[House Hearing, 113 Congress]
[From the U.S. Government Publishing Office]
THE GROWTH OF FINANCIAL REGULATION
AND ITS IMPACT ON
INTERNATIONAL COMPETITIVENESS
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON OVERSIGHT
AND INVESTIGATIONS
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED THIRTEENTH CONGRESS
SECOND SESSION
__________
MARCH 5, 2014
__________
Printed for the use of the Committee on Financial Services
Serial No. 113-69
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HOUSE COMMITTEE ON FINANCIAL SERVICES
JEB HENSARLING, Texas, Chairman
GARY G. MILLER, California, Vice MAXINE WATERS, California, Ranking
Chairman Member
SPENCER BACHUS, Alabama, Chairman CAROLYN B. MALONEY, New York
Emeritus NYDIA M. VELAZQUEZ, New York
PETER T. KING, New York MELVIN L. WATT, North Carolina
EDWARD R. ROYCE, California BRAD SHERMAN, California
FRANK D. LUCAS, Oklahoma GREGORY W. MEEKS, New York
SHELLEY MOORE CAPITO, West Virginia MICHAEL E. CAPUANO, Massachusetts
SCOTT GARRETT, New Jersey RUBEN HINOJOSA, Texas
RANDY NEUGEBAUER, Texas WM. LACY CLAY, Missouri
PATRICK T. McHENRY, North Carolina CAROLYN McCARTHY, New York
JOHN CAMPBELL, California STEPHEN F. LYNCH, Massachusetts
MICHELE BACHMANN, Minnesota DAVID SCOTT, Georgia
KEVIN McCARTHY, California AL GREEN, Texas
STEVAN PEARCE, New Mexico EMANUEL CLEAVER, Missouri
BILL POSEY, Florida GWEN MOORE, Wisconsin
MICHAEL G. FITZPATRICK, KEITH ELLISON, Minnesota
Pennsylvania ED PERLMUTTER, Colorado
LYNN A. WESTMORELAND, Georgia JAMES A. HIMES, Connecticut
BLAINE LUETKEMEYER, Missouri GARY C. PETERS, Michigan
BILL HUIZENGA, Michigan JOHN C. CARNEY, Jr., Delaware
SEAN P. DUFFY, Wisconsin TERRI A. SEWELL, Alabama
ROBERT HURT, Virginia BILL FOSTER, Illinois
MICHAEL G. GRIMM, New York DANIEL T. KILDEE, Michigan
STEVE STIVERS, Ohio PATRICK MURPHY, Florida
STEPHEN LEE FINCHER, Tennessee JOHN K. DELANEY, Maryland
MARLIN A. STUTZMAN, Indiana KYRSTEN SINEMA, Arizona
MICK MULVANEY, South Carolina JOYCE BEATTY, Ohio
RANDY HULTGREN, Illinois DENNY HECK, Washington
DENNIS A. ROSS, Florida
ROBERT PITTENGER, North Carolina
ANN WAGNER, Missouri
ANDY BARR, Kentucky
TOM COTTON, Arkansas
KEITH J. ROTHFUS, Pennsylvania
Shannon McGahn, Staff Director
James H. Clinger, Chief Counsel
Subcommittee on Oversight and Investigations
PATRICK T. McHENRY, North Carolina, Chairman
MICHAEL G. FITZPATRICK, AL GREEN, Texas, Ranking Member
Pennsylvania, Vice Chairman EMANUEL CLEAVER, Missouri
PETER T. KING, New York KEITH ELLISON, Minnesota
MICHELE BACHMANN, Minnesota ED PERLMUTTER, Colorado
SEAN P. DUFFY, Wisconsin CAROLYN B. MALONEY, New York
MICHAEL G. GRIMM, New York JOHN K. DELANEY, Maryland
STEPHEN LEE FINCHER, Tennessee KYRSTEN SINEMA, Arizona
RANDY HULTGREN, Illinois JOYCE BEATTY, Ohio
DENNIS A. ROSS, Florida DENNY HECK, Washington
ANN WAGNER, Missouri
ANDY BARR, Kentucky
C O N T E N T S
----------
Page
Hearing held on:
March 5, 2014................................................ 1
Appendix:
March 5, 2014................................................ 25
WITNESSES
Wednesday, March 5, 2014
Barr, Michael S., Professor of Law, University of Michigan Law
School......................................................... 10
Bennetts, Louise C., Associate Director of Financial Regulation
Studies, the Cato Institute.................................... 5
Hillel-Tuch, Alon, Co-Founder and Chief Financial Officer,
RocketHub...................................................... 6
Wallison, Peter J., Arthur F. Burns Fellow in Financial Policy
Studies, the American Enterprise Institute..................... 8
APPENDIX
Prepared statements:
Barr, Michael S.............................................. 26
Bennetts, Louise C........................................... 32
Hillel-Tuch, Alon............................................ 46
Wallison, Peter J............................................ 60
Additional Material Submitted for the Record
McHenry, Hon. Patrick:
Written statement of the National Association of Federal
Credit Unions (NAFCU)...................................... 74
Written statement of the U.S. Chamber of Commerce............ 78
Green, Hon. Al:
Written statement of Professor Chris Brummer, J.D., Ph.D.,
Georgetown University Law Center........................... 80
THE GROWTH OF FINANCIAL
REGULATION AND ITS IMPACT ON
INTERNATIONAL COMPETITIVENESS
----------
Wednesday, March 5, 2014
U.S. House of Representatives,
Subcommittee on Oversight
and Investigations,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 2:02 p.m., in
room 2128, Rayburn House Office Building, Hon. Patrick McHenry
[chairman of the subcommittee] presiding.
Members present: Representatives McHenry, Fitzpatrick,
Barr, Rothfus; Green, Cleaver, Sinema, Beatty, and Heck.
Chairman McHenry. This hearing of the Subcommittee on
Oversight and Investigations will come to order. Without
objection, the Chair is authorized to declare a recess of the
subcommittee at any time.
I want to welcome our witnesses and members. This hearing
is entitled, ``The Growth of Financial Regulation and its
Impact on International Competitiveness.'' The purpose is to
examine the impact of increasing regulations on U.S. financial
institutions and markets, as well as to evaluate whether
differences between domestic and foreign regulations create
competitive disadvantages and decrease the attractiveness of
U.S. financial markets.
I will now recognize myself for 5 minutes for an opening
statement. For a century, American dominance in the financial
services industry has proven vital to the strength of our
national economy. Through the Great Depression, the Great
Recession, and many ups and down in between, American supremacy
in this sector has provided access to capital and economic
freedoms that other nations can only aspire to create. And yet,
it should not be taken for granted. We live in an extremely
competitive and dynamic global marketplace, and the United
States faces a period of rising regulation.
In the course of implementing the Dodd-Frank Act and Basel
III rules, U.S. regulators have imposed and continue to impose
regulations that will undoubtedly constrain banking and
financial services. This hearing will examine both the
cumulative impact of these regulations and the extent to which
differences between domestic and foreign regulatory regimes
have made it more difficult for U.S. financial institutions to
compete. In remarks before the International Monetary
Conference in June 2011, then-Treasury Secretary Timothy
Geithner explained why Congress and financial regulators needed
to consider the competitiveness of U.S. financial markets.
He said, ``We live in a global financial marketplace with
other financial centers competing to attract a greater share of
future financial activity and profits.'' The divergence of
regulation across borders, however, creates the risk of
regulatory arbitrage, in which financial institutions and
markets direct resources and locate their activities to
minimize the cost of regulation. As U.S. regulators continue to
implement the Dodd-Frank Act, including the Volcker Rule, and
set capital and liquidity requirements that exceed the Basel
III recommendations, other countries have been slow to adopt
similar rules or have refused to adopt them at all.
