[House Hearing, 110 Congress]
[From the U.S. Government Publishing Office]


 
                         THE STATE OF THE BOND 
                           INSURANCE INDUSTRY 

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

                                HEARING

                               BEFORE THE

                    SUBCOMMITTEE ON CAPITAL MARKETS,

                       INSURANCE, AND GOVERNMENT

                         SPONSORED ENTERPRISES

                                 OF THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                       ONE HUNDRED TENTH CONGRESS

                             SECOND SESSION

                               __________

                           FEBRUARY 14, 2008

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 110-91

                                ----------
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41-182 PDF                    WASHINGTON : 2008 

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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                 BARNEY FRANK, Massachusetts, Chairman

PAUL E. KANJORSKI, Pennsylvania      SPENCER BACHUS, Alabama
MAXINE WATERS, California            DEBORAH PRYCE, Ohio
CAROLYN B. MALONEY, New York         MICHAEL N. CASTLE, Delaware
LUIS V. GUTIERREZ, Illinois          PETER T. KING, New York
NYDIA M. VELAZQUEZ, New York         EDWARD R. ROYCE, California
MELVIN L. WATT, North Carolina       FRANK D. LUCAS, Oklahoma
GARY L. ACKERMAN, New York           RON PAUL, Texas
BRAD SHERMAN, California             STEVEN C. LaTOURETTE, Ohio
GREGORY W. MEEKS, New York           DONALD A. MANZULLO, Illinois
DENNIS MOORE, Kansas                 WALTER B. JONES, Jr., North 
MICHAEL E. CAPUANO, Massachusetts        Carolina
RUBEN HINOJOSA, Texas                JUDY BIGGERT, Illinois
WM. LACY CLAY, Missouri              CHRISTOPHER SHAYS, Connecticut
CAROLYN McCARTHY, New York           GARY G. MILLER, California
JOE BACA, California                 SHELLEY MOORE CAPITO, West 
STEPHEN F. LYNCH, Massachusetts          Virginia
BRAD MILLER, North Carolina          TOM FEENEY, Florida
DAVID SCOTT, Georgia                 JEB HENSARLING, Texas
AL GREEN, Texas                      SCOTT GARRETT, New Jersey
EMANUEL CLEAVER, Missouri            GINNY BROWN-WAITE, Florida
MELISSA L. BEAN, Illinois            J. GRESHAM BARRETT, South Carolina
GWEN MOORE, Wisconsin,               JIM GERLACH, Pennsylvania
LINCOLN DAVIS, Tennessee             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 A. 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                  KEVIN McCARTHY, California
                                     DEAN HELLER, Nevada

        Jeanne M. Roslanowick, Staff Director and Chief Counsel
 Subcommittee on Capital Markets, Insurance, and Government Sponsored 
                              Enterprises

               PAUL E. KANJORSKI, Pennsylvania, Chairman

GARY L. ACKERMAN, New York           DEBORAH PRYCE, Ohio
BRAD SHERMAN, California             JEB HENSARLING, Texas
GREGORY W. MEEKS, New York           CHRISTOPHER SHAYS, Connecticut
DENNIS MOORE, Kansas                 MICHAEL N. CASTLE, Delaware
MICHAEL E. CAPUANO, Massachusetts    PETER T. KING, New York
RUBEN HINOJOSA, Texas                FRANK D. LUCAS, Oklahoma
CAROLYN McCARTHY, New York           DONALD A. MANZULLO, Illinois
JOE BACA, California                 EDWARD R. ROYCE, California
STEPHEN F. LYNCH, Massachusetts      SHELLEY MOORE CAPITO, West 
BRAD MILLER, North Carolina              Virginia
DAVID SCOTT, Georgia                 ADAM PUTNAM, Florida
NYDIA M. VELAZQUEZ, New York         J. GRESHAM BARRETT, South Carolina
MELISSA L. BEAN, Illinois            GINNY BROWN-WAITE, Florida
GWEN MOORE, Wisconsin,               TOM FEENEY, Florida
LINCOLN DAVIS, Tennessee             SCOTT GARRETT, New Jersey
PAUL W. HODES, New Hampshire         JIM GERLACH, Pennsylvania
RON KLEIN, Florida                   TOM PRICE, Georgia
TIM MAHONEY, Florida                 GEOFF DAVIS, Kentucky
ED PERLMUTTER, Colorado              JOHN CAMPBELL, California
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
















































                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    February 14, 2008............................................     1
Appendix:
    February 14, 2008............................................    83

                               WITNESSES
                      Thursday, February 14, 2008

Ackman, William A., Managing Member, Pershing Square Capital 
  Management, L.P................................................    55
Buckley, Keith M., Group Managing Director and Global Head of 
  Insurance, Fitch Ratings.......................................    58
Callen, Michael, Chairman and Chief Executive Officer, Ambac 
  Financial Group................................................    63
Chaplin, Charles, Chief Financial Officer, MBIA Inc..............    65
Dinallo, Eric R., Superintendent, New York State Insurance 
  Department.....................................................    34
Larkin, Richard P., Senior Vice President, Herbert J. Sims & Co., 
  Inc............................................................    61
Leighton, Hon. Thomas M., Mayor, Wilkes-Barre, Pennsylvania......    42
Parkinson, Patrick M., Deputy Director, Division of Research and 
  Statistics, Board of Governors of the Federal Reserve System...    40
Sirri, Erik R., Director, Division of Trading and Markets, U.S. 
  Securities and Exchange Commission.............................    38
Spitzer, Hon. Eliot, Governor, State of New York.................     6

                                APPENDIX

Prepared statements:
    Kanjorski, Hon. Paul E.......................................    84
    Ackman, William A............................................    86
    Buckley, Keith M.............................................    93
    Callen, Michael..............................................   102
    Chaplin, Charles.............................................   111
    Dinallo, Eric R..............................................   219
    Larkin, Richard P............................................   224
    Leighton, Hon. Thomas M......................................   236
    Parkinson, Patrick M.........................................   244
    Sirri, Erik R................................................   251
    Spitzer, Hon. Eliot..........................................   261

              Additional Material Submitted for the Record

Kanjorski, Hon. Paul E.:
    Statement of the Association of Financial Guaranty Insurers..   269
    Letter from 35 Pennsylvania bankers, dated February 14, 2008.   324
    Letter from the Illinois Finance Authority, dated February 
      13, 2008...................................................   327
    Letter from the Pennsylvania Higher Educational Facilities 
      Authority, dated February 12, 2008.........................   332
    Letter to the Department of Labor, dated January 30, 2008....   334
    Response letter from the Department of Labor, dated February 
      11, 2008...................................................   336
    Letter to the Federal Reserve System, dated January 23, 2008.   338
    Response letter from the Federal Reserve, dated February 4, 
      2008.......................................................   340
    Letter to the Comptroller of the Currency, dated January 23, 
      2008.......................................................   342
    Response letter from the Comptroller of the Currency, dated 
      February 1, 2008...........................................   344
    Letter to the SEC, dated January 23, 2008....................   348
    Response letter from the SEC, dated January 31, 2008.........   350
    Letter to the National Association of Insurance 
      Commissioners, dated January 23, 2008......................   356
    Response letter from the National Association of Insurance 
      Commissioners, dated February 4, 2008......................   358
    Letter to the Maryland Insurance Administration, dated 
      January 23, 2008...........................................   360
    Response letter from the Maryland Insurance Administration, 
      dated February 1, 2008.....................................   362
    Letter to the State of New York Insurance Department, dated 
      January 23, 2008...........................................   379
    Response letter from the State of New York Insurance 
      Department, dated February 4, 2008.........................   381
    Letter to the Wisconsin Commissioner of Insurance, dated 
      January 23, 2008...........................................   433
    Response letter from the Wisconsin Commissioner of Insurance, 
      dated February 4, 2008.....................................   435
    Letter to the Federal Reserve Bank of New York, dated January 
      23, 2008...................................................   441
Bachus, Hon. Spencer:
    Letter to the U.S. Securities and Exchange Commission, dated 
      January 23, 2007...........................................   443
    New York Governor Eliot Spitzer's veto message no. 109.......   444
Capito, Hon. Shelley Moore:
    Letter from West Virgina community bankers, dated February 
      14, 2008...................................................   447
Castle, Hon. Michael:
    Securities and Exchange Commission Form 8-K, dated April 26, 
      2007, re: MBIA Inc.........................................   449
Price, Hon. Tom:
    Statement of Comptroller of the Currency John C. Dugan 
      Responding to New York Governor Eliot Spitzer..............   465


                         THE STATE OF THE BOND
                           INSURANCE INDUSTRY

                              ----------                              


                      Thursday, February 14, 2008

             U.S. House of Representatives,
                   Subcommittee on Capital Markets,
                          Insurance, and Government
                             Sponsored Enterprises,
                           Committee on Financial Services,
                                                   Washington, D.C.
    The subcommittee met, pursuant to notice, at 11:36 a.m., in 
room 2128, Rayburn House Office Building, Hon. Paul E. 
Kanjorski [chairman of the subcommittee] presiding.
    Members present: Representatives Kanjorski, Sherman, Meeks, 
Capuano, McCarthy, Scott, Moore of Wisconsin, Davis of 
Tennessee, Sires, Klein, Perlmutter; Pryce, Castle, Royce, 
Capito, Feeney, Price, and Bachmann.
    Also present: Representatives Maloney and Bachus.
    Chairman Kanjorski. This hearing of the Subcommittee on 
Capital Markets, Insurance, and Government Sponsored 
Enterprises will come to order.
    Without objection, all members' opening statements will be 
made a part of the record.
    Good morning. The Capital Markets Subcommittee meets today 
to learn about the causes and effects of recent bond insurer 
ratings downgrades. We will, in particular, focus on the 
spillover effects for municipalities and the financial services 
industry.
    Bond insurance represents a microscopic segment of the 
insurance marketplace. In 2006, bond insurers collected less 
than one-third of a percentage point of the total premiums 
collected by the insurance industry.
    We now know, however, that even though it is very small, 
the importance of the bond insurance industry is significantly 
greater. Its recent volatility, unless quickly addressed, could 
produce many negative consequences and affect the financial 
stability of the broader economy.
    Since the issuance of the first license in the early 
1970's, bond insurers have guaranteed a stable risk: the timely 
payments of principal and interest on municipal bonds. In 
recent years, many bond insurers expanded into insuring 
structured finance products, including those backed by subprime 
mortgages.
    These business decisions and the decline in the value of 
the subprime debt have now resulted in downgrades or the threat 
of downgrades by credit rating agencies.
    It now appears that like a child who finds a book of 
matches, they have gotten burned. We must hope that they did 
not ignite our economic house as well.
    The ratings downgrades of a few bond insurers has produced 
spillover effects and caused considerable anxiety. A report or 
rumor about a bond insurer has already led to swings of several 
hundred points in the Dow Jones Average.
    The limited availability of bond insurance has also led to 
a number of recent failures in the offerings of auction rate 
securities. These breakdowns have caused significant problems 
in the financing of student loans. They have also resulted in 
some municipalities paying 10 percent or more on their 
outstanding short-term debts.
    Ratings downgrades additionally have the potential to 
reduce the value of bank holdings and insurer reserves causing 
them to take write-downs or increase capital levels. Moreover, 
individual investors holding bonds could feel the impact if 
they want to sell the bonds they hold. Most troublesome to me 
is the effect of these downgrades on municipalities. Municipal 
markets issue approximately $2.6 trillion in bonds, about one-
half of which are insured. States and localities often use 
municipal bonds to operate more efficiently, ease budgeting 
shortfalls, repair bridges, fix roads, and build schools, among 
other things.
    The recent downgrades could therefore cause cities and 
towns to make difficult decisions about whether they can afford 
to pay more for bond insurance, pay higher interest on bonds 
issued without insurance, or delay much needed projects. In 
this regard, I am especially pleased that Mayor Tom Leighton of 
Wilkes-Barre, Pennsylvania, is here today. He can describe how 
municipalities use bond insurance and what the implications of 
the ratings downgrades are.
    In preparation for today's hearing, I previously contacted 
key regulators to open discussions about these serious matters 
and determine the most efficient and responsible manner to act. 
Today, we will hear from many of them. We will also hear from 
bond insurers, their critics, market analysts and rating 
agencies.
    Everyone--even State insurance regulators--agrees on the 
need for regulatory reform. We need to prevent a similar 
situation from happening again in the future. I am hopeful that 
as we further our understanding of these issues today, we will 
also begin to explore what we should do going forward. Some 
policy options include prohibiting bond insurers from 
guaranteeing complex structured financial products in order to 
protect municipal bond insurers and creating a Federal bond 
insurance corporation modeled after the FDIC.
    We could also mandate Federal insurance supervision in this 
narrow field in order to provide greater stability for our 
entire financial system. Additionally, we could enact a law 
allowing the Federal Home Loan Banks to enhance municipal bonds 
with letters of credit like Fannie Mae and Freddie Mac already 
do. Moreover, we could work toward better transparency in the 
municipal bond markets. Other policy options include imposing 
new requirements for credit rating agencies and addressing the 
differences between ratings on structured financial products, 
corporate debt, and municipal bonds.
    In closing, I look forward to the opening of dialogue 
today. I want to thank each of the witnesses for appearing. 
Your thoughts will help the members of the Capital Markets 
Subcommittee to understand these issues and to determine the 
best course of action to ensure that our municipal finance 
markets remain viable and our financial system stays dynamic 
and strong.
    I would now like to recognize Ms. Pryce for her opening 
remarks.
    Ms. Pryce. Thank you very much, Mr. Chairman, for holding 
this hearing today and for your leadership on this issue. It is 
clear we are facing a crisis of confidence in the bond 
insurance marketplace.
    Dating back to the 1970's, bond insurers have served a very 
clear cut function, guaranteeing the timely payment of 
principal and interest on municipal bonds. They have put 
investors further at ease about the risk of default in a 
marketplace that has a rate of default of less than 1 percent.
    In the 1990's, insurers began to diversify and to guarantee 
securities backed by pools of auto, mortgage, credit card, and 
student loans, and they did not stop there. In recent years, 
they branched out even further into risky debt products backed 
by some subprime mortgages.
    The stability of the industry rested on the assumption that 
the insurers and the rating agencies who rated them accurately 
priced the risk of default of these assets. It is clear now 
that they got it wrong. In recent months, the prediction of 
record home loan foreclosures moved credit rating agencies to 
call into question the capital reserve levels of bond insurers. 
To date, all but one of the major bond insurers has either been 
downgraded or placed on a negative watch.
    We wish we could turn back the clock, increase capital 
reserves, and restore the reputation of the industry. However, 
we are left with the future of a once stable industry in limbo. 
Investors are not the only ones with something to lose.
    There are far reaching consequences in our capital markets. 
Real concern exists that institutional investors required to 
invest only in Triple A securities will be forced to sell.
    I am particularly worried, as is the chairman, about the 
effects on small towns, cities, and counties and places like my 
district in central Ohio, which uses municipal bonds to help 
raise funds for important projects and improvements. Downgrades 
on existing bonds and pressure on prices moving forward add to 
the cost of living in small town America.
    This hearing is an important step in determining the future 
of the bond insurance industry. I share the chairman's 
sentiment that this crisis gives us pause, and his lengthy list 
of possible solutions is admirable.
    We pause to evaluate the regulatory structure of the 
industry and the need for better oversight.
    I look forward to the testimony of all of our witnesses 
today. Thank you very much for your participation, and I yield 
back.
    Chairman Kanjorski. Thank you, Ms. Pryce. We will now hear 
an opening statement from the ranking member of the full 
committee, Mr. Bachus of Alabama.
    Mr. Bachus. Thank you, Chairman Kanjorski.
    Three months ago, very few Americans were familiar with the 
bond insurance industry and the role that financial 
institutions play in the capital markets.
    This once obscure industry is now at the center of an 
ongoing credit and liquidity crisis in the financial markets in 
recent months, causing tens of billions of dollars of losses to 
investors and financial institutions, and unraveling many 
secondary debt markets.
    Unlike other events that have de-stabilized markets since 
the credit crunch began last summer, where the pain has been 
felt largely on Wall Street, the fall out from the troubles in 
the bond insurance industry is hitting Main Street, our cities, 
our counties, our States, and our different authorities, 
government authorities.
    Bond insurers guarantee over $2 trillion of debt 
securities. Roughly 50 percent of municipal bonds and a large 
number of structured financial vehicles are guaranteed by the 
bond insurers in order to make them safe investments with a 
Triple A rating.
    This provides the credit markets with increased liquidity 
and reduced borrowing costs particularly for cities, counties, 
and States that pay lower interest on debt issued to support 
their infrastructure needs.
    The bond insurers' decision several years ago to expand 
their business lines beyond municipal issues and into more 
complex securities, including mortgage pools backed by subprime 
mortgages, has had disastrous consequences.
    Bond insurers fundamentally misjudged the risk associated 
with the cyclic mortgage markets and lenders' lax subprime 
underwriting standards.
    The credit rating agencies have now downgraded seven of the 
top nine bond insurers, calling into question their ability to 
make good on hundreds of billions of dollars in potential 
mortgage related defaults.
    Investors in insured bonds relied heavily on analysis by 
credit rating agencies that were fundamentally flawed. Too 
late, the credit rating agencies have recognized the added risk 
of subprime related guarantees to the thinly capitalized bond 
insurers, which has served to aggravate the credit crunch and 
create massive uncertainty among market participants.
    Local governments across the country are now facing an 
unfavorable environment in which to raise funds, with new 
issues plummeting and many municipalities being forced to pay 
significantly higher interest rates.
    For example, in Jefferson County, Alabama, the rate on 
their insured sewer bonds issued in 2002, this month has 
increased from 3 percent to 10 percent, more than a triple 
increase in their payments.
    These costs will inevitably be passed along to local 
taxpayers in the form of reduced services or higher fees and 
taxes. The impact is also extended to the credit markets, as 
new offerings of residential mortgage-backed securities have 
largely dried up.
    Fortunately, our economy is still fundamentally sound and 
not all market participants roll the dice in subprime markets.
    Two bond insurers have had their credit ratings affirmed, 
providing some measure of stability to the bond markets. 
Several other bond insurers are seeking or have obtained 
private equity financing and quick action by regulators has 
helped bring new entrance, such as Berkshire Hathaway, into the 
industry, to support the ongoing viability of the municipal 
bond insurance markets.
    Last year, SEC Chairman Cox presented a vision for 
increased integrity, transparency, and accountability in the 
municipal securities market. Chairman Cox's initiative would 
require meaningful public disclosures that are current and 
understandable, with a full accounting of all material 
information at the time of a new municipal bond issuance.
    This committee should closely consider Chairman Cox's 
proposal, keeping in mind that any Federal reforms of the 
municipal securities market must take into account the 
legitimate interest of States and municipalities.
    Systemic risk relating to the bond insurance marketplace, 
while remote, is a risk that could have been avoided with 
prudent oversight by our credit rating agencies and other 
regulators.
    We need to ensure that our regulators maintain a larger 
perspective on the potential impact of difficulties in one 
sector of the financial services industry spilling over into 
others as has happened with bond insurance.
    In addition to guarding against risk to the financial 
system, Congress must make sure that someone is watching out 
for the taxpayers. Fourteen months ago, well before the 
subprime crisis called into question the financial soundness of 
bond insurers, I met with Chairman Cox and communicated my 
concern about the municipal securities market in a letter to 
him, a follow-up letter.
    I would like to introduce that letter for the record. It is 
a letter of January 5, 2007, 14 months ago.
    Chairman Kanjorski. Without objection, it is so ordered.
    Mr. Bachus. Now my fears expressed in that letter have been 
realized as the situation in Jefferson County, Alabama, and 
throughout the country unfolds. Protecting taxpayers and rate 
payers as well as investors is a major concern for all of us 
and will guide our efforts going forward.
    Hopefully, Chairman Cox's efforts and forthcoming proposals 
by the Treasury Department on the need for more comprehensive 
regulatory oversight of the financial services industry will 
help to inform the committee on the review of these complex 
issues.
    Thank you again, Chairman Kanjorski, for holding this 
hearing. I am grateful today to all of the witnesses for 
joining us and I look forward to their testimony.
    Chairman Kanjorski. Thank you very much, Mr. Bachus.
    We will now hear from Mr. Royce of California.
    Mr. Royce. Thank you very much, Mr. Chairman. I appreciate 
you holding this hearing, especially given the turmoil that we 
are seeing in the bond insurance industry. I think it is 
timely.
    From the information that surfaced in recent weeks, it 
appears that the problems faced by these financial guarantee 
corporations are largely the result of failed business models, 
but as we listen to the three panels of witnesses that we are 
going to hear today, it is worth noting that we are not going 
to hear from an expert on insurance matters from within the 
Federal Government because no such position exists in our 
Federal Government.
    Mr. Sirri is here representing the SEC. He is going to 
provide the committee with insights into the current bond 
insurance turmoil as it relates to the securities industry.
    The Federal Reserve can comment on the banking sector, but 
because these bond insurers, like all insurers, are overseen 
solely at the State level, we do not have the same type of 
Federal representation from the insurance sector that we have 
from the securities and banking industry here today.
    I am, of course, the co-author of the National Insurance 
Act, along with Representative Melissa Bean, and what that bill 
would have done and will still do if we pass it is establish a 
world class regulator for the insured and the insurers of our 
country.
    This Federal regulator would be able to provide Congress 
with valuable insight into the industry it oversees, whether we 
are responding to a national crisis or we are formulating tax 
policy, or we are negotiating a major trade agreement to try to 
get our insurers into other countries.
    It is regrettable frankly that it has taken an incident 
such as this one being discussed to highlight this point. I 
believe this point has to be made because we are going to have 
more problems like this one.
    The lack of a world class regulator able to effectively 
comment on the broader insurance industry as it relates to the 
national economy and capital markets around the world is going 
to continue to hamper that industry and it is going to continue 
to hamper our Nation's economy until Congress acts.
    Again, I would like to thank Chairman Kanjorski for holding 
this timely hearing, and I certainly look forward to hearing 
from our witnesses, but I look forward to the day when we can 
really effectively from Congress address this issue with the 
type of oversight we need, and that requires the National 
Insurance Act.
    Thank you again.
    Chairman Kanjorski. Thank you very much, Mr. Royce.
    Are there any other members of the subcommittee who seek 
recognition for an opening statement?
    [No response]
    Chairman Kanjorski. It is time we turn to the witnesses. We 
will establish the first panel. Without objection, all 
witnesses' written statements will be made a part of the 
record, and each will be recognized for a 5-minute summary of 
their testimony.
    For the first panel, we have the Honorable Eliot Spitzer, 
the Governor of the State of New York, and a long time friend 
of mine. When he occupied the attorney general position, we 
worked together on many issues, and now to have him on this 
issue, I feel at least this committee is supported by a fine 
equipped mind in the right direction.
    Governor, welcome to the committee.

