[Senate Hearing 113-471]
[From the U.S. Government Publishing Office]




                                                        S. Hrg. 113-471


  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

                             SECOND SESSION

                                   ON

  REVIEWING THE FINANCIAL STABILITY OVERSIGHT COUNCIL'S ANNUAL REPORT

                               __________

                             JUNE 25, 2014

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs


                 Available at: http: //www.fdsys.gov/

                                   ______

                   U.S. GOVERNMENT PUBLISHING OFFICE 

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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

         Brett Hewitt, Policy Analyst and Legislative Assistant

                  Greg Dean, Republican Chief Counsel

              Jelena McWilliams, Republican Senior Counsel

                       Dawn Ratliff, Chief Clerk

                       Taylor Reed, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                  (ii)


                            C O N T E N T S

                              ----------                              

                        WEDNESDAY, JUNE 25, 2014

                                                                   Page

Opening statement of Chairman Johnson............................     1

Opening statements, comments, or prepared statements of:
    Senator Crapo................................................     2
    Senator Shelby...............................................    35

                                WITNESS

Jacob J. Lew, Secretary, Department of the Treasury..............     3
    Prepared statement...........................................    35

              Additional Material Supplied for the Record

The 2014 Financial Stability Oversight Council Annual Report to 
  Congress.......................................................    42

                                 (iii)

 
  THE FINANCIAL STABILITY OVERSIGHT COUNCIL ANNUAL REPORT TO CONGRESS

                              ----------                              


                        WEDNESDAY, JUNE 25, 2014

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:10 a.m. in room 216, Hart Senate 
Office Building, Senator Tim Johnson, Chairman of the 
Committee, presiding.

           OPENING STATEMENT OF CHAIRMAN TIM JOHNSON

    Chairman Johnson. I call this hearing to order.
    Today, we welcome Secretary of the Treasury Jack Lew back 
to the Committee for his testimony on the 2014 Financial 
Stability Oversight Council Annual Report to Congress.
    FSOC has played a critical role in coordinating the 
implementation of the Wall Street Reform Act among State and 
Federal regulatory agencies.
    Since the last hearing on the FSOC Annual Report, the 
agencies have reached some important milestones for Wall Street 
Reform implementation, including a finalized Volcker Rule, new 
bank capital and leverage rules, enhanced prudential standards 
for large U.S. banks and the U.S. operations of large foreign 
banks, and clearing requirements in swaps markets. And, for the 
first time, FSOC made final determinations with respect to 
systemically important nonbank financial companies.
    Secretary Lew has, on numerous occasions, stated the 
importance of finalizing the financial reform rulemakings, and 
I look forward to hearing about the continued progress.
    In addition, the 2014 Annual Report lays out a number of 
potential risks that could threaten the stability of the 
financial system. These include issues that have been noted by 
FSOC in the past, such as reliance upon short-term wholesale 
funding, the risk-taking incentives of large institutions and 
operational risks like cyber-attacks. It also includes newly 
identified risks, such as potential threats to the financial 
stability from new financial products, business practices and 
regulatory arbitrage.
    The recommendations made by the Council address structural 
vulnerabilities that remain in the system and point to the need 
for heightened risk management and supervisory attention.
    Now, nearly 4 years after the passage of the Wall Street 
Reform Act, regulators should continue to collaborate with each 
other and with the private sector to determine what is working 
and what more needs to be done, to ensure that financial 
markets remain safe, transparent and stable. I have no doubt 
that FSOC will continue to play a key role in leading that 
effort.
    Secretary Lew, I look forward to your testimony.
    I will now turn to Ranking Member Crapo for his opening 
statement.

                STATEMENT OF SENATOR MIKE CRAPO

    Senator Crapo. Thank you, Mr. Chairman.
    I look forward to Secretary Lew's testimony on FSOC's 2014 
Annual Report.
    This year's 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. One of the issues 
highlighted in the report is the need for a broad reform of the 
housing finance system and the return of private capital into 
mortgage finance.
    We have referred bipartisan legislation out of this 
Committee, and Chairman Johnson and I continue to engage with 
our colleagues on this important issue.
    As I said at the last FSOC hearing, and I will repeat it 
today, the U.S. capital markets must remain the preferred 
destination for investors throughout the world. Unfortunately, 
regulatory uncertainty and infighting among U.S. financial 
regulators, and with their overseas counterparts, are causing 
investors to look elsewhere.
    I encourage Secretary Lew to lead an effort among FSOC 
members to identify other measures Congress should consider to 
ensure that our financial markets remain competitive.
    The frustration from foreign regulators over the lack of 
international coordination on financial reform is an ongoing 
concern. The European Commission just announced that it will 
grant equivalence to foreign clearinghouse rules in Australia, 
Hong Kong, India, Japan and Singapore but not the United States 
in what some observers view as regulatory backlash.
    Last year, I suggested the Secretary Lew engage with 
foreign regulators to address cross-border conflicts and the 
unnecessary costs imposed by them. I look forward to hearing 
about the progress Secretary Lew has made in that area.
    I continue to have concerns about the lack of transparency 
of FSOC's process for designating nonbanks, Systemically 
Important Financial Institutions, or SIFIs. I have requested 
the Government Accounting Office to review FSOC's nonbank SIFI 
designation process and look forward to reviewing that report 
when it is finalized later this summer.
    There must be a transparent and measurable process to 
determine whether or not companies could become SIFIs. In order 
to make that determination, everyone needs to know what 
criteria FSOC is using.
    The FSOC should either publish such criteria in the Federal 
Register for public comment or, at the very least, specify in 
great detail why each of the already designated nonbank SIFIs 
qualified. Unfortunately, the publicly released documents 
designating the three nonbank SIFIs to date have provided 
little useful insight into the specific criteria FSOC used.
    The SIFI designation process cannot take place in a black 
box. Too much is at stake. That is why FSOC must be accountable 
and in full public view.
    Lastly, I am concerned that the report on the asset 
management firms issued by the Office of Financial Research 
last fall does not properly account for the role asset managers 
play in our financial system. The Securities and Exchange 
Commission's decision to put the OFR report out for public 
comment was a good step forward toward transparency and giving 
the public the opportunity to comment.
    I encourage Secretary Lew to consider making nonbank SIFI 
designation criteria also available for public comment.
    I look forward to discussing these and other issues at 
today's hearing.
    Thank you, Mr. Chairman.
    Chairman Johnson. Thank you, Senator Crapo.
    Are there any other Members who would like to give a brief 
opening statement?
    Senator Shelby. Mr. Chairman, I would like my written 
statement to be made part of the record.
    Chairman Johnson. Without objection.
    Chairman Johnson. I want to remind my colleagues that the 
record will be open for the next 7 days for opening statements 
and any other materials you would like to submit.
    Today's witness is the 76th Secretary of the U.S. 
Department of the Treasury.
    Secretary Lew, welcome back to the Committee. Please begin.

