[House Hearing, 116 Congress]
[From the U.S. Government Publishing Office]
PROMOTING FINANCIAL STABILITY:
ASSESSING THREATS TO THE
U.S. FINANCIAL SYSTEM
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON CONSUMER PROTECTION
AND FINANCIAL INSTITUTIONS
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED SIXTEENTH CONGRESS
FIRST SESSION
__________
SEPTEMBER 25, 2019
__________
Printed for the use of the Committee on Financial Services
Serial No. 116-52
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
__________
U.S. GOVERNMENT PUBLISHING OFFICE
42-352 PDF WASHINGTON : 2020
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HOUSE COMMITTEE ON FINANCIAL SERVICES
MAXINE WATERS, California, Chairwoman
CAROLYN B. MALONEY, New York PATRICK McHENRY, North Carolina,
NYDIA M. VELAZQUEZ, New York Ranking Member
BRAD SHERMAN, California PETER T. KING, New York
GREGORY W. MEEKS, New York FRANK D. LUCAS, Oklahoma
WM. LACY CLAY, Missouri BILL POSEY, Florida
DAVID SCOTT, Georgia BLAINE LUETKEMEYER, Missouri
AL GREEN, Texas BILL HUIZENGA, Michigan
EMANUEL CLEAVER, Missouri SEAN P. DUFFY, Wisconsin
ED PERLMUTTER, Colorado STEVE STIVERS, Ohio
JIM A. HIMES, Connecticut ANN WAGNER, Missouri
BILL FOSTER, Illinois ANDY BARR, Kentucky
JOYCE BEATTY, Ohio SCOTT TIPTON, Colorado
DENNY HECK, Washington ROGER WILLIAMS, Texas
JUAN VARGAS, California FRENCH HILL, Arkansas
JOSH GOTTHEIMER, New Jersey TOM EMMER, Minnesota
VICENTE GONZALEZ, Texas LEE M. ZELDIN, New York
AL LAWSON, Florida BARRY LOUDERMILK, Georgia
MICHAEL SAN NICOLAS, Guam ALEXANDER X. MOONEY, West Virginia
RASHIDA TLAIB, Michigan WARREN DAVIDSON, Ohio
KATIE PORTER, California TED BUDD, North Carolina
CINDY AXNE, Iowa DAVID KUSTOFF, Tennessee
SEAN CASTEN, Illinois TREY HOLLINGSWORTH, Indiana
AYANNA PRESSLEY, Massachusetts ANTHONY GONZALEZ, Ohio
BEN McADAMS, Utah JOHN ROSE, Tennessee
ALEXANDRIA OCASIO-CORTEZ, New York BRYAN STEIL, Wisconsin
JENNIFER WEXTON, Virginia LANCE GOODEN, Texas
STEPHEN F. LYNCH, Massachusetts DENVER RIGGLEMAN, Virginia
TULSI GABBARD, Hawaii
ALMA ADAMS, North Carolina
MADELEINE DEAN, Pennsylvania
JESUS ``CHUY'' GARCIA, Illinois
SYLVIA GARCIA, Texas
DEAN PHILLIPS, Minnesota
Charla Ouertatani, Staff Director
Subcommittee on Consumer Protection and Financial Institutions
GREGORY W. MEEKS, New York, Chairman
DAVID SCOTT, Georgia BLAINE LUETKEMEYER, Missouri,
NYDIA M. VELAZQUEZ, New York Ranking Member
WM. LACY CLAY, Missouri FRANK D. LUCAS, Oklahoma
DENNY HECK, Washington BILL POSEY, Florida
BILL FOSTER, Illinois ANDY BARR, Kentucky
AL LAWSON, Florida SCOTT TIPTON, Colorado, Vice
RASHIDA TLAIB, Michigan Ranking Member
KATIE PORTER, California ROGER WILLIAMS, Texas
AYANNA PRESSLEY, Massachusetts BARRY LOUDERMILK, Georgia
BEN McADAMS, Utah TED BUDD, North Carolina
ALEXANDRIA OCASIO-CORTEZ, New York DAVID KUSTOFF, Tennessee
JENNIFER WEXTON, Virginia DENVER RIGGLEMAN, Virginia
C O N T E N T S
----------
Page
Hearing held on:
September 25, 2019........................................... 1
Appendix:
September 25, 2019........................................... 37
WITNESSES
Wednesday, September 25, 2019
Brainard, Hon. Lael, Governor, Board of Governors of the Federal
Reserve System................................................. 5
Falaschetti, Hon. Dino, Director, Office of Financial Research,
U.S. Department of the Treasury................................ 6
APPENDIX
statements:
McHenry, Hon. Patrick........................................ 38
Brainard, Hon. Lael.......................................... 40
Falaschetti, Hon. Dino....................................... 49
Additional Material Submitted for the Record
Meeks, Hon. Gregory W.:
Letter to the Fed, the FDIC, and the OCC from Hon. Maxine
Waters and Hon. Sherrod Brown.............................. 57
Press release from Chairwoman Waters......................... 60
PROMOTING FINANCIAL STABILITY:
ASSESSING THREATS TO THE
U.S. FINANCIAL SYSTEM
----------
Wednesday, September 25, 2019
U.S. House of Representatives,
Subcommittee on Consumer Protection
and Financial Institutions,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 10:07 a.m., in
room 2128, Rayburn House Office Building, Hon. Gregory W. Meeks
[chairman of the subcommittee] presiding.