Given advances in communications technology, financial
institutions are looking outside the United States to avoid the
burdens of U.S. regulation. As policymakers, we need to be
aware of that. Because U.S. financial institutions are in the
process of building the compliance structures necessary to
comply with hundreds of new rules, the aggregate cost of all
these rules cannot be quantified. Because regulators have
refused to undertake cost-benefit analyses for these new rules,
estimating their cost is difficult. Nonetheless, these
regulatory burdens will impose costs in the form of anemic
economic growth and weak job creation.
In a world in which capital knows no boundaries and
competition is global, the extent to which new financial
regulations impose greater burdens on U.S. firms and financial
markets relative to Europe, Asia, and other advanced economies
will further harm the U.S. economy as foreign banks and capital
markets grow at our expense. Now, we have to talk about the
regulation within our regime and what we can control. That is
what this hearing is about. Overregulation extends to all areas
of finance, even those intended to help small entrepreneurs
seeking to raise capital through crowdfunding.
Rather than helping these entrepreneurs access a new source
of capital, the regulations issued by the Securities and
Exchange Commission require these small businesses to comply
with a proposed rule that was so complicated that it required
568 pages for the SEC to explain it. This is unacceptable. As
the United States awaits a final rule from the SEC, European
securities-based crowdfunding has been permitted to operate
under a much more reasonable regulatory framework that is
continually expanding. Other opportunities in Asia are already
existent. We are slow to catch up when it comes to
crowdfunding.
As it stands today, the United States is a net importer of
capital and a net exporter of financial services. And yet, the
United States' financial services faces a period of rising
regulation that could threaten this advantage. Financial
regulators implementing Dodd-Frank in international courts have
imposed, and continue to impose, regulations to prevent our
constrained banking and financial services in virtually all of
its capacities. As we continue down this path it is imperative
that we view the regulatory costs and burdens in a larger
global context. That is how the capital markets view it, and as
policymakers, that is how we must view it.
I look forward to hearing from our witnesses today, and the
questions our Members have, and I know that we can benefit from
the broad expertise of this panel.
With that, I will now recognize the ranking member of the
subcommittee, Mr. Green, for 5 minutes.
Mr. Green. Thank you, Mr. Chairman. I also thank the
witnesses for appearing this afternoon.
Mr. Chairman, America has long been a leader within our
global community. Many look to us and see a land of
opportunity, where hard work and persistence can mean a better
life. Many more view our great Nation as an economic superpower
whose leadership is central to the success of the entire global
economy. The question of whether America should lead or be led
is one that we in Congress confront daily. And I am confident
that no Member of Congress believes that America should follow
when our leadership is needed.
This is why, when the question of American competitiveness
in the global economy is raised in the context of regulatory
reform, I do not oppose a thorough discussion that considers
many points of view. Such a discussion should include, at
minimum, some laconic indication as to why a global economic
meltdown was imminent, how it was avoided, and what was done to
avoid a recurrence.
Why was the global meltdown imminent in 2009? Among many
reasons advanced were a lack of regulatory structure, such that
risky products gained global acceptance, significant capital
quality was poor, risk-based capital ratios of too many huge
corporations were too low, countercyclical capital was too low,
leverage ratios of many significantly significant financial
institutions were too high, liquidity standards were generally
inadequate among some major financial institutions, and capital
standards for many systemically significant financial
institutions were insignificant or insufficient.
The conditions led to a circumstance wherein capital was
frozen to the extent that banks would not lend to each other,
and FDIC coverage had to be increased from $100,000 to $250,000
to maintain depositor confidence.
How was the global meltdown avoided? When the markets
nearly collapsed, costing an estimated $13 trillion in economic
output, countries were devastated as the housing bubble burst.
The U.S. Government took unprecedented steps to avoid a global
economic depression by supporting American financial
institutions critical to the global markets, extending over $1
trillion in support, including an estimated $580 billion in
liquidity swap blinds for foreign countries, all of which is to
be repaid.
Now, what was done to avoid a recurrence? The codification
and passage of Dodd-Frank--this legislation deals with too-big-
to-fail taxpayer bailouts--indicates America's leadership, and
this is a great piece of legislation that was passed. Many
other countries have followed suit and have begun considering
their own similar regulatory efforts.
Mr. Chairman, I believe--I have always contended and
believed that we should amend Dodd-Frank, not end it.
Legislation of this magnitude is rarely perfect, and I believe
that we must do all that we can to avoid unintended
consequences. However, I also believe that Dodd-Frank was, and
is, necessary. Important evidence of the necessity for Dodd-
Frank is the fact that Congress passed Dodd-Frank in this time
of a divided Congress. As I mentioned earlier, any analysis of
American economic competitiveness merits a thorough discussion.
It is important for the record to reflect that much of Dodd-
Frank's rulemaking has not been finalized. Further, it is also
important to note that many times, our Federal regulators have
amended the rules when the public and Congress has raised
concerns.
The Basel III framework was originally agreed upon in 2010.
However, the provisions of the agreement are still being
implemented, and some are scheduled to come online as late as
2019. In addition, other important regulatory rulemakings have
not been finalized at this time, and we should consider their
impacts as I am concerned it may be premature, at this time, to
draw final conclusions on rules that are far from final without
evidence of an adverse impact.
The SEC is woefully underfunded, to the extent that
mission-critical capacity may be compromised. This is why, in
part, I support the President's requested amount, and believe
that in so doing, in funding the SEC, we might engender greater
progress and stronger enforcement, which means better investor
protection. When we comport with the belief that regulatory
reform places America at a competitive global disadvantage, we
expose ourselves to the risk of a great irony: there will
always be the fear of failing, or falling behind the innovation
curve. That is what has led to the new regulations and has
caused us to turn a blind eye to securities markets that caused
a great downturn and that we still do not fully understand.
America must lead. We did this with Dodd-Frank, and we must
expect the same from our global counterparts as they work to
strengthen their regulatory frameworks.
I look forward to hearing from our witnesses, and I thank
you, Mr. Chairman. I yield back the balance of my time.
Chairman McHenry. We will now recognize our distinguished
witnesses. I will introduce the panel, and then we will begin
and go in order here.
First, Louise Bennetts is the associate director of
financial regulation studies at the Cato Institute. She focuses
on the impact of financial regulatory reform since 2008,
including attempts to address too-big-to-fail and the impact of
cross-border regulatory initiatives on financial stability and
global capital flows.
Second, we have Alon Hillel-Tuch, the co-founder and CFO of
RocketHub, which is a rapidly expanding online crowdfunding
portal. He was previously a special situations manager at BCMS
Corporate.
Third, Peter J. Wallison is co-director of the American
Enterprise Institute's program on financial policy studies.
Previously, as General Counsel to the U.S. Treasury Department,
he had a significant role in the development of the Reagan
Administration's regulatory reforms in the financial services
marketplace.
And finally, Michael Barr is a law professor at the
University of Michigan Law School. He was previously on leave
in 2009 and 2010, serving as the Treasury Department's
Assistant Secretary for Financial Institutions. He was very
involved in the development of the Dodd-Frank Act during that
time, as well.
Now, for those of you who are well-acquainted with this,
you understand the lighting situation we have here in Congress.
As Members of Congress, we need very simple rules of the road.
And so green means go, yellow means hurry up, and red means
stop.
Without objection, the witnesses' written statements will
be made a part of the record. And the idea here is for you to
summarize your written statement in 5 minutes.
We will begin with Ms. Bennetts.
STATEMENT OF LOUISE C. BENNETTS, ASSOCIATE DIRECTOR OF
FINANCIAL REGULATION STUDIES, THE CATO INSTITUTE
Ms. Bennetts. Chairman McHenry, Ranking Member Green, and
distinguished members of the subcommittee, I thank you for the
opportunity to testify in today's important hearing. As
Chairman McHenry noted, I am Louise Bennetts, the associate
director of financial regulatory studies at the Cato Institute,
which is a non-profit, nonpartisan public policy institute here
in Washington, D.C.
