[Senate Hearing 112-183]
[From the U.S. Government Publishing Office]
S. Hrg. 112-183
OVERSIGHT OF DODD-FRANK IMPLEMENTATION: MONITORING SYSTEMIC RISK AND
PROMOTING FINANCIAL STABILITY
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED TWELFTH CONGRESS
FIRST SESSION
ON
CONTINUING OVERSIGHT OF THE IMPLEMENTATION OF THE DODD-FRANK WALL
STREET REFORM AND CONSUMER PROTECTION ACT (DODD-FRANK ACT), FOCUSING ON
PROVISIONS RELATED TO MONITORING SYSTEMIC RISK AND PROMOTING FINANCIAL
STABILITY
__________
MAY 12, 2011
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
Available at: http: //www.fdsys.gov /
----------
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
TIM JOHNSON, South Dakota, Chairman
JACK REED, Rhode Island RICHARD C. SHELBY, Alabama
CHARLES E. SCHUMER, New York MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey BOB CORKER, Tennessee
DANIEL K. AKAKA, Hawaii JIM DeMINT, South Carolina
SHERROD BROWN, Ohio DAVID VITTER, Louisiana
JON TESTER, Montana MIKE JOHANNS, Nebraska
HERB KOHL, Wisconsin PATRICK J. TOOMEY, Pennsylvania
MARK R. WARNER, Virginia MARK KIRK, Illinois
JEFF MERKLEY, Oregon JERRY MORAN, Kansas
MICHAEL F. BENNET, Colorado ROGER F. WICKER, Mississippi
KAY HAGAN, North Carolina
Dwight Fettig, Staff Director
William D. Duhnke, Republican Staff Director
Charles Yi, Chief Counsel
Laura Swanson, Policy Director
Colin McGinnis, Professional Staff Member
Brett Hewitt, Legislative Assistant
Andrew Olmem, Republican Chief Counsel
Hester Peirce, Republican Senior Counsel
Michael Piwowar, Republican Senior Economist
Dawn Ratliff, Chief Clerk
Levon Bagramian, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
(ii)
C O N T E N T S
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THURSDAY, MAY 12, 2011
Page
Opening statement of Chairman Johnson............................ 1
Opening statements, comments, or prepared statements of:
Senator Shelby............................................... 2
Prepared statement....................................... 34
WITNESSES
Neal S. Wolin, Deputy Secretary, Department of the Treasury...... 3
Prepared statement........................................... 34
Responses to written questions of:
Senator Shelby........................................... 71
Senator Reed............................................. 75
Senator Crapo............................................ 77
Senator Corker........................................... 78
Senator Vitter........................................... 80
Senator Toomey........................................... 81
Senator Moran............................................ 83
Ben S. Bernanke, Chairman, Board of Governors of the Federal
Reserve System................................................. 4
Prepared statement........................................... 42
Responses to written questions of:
Senator Corker........................................... 84
Senator Moran............................................ 86
Sheila C. Bair, Chairman, Federal Deposit Insurance Corporation.. 6
Prepared Statement........................................... 44
Responses to written questions of:
Senator Shelby........................................... 86
Senator Reed............................................. 88
Senator Hagan............................................ 92
Senator Crapo............................................ 93
Senator Corker........................................... 95
Senator Vitter........................................... 96
Senator Toomey........................................... 98
Senator Kirk............................................. 101
John Walsh, Acting Comptroller of the Currency................... 8
Prepared Statement........................................... 54
Responses to written questions of:
Senator Shelby........................................... 101
Senator Reed............................................. 102
Senator Crapo............................................ 111
Senator Corker........................................... 114
Senator Vitter........................................... 116
Senator Toomey........................................... 117
Senator Kirk............................................. 119
Mary L. Schapiro, Chairman U.S. Securities and Exchange
Commission
Prepared Statement........................................... 60
Responses to written questions of:
Senator Shelby........................................... 119
Senator Hagan............................................ 121
Senator Crapo............................................ 123
Senator Vitter........................................... 125
Senator Toomey........................................... 126
Senator Moran............................................ 131
Gary Gensler, Chairman, Commodity Futures Trading Commission
Prepared Statement........................................... 66
Responses to written questions of:
Senator Shelby........................................... 132
Senator Crapo............................................ 134
Senator Vitter........................................... 136
Senator Toomey........................................... 136
OVERSIGHT OF DODD-FRANK IMPLEMENTATION: MONITORING SYSTEMIC RISK AND
PROMOTING FINANCIAL STABILITY
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THURSDAY, MAY 12, 2011
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 9:37 a.m. in room SD-538, Dirksen
Senate Office Building, Hon. Tim Johnson, Chairman of the
Committee, presiding.
OPENING STATEMENT OF CHAIRMAN TIM JOHNSON
Chairman Johnson. I would like to call this hearing to
order.
Today, as the Committee continues its oversight of the
Dodd-Frank Wall Street Reform and Consumer Protection Act, I
welcome our witnesses back to talk about systemic risk and
financial stability. Last year, when this Committee set out to
respond to the worst economic crisis in generations, addressing
systemic risk and ``too big to fail'' were key tasks. Any
serious financial reform effort had to include an early warning
system that could detect systemic risk before it could threaten
to bring down the entire economy. Equally important was
creating a new orderly liquidation process to prevent future
bailouts and to force large risky financial firms to plan ahead
for their own possible failure.
In Dodd-Frank, we accomplished these goals, but those
changes cannot just take place at the flick of a switch. Today
our witnesses will provide us with an update on the
implementation of the provisions related to monitoring systemic
risk and promoting financial stability less than 10 months
after the legislation was signed into law. Each of these
agencies here is part of the Financial Stability Oversight
Council, or FSOC, established to be the early warning watchdog
for our financial system.
It is important to note that the seats of two voting
members of the FSOC remain vacant--the CFPB Director and the
independent insurance member. We need to nominate and confirm
those members as soon as possible. Any political game plan
surrounding these nominees to try to subvert critical Wall
Street reforms would be irresponsible and risk our Nation's
economic recovery.
One of FSOC's early tasks is to write rules for designating
large risky nonbank financial institutions for enhanced
supervision. The so-called shadow banking system was one of the
key pieces that led to the crisis. And while it is important to
provide oversight of the shadow banking system, it is also
important that this designation does not become a synonym for
``too big to fail.''
The Dodd-Frank Act ended ``too-big-to-fail'' bailouts by
establishing the orderly liquidation authority to unwind
failing financial firms without putting the financial system or
taxpayers at risk. In fact, Ranking Member Shelby worked
closely with then-Chairman Dodd to craft an amendment that
became the final text of this provision in Dodd-Frank, and I
want to thank Ranking Member Shelby for his work.
While we will never be able to anticipate every possible
cause of a future crisis, we are much better equipped to deal
with the next crisis if and when it occurs. We should never
forget the magnitude of the costs of the financial crisis,
especially the destruction of millions of jobs and trillions of
dollars of household wealth.
Opponents of financial reform may want to use revisionist
history, but Americans have not forgotten that the recession
was caused in part by excessive risk among some of the largest
financial firms. With Dodd-Frank, we have created a new, sound
economic foundation that will protect against the entire
economy being exposed the next time a large financial firm
rolls the dice on a bet it cannot back up. The effective,
timely, and well-coordinated implementation of these reforms is
critical to our economic security.
I want to remind my colleagues and the witnesses that as
soon as we have a quorum present, we will move into executive
session to report our six nominees. When finished with the
nominees, we will return to our hearing. Given the time
constraints today, only the Chairman and the Ranking Member
will deliver opening statements.
Ranking Member Shelby.
STATEMENT OF SENATOR RICHARD C. SHELBY
Senator Shelby. Mr. Chairman, to expedite the hearing, I
ask unanimous consent that my opening statement, which is
lengthy, be made part of the record, and we can get on with the
witnesses.
Chairman Johnson. It will be included.
Senator Shelby. Mr. Chairman, I believe I am right on the
number, but you are the counter. I believe we just need one
more person to show up to have a quorum.
[Pause.]
Chairman Johnson. Mr. Wolin, please proceed--we have a
quorum.
[Whereupon, at 9:42 a.m., the Committee proceeded to other
business and reconvened at 9:55 a.m.]
Chairman Johnson. Before I begin the introductions of our
witnesses today, I want to remind my colleagues that the record
will be open for the next 7 days for any materials you would
like to submit.
Our witnesses today have all been before this Committee
numerous times this year, so I will keep the introductions
brief.
The Honorable Neal S. Wolin is Deputy Secretary of the U.S.
Department of the Treasury.
The Honorable Ben S. Bernanke is currently serving his
second term as Chairman of the Board of Governors of the
Federal Reserve System.
The Honorable Sheila C. Bair is Chairman of the Federal
Deposit Insurance Corporation. Chairman Bair recently announced
that she will be stepping down as the Chairman of the FDIC at
the beginning of July when her current term expires. Sheila, I
would like to thank you for all your work you have done to
serve the people of the United States. I will truly miss you
come July, and we wish you well in any future endeavors that
you pursue.
The Honorable Mary L. Schapiro is Chairman of the U.S.
Securities and Exchange Commission.
The Honorable Gary Gensler is the Chairman of the Commodity
Futures Trading Commission.
Mr. John Walsh is Acting Comptroller of the Currency of the
Office of the Comptroller of the Currency.
I thank you all for being here today. Secretary Wolin, you
may begin your testimony.
STATEMENT NEAL S. WOLIN, DEPUTY SECRETARY, DEPARTMENT OF THE
TREASURY
Mr. Wolin. Thank you, Mr. Chairman.
Chairman Johnson, Ranking Member Shelby, members of the
Committee, I appreciate the opportunity to update you on the
Treasury Department's implementation of the Dodd-Frank Act.
Although our economy and financial markets have made
progress toward recovery, we cannot forget why the Congress
passed and the President signed the Dodd-Frank Act last year.
In the fall of 2008, we witnessed a financial crisis of a
scale and severity not seen in decades. The crisis exposed
fundamental failures in our financial system. Our system
favored short-term gains over stability and growth. Our system
was weak and susceptible to crisis, and our system left
taxpayers to save it in times of trouble.
We had no choice but to build a better, stronger system.
Enacting Dodd-Frank was the beginning of that process, and as
we move forward with implementation, our efforts are guided by
broad principles.
We are moving quickly but carefully. Treasury and
regulators are seeking public input and are committed to
getting the details right.
We are conducting this process in the open, bringing full
transparency to implementation. We are consulting broadly,
making input on rulemakings publicly available, and posting the
details of senior officials' meetings online so that the
American people can see who is at the table.
Wherever possible, we are seeking to streamline and
simplify Government regulation. Dodd-Frank consolidates
organizational structures and oversight responsibilities,
updating and rationalizing patchwork regulations built up over
decades.
We are creating a more coordinated regulatory process.
Regulators are working together to close gaps and to prevent
breakdowns in coordination--and within the Financial Stability
Oversight Council, we are working across agencies and
instilling joint accountability for the strength of the
financial system.
We are working to ensure a level playing field. We are
working hard internationally to develop similar frameworks on
the key issues where global consistency is essential, such as
liquidity, leverage, capital, and OTC derivatives.
We are working hard to achieve a careful balance and to
protect the freedom for innovation that is absolutely necessary
for growth. We are keeping Congress fully informed of our
progress on a regular basis.
Treasury has made significant progress in the short time
since the Dodd-Frank Act was enacted. In those months, we have
stood up the FSOC, which is working to identify risks to U.S.
financial stability and promote market discipline, while
developing procedures for deciding which nonbank financial
institutions and financial market utilities will be subject to
heightened prudential standards.
We have made significant progress in creating the Office of
Financial Research, which is working to improve the quality of
financial data available to policymakers and to facilitate more
robust and sophisticated analysis of the financial system.
Dodd-Frank creates, and the Treasury is standing up, the
Consumer Financial Protection Bureau, which is working to
protect consumers, making sure they have the information they
need to understand the terms of financial products.
Treasury is also working to enhance our ability to monitor
the insurance sector through the Federal Insurance Office,
which, for the first time provides the U.S. Government
dedicated expertise regarding the insurance industry.
We have made significant progress in the 10 months since
enactment. Continuing to move forward is essential to our
country's financial well-being. There is no responsible
alternative because if we do not invest in reform now, we run
the unacceptable risk that we will pay dearly later. We cannot
allow that.
Dodd-Frank Act was enacted to make sure that our financial
system is the world's strongest, most dynamic, and most
productive.
Thank you, Mr. Chairman.
Chairman Johnson. Thank you, Mr. Wolin.
Chairman Bernanke.
STATEMENT BEN S. BERNANKE, CHAIRMAN, BOARD OF GOVERNORS OF THE
FEDERAL RESERVE SYSTEM
Mr. Bernanke. Thank you. Chairman Johnson, Ranking Member
Shelby, and other Members of the Committee, thank you for the
opportunity to testify on the Federal Reserve Board's role in
monitoring systemic risk and promoting financial stability,
both as a member of the Financial Stability Oversight Council
and under our own authority.
The Dodd-Frank Act created the FSOC to identify and
mitigate threats to the financial stability of the United
States. During its existence thus far, the FSOC has promoted
interagency collaboration and established the organizational
structure and processes necessary to execute its duties.
The FSOC and its member agencies also have completed
studies on limits on proprietary trading and investments in
hedge funds and private equity funds by banking firms--the so-
called Volcker rule--on financial sector concentration limits,
on the economic effects of risk retention, and on the economic
consequences of systemic risk regulation. The FSOC is currently
seeking public comments on proposed rules that would establish
a framework for identifying nonbank financial firms and
financial market utilities that could pose a threat to
financial stability and that, therefore, should be designated
for more stringent oversight. Importantly, the FSOC has begun
systematically monitoring risks to financial stability and is
preparing its inaugural annual report.
In addition to its role on the FSOC, the Federal Reserve
has other significant financial stability responsibilities
under the Dodd-Frank Act, including supervisory jurisdiction
over thrift holding companies and nonbank financial firms that
are designated as systemically important by the Council. The
act also requires the Federal Reserve (and other financial
regulatory agencies) to take a macroprudential approach to
supervision and regulation; that is, in supervising financial
institutions and critical infrastructures, we are expected to
consider the risks to overall financial stability in addition
to the safety and soundness of individual firms.
A major thrust of the Dodd-Frank Act is addressing the
``too-big-to-fail'' problem and mitigating the threat to
financial stability posed by systemically important financial
firms. As required by the act, the Federal Reserve is
developing more stringent prudential standards for large
banking organizations and nonbank financial firms designated by
the FSOC. These standards will include enhanced risk-based
capital and leverage requirements, liquidity requirements, and
single-counterparty credit limits. The standards will also
require systemically important financial firms to adopt so-
called living wills that will spell out how they can be
resolved in an orderly manner during times of financial
distress. The act also directs the Federal Reserve to conduct
annual stress tests of large banking firms and designated
nonbank financial firms and to publish a summary of the
results. To meet the January 2012 implementation deadline for
these enhanced standards, we anticipate putting out a package
of proposed rules for comment this summer. Our goal is to
produce a well-integrated set of rules that meaningfully
reduces the probability of failure of our largest, most complex
financial firms and that minimizes the losses to the financial
system and the economy if such a firm should fail.
The Federal Reserve is working with other U.S. regulatory
agencies to implement Dodd-Frank reforms in additional areas,
including the development of risk retention requirements for
securitization sponsors, margin requirements for noncleared
over-the-counter derivatives, incentive compensation rules, and
risk management standards for central counterparties and other
financial market utilities.
The Federal Reserve has made significant organizational
changes to better carry out its responsibilities. Even before
the enactment of the Dodd-Frank Act, we were strengthening our
supervision of the largest, most complex financial firms. We
have created a centralized multidisciplinary body to oversee
the supervision of these firms. This Committee uses horizontal,
or cross-firm, evaluations to monitor interconnectedness and
common practices among firms that could lead to greater
systemic risk. It also uses additional and improved
quantitative methods for evaluating the performance of firms
and the risks that they might pose. And it more efficiently
employs the broad range of skills of the Federal Reserve staff
to supplement supervision. We have established a similar body
to help us effectively carry out our responsibilities regarding
the oversight of systemically important financial market
utilities.
More recently, we have also created an Office of Financial
Stability Policy and Research at the Federal Reserve Board.
This office coordinates our efforts to identify and analyze
potential risks to the broader financial system and the
economy. It also helps evaluate policies to promote financial
stability and serves as the Board's liaison to the FSOC.
As a complement to those efforts under Dodd-Frank, the
Federal Reserve has been working for some time with other
regulatory agencies and central banks around the world to
design and implement a stronger set of prudential requirements
for internationally active banking firms. These efforts
resulted in the agreements reached in the fall of 2010 on the
major elements of the new Basel III prudential framework for
globally active banks. The requirements under Basel III that
such banks hold more and better quality capital and more robust
liquidity buffers should make the financial system more stable
and reduce the likelihood of future financial crises. We are
working with the other U.S. banking agencies to incorporate the
Basel III agreements into U.S. regulations.
More remains to be done at the international level to
strengthen the global financial system. Key tasks ahead for the
Basel Committee and the Financial Stability Board include
determining how to further increase the loss-absorbing capacity
of systemically important banking firms and strengthening
resolution regimes to minimize adverse systemic effects from
the failure of large, complex banks. As we work with our
international counterparts, we are striving to keep
international regulatory standards as consistent as possible,
to ensure both that multinational firms are adequately
supervised and to maintain a level international playing field.
Thank you, and I would be pleased to take your questions.
Chairman Johnson. Thank you, Chairman Bernanke.
Chairman Bair.
STATEMENT OF SHEILA C. BAIR, CHAIRMAN, FEDERAL DEPOSIT
INSURANCE CORPORATION
Ms. Bair. Thank you, Mr. Chairman. Chairman Johnson,
Ranking Member Shelby, and Members of the Committee, thank you
for the opportunity to testify today on behalf of the FDIC.
The recent financial crisis has highlighted the critical
importance of financial stability to the functioning of our
real economy. While emergency measures taken in the crisis
stabilized financial markets and helped end the recession, in
its wake, almost 14 million Americans remain out of work and
our nation faces a number of other serious economic challenges.
Consistent with historical precedent, a central cause of
the crisis was excessive debt and leverage in our financial
system. In the fall of 2008, many of the large intermediaries
at the core of our financial system had too little capital to
maintain market confidence in their solvency. In the period
leading up to this crisis, we saw excess leverage of financial
institutions and securitization structures and in real estate
loans that made our entire system highly vulnerable to a
decline in home prices and a rise in problem mortgages. The
need for stronger bank capital requirements is being addressed
through Basel III and through implementation of the Collins
Amendment here in the United States.
One of the most powerful inducements toward excess leverage
and institutional risk taking before the crisis was the de
facto policy of ``too big to fail.'' With the expectation of a
Government backstop the largest financial companies are
insulated from the normal discipline of the marketplace that
applies to smaller banks and practically every other private
company. This situation represents a dangerous form of state
capitalism, in which the market expects these companies to
receive generous Government subsidies in times of financial
distress. Unless reversed, the result is likely to be more
concentration and complexity in the financial system, more risk
taking at the expense of the public, and in due time, another
financial crisis.
However, the Dodd-Frank Act does provide the basis for a
new resolution framework designed to make it possible to
resolve systemically important financial institutions, or
SIFIs, without a bailout and without sparking a systemic
crisis. Being designated as a SIFI will in no way confer a
competitive advantage by anointing an institution as ``too big
to fail.'' The heightened supervisory requirements placed on
SIFIs, including higher capital requirements and the need to
maintain resolution plans, seems to represent a powerful
disincentive for large institutions to seek SIFI status.
A key consideration in designating a firm as a SIFI should
be whether it could be resolved in a bankruptcy process without
systemic impact. Provided we have sufficient information to
evaluate the resolvability, it is likely that relatively few
non-bank financial companies will ultimately be designated as
SIFIs and subject to the heightened supervisory requirements.
But we do need the information to make that determination.
The orderly liquidation authority has been called a bailout
mechanism by some and a fire sale by others, but neither is
true. Instead, it is, I believe, a highly effective resolution
framework that greatly enhances our ability to provide
continuity and minimize losses and financial institution
failures.
Excess leverage is a problem that extends beyond the
purview of financial regulators to a broader range of economic
policies that encourage the use of debt as opposed to equity,
and this is where I hope the Members of the Senate Banking
Committee can perhaps play a leadership role in promoting
economic policies, including tax measures and fiscal reforms
that can reduce or eliminate incentives for excess leverage in
our financial system and our economy.
There are two additional risk management issues that I feel
should be high priorities for the new Financial Stability
Oversight Council under its mandate to identify and address
emerging risks to financial stability. First, mortgage
servicing deficiencies remain a serious area of concern.
Although the FDIC does not supervise the largest loan
servicers, over 4 years ago, we began identifying and trying to
address these problems using the authorities at our disposal.
Problems in mortgage servicing are yet another result of the
misaligned incentives in the mortgage process, where fixed
compensation provides few incentives to implement the more
costly, labor intensive servicing techniques that are necessary
to deal with high volumes of problem loans. Not only do these
problems represent significant operational, reputational, and
litigation risks to mortgage servicers, which we insure, they
are also holding back the recovery of U.S. housing markets. The
FSOC needs to consider the full range of potential exposure to
this problem and the related impact on the industry and the
real economy.
We also believe the FSOC needs to actively monitor interest
rate risk, or the vulnerability of borrowers and financial
institutions to sudden volatile spikes in interest rates.
Borrowers and depository institutions may be subject to sudden
increases in interest costs when interest rates rise--and they
will inevitably rise. This issue takes on particular urgency
now in light of the current low level of interest rates and
rapid growth in U.S. Federal debt. Developing policies that
clearly demonstrate the sustainability of the U.S. fiscal
situation will be of utmost importance in maintaining investor
confidence and ensuring a smooth transition to higher interest
rates in coming years.
Thank you again for the opportunity to testify about these
critically important issues. I would, of course, be pleased to
answer your questions.
Chairman Johnson. Thank you, Chairman Bair.
Because our Republican colleagues need to leave shortly, I
ask that the remaining witnesses' testimony be submitted for
the record. We will now move directly to questions.
STATEMENT OF JOHN WALSH, ACTING COMPTROLLER OF
THE CURRENCY
Chairman Johnson, Ranking Member Shelby, and Members of the
Committee, I appreciate the opportunity to provide an update on
the OCC's work to implement the Dodd-Frank Act provisions
related to monitoring systemic risk and promoting financial
stability, and our perspectives on the functions and operations
of the Financial Stability Oversight Council, or FSOC.
The Dodd-Frank Act includes several provisions to address
systemic issues that played a role in the financial crisis.
These include constraining excessive risk taking, instituting
stronger capital requirements and more robust stress-testing
requirements, and bridging regulatory gaps. The OCC is among
the financial regulators that have rulewriting authority for
many of these provisions, and my testimony describes our
progress in these areas.
One of the key provisions of the Dodd-Frank Act created the
Financial Stability Oversight Council, which brings together
the views, perspectives, and expertise of the financial
regulatory agencies and others to identify, monitor, and
respond to systemic risk.
FSOC has three major objectives: to identify risks to the
financial stability of the United States; to promote market
discipline, and to respond to emerging threats to the stability
of the U.S. financial system.
In some cases, the Council has direct responsibility to make
decisions and take actions. This includes designating certain
non-bank financial companies to be supervised by the Federal
Reserve and subject to heightened prudential standards should
the Council determine that material financial distress at such
companies would pose a threat to the financial stability of the
United States. In other areas, the Council's role is more of an
advisory body to the primary financial regulators, such as
conducting studies and making recommendations to inform future
agency rulemakings.
The varied roles and responsibilities that Congress assigned to
the Council appropriately balance and reflect the desire to
enhance regulatory coordination for systemically important
firms and activities, while preserving and respecting the
independent authorities and accountability of primary
supervisors.
As detailed in my written statement, FSOC has taken action on a
number of items, including the publication of two required
studies and proposed rulemakings on the designation of
systemically important non-bank financial firms and financial
market utilities.
The Council and its committees are also making strides in
providing a more systematic and structured framework for
identifying, monitoring, and deliberating potential systemic
risks to the financial stability of the United States.
Briefings and discussions on potential risks and the
implications of current market developments on financial
stability are a key part of the closed deliberations of each
Council meeting.
While I believe FSOC enhances the agencies' collective ability
to identify and respond to emerging systemic risks, I would
offer two cautionary notes.
First, I believe the Council's success ultimately will depend
on the willingness and ability of its members and staff to
engage in frank and candid discussions about emerging risks,
issues, and institutions. These discussions are not always
pleasant as they can challenge one's longstanding views or ways
of approaching a problem. But being able to voice dissenting
views or assessments will be critical in ensuring that we are
seeing and considering the full scope of issues.
In addition, these discussions often will involve information
or findings that require further verification or that are
extremely sensitive to the operation of either an individual
firm or an entire market segment. In some cases, the
discussions, if misconstrued, could undermine public and
investor confidence and create or exacerbate problems in the
financial system. As a result, I believe that it is critical
that these types of deliberations--both at the Council and
staff level--be conducted in a manner that assures their
confidential nature.
Second, even with fullest deliberations and best data, there
will continue to be unforeseen events that pose substantial
risks to the system, markets, or groups of institutions. We
should not expect FSOC to prevent such occurrences. FSOC will,
however, provide a mechanism to communicate, coordinate, and
respond to such events to help contain and limit their impact.
The issues that the Council will confront in carrying out these
duties are, by their nature, complex and far-reaching in terms
of their potential effects on our financial markets and
economy. Developing appropriate and measured responses to these
issues will require thoughtful deliberation and debate among
the member agencies. The OCC is committed to providing its
expertise and perspectives and in helping FSOC achieve its
mission.
Thank you, and I'll be happy to respond to your questions.
Chairman Johnson. Senator Shelby.
Senator Shelby. Mr. Chairman, thank you for yielding to us.
We are all, as you know, going down to the White House to meet
with the President. I yield my time to Senator Toomey.
Senator Toomey. Senator Shelby, thank you very much. I
appreciate that as well as all of your cooperation in this
process and in many other matters. Thank you.
Mr. Chairman, thank you very much for holding this hearing.
I think it is a very important topic and I appreciate your
doing this, and to all the witnesses, I know how busy you are
and I am grateful that you are here once again to answer our
questions.
I would like to zero in, if I could, on the process by
which the Council will be designating non-bank financial
institutions as SIFIs. I think this is a very, very important
issue, and I will confess up front, I am hoping that this
Council will cast the narrow net rather than a very broad net,
and I think it is vitally important that we have a well defined
and very objective process by which we make these designations.
The Notice of Proposed Rulemaking that came out in January,
I would suggest, lacked the necessary specificity that we need
to understand how this process is going to unfold. As I think
everybody knows, it essentially restated the statute and did
not provide the kind of guidance on how the statute will be
applied.
Now, I think several of you, maybe all of you, have
acknowledged in your written testimony the intent to provide
additional guidance, and I appreciate that. But I feel very
strongly that the form that that additional guidance takes
really needs to be a new proposed rule, and that new proposed
rule needs to have a comment period, and that comment period
needs to be at least 60 days because we just have not had a
chance for anybody to evaluate how this is going to be applied.
So I would appreciate it if each of you would confirm that
it is your intent to issue a new proposed rule and to provide
such a comment period.
Mr. Wolin. Senator, as our written testimonies have
indicated, we will be issuing additional guidance. It will be
in the form of some public rulemaking and we will be seeking
public comment. I think the Council has not yet landed on
precisely how the rule will be styled and exactly what the
length of the comment period will be. Obviously, we want to
make sure that we get sufficient public input, as we think we
have already given a few opportunities for public input. I
think as we provide further clarification as to how this
process will unfold, we will want to make sure we provide
adequate opportunity for people to react and provide their
views.
Senator Toomey. If I could, just very briefly, I appreciate
that. I just would like to underscore there has been really no
opportunity to respond yet on how the statute will be applied,
and so the President's Executive Order called for all agencies
to, as a general matter, provide 60 days. I really think that
is a minimum that is necessary, but I am sorry. I am
interrupting.
Mr. Bernanke. Senator, I think more details are necessary.
I favor providing more information to the public and getting
robust input and comment.
I should say that while I think we can provide more
information in terms of the metrics and criteria, I do not
think that we could provide an exact formula that will apply
mechanically without any application of judgment. I think,
ultimately, we are going to have to look at a whole variety of
issues which cannot always be put into a numerical metric. That
being said, I certainly agree with you that we should get all
the input we can from the public on this process.
Ms. Bair. Yes, we support going out for comment again with
more detailed metrics, and the 60-day comment period is
something we have tried to adhere to in our rulemaking for
major rulemakings. So, I think it is important to get public
comment and to provide more clarity and hard metrics.
That said, I would agree with Chairman Bernanke. I do not
think we can provide complete bright lines. There will need to
be some area for judgment. But clearly, we can do a better job
than we have done so far in getting more detailed metrics out.
Senator Toomey. And is it your view that the form that that
should take would be a Notice of Proposed Rulemaking?
Ms. Bair. That is a good question, Senator. I would be fine
with that. I understand there may be a legal issue with the
FSOC's ability to write rules with this kind of criteria versus
guidance and I would defer to the Treasury Legal Counsel on the
format. If we have legal authority to do it as a rule, I think
that would be fine, but I would defer to Treasury on that.
Ms. Schapiro. Senator, I agree with, really, everything
that has been said, and particularly with Chairman Bernanke
about the need to balance reliance on objective factors with
the exercise of reasonable judgment. But that said, I think
more transparency and more specificity about this process would
be very valuable, and I think a robust comment period will
inform the process greatly, so I would be very supportive of
that.
Mr. Gensler. Senator, just concurring, again, I think
Chairman Bernanke said it well. I think it is a mixture of
judgment and metrics. I think it would be good to put the
metrics out to public comment. We at the CFTC have generally
used 60 days. I think that is a good period of time. Whether it
is guidance or an actual rule, I really have not had an
informed view on and largely have to hear from Treasury as to
the--the guidance, I think, works very well, often, as well, as
long as we get the public input.
Mr. Walsh. Well, going sixth, it would be hard to think of
something new to say----
[Laughter.]
Mr. Walsh.----but certainly, going out again with greater
detail and greater clarity and seeking views and pursuing a
process of review and comment, I think is entirely appropriate.
Senator Toomey. Let me just strongly urge that we go with a
Notice of Proposed Rulemaking as the mechanism by which we do
this and we have at least 60 days. I think this is very
important.
I would also like to stress, I think we really have to have
this as objective as possible. The implications for a firm
being designated are huge, as you know very, very well. It is
really profound. And so it is perfectly reasonable for firms to
be able to expect to be able to anticipate whether or not they
will be brought in by virtue of these objective standards. So I
would strongly urge you to pursue that.
If I have time for one quick additional question, Mr.
Chairman----
Chairman Johnson. Yes.
Senator Toomey. Thank you very much. I would like to touch
on specifically the question of mutual funds, and again, I will
say that by their very nature, their inherent characteristics,
I think as a general matter, it is very unlikely that mutual
funds are systemically significant to the degree that would
justify this designation. I understand certain issues
surrounding money market funds that occurred during the crisis
are very important, but I also know that the SEC has taken
significant steps to address some of these in the rules of last
year, in a new set of rules or regulations that are being
contemplated now that deal with issues like liquidity and
reserves.
So my question is, are money market funds currently under
consideration for this designation, and if so, why? Mr. Wolin?
Mr. Wolin. Senator, I think it is premature for me to be
able to answer that question. The deputies of the FSOC have
been putting together some preparatory material. I think as we
just confirmed to you, we are planning on putting out
additional guidance for the public to comment, and until we do
that and get the responses from the public and until the FSOC
principals have an opportunity to have these kinds of
conversations, I think it is hard to know what the right answer
to that question is. We will move forward, obviously, with the
public's input and with the transparency that the FSOC has been
providing to date.
Senator Toomey. Would anybody else like to comment?
Ms. Schapiro. Senator, I would just add that I think the
SIFI determination is really an institution-by-institution
designation and not an entire sector. So under any
circumstances, I think we would have to look at individual
entities. And we held a one-day roundtable this week exploring
the systemic risk issues that are implicated with respect to
money market funds and how they invest, and I think that will
inform us at the SEC as we go forward in making determinations
about what further efforts we might make specifically with
regard to the regulation of money market funds. Also, all FSOC
members were represented at that roundtable and were able to
participate in a very robust discussion directly with the
mutual fund industry as well as with European regulators. So I
think we will be well informed when we get to the process of
thinking about institution-by-institution designation in the
money market fund or mutual fund area.
Senator Toomey. I see my time has long since expired, so I
thank you, Mr. Chairman.
Chairman Johnson. Thank you, Senator Toomey.
Secretary Wolin, Chairman Bernanke, and Chairman Bair,
Titles I and II are important cornerstones of the Dodd-Frank
Act, yet the House Republican budget proposal includes the
repeal of Title II. In addition, other legislation has been
introduced in both Houses to repeal the entire Dodd-Frank Act.
What do you think of these repeal efforts? Should we go back to
the system of regulation that existed before the financial
crisis?
Mr. Wolin. Mr. Chairman, as I said in my opening comments,
I think that there is no alternative but to move forward with
the Dodd-Frank statute as enacted. The idea that taxpayers
would continue to be on the hook in these moments of stress is
one that is unacceptable and I think the statute clearly puts
an end to. We think it is critical that in the areas that you
discussed in your opening statement, orderly liquidation
authority and the resolution plans that need to be put forward
to both the Fed and to the FDIC, that these are critical
elements of making sure that we end ``too big to fail'' and
that we make certain that taxpayers are no longer on the hook.
Chairman Johnson. Chairman Bernanke?
Mr. Bernanke. Mr. Chairman, it was clear that the
regulatory system that was existing during the crisis was
insufficient. There has been a long and thoughtful process
about how to reform financial regulation. I would reiterate
what Mr. Wolin said about the importance of addressing ``too
big to fail.'' Chairman Bair also mentioned this. The new
legislation addresses this on a number of levels, including
enhanced oversights, tougher capital liquidity requirements,
and the resolution regime, which is also very important. Just
getting rid of ``too big to fail'' would be a very important
step.
More generally, the philosophy of Dodd-Frank, which is to
encourage a systemic or macro prudential approach to regulation
where broad systemic risks are taken into account as well as
individual firm or market risks, I think is a very important
step and one that is being adopted globally as well as by the
United States.
Chairman Johnson. Chairman Bair?
Ms. Bair. Yes. I think it would be very harmful to repeal
it. There is a lot of work going on now that is moving toward
ending ``too big to fail.'' The tools are there. The
implementation capability is there. I would not want that work
to be diverted. I think repealing and trying to revert back to
a bankruptcy process, we know bankruptcy does not work, and so
that will be an open invitation to more bailouts if there is no
alterative to that.
So we are working very hard to implement this authority, to
convince the market that it can and will be used. There were
some very highly important and constructive improvements
sponsored by Senators Dodd and Shelby during consideration of
the Dodd-Frank Act that passed overwhelmingly--I think the vote
was 93 in favor--that put in additional important safeguards,
like the clawback authority. So I do think it is a very good
provision and one that we are taking very seriously to
implement and I hope will be getting bipartisan support to
continue that process.
Chairman Johnson. According to Chairman Angelides of the
FCIC, who testified before the Committee on Tuesday, as well as
others, the fear of the Federal bank regulators to address the
significant consumer protection issues contributed to the
financial crisis. Secretary Wolin and Chairman Bair, would you
please discuss why we need an independent consumer protection
agency and how this new agency can identify and mitigate
systemic risks.
Mr. Wolin. Mr. Chairman, I think that it is clear that
failures of consumer protection were very much at the core of
what caused the financial crisis we have just been through. The
Federal Government was not well equipped to make sure that
consumer protection issues were handled well. The
responsibility for consumer protection was spread out across a
wide range of agencies in the Federal Government. It is
absolutely critical, in our view, that there is an agency that
focuses very intensely on consumer protection issues. We need
to ensure that consumers have the information they need to make
responsible choices, to make sure that the kinds of judgments--
which contributed in the individual and certainly in the
aggregate so mightily to our financial stress--are looked
after.
The Consumer Financial Protection Bureau implementation
team is off to a very strong start. They are making sure that
they put together a set of rules, efficient but nonetheless
clear, that consumers can use to make sure they understand the
implications of their judgments--to make sure that those rules
are adhered to across the financial system, not just amongst
banks, but also amongst the non-bank parts of the financial
system, which have heretofore not been something that the
Federal Government has had authority to focus on.
Chairman Johnson. Chairman Bair?
Ms. Bair. Yes, I think the regulatory arbitrage for
consumer protections was a very profound problem leading up to
the crisis. We had a Community Banking Advisory Committee
meeting yesterday. We have a number of community banks on our
Advisory Committee that are mortgage originators and in the
years leading up to the crisis, as the craziness continued,
they lost significant market share to essentially completely
unregulated third-party mortgage originators that had not much
in the way of consumer protection requirements. So I think
these are good lenders and people who want to do the right
thing for their customer and they are regaining market share
again in this area.
But as we get farther and farther away from the crisis, a
lot of this could startup again and I think we really do need
an agency to provide good, strong, common sense standards
across the board. I think it will be good for consumers and I
think it will also be good for more heavily regulated sectors
and for the good players in the industry who are trying to do
the right thing.
That said, I think it is important for there to be a market
approach to consumer regulation, and the focus is, as I think
the current leadership has indicated, on having simpler
disclosures and better information to consumers so they can
make their own decisions. That is really what we need, and I
think that will be a very important value added from the
consumer agency.
Chairman Johnson. Senator Brown.
Senator Brown. Thank you very much, Mr. Chairman. I
appreciate that.
I have questions for the panel concerning the SIFIs, but I
am going to say a couple of things first. Before any
institution will be subject to stronger examination and rules
for capital risk, it must first be designated as a SIFI, and
the Council will soon be missing five full-time members, and I
am sorry our colleagues are not here to hear this because I do
want to speak pretty bluntly about this. The five are the heads
of the FDIC, the CFPB, OCC, FHFA, and the insurance
representative, and that will undoubtedly make it harder to
designate new companies as systemically important. We need
strong nominees who will not be afraid to take bold steps to
prevent a new financial crisis.
But if qualified nominees for these important positions are
blocked, it will increase the likelihood we have another AIG or
Lehman Brothers. I would urge everyone on the Committee to
remember what happened to the financial system and the economy
3 years ago and that this is serious business and should not be
so politicized that they block nominee after nominee after
nominee. I think we all--I am sure people on the panel agree
with that. I am, again, sorry my colleagues are not here to at
least discuss this and think clearly through what actually can
happen.
My question for Deputy Secretary Wolin is about the
financial crisis. It was in large part precipitated by shadow
banking complex activities initiated by Wall Street firms that
typically fell outside the scope of regulation. The designation
of systemically important financial institutions is supposed to
address this problem.
I want to agree with Senator Toomey's comments and his
questions to each of you that the Council-proposed rule seems
like a reflection, not an elaboration or road map to determine
what is systemically important. It is not clear to me, and I
guess from the answers to his questions, from you, at what
point a large, highly leveraged hedge fund becomes systemically
important. It is impossible to know whether heavily regulated
Main Street property and casualty insurers would be
systemically important.
And my question, Mr. Secretary, is do you believe that
mutual companies engaging in personal lines of insurance, do
you think they pose a threat to the financial stability of our
economy? Should they be categorized as systemically important?
Mr. Wolin. Senator, thank you for that question. We are
amidst a process under which we are going to provide further
elaboration. I think it is, again, premature for me to make
judgments about who is in and who is out. It is a firm-specific
kind of consideration, as Chairman Schapiro mentioned. The
statute obviously lays out the factors that are relevant.
The Council will put out additional guidance and
clarification about how we think about those various factors.
Firms, in the first instance, will make judgments about whether
they think they are of sufficient size, sufficient
interconnectedness, sufficient leverage, and so forth. I think
until that process reaches a further level of maturity, until
the members of the Council have an opportunity to have
conversations about how to think about those criteria, I am not
in a position to rule any particular firm in or out.
Firms can make judgments based on whether they have those
kinds of attributes or not based on the additional guidance
that we give, and we will be giving firms an opportunity to be
heard on these questions. That is in the statute. We have laid
out in our own rulemakings what the process will be. Even
before there is a proposal for a designation, they will have an
opportunity to come to the FSOC and lay out what they think
about the application of these factors to their particular
circumstance. So there will be a long process in which
individual firms have a very substantial opportunity to be
heard and their views be considered before any designations are
made.
Senator Brown. Thank you, and thank you, Mr. Chairman. I
just wanted to say to Chairman Bair, thank you for your service
the last half-decade. You have served your country well and you
have been very helpful to so many of us. Thank you.
Chairman Johnson. Senator Bennet.
Senator Bennet. Thank you, Mr. Chairman, and thank you very
much for holding this hearing. Thank you to all of you for
everything you are doing to try to implement this bill so that
we do not have the kind of systemic risk we faced on the front
end of the crisis, and I think the oversight of this Committee
is a very important part of this.
And it is in that spirit I wanted to ask Secretary Wolin
and Chairman Bernanke whether, in your analysis of what we are
facing in the economy right now, that there is anything that
would create more systemic risk to our economy than the U.S.
Congress failing to raise the debt ceiling of the United
States.
Mr. Wolin. Well, Senator Bennet, I think it is absolutely
unthinkable that we would not raise the debt ceiling in order
to make good on obligations that Congresses and Presidents in
the past have made. Secretary Geithner has spoken many times
publicly about the wide range of catastrophic implications to
failing to raise the debt limit as necessary with respect to,
first of all, losing this great national asset that we have,
which is that the full faith and credit of the United States
has been considered sacred. The real implications with respect
to funding rates and interest rates, that will affect not just
the U.S. Government, ironically, which has its own set of
fiscal implications, but also individuals----
Senator Bennet. Let me just stop you there for 1 second.
Has its own set of fiscal implications in the sense that it
would actually make our fiscal condition worse rather than
better?
Mr. Wolin. It would, Senator, because it would require us
to spend more money to finance the deficit that has already
built up. If the interest rates go up, our funding rates go up.
Senator Bennet. And you were headed--I interrupted you, but
where you were headed was what the implications were for people
living in places like Colorado, so----
Mr. Wolin. Right. So every American, whether they are
buying a house or buying a car or just paying off their credit
card bills will have to experience higher interest rates, which
will have very real effects on their pocketbooks. But I think
more broadly, the effects on wealth and so forth, people's
balances in their mutual fund accounts and so forth, all will
be put in jeopardy in ways that are unthinkable. The
implications are enormous. It is something that we think of as
enormous risk.
We have said and we believe that, as has been the case in
the past, Congress will increase the debt limit. It is
absolutely critical that that happen and that we work through
the broader set of fiscal issues, which are obviously
enormously important and ones that the President has been very
clear need to be addressed, but that we not hold the debt limit
as hostage to those critically important discussions.
Senator Bennet. Mr. Chairman?
Mr. Bernanke. Senator, first, let me say that this is in
the context of a broader discussion about fiscal sustainability
and fiscal discipline, and I fully support all the efforts of
the Congress--and I know they are very difficult challenges--to
bring the long-term fiscal situation into something closer to
balance. So in no way do I disagree with those objectives.
That being said, I think using the debt limit as a
bargaining chip is quite risky. We do not know exactly what
would happen if the debt limit was not approved. There are
certainly significant operational problems, legal problems
associated with making sure that the debt is paid. Even if the
debt is paid, there is the issue of market confidence and how
the market will respond to the risk of default or even the
default on non-debt obligations. So I think it is a risky
approach, not to raise the debt limit at a reasonable time.
Again, the costs. At minimum, the costs would be an
increase in interest rates, which would actually worsen our
deficit and would hurt all borrowers in the economy, including
mortgage borrowers and the like. The worst outcome would be one
in which the financial system was again destabilized, as we saw
following Lehman, which, of course, would have extremely dire
consequences for the U.S. economy.
Senator Bennet. Well, I share, obviously, your concern
about the fiscal conditions, as well, and I believe that we are
going to be able to have a constructive conversation about it.
One thing I would like to say, or ask you, Secretary Wolin,
maybe in particular, is the longer this goes on the debt
ceiling, is there not risk that the markets will react even
before the August date that Secretary Geithner has given us to
get this done? Or is there risk?
Mr. Wolin. Senator, we have not seen it to date, but there
is that risk if we get too close and the markets do not see a
credible way through this, yes.
Senator Bennet. Thank you, Mr. Chairman.
Chairman Johnson. Senator Reed.
Senator Reed. Thank you very, very much, Mr. Chairman.
Thank you, ladies and gentlemen.
Chairman Bair, let me join my colleagues and thank you for
your extraordinary service and wish you well. Your testimony
reflects on one of the most pressing economic problems we have
throughout the country, and that is the housing crisis. We have
taken extraordinary measures to assist the financial sector. We
have taken very few effective measures to assist homeowners.
Twenty-eight percent of homeowners in the United States are
underwater today. That is probably the biggest, in my view,
drag on the economic expansion and recovery we face, yet the
most recent attempt by the regulators to provide some clarity
in my view is woefully inadequate. I wonder if you might
comment on that and what we have to do to be as fair to
homeowners as we have been to the financial industry.
Ms. Bair. Well, I do think the regulatory orders are just
one step, and the examinations were focused on process issues.
They did not really get into broader issues of whether loan
modifications were appropriately evaluated and approved or
denied.
We have done some broader analysis of banks that service
loans under loss share agreements and have found not
insignificant error rates in making a net present value
determination about whether the borrower should qualify for a
mortgage modification.
So, we think in the next phase of this--the third-party
lookback that the orders require--it is very important that
they view 100 percent of consumer complaints and certainly 100
percent of modification denials, because we are seeing that
there are, again, a not insignificant number of errors in these
calculations based on the sampling we have done with our loss
share acquirers.
I think more broadly we need to be thinking about
simplifying the servicing process, the modification process, as
well as the relocation process for borrowers who are not going
to make it, and there are some out there.
We have also been exploring ways to provide relocation
assistance as an incentive when there is not the possibility of
a loan modification for the borrower because they simply do not
have the income to make an economically viable restructuring.
We think that will save us money because the foreclosure
process is so backed up now, and this is one of the reasons the
housing market is not clearing, and it cannot recover until it
clears. The short sales or relocation assistance can shorten
the time that it takes to get the property back on the market,
and that also can mitigate losses, which we see is in our
financial interest to do.
So, yes, I think there needs to be much more aggressive
action in terms of looking back for the borrowers that have
already been harmed. Looking forward, we need more streamlined
processes. We need single points of contact to make sure there
is one person, which would be an important quality control on
servicing to make sure that the borrower is appropriately dealt
with and loss mitigation and loan restructuring efforts occur
where they should. So I think that is positive. But there is
just a lot more work to be done, and the market is not going to
clear until we get this fixed.
Senator Reed. You know, what you have said--and I agree
with it--has been said repeatedly for the last 2 years, and yet
all of you collectively as the Federal regulators had the
chance to make these things happen. And essentially what I
think you chose to do was to just kick the can down the road a
bit further, let the banks appoint an independent evaluator to
go in and look again.
Can I ask you, what is the definition of ``independent''?
Would this be someone who has never done any business with the
bank before? Is this a division of a company that has big
contracts with all these banks and would be independent in the
sense that the rating agencies were independent?
Ms. Bair. Well, we are not the primary regulator of any of
the major servicers, so the representatives of the primary
regulators might want to respond to that.
We do have one bank that originates loans for a servicer
who has problems, and we put an order on that bank--to tell the
bank that the servicer for them needed to take some significant
remedial steps. Our view is that the third party does need to
be independent, and there also needs to be some validation
process done independently by the regulators.
