    [House Hearing, 111 Congress]
    [From the U.S. Government Publishing Office]

                         PERSPECTIVES ON SYSTEMIC RISK

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

                                    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 ELEVENTH CONGRESS

                                 FIRST SESSION

                                   __________

                                 MARCH 5, 2009

                                   __________

           Printed for the use of the Committee on Financial Services

                               Serial No. 111-10

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                     HOUSE COMMITTEE ON FINANCIAL SERVICES

                     BARNEY FRANK, Massachusetts, Chairman

    PAUL E. KANJORSKI, Pennsylvania      SPENCER BACHUS, Alabama
    MAXINE WATERS, California            MICHAEL N. CASTLE, Delaware
    CAROLYN B. MALONEY, New York         PETER T. KING, New York
    LUIS V. GUTIERREZ, Illinois          EDWARD R. ROYCE, California
    NYDIA M. VELAZQUEZ, New York         FRANK D. LUCAS, Oklahoma
    MELVIN L. WATT, North Carolina       RON PAUL, Texas
    GARY L. ACKERMAN, New York           DONALD A. MANZULLO, Illinois
    BRAD SHERMAN, California             WALTER B. JONES, Jr., North
    GREGORY W. MEEKS, New York               Carolina
    DENNIS MOORE, Kansas                 JUDY BIGGERT, Illinois
    MICHAEL E. CAPUANO, Massachusetts    GARY G. MILLER, California
    RUBEN HINOJOSA, Texas                SHELLEY MOORE CAPITO, West
    WM. LACY CLAY, Missouri                  Virginia
    CAROLYN McCARTHY, New York           JEB HENSARLING, Texas
    JOE BACA, California                 SCOTT GARRETT, New Jersey
    STEPHEN F. LYNCH, Massachusetts      J. GRESHAM BARRETT, South Carolina
    BRAD MILLER, North Carolina          JIM GERLACH, Pennsylvania
    DAVID SCOTT, Georgia                 RANDY NEUGEBAUER, Texas
    AL GREEN, Texas                      TOM PRICE, Georgia
    EMANUEL CLEAVER, Missouri            PATRICK T. McHENRY, North Carolina
    MELISSA L. BEAN, Illinois            JOHN CAMPBELL, California
    GWEN MOORE, Wisconsin                ADAM PUTNAM, Florida
    PAUL W. HODES, New Hampshire         MICHELE BACHMANN, Minnesota
    KEITH ELLISON, Minnesota             KENNY MARCHANT, Texas
    RON KLEIN, Florida                   THADDEUS G. McCOTTER, Michigan
    CHARLES A. WILSON, Ohio              KEVIN McCARTHY, California
    ED PERLMUTTER, Colorado              BILL POSEY, Florida
    JOE DONNELLY, Indiana                LYNN JENKINS, Kansas
    BILL FOSTER, Illinois                CHRISTOPHER LEE, New York
    ANDRE CARSON, Indiana                ERIK PAULSEN, Minnesota
    JACKIE SPEIER, California            LEONARD LANCE, New Jersey
    TRAVIS CHILDERS, Mississippi
    WALT MINNICK, Idaho
    JOHN ADLER, New Jersey
    MARY JO KILROY, Ohio
    STEVE DRIEHAUS, Ohio
    SUZANNE KOSMAS, Florida
    ALAN GRAYSON, Florida
    JIM HIMES, Connecticut
    GARY PETERS, Michigan
    DAN MAFFEI, New York

            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           SCOTT GARRETT, New Jersey
    BRAD SHERMAN, California             TOM PRICE, Georgia
    MICHAEL E. CAPUANO, Massachusetts    MICHAEL N. CASTLE, Delaware
    RUBEN HINOJOSA, Texas                PETER T. KING, New York
    CAROLYN McCARTHY, New York           FRANK D. LUCAS, Oklahoma
    JOE BACA, California                 DONALD A. MANZULLO, Illinois
    STEPHEN F. LYNCH, Massachusetts      EDWARD R. ROYCE, California
    BRAD MILLER, North Carolina          JUDY BIGGERT, Illinois
    DAVID SCOTT, Georgia                 SHELLEY MOORE CAPITO, West
    NYDIA M. VELAZQUEZ, New York             Virginia
    CAROLYN B. MALONEY, New York         JEB HENSARLING, Texas
    MELISSA L. BEAN, Illinois            ADAM PUTNAM, Florida
    GWEN MOORE, Wisconsin                J. GRESHAM BARRETT, South Carolina
    PAUL W. HODES, New Hampshire         JIM GERLACH, Pennsylvania
    RON KLEIN, Florida                   JOHN CAMPBELL, California
    ED PERLMUTTER, Colorado              MICHELE BACHMANN, Minnesota
    JOE DONNELLY, Indiana                THADDEUS G. McCOTTER, Michigan
    ANDRE CARSON, Indiana                RANDY NEUGEBAUER, Texas
    JACKIE SPEIER, California            KEVIN McCARTHY, California
    TRAVIS CHILDERS, Mississippi         BILL POSEY, Florida
    CHARLES A. WILSON, Ohio              LYNN JENKINS, Kansas
    BILL FOSTER, Illinois
    WALT MINNICK, Idaho
    JOHN ADLER, New Jersey
    MARY JO KILROY, Ohio
    SUZANNE KOSMAS, Florida
    ALAN GRAYSON, Florida
    JIM HIMES, Connecticut
    GARY PETERS, Michigan

                                C O N T E N T S

                                  ----------
                                                                       Page
    Hearing held on:
        March 5, 2009................................................     1
    Appendix:
        March 5, 2009................................................    61

                                   WITNESSES
                            Thursday, March 5, 2009

    Baker, Hon. Richard H., President and Chief Executive Officer,
      Managed Funds Association (MFA)................................    10
    Bartlett, Hon. Steve, President and Chief Executive Officer, The
      Financial Services Roundtable..................................    12
    DiMuccio, Robert A., President and Chief Executive Officer, Amica
      Mutual Group, on behalf of the Property Casualty Insurers
      Association of America (PCI)...................................    16
    Ryan, T. Timothy, Jr., President and Chief Executive Officer,
      Securities Industry and Financial Markets Association (SIFMA)..    18
    Vaughan, Therese M., Ph.D., Chief Executive Officer, National
      Association of Insurance Commissioners (NAIC)..................    14
    Williams, Orice M., Director, Financial Markets and Community
      Investment, U.S. Government Accountability Office..............     8

                                    APPENDIX

    Prepared statements:
        Bachmann, Hon. Michele.......................................    62
        Klein, Hon. Ron..............................................    64
        Baker, Hon. Richard H........................................    65
        Bartlett, Hon. Steve.........................................    73
        DiMuccio, Robert A...........................................   100
        Ryan, T. Timothy, Jr.........................................   127
        Vaughan, Therese M...........................................   147
        Williams, Orice M............................................   156

                  Additional Material Submitted for the Record

    Kanjorski, Hon. Paul E.:
        Written statement of the American Academy of Actuaries.......   188
        Written statement of the American Council of Life Insurers
          (ACLI).....................................................   193
        Written statement of the National Association of Mutual
          Insurance Companies (NAMIC)................................   200
    Biggert, Hon. Judy:
        Article from Investor's Business Daily entitled, ``For Banks,
          Help Isn't On The Way,'' dated March 4, 2009...............   209
    Hinojosa, Hon. Ruben:
        Responses to questions submitted to Hon. Steve Bartlett......   211
    Maloney, Hon. Carolyn:
        Letter to Hon. Ben Bernanke, dated March 4, 2009.............   219
    Royce, Hon. Ed:
        Article from The Wall Street Journal entitled, ``AIG
          Increases Borrowings While Racing to Sell Assets,'' dated
          October 10, 2008...........................................   223
        Initiative on Business and Public Policy at Brookings report
          entitled, ``Regulating Insurance After the Crisis,'' dated
          March 4, 2009..............................................   226
    Scott, Hon. David:
        Responses to questions submitted to Hon. Richard H. Baker....   244

                         PERSPECTIVES ON SYSTEMIC RISK

                                  ----------

                            Thursday, March 5, 2009

                 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 10:03 a.m., in
    room 2128, Rayburn House Office Building, Hon. Paul E.
    Kanjorski [chairman of the subcommittee] presiding.
        Members present: Representatives Kanjorski, Ackerman,
    Sherman, Capuano, McCarthy of New York, Baca, Lynch, Scott,
    Maloney, Bean, Perlmutter, Donnelly, Carson, Wilson, Foster,
    Adler, Kilroy, Kosmas, Grayson, Himes, Peters; Garrett, Price,
    Castle, Manzullo, Royce, Biggert, Hensarling, Campbell,
    McCotter, Neugebauer, McCarthy of California, Posey, and
    Jenkins.
        Ex officio present: Representative Bachus.
        Chairman Kanjorski. This hearing of the Subcommittee on
    Capital Markets, Insurance, and Government Sponsored
    Enterprises will come to order.
        Pursuant to agreement with the ranking member, and to allow
    as much time as possible for members' questions, opening
    statements today will be limited to 10 minutes on each side.
    Without objection, all members' opening statements will be made
    a part of the record.
        We meet today to discuss the issue of systemic risk. The
    bailout of American International Group, the bankruptcy of
    Lehman Brothers, and the takeover of Bear Stearns each
    demonstrate that systemic risk is not just confined to the
    banking sector. We therefore will focus our examinations at
    this hearing on insurance, securities, and capital market
    issues.
        The ongoing turmoil in our financial markets has led us to
    a crossroads. Because our current regulatory regime has failed,
    we must now design a robust, effective supervisory system for
    the future. In doing so, we must move expeditiously in order to
    help restore confidence in our markets and to get our economy
    moving again.
        We must, however, also move carefully and take the time to
    do it right. We should not rush to judgment on developing a new
    systemic risk overseer. We must also put aside our partisan
    differences and aim at the onset to reach a genuine consensus.
    Perhaps most importantly, we must start at the beginning and
    ask some basic questions.
        First, we must define ``systemic risk.'' Does a financial
    services company pose a systemic risk if it is too big to fail,
    too interconnected to fail, or too leveraged to fail? Could the
    independent actions of many small players compound and create a
    systemic risk? Do only financial services providers pose a
    risk? For example, could the technology used in our financial
    markets pose a risk to the broader economy?
        Moreover, are there certain financial products, business
    activities, or industry segments more likely to cause risk than
    others? How can we distinguish which is which? Today's
    witnesses will help us to start answering these complex
    questions and to begin defining more concretely the amorphous
    concept of systemic risk.
        Second, we need to ask ourselves how the government can
    work to diminish systemic risk. Should we create an umbrella
    overseer? If so, how should such an entity operate?
    Alternatively, could existing regulators overtake this
    objective? If so, how should we address the products and
    parties that operate in the shadows of our financial system and
    outside of regulatory oversight?
        Third, and arguably most important, how can the government
    prevent an institution from becoming too important to fail,
    going forward? Should we impose a systemic risk test as part of
    a governmental review of mergers? Moreover, could the financial
    innovations of one company or one sector contribute to systemic
    risk?
        Today, we will spend much time studying insurance issues.
    Our panel has examined insurance regulation many times, but
    this debate is different. This debate is about recognizing that
    insurance is a part of an integrated financial services system.
        Insurance companies and their affiliates, in some
    instances, could pose risk to the broader system. American
    International Group is a perfect, and severe, example of this
    reality. In other instances, insurers could be negatively
    impacted by ratings downgrades, capital impairments resulting
    from external events, and the application of accounting
    standards.
        We will also learn more about credit default swaps, a
    product that sometimes operates as an insurance contract and
    sometimes as a securities product. Credit default swaps have
    generally fallen through the cracks of our fragmented
    regulatory system. Therefore, Congressman Bachus joined me in
    asking the Government Accountability Office to study credit
    default swaps, and an expert will share GAO's findings today.
        Hedge funds, too, are largely unregulated. After the
    government organized the rescue of Long Term Capital Management
    in 1998, the President's Working Group made legislative
    recommendations for preventing future systemic risk by hedge
    funds. I subsequently joined with then-Capital Markets Chairman
    Richard Baker in proposing the Hedge Fund Disclosure Act, and
    moving it through a subcommittee mark-up.
        Even though our bill did not become law, I welcome Mr.
    Baker back to Congress today in his role as the leader of the
    Managed Funds Association. At this time, he and I have another
    chance to ensure that hedge funds are appropriately regulated
    and our economy better protected from systemic risk. This time,
    we will hopefully succeed.
        In closing, the work ahead of us is important and
    necessary. I look forward to the testimony of our witnesses and
    to engaging in a productive debate on these issues.
        I would like to recognize Ranking Member Garrett for 4
    minutes for his opening statement.
        Mr. Garrett. Thank you, Mr. Chairman. As always, it is a
    pleasure working with you on this subcommittee's business and I
    look forward to today's hearing and hearing different
    perspectives on these financial market regulatory systems.
        For me as with you, there are several fundamental questions
    that need to be answered as we embark on examining the
    potential future for such a systemic regulator.
        First, as you say, we still do not have a single agreed-
    upon definition of exactly what is a ``systemic risk,'' nor do
    we know exactly what a systemic regulator would be, what roles
    it would have, who would be under its jurisdiction, etc.
        Secondly, the committee needs to be careful not to get
    ahead of itself. We cannot come up with an appropriate solution
    in this area until we have a better understanding and more
    consensus on actually what are the causes of our current
    financial situation.
        This subcommittee and the full committee have a lot on
    their plates, and a lot is at stake on what this Congress
    ultimately decides to do in the area of regulatory reform.
        I cannot stress this point enough. We need to get this
    right and not move too quickly simply to illustrate that we are
    ``doing something.''
        What we do know is that many areas of our financial
    services sector already are subject to significant regulation,
    some of the areas with most of the problems--Bear Stearns,
    Lehman Brothers, not to mention the Bernie Madoff situation.
        They were regulated by the SEC. Indy Mac and Washington
    Mutual were both regulated by the Office of Thrift Supervision.
    Additionally, OTS has oversight responsibility for the unit of
    AIG where most of its problems originated.
        The Federal Reserve itself, which is often mentioned as a
    potential candidate for a systemic risk regulator, certainly
    has a regulatory record that really leaves a lot to be desired.
    Its handling of monetary policy in the years leading up to the
    current crisis is often mentioned by many experts as enabling
    the events.
        Furthermore, the Fed already has the role of safety and
    soundness and prudential limits regulated for large banks,
    holding companies, companies such as Citi and Bank of America,
    which are two of the largest recipients, I should point out, of
    Federal TARP funds, and whose perceived uneasy state have led
    to much of the uncertainty in the rest of the market.
        If you think about it, all these and other regulators were
    already on the job but did not do a good job with the powers
    vested in them, so why should we have faith that a new super
    regulator of systemic risk will do any better than them?
        The Fed in particular raises certain concerns for me. It
    already has significant responsibilities in areas of monetary
    policy as well as its ongoing bank regulatory role.
        In addition, as an independent institution, there seems to
    be a certain lack of political accountability for its actions.
    I am not sure it is really wise to consolidate so much
    additional responsibility in an entity that does not have to
    answer to the American people.
        Furthermore, the Fed has no particular expertise regulating
    entities outside the banking area such as insurance and
    securities, two potential areas that it would be asked to
    oversee if it was to become the regulator.
        There are other aspects that concern me about certain
    systemic risk regulator proposals that have come out. Chief
    among these is concerns in identifying institutions with
    systemic significance.
        If this were to be done, the market would likely view these
    institutions as having de facto guarantee of Federal Government
    support during times of financial stress.
        Does that sound familiar? Not only would this designation
    likely lead to unfair advantages in the marketplace such as
    lower cost of capital, but it also will socialize market
    failure while leaving profits in the private hands.
        This is exactly what happened with Freddie Mac and Fannie
    Mae and we have all seen how that ended up.
        In sum, Mr. Chairman, I am not convinced that there is a
    workable systemic regulator solution that would provide the net
    benefit to our economy going forward, but with that being said,
    we are just at the beginning and not the end, and I look
    forward to the testimony here as we go forward, and I thank all
    the witnesses for joining us here today.
        Chairman Kanjorski. Thank you, Ranking Member Garrett.
    Next, we will hear from Mr. Ackerman of New York for 2 minutes.
        Mr. Ackerman. Thank you, Mr. Chairman. In my view, our
    examination of systemic risk must include both an in-depth
    analysis of the role that credit ratings and credit rating
    agencies played in creating the current economic crisis, as
    well as consideration of the mark-to-market accounting
    standard.
        I have long believed that allowing the SEC to grant the
    largest credit rating agencies nationally recognized
    statistical rating organization status is the equivalent of
    stamping a government seal of approval on the ratings that they
    issue.
        Unfortunately, as we know now, the SEC was woefully
    inattentive to the rating process over the last several years,
    and many AAA rated securities, particularly those that were
    mortgage backed, did not in fact exhibit the fundamental
    characteristics of a sound and safe investment.
        Mr. Castle and I have reintroduced legislation to institute
    a dual structure for credit ratings issued by NRSROs. Credit
    rating agencies would still be permitted to assign their own
    ratings to securities composed of different types of assets
    that are then consolidated within packages of different types
    of financial products. However, a new class of ratings would be
    created under which only homogeneous securities with proven
    track records could be rated.
        As the committee moves to consider reforming our country's
    financial services regulatory structure, I would urge our
    colleagues to take a look at H.R. 1181.
        I am eager to hear our witnesses' perspectives on the
    effect that mark-to-market has had on the current market
    conditions, and if not rescinded, their forecasts for the
    impact mark-to-market will have on systemic risk in the
    immediate future.
        In the current economy, it makes no sense to compel
    companies to mark their assets to market since there often is
    no market. The drastic overnight write down's that many
    companies have been forced to take because of mark-to-market
    has surely exacerbated systemic risk, and I am interested to
    hear from our witnesses how we can alleviate this effect while
    maintaining an effective and transparent standard for
    evaluating assets.
        I thank you, Mr. Chairman, and I look forward to hearing
    from our witnesses and welcome back our former colleagues, whom
    I think I have not seen in about 1 year.
        [laughter]
        Chairman Kanjorski. One year? Thank you very much, Mr.
    Ackerman. Now we will hear from the gentleman from California,
    Mr. Royce, for 3 minutes.
        Mr. Royce. Thank you, Mr. Chairman. The fact that many of
    our financial institutions have become too big to fail or too
    interconnected to fail has become shockingly apparent.
        The steps taken by the Federal Government and the amount of
    tax dollars allocated because of systemic threats have not been
    seen in recent history, either here or in the U.K. or by other
    Central banks around the world or other democracies around the
    world.
        The long term effect of these actions will not be fully
    understood for some years to come. We cannot wait until then to
    act on the regulatory shortcomings that have been exposed so
    far by our economic downturn.
        The exact make-up of these reforms will be debated here in
    the coming months. As the President of the Richmond Federal
    Reserve has noted, the critical policy question of our time
    will be where to establish the boundaries around the public
    sector safety net provided to public market participants now
    that those old boundaries are gone.
        The moral hazard problem created by the implicit government
    guarantee of Fannie Mae and Freddie Mac is a perfect example of
    what not to do. This quasi-public model and the apparent market
    distortions it caused must become a thing of the past.
        Richard Baker is here with us today. He--along with the
    Federal Reserve Chairman and the Treasury Secretaries--came
    before this committee 16 times, I counted, and warned about the
    overleveraging at 100 to 1 at Fannie Mae and Freddie Mac,
    warned about the legislative mandates for those institutions to
    purchase subprime and Alt-A loans and package them into
    mortgage backed securities in order to drive affordable
    housing.
        They all warned of the systemic risk of this, and we all
    witnessed the central role these Government Sponsored
    Enterprises played in the run up to the housing bubble. Now all
    Americans are feeling the pain of the economic fallout that
    originated in our housing sector.
        The invitation for political and bureaucratic manipulation
    will remain as long as the line between the Federal Government
    and private institutions is blurred.
        Beyond re-establishing clear boundaries around the Federal
    Government's safety net, it is critical that regulatory gaps in
    our current system be filled.
        Our acting systemic risk regulator, Ben Bernanke, made his
    feelings known earlier this week in this committee when he
    expressed his frustration first over on the Senate side with
    AIG's ability to exploit a huge gap in the regulatory system.
    This regulatory gap must be filled by a world class Federal
    regulator for insurance, a step supported here last week by Ben
    Bernanke, the Chairman of the Federal Reserve.
        The various State insurance regulators simply do not have
    the ability to oversee massive global financial firms like AIG.
    This void has gone unfilled for too long, and the problems that
    have resulted because of this gap are many.
        The Federal Government and now the American taxpayers have
    a vested interest in the ability of this Congress to establish
    a world class regulatory alternative to the fragmented 50 State
    system overseeing the insurance market.
        Again, thank you for holding this hearing, Mr. Chairman,
    and I yield back the balance of my time.
        Chairman Kanjorski. Thank you, Mr. Royce. Now we will hear
    from the gentleman from California, Mr. Sherman, for 2 minutes.
        Mr. Sherman. Thank you. Systemic risk regulator--everybody
    knows that we need one, but nobody knows what it is.
        We ought to have many entities that are not regulated,
    particularly if they are not--when I say ``not regulated,'' not
    regulated by a systemic risk regulator--if they are not too big
    and they do not sell insurance.
        Other than the bond rating agency problem Mr. Ackerman
    pointed out, I think one of the key problems that got us into
    this mess is that companies issued insurance on portfolio's
    without insurance regulation or insurance reserves. We
    discovered that a credit default swap is just as risky as
    earthquake insurance sold in the San Fernando Valley.
        I am concerned that we are seeing taxpayer money
    transferred to Wall Street based on the political power of the
    entities involved. We just saw $20 billion transferred to the
    AIG counterparties, billions of taxpayer dollars transferred to
    foreign entities.
        We are in effect providing Federal insurance to the general
    creditors because the counterparties of AIG have more political
    power than the uninsured depositors at Indy Mac Bank.
        I look forward to matching regulation with the needs of the
    market without seeing us prevent venture capitalists and others
    from providing some of the benefits of cowboy capitalism that
    we have enjoyed, particularly in my State of California.
        I yield back.
        Chairman Kanjorski. Thank you very much. Now we will hear
    from the gentleman from Georgia, Mr. Price, for 2 minutes.
        Mr. Price. Thank you, Mr. Chairman. Certainly everyone on
    this committee believes that our existing financial regulatory
    structure has gaps, but that does not mean that more regulation
    will be better or that it is possible to create an effective
    systemic risk regulator to prevent financial crises down the
    road.
        What industry is more regulated than the U.S. financial
    industry? Despite layers of regulation, we still find ourselves
    in the midst of a major economic contraction. We ought not lose
    sight of this fact as we consider the best way to regulate
    while preserving a growing and globally competitive U.S. market
    that will attract investors.
        The idea of a systemic risk regulator raises real concerns.
    If a specific institution is designated as systemically
    significant, it sends the message that the government will not
    let it fail.
        This clearly gives these institutions a huge competitive
    advantage over non-systemically significant institutions that
    will be unable to benefit from the implied Federal backing.
        This classification takes us even further into a political
    economy where the government picks winners and losers, not a
    market economy where the wonder of America thrives.
        To quote AEI's Peter Wallison, ``If we go forward with this
    idea, we will be creating an unlimited number of Fannie Maes
    and Freddie Macs, companies that are seen in the market as
    ultimately backed by the Federal Government. Given the fact
    that the government actually had to take over these entities
    because they were so unstable, I do not believe we should use
    them as business models for success.''
        This reminder should caution all of us as we consider a
    proposal that will completely change the way our financial
    system operates and is regulated.
        I look forward to an open, honest, and vibrant debate as we
    move forward. I thank the chairman.
        Chairman Kanjorski. Thank you very much, Mr. Price. Now we
    will hear from the gentlelady from Illinois, Ms. Bean, for 1
    minute.
        Ms. Bean. Thank you, Mr. Chairman. Thank you for holding
    today's hearing and yielding me the time and to those of our
    witnesses who are here to testify and share your subject matter
    expertise, we greatly appreciate it.
        Last Fall we learned the dangers of allowing antiquated,
    inefficient regulation of our financial system, and we have all
    suffered the consequences.
        While there is a difference in viewpoints on what actions
    are necessary moving forward to stabilize our financial system,
    most of us agree that we need to create a systemic risk
    regulator who can monitor the financial data of industry
    players and positions to prevent systemic wide risk.
        The values of our portfolios, homes, and businesses are in
    decline and there is no question that in good part, the lacking
    Federal oversight from a regulatory level has contributed,
    whether you are talking about the roughly $62 trillion
    unregulated credit default swap market or whether you are
    talking about the complex and growing insurance industry as an
    important financial service sector player, lacking any Federal
    oversight as well.
        Moving forward, I think the most important thing we can do
    is make sure we have a regulator in place who can detect and
    prevent potential risks and work to make sure that one
    financial service product, player, or sector's downturn doesn't
    turn into a problem industry-wide.
        Thank you. I yield back.
        Chairman Kanjorski. Thank you, Ms. Bean. Now we will
    recognize the gentleman from Delaware, Mr. Castle, for 1
    minute.
        Mr. Castle. Thank you, Mr. Chairman. I sort of believe that
    we should have a systemic risk regulator. I am not sure I can
    really define ``systemic risk'' as well as I would like to or
    what that regulator should be.
        I also have questions about whether the Fed should do it or
    somebody else should do it.
        The bottom line is, I think, a year-and-a-half to 2 years
    ago, most of us on this committee could not define a ``credit
    default swap.'' There are other leverage financial investments
    that we really do not completely understand.
        I am not sure that the regulators who are looking at bottom
    line accounting numbers in the various institutions really
    understood all that as well. I think the bottom line is you
    need somebody who is looking at the new innovations, those
    things that are happening economically in our economy, and my
    sense is this could be a positive step for everybody.
        I do not know exactly what the position of all our
    witnesses is going to be, but I think we should be looking at
    this possibility. Maybe the role of the systemic risk regulator
    should be lesser rather than greater.
        I do not know what the answer is. At least information
    coming from that and letting us know what is going on would be
    important.
        I yield back the balance of my time.
        Chairman Kanjorski. Thank you very much, Mr. Castle.
        Now I will introduce the panel. Thank you for appearing
    before the subcommittee today, and without objection, your
    written statements will be made a part of the record. You will
    each be recognized for a 5-minute summary of your testimony.
        First, we have Ms. Williams, Director of Financial Markets
    and Community Investment at the Government Accountability
    Office.
        Ms. Williams will outline the results of a study on credit
    default swaps that I requested last July, on which Ranking
    Member Bachus later joined me.
        Ms. Williams?

