[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]



 
                   THE IMPACT OF THE DODD-FRANK ACT: 
                   WHAT IT MEANS TO BE A SYSTEMICALLY 
                    IMPORTANT FINANCIAL INSTITUTION 

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

                                HEARING

                               BEFORE THE

                 SUBCOMMITTEE ON FINANCIAL INSTITUTIONS

                          AND CONSUMER CREDIT

                                 OF THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                      ONE HUNDRED TWELFTH CONGRESS

                             SECOND SESSION

                               __________

                              MAY 16, 2012

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 112-125

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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                   SPENCER BACHUS, Alabama, Chairman

JEB HENSARLING, Texas, Vice          BARNEY FRANK, Massachusetts, 
    Chairman                             Ranking Member
PETER T. KING, New York              MAXINE WATERS, California
EDWARD R. ROYCE, California          CAROLYN B. MALONEY, New York
FRANK D. LUCAS, Oklahoma             LUIS V. GUTIERREZ, Illinois
RON PAUL, Texas                      NYDIA M. VELAZQUEZ, New York
DONALD A. MANZULLO, Illinois         MELVIN L. WATT, North Carolina
WALTER B. JONES, North Carolina      GARY L. ACKERMAN, New York
JUDY BIGGERT, Illinois               BRAD SHERMAN, California
GARY G. MILLER, California           GREGORY W. MEEKS, New York
SHELLEY MOORE CAPITO, West Virginia  MICHAEL E. CAPUANO, Massachusetts
SCOTT GARRETT, New Jersey            RUBEN HINOJOSA, Texas
RANDY NEUGEBAUER, Texas              WM. LACY CLAY, Missouri
PATRICK T. McHENRY, North Carolina   CAROLYN McCARTHY, New York
JOHN CAMPBELL, California            JOE BACA, California
MICHELE BACHMANN, Minnesota          STEPHEN F. LYNCH, Massachusetts
THADDEUS G. McCOTTER, Michigan       BRAD MILLER, North Carolina
KEVIN McCARTHY, California           DAVID SCOTT, Georgia
STEVAN PEARCE, New Mexico            AL GREEN, Texas
BILL POSEY, Florida                  EMANUEL CLEAVER, Missouri
MICHAEL G. FITZPATRICK,              GWEN MOORE, Wisconsin
    Pennsylvania                     KEITH ELLISON, Minnesota
LYNN A. WESTMORELAND, Georgia        ED PERLMUTTER, Colorado
BLAINE LUETKEMEYER, Missouri         JOE DONNELLY, Indiana
BILL HUIZENGA, Michigan              ANDRE CARSON, Indiana
SEAN P. DUFFY, Wisconsin             JAMES A. HIMES, Connecticut
NAN A. S. HAYWORTH, New York         GARY C. PETERS, Michigan
JAMES B. RENACCI, Ohio               JOHN C. CARNEY, Jr., Delaware
ROBERT HURT, Virginia
ROBERT J. DOLD, Illinois
DAVID SCHWEIKERT, Arizona
MICHAEL G. GRIMM, New York
FRANCISCO ``QUICO'' CANSECO, Texas
STEVE STIVERS, Ohio
STEPHEN LEE FINCHER, Tennessee

           James H. Clinger, Staff Director and Chief Counsel
       Subcommittee on Financial Institutions and Consumer Credit

             SHELLEY MOORE CAPITO, West Virginia, Chairman

JAMES B. RENACCI, Ohio, Vice         CAROLYN B. MALONEY, New York, 
    Chairman                             Ranking Member
EDWARD R. ROYCE, California          LUIS V. GUTIERREZ, Illinois
DONALD A. MANZULLO, Illinois         MELVIN L. WATT, North Carolina
WALTER B. JONES, North Carolina      GARY L. ACKERMAN, New York
JEB HENSARLING, Texas                RUBEN HINOJOSA, Texas
PATRICK T. McHENRY, North Carolina   CAROLYN McCARTHY, New York
THADDEUS G. McCOTTER, Michigan       JOE BACA, California
KEVIN McCARTHY, California           BRAD MILLER, North Carolina
STEVAN PEARCE, New Mexico            DAVID SCOTT, Georgia
LYNN A. WESTMORELAND, Georgia        NYDIA M. VELAZQUEZ, New York
BLAINE LUETKEMEYER, Missouri         GREGORY W. MEEKS, New York
BILL HUIZENGA, Michigan              STEPHEN F. LYNCH, Massachusetts
SEAN P. DUFFY, Wisconsin             JOHN C. CARNEY, Jr., Delaware
FRANCISCO ``QUICO'' CANSECO, Texas
MICHAEL G. GRIMM, New York
STEPHEN LEE FINCHER, Tennessee



                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    May 16, 2012.................................................     1
Appendix:
    May 16, 2012.................................................    55

                               WITNESSES
                        Wednesday, May 16, 2012

Auer, Lance, Deputy Assistant Secretary for Financial 
  Institutions, U.S. Department of the Treasury..................     7
Elliott, Douglas, Fellow, The Brookings Institution..............    43
Gibson, Michael S., Director, Division of Banking Supervision and 
  Regulation, Board of Governors of the Federal Reserve System...     9
Harrington, Scott E., Alan B. Miller Professor, The Wharton 
  School, University of Pennsylvania.............................    37
Quaadman, Thomas, Vice President, Center for Capital Markets 
  Competitiveness, U.S. Chamber of Commerce......................    39
Wheeler, William J., President, Americas, MetLife, Inc...........    40

                                APPENDIX

Prepared statements:
    Auer, Lance..................................................    56
    Elliott, Douglas.............................................    62
    Gibson, Michael S............................................    66
    Harrington, Scott E..........................................    72
    Quaadman, Thomas.............................................    78
    Wheeler, William J...........................................    93

              Additional Material Submitted for the Record

Capito, Hon. Shelley Moore:
    Written statement of the Financial Services Roundtable.......   101
    Written statement of the National Association of Insurance 
      Commissioners (NAIC).......................................   109
    Written responses to questions submitted to Michael S. Gibson   112
    Written responses to questions submitted to Lance Auer.......   115


                   THE IMPACT OF THE DODD-FRANK ACT:
                   WHAT IT MEANS TO BE A SYSTEMICALLY
                    IMPORTANT FINANCIAL INSTITUTION

                              ----------                              


                        Wednesday, May 16, 2012

             U.S. House of Representatives,
             Subcommittee on Financial Institutions
                               and Consumer Credit,
                           Committee on Financial Services,
                                                   Washington, D.C.
    The subcommittee met, pursuant to notice, at 10:02 a.m., in 
room 2128, Rayburn House Office Building, Hon. Shelley Moore 
Capito [chairwoman of the subcommittee] presiding.
    Members present: Representatives Capito, Renacci, Royce, 
Manzullo, Hensarling, McHenry, Luetkemeyer, Duffy, Canseco, 
Grimm; Maloney, Hinojosa, Baca, Miller of North Carolina, 
Scott, and Carney.
    Ex officio present: Representative Bachus.
    Also present: Representatives Garrett and Green.
    Chairwoman Capito. This hearing is called to order. I want 
to welcome everyone.
    This morning the Financial Institutions and Consumer Credit 
Subcommittee will examine the impact of being designated as a 
systemically important financial institution (SIFI) 
specifically for nonbank financial entities. But I couldn't 
begin the hearing without talking about the most topical 
subject of the day or of the week.
    There is no doubt that this week's news of JPMorgan's 
trading losses has raised significant questions about the 
supervision of risks within an institution. The story is still 
unfolding, and although it appears that the firm had sufficient 
capital to absorb this significant loss, one of the questions I 
would ask is, would a less capitalized institution survive a 
similar loss? Are other financial firms that are determined 
systemically significant sufficiently capitalized? Where did 
the lapses in the internal risk controls within the firm occur? 
Were Federal financial regulators aware of the position that 
JPMorgan was taking? Transparency is a question, I think. Did 
they do an adequate job of supervising the firm's risk? Are 
they able to supervise the complexity of the firm's positions?
    The losses at JPMorgan emanated from their London office, 
which begs the question, how well are our Federal financial 
regulators coordinating with their counterparts across the 
globe? And how did the provisions in Dodd-Frank help or 
exacerbate the problem?
    I think there are plenty of questions that we will be 
answering, certainly in the next several weeks.
    But this morning's hearing focuses on the effect of 
designating nonbank financial firms as systemically important. 
The Dodd-Frank Act grants the Financial Stability Oversight 
Council, better known as FSOC, the authority to designate firms 
as systemically important. While the statute is clear which 
financial institutions will be designated, it is less clear 
about designating nonbank financial institutions.
    The FSOC was tasked with promulgating rules to determine 
the criteria for nonbank financial institutions to be 
designated as systemically important, and the Federal Reserve 
is in the process of finalizing rules to supervise the entities 
that are designated.
    There are many questions again about the effect the 
systemically significant designation will have on these nonbank 
firms. We have already seen with the largest banks that 
systemic significance equates to market participants viewing 
these institutions as being too-big-to-fail and expects the 
government to intervene in times of severe distress. The 
implied government guarantee also results in lower borrowing 
costs.
    It is less clear what effect this designation will have on 
nonbank entities. I know that many of our witnesses on the 
second panel have serious concerns about the standards used for 
not only designating the firm but also for the supervision of 
nonbank firms once it is designated. There are legitimate 
questions about how these standards will work with the various 
business models of nonbank firms.
    Does the Federal Reserve have the expertise to supervise 
nonbank firms from different industries? How well will the FSOC 
and the Federal Reserve coordinate to ensure the standards for 
designation supervision are in harmony? And are they working 
with their counterparts across the globe to harmonize standards 
for systemic significance in the United States with global 
systems significance?
    These are questions that deserve a robust discussion. I am 
hoping we get to that in this morning's hearing.
    I would like to thank our witnesses for appearing before 
the subcommittee this morning.
    I now recognize the ranking member of the subcommittee, the 
gentlewoman from New York, Mrs. Maloney, for the purpose of 
making an opening statement.
    Mrs. Maloney. First of all, I want to thank you, Madam 
Chairwoman, for calling this hearing, and I welcome our 
witnesses.
    This hearing today is about a very important set of issues 
around designation of nonbank companies as systemically 
significant. There are certainly a lot of perspectives and 
issues around it that have been raised already by the Chair, 
but I think these are important issues and that we should stay 
focused on them.
    If there was one area where we learned from the financial 
crisis in 2008, it was that the regulators did not have the 
tools to regulate complex, interconnected nonbank companies, 
like AIG, and did not have the ability to wind down these 
companies in the event of a failure without disrupting the 
system and without taxpayer funding. As a result, these highly-
interconnected overleveraged firms nearly brought this entire 
country and its financial system to its knees, and it was 
quickly recognized that key supervision for these nonbank areas 
was missing.
    We did two important things in Dodd-Frank to address this 
by eliminating the hiding places from regulation, and by ending 
too-big-to-fail. First, we gave the FSOC, the Financial 
Stability Oversight Council, the authority to require Federal 
supervision of nonbank financial companies that pose a systemic 
risk and required the Federal Reserve (Fed) to impose 
heightened regulatory requirements on these companies, as well 
as any bank holding company with at least $50 billion in 
assets. These changes also leveled the playing field between 
nonbanks and banks.
    Second, if a company does fail in spite of the heightened 
requirements and supervision, we also provided an Orderly 
Liquidation Authority (OLA) in Title II of Dodd-Frank so that 
regulators would not be faced with the horrible choice between 
either bailing a company out at taxpayer expense, which we did 
with AIG, or letting it fail, to the great detriment of the 
broader financial system.
    Designation of nonbank companies is a two-step process. The 
entities must first be identified as nonbank SIFIs, and then 
they must be subjected to heightened supervision. FSOC rule was 
not required by Dodd-Frank and really was done to provide 
clarity to the public and companies about how FSOC will 
designate nonbanks as SIFIs.
    I understand it has been estimated that about 50 entities 
will be considered for heightened regulation based on the size 
and scope of their financial activities. Once designated, these 
companies will be subject to stricter standards under rules 
that the Fed is currently developing and on which it has asked 
for detailed input.
    So, I look forward to hearing from the panels, and I also 
look forward to hearing from the firms.
    I also would like to ask unanimous consent for Mr. Green to 
have privileges as a subcommittee member today so he may 
question the witnesses.
    I welcome our panelists today, and I yield back.
    Chairwoman Capito. Without objection, it is so ordered.
    I would like to recognize the chairman of the full 
Financial Services Committee, Chairman Bachus, for 3 minutes 
for an opening statement.
    Chairman Bachus. I thank the chairwoman.
    At today's hearing, we will have an opportunity to examine 
one of Dodd-Frank's most vague and potentially problematic 
mandates. We are here to better understand what it means to be 
systemically important, a euphemism for too-big-to-fail. Which 
institutions will be categorized is significantly important. 
What are the consequences of being deemed systemically 
important? What are the advantages and what are the 
disadvantages? How will these institutions be regulated? And 
how will counterparties and other market participants interact 
with them?
    We have been told by the FDIC that part of this interaction 
will be to indemnify certain creditors and counterparties, and 
that seems very similar to AIG. And Members on both sides 
pledged that we would not get into another bailout situation.
    Many companies are asking themselves the same questions and 
whether the regulators think they are systemically important. 
The Financial Stability Oversight Council's final rule is not 
at all clear. It is therefore my hope that the regulators 
testifying here today can help provide the committee and all 
affected parties with some much-needed clarity on these 
important issues. I look forward to this discussion and I thank 
the witnesses for being here.
    I do want to say, in conclusion, that because of the 
JPMorgan Chase situation, we are again hearing from some of our 
colleagues that we need a law which will essentially prevent a 
business from losing money or taking risk, and no law can do 
that, nor should a law attempt to prohibit a company from 
taking risk. In fact, that is just an impossibility. Now, when 
taxpayer funds are at risk, and a bailout situation would 
certainly be one of those, or deposits, then that is another 
question.
    Just to put it in perspective, JPMorgan Chase--and if you 
are concerned about deposits in that institution, let me put 
that trading loss in perspective. Their pre-tax profit last 
year was $25 billion, so a $2 billion loss would represent 1 
month of earnings. If it had been last year, it would reduce 
their earnings to $23 billion. The loss is about 1/100th of the 
firm's $189 billion net worth and roughly 1/1000th of the 
firm's $2.3 trillion in assets.
    Even with this loss, I believe they are one of the most 
profitable financial institutions in the country, and unless 
the facts are diametrically different from what we have heard, 
there is no risk from this loss to depositors or to taxpayers. 
JPMorgan Chase remains a very profitable and viable 
institution.
    Thank you, Madam Chairwoman.
    Chairwoman Capito. Thank you.
    Mr. Baca for 2 minutes.
    Mr. Baca. Thank you, Madam Chairwoman.
    I want to thank you for calling this hearing, along with 
the ranking member.
    I also want to thank both of the panelists for being here 
with us today to offer their insight on this important topic.
    As we know on the Financial Services Committee, Federal 
Reserve Chairman Greenspan came to us many times and said to, 
``trust them, they know what they are doing.'' I guess we are 
still trying to figure out if we should trust them, and 
apparently, we should not have trusted them. But we did.
    One of the biggest developments during the economic crisis 
in 2008 was the realization of how much of the impact could be 
felt from the collapse of the too-big-to-fail firms. Until the 
problem arose, it seemed that no one quite understood the level 
of interconnectedness that some of these firms had. As a 
result, our government took drastic action to limit the stress 
the collapse of these institutions could have caused. And 
obviously, no one wants to see the events of 2008 repeated.
    In writing and passing Dodd-Frank 2 years ago, I believe we 
created a sound framework. I state, I believe we created a 
sound framework that will allow us to stay ahead of the curve 
with these systemically important institutions, to make sure 
that we regulate them and also that we do a lot of the 
enforcement that needs to be done. It is not just regulating 
them, but how are we going to enforce them, and what action 
will actually be taken to make sure we don't develop additional 
crises and that we work to solve the problem?
    This framework will allow the regulators to work with 
market participants in creating an efficient and secure 
regulatory structure. At the same time, it will allow the 
market to continue to operate in a free manner that will not be 
dictated by the needs and demands of the regulators.
    Finally, if a firm does run into trouble, the market has 
the confidence that the mistakes of a few will not impact the 
actions of many, and that is only if the action is taken and it 
is brought before us to make sure that it doesn't affect a lot 
of the consumers or individuals involved.
    At the end of the day, what everyone is looking for is 
certainty. Industries want to be certain that they can run 
their business in a manner where they don't fear becoming too 
unsuccessful but at the same time doing what is right. 
Regulators want to be certain that they can step in and act in 
a timely manner to correct the bad behaviors, and that is going 
to be the key right there. And the American public wants to 
know that all parties involved are doing their best to ensure 
that the abusive behavior is not something that will be allowed 
to be repeated.
    Again, I want to thank the ranking member and the 
chairwoman for having this hearing.
    Chairwoman Capito. Thank you.
    Mr. Garrett for 1\1/2\ minutes.
    Mr. Garrett. I thank the Chair also for this important 
hearing with regard to the designation of firms that are 
systemically important financial institutions, or SIFIs. But 
instead of calling these firms systemically important financial 
institutions or SIFIs, I think what we should call them is what 
we all know they are and what the market calls them as well, 
and that is too-big-to-fail institutions. If you are honest 
about it, Dodd-Frank basically codified too-big-to-fail in the 
law and then just simply changed the name over to SIFIs or 
systemically important financial institutions.
    And when you change the name, you really haven't changed 
anything about the characterization of them or the substance of 
them. You really haven't solved the too-big-to-fail problem.
    The firms now that are on the list of firms were chosen by 
this Administration and FSOC that are formerly designated as 
too-big-to-fail, they basically still have funding advantages 
in the marketplace because of that designation and they are 
subject to a resolution process that still allows the 
government to use taxpayer money at the end of the day to 
decide which creditors are going to win and which creditors are 
going to lose.
    So if you really ended too-big-to-fail, then Members on the 
other side of the aisle over here would not state that one of 
their goals for the next Congress is, ``Let's end too-big-to-
fail.'' And if we really had ended too-big-to-fail, then there 
would be no reason whatsoever in the media or anyplace else for 
people to be all concerned about JPMorgan's $2 billion loss, 
because the taxpayers would not be on the hook, and they would 
be protected from it.
    So, lets's be honest here. The entire debate about SIFI 
designation is nothing more than a charade, and we should call 
it what it is. It is a debate about which financial 
institutions are too-big-to-fail. And we should not be debating 
which companies to call too-big-to-fail. We should be debating, 
how do we end the taxpayer being on the hook for these 
institutions?
    I yield back.
    Chairwoman Capito. Thank you.
    Mr. Scott for 2 minutes.
    Mr. Scott. Thank you very much, Madam Chairwoman.
    I think we need to make sure that as we look at the 
situation we are in today, the results of our financial crisis 
from a few years ago, even the JPMorgan Chase situation, that 
we have to do everything we can to make sure it doesn't happen 
again, that all of that is taken into consideration.
    But I caution on this point. I think we need what I refer 
to as a ``delicate balance'' here. We need to make sure we have 
the regulations to make sure this is done. Dodd-Frank is in 
place to do that. It is an excellent framework. It put the FSOC 
in there so that it could marshal our efforts for stability. 
There is no assignation for SIFIs within the Dodd-Frank bill. 
We are leaving those kinds of threats and identification up to 
the FSOC.
    And I agree that the crisis we had a few years ago, the 
JPMorgan situation, certainly has to be avoided, but we have to 
make sure that any additional regulation for our financial 
institutions, including both banks and nonbanks, will not 
stifle the growth of our economy and the creation of American 
jobs. That is the most important thing before us today.
    We have to create jobs. We have to get this economy better. 
We have to also make sure that the forces that generate the 
capital, that disburse the capital, that lend and keep this 
economy going, are not put in a straitjacket. I say that as a 
proud sponsor of Dodd-Frank and also one who understands we 
have to make sure that the abuses don't happen. But all I am 
simply saying is that it has to pass that ``delicate balance'' 
test. First and foremost, economic growth must not be stifled.
    Now, we are making some great progress here. The jobless 
rate is coming down, all of this. So all I am saying is as we 
move forward, let's move forward with a jaundiced eye on this 
and do it correctly.
    Thank you, Madam Chairwoman.
    Chairwoman Capito. Thank you.
    Mr. Royce for 1 minute.
    Mr. Royce. Thank you, Madam Chairwoman.
    More than any other, Section 165 of Dodd-Frank is 
emblematic of Washington taking its eye off of the ball, 
because instead of focusing on those institutions everyone 
knows are too-big-to-fail, instead of getting back to less 
leverage and higher capital requirements for those few firms, 
government instead will publicly stamp institutions, 
potentially dozens of institutions, as systemic.
    And the explicit statement to the market is that Washington 
believes these firms are special and the implicit statement to 
the market is also going to be that Washington will never allow 
these firms to fail. Given the precedent that has been set, 
given the propensity of government to err on the side of 
intervention, err on the side of bailouts to save systemically 
important firms, it is my hope that we can cast the smallest 
possible net in this and designate only the firms that everyone 
agrees are too-big-to-fail. But, frankly, the approach was the 
wrong approach.
    I yield back.
    Chairwoman Capito. The gentleman yields back.
    Mr. Green for 2 minutes.
    Mr. Green. Thank you, Madam Chairwoman.
    And I thank the ranking member as well.
    One thing I am totally absolutely and completely convinced 
of is this: Regardless of how we feel, the public is of the 
opinion that too-big-to-fail is the right size to regulate. It 
is the right size to deal with such that it does not bring down 
the economy.
    AIG is a prime example of what we did not have the 
authority and the ability to properly deal with when it was 
going out of business, as it were. We cannot allow ourselves on 
our watch to simply say, we need to get back to business as 
usual. And I hear a lot of that in other words; let's get back 
to business as usual. We cannot afford business as usual 
because it brings down the economy with these institutions when 
they become so large that they have an impact across not only 
the American economy but the economy of the world.
    So today, I think it is appropriate for us to examine the 
rules, but it is also appropriate to note that we cannot allow 
business as usual to become the order of the day.
    I yield back the balance of my time.
    Chairwoman Capito. The gentleman yields back.
    I believe that concludes our opening statements. I will now 
recognize the witnesses for the purpose of a 5-minute summation 
of your written statements.
    Our first panelist is Mr. Lance Auer, Deputy Assistant 
Secretary for Financial Institutions, U.S. Department of the 
Treasury.
    Welcome.