Senator Reed. But from your participation, there is no
definition of ``independence''?
Ms. Bair. Again, I would defer to Mr. Walsh and Mr.
Bernanke, if they want to share thoughts on that, because they
are the primary regulators of these servicers. But I agree with
you. I think there are a lot of professional banking
consultants out there that may be independent in the sense that
they do not work for the bank, but they may have other business
with them or future business they would like to do with them.
So I think this is a huge issue, and there needs to be some
validation process----
Senator Reed. Let me ask another question, and that is, you
indicated that the loan modification process was explicitly
excluded from this review. Is that correct?
Ms. Bair. This review was focused on mortgage document
processing.
Senator Reed. Again, 2 years of struggling through this,
multiple times we have attempted to fix it. The problem is
foreclosure and modification together, not one or the other.
And this to me is just a way of defining away the problem. And,
frankly, it is very disappointing.
My time has expired. If there is an opportunity again, I
will raise this with the primary regulators. But, frankly, one
of the reasons I raised it with you is that I think you have
been very forthright, and the FDIC going back to 2007 has been
effective, where the other agencies have been more apologetic
than effective.
Thank you.
Chairman Johnson. Senator Schumer.
Senator Schumer. Well, thank you, Mr. Chairman.
First, Chairman Bernanke, I have a couple of statements
that were recently made by the Speaker of the House, John
Boehner, and I would like to ask you about them. The first is
he said, ``We are calling for an end to the Government spending
binge that is crowding out private investment and threatening
the availability of capital needed for job creation.''
Now, several economists have refuted the notion that given
particularly now with our current slack in the economy and
corporate America having lots of money and still being
reluctant to invest it for other reasons, so they have disputed
the notion that we are crowding out private investment with
Government spending.
Do you agree with Speaker Boehner's statement that
Government spending is at this time crowding out private
investment?
Mr. Bernanke. Well, in the near term, I do not think that
there is a lot of crowding out. As you point out, interest
rates are quite low. There is a lot of excess resources
available for firms that need to hire additional workers.
That being said, if we do not address the fiscal trajectory
we are on, we are going to be facing increasingly severe
crowding out problems and perhaps financial stability problems
in the future.
Senator Schumer. But it is not occurring now?
Mr. Bernanke. Not to a substantial extent. I do think that
if we had a long-term plan to reduce our long-term fiscal
deficit, it might help to lower interest rates and increase
confidence today. But under conventional definitions of
crowding out in terms of credit markets and labor markets, we
are not seeing too much of that.
Senator Schumer. Thank you.
The second statement is the inverse of that. Speaker
Boehner said, ``The recent stimulus spending binge hurt our
economy and hampered private sector job creation in America.''
CBO's own analysis seemed to contradict that statement. Do
you agree with Speaker Boehner's statement that the stimulus
spending hurt our economy and hampered private sector job
creation in America?
Mr. Bernanke. Well, again, I would distinguish, Senator,
between the short run and the long run.
Senator Schumer. Now we are just talking about the
stimulus.
Mr. Bernanke. We have a very significant long-run problem,
and to the extent that we are pushing our debt situation
further and further into the red, we are taking greater risks.
That being said, I have cited the CBO analysis in the past
as being a reasonable analysis of----
Senator Schumer. Do you disagree with Speaker Boehner's
view that the stimulus, the stimulus we passed last year, hurt
our economy and particularly hampered private sector job
creation?
Mr. Bernanke. My best guess is that the stimulus increased
employment.
Senator Schumer. Thank you. I am glad you disagree.
Next question. This is also for you. This one is not the
same type of question.
[Laughter.]
Senator Schumer. The Fed, along with other prudent
regulators and the CFTC, issued proposed rules relating to when
counterparties in derivative transactions are required to post
margin, that is, put up cash as security for their obligations.
As you know, I had spoken to you about this shortly after the
rules were announced, and several members of the New York
delegation sent you a letter on this.
I am concerned with the part of the proposal--we all are in
the New York delegation--that would apply only to U.S. firms
and would result in them facing competitive disadvantages vis-
a-vis international competitors.
Here is the basic issue as reported last week in the
Financial Times: If a German car manufacturer were to do an
interest rate swap with a U.S. bank's London arm, it would have
to cough up margin; but if the German car maker did a swap with
a British bank, it would not have to. That is the Financial
Times' summation of this.
So do you agree that this might cause U.S. firms to be at a
competitive disadvantage?
Mr. Bernanke. Yes, I do agree. In transactions with U.S.
customers, both foreign and domestic banks have the same rules.
In transactions with foreign customers, we have put out margin
and capital rules, which have a good purpose, which is increase
the safety of our financial system.
Currently, under the Basel agreement, similar capital rules
will probably be in effect for foreign banks, but at this point
they have not yet done the margin----
Senator Schumer. So that leads to my last question with the
Chairman's indulgence, since I have 16 seconds left. What is
Treasury doing, Secretary Wolin, to ensure that European
regulators adopt the same or very similar rules? And would we
go forward and enact our rules before they did if it put our
U.S. firms at a disadvantage? Because, obviously, I would like
to see American institutions do as much foreign business as
possible. It creates jobs in New York.
Mr. Wolin. Senator Schumer, we are working very hard with
the Europeans in Brussels and also in individual European
capitals to make sure that we have absolutely as much as
possible a level playing field. I think we are making good
progress on that, but we will have to stay vigilant.
On the question of whether we would put forward rules, I
would obviously defer to the Chairman and to the market
regulators as to how they would move forward. But I think it
is, of course, important, as we have said repeatedly, to have
essentially level playing fields so as not to disadvantage U.S.
businesses where that is avoidable.
Senator Schumer. I assume you are urging the regulators to
do just that right here.
Thank you, Mr. Chairman.
Chairman Johnson. Senator Merkley.
Senator Merkley. Thank you very much, Mr. Chair, and thank
you all for your testimony.
I was just downstairs in the gathering of the HELP
Committee in a hearing that was wrestling with the impact on
the middle class over the last 30 years and essentially the
hollowing out of the middle class in America. And I think there
is a chart that captures much of the concern. It is a chart
that shows how middle-class wages rose with the productivity of
the country over the 30 years following World War II, but
starting in roughly 1975, 1974, for the next 30 years enormous
divergence in which middle-class working wages, inflation
adjusted, stayed flat. But we had a tremendous increase in the
wealth of the country and the productivity of the country, but
working families did not share in that. And it really raises
the question of what kind of a country do we want. Do we want a
country where families participate in the wealth of this
Nation, where they are able to send their children to college,
plan for their retirement, own a home, be part of an ownership
society, or one in which essentially fewer and fewer families
are in a position to access those fundamental instruments
related to quality of life? And it is discouraging to see that
path over this last 30 years.
In some ways many of the issues that we dealt with in Dodd-
Frank Act are related. We have seen basically a doubling of the
national debt under the Bush administration and then a tripling
of the national debt as a result of the house of cards that was
built in the mortgage deregulation by the Bush administration.
And now we are seeing the recommendations from the House that
say, OK, well, let us dismantle what is left of the programs to
provide support for families as a consequence of the debt, even
though the debt was created by strategies that were not
designed to support the middle class to begin with. The entire
picture troubles me.
There is a link between this and the Financial Stability
Oversight Council and a couple issues that trouble people in
our working communities. One is the ongoing foreclosure crisis,
and certainly that is related to financial stability. Another
is the speculation driving up the cost of petroleum. And I do
not know if you have all addressed either of these, but if you
have, feel free to be short. But these are kind of nitty-
gritty, on-the-ground economic issues that may not have to do
with whether the financial system as a whole collapses, but it
is certainly related to the performance of the financial system
as it affects families.
So with the anticipated additional wave of foreclosures,
almost 5 million on the horizon, the impact of that on the
construction industry, which affects almost every aspect of my
State economy, and the rising cost of oil, have these been
topics that have been wrestled with the Financial Stability
Oversight Council? Should they be? And I will just open it up
to whoever would care to comment?
Mr. Bernanke. Senator, first, you talk about a number of
broad macro issues, and I cannot do justice to them, but I
would just note that the Federal Reserve in its monetary policy
is trying to address unemployment, which, of course, is a major
source of foreclosures, as well as mortgage interest rates and
other factors affecting the foreclosure crisis. So we are
addressing it in that respect.
Attempting to address the foreclosure crisis directly, you
know, there has been a lot of effort and so far only modest
success. It has proven very difficult to find solutions in many
cases. In other cases, the process has not, you know, been
adequate in the case of banks, and we have already discussed
here a bit the recent review of servicing practices. The
Federal Reserve and the OCC, with the support of the FDIC, have
reviewed those practices. We have issued cease-and-desist
orders to try to stop bad practices and to try to require banks
to go back and discover who was harmed and to help offset those
problems where possible. Going forward, we expect to assess
civil money penalties as well.
But you are right that this remains a very, very difficult
problem, and at some level it is a problem of regulation and a
problem of bank operation. But at some level it is also a
macroeconomic problem, and that needs to be addressed in terms
of global and national employment and economic conditions.
Senator Merkley. Anyone else care to comment on this?
Mr. Gensler. Well, I just thought I would say the Financial
Stability Oversight Council has not talked about some of these
matters, about the rising commodity prices, as a council. It
may have at staff levels. I think the Dodd-Frank Act has a
number of features that helps market regulators like the CFTC
have broader oversight that the markets work better for the
American public. We are not a price setter, and that is not
what Congress or the American public is asking the market
regulator to be. But the Dodd-Frank Act gave us broader
authority to see the whole market, the whole derivatives
market, swaps, stronger anti-manipulation authority in our
case, more similar to the SEC's, to actually bring in some of
the foreign boards of trade, some foreign exchanges, and also
to move forward with what I think Congress said with regard to
limiting some of the size of the speculators' positions in
these marketplaces.
So we have put proposals out on all of these matters
consistent with congressional intent, and we look forward to
public comment and trying to finalize the rules.
Senator Merkley. Thank you.
Chairman Johnson. Senator Tester.
Senator Tester. Yes, thank you, Chairman Johnson.
I appreciate all of you being here today. I want to talk
about debit interchange, of course. Chairman Bernanke, we were
here in February. We talked about the serious risk that the
Durbin amendment would have on small community banks and credit
unions because of the lack of ability to enforce the $10
billion and under exemption. You have gotten more information
since then. Do you still feel, with the information you have
got on hand, that an exemption can work?
Mr. Bernanke. Well, to be honest with you, we were
agnostic. We still are not sure whether it will work. A number
of the networks have expressed their interest or willingness to
maintain a tiered interchange fee system, but that is not
required. There is no law which says they have to do that.
A suggestion that we got was that we should ask or even
require the networks to make public what the interchange fees
were that they were charging, and that would be of at least
some value in terms of the transparency. But, again, there are
market forces that would work against the exemption.
Senator Tester. OK. You have been in the business for a
long time, and you are a very intelligent guy. And I know we
are in a political process here, and I know you probably have
been getting a lot of pressure from people, or at least one
person from the Senate. I am talking about rural America here.
I am talking about community banks and credit unions that if
they go away, it is another nail in our coffin. It is really
important. I think it is really important. Is it going to work?
Mr. Bernanke. I cannot say with certainty, but I think
there is good reason to be concerned about it.
Senator Tester. Very good reason to be concerned about it.
And if it does not work, what are the impacts on rural America?
Mr. Bernanke. Well, it is going to affect the revenues of
the small issuers, and it could result in some smaller banks
being less profitable or even failing.
Senator Tester. OK. Thank you. Wouldn't it seem the prudent
thing to do to step back and get more information? Wouldn't you
agree the amendment was put in rather quickly?
Mr. Bernanke. It was put in quickly, but I think I have to
defer to Congress on what kind of information you want to get.
We have done one review, and we have gotten 11,000 comments.
Senator Tester. Can you make good decisions with bad
information?
Mr. Bernanke. I----
Senator Tester. Can you?
Mr. Bernanke. You cannot, of course, but----
Senator Tester. Can you make good decisions with little or
no information?
Mr. Bernanke. That is not a problem. We have plenty of
information. We have received 11,000 comments, and we have done
an enormous amount of surveying of the industry and so on.
Senator Tester. And you have been able to wade through
those comments?
Mr. Bernanke. That is why we wrote to this Committee that
we were going to be late with our rule, but we are making
considerable progress, yes.
Senator Tester. OK. Chairwoman Bair, before I get done, I
want to thank you for your service. I very, very much
appreciate all the work you have done. As Senator Brown said,
you have been very good at what you have done.
The same issue. From your vantage point, do you think it is
possible to exempt community banks from the debit interchange?
Ms. Bair. I think it is questionable. We had suggested that
the Fed perhaps could try to use the authority under Reg. E to
require that the networks accept two-tier pricing, and our
lawyers probably have different perspectives on that, and I
think that is obviously the Fed's call because it is the Fed's
rule. So if their view is that there is no legal authority to
require that, I think it does become even more problematic. And
so I do think this is going to reduce revenues at a number of
smaller banks, and they will probably have to pass that on to
customers in terms of higher fees, primarily for transaction
accounts.
So I think that is going to happen, and, again, is that the
right result, the result Congress wanted? You need to determine
that. But I think that is what will happen.
Senator Tester. Well, any impact on their safety and
soundness? Community banks I am talking about.
Ms. Bair. In our initial analysis, it does not look like it
would, but it would clearly stress some institutions. Putting
them to the point of failure, no, we do not think that will
happen, but clearly it would stress some, and if there are
other challenges that are confronting the community banking
sector, it is probably something they do not need to be dealing
with right now.
Senator Tester. OK. So you talked about you did not know if
this is what the impact that Congress would have. I trust that
this would potentially mean or probably mean or most certainly
mean higher fees in other areas for consumers?
Ms. Bair. Yes, it would have to be passed on in other fees.
Senator Tester. OK. Mr. Walsh, do you have anything you
would like to add to this issue?
Mr. Walsh. Only that we provided a comment letter that did
not address particularly this distinction. It dealt more with
the flexibility the Fed has to set the overall interchange
level. But we have been doing a fair amount of outreach to
community bankers, and certainly it has been a key concern for
them.
Senator Tester. The impact on community banks, do you see
it very similar to the way--how do you see it? I do not want to
put words in your mouth.
Mr. Walsh. Well, I would just say that to the extent that
it works out as is suggested where it cuts into revenue for
community banks, it is one more stress on them.
Senator Tester. Right. Do you think an exemption can be
implemented?
Mr. Walsh. I have not really studied the issue of whether
that can work.
Senator Tester. OK.
Mr. Walsh. I would defer on that one.
Senator Tester. All right. Thank you. Thank you all very
much.
Chairman Johnson. Senator Warner.
Senator Warner. Well, thank you, Mr. Chairman, and let me
say it is great to see you all again. Let me start by adding my
comments to so many of my other colleagues in thanking Chairman
Bair for her, I think, extraordinary service and lots of help I
know personally to me and Senator Corker as we tried to
navigate through some of these issues.
I hope, Mr. Chairman, we are going to get--since we are
down to the few at this point, maybe we can get a second round
of questions because I have got lots of things I would love to
raise.
First of all, for Deputy Secretary Wolin, I continue to
think the jury is out on whether at least this member's hope
and aspiration of what the FSOC would be will be accomplished.
I think it is a critically important early warning signal. One
of the things that I think will make the FSOC a more informed
entity will be the active creation of the OFR, and I was
wondering as my first question, Do you have any sense of when
we might actually get a nominee for the OFR?
Mr. Wolin. Senator Warner, we certainly hope soon. I
expect, you know, the President will make a nomination for that
important job soon. I want to assure you that in the meantime
we are working with an awful lot of intensity and focus to
stand up the OFR, to make it the important addition to the
landscape that it is beginning to be and that it will be.
We have made, I think, very good progress in hiring senior
people. We have just now in the last few weeks brought on Dick
Berner, a very accomplished individual with lots of experience
in the markets and in risk, with impeccable credentials, to
lead the stand-up effort. We have hired a chief business
officer, someone to run the data center; a chief operating
officer and a range of other folks. They are, I think, together
beginning the work with the other members of the FSOC in
evaluating risk and trying to work through the kinds of debt
issues that will be critical for the OFR to work through in
order to----
Senator Warner. I have got a lot of questions, but I would
like to--again, I appreciate that, but it has been 11 months.
We need a nominee.
I want to also re-echo what a number--Senator Toomey and
Senator Brown mentioned as well in terms of the SIFI
designation. You know, we have got to give some more clarity
here, the sooner the better, and, you know, one of the notions,
at least I personally believe, is that if we give guidance to a
firm in kind of a quasi-safe harbor, if they can take actions
to ensure they are not SIFI designated, I think that inures to
the benefit of the system. That means that, in fact, they will
be managing--limiting their risk exposure so they do not get
this designation. Again, I think that net-net helps us move
along in this process, and I concur with Chairman Bernanke's
comments. This cannot be done with a strict kind of simple
metric of dollars a sense. There has got to be a subjective
judgment. But the sooner we can move this forward the better,
and the notion of some sense of a safe harbor, whether it is
mutual insurance funds, some of the money market funds, I think
is helpful.
I would put one other caveat here, that from some of our
financial institutions that repeatedly would come and appeal to
me--and perhaps Chairman Johnson remembers this as well--during
the formation of Dodd-Frank, when they said, ``Please, please,
do not give us firm guidelines in the legislation. Leave it to
the regulators.'' And now they are coming back and saying,
``Oh, my gosh, the regulators have got so much to do.''
Hopefully those in the audience who were visiting my office
when they were saying please do not, Congress, legislate
specifics, that you will recall that this is some of what you
asked for.
I would also urge that--again, some of our colleagues were
not here, and I know one of my other colleagues asked, the
point of some of this kind of chipping-away effort, my sense is
that there is enormous--while not complete agreement with what
we have done, but across the EU, across the UK, around the
world, they are glad we went first. And any effort to try to
retract that would be, I think, potentially devastating to
international implementation. And I wanted to--I know my time
is gone, but, Chairman Bernanke, one of the things that you
think about with the G-20--and my fear is that as the crisis
gets further away, this financial harmonization issue kind of
falls down the level a little bit. How do we make sure that on
Basel III we really do get there? How do we make sure that as
the UK and the EU look at kind of ``bail-in'' options rather
than some of the resolution activities we have gotten--maybe
Chairman Bair could address this as well--that we keep this
international implementation and international--perhaps
slightly different rules, but at least a unified approach on
track?
Mr. Bernanke. Well, that is a major priority of the whole
process, and I think on the whole it has gone pretty well.
People have joined in in good faith to try to create a level
playing field.
So while there are some international differences, at this
point I do not see very many. Senator Schumer talked about some
aspects of margin requirements and things of that sort. But for
banking in general, I do not see many irresolvable differences
at this point.
Moreover, a very important part of this is ensuring that
the rules are both implemented in a consistent way across
countries and enforced in a consistent way across countries.
And part of what the Basel Committee and the Financial
Stability Board are doing is trying to set up frameworks for
looking at those things as well as at the paper rules.
Senator Warner. Do you or--and my time has expired, but I
will stay around for a second round. Do you or Chairman Bair
want to comment about potential challenges on resolution, for
example, with the UK's bail-in?
Ms. Bair. Well, I think there has been a lot of work. I
think that the international consensus is you do need special
resolution regimes for large financial entities. No one is
trying to use a bankruptcy process. It is just not suited for
it. It should be used as much as it can, but in some instances
it is just not suited for it. And I think the G-20 over a year
ago approved core principles for resolution regimes. We each
co-chaired the Cross-Border Resolution Group at the Basel
Committee and played a leading role in devising those. So,
there is clearly progress moving forward, and I think bail-in
is another tool in the toolkit. I think we have agreement with
the UK on that. We think bail-in as one tool in the toolkit is
a good thing. They are not suggesting it can replace resolution
regimes, because it cannot. You will always need that backstop,
I feel.
Also, bail-in as a post-resolution tool, in other words,
converting some of the unsecured debt into an equity investment
in the new institution, I think there is a lot of progress.
Again, it is one of the structures we might pursue in our
resolution planning.
So I think there is a tremendous amount of progress. We
have entered bilateral agreements already with the UK, China,
and have a number in development with other European countries.
Also--the EU is moving forward with development of special
resolution regimes. So I think there is tremendous progress,
both domestically and internationally, and I hope we can
continue that forward progress. As I said before, there is good
bipartisan political support for it.
Chairman Johnson. At the suggestion of Senator Reed, we
will proceed with a brief second round.
For all the panelists, currently there are several
vacancies at the financial services regulatory agencies. This
summer, there will be several more vacancies. I am increasingly
concerned about comments by some of my colleagues that any and
every nominee will be blocked. Not having strong individuals in
place at the agencies as we continue to implement Dodd-Frank
seems to me to be detrimental to our fragile economic recovery
and financial stability.
What do you believe is the impact of these vacancies?
Mr. Wolin. Mr. Chairman, these are important roles, and it
is important to fill them. The President I think will be making
nominations on these open positions soon, those that he has not
already made nominations for. I think that it is, of course,
important to have leaders in these seats.
Having said that, the work of these various agencies goes
on, and the FSOC has been off to a very strong start and has
been very effective in its early days and will continue to be
so. But that is not to suggest that it is not important to get
folks in these various jobs.
Chairman Johnson. Chairman Bernanke.
Mr. Bernanke. Mr. Chairman, while I do think the agencies
are continuing to do their work, the leadership does set
direction and tone, and I think it is important to have highly
qualified people at the heads of these agencies.
That being said, of course, the Senate has to do its duty
of advise and consent and ensuring that these are qualified
people. But I hope there will not be unnecessary delays and
politically motivated blockages that prevent those qualified
people from undertaking their duties.
Chairman Johnson. Chairman Bair.
Ms. Bair. Yes, I think this is very important. At my own
agency, after I depart on July 8th, our OTS board member will
be gone July 21st, which is obviously the transfer date for the
OTS. We could rapidly go from five to three directors quickly
and actually down to two because one of our internal directors
right now is on holdover status and has other opportunities.
So I think that this is very important, and I think having
a Presidentially appointed, Senate-confirmed nominee is very
important. It is important for the Senate to have their say and
their role in the process. It is important for the President to
have his prerogatives as the one who is constitutionally
charged with nominations and appointments.
So I do think, too, if members want independent thought at
an agency, it is important for that Presidential appointment
and Senate confirmation process. I look back on my last 5 years
and all the tough decisions I had to make, and if I had been in
an acting capacity, it would have been inhibiting to me in
making some of the tough decisions I had to do. So I hope the
process can move forward.
Chairman Johnson. Chairman Schapiro.
Ms. Schapiro. I think, Mr. Chairman, for five-member
commissions such as the Securities and Exchange Commission, it
is really critical that we have, and always maintain, our full
complement of Commissioners. I think it is particularly true
right now given the huge volume of work that the agency is
facing, both with respect to our law enforcement activity but
most particularly with respect to the rule-writing
responsibilities that we have taken on under Dodd-Frank.
We have no vacancies at the moment, although we do have one
Commissioner whose term expired a year ago and has been holding
over in that position.
Chairman Johnson. Chairman Gensler.
Mr. Gensler. Like the Securities and Exchange Commission,
we are a five-person commission and we are fortunate to have
five very able and thoroughly engaged Commissioners, but we do
have a term that comes up. Commissioner Dunn, after serving two
terms, will be up in June, and yesterday, the President did
forward, or at least announced that he is forwarding a
nomination to the Senate. So I was glad to see that and I would
look forward to maintaining a full Commission--I think it is
very helpful to always have five Commissioners who are actively
and thoughtfully engaged.
Chairman Johnson. Comptroller Walsh?
Mr. Walsh. Well, as the one acting agency head here at the
table, I guess I would add the thought that Secretary Geithner
invited me to do this job and certainly encouraged me to do the
job as if it was my job, but the fact is that I have said to
him and said repeatedly that I do think it is very important
for independent supervisory agencies to have nominated and
confirmed heads in place. It is important for that independence
and for the perception of independence, and I think it is
obviously the right way to proceed since that is the structure
that exists. So I would join others in support of that thought.
Chairman Johnson. Senator Merkley, do you have any follow-
up questions?
Senator Merkley. You bet. First, I want to join my
colleagues in thank you, Chairman Bair, for your hard work
during an incredibly difficult time in America's financial
picture, so I wish you well in the next chapter of your life
and will continue to, I am sure, many of us, look to your
insights and advice.
One of the things I wanted to pursue, and Deputy Secretary
Wolin, I think it is probably appropriate to ask you about
this, and that is if we turn the clock back a year and a half,
there was and there continues to be a real challenge in terms
of lending capacity at a lot of our community banks and often
our healthy community banks. In wrestling with this and talking
to many, many experts and stakeholders, we have produced a plan
called Small Business Lending Fund which was to essentially
counter the irrational fear that had followed the irrational
exuberance as that fear related to capitalizing community
banks. And that capitalization, as leveraged, could provide up
to $300 billion in community bank lending. That was something
that was amended into the small business jobs bill in a
bipartisan fashion.
And I have banks coming to me now who are applying and
saying there is no sign that Treasury is ever going to respond
to our applications. It just seems like the process is
absolutely frozen. What is wrong and how is Treasury going to
fix it? This is an important issue to putting our economy back
on track.
Mr. Wolin. Thank you, Senator, for that question. The Small
Business Lending Fund is a critical element of getting credit
flowing again to small businesses. We support it very strongly
and are spending a lot of energy implementing it. We have now
received lots of applications. I think you can expect that we
will start making announcements very quickly in response to
those applications.
Senator Merkley. That is great news, and I thank you, and I
will not have the same stream of folks coming and asking me
what is going wrong.
The second question I wanted to ask, and let me turn to
Chair Schapiro, is related to follow-up to the flash crash from
a year ago. The SEC, I believe, has had the ability to address
greater audit trail for about 20 years and the flash crash kind
of put an exclamation point on the need to both develop a real-
time audit trail and to develop other issues related to
preferential treatment for high volume, high speed trading.
Maybe you can update us on where the SEC process is and your
personal perspectives on how important this is in terms of the
confidence of small investors and others.
Ms. Schapiro. I would be happy to, and let me start with
the last part first. I think it is absolutely essential to the
confidence of small investors that we have a market structure
that is resilient and capable and perceived by all market
participants to be fair and that is fair.
Coming off of May 6, we very quickly made a number of
changes to the market structure to deal specifically with the
extraordinary volatility we saw on that day. We instituted
single stock circuit breakers so that if the price of a stock
moves more than 10 percent in a five-minute period, trading is
halted. It gives time for people to catch their breath,
contraside interest in trading the security to come back into
the marketplace.
We also eliminated the rules that would permit stub quotes,
those executions at one cent and $100,000 that we saw on that
day. The exchanges clarified the rules of the road for when
they would break trades that were clearly erroneous or were not
valid trades in the marketplace, because about 20,000 trades
were broken on that day in May last year.
And finally, we banned naked access to the market so that
customers and broker-dealers' orders must go through a risk
management system and cannot directly enter the marketplace. So
important things have been done.
Our next step with respect to May 6 is to move to a limit
up, limit down proposal, proffered by the exchanges, that would
actually limit the ability to even put into the marketplace an
order that was out of a reasonably tight range around the
current trading, and I think that will be an important
improvement, as well.
But we have broader issues that we are very focused on.
Many of them were raised in our concept release of about 14
months ago, 15 months ago, and they focused a lot on high-
frequency trading and the strategies that are used by
algorithmic traders. We are moving forward with that in pieces
and hopefully will begin to take some action in that area.
Two of the most important pieces are the consolidated audit
trail and the large trader reporting system that were
specifically proposed by the agency a year ago, or almost a
year ago, and it is my hope that those will come back to the
Commission for final approval in the next couple of months.
They are absolutely essential to our ability to reconstruct
trading after an eventful day like May 6, but also for us to be
able to determine whether people are manipulating the markets
or taking advantage of other market participants in any way.
And so the consolidated audit trail, which brings together the
data from the many trading venues that exist in the U.S.
markets, is really a critical regulatory tool. It simply has
not been done and we are going to move ahead and try to get it
done in the next couple of months.
Senator Merkley. I appreciate that it remains something
that you are hard at work on, and thank you.
Ms. Schapiro. I am absolutely committed to it.
Chairman Johnson. Senator Warner?
Senator Warner. Thank you, Mr. Chairman.
I want to pick up where Senator Merkley left off just as
kind of a quick comment. I appreciate the actions that the SEC
has taken. I still have some concerns that can you keep up with
the technological challenges, collocation, the sniffing
techniques, some of the other technology aspects. And one of
the things, Mr. Chairman, I find a little curious is that there
are--some of our colleagues on the other side have attacked the
new Consumer Bureau because of its ability to have a funding
source, and I think we all, as we were trying to get this bill
in place, wanted to make sure that the prudential supervisors
were in at least parity if not a preeminent role vis-a-vis the
new consumer entity, and it is curious that one of the ways you
do that, particularly with the SEC, would have been to make
sure they had adequate funding so they could upgrade their
technology, so when they deal with flash crash technology
challenges, when we are thinking about perhaps loading on a new
challenge to the SEC in terms of reporting back as major
publicly traded companies are subjects of cyber attacks, we
keep layering on additional challenges, and if we are going to
maintain that parity and keep the prudential supervisor, I
think, appropriately in the preeminent role, they have got to
have the resources to do it.
And that brings me now to one of the areas that I want to
ask both Chairman Schapiro and Chairman Gensler on. We are
seeing as, I guess, normally through this process on some of
the swap execution challenges the difference between the SEC's
approach to and the notion that Chairman Gensler has of trying
to, let us get five quotes. I have got--I am not sure where
this should all play out, but I am anxious to see how we,
between the two entities, have that reconciliation and whether
at some point, you know, is this where we will--ultimately it
will be bumped up to an FSOC--recognize you have got different
markets, but at some point having some type of clarity and will
this ultimately end up at the FSOC, on swap execution
facilities.
Ms. Schapiro. Let me begin and then I will turn it over to
Gary. I think it should not be a surprise that we have some
different approaches with respect to specific rules. Some of
those are a result of our having different statutory
foundations and different traditions of how we regulate, but
also because there are differences in some of the products
based on their liquidity characteristics and how they trade,
and that really argues for, in some instances, a different
regulatory approach.
But I will say we are working together extremely closely.
We are still at the proposing stage for all of these rules. We
have sought cross comment. So if the CFTC took a different
approach, for example, SEFs, as they did, then we sought cross
comment. We asked questions about whether that was a better
approach or whether the SEC approach was better or was there an
entirely different way to go. We continue to review each
other's comment letters on our proposals, so we have a good
understanding, and we continue to meet with industry and other
interested parties to talk about what is the optimum approach
for fulfilling the statutory mandate to bring these products
under a regulatory regime, but to do it in a way that is cost
efficient and effective and does not have institutions in
particular subjected to different sets of regulations where
that would be silly and unnecessarily costly.
So we are very focused on all of these issues and our
staffs continue to do really fabulous work together to try to
narrow those differences, and I expect as we get to the stage
where we begin to adopt rules, you will see differences
continue to narrow.
Mr. Gensler. If I could just come back to the one core
piece, transparency is a key part of how markets work best. I
truly believe that open and competitive and transparent markets
are what helps the American public and lowers the systemic risk
of a future crisis.
In terms of our working relationship, it has been
remarkably close in a dozen or 15 joint roundtables and sharing
all the comment letters, as Chairman Schapiro said, and asking
cross comments.
More particularly, on the swap execution facility rule, one
of the challenges that we have is that the futures regime, the
regime for trading futures, was mandated in the 1930s that all
of it is on a central exchange. One hundred percent of it has
to be transparent and out there for the public to see. That is
a good thing, I think, for the American public. The securities
laws are a bit different. So there are gaps when we start
between securities and futures.
So as we come up with rules for swaps, like interest rate
swaps, we have to be mindful that they are not so far off from
the futures market that we start to undermine even our futures
markets that worked very well in this country, even through the
crisis. So we are focused not just on the gap between security-
based swaps and swaps, but we are also focused on are we
creating something that undermines the futures markets when we
do this rule writing for something called swap execution
facilities. So it is trying to marry that up.
Senator Warner. I just want to make sure that we do not
have an indirect result of, for those non-exchange-traded
swaps, that if we have too high a threshold in terms of
additional quotes, that we push it into some----
Mr. Gensler. Well, actually, Senator Warner, this only
relates to something that is cleared. It has to be cleared. It
has to be made available for trading. And third, it cannot be a
block. The way that both of us looked at this rule, it was this
is for the smaller trade. This is for the $5 or $10 million
interest rate swap, not $250 million or $500 million interest
rate swap----
Senator Warner. Right.
Mr. Gensler.----and it is not for the bilateral swaps. It
is not for those swaps done with corporate America as opposed
to--or the non-financial corporate America. This is just
financial entity to financial entity, a transaction that is
cleared, made available for trading, and is not a block. So it
is that.
Senator Warner. Two last questions, very briefly, and I
appreciate the Chairman's granting me this. One is, and I am
not--we clearly need to move as many of these transactions as
possible onto clearinghouses. I just raise a question, not a
critique, but we want to have an open access, to not just
create such a limited number of clearinghouses. I do have some
questions whether your $50 million capital base--I sure want to
make sure that $50 million capital base requirement for any
clearinghouse is true capital and we get that right. I think
trying to have robust competition among clearinghouses is good,
but we have got to make sure that they really have the ability
to give that counterparty assurance.
Mr. Gensler. This is important to ensure robust competition
amongst dealers. What has happened in this world right now, it
is a very closed, concentrated group of dealers.
Senator Warner. Right.
Mr. Gensler. In the futures world and in the securities
world, there are many members of clearinghouses, and that is
allowed. There are 60 to 70 members of the Chicago Mercantile
clearinghouse, for instance. In the swaps world, it is very
closed, and I think there were high and, I believe, arbitrary
limits, that you had to have $5 billion of capital and a $1
trillion swap book, and I think that was in part done to keep a
barrier to entry, frankly.
And I think Congress addressed that by saying that
clearinghouses have to have open access. We have put a proposal
rule out for comment to hear from the public. But it is also
for pension funds and asset managers to have more choices as to
who is going to be their clearing member, who is going to
represent them on the buy side. So I think this is actually a
rule that helps pension funds, the asset managers of America,
the financial entities who are not swap dealers, have access to
this clearing and not be constrained and have to go through a
handful of big Wall Street firms.
Senator Warner. And finally, just again, Secretary Wolin, I
do hope that, and it sounds like the SEC and the CFTC are
working well together, but at some point, it was at least this
member's hope that so that we would not have this patchwork and
siloed approach and duplicative sets of regulations, the FSOC
was hopefully that place that would help resolve these issues.
At some point there needs to be that umpire, and I hope
Secretary Geithner will realize, not just in this particular
case, but in a series of others, if you have any closing
comments. And again, I thank the indulgence of the Chair.
Mr. Wolin. Senator Warner, as you heard from the two
Chairmen, I think they are still early in their process and
will move forward. I think while respecting the independence of
the regulators, obviously, the FSOC does have a responsibility
to look at things that have systemically important implications
and to try to bring to bear consistency across the system where
those issues are systemically relevant. That is something we
have been focused on. There is also, of course, from Treasury's
perspective, a need to worry about the international dimensions
so that not only do we have consistency where we can here
within the United States, but also what is going on elsewhere
in the G-20 and beyond, again, for the sort of level playing
field kinds of implications that we think are important.
Chairman Johnson. Today's hearing has been very helpful and
given us all a better understanding of the important provisions
in the Dodd-Frank Act to promote financial stability in our
nation's economy going forward. We cannot afford to go back to
the old financial system that destroyed millions of jobs and
cost the economy trillions of dollars. The creation of the FSOC
and the other new tools given to our Federal regulators to
monitor systemic risk and to unwind failing financial
institutions address many of the weaknesses in the old system
and this will help the regulators better manage future crises.
Thanks again to my colleagues and our panelists for being
here today.
This hearing is adjourned.
[Whereupon, at 11:32 a.m., the hearing was adjourned.]
[Prepared statements and responses to written questions
supplied for the record follow:]
PREPARED STATEMENT OF SENATOR RICHARD C. SHELBY
Thank you, Mr. Chairman.
Today's hearing will examine the difficult task of defining and
regulating systemic risk. Dodd-Frank established the Financial
Stability Oversight Council and charged it with monitoring risk in the
U.S. financial system. The Council is also responsible for designating
firms for special, systemic risk regulation by the Federal Reserve.
Unfortunately, Dodd-Frank provides little guidance on exactly which
firms should be designated for systemic risk regulation and what that
regulation should involve. Instead, these decisions were left to the
discretion of the regulators through broad delegations of authority.
Accordingly, before regulators move forward, they will need to devise a
well-considered and transparent regulatory scheme that limits adverse
consequences.
So far, regulators appear to be divided on what the final rules
should look like and what entities should be designated as systemically
significant financial institutions. It is not surprising that
regulators are having difficulty determining how to regulate firms for
systemic risk. Many commentators have questioned whether it is even
possible to make such a determination with any degree of accuracy.
Indeed, Secretary Geithner recently told the Special Inspector General
for TARP: ``You won't be able to make a judgment about what's systemic
and what's not until you know the nature of the shock.''
Despite the divergent views of its members, the Council is moving
forward with its framework for designating nonbank financial entities
for extra regulatory scrutiny. Unfortunately, the Council has not yet
released for public comment the detailed rules on how they will
designate firms. Instead, the Council has issued proposed rules that
merely restate the broad statutory parameters. As a result, there is a
great deal of confusion about how the Council will proceed with its
rulemaking. This has created uncertainty in our markets as firms are
unsure which types of activities will cause them to be subject to
systemic risk regulation.
Accordingly, I want to hear more details from our witnesses about
how they envision systemic risk regulation will function in practice. I
am particularly interested in hearing how they will address the
potentially adverse consequences that could arise. Most importantly,
how will regulators ensure that selecting a handful of firms for
enhanced regulation will not increase moral hazard if markets believe
that regulators will never allow a designated firm to fail?
As we saw during the recent financial crisis, regulators may go to
great lengths to rescue a firm in order to cover up their mistakes. In
other words, does the Council's designation responsibility threaten to
undermine one of the Council's other responsibilities--the promotion of
market discipline by eliminating expectations that the Government will
bail out financial institutions if there is a crisis?
In addition, I am interested in hearing how regulators believe
designating firms will impact the competitiveness of our markets. In
the lead up to the financial crisis, our regulators failed on a grand
scale to monitor the activities of individual institutions. There is
good reason to doubt whether our regulators can effectively monitor the
risks posed system-wide.
Thus, the burden is on our regulators to demonstrate that they know
exactly what they are doing before they begin to implement this new
form of regulation. The last thing our fragile economy needs is a far-
reaching Government experiment that destabilizes the financial system
it is intended to protect.
Thank you.
______
PREPARED STATEMENT OF NEAL S. WOLIN
DEPUTY SECRETARY, DEPARTMENT OF THE TREASURY
May 12, 2011
Chairman Johnson, Ranking Member Shelby, and Members of the
Committee, I appreciate the opportunity to provide an update on the
Treasury Department's implementation of the Dodd-Frank Act.
Last year, the President signed into law the most sweeping
financial reforms since the Great Depression. Although our economy and
our financial markets have made important progress on the path toward
recovery, we cannot forget why we enacted this legislation.
In the fall of 2008, we witnessed a financial panic of a scale and
severity not seen in decades. The crisis was brought about by
fundamental failures in our financial system. The failures were many
and they were varied. The crisis erased trillions of dollars of wealth,
put Americans out of work across the country, and shook the foundations
of our entire economy. And the crisis exposed the fundamental flaws in
our financial system.
There was no alternative to reform. The system we had favored
short-term gains for individual firms over the stability and growth of
the economy as a whole. The system we had was weak and susceptible to
crisis. And the system we had left taxpayers to save it in times of
trouble.
We had no choice but to build a better, stronger system. That's why
we proposed, Congress passed, and the President signed into law a
sweeping set of reforms to do just that.
But enacting this law was just the beginning.
We are now undertaking the difficult and complex process of
implementation, and today I'd like to discuss some of our
accomplishments and our next steps as we approach the 10 month mark
since enactment.
Before I describe how we are implementing the Dodd-Frank Act, I
want to detail the broad principles guiding our efforts. First, we are
moving as quickly and as carefully as we can.
Wherever possible, we are quickly providing clarity to the public
and the markets. But the task we face cannot be achieved overnight. We
are writing rules in some of the most complex areas of finance;
consolidating authority that was previously spread across multiple
agencies; setting up new institutions for consumer protection and for
addressing systemic risks; and negotiating with countries around the
world. In getting this done, we are making sure to get it right.
After the Dodd-Frank Act was signed into law, many who criticized
the legislation said that it lacked details, and that the uncertainty
of the shape of final regulations made it difficult for businesses to
plan for the future. These critics called for clarity without delay.
Now many of these same critics suggest that the pace of
implementation, as prescribed by law, is moving too fast.
Treasury and regulators have consistently indicated--then and now--
that we would move quickly but carefully to implement the legislation,
that we would seek public input into the process, and that it was
critical to get the details right. Over the past 10 months, Treasury
and regulators have been doing just that--implementing the statute in a
careful, considered, and serious manner.
Second, we are conducting this process out in the open, bringing
full transparency to implementation activities.
As new rules have been proposed, we have consulted with a broad
range of groups and individuals. The American people are able to see
who is at the table. Comments have been made publicly available.
Treasury has made public the topics of meetings on Dodd-Frank
implementation and the names of the attendees.
In addition to providing transparency across Treasury's activities,
the studies and rulemaking processes conducted at Treasury or through
the Financial Stability Oversight Council (FSOC or Council) have
benefited from significant public outreach and comment, often through
both Advanced Notice of Proposed Rulemaking and Notice of Proposed
Rulemaking. This process allows interested parties the opportunity to
provide input, as well as understand the evolution of rules.
The Office of Financial Research (OFR), Federal Insurance Office
(FIO) and Consumer Financial Protection Bureau (CFPB) have all provided
transparency and sought public input in their efforts to implement
Dodd-Frank reforms.
Third, wherever possible, we are seeking to streamline and simplify
Government regulation.
Over the years, our financial system has accumulated layers upon
layers of rules, which can be overwhelming. That is why alongside our
efforts to strengthen and improve protections through the system, we
seek to avoid duplication and to eliminate rules that do not work. For
example, Dodd-Frank exempts small companies from complying with certain
internal control rules of Sarbanes-Oxley.
The Dodd-Frank Act recognizes the need to update and rationalize
the patchwork regulatory framework that was built over decades.
Consolidation of organizational structures and oversight
responsibilities are a critical part of the statute's reforms.
In addition, the statute requires many joint rulemakings, and even
where rules are not required to be issued jointly, agencies must often
coordinate to adopt comparable rules for functionally or economically
similar products or entities. Through this process we seek to avoid
overlapping and inconsistent rules.
These efforts build on a core priority of President Obama. In
January, the President issued an Executive Order relating to
streamlining and simplifying regulations, seeking to ensure cost-
effective, evidence-based regulations that are compatible with economic
growth, job creation, and competitiveness. Among other things, the
Order requires that agencies: consider costs and benefits and choose
the least burdensome path (to the extent consistent with law);
encourage public participation in rulemaking; attempt to coordinate,
simplify, and harmonize regulations to reduce costs and promote
certainty; and conduct retrospective analyses of rules, on a periodic
basis, to identify rules that ``may be outmoded, ineffective,
insufficient, or excessively burdensome.''
We are following these priorities as we implement Dodd-Frank.
Indeed, we believe that the enactment of Dodd-Frank provides a historic
moment for all of the affected agencies to pause and take stock: an
opportunity to ensure that future regulation is consistent with these
priorities, and that rules currently on the books are serving their
intended purposes. Properly applied, these priorities and guidelines
can help strike the right regulatory balance: ensuring that regulations
protect our financial system and improve the performance of our
economy, without imposing unreasonable costs on society.
Fourth, we are creating a more coordinated regulatory process.
Dodd-Frank requires regulators, more than ever before, to work
together to close gaps in regulation and to prevent breakdowns in
coordination--this is a central change brought about by the law. Beyond
joint rules and consultation required on specific rulemakings, the
statute requires working together where issues cut across multiple
agencies, to make the pieces of reform fit together in a sensible,
coherent way.
While our financial regulatory system is built on the independence
of regulators--and given the importance of Dodd-Frank implementation,
independent regulators will have different views on complicated
issues--working through differences is an important part of getting the
substance right.
The Dodd-Frank Act preserves agency independence, while providing a
new forum for collaboration and consultation among regulators. The
Financial Stability Oversight Council, which is a key component of
Dodd-Frank, has a mandate to coordinate across agencies and instill
joint accountability for the strength of the financial system.
Already, we have worked through the FSOC to develop an integrated
roadmap for implementation, to coordinate an unprecedented six-agency
proposal on risk retention, and to develop unanimous support for
recommendations on implementing the Volcker Rule. As Chair of the FSOC,
the Secretary of the Treasury will continue to make it a top priority
that the work of the regulators is well-coordinated.
Fifth, we are working to ensure a level playing field.
We are working hard at the international level to make sure that
others put in place similar frameworks on the key issues where
international consistency is essential--such as OTC derivatives, and
financial institutions' liquidity, leverage, and capital.
The details of these rules governing complex markets and
institutions are critical and when different jurisdictions implement
commonly agreed-to international principles, disagreements may arise.
That is why in addition to dialogue in international fora like the G-20
and the Financial Stability Board, we work every day with our foreign
counterparts, especially in Europe, through our financial market and
regulatory dialogue.
But as we work in the international sphere to promote a level
playing field, we must not fail to implement our reforms at home. U.S.
leadership on reform is essential to making sure that a level playing
field is in place. Ultimately, if we fail to do what is necessary to
reform and protect our system, we put at risk its fundamental strength
and resilience.
Detailed rules of financial regulation will always vary among
sovereign nations. What's important, what we have made good progress
on--and what we are committed to--is closing regulatory gaps, ending
opportunities for geographic arbitrage, and preventing a global race to
the bottom.
Sixth, we are working to protect the freedom for innovation that is
absolutely necessary for growth.
Before the crisis, our financial system allowed too much room for
abuse and excessive risk. But as we put in place rules to correct those
mistakes, we have to achieve a careful balance and safeguard the
freedom for competition and innovation that is essential for growth.
For example, as enhanced capital requirements are introduced, we
will work to achieve a balanced regime that strengthens firms so they
can withstand stress, but that also allows U.S. firms to compete
effectively on a global basis.
Moreover, new provisions in Dodd-Frank will increase transparency
and reduce risks in the derivatives markets. These electronic trading
and central clearing provisions will tighten spreads, reduce costs, and
increase understanding of risks for market participants. These new
transparent structures will promotes efficient markets, capital
formation, and growth in the broader economy, while reducing the risk
and potential costs of another destabilizing financial crisis.
Implementation of Dodd-Frank will result in a strong, stable
financial system, which is the foundation needed to foster competition,
innovation and economic growth.
Seventh, we are keeping Congress fully informed of our progress on
a regular basis.
Guided by these principles, we have made significant progress since
Dodd-Frank was enacted almost 10 months ago. I'd like to update you on
a few of the institutions at the heart of this legislation--the
Financial Stability Oversight Council, the Office of Financial
Research, the Federal Insurance Office and the Consumer Financial
Protection Bureau.
FINANCIAL STABILITY OVERSIGHT COUNCIL
The Dodd-Frank Act created the Financial Stability Oversight
Council to coordinate across agencies and instill joint accountability
for the stability of the financial system. The Council is mandated to
identify and monitor risks to U.S. financial stability, respond to any
emerging threats in the system and promote market discipline. The Act
also provides the Council with a leading role in several important
regulatory decisions, including which nonbank financial institutions
and financial market utilities will be designated for heightened
prudential standards.
