[House Hearing, 113 Congress]
[From the U.S. Government Publishing Office]
EXAMINING THE DANGERS OF
THE FSOC'S DESIGNATION
PROCESS AND ITS IMPACT ON
THE U.S. FINANCIAL SYSTEM
=======================================================================
HEARING
BEFORE THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED THIRTEENTH CONGRESS
SECOND SESSION
__________
MAY 20, 2014
__________
Printed for the use of the Committee on Financial Services
Serial No. 113-79
U.S. GOVERNMENT PRINTING OFFICE
88-541 PDF WASHINGTON : 2014
-----------------------------------------------------------------------
For sale by the Superintendent of Documents, U.S. Government Printing
Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800;
DC area (202) 512-1800 Fax: (202) 512-2104 Mail: Stop IDCC,
Washington, DC 20402-0001
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 BRAD SHERMAN, California
EDWARD R. ROYCE, California GREGORY W. MEEKS, New York
FRANK D. LUCAS, Oklahoma MICHAEL E. CAPUANO, Massachusetts
SHELLEY MOORE CAPITO, West Virginia RUBEN HINOJOSA, Texas
SCOTT GARRETT, New Jersey WM. LACY CLAY, Missouri
RANDY NEUGEBAUER, Texas CAROLYN McCARTHY, New York
PATRICK T. McHENRY, North Carolina STEPHEN F. LYNCH, Massachusetts
JOHN CAMPBELL, California DAVID SCOTT, Georgia
MICHELE BACHMANN, Minnesota AL GREEN, Texas
KEVIN McCARTHY, California EMANUEL CLEAVER, Missouri
STEVAN PEARCE, New Mexico GWEN MOORE, Wisconsin
BILL POSEY, Florida KEITH ELLISON, Minnesota
MICHAEL G. FITZPATRICK, ED PERLMUTTER, Colorado
Pennsylvania JAMES A. HIMES, Connecticut
LYNN A. WESTMORELAND, Georgia GARY C. PETERS, Michigan
BLAINE LUETKEMEYER, Missouri JOHN C. CARNEY, Jr., Delaware
BILL HUIZENGA, Michigan TERRI A. SEWELL, Alabama
SEAN P. DUFFY, Wisconsin BILL FOSTER, Illinois
ROBERT HURT, Virginia 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 STEVEN HORSFORD, Nevada
ROBERT PITTENGER, North Carolina
ANN WAGNER, Missouri
ANDY BARR, Kentucky
TOM COTTON, Arkansas
KEITH J. ROTHFUS, Pennsylvania
LUKE MESSER, Indiana
Shannon McGahn, Staff Director
James H. Clinger, Chief Counsel
C O N T E N T S
----------
Page
Hearing held on:
May 20, 2014................................................. 1
Appendix:
May 20, 2014................................................. 59
WITNESSES
Tuesday, May 20, 2014
Atkins, Paul S., Chief Executive Officer, Patomak Global Partners 8
Barr, Michael S., Professor of Law, the University of Michigan
Law School..................................................... 13
McNabb, F. William III, Chairman and Chief Executive Officer, the
Vanguard Group, Inc., on behalf of the Investment Company
Institute (ICI)................................................ 10
Scalia, Eugene, Partner, Gibson, Dunn & Crutcher LLP............. 12
Smithy, Deron, Treasurer, Regions Bank, on behalf of the Regional
Bank Coalition................................................. 15
Wallison, Peter J., Arthur F. Burns Fellow in Financial Policy
Studies, the American Enterprise Institute..................... 17
APPENDIX
Prepared statements:
Atkins, Paul S............................................... 60
Barr, Michael S.............................................. 70
McNabb, F. William III....................................... 73
Scalia, Eugene............................................... 88
Smithy, Deron................................................ 105
Wallison, Peter J............................................ 118
Additional Material Submitted for the Record
Lynch, Hon. Stephen:
``Systemic Risk and the Asset Management Industry,'' by
Douglas J. Elliott, Fellow, The Brookings Institution,
dated May 2014............................................. 134
EXAMINING THE DANGERS OF
THE FSOC'S DESIGNATION
PROCESS AND ITS IMPACT ON
THE U.S. FINANCIAL SYSTEM
----------
Tuesday, May 20, 2014
U.S. House of Representatives,
Committee on Financial Services,
Washington, D.C.
The committee met, pursuant to notice, at 10:01 a.m., in
room 2128, Rayburn House Office Building, Hon. Jeb Hensarling
[chairman of the committee] presiding.
Members present: Representatives Hensarling, Bachus, Royce,
Capito, Garrett, Neugebauer, McHenry, Pearce, Posey,
Westmoreland, Luetkemeyer, Huizenga, Hurt, Stivers, Fincher,
Stutzman, Hultgren, Ross, Pittenger, Barr, Cotton; Waters,
Maloney, Sherman, Meeks, Hinojosa, McCarthy of New York, Lynch,
Scott, Green, Moore, Ellison, Perlmutter, Himes, Peters,
Carney, Sewell, Foster, Kildee, Delaney, Sinema, Beatty, Heck,
and Horsford.
Chairman Hensarling. The committee will come to order.
Without objection, the Chair is authorized to declare a recess
of the committee at any time.
The title of today's hearing is, ``Examining the Dangers of
the FSOC's Designation Process and Its Impact on the U.S.
Financial System.'' I now recognize myself for 4 minutes to
give an opening statement.
The committee's hearing today is on the Financial Stability
Oversight Council which, like most Washington bureaucracies,
has come to be known by its acronym, FSOC. FSOC was
established, or so its supporters tell us, to make it easier
for regulators to communicate and share information with each
other. But the regulators didn't need an act of Congress to do
that, and information-sharing is not what FSOC is really all
about.
Instead, FSOC is about one thing: increasing Washington's
control over the U.S. economy, thus curtailing both economic
freedom and economic prosperity. And FSOC does this through its
power to designate systemically important financial
institutions, or in bureaucratic speak, SIFIs.
Having failed to prevent the last financial crisis,
notwithstanding having every regulatory power necessary to do
so, regulators were rewarded with even more power by the Dodd-
Frank Act. The Dodd-Frank Act represents a breathtaking
outsourcing of legislative power to the Executive Branch.
Federal agencies now have virtually unfettered discretion to
expand their regulatory control through a designation process
that is opaque, secretive, vague, open-ended, and highly
subjective. And by empowering FSOC to designate SIFIs, Dodd-
Frank allows the Federal Reserve to impose bank-like standards
on nonbank institutions. In other words, to move institutions
from the nonbailout economy to the bailout economy.
And that is what FSOC is doing, expanding the Fed's power
to control the financial system using the pretext that size
alone poses a systemic risk. Rather than offering up detailed
data and compelling analysis to justify its efforts to
commandeer large financial institutions, FSOC's perfunctory
explanations are typical of an unaccountable group of agencies
that feel they don't need to justify their actions to anyone.
Many think it odd that FSOC has chosen insurance companies
and asset managers as targets for SIFI designation when there
are others that clearly pose far greater risk to financial
stability. Insurance companies are already heavily regulated at
the State level, and asset managers operate with little
leverage. And since they manage someone else's funds, it is
almost inconceivable that an asset manager's failure could
cause systemic risk.
In contrast, there were Fannie Mae and Freddie Mac, which
were at the epicenter of the financial crisis. They were highly
leveraged before the crisis and remain highly leveraged today.
They are not only a source of systemic risk; they are its very
embodiment. Then, there is the Federal Government itself. As I
watch the national debt clock turn to my left and right, having
borrowed upwards of $17 trillion, it is perhaps the most
leveraged institution in world history, and, like charity,
perhaps SIFI designation should begin at home.
Americans should also be worried that FSOC seems to take
its direction from an international organization that meets
secretly: the Financial Stability Board (FSB). Though the
United States is represented, and I use that word advisedly, on
this international board by the Treasury Department, the
Federal Reserve, and the Securities and Exchange Commission,
neither the Treasury, the Fed, nor the SEC has ever reported to
Congress about its participation, nor have they ever asked for
Congress' approval to participate in the global organization.
Now, while Administration officials are fond of invoking
the risks that supposedly lurk in the so-called shadow banking
system, great risks also lurk to U.S. financial stability and
competitiveness in a shadow regulatory system in which Treasury
and the Federal Reserve may have ceded U.S. sovereignty over
financial regulatory matters to a secretive, unaccountable
coalition of European bureaucrats. Just days ago, in this very
hearing room, Secretary Lew refused to answer key questions
regarding Treasury's participation in the FSB designation
process.
To most Americans, the SIFI designation process may seem
like a classic inside-the-Beltway exercise, but the stakes are
enormous. Designation anoints institutions as too-big-to-fail.
Today's designations are tomorrow's taxpayer-funded bailouts.
Americans may find themselves paying more to insure their homes
and their families. Investors who relied on mutual funds to
save for their children's education or their own retirement
will find they have earned less. And our economy will suffer as
sources of long-term investment capital dry up. I once again
call upon FSOC to cease and desist further SIFI designations
until Congress can review the entire matter.
I now yield 6 minutes to the ranking member for an opening
statement.
Ms. Waters. Thank you, Mr. Chairman.
Six years ago this March, our regulators were faced with
the first of many difficult decisions related to the financial
crisis: bail out Bear Stearns or risk its bankruptcy, spreading
instability worldwide. This was the first of several
interventions during an economic collapse that resulted in the
destruction of trillions of dollars of wealth, millions of
families' economic livelihood, and the world's confidence in
our markets and our way of life.
Despite the revisionist views of my Republican colleagues,
this crisis resulted in part from an inability of markets to
police themselves, which was compounded by the inability of the
previous Administration and regulators to stop predatory
practices on Wall Street. At the end of the day, Wall Street's
greed had disastrous effects on Main Street.
As we picked up the pieces, we learned that regulators
lacked authority to regulate entire markets, such as the $600
trillion over-the-counter derivatives market. Even worse, they
did not have a comprehensive understanding of the companies
they regulated, like AIG. For example, State regulators were
barred from regulating AIG's derivatives as insurance products,
but at the same time neither Federal regulators, nor AIG's own
executives, understood the massive risk it was taking.
Democrats responded to the massive vulnerabilities in our
system by enacting the Wall Street Reform Act, which created
the Financial Stability Oversight Council (FSOC) to identify
such risks and take the steps necessary to prevent them from
threatening our economic well-being. Because of the FSOC,
supported by the Office of Financial Research (OFR), we now
have a more complete view of the entire market, and when
necessary the FSOC can subject financial firms to safeguards
intended to prevent certain threats from harming the economy,
and it can make recommendations to address risky activities or
practices.
Congress determined as a starting point that the FSOC would
look at all bank holding companies with more than $50 billion
in assets, but also directed the Council to look more broadly.
Any firm or activity whose unregulated risk could create an
economic pandemic should be identified and dealt with now,
before it is too late. To date, the FSOC has identified two
insurance companies that fit the designation, AIG and
Prudential, as well as a finance company, GE Capital.
It is important to note that these companies weren't just
singled out without evidence. FSOC has provided an informative,
detailed analysis that paints a picture of their exposure. For
example, in the case of AIG, the FSOC determined that a large
number of corporate and financial entities have significant
exposure in its capacity as a global insurer and could suffer
losses in the event of financial distress at AIG.
Now, while these designations must be made on a strong
analytical basis, at the same time I support a strong appeals
process if industry stakeholders feel as if FSOC got it wrong.
However, to date, I have not seen anything to suggest that
FSOC's appeals process has failed. I have reviewed this appeals
process with my staff, and I am convinced that the industries
have an opportunity to make their case.
The financial crisis demonstrated a need for heightened
supervision of nonbank financial institutions, not just in the
United States, but globally as well. That is why I have been
mystified to see FSOC's decisions criticized as forgone
conclusions based on the recommendations of the international
coordinating body, the Financial Stability Board. Not only is
there not a shred of evidence that supports this theory, but
these critics are missing the point. Constructive engagement by
U.S. representatives with the Financial Stability Board and the
global boards coordinating insurance and securities regulation
promote our global financial stability.
Mr. Chairman, we in Congress have been clear that we expect
FSOC's actions to be crafted in a way that mitigates specific
risks. One-size-fits-all solutions are more likely to cause
harm than promote stability. But I believe Congress must
continue to support the Wall Street Reform Act, and as a result
we must hold the FSOC accountable to its mission to prevent any
one company or risky activity from ever threatening our
livelihood again.
Mr. Chairman, I have talked with many representatives from
the industries that are concerned about whether or not FSOC is
attempting to treat them as banks, and I am sympathetic to that
argument, and I am looking very closely to see if this is true.
And I, again, support an appeals process where these companies
have an opportunity to lay out their case and to challenge the
FSOC, and I am looking to see how this is going to work,
because I do believe that the industries have a right to
question this, but I also believe that FSOC by law has a
responsibility to mitigate risk in this country.
And with that, I yield back the balance of my time.
Chairman Hensarling. The Chair now recognizes the gentleman
from New Jersey, Mr. Garrett, the chairman of our Capital
Markets and GSEs Subcommittee, for a minute and a half.
Mr. Garrett. Thank you, Mr. Chairman.
I thank the witnesses for being here to share their
knowledge and their insights on this important issue on FSOC.
For some time now, this committee has been focused on the many
failings of FSOC and its structure and its operation. We did
that in hearings and letters and speeches, and we have asked
FSOC for explanation and changes to address our concerns. So
far, however, we have been met simply by stonewalling.
Apparently some members of FSOC feel that public policy is best
made under a blanket of secrecy and that argumentativeness is
the best way to engage with Congress. The few answers that we
do get are often strawman arguments that claim the only choices
we have are FSOC's current way of doing things or nothing at
all.
Well, I don't accept that. FSOC did not come down from
heaven, perfect in every way, and there is certainly room for
improvement. To that end, I have introduced H.R. 4387, the FSOC
Transparency and Accountability Act. This bill subjects FSOC to
the Sunshine Act and Federal Advisory Committee Act. It also
allows all members of the commission and boards represented on
FSOC to attend and participate in the meetings. It also
requires that an agency's vote represents the collective vote
of the entire commission or board, not just the Chair. And
finally, the bill permits members of the House Financial
Services Committee and the Senate Banking Committee to attend
FSOC meetings, as I have tried to do but was turned away in the
past. So far, FSOC has done little to reassure this committee
that it is a responsible body, and it would not be far-fetched
to say that FSOC itself is one of the greatest threats to
financial stability that we face today.
Finally, Mr. Chairman, I agree with the chairman that the
FSOC should be refrained from any additional designations until
we understand more about the process and impact of SIFI
designation. And I yield back.
Chairman Hensarling. The Chair now recognizes the gentleman
from Massachusetts, Mr. Lynch, for 2 minutes.
Mr. Lynch. Thank you, Mr. Chairman. I thank the ranking
member, as well, and the witnesses for helping the committee
with its work.
In the wake of the historical global financial crisis that
cost the U.S. economy over $22 trillion, the landmark Dodd-
Frank Wall Street Reform and Consumer Protection Act set
systemic risk mitigation as one of the primary goals of
comprehensive financial regulatory reform. To this end, Dodd-
Frank created the Financial Stability Oversight Council (FSOC),
which is a collaborative body designed to identify
institutional sources of risk and instability within our
financial system.
In furtherance of that mission, Section 113 of Dodd-Frank
authorizes the Council to determine that a U.S. nonbank
financial institution is systemically important upon a finding
that, and this is a quote from the statute, ``material
financial distress at the company or the nature, scope, size,
scale, concentration, interconnectedness, or mix of activities
of the company could pose a threat to the financial stability
of the U.S.''
Mr. Chairman, I support the FSOC. I think it could be an
institutional and collaborative force for stability in our
financial markets. However, in order to better ensure that the
Council's evaluation process for all our financial companies
under Section 113 of Dodd-Frank reflects the seriousness of
SIFI designation, I would urge the Council to make every effort
to conduct its review in a manner that maximizes transparency
and accountability without compromising the laudable goals of
our financial reform efforts.
In addition, I would note that Dodd-Frank specifically
contemplates that each financial company is different for the
purposes of evaluating the risk it poses to the U.S. financial
system. That is precisely why Dodd-Frank set forth the series
of factors that the Council must consider in determining
whether a nonbank financial institution is systemically
important. These factors include the extent of a company's
leverage and off-balance sheet exposures, the degree to which a
company is already subject to regulation by one or more primary
regulators, and the extent to which the assets are managed.
I see I am running out of time. I think that in many cases
those factors tend to favor acquittal on behalf of some of our
mutual funds, and I just ask that FSOC take those
recommendations to heart.
Chairman Hensarling. The time of the gentleman has expired.
The Chair now recognizes the gentlelady from West Virginia,
Mrs. Capito, the chairwoman of our Financial Institutions
Subcommittee, for a minute and a half.
Mrs. Capito. Thank you, Mr. Chairman. And I want to thank
the gentlemen for joining us for the hearing today.
As we have heard, the FSOC was originally envisioned as a
mechanism for regulatory agencies to share information about
potential risks, but it has morphed into an opaque entity that
is subverting the prudential regulatory agencies by ignoring
their expertise on specific industries that they are charged
with supervising.
There are some very real economic consequences for many of
the decisions that the FSOC is making, and this hearing will
get to the heart of that. One of the tasks FSOC is charged with
doing is designating nonbank SIFIs. In September of 2013, the
FSOC designated a large life insurer as systemically
significant despite extensive dissenting opinions from the
FSOC's independent member having insurance experience. The one
member of the FSOC who is charged with having a significant
understanding of the industry argued that the FSOC's basis for
the designation simply did not support the likelihood that the
failure of the firm would cause disruption to the financial
system. Furthermore, he argued that the majority of the FSOC
that had approved the designation simply did not understand the
basic fundamentals of the insurance industry.
Similarly, we will hear concerns about a one-size-fits-all
approach to the regulation of financial institutions larger
than $50 billion in assets. I have long been concerned about
how the various asset designations and thresholds are
designated in Dodd-Frank. We need to move past these ambiguous
thresholds and change the regulatory agencies, charge them with
determining the financial risk to the system based on the
riskiness of their operations. I yield back.