    STATEMENT OF ORICE M. WILLIAMS, DIRECTOR, FINANCIAL MARKETS AND
      COMMUNITY INVESTMENT, U.S. GOVERNMENT ACCOUNTABILITY OFFICE

        Ms. Williams. Thank you. Chairman Kanjorski and members of
    the subcommittee, I appreciate the opportunity to testify
    before you this morning on systemic risk in general and credit
    default swaps or CDS, in particular.
        While the work we initiated at the request of Ranking
    Member Bachus and Subcommittee Chairman Kanjorski is the
    primary focus of my written statement, I would like to
    highlight a few issues related to systemic risk as well as CDS
    and the lessons learned from recent events.
        While CDS have received much attention recently, the rapid
    growth in this over-the-counter derivative more generally
    illustrates the emergence of increasingly complex products that
    have raised regulatory concerns about systemic risk, which is
    the risk that an event could broadly affect the financial
    system and ultimately the real economy, rather than just one or
    a few institutions.
        While bank regulators may have some insights into the
    activities of their supervised banks that act as derivatives
    dealers, CDS, like other OTC derivatives, are not regulated
    product markets. The transactions are generally not subject to
    regulation by SEC, CFTC, or any other U.S. financial regulator.
        Thus, CDS and other OTC derivatives are not subject to the
    disclosure and other requirements that are in place for most
    securities and exchange traded futures products.
        Although recent initiatives by regulators and industry have
    the potential to address some of the risk from CDS, these
    efforts are largely voluntary and do not include all CDS
    contracts.
        In addition, the lack of consistent and standardized margin
    and collateral practices continue to make managing counterparty
    credit risk and concentration risk difficult, and may allow
    systemically important exposures to accumulate without adequate
    collateral to mitigate associated risk.
        This area is a critical one and must be addressed going
    forward.
        Gaps in the regulatory oversight structure of and
    regulations governing financial products such as CDS allow
    these derivatives to grow unconstrained, and little analysis
    was done on their potential for systemic risk.
        Regulators of major CDS dealers may have had some insight
    into the CDS market based on their oversight of the entities,
    but they had limited oversight of non-bank market participants
    such as hedge funds or operating subsidiaries of others like
    AIG Financial Products, whose CDS activities appear to have
    contributed to its financial difficulties.
        This fact clearly demonstrates that risk to the financial
    system and even the economy can result from institutions that
    exist within the spectrum of supervised entities.
        Further, the use of CDS creates interconnections among
    these entities, such that the failure of any one counterparty
    can have widespread implications regardless of its size.
        AIG Financial Products, which had not been closely
    regulated, was a relatively small subsidiary of a large global
    insurance company, yet the volume and nature of its CDS
    business made it such a large counterparty that its difficulty
    in meeting its CDS obligations not only threatened the
    stability of AIG but of the entire financial system.
        In closing, I would like to briefly mention what the
    current issues involving CDS have taught us about systemic risk
    and our current regulatory system.
        The current system of regulation lacks a clear mechanism to
    effectively monitor, oversee, and reduce risks to the financial
    system that are posed by entities and products that are not
    fully regulated, such as hedge funds, unregulated subsidiaries
    of regulated institutions, and other non-bank financial
    institutions.
        The absence of such authority may be a limitation in
    identifying, monitoring, and managing potential risk related to
    concentrated CDS exposures taken by any market participant.
        Regardless of the ultimate structure of the financial
    regulatory system, a system-wide focus is vitally important.
        The inability of regulators to monitor activities across
    the market and take appropriate action to mitigate them has
    contributed to the current crisis and the regulators' inability
    to address its fallout.
        Any regulator tasked with a system-wide focus would need
    broad authority to gather and disclose appropriate information,
    collaborate with other regulators on rulemaking, and take
    corrective action as necessary in the interest of overall
    market stability, regardless of the type of financial product
    or market participant.
        This concludes my oral statement. I would be happy to
    answer any questions at the appropriate time. Thank you.
        [The prepared statement of Ms. Williams can be found on
    page 156 of the appendix.]
        Chairman Kanjorski. Thank you, Ms. Williams.
        Next, we have the distinct honor of hosting our
    subcommittee's former chairman, the Honorable Richard H. Baker,
    President and Chief Executive Officer of the Managed Funds
    Association.
        Welcome, my friend. The floor is yours.

      STATEMENT OF THE HONORABLE RICHARD H. BAKER, PRESIDENT AND
        CHIEF EXECUTIVE OFFICER, MANAGED FUNDS ASSOCIATION (MFA)

        Mr. Baker. Thank you, Mr. Chairman. I am honored to be
    here. I want to specifically note Mr. Ackerman's kind
    affirmation on the record that I have not spoken to him for a
    year. That could be a value going forward.
        For the record, it has been 1 year and 1 month since my
    retirement. I am delighted to be back and engage my former
    colleagues in discussions as we go forward.
        Mr. Chairman, Ranking Member Garrett, I am here today in my
    capacity as President and CEO of the Managed Funds Association,
    which represents the majority of the world's largest hedge
    funds, and is the principal advocate for sound business
    practice among my members.
        Over the last several months, our members have engaged in
    significant discussions on many of the topics that are of
    interest to members of this committee.
        First, a word about our industry. Hedge funds do provide
    liquidity to markets and enable effective price discovery and
    provide capital for businesses to succeed and grow.
        We also provide risk management tools to sophisticated
    investors such as managers of pensions and endowments.
        To perform these tasks, our Funds require sound
    counterparties and stable market conditions. The current lack
    of certainty with regard to large financial institutions
    inhibits investors' willingness to put capital at risk in such
    market conditions.
        Establishing a regulatory system that will aid in
    restoration of market stability will be a service, I believe,
    to all market participants.
        I must also state that the current market circumstance was
    not initiated in proximate cause by our members, and in fact,
    some of our members are just as adversely impacted as any other
    investor in the market.
        In many cases, our members have been a vital source of
    liquidity in these times in helping to establish a supportive
    floor of value in a declining market.
        Notwithstanding these facts, the Association believes that
    smart regulation will improve overall functioning of the
    financial system. Regulation by itself, I would quickly add,
    however, is not sufficient as past circumstances have clearly
    demonstrated.
        Our own industry best practices, which have been developed
    over years of market observation by the MFA, coupled with
    appropriate investor due diligence, will promote efficient
    capital markets, market integrity, and provide needed investor
    protection.
        Over the last several months, our members have engaged in
    discussion of what constitutes an appropriate systemic risk
    regulatory framework. Effective systemic risk regulation would
    require oversight of the entire financial system. A single
    regulatory entity should perform this task. Multiple systematic
    risk regulators would likely have coverage gaps or worse,
    overlapping and duplicative examination.
        To provide this regulator with the appropriate data for
    this enormous task, MFA supports confidential reporting to a
    systemic risk regulator of the required information. The
    substance of that report should be left for the regulator to
    determine and not, Mr. Chairman, established by statute; and
    that should be warranted by the current economic conditions at
    hand for the purpose of assessing a systemic risk potential.
        This authority should also enable a forward looking
    capability as waiting until the adverse event has occurred will
    protract time for recovery.
        We believe granting broad authority with respect to
    information reporting along with ensuring the regulator has
    sufficient resources to conduct effective analysis is an
    appropriate construct.
        It is essential, however, that with such a broad ground of
    authority for reporting virtually any aspect of financial
    conduct deemed appropriate, that this disclosure be granted
    full protection from public disclosure.
        This can be done and must be done without any adverse
    effect or in any manner inhibiting the ability of the regulator
    to conduct its important work.
        We also believe it is very important to establish legal
    clarity in this role of the regulatory mission. It is our
    recommendation that the singular duty of this office is to
    preserve and protect the integrity of the financial system.
    Market integrity and investor protection would remain the
    responsibility of the current regulatory entities.
        Further, the systemic risk regulator should not focus on
    preventing the failure of any single firm, unless it is
    determined that such failure would precipitate systemic
    consequences of grave concern.
        Authority to prevent systemic risk should be exercised very
    carefully, as not to create the moral hazard from the
    appearance of an implied government guarantee against future
    failure.
        Systemic risk concerns may arise from a combination of
    factors. Therefore, the regulator should implement its
    authority by taking an approach that focuses on all relevant
    sectors of the financial market as well as product.
        The regulator would therefore need clear authority to seek
    to prevent systemic risk in a forward looking manner, to
    address systemic concerns once they have been identified
    without hesitation, and to ensure that a failing firm does not
    threaten the financial system in a systemic manner.
        Mr. Chairman, we are committed to being a constructive
    voice in this ongoing discussion, which we recognize will be
    difficult and complicated, but we stand ready to cooperate, and
    we look forward to responding to your questions.
        [The prepared statement of Mr. Baker can be found on page
    65 of the appendix.]
        Chairman Kanjorski. Thank you, Mr. Baker.
        Next, the Honorable Steve Bartlett, President and Chief
    Executive Officer of The Financial Services Roundtable, here to
    discuss perspectives on systemic risk, especially with regard
    to the insurance industry, and, I may add, another former
    Member whom we welcome back.
        Steve?

    STATEMENT OF THE HONORABLE STEVE BARTLETT, PRESIDENT AND CHIEF
          EXECUTIVE OFFICER, THE FINANCIAL SERVICES ROUNDTABLE

        Mr. Bartlett. Chairman Kanjorski, Ranking Member Garrett,
    and members of the subcommittee, there is no end to the
    theories and proposals as to exactly how to start the economic
    recovery, but the fact is that America's economic recovery will
    start here with the financial services industry and in some
    ways, it starts today with this committee.
        The recovery starts with every new loan, with every new
    mortgage, with every mortgage modification, with every addition
    to a retirement portfolio. Most importantly, it starts today
    with a strong, stable financial services sector, and a coherent
    foundation of a consistent and coherent regulatory structure.
        Our current regulatory non-systemic structure, Mr.
    Chairman, was created in 20 separate pieces of legislation
    beginning in 1913, including 1933, 1934, 1989, 1999, 2003, and
    so on, in a way that often added another agency, structure, or
    feature, often unrelated to the previous structure.
        To say that the financial regulatory system is fragmented
    and uncoordinated would be an understatement. By 2008, the
    weight and inconsistency of the patchwork system could bear it
    no longer.
        On that note, The Financial Services Roundtable recommends
    that the Federal Reserve be created as a systemic risk
    regulator, but that would not be a super regulator or a new
    regulator or a regulator of individual institutions, and that
    it not be merely bolted onto the existing chassis as has
    happened so often in the past, but rather to be integrated into
    the system.
        Webster's defines ``systemic'' as ``related to a system,''
    and that should be the test for this committee.
        The Roundtable's proposed systemic restructuring includes
    the following:
        First, by statute, expand the membership of the Executive
    Order Agency called the President's Working Group, which has
    the right idea but no authority, and rename it the ``Financial
    Markets Coordinating Council.'' The Council should serve as a
    forum to coordinate national and State financial regulatory
    policies.
        Second, the Federal Reserve be designated by statute as a
    market stability regulator with NIFO, what it is called in
    corporate board governance work, NIFO, or ``nose in, fingers
    out'' authority.
        The Fed would be authorized to act only through Federal
    prudential supervisors and not unilaterally. The Fed would be
    entitled to receive information from those primary regulators
    and act jointly through them when sanctions are required.
        The definition of ``systemic risk'' should not be size
    based and thus, avoiding the too big to fail syndrome. Rather,
    systemic risk would be any risk to the broader system that can
    arise from the collective actions of hundreds or from
    significant actions of a few.
        For example, recent example, a combination of bad
    underwriting of mortgages, mortgage insurance without proper
    reserves or oversight, securitizations based on credit ratings
    alone, little due diligence for mortgage backed securities
    pools, and off balance sheet vehicles combined collectively or
    systemically to create the systemic risk that we are now
    suffering from. That was across several, perhaps hundreds of
    regulatory agencies.
        The Fed would not be a super regulator but would work with
    and through other regulators. The only exception would be in
    the event of a well-defined emergency.
        That leads to a related point. A market stability regulator
    does indicate the need for a national insurance regulator. The
    Fed should work through a national insurance supervisor, not in
    a vacuum.
        A market stability regulator to reduce risk creates the
    additional need for a national insurance regulator to gather
    information and to act upon risky market activities in the
    Federal space in a timely and uniform manner.
        The third part of this is to consolidate existing Federal
    prudential supervisors such as the OCC and the OTS into a
    single national financial institutions' regulator. The new
    agency would be a consolidated prudential and consumer
    protection agency for banking, securities, and insurance.
        Fourth, create the National Capital Markets Agency through
    the mergers of the SEC and the CFTC, and use that, to the point
    that was made earlier, to supervise or oversee FASB jointly
    with the Federal Reserve.
        Fifth, create the National Insurance and Resolution
    Authority for depository institutions from the basis of the
    foundation of the FDIC to create an uniform and coherent way of
    disposing of failed institutions.
        Finally, we proposed that the current Federal Housing
    Finance Agency remain in place temporarily, pending a full
    review of the role and structure of the housing GSEs in the
    future but near term.
        Mr. Chairman, thank you for the opportunity to discuss this
    overwhelming need for a market stability regulator as a
    necessary first step in a broader reform of our financial
    regulatory structure.
        [The prepared statement of Mr. Bartlett can be found on
    page 73 of the appendix.]
        Chairman Kanjorski. Thank you very much, Mr. Bartlett.
        Next, we will hear from Dr. Therese Vaughan, chief
    executive officer of the National Association of Insurance
    Commissioners.
        Dr. Vaughan?