Before I begin, I would like to highlight that all comments
I make and opinions I express are my own and do not represent
any official positions of the Cato Institute or any other
organization.
In the United States, since 2010, we have seen the rollout
of one of the most comprehensive reform agendas targeting the
financial services industry. The centerpiece of the reform
agenda, the Dodd-Frank Wall Street Reform and Consumer
Protection Act, has 394 associated rulemaking requirements, and
has already spurred thousands of pages of related rules.
But this is just the tip of the iceberg. As of February
2014, only 52 percent of the rules required by the Act have
been finalized. Around 20 percent have yet to be proposed. And
Dodd-Frank is but one component of a much, much larger
financial regulatory reform agenda which includes a complete
overhaul of capital and liquidity rules imposed on the U.S.
banking sector; a radical revision of the regulation of non-
bank financial companies, such as insurance firms and asset
managers; changes in the regulation of U.S. operations of
foreign banks; changes in the regulation of consumer credit;
and the imposition of new monitoring and enforcement
obligations on behalf of the Federal Government.
And all of these obligations are multiplied for banks that
operate cross-border. In addition, barely a month passes
without a new financial initiative being proposed either in
Congress or through the regulatory agencies. While many of
these proposals will never see the light of day, they
nonetheless impose a significant cost on the private sector in
terms of the uncertainty they generate. The question before the
committee today is, how is this regulatory overhaul impacting
the global competitiveness of the American financial services
sector and, indeed, American consumers of financial services?
To date, no assessment has been made of the cumulative
impact or cost of all of this regulation. To answer it, in my
view, we need to address two related issues. The first is, what
are the individual and cumulative costs? And second, and more
importantly, are we likely to achieve the desired outcome, that
is, creating a financial system that is safer and more
transparent, without damaging credit provisions.
First, I would like to make a few observations about the
United States' position in the global economy. As Chairman
McHenry noted, the United States is a net importer of capital
and a net exporter of financial services. And despite its
fragmented regulatory system and its crisis-prone banking
history, the United States has nonetheless developed the
world's most vibrant capital markets and currently has the only
well-developed debt market and short-term or overnight dollar
funding market. Most foreign companies and banks raise a
significant portion of their non-depository funding here in the
United States. Because of this, the United States today has the
world's reserve currency and is able to finance its significant
deficits, where other countries have struggled to do so.
However, while the United States may have had a head start,
one cannot assume a permanent state of dominance. Steps are
being taken to develop high-yield and other short-term funding
markets, particularly in Southeast Asia, as well as in Europe,
although I note that the European funding markets remain weak.
In addition to the large European banks, several emerging
markets, most notably China, are taking noteworthy steps
towards the creation of worldwide banking conglomerates. Both
defendants and opponents of the current regulatory reform
agenda frequently present this issue as a binary choice between
profitability and competitiveness one hand, and safety and
stability on the other.
For the reasons we will discuss today, and as set out in my
written testimony, I view this as a false dichotomy. The time
has come to acknowledge that we are at a crossroads globally
and domestically. One path leads to a system where American
banks and financial services firms, buckling under the weight
of excessive regulation, become less diversified, less
competitive globally, more inward-looking and, in my view,
potentially more unstable. This path leads to a suboptimal
outcome, where firms are focused on pleasing regulators rather
than on market risk and meeting the needs of their consumers.
Another path begins with the recognition that we really may
have gone a step too far. The time has come to ask ourselves
what was the purpose of all of this? If the purpose is to make
the United States banking sector less crisis-prone, safer, and
more competitive, we need a comprehensive and realistic
assessment of whether all these regulations, given their costs,
are achieving this outcome.
I thank you for the opportunity to testify today.
[The prepared statement of Ms. Bennetts can be found on
page 32 of the appendix.]
Chairman McHenry. Thank you, Ms. Bennetts.
Mr. Hillel-Tuch?
STATEMENT OF ALON HILLEL-TUCH, CO-FOUNDER AND CHIEF FINANCIAL
OFFICER, ROCKETHUB
Mr. Hillel-Tuch. Mr. Chairman and members of the
subcommittee, thank you for this opportunity to provide
testimony. My name is Alon Hillel-Tuch. I am a co-founder and
chief financial officer of RocketHub. RocketHub is an
established crowdfunding platform that has initiated over
40,000 campaigns and has provided access to millions of dollars
worth of capital for entrepreneurs and small businesses in over
180 different countries.
My testimony today is based on my field experience working
closely with new and small business. Domestic job growth comes
from the new and small business sector. Approximately 90
percent of U.S. firms employ 19 or fewer workers, and these
companies create jobs at nearly twice the rate of larger
companies. According to January's ADP national employment
report, between December and January small businesses with
fewer than 50 employees added 75,000 positions. That is more
than double the number of jobs large businesses created in the
same period.
Job creation is the most prevalent in new companies. And if
our job goal is to drive job growth within the United States,
our focus should be on new business formation. The spirit of
entrepreneurship in the United States is unparalleled and, as a
result, more Fortune 500 companies exist in the United States
than anywhere else in the world. Those large companies are
serviced well by big banks and the public markets. But new and
small businesses often find it difficult to access capital.
In the United States, investment capital is mainly limited
to regions such as New York City, Boston, and Silicon Valley.
However, most new and small businesses do not have access to
these capital zones, let alone the innovation hubs recently
created by the White House. Crowdfunding platforms such as
RocketHub provide capital access to new and small businesses
that are either neglected by large banks or face unmanageable
interest rates due to different risk mechanisms.
Until recently, the crowdfunding market was allowed to
evolve and innovate without government oversight. Platforms
sprouted, and the public quickly adopted this social form of
capital formation. Equity crowdfunding was the next
evolutionary step in the market, and the first time Congress
became involved. The House of Representatives passed several
bills focused on economic revitalization and democratizing
access to capital. This became the Jobs Act that the President
signed into law on April 5, 2012.
But since then, implementation delays have been
significant. It took the FCC 566 days to release proposed rules
for Title III. In the meantime, basic forms of equity
crowdfunding have been operational for almost 3 years in the
United Kingdom and the Netherlands, and for nearly 5 years in
Australia. The United States is a market that is a magnet for
domestic and foreign entrepreneurs. But they must have the
necessary tools available within the United States to innovate
and grow.
And other countries are actively pursuing these
entrepreneurs. For example, Chile has a special visa program
for foreign entrepreneurs that includes a $40,000 grant. And
they proactively approached RocketHub. They sat down with me to
discuss leveraging crowdfunding, including equity-based
crowdfunding, within the Chilean market. I have had similar
discussions with foreign direct investment agencies in France,
as well as the Ontario securities commission in Canada. The
World Economic Forum's global competitive report identifies the
United States as an innovation powerhouse, yet we rank only 5th
in competitiveness.
Certain countries that ranked lower in competitiveness,
such as the Netherlands (8th) and the United Kingdom (10th) are
catching up. And they are doing this by being forward-thinking
market innovators, encouraging new capital formation policies
such as equity-based crowdfunding, well in advance of the
United States. This is not a brand-new market. It is a market
that has been in existence for awhile. And it has its wings
clipped in the United States by overregulation. This is an
important economic tool that helps small and young businesses
grow, which will drive job creation.
And if it is not allowed to continue to develop in the
United States, the market will ultimately continue to develop
outside this country. The Jobs Act, and Title III in
particular, was intended to mandate low-cost regulation that
relied on individuals within the marketplace and their
socially-informed investment appetite. However, it has evolved
into a high-cost solution relying heavily on frameworks
developed over 80 years ago.
At this point, legislative support is needed to assist the
Securities and Exchange Commission in creating functional rules
for Title III. Checks and balances within emerging markets are
critical not only for consumer protection purposes, but also to
generate trustworthiness in the market. I believe appropriate
regulation, leveraging a soft yet informed approach, is
crucial. With congressional support, we can increase the
economic benefit provided by crowdfunding and remain
competitive in the international market.
