[Senate Hearing 113-42]
[From the U.S. Government Publishing Office]
S. Hrg. 113-42
THE FINANCIAL STABILITY OVERSIGHT COUNCIL ANNUAL REPORT TO CONGRESS
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED THIRTEENTH CONGRESS
FIRST SESSION
ON
REVIEWING THE FINANCIAL STABILITY OVERSIGHT COUNCIL'S ANNUAL REPORT,
DISCUSSING FSOC'S EFFORTS, ACTIVITIES, OBJECTIVES, AND PLANS, AND
CONTINUING ITS OVERSIGHT OF THE IMPLEMENTATION OF DODD-FRANK WALL
STREET REFORM AND CONSUMER PROTECTION ACT
__________
MAY 21, 2013
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
TIM JOHNSON, South Dakota, Chairman
JACK REED, Rhode Island MIKE CRAPO, Idaho
CHARLES E. SCHUMER, New York RICHARD C. SHELBY, Alabama
ROBERT MENENDEZ, New Jersey BOB CORKER, Tennessee
SHERROD BROWN, Ohio DAVID VITTER, Louisiana
JON TESTER, Montana MIKE JOHANNS, Nebraska
MARK R. WARNER, Virginia PATRICK J. TOOMEY, Pennsylvania
JEFF MERKLEY, Oregon MARK KIRK, Illinois
KAY HAGAN, North Carolina JERRY MORAN, Kansas
JOE MANCHIN III, West Virginia TOM COBURN, Oklahoma
ELIZABETH WARREN, Massachusetts DEAN HELLER, Nevada
HEIDI HEITKAMP, North Dakota
Charles Yi, Staff Director
Gregg Richard, Republican Staff Director
Laura Swanson, Deputy Staff Director
Glen Sears, Deputy Policy Director
Mike Piwowar, Republican Chief Economist
Hope Jarkowski, Republican Senior Counsel and SEC Detailee
Dawn Ratliff, Chief Clerk
Kelly Wismer, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
(ii)
C O N T E N T S
----------
TUESDAY, MAY 21, 2013
Page
Opening statement of Chairman Johnson............................ 1
Opening statements, comments, or prepared statements of:
Senator Crapo................................................ 2
WITNESS
Jacob J. Lew, Secretary, Department of the Treasury.............. 4
Prepared statement........................................... 34
Responses to written questions of:...........................
Chairman Johnson......................................... 223
Senator Crapo............................................ 226
Senator Menendez......................................... 229
Senator Merkley.......................................... 233
Senator Shelby........................................... 236
Senator Vitter........................................... 236
Senator Coburn........................................... 239
(iii)
THE FINANCIAL STABILITY OVERSIGHT COUNCIL ANNUAL REPORT TO CONGRESS
----------
TUESDAY, MAY 21, 2013
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:15 a.m., in room 538, Dirksen
Senate Office Building, Hon. Tim Johnson, Chairman of the
Committee, presiding.
OPENING STATEMENT OF CHAIRMAN TIM JOHNSON
Chairman Johnson. Good morning. I call this hearing to
order.
I would like to start by saying that my thoughts and
prayers are with the families of Moore, Oklahoma, and our
colleague here on the Committee, Senator Coburn. It is a
difficult time as families mourn the loss of loved ones and
begin rebuilding their community.
Today, we welcome Secretary Jack Lew to the Committee for
the first time since he was confirmed.
While this Committee lacks jurisdiction over the IRS, I
must personally express my sincere disappointment and anger
regarding the recent revelation that some IRS employees were
targeting political organizations. Democrats and Republicans
agree that politics has no place at the IRS, and I commend
Secretary Lew and President Obama for taking swift action last
week. As should be the case, the DOJ is looking into whether
any laws have been broken and the appropriate Senate committees
of jurisdiction are holding hearings so that we can get to the
bottom of this.
With that said, this Committee has the duty to oversee
efforts to strengthen U.S. financial stability, especially in
light of the costly crisis our economy continues to recovery
from. So today, Secretary Lew will focus on the Financial
Stability Oversight Council's Annual Report to Congress, as
required by the Wall Street Reform Act.
I am pleased that this year's FSOC report notes progress in
key areas that this Committee has devoted attention to over the
last year, including money market funds, the tri-party repo
market, the housing market, LIBOR, and the economic situation
in Europe. The report also highlights emerging operational
risks for financial companies like cybersecurity attacks, new
technologies in the equity markets, and financial services
preparedness for natural disasters. Furthermore, the FSOC has
made important recommendations in many of these areas to
further safeguard our economy that should be considered.
All indicators point to a well-coordinated FSOC, and I will
note that since the last report, the Senate has confirmed the
first Director of the Office of Financial Research, a key
position and office that is assisting FSOC with critical
research and analysis.
But more needs to be done to improve our Nation's financial
stability, and some high-priority rules await completion by
potential regulators. These include enhanced prudential
standards for large systemic firms required by Wall Street
Reform, the Basel III agreements, and the Volcker Rule. FSOC
itself also continues to work on the nonbank SIFI designations.
We also expect additional reforms and action from the
regulators on money market funds, the tri-party repo market,
and other proposals to curtail systemic risk and ensure no firm
is too-big-to-fail.
While it is always important to get the rules right, the 3-
year anniversary of Wall Street Reform becoming law and the 5-
year anniversary of the financial crisis are fast approaching.
The remaining pieces of Wall Street Reform must be finalized
soon so that Congress can appropriately assess whether it is
necessary to do more.
Mr. Secretary, I look forward to hearing your testimony and
learning what specific steps you are taking as FSOC's chair to
strengthen financial stability and seeing to it that key Wall
Street Reform rules are completed in the next few months, not
the next few years.
With that, I will turn to Ranking Member Crapo for his
opening statement.
STATEMENT OF SENATOR MIKE CRAPO
Senator Crapo. Thank you, Mr. Chairman, and before moving
on to my opening statement, I, too, want to join with you in
extending my deepest condolences to the families of those who
were killed yesterday as a result of the devastating tornadoes
in Oklahoma. All of us keep the people of Oklahoma in our
hearts and in our prayers, and I appreciate your mentioning
that.
Today, Secretary Lew comes before the Committee to testify
in his first hearing as the Secretary of the Treasury. The
Secretary of the Treasury wears many hats. He is responsible
for formulating and recommending a number of domestic and
international financial, economic, and tax policies for the
Administration. As FSOC Chairman, he is required to appear
before this Committee annually to testify on the activities of
the Council and to answer questions concerning the Council's
most recent annual report.
The Council's 2013 Annual Report covers many areas of the
Council's activities and lists a number of potential emerging
threats to the financial stability of the United States. I want
to focus my opening statement on one particular area, Mr. Lew,
that needs your personal attention.
The U.S. capital markets must remain the preferred
destination for investors throughout the world. Capital is the
lifeblood of U.S. businesses, which, in turn, are the engines
of job creation and economic growth. And, unfortunately,
infighting among U.S. financial regulators and their overseas
counterparts is causing investors to look elsewhere for
productive investment opportunities.
The list of problematic cross-border issues that need to be
addressed is growing, and the frustration from foreign
regulators over the lack of international coordination on
financial reform measures has reached an unprecedented level.
After the so-called Volcker Rule was proposed in 2011, a number
of foreign regulators submitted a letter to the Treasury
Department expressing concerns that the proposed rule could
reduce the liquidity of the sovereign bonds and damage
international cooperation efforts.
More recently, a number of foreign regulators have weighed
in on the Federal Reserve's proposed rule to implement enhanced
prudential standards for foreign banking operations. For
example, the European commissioner in charge of financial
regulation, Michel Barnier, warned in a letter to Federal
Reserve Chairman Ben Bernanke that the Fed's proposed rules
affecting European banks doing business in the United States
will duplicate work already done in Europe and create
additional cost. Commissioner Barnier also warned that the
Fed's proposal could risk a protectionist backlash and threaten
the global economic recovery.
The frustration reached a new level when nine finance
ministers wrote to Secretary Lew expressing their concerns
about the lack of progress in developing workable cross-border
rules as part of reforms of the OTC derivatives market. They
warned that without clear direction from regulators working
together, derivatives markets will recede into localized and
less efficient structures. Derivatives end users will find it
more difficult to manage risk and suffer from burdensome
regulatory conditions.
I look forward to hearing from you, Secretary Lew, about
the specific steps you intend to take to avoid these cross-
border conflicts and the unnecessary costs imposed by them.
Finally, although this hearing is focused on Secretary
Lew's role as Chairman of the FSOC, I would be remiss if I did
not take this opportunity to question him about the recent IRS
scandal. We are literally conducting an investigation into the
IRS circumstances about three floors below us in this building
at this moment as we meet, and I may need to step out, Mr.
Chairman, to get down to that hearing on an occasion or two
here.
The largest bureau within the Treasury Department is the
Internal Revenue Service. Last week, the Treasury Inspector
General for Tax Administration issued a report that documents a
number of troubling and disturbing actions regarding the
targeting of conservative groups by the IRS. These actions
should never be tolerated. President Obama has directed
Secretary Lew to make sure that all of the Inspector General's
recommendations are implemented quickly. I look forward to
hearing how the Secretary will carry out this Presidential
directive. I also look forward to hearing what additional steps
Secretary Lew is taking to ensure that no future income tax
audits will be conducted in such a discriminatory manner ever
again.
Thank you, Mr. Chairman.
Chairman Johnson. Thank you, Senator Crapo.
In order to get to Secretary Lew's testimony and Member
questions, opening statements will be limited to the Chair and
Ranking Member today. I want to remind my colleagues that the
record will be open for the next 7 days for opening statement
and any other materials you would like to submit.
Today's witness is the 76th Secretary of the U.S.
Department of Treasury. Secretary Lew, welcome to the
Committee.
Before you begin your statement and the FSOC Annual Report,
there is understandably a lot of concern regarding previous
actions at the IRS. If you would like to say a few words on
that matter, please do that before you begin your testimony.
You may begin.
STATEMENT OF JACOB J. LEW, SECRETARY, DEPARTMENT OF THE
TREASURY
Mr. Lew. Thank you, Mr. Chairman.
I would like to begin by expressing my own condolences to
the people of Oklahoma who are suffering so much today and to
say that the families are in our thoughts and prayers as they
go through the recovery from the devastating tornado in
Oklahoma City.
Chairman Johnson, Ranking Member Crapo, Members of the
Committee, thank you for the opportunity to testify today on
the Financial Stability Oversight Council's 2013 Annual Report.
Before I address the report, I would like to say a few
words about the Treasury Inspector General for Tax
Administration's report last week that showed that some
employees at the IRS used outrageous methods to determine if
certain groups qualified for tax-exempt status.
As the Inspector General's report indicates, while this
conduct was not politically motivated, it was unacceptable and
inexcusable. Administering the tax code without any hint of
bias is a solemn obligation that must be carried out with the
highest of standards. That is why I moved quickly to take steps
to restore confidence in the IRS. Within 24 hours of the report
coming out, I asked for and received the resignation of the
Acting Commissioner. And within 24 hours later, the President
appointed a new Acting Commissioner. He is a person of high
integrity and he has earned the confidence of Democrats and
Republicans for his professionalism.
I have directed incoming Acting Commissioner Daniel
Wuerffel to carry out a thorough review of this conduct and to
take action on three specific things. First, making sure that
those who acted inappropriately are held accountable for their
actions. Second, examining and correcting any failures in the
system that allowed this behavior to happen. And, third, taking
a forward-looking view and determining whether the IRS has
systemic problems that need to be addressed.
The Acting Commissioner will hit the ground running on
Wednesday. That is tomorrow. He is going to take actions as
they are needed, and he will report back to me on his progress
within 30 days so that we can report back to the President. And
we are going to make sure that nothing like this ever happens
again.
I would like to turn to the Council's Annual Report, which
is the subject of this hearing. This report represents
extensive collaboration among Council members, agencies, and
staff. And it gives us a chance to provide the Congress and the
public with the Council's assessment of significant financial
market and regulatory developments, potential emerging threats
to financial stability, and recommendations to strengthen the
financial system.
I want to point out that the strength of our financial
system depends greatly on the strength of our economy. Now,
there is no doubt that we have made significant progress
recovering from the worst economic crisis since the Great
Depression. The economy has grown for 15 consecutive quarters.
The private sector has been creating jobs for 38 straight
months. The housing market is healing. Our deficits are falling
at the fastest rate in decades. But there is more work to do.
We need to keep our foot on the accelerator, and economic
growth and job creation need to be more rapid.
The President has put forward a comprehensive jobs and
growth plan. His path forward strengthens the recovery by
making needed investments in manufacturing, innovation,
infrastructure, and worker training while taking a balanced
approach to restoring our long-term fiscal health. This
strategy will not only help grow our economy now and well into
the future, it will replace the sequester with sensible deficit
reduction measures.
Since the Council's last Annual Report, our financial
system has grown stronger in a number of ways. Capital and
liquidity levels for the largest financial institutions have
increased. Regulators have taken additional steps toward
improving transparency and risk mitigation in derivatives and
other markets. And the implementation of the Dodd-Frank Act and
international coordination on G-20 reform priorities have
brought significant progress toward establishing a more
resilient and stable financial system, both domestically and
globally.
On the topic of Dodd-Frank implementation, the Council and
its member agencies continue to put reforms in place. It is
important to note that while additional work remains, we are
much closer to the end of the process than we are to the
beginning. We have seen a good deal accomplished recently,
including progress on the Council's evaluation of an initial
set of nonbank financial companies for potential designation.
Progress on a new framework for the consolidated supervision of
large financial institutions, progress on a new framework for
the orderly liquidation authority, progress on implementing
provisions relating to living wills, progress on reducing risk
and increasing transparency in the derivatives markets, and
progress on enhancing protections for borrowers and other
participants in the mortgage markets.
Despite these positive developments, there are still risks
to U.S. financial stability. The Council's report identifies
those risks and makes specific recommendations to mitigate
them. For instance, it is our judgment that the market
participants and regulators need to take steps to reduce
vulnerabilities in wholesale funding markets; that Government
agencies, regulators, and businesses need to address
operational risks posed by technology failures, natural
disasters, and cyber attacks; and that reforms are needed to
address the reliance on self-reported reference interest rates,
like LIBOR.
Mr. Chairman, I want to thank the other members of the
Financial Stability Oversight Council and all the staff
involved with the 2013 Annual Report for their hard work and
dedication. This is an ongoing effort and we look forward to
continuing to work with you, this Committee, and Congress to
make sure we have a more resilient and stable financial system.
With that, I thank you and look forward to answering your
questions.
Chairman Johnson. Thank you very much for your testimony.
As we begin questions, I will ask the Clerk to put 5
minutes on the clock for each Member.
Mr. Secretary, the Wall Street Reform Act provides
regulators, including FSOC, a number of tools to enhance
financial stability. Do you believe Wall Street Reform provides
the needed tools to not only strengthen our financial system,
but also to end too-big-to-fail?
Mr. Lew. Mr. Chairman, I think that the Wall Street Reforms
enacted in the Dodd-Frank legislation provide powerful tools
for the regulators, and by creating FSOC, which I chair. I
think that the policy of Dodd-Frank was very clear, that too-
big-to-fail is an unacceptable policy and it had to end and it
provided the tools so that it could end.
As I indicated in my testimony, we have made substantial
progress in the implementation of Dodd-Frank, but there is
still more progress to be made. I think that there are a number
of issues where the different agencies are still determining
how to set the levels in various areas so that, in the end, we
will be able to say that too-big-to-fail has ended.
But one of the principles that I think is very important is
we must implement Dodd-Frank, and we need to do it quickly, but
we are also going to need to take an ongoing look at the
system. One of the problems between the Great Depression and
the financial crisis of 2008 was that too long a period went by
when the markets evolved and the regulatory authorities did not
evolve with the markets and we lost our ability to see what was
going on and to regulate it effectively.
So one of the things that, as we implement Dodd-Frank, we
need to do is make the resolve, the determination to keep
asking the question, as we finish implementing it and going
forward, whether we still have the tools we need or whether we
need more.
Chairman Johnson. What are you, Mr. Secretary, and FSOC
doing to ensure key rules that strengthen financial stability
and end too-big-to-fail are completed as soon as possible? Will
we see final rules later this year? And when should we expect
to see SIFI designations made?
Mr. Lew. Mr. Chairman, I have been Secretary for just under
3 months and I have had three meetings of FSOC, and in between
the meetings, I have had numerous conversations and meetings on
various matters that are still outstanding to implement the
Dodd-Frank legislation. I have made clear to all of the members
of FSOC that it is a matter of enormous priority that we
complete the rules to make the rulemaking process one where all
the participants in the market know what the policy is and
where we have taken the steps that we have the tools to use now
to protect the public from another financial crisis.
I think that there will be progress this year. We have
indicated at the last public meeting that we are making
progress on the nonbank designations. I am hoping that we are
soon going to be in a position to make a final determination in
that area. I think that there is ongoing work in all the areas
that I mentioned in my opening statement, and one of the things
that I see as my role as Chairman of the FSOC is to make sure
that we do not measure our progress in months and years, but we
start to measure our progress in weeks and months.
Chairman Johnson. How soon do you see SIFI designations
made specifically?
Mr. Lew. Well, I do not want to jump ahead of a decision
that requires a vote of the Council, but we have substantial
staff work going on between meetings. We have another meeting
scheduled the week after next. And we are trying to get this
matter up for a decision as quickly as possible.
Chairman Johnson. Mr. Secretary, international coordination
and cooperation is important for successful financial reform.
Are there specific areas regarding cross-border resolution,
enhanced prudential standards, insurance, or derivatives where
more can be done to strengthen coordination with our global
counterparts?