    STATEMENT OF JACOB J. LEW, SECRETARY, DEPARTMENT OF THE 
                            TREASURY

    Mr. Lew. Thank you, Mr. Chairman and Ranking Member Crapo 
and Members of the Committee. I appreciate this opportunity to 
testify today on the Financial Stability Oversight Council's 
2014 Annual Report.
    Nearly 4 years ago, President Obama signed into law the 
Dodd-Frank Wall Street Reform and Consumer Protection Act, 
creating the strongest safeguards for consumers and investors 
since the aftermath of the Great Depression. After an anomalous 
first quarter, where bad weather and other factors were at 
play, we expect to see strengthening growth in the remainder of 
the year.
    As everyone here recognizes, a stable, thriving financial 
sector is critical to our economic growth and prosperity. That 
is why these historic safeguards were established.
    Today, our financial system is more resilient, confidence 
in our markets is robust, and the agencies charged with 
protecting consumers and investors are in a strong position to 
respond to emerging threats that could hurt our economy, damage 
Main Street businesses and destroy jobs.
    One of the lessons from the financial crisis was 
recognizing how important it is to detect and mitigate risks to 
financial stability because in the lead-up to the crisis 
individual regulators were focusing on individual institutions, 
functions or markets. This siloed approach allowed risks to 
fall through the cracks.
    Congress changed that by creating the Financial Stability 
Oversight Council. Now, regulators are obligated by statute to 
collectively monitor the stability of the entire U.S. financial 
system, to look over the horizon to identify potential risks 
and to respond to threats that have been detected.
    In short, the Council's work to detect possible risk is not 
only mandated by law; it is sound economic policy.
    That is why it both defies common sense and ignores recent 
history that some have suggested curtailing the Council's 
ability to analyze information regarding particular financial 
sectors, firms or activities. The Council cannot simply cordon 
off any sector or activity that could pose a threat. That would 
be a dereliction of its responsibilities and a complete 
disregard for the very purpose of the Council.
    Some have even gone so far as to suggest the Council should 
be prohibited from simply asking questions about certain 
activities or companies that could threaten financial 
stability. We have to be allowed to ask questions. As everyone 
knows, during the run-up to the financial crisis, regulators 
should have asked more questions about institutions and 
activities, not fewer.
    And, to be clear, asking questions does not equal 
regulatory action. Sometimes questions result in a conclusion 
that the Council does not need to act, that it needs to examine 
the issue further or that it needs to gather more information.
    The Council asks questions with an open mind and without a 
predetermined outcome. In that vein, the Council's procedures 
are transparent. It has put in place a comprehensive, 
deliberative approach to its evaluation of risks, and it 
solicits public input and carefully considers all points of 
view.
    In fact, the Council's Annual Report exemplifies the 
Council's commitment to transparency and collaboration. It 
reflects the collective analysis and conclusions of council 
members regarding the key risks to financial stability, and it 
is an important example of how the Council shares information 
about its work with the Congress and the public.
    Each Annual Report also provides a road map for the 
Council's agenda for the upcoming year--what areas it will 
focus on, what areas will likely require additional attention 
and how the Council expects to address them.
    This year's report focuses on nine areas that warrant 
continued attention and possibly further action from its 
members. These areas include wholesale funding markets, the 
housing finance system, cyber-security threats, risk-taking by 
large financial institutions and potential interest rate 
volatility.
    Before closing, let me point out that since the Council's 
last Annual Report, we have reached a number of key milestones 
in financial reform implementation. That means home buyers, 
retirees and investors have better safeguards and protections.
    And, to that end, the Volcker Rule has been finalized, 
qualified mortgage standards have gone into effect, tough 
capital standards are now in place, over-the-counter 
derivatives are now moving onto electronic trading platforms 
and into centralized clearing, fines have been imposed for 
abusive actions related to the manipulation of LIBOR and other 
financial benchmarks, and the international community is making 
progress on increasing the stability of the global financial 
system.
    Mr. Chairman, I want to thank the other members of the 
Council and all the staff involved in the 2014 Annual Report 
for their tireless work and commitment.
    As the Council fulfills its obligations to strengthen our 
financial system and limit risk to our economy, we will 
continue to work with you, the Committee and Congress to make 
real progress for all Americans.
    Thank you very much, and I look forward to answering your 
questions.
    Chairman Johnson. Secretary Lew, thank you for your 
testimony.
    Will the Clerk please put 5 minutes on the clock for each 
Member's questions?
    Before I begin my questions, Secretary Lew, I would like to 
apologize in advance that I will need to excuse myself shortly 
to attend to other Committee-related matters. Senator Reed has 
kindly agreed to take the gavel for the remainder of the 
hearing, and I will follow up with you personally if I have any 
further questions.
    Secretary Lew, the current Export-Import Bank authorization 
ends in September. As you know, this program has been 
historically supported by members on both sides of the aisle 
but recently has become more partisan.
    Why is it important for U.S. companies and workers that 
Congress reauthorize the Export-Import Bank?
    Mr. Lew. Mr. Chairman, I think the Export-Import Bank is 
extremely important for our companies, large and small, that 
are exporting in a world market where other countries have 
export support programs.
    For us not to have an Export-Import Bank would be for us to 
unilaterally remove our support while other countries are 
giving support to their companies, and it would disadvantage 
U.S. exporters. I think that this would immediately translate 
into lower sales and, therefore, lower jobs.
    It is a whole different question if there were to be an 
international agreement that everyone would step back from 
export support programs, but to fail to extend the Export-
Import Bank would be a unilateral action that, I think, would 
hurt the American economy.
    Chairman Johnson. Secretary Lew, I want to thank you and 
your staff for all the hard work in helping the Committee 
revise and mark up housing finance reform legislation. I 
appreciate your support for S. 1217 as amended.
    Could you explain to the Committee why legislation is 
necessary to reform the housing finance system?
    Mr. Lew. Well, Mr. Chairman, we worked, as you have noted, 
closely with you and with Senator Crapo, as we did with Senator 
Corker and Senator Warner earlier, and we believe that the 
unfinished business of housing reform is really the unfinished 
business that we need to attend to in terms of what actions are 
required after the financial crisis.
    We all saw and understood clearly a few years ago how 
exposed U.S. taxpayers were to the current system. We have seen 
since then a move away from private lending in the marketplace. 
Most mortgages are either made by FHA or supported by the GSEs.
    We know that this is an area where, were there another 
financial crisis, we are still in a very exposed position, and 
U.S. taxpayers are still in a very exposed position.
    I think the elements of housing finance reform that are 
important are many.
    One is to make sure that there is a private market for 
mortgage lending.
    Another is to make sure that there is access to credit that 
is fair and widely spread and that helps to even the playing 
field for those who have trouble getting mortgages now.
    A third is that any backstop has to be clearly defined and 
very narrow, and it has to come after a very secure position by 
private parties who absorb the first risks themselves.
    I think that any of us writing legislation alone might do 
it differently than we do when we try to come up with a 
consensus product or a bipartisan product, but we think this is 
an important area for Congress to act on.
    Chairman Johnson. There has been a lot of focus on FSOC's 
designation process, including concerns about transparency and 
due process.
    Broadly speaking, how does FSOC address those concerns, 
especially when a firm is at stage two or three in the process?
    Mr. Lew. Mr. Chairman, I actually think that the process 
that FSOC goes through with companies is an excellent process 
that protects the right of parties, both to confidentiality of 
information that should not be public but also full access to 
the process to make their views known.
    When a company is in stage three, which is the time when 
there is an active back and forth, there are just numerous, 
probably hundreds, of exchanges of information in writing and 
verbally where a company makes its positions known, the FSOC 
staff gets to ask questions, and it is briefed up to the 
members of FSOC in a way that permits a balanced and fair 
judgment to be made. At the end of the process, a company has 
the right to ask for a face-to-face hearing.
    There have been eight designations of nonbank utilities, 
two designations of insurance companies. Only one of those 
firms has sought the face-to-face hearing. It was granted.
    It was actually an excellent hearing. I have talked to the 
company afterwards. They felt the same way. And it helped the 
process to both be open to the party that was potentially to be 
named and also informed the FSOC about the issues it was going 
to be deciding on.
    I think that, you know, there is also judicial review of 
FSOC determinations, and I think it is interesting to note that 
there has been no judicial review taken of any of the actions 
that I have mentioned.
    Chairman Johnson. Senator Crapo.
    Senator Crapo. Thank you, Mr. Chairman.
    Before I get into my main questions, I wanted to follow up 
on the Chairman's question about housing finance reform and, 
frankly, just again, to thank you for your increased and 
continued focus on the criticality of that issue.
    I think, as you said, the U.S. taxpayers continue to be 
very much on the hook and at risk as we do nothing to reform 
our system and maintain the current structure in which we have 
Fannie Mae and Freddie Mac under U.S. Government control. So 
thank you for your renewed focus on that.
    In my opening statement, I indicated the FSOC should either 
publish a list of criteria that it uses to designate a firm as 
a SIFI or to provide a detailed analysis of why a firm has been 
designated so that other firms have some guidelines on whether 
or not they could become SIFIs.
    Are you willing to publish such specific criteria?
    Mr. Lew. Well, Senator, the numerical threshold for being a 
stage one company is well known. It is published. It is 
something that all of the financial institutions are aware of.
    The process of going through the review of each firm 
obviously depends on what kind of a business it is in, how it 
is interconnected to the financial markets and what the risks 
of a failure at that firm would mean in terms of potential 
spread to other parts of the financial system.
    So I think that the stage three process is one where 
companies see very clearly what kinds of considerations are 
being thought through. They submit voluminous information and 
data to support a decision that, presumably, is informed by 
their point of view.
    And I think we have to be kind of careful about having 
there be too rigid a standard because it is not just a question 
of size alone. There can be a very large firm that does not 
present systemic risk. There can be a smaller firm that because 
of the kind of business it is in that presents a greater 
systemic risk.
    And we are trying in a fairly new process to be very 
systematic and disciplined about it, and I am very proud of the 
quality of work that has been done.
    Senator Crapo. Well, from what I understand, it is a 
different picture than you paint here today, from the 
information that I received from many of those going through 
the process.
    They certainly would agree with you, I think, that 
tremendous amounts of information are begin requested and that 
there is this process of significant back and forth that goes 
on.
    But there is a lack of understanding or information being 
provided about what the purpose of the information is, how it 
is to be used, how they could better analyze or help to analyze 
the issue being address, and so forth.
    Although I agree with you also, that we do not want to get 
into rigid standards that do not have the flexibility needed 
for the circumstances at bay, I do believe that a significant 
focus needs to be made on whether or not the adequate 
transparency is being provided and adequate explanation of 
criteria being used is being made to those who are potentially 
going to be designated. And I would just encourage you to pay 
greater attention to that issue.
    Mr. Lew. Senator, we value transparency and openness 
highly. We have tried to come up with a balance between 
transparency but also protecting the legitimate concerns of 
firms for having their proprietary information not be in the 
public space.
    You know, it is obviously a new organization, and we are 
developing these procedures in real time, and we will continue 
to try to get that balance right.
    Senator Crapo. All right. Thank you.
    On a related issue, early in June, the Fed and the FDIC and 
OCC published the first of a series of requests for comments to 
identify outdated, unnecessary or unduly burdensome regulations 
that are imposed on insured depository institutions. I think 
that is a very positive development.
    Mr. Lew. I agree.
    Senator Crapo. And I am very hopeful that that will result 
in our ability to go in and, if you will, weed out some of the 
unnecessary and overly burdensome regulations in our system, to 
help streamline them and make them more effective, without 
sacrificing any safety or soundness in the system.
    Are you prepared to encourage other FSOC members to review 
existing regulations and to lead similar efforts among other 
agencies?
    Mr. Lew. Senator, I have been encouraging agencies to do 
that in multiple roles for many years. When I was OMB Director, 
we did a look-back for all the executive branch agencies that 
OMB has oversight over. We asked for the independent regulators 
to do the same thing at the time.
    I think it is an excellent thing that the agencies are 
moving in that direction and it is the right way for us to deal 
with the kind of accumulation of issues. There are things that 
made sense 20 years ago that if you look at them now do not 
reflect decisions we would make today.
    And I totally agree; it does not mean unwinding anything 
that gets to safety and soundness.
    It is a question of asking, are there things in place that 
you do not need any more or you would do differently?
    Senator Crapo. Well, let me make just one specific 
recommendation in that regard, and that is over the last few 
years we have had a lot of different witnesses talk to us about 
the impact that the community banks are facing under the 
cumulative regulatory system they now face.
    I think that maybe at one of your next FSOC meetings it 
would be very helpful for the relevant agencies to undertake a 
similar effort as they are with insured depository institutions 
in general, to focus on community banks and see if we cannot do 
exactly what you and I have just talked about--identify ways we 
can reform and streamline our regulatory system with regard to 
them.
    Mr. Lew. I cannot speak to whether there has been a look-
back, I suspect, because they are just beginning now to do the 
look-back. It is just happening, so in real time.
    But I can tell you that as new regulations come out there 
is not a regulator that we work with--and we work with all of 
them--who is not very much attentive to the special concerns 
and needs of community banks and the value that they play in 
our system. So I suspect there would be an openness to asking 
that kind of question.
    Senator Crapo. Thank you. I hope you will be willing to do 
that.
    Chairman Johnson. Senator Reed.
    Senator Reed. Well, thank you very much, Mr. Chairman.
    Thank you, Mr. Secretary.
    One of the issues that is rapidly emerging as a major 
systemic, or at least macroeconomic, problem is the student 
debt.
    And there are many facets of this, but I was interested in 
the comment that Deputy Treasury Secretary Sarah Bloom Raskin 
made about looking back and comparing the way the service 
industry for mortgages was underperforming when the crisis hit 
and suggesting that it might be fruitful work to look at 
student loan servicers.
    But just in general, can you describe how FSOC is dealing 
with the issue of the student debt and student loans? It is 
growing as an issue.
    Mr. Lew. Student debt is definitely growing as an issue.
    And I think that we have to separate the question of what 
does it mean in terms of the economic capacity of students who 
are burdened with debt, what does it mean in terms of potential 
finance stability concerns, and what does it mean in terms of 
how well we are running our programs?
    I think that while it is a very large number, to date, I 
have not seen issues raised that suggest that it is of systemic 
risk the way other things have been.
    But there are macroeconomic concerns because if the 
overhang of student debt is causing individuals to not start 
their own household and not either rent or purchase and do all 
of the other consumer activity that is associated with that, 
that cumulatively makes a difference in terms of our economy.
    It also makes a big difference in terms of the career paths 
that people choose and the kinds of options they have that the 
education that they have paid for is supposed to open up.
    And I know that Senator Warren has introduced legislation 
in this area. We have supported that legislation.
    I think it is a complicated area where, frankly, we do not 
fully understand all of the ramifications, and it is something 
that we have to continue focusing on each of those three 
aspects.
    Senator Reed. Just one of the issues here perhaps can be 
described as mechanical. We discovered in the housing market, 
when we were trying to modify mortgages, that the servicers 
were just not built to do that. They had a one-way ratchet. 
They collected premiums and distributed them out.
    I would hate to get to the point where we make a policy 
decision that we are going to go ahead and somehow help 
students refinance and discover that the mechanics do not work.
    Is that an issue that FSOC or someone within your----
    Mr. Lew. Well, I do not know that it is FSOC per se.
    Senator Reed. But somebody?
    Mr. Lew. I know Treasury has been working with the 
Department of Education on the kind of plumbing of the system 
to make sure that it is capable of doing things that we might 
ask for it to do.
    Senator Reed. So, as the Secretary of the Treasury--you are 
working on it?
    Mr. Lew. Yeah, and I have been working with Secretary 
Duncan for the entire time that I have been in my current role.
    Senator Reed. Let me shift to another issue which has huge 
macroeconomic consequences. That is the housing market.
    The Treasury Department has obligated a total of about $38 
billion for foreclosure prevention and stabilization. To date, 
only about $12 billion has been spent. There is $25 billion, 
roughly, that is out there to put into the market, which would 
have a huge effect in terms of stimulus demand, giving people 
on Main Street a better--why can't we get this done?
    I mean, this is not a situation where we have good 
intentions and no resources. We have got the resources.
    Mr. Lew. Senator, I think that if you look at the money 
that is available, some of it has actually been spent; other 
has been obligated and, because of the nature of the program, 
will be spent when homeowners reach certain trigger points. You 
know, after a certain period of time you have a certain amount 
of principal forgiveness or other support.
    Our estimate is that roughly $25 billion is on a path 
toward being spent, which is 65 percent of the money, even 
though it has all been obligated.
    We are constantly looking at funds that are obligated that 
may or may not be spent, and we are looking at the authorities 
we have to see if there are things we can do to help the 
homeowners who it was intended to be helping. Our commitment is 
to use those resources to help the people it was designed for.
    Senator Reed. Well, the faster those resources are 
deployed, the better off people will be----
    Mr. Lew. I agree.
    Senator Reed.----and the better off the economy will be.
    Thank you, Mr. Chairman.
    Chairman Johnson. Senator Shelby.
    Senator Shelby. Thank you, Mr. Chairman.
    Mr. Secretary, basically, this has been raised before. Is 
there some type of collaboration between FSOC and the FSB?
    For example, considering the timeliness and the 
commonalities between SIFI and G-SIFI designations, it is hard 
to believe the process is not conducted sometimes with some 
level of collaboration. Some even reference the relationship 
between FSOC and the FSB as collusion.
    Actually--my question to you--how likely is the FSOC to 
make an independent determination that a firm designated as a 
G-SIFI will not be designated by the FSOC as a SIFI?
    Mr. Lew. Senator, there is a great deal of cooperation 
between members of FSOC and the FSB.
    Senator Shelby. Cooperation rather than collusion, right?
    Mr. Lew. Yeah. I think that what is important to know is 
that the FSB does not make decisions for national authorities. 
National authorities make their own judgments. They are 
parallel processes.
    Now I am not going to say that when you ask the same 
questions and analyze the same data you necessarily reach 
different conclusions, but that is that appropriate level of 
cooperation.
    There is no decision that FSOC has made, or I believe will 
make, on a designation other than decisions based on the 
process run by FSOC where we have our staff work up the 
analysis and we go through all of the processes. And that means 
that we may, at some point, not make judgments that are 
identical to the FSB.
    But I do think it is important to look at the quality of 
the work that we are doing in the FSB as bringing international 
standards closer to our own, which makes our financial system 
more secure.
    Senator Shelby. You are not letting the international 
standards be our standards without a lot of thought, I hope.
    Mr. Lew. No. I actually think that if you were to ask the 
other participants in FSB, they think we are driving them to 
our standards in general, whether it is on capital, on 
leverage, on how we treat nonbank institutions.
