[Senate Hearing 111-799]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 111-799

                        REFORMING U.S. FINANCIAL
                           MARKET REGULATION

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

                                HEARING

                               before the

                       COMMITTEE ON AGRICULTURE,
                        NUTRITION, AND FORESTRY

                          UNITED STATES SENATE


                     ONE HUNDRED ELEVENTH CONGRESS

                             FIRST SESSION


                               __________

                           NOVEMBER 18, 2009

                               __________

                       Printed for the use of the
           Committee on Agriculture, Nutrition, and Forestry









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           COMMITTEE ON AGRICULTURE, NUTRITION, AND FORESTRY



                 BLANCHE L. LINCOLN, Arkansas, Chairman

PATRICK J. LEAHY, Vermont            SAXBY CHAMBLISS, Georgia
TOM HARKIN, Iowa                     RICHARD G. LUGAR, Indiana
KENT CONRAD, North Dakota            THAD COCHRAN, Mississippi
MAX BAUCUS, Montana                  MITCH MCCONNELL, Kentucky
DEBBIE STABENOW, Michigan            PAT ROBERTS, Kansas
E. BENJAMIN NELSON, Nebraska         MIKE JOHANNS, Nebraska
SHERROD BROWN, Ohio                  CHARLES GRASSLEY, Iowa
ROBERT CASEY, Jr., Pennsylvania      JOHN THUNE, South Dakota
AMY KLOBUCHAR, Minnesota             JOHN CORNYN, Texas
MICHAEL BENNET, Colorado
KIRSTEN GILLIBRAND, New York

               Robert Holifield, Majority Staff Director

                    Jessica L. Williams, Chief Clerk

            Martha Scott Poindexter, Minority Staff Director

                Anne C. Hazlett, Minority Chief Counsel

                                  (ii)


                            C O N T E N T S

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Hearing(s):

Reforming U.S. Financial Market Regulation.......................     1

                              ----------                              

                      Wednesday, November 18, 2009
                    STATEMENTS PRESENTED BY SENATORS

Lincoln, Hon. Blanche L., U.S. Senator from the State of 
  Arkansas, Chairman, Committee on Agriculture, Nutrition, and 
  Forestry.......................................................     1
Chambliss, Hon. Saxby, U.S. Senator from the State of Georgia....     3

                                Panel I

Gensler, Hon. Gary, Chairman, Commodity Futures Trading 
  Commission, Washington, DC.....................................     5

                                Panel II

Billings, Jeff, Manager of Risk Management, Municipal Gas 
  Authority of Georgia, on behalf of the American Public Gas 
  Association, Kennesaw, Georgia.................................    35
Boling, Mark, Executive Vice President and General Counsel, 
  Southwestern Energy Company, Houston, Texas....................    32
English, Glenn, Chief Executive Officer, National Rural Electric 
  Cooperatives Association, Arlington, Virginia..................    28
Johnson, Robert A., Director of Economic Policy, The Roosevelt 
  Institute, on behalf of Americans for Financial Reform, New 
  York, New York.................................................    36
Schloss, Neil M., Vice President And Treasurer, Ford Motor 
  Company, Dearborn, Michigan....................................    30
                              ----------                              

                                APPENDIX

Prepared Statements:
    Nelson, Hon. E. Benjamin.....................................    52
    Billings, Jeff...............................................    54
    Boling, Mark (with attachments)..............................    65
    English, Glenn...............................................    75
    Gensler, Hon. Gary...........................................    79
    Johnson, Robert A............................................    90
    Schloss, Neil M..............................................   122
Document(s) Submitted for the Record:
    Joint Association Statement on Proposed Reform of Over-The-
      Counter Derivatives Markets................................   128
Question and Answer:
Lincoln, Hon. Blanche L.:
    Written questions for and responses from Jeff Billings.......   134
    Written questions for and responses from Mark Boling.........   136
    Written questions for and responses from Glenn English.......   142
    Written questions for and responses from Gary Gensler........   144
    Written questions for and responses from Neil M. Schloss.....   152
Conrad, Hon. Kent:
    Written questions for and responses from Gary Gensler........   147
Klobuchar, Hon. Amy:
    Written questions for and responses from Gary Gensler........   150
Stabenow, Hon. Debbie:
    Written questions for and responses from Gary Gensler........   148
    Written questions for and responses from Neil M. Schloss.....   152


 
                        REFORMING U.S. FINANCIAL
                           MARKET REGULATION

                              ----------                              


                      Wednesday, November 18, 2009

                              United States Senate,
         Committee on Agriculture, Nutrition, and Forestry,
                                                     Washington, DC
    The committee met, pursuant to notice, at 9:36 a.m., in 
Room 106 Dirksen Senate Office Building, Hon. Blanche Lincoln, 
Chairman of the committee, presiding.
    Present or submitting a statement: Senators Lincoln, 
Conrad, Stabenow, Nelson, Casey, Gillibrand, Chambliss, Lugar, 
Cochran, Johanns, Grassley, and Thune.

  STATEMENT OF HON. BLANCHE L. LINCOLN, U.S. SENATOR FROM THE 
    STATE OF ARKANSAS, CHAIRMAN, COMMITTEE ON AGRICULTURE, 
                    NUTRITION, AND FORESTRY

    Chairman Lincoln. The Senate Committee on Agriculture, 
Nutrition, and Forestry will now come to order.
    I want to thank Senator Chambliss and fellow members of the 
committee for being here today as we address one of the more 
important issues facing our nation and particularly our 
economy. I cannot overstate the significance of the subject 
matter of our hearing today. Financial market oversight reform 
is, quite simply, the single most important factor in our long-
term economic recovery. It will be the foundation for our 
nation's financial future, and reform is essential to reaffirm 
the integrity and the soundness of our financial system and to 
maintain our nation's preeminence as a global leader in 
worldwide financial markets. Perhaps most importantly, we need 
financial reform to give comfort to our consumers and the 
businesses so that they can trust our markets to determine fair 
prices and to help manage risk.
    Over the last decade, we have seen deregulation sweep over 
America in a way that has simply devastated our economy. From 
the tragedy of the Enron bankruptcy in 2002 to the massive 
failures of Bear Stearns and AIG in 2008, a steady stream of 
market calamities has exposed fatal flaws in our regulatory 
system. These flaws have cost America dearly.
    And given this reality, business as usual is simply not 
acceptable. Fundamental financial market oversight reforms must 
pass. It is important to remember that while we must correct 
mistakes of the past, we do not want to overreact or veer too 
far in the other direction. We have a very difficult needle to 
thread here, but we are certainly all very capable of it. We 
have no desire to, nor will we, act in a way that will prevent 
legitimate business activity or stifle innovation.
    But the word ``innovation'' cannot be a code word for 
unacceptable practices. Smoke-and-mirrors accounting schemes, 
massively leveraged by under- or non-capitalized transactions, 
or house-of-cards entities posing as investment vehicles are 
not the kind of innovation that prudent financial market 
oversight should foster. We can do better and we will.
    The task that is set before us is considerable, but it is 
not impossible. It is difficult, but it is not unattainable. It 
will be at times confusing, but the answers really are not 
impenetrable. We will get it done.
    Senator Chambliss and I intend to work together to produce 
legislation that will bring much-needed transparency and 
accountability to the over-the-counter derivatives market. In 
our legislation, I am looking to address issues such as 
prudential regulation related to enhanced capital and margin 
requirements, clearing of over-the-counter transactions, as 
well as a host of other matters, including forex trading and 
foreign boards of trade. The list is long, but we will get 
there.
    And I look forward to hearing from all of the interested 
participants, getting their views and cultivating a healthy 
debate on this topic. Today, we will focus specifically on 
three areas: End user margin and clearing, the definition of 
major swap participants, and mandatory clearing of standardized 
products.
    I particularly look forward to today's testimony from end 
users. Knowing the importance of cash flow and working capital 
to businesses, I will be paying great attention to what they 
say about clearing requirements and margin as I will to how we 
address systemic risk.
    On December 2, we plan to hold a second hearing, at which 
Treasury Secretary Geithner will testify, and we will further 
analyze these and other issues. I look forward to hearing views 
from all sides on these very important matters to all 
Americans.
    Lastly, I want to commend Senator Dodd for the draft 
legislation he released last week and its comprehensive view of 
the nation's banking oversight system. There are areas of 
mutual interest in financial market oversight, and I look 
forward to working cooperatively with him and his committee as 
we move forward.
    There is a lot of work to be done, but I know that we will 
pass reform legislation that truly does build something better. 
We owe that to America's consumers and businesses, and they 
deserve no less than our very best efforts to ensure that the 
U.S. financial oversight system promotes and fosters the most 
honest, open, and reliable financial markets in the world. It 
is our responsibility as Americans to be leaders in this 
direction.
    Thank you all for your time today. I look forward to 
hearing from our witnesses and from my colleagues as we move 
forward to reach this goal. And as I said before, it may not be 
easy, but we can do it and we will.
    So thank you all for being here today. I will turn to my 
friend and colleague, Senator Chambliss, for his opening 
statements and then we will return to our witness.

STATEMENT OF HON. SAXBY CHAMBLISS, U.S. SENATOR FROM THE STATE 
                           OF GEORGIA

    Senator Chambliss. Well, thank you, Madam Chairman, first 
of all, for your leadership on this issue and in particular for 
holding this hearing today.
    As you and I have discussed previously, we both strongly 
believe that the Senate Agriculture Committee and the Commodity 
Futures Trading Commission must be engaged in the development 
of any legislation addressing financial regulatory reform. This 
committee also has a responsibility to ensure that the CFTC 
continues to be able to effectively carry out its duties, and 
that is why I am really pleased that we have once again 
Chairman Gensler back with us to talk about not only the 
complexities of the issues, but the practicalities of where we 
need to go with respect to regulatory reform.
    While this issue is complicated, we cannot let the 
complexity of futures and swaps be an excuse for ignoring good 
public policy and ensuring that our markets are both safe and 
functional.
    In the past couple of years, a lot of people have become 
acquainted with one particular type of derivative known as a 
credit default swap, or CDS, which permits one party to 
transfer the credit risk of bonds or syndicated bank loans to 
another party. Since AIG was heavily involved in CDS, it seems 
simple enough to just blame swaps in general for the current 
financial crisis. However, that would be inaccurate, because 
the real situation is much more complicated.
    We need to distinguish between credit default swaps and the 
actual underlying securities represented by these swaps. Before 
we make a big policy change, like an outright ban on all over-
the-counter derivatives or a requirement that these products 
only trade on an exchange, we need to ask ourselves whether 
this will even address the underlying problem. Why take a 
chance in these uncertain times to make legislative and 
regulatory changes that could possibly make things worse, 
potentially dry up more capital and force the cost of doing 
business higher?
    This does not mean that there isn't room for improvement. I 
think the volatility that we have seen over the past year in 
some markets warrants extensive analysis and some regulatory 
changes. And while I may have concerns with some of the 
proposals that have been discussed to date, I am absolutely 
convinced that the market volatility and financial meltdown of 
the recent past make the case for more market transparency.
    How can we in Congress be sure of the outcome of sweeping 
reforms without first properly identifying the cause of these 
problems? And how can we identify the cause of the problem 
without authorizing and requiring more transparency through the 
collection of necessary data? Beyond requiring more 
transparency, I also believe this committee should explore how 
most effectively to regulate swaps, some of which are 
statutorily excluded from CFTC regulation and oversight. And we 
need to determine how best to encourage the clearing of certain 
derivative products without jeopardizing either the use of 
these risk management tools or the sustainability of our 
clearinghouses.
    If Congress is truly interested in addressing the problem 
as opposed to politicizing a solution, we can no longer ignore 
the complexities of these markets. We must devote time to 
understanding these instruments and their applications. We must 
seek to understand the legitimate purposes that these complex 
instruments serve for large and small businesses in each of our 
States. That is why this hearing is so critically important.
    I want to raise one final concern about financial 
regulatory reform. I would hope that as this legislation 
progresses through Congress, we will take whatever steps are 
necessary to ensure that it does not conflict with the Farm 
Credit Act and that it does not inadvertently hamstring the 
Farm Credit Administration and the entities that it regulates, 
the Farm Credit System and Farmer Mac. We know that the Farm 
Credit System and Farmer Mac did not cause or contribute to 
last year's financial crisis and that they have done a good job 
fulfilling their Congressionally mandated mission of providing 
competitive credit to farmers, ranchers, and rural America.
    We can thank our colleagues on this committee and the House 
Agriculture Committee for their insight and leadership years 
ago in establishing these entities and providing for a strong 
regulatory system through the Farm Credit Administration. I 
look forward to working with the Chairman and all of our 
colleagues on the Banking Committee to make sure the financial 
regulatory package does not negatively effect the Farm Credit 
Administration.
    Again, to my friend, the Chairman, thanks for holding this 
hearing. I know that it is a beginning of a process that 
recognizes the role of the Senate Agriculture Committee in 
broader financial regulatory reform efforts and I look forward, 
as always, to working side-by-side with you. Thank you very 
much.
    Chairman Lincoln. Thank you, Senator Chambliss, and I, as 
always, look forward to working with you. I think we have got a 
great opportunity to find a good outcome and really be 
productive for the people of this country and certainly the 
marketplace, which we want them to have greater confidence in, 
and we can do that from here.
    I would also like to echo the comments of my colleague, 
Senator Chambliss, on the Farm Credit Administration and the 
importance of recognizing that there is not a necessity here in 
any way or shape or form to try to put them into a position 
where they are hamstrung or not able to continue to do the good 
work that they have done, so I appreciate his comments there.
    We would now like to welcome Chairman Gary Gensler to the 
committee. Chairman Gensler, welcome once again to the 
committee. We are proud that you are here and looking forward 
to working with you on this tremendously important issue as we 
move forward and working through the details of how we put our 
markets and our economy back on track. I know you have got a 
great insight into this in your work from multiple different 
areas where you come. And I am also usually relieved because I 
know that when the day has ended, that you usually get your 
marching orders from four lovely ladies at home.
    So we appreciate how you are grounded and, more 
importantly, how you are working hard to make sure that we get 
this right. So we look forward to your testimony today, and 
welcome to the committee.