Mr. Lew. Mr. Chairman, I actually think we have seen a
substantial improvement in international cooperation as we have
gone through this process. The G-20 is working hard on trying
to coordinate in this area. There are informal groups of
regulators and central bankers and finance ministers
coordinating on this. And these are tough issues. They are
tough issues for each of us within our borders. They are tough
issues between countries.
And one of the principles that we are making paramount is
that our mandate is to protect the U.S. taxpayer and the U.S.
economy by setting standards at the level that we think is
appropriate. We are trying very hard in the international
community to make it a race to the top, not a race to the
bottom. If we can all agree on high standards, a lot of these
issues are resolved by having compatible high standards. And I
think we are making a lot of progress in that regard.
I know that these are going to be challenging times for
competition in the financial markets. It is important to us
that the United States remain a competitive financial market,
but it is equally important to us that it remain a competitive
financial market where we have the safeguards to protect
against having taxpayers left in the position they were in
after the economic crisis in 2008.
Chairman Johnson. Senator Crapo.
Senator Crapo. Thank you very much, Mr. Chairman.
And, Secretary Lew, I would like to start with a few
questions about the IRS situation. When did you first become
aware of the allegations that the IRS was targeting
conservative groups?
Mr. Lew. Senator, I first became aware that there was an
audit underway on March 15, when I had a meeting with the
Inspector General. It was in my early weeks at the Treasury
Department. It was a process of really having initial getting-
to-know-you meetings.
The Inspector General flagged a number of items without
going into great detail. He mentioned that there was an audit
of 501(c)(4) activity, told me that there might be troubling
findings, did not describe them in detail. I then did not learn
any more about it until it became public.
Senator Crapo. So, that was my next question. When did you
first receive confirmation that those allegations were, in
fact, true?
Mr. Lew. Well, the first I heard was when it was publicly
reported a week ago Friday. I was actually at the G-7 meetings
in the United Kingdom and I was outraged at the time. I did not
yet have the IG report. I did not actually get the IG report
until Tuesday, and I was--when I got the report, my immediate
reaction was to take the steps that I noted in my opening
statement, to ask for and receive the resignation of the Acting
Commissioner, to help as the President made the decision to
appoint a new Acting Commissioner, and then to charge the new
Acting Commissioner with the responsibilities that I described.
Senator Crapo. As I am sure you are aware, in Congressional
testimony last week, the Acting IRS Commissioner admitted that
the agency planted a question at the American Bar Association
Conference in order to reveal its actions before notifying
Congress. Were you personally involved in that decision?
Mr. Lew. No.
Senator Crapo. Do you believe that was an appropriate way
to make the information public?
Mr. Lew. You know, Senator, as the news reports overnight
indicated, there were some conversations at a staff level
between Treasury and IRS. It was the discretion of the IRS to
decide how to manage this matter. The guiding principle for the
Treasury Department in IRS investigations is to not interfere
in any way, to not interfere with the IG's ability to find
facts, to interview people, to find records, and in no way to
color the outcome. So I am not aware of any action that was
taken at the Treasury Department that is inconsistent with that
well-established practice.
You know, I was not asked about this. I would have advised
against doing that. But it was a decision for the IRS to make.
Senator Crapo. Thank you. And my time is quickly running
out and I probably will not get to the questions on FSOC in
this round, but one last point with regard to the Internal
Revenue Service. As revelations about actions of different
Federal agencies come forward in any administration, it is
clear to me why revelations of the type we are seeing relating
to the IRS bring such concern to the American public, because
there is a very real and, I think, justified perception among
the people of the United States that the Internal Revenue
Service is in many real ways the prosecutor, the judge, the
jury, and the executioner.
Now, I understand that there are legal points in the
process of the IRS exercising its activities at which people
can get some review. But there is a very real concern, in my
opinion, that the IRS has such incredible power that abuses at
the IRS are viewed by the American public with great concern.
And my question to you is, given the fact the President has
directed you to quickly implement the Inspector General's nine
requests, or nine recommendations----
Mr. Lew. Recommendations.
Senator Crapo.----what additional steps have you taken to
restore public trust in the integrity of the IRS and the
Treasury Department and, frankly, to ensure that no future
income tax audits will ever again be conducted in this kind of
a manner?
Mr. Lew. Well, Senator, first, I cannot say strongly enough
how unacceptable this behavior was and how outraged I was when
I learned about it. I think that the IRS process or tax
administration system has to be beyond politics.
Now, there is a certain distance between Treasury and the
IRS in the administration of the tax system for proper reasons.
The IRS has a semi-independent character because there is the
concern that in past decades, there was political interference
in the IRS.
I will take every step that I can to make sure that in the
management structure and in the way the IRS conducts its
business that it is set up in a way to prevent this from
happening in the future. I have already had that conversation
with the new Acting Commissioner, who takes over tomorrow, and
he has a very short period of time to help identify who should
be held accountable, how we get to the bottom of how the
management and communication systems broke down to permit this
to happen, and to look systemically at what other steps need to
be taken.
The thing I will not do, I will not cross that line into
the administration of the tax system because the cure could be
worse than the disease. We need to make sure that there is no
political involvement in the administration of the tax system,
and the management of the IRS is very much the responsibility
of the Treasury Secretary. The administration of the tax system
has to be within the IRS and apart from politics.
Senator Crapo. Thank you. I see my time is up.
Chairman Johnson. Senator Reed.
Senator Reed. Well, thank you very much, Mr. Chairman.
Thank you, Mr. Secretary.
Mr. Secretary, one of the issues raised by the FSOC's
report is the systemic risk potentially caused by the default
of broker-dealers that were relying on tri-party repos. They
urge, and your report urges, that the markets respond to this.
Which specific policies or regulatory tools does the Council
suggest be employed to deal with this potential systemic risk?
Mr. Lew. Senator, this is a serious systemic concern and it
is part of a broader set of systemic concerns that have to do
with wholesale funding, the short-term funding for longer-term
obligations, because there is a very real risk that if the
short-term funding ceases to be available and it is not well
collateralized, that there begins an unraveling process that
could become systemically very, very damaging.
The regulation in this area is kind of--is in different
parts because it is--tri-party repo is three different parties.
I believe the Fed, Federal Reserve Board, is looking at the
rules that govern the banks that do the short-term lending to
the broker-dealers and it is looking at the adequacy of
collateral and other issues to try and make sure that they are
taking prudential steps in this area.
I think the FSOC report identified this along with money
market funds as a source of real concern, and I must say, it is
something that I have put a fair amount of attention into as
Treasury Secretary as Chair of the FSOC.
Senator Reed. Thank you, Mr. Secretary.
Following on, in some respects, the Chairman's discussion
of the SIFIs, in Section 171 of Dodd-Frank, there were enhanced
capital requirements for the bank-holding companies. In fact,
Senator Collins of Maine was, I think, instrumental in getting
this very sensible piece of legislation included in the
legislation. But as you look at SIFIs, you go beyond the
typical notion of the bank-holding company that may have
deposit-taking activities, commercial lending, even investment
banking activities, and get into the realm of, frankly, some
large insurance companies. Have you given any thoughts to the
applicability of this section with respect to the insurance
companies, in particular?
Mr. Lew. Senator, I think that the first step is to make
the determination as to whether or not these nonbanks should be
designated because they are significant, and the standard is
whether they--the material distress in those institutions is a
threat to U.S. financial stability.
So we have been going through the process in a very orderly
way of reviewing the potential designations against that
standard. If the designation is made, the regulation--the
authority to regulate will go to one or another institution.
The Federal Reserve Board would have a substantial
responsibility in this area. I know that there are questions
that have been raised as to whether or not the tools are
perfectly fitting for nonbanks and I think that is an issue
that they will look at and we will look at if designations are
made.
Senator Reed. Thank you. You have already indicated in the
report and in your public comments that the LIBOR, because it
is a self-reporting and highly subjective measure, probably has
to be replaced. Any thoughts about, in the short run and the
long run, how we should replace it and how quickly they have to
move to replace it?
Mr. Lew. Senator, the urgency that the FSOC report notes is
the need for there to be a replacement, because, frankly, there
is not a ready replacement. LIBOR is something that the markets
self-designated and it is contractually something that parties
have signed onto, and there is not an immediate substitute that
would be available.
There is an international process that involves regulators
from multiple nations and market participants from multiple
nations, and the FSOC report, I think, properly noted the
urgency of developing an alternative so that if there is a
transition, there can be an orderly transition, because LIBOR
is a reference rate that is included in millions of contractual
agreements, and if there is a move to another rate, it will
have to be pursuant to those contractual terms.
So I think there is a great deal of importance that that
process move speedily and that a reference rate as an
alternative be available in the event that there is a need to
move.
Senator Reed. Just a quick follow-up question, Mr.
Secretary. It is there. It is ubiquitous. It is in every
contract--most every contract.
Mr. Lew. Yes.
Senator Reed. This is being regulated very loosely, I
presume, by the British authorities, and are they being very
aggressive in ensuring, even though it is subjective, that it
is less subjective than before?
Mr. Lew. Well, Senator, obviously, there were cases of
manipulation that were totally unacceptable. I think the
British authorities have recognized that that was an
unacceptable set of events and they are determined to not let
that be repeated.
I think the challenge is that the rate is an inherently
uncertain one because it is referenced to overnight lending
between banks at a time when there is much less overnight
lending between banks, which is one of the reasons there needs
to be a reference rate that is less susceptible to
manipulation.
Senator Reed. Thank you, Mr. Secretary. Thank you, Mr.
Chairman.
Chairman Johnson. Senator Shelby.
Senator Shelby. Thank you, Mr. Chairman.
Welcome, Mr. Secretary.
Mr. Lew. Good to be here.
Senator Shelby. Mr. Secretary, it is my understanding that
the set up at the Treasury Department is the IRS Commissioner
reports to the Treasury Secretary through the Deputy Secretary
of the Treasury. Is that correct?
Mr. Lew. That is correct.
Senator Shelby. Who was the Deputy Secretary of Treasury in
2012?
Mr. Lew. The current Deputy Secretary, Neal Wolin.
Senator Shelby. Neal Wolin. Have you talked to him about
the IRS situation?
Mr. Lew. Yes, I have.
Senator Shelby. Did he relate to you any knowledge that he
may have had about what was going on in Cincinnati, where the
IRS was targeting these conservative groups?
Mr. Lew. He and I both received the IG's report at the same
time last Tuesday, and we have had numerous conversations about
it since then.
Senator Shelby. OK. But you also testified that you met
with the Inspector General in March, several months back,
shortly after taking office, and that the Inspector General
presented a list of ongoing investigations, including the IRS
targeting of conservative groups, is that correct?
Mr. Lew. Well, what he indicated to me was that there was
an audit taking place of the 501(c)(4) Determination Unit, and
he did indicate that there were potentially----
Senator Shelby. Did you pursue that? Did you ask him, why
would they do such a thing----
Mr. Lew. Senator----
Senator Shelby.----or anything? What did you do?
Mr. Lew. Senator, the practice at Treasury, quite
appropriately, is when you are notified of an IG investigation,
you allow the IG to do their work. You do not get in the way.
You make sure that they have access to whatever they need
access to to complete their audit. And that is what Treasury
was doing. I do not think he expected me to take any action at
that time because I was awaiting his report, which I received
last Tuesday.
Senator Shelby. Before you were named Secretary of the
Treasury and confirmed and in your present job, you were the
Chief of Staff at the White House, correct?
Mr. Lew. Correct.
Senator Shelby. And when did you become the Chief of Staff
at the White House?
Mr. Lew. In January 2012.
Senator Shelby. Twenty-twelve. So when this was going on in
Cincinnati, you were the Chief of Staff at the White House?
Mr. Lew. Correct.
Senator Shelby. And you had no knowledge whatsoever of
anything amiss dealing with the IRS approval, disapproval,
delay, or anything of specific groups?
Mr. Lew. I was not aware of this audit until I met with the
Inspector General on March 15, 2013.
Senator Shelby. Had you heard anything at the White House
regarding----
Mr. Lew. I was not aware of any specific facts. You know, I
know the questions had been raised. The fact is, this audit was
a publicly posted audit in October 2012. So the fact that an
audit was going on was a matter of public record. I had no
specific knowledge.
Senator Shelby. Do you believe that someone at the
Cincinnati office would just, on their own, start targeting the
conservative groups, slowing them down, or is that part of a
culture at the Obama White House?
Mr. Lew. Senator, I think--I have read the IG report quite
carefully and I think it is very important to note that there
is no suggestion of any political interference with the process
of making these determinations. There is unacceptable behavior
that happened at the IRS. That has to stop, and it cannot
happen again. But there was no suggestion of any political
intervention. And, frankly, the way we manage IG reports is
meant to keep politics out of any review and to make sure that
IGs have complete freedom to find whatever facts they find.
When I met with the IG and he raised the list of concerns
with me, I said to him what I have said to every auditor I have
ever worked with. You have my support. If there are problems, I
want to know about the problems and I want to fix them.
Senator Shelby. Is the IG report complete now? Is that
finished?
Mr. Lew. Well, the audit is complete.
Senator Shelby. The audit. So could the IG, if he saw fit,
recommend to the Justice Department possible prosecution of
people that were abusing the public trust and abusing IRS
regulations and, perhaps, laws?
Mr. Lew. Well, the IGs do have the power to make
recommendations. I am not aware of any recommendation in this
case, though I am aware that the Attorney General has indicated
that they will investigate whether or not there has been any
criminal activity.
Senator Shelby. As Secretary of Treasury, do you have the
power to recommend things to the Justice Department for
possible prosecution of people who abuse the IRS for political
reasons?
Mr. Lew. Senator, I believe in this and all matters that
nobody is above the law. So I think the first question that we
have is who is responsible and holding people accountable for
their actions.
We started the day after the report was made public by
asking for and receiving the resignation of the Acting
Commissioner. We will continue, as the new Acting Commissioner
takes over tomorrow, to hold people accountable for their
actions because it was unacceptable and we have to restore
confidence in the IRS and the IRS has to be free of any bias.
Senator Shelby. Are you concerned at all from your position
as Secretary of the Treasury that some of this criteria that
was used in Cincinnati to target conservative political groups
could have been explicitly or implicitly endorsed by
individuals higher up in this Administration?
Mr. Lew. Senator, I have seen no suggestion of any
political involvement at all. What I have said and what I
believe is that it was unacceptable and whoever is responsible
should be held accountable.
Senator Shelby. But you do not think it just happened out
of thin air. There was something triggering all this. Was it
either a culture or somebody pushing it inside? Do you not
think that happened?
Mr. Lew. Senator, what I think is that the Cincinnati
office exercised very poor judgment and used criteria that are
unacceptable, and we have made it clear that the IRS has to be
beyond any suspicion of bias.
Senator Shelby. The IRS should be above suspicion, period.
Should it not?
Mr. Lew. Yes.
Senator Shelby. Thank you, Mr. Chairman.
Chairman Johnson. Senator Menendez.
Senator Menendez. Thank you, Mr. Chairman.
Thank you, Mr. Secretary, and I appreciate your answers
with reference to the IRS. I think they are pretty forthright
and determined to make sure we have an agency the American
public can have faith and confidence in.
I want to call to your attention as an element of that
something that I am concerned about which talks about the more
broader structure and how the agency pursues their
determinations. You know, in April, the Citizens for
Responsibility and Ethics in Washington filed a petition with
the Treasury Department and the IRS looking for a revision in
their regulations which they believe would clean up the mess we
are dealing with today, because the statute that Congress
passed for eligibility says civil leagues or organizations not
organized for profit but operated exclusively--exclusively for
the promotion of social welfare are eligible for 501(c)(4)s.
The IRS regulation for the statute, however, says an
organization is operated exclusively for the promotion of
social welfare if it is primarily engaged in promoting in some
ways the common good and general welfare.
I do not think that Congress meant ``primarily'' when they
passed a statute that says ``exclusively.'' And so that is an
example of how an agency gets away from the Congressional
intent, and something I hope that when we are looking at the
totality of this problem, we are pursuing, as well.
Mr. Lew. Senator, one of the recommendations that the IG's
report made was to take a look at this very issue, which is
something that will be going on immediately with the new Acting
Commissioner coming in.
Senator Menendez. Now, with reference to what this hearing
is about, which is the FSOC, let me ask you and follow up on
something Senator Reed talked about, which I have raised in
previous hearings on FSOC, which is the LIBOR interest rate.
And I heard your response, but I want to get a sense of how
much effort are we putting into finding alternatives here,
because even you noted that in referencing the LIBOR, you said,
quote, ``It diminishes market integrity and will be
unsustainable in the long run.''
So, how much effort are we putting in seeking alternatives
to the LIBOR, because if it is not sustainable in the long run,
we should be starting to deal with that challenge now.
Mr. Lew. I totally agree, Senator. There is an enormous
amount of effort being put into it. The Chair of our
Commodities Futures Trading Commission has been working with
international regulators on this for some time. I have been at
several international meetings where finance ministers and
central bank heads have discussed it. There is a common sense
that there is an urgency to develop an alternative, because any
transition has to be orderly. The fact that there is a problem
is one part of the analysis. There has to be a solution. And at
the moment, there is not an easy alternative, which is why it
is so critical, and as the FSOC report noted, a matter of high
priority to develop a reference rate that could be used as an
alternative to LIBOR.
Senator Menendez. I am looking forward to that, because I
am seriously concerned about LIBOR interest rate manipulation
and the consequences it has in ensuring the integrity of
interest rates. That affects everybody, consumers, businesses,
and communities.
