. I have some significant questions
about where we stand with this matter.
From the President's Working Group recommendations of April
1999, there were at that point in financial history some
observations I think worthy of reviewing. The Working Group
recommendations at that moment emphasize the promotion of sound
risk management practices by all market participants and to
allow individual market participants therefore to make more
informed investment and credit decisions.
So the message in 1999 was to the market, get your act
together so people can make informed decisions. I think some
assessment of what has taken place from 1999 until now on the
market side of the fence might be instructive for the committee
to hear in light of the fact of market factors that have
changed rather dramatically since 1999.
There was legislation that was filed pursuant to the 1999
report, H.R. 2924, implementing the Working Group
recommendations, requiring, interestingly enough, the largest
unregulated funds to disclose certain public information which
was nonproprietary, including a new meaningful measurement of
risk.
I also note that the internationally generally accepted FSA
regime does require the larger funds to make such disclosure of
nonproprietary information to enable governmental regulators to
assess not only leverage, but the potential for systemic risk
events. Consistent with the 1999 Working Group, H.R. 2924 did
not call--and I can't make this any more clear--for direct
regulation, but instead provides for enhanced public disclosure
by only those funds that, if large enough, if one were to fail,
that failure could potentially pose systemic risks to those
innocent third parties.
That set of findings and comments were made by Mr. Sachs,
who was then the Assistant Secretary for Financial Markets for
the Department of the Treasury. Mr. Patrick Parkinson's
comments, who was an Associate Director, Division of Research,
for the Federal Reserve, went on to say that there was strong
support for the 1999 Working Group recommendations and that the
very largest funds should be required to publicly disclose
information about their financial activities.
The only modification to H.R. 2924 suggested by the Fed at
that time was that the disclosure should be made to the SEC
rather than the Federal Reserve Board because of the SEC's
broader responsibilities in the field of public disclosure.
My point is that from 1999 until now, it is not only the
explosive growth in the number of funds, but the enormity of
growth in individual's funds. The advent of the fund of funds,
which enables the $25,000 investor to take on risks that were
intended for sophisticated, qualified investors and that
pension funds now, as a matter of practice, routinely invest in
funds for which I do not believe fund managers necessarily are
adequately equipped to assess the risk for which the third
parties they represent are undertaken.
I foresee a circumstance in which an Amaranth matter might
lead to significant upheaval in State pension funds of some
region. I can think of several in my own State that have
displayed significant inadequate governance capabilities that
would then lead to a school teacher or a fireman or a policeman
to find their reserves for retirement dissipated because the
fund manager did not fully understand the counterparty risk
that the hedge fund investment really represented.
I don't have a remedy for this problem, but I have an
observation about what the recommendations may mean if not
fully heeded by the market, if the 2007 Working Group
recommendations and that message is not fully received. And I
have concerns because the message was sent in 1999, and I don't
know that market discipline has yielded any regulatory
constraints in market practice. Should we have one of those
undesirable events I read from the 1999 Working Group report,
page 26, ``Generally government regulation becomes necessary
because of a market failure or the failure of pricing
mechanisms to account for all social costs. Government
regulation of markets is largely achieved by regulating
financial intermediaries who have access to the Federal safety
net, the banks, that play a central dealer role or that raise
funds from the general public. Any resort to governmental
regulation should have a clear purpose and be carefully
evaluated in order to avoid unintended consequences.''
I think here my cautionary note is if self-regulation in
the market does not work, and we have an untoward event, the
resulting actions of this Congress will be very unhelpful to
the market at large. This is no casual warning. This is a plea
for the market to act, and if they do not, the consequences are
very undesirable.
Thank you, Mr. Chairman.
The Chairman. The gentleman from Pennsylvania is recognized
for such time as he consumes.
Mr. Kanjorski. Thank you very much, Mr. Chairman.
First of all, let me thank the chairman and ranking member
for commissioning this hearing. It is certainly a topic in
which all of us are interested, and I think that we have
labored in the forest together with Mr. Baker over the years to
get some information and enlightenment.
From my perspective, I look forward to hearing a real
definition of a hedge fund. I understand that you all have
defined it today so that I will be able to clearly understand
the entity with which we are dealing.
But in all seriousness, the difficulty lies in defining
what a hedge fund is and the import of how it operates in the
marketplace; I myself am not worried about protecting
individuals of high net worth or constricting their right to
invest and participate in helping the marketplace to level the
field and provide the liquidity that is necessary out there.
On another point, I am disturbed about potential systemic
risk and particularly about the great deal of financing that
comes out of federally insured institutions. This leveraging
could cause risk to the government or systemic risks to the
system. I think we are going to rely on the testimony of this
group today to see where we are headed and what the Congress
should do in response to some of the existing problems out
there.
But, I would also agree with Mr. Baker: We hope self-
regulation can be the order of the day. However, if it fails, I
hope we do not hear the cry that we have over-regulated because
the Congress will be called upon to move in very swiftly and
very deeply into a control situation. We hope that is not
necessary.
I look forward to the Working Group's report to the
Congress today, and I look forward to working with them in the
future.
Thank you, Mr. Chairman.
The Chairman. The gentleman from Delaware is recognized for
2 minutes.
Mr. Castle. Thank you, Mr. Chairman. I thank you and the
ranking member for holding this hearing, and I agree with your
comments, those of the ranking member and everybody else who
has spoken, particularly Mr. Baker, with respect to pension
funds and their investments.
This Working Group has already indicated the tremendous
influence hedge funds have on our markets. The hedge funds have
more than doubled in the past 5 years, growing to over 9,000
hedge funds. Since your last study in 1999, the industry has
grown by more than 400 percent, now totaling nearly $2
trillion. And the combined assets of the 100 largest hedge
funds represent about 65 percent of the total industry.
Secretary Steel further explained the vast amount of
trading volume hedge funds are generating. It is speculated
that they may represent up to 50 percent of trading in
particular instances, which is something to think about. The
group also discussed how institutional investors like pension
funds constitute more than half of the investments in hedge
funds.
With pension funds placing more of their money in hedge
funds, American workers, retirees, and other average investors
may unknowingly be exposed to hedge fund losses. The
President's Working Group recommended that investors in hedge
funds gather necessary information regarding the fund's
strategies, terms, conditions and risk management to make
informed investment decisions and perform due diligence, yet
hedge funds are not required to disclose this information.
I am concerned with this lack of transparency because the
manager of a pension fund cannot fulfill their fiduciary duty
and may not understand the risk to their investments to perform
due diligence before committing funds. The lack of transparency
in the industry may also pose systemic risk. The long-term
capital management incident showed how overexposure of
counterparties had the potential to cause systemwide damage to
financial markets.
After LTCM, the Working Group recommended the very largest
hedge funds be required to disclose information about their
financial activities, including meaningful and comprehensive
measures of market risk. The Working Group now concludes that
no government agency needs any information about hedge fund
activities and that we can rely on hedge fund investors
themselves to protect the markets from systemic risk.
It is unclear to me why the Treasury now appears a lot less
cautious than they were in 1999 since the industry has grown
considerably. More recently the New York Federal Reserve has
repeatedly warned that hedge funds pose the largest risk since
the LTCM crisis and Treasury officials have forewarned
financial institutions about hedge fund vulnerability.
There are many instances of pension fund involvement now.
And the bottom line is that while I don't know the answers
either, as the chairman and ranking member indicated, I do
think we need to be looking very carefully at what we are doing
here. I yield back the balance of my time.
The Chairman. The gentlewoman from California for 2
minutes, or as much time as she consumes.
Ms. Waters. Thank you very much, Mr. Chairman and members.
I want to thank Chairman Frank and Ranking Member Bachus for
holding the second in a series of hearings on the issue of
hedge funds.
These hearings are designed to examine the emerging role of
hedge funds and private equity pools in the United States and
global markets. Indeed, this is a timely hearing because I have
become somewhat fascinated by hedge funds and their dramatic
growth over the last several years.
The estimate suggests that hedge funds have grown in number
to more than 9,000--double what they were just 5 years ago. The
assets have also grown by some 400 percent to $1.4 trillion.
The primary purpose of hedge funds is to reduce volatility
and risk while attempting to preserve capital and deliver
positive returns under all market conditions.
Have the funds grown because they are the most flexible
investment tool in today's volatile financial system? I ask
this question because in the past few months it has been
revealed that a number of hedge funds are heavily invested in
mortgage backed securities related to subprime loans.
According to the New York Times, the Bear Stearns Company,
an investment bank, pledged up to $3.2 billion in loans to bail
out one of the hedge funds that was collapsing because of bad
bets on subprime mortgages. It is the biggest rescue of a hedge
fund since 1998 when more than a dozen lenders provided $3.6
billion to save Longterm Capital Management.
Unfortunately, it is precisely this type of investment
activity that raises concerns in the marketplace. I'm sure that
we have just seen the tip of the iceberg as it relates to
subprime lending, 2.2 million defaults, according to some
estimates, by next year.
Interestingly, some hedge fund strategies are designed to
capitalize on these negative conditions in the market. So what
are the cost benefits associated with hedge fund activity in
the United States and in the global economy?
I thank you and I look forward to hearing our witnesses
today. I yield back the balance of my time.
The Chairman. The gentleman from California, Mr. Royce, is
recognized for 3 minutes.
Mr. Royce. Thank you very much, Mr. Chairman.
The Chairman. Before the gentleman begins, let me just say
to the people here that we have a limited number of opening
statements. We have about 10 more minutes of opening
statements, so I do want to reassure people that we will get to
you.
The gentleman from California.
Mr. Royce. Thank you, Mr. Chairman, and thank you for
holding this hearing on hedge funds and the effect on our
capital markets that they have. I'd also like to commend the
members of the President's Working Group for their work on this
issue.
The role of hedge funds clearly continues to evolve, and as
you've mentioned, the hedge funds have experienced incredible
growth--the numbers I've seen, from $50 billion in assets in
1988, to today totaling over $1 trillion. While both the size
and scope of these private pools of capital have changed over
the years, their unique ability to bring significant benefits
to the financial markets still remain.
The varying strategies utilized by hedge funds, which
results in additional liquidity, has helped the U.S. financial
markets become the deepest and most liquid markets in the world
today. The ability of hedge funds to target price
inefficiencies between markets has also proven to be a useful
tool that has resulted also in more efficient markets.
Furthermore, their ability to transfer and distribute risk
allows market participants to more easily manage the level of
risk held on their portfolio. While the broader financial
system has gained from the presence of hedge funds, an inherent
risk will always accompany those private pools of capital that
we call hedge funds.
Banks and other depository institutions that choose to
extend credit or choose to be counterparties to hedge funds
must make well-informed, sound business decisions. Regulators
with authority over banking systems should focus their
attention on preventing the institutions which they oversee
from taking on excessive risk. If market discipline and prudent
risk management is practiced, the likelihood of a systemic
shock will be greatly reduced.
Again, Mr. Chairman, I would like to thank you for
exploring this issue today, and I look forward to hearing from
our distinguished witnesses.
The Chairman. The gentlewoman from New York, for 3 minutes.
Mrs. Maloney. Thank you, Mr. Chairman, and Ranking Member
Bachus, for holding this incredibly important hearing. I
welcome the members of the President's Working Group, and I
very much look forward to your testimony.
