[House Hearing, 111 Congress]
[From the U.S. Government Publishing Office]
HEARING TO EXAMINE THE REGULATION OF OVER-THE-COUNTER DERIVATIVES
=======================================================================
JOINT HEARING
BEFORE THE
COMMITTEE ON AGRICULTURE
AND THE
COMMITTEE ON FINANCIAL SERVICES
HOUSE OF REPRESENTATIVES
FIRST SESSION
__________
JULY 10, 2009
__________
Serial No. 111-23
(Committee on Agriculture)
Serial No. 111-55
(Committee on Financial Services)
Printed for the use of the Committee on Agriculture
agriculture.house.gov
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COMMITTEE ON AGRICULTURE
COLLIN C. PETERSON, Minnesota, Chairman
TIM HOLDEN, Pennsylvania, FRANK D. LUCAS, Oklahoma, Ranking
Vice Chairman Minority Member
MIKE McINTYRE, North Carolina BOB GOODLATTE, Virginia
LEONARD L. BOSWELL, Iowa JERRY MORAN, Kansas
JOE BACA, California TIMOTHY V. JOHNSON, Illinois
DENNIS A. CARDOZA, California SAM GRAVES, Missouri
DAVID SCOTT, Georgia MIKE ROGERS, Alabama
JIM MARSHALL, Georgia STEVE KING, Iowa
STEPHANIE HERSETH SANDLIN, South RANDY NEUGEBAUER, Texas
Dakota K. MICHAEL CONAWAY, Texas
HENRY CUELLAR, Texas JEFF FORTENBERRY, Nebraska
JIM COSTA, California JEAN SCHMIDT, Ohio
BRAD ELLSWORTH, Indiana ADRIAN SMITH, Nebraska
TIMOTHY J. WALZ, Minnesota ROBERT E. LATTA, Ohio
STEVE KAGEN, Wisconsin DAVID P. ROE, Tennessee
KURT SCHRADER, Oregon BLAINE LUETKEMEYER, Missouri
DEBORAH L. HALVORSON, Illinois GLENN THOMPSON, Pennsylvania
KATHLEEN A. DAHLKEMPER, BILL CASSIDY, Louisiana
Pennsylvania CYNTHIA M. LUMMIS, Wyoming
ERIC J.J. MASSA, New York
BOBBY BRIGHT, Alabama
BETSY MARKEY, Colorado
FRANK KRATOVIL, Jr., Maryland
MARK H. SCHAUER, Michigan
LARRY KISSELL, North Carolina
JOHN A. BOCCIERI, Ohio
SCOTT MURPHY, New York
EARL POMEROY, North Dakota
TRAVIS W. CHILDERS, Mississippi
WALT MINNICK, Idaho
______
Professional Staff
Robert L. Larew, Chief of Staff
Andrew W. Baker, Chief Counsel
April Slayton, Communications Director
Nicole Scott, Minority Staff Director
(ii)
?
COMMITTEE ON FINANCIAL SERVICES
BARNEY FRANK, Massachusetts, Chairman
PAUL E. KANJORSKI, Vice Chairman, SPENCER BACHUS, Alabama, Ranking
Pennsylvania Minority Member
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, North Carolina
GREGORY W. MEEKS, New York JUDY BIGGERT, Illinois
DENNIS MOORE, Kansas GARY G. MILLER, California
MICHAEL E. CAPUANO, Massachusetts SHELLEY MOORE CAPITO, West
RUBEN HINOJOSA, Texas Virginia
Wm. LACY CLAY, Missouri JEB HENSARLING, Texas
CAROLYN McCARTHY, New York SCOTT GARRETT, New Jersey
JOE BACA, California J. GRESHAM BARRETT, South Carolina
STEPHEN F. LYNCH, Massachusetts JIM GERLACH, Pennsylvania
BRAD MILLER, North Carolina RANDY NEUGEBAUER, Texas
DAVID SCOTT, Georgia TOM PRICE, Georgia
AL GREEN, Texas PATRICK T. McHENRY, North Carolina
EMANUEL CLEAVER, Missouri JOHN CAMPBELL, California
MELISSA L. BEAN, Illinois ADAM H. PUTNAM, Florida
GWEN MOORE, Wisconsin MICHELE BACHMANN, Minnesota
PAUL W. HODES, New Hampshire KENNY MARCHANT, Texas
KEITH ELLISON, Minnesota THADDEUS G. McCOTTER, Mississippi
RON KLEIN, Florida KEVIN McCARTHY, California
CHARLES A. WILSON, Ohio BILL POSEY, Florida
ED PERLMUTTER, Colorado LYNN JENKINS, Kansas
JOE DONNELLY, Indiana CHRISTOPHER JOHN LEE, New York
BILL FOSTER, Illinois ERIK PAULSEN, Minnesota
ANDRE CARSON, Indiana LEONARD LANCE, New Jersey
JACKIE SPEIER, California
TRAVIS W. CHILDERS, Mississippi
WALT MINNICK, Idaho
JOHN H. ADLER, New Jersey
MARY JO KILROY, Ohio
STEVE DRIEHAUS, Ohio
SUZANNE M. KOSMAS, Florida
ALAN GRAYSON, Florida
JAMES A. HIMES, Connecticut
GARY C. PETERS, Michigan
DANIEL B. MAFFEI, New York
______
Professional Staff
Jeanne M. Roslanowick, Staff Director and Chief Counsel
(iii)
C O N T E N T S
----------
Page
Bachmann, Hon. Michele, a Representative in Congress from
Minnesota, prepared statement.................................. 7
Bachus, Hon. Spencer, a Representative in Congress from Alabama,
opening statement.............................................. 6
Frank, Hon. Barney, a Representative in Congress from
Massachusetts, opening statement............................... 5
Lucas, Hon. Frank D., a Representative in Congress from Oklahoma,
opening statement.............................................. 4
Submitted letter............................................. 59
Submitted material........................................... 60
Minnick, Hon. Walt, a Representative in Congress from Idaho,
opening statement.............................................. 2
Peterson, Hon. Collin C., a Representative in Congress from
Minnesota, opening statement................................... 1
Prepared statement........................................... 2
Witness
Geithner, Hon. Timothy F., Secretary, U.S. Department of the
Treasury, Washington, D.C...................................... 8
Prepared statement........................................... 11
Submitted questions.......................................... 63
HEARING TO EXAMINE THE REGULATION OF OVER-THE-COUNTER DERIVATIVES
----------
FRIDAY, JULY 10, 2009
House of Representatives,
Committee on Agriculture,
joint with
Committee on Financial Services,
Washington, D.C.
The Committees met, pursuant to call, at 10:04 a.m., in
Room 1100, Longworth House Office Building, Hon. Collin C.
Peterson [Chairman of the Committee on Agriculture] presiding.
Members present for Committee on Agriculture:
Representatives Peterson, Holden, McIntyre, Boswell, Baca,
Scott, Marshall, Cuellar, Costa, Ellsworth, Walz, Kagen,
Schrader, Dahlkemper, Pomeroy, Childers, Minnick, Lucas,
Goodlatte, Moran, Johnson, Rogers, King, Neugebauer, Conaway,
Smith, Latta, Roe, Luetkemeyer, Thompson, Cassidy, and Lummis.
Members present for Committee on Financial Services:
Representatives Frank, Kanjorski, Waters, Maloney, Watt,
Sherman, Meeks, Moore of Kansas, Capuano, Hinojosa, McCarthy of
New York, Baca, Lynch, Miller of North Carolina, Scott, Green,
Cleaver, Bean, Ellison, Wilson, Perlmutter, Donnelly, Foster,
Carson, Childers, Minnick, Adler, Kilroy, Kosmas, Himes,
Peters, Bachus, Royce, Lucas, Manzullo, Biggert, Hensarling,
Garrett, Gerlach, Neugebauer, Putnam, Bachmann, Marchant,
McCotter, Posey, Jenkins, Lee, Paulsen, and Lance.
Staff present for Committee on Agriculture: Robert L.
Larew, Claiborn Crain, Adam Durand, Scott Kuschmider, Merrick
Munday, Clark Ogilvie, James Ryder, April Slayton, Rebekah
Solem, Kevin Kramp, Tamara Hinton, Bill O'Conner, and Jamie
Mitchell.
OPENING STATEMENT OF HON. COLLIN C. PETERSON, A REPRESENTATIVE
IN CONGRESS FROM MINNESOTA
Chairman Peterson. Good morning everybody, and welcome to
today's hearing. I want to welcome Treasury Secretary Geithner,
and thank him for his time, and I want to thank Financial
Services Chairman Frank and his staff for working with me and
my staff to have this joint hearing today.
In the interest of time, I will submit my full statement
for the record, we have 111 Members of Congress who serve on
these two Committees. And I know many of my colleagues who are
attending today's hearing have questions for the Secretary.
Last month, the White House presented broad reform
proposals to overhaul the financial regulatory system. I am
pleased to note that several key provisions regarding over-the-
counter derivatives are similar to what the House Agriculture
Committee passed this year as part of a bipartisan bill H.R.
977, which would strengthen oversight of futures, options and
over-the-counter markets. However, the devil is always in the
details and I look forward to hearing additional details today
about the Administration's reform ideas. And I hope Secretary
Geithner's appearance today will get us into the weeds on how
this will work.
[The prepared statement of Mr. Peterson follows:]
Prepared Statement of Hon. Collin C. Peterson, a Representative in
Congress from Minnesota
Good morning, and welcome to today's hearing. I want to welcome,
and thank, Treasury Secretary Geithner for his time, and I want to
thank Financial Services Chairman Frank and his staff for working with
me and my staff to have this joint hearing today.
In the interest of time, I will submit a full statement for the
record. We have 111 Members of Congress who serve on these two
Committees and I know many of my colleagues who are attending today's
hearing have questions for the Secretary.
Last month, the White House presented broad reform proposals to
overhaul the financial regulatory system. I am pleased to note that
several of their key provisions regarding over-the-counter derivatives
are similar to what the House Agriculture Committee passed earlier this
year as part of a bipartisan bill, H.R. 977, which would strengthen
oversight of futures, options, and over-the-counter markets.
However, the devil is always in the details. I look forward to
hearing additional details today about the Administration's reform
ideas, and I hope Secretary Geithner's appearance today will help get
into the weeds on how this will all work.
I now want to yield 2 minutes of my opening statement time to a
Member of both the Agriculture and Financial Services Committee, who
has some knowledge about this area, the gentleman from Idaho, Mr.
Minnick.
Chairman Peterson. I now want to yield 2 minutes of my
opening statement to a Member of both the Agriculture and
Financial Services Committee who has done a lot of work and has
some knowledge in this area, the gentleman from Idaho, Mr.
Minnick for 2 minutes.
OPENING STATEMENT OF HON. WALT MINNICK, A REPRESENTATIVE IN
CONGRESS FROM IDAHO
Mr. Minnick. Chairman Peterson and Chairman Frank, I am a
farm boy who grew up skeptical of Wall Street wondering how a
loaf of bread could cost a dollar when it contained only a few
cents worth of wheat. I also spent over 20 years as the CEO of
substantial companies which relied on Wall Street and used
customized derivatives to hedge currency and interest rate
risk. I learned that these financial instruments are essential
to the proper functioning of our 21st century economy.
I have listened to many experts and studied the
Administration's 84 page concept paper. If we are to craft a
regulatory structure which can keep our nation from ever again
repeating the financial excesses which have brought today's
economy to its knees, we need to give serious consideration to
the following reforms which go beyond those proposed by the
Administration.
First, we should merge the SEC and the Commodity Futures
Trading Commission. Financial derivatives whether they
originate----
Chairman Frank. Mr. Minnick, one of the Members on the
Republican side just pointed out the acoustics in this room are
terrible. Now, when Ways and Means holds forth in this room,
this is their room, they consider that an advantage. But we are
here not marking up a tax bill but having an important public
hearing so we are going to ask everybody to speak fairly
loudly, particularly you, Mr. Secretary, because while I can't
see you, I would like to be able to hear you. Mr. Minnick may
resume.
Mr. Minnick. First we should merge the SEC and the
Commodity Futures Trading Commission. Financial derivatives
whether they originate in a commodity, a security, or neither,
like weather futures are functionally identical and must be
traded, cleared and settled subject to the same rules.
Bifurcated responsibility might be made to work
temporarily, but is a poor long-term solution which will
discourage bold action when crises arise and will encourage
regulatory arbitrage.
Second, banking regulation should be removed from an
already overburdened Federal Reserve and the remaining three
Federal depository institution regulators, the OTS, the FDIC
and the OCC should be combined into a single Federal bank
regulator; which should also be given broad consumer protection
responsibility and resolution authority for both banks and all
other entities deemed systemically risky.
Powerful global institutions like Citibank, Bank of
America, or AIG should not be allowing to shop for the weakest
Federal regulator. Finally, the proposed systemic risk
oversight counsel should have the highest quality permanent
staff if it is to respond appropriately as future dangers
arise. Because the Federal Reserve is the more institutionally
independent Executive Branch agency, and has increasing global
responsibilities, that staff should be housed in the Fed and
the counsel should be chaired by the Fed Chairman. I thank both
chairs and yield back.
Chairman Peterson. I thank the gentleman and just for
clarification, the gentleman spent a lot of time looking at
this, but Mr. Frank and I, at least the two of us, have come to
the conclusion that we are not going to be merging the SEC and
CFTC, but we appreciate the gentleman's comments.
Now, I want to recognize the Chairman of the Financial
Services Committee, Mr. Frank. He and I have gotten together
and we have a good working relationship, and we think we are
close to having a consensus on where to move with this. You can
see by this hearing today that we have a good cooperation going
on between the two Committees. Mr. Frank. Oh, excuse me, I am
sorry, I screwed up. I am supposed to recognize Mr. Lucas, I am
getting ahead of myself. I didn't mean to overlook you, Mr.
Lucas, my good friend from Oklahoma, who worked with us to get
H.R. 977 out of the Agriculture Committee last February. Mr.
Lucas is recognized. And by the way, we are going to limit
people to 4 minutes because of all of the Members that are
involved, so we would hope that everybody would abide by that.
Mr. Geithner, we are not going to hold you to 4 minutes, we
want to hear what you have to say. Mr. Lucas.
OPENING STATEMENT OF HON. FRANK D. LUCAS, A REPRESENTATIVE IN
CONGRESS FROM OKLAHOMA
Mr. Lucas. Thank you, Mr. Chairman and thank you to both
Chairmen for holding this joint hearing to hear the Treasury's
proposal to regulate over-the-counter derivatives, as well as
examine the legislation that the House Agriculture Committee
passed a few months ago. I, as Ranking Member of the House
Agriculture Committee and senior Member of the Financial
Services Committee, I would like for this occasion to examine
the issue from two different perspectives. The Agriculture
Committee has been very active in exploring the role
derivatives play in the marketplace, and in the overall
economy.
The Committee has held numerous hearings to gain further
information and insight into the complex nature of credit
default swaps and how they should be regulated. In February of
this year, as the Chairman noted, the Agriculture Committee
passed H.R. 977, the Derivatives Markets Transparency and
Accountability Act.
No one can argue that the concepts of transparency and
accountability are wrong, but we must make certain that our
actions call for an appropriate level of regulation that will
respect the nature of the marketplace and encourage product
innovation and economic growth. Derivatives do serve a valid
purpose in the marketplace when used with judgment. They are
essential for managing risk. We must consider that there are
numerous industries that have legitimate price risk and there
must be a way to mitigate that. Derivatives provide a
legitimate means for managing that risk. The financial problems
that we have seen recently are not the result of merely the
existence of derivatives, but rather because there are problems
in measuring their true performance, or knowing with certainty
the depth and breadth of the over-the-counter market, or
knowing with confidence the creditworthiness of the
counterparty.
Simply put, the marketplace can be protected from market
failures if regulators are fully aware of the threat. Ignorance
of this relatively new financial instrument caused much of the
financial failures. We now know that these complex markets need
better models and methods for oversight and transparency.
However, we must be careful not to overreach and force
businesses into very expensive clearing operations that cost
capital that they do not have, or force them out of risk
mitigation all together. Business will then be forced to manage
risk with higher prices, which will ultimately be passed on to
consumers. The need to avoid artificial costs for business was
the reason I opposed the clearing requirement in H.R. 977.
There is considerable concern that section 13, as currently
drafted, which relates to the clearing requirement will stifle
invasion in the over-the-counter market.
CFTC needs more authority to waive the clearing
requirements in section 13 so new and safer products can get to
the market in a timely fashion. This would recognize the fact
that not all contracts can be cleared and that there is a need
for customized contracts. These are just a few of the concerns
I have on my part as we move forward today.
Again, I thank you for the opportunity to discuss the
issues regarding these important financial institutions. And
Secretary Geithner, I look forward to your testimony and the
answers to the questions posed by the panel. Thank you,
Chairman.
Chairman Peterson. I thank the gentleman, and now I am
pleased to recognize my good friend the Chairman of the
Financial Services Committee, Mr. Frank.
OPENING STATEMENT OF HON. BARNEY FRANK, A REPRESENTATIVE IN
CONGRESS FROM MASSACHUSETTS
Chairman Frank. Thank you, Mr. Peterson and I begin with an
apology to our friends in the media, there is no fight to cover
between these two Committees. I know that that is an easier
topic than the complexities of how to actually do something.
But I believe that the besetting sin of the House of
Representatives is jurisdictional fights, in which our egos get
in the way of good public policy. I am very proud that Chairman
Peterson and I and other Members of our Committee, as well as
Chairman Gensler and Chairwoman Shapiro have made very extra
special efforts to avoid that. And I believe we have achieved
that. And there will be some disagreements, but they will be
based on substance.
There are some areas where there are no disagreements.
Clearly we will be significantly expanding the regulation of
derivatives. And I want to address the issue that was raised by
the very thoughtful gentleman from Idaho, with whom I agree on
most issues, but not on the question of the merger. I will say
that if we were starting from scratch, I don't think we would
have the current organizational structure. But we are not
starting from scratch, and I don't think it is practical to
talk about making those major changes. But I will also say
this, there have been some complaints that what the Obama
Administration has proposed, and they have a great deal of
credit coming to them for the initiatives they are taking, the
a broad range of financial restructuring, and some of what we
are talking about. Some people have complained there is not
enough structural change.
Frankly, I think that is the wrong issue. What we should be
held accountable for is making substantive changes in the
rules. Who does these things is less important to me than what
is done. And by the time we are through in the collaboration
between these two Committees, in the work of the Congress as a
whole, and in the work that the Financial Services Committee
will do, we will, I believe, have substantially increased the
authority of regulators to deal with these things. We have
within our jurisdiction the question of hedge funds. I believe
that hedge funds should be required to register. We will be
talking about further expansion derivatives and undoing some of
the decisions not to deal with them in the past. We will be
talking about a number of other areas where we will be making
some important substantive changes and giving the regulators
the authority to do things.
With regard to derivatives, clearly the gentleman from
Oklahoma is correct, they play an important role. The problem
we have is this: the role of the financial sector is to be an
intermediary between people who are engaged in the productive
activity of the economy, and people who have the money that
they need to do that. The role of the intermediaries is to
gather up money in reasonably small amounts from large numbers
of people and have them available to those people who will do
productive activity.
I believe that one of the problems that we have seen in the
past couple of decades is that there has become a confusion
between ends and means, that is activity that is a very
important means to the end of productive activity has become
for some in our society an end in itself. Our job is to try and
separate those things out. Where we have instruments,
activities, entities that are an important means to gathering
the funds that our private sector economy needs to do
productive activity, we need to protect that.
We need to make sure it is done with integrity, we need to
give encouragement to investors who may be afraid to invest,
that is why I regard sensible regulations of the market as very
pro-market. You protect the people with integrity from those
who might try to cut corners. You give some encouragement to
those who should be investing.
Our job is to reduce the extent to which there are things
that go on for their own sake. I believe we are capable of
doing that, and I am very pleased, Chairman Peterson and I, and
our Committees are well on the way in cooperation with the
Administration to adopting such rules.
And I now recognize the Ranking Member of the Financial
Services Committee, the gentleman from Alabama, Mr. Bachus.
OPENING STATEMENT OF HON. SPENCER BACHUS, A REPRESENTATIVE IN
CONGRESS FROM ALABAMA
Mr. Bachus. Thank you, Mr. Chairman. As the Chairman and
the Ranking Member of the Agricultural Committee have said,
derivatives serve an important function in the market, they
allow--they allow thousands of companies--I am going to start
over.
Thank you. Does that work? All right.
As the three gentlemen before me said, derivatives serve an
important function in the market. They allow companies to hedge
against risk, to deploy capital more effectively, to lower
their costs and to offer protection against fluctuating prices.
Derivatives are about shifting risk, and my greatest concern is
that we do not want a system, and I fear that the
Administration is going down the path of shifting that risk,
not to the investors or to the dealers, but ultimately to the
taxpayers. The companies, the four companies that will deal in
these derivatives--over-the-counter derivatives--the most will
be four or five of the largest companies, financial companies
in America. All of them will be deemed to be systemically
significant.
Part of the Administration's proposal is for when these
companies get in trouble, and one reason they could get in
trouble is trading in these over-the-counter derivatives,
because they can protect against risk, they can lower costs.
But as we saw with, I guess, Enron as a great example, they can
take both dealers and investors down. And when that happens I
would like some assurance that the taxpayers are not going to
ultimately be the ones who assume that risk, that is not what
we ought to be about.
Now, leading up to last September, a lot of people made
investments, they wrote over-the-counter derivatives, they made
billions of dollars, profits on the way up, but when things
turned down who was asked to come in and backstop them? Who was
asked to take the risk, to suffer the loss? It was the
taxpayer.
Now I personally believe that we ought to allow
corporations to continue to write customized derivatives and
that yes, the government can look at them. But another thing
that we ought to consider is whether the government is the best
party to judge risk? And I say, no. I think the government has
a very poor track record of regulators in identifying risk. Are
we going to leave--when we start having standardized trading of
over-the-counter derivatives, particularly the more complex
ones and the regulators bless those trades, or say that they
are safe, are we going to attract a whole new generation of
investors who think that they are investing in a safe security
or future.
We found out with Fannie and Freddie that people began to
think it was an implied government guarantee and they invested
in those stocks. We need to totally avoid any implication that
just because the government is going to regulate these markets
they are going to insure these markets or backstop these
markets. And I would like some assurance from the Secretary of
the Treasury that however we ultimately decide the level of
regulation--I look forward to the Memorandum of Understanding
between the Fed, the CFTC and the SEC--that ultimately the
taxpayers do not come in and take the burden, the risk, and the
cost of over-the-counter derivatives gone bad. Thank you, Mr.
Secretary.
Chairman Peterson. I thank the gentleman and I thank the
Members for their attendance and the Chairman, and the Ranking
Members for their statements. The Chairman requests that other
Members submit their opening statements for the record.
[The prepared statement of Mrs. Bachmann follows:]
Prepared Statement of Hon. Michele Bachmann, a Representative in
Congress from Minnesota
Thank you, Mr. Chairman. And, what a pleasure it is to have a
fellow Minnesotan co-chairing this hearing today. Thank you, Mr.
