[House Hearing, 114 Congress]
[From the U.S. Government Publishing Office]
THE IMPACT OF REGULATIONS
ON SHORT-TERM FINANCING
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON CAPITAL MARKETS AND
GOVERNMENT SPONSORED ENTERPRISES
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED FOURTEENTH CONGRESS
SECOND SESSION
__________
DECEMBER 8, 2016
__________
Printed for the use of the Committee on Financial Services
Serial No. 114-113
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HOUSE COMMITTEE ON FINANCIAL SERVICES
JEB HENSARLING, Texas, Chairman
PATRICK T. McHENRY, North Carolina, MAXINE WATERS, California, Ranking
Vice Chairman Member
PETER T. KING, New York CAROLYN B. MALONEY, New York
EDWARD R. ROYCE, California NYDIA M. VELAZQUEZ, New York
FRANK D. LUCAS, Oklahoma BRAD SHERMAN, California
SCOTT GARRETT, New Jersey GREGORY W. MEEKS, New York
RANDY NEUGEBAUER, Texas MICHAEL E. CAPUANO, Massachusetts
STEVAN PEARCE, New Mexico RUBEN HINOJOSA, Texas
BILL POSEY, Florida WM. LACY CLAY, Missouri
MICHAEL G. FITZPATRICK, STEPHEN F. LYNCH, Massachusetts
Pennsylvania DAVID SCOTT, Georgia
LYNN A. WESTMORELAND, Georgia AL GREEN, Texas
BLAINE LUETKEMEYER, Missouri EMANUEL CLEAVER, Missouri
BILL HUIZENGA, Michigan GWEN MOORE, Wisconsin
SEAN P. DUFFY, Wisconsin KEITH ELLISON, Minnesota
ROBERT HURT, Virginia ED PERLMUTTER, Colorado
STEVE STIVERS, Ohio JAMES A. HIMES, Connecticut
STEPHEN LEE FINCHER, Tennessee JOHN C. CARNEY, Jr., Delaware
MARLIN A. STUTZMAN, Indiana TERRI A. SEWELL, Alabama
MICK MULVANEY, South Carolina BILL FOSTER, Illinois
RANDY HULTGREN, Illinois DANIEL T. KILDEE, Michigan
DENNIS A. ROSS, Florida PATRICK MURPHY, Florida
ROBERT PITTENGER, North Carolina JOHN K. DELANEY, Maryland
ANN WAGNER, Missouri KYRSTEN SINEMA, Arizona
ANDY BARR, Kentucky JOYCE BEATTY, Ohio
KEITH J. ROTHFUS, Pennsylvania DENNY HECK, Washington
LUKE MESSER, Indiana JUAN VARGAS, California
DAVID SCHWEIKERT, Arizona
FRANK GUINTA, New Hampshire
SCOTT TIPTON, Colorado
ROGER WILLIAMS, Texas
BRUCE POLIQUIN, Maine
MIA LOVE, Utah
FRENCH HILL, Arkansas
TOM EMMER, Minnesota
Shannon McGahn, Staff Director
James H. Clinger, Chief Counsel
Subcommittee on Capital Markets and Government Sponsored Enterprises
SCOTT GARRETT, New Jersey, Chairman
ROBERT HURT, Virginia, Vice CAROLYN B. MALONEY, New York,
Chairman Ranking Member
PETER T. KING, New York BRAD SHERMAN, California
EDWARD R. ROYCE, California RUBEN HINOJOSA, Texas
RANDY NEUGEBAUER, Texas STEPHEN F. LYNCH, Massachusetts
PATRICK T. McHENRY, North Carolina ED PERLMUTTER, Colorado
BILL HUIZENGA, Michigan DAVID SCOTT, Georgia
SEAN P. DUFFY, Wisconsin JAMES A. HIMES, Connecticut
STEVE STIVERS, Ohio KEITH ELLISON, Minnesota
STEPHEN LEE FINCHER, Tennessee BILL FOSTER, Illinois
RANDY HULTGREN, Illinois GREGORY W. MEEKS, New York
DENNIS A. ROSS, Florida JOHN C. CARNEY, Jr., Delaware
ANN WAGNER, Missouri TERRI A. SEWELL, Alabama
LUKE MESSER, Indiana PATRICK MURPHY, Florida
DAVID SCHWEIKERT, Arizona
BRUCE POLIQUIN, Maine
FRENCH HILL, Arkansas
C O N T E N T S
----------
Page
Hearing held on:
December 8, 2016............................................. 1
Appendix:
December 8, 2016............................................. 33
WITNESSES
Thursday, December 8, 2016
Carfang, Anthony J., Managing Director, Treasury Strategies, a
Division of Novantas, Inc...................................... 6
Deas, Thomas C., Jr., Chairman, National Association of Corporate
Treasurers, on behalf of the U.S. Chamber of Commerce.......... 7
Konczal, Mike, Fellow, Roosevelt Institute....................... 9
Toomey, Robert, Managing Director and Associate General Counsel,
Securities Industry and Financial Markets Association.......... 11
APPENDIX
Prepared statements:
Carfang, Anthony J........................................... 34
Deas, Thomas C., Jr.......................................... 77
Konczal, Mike................................................ 89
Toomey, Robert............................................... 104
Additional Material Submitted for the Record
Rothfus, Hon. Keith:
Written statement of the Coalition for Investor Choice....... 115
Letter to Hon. Paul Ryan from the State Financial Officers
Foundation................................................. 123
Written responses to questions for the record submitted to
Anthony J. Carfang......................................... 125
Written responses to questions for the record submitted to
Thomas C. Deas, Jr......................................... 129
Written responses to questions for the record submitted to
Michael Konczal............................................ 131
Scott, Hon. David:
Letter to Hon. Gwen Moore from various undersigned
organizations.............................................. 133
THE IMPACT OF REGULATIONS
ON SHORT-TERM FINANCING
----------
Thursday, December 8, 2016
U.S. House of Representatives,
Subcommittee on Capital Markets and
Government Sponsored Enterprises,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 9:30 a.m., in
room 2128, Rayburn House Office Building, Hon. Scott Garrett
[chairman of the subcommittee] presiding.
Members present: Representatives Garrett, Royce,
Neugebauer, Huizenga, Duffy, Hultgren, Wagner, Messer,
Schweikert, Poliquin, Hill; Maloney, Scott, Foster, and Carney.
Ex officio present: Representative Hensarling.
Also present: Representative Rothfus.
Chairman Garrett. Good morning. The Subcommittee on Capital
Markets and Government Sponsored Enterprises will now come to
order.
Without objection, the Chair is authorized to declare a
recess of the subcommittee at any time.
Also, without objection, any members of the full Financial
Services Committee who are not members of the subcommittee are
authorized to participate in today's hearing, although I am not
sure we will have that.
With that said, I will recognize myself for 2 minutes with
regard to this committee meeting and, before I do that,
actually, just to say we have been notified that there will be
votes right in the middle of things, as is often the case here.
So, in reality, what we will probably be doing is doing our
opening statements by the members, a couple of members, and
then going to opening statements from the panel. And I bet that
will be just about when votes will interfere with us. So we
will go on, take a break, go on recess, and then come back for
the deep and penetrating questions that will enliven the
discussion for the next 3 or 4 hours. Well, maybe not.
So let me just address the matter before us as far as the
hearing today. During the last couple of years, this
subcommittee and the full committee have comprehensively sought
to facilitate capital formation by considering some 40 pieces
of legislation, many of them bipartisan legislation--actually,
the majority of them I think bipartisan legislation. In doing
so, we examined the activities of the SEC's major divisions and
offices and conducted oversight of the many self-regulatory
organizations that oversee different pieces of capital markets.
And, today, the subcommittee meets to examine the impact of
regulations on short-term financing in the U.S. capital
markets. The Federal securities laws, which are the bedrock of
our capital markets, were put in place eight decades ago to
promote the transparency of security offerings and to mitigate
and enforce against fraud in the markets. And it created the
SEC to carry out this important mission.
As this subcommittee is well aware, the SEC's mission is
what? It is threefold: to protect investors; maintain fair and
orderly and efficient markets; and to facilitate capital
formation. Congress and market participants have long
understood the SEC's mission as such and have recognized that
the securities laws were not created and were never intended to
be a roadblock to access to capital.
If you want to revitalize the economy, Congress needs to
promote investment to reduce red tape and to do so by making it
easier for investors and businesses across the country to
access capital and to grow. New rules must not be duplicative
nor contradictory nor counterproductive or inspired by
regulatory regimes designed for wholly different entities.
And so it is clear that Main Street is feeling the impact
of nearly hundreds of new rules heaped upon our economy over
the last few years. And so this hearing is yet another
opportunity to examine the impact of the Volcker rule, Basel
liquidity, and capital rules, and other financial crisis
actions are having on the capital markets and, specifically
what we are looking at here, short-term financing.
And so, with that, I do thank each member of the panel for
coming today, and I will recognize you shortly. But at this
point--
Chairman Hensarling. Mr. Chairman, I ask unanimous consent
to speak out of order for 2 minutes.
Chairman Garrett. So ordered.
Chairman Hensarling. I thank the gentleman for yielding.
But as he yields, I feel a heavy heart, but I also feel pride.
I am proud that the chairman of this subcommittee has been my
friend and colleague for 14 years, as has the gentleman from
Texas, Mr. Neugebauer. And my heart is heavy in that this will
be their last hearing with us and the last hearing that Mr.
Garrett will preside over. Both of these fine gentlemen have
fought for the cause of freedom and free enterprise and
prosperity. They have acted with dignity and principles and
courage. They have commanded respect on both sides of the
aisle. With their departure, this will be a lesser committee
and Congress will be a lesser institution. No one can fill
their shoes or, in the case of the gentleman from Texas, no one
can fill his boots. But people will at least follow in their
footsteps. So I did not wish to have the moment pass without
recording for the record the contribution of the gentleman from
Texas, Mr. Neugebauer, and the contribution of the gentleman
from New Jersey, Mr. Garrett, to this committee.
And whatever the future holds for Chairman Neugebauer and
Dana, and whatever the future holds for Chairman Garrett and
Mary Ellen, know that you go with our respect, and you go with
our blessing. You will always have permanent friends here. And
anything that we achieve in this broader committee, please know
it is based upon your work. We stand on your shoulders and you
will never, ever be forgotten among this group of friends.
Godspeed and thank you.
And I yield back.
Chairman Garrett. I thank the chairman and a unanimous
consent to speak out of order as well at this point. But we
will get to the panel.
I very much appreciate that, and I echo the comments that
the gentleman makes to our colleague and friend and leader from
Texas. We came in about the same time, worked together with the
chairman.