The Council has made significant progress in the short time since
the Dodd-Frank Act was signed into law. Since enactment, the Council
has: (1) built its basic organizational framework; (2) laid the
groundwork for the designation of nonbank financial companies and
financial market utilities; (3) initiated monitoring for potential
risks to U.S. financial stability; (4) carried out the explicit
statutory requirements of the Council, including the completion of
several studies; and (5) served as a forum for discussion and
coordination among the agencies implementing Dodd-Frank.
COUNCIL STRUCTURE AND OPERATIONS
We have built a structure for the Council that is designed to
promote accountability and action. Every 2 weeks, a Deputies Committee
comprised of senior officials from each of the member agencies meets to
set the Council's agenda, and to direct the work of the Council's
Systemic Risk Committee and five functional committees. The functional
committees are organized around the Council's ongoing statutory
responsibilities: designations of nonbank financial companies,
designations of financial market utilities, heightened prudential
standards, orderly liquidation and resolution plans, and data.
In the 10 months since Dodd-Frank was enacted, the Council's
principals have met four times and plan to meet again later this
month--significantly more often than the statutorily required quarterly
meetings.
At each meeting to date, the Council has held a public session.
This exemplifies a commitment to conduct its work in as open and
transparent a manner as practicable given the confidential supervisory
and sensitive information that is at the heart of the Council's work.
DESIGNATIONS
For the first time, Dodd-Frank requires consolidated supervision of
and heightened prudential standards for the largest, most
interconnected nonbank financial companies that could pose a threat to
the financial system. The statute also authorizes heightened standards
be applied to designated financial market utilities and payment,
clearing and settlement activities.
The Council is engaging in two parallel rulemakings to establish a
process and define criteria for these designations that are robust and
transparent. While the statute carefully outlines the considerations
and process requirements for making these designations, the Council is
conducting rulemakings to ensure transparency and to obtain input from
all interested parties.
For its nonbank designations work, the Council issued an Advanced
Notice of Proposed Rulemaking or ``ANPR'' in October 2010 and a Notice
of Proposed Rulemaking or ``NPRM'' in January 2011 providing guidance
on the statutorily mandated criteria and defining the procedures that
the Council will follow in considering the designation of nonbank
financial companies. For designations of financial market utilities,
public comments from last November's ANPR informed an NPRM released in
March. The comment period for that NPRM is 60 days and closes on May
27. The Council's member agencies continue to work in close
collaboration, having received significant input from market
participants, non-profits, academics, and members of the public to
develop an analytical framework for designations that will provide a
consistent approach and will incorporate the need for both quantitative
and qualitative judgments. We plan to provide additional guidance
regarding the Council's approach to designation and we will seek public
comment on it.
It is important to understand that the Council needs to retain
flexibility to exercise judgment as it considers both quantifiable
metrics and the unique risks that a particular firm may present to the
financial system. Moreover, flexibility is needed because financial
markets are dynamic and the designation process must take into account
changes in firms, markets and risks. That is one of the key reasons
that the statute mandates an annual reevaluation of any designation
made by the Council.
The Council's commitment to a robust designations process goes
beyond transparency during the rulemaking process. Every designation
decision will be firm-specific and is subject to judicial review.
Moreover, even before the Council votes on a proposed designation, a
company under consideration will have the opportunity to submit written
materials to the Council on whether, in the company's view, it meets
the standard for designation. Only after Council members have reviewed
that information will they vote on a proposed designation, which
requires the support of two-thirds of the Council (including the
affirmative vote of the Chair) and requires the Council to provide the
company with a written explanation of the basis of the proposed
designation to the firm. If challenged, the proposed designation is
subject to review through a formal hearing process and a two-thirds
final vote. Upon the final vote approving the designation, the Council
must then submit a report to Congress detailing its final decision.
MONITORING THREATS TO FINANCIAL STABILITY
Monitoring threats to financial stability is the cornerstone of the
Council's responsibilities. This macroprudential role demands
coordination, collaboration and information sharing among each of the
members of the Council. We are working together to bring the best
information to bear, while protecting the security and confidentiality
of sensitive information.
The Council has established a committee structure to support its
monitoring function. The structure is intended to balance the need for
an interdisciplinary and cross-cutting approach with the need to
leverage existing expertise and experience, and is the locus of
accountability for systemic risk monitoring.
Through this structure, the FSOC focuses on identifying and
analyzing cross-cutting risks that may affect financial institutions
and financial markets in the medium and longer term. With respect to
financial institutions, the FSOC focuses on structural issues such as
trends in leverage or funding structure, new products, or exposures to
particular risks. With respect to financial markets, the FSOC focuses
on issues such as trends in volatility or liquidity, market structure,
or asset valuations.
In addition, the FSOC serves as a forum for agencies to discuss
emerging issues of immediate importance as well as share information
about issues that arise in the course of their supervisory and
oversight work that could impact financial stability.
The Dodd-Frank Act provides for a public report to Congress
detailing this monitoring in the form of an annual report on the
activities of the Council and the health of the financial system. As
stated in the statute this report will: outline the activities of the
Council, including any designations or recommendations made with
respect to activities that could threaten financial stability; detail
significant financial market and regulatory developments, including
insurance and accounting regulations and standards; and, describe
potential emerging threats to the financial stability of the United
States. The statute also requires that the report provide
recommendations to enhance the integrity, efficiency, competitiveness,
and stability of United States financial markets; promote market
discipline; and maintain investor confidence.
Staff at each of the member agencies is hard at work preparing the
Council's first annual report.
STUDIES
On January 18, the Council released a study and recommendations on
the implementation of the Dodd-Frank Act's ``Volcker Rule.'' The
Council sought input from the public in advance of the study on issues
associated with the statutory required considerations and received more
than 8,000 comments. The study recommends principles for implementing
the Volcker Rule and suggests a comprehensive framework for identifying
activities prohibited by the Rule. That framework includes an internal
compliance regime, quantitative analysis and reporting, and supervisory
review.
Also, at its January meeting, the Council approved a study of the
effects of the Dodd-Frank Act's limits on the concentration of large
companies on financial stability and released the study's
recommendations for public comment. The Council's study found that the
concentration limit will reduce moral hazard, increase financial
stability, and improve efficiency and competition within the U.S.
financial system. The study also made largely technical recommendations
to mitigate practical difficulties likely to arise in the
administration and enforcement of the concentration limit, without
undermining its effectiveness in limiting excessive concentration among
financial companies. The Council received six comments and is currently
reviewing those comments to determine whether any of the
recommendations should be modified.
The Council continues to have specific responsibilities to study
key issues outlined in Dodd-Frank. For instance, the Council must
complete a study regarding the treatment of fully secured creditors in
the context of the Act's orderly liquidation authority by July and a
study regarding contingent capital instruments by July 2012.
INTERAGENCY REGULATORY COORDINATION
The Council also has served as a forum for discussion and
coordination among the agencies implementing the Dodd-Frank Act. For
the Council's first meeting in October 2010, the staff of member
agencies developed a detailed, public road map for implementation of
the legislation. This integrated roadmap outlined a coordinated
timeline of goals, both for the Council and its independent member
agencies, to fully implement the Dodd-Frank Act.
As Chair of the Council, the Treasury Secretary is required to
coordinate several major rulemakings under the Dodd-Frank Act. For
example, to facilitate the joint rulemaking on credit risk retention,
Treasury staff held frequent interagency discussions beginning shortly
after the Dodd-Frank Act was passed to develop the rule text and
preamble. This joint rulemaking required reaching consensus among six
rulemaking agencies. The proposed rule, released on March 31,
demonstrates our ability to promote effective collaboration, and it is
a significant step toward strengthening securitization markets.
Treasury staff is currently engaged in a similar process with the staff
of member agencies tasked with drafting the Volcker Rule.
The Council's regulatory coordination role is greater than the
specific statutory instances where coordination is required. Deputies
meetings have served as a forum for sharing information about
significant regulatory developments, particularly those that impact the
work of more than one member agency and relate to financial stability.
For example, the Federal Reserve recently briefed deputies on the
results of its Comprehensive Capital Analysis and Review. Treasury has
provided updates on housing finance reform.
OFFICE OF FINANCIAL RESEARCH
In order to constrain systemic risk effectively, the Council and
its members must have the ability to effectively monitor it.
The Dodd-Frank Act established the Office of Financial Research
(OFR) to improve the quality of financial data available to
policymakers and facilitate more robust and sophisticated analysis of
the financial system.
In the lead-up to the financial crisis, financial reporting failed
to adapt to a rapidly evolving financial system. Supervisors and market
participants lacked data about the increasing leverage in the rapidly
growing shadow banking system. Policymakers and investors responded to
the crisis with inadequate information about the interconnectedness of
firms and associated risks to the financial system.
The Dodd-Frank Act established two complementary centers within the
OFR--one focused on data, and one focused on research and analysis--to
help ensure that, going forward, regulators' understanding of the risks
within the financial system can keep pace with innovation and with
market developments.
The OFR will standardize and provide data and analytical tools for
OFR researchers, the FSOC, its members, and the public. In collecting
information, the OFR will minimize the reporting burden on industry by,
whenever possible, relying on data already in the regulatory system,
and by assisting Council members in standardizing information collected
by those members. The OFR is already working to accomplish both goals
and its staff is working closely with the regulatory community to
catalog data already collected to help ensure duplication will not
occur. And the OFR is collaborating with the SEC and CFTC to
standardize reporting of parties to swap transactions.
More broadly, the OFR is exploring ways in which it can help make
Government more efficient. For example, the OFR is investigating how it
might act as a central warehouse of data for the regulatory community
and other ways in which it could facilitate data sharing. The OFR has
also been soliciting input from FSOC member agencies to find ways to
support their efforts.
The OFR's Research and Analysis Center, will measure and analyze
factors affecting financial stability and help to develop policies that
promote it. The OFR will also report to the Congress and the public on
its analysis of significant financial market developments, potential
emerging threats to stability and policy responses. The combination of
better, more granular data, and new analytic capabilities focused on
systemic threats can help all market participants--industry as well as
regulators--better understand risks within the financial system.
Attracting and hiring top quality senior leadership is critical to
OFR and in guiding its mission.
The search for an OFR Director is ongoing and a high priority for
the Administration. The Administration is evaluating candidates based
on a combination of strong analytical ability, experience in financial
services, management experience, and communication skills. In the
meantime, key personnel have been hired.
Richard Berner recently joined the Treasury Department as Counselor
to the Secretary with the responsibility to oversee the implementation
of the Office of Financial Research. Mr. Berner is a well-respected
economist who will bring judgment and leadership to the OFR
implementation team, along with critical risk management and financial
industry expertise.
The OFR also is filling senior personnel roles including its Chief
Operating Officer, Chief Data Officer and Chief Business Officer. The
OFR is hiring top-tier talent with deep industry experience in data
management, technology, and risk management. Industry experience will
help ensure that the organization will collect data in a systematic,
structured, and non-duplicative way, with clear benefits to industry
and regulators.
The OFR is also making progress in establishing its research team
and network, which will include academics from across the country and
in a variety of disciplines. The interdisciplinary research team will
add significant capacity to the FSOC's ability to measure and analyze
the many dimensions of financial stability.
We project that by the end of September, the OFR will have over 60
full-time employees. Treasury is committed to providing this
implementation team with needed support and guidance, and I, along with
other senior Treasury officials, are meeting with the team weekly to
make sure priorities are identified, progress is measured and that the
stand-up of the OFR is well executed.
As the OFR continues to recruit highly qualified individuals to
lead and support its work, current staff is already working with
regulators and industry to standardize financial reporting. This will
improve the ability of policymakers and private industry to aggregate
information-critical to risk management. It will also facilitate more
efficient processing by private firms and markets.
The OFR's first step in this direction has been to promote the
establishment of a global standard for identifying parties to financial
transactions: a legal entity identifiers (LEI). During the financial
crisis, a LEI could have given policymakers and private institutions a
clearer understanding of the interconnections among financial
institutions.
The LEI initiative is moving forward quickly. The OFR is working
closely with U.S. and foreign financial regulators to define consistent
requirements, and is using established international forums, such as
the Financial Stability Board, to engage in multilateral discussions.
The OFR already published a framework in its November Policy Statement,
consistent with the requirements set forth by the SEC and CFTC in their
Notices of Proposed Rulemakings for swap transaction reporting.
Meanwhile, various financial trade associations and their members
formed a global coalition to produce a common set of requirements for
such a standard. Last week they published a white paper that lays out
draft requirements, and they are seeking input from public and private
entities. The International Organization for Standardization--which has
deep expertise in this area and representation from industry and
regulators--is moving quickly to define a new standard that it intends
to be consistent with public and private requirements.
In addition to these efforts, OFR staff is supporting the work of
the Financial Stability Oversight Council. This includes data and
analysis in support of the FSOC's evaluation of nonbank financial
companies for designation and its report on systemic risk.
The OFR is also establishing forums and networks to allow experts
within and outside the regulatory system to contribute to the Council's
mission. This year, the OFR will host along with the National Science
Foundation, a conference that brings together top academics in finance,
economics, and computer science, and members of industry and the
regulatory community on systemic risk monitoring and potential
responses. OFR staff also will be participating in the academic
community through its publications.
CONSUMER FINANCIAL PROTECTION BUREAU
While the Council and the Office of Financial Research are designed
to help us monitor and address risk in the broader financial system,
the Consumer Financial Protection Bureau was created to address a
specific gap in our regulatory structure--the need for a single agency
dedicated to consumer protection.
The CFPB, which will assume existing authorities of seven Federal
agencies on July 21, 2011, will work to make sure that consumers have
the information they need to understand the terms of their agreements
with financial companies. It will also work to make regulations and
guidance as clear and streamlined as possible in order to ease the
burden on providers of consumer financial products and services.
The CFPB will consolidate existing Federal rulemaking authorities
with respect to consumer financial products and services, have
enforcement and supervision authority for depository institutions with
over $10 billion in assets and their affiliates, as well as supervise
the consumer financial services activities of many non-bank financial
firms that sell consumer financial services.
The Act charges the Secretary of Treasury with standing up the CFPB
until a director is appointed. Under his leadership we set up an
implementation team with a clear mandate shortly after enactment.
Elizabeth Warren, as Special Advisor to the Secretary, is leading
Treasury's effort to build the CFPB. The CFPB implementation team, now
consisting of over 200 staff members, is focused on setting up key
functions of the bureau such as bank supervision, fair lending and
enforcement programs and research, markets, and regulation teams. In
order to do this, CFPB is making major investments in infrastructure
and human capital. The CFPB implementation team has reached agreement
with the six agencies transferring staff with regards to a process for
transferring staff to CFPB that will minimize disruption to existing
agencies while allowing CFPB to gain from existing expertise.
The CFPB implementation team has made a concentrated effort to
reach out to the public, industry, and other concerned groups during
the initial stand up of the CFPB. As an example of this extensive
outreach, Elizabeth Warren has made it a priority to meet with
community bankers and credit unions from all 50 States. She has also
met with dozens of CEOs and other executives of the largest financial
institutions and consumer advocates. The CFPB's office of servicemember
affairs, led by Holly Petraeus, is actively working with the Department
of Defense to help inform and protect servicemembers from financial
tricks and traps.
The CFPB is well on track to meet the statutory deadlines for
reports mandated by Dodd-Frank, and the CFPB implementation team is
planning and preparing for the promulgation of certain rules mandated
by the Dodd-Frank Act. For example, the CFPB implementation team is
actively working to complete initial steps toward the consolidation of
the TILA/RESPA mortgage disclosure forms. This consolidation will allow
us to reduce the regulatory burden on industry and provide consumers
with more of the information they need to make the right decision.
There has been significant progress toward standing up core
elements of the CFPB by the designated transfer date of July 21, 2011.
In addition to its bank supervision program, the CFPB will stand up
components of its consumer response system and be prepared to take over
rule writing projects that will transfer over to the bureau.
And the agency will be accountable in executing these tasks. Dodd-
Frank includes several provisions to ensure the agency's
accountability.
The CFPB must submit annual reports to Congress, the Director must
testify multiple times each year on the agency's budget and activities,
and the GAO audits the CFPB's expenditures annually. Furthermore, the
CFPB is currently subject to the oversight of the inspectors general of
Treasury and the Federal Reserve. And, most importantly, there is
direct oversight of the agency's rulemaking: the FSOC can review and
even reject the CFPB's rules, and, as with any other regulator,
Congress has the ability to overturn any of the CFPB's rules.
The goal of the CFPB is to make markets for consumer financial
products and services work for Americans--whether they are applying for
a mortgage, choosing among credit cards, or using any number of other
consumer financial products. The CFPB implementation team is on track
to standing up an agency capable of accomplishing this goal.
FEDERAL INSURANCE OFFICE
In addition to providing for new regulatory protections and
oversight for consumers, the Dodd-Frank Act enhances the Federal
Government's ability to monitor the insurance sector and coordinate and
develop Federal policy on major domestic and international insurance
issues. The crisis highlighted the lack of expertise within our Federal
Government regarding the insurance industry. In response, the Act
establishes the Federal Insurance Office (the ``FIO''), which will
provide the U.S. Government--for the first time--dedicated expertise
regarding the insurance industry.
The FIO will monitor for problems or gaps in insurance regulation
that can contribute to a systemic crisis in the insurance industry or
the financial system; gather data and information on the industry and
insurers; and coordinate Federal policy in the insurance sector.
The Act does not provide the FIO with general supervisory or
regulatory authority over the business of insurance. The States remain
the functional regulators. Through the FIO, however, the Federal
Government will work toward modernizing and improving our system of
insurance regulation.
Secretary Geithner announced at the March FSOC meeting that Michael
McRaith has been selected to become the Director of the FIO. Mr.
McRaith is currently the Director of the Illinois Department of
Insurance, and will bring significant experience and judgment to the
FIO.
Treasury also recently announced that the Department will establish
a Federal Advisory Committee on Insurance. The objective of the
Committee is to present advice and recommendations to the FIO to assist
the Office in carrying out its duties and authorities. The Advisory
Committee will reserve half of its membership for the State insurance
commissioners so that the FIO will benefit from the knowledge and
regulatory experience of our functional regulators. The remaining
members will represent a diverse set of expert perspectives from the
various sectors of the insurance industry (life, property and casualty,
reinsurance, agents and brokers), as well as academics, consumer
advocates, or experts in the issues facing underserved insurance
communities and consumers.
The FIO has served an important consultative role in advising on
several Dodd-Frank studies, rule writing processes and ongoing
responsibilities. These include providing expert advice on the Volcker
Rule study and rule writing, Orderly Liquidation Authority rule writing
and participating in the FSOC insurance working group.
The Federal Insurance Office has become a provision member of the
International Association of Insurance Supervisors (IAIS), where it
will represent the United States, and it is expected to be voted-in as
a full member in the fall. The FIO is also leading the U.S. delegation
for the insurance and pensions committee of the Organization for
Economic Co-operation and Development.
The Secretary of the Treasury, supported by the FIO, together with
the United States Trade Representative, is now empowered to negotiate
certain international agreements regarding prudential insurance
measures. We anticipate that the FIO will be actively involved, for
example, in working with the representatives of other countries on
reinsurance collateral and U.S. equivalence under Solvency II.
CONCLUSION
The Dodd-Frank Act builds a stronger financial system by addressing
major gaps and weaknesses in regulation. It puts in place buffers and
safeguards to reduce the chance that another generation will go through
a crisis of similar magnitude. It protects taxpayers from bailouts. It
brings fairness and transparency to consumers of financial services.
And it lays the foundation for a financial system that is pro-
investment and pro-growth. The Act and its successful implementation
will help ensure that our financial system becomes safer, stronger and,
just as in the past century, the world leader.
Thank you very much.
______
PREPARED STATEMENT OF BEN S. BERNANKE
CHAIRMAN, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
May 12, 2011
Chairman Johnson, Ranking Member Shelby, and other Members of the
Committee, thank you for the opportunity to testify on the Federal
Reserve Board's role in monitoring systemic risk and promoting
financial stability, both as a member of the Financial Stability
Oversight Council (FSOC) and under our own authority.
Financial Stability Oversight Council
The Dodd-Frank Wall Street Reform and Consumer Protection Act
(Dodd-Frank Act) created the FSOC to identify and mitigate threats to
the financial stability of the United States. During its existence thus
far, the FSOC has promoted interagency collaboration and established
the organizational structure and processes necessary to execute its
duties.\1\ The FSOC and its member agencies also have completed studies
on limits on proprietary trading and investments in hedge funds and
private equity funds by banking firms (the Volcker rule), on financial
sector concentration limits, on the economic effects of risk retention,
and on the economic consequences of systemic risk regulation. The FSOC
is currently seeking public comments on proposed rules that would
establish a framework for identifying nonbank financial firms and
financial market utilities that could pose a threat to financial
stability and that therefore should be designated for more stringent
oversight. Importantly, the FSOC has begun systematically monitoring
risks to financial stability and is preparing its inaugural annual
report.
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\1\ The FSOC's internal structure consists of a Deputies
Committee--composed of personnel from all of the voting and nonvoting
members--and six other standing committees, each with its own specific
duties. The Deputies Committee, under the direction of the FSOC
members, coordinates the work of the six committees and aims to ensure
that the FSOC fulfills its mission in an effective and timely manner.
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Additional Financial Stability-Related Reforms at the Federal Reserve
In addition to its role on the FSOC, the Federal Reserve has other
significant financial stability responsibilities under the Dodd-Frank
Act, including supervisory jurisdiction over thrift holding companies
and nonbank financial firms that are designated as systemically
important by the council. The act also requires the Federal Reserve
(and other financial regulatory agencies) to take a macroprudential
approach to supervision and regulation; that is, in supervising
financial institutions and critical infrastructures, we are expected to
consider the risks to overall financial stability in addition to the
safety and soundness of individual firms.
A major thrust of the Dodd-Frank Act is addressing the ``too-big-
to-fail'' problem and mitigating the threat to financial stability
posed by systemically important financial firms. As required by the
act, the Federal Reserve is developing more-stringent prudential
standards for large banking organizations and nonbank financial firms
designated by the FSOC. These standards will include enhanced risk-
based capital and leverage requirements, liquidity requirements, and
single-counterparty credit limits. The standards will also require
systemically important financial firms to adopt so-called living wills
that will spell out how they can be resolved in an orderly manner
during times of financial distress. The act also directs the Federal
Reserve to conduct annual stress tests of large banking firms and
designated nonbank financial firms and to publish a summary of the
results. To meet the January 2012 implementation deadline for these
enhanced standards, we anticipate putting out a package of proposed
rules for comment this summer. Our goal is to produce a well-integrated
set of rules that meaningfully reduces the probability of failure of
our largest, most complex financial firms, and that minimizes the
losses to the financial system and the economy if such a firm should
fail.
The Federal Reserve is working with other U.S. regulatory agencies
to implement Dodd-Frank reforms in additional areas, including the
development of risk retention requirements for securitization sponsors,
margin requirements for noncleared over-the-counter derivatives,
incentive compensation rules, and risk-management standards for central
counterparties and other financial market utilities.
The Federal Reserve has made significant organizational changes to
better carry out its responsibilities. Even before the enactment of the
Dodd-Frank Act, we were strengthening our supervision of the largest,
most complex financial firms. We created a centralized
multidisciplinary body called the Large Institution Supervision
Coordinating Committee to oversee the supervision of these firms. This
committee uses horizontal, or cross-firm, evaluations to monitor
interconnectedness and common practices among firms that could lead to
greater systemic risk. It also uses additional and improved
quantitative methods for evaluating the performance of firms and the
risks they might pose. And it more efficiently employs the broad range
of skills of the Federal Reserve staff to supplement supervision. We
have established a similar body to help us effectively carry out our
responsibilities regarding the oversight of systemically important
financial market utilities.
More recently, we have also created an Office of Financial
Stability Policy and Research at the Federal Reserve Board. This office
coordinates our efforts to identify and analyze potential risks to the
broader financial system and the economy. It also helps evaluate
policies to promote financial stability and serves as the Board's
liaison to the FSOC.
International Regulatory Coordination
As a complement to those efforts under Dodd-Frank, the Federal
Reserve has been working for some time with other regulatory agencies
and central banks around the world to design and implement a stronger
set of prudential requirements for internationally active banking
firms. These efforts resulted in the agreements reached in the fall of
2010 on the major elements of the new Basel III prudential framework
for globally active banks. The requirements under Basel III that such
banks hold more and better-quality capital and more-robust liquidity
buffers should make the financial system more stable and reduce the
likelihood of future financial crises. We are working with the other
U.S. banking agencies to incorporate the Basel III agreements into U.S.
regulations.
More remains to be done at the international level to strengthen
the global financial system. Key tasks ahead for the Basel Committee
and the Financial Stability Board include determining how to further
increase the loss-absorbing capacity of systemically important banking
firms and strengthening resolution regimes to minimize adverse systemic
effects from the failure of large, complex banks. As we work with our
international counterparts, we are striving to keep international
regulatory standards as consistent as possible, to ensure that
multinational firms are adequately supervised, and to maintain a level
international playing field.
Thank you. I would be pleased to take your questions.
______
PREPARED STATEMENT OF SHEILA C. BAIR
CHAIRMAN, FEDERAL DEPOSIT INSURANCE CORPORATION
May 12, 2011
Chairman Johnson, Ranking Member Shelby, and Members of the
Committee, thank you for the opportunity to testify today on behalf of
the Federal Deposit Insurance Corporation (FDIC) on issues related to
monitoring systemic risk and promoting the stability of our financial
system.
The recent financial crisis has highlighted the critical importance
of financial stability to the functioning of our real economy. In all,
over eight and a half million jobs were lost in the recession and its
immediate aftermath, and over half of these were lost in the 6-month
period following the height of the crisis in September 2008. While the
economy is now in its eighth consecutive quarter of expansion, to date
only about 20 percent of the jobs lost in the recession have been
regained, and the number of private sector payroll jobs stands at the
same level it did 12 years ago, in the spring of 1999.
A central cause of this crisis--as has been the case with most
previous crises--was excessive debt and leverage in our financial
system. At the height of the crisis, the large intermediaries that make
up the core of our financial system proved to have too little capital
to maintain market confidence in their solvency. The need for stronger
capitalization of our financial system is being addressed in part by
strengthening bank capital requirements through the Basel III capital
protocols and implementation of the Collins amendment. We also learned
in the crisis that leverage can be masked through off-balance-sheet
positions, implicit guarantees, securitization structures, and
derivatives positions. The crisis showed that the problem with leverage
is really larger than the bank balance sheet itself. Excessive leverage
is a general condition of our financial system that is subsidized by
the tax code and lobbied for by financial institutions and borrower
constituencies alike, to their short-term benefit and to the long-term
cost of our economy.
The ability of many large financial institutions to operate with
relatively thin levels of capitalization was enabled by the market's
perception that they enjoyed implicit Government backing; in short,
they were ``too big to fail.'' This market perception was ratified in
the heat of the crisis when policymakers were faced with the dilemma of
providing this assistance or seeing our economy endure an even more
catastrophic decline.
As a consequence, the Dodd-Frank Act mandates higher prudential
standards for systemic financial entities. Importantly, the Act
authorizes the creation of a new resolution framework for systemically
important financial institutions (SIFIs) designed to ensure that no
institution is too big or too interconnected to fail, thereby
subjecting every financial institution to the discipline of the
marketplace. My testimony will summarize the progress to date in
implementing the elements of this framework and will highlight specific
areas of importance to their ultimate effectiveness.
In addition to discussing FDIC efforts to implement provisions of
the Dodd-Frank Act that address key drivers of the recent financial
crisis, I will also discuss future risks to our system which I believe
must be proactively addressed by the Government. These include deeply
flawed servicing practices which have yet to be corrected and the
resulting overhang of foreclosures and looming litigation exposure
which is further depressing home prices. Also of concern is interest
rate risk and the impact sudden, volatile spikes in interest costs
could have on banks and borrowers who rely upon them for credit.
Excessive Reliance on Debt and Financial Leverage
A healthy system of credit intermediation, where the surplus of
savings is channeled toward its highest and best use by household and
business borrowers, is critically important to the modern economy.
Without access to credit, households cannot effectively smooth their
lifetime consumption and businesses cannot undertake the capital
investments necessary for economic growth. But a starting point for
understanding the causes of the crisis and the changes that need to be
made in our economic policies is recognition that the U.S. economy has
long depended too much on debt and financial leverage to finance all
types of economic activity.
In principle, debt and equity are substitute forms of financing for
any type of economic activity. However, owing to the inherently riskier
distribution of investment returns facing equity holders, equity is
generally seen as a higher-cost form of financing. This perceived cost
advantage for debt financing is further enhanced by the standard tax
treatment of payments to debt holders, which are generally tax
deductible, and equity holders, which are not. In light of these
considerations, there is a tendency in good times for practically every
economic constituency--from mortgage borrowers, to large corporations,
to startup companies, to the financial institutions that lend to all of
them--to seek higher leverage in pursuit of lower funding costs and
higher rates of return on capital.
What is frequently lost when calculating the cost of debt financing
are the external costs that are incurred when problems arise and
borrowers cannot service the debt. As we have witnessed so many times
in this crisis, the lack of a meaningful commitment of equity capital
or ``skin in the game'' feeds subpar underwriting and imprudent
borrower behavior that ultimately results in defaults, workouts,
repossessions, or liquidations of repossessed assets in order to
satisfy the claims of debt holders. These severe adjustments, which
tend to occur with high frequency in economic downturns, impose very
high costs on economic growth and our financial system. For example,
foreclosures dislodge families from their homes, create high legal
costs, and, when experienced en masse, tend to lower the values of
nearby properties. Commercial bankruptcies impose losses on lenders and
tend to remove assets from operating businesses and place them on the
open market at liquidation prices. When financial institutions cannot
meet their obligations, the result can be, at best, an interruption in
their ability to serve as intermediary and, at worst, destabilizing
runs that may extend across the financial system.
As demonstrated in the recent financial crisis, the social costs of
debt financing are significantly higher than the private costs. When a
household, business or financial company calculates the cost of
financing its spending, it can no doubt lower its financing costs by
substituting debt for equity--particularly when interest costs on debt
are tax deductible. In good economic times, when few borrowers are
forced to default on their obligations, more economic activity can take
place at a lower cost of capital when debt is substituted for equity.
However, the built-in private incentives for debt finance have long
been observed to result in periods of excess leverage that contribute
to financial crisis.
As Carmen Reinhart and Kenneth Rogoff describe in their 2009 book
This Time Is Different:
If there is one common theme to the vast range of crises we
consider in this book, it is that excessive debt accumulation,
whether it be by the Government, banks, corporations, or
consumers, often poses greater systemic risks than it seems
during a boom.\1\
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\1\ Reinhart, Carmen and Ken Rogoff. This Time Is Different: Eight
Centuries of Financial Folly. Princeton: Princeton University Press.
2009. p. xxv.
This is precisely what was observed in the run up to the recent
crisis. Mortgage lenders effectively loaned 100 percent or more against
the value of many homes without underwriting practices that ensured
borrowers could service the debt over the long term. Securitization
structures were created that left the issuers with little or no
residual interest, meaning that these deals were 100 percent debt
financed. In addition, financial institutions not only frequently
maximized the degree of on-balance-sheet leverage they could engineer;
many further leveraged their operations by use of off-balance-sheet
structures. For all intents and purposes, these off-balance-sheet
structures were not subject to prudential supervision or regulatory
capital requirements, but nonetheless enjoyed the implicit backing of
the parent institution. These and many other financial practices
employed in the years leading up to the crisis made our core financial
institutions and our entire financial system more vulnerable to
financial shocks.
One important element to restraining financial leverage and
enhancing the stability of our system is to strengthen the capital base
of our largest financial institutions. The economic costs of the crisis
were very much on the mind of the Basel Committee on Bank Supervision
(BCBS) when it published the December 2009 paper that ultimately led to
the Basel III capital accord.\2\ Basel III is not perfect, but it is a
great improvement over what came before. The accord not only addresses
the insufficient quality and quantity of capital at the largest banks,
but also requires capital buffers over and above the minimums so that
the macroeconomy is not forced into a deleveraging spiral as banks
breach these minimums during a period of high losses. Importantly,
Basel III includes an international leverage requirement, a concept
that was met with derision when I proposed it in 2006 but has now been
embraced by the Basel Committee and the G-20. Finally, the Basel
Committee has committed to additional capital and liquidity
requirements for large, systemically important institutions that are
higher, not lower, than those applicable to small banks. I firmly
believe that this extra capital requirement must result in a meaningful
cushion of tangible common equity capital. Moreover, I believe we
should impose even higher capital charges on systemic entities until
they have developed a resolution plan which has been approved as
credible by their regulators. This would help ensure that large
institutions in all BCBS member countries take seriously their
obligation to demonstrate that they can be unwound in an orderly way
should they fail.
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\2\ See http://www.bis.org/publ/bcbs164.htm.
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As the Basel Committee has considered ways to strengthen capital
requirements, the financial industry has repeatedly warned of economic
harm if it is required to replace debt financing with equity. A 2010
report by the Institute of International Finance argued that the new,
higher capital requirements and other reforms will raise bank funding
costs, raise the cost of credit in the economy, and have a significant
adverse impact on the path of economic activity.\3\ But the bulk of
credible research shows that higher capital requirements will have a
relatively modest effect on the cost of credit and economic activity.
These studies, conducted by economists at Harvard, Stanford, the
University of Chicago, Bank of England and the Bank for International
Settlements, account for not only the private costs and benefits of
funding through equity capital, but also the social costs and
benefits.\4\ As we saw in 2008, when a crisis hits, highly leveraged
financial institutions dramatically contract credit to conserve
capital. FDIC-insured institutions as a group have reduced their
balances of outstanding loans during nine of the last 10 quarters, and
their unused loan commitments have declined by $2.5 trillion since the
end of 2007. As we have seen, these procyclical lending policies can
have a devastating impact on the real economy. As we move forward with
important regulatory changes to improve institutional structures in
finance, we must do so with an eye to what is in some ways a larger,
built-in distortion in our financial system--excessive reliance on debt
as opposed to equity.
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\3\ See: ``Interim Report on the Cumulative Impact on the Global
Economy of Proposed Changes in the Banking Regulatory Framework,''
Institute of International Finance, June 2010. http://www.iif.com/
press/press+151.php.
\4\ See: Admati, Anat, Peter M. DeMarzo, Martin R. Hellwig and Paul
Pfleiderer. ``Fallacies, Irrelevant Facts, and Myths in the Discussion
of Capital Regulation: Why Bank Equity is Not Expensive.'' Stanford
Graduate School of Business Research Paper No. 2065, March 2011. http:/
/www.gsb.stanford.edu/news/research/Admati.etal.html.
Hanson, Samuel, Anil Kashyap and Jeremy Stein. ``A Macroprudential
Approach to Financial Regulation.'' Working paper (draft), July 2010.
http://www.economics.harvard.edu/faculty/stein/files/JEP-
macroprudential-July22-2010.pdf.
Marcheggiano, Gilberto, David Miles and Jing Yang. ``Optimal Bank
Capital.'' London: Bank of England. External Monetary Policy Committee
Unit Discussion Paper No. 31, April 2011. http://
www.bankofengland.co.uk/publications/externalmpcpapers/
extmpcpaper0031revised.pdf.
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Under the provisions of Section 941 in the Dodd-Frank Act, the FDIC
and other agencies recently issued proposed rules to address the
excessive risk-taking inherent in the originate-to-distribute model of
lending and securitization. These rules require originators of asset-
backed securities to retain not less than 5 percent of the credit risk
of those securities, and define standards for Qualifying Residential
Mortgages (QRMs) that will be exempt from risk retention when they are
securitized. The proposal sets forth a flexible framework for issuers
to achieve the 5 percent risk retention requirement. Together, the risk
retention and QRM rules will help to limit leverage and better align
financial incentives in asset-backed securitization, and give loan
underwriting, administration, and servicing much larger roles in credit
risk management. They are an important step in restoring investor
confidence in a market where the volume of issuance remains depressed
in the aftermath of the crisis.
Ending Too Big to Fail by Facilitating Orderly Resolutions
One of the most powerful inducements toward excess leverage and
institutional risk-taking in the period leading up to the crisis was
the lack of effective market discipline on the largest financial
institutions that were considered by the market to be ``too big to
fail.'' The financial crisis of 2008 centered on the so-called shadow
banking system--a network of large-bank affiliates, special-purpose
vehicles, and nonbank financial companies that existed not only largely
outside of the prudential supervision and capital requirements that
apply to federally insured depository institutions in the United
States, but also largely outside of the FDIC's process for resolving
failed insured financial institutions through receivership.
Several large, complex U.S. financial companies at the center of
the 2008 crisis could not be wound down in an orderly manner when they
became nonviable. Major segments of their operations were subject to
the commercial bankruptcy code, as opposed to bank receivership laws,
or they were located abroad and therefore outside of U.S. jurisdiction.
In the heat of the crisis, policymakers in several instances resorted
to bailouts instead of letting these firms collapse into bankruptcy
because they feared that the losses generated in a failure would
cascade through the financial system, freezing financial markets and
stopping the economy in its tracks.
As it happened, these fears were realized when Lehman Brothers--a
large, complex nonbank financial company--filed for bankruptcy on
September 15, 2008. Anticipating the complications of a long, costly
bankruptcy process, counterparties across the financial system reacted
to the Lehman failure by running for the safety of cash and other
Government obligations. Subsequent days and weeks saw the collapse of
interbank lending and commercial paper issuance, and a near complete
disintermediation of the shadow banking system. The only remedy was
massive intervention on the part of governments around the world, which
pumped equity capital into banks and other financial companies,
guaranteed certain non-deposit liabilities, and extended credit backed
by a wide range of illiquid assets to banks and nonbank firms alike.
Even with these emergency measures, the economic consequences of the
crisis have been enormous.
Under a regime of ``too big to fail,'' the largest U.S. banks and
other financial companies have every incentive to render themselves so
large, so complex, and so opaque that no policymaker would dare risk
letting them fail in a crisis. With the benefit of this implicit safety
net, these institutions have been insulated from the normal discipline
of the marketplace that applies to smaller banks and practically every
other private company.
Having recently seen the nation's largest financial institutions
receive hundreds of billions of dollars in taxpayer assistance, the
market appears to expect more of the same going forward. In February,
Moody's reported that its ratings on the senior unsecured debt of eight
large U.S. banking organizations received an average ``uplift'' of 2.2
ratings notches because of the expectation of future Government
support. Meanwhile, the largest banks continue to enjoy a large
competitive advantage over community banks in funding markets. In the
fourth quarter of last year, the average interest cost of funding
earning assets for banks with more than $100 billion in assets was
about half the average for community banks with less than $1 billion in
assets. Indeed, I would also argue that well-managed large banks are
disadvantaged by ``too big to fail'' as it narrows the funding
advantage they would otherwise enjoy over weaker competitors.
Unless reversed, we could expect to see more concentration of
market power in the hands of the largest institutions, more complexity
in financial structures and relationships, more risk-taking at the
expense of the public, and, in due time, another financial crisis.
However, the Dodd-Frank Act introduces several measures in Title I and
Title II that, together, provide the basis for a new resolution
framework designed to render any financial institution ``resolvable,''
thereby ending the subsidization of risktaking that took place prior to
these reforms.
The new SIFI resolution framework has three basic elements. First,
the new Financial Stability Oversight Council, chaired by the Treasury
Secretary and made up of the other financial regulatory agencies, is
responsible for designating SIFIs based on criteria that are now being
established by regulation. Once designated, the SIFIs will be subject
to heightened supervision by the Federal Reserve Board and required to
maintain detailed resolution plans that demonstrate that they are
resolvable under bankruptcy--not bailout--if they should run into
severe financial distress. Finally, the law provides for a third
alternative to bankruptcy or bailout--an Orderly Liquidation Authority,
or OLA, that gives the FDIC many of the same trustee powers over SIFIs
that we have long used to manage failed-bank receiverships.
I would like to clarify some misconceptions about these authorities
and highlight some priorities I see for their effective implementation.
SIFI Designation It is important at the outset to clarify that
being designated as a SIFI will in no way confer a competitive
advantage by anointing an institution as ``too big to fail.'' The
reality is that SIFIs will be subject to heightened supervision and
higher capital requirements. They will also be required to maintain
resolution plans and could be required to restructure their operations
if they cannot demonstrate that they are resolvable. In light of these
significant regulatory requirements, the FDIC has detected absolutely
no interest on the part of any financial institution in being named a
SIFI. Indeed, many institutions are vigorously lobbying against such a
designation.
We believe that the ability of an institution to be resolved in a
bankruptcy process without systemic impact should be a key
consideration in designating a firm as a SIFI. Further, we believe that
the concept of resolvability is consistent with several of the
statutory factors that the FSOC is required to consider in designating
a firm as systemic, those being size, interconnectedness, lack of
substitutes and leverage. If an institution can be reliably deemed
resolvable in bankruptcy by the regulators, and operates within the
confines of the leverage requirements established by bank regulators,
then it should not be designated as a SIFI.
What concerns us, however, is the lack of information we might have
about potential SIFIs that may impede our ability to make an accurate
determination of resolvability before the fact. This potential blind
spot in the designation process raises the specter of a ``deathbed
designation'' of a SIFI, whereby the FDIC would be required to resolve
the firm under a Title II resolution without the benefit of a
resolution plan or the ability to conduct advance planning, both of
which are so critical to an orderly resolution. This situation, which
would put the resolution authority in the worst possible position,
should be avoided at all costs. Thus, we need to be able to collect
detailed information on a limited number of potential SIFIs as part of
the designation process. We should provide the industry with some
clarity about which firms will be expected to provide the FSOC with
this additional information, using simple and transparent metrics such
as firm size, similar to the approach used for bank holding companies
under the Dodd-Frank Act. This should reduce some of the mystery
surrounding the process and should eliminate any market concern about
which firms the FSOC has under its review. In addition, no one should
jump to the conclusion that by asking for additional information, the
FSOC has preordained a firm to be ``systemic.'' It is likely that,
after we gather additional information and learn more about these
firms, relatively few of them will be viewed as systemic, especially if
the firms can demonstrate their resolvability in bankruptcy at this
stage of the process.
The FSOC issued an Advanced Notice of Proposed Rulemaking (ANPR)
last October and a Notice of Proposed Rulemaking (NPR) on January 26,
2011 describing the processes and procedures that will inform the
FSOC's designation of nonbank financial companies under the Dodd-Frank
Act. We recognize the concerns raised by several commenters to the
FSOC's ANPR and NPR about the lack of detail and clarity surrounding
the designation process. This lack of specificity and certainty in the
designation process is itself a burden on the industry and an
impediment to prompt and effective implementation of the designation
process. That is why it is important that the FSOC move forward and
develop some hard metrics to guide the SIFI designation process. The
sooner we develop and publish these metrics, the sooner this needless
uncertainty can be resolved. The FSOC is in the process of developing
further clarification of the metrics for comment that will provide more
specificity as to the measures and approaches we are considering using
for designating non-bank firms.
SIFI Resolution Plans A major--and somewhat underestimated--
improvement in the SIFI resolution process is the requirement in the
Dodd-Frank Act for firms designated as SIFIs to maintain satisfactory
resolution plans that demonstrate their resolvability in a crisis.
When a large, complex financial institution gets into trouble, time
is the enemy. The larger, more complex, and more interconnected a
financial company is, the longer it takes to assemble a full and
accurate picture of its operations and develop a resolution strategy.
By requiring detailed resolution plans in advance, and authorizing an
onsite FDIC team to conduct pre-resolution planning, the SIFI
resolution framework regains the informational advantage that was
lacking in the crisis of 2008.
The FDIC recently released a paper detailing how the filing of
resolution plans, the ability to conduct advance planning, and other
elements of the framework could have dramatically changed the outcome
if they had been available in the case of Lehman.\5\ Under the new SIFI
resolution framework, the FDIC should have a continuous presence at all
designated SIFIs, working with the firms and reviewing their resolution
plans as part of their normal course of business. Thus, our presence
will in no way be seen as a signal of distress. Instead, it is much
more likely to provide a stabilizing influence that encourages
management to more fully consider the downside consequences of its
actions, to the benefit of the institution and the stability of the
system as a whole.
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\5\ ``The Orderly Liquidation of Lehman Brothers Holdings under the
Dodd-Frank Act,'' FDIC Quarterly, Vol. 5, No. 2, 2011. http://
www.fdic.gov/regulations/reform/lehman.html.
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The law also authorizes the FDIC and the Federal Reserve Board to
require, if necessary, changes in the structure or activities of these
institutions to ensure that they meet the standard of being resolvable
in a crisis. In my opinion, the ultimate effectiveness of the SIFI
resolution framework will depend in large part on the willingness of
the FDIC and the Federal Reserve Board to actively use this authority
to require organizational changes that promote the ability to resolve
SIFIs.
As currently structured, many large banks and nonbank SIFIs
maintain thousands of subsidiaries and manage their activities within
business lines that cross many different organizational structures and
regulatory jurisdictions. This can make it very difficult to implement
an orderly resolution of one part of the company without triggering a
costly collapse of the entire company. To solve this problem, the FDIC
and the Federal Reserve Board must be willing to insist on
organizational changes that better align business lines and legal
entities well before a crisis occurs. Unless these structures are
rationalized and simplified in advance, there is a real danger that
their complexity could make a SIFI resolution far more costly and more
difficult than it needs to be.
Such changes are also likely to have collateral benefits for the
firm's management in the short run. A simplified organizational
structure will put management in a better position to understand and
monitor risks and the inter-relationships among business lines,
addressing what many see as a major challenge that contributed to the
crisis. That is why--well before the test of another major crisis--we
must define high informational standards for resolution plans and be
willing to insist on organizational changes where necessary in order to
ensure that SIFIs meet the standard of resolvability.
Orderly Liquidation Authority (OLA) There also appear to be a
number of popular misconceptions as to the nature of the Orderly
Liquidation Authority. Some have called it a bailout mechanism, while
others see it as a fire sale that will destroy the value of
receivership assets. Neither is true. While it is positioned as a
backup plan in cases where bankruptcy would threaten to result in wider
financial disorder, the OLA is actually a better-suited framework for
resolving claims against failed financial institutions. It is a
transparent process that operates under fixed rules that prohibit any
bailout of shareholders and creditors or any other type of political
considerations, which can be a legitimate concern in the case of an ad-
hoc emergency rescue program. Not only would the OLA work faster and
preserve value better than bankruptcy, but the regulatory authorities
who will administer the OLA are in a far better position to coordinate
with foreign regulators in the failure of an institution with
significant international operations.
The FDIC has made considerable progress in forging bilateral
agreements with other countries that will facilitate orderly cross-
border resolutions. In addition, we currently co-chair the Cross Border
Resolutions Group of the Basel Committee. It is worth noting that not a
single other advanced country plans to rely on bankruptcy to resolve
large, international financial companies. Most are implementing special
resolution regimes similar to the OLA. Under the OLA, we can buy time,
if necessary, and preserve franchise value by running the institution
as a bridge bank, and then eventually sell it in parts or as a whole.
It is a powerful tool that greatly enhances our ability to provide
continuity and minimize losses in financial institution failures.
While the OLA strictly prohibits bailouts, the FDIC could use the
authority to conduct advance planning, to temporarily operate and fund
the institution under Government control to preserve its value as a
going concern, and to quickly pay partial recoveries to creditors
through advance dividends, as we have long done in failed-bank
receiverships. The result would be a faster resolution of claims
against the failed institution, smaller losses for creditors, reduced
impact on the wider financial system, and an end to the cycle of
bailouts.