Peterson, as well.
And, thank you, Secretary Geithner, for being here today and I look
forward to the discussion.
Many U.S. companies responsibly utilize over-the-counter
derivatives on a daily basis to manage their risks and limit damage to
their balance sheets. These end-users are America's job-creators and
Congress should be careful not to over-reach and infringe on their
ability to hedge risks responsibly.
Our Subcommittee on Capitol Markets held a helpful hearing on this
issue in June. Chairman Kanjorski invited end-users such as 3M, a
global company headquartered in Minnesota, to testify so that we could
hear their perspective on this important issue. We heard the sincere
concern of end-users and manufacturers about losing their ability to
use customized over-the-counter derivatives to hedge against foreign
exchange, interest rate, and commodity price risks.
I agree with Chairman Kanjorski's sentiment from that hearing that
we should try to find the right balance as we move forward on this
issue. While we want to improve oversight and transparency of the
derivatives market, as Chairman Kanjorski stated, ``subjecting all
contracts to mandatory exchange trading may cast too wide a net.''
(Financial Times, 6/10/09)
The proposal submitted by the President, the legislation reported
out of the Agriculture Committee in February (H.R. 977), and the
Waxman-Markey cap-and-tax bill (H.R. 2454) all cast very wide nets and
do not seem to make any attempt to differentiate between varying types
of derivatives products. They ignore the concerns we've heard from
American businesses about why mandatory clearing for all these
financial products could hamper their ability to properly hedge risks.
Particularly in the current economic climate, I question the
prudence of impairing their ability to manage genuine operating risks.
The end result would likely be unnecessarily sidelining precious
capital--capital that we need in the marketplace to create jobs and
help the economy recover.
We should be looking for ways to improve our current patchwork of
financial regulation and move toward a more effective and efficient
system that legitimately improves safety and soundness.
Thank you, Mr. Chairman, and I yield back the balance of my time.
Chairman Peterson. Mr. Secretary, we appreciate you being
with us. We look forward to your statement, and Members I guess
we have votes coming up at 10:30, but we will have time for the
Secretary's statement and maybe a couple of questions. So Mr.
Secretary.
STATEMENT OF HON. TIMOTHY F. GEITHNER, SECRETARY, U.S.
DEPARTMENT OF THE TREASURY, WASHINGTON, D.C.
Secretary Geithner. Thank you, Chairman Peterson, Chairman
Frank, and Ranking Members Lucas and Bachus. I am grateful for
the chance to come before you today. I want to compliment both
of you and your colleagues for already doing so much thoughtful
work in trying to lay the foundation for reform, and for
bringing this basic spirit of pragmatic cooperation,
transcending the classic institutional differences that have
made it harder to make progress in these areas in the past.
Before I get to the subject of this hearing, which is the
important need to bring comprehensive oversight and regulation
to the derivative markets, I just want to make a few broader
points about the imperative of comprehensive reform. There are
some who have suggested that we are trying to do too much too
soon, that we should wait for a more opportune moment when the
crisis has definitively receded. There are some who are
beginning to suggest that we don't need comprehensive change,
even though the cost of this crisis has been brutally damaging
to millions of Americans to hundreds of thousands of
businesses, to economies around the world, and to confidence in
our financial system.
And there are some who argue that by making regulations
smarter and stronger will destroy innovation. And there are
even some who argue that we should leave responsibility for
consumer protection for mortgages and consumer credit products,
largely, where it is today.
Now, in my view, these voices are essentially arguing that
we maintain the status quo, and that is not something we can
accept. Now, it is not surprising that we are having this
debate, it is the typical pattern of the past. As the crisis
starts to recede, the impetus to reform tends to fade in the
face of the complexity of the task, and with opposition by the
economic and institutional interests that are affected. It is
not surprising because the reforms proposed by the President,
and the reforms that your two Committees are discussing, would:
substantially alter the ability of financial institutions to
choose their regulator; shape the content of future regulation;
and to continue the financial practices that were lucrative for
parts of the industry for a time, but did ultimately prove so
damaging. But this is why we have to act and why we need to
deliver very substantial change.
Any regulatory reform of this magnitude requires deciding
how to strike the right balance between financial innovation
and efficiency on the one hand, and stability and protection on
the other. And we failed to get this balance right in the past.
And if we do not achieve sufficient reform, we will leave
ourselves weaker as a nation, weaker as an economy and more
vulnerable to future crises.
Now one of the most significant developments in our system
during recent decades has been the very substantial growth and
innovation in the market for derivatives, in particular the
over-the-counter derivative market. Because of this enormous
scale and the critical role these instruments play in our
markets, establishing a comprehensive framework of oversight
for derivatives is crucial.
Although derivatives bring very important benefits to our
economy by enabling companies to manage risk, they also pose
very substantial challenges. Under our existing regulatory
system, some types of financial institutions were allowed to
sell very large amounts of protection against certain risks
without adequate capital to back those commitments. The most
conspicuous and the most damaging examples of this were the
monoline insurance companies and AIG. Banks were able to reduce
the amount of capital they held against risk by purchasing
credit protection from thinly capitalized, special purpose
insurers subject to little or no initial margin requirements.
The complexity of the instruments overwhelm the checks and
balances risk management and supervision, weaknesses that were
magnified by very systematic failures in judgment by the credit
rating agencies. These failures enabled a substantial increase
in leverage both outside and within the banking system.
Inadequate enforcement authority and information made the
system more vulnerable to fraud and to market manipulation, and
because of a lack of transparency in the OTC derivative markets
the government and market participants did not have enough
information about the location of risk exposures, or the extent
of mutual interconnection among firms. And this lack of
visibility, magnified contagion as the crisis intensified,
causing a very damaging wave of deleveraging, and margin
increases, the classic margin spiral, contributing to a general
breakdown in credit markets.
Now these problems in derivatives were not the sole or the
principal cause of the crisis, but they made the crisis more
damaging and they need to be addressed as part of the
comprehensive reform. Our proposals for reform are designed to
protect the stability of our financial system, to prevent
market manipulation, fraud and other abuses, to provide greater
transparency, and protect consumers and investors by
restricting inappropriate marketing of these products to
unsophisticated parties.
This proposed plan will provide strong regulation and
transparency for all OTC derivative products, both standardized
and customized, and strong supervision and regulation for all
OTC derivative dealers and other major market participants in
these markets. And we propose to achieve these goals with the
following broad steps. First, we propose to require that all
standardized derivatives contracts be cleared through, well-
regulated central counterparties and executed either on
regulated exchanges or regulated electronic trade execution
systems. Central clearing makes possible the substitution of a
regulated clearinghouse between the original counterparties to
a transaction. And with central clearing, the original
counterparties no longer have credit exposure to each other.
They place that credit exposure to a clearinghouse, backed by
financial safeguards that are established through regulation.
Second, we propose to encourage substantially greater use
of standardized OTC derivatives, and thereby to facilitate a
more substantial migration of these OTC derivatives onto
central clearinghouses and exchanges. We will also require, and
I want to underscore this, that regulators police any attempts
by market participants to use spurious customization to avoid
central clearing and exchanges. And in this context, we will
impose higher capital and margin requirements for
counterparties using customized and non centrally cleared
derivative products to account for higher level of risk.
Third, we propose to require that all OTC derivative
dealers and all major market participants be subject to
substantial supervision and regulation, including appropriately
conservative capital margin requirements, and strong business
conduct standards, to better ensure that dealers have the
capital needed to make good on the protection they provide.
Fourth, we propose steps to make OTC derivative markets
fully transparent. Relevant regulators will have access, on a
confidential basis, to all transactions and open positions of
individual market participants. The public will have access to
aggregated data on opening positions and trading volumes. To
bring about this high level of transparency we require the SEC
and CFTC to impose record-keeping and reporting requirements,
including an audit trail on all OTC derivatives and trades, and
to provide information on all OTC derivative trades to a
regulated trade repository.
Fifth, we propose to provide the SEC and the CFTC with
clear unimpeded authority to take regulatory and civil action
against fraud, market manipulation and other abuses in these
markets. And we will work with the SEC and the CFTC to tighten
the standards to govern who can participate in these markets.
And finally we will continue to work closely with our
international counterparts to help ensure that our regulatory
regime is matched by similarly affected efforts in other
countries, these are global markets and for these standards to
be effective they have to be applied and enforced on a global
basis. Now with these reforms we will bring protection that
exists in other financial markets, protections that exists to
prevent fraud and manipulation in other markets, and preserve
market integrity of the OTC derivative markets. The SEC and
CFTC will have full enforcement authority. Firms will no longer
be able to use derivatives to make commitments with inadequate
capital.
No dealer in these markets will escape oversight, and we
will bring the risk reducing and financial stability promoting
benefits of central clearing to these important markets.
Now turning these proposals into law will require complex,
difficult judgments. And some of these judgments will involve
assigning jurisdiction over particular transactions and
particular participants to our regulatory agencies. I want to
say we have been working closely as you have with the SEC and
CFTC over the last few months to develop a sensible, pragmatic
allocation of duties and have made very, very substantial
progress in narrowing the issues. And I want to join the
Chairman in complimenting Chairman Schapiro and Chairman
Gensler for working so closely and productively together.
As Congress moves to craft legislation, we are moving
quickly, along with other relevant agencies, to advance the
overall process of reform. Just as an example, we provided
detailed legislative language for the establishment of the
Consumer Financial Protection Agency to Congress just last
week. The SEC is moving forward with new rules to govern and
reform credit rating agencies. And the CFTC as you saw,
announced hearings recently on whether to impose limits on
speculation in energy derivatives in order to dampen price
swings, and to require new disclosure by derivative traders.
Those are just some examples of things we are doing as you move
forward to consider legislation.
Now we welcome the commitment of these Committees, and of
the Congressional leadership, to move forward in legislation
this year. This is an enormously complicated project and it is
important we get it right. We share responsibility for fixing
the system, and we can only do that with comprehensive reform.
I look forward to answering your questions and talking through
the range of important complex issues we face in the reform
effort. Thank you, Mr. Chairman.
[The prepared statement of Secretary Geithner follows:]
Prepared Statement of Hon. Timothy F. Geithner, Secretary, U.S.
Department of the Treasury, Washington, D.C.
Chairman Frank, Ranking Member Bachus, Chairman Peterson, Ranking
Member Lucas, Members of the Financial Services and Agriculture
Committees, thank you for the opportunity to testify today about a key
element of our financial regulatory reform package--a comprehensive
regulatory framework for the over-the-counter (OTC) derivatives
markets.
Over the past 2 years, we have faced the most severe financial
crisis in generations. Some of our largest financial institutions
failed. Many of the securities markets that are critical to the flow of
credit in our financial system broke down. Banks came under
extraordinary pressure. And these forces magnified the overall downturn
in the housing market and the broader economy.
President Obama, working with the Congress, has taken extraordinary
steps to stabilize the economy and to repair the damage to the
financial system. As we continue to put in place conditions for
economic recovery, we need to lay the foundation for a safer, more
stable financial system in the future.
This financial crisis has exposed a set of core problems with our
financial system. The system permitted an excessive build-up of
leverage, both outside the banking system and within the banking
system.
The shock absorbers that are critical to preserving the stability
of the financial system--capital, margin, and liquidity cushions in
particular--were inadequate to withstand the force of the global
recession, and they left the system too weak to withstand the failure
of major financial institutions.
In addition, millions of Americans were left without adequate
protection against financial predation, particularly in the mortgage
and consumer finance areas. Many were unable to evaluate the risks
associated with borrowing to support the purchase of a home or to
sustain a higher level of consumption.
The United States entered this crisis without an adequate set of
tools to contain the risk of broader damage to the economy and to
manage the failure of large, complex financial institutions.
Many forces contributed to these problems. Household debt rose
dramatically as a share of total income, financed by a willing supply
of savings from around the world. Risk management practices at
financial firms failed to keep abreast of the rising complexity of
financial instruments. Compensation rose to exceptionally high levels
in the financial sector, with rewards for executives unmoored from an
assessment of long-term risk for the firm, thus mis-aligning the
incentive structures in the system. Our framework of financial
supervision and regulation, designed in a different era for a more
simple bank-centered financial system, failed in its most basic
responsibility to produce a stable and resilient system for providing
credit and protecting consumers and investors.
The Administration proposed in June a comprehensive set of reforms
to address the problems in our financial system that were at the core
of this crisis and to reduce the risk of future crises.
We proposed to establish a new Consumer Financial Protection Agency
with the power to establish and enforce protections for consumers on a
wide array of financial products.
We proposed to put in place more conservative constraints on risk
taking and leverage through higher capital requirements for financial
institutions and stronger cushions in the core market infrastructure.
We proposed to extend the scope of regulation beyond the
traditional banking sector to cover all firms who play a critical role
in market functioning and the stability of the financial system.
We proposed to put in place stronger tools for managing the failure
of large, complex financial institutions by adapting the resolution
process that now exists for banks and thrifts.
We proposed to reduce the substantial opportunities for regulatory
arbitrage that our system permitted by consolidating safety and
soundness supervision for Federal depository institutions, eliminating
loopholes in the Bank Holding Company Act, moving toward convergence of
the regulatory frameworks that apply to securities and futures markets,
and establishing more uniform standards and enforcement of standards
for financial products and activities across the system.
And we proposed to work with other countries to establish strong
international standards, so the reforms we put in place here are
matched and informed by similarly effective reforms elsewhere.
Any regulatory reform of magnitude requires deciding how to strike
the right balance between financial innovation and efficiency, on the
one hand, and stability and protection, on the other. We failed to get
this balance right in the past. The reforms that we propose seek to
shift the balance by creating a more resilient financial system that is
less prone to periodic crises and credit and asset price bubbles, and
better able to manage the risks that are inherent in innovation in a
market-oriented financial system.
We consulted widely with Members of Congress, consumer advocates,
academic experts, and former regulators in shaping our recommendations.
And we look forward to refining these recommendations through the
legislative process.
One of the most significant developments in our financial system
during recent decades has been the substantial growth and innovation in
the markets for derivatives, especially OTC derivatives.
Because of their enormous scale and the critical role they play in
our financial markets, establishing a comprehensive framework of
oversight for the OTC derivative markets is crucial to laying the
foundation for a safer, more stable financial system.
A derivative is a financial instrument whose value is based on the
value of an underlying ``reference'' asset. The reference asset could
be a Treasury bond or a stock, a foreign currency or a commodity such
as oil or copper or corn, a corporate loan or a mortgage-backed
security. Derivatives are traded on regulated exchanges, and they are
traded off-exchanges or over-the-counter.
The OTC derivative markets grew explosively in the decade leading
up to the financial crisis, with the notional amount or face value of
the outstanding transactions rising more than six-fold to almost $700
trillion at the market peak in 2008. Over this same period, the gross
market value of OTC derivatives rose to more than $20 trillion.
Although derivatives bring substantial benefits to our economy by
enabling companies to manage risks, they also pose very substantial
challenges and risks.
Under our existing regulatory system, some types of financial
institutions were allowed to sell large amounts of protection against
certain risks without adequate capital to back those commitments. The
most conspicuous and most damaging examples of this were the monoline
insurance companies and AIG. These firms and others sold huge amounts
of credit protection on mortgage-backed securities and other more
complex real-estate related securities without the capacity to meet
their obligations in an economic downturn.
Banks were able to get substantial regulatory capital relief from
buying credit protection on mortgage-backed securities and other asset-
backed securities from thinly capitalized, special purpose insurers
subject to little or no initial margin requirements.
The apparent ease with which derivatives permitted risk to be
transferred and managed during a period of global expansion and ample
liquidity led financial institutions and investors to take on larger
amounts of risk than was prudent.
The complexity of the instruments that emerged overwhelmed the
checks and balances of risk management and supervision, weaknesses that
were magnified by systematic failures in judgment by credit rating
agencies. These failures enabled a substantial increase in leverage,
outside and within the banking system.
Because of a lack of transparency in the OTC derivatives and
related markets, the government and market participants did not have
enough information about the location of risk exposures in the system
or the extent of the mutual interconnections among large firms. So,
when the crisis began, regulators, financial firms, and investors had
an insufficient basis for judging the degree to which trouble at one
firm spelled trouble for another. This lack of visibility magnified
contagion as the crisis intensified, causing a very damaging wave of
deleveraging and margin increases, and contributing to a general
breakdown in credit markets.
Market participants and investors used derivatives to evade
regulation, or to exploit gaps and differences in regulation, and to
minimize the tax consequences of investment strategies.
The lack of transparency in the OTC derivative markets combined
with insufficient regulatory policing powers in those markets left our
financial system more vulnerable to fraud and potentially to market
manipulation.
These problems were not the sole or the principal cause of the
crisis, but they contributed to the crisis in important ways. They need
to be addressed as part of comprehensive reform. And they cannot be
adequately addressed within the present legislative or regulatory
framework.
In designing its proposed reforms for the OTC derivative markets,
the Administration has attempted to achieve four broad objectives:
Preventing activities in the OTC derivative markets from
posing risk to the stability of the financial system;
Promoting efficiency and transparency of the OTC derivative
markets;
Preventing market manipulation, fraud, and other abuses; and
Protecting consumers and investors by ensuring that OTC
derivatives are not marketed inappropriately to unsophisticated
parties.
Our proposals have been carefully designed to provide a
comprehensive approach. The plan will provide for strong regulation and
transparency for all OTC derivatives, regardless of the reference
asset, and regardless of whether the derivative is customized or
standardized. In addition, our plan will provide for strong supervision
and regulation of all OTC derivative dealers and all other major
participants in the OTC derivative markets.
We propose to achieve this with the following broad steps:
First, we propose to require that all standardized derivative
contracts be cleared through well-regulated central counterparties and
executed either on regulated exchanges or regulated electronic trade
execution systems.
Central clearing involves the substitution of a regulated
clearinghouse between the original counterparties to a transaction.
After central clearing, the original counterparties no longer have
credit exposure to each other--instead they have credit exposure to the
clearinghouse only. Central clearing of standardized OTC derivatives
will reduce risks to those on both sides of a derivative contract and
make the market more stable. With careful supervision and regulation of
the margin and other risk management practices of central
counterparties, central clearing of a substantial proportion of OTC
derivatives should help to reduce risks arising from the web of
bilateral interconnections among our major financial institutions. This
should help to constrain threats to financial stability.
Second, through capital requirements and other measures, we propose
to encourage substantially greater use of standardized OTC derivatives
and thereby to facilitate substantial migration of OTC derivatives onto
central clearinghouses and exchanges.
We will propose a broad definition of ``standardized'' OTC
derivatives that will be capable of evolving with the markets and will
be designed to be difficult to evade. We will employ a presumption that
a derivative contract that is accepted for clearing by any central
counterparty is standardized. Further attributes of a standardized
contract will include a high volume of transactions in the contract and
the absence of economically important differences between the terms of
the contract and the terms of other contracts that are centrally
cleared.
We also will require that regulators carefully police any attempts
by market participants to use spurious customization to avoid central
clearing and exchanges. In addition, we will raise capital and margin
requirements for counterparties to all customized and non-centrally
cleared OTC derivatives. Given their higher levels of risk, capital
requirements for derivative contracts that are not centrally cleared
must be set substantially above those for contracts that are centrally
cleared.
Third, we propose to require all OTC derivative dealers, and all
other major OTC derivative market participants, to be subject to
substantial supervision and regulation, including conservative capital
requirements; conservative margin requirements; and strong business
conduct standards. Conservative capital and margin requirements for OTC
derivatives will help ensure that dealers and other major market
participants have the capital needed to make good on the protection
they have sold.
Fourth, we propose steps to make the OTC derivative markets fully
transparent. Relevant regulators will have access on a confidential
basis to the transactions and open positions of individual market
participants. The public will have access to aggregated data on open
positions and trading volumes.
To bring about this high level of transparency, we will require the
SEC and CFTC to impose record-keeping and reporting requirements
(including an audit trail) on all OTC derivatives. We will require that
OTC derivatives that are not centrally cleared be reported to a
regulated trade repository on a timely basis.
These reforms will bring OTC derivative trading into the open so
that regulators and market participants have clear visibility into the
market and a greater ability to assess risks in the market. Increased
transparency will improve market discipline and regulatory discipline,
and will make the OTC derivative markets more stable.
Fifth, we propose to provide the SEC and CFTC with clear authority
for civil enforcement and regulation of fraud, market manipulation, and
other abuses in the OTC derivative markets.
Sixth, we will work with the SEC and CFTC to tighten the standards
that govern who can participate in the OTC derivative markets. We must
zealously guard against the use of inappropriate marketing practices to
sell derivatives to unsophisticated individuals, companies, and other
parties.
Finally, we will continue to work with our international
counterparts to help ensure that our strict and comprehensive
regulatory regime for OTC derivatives is matched by a similarly
effective regime in other countries.
Turning our proposals into law will require that a number of
difficult judgments be made. Some of these judgments involve assigning
jurisdiction over particular transactions or particular market
participants to particular regulatory agencies. We have been working
with the SEC and the CFTC over the past few months to develop a
sensible allocation of duties. We have made great progress in narrowing
the outstanding issues, and intend to send up draft legislation that
will provide for a clear allocation of oversight authority between the
SEC and CFTC. In making these decisions, we are striving to utilize
each agency's expertise, eliminate gaps in regulation, eliminate
uncertainty about which agency regulates which types of derivatives,
and maximize consistency of the regulatory approach of the two
agencies.
Our plan will help prevent the OTC derivative markets from
threatening the stability of the overall financial system.
By requiring central clearing of all standardized derivatives and
by requiring all OTC derivative dealers and all other significant OTC
market participants to be strictly supervised by the Federal
Government, to maintain substantial capital buffers to back up their
obligations, and to comply with prudent initial margin requirements,
the regulatory framework that we seek to put in place should help lower
systemic risk.
Our plan will help make the derivatives markets more efficient and
transparent.
By requiring all standardized derivatives to be cleared through
regulated central counterparties and executed on regulated exchanges or
through regulated electronic trade execution systems and by requiring
that detailed information about all types of derivatives be readily
available to regulators, our plan will help ensure that the government
is not caught--as it was in this crisis--with insufficient visibility
into market activity, risk concentrations, and connections between
firms.
Our plan will help prevent market manipulation, fraud and other
abuses by providing full information to regulators about activity in
the OTC derivative markets and by providing the SEC and the CFTC with
full authority to police the markets.
Finally, our plan will help protect investors by taking steps to
prevent OTC derivatives from being marketed inappropriately to
unsophisticated parties.
As Congress moves to craft legislation to reform our financial
system, we are moving quickly to advance the overall process.
Following the release of our White Paper on financial regulatory
reform in mid-June, we sent up detailed legislative language for the
establishment of the Consumer Financial Protection Agency.
We have used the President's Working Group on Financial Markets to
pull together all government agencies that oversee elements of the
financial system to begin the process of formulating more detailed
proposals for implementing the comprehensive reforms outlined by the
President.
The SEC is moving forward to put in place new rules to govern
credit-rating agencies, which failed to adequately assess the risks of
mortgage-backed and other structured securities at the center of the
crisis.