  STATEMENT OF HON. GARY GENSLER, CHAIRMAN, COMMODITY FUTURES 
               TRADING COMMISSION, WASHINGTON, DC

    Mr. Gensler. I thank you, Chairman Lincoln. I will mention 
to my three daughters your hello. And Ranking Member Chambliss 
and members of this committee, thank you for inviting me to 
testify on behalf of the full Commission today regarding 
regulation of over-the-counter derivatives markets and, if I am 
allowed, I am going to say a comment or two at the end about 
our joint efforts with the SEC on some harmonization efforts.
    But before I begin, I would really like to congratulate the 
new Chairman, Chairman Lincoln. I think this is the first time 
I am testifying before you as Chair. I want to thank Senator 
Harkin for his leadership of this committee and I look forward 
to working with all of you going forward.
    I would like to address regulation of the over-the- counter 
derivatives market in the context of two principal goals that I 
think there is a broad consensus around. One is promoting 
transparency of the markets, and two, lowering risk of these 
markets to the American public.
    In terms of transparency, the administration proposed and I 
fully support the following priorities. First, that all 
standardized derivative transactions should be moved onto 
regulated exchanges or transparent trade execution facilities, 
similar to what we have in the securities or futures markets. 
Increasing transparency for the standardized derivatives should 
enable both large and small end users to obtain better pricing 
on their derivative products. Just as transactions are on the 
securities markets and the futures markets available and you 
can see trade by trade what occurs there, and every corporate 
treasurer, assistant treasurer, or municipal government can see 
the transactions, we believe that same transparency will help 
benefit growth in America and promote market efficiency in 
America.
    If Congress were to exempt some end users--and I know you 
have a panel of end users you are going to be chatting with--
exempt end user transactions from a clearing requirement, I 
think that--and I believe that those transactions could still 
be required to be brought onto the trading platform--a trade is 
where buyers and sellers meet-- and still exempt them and 
separate out from the clearing requirement where there is this 
issue of posting margin that I know you will be talking about.
    Second, I believe all non-cleared transactions--these are 
the customized transactions which should still be allowed--
should be reported to a trade repository so that the regulators 
can at least see those transactions.
    Third, data on the transactions themselves should be 
aggregated and made available to the public in an aggregate 
form, for both the customized and the standardized products.
    And fourth, stringent recordkeeping and reporting 
requirements should be required for the swap dealers with an 
audit trail so that we can effectively look into these markets 
even after the fact.
    The administration has proposed, and at the CFTC we support 
lowering risk for American public. Again, I will talk about 
four principal components. First, standard over-the-counter 
derivatives transactions should be required to be cleared on a 
robustly regulated central clearinghouse. By guaranteeing the 
performance of these contracts submitted for clearing, clearing 
significantly reduces systemic risk. Clearinghouses 
significantly reduce systemic risk by removing the 
interconnectedness in this marketplace.
    I believe that all clearable transactions should be 
required to be brought into clearinghouses regardless of the 
end user, but if Congress were to decide to exempt transactions 
for certain end users, I would hope that would be narrowed to 
the corporate end users and it wouldn't exempt transactions, 
for instance, with hedge funds and other financial investment 
funds. I think there is a difference in the needs of those. 
Also, I would hope we would still bring them into the trading 
requirement and exempt them from the margin or the clearing 
requirement.
    Second, swap dealers and major swap participants would be 
explicitly regulated for capital, so they have a cushion 
against risk.
    Third, the dealers would be required to post margin 
themselves. This would be the dealers posting margin, not the 
end users in this case.
    And fourth, the CFTC and SEC should be authorized to 
mandate robust business conduct standards to protect the 
marketplace against fraud, manipulation, and even aggregation 
position limits for the commodity space in this marketplace.
    If I might just take a moment to say, we have been working 
with the SEC to harmonize some of our rules. We are different 
agencies. We have different missions, but we have a lot of 
overlap. We have actually put together a report the President 
requested with 20 recommendations, 11 of which will require 
legislative assistance from this committee and the rest of 
Congress. Some of them are in the administration proposal we 
have already sent up. I just wanted to highlight in my 15 
seconds left two, really quickly.
    One is I do believe with the significant risks that are in 
these clearinghouses, both futures clearinghouses, and new swap 
clearinghouses, that it is appropriate to look back to our 
oversight, the CFTC's oversight, of clearinghouses, bring some 
of the core principles that have worked well to international 
standards, and ensure that in certain circumstances that the 
CFTC has a little bit more authority to write rules. This was 
included in the administration's proposal and we have been 
working with the exchanges directly on some of that language.
    Second, we have found that our ability to enforce the 
markets and protect them against manipulations can be enhanced, 
and we have legislative language that we will be sharing with 
this committee on specific disruptive trading practices that we 
think it would be appropriate to try to enhance our ability to 
police these markets for manipulation.
    Again, we will be working with this committee on the other 
nine recommendations that need legislative assistance and I 
have included that in my written testimony. I look forward to 
working with this committee and Congress to bring this much-
needed reform to the over-the-counter derivatives marketplace.
    [The prepared statement of Mr. Gensler can be found on page 
79 in the appendix.]
    Chairman Lincoln. Thank you, Chairman Gensler. I appreciate 
your comments here today and am looking forward to working with 
you.
    I will start with my questions and then turn to my 
colleague, Senator Chambliss, and then we will go in the order 
that people arrived to the hearing.
    Chairman Gensler, it's my understanding that the more 
standardized a product is, the easier it should be or would be 
to clear and exchange trade, and that clearing and exchange 
trading are in some ways gold standard of risk management in 
the derivatives world. Given that, I do believe that moving as 
many of these contracts as we can through a clearinghouse or 
onto that regulated exchange is important. But I also believe 
there is a place for tailored contracts and some over-the-
counter market transactions.
    My question is really who should make the determination as 
to what is standardized and should be cleared? Should it be the 
clearinghouse or should it be the regulator? If it is the 
clearinghouse, in my opinion, that does look to be somewhat of 
a--I don't know. There is some concern there. My question to 
you is if, in fact, the clearinghouse was asked to do the 
clearing determination, what safeguards would need to be there 
and what is your position on who should make that 
determination?
    Mr. Gensler. I----
    Chairman Lincoln. Maybe you could also mention some of your 
response to Chairman Frank. I know that there was a back-and-
forth on that, as well.
    Mr. Gensler. Sure. I recall the first time I was in this 
committee room on February 25 for my confirmation hearing. This 
very question came up with then-Chairman Harkin. I believe that 
the regulators, the SEC and the CFTC, should have clear 
authority to determine that contracts are standard enough to be 
cleared. I believe we should also be able to rely on market 
mechanisms, that there is some presumption that if a 
clearinghouse were to accept it for clearing, that we should be 
able to hopefully rely on that, and the presumption is to get 
as many transactions and as many contracts to be cleared, and 
hopefully on these transparent trading venues.
    So to answer your question, I think the regulators should 
have clear authority to make the determination, but also be 
able to rely on some market mechanisms that the clearinghouses 
might, in fact, determine something is clearable, but we could 
add to that list and we would have to approve--to have a 
safeguard against the clearinghouse, we should also approve 
which transactions are clearable, hopefully by class of 
transaction just for efficiency. But in certain circumstances, 
we would do it contract by contract.
    Chairman Lincoln. But to make sure I understand what you 
are saying, you are saying that should be predetermined?
    Mr. Gensler. I think that it should be transparent. The 
marketplace should clearly know if they are entering a 
transaction--if an end user is entering into a transaction, 
they should know, is this one that has already been designated 
by the regulators and the clearinghouse to be, quote, 
``standard'' or clearable, and I do believe, thus, it should be 
transparent, and as you say, predetermined, and that the 
clearinghouses have a role to play, but the regulators should 
have clear authority to make a determination.
    Chairman Lincoln. Thank you.
    A major swap participant is defined in the Treasury 
proposal as a non-dealer who maintains a substantial net 
position in outstanding swaps for the purpose other than to 
create and maintain an effective hedge, under the GAAP 
standards. I understand that some of the players want a limited 
definition of the MSP so as to not to kind of get pulled into 
that category, perhaps. Maybe there is reason for that for 
some, and for some, maybe there is not.
    Are you comfortable with the Treasury's definition of major 
swap participant? Are the GAAP standards the appropriate 
standard to determine hedging, and if not, what is? Is a 
substantial net position standard workable and is it going to 
capture all the institutions that pose the kind of systemic 
risk that we are trying to get at?
    Mr. Gensler. What we are trying to do in the legislation is 
ensure that there are two complementary regimes, that the 
dealers are regulated, they have to register and be regulated, 
have capital and business conduct standards, and then that the 
markets themselves have these clearing and trading 
requirements.
    Major swap participant is a term that nine months ago none 
of us knew. It was just created in the legislative language. 
But what it is really trying to address is the next AIG or the 
near-dealer, something that is not quite a financial 
institution, but it holds itself out to the public, as a 
substantial net swaps business. There are many counterparties 
that would be at risk if it failed. I don't know its broad 
category. It is not meant to pick up the thousands of end users 
or even the hundreds of end users. But I believe it should be a 
category that is included, that we not just bring this 
regulation to the five or six large financial institutions. 
They are sort of the next AIG or the next swap dealer category.
    Chairman Lincoln. Well, depending on what standards are 
going to be used to determine that, as an alternative, I mean, 
when you are looking for Congress to be helpful, could Congress 
use a gross notional exposure standard to determine who is 
going to register as a major swap participant, and if a gross 
notional exposure test is appropriate, what should the level 
be?
    Mr. Gensler. I would want to work with you and the 
committee to see if that would be appropriate. I think, most 
importantly, is that the full registration and regulation would 
be of swap dealers and the next, I don't know if it is several 
dozen, but the next several that really hold themselves out to 
the public as almost like a swap dealer and have a significant 
book of business with a lot of counterparties. And so I think 
it is more with regard to do they have other end users as 
counterparties as contrasted to are they just doing their 
business with Wall Street, would be the best test.
    And again, that is separate and apart from these issues of 
whether end users post margin or whether end user transactions 
are brought to trading venues. We should try to bring as many 
of these end user transactions into transparency.
    Chairman Lincoln. Well, I mean, obviously, if we are 
working toward something that is going to provide more 
oversight and regulation, then standardization and what we use 
to standardize is going to be a key question. So we look 
forward to working with you on that as I definitely think that 
is going to be important, to have something more definitive 
about what that standard is going to be.
    And I have gone over my time, so I am going to wait for my 
second round and I will defer to my colleague, Senator 
Chambliss.
    Senator Chambliss. Mr. Chairman, I guess if we could write 
down on paper very clearly what is standard and what is not 
standard, it would make our job a lot easier, and certainly 
that is something we are going to continue to wrestle with and 
work with you on.
    I want to, first of all, ask you a very practical question. 
We have got a very valued member of this committee who is here 
who also happens to be Chairman of the Budget Committee. As he 
moves forward next year, irrespective of what we do, we have 
got to have a clear picture of what it is going to cost. Part 
of the cost obviously is increasing the resources to CFTC to 
make sure that the new challenges that we give you, you are 
obviously capable of carrying out.
    CBO indicated that the House legislation would require an 
additional 235 employees by 2011 for CFTC--that is a 40 percent 
increase--resulting in an increased cost of $291 million over 
the next five years. Your agency's total appropriation for 
fiscal year 2009 was only $146 million. How will you implement 
these changes that are set forth in the House bill, for 
example, if you do not get the necessary increases in 
appropriations?
    Mr. Gensler. Well, I thank you, Senator. I think our 
agency, unfortunately, has been sorely under-resourced for a 
number of years. With Congress's help, we are just now back to 
the same staffing we were at in 1999, and that is even though 
the markets have grown at least four-fold and we have not yet 
even taken on this new authority, over what is nearly a $300 
trillion market. The swaps market is roughly, in notional 
amount, 20 times our economy. So that means every time you buy 
a tank of gas, you can think of about $1,000 of derivatives 
behind that $50 tank of gas, somewhere, on average, in the 
economy.
    So in staffing, we do believe that we would need probably 
in the order of magnitude, 235 people to add to the approximate 
2010 staffing level of about 650 people.
    Senator Chambliss. Okay. Many end users of derivatives have 
informed us that they do not believe that the benefit of 
clearing is worth the expense of posting margin at a 
clearinghouse, and we have talked through this time and time 
again. You have proposed that clearing members of a 
clearinghouse, such as financial institutions, could post 
margin to the clearinghouse for their end user counterparties 
who would then meet collateral requirements through credit 
arrangements involving non-cash collateral.
    I want you to help us think through this and help us 
understand how this would work with respect to daily margin 
settlement. What sort of expense do you believe these end users 
would incur in the form of fees or variation margin charges if, 
as you have proposed, their dealers were posting margin to the 
clearinghouse on their behalf?
    Mr. Gensler. The goal, I think, is to lower risk in the 
system and to move as much of these transactions off the books 
of the financial institutions once they have arranged them, and 
that is where the clearinghouse comes into place because it is 
safer than the financial institutions. No matter what we do in 
financial reform, financial institutions still, I believe, are 
going to be very large, complex, and they will house risk. That 
is their business.
    So if we can move these transactions in the clearinghouse, 
allow end users, just as they do now, to have individual credit 
arrangements, maybe unsecured or secured arrangements with the 
banks and have the banks move them to the clearinghouse and 
post the margin. Today, they are charged a credit arrangement. 
These swaps do have a credit fee in them.
    End users have raised their concern it might still raise 
their costs. They recognize there is a credit arrangement 
already, but it might raise their costs, and I recognize 
Congress might decide to exempt them. I hope we would keep any 
exemptions narrow, just to the corporate end users, hopefully 
not to the financial end users like hedge funds that do have 
liquidity and could post margin.
    Senator Chambliss. One practical aspect of that that I have 
a problem with is, for example, Delta Airlines, who is a big 
user of this type of transaction, having to put up an airplane, 
a 777, for each transaction, or any other company taking part 
of their non-cash collateral that they normally would post for 
a line of credit and having to put it up as collateral of some 
sort for one of these type transactions. Again, I am not sure 
how we resolve that to make sure that we do lower that risk you 
are talking about, but don't hamstring these companies from not 
having the ability to post those non-cash collateral assets for 
lines of credit that they have got to have.
    Mr. Gensler. Well, actually, Senator, today, many large 
institutions--I am not familiar enough with Delta's own 
finances, but many large corporations have credit arrangements 
with the large Wall Street firms that say if we hedge a 
transaction and there is an exposure that develops six months 
or a year later, that they do have some arrangement. They might 
not be securing it with an airplane, but in some way, they are 
being charged for that credit arrangement. Even today, there is 
no free lunch there. There is a charge for the credit 
arrangement. It is just that they are not posting cash, and I 
don't think they need to post cash in the future.
    Senator Chambliss. Let me go to one other area that we have 
talked about before, and you know my concern regarding, making 
sure that we don't take any action from a legislative 
standpoint going forward that handicaps U.S. markets as 
competitors from the standpoint of individuals utilizing 
foreign markets to carry out the same type of transaction that 
they are doing today on U.S. markets, and that we don't 
overregulate them.
    In your testimony and in previous discussions, we have 
talked about the fact that you want to make sure that any U.S. 
company that trades on foreign markets still provides CFTC with 
information regarding those transactions so that we can have 
total transparency, and I understand why that is absolutely 
necessary. If you have got somebody trading on a U.S. market 
and a foreign market, if we are going to be able to let the 
general public know the financial condition, obviously, you 
need to be aware of both those transactions, whether it is on 
foreign or U.S. market.
    Give us your thoughts about your impressions on the, number 
one, ability of foreign markets to give you the right kind of 
information, and secondly, on the receptiveness that you have 
seen from foreign regulators regarding providing information to 
U.S. regulators, both SEC and CFTC.
    Mr. Gensler. I think that the crisis was so severe, both in 
Europe and in the United States and in Asia, that we do have a 
very good consensus. I am optimistic. I have worked in Europe, 
I have been over there and I have talked to the regulators 
almost on a weekly basis. They put out a paper about a month 
ago that said that they are going to be mandating that the 
standardized contracts be brought into transparent trading 
venues, just as we are considering here, mandating that the 
standard contracts be brought into central clearing, and they 
have also said that for the non- standard contract, they would 
be requiring the banks to hold higher capital. They actually 
used the word, I think, ``significantly'' higher capital.
    Now, their legislative process is different. They will take 
this to the European Parliament next summer. So they are really 
watching very closely what the Senate and the House do here. 
But I am very optimistic that though different cultures, 
different political systems, we will come out about the same on 
this with Europe, and between Europe and the United States, 
that is over 80 percent of these markets, and I think Canada, 
Mexico, and Japan are likely to work with this, as well, along 
the way.
    So I think you are absolutely right, Senator, but I am 
optimistic that we will be able to achieve consistent 
approaches.
    On information sharing, we have been very clear. We just 
wouldn't want bank secrecy laws in another country to hold back 
that information.
    Senator Chambliss. Today, on certain oil contracts that are 
traded on the London Exchange, the London Exchange provides 
CFTC with certain information to help with that transparency. 
Is the information that you are getting today from the London 
Exchange on those contracts, for example, adequate to allow you 
to feel that there is total transparency with those customers?
    Mr. Gensler. It is the futures market, not swaps, but they 
have been very helpful. First, a year ago, they agreed to give 
us positions, and then two months ago, we negotiated further. 
Now they are giving us transaction data, as well.
    Senator Chambliss. And is that the type of cooperative 
effort that it is going to take from all foreign markets?
    Mr. Gensler. I believe it will, and as I said, I think I am 
optimistic that we will be able to see into their trading and 
trade repositories and vice-versa.
    Senator Chambliss. Thanks, Madam Chairman.
    Chairman Lincoln. Senator Stabenow?
    Senator Stabenow. Thank you, Madam Chairman, and welcome, 
Chairman Gensler. It is great to see you again. Madam Chairman, 
I also want to thank you for inviting Neil Schloss, the 
Treasurer of Ford Motor Company, a great Michigan company, to 
testify on a very important part of the discussion about end 
users. We welcome all of the others on the second panel, as 
well.
    To follow up on what Senator Chambliss was talking about in 
terms of the international cooperation, it sounds like you 
believe that we can develop a system for regulating the futures 
markets internationally, that what is happening--am I hearing 
you right--is something that you believe will allow us to do 
that? One of my concerns is that without having an 
international regulatory regime for energy commodity futures 
and derivatives tradings and so on, that we are going to see 
companies that use derivatives to hedge legitimate business 
risks being placed at a competitive disadvantage, potentially, 
if we are not confident that we can do that.
    So am I hearing you say that you are confident, and what 
else would you need from us to be able to support your effort 
to be able to make sure there is an international agreement 
that is good for our businesses?
    Mr. Gensler. I am optimistic. When the President met with 
20 heads of State in Pittsburgh, I think now we are about two 
months ago, he was successful in negotiating these core 
principles right in the G-20 statement to ensure that we 
brought the standard part of the markets onto clearing and onto 
trading venues. It was at that high a level, at the G-20 
included. And then the European Commission, as I said, followed 
up.
    So I am confident. It won't be exactly the same. It is two 
different cultures and two different political systems. But I 
am confident, and I agree with you, Senator, that we need that.
    I think it is important in the statutory language you pass 
here, if successful, that there be some recognition explicit 
authority for the Commodity Futures Trading Commission to 
register some foreign boards of trade. We have been using what 
is called a ``no action'' process, and I think that could be 
enhanced in statute. But I am confident overall that we will 
come close, maybe not exactly the same.
    Senator Stabenow. All right. Thank you. You and I have 
talked about concerns about end users and the impact of 
whatever we do, and we know that 92 percent of the largest 
American companies and over 50 percent of mid-size companies 
use derivatives to hedge business risk. So whether it is 
hedging the business risks associated with oil prices, as has 
already been talked about, or currency exchanges, the ability 
to provide financial certainty to companies' balance sheets is 
absolutely critical for them and for us in terms of jobs and so 
on.
    So I appreciate your comments and your efforts to protect 
end users from diverting needed capital by providing the option 
to post non-cash collateral to meet the clearing requirements. 
However, we are in a situation where we have many companies 
that can't use their non-cash collateral, such as a 
manufacturer who has a mortgage on a building because the 