You know, the chairman has been most gracious and has done
something that I don't know happens that often, has had
multiple sort of going-away events, and so you hear nice things
said each time. I am hoping that he is--Randy and I are both
hoping that he is planning at least three or four more of those
going-away things because I know, once I leave D.C., I will not
hear any of those nice things anymore. I certainly didn't hear
them over the last year and a half of the campaign, so this
makes up for it--sort of.
But thank you very much. It is--I wasn't going--I was going
to go right into the meeting, actually. But I said to someone
the other night at one of the going-away events--and I said it
in jest toward one Member--I said: It has been an honor and a
privilege to work with some of the most dedicated, smart,
intelligent in a different way, committed to trying to do all
they can for the people of this country, to lift people up in
all walks of life, regardless of whether they support them or
not in their districts, trying to do it for this generation and
for the next generation. We have been on the same page for so
many issues in that regard. And throughout that time, we have
had some battles that we won, and that was fun; and we had some
battles that we lost, and we just marked it up to what we had
to do the next time. But we just kept on going forward. And I
looked at my colleagues and my friends as well, knowing that,
through it all, as scripture tells us, that you run the race,
you stay the course, and you keep the faith. And I could not
have chosen a better group of people to be with during these
last 14 years than the people right here and the people who
didn't show up as well. And we are taking down names.
Mr. Neugebauer. Mr. Chairman?
Chairman Garrett. I yield to the gentleman from Texas.
Mr. Neugebauer. May I speak out of order?
Chairman Garrett. Absolutely. No objection.
Mr. Neugebauer. I thank the gentleman from Texas for his
kind words as well the gentleman from New Jersey. It has been
an honor and a privilege to serve with these two great guys and
the ladies and gentlemen who are on the committee as well. You
know, Scott and I have had some--heard some nice things said
about us. And one of the things I keep regretting, though, is
that my mother-in-law is not here to hear those.
But, anyway, Scott has provided great leadership on this
subcommittee, and I have enjoyed serving on it with you and
also the other projects that we worked on.
And to my colleagues on the other side of the aisle, I see
several there that we have worked together on some issues, and
so I thank you for the opportunity to hang out with you for a
few years.
Chairman Garrett. And now we will have time to hang out
even more.
The gentleman yields.
Mrs. Maloney. I also ask to speak out of order.
Chairman Garrett. The gentlewoman is recognized.
Mrs. Maloney. I would like to be associated with the
comments of the chairman and Mr. Neugebauer and in speaking
about all the fine things about our chairman. The chairman and
Mary Ellen have been friends of mine on a personal level. He
has been a friend and an outstanding, dedicated, and effective
public servant. We did not always agree, but it was never
personal. And it was always an honest and, in some cases, fun
debate. And he is devoted to his constituents and to serving
this body. I will miss him. He is a fine Representative. It has
been an honor for me to work with him in every way. And we did
some work together. We passed some bills together.
And I just feel sad that you are leaving. And I appreciate
your friendship and your support, particularly when my husband
passed away. I will never forget how nice you were to me. In
any event, you have been an outstanding chairman, and it has
been a privilege to work with you. I will miss you.
Mr. Scott. Mr. Chairman, over here.
Chairman Garrett. The gentleman is recognized.
Mr. Scott. We all are going to really miss you. And as you
know, we both came in together 14 years ago, and it has been a
pleasure working with you. I want you to know that you have
made some very sterling contributions to the financial
stability of our great country. It has been a pleasure serving
with you as the chairman. I have served on this Capital Markets
Subcommittee with you for all these years, and I really
appreciate the great opportunities we had to cosponsor some
bills together, work on amendments, and debates on the floor.
And I will tell you: there is not a more acute mind of
knowledge to understand the basic fabric and the foundation of
our finance system as you. And I want you to go away knowing
that, not only the people of New Jersey, but the people of this
Nation are really grateful for your service. Thank you very
much for our working together.
Chairman Garrett. Thank you. It has been an honor and a
pleasure.
And, with that, we can focus--oh. Opening statement. With
that, I turn to the gentlelady from New York, who I will be
looking forward to for now personal invitations to events in
New York City.
Mrs. Maloney. You will get them.
Chairman Garrett. There we go. The gentlelady from New York
is now recognized.
Mrs. Maloney. Thank you so much, Mr. Chairman.
The title of this hearing is, ``The Impact of Regulations
on Short-Term Financing,'' and for once, we can agree:
regulation definitely has had an impact on short-term financing
markets. But this was entirely intended. The financial crisis
revealed huge problems with many short-term financing markets,
some of which completely broke down during the crisis. We
discovered that the largest banks have become overly reliant on
short-term wholesale financing markets, such as the repo
market, which can dry up in a heartbeat and suffered a massive
run during the crisis.
The point of many postcrisis regulations has been to reduce
the banks' reliance on unstable short-term financing, which has
significantly improved the stability of the largest banks. A
reduction in short-term financing markets was an intended
consequence of financial reform. Now we have an ongoing debate
about whether certain postcrisis regulations have had
unintended consequences for some short-term financing markets,
but that debate is far from settled. And I believe we need to
seek compelling evidence of harm before we roll back core
postcrisis protections.
There has also been a lively debate about the SEC's money
market fund reforms, which took effect in October. These
reforms were intended to make the pricing of money market funds
more transparent and to reduce the first-mover advantage that
can lead to devastating runs. The reforms also provided funds
with tools to manage large-scale investor redemptions in an
orderly fashion.
In anticipation of the reforms taking effect in October,
many investors moved their cash out of prime and municipal
money market funds and into government money market funds,
which we were less affected by the SEC's reforms. It is true
that short-term borrowing costs for corporations and
municipalities have increased recently. And some commentators
have attributed this entirely to the SEC's rules. Most market
participants believe that this increase has been driven
primarily by the expectation of a Fed interest rate hike this
December. In fact, the data clearly shows that corporate
borrowing rates first started to increase shortly before the
Fed raised rates the first time last year, which is exactly
what you would expect if the increase was driven primarily by
the Fed's monetary policy, rather than the SEC's rules.
Moreover, while one bill has been introduced that would
repeal the requirement in the SEC's rule that certain funds are
at floating net asset value or NAV, my understanding is that
most investors who have taken their money out of prime funds
have done so because of the mandatory gates and fees, not the
floating NAV. Therefore, it is not clear to me that simply
repealing the SEC's floating NAV requirement would actually
accomplish anything. Once investors get comfortable with the
new rules, I believe at least some of this money will return to
prime funds. Much of it will never come back, but again this
was an intended consequence of reform. It would be very strange
if the SEC's reforms, which were among the most important
postcrisis reforms, produced no change at all in the money
market funds.
So, therefore, I look very much forward to the hearing
today and what our witnesses have to say. Thank you very much.
I yield back, and I will miss you.
Chairman Garrett. Thank you, the gentlelady yields back. We
now go to the witnesses and hopefully the message from
leadership was wrong as far as when they are going on to a
break for the votes.
So we will begin--for the witnesses, you will each be
recognized for 5 minutes. Your full testimony will be made part
of the record. There should be little lights or something in
front of you to indicate your time. Green is for 5 minutes.
Yellow, it means you have 1 minute left remaining. And red is
at the end, saying your time is up.
So, at the very beginning, Mr. Carfang, welcome and you are
recognized for 5 minutes.
STATEMENT OF ANTHONY J. CARFANG, MANAGING DIRECTOR, TREASURY
STRATEGIES, A DIVISION OF NOVANTAS, INC.
Mr. Carfang. Thank you, Chairman Garrett, Ranking Member
Maloney. I am pleased to be here today.
My name is Tony Carfang, and I am a managing director with
Treasury Strategies. We are a division of Novantas. We are a
consulting firm specializing in Treasury payments and
liquidity. And we work with hundreds of corporations,
municipalities, healthcare organizations, and financial
institutions around the country.
The issues we are talking about today are very important to
our clients, and there are three--when I say the big three
regulations that have come out of the financial crisis, are
Basel III, Dodd-Frank, and money market fund reform. These are
bold experiments. And as we all learned in high school
chemistry, when you do an experiment, you pour the chemicals in
slowly and carefully. What has happened in this case is all the
experiments went into the test tube at the same time. And that
test tube is America's businesses and America's consumers.
We are now seeing the reaction and, in some cases, the
uncontrolled reaction of that. For example, in the 5 years
since the postcrisis regulation has been going into effect,
there are 1,500 fewer banks in the United States. That is more
than a 20-percent decrease. America used to create about 150 to
170 new banks per year. That is an 80-year average. Since 2010,
only two new banks have been formed in the United States. I
think that gives you a sense of how crushing the regulations
have been.
What I would like to do today is focus on money market
mutual funds and point out first that, in 2010, the SEC
introduced a set of reforms to improve transparency and
liquidity, and those regulations were very successful in terms
of providing safety and soundness to not only money market
funds but the entire financial system without impairing the
utility of those funds to investors. Unfortunately, in 2014,
the SEC again came out with an extended set of regulations
that, in effect, prohibited what they called non-natural
persons from investing in stable net asset value prime and
municipal money market funds. The result of that has been for
investors to exit those funds. And what we have seen is in
prime funds--and by the way, prime funds are private sector
funds; they invest in the commercial paper or other debt of
corporations and financial institutions providing the day-to-
day working capital for those organizations--assets have fallen
almost 75 percent, from $1.4 trillion down to about $380
billion. That is hardly a scaling back. They have been crushed.
They have been decimated. And the borrowers who rely on those
funds for financing, where they are able to find credit
elsewhere, have a much higher cost to that credit.
On the municipal funds, here the impact is particularly
profound. We have seen a decrease of 50 percent from about $260
billion down to $130 billion in assets. These are the funds
that finance municipalities, schools, hospitals, and
universities.
To give you some examples, the State of New York has seen,
just this year, a decrease in funding from $39 billion down to
$19 billion; California healthcare finance from $2 billion down
to 1.3. The total decline has been $1.2 trillion. Let me point
out: this money has moved from the private sector to the public
sector. And to put that in perspective, the $1.2 trillion is
more than the entire TARP program several years ago. It is more
than the stimulus program, and it is several times more than
the amount of cash we expect to get back from overseas if we
can get corporations to repatriate. These are huge numbers.
In addition to States losing financing, let me just point
out the Metropolitan Transit Authority in New York City has
seen its financing fall from $2.34 billion down to $800
million. They have lost a billion and a half that municipal
money funds used to finance. Harris County, Texas, educational
facilities have lost--they have gone from $1.1 billion down to
$580 million. These are very real consequences.
H.R. 4216 is designed to provide a simple fix to allow non-
natural persons to again invest in stable value money market
funds. This will restore funding--it is the stable value that
is the threshold issue that makes this money funds a cash-
management tool for corporate treasurers. Without that stable
value as a source of financing, we lose a couple trillion
dollars. This is all about preserving money market funds as an
effective financing tool.
Mr. Chairman, thank you very much.