Members present: Representatives Meeks, Scott, Velazquez,
Heck, Foster, Lawson, Tlaib, Porter, Wexton; Luetkemeyer,
Posey, Barr, Tipton, Williams, Loudermilk, Kustoff, and
Riggleman.
Ex officio present: Representatives Waters and McHenry.
Also present: Representatives Cleaver, and Garcia of
Illinois.
Chairman Meeks. The Subcommittee on Consumer Protection and
Financial Institutions will come to order. Without objection,
the Chair is authorized to declare a recess of the subcommittee
at any time. Also, without objection, members of the full
Financial Services Committee who are not members of this
subcommittee are authorized to participate in today's hearing.
I now recognize myself for 4 minutes to give an opening
statement.
Today's hearing is entitled, ``Promoting Financial
Stability: Assessing Threats to the U.S. Financial System.''
This committee considers many important issues that impact the
lives of American families and households, but I would argue
that no issue cuts across every district, every ZIP code, and
impacts every American like a financial crisis.
While 10 years may seem like a long time ago, it frankly
feels like yesterday when it comes to the financial crisis and
the Great Recession. I was here and recall vividly, in 2008,
when Secretary Paulson came to the House Floor and told us that
we literally had just a few days to save the entire American
economy and financial system from total collapse.
I was here, as Chair of the International Monetary Policy
Subcommittee, and a member of the Conference Committee, when we
drafted the Dodd-Frank Wall Street Reform and Consumer
Protection Act. I know that documentaries and movies have been
made about it, but there is frankly no way to describe or fully
capture the deep, sinking feeling of being told that the
greatest economy in the world is days away from a collapse,
dragging the rest of the world with us.
Today, the U.S. economy is slowing. Global trade is in
turmoil. Chinese growth is stalling. European economies are
slowing, with some entering recession and a hard Brexit poses a
potential shock to global markets. Big sections of Latin
America are in turmoil, oil markets are literally under attack,
and I could go on.
We are entering a period that may prove to be the first
real test of the new regulatory framework put in place
following the financial crisis. I fear that some actors in the
economy, and even in government, suffer from a worrisome form
of amnesia or selective memory. As they say, history may not
repeat itself, but it certainly rhymes.
There are echoes, not just of the last financial crisis,
but of elements of previous crises in the state of the economy
and markets today which cause me great concern. There are also
new emerging threats, and I question whether the
Administration, the Financial Stability Oversight Council
(FSOC), or the Office of Financial Research (OFR) and
regulators are taking seriously enough the potential risk to
the economy. I hope so.
Among those, I would include high equity valuations that
appear well above fundamentals, seizures in short-term funding
markets, leveraged lending that burdens companies with high
debts and creates new complex securitization schemes, and an
economy meant to be the best in 50 years propped up nearly
entirely by consumers while 40 percent of American households
barely make ends meet and can't afford a $400 emergency
expenditure. Also, rapid concentration of the banking sector
and disappearance of community banks and minority banks,
creating expanding banking deserts and exposing a growing share
of the population to predatory actors, and leaving many
financially disenfranchised. Cyber-attacks and data breaches,
and again, I could go on.
So I am here, and we are here today, and I urge the
regulators, FSOC, and, in particular, the Office of Financial
Research, to invest in required resources to monitor, map, and
quantify existing and emerging systemic risk. We owe it to
every American family, worker, and homeowner to take an
intellectually honest approach to monitoring and regulating
markets to prevent the fallout of yet another financial crisis.
The Chair now recognizes the ranking member of the
subcommittee, Mr. Luetkemeyer, for 4 minutes for an opening
statement.
Mr. Luetkemeyer. Thank you, Chairman Meeks. A decade after
the financial crisis, all signs are pointing towards a healthy
U.S. financial system that is vastly safer and more resilient.
According to FDIC Vice Chairman of Supervision Randy Quarles,
every time we go through this analysis we conclude that
financial stability risks are not meaningfully above normal
because there is so much capital in the banking sector.
Financial institutions across the nation are injecting capital
into their communities and supporting American consumers,
homeowners, and business owners through increased lending.