Second, more broadly, I am also interested in whether any
of the Federal Reserve or Financial Stability Oversight Council
projections are based in whole or in part on surveys or
estimates made by institutions with a financial stake in the
outcome. In other words, are the projections about inflation
and other trends in the economy that the Fed uses to take
monetary policy decisions, or that FSOC uses to make decisions
about risk to the overall economy, susceptible to the same
risks of manipulation as LIBOR?
Mr. Lew. Senator, I would actually have to take that
question. I read the Federal Reserve Board's economic
projections. They have a very talented team of economists that
work there and they, I know, consult all of the major forecasts
as we do when we do our economic forecasts. What specific
forecasts they use, I would have to check.
Senator Menendez. Well, I would like to hear back from the
Department on that because it makes me concerned that if, you
know, those who have an interest at the end of the day are
giving the information that makes the determination, it raises
the question as to a bit of is this the fox guarding the
chicken coop. So if we are going to have transparency and
greater confidence in our financial institutions, we want to
have that across the spectrum.
Mr. Lew. Yes, and Senator, I can tell you, from the point
of view of the Administration's economic assumptions, we do our
own economic assumptions and we then compare them to the blue
chips. We compare them to the CBO economic assumptions. We test
them against the Fed's economic assumptions. So the general
practice is you do your own economic projections and you see
where they fit on the spectrum of others, because if there is
an outlier estimate, that suggests there are questions that you
would like to ask.
Senator Menendez. And, finally, I would like to just call
your attention to two things. One, which has been endorsed by
the Administration, is Senator Boxer and my Responsible
Homeowner Refinancing Act. We think we could help millions of
families unlock economic potential, as well, and we hope that
this will be an advocacy point because the window is only open
for so long as interest rates remain historically low and, as
well, the whole question of our efforts, which I have mentioned
to you before, on making sure that we unlock the potential,
which the Administration also has acknowledged, in FIRPTA.
Those are things that actually will not cost the Federal
Government money at the end of the day and have a tremendous
potential to help us move this economy and help homeowners.
Mr. Lew. Senator, I have to strongly agree that opening the
opportunity to refinancing to more homeowners who are
creditworthy is an urgent matter. The window will not remain
open forever. We do not know exactly when interest rates will
go up, but when you are at historically low interest rates, the
thing you know for sure is that, over time, interest rates will
go up, and it would be just profoundly unfair if middle class
working Americans who, through no fault of their own, are
either underwater or have lost some of the value in their home
because of the financial crisis while they are still
creditworthy are unable to refinance at lower interest rates.
It would be hugely beneficial to them in terms of the
affordability of their housing. It would be hugely important to
the economy in terms of promoting economic growth. And it is
something that we do believe legislation like yours would help
fix and we would very much like to work with you to get that
enacted.
Chairman Johnson. Senator Corker.
Senator Corker. Thank you, Mr. Chairman, and Mr. Secretary,
thank you for being here today.
I may surprise you in that I am going to mostly stick to
the subject at hand today.
I do want to say on the IRS issue, it is my understanding
when the FBI comes to a company that is accused of corrupt
practices, a lot of times, they will go to the top, even though
they may not have known specifically of the activities, and, in
essence, engage them because of the culture that they have
created there. And, therefore, they end up being culpable for
some of the activities at the lower levels.
I know that you have not been at the Treasury long. I do
want to say that the indignation that you showed on the front
end, to a degree, is kind of laughable in that when you have
the President of the United States and the Vice President and
other leading folks in our Administration using the type of
language to describe the folks that were targeted, demonizing,
villainizing, I think you would expect that bureaucrats at
lower levels are going to act in a way that they acted. It is
reprehensible what happened, but it will be interesting to see
as this goes about whether this culture--really, where it came
from.
And again, I know that you have not been there long, but I
do think that the demonizing and the type of language that was
used probably caused these bureaucrats to feel empowered to go
out and do the things that they did, which really offend all of
our sensibilities, including yours, as you stated on the front
end.
Mr. Lew. Senator, I have to say that the President's
reaction to this was exactly the same as mine. It was outrage--
--
Senator Corker. I am just saying, it should not have been a
surprise.
Mr. Lew. He has taken no step, ever, to condone this kind
of behavior----
Senator Corker. I understand.
Mr. Lew.----and would never. There has been no political
action that I am aware of.
Senator Corker. I understand. It is the culture that is
created when you demonize enemies like that.
Mr. Lew. And the issue that we are dealing with is whether
or not the IRS engaged in unacceptable behavior in screening
applications for----
Senator Corker. I know exactly what we are----
Mr. Lew. We are not discussing the merits of the activities
of the organization. That is a separate issue.
Senator Corker. I understand.
Mr. Lew. It is irrelevant. There should be no bias in the
review of applications.
Senator Corker. I could not agree more, but I think when
people, just like in a corporation, when they hear the CEO
saying things, it affects people on down lower levels. That is
typically what happens in a case against a company. And I am
not trying to implicate. I am just saying, people should not be
surprised that bureaucrats at lower levels took it upon
themselves to do what they did when, at the highest levels,
people were being demonized and villainized in the way they
were.
So, let us move on to the subject at hand. I wrote a letter
to the FSOC on March 12 and asked about Section 121, and the
question is--I have not received a response--do you believe
that the FSOC has the ability to break up a company that is
healthy but one that they believe could pose systemic risk
because of the kind of activities or the size that they are? I
have not received a response and I am wondering if you might do
so.
Mr. Lew. Senator, I have not seen the letter. I apologize.
I will make sure that I do see the letter. You know, the
authorities that the FSOC has are to coordinate the activities
of the different agencies that make up the membership of the
Council. There are some limited areas where there is the
authority to take actions, such as the nonbank designations.
You know, I am happy to look at your letter and get back to
you.
Senator Corker. I appreciate that.
One of the things--Title II in Dodd-Frank talked about
orderly liquidation, and I think that most of us thought that
when a company failed, they were going to be liquidated. And I
think that the FDIC, and I understand for good reason--I had a
lot of conversations with them about this--they have realized
these organizations are so complex that you really cannot
orderly liquidate. And so they have decided, or at least as
they sit today, you cannot orderly liquidate them. So they have
come up with a single point of entry where what they are going
to do is basically attack the shareholders and the creditors,
rightfully so, at the holding company level.
One of the things we have been pursuing is making sure that
there is enough long-term credit held at the holding company.
We still have not received a response, but I think that--I
would just love to hear your thoughts on that. I think,
obviously, what people are going to do is start loaning to the
subsidiaries, knowing that they are going to stay intact, and
not at the holding company level if something does not change,
and I just wondered if you would address that issue.
Mr. Lew. Senator, the orderly liquidation authority and the
single point of entry is a huge improvement in terms of our
ability to manage any future crisis or problems that develop. I
totally agree that there has to be adequate capital available
in order for that to work. In general, raising capital
standards has been a big part of the activity of the last
couple of years. It is a combination of the things, the
combined looking at capital, what the content of investment
activities are, how much leverage there is.
But the creation of a single point of entry will only work
if there is the ability to attach the assets that are in the
equity and the credit, and we would be happy to follow up and
work with you on that.
Senator Corker. And I know that, right now, this is not
your most expert area, if you will. But you would agree,
generally speaking, that we need to have a certain amount of
capital at the holding company level. Otherwise, the single
point of entry will not be useful.
Mr. Lew. There needs to be sufficient capital at the point
when there is a liquidation in order for the process to work,
and how it gets there and how it is maintained is something
that they are working through right now.
Senator Corker. And just one more question. I know some
other people have gone over slightly. We talked a little bit in
our office, and I was a little disappointed by the meeting,
about trying to make our financial regulation work a little bit
better. The community banks around our country are dealing with
Basel III. It is very complex. And there has been some
discussion about just a minimum capital ratio for our community
banks. We still have not resolved that, but I know it is a big
issue to them and it, candidly, could make them far more secure
if we just had a simpler capital ratio. I think many of us
would like to see them raised even at other levels. But is that
something that you would consider doing, is bifurcating Basel
III from the smaller community banks around our country and
allowing them to have a simplified capital ratio that would be
better for them to operate under and, candidly, better for our
country?
Mr. Lew. Senator, I have met with representatives of the
small- and medium-sized banks. I have listened to their
concerns, as many Members of this Committee have. And I have
shared the concerns that I have heard with the regulators who
have the direct responsibility to take action in that area. I
think that they share the concern. They have listened, as they
finalize their regulations, looking for ways to make
appropriate distinctions to have the burdens be commensurate
with the risk and not have small institutions that are not a
source of risk be treated the same as large institutions that
have a great deal of risk.
One thing I would be cautious about is history did not
begin in 2008. We had a financial crisis in the 1980s, which
was a savings and loan financial crisis. So I think all of the
regulators have to make sure that they are looking ahead and
taking prudential steps that address all of the potential
sources of systemic risk. And there is not a one-size-fits-all
approach. There are many, many provisions, both of law and of
rule, that reflect the differences between large and small
institutions, between money center banks and community banks.
And I have shared my concern with the regulators. I have
heard that they share those concerns. And I think we have to
leave them with a little bit of time to complete the process.
Chairman Johnson. Senator Brown.
Senator Brown. Thank you, and welcome, Mr. Secretary.
I want to make a couple comments on the remarks just a
second ago from Senator Corker. Our legislation, Senator
Vitter's and my legislation, Brown-Vitter, addresses a lot of
that. It sets capital standards at 15 percent for the banks
over $500 billion. For those over 50, it sets it at 8 percent.
That is why community banks support this legislation. It also
pulls us out of Basel III, so it deals with a lot of those
issues in a way that I want to ask Secretary Lew about.
FSOC's Annual Report cites risk taking at large
interconnected banks, what we would call the too-big-to-fail
banks, those that--the six banks over $500 billion in assets.
It cites risk taking as a threat to our economy. The report
says, and I will quote, ``Market participants may continue to
perceive that some institutions receive special treatment by
virtue of their size.'' You acknowledged at your confirmation
hearing that this perception gives the megabanks a funding
advantage to the capital markets. That is pretty clear. The
FSOC report shows that the large megabanks get a one or two
notch up, if you will, boost in their credit rating.
Standard and Poors said that Brown-Vitter, our legislation,
which calls for higher capital requirements, will, in fact,
eliminate the too-big-to-fail funding advantage they get. Dodd-
Frank requires, as you know, FSOC to make recommendations in
its annual report to promote market discipline.
So my question, Mr. Secretary, is why has FSOC failed to
meet this requirement by recommending higher capital
requirements for these six largest too-big-to-fail banks?
Mr. Lew. Well, Senator, I think that a number of the issues
that you have raised or that are raised in your legislation are
issues that the regulators are working on right now. The
capital standards have not been finally set. The Basel III
rules at the Fed have not been finalized. Basel III is a floor.
It is not a ceiling. There are a number of regulatory
approaches that would considerably raise the cost of being a
large bank, and I think we have to see where that process ends
in order to be able to answer the question whether we have
fully solved the problem.
It is certainly the objective to be able to say at the end
that we have ended too-big-to-fail and that we have eliminated
any subsidy that might exist. The fact that the market implies
a subsidy when we have said as a matter of policy that too-big-
to-fail is not our policy is a bit of a challenge, and we are
saying it as often as we can, but we are going to have to
demonstrate it with the rules we put in place that make it
quite costly to be a large bank in terms of the requirements
that are put in place.
You know, the one issue that I would like to kind of take a
little bit of issue with is in replacing Basel III. I worry
that--Basel III is a floor, not a ceiling, but for a lot of the
world, it becomes an aspirational goal and we are trying to
encourage the world to race to the top, not race to the bottom.
And Basel III is actually working to pull a lot of other
countries up.
Right now, when we look at the sources of financial risk,
one of the things that we worry about, given the global
interconnection of our financial institutions, is the risk that
is presented to the United States from undercapitalized
institutions around the world. So I think we have to get a
balance in the approach and we look forward to working
together----
Senator Brown. Mr. Secretary, you are a sophisticated guy,
and to make that statement that if we back out of Basel III but
build 8 percent capital standards for mid-size banks and 15
percent for large banks when Britain is doing what it is doing,
and, I mean, London and New York have incredible influence,
Basel III aside, I mean, incredible influence--but you said
something else, that the market implies that too-big-to-fail
may still be around. It is more than implying. It does not
really matter what Jack Lew or Sherrod Brown or David Vitter
thinks about this. It is what the markets think, and the
markets continue to say that too-big-to-fail is alive and well.
Several members of FSOC have agreed that too-big-to-fail
banks should have more capital. A recent Huffington Post report
said the U.S. Treasury has avoided publicly weighing in on this
debate. This is not really a question, it is more sort of a
summary statement. But your legal responsibility as FSOC
Chairman is to promote market discipline and eliminate the
perception. The perception is still there.
Dodd-Frank--as I said, you are a sophisticated guy. You
have seen what has happened when one of the leading bank
lobbyists after the legislation was signed said, this is
halftime, and then put an even larger, more powerful legion of
lobbyists on ways to weaken these standards at the same time
Basel III may be better than now, but with what it has done
with risk adjustment and risk assessment and all, you know that
Basel III is not going to be very strong capital standards. It
is minimal compared to what the market says we should do. And I
just hope you take this legal responsibility as Chair of FSOC
to promote market discipline and eliminate that perception of
too-big-to-fail.
Mr. Lew. I want to emphasize things that I think we are
agreeing on, and I think if you look at the statements made by
many of the regulators, what I am saying is consistent with the
statements made by Fed Governor Tarullo, for example.
We, as the final rules are put in place, need to set
adequate capital standards and put other requirements in place
that meet our standard so that we can fulfill the obligation of
ending too-big-to-fail. I totally agree with that.
What the market is assuming is partially a political
judgment. It is a political judgment that the Government would
jump in again if there is a problem. Our job is to make sure
that there is a thick enough layer of capital and that there is
no need to even get to that point. And we are committed to
making that happen.
Senator Brown. But the market understands what Basel III is
about, and the market assumes Basel III will go into effect,
likely, and that probably Brown-Vitter will not any time in the
next few months, minimally, and the market still says--
Bloomberg says $83 billion. Lots of other analysts have said
70, 80, 90 basis points advantage. We are seeing the incredible
concentration, $2 trillion among the largest banks, increase in
assets. The largest six banking institutions in this country
have 60 percent of assets. You know these things. The market
sees these. Again, it does not matter what you and I and
Senator Vitter think. It matters what the market is seeing.
Their fears are not allayed in this and their worst nightmares
may be realized if we do not act on this.
Mr. Lew. Well, the only thing I would respond by saying is
that we are not yet completed in the process. We should make
more progress this year. We need to make substantially more
progress this year. And the challenge be, when we have
completed--when all the rules are completed, can I sit here and
have this discussion saying that we have made the progress----
Senator Brown. Well, but the market has also seen how long
this has taken to implement these rules----
Chairman Johnson. Senator Heller.
Senator Brown.----and the weakening of these rules and the
dilution of them as they are being made.
I am sorry, Mr. Chairman. Thank you.
Senator Heller. Thank you, Mr. Chairman.
Mr. Lew, thank you for being here. Could you repeat the tag
line that you explained to Mr. Shelby about when you had
knowledge of the IRS issues and when you had discussions with
the auditor?
Mr. Lew. Senator, I had one conversation with the Inspector
General. It was on March 15. It was a session that was one of
many meetings I had to meet with senior officials at the
Department soon after becoming Secretary. I then saw the
results of the report when they became public.
Senator Heller. Were you curious to ask, when you talked to
the Inspector General, about what the impact of that may have
been?
Mr. Lew. Senator, what I said to the Inspector General was,
you have my full support. I want to know the findings when you
have them and I am going to take actions to fix any problems
you find.
Senator Heller. What did the Inspector General say
specifically, though, that caught your attention?
Mr. Lew. Senator, it was a very brief conversation on this
matter. It was noting that there was an audit underway,
suggesting that there might be troubling findings, and that was
it.
Senator Heller. And you did not ask any additional
questions?
Mr. Lew. Senator, you know, the IG process is one where a
head of an agency ought not to be in any way getting in
between----
Senator Heller. See, I disagree with that.
Mr. Lew.----the Inspector General and their work.
Senator Heller. I have been through a number of audits in
my political career through Government agencies, and any time--
and you always have preliminary findings and you sit down and
talk to them before they issue their final report. And I am
just surprised that you had no additional questions if there
were troubling findings.
Mr. Lew. Senator, I think that there is a well-established
practice at the Treasury Department of not bringing audit
findings to the Secretary until they are final. Audit findings
in preliminary form change frequently. They change in
direction. They change in degree. They are not actionable until
they are final. At the moment they are final----
Senator Heller. I understand----
Mr. Lew.----they come to the Secretary.
Senator Heller.----but I would think you would be curious
enough to ask additional questions and want to know more if
there are troubling findings.
Mr. Lew. Senator, I said to the IG what I have said to
every auditor I have ever worked with, which is you need to
complete their work. If there is a problem, you have my
commitment of support and we will fix anything that is wrong.
Senator Heller. Why is Sarah Hall Ingram still employed
with the IRS?
Mr. Lew. Senator, the individual you are describing is not
working in the area that is certainly at issue.
Senator Heller. She was at the time.
Mr. Lew. Well, the chronology matters, and she was at the
time assigned to work on the implementation of the Affordable
Care Act, which she has been doing since. So she was actually
not working on this, to the best of my knowledge.
Senator Heller. That is not----
Mr. Lew. I can say this, Senator, that any individual who
is responsible will be held accountable, but we also have to
wait until the facts are clear.
Senator Heller. Yes, but she testified in 2011 that she was
the Commissioner of the Tax-Exempt and Government--while all
this was going on. She also said in 2012 testimony before the
Senate Finance Committee on Indian Tribes that she was Tax-
Exempt Status. So she has testified over the last couple years,
up until recently, that she was the Commissioner over this.