    Our schedules are not entirely in sync, and that creates 
this parallel process where sometimes we make decisions in a 
different timeframe.
    Senator Shelby. Could you outline for the Committee, 
briefly, the specific quantitative measures used to determine 
the minimum level of interconnectedness for both bank and 
nonbank SIFIs and the difference between the two standards?
    Mr. Lew. Senator, I would have to get back to you on the 
arithmetic.
    Senator Shelby. OK. Would you do this for the record?
    And how does that FSOC quantify the interconnectedness, for 
example, of Prudential Financial?
    Mr. Lew. If I could answer the question a bit more 
qualitatively than quantitatively, what we do whenever we 
review a firm is we look at the complete financial picture of 
the firm. We look at how connected it is to other sensitive 
parts of our financial system. And we look at what happened in 
circumstances that are not really of our imagination.
    We know what the financial crisis looked like in '07-'08. 
We know what the Great Depression looked like. There are kind 
of very high-stress scenarios that have historical roots. It 
does not mean that you go through every scenario under the sun.
    I do think that one of the parts of our review that is 
important is we do not ask what happens in good times only; we 
ask what happens in bad times because that is when you face the 
real risk.
    Senator Shelby. I have just got a minute. So in a recent 
speech--you are familiar with this, I am sure--the Managing 
Director of the International Monetary Fund, Christine LaGarde, 
suggested that increasing the capital standards 2.5 above Basel 
III for our largest banks would work to reduce the systemic 
risk a trillion-dollar bank by a quarter.
    Have you seen her speech, and have you looked at the 
possibility of raising capital standards above the Basel 
framework and how it could reduce systemic risk and maybe you 
would not need the designations?
    Mr. Lew. Well, Senator, I think that we have made enormous 
progress raising capital, which is essentially a buffer so that 
companies, banks and financial institutions have on their books 
the resources to absorb the shocks or losses they may 
experience. We have actually already been more aggressive than 
Basel, and our regulators have taken more steps than Basel 
required in terms of capital.
    I actually think the concern we have is that the rest of 
the world needs to give as much attention to capital as we do 
because of the global interconnection of the system, and that 
is a conversation I have with my international counterparts on 
a regular basis.
    Senator Shelby. How are you doing with that challenge?
    Mr. Lew. You know, I think we are doing better. I think we 
are doing better, but I do think there is more work to do.
    You know, we have some important discussions that are going 
on now in terms of how the gone-loss absorbency capacity of 
institutions will be met. It is an important area where we 
think banks have to have a deeper cushion of reserve.
    We are going to keep pressing for more progress here. And I 
think we have most of the world actually agreeing with us, but 
it is a situation where we need to get consensus.
    Senator Shelby. Thank you.
    Chairman Johnson. Senator Warner.
    Senator Warner. Thank you, Mr. Chairman.
    Thank you, Mr. Secretary, for your good work.
    I want to go back to the SIFI designation process for 
nonbanks.
    I mean, I believe very strongly a nonbank entity can be 
SIFI, but I wonder at times. There seems to be a lot of concern 
in the industry that FSOC, being dominated by banking 
regulators, is applying banking standards in a bank-centric 
approach to nonbank entities.
    Did you feel comfortable that within the FSOC or the OFR 
you are getting or that you have enough expertise to really 
look at not simply asset size but as we will get capital 
standards but actually lines a business in terms of the whole 
nonbank SIFI designation?
    Mr. Lew. Senator, I believe that there--first of all, that 
FSOC includes the market regulators as well as the banking 
regulators.
    Senator Warner. I am aware.
    Mr. Lew. And there is a very thorough discussion. Even the 
OFR study that we have discussed a bit, on asset managers, was 
heavily commented on by the market regulators as it was 
developed.
    I guess it is important to distinguish the determination of 
systemic risk from what the remedies are.
    And I do think that if you look at how risks spread from 
nonbank institutions in the financial crisis in '07-'08, there 
is no doubt that it spread into the broader financial system 
from a number of nonbank entities.
    So I think that when you look at where the burden of 
dealing with that fell at the time, it often fell to 
institutions like either the Fed or Treasury to deal with some 
of the consequences.
    So I do not think you can separate the discussion, saying 
market regulators should look at one thing; banking regulators 
should look at another.
    FSOC was created so we would look across the silos and see 
the systemic risk that comes from that.
    Senator Warner. I understand that. I was involved in the 
creation.
    But I sometimes feel that it appears from the outside that 
we are looking more at assets on a manager or asset size when 
it may be line of business that may actually be the 
systemically important component.
    Mr. Lew. I actually do not think that is how the discussion 
has been going on, and again, I will use asset managers as an 
example. There has been a lot of discussion as if a decision 
has been made. No decision has been made.
    OFR did a study. There is a process of review going on in 
FSOC. There are many factors being considered. And I think 
there actually is a keen sensitivity to the fact that custodial 
assets are different from other assets.
    There are questions about systemic risk that have to be 
asked and answered. Until you go through that, it does not get 
to the point of a remedy.
    We benefit from the fact that there are multiple points of 
expertise flowing into the process, and I actually think that 
is the strength of the FSOC.
    Senator Warner. But one of the things--and I know what kind 
of--this is a process of first impression now with these 
nonbank SIFI designations and trying to get it right.
    I do wonder whether waiting until stage three before the 
FSOC engages with the institution at the principals' level 
really makes sense, whether there ought to be some--you know, 
after the first round of questions, one level of kind of 
principals' presentation, and then you might have a second 
round as well.
    But are you comfortable that waiting to stage three is the 
right process?
    Mr. Lew. We often hear from firms because they know that 
they are at a size level that clears the kind of initial stage 
one threshold. So I think there is a back and forth even before 
there is an active notification that there is a process 
underway.
    I do think there is a tension. If we notify a company and 
engage with them, then do they have to make public disclosures 
that there is that process underway even if it is just in the 
most preliminary stages and it may not end up going anywhere?
    So I do not know that it actually serves the interest of 
firms to be brought in, in a formal way, earlier.
    Stage three is the kind of heart of the process. I think 
they have full access to the process at the point when the 
meaningful decisions are being made, and the analysis of public 
information is what really fuels stage one and stage two.
    Senator Warner. But this is the tension, and I think 
Senator Crapo raised it as well. I think you make a point that 
you do not want to have such hard and fast rules because they 
are unique firms. Yet, if there is not the appearance of due 
process, since we are not aware of all of the back and forth, 
we are only hearing perhaps one side of this argument.
    And I think getting particularly, as you move through stage 
three, these first few nonbank SIFI designations right so that 
industry at large feels the process is fair is really 
important.
    Mr. Lew. Well, I totally agree with that, Senator. And we 
are committed to a process where every firm that we review has 
full visibility, and hundreds and hundreds of pages go back and 
forth, and there are more numerous conversations than can be 
counted.
    I actually think the firms that have gone all the way 
through the process have recognized a lot of what I have said, 
at least in private.
    Senator Warner. Thank you, Mr. Chairman.
    Chairman Johnson. Senator Corker.
    Senator Corker. Thank you, Mr. Chairman.
    And, Mr. Secretary, thank you for being here and for your 
service.
    I know that many of us shamelessly run our own book at 
these meetings, and I am going to gladly participate in that.
    Mary Miller gave a speech on GSEs recently, where she said 
it would take 20 years to capitalize them. I think that was a 
shock to a lot of people that have not been involved in looking 
where they are.
    Would you care to comment on that?
    Mr. Lew. Well, I think that the current GSEs; even in the 
course of the last few weeks, we have seen estimates of what 
kind of exposure they might have in a distressed situation, and 
it would take a very long time. I would defer to Mary's 
analysis on the length of time.
    There were a couple of years of very strong GSE profits, 
but people, I think, have misread that. There were a lot of 
profits that came from really accounting changes in terms of 
the treatment of certain taxes.
    To buildup the kind of capital reserves that they would 
need to fully bear the risks that they would face in an 
economic downturn would take a very long time.
    Senator Corker. Well, listen, thank you for those comments, 
and as Mr. Crapo mentioned, thank you for your assistance in 
helping move legislation through. Hopefully, at some point we 
will actually have a solution that works for our country.
    Let me ask you a question on Dodd-Frank Section 121, and we 
have asked this over at the Fed; we have asked it several 
places. Do you think Section 121, regarding the FSOC, should 
have the Fed break up a firm if it is too big or too complex 
even if it is healthy?
    I mean, this is a question we keep asking folks.
    I think the language in 121 gives the Fed that ability, to 
actually break up a firm even if it is healthy if, through a 
bankruptcy process--and let me specify that because I know we 
actually have sort of two different standards.
    We have the resolution that is laid out in Dodd-Frank, and 
that is a different process from bankruptcy.
    But through a bankruptcy process, if a firm could not 
resolve itself through bankruptcy without creating problems 
within our system, does the Fed itself have the ability, even 
if they are healthy, to break them up?
    Mr. Lew. Senator, I think that what the Fed has done in 
reviewing stress tests, in reviewing living wills, in terms of 
evaluating the health of certainly the largest financial firms; 
we have come a very long way.
    They have not gotten to the question yet that you are 
raising, and I do not know that I should get ahead of the 
process.
    The challenge is to have standards where the precautions 
that we have put in place to make sure that these institutions 
are resolvable actually work effectively.
    I think that some of the actions taken by the Fed reflect 
both qualitative and quantitative concerns. The quantitative 
concerns we kind of understand more simply because it is a 
question of how much capital do they have. The qualitative 
concerns get to the question of are they too complicated to 
carry out the resolution plans that they quantitatively could 
meet.
    I think that we are still in the early stages of 
implementing some very important reforms that were part of 
Dodd-Frank. And I think the regulators, not just the Fed but 
the Fed and the FDIC and others, are pressing ahead on this.
    The idea of going all the way to the point of breaking up 
firms is kind of an end of all other things did not work, and I 
do not want to get ahead of the process.
    Senator Corker. It kind of seems to be, though, an issue 
that we ought to either know or not know. I am not saying this 
in any way to be confrontational to you.
    Mr. Lew. No, I did not take it that way.
    Senator Corker. Just, so we passed this bill. I think it 
probably pretty clearly states that they have the ability to 
break up firms even if they are healthy. And it seems to me 
that we might want to figure out, as a Committee, what that is 
going to mean in process, what it is going to mean--you know, 
how they are going to go about doing that. And I wonder if you 
might--again, this is not confrontational.
    Mr. Lew. No, I did not take it that way.
    Senator Corker. Nobody really has addressed this issue.
    Mr. Lew. I actually think it is a very important question.
    You know, in some ways, it would be easier to say simply 
yes or no, but I actually think it is more complicated than 
that.
    The fact that they have an authority does not mean that it 
was the desire of the legislation to use it unless they needed 
to.
    And I think they are in a process where the purpose was to 
create a situation where there was transparency and 
resolvability and the ability to make sure the taxpayers do not 
end up having to step in again in the future.
    I do not know the answer to the precise question you are 
asking because I have not seen all of those things.
    I do know that it is still a very complicated financial 
system. There are still challenges in making sure that we have 
the degree of transparency that was intended.
    Senator Corker. Well, my time is up.
    Really just speaking to my colleagues here, I know that 
Senator Toomey wrote a bill relative to revising the bankruptcy 
code.
    But since Dodd-Frank refers specifically to bankruptcy, not 
resolution, I have to believe that we have firms in our Nation 
today that if they fail and went through the bankruptcy process 
it would be highly detrimental to our system. And, I mean, I 
have got to believe that is the case.
    And it seems to me that maybe that is an issue that this 
Committee needs to look at a little more closely, see whether 
the bankruptcy rules, which I know are not in our jurisdiction, 
but whether they are adequate, but also, what this statute 
actually means and how we should go about, really, oversight 
relative to what the Fed is doing in this regard.
    But I am taking too much time. You might want to comment.
    Mr. Lew. Mr. Chairman, may I just comment briefly?
    Senator Reed. [Presiding.] Please.
    Mr. Lew. I think it is important as one asks those 
questions that we would be happy to look at questions regarding 
bankruptcy issues.
    I do not think it should be either/or.
    It should not be that we take the very well-developed 
resolution process and say let's go from there to bankruptcy.
    It may well be that there are additional tools that would 
be helpful. I just do not think it is particularly helpful to 
think of them as alternatives.
    Senator Corker. Yes. Thank you so much.
    Senator Reed. Senator Menendez, please.
    Senator Menendez. Thank you, Mr. Chairman.
    Mr. Secretary, since the financial crisis, consumer debt 
burdens have been a major factor holding back our economy, and 
high levels of mortgage and other debt have caused consumers to 
defer expenses, cut back on other spending, which has led 
businesses to reduce investments and create fewer jobs, feeding 
a cycle that has been difficult to escape and, in my view, 
slowing our recovery.
    And consumers have worked hard to reduce their debt, often 
at great cost, but we are not out of the woods yet. Nationwide, 
we have more than 6 million homes that still have underwater 
mortgages, including more than 14 percent of homes in my home 
State of New Jersey, and another 10 million have less than 20 
percent equity.
    Do you agree that stronger consumer balance sheets would 
reduce risk in the financial system, both directly and by 
promoting stronger and broader-based economic growth?
    Mr. Lew. Senator, I think that we have seen some 
considerable healing in household balance sheets. We still have 
problems, as you have noted, but we are in a much better place 
than we were before. We are actually seeing consumer borrowing 
in many areas going up, and one has to ask, you know, keep an 
eye on that in terms of making sure that people are not getting 
back into trouble in some cases.
    I think that there are pockets that are particularly slow 
to recover, and that is one of the reasons why we need to make 
sure that we continue to use the tools we have to help 
underwater homeowners. And that is what I was discussing with 
Senator Reed.
    Senator Menendez. Yes, mortgages are only one example of 
consumer debt. You still have significant credit card debt.
    Mr. Lew. Yes.
    Senator Menendez. You have student loan debt.
    Should we be considering policy actions that help consumers 
continue to reduce their debt burden?
    Mr. Lew. Well, I think we have taken a lot of policy 
actions.
    I am not sure which of the aspects of consumer debt you are 
talking about.
    Senator Menendez. Well, you could, for example, allow the 
Menendez-Boxer bill to help refinance at historically lower 
rates and eliminate a series of barriers that exist. That would 
significantly reduce mortgage debt for a fair number of 
Americans in this country.
    Mr. Lew. Which we have supported, yes.
    Senator Menendez. You could look at student loans. The 
President has talked about helping refinance student loans as a 
way of reducing consumer debt.
    Mr. Lew. Right.
    Senator Menendez. Those are the types of initiatives that I 
am thinking of as we talk about if you can reduce the debt 
burden, then you have greater spending capacity, which creates 
a ripple effect in the economy.
    Mr. Lew. There is no doubt, when we were discussing the 
issue of student loan debt in particular a few moments ago, I 
do believe there is a macroeconomic significance to people 
being highly constrained by indebtedness. If you do not feel 
you can start a new household, then you are not buying a home, 
or renting a home, and you are not engaging in all of the 
consumer transactions that we all know go into starting a new 
household. That has an effect on the economy.
    If you look at the recovery to date, the area where it has 
really been the most behind is construction and housing, and I 
do not think it is unrelated to consumer indebtedness. It is 
more than that.
    I think that there is a question of confidence and people 
took a hard hit from the recession, and feeling comfortable to 
go out on their own is more than just a question of do they 
have a job today.
    So I do not think it is just that one issue, but I do think 
it is part of it.
    Senator Menendez. Let me ask you to turn your attention to 
something else that I have concerns with, and that is 
Treasury's implementation of Section 908 of the Affordable Care 
Act, which imposes an annual fee on manufacturers or importers 
of prescription drugs.
    When the Finance Committee, which I have the privilege of 
sitting on as well, imposed the pharmaceutical fee during the 
ACA mark-up process, the Congressional intent, I can tell you 
very clearly, was to exclude drugs used to specifically treat 
orphan diseases. These are diseases that obviously do not have 
broad-based, mainstream demands which can compensate a company.
    But I continue to be concerned that the Department's 
current interpretation of this provision, as expressed in its 
temporary branded prescription drug fee regulation, would 
create disparate treatment between FDA-designated orphan drugs 
by requiring that the exemption from the pharmaceutical fee be 
contingent only upon receipt--receipt--of the orphan drug tax 
credit for that particular product.
    The orphan exemption from the pharmaceutical fee would 
logically be based on a drug's designation as an orphan drug 
and not just its tax status.
    Would you agree that the most logical tax policy outcome 
would be to allow the exemption for all FDA-designated orphan 
drugs, not just those of a certain tax status?
    Mr. Lew. Senator, I am happy to take a careful look at the 
orphan drug issue.
    Senator Menendez. Here is my problem; every time you tell 
me you are going to take a careful look, I never hear back.
    So, on this and on FIRPTA, since your nomination I have 
been pursuing these questions, and I would like to get a 
response. If you are going to give me a negative response, give 
me one, but I would like to get a response.
    Mr. Lew. I am happy to follow up with you, Senator.
    On FIRPTA, we have had several conversations, and I wish I 
had a tool to deal with it. The legislative proposal that we 
have made I do believe is the right way to deal with it. If you 
have other ideas about the administrative options, we can have 
a conversation about that as well.
    Senator Menendez. I thank you, Mr. Chairman.
    Senator Reed. Senator Moran.
    Senator Moran. Mr. Chairman, thank you very much.
    Mr. Secretary, thank you for your presence this morning.
    While certainly the economics of our country is front and 
center and particular in light of today's announcement about a 
significant drop in first quarter GDP, we ought to be spending 
a lot of time talking about the economy and job growth, but let 
me take you to a topic that in my mind relates to your and your 
Department's credibility. I want to ask you the Watergate-kind 
of question about what did you know and when did you know it 
related to the IRS.
    I grew up with Watergate in the background of my life--the 
political influence of the way I look at things. And the 18 \1/
2\ minute gap is a significant component at the downfall of a 
president.
    And I find it difficult to give credibility to the belief 
that these emails have disappeared by mistake, in an error, 
something uncontrollable.
    And my question is, what do you know; when did you know it?
    Have you asked the commissioner of the IRS and others at 
the IRS independently--let me ask this question; have you 
investigated this independently of what you have been told by 
the IRS?
    Do you have additional information to provide to us than 
what the commissioner has testified to in front of the House in 
recent days?
    Mr. Lew. Senator, Commissioner Koskinen has testified, and 
the IRS has presented a lengthy report to the Congress, about 
10 pages detailing what happened, and I would refer you both to 
the commissioner and to that report.
    I think if you look at the broader issue, in terms of the 
whole set of activities at the IRS, a year ago when we got a 
report from our IG saying that there was a problem in this 
unit, we took immediate action. We brought in an acting 
commissioner, who I think did a lot very quickly to fix the 
situation in that he brought in new managers all the way down 
to the program level, changed the procedures, followed every 
one of the IG's recommendations.
    I understand, and I share, the frustration that a broken 
hard drive has led to a gap in what is available.
    But I do want to point out that what the IRS has done is 
extraordinary in terms of going back and trying to recreate 
after a mechanical problem as complete a record as is possible. 
And 70,000 emails have been provided. They have gone through 
the recipient emails to trace back, not just from the sender 