    STATEMENT OF LANCE AUER, DEPUTY ASSISTANT SECRETARY FOR 
    FINANCIAL INSTITUTIONS, U.S. DEPARTMENT OF THE TREASURY

    Mr. Auer. Thank you. Chairwoman Capito, Ranking Member 
Maloney, and members of the subcommittee, thank you for the 
opportunity to discuss the Financial Stability Oversight 
Council's rule and guidance for identifying nonbank financial 
companies that will be subject to standards and supervision by 
the Federal Reserve.
    In the 2008 financial crisis, financial distress at certain 
nonbank financial companies contributed to a broad seizing-up 
of the financial markets. To address potential risks posed to 
U.S. financial stability by these types of companies, the Dodd-
Frank Wall Street Reform and Consumer Protection Act authorizes 
the Council to determine that certain nonbank financial 
companies could pose a threat to U.S. financial stability and 
will be subject to the supervision of the Federal Reserve and 
to enhanced prudential standards.
    Although the Dodd-Frank Act specifically outlined 
substantive considerations and procedural requirements for 
designating nonbank companies, the Council elected to engage in 
a rulemaking process in order to obtain input from all 
interested parties and to provide increased transparency to the 
public. To these ends, the Council provided the public with 
three separate opportunities to comment on its proposal.
    After receiving significant input from market participants, 
nonprofits, academics, and other members of the public, the 
Council approved its final rule in April of this year. The 
final rule provides a robust process for evaluating whether a 
financial company should be subject to Federal Reserve 
supervision and enhanced prudential standards. The Council will 
approach each determination using a consistent framework, but 
ultimately each designation must be made on a company-specific 
basis, considering the unique risk to the U.S. financial 
stability that each nonbank company may pose.
    The Council's rule and guidance explain the three-stage 
process that the Council intends to use in assessing nonbank 
financial companies.
    In stage one, the Council will apply uniform quantitative 
thresholds to identify those nonbank financial companies which 
will be subject to further evaluation. The use of clear 
thresholds in stage one enables the public to assess whether a 
particular company is likely to be subject to further 
evaluation by the Council.
    In stage two, the Council will analyze the nonbank 
financial companies identified in stage one using a broad range 
of information available to the Council, primarily through 
existing public and regulatory sources. This review will 
include both quantitative and qualitative information.
    In stage three, the Council will contact each nonbank 
financial company that the Council believes merits further 
review to collect information directly from the company which 
was not available in prior stages for an in-depth review. Each 
nonbank financial company that is reviewed in stage three will 
be notified that it is under consideration and will be provided 
an opportunity to submit written materials to the Council for 
the Council's consideration.
    If the Council votes to approve a proposed determination, 
the nonbank financial company will receive a written 
explanation of the basis of the proposed determination. The 
company may also request a hearing to contest the proposed 
determination. After the hearing, a final determination 
requires a second vote of the Council.
    The authority under the Dodd-Frank Act for the Council to 
designate nonbank financial companies for enhanced prudential 
supervision standards and Federal Reserve supervision is an 
important part of the Council's ability to carry out its 
statutory duties to identify risks to U.S. financial stability 
and respond to such threats in order to better protect the U.S. 
financial system.
    Thank you, and I would be happy to answer any of your 
questions.
    [The prepared statement of Mr. Auer can be found on page 56 
of the appendix.]
    Chairwoman Capito. Thank you.
    Our second witness is Mr. Michael Gibson, Director, 
Division of Banking Supervision and Regulation, Board of 
Governors of the Federal Reserve System.
    Welcome.

 STATEMENT OF MICHAEL S. GIBSON, DIRECTOR, DIVISION OF BANKING 
 SUPERVISION AND REGULATION, BOARD OF GOVERNORS OF THE FEDERAL 
                         RESERVE SYSTEM