 STATEMENT OF THE HONORABLE ELIOT SPITZER, GOVERNOR, STATE OF 
                            NEW YORK

    Governor Spitzer. Thank you, Mr. Chairman, for your 
hospitality and your kind words and introduction. All the 
members of the committee, thank you for permitting me this 
opportunity to spend a few minutes to explain our concerns and 
some of the history that I will relate to you and how this 
problem/crisis has emerged.
    You will hear in the next panel from Eric Dinallo, who is 
the superintendent of insurance in the State of New York, and 
is exquisitely schooled in the intricacies, and indeed, Mr. 
Dinallo is a world class expert on all insurance matters and 
has done a world class job addressing this issue.
    What I want to do is summarize to a certain extent some of 
the steps that have preceded the emergence and the public 
perception of this crisis because I think it bears reflection 
that this is a deeper problem than perhaps is understood.
    Let me first frame this as many of you have observed. There 
are many victims in the current market uncertainty and the 
unsettled marketplace that is exacting a price upon many 
different sectors and groups of individuals.
    I begin with individual investors, those individuals around 
the Nation, virtually every individual who invests in a muni 
fund, in a 401(k), in a mutual market fund of any sort, holds 
municipal bonds. Those municipal bonds have dropped in value 
and as a consequence, there has been an asset value lost to 
virtually every investor in the Nation, and that is the pool of 
individuals whom I first think about as their life savings are 
indeed being if not jeopardized, at least put under temporary 
pressure because of the market uncertainty.
    Second, as you have all referred to, governments. 
Governments are paying an enormous cost for the spike in 
interest rates that is being forced upon them in terms of their 
financing. You have referred to several examples.
    You will hear from the Mayor of Wilkes-Barre on the next 
panel.
    This is typical of what every government entity across the 
Nation is going through. Indeed, just yesterday, the auction 
rate securities, which are vehicles used by many governments, 
many authorities/agencies around the Nation, some 60 percent, I 
believe, of the auction rate security bond auctions failed 
leading to a spike in what is called a ``reset'' in the 
interest rates paid.
    The Port Authority of New York and New Jersey, which has 
very significant outstanding debt and uses the auction rate 
securities, is now paying 20 percent on some debt that of 
course was in the low single digits before yesterday.
    This, I should observe, has absolutely nothing to do with 
the underlying security of the debt offering. It is merely a 
consequence of the uncertainty and the unsettled nature of the 
capital markets.
    Third, the third impact we need to think about is to our 
financial services sector that has needed to take very 
significant write-downs and although one could say to a certain 
extent they are responsible for their own willingness to incur 
this debt, this has had an enormous impact because of their 
capitalization need, to seek renewed capital and in the 
intervening period, their inability to extend the liquidity out 
into the marketplace that we might want has had an enormous 
impact and not only on their balance sheets and on their market 
valuation, but also on the economy at large.
    Those are the three major entities that have been affected.
    Let me quickly run through the sequence of events that got 
us where we are. I think it is important to remember this data 
is derived from a great extent from the subprime market, 
mortgage marketplace.
    That is the marketplace where we saw this enormous 
explosion of debt, debt that is now substantially under 
pressure, debt that is not and was not, we now understand, 
affordable by those who incurred it, debt that to a certain 
extent was marketed with teaser rates that were going to 
explode, teaser rates that were often not explained, and teaser 
rates that were unworkable for those who were incurring the 
long term debt.
    There is a fair debate that goes on where the liability and 
responsibility for incurring that debt should rest, but we 
should all understand that as an initial matter, much of this 
derives from the subprime mortgage market, and that is where 
this debt that is now causing problems comes from.
    I will not go through the details but you may have seen a 
piece that I had in this morning's Washington Post, in which I 
said that one of the entities that clearly should have been a 
responsible party in examining the magnitude of the mortgage 
debt that was being offered and was being incurred and was 
resting on the balance sheets of many entities was the OCC.
    I think it is a very fair question, why the OCC, given its 
responsibility to ensure that the balance sheets of our banks 
are stable, did not do much more to examine whether this debt 
was being issued properly but in fact chose to shut down those 
of us who were attorneys general at the time in our effort to 
examine that.
    Step two. If step one was the issuance of a debt, step two 
was the securitization of the debt, this effort to homogenize 
what was an enormous pool of debt, much of it which was 
uncertain in its underlying nature, and to somehow transform 
bad debt into good debt.
    As the old cliche goes, garbage in, garbage out. You cannot 
transform bad debt into good debt simply by homogenizing it 
through the securitization marketplace. Securitization is of 
course a critical part of our capital markets. It is necessary. 
It is good. It has permitted greater liquidity, but it cannot 
be used to mask the underlying risks of the debt that is 
outstanding.
    The third step was the credit ratings that were applied to 
much of this debt, and I think it is a critical question that 
we all must ask, where have the credit rating agencies been.
    I think the best way to ask this question quite frankly is 
have they ever picked up a major inflection point in the debt 
markets. If you look back over the bubbles, if you look back 
over the market crises of the past 15 or 20 years, the question 
I would be tempted to ask, as the SEC as the overseer of these 
agencies should ask, I believe, is where have they ever been 
attuned to the underlying realities as opposed to simply 
following the trend line that the marketplace wants us to 
follow.
    Those trend lines do not continue in one direction forever. 
If they have missed these inflection points, then are they 
providing the guidance the marketplace needs.
    Step four, as we now are focusing upon, was the insurance 
of the underlying securities, the insurance of these enormous 
pools of capital, and the point I would make here, and Mr. 
Chairman, you alluded to this, the bond insurance companies 
which are, as you pointed out, infinitesimal, very small 
participants in the larger bond marketplace, began, and for 
most of their lives, served only one purpose, and hence their 
name, monolines, their purpose was to insure municipal debt.
    Municipal debt, which is one of the two big pockets we are 
talking about here, the other being the securitized, the CDOs 
and all of those sort of acronyms that have emerged over the 
past couple of years, the municipal debt market is remarkably 
secure.
    When the bond insurance companies' primary and indeed 
exclusive responsibility and business model was to insure that 
debt, those insurers themselves were remarkably secure.
    It was only when the bond insurance companies decided that 
whether for reasons of profitability or interest, whatever the 
rationale may have been, to expand their jurisdiction and began 
to veer into the securitized market of the subprime mortgage 
debt and other more sophisticated instruments that they began 
to incur exponentially greater risk.
    That is why we have the problem we have today. Their 
expansion from monolines to dual lines is what has generated 
the crisis that we are faced with and what we must think about.
    Let me make one point here having seen that sequence as it 
has gone from the initial issuance, the origination of the 
debt, to the insurance of the debt by the bond insurance 
companies.
    We are now seeing this unravel piece by piece, as it is 
clear that the potential implications of a downgrade for the 
insurance companies, the bond insurance companies, could be to 
generate a tsunami of selling and could be to generate the 
necessity of selling into a marketplace that is not terribly 
liquid which would then generate additional write-downs through 
the financial services companies, less liquidity, more cost to 
governments, and more costs to investors.
    We are saying to ourselves, how can we stop this? There are 
many proposals before us. Mr. Chairman, I think you gave us the 
array and the spectrum that we should probably consider.
    I want to make just two points, if I might. First, the role 
of the States here is necessary because the Federal Government 
until now and perhaps even as we look into the future, the 
Federal Government has hesitated and indeed refused to 
participate as a regulator in a meaningful way in the insurance 
sector.
    Several years earlier, years back, I was here testifying 
about some investigations that my then Office of the Attorney 
General was conducting into improprieties in the insurance 
sector, and I spent a fair bit of time chatting with Members of 
Congress on both sides of the House and the Senate to see if we 
could generate support for the notion of a Federal regulatory 
role in the insurance sector.
    I will tell you there was no interest. Whether this was a 
consequence of a political dynamic or an economic perspective 
is a question we could discuss, but there really was no 
interest in creating at that time a Federal role in the 
oversight of insurance.
    Consequently, it has fallen to the States to do this. I 
think they have done it by and large extraordinarily well.
    I know, Mr. Royce, that you want to create a Federal entity 
and we could have that conversation, but I think it should not 
be ignored that the States have done an extraordinary job 
through most of the market up's and down's in regulating the 
insurance sector.
    I want to say that Mr. Dinallo has really, I think, done 
yeoman's work trying to resuscitate the capital of the 
underlying insurance, bond insurance companies, to try to 
preserve their creditworthiness and their credit rating.
    The final point I would make is that as the clock is 
ticking, and as we are moving forward, we are seeing real harm 
not only to investors and governments, but to the capital 
markets.
    Therefore, it is time for people to act. It is time either 
for deals to get done, in which case there would be a 
recapitalization of the underlying bond insurance companies, 
which is something we hope for, as Secretary Paulson testified 
earlier today on the Senate side, those are private 
transactions. There is only so much a government entity can do 
to encourage or cajole, but we certainly have been doing what 
we can do to encourage a recapitalization of those companies.
    If that does not happen, given the uncertainty in the 
auction markets, we will be forced to act sooner rather than 
later. What that might lead to is what we call the ``good book/
bad book'' structure, where we peel off the municipal piece of 
business.
    There are, as you are well aware, offers to purchase that, 
whether it is from Berkshire Hathaway or others who have 
recently stepped into this market void, there are offers that 
would permit us to essentially restore stability to the 
municipal part of this business.
    If we get to the point where we think the pain to the 
municipal part is too great, where governments and investors 
are suffering too much, we will need to move in that direction.
    My message to those who are contemplating various 
transactions that could be done that are frankly preferable, it 
is not our first choice that we move in that direction. My 
encouragement to those individuals, entities, banks, investors 
of any sort, private equity or major financial institutions, is 
that they move with some increase in rapidity because time is 
short.
    At this moment, I would welcome your questions.
    [The prepared statement of Governor Spitzer can be found on 
page 261 of the appendix.]
    Chairman Kanjorski. Thank you very much, Governor.
    I actually took the effort this morning to watch your 
presentation on CNBC in regard to your evaluation of cause, 
effect, and responsibility. I tend to agree somewhat but not 
entirely with you as to the position.
    Do you not agree, Governor, that the important thing is in 
the latter part of your statement, to get to stability as 
opposed to finding fault at this point?
    Governor Spitzer. Absolutely. There is no question. The 
look back, as it were, and the finger pointing is useful only 
to the extent that it will be instructive as we look forward to 
the creation of either an alternative model that Mr. Royce may 
support in terms of national regulation of the insurance 
markets, or changes in the way that we look at the underlying 
credit analysis that we get from S&P, Moody's, and others.
    I think the most important thing we need to do right now is 
to restore stability, which means hopefully not getting to a 
point where the bond insurance companies themselves suffer the 
downgrades that could then generate the cascading effect 
through the capital markets. That is why we are encouraging as 
we can the infusion of capital into those entities.
    Chairman Kanjorski. If the New York Secretary's suggestion 
of infusion of capital or investment, new equity investment 
markets, for some reason or another does not come about, do you 
agree that it would be pertinent for the Congress to act and 
create either temporarily or permanently a corporation of some 
sort to underwrite the municipal bond field, to make sure that 
it continues to exist and go forward, or to authorize the 
Federal Home Loan Banks to issue letters of credit? Is it so 
instrumental, is what my question is, that we set a deadline if 
we can, and then proceed to tell everyone we are going to act 
accordingly, or just leave the free market flow as it is 
flowing?
    I am particularly aware of what I consider a cascading 
effect here when you think it all started in the subprime 
market, but just in the last 4 or 5 weeks, we have seen 
different elements of the credit market impacted in a very 
major way. Now some of the markets are absolutely frozen; I am 
told there just is not a marketplace out there of investors for 
corporate bonds at this point. The same is true for rating 
securities--auction rating securities are not being purchased.
    It seems to me that we are flying down a road at a 
tremendous speed here that could bring into collapse the entire 
financial market as we know it today, not only in the United 
States but potentially it could move around the world and 
metastasize.
    I am just disturbed that there are not too many people who 
are really speaking to the issue, and those who are speaking to 
the issue are assuming that somebody else is doing something 
about it. Maybe I would like to know what the Governor of New 
York and what the superintendent of insurance of New York feel 
you can do surgically in the areas in which you have 
jurisdiction?
    Governor Spitzer. Yes, sir. I agree with your final 
conclusion there. I am torn between two objectives. One, as I 
just said in my opening statement, is to generate a sense of 
concern such that we can move any potential deals with great 
rapidity, and on the other hand, not to speak with such dire 
prognostication that the capital markets begin to sense there 
is no hope out there, because so much of this is emotional and 
driven by the analysis of what is likely to happen rather than 
what actually has happened, not to generate that cascading 
effect that we are concerned about.
    With all due respect to Congress, I am not sure 
congressional enactment could result with sufficient speed if 
we believe that sometime in the next 3, 4, or 5 business days 
we would like to see resolution here, which I think is ideally 
what we would like to see happen.
    I think your notion of a Federal guarantee has been raised 
in a number of articles and it is a very worthy idea and quite 
frankly, I think, had a guarantee of this sort been discussed 
and perhaps extended several weeks or several months ago, it 
would have cut off the decline in our national economy probably 
to a much greater extent than a stimulus package that perhaps 
will boost consumer spending but does not go to the underlying 
concerns of the lack of credit flowing through the economy.
    I think your analysis is exactly correct. It is because of 
the capacity to move with greater speed that Eric Dinallo, the 
superintendent of insurance, has been working with the Fed and 
with Treasury to generate interest in the recapitalization of 
these markets.
    I would say to add one more aspect to it, it is a fair 
question whether the State of New York as the State of New York 
indeed going forward will seek or need or use bond re-
insurance, if you look at one of the interesting things out in 
the marketplace.
    Some of the municipal debt that has been offered and is in 
the marketplace without the so-called Triple A wrap is selling 
at a higher price than debt without it.
    There could be in an odd way right now a negative effect on 
pricing by merely being involved with some of these bond re-
insurance companies.
    There will be a transformation of that marketplace but 
certainly in the near term, we would like to see a 
recapitalization. If that does not work, a guarantee of some 
sort certainly would be an interesting approach.
    Chairman Kanjorski. Thank you, Governor. Ms. Pryce?
    Ms. Pryce. Thank you, Mr. Chairman. Thank you, Governor, 
for your testimony.
    There certainly is enough blame to go around. There is no 
sense, aside from the instructive nature of it, pointing many 
fingers.
    The State of New York certainly has a lot on its plate now. 
I was very interested to hear you say that in years past, you 
have been up on the Hill talking about a Federal regulatory 
role.
    I know that this current Congress and this committee has 
investigated that and has shown much interest in it. I just 
wonder where you fall on that spectrum of advice you might give 
this committee as to how well that might work.
    Governor Spitzer. I am testifying with the superintendent 
of insurance of the State of New York sitting behind me, so I 
am trying to be loyal to him. I do not think he wants me to 
support limiting his jurisdiction in any way.
    I will confess that you may remember, I went through an 
interesting dance with the other Federal financial services 
regulators, whether the OCC, the SEC, or the Fed at different 
times when I was attorney general, arguing that State 
jurisdiction was critically important to not only fill in but 
step into the front of the regulatory world when there was a 
void created by a failure of those Federal regulatory entities 
that had jurisdiction but failed to exercise it.
    I do not want us to fall into the mistaken view that merely 
creating a Federal regulatory entity will solve the problem. 
There are many Federal regulatory entities that could have 
acted that did not act. That has been true in many crises in 
the past, whether it was the issue of the analysts, which is a 
crisis that cost investors untold billions of dollars and had 
its own consequences a number of years ago, or the context of 
insurance where there were other ways to address this.
    Bottom line, I feel there might not be any harm that would 
result from having a more structured organized national 
regulator for the insurance sector, but I do not want it to be 
a regulator that would totally supplant the role of the States.
    There is a dualism in the banking system and in many other 
areas of our financial services that benefits consumers and 
investors, because where one regulator fails, sometimes 
somebody else steps in and picks up the pieces.
    The notion of a Federal regulatory presence is something 
that we should consider. I suggested several years ago the SEC 
expand its portfolio to include insurance, especially given the 
convergence of so many financial instruments.
    It is no longer quite as clear that there are discrete 
silos, as people call them, of financial instruments. We might 
as well expand and have one entity that can examine all these 
products.
    Ms. Pryce. I do not disagree. I think part of the problem 
is there are so many entities, nobody knows who the ultimate 
authority and jurisdiction rests with. Your ``garbage in/
garbage out'' analogy, someone is responsible for assessing the 
risk of the garbage. That did not happen correctly, with these 
facts, as we have had the luxury of looking at them in 
hindsight.
    The dual nature of a regulatory system, I think, is 
something that this committee grasps well and has worked and 
could work.
    I just wanted to know if you were willing to go on record.
    Governor Spitzer. I certainly think it is something we need 
to look at. The devil is not only in the details but 
conceptually, we need to think how this would work.
    Frankly, many of the insurance companies, let alone the 
bond re-insurance companies, which is really as the chairman 
pointed out, a tiny little subsector of the industry, the 
insurance industry itself, despite some noises to the contrary, 
does not support, in my experience, the creation of a Federal 
entity.
    There is a comfort level right now for reasons we could 
discuss with a de-Balkanized State-led regulatory structure, 
and I think that may be part of the problem.
    It will be a heavy lift, I will tell you, politically, to 
move this forward. It might be better nonetheless for the 
markets to move in that direction, but just to pick up on my 
comment of ``garbage in/garbage out'' that you picked up on; I 
am usually for recycling.
    The problem is we are recycling this garbage in and out of 
the financial services sector and it is not helping anybody.
    Ms. Pryce. Thank you very much, Governor.
    Chairman Kanjorski. Thank you, Ms. Pryce. Mr. Capuano?
    Mr. Capuano. Governor, I want to preface my remarks by 
simply stating to you that I am a former mayor. I floated 
municipal bonds and I will tell you that every single time I 
did, when it came to the credit agencies, we can call them all 
the nice things they want, it was legal extortion.
    Not a single community in Massachusetts has defaulted on a 
single bond in memory. In memory. Yet, it did not matter. It 
did not matter one bit. Still needed credit enhancements 
because I came from a working class city and well, you know, we 
are not so sure.
    So, legal extortion. That is what it was. That is what it 
is today. I for one will not stand here for 1 minute and defend 
any of the bond insurers who took municipal money, good debt, 
and put it into bad debt.
    I know you say they cannot do it, and I agree with you, but 
they did. This is not the only case. Subprime is part of it. It 
is a huge animal that we are looking at. We are looking at one 
little tail today. It is a big one, but it is just a tail.
    For me, I think it is a little bit more than just we have a 
little market problem. We have people who have been engaged in 
legal extortion for generations, and nobody said a word.
    Cities and counties across this State were forced to pay 
them without adequate reasons. Nobody looked at it and nobody 
cared until today.
    I am glad we are here today. I do not think we can just say 
we only have to look forward; I do think we have to look back. 
This is not the beginning. I respectfully disagree with the--I 
generally agree with everything you said, the big stuff, I 
agree. It is not the beginning.
    Subprime is not the beginning of this. Enron was not the 
beginning of it. It was the same type of thing. The word 
``regulation'' has become a swear word here in Washington, 
D.C.--don't regulate anything; let the free market go. I am all 
for a free market to a certain extent.
    I just want to ask, to some extent, you have said there 
should be Federal regulation. I disagree with you. Some of the 
insurance companies are now coming to see that. They are trying 
to get ahead of the curve, which I think is smart.
    I agree with you totally that it should be dualistic, but I 
wonder, do you really think that the State system alone has 
really worked? If it really worked, why are we here?
    If it really worked, how do we get to long term capital? 
How do we get to Enron? How do we get to all the subprime 
problems? How do we get credit rating agencies that are doing 
what they are doing? How do we get all these things if the 
State system alone really worked?
    I am not saying it has not worked well in retrospect. Once 
they realize a problem, they do act reasonably well. I think 
your State is a leading example of it on many situations.
    Governor Spitzer. I would answer, sir, in the following 
way. First, to begin with your point about the rating agencies 
and since they rate New York State bonds and I have to meet 
with them next week, I will not call it ``legal extortion.'' I 
will try to be a little more polite than that.
    Mr. Capuano. You did not have to deal with them as a mayor. 
I did. I am getting back at them.
    Governor Spitzer. I got that sense, I have to say.
    [Laughter]
    Governor Spitzer. You may want to run for Governor some day 
and then you will find out--no. We will talk about that.
    [Laughter]
    Mr. Capuano. I already said ``no'' to that.
    Governor Spitzer. I would say this. You heard me say 
earlier that New York State may not in fact use this re-
insurance model in the future because there are many debt 
offerings out there, municipal debt offerings, and as I pointed 
out, this is the rock solid part of the market that are selling 
at par and above without the insurance where those that have 
been insured that are selling below par.
    We are going to look at that. As you have just articulated, 
it is not clear what value we get.
    I agree with your larger point. It must be at most a dual 
system. I would not agree to exceed regulatory authority from 
the State exclusively to the Federal Government. Too often, 
that is used merely as a vehicle to drop the bar too low and 
them preempt States from coming in to protect either consumers 
or government entities or whomever. That, I would certainly not 
agree with.
    I disagree with you only to the extent that when you bring 
in several of the prior scandals, whether long term capital or 
Enron or the analyst scandal, those were areas where the 
Federal Government had existing regulatory authority that was 
not exercised.
    Those were not areas where the State in the first instance 
would have been viewed as the entity that should have stepped 
into the void.
    I agree with your larger point, and I made this point 
earlier today on CNBC, when you have Federal regulators who 
invoke ``and ran'' as the definition of what the market should 
be, then we have a problem. When you have Federal regulators 
who run away from fulfilling their job, which is to ensure that 
the rules are enforced, there is integrity in the marketplace, 
we generate these crises.
    Mr. Capuano. I agree with you, Governor. Thank you.
    Governor Spitzer. I think what we have to take away from 
this, as we should have from prior scandals, is that when 
regulators are asleep on the job, the ultimate victim is going 
to be the investor, the taxpayer, and the government.
    Mr. Capuano. We have had regulators come to this committee 
and tell us they did not have the authority to do the very 
things that--I agree with you. I think they had the authority 
to do all these things. They claim they did not.
    I have had them just recently with banks, who have these 
off the books CDOs, saying oh, no, we do not regulate them 
because they were not on the books. If they were not on the 
books, why are they raising money now to pay them off?
    I totally agree with you but understand, in Washington 
lately, regulators are the first to say we do not have any 
power, which I think is completely back asswards, but it is 
unfortunately the life we live down here.
    Thank you, Governor.
    Governor Spitzer. Thank you.
    Chairman Kanjorski. The gentleman from Alabama, Mr. Bachus.
    Mr. Bachus. Thank you, Governor. Governor, in your written 
testimony and your oral testimony today and in some of your 
public statements, you have talked about shortcomings at the 
OCC?
    Governor Spitzer. Yes, sir.
    Mr. Bachus. You have talked about investment banks and some 
things they have failed to do?
    Governor Spitzer. Yes, sir.
    Mr. Bachus. You have talked about the SEC, where they 
should have had greater scrutiny?
    Governor Spitzer. Yes, sir.
    Mr. Bachus. And the credit rating agencies. Your testimony 
today, I did not actually hear you talk about the one entity 
that regulates the bond insurers, and that is the New York 
State Insurance Department.
    Do you also have some criticism of their shortcomings and 
their failures?
    Governor Spitzer. Certainly not since January 1, 2007, when 
I became Governor, and when Mr. Dinallo shortly thereafter took 
over, at which point he has thoroughly and totally revitalized 
an agency that until then was not exercising the oversight 
perhaps that it should have.
    But understand and that is why I laid out before you the 
history of how this problem emerged and how it was an accretion 
of issues and developments within the financial services 
industry that built upon themselves to the point where then you 
had the bond re-insurers extending their guarantee and applying 
their creditworthiness or supposed creditworthiness to entities 
that should not have been within their domain arguably to 
insure in the first place or with respect to which they did not 
have enough capital to extend that insurance.
    You will hear Mr. Dinallo testify in the next panel. He 
will explain to you with some precision precisely what 
standards his office applies to the re-insurance entities and 
why they are trying to get them to--
    Mr. Bachus. Let me ask you this. During your tenure, and I 
think what you are saying is you are acknowledging there was a 
fundamental failure of the New York Department of Insurance.
    Governor Spitzer. No. What I am saying is there was a 
multitude and a sequence of events that led to the subprime 
mortgage guarantees--
    Mr. Bachus. Doesn't the New York Department of Insurance--
they approved the bond insurers investing in the subprime 
securitization market which was a risky market.
    Governor Spitzer. I think that is a topic of conversation, 
and as I said, one of the underlying causes here was expansion 
of their jurisdiction from what used to be monoline businesses 
into the much more risky area of the securitized market.
    Mr. Bachus. The State Department of Insurance would have to 
approve their investment.
    Governor Spitzer. It is a fair question whether that is a 
wise business model to embrace and whether in fact, as your 
colleague from Massachusetts has indicated, whether this has 
not led to the cross subsidization from the municipal market 
over to the other side of the business.
    Mr. Bachus. Let me ask you this. Since 2007, when you 
became Governor, your insurance commissioner who will testify 
in a few minutes, he approved both regular dividends and 
special dividends where capital was transferred from the bond 
insurers to their parent companies, which made them lower their 
capitalization. Is that true?
    Governor Spitzer. I do not know if that is the case or not. 
I will tell you this, that it was only in the past months that 
we have seen a subprime crisis that the Bush Administration, 
the Fed, the Treasury, the SEC, and the OCC failed to address 
over the last--
    Mr. Bachus. I am not debating that.
    Governor Spitzer. Mr. Bachus, you are involved in a finger 
pointing exercise. I am more than happy, sir, to get involved 
in that and go through with precise detail where this 
Administration failed at a regulatory level to stop multiple 
scandals.
    Mr. Bachus. I will say I actually introduced the first 
subprime bill into this.
    Governor Spitzer. If you wish to hear from us about the 
Insurance Department in the State of New York, we will explain 
to you how we have stepped into this breach to save 
governments, investors, and taxpayers billions of dollars.
    Mr. Bachus. Governor, since you became Governor, you 
approved special dividends which drained resources from--
    Governor Spitzer. No, sir. What the superintendent has done 
is act diligently to protect investors, governments, and 
taxpayers and recapitalize these markets where others did not.
    Mr. Bachus. Let me ask you this, Governor. Since 2007, we 
now all agree there was not adequate capital standards, has 
your superintendent raised those capital standards since 2007?
    Governor Spitzer. We are taking the lead. In fact, if you 
look at the press, we have done everything possible within our 
jurisdiction to increase the capitalization--
    Mr. Bachus. When was that done, Governor?
    Governor Spitzer. That was done the moment this problem 
began to emerge.
    Mr. Bachus. And when was that?
    Governor Spitzer. We can get you that date, sir.
    Mr. Bachus. Was it in the last month or two?
    Governor Spitzer. No, it precedes that. The dividend was 
approved by the prior Administration, sir.
    Mr. Bachus. There was a special dividend approved in early 
2007.
    Governor Spitzer. In fact, the dividend was approved by the 
prior Administration and was cut back when Mr. Dinallo got here 
because he believed there was an issue here.
    If you want to pursue that, you can do so, sir.
    Mr. Bachus. How about the regular dividends, were they 
suspended or have they been suspended?
    Governor Spitzer. You cannot do so.
    Mr. Bachus. Let me ask you this, if we address--
    Governor Spitzer. Mr. Bachus, are you saying that the 
superintendent should be in the position to suspend the 
dividend payment of a public company?
    Mr. Bachus. No. I am saying if there are not adequate 
capital requirements, he can--
    Governor Spitzer. Do you think the superintendent should be 
in a position to suspend dividend payments of a publicly traded 
company, sir? We could do for General Motors. We could do it 
for Exxon. We could do it for others.
    Mr. Bachus. I believe to protect those that are relying on 
the bond insurers' capitalization, I believe the superintendent 
of the New York Insurance Department could have raised the 
capital standards.
    Governor Spitzer. Sir, I think you misapprehend--
    Mr. Bachus. I believe there was inadequate capitalization.
    Governor Spitzer. And the role that he has played stepping 
into the breach when this problem, as the chairman said 
metastasized because of the meltdown in the subprime mortgage 
market. That was the causative factor, as I laid out before 
you, that led to the credit failures that have generated this 
problem.
    Mr. Bachus. We have had several CEOs of major financial 
companies who have resigned because they invested in these 
subprime derivatives. That was a mistake. Those were risky 
investments.
    I am just saying that if we are to say what went wrong, the 
one entity that regulated, that was the regulator for the bond 
insurers, it was not the SEC, it was not the credit rating 
agencies. I am not absolving them.
    I am simply saying that to avoid this problem in the 
future, if New York State is going to continue to regulate 
these entities, they are going to have to do a much better job. 
Would you agree?
    Governor Spitzer. No, sir. I think the State Insurance 
Department has done a spectacular job over the last year under 
Superintendent Dinallo examining not only this problem but a 
multitude of other problems in the insurance sector that are 
the consequence of failed national Federal policies which have 
permitted this debt to ripple through the economy and to 
metastasize and to generate a credit crisis that should have 
been addressed much earlier.
    Mr. Bachus. Governor, Mr. Ackman, I have read his 
testimony, he actually says that 6 years ago, he pointed out--
let me see what he said--he pointed out some of the problems 
with the bond insurers and that actually you launched an 
investigation of those criticisms and to MBIA.
    Did you find his criticisms to be credible?
    Governor Spitzer. There is a distinction, I'm sure you will 
appreciate, between fraud, which is the jurisdiction of the 
attorney general's office, and there being regulatory risk that 
perhaps one should not assume.
    What we found after an exhaustive inquiry was that there 
was risk that was within tolerable bounds of business behavior, 
so we did not, and we would stand by this after a thoroughly 
exhaustive inquiry, did not believe there was fraud being 
conducted.
    We did that investigation. What we found, and Mr. Ackman, 
whom I know well from both that set of allegations that he 
raised and other dealings in New York State, he is a short 
seller, and I say that not in any critical way, obviously his 
predictive skills in this one have been correct, but he 
certainly was for many years now saying there could be 
inaccuracies here, but that is a different matter than the 
fraud.
    Mr. Bachus. What I guess I am saying is you have said, and 
I am not disputing it, that it was only in the last 2 or 3 
months that you became aware that the bond insurers may have 
been inadequately capitalized, but 6 years ago, Mr. Ackman made 
the representation that they were inadequately capitalized.
    As a result of that, the attorney general's office, you 
actually investigated them for fraud, but--
    Governor Spitzer. And we concluded there was none.
    Mr. Bachus. His representations were that they were 
inadequately capitalized.
    Governor Spitzer. The conclusions we drew then in the 
jurisdiction of the attorney general's office is to pursue 
fraud and legal impropriety.
    Mr. Bachus. I understand that, Governor.
    Governor Spitzer. What we concluded was that there was 
none, but that the market risks there were real.
    Mr. Bachus. When he said 6 years ago that they were 
inadequately capitalized, did you see any indication of that 6 
years ago?
    Governor Spitzer. That was not an issue that we really 
asked. We do not examine inadequate capitalization at the 
attorney general's office. What we examine is fraud, 
impropriety, and failure to disclose to the marketplace. Those 
are pretty distinct issues.
    Mr. Bachus. Would you agree today they were in fact and are 
inadequately capitalized?
    Governor Spitzer. Back then?
    Mr. Bachus. No, now.
    Governor Spitzer. Of course they are now because that is 
what we have been working diligently and Mr. Dinallo has been 
working diligently as many people in State government have to 
recapitalize those companies.
    Mr. Bachus. I very much appreciate that.
    Governor Spitzer. That is the critical link that is now 
being challenged.
    Mr. Bachus. I guess my only point is as we look at these 
various agencies, the credit rating agencies, the investment 
banks, I think the State of New York has to accept some 
responsibility in that they were primarily--the bond insurers--
were regulated by the New York Department of Insurance. Whether 
that was under your watch or someone else's, I think that is a 
fact.
    Governor Spitzer. We are trying to recapitalize these 
companies because the market conditions that exploded changed 
the adequacy of the capital sufficiency and the analysis that 
would go into that.
    Mr. Bachus. Yes, and I compliment you for that. Thank you.
    Chairman Kanjorski. Thank you, Mr. Bachus. Mr. Meeks?
    Mr. Meeks. Thank you, Mr. Chairman. I would like to welcome 
my Governor from the great State of New York. It is always good 
to see you and to be with you.
    I just have a couple of quick questions for you, Governor, 
to get your opinion on. How at risk do you believe the 
municipal bond assets are right now?
    Governor Spitzer. I think first it is always great to see 
you, Mr. Meeks, Congressman. I would say the municipal market 
is as stable now in terms of the creditworthiness of the 
underlying securities as it ever has been, and as you will hear 
repeatedly, the default rate is de minimis within that market, 
and therefore, I think investors should take great comfort from 
the fact that their holdings in that area are secure.
    Mr. Meeks. Maybe this happened with Mr. Capuano when I 
walked in. In your opinion, because I heard you talking about 
regulatory steps, etc., and what the regulatory agencies do or 
do not do, one of the questions I had for you was what steps do 
you think the Federal Government should take to support and to 
address the effects of downgrading for bond insurers?
    Governor Spitzer. I think the concern we have about a 
downgrade for the bond insurance entities is that it would then 
have a cascading effect of a market evaluation of an enormous 
volume of bonds that are in the marketplace.
    What we therefore think the first and best step to 
undertake is a recapitalization of the bond re-insurance 
companies so that they do not themselves get downgraded.
    In the absence of that, Chairman Kanjorski has raised at 
one extreme, the possibility of a Federal guarantee that would 
come in to reassure the marketplace that these bonds are not in 
fact going to default.
    At the other end of the spectrum, one can imagine lesser 
steps such as the creation of new insurance entities, and Mr. 
Dinallo has very effectively sought the entry of other 
potential participants, whether it is Berkshire Hathaway's 
offer to buy the muni part of the book of these companies or 
something between that and a full Federal guarantee.
    Mr. Meeks. Lastly, Governor, Mr. Buffett made an offer the 
other day about putting in or underwriting re-insurance 
policies of about $800 billion on municipal bonds.
    My question is, good move? Bad move? What do you think of 
his offer?
    Governor Spitzer. I would not want to second guess Mr. 