but from the recipient.
    And I have no reason to believe that I have anything to add 
to what the commissioner has said.
    Senator Moran. Have you analyzed this independent of what 
the commissioner has said?
    Mr. Lew. I mean, we have been in contact, obviously, and 
understand what they have done, but the IRS is managing this.
    Senator Moran. I do not mean these questions in any 
particular political context, but the idea--I mean, I assume 
you understand the nature of the IRS and what it expects of the 
American people and the sense of what a double standard this 
is, that the IRS cannot find records and, yet, American 
taxpayers are required to maintain.
    You also have an ongoing lawsuit in which, by the Code of 
Civil Procedure, they are required to keep the emails.
    So it seems to me there are a series of problems that the 
IRS faces as a result of the loss of this hard drive.
    And it goes in a broader sense to me about the relationship 
between the Treasury Department and Congress in trying to 
establish some level of credibility as we have conversations 
about what the truth is.
    And it seems to me that this is one more example of what I 
find very difficult in dealing with the Department, in getting 
answers to questions that have substance.
    Mr. Lew. Senator, the IRS put together an analysis of what 
happened, and when that analysis was complete and they knew all 
the facts, they shared it with Congress. I think that it is 
fair to say that it was their sharing of that information with 
Congress which is why it is known to all of us.
    So I think Commissioner Koskinen is one of the most 
outstanding public servants I have ever worked with. He is a 
person who spent five decades building a reputation on both 
sides of the aisle for integrity and character, and I have 
total confidence in him.
    Senator Moran. Mr. Secretary, thank you for your responses. 
I have other questions that we will pursue if I have additional 
time.
    Senator Reed. Thank you very much.
    Senator Brown.
    Senator Brown. Thank you, Mr. Chairman.
    Secretary Lew, it is nice to see you again. Thank you for 
being here.
    The FSOC's report identifies short-term wholesale funding 
as a potential source of financial instability. Governor 
Trujillo--Federal Reserve President of New York Bill Dudley has 
had some interesting things to say. I will follow up with you 
in a letter with the QF, if you would give us questions for--
with questions for the record. I will get that to you soon 
after this hearing.
    I want to go a couple of other places.
    Last July, you said, ``If we get to the end of this year we 
cannot, with an honest, straight face, say that we have ended 
too-big-to-fail. We are going to have to look at other 
options.''
    That was about a year ago.
    December, you basically said, mission accomplished.
    You said, ``Based on the totality of reforms we are putting 
in place, I believe we will meet that test.''
    This is despite the views of Federal Reserve Chair Yellen, 
Governor Trujillo, the FDIC, the OCC, that our work on too-big-
to-fail is not finished. It almost does not matter what they 
say because the markets still say that on too-big-to-fail the 
work is not finished.
    Yesterday, you appeared to have a perhaps slight change of 
heart when you told Chairman Hensarling, I am not sure we will 
know the answer to that question until we have the next 
financial crisis.
    Now that we all agree we cannot honestly say that too-big-
to-fail is over, what are we going to do to finally put the 
issue to rest?
    Mr. Lew. Senator, I have said on many occasions that the 
real test only comes in the next financial crisis, which I 
believe is the case. We have to take the steps that we believe 
are most effective, and we do our analysis, but the only real 
moment when you know for sure is when there is a crisis.
    I believe if you look at what we have done we have done an 
enormous amount. The capital that these institutions have----
    Senator Brown. I have never questioned whether you have 
done a decent amount.
    I have questioned that the markets still say there are 
advantages for the largest banks on the capital markets, and so 
many others are saying that.
    Mr. Lew. On the question of the advantage, obviously, there 
is a lot of work being done. There is a GAO report that is 
being completed I believe at your request.
    There are a lot of market indicators that show that the 
assumption that there is a price advantage is going way down. I 
am not saying it is eliminated. It might be. There are some who 
argue.
    But I think that in terms of the market advantage, it is 
certainly shrinking, if not gone. I do not know that that is 
the only test.
    Senator Brown. If not gone?
    Mr. Lew. I am just saying there are people who have 
expressed the view that it is shrinking, others who have said 
that it is gone.
    Senator Brown. And your view is which?
    Mr. Lew. It is definitely dramatically reduced.
    The data are still being analyzed, and we will continue to 
look at it.
    Senator Brown. Well, one of----
    Mr. Lew. We are not going to defer to a rating agency or 
one other. We have to keep looking.
    Senator Brown. Well, it is way more than rating agencies 
that contend that.
    Mr. Lew. Yeah.
    Senator Brown. I mean, FSOC's mission is under the Dodd-
Frank. One of its missions is that we restore discipline to the 
markets through our clear message that no institution is immune 
from failure.
    And you know that. That is your responsibility.
    Your statements have been a little, I think, off of that, 
but I----
    Mr. Lew. Well, I actually do not think so.
    I mean, I think we need to do everything that we can to 
reduce the risk. The law has been changed so that we do not 
have rules----
    Senator Brown. But implying mission accomplished does not--
implying or saying mission accomplished does not get us there.
    Mr. Lew. I actually did not say--I did not say mission 
accomplished.
    I said we have to stay vigilant and keep asking questions 
and our work is not done. I have raised issues about shadow 
banking. I have raised issues about international 
collaboration.
    I think we have a lot more work to do.
    The question of whether or not--you know, I do think it is 
important to look at things like capital standards, like the 
Volcker Rule, like the resolution authority. There is enormous 
progress.
    I am not sure that anyone sitting where I sit should ever 
be comfortable that they are done with their work.
    To the extent that these institutions are so very complex, 
as I was saying earlier, I think that presents issues that 
require our ongoing attention.
    So I am not saying that we are done with our work, but I do 
think that on the question of whether or not these institutions 
can now absorb losses and economic shocks that they could not 
before, we are in a very different place than we were a few 
years ago.
    Senator Brown. OK, OK. Let me close with a quick statement, 
Mr. Chairman.
    Respond, if you would like, Mr. Secretary.
    I am concerned about financial deregulation and 
disarmament, if you will, through international regulations. 
Last year, Chairman Bernanke told this Committee that Basel 
III, international capital accordance--he said, least common 
denominator.
    We saw an example of that 2 weeks ago when the E.U.'s 
finance minister came to Washington and lobbied the Fed to 
delay a rule requiring large banks to have minimum levels of 
loss-absorbing capital and long-term debt.
    I am especially worried that including financial services 
in TTIP could undermine U.S. financial regulations. Our safety 
and soundness rules are obviously superior to theirs.
    We have heard concerns that negotiations on capital 
standards for international insurers could move the U.S. to a 
European model of regulation.
    From what I have heard, the Administration--and I thank you 
for this--both you and Ambassador Froman, have stood firm on 
not including financial services in TTIP, the Translation Trade 
and Investment Partnership. I urge you to continue that 
advocacy in international negotiations, to preserve U.S. 
regulators' authority to do whatever is necessary to make sure 
that our financial system is safe and sound.
    So I thank you for that.
    Mr. Lew. Senator, we totally agree on that. I have made 
clear to our negotiating partners that we do not think it is 
appropriate to bring prudential regulatory standards into a 
trade negotiating context and a trade dispute resolution 
process.
    What we do try to do is use entities like the G-20 and the 
FSB to drive international standards up. It ought to be a race 
to the top, and I do think it is important that we remain very 
engaged in that process.
    Senator Brown. Thank you, Mr. Secretary.
    Thank you, Mr. Chairman.
    Senator Reed. Senator Toomey.
    Senator Toomey. Thank you, Mr. Chairman.
    Thank you, Secretary Lew, for being with us today.
    Just a few quick points I would like to make before I get 
to a couple of questions.
    One is I wholeheartedly agree with Senator Menendez's point 
about the orphan drugs. It is a very, very real issue. I think 
it is an unintended consequence of the way the policy was 
drafted.
    And I would just ask you, as you respond to him on this 
issue, if you would please include me in your response----
    Mr. Lew. Happy to.
    Senator Toomey.----because he and I have been working 
together on this. He is exactly right about the substance of 
the problem.
    Very quickly on the Ex-Im Bank, which came up earlier, I 
understood you to say, if I could paraphrase, essentially, 
since our leading trading competitors engage in Government-
sponsored export financing, we need to do it too in order to 
remain competitive. But you went on to say it would be a 
different question if everyone would step back from this 
Government-sponsored export financing.
    Of course, that stepping back will not happen by itself. It 
is going to require some leadership.
    And so I, in fact, at the last reauthorization debate, 
proposed exactly this encouragement, that we would have a 
mutual stepping-back from forcing all of our respective 
taxpayers to subsidize certain companies in their exports.
    Would you support pursuing an effort to engage our trading 
partners and competitors in this mutual and reciprocal scaling-
back of Government-sponsored export financing?
    Mr. Lew. Senator, we actually are engaged in conversations 
like that. Just 2 weeks ago there was a meeting at Treasury 
with 15 countries, discussing this. I am not going to suggest 
that it is very far along, but there is an engagement on this.
    It is just I do not believe the same to think of it as a 
unilateral decision as to think about what would happen if the 
world community took action together. I am not particularly 
optimistic that it will have the resolution that would have 
everyone step back, but I do think it is a different question 
then.
    Senator Toomey. Yes, well, it is a different question.
    Surely, we will not make progress in that direction without 
American leadership. So I hope that you will help to provide 
that leadership. It would be a better world and better for 
Americans if our taxpayers were not at risk to these financing 
exercises.
    I would like to follow up on an issue that Senator Crapo 
raised, and this is something on which we may disagree, but I 
feel very strongly that there ought to be more transparency in 
the SIFI designation process.
    And, specifically, I do very much agree with Senator Crapo, 
as I understood his comments, to suggest that we ought to have 
objective criteria disclosed in advance for a variety of 
reasons, including, in my view, an institution that is 
potentially subject to a SIFI designation ought to have the 
opportunity to consider changing its business model, divesting 
itself or otherwise being able to avoid the criteria that the 
FSOC deems to be sufficiently risky for such a designation. And 
I do not think there is enough transparency for a company to 
make that judgment.
    So shouldn't a company be able to make a judgment about 
whether they want to pursue lines of business that result in 
the SIFI designation?
    Mr. Lew. Yeah, I think it is a fair question. We will 
continue to strive to strike the best balance between 
transparency and other considerations in the process, like the 
protecting the private information that companies have.
    I think that on the question of whether companies get 
enough feedback to know, I think in stage three companies have 
ample opportunity to know what the standards are.
    And it is also not a one-time determination. There is an 
annual review after a determination. So a company can choose 
afterwards also to make a change.
    I am happy to look at this question more.
    It is not that we are lacking transparency here. I think 
that it is there are very different kinds of firms, and I think 
that it is a question of whether there is one set of criteria 
that would be appropriate for all of them.
    Senator Toomey. OK. Well, certainly, I am not suggesting 
that there is one set of criteria. Right, totally different 
kinds of firms. That is one of the problems I have with this.
    The idea that we would, for instance, impose bank-type 
capital requirements on, say, fund managers which are not 
acting as principals but, rather, as agents is completely 
inappropriate.
    But I still think that the transparency need not be about 
the specific information about a given firm but, rather, the 
criteria that FSOC would use. And I would encourage greater 
transparency in that space.
    The last thing I wanted to touch on briefly is my 
understanding is that our regulators are in the process of 
proposing the implementation of the Liquidity Coverage Rule, 
which originated with Basel, of course. Two concerns I have 
with this:
    One, it is my understanding this was meant to address 
liquidity challenges that would arise specifically from 
multinational/international activity, and yet, the criteria for 
applying it is an asset size, which is $250 billion in assets.
    And there are some banks in America, for instance, who 
might be of that size but do not engage in much cross-border 
activity. They actually look more like a series of community 
banks than a money center bank.
    Second--and if you could just comment on both of these--is 
the fact that there is an extremely high capital requirement on 
securitized credit facilities, which I think you could argue is 
actually less of a credit risk than direct lending sometimes 
for a variety of reasons, and yet, this rule would require 10 
times the capital that direct lending would apply.
    Are those issues of concern to you?
    Mr. Lew. Senator, I think that the overarching concern is 
to make sure that firms have a thick layer of capital that is 
there for them to turn to and that they not be overleveraged to 
the point of creating systemic risk. There is an interplay 
between the requirements in terms of which standard will be 
binding for a different firm, depending on what the composition 
of their assets is.
    The Fed has worked very hard on these rules. The FDIC is 
working on these rules.
    I am happy to go back and look at the question you are 
raising.
    Senator Toomey. I appreciate it.
    Thank you, Mr. Chairman.
    Senator Reed. Thank you, Senator Toomey.
    Senator Manchin, please.
    Senator Manchin. Thank you, Mr. Chairman.
    And thank you, Secretary Lew, for being here.
    I know you touched on this briefly; I think with Chairman 
Crapo, but I want to go back to the Export-Import Bank because 
I think there are a few things that need to be talked about 
here. I know they are getting beat up pretty good right now.
    And the thing I am looking at is the facts of what we are 
dealing with:
    Returning over a billion dollars to the Treasury, one of 
the few agencies to actually make money for our Government.
    And for supporting 205,000 American jobs, and these are 
real jobs in States like mine, of West Virginia, and every 
State up here.
    And also, helping about 3,400 companies, a lot of small 
companies.
    We just had a seminar and had the Export-Import Bank in 
West Virginia to really expose them more.
    I have small businesses that are really poised to export, 
but they do not know how to get into that market and are afraid 
to get into that market. They do not have the wherewithal, and 
they will not tiptoe in that without the support of Export-
Import Banks.
    And I want to give my colleagues--I am trying to give my 
colleagues a comfort level on the other side of the aisle, if 
they would, and work with us. They have before.
    And I am just trying to find that middle ground if I can 
because--tell me where we are poised on a global market without 
this type of tool, if you will, the Export-Import Bank, and how 
we can go it alone without that also.
    Mr. Lew. Senator, I think the Export-Import Bank provides 
enormous benefit to both small and large firms--different kinds 
of benefit. For the small firms, as you are mentioning, it is a 
pathway to understanding how to export. With the larger firms, 
there is a real need to level the playing field.
    You look at areas like aviation sales. If other countries 
are subsidizing their aircraft and we do not have export 
supports, that is going to have a direct impact on jobs.
    Senator Manchin. We are not even asking for a subsidy.
    Mr. Lew. No.
    Senator Manchin. We just basically are guaranteeing that, 
and they are paying the full.
    Mr. Lew. Now it is a support to the export.
    Senator Manchin. Sure.
    Mr. Lew. I do not think we can say it is not a support. I 
think ours are actually more appropriate than the subsidies 
that others provide.
    But what I do know is that whether it is a small firm or a 
large firm, if we would remove the Export-Import Bank, both 
access to exports would be reduced and the level playing field 
would be made much more anticompetitive to the United States.
    Senator Manchin. What happens to us in September if we do 
not have a reauthorization?
    Mr. Lew. I believe the Export-Import Bank loses its ability 
to enter into the guarantees.
    Senator Manchin. Anymore guarantees, basically, from that 
point going forward?
    Mr. Lew. I do not know what happens to the ones in the 
pipeline. That is a question I would have to ask.
    Senator Manchin. If you could find that out for me, sir, I 
would--I just think it would be devastating. If it was not for 
the export markets right now, our economy would be very much 
hurting in West Virginia and I am sure around other States 
around this country.
    Mr. Lew. And I know that, whether it is construction 
equipment or aviation equipment or small manufactured goods, 
exports are an area of enormous potential for our economy and 
big firms and small firms.
    Senator Manchin. And, sir, I finally want to touch on one 
other thing, which is the big fix. Ever since the first day I 
arrived here, I thought we needed to do a financial overhaul, 
and I continue to feel that way.
    When I was Governor, I know we did some big things. In the 
first 7 days I was there I called a special session. It was all 
about finances. Get our financial house in order.
    Our economy took off unbelievable after that, and we never 
looked back during the recession because people had confidence. 
They were investing. They knew they would be treated fair, and 
they knew there was a fair system in place.
    The uncertainty we have in our system right now, I think, 
makes that questionable, and people are looking.
    Are we protecting winners and losers?
    Are we trying to give too much to the people we think have 
not had a fair shot and trying to balance this thing out but 
without really having a concise financial or tax plan for 
corporations and our individuals?
    Mr. Lew. I could not agree with you more. We have a lot of 
unfinished business. If we could do business tax reform, I 
think it would help enormously in terms of----
    Senator Manchin. Do you all intend to go after that in the 
last 2 years of this Administration?
    Mr. Lew. Well, we----
    Senator Manchin. Let me just say one other thing real 
quick, and then you can go ahead.
    The economy shrank 2.9 percent in this first quarter. I 
know it was a shock to all of us to see that much. There could 
be a lot of contributing factors; I understand that--tough 
winter, things of that sort. But it really set us back on our 
heels a little bit.
    I just believe that if you are going to leave a legacy, 
fixing this financial mess, whether you inherited it, whether 
we have help create it, whether we are all at fault, Democrats 
and Republicans, this would be a tremendous legacy to leave.
    Mr. Lew. Yeah, there is no question that the first quarter 
of this year was not good performance, but I do think there are 
idiosyncratic factors that explain it, ranging from the weather 
to the fact that in the fourth quarter of last year we had a 
huge inventory buildup that got drawn down in the first 
quarter.
    And there is something in terms of the demand for health 
care goods, health care services, that is throwing these 
numbers into a place that feels very anomalous.
    Senator Manchin. In your heart of hearts, do you think that 
we will tackle--do you think that the President and the 
Administration will tackle a major overhaul of our finances?
    Mr. Lew. Well, if you mean our tax system?
    Senator Manchin. Our tax system.
    Mr. Lew. Look, I think the President remains committed to 
it. The President put a proposition on the table that I think 
is one Congress should come back to, which is do business tax 
reform, use a one-time savings to fund infrastructure 
investment and solve two problems we have to get our economy 
moving. We can replace a tax code that is riddled with 
loopholes by lowering the statutory rate, and we can pay to fix 
our bridges, roads and ports so we can compete in the next 
century.
    I think it is win-win.
    Senator Manchin. And you are OK if we dedicate that 
additional revenue toward infrastructure only----
    Mr. Lew. Yes.
    Senator Manchin.----so we do not grow the size of 
Government?
    Mr. Lew. Absolutely. It is one-time savings. You could not 
use the one-time savings to cut rates or you would lose money 
in the out years.
    Senator Manchin. No, I know that.
    I am just saying, if you are on record as wanting that, 
that would be great.
    Mr. Lew. Absolutely.
    Senator Manchin. Thank you, sir.
    Senator Reed. Thank you.
    Senator Vitter.
    Senator Vitter. Thank you, Mr. Chairman.
    Mr. Secretary, I want to return to the IRS scandal that my 
colleague touched on.
    The IRS first said that there was no targeting of political 
groups. Then it said that it was a few rogue agents in 
Cincinnati. Then it said that there was also equal 
scrutinization of progressive groups. All of those things have 
been now provided untrue.
    Now it is saying that these Lois Lerner emails have lost 
forever because of a hard drive crash. And then only when 
asked, they disclosed--the IRS disclosed--that six other hard 
drives belonging to IRS officials being investigated had also 
crashed.
    Given all that history, do you personally believe that 
``crash'' was truly an accident and a coincidence?
    Mr. Lew. Senator, I do not agree with the history that you 
cited.
    I think there is no evidence that has come forward to show 