I hope that I hear in your testimony answers to some of the
concerns that my colleagues and I have about hedge funds. There
has been a tremendous amount of media coverage of the potential
that a fire sale of CDOs triggered by Bear Stearns hedge funds
could have upon the entire financial system.
At the heart of these concerns appears to be a fear that
such a public sale of CDOs would clearly set market prices that
are way below the value at which many pension funds and
endowments and banks are carrying these products on their
books.
I specifically hope to hear what steps the President's
Working Group is taking to ensure that there are best practices
for evaluation of these types of securities and products across
all types of institutions. I specifically want to hear, did any
of the agencies comprising the President's Working Group weigh
in with the creditors of the Bear Stearns fund to encourage
them to forebear on selling off the collateral until such time
as Bear could decide to back the funds with their own capital.
I share the concerns of my colleagues of the impact this
has on pension funds invested in hedge funds. I am deeply
concerned and hope you will address what, if any, concerns you
have with the size and complexity of collateralized debt
obligations, these CDOs, especially the difficulty investors
have in adequately understanding and identifying the true value
of these securities.
And given the difficulty in having a day-to-day value on
collateralized debt obligations and given the sheer size of
these CDOs, what concerns do you have about the systemic risk
of these securities?
I was really surprised and startled to learn from the head
of the SEC, Chairman Cox, that he is investigating 12 separate
investigations in this particular area, which raises a concern
that he must have, and I want to know, do you share that
concern, and what best practices and advice do you give us
today? I thank you for your work and for your time.
The Chairman. The gentleman from Texas, Mr. Hensarling, for
2 minutes.
Mr. Hensarling. Thank you, Mr. Chairman. I too look forward
to this hearing.
As of yet, I haven't seen evidence of a level of systemic
risk that warrants direct Federal regulation but I certainly
have an open mind so I look forward to hearing from the
witnesses.
I have noted in previous statements of our former Fed
Chairman and our present Fed Chairman that have cautioned us
about the risk involved in direct regulation of the hedge fund
industry. And although it has been many years, and I hold
myself as no expert, there was a time when I was employed at a
hedge fund. And at that point I saw a level of expertise from
the investors, endowments, pension funds, and charitable
foundations that led me to believe that certainly private
market discipline was alive and well and that properly informed
sophisticated investors provide that level of discipline which
is needed.
We all know that there has been a certain amount of
negative press recently regarding hedge funds and I hope we all
remember in this committee the role that they play in helping
create jobs and our economy, helping our investors receive
superior returns, and keeping the economy growing.
And as the gentleman, the ranking member from Alabama well
noted, capital can move overseas. So the area of regulation is
one that we need to approach, I believe, with some trepidation.
Although this hearing is focusing on systemic risk, I am
too disturbed, as the ranking member noted, by a flurry of
proposals to do everything from increasing taxation on carried
interest to penalizing tax exempt organizations that invest in
hedge funds. And potentially these proposals may pose even a
greater risk to our economy, and so I believe that should be
duly noted.
And I trust any of these proposals that come around will be
thoroughly vetted and debated at some length. With that, I
thank again, Mr. Chairman, for holding this hearing. I yield
back the balance of my time.
The Chairman. The gentleman from Georgia.
Mr. Scott. Thank you, Mr. Chairman. This is indeed a very
important hearing, but I think we have to look at the facts and
be able to make some very objective decisions.
Hedge funds are playing a very important and significant
economic role in our economy. The whole private equity
transactions in the United States last year totaled over $400
billion, and between 1991 and 2006, created more than $30
billion in profit for our investors.
The funds hold unmatched sway over our markets. They are
responsible for more than a third of our stock trades, control
more than $2 trillion worth of assets, and each of the top
hedge fund managers earned more than $1 billion in 2006. So
this is a very serious and impactful area.
My major concern is, taking the example of Bear Stearns,
which recently admitted it would need to add some $1.6 billion
to prevent the fund from a total collapse--now granted, many
bankers and regulators consider this process to be one of the
great advances in finance over the past 5 years, however the
trouble, as Bear Stearns points out and shows that this system
may not be as crash-proof as we once thought.
How dependent has our system now become on hedge funds, for
example? Are these trades becoming more risky? Should more of
these funds begin to unravel? Who absorbs the losses and at
what costs to all who are involved?
What I'm really concerned about is that no one really
knows, including the funds' lenders, what its exotic portfolio
or risk mortgage derivatives is really worth.
And finally, as hedge funds are purchasing all sorts of
illiquid, hard-to-value assets, are we worried about or do we
even care to know what these assets are really worth, and are
we worried that hedge funds' managers are coming up with
suspicious valuations using financial models that aren't
necessarily based on what the assets would fetch in the open
market?
These are very serious questions. No decision has been made
whether we--and what type of regulation, but it is very, very
incumbent upon us to ask the serious, in-depth, clear, incise
questions when you look at the extraordinary economic impact
that hedge funds have in our investment community.
Thank you, Mr. Chairman. I yield back the balance of my
time.
The Chairman. I thank the gentleman.
As we proceed to the testimony, several of us have talked
about the international aspect. We have, I am pleased to
acknowledge, recognition of that because observing the hearing
is Duzana Vavrova, who is the administrator in the directorate
general on internal policies of the Committee on Economic and
Monetary Affairs of the European Parliament, presumably our
counterpart. So we welcome this.
Several of us have been meeting with our European
counterparts. Indeed, a delegation from this committee, members
and staff, bipartisan staff met in both London and Brussels
with EU and British regulators because of the importance of
this.
Secondly, I'm going to ask unanimous consent to introduce
into the record two items. First, an item which is related, not
specifically to hedge funds, but a very interesting and
sobering comment from Moody's Investors Service, a special
comment of July 2007 on rating private equity transactions
expressing some concerns about their ability to do that and
about the risks that are increasing.
And second, an article from yesterday's Financial Times by
Mohamed El-Erian, who runs the Harvard Firm, entitled, ``How to
Reduce Risk in the Financial System,'' expressing concern that
some of the investors in these funds are themselves regulated
by entities that are not up to the job of regulating
instruments of this degree of complexity. None of you here,
you're off the hook. But they are talking about some of the
buyers, and it relates to pension funds, insurance industry.
As we know, one of the things that this committee will be
looking at is the structure of the insurance industry because
uniquely in America you have this very important financial
industry, the insurance industry, particularly in the life side
but in general that's entirely State-regulated. And what that
means is to the extent that insurance companies are big players
here, and pension funds to a great extent, none of you have the
kind of supervisory role that you'll have over banks and other
counterparties.
And that is one of the issues that will deserve some
attention, so I ask that these two articles be put into the
record. There being no objection, they will be put in.
And we will begin our testimony, and we will begin with an
introduction. Our colleague from Connecticut, he's very busy
when we deal with hedge funds because half the time he's
introducing the people who run hedge funds, and live in his
district, and then the other half he's introducing the people
who regulate the hedge funds who live in his district.
So if we just--we could probably move the whole thing to
Greenwich and save a lot of travel time on witness fees. But
the gentleman from Connecticut is recognized.
Mr. Shays. Thank you, Mr. Chairman. I feel a little guilty,
because last time I didn't introduce this individual, and I did
introduce someone else, so I would like to welcome all our of
witnesses, but in particular, Under Secretary Robert Steel, who
hails from Connecticut's 4th District, and you nailed Greenwich
pretty well, Mr. Chairman.
The Under Secretary leads the Treasury Department's
activities with respect to the domestic financial system,
fiscal policy and operations, government assets and
liabilities, and related economic and financial matters. I have
appreciated the chance to get to know Secretary Steel, who has
extensive experience in the private sector as well as academia.
Bob Steel is straightforward, sharp, and someone whose
perspectives and recommendations I appreciate and respect a
great deal, and I welcome him.
The Chairman. Thank you. Mr. Steel, with that, why don't
you begin with you, and we'll down the list after that.
STATEMENT OF THE HONORABLE ROBERT K. STEEL, UNDER SECRETARY FOR
DOMESTIC FINANCE, U.S. DEPARTMENT OF THE TREASURY
Mr. Steel. Good morning, Chairman Frank, Ranking Member
Bachus, and members of the committee. It's a privilege to be
with you today. Thank you for holding this hearing and inviting
the Treasury Department to present our perspective on the
important topic of hedge funds and systemic risk.
Today I am representing both the Treasury Department and
more specifically, Secretary Paulson, in his capacity as the
Chairman of the President's Working Group on Financial Markets.
Fostering financial preparedness is part of the core mission of
the Treasury Department.
Under Secretary Paulson's leadership, the four members of
the President's Working Group, along with the Office of the
Comptroller of the Currency and the Federal Reserve Bank of New
York, have issued a call to action directing all market
participants to undertake efforts that mitigate the likelihood
and impact of a systemic risk event caused by private pools of
capital.
Private pools of capital, which include hedge funds as well
as private equity and venture capital funds, exemplify the
innovation that make our capital markets the strongest in the
world. These investment vehicles bring many benefits to our
markets, including liquidity, price discovery, and risk
dispersion. Yet the rapid growth in size and scope of private
pools of capital has brought challenges to our markets,
particularly in areas of investor protection, market integrity,
and the potential for systemic risk.
To address these challenges, the President's Working Group
released principles and guidelines for private pools of capital
in February. These ten principles and the clarifying guidelines
do not represent an endorsement of the status quo, but instead
reflects, we hope, the uniform view of all relevant regulators
that heightened vigilance is necessary and appropriate.
While it is not our current expectation, we should remain
vigilant to the possibility that significant losses by a highly
leveraged hedge fund could present systemic challenges to the
broader financial system. Therefore, the principles and
guidelines make a number of very specific suggestions for
improved vigilance in market discipline so as to mitigate
systemic risk.
Hedge funds' clientele, originally wealthy investors, has
shifted to become one that is comprised more of institutional
investors, in many cases representing individual investors who
may be less sophisticated. Investment fiduciaries, such as
pension funds, do have a responsibility to perform due
diligence to ensure that their investment decisions on behalf
of these beneficiaries and clients are prudent.
These principles also emphasize the responsibility of
managers to provide accurate and timely information so that
investors can make informed decisions. Additionally,
supervisors must work within the existing regulatory framework,
utilizing their broad anti-fraud and anti-manipulation
authority to address these issues of investor protection.
Our next step is to ensure that all four groups of the
market participants--the regulators and supervisors, the
counterparties, and the creditors, the actual managers of the
private pools of capital themselves, and the pool investors--
adopt and use these principles and guidelines. We are very
encouraged by the initial response, as much good progress is
currently underway.
Additionally, these principles and guidelines have been
very well received by policymakers, regulators, industry
leaders, and the general public, both in the United States and
overseas.
Regulators and supervisors are already involved in a range
of important initiatives. Supervisors are engaged in ongoing
reviews of creditors' and counterparties' practices. These
efforts are aimed at improving the sophistication of stress-
testing practice, counterparty credit risk management and over-
the-counter derivatives, structured credit, hedge funds, and
the post-trade processing infrastructure of the over-the-
counter derivatives market.