    Mr. Gibson. Chairwoman Capito, Ranking Member Maloney, and 
members of the subcommittee, thank you for the opportunity to 
testify today on implementation of the Dodd-Frank Act as it 
relates to the designation, supervision, and regulation of 
systemically important nonbank financial companies.
    The recent financial crisis showed that some financial 
companies, including nonbank financial companies not 
historically subjected to consolidated prudential supervision, 
had grown so large, so leveraged, and so interconnected that 
their failure could pose a threat to overall financial 
stability. The sudden collapses or near collapses of major 
financial companies were among the most destabilizing events of 
the crisis.
    The Dodd-Frank Act addresses key gaps in the framework for 
supervising and regulating systemically important nonbank 
financial institutions through a multi-pronged approach that 
includes: first, the establishment of the Financial Stability 
Oversight Council, which has the authority to designate nonbank 
financial companies that could pose a threat to financial 
stability; second, a new framework for consolidated supervision 
and regulation of nonbank financial companies designated by the 
Council; and third, improved tools for the resolution of failed 
nonbank financial companies.
    With respect to the first prong, the Financial Stability 
Oversight Council was created to coordinate efforts to identify 
and mitigate threats to U.S. financial stability across a range 
of institutions and markets, including by establishing a 
framework for designating nonbank financial companies whose 
failure could pose a threat to financial stability.
    On April 3rd, the Council issued a final rule and 
interpretive guidance setting forth the criteria and the 
process it will use to designate nonbank financial firms as 
systematically important. The Council's issuance of this rule 
is an important step forward in ensuring that systemically 
important nonbank financial firms will be subject to strong 
consolidated supervision and regulation.
    With respect to the second prong, the enhanced prudential 
standards, Sections 165 and 166 of the Dodd-Frank Act require 
the Federal Reserve to establish enhanced prudential standards 
both for the largest bank holding companies and for nonbank 
financial companies designated by the Council. These enhanced 
prudential standards include requirements for enhanced risk-
based capital and leverage requirements, liquidity, risk 
management, stress testing, and resolution planning, as well as 
single counterparty credit limits and an early remediation 
regime.
    In December, the Federal Reserve issued proposed rules 
which would apply the same set of enhanced prudential standards 
to covered companies that are bank holding companies and 
covered companies that are designated nonbank financial 
companies. The Federal Reserve may tailor the application of 
the enhanced standards to different companies on an individual 
basis or by category.
    Working out the exact details of how enhanced prudential 
standards will apply will certainly require a thoughtful and 
iterative analysis of each designated company over time. The 
Federal Reserve is committed to assessing the business model, 
capital structure, and risk profile of each designated company 
and tailoring the application of the enhanced standards to each 
company.
    With respect to the third prong, resolution, the Dodd-Frank 
Act provides two important new regulatory tools, both of which 
extend to systemically important nonbank financial companies. 
First, each of the largest bank holding companies and each 
nonbank financial company designated by the Council is required 
to prepare and provide to the FDIC and the Federal Reserve a 
resolution plan or a living will for its rapid and orderly 
resolution under the U.S. Bankruptcy Code.
    Second, Title II of the Dodd-Frank Act provides for an 
orderly resolution process to be administered by the FDIC.
    Thank you very much for your attention. I would be pleased 
to answer any questions you may have.
    [The prepared statement of Mr. Gibson can be found on page 
66 of the appendix.]
    Chairwoman Capito. Thank you.
    Thank you both. I will begin with the questions.
    As you are probably well aware, many different companies 
from various industries,--and both of you emphasized the 
tailoring of the designation procedure and the resolution 
procedure--some that have been mentioned as candidates for 
systemic designation, are concerned about a sort of one-size-
fits-all, where let's say you are assessing a large insurance 
company on the same sort of criteria that you would judge a 
bank institution, and a nonbank institution the same.
    You kind of mentioned this in your statement, but how will 
you deal with the differences in the industry business models? 
I will start with the Treasury.
    Mr. Auer. Thank you, Madam Chairwoman.
    The process that the Council developed in putting out its 
proposed rule for comment on three different occasions was to 
devise a three-stage framework. The first stage provides 
clarity and consistency by using uniform quantitative 
thresholds that are based on publicly available data, so that 
they could screen out the large number of firms that the 
Council is unlikely to consider for further evaluation.
    It is very explicit in stages two and three that the 
Council plans to take an individualized look at each particular 
nonbank financial company under consideration, to look at all 
of its activities, all of its businesses, the types of business 
it is in, the type of activities it engages in, so that it can 
take into account the specific factors of that firm and of that 
industry in coming up with a final proposal for the Council.
    Chairwoman Capito. Thank you.
    Mr. Gibson?
    Mr. Gibson. We have made it clear in our proposal for 
enhanced financial standards that we do intend to tailor the 
standards to the characteristics of the companies that are 
designated by the Council. What we have proposed is a single 
set of standards that apply to both the bank holding companies 
and the nonbank companies, but we have said that once the firms 
are designated, we will consider tailoring the standards, and 
the Dodd-Frank Act explicitly gives us the authority to do 
that.
    Now, we understand that there are some nonbank companies 
for which the bank-like standards that we proposed would likely 
be a bad fit and we have committed to looking at that when 
those companies are designated and doing what we can to tailor 
the standards. However, there are other companies that could be 
designated that are not that different from a bank, and for 
those companies, we would expect that the bank-like standards 
we have would require less tailoring.
    Chairwoman Capito. Would the Federal Reserve be doing that 
particular exercise in terms of trying to tailor, let's say, if 
you are looking at enhanced capital or such, would that be done 
within the Federal Reserve or within the FSOC?
    Mr. Gibson. That would be done by the Federal Reserve.
    Chairwoman Capito. Do you have the expertise to oversee all 
the different types of business models that you are probably 
looking at here, or am I making it more complicated than it is?
    Mr. Gibson. We have a lot of expertise across a range of 
activities.
    Chairwoman Capito. Right. Financial activities, yes.
    Mr. Gibson. Bank holding companies engage in a lot of the 
activities that the nonbank companies are engaging in, so in a 
lot of cases, we feel like we would have sufficient expertise. 
But if there are cases where we need to bring in more expertise 
for nonbank companies that are designated, we would certainly 
do that.
    Chairwoman Capito. I would assume that the designation just 
simply by the name obviously means that if one institution were 
to fail, that there would be systemic problems to other 
institutions, bank or nonbank. We obviously found that in 2008. 
Is that one of the main criteria to having the designation?
    Mr. Auer. Yes. The statutory standard is that the Council 
should designate firms that could pose a threat to the 
financial stability of the United States. The Council in its 
rule and guidance has stated that a threat to the financial 
stability is where an impairment to financial remediation or 
financial activity could have a real effect on the real 
economy. So that is the standard on which a designation would 
ultimately be based.
    Chairwoman Capito. Okay. One of the concerns I have is with 
the Orderly Liquidation Authority. You are probably aware that 
we tried to go with an enhanced bankruptcy look on this and 
failed and said the Orderly Liquidation Authority rests with 
the FDIC.
    Again, I will go back to my original question. When you are 
looking at a nonbank entity, the FDIC obviously is more 
accustomed to working with banking entities. I want some 
confidence, and I know you probably can't make a judgment 
statement, but is the confidence there that the FDIC has the 
expertise, again, to make judgments when trying to unwind 
nonbank institutions? Is that a concern?
    Mr. Auer. Madam Chairwoman, we, the Treasury Department and 
other FSOC members that will be involved in any Orderly 
Liquidation Authority have been working with the FDIC to 
understand what their approach will be to designating--I am 
sorry, to putting a firm in liquidation authority and how they 
would handle that. They have devoted significant resources to 
that process. But ultimately what resources and the details of 
their approach is a question you would have to pose to them.
    Chairwoman Capito. All right. My time is up so I am going 
to go to Mrs. Maloney.
    Thank you.
    Mrs. Maloney. Thank you.
    I would like to ask Mr. Auer, I understand the criteria the 
Council has established by regulation and statute, but I would 
like more clarity on the exact metrics that will be used in 
designating nonbank financial companies as SIFIs. For example, 
how much interconnectedness makes a firm an SIFI? Could you 
elaborate in this area?
    Mr. Auer. Certainly. Again, in the multiple rounds of 
public comment that we received, there was a desire that led to 
the development of a three-stage process. The first stage is 
based on publicly available data and easily calculable metrics 
in order to provide greater clarity to the public about the 
types of entities the Council is likely to want to examine 
further in stages two and three.
    However, the Council is very clear that it wants to look in 
stages two and three on a firm-by-firm basis, and the rules and 
guidance layout a specific framework for it to do so. 
Interconnectedness is one of the elements that the Council will 
be looking at in stages two and stages three, but it is one of 
six broad categories of frameworks. The others are size, 
substitutability, leverage--
    Mrs. Maloney. How do you define interconnectedness?
    Mr. Auer. After much analysis and work, the Council does 
not believe that there is a single metric or formula that can 
measure interconnectedness. The Council believes that rather 
than trying to have a one-size-fits-all measure of 
interconnectedness, interconnectedness is simply one of the 
measures that it must look at it when it looks at any 
particular firm, and different firms might be interconnected in 
different ways, which is why you can't have a formula for 
calculating that factor.
    Again, the final determination of a firm for enhanced 
prudential standards for Federal Reserve supervision is if that 
firm can pose a threat to the financial stability of the United 
States, whether through interconnectedness, lack of substitutes 
or other factors.
    Mrs. Maloney. Thank you.
    Mr. Gibson, will the Federal Reserve's prudential standards 
proposal for SIFIs be modified to adopt to the unique and 
distinct profile of nonbank SIFIs? Different businesses with 
different business models will require different regulatory 
standards, do you agree? And specifically, insurance companies 
are very different from banks. Private businesses are very 
different.
    Mr. Gibson, could you elaborate on that?
    Mr. Gibson. We understand that different types of nonbank 
financial companies will have different characteristics and 
different business models that may make it necessary or 
desirable for us to tailor the enhanced prudential standards, 
and we have committed that we will do that when the companies 
are designated.
    In terms of the proposed rule that we put out for comment 
in December, the comment period is still open. We have received 
many, many comments, including from many nonbank financial 
companies that were worried about the possibility of being 
designated, and we are currently in the process of weighing the 
comments. So I can't predict where the final rule will come out 
on that. But we have committed that after the companies are 
designated, we will take a look at the need for tailoring the 
standards.
    Mrs. Maloney. Okay. Mr. Auer, you said in your testimony 
you are going to be very transparent. So what are the plans to 
make the designation decisions transparent?
    Mr. Auer. First, I should note that the Council was not 
required to issue any sort of rule around its nonbank 
designations process. However, in a desire to provide greater 
transparency and gain greater input from the public, it 
wouldn't actually--
    Mrs. Maloney. And what is the timing? When do you expect to 
make this public?
    Mr. Auer. The rule and guidance were finalized in April and 
went into effect this month. The Council is now beginning its 
process for looking at calculating the stage one, which firms 
passed the stage one thresholds. It is collecting that data and 
making sure it is accurate. The Council will then move through 
stages two and three. As the Secretary has said publicly, at 
least he hopes that the Council will begin the first of its 
designations sometime this year.
    Mrs. Maloney. My time is almost over, but Mr. Gibson, what 
is the timing for the development of prudential standards for 
nonbanks, and do you need to know who they are before you 
develop these standards?
    Mr. Gibson. As to finishing our rulemaking on Sections 165 
and 166--we have put the proposed rule out for comment. We have 
received a lot of comments. We are in the process of reviewing 
those comments, and we are working towards a final rule. But we 
will still have the possibility even after the final rule is 
done and once a specific nonbank company is designated to 
tailor our standards to that particular company.
    Mrs. Maloney. My time has expired.
    Thank you.
    Chairwoman Capito. I now recognize the chairman of the full 
Financial Services Committee, Chairman Bachus, for 5 minutes.
    Chairman Bachus. Thank you.
    Mr. Gibson, I am reading Section 113--you have to read 
Section 113, I guess, in connection with Section 165, is that 
correct, in determining what is an SIFI and what is not?
    Mr. Auer. Section 113 lays out the rules for designating 
firms, and Section 165 describes the standards that apply to 
the firms.
    Chairman Bachus. The standards that apply, right. It 
appears the prudential standards that are in Section 165, once 
you designate, are bankcentric, are they not?
    Mr. Gibson. Yes. The prudential standards in Sections 165 
and 166 are bankcentric, and they are some of the traditional 
standards that we have had, such as capital liquidity, and the 
requirement is to enhance those standards, make them higher 
standards for systemically important firms.
    Chairman Bachus. I noticed when you read Section 113, which 
is really the section that determines whether something is 
designated, it says, ``Nonfinancial activities of the companies 
shall not be subject to the supervision of the Board of 
Governors and prudential standards of the Board.''
    Would insurance activities be considered nonfinancial?
    Mr. Gibson. Insurance activities are considered financial.
    Chairman Bachus. They are. Okay. But the standards don't 
appear to apply to insurance. There is no discussion of 
reserves or policies. In fact, if you look at what you discuss 
in Section 113 and you talk about the extent and nature of--you 
talk about underserved low-income communities, their outreach 
there. Does there need to be a different set of standards 
developed for insurance companies?
    Mr. Gibson. The Federal Reserve currently in its role as 
bank holding company supervisor and savings and loan holding 
company supervisor already supervises some companies that have 
insurance operations, so we are already doing supervision and 
regulation of holding companies with insurance activities.
    Chairman Bachus. But would you agree that the standards are 
bankcentric, and these are not banks?
    Mr. Gibson. That is right. What we have done is in the 
existing cases of insurance companies that are supervised by 
the Federal Reserve because they have chosen to be bank holding 
companies or savings and loan holding companies, we have taken 
an approach that has applied some capital, the capital and 
leverage requirements to the holding company, but we do rely on 
the State functional regulators of the insurance companies 
which have traditionally focused on the risks and the 
individual legal entities that are insurance companies.
    Chairman Bachus. So you will consult with those State 
insurance regulators?
    Mr. Gibson. Yes, we already do work closely with them in 
the existing--
    Chairman Bachus. You will before a designation is made? For 
instance, you are trying to determine leverage or whether there 
is capital or enough cap reserves, and that would obviously--if 
you are talking about an insurance company, an important part 
of that would be their insurance policies.
    Mr. Gibson. The FSOC includes members who have insurance 
expertise.
    Maybe I should let you respond, Mr. Auer?
    Mr. Auer. Yes, the FSOC contains at least three members who 
are primarily focused on insurance expertise. And as the 
Council gets into stages two and three of looking at any 
particular firm, we do expect to be working with State 
insurance commissioners to ensure that we have a good 
understanding of the unique nature of those firms.
    Chairman Bachus. Is there any recognition by either of the 
two of you gentleman that these standards don't really appear 
to fit, say, asset managers or money markets or captive finance 
companies or insurance companies? You can look at them as a 
bank and tell what you are going to do, but they need a lot of 
work in nonbank financial companies.
    Mr. Gibson. Regarding some of the nonbank financial 
companies that you mentioned, such as asset management 
companies or captive finance companies, we would certainly have 
to look at the need to tailor the standards that are in the 
proposed rule to the specific characteristics of those 
companies. And as you point out, an asset management company is 
very different from a bank because the assets it manages are 
not on its own balance sheet; they are held in custody for 
customers. That is an important difference.
    We have experience with asset management companies because 
there are large bank holding companies that are significant 
participants in asset management, but we don't have the 
experience of writing capital and other prudential standards 
for a company that only engages in asset management, and that 
is what we would need to tailor--if and when those companies 
are designated, we would tailor the standards.
    Chairman Bachus. But your original threshold is $50 
billion, so that would capture--I know you said 50 or 60 
companies, but wouldn't it be closer to 100 companies that 
could possibly be designated?
    Mr. Auer. The stage one thresholds include a $50 billion 
consolidated assets test. As we say in the final rule and 
guidance, we expect that would capture less than 50 companies 
in total.
    Chairman Bachus. Okay.
    Chairwoman Capito. The gentleman's time has expired.
    Mr. Hinojosa for 5 minutes.
    Mr. Hinojosa. Thank you, Madam Chairwoman.
    Most people agree that the lack of the regulation of the 
nonbank segments of the financial industry, such as the nonbank 
mortgage lenders and the derivatives market, was a very large 
contributor to the recent financial crisis. One of the 
cornerstones of the Wall Street Reform Act was to ensure that 
going forward, the regulators can reach any financial company 
whose failure or activities could threaten our whole system.
    My question to Mr. Auer is, do you agree that the Wall 
Street Reform Act mechanism for designating nonbank financial 
companies for Fed supervision as implemented by the FSOC's 
recent final rule will help prevent future crises by ensuring 
that there is no place to hide from appropriate regulation?
    Mr. Auer. Thank you, Congressman.
    Yes, we view the authority to designate nonbank financial 
companies that could pose a threat to the financial stability 
of the United States as a key part of the Dodd-Frank reforms 
and an essential element to ensure that those types of firms 
that encounter distress and were at the heart of the last 
financial crisis can be better identified going forward and 
subject to heightened standards, better risk management, and 
capital and liquidity rules, so that they are less likely to 
get into distress in the future as well as being subject to an 
Orderly Liquidation Authority and a requirement to provide 
living wills that will describe how they can be wound down 
without government support in a bankruptcy without causing 
disruption to the rest of the financial system. We think this 
nonbank designation process is a key element of achieving those 
goals.
    Mr. Hinojosa. There has been, of course, a lot of effort 
made to go back to the old regulations. Do you think that this 
new regime for regulating significant nonbank financial 
companies will level the playing field between the banks and 
their nonbank competitors that provide comparable services?
    Mr. Auer. I think the key goal and objectives of 
designating nonbank financial companies is if they pose a 
threat to the financial stability of the United States, 
regardless of their legal structure or business line. If a firm 
does pose such a threat, regardless of its activities, it ought 
to be designated and subject to heightened standards so that 
all firms that could pose such a threat are treated equally.
    Mr. Hinojosa. Mr. Gibson, I have heard repeated criticism 
from community banks I represent that Wall Street reform 
increased regulatory burdens on them, the community banks. Does 
anything in this regulation affect community banks directly? Do 
you think that the increased prudential standards on these 
larger, riskier companies could actually lead to an improved 
competitive atmosphere for our community banks?
    Mr. Gibson. The majority of Sections 165 and 166 does not 
apply to community banks. What we are doing is raising 
standards for bank holding companies that are $50 billion and 
above, which is far above the level of a traditional community 
bank. So any bank holding company that is above $50 billion in 
size would be subject to these higher standards.
    You asked the question of whether that could give a 
competitive advantage to community banks. The potential is 
there for that to happen, because community banks will not be 
subject to the higher capital, liquidity, and the other 
standards to which the bank holding companies $50 billion and 
above or the nonbank companies will be subject.
    Mr. Hinojosa. I have seen that we have a small group of 
banks, then the medium-sized banks, and then the very large 
banks, the too-big-to-fail banks, and it seems to me that the 
medium-sized, those in the $12 billion, $13 billion in assets 
or larger, are coming together with community banks to come 
visit me in my office and together point out that these 
regulations are overreaching and that we should just throw them 
all out.
    From listening to your answer, it seems to me that in most 
cases the Consumer Financial Protection Act exempts those 
community bankers, but that is not the perception that is out 
there. What can we do to clarify that?
    Mr. Gibson. I have encountered the same perception when I 
have talked to community bankers, and I think it is a fear 
based in part on what has happened in the past, that 
requirements which are imposed on the large banks eventually 
roll down and affect community banks as well. What we are 
trying to do as we implement the Dodd-Frank provisions is to 
make it clear, in both our rules and when we put out guidance, 
which parts apply to community banks and which parts do not 
apply to community banks. We have started to put statements at 
the beginning of both to say either this does not apply to 
community banks at all, or only these particular sections apply 
to community banks to try to counteract that perception.
    Mr. Hinojosa. Thank you for that explanation.
    I yield back.
    Chairwoman Capito. Thank you.
    Mr. Renacci for 5 minutes.
    Mr. Renacci. Thank you, Madam Chairwoman, and I thank both 
of the witnesses for being here today.
    As a business owner for the last 28 years before coming to 
Congress, one of the biggest challenges was not the regulation, 
but the certainty and predictability and timing of the 
regulation. And what I am hearing so far--I know when Ranking 
Member Maloney asked about timing, I really never thought I 
heard a good answer from either of you about timing, which is a 
problem for the business owner, but also the certainty and 
predictability. So those are things that concern me as we move 
down this path, not as much the regulations, but understanding 
where you are going.
    Mr. Gibson, Title I of Dodd-Frank defines a nonbank 
financial company as a company that is predominantly engaged in 
financial activities. However, there has been some confusion 
over what it means to be engaged in financial activity. Doesn't 
this confusion need to be resolved before FSOC can start 
designating nonbank financial companies for supervision by the 
Federal Reserve?
    Mr. Gibson. The Federal Reserve has a proposed rule out for 
comment that would define the phrase in the Dodd-Frank Act as 
activities that are financial in nature, which defines the set 
of nonbank financial companies that could be designated.
    We issued a proposed rule in February of 2011. We received 
a lot of comments on that proposed rule. In response to the 
comments, we issued a supplemental proposed rule in April of 
this year that clarifies certain aspects of that definition. 
But the FSOC has noted that they don't believe they have to 
wait until the Federal Reserve's rule is final to designate the 
companies.
    Mr. Renacci. So how did the Fed determine which activities 
are financial?
    Mr. Gibson. What we have defined as financial in nature are 
activities that are referenced in certain sections of the law 
that define what activities are permissible for a bank holding 
company. By referring to that section of the law, we are 
incorporating the existing definitions of what is a financial 
activity into this definition of nonbank financial company.
    Mr. Renacci. Are there really any limits then to what the 
Fed can determine as financial activities?
    Mr. Gibson. Yes.
    Mr. Renacci. Financial activities are widespread. You can 
almost go into any company and say they have financial 
activities.
    Mr. Gibson. Right. It is required that a certain percentage 
of your business has to be financial. Commercial companies that 
do a small amount of trade finance or the like would typically 
not be defined as financial if that is the only financial 
activity that they are doing. But the definition is designed to 
capture any company whose financial activity rises to a level 
that would put it into the category of posing a systemic risk.
    Mr. Renacci. So the answer really is any company with that 
particular--
    Mr. Gibson. There is a well-defined set of activities that 
are familiar to the legal community that deals with bank 
holding company regulation and what is permissible for a bank 
holding company, and they understand what these activities are. 
So, we are just trying to use the existing body of knowledge to 
say what is financial in this case. We are not trying to invent 
a new definition of what is a financial activity.
    Mr. Renacci. Are companies that are subject to a 
determination not entitled to an evidentiary hearing as part of 
the appeals hearing? And what recourse do they have if they are 
so designated?
    Mr. Auer. So in the final rule and guidance that the 
Council published, the Council went above the statutory 
requirements in providing for opportunities for firms to 
challenge or present information about why they should or 
should not be designated.
    Specifically, starting in stage three, a firm will be sent 
a notification that it is under consideration, and the firm 
would have the option to provide any material or arguments or 
information it wishes to the Council either in support or in 
opposition to its designation, and the Council will take those 
into account.