The CFTC has announced hearings on whether to impose limits on
speculation in energy derivatives in order to dampen price swings, and
to require new disclosures by derivative traders.
SEC Chairman Schapiro and CFTC Chairman Gensler were recently on
Capitol Hill testifying together about progress in coordinating their
agencies' approaches to derivatives and developing a reasonable
division of labor in the oversight of these markets.
We welcome the commitment of the Congressional leadership and of
the key Committees to move forward with legislation this year. This is
an enormously complex project. It is important that we get it right.
And we need a comprehensive approach.
This crisis caused enormous damage to trust and confidence in the
U.S. financial system and to the American economy.
We share responsibility for fixing the system and we can only do
that with comprehensive reform.
We look forward to working with you to achieve that objective.
Chairman Peterson. Thank you, Mr. Secretary.
We have 8 or 9 minutes before votes, so I will go ahead
with a couple of questions here.
First of all--in our bill--we propose mandatory clearing,
and if they can not be cleared, then we give CFTC the
requirement that they put some margin and collateral
requirements on the transaction. One of the questions that I
still have, apparently you are not ready to give us a detailed
response on how this is going to work, but, it mentions a broad
definition of standardized, the presumption of standardized and
cleared and that high volume will be an attribute of a
standardized contract, which for me kind of just raises even
more questions about what is going on here.
So while you may not be able to give us a detail of what a
standardized OTC derivative is today, can you tell us to what
degree of certainty will a swap dealer or end-user of
derivatives be able to know going into a swap whether it is
going to be classified as standardized or customized, will the
answer be in the statute itself or a regulation promulgated by
Federal regulators? Will clearinghouses be providing answers
based on if they choose to clear the derivative or not, or will
the market, as a whole, show the way based on volume of the OTC
derivative? And how much confidence will market participants
have beforehand whether the OTC derivative they enter into will
be judged standardized or customized?
Secretary Geithner. Mr. Chairman, of course we want to
have--we want to give people as much clarity as we can ex ante.
I don't think we made a final judgment yet about to what extent
we wanted to find those attributes and standardize them in
statute or in regulation. I think my suspicion of what we will
recommend is that we will lay out broad principals in statute,
and have them defined with more clarity in regulation.
I think the important thing is that, again, that we move
the standardized derivatives onto central clearing, but we
establish comprehensive enforcement authority, comprehensive
transparency, comprehensive reporting, sufficiently
conservative margin and capital requirements across the entire
market. And to avoid the risk that our definition of
standardized is arbitraged, that people try to get around that
definition and design customized products to escape the
protections that come with that, we are going to propose to put
higher capital requirements on the customized products to limit
that risk.
Again, the basic design of this proposal is to make sure
there is comprehensive oversight over all transactions in these
markets, and comprehensive authority to the SEC and CFTC to
police and deter fraud and manipulation in those markets, and
to make sure there are appropriately conservative capital
margin requirements across those instruments.
Chairman Peterson. Thank you. Thank you. What about if the
clearinghouse determines there is too much risk, too little
profit in clearing some standardized OTC transaction? Or what
happens it no central counterparty will clear a standardized
contract, or do you think the central counterparties should be
required to take on this business?
Secretary Geithner. Having thought through that, I don't
think that is likely to be a significant risk, because, I think
the economic instruments of the participants will encourage
central clearing. As the markets become more standardized, it
is more economically efficient for a greater share of those
products to move to central clearing. Both sides of the parties
will be, particularly the users of the markets, will have an
interest in seeing that, but that is something we will think
through carefully with you.
Chairman Peterson. Well, thank you very much. I think we
are going to recess the Committee and go over and vote. I don't
know how many there are, but we will come back promptly after
the votes. Secretary, we appreciate your patience being with
us. We will stand in recess.
[Recess.]
Chairman Frank. The next Member of the panel to question is
the senior Republican on the Agriculture Committee, the
gentleman from Oklahoma, Mr. Lucas.
Mr. Lucas. Thank you, Mr. Chairman.
And I would ask, by unanimous consent, a letter from
Chesapeake that was copied to me and, I believe, the Secretary
to be entered into the record, if that is possible, sir.
Chairman Peterson. Without objection.
[The document referred to is located on p. 59.]
Mr. Lucas. Thank you, Mr. Chairman.
Mr. Secretary, OTC contracts are used to manage, of course,
very real risks. And the OTC market's very purpose is to
provide customized solutions that meet the individual needs of
customers. Denying or effectively limiting access to these risk
tools by eliminating, in effect, OTC contracts, which mandated
clearing essentially does, jeopardizes the ability to hedge
market risk, exposing customers to increasing price volatility.
Why isn't reporting of OTC trades enough, sir?
Secretary Geithner. If we were to mandate clearing, central
clearing of all derivative products, we would, in effect, be
banning customized products. We are not proposing to do that,
in part because we believe that there are a broad range of
risks that cannot be adequately hedged and managed without
recourse to more specialized, tailored instruments.
We also believe, however, that we need to have, as I said
earlier, a comprehensive framework of reporting, enforcement
authority, and capital requirement protections across all those
instruments. But for the reasons you said, and many people have
pointed out, to force clearing of all derivatives would ban
customized. We do not believe that is necessary, even though we
think it is very important to have a comprehensive framework of
protections around all those products.
Mr. Lucas. So, then it is fair to say, Secretary, that you
would agree that if the regulator knows about the trades, if
the regulator has the necessary tools, that that should be
sufficient to address and to avoid potential systematic risk?
Secretary Geithner. I believe that for the customized part
of the market----
Mr. Lucas. Customized part, of course.
Secretary Geithner.--you want to make sure that there is
adequate capital and margin held against those exposures. That
the SEC and the CFTC, the relevant authorities in this case,
have the full protections to police those markets to prevent
manipulation and fraud. And that requires a level of reporting
and transparency that we do not have today.
Mr. Lucas. And you indicated in your opening comments,
Secretary, that for these kind of contracts, potentially, the
capital requirements could be substantially higher than for the
standardized contracts, the things that would be traded by an
exchange.
Could you give us a feel for, in your mind, how much more
the standards would be for these kind of products?
Secretary Geithner. I can't tell you how much higher, but
let me just explain the rationale for that.
The first is, of course, that these customized products can
often entail more leverage, more uncertainty about future risk,
less capacity to judge future risk. And that, in and of itself,
requires a higher level of capital, to compensate for that
level of risk.
The second is, of course, we want to avoid creating a
situation where people are encouraged to use customized when
there is a standardized option that is economically compelling.
Mr. Lucas. But you would agree that there are a number of
industries, whether it is ag or energy, or a variety of
industries, where the circumstances are so unique that there
has to be an option for these customized contracts?
Secretary Geithner. I do believe that. And I have a stack
of letters here in my book from companies across the country in
the power business, in the commodities business, in the
business of producing large-scale machinery, that speak to the
importance of maintaining that option.
But I want to underscore that, because those products come
with a lot of risk--and a lot of the losses that were so
conspicuous in the monoline insurance companies and AIG were
from institutions writing protections against the customized
products. And, therefore, it is important that there be, as I
said, a comprehensive framework of oversight and authority over
those instruments, as well.
Mr. Lucas. Thank you, Secretary. I see my time has expired.
Chairman Frank. The first questioner on our side now will
be the Chairman of the Financial Services Committee
Subcommittee on Capital Markets, who has been working hard on
this issue, Mr. Kanjorski.
Mr. Kanjorski. Thank you, Mr. Chairman.
Mr. Secretary, the white paper requires that the SEC and
the CFTC make recommendations on harmonizing their statutes and
regulations by the end of September. And, as you know, we have
been meeting with the two regulators, yourself, and
representatives of the Treasury Department over these last
several weeks.
It seems they have made tremendous progress on many things,
but it is clear that, on some things, they, themselves, will
not come to a resolution. And I am just curious if you could
give us some insight, particularly because of the timing of all
this.
You mentioned four or five different positions people have
taken, and I didn't fit in any of those categories. I am in
favor of comprehensive reform, but, also taking our time to
make sure we don't cause unintended consequences.
And, with that in mind, have you, in your mind, formulated
what you would do, or have you considered a joint task force of
Treasury and the Congress in a prepositioned position to start
formulating, if they don't agree on certain issues, what
positions we can take to help facilitate the moving of this
legislation on a faster track?
Secretary Geithner. We would like to come to you with a
recommendation before the deadline we put in the white paper,
which was the end of September, because we know you want to
move forward more quickly on this.
And I agree with you, they have made a lot of progress but
they are not there yet. And what we are doing is working
closely with both agencies to try to explore options and bring
them together to a position both can support.
But, in that process, as you know, we are consulting very
closely with both these Committees, so that we are working in
parallel to a point that it is going to be, not just that we
have them together with the Treasury on a common position, but
that we are more likely to find the common ground that both
your Committees can support.
But we are not quite there yet.
Mr. Kanjorski. Well, I appreciate that. And, of course,
anything that we can do on the Congressional side, we offer our
assistance. Because I am getting a little pessimistic as to
whether or not the deadlines we are setting are going to be
met. And not that that would be tragic if they are not met, but
we are causing great expectations constantly with these
deadlines that make it look a little difficult, or perhaps the
perception is that we are not being as successful as we hope we
can be.
Mr. Secretary, have you given up, and has the
Administration given up, on the long-term prospect of joining
these two agencies together, the SEC and the CFTC?
Secretary Geithner. There are a lot of compelling reasons
made by people in this room, and many others over a long period
of time, for merging both those agencies. In our judgment it is
a necessary condition and the most important and, in some ways
the hardest, thing to do is to bring the underlying statutes
and laws into conformity and convergence.
We think that is the most important thing to do, in part
because, as your colleague Chairman Frank said, the critical
test of whether we do enough to improve the system is going to
be what we do to the basic constraints and incentives, the
substance of regulation.
So what we proposed in the white paper to do is to begin
with that task, which we think is going to be enormously
difficult and complicated. And that would provide a better
basis for the Congress to consider institutional reforms in the
future.
Mr. Kanjorski. So you are not cutting short the fact--you
are anticipating that we are going to do these preliminary
reforms, and then continue on over a series of years with
better reform.
Secretary Geithner. Well, I think that is a judgment you
would have to make. But, there is enormous value--and this is
an enormously complicated task--in bringing those underlying
statutes into conformity, so that you don't have different
standards, different entities, different enforcement authority
over what are economically very similar types of products.
Mr. Kanjorski. All right. Thank you, Mr. Secretary.
Chairman Frank. I thank my colleague, although the prospect
of several more years of this is not the happiest that is
before me.
The gentleman from Florida, Mr. Posey, is now recognized.
Mr. Posey. Thank you, Mr. Chairman.
Mr. Secretary, I had a couple of questions I wanted to ask
when you were before our Committee earlier, and each time
something came up before I got to ask my questions. So, just to
put things into proper perspective, I would like to pose a
couple of them now.
The stimulus bill was advertised to reduce unemployment and
help us get back on track. It apparently hasn't done that. I
have seen some information which indicates, in fact,
unemployment has gone up to about 9\1/2\ percent from below 8
percent, instead of having the other effect. And I know the
Vice President, the other day, said that it was something that
the economy--that no one had anticipated and that they misread
the economy.
And I was just wondering where you think your plan went
wrong.
Secretary Geithner. Congressman, thank you for raising that
question.
I think if you step back and look at where we are today
relative to where we were at the end of the year, we have
achieved the critically important effect of helping slow the
rate of decline in the economy, helped to stabilize the
financial system. Business consumer confidence has improved
very substantially. The rate of decline in economic activity
globally has slowed and stabilized. Financial systems are
starting to heal. The cost of credit, broad concern about
catastrophic risk in the economy and the financial system has
receded very dramatically.
Those are critically important signs of initial progress,
and they are due entirely to the actions this Congress took and
the Administration took to put in place the largest recovery
program in peacetime in the United States.
The stimulus package is on its expected path, in terms of
the rate of change, and in terms of putting money in the
pockets of taxpayers, to provide substantial forms of
assistance to states to reduce the risks that they are forced
to fire tens of thousands of teachers, workers, and firemen.
And there are very substantial investments in infrastructure
products that have already started to take effect and will have
their maximum impact on the economy in the second half of this
year.
So my own sense is, and I think this is a consensus of
broad-based economists, that there has been substantial
improvements in arresting what was the worst recession globally
we have seen in generations. And those are the result of the
actions this Congress took, the Administration put in place,
and complementary actions taken by governments around the world
to, again, help address what the worst crisis we have seen in a
long period of time.
Mr. Posey. Mr. Chairman, the chart just indicates the
opposite. It shows----
Secretary Geithner. No, I don't think that is true. I don't
think that is true, Congressman.
If you look at the dynamics of all recessions, even as
growth starts to improve and turn positive, unemployment tends
to continue to rise. That is the inescapable natural element of
recessions. That is not an argument for not acting very
forcefully in the face of crises of this magnitude.
And so, I think, what the Congress did, what the President
did was necessary and critically important, again, to reduce
the risk that we see hundreds of thousands of further losses of
jobs, we see millions of job losses beyond this point, and we
see thousands more businesses fail unnecessarily.
Mr. Posey. You know better than me how cyclical they are--
anyway, the next question is, we know, even in our districts,
banks have money to lend, but they are not lending it. People
have money to buy a new car, but they are not buying them.
People have money to take a vacation, but they are not taking
them. Consumer confidence isn't what we would like it to be,
and the money is not getting spent.
And, personally, I think it is because they don't know what
is coming. The banks are afraid to loan it. They don't know
what the next issue is going to be, and we are looking, really,
kind of, for a plan.
Chairman Frank. Let me just repeat again. If Members go
right to the end of the time with their questions, the answer
will have to be 10 seconds. But if Members want to have an
answer, they are going to have to leave time for it.
Mr. Secretary, briefly.
Secretary Geithner. Households across the country borrowed
enormous amounts of money relative to income in the run-up to
this crisis. What the economy is going through is a necessary
and very healthy adjustment, as families and the Government of
the United States goes back to living within their means.
That is causing a greater contraction and demand for credit
than we normally see in recessions. And you are seeing a very
healthy increase in private savings behavior, I think, probably
in response to that.
I think those are necessary healthy dynamics, although they
will produce a slower recovery.
Chairman Peterson. I thank the gentleman.
The gentleman from Pennsylvania, the Vice Chairman of the
Committee, Mr. Holden.
Mr. Holden. Thank you, Mr. Chairman.
Mr. Secretary, as you know, the majority of over-the-
counter derivatives are traded here and in Europe. Have you
been discussing your proposal with your European counterparts?
And if you can come to an agreement with the European
Commission and the European Parliament follows suit, what is to
prevent these markets to go to some other nation with a less
regulatory regime to follow.
Secretary Geithner. That is a very important question.
We have been working very closely with them, and there is
very substantial convergence in overall approach. And, I think,
the broad strategy that we are going to embrace here will be
embraced in the UK, will be embraced in continental Europe,
will be matched by the other major financial centers of the
world. And, again, I think they see a broad interest, as do we,
as do these Committees, in trying to raise the basic quality of
standards in these markets.
Now, of course, as many of you said, it is all in the
details and getting those right. But we are trying to do
something we haven't done in the past, which is to move in
parallel with other countries, that we are not left with a
position that we raise standards substantially here and we just
find that risk migrates to other countries.
But, again, I am quite encouraged, and I think there is
broad convergence in approach.
Mr. Holden. But if we come to an agreement with the
Europeans, what is to stop the markets from moving to Dubai,
Hong Kong?
Secratary Geithner. Well, again, we are not going to stop
with the Europeans. I think the important point is to say, in
all the major areas of financial activity, you want to have
global standards enforced more evenly, applied more
effectively, for just the reason you said.
Mr. Holden. Thank you, Mr. Secretary.
Thank you, Mr. Chairman.
Chairman Peterson. I thank the gentleman.
I now recognize the gentleman from Virginia, the former
Chairman and Ranking Member of the Committee, Mr. Goodlatte.
Mr. Goodlatte. Thank you, Mr. Chairman.
Mr. Secretary, welcome.
Sitting here in the august surroundings of the House Ways
and Means Committee, with its fine audio system, and with our
good friends from the Financial Services Committee along side
us, some of us on the Agriculture Committee might say that they
feel that they are sitting in ``tall cotton.''
However, I must say that, having said that and how much we
appreciate you taking this time, I think this hearing is
premature. The fact of the matter is that I very much agree
with you that we need to have as much transparency in these
markets as possible. But we also must have that much
transparency and more in the deliberation of this legislation.
It is critically important that you be able to answer questions
from Members on both sides of the aisle about the specific
details of legislation which does not yet exist.
So I would ask you first, would you be willing to return to
meet with these two Committees and answer our questions when we
actually have the substance of the legislation in front of us
and can get more precise answers from you?
Secretary Geithner. I would respond to any invitation by
your Chairmen to come before you and help make the legislative
process work on the pace that is appropriate.
Mr. Goodlatte. That is a good answer. And I would convey to
both Chairmen my hope that they will make this an open and
bipartisan process and assure us that, once the legislation is
in writing, that we won't rush to mark it up without having the
opportunity for the millions of Americans who are very much
affected by it as well as their Representatives having the
opportunity to ask the questions that need to be asked.
In particular, I would note that you had indicated you hope
that the Members of the Committee would write legislation that
would establish broad principles upon which, then, the various
agencies would write the particularity in the regulations. But
we don't even, at this point, have those broad principles in
front of us to know how we think that process would work.
But let me ask you specifically about one area that is of
considerable concern to me and many others. You told us that
the SEC and the CFTC are still working on how best to divide up
the jurisdiction over the OTC derivatives markets and dealers.
When this division of jurisdiction and responsibility is
finalized, does the Administration intend that each agency
would exercise exclusive regulatory jurisdiction over their
assigned area?
The exclusive jurisdiction provision of the Commodity
Exchange Act has worked well to avoid regulatory duplication
and conflict. And I would hope that it would be built into the
legislation on OTC derivatives, as well. Can you confirm to me
that it will be?
Secretary Geithner. Good question. There is a lot of merit
in that approach. And I would say that probably because of the
precedent established, that is the presumption we are going to
bring to this.
But, again, until we see the full package and have a chance
to walk you through that, I don't want to respond in detail--or
I don't want to get ahead of the delicate, careful process we
are trying to work through now with those two agencies.
Mr. Goodlatte. I see that you have the same problem that I
have with this process, then. And I wonder if you could----
Secretary Geithner. Well, yes Congressman, of course, I
agree that it is going to be all in the substance and the
details of this. And we do carry the burden of presenting
before you detailed proposals in legislative form so that you
can consider those recommendations. And we are going to deliver
on that commitment.
Mr. Goodlatte. I thank you.
I wonder if you would be willing to assure the Committees
that you would get back to us on that specific question in
writing once you have the information in front of you that
would enable you to----
Secratary Geithner. Absolutely. I think that when we
propose our recommendations on how to solve these
jurisdictional questions, a necessary part of the answer will
be a response to the question you raised.
Mr. Goodlatte. Thank you, Mr. Chairman.
Chairman Peterson. I thank the gentleman.
And I would just remind the gentleman that we marked our
bill up and passed it out of the Committee in February under an
open process. It has been out there since then. I think we can
assure you that we are going to continue that open process.
We are having a hearing here today, and we are probably not
going to get around to this until, maybe, September, so we are
being as open as we can be.
Mr. Goodlatte. Mr. Chairman, if you might yield on that
point, would that be an indication that we might actually have
a hearing on the legislation itself rather than the subject?
Chairman Frank. Of course. I am puzzled by the inference
that we didn't plan to do that, and I am puzzled by the
argument that it is premature to have a hearing. I didn't
subpoena the gentleman here. He is free to go off and do other
things. But I would think having a hearing well in advance of
when we actually start to get the legislation would be seen as
a useful part of the process, to begin to open the subject up.
Of course there will be a hearing on the bill itself.
Mr. Goodlatte. If the gentleman would yield, if that is
coupled with a follow-up hearing on actually what we are going
to do, then I would agree with the gentleman.
Chairman Frank. Yes. But the gentleman said it was
premature. I must say, that is an odd accusation that now----
Mr. Goodlatte. It is not an accusation. It is a question.
Chairman Frank. Well, ``premature'' is not a question. It
is at least a description. Maybe the gentleman regards it as
something good to be premature; I have never done that. But the
point is that we are having a chance now to air the questions.
I now recognize the gentlewoman from California, Ms.
Waters.
Ms. Waters. Thank you very much, Mr. Chairman.
There is substantial attention given to OTC derivatives in
your testimony. And, as you know, I have been talking a lot
about credit default swaps. And I remember what you told me the
last time I asked you; you said that if we ban credit default
swaps, they will just emerge in another way, that the
sophistication and creativity of those who deal in these
markets is such that they will just find another way to do what
they want to do.
Basically, what I am reading from your testimony is that
you think that credit default swaps are necessary. However,
this country did very well without them for a long period of
time.
If credit default swaps do such a good job at diffusing
risk, why did so many financial institutions lose so much
money, even when they were using credit default swaps as a
hedge? Doesn't this prove that these products are more
dangerous than originally thought? And why not ban credit
default swaps?
Secretary Geithner. I think, as I said in my testimony, the
principal risk these instruments presented came from the fact
that a set of institutions wrote a lot of commitments without
capital to back those commitments. And the regulatory
authorities of the nation charged with policing these markets
to prevent fraud and manipulation were not given authority over
those basic markets. We are proposing to address those two
critical features.
Now, this country has decades of experience with derivative
products of all classes. They provide, as many of your
colleagues have said, an important economic function in helping
companies and businesses across the country better hedge
against their risk. And, our responsibility and job is to make
sure that those benefits come with appropriate protections for
financial stability of investors and consumers. And that is the
package of reforms we have proposed.
Ms. Waters. Mr. Secretary, you are talking in your
testimony about all of these steps that it will take in order
to supervise and manage and oversee credit default swaps.
If you have to work that hard at trying to make them more
substantial in terms of having the collateral to back up the
risk, why do you have to do them at all, if you have to work
this hard at it?
Secretary Geithner. I don't think we have to work so hard,
but Congress has to legislate the authority to make that
possible. And that authority didn't exist before, and we are
proposing Congress provide that authority.
But I don't think it is a challenge beyond the capacity of
the people in this room, or in the Congress, or the regulatory
authorities to do that.
Again, we are proposing, in some sense, to extend and
recreate and apply the protections that have existed in the
range of other markets to these markets where they did not
exist. And that is not a task that is too complicated for us to
manage.
Ms. Waters. Thank you, Mr. Chairman. I yield back.
Chairman Frank. The Ranking Member of the Financial
Services Committee, the gentleman from Alabama, Mr. Bachus, for
4 minutes.
Mr. Bachus. Thank you, Mr. Secretary.
Mr. Secretary, on more than one occasion, you have said we
are not going to make the system stronger by banning products.
Doesn't the proposal give that authority to the Consumer
Finance Protection Agency, and do it without any review or
oversight?
Secretary Geithner. Well, it is true that, in the consumer
credit area, where we have seen just terrible examples of
predation and failure of basic underwriting standards, basic
protections for consumers, we are proposing to give this new
agency comprehensive rule-writing and enforcement authority.