Consistent with my representation that we are not standing
still, just 2 weeks ago, Secretary Paulson announced that we,
at the President's Working Group, will work with the private
sector to develop and adopt industry best practices for both
investors and the asset managers of hedge funds.
The President's Working Group is facilitating the
establishment of two separate yet complementary private sector
groups, one comprised of hedge fund managers, and the other
comprised of hedge fund investors. These two groups will
develop best practices for their respective stakeholder groups
that address investor protection, enhanced market discipline,
and also help to mitigate systemic risk.
The President's Working Group will serve as an ongoing
facilitator for these groups. We are engaging a broad spectrum
of market participants to develop high quality best practices.
The nature of a competitive marketplace is such that when
leaders adopt best practices, others in the industry feel
pressure to do the same. All market participants must be
accountable to help ensure the integrity of our capital
markets.
While substantial progress has already been made, there is
still much work to be done. Building upon efforts to date, all
stakeholders must continue to do more. We look forward to the
development and implementation of coherent best practices for
the investors and hedge fund managers.
Our system works well when market participants recognize
the benefits, mitigate the risks, and choose to be diligent. We
look forward to a continued dialogue with this committee on
these important issues.
Thank you, sir, and I look forward to your questions.
[The prepared statement of Under Secretary Steel can be
found on page 61 of the appendix.]
The Chairman. Next we'll hear from Kevin Warsh, who is a
member of the Board of Governors of the Federal Reserve System.
STATEMENT OF THE HONORABLE KEVIN M. WARSH, MEMBER, BOARD OF
GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Mr. Warsh. Thank you very much, Chairman Frank, Ranking
Member Bachus, and other members of the committee here today. I
appreciate the opportunity to appear on behalf of the Board of
Governors of the Federal Reserve System to discuss the systemic
risk implications of hedge funds.
The Board believes that the increased scale and scope of
hedge funds has brought significant net benefits to financial
markets. Indeed, hedge funds, as many of you have mentioned in
your opening statements, have the potential to reduce systemic
risk by disbursing risks more broadly and by serving as a large
pool of opportunistic capital that can stabilize financial
markets in the event of disturbance.
At the same time, the recent growth of hedge funds presents
some formidable challenges to the achievement of key public
policy objectives, including significant risk management
challenges to market participants. Of course, if market
participants prove unwilling or unable to meet these
challenges, losses in the hedge fund sector could pose
significant risks to financial stability.
The Board believes that the principles and guidelines
regarding private pools of capital issued by the President's
Working Group on Financial Markets, just in February, provide a
sound framework for addressing these challenges associated with
hedge funds, including the subject of today's hearing, the
potential for systemic risk.
The Board shares the considered judgment of the PWG: The
most effective mechanism for limiting systemic risks from hedge
funds is market discipline. And the most important providers of
market discipline are the large global, commercial, and
investment banks that are their principal creditors and
counterparties.
This emphasis on market discipline neither endorses the
status quo nor implies a passive role for government. In recent
years, the global banks have significantly strengthened their
practices and procedures for managing risk exposures. But
further progress on this front is needed, in no small part
because of the increasing complexity of structured credit
products such as collateralized debt obligations.
The Board believes that even those banks with the most
sophisticated risk management practices must further strengthen
their enterprise-wide systems to put the PWG principles fully
into practice. As these principles rightly emphasize,
supervisors of global banks are responsible for promoting
market discipline by monitoring and evaluating banks'
management of their exposure to hedge funds.
As the umbrella supervisor of U.S. bank holding companies,
the Fed continues to pay keen attention to hedge fund exposures
and is working to ensure stronger risk management practices. In
addition, through the Reserve Bank of New York, the Fed is
actively facilitating collaboration and coordination among
domestic and international supervisors of these global banks
that are key counterparties and key creditors.
This area of significant focus targeting management of
exposure to hedge funds is part of a broader, comprehensive set
of supervisory initiatives that seeks to ensure that banks'
risk management practices and market infrastructures are
sufficiently robust to cope with stresses that may accompany a
deterioration in market conditions.
To this end, the Federal Reserve has been focusing on five
key supervisory initiatives: First, comprehensive review of
firms' stress-testing practices; second, a multilateral
supervisory assessment of the leading banks' current practices
for managing their exposures to hedge funds; third, a review of
the risks associated with the rapid growth of leveraged
lending; fourth, a new assessment of practices to manage
liquidity risk; and fifth, continued efforts to reduce risks
associated with weaknesses in the clearing and settlement of
credit derivatives and other over-the-counter derivatives.
Indeed, this committee should be assured that the Federal
Reserve has taken on these initiatives with great purpose and
resolve. The initiatives are fully consistent with the founding
purpose assigned to the Fed by Congress to help mitigate the
risks to the financial system and the broader economy caused by
periodic bouts of instability and financial stress.
Thank you again, Mr. Chairman. I'd be happy to respond to
your questions.
[The prepared statement of Governor Warsh can be found on
page 67 of the appendix.]
The Chairman. Next, Mr. Jim Overdahl, who is the Chief
Economist at the Commodity Futures Trading Commission. We
welcome you in your rare appearance away from the Agriculture
Committee here, where you really belong.
[Laughter]
STATEMENT OF JAMES A. OVERDAHL, CHIEF ECONOMIST, U.S. COMMODITY
FUTURES TRADING COMMISSION
Mr. Overdahl. Thank you, Mr. Chairman, Congressman Bachus,
and members of the committee. I am pleased to have this
opportunity to testify on behalf of the CFTC regarding hedge
funds and systemic risk.
The Chairman of the CFTC is a member of the President's
Working Group on Financial Markets, and he participated in the
deliberations that resulted in the agreement announced by the
PWG in February, setting out principles and guidelines
regarding private pools of capital, including hedge funds.
I will focus my remarks today on how hedge funds intersect
with the CFTC's responsibilities under its governing statute,
the Commodity Exchange Act, or CEA. At the outset, I should
emphasize that the CFTC does not regulate hedge funds per se.
However, the CFTC encounters hedge funds as it performs two of
its critical missions under the CEA--promoting market integrity
and protecting the public from fraud in the sale of futures and
commodity options.
Hedge funds are on the CFTC's market surveillance radar
when they trade in regulated futures and commodity options
markets regardless of whether their operators and advisors are
registered or not. With respect to investor protection, if a
collective investment vehicle such as hedge fund trades futures
or commodity options, the fund is a commodity pool, and its
operator and advisor may be required to register with the CFTC
and meet certain disclosure, reporting, and recordkeeping
requirements.
Futures markets serve an important role in our economy by
providing a means of transferring risk from those who do not
want it to those who are willing to accept it, for a price. In
order for businesses to hedge the risk they face in their day-
to-day commercial activities, they need to trade with someone
willing to accept the risk the hedger is trying to shed. Data
from the CFTC's larger trader reporting system are consistent
with the notion that hedge funds and other professionally
managed funds often are the ones absorbing the risks hedgers
are trying to shed.
Hedge funds also play a vital role in keeping the prices of
related futures contracts in proper alignment with one another.
In addition, hedge funds add to overall trading volume, which
contributes to the formation of liquid and well functioning
markets. Over the past decade, the average number of funds
participating in futures markets has grown across nearly all
market segments. Also it appears that funds, on average, hold
positions in more markets today than they did a decade ago.
One notable development over the past 5 years has been the
increased participation by hedge funds and other institutional
investors in futures markets for physical commodities. These
institutions have allocated a portion of the investment
portfolios they manage into commodity-linked investment
products. A significant portion of this investment finds its
way into futures markets, either through the direct
participation of those whose commodity investments are
benchmarked to a commodity index, or through the participation
of commodity index swap dealers who use futures markets to
hedge the risk associated with their dealing activities.
The CFTC relies on a program of market surveillance to
ensure that markets under CFTC jurisdiction are operating in an
open and competitive manner. The heart of the CFTC's market
surveillance program is its large trader reporting system. For
surveillance purposes, the larger trader reporting requirements
for hedge funds are the same as for any other larger trader. In
addition to regular market surveillance, the CFTC conducts an
aggressive enforcement program that deters would-be violators
by sending a clear message that improper conduct will not be
tolerated.
The financial distress of any large futures trader poses
potential risks to other futures market participants. With
respect to commodity pools operating as hedge funds, the CFTC
addresses these risks through its oversight of futures
clearinghouses and the clearing member firms of each
clearinghouse. This oversight regime is designed to ensure that
the financial distress of any single market participant,
whether or not that participant is a hedge fund, does not have
a disproportionate effect on the overall market. It is through
this oversight regime that the CFTC does its part in helping to
mitigate systemic risk.
In closing, the CFTC will remain vigilant in utilizing the
tools provided in the CEA: Market surveillance; disclosure;
reporting; recordkeeping; and enforcement authority, to fulfill
its statutory responsibilities as hedge fund participation in
futures markets continues to expand.
This concludes my remarks, and I look forward to your
questions.
[The prepared statement of Mr. Overdahl can be found on
page 42 of the appendix.]
The Chairman. Next, Dr. Erik Sirri, who is the Director of
the Division of Market Regulation at the SEC.
STATEMENT OF ERIK R. SIRRI, DIRECTOR, DIVISION OF MARKET
REGULATION, U.S. SECURITIES AND EXCHANGE COMMISSION
Mr. Sirri. Chairman Frank, Ranking Member Bachus, and
members of the committee, on behalf of the Securities and
Exchange Commission, I appreciate the opportunity to speak to
you today regarding recent initiatives being taken by the
Commission with respect to hedge funds.
As you know, the President's Working Group released
principles and guidelines regarding private pools of capital.
These principles complement and inform the regulatory and
supervisory work of each of the PWG agencies with respect to
investors, fiduciaries, creditors, and counterparties.
Even as the Commission believes that private pools of
capital such as hedge funds bring significant benefits to
financial markets, the Commission is also working diligently to
protect hedge fund investors and other market participants
against fraud, and to ameliorate, through its oversight of
internationally active securities firms, the broader systemic
risks such funds potential pose to our financial system.
The Commission's work in this area includes vigorous
enforcement activities related to the Federal securities laws,
the Commission's Consolidated Supervised Entity Program, and as
appropriate, regulatory improvement.
I will focus my oral remarks today on the oversight
function. At present the Commission supervises five securities
firms on a consolidated or groupwide basis. These include Bear
Stearns, Goldman Sachs, Lehman Brothers, Merrill Lynch, and
Morgan Stanley. These firms are known as the CSEs. For such
firms, the Commission oversees not only the registered broker-
dealer but also the consolidated entity; that is, the holding
company, which may include regulated entities, such as foreign-
registered broker-dealers and banks, as well as unregulated
entities, such as derivatives dealers and the holding company
itself.
The Commission's CSE program is designed to provide holding
company supervision in a manner that is broadly consistent with
the oversight provided to bank holding companies by the Federal
Reserve. The aim of this program is to diminish the likelihood
that weakness in the holding company itself or any of the
unregulated entities places a regulated entity, such as a bank
or a broker-dealer, or the broader financial system, at risk.
The CSEs are subject to a number of requirements under the
program, including monthly computation of a capital adequacy
measure consistent with the Basel II Standard, maintenance of
substantial amounts of liquidity at the holding company level,
and documentation of a comprehensive system of internal
controls that are subject to Commission inspection.