Buffett, but I think I would state it this way. The fact of the 
offer has been very affirmative for the marketplace, because 
what it has done is demonstrate to municipal bond holders and 
the municipal marketplace that there is as a backstop always 
the possibility of this division of the businesses into what is 
referred to as the good bank/bad bank, so that you could split 
off the municipal part of it, which is secure and find a 
guarantor to lend stability to that marketplace.
    It is not perhaps the optimal result because it would be 
preferable to have the entire bond insurance market stabilized 
without taking away the municipal part of from the other piece 
of business, making sure, as your colleague from Massachusetts 
suggested, that there not be a subsidy that goes from 
municipalities over to the other part of the business is also, 
I think, a legitimate governmental objective.
    While we are happy that there is the offer from Mr. Buffett 
and arguably others who could step in based upon their own 
valuation of that business, we are also hopeful that there 
could be a resolution that does not require that sort of 
division.
    Mr. Meeks. Thank you, Governor. I yield back.
    Chairman Kanjorski. Thank you, Mr. Meeks. Mr. Feeney?
    [No response]
    Chairman Kanjorski. Mr. Castle?
    Mr. Castle. Thank you, Mr. Chairman. Thank you, Governor, 
for taking the time to be here and to educate us about these 
issues.
    My question may be a little different but it pertains to 
the subject of the credit issues in this country. As we all 
know, we face an ongoing credit and liquidity crisis that has 
caused billions of dollars of losses to investors and financial 
institutions.
    I am concerned that recently introduced legislation to 
regulate the credit card industry has the potential to make the 
credit crisis much worse.
    I raise this issue today, Governor, because it seems that 
you might agree. In August, you vetoed a bill that would have 
prohibited credit card issuers from raising the cardholder's 
interest rate or imposing a fee based solely on the reported 
delinquency of the cardholder on another creditor's account. 
This is commonly referred to as ``universal default.''
    You said, ``To the extent that this bill might have a 
practical impact, it would harm rather than benefit New York 
credit card customers,'' and then you added, ``In particular, a 
consumer's delinquency on a creditor's account is an indication 
that the consumer may be at risk of not paying other accounts. 
This bill would force credit bill issuers to increase interest 
rates or fees charged to all credit card holders, shifting the 
financial burden from those who are in default on an account to 
those who are not.''
    My question is if the bill or provisions to ban universal 
default is appropriate right now during these difficult 
economic times?
    Governor Spitzer. I would have to think about that and 
analyze it more carefully. As you can see from my veto message 
then, I believe there were also preemption issues that were at 
play in terms of whether or not the State was empowered to do 
certain things or the things that were in the bill, if I 
remember it. I would have to look at the whole veto message.
    Also, as you can see from the portion you read, what we 
were trying to do was determine what the benefits would be to 
various payers and what the cross subsidy would be between 
those who had good credit and those who did not have good 
credit, and whether or not this amounted to a subsidy that we 
did not want to ask some consumers to foot.
    Mr. Castle. I thank you. Let me change subjects. I want to 
talk about the credit rating agencies. This may not be a 
correct interpretation, but I believe there are discrepancies 
in how they are paid. Often they are paid by the entity they 
are doing the rating for.
    Also, I am a little concerned about the fact that once 
something is rated, they are able to go from a bank which has 
issued a mortgage to a conglomeration putting together a 
package to be sold. Sometimes these ratings follow the 
customer, which also concerns me. Are you looking at the 
general subject of the credit rating agencies in terms of how 
they go about their business? Should there be any kind of a 
Federal role in this? I am not saying there should be; I am 
just asking the question about whether or not all this is being 
handled correctly.
    My suspicion in watching all of this unfold over the last 
several months is that there is something not quite right in 
the whole credit rating agency business.
    Governor Spitzer. As I think I said earlier and you have 
heard from some of your colleagues, there is a general 
perception that the credit rating agencies have not always 
picked up on those inflection points and led the market, rather 
they have followed, which is of course not really their 
purpose.
    The particular issue you point to, which is the potential 
conflict of interest that derives from the fact that they are 
paid by the very entities whose ratings they are issuing, is 
something that has been examined and nobody has yet forced any 
change in that.
    I think it is a fair topic of conversation. There are 
others who have suggested what I think is called a 
``subscription model,'' everybody pays in and therefore there 
are different ways of generating the funding stream to do the 
credit analysis.
    More particularly, I think just as regulated entities, they 
go back to the SEC in terms of the SEC having direct oversight 
of their behavior. I am not sure that means that the SEC should 
be faulted necessarily for not challenging this particular 
structure, but I do believe the SEC is examining right now 
whether the credit rating agencies themselves have been 
handling those determinations properly.
    Mr. Castle. Thank you, Governor. I think it is at least a 
fair subject for examination. I am not sure what the outcome 
should be.
    Governor Spitzer. Critical subject for examination because 
as I think we would all agree, if you cannot rely upon the 
value of those ratings which are relied upon for better or for 
worse by many investors, then a fundamental piece of 
information in the marketplace is not doing what it should be 
doing.
    Mr. Castle. Thank you, Governor. I yield back, Mr. 
Chairman.
    Mr. Bachus. Mr. Chairman, if I could ask unanimous consent 
to introduce into the record the Governor's signing statement 
on the legislation that would have restricted universal 
default, to offer that into the record.
    Chairman Kanjorski. Is there any objection?
    [No response]
    Mr. Bachus. By the way, I totally agree with what you said 
in that signing statement.
    Governor Spitzer. Thanks. I am happy to send you an 
original.
    [Laughter]
    Chairman Kanjorski. Without objection, it is so ordered.
    Mrs. McCarthy of New York.
    Mrs. McCarthy. Thank you. Thank you, Governor, for being 
here. One of the concerns that I have with all this fallout are 
my little towns and villages and their ratings and how that is 
going to be affected.
    Certainly, on Long Island, where we are paying high taxes, 
each one of my villages is really just hanging on by a shoe 
string in the majority of cases, even when they need the 
capital improvements.
    Following through with my colleague from Massachusetts, Mr. 
Capuano, when he was talking about when my villages apply for 
their ratings and basically have to pay extra money to be 
wrapped up so they can have a better rating, is there any way 
that the municipalities can get out of dealing with the bond 
insurance without putting at risk being the history, as my 
colleague has mentioned, the defaults are very, very, very 
rare?
    Governor Spitzer. We can imagine a different structure but 
I think as of this moment, the reality is that for those 
municipalities, villages, towns, authorities, and agencies, the 
smaller entities whose creditworthiness is not routinely 
analyzed by the marketplace at large, it would end up being 
unfortunately somewhat difficult to float the bonds and gain 
the liquidity they need and actually get the marketplace to 
accept their debt offerings unless there is some arbiter of 
creditworthiness, which at this moment at least is or are the 
very credit agencies that we are talking about.
    I can imagine an alternative structure where government 
itself, because as I think we have all agreed, the default rate 
among government issued debt is de minimis at most and really 
almost negligible and even where there has been technically a 
default, there has been payment, one can imagine another 
structure where that role was played by some other type of 
entity, so you would not necessarily need to go back to those 
particular entities that now fill that market function.
    Mrs. McCarthy. Thank you. The other thing that I was 
curious about, when these bond agencies come into my village 
and they are basically negotiating, and I understand the bond 
insurance industry said they are separate, but when they wrap 
up somebody who might be an A or an A-, and they wrap them up 
and bring them up to a Triple A, is that not kind of a conflict 
of interest?
    Governor Spitzer. I think the tensions that are there are 
real and as I said in response to Congressman Castle's 
questions, I think there are some issues that could be 
investigated and probed about whether or not that has played 
any role.
    I think the larger problem is whether the underlying credit 
analysis itself has been proper, whether or not there was a 
conflict that motivated it, which is always harder to prove. I 
think there is now some sense that there has not been just the 
adequate analysis of much of this underlying debt.
    Mrs. McCarthy. Thank you. Just to mention that I did not 
want you to think that I was ignoring you. I never do opening 
statements. I happen to believe that I would rather hear from 
the witnesses than everybody on the panel.
    Thank you.
    Governor Spitzer. Thank you.
    Chairman Kanjorski. Mr. Price of Georgia.
    Mr. Price. Thank you, Mr. Chairman. I appreciate it. 
Governor, welcome. We thank you for coming today.
    I want to remind you and others that the title of this 
hearing is, ``The State of the Bond Insurance Industry.'' If I 
might ask a question about the bond insurance industry, and I 
will delve into the other things in just a moment.
    Who is it that regulates the bond insurers?
    Governor Spitzer. There are really multiple layers. There 
is one layer, obviously, the State insurance department, which 
oversees their solvency and that is something that we have 
done, which is why we are trying to recapitalize them. There 
are obviously many other entities that oversee aspects of what 
they do.
    Mr. Price. In the area we are talking about right now, it 
is the States?
    Governor Spitzer. We have a role; absolutely.
    Mr. Price. Do you think that ought to change?
    Governor Spitzer. As I said in my conversation with 
Congressman Royce, I think there is a discussion that could be 
had about a duality, that one could imagine an entire Federal 
overlay of regulation in the insurance sector at large.
    I think if you are going to have a conversation about where 
insurance regulation should reside, Federal or State, the 
conversation should go way beyond the bond insurance sector.
    That is as the chairman pointed out really a tiny subset of 
the marketplace. It is a subset right now that is critically 
important, but I think the larger question is does the Federal 
Government want to intercede and become part of the regulatory 
environment with respect to insurance.
    Mr. Price. We got to where we are right now with the States 
regulating the bond insurers.
    Governor Spitzer. No. We got where we are today because of 
a multitude and a sequence of decisions, and that is why I laid 
it out as I did in my testimony.
    Mr. Price. I asked an incorrect question. Up until this 
point, the States have regulated the bond insurers and we find 
ourselves in the situation that we find ourselves for a variety 
of reasons that we could talk about. Would that be accurate?
    Governor Spitzer. We could sparse that statement and say as 
each piece of it is correct, but I think it does not properly 
capture the causative factors that got us--
    Mr. Price. I got you. You have had some criticisms, 
significant criticism for the OCC. Their jurisdiction is truly, 
in this instance, in this capacity, just over the national 
banks; is that not accurate?
    Governor Spitzer. Their jurisdiction is to examine the 
creditworthiness and ensure the solvency of national banks but 
I would point out that was the foundation upon which they 
argued that we at the State level in an effort that all 50 
attorneys general and the 50 State treasurers of both parties 
sought to participate in, to examine the issuance of much of 
the subprime debt by subsidiaries of those national banks.
    In other words, much of that was issued by subsidiaries of 
the national banks.
    Mr. Price. I will get to the subsidiaries in just a second. 
You are not suggesting that the OCC ought to regulate the State 
banks?
    Governor Spitzer. No, we are not. What we are suggesting is 
that the OCC, when it sought to preclude, if you were to go 
back to the litigation where the States sought to overturn the 
preemptive acts of the OCC, what we sought to argue, 
unsuccessfully as a matter of law, but I think as a matter of 
policy, we were correct, that by acting as it did, the OCC 
prevented States from enforcing laws of general applicability 
in terms of both consumer fraud and fairness and consumer 
protection with respect to an entire sector that has now, to 
use the chairman's phrase, metastasized, such that much of that 
debt has become toxic in the capital markets.
    Mr. Price. I think there is some question as to whether or 
not the preemption actually provided for that to occur or not.
    Governor Spitzer. Could I interrupt for just one second? I 
think you and I might agree on that point, but the preemption 
that they invoked was deemed sufficient, as a matter of law. 
They won in the Second Circuit.
    Mr. Price. I got you. I'm running out of time.
    Governor Spitzer. In other words, they succeeded as a 
matter of law.
    Mr. Price. It is my understanding of the subprime loans 
that are out there, that the financial banks were responsible 
and their subsidiaries for only about 10 percent. Is that a 
number you would agree with, in that ball park?
    Governor Spitzer. I simply do not have that number before 
me right now. I do not know.
    Mr. Price. I think that is probably the case. That is my 
understanding. I would hope that as we concentrate on the issue 
of the bond insurers and for whom we ought to address a 
solution, if there is in fact a Federal solution, that the OCC 
and national banks are probably not the area where the bulk of 
the problem lies.
    Governor Spitzer. Again, I think it would depend on how you 
measure it. As I said, the preemptive acts and the preemptive 
efforts by the national banks was read as broadly as possible.
    We were successful, the State of New York and many other 
States, many multi-State actions in changing behavior. One of 
the early cases was Delta. Then there were a sequence of cases 
with settlements and change in behavior that totaled hundreds 
of millions of dollars over the course of the intervening 
years.
    We were pursuing this in a multi-State level with as much 
breadth as was possible against those non-Federal banks as we 
could.
    Mr. Price. One final question, if I may, Governor. I am 
aware of some press reports that there has been some pressure 
that has been placed on rating agencies by New York State 
officials to delay further downgrades of the bond insurers 
during the bailout discussions organized by your 
superintendent.
    Are you aware of those reports and if so, are they true?
    Governor Spitzer. I have seen those reports. In fact, I 
would say if there are reports which discuss pressure, those 
would be improper. In other words, it would be wrong for any 
government entity to pressure a rating agency to do anything 
one way or the other in terms of an analysis of the 
creditworthiness of an institution.
    There have been conversations with the rating agencies. I 
have not had any, but I know there have been conversations 
including Federal officials at many Federal agencies as well as 
State agencies to keep them informed of what is happening 
because it is critically important information for them to make 
their appropriate and relevant determinations.
    They have sought information as a part of their effort to 
ensure the flow of information they are responsible for into 
the marketplace is accurate.
    They have sought and been provided with ongoing information 
about what is transpiring.
    Mr. Price. You would not describe those as pressure, those 
conversations?
    Governor Spitzer. As I said, I have not had any of those 
conversations personally. I have had zero contact with the 
rating agencies.
    I know that Federal entities and individuals have. State 
entities have as well.
    Not having been a party to them, I was not there, but I 
would say that certainly nobody should or would and that I am 
aware of, nobody has, done anything that would suggest 
pressure. It is a question of keeping them informed.
    Mr. Price. Thank you. Thank you, Mr. Chairman.
    Chairman Kanjorski. Mr. Scott of Georgia.
    Mr. Scott. Thank you, Mr. Chairman.
    Governor, I would like very much to get your thoughts on 
what Congress has done so far, particularly given the fact that 
from what I understand, you are saying that so many of our 
subprime mortgages or the insurance for those are provided by 
bond insurance companies, costs are going on, there is a direct 
impact on what is happening from the frontal cause of the 
subprime mortgage crisis, as you point out in both your 
testimony and in your statements.
    I think it would be very interesting for the committee to 
know what your thoughts are on the reaction that Congress has 
given so far to this, and the economic stimulus package.
    First of all, is this sufficient? Does it get to where we 
are? Is there something more we need to do, specifically in the 
part where we are trying to deal with some stemming of the 
foreclosure rate in terms of expanding the loan capacities of 
FHA loans with the Federal Government guarantee, and also this 
1-year extension of increasing the loan limits for Freddie Mac 
and Fannie Mae from about $430,000 level mortgages up to about 
$785,000 mortgages.
    Your thoughts on that. Is what we have done so far 
sufficient to kind of respond to this, and what would you 
recommend we do going forward?
    Governor Spitzer. I would say the response has been 
judicious and measured and thoughtful. I think it has all been 
affirmative but the bottom line, not sufficient.
    I think that the inquiry the chairman is conducting today 
is hugely important and the ideas that the chairman has 
proposed in terms of using as a final backstop the notion of a 
Federal guarantee is an important notion to place in the 
marketplace. Hopefully, we do not need to get there.
    Having said that, I think it is a concept that perhaps 
would have been more important and more useful as a stimulus 
package than the stimulus package that was actually enacted, 
which is certainly beneficial and helpful to many consumers and 
taxpayers and will help and provide some supposedly measurable 
bump to the economy, but did not address the underlying credit 
crisis that I think is what is hindering the economic growth at 
this moment.
    I think that the notions of resuscitating credit by 
relieving the credit markets of some of the overhang of the bad 
debt would probably be more important in the long run.
    Mr. Scott. Let me ask your opinion on the national 
regulator. You may have mentioned that prior to my coming in. 
Where do you fall down on that and why?
    Governor Spitzer. I think it is a notion we should discuss. 
As I mentioned, it is an issue I raised and a notion I raised 
several years back when I was involved in another set of 
inquiries into the insurance sector.
    There did not at that point in time seem to be tremendous 
receptivity for the notion here in D.C., but I think as an 
overlay on some of the State regulation, it is certainly 
something we should consider.
    As an effort to supplant entirely State regulation, I think 
you would find significant opposition, and I think you would 
also find significant opposition if it were an effort to impose 
regulation and then preempt State regulations with a bar that 
was too low in terms of the effectiveness of the regulatory 
framework.
    Mr. Scott. Let me just get your thoughts on this somewhat 
complicated issue of the impact on municipal bonds. I am 
particularly concerned about that because so many of our 
smaller and rural communities rely on municipal bonding.
    I am just concerned about the impact that is being placed 
on this from these just astronomical higher borrowing costs, 
and what impact that will have on their capital projects.
    Governor Spitzer. It will have unfortunately a very 
detrimental effect. In my testimony, you will see that I 
delineate at least three victims, as it were, of the current 
credit crisis. One of them is the municipal governments whose 
resources, scarce resources, especially these days, are being 
forced to be used to pay higher interest rates, and if you look 
at the auction rate security market, just yesterday, a lot of 
that debt was reset as high as 20 percent, those are scare 
dollars that are now being used to pay interest rates that 
should be much lower if you merely look at the credit risk of 
the underlying securities.
    Mr. Scott. Finally, I have a serious problem with these 
teaser rates. How do you feel about these teaser rates? Should 
we get to a point where we should just basically outlaw them?
    So much of the problem that we have now with our mortgages, 
these loan originators are going in there knowing full well 
that these people cannot pay. Their credit is bad. They tease 
them in. When the adjustable rates come in, you know, there 
goes the home.
    Governor Spitzer. Congressman, I think what we have is a 
crisis that results from the inappropriate marketing of many 
mortgages and borrowing by individuals who did not perhaps 
understand what the transaction was.
    It is very hard to define what a teaser rate would be in 
any individual transaction, in any individual instance, and who 
can pay what.
    What we have focused on more in our effort, whether it was 
some of the cases I made when I was attorney general, or where 
we are now crafting legislation at the State level, is to 
ensure that there be an analysis done to ensure a capacity to 
pay.
    Often what happens with much of the subprime debt is people 
saw a teaser rate that did, as the term would suggest, seduce 
them in, but no underlying analysis was done about the capacity 
of the borrower to pay once that teaser rate expired and there 
was a significant jump to the rate that would apply for most of 
the duration of the mortgage.
    We have sought to ensure that lenders go through that sort 
of analysis in order not to create the sorts of problems that 
we have today.
    Mr. Scott. Thank you, Mr. Chairman.
    Mr. Price. Mr. Chairman?
    Chairman Kanjorski. Yes, Mr. Price.
    Mr. Price. Thank you, Mr. Chairman. I ask unanimous consent 
that a statement from the Comptroller of the Currency, Mr. 
Dugan, be allowed to be placed into the record.
    Chairman Kanjorski. Without objection, it is so ordered.
    Mr. Price. Thank you.
    Chairman Kanjorski. Mrs. Capito, you are recognized for 5 
minutes.
    Mrs. Capito. Thank you, Mr. Chairman. Thank you, Governor, 
for being here today.
    I have two questions. First of all, I want to ask with the 
chairman's permission to insert into the record a letter from 
my community bankers.
    Chairman Kanjorski. Without objection, it is so ordered.
    Ms. Capito. I am from the State of West Virginia, a very 
rural State.
    Knowing you were going to be before us when we were talking 
about bond insurance, they are calling attention to H.R. 2091, 
which would allow community banks to partner with Federal Home 
Loan Banks. It is actually not in our jurisdiction but I wanted 
to highlight that.
    They feel that this legislation would allow our banks to 
assist smaller West Virginia communities, charitable health 
care facilities and institutions of higher education to raise 
tax exempt funds where such borrowers are unable to obtain bond 
insurance or letters of credit from large market players on or 
at more attractive terms.
    Do you find as Governor of your State that you do have 
these entities that are really sort of left out because of the 
expense of the bond insurance and other things, and that we 
need to try to find, for instance, something like this, to be 
more a more creative backstop for them?
    Governor Spitzer. I certainly support the concept of 
providing greater access to the capital markets in ways that 
might circumvent the need to get the bond insurance. I am not 
sure I could say definitively as I sit here that there are 
entities in New York State that have been precluded from 
getting the raise in capital they need because of this. I just 
do not know if that is how the market has played out.
    I certainly believe as we look back now at the premiums 
that are paid and ask what is the value derived for it, that is 
a fair question, whether government entities are getting fair 
value or whether or not this is the best mechanism for them to 
raise capital.
    Mrs. Capito. I think this is a topic I would like to get 
into in terms of small community banks.
    The other thing I would like to ask you is in our 
background information on this hearing, I have been reading 
about this because this is very complicated and most of the 
bond insurers, I understand, are domiciled in New York? Is that 
correct, as far as you know?
    Governor Spitzer. I think most of them are, yes; that is 
correct. Some of them are elsewhere in the Nation, but yes, 
most of them are in New York State.
    Mrs. Capito. It goes onto say that generally speaking, 
since they are State regulated, that basically New York State 
is sort of looked at as the marque.
    Do you feel that because most of these entities are 
domiciled in New York--do you feel like your insurance 
commissioner or you call him the--
    Governor Spitzer. Superintendent.
    Mrs. Capito. --superintendent, has been a default Federal 
regulator?
    Governor Spitzer. I think it is to a certain extent the 
case that when there are a limited number of entities that act 
in a particular sector and they all, as you say, by default or 
by statute are regulated by one entity, it has a national 
impact. One could even argue an international impact.
    By virtue of that, yes, the superintendent's office in New 
York has become the regulatory entity that has defined to a 
certain extent the playing field.
    Mrs. Capito. Taking that one step forward in defining some 
of the issues, and I realize that you have lined out several 
areas where you think maybe to lay the blame or wherever things 
fell through the cracks or however you want to state it, 
lessons learned, I guess, through your superintendent being the 
default Federal supervisor over these bond insurers.
    I suppose we could look to New York to help us develop in a 
very professional way ways that we could avoid this in the 
future.
    Governor Spitzer. I certainly would hope so. The 
superintendent is sitting right behind me. I think he will be 
on your next panel. I am sure he will volunteer some ideas that 
he thinks at least will benefit or could benefit the 
marketplace as we move forward to try to create that regulatory 
framework.
    Mrs. Capito. Thank you, Governor. Lastly, I would like to 
echo some of the comments of my fellow members from the other 
side of the aisle.
    In representing small communities, it is extremely 
important for infrastructure development, for clean water, for 
all the things that maybe big city livers think, you know, 
everybody has, we still have a great need and I know you do in 
the State of New York as well.
    The stability in this market and affordability is extremely 
important for us to be able to move forward.
    I thank you.
    Governor Spitzer. Thank you.
    Chairman Kanjorski. Thank you, Mrs. Capito. Ms. Moore?
    Ms. Moore. Thank you so much, Mr. Chairman, and thank you, 
Governor.
    I have listened very carefully and perused your testimony 
with great interest. You seem to have laid out really where you 
think this problem has started, with the subprime miss and the 
underwriting that was poorly done or fraudulent, whatever the 
case may be, and then step two, securitization, which you say 
will continue. We cannot really look at that not being 
something that we are not going to do.
    And then the credit rating agencies, make them appear to be 
safe, and then finally, the monoline insurers, make them appear 
to be even more safe.
    Here we are talking about more Federal oversight. Do you 
think that it is possible that these monoline insurers have 
done a great job with floating municipal bonds?
    We all agree it is very little de minimis risk, and this is 
what they were accustomed to doing, and in order to remain 
competitive and to have more customers, they sort of ran ahead 
of their lights.
    When they are evaluating the risk, there are three things 
they look at: Credit risk; market risk; and liquidity risk.
    Do you think it is possible that there is something 
missing? I do not know what it would be called, maybe re-
marketing risk. It seems that at the point at which the 
underwriting is bad and the securitization occurs, that there 
just seems to be a rubber stamp, rubber stamp, rubber stamp to 
these monoline insurers.
    Is it possible or is there any discussions going on about 
revamping or re-evaluating how risk is evaluated, particularly 
as these asset backed securities and credit swaps occur?
    I do not know. Maybe this will be a re-marketing or 
transitory risk added on top of it. Sort of like your mother's 
favorite recipe. You start adding more stuff in and taking 
other stuff out. It is not what you are used to in the recipe.
    Governor Spitzer. At risk of picking up on your metaphor 
because I am not a great chef, but I think really what happens 
is they just completely changed the recipe.
    I think what happened was when they were dealing with the 
municipal debt, basically the market would say got it right, 
and as you pointed out, they were reasonably effective, and you 
could argue, and some of your colleagues have said that the 
towns and villages around the Nation did not necessarily either 
need them or get full value and they felt somewhat abused by 
the fee structure, and that is a fair topic of conversation.
    I think nobody has yet really challenged the underlying 
analysis they conducted in that context, whereas when you 
switch over to the other sectors in which they were active, you 
do begin to feel that somehow the analysis was lacking and the 
analysis upon which they relied and which they then projected 
into the marketplace was inadequate.
    Ms. Moore. My question is, do you know of, or is this 
another panel's question, is there any conversation about 
evaluating these indices of risk?
    These are very broad generalized indicators. Credit risk, 
market risk, liquidity risk. When is the last time they have 
revamped these? We have all these new derivatives and new 
products.
    When is the last time that they have really overhauled how 
they look at risk?
    Governor Spitzer. I think part of the problem is they just 
got it wrong, when we now look back at some of the analysis 
that was done about some of the more sophisticated instruments 
and the underlying debt, people now say wait a minute, it was 
much more risky than was understood.
    I am not sure the methodology was wrong. They just drew the 
wrong conclusions because they did not look at the data, did 
not gather the right data. There was this enormous--as I said 
earlier on, they tried to homogenize a lot of bad debt and 
somehow by the end claim it was good debt. You cannot do that.
    The analysis was wrong. It has come back to bite us.
    Ms. Moore. Without trying to assign more or less guilt, it 
concerns me that the monoline insurers have a really strong 
profit incentive, you know, in order to expand their business 
from their usual municipality bond rating, to not really 
evaluate the risk.
    Did they know that these securitized instruments were as 
risky as they were? Did they know that the underwriting was 
tenuous? Were they just bamboozled, lied to?
    Governor Spitzer. I have not seen any evidence to suggest 
that they knowingly misstated risk or that they knowingly took 
their credit rating by insuring the underlying debt and 
therefore put themselves at risk.
    I think you could argue that if they intended to play that 
game, they are now the ultimate losers because if there is, and 
it is an ``if,'' if there is a successful effort to 
recapitalize themselves, their own companies, there will be 
significant dilution to current shareholders.
    It has not been in their interest to play that game if that 
is what they understood. I think it is more likely they just 
got it wrong.
    Ms. Moore. My time is running out. Just one last question. 
What we have to determine here in Congress is whether to 
regulate more, get some other bureaucracy in place to regulate 
again, or have the industry inside to sort of re-assess how 
they evaluate risk.
    Do we do both? Do we do one or the other or what?
    Governor Spitzer. We certainly at this point think about 
doing both. There is no question that the re-insurance 
companies as well as the credit agencies themselves and all the 
other entities involved in the steps that preceded are going to 
have to evaluate what they did and how they did it.
    The bottom line answer to your question is certainly the 
re-insurance companies are looking very hard at what they did 
and how they extended the re-insurance. The credit analyst 
companies are doing the same thing.
    As the chairman suggested, there is serious thought being 
given to an overlay of a Federal regulatory structure that 
could perhaps lend some additional buttressing to this entire 
effort.
    Ms. Moore. Thank you.
    Chairman Kanjorski. Thank you, Ms. Moore. Mrs. Maloney of 
New York, one of your constituents, Governor.
    Mrs. Maloney. Thank you very much, Mr. Chairman, for giving 
me the privilege to ask a question even though I am not a 
member of this particular subcommittee, but I am a member of 
the overall committee.
    First of all, welcome, Governor, and thank you for your 
help and your department's help in the passage of TRIA, the 
reform bill. It is very, very important. It is good to see you 
here trying to help us with this challenge today.
    First of all, very briefly, how did the bond insurance 
marketplace get to where it is now, and is it possible for this 
sector to continue as an Triple A business?
    Governor Spitzer. Very briefly, it got to where it is today 
by evolving from what we refer to as the monolines, where they 
really did limit themselves to the municipal market and 
expanded their scope in the insurance they extended to much 
more sophisticated and what we now know to be much more risky 
types of investments in securities.
    Can they maintain themselves as a Triple A? Of course. Will 
that necessarily happen? Only the marketplace will let us know 
hopefully in the next few days as we see what steps are taken 
to recapitalize either those companies or new companies 
emerging to step into that void.
    Mrs. Maloney. Governor, what will you do if the financial 
guarantee insurers are unable to complete their own 
restructuring deals?
    Governor Spitzer. What I have suggested and I think the 
superintendent will testify to some greater detail about is if 
the progression is such that there is no opportunity to 
resuscitate the existing companies by recapitalizing them, it 
would perhaps--this is not our optimal choice--it would perhaps 
be necessary to move forward with what have been referred to as 
a good bank/bad bank structure to protect the municipal 
marketplace, which is at its core the first marketplace that we 
should be concerned with.
    Mrs. Maloney. What does the Berkshire Hathaway offer mean 
to the industry, and would you ever insist or compel a company 
to accept the Berkshire offer?
    Governor Spitzer. I would state it differently. I think one 
can imagine--first of all, I would say the offer has been 
beneficial to the marketplace. I think when it became public 
that offer had been extended, I am not sure there is 
necessarily causation, but the Dow jumped pretty quickly.
    I think the marketplace appears at least to have taken that 
as a positive sign with respect to the likelihood of the bond 
reinsurers' underlying economic security.
    Having said that, I am not sure that we would in as many 
words force companies to enter into a transaction where they 
accepted that offer.
    The superintendent has significant regulatory authority and 
he can explain the scope of it a bit later on.
    I am not sure I would use the words ``force them'' to enter 
into that transaction.
    Mrs. Maloney. What regulatory lessons have you learned from 
this experience?
    Governor Spitzer. I think once again there was an accretion 
of market steps, each of which contributed to the situation we 
are in right now, and that is why I replayed that sequence to 
make it clear that there were a series of moments where 
intervention would have been possible, could have been called 
for, and the due diligence that was done perhaps was not 
sufficient to prevent our getting to a point where we now have 
a very significant volume of debt that has been insured where 
the underlying debt insurer claimed to be Triple A, where the 
underlying debt is really significantly more at risk.
    Mrs. Maloney. Lastly, the OCC decision, many of us are 
being criticized now in Congress and regulators are being 
criticized that we did not act quickly enough in the subprime 
crisis, that we did not intervene earlier.
    What is your view of the decision that really said that 
attorneys general could not get involved in the subprime 
problem solving and were preempted by the OCC?
    Governor Spitzer. I disagree with the OCC's actions in that 
regard, in extending their notion of preemption to extend not 
only to all subsidiaries of national banks but in a way that 
precluded the application of laws of general applicability in 
terms of consumer fraud and certain principles of fairness that 
should be taken as elementary in the capital markets.
    Having said that, I think the lesson we take from that is 
that as we discuss the potential of Federal regulation here, we 
need to be careful that the mere presence of a Federal 
regulation does not give us some false sense of comfort, that 
by the mere presence of a Federal regulatory entity, all 
problems will be solved.
    I think that regulatory entities, whether at the State or 
Federal level, can be either successful or unsuccessful based 
upon who runs them and what their view is of the marketplace 
and whether they have the appropriate decision making capacity.
    Mrs. Maloney. Certainly the question is if someone wants to 
help a consumer, why in the world would you cut off the 
opportunity to help the consumer.
    Governor Spitzer. In that vein, we were somewhat 
frustrated, as I said, by the OCC's response, and as we said to 
them, fine, if your view is you are the exclusive entity that 
can in fact oversee this area, then at least we would like to 
see you fulfill that mandate.
    What frustrated us was that having invoked preemption, the 
OCC then stepped away from the problem and permitted it to 
fester.
    Mrs. Maloney. My time has expired. Thank you very much for 
being with us today.
    Governor Spitzer. Thank you, my good friend, Congresswoman 
Maloney.
    Mrs. Maloney. Thank you.
    Chairman Kanjorski. Thank you, Mrs. Maloney.
    I thank the Governor for participating in today's hearing. 
We have a vote in process on the House Floor. We are going to 
stand in recess to make that vote and then come back for the 
second panel who will be taking their place in the interim.
    Governor, I want to thank you for your participation today. 
We certainly have an issue here that is not only important to 
this committee and to the Federal Government, but certainly to 
the State of New York. We hope to work in cooperation to come 
up with some solutions, I want to say in the plural, to see if 
we cannot stabilize and increase the faith and support of this 
great marketplace without further erosion to the American 
economy.
    I thank you very much for coming and participating today.
    Governor Spitzer. Thank you, Mr. Chairman.
    [Recess]
    Chairman Kanjorski. I cannot say this never happens but it 
does not happen quite as severely as it happened today.
    I was thinking on the Floor, for a hearing that was 
supposed to start at 10:00, we had a death in the House that 
interfered with our starting time. Then we had a motion during 
the memorial service that caused a personal privilege question 
that went on the Floor, and then we had 12 or 14 votes 
interspersed there.
    We actually were--some people would call it ``working''--we 
actually were occupying our time. I am not sure we were 
working.
    This among other panels in the House have been held up 
severely because of that.
    I do not know how I make up for Mr. Sirri's wife and the 
plane on Valentine's Day. You will just have to tell her that 
it was because we love you so much that we kept you here.
    [Laughter]
    Chairman Kanjorski. We will make it up to her in some way, 
do something.
    I was talking with the Governor. We were talking over some 
of the testimonies and how much we were looking forward to 
these two additional panels.
    First, let me welcome the second distinguished panel. I see 
the Mayor is here, too. Very good.
    Our first witness will be the Honorable Eric Dinallo, 
superintendent of the New York State Insurance Department.
    Mr. Dinallo?