mortgage agreement is preventing them from using it. I would 
dare say that anything right now that is viewed as non-cash 
collateral is taken, I would guess, for many, many of our 
manufacturers.
    So that still raises a great concern to me. I know you 
spoke a moment ago about arrangements that already exist, but 
this is very serious for our manufacturers and I wonder if you 
might speak to how you would handle that situation.
    Mr. Gensler. Well, I think that every manufacturer in your 
State and in all of the States suffered gravely when AIG went 
asunder and $180 billion of our taxpayer money, I mean, roughly 
$3.5 billion per State. I think in Michigan, it would be bigger 
because per person----
    Senator Stabenow. Right.
    Mr. Gensler. You could do the calculation. And so that is 
the risk we are trying to protect again, that large financial 
institutions aren't so interconnected with the economy at large 
and that we try to move these transactions over to these well-
regulated clearinghouses.
    I do think that there is a competing public policy interest 
that you just raised about the posting of margin, and that is 
what Congress is debating, these two public policy interests. 
One is lowering the risk of these financial institutions, and 
two is the interface with the end users.
    And that is why I truly believe we can also lower the cost 
to these end users by having every treasurer, every assistant 
treasurer being able to see on a screen where the transactions 
have traded. And so a manufacturer in Michigan would be able to 
see where a manufacturer in New York last traded and price and 
volume of the transactions. Even if Congress decides to exempt 
it from the clearing requirement, I think that would be just an 
unfettered good for manufacturers, to see the prices and the 
volumes of these transactions and have them--just as we do in 
securities markets.
    Senator Stabenow. Mr. Chairman, I agree with you on 
transparency, that is critical, and we are working through how 
we balance minimizing the risk to businesses, to consumers, to 
all of us in our economy and at the same time not creating a 
situation where we are diverting working capital that is so 
critically needed right now for so many of our businesses. And 
so I look forward to working with you as we work our way 
through to find the right balance.
    Thank you, Madam Chairman.
    Chairman Lincoln. Senator Gillibrand.
    Senator Gillibrand. Thank you, Madam Chairwoman.
    Today, we are going to hear from a number of our corporate 
end users on derivatives, and these companies obviously, as we 
have discussed already this morning, use derivatives on a daily 
basis to hedge risks that are an integral part of their daily 
risk and of their businesses.
    As we look at the regulation of derivatives going forward, 
my question is, do you see a difference in the various sources 
of derivatives and their ultimate uses, and I will give you 
some examples. For example, would you see a difference in a 
futures contract for copper that might be used to hedge the 
future costs of a manufacturing company's basic materials, 
which is sort of what Senator Stabenow is concerned about, 
than, say, an instrument like a credit default swap, which 
might have a less obvious benefit and has recently shown to 
have a greater potential detriment to the financial system?
    And just to boil that down a little bit, in the credit 
default swap market, we have two kinds. We have naked and we 
have covered. Naked means there is no underlying ownership of 
the assets that you are talking about. Covered is much more 
like an insurance policy. It is quite ironic that we heavily 
regulate gambling, which is like the naked variety, and we 
heavily regulate insurance, which is like the covered variety, 
but we don't regulate at all if it is called a credit default 
swap, which I think is what goes to your point, Mr. Gensler, 
about some of your concerns.
    So if there is greater risk associated with a specific 
derivative class, should they be regulated in a different 
manner with significantly higher safeguards associated with 
that regulation? For example, if you are going to be in the CDS 
market, do you want higher capital requirements so it doesn't 
undermine what Senator Stabenow is trying to say for a 
manufacturer that is trying to offset the price of copper 
because that is an input for their business, vis-a-vis another 
financial firm that may be using CDSs because it is a great way 
to create capital or a great way to hedge risk in a different 
respect?
    Mr. Gensler. I think, Senator, you raise an excellent 
point. I believe the draft administration bill allows this, but 
if it doesn't, it would be a worthy enhancement, to make sure 
that business conduct standards, capital charges, and the like 
could be set by different class--in terms of capital, it would 
be the bank regulators largely setting capital, but that they 
might be able to set capital different by class of contract. 
Credit default swaps are event contracts. One day, you think it 
is only this, and the next day, it gaps out and has a far 
different value because of the default. So it might be worthy 
to have different capital charges as an event contract, as you 
say. So I do believe there may be differences.
    On business conduct standards, the administration bill, I 
think, has a robust set of charges to the SEC and CFTC to write 
business conduct standards. Credit default swaps also have a 
very real interplay to the securities markets, with individual 
stocks and protecting against insider trading and manipulation. 
I believe it is there already, but we would look forward to 
working with you if you think there is more that needs to be in 
the administration proposal on business conduct standards.
    Senator Gillibrand. Well, I was mostly just interested in 
your opinion, if you think that this is an important issue to 
analyze fully and make recommendations on or not.
    Mr. Gensler. I do think that there are unique qualities of 
each category of swaps. Interest rate and rate swaps are very 
different than energy swaps, for instance.
    Senator Gillibrand. Right.
    Mr. Gensler. We have asked for authorities to set aggregate 
position limits across markets where they perform a significant 
price discovery function. I think that is important in the 
commodity space. It is not really applicable to interest rate, 
for instance.
    Senator Gillibrand. Right.
    Mr. Gensler. Credit default swaps, I do think have unique 
circumstances, particularly the interplay that you mentioned to 
the securities market and to issuers.
    Senator Gillibrand. Okay. Second area of inquiry: Has the 
CFTC examined the impacts of the reform proposals on small 
businesses and farmers who may not directly participate in the 
swaps market but may indirectly be utilizing derivative 
contracts through an intermediary? And an example of this is a 
greenhouse farmer may enter an agreement to receive natural gas 
at a certain rate through an intermediary, who in turn would 
then use a derivative contract with a supplier to lock in a 
fixed price for that gas. So my concern is what impact would 
these small businesses and farmers see from the proposals that 
are currently before Congress?
    Mr. Gensler. I believe, Senator, they would have a very 
real benefit. Right now, for many small businesses or small 
municipalities and nonprofits, when they use a derivative, they 
might just do one every two or three years. They often have to 
go out and hire a financial advisor, maybe pay $50,000 or 
$100,000 just for that advisor to give them advice. What do 
they do on this hedge, this important hedge for their business 
or hospital?
    I think if we bring transparency all the treasurers and 
assistant treasurers can see the pricing, we are going to see 
that small businesses actually are benefited. That is where the 
biggest information deficit is, is small and medium-sized 
businesses.
    Senator Gillibrand. Thank you. Thank you, Madam Chairwoman.
    Chairman Lincoln. Senator Conrad.
    Senator Conrad. Thank you, Chairman Lincoln, and thank you 
and welcome to the Chairmanship of the committee. We are 
delighted to have you as our leader and have great confidence 
in the skills that you will bring to this committee. We 
especially appreciated the leadership you provided in the last 
farm bill discussion, along with the Ranking Member, the 
current Ranking Member. We had a good team and we have got a 
lot of challenges ahead.
    I think this is one of the most important hearings of the 
year. I remember very well, Senator, several years ago, Warren 
Buffet called derivatives a nuclear time bomb, and we saw the 
bomb go off. I will never forget as long as I live being called 
after one of our Group of Ten meetings, Senator Chambliss, 
being called to the Leader's office, and I got there and there 
were the leaders, Republican and Democrat, of Congress and the 
Chairman of the Federal Reserve and the Secretary of Treasury 
and they were telling us they were taking over AIG the next 
day. They weren't there to ask us, they were there to inform 
us. And they told us in no uncertain terms they believed if it 
was not done, there would be a global financial collapse. That 
is about as stark as anything can be.
    So already, just on the AIG debacle, we have seen taxpayers 
saddled with $180 billion of debt. We must act to prevent that 
from ever happening again. I believe the administration 
proposals are important and balanced and a good beginning.
    I do want to register skepticism about a super- regulator. 
After having served on this committee for 23 years, I am 
concerned that CFTC would be down the end of a long dark 
hallway at the SEC, and I don't think that is appropriate. I 
would be very concerned about them not having the knowledge of 
the commodities that CFTC oversees that have been in CFTC's 
jurisdiction and domain and, frankly, in the domain and 
jurisdiction of this committee. So I do want to register 
skepticism on the notion of a super-regulator, but that is not 
what I want to ask you about, Chairman Gensler.
    We have heard from several end users who will be testifying 
on the second panel that if they are forced to come up with 
additional capital to meet the clearing costs, the additional 
capital required of clearing costs, that would put them in a 
difficult situation. One thing I would like to understand is 
how much are we talking about in terms of clearing costs? Can 
you put in perspective what we would be talking about in terms 
of margin requirements in a clearing situation?
    Mr. Gensler. Senator, I first want to thank you for your 
comment and support for the Commodity Futures Trading 
Commission. I, too, have found great expertise in the building, 
great staff that knows the derivatives market. As you look to 
the broader financial reform and councils and powers that are 
possibly considered for other regulators, I think it is 
important that market regulators, the SEC, as well, stay as 
independent, vigorous protectors of the markets and investors.
    In terms of the cost. You are correct. There is potentially 
a cost of the extension of credit. If somebody wants to hedge a 
risk, maybe they are hedging $100 million, a big risk, $100 
million of oil delivery, on the first day, the prices haven't 
moved. But a month later, the prices have moved and the 
question is, do they have to post something for that valuation 
difference.
    In the futures markets, one does that already. That is how 
futures have been regulated for 70-some years. In the swaps 
markets, it is all individually negotiated, and that is why I 
have used the same words--I have said, leave it individually 
negotiated between those end users and Wall Street. Allow them 
to do what they wish. Currently, there is some pricing in that 
credit arrangement. The end users have said they are concerned 
that if we require it, it might go up, and it is very hard to 
tell whether that is correct, whether that is one basis point 
in that example of $100 million.
    In natural gas, I am told, a lot of these current swaps 
will charge as much as five cents a million cubic foot for the 
credit arrangement. We don't have transparency in these markets 
right now, so I don't have good statistics.
    Senator Conrad. All right. My time has expired, but I would 
just say to you, I think you will find a lot of allies on both 
sides of the aisle on this committee with respect to CFTC 
jurisdiction. It is critically important to commodities, and 
many of us represent commodity States, that the regulator 
understand commodities. So I think you will find strong allies 
on this committee.
    Mr. Gensler. I thank you.
    Chairman Lincoln. Thank you, Senator Conrad, and I don't 
know that I need to echo that, but I will, that this committee 
does, or at least many of us do believe that.
    Senator Lugar.
    Senator Lugar. Chairman Gensler, a bipartisan financial 
crisis inquiry commission has been established to look at the 
whole crisis and derivatives. It is my understanding that they 
are to report their findings by December of 2010. Now, I 
remember a hearing in this committee held a year ago October by 
Senator Harkin, and we had excellent witnesses. They described 
at that point, and this is a year or more ago, that mortgages 
had been issued by local bankers and they sold them on to 
higher levels. They sold them on, packaging and packaging. 
Finally, they got pretty big packages at certain levels in the 
financial community and they sought firms like AIG, as it was 
mentioned prominently in that hearing, to get insurance. They 
were describing the derivative process as one of trying to 
obtain insurance for whatever risk there might be in those 
large packages.
    But then one witness intrigued us by saying that you could 
buy not only insurance, but you could also express opinions 
through derivatives. So we said, what is this, a public opinion 
poll? They said, not exactly, but nevertheless, if you still 
felt that you were not quite secure, you might bet on, for 
example, the failure of the banking system of Iceland, or 
Pakistan, or something of this variety. Some of these 
situations or opinions might come home and balance out your 
risks some more.
    Now, this was startling to all of us, but nevertheless, 
whether opinions are being expressed in such extravagant ways 
in derivatives, the mortgage thing did catch people's 
attention. I have read reports, and maybe you could confirm 
this, that as many as 25 million mortgages were issued that 
were subprime quality or worse. There was large encouragement 
by the United States Government for much of this. Some of it 
came really through some of our government firms. Private firms 
were encouraged, and banks, likewise, to do the same thing. 
This may not be the entirety of the world crisis, but it is a 
very large part of it, and that is why this inquiry by this 
commission is important. They need to identify really what it 
is that we are looking at here.
    At the end of the day, whether it was extravagance in terms 
of idealism by our government that everyone should own a house, 
even if they could not pay for it, and everyone ought to have a 
mortgage, and people tried to keep insuring this through 
various derivative instruments, it was a catastrophe. How do we 
prevent these kinds of excessive public sentiments? Is the 
transparency that might come through the legislation now, or 
with amendments that might be suggested by you, likely to 
solidify unwise decisions with regard to things like prime or 
subprime mortgages or other unusual loans or transactions? And 
what is meant when people called about the dark passages or the 
ideas that somehow there are sort of blacked out areas that 
those of us who are unsophisticated really don't know about and 
should not know about? Are all of these going to be uncovered? 
Will the transparency bring to light good transactions, and 
bad, transactions?
    Can you make a general comment about how we avoid the 
crisis again and how we identify correctly what happened this 
time so at least we might correct through public policy some of 
those areas?
    Mr. Gensler. Senator, I think there are many causes of the 
crisis, but I think we could all agree that the over- the-
counter derivatives marketplace was one of the factors--not the 
only factor. And in the marketplace, it is currently not 
regulated in Europe or here, or in Asia, so there is not 
transparency. But at the size that it is, and a notional amount 
nearly 20 times our economy, just to give it a whole size, 
there are many important and fundamental things it does--
hedging, corporations hedging their risk, interest rate, oil 
risks, and so forth. But there are, as you said, some event 
contracts, expressions of opinion, as you say.
    I do think that transparency in this marketplace, if we 
could bring as much as possible onto regulated exchanges, would 
help market participants foremost, that they would see the 
pricing. As Senator Chambliss earlier said, it was to determine 
the fair prices and hedge risk. I think moving transactions 
will allow end users to do that, but also that regulators could 
see the pricing.
    I think that we need to make sure that dealers have 
sufficient capital and that there are business conduct 
standards, and real rules of the road. It used to be, well, 
this is an institutional market. We don't need rules of the 
road because it is all big women and big men dealing with each 
other. And we are really saying, no, we need some business 
conduct standards here, as well.
    Senator Lugar. Well, I strongly favor the transparency that 
you are talking about. Likewise, I am cognizant of the costs 
that come with people who are using these markets. I think we 
must be thoughtful about this. The results of this catastrophe 
are really unparalleled, and the long term costs of this are 
going to be borne by our grandchildren. This is not just simply 
a business transaction proposition.
    Now, I am hopeful that transparency, at least inclusion of 
as much of this, leads to better decision making, both by 
businesses and government. My fundamental question is this. 
Even after we know the score, how do we prevent mistakes? Is 
the transparency likely to bring these things to the fore?
    Mr. Gensler. I think it is a big component. It is not the 
only component, and that is why we, I believe, need to also 
lower risk in the four ways that I mentioned in my testimony, 
getting as many transactions into the clearinghouse, away from 
these concentrated financial institutions. I mean, we only have 
five, six, seven that are really large in this industry right 
now here in the United States, and the same number overseas. So 
they are, in a sense, too big and too interconnected to fail. 
So we move the transactions away and make sure they have 
sufficient capital, as well.
    Senator Lugar. And hopefully give you sufficient capital to 
be able to enforce whatever the situation is.
    Mr. Gensler. Well, yes, because our $147 million this past 
year is small compared to any one department--any one swaps 
department of a large Wall Street firm. It is billions of 
dollars of revenue and costs.
    Senator Lugar. Thank you. Thank you, Madam Chairman.
    Chairman Lincoln. Thank you, Senator Lugar.
    Senator Cochran.
    Senator Cochran. Madam Chairman, thank you.
    One thing occurs to me, and that is what is the practical 
consequence of the changes the Obama administration is 
recommending that we make? What are the practical consequences? 
I know we have another panel that will come along and tell 
about how they use the markets to transact their business and 
to market what they sell and finance the transactions that they 
have to make to be successful in the marketplace. From your 
standpoint, though, are they wrong when they say that the Obama 
administration's proposals are going to cost more? Isn't that 
going to be passed on to consumers, like people who borrow 
money to buy cars or whatever, or businesses who use airplanes? 
Are the operational costs going to go up? What is your 
reaction?
    Mr. Gensler. I think the practical effect of the 
administration proposal, which I do fully support, is to lower 
the risk to the American public. Now, lowering the risk of 
these large financial institutions, which I think in some 
regards were mispricing liquidity, mispricing their capital, 
and had too little capital, could well take some leverage out 
of the system, some risk out of the system. And when you do 
that, they may well pass on costs. But I don't believe there is 
any free lunch, that the financial firms did get too highly 
leveraged and too much debt and through derivatives were 
possibly extending too easy credit, so to speak.
    So I do believe that the end users would be able to hedge 
their risk. They would be able to tailor products. We are fully 
supportive that they could customize products. I do believe 
they would get lower execution costs by the transparency 
initiative, and where the real sort of rubber meets the road is 
whether they are included in this clearing requirement, which 
it may well be that Congress decides not to require that, and 
that is the balancing act that Congress is looking at.
    Senator Cochran. Thank you. Thanks, Madam Chair.
    Chairman Lincoln. Senator Johanns.
    Senator Johanns. Madam Chairman, thank you.
    Mr. Chairman, it is good to see you. I want to start out 
and tell you how much I appreciate you taking the time to get 
around and stop by our offices. I think that is a very decent 
thing to do and very, very helpful in kind of thinking through 
some of these issues.
    I think you have a committee here that kind of approaches 
this and recognizes the obvious need to do some things here, 
but I think we also recognize that, done wrong, this has some 
very, very serious consequences even for farmers in North 
Dakota or Nebraska in terms of how they manage their risk and a 
whole host of other people, not to just mention the agriculture 
community.
    And I have some concerns here, I must admit. There is never 
time to go into all the concerns, so I am going to try to jump 
into a couple of things that just kind of jump out at me every 
time I think about this.
    The first concern is, to be very candid with you, this 
reminds me a little bit of the climate change legislation. In 
theory, we can all agree about its merits and what it might be 
doing, but in reality, if you don't get the world on board, you 
are not going to get very far.
    Now, if I were a small country out there, recognizing that 
just by its nature derivative trading is an international 
phenomena--I mean, we are trading in oil and commodities that 
sell in the international marketplace and hedging risk, et 
cetera--just by its nature, if I were a president of a small 
country out there, I would wait for the rest of the world to 
pressure down the regulatory atmosphere for the business 
community, and then I would find the sweet spots and I would do 
something different and I would gather all the business. What 
is going to stop that from happening?
    Mr. Gensler. Well, I think, Senator, that you are right 
that capital and risk know no geographic boundary or border. 
But I am optimistic, having worked closely with the Europeans 
and some of the other North American regulators, that we are 
going to come out with a consistent framework. There is still a 
lot in front of us, in front of this Congress, in front of the 
European Parliament. And I think these are the major centers of 
capital. So if we regulate our derivative dealers and the 
Europeans regulate theirs and we ensure through legislation 
that they can only have access to U.S. customers if they are 
comparably regulated, consistently and comparably regulated, I 
think that goes a far way.
    That hypothetical that you mentioned always gnaws at us and 
we have to find ways to close that. But that small country that 
you mentioned wouldn't have the capital, wouldn't have the end 
users in that country.
    Senator Johanns. But it might be able to attract it through 
its sympathetic regulatory atmosphere. I appreciate today it 
may not be much of a player, but it may be sophisticated enough 
to recognize. And you are--well, let me get to this, without 
bantering too much about this. You are never going to be able 
to assure us of that, are you? I mean, that is always going to 
be a risk and possibility if this legislation passes.
    Mr. Gensler. But I could ensure you this. If we don't do 
this in the United States, others won't do it. We have to show 
the leadership and, I think, rise to the occasion to bring 
regulation here. And the President was successful in Pittsburgh 
to get 20 heads of state to sign on. It was a brief statement, 
but an important statement about this. I think it is very 
encouraging.
    Senator Johanns. That is what we are being told about 
climate change, too.
    The second thing I wanted to ask about--two things relative 
to the margin requirements. Again, I would love to have an hour 
with you to delve into that deep, but let me delve into----
    Mr. Gensler. Tell me when you want to schedule it.
    Senator Johanns. Okay, great. We might do that. We will do 
that.
    Here is what worries me about the margin requirements. 
Number one, if I take this bank of money to put it into 
bringing down risk by posting, in effect, a cash bond of sorts, 
because that is basically how it works, I have taken that money 
out of the economy and it is now on the sidelines. Now, I have 
probably brought some risk down. In fact, in the no-risk 