Chairman Hensarling. The Chair now recognizes the
gentlelady from New York, Mrs. Maloney, the ranking member of
our Capital Markets Subcommittee, for 2 minutes.
Mrs. Maloney. I thank the chairman, and I apologize for
being late. I was doing an event with Congressman Poe on the
anti-trafficking, sex trafficking bills that will be on the
Floor later on today, and which I hope will enjoy wide
bipartisan support.
Mr. Chairman, one of the key lessons that we have learned
from the financial crisis was that nonbank financial
institutions that pose greater systemic risks need to be
subject to stricter prudential standards. To implement this,
Dodd-Frank created the Financial Stability Oversight Council,
or FSOC, which is in charge of identifying the financial
institutions that pose systemic risk and designating them as
systemically important financial institutions (SIFIs). This is
an important and necessary power, and without it we would have
no protection against examples such as the AIG challenge that
we faced.
However, the fact that this power to designate firms as
systemically risky is so important also means that it should be
exercised with great care, especially for firms that don't
operate like traditional banks, like asset managers. We must
also make sure that any proposed changes to the SIFI
designation process do not hinder the FSOC's ability to carry
out its mission of identifying and mitigating systemic risks in
the financial system. Policymakers have to strike a careful
balance between ensuring that there is a fair and thorough
process for designating firms as systemically important on the
one hand, and preserving the FSOC's ability to identify and
mitigate systemic risk on the other hand.
I look forward to the hearing today, and I thank you very
much. My time has expired.
Chairman Hensarling. The Chair now recognizes the gentleman
from Texas, Mr. Neugebauer, the chairman of our Housing and
Insurance Subcommittee, for a minute and a half.
Mr. Neugebauer. Thank you, Mr. Chairman, for holding this
important hearing on the Financial Stability Oversight
Council's designation process. The identification of nonbank
systemically important firms is a serious exercise that has
major implications for the competitiveness of U.S. firms and
the stability of our financial markets.
This has been an area where I have been outspoken since the
beginning, as I strongly believe FSOC's structure and its
process for designating systemically important firms is fatally
flawed. Rather than using data, history, and economic analysis
to justify SIFI designations, FSOC has used far-fetched, highly
speculative, worst-case scenarios to justify an aggressive
expansion of regulatory power for Washington. In addition, many
of the targets of this new regulatory overreach had nothing to
do with the financial crisis and pose very little risk to
financial stability.
No designation has been more symbolic of FSOC's flaws than
the recent designation of an insurance company, Prudential
Financial, as an SIFI. The Prudential designation ignored the
expertise of the company's primary regulator, as well as FSOC's
members specifically created to provide expert knowledge in the
field of insurance. One of those members, Director John Huff, a
State insurance commissioner from Missouri, recently stated
that FSOC's misguided overreliance on bank concepts is nowhere
more apparent than in FSOC's basis for designation of
Prudential Financial. He went on to say that the basis for the
designation was grounded in implausible, even absurd scenarios.
The designated insurance expert, Mr. Roy Woodall, stated that
the underlying analysis used by FSOC on the Prudential
designation ran counter to fundamental and seasoned
understanding of the business of insurance.
Chairman Hensarling. The time of the gentleman has expired.
Finally, the Chair recognizes the gentleman from Missouri,
Mr. Luetkemeyer, the vice chairman of our Financial
Institutions Subcommittee, for a minute and a half.
Mr. Luetkemeyer. Thank you, Mr. Chairman.
For the most part the SIFI designation process seems to be
shrouded in secrecy. We have seen no meaningful metrics used in
decisions, and Secretary Lew and other officials have refused
to answer questions about the process. While the designation
process is opaque at best for many firms, it is pretty
straightforward for bank holding companies--straightforward and
thoughtless. If an institution has more than $50 billion in
assets, it is an SIFI. It doesn't matter if a bank is smaller
but engages in risky behavior or if a bank is larger but
engages in no risky behavior. The only thing that matters is
one arbitrary figure related to size. What kind of an
evaluation is that?
I understand that common sense is in short supply in this
town, but FSOC's designation process has serious implications
on the financial system and needs to incorporate some element
of logic and transparency. I look forward to the hearing with
our witnesses today. And I yield back the balance of my time,
Mr. Chairman.
Chairman Hensarling. We now turn to our witnesses. The
Honorable Paul Atkins is the CEO of Patomak Global Partners, a
financial consulting firm. He previously served as a Member of
the Congressional Oversight Panel for TARP and as a
Commissioner on the Securities and Exchange Commission. Mr.
Atkins holds a law degree from Vanderbilt University.
Mr. William McNabb is the chairman and CEO of the Vanguard
Group, a position he has held since 2009. Before becoming CEO,
Mr. McNabb served as managing director of Vanguard's
institutional and international businesses. Today, we welcome
his testimony on behalf of the Investment Company Institute.
Mr. Eugene Scalia is a partner at Gibson, Dunn & Crutcher,
where he is co-chair of the firm's Administrative Law and
Regulatory Practice Group. He earned his law degree from the
University of Chicago.
Professor Michael Barr teaches financial institutions,
international finance, and other aspects of financial law at
the University of Michigan Law School. He previously served as
Treasury Secretary Rubin's Special Assistant, and in other
capacities at the Treasury Department. He earned his law degree
from Yale Law School.
Mr. Deron Smithy is the treasurer of Regions Bank, which is
based in Birmingham, Alabama. Today, we welcome his testimony
on behalf of the Regional Bank Coalition.
Last but not least, and no stranger to our committee, Mr.
Peter Wallison is the Arthur F. Burns Fellow in Financial
Policy Studies at the American Enterprise Institute.
Without objection, each of your written statements will be
made a part of the record. Hopefully, each of you is familiar
with our green, yellow, and red lighting system on the witness
table. I would ask each of you to please observe the 5-minute
time allocation.
Mr. Atkins, you are now recognized for a summary of your
testimony.
STATEMENT OF PAUL S. ATKINS, CHIEF EXECUTIVE OFFICER, PATOMAK
GLOBAL PARTNERS
Mr. Atkins. Thank you. Good morning. Mr. Chairman, Ranking
Member Waters, and members of the committee, it is a pleasure
to be back before you all today. As the chairman said, I
believe you have my formal statement, and I know the chairman
is a stickler for time, so I shall try to highlight a few of
the central points.
But as a preliminary matter, I believe there is some
clarification as to basic pronunciation that is in order. As
you all know, Dodd-Frank gives the FSOC authority to label
entities within the financial services industry as systemically
important financial institutions, abbreviated as S-I-F-I. Now,
former chairman Barney Frank quipped the other day that
``SIFFY,'' as with all due respect some people, including on
the committee, have pronounced it, sounds like a disease, but
that is because, I think, with all due respect, that there is a
mispronunciation. So how does one pronounce this? It is WiFi,
and this is hi-fi, and this is SIFI. And by no coincidence, it
has a homonym, sci-fi. And SIFI designation I think is the
statutory gateway to a new level, and for some entities a whole
new world of potentially a twilight zone of regulation by the
Federal Reserve.
I have two fundamental points. First, designating managed
investment funds, particularly mutual funds, much less their
advisers as SIFIs is a bad idea that lacks any demonstrated or
I believe demonstrable analytic foundation. That point has
nothing whatsoever to do with partisan politics or whether one
is in favor of or opposed to Dodd-Frank.
Second, facts matter. Investment funds and investment
management are fundamentally different from banks or the
banking business. Bank regulators' prudential regulation of the
largest mutual funds or their advisers will not be a
complement, much less a viable substitute for the existing
capital markets' regulatory regime.
Let me briefly touch on the two regulatory bodies affected.
I am not here to defend the SEC's jurisdiction. If this were
some sort of turf war, you wouldn't be hearing from me about
it. The SEC is expert at regulating capital markets--risk
markets. That is simply not what the Fed does, much less the
FSOC. The Fed regulates to preferred outcomes. Central bankers
are central planners. The SEC's entire experience and focus is
on maintaining free and fair capital markets, while the Fed
exists to ensure the safety and soundness, the continued
viability of the banking system. So there is nothing in the
Fed's 100-year history that even begins to suggest that
applying prudential standards to capital market participants
would be a benefit or that the Fed would be an effective
capital markets regulator.
I want to underscore a further point in that connection.
Were the Fed to impose capital requirements on SIFI-designated
funds or even advisers, investors, notably ordinary individual
investors saving for retirement or a downpayment in their
401(k) plans, would have to pony up or face Fed-imposed
redemption restrictions. In fact, investment funds are
overwhelmingly providers of capital. Mutual funds in particular
tend to carry little or no leverage. A mutual fund does not
transmit, but bears counterparty risk. To that extent, at
least, mutual funds are the very opposite of the sort of highly
leveraged entity enhanced Federal Reserve supervision was
designed to address.
So what, in sum, could we expect if a mutual fund were
designated an SIFI and subjected to the Fed's prudential
supervision? Besides higher costs and lower returns, there will
be less flexibility and more exposure to uncertain market risk.
The Fed could constrain investors' ability to redeem their
shares on demand or elect to require fund managers to remain in
positions that they otherwise would have exited. Imagine that
disclosure to investors?
Also, sound funds could be subjected to Fed demands to
support failing banks under Dodd-Frank Section 210(o). Think of
it as an investor-funded ``TARPs-are-us.'' The unfortunate
investors in SIFI funds would be at risk of supporting too-big-
to-fail financial institutions under that section. None of this
would provide any advantage to fund investors. Indeed, such Fed
demands could easily force conflicts with the fund manager's
fiduciary duty to the fund and therefore to investors.
Moreover, if FSOC's cavalier treatment of the insurance
industry is any precedent, we should all be extremely concerned
that equally misguided and uninformed treatment of regulated
investment funds, notably mutual funds, is soon to follow. Any
FSOC move to designate regulated investment funds as SIFIs
lacks analytic foundation. There is nothing in last September's
self-serving--I would say sophomoric--OFR report (Office of
Financial Research report) to suggest otherwise. And with that,
my time has expired. Thank you.
[The prepared statement of Mr. Atkins can be found on page
60 of the appendix.]
Chairman Hensarling. Mr. McNabb, you are now recognized for
a summary of your testimony.
STATEMENT OF F. WILLIAM MCNABB III, CHAIRMAN AND CHIEF
EXECUTIVE OFFICER, THE VANGUARD GROUP, INC., ON BEHALF OF THE
INVESTMENT COMPANY INSTITUTE (ICI)
Mr. McNabb. Thank you, Chairman Hensarling, and members of
the committee, for the opportunity to participate in today's
hearing. I am Bill McNabb, chairman and CEO of the Vanguard
Group, one of the world's largest mutual fund organizations. We
have some $2.6 trillion in U.S. mutual fund assets entrusted to
us by everyday people saving for college, retirement,
education, and other goals.
I appear today in my capacity as chairman of the Investment
Company Institute. ICI's membership includes U.S. mutual funds,
exchange-traded funds, closed-end funds, and unit investment
trusts with aggregate assets of nearly $17 trillion. ICI
members are subject to substantial regulation and oversight by
the SEC and other agencies, and we support appropriate
regulation to ensure the resiliency and vibrancy of the global
financial system. But we are deeply concerned about the way in
which regulators in the United States and globally are
considering large mutual funds and their managers for
designation as SIFIs. The Financial Stability Oversight Council
here in Washington, and the FSB operating globally, appear to
be singling out large U.S. funds or their managers to subject
them to an added burden of bank-style regulation.
Let me speak plainly. There is no justification for
designating mutual funds or their managers as SIFIs. Stock and
bond funds did not contribute to the financial crisis and do
not pose threats to financial stability. If mutual funds or
their managers are designated, millions of individual Americans
could pay a tremendous price.
ICI is concerned that many of those involved in FSOC are
predisposed to view the world through a banking lens. There are
important fundamental differences between banks and funds.
Unlike banks, fund managers act as agents, investing the money
of others, not as principals putting their own capital at risk.
Unlike bank depositors, fund investors understand they can lose
money, and unlike banks, funds operate without any need for
government intervention.
There are several compelling reasons why even the largest
funds are not SIFIs. First, mutual funds use little to no
leverage, which is the essential fuel of most financial crises.
The very largest U.S. funds have roughly 4 cents of debt for
every dollar of shareholder equity. The largest U.S. banks by
contrast have $9.70 of debt for every dollar of equity.
Second, funds don't experience financial distress that can
threaten U.S. financial stability. Hundreds of funds exit the
business every year, and none of them requires government
intervention or assistance.
Third, stock and bond funds don't face so-called runs even
in the most turbulent markets. While domestic stock funds own
about 25 percent of U.S. stocks, their gross stock sales during
the financial crisis represented less than 6 percent of market
trading per month. If anything, these funds and their long-term
investors have a dampening effect on market volatility. They
enjoy a stable investor base because 95 percent of assets in
stock and bond funds are held by everyday households, and
virtually all of those households report that they are
investing for long-term goals, such as retirement and
education.
Fourth, the structure and comprehensive regulation of
mutual funds limits risk and the transmission of risk. For
example, daily valuation of fund portfolios, portfolio
liquidity requirements, limits on borrowing, and simple
transparent structures are among the features that both protect
investors and limit risk. If the FSOC designates funds as
SIFIs, the consequences for investors would be severe. Under
Dodd-Frank, a designated fund could be subject to bank-level
capital requirements with investors bearing the cost through
higher fees and lower returns.
It is particularly troubling that investors in a designated
fund could be forced to help shoulder the costs of bailing out
large failing financial institutions under the orderly
liquidation provisions. This is essentially a tax on retail
investors, and Congress wrote Dodd-Frank specifically to avoid
burdening taxpayers with these costs.
We are also concerned that the Federal Reserve's prudential
supervision could conflict with a fund manager's fiduciary duty
to act in the best interests of the fund. To protect the
stability of the banking system, the Fed might pressure a fund
manager to stay in certain markets or to maintain financing for
troubled institutions, even if the manager believes those
actions would harm investors. We don't believe that Congress
created Dodd-Frank to target funds or to appoint the Fed as a
significant capital markets regulator, and it is clear to us
that SIFI designation, which was intended to be used quite
sparingly, is not the right tool for addressing risk in these
markets. If regulators believe specific activities or practices
pose risk, they appropriately have considerable authority to
address those risks.
Members of this committee from both sides of the aisle have
focused a great deal of attention on the FSOC's lack of
transparency and vague processes. We share your concern. Mr.
Chairman, we agree that FSOC should cease and desist on further
designations until Congress can better understand the process.
Thank you, and I will be happy to take questions at the
appropriate time.
[The prepared statement of Mr. McNabb can be found on page
73 of the appendix.]
Chairman Hensarling. Mr. Scalia, you are now recognized for
5 minutes.
STATEMENT OF EUGENE SCALIA, PARTNER, GIBSON, DUNN & CRUTCHER
LLP
Mr. Scalia. Mr. Chairman, Ranking Member Waters, and
members of the committee, thank you for the opportunity to
testify today regarding the Financial Stability Oversight
Council. I am a lawyer at the firm of Gibson, Dunn & Crutcher,
and this morning I would like to offer a few observations on
FSOC from the perspective of the requirements of administrative
law.
The FSOC designation process is an unusual one. If there is
a similar process before another government agency, I am
unaware of it. The process begins with a company being told
that it is being considered for designation. It is not told
why, yet it is singled out and considered on a solitary and
secretive basis. This is very different than a rulemaking, for
instance, where the companies in an industry are publicly told
that the government is considering changing the requirements
that apply to them, and what follows is an open and public
discussion about the proper outcome.
A company that has been notified of potential designation
is kept in the dark in at least two ways. First, the process
itself is largely closed and unknown to the company. Until the
very late stages it does not know why it is being considered,
it does not know what opinions have been formed about it or
what concerns and tentative conclusions have been reached. FSOC
compiles extensive information on the company. None of that
information is shared until after the FSOC members' proposed
designation. Access to FSOC decision-makers is closely guarded,
and as a practical matter is impossible.
Second, the company has inadequate notice on the legal
standards that will be applied to it. As a Nation, we value
fair notice to the public of their legal obligations for two
principal reasons. First, when we are told what the law is, we
are able to conform our conduct to comply in order to avoid
sanctions. Second, when the government commits itself in
writing to what the law is, it limits its discretion and power,
and that in turn helps prevent arbitrary government conduct.
When it comes to SIFI designation, though, FSOC has done
little more than list numerous factors it will consider without
identifying the relative weight the factors will be given or
what constitutes a passing grade under any one factor.
Moreover, its SIFI designation decisions to date have applied
such loose and subjective reasoning that other companies being
considered have no way of knowing whether they will be
designated or what changes they could make so they are not
designated.
This brings me to the substance of FSOC's designation
decisions to date as reflected in the leading Prudential
decision. That decision is an exceptionally weak specimen of
regulatory reasoning by a government agency. I do not believe
it would have survived review in a court. The problems with
their decision are addressed at length in my written testimony.
They include unsubstantiated conjecture; a subjective,
standardless notion of excessive risk; and repeated disregard,
as a number of you have mentioned, for the existing system of
insurance regulation by the States.
I want to conclude by emphasizing another aspect of the
FSOC designation process that is very unusual and is a terrible
way to make government decisions. FSOC is not considering the
consequences of its actions. It is singling out individual
companies and subjecting them to an entirely new regulatory
regime without knowing what effect that regulatory framework
will have. Suppose that just two or three companies in a
robustly competitive industry are designated systemic, and
suppose that SIFI designation will subject those companies to
significantly more costly regulatory requirements than their
competitors. Those increased costs should be an extremely
important consideration for FSOC. Remember, designation is
supposed to be buttressing companies, supposed to be shoring
them up, but what if it actually weakens them by making them
less competitive? In that case, SIFI designation may be doing
exactly the opposite of what is intended.
The government should never act without considering the
consequences of its action. That is elementary. But FSOC does
not make the consequences of designation part of its decision-
making process. Worse, FSOC does not know what regulatory
requirements will result from designation. It does not know
what capital standards will apply to companies that are
designated, although it has every reason to believe that under
current law, those capital standards will be essentially bank-
based, which are improper for other financial firms, such as
insurance companies.
Before asserting that designation is appropriate because it
will bring better protections, the government must determine
what those protections are and what effects they will have.