        STATEMENT OF THERESE M. VAUGHAN, Ph.D., CHIEF EXECUTIVE
    OFFICER, NATIONAL ASSOCIATION OF INSURANCE COMMISSIONERS (NAIC)

        Ms. Vaughan. Chairman Kanjorski, Ranking Member Garrett,
    and members of the subcommittee, thank you for inviting me to
    testify before the subcommittee on systemic risk.
        My name is Therese Vaughan. I am the chief executive
    officer of the National Association of Insurance Commissioners
    or NAIC.
        Prior to joining the NAIC, I was a professor of insurance
    and actuarial science at Drake University, where I focused on
    the management and regulation of financial institutions. From
    1994 to 2004, I was the insurance commissioner in the State of
    Iowa, and I was the NAIC president in 2002.
        I am pleased to be here today to discuss the NAIC's
    activities in the area of financial stability regulation and to
    offer our assistance and expertise as the committee tackles the
    enormous challenge of developing legislative solutions to the
    current financial crisis.
        The NAIC is a full partner with Congress and the
    Administration in seeking ways to improve the financial
    regulatory system and promoting financial stability.
        The State-based insurance regulatory system is one of
    critical checks and balances. We have a long history of
    consumer protections, solvency, oversight, and market
    stability, so any system of financial stability regulation can
    and must build on this proven regime.
        While the current financial crisis illuminates the need for
    review of regulatory oversight, consumer protections and
    prudent solvency oversight must not be compromised in the
    effort to improve or enhance financial stability.
        In our view, an entity poses a systemic risk when that
    entity's activities have the ability to ripple through the
    broader financial system and trigger problems for other
    counterparties such that extraordinary is necessary to mitigate
    it.
        The nature of the insurance market and its regulatory
    structure makes the possibility of systemic risk originating in
    this industry less than in other financial sectors. The
    insurance industry is more likely the recipient of systemic
    risk from other economic agents rather than the driving force
    that creates systemic risk.
        Most lines of insurance have numerous market participants
    and ample capacity to absorb the failure of even the biggest
    market participant.
        If the largest auto insurer in the United States were to
    fail, its policyholders would be quickly absorbed by other
    insurers, and backed up further by the State guaranty fund
    system. This would not pose systemic risk as the impact is
    isolated, does not ripple to other financial sectors, and does
    not require extraordinary intervention to mitigate.
        Risks in insurance are different from bank risks for three
    reasons. First, insurers tend to be less leveraged than banks.
    Second, insurers tend to have liabilities that are different
    from those of banks, more independent of economic cycles.
    Third, insurers tend to have a longer time horizon. They
    typically do not have to sell assets on a regular basis to meet
    short-term demands.
        An insurance business having special interconnections to
    capital markets may be capable of generating systemic risk,
    however, but financial and mortgage guarantee lines have been
    stressed because of their coverage of mortgage related
    securities, and as has been well-documented, large, complex
    financial institutions with insurance operations, like AIG,
    have produced systemic risks within the economy.
        The insurance businesses in these holding companies have
    thus far been adequately protected by State insurance
    regulators. State insurance regulators recognize that action is
    needed at the Federal level to identify and manage systemic
    risk within the Nation's financial marketplace.
        That should not be misconstrued, however, as simple
    acquiescence on our part to preemption.
        Recognizing the critical need for action in this area, the
    NAIC has developed a series of principles for systemic risk
    regulation as it relates to insurance, which we believe must be
    incorporated into any comprehensive systemic risk system. Our
    principles recognize that greater collaboration among financial
    services regulators is needed, preserving the principle of
    functional regulation.
        Any framework established to regulate financial stability
    must integrate but not displace the successful State-based
    system of insurance regulation. A Federal financial stability
    regulatory scheme must provide for sharing of information and
    formal collaboration among all financial regulators.
        In consultation with functional regulators, any financial
    stability regulator should develop best practices for systemic
    risk management. Preemption of functional regulatory authority,
    if ever appropriate or necessary, should be limited to
    extraordinary circumstances that present a material risk to the
    continued solvency of the holding company or threaten the
    stability of the financial system.
        For more than 150 years, State insurance regulators,
    working together with State legislators, have continued to
    improve, enhance, and modernize State-based insurance
    regulation for the benefit of consumers and industry alike.
        We want to bring the best regulatory minds to bear on the
    challenges ahead and to serve as your resource as you navigate
    and analyze the current financial landscape.
        I thank you for the opportunity to testify, and I would be
    happy to answer any questions.
        [The prepared statement of Dr. Vaughan can be found on page
    147 of the appendix.]
        Chairman Kanjorski. Thank you very much, Dr. Vaughan.
        Next, we will hear from Mr. Robert A. DiMuccio, president
    and chief executive officer of Amica Mutual Group, on behalf of
    the Property Casualty Insurers Association of America.
        Mr. DiMuccio?

    STATEMENT OF ROBERT A. DiMUCCIO, PRESIDENT AND CHIEF EXECUTIVE
    OFFICER, AMICA MUTUAL GROUP, ON BEHALF OF THE PROPERTY CASUALTY
                 INSURERS ASSOCIATION OF AMERICA (PCI)

        Mr. DiMuccio. Thank you, Mr. Chairman. I thank you and the
    members of the subcommittee for this opportunity to present the
    PCI's solutions for addressing our systemic risk crisis, and
    thank you for your leadership and that of your colleagues.
        I am appearing on behalf of the PCI, the leading property
    casualty insurance trade association, representing more than
    1,000 insurers of different lines and sizes.
        I will address three points: One, the definition of
    ``systemic risk;'' two, that systemic risk legislation should
    be the critical first priority addressed to prevent another
    economic crisis from occurring; and three, how a systemic risk
    overseer would function.
        PCI has defined ``systemic risk'' of a financial
    institution as ``the likelihood and the degree that the
    institution's activities will negatively affect the larger
    economy such that unusual and extreme Federal intervention
    would be required to ameliorate the effects,'' or simply
    stated, if the government has to step in to bail out a company
    to protect the larger economy, that is a systemic risk.
        Traditional antitrust analysis focuses on too big to fail.
    Recent government intervention decisions have shifted toward
    too interconnected to fail, which is measured by the degree a
    company's activities are leveraged throughout the economy such
    that its impairment would cause additional failures, and the
    extent to which its failure risk is correlated with other
    systemic downturns.
        For example, even a large auto insurer failure would not
    create a ripple effect of company failures. Its market share
    would be quickly absorbed by competitors. Conversely, some
    small credit default providers have highly leveraged
    counterparties, with recessions increasing default rates and
    provider impairment exacerbating the recession.
        My written testimony lists the systemic risk
    characteristics of the different lines of property and casualty
    insurance, and a similar analysis could be applied to other
    financial products.
        To address the current economic crisis, restore investor
    confidence, and prevent another economic disaster from
    occurring, a systemic risk overseer should be created.
        The Federal Reserve Board should serve as the systemic risk
    overseer as it has the appropriate mission and expertise.
    However, the Federal Reserve Board's systemic risk oversight
    should be completely separate from other bank holding company
    oversight powers.
        Jurisdiction would include any institution engaged in
    financial activities that in aggregate present a significant
    systemic risk. Also included would be any institution engaged
    in financial activities that chooses to submit to Federal
    systemic risk oversight such as for international equivalency
    treatment.
        Systemic risk oversight power should be flexible and
    include the authority to require the following: appropriate
    transparency and disclosure to overseers for all entities
    within the regulatory jurisdiction; escalating information
    sharing with other U.S. and international overseers as a
    company's systemically risky activities increase; and risk
    management for specific entities whose financial activities
    present a significant systemic risk.
        However, systemic risk oversight powers would not include
    the following: solvency oversight for individual companies;
    business conduct oversight, such as licensing, market conduct,
    or product approval; duplicative disclosure or transparency
    information requirements; and general Federal compliance, such
    as privacy standards and other elements of bank holding company
    oversight.
        Regarding oversight of risk management, oversight standards
    could consist of: overseeing holding company capital standards
    and group risk management; monitoring of affiliate transactions
    and significant off balance sheet obligations; collecting and
    sharing information related to group systemic risk and holding
    company solvency; requiring coordination of examination and
    visits regarding systemic risk; and eliminating duplicative
    oversight of holding companies.
        PCI proposes increasing coordination to detect fraud and
    improve early risk monitoring through enactment of the
    Financial Services Antifraud Network that passed the House in
    2001.
        PCI also proposes requiring the Presidential Working Group
    on Financial Markets to implement limited information sharing
    coordination with international overseers regarding potential
    threats to cross border market stability.
        These proposals are practical solutions to solving the
    systemic risk crisis that do not require a vast new
    bureaucracy. It does require filling regulatory gaps.
        Three final points. To address congressional imperatives,
    larger regulatory reform and oversight could be analyzed in a
    second phase. We should not confuse solvency with systemic
    risk. Solvency regulation is best done by functional regulators
    to ensure that companies have sufficient capital to fulfill
    their promises.
        Systemic risk regulation is macro oversight to prevent
    holding company failures from contaminating other markets in
    the larger economy. Merging solvency regulation into systemic
    risk oversight will simply create a regulator who is too big to
    fail.
        PCI is committed to working with this committee in
    advancing appropriate solutions to stabilize the markets and
    prevent another economic crisis from occurring. Addressing
    systemic risk is the best action to do so, and we stand ready
    to assist in any way.
        I thank the subcommittee for their time. We would be
    willing to answer any questions.
        [The prepared statement of Mr. DiMuccio can be found on
    page 100 of the appendix.]
        Chairman Kanjorski. Thank you, Mr. DiMuccio.
        Now, we will hear from Mr. Timothy Ryan, Jr., president and
    chief executive officer of the Securities Industry and
    Financial Markets Association.
        Mr. Ryan?

        STATEMENT OF T. TIMOTHY RYAN, JR., PRESIDENT AND CHIEF
     EXECUTIVE OFFICER, SECURITIES INDUSTRY AND FINANCIAL MARKETS
                          ASSOCIATION (SIFMA)