And, in this context, we would expect them to proscribe certain
types of marketing practices; and, that would be appropriate,
given what we have been through. That is an approach that has,
sort of, come in lots of other areas before.
But I do think it is important to recognize--and if you
look at what the Congress of the United States did in the wake
of the Great Depression, we put in place this comprehensive set
of reforms to help protect consumers and investors and
depositors to ensure the integrity of market functioning.
What we are proposing to do is in the spirit of that. In
many ways, the big mistake we made as a country was we allowed
a huge array of activity, financial activity, to build up and
exist outside those protections. But----
Mr. Bachus. Mr. Secretary, they would be allowed to ban
products, though.
Secretary Geithner. They would be allowed. There are some
consumer practices that we believe should not be permitted. But
we are proposing that the Congress establish the basic
standards that would govern regulation in those areas.
Mr. Bachus. So their actions would have to be based on
existing statutes? Or could they go beyond those?
Secretary Geithner. No. No, I think we are going to propose
that you legislate a framework of standards that would help
shape and govern regulation and rules that that agency would
write and enforce. But that is a responsibility that you would
have to set initially.
Mr. Bachus. You know, you have said--I am just following
your testimony--sometimes you don't believe in banning
products. But you have said they can prohibit certain products
if they are not appropriate for consumers. Now----
Secretary Geithner. Well, Congressman, if you are asking,
again, whether we think it is appropriate in the consumer
protection area--again, this is the marketing of financial
products to individual consumers--there are some practices that
I do think should be proscribed.
Mr. Bachus. Right.
Secretary Geithner. But, again, I think the statue would
have to describe, in some sense----
Mr. Bachus. I am not arguing with you. I am just--but, now,
what would be the determinant on whether a product was
appropriate? What if it was appropriate for 95 percent of the
population but not for five percent?
Secretary Geithner. Well, I think that is exactly a good
way to frame the basic dilemma. And, the centerpiece of our
proposed approach to reform in this area is to encourage more
simplicity and standardization so that consumers have the
choice of a more accessible, easier-to-understand suite of
financial instruments. But they would still preserve the
option, in our proposed frameworks, to adopt or embrace a
different type of product, a less standardized product.
So I think there is less contrast in the basic philosophy
on the consumer side and this other area than I think you are
implying.
Mr. Bachus. Who would review their actions? You know, with
a lot of the Fed's actions you have said the Treasury would
have to have approval there. Who is the reviewing authority
over the Consumer Finance Protection Agency?
Secretary Geithner. Well, Congressman, I am not a lawyer or
a student of administrative law, but my belief in this context
is the Congress is accountable for, and these agencies would be
accountable to the Congress under the basic model that exists
for the SEC----
Mr. Bachus. Would we have to approve their actions?
Secretary Geithner. Not their individual actions, no. But
the statute would establish, as it does for the CFTC and the
SEC today, that basic relationship.
Mr. Bachus. All right.
Let me ask you something else. Back in 1998--and I will
just ask this--Larry Summers testified in the Senate against
the notion of regulating derivatives. Among the things he said
is, ``It would cast the shadow of regulatory uncertainty over
an otherwise thriving market, raising risk for the stability
and competitiveness of the American derivatives trading. Even
small regulatory changes could throw the whole system out of
whack.'' That was after Chairman Boren proposed regulating
derivatives.
What has changed? Or do you have those same concerns today?
Secretary Geithner. I think there has been dramatic changes
in the basic scale, design, and development of those markets.
And even though, as I said in my testimony, the failures in
those markets were not the principal cause of this crisis, they
did cause substantial damage. And I think that justifies
substantial reform.
Mr. Bachus. Sure. And I am not saying it hasn't changed.
But I guess I would say, do you still share some of his
concerns?
Secretary Geithner. The proposal the President laid out
reflects--and, of course, I played a substantial role in
shaping those proposals--my judgment, our collective judgment
about what is appropriate, given the risk we have seen
illustrated by this crisis.
Chairman Peterson. The gentleman's time has expired.
Mr. Bachus. Thank you.
Chairman Peterson. The Subcommittee Chairman from Iowa, Mr.
Boswell.
Mr. Boswell. Thank you, Mr. Chairman. And thank you both
for this hearing.
Mr. Secretary, you are well aware that the market price in
agriculture has been very volatile, and it is a concern.
Experts tell me that the population of the world is growing by
90+ million per year. Food is important.
And I just want to say this: Please remember in all those
discussions you have, that we have--we are envied around the
world. We have the most plentiful, the safest, and the least
expensive food in the world because Maxine and I--she lives in
LA and I live in Iowa, but we contribute the same and we get
something. We get what I just said. So keep that in mind.
Now, I am concerned about over-the-counter, all these
derivatives transactions will need to be registered with some
agency. Would this include rural entities using derivatives
like grain elevators?
They have to hedge; they have to be careful. They get
caught out there in a weak position, and they can go down, and
there is no market out there in the marketplace for the
producer.
Secretary Geithner. Congressman, if I understand your
question correctly, we are preserving, and I think it is
appropriate to preserve, the ability of grain elevator
operators, a whole range of companies and businesses across the
country, to make sure they have the ability to hedge against
this unique and specific risk they face.
But, again, the markets as a whole, even in those
customized areas, need a greater level of transparency,
oversight, and protection.
Mr. Boswell. Well, thank you.
And, Mr. Chairman, I am going to use my remaining time to
make a statement.
I am getting frustrated. I just heard my colleague from
Florida a minute ago ask him, where did you fail? Now, wait a
minute. Let's just review this for a minute. We all ought to be
involved in making this a success. Dammit, it is time to get
together.
Here we are, just review a little bit. Let's go back. Last
Administration, $700 billion was asked for us to catch things
up. And then unbeknown to many of us, the Fed spent $800
million. That is $1.3 trillion. And so, by as early as
February, I believe it was, folks are saying across the aisle,
``Look what you have done to us.'' Horse feathers. That is just
not the way it happened.
Now, let's think of this. Dr. Kagen, I am looking right at
you. Recently I had a loved one at the Mayo Clinic. There were
many doctors, and I asked them time and again, ``Is getting
well thinking you can get well? Is that about 90 percent of
it?'' And every one of them said yes.
Well, this country is in that position. We have to get
well. And we ought to all be hoping and praying that we are
going to make this thing work, and quit picking fault with it
and saying why it won't work. And then if you want to
politicize afterward and take over the majority, go for it. But
let's get this country back in shape, and let's do it together.
Chairman Peterson. I thank the gentleman.
One of our Subcommittee Ranking Members, Mr. Moran from
Kansas.
Mr. Moran. Mr. Chairman, thank you.
Secretary Geithner, it is too infrequent that we have the
opportunity to hear from you and to have a dialogue. And I am
going to ask questions, or at least ask you to respond to some
thoughts that I have somewhat unrelated to the topic of today's
hearing.
But most of the banks in my state did not contribute to the
financial crisis that our country faces today. They did things
right. We still have bankers who say, ``No, I am sorry, I can't
make this loan; you can't afford to repay it.''
And yet, my banks, which ultimately affect my constituents,
are facing an increasing and uncertain regulatory environment.
Examinations are becoming perhaps more frequent, but the
uncertainty of the exam is clearly there. The FDIC insurance
premiums have increased. And we now hear of a new consumer
financial product safety commission with potential additional
regulations upon banks.
And, again, I want to stress that the banks that we have at
home are not the financial institutions that we have been
engaged in in regard to Wall Street.
The consequence of this uncertainty is direct upon the
economy. I have had this conversation with officials at the
Fed. And, while the Federal Reserve has lowered interest rates
in hopes of encouraging consumers to borrow money and to
consume, the regulatory environment, particularly with the
examinations, has discouraged banks from making loans.
So we are at cross purposes, it seems to me, as we try to
improve the economy. That uncertainty lends itself to borrowers
that I visit with who say, ``We are current, our company is
making a profit, and yet our banks can't tell us whether they
are going to reauthorize/renew our loans.''
In addition to that, it means potentially higher interest
rates, which will reduce the demand, therefore potentially
stifle the economy. And, ultimately, the increasing cost of
being in the banking business means that we will see increased
consolidation. And, yet, one of the theories, at least that I
think we have operated under, is that we want to avoid
institutions that are too big to fail.
And, yet, many of the things, it seems to me, that are
happening at the Department of the Treasury and within our
financial system is increasing the role for consolidation.
Increased cost of being in business means that we are going to
spread the cost, as best we can, among a larger group of banks.
And so we see continual consolidation in the industry.
My point is that, while it is damaging to my bankers, it is
ultimately damaging to their borrowers, which is ultimately
damaging to the United States economy. And I would appreciate
any response that you might tell me that would give me comfort
that that is recognized in the counsels that you are engaged
in.
Secretary Geithner. It is absolutely recognized, and it is
a significant issue of concern.
But, what is causing those pressures on both borrowers and
banks is the fact that large parts of the financial system in
this country just took on too much risk during the boom. And
the costs of that--it is fundamentally unfair, but that is what
happens in financial crises--fall not just on those who took
too much risk, but they fall on a bunch of businesses and banks
across the country which were very responsible and prudent.
And that is why these things can be so damaging. And that
is why it is very important that we do everything we can to put
a better foundation for recovery in demand and growth, and try
to make sure that the financial system has capital where it is
necessary, and that these markets for credit start to get
moving again. And that is the basic philosophy that has
underpinned everything we have done.
You are also right that there is a risk in financial crises
that people overcorrect; that, after a period of taking on too
much risk, that they take too little. People that got way
overextended pull back too much. And that can cause, also, a
lot of collateral damage. And, again, that is the basic
rationale in a financial crisis for trying to make sure you do
as much as you can to provide enough support for the economy to
get back on track.
But, I am very much aware of the concerns you expressed. I
believe that the principal bank supervisors are, too. They are
carefully managing those risks. And you are also right that any
time you think about reform to legislation in the financial
area, that is going to come with a period of uncertainty. We
need to minimize that uncertainty.
And, that is one reason why we want to bring clarity,
relatively quickly, to the rules of the game that govern our
financial system, going forward. If we were to wait years to do
this, the markets would be left with a greater period of
uncertainty, and that might deter more lending and risk taking.
Mr. Moran. I simply would ask that you continue to
differentiate, or begin to differentiate, in my opinion, the
difference between the significant financial players, and those
that are out there in the business every day of making loans to
more consumers to buy an automobile, to purchase a home, to
plant a crop.
It does seem to me that differentiation between those kind
of banking institutions and the financial institutions ought to
be--they ought to be treated differently. And I would hope that
that would be the case.
Chairman Peterson. The gentleman's time has expired.
Secretary Geithner. Mr. Chairman, could I respond very,
very briefly?
Just want to say, I completely agree. And the approach we
have taken is to apply more exacting standards to the largest
institutions than we are to the 9,000 banks across the country
that are in a somewhat different set of circumstances.
And we are very committed to make sure that we have
preserved that basic balance. A great strength of our financial
system is that we are not a nation of three banks, or four
banks, or five banks, or ten banks, which is true across many
industrial economies. We are a nation of 8,000, 9,000 very
diverse financial institutions. And that is a source of
resilience and strength, and we want to preserve that.
Mr. Moran. Thank you for your answer. Thank you for
listening to my point.
Thank you, Mr. Chairman.
Mr. Kanjorski [presiding.] The Subcommittee Chairman of
Domestic Policy, the gentleman from North Carolina, Mr. Watt.
Mr. Watt. Thank you, Mr. Chairman.
Mr. Secretary, I am over here, right in front of you,
behind this tall guy.
Last year, our mutual good friend, Rahm Emanuel and I, and
Sue Myrick, our bipartisan cosponsor, introduced a bill calling
for a pilot program to execute interest rate swaps on a
transparent electronic execution platform. People perceived
that he was from Chicago and was the CFTC guy, and I was from
Charlotte the banking side guy, and we came together on this
notion that that was a good thing.
I note that that is an important part of your proposal this
year, and I want to ask you two questions about it. This is not
a clearinghouse or an exchange. There is something before you
get to that. And it seems to me that the regulators could
already be mandating this part of what you have proposed in
legislative form now.
So the first question is, do you see that the regulators--
Comptroller of the Currency, the other regulators--are really
aggressively pushing that notion to your satisfaction, even
before this legislation is passed?
And, number two, I have been somewhat disappointed that,
because we have control over Fannie and Freddie, no direction
has really been given to them to use aggressively these
electronic trading platforms. So I would like to have your
assessment of whether you think that would be a good idea, and
when that might be in the works.
Secretary Geithner. Congressman, I thought the basic spirit
of your proposals when you proposed them were right. And you
are right that we have adopted the basic recommendation, not
only to have central clearing of standardized products, but we
want those to be traded on either organized exchanges or on
transparent trade execution systems, for the reasons you
proposed.
I don't believe, though, that we can move substantially in
that direction without the legislation being clarified. So my
own sense is we need to get the broader legislation in place
before we can bring about this broad transformation in that
market activity.
I do believe, though, that the economic benefits of, not
just central clearing, but more exchange-traded and transparent
electronic trading for some traded products in these areas, is
are going to be very compelling to the users in these markets.
So I believe, once the legislative framework is clarified, that
you are likely to see much, much greater use of those
platforms.
Mr. Watt. What about the Fannie and Freddie----
Secretary Geithner. Including by all users and
beneficiaries of those types of products.
Mr. Watt. I mean, we have control over Fannie and Freddie
now. Wouldn't we be in a different position with respect to
them to insist on a more aggressive, forward-looking approach
to this than we would be, possibly, with private-sector
entities that are under regulation?
Secretary Geithner. Well, in many ways, because of what
Congress proposed, the legislative framework over Fannie and
Freddie has come closer to match what exists for banks and
regulated financial institutions. But I think you want the
market to move in this direction as one. And, again, I think
there would be good risk management benefits for moving in this
direction and good economic benefits.
So, once we have the broad framework legislated, I think
you are going to see very substantial movement in that
direction.
Mr. Watt. Thank you, Mr. Chairman. I yield back.
Mr. Kanjorski. Thank you, Mr. Watt.
The gentleman from Texas, Mr. Neugebauer.
Mr. Neugebauer. Thank you, Mr. Chairman.
Thank you, Mr. Secretary, for coming.
We had a little bit of a dialogue, the other night, about
capital and equity, and I want to go back to that. Because when
we look at the standardized and the customized transactions,
the question I have is--I hear you talking about margin
requirements, capital equity.
In traditional commodities, the clearinghouses set the
margins for clearing those transactions. The regulator then
determines whether the clearing agency has adequate capital for
the activities they are involved in.
As we move to the trading of these derivatives, do you see
that same structure? Because, sometimes, I hear you saying that
the regulator would start setting the margin requirements for
these transactions. And I wanted to be clear about my
understanding of where you are on that issue.
Secretary Geithner. Congressman, I think you said it right.
I think for central counterparties, central clearinghouses,
they design the margin rules, they design the financial
safeguards against default by a member, by a participant.
The regulators have an important obligation to ensure,
because central clearing can concentrate risk, that those
safeguard margin cushions are adequate. That is an important
obligation of the CFTC and SEC under our basic framework. And
you want to make sure that people don't compete, take advantage
of the existence of multiple agencies to try to attract volume
and activity by having imprudently thin margins and cushions in
central counterparties.
For those products that are not centrally cleared, it is
very important that there is capital margin required through
supervision and regulation against the risk those positions
impose.
So I think you need to have that basic balance. But it
depends, the approach varies depending on whether it is the
centrally cleared stuff or the products where the risk is still
bilateral.
Mr. Neugebauer. And looking at the customized products that
aren't going to be cleared in this regulatory structure that
you are going to propose, where would the margin requirements
and capital requirements for the customized transactions, where
do you see that falling?
Secretary Geithner. I think that is a judgment that is
going to have to be reached in cooperation between the SEC, the
CFTC, and the Federal Reserve. Because, again, I think you are
going to have a bunch of different entities in these markets;
they are going to have different regulatory authorities. Well,
we want to make sure that there is going to be a common
approach that is sufficiently conservative. That is a similar
approach we bring to thinking about the design of capital
requirements generally.
Mr. Neugebauer. How would you--with multiple entities like
that involved, what kind of coordination needs to happen so
that--as you have alluded to a couple of times, shopping places
to do business. So if you have the Fed, the SEC, CFTC trying to
have jurisdiction over a particular clearing opportunity or a
particular customized transaction, how would that coordination
happen?
Secretary Geithner. Better than it has. It is going to have
to be substantially better than it has.
Again, the important imperative is there has to be an
appropriately conservative capital margin requirement set
across the core institutions in these markets and the areas
where risk is centralized. And that has to be--and this is
critically important--has to be enforced more evenly.
If you just take the example of banks and thrifts, they had
nominally similar capital requirements. Because of very
different enforcement regimes, a lot of banks chose to become
thrifts. A lot of institutions were set up to take advantage of
what they thought were lower, weaker enforcement standards.
So you need both stronger standards set uniformly with more
consistent enforcement across the basic entities. And it is
harder to do than it is to say.
Mr. Neugebauer. Well, you wouldn't foresee forcing,
requiring these customized transactions to have a third-party
counterparty to hold those transactions.
Secretary Geithner. I think the definition of a customized
product in some ways is that it is not so standardized that it
could be centrally cleared. The risks are complicated enough
that a clearinghouse would not want to, or would not believe it
could, adequately manage those risks.
Now, that is not a detailed enough standard to divide the
line between standardized and customized, but I think that is
the way to think about the economic difference between them.
Mr. Neugebauer. Thank you.
Chairman Peterson. The gentleman's time has expired.
Now recognize the Chairman of the Livestock, Dairy, and
Poultry Subcommittee, from Georgia, Mr. Scott.
Mr. Scott. Thank you very much, Mr. Chairman.
I am over here, Mr. Secretary, over here in the corner. I
would like to see if I could squeeze in a couple of questions.
First of all, I have a concern that your proposal could
very well force non-financial dealers to meet capital
requirements in order to provide legitimate managed risk. But,
given that these non-financial dealers do not have depositors,
unlike large financials, and a low or no systemic risk profile,
is it possible that such a requirement could unintentionally
create a bank monopoly in the over-the-counter derivatives
market? And wouldn't that reduce competition, reduce liquidity,
raise prices, and increase systemic risk by consolidating the
markets?
Secretary Geithner. I don't think so. But you are right; if
that were the result of what we are proposing, that would be a
subject of concern, both to us and to many other people.
But maybe I could respond this way. The centerpiece of our
proposals is to make sure that the major participants in these
markets, because of their importance to the economy, be held to
more exacting standards, higher, more constraining requirements
for leveraging capital in the future.
And that is one way to protect against the risks that both
you and Ranking Member Bachus have pointed out. So, more
exacting requirements for the major participants will help
reduce that risk.
Mr. Scott. Well, why would we not just have those capital
requirements limited to firms whose failure could, indeed,
create the systemic risk to the U.S. economy?
Secretary Geithner. I think, again, you need to have
capital backing risk where risk is taken and where entities are
taking short-term liabilities, borrowing short-term and taking
longer-term risk. That requires capital to protect the system.
If you don't apply a uniform set of prudential requirements
around those entities, then what will happen is the risk will
migrate to those parts of the system where there are lower
standards, as we have already seen in this financial crisis. So
that is important to guard against.
Now, that doesn't mean you have to be completely
comprehensive, but you have to capture enough of the core
participants that you avoid that risk.
Mr. Scott. Another area that I am concerned about is, we
are going to be doing some sweeping limits on the trading of
energy derivatives. Take, for example, oil, which to me is what
has really been the driving force behind the call for increased
regulation of over-the-counter markets.
Oil, as you know, is globally traded, and its price is set
not solely by activities in the United States market, but by
other markets. So I find it kind of dubious that we can control
speculation and hold down the price of oil simply by
unilaterally regulating our markets.
Would not businesses simply move to less regulated markets
and, in effect, diminish our opportunity to legitimately hedge
in the domestic markets?
Secretary Geithner. I share that skepticism and concern,
and I think you are right in seeing it that way.
I think what the CFTC Chairman proposed the other day, and
what is an appropriate approach to think about policy in this
area, is to look for ways to limit volatility.
And it is very hard to not look at the last 2 years of
pattern in the global energy markets, even though there has
been such enormous shifts in confidence about the strength and
weakness of the global economy, and not to believe we have seen
a level of volatility that has been damaging, fundamentally, to
the capacity of businesses to manage risk and damaging to
confidence.
And so it is worth trying to see whether you can, through
better disclosure, limit that risk. Hard to do. Lots of people
have tried it unsuccessfully. But, you are also right that, if
you are going to do that effectively, you have to try and do it
in a common approach where oil and other commodities are traded
globally.
Mr. Scott. So have other countries taken steps, or have
there only been promises or loose commitments?
Chairman Peterson. I apologize. Nobody else has the timer
but myself. The gentleman's time has expired. So thank you, Mr.
Subcommittee Chairman.
Mr. Scott. Thank you.
Thank you, Mr. Secretary.
Chairman Peterson. And I would like to--well, I have one
more on my side, Mr. Chairman.
Chairman Frank. Oh, I didn't know which capacity Scott was
in. Scott's a two-fer, not for the first time in his life.
Chairman Peterson. We had a two-fer over here, too, with
Mr. Neugebauer.
I would just like to announce that the Secretary has to
leave about 1:10 or so. And there may be votes, I don't know,
12:30, 12:45. If that is the case, that will probably be the
end of this. So I would just encourage Members, even though we
had set this 4 minute limit, if you could keep it to one
question, we will try to get through as many Members as we can.
The gentleman from Alabama, Mr. Rogers.
Mr. Rogers. Thank you, Mr. Chairman.
And thank you, Mr. Secretary, for being here and for your
service.
I want to go back to the answers you gave Mr. Posey a
little earlier. You know, I live in Alabama, and we have been
devastated economically with the car industry. You know what is
happening there with all the supplier plants. And I was on the
phone this morning with a tractor dealer who is a large tractor
dealer in Birmingham, who told me he has invested $70 million
in recent years opening new stores throughout the South, but
that he has completely lost confidence and is not going to open
any more. He has had to lay off 250 employees, and have others
take early retirements.
I have another company in my district called Metalcraft,
which makes wrought iron railings, the largest one in the
world, for outdoor furniture. They are having to go out of
business because their bank, which is one of the banks that
received TARP funding, has changed their lending criteria. And
even though this is a profitable business, they can no longer
get capital to work.
I hear those stories, those anecdotal stories, all around
my district of how we are in a crisis of confidence. People are
scared to death. Even the people who haven't lost their jobs
are worried they are going to.
So when I hear you answer Mr. Posey's question with,
``Business and consumer confidence has improved greatly.''
``There has been a substantial improvement in arresting what is
the worst recession in history,'' how do I reconcile that with
what I am seeing in the real world?
Secretary Geithner. I think you are right, Congressman,
that across the country, not just in your district, you still
see businesses and families under enormous financial pressure.
And you are still--and we are going to be living, for some
time, with the consequences of digging out of this mess we
started this year with.