transaction, we would require 100 percent and then there 
wouldn't be a risk. But that is not how a free economy works. 
So that is the number one concern, and I see I have just run 
out of time, but the second concern is this.
    The little guy out there, the small, medium-sized risk 
hedger, whoever that is, is going to be very limited in how 
much margin they can put up, how much capital they have access 
to in reality, and so I just worry that what you are really 
doing here, if you pound down on these margin requirements, is 
you have just set a course where bigger gets bigger and we 
exacerbate the problem of too big to fail. And I will guarantee 
you, sitting on the Agriculture Committee and the Banking 
Committee, it is a very bipartisan frustration that we are 
dealing with, too big to fail.
    Mr. Gensler. I share that frustration and that is what 
animates me. On the other side, is I think that the large 
financial houses are keeping a great deal of risk on their 
books. The largest financial houses often have between ten and 
20 percent of their balance sheet extending credit. Credit is 
being extended in these derivative contracts. They are central 
counterparties. They are not well regulated for it. They are 
also in the underwriting business and proprietary trading 
business and the leasing businesses and so forth.
    So that is why, as a public policy matter, and Congress 
will weigh trying to move as much of this into central 
clearinghouses but also weigh the concerns of these end users 
about posting margin. If they are exempted, I think the next 
panel, I am hoping you will hear, is fine and, in fact, it is a 
huge benefit for small and medium-sized companies to see the 
transactions trade by trade on trading platforms.
    Senator Johanns. Yes. I will just wrap up with this, before 
my microphone gets shut off. Transparency is good. I like 
transparency. I have tried to emphasize transparency is a good 
thing. How you execute that, again, I think it can send you 
down a pathway of just encouraging bigger and bigger and bigger 
to meet the requirements that we impose upon the private 
sector. Thank you.
    Chairman Lincoln. Senator Thune.
    Senator Thune. Thank you, Madam Chair.
    Mr. Chairman, I think the whole focus of this debate has 
got to be how do we figure out the right way, the balanced way 
to constrain some of the risk that led to this massive collapse 
and meltdown that we saw last fall. And I think a lot of this 
debate, too, comes down to some definitions, who is in, who is 
out, who is covered, who is not.
    And one of the questions I guess I would ask of you, 
because you stated earlier that the regulator should be the 
appropriate entity to determine what is a standardized 
contract, and I guess I would ask you, in light of that, how 
would you define a standardized contract?
    Mr. Gensler. I think--a very good question. I think there 
should be a presumption that if it can be cleared, a 
clearinghouse accepts it, it would be a presumption that it 
would be clearable. If it had a volume of transactions and had 
a pricing, clear pricing--one of the things about 
clearinghouses, they need to know what the pricing is of these 
transactions.
    I remember in February, actually, in front of the committee 
when then-Chairman Harkin asked me the question, I provided in 
writing, and I would be glad to get it to you, Senator, five 
different factors that could be. But it was related to a 
presumption that if it is accepted for clearing, then it would 
be standardized, if the clearinghouse took it. If there was 
such volume in the contract. If it was so similar, there was 
just one feature that was different, as if somebody was trying 
to evade the standardization, that would be a factor, for 
instance.
    Senator Thune. Okay. Do all derivative end users, in your 
opinion, create systemic risk to the financial markets?
    Mr. Gensler. I think that the greatest systemic risk is 
housed within the large financial entities. And though 
individual transactions don't, or even sometimes collection of 
transactions don't pose that type of risk, that when you go 
across, if we exempt a whole class of transactions, it is a 
significant part of the market. Again, there is not much 
transparency here. But the end user transactions are 
significant in dollar amount and even a larger number of the 
individual transactions, because usually end users have smaller 
transactions.
    Senator Thune. Right. Do you think that all end users ought 
to be subject to the same level of Federal oversight?
    Mr. Gensler. I am glad you asked the question. I am not for 
the end users having oversight. I am for the swap dealers 
having oversight and that the requirement would be on the swap 
dealer to bring the transaction into a trading venue, and that 
would benefit the end user. If Congress were to say that the 
transaction was brought into the clearinghouse, it would be the 
responsibility of the swap dealer to bring it in. But the end 
user wouldn't have oversight, if I can----
    Senator Thune. Okay. If you have a derivative end user 
like, say, for example, a rural electric cooperative who relies 
on standard over-the-counter contracts, should they be forced 
onto exchanges or central clearinghouses if it is a legitimate 
hedging transaction, something that they are simply doing to 
manage risk?
    Mr. Gensler. I think they should be able to manage risk 
however they wish to manage risk. If it is a customized or 
tailored transaction, then I would say no. But if a trading 
venue actually listed it for trading, it was so standard, it is 
a one-year contract for natural gas and it was similar to many 
of the transactions currently listed on the exempt commercial 
markets that we know of and talk about, ICE Atlanta, then the 
swap dealer would be required to bring it and make sure that 
small rural electric cooperative would be able to see the 
transactions of similar electric cooperatives in other States. 
They would never see the name, but they would see the price and 
volume. I think that would benefit them.
    Senator Thune. Okay. Thank you, Madam Chair. Thank you, Mr. 
Chairman.
    Chairman Lincoln. I think----
    Senator Conrad. Madam Chair?
    Chairman Lincoln. Sure?
    Senator Conrad. Might I just make a quick observation that 
in that meeting that I described where we were told government 
was going to take over AIG because there would be a global 
financial collapse if it was not done, what became clear is 
that AIG had written insurance contracts and they didn't have 
the capital to back up the commitment. And somehow, we have got 
an absolute obligation to make sure that can't happen again, 
and I don't know how you do that without some margin 
requirement. It would be unthinkable that we were to permit 
that same circumstance to occur again.
    Chairman Lincoln. I think we have got a few questions left, 
but we would like to do maybe one quick round, because we do 
have another panel and we do have a nomination hearing, so I am 
going to defer to my colleague, Senator Chambliss. I know he 
has got to step out for a few moments.
    Senator Chambliss. Thank you, Madam Chairman.
    Picking up where Senator Conrad left off there, you talked 
about some of these institutions being too big to fail and the 
sophisticated institutions that were dealing in this--that do 
deal in this market, and that those are the regular players, so 
to speak, in the market, versus the small businessman who might 
kind of almost inadvertently get involved in this.
    If we had total transparency, if AIG had been required to 
report to you or to the CFTC the nature and the details of all 
of their transactions, would not that have put not only CFTC in 
a better position, but the potential buyers of AIG products or 
investors in AIG products in a much better position to look at 
them and say, wow. They have got all these transactions out 
there and all these obligations out there, but they don't have 
the capital. And aren't these sophisticated traders just that? 
They are so sophisticated that they would have known that AIG 
was not capable of delivering on the products that they were 
selling, or that their capital was so low that there was no way 
they could meet those commitments and they wouldn't have made 
the investment if there had been total transparency at that 
time. Is my thinking right there?
    Mr. Gensler. Senator, I think that the markets need more 
than that. Transparency is critical----
    Senator Chambliss. I understand that----
    Mr. Gensler. --but as Senator Conrad said, I think the need 
to have the authority to effectively say an AIG or the next AIG 
has to have capital, has to have cushions really built in, and 
even business conduct standards and so forth, are critical, as 
well.
    Senator Chambliss. I understand that, and that is why we 
have got to look at the other portion of that. But from a 
transparency standpoint, isn't that correct, that investors 
would have been so sophisticated that they would not have made 
additional investments in AIG?
    Mr. Gensler. Though I would like to agree with you, as I 
would like to agree with every Senator, I think that the crisis 
showed that many sophisticated actors made whopping big 
mistakes. And AIG--I think we can't just rely on sophisticated 
actors making the choices. I think we need to regulate the big 
swap houses and make sure they have the capital and the 
business conduct standards right there.
    Senator Chambliss. I guess my point is, I don't disagree 
with what you are saying, but I agree that there has got to be 
transparency, and I think we have all said that today. There 
will be some additional issues relative to the margin 
requirements, position limits, whatever, but my point is that 
if we don't put in legislative language a requirement that 
there be total transparency and that transparency would lead an 
investor to shy away from somebody who is undercapitalized, 
then I think we have failed. So I want to make sure that we are 
talking along the lines of putting in legislative language the 
capability of an investor to be assured that the seller of a 
product does have the capital to back up that product.
    Mr. Gensler. I think such transparency would be a positive 
and a net benefit to the markets and I think it sounds like we 
are in agreement, but we need other factors, as well, in this--
--
    Senator Chambliss. I don't disagree with that, but yes. 
Okay. Thank you.
    Chairman Lincoln. Just quickly, in the last farm bill, we 
passed some reforms that granted CFTC the authority to regulate 
contracts with a significant price discovery function. I would 
just like to hear from you how those reforms are working. 
Specifically, how many of the SPDC reviews have you undertaken 
since you have been given the authority to do so and how do you 
plan to use this authority in the future?
    Mr. Gensler. I thank you. The authority really was looking 
at trading venues called exempt commercial markets and trying 
to bring greater regulation to those where the contracts were 
similar or look-alike, as the documents had significant price 
discovery. We went through rule writing in the spring, and then 
subsequent to the rule writing have put out the determination, 
I think it is 43 individual contracts. Because----
    Chairman Lincoln. That is more than predicted, I believe.
    Mr. Gensler. More than was predicted, that is correct. But 
subject to the rules, there are four factors to be considered. 
We have put them out. One has actually been determined to be--
because it was the first one we put out, the other 42 are still 
getting public comment and so forth-- one has been determined. 
It is the natural gas contract on ICE, and then ICE Atlanta 
then had to put in place the self- regulatory functions that 
this committee and Congress required of them, and we are 
getting now the reporting and so forth. And we are going to 
sort through--we are in a determination phase now, but we are 
going to sort through the other contracts. Most of them are in 
the--in fact, I think all of them are in the energy space.
    Chairman Lincoln. Thank you.
    Senator Conrad?
    Senator Conrad. Thank you, Madam Chairman.
    I want to go back to this question that was kind of ping-
ponging back and forth with Senator Chambliss, because I think 
it is very important we get this right. A couple of years ago, 
I was at a charity dinner and had seated next to me a man who 
was in charge of all derivatives trading worldwide for a major 
financial institution that no longer exists. They were brought 
down by this derivatives disaster. And during the course of 
this dinner, we talked about derivatives.
    I raised with him--because just a few weeks before, I had 
asked my staff to bring me a formula that is used to measure 
the risks of a derivative deal. I wanted to see if I could 
understand it, because I have a Master's in business and I 
would have had that training about the time most of the people 
running these companies would have had their training. So I 
just wanted to see, would I be able to understand it. They 
brought me a formula. I couldn't make heads nor tails out of 
it.
    I said to this man, again, who was in charge of all 
derivatives trading for this major firm worldwide, I said, how 
many of the top executives of your firm do you think understand 
these formulas that determine, supposedly measure the risk of a 
deal? He said, ``I don't think any of them understand it.'' He 
said, ``I don't understand it.''
    And I tell you, I remember my feeling when he told me that. 
My God, this is the guy that is in charge of derivatives 
trading worldwide for a major company and he doesn't understand 
the formulas. And I understood, because, you know, I am pretty 
good in math. I couldn't understand it. And I will bet you a 
lot of money these guys would go to board meetings. Nobody 
wanted to be embarrassed and ask the question, what does this 
really mean?
    And in AIG's case, the vast majority of that company was 
sound. They were doing strong business worldwide. What brought 
them down was a 500-member outfit that engaged in these 
derivative deals, and they never--they couldn't conceivably 
back up the insurance products that they were selling. And they 
almost brought this whole thing to its needs.
    So for this member, transparency, absolutely. And to the 
point Senator Chambliss was raising, I do think it would make a 
difference if people were able to see, because, I mean, this 
gentlemen told me nobody knew how many derivatives deals were 
out there because there was no place it was reported. That has 
got to be.
    But then we have got to go another step. We have got to 
make certain that folks have the capital to back up the 
promises that we are making. Is that your position?
    Mr. Gensler. It is, Senator. I think that one of the 
critical functions of the regulatory group--and financial 
regulation failed the American public. I mean, there is no 
doubt about that. But the financial system also failed, and it 
wasn't just AIG. It is to make sure that these financial 
institutions, and they are more highly concentrated today than 
they were ten years ago--it is not uncommon, it happened in the 
airline industry, it happened in the drug industry--but in this 
industry, it is so consequential because they are intertwined 
in the fabric of every company, all the end users you will hear 
from and so forth, that they have enough capital, that their 
business conduct is such that it lowers risk, not heightens 
risk, and in my recommendation that we move what we can off the 
books into these central clearinghouses.
    They operate as a fiduciary duty, with a profit motive, as 
they should. They are for-profit companies. That means they 
want to make as much profit on as little capital and survive. 
They don't want to go under. But that is different than the 
responsibility to the taxpayers that I feel in my job every 
day, is to make sure that there is enough capital that this 
crisis can't happen again.
    Chairman Lincoln. Senator Lugar, anything else? Senator 
Cochran, Senator Johanns?
    Senator Johanns. I hope you don't take my asking hard 
questions as feeling one way or the other about this. I just 
think we have to ask hard questions. I once had a law school 
professor tell me--and anybody who has gone through law school 
has probably heard this--hard cases make bad law, this law 
professor said, and it is true. The most difficult AIG kind of 
cases can sometimes lead to terrible results if we are not 
paying attention.
    So let me just ask you on this margin phenomena, could AIG 
borrow money to make the margin call? I mean, they have access 
to great--or did have access to great capital at one time. 
Could a company go out under the administration proposal and 
meet the margin requirements by borrowing money?
    Mr. Gensler. They could. They could. But importantly, the 
large financial houses, like an AIG in the future, would be 
less interconnected because these transactions would have to be 
moved off of their books into these clearinghouses. What 
happened in AIG, they had about a $450 billion credit default 
swap book and their counterparties were not asking for margin 
to be posted. They said, well, they are fine, you know. And one 
day in September of last year, they were downgraded by the 
rating agencies and all of a sudden they had to post $30 
billion, and you know the rest of the story. The taxpayers put 
it up.
    Senator Johanns. It is just, you look at AIG and you wonder 
how people got paid so much to make such poor decisions, to be 
very blunt about it. And it is not just AIG. There were a lot 
of very, very bad things going on.
    To follow up on this question of capital to cover risk 
exposure, I mean, all of our economy is working with risk 
exposures. I buy a million-dollar life insurance policy, 
hypothetically. They are banking that they get to use my 
premiums long enough before they have to pay out on that. And 
in the world, some risk is--a situation in life insurance, 
well, some die sooner than expected, others don't, and on and 
on. But if you had a phenomena, say, in the casualty industry 
where you had a massive hurricane event, for example, yes, the 
claim problems can be absolutely overwhelming. They do not have 
oftentimes enough money sitting there to cover all of the 
claims, right? And isn't that the balance we are trying to 
strike here?
    Mr. Gensler. It certainly is, but I think this was more 
than just, if I can say it, an analogy of the 50-year flood or 
the 100-year flood. I think that the financial system had--and 
the regulatory system had real gaps and this over-the-counter 
derivatives marketplace is a real gap.
    We do have regulated securities markets. We have regulated 
futures markets.
    Senator Johanns. Sure.
    Mr. Gensler. This market is larger than the futures markets 
by orders of magnitude. I think we need to bring similar 
discipline to it.
    Senator Johanns. And again, I am going to work with you to 
try to get there. I just want to make sure that in this hard 
case, we don't make bad law. That is why I ask these questions. 
I think it is just important that we try to get a sense of what 
we are doing here, so thank you, Mr. Chairman.
    Mr. Gensler. I appreciate the hard ones and even the easy 
ones.
    Senator Johanns. Great. Thanks.
    Chairman Lincoln. Senator Grassley, we are finishing up the 
second round. If you have got anything for the Chairman, we 
would ask it now and we will then move to our second round.
    Senator Grassley. Thank you. We have questions from end 
user witnesses after you and they are going to testify that 
exemptions for bona fide hedgers and legitimate end users 
should be granted from regulated exchange requirements because 
it will, in short, break the bank. CAn you elaborate on what 
specific threats these users pose to financial stability?
    Mr. Gensler. Good to see you again, Senator. I believe that 
it is the large financial institutions that pose the greatest 
risk. But at the end of every financial institution, there are 
thousands of end users. So it is not any individual end user, 
but what we are really trying to do is lower the risk to the 
American public and promote transparency.
    Exchanges that you mentioned are actually a benefit to end 
users, and I think most end users would like to have 
transparency. What they are worried about is posting margin on 
something called a clearinghouse. A clearinghouse happens after 
the transaction, and while it is related to an exchange, I 
think that is what they are most worried about, is the cost of 
possibly posting margin. But the real risk is the large 
financial institutions being so interconnected.
    Senator Grassley. Your testimony includes support for a 
trade repository that would assist regulators. Could you expand 
on who and how this repository would be administered and how 
will this be kept independent from market players?
    Mr. Gensler. I think it is important that trade 
repositories and clearinghouses, which will serve in some way 
the public, broad public, be robustly regulated by the market 
regulators for governance, that the governance is an open 
governance and not sort of controlled by sort of a club deal 
amongst dealers. And the trade repositories are a place where 
all the regulators should be able to see the transactions. That 
is a regulatory transparency. And that our trade repositories 
and the European trade repositories, I believe, should be open 
and available that we can see as regulators that information.
    Senator Grassley. Okay. Probably all the witnesses at the 
hearing will agree with you that greater transparency and more 
information for both market participants and consumers will be 
beneficial. One recommendation is to aggregate data on the OTC 
trades and make them available to the public. Could you explain 
how you would make this available to the public but at the same 
time safeguard information that could be used to manipulate the 
markets?
    Mr. Gensler. As we do it, the CFTC, we put out a weekly 
report right now on the futures market and we aggregate data 
around large traders and we put that out every Friday. I think, 
similarly, we should promote aggregate data of customized and 
standardized product out to the marketplace. I do think market 
participants also benefit if individual trades are transparent, 
if they are standard enough to be listed on execution 
facilities. And that is really one of the best ways to protect 
against manipulation.
    But I also hope to work with this committee and you, 
Senator. I think we need to enhance the CFTC's authority to 
police the markets against manipulation and we do have some 
statutory language to address specific disruptive practices.
    Senator Grassley. Thank you, Madam Chairman.
    Chairman Lincoln. Thank you, Senator Grassley.
    Chairman Gensler, thank you again. You have been most 
gracious with your time. We appreciate that. We look forward to 
continuing to work with you as we move forward to find the kind 
of solutions that will really put our economy back on track and 
provide that kind of confidence in the consumer and the 
marketplace that we all know that we need, and more 
importantly, that we can provide, so----
    Mr. Gensler. Madam Chairman, members of the committee, I 
thank you and I look forward to working with all of you and 
making our staff and me available to any questions you have.
    Chairman Lincoln. Great. Thank you for joining us today.
    We would like to now call the second panel, if we could. 
First of all, we have got Glenn English, who became the fourth 
executive officer of the National Rural Electric Cooperative, 
chief spokesman for the nation's consumer-owned cooperative 
electric utilities. He represents the national interest of 
electric cooperatives and their consumers before
    the United States Congress and executive branch, the 
Federal agencies.
    We are also being joined by Mr. Neil Schloss, Treasurer for 
Ford Motor Company, a position to which he was elected in March 
of 2007. He joined the Ford Motor Company in 1982 as a 
financial analyst in the comptroller's office. From there, he 
has progressed through a series of finance positions at Ford 
Aerospace before transferring to Ford in 1990.
    We would also like to welcome Mark Boling, who is an 
Executive Vice President and General Counsel of Southwestern 
Energy Company. Prior to joining Southwestern in January of 
2002, he was in private practice in Houston, specializing in 
oil and gas transactional work.
    We are also being joined by Jeff Billings of the Municipal 
Gas Authority of Georgia, Manager of Risk Management. Jeff is 
responsible for the development and the execution of hedging 
strategies for the Gas Authority's hedging program. He also 
works closely with the members and partners of the Gas 
Authority to develop and implement hedging plans.
    And we are also joined by Dr. Robert Johnson. Dr. Johnson 
is an international investor and consultant to investment funds 
on issues of portfolio strategy. He currently serves on the 
United Nations Commission of Experts on International Monetary 
Reform under the Chairmanship of Joseph Stiglitz. Dr. Johnson 
is also the Director of Economic Policy for the Franklin-
Eleanor Roosevelt Institute in New York, and we are pleased to 
be joined by him as well.
    Thank you, gentlemen, for coming to work with the committee 
on such a critical issue and we look forward to your testimony 
and then are, again, grateful for your being able to stay and 
answer our questions, as well.
    Congressman English.