Until then, designation decisions are premature.
I want to conclude by commending the members of this
committee for bringing attention to these issues. Our system of
government rests on the belief that the government makes
better, fairer decisions when it acts openly, through processes
where the public, including Congress, have insight and input.
Thank you for inviting me to speak here today, and I look
forward to your questions.
[The prepared statement of Mr. Scalia can be found on page
88 of the appendix.]
Chairman Hensarling. Professor Barr, you are now recognized
for 5 minutes.
STATEMENT OF MICHAEL S. BARR, PROFESSOR OF LAW, THE UNIVERSITY
OF MICHIGAN LAW SCHOOL
Mr. Barr. Thank you, Mr. Chairman, and Ranking Member
Waters. I am pleased to appear before you today to discuss the
key role of the Financial Stability Oversight Council in
reducing risks in the financial system.
In 2008, the United States plunged into a severe financial
crisis that shuttered American businesses and cost millions of
households their jobs, their homes, and their livelihoods. The
crisis called for a strong response. Under the Dodd-Frank Act,
there is new authority to regulate major firms that pose a
threat to financial stability without regard to their corporate
form; to wind down such firms in the event of a crisis without
feeding a panic or putting taxpayers on the hook; to attack
regulatory arbitrage, restrict risky activities, and beef up
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 to look out for American families.
The Act also established a Financial Stability Oversight
Council, with the authority to designate systemically important
firms and financial market utilities for heightened prudential
oversight, to recommend that member agencies put in place
higher prudential standards when warranted, and to look out for
risks across the financial system.
One of the major problems in the lead-up to the financial
crisis was there was not a coherent system of supervision for
major financial institutions. The Federal financial regulatory
system that existed was broken. Major financial firms were
regulated according to their formal labels, as banks, thrifts,
investment banks, insurance companies, and the like, rather
than according to what they actually did. Risk migrated to the
less well-regulated parts of the system and leverage grew to
dangerous levels.
The designation of systemically important financial
institutions is a cornerstone of the Dodd-Frank Act. A key goal
of reform was to create a system of supervision which ensured
that if an institution posed a risk to the financial system, it
would be regulated, supervised, and have capital requirements
that reflected its risk regardless of its corporate form. The
Dodd-Frank Act established a process through which the largest
and most interconnected firms could be designated as
systemically important and then supervised and regulated by the
Fed.
The Council has developed detailed rules, interpretive
guidance, and a hearing process, including extensive engagement
with affected firms, to implement this designation process. The
existing rules provide for a sound deliberative process,
protection of confidential and proprietary information, and
meaningful and timely participation by affected firms.
Critics of designation contend that it fosters too-big-to-
fail, but the opposite is the case. Regulating systemically
important firms reduces the risk that failure could harm the
real economy and destabilize the financial system. It provides
for robust supervision in advance and provides for a mechanism
to wind down such a firm in the event of a crisis.
Other critics argue that the FSOC should be more beholden
to the regulatory agencies that are its members, but again the
opposite is true. Congress wisely provided for its voting
members, all of whom are confirmed by the Senate, to
participate based on their individual assessment of risks in
the financial system, not based on the position of their
individual agencies, however comprised.
Some critics also contend that certain types of firms in
certain industries or under certain sizes should be
categorically walled off from heightened prudential
supervision, but such steps will expose the United States to
the very risks we faced in the lead-up to the last devastating
crisis. The failure of firms of diverse types and diverse sizes
at many points, even in very recent memory, from Long-Term
Capital Management to Lehman and AIG, suggests that blind spots
in the system should at the very least not be intentionally
chosen in advance by the Congress.
The way to deal with the diversity of sizes and types of
institutions is to develop regulation, oversight, and capital
requirements that are graduated and tailored to the types of
risks that such firms might pose to the financial system.
Beyond designation, FSOC and member agencies have other tools
available, including increased data collection, transparency,
collateral and margin rules, operational and client safeguards,
risk management standards, and other measures that can be used
in appropriate circumstances.
Lastly, some critics complain that the FSOC's work is too
tied to global reforms, including reforms by the Financial
Stability Board, but global coordination is essential to making
the financial system safer. And these global efforts are not
binding on the United States. Rather, the FSOC and U.S.
regulators make independent regulatory judgments about domestic
implementation based on U.S. law.
In sum, significant progress has been made in making the
financial system safer and fairer and better focused on serving
households, businesses, and the real economy. Now is not the
time to turn it back.
[The prepared statement of Mr. Barr can be found on page 70
of the appendix.]
Chairman Hensarling. Thank you.
The Chair now recognizes Mr. Smithy for 5 minutes.
STATEMENT OF DERON SMITHY, TREASURER, REGIONS BANK, ON BEHALF
OF THE REGIONAL BANK COALITION
Mr. Smithy. Good morning, Chairman Hensarling, Ranking
Member Waters, and members of the Financial Services Committee.
My name is Deron Smithy, and I am the treasurer of Regions
Bank, based in Birmingham, Alabama. I appreciate the
opportunity to speak to the committee about the systemic risk
designation, its impact on regional banks, and the ways in
which it can be improved.
Regions Bank is a member of the Regional Bank Coalition, a
group of 18 traditional lending institutions that play a
critical role in the Main Street economy. Each of these banks
are larger than $50 billion in assets, but operate basic,
straightforward businesses that do not individually threaten
the U.S. financial system. Regions Bank, for example, is a
diversified, community-focused lender offering a full range of
consumer and business lending products and services in 16
States. We have a time-honored and relatively simple operating
model that focuses on relationship banking, matching high-
quality customer service with industry expertise. Regions
serves more than 500,000 commercial customers, including
450,000 small business owners, and we bank nearly 4.5 million
consumer households.
Collectively, the banks in our coalition operate in all 50
States, hold one-fourth of the U.S. banking deposits, and have
credit relationships with more than 60 million American
households, yet no regional bank maintains a national deposit
share greater than 3 percent of total deposits. In aggregate,
our asset base is less than 2 percent of GDP, roughly
equivalent to that of the single largest U.S. bank. We are
traditional banks that fund ourselves primarily through
deposits, and we loan those deposits back into our communities.
Regional banks are an important source of credit to small
and medium-sized firms, competing against banks of all sizes
throughout our markets. Regional banks are not complex. We do
not engage in significant trading or international activities,
make markets in securities, or have meaningful interconnections
with other financial firms. Regional banks are not systemic and
do not threaten U.S. financial stability.
The Dodd-Frank Act adopted a blunt definition of systemic
risk for banks, relying on a simple $50 billion asset
threshold. I would note Federal Reserve Governor Tarullo's
recent speech in which he highlighted the need to rationalize
the regulatory structures so that regulators can more precisely
consider differences among firms. He questioned many of the
existing bright line, asset-only thresholds and contended that
the aims of prudential regulation should vary according to the
business activities. He also suggested that the 80-plus banks
larger than $10 billion, but those not deemed global
systemically important, are overwhelmingly recognizable as
traditional commercial banks.
On these points we would agree with Governor Tarullo, and
we would support the bipartisan bill, H.R. 4060, introduced by
Congressman Luetkemeyer and five other members of the
committee. The bill would have regulators review five factors--
size, complexity, interconnectedness, international activity,
and substitutability--before making a systemic designation. All
are factors that regulators have used in other contexts to
determine how firms might impact U.S. financial stability.
Regional banks constantly react to regulatory and policy
changes made in Washington, and these rules affect how we
manage our organizations. Systemic regulation has both direct
and indirect cost, and for individual regional banks these
costs add up to hundreds of millions of dollars each year. They
impact how we lend and how we price credit.
Even absent systemic designation, protective regulatory
guardrails that have evolved since the financial crisis would
remain in place for regional banks. The Federal Reserve has the
authority to continue the capital planning and stress testing
processes started before Dodd-Frank. Moreover, regional banks
would remain subject to new Basel III capital and liquidity
requirements, as well as numerous other rules outside of Title
I's enhanced prudential standards.
To reiterate, the current designation process is imprecise
and the costs incurred by regional banks are not commensurate
with its impacts. Regional bank activities do not threaten the
country's financial stability, nor are we complex organizations
that would be difficult to resolve in a crisis. The current
standard does not best serve the banks, taxpayers, and
communities we serve, or the regulators. The regulators have
requested clearer, less ambiguous ways to determine systemic
risk. A multifactor, activity-based test would do this.
Thank you again for the opportunity to testify before the
committee today, and I look forward to answering any questions
you may have.
[The prepared statement of Mr. Smithy can be found on page
105 of the appendix.]
Chairman Hensarling. To bat cleanup, Mr. Wallison, you are
now recognized for your testimony.
STATEMENT OF PETER J. WALLISON, ARTHUR F. BURNS FELLOW IN
FINANCIAL POLICY STUDIES, THE AMERICAN ENTERPRISE INSTITUTE
Mr. Wallison. Thank you, Mr. Chairman, Ranking Member
Waters, and members of the committee. Thank you for the
opportunity to testify this morning.
Under Dodd-Frank, the Financial Stability Oversight Council
(FSOC) has the authority to designate any nonbank financial
firm as a systemically important financial institution, or
SIFI. That is if the institution's financial distress will
cause instability in the U.S. financial system. Firms
designated as SIFIs are turned over to the Fed for what appears
to be bank-like regulation.
The troubling aspects of the FSOC's authority were revealed
recently when it designated Prudential Financial as an SIFI.
Every FSOC member who was expert in insurance and not an
employee of the Treasury Department itself dissented from that
decision. Virtually all of the other members, knowing nothing
about insurance or insurance regulation, dutifully voted in
favor of Prudential's designation.
Now, how could we entrust the decision to regulate a large
insurer like a bank to a group with no expertise about
insurance regulation, and when the FSOC could not possibly have
known how the Fed would actually regulate an insurance firm?
Even more troubling was the fact that the FSOC offered no
facts, no analysis, and no standards in support of its
decision. For example, interconnections are supposed to be one
of the main reasons that SIFIs are SIFIs. All financial
institutions are interconnected in some way, but the FSOC's
Prudential decision says nothing about the degree of
Prudential's interconnections or why they are a danger to the
financial system. The same is true of all the other prior FSOC
designations.
Let me say it plainly: On the evidence of the Prudential
decision, this emperor has no clothes. The FSOC seems to have
no idea how to assess the danger of interconnections or any of
the other reasons that SIFIs are considered such a threat to
the financial stability that they require Fed bank-like
regulation. This means the decisions are completely arbitrary.
And since these decisions have a seriously adverse effect on
competition and economic growth, they should not be allowed to
continue until the FSOC can explain its decisions to Congress.
There are other reasons to be concerned. Two months before
the FSOC's Prudential decision, the Financial Stability Board
(FSB), an international body of regulators empowered by the G-
20 leaders to reform the international financial system, had
already declared Prudential an SIFI, also without facts and
analysis. Since the Treasury and the Fed are members of the
FSB, they had already approved the FSB's designation well
before the FSOC designated Prudential as an SIFI in September.
This raises two questions: first, the fairness and
objectivity of the FSOC's designation process; and second,
whether the FSOC will simply rubber-stamp the decisions of the
FSB in the future. This is important because the FSB looks to
be a very aggressive source of new regulation of nonbank
financial firms.
In early September, the FSB published plans to apply what
it called its SIFI Framework to securities firms, finance
companies, asset managers, and investment funds, including
hedge funds. These firms are the so-called shadow banks that
bank regulators are so eager to regulate. It will be very
difficult to show that these nonbank firms are a threat to the
financial system, but the Prudential decision shows that
neither the FSB, nor the FSOC believes it has any obligation to
demonstrate this.
The question before this committee is not solely whether
investment funds are SIFIs. The FSB has already suggested it
will apply the SIFI Framework to securities firms, mutual
funds, hedge funds, and many, many others. If the FSOC follows
suit, and that has been the pattern, we may see many of the
largest nonbank firms in the U.S. financial system brought
under bank-like regulation.
As shown in my prepared testimony, these capital markets
firms and not the banks are the main funding sources for U.S.
business. Subjecting them to bank-like regulation will reduce
their risk-taking and innovation and thus have a disastrous
effect on competition and economic growth, and this outcome
would be the result of decisions by the FSB carried out by the
FSOC.
About 2 weeks ago, Mr. Chairman, you said that the FSOC
should cease and desist on designations until Congress can
assess the consequences. I hope that request is honored.
[The prepared statement of Mr. Wallison can be found on
page 118 of the appendix.]
Chairman Hensarling. Thank you.
The Chair now recognizes himself for 5 minutes for
questioning.
Mr. McNabb, you run one of the largest mutual fund
companies in America. I assume there are a lot of mom and pops
who entrust their savings with you to send somebody to college,
maybe start a small business, maybe plan for retirement.
Recently, I had a study come across my desk by Douglas
Holtz-Eakin, the former Director of the Congressional Budget
Office, which estimated that designating asset managers as
SIFIs--sorry, Mr. Atkins, I am not sure the ``sci-fi'' is going
to catch on, but it was compelling--over the lifetime of their
investment, their investment portfolio could be hurt by as much
as 25 percent, $108,000 per investor.
Have you seen this study? Have your people analyzed it? And
if that is in the ballpark, knowing that you deal with a lot of
hard-working Americans' savings, what is this SIFI designation
going to mean to the individual trying to save for retirement
or send a kid to college?
Mr. McNabb. Thank you for the question, Mr. Chairman. You
are right. We do serve a lot of mom and pops. We have 25
million investors, roughly, scattered around the country.
Savings for retirement and for education would be the two
primary reasons.
I actually have a copy of that study; it just came across
my desk yesterday. I am guessing the numbers are actually
conservative in terms of the calculations because they did it
as a one-time--they looked at a one-time investment and what
would the consequences of bank-like capital be on the accrual
of the account, if you will, and the estimate was that over a
long period of time, the account value would be 75 percent of
what it would have been were there no capital requirements.
We have also looked at a couple of other analyses that are
similar, where instead of looking at capital requirements, we
looked at some of the proposed so-called SIFI taxes. In those
cases, if you are an investor, for example, in our S&P 500
Fund, which is one of the more basic funds we offer, your fees
would quadruple. And at that level, it would be pretty
disastrous for many investors.
Chairman Hensarling. Mr. Wallison, as I was listening to
your testimony, I think you said to some extent that the
decision-making formula for FSOC to designate a nonbank SIFI
was completely arbitrary. You mentioned about the G-20
Financial Stability Board, their process that designated, I
think, three U.S. insurers as global SIFIs. Wasn't it, I don't
know, 10 or 12 days ago that we had Secretary Lew in this
hearing room where I asked him, as head of FSOC, did Treasury
consent or object to these designations? He refused to answer
the question 3 different times. I suppose there is a
possibility their representatives fell asleep during the
proceedings and neither objected or consented. So that would
seem to suggest that either the United States adopted whatever
the criteria is of SSB, or they have their own, but yet they
refuse to reveal it. I am not sure that anyone has been able to
discern what this approach is.
I noticed that yesterday, Treasury Under Secretary Mary
Miller said that she was surprised that anyone would believe
that FSOC is considering possibly designating the asset
management industry as an SIFI. And she was quite adamant that
FSOC did not follow the G-20's Financial Stability Board's
designation of these three U.S. insurers.
How credible is it to you that the FSB would have made
these designations without the consent of Treasury and other
U.S. participants?
Mr. Wallison. It seems to me completely unreasonable to
believe that the FSB would go ahead with a designation of U.S.
firms without the agreement of the U.S. participants,
particularly the Treasury Department and the Fed.
Chairman Hensarling. What concerns do you have if the
United States would continue to follow the FSB's lead?
Mr. Wallison. I have a very serious concern about process
here, because at least in the banking area, the Basel capital
requirements are put into place by a group of regulators, and
then they are put into place by the U.S. bank regulators here
in the United States. I am afraid that some people are looking
at the process of the FSB as similar to the bank capital
process that is undertaken in Basel, and if that is so, they
are expecting at the FSB that once they designate an
institution as an SIFI, the FSOC here in the United States will
simply take that designation and apply it in the United States.
That is not, I think, what Congress intended when it set up
the FSOC and expected some kind of analysis. And it is not
getting that analysis anyway.
Chairman Hensarling. The Chair needs to gavel himself down.
The Chair now recognizes the ranking member, Ms. Waters,
for 5 minutes.
Ms. Waters. Thank you very much, Mr. Chairman.
Mr. McNabb, I spent a considerable amount of time following
this subprime meltdown that we had in this country, and I
worked very hard to convince a lot of people, despite the fact
I and others were criticized for it, to do this bailout because
we felt that this country's economic future was at stake. And
we felt that the recession could morph into a depression, and
so we worked very hard to try and do what we thought was the
best thing.
In all of the work that we were doing, AIG, for example,
emerged as a real problem, an insurance company. So my decision
about whether or not I support FSOC being able to take a look
at nonbank companies is based on some of what I learned during
that awful period of time that we went through.
Now, we find that AIG again is designated as an SIFI, and
so I want to understand from you why you think FSOC is wrong in
taking a look at something like AIG. It doesn't have to be
specific, but I use that as an example.
Mr. McNabb. Thank you, Ranking Member Waters.
The AIG question actually, I think, highlights an important
point. When you look at what happened at AIG, it was the
activities at the firm. AIG had morphed into much more than an
insurance company, and it was the activities that really led to
their demise. The activities were extraordinary leverage and
excessive risk-taking. And I would say both those kinds of
activities have been present in almost every financial crisis
going back 500 years.
When we talk about the mutual fund industry, as an example,
funds employ no leverage. And the other difference, of course,
is that funds are acting as agents as opposed to proprietary
traders and so forth, and that is a very big difference.
And so the activities that drove AIG to the brink are
certainly the kinds of activities that should be looked at. But
it is not really based on the firm, it is really the leverage
and the activities, much as my colleague Mr. Smithy here on the
panel suggested regarding the regional banks.
Ms. Waters. So you don't think that AIG, Prudential, as
well as maybe GE Capital should be designated?
Mr. McNabb. I am not expert enough on GE Capital or
Prudential. Again, my take would be to look at the factors that
make those firms either more risky or less risky. And it is not
the firm's size or even the assets under--
Ms. Waters. It is about risk, Mr. McNabb.