    If the Council, after completing stage three, decides to 
vote for a proposed determination, the firm has the right to 
request a hearing in front of the Council to contest its 
proposed designation. If, after that hearing, the Council 
decides to vote in the affirmative for a final determination, 
the firm then has recourse to an appeal to the Federal court 
system.
    Mr. Renacci. Thank you.
    I am running out of time, so I yield back.
    Chairwoman Capito. Mr. Scott for 5 minutes.
    Mr. Scott. Yes, thank you very much, Mr. Gibson and Mr. 
Auer.
    Let me ask you this first question. Is the FSOC the only 
way to further regulate systemically important nonbanks, or 
have alternative methods been contemplated?
    Mr. Auer. Some nonbank companies are already subject to 
some degree of regulation. Many insurance legal entities are 
subject to State insurance supervision, even if their holding 
companies are not. Hedge funds have to have certain reporting 
requirements, as do asset managers. So there are bits and 
pieces, elements in which nonbank financial companies may in 
some cases already be subject to supervision. But the rule in 
the Dodd-Frank Act that provides for the Council to identify 
those firms which are a threat to the financial stability of 
the United States is designed to ensure that those firms that 
could pose such a threat are subject to consolidated 
supervision and enhanced prudential standards.
    Mr. Scott. Does it seem prudent to impose bank-like 
regulations on nonbanks?
    Mr. Gibson. In our proposed rule to implement Sections 165 
and 166, it applies to both bank holding companies that are $50 
billion and above and any nonbank companies that are designated 
by the Council. The standards that we have proposed are focused 
on the banks, but we have been given the authority in Dodd-
Frank to tailor the standards to the characteristics of a 
nonbank company that is designated, and we have said that we 
will use that authorization to tailor the standards as 
appropriate.
    Mr. Scott. Has is the FSOC conducted a thorough cost-
benefit analysis on the designation of nonbanks as systemically 
important, specifically in regards to asset managers?
    Mr. Auer. The FSOC member agencies are obviously very 
concerned about the costs and benefits of their actions. They 
want to bear in mind that this rule was not required in 
statute. The rule was designed to provide greater clarity about 
the purpose of the process by which the Council would engage in 
designations.
    Mr. Scott. Let me just ask you also, have you all taken a 
look at or considered any adverse effects of the designation?
    Mr. Auer. The effects of a designation are--
    Mr. Scott. Adverse effects.
    Mr. Auer. Right, well, there are certain effects that--for 
instance requirements for greater supervision, heightened 
capital standards, liquidity requirements--I don't think those 
are adverse effects. I think those are effects that are 
appropriate to a firm that could pose a threat to the financial 
stability of the United States.
    Mr. Scott. Okay. And involved in this in an intricate way 
are indeed the asset managers. Now, asset managers do not 
invest with their own balance sheets. They invest on behalf of 
their clients. So when a client changes asset managers, it does 
not result in an immediate portfolio liquidation?
    And the point that I am getting at is, where will this 
process end? If nonbank financials are designated systemic, 
will there be other nonbank industries that are systemic as 
well?
    Mr. Auer. The Council's determination about whether a firm 
could pose a threat to financial stability and hence should be 
designated is going to be done, not on an industry-by-industry 
basis, but on a firm-by-firm basis.
    So, the degree that an asset management firm largely has 
its activities in custody and on behalf of customers and, as a 
result, does not pose a threat to financial stability, it is 
unlikely to be designated. To the degree it engages in 
activities that could pose a threat to financial stability, 
then the Council would likely make such a designation, but that 
assessment will be done on a firm-by-firm basis.
    Mr. Scott. And then, finally, will the FSOC evaluate 
business models, capital structures, and risk profiles as 
intended by Congress before pursuing designations?
    Mr. Auer. As part of its designations, the Council will 
look at all of those factors you mentioned for each individual 
firm to see whether or not in total that firm could pose a 
threat to the financial stability of the United States.
    Mr. Scott. Thank you very much, Madam Chairwoman.
    Chairwoman Capito. Mr. Royce for 5 minutes.
    Mr. Royce. Thank you, Madam Chairwoman.
    I would like to ask a question of Mr. Auer just to get his 
feedback on a problem I see here that I don't think is going to 
go away, which is that the market is going to make a 
determination once these firms are designated systemically 
significant by you. And it is reflected in the credit rating 
agencies deciding already that the cost of borrowing, based 
upon their decision--they have shared with us that they believe 
that implicitly, there is a likelihood of government support. 
So the cost of borrowing is lower for these firms than their 
competitors.
    And the consequences when you are in a situation like that, 
you can often gobble up your competitors, your smaller 
competitors especially. You can outperform them. Frankly, you 
can overleverage. But you acquire your competition, and the 
competition shrinks in the market as a consequence of this 
reality.
    Orderly liquidation authority was supposed to imply, I 
think at some point liquidation, but these firms will never 
fail. I just want to quote back to you the new head of the 
FDIC, Mr. Gruenberg's, recent comments, and get your reflection 
on this. He said, ``Three of the goals of the OLA are to ensure 
financial stability, accountability, and viability, which means 
converting the failed firm into a new, well-capitalized and 
viable private sector entity.''
    Now, when the market hears that, they don't think that is a 
firm that he is going to fail. The implication here, and it may 
not be for the stockholders but certainly the creditors, is 
that if you loaned to that firm, there is a very good chance--
that is, not to talk about death panels or what is going to 
happen to the firm. It sounds like the goal here is the same as 
it was in 2008, unfortunately. And although part of that goal 
is to stop the crisis from spreading, the other part is the 
nursing that insolvent firm back to health, essentially through 
either public dollars or new debt, which I think we can argue 
that it likely will be guaranteed by the government.
    So the assumption here again is that these firms will be 
punished by the market by being designated as an SIFI. That is 
what we would like to believe is going to happen. But that does 
not seem to hold water, given the reaction by the market, given 
the reaction when we talked to the credit rating agencies about 
this, because the presumption is they are going to receive very 
favorable treatment by the agency tasked with unwinding it, by 
the FDIC.
    Mr. Gruenberg's comments certainly would imply that, and I 
just wanted to get your take on that.
    Mr. Auer. I can't speak for Mr. Gruenberg's comments, but I 
can say my understanding of the application of orderly 
liquidation authority is that when a firm is put into orderly 
liquidation, all of its equity holders would be wiped out, and 
its debt holders would be given haircuts or only paid back in 
part. The result is it will allow the new company that survives 
to be well-capitalized.
    Mr. Royce. I understand that. But understand that the 
market arguably looks at that and says, that haircut is not the 
equivalent of what a haircut would be if they went through 
bankruptcy, and because they have now this potential pathy, we 
are going to evaluate that as an advantage for creditors. And 
it is implied through the decisions by the credit rating 
agency.
    Last question: capital, capital, and more capital. 
Secretary Geithner said that, and it bears repeating. This is 
the only way to ensure that banks are going to be able to 
absorb unforeseen losses, and luckily, banks have been 
increasing the amount of cash on their books largely, I think, 
because of Basel III. And there were some that have been 
critical of the Fed and the international work being done by 
Basel as having the potential to harm economic growth. I hope 
that recent incidents put that argument at rest. I think that 
these requirements for more capital have been borne out here, 
and I would like your view on that.
    Mr. Auer. One of the requirements of any firm that is 
designated on the basis that it may pose a threat to financial 
stability is enhanced prudential standards, including increased 
capital tailored to the risk that that firm poses.
    Mr. Gibson. I would certainly agree that the reforms to 
raise capital standards for the largest bank holding companies 
are an appropriate response to the crisis and are necessary.
    Chairwoman Capito. Mr. Carney for 5 minutes.
    Mr. Carney. Thank you, Madam Chairwoman.
    Thank you for having this hearing today.
    And thank you to the panelists for coming.
    Mr. Auer, your written testimony provides I think a pretty 
clear walk-through for determination, but I would like to run 
through it and see if you could put a timetable and make sure 
that I understand.
    So the first--as you said in your remarks--to cut is the 
stage one and just these quantitative measures that are listed 
on page 3 of your written testimony, the $50 billion, then $30 
billion in gross notional credit default swaps, $3.5 billion 
derivatives, so on and so forth.
    So you will look at all of these. When will that test--when 
will the process start?
    Mr. Auer. The process has started. The final rule was 
published in April. It went into effect this month. So the 
Council, member agencies, and the Office of Financial Research 
are collecting data to assess which firms pass the stage one 
thresholds.
    Mr. Carney. So you are in the stage one assessment process, 
determining which firms meet these criteria?
    Mr. Auer. That is correct.
    Mr. Carney. When you do that, will there be any 
notification to those firms? It is just not clear here. Will 
you just then go to stage two?
    Mr. Auer. Then we go to stage two.
    Mr. Carney. Explain that a little better, please. You 
mentioned quantitative--I guess additional quantitative 
measures and qualitative measures. What would they look like?
    Mr. Auer. Stage two is designed around a six-factor 
framework for analysis. That are several factors that relate to 
sort of probability that a firm might get into distress, things 
like leverage, liquidity, existing regulatory scrutiny. There 
are also factors that indicate whether a firm might transmit 
that distress, including lack of substitutes, 
interconnectedness, and size.
    The stage two process will look at all of those factors. It 
will take all publicly available data and any data already 
available to regulators and try to provide an in-depth and 
comprehensive analysis of how that firm might or might not pose 
a threat to financial stability.
    Mr. Carney. So leading up to this stage three question--on 
page 5 of your written statement--which says whether the 
company's material financial distress or whether the nature, 
scope, size, scale, so on and so forth, could pose a threat to 
the U.S. financial stability. That is a judgment that is both 
subjective and objective. How would you characterize that 
judgment?
    Mr. Auer. The Council used--in stage three, the firm will 
be notified that it is under consideration by the Council. The 
firm will have an opportunity to provide any arguments, 
information, or data that it feels would be useful to the 
Council in making its determination. The Council may also ask 
the firm--
    Mr. Carney. Can I stop you there? So that after a two-
thirds vote of the Council--
    Mr. Auer. No.
    Mr. Carney. So there is this process first, and then there 
is a two-thirds vote. And then there is an additional hearing 
and a process, and an additional vote if there is a hearing; 
correct?
    Mr. Auer. That is correct.
    Mr. Carney. It is a pretty involved kind of back-and-forth 
and certainly an adequate opportunity for the firm to question 
some of the conclusions that are made, but certainly a lot of 
opportunity for feedback.
    Mr. Auer. There are multiple points at which a firm can 
engage with the Council and its member agencies about its 
designation.
    Mr. Carney. So you get through this whole process, and you 
determine that here is a big firm which has a lot of this 
interconnectedness and meets all of these qualitative criteria 
and quantitative criteria and by a two-thirds vote is 
determined to pose a threat to the financial system. Do you 
expect that many of these nonbank firms will meet that type of 
criteria at the end of the day?
    Mr. Auer. As we say in the final rule and guidance, we 
expect that less than 50 firms will pass the stage one 
thresholds. Stage one thresholds however are not meant to be 
definitive in any way. They are more of a screening device to 
identify those firms where the Council will spend more of its 
time and effort. I think it would be premature and 
inappropriate to speculate how many firms are designated before 
we have analyzed them.
    Mr. Carney. Sure. Fair enough.
    Thank you.
    Chairwoman Capito. Mr. Hensarling for 5 minutes.
    Mr. Hensarling. Thank you, Madam Chairwoman.
    Mr. Gibson, in your testimony you stated that the Dodd-
Frank Act addresses the market perception that such firms are 
too-big-to-fail. It seems to be fairly well-documented that the 
larger investment banks still enjoy funding advantages over 
their smaller competitors, and since the passage of Dodd-Frank, 
we know that the big have gotten bigger and the small have 
gotten fewer. So I am curious about your observation of market 
perception.
    Mr. Gibson. It is certainly true that some market 
perceptions still exist, and as was mentioned previously by 
rating agencies and others, the market does not seem to be 
fully convinced that the tools given under Dodd-Frank will be 
used. I think we, the regulators, still have a ways to go to 
prove to the market that we will use those tools in a way--
    Mr. Hensarling. So you posit that the Act addresses market 
perception, it is just the market doesn't understand it? Is 
that what you are trying to tell me?
    Mr. Gibson. I think the market is skeptical that the 
regulators will have the means and the will to use the tools, 
and they are waiting to see.
    Mr. Hensarling. Count me as part of the market.
    The other question I have, and I think the gentleman from 
Ohio, Mr. Renacci, asked a somewhat similar question, but when 
we are looking at potentially designating nonbank SIFIs, and if 
we are looking at the first part test of the financial 
activities, a company that the market may not perceive to be 
financial, if they, for example, import some type of raw 
material from overseas, they have to manage potentially 
currency risk, commodity risk, interest rate risk, operational 
and shipping risk, and I thank the Chamber for their upcoming 
testimony and helping to elucidate this question.
    But if these activities are found to be financial in 
nature, if this helps trigger the threshold test, isn't it 
possible that some firms, nonbank financial firms or nonbank 
firms that wish to avoid an SIFI designation, may indeed decide 
not to hedge certain risk, in which case have we not perhaps 
concentrated more risk where we don't want it and maybe they 
will go naked on these positions?
    Has that been considered?
    Mr. Gibson, I will go to your rule.
    Mr. Gibson. The Federal Reserve has a proposed rule out for 
comment on the definition of what are financial activities that 
would make a firm potentially subject to designation. It has to 
be predominantly financial, a very high percentage financial.
    Mr. Hensarling. Are the activities that I just described 
financial or does it depend upon the motives? Does it depend 
upon the underlying business entity? What does it depend on?
    Mr. Gibson. It depends on the particular activities as they 
are defined in the current bank holding companies for what are 
permissible activities for bank holding companies. Some of 
those same definitions are being used for the definition of 
financial activities, but it is a very high threshold. So a 
commercial company that does a small amount of financial 
activities, hedging or financing, typically would not be deemed 
predominantly financial. But of course, it depends on the facts 
and circumstances of a particular company.
    Mr. Hensarling. But also included in FSOC's rules, once you 
outline the criteria by which one is adjudged in stage one to 
be a nonbank SIFI to go to stage two, isn't your last criteria 
essentially, we can ignore all of our other criteria and still 
decide to send a potential firm to stage two? I am trying to 
figure out, if you are trying to add some clarity to the 
definition, you seemingly take--whatever you provide with one 
hand, you take away with another. Where is the clarity here?
    Mr. Auer. Let me make one point. In order for a firm to be 
designated and determined to be a nonbank financial company, at 
least 85 percent of its assets or 85 percent of its revenues in 
nature. So that should be very effective in limiting the types 
of firms that are merely engaging in some hedging activities of 
their commercial business. Such firms would be unlikely to trip 
the 85 percent threshold.
    The Council, in designing the stage one thresholds, want to 
provide clarity about the types of firms that it was likely to 
focus on and for further evaluation and to give some clarity 
about its thinking in that regard and to act as an initial 
screen. However, the Council is reluctant to put itself in a 
position where a very risky firm, that through whatever gaming 
techniques was able to avoid the stage one thresholds--
    Mr. Hensarling. I see my time has expired. If I could, as I 
read the guidance provided from FSOC, it says, ``FSOC may 
advance a nonbank company to stage two irrespective of whether 
such company makes the threshold in stage one.'' Again, I see 
no clarity here.
    I yield back.
    Chairwoman Capito. Mr. Green for 5 minutes.
    Mr. Green. Thank you, Madam Chairwoman.
    I thank you and the ranking member again.
    Let's start with SIFI. To a good many members of the 
public, SIFI is ``SciFi.'' It really is. And perhaps we can 
find a way to explain this in a much more intelligible fashion 
for persons who are not privy to much of the intelligence that 
you two fine witnesses are sharing with us. So let's start with 
a very basic question: Was AIG a nonbank financial institution?
    Mr. Gibson?
    Mr. Gibson. Yes.
    Mr. Green. Thank you. I tend to ask questions that you can 
answer yes or no.
    Was AIG into many different kinds of products, exotic 
products, if you will, credit default swaps, derivatives? Was 
AIG into what we now refer to as exotic products, Mr. Gibson.
    Mr. Gibson. With the caveat that the Federal Reserve was 
not the supervisor of AIG, I am pretty sure the answer to your 
question is yes.
    Mr. Green. I understand the Federal Reserve was not, and I 
am not going there. But I am going here: Was AIG the type of 
institution that FSOC would be designed to have an impact on?
    Do you want to pass, Mr. Gibson? I am still with you.
    Mr. Gibson. I would say that looking at the quantitative 
screens in stage one of the FSOC's process, AIG would trip many 
or all of those.
    Mr. Green. Of course, it would. It was over $50 billion, 
wasn't it?
    Mr. Gibson. Yes.
    Mr. Green. Go on, elaborate. Tell us the reasons why AIG 
would come under the auspices of FSOC
    Mr. Gibson. Under the FSOC's rule, the characteristics that 
make up systemic importance, which have already been listed, 
some of the most important ones are the size of the company and 
the interconnectedness of the company.
    And what we learned about AIG after its near failure was 
that its size was of an extent that was seen to pose a systemic 
failure, and its interconnectedness with other large financial 
firms was also substantial.
    Mr. Green. Who knew that AIG was part of the glue that was 
holding the company together?
    Mr. Auer, it was discovered after the fact that AIG was 
part of the glue holding the economic order together, true?
    Mr. Auer. I think AIG was intimately involved in and highly 
interconnected with a great number of financial firms.
    Mr. Green. And that would be your way of saying yes?
    Mr. Auer. Thank you.
    Now, given that we know that there are other AIG's, not in 
the sense that they are right now about to go out of business, 
but there are other big businesses that may pose systemic risk. 
They may become SIFIs and because we know that they may become 
or maybe they are SIFIs, is this not a means by which we can 
deal with them without making an attempt to prevent them from 
making bad business decisions?
    Here is what I am saying: We can't stop businesses from 
making bad business decisions. My belief is that happens and 
that is a part of the ebb and flow of doing business. But we 
can deal with the consequences of bad decisions. Is that what 
we are attempting to do here, Mr. Gibson, to deal with the 
consequences of bad decisions by these mega businesses?
    Mr. Gibson. Yes, and one of the enhanced prudential 
standards that nonbank companies which are designated by the 
Council will be subject to are enhanced capital requirements 
that will make sure that a buffer exists to cover unexpected 
losses such as the type you are describing.
    Mr. Green. And for edification purposes, those who would 
like to, go back to the stock market crash and read about how 
the resistance took place when we were trying to put the FDIC 
in place. And FDIC has proven to be very beneficial when we are 
looking for an orderly means by which we can liquidate banks.
    True, Mr. Gibson?
    Mr. Gibson. Yes--
    Mr. Green. Are we trying to do the same thing now with 
nonbank institutions?
    Mr. Gibson. The intention of the Title II Orderly 
Liquidation Authority is to extend what the FDIC currently has 
for banks to nonbanks.
    Mr. Green. I would simply close with this: We can do this 
and not overregulate. And I think that is what we are trying to 
accomplish today.
    Do you agree we can do this and not overregulate, Mr. 
Gibson?
    Mr. Gibson. That is what we are trying to do.
    Mr. Green. Mr. Auer?
    Mr. Auer. I would agree.
    Mr. Green. Thank you very much.
    Thank you, Madam Chairwoman.
    Chairwoman Capito. Mr. Luetkemeyer?
    Mr. Luetkemeyer. I have a question with regards to FSOC. 
Coming from the small bank, community bank perspective, some of 
the things that have come down obviously do not affect them. 
But there are a lot of rules in Dodd-Frank that do. Is FSOC 
going to go through and look at some of the rules? I believe 
that Dodd-Frank was sort of a shotgun approach. Are we going to 
go back and take some of the pellets out the bullets so we can 
go back to a rifle approach and make sure that the rules are 
specific to the larger institutions and take some of those back 
off the smaller institutions and nonbank-lending folks?
    Mr. Auer. The FSOC regularly discusses existing and 
upcoming regulations that are part of Dodd-Frank, and I expect 
it will continue to do so and try to encourage cooperation and 
consistency across the agencies as they develop the rulemaking 
process, and that helps ensure that any rules and regulations 
that are promulgated are handled appropriately.
    Mr. Luetkemeyer. But they are not going to go back and take 
some of them back out or make them streamlined or more 
appropriate to just the bigger folks, who are the problem areas 
here, and alleviate the smaller folks?
    Mr. Auer. The FSOC itself is not a regulatory agency--
    Mr. Luetkemeyer. But they can surely provide some guidance, 
could they not?
    Mr. Auer. Many of its members are regulatory entities and 
you discussed their upcoming regulations with other Council 
members. I don't know what those agencies' plans are for their 
previously issued--
    Mr. Luetkemeyer. With regard to the rules that are 
promulgated, is there a cost-benefit analysis done on any of 
those rules?
    Mr. Auer. On which rules?
    Mr. Luetkemeyer. On the FSOC rules.
    Mr. Auer. The FSOC has issued at least two rules that I am 
aware of today. One is the rule we are discussing, which was 
published in April. That is a rule which does not directly 
impose any restrictions.
    Mr. Luetkemeyer. My time is limited. Can you give me a yes 
or no?
    Mr. Auer. There is no need to do a cost-benefit analysis.
    Mr. Luetkemeyer. What enforcement mechanisms are in place?
    Mr. Auer. To enforce what?
    Mr. Luetkemeyer. The rules.
    Mr. Auer. This rule does not, as I said, put in place any 
restrictions or limitations on firms. What it does is it helps 
explain the Council's process by which it will identify nonbank 
financial companies that can pose a threat to financial 
stability.
    Mr. Luetkemeyer. We leave that to the regulators then to 
enforce?
    Mr. Auer. Yes, the regulators--
    Mr. Luetkemeyer. As a regulator, what is your enforcement 
mechanism?
    Mr. Gibson. We will have the same enforcement tools for 
enforcing the enhanced prudential standards on any nonbank 
companies that are designated that we currently have.
    Mr. Luetkemeyer. Which are what?
    Mr. Gibson. Which are our supervisory tools, examinations.
    Mr. Luetkemeyer. Which are? What is your enforcement? If 
they are bad actors, and they do something wrong, what are you 
going to do?
    Mr. Gibson. We can impose on them written agreements, 
memoranda of understandings, civil money penalties, the full 
range of tools we currently have with bank holding companies.
    Mr. Luetkemeyer. Okay. Whenever you designate someone as an 
SIFI, is this going to be public knowledge, or is this going to 
be just something that is internal between your agencies and 
the individual company?
    Mr. Auer. The final designation of any particular firm is, 
for Federal Reserve supervision and enhanced prudential 
standards, would be a public event.
    Mr. Luetkemeyer. One of the things that I, quite frankly, 
like about the Dodd-Frank Act is the living will that these 
agencies--not agencies but entities--are going to have to put 
together. Can you describe to me some of the tenants that would 
be in a living will that would be important to you to see that 
were in there and how it would operate?
    Mr. Auer. The living will requires that the company 
describe how it could be resolved under the Bankruptcy Code. So 
for companies that are very complicated, the living will needs 
to have a description of how different legal entities within 
the company interact with one another, so that if different 
legal entities are subject to different bankruptcy procedures 
or different regulatory procedures, exposures of one entity 
aren't so tied in with another that it just creates an 
intractable situation.
    By having that information in advance, and especially by 
requiring the companies to produce that information and 
understand what those impediments to resolution could be, we 
can then use our supervisory process to push the companies to 
reduce the impediments to resolution and make them more 
resolvable.
    Mr. Luetkemeyer. What you are saying is a living will 
basically lays out the connectivity of all of the things that 
are going on within that company?
    Mr. Auer. That is one of the important aspects of it, yes.
    Mr. Luetkemeyer. I see my time has expired.
    Thank you, Madam Chairwoman.
    Mr. Miller for 5 minutes.
    Mr. Miller of North Carolina. My questions are about the 
losses in Chase's synthetic credit portfolio, and I don't claim 
to understand that entirely. The details have been sort of 
sketchy, but it also appears that nobody at Chase really 
understood it, either. So that makes me feel a little better.
    There has been some criticism by defenders of the banks 
that the critics of the banks are taking too much pleasure over 
the loss, are gloating over the loss. I don't think I have been 
gloating. But it is also hard to see this as something to 
grieve over. Because it is not like a factory, a $2 billion 
factory burned down that was making something useful and giving 
jobs to people who want to make an honest living. It has just 
sort of shifted $2 billion. It was Chase's $2 billion, around 
to probably some hedge funds.
    So it really appears that the only thing to worry in all of 
that is the effect that it might have on the soundness of any 
given banks engaged in these kinds of transactions, or 
especially to the system as a whole, whether it creates a 
systemic risk.
    I am wondering how on Earth we even have a fighting chance 
to figure that out. Ina Drew, the chief investment officer of 