[The prepared statement of Mr. Carfang can be found on page
34 of the appendix.]
Chairman Garrett. And I thank you. That is interesting.
Next, speaking on behalf of the U.S. Chamber of Commerce,
Mr. Deas, welcome, and you are recognized for 5 minutes.
STATEMENT OF THOMAS C. DEAS, JR., CHAIRMAN, NATIONAL
ASSOCIATION OF CORPORATE TREASURERS, ON BEHALF OF THE U.S.
CHAMBER OF COMMERCE
Mr. Deas. Thank you, Chairman Garrett, Ranking Member
Maloney, and members of the subcommittee. I am Tom Deas. Today,
I am testifying on behalf of the U.S. Chamber of Commerce and
its Center for Capital Markets Competitiveness. I am also the
chairman of the National Association of Corporate Treasurers.
These organizations are fully supportive of the bipartisan
efforts of the chairman, ranking member, and other
distinguished members of this subcommittee to protect Main
Street companies from regulations that, however well-intended,
place an undue burden on job creators at the heart of our
economy as they work every day to finance their businesses,
safeguard their cash and other assets, and hedge risk in their
day-to-day operations in the most efficient and effective ways
as possible.
When it comes to the needs of Main Street businesses, the
Members of the House have worked together to get things done.
In this 114th Congress, you have led the charge in enacting
both the enduser margin bill and the centralized Treasury unit
bill benefitting directly the enduser community. We appreciate
your efforts, thank you.
We support the overall goals to increase the financial
markets' transparency, safety, liquidity, and efficiency.
However, there are areas where conflicting regulations compel
endusers to appeal for relief. We are seeing compounded adverse
effects from the elaborate web of new regulations imposed and
so urge a study of the cumulative effects of how these rules
interact to produce a greater impact than an analysis of them
taken individually would predict.
In the area of money market fund reform, in mid-October new
rules affecting these money markets came into force that had
the effect not only of taking $1 trillion out of the market
that has long provided treasurers with a diversification away
from bank time deposits for investments of temporary excess
cash balances but which also diminished an important source of
funding for treasurers seeking to issue commercial paper to
fund their day-to-day needs.
Conflicting with the importance of diversification, the
Treasury's rule for simplifying the tax consequences of
investors having to track money market fund investments and
share prices to the nearest hundredth of a cent now, along with
liquidity fees and redemption gates, we instead have greater
concentration, fewer funds as alternative, purchasing less
nonfinancial enduser commercial paper, resulting in higher
borrowing costs and greater risks of less liquid funding
sources.
We believe that the net stable funding ratio, also a rule
proposed by banking regulators, must have higher--result in
higher short-term funding costs for Main Street companies. For
example, it requires banks buying a company's overnight
commercial paper to hold reserves against that purchase in the
form of significantly higher long-term funding for 85 percent
of the balance. As an example of the need for a cumulative
impact study, consider the interaction of money market fund
reforms and the NSFR rule. The money fund reforms' drive for
greater liquidity has driven funds holdings maturing in less
than a week, including bank certificates of deposits and
commercial paper, to increase from 54 percent at June 30 to 68
percent at the end of November. However, the very structure of
the NSFR is to force banks to issue their funding not at 1 week
or less, but on a far longer term basis with higher costs
passed on to their borrowers, Main Street companies.
These conflicting regulatory company conflict--these
conflicting regulatory forces will tend to increase our costs.
The rules were adopted without an economic analysis of their
implications and ultimate costs.
To summarize, Congress was instrumental in clarifying that
nonfinancial endusers should not divert capital from
investments in their businesses to unproductive regulatory set-
asides, such as the daily posting of cash margin for their
derivative positions. However, the banking regulators have
implemented rules on capital that banks must hold against
derivative positions as well as against loans to endusers and
other advances to them that have the same economic effects.
These capital and liquidity rules create real impacts and
costs on endusers' ability to manage risk and access capital.
This is why we support undertaking a cumulative assessment of
the impact of these rules on endusers. The imposition of
unnecessary burdens on endusers, businesses, restricts job
growth, decreases investment, and undermines our ability to
meet and beat our foreign competition, leading to material
cumulative impacts on corporate endusers and the U.S. economy.
Thank you again for your attention to the needs of Main
Street companies.
[The prepared statement of Mr. Deas can be found on page 77
of the appendix.]
Chairman Garrett. Great, I appreciate your testimony.
Next, Mr. Konczal, you are recognized for 5 minutes and
welcome to the panel.
STATEMENT OF MIKE KONCZAL, FELLOW, ROOSEVELT INSTITUTE
Mr. Konczal. Thank you, Chairman Garrett, Ranking Member
Maloney, and members of the subcommittee. Thank for the
opportunity to testify.
My name is Michael Konczal. I am a research fellow at the
Roosevelt Institute. Previously, I was a financial engineer at
Moody's KMV, a provider of credit analysis tools to lenders and
investors.
The 2010 Dodd-Frank Act has many important accomplishments,
one of which is reducing the regulatory arbitrage that
characterizes shadow banking. Here I will refer to the
financial activity that follows the functions of traditional
banking without exclusive banking regulations or access to
deposit insurance or emergency lending. The sector is often
regulated through securities law, which emphasizes disclosure
over prudential regulation. One of the primary elements of
shadow banking is money market funds, whose collapse in the
aftermath of the failure of Lehman Brothers was the defining
moment of the panic.
As a legal matter, money market funds function as mutual
funds and are regulated as such. But as an economic matter,
money market funds share functions identical to bank deposits.
They allow for investments to be liquidated at any time at par
with the expectation that they will return the capital amount
invested plus interest. This exposes them to runs. This has
been covered up previously because of the ability of sponsor
funds to provide capital injections. Yet they blur the line
between these two regulatory worlds of securities and banking
law. The history of these funds has always been tied to this
regulatory blurring, as former Federal Reserve Chairman Paul
Volcker recently noted: I was there at the Federal Reserve
Board when these funds were born. It was obvious at the time
that these products were created to skirt banking regulations,
end quote.
Since the crisis, the SEC has imposed several regulations
on money market funds designed to increase their stability and
reduce the likelihood of runs. The most important requires the
use of a floating net asset value for prime institutional
funds. As SEC Commissioner Daniel Gallagher noted at the time,
quote: This will address the three decade old error in a
nuanced and tailored manor to reinstate market-based pricing,
end quote.
With this change, there is less of an incentive for mass
withdrawal under stress conditions. There's no cliff effect of
breaking the buck, and it reduces the first-mover incentive.
There is also an issue of transparency that gives investors a
better understanding of the risk they face.
It is worth noting previous efforts to educate investors
that these instruments do not function as deposits and could
break the buck had they not worked. This was attempted in both
1991 and 1996 by the SEC with language provided in my written
testimony.
Disclosures are not a sufficient substitute for proper
regulation and market-based pricing. Beyond this, Dodd-Frank
provides for the graduated, consolidated level liquidity and
leverage requirements from the largest financial players. These
are essential for risk management. By itself, risk-weighted
requirements are procyclical and can be subject to unexpected
assetwide downgrades. Leverage requirements provide a backstop
and an important complement to other regulatory capital tools.
Just as equity is regulated, debt should be regulated too and
ensure that the term structure of debt of a firm ensures
sufficient liquidity to survive a panic without massive capital
lender of last resort backstops.
There are concerns that this is affecting the real economy.
It is difficult to see actions in the real economy that would
indicate this negative effect. According to analysts at the New
York Fed, ``price-based liquidity measures--bid-ask spreads and
price impacts--are very low by historical standards, indicating
ample liquidity in corporate bond markets.''
We did not see this in the survey data either. In surveys
conducted just this month in--monthly by the National
Federation of Independent Business, only 4 percent of small
businesses indicate that their borrowing needs were not
satisfied in the past 3 months. This number is down over the
past several years. Instead, the National Federation of
Independent Business' researchers find that a ``record number
of firms remain on the credit sidelines, seeing no good reason
to borrow.''
This is mirrored in the Federal Reserve survey of loan
offices, which indicate declining credit spreads over the past
several years. We also do not see this financing constraining
corporate governance decisionmaking. If Dodd-Frank was reducing
the ability of corporations to borrow to invest, we would
expect firms to retain more earnings, substituting against
other types of capital streams capable of sustaining
investment.
However, total shareholder returns on the S&P 500 set a 12-
month record high in 2016. 2014 spending on buybacks and
dividends across the nonfinancial corporate sector was larger
than the combined net income across all publicly traded,
nonfinancial U.S. companies for the first time out of
recession. We do not see, certainly as a macro economic effect,
the shifts associated with reduced financing for investments.
Even with all this work done, experts rightfully remain
concerned about destabilizing elements in the shadow banking
market. Efforts should go further. There are several avenues
that could be investigated.
More broadly, important reforms remain in establishing a
system of minimum haircuts for securities financing
transitions, and revisiting the Bankruptcy Code's carving out
of derivatives and other financing contracts can help provide
stability and reduce the potential to runs. These risks are
real, and they still remain. I think it is important to be
diligent to them as we go forward as the crisis recedes into
the background.
Thank you and I look forward to your questions.
[The prepared statement of Mr. Konczal can be found on page
89 of the appendix.]
Chairman Garrett. Thank you. The gentleman yields back.
And last, but not least, from SIFMA, Mr. Toomey is
recognized for 5 minutes.
STATEMENT OF ROBERT TOOMEY, MANAGING DIRECTOR AND ASSOCIATE
GENERAL COUNSEL, SECURITIES INDUSTRY AND FINANCIAL MARKETS
ASSOCIATION
Mr. Toomey. I thank you, Mr. Chairman. Chairman Garrett,
Ranking Member Maloney, and the distinguished members of the
subcommittee. Thank you for providing me the opportunity to
testify on behalf of SIFMA and to share our member firms'
perspective on the impact of regulation on the capital markets.
Before turning to my opening statement, though, I want to
take a brief moment on behalf of SIFMA to thank Chairman
Garrett for his years of service on this committee and years of
leadership of the Capital Markets Subcommittee. We always
appreciated the thoughtfulness with which you approached an
issue. Thank you.
Regarding the topic of today's hearing, let me start by
applauding your focus on ensuring that an appropriate balance
is struck between regulation and growth. We believe it is time
for an evaluation of the intended and unintended consequences
of postcrisis reforms. Much of the regulation that has been
implemented seeks to address key contributors to the financial
crisis and has made both banks and the system safer and
sounder.
Recently, however, market participants have raised concerns
that the reforms have resulted in reductions in market
liquidity beyond what was intended, particularly for the high-
quality liquid assets that underpin the financial system and
our economy. We see the resiliency and depth of market
liquidity as a critical objective for policymakers to consider.