 STATEMENT OF GLENN ENGLISH, CHIEF EXECUTIVE OFFICER, NATIONAL 
  RURAL ELECTRIC COOPERATIVES ASSOCIATION, ARLINGTON, VIRGINIA

    Mr. English. Thank you very much, Madam Chairman. I, too, 
want to join others in congratulating you on your new position. 
We certainly are enthusiastic about the kind of leadership that 
we know that you will provide to this committee and to rural 
America in general, so congratulations once again.
    Chairman Lincoln. Thank you very much.
    Mr. English. Thank you. I think most of the members of this 
committee, certainly those that are present, are very familiar 
with electric cooperatives. I don't need to really go into the 
background about there being not-for- profit, consumer-owned, 
930 cooperatives in 47 States all across this country.
    But certainly we have a great interest in the subject at 
hand. We want to commend the committee and certainly encourage 
transparency, encourage any action that you can take that will 
deal with any market manipulation that may be taking place and 
any abuses that we may have seen in the past.
    I recall some 20 years ago--goodness, it doesn't seem that 
long, but 20 years ago when I served as Chairman of the 
subcommittee in the other body dealing with this very same 
issue, wrestling with some of the very same questions that I 
heard asked this morning. So this is one that has been with us 
and I commend you for continuing to work to get it right and to 
get it focused.
    I certainly appreciate and understand also that much of the 
discussion this morning is with regard to some of the larger 
participants in the derivatives market and the impact that they 
have had recently on our economy and some of the shortcomings 
that we have seen in that marketplace.
    I am here to represent some of the smallest of the 
participants in this particular market, but we have just as 
great an interest in a functioning market and legislation could 
have just as great an impact with regard to electric bills for 
those 21 million people who are represented on the Agriculture 
Committee through the cooperatives that you have in your 
particular States. And in this particular case, we find that we 
are concerned about one thing, and that is affordability.
    It is important for us to be able to hedge. It is important 
for us to be able to reduce risk. And certainly that has helped 
in keeping electric bills reasonable and affordable for our 
membership, and we need to continue to do that in the future. I 
think that a lot of the members of the committee fully 
understand how volatile fuels can be and the impact that can 
have on the electric bills of your constituents. Certainly, 
anything that we can do to bring stability in that area is 
certainly beneficial. So we want everyone to understand where 
we are coming from there.
    Interest rates swaps are also very important to us and can 
have a very big impact. As you know, we don't have a lot of 
cash on hand. Much of our cash has to go into that 
infrastructure. The 42 percent of the distribution lines of 
this country that are owned by electric cooperatives must be 
maintained by electric cooperatives. So we have a huge amount 
of infrastructure that has to be dealt with and a lot of the 
resources that we have go into that particular region.
    Not having money on hand puts us in the difficult position 
that the more volatility that is brought into constructing our 
plants and financing our infrastructure obviously means we have 
to go into the marketplace and borrow more money, and in some 
cases we have to borrow a lot of money. If we have one other 
element added, namely the volatility of fuels if we can't hedge 
without clearing, if we can't deal with swings in the 
marketplace, because it means we have to borrow a great amount 
of money for margin that is going to impact those electric 
bills each and every month.
    As the Chairman just recently discussed in response to a 
question from this committee, there is no question that the 
margin call issue is a big issue for us. It is a big concern 
for us. If, in fact, we are suddenly hit with the need for a 
margin call to go out and borrow a lot of money to be able to 
meet that margin call, that can have a huge impact as far as 
the electric bills of some local electric cooperatives. So 
where we are coming from and what we are focused on is dealing 
with this particular issue.
    Of the legislative proposals that we have seen put forth, 
both from Treasury and from others here within the Congress, we 
have been working with the various committees and trying to 
find out if there isn't some way that the smallest of those who 
use these markets, not for speculative purposes but for 
purposes of legitimate hedging, if there isn't some way in 
which we can assist the committee in this issue of providing a 
great deal more transparency while dealing with manipulation, 
but at the same time not impacting those electric bills of the 
folks back home, in trying to keep this thing at a manageable 
degree.
    Now, attempts have been made. Certainly, the Treasury 
Department has made that attempt, and one of the proposals here 
in Congress is to use GAAP. The difficulty that we have with 
using GAAP is that while it does through its exclusion provide 
a way in which you can deal with the margin issue, the question 
is whether we can qualify on any particular trade for GAAP. So 
it brings more uncertainty in, and uncertainty itself provides 
us with difficulty.
    So as the committee wrestles with this issue, as you look 
at how we can provide more transparency, if you look at how we 
might deal with any manipulation that might be taking place, I 
would simply urge the committee to do everything that they can 
to also keep affordability for some of the small users that are 
using it for legitimate hedging purposes in mind, as well.
    I thank the committee and I appreciate it very much.
    [The prepared statement of Mr. English can be found on page 
75 in the appendix.]
    Senator Conrad. [Presiding.] Thank you, Mr. English.
    We will go next to Mr. Schloss, the Treasurer of Ford 
Motor. Welcome.