And so, in acknowledging and pointing out the fact that we
have made very substantial progress in trying to repair the
damage caused by this crisis and lay the foundation for
recovery, we do not yet have an economy that is growing again.
And, it is likely that this is going to take a while to come
out of.
But, that underscores, and the examples you pointed out,
underscores the importance of this government doing everything
we can to try to mitigate these pressures. And that is what the
Recovery Act is designed to do, and that is what the programs
we have done to help get credit flowing again are designed to
do.
And they are having their necessary desired effect; they
are starting to get some traction. But you are absolutely right
to emphasize that we have a ways to go. And, again, this is in
families across the country that still feel they are under
enormous financial strain.
Mr. Rogers. What timeline is ``a while,'' in your mind?
Secretary Geithner. Well, again, this was a--it took us a
long time to get into this. You know, as a nation, we just were
living way beyond our means for a long period of time. People
took on way too much debt. And it will take some time to work
through that.
But we are making progress. You have already seen a very
substantial increase in private savings. As I said, that is a
healthy, necessary process. Our current account deficit, which
approached seven percent of GDP only 2 years ago, is now under
three percent of GDP.
We are starting to see this country get back to a point
where we are going to have a stronger foundation for
sustainable growth, going forward, but it is going to take some
time.
Mr. Rogers. And that is a great point. You made the
statement also a little while ago in answering one of the
questions, tightening of spending and greater rate of savings
is a healthy trait that we are seeing in our country.
Why are we not seeing it in our government? That is what
folks back home want to know. We are spending up here like
drunken sailors, and it is all borrowed money. Why is it good
and healthy for individuals and small businesses, but why
aren't we practicing what we preach?
Secretary Geithner. I think, Congressman, that is an
excellent question. We could debate this for hours.
But the lesson of the financial crisis here in the United
States, and around the world, is that when you face a loss of
confidence and a loss of demand of this magnitude, when you
have a financial system on the edge of collapse, the only path
to mitigate the damage is for the government to do what this
Congress did and this government did, which was to try to make
sure you were providing support for investment, for targeted
tax cuts, to try to get demand going again.
That is necessary but not sufficient. It also requires
making sure you stabilize the financial system and help get
credit flowing again. And that is the basic strategy that this
country, fortunately, has adopted.
Mr. Rogers. Thank you.
Chairman Frank. Thank you.
And let me just say--and we only have the one timer--what
we should do is a tap when a Member has 30 seconds left,
because it is tough. So the next time, for questions, if you
hear the one tap that will mean 30 seconds. It will give people
a chance to wind up.
And next is the gentleman from New York, Mr. Meeks.
Mr. Meeks. Thank you, Mr. Chairman.
Thank you for your service.
Let me ask--I learned, coming in here, that there is always
a question of, and trying to think forward so that we don't get
involved in unintended consequences and things of that nature.
And there are two concerns that I have and I will give examples
of.
For example, many small businesses use derivatives for
legitimate risk management purposes that pose no systemic risk
to the system. And many of these may opt out of, I am afraid,
of hedging interest rates and currency risk if oil trades are
moved to exchanges, and they can no longer customize and/or
require homogenous collateral requirements. And this may lead
to smaller firms doing more riskier things. So, that could be
an unintended consequence.
The concern with the dealer banks who rushed to establish
proprietary exchanges and pushed their transactions to owned
clearinghouses or exchanges, which would create--seem to be a
strong incentive for this and could potentially stifle
competition in the market and further concentrate the market,
which could create more of a systemic risk.
I was wondering if you could give us your thoughts.
Secretary Geithner. I think you said it well. I think the
risk is overstated that if we move to greater standardization
and greater sense of clearing, more exchange trading, more
trading on electronic trading platforms, that that would make
it harder and more expensive for businesses to hedge risk. I
think that is quite unlikely. But we are preserving, as I said
several times, we are preserving the ability for small
businesses and large businesses to engage in more customized,
more tailored hedges against the specific and unique risks they
face, in the event the standardized products don't provide
adequate protection. So we are preserving that capacity. We
think it is important for the economic benefits you laid out.
Mr. Meeks. Let me just ask this question: There is some
concern that pushing all derivatives to clearinghouses or
exchanges will create the natural monopolies. I just want to
talk, have a concern about that. But simply reducing the
innovation factor and proper risk management system, should we
consider creating some type of utility type clearinghouse?
Secretary Geithner. I am worried about the same risk. But,
again, I want to make clear, we are not proposing to force all
derivatives onto exchanges, in part, because of the risks you
pointed out. We are proposing to make sure that the
standardized products that can centrally be cleared and traded
on exchanges and electronic trading platforms, that more of
that happens, because we think that will create a more stable
system. But we are still in a--with careful oversight,
appropriate capital requirements, authority to address foreign
manipulation, we also want to make sure there are adequate
protections over the more tailored, customized derivatives
area.
Mr. Meeks. Thank you. I yield back.
Chairman Frank. The gentleman from New Jersey, Mr. Garrett.
Mr. Garrett. Mr. Secretary, thank you. Your opening
comments were to the tune of those people who think that we are
moving too soon or that we don't need change right now, or your
third point was that smarter regulations might basically
destroy innovation. Those people you said were----
Secretary Geithner. Those people are not in this room.
Mr. Garrett. Excuse me?
Secretary Geithner. They are not in this room.
Mr. Garrett. Well, or you are saying they want the status
quo. I appreciate that last little comment, because there are
people here in this room who think that maybe we don't want to
move too soon, that we do want to be thoughtful about this. And
maybe somebody else, before I came here, said that we want to
be able to read and digest the entire legislation before, and
some say that we want to do it at the appropriate time. And you
are in agreement with that?
Secretary Geithner. Well, I am absolutely in agreement that
we need to get this right. I am absolutely in agreement that
this is enormously complicated. I think you need to look at it
comprehensively. You need to look at the entire package before
you evaluate.
Mr. Garrett. To a point that you and I agree on, with
regard to naked CDSs: Some people around here demonize these
things. Would you demonize naked CDSs, or do you think that
they actually play a valuable role that we should not be just
totally outlawing them? I think we agree.
Secretary Geithner. I am not sure I want to use the term
demonize. I am not sure I would spend a huge amount of time
extolling their merits. But, like across our financial system,
it is important that people have the capacity to hedge risks
that they face.
Mr. Garrett. Would you want to eliminate them?
Secretary Geithner. I do not believe it is necessary or
appropriate for us to abandon them. But I want to underscore,
as we have said, we do believe there needs to be comprehensive
oversight over these markets, both the standardized and the
customized.
Mr. Garrett. And we do that because we want to get to the
underlying causes that brought us to this morass in the first
place. Right?
Let's take a look at one of those pictures which is always
on the front page, the AIG situation. The AIG situation, with
the derivatives that they were involved with there, the
underlying problem there was, what, mortgage-backed securities.
Right?
Secretary Geithner. Right.
Mr. Garrett. Those instruments, as far as I understand,
would not be by any stretch of the imagination a standardized
product. Is that correct?
Secretary Geithner. I am not sure which way you are going
with this. But, you are right to say in the AIG case and in the
case of the monolines, the largest part of the protection they
wrote, and ended up with, could not back with capital were
credit protection on real estate-related asset-backed
securities.
Mr. Garrett. But the products that they were dealing with
would not be defined as a standardized product that would
necessarily be able to go through a clearinghouse. Is that
correct? Because you are dealing with these underlying
mortgage-backed securities which are all over the spectrum, all
over the field; and, therefore, to try to say we are going to
standardize them might be problematic.
Secretary Geithner. I agree. But, again, our proposals
would get at the core of that specific problem, though, by
trying to make sure that there is sufficient capital held
against commitments financial institutions make to hedge
against certain risks, regardless of how they do it. We are
addressing the core of that basic problem.
Mr. Garrett. And you would do that, though, with the AIG
type situation: not because they would be able to go through
the clearinghouse over here and be standardized and create
liquidity over here, but because they would be nonstandardized
products and you would raise stricter capital requirements in
order to facilitate them.
Secretary Geithner. And on the firm as a whole. But, again,
the capital is central to this. A core part of what brought the
system to the edge of collapse was inadequate capital against a
range of commitments, banks, and institutions like AIG made.
Mr. Garrett. Okay. One last area in 30 seconds: In the
energy field--I don't know if anybody else talked about this.
Is it not problematical for those who deal in the energy area
to have those capital requirements, to potentially have the
elimination of the naked swaps as well because of the nature of
that industry and the nature of the trades of those and the
liquidity, and the inability to put the capital behind it, at
least under the system that we have now?
Secretary Geithner. I don't think what we are proposing has
that risk. But, of course, we will look carefully at any
concerns in that area. I don't think what we are proposing has
that risk, though.
Chairman Frank. I apologize, I didn't pay attention to the
30 seconds. I apologize.
Mr. Garrett. You want me to keep going?
Chairman Frank. No. I have never had that motion.
Chairman Peterson. The gentleman from California, Mr.
Costa.
Mr. Costa. Thank you very much, Mr. Chairman. I thank both
Chairmen for holding this important hearing. And thank you, Mr.
Secretary.
I want to focus my questions in the area of commodities. I
represent a large agricultural area, and obviously commodity
trading is very important. You have spoken about a good way to
avoid the future AIG situations as to ensure that all parties
have a stake in the game, or skin in the action, or whatever
you want to call it--skin in the game, I guess. I think that is
more achievable in terms of the financial institutions, but
commodity hedgers don't generally have the same access to cash
and capital in order to be a player in these markets. Their
assets oftentimes tend to be tied up in reinvestments and their
own company growth.
What sort of impact do you think this is going to have on
capital requirements on nonfinancial entities that have an
appropriate role to be engaged in this market and to have the
access to it?
Secretary Geithner. Congressman, we will take a careful
look at that. And, again, as people see the details of these
proposals, they raise those concerns, then we would be happy to
work with you on how to address that.
You know, we are not trying to--we want to get the balance
right. And, again, a systematic source of problems across our
finance system was inadequate capital, people taking risks that
they did not understand, could not support. So we want to make
sure we fix that. But we are going to try to be careful to get
the balance right, and we will be happy to respond to any
detailed concerns raised when you see our proposals.
Mr. Costa. The balance, I agree with you, we have to get it
right. But is it possible you think that in terms of trying to
do that, that we are consolidating these types of trades in the
hands of financial institutions that do have access?
Secretary Geithner. Again, I don't think that is the likely
consequence of what we are proposing. But, again, we would be
happy to respond.
Mr. Costa. Because I am concerned about consolidation,
getting back to the point of being too big to fail. I don't
want to go there.
Secretary Geithner. I share that concern.
Mr. Costa. We have been there.
Secretary Geithner. I share that concern. And, again, I
don't think our proposals carry that risk. But we would be
happy to respond to any concerns raised by them.
Mr. Costa. In the same ballpark, in follow-up to
Congressman Scott's question, you talked about capital
requirements being uniform between financial and nonfinancial
traders. How would you visualize that taking place between
commodities, a company continuing to participate in the market,
if they are required to have an extensive cash capital?
Secretary Geithner. Congressman, again, I am not sure that
I can be responsive now. But, again, my principal concern--our
principal concern has to be by making sure that financial
intermediaries provide the basic economic function that
Chairman Frank outlined at the beginning of the hearing. Those
intermediaries, because of the leverage they take on, should
hold adequate capital against risk. That is the centerpiece of
our proposals. But I have heard your concerns, and would be
happy to work with you to make sure we address those concerns.
Mr. Costa. Final question, moving over to community banks
which provide an important source of lending in my communities.
Under the framework, you are saying that agencies also will
have the ability to subject banks to additional capital
requirements. That is not new, of course. How does the
Administration plan to do that? You know, it has been tried in
the past.
Secretary Geithner. Sir, to subject the largest
institutions to higher capital requirements?
Mr. Costa. No. Community banks to higher capital
requirements.
Secretary Geithner. Again, we need to take a fresh, cold
look at capital requirements across the banking industry,
banks, thrifts, large and small. Because my general view is--
and I think this is supported by the evidence in the crisis--
that those capital requirements did not provide sufficient
protection. So in addition to looking at the entire framework
of capital requirements across large and small banks, we are
going to hold the largest institutions to more exacting
standards.
Mr. Costa. Thank you very much. I yield the balance of my
time.
Chairman Peterson. I thank the gentleman. The gentleman
from Texas, Mr. Conaway.
Mr. Conaway. Thank you, Mr. Chairman. Secretary Geithner,
thank you for being here this morning. I have an observation
and a question. And let me get them both out, and you can use
the rest of the time in your response.
You occupy one of the most important positions in this
arena, and we need you speaking with the most credible voice
possible in order to help lead this effort. I was startled when
I heard your response to Mr. Posey, you went through a litany
of things that have you turning the corner or looking like they
are going to turn the corner.
Secretary Geithner. No. I didn't use those words.
Mr. Conaway. Let me finish. That is fine. But then you
followed up by saying, and you pandered to us and yourself and
the Administration when you said that that was due entirely to
the work of the Congress and the Administration. So that is not
credible with me and maybe some other folks.
The question I have, if we put this regulatory scheme in
place, and none of us will get it exactly the way we want it.
There will be some compromises that we will have to make. If we
put that in place and business, and the rest of the world says
no, thanks, we are not going to do it, as they said with
climate change over the weekend. If business begins to go to
active markets like Dubai and places where they are not as
regulated, can you quantify for us the reduced role that
America's domestic financial markets will play worldwide with
the consummate loss of jobs and wealth and influence across the
scheme?
Secretary Geithner. Congressman, I am very worried about
that risk. I spent a large part of my professional life in
trying to make sure we have more cooperation, more uniform
standards, partly to reduce that risk. But my general view is
that our system is stronger, has been stronger over time where
we were prepared to take the leadership role in strengthening
protections for investors and providing greater protections
against systemic risk. Where we got that right in the past, it
proved to be a great competitive asset to our financial
institutions and our markets in the past. I think that basic
philosophy should underpin what we do. But as you pointed out,
because technology has made it much more easy for capital to
move where standards are lowest, we have to do a much better
job, as we raise standards here, in trying to bring the world
with us. And you will be able to watch with us how successful
we are in that. But I believe deeply in the importance of that,
and you are right to underscore the importance.
Mr. Conaway. Well, I appreciate your recognition that there
is some risk that if we don't in fact get it right, and even if
we do get it right, we may have to collectively agree that that
is a result that we are going to have to live with until the
rest of the world can catch up.
So thanks for being here today. I yield back.
Chairman Frank. The gentleman from California, Mr. Sherman.
Mr. Sherman. Thank you. We have folks who bought
derivatives last year. And they didn't just look at the capital
that was available by the issuer; they said, well, this issuer
is too big to fail now, maybe not; too interconnected to fail,
maybe not; too well-connected to fail. And these derivative
purchasers correctly realized that the taxpayer would bail them
out, as it has.
Today, derivatives are being sold, and the buyers of those
derivatives are looking at their counterparty and they are
saying, well, there may not be enough capital there. But one
additional source of capital is there may be more bailout.
Can you correct that misconception and make a clear
statement now that derivatives that are sold today are not
going to be the subject of bailouts for either the issuer or
the purchaser, that capitalism is back?
Secretary Geithner. Congressman, I understand your concern
and I believe I share its fundamental premise. If we are going
to be successful in creating a more stable system, we have to
make sure that we address and reduce the moral hazard risk
produced by the interventions expressed.
Mr. Sherman. Mr. Secretary, even before we create a new
system--I am talking about today, literally today--can you tell
people who are buying derivatives today that they can't look to
the taxpayer for any kind of bailout should the issuing party
be unable to----
Secretary Geithner. Again, Congressman, let me just start
with your premise. A principal source of losses to the core of
the financial system came from institutions like the monolines
that are relatively small institutions. Nobody thought they
were too big to fail and they received no assistance from the
government, writing protection well in excess of their capital
requirements. So I don't think I believe in the basic premise
of your question, although I share your concerns.
Mr. Sherman. Mr. Secretary, I am not asking for philosophy
here, whether you agree with me on the premise. I am asking a
very simple statement: Is it at least theoretically possible
that a derivative issued today will be subject to a bailout
tomorrow?
Secretary Geithner. Congressman, I just don't think that
there is an enormously complicated set of legal conventions
around the diversity of financial products in our markets, and
I don't think that that question, as you phrased it, I can
respond to----
Mr. Sherman. Let me ask the question a different way. Do
you want to use this opportunity to tell the financial markets
that there is no bailout or a possibility of one? Or do you
want to use this opportunity to tell our constituents that
derivatives being sold today might result in the bailout
payments of tomorrow?
Secretary Geithner. Congressman, what I want to use this
opportunity to do is to lay the case for why we need
comprehensive oversight and regulation of the participants in
the derivatives markets and those instruments.
Mr. Sherman. Mr. Secretary, I can understand why you prefer
to answer somebody else's question, but I get 4 minutes. It is
a very simple thing.
Secretary Geithner. You can ask it different ways if you
want, but----
Mr. Sherman. I want a yes or no answer.
Secretary Geithner. No, I am not going to answer that way,
because what you are asking me to do is to give an
irresponsible answer to a complicated legal question. And I am
not going to add to what----
Mr. Sherman. What you are basically saying is that you
think it would be irresponsible to tell people that derivatives
issued today are not possibly going to get----
Secretary Geithner. No, I am not prepared to answer that
question that way as it was framed. But I will happy to talk to
you about this at any length you would like and try to make
sure we come to a better understanding about the legal
complexities.
Mr. Sherman. I look forward to those discussions. Thank
you.
Chairman Frank. The gentleman from California, Mr. Royce,
appears to be next on this list.
Mr. Royce. Thank you, Mr. Chairman.
And, Secretary Geithner, I would like to begin by thanking
you for your work on this regulatory reform package. I think
there are a number of provisions in there that I am encouraged
by that are contained in the white paper. There is, however,
one that raises concerns, and let me raise that with you, and
that is to ask you about the resolution authority that you
discussed in the white paper. This idea, as you portrayed it,
is for government to unwind failed institutions. But it seems
to allow for simply propping up struggling firms. It seems to
be basically permanent bailout authority.
And I guess the reason I am concerned, you have the
government--you have politicization of the economy as it is. We
are looking at a situation where we might have a government
takeover of health care, of the energy markets, the government
is running GM and Chrysler. And now, you look on page 77 of the
reform proposal, and this is how it reads:
``The regime also should provide for the ability to
stabilize a failing institution by providing loans to the firm,
purchasing assets from the firm, guaranteeing the liabilities
of the firm, or making equity investments in the firm.''
This sounds like the FDIC's open bank assistance authority,
which provides direct funding to an operating insured bank to
keep it from failing. And such authority is of course markedly
different from a resolution authority that would entail an
orderly unwinding of a failed institution. So you could have
basically permanent bailout authority where the Federal
Government continues just to keep putting taxpayer money into
institutions.
Secretary Geithner. Congressman, if we were proposing that,
what you described, you would be right to be concerned and I
would not support a proposal described as you did. What we are
proposing to do is to take the basic framework that the
Congress legislated to allow the country to deal with risks to
the financial system posed by the failure of banks and thrifts,
and to adapt that framework to give us similar authority to
deal with a large complex financial institution.
The absence of that framework and that authority was
enormously damaging to this country. We are going to take a
framework that was carefully designed by the Congress, with
good checks and balances, lots of experience over time, and
simply adapt that framework to give us similar tools to help
manage the unwinding and the failure of large complex
institutions. That is the proposal. Again, there is--the virtue
of using the model we have, which is the FDIC resolution
framework, is that that has been tested, people understand its
merits and complexity, and gives us a little bit better basis
for finding consensus on the right approach.
Mr. Royce. But, of course, given recent actions and given
the fact that this is worded in a way that it does not require
an unwinding process. Given the fact that based on current
action we are left with the assumption that this certainly
would allow, the way it is written, ongoing government
involvement in a way which would continue to put taxpayer funds
into an entity without limit. And let me ask you another
question.
Secretary Geithner. I don't think it has that risk,
Congressman, again, because the centerpiece of our reform
proposals are to create a system that is strong enough to
withstand the failure of major institutions. But to do that
effectively, we need authority Congress gave----
Mr. Royce. Let me ask my last question. You were at the
table for many of the discussions to either provide a lifeline
or to let an institution fail. These were very difficult
decisions at a critical time. If I could ask you to commit your
staff to provide for the record a detailed analysis, walking us
through how this authority would have changed the way in which
AIG or Lehman Brothers were handled, and exactly how the
counterparties of these firms would have been treated
differently under this regime.
Secretary Geithner. Hard to do, but I will be happy to try
to do that well. And I am sure I will have the opportunity to
testify before the Financial Services Committee on the broad
range of----
Mr. Royce. I would appreciate it, Mr. Secretary.
Chairman Peterson. I thank the gentleman. The gentleman
from Georgia, Mr. Marshall.
Mr. Marshall. Thank you, Mr. Chairman.
I suppose, had you chosen to answer Mr. Sherman's question,
you might have said that the United States is going to stand
behind its money supply. We are going to design our regulations
to assure that there is no necessity for the government to
intervene and prop up the money supply in the future. And, it
would be very foolish for anybody investing now to even vaguely
think that it is likely that we will fail to do that. But in
the event that we fail, the world can rely upon the American
money supply. We will take the actions necessary to protect the
money supply.
Mr. Sherman and I just had a difference of opinion
concerning whether or not TARP was an ill-advised move. I
thought it was, he thought it wasn't. I thought it was dreadful
that we had to do this and a real failure by leadership in this
country across a broad range. But it was something that I
thought we needed to do. And I would be shocked if we wouldn't
do something similar in the future if it was necessary, but
also shocked if we don't take the kind of action that is
necessary to assure that it is not necessary in the future.
Mr. Secretary, you have in your written testimony the
reference to we were going to require this, require this,
require that, et cetera.
Secretary Geithner. Proposed to require.
Mr. Marshall. Well, we also will require, is the way you
put it. I think there are good things to require. The devil is
in the details of course. We will work those details out. But
the specter we have is we don't want to disadvantage American
business, we don't want to disadvantage the American financial
industry. And you also referred to: ``Finally, we will continue
to work with our international counterparts to assure that our
strict and comprehensive regulatory regime for OTC derivatives
is matched by a similarly effective regime in other
countries.''
Chairman Peterson led a CODEL to Europe. We talked with
other countries about this very question, regulatory arbitrage
country-to-country. It has been a challenge for us. I have no
real confidence that you are going to be able to line up all of
the countries; that some country won't decide to not adopt the
strict requirements that we think are advisable in order to
have a competitive advantage, in order to have that country
become a financial center. Hence, things like the Cayman
Islands, et cetera, pop up. I think it just denies history to
suggest that there won't be countries like that.
Has any thought been given to the United States perhaps
teaming up with Europe and coming up with a fundamental
regulatory scheme, sort of minimum standards that are
acceptable. And then simply announce that investors will not be
permitted in any way, directly or indirectly, we are going to
look at substance, not the form, to be in our markets if they
are elsewhere playing in markets that are not living up to this
minimum regulatory standard? Because it just seems to me
unrealistic to think that we are going to be able to do much
more than that. So if there has been thought given to it, could
you share that with us?