If market participants' ability to access liquidity is
impaired, particularly during stress periods, it will
negatively impact functioning of financial markets with broad
ramifications for the economy. Regulations that are risk-
insensitive and regulations that target the same risk multiple
times through overlapping rules may weigh particularly heavily
on vital market functions. As such, we believe now is an
appropriate time to assess the existing framework.
Specifically, we recommended an assessment of coherence and
cumulative impacts on a forward-looking basis to identify cases
where there may be unnecessary duplication or conflicts between
specific regulatory requirements and broader policy goals.
A recent effort undertaken by the European Commission
provides an example of the type of call for evidence or review
that we think is both warranted and timely. The Commission
specifically sought feedback on the impact of financial
regulation on the ability of the economy to finance itself, and
growth, unnecessary regulatory burdens, and interactions,
inconsistencies, gaps, and unintended consequences. These are
exactly the right areas of inquiry.
For any review undertaken domestically, we would note a few
areas for consideration. First, in looking at the full rule set
in place today and what we expect to come on line in the near
future, we find potential conflicts between the rules that
together could have negative impacts.
Second, the treatment of low-risk, high-quality assets like
cash and cash equivalents varies depending on the rule and
often does not reflect their low-risk or risk-free status.
Finally, the assessment should examine the calibration of
specific rules that are designed to serve as backstops but that
actually operate as binding constraints.
Turning to the specific focus of the hearing, I would
highlight the importance of the short-term funding markets in
the financial system. In particular, repo markets provide the
necessary grease that allows the U.S. capital markets to remain
the most efficient and liquid in the world. This facilitates
lower cost credit to businesses, municipalities, and the
Federal Government.
Several significant regulations, some of which are not
fully in place yet, have been proposed and are adopted that
have a direct impact on the repo market and other short-term
funding markets. While some of these impacts are clearly
intentional and reflect the policy concern for overreliance by
financial institutions on short-term funding. SIFMA believes
that the cumulative impact of these regulations reflect neither
the risk to the financial system nor individual firms. Rules,
including the supplemental leverage ratio, the liquidity
coverage ratio, the net stable funding ratio, may impact short-
term funding in different ways, but the overall interaction of
these regulations is unclear. Our concern is that these
potential conflicts will become evident during stressed
environments.
In conclusion, the time is right to provide a wholesale
review of the impact and coherence of these requirements with a
view toward a better balance of safety and soundness on the one
hand and efficiency, liquidity, and capital availability on the
other. As liquidity diminishes or becomes more brittle in these
markets, higher costs of capital may be inevitable for both the
government and Main Street.
I thank you for your interest in this important topic and
look forward to your questions.
[The prepared statement of Mr. Toomey can be found on page
104 of the appendix]
Chairman Garrett. Great. Thanks. So the Floor has called,
but we will have time to do a couple of questions. I will start
with myself.
So it appears that there is some uniformity in most of the
testimony as far as, to use your words, Mr. Toomey, some
brittleness of the market and the tightening of liquidity. One
aspect of that is there was a study done--I forget if it was in
the testimony or not--by Deutsche Bank saying it estimated that
dealers have cut down their inventory by something like 80-some
odd percent, right--you are nodding your head--which to me, I
think, in layman's terms, that is like, in manufacturing or
retail, that you are getting into it just in time--you are
hoping to have a just-in-time delivery at that point if what is
on the shelf is way down. What is the reaction to the
marketplace to that, as I coined it, just-in-time delivery? Are
they able to deal with that?
Mr. Carfang. Well, the just-in-time inventory means bids
and ask spreads are wider, which means costs go up for everyone
participating.
Chairman Garrett. So what does that mean to the layman that
the bids are wider to Main Street as far as my borrowing costs?
Mr. Carfang. It means, when you are borrowing, you pay a
slightly higher price; when you are lending, you get a slightly
lower yield.
Chairman Garrett. Right. So what does that mean as far as
me as a local small business or as a medium-sized business as
far as my ability to expand or what have you in that
marketplace?
Mr. Carfang. Well, at the margin, funding becomes more
expensive, and at some point, you are going to decide not to do
the project or hire the employee.
Chairman Garrett. And so that was not the intention,
obviously, in legislation that Congress passed.
I go to Mr. Deas on this as far as you were referring to
something--oh, I know. It was on the endusers, and the
intention of Congress here was not to have the higher
requirements, reserves requirements there, right, to the
specific endusers in that category. But you point out what I
would sort of--I would coin a phrase an end run, if you will,
by the banking regulators saying: Well, if Congress is saying
we are not going to be able to propose those requirements over
here, we are going to do it, how? As you were suggesting, over
here through the banks, right, through the banking regulators.
Do you want to speak on that again? I have 30 seconds.
Mr. Deas. Yes, sir. This committee was very clear in
directing the banking regulators that they should not require
endusers to set aside cash to margin their derivative
positions. And yet, in the regulations they have imposed, they
are essentially requiring the banks to do that. And what we
focus on as endusers is the banks; the way we look at them,
they are mere intermediaries in the system. In the end, we are
the productive economy. They get the money from where it is
generated to where it is needed. And if an extra cost is put on
them, it is ultimately borne by us, the productive
manufacturing companies of this country.
Chairman Garrett. I got it. So you add that to what Mr.
Carfang was talking about this other problem, what Mr. Toomey
was talking about as well as far as using the word
``brittleness'' to it and the expansion of the spreads and the
cost to the system, right? So what is the result of that?
Well, besides result, because we have heard the result. You
are seeing that in the marketplace, right?
Mr. Deas. Yes, sir.
Chairman Garrett. And we are seeing occasional
exasperations of that through the flash crash and that sort of
thing, right? But we don't hear that from the regulators.
Treasury Secretary, the Fed Chair reject any notion. They have
been here a number of times in the past. We would throw these
questions out to them, and we say: Gee, is there a problem
here? Is there a liquidity problem here? And they see no evil
in that area.
Why is that you are seeing something--and I throw this to
the panel--that the regulators can't seem to be seeing?
Mr. Deas. Well, sir, we will see it when it comes to a
tightened or a stressed financial market. When this kind of
capital flows out of the market for endusers, when a trillion
dollars that was in prime money funds, much of which--in April
of 2012, money funds bought 40 percent of commercial paper,
nonfinancial commercial paper. It is now, at the end of
November, down to 5 percent. So the supply-demand has been
imbalanced. When in these times, where markets are steady, we
are not seeing so much of an effect; we are seeing the numbers,
as I have demonstrated in my testimony. But when we get into
more strained conditions, we will see it very much.
Chairman Garrett. And give credit as credit is due, as my
dad always said, to the Fed Chair because--I mean to the SEC
Chair, that she recognized this and saw it but would not
attribute actually what the cause was. And I think, from most
the panel here, part of reason why they are not attributing and
she is not attributing the cause is because of why? We haven't
done a full study to see exactly what the cumulative effect was
of all of these regulations. I know we have had all the Fed
Chair and others and Treasury Secretary here as well, and we
have always asked them: What is it really costing the system
what you are doing? What are you really costing the system of
Dodd-Frank and the 400 regulations? And to a man or to a woman,
they can't give an answer to that, correct?
Mr. Deas. Yes, sir. We would very much urge that these
interactions be studied. The regulations have been looked at
individually, but they don't see the compound effect.
Chairman Garrett. Cumulative effect. Yes.
Mr. Deas. Money market funds are not just a source of
short-term investing opportunity for treasurers, but they buy
our commercial paper. They finance our businesses. And when a
trillion dollars flows out of them, we pay more to finance day-
to-day operations.
Mr. Toomey. So these new regulations, though, should be
rolled back while the study is going on so that they don't
continue to do ongoing damage.
Chairman Garrett. First, do no harm.
With that, I yield now to the gentlelady of New York.
Mrs. Maloney. Thank you everyone for your testimony.
I would like to ask Mr. Konczal and Mr. Carfang a question
and get both of your perspective on it. I was, quite frankly,
struck by the decline of money--municipal money market funds in
New York, the city that I represent. But my office is telling
me they called the city and they don't see this as a big
problem, which is hard for me to understand. If you have a 50-
percent decline, that is a pretty serious thing in my mind.
So I would like to say that, obviously, we have seen
investors pull out a substantial amount of money from the money
market funds this year, and some claim that this is all due to
the floating NAV requirement in the SEC's rule, but the bill
only deals with the floating NAV. But some of the investors
that I have talked to say that the bigger problem is the gates
and fees aspect of this SEC rule, which gives funds the ability
to suspend withdrawals in times of stress. Many people use
their money market fund as a liquidity access point, and they
don't like the point that they may not be able to pull their
money out so that is why they are pulling it out.
So I would like to ask both of you: Do you think that, if
we did away with just the floating NAV requirement, that that
would cause investors to put all their money back into the
money market funds, or are the gates and fees the bigger
problem here?
Mr. Toomey. You make an excellent point: gates and fees as
well as the floating NAVs are all problems. I have testified to
that in the past. The floating NAV is the threshold issue,
however, because NAVs started to float beginning October 14.
Corporate treasurers would have needed to change their
investment policies, get board approval, implement systems,
change their tax reporting. That was the threshold issue that
caused the problem. Gates and fees are clearly a longer run
problem. In a black swan event, the possibility of a gate
clearly is a problem. We think that, if we can change that
threshold issue on the FNAV for non-natural persons, that can
begin the process of at least bank sweep accounts going back
into money market funds as well as institutional investors.
Longer term, the Commission itself I believe needs to
address the fees and gates issue of that. But we need to get--
4216 sends a signal to the Commission that this committee wants
to keep money market funds in business, reinstitute the
floating NAV, and the Commission itself can deal with the
regulatory aspects of fees and gates.
Mrs. Maloney. Mr. Konczal?
Mr. Konczal. A quick point, on the previous question, there
is still very little evidence right now of increased bid-ask
spreads in the corporate bond market. Research differs on this,
but it is important to remember there is a distinction between
what is happening right now and what could happen in a crisis.
In a crisis, we have already seen $400 billion of institutional
prime money market funds flow into Treasurys essentially in a
very short period of time, in essentially less than a week. So
we know what it looks like already stressed under a fixed NAV
market. I do think there are some concerns about removing the
floating NAV with keeping the gates and fees. I think there is
an additional incentive, increased incentive to run under those
conditions.
We should distinguish also between an evolving credit
market, where it is going to look a lot more like the stock
market, a just-in-time, as people brought up--as the chairman
brought up. And, also, we should distinguish between liquidity
and Treasury markets, which function a lot more like the stock
market at this point with algorithmic training, where you could
see some things like a flash crisis, but that has less to do
with bid-ask spreads and a lot more to do with just algorithms.
Mrs. Maloney. Would anyone else like to comment on this
question?
Listen, we have a vote. So I have 55 seconds left, but I am
going to yield back my time and run to make sure I don't miss
my vote.
Thank you all for your testimony. I will be back.