You know, you named some employees. Will she be held
accountable?
Mr. Lew. Senator, what I have said is our policy. Anyone
whose actions are such that they should be held accountable
will be held accountable. There will be a new Acting
Commissioner as of tomorrow. His first order of business is to
make the factual determinations of who is to be held
accountable.
Senator Heller. Thank you. You know, we are talking
financial security here. This is what this is all about, is
financial security. You know, there is probably spent more time
around the kitchen table talking about their finances between
Mom and Dad and the grandparents than any single issue, and
probably more so in Nevada, where the highest unemployment,
highest foreclosures, highest bankruptcies. So you can imagine
the kitchen table talk that is going on. And there is not any
agency in America that probably has more control or more input
on your ability to win or lose, your ability to have financial
security or not have financial security.
I just did a tele-town hall meeting recently, over 6,000
calls. This was last week. And we asked the question about
hiring 16,000 new IRS agents after everything--by the way, the
adjectives in this tele-town hall meeting was that the IRS is
biased, they are corrupt, they are politicized, and they are
eager to attack White House adversaries. This is coming out of
my State.
In essence, I believe the IRS has violated the trust of the
American people, and when you ask them a question, should we
hire 16,000 new IRS agents, 61 percent say, absolutely not. So
I am concerned. If you cannot trust them, if you cannot trust
them with your own taxes, if every businessman that comes up to
me that gets audited is wondering if the IRS is doing it for
political reasons or for reasonable steps and following their
own regulations, that is a difficult question for me today to
answer.
Mr. Lew. Senator, I have said, the President has said, that
the actions here were unacceptable. But I think it is important
to note, there is nothing in the Inspector General report to
suggest in any way that there was any political direction or
political pressure brought to bear.
These actions were unacceptable. They have to be corrected.
They cannot be allowed to happen. We have to restore confidence
in the IRS. The IRS has to be beyond any suspicion of bias.
Senator Heller. Do you oppose a Special Counsel?
Mr. Lew. Senator, there are a lot of investigations going
on right now. I have made clear----
Senator Heller. Do you think the IRS is good enough to
police themselves?
Mr. Lew. I think that we--there are many committees of
Congress now looking at it. The Justice Department is looking
at it. And we have a new Acting Commissioner coming in who is
going to do a top-to-bottom review beginning tomorrow.
Senator Heller. For the record, let me just be very clear
that I want my name in those who are asking for a Special
Counsel for the IRS.
Thank you, Mr. Chairman.
Chairman Johnson. Senator Merkley.
Senator Merkley. Thank you, Mr. Chair, and thank you, Mr.
Secretary.
When Senator Shelby asked a question about the IRS, you
replied--this is more or less accurate--``I believe in this and
all matters that no one is above the law.'' And as you said
that, I was thinking about the situation with HSBC, where,
essentially for 10 years, they laundered money repeatedly. They
were admonished to stop doing it. The money laundering was
related to countries where we have basically embargoes because
of their policies to acquire nuclear weapons, Iran
specifically. These were terrorist organizations which put at
risk our men and women around the world, our companies around
the world. These were drug organizations in Northern Mexico,
and some 40,000 people have died from the operations of those
drug operations. This money laundering took place continuously
after multiple efforts to stop it and our AG decided not to
prosecute.
When you think about your statement that no one should be
above the law and you look at what HSBC did, are you deeply
disturbed that this prosecution free zone has been created for
HSBC and other large financial institutions?
Mr. Lew. Senator, there were civil penalties that the
Treasury Department was responsible for that were brought to
bear.
Senator Merkley. Well, let us pass that, the civil side,
because I am talking--these were criminal activities.
Mr. Lew. It is not my responsibility as Treasury Secretary
to make decisions on criminal matters. I can tell you my view
is that no one is above the law, and where there is criminal
wrongdoing, investigations are appropriate and prosecutions are
appropriate. I cannot speak to the prosecutorial decisions that
were made. I was not at Treasury at the time, obviously. But it
is also not--it is not in my area of responsibility to make
criminal----
Senator Merkley. Is it your sense that when a major
organization is engaged in such longstanding money laundering--
which they have admitted to, so that is not the question, it is
not a question of the facts--and they are given a free pass on
criminal prosecution, that that draws into question whether or
not, in fact, there are organizations that are above the law,
and what does that convey to ordinary Americans?
Mr. Lew. Senator, I have testified on a number of occasions
that my view is no one is above the law. I can state it again,
but I cannot comment on specific prosecutorial----
Senator Merkley. OK. Well, I would encourage you to weigh
in, because your world is a world involving large financial
institutions, so there is an overlap between your world and the
AG's world in this regard.
I wanted to turn to the IG's report regarding the IRS, and
Senator Menendez noted that we have this unusual situation
where the statute of the law says that with a 501(c)(4),
donations will be used exclusively--the word is
``exclusively''--for charitable activities. But the IRS
regulation says, and this is the most bizarre thing I have
encountered in public life, that the word ``exclusively'' means
``primarily.''
Now, the IRS has not identified what percentage is
associated with ``primarily,'' but mathematically, that is
considered 50.1 percent, if you will. And so how is it
acceptable that an IRS regulation completely ignores and
overturns the 100 percent standard set in the law?
Mr. Lew. Senator, as I responded to Senator Menendez, this
is one of the issues coming out of this matter that is going to
have to be reviewed. It is something that we would look forward
to working with Congress on as we look at it, because this is a
controversial area. Any action one takes one way or the other
to change the policy is something that really requires careful
consideration.
Senator Merkley. Well, let me be clear. Congress has
already written the law and it says ``exclusively.'' It is the
IRS regulation. That is under your jurisdictions.
Mr. Lew. I understand, and what I am saying is the process
of reviewing that policy will begin immediately and we will
consult as we go through it.
Senator Merkley. OK. It has been noted by many that we have
a political organization under the law called 527. We have a
charitable organization called 501(c)(3). We have another
charitable organization, 501(c)(4), but in that case, the IRS
regulation has created enormous confusion about what can be
done, because once you say ``primarily,'' it means half your
activity can be noncharitable activity, contrary to the clear
language of the law. That confusion has now sown enormous
problems, and is it not important in your leadership and
oversight of the IRS to end that confusion and make the
regulation consistent with the law for the benefit of all
concerned?
Mr. Lew. Senator, there is no doubt that there is confusion
in this area and it is something that we are now going to need
to look at, and I will be in a position to respond after there
is a review.
Senator Merkley. Thank you.
Chairman Johnson. Senator Kirk.
Senator Kirk. Mr. Secretary, I would like to take you back
to something----
Chairman Johnson. Turn your microphone on.
Senator Kirk.----which is Iran's progress toward a nuclear
weapon and sanctions that Steve on my staff has put together a
chart showing the effect of the Kirk-Menendez Amendment. I do
not think I have ever seen actions by the U.S. Senate that have
been so effective against a rogue nation. This shows the value
of the Iranian currency, which is called the rial, against the
dollar, a 74 percent drop since Menendez-Kirk passed the Senate
on December 1, 2011.
I would just like to add on that we have a next step for
you, to follow a Dutch initiative to restrict access to Iranian
Euro-denominated accounts which would cost the Iranians about
$30 billion. I hope that you could help the Senate move on to
take that next step, which is to adopt the Manchin-Kirk
legislation, S. 892. We already have 21 Senators and several
Members of this Committee on this legislation.
If you look at what has happened to the rial, if you look
at the details, you will see that Iran has lost 50 percent of
their oil purchasing power, meaning we have significantly
impacted the purchasing power parity of the mullahs in Iran.
Mr. Lew. Senator, you and I have discussed this on a number
of occasions and I agree with you that our sanctions policies
and the implementation of them on a unilateral and multilateral
basis has had an enormous impact on the economy of Iran and it
is making life very hard in Iran. Now----
Senator Kirk. I have a subset question for you, which is
what you can do to support the Dutch initiative to cutoff
Iranian access to Euro-denominated accounts.
Mr. Lew. So, Senator, I was actually going to say that I
have raised the issue of access to Euro-denominated accounts
with many of my counterpart finance ministers in Europe.
Senator Kirk. Thank you.
Mr. Lew. I think that after you and I talked about this and
I brought that to their attention, it actually heightened the
level of awareness of the issue. It is largely an
administrative problem in Europe. The law is a strong law and I
think we have asked them to get that into place where it is
working better and I would look forward to working with you on
it going forward.
Senator Kirk. I very much hope we back our Dutch allies on
this EU initiative.
Mr. Lew. Yes. I am not familiar with the specific Dutch
initiative you are describing, but I will become familiar with
it.
Senator Kirk. Thank you. Thank you, Mr. Chairman.
Chairman Johnson. Senator Hagan.
Senator Hagan. Thank you, Mr. Chairman, and Secretary Lew,
it is a pleasure to have you here.
In your written testimony, you made reference to the
housing finance system. Much attention has been paid in recent
months to the question of how to return private capital to the
market and how to resolve the conservatorship of Fannie Mae and
Freddie Mac. In fact, just last week, Senator Tester and
Senator Johanns held a hearing on this topic in the Securities
and Investment Subcommittee. Can you talk about the FSOC's
recommendation for how to phase in a return of private capital
to the housing market?
Mr. Lew. Senator, this is obviously an area where there is
considerable need for action. We in FSOC have identified it as
an area that requires attention. It is obviously not a place
where FSOC has put a specific plan out there. The
Administration has laid out some broad principles in this area
and we would look forward to working on a bipartisan basis to
go forward with that.
I think that the issue of winding down the conservatorship
is going to take a while. We are making progress. We are
determined. We are determined that we will get taxpayers as
much of their money back as we possibly can for having bailed
out Fannie and Freddie. It is going to take a while, but we are
making considerable progress there. I think we are looking
right now at a housing finance sector which is too dominated by
Government-issued or Government-guaranteed mortgages. We need
to get private capital back into the market.
One of the things that I do think we need to do is finalize
the rules that are in the qualified mortgage area so that banks
know what the rules of the road are. I have heard from quite a
number of bankers that we want to be in the space, we are
willing to do our part, but we have to know how much it is
going to cost us, what the capital requirements will be, what
the risks will be. Those rules are being finalized.
Going forward, I think we do need to move ahead on next
steps. The FHFA has taken some steps to bring into place some
common utilities for follow-on entities to use. But there are
some big policy issues that we are going to have to grapple
with and we are going to be continuing to work on that going
forward.
Senator Hagan. Do you have a figure as to how much the
public has spent on Fannie and Freddie?
Mr. Lew. I would be happy to get back to you with the exact
number.
Senator Hagan. Many Dodd-Frank rulemakings still need to be
completed. What rulemakings--you mentioned QM and QRM--need to
be completed to start this process? Do you have any sort of
timeframe?
Mr. Lew. Well, I think that----
Senator Hagan.----because QRM Rulemaking has been going on
for quite a while.
Mr. Lew. You know, it has been going on for quite a while.
Obviously, I have been Secretary for just under 3 months.
Senator Hagan. I understand.
Mr. Lew. I have made it a matter of enormous priority for
me personally to be driving this process. I think we also have
to look at what was going on in the first 2 years of Dodd-
Frank's existence. There was an enormous effort to repeal Dodd-
Frank. There was an effort to put every delay in the way of
implementing the rules that you could imagine.
I think, since November, that has changed. What I am
hearing now is there is a desire for things to settle down, for
there to be certainty. There is an acceptance that Dodd-Frank
is the law of the land and it is not going anywhere.
Now, I have actually stepped on the accelerator. I have
gone to all the regulators and said, you know, this is more
than just a question of implementing Dodd-Frank. This is a
question of public trust in the Government's ability to
implement important policy that it said it is going to
implement. And I am going to, at the risk of becoming tiresome,
keep this at the top of the agenda of all the agencies that are
part of FSOC.
Now, I do not have the ability to direct specific action in
every case. This is more a question of coordination and kind of
moral suasion. But I will use every tool that I have to get
decisions made in these areas.
Senator Hagan. Thank you for that. We will be following up.
Thank you, Mr. Chairman.
Chairman Johnson. Senator Manchin.
Senator Manchin. Thank you, Mr. Chairman, and thank you,
Secretary Lew, for coming in the job that you have been put
into at a most appropriate time.
With that being said, a lot of the questions have been
asked and talked. I would like to talk more or less about just
the whole premise of what is going on with the American people
in West Virginia, how we feel. Government should be your ally
and should be your partner, and I think people believe in West
Virginia, Government has become the adversary relationship and
it is basically not your friend anymore. It could be your
enemy.
And the IRS has always been the elephant in the room, if
you will, and the gorilla, and just seeing how it has gotten to
the level that we have gotten to now, thinking that people
could be targeted. I am not taking this. I have got individuals
that believe they have been targeted, and they might be on the
same political--or they did not have anything political. They
thought it was just a pervasive attitude of the institution
that has gotten so large and how this whole was permeated.
And I guess in saying that--and I am not talking just about
the IRS. I am talking about Government, in general. If
anybody--and I do not know how you would feel about this, if
you would even want to comment about it--anybody in any agency
that would use, for their own personal agenda or a political
agenda against a class of people or an individual, should not
be maybe losing their job, losing the benefits they have
accrued, and even facing jail time. I do not know how--you
know, right now, we are just hitting on the IRS, but it is all
through Government.
Mr. Lew. Senator, I have tried to state in the clearest
terms that I possibly can how unacceptable it is for this
behavior to have happened.
Senator Manchin. Sure.
Mr. Lew. I have spent most of my career in public service.
I hold myself and everyone that I work with to a very high
standard. There is no place, no place for bias in the
implementation of our tax laws or our other laws. We have to be
implementing the law fairly and equally.
I would be reluctant to go beyond the facts that are in
front of us now and assume any broader issue. I think that it
is a bad enough set of facts that we are looking at, that we
need to understand them, take the actions to fix them, look in
the IRS and make sure that if there are systemic problems, we
fix them.
But I would not--I would be reluctant to accept the notion
that this is a pervasive problem unless presented with facts to
that effect. We have to be vigilant to make sure it does not
ever become that. We have to be a Government of laws. We have
to be observing standards of neutrality in the way we implement
the laws and fairness. And that is what I believe in and it is
what I have always tried to accomplish.
Senator Manchin. Well, I would like to, with your
leadership, if especially the Treasury Department could work
more as my partner----
Mr. Lew. I would look forward to it.
Senator Manchin.----and my friend, I would appreciate very
much. I know the citizens of West Virginia would be very
appreciative of that.
With that being said, in the late 1980s and early 1990s, we
investigated the Keating Five, if you recall in history, for
the savings and loan crisis. That crisis may not have been as
big as our 2008 collapse that we had, but it was far-reaching
and it cost the Federal Government billions of dollars. We not
only investigated bank executives, we investigated U.S.
Senators. And I think the people are looking back now, saying,
why are we not--why has it gotten so big? Has it gotten to the
point to where these banks are getting so large that they are a
protected class or species, and the people that are involved in
those at the highest level cannot be touched because we are
afraid of a collapse?
Mr. Lew. Senator, I have indicated today and on many
previous occasions----
Senator Manchin. Sure.
Mr. Lew.----that I do not believe that anyone is above the
law and I do not think that there should be any acceptance of
that principle.
Senator Manchin. Well, a bank that is too-big-to-fail, if
the bank gets that big, and that is the pervasive thought,
should it not be you all's recommendation that we should not
let banks get to the size that they are that they get in that
position?
Mr. Lew. So, I think there is a question of how you make
sure that we have ended too-big-to-fail. One approach is to say
there is a certain limit or you can divide up what activities
can be held, take place in any one institution.
Another approach is you use the tools that we have in Dodd-
Frank and in other regulatory authorities to make it more
expensive to be big and it becomes a market determination that
limits the size.
Senator Manchin. So the bill that Senators Brown and Vitter
are working on, basically with capital requirements, is
something that you are looking at?
Mr. Lew. Well, as I said to Senator Brown, I think we have
to see where the rules end up when Dodd-Frank is fully
implemented to see if it solved the problem.
Senator Manchin. You can understand the citizens' concerns,
basically, that there is a protected--the people that caused
the problem, and now the community banks and the regional banks
are feeling the fallout of that and seem to be getting hit the
hardest putting capital back on the streets to get the economy.
But the people that caused the problem are the people that
benefited the most from the turn of the economy.
Mr. Lew. Well, Senator, in the aftermath of the financial
crisis, Congress took bold action in passing powerful tools,
which we are now using, and we are determined to be----
Senator Manchin. I appreciate your explanation, also why it
has taken us so long to get Dodd-Frank implemented, because
there is a lot of criticism about why are we sitting on our
hands, and this political toxic atmosphere that we live in
every day is probably the reason that it has been. I hope it
stops. Thank you, sir.
Chairman Johnson. Senator Warren.
Senator Warren. Thank you very much, Mr. Chairman and
Ranking Member Crapo. Thank you for having this hearing.
I also want to say, thank you both very much and thank you,
Secretary Lew, for starting out and taking time to remember the
families in Oklahoma. I just want to add that I will hold them
all in my prayers. It is a terrible catastrophe there, and
thank you for mentioning it publicly.
Thank you for being here, Secretary Lew. I want to start by
talking about a different Brown Amendment, and that is you may
remember that Senator Brown joined with Senator Kaufman back
during the Dodd-Frank debates to introduce an amendment that
would have broken up the country's largest banks. The amendment
had bipartisan support behind it, but it did not pass, and we
all know what has happened since then.