  STATEMENT OF NEIL M. SCHLOSS, VICE PRESIDENT AND TREASURER, 
             FORD MOTOR COMPANY, DEARBORN, MICHIGAN

    Mr. Schloss. Thanks very much, and good morning.
    Senator Conrad. Please proceed.
    Mr. Schloss. Madam Chairman, Ranking Member Chambliss, and 
members of the committee, my name is Neil Schloss and I am the 
Treasurer of Ford Motor Company. I want to thank the committee 
for inviting me to testify and share the views of Ford Motor 
Company on a very important issue regarding financial 
derivatives and their regulation. The views that I express 
today are those of Ford Motor Company and their subsidiaries.
    Derivatives are an integral part of Ford's business of 
manufacturing, sale, and financing of vehicles worldwide. Ford 
employs derivatives to manage business risk so we can achieve 
stable cash flow and profitability in an increasing volatile 
global economy. We do not use derivatives to speculate or bet 
on potential changes in the economy or the financial markets. 
Our use of derivatives are focused on mitigating risks arising 
from our normal business operations.
    We fully support the legislation to increase transparency 
and oversight of the over-the-counter markets and participant 
activities. As an end user of derivatives, Ford would benefit 
from strengthening the derivative market and bank 
counterparties. We agree with general intent of most of the 
draft legislation that focuses on swap dealers and major swap 
participants and to exclude end users such as Ford and its 
affiliates from clearing, margin, and capital requirements.
    Like other end user manufacturers with captive finance 
companies, we are concerned that margin requirements would 
significantly increase our costs and liquidity requirements and 
could provide a disincentive to hedging our business risks. 
Most corporations do not have immediate and low-cost access to 
liquidity, such as the Federal Reserve discount window or FDIC-
insured deposits. An end user raising capital requires lead 
time and is often very expensive.
    Ford's use of derivatives shows why the regulations are 
critically important to all end users. As of September 30, the 
net fair value of our derivatives was about $800 million, and 
this is the amount that the bank counterparties would have to 
pay us to terminate existing transactions. Our total derivative 
notional outstanding is about $108 billion, which includes $93 
billion of hedging interest rates, $14 billion hedging foreign 
exchange, and about a billion hedging commodity price risks. 
The automotive derivative book is just over $7 billion, and 
that is small compared to historical levels, and especially 
small compared to our financial services book, which is about 
$101 billion. But as the markets change and as our business 
grows, that could change significantly.
    Although we see the merits of credit default swaps, or CDS, 
in facilitating risk management and access to capital, we do 
not buy or sell CDS derivatives ourselves.
    In the automotive business, Ford uses derivatives to hedge 
currencies and commodities in order to lock in near- term 
certainty for our revenue and costs for global vehicle 
production. We are a capital-intensive business with various 
manufacturing facilities producing and selling cars around the 
world. For example, we use over-the-counter derivatives to 
hedge currency exposure resulting from our F- series production 
here in America in U.S. dollars and some of the sales being 
sold in Canada and Mexico in Canadian dollars and pesos. 
Similar exposures and trade flows exist all over Ford's 
worldwide operations on finished products, components, and raw 
material.
    We also use over-the-counter derivatives to hedge 
commodities, such as aluminum and copper, and we opt to long-
term supply agreements to hedge those commodities that do not 
have a deep or liquid derivative market.
    Many of the product and sourcing decisions are made years 
in advance of when the product actually reaches the customer. 
Without hedging, we would be exposing ourselves and our 
customers to high volatility and price risk.
    One of the biggest concerns relating to the derivative 
market reform is the potential disruption that would have on a 
pretty fragile asset-backed securitization market. Mandatory 
clearing and margin requirements for securitization 
derivatives, which as you all know makes up a significant part 
of Ford Credit's funding today, would cause major structural 
changes on our existing transactions and future transactions in 
what is still a fragile market, despite TALF's success.
    During the credit crisis, many financial institutions 
curtailed credit capacity, but Ford consistently supported most 
of its 3,000-plus dealers and Ford Credit's portfolio of more 
than three million active retail accounts. It is vital in that 
recovery that the securitization market continue so we can 
continue to support our dealers and our customers.
    In our view, securitization trusts should qualify for end 
user exemption, as well, because securitization derivatives are 
uniquely structured and only protect the investor. In absence 
of end user exemption, we would strongly advocate that 
securitization derivatives be allowed an exemption similar to 
that which is being widely distributed for foreign exchange 
swaps and forwards in various Senate and House proposals.
    So in summary, we appreciate that Congress recognizes that 
end users such as Ford use derivatives to mitigate risk. As 
legislation is crafted, the distinction between pure risk 
mitigation and speculation is important to maintain. End users 
represent only a small fraction of the estimated $600 trillion 
outstanding in the over-the-counter market. All our derivatives 
are used to risk mitigate, and credit risk that is entailed 
within them are priced and fully paid up front when the 
transaction begins.
    We thank this committee for giving derivative market reform 
the serious attention it deserves and inviting us to share our 
views with you, and at the end of the panel, I welcome your 
questions. Thank you.
    [The prepared statement of Mr. Schloss can be found on page 
122 in the appendix.]
    Senator Conrad. Thank you, Mr. Schloss.
    Mr. Boling.

STATEMENT OF MARK BOLING, EXECUTIVE VICE PRESIDENT AND GENERAL 
      COUNSEL, SOUTHWESTERN ENERGY COMPANY, HOUSTON, TEXAS

    Mr. Boling. Thank you. My name is Mark Boling and I am 
Executive Vice President and General Counsel of Southwestern 
Energy Company, an independent energy company primarily engaged 
in natural gas exploration and production within the United 
States. I appreciate the opportunity to appear before you today 
and provide testimony regarding the very important legislative 
effort to reform the over-the- counter derivatives market.
    One of the biggest challenges in enacting legislative 
reforms for the over-the-counter derivatives market is that the 
term ``over-the-counter market'' covers a vast array of 
products across a number of markets, thereby making it 
extremely difficult to implement an effective one-size-fits- 
all solution. In this regard, it is important to note that 
energy derivatives did not cause the financial crisis of 2008. 
Credit default swaps and subprime mortgages did. It is also 
important to note that while we have witnessed the greatest 
economic crisis in 80 years and perhaps the most volatile 
commodity markets Southwestern ever experienced, over-the-
counter derivatives in the energy markets performed well, did 
not create systemic risks, and, in fact, helped many end users 
manage and hedge their risks during this very difficult time of 
extreme volatility.
    We support all legislative efforts to improve the 
transparency and stability of the over-the-counter derivatives 
markets and to ensure market integrity by preventing excessive 
speculation, manipulation, and other abusive practices. 
However, we believe that any such legislation must recognize 
the significant differences between the various derivative 
markets and make a clear distinction between those market 
participants that engage in hedging transactions with a goal of 
managing the price risk inherent in their business and those 
market participants that engage in speculative transactions 
with the goal of achieving profits through the successful 
anticipation of price movements.
    My testimony today will focus on four things: Why over-the-
counter swaps are so important to independent energy companies 
like Southwestern; the impact on Southwestern and other 
independent energy producers if they are required to clear or 
post cash margin for their hedging transactions; Southwestern's 
recommendation for the treatment of hedging transactions; and 
Southwestern's support of market transparency and reporting.
    Southwestern Energy Company is a growing independent energy 
company. Since 2005, Southwestern invested over $6.5 billion in 
its operations, all of which are located in the United States. 
These investments have resulted in substantial domestic job 
creation, increased direct and indirect business expansion, and 
significant Federal, State, and local tax revenues. Within our 
company alone, we have increased our employee base from 248 
employees at year-end 2004 to approximately 1,500 employees 
today, an increase of over 600 percent.
    Our ability to make over $6.5 billion of capital 
investments and create thousands of job opportunities during 
this period was primarily due to our ability to generate a 
reliable cash flow from the sale of our natural gas production 
and to gain access to additional funds borrowed under our bank 
revolving credit facility. The ability to generate our reliable 
cash flow was due in large part to our use of over-the-counter 
derivatives to lock in natural gas prices. Southwestern uses 
these derivatives as a risk management tool for our natural 
gas, a commodity that we produce, own, possess, and market. We 
do not use derivatives for speculative purposes.
    Southwestern regularly hedges its natural gas price 
exposure by entering into over-the-counter swap transactions 
with multiple counterparties with S&P credit ratings ranging 
from triple-B-plus to double-A. Southwestern has typically 
hedged 60 to 80 percent of its expected natural gas production 
volumes for the following year. Southwestern does not post 
collateral with any swap counterparty for a very good reason. 
Natural gas swaps lower Southwestern's business risk and makes 
it a much more stable company. Like all commodity producers, 
Southwestern is naturally long in commodity, and hence 
naturally subjected to the risk of falling commodity prices. 
Southwestern's swap counterparties understand that Southwestern 
is reducing its business risk when transacting over-the-counter 
swaps, and therefore the credit risk to the swap dealer is 
greatly diminished, thereby eliminating the need for 
Southwestern to post collateral.
    Increasing hedging costs by forcing all standardized 
derivative trades onto a clearinghouse will result in fewer 
market participants, more price volatility, and less price 
discovery. Because of the increased cost, fewer market 
participants will be able to hedge, or the ones that can hedge 
will hedge a lower volume. With fewer transactions and fewer 
participants in the marketplace, there will be more price 
volatility and less price discovery. By driving out the bona 
fide hedgers, the market share of speculators will increase, 
which does not create a healthy functioning environment. A 
healthy market requires a balance between bona fide hedgers and 
speculators.
    Finally, if the independent energy producers are forced to 
post cash collateral for natural gas hedging activities, they 
will be unable to fully invest in their business, the 
exploration and production of natural gas. The additional cost 
from posting cash collateral will be substantial and 
necessarily require that independent energy producers reduce 
their capital investments, resulting in a dramatic reduction in 
drilling activity, fewer jobs, and a significant decrease in 
domestic natural gas production.
    After analyzing the potential costs of posting cash 
collateral, Southwestern determined that during 2009, without 
hedging, Southwestern would have drilled 240 fewer wells in its 
Fayetteville Shale Project, resulting in the loss of 1,500 jobs 
and a total economic impact to the State of Arkansas of $1.6 
billion. In addition, fewer wells drilled in the United States 
means less domestic gas is produced, and less gas produced 
unfortunately means higher prices for consumers. There is a 
real world effect to a mandatory clearing requirement for all 
standardized over- the-counter derivatives.
    Southwestern believes the solution to these problems would 
be to provide an exemption from the clearing and margining 
requirements for bona fide hedging transactions where at least 
one party involved is a company that produces, owns, and sells 
the commodity and the transaction is directly related to 
managing commodity pricing risk inherent to that company's 
operating activities.
    In conclusion, a clearing requirement for over-the- counter 
derivatives, when applied appropriately, can play an important 
role in mitigating operational and counterparty risk for large 
segments of the over-the-counter derivatives market. However, 
we believe the broad application of a clearing requirement for 
all over-the-counter derivatives will hurt many American 
companies, particularly in the energy sector, by effectively 
taking away the most powerful tool for managing price-related 
risk.
    It is our hope that the concerns we have raised are 
addressed so that any proposed legislation does not 
significantly impair our ability to use derivatives to 
prudently hedge the risks we face in our day-to-day operations 
or to ensure our continued access to the credit sources we rely 
upon to grow our business. Ultimately, what matters most is 
that American companies continue to be allowed to cost 
effectively manage risk in a manner that enhances market 
stability and contributes to both the overall health of the 
economy and our country's goal of achieving energy 
independence.
    Madam Chair and members of the committee, this concludes my 
testimony. I would be happy to answer any questions.
    [The prepared statement of Mr. Boling can be found on page 
65 in the appendix.]
    Chairman Lincoln. [Presiding.] Thank you.
    Mr. Billings.

    STATEMENT OF JEFF BILLINGS, MANAGER OF RISK MANAGEMENT, 
 MUNICIPAL GAS AUTHORITY OF GEORGIA, ON BEHALF OF THE AMERICAN 
           PUBLIC GAS ASSOCIATION, KENNESAW, GEORGIA

    Mr. Billings. Thank you. Madam Chairman Lincoln, Ranking 
Member Chambliss, members of the committee, I appreciate this 
opportunity to testify before you today. My name is Jeff 
Billings and I am the Risk Manager for the Gas Authority of 
Georgia. The Municipal Gas Authority of Georgia is the largest 
nonprofit natural gas joint action agency in the United States. 
We have 76 public gas system members in five States, including 
Georgia, Florida, Alabama, Pennsylvania, and Tennessee. 
Together, these systems meet the gas needs of approximately 
243,000 customers.
    I testify today on behalf of the American Public Gas 
Association. APGA is the national association for publicly- 
owned not-for-profit natural gas retail distribution systems. 
There are approximately 1,000 public gas systems in 36 States.
    APGA's number one priority is the safe and reliable 
delivery of affordable natural gas. If we are to fully utilize 
natural gas at long-term affordable prices, we ultimately need 
to increase the supply of natural gas. However, equally 
critical is to restore public confidence in the pricing of 
natural gas. This requires a level of transparency in natural 
gas markets which assures consumers that market prices are a 
result of fundamental supply and demand forces and not the 
result of manipulation or other market abuses.
    Public gas systems depend upon both the physical commodity 
markets as well as the over-the-counter derivatives markets to 
meet the natural gas needs of our consumers. Both markets play 
a critical role in public utilities securities natural gas 
supplies at stable prices.
    Since 2005, APGA has been a strong supporter of increasing 
market transparency, limiting excessive speculating, and 
providing the CFTC with the resources it needs to protect 
consumers. APGA believes that provisions relating to the 
unregulated energy trading platforms contained in the CFTC 
Reauthorization Act passed last Congress was and is a 
critically important step in addressing our concerns.
    We commend this committee for its work on the 
Reauthorization Act. However, APGA believes that significant 
regulatory gaps still exist with respect to the over-the-
counter markets. Congress should provide the CFTC with 
additional statutory authorities to enhance transparency, limit 
excessively large speculative positions, and help prevent 
market abuses.
    As this committee considers reforms to OTC markets, we are 
extremely concerned about the cost impacts of proposals that 
would require all standardized OTC transactions to be cleared. 
Mandatory clearing would significantly impair the ability of 
public gas systems to engage in the gas supply strategies that 
we have historically utilized.
    Under current practices in the OTC markets, many public gas 
systems, based upon their very high creditworthiness, are not 
required to post collateral as long as their exposure stays 
below a predetermined threshold. In contrast, the mandated 
clearing of all OTC transactions would require public gas 
systems to post initial margin for all transactions and to meet 
maintenance margin calls whenever required and on little 
notice. This would constitute a significant financial and 
operational burden on public systems that would be borne 100 
percent by consumers.
    In the case of the Municipal Gas Authority of Georgia, 
mandated clearing would require, based upon our current hedge 
positions, the posting of initial margin in the range of $163 
to $243 million. In addition to the initial capital 
requirements, we would also be responsible for additional 
capital contributions based on mark-to-market calculations.
    It has been suggested that the clearing requirements would 
be less burdensome if some end users are given the option of 
posting non-cash collateral. Unfortunately, the alternative of 
using non-cash collateral would not provide any relief to 
public gas systems. Non-cash collateral would entail the 
deposit of liquid assets and public gas systems simply do not 
maintain liquid assets in the quantity necessary to meet the 
requirements associated with clearing.
    APGA understands that proposals to require clearing of all 
OTC transactions are intended to address issues related to 
systemic risk and prevent future bailouts. However, the hedging 
of natural gas supply purchases by public gas systems using 
non-cleared bilateral OTC derivatives do not prevent systemic 
risks to the market.
    In addition, the proposed mandate to clear all standardized 
OTC derivative transactions would increase costs for public gas 
systems and their municipalities, an increase which, again, 
would be borne 100 percent by consumers. This increase in 
consumer cost comes without any benefits. In essence, we feel 
it would be punishing the victims.
    We look forward to working with the committee towards the 
passage of legislation that strikes an appropriate balance that 
allows end users, such as public gas systems, to continue to 
use the over-the-counter markets without incurring additional 
costs to hedge risk while enacting reforms that would protect 
our financial system. Thank you.
    [The prepared statement of Mr. Billings can be found on 
page 54 in the appendix.]
    Chairman Lincoln. Thank you.
    Dr. Johnson.

