[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



                  U.S. GOVERNMENT PRINTING OFFICE
48-863                    WASHINGTON : 2009
-----------------------------------------------------------------------
For sale by the Superintendent of Documents, U.S. Government Printing 
Office  Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; 
DC area (202) 512-1800 Fax: (202) 512-2104  Mail: Stop IDCC, 
Washington, DC 20402-0001







                 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


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]