This is not to say that we cannot improve. The stranglehold
of regulatory burdens continues to affect financial
institutions across the nation. The Trump Administration has
been a strong partner in easing overly burdensome regulations,
and together we can do more to free up additional capital. It
is our responsibility, on this committee, to support pro-growth
policies and responsible regulations that ensure the continued
safety and stability of our financial system.
When the CEOs of America's largest banks testified before
this committee in April, they were asked to cite the biggest
threat that their institutions faced. Many identified
cybersecurity as a major threat, with Bank of America CEO Brian
Moynihan going as far as to say thagt we are effectively in a
war on cybersecurity.
At a House Financial Services markup last year, I lamented
that at some point there will be another major breach, and
without a comprehensive solution, our constituents will pay the
price for our inaction. Fast forward a year, and we have seen
numerous data breaches spanning every industry from financial
services to retailers to social media companies.
Data security is a challenging and constantly evolving
issue that, unfortunately, doesn't get the attention it
deserves until there is yet another breach affecting millions
of Americans. We need clear rules of the road surrounding data
security and breach notification across the nation.
Unfortunately, this committee has not had any data security
hearings this year. Current data security notification
standards leave millions woefully unprotected, and the American
people deserve more than a deafening silence on this critical
issue.
In addition to data security, I have been raising alarms
with regard to the threat posed by the Financial Accounting
Standards Board's (FASB's) Current Expected Credit Losses
(CECL) standard. While FASB will vigorously argue that CECL has
been years in the making, members of the Board have also
admitted that there has not been, nor will there be an economic
impact study performed, despite repeated warnings that the
procyclical nature of CECL could exacerbate a downturn.
JPMorgan Chase CEO Jamie Dimon, in this very committee,
went as far as to say that CECL would put smaller institutions
in a position that when a crisis hits, they will virtually have
to stop lending, because putting up those reserves would be too
much at precisely the wrong time.
It is irresponsible for Congress to stand by and allow
short-sighted, hastily implemented standards to threaten the
ability of our financial institutions to continue lending. I
welcome today's witnesses and I look forward to a robust
discussion on how to support continued financial stability in
the United States.
With that, Mr. Chairman, I yield back.
Chairman Meeks. Thank you. The gentleman yields back the
balance of his time.
I now recognize the gentleman from Georgia, Mr. Scott, for
one minute.
Mr. Scott. Thank you very much, Chairman Meeks, and it is
really good to have Governor Brainard and Director Falaschetti
here with us, because this is an incredibly important and
timely hearing. We find ourselves now 10 years out from the
collapse of our financial system. Our economy has come a long
way. I think we have done a good job. The passage of Dodd-Frank
took important steps to expose the cracks in the foundation of
our financial structure and mitigate the damage that was done
by decades of financial recklessness.
Now, as we hear from our top regulatory experts, we must
evaluate not only our efforts to correct past missteps, but we
also must find ways to remain vigilant against new threats to
our great financial stability and our great financial industry.
So I look forward to the insights of my colleagues, and
those of my colleagues on the subcommittee, and from our
distinguished panelists.
Thank you, Mr. Chairman.
Chairman Meeks. The gentleman's time has expired.
I now recognize Mr. Luetkemeyer for a unanimous consent
request.
Mr. Luetkemeyer. Thank you, Mr. Chairman. Ranking Member
McHenry wanted to be here and had a statement that he was going
to read, but in his absence, I will just ask the subcommittee,
without objection, to add it to the record.
Chairman Meeks. Without objection, it is so ordered.
Today, we welcome the testimony of two witnesses.
First, Fed Governor Lael Brainard took office as a member
of the Board of Governors of the Federal Reserve System on June
16, 2014, to fill an unexpired term ending January 31, 2026.
Prior to her appointment to the Board of Governors, Dr.
Brainard served as Under Secretary of the U.S. Department of
the Treasury from 2010 to 2013, and as Counsel to the Secretary
of the Treasury in 2009.
During this time, she was the U.S. representative to the G-
20 finance deputies and the G-7 deputies, and was a member of
the Financial Stability Board. She received the Alexander
Hamilton Award for her service.
Dr. Brainard was also previously assistant and associate
professor of applied economics at the Massachusetts Institute
of Technology's Sloan School of Management. She received a BA
with university honors from Wesleyan University in 1983. She
received an MS and a Ph.D. in economics in 1989 from Harvard
University, where she was awarded the National Science
Foundation fellowship. She is also the recipient of a White
House fellowship.
Welcome, Governor Brainard.
Also testifying is OFR Director Dino Falaschetti. Mr.
Falaschetti was confirmed by the U.S. Senate and sworn in as
Director of the Office of Financial Research in June 2019. He
started his career by leading financial statement audits and
managing at Fortune 100 corporate financial departments.
Subsequently, he served as a professor of law, economics, and
finance, where he leveraged professional experiences in
business, policy, and law with firmly grounded data analytics
to build a top-ranked research program. He earned tenure in
both law and economics, an endowed Chair in finance, and
research appointments at Stanford University and the University
of California at Berkeley.