 STATEMENT OF ROBERT A. JOHNSON, DIRECTOR OF ECONOMIC POLICY, 
 THE ROOSEVELT INSTITUTE, ON BEHALF OF AMERICANS FOR FINANCIAL 
                   REFORM, NEW YORK, NEW YORK

    Mr. Johnson. Madam Chairman, Ranking Member Chambliss, and 
members of the committee, I want to thank you for inviting me 
to testify before you here today. I represent on this day 
Americans for Financial Reform, who are a collection of 200 
organizations who are taxpayers, workers, and the end users' 
end user.
    The American people clearly sense that there is something 
deeply flawed in the current structure of our financial 
markets. The financial sector calamity spilled over and did 
great harm to the lives of many Americans and people throughout 
the world. When they are properly designed, financial markets 
play a fundamental role in the resource allocation of our 
society. Financial markets serve to aggregate savings and 
allocate them to productive use and to transfer risk to 
entities that bear it most comfortably. The system we have had 
in place in recent years and the one that is still in place as 
we meet today has revealed itself to be profoundly flawed.
    Efforts to repair these market structures in light of the 
crisis should address and seek to rectify four core problems: 
Excessive leverage, opacity and complexity, the ability to buy 
insurance without an insurable risk, and the misalignment of 
incentives, where the private incentive to take risk exceeds 
the social desire to bear that risk.
    Certain types of derivative structures have contributed to 
all of these problems and it is time for a thorough redesign of 
the market system to fortify the real potential derivative 
instruments and repair the obvious flaws in structure that have 
caused so much harm.
    I must admit that I am very surprised by the intense focus 
on end users of derivative instruments. They are at present, by 
their own claim, a relatively small part of the market, and 
that focus does appear to me to have substantially misdirected 
energy away from the essential task of financial reform that is 
before the United States Congress and that centers on the 
regulation of large-scale financial institutions who threaten 
our economic system.
    This diversion of focus on end users is not independent of 
that quest and it is a dangerous exercise for at least two 
reasons. First, efforts to legislate what type of institutions 
are exempt from restrictions of healthy market practice runs 
the risk of creating loopholes that could be large enough to 
drive a jet aircraft through. End users' exemptions are drawn 
too broadly and they would allow anyone and everyone to claim 
them, especially the large ``too big to fail'' institutions 
that stand next to the public treasury and are the dominant 
actors in the opaque OTC market. That would directly undermine 
the need to bring these markets out of the dark. It would 
enable the largest market participants to remain in the shadow, 
where they earn profits--extraordinary profits--but put society 
and the public treasury in peril.
    In addition, end user exemptions may inadvertently spawn 
large organizations or divisions of the organizations the 
incentive to create Enron-like entities as the risk implicit in 
creating legislation that confers special advantage for special 
types of market participants.
    A second danger is the exemption of certain classes of 
financial products, such as foreign exchange forwards and swaps 
or any products that are traded on foreign platforms and serve 
to drive more activity offshore, perhaps to locations where the 
underpinning market structures are themselves quite unsound. 
Foreign exemptions will also divert creative energy into the 
creation of complex foreign exchange-based products to qualify 
for the exemptions and avoid the scrutiny and structures that 
they require for systemic safety.
    There has been a great deal of recent testimony, and it 
goes into some length to justify end user exemptions. This body 
of testimony tries to illuminate the consequences for end 
users, require them to trade upon exchanges or submit their 
transactions to clearinghouses. While I do agree that some 
increase in cost will be borne by these end users if the 
current structures are replaced by more robust and healthy 
market structures, I believe the magnitudes of the costs they 
report that they would incur pale in comparison to the cost 
this crisis inflicted on society.
    I do agree that the end users were not the primary cause of 
the recent crisis and they are not deserving of any particular 
punishment. Yet punishment is different than the adjustment to 
the removal of unhealthy subsidies. I don't believe their 
arguments should dissuade you from undertaking profound 
institutional reform, even reform that impacts their practices.
    Economists are fond of saying there is no such thing as a 
free lunch, and efforts to hedge market exposures by commercial 
users are primarily a transfer of risk rather than a diminution 
of underlying risk. An oil hedger is not reducing the 
volatility of oil prices, but merely transferring the risk to 
another party who will bear that risk for a price.
    When market structures are weak and unsound, they 
underprice that insurance and encourage the over-use of 
insurance. In the case of OTC derivatives that are largely run 
by the handful of ``too big to fail'' banks, the insurance 
offered to end users is often underpriced because the risk is 
borne in part by the public or the taxpayer who underpin the 
safety net that backstops these banks.
    Removing the back room subsidy and excessive use it 
inspires, something oftentimes referred to as moral hazard, 
would lead to an increase of cost to providing that risk 
insurance. Removing the subsidy would diminish profits for end 
users. That leads to less use of insurance and some greater 
cost for the consumers of those end users' services.
    Where I differ with many of the end users is the claim, I 
believe this would be a good thing--is that I claim this would 
be a good thing for the nation as a whole. Removing subsidies 
to the buyers of insurance does not make the world a more 
dangerous place. It merely redistributes who bears that risk 
away from those who had provided the subsidy.
    The American private sector, be it end users of financial 
products or financial institutions, do not need to clamor for 
subsidies from the taxpayer in order to thrive. That type of 
rent-seeking behavior is demoralizing for society and it is 
unproductive. It weakens the economy in the long term, and 
furthermore, government willingness to abide efforts to exact 
subsidy actually weaken the companies who receive them. The 
dependence on government subsidy allows the private sector's 
creative powers to atrophy. We would all do much better in the 
long term if we were shown tough love, were refused state 
welfare and forced to focus on new product development and 
innovations in the marketplace that would create a strong, 
profitable, productive future in the business sector and for 
the nation.
    Reforming the financial structure of the U.S. marketplace 
is essential to restore confidence in the United States. 
Transparent market structures, proper capitalization, 
regulation, restoration of market discipline to our largest 
financial institutions are the essential ingredients that are 
needed to restore that confidence.
    Finally, if this is done properly, it will also greatly 
diminish the possibility that future financial bailouts will 
reemerge and crowd out the use of our public finances for much-
needed infrastructure, education spending, health care, and 
other things that make our society stronger and our lives more 
secure.
    I will submit the balance of my remarks for the record. I 
thank you, and I look forward to your questions.
    [The prepared statement of Mr. Johnson can be found on page 
90 in the appendix.]
    Chairman Lincoln. Thank you, Dr. Johnson, and thanks to all 
of you all for joining us today.
    We have heard some testimony today that our financial 
system has been put at risk by certain actors who have been 
over-leveraged and undercapitalized. It is important we find a 
balance to protect markets and consumers, and to that end, I 
just have a couple of questions for all of you and then a 
couple of specific ones for you, Dr. Johnson.
    It has been argued that with wider bid-ask spreads, capital 
charges, and other fees, that using OTC derivatives to hedge 
might be more convenient, but it is not necessarily less 
expensive than exchange trading, even without factoring in the 
possibility of mandated margin costs. To that end, would you 
compare the costs maybe, and you don't have to do this today if 
you don't have it at your fingertips, you could certainly 
submit it for us, which I think would be very helpful, but to 
compare the costs for me of one of your most standard contracts 
conducted over-the-counter versus similar costs of an exchange-
traded hedge. As I said, if you don't have that breakdown now, 
it is certainly something you can get to us in detailed data 
later, which I think just would be very helpful to members of 
the committee, to really see what that comparison might be.
    And then the other question is to discuss the parameters of 
a possible end user exemption that you or your group members 
might support. Do you believe that the financial end users or 
their affiliates should be permitted to use such an exemption, 
or should we work to exempt smaller end users and if so, where 
would you draw the line between the less and more significant 
players? Or maybe would you suggest some other type of a test 
in terms of what we could put in there.
    So those are the questions I would like to throw out for 
you all and would like you to answer.
    Dr. Johnson, you have heard these end users' arguments 
today, and obviously you have heard them before, but they are 
very concerned about the additional margin requirements of 
mandatory clearing and that those requirements will make 
hedging with futures contracts prohibitively expensive. What do 
you make of their arguments, and if there were to be an 
exemption for end users, what should it look like, in your 
opinion, or are you adamantly opposed to any exemption?
    Also, what are your thoughts on a new resolution regime? I 
think it is very important for us to eliminate the prospect of 
``too big to fail'' and I understand that we need a resolution 
regime in place that would account for how we very methodically 
deal with those who think they are too big to fail. We must 
make sure that they are not.
    So I am just opening it up to the panel. Yes, Congressman 
English.
    Mr. English. I will take a crack at that. Some of our 
members have formed and gone together, because we are so small, 
with our own entity we have created and we own it that does 
these kinds of hedging for our membership. We did take a look 
at--earlier this year, we had about 18 of our members who were, 
in fact, hedging, and if they had gone to a clearing device 
that they would have to, in order to meet these requirements, 
they would have likely had to come up with about $300 to $400 
million in order to cover what we would anticipate would be the 
margin cost. If you look at that at about five percent, you are 
talking about roughly somewhere in the neighborhood of $15 
million that those 18 entities would have to incur in 
additional expense.
    We do have some of our trades that are on the exchanges, so 
it is not that everything is over-the-counter. Most are, and 
this is the primary reason for it.
    Chairman Lincoln. Thank you.
    Mr. Schloss. I guess I will cover a couple of the questions 
that you asked, because I think the cost comparison one is one 
that, from a transaction-specific base, we all in the case of 
over-the-counter derivatives pay a credit charge up front from 
the standpoint of the unique credit charge. So how would that 
compare to what it would actually cost if you did to go an 
exchange, I think is yet to be seen if you go that way from the 
standpoint of the market development.
    I think for end users, and in our case specifically, the 
margin requirement that would come from a standpoint of not 
only the up-front margin for every transaction, but as you 
heard earlier today, as you go in time, the market value of 
that transaction changes, so the posting of margin changes. And 
going through an exchange will tie up valuable working capital, 
which for us is a tradeoff between margin versus product 
programs. You know, a half-a-billion dollars of margin could be 
a very significant new product from the standpoint of our 
ability to stay competitive, not only domestically, but against 
foreign competition. So I think there is a cost of that capital 
and an alternative use for that capital that is very important 
for us.
    As you get into defining end users, and I recognize the 
problem that you all face, because everybody is going to be 
here talking about why they need exemptions, and end users all 
have a different flavor for why they need it, our--and the 
problem that we all have is that we are a very small piece of 
the market from the standpoint of the overall over- the-counter 
market, and there have been studies that we make up something 
about ten to 15 percent of the overall market.
    The end users from our perspective, or from Ford's 
perspective, clearly will center around who are the market 
makers versus who has the underlying business risk. We use 
over-the-counter derivatives to hedge an underlying business 
risk that is generated from either selling of cars made 
domestically and shipped foreign or vice-versa, interest rate 
hedging from a standpoint of our ability to continue to fund 
our customers and our dealers. So there is an underlying 
business risk that if we aren't able to hedge or aren't able to 
hedge effectively, we are making a risk tradeoff from the 
standpoint of our overall business.
    So I think those are our two points very specific to Ford 
from the standpoint of both end user as well as cost.
    Mr. Boling. To answer your questions in kind of reverse 
order, Southwestern hedges its natural gas price risk using two 
different types of derivative instruments, over-the-counter 
swaps and costless collars. And both of those instruments 
require no initial net investment payment up front to 
Southwestern.
    With respect to what would happen if the clearinghouse 
requirements were in place as has been proposed by some 
legislation, we did our own internal estimates, and if you 
estimated if they were in effect June 30, 2008, if the 
clearinghouse margin requirements had been in place, we would 
have been required to post $740 million in cash margin. But by 
the end of the year, that would have changed because of the 
volatility in prices down to $118 million at year end 2008.
    And just to put these numbers in context, as of December 31 
of 2008, our company's total debt outstanding was $735 million. 
So these clearinghouse requirements and the margin requirements 
would have required us to come up with additional money 
somewhere of $740 million.
    Mr. Billings. On the cost issue, and our hedging is very 
much, as the other gentlemen here have described, we are 
hedging future gas costs for our municipal members and 
ultimately their customers. We deal primarily in the over- the-
counter market. We also have no collateral arrangements, and so 
not required to post collateral when we hedge.
    As far as the costs go, a couple of things. Chairman, on 
your point about bid-offer spreads, I don't know that I have 
seen anything--it sounds good in practice, but I don't know 
that I have seen anything to convince me, anyway, that we are 
going to see a big change in bid-offer spreads just because we 
force everything to clear. It is possible.
    From a cost standpoint, when we go out to do a hedge-- and 
I am in these markets every day--when we go out and do a hedge, 
I may pay a half-a-cent or a cent per MMBtu over the stated bid 
or offer on the exchange to trade over-the-counter. That is a 
very minor cost for us. We are very comfortable with that cost. 
We have several counterparties we deal with. I can try to work 
that cost down through competition.
    On the other side, now, if I am forced to clear everything, 
we are going to have a large line of credit in place. We don't 
have a large amount of cash on hand. This really is going to 
change what we are doing, and so we are going to have to go out 
and get a big line of credit. Our estimate, we weren't exactly 
sure what standardized meant, so I took a look at if we had to 
clear every swap that we have on our books and had to have 
enough cash on the side for maintenance margins, we estimated 
we could have possibly up to a $500 million line of credit that 
we would have to have. Just having the line of credit, 50 to 75 
basis points. Using it, and then we are talking about, as Mr. 
English said, five percent, those dollars add up quickly. We 
estimated it could be as much as $10 million per year of 
additional cost.
    So for me, it is very simple. The cost of having a line of 
credit far exceeds anything that I could see in improvements in 
the bid-offer spreads.
    And then we also--we are concerned that having to put a big 
additional debt on our balance sheet could impact our credit 
rating, so it could have trickle-down effects in other things 
that we do, if we are trying to do infrastructure updates or 
help a system reach a new customer. Anything where we have to 
issue debt, if the rating of that debt is impacted by this 
large line of credit that we might have to have, there are 
other impacts to our systems that we are very concerned about.
    Chairman Lincoln. Dr. Johnson.
    Mr. Johnson. First of all, let me start by saying that I am 
much less intimately familiar with the individual businesses of 
each of the gentlemen to my right. So I don't think--to dispute 
them regarding the individual costs, I just have no basis for 
that.
    As I say in my written testimony, I do believe that we have 
had a system that has been reliant upon the guarantees of the 
taxpayers via the marketplace that was the ``too big to fail'' 
institutions, and we have had underpriced insurance. And as 
each of them discusses, the change to an exchange or to a 
clearinghouse would in all likelihood entail--the process of 
obtaining that insurance would be more costly for each of them. 
It would be more costly in the cash management realm. Some 
would go without insurance and the consequences would likely be 
diminished profits in their sector or at their firms and it 
would also likely be the case that their pricing, they would 
pass through to their customers and they would bear some of 
that burden.
    But philosophically, what I am saying is that is a removal 
of a subsidy, and it might have even been what you might call 
an implicit design, not something that we all sat down and 
said, we want to subsidize this credit. We just have revealed 
in light of episodes that that is the case.
    I would anticipate, if you moved to exchange trading, that 
we would experience a narrowing of bid-ask spreads, more 
transparency of market prices, and an integrity of the system, 
which would also diminish the contingency of a big wipe-out-
like crisis that we just had, and that indirectly should be 
factored into their costs. The collapse of demand, the layoffs, 
and all of the other things that all of our firms and our 
society are adjusting to right now, in my opinion, dwarf the 
kind of calculations that we are talking about today, however 
real they happen to be.
    Chairman Lincoln. Thank you.
    I have to apologize. I have gone way over my time and I 
need to defer to my colleague, Senator Chambliss, to move on. 
Thank you.
    Senator Chambliss. All of you have heard the previous 
discussion we have had about transparency and moving towards a 
different form of reporting requirement. Whether it is a 
clearinghouse for all transactions or not obviously is still 
going to be up for debate. But from the standpoint of each of 
you four, if we required full transparency of all transactions, 
irrespective of whether you have an exemption or not, is there 
any issue with doing that? I mean, are all of you willing to be 
fully transparent about the swaps and derivatives that you 
enter into? Glenn?
    Mr. English. Yes.
    Mr. Schloss. Absolutely.
    Mr. Boling. Yes.
    Mr. Billings. Yes, without question. We have been in favor 
of more transparency for many years.
    Senator Chambliss. All right. The question that I was 
getting to with Chairman Gensler, I think I finally understood 
his answer, and that is as each of you deal with the respective 
financial institutions or sellers of products or whatever it 
may be, if you have the benefit of the full transparency of all 
of their transactions prior to your engaging them in a swap or 
a derivative, would the information that you could glean as a 
result of knowing their financial position and their capital 