Chairman Garrett. The gentlelady yields back.
We do have a minute left--or we have 45 seconds left in our
vote, so we will call recess for this committee and reconvene
immediately after the floor votes.
The committee is in recess.
[recess]
Chairman Garrett. Thank you, gentlemen.
The meeting is called back into order, and the gentlelady
from Missouri is recognized for 5 minutes.
Mrs. Wagner. Thank you very, very much, Mr. Chairman. And
thank everyone for appearing today to discuss the impact of
Dodd-Frank regulations as well as actions by FSOC and the Basel
Committee have had on short-term financing and the U.S. capital
markets.
As Mr. Deas noted in his testimony, ``liquidity is the
lifeblood of any business,'' and that, as I go on, ``Without
having ample liquidity, production comes to a halt, inventories
run low, and bills are not paid on time.'' I appreciate those
words.
Treasury Secretary Lew has continually refused to
acknowledge the possibility that regulations such as the
Volcker rule as well as other post-crisis regulations are
contributing to illiquidity in certain segments of the fixed
income markets. However, other government officials, including
Federal Reserve Board of Governors, had acknowledged that these
regulations may in fact be a factor.
Mr. Deas, do you believe that Dodd-Frank, Basel III, and
other regulations, are a contributing cause of diminished fixed
income liquidity?
Mr. Deas. Congresswoman, yes, I certainly--it certainly is
the case that when $1 trillion has flowed out of prime money
market funds, which went from a position of buying 40 percent
of manufacturing and other nonfinancial companies' commercial
paper in April of 2012, to now at the end of November, only 5
percent of their commercial paper, and that source has dried
up, that has been a direct result of these changes. And it has
increased the cost. For instance, the cost of prime money fund,
the yield that they are paying now is 22 basis points higher
than equivalent government money market funds for the same
maturity, for 1-week maturity.
Mrs. Wagner. Twenty-two basis points higher.
Mr. Deas. Yes, ma'am.
Mrs. Wagner. Outrageous. What are the real world
consequences besides that of reduced liquidity in the corporate
bond markets for U.S. companies, their employees, and
individuals that are saving for retirement, to send their kids
to college?
Mr. Deas. Well, we have all supported the goal of greater
price transparency. And when there is no liquidity in the
corporate bond market, then when an industrial company comes to
the market to issue its bonds, it doesn't know, nor do its
underwriters know, what is the right price. And in order to
assure that they get the issue off successfully and there isn't
an embarrassing withdrawal of the issue from the market, they
may well overprice it. And so they will price it to clear the
market.
And sometimes you get the effect of selling your house and
the real estate agent tells you they have sold it in 1 day, you
may wonder how that was priced, and that is what happens in the
corporate bond market. And that is a burden that you have to
pay for the remaining 10 years or 30 years of the corporate
bond issue.
Mrs. Wagner. Good analogy. What resources is the SEC or
FSOC devoting to understanding or combatting this problem?
Mr. Deas. Well, we think not enough resources when it comes
to analyzing the effect through a cumulative impact study of
the interaction of all these forces. In some cases, they have
analyzed the individual effects, but there is a cumulative
effect and an interaction, as I demonstrated in my comments on
how money funds relate to commercial paper borrowing costs for
companies. And they haven't studied that. And we think it would
be important for this committee and for Congress to mandate
that these regulators conduct such a study.
Mrs. Wagner. Thank you. And in my limited time, the EU
recently undertook a call for evidence to analyze the
cumulative impact of post-crisis financial regulations to
identify areas where they have interacted in ways harmful to
economic growth. In your testimony, you noted several times the
need to study the effects of all of these rules and their
interactions with one another. Do you think a similar
initiative as the EU's call for evidence would be valuable here
in the U.S. as we transition into a new administration, sir?
Mr. Deas. Yes. I think it very much would be, as well--I
mean, in the European community, they have specifically
exempted end users. They have recognized that end users'
participation in these markets is for productive purposes, that
they are not engaged in speculative activity. And so the burden
that would be placed on a trader maintaining an open book for
financial speculative purposes should not be placed on end
users. And we have been much less consistent in the
implementation of that philosophy here. So studying the actual
costs would be what we would highly recommend.
Mrs. Wagner. Absolutely. Thank you for your testimony, for
your presence here today.
Mr. Chairman, thank you. I yield back. And I thank you for
my time serving with you on this committee.
Chairman Garrett. I thank you. Thank the gentlelady.
Mr. Carney.
Oh, I am sorry. Mr. Scott.
Mr. Scott. Thank you. Thank you.
Panel, I was very seriously concerned about the health of
the market for money market funds, when, as you know, during
the financial crisis we saw funds breaking the buck. And I
think you know what I am talking about there. Sort of money
market funds seek to maintain a stable net asset value, or
called NAV, so that each share in the fund is worth one dollar.
But during a catastrophic event like the financial crisis, when
shareholders in the fund all redeemed very quickly, the fund's
NAV can drop below one dollar, which is why they call it
breaking the buck.
Now, recently the FSOC took notice of this and the
Securities and Exchange Commission adopted the floating NAV
rule, applying it to non-retail investors and tax-exempt funds.
The theory was that those funds mostly catered to the retail
investor and the impact would be minimal. But it is my
understanding, however, that the impact has been anything but
stable. And what we are seeing today is that tax-exempt funds
have been very negatively impacted, regardless of whether those
funds are serving retail or institutional investors.
So I would like to ask the panel, if you all would respond
and comment on whether you think that the Securities and
Exchange Commission did a sufficient job at understanding the
impact of this rule and the impact it might have on the market,
or if there are other factors outside of the Securities and
Exchange rule that may be contributing to rising short-term
borrowing costs.
Mr. Carfang. Thank you, sir.
Mr. Scott. You're welcome. Mr. Carfang.
Mr. Carfang. I don't think anyone, including the Securities
and Exchange Commission, imagined that $1.2 trillion was going
to leave. I think that exceeds everyone's wildest worst-case
scenario. And in that regard, you know, I think it is important
to step back and understand what factors took place.
In my testimony, when I talk about rates rising, I am
looking at spreads. So the Fed rate hike, for example, last
December impacted the markets. But what--if you look at the
spread of LIBOR, which is the basic business borrowing costs
over treasuries, that spread has widened. Market rate changes
impact both of those identically. So we are actually seeing
evidence of about a 25 or 30 basis point increase in borrowing
costs over and above what the Fed rate changes have done.
Mr. Scott. Okay.
Mr. Konczal. I would--
Mr. Scott. Yes, Mr. Konczal.
Mr. Konczal. I would just like to--like us to remember that
the SEC came to this decision slowly and carefully. You know,
immediately after the crisis, it instituted certain kinds of
reserving in liquidity issues to deal with the immediate
aftermath. But then in conjunction with FSOC, in conjunction
with international regulators, and in conjunction with many
studies of the market as a whole, in 2014, only after those
many years of study, that it did take this action.
We do want to remember that we are in an environment of
general increasing interest rates. You know, Goldman Sachs has
predicted, you know, large deficits in the near future and
which will obviously lead to a more quicker than normal
normalization of Federal Reserve policy. So it is very
difficult to disjoint what has happened in the past month from
the broader macroeconomic condition, which has certainly
changed. But, you know, SEC came to this decision very slowly
and carefully after considering whether its initial actions
were sufficient and broad agreement through FSOC that it was
not.
Mr. Scott. Do any of you feel, as some suggest, that the
investors are overreacting in pulling their short-term cash out
of money market funds that do not offer a stable NAV? That
suggests that once investors understand floating NAV funds
better, they will flock back in. Do you agree with this?
Mr. Deas. Congressman, we--the practicalities of this rule
change requiring now to keep track of investments in money
market funds down to the nearest hundredth of a cent, and to do
so for both Federal and State income tax purposes, and to
record gains and losses if an investment is made on Tuesday and
the company needs to liquidate part of that investment on
Thursday to meet its payroll, then that is a recordkeeping
burden that we warned the SEC companies are not prepared to
fulfill.
And within a company there are--is a competition for
resources between departments that are engaged in profit-making
activities and those that are engaged in compliance, and
profit-making usually wins. So what happened was, money was
pulled from these investments requiring this kind of
recordkeeping and to the tune of $1.2 trillion.
Mr. Scott. That is right. Very good.
Thank you very much, Mr. Chairman.
Chairman Garrett. The gentleman is out of time.
Mr. Messer.
Mr. Scott. Oh, Chairman, I am sorry.
Chairman Garrett. Yes, sir.
Mr. Scott. Thank you, Tanner.
I would like to ask unanimous consent to include this
letter to Ms. Moore in the record.
Chairman Garrett. Without objection, it is so ordered.
Mr. Messer. I would like to follow up on those questions.
And I am going to start with Mr. Deas. You know, we often talk
about it here in this committee. But in life and in public
service, we are not just accountable for our intentions, we are
also accountable for our results. And that's actually--if you
ask the American people, the results matter a lot more than our
intentions. Sometimes things done with the best of intentions
can end up with results that are maybe unintended but
catastrophic.
And following up on the money market reform debate we were
just having, the floating net asset value rule, I just want to
ask you a very direct question, again to Mr. Deas, do you think
the economic benefit of the rule is worth the cost?
Mr. Deas. Sir, thank you for that question. I think, just
to reiterate what my colleague Tony Carfang has said, we have
measured the cost. So it is upwards of 25 or so--20 to 25 or 30
basis points in higher cost. We view, from the point of view of
manufacturing company treasurers, that the financial system is
a mere intermediary getting the money from where it is
generated to where we need it. And that is an extra burden that
we now have to cut some other costs or decrease employment in
order to overcome.
Mr. Messer. I think that the answer is no, you don't think
it is worth the cost.
Mr. Deas. Yes, sir. I agree.
Mr. Messer. Mr. Carfang, I don't know if you want to add
anything to that.
Mr. Carfang. Well, and the increased cost that is 25 or 30
basis points is against $10 trillion of debt keyed off of the
LIBOR rate. So we are talking about an increase of $30 billion
of cost. And, you know, companies like FMC where Tom was
treasurer, you know, aren't even going to consider that and
obviously exit.
Mr. Messer. Mr. Carfang, I wanted to follow up with you and
ask this question: Do you believe--you talked about this
imbalance. Do you think it is going to get worse in the coming
months or better?
Mr. Carfang. Well, it looks like the decline out of prime
funds has stabilized. But as one of my colleagues told me, you
know, falling off a cliff and hitting a rock and calling your
fall stabilized is not necessarily what you want to--
Mr. Messer. That's not a laughing matter, but, I mean--
Mr. Carfang. No, it is not happy. I don't think it can turn
around until we get relief on the fluctuating net asset value
short term and then fees engaged in--
Mr. Messer. And once again, I think the followup is fairly
common sense but still would ask you to articulate, could you
expand on--I mean, what is the answer here? What do we need to
do in response to this trillion dollar drop?