The history of the recent crisis is replete with examples of missed
opportunities to sell or recapitalize troubled institutions before they
failed. But with bailout now off the table, management will have a
greater incentive to bring in an acquirer or new investors before
failure, and shareholders and creditors will have more incentive to go
along with such a plan in order to salvage the value of their claims.
These new incentives to be more proactive in dealing with problem SIFIs
will reduce their incidence of outright failure and also lessen the
risk of systemic effects arising from such failures.
In summary, the measures authorized under the Dodd-Frank Act to
create a new, more effective SIFI resolution authority will go far
toward reducing leverage and risktaking in our financial system by
subjecting every financial institution, no matter its size or degree of
interconnectedness, to the discipline of the marketplace. Prompt and
effective implementation of these measures will be essential to
constraining the tendency toward excess leverage in our financial
system and our economy, and in creating incentives for safe and sound
practices that will promote financial stability in the future. In light
of the ongoing concern about the burden arising from regulatory reform,
I think it is worth mentioning that none of these measures to promote
the resolvability of SIFIs will have any impact at all on small and
midsized financial institutions except to reduce the competitive
disadvantage they have long encountered with regard to large, complex
institutions. There are clear limits to what can be accomplished by
prescriptive regulation. That is why promoting the ability of market
forces to constrain risk taking will be essential if we are to achieve
a more stable financial system in the years ahead.
Macroprudential Supervision
Beyond the regulatory steps to ensure that the core of our
financial system is more resilient to shocks, we also need a regulatory
process that is much more attuned to developing macro risks and how
they may affect systemically important institutions. This task,
generally referred to as macroprudential supervision, has been assigned
collectively to the FSOC. Among other things, the Dodd-Frank Act
directs the FSOC to facilitate regulatory coordination and information
sharing among its member agencies regarding policy development,
rulemaking, supervisory information, and reporting requirements. The
FSOC is currently working on a number of fronts to better identify and
respond to emerging risks to our financial system. The Dodd-Frank Act
requires that the FSOC produce annual financial stability reports and
that each voting member submit a signed statement stating whether the
member believes that the FSOC is taking all reasonable actions to
mitigate systemic risk.
The success of the FSOC in accomplishing its goals will depend on
the diligence and seriousness about those goals on the part of the
members. So far, the FDIC believes that the FSOC member agencies are
committed to the success of the Council, and we have been impressed
with the quality of staff work in preparation for the meetings as well
as the rigor and candor of the discussions. We also believe that the
FSOC has provided an efficient means for agencies to jointly write
rules required by the Dodd-Frank Act and to seek input from other
agencies on independent rules. The FDIC strongly supports the FSOC's
collective approach to identifying and responding to risks. Conducting
multidisciplinary discussion and review of issues that cut across
markets and regulatory jurisdictions is a highly effective way of
identifying and mitigating risks, even before they become systemic.
In response to the Committee's request for additional information
on potential risks to the financial stability of the United States, I
would like to offer some observations on two specific topics: problems
in mortgage servicing documentation and interest rate risk at financial
institutions in light of rapid growth in U.S. Government debt.
Problems in Mortgage Servicing Documentation Mortgage servicing is
a serious area of concern and one which the FDIC identified years ago.
As early as the Spring of 2007, we were speaking to the need for
mortgage servicers to build programs and resources to restructure
troubled mortgages on a broad scale. When, over a year ago, we proposed
a new safe harbor for bank-sponsored securitizations, we included
requirements for effective loss mitigation and compensation incentives
that reflect the increased costs associated with servicing troubled
loans. In my testimony at the end of last year, in the wake of mounting
problems with mortgage servicing and foreclosure documentation at some
of the nation's largest servicing companies, I emphasized the need for
specific changes to address the most glaring deficiencies in servicing
practices, including a single point of contact for distressed
borrowers, appropriate write-downs of second liens, and servicer
compensation structures that are aligned with effective loss
mitigation.
The FDIC believes that mortgage servicing documentation problems
are yet another example of the implications of lax underwriting
standards and misaligned incentives in the mortgage process. In
particular, the traditional fixed level of compensation for loan
servicing proved wholly inadequate to cover expenses required to
implement the high-touch and specialized servicing on the scale needed
to deal with the huge increase in problem mortgage loans caused by
risky lending practices.
We now know that the housing bust and the financial crisis arose
from a historic breakdown in U.S. mortgage markets. While emergency
policies enacted at the height of the crisis have helped to stabilize
the financial system and plant the seeds for recovery, mortgage markets
remain deeply mired in credit distress and private securitization
markets remain largely frozen. Serious weaknesses identified with
mortgage servicing and foreclosure documentation have introduced
further uncertainty into an already fragile market.
The FDIC is especially concerned about a number of related problems
with servicing and foreclosure documentation. ``Robo-signing'' is the
use of highly automated processes by some large servicers to generate
affidavits in the foreclosure process without the affiant having
thoroughly reviewed facts contained in the affidavit or having the
affiant's signature witnessed in accordance with State laws. The other
problem involves some servicers' inability to establish their legal
standing to foreclose, since under current industry practices, they may
not be in possession of the necessary documentation required under
State law. These are not really separate issues; they are simply the
most visible of a host of related problems that we continue to see, and
that have been discussed in testimony to this Committee over the past
several years.\6\
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\6\ Hearings before the U.S. Senate Committee on Banking, Housing,
and Urban Affairs: July 16, 2009; November 16, 2010; December 1, 2010.
---------------------------------------------------------------------------
As you know, even though the FDIC is not the primary Federal
regulator for the largest loan servicers, our examiners participated
with other regulators in horizontal reviews of these servicers, as well
as two companies that facilitate the loan securitization process. In
these reviews, Federal regulators cited ``pervasive'' misconduct in
foreclosures and significant weaknesses in mortgage servicing
processes.
Unfortunately, the horizontal review only looked at processing
issues. Since the focus was so narrow, we do not yet really know the
full extent of the problem. The Consent Order, discussed further below,
requires these servicers to retain independent, third parties to review
residential mortgage foreclosure actions and report the results of
those reviews back to the regulators. However, we have heard concerns
regarding the thoroughness and transparency of these reviews, and we
continue to press for a comprehensive approach to this ``look back.''
I want to underscore that the housing market cannot heal and begin
to recover until this problem is tackled in a forthright manner and
resolved. As the insurer of the deposits at these banks, we will not
know the full extent of the problems and potential litigation exposure
they face until we have a thorough review of foreclosed loan files.
These servicing problems continue to present significant
operational risks to mortgage servicers. Servicers have already
encountered challenges to their legal standing to foreclose on
individual mortgages. More broadly, investors in securitizations have
raised concerns about whether loan documentation for transferred
mortgages fully conforms to applicable laws and the pooling and
servicing agreements governing the securitizations. If investor
challenges to documentation prove meritorious, they could result in
``putbacks'' of large volumes of defaulted mortgages to originating
institutions.
There have been some settlements regarding loan buyback claims with
the GSEs and some institutions have reserved for some of this exposure;
however, a significant amount of this exposure has yet to be
quantified. Given the weaknesses in the processes that have been
uncovered during the review, there appears to be the potential for
further losses. Litigation risk is not limited to just securitizations.
Flawed mortgage banking processes have potentially infected millions of
foreclosures, and the damages to be assessed against these operations
could be significant and take years to materialize. The extent of the
loss cannot be determined until there is a comprehensive review of the
loan files and documentation of the process dealing with problem loans.
This is one reason that I have urged the servicers and the State
Attorneys General to reach a global settlement. We believe that the
FSOC needs to consider the full range of potential exposure and the
related impact on the industry and the real economy. FSOC members have
a range of relevant expertise in regulating the various participants
and processes associated with the foreclosure problem. We need to fully
understand the potential risks and develop appropriate solutions to
address these deficiencies.
In April 2011, the Federal banking agencies ordered fourteen large
mortgage servicers to overhaul their mortgage-servicing processes and
controls, and to compensate borrowers harmed financially by wrongdoing
or negligence. The enforcement orders were only a first step in setting
out a framework for these large institutions to remedy deficiencies and
to identify homeowners harmed as a result of servicer errors. The
enforcement orders do not preclude additional supervisory actions or
the imposition of civil money penalties. Also, a collaborative
settlement effort continues between the State Attorneys General and
Federal regulators led by the U.S. Department of Justice. It is
critically important that lenders fix these problems soon to remedy the
foreclosure backlog, which has become the single largest impediment to
the recovery of U.S. housing markets.
Interest Rate Risk At the end of 2010, the U.S. domestic financial
and nonfinancial sectors owed credit market debt totaling just over $50
trillion, a figure that is some 92 percent higher in nominal terms than
it was just a decade ago. Much of this debt was issued during the
recent period of historically low interest rates. Not only did the
Federal Open Market Committee lower the Federal funds target rate to a
49-year low of 1 percent for a 12-month period in 2003 and 2004, but it
has continuously held the fed funds target rate at an all-time low of 0
to 0.25 percent since December 2008. Long-term rates have also been at
historic lows during this period. The average yield on 10-year Treasury
bonds over the past decade was the lowest for any 10-year period since
the mid-1960s. It is clear that the most likely direction of interest
rates from today's historic lows is upward. The question is how far and
how fast interest rates will rise, and how ready lenders and borrowers
will be to cope with higher rates of interest.
In theory, rising interest rates will represent a zero-sum game in
which the higher interest payments demanded of borrowers will be
perfectly offset by the higher interest income of savers in the
economy. In practice, however, rising interest rates can impose
considerable distress on borrowers or lenders depending on how debts
are structured. Floating-rate or short-term borrowers will see their
interest costs rise over time with the level of nominal interest rates.
Not only will this have an effect on their bottom line, but higher
borrowing costs could lead them to demand a lower volume of credit that
they did at lower rates. However, in the case of long-term, fixed-rate
debt, it is often the lender that suffers a capital loss, a decline in
operating income, or both as interest rates rise. Depository
institutions are traditionally vulnerable to losses of this type in
times of rising interest rates because their liabilities are typically
of shorter duration than their assets.
Given the prospect for higher interest rates going forward,
effective management of interest rate risk will be an essential
priority for financial institution risk managers in coming years.
Unfortunately, there is a tendency during periods of high credit
losses, such as the past few years, for risk managers to focus their
attention mostly on credit risk, and to divert their attention away
from interest rate risk at just the time that their portfolio is
becoming more vulnerable to rising rates. It was just this type of
inattention to the implication of rising interest rates that
contributed to growth in structured notes in the early to mid-1990s,
when a number of banks took on complex and interest-rate-sensitive
investments that they did not understand in search of higher yields.
The FDIC has been actively addressing the need for heightened
measures to manage interest rate risk at this critical stage of the
interest rate cycle. In January 2010 we issued a Financial Institution
Letter (FIL) clarifying our expectations that FDIC-supervised
institutions will manage interest rate risk using policies and
procedures commensurate with their complexity, business model, risk
profile, and scope of operations.\7\ That same month, the FDIC hosted a
Symposium on Interest Rate Risk Management that brought together
leading practitioners in the field to discuss the challenges facing the
industry in this area.\8\
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\7\ See http://www.fdic.gov/news/news/financial/2010/fil10002.html.
\8\ See http://www.fdic.gov/news/conferences/
symposium_irr_meeting.html.
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Effective management of interest rate risk assumes a heightened
importance in light of the recent high rates of growth in U.S.
Government debt, the yield on which represents the benchmark for
determining private interest rates all along the yield curve. Total
U.S. Federal debt has doubled in the past 7 years to over $14 trillion,
or more than $100,000 for every American household. This growth in
Federal borrowing is the result of both the temporary effects of the
recession on Federal revenues and outlays and a long-term structural
deficit related to Federal entitlement programs. In 2010, combined
expenditures on Social Security, Medicare and Medicaid accounted for 44
percent of primary Federal spending, up from 27 percent in 1975. The
Congressional Budget Office (CBO) projects that annual entitlement
spending could triple in real terms by 2035, to $4.5 trillion in 2010
dollars. According to CBO projections, Federal debt held by the public
could rise from a level equal to 62 percent of gross domestic product
in 2010 to an unsustainable 185 percent in 2035.
The U.S. has long enjoyed a unique status among sovereign issuers
by virtue of its economic strength, its political stability, and the
size and liquidity of its capital markets. Accordingly, international
investors have long viewed U.S. Treasury securities as a haven,
particularly during times of financial market uncertainty. However, as
the amount of publicly held U.S. debt continues to rise, and as a
rising portion of that debt comes to be held by the foreign sector
(about half as of September 2010), there is a risk that investor
sentiment could at some point turn away from dollar assets in general
and U.S. Treasury obligations in particular.
With more than 70 percent of U.S. Treasury obligations held by
private investors scheduled to mature in the next 5 years, an erosion
of investor confidence would likely lead to sharp increases in
Government and private borrowing costs. As recent events in Greece and
Ireland have shown, such a reversal in investor sentiment could occur
suddenly and with little warning. If investors were to similarly lose
confidence in U.S. public debt, the result could be higher and more
volatile long-term interest rates, capital losses for holders of
Treasury instruments, and higher funding costs for depository
institutions. Household and business borrowers of all types would pay
more for credit, resulting in a slowdown in the rate of economic growth
if not outright recession.
Over the past year, the U.S. fiscal outlook has assumed a much
larger importance in policy discussions and the political process.
Members of Congress, the Administration, and the Presidential
Commission on Fiscal Responsibility and Reform have all offered
proposals for addressing the long-term fiscal situation, but political
consensus on a solution appears elusive at this time. It is likely that
the capital markets themselves will continue to apply increasing
pressure until a credible solution is reached. Already, the cost for
bond investors and others to purchase insurance against a default by
the U.S. Government has risen from just 2 basis points in January 2007
to a current level of 42 basis points.
Financial stability critically depends on public and investor
confidence. Developing policies that will clearly demonstrate the
sustainability of the U.S. fiscal situation will be of utmost
importance in ensuring a smooth transition from today's historically
low interest rates to the higher levels of interest rates that are
inevitable in coming years. Government policies to slow the growth in
U.S. Government debt will be essential to lessening the impact of this
shock and reducing the likelihood that it will result in a costly new
round of financial instability.
Conclusion
The inherent instability of financial markets cannot be regulated
out of existence. Nevertheless, many of the Dodd-Frank Act reforms, if
properly implemented, can make the core of our financial system more
resilient to shocks by restoring market discipline, limiting financial
leverage, and making our regulatory process more proactive in
identifying and addressing emerging risks to financial stability.
Working together on these reforms, regulators and the financial
services industry can improve financial stability and minimize the
severity of future crises. With this in mind, the FDIC will continue to
carefully and seriously perform its duties as a voting member of FSOC,
expeditiously complete rulemakings, and actively exercise its new
authorities related to orderly liquidation authority and resolution
plans.
The stakes are extremely high. To continue the pre-crisis status
quo would be to sanction a new and dangerous form of state capitalism,
where the market assumes that large, complex, and powerful financial
companies are in line to receive generous Government subsidies in times
of financial distress. The result could be a continuation of the market
distortions that led to the recent crisis, with all of the attendant
implications for risk-taking, competitive structures, and financial
instability. In order to avoid this outcome, we must follow through to
fully implement the authorities under the Dodd-Frank Act and thereby
restore market discipline to our financial system.
Finally, I would like to emphasize that many of the problems and
challenges confronting the financial sector are beyond the control of
the regulatory community. Obviously, restoration of fiscal discipline
is the province of the executive and legislative branches. Similarly,
tax code changes that could reduce or eliminate incentives for leverage
by financial institutions and borrowers must be acted upon by Congress.
So it is my hope that Senate Banking Committee members can play a
leadership role in making sure that the ongoing budget and tax
discussions include consideration of the ramifications of different
policy options for the stability of the financial system going forward.
Thank you again for the opportunity to testify about these
critically important issues. I would be pleased to answer any
questions.
______
PREPARED STATEMENT OF JOHN WALSH
Acting Comptroller of the Currency
Office of The Comptroller of the Currency
May 12, 2011
I. Introduction
Chairman Johnson, Ranking Member Shelby, and Members of the
Committee, I appreciate the opportunity to provide an update on the
Office of the Comptroller of the Currency's (OCC) implementation of the
Dodd-Frank Act, and in particular, those provisions related to
monitoring systemic risk and promoting financial stability, and on the
operations and activities of the Financial Stability Oversight Council
(FSOC).*
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* Statement Required by 12 U.S.C. 250: The views expressed herein
are those of the Office of the Comptroller of the Currency and do not
necessarily represent the views of the President.
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As I described before this Committee in February, the OCC is
actively working on approximately 85 Dodd-Frank Act projects. Broadly
speaking, these projects fall into three major categories: our
extensive efforts to prepare to integrate the OTS's staff and
supervisory responsibilities into the OCC, and to facilitate the
transfer of specific functions to the CFPB; our consultative role in a
variety of rulemakings being undertaken by other agencies; and our own
rule-writing responsibilities for implementing key provisions of the
Act.
There are numerous provisions within the Dodd-Frank Act that
address systemic issues that contributed to, or that accentuated and
amplified the effects of, the recent financial crisis. These provisions
include those that address flawed incentive structures and are designed
to constrain excessive risk-taking activities; those that strengthen
the resiliency of individual firms to financial shocks through stronger
capital requirements and more robust stress-testing requirements; and
those that address previous regulatory gaps, including the supervision
of systemically important non-bank financial companies, and the orderly
resolution of large banking organizations and non-bank financial
companies in the event of failure. The OCC, along with other financial
regulators, has rule-writing authority for many of these provisions,
and I am pleased to report that we are making good progress on our
rulemaking efforts on these critical provisions. Since I last appeared
before the Committee, the OCC and other agencies have issued notices of
proposed rulemaking on the following provisions:
Section 956, that prohibits incentive-based compensation
arrangements that encourage inappropriate risk taking by
covered financial institutions and are deemed to be excessive,
or that may lead to material losses;
Section 941, that addresses adverse market incentive
structures by requiring a securitizer to retain a portion of
the credit risk on assets it securitizes, unless those assets
are originated in accordance with conservative underwriting
standards established by the agencies in their implementing
regulations;
Sections 731 and 764, that establish, for security-based
swap dealers and major swap participants, capital requirements
and margin requirements on swaps that are not cleared.
In my role as a director of the Federal Deposit Insurance
Corporation, I also have approved the issuance of the FDIC's recent
rulemakings under Title II of the Dodd-Frank Act related to its orderly
liquidation authority.
Certainly one of the key provisions of the Dodd-Frank Act as it
relates to systemic risk and financial stability, and the focus of my
testimony today, is the creation of the Financial Stability Oversight
Council. The FSOC brings together the views, perspectives, and
expertise of Treasury and all of the financial regulatory agencies to
identify, monitor, and respond to systemic risk. As my testimony will
detail, Congress has set forth very specific mandates regarding the
role and function of FSOC in a number of areas, but certainly the
overarching mission that Congress assigned to the Council is to
identify risks to the financial stability of the United States, to
promote market discipline, and to respond to emerging threats to the
stability of the U.S. financial system.\1\
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\1\ See Section 112(a)(1).
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I believe FSOC enhances the agencies' collective ability to fulfill
this critical mission by establishing a formal, structured process to
exchange information and to probe and discuss the implications of
emerging market, industry, and regulatory developments for the
stability of the financial system. Through the work of its committees
and staff, FSOC also is providing a structured framework and metrics
for tracking and assessing key trends and potential systemic risks. I
would note that FSOC's activities and mandates complement the separate
roles, responsibilities, and authorities that the OCC and other
financial regulators have with respect to implementing specific
provisions of the Dodd-Frank Act and more broadly in monitoring risks
and conditions within the financial industry. For example, the OCC will
continue to use our National Risk Committee and the insights we gain
through our on- and offsite supervisory activities to identify,
monitor, and respond to emerging risks to the banking system. We will,
of course, also continue to share our insights and expertise with the
FSOC in its deliberations.
While the process and systems that FSOC has created are positive
steps forward, I would offer two cautionary notes.
First, FSOC's success ultimately will depend not on its structure,
processes, or metrics, but on the willingness and ability of FSOC
members and staff to engage in frank and candid discussions about
emerging risks, issues, and institutions. These discussions are not
always pleasant as they can challenge one's longstanding views or ways
of approaching a problem. But being able to voice dissenting views or
assessments will be critical in ensuring that we are seeing and
considering the full scope of issues. In addition, these discussions
often will involve information or findings that will need further
verification; that are extremely sensitive either to the operation of a
given firm or market segment; or if misconstrued, that could undermine
public and investor confidence and thereby create or exacerbate a
potentially systemic problem. As a result, the OCC believes that it is
critical that these types of deliberations--both at the Council and
staff level--be conducted in a manner that assures their confidential
nature.
Second, even with fullest deliberations and best data, it is
inevitable that there will still be unforeseen events that may result
in substantial risks to the system, markets, or groups of institutions.
Business and credit cycles will continue. It is not realistic to expect
that FSOC will be able to prevent such occurrences. However, FSOC will
provide a mechanism to communicate, coordinate, and respond to such
events so as to help contain and limit their impact, including, where
applicable, the resolution of systemically important firms.
The remainder of my testimony focuses on FSOC, with a discussion of
the specific mandates Congress has given to the FSOC; its structure and
operations; and finally its achievements to date.
II. FSOC's Statutory Mandates
FSOC's primary mission, as set forth in section 112 of the Dodd-
Frank Act is to:
1) Identify risks to the financial stability of the United States
that could arise from the material financial distress or
failure, or ongoing activities, of large, interconnected bank
holding companies or non-bank financial companies, or that
could arise outside the financial services marketplace;
2) Promote market discipline by eliminating expectations on the part
of shareholders, creditors, and counterparties of such
companies that the Government will shield them from losses in
the event of failure; and
3) Respond to emerging threats to the stability of the U.S.
financial system. The Dodd-Frank Act assigns FSOC a variety of
roles and responsibilities to carry out its core mission\2\
that are described in greater detail throughout the Act. In
some cases, the Council has direct and ultimate responsibility
to make decisions and take actions. Most notable of these is
the authority given to FSOC to determine that certain non-bank
financial companies shall be supervised by the Federal Reserve
Board and subject to heightened prudential standards, after an
assessment as to whether material financial distress at such
companies would pose a threat to the financial stability of the
United States.\3\ Similarly, the Council is charged with the
responsibility to identify systemically important financial
market utilities and payment, clearing, and settlement
activities.
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\2\ See section 112.
\3\ See section 113(a)(1).
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In addition, affirmation by two-thirds of the Council is required
in those cases where the Federal Reserve determines that a large,
systemically important financial institution poses a grave threat to
the financial stability of the United States such that limitations on
the company's ability to merge, offer certain products, or engage in
certain activities are warranted, or if those actions are insufficient
to mitigate risks, the company should be required to sell or otherwise
transfer assets or off-balance items to unaffiliated entities.\4\
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\4\ See section 121.
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The FSOC is also empowered to collect information from member
agencies and other Federal and State financial regulatory agencies as
necessary in order to monitor risks to the financial system, and to
direct the Office of Financial Research under the Treasury Department
to collect information directly from bank holding companies and non-
bank financial companies.\5\
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\5\ See section 112.
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The Dodd-Frank Act also identified specific areas where the Council
is to provide additional studies, including recommendations, to inform
future regulatory actions. These include studies of the financial
sector concentration limit applicable to large financial firms imposed
by the Act;\6\ proprietary trading and hedge fund activities;\7\ the
treatment of secured creditors in the resolution process;\8\ and
contingent capital for nonbank financial companies.\9\
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\6\ See section 622.
\7\ See section 619.
\8\ See section 215.
\9\ See section 115.
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In other areas, the Council's role is more of an advisory body to
the primary financial regulators. For example, the Dodd-Frank Act
requires the Council to make recommendations to the Federal Reserve
concerning the establishment of heightened prudential standards for
risk-based capital, liquidity, and a variety of other risk management
and disclosure matters for non-bank financial companies and large,
interconnected bank holding companies supervised by the Board.\10\ The
Federal Reserve, however, retains the authority to supervise and set
standards for these firms.\11\ The Council is also given authority to
review, and as appropriate, may submit comments to the Securities and
Exchange Commission and any standard-setting body with respect to an
existing or proposed accounting principle, standard, or procedure.\12\
Similarly, FSOC is assigned a consultative role in several rulemakings
by member agencies, including for all of the rules that the FDIC writes
pursuant to Title II of the Dodd-Frank Act regarding the orderly
liquidation of failing financial companies that pose a significant risk
to the financial stability of the United States. The Council may also
recommend to member agencies general supervisory priorities and
principles \13\ and issue nonbinding recommendations for resolving
jurisdictional disputes among member agencies.\14\
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\10\ See section 112.
\11\ See section 165.
\12\ See section 112.
\13\ See section 112.
\14\ See section 119.
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The varied roles and responsibilities that Congress assigned to the
Council appropriately balance and reflect the desire to enhance
regulatory coordination for systemically important firms and activities
while preserving and respecting the independent authorities and
accountability of primary supervisors. For example, under section 120,
FSOC has the authority to recommend to the primary financial agencies
that they apply new or heightened standards and safeguards for a
financial activity or practice conducted by firms under their
respective jurisdictions should the Council determine that the conduct
of such an activity or practice could create or increase the risk of
significant liquidity, credit, or other problems spreading among
financial institutions, the U.S. financial markets, or low-income,
minority, or underserved communities. Each agency retains the authority
to not follow such recommendations if circumstances warrant and the
agency explains its reasons in writing to the Council.
III. FSOC Structure and Operations
The FSOC has established committees and subcommittees comprised of
staff from the member agencies to help carry out its responsibilities
and authorities. These groups report up through a Deputies Committee of
senior staff from each agency. The Deputies Committee generally meets
on a bi-weekly basis to monitor work progress, review pending items
requiring consultative input, discuss emerging systemic issues, and
help establish priorities and agendas for the Council. A Systemic Risk
Committee and subcommittees on institutions and markets provide
structure for the FSOC's analysis of emerging threats to financial
stability. Five standing functional committees support the FSOC's work
on the following specific provisions assigned to the Council:
designations of systemically important non-bank financial companies and
of financial market utilities and payment, clearing, and settlement
activities; heightened prudential standards; orderly liquidation
authority and resolution plans; and data collection and analysis. OCC
staff are active participants and contributors to each of these
committees. In addition to these groups, the FSOC also has an informal
interagency legal staff working group that assists with various legal
issues concerning the Council's operations and proceedings. Each of
these committees and work groups is supported by staff from Treasury.
IV. Accomplishments To Date
Since its creation with the enactment of the Dodd-Frank Act, the
Council has met four times, with meetings occurring approximately every
6 weeks. As with any newly formed body, a large proportion of the
Council's early work was focused on the necessary administrative rules
and procedures that will govern the Council's operations. In addition
to the creation and staffing of the aforementioned committees, this
work has included the adoption of a transparency policy for Council
meetings; rules of organization that describe the Council's
authorities, organizational structure, and the rules by which the
Council takes action; establishment of a framework for coordinating
regulations or actions required by the Dodd-Frank Act to be completed
in consultation with the Council; approval of an initial operating
budget for the Council; and the publication of a proposed rulemaking to
implement the Freedom of Information Act requirements as it pertains to
Council activities.
The Council has also taken action on a number of substantive items
directly related to its core mission and mandates. These include the
following:
Study and Recommendations Regarding Concentration Limits on
Large Financial Companies \15\--Section 622 of the Dodd-Frank
Act establishes a financial sector concentration limit that
generally prohibits a financial company from merging,
consolidating with, or acquiring another company if the
resulting company's consolidated liabilities would exceed 10
percent of the aggregate consolidated liabilities of all
financial companies. Pursuant to the mandate in section 622, on
January 18, 2011, the Council approved the publication of this
study of the extent to which the concentration limit would
affect financial stability, moral hazard in the financial
system, the efficiency and competitiveness of U.S. financial
firms and financial markets, and the cost and availability of
credit and other financial services to households and
businesses in the United States. The study concludes that the
concentration limit will have a positive impact on U.S.
financial stability. It also makes a number of technical
recommendations to address practical difficulties likely to
arise in its administration and enforcement, such as the
definition of liabilities for certain companies that do not
currently calculate or report risk-weighted assets.
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\15\ A copy of the study is available at: http://www.treasury.gov/
initiatives/Documents/
Study%20on%20Concentration%20Limits%20on%20Large%20Firms%2001-17-
11.pdf.
Study and Recommendations on Prohibitions on Proprietary
Trading and Certain Relationships with Hedge Funds and Private
Equity Funds \16\--As mandated by the Dodd-Frank Act, FSOC
conducted a study on how best to implement section 619 of the
Act (commonly known as the ``Volcker Rule''), which is designed
to improve the safety and soundness of our nation's banking
system by prohibiting propriety trading activities and certain
private fund investments. To help formulate its
recommendations, the Council published a Notice and Request for
Information in the Federal Register on October 6, 2010, and
received more than 8,000 comments from the public, Congress,
and financial services market participants. Key themes in those
comments urged agencies to:
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\16\ A copy of the study is available at: http://www.treasury.gov/
initiatives/Documents/
Volcker%20sec%20%20619%20study%20final%201%2018%2011%20rg.pdf.
Prohibit banking entities from engaging in speculative
proprietary trading or sponsoring or investing in prohibited
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hedge funds or private equity funds;
Define terms and eliminate potential loopholes;
Provide clear guidance to banking entities as to the
definition of permitted and prohibited activities; and
Protect the ability of banking firms to manage their risks
and provide critical financial intermediation services and
preserve strong and liquid capital markets.
After careful consideration of these comments, on January 18, 2011,
the Council approved publication of its study and recommendations that
are intended to help inform the regulatory agencies as they move
forward with this difficult and complex rulemaking. The study endorses
the robust implementation of the Volcker Rule and makes ten broad
recommendations for the agencies' consideration.\17\
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\17\ See: Financial Oversight Council, Study & Recommendations on
Prohibitions on Proprietary Trading & Certain Relationships with Hedge
Funds & Private Equity Funds, (January 2011) at 3.
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As I noted at the Council meeting at which this matter was
considered, the OCC believes this study strikes a fair balance between
identifying considerations and approaches for future rulemaking, and
being overly prescriptive. As noted earlier, this is an area where
Congress chose to make a careful and, in my view, judicious distinction
in authorities--requiring the Council to conduct the study and make
recommendations, but leaving responsibility for writing the
implementing regulations to the relevant supervisory agencies.
Recognizing this distinction is essential to the process because the
rulewriting agencies are required by law to invite--and consider--
public comments as they develop the implementing regulations. This
means the agencies must conduct the rulemaking without prejudging its
outcome. We and the other agencies are in the midst of developing the
proposed implementing rule and will be soliciting comment on all
aspects of it when it is published.
Proposed Rulemakings on Authority to Require Supervision
and Regulation of Certain Non-bank Financial Companies--As
noted earlier, in contrast to the Volcker Rule where the
Council's role is primarily one of an advisory body, the
Council is directly given authority under the Dodd-Frank Act to
designate systemically important non-bank financial firms for
heightened supervision. On October 1, 2010, the Council
approved for publication an advance notice of proposed
rulemaking (ANPR) that sought public comment on the
implementation of this provision of the Dodd-Frank Act.
Approximately 50 comments were received on the ANPR. On January
18, 2011, the Council approved publication of a notice of
proposed rulemaking (NPRM) that outlines the criteria that will
inform the Council's designation of such firms and the
procedures the FSOC will use in the designation process. The
NPRM closely follows and adheres to the statutory factors
established by Congress for such designations. The framework
proposed in the NPRM for assessing systemic importance is
organized around six broad categories, each of which reflects a
different dimension of a firm's potential to experience
material financial distress, as well as the nature, scope,
size, scale, concentration, interconnectedness, and mix of the
company's activities. The six categories are: size,
interconnectedness, substitutability, leverage, liquidity, and
regulatory oversight.
The comment period for this NPRM closed on February 25, 2011, and
staffs are in the process of reviewing the comments received and
assessing how we should move forward with implementing this important
provision of the Dodd-Frank Act. In response to concerns raised by
commenters, there appears to be general agreement among the agencies on
the need to provide and seek comment on additional details regarding
FSOC's standards for assessing systemic risk before issuing a final
rule. I fully support this decision. It is critical that FSOC strikes
the appropriate balance in providing sufficient clarity in our rules
and transparency in our designation process, while at the same time
avoiding overly simplistic approaches that fail to recognize and
consider the facts and circumstances of individual firms and specific
industries. Ensuring that firms have appropriate due process throughout
the designation process will be critical in achieving this balance. In
this regard, consistent with statutory provisions, the designation of a
non-bank firm as systemically important will require consent by no
fewer than two-thirds of the voting members of the Council, including
the affirmative vote of the Chairperson of the Council. Before being
designated, a firm will be given a written notice that the Council is
considering making a proposed determination with an opportunity to
submit materials applicable to such a determination. Firms also are
provided the right to a hearing once they receive a written notice of
proposed determination.
Proposed Rulemakings on Authority to Designate Financial
Markets Utilities as Systemically Important--Section 804 of the
Dodd-Frank Act provides FSOC with the authority to identify and
designate as systemically important a financial market utility
(FMU) if FSOC determines that the failure of the FMU could
create or increase the risk of significant liquidity or credit
problems spreading among financial institutions or markets and
thereby threaten the stability of the U.S. financial system. On
December 21, 2010, the Council published an ANPR regarding the
designation criteria in section 804. The Council received 12
comments in response to the ANPR. At its March 18, 2011,
meeting, the Council approved the publication of a NPRM that
describes the criteria, analytical framework, and process and
procedures the Council proposes to use to designate an FMU as
systemically important. The NPRM includes the statutory factors
the Council is required to take into consideration and adds
subcategories under each of the factors to provide examples of
how those factors will be applied. The NPRM also outlines a
two-stage process for evaluating and designating an FMU as
systemically important. This process includes opportunities for
a prospective FMU to submit materials in support of or
opposition to a proposed designation. Consistent with statutory
provisions, any designation of an FMU will require consent by
the same supermajority and affirmative vote procedure described
above for designation of non-bank firms. The Council must also
engage in prior consultation with the Federal Reserve Board and
the relevant Federal financial agency that has primary
jurisdiction over the FMU.
Systemic Risk Monitoring--The Council and its committees
are also making strides in providing a more systematic
framework for identifying, monitoring, and deliberating
potential systemic risks to the financial stability of the U.S.
Briefings and discussions on potential risks and the
implications of current market developments--such as recent
events in Japan, the Middle East, and Northern Africa--on
financial stability are a key part of the closed deliberations
of each Council meeting, allowing for a free exchange of
information and insights. As part of these discussions, members
assess the likelihood and magnitude of the risks, the need for
additional data or analysis, and whether there is a current
need to supplement or redirect current actions and supervisory
oversight to mitigate these risks. In addition, the Council's
Data Subcommittee has overseen the development and production
of a standard set of analyses that FSOC members receive prior
to each Council meeting that summarize current conditions and
trends related to the macroeconomic and financial environment,
financial institutions, financial markets, and the
international economy.
Annual Systemic Risk Report--Section 112 of the Dodd-Frank
Act requires the FSOC to annually report to and testify before
Congress on the activities of the Council; significant
financial market and regulatory developments; potential
emerging threats to the financial stability of the United
States; all determinations regarding systemically important
non-bank financial firms or financial market utilities or
payment, clearing and settlement activities; any
recommendations regarding supervisory jurisdictional disputes;
and recommendations to enhance the integrity, efficiency,
competitiveness, and stability of U.S. financial markets, to
promote market discipline, and to maintain investor confidence.
Work is under way in preparing the first of these reports and
much of the aforementioned work on systemic risk monitoring
will help shape its content. It is our understanding that
Treasury plans to issue the report later this year.
Consultative and Regulatory Coordination--FSOC and its
committees have also facilitated consultation and coordination
on a number of important Dodd-Frank Act rulemakings. For
example, Treasury played a coordinating role in the recently
released notice of proposed rulemaking that would implement
section 941 on credit risk retention, and is engaged in a
similar role with respect to the Volcker rulemaking activities.
As part of each Deputies Committee meeting, Treasury circulates
a bi-weekly consultation report that provides a snapshot of
pending rules for consultation. In this regard, the Council's
Resolution Authority/Resolution Plans Committee has provided
input to the FDIC and FRB, and recommendations to the Council,
on issues related to the various Title II rulemaking
initiatives. These have included input on the FDIC's and FRB's
recent joint rulemaking to implement resolution plan
requirements for certain non-bank financial companies and bank
holding companies pursuant to Section 165(d) and the FDIC's
rulemakings on its orderly liquidation authority pursuant to
Section 209.
V. Conclusion
The Dodd-Frank Act has assigned FSOC important duties and
responsibilities to help promote the stability of the U.S. financial
system. The issues that the Council will confront in carrying out these
duties are, by their nature, complex and far-reaching in terms of their
potential effects on our financial markets and economy. Developing
appropriate and measured responses to these issues will require
thoughtful deliberation and debate among the members. The OCC is
committed to providing its expertise and perspectives and in helping
the Council achieve its mission.
______
PREPARED STATEMENT OF MARY L. SCHAPIRO
Chairman, Securities and Exchange Commission
May 12, 2011
Chairman Johnson, Ranking Member Shelby, Members of the Committee:
Thank you for the opportunity to testify \1\ regarding the
Securities and Exchange Commission's efforts to monitor systemic risk
and promote financial stability, two functions that are critical in
fulfilling our mission to protect investors, maintain fair, orderly,
and efficient markets, and facilitate capital formation. Over the past
few years, all financial regulators have been faced with key issues of
systemic risk and financial stability. At the SEC, our activities have
included a broad-based appraisal of both the strengths and weaknesses
of our current equity market structure, and our capacity to monitor
trading across all trading venues and to enforce the securities laws
and regulations and self-regulatory organization (SRO) rules.
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\1\ The views expressed in this testimony are those of the Chairman
of the Securities and Exchange Commission, a member of FSOC, and do not
necessarily represent the views of the full Commission.
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With the passage of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (``Dodd-Frank Act''), Congress provided the SEC with
important tools to better meet the challenges of today's financial
marketplace. These provisions included a mandate for oversight of the
over-the-counter derivatives marketplace, private fund adviser
registration and reporting, and rulemakings related to nationally
recognized statistical rating organizations (``NRSROs''). Additionally,
Title I of the Dodd-Frank Act created the Financial Stability Oversight
Council (``FSOC''), and with it, a formal structure for coordination
amongst the various financial regulators to monitor systemic risk and
to promote financial stability across our nation's financial system.
Each of these developments has enhanced the Commission's ability to
protect America's investors and oversee financial markets.
Strengthening Market Structure
Market structure encompasses all aspects of the organization of a
market, including the number and types of venues that trade a financial
product and the rules by which they operate. Although these issues can
be complex and the rules technical, a fair, orderly and efficient
market structure is the backbone of the equity markets and has
significant implications for our financial system more broadly. The
Commission has undertaken a broad-based appraisal of both the strengths
and weaknesses of our current equity market structure. This review
includes an evaluation of recent market structure performance and an
assessment of whether rules have kept pace with recent significant
changes in trading technology and practices. The goal of this
evaluation is to effectively address any market structure weaknesses
while preserving its strengths.
In addition, last year, the SEC published a concept release on
equity market structure in (the ``Concept Release''). The Concept
Release described the current market structure and then broadly
requested comment from the public on three categories of issues: (1)
the quality of performance of the current market structure, (2) high
frequency trading, and (3) undisplayed liquidity in all its forms.
To date, the Commission has received more than 200 comments in
response to the Concept Release. A number of commenters identified
benefits of the current market structure, in particular noting that it
has fostered competition among trading venues and liquidity providers
that has lowered spreads and brokerage commissions. These investors
cautioned against regulatory changes that might lead to unintended
consequences. Other commenters, however, raised concerns about the
quality of price discovery and questioned whether the current market
structure continues to offer a level playing field to investors in
which all can participate meaningfully and fairly. These commenters
suggested a variety of possible initiatives.
The Commission continues to evaluate these issues in a responsible,
timely, and comprehensive fashion, with particular focus on obtaining
the appropriate data and analysis to support our decisions to proceed
with or to table any particular initiative.
Responses to May 6 Trading Disruption
Just over 1 year ago, the U.S. equity markets experienced one of
the most significant price declines and reversals since 1929. In
September, the staffs of the SEC and the Commodity Futures Trading
Commission (CFTC) published their second joint report on their inquiry
into the day's events. Producing the report required an extraordinary
amount of staff resources. On the securities side in particular, much
of the time and effort was devoted to collecting and then painstakingly
sifting through the data necessary to reconstruct trading. These
efforts highlighted the pressing need for enhanced data functionalities
in the securities markets.
The joint report lays out the multiple factors that in our view
significantly contributed to the liquidity failure and disruptive
trading on that day, outlining the complex interplay of multiple
factors across the securities and futures markets. This interplay is
significant because it demonstrates the need for a multi-faceted
regulatory response that addresses the full scope of the risks in a
comprehensive and responsible way.
It is vital that the rules that govern market structure and market
participant behavior support equity markets that warrant the full
confidence of investors and listed companies. The Commission recently
has adopted a number of important initiatives to further this goal:
Less than 2 weeks after May 6, the Commission posted for
comment proposed exchange rules that would halt trading for
certain individual stocks if their price moved 10 percent in a
5-minute period. Barely more than 6 weeks after the event,
exchanges began putting in place a pilot uniform circuit
breaker program for S&P 500 stocks. In September, the program
was extended to stocks in the Russell 1000 Index and specified
exchange-traded products. The aim of this program is to halt
trading under disorderly market conditions, which in turn
should help restore investor confidence by ensuring that
markets operate only when they can effectively carry out their
critical price-discovery functions.
In September, the Commission approved pilot exchange rules
designed to bring order and transparency to the process of
breaking ``clearly erroneous'' trades. On May 6, nearly 20,000
trades were invalidated for stocks that traded 60 percent or
more away from their price at 2:40 PM. That 60 percent
benchmark, however, was set after the fact. We now have
consistent rules in place governing clearly erroneous trades
that will apply to a future disruption.
In November, the Commission approved exchange rules to
enhance the quotation standards for market makers. In
particular, the new rules eliminate ``stub quotes''--a bid to
buy or an offer to sell a stock at a price so far away from the
prevailing market that it is not intended to be executed, such
as a bid to buy at a penny or an offer to sell at $100,000.
Executions against stub quotes represented a significant
proportion of the trades that were executed at extreme prices
on May 6 and were subsequently broken.
Also in November, the Commission took an important step to
promote market stability by adopting a new market access rule.
Broker-dealers that access the markets themselves or offer
market access to customers will be required to put in place
appropriate pre-trade risk management controls and supervisory
procedures. The rule effectively prohibits broker-dealers from
providing customers with ``unfiltered'' access to an exchange
or alternative trading system. By helping ensure that broker-
dealers appropriately control the risks of market access, the
rule should prevent broker-dealers or their customers from
engaging in practices that threaten the financial condition of
other market participants and clearing organizations, as well
as the integrity of trading on the securities markets.
In addition, the Commission recently proposed exchange and
FINRA rules that provide for a limit up/limit down procedure
that would directly prohibit trades outside specified
parameters, while allowing trading to continue within those
parameters. This procedure should prevent many anomalous trades
from ever occurring, as well as limiting the disruptive effect
of those that do occur.
In addition to these rules, the Commission has proposed large
trader reporting requirements and a consolidated audit trail system to
improve our ability to regulate the equity markets. These proposals
would tremendously enhance regulators' ability to identify significant
market participants, collect information on their activity, and analyze
their trading behavior. Both of these initiatives seek to address
significant shortcomings in the agency's present ability to collect and
monitor data in an efficient and scalable manner and to address
discrete market structure problems.
Today, there is not a standardized, automated system to collect
data across the various trading venues, products and market
participants. Some, but not all, markets have their own individual and
often incomplete audit trails. As a result, regulators tracking
suspicious activity or reconstructing an unusual event must obtain and
merge a sometimes immense volume of disparate data from a number of
different markets. And even then, the data does not always reveal who
traded which security, and when. To obtain individual trader
information the Commission must make a series of manual requests that
can take days or even weeks to fulfill. In brief, the Commission's
tools for collecting data and surveilling our markets do not
incorporate the technology currently used by those we regulate.
Further, they do not provide the Commission with adequate information
to conduct timely reconstructions of market events.
If implemented, the consolidated audit trail would, for the first
time, allow SROs and the Commission to track trade data across multiple
markets, products and participants simultaneously. It would allow us to
rapidly reconstruct trading activity and to more quickly analyze both
suspicious trading and unusual market events. It is important to
recognize, however, that implementation of the consolidated audit trail
is a significant undertaking, and thus will need to be implemented in
phases over time. In addition, in order to obtain the maximum benefit
from this new infrastructure, the Commission's own technology and human
resources will need to be expanded beyond their current levels.
Finally, a principal lesson of the financial crisis is that,
because today's financial markets and their participants are dynamic,
fast-moving, and innovative, the regulators who oversee them must
continuously improve their knowledge and skills to regulate
effectively. In response to the ever-changing nature of our financial
system, the SEC's Office of Compliance, Investigations and Examinations
and our Division of Enforcement have adopted new approaches to promote
fair, orderly and efficient operation of the markets.
New Tools Provided by the Dodd-Frank Act
The Dodd-Frank Act includes over 100 rulemaking provisions
applicable to the SEC. Several of those provisions will play an
important role in enhancing the Commission's ability to mitigate
systemic risk and promote financial stability.
Over-The-Counter Derivatives. The Dodd-Frank Act mandates oversight
of the OTC derivatives marketplace. Title VII of the Act provides that
the Commission will regulate security-based swaps and the CFTC will
regulate other swaps. To implement the security based swap provisions,
the SEC is writing rules that address, among other things, mandatory
clearing, the operation of security-based swap execution facilities and
data repositories, capital and margin requirements and business conduct
standards for security-based swap dealers and major security-based swap
participants, and regulatory access to and public transparency for
information regarding security-based swap transactions. This series of
rulemakings should improve transparency and facilitate the centralized
clearing of security-based swaps, helping, among other things, to
reduce counterparty risk. It should also enhance investor protection by
increasing disclosure regarding security-based swap transactions and
helping to mitigate conflicts of interest involving security-based
swaps. In addition, these rulemakings should establish a regulatory
framework that allows OTC derivatives markets to continue to develop in
a more transparent, efficient, accessible, and competitive manner.
Private Fund Adviser Registration and Reporting. Under Title IV of
the Dodd-Frank Act, hedge fund advisers and private equity fund
advisers will be required to register with the Commission, which is
expected to occur in the first quarter of 2012. Under the Act, venture
capital fund advisers and private fund advisers with less than $150
million in assets under management in the United States will be exempt
from the new registration requirements. In addition, family offices
will not be subject to registration. To implement these provisions, the
Commission has proposed:
Amendments to Form ADV, the investment adviser registration
form, to facilitate the registration of advisers to hedge funds
and other private funds and to gather information about these
private funds, including identification of the private funds'
auditors, custodians and other ``gatekeepers;''\2\
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\2\ See Release No. IA-3110, Rules Implementing Amendments to the
Investment Advisers Act of 1940 (November 19, 2010), http://
www.sec.gov/rules/proposed/2010/ia-3110.pdf.
To implement the Act's mandate to exempt from registration
advisers to private funds with less than $150 million in assets
under management in the United States; \3\
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\3\ See id.
A definition of ``venture capital fund'' to distinguish
these funds from other types of private funds;\4\ and
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\4\ See Release No. IA-3111, Exemptions for Advisers to Venture
Capital Funds, Private Fund Advisers with Less Than $150 Million in
Assets Under Management and Foreign Private Advisers (November 19,
2010), http://www.sec.gov/rules/proposed/2010/ia-3111.pdf.