I want to move to Mr. Barr now. Mr. Barr, I have heard a
lot about the incompetence of FSOC. They don't know what they
are doing, they don't know how to regulate or determine risk of
insurance companies, et cetera.
Do you agree that the FSOC has both the expertise and the
authority to appropriately assess nonbank financial
institutions such as insurance companies? Do they have the
authority and the expertise?
Mr. Barr. I believe they do, Ranking Member Waters. I
believe that the FSOC has developed a quite extensive staff and
expertise across the financial sector. They could always do
more. I think the process of building expertise in a new agency
is a challenging one. I think they should do more to build up
their staff and the staff of the independent Office of
Financial Research as well.
But they certainly have the authority, and they have plenty
of people with experience.
Ms. Waters. Mr. Wallison, you made quite a point of talking
about the lack of competence and expertise at the FSOC. If they
were competent, if they had the expertise, if they could be
designed in a way that you would design them, do you think
there should be an FSOC?
Mr. Wallison. Yes, I always thought there should be an
opportunity, as there was with the Presidential Council that
used to meet and talk about common problems in the regulatory
area. And, in fact, something like FSOC could get together and
talk about whether they think that there are systemic issues
developing in the economy.
My problem with FSOC is that it has the power to make
decisions to turn over certain institutions to the Fed for
bank-like regulation without even knowing what bank-like
regulation would be, for example, for an insurance company, and
without actually showing us the basis for those decisions.
If we think about those decisions, they have to do with the
future. Will a firm's distress cause instability in the U.S.
economy? Those are guesses about the future, and if they
provide no data about what they think will happen, I don't
think this is a credible decision.
Chairman Hensarling. The time of the gentlelady has
expired.
The Chair now recognizes the gentleman from New Jersey, Mr.
Garrett, the chairman of our Capital Markets Subcommittee, for
5 minutes.
Mr. Garrett. Thanks, Mr. Chairman.
Mr. Wallison, can you briefly say, in your view, does SIFI
designation reinforce too-big-to-fail?
Mr. Wallison. Yes, I think that is one of the problems with
it, of course, and that is once you are said to be an
institution whose failure might cause the instability in the
United States economy, you are saying it is too-big-to-fail.
Mr. Garrett. Right.
You heard the testimony of Professor Barr. He seemed to be
saying that all is well with FSOC, with their expertise and the
like. Do you concur?
Mr. Wallison. I don't know any of the experts they have,
but if you look at the decision that they made in the
Prudential case, they provided no data that would suggest that
they are experts. And--
Mr. Garrett. That is a good point. So, Professor Barr, you
just said a minute ago that they had the expertise, and you
referred to the OFR. Have you read the OFR report that was--but
for the fact that SEC put it up on their Web site would not
have been disclosed? Have you looked at that? And is that what
you base the fact that you think they have the expertise to do
the job?
Mr. Barr. I believe the question was asked about the
expertise of the FSOC, which I think is strong. I think the OFR
is a new organization and is still building.
Mr. Garrett. You referred back to them and said--you
referred back and said one of their bases of expertise is the
OFR. So have you looked at the report?
Mr. Barr. Yes, I have.
Mr. Garrett. And do you know that virtually every one of
the commentators on there have basically criticized it and said
there is absolutely no empirical data in it? Did you find
empirical data it in?
Mr. Barr. The report was not something I would hang my hat
on.
Mr. Garrett. All right. So, you wouldn't hang your hat on
it, but apparently FSOC hung their hat on it. So if that is--
Mr. Barr. I have no idea--sorry, sir, to interrupt--one way
or another about that.
Mr. Garrett. That is a good point. So then, how can you say
that they are acting with empirical data if you are not able to
say, and we are not able to say, and I think that is Mr.
Wallison's and Mr. Atkins' points as well, that when we look at
FSOC, we cannot figure out what are their facts, what is their
analysis, and what are their standards? And if we can't figure
those things out from FSOC, how can you sit there and say that
they are operating with facts, analysis, and standards?
Mr. Barr. I am not privy to the internal processes at all
of what is going on at the FSOC, but my understanding is they
have not acted in any way with respect to some designation of
asset managers. So I have no way of knowing one way or the
other the extent to which the OFR report may or may not play a
role in that process.
Mr. Garrett. And isn't that really the point? That not only
are you not privy to it, Members of Congress are not privy to
it. I guess no one actually is privy to it. Even commissioners
from the various agencies where the chairmen are members of are
not privy to it.
And I think that is one of the simple things that we could
do is to allow the American public to be privy to this
information, to be privy to how they make the decisions, what
the facts are, what the analysis is.
Mr. Atkins, would you agree that this sort of information
by FSOC, how they make this, what the standards are, should be
open to the American public and the industry as well?
Mr. Atkins. Absolutely, Congressman Garrett.
Mr. Garrett. Why is that?
Mr. Atkins. Because when you look at it--this goes back to
the essence of bank regulation, I think, versus other sorts of
regulation--it comes down to transparency. And bank regulators
love, because they are focusing on safety and soundness, to
lurk in the shadows and do their regulation not in the broad
daylight like other regulators do. I think that is part of the
problem here with the FSOC.
Mr. Garrett. I have a bill out there, and basically it
would subject FSOC to the Sunshine Act and the Federal Advisory
Committee Act. I will just throw this out to the whole panel.
Is there anybody on the panel who would say that there
should not be more transparency with FSOC? Is there anybody on
the panel who would say that they should not have to operate
like just about every other agency in the Federal Government
and have a little bit of sunshine? Does anybody disagree with
more transparency at FSOC?
Mr. Barr. I think, Mr. Garrett, there ought to be
regularized processes and transparency. I am not sure that the
Sunshine Act is always the best way of doing that. And if you
are asking me about the other regulatory agencies, I think that
the Sunshine Act often makes, in its particular formulations,
it difficult to do their job in a transparent way and in a way
that is considered.
So I would be for more transparency and regularization, but
maybe not quite with that particular mechanism as the tool to
do it.
Mr. Garrett. Okay. I appreciate that. And I guess the rest
of the panel is, instead, open to more transparency.
Let me ask this, then. Until we get to that point, whether
it is as far as I would like to go and other Members would like
to go, or, as Professor Barr finds, some intermediate, is there
anyone who would disagree with this statement, that until we
get more transparency, more openness, and understand what the
facts, analysis, and standards are, and they should cease and
desist what they are doing right now? Does anybody disagree
that they should be on hold until we know this?
Mr. Scalia. I certainly agree with that prescription for
two reasons: first, so that there can be a better public
understanding of what the law is that they are applying; and
second, because they need to look more closely at what the
consequences of their designation decisions are going to be.
And until we have those things, I do think it is precipitous
for them to continue designations.
Mr. Garrett. I appreciate that. And I thank the chairman.
Chairman Hensarling. The time of the gentleman has expired.
The Chair now recognizes the gentlelady from New York, Mrs.
Maloney, the ranking member of our Capital Markets
Subcommittee, for 5 minutes.
Mrs. Maloney. Thank you, Mr. Chairman, and Ranking Member
Waters.
Professor Barr, I am looking at the law right now, and
there is an appeals process, and an open appeals process, in
Title 1 of the bill. And it says, notice and opportunity for
hearing and final determination.
If I remember, we had a whole appeals process. If someone
was designated, they could say, I disagree. There could be
other hearings, another whole determination. And people say
that the FSOC Board is not competent. It is composed of the
head of the Treasury, the Federal Reserve, the OCC, the FDIC,
the SEC, the CFTC, the CFPB, the FHFA, and the NCUA, and the
independent insurance expert. So, it is the basic financial
regulators.
I would say we are in big trouble if our financial
regulators, the head of these departments, are incompetent.
That is just my statement. I think they are fully vetted and
very competent.
But, in any event, they can appeal the process, and even if
they are designated over their objections, there is an appeal
to the courts, where everything is publicly debated, and
assessments are made before a court. Is that correct?
Mr. Barr. That is correct.
Mrs. Maloney. So I would argue there is an extensive appeal
process as we see it.
Now, there has been a lot of designation, or, rather,
conversation, about AIG. And AIG was an insurance company, but
what designated them as an SIFI was their financial
entrepreneurship, shall we say. It was not the insurance area.
The insurance area was well-run, was not a problem. It was the
London office where they were in all types of risky products,
which brought this country to a debt of $185 billion. So, that
is what designated them.
I have one question for the panel: Has any insurance
company that is just totally insurance been preliminary
designated or designated as an SIFI?
It is my understanding that no insurance company that is a
real insurance company--if you are experimenting in financial
products, then they have been designated, but not one that is a
pure insurance company. Has anyone been designated that is a
pure insurance company?
Mr. Scalia. Prudential was designated essentially
exclusively on the basis of its insurance activities, which
drew dissents from both members of FSOC who have expert in
insurance. They spoke at length about how their colleagues on
FSOC appeared to have no appreciation whatsoever for the
industry.
Mrs. Maloney. Then, why was that designated and other
insurance companies were not? What was Prudential doing that
was different in financial areas? I would like to ask Mr. Barr,
since he is a professor and not involved in the industry. I
respect the industry, but I want to hear from the professor and
then from you.
Mr. Barr. I don't know whether other insurance companies
will or won't be designated in the future. My understanding is
that the FSOC was concerned with the extent of the activity of
Prudential that occurred both with respect to its investment
activities and the relationship of various of its
subcomponents. But I don't know whether or not the FSOC will be
similarly concerned with other types of insurance firms in that
regard.
And I think that you are correct to point out with respect
to AIG that AIG's activities obviously extended far beyond the
regular activity of an insurance firm. There were also problems
within AIG with respect to securities financing among the
various affiliates within AIG that created additional risk.
Mrs. Maloney. Let's go to Prudential. Was Prudential
involved in any innovative entrepreneurship financing that was
different from regular insurance? No?
Mr. Barr. I have not examined with any detail for this
hearing the balance-sheet and off-balance-sheet activities of
Prudential.
Mrs. Maloney. I would like to look at it and read the
report and then get back with more questions.
But I also have some other questions. I wanted to ask Mr.
McNabb, in your testimony you noted that under the current law,
the SEC now requires, I believe, at least 83 percent or 85
percent to be liquid in their portfolios. And in your
experience, during the crisis, did this remain liquid or not?
Mr. McNabb. In our experience, it remained fully liquid.
Mrs. Maloney. Okay. Would anybody else like to comment?
And also during the redemption period when people--there
was a run really on mutual funds and everything else. During
the redemption period, were they in any stress at all that you
are aware of?
Mr. McNabb. First of all, I would say there was not a run,
with all due respect.
Mrs. Maloney. Okay.
Mr. McNabb. A run really refers--
Mrs. Maloney. Demand, shall we say, a demand.
Mr. McNabb. Redemptions--monthly redemptions never totaled
more than roughly 2 percent of fund assets on average; even in
the most extreme cases it was single digits. And again--
Mrs. Maloney. So there wasn't a--
Mr. McNabb. There was plenty of liquidity in the equity
markets.
Mrs. Maloney. There was no crisis.
Mr. Garrett [presiding]. The gentlelady's time has expired.
Mrs. Maloney. Unfortunately. This is a fascinating panel. I
want to thank all of you.
Mr. Garrett. It is.
I now yield to the gentleman from Alabama, Mr. Bachus, the
chairman emeritus of the committee, for 5 minutes.
Mr. Bachus. Thank you.
The first point Mrs. Maloney has made is that AIG--it was
their counterparty risk arising from the credit default swaps,
which was nothing to do with your traditional insurance
business. And any argument that insurance companies ought to be
regulated because of AIG just simply fails on the facts.
Insurance companies don't have the same problems with
banks. Their obligations are long-term. They don't depend on
short-term deposits and then lend long. So, it is just an
absolute fallacy.
Mr. Barr, I remember you sitting in the conference
committee where about a third of Dodd-Frank was written, sort
of orchestrating the different pieces with Chairman Dodd and
Chairman Frank. So I think you are probably as close as anybody
to being the author of it. It probably ought to be called Dodd-
Frank-Barr.
So, I am not surprised--
Mr. Barr. I doubt they would agree with that.
Mr. Bachus. I am not surprised you are here defending it.
I think Mr. McNabb makes an excellent point that I didn't
know. I always learn something in these hearings that I didn't
know, and that is that while the market was dropping 40, 50
percent, and people were liquidating their entire portfolios,
the mutual funds only sold 6 percent of their stock. So they
were really more of a stabilizing influence during the
financial crisis. Thank goodness that some of the pension funds
weren't unloading, and the mutual funds weren't unloading. I
can't imagine what it would have been like otherwise. And their
structure, their operation, their risk profile, comparing them
to a bank is--it is apples and oranges.
Is there anybody who disagrees with that, maybe other than
Mr. Barr?
Mr. Barr. Let me address an aspect of that if I could, Mr.
Bachus. I think that the portion of the industry that did
experience a run is the money market mutual fund part of the
industry. Money market mutual funds experienced quite a
destabilizing run in the wake of Lehman Brothers' failure, and
it was stemmed only with a $3 trillion guarantee--
Mr. Bachus. It was less than 1 percent.
Mr. Barr. --from the Treasury Department.
Mr. Bachus. Again, their problems were sort of--when you
have a panic, there was certainly maybe a perception, but there
was absolutely no reality. And I am sure a lot of people went
there because they were losing money and liquidity and cash
from some of the pullback in lending.
I understand what you are talking about. You are talking
about maybe one money market fund, and it was less than 1
percent. You are talking about ``breaking the buck.'' Is that
what you are referring to?
Mr. Barr. I am talking about the breaking the buck and the
Reserve Primary Fund, but also the run that occurred in the
money market mutual fund system that was arrested--
Mr. Bachus. Was there really a run?
Mr. Barr. --with a $3 trillion guaranteed--
Mr. Bachus. Let me call on--
Mr. Barr. --by the Federal Government.
Mr. Bachus. Mr. Atkins, was there a run?
Mr. Atkins. No. Well, I just heard of that. I think the
empirical evidence and studies, like one by the firm Treasury
Strategies, shows that was actually not the case.
Mr. Bachus. I just think that there is a perception, just
like this perception that AIG, their insurance business; they
were fully reserved, their insurance business.
Mr. Barr. I think we just have a--
Mr. Bachus. I think we have to start with the facts, and
the facts are when you are talking about a mutual fund, you are
talking about a bank regulator regulating something that is not
a bank in any way.
Mr. Barr. I was--I'm sorry.
Mr. Bachus. Let me ask you this. I am a cosponsor of Mr.
Luetkemeyer's bill, for two reasons. One, Mr. Scalia mentioned,
that we don't know what their criteria is. It is not an open
process. You don't know what to address because you don't know
what--why they are deciding, which, to me, is against the whole
democratic process, rule of law. You don't know what the law
is--Mr. Garrett going over and not being able to even attend.
Don't you see a problem with that, that it is not open and
transparent and--
Mr. Barr. I think actually having congressional involvement
in the FSOC would undermine the ability of the Congress to
provide independent and effective oversight of the FSOC through
forums such as this.
Mr. Bachus. Okay. So if we understood what was going on, it
would undermine our ability to have oversight?
Mr. Barr. I do.
Mr. Bachus. Okay. That makes a lot of sense.
Thank you.
Mr. Garrett. On that note, I yield now to the gentleman
from California.
Mr. Sherman. Mr. Atkins, I refuse to use ``sci-fi'' in lieu
of SIFI because I don't want to besmirch my favorite genre of
fiction.
The gentlelady from New York points out that there is an
appeals process, but, Mr. Scalia, I think you point out there
are no standards to be applied. So if you can appeal to the
Supreme Court and say, we don't meet the standard, but the
standard is you are an SIFI because we say you are an SIFI, I
think the Supreme Court would say, yes, you meet the standard.
But, Mr. Scalia, I think you have it wrong when you say the
FSOC is the most opaque government agency in making its
decisions because you are clearly not familiar with the
Financial Accounting Standards Board and its process. So at
most, they are in second place.
I think the FSOC got it wrong. By looking at everyone in
this room, you all represent folks, with the exception of the
professor, who might be designated SIFIs. The entities that
were at the core of the meltdown were the credit rating
agencies. They are not here because their balance sheets are in
the millions, and your balance sheets are in the trillions.
But the fact is that the decisions made by the credit
rating agencies, paid for by the issuers, selected by the
issuers, umpire selected by one of the teams, controls far more
trillions of dollars than decisions made by the witnesses in
this room.
And the fact that the SEC hasn't even implemented the
modest provisions of Dodd-Frank with regard to the selection of
credit rating agencies makes me think I am going to be back in
this room in 5 or 10 years talking about another meltdown.
The gentleman from Alabama, I think, points out that
insurance companies are different. I think the proof that we
had better regulation in the States than we had in Washington
is that AIG was obviously run at the top by drunken sailors.
They crashed on the rocks all the ships that they were allowed
to control. But even under that management, all of the ships,
that is to say subsidiaries, that were subject to State
insurance regulations survived and have even provided
sufficient profits to resurrect the fleet.
The problem, therefore, is not in the States, it is here in
Washington, where we prohibit calling a credit default swap
insurance, which is, of course, crazy. If I ran a fire
insurance company and said, I am unregulated; if your house
burns down, I won't give you a check, I will give you a U.S.
bond; you can trade your house, your burnt-down house for a
U.S. bond, that would be an end run around, say, fire insurance
regulation, and we wouldn't allow it. But instead, we have this
bizarre notion that if we insure your portfolio, that is
insurance, but if you can trade your burned-down portfolio for
U.S. bonds, that is not insurance.
And so Congress allowed AIG and continues to allow these
unregulated insurance policies on portfolios to be issued
without any insurance regulation.
Finally, I will point out that too-big-to-fail is too-big-
to-exist. It shouldn't be just a matter that these entities are
so large that we will give them special regulation, and then
they will save 80 basis points on their cost of funds.
Mr. McNabb, you have all my money. You may not know this.
The only way you are an SIFI in the sense that you could take
an action that could cost Americans trillions of dollars would
be if the money you say you are holding for me isn't in your
vault.
I am responsible for the investment decisions. Putting
aside all the things you do voluntarily, and all the things you
do as part of industry, and looking only at the requirements
imposed by government, what requirements are there so that I
know that the value of the assets in your vault is equal to all
the statements you have mailed out to everybody in the country?