 STATEMENT OF ERIC R. DINALLO, SUPERINTENDENT, NEW YORK STATE 
                      INSURANCE DEPARTMENT

    Mr. Dinallo. Thank you, Mr. Chairman, it is a pleasure to 
be here. You obviously heard from the Governor. We have also 
separately submitted about 30 pages of material to you.
    I thought I would just take the time to just go over for 
you what the Department of Insurance is doing and what our 
plans are, and a brief chronology of how we got here today I 
thought would be helpful.
    I took office in very late January at the Department. I 
first became concerned in the early spring when MBIA requested 
the billion dollar dividend that was referred to previously.
    It was within the four corners of the law and had been 
previously okay'ed by my predecessor, and in fact, even when it 
was okay'ed by him, the company was Triple A rated by all the 
rating agencies, and in fact, no monoline insurer had been 
downgraded, and there was no concern for the subprime area at 
that time.
    I was beginning to have some concerns about the economy and 
about the subprime area. It was extraordinary but I reversed 
the decision, so to speak, and I cut it in half is what I did, 
based on where I thought we were.
    That, so to speak, is actually something that I am proud 
of, not very embarrassed of. I wish Congressman Bachus was here 
to talk about it, but I thought it was the right decision and 
it seemed to be the prudent thing to do.
    Then they came back in June or July, I do not remember 
when. I think it was early to mid-summer, requesting another 
$500 million, the balance of the billion.
    At that time, they were still Triple A rated by all the 
insurers. No monoline had been downgraded. All the senior 
traunches, in fact, all of the CEOs were at their original 
ratings, there had been no indication of what was coming, but 
we denied that request because I just felt and the Department 
felt and the staff at the Department felt that what looked like 
on the horizon as a potential for a recession or something 
around the subprime area made it so that we wanted to decline 
it and we did.
    Obviously, there are regular dividends. We cannot really 
decline those. Those are in the statute. Indeed, these are 
publicly traded companies. I think there would be other 
regulators that would have a problem if we went to court and 
without the proper basis started to put a request on stopping 
the dividends.
    At that same time, we sent inquiries to the financial 
guarantee insurance companies concerning their activities in 
these areas. We also began the process of getting permission to 
hear directly from the rating agencies about the financial 
guarantee companies and that the financial guarantee companies 
would agree to give us sort of real time information about 
their process with the rating agencies.
    We began to have regular meetings with them and almost 
daily contacts. We began some discussion at the staff level 
with the Federal Reserve and other regulators.
    In the fall, it became apparent that the rating agencies 
were possibly going to downgrade some of the monolines. We 
continued to meet with them on a regular basis. The company 
would keep in daily contact with us. We had a very good 
dialogue with the rating agencies at this point.
    The subprime situation then was starting to deteriorate. We 
had concerns over the broader financial markets.
    That would bring us to about the very beginning of 
November, maybe late October, and we developed a three point 
plan at that point.
    Here was the three point plan: to inject or seek to inject 
new capital into preexistent monoline insurers, and to begin to 
bring other players into the monoline industry who were not 
encumbered, sort of fresh capital in freshly minted companies, 
to deal with potentially distressed companies in the monoline 
area, and to sort of re-write the rules of the road, begin to 
think about how to re-write the regulations in this area.
    We also then send inquiries to the monoline companies 
concerning exactly where their positions were on structured 
investment vehicles.
    On November 15th, I called Ajit Jain of Berkshire Hathaway 
and asked him if we could talk about the possibility of 
Berkshire entering the market, and I sort of promised him we 
could get him a license in a week or two. My staff fainted 
apparently when that was communicated to them.
    We did proceed at a record pace and we had them licensed by 
the end of the year, and started the process of having them 
licensed across the country working with NAIC, and that was the 
beginning of the execution of point number one of the plan.
    We then started to facilitate injection of capital into 
preexistent players. With MBIA, we very quickly facilitated the 
senior note that was for, I believe, $1 billion.
    We became concerned that Ambac at pretty much the middle of 
January was potentially going to suffer a downgrade, and we 
sent examiners to Ambac on January 17th and 18th, I think.
    Although it is regulated primarily by Wisconsin, they are 
in New York City, and I felt that we needed to make sure we 
were on top of any situation that could be developing.
    From January 7th to the 19th, we held daily meetings and 
calls with the companies, the rating agencies, and some of the 
Federal authorities. We had lots of internal meetings.
    Over the Martin Luther King weekend, I received some very 
concerned calls from some of the counterparties, some of the 
insurance companies and some of the representatives of those 
parties.
    I cut my family trip short and had a lot of those 
conversations and then came in on Martin Luther King Day to 
meet again with Ajit Jain to ask him if he could give us a 
price for the municipal side of the book.
    The letter that you have heard about, his offer on the 
municipal side of the book, was something that came out of 
conversation with him over Martin Luther King Day weekend.
    And then we come to Tuesday, January 22nd. We called the 
rating agencies to get a feel for what kind of capital would be 
necessary across the whole space, not a company by company 
discussion, and we got an answer of something in the magnitude 
of $5 billion currently, but of course, estimates and 
assumptions could change and it could go as high as an 
additional $10 billion.
    On that same day, I called about 10 or 12 of the investment 
banks who were counterparties to the insurance companies, asked 
them to come in. We held a meeting at the Department on the 
23rd. At the meeting, I sought their advice and said here is 
the problem, which I will lay out in a second, and I asked them 
what they would do with the following concerns that I had.
    The concerns were that we were potentially looking at a 
systemic or credit freeze if there was a downgrade, that there 
were potential markdowns of the books they were holding if 
there was such a downgrade, and with a downgrade of one of the 
insurance companies, would come not just a mark down of their 
books at the banks, but also a capital call because now instead 
of holding Triple A, they were holding say Triple B, and that 
requires a lot more capital to hold those on the books of the 
investment banks.
    I was concerned about the auction rate security market 
looking sort of down the horizon. I thought the optics were 
going to be difficult, that if in some way it seemed that Wall 
Street hurt the municipal side of the book here, it would be a 
damaging situation.
    I was very concerned that downgrades were coming in the 
next several days and there could be a lack of confidence if we 
did not come up with a plan.
    The solutions we discussed at the meeting were the $5 
billion of a potential equity investment with a $10 billion 
backstop, or a $10 billion line of credit, a backstop rights' 
offering, or some other kinds of capital infusions where maybe 
at the beginning if the insurance companies were corrected, 
they were totally okay, it would be less beneficial to the 
banks, and if the insurance companies were wrong, more control 
by the investors would come at that point.
    I discussed that the potential outcomes were basically 
either some kind of a capital infusion or as has been reported, 
there might be a split of the book. That was talked about way 
back then. It is not something that just came up out of 
desperation. It has been something that we have been discussing 
for several weeks.
    I also told them that I was considering having the 
Department retain an advisor in the form of Corrella & 
Weinberg, and they thought that was a good idea, because we 
would have to communicate about complex deals, etc.
    For the next couple of weeks, I sort of felt a little bit 
like Cassandra or Will Smith in ``I Am Legend,'' because I went 
around trying to make sure that people understood how serious 
the problem was potentially.
    I spoke to a lot of the banks, their CEOs, whom I had 
originally called on that day, the insurers and the rating 
agencies. I also spoke to other sources of potential income, 
large shareholders in the companies themselves, private equity, 
large insurers outside of the space, and held constant meetings 
to sort of begin to determine what the best path is.
    Here we are today, I can sort of conclude and just tell you 
where we are in the three point plan. Obviously, some of the 
companies are in discussions with their counterparties. There 
are possible deals. I have optimism. Nothing is a certainty. I 
do believe that a lot of progress has been made.
    But remember, there are several monoline insurers and you 
could have different outcomes for each one. For some, you could 
have a split book. For some, you could have a consortium based 
capital infusion, and for some, you could have some kind of a 
good book/bad book outcome.
    In all of those, you are sort of dealing with what is 
clearly a distressed situation.
    On the rules of the road, we are working very hard on that. 
We do have the beginnings of drafts of regulations, which I am 
happy to share and I want expert input on that.
    Obviously, on new capital and new players, you see the 
results with Berkshire Hathaway, and other large institutions, 
large financial institutions have come in and have applied to 
begin the process of being a monoline insurer with us.
    The hallmark here is that under no circumstances, I think, 
should the whole book get downgraded. The municipal book should 
be preserved. That was always the point of having the meeting. 
It was not about bailing out these insurers or in some ways 
worrying about the stock price of the companies.
    It was always about the policyholders and that you need the 
Triple A rating to have that across-the-board, and to get to 
what we did wrong--I am actually proud of what we have done 
across the year. I am even proud of the Department's work in 
this historically.
    What I think we did wrong, and I can explain more later, is 
there is a very important distinction between a Triple A rating 
and the solvency of an insurance company. They are not the same 
thing. I can explain some more of that in questions and 
answers.
    I think we could regulate more towards the rating in the 
monoline because it turns out that the rating is maybe as 
important as the solvency of the company when you are linking 
everyone's Wall Street activity to it.
    Thank you.
    [The prepared statement of Mr. Dinallo can be found on page 
219 of the appendix.]
    Chairman Kanjorski. Thank you very much, Mr. Dinallo.
    Next we will hear from Erik R. Sirri, Director of the 
Division of Trading and Markets, United States Securities and 
Exchange Commission.

 STATEMENT OF ERIK R. SIRRI, DIRECTOR, DIVISION OF TRADING AND 
        MARKETS, U.S. SECURITIES AND EXCHANGE COMMISSION

    Mr. Sirri. Chairman Kanjorski, and members of the 
subcommittee, thank you for inviting me here to testify on 
behalf of the SEC about recent events in the financial markets 
and the implications arising from concerns about the 
creditworthiness of certain bond insurers.
    As a threshold matter, the Commission does not regulate 
these financial guarantors, commonly known as monoline 
insurers. However, the securities markets and their 
participants, which the Commission does regulate, may be 
affected by the declining creditworthiness of the monoline 
insurers.
    One example of this is the large securities firms or 
investment banks that the Commission supervises on a 
consolidated basis through its CSE or Consolidated Supervised 
Entity Program.
    Commission staff has discussed and reviewed the CSE's 
current and potential exposure to monoline insurers. These 
exposures fall into three categories: Credit risk; market risk; 
and liquidity risk.
    In terms of credit risk, many CSE's firms execute 
derivatives trade with monolines, generating direct 
counterparty credit exposure. For instance, a CSE may purchase 
a credit default swap from a monoline. In such a transaction, 
should the credit underlying the credit default swap default, 
the monoline would be expected to make a protection payment to 
the CSE.
    In terms of market risk, the CSE firms are exposed to the 
perceived creditworthiness of monolines through wrapped 
securities they may hold in inventory. These include municipal 
securities, tender option bonds, auction rate securities, and 
certain mortgage products.
    In addition, most of the CSE firms have trading and hedging 
positions linked to the monolines' creditworthiness. Finally, 
the CSE firms may also have an implicit and explicit liquidity 
risk exposure to monolines through their activities as re-
marketing agents for certain products, such as auction rate 
securities and tender option bonds.
    These programs fund longer term obligations such as 
municipal debt with liabilities that have characteristics of 
short term paper. Often, monolines wrap the underlying long 
term obligations. A CSE may be at a liquidity risk explicitly 
by acting as a liquidity provider for a particular program. For 
example, for tender option bonds or variable rate demand 
obligations.
    A CSE bears an implicit liquidity risk when acting as the 
re-marketing agent on a program, as it may decide to support 
the program and take securities on its balance sheet out of 
client franchise considerations.
    The CSE firms are highly aware and actively manage their 
exposures to the monoline sector. Although the exposures may in 
some instances be significant, based on the information 
available to us through our supervision of the firms, we 
believe the CSEs have adequate capital and liquidity to deal 
with the consequences of a downgrade or even default of one or 
more monoline insurers.
    The Credit Rating Agency Reform Act of 2006 permits credit 
rating agencies to apply to register with the Commission as 
nationally recognized statistical rating organizations or 
NRSROs, and establishes a regulatory regime for those that 
become registered.
    Nine credit rating agencies have voluntarily registered as 
NRSROs, including three that assign ratings to monoline 
insurers, Fitch, Moody's, and S&P.
    Beginning in December 2007, these three rating agencies 
have undertaken a number of rating actions on monoline 
insurers. Each of the three has issued downgrades to the 
ratings of certain monoline insurers and each has placed others 
on review for possible downgrade.
    The rating actions on monoline insurers have primarily been 
driven by the poor performance of subprime residential 
mortgage-backed securities and CDOs, for which the monoline 
insurers have provided guarantees.
    Using our new authority, the Commission staff has been 
examining credit rating agencies to see if they diverge from 
their stated methodologies and procedures for determining 
credit ratings, and to see if they follow their stated 
procedures for managing conflicts of interest.
    I expect the findings of these examinations will better 
inform the Commission's oversight of rating agencies including 
the ratings of monoline insurers.
    The Commission staff is also closely monitoring 
developments in the municipal securities markets to the 
concerns about creditworthiness of monoline insurers, and the 
actual or potential downgrades of bond insurers and associated 
rating changes on insured municipal securities, which comprise 
about half of all outstanding municipal bonds.
    Downgrades and withdrawals of ratings on many bonds issues 
result from the downgrades of a bond insurer. Although such 
downgrades will negatively effect the prices of most bonds 
insured by the companies that have been downgraded, the issuers 
with primary responsibility for the payment of these securities 
generally have been investment grade credits or higher, 
investment grade credits or equivalent credit string, 
mitigating the effect of downgrades for other insurance 
providers.
    We are aware of the failures of recent auctions of auction 
rate securities in the municipal and corporate markets in which 
too few bidders participated in the auction to establish a 
clearing rate resulting in higher interest rates on those 
securities for a period of time.
    The Commission staff is closely monitoring these bonds with 
respect to bond insurers and their actual or potential effects 
on municipal bond and money market funds.
    Investment companies of all types hold 37 percent of the 
$2.5 trillion municipal securities bonds outstanding. The vast 
majority of these municipal bonds that funds hold are in so-
called municipal or tax exempt funds. A small percentage of the 
tax exempt funds primarily invest their assets in municipal 
bonds that carry insurance issued by the monolines.
    These funds generally have the word ``insured'' in their 
name and have an investment policy that requires at least 80 
percent of their assets be invested in muni bonds, the payment 
of interest and principal on which is guaranteed by a Triple A 
rated insurance company.
    Although it is difficult to predict the effective declining 
creditworthiness of bond insurers on municipal bond funds, a 
downgrade may require many insured funds to change their 
investment policy with respect to the rating quality of their 
portfolio holdings.
    In addition, portfolio securities held by tax exempt money 
funds are often wrapped or guaranteed by monoline insurers, and 
may have liquidity backstops provided by large financial 
institutions.
    In most cases, the liquidity backstops require that the 
muni bonds maintain certain ratings, which may be threatened by 
the ratings downgrade of the monolines.
    Based on its oversight of the industry, Commission staff is 
presently unaware of any municipal money market fund currently 
threatened with breaking the buck as a result of recent 
downgrading and potential downgrading of the monoline insurers.
    In the long term, however, the inability of bond insurers 
to maintain high credit ratings may restrict the supply of high 
quality paper for municipal money market funds.
    Thank you for the opportunity to testify and I would be 
happy to answer any questions.
    [The prepared statement of Mr. Sirri can be found on page 
251 of the appendix.]
    Chairman Kanjorski. Thank you. Next, we will hear from 
Patrick Parkinson, Deputy Director, Division of Research and 
Statistics, of the Board of Governors, Federal Reserve System.
    The Federal Reserve does not regulate the monoline 
insurers, but clearly has an interest in the soundness of the 
overall financial system. As such, we understand it is 
monitoring the ongoing situation.
    Moreover, many of the entities that the Federal Reserve 
directly regulates use the monolines as counterparties for 
their transactions.
    Mr. Parkinson?