Secretary Geithner. I am not sure I would go quite that
far. I think our basic approach is very similarly laid out. And
there is an elaborate cooperative framework now in place that
has the United States at the table with, not just Europe, but
the other major financial centers to design minimum standards,
and make sure they are more evenly enforced. I am not sure we
can go quite as far as you suggested. But the basic philosophy
you laid out----
Mr. Marshall. Mr. Secretary, is it your impression that all
of these countries are going to agree with the different things
that you are suggesting we should require?
Secretary Geithner. I completely agree with you that it is
going to be enormously difficult, but it is the right thing to
try to attempt.
Mr. Marshall. Mr. Secretary, if we move forward and require
these things, are we going to be disadvantaged?
Secretary Geithner. I think that if we get the balance
wrong and do it poorly, we will face that risk. But we are
going to try to be careful to do it in a way that improves
confidence in our markets, in a way that reinforces what has
been substantial assets for this country, which typically had
stronger standards than those that were applied around the
world. But, again, this crisis has been so searing for
countries, not just in Europe, but across the world, there is
going to be substantial interest in raising standards there,
too.
Mr. Marshall. Thank you, Mr. Chairman. Thank you, Mr.
Secretary.
Chairman Frank. Chairman Peterson and I have discussed
this. It will be our intention to include in legislation strict
instructions to all the American financial regulators to apply
the strictest possible sanctions to any outlying country like
that. I would agree, with the EU, with Japan. And we have had a
lot of conversations. But I believe that we should then say
that any country that allows itself to be the host to that
loses access to the American banking system, et cetera. And I
believe we will have very strict instructions in there that is
at least a substantial protection. The gentleman is absolutely
right.
Chairman Peterson. The gentleman from Louisiana, Mr.
Cassidy.
Mr. Cassidy. Mr. Secretary, you know far more about this
than I. I am not challenging you, rather just posing these for
thoughts. Natural gas, that would be currently OTC. And public
utilities sometimes, I am told, put up their physical assets as
collateral, and it is a straightforward swap without an
additional fee imposed by the exchange.
Now, I understand speculators are, well, speculators, they
either drive up costs or manipulate the market allegedly, but
also provide liquidity. And so my question is, though, if we
require these public utilities to go through an exchange,
perhaps put up cash, disrupting their cash flow, certainly
potentially paying a fee, it seems like we are going to pass on
higher costs to consumers from entities which are really not
out there to disrupt the market, but rather hedging future
costs.
Is there a way that we can carve out these entities from
the central clearing, for example, as one solution, or some
other way to mitigate the increased costs that will be passed
on to consumers?
Secretary Geithner. Congressman, again, I think this is
going to be an important issue. I believe that the experience
with central clearing where it has existed, and the experience
with the migration of derivatives onto exchanges has generally
reduced costs to users. I think that is encouraging. But as we
have said many times, we are still going to preserve the
capacity for a range of companies throughout and across the
country to engage in on a bilateral basis customized hedges
outside the standardized clearing area. We just want that to at
least come up with some protections.
Mr. Cassidy. You were saying that, and you have given good
testimony. It seems, though, that, my gosh, public utilities
would not be customized; rather, it seems like that that would
be----
Secretary Geithner. In fact, I have received a lot of
letters, and I suspect many of you have, from utilities saying
that we want to preserve the capacity to engage in, embark in
more customized sets of hedges, and we want to preserve that
capacity. But, again, we want the system to be protected
against the risks those things present, so there needs to be
broader oversight for the SEC and the CFTC over those
activities. But I don't think we are in a different place, and
are very sensitive to the concern you laid out.
Mr. Cassidy. So just to follow up, because I do think we
are close to a similar place. Your definition of something that
would be standardized, I think, was high volume. So I was, if
you will, gathering from that that almost by definition these
contracts would be considered standardized. But even if they
are high volume, they still may go into a customized category.
Secretary Geithner. I think the question is, are the terms
common and more typically uniform? Or, do you need a--can you
not meet your individual needs to hedge against the risk you
face with those commonly prevailing terms. I think that is the
way to think about the definition. But, again, this is a
complicated thing to get right, and we are going to do our best
to make proposals to you to get the balance in the right place.
Mr. Cassidy. And just to follow up one more aspect of my
question quickly. Again, I am told that sometimes the utilities
will put up their physical assets as collateral as opposed to
cash. Will that be part of this kind of balance?
Secretary Geithner. That is something I have to think about
and get back to you on. I don't think I can do justice to the
details of what market practice is in that area today. But I
will be happy to try to get back to you on that particular
question. Several of your colleagues have raised it.
Mr. Cassidy. Thank you very much. I yield back.
Chairman Peterson. I thank the gentleman. And I would just
like to comment that there has been a lot of talk about these
customized versus standardized. What people need to understand
is that these banks make a lot more money on customized trades
than they do on standardized. So keep that in mind.
Secretary Geithner. Mr. Chairman, could I just say
something in response to what you just said on that question? I
think you are right, and that is why I think that as you go
through this process you want to make sure you are not
listening just to New York and Chicago. You want to make sure
that you are listening to the range of companies that rely on
these markets as their risks. I think here there really is an
interesting diversity of opinion. But what we are proposing is
to make sure that where there is a good compelling case for the
customized, that it comes with protections so that the system
is not vulnerable to the risks those present.
Chairman Frank. That recalls to me my own distinction
between ends and means. We are talking about the end-user, not
the people who make money on the instruments, per se.
The gentleman from Kansas, Mr. Moore.
Mr. Moore. Thank you, Mr. Chairman.
Mr. Secretary, many Americans probably never heard of
derivatives before the financial meltdown, although many
companies in the United States used derivatives to manage and
hedge their risks. It appears there are two sides of risk from
looking at how best to oversee the OTC derivatives market. On
the one hand there is the risk to the financial system if they
are left unregulated, and on the other hand there is the
beneficial tool of risk management that derivatives can provide
to many businesses, large and small.
Mr. Secretary, I believe we need to regulate this part of
the system that was ignored for too long, but we should be
careful of unintended consequences.
When we consider the United States companies that played no
role or part in the financial crisis, how should we weigh
systemic stability against higher requirements for firms that
are end-users of derivatives? Is there a chance systemic risk
could actually grow if companies are forced to stop hedging the
risks that they have on their books?
Secretary Geithner. Yes. I do believe that if you deprive
institutions of the capacity to manage their risks effectively,
you could create a less stable system.
Mr. Moore. Some claim that the Administration's plan will
cost hundreds of billions of dollars that companies would have
to post to a clearinghouse. Have you done any cost analysis of
the effects on these companies?
Secretary Geithner. It is a hard thing to do well. But,
again, it is about the balance. The benefits to the system of
having more conservative margin requirements than we had coming
into this crisis are going to be very, very substantial
economically. But you don't want to have them to be so high
that you push a bunch of risk offshore or to other places. And
that is going to be a hard thing to get right. But I don't
think you can look at the last couple years of history and say
that we erred on the side of having to be too conservative.
Mr. Moore. Thank you, Mr. Secretary. I yield back.
Chairman Frank. The gentlewoman from Illinois, Mrs.
Biggert.
Mrs. Biggert. Thank you, Mr. Chairman. And thank you, Mr.
Secretary, for being here.
The Administration's proposal strips all of the consumer
protection functions from all the banking regulators and puts
them in a separate agency, to me essentially making the
government bigger but not better for consumers. Won't your
proposal deny the regulators the ability to manage the risk of
a financial institution, and won't these new agencies tell
consumers what they can and cannot have, and tells business
what products they can and cannot offer conflict with the
safety and soundness role of the banking regulators? Can you
give me a yes or no answer?
Secretary Geithner. No. But maybe I could--could I say a
few more things in response? We are not making government
bigger in this case. As you said, we are taking authority that
exists in a bunch of different places, both rule writing and
enforcement authority, and we are moving that to a central
place where there will be more accountability and, we hope,
better outcomes than we achieved with the system that we have
been living with.
Mrs. Biggert. Well, then what is the function of the
banking regulators, the safety and soundness?
Secretary Geithner. Principally, safety and soundness. But
as you and I have discussed in the past, there are areas where
these things overlap. So it is not going to be a completely
bright line. But we want bank regulators to be principally
responsible for safety and soundness, and we think we are going
to have both better consumer protection and better safety and
soundness regulation if we have better separate accountability
for those functions.
Mrs. Biggert. Do you see then the Consumer Financial
Protection Agency trumping the existing regulators?
Secretary Geithner. Again, we are proposing, to give them
rule writing authority and primary enforcement authority over
consumer protection, not over safety and soundness.
Mrs. Biggert. It seems like there will be a lot of
duplication of effort.
Secretary Geithner. We want to avoid that, but again there
is a lot of duplication of effort in our system. Our system is
characterized by a, frankly, difficult to defend mix of parts
of the system with incredible overlapping authority and parts
of the system where nobody had good authority. So it is not a
system we would have designed if we were starting from scratch
today. We are going to try to get clearer accountability, more
focused accountability, less overlap but better safeguards
where they didn't exist.
Mrs. Biggert. How do you do that if you separate those?
Secretary Geithner. Well, they are very different types of
functions. They have not been done particularly well when they
were done as they have been done to date. What we argue here is
separating is more simple and clearer.
Mrs. Biggert. I have concerns about the recently passed
cap-and-trade bill, and it had--about derivatives in there, and
language is included to regulate the OTC markets and limit
participation in the markets. I would like to know, what is the
Administration's position on the bill's new tax on
transactions? And I know that there was a caveat in the 3 a.m.,
300 page manager's amendment which put in a caveat that if
there is legislation passed this would be null and void. But
what did you think about what was in that bill? And will some
of that carry over into other legislation?
Secretary Geithner. Congresswoman, for reasons that I think
you can appreciate, can I respond to that in writing----
Mrs. Biggert. I would appreciate it.
Secretary Geithner.--or separately in some appropriate
form? It is a complicated bill that has a lot of complicated
provisions in these areas, and I want to do it well.
Mrs. Biggert. Just one quick question. I am still worried
that we are going to incentivize much of the market to move
overseas if we impose new regulations on the market, the over-
the-counter market. How could we really forestall that?
Secretary Geithner. Well, it is an important thing to
avoid. But if you look carefully at what the Europeans are
proposing now, what the U.K. has proposed in public now, there
is much more convergence in our approach than we have seen in a
long period of time, and that is encouraging. But we share your
commitment to that and want to be careful to avoid that risk.
Mrs. Biggert. Thank you. I yield back.
Chairman Peterson. The gentleman from Indiana, Mr.
Ellsworth.
Mr. Ellsworth. Thank you, Mr. Chairman.
Secretary Geithner, we have all got hundreds of questions
we could ask you, and luckily for you we have only got 4
minutes to do it. I would like to go back in time, since this
is our first meeting, back in time a little bit.
The first time I heard about a credit default swap was, I
think it was, in a TIME magazine article maybe 7 months ago,
something like that. I thought it was just me living under a
rock until I started polling people back home, and most people
have not heard of that term.
Can you tell me, for my reference and my education, how we
got there? If this was a life insurance company that was
selling policies that they had no capital or were
undercapitalized they would be in jail. Bernie Madoff has now
been sentenced to what is essentially life in prison for a
Ponzi scheme. Can you give me some background to how we got
there and how we are going to prevent that in the future? And
if you can throw in what, if we know the dollar figure on what
these credit default swaps are worth. I have heard trillions.
If you can tie that even to a broad range, I would appreciate
it, sir.
Secretary Geithner. I would be happy to respond. The
overall estimates of magnitude of the total face value of these
markets are in the $600 trillion range. The market value of
those contracts, my testimony, says are more in the $20
trillion range. That still itself doesn't really capture the
risk. It probably substantially overstates it. But these are
enormously large markets, enormously important to how our
markets function. These markets include interest rate risk,
exchange risk, equity derivatives, commodity derivatives,
energy, food, et cetera.
And the way this happened in credit derivatives was very
similar to what happened in commodity derivatives and others,
which is that decades ago people figured out a way to offer a
company the ability to hedge against a particular risk, the
cost of energy, cost of seeds, cost of movement in exchange
rates, cost of a change in interest rates, and over time
products emerged to meet that economic demand.
What we did not do in our country is stay abreast of that
innovation and put in place the framework of protections over
those markets that was commensurate with the risk they
proposed. We were behind that curve. And we had a lot of
institutions, including regulated institutions like the
monoline insurance companies and AIG that wrote a huge amount
of protections without the capital to back it, and that
combination of factors helped bring us to the edge of this very
severe crisis. And it is an obligation we all share to make
sure that we not just address those principal causes of this
crisis, but we have a stronger framework to address future
vulnerabilities, and that our framework adapts more quickly in
the future. And that is what we are trying to do.
Mr. Ellsworth. What would be the consequences--whether we
voted for the bailout, the TARP, any of that. What would be the
consequences if these were called in, these credit policies?
Could they be called in, cashed in, make due on the credit
default swaps?
Secretary Geithner. I wouldn't think about the economic
risks in what the Congress authorized for the financial sector
as being principally affected by what happens in these
derivative markets. The principal risk, the economy, as many of
your colleagues have said, is we are living still with a very
challenging set of economic risks in the future. But if we are
successful working together, putting in place a stronger
foundation for recovery, then the ultimate risk to the
taxpayer, the things we want to do, will be lower.
Mr. Ellsworth. I will yield back.
Chairman Peterson. The gentleman from Pennsylvania, Mr.
Thompson.
Mr. Thompson. Thank you, Mr. Chairman. Thank you, Mr.
Secretary, for being here, for answering these questions. With
your proposal, I wanted to just seek some clarification.
Is it your intent to force private commodity pool operators
to register with the SEC as a hedge fund instead of the CFTC?
And, if so, why?
Secretary Geithner. I haven't quite come to a firm
conviction on that question, but we are working through it with
the SEC and the CFTC. What we have been explicit about is that
we want to make sure the hedge funds above a certain size are
compelled to register. But you raise a very important question,
thinking about how we treat other entities that are doing
similar things, and there are a bunch of entities in those
markets that are already forced to register, and we will have
to think through carefully the implications of doing what we
propose on hedge funds. We are not quite there yet, though.
Mr. Thompson. Your proposal talks about harmonizing the SEC
and CFTC. Your opening remarks talked about, or more earlier
responses talked about statutes, both need to be brought in
line. And I wanted to just see, where is that harmonization
needed and where is it possible?
Secretary Geithner. Well, we hope it is possible generally
across the board because you have these two differences. You
have different basic statutes across the markets they are
responsible for, and you have different enforcement cultures
and enforcement approaches. And those two differences
themselves create a system that is not as good and strong as we
think we can have. So what we are trying to do is get the SEC
to bring them together and get them to propose ways to bring
those into conformance. And they are making some progress, but
they have a long way to go. But we are going to want to spend a
lot of time working through the detailed merits, alternatives,
of different approaches in those areas. But we are not far
enough along yet to go into any detail today.
Mr. Thompson. Thank you, Mr. Secretary. I yield back.
Chairman Frank. The gentleman from Massachusetts, Mr.
Lynch.
Mr. Lynch. Thank you, Mr. Chairman.
Thank you, Mr. Secretary. We had a chance to chat about
this a little earlier in the week. But I want to go back to the
system that the President's plan envisions, where you have
standard derivatives traded over an exchange, standard ones
being linear in many cases, well understood. And yet you have
another system right beside that parallel system for custom
derivatives trading privately with far less transparency. There
are a number of moral hazards here, and I want to have you
address them.
Number one, as the Chairman pointed out earlier, there is a
big payday for the banks and for the derivative designers on
the custom side of the house, much more so than on the
standards side.
Second, experience has shown us whenever you have a
regulated system operating beside an unregulated system, the
markets favor that unregulated system and the money migrates
over.
Third, the absence of an exchange by--the exchange serves a
purpose as a pricing mechanism, and a major problem with these
derivatives has been the accurate pricing of risk. And so you
are putting these custom derivatives off the exchange where
there will be, again, a mispricing of risk that will continue.
And, last, we are still allowing these gratuitous side bets
where folks can come in and take a bet where they have no
interest at all in the underlying asset. And those are all
moral hazards that are going to lead us to continue to have a
system that has gaping holes in it. And I just don't know how I
can support such a system.
Secretary Geithner. Congressman, I thank you for giving me
another chance to respond to that concern. We are proposing
comprehensive oversight, but we are not just overseeing the
participants in these markets but over all the products,
standardized or customized. We are proposing to give the SEC
and CFTC the authority they do not now have to enforce fraud
activities effectively in those key markets, whether
standardized or customized. And like you would expect us to do
everywhere, we are trying to make sure that the capital
requirements and margins are higher where risk is higher. And
that will help.
Mr. Lynch. But, sir, could I ask you about the pricing
mechanism? Where there is no exchange, you have these custom
derivatives being sold by private parties.
Secretary Geithner. But you are exactly right that you want
to have the standardized parts where you can have price
discovery and competition. The terms are standardized traded on
exchanges or on, as we said, open, transparent, electronic
trading platforms because of the benefits of price discovery.
But a customized unique special hedge that a utility that
provides energy needs, that is going to have to be a negotiated
product by definition. Because if they can't meet the needs
through the standardized product, they need to have the
capacity to go in that direction.
Now, you are in effect suggesting, as some have suggested,
that we force all of this stuff onto exchanges effectively
banning the capacity to the customized. And I would just would
caution you to listen carefully to the users of these markets
because you will find, as I am sure you are aware, companies in
industries across the country, small and large, trying to make
sure that we preserve that capacity.
So we are going to try to get that balance right where
there are the concerns you said. I think we proposed a
substantially better balance then we have today.
Chairman Frank. The gentleman from Texas, Mr. Hensarling.
Mr. Hensarling. Thank you, Mr. Chairman.
Mr. Secretary, I am going to paraphrase part of your
testimony. You essentially said, I believe, we are here because
the Administration inherited an economic mess. I don't
necessarily disagree with that assessment. I would say the
question is whether or not the Administration's policies are
making this mess better or worse.
Since the Administration has come to office, clearly you
know that unemployment has risen to 9.5 percent, the highest in
a quarter century: 2.6 million additional jobs have been lost
since the Administration has taken office. The public debt has
increased by almost $1 trillion or $7,430 per household.
Given that backdrop, I am having to look at this new
proposal that you bring before us today. In the Capital Markets
Subcommittee last month the 3M Company testified that they
projected that they would be looking at $100 million per year
on average in additional costs for a mandatory clearing
environment.
Now, I believe in questions by the gentleman from Kansas,
Mr. Moore, I believe you said something along the lines of: It
is very difficult to ultimately gauge the cost burden for those
who may have to go to a mandatory clearing.
Secretary Geithner. But I also said that typically the
costs of central clearing exchange are substantially lower.
Mr. Hensarling. I would ask this question, Mr. Secretary,
given this is just one corporation, but I have heard this from
other corporate entities as well. And listen, I am not
unsympathetic that improvements can be made in clearing these
derivatives, particularly with respect to transparency, with
respect to margins. But I am very concerned about a proposal
that at least, as of today, seems like we are trying to still
pin the proverbial Jell-O on the wall. If we don't ultimately
know the cost, we do know this: Less hedging can create less
credit, and less credit can create fewer jobs. And in this
economy, I am just very leery until I have convincing evidence
about the ultimate cost and the ultimate impact on our job
environment for moving forward on this.
And so I guess the question would be, when will the
Administration do modeling on jobs? When do we expect that
analysis?
Secretary Geithner. Congressman, as you know, you and I are
going to disagree very fundamentally on where you began your
question, which is the appropriate response of a country facing
a crisis like we inherited. But on the question you are
raising, which is about the benefits of hedging and how we get
the balance right between stability, innovation, and the
future, I suspect that our differences are much narrower,
again, because, as I have said many times here today, we trying
to preserve the capacity for hedging. We are trying to make it
better, more possible for our country to have both a more
stable, more resilient system, and preserve the capacity of
people that hedge against these risks. We are basically
committed to that. We are trying to make sure that innovation,
which is a great strength of our financial system, can proceed
in the future with less risk of catastrophic damage. But I
suspect that we don't--our differences are not as great. They
are probably very great where you began your question. And I
would be happy to talk about that at any time.
Mr. Hensarling. I hope that proves true, Mr. Secretary.
Sometimes I find myself agreeing with 80 percent of the
Administration's rhetoric and about 20 percent of their
policies.
The next question, Mr. Secretary, in your opening
statement----
Secretary Geithner. I am happy to consider alternative
recommendations and policies all the time.
Mr. Hensarling. I don't mean to put words in your mouth,
but I now have 30 seconds. I think you said again that some of
your critics you said were wanting to maintain the status quo.
Many economists believe that the greatest cause that we have
for the economic crisis was Fannie and Freddie, and yet your
reform proposal does nothing about Fannie and Freddie.
Secretary Geithner. I am very glad you raised that. It is
absolutely true that those institutions over time took on
enormous risk because of the implicit commitment of the
government to back them. And that is why Congress legislated a
reform framework over those entities last year, but that came
unfortunately late in the process.
Now, we are going to have to come to the Congress and
propose how to deal with the future of those entities. But now
is not the time to do that. And we are going to try and do that
carefully and well. But we agree with you that that is
something we are going to have to confront together, and we
will come to you. It is our responsibility to do that with our
best judgment about what to do, but we will look at a range of
options and we will work through that together.
Mr. Hensarling. Thank you.
Chairman Peterson. I thank the gentleman. The gentleman
from New York, Mr. Murphy.
Mr. Murphy. Mr. Secretary, I want to say thanks for all
your hard work on this, and I know that you have been pushing
for clearing of credit default swaps long before any of us ever
heard about it. I know you were out there and wish that we had
been able to get that done earlier than we are now. I have a
couple nuanced questions. I missed some of the testimony and
you may have answered this already.
In your testimony, you talk a lot about clearinghouses and
clearing stuff, putting it on exchanges. Do you see those as
one-to-one, or is there some transactions that might be cleared
and not on an exchange, or vice versa?
Secretary Geithner. Absolutely. There are some things that
can't be cleared and, therefore, can't be put on-exchange. And
you can have some products that can be essentially cleared that
don't need to clear on the exchange. But, yes, the answer is
that there are some products that, to meet a demand for a
particular utility to hedge a particular energy cost, you
probably can't centrally clear. A clearinghouse wouldn't want
to take on that product, wouldn't think that they could manage
that risk.
Mr. Murphy. Well, I don't want to discourage you from
products that we may be able to drive to central clearing,
because I think that does reduce systemic risk, that we not
require be on an exchange if there is not enough volume for an
exchange to want it, or for there to be any real price
discovery there.
Secretary Geithner. You are right to emphasize that. We
have been very clear to say we want to encourage standardized
to be centrally cleared. In fact, we are going to compel that.
And, we would like to see those products that are centralized
ending up traded either on exchanges or on electronic
transparent trading platforms, because of the benefits you get
to price discovery and liquidity in that method.
Mr. Murphy. The second point: Would considering putting
minimum requirements from margins for the clearinghouses?
Secretary Geithner. For the clearinghouses, absolutely. I
think one of the important things, because they concentrate
risk, you need to make sure that there are adequate margin
safeguards against the risk of default.