The primary concern of the CSE program with regard to hedge
funds revolves around the risks they potentially pose to CSE
firms specifically, and through CSEs to the financial system.
The Commission's CSE program monitors and assesses these
risks in several ways.
First, the Commission staff meets at least monthly with
senior risk managers at the CSEs to review market and credit
risk exposures, including those to hedge funds. The process
provides information not only concerning the potential risk to
CSEs, but also a broader window into the relationship with
hedge funds, and those hedge funds' potential impact on the
broader financial markets.
Second, Commission staff has recently engaged in targeted
discussions with the CSEs about the challenges of measuring
credit exposures to hedge funds.
And finally, the Commission's staff has embarked on a joint
project with the Federal Reserve and the UK's Financial
Services Authority to understand current in Street practices of
banks and broker-dealers in managing their exposures to hedge
funds. The agencies have identified a number of issues related
to the extension of credit to hedge funds and are now
addressing those issues in a second phase which entails more
detailed work by the principal regulator of each firm.
Taken together, these efforts allow us to identify some
trends that we and our supervisory colleagues, as well as the
risk managers at the large banks and securities firms, will
follow more closely. The demise of Amaranth and the issues
associated with the Bear Stearns managed hedge funds also
provide some interesting datapoints to consider.
First, some of the largest and most systemically important
hedge funds are beginning to look more and more like mature
financial institutions, diversifying their portfolios beyond
leveraged equity and fixed-income strategies, and diversifying
beyond their activities in proprietary trading.
Second, hedge funds generally have become more
sophisticated about risk management, in part by negotiating
more flexible credit terms with dealer banks.
Third, in some markets, hedge funds are the major providers
of liquidity. The impact that the Bear Stearns' hedge funds
losses is having on the subprime market illustrates this point.
Finally, leverage can be achieved in a myriad of ways. The
ability to engineer economic leverage through structured
products is almost infinite, and that can be seen in the CDO
markets.
The supervisory focus on excessive leverage, we believe, is
the right one. It is far from simple in today's innovative
financial markets. While these trends will continue to
challenge the regulated institutions and their supervisors, the
focus in recent years on counterparty credit risk management
has clearly been good for financial institutions and the
financial system as a whole.
After the failure of long-term capital management in 1998,
the Counterparty Risk Management Policy Group brought together
senior policy managers from the major commercial and investment
banks--excuse me, senior risk managers--to consider the lessons
of that event. The report addressed systemic risk concerns by
articulating best practices in counterparty risk management
appropriate to such regulated entities such as banks and
securities firms.
The Counterparty Risk Management Policy Group also issued a
second report in July of 2005 that dealt with developments
since the initial report, including the proliferation of
products with embedded leverage and securitization. More work
remains to be done in these areas, and we must not in fact
become complacent here.
In conclusion there is no guarantee that the favorable
conditions that allowed for the orderly unwinding of Amaranth,
and thus far Bear Stearns managed hedge funds will persist. We
must assume, in fact, that they will not. The supervisory
community must continue to engage with systemically important
banks and securities firms and encourage additional efforts to
expand their risk management capabilities.
We will continue to work with our PWG colleagues and other
market participants, hopefully including some of the larger
hedge funds, to further this agenda.
I thank you for the opportunity to testify today, and I'd
be happy to take any of your questions.
[The prepared statement of Mr. Sirri can be found on page
49 of the appendix.]
The Chairman. Thank you. I'm going to begin with a very
specific question. It would be aimed to probably the SEC. When
we had the hedge fund managers, a panel of them before us, one
issue that came up was that they noted that many of them are
already required to register with somebody or another. Ms.
Robinal mentioned many of them do that.
One suggestion that somebody made, I forget who, but they
all seemed to agree with was this: There is a potential for
insider trading here because of the kind of integrated degree
of activity. There was a proposed suggestion that all of them
agreed to that over and above any other form of regulation or
registration, there be a document retention requirement so that
if allegations came up of inappropriate practices, that could
be done.
You mentioned, Dr. Sirri, that you're working on
enforcement. What would your response be to a document
retention requirement for those entities that did not otherwise
have one because they were required to register for some other
reason?
Mr. Sirri. Well, I think it's important to consider the
Commission's authority over hedge funds. You quite correctly
make the distinction that there are two groups of hedge funds.
There are those that are registered--there are about 2,000 of
those--and then there are those that are unregistered.
But it's important to realize that with respect to either
of those, the Commission maintains anti-fraud authority--
The Chairman. Well, I understand that. But what some people
suggested was that the ones that are unregistered don't have a
document retention requirement. And the suggestion was simply
to give a document retention requirement to those so that was
there if you needed enforcement.
Mr. Sirri. Sure. And on the registered end, books and
records requirements are in place. For the unregistered
entities, we would have no authority to require that. That may
be--
The Chairman. Well, I understand that. But you're not
before a court now. You're before the Congress. We make the
laws, sometimes. Sometimes we don't. My question to you, I'm
sorry if it wasn't clearer, is what would you think about our
passing a law that would enhance your authority to require
document retention among the unregistered?
Mr. Sirri. I think we'd have to be very careful of the
tradeoff there. The potential benefit of something like that
has to do with fraud in the markets and the example that you
gave. The potential cost of something like that is to cause
those hedge funds to leave the United States and perhaps locate
overseas.
The Chairman. But I will say, none of them raised that when
we asked them. They all--or maybe we had an unusually quiescent
group. I don't think we tried to find that.
Let me just ask you, with regard to registration, Mr.
Overdahl, you mentioned that some are registered with you. Now
you say 2,000 are registered with the SEC. Are there funds that
register with the CFTC that don't register with the SEC?
Mr. Overdahl. We do not register funds per se. We register
advisors and operators.
The Chairman. Right.
Mr. Overdahl. And there will often times be overlap
between--
The Chairman. Are there some that register with you,
though, that don't have to register with the SEC?
Mr. Overdahl. Absolutely. There are some funds or operators
of funds that are operating pools that are exclusively futures
pools that will be registered with us as opposed to the SEC.
The Chairman. Is that at all a problem that jurisdiction,
should you share information about them? How does that work? We
have entities that many of us would think are doing very
similar things, and some of them aren't registered at all, and
some are registered with the SEC, and some are registered with
the CFTC. My sense is that was due to nobody's plan, but that
just was a result of other decisions. Is that something we
ought to be trying to rationalize? Let me ask Mr. Steel, what's
your sense of how that breaks out? In terms of the split
between those that register at the CFTC, those that register at
the SEC, and those that aren't registered--is that a rational
distribution now, do you believe?
Mr. Steel. No. I think that consistent with things that
we've talked about at Treasury, this has developed in a
patchwork basis, and there isn't an overarching strategy, that
people have chosen a regulator or chosen not to be regulated,
and that's the reality of the situation today.
The Chairman. Should we change that if we could work
together on a collaborative way to do that?
Mr. Steel. Well, I think that there's no question. Just a
week or two ago, Secretary Paulson announced that one of the
goals he had was to look at this on a holistic basis, and I
would think that as part of that examination, with the goal of
writing a blueprint of what regulations should look like--
The Chairman. Very good.
Mr. Steel.--that this would be part of that.
The Chairman. Well, I appreciate it. So in other words,
when we talk about the regulation, which includes banking and
other things, I think that's--I mean, whatever one thinks about
what degree of registration or whether there should be or
shouldn't be, it ought to be the result of conscious decisions
by people, not just random.
Let me say in closing, and I understand we're not rushing
to register and regulate, but regulation shouldn't be a bad
word. As we look at the subprime crisis, it strikes me that
there are two groups of entities that have made loans to people
in the subprime category: regulated entities, i.e., depository
institutions regulated by the banks; and unregulated entities,
brokers and others, who are subject to no such regulation.
I think it's fairly clear. If only regulated entities had
made subprime loans, we wouldn't have a crisis. The
overwhelming number of loans that have caused problems were
made by unregulated entities. And it does seem to me an
argument for the sensible kind of regulation that I believe we
have with regard to depository institutions. So I would hope
that people would not automatically assume that regulation has
to be a bad thing. If we would have had more regulation of
lenders in the subprime area, we would have had less of a
subprime crisis.
The gentleman from Alabama.
Mr. Bachus. Thank you, Mr. Chairman. Mr. Chairman, first
I'd like to acknowledge our former staff director of the
committee, Bob Foster. Bob, if you'd stand up, we welcome you
back to the committee. You did a very professional job here,
and I think you will do the same at the Treasury Department.
The Chairman. You haven't mentioned his new position. You
just had him stand up. You didn't mention his new job.
Mr. Bachus. He is--Under Secretary Steel, is he--
Mr. Steel. He's working in Legislative Affairs as a Deputy
Assistant Secretary, and we welcome him to Treasury with his
good wisdom.
Mr. Bachus. Thank you.
The Chairman. And he comes with a due respect for
congressional prerogative.
[Laughter]
Mr. Bachus. Or disrespect. Let me start by saying, I don't
think anyone on the Republican side discounts the existence of
risk. In fact, you know, risk is inherent in the market and
probably--the markets, so there's a high degree of risk in the
markets at this time. I think the President's Working Group has
acknowledged that some of these sophisticated investments,
although they diminish risk in many respects, there is the
potential for systemic risk.
I think what many of us, Mr. Hensarling and I particularly
discussed in our opening statements, what we discount is the
ability of Congress to intervene constructively at this point.
In other words, as the chairman said, pass a law.
I'm not sure that that--I don't see that bringing stability
to the market. In fact, especially some calls recently to
increase taxation on capital, I don't in any way see how that
could bring stability or have a positive effect on the market.
So, in fact, I see them having a very detrimental effect at
this particular time.
Some of the members in their opening statements also
mentioned transparency and disclosure. You know, we talk about
those terms almost as ``mom'' and ``apple pie.''
But--Secretary Steel, you made a speech to the Manhattan
Institute when you talked about one potential problem with
further regulation, and that's that investors begin to take
comfort in, you know, the--almost like a stamp of approval. The
government is regulating these. Would you like to comment on
that?
And before you do, Dr. Sirri pointed out something else.
Yes, you know, we could require or regulators could require
more disclosure, more transparency, but, you know, we run into
two things, two problems there that I see. One is that a lot of
this is proprietary. These are proprietary methods. There are
strategies that they engage in, and I'm not sure that would not
have a chilling effect, and I'm not sure even some
constitutional limitations we may have on asking people to give
out their proprietary--you know, their actually property right.
But as Dr. Sirri pointed out, they have an option to
disclose. They have an option to paying greater taxes, and that
option is taking that capital to China or India or South
America or offshore. And I can tell you, if anything that I do
believe this morning, withdrawing capital out of the United
States, I do know that would have a destabilizing effect on our
economy and our market, and just the last thing we need at this
time is taxation or regulation that would cause a flight of
capital out of the United States.
So with that, let me ask Secretary Steel, would you comment
again on your remarks at the Manhattan Institute, which I
believe are very valid?
Mr. Steel. I think if I could frame this through the lens,
as you said, of the important issues of transparency and
disclosure, and then I think you asked me to comment further on
the issue of moral hazard, I think that you're correct.