        Mr. Ryan. Thank you, Mr. Chairman, and members of the
    subcommittee.
        The purpose of my testimony will be to detail SIFMA's views
    on a financial markets stability regulator or systemic
    regulator, including the mission and the purpose of such a
    regulator, and to highlight certain powers and duties that you
    might want to consider providing to such a regulator.
        Systemic risk has been at the heart of the current
    financial crisis. We at SIFMA have, through committees of our
    members and roundtable discussions with experts, devoted
    considerable time and resources of thinking about systemic risk
    and what can be done to identify it, minimize it, maintain
    financial stability, and resolve a financial crisis in the
    future. Through this process, we have identified a number of
    questions and tradeoffs that will confront policy makers in
    trying to mitigate systemic risk.
        Although our members continue to consider this issue, there
    seems to be a consensus that we need a financial markets
    stability regulator as a first step in addressing the
    challenges facing our overall financial regulatory structure.
        At present, no single regulator or collection of
    coordinated regulators, has the authority or the resources to
    collect information system-wide or to use that information to
    take corrective action across all financial institutions and
    markets regardless of charter.
        We believe that a single accountable financial markets
    stability regulator will improve upon the current system.
        While our position on the mission of the financial markets
    stability regulator is still evolving, we currently believe
    that its mission should consist of mitigating systemic risk,
    maintaining financial stability, and addressing any financial
    crisis.
        In my prepared remarks submitted to the subcommittee, I
    have provided an outline of certain powers and duties of the
    financial markets stability regulator might have, and some
    issues you might want to consider in determining the scope of
    those powers and duties.
        I will briefly touch on those powers and duties, but note
    that my prepared remarks provide a very full discussion of
    these issues.
        The financial markets stability regulator should have
    authority over all financial institutions and markets
    regardless of charter, functional regulator, or unregulated
    status.
        In carrying out its duties, the financial markets stability
    regulator should coordinate with the relevant functional
    regulators as well as the PWG, in order to avoid duplicative or
    conflicting regulation and supervision. It should also
    coordinate with regulators responsible for significant risk in
    other countries.
        It should have the authority to gather information from all
    financial institutions and markets, make uniform regulations
    related to systemic risk that are binding on all, and act as a
    lender of last resort to all.
        It should probably have a more direct role in supervising
    systemically important financial groups, including the power to
    conduct examinations, take prompt corrective action, and
    appoint and act as the receiver or conservator of such
    systemically important groups. These more direct powers would
    end if a financial group were no longer systemically important.
        There are a number of options of who might be the financial
    markets stability regulator. Whomever is selected, the
    financial markets stability regulator should have the right
    balance between accountability to and independence from the
    political process.
        It needs to have credibility in the markets and with
    regulators in other countries. It should have the tools
    necessary to identify systemic risk, take prompt action to
    prevent the financial crisis, and to resolve a financial crisis
    if it occurs.
        To be truly effective, the financial markets stability
    regulator would need to have the power to act as the lender of
    last resort or to provide emergency financial assistance to the
    markets, and have prompt corrective action and resolution
    powers over failed or failing financial institutions that are
    systemically important.
        I stand ready to answer any of your questions, Mr.
    Chairman, and members of the subcommittee. Thank you.
        [The prepared statement of Mr. Ryan can be found on page
    127 of the appendix.]
        Chairman Kanjorski. Thank you, Mr. Ryan.
        I thank the panel for their testimony. I am sure we all
    have some interesting questions. Let me start off with my
    questioning period.
        The thing that sort of disturbs me is what my ranking
    member referred to in his opening remarks, and that is we have
    to get this one right. We cannot just hurry to expeditiously
    conclude something or pass something that appears to be a fix
    when in fact it does not really accomplish something of a
    significant nature.
        The thing that disturbs me is trying to get my arms around
    the idea of just what is a ``systemic risk.'' We have all
    talked about it, I can assure you, and we have heard you.
        I think when the question came up in 1964, Justice Potter
    Stewart, in trying to explain what was ``obscene,'' he said the
    following, ``I shall not today attempt further to define the
    kinds of materials I understand to be embraced, but I know it
    when I see it.''
        I think probably with systemic risk, after the fact, we
    seem to all know it when we see it, but before it arrives, we
    have no idea. If you make the proper conclusions, we would not
    be in the crisis we are in today, if people could have rapidly
    seen systemic risk would have occurred. We certainly have
    enough regulators who had eyes on the situation. They just were
    not analyzing or seeing the situation.
        I, myself, think we have in the past constructed some
    interesting areas, some of which now have been passed over, but
    the prior practice of the Justice Department to honestly decide
    whether or not there were antitrust violations in reviewing
    mergers and consolidations.
        With that in mind, it very often accomplished proactively
    responding to something before it happened, before it caused
    the occasion to cause something, monopolistic or otherwise, to
    occur in the system.
        That is what we are attempting to do. When I think of it,
    in most instances in our government at least, we regulate
    entities. We do not regulate conclusions or finalities that
    occur.
        When you think of it, almost anything could be a systemic
    risk. I was just talking to my staff and I said if you really
    think about it, a bad virus could be a systemic risk.
    Obviously, we are not going to try to regulate viruses so they
    do not cause systemic risk.
        On the other hand, I see a big challenge ahead of us. That
    is why I agree with the ranking member. You know, we are
    treading very closely to government authority to encompass
    regulation of everything, under the excuse of well, it may grow
    into systemic risk, therefore, we have the right to inquire
    into it and possibly be an active Congress, we have the right
    to limit or control that action.
        That seems to be an unusually extended role of government,
    and we have to be very careful we do not carte blanche offer
    that.
        On the other hand, if we do not do something that is
    severe, we are going to run into the same problem we are in
    now, in terms of allowing things to grow.
        I just point out to the panel, we had the automobile
    industry here several weeks ago. Their argument to a large
    extent was they constituted a systemic risk in that if the U.S.
    Government allowed any one of the three American auto companies
    to fail because of their intertwined nature of having similar
    dealers and similar suppliers, those suppliers or dealerships
    would fail, and therefore, it would fail for all three of the
    auto companies, not just for the one that had to go into
    bankruptcy, and that would constitute a systemic risk for the
    auto industry.
        It makes sense. Could we have stopped that from happening?
    Would we have anticipated that? Is there some magnificent
    character out there who has the brain power to anticipate all
    those realities?
        I am not even certain in the auto industry that it was
    controlled by a thinking power, I think it just occurred.
        Is that what we are talking about with systemic risk, and
    now adding on this feature of going to a global economy. It is
    a frightful thing. I think you have a good idea there, Scott.
    We have to take our time. We have to make sure we get this
    right.
        Could some of the members of the panel give me an idea, do
    you see a very grave difficulty in defining what a ``systemic
    risk'' is and what part of that risk we really want to pay
    attention to in the nature of creating some laws?
        Mr. Bartlett?
        Mr. Bartlett. Mr. Chairman, I do not think it will be
    difficult. It will require some thought by the committee, as
    you have, and by others. I think it is not difficult so long as
    the committee is looking for a systemic pattern and then the
    regulation is still by the principal supervisors, by the
    primary prudential supervisors at the national level.
        I heard the consistency on the panel that there is no call
    here for a new regulator or super regulator to take the place,
    but rather someone to connect the dots.
        A clear example, there were hundreds of regulators
    regulating thousands of regulated banks and tens of thousands
    of non-regulated mortgage originators, and those regulators
    collectively and individually concluded that those things that
    were called ``subprime mortgages'' were unsafe, unsound, and
    bad underwriting.
        But they had no connection like upstream to Wall Street to
    say by the way, so the regulators said you cannot own them, so
    they did not own them. They sold them. There was no connection
    to the rest of the system to say that somebody down here has
    concluded they were unsafe and unsound.
        It is that connecting the dots' system that we are calling
    for, not a new regulator.
        Chairman Kanjorski. Mr. Bartlett, to connect those dots,
    would that not encompass authority for the existing various
    regulators that we have to share information and confidential
    information with one another, and is that not sort of
    dangerous? Is that not what we would worry about?
        Mr. Bartlett. Mr. Chairman, it is not dangerous. It is
    dangerous not to. We have discovered that. It does require
    legislation. Let me say that crystal clear. This cannot just
    happen because the statutory authority is not there, but it
    requires the authority of the Federal Reserve and the
    prudential supervisors to collaborate and share information
    with one another.
        Chairman Kanjorski. You would be perfectly agreeable to
    allowing a set of regulators, if we ever get around to
    regulating hedge funds--I am going to pick on Mr. Baker for a
    second--that the information they would obtain from the various
    hedge funds from around the country as to what their investment
    policy was, that should be disclosed across the regulatory
    network?
        Mr. Bartlett. No, sir. Disclosed to the Federal Reserve or
    to the market stability regulator because it is a systemic
    regulation function.
        I think you could make other decisions on disclosure and
    non-disclosure, but the Fed needs the information to know what
    is going on.
        The first call on Bear Stearns did not come from the SEC
    and it did not come from Bear Stearns. It came from Treasury,
    who did not have a regulatory role. They called the Fed as the
    systemic regulator, even though there was no statutory mandate
    for the Fed to be a systemic regulator, but the Fed was all
    they had. It was outside the system, if you will.
        Chairman Kanjorski. You are really talking there about the
    diagnostician, after a set of facts and circumstances occurred,
    somebody to blow a whistle, to connect the dots and blow a
    whistle.
        Are we not really talking about someone doing an analysis
    before the decisions are made, to make the review, so we are
    one step ahead of where it is easier to define what we are
    doing?
        Mr. Bartlett. That is precisely the point. How would Bear
    Stearns have been different had the Fed been authorized to
    conduct some kind of systemic risk analysis a year or 2 years
    earlier? Would it have prevented the crisis? I do not know.
        The outcome would have been different, and I think better.
    The first call that there was a systemic problem came after the
    horses were out of the barn and running around in the pasture.
        Ms. Vaughan. Mr. Chairman, may I speak to this, please?
        Chairman Kanjorski. Yes, I am going to let you speak, but I
    am already over my time. Go ahead, Doctor.
        Ms. Vaughan. Thank you. I used to teach a class at Drake, I
    mentioned when I started, on the regulation of financial
    institutions. It was a graduate class.
        We would spend some time talking about systemic risk. I
    find the evolution of this discussion very interesting because
    if you look at kind of the way systemic risk was thought about
    around the time of the savings and loan crisis, way back when,
    that was very bank centric.
        It was because the banks are connected to the payment
    system, because of the way banks extend credit, that a
    contagion within the banking system creates systemic risk.
        When Long Term Capital Management happened, we began to
    think about hedge funds and the possibility for them having
    systemic risk.
        I think what we have learned with AIG is there is an issue
    about activities that create interconnectedness, that we have
    these credit default swaps that it would have been nice if
    someone had been looking at this and saying, boy, look at the
    amount of credit default swaps that the banks have, you know,
    going in both directions, and where is this stuff going, and
    who is watching the way this is playing out through the
    marketplace, and making a decision as to whether these should
    be regulated.
        It strikes me that going back to your suggestion that we
    are talking about someone who is looking at the marketplace and
    trying to identify problems before they happen, I think that is
    one of the things that is very consistent with what the
    regulators have been saying. It is not the only model but that
    is consistent with what we have been saying.
        We have seen because of AIG--we have a better recognition
    of how systemic risk impacts our ability to protect our
    policyholders.
        We think it would be helpful to have some mechanism that is
    monitoring systemic risk within the industry so that we can
    work with them to make sure that it is not interfering with our
    ability to do what we do.
        Chairman Kanjorski. Thank you, Dr. Vaughan.
        Mr. Garrett?
        Mr. Garrett. Thank you, all, and thank you, Mr. Chairman. I
    appreciate your comments with regard to the auto industry and
    as to what the systemic risk is there.
        I am thinking at the same time about the technology
    industry as well, the electronic industry, and all the other
    ones outside the financial sector that we would have to begin
    to throw into this mix. Any one of these, if they ever were to
    fail, could have a systemic problem.
        It was prior to everything blowing up in August of last
    year when Chairman Bernanke said with regard to setting up a
    regulator, ``Some caution is in order. However, as this more
    comprehensive approach,'' which has basically been described by
    some of you, ``would be technically demanding.''
        He went on to say, ``We should not underestimate the
    technical and information requirements of conducting such
    exercises effectively.''
        I think he hit it right on the point. How do you do that?
    When you look to see what the track record has been already for
    our regulators, who would you suggest that we take to put into
    this sort of regulator or just a council or what have you?
        Should we take it from the SEC, in light of their
    experience with the Madoff situation and some of these other
    situations that they have been involved in? Should we take it
    from the OTS, with respect to what they have done with the
    banks and AIG subs? Should we take it from the Federal Reserve,
    with their experience with setting monetary policy, and their
    experience with the national banks as well?
        Should those be the people whom we are drawing from in
    order to be able to sit back and get a more comprehensive
    approach?
        On the Federal Reserve, just remember, and I appreciate
    your comments, Mr. Bartlett, about them looking at one area,
    but was it not the Boston Federal Reserve back in the early
    1990's who said, ``The banks could consider such things as
    welfare payments and unemployment insurance when they decided
    whether or not they should be giving bank loans to
    individuals.''
        Should it be those same individuals that we call upon to be
    our super regulator in the future, to be able to make these
    decisions?
        If they were not able to do it for the narrow area that we
    have charged them with, that they had the authority to do, who
    on the panel thinks we should be drawing from them to be making
    the decisions for us on an overarching responsibility?
        [show of hands]
        Mr. Garrett. You do. Who do you think?
        Mr. Bartlett. Mr. Garrett, I understand your question. The
    Federal Reserve gathers information and it has for a decade on
    the production and distribution of corrugated box containers to
    help them with information about the economy and what is
    happening in the economy. They are not permitted to gather
    information about the reserves against the hundreds of billions
    of dollars of CDS because that is excluded to them.
        The Federal Reserve was given the responsibility by
    regulation, rightly or wrongly, to regulate as a small
    regulator, HOEPA, and they were busy doing that and regulating
    it as a consumer protection issue, when the entire system of
    subprime mortgages collapsed, because they were not authorized
    to look at that system, but they could look at HOEPA and
    consumer protection.
        We are not, and I do not believe anyone is advocating a
    super regulator. Rather, we are advocating someone to connect
    the dots.
        Mr. Garrett. I understand that. In your experience in
    Congress in the past, when is it ever the case where you have a
    regulator in place that does not try to grow in its extent of
    authority? Do they ever just sit and say, ``This is our realm
    of responsibility here and we are not going to exert it more
    so.''
        Is that your experience?
        Mr. Bartlett. That is why God made oversight committees.
        Mr. Garrett. Ms. Williams, I have a question. I just need a
    better picture on this. It is on one of the points I just
    raised, and I appreciate your testimony.
        When OTS is out there, and you used the expression ``making
    their examinations,'' and you said they had a problem--not a
    problem--they had the aspect that they were not able to get
    into the hedge funds and they were not able to have information
    more particularly with regard to the AIG situation, as far as
    their offline business and what have you. Can you in a sentence
    or two elaborate on that? What should have been their authority
    there? Did they not have the ability to at least look at that
    and say here is an area where we know something is going on,
    but we do not have the authority to look at it, we want to
    investigate it more, or they just simply did not know that at
    all?
        Ms. Williams. This is the challenge with holding company
    oversight, because they have the authority to look at the
    holding company. In this case, it is a thrift holding company
    that we were talking about in the case of AIG.
        They could look at the holding company and any threats to
    the holding company, but it creates an issue of they can go in
    if they believe there is a threat to the holding company, but
    if you are not looking at all of the subsidiaries within the
    holding company, how are you going to identify the threat?
        Mr. Garrett. Could they look at all the subsidiaries?
        Ms. Williams. To the extent it poses a threat to the
    holding company, there are specific cases that they could go in
    and look at it.
        My understanding is that is what they did once the internal
    auditor raised concerns about risk management of AIG Financial
    Products. They went in once those concerns were raised because
    that raised an issue for the holding company.
        Mr. Garrett. I appreciate it. I might have additional
    questions later. Thank you.
        Chairman Kanjorski. Thank you, Mr. Garrett.
        Now, we will have the gentleman from New York, Mr.
    Ackerman.
        Mr. Ackerman. Thank you, Mr. Chairman.
        Before I ask my questions, I just want to respond to some
    of the things some of my colleagues put forth as statements or
    theories or postulates, in saying that the problem that we face
    really is there is too much regulation. Some of them said it in
    different ways.
        I would just like to analogize that if we had a super
    highway system for use of mixed vehicles, different kinds,
    cars, trucks, etc., and there were speed regulations, a lot of
    speed regulations, but nobody was enforcing the speed
    regulations because the State Police just neglected to patrol
    or fine anybody who was speeding. Suddenly, systemically, the
    entire highway system is filled with crashes and carnage. Is
    the problem: (a) there are speed requirements; (b) the police
    are not patrolling; (c) the people trying to figure it out are
    from outer space; or free feel to add, (d) all of the above.
        I think we are getting into an area here where we are
    talking about philosophy versus fact. That is my observation.
        A question: Mark-to-market, where there is no market, and
    arguably sometimes there is no market, how do you require
    companies to mark down the value of their company setting off
    all kinds of crises in the economy and expect there not to be
    problems?
        Anybody?
        Mr. Baker. I will take a pass at it, Mr. Ackerman. I come
    at it from the experience of the savings and loan debacle, the
    creation of the RTC and the resolution of property owned by the
    U.S. taxpayers as a result of closure of significant numbers of
    institutions.
        Real property was sold for about 20 cents on the dollar,
    notes and securities for 12 and 13 cents. It was a contained
    geographic downturn in Louisiana and Texas, and the residual
    economic effects of that distress sale in that environment
    caused a decade long downturn in those regional economies.
        To a great extent, it was brought on by in essence a mark-
    to-market philosophy, let's get the stuff out the door at an
    emergency price.
        At the same time, I would be quick to add, however,
    efficient market function only comes with accurate disclosure
    of values. There will be a very difficult decision to be made
    by someone in an administrative agency as to how to proceed
    with government-owned resources in the current environment.
        If a bank is to liquidate an asset and it is below whatever
    value was on the books, they will have to raise capital in a
    very tough marketplace to offset that material loss.
        If they expect to have it sold and--
        Mr. Ackerman. Which is why the banks are holding onto all
    that money we gave them.
        Mr. Baker. To a great extent, that is a contributing
    factor. There would be others better able to respond to that
    observation than I, but I would also suggest that in order to
    sell that asset in a difficult market at above book value, it
    is very problematic for the acquirer because he knows he is not
    paying market value.
        This is going to be a continued and long term problem of
    resolution. I cannot dispute the fact your observations have
    merit, although I would say to act without true valuations and
    allowing parties to come to a negotiated price on any asset
    disposition, we could not expect that to be the end conclusion
    either.
        Mr. Ackerman. Dr. Vaughan?
        Ms. Vaughan. If I can just speak to this from an insurance
    perspective a little bit, I have found myself for the last year
    or so re-thinking myself around this subject of mark-to-market.
    I would say that a couple of years ago, I tended to be thinking
    that movement, that direction, was a good thing.
        When you have a world like we are in today where the
    liquidity situation is so difficult, and we know that the
    market values of these assets are depressed for two reasons,
    one is there are real credit losses coming down the road, but
    second, there is a depression in market values simply because
    of the liquidity of the market.
        We do not know what the mix of those two is, but to force
    companies that are going to hold these assets long term that do
    not have to sell in this illiquid market, to force them to
    write down to a value that reflects current illiquidity, I am
    wondering, again, just sort of thinking through it, whether it
    is sending the wrong signal to the marketplace, and
    particularly, I think about consumers, is it sending the wrong
    signal to consumers about the capital that is in these
    companies and how strong these companies are.
        One of my colleagues likes to say the greatest risk we have
    right now is a crisis of confidence. It is that people are
    scared. We know our policyholders are scared.
        That is one of the reasons that the insurance regulators
    have really been struggling with what kind of reporting
    requirements should we be having in this environment right now
    where the markets are not anything that we have ever lived with
    before, not in my lifetime.
        Mr. Ackerman. We cannot address or we certainly cannot
    legislate the confidence in the market. We are going to do a
    lot of cheerleading to do that.
        In addition to that, if I may for a couple of seconds, Mr.
    Chairman, just say among the risk to the system, I would think,
    you have loopholes, which we can do something about, and greed,
    which we can do nothing about.
        Within greed, there are things that we can do to eliminate
    the loopholes, which include things like reinstating the uptick
    rule, where people, for reasons of their own, beat down the