Mr. Carfang. Well, I think, first of all, you know H.R.
4216 will restore the floating NAV for non-natural persons. And
that sends a message to the commission that Congress really
wants to protect and defend the money market fund as a primary
investment vehicle, as it has been for 40 years and several
trillions of dollars.
Getting the fluctuating NAV fixed for non-natural persons
will remove the administrative barriers to corporate treasurers
investing in these funds. It will also allow banks who sweep
into money market funds, and by definition then must sweep into
a constant net asset value fund, to pull some of their assets
back in, as well as Roth management groups and brokers who
sweep on behalf of both retail and corporate clients. So that
begins to open the door for some of the money to come back. And
then that would allow the commission, then, to go back and
alter the fees and gates part of this.
Mr. Messer. Thanks.
Mr. Deas, you look like you might have something to add.
No?
Mr. Deas. No, sir.
Mr. Messer. Okay. Great.
With that, I yield back the balance of my time, Mr.
Chairman.
Chairman Garrett. The gentleman yields back.
The gentleman is recognized, Mr. Carney.
Mr. Carney. Thank you, Mr. Chairman. Let's just continue
this conversation, if we may. And I would like someone, maybe
you, Mr. Konczal, to remind us why we got to the point of
considering a floating NAV and what the issue there was and--so
we can evaluate the action that has been taken and the costs
that you question in terms of 20, 25 basis points. Could you
remind us of how we got to this point?
Mr. Konczal. Absolutely. The cost of the financial crisis,
for instance, from the Federal Reserve Bank of Dallas, is about
10 or $15 trillion. So money market--
Mr. Carney. That is a little bit higher than what we have
been talking about in terms of the effect of this move, which
you would argue is, in part, just a movement of interest rates
on the way up kind of naturally.
Mr. Konczal. Absolutely. And if money market funds
contributed 3 percent of that crisis, which I think would be a
low estimate, suddenly you are talking about a really big wave
of cost-benefit analysis.
Mr. Carney. And what was the issue there with respect to
the money markets and how they performed or didn't perform, the
concerns that were raised vis--vis the breaking the buck, if
you will?
Mr. Konczal. Absolutely. So as economists across the
spectrum have agreed, that the way money market funds were
legislated and regulated as fixed NAVs is indistinguishable
from bank deposits. So it encourages runs, encourages first
mover advantage to remove those funds, and it--
Mr. Carney. Is that actually true, though? Does that
actually happen? Do we have the kind of runs that were--that
were theorized? Does the data suggest that?
Mr. Konczal. Absolutely. We saw $400 billion leave money
market funds to go to treasuries, a safe asset, within--within
weeks in the aftermath of the Lehman Brothers failure. The
failure of Lehman caused the Reserve fund bank to break the
buck. But the contagion was not limited to money market funds
with exposure to Lehman. I think that is very important to
remember. If it was an issue of just due diligence against the
credit risk of one firm, we would have a different
conversation. But the panic that spread across the funds as a
whole led to a complete contraction, a complete collapse of
commercial paper in a way far beyond anything we are talking
about at the margins here.
You know, there has been an express--expressed interest of
Congress to avoid future bailouts. And I believe that floating
NAV provides a market-based transparency and a market-based
price for what the actual risk of these investments are when
treasurers in other companies take them on.
Mr. Carney. What about the point, I think a good one, that
there ought to be some analysis of the effect of these
regulations and how they interact with one another in decision-
making? Do you think that has been done effectively or does
there need to be more done there?
Mr. Konczal. I can't comment to the extent that there needs
to be a formal review. But I would say that it is by--the
capital requirements that we are discussing separately here,
leverage ratio, risk-weighted assets, LCR liquidity, and TLAC,
are designed to work together. They complement each other in
very powerful and important ways, where risk weighting--
Mr. Carney. Do they also provide more of a burden, if you
will, a regulatory burden?
Mr. Konczal. I don't know if--
Mr. Carney. In combination as opposed to on their own.
Mr. Konczal. No. I believe together they actually amplify
and make each other work better from a systemic risk point of
view. For instance, we know risk-weighting assets are pro-
cyclical. They--you know, they are less binding and less--less
important in times of credit booms and credit expansions, where
leverage requirements are not. You know, if you have the safest
assets but you are funded overnight, if there is a little bit
of a problem, you can suddenly end up in big trouble if you
don't have the liquidity needed to survive 2 months--or to
survive 1 month as per the Bear Stearns rule. So I feel we want
to--we do want to understand them as overlapping in a good way
because they were designed to do that.
Mr. Carney. So what about the argument that, again sounds
compelling to me, that there is a significant administrative
burden, you know, in terms of keeping track of this and that,
that otherwise those resources could be used for something else
in a firm?
Mr. Konczal. And, you know, there perhaps is low-hanging
fruit--
Mr. Carney. I mean, is there a better way to do it, I
guess, is ultimately the question.
Mr. Konczal. The issue of tax law I can't speak to. I know
the IRS has worked with the SEC and they can talk more. But the
actual issue of the floating NAV, I think, is the crucial
component, and it is what really defines the market-based
pricing of these things. And it prevents the runs and dynamics
that we saw in the crisis and we absolutely must prevent in
future crises.
Mr. Carney. I don't have much time left, but, Mr. Deas, do
you--you obviously have a different view of that. What would
you highlight as the difference--the important differences?
Mr. Deas. Yes, sir. Just on the last point you made, the
Treasury Department--or my colleague made, the Treasury
Department did come out with rules to simplify the tax
recordkeeping. The effect of those rules is to force a
corporate treasurer to invest all the company's money in a
single money market fund which increases concentration and
creates much higher systemic risk.
Mr. Carney. So you think there--there is a better way to
accomplish the same thing?
Mr. Deas. Well, a fixed NAV would do that.
Mr. Carney. Well--
Mr. Deas. And it would be offset by greater reporting,
visibility, transparency of what the fund's holdings are so
that investors can look at that on a daily basis and make their
own choices. Some of these were instituted in 2010 reforms, and
we think that sunshine is the best medicine.
Mr. Carney. So with the chairman's indulgence, so assuming
a floating NAV. Right? So is there a better way to do that or
is this the best way to do it, in your view? I mean, I
understand you would go back to a fixed NAV. But I am talking
about given a floating NAV, are there things that can be done
to make it less administratively burdensome?
Mr. Deas. Well, the reality is with corporate systems and
cash management systems, it takes literally months to modify
those systems to keep track down to the nearest hundredth of a
cent of investing the company's funds at a floating NAV. And
when we are asked is there an alternative to spending this
money for information technology changes, the answer is, well,
yes. I can buy a government money market fund. And enough yes
answers were made so that $1 trillion left. And that money is
not available for productive purposes. It is available to funds
government entities being financed through these government
money market funds.
Mr. Carney. I tell you, I am sympathetic to the argument
with respect to administrative costs. You know, the question
gets to be, you know, what are the tradeoffs, you know. And I
think it is every--it should be everybody's objective to keep
your borrowing costs as low as possible so that you can keep
people working. And that is what is really most important to me
and I know my colleagues on both sides of the aisle. And it
would be nice if we could kind of work together and find the
best way to do that, to address some of the issues and concerns
that came out of the financial crisis and move forward in a way
that is productive for job creation and administratively not as
burdensome for firms that create those jobs.
Thank you, Mr. Chairman, for your indulgence. I yield back.
Chairman Garrett. That was a good question. Good questions.
The gentleman from Pennsylvania, recognized for maybe the
last word.
Mr. Rothfus. Mr. Chairman, I thank you for holding this
hearing and I thank you for giving me the opportunity to join
the committee just for the day to ask some questions. And I
also want to thank you for your service and your friendship on
the committee, your friendship to us. And you will be sorely
missed.
I am glad we are having this hearing because I have become
concerned about the significant dislocation that we are seeing
as a result of the regulatory changes that went into effect in
October. This rule which forces institutional prime and tax-
exempt money market funds to have floating NAVs has effectively
nationalized the money market industry. One point two trillion
dollars has left institutional prime and tax-exempt funds, and
much of it has migrated to government funds and treasuries. The
rule thwarts investor preference and effectively, in my
opinion, subsidizes Fannie and Freddie and the Federal
Government. Municipalities, universities, hospitals, and
corporations are seeing their borrowing costs go up, and we can
trace this directly to the dislocation caused by this rule.
That is why I am a strong supporter of H.R. 4216 which
corrects this problem. I understand the concerns that some
members of this committee have raised, but in addition to the
fact that money market funds are historically very secure
investments, this bill makes clear that taxpayers will not be
on the hook to bail out a failing fund. There is an express
prohibition on that.
Mr. Carfang, as you know, I asked Treasury Secretary Jack
Lew about this issue at a full committee hearing in September.
His response surprised me. At that point, nearly $1 trillion
had moved in anticipation of the rule's implementation, yet
Secretary Lew said that we were, ``not seeing dislocations in
the marketplace on a broad basis.'' He went on to add that,
``We are not seeing problems arising in the market where
funding needs can't be met.''
I am wondering if you could respond to Secretary Lew's
comments.
Mr. Carfang. Well, I would be concerned if he did see a
dislocation that--this change had been telegraphed for 2 years,
and the Treasury itself announced it was watching and stood
ready for greater debt issuance if the markets needed the Fed
to--the Treasury to step in.
These dislocations are real. Companies are paying higher
interest rates. Municipalities are losing funding from tax-
exempt funds and having to turn to other--
Mr. Rothfus. When he says funding needs can't be met, I
mean, is that necessarily the question? I mean, that is one of
the questions. But there is also a cost associated with that.
Mr. Carfang. Well, sure.
Mr. Rothfus. You might--
Mr. Carfang. But there are funds available in the market
but at a cost. I can go to my father-in-law to borrow money,
but I certainly wouldn't want to do that at his price. You
know, I would rather borrow from, you know--you know, corporate
treasurers need to borrow from the most deep and efficient
markets, like the commercial paper market and the bank markets.
Mr. Rothfus. In looking at the municipal context where I
think you testified that assets and taxable funds and prime
funds have fallen--well, let's look at tax-exempt--fallen
roughly by half.
Mr. Carfang. Right.
Mr. Rothfus. This is funding used by municipalities,
schools, hospitals. It stands to reason that this rule is to
blame for driving some of the money out of these assets. Yes?
Mr. Carfang. That is correct. Well, as a matter of fact,
the fluctuating NAV and the non-natural person restriction
almost makes it impossible for a bank trust department to now
invest in a tax-exempt fund. Because a bank trust department
has no way of seeing down through into the natural person/non-
natural person question.
Mr. Rothfus. But a natural person still gets to invest in a
fixed--a natural person would still be able to invest in a
fixed.