Mr. McNabb. First of all, thank you, sir, for being an
investor. I am very grateful for that.
Mr. Sherman. Thanks for the low fees.
Mr. McNabb. We are endeavoring to keep them as low as
possible.
The structure of mutual funds is very different--this is
the big difference between funds and a bank-like organization.
Each fund is a separate entity and is separately managed, has a
separate board of directors, and the assets are custodied
separately. So actually, there is no Vanguard vault where your
assets reside; they are held by a separate custodian. And funds
cannot be commingled.
So, let us use the S&P 500 Fund as an example. If
Vanguard--
Mr. Sherman. You picked the one that has all my money.
Mr. McNabb. If Vanguard went out of business tomorrow, then
the fund's board would simply arrange another advisory
agreement with another firm to manage these assets. Those
assets would be separate and whole. Different funds also cannot
commingle assets. So one fund being down can't borrow from
another fund in order to ``make it whole.'' Each fund has to be
treated as a separate entity.
And again, this goes to the whole nature of the difference
between funds and banks. We are acting as agents. You are an
equity holder in a fund, and we are acting on your behalf,
whereas a bank is a proprietary institution.
Chairman Hensarling. The time of the gentleman has expired,
but the Chair found the answer interesting.
The Chair now recognizes the gentleman from Texas, Mr.
Neugebauer, the chairman of our Housing and Insurance
Subcommittee, for 5 minutes.
Mr. Neugebauer. Thank you, Mr. Chairman.
The identification of a nonbank systemically important firm
is a fairly serious exercise. And I think it has a lot of
implications for the competitiveness of some of those firms. It
says to the world that this institution has systemic risk to
the financial markets.
It has been discussed that recently Prudential was found to
be one of these SIFIs. And it was interesting, and I think it
has been brought out in testimony, that several of the people
who sit on FSOC, either in an advisory capacity or a voting
capacity, didn't agree with that decision. In fact, John Huff
said that FSOC's misguided overreliance on banking concepts is
no more apparent than FSOC's basis for the designation of
Prudential Financial. He went on to say that the basis for that
designation was grounded in implausible, even absurd scenarios.
Mr. Scalia, what were your views on FSOC's mythology and
their final decision?
Mr. Scalia. The Prudential decision is an unusually thinly
reasoned and poorly substantiated decision for a government
agency in several ways. As you note, the members of FSOC who
had the expertise in insurance were very troubled by the
analysis or lack thereof.
Mr. Wallison talked about the coordinating function of
FSOC. We have talked about the expertise of FSOC. Those can be
valuable things, but if those members of FSOC who have the
expertise in that specific industry are deeply troubled and
ignored, that is going to yield a very poor government
decision, which is exactly what happened there. So I don't
think that FSOC--to the extent it has expertise--functioned
properly in that case.
Mr. Neugebauer. There has been a lot of discussion about
what does that mean, and what does that mean to that company.
What would you see some of the consequences that a firm might
experience, and its customers, for being designated as an SIFI?
Mr. Scalia. The consequence of SIFI designation that is, I
think, most apparent is being subjected to different capital
requirements. And we currently, under Dodd-Frank as written and
as interpreted by the Fed, have every reason to believe that a
designated company will be held to the capital requirements
applied to a bank, which is remarkable, because I think there
is unanimity that bank-based capital standards are really
inappropriate for other kinds of financial institutions.
I think what is transpiring is that FSOC is taking the
position, ``We don't make the capital standards decision, the
Fed does;'' and the Fed says, ``We don't make the designation
decision, really, FSOC does.'' And so, you have designation
with consequences that everybody recognizes are quite
problematic, but the answer seems to be, that is okay because
the left hand doesn't know what the right hand is doing, which
is not ordinarily how the government ought to defend its
actions, particularly when you have this body, FSOC, which is
supposed to be coordinating and ensuring consistent
intelligence in how regulatory matters are approached.
Mr. Neugebauer. Thank you.
Mr. Wallison, you described FSOC's designation of
Prudential as perfunctory and data-free, I believe. In fact,
you said that the only useful numbers in its designation were
the page numbers.
So should the FSOC's designation process be more rigorous
or more transparent, or what would you think is a more
appropriate process for FSOC to go through for these
designations?
Mr. Wallison. I think we have to recognize from the
beginning that what they are doing is very serious for the
firms involved, and serious, actually, for the economy as a
whole. And so we would expect that when they make a
designation, they would actually be able to show us, especially
show Congress, what it was they based the designation on.
I also said in my remarks that the FSOC used the word
``significant'' 47 times in a 12-page paper, which was their
entire justification for designating Prudential as an SIFI.
This is not adequate. And one of the reasons I said that they
seemed to be an emperor without any clothes is that I went back
and looked at what they did for the other previous designees,
AIG and for GE Capital. Same thing. No specifics.
So I have the idea--and I would like to see it disproved--
that they have no way of demonstrating the things that they are
required to demonstrate, which is that a firm's financial
difficulties would lead to instability in the U.S. economy. And
if they have no way of demonstrating that, they shouldn't be
allowed to make these decisions arbitrarily.
Mr. Neugebauer. Thank you. My time has expired.
Chairman Hensarling. The time of the gentleman has expired.
The Chair now recognizes the gentleman from Texas, Mr.
Hinojosa, for 5 minutes.
Mr. Hinojosa. Thank you, Mr. Chairman.
Before the financial crisis, the financial regulators
focused on different segments of the market, which caused a
fragmented approach to oversight. There was no organization
tasked with taking an eagle's-eye view of the entire financial
system to watch for impending trouble.
The Financial Stability Oversight Council was created to do
just that. Had there been a council in place, it is possible
they might have identified the systemic risk infecting the
economy and could have diverted the crisis.
The Financial Stability Oversight Council is the
cornerstone of the Dodd-Frank Act. Let us not forget the cost
of the disjointed approach to financial regulation prior to
that crisis. The Government Accountability Office estimates
that the 2008 financial crisis cost the U.S. economy more than
$22 trillion. Whereas today's hearing supposedly seeks to
examine the dangers of the FSOC's designation process, the real
danger to the American economy arises when our regulators are
asleep at the switch.
As the Financial Stability Oversight Council proceeds with
identifying systemically important institutions, Congress
should seek to improve its effectiveness, not hinder it.
Some criticize that the FSOC's designation process has been
opaque. My first question is to Mr. Barr. Do you have any
suggestions for increasing transparency in this process?
Mr. Barr. I think that you are correct that the FSOC
designation process is essential to policing the boundaries of
systemically important financial institutions and ensuring that
there is a safe system in place.
There are undoubtedly ways that the process, which is a
quite new process, can be made more standardized and more
transparent over time. I think that the FSOC has done a good
job, given the new nature of the proceedings, to get started.
There may be ways of providing more information in advance to
firms that are more specific about the types of showings that
will be required. As it currently exists, a lot of that
information is provided to firms during the process of the--the
provisional designation, and it may be possible over time to
move that data and information up further in the process.
Mr. Hinojosa. Mr. Barr, is the FSOC appropriately balancing
the need for transparency against the need to protect sensitive
market and supervisory information?
Mr. Barr. I think the balance they have struck so far is a
reasonable one. It is not the only one you could strike, but I
think that it is a reasonable one. And I think that firms have
a great deal of time to participate in the process, the ability
to provide essential information to the FSOC that is necessary
for a designation.
Again, I think over time it may be that the FSOC, after
reviewing its experience over the initial period, may move the
process one way or another along the lines of providing greater
transparency, but I think the path they have chosen thus far is
a reasonable one, given the newness of the process.
Mr. Hinojosa. Lastly, Mr. Barr, do you agree that the FSOC
has both the expertise and the authority to appropriately
assess the nonbanking financial institutions, such as insurance
companies?
Mr. Barr. I do. It certainly has the expertise and the
authority to act in these areas based on not only its own
staff, but the staff of its member agencies. As with any
organization, I think that it is going to continue to want to
build the expertise, the in-house capacity, the data analytics,
the data collection that is necessary to be effective, but I
think they are doing a good job so far.
Mr. Hinojosa. I yield back, Mr. Chairman.
Chairman Hensarling. The Chair now recognizes the
gentlelady from West Virginia, Mrs. Capito, the chairwoman of
our Financial Institutions Subcommittee, for 5 minutes.
Mrs. Capito. Thank you, Mr. Chairman. And I apologize for
having to step out of the hearing during your statement. I just
have a couple of questions.
One question I wanted to ask was alluded to in my opening
statement, and that is the $50 billion threshold for automatic
SIFI designation for banks. As you know, there has been a lot
of discussion as to whether that is an arbitrary deadline--
arbitrary designation threshold. And I guess I would like to
ask each of you to answer the question.
There have been a lot of folks who have said that we need a
more nuanced approach where we are looking more at the risk
profiles and deeper into each institution's business models as
opposed to just using a specific $50 billion as a threshold. So
I am just going to go down the line and ask each of you if you
have an opinion on that, and I will start with Mr. Atkins.
Mr. Atkins. Thank you.
I think that to have an arbitrary type of threshold like
that does not make a lot of sense. But I think, to what is
being discussed here, if you look at what even President
Obama's designee on the FSOC said about the whole process with
respect to Prudential, he criticized and said it was not
reasonable, not supportable, no data was run. So even the
President's own insurance designee had that to say about the
flow of process.
Mrs. Capito. Okay. Mr. McNabb?
Mr. McNabb. Again, the asset level makes no sense to me
either, neither for banks nor for investment companies.
I would say any focus that the FSOC should have should be
on activities as opposed to institutions or asset levels.
Mrs. Capito. Is there a feeling that the threshold is too
low? It should go to $100 billion, or just an arbitrary
threshold is--
Mr. McNabb. I think just arbitrary.
Mrs. Capito. Okay. Mr. Scalia?
Mr. Scalia. My principal concern with the threshold is that
there is no evidence that there is anything beyond that
threshold that is being considered and resulting in
designation. It appears to be the case, for example, when you
read the Prudential decision that once you hit the threshold,
the agency will simply engage in a series of speculative
hypotheses and designate you.
Mr. Wallison has pointed out that the sort of undefined
word ``significant'' appears 47 times. There is actually a word
that appears almost twice as much. In this 12-page decision,
the word ``could'' is used 87 times. The words ``would'' or
``will,'' which constitute findings, scarcely appear at all. So
there is this very speculative approach once you hit that
threshold.
Mrs. Capito. Mr. Barr?
Mr. Barr. I think the key question is, the key point is to
make sure that the approach that is taken to firms is a
graduated approach and a nuanced approach that is consistent
with not just their size, but their risk profiles. So I don't
think there is an on/off switch. If you are a $50 billion plain
vanilla bank, you need a much lighter touch form of oversight
than if you are a complicated institution. And I think having
nuance and graduated approaches that are tailored to the risks
that firms do or don't pose is the essential thing.
Mrs. Capito. Right. But that doesn't exist presently. It is
just a threshold and on type of approach, correct?
Mr. Barr. In the current structure, it is not just an on/
off switch; there is a graduated approach to regulation. I
think that the--the point would be making sure that it is
graduated enough and nuanced enough. It is not an on/off switch
now. There are higher, more intrusive forms of regulation, of
supervision, of capital requirements, of stress testing, of
resolution planning that are more stringent at much higher
levels of asset size--
Mrs. Capito. Right.
Mr. Barr. --than they are for a smaller firm. I think that
is good and appropriate. And the question is, I think, can you
just make that even more of a graduated nuanced approach? I
think there is room to do that.
Mrs. Capito. Okay. Mr. Smithy?
Mr. Smithy. Thank you.
So as we stated in our written testimony, we do believe an
arbitrary asset size threshold is inappropriate, as we stated.
Our business models are very straightforward. We are simple. We
take deposits and make loans. We are not engaged in the range
of activities that would lead to a situation where it threatens
the U.S. financial system, and so we do believe the arbitrary
nature of that threshold is inappropriate. We think a more
activity-based approach would give regulators the flexibility
to tailor regulation to the risks inherent in each firm.
Mrs. Capito. Thank you.
Mr. Wallison?
Mr. Wallison. If regulators on the FSOC are able to
designate nonbank financial institutions as SIFIs, then they
ought to be able to do exactly the same thing for banks, and
that is not what they are told to do. They have been told to
choose an arbitrary number.
I might mention that the International Association of
Insurance Supervisors made up a methodology for how you judge
the riskiness of an insurance company, and they provided that
to the FSB, which apparently was never used. But, in any event,
what it said is that size is about 5 percent of the question.
There are other, much more important questions that don't have
anything to do with size.
Mrs. Capito. Thank you. I think my time just expired.
Excuse me.
Chairman Hensarling. The time of the gentlelady has
expired.
The Chair now recognizes the gentleman from Massachusetts,
Mr. Lynch, for 5 minutes.
Mr. Lynch. Thank you, Mr. Chairman.
Mr. Chairman, I just have a couple of procedural things. I
have here a letter from Damon Silvers, he is the policy
director and special counsel for the AFL-CIO; a letter from the
Americans for Financial Reform; and a white paper by Douglas J.
Elliott, a fellow at the Brookings Institution, assisted by
William Becker. The title of it is, ``Systemic Risk and the
Asset Management Industry.'' I would like to have those entered
into the record.
Chairman Hensarling. Without objection, it is so ordered.
Mr. Lynch. This piece by Douglas Elliott is particularly
good. I don't necessarily agree with all of it, but I think it
serves the purposes of what we are talking about here today.
I think it is an easy question. I want to thank the
witnesses. It has been a very helpful discussion.
The easy case, I think, is the case of a garden-variety
mutual fund. I think there are a lot of aspects that you have
all pointed out that acquit the idea of SIFI designation for
mutual funds. The revenue stream is fairly stable, they get
their money from fees, very low use of leverage, much smaller
balance sheets than what we are generally concerned about, very
little debt. The share price is published and recalculated each
day, and shareholders are free to redeem their shares every
day.
And, best of all, mutual funds have really allowed average
families, average working families, to assemble wealth. It has
been an enormous benefit to a lot of American families, and it
would be--as Mr. Elliott points out in his paper--a shame if we
were to regulate these funds in such a way that destroyed that
opportunity for a lot of hard-working families.
The tougher question really, and I think, Mr. Barr, you
have tried to address this on a couple of occasions, is the
question of hedge funds that operate more like banks and that,
quite differently, have no limits on leverage. They are not
subject to any of the regulations that registered funds are
subject to. They can impose very onerous redemption
restrictions on investors, and they are exempt from many of the
oversight and reporting requirements we have on other funds.
In the other case is money market funds that operate in the
repo market, and you started to talk about that earlier with
the gentleman from Alabama. And those are the tougher
questions, because those are examples of the problems that we
are trying to get at, but they are ``asset managers.''
So, Mr. Barr, how would you get at the risks that these--
look, some hedge funds don't operate high leverage, but a lot
of them do, and there is no limit on the investment strategies
that they adopt. They are sort of out there, and we don't know
a heck of a lot about them until something goes wrong.
How would you address the situation with these hedge funds
and with the money market funds that operate in the repo market
that we saw runs on previously?
Mr. Barr. With respect to money market mutual funds, I am
in favor of the SEC using its existing authority to remove the
regulatory provisions that permit funds to carry a stable net
asset value unless they have capital that deals with the run
risk from such a fund. I think that having that option is the
preferred policy approach.
With respect to hedge funds, the Dodd-Frank Act gave the
SEC the authority to collect information with respect to hedge
funds, and obviously the FSOC and the OFR also have such
authority. And I think having that information on such funds is
the primary way of understanding what is going on in that
marketplace.
If a hedge fund was sufficiently systemically important,
the FSOC also has the ability to designate such a firm and to
subject such a firm to supervision and capital requirements. In
the absence of such a finding, most hedge funds, even highly
leveraged ones, can operate and disappear without anyone
worrying about it.
Mr. Lynch. Yes. What about the money market operating in
the repo market where we have had runs before?
Mr. Barr. I think that repo market reform directly is
probably the most efficient way of getting at that. I think
there is much work that can still be done to reduce risk in the
triparty market in particular, and the Fed has existing
authority to do that.
Mr. Lynch. Thank you. I yield back the balance of my time.
Chairman Hensarling. The Chair now recognizes the gentleman
from North Carolina, Mr. McHenry, chairman of our Oversight and
Investigations Subcommittee, for 5 minutes.
Mr. McHenry. Thank you, Mr. Chairman.
Mr. Barr, you said the OFR's asset management report is not
something you would hang your hat on--I think that is what you
said a little bit earlier. And I think that is interesting,
because the FSOC directed the Office of Financial Research to
issue the report, to undertake this. So, this was a directive
of the FSOC. And it is interesting because OFR has functioned,
as you well know, as basically, a vassal of the Treasury
Department, or contained within it and the reporting structure.
So, do you think that the research would be better done by
independent agencies?
Mr. Barr. The OFR can and does have independent authority
within the Treasury Department, akin to the kind of
independence that the OCC has within the Treasury Department.
And I think that it, from at least all intents and purposes,
was working with that independence in mind.
Do I also think that it would be good for other agencies to
look at the sector? Yes, I do. I think there is expertise in
other member agencies and the FSOC staff at the SEC and
otherwise, and that is healthy for the system.
Mr. McHenry. To that end, at the SEC, they put up this
report for notice and comment. Do you think that was positive?
Mr. Barr. I do. I think that was a very healthy move by the
SEC, as they have done with the money market mutual fund report
and other efforts.
Mr. McHenry. Sure.
But the notice-and-comment part of this is not a
requirement of the FSOC; is that correct?
Mr. Barr. There is a formal process with respect to
designation. The issuance of a report--
Mr. McHenry. But they have to follow the Administrative
Procedures Act.
Mr. Barr. The issuance of a report by any government agency
does not usually require, just for the issuance of the report,
a notice-and-comment process. I think it is a healthy and
useful thing for agencies to do, to put out draft reports and
to get comments on it.
Mr. McHenry. Do you think FSOC should be under the
Administrative Procedures Act?
Mr. Barr. It is governed by the Administrative Procedures
Act with respect to its work.
Mr. McHenry. Should the OFR?