Prior to joining OFR, he served as the Chief Economist for
the U.S. House Financial Services Committee, so he is really
coming back home. He has also served as a Senior Economist for
the White House Council on Economic Advisors, and contributed
in leadership roles at policy research institutions. He earned
a doctorate degree in economics from Washington University in
St. Louis, an MBA with high honors from the University of
Chicago Booth School of Business, and a bachelor of science
degree with distinction from the Indiana University Kelley
School of Business.
I remind the witnesses that your oral testimony today will
be limited to 5 minutes, and without objection, your written
statements will be made a part of the record.
Governor Brainard, you are now recognized for 5 minutes to
give your oral presentation.
STATEMENT OF THE HONORABLE LAEL BRAINARD, GOVERNOR, BOARD OF
GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Ms. Brainard. Thank you, Chairman Meeks, Ranking Member
Luetkemeyer, and members of the subcommittee. I appreciate the
opportunity to be here today, along with my colleague from OFR,
Dino Falaschetti.
Following the financial crisis, Congress created the FSOC
and assigned financial stability responsibilities to domestic
regulators. The Federal Reserve Board, in turn, created a new
board, the Committee on Financial Stability, which I Chair, and
the Division of Financial Stability, which provides a financial
stability assessment each quarter to the Board and to the
Federal Open Market Committee (FOMC), and I just want to
acknowledge Andreas Lehnert, who has led that Division. We now
publish a Financial Stability Report semi-annually in order to
increase transparency and accountability, and I brought a copy
today.
Because the build-up of financial imbalances in good
economic times has the potential to lead to disruptions in
credit that can amplify a subsequent downturn, we assess
financial vulnerabilities as well as mitigants that build
resilience. Let me briefly run through these.
First, overall household borrowing has come down in recent
years and is now growing more slowly than the economy overall.
While much of the increase before the crisis reflected
borrowing that proved unsustainable, more recently it has been
concentrated among households with stronger credit profiles. In
addition, there has been an increase in student debt in recent
years, which deserves attention.
Second, far-reaching reforms have made the regulated
financial sector more resilient. Insurers appear generally
well-capitalized and broker-dealers have lower leverage. Banks
increased capital buffers following the crisis, although the
ratio of capital relative to risk assets at the largest banks
has moved down somewhat as payouts have exceeded earnings over
the past couple of years. Financial reforms have also
importantly reduced funding risks. Large banks subject to
liquidity regulation have stronger liquidity buffers and are
less reliant on unstable short-term wholesale funding.
There are, however, two areas that I am monitoring closely.
First, a range of asset prices are high relative to historical
benchmarks. Relative to Treasury yields, spreads on high-yield
corporate bonds remain somewhat narrow, relative to historical
norms. Spreads on leveraged loans remain in the bottom half of
their range since the crisis, and capitalization rates on
commercial real estate have been low.
Declines in those valuations could make it more challenging
for firms to obtain or extend financing, which could be
amplified by high levels of risky corporate debt, and that is
the second area of note. Business borrowing has risen more
rapidly than GDP for much of the current expansion and now sits
near its historical peak. It appears that firms with high
leverage, high interest expense ratios, and low earnings and
cash holdings have been increasing their debt loads the most.
While the share of high-yield bonds rated ``deep junk'' has
stayed well below the financial crisis peak within the
investment-grade segment, half of those corporate bonds are now
rated at the lowest level, and that is a near record.
Widespread downgrades of those low-rated investment-grade bonds
to speculative-grade ratings could induce some investors to
sell them rapidly, and this bears watching, as total assets
under management and bond mutual funds have more than doubled
in the past decade and they now hold about one-tenth of the
corporate bond market.
In addition, net issuance of leveraged loans grew rapidly
last year. The total is now over a trillion, although the pace
of issuance has slowed as the interest rate environment has
shifted. Covenants issued for the loans issued in the last few
years have weakened notably, and they often include terms that
increase opacity and risk. A substantial share of those are
packaged in CLOs and many large banks originate leveraged loans
with an intent to distribute. While the direct exposures of the
banking system in the form of loan portfolios and warehousing
exposures are being monitored, there are indirect exposures,
including through investments and CLOs and credit lines, and,
of course, non-bank exposures are hard to monitor.
Overall, corporate credit conditions have been favorable.
However, history points to the risk that excesses in corporate
debt markets could amplify negative shock.
That brings me to the final point, recognizing that we must
be especially vigilant to fortify financial system resilience
in good times. Our toolkit includes a countercyclical capital
buffer (CCyB) that is intended to be on top of strong through
the cycle requirements. The CCyB is simple, predictable, and
slow-moving. It applies equally across all large banks. The
criteria for implementing it were released in September 2016.