The four biggest banks, banks that were considered too-big-
to-fail before the crisis, are now 30 percent larger than they
were just 5 years ago, and there have been huge scandals, some
of which have been mentioned today--the LIBOR scandal, the
infamous London Whale, the deliberate foreclosure fraud. It has
been one scandal breaking on top of another. And Attorney
General Holder has said that the Justice Department cannot
consider litigation against Wall Street banks without factoring
in potential systemic economic impact that could result. And
while we all know there are parts of Dodd-Frank that are there
to address the problem, even Federal Reserve Chair Bernanke has
admitted that too-big-to-fail is not yet over.
So, I know you were elsewhere in the Obama administration
during the Dodd-Frank debate and that Treasury's attention is
now elsewhere, but I would like to read you a quote from a New
Yorker article from that time. This is what a senior Treasury
official said about the Brown-Kaufman too-big-to-fail
amendment. ``If we,'' meaning the Treasury Department, ``had
been for it, it probably would have happened. But we were not,
so it did not.''
So, Mr. Secretary, the Treasury Department said its
opposition to breaking up the big banks is an important reason
that my colleague, Senator Brown's, amendment did not pass. The
question I want to ask now is has the Treasury Department's
position changed or are you still opposed to capping the size
of the largest financial institutions?
Mr. Lew. Senator, I have tried to indicate in my response
to other questions today that ending too-big-to-fail is our
policy and we are determined to do it----
Senator Warren. And let me just focus you in here, though,
Mr. Secretary. The question is not, are we all trying to aim
toward ending too-big-to-fail. My question is specifically
about capping the size of the largest financial institutions.
It was an amendment that nearly passed. It had bipartisan
support. The Treasury opposed it, and according to the
Treasury's own folks, it was the Treasury opposition that
killed off breaking up the big banks, and I want to know if
Treasury has changed its position.
Mr. Lew. As you noted, I was not at Treasury at the time--
--
Senator Warren. Fair enough.
Mr. Lew.----so I cannot speak to the exact decisions that
were made there. I think we are on a path now which is the
right path, which is to implement Dodd-Frank and to then take
stock when we are done implementing Dodd-Frank. I think that
there have been a lot of calls for legislation in this area and
I have said the same thing to people who wanted very different
kinds of changes, that our job right now is to implement a very
important law with very powerful tools and then to take stock
of whether or not there are other actions that are required,
and I think that this is not the time to be enacting big
changes to Dodd-Frank or to the regulatory system. We need to
implement the law.
Senator Warren. But the question is, though, Secretary Lew,
this was about concentration. We all said back in 2008, 2009,
the problem that caused the financial crash, in part, was
concentration in the banking industry, and what do we see now?
We see more concentration. One of the tools considered for
Dodd-Frank was a way to end that concentration.
So let me try the question a different way. How big do the
biggest banks have to get before we consider breaking them up?
They are 30 percent bigger now than they were 5 years ago. Do
they have to double in size, triple in size, quadruple in size,
before we talk about breaking up the biggest financial
institutions?
Mr. Lew. Senator, there are many changes that have taken
effect since the passage of Dodd-Frank. We have better
capitalized banks. We have better visibility into the banks. We
have the derivatives being traded in a way where we can see
what is going on and understand it. So there were many things
going on that contributed to the financial crisis and we are
making good progress. We still have more progress to make. I--
--
Senator Warren. So, are you saying, Mr. Secretary, that if
we have increasing concentration in the banking industry, if
the biggest banks double in size, that that does not worry you?
Mr. Lew. I think that what I am worried about is have we
taken into account the measures that prevent systemic risk from
being the kind of threat it was in 2008. Size is one factor,
but size is not the only factor, and----
Senator Warren. Fair enough that it is not the only one,
but size is one that is growing and size is one that is
powerfully important.
Mr. Lew. And I think if we look at what happened from 2008
until now, part of the reason that some of those institutions
grew is that there were other institutions that failed that had
to be reorganized, and it was an unusual period of time where
we were seeing, ironically, a shrinking of the number of
players because of the failures of institutions.
So there are many things going on, and I am not trying to
avoid addressing the question of too-big-to-fail. I am not
trying to--I am trying to address quite clearly that that is an
unacceptable policy. But I think we have to take into account
all the factors that together add up to systemic risk.
Senator Warren. Fair enough, Secretary Lew, but I really
think the evidence suggests that concentration is one of those
factors and that when we see the largest financial institutions
getting bigger and bigger, that it tells us that we are not
clearly on the path to resolving too-big-to-fail----
Mr. Lew. But in fairness, we have not yet seen the capital
surcharges that will be the responsibility of larger firms
fully in effect, and as----
Senator Warren. Fair enough.
Mr. Lew.----it gets more expensive, I suspect it will
change----
Senator Warren. But what we have also seen is one scandal
after another in these largest financial institutions. It is
clear they have not changed their risk-bearing practices, nor
have they decided that they are suddenly going to start
following the law. So I think, at best, we have evidence going
both ways. And we are playing with the U.S. economy here, the
worldwide economy.
I apologize, Mr. Chairman, for running over in this
exchange.
Chairman Johnson. Mr. Secretary, the Ranking Member and I
have a brief follow-up question.
Mr. Secretary, the FSOC report highlights the growing
cybersecurity threat to the financial sector, including the
recent attacks. What can FSOC and each of its members do to
ensure that the financial sector remains vigilant in guarding
against cyber threats?
Mr. Lew. Senator, I think cybersecurity is an enormous
threat and it is something that is, unfortunately, going to be
with us as a threat going forward. So it is not an issue where
we can take an action and say we have solved it because there
are bad forces out there that are always trying to get a step
ahead of any protections that are put into place.
I think that the first thing we have to do is to make sure
that we have the kind of coordination where threats are well
understood and communicated and where there is collaboration
within the industry and between the regulators and the
industry. In my first weeks in office, I met with bank
executives to make that point and to make it clear that we
needed them to step forward and participate and we needed to be
part of that process.
I think that if you look at the Executive Order that the
President issued last year, he has gone about as far as we can
go with administrative authority to put in place the tools to
deal with this. It would be very helpful to get legislation
that would make it even more likely that firms would do the
kind of cooperative work that is needed to be as vigilant as we
can possibly be.
One of the things that I particularly am concerned about is
large institutions have the capacity to do more on their own
than small institutions do, and I think we have to be very
concerned that the risks are not just to the big money center
banks. The risks are much broader than that and the risks are
faced by institutions that need the kind of collaboration and
cooperation that we are talking about to have the full capacity
to respond should there be a threat.
But the short of it is, we are going to have to remain
committed and vigilant, using all of the tools that we have,
both to detect and address these issues, and it is going to
take real cooperation between the financial services sector and
the Government officials.
Chairman Johnson. Senator Crapo.
Senator Crapo. Thank you very much, Mr. Chairman, and Mr.
Secretary, I had just two questions to follow-up on, one on the
IRS and one on FSOC.
I will start off with the IRS. You had indicated in your
response to Senator Heller, I believe, that the Inspector
General's finding indicated that there was not a political
motivation to the IRS's activities----
Mr. Lew. I said no political pressure was brought to bear.
Senator Crapo. And you may have noticed, I had to step out
for a few moments. That was to go down to the Finance
Committee, and I had an opportunity to ask some questions of
the Inspector General at that time, and a couple of very
important things came out there.
First of all, he made it clear that the report does not
make a finding that there was no political pressure or
political motivation. It was that they were not able to find
it. And I asked them what they looked into. He said, we asked
the IRS employees who we interrogated, or interviewed, whether
they had a political motivation. He said none of them admitted
to having such. I asked him if they were under oath. He said
no, that he had taken no testimony or information under oath,
and that it was his opinion that--I think he said to me that he
thought further investigation was necessary into this.
It seems to me that at this point, what we have is a
coalition of targeting certain politically grouped individuals
or organizations, and I will go over again, I mean, we have
the, as I said earlier, an agency that is perceived by many in
America to be the prosecutor, the judge, the jury, and the
executioner in major parts of their lives who is setting up
criteria to look for those who are involved with the tea party,
who use the word ``patriots,'' who use the words, ``make
America a better place to live,'' or criticize how the country
is run, and then later expanding this search or this what they
call a BOLO list, a ``be on the lookout list,'' for those who
want to educate on the Constitution and the Bill of Rights or
who are focused on addressing social economic reform in the
United States.
The question I have to you is, are you or is the IRS taking
the position that, somehow, this coalition of audits that
focused on people from these political perspectives just
happened accidentally or statistically came about in a way that
was not driven by a decision that was aimed at this particular
political philosophy?
Mr. Lew. Senator, I am aware of no evidence that suggests
any political interference in any way. There is a sharp wall
between the Treasury Department and the IRS on the
administration of the tax system. There is--you know, it is a
well, well respected line. And no evidence has been brought to
bear. I read the report. The report said that there was no
evidence of any political pressure. People can ask questions
more and more, and I am not discouraging they ask those
questions. But there is no evidence. So we should be clear.
There is no evidence.
Senator Crapo. And the extent of the evidence at this point
is interviewing those who were implementing the BOLO list and
asking them if they were politically motivated.
Mr. Lew. Senator, we have said that anyone who is
accountable should be held accountable, but there has to be
evidence to hold people accountable.
Senator Crapo. Do you believe the lack of evidence means
that there is no political, or----
Mr. Lew. Senator, I am not going to speculate on facts that
I cannot see and evidence I do not have.
Senator Crapo. OK. Just one other real quick question, Mr.
Chairman, please, on the FSOC.
You had indicated that you thought there was quite a bit of
progress being made in resolving the cross-border issues, and I
just wanted to follow up, because on April 18, you received a
letter from nine foreign ministers of different countries----
Mr. Lew. Yes. I know----
Senator Crapo. These are not regulators. These are----
Mr. Lew. No, no. I know they are counterparts.
Senator Crapo. Yes.
Mr. Lew. I have spoken with many of them about it. I,
frankly, think the letter was ill-informed, that there were
conversations going on between the SEC and the CFTC making real
progress on that. I am not going to speculate about the reasons
that other political officials write letters, but I did say to
them quite directly that it was not a helpful way to promote
conversations with these two independent regulatory agencies,
to write a letter like that that did not even reflect the state
of affairs. So I would not read too much into that letter.
The question is, where are they going to end up? They are
making progress. They are not finished yet. But they have been
working quite effectively to try to deal with this and I think
that letter was something that did not reflect where this
situation was at the time.
Senator Crapo. All right, thank you, and thank you, Mr.
Chairman, for that extra time.
Chairman Johnson. Secretary Lew, I thank you for your
testimony today and your continued focus on matters important
to a civil financial system.
This hearing is adjourned.
[Whereupon, at 12:02 p.m., the hearing was adjourned.]
[Prepared statement and response to written questions
supplied for the record follow:]
PREPARED STATEMENT OF JACOB J. LEW
Secretary, Department of the Treasury
May 21, 2013
Chairman Johnson, Ranking Member Crapo, and Members of the
Committee, thank you for the opportunity to testify today regarding the
Financial Stability Oversight Council's (Council) 2013 annual report.
My testimony today will describe the conclusions and
recommendations made by the Council in its third annual report. The
report represents extensive collaboration among staff of Council
members and member agencies to provide Congress and the public with the
Council's assessment of significant financial market and regulatory
developments, potential emerging threats to financial stability, and
recommendations to strengthen the financial system. The annual report
is a key way that the Council can share its collective perspective and
provide information on its activities to Congress and the public.
Since the Council's last annual report, our financial system has
grown stronger in a number of ways:
Bank capital has increased significantly in terms of both
quality and quantity. This substantial amount of additional
capital gives these companies a much stronger ability to
withstand a future downturn.
Companies' liquidity and funding profiles have strengthened
dramatically as well. As higher liquidity and funding
requirements are implemented in the United States and
elsewhere, the financial system will be much less vulnerable to
the destabilizing runs that we experienced during the crisis.
Progress on comprehensive reform of the over-the-counter
derivatives market has reduced risks in the system, increased
transparency, and strengthened investor protections.
Collectively, these measures help make financial institutions
and the financial system as a whole safer and stronger. In
March, mandatory central clearing of certain swap transactions
began. More categories of swaps and an expanded universe of
financial institutions will be subject to central clearing
requirements as the year progresses, reducing risks to the
financial system and to the financial institutions engaging in
these transactions.
We are seeing continued strengthening of the equity, fixed
income, and housing markets. And implementation of the Dodd-
Frank Act and international coordination on G-20 reform
priorities have achieved significant progress toward
establishing a more resilient and stable financial system, both
domestically and globally.
On the topic of Dodd-Frank implementation, the Council and its
member agencies continue to steadily put reforms in place. The Council
will soon complete its initial evaluation of nonbank financial
companies for potential designation, which would lead to supervision by
the Federal Reserve Board (Federal Reserve) and enhanced prudential
standards. The Council has already designated eight systemically
important financial market utilities for similar increased oversight.
The Federal Reserve issued a new framework for the consolidated
supervision of large financial institutions in December. The Federal
Deposit Insurance Corporation (FDIC) continued to implement the new
framework for the orderly liquidation authority. The Federal Reserve
and the FDIC are implementing provisions related to living wills by the
end of this year. Further, U.S. regulators are continuing to make
significant progress on implementing the Basel III accords to set
internationally agreed heightened capital and liquidity standards,
which are expected to be fully phased in by 2019.
The Securities and Exchange Commission (SEC) and the Commodity
Futures Trading Commission (CFTC) continue to fill in the remaining
pieces of a new comprehensive oversight framework for derivatives that
will reduce risk and increase transparency. The Consumer Financial
Protection Bureau finalized new mortgage rules that provide additional
protections for borrowers. And the Federal Housing Finance Agency
(FHFA) has taken steps to facilitate increased participation by the
private sector in the mortgage markets, including the recent
announcement of an effort to develop a common securitization platform
that will facilitate a more efficient and sustainable housing finance
infrastructure.
Despite these positive developments, there are still risks to U.S.
financial stability. The Council's report identifies those risks and
makes specific recommendations to mitigate them. The Council's 2013
report focuses on seven areas in particular:
First, market participants and regulatory agencies should
take steps to reduce vulnerabilities in wholesale funding
markets that can lead to destabilizing fire sales.
Second, significant reform in the housing finance system is
still needed.
Third, Government agencies, regulators, and businesses
should take action to address operational risks from internal
control and technology failures, natural disasters, and cyber-
attacks, which can cause major disruptions to the financial
system.
Fourth, as recent developments with the London Interbank
Offered Rate (LIBOR) have demonstrated, reforms are needed to
address the reliance on voluntary, self-regulated, and self-
reported reference interest rates.
Fifth, financial institutions and market participants
should be cognizant of interest rate risk, particularly given
the historically low interest rate environment of the past few
years.
Sixth, long-term fiscal imbalances that have potential
economic and financial market impacts should be addressed.
Finally, regulators need to continue to keep a close eye on
potential threats to U.S. financial stability from adverse
developments in the global economy.
I would now like to go into each of these areas in more depth.
Key Areas of Focus of the 2013 Annual Report
Wholesale Funding Markets
The Council remains concerned that vulnerabilities in wholesale
funding markets could lead to destabilizing fire sales. Specifically,
run-risk vulnerabilities related to money market mutual funds (MMFs),
which became apparent during the financial crisis, still remain,
despite an initial set of reforms implemented in 2010. In November
2012, the Council issued proposed recommendations for public comment to
implement structural reforms of MMFs to reduce the likelihood of runs.
Council members should also examine whether similar reforms are
warranted for other cash management vehicles.
Vulnerabilities to fire sales also remain in the tri-party repo
market, particularly with respect to borrowers such as securities
broker-dealers. The Council's report recognizes the positive steps that
have been taken in the last year to reduce the reliance on
discretionary intraday credit, but recommends coordinated efforts by
market participants and financial regulatory agencies to address the
risks associated with the tri-party repo market, notably by better
preparing investors and other market participants to deal with the
consequences of the distress or default of a dealer or other large
borrower.
Housing Finance Reform
The housing finance system requires significant reform to enhance
financial stability and facilitate the proper functioning of
residential lending markets. The residential mortgage market still
relies heavily on Government support, while private mortgage activity
remains muted. The Administration has long called for winding down the
GSEs as part of comprehensive housing finance reform and remains
focused on bringing back private capital into the market. Although
progress was made in 2012, including finalization of some key mortgage
rules, the completion of additional reforms is needed to add clarity to
the market and attract more private capital. Specifically, the Council
recommends that the FHFA continue to pursue changes such as a common
securitization platform, model legal agreements, improvements to the
mortgage recordation and title transfer system, and an improved
compensation system for mortgage servicers.
Operational Risks
The Council remains concerned about operational risks stemming from
certain types of trading activities, natural disasters, and
cybersecurity threats. Trading activity is becoming more dispersed and
automated, raising concern among Council members about operational
failures. The extremely high speeds at which markets operate can
compound the overall impact of even small operational failures. In
2012, equity markets experienced a number of control problems,
including those related to the initial public offerings of BATS and
Facebook, and losses by Knight Capital. The SEC has moved to strengthen
the automated systems of important market participants, and the Council
recommends that regulators continue to monitor the adequacy of internal
control and corporate governance processes of financial institutions
and market utilities.
Additionally, Superstorm Sandy tested the financial infrastructure,
including critical financial utilities, demonstrating the need for
regulators to assess their policies and guidance in the area of
contingency planning. Cybersecurity also continues to be a central
concern, with financial institutions subject to frequent and varied
cyber attacks. The Council recommends that senior management at
financial institutions remain engaged on these issues, improve
communication within and between firms, and that Government agencies
enhance information sharing between the public and private sectors.
However, only so much can be done without comprehensive cybersecurity
legislation that allows for enhanced information sharing while
addressing legitimate privacy and liability concerns. I am hopeful that
continued bipartisan engagement will produce legislation that addresses
these critical issues.