A rule to exempt ``family offices'' and a definition of
``family office'' that focuses on firms that provide investment
advice to family members (as defined by the rule), certain key
employees, charities and trusts established by family members
and entities wholly owned and controlled by family members.\5\
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\5\ See Release No. IA-3098, Family Offices (October 12, 2010);
http://www.sec.gov/rules/proposed/2010/ia-3098.pdf.
In addition, following consultation with staff of the member
agencies of the Financial Stability Oversight Council (FSOC), the
Commission and CFTC jointly proposed rules to implement the Act's
mandate to require advisers to hedge funds and other private funds to
report information for use by the FSOC in monitoring for systemic risk
to the U.S. financial system.\6\ The proposal, which builds on
coordinated work on hedge fund reporting conducted with international
regulators, would institute a ``tiered'' approach to gathering the
systemic risk data, which would remain confidential. Thus, the largest
private fund advisers--those with $1 billion or more in hedge fund,
private equity fund, or ``liquidity fund'' assets--would provide more
comprehensive and more frequent systemic risk information than other
private fund advisers.
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\6\ See Release No. IA-3145, Reporting by Investment Advisers to
Private Funds and Certain Commodity Pool Operators and Commodity
Trading Advisors on Form PF (January 26, 2011), http://www.sec.gov/
rules/proposed/2011/ia-3145.pdf.
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Financial Stability Oversight Council
FSOC was created by Title I of the Dodd-Frank Act and has 10 voting
members: the senior officials at each of the nine Federal financial
regulators\7\ and an independent member with insurance expertise
appointed by the President. FSOC's composition also includes five
nonvoting advisory members: three from various State financial
regulators \8\ as well as the Directors of the new Federal Insurance
Office and Office of Financial Research (``OFR'').\9\
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\7\ The senior officials are the Secretary of the Treasury
(Chairperson); Chairman of the Board of Governors of the Federal
Reserve; Comptroller of the Currency; Director of the Consumer
Financial Protection Bureau; Chairman of the Securities and Exchange
Commission; Chairperson of the Federal Deposit Insurance Corporation;
Chairperson of the Commodity Futures Trading Commission; Director of
the Federal Housing Finance Agency; and Chairman of the National Credit
Union Administration. See Dodd-Frank Act 111(b)(1).
\8\ The State financial regulators include a State insurance
commissioner designated by the State insurance commissioners; a State
banking supervisor designated by the State banking regulators; and a
State securities commissioner designated by the State securities
commissioners. See Dodd-Frank Act 111(b)(2).
\9\ See Dodd-Frank Act 111(b)(2).
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Under the Dodd-Frank Act, Congress has given FSOC the following
primary responsibilities:
identifying risks to the financial stability of the United
States that could arise from the material financial distress or
failure--or ongoing activities--of large, interconnected bank
holding companies or nonbank financial holding companies, or
that could arise outside the financial services marketplace;
promoting market discipline by eliminating expectations on
the part of shareholders, creditors, and counterparties of such
companies that the Government will shield them from losses in
the event of failure (i.e., addressing the moral hazard problem
of ``too big to fail''); and
identifying and responding to emerging threats to the
stability of the United States financial system.\10\
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\10\ See Dodd-Frank Act 112(a)(1).
In fulfilling its responsibilities, FSOC is charged with
identifying and designating certain nonbank financial companies as
systemically important financial institutions (``SIFIs'') for
heightened prudential supervision by the Board of Governors of the
Federal Reserve System (``Federal Reserve Board'').\11\ In addition,
FSOC may make recommendations to the Federal Reserve Board concerning
the establishment and refinement of heightened prudential standards for
firms designated under the SIFI process and large, interconnected bank
holding companies already supervised by the Federal Reserve Board.\12\
Such recommendations may address, among other things, risk-based
capital, leverage, liquidity, contingent capital, resolution plans and
credit exposure reports, concentration limits, enhanced public
disclosures and overall risk management.\13\ In addition, FSOC must
identify and designate financial market utilities (``FMUs'') and
payment, clearing, and settlement activities that are, or are likely to
become, systemically important.\14\
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\11\ See Dodd-Frank Act 112(a)(2)(H) and 113.
\12\ See Dodd-Frank Act 112(a)(2)(I).
\13\ See id.
\14\ See Dodd-Frank Act 112(a)(2)(J) and 804(a).
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The recent financial crisis demonstrated the potential for risks to
quickly spread across the financial sector and undermine general
confidence in the financial system. To address issues of ``siloed''
information and the potential for regulatory arbitrage, another key
responsibility of FSOC is to monitor the financial markets and
regulatory framework to identify gaps, weaknesses and risks and make
recommendations to address those issues to its member agencies and to
Congress.\15\ In addition, by combining the information resources of
its member agencies and working with the OFR, FSOC is responsible for
facilitating the collection and sharing of information about risks
across the financial system.\16\
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\15\ See Dodd-Frank Act 112(a)(2)(C)-(G).
\16\ See Dodd-Frank Act 112(a)(2)(A)-(B).
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FSOC Activities Update
Since passage of the Dodd-Frank Act, FSOC has taken steps to create
an organizational structure, coordinate interagency efforts, and build
the foundation for meeting its statutory responsibilities. In the weeks
leading up to the inaugural October 1, 2010 meeting of the principals
of the FSOC agencies, staff from the Treasury Department coordinated
interagency staff work to establish by-laws and develop a transparency
policy. During that period, FSOC also formed several interagency
committees to address specific statutory requirements.
Designation of Systemically Important Financial Institutions
To begin defining and implementing the process to identify and
designate SIFIs for heightened supervision by the Federal Reserve
Board, FSOC established a SIFI designations committee and several staff
subcommittees to tackle specific tasks.
On October 6, 2010, FSOC issued an advanced notice of proposed
rulemaking soliciting public comment on the specific criteria and
analytical framework for the SIFI designation process, with a focus on
how to apply the statutory considerations for such designations. FSOC
received over 50 comment letters from trade associations, financial
firms, individuals, and others. These comment letters included views on
the designation process itself, as well as suggestions on the specific
criteria and metrics to be used and the frameworks for their
application.
On January 26, 2011, FSOC issued a notice of proposed rulemaking
regarding the SIFI designation process. The proposed rule describes the
criteria that will inform--and the processes and procedures established
under the Dodd-Frank Act for--designations by FSOC. Such criteria would
be rooted in the eleven statutory considerations set forth in the Dodd-
Frank Act for such designations, and would include, among other
considerations, a firm's size, leverage, liquidity risk, maturity
mismatch, and interconnectedness with other financial firms. The
proposed rule also implements certain other provisions of the
designation process, including: (1) the anti-evasion authority of FSOC;
(2) procedures for notice of, and the opportunity for a hearing on, a
proposed determination; and (3) procedures regarding consultation,
coordination, and judicial review in connection with a determination.
We plan to provide additional guidance regarding the Council's approach
to designations and will seek public comment on it.
Designation of Systemically Important Financial Market Utilities
Financial Market Untilities (FMUs) are essential to the proper
functioning of the nation's financial markets.\17\ These utilities form
critical links among marketplaces and intermediaries that can
strengthen the financial system by reducing counterparty credit risk
among market participants, creating significant efficiencies in trading
activities, and promoting transparency in financial markets. However,
FMUs by their nature create and concentrate new risks that could affect
the stability of the broader financial system. To address these risks,
Title VIII of the Dodd-Frank Act provides important new enhancements to
the regulation and supervision of FMUs designated as systemically
important by FSOC (``DFMUs'') and of payment, clearance and settlement
activities. This enhanced authority in Title VIII should provide
consistency, promote robust risk management and safety and soundness,
reduce systemic risks, and support the stability of the broader
financial system.\18\ Importantly, the enhanced authority in Title VIII
is designed to be in addition to the authority and requirements of the
Securities Exchange Act and Commodity Exchange Act that may apply to
FMUs and financial institutions that conduct designated activities.\19\
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\17\ Section 803(6) of the Dodd-Frank Act defines a financial
market utility as ``any person that manages or operates a multilateral
system for the purpose of transferring, clearing, or settling payments,
securities, or other financial transactions among financial
institutions or between financial institutions and the person.''
\18\ See Dodd-Frank Act 802.
\19\ See Dodd-Frank Act 805.
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FSOC established an interagency DFMU committee to develop a
framework for the designation of systemically important FMUs, in which
staff from the SEC has actively participated. On December 21, 2010,
FSOC published an advanced notice of proposed rulemaking seeking public
comment on the designation process for FMUs. In response, FSOC received
twelve comment letters from industry groups, advocacy and public
interest groups, individual FMUs and financial institutions. Among
other things, commenters generally encouraged the development of
metrics and an analytical framework to further define the statutory
considerations for designation contained in Title VIII, and also
emphasized the need for FSOC to apply consistent standards for all FMUs
under consideration for designation that incorporate both qualitative
and quantitative factors.
On March 28, 2011, FSOC published a notice of proposed rulemaking
to provide further information on the process it proposed to follow
when reviewing the systemic importance of FMUs. FSOC is considering
using a two-stage process for evaluating FMUs prior to a vote on a
proposed designation by the Council. The first stage would consist of a
largely data-driven process to identify a preliminary set of FMUs whose
failure or disruption could potentially threaten the stability of the
U.S. financial system. In the second stage, FMUs so identified would be
subject to a more in-depth review, with a greater focus on qualitative
factors and FMU- and market-specific considerations. Under the
proposal, the Council expects to use the statutory considerations as a
base for assessing the systemic importance of FMUs.\20\ Application of
this framework, however, would be adapted for the risks presented by a
particular type of FMU and business model.
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\20\ Section 804(a)(2) of the Dodd Frank Act provides that these
considerations are: (1) the aggregate monetary value of transactions
processed by the FMU or carried out through the PCS activity; (2) the
aggregate exposure of the FMU or a financial institution engaged in PCS
activities to its counterparties; (3) the relationship,
interdependencies, or other interactions of the FMU or PCS activity
with other FMUs or PCS activities; (4) the effect that the failure of
or a disruption to the FMU or PCS activity would have on critical
markets, financial institutions, or the broader financial system; and
(5) any other factors that FSOC deems appropriate.
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Systemic Risk Assessment
In addition to initiating work on the identification of SIFIs and
DFMUs, FSOC has established a Systemic Risk Committee that seeks to
identify, highlight and review possible risks that could develop across
the financial system. The Dodd-Frank Act also requires FSOC to report
annually to Congress regarding these risks,\21\ and we expect the work
of this committee will inform that report.
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\21\ See Dodd-Frank Act 112(a)(2)(N).
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Other Activities
In addition to seeking to identify possible risks in the financial
system, FSOC was required under Section 619(b) of the Dodd Frank Act to
study and make recommendations on implementing the Act's restrictions
on proprietary trading, commonly referred to as the ``Volcker rule,''
to achieve certain goals enumerated in the statute, including:
to promote and enhance the safety and soundness of banking
entities;
protect taxpayers and consumers; and
enhance financial stability by minimizing the risk that
insured depository institutions and their affiliates will
engage in unsafe and unsound activities.
On January 18, 2011, FSOC released its study and recommendations on
implementation of the Volcker rule. The study recommends the creation
of rules and a supervisory framework that effectively prohibit
proprietary trading activities throughout ``banking entities''--as
defined by the Dodd-Frank Act--and appropriately distinguish prohibited
proprietary trading from statutorily described permitted activities.
The recommended supervisory framework consists of a programmatic
compliance regime, metrics, supervisory review and oversight, and
enforcement procedures for violations for the respective regulatory
agencies conducting supervisory review and oversight. In addition, the
study identified potential challenges in delineating prohibited
proprietary trading activities from permitted activities, including
potential difficulties in determining whether a position was taken in
anticipation of near term customer demand or for non-permissible prop
trading purposes.
The study also recognizes that effective oversight by the agencies
will require specialized skills and be resource intensive. For example,
the study notes agencies will need additional resources to develop
appropriate data points, build infrastructure to obtain and review
information, and hire and train additional staff with quantitative and
market expertise to identify and investigate outliers and questionable
trading activity.
Money Market Fund Roundtable
Earlier this week, the SEC hosted a Money Market Fund Roundtable,
which included representatives of each of the voting members of FSOC.
The roundtable featured an in-depth discussion of various policy
options to address the risk that a run on money market funds could have
on the broader financial markets. Participants at the roundtable
included money market fund sponsors, investors, academics, industry
observers and representatives from entities that issue the commercial
paper in which many money market funds invest. The roundtable enabled
SEC Commissioners, FSOC principals and their representatives to discuss
first-hand--and in a public forum--a significant issue related to the
ongoing monitoring of systemic risk. I look forward to continued work
on coordination with FSOC with respect to money market funds.
Next Steps
While FSOC has made substantial progress in taking up its new
responsibilities, its efforts are ongoing, and much remains to be done.
Some of the most challenging issues regarding the potential designation
of systemically important financial institutions and FMUs lie ahead,
and public input both generally on this process--and specifically with
respect to the notices of proposed rulemaking--will be critically
important. In addition, as Dodd-Frank implementation proceeds, the
coordination of the FSOC agencies will continue to be a vital
consideration.
Conclusion
In sum, the Commission recognizes the importance of monitoring
systemic risk and promoting financial stability, and has responded to
the challenges presented by recent market developments. As the
Commission moves forward, we will look comprehensively at the issues,
and take appropriate steps, both within the Commission and with our
regulatory partners in the FSOC, to address any threats to our nation's
financial system in a balanced manner that preserves the strengths of
the system and protects investors. As we move ahead, we look forward to
working closely with Congress to continue addressing these critical
issues. Thank you for inviting me to testify today. I would be happy to
answer any questions you may have.
______
PREPARED STATEMENT OF GARY GENSLER
Chairman, Commodity Futures Trading Commission
May 12, 2011
Good morning Chairman Johnson, Ranking Member Shelby and Members
of the Committee. I thank you for inviting me to today's hearing on
monitoring systemic risk and promoting financial stability. I am
pleased to testify alongside my fellow regulators.
This morning I will provide an update on the status of the
Commodity Futures Trading Commission's (CFTC's) process to implement
the derivatives titles of the Dodd-Frank Wall Street Reform and
Consumer Protection Act and discuss the how the CFTC has contributed to
the Financial Stability Oversight Council (FSOC). Before I begin, I'd
like to thank my fellow Commissioners the hardworking staff of the CFTC
for their continued efforts to implement the Dodd-Frank Act.
Dodd-Frank Implementation Status
The CFTC is working deliberatively, efficiently and transparently
to implement the Dodd-Frank Act. At this point, we have substantially
completed the proposal phase of our rule-writing to implement the Dodd-
Frank Act. Since the President signed the Dodd-Frank Act last July, the
Commission has promulgated rules covering all of the areas set out by
the Act for swaps regulation, with the exception of the Volcker Rule,
for which the Act set a different timeline.
With the substantial completion of the proposal phase of rule-
writing, the public now has the opportunity to review the whole mosaic
of rules. This will allow market participants to evaluate the entire
regulatory scheme as a whole.
To further facilitate this process, last month the Commission
approved reopening or extending the comment periods for most of our
Dodd-Frank proposed rules for an additional 30 days.
This time will allow the public to submit any comments they might
have after seeing the entire mosaic at once. As part of this, I am
hopeful that market participants will continue to comment about
potential compliance costs as well as phasing of implementation dates
to help the agency as we go forward with finalizing rules.
We will begin considering final rules only after staff can analyze,
summarize and consider comments, after the Commissioners are able to
discuss the comments and provide feedback to staff, and after the
Commission consults with fellow regulators on the rules.
One component that we have asked the public about is phasing of
rule implementation. Earlier this month, CFTC staff worked with SEC
staff to host a roundtable to hear directly from the public about the
timing of implementation dates of Dodd-Frank rulemakings. Prior to the
roundtable, CFTC staff released a document that set forth concepts that
the Commission may consider with regard to the effective dates of final
rules for swaps under the Dodd-Frank Act. We also opened a public
comment file last month to hear specifically on this issue. The
roundtable and public comments help inform the Commission as to what
requirements can be met sooner and which ones will take a bit more
time.
Though we have substantially completed the proposal phase of rule-
writing, the public will not be adequately protected until the agency
completes final rules.
Rules Relating to Systemic Risk
The CFTC has proposed rules in three primary areas that are
intended, in part, to lower systemic risk: regulating swap dealers,
promoting transparency in the swap markets and requiring clearing of
standardized swaps.
Regulating Swap Dealers
The financial crisis demonstrated the risk to the public of
ineffectively regulated swap dealers. The Dodd-Frank Act addresses this
by requiring comprehensive oversight of swap dealers. The CFTC has
proposed rules to fulfill the Dodd-Frank Act's mandate that dealers
meet minimum capital requirements to prevent a dealer's failure. We
also have proposed rules mandated by the Dodd-Frank Act to require
margin--or collateral--requirements to help prevent one financial
entity's failure from spreading through the financial system to other
entities and the broader economy. Congress recognized the different
levels of risk posed by transactions between financial entities and
those that involve non-financial entities, as reflected in the non-
financial end-user exception to clearing. Consistent with this, the
CFTC's proposed margin rules focus only on transactions between
financial entities rather than those transactions that involve non-
financial end-users. Further, we have proposed business conduct
standards, including documentation, confirmation and portfolio
reconciliation requirements. Each of these is an important tool to
lower risk that the swap markets pose to the economy.
We also have proposed rules under the Dodd-Frank Act that set
business conduct rules and set position limits to promote market
integrity and protect against fraud, manipulation and other abuses.
This helps ensure that the users of derivatives get the benefit of
transparent, open and competitive markets.
Promoting Transparency
The Dodd-Frank Act includes essential reforms to bring sunshine to
the opaque swaps markets. Economists and policymakers for decades have
recognized that market transparency benefits the public. Transparency
also helps lower systemic risk. The more transparent a marketplace is,
the more liquid it is for standardized instruments, the more
competitive it is and the lower the costs for hedgers, borrowers and,
ultimately, their customers.
The CFTC has proposed rules to implement the Dodd-Frank Act's
mandate to bring transparency to the swaps market in each of the three
phases of a transaction. First, we have proposed rules to bring
transparency to the time immediately before the transactions are
completed, so-called pre-trade transparency. This will be required for
those standardized swaps--those that are cleared, made available for
trading and not blocks--that the Dodd-Frank Act mandates be traded on
exchanges or swap execution facilities (SEFs).
Exchanges and SEFs will allow investors, hedgers and speculators to
meet in a transparent, open and competitive central market. This will
benefit end-users by providing better pricing on derivatives
transactions.
Second, as required by the Dodd-Frank Act, the CFTC has written
rules to bring real-time transparency to the pricing immediately after
a swap transaction takes place. This post-trade transparency provides
all end-users and market participants with important pricing
information as they consider whether to lower their risk through a
similar transaction.
Third, the CFTC has proposed rules as mandated by the Dodd-Frank
Act to bring transparency to swaps over the lifetime of the contracts.
End-users and the public will benefit from knowing the valuations of
outstanding swaps on a daily basis. If the contract is cleared,
proposed rules would require the clearinghouse to publicly disclose the
daily settlement price for each swap cleared by the clearinghouse. If
the contract is bilateral, proposed rules would require swap dealers to
share mid-market pricing with their counterparties every day and agree
on valuation methodologies in their swap documentation. This daily
valuation will help prevent similar scenarios to 2008 when we were
unable to price ``toxic assets.''
Additionally, we have proposed rules to make the swaps markets
transparent to regulators through swap data repositories. The Dodd-
Frank Act Act includes robust recordkeeping and reporting requirements
for all swaps transactions so that regulators can have a window into
the risks posed in the system and can police the markets for fraud,
manipulation and other abuses.
Lowering Risk through Central Clearing
The Dodd-Frank Act also requires that standardized swap
transactions between financial entities be brought to clearinghouses.
Central clearing has been a feature of the U.S. futures markets since
the late-19th century. Clearinghouses act as middlemen between two
parties to a derivatives transaction after the trade is arranged. They
protect the financial system and the broader economy from the failure
of a swap dealer. They require dealers to post collateral so that if
one party fails, its failure does not harm its counterparties and
reverberate throughout the financial system. They have functioned both
in clear skies and during stormy times--through the Great Depression,
numerous bank failures, two world wars and the 2008 financial crisis--
to lower risk to the economy.
Currently, swap transactions stay on the books of the dealers that
arrange them, often for many years after they are executed. Like AIG
did, these dealers engage in many other businesses, such as lending,
underwriting, asset management, securities trading and deposit-taking.
These dealers often are interconnected with other financial entities.
This interconnectedness heightens the risk that a dealer's failure will
reverberate throughout the economy as a whole. Uncleared swaps allow
the failure of one institution to potentially cascade, like dominoes,
throughout the financial system and ultimately crash down on the
public.
The CFTC has proposed rules to implement the Dodd-Frank Act's
clearing mandate and its requirement for enhanced oversight of
clearinghouses. In close consultation with our fellow domestic and
international regulators, and particularly with the Federal Reserve and
the Securities and Exchange Commission (SEC), the CFTC proposed
rulemakings on risk management for clearinghouses. These rulemakings
take account of relevant international standards, particularly those
developed by the Committee on Payment and Settlement Systems and the
International Organization of Securities Commissions.
The Financial Stability Oversight Council
The Dodd-Frank Act established the FSOC to ensure protections for
the American public. The Council is an opportunity for regulators--now
and in the future--to ensure that the financial system works better for
all Americans. The financial system should be a place where investors
and savers can get a return on their money. It should provide
transparent and efficient markets where borrowers and people with good
ideas and business plans can raise needed capital.
The financial system also should allow people who want to hedge
their risk to do so without concentrating risk in the hands of only a
few financial firms. One of the challenges for the Council and for the
American public is that the financial industry has gotten very
concentrated around a small number of very large firms. As it is
unlikely that we could ever ensure that no financial institution will
fail--because surely, some will in the future--we must do our utmost to
ensure that when those challenges arise, the taxpayers are not forced
to stand behind those institutions and that these institutions are free
to fail.
There are important decisions that the Council will make, such as
determinations about systemically important nonbank financial companies
and systemically important financial market utilities, such as
clearinghouses, resolving disputes between agencies and completing
important studies as dictated by the Dodd-Frank Act. Though these
specific decisions are important, to me it is essential that the
Council make sure that the American public doesn't bear the risk of the
financial system and that the system works for the American public, for
investors, for small businesses, for retirees and for homeowners.
The Council's eight current voting members have coordinated
closely. Treasury's leadership has been invaluable. To support the
FSOC, the CFTC is providing both data and expertise relating to a
variety of systemic risks, how those risks can spread through the
financial system and the economy and potential ways to mitigate those
risks. We also have had the opportunity to coordinate with Treasury and
the Council on each of the studies and proposed rules issued by the
FSOC.
I will focus this portion of my testimony discussing a number of
matters that have been on the FSOC's agenda.
Clearinghouses
Title VIII of the Dodd-Frank Act gives the FSOC important roles in
clearinghouse oversight by authorizing the Council to designate certain
clearinghouses as systemically important. Title VIII also permits the
Federal Reserve to join in the examination of such clearinghouses and
to recommend heightened prudential standards in certain circumstances.
The FSOC's notice of proposed rulemaking on designating
systemically important financial market utilities complements the
CFTC's rulemaking efforts that I described above. Public input will be
valuable in determining how the Council should apply statutory criteria
to determine which clearinghouses qualify for designation as
systemically important.
Volcker Rule Study
Section 619 of the Dodd-Frank Act provides that, other than certain
permitted activities, ``a banking entity shall not engage in
proprietary trading, including trading in futures, options on futures
and swaps.'' The CFTC is directed to adopt rules to carry out this
requirement with respect to any entity ``for which the CFTC is the
primary financial regulatory agency.''
As part of the Volcker rule's coordinated rulemaking requirement,
CFTC staff has been meeting frequently with other agencies, including
the Federal Deposit Insurance Corporation (FDIC), Federal Reserve,
Office of the Comptroller of the Currency (OCC), SEC and Treasury
Department. The goal of these meetings is to ensure, to the extent
possible, that our rules on section 619 are comparable and provide for
consistent application.
The FSOC's Study & Recommendations on Prohibitions on Proprietary
Trading & Certain Relationships with Hedge Funds & Private Equity
Funds, also known as the Volcker Rule study, provides thoughtful
recommendations to carry out Congress's intent to separate proprietary
trading from otherwise permitted activities of banking entities. The
study also provides a basis upon which each of our agencies can move
forward with the required rule-writing to carry out Congress's mandate.
In particular, the study covers financial instruments both in the
cash market and in the derivatives and swaps markets. This is
significant, as any risk that a banking entity could take on in the
cash markets also could be expressed through swaps and derivatives. The
inclusion of both prevents regulatory arbitrage. In addition, the study
indicates that the books of banking entities, including swap dealers,
would not be precluded from the definition of a trading account
regardless of whether those accounts held illiquid financial
instruments, such as swaps, and regardless of whether those positions
are short-term or long-term.
Supervision of Certain Nonbank Financial Companies and Concentration
Limits
Title I of the Dodd-Frank Act authorizes the FSOC to determine
whether certain activities of nonbank financial companies could pose a
threat to the financial stability of the United States. Those companies
would be supervised by the Federal Reserve and subject to specific
prudential standards. In January, the FSOC issued a proposed rulemaking
concerning its Authority to Require Supervision of Certain Nonbank
Financial Companies. Effective regulation of systemically important
nonbank financial entities is essential to preventing the next AIG from
threatening the financial system.
The Dodd-Frank Act also includes a provision that no financial
company be permitted to grow through either merger or acquisition if
the resulting companies' consolidated liabilities would exceed 10
percent of all the aggregate consolidated liabilities of all financial
companies. The FSOC's Study & Recommendations Regarding Concentration
Limits on Large Financial Companies is an important step in
implementing Congress's direction. These limits are designed to promote
financial stability by preventing the liabilities of the financial
sector from becoming too concentrated in any given financial entity.
The 2008 financial crisis demonstrated the potential repercussions to
the American public of concentration within our financial sector.
Annual FSOC Report to Congress
Under section 112 of the Dodd-Frank Act, the FSOC is to report
annually to Congress. Staff of the CFTC, including in our Chief
Economist's office, Division of Market Oversight, and Division of
Clearing and Intermediary Oversight, have been contributing to that
effort. I believe this annual report can serve as an important means
for the Council to communicate to Congress on the stability of the
financial system and make recommendations to enhance the U.S. financial
markets and protect the public.
Coordination with FSOC Member Agencies
The CFTC is consulting heavily with the member agencies of the FSOC
to implement the Dodd-Frank Act. We are working very closely with the
SEC, Federal Reserve, FDIC, OCC and other prudential regulators, which
includes sharing many of our memos, term sheets and draft work product.
We also are working closely with the Treasury Department and the new
Office of Financial Research. CFTC staff has had more than 600 meetings
with other regulators on implementation of the Act. This close
coordination has benefited the rulemaking process and will strengthen
the markets. The CFTC will consider final rules only after we have the
opportunity to consult with our fellow regulators.
Conclusion
Thank you for the opportunity to testify. I'd be happy to take
questions.
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM NEAL S.
WOLIN
Q.1. Currently one of the voting seats of the FSOC is empty; no
insurance expert has been nominated for the Council. Will any
decisions with respect to the designation of insurance
companies be made before an insurance expert has been named?
A.1. On June 27, the President nominated Roy Woodall as the
FSOC's independent member having insurance expertise. Mr.
Woodall is a former Commissioner of Insurance for the
Commonwealth of Kentucky. He has also served as a Senior
Insurance Policy Analyst at the Department of the Treasury, an
Insurance Consultant for the Congressional Research Service,
and as President of the National Association of Life Companies
(NALC). Expeditious Senate confirmation of Mr. Woodall to this
position will allow him to begin offering his considerable
expertise to the FSOC.
In the meantime, as the FSOC works carefully and
deliberately to satisfy its responsibilities under the Dodd-
Frank Act, two of its non-voting members have substantial
insurance expertise: Federal Insurance Office Director Michael
McRaith, who most recently served as the Director of the
Illinois Department of Insurance, provides relevant expertise
that helps inform the FSOC's work, and John Huff, the Director
of the Missouri Department of Insurance, Financial Institutions
and Professional Registration, offers the important perspective
of the primary functional insurance regulators.
Q.2 The SEC and CFTC are regulating an overlapping set of
market participants engaging in transactions in similar
products. They are taking two different approaches to the
regulatory mandates they have been given. Is the Council
considering whether the fact that two regulators are regulating
in the same space will dilute accountability and lead to
regulatory arbitrage that could endanger the financial system?
A.2. One of the duties of the FSOC, which the Secretary of the
Treasury chairs, is to facilitate information-sharing and
coordination among the member agencies regarding rulemaking,
examinations, reporting requirements, and enforcement actions.
However, while the Dodd-Frank Act establishes the FSOC as a
forum for collaboration and consultation, it also preserves the
independence of regulators such as the SEC and CFTC. The FSOC
has worked to develop an approach that recognizes that
independence while acting as a coordinator to facilitate a
consistent and integrated approach to implementation. The SEC
and CFTC, as independent regulators, are working together on
their derivatives rulemakings to develop a consistent approach
that reduces regulatory arbitrage. Treasury, as Chair of the
FSOC, has and will continue to prioritize coordination among
the regulators, including the SEC and CFTC on their derivatives
rulemakings, to promote financial stability and market
discipline.
Q.3. In your testimony you mentioned how valuable a recent
executive order by President Obama was in ``seeking to ensure
cost-effective, evidence-based regulations that are compatible
with economic growth, job creation, and competitiveness.'' What
are you doing to encourage the agencies charged with Dodd-Frank
rulemaking to undertake cost-effective, evidence-based
regulations that are compatible with economic growth, job
creation, and competitiveness? Will the FSOC's rulemaking be
subject to the executive order?
A.3. The Treasury Secretary has encouraged FSOC members to
adopt the principles and guidelines set forth in the
President's Executive Order 13563 of January 18, 2011
``Improving Regulation and Regulatory Review.'' Although the
Executive Order does not apply to independent regulatory
agencies, the Secretary encouraged all FSOC members agencies to
adopt the principles and guidelines it sets forth. In addition,
earlier this month, the President signed Executive Order 13579,
asking the independent regulatory agencies to follow the cost-
saving, burden-reducing principles in Executive Order 13563.
These priorities and guidelines can help strike the right
regulatory balance: ensuring that regulations improve the
performance of our economy and protect consumers and investors,
without imposing unreasonable costs on society.
The FSOC strives to perform its duties efficiently and
effectively in achieving its mandate under the Dodd-Frank Act
while avoiding undue burdens on the private sector. In
addition, the FSOC works to fulfill its statutory mandate under
the Dodd-Frank Act to coordinate across member agencies and,
where practicable, ensure consistent regulation.
Q.4. Your testimony mentions that the Council has begun
monitoring for potential risks to U.S. financial stability.
Please provide more detail about who is conducting the
monitoring, how it is being done, and how the monitoring
differs from monitoring that individual Council members
undertook prior to the establishment of the FSOC.
A.4. The Dodd-Frank Act established the FSOC as a forum for
regulators to work together on a permanent basis to identify
issues that could affect financial stability and impact the
economy. The FSOC members--nine Federal regulators, an
independent member with insurance expertise, the Office of
Financial Research (OFR) Director, the Federal Insurance Office
(FIO) Director, and State banking, insurance, and securities
supervisors--contribute their expertise about sectors and
institutions to develop a broader view of trends, risks, and
challenges in the financial system. The FSOC has collective
accountability for identifying, monitoring and responding to
threats to U.S. financial stability.
The FSOC has designed a collaborative structure to promote
the appropriate coordination, cooperation, information-sharing
and transparency necessary for FSOC members to identify,
analyze and respond to vulnerabilities in the system and
emerging threats to U.S. financial stability. The FSOC has
instituted a three-pronged committee structure: the Deputies
Committee, the Systemic Risk Committee and the standing
functional committees. These committees, which are composed of
staff of FSOC member agencies with supervisory, examination,
data, surveillance, and policy expertise, share information to
assess risks that affect financial markets and institutions.
The Systemic Risk Committee, with its subcommittees on
financial institutions and markets, is accountable for
interagency coordination and information-sharing regarding
issues that could impact financial stability. The OFR is also
working closely with the FSOC and member agencies to support
this work, including through the development of tools for risk
measurement and monitoring.
Q.5. The FSOC has an ambitious mandate. It is not clear how
this mandate will work in practice. Has the FSOC developed a
strategic plan for achieving its goals? If so, please provide
the plan.
A.5. The FSOC has identified goals that it is working
diligently to achieve. These goals include building an
effective forum for collaboration and coordination between its
members; carrying out the statutory requirements of the Dodd-
Frank Act; identifying, monitoring, and responding to potential
risks to U.S. financial stability; and laying the groundwork
for designations of nonbank financial companies and financial
market utilities.
To meet these goals, the FSOC has met six times since
inception, exceeding the statutory requirement. Each of the
FSOC member agencies has also designated a senior official to
serve on the Deputies Committee, which meets every 2 weeks to
discuss and make decisions that advance the FSOC's work. In
addition to the Deputies Committee, the FSOC has established a
Systemic Risk Committee and various standing functional
committees focused on policy areas including heightened
prudential standards, resolution, and data. These committees,
which are composed of member agency officials and staff who
have relevant supervisory, examination, data, surveillance, and
policy expertise, communicate and meet regularly to support the
FSOC's ongoing work. The FSOC's statutorily required annual
report, which the FSOC expects to release later this month,
will reflect the extensive discussions and analysis that have
occurred through this collaborative interagency process.
Q.6. The FSOC's transparency policy states that the FSOC will
close meetings, inter alia, under circumstances that
``necessarily and significantly compromise the mission or
purposes of the FSOC, as determined by the Chairman with the
concurrence of a majority of the voting member agencies or by a
majority of the voting member agencies.'' What types of
circumstances would call for holding closed meetings under this
provision of the transparency policy?
A.6. The FSOC's transparency policy states that a central
mission of the FSOC is to monitor risk and emerging threats to
U.S. financial stability. To fulfill this mission, the FSOC
will discuss confidential supervisory information and market-
sensitive data during Council meetings. This information may
concern individual firms, as well as specific transactions and
markets. Protection of this information is necessary to prevent
destabilizing market speculation that could occur if the
information were to be disclosed publicly. The FSOC is
committed to holding open meetings and will hold closed
meetings only when appropriate. It is important to note that
the FSOC has held four public meetings since its inception.
Q.7. In January, the Council issued a Notice of Proposed
Rulemaking Regarding Authority to Require Supervision and
Regulation of Certain Nonbank Financial Companies. There have
been questions about whether the Dodd-Frank Act gives the
Council the authority to adopt such a rule. Does the Council
have the authority to adopt this rule?
A.7. The FSOC has the authority to issue its proposed
regulations on the process for determining that a nonbank
financial company will be supervised by the Federal Reserve,
and to re-propose those rules for further public comment. The
FSOC has already exercised its rulemaking authority to issue a
notice of proposed rulemaking and plans to issue for further
public comment additional guidance regarding its approach to
designations of nonbank financial companies. The FSOC plans to
release a final rule and guidance that will reflect the input
received on its proposals.
Q.8. The Council has established a Deputies Committee and six
other standing committees. Please identify the members of the
Deputies Committee, the six committees, and their
subcommittees. Please also identify the permanent staff and
detailees on the FSOC staff and provide a synopsis of their
qualifications.
A.8. Each of the FSOC member agencies has designated a senior
official to serve on the Deputies Committee. Treasury has
designated Jeffrey Goldstein, the Under Secretary for Domestic
Finance. In addition to the Deputies Committee, the FSOC also
has established a Systemic Risk Committee and various standing
functional committees focused on policy areas including
heightened prudential standards, resolution, and data. These
committees are composed of member agency officials and staff
who have relevant supervisory, examination, surveillance, and
policy expertise. Moreover, the FSOC itself is supported by a
Treasury Deputy Assistant Secretary and a small number of
permanent career Government employees, all of whom have the
necessary experience and expertise to help coordinate and
implement the policies set by the FSOC members' agencies.
Finally, the FSOC member agencies have made various personnel
available through short-term detail arrangements to offer the
FSOC additional support and subject-matter expertise.
Q.9. Under Dodd-Frank, swap data repositories, before sharing
any information with a regulator other than their primary
regulator, must obtain an indemnification agreement with that
other regulator. Will this requirement adversely affect
regulators' ability to obtain a comprehensive view of the swaps
markets?
A.9. The Dodd-Frank Act requires swap data repositories (SDRs)
and security-based swap data repositories (SB-SDRs) to make
data available, on a confidential basis, to certain domestic
and foreign regulators. The Dodd-Frank Act further requires
regulators (other than the primary regulator) that request data
to execute a written confidentiality and indemnification
agreement with the SDR or SB-SDR prior to receiving any data.
The CFTC and the SEC have proposed rules for SDRs and SB-SDRs,
respectively, that require such confidentiality and
indemnification agreements (see 75 FR 80808 (December 23, 2010)
and 75 FR 77306 (December 10, 2010), respectively).
Both agencies acknowledged in their proposed rules that the
indemnification requirement could affect other regulators'
access to the information maintained by SDRs and SB-SDRs.
However, both agencies also highlighted the importance of
ensuring that other regulators have access to swap data to
carry out their regulatory mandates and responsibilities. The
CFTC and SEC have requested comment on the required
confidentiality and indemnification agreements and are
evaluating feedback.
Q.10. One of the Council's purposes is to monitor systemic risk
and alert Congress and regulators of any systemic risks it
discovers. What are the most serious systemic risks presently
facing the U.S. economy?
A.10. The Dodd-Frank Act charges the Council with the
responsibility for identifying risks to the financial stability
of the United States, promoting market discipline, and
responding to emerging threats to the stability of the U.S.
financial system. To help satisfy its mandate, the FSOC
established a Systemic Risk Committee which identifies,
analyzes, and monitors vulnerabilities in the financial system
and emerging threats to maintaining stability. As part of its
ongoing efforts, the Council and its members monitor emerging
issues such as the state of mortgage foreclosures in the United
States, sovereign fiscal developments in Europe and the United
States, and natural disasters such as the earthquake and
tsunami in Japan. The Council will continue to think broadly
about threats to stability from external shocks as well as
structural vulnerabilities within the system. Later this month,
the Council will address a number of these issues in its
statutorily required annual report.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED
FROM NEAL S. WOLIN
Q.1. In early January, I was assured by Secretary Geithner that
Treasury is committed to working with the other FSOC member
agencies to mobilize all tools available to fix that nation's
system of mortgage servicing and foreclosure processing. What
tools have been mobilized? Do these consent orders represent a
full mobilization of all the tools available to FSOC member
agencies? Why or why not? What additional tools do you believe
are necessary?
A.1. The consent decrees issued in April 2011 by the OCC, OTS,
and Federal Reserve to certain financial institutions represent
just one of the tools available to address mortgage servicer
misconduct. Other tools follow from the work that Federal
agencies, including Treasury and other FSOC member agencies,
and their State partners are doing to coordinate a law
enforcement effort that addresses mortgage servicer misconduct
and improper foreclosure processing. Among other things,
members of this group have been conducting onsite reviews of
major mortgage servicers and vendors. These reviews revealed
critical deficiencies in foreclosure processing and mortgage
servicing, including the failure to follow State and Federal
law. Servicers that engaged in improper foreclosure processing
in violation of the law must be held fully accountable for
their actions, and any deficiencies must be corrected.
In addition, Treasury is working with the OCC, the Federal
Reserve, the Federal Housing Finance Agency (FHFA), and the
Federal Deposit Insurance Corporation (FDIC) to develop
national mortgage servicing standards. Work underway includes a
study of measures that would improve borrower protections and
provide clarity and consistency to borrowers and investors
regarding their treatment by servicers, especially in the event
of delinquency. The working group is building on modification
standards Treasury developed for its Making Home Affordable
Program (MHA). The MHA standards have improved mortgage
modifications, including short sales and deeds-in-lieu of
foreclosure, across the industry and have made key changes in
the way mortgage servicers assist struggling homeowners.
Treasury also supports the FHFA's review of servicing
compensation structures and possible alternatives, which could
help improve incentives for servicers to invest the time and
effort to work with borrowers to avoid foreclosure.
Treasury believes continued coordination among Federal and
State partners will be important for developing additional
tools for addressing issues related to foreclosure processing
and mortgage servicing.
Q.2. The GAO also recommended that the Federal Reserve, OCC,
OTS, and FDIC ``assess the risks of potential litigation or
repurchases due to improper mortgage loan transfer
documentation'' and ``require that the institutions act to
mitigate the risks, if warranted'' Has this been done? What are
the estimated costs of potential litigation? Has this issue
been discussed or considered by FSOC? What is Treasury doing,
as Chair of the FSOC, to ensure that these recommendations are
considered?
A.2. Treasury cannot speak on behalf of the independent
regulators regarding analysis, potential litigation, or the
specific regulatory actions they may undertake. However, the
Dodd-Frank Act charges the FSOC with the responsibility for
identifying risks to the financial stability of the United
States, promoting market discipline, and responding to emerging
threats to the stability of the U.S. financial system. Working
groups addressing mortgage servicing and foreclosure processing
have briefed the FSOC, which the Treasury Secretary chairs, on
these issues, and the FSOC will continue to monitor
developments.
Q.3. On April 29th, the Department of the Treasury announced
its intention to exempt foreign exchange swaps and forwards
from the scope of Dodd-Frank. Why should the foreign exchange
swaps and forwards not be subject to the same transparency
provisions as the rest of the derivatives marketplace? Please
explain in detail.
A.3. Recognizing that the unique characteristics and existing
oversight of the foreign exchange swaps and forwards market
already incorporate many of Dodd-Frank's objectives for
reform--including high levels of transparency, effective risk
management, and financial stability--Congress provided the
Secretary of the Treasury with the authority to determine
whether central clearing and exchange trading requirements
should apply to foreign exchange (FX) swaps and forwards. On
May 5, 2011, Treasury requested public comment on a Notice of
Proposed Determination to exempt FX swaps, FX forwards, or
both, from the definition of a ``swap'' under the Commodity
Exchange Act (CEA). As explained in the notice, FX swaps and
forwards trade in a highly transparent market with well-
developed settlement protections. Market participants already
have access to readily available pricing information through
multiple sources, and the prevalence of electronic trading
platforms in these markets--approximately 41 percent and 72
percent of FX swaps and forwards, respectively, already trade
on these platforms--also provides a high level of pre-and post-
trade transparency. The Dodd-Frank Act will further heighten
this transparency by subjecting all derivatives, including FX
swaps and forwards, to mandatory reporting to swap data
repositories.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR CRAPO FROM NEAL S.
WOLIN
Q.1. According to the American Banker, Annette L. Nazareth, a
former SEC Commissioner, called the timetables imposed by the
Dodd-Frank Act ``wildly aggressive.'' ``These agencies were
dealt a very bad hand,'' she said. ``These deadlines could
actually be systemic-risk raising.'' Given the importance of
rigorous cost-benefit and economic impact analyses and the need
for due consideration of public comments, would additional time
for adoption of the Dodd-Frank Act rules improve your
rulemaking process and the substance of your final rules?
A.1. A guiding principle for implementation of the Dodd-Frank
Act has been to move quickly and carefully. Regulators are
working to meet statutory deadlines and to quickly provide
clarity to the public and the markets. At the same time,
rulewriters understand the importance of getting the rules
right and are taking additional time where necessary to improve
the process and substance of their final rules.
The Dodd-Frank Act does not require the FSOC to issue
substantive regulations. Nonetheless, the FSOC has chosen to
conduct rulemakings on the designations of nonbank financial
companies and financial market utilities to promote
transparency regarding the FSOC's decisionmaking process, to
solicit public input, and to provide clarity on the criteria
and process for designations.
Q.2. Chairman Bair's testimony was unclear regarding whether
the FSOC has the authority to issue a revised rule on the
designation of nonbank financial institutions. She and others
indicated some type of guidance might be issued instead. Is it
in fact the case, in general, that the FSOC does not have
authority to issue rules under Title I that have the force and
effect of law? If the FSOC has the authority in general to
issue such rules on designation, why specifically would the
FSOC be precluded from re-proposing a rule that is currently
pending? Is there additional authority the FSOC would need from
Congress to issue such rules or to proceed with re-proposing
its NPR on designation? If yes, what specific authority would
the FSOC need from Congress for the FSOC to have the ability to
proceed?
The FSOC has the authority to issue its proposed
regulations on the process for determining that a nonbank
financial company will be supervised by the Federal Reserve,
and to re-propose those rules for further public comment. The
FSOC has already exercised its rulemaking authority to issue a
notice of proposed rulemaking and plans to issue for further
public comment additional guidance regarding its approach to
designations of nonbank financial companies. The FSOC plans to
release a final rule and guidance that will reflect the input
received on its proposals.
Q.3. In an August speech at NYU's Stern School of Business,
Treasury Secretary Geithner outlined six principles that he
said would guide implementation, and then he added, ``You
should hold us accountable for honoring them.'' His final
principle was bringing more order and integration to the
regulatory process. He said the agencies responsible for
reforms will have to work ``together, not against each other.
This requires us to look carefully at the overall interaction
of regulations designed by different regulators and assess the
overall burden they present relative to the benefits they
offer.'' Do you intend to follow through with this commitment
with some form of status report that provides a quantitative
and qualitative review of the overall interaction of all the
hundreds of proposed rules by the different regulators and
assess the overall burden they present relative to the benefits
they offer?
A.3. One of the duties of the FSOC, which the Secretary of the
Treasury chairs, is to facilitate information-sharing and
coordination among the member agencies and other Federal and
State agencies regarding financial services policy development,
rulemakings, examinations, reporting requirements, and
enforcement actions. In this capacity, the Secretary recently
sent FSOC members a letter encouraging them to review their
regulations in accordance with the principles and guidelines
identified in the President's Executive Order 13563 ``Improving
Regulation and Regulatory Review.'' The Treasury Department,
after conducting its own review, published a preliminary plan
under which it will periodically review its existing
significant regulations in order to identify rules that may be
outmoded, ineffective, insufficient, or excessively burdensome.
The principles and guidelines set forth in the Executive Order
can help ensure that regulations protect our citizens and
improve the performance of our economy without imposing
unreasonable costs on society.
In addition, the FSOC has worked to develop an approach to
coordination that recognizes the independence of the regulators
while bringing consistency and integration to the regulatory
process. For example, soon after Dodd-Frank's passage, the FSOC
worked with member agencies to release an ``Integrated
Implementation Roadmap'' that sets forth a coordinated timeline
of statutory and non-statutory goals for implementation. The
FSOC is also coordinating implementation of rulemakings,
including the Volcker Rule, so that the regulations issued by
the various agencies will be comparable and consistent.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR CORKER FROM NEAL S.
WOLIN
Q.1. Your institutions have been assigned the task of macro
prudential risk oversight. Specifically, the Dodd-Frank Act
tasked the FSOC with ``identifying risks to the financial
stability that could arise from the material financial distress
or failure of large interconnected bank holding companies or
nonbank financial companies.'' As you know nearly all banks
carry U.S. Treasury bills, notes, and bonds on their balance
sheet with no capital against them. They are deemed, both
implicitly and explicitly, as risk free. But with a $14
trillion debt, no one can guarantee that the bond market will
continue to finance U.S. securities at affordable rates. What
steps have you taken to ensure that systemically important
financial institutions could withstand a material disruption in
the U.S. Treasury market from an event such as a major tail at
an auction, the liquidation of securities by a major investor
such as a foreign central bank, concerns that the United States
will attempt to inflate its way out of its debt obligations, an
outright debt downgrade by a major rating agency, or market
concern over the prospects for a technical default? What impact
would an event such as the loss of market confidence in U.S.
debt and subsequent increase in U.S. borrowing rates have on
the institutions in your purview? And what steps can you take
to ensure that the balance sheets of systemically important
institutions could withstand such an event and that such an
event would not lead to a systemic crisis similar to or worse
than that experienced in 2008?