STATEMENT OF PATRICK M. PARKINSON, DEPUTY DIRECTOR, DIVISION OF 
  RESEARCH AND STATISTICS, BOARD OF GOVERNORS OF THE FEDERAL 
                         RESERVE SYSTEM

    Mr. Parkinson. Chairman Kanjorski, and members of the 
subcommittee, thank you for the opportunity to testify on the 
potential effects on financial stability of further financial 
deterioration and ratings downgrades of financial guarantors.
    The growing possibility of credit losses on certain 
collateralized debt obligations of asset backed securities has 
caused some of the guarantors to report financial losses and 
the rating agencies to require those guarantors to raise 
capital to maintain or regain their Triple A ratings.
    Those guarantors reportedly are exploring various options 
for bolstering their financial strength but it is not clear 
that all of them will succeed. Thus, it is well worth thinking 
through how further downgrades to some guarantors' credit 
ratings might affect overall financial stability.
    Such downgrades might adversely affect financial stability 
through several channels. These include: (1) the potential for 
disruptions to municipal bond markets; (2) potential losses and 
liquidity pressures on banks and securities firms that have 
exposures to guarantors; and (3) the potential for further 
erosion in investor confidence in financial markets generally.
    Further downgrades of some guarantors could spark a retreat 
from a municipal bond market by some retail and institutional 
investors. Of particular concern is the potential for 
disruptions to the markets for short term securities based on 
municipal and other tax exempt debt.
    These short term securities include tender option bonds and 
variable rate demand obligations, which typically have credit 
support from one of the guarantors and liquidity support from a 
large bank or securities firm, and auction rate securities, 
which often have credit support from a guarantor but have no 
explicit liquidity support.
    Some money market funds reportedly have already drawn on 
liquidity support facilities for some securities insured by 
those guarantors with significant exposure to CDOs that contain 
subprime residential mortgage-backed securities.
    In addition, earlier this week there was a rash of failures 
of auctions for student loan auction rate securities or ARS. 
Although largely unrelated to concerns about the financial 
guarantors, this development undermined confidence in auction 
rate securities generally, and subsequently quite a few 
auctions for municipal ARS have failed.
    It appears that financial stress on the guarantors has 
restrained new issues of municipal bonds in recent weeks, 
although these effects are difficult to disentangle from the 
effects of tighter budgets for many municipalities, a deepening 
concern about the financial condition of some of the guarantors 
could at least temporarily limit the availability of credit and 
increase the cost of funding for some lower rated or smaller 
municipalities.
    Over time, however, funding for those municipalities would 
be restored as the downgraded firms were replaced by the 
surviving healthy firms and by new entrants.
    U.S. banks' direct exposures to losses from downgrades of 
guarantors' ratings appear to be moderate relative to the 
banks' capital. However, even if banks' losses from exposures 
to the guarantors are moderate relative to their capital, banks 
could experience significant balance sheet and liquidity 
pressures if they take significant volumes of tender option 
bonds or variable rate demand obligations onto their balance 
sheets.
    If these banks take on significant enough volume of such 
securities, the resulting downward pressure on their capital 
ratios might prompt some of them to raise additional capital or 
constrain somewhat the growth of their balance sheets to ensure 
that they remain well-capitalized.
    Efforts to constrain the growth of their balance sheets 
could be reflected in somewhat tighter credit standards and 
terms for a variety of bank borrowers, which would add to the 
financial head winds that the economy already is encountering.
    In addition to the direct effects of stress of financial 
guarantors on the municipal bond markets and banks, stress on 
the guarantors could have adverse indirect effects on investor 
confidence in the financial markets generally.
    If the drop in confidence was sudden, asset markets could 
become less liquid and asset prices could become more volatile.
    However, a sudden drop in confidence seems unlikely. 
Financial market participants seem well aware of the 
difficulties the guarantors are facing and of the potential for 
further ratings downgrades.
    The Federal Reserve has been carefully monitoring and 
assessing the channels through which deterioration in the 
financial condition of the guarantors could adversely affect 
financial stability.
    As primary supervisor of State chartered banks that are 
members of the Federal Reserve System and umbrella supervisor 
for bank holding companies, the Federal Reserve has collected 
and analyzed information on banking organizations' exposures to 
the financial guarantors.
    We also have been monitoring closely developments in the 
municipal securities markets and in the markets for residential 
mortgage-backed securities and asset-backed CDOs, from which 
the principal pressures on the guarantors have originated.
    Thank you. I would be pleased to answer any questions you 
may have.
    [The prepared statement of Mr. Parkinson can be found on 
page 244 of the appendix.]
    Chairman Kanjorski. Thank you very much, Mr. Parkinson.
    Finally, we come to my friend, the Mayor of the City of 
Wilkes-Barre, Mayor Leighton. Mayor, first I want to apologize. 
I know you intended to get out of the City by 4:00 today; we 
may make it if we hurry.
    [Laughter]
    Chairman Kanjorski. That is Washington speak.
    [Laughter]
    Chairman Kanjorski. If you will, Mr. Mayor. If you could 
give us the municipal reaction to all of these technical things 
we have been talking about up to this time.

 STATEMENT OF THE HONORABLE THOMAS M. LEIGHTON, MAYOR, WILKES-
                      BARRE, PENNSYLVANIA

    Mr. Leighton. Chairman Kanjorski, and members of the House 
Financial Services' Capital Markets, Insurance, and Government 
Sponsored Enterprises Subcommittee, thank you for the 
opportunity to testify today on the need to find a solution to 
the turmoil in the bond insurance industry.
    My name is Thomas M. Leighton and I am the Mayor of the 
City of Wilkes-Barre, a city in northeastern Pennsylvania. I am 
a constituent of Chairman Kanjorski who has been a leader in 
economic development issues in our area.
    I would like to thank Chairman Kanjorski for inviting me 
here today and commend him for taking the initiative on this 
very important issue.
    Wilkes-Barre is the urban core and seat of Luzerne County, 
welcoming nearly 100,000 people to our City each day. We have 
the 4th largest downtown workforce in Pennsylvania, but this 
number drastically decreases after the 9:00 to 5:00 p.m. rush. 
We face significant challenges providing municipal services for 
the substantial workforce because only 45,000 residents 
contribute to the City's tax base.
    Upon taking office in 2004, my administration was faced 
with over $10 million in unpaid bills in a technical bond 
default by one of the City's authorities. Because of this 
default in 2002, the City could not utilize traditional bank 
financing because of our weak credit rating. These 
circumstances combined with inherent regional economics created 
a bleak financial outlook for the City of Wilkes-Barre.
    After working diligently to re-establish the City's 
finances and maintain our fiscal responsibility, Ambac 
Financial Group agreed to insure $40 million of debt 
restructuring and new money. Without Ambac's willingness to 
help the City, major layoffs or tax increases would have been 
necessary. Ambac's confidence in the City's future gave us the 
opportunity to access the marketplace, allowing the City to 
continue on a path to a solid financial future.
    Despite making great strides financially, the City of 
Wilkes-Barre still struggles to obtain bond insurance, 
especially at competitive rates. As a result, turmoil in the 
municipal bond market is a significant concern for the City of 
Wilkes-Barre.
    Similar to many other mid-sized cities across the Nation, 
we rely on monolines. When they are faced with volatility in 
the market, there is volatility for us.
    Many small issuers such as the City of Wilkes-Barre are 
dependent on credit enhancements. Without them, we cannot 
access much needed capital for public projects, such as street 
paving, sewer repairs, and other major infrastructure 
improvements. As we work to advance our City, cutbacks in basic 
services like these are not an option.
    Currently, the economic climate in Wilkes-Barre is 
weakening due to the growing expenditures and declining 
revenues. For example, the subprime mortgage crisis has 
resulted in increased foreclosures and decreasing tax revenues. 
Increased need for City services are challenged by lower 
revenues and budget challenges.
    Wilkes-Barre, like other cities nationwide, is forced to 
turn to the debt market to avoid raising taxes, but is unable 
to do so because of the instability in the market.
    Included in the City of Wilkes-Barre's 2008 plan are 
issuance of $4 million in re-funding to fill budget gaps and a 
$5 million in economic development for a Coal Street Park 
renovation project.
    Coal Street's renovation will transform a park into ice 
hockey rings, playgrounds, and athletic fields. Under the 
current market conditions, this necessary development will be 
extremely difficult for the City of Wilkes-Barre to complete.
    In addition to this venture, the City of Wilkes-Barre will 
continue to maintain and improve its aging infrastructure. For 
example, work on the remaining two bridges that span Solomon's 
Creek will be completed. The area surrounding the Creek is 
prone to severe flooding, devastating thousands of residents 
and an area hospital 3 times in the past 4 years.
    In order to meet the basic needs of our residents, such as 
preventing flooding and paving roads, we must be able to access 
the affordable bond insurance market.
    One beneficial piece of legislation is H.R. 2091, which 
would change the Tax Code to allow Federal Home Loan Banks to 
offer letters of credit to communities like Wilkes-Barre. 
Chairman Kanjorski, we want to thank you for supporting this 
helpful legislation.
    The City of Wilkes-Barre is undergoing a comprehensive 
social and economic revitalization. Without access to the 
capital, we will be unable to continue the progress that we 
have worked so hard to accomplish over the past 4 years. We 
will be forced to halt work on major projects such as the Coal 
Street Recreational Park or limit basic services that we 
provide to our residents.
    Mid-sized cities nationwide must have access to the bond 
insurance market to improve their credit ratings. Also, there 
must be stabilization in this market so that Wilkes-Barre and 
other cities can continue to provide basic quality of life 
services for their residents and participate in economic 
development projects.
    I want to thank you for the opportunity to address this 
subcommittee and for considering my perspective as a Mayor of 
this mid-sized city. Thank you.
    [The prepared statement of Mayor Leighton can be found on 
page 236 of the appendix.]
    Chairman Kanjorski. Thank you very much, Mr. Mayor.
    We will now have the questioning. Mr. Dinallo, I am going 
to ask you one or two questions that have been posed to me 
several times over the last 2 weeks.
    That is, that the holding companies can draw on the 
insurance companies' dividends. Do you have legal authority to 
order the suspension of that and to stop it in its entirety or 
would you need some additional legal authority either on the 
State level or the Federal level?
    Mr. Dinallo. I think the answer is the following, when you 
are dealing with extraordinary dividends as we discussed, we 
control those, and we have suspended all of those in the 
monoline insurance companies.
    When you are dealing with regular dividends, they are 
statutorily able to dividend. One way that one could prevent 
the dividend from being processed would be give essentially the 
company an order to bring in more capital, and one way they 
could do it would be to suspend the dividends.
    I think there might be mechanisms to do it. That would be 
in a certain sense us beginning to control the companies, and 
that would be like as if we had put them in rehabilitation or 
taking control of them, we would begin to basically tell 
management how they are going to run the company.
    I think that the answer is on the extraordinary, we have 
pretty much absolute authority. On the regular dividends, 
especially when you are dealing with publicly traded companies, 
I think you would be more likely that you would first get to 
the point where you would be doing either orders of capital 
infusion and if they cannot meet those orders, one could 
presumably put them into rehabilitation or maybe by then they 
would already be losing the rating and you would have the 
possibility of a run off, which we discussed earlier.
    Chairman Kanjorski. So many people have mentioned the fact 
that they cannot comprehend how a division would be sending 
dividends up to their holding company when in fact their 
solvency may be in question, if conditions were to continue as 
they apparently are.
    Mr. Dinallo. I think that is one of the issues, 
Congressman. There is a difference between solvency and the 
rating or the share price. Solvency in the insurance world is a 
fairly simple question. It is the ability to pay claims as they 
come due.
    The rating is a very different question, and here, I think 
it is very important that we kind of de-link them. The question 
of regulating the insurance companies and the questions around 
the dividending process generally goes to the solvency of the 
company.
    We have never regulated, although as I said, I think in the 
last year we have now started to regulate this particular line 
of insurance companies on their rating because of course, it 
does matter.
    I will give you an example. There is a theory under which 
you could put a company into rehabilitation and you could still 
have a Triple A rated company ironically. It would be a closed 
book. It would be Triple A because there would be no dispute it 
was going to pay on the claims as they came due. It probably 
would not trade very high because it would not have a business 
plan except just paying off the claims, and it certainly would 
not have a return on equity and a revenue growth plan, but it 
would in fact be both solvent and highly rated in the sense 
that it could pay on its claims.
    Chairman Kanjorski. There seems to be a legitimate fear 
that because there are two books here, one, the municipal, and 
then the other, the high flyer risk category, that even though 
they appear to be solvent, the likely failures will occur on 
the high risk book and they could drain out all the funds of 
the corporation. When you get down to the municipalities, there 
would be nothing left for them.
    I am really stuck on the idea and the concept that we have 
to return trust and faith to the marketplace as fast as 
possible. I think it is necessary that anything that we can do 
at a governmental level or a regulatory level to accomplish 
that probably should be done now rather than being reactive 
after the circumstances occur.
    Mr. Dinallo. Yes.
    Chairman Kanjorski. If there is something that we can do, 
these are the types of surgical legislation that I would 
certainly be willing to have the committee put together and 
submit for very fast action if necessary, as we move towards 
some sort of resolution of this problem.
    Mr. Dinallo. Obviously, if Congress wanted to help re-
insure the municipal side of the book as you said today in 
essence on CNBC, that would be extraordinarily helpful because 
then you would have a backstop that would certainly help 
capitalize the companies.
    The good book/bad book that you have discussed is done in 
this instance. If we did it quickly, it would be done to 
preserve the rating of the good book. You would have a good 
book of municipal business that would stay Triple A rated, and 
you would have a stressed book that would be substantially 
less.
    It would not necessarily be done right now because of 
solvency or claims paying ability. As you said earlier, there 
is no evidence yet that the claims on the CDO side will exhaust 
the entirety of the municipal book. All the actions we have 
taken and the meetings that I have held and the concerns that I 
have had is they will get downgraded because of the confluence 
of the two books and that will have a systemic impact and will 
put the companies into a run off and will have obviously 
impacts on the economy that we have been discussing.
    It is not yet the case, I believe, that they do not have 
claims paying ability. I think that is an important 
distinction.
    Chairman Kanjorski. Work with us on it. Because the 
stimulus moved through as quickly as it did, I am a little bit 
under the impression that we are going to get unusual 
cooperation from Treasury and the White House.
    Mr. Dinallo. Great.
    Chairman Kanjorski. As a matter of fact, while I was out, I 
was notified that Secretary Paulson announced that I am 
formulating a letter requesting support systems for the student 
loan process.
    I understand that as soon as he receives my letter, and we 
have it being hand carried to Treasury this afternoon, that he 
is going to take action to shore up that marketplace.
    Mr. Dinallo. I will ask if we could have a line of credit 
not even actually capital, a line of credit of $10 billion, my 
instinct is that more capital would come in before that, 
because you would have the line of credit in place, which is 
what I told the banks in the first place, and I think it would 
be an increasingly less likelihood you would ever need the line 
of credit because ironically--
    Chairman Kanjorski. Do these insurance institutions have 
the rate to participate with Federal Home Loan Banks?
    Mr. Dinallo. I am sorry. I did not hear the very last part.
    Chairman Kanjorski. Why could the insurance companies not 
make an application to the Federal Home Loan Bank system for a 
line of credit?
    Mr. Dinallo. I do not know the answer to that. Certainly, 
the investment banks that are the counterparties to their 
policies could make such an application, and you could do the 
re-insurance that way.
    Chairman Kanjorski. We should look into that. I certainly 
would be amenable, and that is one way to spread the risk.
    Mr. Dinallo. That is right, extremely broadly.
    Chairman Kanjorski. Incidently, while we were over voting, 
another insurer, FIGC, was downgraded by Moody's, as you may or 
may not know, from Triple A to A-; that is a big jump, 6 
levels.
    I guess the equity markets sort of gave some indication of 
their appreciation of that by dropping 175 points. I think we 
are into a very volatile situation and things that we should do 
and can do should be done as quickly as possible and as cleanly 
as possible.
    Mr. Dinallo. I have been trying, Congressman. I will take 
the brass cup anywhere.
    Chairman Kanjorski. I am saying on our side, and I am sure 
the Governor would say this would be a bipartisan effort. We 
want to get this done.
    I have a question for our other participants here, both the 
Federal Reserve and the Securities and Exchange Commission: Is 
there a working group being put together at the executive level 
to closely monitor what is happening in the economy so that you 
are not individually by institutions watching what is 
happening, but have a cooperative overall working group view of 
what is happening so that all of us, including the Treasury and 
the White House and the Congress, can get faster information as 
to what we can anticipate, and not from a technocrat 
standpoint?
    I do not want to categorize your testimony in any way as 
technocrat. You all sounded like you were telling us what you 
could do in normal times. Maybe I am unusual in thinking that 
these are extraordinary times.
    Make the assumption of my foolishness to deal with me. If 
we are in extraordinary times, what are we doing 
extraordinarily in the executive and independent agency areas 
of the government to really come together very quickly so we 
can have faster responses, legislatively and by executive order 
if necessary?
    Mr. Parkinson. The SEC, the Fed, Treasury, and CFTC all 
meet as members of the President's Working Group. We have been 
at work for some time to produce a diagnosis of the underlying 
causes of all the problems we are seeing in financial markets 
and to develop a comprehensive package of reforms to address 
that.
    Chairman Kanjorski. That is the Working Group and we are 
awaiting that package of reforms. In the meantime, we could get 
into some financially disastrous circumstances before the 
Working Group is over or before the long-term solutions could 
be put into place.
    I am looking at brakes that could be put on as were put on 
after the 1987 crash on the market that have really worked 
wonders since 1987 to stop run away situations in the equity 
markets.
    Are we thinking along the lines that in the credit markets, 
there are things that can be done, sort of in extraordinary 
circumstances and timeframes that could help us from freezing 
up?
    I was visited last week by issuers of corporate bond 
instruments. The story that they gave me of what they feared 
was extraordinary, that there is no market out there and if we 
do not do something very quickly, what little market is out 
there is going to disappear and the needs of American business 
to have a line of credit to operate in 60 or 90 days is going 
to be fast restricted or disappear.
    That sounds to me like extraordinary circumstances. I am 
not in a position to know whether what they are telling me is 
true. I have no reason to believe it is their benefit to excite 
the market in any way. Of course, I have probably now excited 
the market.
    [Laughter]
    Chairman Kanjorski. We have to find ways to talk to each 
other and to know what is going on.
    I was struck, I will be honest that this is the first time 
in 7 years that I can recall the White House and Treasury 
coming to Congress and asking for fast bipartisan action. This 
is the reason I got very involved in the stimulus package these 
last 2 weeks and the reason this committee got so involved.
    The Administration has not even done this for the war, but 
they did it in the last 2 or 3 weeks. My suspicion is, and it 
is strictly a suspicion, that they have unproven indicators 
that really flash tilted extraordinary extreme situations.
    I am not going to put the Federal Reserve on the spot to 
tell us whether you have that hidden box down there of 
undisclosed indicators, but I suspect you do, or somebody got 
ahold of this and realized this was something serious and we 
ought to make every attempt in the world to get in here and put 
some firewalls up. I think that is what the stimulus package 
was.
    If it was not, then what it means to me is that we have had 
a genuine re-birth at the White House. That is probably good, 
too. I do not expect that happened. I expect what happened is 
the White House got scared, but they have not and we have not 
disclosed it to the American people. Maybe it cannot be 
disclosed or maybe it does not have sufficient validity to be 
disclosed.
    Since that precedent-setting action was taken just in the 
last several weeks between all these important financial 
institutions of our government, and since the Congress did 
positively react, I am just wondering if we cannot find a way, 
because we have not been informed, to my knowledge, no one on 
the committee, including the chairman, has been informed of 
this.
    We have to find ways of knowing how serious things are out 
there, whether there is something we can do or should prepare 
our fellow Members to do, or whether we should just sit around 
with our thumbs in our mouth and wait until something really 
serious happens that we cannot correct.
    Maybe you can address that.
    Mr. Parkinson. I think both the fiscal stimulus package and 
the Federal Reserve's monetary policy actions were taken 
because of the perception there were significant risks coming 
out of the turmoil in the financial markets to future economic 
growth.
    We have taken both those monetary policy actions to try to 
insulate the macro economy from some of the things that are 
going on in the financial system.
    As you were talking about circuit breakers, I was trying to 
think of what the analogy could be in this case, but I was 
struggling a bit. It seems to me that if firms are concerned 
about their inability to issue debt and raise funds in the debt 
markets, putting a floor on the prices of bonds is not going to 
be helpful to them. That would lead in effect to the same sort 
of phenomenons we are having in some of these auction rate 
securities markets where markets have been failing to clear 
because of the imposition of this kind of speed limit to the 
system.
    So my preliminary analysis is that it is unlikely to be 
helpful and in fact, might be harmful in the present context.
    Chairman Kanjorski. Is there anybody down there who has 
been thinking about positive things that could be done that we 
either do not have authority for or would take some time to 
legislate on that we should start thinking about, going through 
the process of legislation?
    Mr. Sirri. I think there have been some examples of things 
that have been done recently. Within our own authority, we have 
been asked to consider certain changes to accounting rules or 
interpretations of accounting rules.
    In this specific instance, it was to allow loans to be 
renegotiated. The determination we had to come to was the 
circumstance under which default would be reasonably 
foreseeable, working with the American Securitization Forum and 
the FASB, we were able to provide some clarity for that 
definition, that allowed loans to be renegotiated without 
having those trusts be brought back onto the balance sheets of 
the intermediaries, necessitating a large capital charge.
    I think another example where we have been changing our 
policy slightly to accommodate the current environment has been 
in the area of money market mutual funds.
    As you know, there have been some defaults and some 
impairments of short-term commercial paper, as the funds have 
held those papers, they have been circumstances where support 
was needed, where subsidies were needed of various kinds, and 
through our rulemaking and no action ability, we have been able 
to facilitate that, allowing the money market mutual funds to 
stay at a $1 NAB.
    Chairman Kanjorski. Somebody raised the question the other 
day, that if the SEC just changed the rating on municipal bonds 
to reflect what the rating is on corporate bonds, that this 
would free up the two distinctions and many of the municipal 
bonds could move on without being forced for sale because they 
have maintained a Triple A. It is Rule 2a-7.
    Could that be addressed? Could that simply be done by 
making that different distinction?
    Mr. Sirri. I think what you are referring to is a portion 
of 2a-7 that provides that if a piece of a long-term paper held 
in a trust is rated below a certain level, in this case, AA, 
then the money market mutual fund would have to sell that 
paper.
    I think the important thing to realize here is why a rule 
like that was put in place. Money market mutual funds are 
substitutes for cash. As such, the primary issue associated 
with them is one of liquidity.
    The Rule 2a-7, which is a very complex definitional rule, 
is all about maintaining liquidity for that money market mutual 
fund. I think we hold that liquidity is paramount here. We 
would never want funds to be encouraged to hold instruments 
that are not very, very liquid. The reason is they could break 
$1.
    Chairman Kanjorski. Let me understand. It is not that these 
municipal bonds have lost their value. It is that laws are 
driving them, because of ratings by rating agencies, to 
potentially be sold and they are being sold into a market 
lacking liquidity, and as a result, their prices are falling 
materially from what their real value is.
    Is that not the problem?
    Mr. Sirri. It is part of the problem, but I think you put 
your finger on it when you talked about liquidity. The thing 
that is important here is that the instrument be liquid.
    It may be as you say that its value is still high, but the 
securities are only worth what you can sell it for at the 
moment, especially in the case of a money market mutual fund. 
We would never want them holding paper that they could not 
liquidate instantly at the value at which they were incurring 
it.
    Chairman Kanjorski. Is not one of the potential remedies 
here if we have a freeze up in the marketplace and we have no 
buyers, that we potentially would have to authorize the 
Treasury to be the buyer of last resort, just to stabilize the 
market?
    We would be expending a lot of money and putting the 
taxpayers' money at tremendous exposure, dollar for dollar 
exposure, as opposed to just recognizing that we may have a 
temporary situation that by adjusting the rating score to 
reflect something different than it does now for municipal 
bonds and just make them rated at the same way corporate bonds 
are rated, they would still carry a Triple A corporate rating. 
They would not be any more or any less at risk than they are 
today, but they would not have to be spun off by some of these 
institutions that are under compulsion by law not to hold these 
securities and to get rid of them.
    Even if we did it for 30 or 90 days, it is somewhat 
analogous to me that at a point, say the subprime market goes 
into the prime market and rather than looking at 2 million 
foreclosures, we are going to look at 6 million foreclosures.
    Is there any doubt that we would not think about declaring 
a moratorium on foreclosure at some point? We did it during the 
depression.
    I would certainly be supportive if I saw a tremendous total 
collapse of the real estate market, which would be a total 
collapse of the financial market, why not go to a moratorium?
    That is an extraordinary measure. We do not want to do it, 
but by doing some surgical repair, potentially, we could hold 
back that situation at no greater cost than if we have to move 
in and do moratoriums or other such remedies that are rather 
limited, and probably are too complicated for the Congress to 
participate in.
    The time and effort that it would take to get this through 
and signed into law, I suppose we could do it, but if we got to 
the point where we could cooperate the way we did last week on 
the stimulus with the White House and the Congress, I have a 
feeling it would be a song of doomsday for the country. That is 
the extreme to which we would be driving. I do not see us 
coming together too often the way we did last week.
    Are there measures that you can all take within the 
independent agencies and the Executive Branch that could 
alleviate some of this pressure even on a short term basis?
    Mr. Dinallo. I think that the one thing that is important 
is in the long term, the Triple A rating, the wrap, is an 
important thing for lots of municipalities, for small 
municipalities, for the boards of schools and hospitals.
    They cannot realistically go forward without a Triple A 
rating because of the depth of distribution of the money market 
account point. I think you could do it for a short period of 
time, but the concept of all these municipalities would sort of 
go without a Triple A rating is really a difficult world to 
conceive of when you are dealing with money market accounts and 
fidelity, etc.
    Chairman Kanjorski. I just want to make a point to the 
Mayor. I know you have so many projects, Mayor, that are either 
going in or about to go in or are in development that could be 
affected by the failure of the bond market to provide the 
liquidity to continue. I hope that does not happen.
    I want to tell you a story. When I come back to Wilkes-
Barre and look around, I always look at the cranes and the 
number of cranes I can see indicates the relative success of 
the economy at the time.
    That also applies down here in Washington. I sit in my 
office and I look out the window. If I can count something less 
than seven cranes, we still have a very healthy economy in 
Washington. When I see more than nine cranes, we are getting 
close to trouble. It has happened that way for 25 years.
    It is very interesting how we tend to go to excess and then 
we get these jolts in the system.
    What we are going to try to do for Wilkes-Barre and other 
medium sized communities is keep the crane count down to the 
right number so we do not have those disasters.
    Now, Mr. Castle, if you will.
    Mr. Castle. Thank you, Mr. Chairman. Let me just start by 
saying a couple of things. Mr. Bachus is at a meeting at the 
Capitol and could not be here. I also want to enter into the 
record pursuant to the conversation which he and Governor 
Spitzer had--there was confusion in that discussion. Governor 
Spitzer indicated that the blame for the bond insurance crisis 
lay with any of the regulators other than his department. His 
department was the only one directly responsible for most of 
the bond insurers.
    He also politely denied there were any special dividends 
approved for a bond insurer during his administration. I would 
like to proffer for unanimous consent to enter into the record 
a Form 8-K filed by MBIA, Inc. with the Securities and Exchange 
Commission. The document says, ``In April 2007, MBIA Insurance 
Corporation received approval from the New York State Insurance 
Department to declare and pay a total of $500 million in 
special dividends to MBIA, Inc. in the second quarter of 
2007.''
    I would note further, for the record, that despite the 
recording of pre-tax net loss on its financial instruments in 
that report, the same company actually increased its dividends 
throughout the entire year of 2007. It also went through an 
additional $660 million in capital in what is perhaps an ill 
conceived stock repurchase program.
    I would like to proffer for unanimous consent the Form 8-K 
from the Securities and Exchange Commission. Thank you.
    Mr. Meeks. [presiding] Without objection.
    Mr. Castle. Let me ask this of you, Mr. Parkinson. I have 
read about Warren Buffett's offer to reinsure the bond 
insurers' muni portfolio for a 50 percent fee above the 
unearned premiums. Nice that he can do that.
    I am concerned about this. Would this not really just spin 
off all of their core good business? I have heard testimony 
from all of you a little bit today, from their bad business, 
leaving crippled run off companies, and while this might 
benefit New York and other municipal debtors, as well as clear 
the future muni market business for Buffett's new company, 
would it not be unfair to the holders of all the other bond 
insurers' other debts, such as banks and hedge funds that 
relied on the bond insurers' wrap based on their entire book of 
business, including the stable portions?
    Mr. Parkinson. I guess as I understand his proposal, it is 
to reinsure the muni bond portion of the--
    Mr. Castle. Just that portion; correct.
    Mr. Parkinson. The trouble I have with that is that I don't 
see how that will solve their current difficulties, how that 
will improve their rating. To be sure, it would mean they have 
additional resources to bear any losses that might arise from 
the muni bond side, and therefore would free up some capital.
    But that would come at the price reducing their revenues 
going forward. Consistent with that analysis, I have read in 
the press that it would not lead the rating agencies to feel 
any better about their current financial condition, and if that 
is the case, it seems to me that it does not solve the 
fundamental problem that they are facing, and therefore, does 
not reduce the likelihood that there would be adverse effects 
on the broader financial markets.
    Mr. Castle. That was my impression, too. I appreciate your 
answer on that.
    Mr. Sirri, the current crisis in our credit markets has 
been exacerbated by the overwhelming lack of transparency. For 
example, a lack of any price reporting mechanism for 
collateralized debt obligations or credit default swaps.
    Do you believe it would be beneficial to our markets to 
allow investors to see the actual prices for these complex 
instruments? What steps could you take as a regulator to make 
that happen?
    Mr. Sirri. The markets you are talking about are over-the-
counter markets. They take place as trades between brokers and 
between dealers. They do not take place on exchanges.
    You are quite right. Prices are not generally produced in 
those transactions that are available to the public.
    If you want to consider whether it makes sense to make 
those prices public, I think it is a difficult analysis and one 
you have to undertake with care.
    These markets are filled with what are known as bistro 
contracts. They are very customized contracts. They do not 
trade broadly. They are only held by a small number of people.
    In such circumstances, you do not generally think of 
providing transparency to those markets. If we did come to a 
determination or if you all came to a determination that would 
be useful, there are mechanisms to do that.
    There is, for example, in the over-the-counter markets for 
fixed income securities, a system called Trace that is operated 
by FINRA. It is a mechanism whereby corporate bond trades are 
reported to and then disseminated publicly within minutes of 
the trade.
    If we thought it was useful to do so, that scheme could be 
broadened to incorporate other classes of securities. For 
example, right now things like agency securities and asset 
backed securities are not covered by Trace. It could be 
broadened to include those kinds of securities, including 
mortgage-backed securities, CDOs, and such.
    Mr. Castle. I realize we have another panel. I do not want 
to take any longer. Just sitting through this today, your panel 
and the one before, and reading some of the testimonies to come 
later, it occurs to me that there are steps that if we all put 
our heads together, perhaps we could be taking them, in terms 
of clarification of regulations, for example. Perhaps the 
transparency issue and a few other issues, I am not saying it 
is at the heart of the credit problems right now.
    I happen to think a lot of this lies in real estate issues 
and other areas. I believe we could have perhaps done a better 
job than we have, and hopefully, when it is all said and done, 
we can come to some sort of agreement to address all of these 
issues better.
    With that, I yield back, Mr. Chairman.
    Mr. Meeks. Thank you. Let me start first with a question to 
my superintendent from the State Insurance, Mr. Dinallo.
    What do you think the State regulators like yourself did 
right or wrong with respect to the bond insurers?
    Mr. Dinallo. What I think we have done right is we 
identified an issue and immediately got on top of it, I think 
well before many other people were confronting the issue. We 
have done our best this year to highlight the issue and come up 
with solutions and particularly private side potential 
solutions in dealing with it.
    If we were to criticize what we did wrong, as I said 
before, I think we emphasized solvency, which is what we are 
supposed to be doing, but here, it turns out that a Triple A 
rating is really important. I guess we could regulate more to 
the rating as opposed to the pure solvency question.
    That is not something that historically we have done. I do 
not think frankly a Federal or State or other regulator would 
necessarily do that. Here where you have such 
interconnectivity, it is not just a claims paying question. It 
does turn out to be a rating question.
    If I could just clarify something I said before, I can see 
we are starting to wind down, in responding to Chairman 
Kanjorski's question about what the Federal Government could 
do, and I know he was on CNBC today talking about sort of the 
FDIC-type backstop, I think we should first, of course, go for 
a private sector solution. We have been trying to facilitate 
that. That is what the entirety of my efforts have been about.
    Failing that, one goes to sort of a good book/bad book 
scenario, and then you get to the Berkshire Hathaway question, 
which is who seeks to reinsure or buy that good side of the 
book. That is the point.
    All I was saying was that if Congress wants to do that or 
even the States altogether, the municipalities could reinsure 
themselves technically, certainly Ajit Jain's offer is a very 
appreciated offer, although any experts will tell you it is a 
very profitable offer for Berkshire Hathaway, and there might 
be a better solution, a cheaper solution, to worry about the 
good side of the book if we cannot get to any other scenario, 
including what I hope is as we are speaking private side 
solutions.
    Mr. Meeks. Mr. Mayor, I was listening to your testimony. As 
you stated, many cities, talking about infrastructure problems 
now, going into debt because of the foreclosures on homes, and 
they are limited in what their resources are and what their 
alternatives are, other than raising taxes, etc.
    Off the beaten path just a little bit, but I know that the 
Senate is doing an investigation into solvent wealth funds, but 
in Indiana, for some infrastructure problems, they had utilized 
some solvent wealth funds to do roads and highways, etc., for 
infrastructure.
    I just wanted to get your opinion. Would something like 
that, given the crisis we have, be an option for cities like 
yours to look into to try to offset some of the financial debt 
that the cities are currently in?
    Mr. Leighton. We are always looking for different sources 
to help us with the debt. Just last month, I attended the 
Conference of Mayors here in Washington and listened to all the 
mayors talk about the infrastructure across this country, 
especially about the bridge that collapsed in Minnesota.
    What it appears is that throughout the United States, the 
aging infrastructure is affecting not only smaller cities like 
Wilkes-Barre, but also bigger cities like Minneapolis. The 
problem we are having is there is insufficient revenue sources 
to fix the aging infrastructure. We are always looking for 
alternative ways of reducing our debt and increasing our 
revenue sources.
    Mr. Meeks. My last question would be to Mr. Sirri. When we 
look at this crisis, the question of transparency is a big 
issue. I would like to know whether or not you think there is a 
role for a group like the New York Stock Exchange to play in 
the transparency issue, something they may be able to do in 
that regard.
    Mr. Sirri. There could be conceivably a role for any number 
of entities that choose to collect and report, disseminate 
information.
    I think the question you have to ask very carefully is to 
what extent would dissemination of information help the 
problem. Largely, in this space, one of the problems were there 
were simply no trades. In the space of CDOs, starting in early 
2007, trades just did not occur. There were no prices.
    I think here, although transparency is often helpful, I 
think it is a difficult analysis and it would take some 
additional work to determine to what extent that would help 
solve this exact problem.
    I would note there are a number of mechanisms that are 
available to disseminate such information. The New York Stock 
Exchange, I think, might be one of them. The Trace system I 
mentioned earlier would be another. There may yet be some 
private sector solutions that would fulfill a need like that.
    Mr. Meeks. Thank you. I want to thank all of you, and 
again, on behalf of the chairman, as he did, apologize for the 
delay. This panel is now dismissed.
    We would like to welcome our third panel. I guess we will 
hear from Mr. William Ackman first, the managing member of 
Pershing Square Capital Management.
    Mr. Ackman will present for 5 minutes.