Chase, who has now resigned, was making $14 million last year. 
And she apparently did not understand these transactions, and 
we are supposed to send in some examiners on government 
salaries, and they are supposed to figure out what kind of 
risks are involved in these transactions.
    It would be easier for an examiner to say or to think, this 
kind of looks like it creates a risk, but it is a $2.3 trillion 
bank. Even if they lose money on this, they are probably making 
it somewhere else. They will be okay, which is the exactly the 
kind of attitude or the kind of thinking that can lead to a 
great risk for an institution that size if every division is 
taking risks like that.
    What sense does it make to create banks this big, and they 
are actually even bigger now than they were before the crisis? 
Why do need to combine what appear to be just entirely discrete 
business all within one huge $2.3 trillion bank that will be 
impossible to regulate, to examine, that will be impossible for 
the market to discipline? Why not have smaller banks so that if 
we can't figure out what risks they have and a risk pulls them 
down, it won't create quite the same effect on the entire 
economy, and even if--and it should be possible to figure out 
more what their business is if it is smaller. So why not have 
smaller banks?
    Mr. Gibson. Under the Dodd-Frank Act, in particular Section 
165 on enhanced prudential standards that we have been talking 
about today, the Dodd-Frank Act asks the Federal Reserve to 
apply--
    Mr. Miller of North Carolina. Part of my question is, does 
the Dodd-Frank Act go far enough? Or should we have done more 
to take apart the big banks? I know the Kanjorski amendment 
allows for breaking up banks based on a very high standard of 
risk, but should they just be smaller?
    Mr. Gibson. What we will be doing as we implement Dodd-
Frank is to impose higher capital and other standards on the 
largest banks, and we will be doing that in a graduated way 
that imposes the highest capital standards, for example, on the 
largest banks and less stringent capital standards on the 
smaller banks. So it will have the effect of tilting the 
incentives away from becoming large simply for the sake of 
becoming large because the largest banks will be subject to the 
capital surcharge eventually once the Basel surcharge is 
implemented in the United States.
    Whether that will work or not, I think, remains to be seen. 
We still have a lot of work to do to implement that, but for 
now, it is an approach that is going in the direction of 
putting higher requirements, stiffer requirements on the very 
largest companies and less stiff requirements on smaller 
companies.
    And that is what we are implementing now.
    Mr. Miller of North Carolina. Why have apparently entirely 
discrete lines of business consolidated into one firm? There 
appear to be no economies of scale, no economies of scope. 
There appears to be no particular reason to do it, and it 
creates conflicts of interest. Why not have servicing units 
be--why do they have to be an affiliate of a bank that holds 
second mortgages on the same homes that they are servicing?
    Mr. Gibson. The approach we are taking by having larger 
capital standards on the largest banks will naturally create an 
incentive if an activity can be done outside of a big mega 
bank, to be done with a lower capital requirement, presumably 
more cost-effectively. So we are providing an incentive where 
there is not a synergy that creates a benefit that would then 
be passed along to the customers, then with those activities, 
logically, there would be an incentive to move them out of the 
largest banks.
    Chairwoman Capito. Mr. McHenry?
    Mr. McHenry. Thank you, Madam Chairwoman.
    Mr. Auer, in designating nonbank SIFIs, how much weight 
will the FSOC give to companies that have existing regulators? 
Perhaps you have an international nonbank financial 
institution, and in their home country, they have supervisory 
authority that is very clear. Would the Fed be--would it be 
likely that the Fed would be designated or less likely?
    Mr. Auer. Both in the 10 statutory or 11 statutory 
considerations as well as in the framework that the Council 
lays out in its rule and guidance for doing it in stages two 
and three, the Council does plan to take into account existing 
regulatory scrutiny, whether that scrutiny is domestic or 
foreign. Whether it is at the consolidated level or at a legal 
entity level, the quality and extent of that regulation will 
all be factors that would lead into the Council's ultimate 
determination about whether or not that firm poses a threat to 
our ultimate responsibility.
    Mr. McHenry. Mr. Gibson, you said earlier that the Fed has 
the authority to ``tailor standards as appropriate to 
nonfinancial companies.'' Isn't this uncharted territory for 
the Fed?
    Mr. Gibson. We have the authority to tailor the standards 
for nonbank financial companies. Commercial companies would not 
be subject to the FSOC designation, but nonbank financial 
companies would. And we have experience with different types of 
nonbank activities in which bank holding companies and 
financial holding companies already engage. There are bank 
holding companies and financial holding companies that own 
insurance companies, that own asset management companies and a 
variety of other nonbank companies. We will use that experience 
that we have and, if necessary, bring in more experience so 
that we are able to do a good job of supervising nonbank 
companies that are designated.
    Mr. McHenry. Will you be consulting with the Federal 
Insurance Office?
    Mr. Gibson. We are already consulting with the Federal 
Insurance Office on our existing supervision of bank holding 
companies and financial holding companies that have insurance 
operations, so yes.
    Mr. McHenry. Moving on to another issue, it is my 
understanding that the counterparty limits the Fed currently 
has put forward is a pretty significant shift in how financial 
institutions manage their risk. I appreciate the challenge of 
managing interconnectedness in the financial system. But what I 
am concerned about is whether the Fed is putting the cart 
before the horse in that there is not sufficient analysis that 
we have seen in the public sphere on the impact that this 
proposal would have on banks, on clearinghouses, on foreign 
sovereigns, and on the rest of the financial system.
    Is there significant data within the Federal Reserve on 
measuring that?
    Mr. Gibson. We put out our proposal for Section 165 in 
December, and the comment period recently closed. One of the 
things we asked for comment on was exactly the question of what 
would the impact of the single counterparty credit level be, in 
terms of how constraining would it be for the banking 
organization's $50 billion and above. We have received a lot of 
comments from the public on that aspect of the proposal, and 
those comments do include some information about the impact, 
and we have done our own analysis through our supervisory 
process as well. And we will be using all that data as we move 
forward toward that final rule.
    Mr. McHenry. Have you done a cost-benefit analysis on the 
proposal?
    Mr. Gibson. We look at the costs and benefits of every rule 
that we put out. On this particular proposal, we are still 
gathering information on the particular counterparty credit 
limits that were proposed, and the alternatives that were 
suggested by the commenters as well.
    Mr. McHenry. Okay. Have you done any analysis on the 
current levels of exposure?
    Mr. Gibson. Yes.
    Mr. McHenry. Would you be willing to share that data with 
us?
    Mr. Gibson. In the proper way that doesn't require me to 
talk about confidential supervisory information, I would be 
happy to provide more information, including the information we 
have gathered and the information that companies have submitted 
to us through the public comment letters which are available to 
you. Companies have also submitted confidential information to 
us through the supervisory process, which they intend for us to 
use as we move forward towards a final rule and have the best 
information available. So, we have all of that information.
    Mr. McHenry. What information will be made public? That is 
sort of my question.
    Mr. Gibson. I can't predict how we are going to move 
forward toward the final rule, but when we do the final rule, 
we will certainly come out with a discussion of how we weighed 
the comments that we received and what judgments we made based 
on those comments to move from the proposed rule to the final 
rule
    Chairwoman Capito. Mr. Canseco?
    Mr. Canseco. Thank you, Madam Chairwoman.
    Good morning, Mr. Auer. I noticed that at the first 
February 1st FSOC meeting, you updated the Council on comments 
that had been received regarding the second notice of proposed 
rulemaking. The meeting that day was gaveled in at 1 p.m., and 
was concluded at 3:13 p.m., and your presentation was one of 5 
or 6 items on that day.
    I am not certain how long the Council discussed your 
presentation or what questions were asked, but I assume it 
couldn't have been more than 20 or 30 seconds. Could you shed 
some light for us on what was discussed that day and some 
concerns that were raised by the Council members?
    Mr. Auer. The discussions at that particular Council 
meeting were not the first time that the nonbank designation 
rule had been discussed by the Council. The Council actually 
put out an advanced notice of proposed rulemaking, a first 
notice of rulemaking, and a second notice of proposed 
rulemaking. In all three cases, we received comments, and in 
all three cases, the Council discussed those comments, how the 
next iteration of the rule would incorporate and respond to 
those comments, so that there was a thorough conversation at 
each point in the process about how the final rule responded to 
the comments from the public.
    Mr. Canseco. Did you discuss the comments that you 
received?
    Mr. Auer. Yes.
    Mr. Canseco. And were those comments and those comment 
letters discussed at that time?
    Mr. Auer. Yes.
    Mr. Canseco. And what were some of the dissensions?
    Mr. Auer. I don't know that there was any dissension. There 
was discussion among the principals about how--and questions 
about how the rule addressed the comments and what changes were 
necessary at various points to address the comments and how 
those were reflected in the final rule.
    Mr. Canseco. So everybody was on the same page?
    Mr. Auer. All Council members asked a lot of questions, but 
the ultimate vote, I believe, if I recall correctly, was 
unanimous in supporting the publication of the rule and 
guidance.
    Mr. Canseco. The final rule was approved 2 months later, so 
can you shed some light on specifically how comments were 
incorporated into the final rule, or were they not incorporated 
into the final rule?
    Mr. Auer. Many comments were not incorporated into the 
final rule throughout the process. The entire three-stage 
process that is enshrined in the rule is a result of comments 
received over the course of the rulemaking process, so that the 
very structure of the rule in fact is built around comments 
from industry. The comments drove other changes to the rule and 
amendments to the rule, for instance, the desire that many 
firms had that they be given some advanced notice that they 
were under consideration, which is what led to the stage three 
notification. I think that is an excellent example. There were 
other answers about ensuring the confidentiality of information 
that is provided to firms, information with regard to the 
Council, so we elaborated on that. So I think every serious 
comment that came in was addressed in one or another.
    Mr. Canseco. Were they incorporated, or were they thrown 
out?
    Mr. Auer. Depending on the comment, I think the rules 
addressed every comment. Certainly, the preamble to the final 
rule described all significant comments and described whether 
that comment was adopted wholesale, adopted in a way that was 
adjusted, or deemed not relevant.
    Mr. Canseco. Thank you.
    Mr. Gibson, in the final rule that was issued in April, it 
was noted that the Fed has authority to issue regulations for 
determining if a company is predominantly engaged in financial 
activities and has issued a proposed rule under this authority. 
So if I am interpreting it correctly, if I say that the FSOC 
has moved forward with a final rule on SIFI designations before 
the Fed has determined the definition of financial activities, 
who is engaging in that? Has it done that?
    Mr. Gibson. We have a proposed rule which has not been made 
final yet on the definition of ``financial'' as it applies to 
the nonbank regulation.
    Mr. Canseco. If that is the case, then when does the Fed 
expect to finalize this rule, and shouldn't it have been done 
before the final SIFI designation?
    Mr. Gibson. I don't think there is any legal requirement 
that it be done before the final FSOC rule, and indeed, the 
FSOC had said--
    Mr. Canseco. I am not asking about legal requirements. I am 
just specifically asking because it seems to me, it is putting 
the cart before the horse. And that is a very common occurrence 
these days.
    Mr. Gibson. I think the rule that defines what it means to 
be activities that are financial in nature will be relevant for 
companies where there is some uncertainty about whether they 
are financial enough. And I think, as we have mentioned, the 
cutoff is 85 percent financial. So there are undoubtedly some 
companies out there that are kind of on the boundary and are 
not sure. But I think there are a lot of companies that are 
clearly financial and where exactly the boundary is drawn is 
not going to affect whether they are determined to be financial 
or not.
    Chairwoman Capito. Mr. Manzullo?
    Mr. Manzullo. Thank you, Madam Chairwoman, for calling this 
hearing.
    I have problems with the fact that the proposed regulations 
sweep insurance companies into the same area as bank holding 
companies. What is unfortunate about the inability to have all 
of the witnesses on one panel is the fact that if you take a 
look at the testimony of MetLife--which will occur shortly when 
William Wheeler testifies--it discusses the fact that the asset 
and liability structures of banks are much different than 
insurance companies. Insurance companies are in for the long 
haul, very solid fixed-income, stable investments. Banks borrow 
money short term and then put it into long term, it could put 
them in a position where you would have a risk taking place. 
Would you agree with that?
    Mr. Auer. Yes.
    Mr. Manzullo. That being the case, if MetLife failed, of 
all the questions to ask is this, if MetLife failed, would the 
failure of the company threaten the stability of the United 
States? We agree the answer is no, we cannot think of a single 
firm that would be brought down by its exposure to MetLife. 
Would you agree with that statement?
    Mr. Gibson. MetLife has been supervised by the Federal 
Reserve because it is a bank holding company.
    Mr. Manzullo. They are getting rid of their bank holding 
company.
    Mr. Gibson. Once they get rid of the bank holding company, 
they will no longer be supervised under the Federal Reserve.
    Mr. Manzullo. Would they come under the new regulations?
    Mr. Auer. MetLife is now a nonbank financial company. I am 
fairly certain that more than 85 percent of its assets or 
revenues are financial in nature. So it would be eligible to be 
designated by the Council, but that does not mean the Council 
would choose to do so.
    Mr. Manzullo. I think it is the largest insurance company. 
If they are eligible, and then you say we are not going to 
regulate, then no insurance company would be regulated. Is that 
correct?
    Mr. Auer. I don't think the Council has done an analysis--I 
know the Council has not done--
    Mr. Manzullo. This is a pretty easy question.
    Mr. Auer. I don't know whether the Council plans to 
designate MetLife or not--
    Mr. Manzullo. Because that is not your decision.
    Mr. Auer. It is not our decision.
    Mr. Manzullo. The reason I bring that up is the fact that 
if you take a large company like MetLife and you treat them 
like a bank holding company, are you gaining anything? Is 
anybody safer?
    Mr. Gibson. The difference in the regulation and 
supervision that the Federal Reserve has been engaged in with 
MetLife and other large insurance companies that chose to 
become bank holding companies is that we are a consolidated 
bank--
    Mr. Manzullo. Remember, they are shedding their bank 
holding company. They will be just an insurance company.
    Mr. Gibson. If you are talking about after they shed the 
bank holding company, then it will be completely up to the FSOC 
to decide if they should be regulated as a--
    Mr. Manzullo. What do you think? They propose no systemic 
risk.
    Mr. Gibson. Also, it is up to the FSOC to make the 
judgment--
    Mr. Manzullo. I understand that, but the reason for this 
hearing is the dragnet that we see taking place here. You are 
imposing standards--no, you are creating standards, and yet you 
don't know to whom they will apply. And then when we show--and 
I am not being critical--but when it is shown that a company 
like MetLife after it sheds its bank holding company would 
produce no systemic risk, then it follows they should not be 
regulated under this new regulation.
    Mr. Auer. If the Council does decide to assess MetLife and 
it comes to the conclusion that MetLife does not pose a threat 
financial stability--
    Mr. Manzullo. But no insurance companies--three insurance 
companies got TARP funds. AIG--maybe two didn't need it. AIG 
got it, but that is because, even the insurance--under Illinois 
rules, they were walled off. Those assets were walled off 
because of Illinois liquidity requirements--I am sorry, reserve 
requirements.
    So what I am just suggesting to you is that I don't see the 
need to drag the insurance companies into this particular rule 
when in fact they did not present a systemic risk in the event 
that--in the terms of MetLife, we cannot think of a single firm 
that would be brought down because of its exposure to MetLife.
    You don't have to answer that question.
    I yield back.
    Chairwoman Capito. Thank you.
    Mr. Grimm for 5 minutes.
    Mr. Grimm. Thank you, Madam Chairwoman.
    And I thank the witnesses for being here today.
    It is interesting, I will tell you that.
    I think Mr. Manzullo's questions hit to the heart of why 
everyone is so confused. The amount of uncertainty has risen to 
an all-time high, and it is getting worse.
    The gentleman from North Carolina asked before why we don't 
have more small banks. That should be obvious to everyone in 
the room because smaller banks can't compete--they can't keep 
up with the administrative costs of all of the rules and 
regulations. And I would purport to you that as we continue to 
add on, in the hopes of getting rid of systemic risk, you are 
going to be left with only a few large institutions that can 
afford to keep up, therefore making them systemically risky. 
But maybe I have it backwards. I don't know. Maybe I am missing 
something.
    Let's talk a little bit about asset managers for a second. 
With regard to asset managers, has the Council considered the 
possible adverse effects of a designation for asset managers?
    Mr. Auer. The Council, in its proposed rule and guidance, 
describes how it is going to go about assessing whether or not 
a firm poses a threat to the financial stability of the United 
States. The consequences of being designated are that a firm 
will be subject to enhanced capital requirements--I am sorry, 
the consequences of being designated will be the firm would be 
subject to enhanced prudential standards, including capital 
requirements, liquidity and requirement for living wills, among 
others.
    Mr. Grimm. Is that a yes?
    Mr. Auer. The Council is aware of what the consequences of 
being designated an asset management firm are, yes.
    Mr. Grimm. So you have considered the adverse effects?
    Mr. Auer. I am not sure what you mean by adverse effects.
    Mr. Grimm. Let me ask you this: Have asset managers been 
involved in the OFR study to date?
    Mr. Auer. The OFR is engaging in an analysis of the extent 
to which there are potential threats to financial stability 
from asset management firms. The OFR has begun the process of 
talking with people in the asset management industry and will 
continue to do so. The OFR, the Council and its member agencies 
welcome any comments or--
    Mr. Grimm. Is there a formal process for conducting the due 
diligence for asset managers?
    Mr. Auer. Any asset management firm or other entity that 
wants to meet with the Council staff or member agency staff 
about the designations process is welcome to contact any 
Council member agency or the OFR, and we will try to set up 
meetings for that firm.
    Mr. Grimm. What I am concerned with is, is the FSOC 
evaluating the substitutability of asset managers? Asset 
managers, they don't invest in their own balance sheets. They 
are investing on behalf of clients. So when a client changes an 
asset manager, that doesn't mean that the portfolio is 
immediately liquidated. So I just hope that the FSOC is looking 
at that and that there certainly would be adverse effects, and 
I wish they would certainly consider that.
    Following up, before, we heard a little bit about the 
transparency. I have been hearing, and correct me if I am 
wrong, but I am hearing that it has not been a transparent 
process. I am hearing that the FSOC is almost working in a 
black box, so-to-speak. And I just want to know--let's take an 
example to make it easy. When a nonbank entity is put into 
designated stage three, it seems that there is no explanation 
why. Can you elaborate on that?
    Mr. Auer. If any firm makes it, any particular firm makes 
it to stage three, that firm will be provided a notification 
that it is in stage three. That begins the process of having a 
discussion with the firm. The firm has the opportunity to 
provide comments, arguments, and data to the FSOC and its 
member agencies about why it should or should not be 
designated--
    Mr. Grimm. Let me just stop you there for a second, if I 
may. So a company may have to disclose this information, that 
they have been put in stage three, but all they have is a 
notification with no explanation. Do you see how that could be 
an untenable situation for these companies?
    Mr. Auer. I think that the desire to create a stage three 
was put specifically at the request of companies in the 
comments that we received on the various stages of developing 
the rule where they wanted an advance notice of whether or not 
they would be under consideration. While the exact composition 
of what will be in that notice is yet to be determined, the 
Council can't, before finishing its analysis, provide a firm 
with all of the reasons that it thinks the firm may or may not 
be designated. That would prejudge the outcome.
    Mr. Grimm. The cart before the horse seems to be the theme 
of the day. Thank you so much.
    I yield back.
    Mr. Renacci [presiding]. Mr. Garrett for 5 minutes.
    Mr. Garrett. I thank the Chair, and I thank the gentlemen 
on the panel.
    So the Fed, Mr. Gibson, as has already been discussed, has 
proposed a rule to define ``financial activity'' for the 
definitions purposes of Dodd-Frank, but it would appear that a 
few additional lists of financial activities that are different 
from what Dodd-Frank had intended and from those activities as 
it is defined under bank holding companies are now included. In 
other words, Dodd-Frank clearly says that the Fed has the 
authority to define the criteria for falling into this 
category, but it doesn't give the Fed the option to redefine 
terms that are already set forth in Dodd-Frank.
    So I guess my opening question is, why do you think the Fed 
has this authority to go beyond what Dodd-Frank is explicitly 
setting forth as far as defining terms?
    Mr. Gibson. I am not aware of any ways that the proposed 
rule is going beyond or trying to redefine terms. I think the 
proposed rule, which has been reproposed now for a second time, 
is responding to the comments we received in response to the 
first proposal with some suggested changes, and in order to 
incorporate those, we put out a second proposal.
    Mr. Garrett. Let me just give you an example. And I know 
how this all came down with regard to Dodd-Frank. Normally, 
during a thoughtful and deliberative piece of legislation, I 
think the Fed would be responsive to what that legislation is. 
I am not sure whether we are talking about the same thing. We 
are not talking about Dodd-Frank as being thoughtful and 
deliberative. But I know there was concern by the various 
industries, when there was talk about the Fed being able to 
designate nonbank financial institutions, that it might be 
overly broad going forward, so a specific amendment was adopted 
into the law. And what it says was to define this area was, 
``predominantly engaged in financial activities'' defined under 
existing law, Section 4(k) of the Bank Holding Act.
    But now, the Fed has gone beyond that, because here in 
Dodd-Frank it describes specifically, ``predominately engaged 
in financial activities is described as Section 102(a)(6) to 
mean a company that derives 85 percent or more of its revenue 
or assets from activities that are financial in nature as 
defined in Section 4(k) of the Bank Holding Act of 1956. 
Section 102(b) further provides the Board of Governors shall 
establish by regulation the requirements for determining if a 
company is predominantly engaged in those sections, again,'' as 
defined in Section (a)(6).
    It seems as though it is laying out there pretty clearly in 
the statute that financial activities are already defined in 
(a)(6). So it makes sense that the list of activities for 
financial companies, bank holding companies and the like, would 
be the same for nonbank holding companies. And yet, that is not 
what is occurring here. So that is why I make the supposition 
that the Fed is going beyond what is clearly set forth was part 
of that deliberation of Congress in that amendment to try to 
make sure that it would be limited to this area.
    Mr. Gibson. We have the reproposal out for comment. The 
comment period ends on May 25th. Part of the reproposal in 
April included a list of the activities that would be 
considered to be financial activities because we were 
requested, and to be responsive to that, to provide additional 
clarity on activities that are financial in nature for the 
purpose of determining whether a company is predominantly 
financial or not. So we are trying to be responsive to the 
request for more clarity, and we are open to the comments we 
receive and will use those comments as we go along.
    Mr. Garrett. Is that list then potentially or actually 
beyond what would be those lists of financial activities under 
the Bank Holding Act as defined in the statute?
    Mr. Gibson. I am not aware that it is, but I think that the 
comments that come in will help us determine whether we got it 
right or not in the proposal.
    Mr. Garrett. I am watching my time here--I think it was Mr. 
Royce who ran down the list and the possibility as far as the 
fact that once a company, once a bank, a financial institution 
becomes designated, there may be certain benefits to the 
institution as far as lending and the like, and so there is an 
anticompetitive nature, if you will, with regard to those bank 
financial institutions vis-a-vis other nondesignated 
institutions.
    He didn't go this far, but I will go this far, now you 
carry that potentially one step further, right? Because now if 
you designate nonbank firms such as insurance companies or 
finance companies as an SIFI, that same aspect of benefits for 
that designation will now inure to their benefit, and whereas 
before you were trying to alleviate the anticompetitive effect 
for banking institutions, now we have just spread it over to 
nonbank institutions as well. Is that something that we really 
want to do?
    Mr. Gibson. The intent of what we are trying to do with the 
enhanced prudential standards that will be imposed on the 
nonbank companies that are designated is to impose tougher 
regulation, higher enhanced capital requirements, not easier. 
We meet with a lot of nonbank companies, and they are all more 
worried about being designated than desiring to be designated.
    Mr. Garrett. I see my time is up. I yield back. Thank you.
    Mr. Renacci. I recognize Mr. Duffy for 5 minutes.
    Mr. Duffy. I pass.
    Mr. Renacci. Okay. I want to thank the gentlemen for their 
testimony this morning.
    At this time, this panel is dismissed. I will now recognize 
the second panel. The first witness is Mr. Scott Harrington, 
Alan B. Miller Professor at The Wharton School, University of 
Pennsylvania. You are recognized for 5 minutes for your 
testimony.