A.1. The Treasury Department does not believe the potential
disruptions to Treasury markets that you mention are likely to
occur because we believe that Congress will raise the debt
limit in a timely fashion. Demand for Treasuries remains
extremely strong. Rates are at historically low levels, and
auctions are showing high levels of coverage. This reflects the
confidence that markets currently have in the creditworthiness
of the United States.
The Financial Stability Oversight Council (FSOC) continues
to identify, monitor, and respond to vulnerabilities in the
financial system and emerging threats to financial stability,
including the risks you mention. More immediately, the threat
posed by the failure to raise the debt limit grows every day
that we fail to address it, and FSOC members remain focused on
this issue. If the debt limit is not raised on a timely basis,
the United States would be forced to default on the existing
legal obligations made by past Congresses and Presidents of
both parties.
The Administration is committed to addressing the serious
fiscal challenges our country faces and working with you and
other Members of Congress to do so. The ongoing discussions
convened by the President with leaders from both parties and
both houses of Congress have been constructive and all
participants are working to reach agreement as soon as
possible. However, regardless of the path we choose to bring
down our deficits, Congress must raise the statutory debt
limit.
Q.2. What other major systemic risks are you currently most
concerned about? What steps are you taking to address these?
A.2. The Dodd-Frank Wall Street Reform and Consumer Protection
Act (Dodd-Frank Act) charges the FSOC with the responsibility
to identify and monitor risks to the financial stability of the
United States to promote market discipline, and to respond to
emerging threats to the stability of the U.S. financial system.
To help satisfy this mandate, the FSOC established a Systemic
Risk Committee which identifies, analyzes, and monitors
vulnerabilities in the financial system and emerging threats to
financial stability. As part of its ongoing efforts, the FSOC
and its members monitor emerging issues such as the state of
mortgage foreclosures in the United States, sovereign fiscal
developments in Europe, and natural disasters such as the
earthquake and tsunami in Japan. The FSOC will continue to
monitor and assess the threats to financial stability from
external shocks as well as structural vulnerabilities within
the system. Later this month, the FSOC will address a number of
these issues in its statutorily required annual report.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR VITTER FROM NEAL S.
WOLIN
Q.1. Dodd-Frank set forth a comprehensive list of factors that
FSOC must consider when determining whether a company posed a
systemic risk and deserves Fed oversight. The council, in its
advanced notice of proposed rulemaking, sets forth 15
categories of questions for the industry to comment on and
address. However, the proposed rules give no indication of the
specific criteria or framework that the council intends to use
in making SIFI designations-other than what is already set
forth in Dodd-Frank. As a result, potential SIFIs have no idea
where they may stand in the designation process. Will the
council provide additional information about the quantitative
metrics it will use when making an SIFI designation?
A.1. The Council will seek comment on additional guidance
regarding its approach to these designations. The Council is
working to strike the right balance between the use of
quantitative metrics and for the exercise of judgment when
assessing the unique risks that a particular firm may present
to the financial system.
Q.2. Would the council agree that leverage is likely to be the
one factor that is most likely to create conditions that result
in systemic risk? If so, how will the council go about
identifying which entities use leverage?
A.2. The Dodd-Frank Act requires the Council to consider a
variety of factors, including leverage, when evaluating what
firms will be designated. No one factor will form the basis of
a designation. Every designation will be firm-specific, taking
into account each firm's comprehensive risk profile. The FSOC
intends to obtain relevant data from its members, the OFR, and
publicly available information. The Council continues to work
toward an approach that will allow firms to assess whether they
are likely candidates for designation while maintaining
flexibility as the nature of institutions and markets changes.
Q.3. One of the first steps in the systemic designation
process, as outlined in the proposed rule, is that after
identifying a nonbank financial company for possible
designation the FSOC will provide the company with a written
preliminary notice that the council is considering making
proposed determination that the company is systemically
significant. Is receipt of such a notice a material event that
might affect the financial situation or the value of a
company's shares in the mind of the investors? If so, wouldn't
it need to be disclosed to investors under securities laws?
A.3. The SEC is charged with determining the disclosure
requirements applicable to public companies, and I respectfully
defer to the SEC's judgment on this question.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR TOOMEY FROM NEAL S.
WOLIN
Q.1. As FSOC considers how to determine the systemic relevance
of the investment fund asset management industry, wouldn't it
be more appropriate for FSOC to look at the various individual
funds themselves, of which there may be several under one
advisor, rather than focus on the advisor entity?
a. LIsn't it true that each of those funds may operate with
separate and distinct investment strategies, each with
its own unique risks?
b. LIsn't it the case that the vast majority of the assets
are located at the funds and not at the adviser entity?
A.1. Individual investment funds may operate with their own
strategies and unique risk profiles, and for many asset
management firms, most of the assets are not held on the
balance sheet of the advisor entity. The FSOC recognizes that
there are differences between the advisor entity and the
individual funds, and both the funds and advisor may present
different sets of risks. In accordance with the Dodd-Frank Act,
in making determinations of nonbank financial companies to be
supervised by the Federal Reserve, the FSOC will consider the
extent to which assets are managed, rather than owned, by
investment advisors.
Q.2. What additional protection/supervision could the Fed
provide for mutual funds that the SEC isn't already providing?
Do we really need to subject this industry to an additional
layer of regulation, especially a ``systemic risk'' regulation?
A.2. Section 113 of the Dodd-Frank Act gives the FSOC authority
to designate U.S. nonbank financial companies ``if the Council
determines that material financial distress at the U.S. nonbank
financial company, or the nature, scope, size, scale,
concentration, interconnectedness, or mix of the activities of
the U.S. nonbank financial company, could pose a threat to the
financial stability of the United States.'' Additionally, one
of the 10 considerations the Dodd-Frank Act requires the FSOC
to take into account during the designation process is ``the
degree to which the company is already regulated by one or more
primary financial regulatory agencies.''
Categorical exclusion of mutual funds, or any other type of
nonbank financial company, from the possibility of designation
without evaluating all of the considerations the FSOC is
statutorily required to take into account would be premature.
Q.3. Can you share with us what the FSOC, OFR, FDIC and Fed are
contemplating by way of fees that they may assess on SIFIs?
A.3. The Dodd-Frank Act created the Financial Research Fund to
support the operations of the OFR and the FSOC. The Federal
Reserve Board is required by statute to provide interim funding
for the first 2 years after enactment of the Dodd-Frank Act.
After this period, the Treasury Secretary, with the Council's
approval, must establish by rule an assessment schedule for
Federal Reserve-supervised bank holding companies and
designated nonbank financial companies to cover these expenses.
The FSOC and the OFR have not finalized their budget
estimates beyond FY 2012; however, funding estimates for the
Financial Research Fund for FY 2011 and FY 2012 were made
public in the President's budget request earlier this year.
International Competitiveness
Q.4.a. It is critical for the continued competitiveness of the
U.S. markets that a regulatory arbitrage does not develop among
markets that favors markets in Europe and Asia over U.S.
markets. Will the FSOC commit to ensuring that the timing of
the finalization and implementation of rulemaking under Dodd
Frank does not impair the competitiveness of U.S. markets?
Q.4.b. How will FSOC ensure that U.S. firms will have equal
access to European markets as European firms will have to U.S.
markets?
Q.4.c. How will FSOC ensure that Basel III will be implemented
in the United States in a manner that is not more stringent
than in Europe, making U.S. firms less competitive globally?
A.4.a.-c. The Council understands that major financial centers
in Europe and Asia need to adopt strong measures similar to the
Dodd-Frank Act to help maintain a level playing field for U.S.
firms and reduce the opportunity for regulatory arbitrage. The
United States has taken a leading role in laying the groundwork
to set an international effort in motion, and the Council's
members are playing an important part in coordinating this
effort so that implementation across national authorities is
consistent and timely.
The Council's members are working through international
forums like the G-20 and Financial Stability Board to build a
global regulatory framework, including areas like capital
standards and derivatives regulation, so that markets remain
competitive and accessible. The Council's members are also
engaging with their counterparts around the globe, including
through bilateral financial dialogues with the European
Commission, Japan, China, India, Singapore, and Canada, to
develop consistent approaches of regulating major financial
jurisdictions.
Q.5. Is a broker/dealer that is not self-clearing less likely
to pose systemic risk because it receives the financial backing
and risk management attention of its clearing firm which
already performs extensive monitoring of risk for the broker-
dealers and which in all likelihood will itself be a SIFI?
A.5. As reflected in Title VII of the Dodd-Frank Act, central
clearing is an important means of addressing the threats to the
financial system posed by counterparty defaults in the context
of certain derivatives transactions. However, these threats can
also spread through other transmission mechanisms, including
asset fire sales, withdrawals of funding or demands for
additional collateral. As a result, broker-dealer clearing
arrangements, including clearing through a clearing firm, may
reduce, but do not eliminate these risks.
Q.6. Titles I and II of Dodd-Frank references an entity's
``asset threshold'' or ``total consolidated assets'' several
times. Are such calculations to be made in accordance with
generally accepted accounting principles (GAAP)?
A.6. When establishing capital measures, many U.S. regulators
require an entity to adjust its GAAP-based results and apply
regulatory accounting principles. This adjustment is made to
ensure that the regulators' objectives are met.
For purposes of calculating ``asset threshold'' and ``total
consolidated assets,'' we expect that regulators would adopt a
similar approach. They would use the principles established
under U.S. GAAP, but would require adjustments to these
calculations to meet their objectives.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR MORAN FROM NEAL S.
WOLIN
Q.1. One of the first steps in the designation process is that
after identifying a nonbank financial company for possible
designation, the FSOC will provide the firm with a written
notice that the Council is considering them for possible
designation. Can you walk us through this step and describe
possible scenarios in which there is some question as to a
firm's systemic significance? Who decides to whom the notice
will be sent if no vote is taken?
A.1. The FSOC issued a notice of proposed rulemaking regarding
the criteria and procedures for the designation of nonbank
financial companies. The FSOC requested public comment on
various parts of the proposed rule, including on the provisions
governing notice of a proposed determination. The FSOC is
continuing to work through the details of this process, and
expects to release for public comment additional guidance on
the proposed procedures.
Q.2. You are aware of my concerns with the structure
established in Dodd-Frank. In fact, I favor the approach first
sent to the Hill by your Administration almost 2 years ago; a
5-member Board. That being said, can you please tell us why it
has taken more than 10 months to secure a suitable candidate
for this position? Back in November of 2010, Congressman Bachus
asked Secretary Geithner when we might expect the President to
nominate someone to head the CFPB and the Secretary responded
``soon.'' When will we see a nomination? Would it have been
more appropriate for the first Director of this Bureau to be
the individual hiring several hundred employees, establishing
the agenda, setting a budget?
A.2. Earlier this week, the President nominated Richard
Cordray, who is currently the Chief of Enforcement at the CFPB,
to serve as its Director. Mr. Cordray is a former Attorney
General and State Treasurer of Ohio. Earlier in his career, Mr.
Cordray was an adjunct professor at the Ohio State University
College of Law, served as a Ohio State Representative, and was
the first Solicitor General in Ohio's history. In the Dodd-
Frank Act, Congress granted the Secretary of the Treasury
interim authority to stand up the CFPB before a Director is
confirmed. To ensure an orderly stand-up of the agency and a
responsible transfer of functions from seven Federal agencies,
this process has necessitated extensive research, planning,
budgeting, and hiring.
Q.3. My initial research tells me that over the past 100-years
or more of U.S. history, there is not a single instance in
which an agency of this size and status was filled with a
recess appointed head in its inception. Can you commit to us
that your Administration will not break this long-established
precedent and make an end-run around the Senate?
A.3. Filling existing vacancies, including the CFPB Director
position, is a priority for this Administration. I cannot,
however, speak for the President with respect to any particular
nominations.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR CORKER FROM BEN S.
BERNANKE
Q.1. Your institutions have been assigned the task of macro
prudential risk oversight. Specifically, the Dodd-Frank Act
tasked the FSOC with ``identifying risks to the financial
stability that could arise from the material financial distress
or failure of large interconnected bank holding companies or
nonbank financial companies.'' As you know nearly all banks
carry U.S. Treasury bills, notes, and bonds on their balance
sheet with no capital against them. They are deemed, both
implicitly and explicitly, as risk free. But with a $14
trillion debt, no one can guarantee that the bond market will
continue to finance U.S. securities at affordable rates. What
steps have you taken to ensure that systemically important
financial institutions could withstand a material disruption in
the U.S. Treasury market from an event such as a major tail at
an auction, the liquidation of securities by a major investor
such as a foreign central bank, concerns that the United States
will attempt to inflate its way out of its debt obligations, an
outright debt downgrade by a major rating agency, or market
concern over the prospects for a technical default?
What impact would an event such as the loss of market
confidence in U.S. debt and subsequent increase in U.S.
borrowing rates have on the institutions in your purview? And
what steps can you take to ensure that the balance sheets of
systemically important institutions could withstand such an
event and that such an event would not lead to a systemic
crisis similar to or worse than that experienced in 2008?
A.1. I agree that the fiscal situation is a serious problem
that must be addressed. Currently, the Federal debt-to-income
ratio is at levels not seen since World War II in part because
the budgetary position of the Federal Government has
deteriorated substantially during the past two fiscal years.
The recent deterioration was largely the result of a sharp
decline in tax revenues brought about by the recession and the
subsequent slow recovery, as well as by increases in Federal
spending needed to alleviate the recession and stabilize the
financial system. Looking out a few years, under current policy
settings, the Federal budget will be on an unsustainable path,
with the debt-to-income ratio of the United States rising at an
increasing pace.
That said, financial market participants evidently expect
the Congress and the Administration to come to a solution that
puts the United States on a sustainable fiscal path. Yields on
10-year Treasury bonds are currently at extremely low levels,
consistent with investors requiring little compensation for the
risk of lending the U.S. Government for an extended horizon. If
investors were to seriously doubt the United States'
willingness to meet its obligations, the result could be
widespread financial disruptions that could derail the recovery
and that would almost certainly raise the long-term cost of
borrowing for the Government, further complicating our fiscal
problem.
As a regulator, we have conducted extensive analyses of the
impact that an abrupt rise in interest rates would have on the
institutions we supervise and will continue to monitor any
impact that interest rates increases have on these
institutions. However, we recognize that a material disruption
in the U.S. Treasury market from investor concerns about a
sustainable fiscal path would not just affect these
institutions but, as noted, would have more widespread
consequences.
Q.2. What other major systemic risks are you currently most
concerned about? What steps are you taking to address these?
A.2. There are a number of risks that we are monitoring and
assessing in our role as a member of the FSOC, as well as in
meeting the Federal Reserve's independent responsibility to
promote financial stability. The FSOC Annual Report, submitted
to Congress in July, identifies a number of potential systemic
risks and makes recommendations to mitigate these risks and
promote financial stability. Among those identified are
structural risks, including features of money market funds that
make them susceptible to runs, fragilities in the tri-party
repo market, inadequate mortgage servicing practices, and
weaknesses in capital and liquidity risk management practices
at some of the largest financial institutions. The Federal
Reserve, as well as the FSOC, has publicly urged the SEC to
take additional steps to mitigate the risk of runs in money
market funds, including pursuing reform alternatives such as
mandatory floating net asset value (NAV), capital buffers to
absorb fund losses, or deterrents to redemptions. In addition,
the Fed is an active participant in the Task Force on Tri-Party
Repo Infrastructure, which is taking steps to reduce intraday
credit exposures and strengthen collateral management practices
to increase the stability of this market. As a banking
supervisor, we are working to establish improved national
mortgage servicing practices. We also conducted the
Comprehensive Capital Analysis and Review exercise earlier this
year, and have been working with institutions to further
improve their capital planning processes, including
contingencies for resolution that would facilitate
resolvability without Government assistance. In addition, the
Fed is working on proposed enhanced prudential standards for
certain large and complex financial firms, which need to be
implemented in a consistent manner across the global financial
system, and is working with FSOC to designate systemically
important nonbank financial institutions. There also are a
number of emerging risks that the FSOC identified, including
unexpected increases in interest rates, declining discipline in
underwriting standards for some financial assets, and more
generally new and developing emerging financial products and
practices, and the Federal Reserve is closely monitoring these
developments. Going forward, the Federal Reserve will continue
to work with the FSOC and its other member agencies to identify
risks and structural vulnerabilities in the financial system,
and to take steps to increase its resilience.
------
RESPONSE TO WRITTEN QUESTION OF SENATOR MORAN FROM BEN S.
BERNANKE
Q.1. In a recent speech, Governor Tarullo stated that the list
of ``systemically significant'' institutions will be short, and
that the standard for designation set by Congress ``should be
quite high.'' There has been conflicting reports that there are
some on the FSOC which would like a more inclusive group of
firms, in effect casting a wider net. Do you agree with
Governor Tarullo that the list is likely to be limited to a
small group of truly interconnected institutions?
A.1. I believe that the Financial Stability Oversight Council
(FSOC) should designate any nonbank financial company if the
FSOC determines that material financial distress at the nonbank
financial company, or the nature, scope, size, scale,
concentration, interconnectedness, or mix of the activities of
the nonbank financial company, could pose a threat to the
financial stability of the United States. Whether a firm meets
this standard inevitably involves a judgment on the combined
effect of all potential transmission channels from the firm to
the broader financial system and economy. At this time, I
expect that a relative handful of firms likely meet this
standard. Because the FSOC is still developing its analytic
framework and is still working on a final rule for the
designation process, it is too soon to know how many firms the
FSOC will designate.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM SHEILA C.
BAIR
Q.1. In your testimony, you note--and I agree--that allowing
continuation of the pre-crisis status quo would be to sanction
a new and ``dangerous form of state capitalism.'' However, you
also state that ``the FDIC should have a continuous presence at
all designated SIFIs'' and the FDIC and the Federal Reserve
should ``actively'' use their authority to require
organizational changes at SIFIs. Does such an active
Government-financial institution partnership run the risk of
laying the groundwork for, as you described it, a dangerous
form of state capitalism in which a few large financial
entities operate under the shadow and protection of the
Government?
A.1. It is important at the outset to clarify that being
designated as a SIFI will in no way confer a competitive
advantage or suggest that it operates under the protection of
the Government by anointing an institution as ``too big to
fail.'' SIFIs will be subject to heightened supervision and
higher capital requirements. They also will be required to
maintain resolution plans and could be required to restructure
their operations if they cannot demonstrate that they are
resolvable. In light of these significant regulatory
requirements, the FDIC has detected absolutely no interest on
the part of any financial institution in being named a SIFI.
Indeed, many institutions are vigorously lobbying against such
a designation.
As shown by the recent crisis, the larger, more complex,
and more interconnected a financial company is, the longer it
takes to assemble a full and accurate picture of its operations
and develop a resolution strategy. By requiring detailed
resolution plans in advance, and authorizing an onsite FDIC
team to conduct pre-resolution planning, the SIFI resolution
framework regains the ability to gather information that was
lacking in the crisis of 2008. The FDIC should have a
continuous presence at all designated SIFIs under the new
resolution framework, working with the firms and reviewing
their resolution plans as part of their normal course of
business. Thus, our presence should in no way be seen as a sign
of Government protection or a signal of distress. Instead, it
is much more likely to provide a stabilizing influence that
encourages management to more fully consider the downside
consequences of its actions, to the benefit of the institution
and the stability of the system as a whole.
Q.2. Your testimony calls into question claims that higher
capital requirements will adversely affect economic growth. If
higher capital requirements had been in effect before the
crisis, what effect do you think that would have had on the
number of institutions that failed?
A.2. At the height of the crisis, the large financial companies
that make up the core of our financial system proved to have
too little capital to maintain market confidence in their
solvency. Thin levels of capital exacerbated the limited tools
policymakers had to deal with several large, complex U.S.
financial companies at the center of the 2008 crisis when they
became nonviable.
With respect to banks that failed during the crisis,
failures were highest in certain areas of the country that were
hardest hit by the collapse of the real estate market, such as
the southern States of Florida and Georgia, the Great Lakes
Region, and along the Pacific Coast. Many of these banks had
other risk factors, such as high concentrations in construction
loans and other higher-risk types of real estate loans, heavy
reliance on noncore funding dependence, and poor underwriting
and risk management practices, among others. However, even when
operating in difficult markets, many banks survived because
they took steps to mitigate risks, for example, by not engaging
in lax underwriting or credit practices and by maintaining
sufficient capital to absorb losses or successfully
recapitalizing when market conditions changed.
Q.3. One of the Council's purposes is to monitor systemic risk
and alert Congress and regulators of any systemic risks it
discovers. What are the most serious systemic risks presently
facing the U.S. economy?
A.3. From the FDIC's perspective, the most important systemic
risks and emerging threats to our financial system at the
present time involve excessive reliance on debt and financial
leverage, continued lack of market discipline due to
perceptions of ``too big to fail,'' lingering problems in
mortgage servicing, and interest rate risk. My written
statement to the Committee describes these areas more fully,
along with the steps being taken to address them.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED
FROM SHEILA C. BAIR
Q.1. At your speech at the Chicago FRB conference, you offered
some interesting ways forward on the designation of nonbank
financial institutions (SIFI). In that speech, you noted that
the resolvability of the non-bank financial firm should be the
ultimate deciding factor in the designation process. That
approach seems logical--can you elaborate on how it would work?
A.1. SIFIs will be subject to heightened supervision and higher
capital requirements. They also will be required to maintain
resolution plans and could be required to restructure their
operations if they cannot demonstrate that they are resolvable.
We believe that the ability of an institution to be resolved in
a bankruptcy process without systemic impact should be a key
consideration in designating a firm as a SIFI. Further, we
believe that the concept of resolvability is consistent with
several of the statutory factors that the FSOC is required to
consider in designating a firm as systemic, those being size,
interconnectedness, lack of substitutes, and leverage. If an
institution can reliably be deemed resolvable in bankruptcy by
the regulators, and operates within the confines of the
leverage requirements established by bank regulators, then it
should not be designated as a SIFI.
The approach of using resolvability as the deciding factor
in the SIFI designation process seems relatively
straightforward. However, we are concerned with the lack of
information we might have about potential SIFIs that may impede
our ability to make an accurate determination of resolvability
before the fact. This potential blind spot in the designation
process raises the specter of a ``deathbed designation'' of a
SIFI, whereby the FDIC would be required to resolve the firm
under a Title II resolution without the benefit of a resolution
plan or the ability to conduct advance planning, both of which
are critical to an orderly resolution. This situation, which
would put the resolution authority in the worst possible
position, should be avoided at all costs.
Thus, we need to be able to collect detailed information on
a limited number of potential SIFIs as part of the designation
process. We should provide the industry with some clarity about
which firms will be expected to provide the FSOC with this
additional information, using simple and transparent metrics
such as firm size, similar to the approach used for bank
holding companies under the Dodd-Frank Act. This should reduce
some of the mystery surrounding the process and should
eliminate any market concern about which firms the FSOC has
under its review. In addition, no one should jump to the
conclusion that by asking for additional information, the FSOC
has preordained a firm to be ``systemic.'' It is likely that
after we gather additional information and learn more about
these firms, relatively few of them will be viewed as systemic,
especially if the firms can demonstrate their resolvability in
bankruptcy at this stage of the process.
Q.2. The interaction of global capital requirements (Basel III)
and U.S. requirements (FSOC) could result in different criteria
being applied to the same financial institution. For example,
an institution could be deemed systemically important to the
global financial system but not to the financial system in the
United States. How is this being addressed? Does this pose any
unique risks?
A.2. Per the Dodd-Frank Act, all bank holding companies
operating in the United States with $50 billion or more in
assets have been deemed systemically important and thus subject
to enhanced supervision and prudential supervision, including
risk-based capital requirements. The asset threshold for
globally systemically important banks (G-SIBs) set by the Basel
Committee will likely be many times higher than that set by the
Dodd-Frank Act. Therefore, it is unlikely that a U.S. bank
holding company designated as G-SIB by the Basel Committee
would not also be systemically important in the United States.
As members of the Basel Committee, the U.S. banking
agencies are actively participating in the Committee's
designation of G-SIBs and determining the capital surcharge
that will be imposed. At the same time, in the United States,
the FDIC and our fellow FSOC members are addressing any issues
and potential risks as they arise to ensure both approaches are
complementary. Finally, the implementation of both the Basel
proposals for G-SIBs and the U.S. approach for systemically
important bank holding companies will be subject to the U.S.
notice and comment rulemaking process.
Q.3. A number of commentators and academics have asserted that
Basel III capital requirements are too low. For example, a
recent Stanford University study (Admati et al, published in
March 2011) stated that ``equity capital ratios significantly
higher than 10 percent of un-weighted assets should be
seriously considered.'' It also noted that ``bank equity is not
socially expensive'' and ``better capitalized banks suffer from
fewer distortions in lending decisions and would perform
better.'' In addition, Switzerland has adopted capital ratios
for its banks in excess of Basel III. What are the strengths
and weaknesses of capital adequacy ratios in excess of those
considered under Basel III? (Adinanti, DeMarzo, Hellwig,
Pfleiderer, ``Fallacies, Irrelevant Facts, and Myths in the
Discussion of Capital Regulation: Why Bank Equity is not
Expensive.'' Stanford Graduate School of Business Research
Paper No. 2065, March 2011.)
A.3. The FDIC agrees that strong, uniform capital requirements
are an essential element of a stable banking system. The first
and most obvious reason is that banking and financial crises
have devastating effects on economic growth and job creation.
Maintaining strong capital levels consistent with a safe-and-
sound banking system both promotes long-term economic growth
and makes bank lending less procyclical.
The rapid depletion of capital in the early stages of the
crisis contributed to a massive deleveraging in banks and other
financial intermediaries. Loans and leases held by FDIC-insured
institutions have declined by nearly $750 billion from peak
levels, while unused loan commitments have declined by $2.5
trillion. Trillions more in capital flows were lost with the
collapse of the securitization market and other ``shadow''
providers of credit. A similar pattern has been observed
following previous financial crises around the world.
Some observers, especially those representing banks, have
expressed concern that higher capital requirements will curtail
credit availability and hurt economic growth. However, the
consensus of recent academic literature, including the March
2011 studies by Admati et al, is that increases in capital
requirements, within the ranges currently being discussed, have
a net positive effect on long-term economic growth. The reason
for this conclusion is that the costs of banking crises for
economic growth are severe, as outlined in my written
testimony, so that reducing their frequency and severity is
highly beneficial. On the other hand, the literature suggests
the cost of higher capital requirements in terms of lost
economic output is modest.
Arguments that balance sheet constraints associated with
higher capital requirements reduce banks' ability to lend
typically assume, explicitly or implicitly, that banks simply
cannot raise new capital. Thus, according to this argument, the
industry's fixed dollar amount of capital can support less
lending the higher the capital requirement. But it is the
FDIC's experience that most banks can and do raise capital when
needed, often even banks in extreme financial difficulties.
As I have testified previously, I was disappointed the
Basel Committee did not propose somewhat higher capital
requirements than were contained in the Basel III paper
published in December 2010. I had hoped for a total common
equity requirement across all banks of 8 percent, but the
Committee agreed on 7 percent--a 4.5 percent minimum plus a 2.5
percent capital conservation buffer, all comprised of common
equity. Nonetheless, that is a significant improvement over the
pre-crisis requirement of what was effectively 2 percent common
equity.
Now the Basel Committee is working on an additional capital
surcharge for globally systemically important banking
organizations (G-SIBs). Switzerland has adopted an additional
capital surcharge for their largest banks additional common
equity and a requirement for contingent capital in addition to
the additional common equity. The additional common equity
Switzerland is requiring for its largest banks may prove to be
in line with the Basel requirements for G-SIBs.
Finally, although the focus has been on the risk-based
capital ratios, the Basel Committee has taken the important
step of proposing an international leverage ratio as a backstop
for the risk-based capital ratios. A major shortcoming of the
Basel II regime (the advanced approaches) is that it allowed
large banks to use their own models to steadily reduce their
capital requirements, while their leverage increased. The
leverage ratio is an essential part of a strong regulatory
capital framework.
Q.4. In March, Bloomberg noted that 77 percent of the banking
assets are held by the nation's ten largest banks--with 35
banks holding assets of $50 billion or more. In February,
Moody's granted higher ratings to eight large U.S. banks
because of an expectation of future Government support--
implicitly suggesting that risky behavior by large banks would
be more tolerated, and they would be insulated from failure.
Has systemic risk increased after the financial crisis? Why or
why not? How is this being addressed?
A.4. While banks and other financial companies continue to
address elevated levels of problem assets and cope with
refining their business plans during what has been a sluggish
recovery, overall, bank balance sheets and the financial system
as a whole are healing slowly. In the wake of the recent
crisis, the FDIC and other regulators are working to implement
an updated statutory mandate under the Dodd-Frank Act to reduce
systemic risk by improving the resilience of our financial
system.
As described more fully in my written statement, several
large, complex U.S. financial companies at the center of the
2008 crisis could not be wound down in an orderly manner when
they became nonviable, which resulted in a terrible dilemma for
policymakers: bail out these firms or expose the financial
system to destabilizing liquidations through the normal
bankruptcy process. While necessary, there is genuine alarm
about the immense scale and seemingly indiscriminate nature of
the Government assistance provided to large banks and nonbank
financial companies during the crisis, and what effects these
actions will have on the competitive landscape in banking.
Nevertheless, the ``uplift'' in ratings for large financial
institutions suggests that despite having recently seen the
nation's largest financial institutions receive hundreds of
billions of dollars in taxpayer assistance, the market appears
to believe that they are ``too big to fail,'' although rating
agencies have recently indicated a reassessment of the
likelihood of Federal support. Under a regime of ``too big to
fail,'' the largest U.S. banks and other financial companies
have every incentive to render themselves so large, so complex,
and so opaque that no policymaker would dare risk letting them
fail in a crisis. With the benefit of this implicit safety net,
these institutions have been insulated from the normal
discipline of the marketplace that applies to smaller banks and
practically every other private company.
A major improvement in reducing systemic risk and restoring
market discipline for large financial companies, and one that,
in my opinion, has been somewhat underestimated by the
skeptics, is the requirement for SIFI resolution plans. When a
large, complex financial institution gets into trouble, time is
the enemy. The larger, more complex, and more interconnected a
financial company is, the longer it takes to assemble a full
and accurate picture of its operations and to develop a
resolution strategy. By requiring detailed resolution plans in
advance, and authorizing an onsite FDIC team to conduct pre-
resolution planning, the SIFI resolution framework regains the
ability to gather information that was lacking in the crisis of
2008.
The large financial companies that collapsed during the
crisis (and many other companies today) maintained thousands of
subsidiaries and managed their activities within business lines
that cross many different organizational structures and
regulatory jurisdictions. This can make it very difficult to
implement an orderly resolution of one part of the company
without triggering a costly collapse of the entire company. To
solve this problem, the FDIC and the Federal Reserve must
define high informational standards for resolution plans and be
willing to insist on organizational changes where necessary in
order to ensure that large financial companies meet the
standard of resolvability well before a crisis occurs. Unless
these structures are rationalized and simplified in advance,
there is a real danger that their complexity could make a large
financial company resolution far more costly and more difficult
than it needs to be.
------
RESPONSE TO WRITTEN QUESTION OF SENATOR HAGAN FROM SHEILA C.
BAIR
Q.1. Chairwoman Bair, inherent in any discussion of capital
levels is a tradeoff between economic growth and the
possibility of disruptive bank failures. With high
unemployment, sluggish output, and extraordinary monetary
policy in many developed countries, the economic impact of
higher capital levels requires special attention.
It is my understanding that the Basel Committee on Banking
Supervision and the Financial Stability Board are considering a
further increase in capital requirements for Systemically
Important Financial Institutions, including the possibility of
as much as 300 basis points on firms deemed to be systemically
important on a global basis.
One of the costs traditionally associated with a bank
failure is the loss of proprietary information and knowledge at
the institution. This is one argument for higher capital
requirements. With the robust resolution mechanisms in place in
the United States, should domestic banks face equal capital
charges as institutions in jurisdictions with less robust
resolution frameworks?
A.1. A robust resolution framework, combined with resolution
plans for large bank holding companies and SIFIs, can mitigate
the impact on the financial system of the failure of a large,
complex, and interconnected financial company. Even more
importantly, we need a robust cross-border resolution framework
internationally that harmonizes national resolution laws and
processes. While there is much to be done internationally, we
are making progress--there are new statutory regimes in
Germany, the United Kingdom, and of course in the United
States.
To spur the development of robust resolution frameworks
internationally, the Basel Committee's consultative paper on
the capital surcharge on systemically important banks includes
the understanding that a country can add an additional 1
percent common equity requirement if the banking organization
does not have an acceptable resolution and recovery plan This
additional 1 percent would be on top of the 2.5 percent capital
surcharge for globally systemically important banks, all of
which will be filled with common equity. The Basel Committee
and the Governors and Heads of Supervision agreed that there
was too much uncertainty about contingent capital and bail-in
debt to consider these hybrid capital instruments as loss
absorbing capital for the capital surcharge. (The consultative
paper on the capital surcharge for systemically important banks
should be published in mid-July 2011.)
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR CRAPO FROM SHEILA C.
BAIR
Q.1. According to the American Banker, Annette L. Nazareth, a
former SEC Commissioner, called the timetables imposed by the
Dodd-Frank Act ``wildly aggressive.'' ``These agencies were
dealt a very bad hand,'' she said. ``These deadlines could
actually be systemic-risk raising.'' Given the importance of
rigorous cost-benefit and economic impact analyses and the need
for the consideration of public comments, would additional time
or adoption of the Dodd-Frank Act rules improve your rulemaking
process and the substance of your final rules?
Chairman Bair's testimony was unclear regarding whether the
FSOC has the Authority to issue a revised rule on the
designation of nonbank financial institutions. She and others
indicated some type of guidance might be issued instead. Is it
in fact the case, in general, that the FSOC does not have
authority to issue rules under Title I that have the force and
effect of law? If the FSOC has the authority in general to
issue such rules on designation, why specifically would the
FSOC be precluded from re-proposing a rule that is currently
pending? Is there additional authority the FSOC would need from
Congress to issue such rules or to proceed with reproposing its
NPR on designation? If yes, what specific authority would the
FSOC need from Congress for the FSOC to have the ability to
proceed?
In an August speech at NYU's Stern School of Business,
Treasury Secretary Geithner outlined six principles that he
said would guide implementation, and then he added, ``You
should hold us accountable for honoring them.'' His final
principle was bringing more order and integration to the
regulatory process. He said the agencies responsible for
reforms will have to work ``together, not against each other.
``This requires us to look carefully at the overall interaction
of regulations designed by different regulators and assess the
overall burden they present relative to the benefits they
offer.'' Do you intend to follow through with this commitment
with some form of status report that provides a quantitative
and qualitative review of the overall interaction of all the
hundreds of proposed rules by the different regulators and
assess the overall burden they present relative to the benefits
they offer?
A.1. The FDIC is actively engaged in striving to meet the
mandated timeframes for the interagency rulemakings set forth
in the Dodd-Frank Act. With respect to questions about the
FSOC's authority to issue regulations, the FDIC defers to the
Treasury Secretary's legal counsel. The FSOC issued an ANPR and
NPR describing the processes and procedures that will inform
the FSOC's designation of SIFIs. Concerns have been raised
about the lack of detail and clarity regarding the designation
process, and the FDIC agrees that it is important that the FSOC
seek further comment on its plans for designating firms and
provide additional specificity, both qualitative and
quantitative, that the Council expects to employ when making
SIFI designations.
One of the purposes of the FSOC is to facilitate regulatory
coordination and information sharing regarding policy
development, rulemaking, supervisory information, and reporting
requirements. The FDIC and other financial regulators have had
a longstanding practice of information sharing, but the FDIC
believes that the FSOC has provided more order and integration
to that process.
The FDIC assesses the costs or burden versus the benefits
of its rulemakings in the normal course of our business. Many
of our regulations are required by statute and/or are aimed at
protecting the Deposit Insurance Fund. That being said, the
FDIC has had a longstanding policy to ensure that the rules it
adopts are the least burdensome to achieve those goals. The
FDIC's policy recognizes our commitment to minimizing
regulatory burdens on the public and the banking industry and
the need to ensure that our regulations and policies achieve
legislative and safety and soundness goals effectively.
The FDIC also follows express statutory requirements that
mandate consideration of the economic and other effects of
proposed rules, such as the Regulatory Flexibility Act (effect
on small entities), the Paperwork Reduction Act, the
Congressional Review Act, and the Federal Deposit Insurance Act
(for example, in connection with assessments). The FDIC is
fully prepared to cooperate with the Treasury Secretary, in the
capacity as FSOC Chairman, if he decides to prepare an
integrated status report of rulemaking cost benefit analyses
across the FSOC agencies.
As you know, the FDIC's Office of Inspector General
recently provided a review, at the request of you and some of
your colleagues on the Senate Banking Committee, on the FDIC's
economic analysis performed in three specific rulemakings. The
FDIC OIG reported that, in all three cases, the FDIC performed
quantitative analysis of relevant data, considered alternative
approaches to the extent allowed by the legislation, requested
comments from the public on numerous facets of the rules, and
included information about the analysis that was conducted and
the assumptions that were used in the text of he proposed rule.
In addition, the report notes that the FDIC is also considering
the cumulative burden of all Dodd-Frank Act rulemakings.
Q.2. On April 12, 2011, the Federal Reserve Board, the Federal
Deposit Insurance Corporation, the Federal Housing Finance
Agency, the Farm Credit Administration, and the Office of the
Comptroller of the currency published proposed rules governing
margin and capital requirements applicable to covered swap
entities that are banks. The proposed rules appear (i) to
require those covered swap entities to collect margin from
nonfinancial end-users that exceed margin thresholds, and (ii)
to specify that such margin be in the form of cash or cash
equivalents only. Is this proposal consistent with section 731
of the Dodd-Frank Act which specifically provides that
prudential regulators ``shall permit the use of noncash
collateral, as the regulator . . . determines to be consistent
with . . . preserving the financial integrity of markets
trading swaps; and . . . preserving the stability of the United
States financial system''?
A.2. For swap dealers, major swap participants, and financial
end-users, the Agencies were cautious in the proposed rule with
respect to the allowable types of noncash collateral; limiting
such collateral to only certain types of highly liquid, high-
quality debt securities. The Agencies' are concerned about the
procyclicality associated with other forms of collateral. That
is, during a period of financial stress, the value of non-cash
collateral pledged as margin is more likely also to come under
stress just as counterparties default and the noncash
collateral is required to offset the cost of replacing
defaulted swap positions. However, the Agencies are mindful of
the need to fully consider other forms of noncash collateral
and have included in the NPR a request for comment on whether
the Agencies should broaden the list of acceptable noncash
collateral and, if so, what haircut should be applied to such
collateral.
The Agencies noted in the NPR that even without expanding
the list of acceptable collateral, counterparties that wish to
rely on other noncash assets to meet margin requirements could
pledge those assets with a bank or group of banks in a separate
arrangement, such as a secured financing facility, and could
draw cash from that arrangement to meet margin requirements.
For non-financial end-users, who are the most likely type of
counterparty to wish to post noncash collateral, the proposed
rule provides credit exposure thresholds, under which a covered
swap entity may determine the extent to which available noncash
collateral appropriately reduces the covered swap
entity'scredit risk, consistent with its credit underwriting
expertise. As such, commercial end-users will likely find that
they will be able to continue to post the same forms of noncash
collateral as they currently post.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR CORKER FROM SHEILA C.
BAIR
Q.1. Your institutions have been assigned the task of macro
prudential risk oversight. Specifically, the Dodd-Frank Act
tasked the FSOC with ``identifying risks to the financial
stability that could arise from the material financial distress
or failure of large interconnected bank holding companies or
nonbank financial companies.'' As you know nearly all banks
carry U.S. Treasury bills, notes, and bonds on their balance
sheet with no capital against them. They are deemed, both
implicitly and explicitly, as risk free. But with a $14
trillion debt, no one can guarantee that the bond market will
continue to finance U.S. securities at affordable rates. What
steps have you taken to ensure that systemically important
financial institutions could withstand a material disruption in
the U.S. Treasury market from an event such as a major tail at
an auction, the liquidation of securities by a major investor
such as a foreign central bank, concerns that the United States
will attempt to inflate its way out of its debt obligations, an
outright debt downgrade by a major rating agency, or market
concern over the prospects for a technical default? What impact
would an event such as the loss of market confidence in U.S.
debt and subsequent increase in U.S. borrowing rates have on
the institutions in your purview? And what steps can you take
to ensure that the balance sheets of systemically important
institutions could withstand such an event and that such an
event would not lead to a systemic crisis similar to or worse
than that experienced in 2008?
A.1. Financial institutions as well as other investors have
significant holdings in U.S. Government-related debt, so
material events related to these investments could have a
substantial credit impact on these firms. Moreover, as more
fully described in response to question 2 below, the loss of
confidence in U.S. debt could create sudden volatility in
interest rates, which could prove challenging to bank and bank-
holding company revenue streams. These firms are in a
substantially better position with regard to capital and
liquidity to withstand stress than they were in 2008; however,
depending on the length and depth of an event such as
described, this would have a significant adverse impact on
their operations.
The largest banks and bank-holding companies are generally
supervised by the Office of the Comptroller of the Currency and
the Board of Governors of the Federal Reserve System (Federal
Reserve). Nevertheless, in the normal course, the FDIC works
with these agencies to evaluate the level of capital and
liquidity they hold relative to specific asset classes and
their overall risk structure and to evaluate these firms'
ability to withstand stress events. Going forward, Section 165
of the Dodd-Frank Wall Street Reform and Consumer Protection
Act (Dodd-Frank Act) requires stress testing by the regulators
and the firms themselves, for large banking organizations and
systemically important nonbank financial institutions (SIFIs)
supervised by the Federal Reserve.
Additionally, just last week, Federal banking regulators
issued supervisory guidance for comment to outline broad
principles for a satisfactory stress testing framework and how
stress testing can be employed as an important component of
risk management.
Q.2. What other major systemic risks are you currently most
concerned about? What steps are you taking to address these?
A.2. The primary purpose of the Financial Stability Oversight
Council (FSOC) is to identify risks to financial stability,
respond to emerging threats in the system, and promote market
discipline. From the FDIC's perspective, the most important
systemic risks and emerging threats to our financial system at
the present time involve excessive reliance on debt and
financial leverage, continued lack of market discipline due to
perceptions of ``too big to fail,'' lingering problems in
mortgage servicing, and interest rate risk. My written
statement to the Committee describes these areas more fully,
along with the steps being taken to address them.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR VITTER FROM SHEILA C.
BAIR
Q.1. Dodd-Frank set forth a comprehensive list of factors that
FSOC must consider when determining whether a company posed a
systemic risk and deserves Fed oversight. The council, in its
advanced notice of proposed rulemaking, sets forth 15
categories of questions for the industry to comment on and
address. However, the proposed rules give no indication of the
specific criteria or framework that the council intends to use
in making SIFI designations--other than what is already set
forth in Dodd-Frank. As a result, potential SIFIs have no idea
where they may stand in the designation process. Will the
council provide additional information about the quantitative
metrics it will use when making a SIFI designation?
A.1. The FSOC issued an ANPR and NPR describing the processes
and procedures that will inform the FSOC's designation of SIFIs
under the Dodd-Frank Act. Concerns have been raised about the
lack of detail and clarity regarding the designation process in
the ANPR and NPR. The FDIC agrees that it is important that the
FSOC move forward and develop some hard metrics to guide the
SIFI designation process. The FSOC is in the process of
developing further clarification of the metrics for comment
that will provide more specificity as to the measures and
approaches being considered.
Q.2. Would the council agree that leverage is likely to be the
one factor that is most likely to create conditions that result
in systemic risk? If so, how will the council go about
identifying which entities use leverage?
A.2. The FDIC does not speak for the FSOC as a whole, but from
the FDIC's perspective, excessive reliance on debt and
financial leverage is currently one of the most important
systemic risks and emerging threats to our financial system,
along with continued lack of market discipline due to
perceptions of ``too big to fail,'' lingering problems in
mortgage servicing, and interest rate risk. My written
statement to the Committee describes these areas more fully,
along with the steps being taken to address them.
The Federal banking agencies that are members of FSOC
closely monitor leverage in the banking system through the
normal supervision process. Also, under the Dodd-Frank Act, the
largest, most interconnected financial institutions--banks and
nonbank financial companies--will be subject to enhanced
prudential standards. Core elements of these enhanced standards
will be strengthened capital and liquidity requirements.
The FDIC believes that recent efforts to strengthen the
capital base of our largest financial institutions are an
important element to restraining financial leverage and
enhancing the stability of our system. Going forward, the FSOC
and its member agencies will need to continue to monitor and
look for ways to reduce excess leverage throughout the system.
Q.3. One of the first steps in the systemic designation
process, as outlined in the proposed rule, is that after
identifying a nonbank financial company for possible
designation the FSOC will provide the company with a written
preliminary notice that the council is considering making
proposed determination that the company is systemically
significant. Is receipt of such a notice a material event that
might affect the financial situation or the value of a
company's shares in the mind of the investors? If so, wouldn't
it need to be disclosed to investors under securities laws?
A.3. The FSOC is responsible for designating nonbank SIFIs. A
company designated as a SIFI will continue to be required to
comply with other applicable laws, such as the securities laws,
which require certain public disclosures. The FDIC does not
administer securities laws and thus defers to the Securities
and Exchange Commission on questions regarding a public
company's disclosure requirements under U.S. securities laws.
While a preliminary notice from the FSOC could be
significant for a company, in many cases the market may already
have anticipated such a designation with respect to the value
of a company's shares.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR TOOMEY FROM SHEILA C.
BAIR
Q.1. Last week, Chairman Bernanke indicated that bank holding
companies larger than $50 billion, designated as systemically
significant by the Dodd-Frank Act, will be treated on a tiered
scale when you establish enhanced supervisory standards. These
institutions range from relatively basic commercial banks not
much larger than the $50 billion to more complex and
interdependent global financial firms that are up to 40 times
the threshold. Do you expect the tiered standards to be based
on a firm's asset size or on factors more directly related to
financial system risk, such as complexity of a firm's
businesses, its funding sources and liquidity, its importance
to the daily functioning of the capital markets and its
interconnectedness to other financial firms?
A.1. The tiered standards mentioned in the question relate to
the way the Federal Reserve will apply heightened prudential
standards to bank holding companies as the primary Federal
regulator of these companies. The FDIC will be dealing with
these firms from a resolution perspective, and their resolution
plans will reflect the complexity of their operations. While
there will not be any formal tiering of plan review and
monitoring at this point, there are some natural breaks in the
size and complexity of the firms. The larger more complex and
interdependent global financial firms' resolution plans will be
very large and will require substantial resources to analyze
and monitor. They are expected to cover every aspect of a
firm's operations so the larger the firm the more extensive the
plan. Smaller firms will be expected to have the same
comprehensive coverage of their operations; however, because of
the smaller size and less complex nature of their operations,
the firm's plans will be significantly smaller and therefore
take less time to analyze and monitor.
Q.2. As FSOC considers how to determine the systemic relevance
of the investment fund asset management industry, wouldn't it
be more appropriate for FSOC to look at the various individual
funds themselves, of which there may be several under one
advisor, rather than focus on the advisor entity?
LIsn't it true that each of those funds may operate
with separate and distinct investment strategies, each
with its own unique risks?
LIsn't it the case that the vast majority of the
assets are located at the funds and not at the adviser
(sic) entity?