Mr. Barr. It is already under the Administrative Procedures
Act, but, again, normally the issuance of a report is not the
kind of regulatory step that would require a formal process. I
think it is healthy and good for regulators for all government
agencies when they are issuing a report do so.
Mr. McHenry. I appreciate it. Thanks.
Mr. McNabb, when the Financial Stability Board has already
decided that asset managers are systemically important, so it
seems like the FSOC's designation, because we just assume they
are going to go forward with this designation of asset
managers, it is sort of mindlessly following the FSB on this.
So what I don't understand is asset managers being not--
they are not leveraged, so how do higher capital standards
actually--how does that actually make sense? Higher capital
standards would have absolutely no impact on an asset manager's
ability to run its funds.
Mr. McHenry. So to actually put bank-like regulations,
capital requirements is completely unfitting with what asset
managers do. Is that right?
Mr. McNabb. That is correct, sir.
Mr. McHenry. Okay.
Mr. Wallison, you wrote that the designation process will
result in one of two things, and let me quote you: ``Either we
will have large, successful, government-backed firms that
swallow up smaller competitors or we will have large,
unprofitable, heavily-regulated giants that are gradually
driven to failure by their more nimble and less-regulated
competitors. In the former case, small firms are the victims
and in the latter case taxpayers will pay for the bailouts.''
So, designation must be the proverbial ill wind that blows
no good. Would you concur?
Mr. Wallison. It looks that way to me because I was talking
there about the question of too-big-to-fail, and many people
have said, including the former chairman of this committee,
that, well, why is everyone opposing becoming an SIFI if, in
fact, it is a benefit if you are too-big-to-fail? And the
answer is that nobody really knows what the consequences will
be. There may be benefits in the financing that you get, but
there may be detriments in the cost of the regulation you have
to suffer.
And the point I was trying to make in the paragraph that
you read is either way, as a public policy matter, it is a bad
idea, because either we have firms that are benefited and
outcompete those that are not designated as SIFIs or, in the
other way, they are hurt by excessive regulation, and as a
result they fail and the taxpayers have to come in and bail
them out.
Chairman Hensarling. The time of the gentleman has expired.
The Chair now recognizes the gentleman from Georgia, Mr.
Scott, for 5 minutes.
Mr. Scott. Thank you very much, Mr. Chairman.
First, Mr. William McNabb, let me welcome you to the
committee. You are a graduate of the Wharton School of Finance
at the University of Pennsylvania, the absolute greatest school
of finance and business in the world. Of course, I am graduated
from there, and I got my MBA there as well. And we both spent a
lot of tough times in Lippincott Library and Dietrich Hall.
Welcome.
Mr. McNabb. Thank you.
Mr. Scott. Let me just ask you this: How do you rank the
basic general risk in the market now?
Mr. McNabb. Could you be a little bit more specific? Equity
markets or the bond markets or--
Mr. Scott. As we look at this, in either market, what do
you see as our greatest challenges as far as risk in the market
today, whether it is the bond market--maybe the bond market. I
will wait for you to assume which of the markets has the
greatest risk. But I think it would be helpful to this
committee if you could tell us what you see as the top three
threats, risks to the market.
Mr. McNabb. The largest threat I see to the markets is one
that actually hasn't been talked about in any of the
discussions, and it is the cyber risk that exists out there.
And it is more than just a financial institution risk, it is
really a risk to all businesses. When you look at what has
happened in the last 18 months where nation-states are getting
way more involved in this, that trumps almost anything I have
seen in my career.
Mr. Scott. Good.
While I have the time, I also want to go to you, Mr.
Smithy. You referenced Governor Tarullo's speech on prudential
regulation in your comments. Why do you think that he seems
willing to reconsider some of the existing asset thresholds
from regulatory supervision?
Mr. Smithy. Thank you. Based on my read of his speech, I
think he thinks an arbitrary asset threshold is imprecise in
its nature, and he is in favor of more tailored solutions
reflecting the differences among firms, and he is in favor of
regulation that is commensurate with the risk of each of these
firms. And in his comments, I think he believes that an asset-
only threshold only subjects firms that do not engage in risky
activities to the added burden of regulation.
Mr. Scott. Now, correct me if I am wrong, but is it not
true that regional banks hold one-fourth of the Nation's total
bank deposits? Is that an accurate statement?
Mr. Smithy. The 18 banks in the Regional Bank Coalition do
hold one-fourth of the Nation's deposits, yes.
Mr. Scott. And let me ask you what your greatest concerns
are, given the status of the regional banks, as opposed to our
much larger banks in relationship to this asset threshold
supervision.
Mr. Smithy. The cost burden is both direct and indirect.
For Regions Bank, which I can speak to specifically, the cost
of compliance and regulation has more than doubled over the
last 5 years. It is the largest single increasing cost in our
operating structure. There are many elements to it that seem
unnecessary, given the activities that we are engaged in. A
point I would give you is we now have more folks in compliance
activities than we do in commercial lending, than commercial
lenders at our bank. So, again, I think that speaks to the
direct costs of compliance.
There are also indirect costs, which are management and
board's time and attention focusing on compliance matters and
away from serving the needs of our communities and our
customers.
Mr. Scott. And if I am also clear, regional banks, unlike
other size banks, probably do more of asset building and
lending to small businesses as a percentage of what you do. Is
that correct?
Mr. Smithy. That is correct. We serve a lot of smaller and
medium-sized markets, much like the community banks. The larger
banks, the more internationally active banks tend to focus on
larger organizations. So we are an important source of credit
for small and medium-sized firms in smaller and medium-sized
markets.
Mr. Scott. So this asset threshold regulatory supervision
issue that you are talking about would have a negative impact
on your ability to assist small businesses?
It looks like my time is up on that, and the chairman has
done it twice. So I take the message.
Mr. Luetkemeyer [presiding]. Thank you.
With that, the gentleman from California, Mr. Royce, the
chairman of the House Foreign Affairs Committee, is recognized
for 5 minutes.
Mr. Royce. Thank you, Mr. Chairman.
I have a question for Mr. Wallison and Mr. McNabb, and I
have a question about the now infamous OFR asset management
report, a report that even Michael Masters' Better Markets shop
called inexplicably and indefensibly poor quality, and today a
report that Professor Barr said he would not hang his hat on.
And so, as has been referenced, the SEC opened the OFR's report
for comment, which gave the public the opportunity to directly
point out the flaws and poor analysis in the report. I think
this simple but important step by the SEC has raised some
serious questions about whether the OFR should be required to
follow the same notice-and-comment procedures as financial
regulatory agencies.
As it relates to reports, is there any good public policy
reason to exempt the OFR from providing public notice and
comment as the American people expect from other regulators in
a system that we are trying to run here that is transparent and
open? And is there any good public policy reason to exempt the
OFR from consulting with and incorporating changes proposed by
prudential regulators, proposed by the safety and soundness
regulators? And would you support congressional action to
mandate this openness and inclusion of outside expertise?
Mr. Wallison?
Mr. Wallison. Yes, I think it makes all kinds of sense for
these organizations like OFR to make their reports public. The
public is paying for those reports, and the other agencies are
relying on those reports. It is essential that people know what
is in the reports that institutions, agencies are relying on,
and the quality of those reports. If the SEC had not put out
this report for comment, no one would have realized what a poor
quality piece of work it was. The likelihood is the FSOC would
have relied on it, might have even stated they were relying on
it, and no one would have known that it provided no substantial
guidance. So I certainly agree that, with your legislation,
that is what should be required.
Mr. Royce. Thank you, Mr. Wallison.
Mr. McNabb?
Mr. McNabb. I would agree with Mr. Wallison. When you look
at the consequences of a report like this and the amount of
activity that has been created since its release, I think it
goes without saying that it should be available to the public
and should be available for comment. I think the SEC comment
period offered an opportunity for many people who really
understand these issues pretty deeply to point out some of the
data inaccuracies and the flaws in the report.
Mr. Royce. The other aspect of my question was, in terms of
the functional regulators, what about the concept of having the
OFR, currently exempted from consulting with, what about a
mandate for a consultation there where you allow an
incorporation of the changes of those who have the
responsibility to look at such issues as prudential regulation
and so forth?
Mr. McNabb. That would make sense to me in that it would
lead to a better outcome, a better, more accurate report.
Mr. Royce. Thank you.
And I was going to ask Mr. Atkins, this issue was raised
previously, but not to you directly. So when we are talking
about SIFI designation, or as you have termed it ``sci-fi''
designation, and we look at that designation of asset managers,
what we are really talking about is something here that lends
to the destruction of wealth because of the costs involved.
Because of the regulatory burden, the compliance costs that
come with it, it is a destruction of wealth, but it is not Wall
Street's wealth here. If you think it through, it is wealth
held by average Americans, those saving for retirement, those
saving for a downpayment, those saving for college tuition.
They are going to have a lower return on their investment
because of the higher costs.
And it is not really justified by a risk in the market,
given that the asset managers themselves are controlling or are
handling accounts by individuals. Can you explain more clearly
why designating asset managers as SIFIs would harm average
investors? Do you want to walk through that argument?
Mr. Atkins. Thanks for that question. Like you are saying,
being designated as an SIFI is not just joining a club or some
exclusive club. There are consequences to it, and that is the
imposition potentially of a bank capital type of regulatory
structure. And like we were saying with asset managers, it is
ultimately the investors who bear the burden because, as Mr.
McNabb was saying, it is investors' capital, it is 100 percent
capital in most cases in mutual funds, it is either on them or
on the asset manager. And so it is all inapposite.
Mr. Royce. Thank you, Mr. Atkins.
Thank you.
Mr. Luetkemeyer. Thank you.
With that, we will go to Mr. Meeks for 5 minutes, the
gentleman from New York.
Mr. Meeks. Thank you, Mr. Chairman.
Let me just say this first because sometimes I think we
forget how we got here in the first place. We created FSOC
because it was quite evident that we needed an interagency
process to better understand the very complex multisector and
multimarket nature of systemically important financial
institutions and companies, and to adopt a stronger
microprudential approach to financial supervision. And the
Financial Stability Board was created to address the lack of
coordination of these issues at the global level, as these very
large institutions and companies act on a global scale, with
global interconnectedness and risk exposures.
Furthermore, FSB was meant to deal with harmonization of
financial regulations across the global financial markets, and
I have often talked about how vital harmonization of rules to
ensuring that American banks and companies can compete on a
level playing field. This is vital to our economic interests
and job creation here in America.
And I know that sometimes I have raised concerns also about
heightened supervision of insurance companies by the Federal
Reserve and the risk of applying banking standards to an
industry that operates a completely different business model.
But that is not a valid reason to undermine the FSOC
designation process, and designation is separate and different
from supervision and rulemaking.
So my question goes first to Mr. Wallison. Do you think it
is wrong for domestic authorities to come together on an
international level and cooperate with one another as the FSB
and G-20 are demonstrating currently?
Mr. Wallison. I don't think it is wrong at all. I think
those kinds of consultations should occur all the time, it is
very important. It is important here in this country and it is
important internationally. The only question is whether these
international bodies should take positions that have an effect
on our domestic economy, and I am afraid that the positions
that they are talking about will have very adverse effects on
our economy.
Mr. Meeks. Then, would you not say that FSB and the G-20
are playing significant and important roles in terms of seeking
the global cooperation and harmonization on financial markets
and international banking rules?
Mr. Wallison. That isn't my understanding of what the G-20
told the FSB to do. It wasn't just harmonization. They told
them to develop reforms to the international system to avoid
the next financial crisis. And the FSB has taken that baton and
run with it to attempt to designate individual companies that
ought to be regulated specially in order to achieve that goal.
That isn't the only way to achieve that particular goal. It
is the regulators' way of achieving that goal, and that is to
get hold of companies and tighten the regulations on them. That
isn't necessarily the way that you would ordinarily do it if
you were asked to attempt to prevent the next financial crisis.
That is, however, how the FSB interpreted the G-20's
instructions.
Mr. Meeks. Mr. Barr, let me ask you the same two questions.
How would you respond?
Mr. Barr. I think the role of the G-20 and the Financial
Stability Board are absolutely critical in not only
harmonizing, but also raising standards internationally, and
that is helping to make the U.S. financial system and the
global financial system safer. I think that there are probably
initiatives that the FSB could take to make its own process
more transparent and more regularized that would be helpful.
And I should just point out, as I did in my testimony, that
the actions that are taken by the G-20 and the FSB are not
binding on the United States. The United States makes
independent judgments about how to and whether to adopt or
adapt international rules, international standards,
international designations in the domestic context. And you
have seen already lots of examples where the United States has
chosen to take a somewhat different course from the
international standard-setting bodies, and you see other
countries around the world doing that, too, the U.K.,
Switzerland, and the like.
So there is flexibility to approach the domestic regulatory
questions independently and in light of our own domestic
judgments about risk.
Mr. Meeks. I would ask another question, but I only have 15
seconds, and the chairman has a quick hand with that hammer, so
I guess I will just yield back the balance of my time.
Mr. Luetkemeyer. I thank the gentleman. I don't think it is
that quick. We had a little leeway here with a couple of them.
But, thank you.
With that, the chairman grants himself 5 minutes for
questions. My first comment is to Mr. Atkins.
I understand your concern with ``sci-fi'' and SIFI, Mr.
Atkins. I come from ``Missouree'' or ``Missouruh,'' nobody
knows for sure, so I understand your concern.
But thank you all for being here today. It is an
interesting discussion. As Mr. Smithy indicated, I have a bill
that tries to address some of this, as far as the banking
institutions anyway.
And with that, Mr. Smithy, I have a couple of questions for
you. I have here in front of me a chart that actually lists one
bank, JPMorgan, and then the next 14, the largest 14 regional
banks in size, they only make up as much as what JPMorgan is.
And I think this gives you an idea of the relationship and size
with regards to the different entities we are talking about. It
puts things in perspective.
When you are looking at derivative contracts, the top 4
bank holding companies have 76 percent trading assets, 84
percent of the total market, credit default exposure 94
percent, whenever these regional banks have less than 1 or 2
percent of all that. So I think we are looking not only at
size, but you are also looking at the size of the risk, the
risky activities they are engaged in, and it would seem to me
that it would flow that FSOC would take a rather positive view
of this.
However, that being said, it seems that they have a
different idea. And I would just like your comment with regards
to that, Mr. Smithy, with regards to how you view, after seeing
these statistics and your position on this, where we are at
with FSOC.
Mr. Smithy. Sir, obviously we do not go through that
process currently. We are deemed an SIFI based on asset size
alone, which is at the heart of the issue for us. As you point
out in that chart, we are traditional lenders. Our sizes in
aggregate only rank as large as the largest U.S. bank. But I
think more than that, it is the range of activities within
which we are engaged. We don't have the complex legal
structures that are difficult to resolve in a crisis, we do not
engage in securities market making, we are not in trading
activities. We are simply traditional lenders.
We are simply asking for due process similar to what the
nonbanks would go through in determining whether or not the
range of activities within which we are engaged would deem us
systemic, and that is what we would expect, that the FSOC would
put us through a similar process as they do the nonbanks.
Mr. Luetkemeyer. Mr. Wallison, I have been in a meeting
where you were engaged in discussing this subject as well, and
you seem to have a similar opinion to what Mr. Smithy does of
institutions. You base it on risk, connectivity, not just asset
size.
Mr. Wallison. Yes, especially for banks, as I said before.
If the FSOC is really able to designate nonbanks as SIFIs, then
certainly for banks, they could do the same thing. And so we
shouldn't actually set any kind of arbitrary size for these
institutions but rather look at their activities and determine
whether they could cause an instability in the financial
markets if they ran into some sort of financial difficulty.
Mr. Luetkemeyer. It is kind of interesting--the gentlelady
from New York made a comment a while ago about all the experts
on FSOC, yet whenever FSOC made its SIFI designation to
Prudential, it disregarded all the insurance experts on the
committee. I wonder why? Interesting. It would seem to me that
maybe they are trying to justify their existence by doing
something rather than allowing the actual existence of facts
and data to drive their decisions versus trying to justify
their existence.
Mr. Scalia, you had made some interesting comments during
the course of your commentary. I jotted down in my notes that
you made some comments with regards to how most of the
decisions of FSOC couldn't pass legal muster from the
standpoint that they don't justify what they are doing, there
is no transparency, and if you ask them how they could come up
with this decision, there isn't a logical or reasoned way to do
it that could actually, if this was taken to court, pass
muster. Would you agree with that comment of mine or my
assessment of your comments?
Mr. Scalia. That is accurate. Actually, it was the ranking
member who said that what we should expect from an SIFI
designation is a strong analytical basis, and I think we all
agree, and that is what is so sorely absent. The Prudential
decision, for example, it is meant to be a risk assessment,
right? We are doing a risk assessment. Well, a risk assessment
considers the probability of the event and the magnitude, and
neither of those things is determined or even estimated in the
decisions that have been issued so far by FSOC.
Mr. Luetkemeyer. Okay. Thank you.
With that, I will turn next to the gentleman from Texas,
Mr. Green.
Mr. Green. Thank you, Mr. Chairman. I thank the ranking
member as well, and I thank the witnesses for appearing.
If you are of the opinion that there should not be an FSOC,
would you kindly extend a hand so that I may identify you. I
think the record should reflect that Mr. William--is that
correct?
Mr. Wallison. Wallison.
Mr. Green. Wallison, excuse me, my vision is poor, and the
distance is quite a ways from me. And who is the other person?
Would you speak your name again?
Mr. Atkins. Paul Atkins.
Mr. Green. Mr. Atkins. The two of you are of the opinion
there should be no FSOC at all?
Mr. Atkins. As currently constituted, right.
Mr. Green. Thank you. And let's go into some other areas
now. Do you agree that Prudential was a $1 trillion company in
terms of assets, above a trillion? Or is?
Mr. Wallison. If you are asking me, I don't know the exact
number, but I will accept a trillion.
Mr. Green. It wouldn't surprise you to know that it was a
trillion?
Mr. Wallison. No.
Mr. Green. Okay.
And let's go to Mr. Barr. Mr. Barr, this company,
Prudential, had the right to appeal. Is this correct?
Mr. Barr. Yes.