Mr. Carfang. Well, except a natural person and non-natural
person is kind of a fiction. You know, it gets down to the
question of who is making the investment decision deep down
inside of an omnibus account. And the banks simply have no way
of knowing that.
Mr. Rothfus. If I could quickly go to Mr. Deas. In your
testimony you wrote that the SEC's rules raises heightened
concerns about money market funds' liquidity, stability, and
overall utility. Can you elaborate a little bit more on the
systemic risks that you see as a result of the rule?
Mr. Deas. Yes, sir. We have focused on the amount of money
that is left, and we pointed out to the SEC several times that
when you change the rules affecting this investment vehicle
known as money market funds, remember that it also has been a
significant source of financing for Main Street companies. And
we have seen the amount of non-financial commercial paper that
money funds buy decline from 40 percent in April of 2012 to
just 5 percent at the end of last month. And that supply/demand
imbalance has resulted in higher costs for Main Street
companies. And when we get into a time of heightened financial
crisis, then it will dry up, because money funds not only have
their amounts gone down, but the actual number of funds has
declined from 600 funds to 400 funds. So it is not going to be
there and it will become more evident when we get into strained
conditions.
Mr. Rothfus. Mr. Chairman, I see my time has expired. If I
could offer to the record a letter from the State Financial
Officers dated December 1st to Speaker Ryan, and from the
Coalition for Investor Choice to you and to the ranking member.
Chairman Garrett. Without objection, it is so ordered.
And your last word apparently sparked other interest. And
so now we turn to the gentleman from California. And Ed is
recognized for 5.
Mr. Royce. Well, Mr. Chairman, thank you. Thank you very
much. And I thank the witnesses on the panel for being with us
today.
So we are home to capital markets that are unmatched in
terms of the size of our markets, the transparency in it, the
depth, the resiliency, as we have seen. And they provide,
really, the fuel that keep the largest economy in the world
moving and allow for investment and development and ultimately
allow for job growth. Because at the end of the day, wages per
worker are dependent upon productivity per worker. That is
dependent upon investment per worker, and that is dependent
upon the capital markets and getting everybody into the capital
markets. So it is interesting.
The European Commission recently engaged in what they
called a call for evidence. And that was a request that the--to
the public for feedback on interactions, inconsistencies, and
gaps, and unintended consequences created by Europe's
regulatory framework, created by their bureaucracy. And I was
going to ask should, and maybe of Mr. Toomey, should U.S.
regulators engage in a similar project as the EU's call for
evidence and maybe ask what the benefits would be of such an
undertaking?
Mr. Toomey. Yes. Thank you. And I think as we mentioned in
our opening remarks, European Commission effort and the call
for evidence provides a framework for doing this cumulative
analysis on the effects of all these different and overlapping
regulations. And we think particularly the parameters that the
European Commission outlined, the impact on economic growth, we
think is key. Obviously, the interactions and the
inconsistencies is key to understand. And I think the ultimate
output from a domestic standpoint is understanding how all
these dispirit rules attacking and addressing different types
risks, whether they are overshooting their policy goals to the
detriment ultimately of the economy.
So I think, basically, when we look at the European
Commission effort, the parameters they outline are very similar
to what we believe should be done. And now is a good time to do
it, given that the rules have been in place for some time. At
least some of them have.
Mr. Royce. Well, I would also ask Mr. Deas, on the
testimony that you submitted focused on the impact of bank
capital and liquidity rules on end users and on corporate
treasurers. This argument, less liquidity, can mean production
comes to a halt. Less liquidity means often that the
inventories run low, that the payroll isn't made on time. All
of which, of course, harm the people that rely upon these
businesses and harm the economy. And I would just ask what
could we do in Congress here to address exactly these concerns.
Mr. Deas. Congressman, thank you very much for that
question. I would say that for you to mandate that the banking
regulators undertake an analysis of both the individual effects
but equally as important the cumulative effects based on their
interactions of these different rules as they affect Main
Street companies. We made the point and got bipartisan
agreement that, for instance, requiring end users to margin
their derivative positions with cash, which was a direct
dollar-for-dollar diversion from funds that would otherwise be
invested to grow inventory, to conduct research and
development, to buy new plant and equipment, and otherwise to
sustain and we hope grow jobs, was something that should be
done. And in this Congress that was done.
But the banking regulators have taken steps that put that
capital burden instead on the banks, I think, without fully
appreciating that, in the end, they are intermediaries and we
bear--we the end users and the manufacturing companies of this
country bear those costs.
Mr. Royce. You know, our chairman of this committee has a
firm grasp on history as well as economics. And I would just,
Mr. Chairman, quote Aristotle on this, ``Balance in all things
that are unbalanced.'' And my fear here is that we have tipped
the scales too much towards bureaucracy. Collective action
really is needed at this point, because at the end of the day,
bureaucracy can't take all risk and regulate it out of the
market. And the facts are that we have to keep our eye on the
main function of the market and drive that job growth.
But with that I will yield. And I thank you, Mr. Chairman,
for your good leadership of this subcommittee.
Chairman Garrett. And I thank the gentleman from
California.
Moving up north to--oop. The gentleman from California has
arrived. Then we shall--the gentleman from Maine.
Mr. Poliquin. Thank you, Mr. Chairman, very much. Those of
us that--or those of you who are here today probably don't know
that with the chairman's moving on, he will be spending more
time in the great State of Maine that I represent. And I would
like to make it public that, Mr. Chairman, you would be so
welcomed up in Maine with your family. You have no idea. Just
bring as much money as you can. We need the business. And
February is a wonderful time go to Maine, Mr. Chairman. And I
know you know that.
With that, you know, I am scratching my head here a little
bit, folks. Here we have a product, money market fund product,
that has been around for decades. And it has been used very
effectively by not only individual investors but by
institutional investors to manage their cash, to make sure that
there is a way to finance expansion. And, of course, when
businesses grow, they hire more people and they pay them more
money.
I was a State treasurer for a couple years up in Maine. And
we used money market funds effectively, different types of
funds, to manage our cash such that we could build a new sewage
treatment plant in Auburn or a new bridge over the Penobscot
River in Bangor, for example. So there are all kinds of
opportunities to use this product. Now, all of a sudden, you
know, government comes along and we have a new regulation and
we see money flying from this product that has worked for
decades well. We see players leaving the space. We see costs
going up. And there is less liquidity in the market and less
opportunity to grow our economy and do what we want and have
more opportunity and more jobs for our kids.
So my question is, Mr. Toomey, to you, please, my first
question, is one of the concerns the SEC has and others have in
this--that have been dealing with this issue is a run on the
bank, accelerated redemptions. And do you have any evidence or
do the folks that you work with have any evidence that this new
rule dealing with market to market or floating NAV or whatever
you want to call it would have an impact in slowing down or
stopping accelerated redemptions at a tough time?
Mr. Toomey. I am actually not the best person in my shop to
answer that question. But we can get back to you on that one.
Mr. Poliquin. Thank you.
Anybody else on the panel like to take a shot at that?
Mr. Carfang. Well--
Mr. Poliquin. Mr. Carfang, you look like you are ready to
say something.
Mr. Carfang. Well, sure. It will not stop a run. And, in
fact, if you go back and look at what happened during the
financial crisis, while the reserve fund broke a buck and
investors fled, i.e., a run, that was on the Monday morning
that Lehman went bankrupt. The run didn't spread until it hit
the entire capital market on the Wednesday, which was after the
Federal Reserve announced a bailout of AIG. It wasn't the
reserve fund that spread to other prime funds. It was when the
entire market collapsed.
Mr. Poliquin. So what I am hearing you say, sir, is that
market conditions, whether it be economic or capital market
conditions, really determine investor behavior.
Mr. Carfang. Exactly.
Mr. Poliquin. Okay.
Mr. Konczal. I would like to also respond to that,
Congressman.
Mr. Poliquin. Please.
Mr. Konczal. To the historical stability of the money
market fund, that it is worth noting that there has been over
200 capital injections by sponsor funds going back to the early
1980s. These sponsor capital injections are, basically, the
only way to handle a lot of the failures of these and--of these
funds. And crucially, they are ad hoc and they are opaque to
investors. So they are not even sure when they happen. You
know, they can't be anticipated in the way that it happens.
And so, you know, if you want to talk about reducing
bureaucracy of these kinds of things, market pricing strikes me
as the best way to ensure that these funds are properly matched
to investors' expectations and to also decrease the possibility
of a bailout.
Mr. Poliquin. Mr. Konczal, let's stick with you, if you
don't mind, and ask my final question in the time I have
remaining here. We have a change in administration that is
underway now. It will be effective as of noontime on January
20. Presumably, there will be a couple new commissioners on the
SEC and Chair White is moving on at the end of the current
administration. Doesn't it make sense to you that we let the
new SEC commissioners deal with this issue?
Mr. Konczal. Well, the SEC has already dealt with this
issue in 2014 through a very long process of international
coordination, coordination with FSOC and other regulators.
There is an important reason they put this in. They were
initially reluctant to do it, and they had to think about it
and do a significant amount of analysis to do it. So it was not
entered into lightly and it was not entered into carelessly. I
feel it really does reflect something that went wrong in the
crisis that is widely acknowledged to have gone wrong in the
crisis. And if this is not the appropriate regulation, going
back to the regulatory environment of 2007 strikes me as a step
backwards, not a step forward.
Mr. Poliquin. Mr. Deas, would you like to comment on that
with respect to the new administration coming in and how they
will be populating the SEC?
Mr. Deas. Yes, sir. I think it should be undertaken along
the lines of this cumulative impact study that I mentioned. And
we have always said that sunshine is the best medicine.
Prior to the financial crisis, money market funds did not
report their underlying holdings except on a very infrequent
basis. I think it was every 60 days and--or with a delay. And
one of the improvements that the SEC has made is more frequent
reporting of even daily positions. And we think this provides
market participants enough information that they can make their
own decisions when to trade out of a fund that is becoming more
risky based on their analysis of that underlying data.
Mr. Poliquin. Thank you all very much.
Mr. Chairman, again, I salute you, congratulate you, and I
thank you for your service to the great State of New Jersey,
and to our country. Thank you, sir.
Chairman Garrett. And I will see you in February.
The gentleman from California. Actually, I may be in
California in February. That sounds like a better place to be.
Mr. Sherman. That was my point. If the gentleman from Maine
is going to convince you that that is the place you want to be
in February, you are more gullible than I previously thought.
Chairman Garrett. The gentleman is recognized.
Mr. Sherman. Shadow banking is an interesting phrase. Can't
imagine anybody being in favor of shadow banking. We want
transparency and light. Shadow banking sounds dangerous. Is
this term accurate? Where does it derive from? And is there a
less pejorative term that would be more accurate? I will ask
the gentleman from the Roosevelt Institute.