Mr. Murphy. I want to be confident. I think competition is
good, but I want to be sure we don't have a race to the bottom
where people shop for the cheapest clearinghouse.
Secretary Geithner. You are absolutely right.
Mr. Murphy. The last question, hedge accounting. I hear
from a lot of the companies I talk to that hedge accounting, to
be specific enough to get the treatment they want, requires
them into a customized OTC marketplace, kind of going against
what we are trying to do.
How can we address that to try to bring that together,
where people who truly are hedging aren't pushed to do
something that takes them off of a standard, or exchange
traded, or cleared product?
Secretary Geithner. You are absolutely right. The part of
the concern businesses have with banning customized products is
they are concerned that the accounting requirements--they would
not be able to meet those basic requirements. And that is one
important concern. But, the more fundamental concern is, again,
that not all risks that people have an interest in trying to
protect themselves against can be adequately captured by a
standardized instrument.
Mr. Murphy. I agree. But I guess the question is how do we,
for the risk that probably shouldn't be in the OTC market, not
let our accounting rules drive us into that? I guess I want you
guys as you are working on this, and for us to keep in mind,
that we should try to harmonize that so we don't drive stuff
into the OTC market that doesn't need to be there.
Secretary Geithner. Yes, I think that is a good thing to
take a look at. And of course we have an elaborate protection
independent of political influences, trying to think through
the accounting standards, and--but I agree with you that is
important to look at.
Generally, we have a problem where a lot of accounting
stuff runs against the basic interests of--well, I want to be
more careful in how I say that. I think you are right to try to
point out the importance of that.
Mr. Murphy. I think it is an important part of getting this
all right. We can try to push it in one direction, but if we
get into the accounting rules where we are marking one side of
the balance sheet to market and not the other, or we are
driving them to do something that moves them out of what is the
most stable financial system, those rules can actually have a
big impact on what people decide to do over here.
I yield back my time.
Chairman Peterson. I thank the gentleman. The gentleman
from Missouri, Mr. Luetkemeyer.
Mr. Luetkemeyer. Thank you, Mr. Chairman. Secretary
Geithner, welcome. I am just curious about the final comment in
your statement today or your suggestions in your statement
today was about working with our international counterparts to
ensure strict and comprehensive regulatory regime in our over-
the-counter derivatives. And I know we addressed it a couple
times here and got around some of the edges of it. Could you
just discuss that for a few minutes as to the size of the
involvement of our foreign counterparts. If you have had any
negotiations with those folks at this point; where do you see
the problems, or where you see the positives of where we need
to go with this?
Secretary Geithner. Let me give you one example to show you
how important this is and how you can do it and do it well.
Starting in 2004, 2005, the New York Fed brought together
the supervisors responsible for these markets, and for all the
major derivatives dealers responsible for 95 percent of trading
activities in these markets, around one table and compelled
them to agree to a set of measurable benchmarks for improving
standardization, automation, basic risk management, quality of
infrastructure in these core markets, because they were global
markets. And so that is one way to do it.
Mr. Luetkemeyer. How did you compel them to do that?
Secretary Geithner. Well, what we did is by getting the
supervisors to agree on a common framework of constraints and
reporting standards. We made it possible for each of those
institutions that exist in different countries, different
jurisdictions to be held to common standards. And we tried to
enforce it not through just supervision, but make sure there
was transparent reporting of performance across firms. And that
helped make sure there was a level playing field. That is just
one example.
The U.S. has been terrifically effective in the past in the
capital area decades ago in trying to get the world to come to
our higher standards, but we didn't--we are not effective
enough. But we are going to be very focused, as I said, in
trying to make sure we bring the world together around a table
to do it. We have a very elaborate set of cooperative
mechanisms in place today working alongside the legislative
process here.
Mr. Luetkemeyer. How much participation do we have from
other countries versus the amount of participation within our
own country? Do you have a percentage roughly on something like
that?
Secretary Geithner. You mean in terms of where market share
in these things are?
Mr. Luetkemeyer. Yes.
Secretary Geithner. I believe that--it varies a lot across
products, but I would say it is probably on average roughly 50/
50 U.S. and Europe. But don't hold me to that. I would be happy
to----
Mr. Luetkemeyer. Well, that gives us an idea of the
importance of the issues.
Secretary Geithner. I agree with you.
Mr. Luetkemeyer. Do you have some things that are some
problems right now with the way other countries are regulating
their securities markets that we need to be concerned about and
we need to watch for?
Secretary Geithner. Well, there is a--one concern I have,
is that these are global markets and you want to have a common
global framework, and there is a tendency in Europe to try to
come up with a European solution to managing risk in these
areas. And we had been very successful in the past in working
with Europe to come up with a common approach, because we think
that will be more effective in reducing risk.
And that is one example where, frankly, I am a little
concerned, that they want to come up with a separate approach.
And so we are going to try to work with them to make sure that
we end up with a thing that works for these markets and is
reducing overall risk.
Mr. Luetkemeyer. Thank you, Mr. Secretary.
Thank you, Mr. Chairman.
Chairman Frank. I have a proposal. We have a vote. There
are three Members left on the Democratic side. I am wondering
if Members could each do a minute and a half, pose a question
and have the Secretary respond. Would that be acceptable.
The gentleman from North Carolina, gentleman from Texas,
gentleman from Illinois. Maybe we can shave it a little bit
down to 1\1/2\ or 2 minutes for questions.
Mr. Miller of North Carolina. Good morning, Mr. Secretary--
or, good afternoon, Mr. Secretary.
Most of what you have discussed, justifying derivatives--
the purpose of derivatives is they are risk mitigation. They
are like insurance. But it appears that there is no requirement
with respect to derivatives that any party of the transaction
actually have an interest in the underlying asset, the asset
from which the derivative is derived.
Obviously, if there is no risk to mitigate, it can't be
risk mitigation. It doesn't appear to have anything to do with
capital allocation. The only justification I have heard is it
assists price discovery, and that the more transactions are
based upon the value of an asset, the more accurate the price
is. But that seems pretty thin given how huge the derivatives
market is.
Did you give any consideration to whether or not these
products should be allowed at all, if they do anything useful
for society? Do you think they----
Chairman Frank. The gentleman from--well, let's get the
question. The gentleman from Texas, do you have a question, a
quick question?
Mr. Green. I am sorry?
Chairman Frank. Does the gentleman from Texas want to ask a
question? We will try and get all the answers.
Mr. Green. Yes, sir.
Chairman Frank. Well, please ask your question, quickly, if
you will. That is what I had announced.
Mr. Green. Thank you, Mr. Secretary. I will get right to
it.
We have 8,246 depository institutions in this country. We
require that they be well-capitalized. We have a coffer within
which they pay an assessment, so as to provide the capital to
wind them down when they go out of business.
Is it true that what you plan to do is provide a similar
circumstance for nondepository institutions such that, when
they become troubled, we can wind them down, they are not to be
over-leveraged, they can engage in hedging without being over-
leveraged, such that we can wind them down in a similar
fashion?
Secretary Geithner. Yes.
Chairman Frank. All right. Ms. Bean, and then we will see
if we can get an answer. We will have one last questioner.
Ms. Bean?
Ms. Bean. Thank you, Mr. Chairman.
Thank you, Mr. Secretary, for being here today.
To pick one question, there have been concerns raised about
mandating clearinghouses to clear illiquid derivatives could
force untenable risk levels onto the clearinghouses from the
derivatives markets. How would you or your proposal address
that concern?
Secretary Geithner. Can I go in reverse order? Well, I will
go in a different order. I said yes to you----
Chairman Frank. Go.
Secretary Geithner. Okay. You need to make sure that there
are margin requirements and financial safeguards in the central
counterparties that are adequate to compensate for that
dramatic concentration of risk. That is the way to do it; you
want to make sure it is uniform across those.
You will have a chance to listen to businesses across the
country speak to your question, which is, is there economic
value in my capacity to take advantage of a derivative to hedge
against a risk? And, again, our judgment is, yes, there is, but
the system has to have greater protections around that.
But the existence of an underlying asset is not a good
measure about whether there is an economic value in the ability
to hedge. But this is a complicated question. I would be happy
to talk to you in more detail in another context.
Chairman Frank. The gentleman from New York, Mr. Lee, is
our last questioner.
Mr. Lee. I will shift gears here since I am sure you are a
little tired of discussing this. But this is an issue that is
near and dear to my heart and dozens of my colleagues on both
sides of the aisle, and it has to do with the Delphi retirees.
And hopefully you are familiar with this with the auto task
force, and the fact that you have, really, two groups here
being treated completely differently in terms of their pension
responsibilities.
The hourly workers got 100 percent coverage while the
salaried workers stand to lose potentially up to 70 percent of
their pension. In this past year, all of these salaried
retirees have lost their health care benefits and their life
insurance.
Being the fact that we now, in the government, own 60
percent of General Motors, I have been trying to reach out to
your organization, the auto task force, and trying to get some
answers for these retirees who are extremely frustrated. And I
would like your thoughts on this inequity and what we can do
about it.
Secretary Geithner. Congressman, there are an enormously
complicated set of tradeoffs in the judgments that have had to
be made as part of this restructuring process. And I would be
happy to have our team come meet with you and talk you through
why the judgments that have been made have been made and why
the alternatives were not tenable. I would be happy to do that.
Mr. Lee. Well, I would like to hopefully come up with a
solution. But, yes, I would appreciate having that opportunity.
So thank you.
Chairman Peterson. I thank the gentleman.
The gentleman from Oklahoma has a question.
Mr. Lucas. Mr. Chairman, I would like to add a letter from
3M on behalf of one of my colleagues, Mrs. Bachmann, and
another letter from the National Business Roundtable and a
number of other groups.
Chairman Peterson. Without objection.
[The document referred to is located on p. 59, and the
prepared statement of Mrs. Bachmann is located on p. 7.]
Chairman Frank. Mr. Peterson, I would just ask general
leave for any of the Members to include any materials that they
want.
Chairman Peterson. Without objection.
Chairman Peterson. With that, we will bring this to a
close. I want to thank Chairman Frank and all the Members of
both Committees for a great hearing, good questions, good
dialogue. And we look forward to working with the two
Committees together, along with the Administration, to make
this thing work. So thank you all.
Thank you, Mr. Secretary.
The Committees are adjourned.
[Whereupon, at 1:07 p.m., the Committees were adjourned.]
[Material submitted for inclusion in the record follows:]
Joint Submitted Letter by Hon. Frank D. Lucas; on Behalf of Business
Roundtable; Grocery Manufacturers Association; National Association of
Manufacturers; U.S. Chamber of Commerce
Hon. Barney Frank, Hon. Spencer Bachus,
Chairman, Ranking Minority Member,
Committee on Financial Services; Committee on Financial Services;
Hon. Collin C. Peterson, Hon. Frank D. Lucas,
Chairman, Ranking Minority Member,
Committee on Agriculture, Committee on Agriculture,
Washington, D.C. Washington, D.C.
Dear Chairmen Frank and Peterson and Ranking Members Bachus and
Lucas:
Businesses from diverse sectors and sizes across the United States
enter into over-the-counter (``OTC'') derivative transactions to manage
risks associated with their business operations, including fluctuations
in interest rates, currency exchange rates and commodity prices. A
survey of publicly-available information conducted by the International
Swaps and Derivatives Association found that more than 90 percent of
Fortune 500 companies use OTC derivatives. It is critical to note that
many of our members use them--not to speculate or augment short-term
profits--but as a normal course of business.
Many OTC derivatives contracts are bought and sold with standard
terms and conditions; however, there are also many derivatives
contracts that are customized to meet the unique needs and risk
exposures of individual companies, including such basic terms as dates,
rates and notional amount. When businesses employ derivatives in this
manner, they are not taking speculative positions. Quite the opposite;
they are seeking to reduce risks that arise from their business
activities. Whether standard or custom, OTC derivatives help American
businesses protect themselves from risk and improve their access to
credit.
We support efforts to ensure appropriate regulatory oversight of
market participants and their derivatives activities, consistent with
the objectives outlined by the Obama Administration in its white paper,
Financial Regulatory Reform: A New Foundation. More specifically, we
believe the right approach encourages central clearing for standardized
contracts where appropriate, while promoting transparency of customized
contracts through a reporting regime that ensures regulators have the
information necessary to oversee the markets. This approach strikes the
right balance: it reduces counterparty risk and enhances transparency
while maintaining an OTC market and the benefits it provides to our
members.
However, legislation requiring that all contracts be traded on
exchanges or be centrally cleared will prevent companies from using
non-standard products to reduce the volatility of their financial
statements and lower their cost of capital--thereby expanding, not
reducing, risk to companies. Such legislation would require companies
to divert cash from being used to sustain and grow their businesses to
meeting collateral and margin requirements. In short, the proposal
could dramatically expand the need for liquidity in the midst of a
liquidity crisis.
The customized terms and conditions of OTC derivatives contracts
cannot reasonably be standardized for exchange trading or mandatory
clearing. In fact, in order for companies to utilize hedge accounting
under FAS 133, and thus reflect the offsetting nature of a hedge in
their financial statements, they must prove a close and consistent
correlation between the derivative and the underlying asset or
liability. If a company could not do so, as likely would be the case if
only standardized instruments were available, the benefits of its hedge
transactions would not be shown in its financial statements, thereby
increasing earnings volatility.
In short, please ensure that any regulatory reform legislation that
moves in the House preserves the ability of our member companies to use
OTC derivatives to manage risk at prices and under terms that are
reasonable and continue to make sense from a business perspective. We
urge you to prevent an anti-derivatives sentiment from translating into
anti-business legislation.
Thank you for your consideration of our views and we look forward
to working with you.
Sincerely,
[GRAPHIC] [TIFF OMITTED] T1123.002
Larry D. Burton, Mary C. Sophos,
Executive Director, Senior Vice President and Chief
Business Roundtable; Government Affairs Officer,
Grocery Manufacturers Association;
[GRAPHIC] [TIFF OMITTED] T1123.001
Dorothy Coleman, R. Bruce Josten,
Vice President, Tax and Domestic Executive Vice President,
Economic Policy, Government Affairs,
National Association of U.S. Chamber of Commerce.
Manufacturers;
cc: The Members of the U.S. House of Representatives
______
Submitted Statement by Hon. Frank D. Lucas; on Behalf of 3M Company
3M Company (``3M'') is a large U.S.-based employer and manufacturer
established more than a century ago in Minnesota. Today, 3M is one of
the largest and most diversified technology and manufacturing companies
in the world.
3M thanks the Committees for studying the critical details related
to reforms to the U.S. financial system and for considering our
perspective in this important debate. In examining the concepts
outlined in the recent U.S. Treasury proposal on financial system
reforms, 3M respectfully urges the Committees to carefully consider the
distinct differences among various derivative products and how they are
used, and encourages the Committees to preserve commercial users'
ability to continue using derivative products to manage various aspects
of corporate risk while addressing concerns about stability of the
financial system.
Background on 3M
In 1902, five northern Minnesota entrepreneurs created the
Minnesota Mining & Manufacturing Company, now known today as 3M. 3M is
one of the largest and most diversified technology companies in the
world. 3M is home to such well-known brands as Scotch, Scotch-Brite,
Post-it, Nexcare, Filtrete, Command, and Thinsulate. 3M designs,
manufactures and sell products based on 45 technology platforms and
serves its customers through six large businesses: Consumer and Office;
Display and Graphics; Electro and Communications; Health Care;
Industrial and Transportation; and Safety, Security and Protection
Services. 3M achieved $25.3 billion of worldwide sales in 2008.
Headquartered in St. Paul, Minnesota, 3M has operations in 27 U.S.
states, including over 60% of 3M's worldwide manufacturing operations,
employing 34,000 people. 3M's U.S. sales totaled approximately $9.2
billion in 2008. While its U.S. presence is strong, being able to
compete successfully in the global marketplace is critical to 3M. 3M
operates in more than 60 countries and sells products into more than
200 countries. In 2008, 64% of 3M's sales were outside the U.S., a
percentage that is projected to rise to more than 70% by 2010.
Ahead of their peers, 3M's founders insisted on a robust investment
in R&D. Looking back, it is this early and consistent commitment to R&D
that has been the main component of 3M's success. Our diverse
technology platforms allow 3M scientists to share and combine
technologies from one business to another, creating unique, innovative
solutions for our customers. 3M conducts over 60% of its worldwide R&D
activities within the U.S.
Our commitment to R&D resulted in a $1.4 billion investment of 3M's
capital in 2008 and a total of $6.8 billion during the past 5 years
while producing high quality jobs for 3,700 researchers in the U.S. The
success of these efforts is evidenced not only by 3M's revenue but also
by the 561 U.S. patents awarded in 2008 alone, and over 40,000 global
patents and patent applications in force.
Our success is also attributable to the people of 3M. Generations
of imaginative and industrious employees in all of its business sectors
throughout the world have built 3M into a successful global company.
Our interest in speaking with you today is to preserve our ability to
continue to invest and grow, creating substantive jobs and providing
high quality products to a growing base of customers.
Treasury Proposal
Treasury Secretary Geithner proposed the establishment of a
comprehensive regulatory framework for OTC derivatives that is designed
to:
1. Prevent activities in those markets from posing risk to the
financial system.
2. Promote the efficiency and transparency of those markets.
3. Prevent market manipulation, fraud and other market abuses.
4. Ensure that OTC derivatives are not marketed inappropriately to
unsophisticated parties.
OTC Derivatives: Helping U.S. Companies Manage Risk in a Competitive
Marketplace
While 3M unequivocally supports these objectives, we have strong
concerns about the potential impact on OTC derivatives and 3M's ability
to continue to use them to protect our operations from the risk of
undue currency, commodity, and interest rate volatility.
Derivative products are essential risk management tools used by
American companies in managing foreign exchange, commodity, interest
rate and credit risks. The ability of commercial users to continue to
use over-the-counter (``OTC'') derivatives consistent with the
requirements of hedge accounting rules is critical for mitigating risk
and limiting damage to American businesses' financial results in
volatile market conditions.
We urge policy makers to preserve commercial users' access to
existing derivative products as you design new regulations. We share
the following comments with you in the spirit of working together to
address the concerns about the stability of the financial system:
1. Preventing Activities Within OTC Markets From Posing Risk To
Financial System:
We agree that the recent economic crisis has exposed
some areas in our financial regulatory system that should
be addressed. However, not all OTC derivatives have put the
financial system at risk and they should not all be treated
the same. The OTC foreign exchange, commodity, and interest
rate markets have operated uninterrupted throughout the
economy's financial difficulties. We urge policy makers to
focus on the areas of highest concern, such as credit
default swaps.
We would like to work with policy makers to address
oversight where warranted, but recommend that it be
targeted and not applied to all segments and market
participants.
2. Promoting Efficiency and Transparency within the OTC Markets:
We understand the need for reporting and record-
keeping. Publicly held companies are currently required by
the SEC and FASB to make significant disclosures about
their use of derivative instruments and hedging activities,
including disclosures in their 10Ks and 10Qs.
We would like to work with policy makers on ways to
efficiently collect information and enhance transparency.
Specifically, proposals have been made to establish a data
repository for OTC derivatives to ensure transparency and
disclosure. We understand and support this need for greater
transparency and oversight and could support providing on a
real-time basis the critical terms (amount, currency,
counterparty, rate(s), maturity) for transactions over a
specified minimum size (e.g., $250,000) for such a data
repository. Proposals have also been made to establish
regulatory supervision of the data, and we would look
forward to working with the regulating entity to develop
oversight parameters and participant practices that would
meet the goals established by Congress.
We oppose a mandate to move all derivatives into a
clearing or exchange environment. One key characteristic of
OTC derivatives for commercial users is the ability to
customize the instrument to meet a company's specific risk
management needs. Provisions that would require the
clearing of OTC derivatives would lead to standardization,
thus impeding a company's ability to comply with the
requirements of Financial Accounting Standard 133 (FAS
133). The inability to precisely hedge specific risks,
whether currency, interest rates or commodities within the
context of FAS 133, would expose corporate financial
statements to unwanted volatility and uncertainty. Results
could include lower valuations for companies as well as a
reluctance to undertake as many growth investments because
of the need to maintain some dry powder for adverse impacts
from unhedged financial risks.
While we are mindful of the reduction in credit risk
inherent in a clearing or exchange environment, robust
margin requirements would create substantial incremental
liquidity and administrative burdens for commercial users,
resulting in higher financing and operational costs.
Capital currently deployed in growth opportunities would
need to be maintained in a clearinghouse. This could result
in slower job creation, lower capital expenditures, less
R&D and/or higher costs to consumers. Hedging in the OTC
market is customized to fit the actual underlying business
risks being hedged. The clearinghouse concept relies upon
high volumes of standardized products, a characteristic
that does not exist in the customized hedging environment
of the OTC market.
By imposing initial and variation margin requirements,
clearinghouses will add significant capital requirements
for end-users, adding significant costs, discouraging
hedging, and diverting scarce capital that could otherwise
be used in further growing American businesses.
3. Preventing Market Manipulation, Fraud, and Other Market Abuses.
We support the appropriate regulatory agencies having
the authority to police fraud, market manipulation and
other market abuses. The CFTC is utilizing its existing
statutory and regulatory authority to add significant
transparency in the OTC market, receive a more complete
picture of market information, and enforce position limits
in related exchange-traded markets. The comment period
remains open on the CFTC proposal and this work should be
allowed to continue.
4. Ensuring That OTC Derivatives Are Not Marketed Inappropriately
to Unsophisticated Parties.
We support modifications to current law that would
improve efforts to protect unsophisticated parties from
entering into inappropriate derivatives transactions.
``Clearing'' in the OTC Market
The obvious benefits of clearing are the elimination of
counterparty risk and the facilitation of ``data collection'' for
executed transactions. By requiring a greater swath of derivatives to
be cleared, the ``costs'' of trading (for both dealers and end-users)
will rise. Increased costs will come in the form of trading fees,
margin/capital requirements, and administrative burden associated with
management of the margin requirements. This will likely result in:
1. an increase in market concentration among dealers, as marginal
players lose profitability, and
2. a decrease in hedging among end-users, as margin requirements
will pressure their capital/liquidity.
The second impact will likely hasten the concentration effect
mentioned above. Further, a clearing environment requires the use of
standardized instruments. Standardized contracts are unusable to most
end-users, as they do not permit companies to precisely hedge the risks
of their business. Any ``mismatch'' between business exposure and hedge
instrument could result in the end-user's loss of hedge accounting
treatment (FAS 133), thus creating additional income statement
volatility.
We believe that clearing should only apply to some of the products.
The currency, interest rate, and most of the commodity markets operated
well throughout the recent financial crisis. Clearing, however, may be
appropriate in other areas where authorities believe there is a high
degree of systemic risk present. Likewise, clearing may be appropriate
in the case of standardized instruments. Customized derivatives,
however, need to be tailored to meet end-users' business risk
management needs, making clearing problematic.