The current market dynamics abroad, demonstrated by
countries such as Canada, the United Kingdom, the Netherlands,
Australia, Italy, and now New Zealand make it clear that only a
proactive approach in ensuring functional regulation will
enable the United States to maintain a dominant international
position for new and small businesses. I hope to have the
opportunity to elaborate further on key provisions.
And I thank you for your time.
[The prepared statement of Mr. Hillel-Tuch can be found on
page 46 of the appendix.]
Chairman McHenry. Thank you.
Mr. Wallison?
STATEMENT OF PETER J. WALLISON, ARTHUR F. BURNS FELLOW IN
FINANCIAL POLICY STUDIES, THE AMERICAN ENTERPRISE INSTITUTE
Mr. Wallison. Chairman McHenry, Ranking Member Green, and
members of the subcommittee, my testimony today will focus on a
different aspect of financial regulation and competition: the
competition between banks and non-bank financial firms, what
bank regulators call ``shadow banking.'' This needs much more
attention from Congress. Under the Dodd-Frank Act, the
Financial Stability Oversight Council (FSOC) has the authority
to designate any financial firm as a systemically important
financial institution (SIFI) if the institutions's financial
distress will cause instability in the U.S. financial system.
Non-bank financial firms designated as SIFIs are then
turned over to the Federal Reserve for what appears to be
prudential bank-like regulation. The troubling extent of the
FSOC's authority was revealed recently, when it designated the
large insurer, Prudential Financial, as a SIFI. Every member of
the FSOC that was an expert in insurance and was not an
employee of the Treasury Department dissented from the
decision, arguing that the FSOC had not shown that Prudential's
financial distress would cause instability in the financial
system.
Virtually all other members, knowing nothing about
insurance or insurance regulation, dutifully voted in favor of
Prudential's designation. Indeed, there was little data in the
document that the FSOC issued in support of its decision. The
best way to describe the decision is perfunctory. There is a
reason for this. In effect, the decision on Prudential had
already been made before the FSOC voted. The previous July, the
Financial Stability Board (FSB), an international body of
regulators, empowered by the G20 leaders to reform the
international financial system, had already declared that
Prudential was a SIFI.
The FSOC's action was simply the implementation in the
United States of a decision already made by the FSB. Since the
Treasury and the Fed are members of the FSB, they had already
approved its July action. This raises a question of whether the
FSOC will be doing a thorough analysis of whether financials
firms are SIFIs, or simply implementing decisions of the FSB.
This is important because the FSB looks to be a very aggressive
source of new regulation for non-bank financial firms.
In early September, it said that it was looking to apply
the ``SIFI framework,'' as it called it, to securities firms,
finance companies, asset managers, and investment funds,
including hedge funds. These firms are the so-called ``shadow
banks'' that regulators want so badly to regulate. But it will
be very difficult to show that these non-bank firms pose any
threat to the financial system. For example, designating large
investment funds as SIFIs would be a major and unwarranted
extension of bank-like regulation. Collective investment funds
are completely different from the banks that suffered losses in
the financial crisis.
When a bank suffers a decline in the value of its assets,
as occurred when the mortgage-backed securities were losing
value in 2007 and 2008, it still has to repay the full amount
of the debt it incurred to acquire those assets. Its inability
to do so can lead to bankruptcy. But if an investment fund
suffers the same losses, these pass through immediately to the
fund's investors. The fund does not fail, and thus cannot
adversely affect other firms. Asset management, therefore,
cannot create systemic risk.
Nevertheless, right after its Prudential decision, and
following the FSB's lead, the FSOC now seems to be building a
case that asset managers of all kinds should also be designated
as SIFIs and regulated by the Fed. It recently requested a
report from the Office of Financial Research, another Treasury
body created by Dodd-Frank, on whether asset management might
raise systemic risk. Not surprisingly, OFR reported that it
did. Unless the power of the FSOC is curbed by Congress, and
soon, we may see many of the largest non-bank firms in the U.S.
financial system brought under the control of the FSOC, and
ultimately the Fed, and regulated like banks.
As shown in my prepared testimony, these capital markets
firms, and not the banks, are now the main funding sources for
U.S. business. Bringing them under bank-like regulation will
have a disastrous effect on economic growth and jobs. And this
outcome could be the result of decisions by the FSB, carried
out by the FSOC. This is an issue Congress should not ignore.
I look forward to your questions. Thank you.
[The prepared statement of Mr. Wallison can be found on
page 60 of the appendix.]
Chairman McHenry. Thank you, Mr. Wallison.
And last, we will hear from Professor Barr.
STATEMENT OF MICHAEL S. BARR, PROFESSOR OF LAW, UNIVERSITY OF
MICHIGAN LAW SCHOOL
Mr. Barr. Chairman McHenry, Ranking Member Green, and
members of the subcommittee, I am pleased to appear before you
today to discuss financial regulation and U.S. competitiveness.
In 2008, the United States plunged into a severe financial
crisis, one that shuttered American businesses and cost
millions of households their jobs, their homes, and their
livelihoods. The crisis was rooted in unconstrained excesses
and prolonged complacency in major financial capitals around
the globe.
In the United States, 2 years later, the Dodd-Frank Act
created the authority: to regulate these major firms that pose
a threat to financial stability without regard to their
corporate form, and to bring shadow banking into the daylight;
to wind down major firms in the event of a crisis without
feeding a panic or putting taxpayers on the hook; to attack
regulatory arbitrage, restrict risky activities, regulate
short-term funding, and beef up banking supervision; to require
central clearing and exchange trading of standardized
derivatives, and capital, margin and transparency throughout
the market; to improve investor protections; and to establish a
new Consumer Financial Protection Bureau (CFPB) to look out for
American households.
Since enactment, the CFPB has been built and is helping to
make the marketplace level and fair. New rules governing
derivatives transactions have largely been proposed. Resolution
authority and improvements to supervision are being put in
place. The Financial Stability Oversight Council has begun to
regulate the shadow banking system by designating non-bank
firms for heightened supervision. And regulators have recently
finalized the Volcker Rule.
To continue to make progress on reform, the Federal Reserve
needs to finalize its limits on counterparty credit exposures
and propose a cap on the relative size of liabilities held by
the largest firms. It must also continue the reform of REPO and
other short-term funding at the heart of the financial panic.
Five years after the money market mutual fund industry faced a
devastating run, stopped only with a $3 trillion taxpayer
bailout, we still do not have fundamental reform of that
sector, with the necessary buffers to prevent a financial
collapse.
And we need legislation to determine the ultimate fate of
the government-sponsored enterprises in a way that protects
taxpayers, while assuring that the mortgage system works for
American families. Strong and effective regulation in the
United States is crucial to a safer and fairer financial
system, but it is not enough. We also need global reforms.
Strong capital rules are one key to a safer system. There is
already double the amount of capital in the major U.S. firms
than there was in the lead-up to the financial crisis.
At the same time, globally, regulators are developing more
stringent risk-based standards and leverage caps for all
financial institutions, and tougher rules for the biggest
players. More needs to be done to make resolution of an
international firm a practical reality. In the United States
and Europe, further work is needed on implementing structural
reforms that could reduce risks, improve oversight, and make
the largest firms more readily resolvable in the event of a
crisis.
On derivatives, while much progress has been made, the
United States remains concerned about whether Europe's rules
will end up strong enough. And many in Europe worry about
whether the United States will extend the reach of its rules
too far. Yet, the global system is moving to a more coordinated
approach for derivatives that is making a meaningful
difference. The United States has taken a strong lead in all of
these efforts, galvanizing the G20 and pursuing global reforms.
Now is not the time to weaken this global effort.