   STATEMENT OF WILLIAM A. ACKMAN, MANAGING MEMBER, PERSHING 
                SQUARE CAPITAL MANAGEMENT, L.P.

    Mr. Ackman. Mr. Chairman, and embers of the subcommittee, 
thank you for the opportunity to share my perspective on the 
bond insurance industry.
    In my remarks, I will introduce my firm, Pershing Square 
Capital Management. I will explain how the bond insurance 
industry grew beyond its original roots to its current troubled 
state, share my views on recent attempts to bail out some of 
the insurers, and propose solutions to mitigate the potential 
for systemic risk due to a failure of some or all of the bond 
insurers.
    Briefly, on Pershing Square, we are a registered investment 
advisor that manages $6 billion of capital, and we are 
principally value investors. We have large stakes in companies 
like Target, Barnes & Noble, and Sears. As a result, our 
success is highly dependent on the strength of the economy and 
the American consumer.
    I am actually here today not to talk about our long 
investments. I am here to talk about a short position we have 
in the holding companies for the two largest bond insurers, 
MBIA and Ambac.
    By way of explanation, the holding companies are the 
publicly traded owners of the regulated insurers, and the 
insurers are the companies that are the subject of the hearing 
today.
    Just briefly on short selling, because I think it can be 
somewhat controversial and some people say you cannot rely on 
short sellers because they are biased. I think the point I 
would make is that you have to remember that management is also 
biased. Management owns stock and options, short stock and 
options. They are long. We are short. We both have, you could 
argue, a bias.
    While our interests are actually adverse to the holding 
company executives, our interests actually align with the 
policyholders who are the beneficiaries of the guarantees from 
the insurer. We want the insurance subsidiaries to retain as 
much capital as possible so they have a higher probability of 
making good on their obligations to policyholders.
    Just briefly on background on the industry, we have heard a 
lot about it today, so I will take you through it quickly. The 
industry began in the 1970's. For 20 years, it was principally 
a mutual bond insurer. The holding companies went public in the 
late 1980's/early 1990's. I think that is a significant event 
in the history of the companies, at which point the holding 
company executives began to be compensated based on the 
performance of the holding companies by getting stock options 
and restricted stock, and then the business became more 
competitive as there were more entrants, and a desire for 
greater profits led holding companies to push their 
subsidiaries into riskier lines of business.
    Over time, the interests of the holding company executives, 
in our opinion, and the bond insurers themselves, diverged. 
Over the last decade, risk taking accelerated. Massive subprime 
and derivative exposures developed and we have heard a lot 
about that today.
    Who is responsible for the industry's problems? In our 
view, the holding companies bear principal responsibility for 
poor risk management.
    We think the rating agencies also share responsibility 
because they encourage the bond insurers to diversify and to 
structure finance. We think they understated the risk and 
overstated the ratings for that part of the business.
    We think regulators overly relied on the rating agencies 
and the managements, and that contributed to the problem as 
well.
    The problem today, of course, as we have heard, is losses 
from subprime exposures will likely in our view overwhelm the 
capital of the bond insurers, leaving policyholders at risk.
    We have heard a lot from Superintendent Dinallo. I would 
like to say listening to what he has been working on over the 
last several months, I think he has actually done an excellent 
job managing a very difficult situation.
    I think bringing in additional capital into the industry is 
a positive. We are very supportive of that development. 
Berkshire Hathaway is a true Triple A rated company. I think 
that is a very good development.
    We do object. We do think it is not good for the capital 
markets for a bailout to take place where the bailout 
participants are the counterparty banks to these exposures.
    What I mean by this is that if private equity wants to come 
into the bond insurance business, we think that is a wonderful 
thing. If a bank that has counterparty risk that they do not 
want to write down wants to take advantage of the fact that the 
bond insurers have lower capital requirements than banks, 
having lower rating agency standards than banks, and they can 
put a few billion in, to not take $30 or $40 billion of losses, 
we think that is actually bad for the capital markets because 
it reduces transparency.
    There are some investors that might be hurt as a result of 
a downgrade to the bond insurers, about $1.5 or $1.6 trillion 
in mature muni bonds are at risk for downgrades.
    We have heard about municipal money market funds that might 
be forced to sell securities if they get downgraded below the 
AA. You heard today in the front page headlines on muni auction 
selling.
    Here is why I have an interesting solution that I think is 
worth considering. The good news, if I can call it that, is 
that the rating agencies have systematically under rated 
municipal bonds.
    The simple example of that is a Triple B municipal bond has 
one-fourth the probability of default of a Triple A corporate. 
That is a stunning fact. It is a fact that is not that well 
known in the broader investment community.
    I guess the best way I would explain it is if you look at 
all the municipalities in the country and you are in the 
business of giving ratings, and almost all of them are Triple 
A, in order to have a business, you have to grade them a little 
more harshly, so you have various levels that you can address.
    There is something called the municipal rating scale, which 
I think Chairman Kanjorski was touching on, and the corporate 
rating scale.
    We heard the Congressman from Massachusetts talking about 
the grade of his Massachusetts' community's debt. We think the 
same scale should be used for corporate ratings and all 
municipal ratings. What that will do is it will lead to a 
systematic upgrading of municipalities around the country, and 
we think--Moody's and S&P have more data on this than we do.
    We think the vast majority of municipalities will be AA- or 
higher on the corporate rating scale, which means even in the 
event the bond insurers are downgraded, the underlying ratings 
will qualify for the Rule 2a-7 test and for many fiduciaries, 
like pension funds, that are only able to hold highly rated 
bonds.
    I want to talk briefly about the Buffett proposal. I think 
the media has not gotten it quite right. I do think it is a 
very interesting proposal, if the goal here is to protect the 
municipal holders.
    What Buffett is offering is a private sector solution. In 
my view, as an American, you do not go to the government for 
money if there is a private sector alternative. You want to 
protect bond holders.
    Buffett is offering to reinsure the entire municipal books 
of three of the biggest bond insurers. What he is doing is he 
is putting the municipal holders at the front of the line, as 
he calls it.
    The concern is that the structured finance risk will burn 
through the capital of the bond insurers and 5 years from now, 
there will be nothing left for municipal holders.
    What he is doing is he is taking that risk away from them, 
he is giving them a Triple A rating, and he is charging what he 
thinks is a market price.
    What I think is very interesting about it, if this turns 
out to be a wonderful deal for Mr. Buffett, he is giving a 30 
day period of time where anyone else can put in a bid, so he is 
creating a ceiling on the maximum price the bond insurers have 
to pay for this insurance, and if AIG or GE or another well-
capitalized company wants to come in and do it at a lower 
price, and they are free to do it at a lower price, and this is 
a very efficient way to establish an auction price to reinsure 
that book of business.
    Systemic risk. The other big piece here, of course, from a 
systemic standpoint, is the structured finance part of the 
business. Here I am relying on Oppenheimer estimates.
    There is $125 billion of CDOs where the banks are 
counterparties to the bond insurers. The estimates are there 
will be $35 to as much as $70 billion of losses here. These are 
exposures that the banks have reinsured with the bond insurers. 
If the bond insurers go away, the banks will be exposed to this 
risk, less whatever they collect in terms of claims.
    Buffett describes it. He says look, it is poetic justice 
that the people who sold this kool-aid end up drinking it in 
the end, so there is a little poetic justice.
    That said, we heard from the SEC just on the previous panel 
that the banks are positioned to absorb these write-downs if 
they have to. We think if there is going to be a loss and it 
turns out it hurts a bank, if a bank needs to be recapitalized, 
we think a bank should be recapitalized directly as opposed to 
through the mechanism of the bond insurers.
    Mr. Meeks. Could I just ask you to start wrapping up, 
please?
    Mr. Ackman. Sure. These are my final remarks.
    What should regulators do? We heard about special 
dividends. MBIA took out $1 billion in special dividends 
between December of 2006 and April of 2007.
    The goal of holding companies is really to take out as much 
capital as possible so they can pay dividends and buy back 
stock.
    We heard from Superintendent Dinallo that he can stop 
special dividends, but not ordinary dividends. That really 
comes down to the fact that the executives themselves determine 
the amount of statutory capital that an insurer has.
    If there is policyholder surplus, they can take out 
ordinary dividends. What determines policyholder surplus is 
what the estimates management has for losses. The big debate 
here is what the losses are going to be.
    Our suggestion is that the regulators, and Eliot Spitzer, 
the Governor, talked about some Federal assistance, I think the 
best place for Federal assistance here would be for the Federal 
Reserve, the Comptroller of the Currency, and the Treasury, to 
help the New York State Insurance Department and other 
insurance departments to value the exposures of the bond 
insurers, figure out whether they are adequately capitalized, 
whether the reserves are adequate, and if not, there is a very 
simple solution where the State Insurance Department can fix 
the problem.
    We need transparency on what the losses are. We need an 
independent third party with the resources to evaluate it. I 
think we have it in the form of our banking regulators.
    I thank you for the time.
    [The prepared statement of Mr. Ackman can be found on page 
86 of the appendix.]
    Mr. Meeks. Thank you. Next we will hear from Mr. Keith 
Buckley, the group managing director and global head of 
insurance for Fitch Ratings.

  STATEMENT OF KEITH M. BUCKLEY, GROUP MANAGING DIRECTOR AND 
            GLOBAL HEAD OF INSURANCE, FITCH RATINGS

    Mr. Buckley. I would like to thank you, Mr. Chairman, for 
the opportunity for Fitch Ratings to give our views on the bond 
insurance industry.
    What I plan to discuss is Fitch's history of rating the 
bond insurance industry. I will provide a general overview of 
our rating methodology, and then I will discuss recent rating 
actions that we have taken, including downgrades of three of 
the Triple A bond insurers.
    From a historical perspective, Fitch began rating the bond 
insurers in 1991. We currently rate eight bond insurers 
including each of the big four bond insurers that together make 
up about 83 percent of the gross insured power in the industry.
    All but one of these eight companies was originally rated 
Triple A, and all of these companies maintained their original 
ratings until very recently.
    Accordingly, our bond insurer ratings have exhibited high 
levels of historic stability.
    Our methodology is consistent with that which we use for 
other types of insurance companies and financial institutions, 
also recognizing the unique attributes of bond insurance. We 
look at both qualitative and quantitative attributes, with 
qualitative including such things as management, corporate 
governance and franchise, and quantitative aspects including 
things such as capital adequacy, risk management, financial 
performance, and liquidity.
    Although all of the quantitative factors are important, 
arguably the most important is capital adequacy. We assess that 
via a proprietary model that we developed earlier last year, 
where we analyze the relative risk of the municipal structure 
and infrastructure bonds that are insured by the bond insurers, 
and based on that analysis, come up with relative amounts of 
capital they need to maintain in order to meet a Triple A 
rating threshold.
    Generally, the greater the risk in the portfolio, the 
higher the amount of capital that needs to be held.
    A key input into our modeling are the underlying ratings on 
the deals that are insured by the bond insurers. We generally 
take into account our own rating, if it exists. If not, we use 
the lower of the Moody's and S&P ratings.
    I think it is also important to note that the bond insurers 
themselves maintain their own underlying ratings and employ 
their own credit staffs. They do a lot of work beyond what the 
rating agencies do to assess their own risks.
    The ratings that we assign to the bond insurers are called 
financial strength ratings. They are assigned at the insurance 
operating companies that are regulated at the State level.
    It is the regulatory protections that in part allow us to 
assign Triple A ratings because those liabilities are protected 
by statute.
    I think it is very important to recognize that IFS ratings 
indicate the likelihood that a bond insurer will fail and 
become insolvent. The ratings do not provide and were never 
intended to provide any indication as to the likelihood that a 
bond insurer may be downgraded.
    In fact, with most financial institutions and insurance 
companies, downgrades are common during periods of financial 
stress and when it comes to the subprime markets that a lot of 
insurance companies and financial institutions deal with, we 
are in such a period of stress.
    Our recent rating actions came in two phases. Back in the 
second quarter of 2007, we began to get worried that because of 
subprime issues, in underlying deals rated by the bond 
insurers, that there would be downgrades in underlying 
collateral which would lead to increases in capital 
requirements, which in turn could put pressure on bond 
insurers' ratings.
    We first did a stress test of this analysis and published 
it in September of 2007. When things seemed to get worse with 
subprime, on November 5th, we announced a formal review of the 
industry.
    At that point, we said when we completed our analysis, if 
companies were shown to have inadequate capital relative to our 
Triple A standard, we would give them a period of 4 to 6 weeks 
in order to raise new capital, and if they were unable to do 
that, we would downgrade their rating consistent with what 
their credit metrics implied.
    We thought it was important to give a timeframe such as 4 
to 6 weeks for 2 reasons. One is that we think that Triple A 
companies, including bond insurers, need to demonstrate 
financial flexibility during all periods, either stressful 
periods or good periods. It is important to judge that.
    Also, bond insurers have made unflinching representations 
of their willingness to support their Triple A ratings, and we 
felt the willingness of management to act quickly to support 
Triple A ratings was a very important qualitative factor in 
maintaining their ratings.
    At the conclusion of our analysis, two bond insurers did 
raise capital or had commitments that allowed us to affirm 
their ratings, but three companies did not, and those ratings 
were downgraded.
    Two other companies did not have material subprime exposure 
and their ratings were affirmed and remained stable.
    We then announced a second phase of analysis on February 
5th, after additional studies were done based on new economic 
data looking at subprime, that indicated losses were growing 
even higher.
    Based on indications from our residential mortgage-backed 
securities group, we increased our loss assumptions and that 
indicated that maybe additional capital would be needed.
    Concurrent with that decision, we announced that the 
ratings of two bond insurers that were previously affirmed were 
now put on rating watch negative because the capital they raise 
may not be adequate to cover the shortfall.
    That analysis is ongoing. We have not announced a timetable 
as to when we think that will be completed, but I do think it 
will be in the relatively near term.
    We do think to the extent that additional capital is 
required and additional downgrades were to occur, we do think 
the companies would remain solidly in the investment grade 
category.
    In conclusion, I think Fitch's outlook for the bond 
insurance industry is somewhat uncertain at this point. We 
think there is a possibility that some companies may decide to 
voluntarily exit the market if they cannot return to Triple A 
ratings and retain trading values.
    We think it is also likely that other companies may 
consolidate and thus try to deal with their issues that way.
    We also would expect new entrants, and I think Berkshire 
Hathaway has been spoken about several times.
    One thing that is important is because of the escalating 
losses related to subprime and because we have noticed some 
companies did not raise capital within the timeframes we set 
and because there are declines in franchise value, we are not 
sure the capital raising alone is sufficient to allow 
downgraded companies to return to Triple A.
    At this point, reforming our methodologies as far as what 
does it take for a downgraded company to come back to Triple A, 
as far as those parameters and timeframes, and we will clarify 
that for the market in the near term.
    I think what is important to recognize, too, at this stage, 
consistent with our original Triple A ratings, we are not 
envisioning solvency problems for the bond insurers. Again, 
this is a rating downgrade issue, not a solvency issue. I think 
that is a very important consideration.
    Thank you very much for inviting me to testify.
    [The prepared statement of Mr. Buckley can be found on page 
93 of the appendix.]
    Mr. Meeks. Thank you, Mr. Buckley. Next we will hear from 
Mr. Richard P. Larkin, senior vice president of Herbert J. Sims 
& Co., Inc.

STATEMENT OF RICHARD P. LARKIN, SENIOR VICE PRESIDENT, HERBERT 
                      J. SIMS & CO., INC.