Mr. Green. And this is in a Federal court. Is this correct?
Mr. Barr. Yes.
Mr. Green. And would you just briefly outline the process
that allows a Prudential or any company similarly situated to
appeal?
Mr. Barr. There is a process that is set out by the statute
and by the FSOC internal rules and guidance that describes
three stages of review--a first stage review, a second stage
review, and a third stage review--that ultimately could lead to
a provisional determination and a final determination. At the
conclusion of a final determination, the affected company has a
right to seek review in Federal court of that final
determination to assess whether that determination meets the
legal requirements for a designation.
Mr. Green. Is it fair to say that Prudential, a $1 trillion
corporation, has some pretty good lawyers? Is that a fair
guess?
Mr. Barr. I actually don't know their legal counsel at all.
Mr. Green. Would you just guess that a $1 trillion
corporation has some pretty good lawyers?
Mr. Barr. I have seen terrific lawyering and bad lawyering
at all levels of our economy.
Mr. Green. I will speak for you. With a trillion dollars,
my suspicion is that they can afford some pretty good lawyers.
Mr. Barr. I would agree with that statement.
Mr. Green. All right, they can afford pretty good lawyers.
Is it true that they did not appeal?
Mr. Barr. It is true.
Mr. Green. Is it true that they had the right to appeal?
Mr. Barr. Yes.
Mr. Green. If they did not appeal, is it also correct that
perhaps they concluded that there was good reason to stay
within the system and to abide by the rules and regulations
imposed upon it?
Mr. Barr. I am not privy to their internal deliberations,
and often firms have a complex range of reasons for taking or
not taking legal action. So I would rather not opine on what
they were thinking.
Mr. Green. Is it true that some of your colleagues have
opined and concluded that they were not treated fairly?
Mr. Barr. I'm sorry, I don't--
Mr. Green. Some of your colleagues on the panel--
Mr. Barr. Oh.
Mr. Green. --have concluded that they have not been treated
fairly?
Mr. Barr. I should maybe let them speak for themselves
about that. I understood them to be critical of the FSOC
process.
Mr. Green. The process. If the process is in some way
flawed, would not appeal be a means by which--or if the
decision is one that you believe to be inappropriate or unfair,
would appeal be an appropriate remedy for you?
Mr. Barr. I think that a Federal district court is,
generally speaking, a pretty tough and good place to go seek
redress if legal procedures have not been followed. My
experience is that the Federal courts are quite attentive to
failures by regulatory agencies to follow the rules that are
set out for them.
Mr. Green. And in that process would a Prudential or any
entity have an opportunity to have some degree of discovery?
Mr. Barr. I haven't looked carefully at what materials were
already provided and what would be protected material and not
protected material in that context. They would certainly be
able to gather and present information about whether the
procedures were followed and whether the standards set forth in
the statute were met in their case.
Mr. Green. Let me just close with this comment. Assuming
that Prudential disagreed, and a lot has been said about
Prudential, there was the ability and the right to appeal. A $1
trillion corporation which had the ability to hire good
lawyers, could have appealed, and did not do so.
Mr. Barr. Correct.
Mr. Green. I trust the judicial system in this country. I
don't always agree with it. And I think that in and of itself
gives FSOC some credibility, as well as OFR, because the appeal
process is readily available to any company that believes it
has a grievance as a result of a decision made by FSOC.
Thank you, Mr. Chairman.
Mr. Luetkemeyer. With that, we will turn next to the
gentleman from New Mexico, Mr. Pearce.
Mr. Pearce. Thank you, Mr. Chairman.
And I thank each one of you for your presentations here
today.
Mr. Barr, Mr. Scalia was very precise in his descriptions
of the Prudential decision. He says it presupposes severe
financial distress with no consideration at all to whether
there is any indication that such distress is likely to occur,
then relies on a broad unsubstantiated assertion to conclude
that material financial distress could pose a threat. Do you
have an opinion about that same case that would differ from the
observations by Mr. Scalia? Because to me, sitting up here, I
find those accusations to be intensely interesting in the
process. And so, do you find that not so concerning as he does?
Mr. Barr. I have not reviewed in detail the Prudential case
to judge item by item what my views of the substantive merits
are.
Mr. Pearce. Okay, that is fair.
Mr. Barr. I would say that the process that the FSOC
followed with respect to that decision was an engaging and
searching process, at least as it appeared from the outside. I
am just judging based on the extensive review process that they
engage in, the provisional determination, and then final
determination.
Mr. Pearce. In your testimony, you indicate that Dodd-Frank
was created to create a system of supervision which ensured
that if an institution poses risk to the financial system, it
would be regulated, supervised, blah, blah, blah. So you lay
out the requirements. Are Fannie and Freddie supervised under
Dodd-Frank?
Mr. Barr. Fannie and Freddie are currently supervised by
the FHFA under the authority granted through HERA.
Mr. Pearce. Do they come under FSOC?
Mr. Barr. I think that one could make a case that they are
subject to the same rules as anyone else and that the FSOC
should review them.
Mr. Pearce. I am taking from your answer that, no, they
don't, they are not currently included in the scope of work of
the FSOC.
Mr. Barr. No, I wasn't saying that, sir. I was saying that
I think that under the provisions of the Dodd-Frank Act, the
Dodd-Frank Act could provide authorization for FSOC review of
those entities. I have no idea whether or not they are
separately under FSOC review. Obviously, the FHFA is their
current regulator and sits on the FSOC.
Mr. Pearce. If I could take the time back, there are many
people who think they don't come under the, that they are
limited from discussion of those two entities, and definitely
they do have the potential, they are big enough size to where
they might ought to be considered.
Mr. Scalia, you had mentioned in one of your comments that
the access to FSOC data is closely guarded. And so my question
is, what are the risks if--is that data fairly important in a
competitive sense, fairly important to other firms, the data
that is being collected?
Mr. Scalia. I'm sorry, the question is whether designation
is important?
Mr. Pearce. No, no, no, whether the access to the data,
that data that is collected, is that fairly important data in a
competitive sense?
Mr. Scalia. Some of the data can be competitive. However,
much of the data that FSOC compiles and presumably relies upon
in its designation decisions is about markets generally. And
there has been discussion about the appeal process, for
example. Ordinarily in, say, an appeal process where a record
is created before the agency, the parties who are going to be
affected get the chance to see that and to provide their views
so that they are heard by the decision-maker. But that kind of
opportunities is not being provided.
Mr. Pearce. But there is not any data that would be
critical if it is released? That is my question then.
Mr. Scalia. There can be some sensitive data about the
individual companies being considered. Of course, there is no
reason those companies themselves can't see the data about
themselves. But if there were public disclosure of FSOC
proceedings, you would want care about that, but there is
market economic data that is not sensitive and should be
available.
Mr. Pearce. Okay. I just wondered if you had a Snowden-type
release, somebody goes in and takes everything and releases
everything, that is fairly more plausible today than we might
have thought it was a couple of years ago. So, it is just this
accumulation of financial data I always worry about.
Mr. Barr, should the FSOC consider the pension funds? The
estimates are that they are trillions overdrawn. They pull
money in, distribute money out, so they are kind of a bank in
the system. Should the FSOC be looking at pensions?
Mr. Barr. I think the FSOC should look at risks throughout
the financial system. Whether or not that is in furtherance of
some regulatory goal or just to understand risks in the system
I think is not the issue, but having the ability of the FSOC to
look broadly across the financial sector and to see where risks
are arising, I think is important.
Mr. Pearce. Thank you. I yield back, Mr. Chairman.
Mr. Ross [presiding]. Thank you. The gentleman's time has
expired.
The gentleman from Delaware, Mr. Carney, is recognized for
5 minutes.
Mr. Carney. Thank you, Mr. Chairman.
And thank you to all the panelists today. It has been a
very interesting discussion. I would like to return to the
discussion we had led by the gentleman from Alabama, Mr.
Bachus, around whether mutual funds present a systemic risk.
During that conversation, Mr. McNabb described the way mutual
funds were structured, at least Vanguard was structured and
kind of walled off, if you will. And it seemed like there was
considerable disagreement among the panelists about whether
mutual funds do pose those kinds of systemic risks.
And, Mr. Barr, I was wondering what your reaction was to
Mr. McNabb's description? I got the impression that you believe
that mutual funds oppose those systemic risks. Could you
explain to us why you think that is the case?
Mr. Barr. I think that asset managers and banks have
fundamentally different business models and fundamentally
different balance sheets and fundamentally different risks that
they face.
Mr. Carney. So you agree with me?
Mr. Barr. The particular issue that I was addressing was
risk to the system from a particular form of mutual fund, money
market mutual funds that are able to maintain and promise, in
essence, a stable net asset value. And that could--
Mr. Carney. If I may interrupt, because we only have a
limited amount of time, so the SEC is dealing with that issue
in terms of the floating NAV and they have a whole series of
regulations. And I don't know, there has been some discussion
and some disagreement on the committee and in the industry
about that, but that is moving in a separate way. So do you
believe, then, that because those money market funds pose
systemic risk that the other mutual funds should be swept in as
SIFIs as well or the larger entities that have those mutual
funds?
Mr. Barr. I think that the presence of risks in the system
may or may not be appropriately dealt with by designation.
There are lots of other regulatory tools. In the case of money
market mutual funds, I think having the ability to either
impose capital requirements on stable funds or to float the NAV
is an appropriate response that is aside from designation. And
similarly, in the asset management field as a whole, there are
operational risks that if they are of sufficient concern can be
addressed in existing frameworks with or without designation.
So I don't think that everything, the risks in the systems
hinge on designation or not designation. They are about
appropriately tailoring a regulatory response to the risk that
you see.
Mr. Carney. Fair enough.
I would like to move on to the bank designations of SIFI.
There are Members on both sides of the aisle here who have been
looking at how to differentiate those designations beyond the
$50 billion threshold, if you will. In fact, Governor Tarullo,
I think last week at a speech at the Chicago Fed, said that he
believed that we should take another look at that and maybe
firms under $100 billion shouldn't be subject to designation as
an SIFI.
Mr. Smithy, I assume you would agree with that? There is
legislation here many of my colleagues have put forward to
differentiate among banks differently than just a $50 billion
or a $100 billion threshold. Do you have any thoughts on that?
Mr. Smithy. So, again, we would agree that an arbitrary
asset-only threshold would not be appropriate. Simply raising
it to $100 billion, though, I don't think solves the issue. We
would favor a multifaceted approach, which is activity-based,
to determine who is indeed an SIFI based on the range of
practices within the organization and the risks they pose.
Mr. Carney. So the kinds of activities like, for instance,
what would it be? There is a bill I think Mr. Luetkemeyer is
the lead sponsor on, I am looking at my colleague Ms. Sewell, I
believe she is a cosponsor of that bill, that would
differentiate based on activities, how risky they might be. Is
that what you are talking about?
Mr. Smithy. Absolutely. We would expect they would review
whether or not you are engaged in significant international
activities, trading activities, whether or not your institution
is substitutable, and the complexity of your overall
organizational structure.
Mr. Carney. I have 29 seconds left. Does anybody else have
any thoughts on Mr. Tarullo's comment about the $100 billion
threshold? Mr. Atkins?
Mr. Atkins. Yes, I think that I agree with the panelists
here that all of these thresholds are very arbitrary. And so, I
think they are actually counterproductive.
Mr. Carney. So it is not really the thresholds, it is the
activity, in your view?
Mr. Atkins. Right.
Mr. Carney. Everybody seems to be shaking their head.
Mr. Barr, would you agree with that? I think you did.
Mr. Barr. I think that within the existing framework you
can tailor and graduate the extent of regulatory compliance. I
don't think it needs a legislative fix, but I agree that much
more nuance could be in the system than is there now.
Mr. Carney. Thank you very much, each and every one of you.
Mr. Ross. Thank you.
The Chair now recognizes himself for 5 minutes.
Mr. Wallison, it was interesting to read your opening
testimony, and in it you state that FSOC uses the word
``significant'' 47 times in their 12-page statement designating
Prudential as an SIFI. And being a litigator for 25 years, I
know that when we have ambiguities we try to look at the plain
meaning of either the statute or the word to determine what was
intended. Based on your extensive legal background, do you have
any definition for the word ``significant'' that is being used?
Mr. Wallison. No, sir, I have no definition for that.
Mr. Ross. I guess my question is, how can these
organizations that are under review for SIFIs anticipate
whether they are going to be designated as such when we really
can't get our hands around what ``significant'' means? As you
point out, it is very arbitrary.
Mr. Wallison. It is arbitrary, it is not a standard, it is
not something that anyone can use to adjust, no firm can use to
adjust its activities. There is really no information that is
conveyed by that term.
Mr. Ross. So not only in the assessment of the
organization, but then after the assessment or designation, if
you will, other organizations--once Prudential is designated,
then how can another insurance company, if you will, act
accordingly to make sure that they are not so designated? There
is no road map, in other words?
Mr. Wallison. There is no road map. I mentioned before that
the IAIS, which is an international insurance group, had set up
a methodology for making this kind of determination, and they
actually put percentage weights on things. That was a very
valid way to proceed. That doesn't necessarily mean I agree
with it, but it is a valid way to proceed. That was ignored by
the FSB.
Mr. Ross. So organizations, a company today has no real
road map to avoid being designated as an SIFI until it is too
late?
Mr. Wallison. That is right.
Mr. Ross. When we look at the McCarran-Ferguson Act, which
I think has been very good for this country for consumers'
purposes and regulating insurance based on a State-by-State
assessment, don't you foresee that there is going to be some
serious conflicts there once an insurance company may be
designated as an SIFI in trying to maintain certain capital
requirements, either as risk-based capital versus GAAP
accounting? How does that help the consumer?
Mr. Wallison. This is pretty radical, what we are talking
about here, and this is something that has never happened
before, and that is that an entire industry will be bifurcated
between those that are regulated at the Federal level by the
Fed differently.
Mr. Ross. Do they keep a separate set of books?
Mr. Wallison. In many ways, of course. But differently by
the Fed, with different capital requirements from the other
similar although smaller institutions that are regulated at the
State level. This will be a very difficult thing for--
Mr. Ross. And a very expensive thing.
Mr. Wallison. And very expensive.
Mr. Ross. Mr. McNabb, just briefly, with regard to the
Basel-type approach of capital requirements and applying it to
asset managers, aren't we really just not only saying to asset
managers what capital they can or cannot reserve, most likely
they must reserve, but aren't we also just basically telling
them what they can and cannot invest in?
Mr. McNabb. I think that is one of the potential
consequences of prudential regulation of asset managers, is
that we as asset managers could be put in a position of
conflict where we are told for ``safety and soundness reasons''
to either invest in something or not invest in something when
it is not in the best interests of the shareholders or in the
prospectus that we have delivered to the shareholders.
Mr. Ross. And don't you foresee that leading to a new cause
of action? If your fiduciary responsibility is to your clients,
and now we have this regulatory arm telling you what you can
and cannot do, and basically who is your obligation to? I guess
what I foresee here is, is that once asset managers are brought
under this tent, I foresee in some of the creative ways a new
cause of action being created that would lead to litigation,
and then greatly increase that $108,000 assessment that now is
going to be placed over the life of the investment, according
to Mr. Eakin.
Mr. McNabb. It is a very large concern.
Mr. Ross. One last thing, I understand that there is a
genuine relationship between risk and return, and they are
directly related. The higher the risk, the greater the return.
But aren't we, what we are trying to do now is to eliminate any
and all risk and as a result lower the return? If we are going
to lower the return, how do we anticipate for retirement
purposes and, more importantly, addressed for student loans,
which is right now the largest liability that this country has?
Mr. McNabb. Mr. Chairman, I think you make a good point in
that there is a lot of confusion between what I would call
idiosyncratic risk, which is the individual risk of a single
fund or a single entity, versus systemic risk, and I think to
other panelists' points earlier, there has not been a clear
definition of what systemic really means versus what we all
know is idiosyncratic today.
Mr. Ross. Thank you. I see my time has expired.
I now recognize the young lady from Alabama, Ms. Sewell,
for 5 minutes.
Ms. Sewell. Thank you, Mr. Chairman.
I want to thank all of our panelists for a very interesting
discussion today.
I wanted to address my questions to Mr. Smithy. Can you
talk to me a little bit about the difference between--in your
testimony you talked about a business model of regional banks
versus your larger peers, and really making the case that
regional banks should be treated differently. Could you
elaborate a little bit on that model?
Mr. Smithy. Absolutely. So as I stated, we are traditional
lenders. We focus primarily on smaller to medium-sized markets,
whereas some of our larger bank competitors are in the larger
metro markets, would focus on larger companies. We are focusing
on small businesses and medium-sized businesses, traditional
lending products, and traditional deposit products as well. We
are not engaged in complex trading activities, we don't make
markets and securities, and we don't have meaningful
interconnections with other financial firms, which I think is a
key differentiator between us and the larger banks.
Ms. Sewell. What about the supervision that you currently
have? If you are not designated as systemic, don't you feel
that the current supervision model that you are operating under
would prevent regional banks from being sort of swept into the
same systemic risks?
Mr. Smithy. Assuming we would go through an evaluative
process such as what is presented in the Luetkemeyer bill, even
if we were deemed not systemic, the regulators still have a
suite of processes that they put us through, annual stress
test, required capital plans, as well as on-site reviews, along
with the Basel 3 capital and liquidity rules, that we think
would be sufficient for regulation of regional banks in the
range of practices in which we are engaged.
Ms. Sewell. How do you think the regulators would deal with
a regional bank failure in such that compared to sort of what
Dodd-Frank would make you do if you were a systemic
institution?
Mr. Smithy. As you know, the regional banks have recently
submitted, at the end of last year, a resolution plan which we
think will lay out or will suggest that regional banks are
resolvable under the traditional bankruptcy framework, either
in whole or in part. I think clearly there is a range of sizes
we are talking about here within the coalition. We think that
all of the banks' business models within the coalition are
fairly homogenous, and so therefore again can be either
resolvable in whole in a normal purchase situation or in part
and absorbed into competitors across their footprints.
Ms. Sewell. Great.
Mr. McNabb, I wanted to ask you how you thought the asset
managers being designated as SIFIs would affect investors? We
have talked a lot about your business model and how it affects
asset managers, but what about investors?