Transparency and disclosure are important issues, but I would
want to frame it with to whom and for what end.
Basically, we believe the key aspects of transparency and
disclosure in the President's Working Group, that we've tried
to codify in the principles and guidelines, really relate to
two specific areas--very good transparency and disclosure from
the fund manager to the regulated entities that are providing
the capital and loaning them money, and the disclosure there
should be quite good. In our guidelines, we've written about
this and tried to give very specific examples of the type of
transparency and disclosure that's appropriate. And if you
don't have that type of very, very high transparency and
disclosure, it should be reflected in margin and the terms of
credit. And that should be the Governor on that issue to
provide the protection, the best protection that we could, for
mitigation of systemic risk.
The second key issue of disclosure really is between the
investor and the fund manager. And once again, in our
guidelines and principles, we tried to give very specific
examples of what one should expect so as to invest. And
hopefully raising that standard, and we intend to raise the
standard further with specificity with the committees that I
described, then we think that's the key issues of disclosure
and transparency.
With regard to the more specific issue about the talk that
I made on moral hazard, I think there's a clear issue. These
are investments of a certain type. They're less liquid. They're
private partnerships, and they're different than buying and
selling a security that offers instant liquidity. And so there
are very specific requirements for investors to meet which the
SEC has outlined historically and is now in the process of
adjusting.
And, therefore, the idea that approval or regulation or
registration provides a comfort, it would be a false comfort
that might not--has the potential to be a false comfort--that
does not recognize the distinct characteristics of the private
pools of capital.
Mr. Bachus. And Governor Warsh, both you and Secretary
Steel have talked about that you all have made recommendations,
principles which you have asked all the stakeholders to put
into practice. How do you assure that they do this? How do you
assure that they do move towards market discipline?
Mr. Warsh. Thank you. I would say that one thing that is
certain, which is by virtue of the oversight that this
committee and others can bring to bear, by virtue of the
discussions that Under Secretary Steel and I have, is that
there is a laser-like focus in the markets on trying to ensure
that all of the stakeholders around hedge funds really need to
continue the progress that has been made in recent years on
subjects of due diligence and valuation, and making sure that
stakeholder community is fully vested and fully understands
what is going on.
This is, I think, an important opportunity for them to step
up to the challenge put before them by the principles outlined
by the President's Working Group.
Moreover, I would say for these hedge funds, the group that
has the most skin in the game--the most responsibility, the
most focus on ensuring that they have the right collateral--are
these very counterparties and creditors that we're talking
about. They are the life blood for hedge funds, maybe equal to
importance of the investors themselves.
And when we talk about market discipline, we say that they
really need to make sure that they're putting their money where
their mouth is, and we are very encouraged by the discussions
that have commenced that they're going to adopt these
principles and put them into action. And, obviously, those of
us here at the table will do our best to make sure of that.
Mr. Bachus. You know, when you have somebody who is both a
creditor and investor and a counterparty at the same time, it
does become very difficult to do that. But I would like to
commend all of you. I believe that you are very active on the
job. You appreciate the danger that you are working with the
stakeholders and market participants, and I commend you for
what you've done.
Mr. Kanjorski. [presiding] Thank you, Mr. Bachus. In the
absence of our chairman, I will take my questioning period now,
if I can.
I am really interested more in the process of what the
Working Group represents and whether or not they have created
certain authorities and where these authorities, whatever
authority that they use, emanate from. One of the important
questions that I have raised up here on the Hill is that so
often now, we fail to provide legislative leadership as to
where we should go: We hold a hearing such as this one where we
invite up a working group about which I am not at all sure.
Maybe I will ask: Who wants to represent the role of chairman
here? Where do you come from? I mean, can you name your
parents? Does anybody want to answer? You know, it is a simple
question, and it is an honest question.
Mr. Steel. Let me start, sir, and I'll invite my colleagues
to comment. The establishment of the President's Working Group
in 1988 was born out of an issue which was basically
understanding and learning from the market dislocation of 1987.
Mr. Kanjorski. Right.
Mr. Steel. And President Reagan had the idea that you
needed to have this multi-headed group look at these issues,
because they crossed borders, crossed markets, and crossed
different jurisdictions, and that was the idea.
And in my brief period, I think that this is the
appropriate way to consider them, and Secretary Paulson has
convened the President's Working Group actively and with all of
the principals of the President's Working Group in, as Governor
Warsh said, in a laser-like way, to use his word, focused on
these issues. And so the idea of financial preparedness, which
really is the link-up to systemic risk, has been the focus, one
of the key focuses of the President's Working Group.
Mr. Kanjorski. Obviously, the Working Group is a continuing
body. As I understand, it emanates from a former White House
executive order in 1988. Has that order been enlarged upon or
drafted subsequent to 1988 to include more authority?
Mr. Steel. Not that I know of. But I would comment that the
Secretary doesn't view our lens on these issues as being
limited or circumscribed--needing any additional scope or
aperture.
Mr. Kanjorski. Now, under normal circumstances, I would
agree with you. But, now you are really propounding regulations
or guidelines. I think you call them guidelines. That is very
interesting. They are not legislatively constructed guidelines.
They are from the Working Group.
Mr. Steel. Yes, sir.
Mr. Kanjorski. And, of course, they come out of the Working
Group's office downtown?
Mr. Steel. They come--Treasury is the convener, as I said.
Mr. Kanjorski. I was being facetious. If I try to locate
the Working Group's office, where would I go?
Mr. Steel. You can call mine, I guess. But the Secretary of
the Treasury is the convener.
Mr. Kanjorski. I understand, and as an initial study group,
it worked well. But why have you not all felt that perhaps
there was a time since 1988--that is 19 years ago--to come to
the Congress to get some legitimate legislative authority to
pursue formal activity? If you really analyze what you're
doing, your whole sense of controlling or influencing industry
and the participants is the threat of your capacity to
regulate. That is a pretty dangerous way of operating within
our system.
You call in the people that you regulate, and you say we
are going to construct guidelines for you. We have no
legislative authority to do that. There is no law allowing us
to do that, just an executive order. But, we anticipate that
you are going to participate and follow those guidelines.
You don't seem to ask why, and I'm just asking the question
now: Why would they follow your guidelines? Other than the fact
that they have the fear of God that if they do not, they have
four massive regulators that are going to come down on them in
some way? Is that a good principle to get things done?
The other area I wanted to ask you about is who is your
counterparty in the Legislative Branch of Government? Who do
you talk to up here on the Hill?
Mr. Steel. Well, the other regulators or people--members
can speak for themselves, but from the Treasury Department,
we're in constant communication and regular communication with
the leadership on the Hill and describing what we're doing
both, as I said when I began, I appear here today as a
representative of the Treasury Department and also Secretary
Paulson as Chairman of the President's Working Group.
And so the regular dialogue that the Secretary has with
leaders in Congress includes that same duality of
responsibility. And I can comment from having been in meetings
that both of those perspectives are discussed and considered.
Mr. Kanjorski. I just want to break into that response
because of a side question that I had. There is a rule in this
Administration that no group or representative of the
Administration comes to the Congress and makes a speech without
having their remarks vetted by the Office of Management and
Budget. Mr. Steel, were your remarks vetted today by the Office
of Management and Budget?
Mr. Steel. Not that I'm aware of, sir.
Mr. Kanjorski. Was anybody else's here?
Mr. Warsh. No, sir.
Mr. Kanjorski. So you have no vetting responsibility any
more in this Administration? I mean, that is great if you do
not. But I understood that you just don't make--
Mr. Steel. Testimony is run by our colleagues and
counterparts in other offices.
Mr. Kanjorski. Who do you vet with?
Mr. Steel. Within Treasury and discuss with other people.
Mr. Kanjorski. Who were those other people?
Mr. Steel. In Treasury, different divisions and different
parts.
Mr. Kanjorski. In Treasury? Nobody outside of the
Department?
Mr. Steel. Well, we would also discuss with people at the
NEC and other areas where we work on economic issues
continually. I think the idea of having a flat organization and
getting the benefit of other people's perspective, but the idea
of vetting, which was your choice of words, would not describe
the situation at all.
Mr. Kanjorski. Do you vet your material with these other
agencies, like your speech?
Mr. Steel. Vet with? With these--my colleagues here?
Mr. Kanjorski. No. I mean, with the other agency. You
mentioned the National Economic Council?
Mr. Steel. They--we shared our perspective with them and
have the benefit of ongoing discussions on economic policy
continually.
Mr. Kanjorski. You have on occasion, as a Working Group,
sent material to the Congress to consider for legislation, have
you not?
Mr. Steel. Not that I'm aware of.
Mr. Kanjorski. Nothing over the 20 years that you've sent
up?
Mr. Steel. Not that I'm aware of.
Mr. Kanjorski. It has never dawned on anyone that it may be
wise to codify guidelines that are going to be worked with?
Mr. Bachus. Would the chairman yield?
Mr. Kanjorski. Oh, surely.
Mr. Bachus. Actually, I think the President's Working
Group, after Long Term Capital and 9/11, submitted requests to
Congress. That's my recollection, but--
Mr. Warsh. Congressman, at the request of Congress, as you
know, the President's Working Group as its constituent members,
have responded to questions and queries that have come up.
We've certainly provided technical assistance. I think the
point worth reiterating is that none of us, at least speaking
on behalf of the Federal Reserve, cede any of the authorities
which Congress has granted to us, to members of the PWG. That
is, the PWG has consulted--
Mr. Kanjorski. Do not call it that. It so disturbs me to
have those initials used. Call it the President's Working
Group. I hate the initials in Washington. It really
illegitimizes your organization, if you know what I mean.
Mr. Warsh. So the point I was trying to make, Congressman,
only is that each of us have authority. Certainly the Federal
Reserve has authorities granted to us by Congress. We're
overseen by this committee in the House.
Mr. Kanjorski. No, but you understand why I am getting a
little disturbed here. I heard in earlier testimony that you
are creating two more working groups. You are having babies. A
new generation is being born here, and I am trying to figure
out when your marriage was held. Where do you think you have
the right to form other groups that will exist out there
interminably and be exercising leadership by virtue of the
coerciveness of regulation?
I mean, does that not disturb anybody at the table?
Mr. Steel. I'll try to describe it, sir, in a way that's
not disturbing, but I view it as encouraging. And basically,
what we're trying to do, as we've described in the guidelines
and principles, is to get people together to share the very
best practices--
Mr. Kanjorski. Admirable.
Mr. Steel. Excuse me.
Mr. Kanjorski. I do not disagree with that, Mr. Steel. I am
saying that what it is a sort of ethereal structure.
Mr. Steel. Excuse me?
Mr. Kanjorski. There is no body to it. There is nothing we
can identify, you know, who is leading it and what rights it
has. We do not know how big you are. We do not know how many
people you have. You probably have the combined number of
employees that exist in every one of your respective
organizations and other people that you can get to participate
in government. You start to become a very large umbrella
operation, and probably find little need to go through the
legislative process.
And then finally, one of the questions I am asking is: What
do we have as a countervailing weight to you up here in the
Legislative Branch of Government? You know, if I want to get
tremendous expertise, I do not have the Congress Working Group
filled with experts of huge abilities. They are not around. How
many people do we have, Mr. Chairman, on the committee? We have
eight people.