    value of a company to take advantage of the system to make lots
    of money while distorting the real value that there might be in
    a company or in the marketplace.
        Thank you, Mr. Chairman.
        Chairman Kanjorski. Thank you very much, Mr. Ackerman. Now,
    we will hear from the ranking member of the full committee, Mr.
    Bachus.
        Mr. Bachus. First of all, let me commend Director Williams
    for her report. I would mention to all of the committee members
    that Mr. Kanjorski and I requested a GAO study on credit
    derivatives, and more specifically, CDS. This report was
    actually filed today. That is what she was giving testimony
    about. It is something I would direct all our attention to.
        Let me make one comment and then I am going to ask
    questions. Mr. Royce and Mr. Bartlett, you both called for a
    Federal regulator for insurance.
        I think at least implied is that the regulation in
    insurance had failed, but I really do not see any evidence of
    that. Our national insurance markets are the strongest
    component of our financial services market now.
        If they are having problems, and they are, it is because of
    the economy, failures in the banking system and other parts of
    our financial system.
        In fact, one member specifically said the failure of
    insurance regulators to do anything on AIG. Well, that was
    actually--that was an alternative investment vehicle that
    operated, really the only regulation you could say of that was
    in London, a 300-employee group, AIG Financial Products. There
    was no insurance regulation of it because it was not an
    insurance business. You could say CDS' are.
        The only Federal regulator was the regulator for a holding
    company, and that was a bank regulator. It was not an insurance
    regulator.
        I am not sure that other than New York with the bond
    insurers that you could--I could find literally thousands of
    instances where we had failures in our bank regulators, but I
    find very few in insurance.
        I am not sure that is a very fair argument to say that what
    has happened--in fact, I think what has happened has shown that
    probably our State insurance regulators have done a better job
    than most everybody else.
        Now, we are asking the Fed--Mr. Bartlett, I think you will
    agree that the President's Working Group in 1988 and then this
    Congress in 1991 actually directed the Treasury and the Fed to
    look at systemic risk and see what sort of powers they ought to
    have to deal with it. Now, we are going to appoint the Fed.
        I would associate myself with Mr. Castle's remarks, I think
    most closely, and Mr. Price's, as to how we address this
    systemic regulator.
        The Congress said that in 1991, a year before I got here.
        Having said that, are any of you troubled by giving the Fed
    so much power with their monetary policy right now? If they are
    regulating somebody but they are also given the right, as some
    of you said in your opening statements, to bail them out--I
    will use those words, you did not use those words, but some of
    you did use ``rescue''--they have been rescuing one institution
    after another.
        Are you troubled by that? Dr. Vaughan, I am going to ask
    Mr. Ryan. I know how you feel. Mr. Ryan?
        Mr. Ryan. I would like to first of all make a general
    comment and maybe I am dirtied up because I was the Director of
    the OTS, first Director of OTS.
        As a former Federal bank regulator, I can tell you--this is
    true basically of all former bank regulators. You can take them
    from all over the globe.
        Right now, as the chairman said, we know what systemic risk
    is and we are living through it right now as we see it.
        We know there is no Federal regulator fully equipped with
    the tools and the information to help us avoid this type of
    problem in the future. What we are looking for here is we are
    looking for someone who has the tools, has the information, has
    the power to hopefully to look a little bit over the horizon.
    Bank regulators are rear view mirror type people. It is all
    looking back.
        That is why we call it not systemic risk regulator, we call
    it a financial markets stability regulator. That is what we
    want this entity to do.
        We need someone to do that job.
        Mr. Bachus. I guess what I am asking, Mr. Ryan, is should
    it be the Fed to do all of that?
        Mr. Ryan. We have not really decided that, Mr. Bachus. That
    is why we kind of dodge that. I think having all these
    hearings--every time you have a hearing, I will come, to any
    one of these committees, I will come. We need input, and you
    all need to make a decision in a timely fashion, and to me that
    is before the end of this year.
        We need a restoration of confidence and a component piece
    of the restoration is having a regulator who can do this job.
        Mr. Bachus. Let me go back and say this: If you look at
    most of the institutions that failed, they were not regulated
    at all. Option One. They were non-banking affiliates, but they
    were not insurance affiliates. They really were non-regulated
    institutions. Even GE. They had a non-regulated WMC.
        You can just go down the line and probably 70 percent of
    the losses were in companies that were not regulated by bank
    regulators or insurance regulators.
        Those are the gaps.
        Mr. Ryan. We have talked about the shadow banking system
    and basically unregulated. We need someone who can look over
    the horizon, not limited by charter, and can pull the
    information together, and then take action, and the action, as
    I said in my testimony, goes from the more simplistic setting
    standards to also the resolution.
        Mr. Bachus. Let me say this. Dr. Vaughan, I know how you
    feel. I think I was favorable to your point of view.
        What about as opposed to rescuing these institutions, what
    about two options? One would be an orderly liquidation. Two
    would be not allowing them to become a systemic risk. Are those
    not two better options than injecting taxpayer dollars or
    guarantees into the system?
        Mr. Bartlett. Mr. Bachus, that is what we are proposing.
    The Fed has a lot of power but they do not have the power to
    prevent. They are called upon, whether they have the statutory
    power or not, they are called upon to resolve with a lot of
    money what they did not have the power to prevent.
        Mr. Bachus. Could Dr. Vaughan just briefly respond? You
    wanted to answer the first one. I am sorry.
        Ms. Vaughan. The first one, good. Not to the question about
    whether we should put taxpayer money into--
        Mr. Bachus. Whichever one.
        Ms. Vaughan. I would rather do the first one. Thanks.
        I appreciate that because it gives me a little bit of an
    opportunity to make a couple of points I wanted to make.
        First of all, the discussion about creating a Federal
    regulator, a couple of years ago when I was an insurance
    commissioner, it was all about efficiency, the inefficiency of
    the State system.
        I find it interesting that suddenly this has morphed into
    we need a Federal regulator so that we have effective insurance
    regulation, when as you pointed out, there is no evidence that
    the system has not been effective. In fact, we do not have any
    policyholders who have lost any money yet.
        The credit default swap problem was not in the insurance
    company because we would not let them do it in the insurance
    company.
        We were regulating that company to protect policyholders.
    Unfortunately, we are getting hit by things outside the system.
        The point I wanted to make is this idea of creating one
    ``uber regulator.'' We are absolutely not in favor of that, are
    absolutely opposed to that. We do not want a system that
    preempts our ability to protect our policyholders, and we think
    that a system of checks and balances is a very good thing, and
    that having a lot of eyes on the problem is a very good thing.
        The story that I have told many people in the last couple
    of weeks is that what has happened in the world over the last
    couple of years has crystallized for me an appreciation of the
    fact that regulators make mistakes.
        I think that is the most important lesson we can draw from
    this. Regulators will make mistakes. A regulatory system will
    fail. When you build a regulatory system, you should build that
    to withstand those kinds of failures.
        Bernie Madoff was a big failure. I am absolutely not
    pointing fingers at the SEC for that failure because I will
    tell you, the insurance regulators have had failures also. We
    have been the recipient of several GAO studies, thank you very
    much, that pointed to problems in our system, and that we then
    went and fixed.
        There was a man named Martin Frankel who, while I was an
    insurance commissioner, took control of seven insurance
    companies. He was a fraudster. He began bleeding the insurance
    companies, stealing money from them.
        He got through several insurance commissioners and when he
    got to the State of Mississippi, which was maybe the 4th State
    he got to, Commissioner George Dale of Mississippi looked at it
    and said, this does not look right, and he brought him down.
    What that illustrates to me is the value of having multiple
    eyes on the problem. That is what we have in the State system,
    multiple eyes on the problem.
        We do not want our eyes taken away when you build this
    system. If you want to add another set of eyes, that is great,
    but do not take our eyes away and our ability to protect our
    policyholders.
        Mr. Bachus. Thank you.
        Chairman Kanjorski. Thank you very much, Doctor.
        As I understand it, we have three votes. We have at least 5
    minutes in which Mr. Sherman get his examination in before we
    recess.
        Mr. Sherman. Thank you. I will start with kind of a
    rhetorical question that you should respond to for the record.
        A number of those on the other side of the aisle have said,
    wait a minute, you get this systemic risk regulator and those
    big enough to be subject to it get this implication of Federal
    stamp of approval, maybe they are viewed as too big to fail,
    which means they will get bailed out, and this gives them an
    advantage in the marketplace, lower interest rates, and worse
    of all, if they do need to get bailed out and there is an
    implication that we are going to bail them out, we might bail
    them out.
        One issue is instead of having too big to fail, regulating
    it in a way that has all the problems that are pointed out by
    Republican colleagues, we could prohibit too big to fail. Say
    any financial institution over a quarter of a trillion dollars
    in size, that is as big as you get. It is time to give your
    shareholders the joy of a spin off. We do not have to put
    ourselves in a position where we have to endure too big to fail
    or we have to insure too big to fail.
        I would now like to shift to AIG, which recently
    transferred, I believe, $20 billion of our money to their
    counterparties as cash collateral.
        I am going to ask first Mr. Bartlett, what portion of those
    counterparties are likely to be foreign entities? Do you have
    an understanding of the customers that AIG would have had for
    its credit default and similar products? Should I as a taxpayer
    assume that a substantial portion of that is going to foreign
    entities?
        Mr. Bartlett. I have no idea. It is a global market.
        Mr. Sherman. It is a global market in which the rest of the
    world is a very substantial part.
        Mr. Bartlett. And we are a substantial part of the rest of
    the world also.
        Mr. Sherman. We would expect that if you are sending $20
    billion to AIG counterparties, you are sending a lot of it
    overseas.
        Dr. Vaughan, I realize that the AIG entity involved is the
    one non-insurance AIG entity. Do you have any understanding as
    to what portion of that money would be going overseas?
        Ms. Vaughan. I really do not.
        Mr. Sherman. Dr. Vaughan, if I went to an investment house
    and I said, your building may burn down and that could be a
    problem for you, and I will offer you insurance against that
    risk, you would probably say that I would have to get
    registered with my State insurance and have reserves and really
    be an insurance company. But if I go to them and say, your
    portfolio may burn down, apparently, I do not need an insurance
    charter.
        What is the definition of ``insurance'' under the various
    State laws that says that insuring a portfolio is not insurance
    subject to State regulation, when clearly most investment
    houses were more worried about their portfolios burning down
    than their buildings burning down?
        Ms. Vaughan. That is a very interesting question that you
    raise, and one that there is a fair amount of discussion going
    on about right now in regulatory circles.
        At one point recently, the New York Superintendent had
    suggested that a credit default swap that was actually covering
    a portfolio, that was insuring a portfolio, would be treated as
    insurance.
        Much of what is being transacted, however, are what you
    call ``naked credit default swaps,'' where there is no
    underlying asset that is being ``insured.''
        Mr. Sherman. Wait a minute. If I sell life insurance on
    somebody's husband, they have an insurable interest. That is
    called ``insurance.''
        Ms. Vaughan. That is right.
        Mr. Sherman. If I sell insurance in my State to somebody
    who does not have an insurable interest--
        Ms. Vaughan. That is called ``gambling.''
        Mr. Sherman. That is called ``gambling,'' but it would be
    insurance. It would be the insurance regulator who would say
    no, I cannot do that. The life insurance companies in my State
    are in fact told what life insurance they can sell and who they
    can sell it to.
        Ms. Vaughan. Right. Actually, the concept of insurable
    interest is a fundamental concept in insurance. In property and
    casualty insurance, in order to collect on a claim, you have to
    have insurable interest at the time of the loss.
        In life insurance, in order to buy a policy, there has to
    be an insurable interest, and it is a little complicated how it
    can arise, but there has to be one at the time you buy the
    policy. That concept of insurable interest is fundamental to
    what we think of as insurance, and then the other part, of
    course, is risk transfer.
        In the issue of credit default swaps, there has been some
    discussion, and I know they are frequently called insurance--
        Mr. Sherman. They serve the role of insurance. They may not
    technically be insurance. As to who would regulate them, one
    argument would be well, it is insurance and we will have the
    State regulators insure.
        The concern I would have is which State, and would there be
    a race to the bottom? What protects me as a Californian in the
    race to a bottom is even if an insurance company is created in
    the Cayman Islands or in some State that races to the bottom,
    my insurance regulator can protect me, and I am not going to
    move to another State. I am not going to move to the Cayman
    Islands to get an insurance policy.
        In contrast, these markets can be moved anywhere.
    Transactions can be anywhere.
        I know you believe in State regulation of insurance for
    consumers, for those who are in a fixed place. I am not sure we
    could have the States regulate the insurance of financial
    interests and/or the gambling on financial interests.
        Ms. Vaughan. Yes. I said there has been a lot of discussion
    about this in insurance regulatory circles. I would say there
    has not been a resolution of where the regulators are.
        I share your concern that there are some differences
    between credit default swaps and other kinds of insurance that
    we are used to dealing with.
        One of the major differences is that credit default swaps
    are so pervasive now with the banks, with the hedge funds,
    throughout the system. I think personally that this would be a
    challenge for the insurance regulators to say we are going to
    regulate that massive marketplace in addition to what we
    already do and by the way, do a very good job.
        Chairman Kanjorski. There are three votes, and we will be
    back in approximately 30 minutes. The subcommittee stands in
    recess.
        [recess]
        Chairman Kanjorski. The subcommittee will come to order. I
    now recognize the gentleman from Delaware, Mr. Castle.
        Mr. Castle. Thank you, Mr. Chairman.
        I was a little surprised with what I thought was almost
    unanimity that we need some sort of a systemic risk regulator
    out there. I do not disagree with that. One of my concerns is
    exactly who should be doing this. Several of you mentioned the
    Federal Reserve.
        Mr. Baker, my recollection of your testimony and I may have
    it wrong, is that you thought it should be an independent
    agency or somebody different than the Federal Reserve. I have
    some concerns about the Federal Reserve taking on much more at
    this point. That is why I asked the question.
        Mr. Baker. Congressman, we as an association have not taken
    a position on the specific location of the regulatory
    responsibility. I would quickly add that your concerns and
    echoed by others relative to the Fed being engaged in monetary
    policy activities and potentially taking on this role as well,
    it is a task of enormous responsibility, and significant new
    resources would have to be made available.
        I do not know whether a different shop, a coordinating
    shop, some have suggested a coordination role, might be
    sufficient in order to perform the task.
        We have focused more on the elements that should be
    identified and what should be done once those are found. The
    actual mechanics of who should do it is not a recommendation we
    have made.
        Mr. Castle. Does anybody else have any concerns about the
    Fed doing it? A lot of you expressed the thought they should be
    able to do it.
        Mr. Bartlett. Mr. Castle, we addressed that issue and
    thought about it. We find the role of systemic risk regulator
    or market stability regulator, as I have described, to be very
    consistent with the Fed's role in terms of the economy and
    monetary policy.
        It is their job to understand and to strengthen the
    economy, and that is really what this is all about. We find it
    to be very consistent.
        Mr. Castle. Mr. DiMuccio?
        Mr. DiMuccio. The PCI also feels that it was consistent
    with the role of the Federal Reserve Board, so we would in fact
    support that position.
        Mr. Castle. Mr. Ryan?
        Mr. Ryan. We have not decided, but I think the most
    important issue for us is that it be done in a timely fashion
    and that the regulator be fully equipped to handle the role
    which will be complicated and difficult, and trying to create
    some new agency will be difficult and will provide delays.
        It is going to be a difficult choice for the committee and
    for Congress as to who should do this role.
        Mr. Castle. Dr. Vaughan, I want to ask you a question, and
    it pertains to AIG. Of all the consternation from what has
    happened in the last several months, AIG is at the top. We
    have--I am going to say, ``thrown money at them'' with loans or
    whatever. It seems to repeat. They reported a $62 billion loss
    quarterly, in the last quarter of last year.
        Part of what I hear is--I do not really know all this--this
    is just anecdotal to me to a degree, that they have a separate
    financial arm and that really caused a lot of the problems.
        I listened to your testimony about being less leveraged and
    longer time payouts and things, and I guess that is basically
    correct for the insurance industry, but then you wonder how did
    AIG, which at its heart was an insurance operation, get into
    this whole separate financial arm and all the credit default
    swaps and all the other things that led to its financial
    demise, and the great taxpayer dollars that are going into it
    and the continuing losses.
        Should we have some sort of separation of the insurance
    industry from even being able to get into things such as that?
    Is there some way this could have been prevented or we could
    prevent it in the future?
        Ms. Vaughan. I think that is an excellent question. I guess
    I would answer it this way. I read something recently that
    Chairman Bernanke said, I think it was Chairman Bernanke, that
    AIG was basically a hedge fund on top of an insurance company.
        The problem is that we did have this--I would say AIG was
    not an insurance company. It was a large complex financial
    institution, large globally complex financial institution.
        We as insurance regulators have authority that is clearly
    laid out in McCarran-Ferguson to regulate insurance, so we were
    protecting those insurance entities.
        As I have said already, the insurance companies still
    remain solvent. What we did was say that these insurance
    companies cannot do this credit default swap business or have
    limitations around what they could do, and constrained their
    ability.
        There was nothing that then prevented this large complex
    financial institution from creating an arm that was unregulated
    to do that. That is where we come to the problem. A lot of what
    was going on here was unregulated activities that then led to
    further issues.
        My members are as interested in solving this as you are
    because we would like to find a structure where if you have a
    large complex financial institution, we can regulate our
    insurance companies in cooperation with other groups that are
    regulating other operations in that holding company, in a
    collaborative, working together kind of way.
        Mr. Castle. My time is up but it seems to be an argument
    for a systemic risk regulator, somebody who can step in and
    take a look at what they are doing. I yield back, Mr. Chairman.
        Chairman Kanjorski. Thank you very much, Mr. Castle. The
    gentleman from Georgia, Mr. Scott, is recognized for 5 minutes.
        Mr. Scott. Thank you very much, Mr. Chairman. This is a
    very timely and important hearing.
        I would like to ask a series of questions, but let me try
    to start out with Ms. Williams with GAO. Could we talk for a
    moment about your report on credit default swaps?
        It seems to me that in the process of dealing with this,
    they seem to have fallen into the crack. Could you give us an
    idea as to how do we best regulate these credit default swaps?
        Ms. Williams. I think I would start with kind of focusing
    on how the product is defined and the definition for CDA was
    basically set up in the Commodities Futures Modernization Act.
    Rather than how it functions economically, the definition of
    the product lies in a statutory definition.
        I think if you back away from that and look at this, it is
    an example of what happens when you focus on a product and
    regulating a product market versus institutions.
        You had OTC derivative dealers who were selling CDS and
    depending on the type of entity that sold the product, that
    dictated the type of regulation and oversight it received.
        If it is a bank dealer, then it was subject to some level
    of oversight by its bank supervisor, but if the dealer was
    affiliated with a conglomerate, AIG, for example, then it was
    not overseen.
        The same would be the case if you had an affiliate that was
    associated with a broker-dealer, for example, so it illustrates
    the gaps that exist in the current structure and the inability
    to have a system-wide view of this particular product.
        I think the focus has to be system-wide.
        Mr. Scott. The best example of that would be AIG being
    under the risk regulator at the holding company level when
    underneath it in many of these sub-institutions, financial
    institutions underneath that, were not under risk regulation.
        They did not look down that far?
        Ms. Williams. Correct. With the holding company regulator,
    the holding company regulator has the ability to go into any
    part of that structure that has the potential to impact the
    holding company, but if you are not going in on a regular
    basis--if there is a concern, you can go in, but if you are not
    going into the subsidiaries on a regular basis, how do you then
    identify if a subsidiary is posing a threat to the holding
    company.
        Mr. Scott. I see. Thank you, Ms. Williams.
        Mr. Baker, good to have you here, my former colleague and
    good friend. While I have you here, Mr. Baker, I would like to
    get some clarification on your thoughts on hedge fund
    operators. Could I do that for a moment?
        Mr. Baker. Certainly.
        Mr. Scott. Why should not the income from those hedge fund
    operators who use other folks' money to make money, why should
    not they be viewed and taxed as regular income as opposed to
    capital gains, when in fact, if I take my direct money, I
    should be valued on capital gains, but if I am making money
    from using somebody else's money, why should I not be evaluated
    on regular tax structure?
        Mr. Baker. Mr. Scott, the shortest and probably most
    responsive answer I can give would be when 5 of our largest
    firms appeared before Chairman Waxman in the last 2 months.
    They were specifically asked a question about tax increases and
    all, save one, I think, expressed the view that they would not
    be surprised to see some adjustment in the taxation system, but
    I think they made it pretty clear as well that they would hope
    that any taxable recommendation would be neutral between
    financial market participants so that the outcome of any tax
    proposal would not be prejudicial to the hedge fund industry
    but treated similarly as you were suggesting.
        I would be happy to provide you with additional information
    and will do so following the hearing.
        Mr. Scott. Do you see the need for any additional
    legislation along those lines for hedge fund operators or
    should we leave it alone?
        Mr. Baker. I am sorry. Could you be more specific?
    Regulation in the context of the funds and how they operate?
        Mr. Scott. In how they report that income. I think that is
    the fundamental issue, how hedge funds' income is regulated and
    reported.
        Mr. Baker. If I can, let me provide, I think, the shism you
    are referring to. Any U.S.-generated income for a hedge fund