The Board voted to set it at zero earlier this year, but many
other jurisdictions have raised their countercyclical buffers
above zero.
Thank you. I look forward to any questions.
[The prepared statement of Governor Brainard can be found
on page 40 of the appendix.]
Chairman Meeks. I now yield 5 minutes to Mr. Falaschetti
for his oral testimony.
STATEMENT OF THE HONORABLE DINO FALASCHETTI, DIRECTOR, OFFICE
OF FINANCIAL RESEARCH, U.S. DEPARTMENT OF THE TREASURY
Mr. Falaschetti. Chairman Meeks, Ranking Member
Luetkemeyer, and members of the subcommittee, thank you for
inviting my testimony on behalf of our Office of Financial
Research (OFR). I am honored to appear with the Governor and
look forward to discussing the productive role that OFR plays
in our government's financial stability framework.
Throughout my career, I have enjoyed developing firmly
grounded perspective on important financial and economic
matters, and I have especially enjoyed doing so through public
service on the President's Council of Economic Advisors, this
committee, and now, as Director of our office.
Before starting my testimony, I want to recognize our
staff. Prior to my appointment, our office extensively
reexamined its mission, culture, and structure. Throughout, our
staff never let go of a mission that they and I support. I am
grateful to each and every one of you for your dedicated
service as individuals and a team. I begin my testimony today
by acknowledging you all. My priority in commitment to them is
a safe, collegial, and fulfilling workplace so that they can
thrive personally and professionally by furthering our
important mission of serving FSOC and its member agencies.
When it comes to economic opportunity, our United States
stands as the world's leader. A resilient financial sector is
vital to every American. While the great financial crisis is
sometimes characterized as a perfect storm, credible warnings
were available. For example, the President's Economic Report in
2006 highlighted the importance of financial services for
upward mobility. In doing so, it also called on regulators to
``mitigate the likelihood of systemic events.'' Despite their
accessibility and timeliness, such warnings could not mitigate,
let alone stop the crisis that was to come.
Reflecting on this history, a prominent economist rejected
calls for increased regulation of an already heavily regulated
sector. Instead, he highlighted opportunities for data analysis
and monitors to increase transparency for inter-institution
exposures and concentrations of risk.
OFR was established to increase the likelihood that future
warnings will be more credible when grounded on economic
fundamentals and informed by high-quality data and careful
research. OFR supports FSOC and its member agencies with data
and research services that work toward this important end.
Our office's latest Annual Report to Congress was published
in November 2018. It saw financial stability risks in the
medium range while indicating relatively high market and
cybersecurity risks. Credit risk appeared moderate overall,
with increased risk from leveraged lending tempered somewhat by
lower risk from consumer credit. Risk from solvency and
leverage remain low, in general, while funding and liquidity
risk was low overall. However, these risks can change quickly.
Cybersecurity risk continued to warrant attention. Our
office first discussed risks from cybersecurity in the
inaugural 2012 annual report. Our 2018 annual report also
highlights how network analysis could provide increased
transparency for cyber risks.
Our office expects publication of its 2019 annual report
later this year. That report remains a work in progress so I
cannot speak to details. Based on currently available data,
however, our overall risk assessment will remain in the medium
range.
American economic opportunity is the envy of the world. The
OFR plays an important role in fortifying financial stability
for the world's greatest economy. I am honored to lead our
office and proud of our good people who wake up every day to
advance its important mission.
Thank you for your invitation to testify. I look forward to
your questions.
[The prepared statement of Director Falaschetti can be
found on page 49 of the appendix]
Chairman Meeks. Thank you. I now recognize myself for 5
minutes for questions.
Let me start with you, Governor Brainard. The Fed has done
a rapid pivot to cutting rates, just last week, and I asked
this question yesterday to the members of the SEC Commission--
they are intervening aggressively in the repo market, short-
term lending. And I get those echoes, as I talked about in my
opening statement, about, ``I don't ever want to be back where
we were in 2008,'' and Secretary Paulson. And then I look at
what is happening with Brexit and the situation with China
slowing down, et cetera.
You mentioned in your opening one of the key risks you
worry about, and I think I heard ``leveraged lending.'' Would
you also expand on leveraged lending, why that may be a
potential risk, and any other factors that you think we should
be really paying attention to?
Ms. Brainard. Thank you for your question. First of all,
with regard to leveraged lending, we really saw very rapid
increases in leveraged lending over the past several years,
although some of that has slowed as the interest rate
environment has made bond issuance again more attractive.
The thing that is notable, apart from the very large
increase in leveraged loan issuance that we saw, is just that
the covenants on those leveraged loans have weakened quite
notably, relative to what they would have looked like
historically, and there are features that make them less
secure, and more opaque, for some of the investors. Now, they
are being securitized, many of them, in CLO structures.