The Chairman. Seventy.
Mr. Kanjorski. Seventy on the full committee, but in terms
of securities staff and things like this, what do we have,
eight or ten people? But you have literally hundreds or
thousands, and yet I thought under our structure we are
supposed to be creating and passing the laws that implement
you, that give you the authorities you will exercise. I am
going to try and find your address downtown so that I can
either come down and meet with you there at the President's
Working Group headquarters, wherever that may be.
Mr. Chairman.
The Chairman. The gentleman from Louisiana, Mr. Baker.
Mr. Baker. Thank you, Mr. Chairman. Dr. Sirri, I don't have
a question, just an observation. In reading over your rather
distinguished resume, I noted your expertise in extra-planetary
exploration, and at first wondered how someone with that
suitability would be a hedge fund expert. But then when I
started thinking about it, anybody who could talk about the
details of exploration of Pluto probably has a pretty good
grasp of what's going on in a hedge fund. So, I welcome you to
the hearing with that acknowledgement.
Mr. Sirri. Thank you.
Mr. Baker. Mr. Overdahl, I was curious. In looking at the
1999 President's Working Group report, there was a
recommendation relative to CPO filings. What is the Commodity
Pool Operator filings? Can you tell me what the current
frequency of reporting is today? Is it still annual, or is it
quarterly?
Mr. Overdahl. I'll have to get back to you on that.
Mr. Baker. Well, my reason for asking is it was annual. The
report suggested that they at least move to quarterly, and the
reason for that suggested modification was to provide
additional transparency to market participants.
Mr. Overdahl. Right.
Mr. Baker. That brings to the fore my generalized
observation about this problem. We can't really describe who it
is that we would like to subject to whatever regulatory regime,
be it self-regulation or government regulation, who should
report. We don't know what it is they should report if we could
identify who they are.
But the most troubling aspect of it all is the frequency of
reporting is so insufficient in light of the trading
strategies, that all you would be able to do is get the license
tag number of the truck that just ran over you. You wouldn't
really get anything that could be instructive before the
untoward event were to occur.
That all leads me to wonder if we couldn't have some set of
triggering devices. For example, those commodity pool operators
have some set of requirements which they must report to you.
But not all hedge funds are registered CPOs. So you have people
outside your regulatory regime, and not all CPOs are hedge
funds. So we seem to have some regulatory arbitrage that would
lead a smart business practitioner to figure out where the
radar is weakest, and that's where I make my border crossing.
If, on the other hand, we had a multi-regulatory team agree
that under certain triggering circumstances--and Mr. Steel, I'm
going to jump to you after I hear Mr. Overdahl's response--if
under certain circumstances, for example, high concentration in
one economic activity, subprime lending, where it represents
some agreed-upon percentage of business activity that would be
generally viewed as aberrant.
In bank terms, we have limits on loans to one borrower. As
a, for example, parallel, where that individual firm is engaged
in a counterparty relationship where the counterparties from a
regulatory perspective might not be as strong financially as we
would like, where that fund has an excessive investment from
certain protected classes; for example, a high degree of
reliance on pension fund monies, where that fund has changed
its profile within a certain period of time from its routine
practice.
Now, all of that said, those are parameters you all should
decide. But under those circumstances, what would be wrong when
we identify that kind of aberrant actor from making a nonpublic
disclosure to the appropriate Federal regulator for the purpose
solely of insulating as best we can from a systemic risk shock?
Do you have a view? Well, either one.
Mr. Overdahl. The way we've handled that at the CFTC, that
is a delegated responsibility of the National Futures
Association. My understanding is that these are annual
disclosures. And beyond that, we do see the operators of the
pools, when they're operating within our markets through our
large trader reporting system, and that's going to be there
whether they're registered, whether they're filing reports or
not. And that's going to be true with--
Mr. Baker. Well, because my time is about to expire, and I
apologize for curtailing it. But I'm just saying a certain set
of factors that would lead one to identify a fund practice as
perhaps aberrant with market practice, shouldn't those folks be
subject to some sort of required disclosure in that event? Mr.
Steel?
Mr. Steel. I agree with you completely that the issue of
transparency to the funding so as to understand these types of
challenges is exactly a good question. I think that the way
we've thought about this is I'm going to defer to Governor
Warsh, who can describe to you how they're convening all of the
regulators to talk about best practices and sharing expertise
to exactly accomplish what you're describing.
Mr. Warsh. Congressman Baker, as you know, these are issues
that cross agency lines. What we've tried to do is to really
have a supervisory review that does the same. Working with the
SEC, the OCC and others, domestically and internationally, we
at the Federal Reserve have tried to track what these risks are
and to compare best practices.
Mr. Baker. Well, it is possible, depending on the funding
source, where a fund could be fairly large and not be subject
to anybody's direct regulation at the table?
Mr. Warsh. Absolutely. I think--
Mr. Baker. Or even reporting? I hate to say ``regulation.''
I'm just talking about a private reporting regime so you can
act on our social benefit behalf.
Mr. Warsh. As you and others have rightly pointed out, the
regime of regulating hedge funds, for example, within the
borders of the United States, is a difficult exercise. This
capital is remarkably nimble, and as a result, we're finding
ourselves increasingly working with our counterparts overseas
to accomplish many of those same objectives.
I think the principles set out by the President's Working
Group have been echoed in substantial respects by many of those
regulators, so I have some degree of confidence that progress
is being made across these jurisdictional lines.
The Chairman. Thank you. Let me just announce, we have
votes in 15 minutes, so I'll ask the indulgence of the panel.
We will have Ms. Waters' questions, and we will then adjourn to
vote. We should be back in less than 40 minutes from the
voting, and the committee will resume as soon as the people
have gotten a chance to vote on the fourth vote.
The gentlewoman from California.
Ms. Waters. Thank you very much, Mr. Chairman, and I'd like
to thank the members of the President's Working Group for being
here today. I am focused on what has happened in the subprime
market. And I'm very much aware of the foreclosures that are
devastating communities across this country. I've been in
communities and cities such as Cleveland, Ohio, and now in
Atlanta, and other places where whole blocks are boarded up.
You know, people are losing their homes, and we all know why.
We know that they were offered exotic products that they could
not afford.
And what we did not know and what we did not understand was
Wall Street's role in these loans that were being extended and
afforded to people, many of whom certainly could not repay
them. We are learning about products such as no verification of
income, of course, the interest only, and on and on and on.
My question is--well, and also understanding and knowing
Bear Stearns' exposure to the subprime loans recently required
the firm to bail out two of its hedge funds. Bear Stearns put
up $3.2 billion to rescue the two funds. What can you tell me
about other hedge funds that might be in trouble because of
exposure to subprime loans? And can we expect, as some are
predicting, a collapse in the financial markets as a result of
the subprime crisis? And recent loan performance in the
subprime market appears to support the premise that the crisis
certainly is not over, particularly with huge numbers of
adjustable rate mortgages setting as we speak here today.
Again, what do you know about this and other hedge funds
that may be in trouble? Why didn't you see this coming? And how
are we going to correct this?
Mr. Sirri. Congresswoman, the question about hedge funds
and what we know about hedge funds, let me address that first,
because your question raised many issues. With regard to--and I
don't want to focus too much on any one event such as Bear
Stearns. But let me explain to you a bit about the funding
situation there.
You raised the point about $3 billion being used to bail
out the funds managed by Bear Stearns. The way that funding is
done is on a secured basis, by which I mean funds are lent
against actual securities themselves. So in that sense, capital
was provided to support that fund, so it was actually only to
one of the two Bear Stearns funds as far as we know, and we
think that number was a little less than $3 billion. We think
it was slightly over $1 billion at the point.
But moving beyond to the general point of your question,
how would we know whether more of this is coming, our main
window--and some of the other questioners asked questions that
were related to this--our main window into this is indirect.
It's through the providers of capital into the financial
systems. The regulated banks and the regulated securities firms
are the primary providers of capital to hedge funds, who in
turn purchase securities or instruments linked to subprime
mortgages.
When we go in to inspect those providers of capital, in the
case of the SEC, we're going to look at prime brokers, the Bear
Stearns, the Morgan Stanleys and such, we look very carefully
at their practices for funding those instruments. We look at
their ability to manage those risks. We look at the valuation
practices that they have.
We look at all of those things holistically and make sure,
as best we can, that they are not impairing the financial
health of the regulated entity itself or of the holding
company. In that sense, by doing that, we believe that we're
appropriately minimizing the risk and managing the risk that a
failure of a large, systemically important firm, such as big
investment bank, would in fact bring risk to the financial
system.
Ms. Waters. Would anyone else like to comment?
Mr. Warsh. Thank you, Congresswoman. Let me speak
principally on the subject of the financial markets, which I
think you raised. Certainly the tumult that you've described
and that is no doubt happening, particularly in certain
communities, is very real and is generating very real losses in
the financial markets.
From the Federal Reserve's perspective, I think our overall
view is that there are certainly concerns that we might not be
at the bottom of this tumult. But these losses don't appear to
be raising, to this point, systemic risk issues. That in no way
would suggest that the very real problems that some of your
constituents and others are having aren't real. And, obviously,
the Federal Reserve, working with other regulators, is doing
its best to try to address those issues.
But the financial markets are certainly repricing risk in
this environment in the housing markets and more broadly. The
losses that have been felt by hedge funds and other financial
intermediaries are certainly forcing them to go back to first
principles, revisit their exposures. And what we're trying to
do in our supervisory capacity is ensure that they still have
adequate cushions, that they still have sufficient capital so
that they can operate robustly in these markets. From the
perspective of the institutions we oversee, we don't see any
immediate systemic risk issues that are brought to bear.
Ms. Waters. Thank you very much, Mr. Chairman. I yield back
the balance of my time.
The Chairman. We'll recess and return in 35 minutes or so,
as quickly as we can. I thank the panel.
[Recess]
The Chairman. The hearing will reconvene. That means the
two people over there talking will please take seats. Sorry
that we are late, but I do not want to inflict any more time
constraints. Let's get those doors closed, please.
And in a very easy choice, I now recognize the gentleman
from Delaware.
Mr. Castle. Thank you, Mr. Chairman. I am glad to be an
easy choice.
Dr. Sirri, I think this question should be addressed to
you. In just reading Business Week in the last week or two, the
magazine, there are all kinds of questions about hedge funds,
etc. One of the ones that caught my attention was in the last
couple of weeks. It says, ``The Street's Next Big Scandal,''
and it goes on to talk about traders and hedge funds colluding
to profit from privileged information. I will not go into a lot
of details on this, you can sort of figure out where it is
going.
They believe, this particular author believes, that the
next big scandal will most likely involve brokerage activities
and proprietary trading which long ago surpassed investment
banking to become Wall Street's chief profit center, that is,
trading on their own accounts in a variety of ways.
At the heart of the new collusion is the practice of
frontrunning, essentially trading ahead of big buy and sell
orders to profit unfairly from the resulting ups and downs in
prices. The concern is that prime brokers are not only tipping
off their own traders about big mutual fund orders on deck, but
also giving the heads up to their hedge fund clients. The
banks' rewards are two-fold, etc., as you can imagine profits
on commissions and profits on the trades.