A.2. In March, the FSOC reviewed broad risks in the structure
of a particular type of mutual fund, money market mutual funds
(MMMFs), SEC regulatory actions to address these risks, and the
additional risk-constraining options presented in the
President's Working Group on Financial Markets' (PWG) report on
MMMFs. As described in the PWG report, MMMFs can be a risk
transmission mechanism for the financial system. For example,
the September 2008 run on money market funds, which began after
the failure of Lehman Brothers, caused significant capital
losses at a large MMMF. Amid broad concerns about the safety of
MMMFs and other financial institutions, investors rapidly
redeemed MMMF shares, and the cash needs of MMMFs exacerbated
strains in short-term funding markets.
These strains, in turn, threatened the broader economy, as
firms and institutions dependent upon those markets for short-
term financing found credit increasingly difficult to obtain.
Forceful Government action was taken to stop the run, restore
investor confidence, and prevent the development of an even
more severe recession. Even so, short-term funding markets
remained disrupted for some time. Last month, the FDIC
participated with other FSOC members in an SEC-sponsored
roundtable with interested stakeholders to discuss reform
options further.
While the FSOC has considered broad systemic risks related
to MMMFs, the thrust of the question above appears to relate to
whether and how the FSOC would designate mutual funds and/or
their advisors as SIFIs. The SEC is the primary regulator of
mutual funds, and we cannot dispute the statements above about
the operations of mutual funds. Nevertheless, the process of
designating which SIFIs will be subject to heightened
supervision by the Federal Reserve under Title I of the Dodd-
Frank Act is not yet complete. Therefore, it is still uncertain
which entities will receive a SIFI designation.
In determining the appropriate way to designate SIFIs, the
FDIC is focused on getting the metrics right rather than
identifying specific types of entities for designation.
Importantly, and as described more fully above, the FDIC
believes that the ability of an entity to be resolved in
bankruptcy without systemic impact should be a key
consideration in the SIFI designation process.
Q.3. What additional protection/supervision could the Fed
provide for mutual funds that the SEC isn't already providing?
Do we really need to subject this industry to an additional
layer of regulation, especially a ``systemic risk'' regulation?
A.3. The SEC is the primary regulator for mutual funds. As
described above, the SIFI designation process is not yet
complete. Therefore, no heighted prudential standards or
capital requirements have been imposed by the Federal Reserve
on any SIFI, nor have any additional regulations on a
particular industry been proposed incident to the SIFI
designation process.
Q.4. Can you share with us what the FSOC, OFR, FDIC and Fed are
contemplating by way of fees that they may assess on SIFIs?
A.4. Section 155(d) of the Dodd-Frank Act requires the Treasury
Secretary, beginning 2 years after enactment, to establish, by
regulation, an assessment schedule applicable to bank holding
companies with total consolidated assets of $50 billion or
greater and nonbank financial holding companies supervised by
the Federal Reserve to collect assessments equal to the total
expenses of the Office of Financial Research (OFR). The FDIC is
not aware of any proposed rule by the Treasury Secretary in
this regard. The FDIC is not contemplating assessing fees on
SIFIs and is not aware of any plans by FSOC to assess such
fees.
International Competitiveness
Q.5. It is critical for the continued competitiveness of the
U.S. markets that a regulatory arbitrage does not develop among
markets that favors markets in Europe and Asia over U.S.
markets. Will the FSOC commit to ensuring that the timing of
the finalization and implementation of rulemaking under Dodd
Frank does not impair the competitiveness of U.S. markets?
How will FSOC ensure that U.S. firms will have equal access
to European markets as European firms will have to U.S.
markets?
A.5. The FSOC's statutory duties under section 112(a)(2) of the
Dodd-Frank Act include monitoring domestic and international
regulatory proposals and developments and advising Congress and
making recommendations in such areas that will enhance the
competitiveness of U.S. financial markets as well as the
integrity, efficiency, and stability of such markets. Also,
under section 752 of the Dodd-Frank Act, the CFTC, the SEC, and
the prudential regulators are required to consult and
coordinate with foreign regulatory authorities on establishing
consistent international standards with respect to the
regulation of covered derivatives.
Consistent standards will ensure equal access to all
markets. The FDIC, however, would not support weak standards in
order to be consistent with lower standards adopted by a
foreign jurisdiction.
With respect to timing, the prudential regulators, the
CFTC, and the SEC have primary authority to address the
effective date of derivatives reform regulations and are able
to take international coordination into account.
Q.6. How will FSOC ensure that Basel III will be implemented in
the United States in a manner that is not more stringent than
in Europe, making U.S. firms less competitive globally?
A.6. International consistency in capital requirements is a
worthy goal. We must, however, guard against pursuing the
competitiveness of U.S. firms in a way that compromises their
safety-and-soundness and the stability of our banking system.
The cost of financial crises for the real economy is severe,
and we need to pursue the changes in capital regulation needed
to prevent a recurrence.
The Federal banking agencies will have primary
responsibility for implementing the Basel III capital and
liquidity standards. Within the Basel Committee we have worked
to ensure as level a playing field as possible for U.S. banking
organizations, not only in Europe but across the rest of the
global financial system. In seeking to restore the resilience
of the international financial system, we have allied ourselves
with those Basel Committee members seeking strong capital and
liquidity standards. However, as always in the international
arena, certain countries believe the Basel III capital and
liquidity standards are too stringent. Of necessity, Basel III
is a compromise. Even so, Basel III goes a long way toward
addressing the weaknesses in the regulatory capital framework
exposed by the financial crisis.
The Basel capital standards always have been stated
minimums and, in the United States, we consistently have had
higher standards than Basel required (and many other Basel
member countries are in the same situation). For example, the
Basel I and Basel II minimum capital requirements were 4
percent tier 1 and 8 percent total risk-based capital ratios.
However, in the United States, to be well capitalized a bank
must have 6 percent tier 1 and 10 percent total risk-based
capital ratios. When Basel II was introduced in the United
States, we set higher floors over a longer period to ensure
that regulatory capital at the largest internationally active
U.S. banks would not decline precipitously. Currently, we also
are one of the few countries to have a leverage ratio that
complements our risk-based capital requirements. We believe our
higher capital requirements strengthen our banks and support
their international competitiveness. However, we are aware that
implementation of capital requirements across a number of Basel
member countries is not as rigorous as in the United States,
and we continually monitor this as part of our normal
supervisory process and through the Basel Committee.
------
RESPONSE TO WRITTEN QUESTION OF SENATOR KIRK
FROM SHEILA C. BAIR
Q.1. Much about SIFI designation focuses on ``too big to fail''
institutions. What about financial management practices that
can weaken a number of smaller players in an industry? What can
FSOC do to encourage best practices of asset/liability
management, or assure the proper allocation of capital that
reflects the risk underlying assets held?
A.1. The primary purpose of the FSOC is to identify risks to
financial stability, respond to emerging threats in the system,
and promote market discipline. The statutory language of the
Dodd-Frank Act in Section 112 addresses these responsibilities
largely in terms of large interconnected bank holding companies
and SIFIs because they can pose significant risks to the
financial stability of the United States, as demonstrated in
the recent crisis.
However, as the primary Federal supervisor for most
community banks in the United States, the FDIC is keenly aware
of their importance in our financial system. Community banks
provide credit, depository, and other financial services to
consumers and businesses on main street, and are playing a
vital economic role as cities and towns recover from the
recession. As the FSOC discusses and issues recommendations
regarding broad issues and best practices, including those
described above, they should consider effects on all players in
the financial system, large and small. In my capacity as an
FSOC voting member and in the FDIC's role as a community bank
supervisor, I am particularly focused on ensuring that the
Council considers community banks and the communities they
serve in its deliberations.
------
RESPONSE TO WRITTEN QUESTION OF SENATOR SHELBY FROM JOHN WALSH
Q.1. One of the Council's purposes is to monitor systemic risk
and alert Congress and regulators of any systemic risks it
discovers. What are the most serious systemic risks presently
facing the U.S. economy?
A.1. The potential loss of investor confidence in U.S. debt and
the impact such a loss would have on interest rates and the
overall economy, is a serious concern that we are monitoring
closely. While current Treasury yields and implied volatilities
remain relatively low, suggesting continued market confidence,
I share the views of many others that over the long term our
nation's current fiscal imbalance is not sustainable and must
be addressed. More generally, we are concerned that the
prolonged low interest rate environment has created incentives
for banks and other investors to take on significant levels of
interest rate risk. In response, the OCC and other U.S. banking
agencies have been emphasizing the need for bankers to improve
their interest rate risk management systems.
As the economy begins to recover, we are seeing some signs
of weakening underwriting standards, especially in the
leveraged loan markets. While our recent annual underwriting
survey did not indicate that standards have weakened
systematically across lending products, we are concerned that
banks not return to the lax underwriting practices that became
widespread prior to the crisis. When we released our survey
results, we cautioned national banks on the need to maintain
prudent underwriting standards. The agencies' Shared National
Credit review, currently underway, will be another key window
in helping us to evaluate the current quality of banks' large
credit portfolios and whether additional action is needed.
The housing sector continues to be an area that poses
substantial risk to the overall economy and many banks' credit
portfolios. While there are many factors affecting this market,
the overhang of distressed properties that need to be resolved
is certainly one of them. The action taken against the mortgage
servicers under our jurisdiction to fix their servicing and
mortgage foreclosure processing problems should help unblock
the system. More broadly, we continue to closely monitor trends
in mortgage loan portfolios, including mortgage modifications,
through our comprehensive Mortgage Metrics database and
reports.
Through the FSOC's systemic risk committee, we continue to
monitor a number of other potential risk areas including the
European debt situation, continued vulnerabilities in short-
term funding markets, and concentrations within the financial
sector.
Finally, as noted in recent remarks before the Housing
Policy Council of The Financial Services Roundtable, I agree
with others that the sheer volume and magnitude of regulatory
changes forthcoming under the Dodd-Frank Act and Basel III
reforms has created uncertainty as supervisors and market
participants attempt to digest and assess the cumulative impact
that these changes may have on markets and business models.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR REED
FROM JOHN WALSH
Q.1.a. The Interagency Review of Foreclosure Policies and
Practices notes that about 2,800 borrower foreclosure files in
various stages of foreclosure were reviewed.
The second footnote in The Interagency Review of
Foreclosure Policies and Practices briefly explains how these
files were selected, but please describe, with as much detail
as possible, the sampling methodology and the population from
which the samples were selected. What attributes were selected
for testing? Please provide the deviations that were found. We
would be particularly interested in what factors affected
``examiner judgment'' in the selection of these files.
A.1.a. The file review sample was judgmentally selected to
include loans from all States where the servicer had
foreclosure activity--both judicial as well as non-judicial
States. In selecting file samples, examiners gave consideration
to States with the highest foreclosure activity and those where
internal self assessments noted issues or concerns. Examiners
also considered complaints filed with the OCC.
Q.1.b. How is the OCC confident that these 2,800 borrower files
constitute a statistically significant sample size?
A.1.b. The file review was not intended to make any statistical
inferences with respect to foreclosure actions. Instead, it was
intended to draw and support general conclusions about servicer
processes, including the accuracy and compliance of legal
filings. While this was not a statistical sample, it was an
objective and unbiased reflection of each servicer's
foreclosure activities.
Q.1.c. Of these 2,800 borrower foreclosure files, how many of
these files reflected completed foreclosures?
A.1.c. Of the 1,697 files reviewed at the eight OCC banks, 623
were completed foreclosure sales.
Q.2.a. The OCC's Consent Order requires banks to hire an
independent consultant to review foreclosures from 2009 and
2010 to ensure that everything was done in accordance with
applicable laws and regulations.
What factors, if any, prevented the OCC from conducting
such a review?
A.2.a. The extraordinary resource demands needed to conduct
foreclosure reviews of the scope that the OCC will require,
make it impossible for the OCC to perform that work within any
reasonable timeframe. In addition, the Government procurement
process for awarding contracts directly with third parties to
conduct foreclosure reviews would be lengthy and significantly
delay implementation of the foreclosure reviews and restitution
to any affected customers. As described below, the OCC has
applied a number of measures to assure that the consultants are
independent and conduct their work independently.
Q.2.b. Please describe all criteria to be used by the OCC in
determining that an independent consultant is acceptable to the
OCC. Will an independent consultant be expected to have
expertise in servicing issues? If so, how will the OCC
determine that this independent consultant has sufficient
expertise to qualify as an independent consultant?
A.2.b. The OCC considers various factors concerning a
consultant's prior work in determining the independence of the
consultant. We also determine if the proposed consultant has
sufficient resources and expertise to successfully complete the
review. And we have required that specific language be included
in the engagement letters entered into between the servicer and
the consultant that makes clear that the consultant takes
direction from the OCC, not the servicer.
Q.2.c. Please describe the process for the OCC to review the
selection of an independent consultant and, if necessary,
object to the selection.
A.2.c. Per the Consent Orders, the OCC must approve the
independent consultant and their engagement letter that sets
forth: (a) the methodology for conducting the foreclosure
review, including: (i) a description of the information systems
and documents to be reviewed, including the selection of
criteria for cases to be reviewed; (ii) the criteria for
evaluating the reasonableness of fees and penalties; (iii)
other procedures necessary to make the required determinations
(such as through interviews of employees and third parties and
a process for submission and review of borrower claims and
complaints); and (iv) any proposed sampling techniques; and (b)
expertise and resources to be dedicated to the foreclosure
review. The independence, expertise and resources of each
consultant will be reviewed by OCC examiners in consultation
with OCC Enforcement and Compliance attorneys.
Q.2.d. What is the definition of an ``independent consultant''?
What is considered to be independent? Would an independent
public accounting firm or contractor that has previously
performed auditing services or other services for the bank be
considered independent?
A.2.d. Consultants hired to undertake the foreclosure review
must function as true ``independent'' parties, with no
conflicting interests or priorities. For example, firms and/or
counsel that currently, or have in the past represented the
servicer in any manner concerning areas addressed in the
Consent Orders may not meet the standards of independence. In
addition, sample segments and sizes must be decided by the
independent consultant and final results must be the product
and opinion of the independent consultant, unaffected by the
views of the institution or its directors or management.
The independent consultants may retain outside counsel to
provide necessary legal expertise in completing the foreclosure
review. However, any such outside counsel must be independent
of the outside counsel retained by the institution to provide
legal representation to the institution with respect to the
Consent Orders or legal advice concerning matters covered by
the Consent Orders. The independent consultant's work may not
be subject to direction or influence from counsel for the
institution.
Likewise, an independent public accounting firm that has
previously performed auditing services or other services for
the bank may be independent, but only if previous work
performed does not conflict with foreclosure review and there
is a clear separation of duties between auditors performing the
foreclosure review and those performing other auditing
services.
Q.2.e. Who at the Bank will be engaging the independent
consultant? The Board of Directors, the CEO, the CFO, an
independent committee, or someone else? Will the OCC be a party
to the engagement letter or have any rights under the
engagement letter?
A.2.e. The OCC requires the independent consultant to be
retained by the bank, and the OCC will not be a party to the
engagement letters. The Board of Directors is responsible for
engagement of the independent consultant, but it may delegate
authority to execute the engagement letter to senior
management.
Q.2.f. Will the letters of engagement be made available to the
relevant Congressional Committees? If the protection of
proprietary information is a concern, will the OCC make the
necessary arrangements to share these letters with the relevant
Congressional Committees so that Congress may conduct its
oversight role?
A.2.f. The engagement letters are confidential supervisory
information.
Q.2.g. How will the OCC ensure that the consultant's procedures
for the Foreclosure Review will be sufficient?
A.2.g. OCC onsite examiners will review action plans developed
by independent consultants including methodology for conducting
foreclosure reviews. In addition, the OCC will conduct a
horizontal review of all engagement letters and action plans
across banks to ensure consistency in foreclosure review
methodology and identify and address common deficiencies. Per
the Orders, the engagement letters will set forth: (a) the
methodology for conducting the foreclosure review, including:
(i) a description of the information systems and documents to
be reviewed, including the selection of criteria for cases to
be reviewed; (ii) the criteria for evaluating the
reasonableness of fees and penalties; (iii) other procedures
necessary to make the required determinations (such as through
interviews of employees and third parties and a process for
submission and review of borrower claims and complaints); and
(iv) any proposed sampling techniques; and (b) expertise and
resources to be dedicated to the foreclosure review. Onsite
examiners will maintain ongoing contact with the independent
consultants during the review process to ensure that the action
plans are appropriately implemented.
Q.3.a. As part of this review, the consultants are supposed to
determine if any errors, misrepresentations, or other
deficiencies identified in the review resulted in financial
injury to the borrower.
Will a consistent methodology be applied to ensure that the
selection criteria provides for a representative sample? If
not, why not? How will the sampling results be considered
reliable absent a statistically valid sampling methodology?
A.3.a. On May 20, 2011, the OCC provided and discussed
Foreclosure Review guidance with all institutions subject to
Consent Orders. The Foreclosure Review guidance addressed
supervisory expectations for the review, including the process
for selecting a representative sample of customer cases.
Certain segments of the population of foreclosure cases may be
subject to a statistically valid sampling methodology to
achieve the objective of the foreclosure review, while other
segments may require more extensive or 100 percent review. The
guidance is expected to be applied consistently across OCC-
supervised institutions.
Q.3.b. If sampling is used, what methodology will OCC utilize
to provide adequate compensation to all persons that were
harmed?
A.3.b. The OCC has instructed all institutions subject to the
Consent Orders that any sampling methodology must include
procedures for extensive investigation of identified errors,
including further ``deep-dive'' reviews as necessary, to ensure
that as many similarly affected borrowers as possible are
identified for appropriate remediation. The biggest factor in
determining an appropriate remedy is to determine the actual
financial harm suffered by homeowners as a result of an
improper foreclosure action. The Consent Orders require the
independent consultants to develop and submit for OCC approval
a plan to remediate all financial injury to borrowers caused by
any errors, misrepresentations, or other deficiencies
identified in the Foreclosure Review Report. The identification
of financial harm will be done through the foreclosure review
by the independent consultant. Given that every case is
different, the remedy must be specific to the details of the
individual case. This could include reimbursing impermissible
or excessive penalties, fees, or expenses, or other financial
injury suffered that could include taking appropriate steps to
remediate any improper foreclosure sale. Restitution will begin
after the OCC has provided supervisory non-objection to the
remediation plan.
Q.3.c. How will you ensure that this Foreclosure Review is
comprehensive, fair, and reliable? What specifically, will you
insist on regarding these points?
A.3.c. OCC actions taken and/or planned to ensure the
foreclosure review is comprehensive, fair and reliable include:
1. LOn May 20, 2011, the OCC provided expectations for
foreclosure reviews, including guidance on consultant
independence, sampling methodology, scope of review,
and the process for submission and review of customer
complaints, to all of the banks and thrifts subject to
Consent Orders.
2. LThe OCC will review all engagement letters to determine
their acceptability prior to the consultants beginning
their review. This supervisory review will include an
assessment of each engagement letter with the
requirements of the Consent Order as well as
foreclosure review guidance. Shortcomings will need to
be corrected prior to commencing the review.
3. LThe independent foreclosure review will achieve
identification of harmed borrowers through two distinct
means: 1) a public complaint process which will provide
borrowers who believe they may have suffered financial
harm as a result of the banks' foreclosure process with
the opportunity to have their complaint reviewed by the
independent consultant, and 2) a sampling of loans to
uncover, for example, borrowers in high risk segments.
We intend to require mortgage servicers to deliver
notice letters to every borrower covered by the look-
back period to inform them of their right to have their
complaint reviewed by an independent consultant.
Multiple attempts to reach borrowers will be required
for any returned notices. Servicers will be required to
undertake a broad range of efforts to reach borrowers
that includes broadscale advertising, outreach to State
attorneys general, Department of Justice, and other
Federal regulatory agencies to solicit information
about borrowers who may have filed foreclosure-related
complaints with those authorities in the 2009-2010 time
period. As well, the consultants are required to
conduct a targeted review of high risk segments that
includes a robust and targeted sampling methodology to
detect borrowers most at risk of harm. This might
include a review of covered borrowers who were denied
loan modifications, or those who submitted a
foreclosure-related complaint to the servicer. Certain
borrower segments will require a 100 per cent review
such as borrowers protected by the Servicemembers Civil
Relief Act and borrowers in bankruptcy whose mortgage
was foreclosed upon and whose home was sold.
4. LAny foreclosure-related complaints received by the OCC's
Customer Assistance Group will be forwarded to the bank
for review by the independent consultant.
5. LOCC examiners will review foreclosure review findings and
results on an ongoing basis and require independent
consultants to take action to address any supervisory
concerns.
6. LIndependent consultants must develop and submit for OCC
approval a plan to remediate all financial injury to
borrowers caused by any errors, misrepresentations, or
other deficiencies identified in the Foreclosure Review
Report.
7. LOCC will review all remediation plans submitted by
independent consultants. Restitution will begin after
the OCC has provided supervisory non-objection to the
remediation plans, and the bank is required to provide
the OCC with a report detailing all payments and
credits made under the plan.
Q.3.d. How will the OCC determine what qualifies as ``financial
injury'' to the borrower or mortgagee? If an affiant, as part
of a foreclosure affidavit, did not have personal knowledge of
the assertions in the affidavit, would this qualify as
``financial injury'' according to the OCC?
A.3.d. For purposes of OCC Consent Orders, ``financial injury
to the borrower or mortgagee'' means monetary harm to the
borrower or the mortgagee or owner of the mortgage loan
directly caused by errors, misrepresentations, or other
deficiencies identified in the foreclosure review. Monetary
harm does not include physical injury, pain and suffering,
emotional distress or other non-financial harm. This definition
of financial injury will be used by independent consultants to
determine financial injury. Cases involving affidavits prepared
by affiants without personal knowledge will need to be
evaluated by the independent consultant for the existence of
financial harm.
Q.3.e. If the independent consultant uncovers potentially
illegal acts, how is the independent consultant expected to
proceed? Will the consultant be required to report this to the
Bank's Audit Committee? Other than the OCC, are there other
regulators who will be informed about these discoveries? Will
these potentially illegal acts be covered and disclosed in the
consultant's written report?
A.3.e. Potentially illegal acts discovered should be included
in the Foreclosure Review Report prepared by the independent
consultant. Under the OCC's supervision, the findings from the
Foreclosure Review Report will be submitted to the Board of
Directors for review and action.
Q.3.f. Why have you limited the scope of this review just to
2009 and 2010? Is the OCC confident that prior to 2009, there
were no ``significant problems in foreclosure processing''
among the banks under the OCC's jurisdiction? As part of its
normal examinations from year to year, did the OCC previously
uncover the issues and problems cited in The Interagency Review
of Foreclosure Policies and Practices? If so, how did the OCC
address these issues and problems? If not, please explain why
the OCC did not identify these issues earlier?
A.3.f. OCC/OTS Mortgage Metrics data shows that the majority of
foreclosure actions occurred in the 2009 and 2010 timeframe.
The OCC did not previously identify the type of unsafe and
unsound practices that were noted in the Interagency Review of
Foreclosure Policies and Practices because: (1) supervisory
efforts were focused on loss mitigation activities; (2)
examiners placed reliance on internal audit and compliance
functions and other third party, external reviews which did not
identify major concerns; and (3) foreclosure processing was
historically considered a low-risk activity performed with the
assistance of outside legal counsel.
Q.3.g. Once the consultant has completed the review, the
consultant, per the OCC's consent order, will be required to
submit a written report detailing the findings of the
foreclosure review. Will this written report be publicly
available? If not, why not? If the protection of proprietary
information will be the reason for not making this report
public, will the OCC, at the very least, make the necessary
arrangements to share this report with the relevant
Congressional Committees so that Congress may conduct its
oversight role?
A.3.g. The Consent Orders require the independent consultants
retained by the servicers to prepare a written report detailing
the findings of the Foreclosure Review within 30 days of
completion of the review, and to submit the report to the OCC.
The reports constitute confidential supervisory information,
subject to privilege and other legal restrictions on disclosure
and, consequently, they will not be publicly available.
However, we expect to provide a public interim report on the
look-back process once the details of the look-back are
finalized, and then to provide a public report on the results
at the end of the process.
Q.4.a. Also as part of this review, the independent consultant
will be reviewing the bank's loss mitigation activities.
Will the OCC be requiring the independent consultant to
review all denied loan modification files as part of this
review? If not, why not?
A.4.a. Foreclosures where the borrower was denied for a loan
modification was discussed with the institutions as a distinct
sampling segment that could be included in their foreclosure
review. To the extent errors are found, we will extensively
investigate identified errors, including further ``deep-dive''
reviews as necessary, to ensure that as many similarly affected
borrowers as possible are identified for appropriate
remediation.
Q.4.b. The Interagency Review of Foreclosure Policies and
Practices notes that the review ``did not focus on the loan-
modification process.'' Why not, especially in light of the
fact that you are asking the consultants to review loss
mitigation activities as part of their review?
A.4.b. The primary scope of the review was centered on
foreclosure documentation preparation, governance and vendor
management because of documented and publicized cases of ``robo
signing.'' However, as part of this foreclosure review,
examiners checked to determine if loss mitigation actions,
including loan modifications, were offered to borrowers in the
sample. If a borrower was denied a loan modification, examiners
determined if there was a documented and sufficient reason for
the denial.
Q.5. The interaction of global capital requirements (Basel III)
and U.S. requirements (FSOC) could result in different criteria
being applied to the same financial institution. For example,
an institution could be deemed systemically important to the
global financial system but not to the financial system in the
United States. How is this being addressed? Does this pose any
unique risks?
A.5. There are a number of areas where the Basel III capital
requirements and the capital-related provisions of the Dodd-
Frank Act intersect that the agencies will need to resolve and
address as we move forward with our rulemakings. Sorting
through and resolving these interactions is one reason why we
have moved more slowly than originally anticipated on some of
these initiatives. With respect the designation of systemically
important financial institutions (SIFIs), we believe the $50
billion threshold established in Dodd-Frank will be more
inclusive than the threshold that will be adopted for the so-
called global SIFI provisions. Thus we do not believe it is
likely that a U.S. bank would be deemed systemically important
to the global financial system but not to the United States.
Q.6. A number of commentators and academics have asserted that
Basel III capital requirements are too low. For example, a
recent Stanford University study (Admati et al, published in
March 2011) stated that ``equity capital ratios significantly
higher than 10 percent of un-weighted assets should be
seriously considered.'' It also noted that ``bank equity is not
socially expensive'' and ``better capitalized banks suffer from
fewer distortions in lending decisions and would perform
better.'' In addition, Switzerland has adopted capital ratios
for its banks in excess of Basel III. What are the strengths
and weaknesses of capital adequacy ratios in excess of those
considered under Basel III? (Admati, DeMarzo, Hellwig,
Pfleiderer, ``Fallacies, Irrelevant Facts, and Myths in the
Discussion of Capital Regulation: Why Bank Equity is Not
Expensive.'' Stanford Graduate School of Business Research
Paper No. 2065, March 2011.)
A.6. While parts of the paper by Admati, DeMarzo, Hellwig, and
Pfleiderer\1\ (hereafter ADHP) are thoughtful and well argued,
many of their arguments are too simplistic in important
respects. The framework used by ADHP to analyze the case for
higher capital standards is incomplete, because there is no
clear mechanism in the paper to create any upper limit to the
required capital ratio. In their hypothetical world, there is
little or no downside to higher capital, because there are
unlimited amounts of liquid assets for banks to hold, and
unlimited amounts of equity capital that can be raised:
---------------------------------------------------------------------------
\1\ Anat R. Admati, Peter M. DeMarzo, Martin F. Hellwig, and Paul
Pfleiderer, ``Fallacies, Irrelevant Facts, and Myths in the Discussion
of Capital Regulation: Why Bank Equity is Not Expensive,'' unpublished
manuscript, Graduate School of Business, Stanford University, March 23,
2011.
[H]igher equity capital requirements do not mechanically limit
banks' activities, including lending, deposit taking and the
issue of liquid, money-like, informationally insensitive
securities. Banks can maintain all their existing assets and
liabilities and reduce leverage through equity issuance and the
---------------------------------------------------------------------------
expansion of their balance sheets. (ADHP, p.ii)
But the U.S. banking system is in fact fairly large
relative to existing markets for equity and liquid securities,
so the banking system cannot in practice adopt the approach
suggested in the ADHP quote above. As a consequence, although
ADHP use the reasoning above to dismiss suggestions that higher
capital requirements might reduce the aggregate amount of
banking activity, they conduct the discussion within a
framework that is incapable of fully addressing the issue.
With regard to higher proposed capital standards in other
countries, it is correct that Switzerland recently announced
minimum capital requirements well above those under discussion
by the Basel Committee as part of Basel III, and that the UK
has announced similar measures. However, these other countries
face situations markedly different from the United States. In
particular, both Switzerland and the UK are home to banks that
are far larger relative to their domestic financial systems
than is the case in the United States. Each of the three
largest UK-based banks has assets that exceed the size of the
British economy. The largest Swiss banks are two to three times
the size of the entire Swiss economy. In contrast, in the
United States the situation is reversed; annual U.S. GDP is
about seven times the asset size of even the largest U.S. bank-
holding company.
As a result, countries such as Switzerland and the UK face
a much different and more acute systemic challenge than the
United States; failure or financial distress at firms of such
sizes relative to the domestic economy would pose an almost
insurmountable challenge for the sovereign. It should not be
surprising that those governments feel compelled to take
drastic measures to reduce the risks associated with large
institutions, and might be willing to do so even at significant
expected economic cost in the near-term. While it is important
not to be complacent about the significant risks posed by large
systemically important institutions in the United States, the
nature and scale of the challenge is distinguishable from that
in many other developed countries. The U.S. economy is much
larger, as are the resources potentially available for
addressing problems. This fact reduces the value of comparisons
to other countries.
Capital requirements that prevent instability are valuable
because unstable banks can be extremely costly to the economy,
as is evident during financial crises. But at some level,
higher capital also tends to raise the cost of providing
banking services, and higher costs lead to those banking
services being provided at higher prices (higher interest rates
on loans, lower interest rates on deposits, and so on), or to a
reduction in the quantity of banking services provided to the
economy, or both.
Q.7. In March, Bloomberg noted that 77 percent of the banking
assets are held by the nation's ten largest banks--with 35
banks holding assets of $50 billion or more. In February,
Moody's granted higher ratings to eight large U.S. banks with
higher ratings because of an expectation of future Government
support--implicitly suggesting that risky behavior by large
banks would be more tolerated, and they would be insulated from
failure. Has systemic risk increased after the financial
crisis? Why or why not? How is this being addressed?
A.7. The mergers and failures resulting from the financial
crisis have left the banking sector more concentrated.
Concentration within the financial sector is an issue that FSOC
is discussing and addressing on a number of fronts. First and
foremost are the efforts being led by the FDIC and Federal
Reserve to implement the orderly liquidation authorities under
Title II of the Dodd-Frank Act that will facilitate liquidation
of large firms. An important corollary to this work will be
heightened prudential capital, liquidity, and risk management
standards that these firms will be required to meet. Pursuant
to section 622 of the Dodd-Frank Act, the FSOC has also issued
a study and made recommendations on the implementation of
section 622 of the Dodd-Frank Act that establishes a financial-
sector concentration limit generally prohibiting a financial
company from merging, consolidating with, or acquiring another
company if the resulting company's consolidated liabilities
would exceed 10 percent of the aggregate consolidated
liabilities of all financial companies. The study, published
for comment, concluded that a concentration limit will have a
positive impact on U.S. financial stability. It also made a
number of technical recommendations to address practical
difficulties likely to arise in its administration and
enforcement, such as the definition of liabilities for certain
companies that do not currently calculate or report risk-
weighted assets. Final recommendations, following the notice
and comment period, are expected later this year.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR CRAPO FROM JOHN WALSH
Q.1.a. According to the American Banker, Annette L. Nazareth, a
former SEC Commissioner, called the timetables imposed by the
Dodd-Frank Act ``wildly aggressive.'' ``These agencies were
dealt a very bad hand,'' she said. ``These deadlines could
actually be systemic-risk raising.'' Given the importance of
rigorous cost-benefit and economic impact analyses and the need
for due consideration of public comments, would additional time
for adoption of the Dodd-Frank Act rules improve your
rulemaking process and the substance of your final rules?
A.1.a. I share the view that the Dodd-Frank Act requires the
agencies to issue a very large number of rules that will affect
businesses and consumers profoundly. The OCC recognizes that we
must balance the requirement that we meet applicable statutory
deadlines with the need to carefully consider the impact of
regulations, and to provide a comment period that allows the
public sufficient time to contribute meaningful comments. While
meeting all of our statutory deadlines will be a challenge, in
my view, we should not favor speed over a robust process
designed to ensure that we get a rule right.
Q.1.b. Chairman Bair's testimony was unclear regarding whether
the FSOC has the authority to issue a revised rule on the
designation of nonbank financial institutions. She and others
indicated some type of guidance might be issued instead. Is it
in fact the case, in general, that the FSOC does not have
authority to issue rules under Title I that have the force and
effect of law? If the FSOC has the authority in general to
issue such rules on designation, why specifically would the
FSOC be precluded from re-proposing a rule that is currently
pending? Is there additional authority the FSOC would need from
Congress to issue such rules or to proceed with re-proposing
its NPR on designation? If yes, what specific authority would
the FSOC need from Congress for the FSOC to have the ability to
proceed?
A.1.b. The FSOC has the authority to issue rules setting forth
its understanding and interpretation of the governing statute.
The process of making systemic risk determinations is a
critical function of the FSOC. As I noted in my testimony, the
FSOC must achieve the right balance between providing
sufficient clarity in our rules and transparency in our
designation process and avoiding overly simplistic approaches
that fail to recognize and consider the facts and circumstances
of individual firms and specific industries and fail to
maintain the necessary flexibility to react to the evolving
nature of firms and markets. In response to concerns raised by
industry participants, the FSOC plans to seek comment on
additional details regarding its standards for assessing
systemic risk before issuing a final rule.
Q.1.c. In an August speech at NYU's Stern School of Business,
Treasury Secretary Geithner outlined six principles that he
said would guide implementation, and then he added, ``You
should hold us accountable for honoring them.'' His final
principle was bringing more order and integration to the
regulatory process. He said the agencies responsible for
reforms will have to work ``together, not against each other.
This requires us to look carefully at the overall interaction
of regulations designed by different regulators and assess the
overall burden they present relative to the benefits they
offer.'' Do you intend to follow through with this commitment
with some form of status report that provides a quantitative
and qualitative review of the overall interaction of all the
hundreds of proposed rules by the different regulators and
assess the overall burden they present relative to the benefits
they offer?
A.1.c. I agree that the various rules required by the Dodd-
Frank Act involve complex issues and, as I have noted, they
will interact in ways that we cannot yet envision. I believe
that an accurate assessment of the overall interaction of all
of the hundreds of rules being proposed by different regulators
cannot be made until the final rules have been issued and we
begin to judge the effect they have on how institutions conduct
business.
Q.2. On April 12, 2011 the Federal Reserve Board, the Federal
Deposit Insurance Corporation, the Federal Housing Finance
Agency, the Farm Credit Administration, and the Office of the
Comptroller of the Currency published proposed rules governing
margin and capital requirements applicable to covered swap
entities that are banks. The proposed rules appear (i) to
require those covered swap entities to collect margin from
nonfinancial end-users that exceed margin thresholds, and (ii)
to specify that such margin be in the form of cash or cash
equivalents only. Is this proposal consistent with section 731
of the Dodd-Frank Act which specifically provides that
prudential regulators ``shall permit the use of noncash
collateral, as the regulator . . .determines to be consistent
with . . . preserving the financial integrity of markets
trading swaps; and . . . preserving the stability of the United
States financial system?
A.2. Currently, the customer relationship between a bank swap
dealer and a commercial end-user generally is broader than
swaps. In addition to acting as the commercial firm's swap
dealer, the bank will typically also act as a lender to the
commercial firm, extending working capital lines of credit and
other types of loans.
Like a line of credit, a swap transaction exposes the bank
to credit risk--the risk that the counterparty will not be able
to make future payments due under the terms of the swap
transaction. Accordingly, banking regulators require banks
under their supervision to manage the credit risk of the swaps
aspect of their customer relationships the same way they manage
other credit relationships, and to manage the combined credit
risks of each customer on an aggregate basis. This includes
steps such as performing independent credit underwriting of new
customers to set a combined credit exposure limit for the
particular customer, monitoring their financial condition and
creditworthiness on an ongoing basis, and reporting all credit
exposures with each customer to management on a combined basis.
If a customer's financial condition declines such that their
existing credit limit is no longer justified, or if the
customer's credit exposure to the bank is nearing the limit for
other factors--such as unanticipated changes in the market
factors underlying swap transactions--banking regulators expect
management of the bank to be proactive in addressing the
situation. Appropriate steps by the bank include enhanced
monitoring, working with the customer to reduce the credit
exposure, working with other credit institutions to see if they
will take over portions of the bank's credit relationships with
the customer, obtaining additional collateral, etc. This
supervisory oversight is a core component of safety and
soundness supervision, and the banking regulators have
maintained published guidance requiring these measures for
years.
The proposed rule makes something of a change, in that it
would codify the central tenet of this guidance into a
regulation. But importantly, it does not contemplate any
fundamental change in current practice. It simply requires
banks, in determining whether to enter into a swap with a
nonfinancial customer, to evaluate the range of credit exposure
that is expected to arise under the swap and, if it exceeds the
bank's all-in credit exposure limit for that customer, decline
the transaction or take other appropriate steps before
proceeding, such as obtaining collateral, freeing up additional
credit limit by reducing undrawn lines of credit, obtaining a
guarantee, etc. If unexpected market factors cause the credit
exposure to exceed the limit over the life of an executed swap
transaction, the bank would be expected to manage it
proactively, as per current standards. But if the bank intends
to enter into swaps exceeding its internal credit exposure
limit for the customer, it must obtain margin. Any other
approach would be contrary to core safety and soundness
principles.
On the topic of noncash collateral and commercial
counterparties, the preamble of the proposed rule notes that
banks may determine the extent to which available noncash
collateral appropriately reduces the bank's credit risk in
setting the commercial counterparty's credit limit, consistent
with the bank's credit underwriting expertise. We believe this
appropriately allows commercial end-users to obtain the benefit
of their noncash collateral in swap transactions consistent
with section 731. There would be profound practical
difficulties incorporating most types of noncash collateral
into the definition of eligible collateral under the
regulations. In order to serve the purpose of having margin
requirements in the first place, margin collateral must be
highly liquid in times of crisis and susceptible to certainty
in its valuation. While certain forms of noncash items can meet
this standard, such as very high quality debt instruments
subject to regulatory-specified ``haircuts'' to account for
their interest rate price risk and liquidity risk as observed
in periods of previous market stress, it is impractical to
attempt to establish haircuts for all the different possible
types of noncash collateral that commercial counterparties
might want to offer. In addition, the haircuts, in order to be
prudent, would of necessity be quite steep.
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RESPONSE TO WRITTEN QUESTIONS OF SENATOR CORKER FROM JOHN WALSH
Q.1. Your institutions have been assigned the task of macro
prudential risk oversight. Specifically, the Dodd-Frank Act
tasked the FSOC with ``identifying risks to the financial
stability that could arise from the material financial distress
or failure of large interconnected bank holding companies or
nonbank financial companies.'' As you know nearly all banks
carry U.S. Treasury bills, notes, and bonds on their balance
sheet with no capital against them. They are deemed, both
implicitly and explicitly, as risk free. But with a $14
trillion debt, no one can guarantee that the bond market will
continue to finance U.S. securities at affordable rates. What
steps have you taken to ensure that systemically important
financial institutions could withstand a material disruption in
the U.S. Treasury market from an event such as a major tail at
an auction, the liquidation of securities by a major investor
such as a foreign central bank, concerns that the United States
will attempt to inflate its way out of its debt obligations, an
outright debt downgrade by a major rating agency, or market
concern over the prospects for a technical default? What impact
would an event such as the loss of market confidence in U.S.
debt and subsequent increase in U.S. borrowing rates have on
the institutions in your purview? And what steps can you take
to ensure that the balance sheets of systemically important
institutions could withstand such an event and that such an
event would not lead to a systemic crisis similar to or worse
than that experienced in 2008?
A.1. The U.S. fiscal situation, and its potential impact on the
market's confidence in U.S. debt securities and on the role of
the dollar as the principal international reserve asset, has
been and continues to be an issue that FSOC is closely
monitoring. Treasury Department staff provides periodic
briefings on their assessments of the U.S. Treasury debt
markets and available short-term tools to provide continued
funding of the U.S. Government under the current statutory debt
limit. Although current Treasury yields and implied
volatilities remain relatively low, suggesting continued market
confidence, I share the views of many others that over the long
term, our nation's current fiscal imbalance is not sustainable
and must be addressed. And indeed there are some signs of
increasing concerns by some market players. For example, the
volume of trading on credit-default swaps insuring U.S.
Treasuries is up sharply.
U.S. Treasury securities represent a fairly small
proportion of national banks' total investment securities
portfolios. As of March 31, 2011, U.S. Treasury securities in
national banks' securities portfolios totaled approximately
$137 billion, representing 8.4 percent of their total
securities holdings and 1.6 percent of total assets. An
additional $28 billion was held in national banks' trading
portfolios (representing only 4 percent of trading assets and
0.3 percent of total national bank assets). While it is true
that under the OCC's risk-based capital rules, U.S. Treasuries
are assigned a zero credit risk-weight, these holdings are
included in a bank's leverage capital ratio and in the market
risk capital requirements for banks with significant trading
portfolios.
Rather than direct losses on their Treasury holdings, the
greater risk posed to national banks from the loss of investor
confidence in U.S. debt is the potential impact such a loss
would have on interest rates and banks' attendant interest rate
risk exposures, and the secondary effects that higher interest
rates would have on the overall economy, and hence banks'
credit portfolios. The potential effect of higher interest
rates on banks' capital and earnings is a risk that the OCC
monitors and our examiners assess as part of our ongoing
supervision of national banks. We have been particularly
concerned that the prolonged low interest rate environment,
coupled with a relatively steep yield curve and lackluster loan
demand, has provided incentives for banks to take on additional
interest rate risk. In January 2010, the OCC and other Federal
banking agencies issued an advisory to all financial
institutions on interest rate risk management. The advisory
highlights the need for institutions to identify, monitor, and
manage their interest rate risk exposures and to conduct
periodic stress tests of their exposures beyond typical
industry conventions, including changes in rates of greater
magnitude (e.g., up and down 300 and 400 basis points) across
different tenors to reflect changing slopes and twists of the
yield curve. Monitoring and assessing banks' interest rate risk
continues to be an area of emphasis in our examinations. At
large national banks that have significant trading operations,
examiners likewise regularly evaluate the market, operational,
liquidity, and credit risks arising from those activities.
These assessments include evaluating the banks' contingency
funding plans, and the use of U.S. Treasury securities as
collateral in those operations.
Q.2. What other major systemic risks are you currently most
concerned about? What steps are you taking to address these?
A.2. In addition to heightened interest rate risk, there are
several other risk areas that we are closely monitoring. As the
economy begins to recover, we are seeing some signs of
weakening underwriting standards, especially in the leveraged
loan markets. While our annual underwriting survey does not
indicate that standards have weakened systematically across
lending products, we are concerned that banks not return to the
lax underwriting practices that became widespread prior to the
crisis. When we released our survey results, we cautioned
national banks on the need to maintain prudent underwriting
standards. The agencies' Shared National Credit review,
currently underway, will be another key window in helping us to
evaluate the current quality of banks' large credit portfolios
and whether additional action is needed.
The housing sector continues to be an area that poses
substantial risk to the overall economy and many banks' credit
portfolios. While there are many factors affecting this market,
the overhang of distressed properties that need to be resolved
is certainly one of them. The action taken against the mortgage
servicers under our jurisdiction to fix their servicing and
mortgage foreclosure processing problems should help unblock
the system. More broadly, we continue to closely monitor trends
in mortgage loan portfolios, including mortgage modifications,
through our comprehensive Mortgage Metrics database and
reports.
Through the FSOC's systemic risk committee, we continue to
monitor a number of other potential risk areas including the
European debt situation, continued vulnerabilities in short-
term funding markets, and concentrations within the financial
sector.
Finally, as noted in recent remarks before the Housing
Policy Council of The Financial Services Roundtable, I agree
with others that the sheer volume and magnitude of regulatory
changes forthcoming under the Dodd-Frank Act and Basel III
reforms has created uncertainty as supervisors and market
participants attempt to digest and assess the cumulative impact
that these changes may have on markets and business models.
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RESPONSE TO WRITTEN QUESTIONS OF SENATOR VITTER FROM JOHN WALSH
Q.1. Dodd-Frank set forth a comprehensive list of factors that
FSOC must consider when determining whether a company posed a
systemic risk and deserves Fed oversight. The council, in its
advanced notice of proposed rulemaking, sets forth 15
categories of questions for the industry to comment on and
address. However, the proposed rules give no indication of the
specific criteria or framework that the council intends to use
in making SIFI designations--other than what is already set
forth in Dodd-Frank. As a result, potential SIFIs have no idea
where they may stand in the designation process. Will the
council provide additional information about the quantitative
metrics it will use when making an SIFI designation?
A.1. In response to concerns raised by commenters and others,
FSOC has agreed to provide and seek comment on additional
details regarding FSOC's standards for assessing systemic risk
before issuing a final rule. While the details of such
additional guidance is still being developed, I anticipate it
will include more specific examples of some of the metrics and
thresholds that FSOC will consider in making these
determinations. As I noted in my written statement, it will be
critical that FSOC strikes the appropriate balance in providing
sufficient clarity in our rules and transparency in our
designation process, while at the same time avoiding overly
simplistic approaches that fail to recognize and consider the
facts and circumstances of individual firms and specific
industries. Ultimately, the decision to designate a company
must be based on an assessment of the unique risks that a
particular firm may present to the financial system.
Q.2. Would the council agree that leverage is likely to be the
one factor that is most likely to create conditions that result
in systemic risk? If so, how will the council go about
identifying which entities use leverage?
A.2. Yes, consistent with the statutory provisions and lessons
learned from the financial crisis, leverage is one of the six
categories of risk factors that FSOC has proposed to consider
in making SIFI designations. As commenters have suggested, FSOC
will need to consider and distinguish between different types
and sources of leverage when evaluating the effect that such
leverage may have on a firm. To the extent possible, FSOC will
use information from existing public and supervisory sources to
make initial assessments about a firm's leverage and other risk
factors. This information may be supplemented with requests for
more specific information from the firm.
Q.3. One of the first steps in the systemic designation
process, as outlined in the proposed rule, is that after
identifying a nonbank financial company for possible
designation the FSOC will provide the company with a written
preliminary notice that the council is considering making
proposed determination that the company is systemically
significant. Is receipt of such a notice a material event that
might affect the financial situation or the value of a
company's shares in the mind of the investors? If so, wouldn't
it need to be disclosed to investors under securities laws.
A.3. The FSOC has not taken up the issue of disclosure in this
regard. The rulemaking is still pending and no designations
have been made yet. As with other possible regulatory actions
with respect to which institutions receive advance notice, an
institution should consult counsel to determine whether receipt
of the notice is a material event requiring disclosure under
securities laws.
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RESPONSE TO WRITTEN QUESTIONS OF SENATOR TOOMEY FROM JOHN WALSH
Q.1. Last week, Chairman Bernanke indicated that bank holding
companies larger than $50 billion, designated as systemically
significant by the Dodd-Frank Act, will be treated on a tiered
scale when you establish enhanced supervisory standards. These
institutions range from relatively basic commercial banks not
much larger than the $50 billion to more complex and
interdependent global financial firms that are up to 40 times
the threshold. Do you expect the tiered standards to be based
on a firm's asset size or on factors more directly related to
financial system risk, such as complexity of a firm's
businesses, its funding sources and liquidity, its importance
to the daily functioning of the capital markets and its
interconnectedness to other financial firms?