And so what is important, I think, going forward, is to be
able to have as much visibility as we can into those structures
and who is holding those loans through those structures. We
look at banking system exposures, but, of course, there is a
very large component, which is non-bank, that I think bears
attention.
I don't know if you wanted me to also turn to repo--
Chairman Meeks. Yes, please.
Ms. Brainard. --but I am happy to do that.
Just to take a brief moment to separate how the FOMC looked
at the economy, so with the interest rate decision, the Federal
funds rate decision that was made at the September FOMC
meeting, that was really a traditional kind of monetary policy
lens, where looking at the economy, looking at downside risks
from trade policy uncertainty, in particular, from slowing
growth abroad, in an environment of muted inflation, the
Committee, or at least in my view, was wise to take out some
insurance against downside risks to the economy.
What is separate from that is the pipes of the short-term
money markets, which is really what we are talking about in the
repo markets, and what we saw was that a number of events--
there was a confluence of both increased supply of Treasury
Securities that needed to be funded at the same time as we also
had some of the suppliers of cash in that market withdrawing
because they had large corporate tax payments that they were
taking care of.
So, it was a confluence of factors that led to an imbalance
of supply and demand in the pipes of the system. I would really
say that the New York Fed is very focused. They have been
providing ample operations to relieve those temporary
frictions. But the operations that they undertook were not for
purposes of monetary policy. It was to address those technical
issues in the pipes in the system.
Chairman Meeks. Thank you very much.
Let me ask the Director, I noticed that you had a staff
reduction of more than 43 percent, and a budget cut of 25
percent. So I am really concerned about OFR having the ability
to have the personnel necessary to do what you were charged to
do.
Can you tell us how you are committed to, and how you plan
on rebuilding the OFR team to ensure that it is clearly focused
on the monitoring and mapping and qualifying systemic risk
wherever it might be, so regulators are well-equipped to do
their work?
Mr. Falaschetti. Thank you for your question, Mr. Chairman.
I just lost my nametag, but you know who I am.
We are in the process right now of--and thank you for the
meeting yesterday--our head count right now is in the
neighborhood of 100 employees at our shop. We are building--we
are recruiting vigorously. We are interviewing and we are
retaining the people that we are bringing on. We are making
good progress on that.
In addition, with our staff, I have a mission which is well
on its way to meet with every staff member in our building. I
host lunches twice a week with our staff members. I want to
hear everything that is going on within our organization, and I
think, going forward, as we fill out that team, it will not
only be a larger team but it will be a more collegial and
effective team.
Chairman Meeks. Thank you. My time has expired. I now yield
5 minutes to the ranking member of the subcommittee, Mr.
Luetkemeyer.
Mr. Luetkemeyer. Thank you, Mr. Chairman. Mr. Falaschetti,
you and I had a conversation last week, I believe, with regards
to your ability to do a study that would give us some idea of
the impact of CECL. And I think you indicated to me that you
need to have some sort of directive from one of the members of
the FSOC or FSOC itself, is that correct?
Mr. Falaschetti. That is correct, sir.
Mr. Luetkemeyer. So exactly what is the process to be able
to get a study? In other words, if Governor Brainard asked you
to do that today, would that be sufficient?
Mr. Falaschetti. It is the members of the FSOC who would
make that decision, and they are regularly briefed on issues
like this. But I understand that has not come up in our FSOC
meetings.
Mr. Luetkemeyer. What would the typical study look like?
What are the factors you would examine?
Mr. Falaschetti. On CECL per se?
Mr. Luetkemeyer. Yes. Do you look at the macroeconomic
effect of it? Is that what you do, I assume?
Mr. Falaschetti. Sure. Yes. Whether it is countercyclical,
procyclical, those sorts of issues could come up.
Mr. Luetkemeyer. Have you taken into account the other
industry reports that I have seen that show the amount of money
they are going to have to have, the additional reserves, the
cost that it would incur that would have to be passed on to
consumers? All of that would be part of it, I assume?
Mr. Falaschetti. Cost-benefit analysis would certainly be
in that report, yes.
Mr. Luetkemeyer. Okay. Thank you.
Governor Brainard, I have discussed this issue with every
single member of the Federal Reserve Board. I think I have even
discussed it with you in the past. This is, obviously,
something that is very concerning to me, because of the impact
I think it would have on our economy, on the financial services
industry, and on our consumers, to be able to have access to
affordable home loans. And so, this is really a big deal to me.
You have heard Mr. Falaschetti's concern, and I think you
know enough about CECL to be willing to--would you be willing
to go to your Board members and ask them to do a study for us?
Ms. Brainard. Thank you, Ranking Member Luetkemeyer. First,
I will say that I have heard from many banks that they don't
understand, especially small banks, how CECL might impact them.
Now, of course, CECL is a standard that is put in place by an
independent standard-setting body, so it is really something
that we are simply obligated to accept. It is not something
that we make determinations on.
