[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
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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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