Meanwhile, mutual funds unwittingly subsidize this scheme
by buying stocks at higher prices or selling at lower ones than
they otherwise would. It's a slippery, slimy slope, lamented a
mutual fund manager, adding that all these leaks make pure
beating returns harder to achieve.
And then it says, ``Regulators have been slow to crack down
on what has quickly become an open secret. The U.S. Attorney's
Office and the SEC have accused brokers from various companies
of allowing clients to listen into their internal speaker
systems.'' A series of things.
I mean the probably--I share very much what the chairman
said, and what the ranking member said, and that is, it is hard
for us to get our arms around exactly what the problems with
hedge funds may be. But I know one thing. When you get a big
money operation like this, people are trying to make money on
it and, obviously, if brokers can take advantage of this, they
may do that. There is just a lot of things we have to do.
And again, like the chairman, and the ranking member, and
all of you, to a degree, I am not sure what we should be doing.
I do not want to over-regulate. I happen to believe that there
is tremendous equity advantage in hedge funds and private
equity capital in terms of our markets and I think, frankly,
all of you do a good job.
It is just that this is sort of new to everybody. And I am
going to get into pension funds here in a moment, but I am
concerned about those allegations. And I am concerned about
what we are doing that might prevent that from happening in the
future without really judging whether it is really happening
now or not and what perhaps, if anything, the SEC is doing in
that particular area of this whole business of collusion and
people just simply take advantage of information and knowledge.
Mr. Sirri. Sure. Let me address that question. First let me
say it is a very important question. It is one that runs to the
heart of the SEC's mission of providing fair capital markets
and investor protection. So there are two things that you put
together that at times I think make sense in this context.
One is the behavior of a broker dealer protecting customer
information and the other is, as you pointed out, the
concentration of wealth and hedge funds and the fact that they
are large entities that, that like they are big clients of the
brokers.
We should be very clear about one thing. The broker dealers
have an obligation to protect the proprietary nature of
customer's order flow. To not do so would violate the
securities laws.
Regardless of whether it is a single entity that is a
person who is being tipped or a large hedge fund that is being
tipped, the broker dealer must protect the confidential nature
of that order flow and not leak it out to people for their own
benefit or for the benefit of their clients. That is a
violation of the securities' law. We have adequate authority to
go after that. And, as you have noted, we have gone after such
behavior. We have brought cases out in that way.
With regard to what you specifically mentioned with hedge
funds having access to such things, our Office of Compliance,
Inspections, and Examinations, has actually publicly said that
we are looking exactly for that.
We have gone and requested out of a large number of broker
dealers information, data, actual detailed trading data and we
are trying to piece together and look for exactly, the
footprint of exactly what you are citing. That is, a tip or a
trade coming and then or an order coming and other trades
front-running the eventual consummation of that trade
benefitting some other parties who were actually in process or
looking for that.
So I would say that it is probably, you know, the article
may have characterized the idea that we are running behind
there, but I think we are very much aware of that. The
difficulty, of course, is detecting, but we are looking with
all our tools to detect that. I think we are crystal clear that
violates Federal securities laws.
Mr. Castle. And I didn't read the entire article to you
obviously, but you may have read it yourself. But it goes on to
say how difficult it is to prove all these things. It is hard
to get cooperative witnesses, etc. So your work is cut out for
you and we appreciate what you are doing on that.
Mr. Sirri. Thank you.
Mr. Castle. Secretary Steel, let me turn to an area that
concerns me that I mentioned. You have talked about the
principles and the guidelines which were revealed earlier this
year and the discussion of the industry's best practices.
My concern--and I'm not that concerned about the extremely
wealthy investors in hedge funds, but I am becoming
increasingly concerned about the institutional investor,
particularly pension funds. There are many individuals who are
not wealthy who may receiving a payment or will receive a
payment from that pension fund, the fiduciary which decides to
get into a hedge fund. And I am not sure what knowledge they
actually have.
I do not know--in some of the due diligence you have spoken
about, in some of the best practices you have adopted in your
principles and guidelines are--is this information which is
available to the individuals who are going to be actually
getting involved in that investment or is it just to you as
regulators?
I mean I want to make sure these people who are
representing more middle America, if you will, actually know
what the heck they are getting into. I cannot judge whether
they are good investors or not. But at least they would have
full knowledge. Is it moving in that direction?
Mr. Steel. Congressman, you ask an important question. And
in my opening comments I chose or tried to highlight this, that
we at Treasury and the President's Working Group think this is
a crucial issue.
As I said, when hedge funds began, it was the province of
wealthy individuals and then it spread to foundations and
endowments. But today it is basically pulling others into the
area where they are affected and in particular through pension
funds and things of that ilk.
When we wrote the principles and guidelines, we dedicated
one of the principles to this specific issue. Principal Number
5 basically talks about the importance of this trend and that
the key front-line defender has to be the fiduciary. And the
fiduciaries representing these people should be a very
demanding investor.
We give specific examples of what they should want to
understand, the importance of diversification as they construct
the proper portfolio for that pension plan.
Next, I'm quite comfortable that the way we're going and
the forward-leaning perspective with our declaration that we
are not confirming the status quo. Instead when we convene the
group of people to help us think about the investors and the
best practice for investors, our plan is to include as key
members of that group the very best people from the pension
world to help set standards and rules that can be a signpost
for people who want to understand best practices as fiduciaries
as they consider allocating part of the assets of a pension
fund to alternative asset products.
Mr. Castle. My time is up. If I could just ask one very
brief--I cannot.
The Chairman. If you want to make a statement?
Mr. Castle. Well, the only statement I was going to make,
Mr. Chairman, is--and I did not get a chance to say this per
se--I understand the fiduciary's responsibility, but ultimately
I think it is very important to make sure that the fiduciary
has the information to be able to make that decision.
I am not 100 percent comfortable with that now although
perhaps I can be persuaded with a little more attention to it.
The Chairman. I think that is right, that is the fiduciary
after all is a fiduciary for other people. We have some
obligation to make sure that if the fiduciary screws up, it is
not only the fiduciary who suffers. So, it is not enough to
say, ``Well, it was the fiduciary's fault.'' Because we have to
protect the people who are the fiduciaries' presumed
beneficiaries.
Mr. Castle. Yes, sir.
The Chairman. Let me just say, Mr. Secretary, I think you
kind of summed up the message. I hope people have taken this
which is the fact that there have not been any new proposals
for increased regulation, etc., is not an endorsement to the
status quo. I think that is the important lesson for people to
take. That there is a recognition that this is an ongoing
issue. The absence of any specific new regulatory scheme right
now is not an endorsement of the status quo. I appreciate your
putting it that way.
The gentleman from Texas.
Mr. Green. Thank you, Mr. Chairman.
I thank the witnesses for appearing today. I also thank the
ranking member, in his absence, and I would like to pick up
where the chairperson left off with the responsibility of the
fiduciary. But let us start with the notion and premise that
historically hedge funds have been available to sophisticated
investors. Sophisticated investors are not sophisticated by
virtue of their knowledge. Knowledge alone does not make one a
sophisticated investor.
Unfortunately or fortunately as the case may be, to become
a sophisticated investor, one has to have a certain amount of
assets. Does anyone differ with that premise? That you have to
have a combination of assets and knowledge to be a
sophisticated investor for the purpose of investing in a hedge
fund traditionally as we define sophisticated investor.
Mr. Sirri. The Federal securities laws provide for various
tests: Income levels, in some instances investments, and in
other instances assets
Mr. Green. Okay. So the assets are important to this
process. And my concern, and it is a serious concern, is the
problem that we have when we commingle sophisticated funds with
what Mr. Steel calls less sophisticated and some others may
have utilized this terminology, I use the term
``unsophisticated'' funds.
When you have these funds commingled, then we have a
problem because no matter how much knowledge the people acquire
who are part of a pension fund, they will not become a
sophisticated investor. The knowledge alone will not make them
sophisticated investors.
Traditionally the reason we have had these sophisticated
investors in hedge funds is because they could suffer the loss.
If they suffered a loss, we had an individual or family that
lost money and as bad as that is, it would not have the kind of
impact that we can have on a market that the system itself, the
people who happen to be a part of society because if a pension
fund takes a serious hit, then we have a lot of people that we
have to concern ourselves with as opposed to a family, as
opposed to an individual who has an inordinate amount of money
and God bless the person who has it. I think everybody ought to
be a millionaire in a country where 1 out of every 110 persons
is a millionaire.
In fact, in this country, it is almost unhealthy not to be
a millionaire, so everybody ought to want to try to become a
millionaire in America. This is the richest country in the
world, a country where we can spend $353 million a day on a war
and still do well.
So my question and my concern have to do with having these
persons who have their pensions who are not sophisticated even
if they have Ph.Ds in economics, they are still not
sophisticated investors.
And when this, if something goes belly up and the stock
market of 1929 would never have gone belly up, should not have
gone belly up, but it did. Enron should not have failed, but it
did. We have had other instances where institutions, long term
capital should not have failed, but it did. And nothing fails
until it does. And when it does, then we have problems and
taxpayers pick up a large portion of the tab because people
eventually who are pensioners will go to the public trough in
the form of public assistance and they need assistance and they
ought to receive it by the way.
So I do concern myself with this notion of a fiduciary
being able to shoulder all of the burden for what can happen
when those funds are intermingled and we have a loss. That is a
real concern for me. And I don't know that I have heard
anything that addresses this concern to the extent that I feel
comfortable with this, the continuation of this as it is
currently.
Perhaps there is a way to do this and my chairman is very
enlightened and I am sure that he will help me through it as
well as others, but maybe there is a way to do this and not
create the consternation that we are going to--that I have and
maybe it is just me but that I have on behalf, I think, of the
working people in this country who are finding more and more of
their money going into the sophisticated market. This is a
sophisticated market. And people who engage in this ought to
have a better understanding and the capital to back up the
losses that they may suffer.
Is that my time, Mr. Chairman?
The Chairman. You still have about 30 seconds.
Mr. Green. Thirty seconds. The question would be this.
Explain to me how we can allay the concern that I called to
your attention with reference to the sophisticated and
unsophisticated or non-sophisticated or less sophisticated
monies being commingled.
Mr. Sirri. Congressman, let me see if I can shed some light
on this. You are quite correct in how you have characterized
sophistication. The Federal securities laws provide that you
have to be--have some little wealth, income or assets to buy a
hedge fund as an individual and that is as you have stated.
You bring up the issue of the fiduciary. One of the
reasons--and you are noting that there seems to be something
that does not match because unsophisticated people find
themselves invested in investments that are normally held by
sophisticated entities.
I think there are two things. One, the first, is what you
observed, the fiduciary. That person has a heightened
responsibility to invest for those people. But the other is the
amount of investment that is made.
A fiduciary, if acting properly for say a pension fund,
would never plunge 50 or 80 percent of their assets into one or
more hedge funds. They would prudently place a small amount of
assets in a hedge fund.
When you turn to an individual, one of the reasons why we
have wealth and income standards is there is a chance that an
individual investor might place half of their wealth in a hedge
fund, and that is dangerous. That is why we have the high
wealth standards.