Reference Interest Rates
Over the past year, the Council has actively monitored developments
related to LIBOR and other reference interest rates and their potential
impact on financial stability. The combination of a weak governance
structure and a small number of actual transactions in the unsecured,
interbank lending market underpinning LIBOR reduce market integrity and
raise financial stability concerns.
Investigations by regulators and law enforcement agencies across
the globe concerning manipulations and false reporting of LIBOR and
similar rates have exposed the structural vulnerabilities of these
benchmarks, which provide significant incentives for misconduct.
The Council recommends that U.S. regulators cooperate with foreign
regulators, international bodies, and market participants to promptly
identify alternative interest rate benchmarks that are anchored in
observable transactions and are supported by appropriate governance
structures, and to develop a plan to transition to new benchmarks. The
Council recommends that steps be taken to promote a smooth and orderly
transition to alternative benchmarks, with consideration given to
issues of stability and to mitigation of short-term market disruptions.
Interest Rate Risk
Yields and volatility in fixed-income markets are very low by
historical standards, which may be providing incentives for market
participants to ``reach for yield'' by investing in lower-grade credit,
investing in longer-maturity assets, or increasing leverage.
Yield-seeking behavior is apparent in several markets. The issuance
of high-yield bonds reached a historical high in the fourth quarter of
2012. While underwriting standards remain conservative in many markets,
there are some examples of loosening standards. In particular, certain
real estate investment trusts, which are highly exposed to a rise in
interest rates, have grown considerably in recent years. The report
makes specific recommendations to regulators and risk managers of
banks, broker-dealers, insurance companies, and pension funds to be
vigilant and scrutinize how potential changes in interest rates could
adversely affect their risk profiles.
Impacts of Fiscal Policy
The strength of our financial system ultimately depends on the
strength of our economy. Over the last several years, political fights
over fiscal policy in Washington--including the debt ceiling crisis in
2011 and failure to come to bipartisan agreement on a balanced package
to replace the sequester as required by the Budget Control Act--have
hurt confidence, which is a key driver of economic activity. The
sequester that went into effect earlier this year was intended to be a
policy so painful and mutually disagreeable that it would ensure
bipartisan action to replace it, but instead, the harsh and
indiscriminate across-the-board spending cuts were triggered, creating
a self-inflicted drag on economic growth and job creation. According to
the nonpartisan Congressional Budget Office, sequestration will shave
off more than half a percent of economic growth in 2013 and cost as
many as 750,000 full-time equivalent jobs. To guard against future
threats to our economy and financial stability, policymakers should
avoid using last-minute resolutions to fiscal policy matters such as
the debt ceiling and deficit reduction as a negotiating tactic.
It is important to note that since 2011 the President and Congress
have ultimately been able to come together to enact a series of
agreements that have resulted in historic reductions to our budget
deficits. Taken in combination, these bipartisan reforms--not counting
the effect of sequestration--have locked in more than $2.5 trillion in
deficit reduction over the next 10 years, with more than two-thirds of
that reduction coming from spending cuts. And today, because of these
policies and other factors, the deficit is falling at the fastest rate
in decades. Now, while more can and should be done to reduce the risk
of long-term fiscal imbalances through sensible measures, shrinking the
budget deficit cannot be the only focus of fiscal policy. Job creation
and economic growth have to be a top priority.
Global Economic and Financial Developments
Although external financial threats appear to have decreased over
the past year, they remain a risk to U.S. financial stability and
economic activity. Global demand has slowed and the euro area economy
is on course to contract for the second year in a row. In the advanced
economies, there is a need to recalibrate the pace of fiscal
consolidation to promote economic growth and employment. Fiscal
sustainability remains a concern, but is much easier to achieve in a
growing economy. The lack of demand rebalancing also remains a risk to
the U.S. economy. China, for example has avoided an abrupt slowdown,
but concerns persist about its ability to transition away from its
export and investment-driven growth model toward increased domestic
consumption. Nevertheless, Council members and member agencies will
continue to monitor global economic and financial developments to
respond to any threats that may arise.
In addition to those seven key areas that the Council has focused
on, I would now like to spend a little time describing the Council's
work over the last year and the progress that has been made on
financial reform.
Activities of the Council
Since its 2012 annual report, the Council has continued to fulfill
its core mission. The Council met 12 times in 2012 to discuss and
analyze emerging market developments, threats to financial stability,
and financial regulatory issues. There were public sessions at three of
those meetings. Through regular meetings of the Council and its staff
committees, the Council plays an important role in facilitating
coordination among Federal and state financial regulators.
The Council is working to evaluate nonbank financial companies for
potential designation for supervision by the Federal Reserve and
enhanced prudential standards. The Council publicly announced that, in
September and October 2012, it advanced an initial set of nonbank
financial companies to the third and final stage of the evaluation
process. The Council discussed its ongoing analysis at its most recent
meeting on April 25, and it expects to vote on proposed designations of
an initial set of nonbank financial companies in the near term.
The Council is also authorized to issue recommendations to a
regulatory agency when financial activities and practices are creating
risk for U.S. financial markets. In November 2012, the Council issued
for public comment proposed recommendations to the SEC with three
alternatives for reform to address the structural vulnerabilities of
MMFs. The Council is currently considering the public comments on the
proposed recommendations. If the SEC moves forward with meaningful
structural reforms of MMFs before the Council completes its process,
the Council expects that it would not issue a final recommendation to
the SEC. However, if the SEC does not pursue additional reforms that
are necessary to address MMFs' structural vulnerabilities, the Council
should use its authorities to take action in this area.
Finally, the Council has authority to designate systemically
important financial market utilities for enhanced risk-management
standards. The Council designated eight systemically important FMUs
last summer, and those entities are now subject to increased oversight
by the SEC, CFTC, and Federal Reserve.
Progress on Financial Regulatory Reform
The annual report also discusses the significant progress that
Council members and member agencies, both individually and
collectively, have made implementing Dodd-Frank Act reforms. As a
result of these activities, consumers have access to better information
about financial products and are benefiting from new protections.
Financial markets and companies have become more transparent. And
regulators have become better equipped to monitor, mitigate, and
respond to threats to the financial system.
Since the Council's 2012 annual report, Dodd-Frank Act
implementation included further strengthening of supervision, capital,
and risk-management standards for financial institutions and financial
market utilities; procedures for stress tests of financial
institutions; rulemakings related to the orderly liquidation authority;
regulation of the derivatives markets to reduce risk and increase
transparency; new standards to protect mortgage borrowers and reduce
risks in the mortgage market; and other measures to enhance consumer
and investor protection.
Nevertheless, important work remains to complete the implementation
of financial reform. The Council, its members, and its member agencies
will continue to strengthen coordination of financial regulation both
domestically and internationally. In developing and implementing the
international financial regulatory reform agenda, the Council members
support the development of policies that promote a level playing field,
mitigate regulatory arbitrage, and address regulatory gaps primarily
through members' engagement with the G-20 and the Financial Stability
Board (FSB). In particular, the Council is focused on:
Strengthening the regulation of large, complex financial
institutions. The Council supports global efforts led by the
FSB, to impose consistent standards on large, complex financial
institutions across jurisdictions.
Developing an international framework to resolve global
financial institutions. Effective cross-border cooperation will
be essential to implementing the FDIC's orderly liquidation
authority under Title II of the Dodd-Frank Act. The United
States has substantially satisfied the FSB's Key Attributes of
Effective Resolution Regimes for Financial Institutions, and
continues to work with international counterparts to ensure
robust resolution coordination.
Increasing the transparency and regulation of over-the-
counter (OTC) derivatives. The Council encourages continued
development of these reforms, as they are essential to increase
transparency and to mitigate risk, including cross border
spillovers, that could arise from the OTC derivatives market.
The FSB has been critical to facilitating international
coordination on this issue.
Data resources and analytics. The Council continues to
recommend that improvement in data standards should be a high
priority for financial firms as part of their risk management
process and for the regulatory community--not just in the
United States, but globally. The Council recommends that the
Office of Financial Research continue to work with the
Council's member agencies to promote data standards for
identification of legal entities, financial products, and
transactions, and to improve access to standardized, aggregate
data by the regulators. The Council also recommends that cross-
border exchange of supervisory data among supervisors,
regulators, and financial stability authorities continues to be
facilitated in a manner that safeguards the confidentiality and
privacy of such information.
Conclusion
The actions of the Council and its member agencies have made the
financial system more stable and less vulnerable to future economic and
financial stress. The Council will continue to focus on the risk areas
I have discussed today, while remaining vigilant to new risks, to
promote financial stability and strengthen the U.S. financial system.
I want to thank the other members of the Financial Stability
Oversight Council, as well as the staff of the members and their
agencies, for the work they have done over the past year and their
efforts in preparing the 2013 annual report.
We look forward to working with this Committee, and with Congress
as a whole, to continue to make progress in creating a more resilient
and stable financial system.
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RESPONSE TO WRITTEN QUESTIONS OF CHAIRMAN JOHNSON FROM JACOB J.
LEW
Q.1. Last year, FSOC used its Wall Street Reform powers to
propose money market fund reform recommendations to the SEC. It
is expected that the SEC will take action on money market funds
the week of June 5th. Does FSOC expect to do more regarding
money market funds?
A.1. As noted in the Council's Proposed Recommendations
Regarding Money Market Mutual Fund Reform, the SEC, by virtue
of its institutional expertise and statutory authority, is best
positioned to implement these reforms. We commend the SEC for
continuing the work to address remaining vulnerabilities to our
financial system presented by MMFs. I don't want to prejudge
the outcomes of the administrative procedures process, and I
encourage public comment on the proposals.
Q.2. Regarding the low interest rate environment, what steps
are FSOC and its member agencies taking with regulated entities
to ensure that the appropriate risk management controls are in
place if there is a sudden rise in rates or a widening of
credit spreads?
A.2. The Council's 2013 annual report makes a number of
recommendations to regulators and risk managers of banks,
broker-dealers, insurance companies, and pension funds to be
vigilant and scrutinize their risk management practices
concerning interest rate risk. With respect to banks and
broker-dealers, the report recommended that regulatory agencies
and private sector risk managers should scrutinize whether
potential sudden changes in interest rates could adversely
affect the risk profiles of financial firms. For insurance
companies, the report said that the Federal Insurance Office
and State insurance regulators should continue to monitor the
interest rate risk of insurance companies, and State insurance
regulators should continue to ensure that the interest rate
risk scenarios run by insurance companies are sufficiently
robust and appropriately capture these and other economic
risks. The Council also recommended that the appropriate
authorities continue to examine how a prolonged period of low
interest rates has affected risk management practices and
preparedness of pension funds in the event of a sudden reversal
of these historic trends.
The Council's Systemic Risk Committee, as part of its
ongoing work, will continue to work with its members to monitor
this threat in addition to the activities undertaken in
response to the Council's recommendations.
Q.3. The 2012 FSOC annual report identified the euro area
crisis as one of the major threats to financial stability, with
large U.S. financial institutions being highly interconnected
with euro area banks and bearing a high degree of exposure to
European markets. The report noted that such interconnectedness
exposed U.S. financial institutions to contagion and spillover
effects from a systemic event in the euro area. The 2013 FSOC
annual report does not identify the euro area crisis as a major
threat to financial stability noting that such threats
decreased in 2012, but the euro area crisis is far from
resolved. Why does the FSOC view the euro area crisis as less
of a threat to U.S. financial stability? What measures has FSOC
or individual agencies taken to reduce such exposures of U.S.
institutions to contagion from a systemic event in the euro
area?
A.3. Europe is in a more stable position today because the
European Central Bank and euro area leaders have demonstrated
their shared commitment to stand behind the euro, and have put
in place a powerful set of financial tools in support of member
states undertaking difficult reforms. Nonetheless, risks remain
in some eurozone countries where unemployment is high and
reforms will take some time to complete.
As our largest economic partner, Europe is an important
source of investment and jobs for the United States, and our
recovery has been affected by headwinds from the euro area.
Europe's financial crisis has curbed demand for exports from
the United States, reduced foreign direct investment (FDI) at
home, and adversely affected the retirement savings of American
workers. Direct U.S. financial sector exposure to the countries
in the euro area with IMF programs, such as Greece, is limited,
although it is difficult to estimate all possible exposures to
the euro area more broadly.
As a result of the significant actions we took after the
crisis, particularly ensuring that our banks have strong
capital bases and improving our regulatory systems, our
financial system is better prepared to handle a Europe-driven
financial shock or shocks from other external sources.
Furthermore, many U.S. financial institutions, including our
major banks and money market funds, have substantially reduced
their exposure to the European economies most under pressure.
Direct money market exposure to banks in peripheral Europe has
been effectively eliminated. Finally, U.S. regulators are in
active dialogue with U.S. financial institutions to not only
ensure that financial exposures to Europe are being monitored
appropriately, but to also improve their ability to withstand a
variety of possible financial contagion stress scenarios
emanating from Europe.
The Financial Stability Oversight Council (FSOC) and its
member agencies will continue to carefully monitor the
potential risks that could emerge from the peripheral European
sovereign debt crisis.
Q.4. The 2013 FSOC report noted progress on two of the three
key vulnerabilities in the tri-party repo market--intraday
credit and risk management. It also highlights fire sales in
the aftermath of a broker-dealer failure as a major
vulnerability. What steps are the FSOC and its member agencies
planning to take to address and mitigate risks from fire sales?
A.4. The Council's 2013 annual report recognizes that a major
broker-dealer's default could threaten financial stability as
the broker-dealer's creditors liquidate the collateral pledged
against their tri-party repo lending. The fire sales of this
collateral could destabilize financial markets and amplify the
negative consequences of such a default. Reforms made since the
financial crisis, such as higher capital and liquidity
requirements, a significant reduction in intraday credit
provided to broker-dealers by clearing banks, and other
operational improvements, have reduced the risk of a dealer
default. However, the Council urged continued coordinated
efforts by market participants and financial regulatory
agencies with relevant authority to address the remaining risks
associated with the tri-party repo market, particularly a
potential fire sale of sizable collateral by lenders in
reaction to the default of a large broker-dealer borrower. The
report recommended better preparing investors and other market
participants to deal with the consequences of a dealer's or
other large borrower's distress or default.
Q.5. Please discuss FSOC's analysis of the short-term wholesale
funding market as a potential systemic risk. Is there inter-
agency coordination of rules and reforms underway, such as MMF
reform, tri-party repo reform, enhanced capital & liquidity
requirements, and others, to help mitigate the risks if it is a
concern?
A.5. The Council's 2013 annual report explains how, although
many of the least-stable funding structures that failed in the
crisis have disappeared, important risks associated with
wholesale funding markets remain. In particular, run risks in
sectors such as money market mutual funds (MMFs) and broker-
dealers continue to persist.
In the past year, the Council took concrete steps in
supporting the implementation of structural reforms to reduce
the likelihood of run risks of MMFs by issuing proposed
recommendations for reform under Section 120 of the Dodd-Frank
Act.
On June 5, 2013, the SEC approved a notice of proposed
rulemaking for MMF reform that contained elements of the
Council's recommendation. The Council will actively monitor the
SEC's progress implementing these necessary reforms to
determine whether further Council action may be necessary to
adequately mitigate the run risk described in the Council's
2013 annual report.
Similarly, there has been some progress in reforming the
tri-party repo market and increasing the resiliency of that
market. The reliance on intraday credit extended by the
clearing banks has begun to decline, and as additional changes
are made to the settlement process this reliance should be
largely eliminated by the end of 2014.
The Council's work related to wholesale funding markets is
a good example of the Council's collaborative approach, as it
works with its members and member agencies to implement and
coordinate reforms to short-term funding markets.
Q.6. Please describe how the Office of Financial Research is
fulfilling its analytical support role for FSOC as envisioned
by the Wall Street Reform Act.
A.6. The OFR has been active in providing key data and analysis
that have supported the Council's work. These activities have
included and will continue to include:
LSupplying data and analysis for the work of the
Council and its Nonbank Financial Company Designations
committee, including calculation and analysis of
threshold metrics for Stage 1 of the Council's nonbank
financial company designations process, and analysis of
the asset management industry;
LSupporting the Council's Systemic Risk Committee by
reporting regularly on developments in financial
markets and activities, in financial stability
measures, and in macroeconomic indicators;
LAcquiring, managing, protecting, and securely
making available to the Council and to its own
researchers data needed for assessing and monitoring
threats to financial stability;
LLeading meetings of and supporting the Council's
Data Committee and associated work regarding data gaps
and data standards;
LProviding data, analysis, and staff support for
producing the Council's 2013 annual report; and
LConducting in-depth analysis and reporting on risks
related to short-term funding markets, money market
funds, credit default swaps, and other areas.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR CRAPO FROM JACOB J.
LEW
Q.1. In a September 2012 report, GAO recommended that the
Secretary of Treasury take 10 specific actions to improve the
accountability and transparency of the FSOC. As the FSOC
Chairman, what specific steps have you taken to address GAO's
recommendations?
A.1. The GAO's report made a number of constructive
recommendations on ways in which the Council could further
enhance its transparency, including improving the Council's Web
site. Subsequently, the Council's Web site was reintroduced, in
December 2012, to improve transparency and usability, to
improve access to Council documents, and to allow users to
receive email updates when new content is added. Additionally,
the Council will continue to refine the appropriate approach in
balancing its responsibility to be transparent with its central
mission to monitor emerging threats to the financial system.