STATEMENT OF SCOTT E. HARRINGTON, ALAN B. MILLER PROFESSOR, THE 
           WHARTON SCHOOL, UNIVERSITY OF PENNSYLVANIA

    Mr. Harrington. Good afternoon, Acting Chairman Renacci, 
Ranking Member Maloney, and members of the subcommittee.
    I am the Alan B. Miller Professor at the University of 
Pennsylvania's Wharton School. I have been studying insurance 
markets for the better part of 30 years. I have done quite a 
bit of work on solvency prediction, capital standards, systemic 
risk, and market discipline in insurance markets. I am pleased 
to be here today to testify in this hearing as an independent 
expert.
    Let me start by just saying the term ``systemic risk'' 
encompasses the risk of financial institutions with spillovers 
on the real economy from large macroeconomic shocks and/or 
extensive interconnectedness among firms. There is a 
distinction between losses from common shocks to financial 
firms and losses that arise from interconnectedness and 
contagion.
    I think it is very important to keep in mind that a primary 
driver of the financial crisis in general and the collapse of 
AIG in particular was the bursting of the housing price bubble 
and declines in the value of mortgage-related securities and 
instruments.
    It is also important to keep in mind that AIG's failure was 
primarily attributable to noninsurance activities, some of 
which were federally supervised, and the risk that there would 
have been significant damage and contagion from an AIG failure 
is still being debated.
    Consistent with the generally favorable performance of core 
insurance activities during the crisis, however, the consensus 
is, and there is a lot of research being done on this, that 
systematic risk is minimal in insurance markets compared with 
banking. Banking crises have much greater potential to produce 
rapid and widespread harm to economic activity and employment, 
and this fundamental difference helps explain historical 
differences in regulation of insurance and banking.
    Significant systemic risk strengthens the case for 
relatively broad guarantees of bank obligations and stringent 
financial regulation to help deal with the moral hazard that 
inherently flows from government guarantees. Because insurance 
poses little or no systemic risk, there is no need for broad 
guarantees of insurers' obligations to policyholders, and there 
is less moral hazard and less need for stringent capital 
requirements.
    State insurance guarantees have been appropriately narrower 
in scope than Federal guarantees in banking. Insurance market 
discipline for safety and soundness is reasonably strong. 
Insurers generally hold quite a bit more capital than required 
by regulation and have not faced strong incentives for 
regulatory arbitrage.
    The FSOC's final rule and accompanying guidance for 
determining systemically important nonbank financial companies 
under Section 213 are essentially the same as its second notice 
of proposed rulemaking issued in October 2011. Much of the 
detail remains in the interpretive guidance.
    As we have heard this morning, it retains the six category 
analytical framework first set forth in the January 2011 
notice. The final rules guidance retains the three-stage 
determination process originally proposed in October 2011.
    As described by Mr. Auer, the first stage analysis would 
employ publicly available information and information from 
regulatory agencies and specific quantitative thresholds to 
identify nonbank financial companies for more detailed 
evaluation than stage two, with perhaps further evaluation in 
stage three prior to any designation.
    A nonbank company would advance to stage two if it has over 
$50 billion of global assets and meets at least one of five 
additional quantitative thresholds. The inclusion of the 
quantitative thresholds provides some guidance to companies, 
presumably reflecting the Council's desire to provide them with 
some degree of guidance and certainty, but the metrics are 
inherently in part subjective and the thresholds are not 
binding. For example, the Council reserves the right at its 
discretion to evaluate further any nonbank financial company, 
irrespective of whether any such company meets the thresholds 
in stage one. The final rule and guidance thus provide the 
Council with very broad discretion for designating systemically 
important nonbank financial companies and companies will face 
considerable uncertainty about such designation.
    Specific application of the final rule, in my opinion, 
should not result in any insurance companies being designated 
as systemically significant. As we have heard, and I think this 
is very important, there is a benefit and a cost associated 
with the overall procedure. Short run, there will be increased 
costs for companies that are so designated. In the longer run, 
I don't think there is any doubt they will be considered too-
big-to-fail.
    In insurance markets, this can be very problematic. Not 
only would it give companies an advantage in borrowing and 
raising capital, but it would give them an advantage in 
attracting customers in these markets, which could be very 
destabilizing over time to competition and safety and soundness 
in the business.
    The enhanced prudential standards as currently proposed are 
certainly bankcentric. They would need to be tailored if they 
were to be applied, tailored significantly to any insurance 
company that would be designated as systemically significant if 
that in fact occurs. I would hope that those prudential 
standards, if an insurance company is designated, would 
piggyback to a great extent off existing capital requirements 
for insurance companies.
    Thank you.
    [The prepared statement of Professor Harrington can be 
found on page 72 of the appendix.]
    Mr. Renacci. Thank you.
    Next, Mr. Thomas Quaadman, vice president, Center for 
Capital Market Competitiveness, U.S. Chamber of Commerce. You 
are recognized for 5 minutes.

   STATEMENT OF THOMAS QUAADMAN, VICE PRESIDENT, CENTER FOR 
   CAPITAL MARKETS COMPETITIVENESS, U.S. CHAMBER OF COMMERCE

    Mr. Quaadman. Thank you, Chairman Renacci, Ranking Member 
Maloney, and members of the subcommittee. I appreciate the 
opportunity to testify today.
    Reasonable risk taking is at the core of the free 
enterprise system. Businesses must have the right to fail in 
order to take risks to grow and create jobs.
    Systemic risk, that is, the possibility of a firm 
imperiling the domestic and global financial system, is a 
matter that is much different. During the last financial 
crisis, it was very apparent that the government did not have 
the ability to identify, understand, and manage systemic risk.
    In November 2008, the Chamber, as part of a larger 
financial regulatory reform package, called for the regulation 
of systemic risk and that it be used sparingly and when 
appropriate. That being said, a balance must be struck to 
manage systemic risk, to flag issues, and to prevent calamitous 
harm, while not constraining reasonable risk taking, which if 
limited will hurt economic growth and job creation.
    In creating Title I of the Dodd-Frank Act, we think 
Congress for the most part got it right in striking that 
balance. So if you take a look at Title I, right off the bat, 
Congress immediately separated systemic risk for banks 
separately from systemic risk for nonbanks, and then Congress 
also created specific delineated tests to determine if a 
nonbank should be determined to be systemically important.
    If you take a look at that system, you take commercial 
companies, mutual funds, insurance companies and the like, they 
then go through the very defined tests to see if they are 
predominantly engaged in financial activities. If they are then 
determined to be nonbank financial companies, then FSOC looks 
through a much broader criteria to determine if they should be 
designated, and if they are designated as systemically 
important financial institutions, then the Federal Reserve and 
the prudential regulator of that company work together in order 
to create enhanced regulations to deal with systemic risk, yet 
at the same time not impacting the nonfinancial activities of 
that company.
    So if you take a look what Congress did, Congress 
understood that sometimes when you travel, you have to travel 
through a dense forest, and if you have to travel through a 
dense forest, you clear a path, you brightly mark it so that 
the travelers can know with safety how to get to where they are 
going. What the regulators are doing, however, is that they are 
taking the markings off of the path so the path is not 
illuminated and forcing more participants into the forest than 
what Congress had envisioned.
    So we have six problems with the way that the regulators 
are implementing Title I.
    Number one, and I think we heard a discussion of it this 
morning, is that the regulators are actually using discretion 
to go around the very specific tests that Congress put in place 
to determine if nonbanks should be designated or considered to 
be predominantly financially engaged.
    We are seeing a one-size-fits-all bankcentric approach in 
order to regulate systemically important financial institutions 
that are nonbanks, but they do not take into account the 
different business models. We are seeing that there is not a 
consideration of conflicts between systemic risk and existing 
regulations. So, for instance, if you have a public company 
that goes into this process, at what point in time does this 
become a material issue that that public company is going to 
have to disclose this to investors? If you do it too soon, you 
could harm capital formation. If you do it too late, the 
company can actually put itself into legal jeopardy.
    We are seeing that the process issues, so that is when FSOC 
is acting as a regulator, that FSOC isn't following the same 
transparency and accountability processes that other regulators 
engage in when they are writing rule makings. We agree if FSOC 
is engaged in discussions about a systemically important 
problem or Title II issue, that should be done in private. But 
when they are acting as a regulator writing rules, that is 
something that is much different.
    I think we have heard testimony this morning which 
buttresses our point about the lack of a cost-benefit analysis. 
During the April discussion of finalization of rules on 
designation, it was determined that to designate systemically 
important financial institutions was not economically 
significant, meaning that it would not have a cost to the 
economy of $100 million or more. Commenters cannot understand 
what the costs and the burdens are.
    Finally, rules are being considered out of order. We are 
going into designations, we have designation rules, but we are 
talking about predominantly financially engaged rules now, 
which is really the start of the process. So we started 
backwards and started to work forward so that people cannot 
understand how the process is going to work or how it meshes.
    Finally, if these issues are resolved, the balanced system 
that Congress put in place can move forward. If these issues 
are not resolved, systemic risk regulation will be impaired and 
normal everyday business practices constrained, harming 
economic growth and job creation.
    I am happy to answer any questions you may have.
    [The prepared statement of Mr. Quaadman can be found on 
page 78 of the appendix.]
    Mr. Renacci. Thank you, Mr. Quaadman.
    Next is Mr. William J. Wheeler, president, Americas, 
MetLife, Inc.