What I am about to point out is that when a fiduciary is
acting, and they are investing a pool of say, pension fund
monies, it is not going to be the case that 30, 50, or 90
percent of that pool is in hedge funds.
It is going to be the case that hopefully a prudent amount
is in hedge funds and it depends on the purpose. And so the
exact quantity will serve to protect you.
Mr. Green. Just a quick response, Mr. Chairman, and then I
yield back my time.
But there is nothing that thwarts a fiduciary from doing
the opposite, the antithesis of what you just said.
Mr. Sirri. Well, the fiduciary has an obligation to invest
prudently and what you are pointing out is that fiduciary would
not have the best interests of their beneficiaries in mind.
If that is the case--I am not saying that could not happen.
But if that is the case, that fiduciary could have just as well
put 100 percent of their investments in tech stocks in the late
1990's.
The Chairman. Would the gentleman yield to me?
Let me say this because I think he is on a very important
point and it is really related to what the gentleman from
Louisiana had said and the gentleman from Delaware. Yes, it is
the fiduciary's responsibility, but if we are talking about an
individual investor, if an individual mis-invests several
million dollars of her own money that is too bad for her. With
a fiduciary, it is other people.
And I think the point is this: You are right. That has
always been a problem. The problem is that hedge funds appear
to many of us to be a new and more enticing opportunity for the
unwary fiduciary. And the problem we think is not just the one
who does not have his or her client's interests at heart or
beneficiaries, but who does not have the smarts to do it.
And that is why we think this increased set of very complex
opportunities promising a very high rate of return create a new
potential problem that particularly with regard to fiduciaries
that we may have to do some new things.
The gentlewoman from New York has arrived and is now
recognized to ask some more questions.
Mrs. Maloney. Thank you very much.
Going back to my original questions, my concern about the
Bear Stearns funds is not whether the funds themselves go
under, or even if a major firm loses money, my main concern is
what effect a sale of CDOs assets would have had on all
institutions holding similar securities. And do each of you
believe that the institutions that you oversee are valuing
those assets properly? Are the credit rating agencies acting
with appropriate speed to downgrade assets that no longer
warrant their investment grade?
And what about the customers such as pension funds,
endowments, and so forth to whom these securities are sold, the
CDOs, other mortgage derivatives. What about them? Are they
valuing them properly?
And what is the systemic consequences of a broad downgrade
or significant deterioration of those types of securities'
values?
So I would like everyone to respond on whether you feel
they are valued. Is there a bubble there? And what is the
systemic, the systemic effect really on the markets with
properly valuing them?
Mr. Warsh. Thank you, Congresswoman. Perhaps I will go
first, but I will defer on the specific matter of Bear Stearns
that you referenced to my colleague from the SEC who has
oversight over them.
Let me talk a little bit more broadly--
Mrs. Maloney. I want to make it clear. I am not asking
about Bear Stearns. I am not talking about a major firm losing
money, but what effect it has on the value of the CDOs and the
systemic problem it could have on the markets and on the proper
valuing of the CDOs.
Mr. Warsh. As you heard from us at the outset, market
discipline is going to have a critically important role to play
here. Market discipline is tough medicine and I think,
Congresswoman, to your point, losses will no doubt be held by
some individuals and institutions that own collateralized debt
obligations and other securities as the markets turn against
them.
And it is these losses which force all institutions to go
back to first principles, revisit their valuations, revisit the
ratings that have put on these securities to make sure they
know where their risks are. The Federal Reserve, as regulators
and supervisors of U.S. bank holding companies, is keenly
focused on ensuring that the risks held by these institutions
are manageable.
We are not in the business of trying to ensure that there
are not losses but only to ensure that there are capital
cushions, risk management processes, and proper oversight to
ensure that those losses do not become systemic.
Mrs. Maloney. But do you believe that these, that they are
being valued--are these assets being valued properly? The
credit agencies are still giving them 100 percent rating. Some
analysts are saying they are really worth 20 percent. This is
problematic.
Do you believe they are being valued appropriately?
Mr. Warsh. I would expect that--
Mrs. Maloney. Is there a bubble out there?
Mr. Warsh. I would expect that the valuations of these
securities are at the crux of what regulated institutions are
reviewing as we speak. The valuations that have been put on
securities that tend to be more complex, that tend to be less
liquid, is both art and science. And I think that those
institutions that rely wholly on models, that rely wholly on
history of the last 4 or 5 years, are learning market lessons.
That is, many of these new products--though they have been
tested to some degree in recent months--may not have been
subjected to the most adverse stress test.
Speaking for the Federal Reserve, that is part and parcel
of one of our priorities to ensure that the stress test work
that we have done with our regulatees is taken to the next
level to ensure that there are not risks that should be brought
to bear.
Mrs. Maloney. Some analysts have said that they believe
there should be broad downgrades. What is the systemic
consequence of broad downgrades on these assets? And I would
like to go to someone else on the panel.
Mr. Warsh. Would you like me to briefly answer that and
then I will defer to--
Mrs. Maloney. I would like to let someone else speak.
Mr. Steel. Thank you. You asked an important question and I
think my response would be in line with Governor Warsh's, that
the key issues here are current pricing which you keep poking
at and the issue of cushions or liquidity margin against them.
And I think that right now the market is adjusting and
seems to be settling at new prices. And right now there is
stress in the subprime market. It does not seem to be a
systemic issue which you have asked repeatedly and that would
be the representation we would make. But it is going through an
adjustment process. And so that will happen as the market
develops and it seems as though it is happening in an orderly
way.
We have the largest residential financial market for
housing in the world. It is $10 trillion, and it is a terribly
important asset to the economy and to the housing market.
It is now going through a process of revaluing certain
parts of it, but I would not describe it in any alarming way
other than it is going to go through the process of resetting
prices, people readjusting their margin as the market adjusts
and as Governor Warsh said, the harsh medicine of market
conditions and the truth of the marketplace.
The Chairman. Thank you. Actually I would say to Governor
Warsh that I think people are very happy that the Fed is
dealing with stress test. The fear is that they will do a
little stress reality with interest rates. That will be the--
stick with the tests.
The gentleman from Texas is now recognized for one last
question and then the hearing will adjourn.
Mr. Green. Thank you, Mr. Chairman.
This will be to Dr. Sirri. Sir, would you oppose a
codification of what you expressed in terms of a judicious
prudent manager surrogate, if you will, having to invest not
more than a certain percentage of a certain pension in a hedge
fund?
Mr. Sirri. I do not, you know--
Mr. Green. The fiduciary.
Mr. Sirri. Sure. I think it is very difficult to place that
kind of a structure. I understand what you are getting at and
let me tell you why. A hedge fund could be in fact a long only
equity fund and be a perfect substitute for a common mutual
fund that you find today. And some hedge funds do exactly that.
Other hedge funds as we have been talking about invest in
exotic instruments. So it is actually the job of the fiduciary
to see through all of that and to find in fact a prudent
packaging of instruments for the beneficial owners.
It is really--it is very, very difficult to take the
fiduciary off the hook in my view here. That is really where
the rubber meets the road. And it extends to the point where a
diligent fiduciary in many ways--for example, a fiduciary
looking to invest for people's retirement who didn't select a
small portion of say alternative investments may not always be
acting in the best interest of investors.
Mr. Green. I yield back. Thank you, sir.
The Chairman. I thank you for returning. The hearing is
adjourned. I must say that I think this has been very useful,
and I hope that people will pay serious attention. We have, I
think, a pretty good consensus that this is an issue that we
have to remain seriously on top of. We have to be considering
it and the final chapter has not been written. I think people
should have some assurance, though, that there is an awareness
of the problems and the risks and serious people are attuned to
it.
[Whereupon, at 12:45 p.m., the hearing was adjourned.]
A P P E N D I X
July 11, 2007
[GRAPHIC] [TIFF OMITTED] T8388.001
[GRAPHIC] [TIFF OMITTED] T8388.002
[GRAPHIC] [TIFF OMITTED] T8388.003
[GRAPHIC] [TIFF OMITTED] T8388.004
[GRAPHIC] [TIFF OMITTED] T8388.005
[GRAPHIC] [TIFF OMITTED] T8388.006
[GRAPHIC] [TIFF OMITTED] T8388.007
[GRAPHIC] [TIFF OMITTED] T8388.008
[GRAPHIC] [TIFF OMITTED] T8388.009
[GRAPHIC] [TIFF OMITTED] T8388.010
[GRAPHIC] [TIFF OMITTED] T8388.011
[GRAPHIC] [TIFF OMITTED] T8388.012
[GRAPHIC] [TIFF OMITTED] T8388.013
[GRAPHIC] [TIFF OMITTED] T8388.014
[GRAPHIC] [TIFF OMITTED] T8388.015
[GRAPHIC] [TIFF OMITTED] T8388.016
[GRAPHIC] [TIFF OMITTED] T8388.017
[GRAPHIC] [TIFF OMITTED] T8388.018
[GRAPHIC] [TIFF OMITTED] T8388.019
[GRAPHIC] [TIFF OMITTED] T8388.020
[GRAPHIC] [TIFF OMITTED] T8388.021
[GRAPHIC] [TIFF OMITTED] T8388.022
[GRAPHIC] [TIFF OMITTED] T8388.023
[GRAPHIC] [TIFF OMITTED] T8388.024
[GRAPHIC] [TIFF OMITTED] T8388.025
[GRAPHIC] [TIFF OMITTED] T8388.026
[GRAPHIC] [TIFF OMITTED] T8388.027
[GRAPHIC] [TIFF OMITTED] T8388.028
[GRAPHIC] [TIFF OMITTED] T8388.029
[GRAPHIC] [TIFF OMITTED] T8388.030
[GRAPHIC] [TIFF OMITTED] T8388.031
[GRAPHIC] [TIFF OMITTED] T8388.032
[GRAPHIC] [TIFF OMITTED] T8388.033
[GRAPHIC] [TIFF OMITTED] T8388.034
[GRAPHIC] [TIFF OMITTED] T8388.035
[GRAPHIC] [TIFF OMITTED] T8388.036
[GRAPHIC] [TIFF OMITTED] T8388.037
[GRAPHIC] [TIFF OMITTED] T8388.038
[GRAPHIC] [TIFF OMITTED] T8388.039
[GRAPHIC] [TIFF OMITTED] T8388.040
[GRAPHIC] [TIFF OMITTED] T8388.041
[GRAPHIC] [TIFF OMITTED] T8388.042
[GRAPHIC] [TIFF OMITTED] T8388.043
[GRAPHIC] [TIFF OMITTED] T8388.044
[GRAPHIC] [TIFF OMITTED] T8388.045
[GRAPHIC] [TIFF OMITTED] T8388.046
[GRAPHIC] [TIFF OMITTED] T8388.047
[GRAPHIC] [TIFF OMITTED] T8388.048
[GRAPHIC] [TIFF OMITTED] T8388.049
[GRAPHIC] [TIFF OMITTED] T8388.050
[GRAPHIC] [TIFF OMITTED] T8388.051
[GRAPHIC] [TIFF OMITTED] T8388.052
[GRAPHIC] [TIFF OMITTED] T8388.053
[GRAPHIC] [TIFF OMITTED] T8388.054