    Mr. Larkin. I would like to thank the subcommittee for 
inviting me. I think it would help for you to know that I 
served 26 years at two major statistical rating agencies over 
my career.
    I would like to spend 2 minutes to answer some questions 
that have come up several times during the committee.
    I am going to talk about low municipal scale ratings. I am 
going to talk about high corporate equivalent ratings, but also 
why is there such as thing as bond insurance and why is it 
needed if there are very few defaults.
    In 1971, Ambac was founded. In 1974, MBIA was founded. Both 
are bond insurance companies. It was a small business. Most 
people at the time thought it was a novelty. However, in 1975, 
New York City had their financial crisis which threatened to 
destroy credit markets across the world, or so people thought. 
It was a major financial crisis in 1975.
    That was followed shortly by Yonkers' almost-bankruptcy, 
the insolvency of the school boards of Chicago and 
Philadelphia, and a meltdown in the City of Chicago.
    In 1982, a large default by the Washington Public Power 
System, and in the middle of that, California, Proposition 13, 
where voters passed and basically eliminated half of the 
taxation of municipalities that had to pay debt in California.
    In those 7 years, there were good reasons for municipal 
bond investors to worry whether or not their bonds were going 
to be paid, and a lot of the reason for why municipal bond 
ratings are as low as they are came out of the 1975 crisis, 
plus those 7 years where there was a lot of stress.
    I would like to say that I believe it is clear that the 
bond insurance crisis is rating driven. While bond insurers 
take responsibility for extending their guarantees into 
volatile and increasingly risky sectors, they could not have 
maintained their Triple A ratings unless the rating agencies 
believed that exposure in this sector would not have weakened 
those ratings.
    Any solutions to this crisis will require actions by the 
NRSROs or changes to the NRSRO system.
    In the last week, the three agencies have announced reforms 
or proposed revisions to their rating process. Because of their 
newness, it is difficult to determine whether or not they will 
be able to prevent reoccurrence of a crisis as the one we are 
witnessing right now.
    There have been studies by rating agencies that point out 
default rates on tax-backed and utility revenue bonds are lower 
than those for Triple A corporate rated debt. As more people 
are educated in the history of infrequent municipal bond 
defaults, I believe demand for municipal bond insurance may be 
less robust in the future than has been the case.
    Despite these low default rates, the median ratings for 
tax-backed and water and sewer utility bonds are only in the 
single A category despite low default rates.
    In March of 2007, Moody's said their municipal scale rating 
were not indicators of default and loss, like their other 
ratings. In the report, Moody's published a map to show that 
these bonds that I am talking about, which are rated as low as 
BAA-3 on their municipal scale, would be rated no lower than 
AA-3 on their global scale.
    The default studies used by this March 2007 Moody's report 
all corroborate what finance professionals and academics have 
said for years, that municipal bonds are the second safest 
investment against default after U.S. Treasury obligations.
    It is clear, however, that the more conservative municipal 
scale ratings with a median single A rating play a large part 
in the usage of municipal bond insurance.
    It is my firm belief that ratings which truly reflect low 
municipal bond defaults, call them global scale or corporate 
scale type ratings, would allow significantly more debt to 
carry ratings of AA and Triple A consistent with Rule 2a-7 
allowing those investments to be carried by municipal money 
market funds.
    Using this scale for retroactive assignments of underlying 
ratings on uninsured debt would also allow more securities to 
be retained by money market funds in the event the bond insurer 
ratings are downgraded below the AA level.
    Here I must disagree with Mr. Ackman in his testimony when 
he said nearly all municipal bonds would probably be upgraded 
by moving to this corporate scale.
    There are classes of municipal bonds where there would 
probably be little or no increase in ratings even going to the 
higher scale. These classes include hospitals, long term care 
providers, nursing homes, toll roads, private colleges, ports, 
and airports. These issuers have the greatest need for a viable 
bond insurance industry and are likely to feel the impact of 
the bond insurance crisis the most.
    To me, the current crisis is primarily bond rating driven. 
As a former bond rating executive, I would like to offer 
several ideas that could provide some immediate relief for 
issuers and investors affected by downgrades to the bond 
insurers.
    One, there could be increased availability of underlying 
bond ratings for insured debt. Underlying ratings are not 
issued automatically. These are the ratings on the issuer 
itself, not including the insurance.
    The issuer must separately request an underlying rating if 
the bond issuing is insured. If underlying ratings were 
assigned a standard procedure, there could be significantly 
more bonds that keep ratings of AA or higher after an insurer's 
downgrade.
    This solution is not without its problems, because the 
issuer pay agency model assigns ratings only upon request, the 
rating agencies may not be permitted or even required to assign 
underlying ratings if the issuers want to keep those ratings 
suppressed.
    In addition, it is unknown whether the rating agencies have 
adequate information on which to assign those accurate 
underlying ratings for every insured bond that is right now 
rated Triple A or AA.
    Another suggestion would be rating agency adoption of those 
global scale or corporate equivalent ratings. As I said before, 
if this were in place, there would be a large increase in AA 
and Triple A rated securities eligible for investment by money 
market funds and could be retained if bond insurers were 
downgraded.
    This, however, assumes that the raters were willing or able 
to increase the number of underlying ratings where they 
currently do not exist.
    In addition, it is unclear as to whether S&P or Fitch 
believe there should be a different rating scale from the 
current system as Moody's does, or whether they are in a 
position to implement such a dramatic change if they thought it 
was right.
    The chairman has mentioned House Bill 2091 for credit 
enhancement using Federal Home Loan Banks for a letter of 
credit. I would support that. I think that could give some 
quick and immediate relief to issuers that need credit 
enhancement in the face of downgrades by the bond insurers.
    Finally, IRS re-issuance regulations. When a municipality 
materially changes the terms of a bond issue, tax regulations 
can trigger negative tax consequences for both issuers and 
investors.
    Today, many States and localities face conditions where 
their bonds are carrying interest rates far in excess of 
reasonable rates due to problems with the bond insurers. Some 
States and localities are prevented by the IRS' re-issuance 
regulations from negotiating new terms with their bond holders. 
Market participants have been talking with Treasury and the IRS 
to address these problems and there may be some relief there.
    I would like to thank the committee for the invitation to 
appear and I would be happy to answer any questions.
    [The prepared statement of Mr. Larkin can be found on page 
224 of the appendix.]
    Mr. Meeks. Thank you, Mr. Larkin.
    Next we will hear from Michael Callen, chairman and chief 
executive officer of Ambac Financial Group Inc.

   STATEMENT OF MICHAEL CALLEN, CHAIRMAN AND CHIEF EXECUTIVE 
                 OFFICER, AMBAC FINANCIAL GROUP

    Mr. Callen. Thank you, Mr. Chairman. I am the interim chief 
executive officer and chairman of the Ambac Financial Group, 
and I commend the subcommittee for these hearings and what is 
going to come out of them.
    Ambac and other insurers have a vital but usually obscure 
corner of the modern financial system. We are crucial to 
financing of municipal governments, school districts, and other 
public sector entities, helping them to get capital they need 
at the lowest possible cost.
    We play a similar role in consumer finance where Ambac 
insured bonds have lowered the cost of financing for homes, 
education, and automobiles.
    Ambac has been in the financial guarantee industry for 35 
years. Today, almost a quarter of the insured municipal bonds 
are guaranteed by Ambac.
    Over the past 3\1/2\ decades, Ambac and the industry has 
successfully survived many cycles and challenges, including 9/
11 and Hurricane Katrina, Orange County, and multiple 
recessions. No holder of an Ambac-insured security has ever 
missed a single payment of interest or principal.
    Almost no one questions the ability of Ambac to make good 
on obligations to holders of our guaranteed debt.
    Instead, our challenge is maintaining the stability of the 
ratings that have supported our business in the past. Ambac is 
committed to do everything we can to maintain our ratings and 
restore the market's confidence, including raising substantial 
additional capital.
    If our goal is a strong and viable monoline industry, who 
are the beneficiaries? First, bond issuers, including States 
and municipal governments. They want and sometimes they need 
the bond insurers to continue to provide market access and 
lower borrowing costs.
    Second, bond investors. Investors benefit from the credit 
analysis that Ambac does prior to closing a transaction. This 
includes on-site due diligence, documentation review, and 
numerical analysis, all performed in-house at Ambac.
    After closing the transaction, Ambac's surveillance team 
monitors the transaction actively and in cases of financial 
stress, can facilitate a restructuring before a default occurs. 
These are functions that many investors cannot do themselves.
    Lastly, the capital markets and the financial system as a 
whole benefit. One of the roots of the problems facing 
financial markets today is the proliferation of participants 
with no skin in the game. These financial intermediaries who 
have nothing to lose generated and sold low quality assets into 
the liquid markets of the prior years.
    In contrast, Ambac has skin in the game and the proper 
incentives to strive to generate high quality financing 
products. Good incentives do not guarantee that mistakes will 
not be made.
    Ambac has made mistakes. We guaranteed overly complex 
securities by the name of CDO squared's. Four transactions. The 
structure of these deals has ended up magnifying rather than 
minimizing the risks involved.
    As a result, Ambac announced that we expect to pay $1.1 
billion in claims in the future on three of these CDO 
squared's, and on one CDO. We are not happy about that.
    With every mistake comes a silver lining of lessons 
learned. We will no longer guarantee CDOs or CDO squared's. We 
have strengthened internal risk controls. We have tightened 
credit standards and raised rating hurdles.
    You may be surprised to hear that actual claim payments to 
date have been low. In 2007, in fact, we recovered more in past 
claims than we paid out.
    This will change. We are after all in the business of 
insuring against credit risk. During periods of credit 
weakness, we should expect to pay claims.
    Last year, we took $1.4 billion in reserves and credit 
impairment charges, which includes the $1.1 billion on the 
CDOs.
    Ambac has claims paying resources of $14.5 billion, and we 
continue to grow this through earnings on our existing 
investment portfolio.
    I would like to make an important point concerning 
liquidity. As you know, it is generally liquidity problems that 
drive failures in the financial industry. Ambac is not exposed 
to liquidity risk.
    When an issuer of an Ambac-insured security defaults, we 
make their principal and interest payments under the original 
schedule. Because we pay out over the original life of the 
bonds and not at the time of default, we know our claim 
obligations well in advance.
    We never have to settle the claims in a lump sum payment as 
do property, casualty, and life insurance companies.
    Let me turn to the possibility that the credit rating 
agencies may downgrade Ambac. What would such a downgrade mean 
in practice? Contrary to some media accounts, it would not 
signify a high risk of default to investors and Ambac-insured 
securities. At a AA rating, Ambac would still be higher rated 
than most financial institutions in the United States.
    Let me emphasize that our ability to meet capital 
requirements associated with a Triple A rating has little to do 
with whether we can handle expected claims. Triple A is not 
about meeting expected obligations. It is about the ability to 
weather the 100-year storm and emerge with excess capital.
    In conclusion, Ambac's ability to meet our obligations is 
not in question. What we are striving for goes beyond this to 
the ongoing viability of this industry, an industry that we 
believe fulfills a vital public purpose.
    Those who benefit from a viable monoline industry are a 
broad and diverse group. They include States, municipalities, 
the consumers, and your constituents.
    We, therefore, are encouraged by your efforts to take the 
time to understand our business before taking action that could 
have unanticipated consequences.
    We are grateful that the subcommittee is making this 
effort, and to Commissioner Dilweg in Wisconsin and New York 
State Insurance Department, particularly, Eric Dinallo, has 
been very energetic and knowledgeable in addressing the issues 
that we have today.
    Thank you.
    [The prepared statement of Mr. Callen can be found on page 
102 of the appendix.]
    Chairman Kanjorski. Thank you very much, Mr. Callen. I 
guess we move now to Mr. Chaplin, chief financial officer of 
MBIA Inc.

  STATEMENT OF CHARLES CHAPLIN, CHIEF FINANCIAL OFFICER, MBIA 
                              INC.