position affect your ability to make a decision on whether or 
not it would be a prudent investment for you to engage with 
that company? Glenn?
    Mr. English. Yes.
    Mr. Schloss. I think to the extent that we could get more 
transparency into the credit charges, I think that would be a 
help. The market itself is pretty transparent already. There 
are plenty of market screens from a standpoint of knowing where 
transactions trade. The difficulty will come when you have a 
very specialized trade, in our case, the securitization world, 
which takes on a very unique piece of the asset. Transparency 
in those transactions, even if everything was reported, I am 
not sure would add a whole lot of value.
    Mr. Boling. Our company has a formal commodity risk 
management policy, and as part of that policy, we engage in 
analysis, credit analysis of all the counterparties that we 
use, which at this time is, I believe there are 13 different 
counterparties. So that is an ongoing thing for us because we 
are concerned about their particular credit exposure in making 
sure it is spread across a number of different counterparties, 
as well as making sure of the financial integrity of each 
counterparty. So anything that would allow us to do that job 
more effectively, we would support.
    Mr. Billings. I really agree with Mr. Boling, that anything 
that helps shed light on potential red flags--we talked about 
AIG earlier--anything that would throw off concern that one of 
our counterparties was undercapitalized would certainly help us 
on the front end make decisions about whom we are trading with, 
so very much so.
    Senator Chambliss. Well, Dr. Johnson makes a good point 
about they fact that we need to make sure that there is 
security in the market, and it is like buying an insurance 
policy. I think that is a pretty good analogy that has been 
used several times today.
    But what I am concerned about is the practicalities, having 
been in business myself, the practicalities that each one of 
you have alluded to. In fact, you, Mr. Billings, have indicated 
that there are no liquid assets that your members could put up 
basically to provide for security or non-cash collateral assets 
or cash collateral assets. And even if you had to put up cash, 
it is going to severely hamstring you.
    But when we modernized the CEA in 2000, we thought we were 
doing the right thing, and I think we did do the right thing, 
to put more flexibility in the marketplace. But what we didn't 
anticipate was the ability of the players in the market to 
package CDSs, for example, and do it the way that, say, AIG did 
it. And where I come down on Dr. Johnson's side is just trying 
to make sure that as we move forward with whatever legislation 
we wind up with, that we don't create an opportunity for 
additional CDSs to collapse the market ten years from now. So I 
think that is what we have got to be careful of.
    I am not concerned about any of the full review. You all 
have got folks you have got to answer to and you have got smart 
people doing your business. But the folks who caused this 
collapse were out there getting greedy and making a lot of 
money and trying to make more money, and they weren't going to 
make it off folks like you all, but they are going to make it 
off of some people who are not as savvy or not as sophisticated 
as the four entities we have got here today.
    So I think our job is going to have to be where do we find 
that middle ground without requiring, Mr. Boling, you put up as 
much for a line of credit as you have in total outstanding 
debt. That makes no sense at all. But yet, we need to make sure 
that there is that security in the marketplace for that 
operator down the line who may be third or fourth removed from 
you as an ultimate customer to make sure that there is no 
collapse in the intervening transaction that is taking place.
    That is why this is such a complicated issue and why I am 
really glad that the Chairman has held this hearing today, 
because I think all of you provided valuable information that 
we are going to have to take back and digest and see if we 
can't find that common ground that is going to allow you to 
continue to operate.
    And Glenn, I guess I am more familiar with your folks than 
anybody else because I know your members are all nonprofit and 
they are made up of farmers and ranchers and small business 
people, primarily, who can't afford the kind of cost that is 
going to be put on them from the standpoint of having to secure 
all of these transactions. And since I am a consumer of yours, 
too, I don't want my utility bill going up.
    And the same thing with Mr. Billings there. He is serving 
Georgia.
    But all of you have provided very valuable practical 
information for us to digest and I thank you for being here and 
giving us that testimony today. It is going to help you through 
this period. We look forward to staying in touch and dialoguing 
with you about the issues that we are going to continue to see 
develop as we go through this process. Thank you.
    Chairman Lincoln. Senator Conrad.
    Senator Conrad. Thank you, Madam Chairman.
    First of all, let me say this is an excellent panel, really 
five outstanding witnesses. All of you have contributed to the 
work of this committee in a very positive way and we appreciate 
that.
    What strikes me about this conversation is transparency, as 
I see it, is necessary but not sufficient. In the case of AIG, 
as my memory serves me, one of the big financial houses wanted 
to go from ten-to-one leverage to 30-to-one leverage. They knew 
there was inherent risk in moving to that kind of leverage. If 
everything is going well, you make a lot more money. If things 
are not going well, you lose a lot more money.
    And so they recognized the need for an insurance product 
and they went to AIG and convinced them to write such insurance 
products, and AIG saw a gift horse and said, oh, yes, we can 
make a lot of money on this deal. What they forgot about is 
having the resources to cover against the down-side risk of 
these transactions. And when the down- side risk occurred, here 
we go. Taxpayers were the ultimate funder of the liability. 
That, we cannot permit to happen again.
    Dr. Johnson, thank you for your testimony. I think it was 
very clear and compelling.
    The one thing that strikes me is, as legislators, we have 
got an obligation to differentiate those places that are 
contributors to systemic risk, those that are not, and 
somewhere in between, because if we try to impose a regime on 
everyone and some of them are in a different category, we won't 
get anything done. I would say that to you. That is the trick 
of legislating.
    As I listened to the first four witnesses, I have high 
regard for Congressman English. He was the Chairman of a 
subcommittee in the House Agriculture Committee when I chaired 
the comparable committee on this side. I can tell you, he is 
one of the smartest and tough negotiators I ever dealt with 
around here. No, I said that wrong. I said smartest and 
toughest. Toughest and smartest.
    [Laughter.]
    Senator Conrad. When I listen, he is a smart guy. I don't 
think those kind of transactions contribute much to systemic 
risk.
    Mr. Schloss, as I listen to your description, that does not 
strike me as in the same category at all of what the hedge 
funds were doing or what certainly AIG was doing, which I 
believe was criminal. I believe some of those people ought to 
go to jail.
    Mr. Boling, I thought you were very persuasive. Mr. Boling, 
you used a phrase there on exemptions. You used language there 
about hedging transactions. I would like to go back and have 
you just reread that specific language, where you were 
proposing an exemption. For those who are hedging transactions, 
people who are hedging real business transactions, I think is 
what you were getting at, rather than, you know, speculation. 
Do you have that? Can you----
    Mr. Boling. I believe I can identify--I believe it was 
under the--was it at the beginning of my remarks or at the end 
where we were making recommendations?
    Senator Conrad. You were making recommendations and you 
were proposing where you would draw a line with respect to 
exemptions----
    Mr. Boling. Yes.
    Senator Conrad. and you were describing that. I don't have 
all the words. I wrote down, hedging actual transactions.
    Mr. Boling. Yes. I believe the language is Southwestern 
believes the solution to these problems would be to provide an 
exemption from the clearing and margining requirements for bona 
fide hedging transactions where at least one party involved is 
a company that produces, owns, and sells, or purchases and 
consumes, the commodity, and the transaction is directly 
related to managing commodity pricing risk inherent to that 
company's operating activities. We believe these transactions 
are easily distinguishable from those that are purely 
speculative, which appears to be the primary focus of the 
proposed derivatives legislation.
    Senator Conrad. In a nutshell, to me, you summed it up with 
that statement. And it seems to me that that is something we 
have got to try to capture here, and I would ask Dr. Johnson--
and Mr. Billings, thank you for your testimony. It was very 
clear. You are in a situation, you don't have a lot of cash. 
Whether it is $500 million or $250 million doesn't make that 
much difference. The point is, you would have to, if you are 
running it through clearing, come up with additional money that 
you would have to finance somehow. Clearly, that would add to 
cost.
    Dr. Johnson's point is, yes, but there is risk in any of 
these, and certainly there is risk. I mean, we have to 
acknowledge that, not nearly the risk in these transactions 
that I see in what I saw hedge funds doing, what I saw AIG 
doing. Would you acknowledge, Dr. Johnson, there is a 
difference between what some of the hedge funds were engaging 
in, what AIG was engaging in, and what these companies have 
been doing?
    Mr. Johnson. Well, first of all, Senator, there clearly is 
a difference, and to echo Chairman Lincoln's comment earlier 
about how to construct an exemption, I was trying in my 
testimony to warn against creating hard and fast rules that 
then we might say lawyers can navigate around and leave us 
where Senator Chambliss talked about with AIG, which was with a 
disaster that was never the intention of the committee in the 
year 2000. So what I would recommend is to see someone like 
Chairman Gensler as the referee, as the arbiter.
    The gentleman sitting to my right, Mr. Billings, talks 
about the various cash flow problems, and no one has any 
intention to drastically impair his business. That is not 
healthy. So the kind of exemption that he would seek is 
something that someone with expertise who could differentiate 
between a hedge fund and his type of risk and his type of 
business structure could make a determination that it was in 
the public interest.
    And while--how would I say--I characteristically am more in 
favor of rules that are clearer than in allowing regulatory 
interpretation, because, as you know, the nature of who is in 
that regulatory chair changes, and that creates a volatility 
that these men probably don't appreciate.
    Senator Conrad. Sure.
    Mr. Johnson. But I think in this instance, because of the 
complexity of derivative markets, I would opt for the exemption 
arbiter, if you will, to be the Chairman of the CFTC.
    Senator Conrad. All right. Thank you. My time has expired.
    Chairman Lincoln. Senator Lugar?
    Senator Lugar. Dr. Johnson, let me go back to the question 
I raised with Chairman Gensler about AIG and the insurance that 
was being sought by the banks that had finally packaged 
together all these residential loans. I gather from your 
testimony, AIG could have charged a higher fee to these banks 
for the insurance they were seeking. If I listened to you 
carefully, AIG was offering a subsidy, of sorts. The subsidy 
ultimately was paid for by the American people in the collapse 
of the system. In other words, by offering these derivatives 
for lower costs than really the type of insurance that was 
required, and AIG not having the resources to pay, should they 
collapse, this huge subsidy, ultimately caused this catastrophe 
that we continue to go through with all of the rescue efforts.
    In this particular situation, how do we require AIG to 
charge the proper amount? In other words, where is the market? 
Is this something up to Mr. Gensler, as the referee, saying you 
are underpricing this derivative. It ought to be much higher, 
or all of us are likely to have systemic risk.
    At the other end of the situation, as you listened to the 
other four on the panel, you said you understand they have cash 
problems, and these are small situations in comparison to what 
we were talking about with AIG. Trying to find an exemption as 
to who comes underneath this--after all, someone at AIG or some 
equivalent company may be clever enough, to sneak underneath 
the tent with those who are being exempted now. You are saying 
perhaps the response we ought to have is not to try to do in 
legislative language the precise exemption, but to have Mr. 
Gensler or somebody like this as a referee, or as an 
arbitrator, who has the expertise, who has the staff, who says, 
``no, you folks really don't qualify as agriculture 
cooperatives or natural gas firms or so forth. You are 
something else.''
    I am just trying to figure this out, because I like your 
idea that somebody pays ultimately. If we had no exemptions, 
then the small businesses here today could say, ``if we are 
going to hedge on behalf of our customers and so forth, this is 
going to cost money. We don't have a whole lot of cash. It 
ultimately has to be passed on to the customers.'' But if it is 
not passed on to the customers and risks are taken, then the 
customers are getting a subsidy in terms of what they ought to 
be paying to begin with for the natural gas or for whatever 
else they are buying for.
    We are more sympathetic with householders and so forth as 
customers than we are with large entities who are getting the 
subsidies from AIG. I am curious, how do we construct this 
legislation so that the subsidy, if it is there, and is clear, 
how do we extract the subsidy out of it? Because at the end of 
the day, why, none of us really are thinking of subsidy. We are 
thinking now of the bailouts of the stimulus package, and how 
are going to pay for it forever, even if we are very small 
individual consumers given the billions and trillions that we 
are borrowing. That is going to be the ultimate result of this 
if it is not done right to begin with.
    How do you spot the subsidy and how do you make sure it is 
not a part of the process?
    Mr. Johnson. You ask me easy questions.
    [Laughter.]
    Mr. Johnson. I think that in the case of AIG--I will start 
with where you started--what was fundamentally missing was an 
equivalent of a supervisor or a regulator that understood that 
they were providing what I will call mirage capital. They were 
providing assurances through the credit default swap market to 
the other ``too big to fail'' institutions, as well as others, 
but it was a mirage in the sense that they were not setting 
aside the resources to be able to meet those claims contingent 
on an event called a default.
    Senator Lugar. Is this fallibility, then, of the President 
or whoever appoints these regulators? How do we know that the 
person that is appointed is going to be bright enough to 
understand?
    Mr. Johnson. Well, that was the next stage, which is the 
first piece you need is for them to be regulated. We have 
insurance companies that are dealing in these actuarial odds 
regarding property, casualty, life insurance, and other things, 
earthquakes and what have you. You are never sure what the odds 
are. The past is not always prologue, and we had an extreme 
outlier in this episode.
    The second--but at some level, somebody should have been 
there, calling on AIG and saying, how come you are paying out 
bonuses and recording this as income and paying dividends and 
not provisioning for these losses? What was called a credit 
default swap to avoid regulation was actually credit default 
insurance.
    The second thing to diminish that is that I would stop 
uninsurable risks. People shouldn't buy insurance on something 
they don't own. So that is what fomented the speculation there.
    With regard to designing the structure and where the 
subsidy lies, what they call the lemon socialism, the downside 
is ours and the upside is private, it really has been the 
architecture of the banking system and the acknowledgement that 
the spillovers from the banking system can harm the real 
economy that has been the basis for that safety system. So I 
would return to that ``too big to fail'' regime and the design 
of the systemic regulator.
    With regard to your specific task--and what I think is 
really fascinating is that the interaction between derivatives 
and ``too big to fail'' is going to put you into a joint 
venture with the Banking Committee, and keeping the derivatives 
simple, transparent, supervised, and provided for with capital 
and margin will diminish the extent to which they can spill 
onto the banks. And one thing I might recommend in legislation 
is over in the Banking Committee in their ``too big to fail'' 
determinations, they are going to speak about tier one 
financial institutions, or systemically significant 
institutions, and I would very much consider-- and I would be 
interested in each of your thoughts on this-- if you go to a 
tier one classification, your legislation could have an 
exemption which says--or have a provision which says no one is 
eligible for an end user exemption in any subsidiary, 
affiliate, branch, or whatever who has been designated a 
systemically significant institution, and that way you would 
avoid this attempt to drive, as I call it, the jet plane 
through the loopholes of language.
    Senator Lugar. Thank you very much.
    Chairman Lincoln. Thanks, Senator Lugar.
    Thanks to all of you all for joining us, and I think, 
actually, Senator Chambliss has one more question.
    Senator Chambliss. Yes. I have one for Mr. Schloss. I want 
to drill down on one particular issue that is important. That 
is, you indicated in your written testimony that your interest 
rate swaps are over-the-counter customized derivatives, and 
some have claimed that interest rate derivatives are an example 
of standardized swaps that can easily be cleared. Could you 
describe why you consider these to be customized as opposed to 
standardized?
    Mr. Schloss. Great question, Senator. There are really 
three pieces, or three types of interest rate derivatives that 
we will use. The biggest one by far is the securitization 
swaps, which are done between the securitization trust and the 
counterparty from the standpoint of protecting the underlying 
investor. And a great example is when we do a retail contract 
to consumers, those are typically done on a fixed-rate interest 
rate. We package hundreds of thousands of those together and 
sell them to investors that are typically floating rate buyers. 
So we have to hedge that interest rate, but they are amortizing 
structures and they are very unique to the underlying asset 
class. So that is probably over half of our interest rate 
derivatives are done in that form.
    The other piece is when we do a long-term debt instrument 
and we try to fund the business longer than our assets, so if 
we do a ten-year bond, our assets are three years, we need to 
match those terms of the bond specifically in order to get FAS 
133 hedging treatment. So those have to be very unique from the 
standpoint of matching the exact same terms of the bonds.
    The other piece of our interest rate hedge are more common 
from the standpoint of taking floating rate to fixed on a more 
standardized basis.
    Senator Chambliss. And again, I am assuming from your 
earlier answer, even if you had an exemption, there is no 
problem with you disclosing all of the financial transactions 
involved in those derivatives----
    Mr. Schloss. No problem whatsoever.
    Senator Chambliss. --to the CFTC. Thank you.
    Chairman Lincoln. Well, thanks again to the panel. You, as 
the members have said, you have been most helpful to us in the 
deliberations. We appreciate your testimony and certainly would 
ask that you not go too far because we would love to be able to 
continue the conversation as we move legislation through the 
committee and have deliberations on how to do a good job 
putting this together.
    I would remind people that we are going to have a second 
hearing on December 2nd, Secretary Geithner will be on our 
first panel there.
    Thank you all for joining us. We appreciate it. We look 
forward to continuing to work with you to solve the problem. 
Take care.
    [Whereupon, at 12:25 p.m., the committee was adjourned.]
      
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