In sum, strong U.S. financial rules are good for the U.S.
economy, good for American households, and good for American
businesses. We cannot afford to roll back the clock on
financial reform in the name of U.S. competitiveness. Engaging
in a race to the bottom is a bad idea for both the United
States and for the global financial system. We should address
the current potential for international regulatory arbitrage by
pushing for more global reforms, not by weakening our own
standards or exposing our own country to the risks of another
financial crisis.
The fact that the United States acted forcefully in
implementing reforms is good for the United States, ensuring
that our financial system is more stable and able to weather
our future financial crises. In contrast, Europe still faces
serious sources of risk in their financial systems. In Europe,
its piecemeal approach to reform has led to considerable
uncertainty that has hurt investment and delayed economic
recovery. Rather than focusing on how we can lower our own
standards, we need to focus on continuing to push for global
reforms so that the risks that could develop overseas do not
come back to our own shores in a future financial crisis.
Thank you very much.
[The prepared statement of Professor Barr can be found on
page 26 of the appendix.]
Chairman McHenry. I will now recognize myself for 5 minutes
for my questions. The success of our capital markets in the
United States has to do a lot with property rights and contract
law and certainty of our regime, as well as wise regulation,
not the absence of regulation, which is a misunderstanding and
a wrong conclusion of the last financial crisis. There was
regulation prior to 2008. It did exist. Perhaps it was bad
regulation that led to some bad outcomes.
But just to put that as a marker down to this first
question I have, which is if you look at the world and the flow
of capital around the world, Ms. Bennetts, is there a rapid
increase in financial regulation? And is that rapid increase of
regulation having an effect on the flow of capital in the
world? Is that a proper understanding, that regulation and
capital have some linkage?
Ms. Bennetts. Yes, and certainly--I think that the most
recent sort of noteworthy study on that was undertaken by the
McKinsey Global Institute. They brought it out, I think, in
about March of last year. And what they have said is that since
the crisis, since about 2007, I think, global capital flows
have declined about 60 percent. Some of that has to do with the
crisis in Europe, which I think is an issue of government data
and placing the banking sector in an extraordinarily difficult
position. And that is a separate issue.
But a lot of it also has to do with the fact that following
a crisis, the natural tendency of regulatory authorities,
wherever they may be, is to look inward and to put barriers,
and it is sort of a process, which I think is frequently
referred to as ``balkanization.'' And that makes the local
sector far more insular and far more inward-looking. That is a
problem because it has a real cost for the flow of capital.
And one other thing I would say about that is, you often
hear or you read in pieces that people say it almost sounds
like these flows are a bad thing, that it is a bad idea to have
capital flowing across borders. But in fact, the crisis would
have been far, far worse in 2008 if we didn't have the free
flow of movement across borders. So that was actually, for the
United States, a very big and important--
Chairman McHenry. But there is a--everyone is talking about
Europe here when they testify--financial regulators in the
United States are testifying about European movements and
perhaps following in a similar direction, as we have in our
regime. But isn't it, in fact, the case that with three of the
world's largest banks being Chinese, there is a movement in
Asia to go a different direction in terms of regulation?
Ms. Bennetts. First of all, Europe is an interesting case.
Because, for example, if you take a recent initiative--and I
will use one that is in both countries--the Volcker Rule,
right? The Volcker Rule came out in the United States and it
is, as we know, a mammoth undertaking. It is a very complex
rule that spans hundreds of pages. There is a lot of
micromanaging within the rule, a lot of ongoing enforcement and
monitoring.
And when you look at the way that the Europeans have
approached it, they have released a similar rule recently. But
theirs is more sort of a principal-based approach. They come
out and say, ``We would prefer that you didn't do this
proprietary trading that has no client benefit, but we are not
really going to institute ongoing and expensive monitoring and
enforcement type requirements.'' So I would argue that is a lot
less burdensome for the institutions which are following it.
That has been a consistent approach that they have adopted.
They certainly have a very different approach in Asia,
certainly in Hong Kong and Singapore, which is where the main
markets are, you don't see the same level of regulation. They
want high capital, but they don't have the same level of
micromanagement.
Chairman McHenry. Mr. Hillel-Tuch, about crowdfunding, I
authored that section of the Jobs Act that has a regime so that
we can have low-dollar equity raising online. You have done a
study on what those 568 pages have--the cost structure on a
crowdfunding raise. Do the regulations have a bearing on the
costs of raising money through crowdfunding?
Mr. Hillel-Tuch. Yes. It took a long time to read through
all those pages. It was quite cumbersome to do, and
unfortunately I have had to do it a few times due to
inconsistencies. But we did an analysis which I included as a
chart in my written testimony that you are free to take a look
at. But there are friction points created within the regulation
that basically allow for up to 50 percent of the money raised
going towards overhead and compliance costs. So what happens
is, you have an act that, instead of becoming a reform act or
an innovation act becomes a regulatory act with regulatory
friction points.
Some of them have to be changed, and that is only something
that could be done with congressional support. Some of them can
be changed at the discretion of the SEC, with proper support
given by not just Congress but other people, as well. It is
quite significant when you are a small business owner and you
are facing up-front costs that can easily go over $30,000
without any kind of a guarantee that you are going to receive
the capital you raised. And that is a significant debt people
should not bear.
Chairman McHenry. My time has expired.
We will now recognize Mr. Cleaver for 5 minutes.
Mr. Cleaver. Thank you, Mr. Chairman. When I played
football, we lived for the moment of getting a running back or
a wide receiver out in the middle of the field, putting your
helmet into him, and hearing the crowd go, ``Ooh.'' That was
delicious. It has been outlawed; you can't do it anymore. You
can't even trip anyone anymore. Tripping used to be one of the
best things going, but you can't trip, they won't let you trip
anymore.
And you can't even--you have to pamper the quarterback. You
have to go in and say, ``Sir, is it okay if I hit you?'' There
are all of these new regulations imposed on these football
teams. And every winter, there is a committee of owners who
meet to consider new regulations. I traveled with the Kansas
City Chiefs playing in Tokyo, actually twice. They played in
Mexico, and then London. Sellouts. And there is a great market
for all of the memorabilia that you buy for the Chiefs and the
Giants and the Cowboys all over the world.
In Canadian football, which is similar to American
football, they constantly look at what we are doing in the
United States to make decisions on what they are going to do in
Canada. We don't alter the American rules to accommodate what
the Europeans or the Africans or Asians are doing in what they
call football, which we call soccer. Football is still the
number one sport in the world economically, just like the
United States is. And there is simply no reason for the NFL to
abandon rulemaking and regulations, because they are making the
game safer.
And I am wondering what is wrong with trying to make the
game safer, as we are talking about the economics of the United
States. I was here with Mr. McHenry and Mr. Green--I guess we
may now be the only three who were here on the day that we had
the economic collapse. I don't ever want that to happen again.
And to the degree that we can make rules and regulations that
will prevent it, how many of you don't--who believes that is
wrong? Anybody else?
Mr. Barr. I think you are right, Mr. Cleaver. I think that
we need to have strong rules of the game that make the system
safer and fairer for American families and businesses, and that
make us have a strong and vibrant financial system. And I think
we are on the right path to do that.
Mr. Cleaver. Mr. Wallison?
Mr. Wallison. I would like to point out that there are, as
the chairman suggested, bad regulations. And one of them is the
Basel regulations, I, II, and III.
Mr. Cleaver. Basel II?
Mr. Wallison. Beginning with the different risk weights
that were put on assets, and as a result, the capital cost was
much cheaper for banks to buy mortgage-backed securities. They
did this in vast numbers because they were only required to
hold 1.6 percent capital for mortgage-backed securities but 8
percent capital for perfectly good corporate securities. The
result of this, of course, was when mortgage-backed securities
collapsed in 2007 and 2008, banks were hurt very badly.
In fact, that was the immediate cause of the financial
crisis. So I think we have to be very careful about the kinds
of regulations that we put in place. Some of them can be
extraordinarily harmful, and that is one.