    manager is fully taxable under ordinary income standards.
        Some of the issues have related to a nonprofit's ability or
    foreign investors to invest in a facility provided by a U.S.-
    based hedge fund offshore. If you did not have that offshore
    capability, those currently prohibited investors in U.S.
    transactions, we would lose that capital to other
    jurisdictions, London or wherever else they may choose to go to
    make those investments.
        You have the UBIT issue for pensions and endowments that we
    would need to revisit.
        You have touched on a pretty complicated set of
    relationships that I certainly want to be responsive and
    knowing your interest, I will get you something back that
    clearly outlines the concerns.
        I do not think at the end of the day, Congress wants to see
    net revenues to the U.S. Government go down as a result of tax
    policy.
        Mr. Scott. My final point is this, Mr. Chairman, if I may,
    there seems to be some confusion as to what is and who is and
    who is not a hedge fund operator. Is that true?
        Mr. Baker. Yes, sir. At this time, there are an estimated
    in excess of 15,000 companies that would call themselves hedge
    funds. The MFA represents about 1,800 of those associations.
        There are many people who fly under--companies--who fly
    under the banner of hedge fund that may be long only shops or
    not utilizing hedge fund strategies in their investment
    practice.
        There is a bit of lack of clarity in what constitutes a
    hedge fund in the current market.
        Mr. Scott. Thank you, sir. Thank you, Mr. Chairman.
        Chairman Kanjorski. Thank you very much, Mr. Scott. Next,
    we will have the gentleman from California, Mr. Royce.
        Mr. Royce. Thank you, Mr. Chairman.
        Earlier, Mr. Bachus alluded to this notion that the
    underwriting side of AIG overseen by the State insurance
    regulators was somehow walled off from the abstract securities
    lending division.
        Unfortunately, news reports, such as the Wall Street
    Journal article that was dated October 10, 2008, which I would
    like to insert into the record, detail the inaccuracy of this
    perception.
        The gentleman from Alabama and I have disagreed in terms of
    this issue of systemic risk regulation. For example, the need
    to have Fannie Mae and Freddie Mac under a regulator who could
    de-leverage those institutions, for systemic risk.
        There was an amendment I had that I brought to the Floor.
    The gentleman from Alabama opposed it. Mr. Baker supported it.
    It failed to pass. I think in retrospect, the fact that we did
    not give the Federal Government the right to regulate for
    systemic risk with respect to Fannie and Freddie was clearly a
    mistake. Now, we are looking at the situation with respect to
    AIG.
        Let me just read from the article from the Wall Street
    Journal: ``Securities lending has long been a reliable side
    business for life insurers, approved by state regulators. But
    Moody's warned in April about the risks that insurers were
    taking related to these programs.
        ``Hampton Finer, a deputy to New York State Insurance
    Superintendent Eric Dinallo, said policyholders in AIG's life-
    insurance subsidiaries weren't at risk due to the securities-
    lending program. But, he said, New York will review what types
    of assets insurers are allowed to invest securities-lending
    collateral in.
        ``Mr. Slape said his team is keeping a close watch on three
    AIG insurance units because of the securities-lending exposure.
    Ohio's Department of Insurance said it is investigating the
    securities-lending activities of at least one life insurer.
    Darrel Ng, a spokesman for the California Department of
    Insurance, said the state is `looking at the securities-lending
    practices of those insurers domiciled in California,' along
    with AIG's.''
        The Wall Street Journal story is accompanied by a graph
    indicating the model AIG used to invest in subprime residential
    mortgage backed securities, which ultimately led to their
    demise.
        The collapse of AIG was an unfortunate episode, but facts
    are stubborn things. As I laid out in my opening statement, the
    various State insurance regulators simply do not have the
    ability to oversee large, complex financial firms like AIG.
        I would like to ask a quick question of Mr. Bartlett, and
    that goes to the issue on the ideal of insurance regulation as
    it relates to systemic risk, financial regulatory restructuring
    efforts are going to be high on the list on the upcoming London
    Summit of the G-20, and as part of those talks, the issue of
    the U.S. 50 State insurance regulatory model is going to arise
    as other countries criticize what they see as the
    inefficiencies and anti-competitiveness of this system.
        As a member of the Foreign Affairs Committee, I have often
    dealt with foreign regulators and parliamentary members, and I
    have heard firsthand the frustration many of them have with the
    piecemeal regulatory structure for insurance. All of Europe has
    one regulator; we have 50-plus regulators.
        As other countries move forward, what might we learn from
    our foreign counterparts when it comes to insurance regulation
    and who is representing the interests of the U.S. Government on
    insurance in these ongoing discussions that we are having
    basically with our competitors overseas?
        Mr. Bartlett. Thank you, Congressman. I concur with your
    point. I would also hope that you would include into the record
    the underlying report from Brookings entitled, ``Regulating
    Insurance After the Crisis'' that was part of that.
        Mr. Royce. Yes, I would like to ask the chairman to include
    the Brookings' report, ``Business and Public Policy,'' and
    their initiative ``Regulating Insurance After the Crisis'' for
    the record.
        Mr. Bartlett. Mr. Royce, the fact is our European allies do
    believe that our 50 State regulation without the opportunity
    for a national charter is a significant trade barrier. We
    concur with that.
        It is clearly a significant trade barrier. It is a trade
    barrier that the Europeans are rightfully angered about. It is
    also quite a high risk to our system and to the global system.
        The fact is that AIG failed. It was not as if AIG is still
    walking around. It has cost the Federal taxpayers so far $145
    billion and counting. It did fail. It failed because there was
    neither a national regulator of the company nor was there a
    systemic risk regulator involved. It failed, and it failed
    under the current system.
        If you keep the current system, then there will be future
    failures that will be similar.
        Mr. Royce. Thank you, Mr. Bartlett. Thank you, Mr.
    Chairman.
        Chairman Kanjorski. Thank you, Mr. Royce.
        Our next gentleman is Mr. Perlmutter for 5 minutes.
        Mr. Perlmutter. Thank you, Mr. Chairman.
        I have not been able to sit through all of your testimony,
    but I appreciate everybody being here today.
        We have now had, I think, about a year's worth of hearings,
    sort of dealing kind of around and about systemic failures,
    systemic regulation. I appreciate everybody really bringing
    their thoughts to the floor on this.
        We have asked our taxpayers to carry a heavy burden to get
    us through this mess. Mr. Baker, it is good to see you. I wish
    you were still on this committee to help us with this chore.
        Mr. Bartlett, I would like to start with you. I am
    concerned even if we have the most brilliant person at the top
    of the pyramid here trying to figure out what is the next thing
    that could cause trouble to our system, because our system is
    so connected.
        Should we not be putting some brakes and barriers back into
    the system? That may take away from the efficiency of the
    system to some degree, you cannot make the last buck but the
    bottom does not fall out either.
        Just throwing a Glass-Steagel kind of approach where you
    try to maintain some degree of separation between insurance and
    banking and the stock market, question number one.
        Question number two, I think you said size should not be a
    factor, but I do think size does count in dealing with this
    kind of problem.
        I am just sort of throwing that open-ended question to you
    and to the other members of the panel.
        Mr. Bartlett. First, Congressman, size does matter but what
    we are saying is size should not be the criteria that decides
    whether it is systemic. Systemic is deciding whether it is
    systemic or not, not how large the individual company is.
        Secondly, again, our proposal is not to create someone at
    the top of the pyramid, but rather to mandate or authorize
    someone to look at the systemic risk or the gap in coverage,
    but look at that not through the eyes of a new regulator or an
    uber regulator, but through the eyes of the prudential
    supervisors.
        Just as the Fed does collect information on the corrugated
    container industry, the Fed should be authorized much more
    importantly to collect information on the total financial
    services industry.
        As far as separation, Congressman, that would be quite
    harmful to the American consumer, harmful to our economy,
    harmful to job creation because financial services is
    interrelated. We cannot put that genie back in the box nor
    should we try. If we were to try, the leakage would be much
    greater than the container to start with.
        A systemic regulator working through the existing
    prudential supervisors, the national Federal prudential
    supervisors, plus the addition of a national insurance
    regulator, working through their powers in order to provide
    better regulation, and second, in order to prevent occurrences
    before they happen instead of responding after they happen.
        Mr. Perlmutter. Dr. Vaughan, do you have a comment?
        Ms. Vaughan. Yes, I do. I really liked Mr. Bartlett's
    comments about looking at it through the eyes of the existing
    functional regulator. I do believe that it is important not to
    lose the things that we have that work, and the expertise that
    we have to try to solve this problem.
        It is a very complicated problem. At least let's leave what
    is working, which gets me to the securities lending, if I could
    just take 2 minutes to talk about what happened with AIG.
        Mr. Perlmutter. How about 1 minute?
        Ms. Vaughan. Okay, 1 minute. AIG did have securities
    lending operations; a number of life companies have securities
    lending operations. No life insurance has gone insolvent
    because of its securities lending operations.
        The New York Superintendent had been working to address the
    issue of securities lending in AIG, and the insurance company
    had reduced the amount, and was in the process of reducing it
    further, when it was overtaken by the problems with the credit
    default swap operation.
        Credit default swaps led to a downgrade in AIG, it led to
    liquidity calls in the insurance company. Still not insolvent
    but there was a liquidity issue.
        What have we learned from this? Well, we have learned two
    things. One, we are looking at our securities, our regulations
    around securities lending. We have disclosures. We have
    strengthened those disclosures. Even before this all happened
    in 2007, I think, we adopted a risk based capital charge
    related to securities lending. We have been working on this for
    several years but the whole credit default swap situation
    overtook some of the work that we were doing.
        Second, the fact that the credit default swap operation at
    AIG again impacted our insurance company is why we believe that
    this discussion around systemic risk regulation is worth
    having, but not to use it as an opportunity to gut a system
    that has worked, which is we protected the insurance companies
    and the insurance policyholders.
        Mr. Perlmutter. Thank you. I yield back, Mr. Chairman.
        Chairman Kanjorski. Thank you very much, Mr. Perlmutter.
    Mr. Posey of Florida.
        Mr. Posey. Thank you very much, Mr. Chairman.
        I think fundamentally we all agree that the whole crisis
    was caused by greed, pure and simple, and there is more than
    enough blame to go around. We can point fingers in all
    directions for the rest of our lives and not get everybody who
    is due some blame and probably include a bunch of people who
    were not.
        Fundamentally, I do not think we had a problem with not
    enough regulation. I think we had too much regulation, too much
    interference by Congress. I never knew a banker who wanted to
    make a bad loan until Congress injected itself into the process
    of determining who should get them and for what.
        Ken Lay is in prison because he caused severe losses to a
    lot of non-risk adverse investors, and yet we have a lot of
    people walking around free who have caused immeasurable
    financial harm to every person living in this country and
    future generations of persons living in this country.
        I think every one of you at this table and I will be dead
    before our country pulls out of this crisis or completely
    recovers from the doldrums that were caused.
        I align myself a lot with the remarks made by Mr. Ackerman
    earlier. I think it is not a matter of too few regulations. I
    think it is a matter of regulations we had not being enforced.
        I like the analogies he made about crime. If your local
    police did not arrest and investigate criminals in your
    neighborhoods, I guarantee crime would be rampant.
        We heard the SEC story with Madoff for a decade ago.
    Basically, no heads fell. Nobody lost their job. Total lack of
    accountability and responsibility on the government's part,
    equal, I think, in guilt as Madoff was.
        I believe the best regulation that we could have is add
    some people with accounting degrees to the Justice Department.
    We need to make sure this fits into RICO statutes. I think that
    self regulation would be the best regulation.
        I think when people commit these horrendous acts of greed
    and cause harm to other people--if they cause physical harm,
    they go to jail. If they cause financial harm, you get a big
    bonus and you do not care whether you work another day in your
    life or not.
        I would like just a yes or no from each one of you as to
    whether or not you think that is a good idea conceptually.
        Ms. Williams?
        Ms. Williams. Self regulation needs to be part of it and it
    also has been part of the current structure.
        Mr. Baker. Our industry does not perform well where markets
    are manipulated. We would like fair and efficient markets.
        Mr. Bartlett. If you commit a crime, you ought to go to
    jail. We do think there should be more effective regulation. We
    think the regulation that was in place clearly failed, as there
    were a lot of other failures, but we look for more effective
    regulation.
        Ms. Vaughan. Enforcement is critical and a system of checks
    and balances increases the chances that will happen.
        Mr. DiMuccio. We think there should be better coordination
    of regulation with the help of a systemic risk regulator.
        Mr. Ryan. We believe there should be a financial stability
    regulator.
        Mr. Posey. I got one clear ``yes'' out of six. That is
    probably pretty good for up here. Thank you, Mr. Chairman.
        Chairman Kanjorski. Thank you, Mr. Posey. The gentlelady
    from Ohio, Ms. Kilroy.
        Ms. Kilroy. Thank you, Mr. Chairman. I appreciate it.
        I would like to ask the panel some questions about credit
    default swaps and your view of those in this overall topic of
    systemic risk.
        I have heard credit default swaps described as a way for
    institutions to manage their credit risk. I have also heard
    them called a dangerous side bet by those with no skin in the
    game, no ownership interest, in terms of stocks or bonds, that
    has played a role in this economic downturn.
        I would like to know how you come down on credit default
    swaps and their role in our financial markets. Are they good
    for us? Are they bad for us? Which way do they tilt?
        Mr. Ryan. Our view is that CDS are not insurance products.
    They are trading products. They do not require an insurable
    interest. It is not an insurance product. It is trading. It is
    a very useful product in today's environment.
        Ms. Kilroy. If they are not an insurance product, what is
    their functional good use then?
        Mr. Ryan. People trade risk on specific names and typically
    they are trading risks around embedded additional investments.
    Sometimes they are not, and that is called ``naked CDS.''
        Ms. Kilroy. Are they more useful products than offside
    betting, if they are not an insurance product?
        Mr. Ryan. For most global financial institutions, they are
    very useful hedging products.
        Ms. Kilroy. Anybody else want to offer on opinion on the
    usefulness?
        Mr. Bartlett. I would comment they are another example, a
    very large example of the gaps in regulatory coverage. CDS are
    just riding the gap. There is no regulation on either side of
    them. That is why we think a systemic regulator should be able
    to look at the gaps as well as the coverage.
        Ms. Kilroy. I understand that we have gaps in regulations,
    but as I understand it, credit default swaps were not permitted
    until about a decade ago. Is that correct?
        Steve Kroft reported that on CBS News, 60 Minutes, that
    credit default swaps had been illegal during most of the 20th
    Century.
        Mr. Bartlett. It had been unheard of before, I suppose. I
    had never heard of them.
        Ms. Kilroy. I guess my question is, should we return to
    that last decade, return to a situation where credit default
    swaps are at a minimum unheard of?
        Mr. Baker. If I may respond, Congresswoman, I certainly
    think that the role that credit default swaps play has a
    structural material business reason for existing.
        If I am doing business with you and you have a train of
    suppliers that enable you to make your product that I am
    relying on purchasing, but I have a concern that one of the
    downstream providers of, let's say, the engine for the car you
    are manufacturing, and the engine manufacturer may be impaired,
    I cannot enter into a financial transaction and be responsible
    to my shareholders without ensuring against identified
    potential risks.
        If I take that credit default swap out so in case something
    does happen to that engine provider, I can be made whole.
        Ms. Kilroy. Should we limit a credit default swap then to
    those with some business reason like that, someone with
    ownership interest, where it is a guarantee?
        Mr. Baker. There is another complicating factor that is
    unfortunately the result of our credit rating agencies'
    missteps. The CDS market is increasingly becoming the de facto
    rating agency because the spreads on credit default swaps are
    an indicator of the underlying financial condition as
    determined by the broad market.
        All I am suggesting is cautionary action. We certainly want
    to be involved in the discussion. We have concerns that
    prejudicial action at this time without fully understanding the
    consequences would not help our economic recovery.
        Ms. Kilroy. That is why I am asking questions so we can
    understand.
        Mr. Baker. Thank you.
        Ms. Kilroy. Should credit default swaps be regulated then
    since they are a form of a guarantee as an insurance product?
        Mr. Baker. If I may further continue, the risk with credit
    default swaps in the current market environment is settlement
    risk.
        There is considerable work done by the New York Fed with
    significant market participants to create future clearinghouses
    or exchanges for the purpose of trading standardized CDS
    contracts.
        The difficulty in pursuing that path alone is there are
    many credit default swaps which are very unique to the two
    business interests that are involved, called ``one off's.''
        You cannot run one off's through an exchange because of the
    fact they are unique, so there will be a continued business
    reason to have credit default swaps continue to be agreed to
    that are not exchange or clearinghouse traded.
        It will help greatly with some of the concerns I think I
    have heard expressed about the potential downside risk of a
    failure to settle.
        Ms. Kilroy. What you are suggesting would certainly give us
    more ``transparency'' in the system, but does that answer the
    need for regulating credit default swaps?
        Let's move from insurance to the banking industry. Banks
    are the major credit default swaps' dealers, but banks which
    are subject now to regulation, the regulators do not take a
    look at credit default swaps.
        Is that something that bank regulators should take a closer
    look at?
        Mr. Baker. I think that would come under the purview of the
    systemic regulator's responsibilities and to determine where
    there was aggregation or exposures that warranted some
    intervention.
        In the current market, I do not respectfully see a reason
    to regulate the instrument. There may be concerns about the
    counterparties' capital standing or their inadequacy to meet
    their obligations, which perhaps could be best handled by
    either the prudential regulator of the counterparty or by the
    systemic risk regulator.
        Ms. Kilroy. I have to express some real concern about AIG
    and the amount of money that our taxpayers have had to pony up
    for AIG and the continuing saga there, and AIG and AIG FP's
    role, an unregulated entity engaging in hundreds of billions of
    dollars in credit default swaps. I have a real concern about
    this area.
        Mr. Baker. I think that would be certainly addressed by a
    systemic regulator, particularly in the case of AIG.
        Ms. Kilroy. Dr. Vaughan?
        Ms. Vaughan. Thank you. Back to your original question
    about is there value to these and should they be regulated, the
    theory always was that the use of credit default swaps would
    allow this risk to be spread throughout the marketplace, and
    therefore, it reduced the systemic risk because credit risk was
    not being held by one bank now. It was being held broadly by
    lots of people, and that was a good thing.
        What we found was that it did not spread the risk. It
    concentrated it, and it concentrated it in places where we did
    not see it and we did not regulate it.
        I would fall on the side of we need to regulate it, and we
    need to deal with it, and how you do that, that is for the
    experts to figure out.
        The issue is making sure, to go to what Mr. Baker said
    about settlement risk, when you have concentrations of this,
    making sure that they are able to pay off on these losses, and
    even more, avoid concentrations.
        Chairman Kanjorski. Thank you very much, Ms. Kilroy. Ms.
    Biggert of Illinois.
        Mrs. Biggert. Thank you, Mr. Chairman. Before I begin, if
    for Ranking Member Garrett, I can put in the record an article
    by Investors Business Daily, ``For Banks, Help Isn't On The
    Way.''
        Chairman Kanjorski. If there are no objections, it is so
    ordered.
        Mrs. Biggert. You know, until the last few years, we have
    had a market that has had a lot of innovation and a lot of new
    products that have come in, with the hedge funds and credit
    default swaps.
        I wonder how we are going to find the balance between smart
    regulation, effective regulation, and really, overregulation.
    We have been through Sarbanes-Oxley and some other things like
    that.
        How would we structure sensible regulation to manage the
    risk posed by the credit default swaps?
        Mr. Ryan?
        Mr. Ryan. As to your first question, the reason our
    industry has not given you specific answers to many of the
    questions is that they are very complex. This type of hearing,
    and I am sure there will be a series of hearings on many of
    these specific issues, should be part of the dialogue back and
    forth so that you hopefully get to an answer that provides the
    comfort and confidence that the marketplace requires without
    stifling innovation.
        Mrs. Biggert. Thank you. Mr. Baker, it is great to see you
    back here. I wish you were still sitting up here. You really
    provided so much expertise to our committee.
        Kind of the same question, how do we judge the credit
    default swaps? What do we look at? Do we look at the leverage
    ratios? What would we look at as far as regulation?
        Mr. Baker. Congresswoman, certainly attention ought to be
    given to where inappropriate aggregation occurs in the market.
    As a related matter, for example, if we had known the number of
    people who had Lehman as their broker-dealer counterparty,
    perhaps some action might have been taken--I cannot say for
    sure--that would have at least mitigated some of the effects.
        As to the settlement responsibility on a CDS exchange, you
    go to the capital adequacy of the person holding the
    obligation.
        Has the company, as in the case of regulated insurance
    companies, had adequate reserves to meet its obligations using
    some sort of reasonable man standard.
        Obviously, in a very frothy economic market where outlooks
    were very positive for continued upswing in values, the pricing
    of the CDS was under market in relation to the risk they were
    actually assuming, but it does not mean the economic
    relationship of acquiring a credit default swap to protect your
    own business interest is something that is inherently wrong.
        It is a way to diversify risk, to spread risk, and to hedge
    against your own losses. Any instrument inappropriately used
    can bring about financial dislocation, which regrettably has
    happened here.
        I go back to the purpose of the hearing in suggesting this
    proposed systemic risk assessment office, if that is what we
    are going to call it, should have some role in looking at where
    people are inappropriately concentrating.
        Concentration issues are always of concern.
        Mrs. Biggert. If we do that, with Bear Stearns and the
    collapse of the two hedge funds in 2007, should there not have
    been a warning sign to regulators that if not properly managed,
    even though they were operating within a regulated entity, that
    there would be a systemic risk?
        Mr. Baker. I think that is what brings most of us here
    today, to observe that there were regulatory gaps and that we