Council members frequently discuss supervisory and other
market-sensitive data during Council meetings, including
information about individual firms, transactions, and markets
that require confidentiality. In many instances, regulators or
firms themselves provide nonpublic information that is
discussed by the Council. Continued protection of this
information, even after a period of time, is often necessary to
prevent destabilizing market speculation or other adverse
consequences that could occur if that information were to be
disclosed.
The Council also took into account the GAO's
recommendations during the drafting of the Council's 2013
annual report, including by more clearly articulating the
Council's intent to assign responsibility for acting on
recommendations to specific member agencies. Where applicable
and appropriate within the Council's authority, timeframes were
also included.
The GAO also recommended that the Council adopt a more
formal and quantitative approach to identifying risks to
financial stability. The Council's Systemic Risk Committee has
worked with the OFR to develop a monitor of key financial and
economic data and to highlight areas of potential concern.
The Council will continue to examine and refine, as
appropriate, its governance and other processes to ensure it is
operating efficiently and effectively.
Q.2. The FSOC 2013 Annual Report states ``The SEC, by virtue of
its institutional expertise and statutory authority, is best
positioned to implement reforms to address the risks that money
market funds present to the economy.'' It is my understanding
that the SEC is likely to propose additional money market fund
reforms this summer. At that time, how will the FSOC make it
clear that it will take no further action on money market
funds?
A.2. We commend the SEC for continuing the work to address
remaining vulnerabilities to our financial system presented by
MMFs. We don't want to prejudge the outcomes of the
administrative procedures process, and we encourage public
comment on the proposals. If the Council elects not to issue a
final Section 120 recommendation, it will consider what, if
any, public comment is appropriate at that time.
Q.3. GAO has recommended that FSOC prioritize the threats to
the financial system that are identified in its annual reports.
However, none of the FSOC annual reports provide any such
prioritization. As FSOC Chairman, what do you believe are the
top two or three threats to U.S. financial stability?
A.3. In its 2013 annual report, the Council organized its
recommendations around a framework of seven specific themes
that require attention. First, market participants and
regulatory agencies should take steps to reduce vulnerabilities
in wholesale funding markets that can lead to destabilizing
fire sales. Second, significant reform in the housing finance
system is still needed. Third, government agencies, regulators,
and businesses should take action to address operational risks
from internal control and technology failures, natural
disasters, and cyber-attacks, which can cause major disruptions
to the financial system. Fourth, as recent developments with
the London Interbank Offered Rate (LIBOR) have demonstrated,
reforms are needed to address the reliance on voluntary, self-
regulated, and self-reported reference interest rates. Fifth,
financial institutions and market participants should be
cognizant of interest rate risk, particularly given the
historically low interest rate environment of the past few
years. Sixth, long-term fiscal imbalances that have potential
economic and financial market impacts should be addressed.
Finally, regulators need to continue to keep a close eye on
potential threats to U.S. financial stability from adverse
developments in the global economy.
These seven themes represent the risk areas most in need of
attention in the coming year, based on the Council's collective
judgment.
Q.4. The final rule describing the procedures that the Council
intends to follow when making nonbank SIFI determinations
states that the Office of Financial Research (OFR) is analyzing
the extent to which there are potential threats to U.S.
financial stability arising from asset management companies.
Will you commit to making that analysis public and allowing
public comment before FSOC takes any action based on the
results of that analysis?
A.4. The Council, its member agencies, and the Office of
Financial Research (OFR) are analyzing the extent to which
asset management companies may present potential threats to
U.S. financial stability. As part of this analysis, OFR staff
have met with market participants, including asset managers, to
learn more about their activities and business models. This
work is ongoing and the Council has not yet determined the
extent to which the research may be made public. However, were
the Council to determine that it would be appropriate to
develop additional metrics that would be used to identify asset
management firms for further evaluation and potential
designation, it intends to provide the public with an
opportunity to review and comment on any such metrics and
thresholds, in accordance with past practice.
Q.5. Does FSOC plan to make any recommendations to the Federal
Reserve for tailoring the prudential standards for nonbank
financial firms, such as asset managers, insurance companies
and broker-dealers? Do you believe that a Basel III capital
standard is a proper standard to be applied to nonbank
financial firms?
A.5. The Council is responsible for designating nonbank
financial companies for Federal Reserve supervision and
enhanced prudential standards. Section 165 specifically permits
the Federal Reserve to take into account differences among
nonbank financial companies under its supervision when
prescribing prudential standards. We expect that the Federal
Reserve will consider this discretionary authority when
finalizing its rulemaking.
Q.6. If the lack of international coordination on financial
reform measures leads to a protectionist backlash, does this
present a threat to the financial stability of the United
States?
A.6. Strong global coordination on financial reform is
occurring in the G-20, Financial Stability Board (FSB),
standard setting bodies, and among nations. The United States
has taken a leading role in an extensive international effort
to improve financial regulation around the globe, and Federal
banking and markets regulators are playing an important part in
coordinating this effort globally so that implementation across
national authorities is consistent and timely.
We support existing efforts by major financial centers in
Europe and Asia to adopt strong measures similar to our Dodd-
Frank Act and encourage further progress where needed to help
maintain a level playing field for U.S. firms and to reduce the
opportunity for regulatory arbitrage, while raising standards
globally. Without international consensus, we risk a race to
the bottom.
Just as we have international standards for capital
requirements for banks, we have proposed establishing global
standards for margin requirements for over-the-counter
derivatives, and this work is underway among the G-20. Uniform
margin requirements will provide buffers against future shocks,
while supporting a level playing field.
A protectionist backlash could lead to reduced cross-border
capital flows and less than optimal economic growth.
International coordination is essential to avoid this outcome.
Q.7. While you were at the White House, you had the opportunity
to look into the Department of Labor's (DOL's) Employee Benefit
Security Administration's (EBSA's) proposed change to the
definition of fiduciary. DOL is currently working on its
planned re-proposal. Among the items lacking in the original
proposal was a comprehensive cost-benefit analysis. In
addition, the rule proposal by the EBSA has significant
ramifications for all Individual Retirement Accounts (IRAs),
including those that are not employee benefits. As you know,
the IRA is a retirement tax account overseen by the IRS. As
Treasury Secretary, will you cede IRS authority and oversight
of IRAs to DOL in light of the fiduciary rule proposal? As FSOC
Chairman, how will you ensure that any DOL re-proposal contains
cost-benefit analyses for the new rule proposal as well as any
class exemptions issued in conjunction with the rule that
includes an assessment of the impact on the availability and
cost of investment advice, particularly in rural areas? How
will you ensure that any DOL re-proposal contains a cost-
benefit analysis that includes an assessment of the impact on
the Securities and Exchange Commission's ability to fulfill its
mission as the primary regulator charged with protecting
investors?
A.7. The Department of Labor (DOL), not the Treasury
Department, has the authority to define who is a fiduciary with
respect to retirement plans and IRAs. This definition applies
to both the ERISA Title I provisions enforced by DOL and to the
Internal Revenue Code. Accordingly, Treasury and DOL have
engaged in discussions regarding some aspects of the DOL's
original proposal. The two agencies will continue to be in
contact with one another regarding any re-proposal with respect
to the fiduciary definition, including any issues within IRS's
jurisdiction. My understanding is that DOL will continue to
coordinate with the Securities and Exchange Commission, the
Commodity Futures Trading Commission, and others as well to
ensure that rulemakings relating to investor protection are not
inconsistent or unduly burdensome. Questions concerning the
details of that coordination are best addressed to DOL.
We also understand that DOL, in connection with its effort
to assess the costs and benefits of re-proposed regulations,
requested information from the financial services industry and
received somewhat limited data in response, and that it has
been in the process of assessing costs and benefits using all
available data.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR MENENDEZ FROM JACOB J.
LEW
Q.1. I was pleased to hear the HARP program was extended an
additional 2 years, through 2015. However, many of my
constituents are left out of the program because of the HARP
eligibility cutoff date of June 2009. The deadline has already
been changed once from March 2009 back to June 2009, and I
would say that the program extension itself represents a
substantive change that nullifies any perceived, ``Covenant
with Investors''. Can you explain the impact that an extension
of the HARP eligibility date would have on homeowners,
investors, and the overall housing market? Do you think leaving
the cutoff date as is, makes it appear that the FHFA weighs
investors? interests above borrowers, who contractually are
equals? What would be the benefits to the overall economy if we
let millions of responsible homeowners take advantage of
today's historically low interest rates by removing barriers to
HARP refinancing?
A.1. The enhancements to HARP have made a significant impact.
These changes were designed to simplify eligibility and
valuation requirements, make deeply underwater borrowers (above
125 percent LTV) eligible for refinancing, lower the fees
associated with refinancing, harmonize representation and
warranty standards, and resolve mortgage insurance concerns.
Since the program's inception in 2009, nearly 2.5 million
homeowners have lowered their monthly payments by refinancing
through HARP. The continued high volume of HARP refinances is
attributed to record-low mortgage rates and the program
enhancements implemented in 2012.
The Administration is committed to ensuring that all
responsible homeowners have the opportunity to refinance and
take advantage of today's low interest rates. As you know, the
President has called for broad-based refinancing to provide
access for all borrowers who are current on their payments to
refinance without the many barriers currently faced by
homeowners including underwater borrowers. Since many borrowers
who purchased their homes within the past 4 years have built up
positive equity, they should be able to refinance without a
program such as HARP that was designed to help underwater
borrowers.
Q.2. In April, I held a hearing on the foreclosure abuses that
have, and continue, to go on. I was pleased to see the CFPB
adopted new rules on mortgage servicing standards in January
2013. I have long advocated for increasing consumer protections
on borrowers before foreclosures, encouraging loan
modifications, eliminating dual tracking, placing limits on
foreclosure fees, and creating an appeals process for those
denied loan modifications as well as a mediation program. In
the FSOC report, you note that this rulemaking, along with
others, is critical to improving mortgage origination. Can you
explain how these mortgage servicing standards impact the
housing market, mortgage originations, and the overall economy?
A.2. As you know, in its 2012 Annual Report, the FSOC
recommended that ``the FHFA, HUD, CFPB, and other agencies, as
necessary, develop comprehensive mortgage servicing standards
that require consistent and transparent processes for consumers
and promote efficient alternatives to foreclosure where
appropriate.''
In January 2013, the Consumer Financial Protection Bureau
(CFPB) issued mortgage-servicing standards for bank and nonbank
mortgage servicers. Some of the changes were specifically
mandated by Dodd-Frank, but many were a response to improper,
and in some cases illegal, default-servicing practices,
observed following implementation of the Administration's
foreclosure prevention efforts in early 2009. The CFPB
standards were modeled in part on the standards set by
Treasury's Making Home Affordable Program, which also served as
a basis for the National Mortgage Settlement standards.
The national mortgage servicing standards being implemented
by CFPB and prudential banking regulators will align incentives
and provide clarity and consistency to borrowers and investors.
Q.3. As you know, in April, I held a Subcommittee hearing on
the settlements that stemmed from the major mortgage servicer
foreclosure abuses. It seems as though the consumers are
getting the short end of the stick, while the major banks are
continuing to see record profits. We know the Independent
Foreclosure Review was a failure, and there are reports that
homeowners are not getting the ``consumer relief'' that the
regulators anticipated with the National Mortgage Settlement.
Can you tell me what you will do to ensure these borrowers are
finally placed at the front of the line? What do you plan to do
get more money into the hands of these borrowers?
A.3. Treasury shares your commitment to ensuring that all
Government foreclosure prevention programs reach eligible
borrowers in need of assistance. Toward that end, we recently
extended the Making Home Affordable Program (MHA) until
December 31, 2015, and continue to work with States in
Treasury's Hardest Hit Fund program to make sure relief is
provided while the need is still great.
Treasury supports the objectives of the National Mortgage
Settlement and the Independent Foreclosure Review; however, we
are not involved in monitoring the compliance or implementation
of these programs. While Treasury did provide technical
assistance on MHA mortgage servicer compliance during the
negotiations of the National Mortgage Settlement, Joseph Smith,
the Monitor of the National Mortgage Settlement, is responsible
for compliance, monitoring, and enforcement of the agreement.
Q.4. What can be done to improve the Financial Stability
Oversight Council's identification of both the financial risks
facing the American people and solutions to lessen those risks?
A.4. The Council's assessment of threats to the financial
system is a collaborative process, driven by review of the best
information available from the markets, institutions, industry,
academia, and expertise from Council members and their
respective agencies and staffs. Council members have been and
continue to be highly engaged in assessing emerging threats and
vulnerabilities.
The Council committee structure includes a standing
Systemic Risk Committee established to identify, analyze, and
monitor vulnerabilities in the financial system and emerging
threats to stability. This committee, which is composed of
staff of Council members and their agencies with supervisory,
examination, data, surveillance, and policy expertise, gathers
information from Council members and their agencies to assess
risks that affect financial markets and institutions. The
Systemic Risk Committee is responsible for interagency
coordination and information sharing regarding issues that
could affect financial stability, and reports to the Council's
Deputies Committee. Also, as noted above, the Council's annual
report is a product of the Council's risk-monitoring function.
It reflects the ongoing work of the Systemic Risk Committee and
the collective judgment of the members of the Council.
The Council is also supported by the Office of Financial
Research (OFR), which was created by the Dodd-Frank Act to
improve the quality of financial data available to
policymakers, and to develop better tools and analysis to
understand the risks in the financial system. The Council's
Systemic Risk Committee has worked with the OFR to develop a
monitor of key financial and economic data and to highlight
areas of potential concern, and it continues to be refined. The
monitoring tool, now known as the OFR Markets Monitor, is
shared across Council members and member agencies and provides
a systematic approach to sharing key financial risk indicators.
The Council continually seeks ways to improve how it
identifies and acts on risks to financial stability.
Q.5. In October, Superstorm Sandy hit the coast of New Jersey,
eventually leaving nearly 6 million people in 16 States without
power, and taking the lives of many Americans. As a result of
the storm, your report identified a few areas of improvement to
strengthen business continuity and resiliency. You found that
clear communication between market participants, at all levels,
is essential to strengthening resiliency. You also found that
the proper planning and testing of contingency systems, key
operations, and personnel would enhance the reliability of our
markets. Can you detail some of the deficiencies that were
found, and what role you play in ensuring these recommendations
are followed?
A.5. The 2013 FSOC Annual Report identified several areas where
further improvements in the resiliency and business continuity
of individual financial institutions would strengthen the
financial system. The sector would benefit from further
development and coordination of protocols for determining if
and when to open or close markets and if and when to deploy the
use of back-up sites. Similarly, institutions should continue
to develop and implement business continuity plans that take
personnel considerations into account. Expanded planning and
testing, involving major market participants as well as
financial market utilities and providers of services from other
sectors, would enhance reliability and market-wide confidence
in back-up systems. Continual assessment of cross-industry and
cross-sector interdependencies will further ensure reliable
redundancy. The Treasury, in its capacity as the Sector-
Specific Agency for the Financial Sector and as Chair of the
Financial and Banking Information Infrastructure Committee,
will continue to engage with industry and government partners
to address these necessary improvements. Additionally, the
Federal financial regulators are working with financial
institutions to increase the resiliency of the sector.
Q.6. The National Housing Trust Fund was authorized in 2008,
and the law called for the Trust Fund to be funded by
contributions from Fannie Mae and Freddie Mac (the GSEs).
However, the GSEs went into conservatorship shortly after the
Trust Fund was authorized, and FHFA temporarily suspended the
contributions due to the financial conditions experienced by
the GSEs at the time. The GSEs have reported profits for
several consecutive quarters. Given this return to
profitability, will FHFA be directing the GSEs to start making
contributions to the National Housing Trust Fund? If not, why
not? Do you have the legal authority to continue suspending the
payments considering that the GSEs are now profitable?
A.6. It is more appropriate for FHFA to answer this question.
FHFA is an independent regulator, and, as conservator of Fannie
Mae and Freddie Mac, is exclusively responsible for making
decisions related to their operations, including whether to
fund the National Housing Trust Fund.
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RESPONSE TO WRITTEN QUESTIONS OF SENATOR MERKLEY FROM JACOB J.
LEW
Volcker Firewall
Q.1. Nearly 3 years since Dodd-Frank became law, the Volcker
Firewall and many other key reform provisions are still not
final and in effect.
Please provide an update on your coordination activities
relating to the Volcker Firewall and identify any obstacles to
issuing a final rule in the near term.
A.1. Since the issuance of the Council's study on the Volcker
Rule in January 2011, Treasury has been working hard to fulfill
the statutory mandate to coordinate the regulations issued
under the Volcker Rule. Although not a rule-writing agency,
Treasury has been focused on achieving a consistent rule across
the five rulemaking agencies. Treasury is working with the
rulemaking agencies to review the 18,000 public comments and
finalize the rules. As I have said publicly, the Volcker Rule
is a particularly important priority to complete this year. I
will continue to push for swift completion of a rule that keeps
faith with the intent of the statute and the President's
vision.
Trade
Q.2. Recent news reports indicate that some are pressing trade
negotiators in the United States and Europe to include
financial regulation as a major topic of upcoming trade
negotiations between the United States and Europe.
Considering the important work already underway at the
Financial Stability Forum, the Basel Committee, and other
international financial regulatory cooperation venues, do you
believe that trade agreements should be used for the
international coordination of financial regulations and
regulators, or remain focused on the traditional matters of
market access for trade in goods and services? Are you
committed to ensuring that any provisions included in a trade
agreement do not undermine the independence and high standards
of U.S. financial regulation and regulators, including their
ability to make determinations regarding substituted compliance
of foreign regulatory systems or to establish prudent
regulation of foreign institutions operating in the United
States?
A.2. The United States and European Union have launched
negotiations on a Transatlantic Trade and Investment
Partnership (TTIP). In these negotiations, as in all our free
trade agreements, the Administration intends to pursue robust
market access commitments for financial services.