A.1. The Federal Reserve has primary rulemaking authority for
this provision of the Dodd-Frank Act. We expect to be
consulting with the Federal Reserve as it moves forward with
its rulemaking.
Q.2. Can you share with us what the FSOC, OFR, FDIC and Fed are
contemplating by way of fees that they may assess on SIFIs?
A.2. While we are aware of the FDIC's recent announced changes
to its insurance assessment structure, the Federal Reserve and
OFR have not yet disclosed their plans for assessing fees on
systemically important institutions.
International Competitiveness
Q.3.a. It is critical for the continued competitiveness of the
U.S. markets that a regulatory arbitrage does not develop among
markets that favors markets in Europe and Asia over U.S.
markets. Will the FSOC commit to ensuring that the timing of
the finalization and implementation of rulemaking under Dodd
Frank does not impair the competitiveness of U.S. markets?
A.3.a. The OCC recognizes that the Federal banking agencies
must proceed carefully as we implement the Dodd-Frank
provisions, so that we do not create unnecessary limitations
that restrict the ability of U.S. banking institutions to
manage risk efficiently, and to compete internationally. As we
draft regulations to implement these provisions, we have
attempted to address these concerns to the extent possible
given the statutory framework. We also support Treasury's
efforts to address any competitive inequalities caused by the
Dodd-Frank Act through the G-20 process.
Q.3.b. How will FSOC ensure that U.S. firms will have equal
access to European markets as European firms will have to U.S.
markets?
A.3.b. Rules and regulations promulgated by the United States
as well as foreign jurisdictions should be assessed
periodically to ensure ``equivalent/national treatment'' across
borders. The FSOC member agencies will have the ability to look
across sectors and jurisdictions to identify areas where
``equivalent/national treatment'' is not afforded to U.S.
firms. Where this is identified, U.S. agencies will work with
their foreign counterparts to effect change, but also assess
whether U.S. rules need to be changed. The FSOC may also seek
legislative changes where needed.
Q.3.c. How will FSOC ensure that Basel III will be implemented
in the United States in a manner that is not more stringent
than in Europe, making U.S. firms less competitive globally?
A.3.c. To implement Basel III in the United States, a rule must
first be drafted. Through the rulemaking process, areas of
potential inconsistency with other jurisdictions may be
identified and rectified to the extent possible. The U.S.
agencies responsible for the supervision of Basel III
implementation are currently responding to questions from firms
about Basel III and reviewing capital plans to determine how
the firms are factoring Basel III into their capital planning
processes. The U.S. agencies will coordinate to ensure
consistent implementation by U.S. firms.
On the international front, the Basel Committee on Banking
Supervision (BCBS) has initiated an ``evergreen'' Basel III
implementation questionnaire that will be completed
periodically to gauge the progress of Basel III implementation
by member jurisdictions. This process will also facilitate the
identification of areas of inconsistency that may require
clarification and/or more guidance from the BCBS regarding
Basel III. The U.S. agencies are actively involved in the BCBS
and will work with their global counterparts to address areas
of inconsistency.
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RESPONSE TO WRITTEN QUESTION OF SENATOR KIRK
FROM JOHN WALSH
Q.1. Much about SIFI designation focuses on ``too-big-to-fail''
institutions. What about financial management practices that
can weaken a number of smaller players in an industry? What can
FSOC do to encourage best practices of asset/liability
management, or assure the proper allocation of capital that
reflects the risk underlying assets held?
A.1. The OCC and other Federal banking agencies have well-
established mechanisms in place to coordinate efforts to
promote and encourage sound risk management practices for
financial institutions of all sizes, including smaller
community banks. Much of this work is facilitated by the
Federal Financial Institutions Examination Council. Because of
heightened concerns about interest rate and liquidity risk, in
2010 the agencies issued an interagency policy statement on
funding and liquidity risk management, and a joint advisory on
interest rate risk management. These policy statements provide
guidance to bankers on sound practices for asset/liability
management. Similarly, virtually all of the Federal banking
agencies' capital rules are developed and issued on a
collaborative basis. As part of the implementation of the
enhanced capital provisions set forth in Basel III, the
agencies are considering and plan to propose revisions to the
general risk-based capital rules that apply to small banking
institutions. Such changes would only go into effect after a
notice and comment process.
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RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM MARY L.
SCHAPIRO
Q.1. If a public company is told by the Council that it is
considering designating it as systemically significant, the
company may believe that such information is material and must
be disclosed to the public under the securities laws. What is
your view on whether a company would have to publicly disclose
the fact that it has been informed that it may be designated by
the Council?
A.1. There are currently no specific ``line item'' requirements
to disclose that a company has been notified that it is being
considered for possible designation or if it has been notified
and not designated. However, a company would need to review its
description of its regulatory status and requirements to
determine whether its disclosure requires updating. The company
and its advisors would need to determine whether being notified
that the company may be systemically important (and, once a
determination has been made with regard to designation, the
outcome of that determination) is material information that
must be disclosed to investors. The test for materiality is
whether there is a substantial likelihood that the disclosure
of the omitted fact would have been viewed by the reasonable
investor as having significantly altered the total mix of
information made available. Whether a contingent or speculative
event is material requires a balancing of both the indicated
probability that the event will occur and the anticipated
magnitude of the event in light of the totality of the company
activity.
If material, the company would need to disclose the
possible designation and/or the final determination as to
designation, for example, in an annual or quarterly report. The
possible designation and/or the final determination as to
designation are more likely to be material if FSOC designations
have had a material effect on other companies' stock prices.
The materiality determination also would be affected by the
consequences of being designated systemically important, such
as capital requirements and limitations on business activities.
Q.2. You began your written testimony with a lengthy discussion
of market structure issues. Do you believe these issues to be
the biggest potential source of systemic risk on your
regulatory agenda? If so, should the Council be paying more
attention to market structure issues than it is now?
A.2. The SEC's regulatory agenda encompasses a broad range of
complex financial activity and firms, including, among others,
equity market structure, broker-dealers, clearing agencies,
money market funds, hedge funds, and over-the-counter
derivatives; and we have been working with the Council members
on all of these. Clearly, however, maintaining the integrity of
the U.S. equity market structure is a vitally important part of
the SEC's regulatory agenda. Accordingly, as discussed in my
testimony, the SEC has undertaken a series of steps to promote
fair and orderly trading and to help prevent extraordinary
volatility in the future.
Q.3. Under Dodd-Frank, swap data repositories, before sharing
any information with a regulator other than their primary
regulator, must obtain an indemnification agreement with that
other regulator. Will this requirement adversely affect
regulators' ability to obtain a comprehensive view of the swaps
markets?
A.3. The Securities Exchange Act of 1934, as amended by the
Dodd-Frank Act, requires a security-based swap data repository
(SDR) to obtain a written agreement from certain domestic and
foreign regulators whereby the regulator agrees to indemnify
the SDR and the Commission for litigation expenses arising from
the disclosure of data maintained by the SDR as a condition for
the SDR to provide information directly to a regulator other
than the Commission.
Some domestic and foreign regulators have expressed concern
about their ability to comply with the requirement to enter
into an indemnification agreement with an SDR in order to
obtain information directly from the SDR. In a recent letter to
Michel Barnier, European Commissioner for Internal Markets and
Services, Chairman Gensler and I noted these potential
difficulties, and set forth circumstances in which this
requirement would not apply to foreign regulators, including
when the SDR is also registered with a foreign regulator and
that regulator, acting within the scope of its jurisdiction,
seeks information from the SDR.
The Commission staff is still considering issues relating
to the indemnification requirement, and is consulting and
coordinating with CFTC staff regarding such issues. Because the
Commission staff has not yet completed its recommendations for
final rules in this area, the Commission has not had the
opportunity to fully consider the application of the
indemnification provision in all scenarios involving requests
from regulators for information in SEC-registered trade
repositories. I anticipate that the Commission will consider
recommendations from our staff designed, consistent with the
provisions of the Dodd-Frank Act and the statutes we
administer, to facilitate the access to information at trade
repositories that regulators need to carry out their
responsibilities.
Q.4. One of the Council's purposes is to monitor systemic risk
and alert Congress and regulators of any systemic risks it
discovers. What are the most serious systemic risks presently
facing the U.S. economy?
A.4. The FSOC is working to complete its annual report called
for by the Dodd-Frank Act, which will describe the overall
macroeconomic environment, significant trends and risks,
including systemic risks, and recommendations for regulatory
action.
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RESPONSE TO WRITTEN QUESTION OF SENATOR HAGAN FROM MARY L.
SCHAPIRO
Q.1. Chairwoman Schapiro and Chairwoman Bair, In March Federal
financial regulators published a proposed rule that would
implement Section 956 of the Dodd-Frank Act. Section 956
requires regulators to issue rules that prohibit ``covered
financial institutions'' from entering into incentive-based
compensation arrangements that encourage inappropriate risks.
``Covered financial institutions'' are defined to include
investment advisers that have $1 billion or more in total
consolidated assets (as opposed to assets under management).
On what basis did the SEC choose to consider only
consolidated assets on the balance sheet of the investment
adviser and not take into account assets under management?
A.1. Paragraph (f) of Section 956 of the Dodd Frank Act exempts
covered financial institutions with ``assets of less than
$1,000,000,000'' from the requirements of Section 956. In
carving out institutions with less than $1 billion in assets,
Congress thus determined that the ``covered financial
institutions'' listed in Section 956(e) with $1 billion or more
in assets are covered by Section 956.
In drafting the proposed rules, the SEC and the six other
agencies charged with rulemaking under Section 956 (together,
the ``Agencies'') considered that the statute uses the term
``assets,'' which is predominantly understood to mean the total
assets of a firm, and does not refer to ``assets under
management,'' which is predominantly understood to mean the
assets that a firm manages on behalf of its clients.
Additionally, the measurement of asset size for most firms
generally is made with reference to the assets on the balance
sheet of the firm. For example, we understand that the size of
a bank generally would be described by reference to the total
assets on the balance sheet of the bank, not by reference to
the amount of customer assets the bank manages (for example, as
the trustee of a customer's trust). Similarly, an investment
adviser's assets under management generally do not appear as
assets on the firm's balance sheet because the assets under
management belong to another individual or entity. As a result,
the Agencies did not propose to include customer assets, such
as assets under management, in the calculation of the $1
billion threshold.
The other important factor to note is that Section 956
requires the Agencies to engage in joint rulemaking. The
Agencies interpreted this statutory directive as requiring the
Agencies to propose a rule that was substantially similar from
agency to agency to the greatest extent practicable, and sought
to maintain the general consistency of the rule from agency to
agency, and between types of covered financial institutions
regulated by the SEC (broker-dealers and investment advisers).
Thus, the SEC proposed an asset test for investment advisers
intended to mirror the way such asset tests are proposed to be
calculated and applied to the other covered financial
institutions, which are based on the total assets on the
balance sheet of each firm, and which exclude in each case
assets that are held for others.
Finally, all of the covered financial institutions, except
investment advisers, report to their respective regulator the
amount of their ``assets.'' For example, banks regulated by the
OCC, Federal Reserve, and FDIC report total assets on Call
Reports, and broker-dealers regulated by the SEC file a year-
end audited consolidated statement of their financial condition
that includes ``total consolidated assets.'' The proposed rule
would rely on the total assets reported in these reports to
determine the size of each firm's ``assets'' for purposes of
section 956. Recently, the SEC proposed to require advisers to
report on Form ADV whether they have $1 billion or more in
total balance sheet assets. Requiring advisers to use the
amount of total assets on their balance sheets, as proposed,
would dovetail with this proposal and be consistent with the
method for evaluating other intermediaries under the proposed
rule.
The Agencies requested comment on whether all of the
Agencies should use a uniform method to determine whether an
institution has $1 billion or more in assets, and whether any
of the Agencies should define total consolidated assets
differently than the proposed calculations. The Agencies also
specifically requested comment on the proposed method of
determining asset size for investment advisers, including
whether the determination of total assets should be further
tailored for certain types of advisers. The Agencies will
carefully review and consider public comments that have been
received discussing this and any other issues. The interagency
drafting committee will take all such comments into account
when developing a final rule proposal for consideration by the
Agencies.
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RESPONSE TO WRITTEN QUESTION OF SENATOR CRAPO FROM MARY L.
SCHAPIRO
Q.1. According to the American Banker, Annette L. Nazareth, a
former SEC Commissioner, called the timetables imposed by the
Dodd-Frank Act ``wildly aggressive.'' ``These agencies were
dealt a very bad hand,'' she said. ``These deadlines could
actually be systemic-risk raising.'' Given the importance of
rigorous cost-benefit and economic impact analyses and the need
for due consideration of public comments, would additional time
for adoption of the Dodd-Frank Act rules improve your
rulemaking process and the substance of your final rules?
A.1. Implementation of the Dodd-Frank Act is a substantial
undertaking. The Act's requirements that a significant number
of Commission rulemakings be completed within 1 year of the
date of enactment poses significant challenges to the
Commission. Throughout, the staff and Commission have been
diligent in working to implement the requirements of the Act
while also taking the time necessary to thoughtfully consider
the issues raised by the various rulemakings.
We recognize that many of our new rules may have near term
market implications and costs and important long-term benefits.
We must carefully consider these implications, including by
engaging in a robust cost-benefit and economic impact analysis.
As a result, we are providing market participants with
sufficient time to understand the obligations that may apply to
them as well as the potential costs and benefits, and economic
implications, of those obligations.
While we are eager to get these important rules in place,
it is critical that we get the rules right, and that we
promulgate the rules in a timely fashion, taking into account
the complexities of the markets being regulated and the number
of rulemakings involved.
To help keep the public informed, we have a section on our
Web site that provides detail about the Commission's
implementation of the Act. We also are taking steps to gather
additional input on our implementation process where
appropriate, such as the joint roundtable held on May 2 and 3
with the CFTC regarding the implementation of derivatives rules
under Title VII. We value, and are committed to seeking, the
broad public input and consultation needed to promulgate these
important rules.
Q.2. Chairman Bair's testimony was unclear regarding whether
the FSOC has the authority to issue a revised rule on the
designation of nonbank financial institutions. She and others
indicated some type of guidance might be issued instead. Is it
in fact the case, in general, that the FSOC does not have
authority to issue rules under Title I that have the force and
effect of law? If the FSOC has the authority in general to
issue such rules on designation, why specifically would the
FSOC be precluded from re-proposing a rule that is currently
pending? Is there additional authority the FSOC would need from
Congress to issue such rules or to proceed with re-proposing
its NPR on designation? If yes, what specific authority would
the FSOC need from Congress for the FSOC to have the ability to
proceed?
A.2. Like the FDIC, the Commission has not conducted its own
independent legal analysis of this issue, but as discussed at
the hearing, members of the FSOC have sought guidance from the
Department of the Treasury, Office of the General Counsel. We
understand from the Treasury Department that the FSOC has the
authority to issue its proposed regulations on designations,
and to repropose those rules for further public comment. The
FSOC has already exercised its rulemaking authority to release
a notice of proposed rulemaking on the designation of nonbank
financial companies to be supervised by the Federal Reserve.
The FSOC plans to seek further public comment on guidance
regarding its approach to designations of nonbank financial
companies, and release a final rule that will reflect the input
received on the proposed rule and guidance.
Q.3. In an August speech at NYU's Stern School of Business,
Treasury Secretary Geithner outlined six principles that he
said would guide implementation, and then he added, ``You
should hold us accountable for honoring them.'' His final
principle was bringing more order and integration to the
regulatory process. He said the agencies responsible for
reforms will have to work ``together, not against each other.
This requires us to look carefully at the overall interaction
of regulations designed by different regulators and assess the
overall burden they present relative to the benefits they
offer.'' Do you intend to follow through with this commitment
with some form of status report that provides a quantitative
and qualitative review of the overall interaction of all the
hundreds of proposed rules by the different regulators and
assess the overall burden they present relative to the benefits
they offer?
A.3. We have been working closely, cooperatively, and regularly
with our fellow regulators to develop the new regulatory
framework and we are committed to continuing to do so.
We meet regularly, both formally and informally, with other
financial regulators. SEC staff working groups, for example,
consult and coordinate with the staffs of the CFTC, Federal
Reserve Board, and other prudential financial regulators, as
well as the Department of the Treasury, on implementation of
the Dodd-Frank Act. Our objective is to establish consistent
and comparable requirements, to the extent possible, taking
into account differences in products, participants, and
markets, and this objective will continue to guide our efforts
as we move forward.
Finally, because the world today is a global marketplace
and what we do to implement many provisions of the Act will
affect foreign entities, we are consulting bilaterally and
through multilateral organizations with counterparts abroad.
The SEC and CFTC, for example, are directed by the Dodd-Frank
Act to consult and coordinate with foreign regulators on the
establishment of consistent international standards governing
swaps, security-based swaps, swap entities and security-based
swap entities. We believe that the recently formed IOSCO Task
Force on OTC Derivatives Regulation, which the SEC co-chairs,
and other international fora, as well as bilateral discussions
with international regulators, will help us achieve this goal.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR VITTER FROM MARY L.
SCHAPIRO
Q.1. Dodd-Frank set forth a comprehensive list of factors that
FSOC must consider when determining whether a company posed a
systemic risk and deserves Fed oversight. The council, in its
advanced notice of proposed rulemaking, sets forth 15
categories of questions for the industry to comment on and
address. However, the proposed rules give no indication of the
specific criteria or framework that the council intends to use
in making SIFI designations--other than what is already set
forth in Dodd-Frank. As a result, potential SIFIs have no idea
where they may stand in the designation process. Will the
council provide additional information about the quantitative
metrics it will use when making an SIFI designation?
A.1. As Department of the Treasury Under Secretary Goldstein
noted in his letter to Senator Shelby:
The Financial Stability Oversight Council (FSOC) recognizes the
importance of a public review of its decisionmaking criteria
and is working diligently to provide the public with greater
detail on the process and framework for making designations.
One of the FSOC's key guiding principles is transparency and
openness, as demonstrated by our deliberate emphasis on
continued public input in the rulemaking process.
The process of determining which companies pose a potential
risk to U.S. financial stability is not an easy task, but it is
imperative that the FSOC get it right. The FSOC continues to
work toward an approach that will allow the financial industry
to assess whether they are candidates for designation while
maintaining flexibility as the nature of institutions and
markets change. Of course, ultimately the decision to designate
a company will be based on an assessment of the unique risks
that a particular firm may present to the financial system. The
FSOC plans to seek public comment on additional guidance
regarding its approach to designations.
In addition to public comments from industry participants, the
FSOC will also rely on the expertise of its members and their
agencies' staff. These individuals have expertise that spans
all aspects of the financial services industry. Any designation
decision will draw on this experience.
Q.2. Would the council agree that leverage is likely to be the
one factor that is most likely to create conditions that result
in systemic risk? If so, how will the council go about
identifying which entities use leverage?
A.2. Leverage is an important element of the systemic risk
analysis and is identified as such in the criteria for making a
SIFI determination under the Dodd-Frank Act. Leverage may be
the factor that is most relevant for some institutions, but
other factors may predominate for other firms. FSOC is pursuing
the identification of specific metrics that could be used for
different types of firms, including metrics with respect to
leverage.
Q.3. One of the first steps in the systemic designation
process, as outlined in the proposed rule, is that after
identifying a nonbank financial company for possible
designation the FSOC will provide the company with a written
preliminary notice that the council is considering making
proposed determination that the company is systemically
significant. Is receipt of such a notice a material event that
might affect the financial situation or the value of a
company's shares in the mind of the investors? If so, wouldn't
it need to be disclosed to investors under securities laws?
A.3. There are currently no specific ``line item'' requirements
to disclose that a company has been notified that it is being
considered for possible designation or if it has been notified
and not designated. However, a company would need to review its
description of its regulatory status and requirements to
determine whether its disclosure requires updating. The company
and its advisors would need to determine whether being notified
that the company may be systemically important (and, once a
determination has been made with regard to designation, the
outcome of that determination) is material information that
must be disclosed to investors. The test for materiality is
whether there is a substantial likelihood that the disclosure
of the omitted fact would have been viewed by the reasonable
investor as having significantly altered the total mix of
information made available. Whether a contingent or speculative
event is material requires a balancing of both the indicated
probability that the event will occur and the anticipated
magnitude of the event in light of the totality of the company
activity.
If material, the company would need to disclose the
possible designation and/or the final determination as to
designation, for example, in an annual or quarterly report. The
possible designation and/or the final determination as to
designation are more likely to be material if FSOC designations
have had a material effect on other companies' stock prices.
The materiality determination also would be affected by the
consequences of being designated systemically important, such
as capital requirements and limitations on business activities.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR TOOMEY FROM MARY L.
SCHAPIRO
Q.1. One of the first steps in the systemic designation
process, as outlined in the proposed rule, is that after
identifying a nonbank financial company for possible
designation the FSOC will provide the company with a written
preliminary notice that the Council is considering whether to
make a ``proposed determination'' that the company is
systemically significant. Is receipt of such a notice a
``material event'' that might affect the financial situation or
the value of a company's shares in the mind of investors? If
so, wouldn't it need to be disclosed to investors under
securities laws?
A.1. There are currently no specific ``line item'' requirements
to disclose that a company has been notified that it is being
considered for possible designation or if it has been notified
and not designated. However, a company would need to review its
description of its regulatory status and requirements to
determine whether its disclosure requires updating. The company
and its advisors would need to determine whether being notified
that the company may be systemically important (and, once a
determination has been made with regard to designation, the
outcome of that determination) is material information that
must be disclosed to investors. The test for materiality is
whether there is a substantial likelihood that the disclosure
of the omitted fact would have been viewed by the reasonable
investor as having significantly altered the total mix of
information made available. Whether a contingent or speculative
event is material requires a balancing of both the indicated
probability that the event will occur and the anticipated
magnitude of the event in light of the totality of the company
activity.
If material, the company would need to disclose the
possible designation and/or the final determination as to
designation, for example, in an annual or quarterly report. The
possible designation and/or the final determination as to
designation are more likely to be material if FSOC designations
have had a material effect on other companies' stock prices.
The materiality determination also would be affected by the
consequences of being designated systemically important, such
as capital requirements and limitations on business activities.
Q.2. As FSOC considers how to determine the systemic relevance
of the investment fund asset management industry, wouldn't it
be more appropriate for FSOC to look at the various individual
funds themselves, of which there may be several under one
advisor, rather than focus on the advisor entity?
LIsn't it true that each of those funds may operate
with separate and distinct investment strategies, each
with its own unique risks?
LIsn't it the case that the vast majority of the
assets are located at the funds and not at the adviser
entity?
A.2. It is true that each of these funds may operate with
separate and distinct investment strategies, each with its own
unique risks. But a manager could advise several funds (and
even separate accounts) with similar or identical investment
strategies in a parallel or similar manner. These advisers may
aggregate the trades for many funds for execution and then
allocate the securities among the various funds. For example,
an asset manager could engage in same trading strategy (which
can be of systemic relevance) across several of the funds it
manages. While the assets may be owned by individual funds,
their trading may be done jointly. Thus in assessing systemic
risk we recognize that it is important to engage in robust
process and examine the issue holistically.
Q.3. What additional protection/supervision could the Fed
provide for mutual funds that the SEC isn't already providing?
Do we really need to subject this industry to an additional
layer of regulation, especially a ``systemic risk'' regulation?
A.3. Under Title I, The Federal Reserve would have authority to
impose enhanced prudential regulation over individual nonbank
financial companies that are designated for oversight by two-
thirds of the FSOC. However, one factor FSOC is required to
consider when determining whether to designate any nonbank
financial company for supervision by the Federal Reserve is
``the degree to which the company is already regulated by one
or more primary financial regulatory agencies.'' We believe,
therefore, that FSOC will consider whether designation is
appropriate for firm after considering current regulation as
well as the other factors the Dodd-Frank Act requires that FSOC
consider before designating any nonbank financial company. It's
also important to note, that while the SEC has significant
legal authority in this area; (1) the SEC's historic mission
has been one of `investor protection' rather than systemic
risk; and (2) the SEC far fewer staff to perform examinations
and oversee firm's activities.
Q.4. Can you share with us what the FSOC, OFR, FDIC and Fed are
contemplating by way of fees that they may assess on SIFIs?
A.4. I understand that such fees would be considered and
adopted by the Federal Reserve Board as part of the authority
assigned it by the Dodd-Frank Act to supervise SIFIs, rather
than by FSOC or the Commission.
International Competitiveness
Q.5.a. It is critical for the continued competitiveness of the
U.S. markets that a regulatory arbitrage does not develop among
markets that favors markets in Europe and Asia over U.S.
markets. Will the FSOC commit to ensuring that the timing of
the finalization and implementation of rulemaking under Dodd
Frank does not impair the competitiveness of U.S. markets?
A.5.a The FSOC was created by Title I of the Dodd-Frank Act.
Under the Dodd-Frank Act, Congress has given FSOC the following
primary responsibilities:
Lidentifying risks to the financial stability of the
United States that could arise from the material
financial distress or failure--or ongoing activities--
of large, interconnected bank holding companies or
nonbank financial holding companies, or that could
arise outside the financial services marketplace;
Lpromoting market discipline by eliminating
expectations on the part of shareholders, creditors,
and counterparties of such companies that the
Government will shield them from losses in the event of
failure (i.e., addressing the moral hazard problem of
``too big to fail''); and
Lidentifying and responding to emerging threats to
the stability of the United States financial system.
The FSOC has 10 voting members, including the Chairman of
the SEC. The SEC is charged with regulating, among other areas,
the security-based swaps markets, and in doing so we consider
the potential impact on the global competitiveness of U.S.
markets. To this end, we have been carefully considering the
potential consequences of certain provisions of Title VII and
our proposed rulemaking for domestic and foreign market
participants--in particular the impact on the ability of U.S.
market participants to compete effectively with foreign market
participants that may not be subject to the Dodd-Frank Act. In
fact, we are required to take into account potential burdens on
competition when engaging in rulemaking, including rulemaking
under the Dodd-Frank Act. Our goal is to establish a level
playing field for all market participants while adhering to the
regulatory requirements and objectives of the Dodd-Frank Act,
and we are considering how to promulgate regulations in a way
that accomplishes this goal.
The SEC has been working closely with the CFTC, the Federal
Reserve Board and other Federal prudential regulators who also
are members of FSOC, in developing a harmonized approach to
implementing the statutory provisions of Title VII to the
extent practicable.
As we move from the proposing stage to implementation, we
recognize that part of balancing regulatory concerns with
competitiveness concerns involves establishing an
implementation process for derivatives regulation that permits
market participants sufficient time to establish systems and
procedures in order to comply with new regulatory requirements
without imposing undue implementation burdens and costs. We
also are cognizant of the timing of legislation, rulemaking and
implementation in other jurisdictions.
To this end, we have been discussing with our fellow
regulators and with market participants what timeframes would
be reasonable for the various rulemakings, and what steps
market participants will need to take in order to comply with
our proposed rules. Further, in addition to our consultation
and coordination with the CFTC and other U.S. authorities, we
have been engaged in ongoing bilateral and multilateral
discussions with foreign regulators and have been speaking with
many foreign and domestic market participants in order to
better understand what areas of derivatives regulation pose
such arbitrage opportunities. We have solicited and welcome
comments on our proposed rulemakings regarding the potential
impact they may have on the position of the U.S. security-based
swap markets, especially comments that offer suggestions for
mitigating regulatory arbitrage opportunities while achieving
the goals of the Dodd-Frank Act.
As Dodd-Frank implementation proceeds, we expect to
continue working closely with the other FSOC agencies.
Q.5.b. How will FSOC ensure that U.S. firms will have equal
access to European markets as European firms will have to U.S.
markets?
A.5.b. Many foreign jurisdictions, including the European
Union, are in the process of adopting derivatives legislation
and implementing regulations, and are at much earlier stages of
development in their efforts than is the United States. While
there are a range of views internationally on the appropriate
level of derivatives regulation, the SEC has been actively
engaged in ongoing bilateral and multilateral discussions with
foreign regulators regarding the direction of international
derivatives regulation generally, and the SEC's efforts to
implement Title VII's requirements.
For example, the SEC, along with the CFTC, the United
Kingdom Financial Services Authority, and the Securities and
Exchange Board of India, is co-chairing the International
Organization of Securities Commissions Task Force on OTC
Derivatives Regulation (``Task Force''). One of the primary
goals of this task force is to work to develop consistent
international standards related to OTC derivatives regulation.
In addition, on behalf of IOSCO, the SEC, along with the
European Commission and an international organization of
central banks, co-chairs the Financial Stability Board's OTC
Derivatives Working Group (``FSB Working Group''). The CFTC and
Federal Reserve Board also are members of the FSB Working
Group.
These and other bilateral and multilateral efforts serve to
keep the SEC informed about emerging similarities or
differences in potential approaches to derivatives regulation
and provide us with an opportunity to work with our
counterparts in other jurisdictions in order to foster the
development of common frameworks and coordinate regulatory
efforts as much as possible with a view to mitigating systemic
risk and preventing regulatory arbitrage.
The SEC expects to continue to work closely with the other
members of the FSOC and recognizes that the FSOC can help bring
agencies together to exchange information.
Q.5.c. How will FSOC ensure that Basel III will be implemented
in the United States in a manner that is not more stringent
than in Europe, making U.S. firms less competitive globally?
A.5.c. The Basel standards relate to bank capital adequacy and
liquidity. The U.S. prudential regulators, including members of
the FSOC have jurisdiction under Dodd-Frank for promulgating
rules for capital and margin requirements for banks, and
accordingly will utilize the Basel III agreement. The SEC has
responsibility for promulgating capital and margin requirements
under Dodd-Frank for nonbank security-based swap dealers.
The SEC has been carefully considering the potential
consequences of certain provisions of Title VII and our
proposed rulemaking for domestic and foreign market
participants--in particular the impact on the ability of U.S.
market participants to compete effectively with foreign market
participants that may not be subject to the Dodd-Frank Act. In
fact, we are required to take into account potential burdens on
competition when engaging in rulemaking, including rulemaking
under Title VII. Our goal is to establish a level playing field
for all market participants while adhering to the regulatory
requirements and objectives of the Dodd-Frank Act, and we are
considering how to promulgate regulations in a way that
accomplishes this goal.
Q.6. Is a broker/dealer that is not self-clearing less likely
to pose systemic risk because it receives the financial backing
and risk management attention of its clearing firm which
already performs extensive monitoring of risk for the broker-
dealers and which in all likelihood will itself be a SIFI?
A.6. Broker-dealers that are not self-clearing (otherwise
referred to as an introducing broker-dealer), as a general
matter, are less likely to pose systemic risk than do clearing
firms because they do not maintain custody of customer assets
and usually do not have proprietary positions in substantial
size such that their failure would result in exposure to other
large firms or result in market impacts from the liquidation of
assets.
Whether a clearing firm would ever be a SIFI will depend on
the approach taken by the FSOC to the designation of SIFIs. At
a minimum, in order to be designated as a SIFI, any firm would
first need to be evaluated by the FSOC with respect to size,
leverage, concentrations, and other relevant factors. Under
Commission rules, an introducing broker-dealer is required to
enter into a contract with a clearing broker-dealer who agrees
to both settle trades and maintain custody of customer assets.
Further, under the Commission's financial responsibility rules,
a clearing broker-dealer must monitor all introduced accounts
and take appropriate actions, including taking capital charges,
in the event those accounts do not have sufficient assets to be
able to ``self-liquidate.'' The failure of an introducing
broker-dealer that handles a large number of customer accounts
could create disruption resulting from the need to transfer
those accounts to one or more other introducing firms, but
generally speaking it should not result in systemic effects of
the type that might accompany the failure of a large clearing
firm.
Q.7. Titles I and II of Dodd-Frank references an entity's
``asset threshold'' or ``total consolidated assets'' several
times. Are such calculations to be made in accordance with
generally accepted accounting principles (GAAP)?
A.7. The terms ``asset threshold'' and ``total consolidated
assets'' appear in a number of places in Title I and Title II,
but the Dodd-Frank Act does not define them. While the terms
appear in connection with the work of FSOC, they do not arise
directly in connection with the Commission's responsibilities.
FSOC is considering what definitions or interpretations of such
terms may be required.
------
RESPONSE TO WRITTEN QUESTION OF SENATOR MORAN FROM MARY L.
SCHAPIRO
Q.1. Regarding this initial consultation phase which will occur
prior to designation, should we assume that the markets and
public will know to whom such notices are sent? Do you believe
that public companies are obligated to disclose receipt of such
a notice in their filings? What would happen if a firm that
disclosed having received a notice was not designated as
systemically significant? Is there a possibility that the
markets would react to that news?
A.1. There are currently no specific ``line item'' requirements
to disclose that a company has been notified that it is being
considered for possible designation or if it has been notified
and not designated. However, a company would need to review its
description of its regulatory status and requirements to
determine whether its disclosure requires updating. The company
and its advisors would need to determine whether being notified
that the company may be systemically important (and, once a
determination has been made with regard to designation, the
outcome of that determination) is material information that
must be disclosed to investors. The test for materiality is
whether there is a substantial likelihood that the disclosure
of the omitted fact would have been viewed by the reasonable
investor as having significantly altered the total mix of
information made available. Whether a contingent or speculative
event is material requires a balancing of both the indicated
probability that the event will occur and the anticipated
magnitude of the event in light of the totality of the company
activity.
If material, the company would need to disclose the
possible designation and/or the final determination as to
designation, for example, in an annual or quarterly report. The
possible designation and/or the final determination as to
designation are more likely to be material if FSOC designations
have had a material effect on other companies' stock prices.
The materiality determination also would be affected by the
consequences of being designated systemically important, such
as capital requirements and limitations on business activities.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM GARY
GENSLER
Q.1. You mentioned in your written testimony that it is
important for ``people who want to hedge their risk to do so
without concentrating risk in the hands of only a few financial
firms.'' How much concentration of the market in the top firms
is too much? Are you concerned that the aggressive approach
that you have taken with respect to swap dealer regulation will
cause the field of dealers to narrow, not broaden, thus further
concentrating the swap dealer business?
A.1. The Dodd-Frank Act brings essential reforms to the swaps
markets that will benefit the American public and end-users of
derivatives. While the derivatives market has changed
significantly since swaps were first transacted in the 1980s,
the constant is that the financial community maintains
information advantages over their nonfinancial counterparties.
When a Wall Street bank enters into a bilateral derivative
transaction with a corporate end-user, for example, the bank
knows how much its last customer paid for similar transactions.
That information, however, is not generally made available to
other customers or the public. The bank benefits from
internalizing this information. The Dodd-Frank Act brings
sunshine to the opaque swaps markets. The more transparent a
marketplace is, the more liquid it is, the more competitive it
is, and the lower the costs for hedgers, borrowers and their
customers.
In implementing the Dodd-Frank Act, the Commission is
adhering closely to the statute with the intent to comply fully
with its provisions and Congressional intent to lower risk and
bring transparency to these markets.
Q.2. You state that end-users will enjoy better pricing on
derivatives transactions because of the rules that the CFTC is
putting into place. Has your agency conducted economic analysis
to support your conclusion that end-users will pay less for
derivatives transactions under the Dodd-Frank framework?
A.2. Economists and policymakers for decades have recognized
that market transparency benefits the public. There are two
types of transparency that Congress, through the Dodd-Frank
Act, sought to bring to the swaps markets. The first is
transparency to the regulators, which will include swap data
repositories that will provide data to regulators. The second
is transparency to the public.
There are three phases that a swap transaction goes through
that will be more transparent under the Dodd-Frank Act. The
first occurs before the transaction takes place by moving
standardized swap transactions onto exchanges or swap execution
facilities (SEFs).
These exchanges will allow investors, hedgers and
speculators to meet in a transparent, open and competitive
central market. The Act includes exceptions from this
requirement for block trades and transactions involving
commercial end-users.
The second phase occurs immediately after the transaction
takes place, when pricing data is made public in real time.
Congress also has been very specific that market participants
and end-users should benefit from such real-time reporting.
This post-trade transparency--other than for block trades--must
be achieved ``as soon as technologically practicable'' after a
swap is executed, which will enhance price discovery. This
requirement applies to both cleared and uncleared swaps.
The third phase occurs over the lifetime of the swap
contract. The Dodd-Frank Act requires that swaps be marked to
market every day until they expire and that such valuations be
shared with market participants. If the contract is cleared,
the clearinghouse will be required to publicly disclose the
pricing of the swap every day. If the contract is bilateral,
swap dealers will be required to share mid-market pricing on a
daily basis with their counterparties.
In implementing the Act, the Commission is adhering closely
to the statute.
Q.3. Judging from the proposed rules we have seen, the CFTC's
rulemaking to date has not been particularly well-coordinated
with the SEC's rulemaking. Are you willing to take your
disputes to the Council for resolution before you move to the
adopting stage, or are you planning to proceed with your
preferred approach ahead of the SEC and hope that they will
follow suit?
A.3. See response to question 4.
Q.4. Your agency is deeply engaged in rulemaking regarding
over-the-counter derivatives. Judging from the proposed rules
we have seen, your rulemaking to date has not been particularly
well-coordinated. Are you willing to take unresolved disputes
to the Council for resolution before you move to the adopting
stage, or are you planning to proceed with your preferred
approach before the SEC acts and hope that the SEC will follow
suit?
A.4. Throughout the Dodd-Frank rule-writing process, the
Commission is consulting heavily with both other regulators and
the broader public. We are working very closely with the SEC,
the Federal Reserve, the Federal Deposit Insurance Corporation,
the Office of the Comptroller of the Currency and other
prudential regulators, which includes sharing many of our
memos, term sheets and draft work product. CFTC staff has held
over 600 meetings with other regulators on implementation of
the Act. Our rule-writing teams are working with the Federal
Reserve in several critical areas. With the SEC, we are
coordinating on the entire range of rule-writing, including
swap dealer regulation, clearinghouse regulation and swap data
repositories, as well as trading requirements, real-time
reporting and key definitions. So far, we have proposed two
joint rules with the SEC as required by Congress. We will
continue to work closely together through the implementation
process.
Q.5. Under Dodd-Frank, swap data repositories, before sharing
any information with a regulator other than their primary
regulator, must obtain an indemnification agreement with that
other regulator. Will this requirement adversely affect
regulators' ability to obtain a comprehensive view of the swaps
markets?
A.5. Under the provision, domestic and foreign authorities, in
certain circumstances, would be required to provide written
agreements to indemnify SEC and CFTC-registered trade
repositories, as well as the SEC and CFTC, for certain
litigation expenses as a condition to obtaining data directly
from the trade repository regarding swaps and security-based
swaps. Regulators in foreign jurisdictions have raised concerns
regarding the potential effect of the provision. However, I
believe that the indemnification provision need not apply when
a foreign regulator, acting within the scope of its
jurisdiction, seeks information directly from a trade
repository registered with both the CFTC and the foreign
jurisdiction. Under the CFTC's proposed rules regarding trade
repositories' duties and core principles, foreign regulators
would not be subject to the indemnification and notice
requirements if they obtain information that is in the
possession of the CFTC.
Q.6. One of the Council's purposes is to monitor systemic risk
and alert Congress and regulators of any systemic risks it
discovers. What are the most serious systemic risks presently
facing the U.S. economy?
A.6. Under section 112 of the Dodd-Frank Act, the Council must
provide an annual report to Congress that sets forth what it
believes are potential emerging threats to the financial
stability of the United States. This annual report represents
the Council and its members' analyses of emerging threats to
financial stability and potential systemic risks to the
economy. The report is prepared by both prudential and market
regulators and identifies both the most serious risks to the
U.S. economy as well as developing risks that may become more
dangerous in the future.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR CRAPO FROM GARY
GENSLER
Q.1. According to the American Banker, Annette L. Nazareth, a
former SEC Commissioner, called the timetables imposed by the
Dodd-Frank Act ``wildly aggressive.'' ``These agencies were
dealt a very bad hand,'' she said. ``These deadlines could
actually be systemic-risk raising.'' Given the importance of
rigorous cost-benefit and economic impact analyses and the need
for due consideration of public comments, would additional time
for adoption of the Dodd-Frank Act rules improve your
rulemaking process and the substance of your final rules?
A.1. The Dodd-Frank Act provides the Commission with ample
flexibility to phase in implementation of requirements. The
CFTC and SEC staff held roundtables on May 2 and 3, 2011, and
have solicited comments from the public regarding such
concerns. This important input informs the final rulemaking
process.
We've also reached out broadly on what we call ``phasing of
implementation,'' which is the timeline for rules to take
effect for various market participants. This is critically
important so that market participants can take the time now to
plan for new oversight of this industry.
Next month, it is my hope that we vote on two proposed
rulemakings seeking additional public comment on the
implementation phasing of swap transaction compliance that
would affect the broad array of market participants. The
proposed rulemakings would provide the public an opportunity to
comment on compliance schedules applying to core areas of Dodd-
Frank reform, including the swap clearing and trading mandates,
and the internal business conduct documentation requirements
and margin rules for uncleared swaps. These proposed rules are
designed to smooth the transition from an unregulated market
structure to a safer market structure.
Q.2. Chairman Bair's testimony was unclear regarding whether
the FSOC has the authority to issue a revised rule on the
designation of nonbank financial institutions. She and others
indicated some type of guidance might be issued instead. Is it
in fact the case, in general, that the FSOC does not have
authority to issue rules under Title I that have the force and
effect of law? If the FSOC has the authority in general to
issue such rules on designation, why specifically would the
FSOC be precluded from re-proposing a rule that is currently
pending? Is there additional authority the FSOC would need from
Congress to issue such rules or to proceed with re-proposing
its NPR on designation? If yes, what specific authority would
the FSOC need from Congress for the FSOC to have the ability to
proceed?
A.2. The FSOC's proposed rule concerning nonbank financial
institutions described the framework that the Council would use
to determine whether an entity should be designated as
systemically important. In response to concerns that have been
expressed, the FSOC is considering a variety of ways in which
it may be able to provide greater guidance and more clarity.
FSOC member agencies are collaborating to develop further
guidance to be provided in a manner consistent with statutory
requirements and are also considering the appropriate form that
updated guidance should take.
Q.3. In an August speech at NYU's Stern School of Business,
Treasury Secretary Geithner outlined six principles that he
said would guide implementation, and then he added, ``You
should hold us accountable for honoring them.'' His final
principle was bringing more order and integration to the
regulatory process. He said the agencies responsible for
reforms will have to work ``together, not against each other.
This requires us to look carefully at the overall interaction
of regulations designed by different regulators and assess the
overall burden they present relative to the benefits they
offer.'' Do you intend to follow through with this commitment
with some form of status report that provides a quantitative
and qualitative review of the overall interaction of all the
hundreds of proposed rules by the different regulators and
assess the overall burden they present relative to the benefits
they offer?
A.3. The Commission is committed to consultation with fellow
regulators here in the United States as well as in other
countries. Throughout our rule-writing process, the Commission
has shared term sheets and draft proposals with other
regulators and sought their feedback. This coordination has
helped to promote consistent and comparable standards. As we
consider final rules, our teams are reviewing the proposals
from other agencies as well to see how they interact with the
Commission's proposals. As part of our significant outreach
with other regulators, CFTC staff has met more than 600 times
with other regulators on Dodd-Frank implementation.
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RESPONSE TO WRITTEN QUESTIONS OF SENATOR VITTER FROM GARY
GENSLER
Q.1. Dodd-Frank set forth a comprehensive list of factors that
FSOC must consider when determining whether a company posed a
systemic risk and deserves Fed oversight. The council, in its
advanced notice of proposed rulemaking, sets forth 15
categories of questions for the industry to comment on and
address. However, the proposed rules give no indication of the
specific criteria or framework that the council intends to use
in making SIFI designations--other than what is already set
forth in Dodd-Frank. As a result, potential SIFIs have no idea
where they may stand in the designation process. Will the
council provide additional information about the quantitative
metrics it will use when making an SIFI designation?
A.1. I expect that the council will provide additional
information in this regard.
Q.2. Would the council agree that leverage is likely to be the
one factor that is most likely to create conditions that result
in systemic risk? If so, how will the council go about
identifying which entities use leverage?
A.2. Leverage may very well be a factor that the FSOC considers
in assessing the systemic risk arising from a firm's
activities. Leverage is traditionally a measure of the
relationship between a firm's total assets and its equity.
Q.3. One of the first steps in the systemic designation
process, as outlined in the proposed rule, is that after
identifying a nonbank financial company for possible
designation the FSOC will provide the company with a written
preliminary notice that the council is considering making
proposed determination that the company is systemically
significant. Is receipt of such a notice a material event that
might affect the financial situation or the value of a
company's shares in the mind of the investors? If so, wouldn't
it need to be disclosed to investors under securities laws?
A.3. This question is more appropriately answered by others on
the panel.
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RESPONSE TO WRITTEN QUESTIONS OF SENATOR TOOMEY FROM GARY
GENSLER
Q.1. Can you share with us what the FSOC, OFR, FDIC and Fed are
contemplating by way of fees that they may assess on SIFIs?
A.1. The FSOC recently received a briefing concerning
appropriate enhanced prudential standards generally, including
discussion of systemically important financial institutions.
These matters are also being considered at the international
level as prudential regulators seek to ensure the development
of consistent standards, particularly with respect to global
systemically important banks. The Federal Reserve and the
Federal Deposit Insurance Corporation have taken the lead on
these matters.
International Competitiveness
Q.2.a. It is critical for the continued competiveness of the
U.S. markets that a regulatory arbitrage does not develop among
markets that favors markets in Europe and Asia over U.S.
markets. Will the FSOC commit to ensuring that the timing of
the finalization and implementation of rulemaking under Dodd
Frank does not impair the competitiveness of U.S. markets?
A.2.a. As a member of FSOC, I believe we should be aware of the
competitive implications of FSOC decisions. I look forward to
working with my fellow members on these issues as we move
toward the finalization and implementation of Dodd-Frank rules.
Q.2.b. How will FSOC ensure that U.S. firms will have equal
access to European markets as European firms will have to U.S.
markets?
A.2.b. It is important that the FSOC consider not only how the
regulatory structure in the United States affects both U.S. and
foreign institutions, but also how foreign regulatory
structures affect those institutions. As a member of FSOC and
Chairman of the CFTC, I regularly review foreign regulatory
standards and proposals and how those standards and proposals
will affect U.S. firms.
Q.2.c. How will FSOC ensure that Basel III will be implemented
in the United States in a manner that is not more stringent
than in Europe, making U.S. firms less competitive globally?
A.2.c. As a member of the FSOC, I consult with prudential
regulators concerning these matters in any way that proves
helpful and will continue to do so going forward.
Q.3. Is a broker/dealer that is not self-clearing less likely
to pose systemic risk because it receives the financial backing
and risk management attention of its clearing firm which
already performs extensive monitoring of risk for the broker-
dealers and which in all likelihood will itself be a SIFI?
A.3. As a member of the FSOC, when deciding whether to
designate an institution as a SIFI, I would consider the
potential systemic risk that the firm's activities may create,
consistent with the statutory framework. I also would consider
any factors that might mitigate such systemic risk.
Q.4. Titles I and II of Dodd-Frank references an entity's
``asset threshold'' or ``total consolidated assets'' several
times. Are such calculations to be made in accordance with
generally accepted accounting principles (GAAP)?
A.4. As a member of FSOC, I look forward to working with my
fellow members to determine how best to apply these statutory
terms to different types of institutions, consistent with the
statutory framework and Congressional intent.