Mr. Luetkemeyer. But now you are going to have to enforce
it. If you have to enforce a rule that is going to be
detrimental to our economy, to the industry that you oversee,
don't you think you ought to push back on that a little bit?
And before you answer that, let me read you what--I don't
normally put credence in any of these political rags around
here, but this one, as of last Thursday, The Hill, is quoting
Chairman Powell directly. And the Chairman said, in response to
a question, ``The Fed has no role in the formulation of trade
policy, but we do take into account anything that can
materially affect the economy relative to our employment and
inflationary goals.''
When you look at the impact of this, that has direct and
material effects on employment and inflationary goals. You are
not going to consider that?
Ms. Brainard. Just to continue, there have been a number of
quantitative studies that have been undertaken. Of course, we
have looked at those very carefully. They do not conclusively
suggest that there would be a negative impact. That said, I am
not, as you know, a representative to FSOC.
Mr. Luetkemeyer. Yes, but you are on the Board, Governor,
and you have nput. I have files from credit union folks, I have
the testimony from the bankers who were in this committee not
too long ago, of billions and billions of additional dollars
that are going after reserve. Those costs have to be passed on.
That should be a concern.
Ms. Brainard. Absolutely, and to the extent that FSOC wants
to ask OFR to do a study, that is certainly something that--
Mr. Luetkemeyer. Would you be willing to help push for
that?
Ms. Brainard. I would certainly be happy to convey these
concerns to the Chair in his role as our representative to--
Mr. Luetkemeyer. Yesterday, I relayed a story, an analogy
of what is going on here, and the analogy goes like this. A few
months ago, we celebrated the 50th anniversary of putting a man
on the moon. Imagine yourself in a lunar module on top of a
rocket, knowing that the last market, i.e., mark to market,
that was done without a study of cost-benefit analysis, blew up
on the launching pad. And now you are sitting on top of another
rocket called CECL, that has not had a cost-benefit analysis or
a study on it. Would you be willing to light that rocket?
Ms. Brainard. Again, I think it is very important to
understand--
Mr. Luetkemeyer. Would you be willing to light that rocket,
without a study or a cost-benefit analysis, knowing that the
last one just blew up?
Ms. Brainard. I think that there have been a fair amount of
quantitative studies done, and, of course, I am always
interested--
Mr. Luetkemeyer. You are the only one who would be willing
to send that rocket--to light it and let it go. Everybody else,
every regulator I have talked to said, no way. They need to be
sure that it is tested, to be sure that--you are willing to put
the economy at risk without a cost-benefit analysis study, that
this gentleman is ready to do. That is not very responsible,
Governor. Thank you.
Chairman Meeks. The gentleman's time has expired. I now
recognize the gentleman from Georgia, Mr. Scott, for 5 minutes.
Mr. Scott. Thank you, Mr. Chairman. Governor Brainard, let
me start with you. In recent weeks, the Fed has had to take
extraordinary steps to maintain liquidity in short-term debt
markets and repo markets, including the actions of the New York
Fed earlier this week. It injected almost $50 billion for
overnight repurchase agreements, or repo, to relieve funding
pressure in money markets. The last time that this happened was
back in 2008, as you probably know, during the financial
crisis. Why is this happening now?
Ms. Brainard. Thank you for your question. We certainly
recognize that we have important pipes in the short-term money
markets, which the repo market is part of, and we want to make
sure there is ample liquidity so that we don't see these kinds
of frictions. And it is important to understand exactly where
these frictions are arising.
Now, market participants did anticipate that there would be
an increased need for repo.
Mr. Scott. Let me ask you this: What are the risks? That is
what I am after. What are the risks to our financial
institutions that they may become unwilling to lend to each
other, as happened in 2008?
Ms. Brainard. From what our market discussions and surveys
are able to tell, this is a very different episode, a different
set of frictions than in 2007-2008. In 2007-2008, we had
counterparties pulling away from each other because there were
concerns about the underlying quality of collateral and the
creditworthiness of those counterparties. Today, we are in a
different environment, and we believe that what we saw was a
simple imbalance between those who were willing to supply and
those who needed to finance repo. I believe that we have said,
the committee has said that we are operating in an ample
reserves regime, and it may simply be that we are close to the
lowest level of reserves that are necessary for the contact of
monetary policy.
But the kind of intervention that the New York Fed too,
that is a pretty standard open-market operation, and my own
inclination would be to look at mechanisms like allowing the
balance sheet to continue organic growth in order to make sure
there are enough reserves in the system so we don't see those
kinds of frictions.