    generally agree that some sort of overview of the system that
    enables some office somewhere to have that aggregated view of
    all the interrelationships would be very helpful.
        It will not prevent business failure. It will not prevent a
    bank or a hedge fund from closing its doors, but it will
    perhaps limit the losses to those appropriately assessed and
    not to innocent third parties.
        Mrs. Biggert. Specifically, how do we address the
    inappropriate behavior that you described?
        Mr. Baker. Well, first the systemic regulator has to
    intervene as appropriate. Then the prudential regulators who
    are charged with the enforcement, market discipline and
    investor protections, who are there today, would continue to
    need to do their role.
        I suspect all those who have been previously identified as
    engaging in inappropriate conduct are in deep conversations
    with a lawyer somewhere.
        I do not know how quickly the resolution will come, but I
    suspect it will be appropriate.
        Mrs. Biggert. Thank you. I yield back.
        Chairman Kanjorski. Thank you very much, Ms. Biggert. Now,
    the gentlelady from Illinois, Ms. Bean.
        Ms. Bean. Thank you, Mr. Chairman. I apologize for running
    late. I had another meeting I had to attend. Thank you all for
    your patience with us today.
        My question is for Dr. Vaughan. I missed part of your
    testimony. I guess my question is, is it your opinion from what
    you have testified to thus far that the insurance subsidiaries
    of AIG are solvent, and if that is the case, why has the latest
    round of Federal dollars gone to the life insurance side of the
    business?
        Ms. Vaughan. The insurance companies are solvent. The
    insurance companies before they got the round of Federal funds
    had positive capital and surplus. There was a question about at
    what level did you want that risk based capital to be, and I
    think that was a determination that was made outside of the
    insurance regulatory system.
        We were fine. Had AIG not gotten that money, no
    policyholders would have lost money, is my understanding.
        Ms. Bean. You are saying the latest round of Federal monies
    going to the insurance companies is not necessary?
        Ms. Vaughan. What I am saying is it is increasing their
    risk based capital ratios. It is not taking an insolvent
    company and making it solvent.
        Ms. Bean. The $30 billion additionally is necessary for the
    insurance companies?
        Ms. Vaughan. What I am saying--I will try again. Sorry. The
    AIG insurance company is solvent. They got additional capital
    through this latest round but it did not take an insolvent
    company and make it solvent. It took a solvent company and made
    it more solvent.
        Ms. Bean. I have another question, if I still have time,
    and I do. What if AIG did not have a thrift company and then
    would not have OTS oversight? Who would be involved?
        Are you also stating that the New York State Commissioner
    would have had the ability and the processes in place to detect
    the challenges of AIG, and does AIG have processes in place to
    make sure that State commissioners cannot?
        Ms. Vaughan. That is an excellent question. The insurance
    commissioners regulate the insurance subsidiaries, and the
    insurance commissioners work together when there are multiple
    insurance subsidiaries in an--
        Ms. Bean. Who regulates the holding company?
        Ms. Vaughan. No one does, and that is part of our problem.
    The insurance commissioners are regulating the insurance
    companies, protecting the policyholders in the insurance
    companies.
        They are looking at the relationship between the holding
    company and the affiliates and the insurance company to make
    sure it does not impair the insurance company and does not
    affect negatively the policyholders.
        What happened here were unregulated affiliates that created
    the problem, and we agree that is a problem that needs to be
    solved.
        Ms. Bean. Clearly, there is no Federal oversight at the
    holding company level to actually see what is going on.
        Ms. Vaughan. Right. Had there not been a thrift, that is
    correct.
        Ms. Bean. Thank you. I yield back.
        Chairman Kanjorski. Thank you very much, Ms. Bean. Mr.
    Campbell?
        Mr. Campbell. Thank you, Mr. Chairman. I also wish to issue
    my apology for coming in late. I had a conflicting committee
    hearing, which some of you are familiar with.
        I have two questions, and what I will do is kind of explain
    my thoughts and background on them, lay them out and let you
    kick them around, answer them as you will.
        My questions will be specifically oriented toward
    insurance, since that is where many of you have at least some
    focus.
        To me, there are two great distinctions in the insurance
    market today. One is between those things where we are insuring
    tangible assets, and those things that are insurance of
    financial products, that have no nexus in any State or anywhere
    in particular.
        Financial products, insurance financial products would
    include such things as life insurance or annuities, but also
    such things as credit default swaps and any other financial
    insurance products.
        Within that financial insurance product bin, I agree with
    my colleague from California, Mr. Sherman, earlier, that there
    are some products which I would say are in the nature of
    gambling, and not actually in the nature of real insurance or
    investment.
        To use life insurance as an example because it is something
    we are all familiar with, Mr. Baker and I enter into a contract
    for the life of Mr. Baker. He has an interest in the life of
    Mr. Baker, and we enter into that contract, and that is
    insurance. That is life insurance. That is the way it works.
        If, however, Mr. Kanjorski and I enter into a contract
    about the life of Mr. Baker and neither one of us have any
    particular--we are not the company that employs you or whatever
    and neither of us has any particular interest, most life
    insurance companies will not go for that because we are just
    gambling. We are just betting.
        He is taking one side of a bet and I am taking the other
    side of a bet on the life of Mr. Baker and we have no interest
    in his life other than the bet. Those to me, are gambling.
        From this world view that I have, I have two questions.
    First of all, in my view, these financial products which are
    insurance in nature and which have no nexus in any State should
    have some Federal regulator.
        Should that Federal regulator be a separate regulator or
    should it be a part of a larger systemic regulator that looks
    not only at insurance things, but also at the banking system
    and all the other systemic issues that we are talking about, or
    do you think either one of those ideas is bad.
        My second question is, do you agree with the viewpoint that
    there are financial insurance products, and frankly, there are
    other types of financial products, not insurance, which are in
    the nature of gambling, and although in my view should not be
    banned or made illegal, but should be segregated, and there
    should be a number of restrictions on who can and is allowed to
    engage in that kind of gambling.
        Those are my questions. I would like to hear answers from
    whomever wants to throw them out.
        Mr. Bartlett. I will try just quickly. We believe that
    first of all there should be a systemic risk regulator, a
    market stability regulator, whether it is an insurance product
    or other kinds of financial services, who would examine the
    systemic risk and examine the gap in coverage, if you will, of
    regulators, working through the Federal prudential supervisors,
    working through their eyes, and with their authority.
        We think that covers the systemic side, if these products
    you describe are systemic, create a systemic risk, the Federal
    Reserve should have some oversight over identifying the risk,
    but then working through the prudential supervisors to take
    action, not taking action unilaterally. Otherwise, you create
    two new regulators that at best on a good day could conflict,
    and on a bad day, avoid the question altogether.
        We also believe there clearly should be for a Federal
    company with interstate, with large systems, whether it is an
    insurance product or other similar kind of product, they should
    have a national charter, at least be allowed to have a national
    charter because it is in the national government's best
    interest to have someone who can regulate those large national
    companies.
        Mr. Campbell. Would that charter be managed then by the
    systemic risk regulator?
        Mr. Bartlett. No, it should be managed similar to banks, it
    should be managed by a national insurance regulator who is
    actually supervising the activities of that company as opposed
    to the systemic.
        Mr. DiMuccio. May I?
        Mr. Campbell. Yes, the question is open for whoever wishes
    to answer.
        Mr. DiMuccio. We believe there should be a systemic risk
    regulator. We believe there are some immediate needs to bring
    confidence back to the markets.
        However, our Association has a concern that there are many
    regulatory issues that are being brought into this round, and
    they need to be talked out. They need to be discussed.
        However, putting them together, the systemic risk regulator
    and the regulation of insurance, into one process that needs to
    get done quickly may possibly hurt or affect a system that has
    worked very well up through now.
        There has been an insignificant number of P and C
    insolvencies in the last couple of years, and the vast majority
    of P and C companies are strong and have worked through this
    crisis serving their markets.
        To disturb a working market and a system that is performing
    very adequately, at this point, we think that is not the right
    answer. We think a systemic risk regulator with principles
    based regulation that allows it to evolve its regulatory
    oversight to take into account changes in the markets is the
    necessary infrastructure that we need to put in place.
        Mr. Campbell. Mr. Ryan and then Dr. Vaughan.
        Mr. Ryan. I would like to associate myself with Mr.
    Bartlett and our Association, the Securities Industry and
    Financial Markets Association, believes there should an
    optional Federal insurance charter.
        Mr. Campbell. Dr. Vaughan?
        Ms. Vaughan. I have said it before and I do not want to
    sound like a broken record, but to repeat what Mr. DiMuccio
    said, we have a system that works.
        We are used to working in a collaborative way with other
    regulators. This State-based system is often presented as a
    system where you have Alabama doing one thing and North Dakota
    doing another and New York doing another. In fact, we have a
    highly coordinated system with lots of oversight of each other
    and nationally.
        I am the CEO of the National Association of Insurance
    Commissioners. My number one job is to make sure that the
    system works together. I have a staff of over 450 people who do
    that.
        We make sure that groups are coordinating, that if there is
    a company like--pick any insurance company that has companies
    in five States, that they are working together and they are
    gathering information.
        We have an office in Kansas City that does its own analysis
    of financially significant companies, and then creates a peer
    review process for other States to look at what is going on
    when they see a problem with that company.
        We are used to working together as regulators. We really
    think that works. We like that model. We would love to have a
    model where we could work with the banking regulators and the
    securities regulators, and let's all get together and work on
    what is going on in this complex financial institution
    together.
        We do it. We know how to do it. We would be happy to work
    with other people on that kind of a model.
        Mr. Campbell. I guess nobody wanted to touch the gambling
    issue. Thank you, Mr. Chairman.
        Chairman Kanjorski. Thank you, Mr. Campbell. Mrs. Maloney
    of New York.
        Mrs. Maloney. Thank you. I thank all the panelists and I
    particularly thank our colleague, Richard Baker. It is good to
    see you again. Thank you for coming to see us. We served
    together for many years.
        I would like to follow up on the chairman's and others'
    questioning on AIG, which has now received over $200 billion in
    taxpayer money, 10 percent of the TARP money, $80 billion from
    the Fed. We continue to use taxpayer dollars to keep AIG from
    going under, an additional $30 billion was allocated last
    Monday.
        Yet, in the words of Fed Chairman Bernanke, ``This was a
    hedge fund basically, that was attached to a large and stable
    insurance company that made huge numbers of irresponsible bets
    and took huge losses. There was no regulatory oversight because
    there was a gap in the system.''
        Today, it was reported in the press that Hank Greenberg, a
    former CEO of AIG, has stated publicly that we should separate
    AIG out from the risky arm that was added to it, and move it
    apart.
        As Dr. Vaughan pointed out, the insurance arm of AIG is
    healthy, strong, well-functioning, and respected worldwide.
        It is this risky arm that is pulling us down. I would
    suggest even better to the systemic regulator, which I support,
    I would not let these risky functions be tied onto core
    services that are needed by the American people.
        When people try to support AIG, it is because of the
    insurance arm. We need insurance. Our businesses and our people
    need insurance.
        Why can we not just separate out this risky arm? I would
    like to begin with Dr. Vaughan, but also add that with $200
    billion of taxpayer dollars in AIG, the American public
    deserves to know, as do researchers in government and out of
    government, where did this money go?
        They are telling us it is systemic risk, but how do we know
    it is systemic risk if we do not even know where the money
    went?
        I respectfully would like to place in the record a letter
    that I have continued to request from the Federal Reserve to
    get this information, so that we can make better policy
    decisions in the future.
        My question, beginning with Dr. Vaughan, and anyone can
    answer, is why not just separate right now by regulation, just
    take that risky arm out of it, and let the healthy arm continue
    to serve the American public and the world with a fine
    insurance product, but let's put this risky arm over on the
    side. Let's see if that is really systemic risk.
        Maybe we do not need to be pouring billions in. We put in
    $200 billion. Once they said they did not need any money. Then
    they said they needed a certain amount. It keeps going and
    going.
        That is my question, and my final question to Mr. Bartlett
    and others and Mr. Baker is, could we have prevented the crisis
    that we are in now, our current economic crisis?
        Do you think it could have been avoided or mitigated if a
    systemic risk regulator had been in place during that period?
    Would that have prevented the crisis that we have?
        What I find so upsetting is that 9/11, which was another
    crisis in our country, I truly do not believe we could have
    prevented it, but we could have prevented the financial
    meltdown that we are in today with better regulation and more
    responsible oversight.
        If you could begin, Dr. Vaughan. Why do we not just
    separate out this risky arm as Hank Greenberg said, who should
    know, he is the former CEO, he said just separate it out and
    let that be over in one area and let the insurance be strong
    and serving the public.
        Dr. Vaughan?
        Ms. Vaughan. That is an interesting idea and I have not had
    a chance to look at what Mr. Greenberg is suggesting.
        I guess I would start by saying that to some extent, we
    have been separating the insurance operations from the risky
    activities, and that is the reason that the insurance companies
    are still healthy, because we walled off the insurance
    companies.
        That is the way our system of regulation works. They are
    walled off.
        Mrs. Maloney. Might I add, when people come to us to bail
    out AIG, they say we have to bail them out because of the
    insurance, the insurance product. If it is off on the side,
    then that is a whole different element of risk.
        Ms. Vaughan. I am not sure I agree with that argument. I
    guess I would have to talk to whomever it is. I think it is an
    interesting idea. Do you just spin the insurance companies off
    and kind of let them go on their way and do their thing.
        We have been trying to work, recognizing that if you spin
    the insurance companies off, that does not solve the bigger
    problem that you have, which is these unregulated entities that
    are soaking up these taxpayer dollars.
        We have been really trying to work with the Federal Reserve
    and the folks who are trying to solve this bigger problem and
    trying to be partners, and trying to do what is going to be
    helpful to the bigger problem.
        If keeping the insurance companies in there is part of the
    solution long term, if it is going to help everyone, then we
    want to work to try to figure out a way to make this work.
        We do go into this knowing that our regulatory structure
    has walled off those insurance companies and we are going to be
    focused on making sure that the policyholders stay protected as
    this happens.
        I appreciate what you are saying.
        Mrs. Maloney. The systemic risk, would that have prevented
    the crisis we are in, Mr. Bartlett?
        Mr. Bartlett. I think it would either have prevented it--
    yes.
        Mrs. Maloney. Mr. Baker?
        Mr. Baker. If I may take just a second, Mr. Chairman. I
    would respond affirmatively to the gentlelady's question about
    systemic risk. I do feel the need just to respond to the
    reference to Chairman Bernanke, referencing AIG as just merely
    a hedge fund.
        Frankly, I wish it had been a hedge fund. It would have
    been better run. Some have expressed surprise about the depth
    of loss. It is the leveraging that took place that magnifies
    the depth and scope of losses that are yet still being
    identified.
        The reason why I wanted to bring this up, I made it a point
    because I hoped somebody would bring up this comment, and we in
    the industry took considerable affront in that
    characterization.
        This perhaps will come as some surprise: 26.9 percent of
    hedge funds use no leverage, zero. Up to 42 percent of hedge
    funds have a leverage ratio of 2 to 1. Media reports that we
    have dug out in the last few weeks indicate--this is technical
    news reports coming from industry surveillance--fund leverage
    may be down to 1.15 industry-wide from last April's 1.4.
        This notion of hedge funds being wild cowboys in the
    economic west is just ridiculous. I do not know what caused the
    Fed Chair to come to that conclusion.
        Thank you for giving me the opportunity to address it.
        Chairman Kanjorski. Thank you very much. Thank you, Mrs.
    Maloney. The gentleman from California, Mr. McCarthy.
        Mr. McCarthy of California. Thank you, Mr. Chairman. I
    appreciate having the opportunity.
        We all realize we need to modernize an outdated system. My
    questions kind of stem from looking in the future, and wanting
    to make sure we get it right. We only get one bite of the
    apple.
        I am a firm believer that structure dictates behavior. You
    will either adapt to the structure or not.
        Being from California, and picking up on what Mr. Baker
    said earlier to Congresswoman Biggert, you said if you had the
    regulator, it still would not prevent failure. Then I started
    looking on the other end, how someone would design this.
        When I look at all the IPOs that were created in
    California, and if you looked at an IPO when it first came out,
    companies that are wildly successful today, but if you looked
    at them when they were entered, the market determined, but they
    were very risky. Not making profit for quite some time, and
    business model people did not understand because it was new
    innovative.
        My fear would be would it not prevent failure, but would it
    also prevent innovation in a way.
        Would you view a new regulator, that IPOs would have to be
    measured or go through a regulator as well?
        Mr. Baker. It certainly would not be our recommendation
    that an IPO or any start up be subject to immediate supervisory
    review by a systemic risk regulator.
        Very small enterprises can in fact cause potential systemic
    risk because of concentration in certain business activities.
        As Mr. Bartlett previously said, assets under management
    should not be the sole criteria by which one is judged to be
    systemically relevant. It is your interconnectivity,
    concentration questions, and it may also be dependent on
    current market conditions. You may not have been systemically
    relevant 6 months ago, but in the current liquidity crisis, you
    may be.
        It would be a large investment of authority and discretion
    in the hands of the systemic regulator to make that judgment.
        I will use one quick example because it reflects how
    complicated this can get. In the 1970's, there was a bank in
    Germany engaged in significant international currency swaps. In
    between the time of accepting a large deposit of Deutsche marks
    and making settlement in U.S. dollars in New York banks, they
    went bankrupt. It was a very significant and adverse event
    which led the Bank of International Settlements to ultimately
    develop a clearing process for currency exchange.
        That is an example of how something no one in New York was
    thinking about a little rural bank in Germany causing that
    complication. It can happen.
        That is the reason why our apparent description of the
    systemic regulator's role is more nebulous than you may like.
    It is very, very difficult to describe what will always be
    appropriate.
        Mr. McCarthy of California. Mr. Bartlett, just before you
    answer, the only other thing, and it kind of stems from Mr.
    Baker's answer, we have some of these functional regulators
    already, the SEC and the Fed.
        When you answer, also think from the perspective, and I am
    just looking forward, would one trump the other if you had a
    new regulator, and would one new regulator look back at
    decisions of these past functional regulators' decisions and
    could that trump another?
        Mr. Bartlett. Our proposal, and this is after a great deal
    of thought and debate, is that the systemic risk regulator or
    the Fed should be a regulator to gather information, to consult
    with the primary regulators, with the Federal financial
    regulators, and then to act through the Federal financial
    regulators with the addition of an insurance national
    regulator, but act through their authority and not with
    additional conflicting authority.
        Mr. McCarthy of California. Is the Fed trumping the new one
    then?
        Mr. Bartlett. There is no trump. They work jointly. The Fed
    would not have the authority to regulate a particular company
    but to work with the supervisors that do have the authority
    over that company.
        The Fed has the authority to look at the system and to
    bring that to the attention of the prudential supervisor. The
    prudential supervisor, the OCC, if you will, the national
    insurance regulator, would have the authority over that
    company. They would have the cease and desist orders, if you
    will. That way, you do not have the conflict.
        This has changed in terms of sort of the body politics
    thinking over the course of the last year, and it seems to be
    the right way to solve it. You end up without a new uber
    regulator. You end up with a systemic look at the system,
    gathering all the information.
        Mr. McCarthy of California. What if those two are in
    disagreement and you are working through one another? One says
    A and one says B. At the end--I am just thinking long term,
    what are the hurdles, what are the challenges.
        Mr. Bartlett. As a practical matter, the Fed always wins,
    but that is a practical matter, not in a statute. That happens
    today. Today, the Fed always wins. I am not contemplating a
    change in statute.
        I think if it is a joint examination and joint finding of
    fact and if the Fed says to a prudential supervisor we believe
    you need some additional action here on this company or these
    sets of companies, then in fact they would work together to
    accomplish it.
        It is way better than what we have now in which the
    prudential supervisors do not have any access to information
    outside that one company or outside that one sector.
        Mr. McCarthy of California. Thank you. I yield back.
        Chairman Kanjorski. Thank you very much, Mr. McCarthy. It
    looks like we are getting awfully close to establishing the
    FSA, if I follow your logic. We will see about that.
        Mr. Foster from Illinois.
        Mr. Foster. Thank you. My first question has to do with
    complexity and whether part of the solution to making a more
    stable system is to limit the complexity. A lot of people talk
    about the complexity of financial instruments, where people are
    trading in things that they frankly do not understand.
        I would like to ask a question about a second kind of
    complexity, that is organizational complexity. If you look from
    a regulator's point of view, the difficulty of regulating a
    diversified entity--you touched on it, Ms. Williams, to do with
    holding company regulations and the difficulties there.
        If you look at the difficulties in unwinding AIG, for
    example, because it was tremendously diversified and a complex
    organization, and you can imagine a different world, maybe a
    future world in which AIG was allowed to exist as an insurance
    company, well understood by a regulator whose only job was to
    look at it as an insurance company, and if it wanted to go play
    in credit default swaps, there would be a credit default swap
    trading house regulator who really understood that market, and
    to deliberately segment the markets.
        Say you can play in this sandbox or you can play in that
    sandbox, but you cannot be a big diversified mass because