any political involvement in the whole 501(c)(4) decisions.
    I think that the actions taken by this Administration and 
by myself have been clear, that we need to replace the people 
who made decisions in senior positions.
    And I have----
    Senator Vitter. Mr. Secretary, do you personally believe 
that this hard drive crash was both an accident and a 
coincidence?
    Mr. Lew. Senator, I have no reason to believe it is not 
just a hard drive that broke. Hard drives do break.
    Senator Vitter. So you believe it was an accident and a 
coincidence.
    Mr. Lew. Look, I know that in 2011, when the hard drive 
broke, it was reported. There was an attempt made to 
reconstruct it. It was a hard drive that broke.
    Senator Vitter. You believe it was an accident and a 
coincidence, basically, according to your testimony before, 
because folks at the IRS told you that?
    Mr. Lew. Senator, sometimes a broken hard drive is just a 
broken hard drive.
    Senator Vitter. But you do not understand the fact that the 
American people think somebody other than folks at the IRS 
should look at this?
    Mr. Lew. Look, I----
    Senator Vitter. Doesn't that make fundamental sense?
    Mr. Lew. I defer to the IRS commissioner who has addressed 
this at great length. They have and will continue to respond to 
questions.
    Senator Vitter. When is the last time a hard drive broke 
like this at the IRS?
    Mr. Lew. I do not know, Senator.
    Senator Vitter. So you have not asked that question?
    Mr. Lew. I do know that hard drives periodically break.
    Senator Vitter. Do you know if it has ever happened before, 
say in the last 10 years, at the IRS?
    Mr. Lew. Senator, I am not an IT expert. I would have to 
get our IT expert.
    Senator Vitter. And you have not asked that question?
    Mr. Lew. Senator, I do know that hard drives break. They 
break in the Congress. They break in agencies. They break in 
our homes.
    And, when a hard drive breaks, you try to recover what you 
can.
    What the IRS has done is gone above and beyond in terms of 
reaching out, not just to the broken hard drive but to the----
    Senator Vitter. Mr. Secretary, the point is nobody trusts 
the IRS to be the only person looking at this issue.
    It is a fundamental point. No one thinks only the folks who 
could get in trouble over it should investigate it.
    You do not think that is a fair response because that is 
certainly the dominant response of the American people?
    Mr. Lew. Senator, I think that the IRS has gone through a 
thorough review. They made a report to the Congress. They are 
testifying and answering questions, and----
    Senator Vitter. Let me ask you this way; when a taxpayer 
files a tax return and takes a bunch of deductions and the IRS 
asks questions about those deductions and the taxpayer has no 
receipts, no documentation of the deductions, because the dog 
ate them, should the IRS accept that without any further 
outside investigation?
    Mr. Lew. Well, actually, the IRS policy, when a taxpayer 
has lost information because of something like a broken hard 
drive, is to work with the taxpayer to recover what can be 
recovered and to make determinations based on the data that are 
available.
    Senator Vitter. That is interesting. I think there are 
going to be a lot of broken hard drives happening in the next 
few months. So I would warn the IRS about that.
    An archivist of the United States testified yesterday that 
the IRS did not follow the law when it failed to report the 
loss of records belonging to a senior IRS executive.
    What consequences will there be for that failure?
    Mr. Lew. Senator, the IRS IG is looking at this whole 
matter. So there are independent eyes being put on it, and I 
would defer to the IRS IG for those matters.
    Senator Vitter. Also, a number of IT professionals disagree 
that these emails are unrecoverable.
    What, if anything, are you doing to bring those 
professionals into the process?
    Mr. Lew. Senator, I am happy to take back any questions 
that arise.
    I am not, as I say, an IT professional. I have been told 
that extraordinary steps have been taken to recover the data.
    Senator Vitter. I just want to emphasize, Mr. Secretary, 
that in the real world, when I talk to folks in Louisiana--
Democrat, Republican, Independent--their reaction to the notion 
that this is a pure accident and coincidence ranges from some 
who are very, very dubious to most who think that that 
assertion is laughable.
    And this is growing the distrust gap enormously between 
Washington and the American people. Something needs to be done 
about it.
    Mr. Lew. Well, Senator, I obviously do not disagree that it 
is unfortunate that the hard drive broke.
    I am answering your questions. The IRS is answering 
questions. It was from 2011, when the hard drive broke, until 
now that every effort has been made to recover.
    Senator Vitter. And the only folks looking into it work at 
the IRS. The only folks looking into it are those who work at 
the IRS.
    Mr. Lew. Senator, the IG is looking into it.
    Senator Reed. Senator Warren, please.
    Senator Warren. Thank you, Mr. Chairman.
    And thank you, Mr. Secretary, for being here.
    You know, Mr. Secretary, there are two tools to address the 
ongoing too-big-to-fail problem. We could address the to-fail 
part by trying to eliminate all the different ways that massive 
financial institutions could take on too much risk, or we could 
address the too-big part of it by breaking up the biggest banks 
so that even if they did take on too much risk we could let 
them fail without worrying that they would bring down the whole 
economy.
    Now Dodd-Frank focused principally on the first approach, 
trying to address the sources of risk in the system.
    But since Congress enacted that law, the risks have 
changed. Banks have gotten more involved in the ownership and 
trading of physical commodities like aluminum, oil and gas. 
They have started offering securities backed by subprime auto 
loans, which look an awful lot like the subprime mortgage-
backed securities that cause the 2008 crisis.
    It seems like we are playing a game of Whack-A-Mole. As we 
address some sources of risk, others start popping up.
    So my question is given how quickly the amount and types of 
risk change for these massive financial institutions and how 
difficult it is for regulators to master these new challenges, 
how confident are you that we can solve the too-big-to-fail 
problem by focusing only on regulating risk rather than using a 
combination of regulating risk and reducing size?
    Mr. Lew. Senator, I actually think that size does not 
always correlate with risk. You could have a smaller 
institution that creates more risk.
    Senator Warren. Let me just stop you there, Mr. Secretary, 
just because you and I have had this conversation before.
    Mr. Lew. We have.
    Senator Warren. And this part of it we can just rehearse 
very quickly by saying the question is not whether it always 
correlates.
    The question is whether or not a large institution that 
takes on more risk poses more risk to the economy than a 
smaller institution that takes on more risk.
    And it is a question of using one tool--that is, you are 
just trying to manage risk--or using two tools, that risk and 
size matter.
    Mr. Lew. Senator, I think that if you look at the approach 
we have taken--and when I say we, I do not mean just Treasury 
but the regulators have taken--it imposes substantial burdens 
on large firms by requiring higher capital reserves, by putting 
tougher standards in place.
    So there has not been an ignoring of size. It has been to 
impose internalized costs to reduce the risk.
    Now whether there is more that needs to be done is 
something we need to continue to look at.
    Senator Warren. But, Mr. Secretary, what has been the 
consequence of your having imposed these, as you put them, 
costs on size? We have watched over the last 5 years the 
largest financial institutions have gotten substantially 
larger.
    So it is not that these tools have been effective to reduce 
the size. They have grown.
    Mr. Lew. Well, they also have much higher capital reserves, 
and they are in a position that is not the same as the position 
they were in at the beginning of the process.
    I mean, at some level, if the price of being big means 
having larger capital reserves and you can build in more 
protections, the question, which I think is a fair question, 
is, is that enough?
    But the approach taken has not been to ignore size is what 
I am saying.
    Senator Warren. Well, all right, but they have gotten 
bigger. So whatever you are doing is obviously not causing them 
to get smaller, and that adds additional risk.
    So let me ask the question then a different way.
    I know that the Treasury Department has supported the big 
banks and objected to steps that would reduce their size, such 
as imposing asset caps or reinstituting Glass-Steagall.
    But the GAO will release a report shortly on whether the 
big banks continue to profit from their too-big-to-fail status.
    Now if that report confirms that too-big-to-fail is still a 
serious problem, will the Department rethink its opposition and 
support taking steps directly to reign in the size of the 
biggest financial institutions?
    Mr. Lew. Senator, I look forward to reading that report and 
other analyses of the issue because, obviously, it is an 
important question--whether there is a funding advantage--and 
the data, as we have discussed many times, are imperfect and 
not as current as we would all like.
    And we are always looking at what we can do to make our 
financial system safer and sounder.
    My reluctance to directly answer the question about kind of 
setting arbitrary size limits is that I worry that that perhaps 
misses the real risks, and I look forward to continuing the 
conversation.
    Senator Warren. Well, I appreciate that, Mr. Secretary.
    You said yesterday--and I will close here since I am over 
time.
    But you said yesterday, in testimony before the House, that 
we will not really know whether we have solved the too-big-to-
fail problem until there is another crisis. I hope that does 
not mean that nothing will change your mind on the question of 
addressing the fact that the biggest financial institutions in 
this country are getting bigger by the day and that size 
intersects with risk.
    Believing that we are using only one tool, and that is 
trying to regulate the risk, without paying attention to size, 
I think, runs some enormous risks.
    I know I do not have to remind you; we cannot afford 
another financial meltdown, and these big banks pose a risk to 
the entire economy.
    Mr. Lew. Senator, I think that there should not be a day 
when we do not look forward at what the risks of the future are 
and challenge our assumptions that we have come to today with 
and ask, do we have the tools we need for the future? That is 
how I approach every issue.
    And we have to rethink things. So I do not have views that 
are locked in based on the past.
    But I do think that if you look at what we have been doing 
we have been keeping a focus on where we think the risks are 
the greatest. So we are keeping a lot of pressure on the 
regulators to act on shadow banking. We are keeping a lot of 
pressure on the international system to meet U.S. capital 
standards so our exposure is not so great in our complex, 
global financial system.
    And I look forward to continuing to look at all these 
issues.
    Senator Warren. I appreciate that.
    I appreciate your willingness to consider and reconsider 
the impact of size and also to continue to take a very hard 
look. These banks are taking on new forms of risk and that--I 
apologize.
    Mr. Lew. I know you are over time and I am over time, but I 
actually think size is not necessarily the only issue. 
Complexity is an issue that may be more important than size.
    Senator Warren. Hence, the reason to use two tools and not 
just one.
    Mr. Lew. But I do not think that leads to an arbitrary 
limit that would not necessarily deal with that problem.
    Senator Warren. Many ways to deal with size without calling 
it an arbitrary limit--I will not let him get the last word.
    Thank you, Mr. Chairman.
    Senator Reed. Senator Heller.
    Senator Heller. Mr. Chairman, thank you.
    And to the Secretary, thank you for being here also.
    I want to begin by saying that I do not share your 
confidence in Commissioner Koskinen. I have been here for 7 \1/
2\ years and have never seen a more arrogant witness in my time 
here. And coming from a city that breeds arrogance, that is 
really saying something.
    I want to begin by following up with Senator Moran's and 
Senator Vitter's questions on the IRS scandal.
    Before I do so, I would like to start with a quote from the 
President last year that said, ``The IRS has to operate with 
absolute integrity, and the Government has to conduct itself in 
a way that is true to the public trust.''
    And I would argue that this Administration has completely 
failed on every single one of those points, and I think there 
are many here in this room that would agree with me.
    Going back to Senator Moran's questions and being very 
specific, Secretary Lew, when were you first personally aware--
when were you first personally aware that Lois Lerner's emails 
were lost?
    Mr. Lew. Senator, as I testified yesterday, I became aware 
of it roughly at the time Congress did, just days before.
    Our attorneys were talking to each other, and I think 
correctly said that they should fully understand the whole 
situation and then bring it forward and disclose it completely, 
and that is what they did.
    Senator Heller. So they found out in April and did not tell 
you until you heard on TV?
    Mr. Lew. No, no, I said I learned just before.
    Senator Heller. So a week ago?
    Mr. Lew. I would have to----
    Senator Heller. Days ago? A week ago?
    Mr. Lew. I learned, you know, a day or two before.
    Senator Heller. OK, you said days ago.
    Did you give or receive any directives of how the IRS 
should handle that?
    Mr. Lew. I am sorry I did not hear you.
    Senator Heller. Did you give the IRS, or have you had 
opportunity to give them, any directives?
    Mr. Lew. Our general counsels engaged on this, and the 
direction----
    Senator Heller. Are you engaged?
    Mr. Lew. The direction that was given was figure out what 
happened and share that information when you thoroughly can 
explain where it is. I think that was the right guidance.
    Senator Heller. But I just want to know. What are the 
discussions between Treasury and the IRS? What has been taking 
place since you found out?
    Mr. Lew. The IRS is responsible in this area, and 
Commissioner Koskinen has been answering questions on it, and I 
have remained abreast of what is going on.
    But, obviously, I am not the IT expert. I cannot go back 
and go through the details of----
    Senator Heller. Are you responsible for the IRS? Are you 
responsible?
    Mr. Lew. The IRS is part of the Treasury Department.
    Senator Heller. Right, right. So you have a hands-off 
approach?
    Mr. Lew. No, I did not say I have a hands-off approach.
    Senator Heller. It sounds to me you have a hands-off 
approach moving forward on this.
    Mr. Lew. Senator, I do not pretend to be an IT expert.
    Senator Heller. I am not asking you to be an IT expert.
    All I am asking you is, are you having discussions today, 
as head of the Treasury Department, with the IRS on this issue? 
Are you having discussions?
    Mr. Lew. There----
    Senator Heller. You can tell me no. That is all right.
    Mr. Lew. No. The direction which was given by Treasury was 
to get to the bottom of this and to understand it and to share 
the information. That is, I think, what was the right thing to 
do.
    Obviously----
    Senator Heller. Have you had any personal discussions with 
the White House about these lost emails?
    Mr. Lew. I am not going to get into specific conversations, 
but there has been--this is something that the IRS has analyzed 
and shared everything that they know.
    Senator Heller. So, as part of your hands-off approach, you 
have not even talked to the White House about this?
    Mr. Lew. Look, the IRS is an agency that I think 
appropriately operates within Treasury with a great deal of 
independence because I do not think it would be in anyone's 
interest for there to be any political interference with the 
IRS.
    But on questions----
    Senator Heller. We can just move on.
    The Federal Records Act requires that all agencies back up 
all official documents and communications.
    Do you believe that the IRS has broken any laws?
    Mr. Lew. The IRS IG is taking a look at this, and I will 
obviously read that report.
    Senator Heller. Can we go somewhere else besides the 
Treasury IG or the IRS IG?
    Can we get an independent review? I think that is what 
Senator Vitter was trying to get to.
    Can we get outside the Treasury Department, outside the 
IRS, and get an independent review of this?
    Mr. Lew. You know, I have never heard a question raised 
about the independence of the IRS IG.
    Senator Heller. Well, you are hearing it. You are hearing 
it.
    Can we?
    Mr. Lew. The IG is an independent investigator.
    Senator Heller. Would you support outside the Treasury 
Department taking a look at this?
    There is a real lack of confidence.
    Mr. Lew. I think the IG investigation is appropriate and is 
underway.
    Senator Heller. You are sounding just like the commissioner 
now. You are sounding just like the commissioner.
    Mr. Lew. Senator----
    Senator Heller. Can you get an independent counsel outside 
the Treasury to take a look at this issue?
    Mr. Lew. Senator, I think the IG review is the appropriate 
step.
    Senator Heller. So you are saying no.
    Mr. Lew. I am telling you what I think the appropriate step 
is.
    Senator Heller. Your answer is no.
    Thank you, Mr. Chairman.
    Senator Reed. Thank you, Senator Heller.
    I am informed that Senator Shelby has one question.
    Senator Shelby. One question, I hope.
    Senator Reed. Asking that question, I will recognize 
Senator Shelby.
    Senator Shelby. Mr. Secretary, I have before me a Treasury 
Order 10105, which breaks down the relationship and supervision 
of officials in the Department of Treasury. That is, you 
designate under the order the Deputy Secretary is authorized to 
work in your behalf and so forth. It has got a list of the 
Under Secretaries, and number 11 is the Commissioner of 
Revenue.
    The IRS Commissioner, as I understand it, according to your 
directive here, reports directly to the Deputy Secretary of the 
Treasury, which reports--the Deputy reports to you. Is that 
right?
    Mr. Lew. That is correct.
    Senator Shelby. OK. Now----
    Mr. Lew. I mean, it is a bit more independent than other 
subunits; we should clear.
    Senator Shelby. Not totally?
    Mr. Lew. Not totally, no, no, no. I never said it was.
    Senator Shelby. Do you believe that the integrity of the 
IRS is of the utmost importance to the functioning of this 
Government?
    Mr. Lew. Look, I have said many times, and I believe 
deeply----
    Senator Shelby. Yes or no--do you believe that?
    Mr. Lew.----that in a functioning democracy the integrity 
of the IRS is critical.
    Senator Shelby. Do you realize--you, the Secretary of the 
Treasury--that the IRS's integrity has been called into 
question all over America, in other words, for what has been 
going on at the IRS the last several years?
    People do not trust the IRS. They do not believe that those 
tapes and hard drives just disappeared.
    You know all this. I think you are an honorable man. I have 
known you a long time.
    But isn't it time--isn't it past time--for us to get past 
you looking at internally, even by an inspector general, and 
get a special prosecutor to restore the integrity of the IRS, 
whatever the cost, wherever it leads?
    Mr. Lew. Senator, I believe that if you look at the amount 
of investigation that has been done, that has produced no 
evidence of any political interference in this process, if one 
looks at the record, the record should actually be reassuring.
    Obviously, there is a desire to keep asking questions. I 
understand that, but I do not think it is because the questions 
have not been thoroughly examined by committee after committee 
of Congress, independently looking at all of the evidence, 
interviewing people, going through millions of pages of 
documents. No evidence of political interference--at some 
point, the process has to recognize that.
    Senator Shelby. Well, I think most people would think there 
has been a lot of interference by the IRS.
    Mr. Lew. There is no evidence of it.
    Senator Shelby. Not just the disappearance of the tapes but 
what went on before them, when they were stonewalling different 
designations that should have been approved.
    But the integrity of the IRS is what is important, and the 
American people--I think that is in question now.
    How do you restore it? I believe you get to the bottom of 
this.
    And I do not believe Treasury and the inspector general and 
others can do this. We need outside special prosecutors to do 
it because it is important, not only to this Administration but 
to the functioning of Government, period.
    Thank you.
    Senator Reed. Thank you, Senator Shelby.
    Thank you, Mr. Secretary, for your testimony.
    As many of my colleagues indicated, they will submit 
written questions to you, and we ask for your prompt response.
    With that, I will say, the hearing is adjourned.
    [Whereupon, at 11:49 a.m., the hearing was adjourned.]
    [Prepared statements and responses to written questions 
supplied for the record follow:]
            PREPARED STATEMENT OF SENATOR RICHARD C. SHELBY
    Thank you, Mr. Chairman.
    My position on the Financial Stability Oversight Council, or FSOC, 
is well known. As I have said in the past, I have strong concerns with 
the Council, which, I believe, was one of Dodd-Frank's ways of 
preserving and codifying preferential treatment for large institutions 
with any hand in financial markets.
    I am afraid that my concerns with the structure of the Systemically 
Important Financial Institution, or SIFI, designation process have 
proven eerily true for financial firms of all sectors. It seems to me 
that not only is the process thoroughly opaque, but aside from an 
introductory threshold, the qualifications for designation are devoid 
of any quantitative data. What constitutes interconnectedness? What 
specific metric does FSOC use to determine a systemically important 
level of interconnectedness? Mr. Chairman, we don't know.
    Further, as I have outlined before, I remain concerned with the 
ideology of a SIFI designation entirely. The Federal Government should 
not pick winners and losers in the market. Yet, that is exactly what a 
designation does; it chooses which firms are too-big-to-fail. Mr. 
Chairman, I understand that this Committee has already had this debate; 
however, I do not believe it is over. I believe stronger-still capital 
standards for the major market players should be on the table. I look 
forward to hearing Chairman Lew's perspective on this matter and on 
many of these other concerns, and I hope he shares them.
    Thank you Mr. Chairman.
                                 ______
                                 