    Mr. Chaplin. Thank you. Chairman Kanjorski and members of 
the subcommittee, thank you for inviting me to address you 
today. I also want to thank you for your stamina, for hanging 
around until the very last witness.
    I am Chuck Chaplin, the vice chair and chief financial 
officer of MBIA Insurance Corp., and I am pleased to be here on 
behalf of MBIA to discuss the issues currently facing our 
company and our industry, and the proactive steps we have taken 
to address them.
    As background, MBIA is an industry leader in bond 
insurance. We have been in the business for 34 years and we 
were the first bond insurer to receive a Triple A credit 
rating.
    We currently insure over $1 trillion of total debt service 
and employ 480 employees in our Armonk, New York, offices and 
11 offices around the world.
    We have the most claims paying resources in our industry at 
over $17 billion, and our capital position relative to any 
solvency measure is unquestioned, and we believe we have in 
excess of $1 billion of excess capital relative to rating 
agency current Triple A standards.
    Our industry has roots in the public sector where bond 
insurance has helped finance some of the country's great public 
works projects, including bridges, ports, utilities, toll 
roads, and other essential infrastructure.
    MBIA has guaranteed financings in all 50 States, and in all 
of the subcommittee members' districts from JFK Airport in 
Queens, New York, to the Wyoming Seminary Prep School in 
Pennsylvania, to the Children's Hospital of Los Angeles, which 
is a deal that we insured only 2 weeks ago.
    Today, municipal finance and essential infrastructure 
account for about 65 percent of our insured portfolio.
    When we insure a bond, we are said to ``wrap'' it. That 
simply means we guarantee the timely payment of interest and 
contracted principal in the event the bond defaults. Our 
guarantee lends our rating to that of the insured bond and the 
pool of potential investors for Triple A rated bonds is much 
larger than that for lower rated paper.
    Also, interest rates are generally lower, so issuers save 
money by borrowing on an insured basis.
    There are 87,000 municipal and State governments in the 
United States, and 50,000 of them have issued debt of which 
about $1.7 trillion is currently outstanding. About half of 
that is wrapped by bond insurers.
    The motivations for local governments has been compelling. 
It saves the taxpayers money. For some smaller governments that 
are less frequent issuers, and we have heard from a couple 
today, bond insurance also ensures that they have access to 
cost effective funding that might not be available on an 
unwrapped basis.
    We also provide a service to the investor and 5 million 
American households own municipal debt. Our guarantee eases the 
burden on them of needing to understand the idiosyncratic 
credit risk and jurisdictional issues associated with borrowers 
in transactions. In effect, the bond insurance commoditizes the 
municipal debt.
    We also provide surveillance and of course, if there are 
problems, remediation services. In effect, investors have 
outsourced those analytic and management functions to the bond 
insurers and we give them a money back guarantee. This broadens 
the universe of potential investors which again tends to reduce 
interest costs.
    In the early 1990's, MBIA expanded its business into 
structured finance. These transactions involve bonds backed by 
assets such as credit card receivables and mortgages. Today, 
our structured finance business makes up 35 percent of the 
insured portfolio.
    The value proposition for many of our structured finance 
customers and investors is really much the same as that for the 
municipal issuers and investors, that is to reduce borrowing 
costs, provide greater liquidity, to commoditize the product, 
and to act on investors' behalf to mitigate losses if they 
occur.
    Until 3 months ago, our industry attracted little attention 
outside of our small community of bankers, regulators, and 
rating agencies. Of course, that was fine with us. In our view, 
a good year at MBIA was kind of like a good airplane flight, 
nothing very exciting happens.
    Over the years, we have operated quietly and efficiently, 
delivering our value proposition to investors and bond issuers, 
and delivering solid returns to our shareholders.
    Of course, that was then. Like many other financial 
institutions, we have exposure to the deepening credit crisis 
through a relatively small part of our structured finance 
business. About 9 percent of our total insurance portfolio is 
related to the U.S. mortgage market.
    We have significant exposure to prime second lien products 
like home equity loans and to mortgages that have been pooled 
in investment vehicles called ``collateralized debt 
obligations'' or CDOs.
    The rapid deterioration of the underlying mortgage loan 
performance and its impact on mortgage-backed securities in the 
second half of 2007 created new expectations of loss that were 
a multiple of any previous market forecast.
    Today, analysts are projecting losses on mortgage 
collateral that have not been seen since the Great Depression.
    S&P reported that actual loss rates on subprime securities 
in December 2007 were 1.4 percent. However, projections of 
eventual losses are now on the order of 20 percent. I note that 
these are projected losses, not actual losses.
    In the fourth quarter of 2007, when MBIA recognized future 
claim payments of approximately $1 billion, we had paid net 
claims equal to $44 million, or far less than 1 percent of our 
total exposure.
    Based on the change in projected losses, we began an 
aggressive plan to raise capital even before the rating 
agencies communicated their increased capital requirements to 
the company.
    In less than 8 weeks, we increased our capital position by 
over $3.1 billion. This level exceeds all worse case stress 
loss scenarios put forth to date by the rating agencies. Today, 
our claims paying resources stand at over $17 billion, the 
highest in the industry.
    During our capital raise, our financial reports are risk 
reports and portfolio details were reviewed in great depth by 
highly sophisticated investors such as Warburg Pincus, who 
after doing their analysis, agreed to invest $800 million in 
our company.
    This information was also thoroughly reviewed by the 
underwriters of our debt and equity security offerings. That is 
these independent parties got comfortable enough after 
scrutinizing every detail of our mortgage exposure to invest 
billions of dollars in our company.
    What did go wrong with our portfolio? How did we, along 
with so many other financial institutions and market 
participants, miss the warning signs of these losses?
    The generally benign credit environment between 2003 and 
early 2007 lowered the appreciation of and the pricing for 
credit risk across all of the credit markets.
    The environment fostered an erosion of underwriting 
standards at all levels across the fixed income market. Because 
of the historically low loss levels and stable performance of 
mortgage products, we also missed this evolution.
    Today, we are paying the price for that. However, we do not 
believe that any kind of a bailout plan is necessary for our 
company. There is not one shred of evidence that MBIA is at 
risk of failing to fully satisfy any and all policyholder 
claims, and private investors have shown a willingness to 
capitalize our company for the long haul. They understand the 
fundamental strengths of our business model and that we are 
focused on learning from this experience.
    We will review our risk management standards and due 
diligence processes to make sure that we do not make this 
mistake again.
    As we look forward, we see more need than ever for bond 
insurance. Formal estimates include $1.6 trillion in U.S. 
infrastructure needs alone over the next 5 years. The needs 
outside the United States are even larger.
    The demand we expect will also be strong for structured 
finance and the structured finance products will continue to be 
important in lowering the costs and creating access to credit 
for consumers and businesses, just as municipal bond insurance 
does for cities, States, and authorities.
    We have been working closely with our primary regulatory, 
the New York State Insurance Department, to review these 
lessons learned, to discuss new guidelines on acceptable 
products and portfolio guidelines.
    The Department has been very proactive in support of our 
effort as Superintendent Dinallo referenced a little bit 
earlier.
    Further, we believe that the Insurance Department is well-
suited to continue to provide this oversight and to create and 
implement any new regulations.
    We appreciate and commend Superintendent Dinallo's efforts 
to date because they will help to ensure the stability of this 
industry's participants.
    In the meantime, we will work to re-build the trust that we 
have spent decades earning with the hope of restoring order and 
stability to the vital bond insurance marketplace.
    Thank you again for your time and I look forward to 
responding to your questions.
    [The prepared statement of Mr. Chaplin can be found on page 
111 of the appendix.]
    Chairman Kanjorski. Thank you very much, Mr. Chaplin.
    I guess you get razzed because of your famous name.
    Mr. Chaplin. Occasionally, it comes up.
    [Laughter]
    Chairman Kanjorski. I am old enough to remember that name, 
but most of the audience is too young to remember.
    We probably have bored the rest of the committee to death, 
but if you do not mind, I am going to bore you a little bit 
longer.
    I spent several days in New York over the last month, 
month-and-a-half, trying to get briefed on what is happening. 
It has been interesting. Each time I go up and get briefed, it 
appears that things are a little more severe, a little more 
dangerous, and a little more widely distributed in the credit 
market in particular.
    I always ask a couple of questions when I have gone into 
the investment banking houses, the insurance companies and 
others: What do they feel caused this credit crunch? I would be 
interested to know if anybody here wants to volunteer their 
response, and most particularly, I think I can anticipate what 
Mr. Ackman's answer will be, but the insurance companies, I 
really would enjoy hearing whether or not you see any viable 
responsibility for any of this yourselves.
    Mr. Chaplin. The short answer is ``yes.'' What we witnessed 
was a period of benign credit conditions that went on for quite 
a while, from 2003 through really almost the first half of 
2007.
    Chairman Kanjorski. On that point, you were licensed by the 
State of New York to do monoline insurance?
    Mr. Chaplin. Correct.
    Chairman Kanjorski. Maybe you can spell out, what does that 
really mean, ``monoline insurance?'' I think I know. It is 
different from what you do; is that correct?
    Mr. Chaplin. We are in the business of insuring bonds, so 
it is a monoline in that sense. We insure only fixed-income 
securities, and we insure fixed-income securities that are 
issued both by municipalities as well as by structured finance 
vehicles.
    Chairman Kanjorski. Were you always in the structured 
finance vehicle line?
    Mr. Chaplin. MBIA started insuring structured finance 
vehicles in the early 1990's. We did not insure structured 
finance--
    Chairman Kanjorski. At that point, you should have been a 
multi-line business; right?
    Mr. Chaplin. I am sorry?
    Chairman Kanjorski. It would be a mistake to call you a 
monoline at that point when you started to do the insurance of 
other vehicles. You should have been a multi-line.
    Mr. Chaplin. I think that is a fair point. The term 
``monoline,'' I believe, was coined to refer to the fact that 
we insured bonds only.
    Chairman Kanjorski. Singular targeted business that you 
were rather expert at. In my other life as a practicing 
attorney, I had the occasion to use some of your companies with 
some of my clients when we would be doing projects and issuing 
bonds.
    Do you think the difficulty you find yourself in today has 
any relationship to the fact that you enlarged or grew your 
business into other lines of exposure?
    Mr. Chaplin. It certainly has to do with some poor 
underwriting judgments that we have made of late.
    Chairman Kanjorski. That is easily said that way. How about 
if you had never gotten into underwriting any other line but 
municipalities? Would we have a problem today?
    Mr. Chaplin. We would have no exposure to the home mortgage 
market.
    Chairman Kanjorski. Would we have a problem today? It is 
not a hard question. I am going to try to insist on it because 
I am trying to drag out of you culpability here.
    Mr. Chaplin. I am totally willing to agree that we are 
culpable and that we did in fact expand our business over time.
    Chairman Kanjorski. And is that the reason that you have a 
difficulty now?
    Mr. Chaplin. The fact that we have engaged in wrapping the 
bonds that we have, particularly in the mortgage sector, has 
resulted in the problems that we are enduring right now.
    Chairman Kanjorski. If you had stayed in your regular 
course of business that you were licensed to do by the State of 
New York for 30 years, we probably would not have even have had 
this hearing today on the threat to municipal bonds; is that 
correct?
    Mr. Chaplin. Certainly not over home mortgage exposures; 
no.
    Chairman Kanjorski. You would not be in it. You would be 
the strongest insurance company in the world because you would 
be getting all this premium and insuring things like municipal 
bonds. I understand some of the testimony today that municipal 
bonds never fail; is that right?
    Mr. Chaplin. Mr. Chairman, we believe that our insurance 
company today is actually very, very strong from a capital and 
liquidity perspective, and to the extent that we were focused 
on the municipal bond business itself, as has come up a couple 
of times today, the general obligation in the municipal bond 
business, where you really do have a low incidence of 
defaults--
    Chairman Kanjorski. Mr. Chaplin, I am pressing you because 
we will not get to a situation where we can really get to the 
fundamentals here and the corrections that have to be made 
unless we are sort of straightforward and truthful with 
ourselves and truthful with the causes.
    It is like arguing that something is not your fault because 
you do not want it to be your fault. I understand that.
    The reality here is, I think, can you accept that if you 
stayed in insuring municipal bonds, wrapping your Triple A 
rating around municipal bonds, there would be no need for a 
hearing at all, there would not be a risk to the municipal 
market at this point?
    Mr. Chaplin. We certainly would not have this problem. I 
agree.
    Chairman Kanjorski. Right. When I was in New York, I asked 
some of the people there, how did these insurance companies 
that were monoline insurance companies, how did they get in 
trouble?
    I could never get any of them to admit that anybody in New 
York encouraged them to do this. I have to assume none of the 
investment houses or anything encouraged your company in an 
earlier time to expand their business and make some more 
friends, basically. Make more profits. Make more revenues.
    Did that happen or did it not happen?
    Mr. Chaplin. I actually was not a part of our company at 
the time, but I am confident that the decision to start 
wrapping other than municipal bonds was motivated by the desire 
to expand our revenue and earnings base by using the skills 
that we had developed in other areas.
    Chairman Kanjorski. Right. Do you think that decision was 
an internal decision of the board of directors or the people 
who ran your company, or did they periodically go to New York 
and meet with the investment banking houses and have some of 
them say hey, you are writing this monoline business.
    It is boring. There are not going to be big profits in it. 
Look down here at these people who are putting securitization 
together and they are making fortunes, why do you not get into 
that business?
    Do you not think that may have happened?
    Mr. Chaplin. I believe that all the decisions about the 
expansion into the structured finance business were made at 
MBIA by MBIA management and the Board of Directors.
    Chairman Kanjorski. And they had no outside influence?
    Mr. Chaplin. It would not be fair to say that people at 
MBIA do not interact every day with all other participants in 
the capital markets, the banks, the broker-dealers, the 
regulators, and the rating agencies.
    There is a very active dialogue there. It would not be fair 
to say that out of those dialogues, it did not generate ideas.
    Chairman Kanjorski. You know what I am trying to get you to 
say is that the problem in some of our bond markets and credit 
markets today is as a result of greed.
    Mr. Chaplin. Yes, but--
    Chairman Kanjorski. Do you think so?
    Mr. Chaplin. You are not going to get me to say the devil 
made me do it.
    [Laughter]
    Mr. Chaplin. It is true. We are in business to make money.
    Chairman Kanjorski. It is better if the devil made you do 
it than nobody.
    [Laughter]
    Mr. Chaplin. I am afraid we have no one to blame but 
ourselves. We are a profit-making institution. We exist for the 
purpose of trying to deliver returns to our shareholders, and 
the fact is the way we deliver returns to the shareholders is--
    Chairman Kanjorski. We are working on a Federal charter, an 
optional Federal charter right now. Would you recommend that 
when we issue a charter to an insurance company, we do not 
allow them to do any other business except if they are 
specifically authorized by the Commissioner of Insurance, the 
Federal Insurance Commissioner, or by their license adjustment? 
That we just are not going to allow it, based on the experience 
we are having now.
    Mr. Chaplin. We have been having just those kinds of 
conversations with Superintendent Dinallo.
    Chairman Kanjorski. Had he considered restricting your 
license or calling you back to practice under the original 
issuance of your license?
    Mr. Chaplin. We have had conversations with the 
superintendent and the department about changing the base of 
business that the bond insurers engage in.
    Chairman Kanjorski. That would mean you would be back in a 
boring business. It would be a safe business.
    Did you all give any consideration to the cascading effect 
or the whirlpool effect that the credit failure has in 
affecting much larger pools of money and creating much greater 
risk out there, or had that not dawned on you?
    Mr. Chaplin. The fact that the companies are today insurers 
of a very large portfolio of bonds, over $2 trillion across the 
bond insurance industry, it does make us an integral part of 
the capital markets. It does mean we have a responsibility, we 
believe, to manage the companies in a prudent manner.
    The fact is we did make a mistake. There is no two ways 
about it. We did insure some bonds that we wished we had not 
insured, because we are taking substantial losses on those 
bonds.
    I want to be clear, those losses do not come anywhere close 
to threatening the solvency or the very high credit quality.
    Chairman Kanjorski. I understand. We do not want to get 
into that. I know you have to answer to your stockholders and 
the public. There is no reason for us to compromise the market. 
I do not want to do that. We are going to assume that you are 
going to work yourself through this and that you can.
    I am interested, however, in finding some of the root 
causes, not only for the municipal bond problems that we are 
having, but others, and getting to the subprime.
    Two years ago, I authored a subprime mortgage act that to 
some extent would have limited what has now happened, if we had 
passed that act. It was not the best act in the world. There 
were a lot of compromises in it because we are dealing with 50 
States that have different practices.
    At least we would have had an organized effort to get our 
arms around that, and we did not do it as a Congress. 
Unfortunately, there was this tremendous compulsion in the last 
2 or 3 years to package anything that walked and even some 
things that did not walk. Astounding how the thirst for profit 
and money will drive people to do extraordinary things.
    I think that is sort of what happened. Do you not agree 
with me, in the subprime market? When people tell me they were 
surprised in August, I am astounded.
    I am going back now to some of my conversations in New 
York. People said until late July or early August, they had no 
idea of this problem. I am thinking, man, if only they had 
known about me because I must be some kind of financial genius. 
I have been worrying about this for 3 or 4 years. All these 
Ph.D.'s and accomplished economists and what not, it did not 
dawn on them until July or August of last year.
    I do not think they could be that myopic, but maybe they 
are. A lot of us have been worried about what ultimately has 
happened. Now, what we are worried about is what do we not know 
that may still be out there and how do we get our arms around 
that, and what do we do about it.
    I did not have the occasion to be here, Mr. Ackman, when 
you testified. I had another problem I had to attend to, which 
was successful, but it was another occurence that happens in 
the course of our lives. It has been a tough day for me.
    People have been pounding me all day today and yesterday 
about why people are allowed to sell short and distort the 
market. I do not know a lot about your business. I do not 
profess to. I thought that is what capitalism was all about, 
you could take any side of the transaction in any way you 
wanted to, and if you were smarter than most of the other guys, 
you made money and if you were not smarter than the other guys, 
you got cleaned.
    Is that not what capitalism is about or did I miss the 
point somewhere?
    Mr. Ackman. I think that is right.
    Chairman Kanjorski. You would be surprised how many people 
want to cut you out of doing business.
    [Laughter]
    Mr. Ackman. Actually, I am principally a long investor. If 
I may, I would love to address the question you asked. I have 
an answer that may or may not be correct but I think it might 
interesting. May I?
    Chairman Kanjorski. Yes.
    Mr. Ackman. I think if you go back to the mortgage lending 
in the Jimmy Stewart era, which actually carried up right 
through to the beginning of securitization, you had a local S&L 
that had a guy who kept a deposit in the bank. The bank manager 
knew him, knew his wife, knew where he lived, and knew what his 
job was.
    One day he decided to buy a home. He came into the bank for 
a mortgage and he applied. Character was considered. How he 
treated other people. There were other factors that went into 
whether he was a creditworthy borrower.
    The mortgage loan was made, secured by the home. It was a 
pretty simple thing. Maybe 80 percent of the value of the home, 
the guy put down a substantial downpayment. Over a 30-year life 
of the mortgage, he hoped to pay it down, some day have a 
mortgage burning party. That was the old way of doing it.
    What happened really in the last 4 to 5 years is the 
incentives changed a fair amount. What would happen is you 
would have mortgage brokers who would get paid a fee for 
finding a borrower and placing a mortgage.
    Then you would have seller servicers, and what they would 
do is they would get a warehouse line of credit from a bank and 
they would originate as many mortgages as they could, and to 
make things efficient, you would call them up on the telephone.
    You would dial 1-800-MORTGAGE or you would go to 
mortgage.com. You would give them your Social Security number, 
your name. They would run a scoring methodology on you. They 
would approve you for a loan.
    The seller servicer would hold the loan for about 60 days 
until he got a big enough pool of loans in that warehouse that 
he could then sell them in securitization. You would have the 
bank that provided the warehouse line of credit would do a 
securitization.
    The mortgage broker would get his fee. The seller servicer 
would get their fee when they sold the mortgage to the 
securitization. The banker, the investment bank, would get his 
fee when he sold the paper from the securitization to the 
holders.
    The problem developed where they had trouble selling some 
of the lower rated but still investment graded pieces of the 
securitization, the so-called ``Triple B'' pieces and sometimes 
the single A pieces.
    They created something. You know, when Wall Street has a 
problem, they come up with a solution. The solution was a CDO, 
which was a place where you could sell things you could not 
otherwise sell.
    Every step along the way, a profit was made and risk was 
being transferred, but there was not a huge incentive to worry 
about how the loan was going to perform more than 30 to 60 
days, a relatively short period of time.
    Then the CDO would be originated by the bank and the bank 
would sell the pieces to whoever could sell the pieces, then 
the super senior piece, a lot of those pieces were sold to bond 
insurers.
    What enabled this process to take place all along the way 
was really the rating agencies. The rating agencies, their 
traditional business, and it is not dissimilar to what happened 
to the bond insurers, they started out in the business of 
really rating corporate obligations.
    How are GM's bonds going to perform. They went into a 
business of rating fairly complex securities where there was 
very little in the way of actuarial data because it was a 
relatively new industry, and they used models and they made 
projections and they were aggressive.
    The rating agencies got fees every time there was a 
securitization done. They did not get their fee unless they 
gave it a Triple A rating.
    I just think human nature is such that if you get $25,000 
if you do not do the deal for the work you do or you get 
$600,000 if you give the Triple A tranche a Triple A rating in 
a CDO, and incentives fuel a machine where people make money 
all along the way.
    I think that, I would say, is the cause for where we are 
today. It is just human nature, incentives. I do not know about 
greed, but people are profit oriented.
    I would submit that is the story.
    Chairman Kanjorski. You call it ``profit'' and not 
``greed?''
    Mr. Ackman. They are similar, I would say.
    Chairman Kanjorski. Profit, everybody is entitled to profit 
for a function that they perform. Excessive profit starts to 
move toward greed.
    In looking at some of these transactions, and I have talked 
to some of the people who have recently gone into creating 
these pools, they just could not keep their eyes off the fees 
and the returns for little or no effort, and no skin in the 
game. They dumped the risk very quickly.
    Mr. Ackman. I agree.
    Chairman Kanjorski. To catch them, it had to be 
catastrophic in timing to get caught. Other than that, they 
were out of the game and made millions on just some pools.
    Mr. Ackman. That is right.
    Chairman Kanjorski. One other thing I have associated with 
this is what you would call the perfect storm in a capitalist 
system. A capitalist system is supposed to have advocates on 
both sides of the transaction to protect themselves, to get 
down to what is the right and fair price. They watch each 
other.
    That is why government does not have to become a regulator. 
We do not have to get in play because these cats in the private 
market, they will scratch their eyes out. All we can do is 
threaten them with jail. They can kill and they will for a 
dollar, and that is good. That keeps the market healthy.
    Unfortunately, when you study these transactions, as you 
described it, everybody is on the one side of profit of the 
transaction. Nobody is on the other side, nobody except the 
last guy down there who bought these things. Only he did not 
buy them. He had a money market manager buy them, making a 
profit by acquiring them. Everybody, even his fiduciary who was 
buying for him, made a profit, by getting him into a bad deal 
and keeping it a secret until the whole line of action is over.
    My question to you is, is there something that can be 
constructed to get back to self regulation? If we do that, are 
they going to distort the market again with the intention of 
making profits, and moving toward greed?
    Are they going to find a way to distort it again, and if 
they are, how can we prevent it from happening except by doing 
something that has always been thought of as being anti-
capitalistic in this system, and that is requiring everybody at 
every line to keep exposure or ``skin'' in the game?
    If everybody had to keep an exposure of 5, 10, or 15 
percent going down that line, I would have to think human 
nature would have said, you know, I do not want this thing to 
come back to me.
    When you are out, the way you describe it, you go on line, 
you sell a bunch of these packages and in 60 days, you are out. 
It is awfully tempting to do that and continue to do that.
    I cannot understand honestly. How do these people get 
involved in no doc loans? These are people who did not have a 
job, did not have any prayer in the world of paying this thing 
back, and they used them as tools to defraud the system 
basically.
    It did not dawn on anybody? There was not any check or 
balance in all these institutions and an internal auditing 
process to find out what we are doing out there?
    I can begin to believe that there may not have been when I 
read about how some trader could handle $7 billion in a bank 
and nobody seems to run a check on what he is doing. That is 
astounding to me.
    But then again, in government, we do the same thing. What 
is our budget, $3.2 trillion? We do not have a lot of checks on 
us, either. Maybe I should not be as surprised.
    What do we do about it? That is really the ultimate 
question.
    Mr. Ackman. Sure.
    Chairman Kanjorski. I feel a little put out because I have 
been one of these anti-Democrats in terms of regulation. I have 
been a firm believer that if the marketplace can be balanced 
and there are checks and balances, you really do not need a 
regulator.
    Now, suddenly, when you look at the rate-making field, the 
easy way to solve that would be to put them under stringent 
Federal control and have all kinds of regulators involved or 
the ultimate rating agency could be a Federal agency, a stamp 
of approval.
    There are some complications with First Amendment rights. 
Everyone I have talked to says that this can be avoided if we 
craft it correctly.
    The problem is that the average taxpayer does not have skin 
in the game if he does not have one of these mortgages. That is 
only 2 or 3 percent of the population that has skin in the game 
from that side.
    What is going to happen if we have a collapsed economic 
system either in the country or in the world? Then everybody in 
the world has skin in the game and they had nothing to do with 
it. They did not even know it was happening.
    When you talk to them about it, they are astounded. They 
are literally astounded that there was such irresponsibility 
out there.
    Does anybody have any idea what we should do? What is the 
role? It is easy for us to say, well, we can step aside and let 
this be handled by the private market. A lot of people are 
urging a private solution.
    I tend to agree with them, except what happens if the 
contagion continues and we have a continued frozen market, and 
60 or 90 days from now, we cannot float bonds to the extent of 
financing operating funds for corporations, very sound 
corporations? General Motors wants to build another car and 
they need money to pay their employees for 90 days and they 
cannot float bonds, and they have to close down.
    What do we do?
    Mr. Ackman. I think what is creating the credit crisis is a 
lack of transparency. Banks do not want to lend banks to other 
banks because they do not know what exposures are on their 
balance sheets.
    We and others have concern about bond insurers because we 
do not know what credit exposures they have. The bond insurers 
have not provided transparency on which asset-backed 
securitization deals they have guaranteed, which CDOs they have 
guaranteed.
    Investors have to rely on either the rating agencies or the 
management of the bond insurer to determine their capital 
adequacy.
    I think the problem came about because people outsourced 
their due diligence to rating agencies. You can just look at 
the stock price of Moody's and see what has happened to the 
reputational equity of that company.
    What I think has to happen is companies need to come clean. 
Banks need to disclose what their exposures are, not just we 
have ``X'' dollars of subprime exposure. The markets will work 
when people provide transparency.
    If you look at what is going on in the municipal market 
right now, one of the big problems is transparency. I am 
frankly interested in investing in municipal bonds right now 
because it seems like an interesting--if I can get 20 percent 
lending to the guy that collects my toll when I cross the G.W., 
that seems like a pretty good interest rate.
    The problem is it is very hard to get documentation on what 
does the balance sheet of the toll road look like.
    Chairman Kanjorski. For transparency, should we require a 
repository of inventory on these types of securities that they 
are recorded and available to the public?
    Mr. Ackman. Yes. It is an easy solution. You have an EDGAR 
system, which was one of the most powerful things we did for 
the capital markets, making on the Internet, companies have to 
make quarterly filings. You get them instantaneously. They are 
free and available to everyone.
    There is no reason why the same thing could not be 
available for CDOs, for asset backed securitizations, and for 
municipal bonds.
    We have tiny little companies that no one has ever heard of 
that you can pull up a 10-K and an 8-K and a proxy and you can 
do the work. We have microcap companies with $12 million market 
caps that can trade efficiently because people can do the work, 
whereas in the municipal bond market, you have a town that is 
miles away. You cannot do any work on it, so therefore, you 
need to have bond insurance or you need to have a rating 
agency.
    You do not need those things. It is much better for 
investors to do their own due diligence, their own analysis.
    Chairman Kanjorski. You are referring to the bond market. 
How about all the other securities that are out there that with 
risk involved?
    Mr. Ackman. No. I think there is no reason not to provide--
no competitive reason why you cannot disclose all of the 
prospectuses for every CDO transaction on the EDGAR system. 
There is no reason for not having it. Then investors can do the 
home work.
    Chairman Kanjorski. Let me find out from the rest of the 
panel. What do you think?
    Mr. Larkin. Mr. Chairman, I want to pick up on something 
that Mr. Ackman said about outsourcing the credit decisions to 
the rating agencies. Let me throw out a radical idea.
    Perhaps there are too many regulations that write the 
rating agencies into investment making decisions.
    Chairman Kanjorski. I am sorry. I am going to ask your 
indulgence for a moment. I have a call from the President. If 
you will just hold where you are and I will be right back.
    [Recess]
    Chairman Kanjorski. Thank you for the indulgence. I have to 
tell you that you have staff assistants out in the anteroom, 
some of the staff are starting to rebel. I just heard them say 
that it is Valentines Day, and it is 6:30, so you better get 
your act together and get out of here or there is going to be a 
revolt.
    [Laughter]
    Chairman Kanjorski. I could stay here all day, quite 
frankly. I think it is a vitally important issue. I am looking 
to panels like this to give us the insight on what to do.
    Mr. Larkin. Mr. Chairman, could I finish the thought?
    Chairman Kanjorski. Yes.
    Mr. Larkin. As Mr. Ackman said, there has been an awful lot 
of outsourcing of the credit decisions to the rating agencies. 
You can start with Rule 2a-7 of the Act of 1940. It basically 
says the rating agencies decide what money market funds can 
hold and what they cannot hold.
    There are things written into bond documents that say if 
this is rated A but an issuer wants to make a change to a 
document, it cannot be done without the bond rating agency's 
approval, otherwise the rating could be downgraded.
    Ultimately is the point I made before, the bond insurers, 
Triple A, they can only do whatever the rating agencies would 
have allowed them to do to be able to maintain the Triple A. 
The bond insurers could not have gotten into this without the 
rating agencies saying it is okay.
    Perhaps we do not need more regulation on the raters or the 
bond insurers. Maybe we have just written the rating agencies 
into too much regulation, to give them this much power.
    Chairman Kanjorski. We have been looking into that. You 
cannot imagine the number of statutes and regulations that they 
are in. It would take us several years to pull the peel off and 
find out what is there.
    I tend to agree. I think some quick action could be taken 
to allow municipal bonds to be treated like corporate bonds are 
on a temporary basis. That would solve all the pressure of 
forcing trustees to sell when there is really no threat to the 
asset.
    I am firmly convinced that this is not a problem of real 
liquidity. It is a problem of trust and faith. The people in 
the market have lost faith in the market. We have to get them 
back.
    Once they get a comfort level, just like after you have 
your first accident, and once you get behind the wheel and you 
drive again, it all comes back to you. If you stay away from it 
and you do not drive, you are never going to drive.
    If we are going to get investors back into the marketplace, 
we have to first show them good product. They have to have the 
transparency to see that product. I think we have to take the 
effort to make sure that happens and then let them ride with it 
for 3, 6, or 9 months, and ultimately the market will solve its 
own problem and be back.
    Mr. Larkin. I think a few people have brought up changes to 
transparency, at least within the municipal bond industry, the 
municipal EDGAR system. It is basically providing information 
and providing disclosure so investors can make those decisions.
    Right now, it is very hit or miss as to whether you can get 
disclosure in the municipal market. The more you can improve 
things like that, the more you will be able to have investors 
able to make decisions. I would even go so far as to say maybe 
you would even have real rating agency competition in the 
municipal area, because right now, you could not start a rating 
agency unless you get the cooperation of the issuers because 
the information is just not readily available.
    Chairman Kanjorski. Right.
    Mr. Larkin. Without the issuers agreeing, and that is why 
the rating agencies only rate upon request, because without the 
issuers' cooperation, you cannot rate it.
    As more transparency comes into the market, maybe we will 
get more rating agency competition.
    Mr. Buckley. Mr. Chairman, I think Fitch would certainly 
strongly endorse and support the concept of greater 
transparency of all the types of transactions we rate.
    There is very good disclosure on corporations via Forms 10-
K, 10-Q, etc. Certainly, we get much more information than the 
investing public on structured finance transactions and on 
municipalities.
    We think it would be better for the capital markets if the 
information that we received was also made available to the 
general investing public by the issuers and structurer's, 
because we do not want to necessarily be the only ones looking 
at the data.
    We think transparency is good and healthy and that it 
allows investors to better understand our ratings and interpret 
our research and talk to us and understand our process.
    Chairman Kanjorski. What would be the difficulty of 
actually defining what has to be transparent? It is so simple 
for various entities, whether they be hedge funds or equity 
funds, to create new constructs that do not quite fall in the 
definition of a bond or a share.
    How do we force that every financial instrument gets 
recorded and is part of the inventory?
    Mr. Buckley. It certainly would be a process, but if you 
look at the disclosure requirements for corporations currently, 
not perfect, but good, robust. If you look at that as sort of a 
starting point and can think of a structured finance or 
municipal finance or other types of instruments that are being 
created, can you bring them to a standard that seems reasonably 
consistent with what corporations need to disclose, given their 
own unique needs.
    I think that might be at least a starting point. That seems 
to have worked reasonably well and can we bring other types of 
instruments to that level playing field.
    Chairman Kanjorski. Normally, for an inventory of that 
sort, we would have considered putting that in the exchanges. 
Now that they have gone for profit, where can we find some non-
profit entity to hold that inventory?
    Mr. Ackman. I think it is as straightforward as putting it 
on the Internet.
    Chairman Kanjorski. Somebody has to be responsible for it. 
Somebody has to tend to it.
    Mr. Ackman. There is a fee that comes out of every bond 
issue of a basis point or less or some small fee, $1,000, that 
goes towards a national repository of information for the 
benefit of investors. It will help issuers reduce their 
issuance costs. I think they would be more than happy to pay 
such a fee.
    It is like a registration fee you pay to the SEC for an 
equity offering.
    In that we are in a hearing about bond insurers, on the 
transparency side, one very simple thing that could happen 
immediately and one of the things that we actually did, wrote a 
letter to Chairman Bernanke and suggested that this would be a 
good thing for the transparency in the bond insurance industry, 
is why do not the bond insurers provide on their Web site a 
list of all their exposures, the underlying ratings for those 
exposures, and then in particular, they have what they call 
classified lists, which are lists of credits where there are 
potential problems. They have different classified, seriously 
classified or medium classified or just barely classified.
    If investors got to see all the riskiest parts that the 
bond insurers have exposure to, if they had a list of all the 
CDOs' transactions and all the asset backed securities that 
they have guaranteed, then investors could do their own due 
diligence. They would not have to rely on the rating agencies' 
Triple A.
    I find it like a little bit like Alice in Wonderland that 
we are sitting at a hearing talking about a group of entities 
that are struggling to raise capital and almost all of them 
still have Triple A ratings.
    Investors clearly do not trust the Triple A, and what would 
create trust would be transparency from just the bond insurers 
coming clean, show us all your exposures.
    Chairman Kanjorski. How long would it take to have those 
disclosures?
    Mr. Ackman. Maybe we can ask Mr. Chaplin. They have this 
information at the tip of their fingertips. I am sure they have 
it in electronic form. They could make it public tomorrow if 
they chose to.
    Chairman Kanjorski. Is that correct?
    Mr. Callen. Mr. Chairman, I usually disagree with Mr. 
Ackman, but on the issue of incentives that he described, I 
fully agree. I think this was an issue of incentives.
    On transparency, I have been the CEO of Ambac for all of a 
month. You cannot find a better expert. The issue is every time 
that I have gone to our chief financial officer to ask him a 
detailed question, he snaps at me to look at our Web site.
    Let me make an exception to this. We have it all on the Web 
site, every municipal exposure. It is one of the most 
transparent businesses there is.
    When you get into something, and here I am talking about in 
our case, four transactions, CDO squared's, there are several 
layers.
    What I recommended at one point is that we actually publish 
the QSIPs. The people that know this technically much better 
than I do came and surrounded me with knives and said are you 
crazy. If you put the QSIPs on there, you are providing 
information that can be used very successfully against you. Are 
there no competitive protections any more?
    I would argue and I would point anybody to the Ambac Web 
site and show me a more transparent Web site anywhere.
    I wanted to do this for our major investors who were very 
injured and very upset and came and pounded on me. The first 3 
weeks in the job, I was talking to investors, apologizing for 
what has happened to them.
    I said to them, some of the most professional investors in 
the world, well, all right, we will put all our QSIPs on, don't 
go that far because that gives--I agree with you on short 
sellers. I think they are every bit as much capitalists as the 
rest of us and there should be short sellers.
    Their point is that will give the short sellers the 
opportunity to go out and take advantage, which I do not think 
we have the time to go into detail here, but I learned how that 
could happen.
    There is a little bit perhaps, just a distant possibility 
of self serving in this conversation, but it would have to be 
examined very carefully.
    I am all for transparency. All the rating agencies know 
everything of ours and they run it through their models.
    The last point I would make is we are really talking here--
let me give you a view of my own of what is happening in the 
market now.
    When you build an airplane, you build it to the 6th sigma. 
You design for 100 people. You build it to withstand 400 
people. Deterministic.
    When you trade in markets, it is probabilistic. You have 
some probability of loss every time you trade. The markets 
right now are locked up because they are working to the 6th 
sigma.
    When we talk to Moody's, which we did for 2 hours yesterday 
about how we are solving the problem they perceive, they are 
saying we want per our model to give you 99.99 percent 
confidence level that the worse thing can happen to you, and 
unless you can do that and then multiply it by 1.3 times, that 
is the amount of capital we want you to have. If you go to AA, 
it is 1.2 times that extreme scenario.
    Let me leave you with one more thought. I have a theory. 
Let us see if I am right. You call a hearing again in 3 months, 
and here is what I believe you are going to find. You are going 
to find that the mortgage losses we are experiencing today are 
a pig in a python. Here is what I mean by that. We had very 
loose underwriting standards in 2006 and 2007, some at the end 
of 2005. Very loose. All the reasons that have been described. 
Bill Ackman is absolutely correct on that.
    There was a lot of fraud and there were a lot of investor 
unoccupied buildings that were financed through mortgages. 
Those, especially the fraud, and the investor transactions, 
when housing prices started to decline, are the first ones to 
default.
    This is a surreal experience for me and I have been in the 
financial industry for 45 years. I have been through the LDC 
stuff, the commercial real estate stuff across the country, 
Orange County. It was all about the world coming to an end at 
the time we were dealing with it.
    This is the first time I have ever experienced a situation 
where it is not how much capital you have, it is not how much 
liquidity you have, it is not what your earnings are, it is 
what you are projecting to happen. It has not happened yet. It 
may never happen.
    If I am right about the pig in the python, it is not going 
to happen.
    That is a real possibility. I think we have to stay tuned 
and see how these loss curves might trend down. Thank you.
    Chairman Kanjorski. Does anyone else on the panel have 
anything to add so we can make friends with your wives and 
significant others?
    Mr. Ackman. Can I make one more romantic interjection?
    [Laughter]
    Mr. Ackman. With all due respect to Mr. Callen, I think if 
providing transparency gives a short seller more information to 
make his argument, then maybe the information is not so bullish 
for the company, and maybe that is why investors are concerned.
    If a company is not willing to be transparent and to 
provide the QSIPs so investors can do their own assessment, if 
it were my company and I thought the losses were only $2 
billion and the world was saying $12 billion, I would say open 
kimono, here is every one of my exposures. Here is every one of 
my troubled exposures.
    You go do the work. I can prove to you I am not going to 
lose money. When you do not disclose anything and you say, 
look, the rating agencies say we are Triple A. Our models say 
we are Triple A. We are just not going to tell you what the 
exposures are, that is when investors lose confidence because 
frankly when a stock is down 80 percent, the market is telling 
you something.
    The solution to the problem is simply transparency. If 
providing transparency gives the short sellers more arguments, 
then perhaps the story is not as good as management has been 
letting on.
    I love short sellers. You would not ask Microsoft to 
publish all of its code. That would be a little silly. When a 
new structure for Morgan Stanley comes out that is fairly 
unique and innovative, you would not ask them to show it all.
    I love short sellers. I think they are an important part of 
the market, but I have to remind people that a year ago, Ambac 
stock was at $96. It closed today at about $12 or $13. We were 
as transparent back then when everybody loved it as we are 
today, and the difference is that the housing market, for 
reasons we could talk about all day, has taken a turn.
    We made a big mistake--``correlation.'' We thought if we 
had mortgages in California and mortgages in Maine, they would 
not both go down together. We were wrong.
    Chairman Kanjorski. This is one of the few national markets 
at this point. It has always been a moving market.
    I think I have gained a lot of information. I am not 
prepared to confess everything that we have learned.
    Would the panel be available in the future either on a 
personal basis when we need additional information or if 
collectively, we call you back? Would you be interested in 
participating?
    Mr. Chaplin. Absolutely.
    Mr. Callen. Of course.
    Mr. Larkin. Absolutely.
    Mr. Buckley. Absolutely.
    Mr. Ackman. Absolutely.
    Chairman Kanjorski. I appreciate that.
    I have to say that the Chair notes that some members may 
have additional questions for today's witnesses, which they may 
wish to submit in writing. Without objection, the hearing 
record will remain open for 30 days for members to submit 
written questions to any of today's witnesses, and to place 
their responses in the record.
    Before we adjourn, the following documents will be made a 
part of the record: The letters that the chairman wrote to the 
Federal and State regulators and their responses; the written 
statements of the Association of Financial Guarantee Insurers 
and the Pennsylvania Higher Educational Facilities Authority; a 
letter from 35 Pennsylvania bankers; and a letter from the 
Illinois Finance Authority.
    Without objection, it is so ordered.
    At this point, the panel is dismissed and this hearing is 
adjourned. Thank you very much, gentlemen.
    [Whereupon, at 6:53 p.m., the hearing was adjourned.]












































































                            A P P E N D I X



                           February 14, 2008

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