Prudential and financial regulatory cooperation should
continue in existing and appropriate global fora, such as the
Financial Stability Board (FSB), the Basel Committee on Banking
Supervision, and the International Organization of Securities
Commissions, as well as through the G-20. We will continue this
ongoing, intensive process toward regulatory and prudential
convergence with ambitious deadlines, alongside the TTIP
negotiations. Our objective is to achieve consistent, robust
international standards similar to those embodied in our own
financial laws and regulations.
International
Q.3. During the financial crisis, 10 of the top 20 banks that
received Federal Reserve emergency lending assistance were
foreign financial institutions. Similarly, many of the
beneficiaries of the rescue of AIG were foreign financial
institutions. At the same time, the losses relating to AIG's
Financial Products unit and JPMorganChase's ``Whale''
demonstrated how quickly risks from overseas activities can
flow back to the United States. The collapse of Long-Term
Capital Management demonstrated similar lessons.
Do you believe that it is important for the United States
to maintain a strong regulatory floor for U.S. financial
institutions operating globally and for foreign financial
institutions operating in the United States, as well as work
with foreign regulatory counterparts to prevent weaknesses
emerging in foreign markets that could flow back to the United
States? Should this regulatory floor include the ability to
safely wind down failed financial firms?
A.3. Since finance is inherently borderless, strong and
consistent regulations at home and in foreign jurisdictions are
important to prevent regulatory arbitrage, and to protect
against vulnerabilities emanating from outside our borders that
could flow back to the United States.
The Dodd-Frank Act gives U.S. regulators the tools they
need to maintain strong prudential standards for U.S. financial
institutions and foreign financial institutions operating in
the United States. Further, international financial regulatory
reform commitments made by the members of the G-20 and
international peer reviews on implementation of these mutually
agreed reforms by the FSB mitigate financial vulnerabilities
emanating outside our country that could flow back to the
United States.
There is broad international agreement on the need to be
able to safely resolve large financial institutions that
operate internationally, and the United States has taken a
strong lead in this area by putting in place the Orderly
Liquidation Authority as part of the Dodd-Frank Act. The FDIC,
other regulators, and Treasury staff are closely engaged with
their foreign counterparts to build the capacity, mutual trust,
and strong communication networks necessary to make resolution
of large internationally active financial institutions
possible. This effort seeks to address all institutions,
whether those institutions are U.S. banks based domestically
and also operating overseas, or foreign banks that maintain
significant operations within our borders.
Emerging Systemic Risks
Q.4. Identifying emerging financial risks is one of the most
important obligations that Congress gave the FSOC. Given that
the regulators apparently only became aware of trading losses
and model manipulation in the London Whale case from public
news reporting, are you satisfied with the level of insight
FSOC and the regulators have into financial institutions and
financial markets, especially related to their trading
activities?
In my view, one of the important aspects of the proposed
Volcker Rule regulation is the data collection requirements
that will give regulators a view into the granular trading
risks that firms are taking firm-wide. Isn't it critical that
regulators get access to that data and knit together risks
across markets?
A.4. It is critically important that regulators have the data
and analytical tools to understand and mitigate the risks faced
by institutions and by the financial system and economy as a
whole. Regulators will receive significantly more and better
data as they continue to implement provisions of the Dodd-Frank
Act related to living wills, derivatives, the Volcker Rule, and
hedge fund activity, among others. This is also one of the
goals of the Office of Financial Research (OFR), which is
acquiring and making available to regulators and to the public,
more and better financial data. With better data and a more
substantial commitment of resources to research and analysis,
we can not only improve how supervisors do their jobs, but also
improve market discipline. The Council and its members,
supported by the work of the OFR, will continue to identify
areas where better data and more research offer the best
return.
Cost-Benefit Analysis
Q.5. Mr. Lew, given the slow pace of rulemaking coming out of
the agencies, are you concerned that agencies are increasingly
being subjected--by industry comments, by some at the agencies,
and ultimately by the courts--to cost-benefit analysis that is
so burdensome that it effectively strangles necessary financial
reforms? Are you committed to ensuring that independent
agencies have the necessary independence and judicial deference
to do the jobs that Congress directed them to do in the Dodd-
Frank Act and other legislation?
A.5. The costs of financial reform must be considered relative
to the cost of another financial crisis. It is important to
remember how close the financial system came to collapsing 5
years ago, the trillions of dollars of wealth destroyed, and
the millions of jobs and homes that were lost.
The financial regulators have made important strides in
issuing proposed and final rules for some of the most important
financial reforms. As required under the Administrative
Procedure Act, agencies solicit and review comments from the
public in order to fully understand a rule's impact. In going
through this process, regulators analyze and think through the
implications and dynamics of new rules.
The President has issued executive orders requiring
executive agencies to engage in an analysis of the costs and
benefits of economically significant regulations, and
encouraging the independent regulatory agencies to do the same.
At the same time, the independence of our financial regulators
is an important feature of our regulatory system. Consistent
with this independence, the individual agencies are best placed
to conduct the appropriate economic impact analyses that are
consistent with their legal mandates. We understand from OMB
that while independent agencies attempt to quantify costs and
benefits wherever possible, when this is not possible, this is
explained in qualitative terms.
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RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM JACOB J.
LEW
Q.1. How many applications for nonprofit status were approved
and how many applications were denied for conservative-leaning
groups between January 2010 and December 2012?
Q.2. How many applications for nonprofit status were approved
and how many applications were denied for liberal-leaning
groups between January 2010 and December 2012?
Q.3. What was the average time it took for the Determinations
Unit to complete processing applications for nonprofit status
that conservative-leaning organizations submitted to the IRS
between January 2010 and December 2012?
Q.4. What was the average time it took for the Determinations
Unit to complete processing applications for nonprofit status
that liberal-leaning organizations submitted to the IRS between
January 2010 and December 2012?
A.1.-A.4. As a general matter, Treasury oversees the IRS with
respect to matters of broad management and tax policy.
Treasury's longstanding practice, spanning administrations of
both political parties, is not to be involved in the details of
tax administration and enforcement.
With respect to your specific questions, a series of
independent reviews began in the weeks following the release of
the TIGTA May 14 report. The purpose of those reviews is to
determine exactly what happened at the IRS, and those reviews
are ongoing. A number of Congressional oversight committees--
including the Senate Committee on Finance, the Senate Permanent
Subcommittee on Investigations, the House Committee on Ways and
Means, and the House Committee on Oversight and Government
Reform--have initiated investigations. Those Committees have
held several hearings and received a substantial amount of
public testimony on some of the very same questions that you
raise. Additional hearings are scheduled, and Treasury and the
IRS have received and are responding to document requests. In
addition to Congress, TIGTA is now conducting a formal
investigation of the IRS, and the United States Justice
Department is conducting a criminal investigation. Treasury
fully supports the ongoing investigations.
------
RESPONSE TO WRITTEN QUESTIONS OF SENATOR VITTER FROM JACOB J.
LEW
Q.1. Secretary Lew, as a member of the Financial Stability
Board (FSB), what has been your involvement regarding the
designation of G-SIBs (global systemically important banks) and
in determining what nonbanks meet the G-SIFIs (global
systemically important financial institutions) distinction?
What will the process be for a firm who is not designated a
SIFI under FSOC but then gets labeled as such by the FSB? Do
you anticipate there being any discrepancies between a domestic
designation and a global one?
A.1. Treasury has been actively involved in the global
systemically important financial institution (G-SIFI)
designation process--which encompasses both G-SIBs and global
systemically important insurers (G-SIIs)--through its
representation on the FSB. Both the FSB and national
authorities, in consultation with the relevant global standard
setters, determine which nonbanks are designated as G-SIFIs, as
well as which banks are designated as G-SIBs. It is up to
national authorities to implement FSB recommendations, and they
have several years to do so.
Treasury is taking a constructive leadership role in
shaping the international designation process for G-SIFIs.
Through the G-20, FSB, and global standard setting bodies, we
are working with our international counterparts to promote
alignment of the Council and international G-SIFI
identification and designation processes such that they remain
consistent, in both the timing of the decisions and the key
substantive judgments made in each process. We aim to set a
high regulatory standard and to provide a level playing field
that will both protect the United States and allow U.S.
financial companies to compete fairly around the world.
Q.2. Secretary Lew, much attention has been given to the
insurance industry and the possibility that several of the
largest insurers could be designated systemically significant,
despite the fact that their capital structure is wholly
different from banks. How do you establish an identical regime
for all SIFIs, both banks and nonbanks, which include minimum
capital and liquidity standards, in addition to counterparty
credit exposure limits?
A.2. The Council's responsibility to consider whether a nonbank
financial company could pose a threat to U.S. financial
stability and should be subject to Federal Reserve supervision
and enhanced prudential standards is set forth in Section 113
of the Dodd-Frank Act. The Federal Reserve Board is responsible
for promulgating rules, such as enhanced prudential standards,
applicable to designated nonbank financial companies. Section
165 of the Dodd-Frank Act authorizes the Federal Reserve to
take into account differences among nonbank financial companies
under its supervision when prescribing prudential standards. We
expect that the Federal Reserve will consider this
discretionary authority while finalizing its rulemaking.
Q.3. Secretary Lew, wouldn't it be prudent to establish stress
tests for insurance company SIFIs under a unique (as opposed to
bank) set of standards?
A.3. The Council is responsible for designating nonbank
financial companies for Federal Reserve supervision and
enhanced prudential standards. Section 165 of the Dodd-Frank
Act authorizes the Federal Reserve to take into account
differences among nonbank financial companies under its
supervision when prescribing prudential standards. We expect
that the Federal Reserve will consider this discretionary
authority while finalizing its rulemaking.
Q.4. Secretary Lew, since this Committee is currently
considering the nomination of Fred Hochberg to be Chairman of
the Ex-Im Bank, and given the response to my question for the
record for Fred Hochberg's confirmation hearing below, what
assurances can you give this committee that you and Chairman
Hochberg will work together to actually begin discussions with
the European Export Credit Agencies to substantially reduce or
eliminate export credit financing for wide body aircraft? Can
you please explain to us what your plan is to comply with the
requirement in the 2012 Reauthorization Act, especially as the
Administration begins its wider discussions with the EU on an
U.S.-EU Free Trade Agreement?
Vitter QFR to Hochberg and Hochberg Answer:
Q. The last Ex-Im Bank reauthorization required the Department
of the Treasury to begin negotiations with the European Export
Credit Agencies supporting Airbus to ``substantially reduce or
eliminate'' export credit financing for wide body aircraft. The
first report on this--which Congress received in November--was
far from a report on negotiations and more of a history of
Export Credit financing. How will you push these required
negotiations moving forward and what kind of substantive
reports can we expect to see on the negotiations from the
Administration moving forward?
A. In Ex-Im Bank's 2012 Reauthorization, Congress mandated that
Treasury initiate and report on the negotiations described in
the question, therefore, Ex-Im Bank is not in a position to
comment on the content of future Treasury reports. Separately,
Ex-Im Bank will continue to play an important role in
supporting Treasury and Administration efforts in the
International Working Group on Export Credits, which represents
an important effort to bring China and other emerging economies
into a multilateral rules-based framework for official export
credits. Ex-Im Bank agrees with Treasury and the Administration
that getting all of the major providers of official export
credits to negotiate and ultimately abide by a common set of
international guidelines is the first step in the process of
reducing, with the ultimate goal of eliminating, trade
distorting export financing programs, and will help ensure that
official export credit support complements market financing,
rather than crowding it out.
A.4. Over the years, Treasury has actively worked to make the
international guidelines on official export financing as
market-oriented as possible. For aircraft, Treasury has sought
to reduce official export credit financing; for example, most
recently Treasury negotiated the 2011 Aircraft Sector
Understanding (ASU) to include terms and conditions that are
more market-oriented, thereby helping to ensure that such
support is used only when market financing is not available and
thus complementing rather than crowding out the market. Since
the 2011 ASU was negotiated, Treasury has continued to engage
regularly with the European Airbus-supporting governments to
discuss possible limitations on the provision of official
export financing support for aircraft. Reducing U.S. financing
support for aircraft exports alongside concurrent reductions by
the European governments would be necessary to help ensure our
objective of maintaining a level playing field for all U.S.
stakeholders.
Moreover, with many major emerging market countries, such
as China, providing more and more official export financing
support, Treasury launched last year the International Working
Group on Export Credits. The working group is a multilateral
effort to negotiate a common rules-based framework that is a
necessary first step in the process of reducing, with the
ultimate goal of eliminating, trade distorting export financing
support in a manner that does not disadvantage U.S.
stakeholders.
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RESPONSE TO WRITTEN QUESTIONS OF SENATOR COBURN FROM JACOB J.
LEW
Q.1. While the annual report identifies the symptom of recent
central bank policies, a prolonged period of unusually low
interest rates, did the Council have any discussions or have
any recommendations for handling the continued proactive role
central banks have assumed in the global economy? Moreover, did
the Council have any discussions on the inflation threat that
the continuance of massive asset purchases by central banks or
the adverse impacts of an eventual exit without marked recovery
have on financial stability?
A.1. The Council's annual report included a discussion of risks
posed by the low interest rate environment. Among the factors
explaining the current low level of yields is the market
expectation of future short-term interest rates, which is
driven primarily by monetary policy expectations. Globally,
central banks have been easing monetary policy in order to aid
the recovery from the global financial crisis, and the Federal
Reserve has provided explicit short-term rate guidance tied to
economic conditions. The annual report makes a number of
recommendations to regulators and risk managers of banks,
broker-dealers, insurance companies, and pension funds to be
vigilant and scrutinize their risk management practices
concerning interest rate risk. With respect to banks and
broker-dealers, the report recommended that regulatory agencies
and private sector risk managers should scrutinize whether
potential changes in interest rates could adversely affect the
risk profiles of financial firms. For insurance companies, the
report said that the Federal Insurance Office and State
insurance regulators should continue to monitor the interest
rate risk of insurance companies, and State insurance
regulators should continue to ensure that the economic
scenarios run by insurance companies are sufficiently robust
and appropriately capture interest rate and other economic
risks.
Q.2. The implementation of Basel III to enhance capital
standards to support the soundness of financial institutions
utilizes risk-weighting standards. Do you believe the existence
of any security or instrument with a zero risk weighting for
capital standards promotes a sound global financial system?
A.2. The use of risk-weightings promulgated under Basel III is
an important part of the effort to promote and monitor the
safety and soundness of financial institutions. Risk-weighting
assets allows regulators and supervisors to account for
differences in the risk presented by particular assets. For
example, you would not want to have a regime in which the same
amount of capital is held against a U.S. Treasury security as
against a highly risky asset. Of course, risk-weighting should
not be the only tool supervisors use to determine capital
requirements, and the U.S. banking agencies have a series of
tools for that purpose, including the leverage ratio and stress
testing.
Q.3. GAO found a lack of transparency with the public as an
issue the Council should address, suggesting keeping detailed
records of closed-door sessions and developing a communication
strategy with the public. What steps has FSOC and the Office of
Financial Research (OFR) taken to increase transparency and
accountability to the public since the September 2012 findings?
A.3. GAO's report made a number of constructive recommendations
on ways in which the Council and the OFR could further enhance
their transparency and accountability, including improving
their Web sites. Subsequently, both Web sites were reintroduced
in December 2012, to improve transparency and usability, to
improve access to Council documents, and to allow users to
receive email updates when new content is added. The OFR has
also assembled dedicated staff to support effective
communications with the public, as well as outreach to industry
and other key partners. Continued enhancements to promote
further transparency are expected over time. However, the
Council must continue to find the appropriate balance between
its responsibility to be transparent and its mission to monitor
emerging threats to the financial system. Council members
frequently discuss supervisory and other market-sensitive data
during Council meetings, including information about individual
firms, transactions, and markets that require confidentiality.
In many instances, regulators or firms themselves provide
nonpublic information that is discussed by the Council.
Continued protection of this information, even after a period
of time, is often necessary to prevent destabilizing market
speculation or other adverse consequences that could occur if
that information were to be disclosed.
Q.4. In its September 2012 report, GAO found that FSOC has not
identified a forward-looking process for emerging threats. To
what extent is FSOC capable of anticipating potential threats
to financial stability and what capabilities does the
organization have to eliminate or mitigate looming threats?
What tools does FSOC have that the regulators did not leading
up to the 2007-08 crisis?
A.4. The Council's assessment of threats to the financial
system is a collaborative process, driven by review of the best
information available from the markets, institutions, industry,
and academia, and expertise from Council members and their
agencies and staffs. Council members have been and continue to
be highly engaged in assessing emerging threats and
vulnerabilities.
The Council committee structure includes a standing
Systemic Risk Committee established to identify, analyze, and
monitor vulnerabilities in the financial system and emerging
threats to stability. This committee, which is composed of
staff of Council members and their agencies with supervisory,
examination, data, surveillance, and policy expertise, gathers
information from Council members and their agencies to assess
risks that affect financial markets and institutions. The
Systemic Risk Committee is responsible for interagency
coordination and information sharing regarding issues that
could affect financial stability, and reports to the Council's
Deputies Committee. Also, as noted above, the Council's annual
report is a product of the Council's risk-monitoring function.
It reflects the ongoing work of the Systemic Risk Committee and
the collective judgment of the members of the Council.
The Council is also supported by the Office of Financial
Research (OFR), which was created by the Dodd-Frank Act to
improve the quality of financial data available to
policymakers, and to develop better tools and analysis to
understand the risks in the financial system. The Council's
Systemic Risk Committee has worked with the OFR to develop a
monitor of key financial and economic data and to highlight
areas of potential concern, and it continues to be refined.