                   PREPARED STATEMENT OF JACOB J. LEW
                 Secretary, Department of the Treasury
                             June 25, 2014
    Chairman Johnson, Ranking Member Crapo, and Members of the 
Committee, thank you for the opportunity to testify today regarding the 
2014 annual report of the Financial Stability Oversight Council.
    Nearly 4 years ago, President Obama signed into law the Dodd-Frank 
Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), the 
most comprehensive set of reforms to our financial regulatory system 
since the Great Depression. As a result of the implementation of these 
new rules, consumers have access to better information about financial 
products and are benefiting from new protections. Financial markets and 
companies have become more resilient. Regulators have become better 
equipped to monitor, mitigate, and respond to threats to financial 
stability. And today, our financial system is better capitalized, more 
transparent, and better prepared to withstand shocks.
    As many of you know, one of the important reforms in the Dodd-Frank 
Act was the creation of the Financial Stability Oversight Council 
(Council). Before the Council, no single authority was accountable for 
monitoring and addressing risks to financial stability, and each 
regulator focused on the institutions, functions, or markets under its 
purview. As we learned, without a mechanism to look at the entire 
financial system, risks to financial stability can spread quickly 
across institutions and markets. This siloed approach allowed certain 
risks to fall through the cracks of the regulatory system and failed to 
protect us in the lead-up to the crisis.
    Congress changed that. With the establishment of the Council, 
senior regulators from across the system now meet regularly to 
facilitate a more coordinated approach to monitoring, identifying, and 
responding to potential threats to financial stability. Today, the 
Council provides a forum to foster regular and close collaboration 
among its members at both the Federal and State levels. This 
collaboration features frequent meetings between senior officials, as 
well as dedicated and ongoing engagement among staff on a near-daily 
basis.
    Independent regulators continue to be responsible for regulating 
the markets and institutions they oversee. But they are now also part 
of a process that enables them to look across markets and institutions 
to monitor the entire financial system and identify potential risks to 
U.S. financial stability. Some now suggest that this function should be 
curtailed, but hindering the Council's ability to analyze information 
regarding particular sectors, firms, or activities runs the risk of 
missing the next threat to our financial system and the U.S. economy. 
This is an important responsibility that the Council must fulfill.
    Today, there are even some who challenge the notion that the 
Council should ask questions about whether certain activities or 
companies might pose risks to the stability of the U.S. financial 
system. But asking questions does not equal regulatory action. We 
learned from the financial crisis that regulators should have asked 
more, not fewer, questions about the institutions and activities that 
they oversaw. And today we should ask these questions equally prepared 
to find a reason to take action or not. But if we avoid or are 
discouraged from asking questions altogether, our financial system will 
be more exposed to unseen risks, potentially leading to large scale 
problems.
    There are many possible outcomes associated with the Council 
examining a particular risk. If the Council determines there is a risk 
that requires action, Congress provided the Council with a broad range 
of authorities and potential remedies. The Council may also conclude 
that it does not need to act, that it needs to examine and issue 
further, or that it must gather additional data. What the Council 
should not do is cordon off any sector or activity without even 
considering it. That would be a dereliction of Council responsibilities 
and a complete disregard for the very purpose of the Council.
    Some also claim that the Council's processes are opaque and its 
outcomes are predetermined, but that is simply wrong. The Council has 
voluntarily adopted a robust transparency policy and put in place a 
comprehensive, deliberative approach to its evaluation of risks, and it 
solicits public input and carefully considers all points of view. Its 
report, which I will be discussing today as the subject of this 
hearing, describes the work of the Council.
    As the distance in time since the financial crisis grows, we must 
not forget the financial and emotional pain endured by millions of 
American families who lost their homes, their retirement savings, or 
their jobs. We cannot return to a regulatory environment that failed to 
detect risks to financial stability and was unequipped to mitigate 
those risks and prevent the damage to our financial system and economy.
    In this context, the Council's annual report stands as a testament 
to how the Council is executing on its statutory duty to identify and 
respond to potential threats to financial stability. The report 
reflects the collective judgment of Council members regarding the key 
risks to financial stability and provides an important example of how 
the Council shares information about its work with Congress and the 
public in a clear and transparent manner. Each annual report is the 
product of a highly collaborative analysis conducted by the Council's 
member agencies to document for the public the Council's sense of the 
risks present in all corners of the market, its assessment of how those 
risks might be transmitted to the broader financial system, and its 
recommendations for specific actions to mitigate those risks.
    The Council's annual report also provides a roadmap for the 
Council's agenda for the upcoming year--what areas it will focus on, 
what areas will likely require additional attention, and how it expects 
to address them. The 2014 annual report focuses on nine areas that 
warrant continued attention and possibly further action from the 
Council's members:

    First, regulatory agencies and market participants should 
        continue to take action to reduce vulnerabilities in wholesale 
        funding markets, including tri-party repo and money market 
        mutual funds, that can lead to destabilizing fire sales.

    Second, regulators should continue to work with 
        policymakers to implement the significant structural reforms 
        needed to reduce taxpayers' exposure to risk in the housing 
        market.

    Third, cybersecurity threats, infrastructure 
        vulnerabilities, and other operational risks remain a top 
        priority for the Council, and regulators should continue to 
        take steps to prevent operational failures and improve 
        resiliency.

    Fourth, as the financial system evolves in response to 
        technological, competitive, and regulatory changes, regulators 
        should remain attentive to financial innovations and the 
        migration of certain activities outside of traditional 
        financial intermediaries that could create financial stability 
        risks.

    Fifth, U.S. regulators should continue to cooperate with 
        foreign counterparts to address concerns about benchmark 
        reference rates such as LIBOR.

    Sixth, regulators and institutions should remain vigilant 
        in monitoring and assessing risks related to interest rate 
        volatility, particularly as investors seek higher yields in a 
        low interest rate environment.

    Seventh, Council member agencies should continue to work 
        with the Office of Financial Research (OFR) to fill financial 
        data gaps and address related issues of data quality and 
        comprehensiveness.

    Eighth, regulators should continue implementation of Dodd-
        Frank reforms to reduce risk-taking incentives of large, 
        complex, interconnected financial institutions.

    And finally, there is a need for continued monitoring of 
        adverse financial developments abroad and their potential 
        impact on the U.S. financial system.
Activities of the Council
    Since its 2013 annual report, the Council has continued to fulfill 
its statutory responsibilities to identify risks to U.S. financial 
stability, promote market discipline, and respond to emerging threats 
to the stability of the U.S. financial system. The Council regularly 
examines significant market developments and structural issues within 
the financial system. For example, over the past year, the Council 
considered issues such as market volatility, the Government shutdown 
and debt ceiling impasse, interest rate risk, economic developments in 
Europe and emerging economies, housing finance reform proposals, the 
NASDAQ trading halt in August 2013, and risks to financial stability 
arising from cybersecurity threats. Recognizing the need to be vigilant 
in responding to new and emerging challenges, the Council will continue 
to monitor potential threats to financial stability and to facilitate 
coordination among its member agencies.
    In addition, last year, the Council made its first designations of 
nonbank financial companies. The Council's designations authority 
addresses a key weakness brought to light by the financial crisis: the 
existing regulatory structure allowed some large, complex nonbank firms 
to pose risks to financial stability that were not subject to adequate 
supervision. As a result, the Dodd-Frank Act allows the Council to 
designate nonbanks whose distress or activities could pose a threat to 
U.S. financial stability, and subject them to supervision by the 
Federal Reserve and enhanced prudential standards. The Council has used 
a thorough and transparent process when considering these companies for 
designation, giving each company numerous and extensive opportunities 
to engage with the Council and its staff and to understand the detailed 
reasons for any designation.
    The Council voted in July 2013 to make final determinations 
regarding American International Group (AIG) and General Electric 
Capital Corporation. In September 2013, the Council voted to make a 
final determination regarding Prudential Financial. The Council had 
notified those companies in the fall of 2012 that they were under 
review for potential designation, and the companies submitted 
information for the Council to consider in its evaluations. The lengthy 
and careful analyses conducted by the Council included frequent and 
substantive interactions with the companies under consideration.
    Let me give you an example. For one of the companies that has been 
designated, Council staff spent over a year conducting an analysis that 
considered more than 200 data submissions from the company that totaled 
over 6,000 pages. The Council or its staff met with the company 20 
times. Prior to a final determination, the Council prepared and shared 
with the company an approximately 200-page document outlining the 
Council's analysis and rationale for a proposed determination. The 
company responded to this document and discussed it with all the 
members of the Council before the Council made a final decision. This 
determination--and any others made by the Council regarding nonbank 
financial companies--was based on the standards set forth by Congress 
in the Dodd-Frank Act and followed the process laid out in the 
Council's public rule and guidance.
    One final point I would like to make here is that given the global 
nature of the financial system, the United States has made strong 
commitments to international efforts to institute financial regulatory 
reforms comparable to and consistent with ours. Such efforts are 
important to safeguarding the U.S. financial system from threats 
resulting from weaker regulation abroad, as well as to promoting a 
level playing field for U.S. firms that operate internationally.
The Council's Governance and Transparency
    The Council is committed to conducting its work publicly. Indeed, 
as I noted publicly at our May meeting, the Council's annual reports 
will continue to serve as a key tool for communicating our activities 
to the public and Congress.
    However, much of the Council's work--particularly in regards to 
companies under consideration for potential designation--relies on 
sensitive company and industry data and information that would not be 
shared by firms or regulators without an expectation of 
confidentiality. Accordingly, the Council is committed to conducting 
its meetings in public whenever possible and to releasing minutes for 
all its meetings. Though no statute requires the Council to do so, we 
believe taking these steps helps provide the public with insight into 
the Council's work. We have kept those commitments over the past three 
and a half years, including holding 12 open meetings and releasing 
minutes for 40 meetings.
    The Council also understands that it can always improve upon its 
commitments. To that end, beginning in 2013, the Council undertook a 
review of its governance and transparency policies to determine whether 
it can even better enhance its openness and accountability to the 
public while still protecting sensitive information. This review has 
included consideration of the practices of other organizations with 
similar structures, memberships, or responsibilities as the Council. 
For example, during a public session in May, the Council revised its 
transparency policy to incorporate several enhancements to improve 
communication with the public. Additionally, the Council adopted bylaws 
for its Deputies Committee that will provide further visibility into 
some of its staff work.
    The Council understands that the perspective of the public enhances 
its analysis. Accordingly, it actively seeks input from outside parties 
to inform its work. For example, in December 2013, a representative 
from the banking sector joined a public meeting of the Council to 
discuss cybersecurity. In May, the Council hosted a public conference 
on asset management to hear directly from industry representatives, 
academics, and other stakeholders on topics related to asset 
management. The Council continues to work with State and foreign 
regulators in the course of its analysis on nonbank financial 
companies. The Council continues to benefit from this type of 
engagement with external stakeholders and expects to continue to be 
informed by outside experts on its work going forward.
Progress on Financial Regulatory Reform
    The 2014 annual report discusses the significant progress that 
Council member agencies, both individually and collectively, have made 
in implementing Dodd-Frank Act reforms. As a result of the 
implementation of these reforms, consumers have access to better 
information about financial products and are benefiting from new 
protections. Financial markets and companies have become more resilient 
and transparent, and regulators have become better equipped to monitor, 
mitigate, and respond to threats to the financial system.
    Over the past year, the regulators reached a number of key 
milestones in financial reform implementation, including:

    finalization of the Volcker Rule, bank capital rules, a 
        supplementary leverage ratio for the largest banks and bank 
        holding companies, enhanced prudential standards for the U.S. 
        operations of large foreign banks, and the development of 
        clearing, trading, and registration requirements for certain 
        swaps markets;

    proposed rulemakings on money market mutual fund (MMF) 
        reform, risk retention for securitizations, and requirements 
        for short-term liquidity coverage for large banking 
        organizations; and

    significant reductions in intraday credit exposures in the 
        tri-party repo market and significant progress on the strategy 
        for financial institution resolution under the orderly 
        liquidation authority.

    On a related note, there has been continued progress toward 
achieving an international minimum standard that would allow national 
authorities in the majority of the world's largest economies to wind 
down failing global banks without the use of taxpayer money. We also 
anticipate progress on a framework for cross-border cooperation in the 
future resolutions of global banks. Now let me provide greater detail 
about the nine areas of focus covered in the report.
Areas of Focus of the Council's 2014 Annual Report
Wholesale Funding Markets
    The Council has highlighted run risks associated with MMFs and the 
tri-party repo market since our first annual report in 2010. Regarding 
MMFs, in June 2013 the SEC proposed rules to reform the structure of 
MMFs in order to make them less susceptible to runs. This proposal 
includes a number of the same principles and concepts, such as 
requiring a floating NAV, that were part of the proposed 
recommendations for reform issued by the Council in November 2012. The 
Council recommends that the SEC move forward and adopt meaningful 
structural reforms designed to address MMF run risk. The Council also 
recommends that its member agencies examine the nature and impact of 
any structural reform of MMFs that the SEC implements to determine 
whether the same or similar reforms are appropriate for other cash-
management vehicles.
    In the tri-party repo market, there has been significant progress 
in reducing market participants' reliance on intraday credit from the 
clearing banks. The share of tri-party repo volume funded intraday by 
the clearing banks fell from 92 percent in December 2012 to under 20 
percent in December 2013. Vulnerabilities to fire sales remain, 
particularly with respect to borrowers, such as broker-dealers, that 
rely heavily on these markets for financing. The Council acknowledges 
the work that has been done in the past year to reduce the reliance on 
discretionary intraday credit, which is forecasted to be less than 10 
percent by the end of 2014. Nevertheless, a default of a broker-dealer 
remains a key vulnerability that could lead to fire sales of repo 
collateral, and may lead to the disruption of certain asset and 
financing markets. The Council recognizes that regulatory reforms 
implemented since the crisis, such as increases in the amount of 
capital, liquidity, and margin changes for U.S. broker-dealers, may 
help to mitigate the risk of default. However, the Council advises all 
U.S. regulators of firms that rely on this market for funding to assess 
whether additional steps must be taken to protect borrowers from 
funding runs.
Housing Finance Reform
    The housing finance system continues to require significant reform 
to enhance financial stability. The residential mortgage market relies 
heavily on Government guarantees, while private mortgage activity 
remains muted. Increasing the presence of private capital and reducing 
risk to taxpayers in housing finance remains a priority. Fannie Mae and 
Freddie Mac achieved their targets for risk-sharing transactions and 
reductions in their mortgage investment portfolios. Member agencies 
also made progress on the risk-retention rule, and infrastructure 
reforms such as the development of the Common Securitization Platform 
are moving forward. The annual report outlines the ongoing need for 
market participants, regulators, and Congress to work together to 
create structural reforms that will help reduce uncertainty in the 
housing finance market, provide access for creditworthy borrowers, and 
protect taxpayers. In the past year, progress was made toward 
establishing a new framework for housing policy, but ultimately 
Congress must pass legislation to achieve comprehensive housing finance 
reform.
Operational Risks
    Cybersecurity remains a top priority for the Council, as deliberate 
attempts to disrupt institutions, markets, and commerce continue, as 
seen in the high-profile cyber-attack on Target that resulted in the 
theft of bank card and customer information. While companies and 
financial markets become more dependent on complex technologies and 
networks, the frequency, severity, and sophistication of such incidents 
are likely to rise. The Council recommends that financial regulators 
continue their efforts to assess cyber-related vulnerabilities facing 
their regulated entities and identify gaps in oversight that need to be 
addressed. In addition, the Council recognizes the importance of 
removing legal barriers to information sharing between public and 
private sector partners to enhance overall awareness of cyber threats, 
vulnerabilities, and attacks in a manner that continues to protect 
privacy and civil liberties, including the passage of comprehensive 
cybersecurity legislation by Congress.
    Market continuity and confidence were also challenged this past 
year with an increase in outages and failures resulting from 
technological and infrastructure vulnerabilities. Some of these 
incidents led to the temporary suspension of trading. Other incidents 
involved software failures that sent involuntary orders through 
automated trading systems, leading to large losses. The vulnerabilities 
that are associated with such incidents may be heightened, particularly 
in fragmented markets, by high-frequency or low-latency automated 
trading activities. The Council recognizes that alternative trading 
venues and methods may present operational and other risks by 
magnifying system-wide complexity. As such, the Council recommends that 
regulators focus not only on centrally traded products, but also on a 
broader set of financial products and trading methods off exchanges.
Financial Innovation and Migration of Activity
    The financial system is constantly evolving, with the development 
of new products, services, and business practices. These changes can 
provide a number of benefits to the financial system, but they may also 
present new risks. While new products or services are often developed 
as a result of technological and competitive forces, sometimes they are 
created to circumvent regulation. In other instances, the migration of 
some activities may move a regulated activity outside of the regulatory 
perimeter. The changing landscape of the post-financial crisis world 
has fostered many innovations which should be monitored for the 
potential to create risks to financial stability.
Reference Rates
    Beginning in the second half of 2012, investigations uncovered 
multiple instances of systematic false reporting and manipulation of 
widely used survey-based benchmark interest rates, such as LIBOR and 
EURIBOR, by reporting banks. More recently, concerns have been raised 
about the integrity of certain foreign exchange (FX) rate benchmarks. 
One important insight from the recent allegations in FX markets is that 
transactions-based benchmarks can also be subject to manipulation and 
adversely impact related markets.
    While some progress has been made to find viable alternative 
interest-rate benchmarks, more work is needed. The Council recommends 
U.S. regulators continue to cooperate with foreign regulators and 
international bodies to identify alternative interest rate benchmarks 
anchored in observable transactions and supported by appropriate 
governance structures, and to assess market practices and benchmarks in 
the FX markets. The Council also recommends development of a plan to 
implement a smooth and orderly transition to any new benchmarks.
Resilience to Interest Rate Volatility
    The prolonged period of low interest rates and low volatility has 
provided incentives for investors and financial institutions to search 
for yield by extending the duration of their portfolios, investing in 
lower-quality credit, increasing leverage, or easing underwriting 
standards. Such strategies may increase short-term profits, but at the 
risk of large losses in the event of a sudden yield curve steepening or 
a large rise in rates.
    Despite the relatively benign impact on financial stability of last 
year's sharp rise in interest rates, volatility remains a potential 
threat to financial stability. For this reason the Council recommends 
that supervisors, regulators, and financial firm management continue to 
monitor and assess the growing risks resulting from search-for-yield 
behaviors as well as the potential risk of severe interest rate shocks.
Data Quality and Comprehensiveness
    High quality and readily available access to financial data is 
critical for regulators, supervisors, and financial firms, but access 
to comprehensive data is limited. For example, regulators lack 
sufficient data to thoroughly analyze all repo markets, and they are 
still unable to effectively monitor securities lending transactions and 
the reinvestment of cash collateral. In addition, some regulators still 
face difficulties in accessing data stored at swap data repositories. 
However, regulators have made significant progress in addressing 
financial data gaps in recent years. They now collect real-time data 
from various markets and institutions. There has also been progress in 
improving the standardization of certain financial data, including the 
legal entity identifier (LEI), which will help to identify parties to 
financial transactions. The widespread adoption of LEI both 
domestically and globally, together with the work to enhance the 
consistency and availability of swaps data reported by swaps data 
repositories, would improve the ability of regulators to monitor 
emerging risks in the financial system. The Council supports these 
efforts and recommends that member agencies and the OFR continue to 
work together to promote high-quality data standards and fill data gaps 
where they exist.
Risk-taking Incentives of Large, Complex, Interconnected Financial 
        Institutions
    Historically, when large, complex, interconnected financial 
institutions became distressed, official authorities often intervened 
to maintain financial stability. The Dodd-Frank Act addresses the 
incentives and abilities of large, complex, interconnected financial 
institutions to engage in excessive risk-taking that could result from 
implicit expectations of future official sector intervention. Financial 
regulatory reforms have created much stronger financial institutions, 
with capital levels doubling compared to pre-crisis levels, 
significantly reducing the likelihood of failure. Reforms have also 
been designed to minimize the damage that any single firm's failure 
would have on the broader financial system.
    During 2013, the largest U.S. financial institutions continued to 
reduce their complexity in some dimensions. Additionally, credit rating 
agency assessments of potential Government support to U.S. bank holding 
companies reflect declining expectations of the likelihood of 
Government support. However, rating agency opinions continue to 
explicitly factor in the possibility that the Government will provide 
support to the largest banks if they become financially distressed. The 
full implementation of the orderly liquidation authority, and the 
phasing in of enhanced prudential standards in coming years, should 
help reduce remaining perceptions of Government support for large, 
complex, interconnected financial institutions.
Foreign Markets Risks
    In 2013, domestic market participants remained concerned about the 
adverse consequences of financial developments abroad. However, the 
areas from which these risks emanate have changed considerably. In 
previous years, stability in peripheral Europe was a key area of 
concern for global financial markets. Over the past year, economic and 
financial conditions in the euro area have stabilized. At the same 
time, potential risks emanating from emerging markets have become more 
prominent. Beginning in the late spring of 2013, emerging market 
economy exchange rates and asset prices became much more volatile, and 
economic growth subsequently slowed in some of these economies. The 
potential spillover effects on the United States from emerging markets' 
stresses appear limited, but a substantial worsening of these stresses 
is a risk.
Conclusion
    In summary, the Council plays a critical role in our financial 
regulatory system by bringing together Federal and State financial 
regulators to identify potential risks across the system and prevent 
problems from falling through the cracks. The annual report is a 
reflection of the collaboration and collective judgment of these 
officials. Its findings and recommendations are a critical statement 
that guides action, promotes transparency, and creates accountability.
    I strongly believe that 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. Still, the Council must 
continue to remain vigilant to new risks while focusing on the risks 
highlighted in the annual report.
    I want to thank the other members of the Council, as well as their 
staffs, for their work over the last year, their efforts in preparing 
the 2014 annual report, and their ongoing contributions to the 
important work of the Council. 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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