Mr. Cleaver. Yes, I would agree. But what you do is that
you revisit any of the rules that became an impediment to the
game, which is not what we are doing. You want to make the
rules better. The problem is that instead of making the rules
better, we attack the rules.
My time has run out, and I didn't even get to basketball.
Chairman McHenry. I didn't follow you at all. I don't
follow football or soccer much, but I do follow NASCAR. So if
you had done that, I would have maybe tracked a little bit--no.
I appreciate my colleague.
I now recognize the vice chairman of the subcommittee, Mr.
Fitzpatrick, for 5 minutes.
Mr. Fitzpatrick. I appreciated Mr. Wallison's comment that
the rules, or in this case the regulations, have to be
thoughtful. They have to be fair, they have to be evenly
applied, and not just simply cumulative or reactionary. I am
mainly concerned about the risk of retaliation against the
United States by foreign regulators, number one. Number two, is
there a possibility that foreign banks will seek to do business
with United States firms from abroad?
And finally, the impact of all of this on jobs here in the
United States, which as we consider rules and regulations and
new laws and cumulative laws, we also have to consider and
weigh carefully the impact of all of this on how it affects
people here in this country, people at home in our districts,
those jobs. And I was wondering, Ms. Bennetts, would you be
able to comment on the question of whether or not--the first
question, is there a risk of retaliation against the United
States by foreign regulators?
Ms. Bennetts. Yes, I think--and Representative Green sort
of mentioned, I think, in his opening statements about being a
leader. The United States is a leader in the global financial
services sector. So what the United States does is important in
the global economy. And one of the problems, for example, a
piece of research I have recently done is on the Federal
Reserve's Foreign Bank Proposal, and the potential impacts of
that down the road.
When you undermine your ability to work with foreign
regulators, and you say, ``We are going to take an approach
where we are essentially going to ring-fence your operations in
our country,'' that really opens up the door for those foreign
regulators to say, ``If you are doing that in your country, we
don't believe firms can be resolved on a global level. So we
are going to do the same to your firms in our country.'' And
that creates a lot of problems, particularly for U.S.
institutions that operate cross-border. And also for
institutions or companies, American companies, that use these
financial services and need the ability to move money and
services across borders.
And then further down the road, I think, as I said, the
United States is in a lucky position today. Because they are
able to--sort of in a unique position because they have these
debt markets that aren't developed elsewhere in the world. But
that is now. And we have seen them move towards developing them
elsewhere. And so all that will happen is foreign banks that do
all that business here will move it elsewhere. And that is a
few years down the road, but it is definitely coming.
Mr. Fitzpatrick. How about the potential for retaliation by
foreign regulators?
Ms. Bennetts. Michel Barnier said, when the first proposal
of the Fed's rule--this is just the most recent example that
came out--one of the letters that came into the Federal Reserve
comment ledgers was from foreign regulators. And they said,
``We are under pressure. If you do this, we are under pressure
to do the same thing in our own markets.'' And so, that is a
big problem. And we will see what happens. It is early days,
but I think they are likely to retaliate.
Mr. Fitzpatrick. Mr. Hillel-Tuch, you do business with a
lot of foreign firms, I assume, from the United States. So what
is the risk that foreign banks are going to say, we will do
business with the United States, but from over here?
Mr. Hillel-Tuch. Yes. What is starting to get interesting
specifically about some of the points that the other witnesses
made is, you are looking at banks that are sort of becoming
incentivized to trade with other foreign banks instead of
entering the United States at all. And you are going to start
getting collaboration between different banks who may not even
want to work with companies such as mine because we are mainly
affiliated with the U.S. banking system.
We are seeing that more and more often. Operating in over
180 different countries, we are on the foreign exchange all the
time for different currencies, having to move that around
globally in real time. That is becoming increasingly harder to
do as people are uncertain about what is happening next. What
that means for me is, I am starting to have to become more
selective on what countries I am operating in as a U.S.-born
firm, and I have to start considering registering in other
countries as an entity purely because I am being kind of
hindered in my ability to operate out of the United States.
Mr. Fitzpatrick. Mr. Wallison, can you address the impact
on jobs here in the United States of what was just discussed?
Mr. Wallison. Certainly. I happen to believe that one of
the reasons that we have had such a slow recovery from the
financial crisis and from the recession that followed is that
the regulations that we have placed on the financial system
have really brought it to its knees, to use the expression that
is used in other contexts. People in the financial world are
now quite afraid of interference by the government, charges of
various kinds by the government, and are unable to understand
the very complex regulations that they have to face.
In particular, I think the Basel regulations have become
enormously complex. It is almost impossible to understand them.
So, we need a much simpler set of regulations, such as a simple
leverage ratio for banks instead of this very complex set of
regulations. They have just gotten worse since Basel I was
adopted in the 1980s.
Mr. Fitzpatrick. I appreciate the comments.
Thank you.
Chairman McHenry. We will now recognize Mrs. Beatty for 5
minutes.
Mrs. Beatty. Thank you, Mr. Chairman, and Mr. Ranking
Member. And thank you to the witnesses for being here today. I
am trying to wrap my head around this whole crowdfunding issue.
So let me kind of go back, and maybe Mr. Barr or anyone who
wants to address it. You will certainly recall that in April
2012, President Obama signed into law the Jumpstart Our
Business Startups Act, or the Jobs Act, which was designed to
spur hiring through relaxed regulations regarding public and
private companies' ability to raise capital.
And the Jobs Act was widely supported and received almost
400 votes from both Democrats and Republicans, who felt that it
was the right way to improve the economic climate in the United
States. However, since its passage, the SEC has come under
scrutiny for having something moving too slowly and creating
new rules, or for creating rules that were still too
restrictive. In particular, some have expressed concerns that
the proposed Title III crowdfunding rules will unduly restrict
access to private capital, especially when compared with the
regulations in place in the U.K.
So with that said, two questions: First, can you speak
generally about what types of considerations must be addressed
when creating rules for the new crowdfunding platforms and
mandatory disclosures?
Mr. Barr. I would be happy to say a few words about it. I
think the question is how to get the balance right. And my
understanding is, the SEC received lots of comments about their
initial proposal from lots of different kinds of parties: small
businesses; sites and brokers that were interested in
participating; and from investors and investor protection
advocates. And no one was especially happy. So the SEC is going
to have to, I think, go back and look at the rule and see if
they can come up with a simpler approach that protects
investors and also permits efficient raising of funds.
My understanding is that the U.K. and the E.U. are in the
midst of reevaluating their current framework, as well, and
they may make adjustments in either direction on where they
are. So I think that it is an evolving area; it is a relatively
new area. And I think getting the balance right is going to be
really critical.
Mrs. Beatty. Let me just follow up, because you also used
the word ``protection.'' Some of the commentators are
suggesting that the businesses that are most likely to seek to
raise capital through crowdfunding are the ones with the
greatest risk of failure. Or they don't have a sufficient track
record to satisfy the concerns of venture capitalists. How
would you categorize the level of risk faced by the investors
who use crowdfunding?
Mr. Barr. There are significant risks involved in investing
in new companies. That doesn't mean it shouldn't be done, but
new companies can be quite risky to invest in, and I think that
is why it is important, while you are expanding access to these
sources of funds, to make sure that the information and
disclosure and protections are there so that investors
understand the risks that they are taking on and engaging in
the funding.
Mrs. Beatty. Have you or any of the panelists had any
instances of failure by businesses that raised capital through
crowdfunding?
Mr. Hillel-Tuch. We have had well over 40,000 campaigns at
this point. We have had no successful instances of fraud. We
have had no significant failures. More revampings. A small
business might have had to change the direction it was looking
to take, which is expected at an early stage of a company. We
have seen everything from idea stage all the way to product
concepts. What is really interesting is that right now, there
are no upfront costs they have to face in trying out what is
currently available, which is perk-based crowdfunding.