Mr. Konczal. I will give you a little bit of a history. It
comes out of analysis of the crisis by PIMCO and other--
particularly on the bond side. The economist Gary Gorton wrote
several books about it in 2009, 2010.
Mr. Sherman. Well, if I was going to sell a book, I would
want something hard hitting like Shadow Banking or the Monsters
of Shadow Banking, the Vampires of Shadow Banking. But is this
an accurate--
Mr. Konczal. Like so many things in finance, it is tough to
find a catchy term for it. But it is absolutely accurate. It
refers to banking activities that occur outside the formal
prudential banking activity. Credit lending through things that
have redemption at par. And as such, you know, it is--evolves
out of the capital markets historically. But basically,
securities industries and--
Mr. Sherman. You are saying it is limited to those
circumstances where you are not going to a regulated depository
institution but you expect to redeem at par.
Mr. Konczal. Exactly. And I don't want to say there is no
regulations because, you know, for instance--
Mr. Sherman. It is not a regulated depository institution.
Mr. Konczal. Absolutely. And does not have contacts for
deposit insurance or other kinds of insurance, prevent runs,
and it doesn't have lender of last resort access. Those aren't
necessarily the right tools to deal with things like shadow
banking. But it gives you a sense of how it has emerged in a
way that creates systemic risk, creates panics and contagion,
but doesn't have the tools around it to help prevent the
systemic risk.
Mr. Sherman. Now, investors want to redeem at par. But, in
fact, they are the owners of shares in a mutual fund where
assets may be worth slightly more or might be slightly less.
Now, one way to deal with this is to simply disguise this and
tell people that their shares are always worth a dollar when,
in fact, they are worth a mil more or a mil less.
Another way for the private market to deal with this is
some sort of insurance where a private sector entity, instead
of disguising the fact that your investment may be worth less
than par, would come in and guarantee that your investment
would be less than par--would be worth full par in return for a
premium that might take away from investors some of the up side
when their investment is worth more than par.
Why do we need to tell investors it is worth par when it
isn't instead of having a private sector insurance so that it
really is worth par? I will go to--I don't know which of you
would like to respond.
Mr. Carfang.
Mr. Carfang. Sure. Daily liquidity is the fundamental cash
management need of corporations. And money market mutual funds
have provided that since their institution over 40 years ago
and--
Mr. Sherman. I get daily liquidity on my S&P 500 fund too.
But it may not be minute liquidity, but it is daily liquidity.
But nobody is going to tell me that it is worth par.
Mr. Carfang. But what you have are ultra short investments
in the funds that can be amortized to maturity and actually
provide that daily liquidity of par. And, you know, this is the
same way that Treasury and government funds operate. So, you
know, this whole argument about separating out the private--the
funds that deal with the private sector and municipalities from
government funds, well, government funds operate under the same
accounting rules as well. So it seems to me that that is a red
herring and--
Mr. Sherman. That may be a red herring, but it is not
relevant to the question I asked. Why have mutual funds that
cater to investors who want to make sure they get absolute par
to the last mil, why have they not simply acquired insurance so
that their assets are never less--worth less than par? Mr.
Konczal. Oh, Mr. Deas, then--
Mr. Deas. Yes, sir. Well, I think in the declared policy of
zero interest rates, which we have lifted off from very
gradually, the cost of the insurance compared to the margin
that is available after all the other expenses to pay for that
insurance is just not going to be there. And so the--
Mr. Sherman. Well, you do also have the up side. I mean,
the--
Mr. Deas. But the cure will--
Mr. Sherman. Just as likely to be worth a mil more than a
mil less than par.
Mr. Deas. But the cure will kill the patient. And the
patient is already $1 trillion in worse shape than when this
effort started, however well intentioned. And I agree that it
would have the beneficial effect that you say, but I am
questioning the cost versus that benefit.
Mr. Sherman. So our way to assure people of par is just
tell them it is worth par whether it is or not--
Mr. Deas. No, sir. What I have testified to is that to
provide them with greater information, with daily information,
and that sunshine is the best medicine. And corporate
treasurers are paid every day to protect the company's funds
and will look at that information and make a wise decision on
behalf of their shareholders.
Mr. Sherman. I believe my time has expired.
Chairman Garrett. Mr. Hultgren is recognized for perhaps
the last word.
Mr. Hultgren. Thank you, Mr. Chairman. And, again, I just
want to thank you so much for your service, Chairman Garrett.
You have been such a help to me and so many others. I just want
to let you know that I appreciate you. I appreciate your family
so much, and wish you all the best. And I am, again, just very
grateful for your friendship and your mentoring to folks like
me. So thank you so much. And, again, all the best to you.
Thank you to our witnesses. Grateful that you are here.
Mr. Carfang, I want to address my at least initial
questions to you if I may. On page 7 of your testimony, you
stated, Tax-exempt funds, a key source of funding for
municipalities, universities, and hospitals, have experienced a
51 percent, or $132 billion decline from $260 billion to $128
billion. How much of this decline is directly attributable to
the SEC's new rules? Do you think there could be other factors
in that?
And then continuing on with my questions, some of my
constituents have raised concerns that the imposition of a
floating NAV is increasing the cost for tax-exempt financing.
However, I have also heard that the liquidity fees and
redemption gates are a bigger issue. What has your research
shown on that?
And then last, during a November hearing before the
Financial Services Committee, SEC Chair Mary Jo White noted
that the recent movements in the money market fund occurred
consistent with their economic analysis. Chair White also
testified that she expects that the institutional prime funds
will stabilize and see a return of funds sometime after the
October effective date. Do you agree with this assessment?
That is a lot of questions. I apologize.
Mr. Carfang. That was a lot of questions.
Well, the first one is what percent of the decline in tax-
exempt funds was due to the SEC regulations? All of it. That is
no question about it. Banks had to, for technical reasons, pull
out of it because they simply couldn't sweep and they couldn't
identify non-natural persons.
Let's see. The second part of your question--
Mr. Hultgren. Well, it was about some constituents raised
concern about imposition of a floating NAV is increasing costs
for tax-exempt financing. But also, I have heard that liquidity
fees and redemption gates are a bigger issue. What has your
research shown on that?
Mr. Carfang. What we have testified, and we have spoken to
the commission as well, that both the floating NAV and the fees
and gates are key issues. And that--that should not have been
imposed the way they have been. The floating NAV is the
threshold issue, though, because there are a number of
mechanical and administrative reasons why a number of
organizations have to move their money out.
So, you know, with the 4216, that actually informs the SEC
that it is the intention of Congress to protect and defend and
restore money market funds. That can be an immediate fix. And
then the fees and gates, which are an issue, can be dealt with
longer term.
Mr. Hultgren. Okay. Let me ask you quickly here. Do you
believe the SEC and other members of FSOC should conduct an
analysis and see what systemic risk could be posed by the
decrease of liquidity in our bond market? To your knowledge,
has the FSOC or any member agency conducted any analysis of the
systemic risk that could result from a lack of liquidity in the
corporate bond market due to misguided regulatory initiatives
like the Volcker rule or Basel III?
Mr. Carfang. Oh, I--I think the rules what--they dry up
liquidity in the market. They depress trading. They reduce
dealer inventories. So as a result, there is less price
discovery and there is less economic efficiency all the way
around. And, you know, a theme I am hearing is that, you know,
the investors in these prime funds don't understand the
valuation or what is going on in the daily liquidity. Frankly,
that is an insult to corporate treasurers all over America.
These are sophisticated folks who know exactly what is in these
funds and understand the risks and make their judgments based
on that.
Mr. Hultgren. Okay. Thank you.
Quickly in my last minute, Mr. Toomey, you note in your
testimony that repo transactions play a vital role within the
financial system and underpin the functioning of the capital
markets. You further describe the repo market as the grease
that allows the U.S. capital markets to remain the most
efficient and liquid in the world so that businesses,
municipalities, and the Federal Government can access needed
credit at a lower cost over time.
There seems to be a great deal of misunderstanding about
the repo market by prudential regulators and others. I wonder
if you could explain quickly further the importance of the repo
market.
Mr. Toomey. Thank you. And quickly on the repo market, it
indeed--it manages to move securities and cash around the
system quickly and safely. In particular, take the example of a
market maker. It allows a market maker to both source
securities to service its clients, as well as provide a venue
for short-term cash that may need to be invested on a short-
term basis. So all of that provides grease, lubricant for the
overall financial system. Allows liquidity to thrive in the
cash markets because cash market participants can always source
securities in the repo market. So I think that important piece
is sometimes missed, and it really does underlie all our cash
markets.
Mr. Hultgren. Thank you. Thank you all.
Chairman, again, thank you so much. And I yield back.
Chairman Garrett. The gentleman yields back.
And with that, seeing no other speakers, I guess I will
just conclude with two things.
The Chair notes that some Members may have additional
questions for this panel, which they may wish to submit in
writing. Without objection, the hearing record will remain open
for 5 legislative days for Members to submit written questions
to these witnesses and to place their responses in the record.
Also, without objection, Members will have 5 legislative days
to submit extraneous materials to the Chair for inclusion in
the record.
And on a personal note, I guess this is my last hearing, my
last speaking and what have you. So I will end--and it is
apropos that I come in on a hearing where the hearing topic is
the impact of regulations on the economy, which I guess is why
I came to--one of the reasons why I came to Washington in the
first place, to figure out why we were doing so many
regulations in Washington and the negative effect that it has
on people back at home.
So it has been an honor to be able to be here in this House
of Representatives and to be in this committee, and to be
actually a chairman of a subcommittee that is so interesting
and so significant to this country. It has been an honor to
know all the folks who are on this committee, to both now and
have left the committee over the years, that we should remember
them as well. It has been an honor to have all the folks behind
me and next to me, my committee designee. But a member of our
committee, Brian and Kevin, and then all the rest here who have
been working with us assigned to the committee over the years
have been really--I will say the appropriate word, it has been
neat working with all of you, and it is really fun on the
sometime very--what some people might say boring issues. But I
think the members of this committee find them fascinating and
extremely important and profoundly significant to this country.
So I guess I will just say: Wish you all well, as people
say to me. As they don't know what I am doing in the future, I
don't know what you guys are all going to be doing in the
future either. So I wish you well in what is going to be an
exciting time for this country where I see in the public
opinion polls there is a huge wave of optimism going forward.
So I am optimistic for all of you folks as well, both here,
behind me, next to me, and in front of me, the people who come
and testify before this committee as well. Optimistic for the
future, what we can do--what you all can do for the country.
And I am also pleased--and she didn't want me to introduce
her or anything else--that my wife Mary Ellen could be with me
on this last day as well.
Thank you, and the committee is adjourned. Thank you, and
God bless.
[Whereupon, at 11:55 a.m., the hearing was adjourned.]
A P P E N D I X
December 8, 2016
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