    frankly, we do not have the intellectual and manpower in the
    regulators to handle a big diversified thing.
        We are in a situation where it looks like the regulators
    are always going to be intellectually and manpower outgunned,
    simply because of the salaries they can give to their
    employees.
        It seems to me there is a big benefit in compartmentalizing
    things. I was wondering if any of you have a reaction to that.
        Mr. Bartlett. In my view, there are a lot more negatives to
    try to compartmentalize because it is a complex world and a
    complex financial services world, and to try to put the
    finances back into individual boxes, it would do great harm and
    do not reduce the risk.
        I think rather you would want to elevate the statutory
    authority of the regulators to be able to look across the
    system, rather than create a smaller system.
        Mr. Foster. Are there studies that have been done that
    actually indicate you have more efficient capital markets when
    you have diversified entities that span many boxes compared to
    specialized companies that live and work very effectively in
    their own boxes?
        Mr. Bartlett. Many specialized companies serve their
    customers well, but the diversified company, yes, there are
    ample studies for the efficiencies. More importantly for the
    convenience to the consumers or to the market.
        I would be happy to make those available to you for the
    record.
        Mr. Foster. Okay. It is very interesting. The tradeoff as I
    see that is there are perhaps more efficient markets from
    diversified entities and a whole lot of wealth that was
    destroyed by the failure to understand the diversified
    entities.
        I would like to see some of the principles we talk about
    look at that tradeoff of complexity versus reliability.
        The second question I have has to do with confidential
    reporting that was mentioned by Mr. Baker and Mr. Bartlett, I
    think.
        How does it extend overseas? Is it realistic that we are
    going to ask Russian billionaires and Saudi princes, I am
    sorry, we have looked at your books, and you have an unbalanced
    position in some very complicated derivative or something like
    this?
        How is that actually going to happen, both in terms of
    reporting--do we have to band together all the well-regulated
    economies and say okay, we are going to have full disclosure
    among a group of countries that agree to be well-regulated, and
    then all these black pools of capital are just not allowed to
    touch us?
        How do you anticipate that might work?
        Mr. Baker. That effort really is ongoing. Our counterpart,
    the Alternative Investment Management Association domiciled in
    London is actually working with the MFA, working through
    regulatory harmonization as to standards of conduct for the
    hedge fund industry. We have much work to do. It is a very
    difficult task.
        I do believe, however, that the U.S. regulatory system has
    every right to ask of those who do business here to comply with
    the rules of the road as you designed them.
        I would suspect that given the global nature of the
    financial marketplace today and the worldwide nature of this
    economic downturn, that for the first time maybe ever, you see
    an appetite for having global standards of conduct so there
    will not be great variance from one jurisdiction to the other.
        There is one significant difference I would like to point
    out, however, between us and the U.K. We tend to wall off our
    hedge funds from taking investments from anyone other than an
    institutional investor or a person of significant net worth. We
    do not engage directly with working families.
        In the FSA and in the U.K., they are contemplating more
    retailization, taking it the other direction. That is one
    significant point of departure where I would want to make you
    aware.
        On the questions of safety and soundness and business
    conduct, we are rapidly trying to move our standards to look
    more alike than different. Of course, that would require
    congressional actions in order for us to be able to do that.
        Mr. Foster. Mr. Ryan?
        Mr. Ryan. This effort of global harmonization is probably
    the most current issue in the financial markets today. I am
    sure you have seen this, if you would look at the G-30 report,
    you look at the recent study by de Larosiere, you look at the
    financial stability form.
        Our people in London spend huge amounts of time trying to
    coordinate what is going to happen between the United States
    and Brussels and other developed countries.
        You will find in our testimony, Securities Industry and
    Financial Markets Association, we have to get this right, not
    just in the United States. These markets are totally global.
    They are totally interconnected. That is a word we keep using
    here.
        We need insight into it, and that is one of the reasons we
    are firmly behind a regulator that has this power and
    information.
        Mr. Foster. You are optimistic it will happen this year?
    That is interesting.
        Mr. Ryan. That is really up to you and your colleagues.
    What I have said is the confidence in the system and in the
    financial markets requires that we take action this year. It is
    really up to you.
        Mr. Foster. I yield back.
        Chairman Kanjorski. Thank you very much, Mr. Foster. The
    gentleman from Connecticut, Mr. Himes.
        Mr. Himes. Thank you, Mr. Chairman. Thank you to the
    panelists for bearing with us and being patient on this very
    important topic.
        You may have noticed this House has a tendency to conduct
    an unedifying debate about whether there is too much regulation
    or too little regulation.
        We have seen that many markets had no regulation. CDS has
    auction rate securities, non-bank banks. They screwed up. We
    have seen heavily, heavily regulated entities like our
    commercial banks and our broker-dealers, also made mistakes
    that we are paying for now.
        To me, this is a question really of intelligent regulation,
    which is driven in my way of thinking by a couple of
    principles. Very good transparency, the concept that risk stays
    with those who make the decision to take the risk, and be very,
    very careful about leverage.
        With those principles in mind, I have two questions for Mr.
    Baker and one for Mr. Ryan.
        Mr. Baker, you said something that caught my attention,
    which is that the hedge funds in particular would be willing to
    disclose their positions but confidentially to a regulator. I
    understand the proprietary nature of the trades that are taken,
    but why should we not demand they be publicly disclosed with
    some reasonable period of time so that there really is good
    transparency and information in the market?
        Mr. Baker. First, and thank you for the question, there is
    no at least identifiable from my perspective public value to a
    disclosure of confidential information currently by a fund to a
    regulator through to the public.
        In fact, there is a perverse potential where selected
    disclosures of pertinent information may in fact skew the
    understandings in the public and cause great harm.
        We, for example, would not want to disclose our short
    positions, although we do not mind disclosing whatever
    information the regulator tells us he wants in whatever form
    the regulator wants it in order to make the judgments about
    improper conduct, concentration questions or other matters that
    may be of importance to the regulator.
        Mr. Himes. Why would you not want to disclose that?
        Mr. Baker. Much of our work has its value in its
    intellectual content. Reverse engineering, in fact, disclosing
    the trades would not require reverse engineering.
        The sophisticated work that is done by our members and
    behind which they place significant financial investment is all
    research. It is academic work. You would be requiring us to
    disclose our Church's fried chicken, Popeye's fried chicken
    recipes to Colonel Sanders.
        Mr. Himes. At what point in time does it cease to be
    proprietary? A month? A week? Two months?
        Mr. Baker. There are varying opinions on that, frankly.
    Some feel after a semi-annual period of time, perhaps that
    would no longer be of value. Some of my members have very
    strong opinions that their analytical skills, once you
    determine their positions, you can then deploy their particular
    tactical strategy in the marketplace.
        I tend to understand. My entities that I represent have
    intellectual value based on hard work. That equally has a right
    to be protected much like not causing a car dealer just to give
    cars away. It is their real asset.
        Mr. Himes. Thank you. Question number two is about
    leverage. You indicated that the levels of leverage in the
    hedge fund industry in particular are down substantially.
        Many hedge fund players have assumed in the past
    substantial leverage, either through the use of debt or through
    derivatives.
        Long Term Capital Management happened to be domiciled in my
    district.
        Is this something we should be focused on when the credit
    markets return and will in fact start lending to hedge funds
    again?
        Mr. Baker. That should be an element of this systemic
    regulator's responsibility to assess and judge. When LTCM went
    down, they were 32 to 1. When Fannie Mae went down, they were
    70 to 1. Fannie was quite heavily regulated and overseen by any
    number of entities.
        I am reminded of a comment by someone, I think it may have
    been a former CEO of Citibank, who said as long as the music is
    playing, how do you quit dancing? As long as the market is
    moving forward, people deploy leverage to take absolute
    advantage of that positive market environment, and the art form
    becomes when do you begin to limit your risk taking to prevent
    the downside risk.
        In our industry, we think our guys do that very well. That
    is why we hedge. We hope it goes well, but if it does not, we
    limit our exposure on the downside.
        Mr. Himes. Thank you. Quick question for Mr. Ryan. Mr.
    Ryan, in your testimony, I noted that you included private
    equity funds as a group or category of entities we should
    consider for systemic risk.
        I do not usually think of private equity funds as employing
    certainly at the fund level or the partnership level a lot of
    leverage.
        What do you see there that I am not seeing?
        Mr. Ryan. The testimony is intended to be all encompassing,
    principally so that the regulator has the authority should a
    private equity firm be deemed to be systemically important to
    have authority to ask for information to regulate that entity.
    That is the intent of the testimony.
        We do not have all the answers as to who is in and who is
    out, your question on transparency. I think you are going to
    have to work through many of these issues. I would suspect that
    Congress is going to have a very difficult time also trying to
    figure out how specific do you want to be and how much
    authority do you want to give to the regulator to make some of
    these decisions.
        In our testimony, we were trying to say in the beginning
    here, we need to look broadly. We are not sure who is
    systemically important today and they may be important today,
    they may not be important tomorrow.
        Mr. Himes. Thank you. Thank you, Mr. Chairman.
        Chairman Kanjorski. Thank you, Mr. Himes. The gentleman
    from Florida, Mr. Grayson.
        Mr. Grayson. Thank you, Mr. Chairman.
        There has been a lot of discussion today about how we
    should deal with systemic risk in the future. I am concerned
    about how we are dealing with it now.
        What I am seeing is a massive transfer of wealth from the
    taxpayers to the banks in the name of systemic risk. I am
    concerned about that.
        Can you tell me if there is any response to a threat to the
    system, a systemic risk, that does not involve the transfer of
    hundreds of billions of dollars out of the taxpayers' pocket to
    the banks?
        Mr. Ryan?
        Mr. Ryan. I do not know where you are really going with
    your question. I am just going to give you my answer.
        In our industry, we are in a very tough situation. I think
    government at all levels has done an excellent job on balance
    with no real play book, and quite frankly, most of the
    regulators with inadequate information.
        In order to keep this system stable, the government needed
    and did make funds available to core financial institutions and
    they are essential to our economic health. I am very pleased
    they have done it.
        What we are talking about here is how do we make sure in
    the future that we have the ability to look over the horizon
    and to make some decisions to limit the possibility that we run
    into this situation again.
        Mr. Grayson. I understand that. Many people seem to regard
    the fact that we have already taken trillions of dollars and
    made them available to certain financial institutions who have
    failed to be sort of a happy coincidence, that we are bailing
    these people out for the good of the country.
        I understand that is the view of many. I am wondering if
    there is any other way to do it. That is my question. Is there
    another way to deal with the systemic risk problem that does
    not involve the transfer of funds from the government, from the
    taxpayers, to private entities? In other words, Wall Street
    socialism.
        Mr. Bartlett?
        Mr. Bartlett. There is one way and that is for this
    committee and the Congress to pass systemic risk legislation
    and provide for statutory authority to regulate systemic risk.
        As far as the current crisis, we are in a crisis. The
    financial services industry is largely illiquid, has a crisis,
    and that crisis then has spread to the rest of the economy,
    whether it is through foreclosures or unemployment.
        The government has taken a number of actions that are
    costly. TARP, the new toxic assets thing, the money market
    guarantees, FDIC guarantees, in order to stabilize the system
    so the economy can recover.
        For the economy to recover, the recovery starts with the
    financial institutions and financial services industry, or it
    does not recover.
        That is why this Congress is authorized and the regulatory
    agencies have taken steps to stabilize the situation.
        Mr. Grayson. Right. What people are sensing is the idea
    that they are not getting anything in return. They are being
    threatened with this idea that the financial system will
    collapse or is collapsing, and therefore, money has to be taken
    from the taxpayers and given to the financial system, basically
    in return for nothing.
        What I am asking is, is there an alternative to that
    because frankly, a lot of people are beginning to see it as
    extortion.
        Ms. Williams?
        Ms. Williams. I would say part of this has to do with the
    investment that is being made. I think it is important to look
    at this in terms of an investment. In particular, if you look
    at TARP and the capital purchase program, the government has
    made an investment.
        We have yet to see what the return will be on that
    investment, but that was the approach that was taken.
        Mr. Grayson. When we talk about systemic risk, it seems
    that we are always talking about letting people off the hook
    for the mistakes they made in the past.
        It seems to me that is the opposite of another concept that
    we have tried to preserve here in Congress, which is moral
    hazard. Is there a way to deal with systemic risk that does not
    involve compromising on moral hazard?
        Dr. Vaughan?
        Ms. Vaughan. Others have mentioned this issue about
    creating a systemic risk regulator and then publicly branding
    institutions and saying this company, this is systemically
    risky, and therefore, does that create an impression of too big
    to fail.
        I do think that is a risk. I really think that is a risk. I
    do not know how to deal with it. I have talked to a lot of
    people and I have had some people say to me, look, the horse is
    already out of the barn and you cannot get it back in.
        I am equally outraged. I am a taxpayer. I am outraged at
    what is going on, this sort of ``heads I win, tails you lose''
    that we seem to have evolved to in the last decade.
        I am not a bank regulator. I am an insurance regulator. I
    cannot tell you how to fix the problem, but boy, I would sure
    like to find a way so it does not happen again. I am with you
    on that.
        Mr. Grayson. Thank you, Mr. Chairman. My time is up.
        Chairman Kanjorski. Thank you very much, Mr. Grayson.
        Ms. Williams, you sat there primarily not getting involved,
    but you just completed a study on CDS. After you have heard all
    this discussion, is there anything you would like to disclose
    to the public, the press, and to the panel, that your study has
    uncovered that may help us with this problem?
        Ms. Williams. Just that I think the study really provides a
    status of CDS, what they are used for, how the industry as well
    as the regulators are trying to deal with certain issues.
        I think one of the things that we really point out is that
    with the exception of some oversight being provided by the bank
    regulators, and it is really focused on bank OTC derivatives'
    dealers, there really is not a view of the overall market.
        CDS to us--it is one of the pieces that we highlight in the
    report we issued in January in terms of creating a framework
    for financial regulation--is to look specifically at products
    like CDS because they illustrate the lack of having any type of
    system-wide focus, and to also stress that we not get caught up
    in the types of entities when we talk about regulation or the
    particular type of product, but to really look to the
    underlying risk that it may pose to the overall system and make
    that the focus when you start thinking about a systemic risk
    regulator.
        Chairman Kanjorski. Thank you very much.
        Mr. Garrett. Just to follow up since I said it at the very
    beginning, along that line, what is it that currently precluded
    them from either going down that road and making that
    investigation in the AIG situation, or if they were precluded,
    you just do not have the authority, what precluded them from
    saying here is an area that we know there is something out
    there, we just do not have the authority, we are going to raise
    a red flag?
        Ms. Williams. It kind of goes back to the conversation
    about the holding company oversight structure. The holding
    company regulator has authority when it comes to the holding
    company, but there are conditions that they have to go beyond
    the regulated pieces.
        To the extent if there is a national bank or a thrift or a
    broker-dealer involved, then there is clearly a functional
    regulator already existing.
        If you have a subsidiary or an affiliate that is not
    subject to regular regulation, there has to be some concern
    about that affiliate for the holding company regulator to then
    go in and say okay, this is posing a threat to the holding
    company.
        I go back to the point that if you are not going into the
    institution on a regular basis, how are you going to identify
    the fact that it may pose a threat to the holding company?
        Mr. Garrett. They are not going into the subsidiary
    institution on a regular basis?
        Ms. Williams. Right.
        Mr. Garrett. How are they going to identify that threat?
        Ms. Williams. Yes. They have the authority to do it, but if
    you are not going in there on a regular basis, how do you know
    that it poses a threat to the holding company.
        Mr. Garrett. They have the authority?
        Ms. Williams. Yes.
        Mr. Garrett. They just do not execute that authority
    because they say we really do not know what is going on over
    there and we are not there on a regular basis, so--
        Ms. Williams. I do not know if it is an issue of that is
    what they are saying. It is that they do not know. It is an
    issue of you do not know what you do not know. Yes, you have
    the authority but until something comes to light to raise an
    issue, and I go back to AIG, my understanding is with OTS, once
    the internal auditors raised a concern about risk management
    with AIG FP in particular, then OTS went in because it posed a
    threat to the thrift holding company.
        Mr. Garrett. I have been an auditor, never for something
    like that, but an insurance company. Where there were aspects
    of the business that we were looking at that we did not know
    about, we did not just step back and say well, there is an area
    of the company that we do not know about, and maybe somebody
    else is looking at it, we are just going to leave it alone
    until somebody says there is a problem there.
        We would go to somebody else in the company and say there
    is a black hole over here that we are not too sure about, and
    we have question marks. That is the way we handled it in the
    insurance aspect.
        Ms. Williams. That is a valid question.
        Mr. Garrett. Thanks a lot for following up from the very
    beginning.
        Chairman Kanjorski. None of your clients or customers
    failed, did they? That is the answer right there.
        I first want to take the opportunity to compliment the
    panel. I did not hear the expression, ``so this does not happen
    again'' used. I think we should send the message out wide and
    clear, the disaster that happened this time is not going to be
    replicated. It is going to be a new disaster.
        What we are trying to do is prepare, as someone said, to
    look over the horizon. With that, I agree.
        Also, a caveat should be entered in there. We ought to
    recognize and accept there is no perfect system and there is
    nothing we can do to prevent future disasters. Maybe we can arm
    regulators with analysis to forestall those potentials, but
    after all, we have been pretty successful for 65 to 70 years
    under the present regimentation of regulation.
        If we can get another 70 years out, none of us will be
    here, so we will not have to worry about it.
        That is what we are going to strive for.
        I want to thank you all very much. I found it very
    enlightening, your testimony. I look forward to you
    participating in very big ways with us in the future, if you
    can. I invite you not to hesitate to send us ideas and
    information that you have.
        One other question, we have a lot of pressure to get this
    done, and you heard some of the opening statements, so that the
    President has a concept paper to take over to the G-20 with him
    or do things in 30 to 60 days.
        Do you believe we should rush to formulate legislation and
    create this potential regulator in that short of time, with the
    ideas particularly of the two Members of Congress, can we
    really do that successfully?
        Mr. Bartlett. Mr. Chairman, in the view of our industry,
    no, you should not rush, but this has some urgency to it. You
    should concentrate all of your intellectual and capacity
    resources on examining this, thinking about it, but then moving
    right along to get it done.
        The other half of my testimony was that Congress in our
    view should act in a comprehensive way and not piecemeal it one
    step at a time, because Webster's says it is systemic, it is
    related to each other, and to take out one piece and try to
    handle that, it means you have neglected the systemic nature.
        There is some urgency to it; yes, sir.
        Mr. Baker. Mr. Chairman, I would suggest you at least beat
    my 20-year record with Fannie Mae and Freddie Mac.
        [laughter]
        Chairman Kanjorski. I spent some of those years with you.
        Mr. Baker. You were right there. I would say, as Mr.
    Bartlett has indicated, this does, however, have some extreme
    importance and serious effects.
        We have not talked much today about our unfunded pension
    liabilities and what it has done to endowments across the
    country. The residual effects of this will be long lasting
    unless you can help us get investor confidence back into these
    markets.
        Chairman Kanjorski. Thank you. Would anyone else like to
    add anything?
        Ms. Williams. I would say that you have to proceed with
    deliberate speed, but do not lose sight of the fact that
    deliberation has to be an important part of the process.
        Chairman Kanjorski. Very good. Do you agree with that,
    Doctor?
        Ms. Vaughan. Yes. I think that was well said.
        Chairman Kanjorski. Mr. DiMuccio?
        Mr. DiMuccio. We believe addressing the systemic risk issue
    first and on a timely basis is important. We also believe that
    bringing in other regulatory aspects too soon to be resolved or
    debated while we are fixing the systemic risk regulatory issue
    could lead to unintended consequences.
        We think they should be separated. There are a lot of
    regulatory issues that can be debated down the road, but we
    believe the systemic risk issue is important and that should be
    addressed first.
        Chairman Kanjorski. Very good. Mr. Ryan?
        Mr. Ryan. I am a little bit of a broken record on this, but
    our hope is that you complete work on a financial stability
    regulator before the close of this year. Our main reason for
    saying that is not only do we need it, but the confidence in
    the financial markets and among our citizens, we think,
    requires it.
        Chairman Kanjorski. Thank you very much. Thank you all. The
    Chair notes that some members may have additional questions for
    this panel, which they may wish submit in writing. Without
    objection, the hearing record will be remain open for 30 days
    for members to submit written questions to these witnesses and
    to place their responses in the record.
        Before we adjourn, the following will be made a part of the
    record of this hearing: Documents provided by the American
    Council of Life Insurers; and the written statements of the
    National Association of Mutual Insurance Companies and the
    American Academy of Actuaries.
        Without objection, it is so ordered.
        The panel is dismissed and this hearing is adjourned.
        [Whereupon, at 1:53 p.m., the hearing was adjourned.]

                                A P P E N D I X

                                 March 5, 2009

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