What is happening with the Jobs Act, though, because of the
equity component we have to put in new regulation, which is
critical. But there are a lot of requirements, in order to
ensure information is correct. It puts the cost burden directly
on the small business. So if you are a small business--let's
say a coffee shop in Kentucky--you really cannot afford, out of
pocket, $30,000 up front in order to then say, ``I am able to
raise over $500,000 because I was able to afford an audit,''
while maybe you don't even have historical financial
information to truly audit.
There are a lot of nonsensical components. The intent was
great, but the execution of it does not actually make sense at
the small business level.
Mrs. Beatty. Thank you.
Thank you, Mr. Chairman.
Chairman McHenry. We will now recognize Mr. Barr of
Kentucky for 5 minutes.
Mr. Barr of Kentucky. Thank you, Mr. Chairman. I want to
kind of focus on the issue of contradictory regulatory
mandates. Has this phenomenon proliferated as a result of Dodd-
Frank? And can you all provide a couple of examples of where
this kind of avalanche of regulations has contributed to
regulatory confusion and contradictory regulatory requirements
imposed on financial institutions?
Ms. Bennetts. Yes, I definitely think that--so, for
example, where you have an issue like the Volcker Rule and you
have several regulatory agencies. This is a big problem in the
Dodd-Frank Act. And we see the United States has a very
fragmented regulatory system, as well, which allows for a lot
of the regulatory arbitrage that we talk about. But Dodd-Frank
made that problem a lot worse because you have many, many
agencies that had mandates over the same rules.
And just for example, it is not exactly an overlapping
mandate, but the SEC has a mandate over security-based swaps.
The FTC has a mandate over ordinary swaps. For an entity that
is trying to put those rules into place, that is an extremely
high cost. So Dodd-Frank is listed with those kinds of
examples.
Mr. Wallison. I think there are other examples in the
Volcker Rule itself. The Volcker Rule is internally
contradictory, from my perspective. And that is one of the
reasons why it took so long for it to be put in final form. The
Volcker Rule says you cannot engage in prop trading, which
means that you cannot buy and sell securities--they are talking
here about debt securities--for your own account. But it also
says that you can continue your market-making activities and
your hedging activities. Both of those are extremely important
for the markets.
Market-making is vital for the markets because if you want
to sell a fixed-income security of some kind, there is always a
very thin market. You may not be able to find a buyer in the
world at large. You have to go to someone who will actually buy
your security, or sell you one. This is because of the thinness
of the market. That is a market-maker. When a market-maker buys
or sells, it is very difficult to tell the difference between
what is a market-making activity and what is a prop trading
activity. And as long as that is true, banks are going to be
very fearful of engaging in market-making when there is some
danger that they might be accused of violating the prop trading
rules.
Mr. Barr of Kentucky. Mr. Wallison, I think you have
included in your prepared testimony also, that in addition to
its role, its mission of identification of a risk to financial
stability, FSOC is also supposed to coordinate regulation among
the multiplicity of regulatory agencies. I take it from your
testimony that FSOC has failed to properly coordinate and limit
this--the contradiction that we see in a lot of these
regulations.
Mr. Wallison. Yes. I don't see any evidence that the FSOC
has attempted to coordinate. It has attempted to press its own
views--these are the views of the Treasury Department--on other
agencies, such as the SEC. But it hasn't attempted to bring the
agencies together to coordinate policies. At least from the
outside, it is very difficult to see that is happening.
Mr. Barr of Kentucky. In my remaining time, let me just
shift over to something else. A lot of the focus of the hearing
so far has been on the proliferation of regulations and
compliance costs. But let me ask the panel just for your views
on the tendency of financial regulators to circumvent the
Administrative Procedures Act requirements related to notice
and comment rulemaking--so-called ``informal rulemaking''--
where there is a requirement of notice and comment. And we see
this in particular with the CFPB, how they have been governing
on an ad hoc basis. Not through rulemaking, which kind of sets
predictable standards before, but instead, after the fact,
there is kind of ad hoc enforcement actions or guidance where
notice and comment and the opportunity for regulated parties of
the consumers to participate in rulemaking is not available.
Can you all comment on whether or not you are seeing a lot
of that guidance, informal interpretive memorandum, general
statements of policy as a means of circumventing rulemaking?
And what effect does that have on financial markets?
Ms. Bennetts. That was a phenomenon that we saw after the
business roundtable decision a couple of years ago, where an
ACC rule--a proxy rule was overturned by the court. And since
then, we have been seeing regulatory agencies, especially where
they are not 100 percent sure that they can do a cost-benefit
analysis or a full analysis as required by the rules, they
release guidance. And we saw, actually, to Peter's point about
the FSOC designation rule, if you looked at the rule it was
actually a very limited rule, where everything, all of the
meat, was in the guidance.
But the guidance was just guidelines, and so you couldn't,
in fact--and I suppose you could comment on them, but it
wouldn't really be taken into account because it wasn't part of
the rule.
Chairman McHenry. The gentleman's time has expired. And I
would announce to the committee, with their indulgence, with 15
minutes to vote on the House Floor just announced, a series of
votes, with the Members' cooperation we will be able to get
everyone in before we adjourn for the votes. That would be the
best thing for the witnesses and for members, as well.
So we will now recognize Mr. Heck for 5 minutes, followed
by Mr. Rothfus for 5 minutes, and then finally the ranking
member, Mr. Green, for his traditional last series here.
Mr. Heck?
Mr. Heck. Thank you, Mr. Chairman. And as someone who is to
the right of the Chair, sitting to the right of the Chair, I am
an individual who comes to this task believing that, in fact,
it is possible to overdo it on the regulatory side and to
stifle competitiveness. You can get them wrong, you can have
too many, you can make them too complex and the like. But at
the end of the day, I am fascinated by the pursuit of the right
balance between competitiveness and stability. I see them as
values, both worthwhile and often in competition with one
another.
And in that spirit, Mr. Wallison, if I can pick on you
briefly, you said something earlier that fascinated me within
this paradigm. And I am paraphrasing, but I think accurately
and in keeping with the spirit of your remark, that regulations
had brought financial institutions to their knees. What is the
evidence of that?
Mr. Wallison. This is a really interesting question. And I
wish there was more attention paid to it. When economists look
at the reasons that we are having such a slow recovery from the
financial crisis, they blame the Fed. And, to some extent,
people blame the Affordable Care Act. But no one is spending
time looking at the costs that are imposed on financial
institutions by regulations. There is a very small paragraph in
my prepared statement that I would offer to you. And that is an
article recently in the newspapers about JPMorgan Chase.
JPMorgan Chase hired 3,000 compliance officers this year.
They hired 7,000 compliance officers last year. But they are
cutting their total employment by 5,000 people this year. What
that means to me is that JPMorgan Chase is now focusing a lot--
not exclusively, but a lot--on the regulations they face. And
they are calling back into headquarters, or eliminating, the
people who actually go out and offer financing to business.
The result of that, of course, is that there is less
interest in financing, there is less credit going to
businesses, there are fewer jobs, and much less economic
growth. However, we don't hear economists who are studying the
economy focusing on that issue. So I think you have raised an
important one. We should be looking at the question of the
regulatory costs not only in dollars, but in terms of what it
does to people's will and people's interest in hiring others to
go out and do--
Mr. Heck. Fair enough, Mr. Wallison. Let the record also
reflect that we have added jobs in the private sector every
month for something like 50 months. And more importantly, and I
think frankly, sir, in absolute stark contrast with your
assertion, the 6 largest banks in America reported $76 billion
in profits in 2013--$76 billion. That is $6 billion short of
their high in 2006, when the housing market was white hot,
which hardly seems to me to translate--excuse me, sir, my
time--to being brought to their knees.
Professor Barr, on the other end of that teeter-totter--and
I am concerned about both sides--is the stability side. I
realize you are not an economist, but I would appreciate and
respect your insight or opinion nonetheless. If we had been at
full employment last year, economists estimate that we would
have grown by an additional trillion dollars. And that is not
full employment in terms of zero; that is full employment as is
generally accepted. And yet, we are significantly below that
and have been since the crash.