Mr. McNabb. I think, again, we don't know the exact
remedies being designated, but if you look at what has been
suggested, costs for investors for those in designated firms or
designated funds would go up. And so, again, our estimate was a
quadrupling of fees in a couple of our most basic funds. That
is going to vary, obviously, firm to firm.
I think you are also going to see a situation, though,
where the competitive landscape is altered. So if you were to
look at the FSB's designation process or at least what they
suggested, they named 14 U.S. funds, which comprise roughly 1
percent of the world's market, as being systemically important.
And if you are an investor you might ask yourselves, why would
I invest in one of those funds when there is a like product
where I am not going to be designated and I am not going to
have to pay these additional fees and possible resolution costs
and so forth?
Ms. Sewell. I know that mutual funds are currently subject
to comprehensive regulations that serve both to protect the
shareholders as well as to reduce the potential for systemic
risks. For example, funds have strict limits on your leverage
and diversification requirements. Can you discuss how these
regulations distinguish mutual funds from other financial
institutions and the impact their potential would have on posed
systemic risks.
Mr. McNabb. Yes. So I think you hit on actually some of the
most important points. Transparency is very important and funds
are valued every day, so an investor knows what his or her
value of the portfolio is. There is little to no leverage in
all funds. There are extremely clear reporting requirements and
transparency to the end investor. So when you add that up, you
have a very heavily regulated product that is really very low
risk from a systemic standpoint, not to say that there aren't
idiosyncratic risks within each individual fund.
Chairman Hensarling. The time of the gentlelady has
expired.
The Chair now recognizes the gentleman from Kentucky, Mr.
Barr, for 5 minutes.
Mr. Barr of Kentucky. Thank you, Mr. Chairman.
Mr. Scalia, in your written testimony, and in your verbal
testimony, you made the point that FSOC's regulations and
interpretive guidance have done little to give potentially
regulated parties adequate notice of the legal standards that
will be applied to them and whether, in view of those
standards, they are likely to be designated systemically
important, and what changes that they could make in their
structure operations so that they are not so designated. Short
of abolishing FSOC, what policy recommendations would you offer
to Congress to either more clearly define FSOC's standards that
they use or what changes could we make to FSOC to provide
regulated parties more notice, more concrete notice?
Mr. Scalia. I think that deliberations such as this are a
valuable step forward. One hopes that FSOC's members are paying
attention to the discussion today and will take account of
those things.
The Dodd-Frank Act itself requires FSOC to consider other
risk-related factors beyond those that are enumerated in the
statute, and one of those factors plainly is the risk to the
company and its customers and shareholders of designation. FSOC
hasn't thought about that yet. So I think that much of what
would be helpful is in the statute.
I did want to briefly talk about the Prudential decision,
and there were questions asked earlier of Mr. Barr regarding
Prudential's decision not to appeal. There are, as actually
Professor Barr I think quite fairly said, a number of different
reasons that a company would decide not to take the government
to court. That is a big step. But the question shouldn't merely
be, well, what opportunity do you have to go to court when the
government has made a serious mistake and violated your rights?
The mere fact that the government has made a serious mistake
and violated your rights is troubling enough. Even when you
decide not to seek government recourse, we have this body, as
well as the courts, to oversee what agencies are doing, and I
think that is an important dynamic regardless of the decision
of an individual company not to take the government to court.
Mr. Barr of Kentucky. As an administrative law
practitioner, what would be helpful in terms of additional
direction from Congress in terms of how FSOC operates?
Mr. Scalia. I think that the statute as written should be
one that FSOC could administer to give much greater respect to
participating companies' rights than it gives currently. But
that said, I think a significant improvement would be if FSOC
considered companies on a broader sort of industry-wide type
basis rather than singling them out one by one. Now, I don't
think that the statute has to be read to require singling them
out one by one, but that is what it is doing, and I think one
change to be considered is that.
There is proposed legislation to increase transparency.
That could be valuable. Perhaps most important, when you look,
for example, at both insurance companies and mutual funds, is
the problem of FSOC designation resulting in the imposition of
bank-based capital standards, which is what Fed Members have
indicated necessarily follows. There is legislation pending
that would make it clear that is not required, and I think that
would be an important change, too.
Mr. Barr of Kentucky. I think the fact that former
Congressman Frank, for whom the Act was named, said that it was
not his intent that asset managers be designated as SIFIs says
a lot about the designation process.
And as a segue, just a final question to Mr. McNabb.
Obviously it is your position that the application of bank-like
regulation of mutual funds would not limit systemic risk, but
would obviously disrupt capital markets and increase costs for
your investors. What is your amplified opinion about what this
would do not only to your investors, but to the capital markets
and capital formation and the ability of retail investors to
provide liquidity to our commercial system?
Mr. McNabb. That is a very hard question to completely
speculate on, but higher costs, if the cost of capital goes up
dramatically--and the mutual funds are roughly 25 percent of
the U.S. equity market, so it is a very important source of
funding--if that cost of capital goes up dramatically, then by
definition, you are going to have slower growth. And if we have
slower growth, it is going to create less jobs and so forth.
Mr. Barr of Kentucky. Thank you. I yield back.
Chairman Hensarling. The time of the gentleman has expired.
The Chair now recognizes the gentleman from Illinois, Mr.
Foster, for 5 minutes.
Mr. Foster. Thank you, Mr. Chairman.
And thank you to all the witnesses.
It seems to me that the SIFI designation process in
principle has the opportunity to take risk out of our system by
negotiating the business model for a firm that is under
consideration for SIFI designation. So my question, I guess to
Mr. Scalia, if you could discuss the actual process that the
analytical staff at the FSOC play in the review and designation
process, and specifically with respect to the reports that the
staff at each agency produces for the voting member and how
important the meetings are, and is there a to and fro between
the analytical staff from each Council member and the companies
under review?
Mr. Scalia. I will do my best to describe that process,
although part of the challenge is that it is opaque. But the
essential process is that a company is told that it is under
consideration after a point, is required to submit information,
and may submit additional information, and then has
opportunities to meet with the staff to make presentations and
answer their questions. However, what is not known is what
additional information and reports the staff and the members
may have access to. Those aren't shared with the company that
is under consideration until at earliest when there is what is
called a proposed designation decision.
Now, once there is a proposed designation decision, a
written explanation of some sort is provided to the company
which can take an appeal which has been described. But here is
what is really unusual. The FSOC members make the proposed
designation, and then internally at FSOC, who do you appeal to?
The same people. I am not familiar with another legal process
like that where a group of people makes a decision against you,
and you get to appeal to them to try to persuade them to change
their minds. That is not really an appeal. I think at that
stage, too, there is a real question of the extent to which the
company has access to the data in the reports that FSOC is
relying upon. Ordinarily, that would be provided.
Mr. Foster. So you wouldn't really characterize it as being
a negotiation where the business model could be adjusted. And
what I am fishing for is whether potentially some future AIG,
they could have said, look, if you stay away from securities
lending, stay away from credit default swaps, you are going to
maintain a lower level of SIFI designation. But that sort of
negotiation, to your knowledge, doesn't really happen here?
Mr. Scalia. I am not aware that it has occurred. And this
relates in part to the question about clear standards that has
been discussed earlier. If there were clear standards, then
companies would be able to look at how they are currently doing
business and saying, oh, if I change these couple of things,
then I wouldn't be supervised by the Fed and have all the added
costs for my customers and shareholders. But that opportunity
is not present now.
Mr. Foster. Now, I sense a lot of enthusiasm from the panel
for gradations in oversight and SIFI designation, that having
it be an approximately binary thing makes it uncomfortable in a
number of ways. And I accept Professor Barr's point that there,
in fact, are different levels of oversight depending on the
exact nature of the company.
But my question is, is there a problem with--there is a
bailout mechanism for assessing industry fees to other SIFIs if
one of them has to be bailed out, and so is this adequately
transparent? I think, when was it, Long-Term Capital had to be
bailed out, there was an assessment after the fact of I think
14 different financial services companies chosen somehow, which
I think was probably not a very transparent operation, but I
was wondering is there a view that there is a lack of
transparency for a future assessment when that mechanism is
called into play? Anyone?
Mr. Barr. Let me just take a first stab. The FDIC is
authorized under the statute, required under the statute to
provide for the assessment schedule, and so there is a process
under which people can comment, provide notice and comment,
provide input into that. And so the basic rules of the game I
think are able to be reasonably established in advance. The
caveat to that is, of course, you don't know in advance whether
a particular firm will be subject to resolution, whether that
firm will be resolved with the assets that are available to the
firm or the FDIC would be required to borrow, and if it
borrowed, what that amount would be.
Mr. Atkins. I think that is the problem of Section 210(o)
of Dodd-Frank where it gives the FDIC huge discretion in this,
in the future. And so folks, if they go down the line to
designate asset managers, you will have real investors, if they
have to pony up capital, then subsidizing the too-big-to-fail
banks or whichever institutions fail.
Mr. Foster. Which is one of the reasons that companies are
kicking and screaming to not be designated because it makes an
unknown potential burden on them.
Mr. Atkins. And investors are kicking and screaming.
Mr. Foster. Right, right. Whereas, a multitiered
designation might avoid some of that.
Mr. Atkins. And, in fact, one of the problems is, I think,
the FSOC has flouted Congress, because Congress in Title I of
Dodd-Frank told the FSOC to come up with parameters for this
designation process. FSOC basically regurgitated the statute in
its rule.
Chairman Hensarling. The time of the gentleman has expired.
The Chair now recognizes the gentleman from North Carolina,
Mr. Pittenger, for 5 minutes.
Mr. Pittenger. Thank you, Mr. Chairman.
And I thank you gentlemen for being here today. You have
discussed, I know, the heightened prudential standards that we
have on insurance companies, but what do you think will happen
5 or 10 years down the road? Give me your perspective of
applying these bank-like risk capital requirements to insurance
companies. Could we start with Mr. Wallison?
Mr. Wallison. One of the problems here, of course, is that
we don't have any idea what kinds of standards are going to be
imposed eventually by the Fed. The Fed will do the imposing and
they have not indicated yet, first of all, whether they are
actually bound to do that. They say they are, but we don't know
what they mean by that. And then, secondly, after a period of 5
or 10 years, what we might find, and this would be the most
troubling thing, is that the ones that are subject to these
bank-like capital standards are failing as a result of the fact
that they are subject to standards that don't fit with the way
an insurance company works.
And so, we then have these very large financial
institutions that are being driven out of business by their
regulatory process. That should be unacceptable. And one of the
reasons we should stop this SIFI process is to make sure that
the FSOC itself knows what the Fed is going to do when it gets
hold of an insurance company or an asset manager, for example.
Mr. Pittenger. Mr. Scalia, would you like to comment on
that?
Mr. Scalia. Just to add to that, that is a central
question, and it is one FSOC itself has never asked, much less
answered during the designation process, what will result once
we designate this company as a consequence of the new
regulatory requirements. They haven't been determined, but the
Fed has indicated they will be bank standards.
The concerns I think are a couplefold. One is the
competitive burden, which Mr. Wallison has talked about. It is
so extraordinary to take as broad an industry as, say,
insurance or mutual funds and pick three or four or five
companies in this enormous industry and only treat them to a
different regulatory set of requirements. I have not seen that
done elsewhere. I believe there is also risk that bank-based
standards will just inaccurately reflect the real risk on the
books of an insurance company or mutual fund, overstating that
risk sometimes, potentially understating sometimes, not
providing accurate read back to investors and regulators the
way that standards designed for insurance companies already do.
Mr. Pittenger. Thank you.
We have a diverse economy that I think we all agree is
better served by a very diverse financial set of institutions.
Are you concerned with the shrinking number of financial
institutions? I know we have lost, I think, 1,700 banks in the
last couple of years. Do you think that our policies are
driving this trend? What would you do to mitigate that? Do you
think it makes sense to regulate large internationally active
money centers the same way that you are going to regulate
smaller banks?
Mr. Smithy from Regions?
Mr. Smithy. Thank you. So, no, as we have stated, we think
it is inappropriate to have the same regulatory framework and
the same standards for banks of all sizes, and in fact just
establishing an asset-only threshold does not get at the heart
of the inherent risk of the banks. We are more in favor of
having regulation that is tailored to the specific risks of the
banks. So we would not think that is appropriate.
Mr. Pittenger. Mr. Atkins?
Mr. Atkins. Yes. I think part of the problem that we have
with respect to the banks in particular is the huge power of
bank examiners and the bank regulators in a very arbitrary and
capricious way to deal with banks in their regulatory realm. So
I think that is what a lot of us--I was a Commissioner at the
Securities and Exchange Commission where things tend to be more
transparent, or hopefully so, than as compared to the banking
side--I think that is what we are concerned about with respect
to this potential designation process.
Mr. Pittenger. Mr. Wallison?
Mr. Wallison. In my prepared testimony, Congressman, I have
a chart which shows that the capital markets and securities
business has far outcompeted the banks in financing business.
And one of the reasons they are doing that is that the banks
are heavily regulated and very expensively regulated so that,
as we just heard, more people are involved in the business of
compliance than are actually making loans. That is a very
troublesome thing and one of the reasons why the banks cannot
provide the kind of financing that is much more efficiently
provided by the capital markets.
Mr. Pittenger. It is troubling when the only jobs you
create are compliance officers.
Thank you. I yield back my time.
Chairman Hensarling. The Chair now recognizes the gentleman
from Illinois, Mr. Hultgren, for 5 minutes.
Mr. Hultgren. Thank you, Mr. Chairman, and I am banking on
the concept that the last shall be first one day.
First, I want to address this to Professor Barr. Earlier, I
know you said to Mr. Bachus that you think congressional
oversight of FSOC would jeopardize its ``independence'' and
therefore--
Mr. Barr. Could I just correct that?
Mr. Hultgren. First of all, I disagree with that concept. I
wondered if you would extend that rationale to other financial
regulators. Should we stop all oversight of the Fed, the SEC,
the OCC? Why should FSOC be beyond accountability to my
constituents?
Mr. Barr. Oh, I completely agree that it should be subject
to full and complete congressional oversight. My response to
Mr. Bachus was to his suggestion about whether a Member of
Congress should participate in FSOC meetings. And my comment
was that participation by Members of Congress in FSOC meetings
would undermine Congress' independence in exercising exactly
the kind of oversight that you are doing today and that I think
is absolutely critical to a functioning democracy. So I am 100
percent in favor of the oversight you are exercising on the
FSOC and on the other financial regulatory agencies.
Mr. Hultgren. I appreciate you clearing that up. So you do
support accountability and transparency and oversight there.
Let me get on to some other things because I have some
other questions I want to ask here quickly. I know throughout
the hearing today we have discussed FSOC's SIFI designation
authority, which lets the FSOC impose a costly regulatory
regime upon certain financial institutions. Unfortunately, I
see that this largely unchecked authority will end up hurting
Main Street instead of protecting it because it imposes
unnecessary regulatory costs upon institutions that really pose
no systemic risk to our financial system.
I want to ask about the structure of the FSOC itself and if
it requires regulators to rule on topics in which they really
have no expertise. One of the reasons that Congress delegates
the task of regulation to independent regulatory agencies is
that we expect the agencies to use their expertise and
experience to tailor regulations that are effective and
appropriate to meet specific needs without being unduly
burdensome. I wonder, is the FSOC structure consistent with
this expectation and does the FSOC structure give appropriate
deference to experience and expertise?
Maybe I will just start with Mr. Wallison, if you have a
thought on that?
Mr. Wallison. I think that the Prudential case shows
precisely the question you are asking is a problem. The two
members of the FSOC who were insurance specialists and experts
and are not employees of the Treasury Department dissented from
the decision in the Prudential case, but it was voted
overwhelmingly to designate Prudential. And who voted for that?
It was bank regulators and it was regulators of other kinds of
financial institutions, none of whom knew anything about what
regulation of an insurance company would entail. In addition,
they dissented because they thought that the standards that
were imposed for the designation were also wrong. And, again,
nobody paid any attention to them.
So if we are going to have regulators, we want them to be
specialists, we want them to understand the industries they are
regulating fully, and here we have a set of regulators who
can't possibly understand all of the nuances of the individual
industries that come before them.
Mr. Hultgren. I want to try and ask one last question in my
minute left. As everyone knows, last September the Office of
Financial Research released a study on the risks associated
with the asset management industry. This study achieved instant
notoriety here in Washington as it was criticized by almost
everyone. Better Markets, which is not normally thought of as a
bastion of deregulatory zeal, pointed out the inexplicably and
indefensibly poor quality of the work presented in the report.
In particular, most observers believed it largely ignored the
extensive regulation of mutual funds that exist already and
focused on dozens of hypotheticals about remote risks that are
extremely unlikely ever to happen.
My question is, what happens if the FSOC implements the
logic of this flawed study and designates certain asset
managers as SIFIs? Mr. McNabb, I know that this hearing has
focused on how asset managers help everyday Americans. The
problem is that people look at a company like BlackRock, which
has around $4 trillion assets under management, and don't think
that it provides a Main Street service. I wonder if you could
explain why it does?
Mr. McNabb. Far be it from me to talk about one of our
largest competitors, but I will attempt to do the best I can.
Mr. Hultgren. Sorry about that.
Mr. McNabb. BlackRock manages nearly $2 trillion in mutual
funds of that $4 trillion, and those mutual funds, much like
ours or Fidelity's or T. Rowe Price's or any of the other big
firms that you are familiar with, serve Main Street.
Collectively, the mutual fund industry serves 95 million
investors, roughly one out of every two households. BlackRock
also manages very large amounts of pension funds, which benefit
everyday workers.
Mr. Hultgren. My time is pretty much up. And you would say
other companies are in that similar situation of providing that
service to Main Street?
Mr. McNabb. Totally.
Mr. Hultgren. With that, I yield back, Mr. Chairman. Thank
you.
Chairman Hensarling. The time of the gentleman has expired.
There are no other Members present in the queue, so I would
like to thank our witnesses for their testimony today.
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.
This hearing stands adjourned.
[Whereupon, at 1:08 p.m., the hearing was adjourned.]
A P P E N D I X
May 20, 2014
[GRAPHIC] [TIFF OMITTED]