It is also important to remember that, particularly with interest
rate swaps and foreign exchange, these are global markets. According to
the Bank for International Settlements Triennial Central Bank Survey
(December 2007), just 15% of daily FX turnover occurred in the United
States, while 24% was the corresponding figure in the interest rate
(single currency) market. U.S. based companies could be put at a
disadvantage versus their foreign competitors should OTC trading
regulations change dramatically in the U.S.
In addition, warehousing is not appropriate for all trades. For
example, a large percentage of trades executed in the foreign exchange
market (well over 50%) are of very short (1 week and under) duration.
It would seem impractical to require warehousing for such transactions.
Warehousing probably makes more sense for ``term'' transactions of
longer maturity.
Conclusion
We thank the Committees for the opportunity to submit our comments
in writing as an employer interested in preserving and enhancing the
global competitiveness of American businesses and workers. 3M looks
forward to working with you as the Committees crafts legislation to
strengthen the U.S. financial system.
______
Submitted Questions
Response from Hon. Timothy F. Geithner, Secretary, U.S. Department of
the Treasury
Question Submitted By Hon. Steve King, a Representative in Congress
from Iowa
Question. Over the past 12 to 18 months, American taxpayers have
watched with great concern as their Federal Government has expanded its
reach deeper and deeper into the inner workings of our free market
economic system. As part of its efforts to stabilize our weakening
economy, the government, led by the Department of the Treasury and the
Federal Reserve, has injected billions of taxpayers' dollars into
various private entities. What's more, the government has taken an
ownership and/or significant financial interest in a number of these
entities. In my view, and in the view of many of the Americans, the
positions that the Federal Government has taken in these entities
amounts to de facto--and in some cases outright--nationalization. To
illustrate this point, I draw your attention to the relationship that
the Federal Government now shares with eight formerly private entities:
GM--Treasury has loaned $50B in taxpayer funds to GM and has
taken a 61% controlling interest in the company. Taxpayers have
also loaned $13.5B to GMAC and have provided $3.5B to the GM
auto supplier support program. The U.S. Treasury's Warranty
Support Program also backs GM's warranties.
Chrysler--Treasury has loaned $12B in taxpayer funds to
Chrysler and has taken a 9.85% equity stake in the company with
a right to appoint four directors. The U.S. Treasury's Warranty
Support Program also backs Chrysler's warranties. Taxpayers
have also extended a $1.5B loan to Chrysler Financial and have
provided $1.5B to the Chrysler auto supplier support program.
Fannie Mae--Fannie is currently under Treasury-directed
conservatorship and has received $34.2 billion in funding from
taxpayers. The Federal Reserve also holds $71.5 billion in
Fannie and Freddie's debt and holds $365.8 billion in mortgage-
backed securities guaranteed by the firms.
Freddie Mac--Freddie is currently under Treasury-directed
conservatorship and has received $51.7 billion in funding from
taxpayers. The Federal Reserve also holds $71.5 billion in
Fannie and Freddie's debt and holds $365.8 billion in mortgage-
backed securities guaranteed by the firms.
AIG--The Federal Government replaced the company's CEO, has
limited executive compensation, has provided $173.4 billion to
AIG, and has taken a 79.9% stake in the company.
Citigroup--The Federal Reserve has guaranteed losses on $306
billion of assets owned by Citigroup and Treasury has purchased
$20B in Citigroup preferred shares.
Bank of America--The Federal Reserve has guaranteed losses
on $118 billion on assets owned by BOA and Treasury has
purchased $20 billion of BOA preferred shares.
Bear Stearns--As part of a government-structured deal for
JPMorgan Chase to acquire Bear Stearns, the Federal Reserve
purchased $30 billion of Bear Stearns' assets through a new LLC
that the Fed created and controls.
Please detail for me the plan the Federal Government is following
to end its financial and/or ownership interest in each of these
entities and every other private entity in which it currently holds
some ownership or financial interest. What is the government's exit
strategy? What are the benchmarks that will be used to track the
progress being made? I believe it is imperative that the American
people be given a candid and thorough answer.
Answer. In late 2008 and early 2009, our country was in the midst
of one of the most severe financial crises of the past century, and the
economy was in danger of even further deterioration or collapse. The
initial actions taken by the Federal Reserve and the U.S. Government at
the onset of the financial crisis and the comprehensive, forceful, and
sustained commitment to fiscal stimulus and financial stability made
under the Obama Administration represented the first stage of our
policy response. Now, in part as a result of these actions, we are
entering the next phase of our efforts: moving from rescue of our
financial system to a period of stabilization, rehabilitation, and
rebuilding.
This next phase will focus on winding down those programs that were
once necessary to prevent systemic failure. The use of those programs,
by design, continues to decline as the financial system recovers, and
the U.S. Government is being repaid for its investments. But this phase
will also involve ensuring that those policies and programs that are
still necessary for financial and economic recovery are maintained and
well executed, making clear that the U.S. Government still stands ready
to do whatever is needed to ensure a lasting recovery.
The government's exit strategy for each policy you identify is tied
to its purpose. There are two basic categories. First, there are broad
policies and programs designed to restore and sustain confidence in
whole classes of financial institutions and the basic functioning of
key financial markets. This includes capital injections for banks, bank
liability guarantees, support for money market mutual funds and the
commercial paper market, initiatives to encourage lending to consumers
and businesses, and programs to stabilize the housing markets. Second,
there are narrow initiatives designed to support key financial
institutions.
I. Stabilization Policies
The broad policies aimed at stabilizing the financial system were
designed to terminate naturally. In part, the programs were designed to
protect taxpayers' interests by being increasingly expensive for
participants. Fees and other pricing aspects make them increasingly
unattractive as time passes and financial conditions stabilize. Indeed,
utilization of many of these programs has already declined
substantially as the participants have succeeded in raising capital in
private markets. Further, many of the programs have sunset provisions.
Below, we discuss these aspects of each of the major programs.
A. Troubled Asset Relief Program (TARP)
Treasury has used TARP authority to make a little over $200 billion
in capital injections in banks through the Capital Purchase Program
(CPP). This program was designed to stabilize the banking system,
because banks' balance sheets had been severely impaired during the
crisis due to losses on mortgage-related assets, increased borrowing
costs, and collapsing share prices. CPP funds were disbursed as
investments in which Treasury received preferred equity (or
subordinated debentures in some cases) and warrants. The preferred
equity provides dividends of five percent for the first 5 years of the
investment and nine percent thereafter.
Over $70 billion invested under the CPP has already been repaid. In
other words, Treasury has recovered over a third of its CPP investment.
In addition, Treasury has received roughly $10 billion in income from
CPP investments, including dividends, interest, fees, and proceeds from
the sale of warrants and some preferred equity. For the 23 institutions
in which Treasury's CPP investments have been fully repaid, Treasury
earned an annualized average return of 17 percent.
The Supervisory Capital Assessment Program (SCAP), more commonly
known as the ``stress test,'' contributed to the repayments to date by
helping to convince market participants that major banks could absorb
the losses that might come with an adverse economic scenario. The
enhanced market confidence enabled financial institutions to raise new
capital which was used to repay Treasury.
Treasury's authority to make new commitments under the CPP and
other programs authorized by the Emergency Economic Stabilization Act
of 2008 (EESA) will expire on December 31, 2009, unless the Secretary
of the Treasury decides to extend that authority to no later than
October 3, 2010. Therefore, the ability to provide new assistance under
EESA is limited to a time frame set by the law.
B. Money Market Mutual Fund Guarantee Program
At the height of the crisis last fall, Treasury established the
Money Market Mutual Fund Guarantee Program to prevent a run on money
market mutual funds in the wake of the failure of Lehman Brothers and
the well-publicized troubles of several large funds. This program--
which provided protection for about $2.5 trillion in investments--
expired on September 18. Due to improved market confidence, Treasury
has determined that it does not need to establish a successor program.
Since inception, Treasury has had no losses under this program. In
fact, it has earned the U.S. Government $1.2 billion in fees.
C. FDIC Programs
In response to the financial crisis, the FDIC's role as guarantor
of liabilities of depository institutions was expanded. Specifically,
the FDIC began insuring noninterest-bearing transaction accounts and
short- and medium-term senior unsecured debt issued under its Temporary
Liquidity Guarantee Program (TLGP).
Like the Treasury's CPP program, TLGP was designed to be expensive
for participants once market conditions improved. Early in the program,
fees to issue debt under the TLGP ranged between 50 to 100 basis
points, depending on maturity. The FDIC increased those fees on April
1, 2009, by 25 to 50 basis points. To date, the fees have generated
roughly $9 billion in income. As markets have stabilized, the cost of
borrowing in private markets has declined to levels that make TLGP fees
unattractive, and utilization of the TLGP debt guarantee program has
declined. Issuance peaked at $113 billion in December and was roughly
$2 billion in August. In addition, the stock of guaranteed debt has
fallen by nearly $50 billion since early June.
These programs are also subject to ``sunset'' provisions. After
receiving comments and determining that the program was still necessary
for market stability, the FDIC recently extended the guarantee on
transaction accounts under the TLGP to June 30, 2010. However, in doing
so it increased the fee from 10 basis points to 15-25 basis points,
depending on an institution's risk category. This fee increase will
help ensure that the program is self-funding and does not impose losses
on the Deposit Insurance Fund.
The last day for new issuance under the TLGP senior debt guarantee
program is currently October 31, 2009. On September 9, 2009, the FDIC
Board of Directors approved the phase out of this program as scheduled.
In conjunction with this phase out, the FDIC is seeking comment on
whether a temporary emergency facility should be put in place for 6
months after the expiration of the current program. Such a facility
could provide additional guarantees for new issuance, at a
substantially higher fee, in the event that participants are unable to
access credit markets due to market disruption or other events beyond
their control.
D. Federal Reserve Programs
The Federal Reserve has implemented a number of programs designed
to stabilize financial markets since the onset of the crisis. One set
of programs provides liquidity directly to borrowers and investors in
key credit markets. Such programs include the Commercial Paper Funding
Facility (CPFF), the Asset-Backed Commercial Paper Money Market Mutual
Fund Liquidity Facility (AMLF), the Money Market Investor Funding
Facility (MMIFF), and the Term Asset-Backed Securities Loan Facility
(TALF).
Utilization of these liquidity programs has declined as market
conditions have improved. For example, credit extended under the CPFF
has declined from a peak of $350 billion in January to $46 billion
recently, and lending under the AMLF has fallen from $152 billion to
$79 million. The Federal Reserve charges interest on loans under each
of these programs. Further, the Federal Reserve announced that it will
terminate the MMIFF on October 30, the CPFF and AMLF on February 1,
2010, and the TALF on June 30, 2010.
II. Policies to Support Systemically Significant Institutions
The government's interventions to support specific systemically
significant companies during this crisis have been focused on the
objective of stabilizing the financial sector and the economy while
protecting the taxpayers' investment. We have set clear principles to
ensure that our investments in those companies are limited and
temporary. We will not seek to participate in the management of their
day-to-day operations. We will exit these investments as soon as
practical, while protecting taxpayers and promoting financial
stability.
A. Auto Industry
The New General Motors and the New Chrysler recently emerged from
expedited bankruptcies. The government's support in that process has
prevented substantial job losses, led to orderly restructurings, and
helped stabilize economic and financial markets. In exchange, the
taxpayer received a combination of debt, preferred equity and equity,
along with a government commitment to manage those investments
commercially and exit from the investments as quickly as is
practicable.
The government has been a reluctant shareholder in General Motors
and Chrysler. It committed tax dollars on the strict condition that
these companies and their stakeholders were willing to fundamentally
transform, address prior bad business decisions, and chart a path
toward long-term financial viability without ongoing government
assistance. The government rejected the initial viability plans of both
companies, and it was only after a lengthy process that acceptable
plans were formulated and implemented, which involved sacrifices and
commitments from all stakeholders. Throughout the restructuring
process, the Auto Task Force has refrained from intervening in the day-
to-day decisions of these companies. Such intervention could seriously
undermine the companies' long-term viability and, consequently, the
government's ability to maximize the recovery of taxpayer dollars.
The termination of the Auto Warranty Commitment Program
demonstrates the government's prudent use of taxpayer funds and
commitment to exit. The government invested $641 million in the
Warranty Program to give confidence to GM's and Chrysler's customers
during a period of substantial uncertainty. Following the companies'
emergence from bankruptcy, the money invested in the program has been
returned, along with interest payments from New Chrysler. Similarly,
Treasury has decreased the commitments under the Auto Supplier Support
Program to $2.5 billion and $1 billion for GM and Chrysler,
respectively.
We also note that Chrysler Financial has fully repaid the
investment made by the government.
B. Government-Sponsored Enterprises
Government-Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac
experienced substantial losses from exposure to the housing market
during the crisis. In September 2008, they were placed in Federal
conservatorship.
The government has invested directly and indirectly in the GSEs to
maintain liquidity in the residential mortgage market. Treasury entered
into Preferred Stock Purchase Agreements (PSPAs) with the GSEs, whereby
Treasury purchased preferred equity in the companies and committed to
provide funding to the companies to compensate for shortfalls in
earnings, up to a maximum of $400 billion combined for both entities.
The GSEs have received approximately $96 billion under these agreements
and paid the government over $2 billion in dividends on the preferred
equity. Treasury and the Federal Reserve also established credit lines
for the GSEs. Neither has been used. Finally, Treasury and the Federal
Reserve have been purchasing mortgage-backed securities (MBS)
guaranteed by the GSEs, and the Federal Reserve has also purchased GSE-
issued debt.
The government's exit strategy for the GSEs varies by program.
Purchases under the PSPAs are limited to $400 billion in the aggregate.
Treasury's credit facility is scheduled to terminate at the end of this
year. Treasury will also complete its purchases of GSE MBS by the end
of 2009, while the Federal Reserve anticipates that it will complete
its purchases of GSE MBS and direct obligations by the end of the first
quarter of 2010. Treasury can hold its portfolio of GSE MBS to
maturity, and, based on mortgage market conditions, Treasury may make
adjustments to the portfolio.
Improving market conditions have benefited the GSEs. Their cost of
borrowing has come down dramatically since the peak of the crisis, and
the Federal Reserve has slowed its purchases of GSE debt. Freddie Mac
reported positive net income and net worth for the second quarter of
2009, while losses slowed at Fannie Mae. As a result, requested draws
under the PSPAs fell to $11 billion in the past quarter.
The government's investments and the conservatorship process have
helped keep mortgage rates at affordable levels for American families
and we look forward to working with Congress on the long term structure
of the GSEs.
C. American International Group (AIG)
Treasury and the Federal Reserve have provided credit to AIG in the
form of equity purchases (Treasury) and secured lending (Federal
Reserve). The Federal Reserve Bank of New York (FRBNY) provided a
credit facility in September 2008, and in connection therewith it
received convertible preferred shares. In November 2008, Treasury
purchased $40 billion in cumulative preferred shares from AIG which was
used to reduce some of the FRBNY's credit facility. In April 2009,
Treasury exchanged those cumulative preferred shares for $41.6 billion
in non-cumulative preferred shares and also created an equity capital
facility, which expires no later than April 17, 2014, under which AIG
may draw up to $29.8 billion as needed. The preferred equity provides a
ten percent dividend, and AIG has requested a little over $3 billion to
date through the Treasury facility.
It should be noted that the FRBNY contributed the convertible
preferred shares to a trust for the benefit of the taxpayer. The trust
is managed by independent trustees who are not government employees.
These trustees have the discretion to vote the shares, which represent
approximately 80% of the voting rights of the outstanding common stock.
They have elected a new board of directors, and that board has chosen a
new chief executive officer.
AIG's new management is working to unwind the complex financial
transactions that have generated substantial losses for the firm, and
they are working to improve the viability of the firm's core
businesses. Treasury will continue to work with the Fed and AIG to
maximize the recovery of taxpayer dollars.
D. Citigroup and Bank of America
The government has invested in Citigroup and Bank of America
through two programs: CPP and the Targeted Investment Program (TIP).
The government also provided guarantees to Citigroup pursuant to the
Asset Guarantee Program (AGP).
Through the TIP, the government purchased $20 billion in preferred
equity in each company. It also received warrants. The preferred equity
pays eight percent in dividends.
Only Citigroup has entered into an agreement with the government to
participate in the AGP. It is structured as a loss-sharing agreement
for $301 billion in residential and nonresidential assets. Citigroup is
responsible for the first $39.5 billion of losses on the assets.
Treasury covers $5 billion of the next loss, with Citi covering an
additional $0.55 billion. The FDIC guarantees the next $10 billion in
losses, and Citi covers an additional $1.1 billion. The Federal Reserve
would then provide a secured loan equal to 90 percent of the remaining
value in the pool collateralized by those assets, with Citi covering
other losses.
In return for their support under the AGP, Treasury and the FDIC
have received roughly $7 billion in Citi preferred equity, which
provides cumulative dividends of eight percent. There have been no
claim payments to Citi under the guarantee.
As part of an exchange offer to strengthen Citigroup's tangible
common equity capital, Treasury converted the preferred stock received
under the CPP investment for common stock which has increased
significantly in value. Treasury and the FDIC also converted the
preferred stock received under the TIP and AGP transactions for trust
preferred securities.
On January 15, 2009, Treasury, the Federal Reserve, and the FDIC
signed a term sheet with Bank of America to provide a guarantee of
losses on $118 billion in assets. The parties never entered into a
definitive agreement, and on September 21, 2009, the parties entered
into a termination agreement with respect to this arrangement, under
which Bank of America paid the government a total of $425 million. The
fee was paid because Bank of America received value from the agreed-to
term sheet, including the representation that the government would
guarantee losses from and after January 15, 2009 and the benefits that
signing the term sheet had on market confidence in the company. The fee
was equal to the fee that would have been payable had the definitive
documentation been entered into, as adjusted for the shorter period and
for certain changes to the asset pool that were discussed in the
negotiations.
We will continue to work with Citi, Bank of America, and their
regulators to ensure that they can repay the taxpayer as soon as they
are able.
E. Bear Stearns/JPMorgan
The Federal Reserve has not directly purchased any assets of Bear
Stearns. It has provided approximately $29 billion in loans secured
against former Bear Stearns assets in an entity called Maiden Lane LLC.
The Federal Reserve is a senior creditor and receives interest payments
for its senior loan.
The Federal Reserve retained an outside financial advisor to manage
the assets held in the Maiden Lane LLC portfolio. The advisor's primary
objective is to pay off the senior loan, including principal and
interest, while refraining from investment actions that would disturb
general financial market conditions. Financial statements for the LLC
are available at http://www.newyorkfed.org/markets/maidenlane.html.
III. Transparency and Oversight
Treasury, FDIC, and the Federal Reserve all publish detailed
information regarding their financial programs online and in printed
publications. Treasury recently published a report entitled The Next
Phase of Government Financial Stabilization and Rehabilitation
Policies, which is available at: http://www.financialstability.gov/
latest/09142009_statusReport.html.
In addition, details regarding Treasury programs authorized by
EESA, including new investments and repayments, are reported on the
Treasury's website: http://www.financialstability.gov/.
The FDIC publishes details of its programs, along with monthly and
quarterly reports, at: http://www.fdic.gov/regulations/resources/TLGP/
index.html and http://www2.fdic.gov/QBP/index.asp.
The Federal Reserve provides details of its programs at http://
www.newyorkfed.org/ and in reports and testimony available at: http://
www.federalreserve.gov/monetarypolicy/bst.htm and http://
www.federalreserve.gov/monetarypolicy/mpr_default.htm.
Several entities provide oversight of the government's financial
programs. For example, Treasury continues to work with the Special
Inspector General for TARP and the Congressional Oversight Panel to
improve transparency and management of its programs. Publications and
testimony from these oversight bodies can be found at: http://
www.sigtarp.gov/ and http://cop.senate.gov/, respectively.
The Office of Management and Budget and the Government
Accountability Office (GAO) also provide oversight of Treasury and FDIC
programs. The Federal Reserve is subject to oversight by Congress.
Board governors and staff testify before Congress frequently to discuss
issues within the Federal Reserve's purview. The GAO also has broad
authority to review and audit Federal Reserve activities. And the Board
of Governors and Reserve Banks undergo internal and external audits.
Question Submitted By Hon. Erik Paulsen, a Representative in Congress
from Minnesota *
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* There was no response from the witnesses by the time this hearing
went to press.
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Question. Some are proposing that all derivatives have to either go
on an exchange or be cleared. There are obvious problems with trying to
shoe-horn customized derivatives onto an exchange. There are also
significant costs to end-users to forcing derivatives to be cleared.
While many talk about the over 90% of Fortune 500 companies that safely
and prudently use customized OTC derivatives today, it is also true
that half of the mid-sized firms and thousands of smaller U.S.
companies also use these tools to manage specific financial risks. Do
you agree that requiring all derivatives to be cleared will lead to
margin requirements for all end-users? Do manufacturers have liquid
collateral for these margins easily at hand right now?
In response to concerns about the costs to clearing, I've heard
some say that companies will either find the money, or maybe fewer
derivatives will be used--and they are ok with that. But companies--big
and small--use these derivatives to protect against risks they face.
What happens to companies that can't find the collateral to finance the
use of derivatives? Would the company face more or less risk in their
day to day business? And is it in the best interest of the economic
growth of U.S. business to have capital tied up this way versus
investing it in research, plants or jobs?
The strict mandate for cash margin and collateral within the
clearinghouse environment has been pointed to as a severe constraint on
the end-users of OTC derivatives. End users say that they often use
plants and equipment and even real estate as collateral in their
current bilateral contracts. Clearing houses I understand have to
require cash under their regulatory rules. What are your thoughts on
the need to omit cash margin/collateral and provide broad flexibility?
By allowing real estate and other seemingly illiquid sources for
collateral/margin are we setting the stage for the next risk bucket or
should cash be king in this arena in light of recent events?
Banks currently use CLS (Continuous Linked Settlement Bank) for
foreign exchange settlements. On average CLS settles up to $10 trillion
each day in foreign exchange related payment obligations and has been
recognized by G10 central banks as a significant mitigator of
settlement risk in the foreign exchange market. Given that a platform
like this already exists in the foreign exchange market, do you support
significant modifications to the way the foreign exchange market works
and if so, why?
Question Submitted By Hon. Bill Cassidy, a Representative in Congress
from Louisiana *
Hon. Timothy F. Geithner,
Secretary,
U.S. Department of the Treasury.
Question. At the July 10, 2009 House Agriculture/Financial Services
Committee joint hearing, we spoke regarding the effects of the
Administration's proposal on publicly-owned utilities.
As follow up, not-for-profit public utilities have asked if
prepayment transactions utilizing tax-exempt financing for the
prepayment of contracts would be eliminated and are concerned that the
imposition of cash-margin requirements would drive up costs to
consumers.
How does the Administration propose to mitigate cash-margin
requirements for these public not-for-profit hedgers? In addition, has
the Administration considered imposing additional reporting
requirements for over-the-counter market transparency without the
standardized clearing requirement?
I appreciate your attention to these important questions as
Congress continues to work with you on striking the appropriate balance
between preserving stability in our markets and fostering innovative
methods for market participants to manage risk.
Sincerely,
[GRAPHIC] [TIFF OMITTED] T1123.003
Hon. Bill Cassidy,
Member of Congress.