STATEMENT OF WILLIAM J. WHEELER, PRESIDENT, AMERICAS, METLIFE, 
                              INC.

    Mr. Wheeler. Acting Chairman Renacci, Ranking Member 
Maloney, and members of the subcommittee, my name is Bill 
Wheeler and I am the president of the Americas Division of 
MetLife. Thank you for the opportunity to testify on behalf of 
MetLife.
    MetLife recognizes the importance of managing systemic risk 
and the need for sensible regulations to protect taxpayers from 
costly bailouts. Coming up with the appropriate regulatory 
formula will not be easy, either for the Financial Stability 
Oversight Council and designated nonbank firms that are 
systemically important, or for the Federal Reserve in 
determining the prudential standards to be applied to those 
firms. Nevertheless, we must get the prescription right. The 
stakes are too high to allow the costs or the benefits of 
regulation to be miscalculated.
    MetLife is the largest life insurer in the United States. 
We are the only one that is also a bank holding company. Our 
experience as an insurance company regulated by the Federal 
Reserve has provided us with unique insights into the pitfalls 
of applying bankcentric rules to nonbank financial companies. 
Indeed, it is because we do not believe our insurance business 
should be governed by regulations written for banks that we 
have decided to sell our depository business and join our peers 
in being regulated as an insurance company.
    I plan to discuss three topics in my testimony today: 
first, why regulated insurance activities generally do not pose 
systemic risk; second, why naming only a few companies as 
systemically important financial institutions, or SIFIs, would 
needlessly upset the competitive landscape in the insurance 
sector; and third, in the event that we are named as a nonbank 
SIFI, why the prudential regulations must be tailored to our 
unique asset and liability characteristics.
    Far from presenting systemic risk to the U.S. economy, 
traditional life insurance activities are a force for financial 
stability. Life insurance companies protect policyholders and 
their beneficiaries from the loss of income that occurs as a 
result of death, disability or retirement.
    In order to make good on these promises, we invest in 
primarily investment-grade fixed-income securities that provide 
us with reliable returns. Unlike banks, insurers generally have 
a stable portfolio of in-force insurance policies with regular 
premium payments and contractual features that prohibit or 
limit early calls by policyholders, such as surrender charges 
or tax penalties.
    Insurance company financial distress occurs far less 
frequently than bank distress. As of mid-2009, only three 
insurance companies had received taxpayer assistance through 
the Troubled Asset Relief Program (TARP), compared with 592 
banks. Quite frankly, I do not believe TARP money needed to be 
provided to at least two of these insurers to prevent any sort 
of systemic event.
    Rather than designate a handful of insurance companies as 
SIFIs and design a whole new set of prudential standards for 
them, a more sensible approach would be to identify and 
regulate those activities that fueled the financial crisis in 
the first place. During the crisis, certain firms that expanded 
significantly into nontraditional and noninsurance activities 
suffered significant distress. Indeed, the main reason 
insurance companies are even part of the discussion about 
systemic risk is because of AIG.
    Yet, AIG's troubles did not stem from traditional insurance 
activities operated within the regulated insurance company. As 
Dodd-Frank recognized, the Office of Thrift Supervision did not 
appropriately regulate the activities of AIG Financial 
Products. Insurance law and insurance regulators would not have 
permitted these activities to occur in the same manner within a 
regulated insurance company.
    If FSOC names only certain insurance companies as SIFIs, it 
will inadvertently be picking winners and losers in the 
insurance industry. Some commentators believe that naming 
MetLife and other life insurance companies as SIFIs would give 
us a competitive advantage over our smaller rivals. An SIFI 
designation would be the Federal Government's signal that we 
are indeed too-big-to-fail and that if we got into financial 
trouble, Federal funds would be used to rescue the firm. The 
implicit backing of the Federal Government could strengthen 
perceptions of our creditworthiness and may give us a 
significantly cheaper cost of funds than our peers.
    At the other end are those who believe that insurance 
companies deemed SIFIs would be placed at a competitive 
disadvantage. They would have to hold more capital and maintain 
higher liquidity levels, which would reduce returns on equity 
for shareholders and impose higher prices on customers. In 
addition, they would have to deal with two levels of regulation 
compared with one for the rest of the industry. I am in the 
second camp, having lived with the Federal Reserve regulation 
and been forced to stand on the sideline as nearly all of 
MetLife's competitors, including those that took Federal 
bailouts, returned capital to shareholders while bankcentric 
rules prevented us from doing so.
    But whether an SIFI designation is a help or a hindrance, 
it seems certain that naming a handful of insurance companies 
as too-big-to-fail will needlessly distort the competitive 
landscape and misallocate capital in the insurance sector.
    In the event FSOC feels compelled to name MetLife and a few 
other life insurers, SIFIs, it would be essential to tailor the 
new prudential rules for insurance companies. Bankcentric 
regulations are wholly inappropriate for an insurance company. 
If the Nation's largest life insurers are named SIFIs and 
subjected to unmodified bank style capital and liquidity rules, 
our ability to issue guarantees would be severely constrained 
at a time when governments are facing their own fiscal 
challenges. Faced with costly requirements, insurers would 
either have to raise the price of the product they offer, 
reduce the amount of capital or risk they take on, or stop 
offering certain products altogether.
    In closing, let me reiterate that I do not believe MetLife 
is or should be designated too-big-to-fail. Even in the event 
of insolvency, we would not threaten the stability of the 
financial system of the United States. Naming only a few large 
insurance companies as SIFIs would needlessly upset the 
competitive landscape in the insurance sector. If FSOC names 
the largest life insurers as SIFIs, I believe it will be 
imperative for regulators to get the prudential rules for 
nonbank SIFIs right.
    Thank you.
    [The prepared statement of Mr. Wheeler can be found on page 
93 of the appendix.]
    Mr. Renacci. Thank you, Mr. Wheeler.
    Our final witness, Mr. Douglas Elliott, a Fellow at the 
Brookings Institute, is recognized for 5 minutes.