Is it not also true that in terms of the issue of wealth
creation and job creation that if we err too much on the side
of the teeter-totter for competitiveness without enough regard
to stability, that we do not just material harm to the economy,
but structural and--if not permanent long-term, as we certainly
have experienced in the last 5 years and as we absolutely
experienced in the many years after the Great Depression onset?
Mr. Barr. I agree with you. I think that having good,
strong regulations is good for financial stability and that is
good for growth.
Chairman McHenry. The gentleman's time has expired.
We will now recognize Mr. Rothfus for 5 minutes.
Mr. Rothfus. Thank you, Mr. Chairman. I would like to talk
a little bit about the new Basel III requirements and their
complexities. Specifically, I will go to Ms. Bennetts and Mr.
Wallison. So if you could--as I give you the background here.
The new Basel III capital requirements introduce enormous
complexity to the capital structure of banks. Multiple
protective buffers are included which contain incentives to
maintain or increase different types of capital.
The regulators have substantial discretion to dictate how
much and what type of capital shall be held at what times.
Furthermore, by maintaining the authority to do change risk
weights when measuring the risk-weighted assets of a bank,
banks can be forced in and out of different financial products
at different times. Given the complexity of the measures of
assets and capital, the market's ability to determine the true
capital position of a bank will be thoroughly clouded. The
uncertainty arising out of the regulators' discretion to modify
measures of capital and assets will cause a permanent concern
that will constrain banking business and increase that
industry's dependence on government.
It is likely that, given the discretion that regulators
have provided themselves, regulators will feel greater
responsibility over a bank's success or failure. Hence, the
manipulation of these capital and asset variables may occur.
Ms. Bennetts, given the complexity of the Basel III cap--Basel
III-based capital requirements, is it more difficult to discern
the true level of regulatory capital held by a financial
institution?
Ms. Bennetts. It is certainly difficult in the sense--I
think that the banks would release, obviously, their tier one
capital, and that would be public knowledge and you would be
able to measure it. But one thing I want to add to that is that
the problem with a risk-weighting system and, more importantly,
a risk-weighting system where everybody uses the same model--
this isn't a bank's internal risk model that it has kind of
come up with of its own markets evaluations, everybody is using
the same model--is that you have increasing asset concentration
in certain pools of assets.
Which, as you correctly noted, are the assets that the
regulators have determined are safe assets at a given point in
time. That does not necessarily mean that the bank is better
capitalized. Because if there is a run on that particular type
of asset--and we saw pre-2008, as Mr. Wallison mentioned
earlier--everybody thought that triple-A rated mortgage-backed
securities were a safe asset. So that is a real problem and a
real flaw in the risk-weighting system.
And because of the complexity, and also, you don't just
have the Basel III capital standards, you also have the
liquidity coverage ratio and all these other measures of
stability. Now, I do think banks need to be well-capitalized.
That is not the argument. The question is, how do you
capitalize them in a way that doesn't create systemic risk?
Mr. Rothfus. Mr. Wallison, would you think that this level
of complexity imposes significant costs and uncertainty on
financial institutions and on those that invest in them?
Mr. Wallison. Of course. The more complex regulations are,
the more attention has to be paid to them by the regulated
industry. They have to hire more people, they have to hire more
accountants to do all this work for them. And then there
becomes, as Louise Bennetts' just suggested, a lot of
difficulty in people outside trying to understand how the bank
has put together its capital position. I would suggest that we
would be much better off if we had a simple leverage ratio for
all banks, rather than these complex rules that began with
Basel I and have now gone through Basel II, and Basel III.
Mr. Rothfus. Would these complex rules be prone to
manipulation by regulators and subject to substantial political
pressure?
Mr. Wallison. That is harder to say. I don't know whether
regulators would manipulate these things for political
purposes. But I would say that there is only one way, really,
to prevent risk in this world. And that is diversification. The
trouble with regulation is that it tends to make everyone do
exactly the same thing. And to the extent they are doing the
same thing, as occurred with the Basel capital rules, they all
fail at the same time when something happens in the world that
no one expected. So we have to start looking at the Basel rules
and other regulations from this perspective, and say--
Mr. Rothfus. Can you comment on how these capital
requirements might impact on economic growth?
Is it the complexity of these regulations?
Mr. Wallison. It does have an impact on economic growth
because the banks, then, are pushed into certain areas that
they have to focus on because they have to comply with the
regulations. And that starves other areas of the economy from
receiving adequate amounts of credit. So the economy is shaped,
in a way, by where the banks are directed to go. I want to
mention one other thing, and that is we are talking about banks
all the time. This hearing was about banks.
The most important funder of the U.S. economy are the
securities markets and the capital markets. In my prepared
testimony, there is a chart which shows that the banks are tiny
in terms of their financing of growth and business in the
United States. The securities markets are where all the action
is, and--
Chairman McHenry. We are going to have to leave it there,
Mr. Wallison. The gentleman's time has expired.
The ranking member is now recognized for 5 minutes. And
with 2 minutes left to vote on the Floor, I will leave it to
the gentleman to determine when we should leave.
Mr. Green. I assure you, Mr. Chairman, I will consider the
time. I would like to ask unanimous consent to place in the
record the testimony of Mr. Chris Brummer, who was originally
scheduled to be a witness but could not make it today because
of the rescheduling.
Chairman McHenry. Without objection, it is so ordered.
Mr. Green. Thank you. I will be very terse with this. Mr.
Wallison, you indicate that bad laws seem to be more of a
problem than a lack of regulation. Permit me to ask you
quickly, what bad law could we have repealed such that AIG
would not have been a liability to the world economy? What bad
law could we have repealed?
Mr. Wallison. I don't think AIG did what it did because of
a bad law, although I don't think--
Mr. Green. I assume, then, that you do agree that there are
times when we have to have additional laws?
Mr. Wallison. Sure.
Mr. Green. That it is just not a question of repealing bad
laws.
Mr. Wallison. Absolutely. Regulation is necessary in some
respects. It can be overdone, as I suggested.
Mr. Green. It can be overdone. And do you agree that it can
be, in the sense of not having enough, underdone? That you can
have a circumstance where you don't have enough regulation?
Mr. Wallison. Sure. In principle, you can; you might not
have enough regulation.
Mr. Green. All right. And do you agree that we do need some
way to wind down these systemically--these very huge
corporations, that we call SIFIs, in the event they become a
liability to the world economy?
Mr. Wallison. No, I don't agree with that.
Mr. Green. Do you think--
Mr. Wallison. First of all, I don't think we understand
what SIFIs are--
Mr. Green. Excuse me, if I may ask quickly because time is
of the essence. Would you just allow them to go into
bankruptcy?
Mr. Wallison. Yes, of course. I would allow large firms and
small firms to go into bankruptcy. That is the way the market
works.
Mr. Green. And do you agree that Dodd-Frank provides
bankruptcy as a remedy?
Mr. Wallison. No, it doesn't.
Mr. Green. You do not agree that Dodd-Frank has bankruptcy
as a remedy?
Mr. Wallison. No, it does not.
Mr. Green. Oh, well, you and I differ. My time has expired,
and I apologize to you for being abrupt. I will yield back to
you, Mr. Chairman.
Chairman McHenry. I thank the ranking member, and I want to
apologize to the witnesses for when they called votes today.
But I certainly appreciate your willingness to testify and to
take Members' questions. I ask unanimous consent to submit for
the record letters from the National Association of Federal
Credit Unions and the Chamber of Commerce of the United States
of America. Without objection, they will be entered into the
record.
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.
I want to thank our witnesses for your testimony, for your
time, and for your input. And without objection, this hearing
is adjourned.
[Whereupon, at 3:18 p.m., the hearing was adjourned.]
A P P E N D I X
March 5, 2014
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