    STATEMENT OF DOUGLAS J. ELLIOTT, FELLOW, THE BROOKINGS 
                          INSTITUTION

    Mr. Elliott. Thank you. Thank you for the opportunity to 
testify here before you again today.
    Regulating SIFIs is crucial. They are the institutions most 
capable of triggering financial crises and therefore merit 
closer regulation than other firms and should be held to a 
somewhat higher standard of financial conservatism.
    The need for closer regulation is not erased by the steps 
taken to reduce the potential for government bailouts. Even if 
creditors and shareholders picked up all the losses, with no 
help from taxpayers, a serious financial crisis would still 
lead to a severe contraction of credit, sending the economy 
into a deep recession. As you know, the recent recession cost 
taxpayers far more than did the bailouts.
    In my brief time, let me just emphasize a few points made 
in my written testimony and in a comprehensive paper that Bob 
Litan and I wrote last year.
    First, no part of the financial industry should receive an 
automatic exclusion from SIFI designation because there is too 
much danger of regulatory arbitrage if we just go by legal 
category.
    Second, there are no absolutes in determining systemic 
importance. There are multiple ways of measuring the level of 
significance and no clear consensus on the exact methods, which 
is why the proposed rules allow for considerable judgment. Even 
within a single measurement approach, there are degrees of 
systemic importance with no bright line where an institution 
flips from unimportant to important.
    Third, we must strive for the right balance between the 
dangers of overdesignation and underdesignation. There will be 
an economic cost to designating firms as SIFIs. Therefore, we 
should do so whenever the safety benefits outweigh those costs, 
but only when they do.
    Your invitation letter and much of the discussion here has 
been around a question as to whether firms might benefit from 
being named as SIFIs. I would just emphasize a point, which is 
that if it is true that funding costs will be lower after 
designation, the primary beneficiaries of that will be the 
managements and the shareholders of these companies. I have 
been heavily lobbied by these companies to take the position 
they shouldn't be SIFIs. I am sure you as actual Members of 
Congress have been lobbied much more heavily. So you may find 
yourself in an ironic position of someone making an argument to 
you that you shouldn't do something to their advantage. I 
simply do not believe for that and other reasons that there 
would be a significant funding cost advantage.
    Fourth, the additional oversight applied to nonbank SIFIs 
must be appropriate to the systemic risk they represent and be 
coordinated as effectively as possible with their existing 
regulation. We need to avoid overlap, conflicting requirements, 
and gaps where no one regulates.
    Fifth, similar activities should be regulated in similar 
ways with similar safety margins to the extent possible, 
regardless of the legal form of the institution doing the 
activity. Otherwise it will be easy to fall prone to regulatory 
arbitrage as well as the inefficiencies that are produced by 
arbitrary differences and competitive advantage.
    So evaluating the proposed rules in light of these key 
points, the regulators appear to be generally on the right 
track, although there is a great deal that cannot be judged 
yet. The rules focus on the right sources of systemic risk, and 
they recognize the need to carefully review the specific facts 
and to apply considered judgment to questions that are 
inherently somewhat subjective.
    It makes sense that the regulators are casting a quite wide 
net in the initial phase in order to determine which 
institutions they will need more information about. As I have 
stressed, there are no straightforward quantitative methods to 
find the answers here so there is a need to gather information 
on a wide array of candidates for designation in order to 
assess each in a deeper way.
    The regulators have also said the appropriate things about 
recognizing the diversity of business models in different parts 
of the financial system. Although there remains cause for 
concern as to whether this will be reflected in actual 
practice, I do share that concern.
    From my point of view, I do not think there are currently 
many true SIFIs among the nonbank financial institutions. But I 
would stress, since this has been an area of much discussion 
today, it is possible that life insurers will fall within that. 
I would dispute the point made earlier that there is a clear 
consensus that life insurers do not present systemic risk. 
There are arguments coming from both sides, which is why I 
think it is premature to form a conclusion on that.
    So, in conclusion of my points, designating a nonbank SIFI 
is by its nature a complex endeavor that requires a careful 
balancing act and substantial human judgment. The rules 
proposed by the regulators generally reflect those 
considerations and I believe that the resulting uncertainty 
about the ultimate outcomes is unavoidable unless we either 
abandon the effort to designate such SIFIs or use cruder 
measurements that would almost certainly produce worse results. 
My larger concern, as I mentioned, is whether the rules might 
indeed be too bankcentric.
    Thank you.
    [The prepared statement of Mr. Elliott can be found on page 
62 of the appendix.]
    Mr. Renacci. Thank you, Mr. Elliott.
    We will now recognize Members for 5 minutes. I recognize 
myself first.
    Mr. Quaadman, although the FSOC has finalized its rules on 
the SIFI designation process and the Federal Reserve has yet to 
finalize its rules on enhanced prudential standards, as a 
result no one can actually know what the effect of SIFI 
designation will have. Should the FSOC wait for the Fed to 
finalize its rule on enhanced prudential standards before it 
begins designating nonbank firms as SIFIs?
    Mr. Quaadman. I think what is interesting is that while 
there is a lot of discussion of the process, there is also 
discussion that they are looking at 50 different companies. A 
big problem that is posed here is that we have the bankcentric 
model that they are not willing to move off of, they are not 
looking at business models of companies, and that if they have 
these 50 companies, they should start to look at whether or not 
there are unique characteristics that they should be looking 
at, as well as discussing that with prudential regulators as 
well.
    Mr. Renacci. Thank you.
    Mr. Harrington, how optimistic are you that enhanced 
supervision of individual companies will reduce the likelihood 
of any future financial crisis?
    Mr. Harrington. I am not optimistic about that given the 
historical record and the dynamism of the markets. I think it 
is very, very difficult to anticipate what is likely to happen 
and what the sources of risk may be. In the near term, I think 
it is likely that there will be heightened scrutiny and some 
reduction in the likelihood of excess risk-taking. But over 
time, as memories tend to fade, I think it is likely that we 
will be in an environment where the inherent risks will be very 
difficult to identify and control.
    Mr. Renacci. Would you agree that the last crisis taught us 
that looking at individual companies in isolation is an 
ineffective way to monitor the systemic risk?
    Mr. Harrington. I think it is preferable to try to look at 
activities, and you can look at companies that are then 
involved in those activities. Looking at individual companies 
is necessary as part of prudential regulation, but I do 
distinguish that from identifying specific companies as subject 
to heightened scrutiny and in, the case of the insurance 
industry, basically Federal regulation that could involve an 
implicit or explicit guarantee of their obligations.
    Mr. Renacci. Thank you.
    Mr. Quaadman, you criticized the Fed in your testimony, 
stating that the Board appears to be creating a one-size-fits-
all bankcentric approach that will not work well with nonbanks 
spanning diverse industries unrelated to banking. What should 
the Fed have done differently?
    Mr. Quaadman. I think they should be doing a number of 
things differently. One is, you also have to look at the Fed 
historically. They are a bank regulator. That is what they are 
used to. That is what they are involved with. If you take a 
look at a manufacturing company, right, if a manufacturing 
company uses derivatives to actually accept raw materials 
because they need to lock in prices and also prevent price 
volatility for consumers, as well as then have a financing arm 
to finance the purchase of their finished goods and services, 
that is a much different model than the bank model.
    So the question is when you go to the start of the process, 
and this is actually an FSOC issue, Congress specifically 
defined what should be looked at in order to determine what a 
company that is predominantly engaged in financial activities. 
The issue that I just raised about the use of derivatives to 
accept goods is specifically not in Reg 4(k), which Congress 
wrote into law in Title I through the Pryor-Vitter amendment. 
So then, from there, the Federal Reserve is now expanding out 
what the regulation should be at the end of the process.
    The problem here, and this is why we also raise the issue 
in terms of the rules being taken out of order, is if you start 
at the beginning of the process and start to have a flawed 
process of review that goes away from what Congress defined, 
then that also affects how the regulation happens at the end, 
and then you overlay on top of that the historic nature of the 
Fed and you create a flawed system.
    Mr. Renacci. Thank you.
    Mr. Wheeler, I know I am running out of time, but I do want 
to get your answer on this: How would naming only a few 
insurance companies as systemically important financial 
institutions upset the competitive landscape of the insurance 
sector?
    Mr. Wheeler. There are a couple of reasons why. One is it 
could be the halo effect, where customers or consumers or 
distributors would think because we have implicit Federal 
backing, we are therefore better to buy products from somebody 
like us if we were named.
    I don't actually think that is what is likely to happen. I 
think the opposite is going to happen. We will be held to 
higher capital standards. We will be seen as an insurer that 
you don't want to buy stock in, that frankly you should buy 
stock in insurance companies that don't have these standards 
because frankly the capital levels won't be quite as high.
    So we think at the end of the day, those few insurance 
companies, which, by the way, will be the largest in the 
industry probably, will be somewhat punished by the marketplace 
for the tighter regulation and higher capital standards.
    Mr. Renacci. Thank you.
    I now recognize Mrs. Maloney, the ranking member, for 5 
minutes.
    Mrs. Maloney. First of all, I would like to welcome all of 
the panelists, especially Mr. Wheeler, whose company is 
headquartered in the great State of New York, and I want to 
compliment your many contributions to the economy in providing 
services to Americans.
    During the financial crisis, we really had only two ways to 
approach a troubled institution. We could either let it fail, 
which we did with Lehman, or we could bail it out, which we did 
with AIG. Neither alternative was a particularly good one. And 
what we tried to do in the Wall Street Reform Act was to try to 
have other tools to help regulators not only manage large 
institutions and hopefully make sure they don't fail, but in 
the event that they did, that we would have a way to structure 
it, like we did with the FDIC, which I think did a brilliant 
job in structuring failing banks and putting them with stronger 
ones and really managing the economy in a way that was less 
disruptive. So that is what we did.
    During that time, we did have a lot of debate over 
insurance companies, and many insurance companies testified. I 
don't know if you did, Mr. Wheeler, or not, but many, many CEOs 
and academics testified that insurance was not the problem, 
that in fact it had been a rock in our troubled economic times 
and had performed well, with the exception of AIG. And although 
many people agreed that most types of insurance activities 
conducted in isolation would not pose a systemic threat, AIG is 
an important and I would say tragic example of how insurance 
activities in combination with other financial risky activities 
could literally threaten and bring down a great company, a 
large organization, and really be a threat to the entire 
financial system.
    The Wall Street Reform Act does not exclude any company for 
that matter or any area. They don't exclude insurance or any 
type of company, because the whole thrust was to make sure 
there were not shadow areas of financial institutions that had 
risk-based factors that could do systemic risk to our entire 
economy.
    I would like to ask the panel, do you agree that a 
framework that applies broadly and evaluates a number of 
riskiness measures is preferable to a framework that 
categorically excludes some companies? Because under the 
definition that I am hearing before the panels today, AIG would 
have been excluded because it is primarily an insurance 
company. That excludes some companies and thereby creates 
hiding places or shadow places where risky activities could 
take place.
    So I would really like to ask, how is MetLife different 
from AIG, and how does your international expansion impact on 
MetLife's risk profile? As we know, AIG was a very strong 
international company.
    So I throw that out to anyone who would like to answer.
    Mr. Wheeler. Maybe I will start, since you referenced 
MetLife, how is it different versus AIG. Of course, what got 
AIG in trouble was its noninsurance activities. The financial 
products division in London was not inside a regulated 
insurance activity. And I think the premise of your question 
makes perfect sense. I think we have to find these areas in the 
shadows. But I worry about--and, for instance, if MetLife were 
doing something outside of its regulated insurance activity 
which was deemed very risky and very interconnected, I think 
that activity should absolutely be regulated by the Fed.
    What I worry about is regulated insurance activity, which 
is not in our opinion systemically risky, and is already, by 
the way, highly regulated.
    So I think that is what I think the Fed, when they think 
about nonbank SIFIs and what kind of activities they should 
regulate, I think that is what they should be focused on. We 
worry about the Fed regulating--being yet another regulator to 
the insurance industry.
    Mrs. Maloney. But could you comment on the fact that your 
firm acquired a good portion of AIG, as I understand it, in 
2010, and what did MetLife pay for this acquisition, and did 
the Federal Reserve have to approve this transaction? Was there 
this a decision by your company, or was this part of the 
government trying to manage risk in the overall economy?
    Mr. Wheeler. During the financial crisis, MetLife performed 
well, and we had to--even though we were a bank holding company 
and eligible for TARP money, we did not take it. We were the 
only large bank holding company that did not. And I suppose 
that is a testimony to how we were managed and our capital 
solvency. But, frankly, I think it is also a testimony to the 
fact that we are not very interconnected with the banking 
system. So problems in the banking sector didn't really spill 
over to Met.
    Coming out of the financial crisis, we were in a strong 
position. AIG, obviously, having been taken over by the 
government, needed to start selling assets to repay the 
government. We acquired a large international life insurance 
division of AIG called Alico for $16 billion. And because we 
are a bank holding company, the Fed did have to approve that 
transaction, and they did, and obviously that money was then 
used to pay back--or a large portion of that money was used to 
pay back the Treasury. So that was good for the Treasury, 
ultimately good for helping AIG get back on its feet, and sort 
of showed kind of the stability of the insurance industry 
throughout this crisis.
    Mrs. Maloney. My time has expired.
    Mr. Renacci. Thank you.
    Mr. Luetkemeyer for 5 minutes.
    Mr. Luetkemeyer. Thank you, Mr. Chairman.
    Mr. Wheeler, you did a good job of explaining the lack of 
risk with the insurance portion of the financial services 
industry. I think it is fair to say that the insurance 
companies are not the problem; it is whenever they get into 
these other financial products, other financial services, that 
they get in trouble. Would that be a fair statement?
    Mr. Wheeler. Yes.
    Mr. Luetkemeyer. Does your company engage in any other 
financial services products, other than life insurance?
    Mr. Wheeler. We own a small bank.
    Mr. Luetkemeyer. You own a small bank. Okay. But your small 
bank apparently doesn't deal in derivatives or default credit 
swaps, is that correct?
    Mr. Wheeler. It does not.
    Mr. Luetkemeyer. Very good. In your judgment, where do you 
think--of course, I guess it is a hypothetical question here in 
trying to figure out what is going on in the minds of the Feds. 
That is always dangerous, isn't it? But where do you think this 
should go, I guess is a better way to put it, from the 
standpoint of, as the ranking member indicated, at least 
putting some protections in place or transparency in place to 
be able to see those groups of folks who are in the business of 
dealing with those instruments and then how to separate that 
out from folks, like yourself, who are not involved in that?
    Mr. Wheeler. I am a little worried that the Federal 
Government is just focused on if you are big, ipso facto you 
must be systemically significant. Okay, MetLife is big. There 
is no doubt about it. But the insurance industry itself, 
especially life insurance, is probably not very interconnected, 
probably not systemically significant. If we were to engage--
there may be the other nonbank SIFIs where that is not the 
case, who are not primarily insurance companies, and so, 
obviously, they should be scrutinized.
    I guess I would also say that if insurers get involved in 
something besides insurance, which could happen and obviously 
did under AIG, if they get involved in something else, and that 
is being a derivatives trader or a creator and seller of 
derivatives or anything else which really connects them to the 
banking sector, then, I think that is fair game. I think that 
should be scrutinized by the Fed and regulated.
    Mr. Luetkemeyer. So you believe that there should be some 
sort of rules in place that describe the connectivity between 
your activity and the financial services markets, and if you go 
over the line, then you fall into the category that you should 
be designated as an SIFI. Is that a fair statement?
    Mr. Wheeler. Yes, I do.
    Mr. Luetkemeyer. Very good.
    Mr. Quaadman, I am just curious. I know the Chamber is very 
concerned about this one-size-fits-all--in your testimony, I 
think that is the way you put it--approach that the Fed is 
taking. What is your solution or what is your suggestion for 
them, for the FSOC people, to look at the regulations and come 
up with a tiered system or a system that allows certain folks 
to get out of it or to go back and review the existing rules to 
see how they are negatively impacting some of the small folks 
who don't need to be in this. Insurance companies that are not 
in the financial services industry, they don't need to be 
regulated. Community banks, other nonlending folks, nondeposit 
folks, they don't need to be in this. They are not a systemic 
risk. Yet the rules that have been put out so far have had a 
dramatic impact on some, I am sure, of your members.
    Mr. Quaadman. Thank you for that question. I think number 
one is that they should follow the law. So if you take a look 
at the predominantly engaged test, which is the first stage to 
see if a company should even be considered, Congress sort of 
constructed that as a 1-inch pipe and now the Federal Reserve 
and FSOC, they are trying to make it a 12-inch pipe. They want 
to try and bring in as many companies as possible, whereas it 
really should be done sparingly.
    I think Mr. Wheeler also made an excellent point as well as 
we are also looking at size. And size isn't necessarily 
determinative either. What is also important as well is that 
the marketplace investors and companies, they need to assess 
how the system works, how it is going to impact companies and 
the like. By taking rules out of order, by not following 
transparency in writing rules, it is impossible to decide that.
    One example is, Vince Lombardi when he started training 
camp every year, he would say, ``This is a football.'' He 
didn't start training camp by saying, ``This is the last play 
we are going to play in the Super Bowl.'' So FSOC and the 
Federal Reserve are starting at the very end trying to work 
forward, where you really should start at the beginning.
    Mr. Luetkemeyer. With regards to the promulgation of the 
rules and the process they are going through, are you 
gentlemen, are your associations, are you at the table with the 
discussions that are going on?
    Mr. Quaadman. We have commented extensively. We have met 
with the regulators in different forums on these issues.
    Mr. Luetkemeyer. Are they receptive to your ideas and your 
concerns?
    Mr. Quaadman. I can say in this and other areas where we 
have spoken to them, we have always brought forth how this 
impacts nonfinancial companies. And, there are times where we 
had very good discussions, but there are also times where it is 
very clear that they are coming at it from a bank approach and 
then are not willing to move off of that.
    Mr. Luetkemeyer. Mr. Wheeler?
    Mr. Wheeler. I think I would agree with that. We are 
obviously very engaged. This is very important to us in dealing 
with the regulators. Obviously, we are regulated by the Fed 
today, so we have conversations with them a lot. Whether we are 
having an impact, whether they are listening, I honestly don't 
know.
    Mr. Luetkemeyer. We won't know until we get the rules, will 
we?
    Mr. Wheeler. Right.
    Mr. Luetkemeyer. Thank you, Mr. Chairman.
    Mr. Renacci. Mr. Manzullo for 5 minutes.
    Mr. Manzullo. Thank you.
    Is there anybody in the room here from the Department of 
the Treasury or the Federal Reserve?
    See? That is the problem. They testify first; then they 
leave, and they don't listen to you. It is a chronic problem 
with the agencies. They refuse to be on the same panel as those 
who are regulated. These Departments and Agencies ought to be 
ashamed of themselves, because it deprives you of the ability 
to interact with the people who represent the Government. That 
is why, Mr. Wheeler, I asked the questions that you wanted to 
ask. And that is the problem with Washington. That is why this 
City is broken, because people who make the regulations don't 
think they have to stick around in order to listen to the 
people impacted.
    Mr. Chairman, I would suggest that at the next hearing we 
have, we put the people impacted first. Force the government 
bureaucrats to listen to the testimony. There is no reason why 
they should have to go first.
    That brings me to another point. It wasn't until October 1, 
2009, that the Fed actually adopted a policy, are you ready for 
this, requiring written proof of a person's earnings before 
that person could even fill out a mortgage application. Now, I 
would say that is pretty basic. They took an entire year to 
review everything, as Chairman Bernanke said, a bottom-up 
review as to what would be necessary. And if it took that long 
to figure out that you don't condone the so-called ``liar 
laws'' that allowed people to do that, I just wonder how the 
Fed is going to start to be able to regulate insurance 
companies.
    I think all of you generally agree, with the exception of 
Mr. Elliott, who also agrees that insurance companies generally 
should not be regulated but may under certain circumstances. 
Can you guys tell me, what would the Fed do in messing up 
MetLife? Do you like that question?
    Mr. Wheeler. That is a great question. Look, as Mr. 
Quaadman said a bit ago, the Federal Reserve, at least part of 
their mandate is to regulate the banking industry. So the 
people who work at the Fed, that is their training, that is 
their experience. They regulate banking. So now MetLife is a 
bank holding company, and therefore regulated by the Fed, and I 
can tell you there was a very strong reluctance on the part of 
the Fed to look at us as anything other than a bank, even 
though, of course, 98 percent of our business is insurance.
    And we were very frustrated by that, and, of course, that 
is probably why I am here today is because of that experience.
    So, I would also tell you that the Federal Reserve--I have 
met a lot of people at the Federal Reserve but I have yet to 
meet somebody who I thought had what I call a sophisticated 
understanding of the insurance industry.
    Mr. Manzullo. It is a mismatch.
    Mr. Wheeler. Right. So it worries me. We are already highly 
regulated by the States. The New York Insurance Department in 
the State of New York is, I would argue, the most sophisticated 
State regulator which regulates us today, and they know what 
they are doing.
    Mr. Manzullo. Can I ask you a question? AIG, I think, was 
in five pieces of the company. Did the insurance division--was 
that ever at risk, or were the Illinois requirements so 
profound that none of the policyholders were imperiled at any 
time? Professor?
    Mr. Harrington. If you look at AIG's total capital and 
surplus in its insurance subsidiaries, it was substantially 
positive throughout the crisis, and the laws were in place that 
overall if you aggregated across those subsidiaries, AIG had 
plenty of capital to meet its obligations to all policyholders.
    There has been some debate about the extent to which 
specific subsidiaries may have run into capital shortfalls, and 
that would raise the question of how fungible the capital held 
by different AIG subsidiaries would be so that heavily 
capitalized subsidiaries, the resources could somehow make up 
for any shortfall at a few of the entities that may have been 
underfunded.
    So that has been debated, and I have not seen a really 
clear coherent analysis that would document whether any of 
those specific subsidiaries would have actually had a crisis 
that would have required regulatory intervention. Overall, 
though there was plenty of money, and the overall system of 
insurance regulation, with the strong walls between the 
subsidiaries and the holding company--
    Mr. Manzullo. So you don't know if those walls could have 
been breached surrounding the insurance division?
    Mr. Harrington. They wouldn't have been breached by having 
money sucked out to support the noninsurance activities.
    Mr. Renacci. Mr. Duffy for 5 minutes.
    Mr. Duffy. Thank you. One of the boogymen of the financial 
crisis was AIG, which was a nonbank financial company. We have 
touched on this a little bit. But just maybe again, and I don't 
mean to pick on Mr. Wheeler, who has been answering a lot of 
questions, but what is the difference between MetLife and AIG?
    Mr. Wheeler. I think for purposes of your question, if you 
look at all our subsidiaries that are the holding company, how 
many of them are engaged in insurance, and how many of them do 
something else? And MetLife is I would say, other than the 
small bank we own, which we are in the process of selling 
because we don't want to be a bank holding company anymore, 
other than the fact of our bank, almost everything we own in 
the holding company is in the business of insurance, whether 
that is P&C insurance or life insurance, in this country and 
around the world.
    AIG was in all those insurance businesses as well in the 
United States and around the world, but they also engaged in a 
lot of other, what I would call noninsurance activity. And the 
one that got so much attention, of course, was something called 
the AIG Financial Products, which was a business they ran in 
London, where they sold credit default swaps on all kinds of 
securities and sold them to banks and other financial 
institutions. And, when the crisis occurred, they weren't able 
to pay, and therefore threatened the security of the bank 
system that was relying on that money. So that is the big 
difference between us.
    And, by the way, most of the insurance industry looks like 
MetLife, okay? They are pretty much pure play insurance 
companies. They aren't involved in a lot of other activities.
    Mr. Duffy. If you are looking at AIG, wasn't the credit 
default swaps and the mortgage-backed securities, wasn't that 
an investment strategy for AIG on the insurance side?
    Mr. Wheeler. That is a good question, and we use 
derivatives, too, in our insurance entities and I think there 
is something you have to understand here. So what Financial 
Products did was create and sell derivatives to others.
    We purchased derivatives from Wall Street, and I will talk 
maybe about why that is okay to do. We have to hold collateral 
against those derivative positions, and they get trued up every 
day. So Lehman Brothers, for instance, which was a big 
derivative counterparty of ours, when they failed, we didn't 
lose any money because we held collateral against their 
derivative positions, and that is the way good derivative 
management practice works.
    We do use derivatives in our insurance company to manage 
risk, and most major financial institutions do. Just investing 
in derivatives to manage risk doesn't in my mind make you 
systemically important.
    Mr. Duffy. Switching gears a little bit, you guys are all 
aware of the three-stage process set up by FSOC for the SIFI 
designation. Do you guys as a group of four agree with that 
three-stage process. Do you think that is a good process to go 
through? Does anyone disagree with the three-stage process? 
Does anyone have a recommendation to change the three-stage 
process?
    You all like it?
    Mr. Wheeler. Look, it is good to have a process. I think it 
is more about the substance of the decision-making. What we 
have heard a lot about is, when somebody said, well, define 
interconnectedness,--I think that was on the last panel--
measure interconnectedness. They can't, of course, because it 
is judgmental.
    And if you think about the six criteria they are going to 
use to designate something systemically important, they talk 
about business being one, but almost everything else is very 
judgmental. And I guess, I am hoping the FSOC has I would say a 
robust discussion about those other more qualitative factors.
    Mr. Duffy. Mr. Harrington or Mr. Quaadman?
    Mr. Quaadman. That is a great question. I think, number 
one, Congress had a process in place to do this system, and the 
regulators are trying to go around this that.
    I think one thing to also think about, and I think this 
also gets overshadowed by the general financial crisis, but if 
you actually look back a few years ago, there was a problem 
with monoline insurance companies that led to liquidity 
problems in State and municipal securities. That is a $3.6 
trillion dollar market. I think the question you should all be 
asking the regulators is, could they find the problem with 
monoline insurance companies with the processes they have set 
up, because if you are just looking at size, you are trying to 
use a searchlight when in fact you probably should be using a 
flashlight.
    Mr. Duffy. Mr. Harrington?
    Mr. Harrington. In general, a three-stage process where you 
do a broad screen and work down is sensible. Actually having a 
process where in the first stage, you get the right criteria 
and the right thresholds, that is very difficult, and I don't 
think there is sufficient information to evaluate the specifics 
in the first stage.
    I am troubled by the overriding amount of discretion in the 
overall system, including the fact that if you don't meet the 
first stage test, you can still be advanced through the screen. 
Unfortunately, I don't have any sharp ideas of how you would 
fix this to optimally trade off the specificity that would be 
desirable versus some degree of discretion.
    Mr. Duffy. I will ask one more question: Would everyone 
agree that nonbank financials should be considered an SIFI? Do 
you all think that is a reasonable area for us to look at? Or 
does anyone on the panel say, no, no, we just want to look at 
banks.
    Mr. Wheeler. No, no. I totally think that is necessary, 
that we catch these activities in the shadows.
    Mr. Quaadman. It should be done through exacting standards, 
so it is only used sparingly but when it is appropriate.
    Mr. Harrington. I am very skeptical of identifying 
individual nonbanks as being systemically significant because 
of the disruptions it can create in competition and incentives 
for safety and soundness. I wish more attention would be paid 
to looking at how we might do this without identifying specific 
companies, but instead looking overall at areas that could 
create systemic risk and having some sort of supervisory regime 
that could deal with that without labeling companies as 
systemically significant, which ultimately will translate into 
``backed by the safety and soundness of the Federal 
Government.''
    Mr. Duffy. I have to say, I don't see a way to do what 
Scott just described. Ultimately, we need each of these 
institutions to be able to handle the claims on them. So in the 
end, we have to say these institutions have enough capital, 
enough liquidity, and enough safety margins in general.
    My time has expired. I will yield back.
    Mr. Renacci. I want to thank all of the witnesses for their 
testimony this afternoon.
    The Chair notes that some Members may have additional 
questions for this panel, which they may wish to submit in 
writing. Without objection, the hearing record will remain open 
for 30 days for Members to submit written questions to these 
witnesses and to place their responses in the record.
    This hearing is adjourned.
    [Whereupon, at 1:03 p.m., the hearing was adjourned.]



                            A P P E N D I X



                              May 16, 2012

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