Mr. Scott. Okay. Now all of this is happening at the same
time that there is an upcoming transition from LIBOR (London
Inter-Bank Offered Rate) to what could be SOFR (Secured
Overnight Financing Rate). I think that this poses one of the
greatest potential disruptions to our financial system ever,
and this is why: uncertainty. It has a large part to play in
how smoothly this transition plays out. We are talking about
$400 trillion on contractors, worldwide, $200 trillion in
contracts here, and this massive change between these benchmark
rates.
And so, we are after a smooth transition in terms of how
this new reference rate will perform, particularly with what we
call these transition legacy contracts. So are you concerned
about this volatility and how it may add to the uncertainty
associated with this rate change? This is a big issue. Can you
explain it to us, and share with me and the audience and C-
SPAN, how serious this issue is?
Ms. Brainard. Thank you. I think the transition away from
the reference rate that was shown to be subject to manipulation
and is becoming increasingly fragile, as fewer participants
provide input into that rate, that transition to a more market-
based rate that is going to be more resilient, and not subject
to manipulation, is a very important transition, and it is a
transition that I think we should all be paying a lot of
attention to, and financial institutions prime among those who
should be paying attention.
Chairman Meeks. Thank you. The gentleman's time has
expired. I now recognize the gentleman from Florida, Mr. Posey,
for 5 minutes.
Mr. Posey. Thank you very much, Mr. Chairman. I appreciate
your and the ranking member's leadership in holding this
hearing today. We are here today to examine the role of our
regulatory community in monitoring and ameliorating the
systemic stability of our financial institutions. I welcome the
witnesses and thank them both for being here today.
The current framework for responding to systemic risk in
our financial system centers on the Financial Stability
Oversight Council's, or FSOC's, as we refer to it, role in
identifying and designating non-bank financial companies as
posing systemic risk. Identifying such a company as posing this
kind of risk makes the company subject to enhanced supervision
by the Federal Reserve Board.
We recall that one of the big interventions during the
financial crisis recently was rescuing the American
International Group (AIG). Assuming FSOC had been in place
prior to the crisis, can you give the committee and the public
a description of how FSOC would have worked to prevent the
outcome we had with AIG?
Governor, you can go first, and then the Director.
Ms. Brainard. I think the intention of the designation--
again, I am not a member of FSOC so I can't speak to the
designation process. But I think the intention certainly of
that designation authority was to be able to take institutions
that were not supervised banks and subject them to consolidated
supervision across all of their activities. And so, of course,
for institutions that had a lot of derivatives exposures that
were not well risk-managed, and that the company was not
prepared to make good on in periods of stress, that kind of
designation authority would have shown the full scope of
activity to the supervisors and put in place resolution
planning, liquidity requirements, and capital buffers against
the full scope of activities, as opposed to the more narrow
pieces that were under regulation.
But again, I am currently not on the FSOC so I can't speak
to the current system.
Mr. Posey. Thank you. Director Falaschetti?
Mr. Falaschetti. Sure, and thank you for your question. The
Council is pursuing an activities-based approach to
designations for non-bank financial determinations, and what
this will do, the benefits that this brings is it will enhance
analytical rigor and transparency in the process that the
Council pursues. Some of the activities, or the
characterizations of these activities are complex or opaque
activities, those conducted without effective risk management
practices, those that are significantly correlated with other
financial products, or either highly correlated or significant
and widespread.
Mr. Posey. I guess, more specifically, how would they have
identified AIG's threat to systemic stability? What metrics
would have disclosed this threat? How would it be different
today?
Mr. Falaschetti. The activities that I outlined here, we
would work through each of those and size up any particular
firm that might be subject to this consideration.
Mr. Posey. So, you think now that FSOC would do the job
that the regulators did not do before?
Mr. Falaschetti. Yes. And again, the transparency and the
accountability of this proposal is what is attractive.
Mr. Posey. Give me an example of how they would identify
derivatives as being dangerous.
Mr. Falaschetti. With this list of the proposed guidance
you have, measure it out. Is it complex? What is the degree of
opaqueness in this market? Is there effective risk management?
Each of these considerations would guide the FSOC.
Mr. Posey. But they should have had those same
considerations before, shouldn't they?
Mr. Falaschetti. They should have, but this wasn't the way
that it used to be implemented, that the conversation went. And
when you designate a firm, one firm, and you have some other
firms in the same sector that--
Chairman Meeks. The gentleman's time has expired. I now
recognize the gentlewoman from New York, Ms. Velazquez, for 5
minutes.
Ms. Velazquez. Thank you, Mr. Chairman. Governor Brainard,
as you know, earlier this summer there was a cybersecurity
breach at Capital One. At the time of the event, Capital One
relied on Amazon Web Services (AWS) for its cloud storage needs
and has continued to rely on AWS, even following the incident.
In its 2018 annual report, the FSOC specifically highlights
the growing reliance of financial institutions on third-party
service providers, like Amazon, as creating risks to the
financial system. Can you explain the risks that are created by
banks' increasing dependence on third-party service providers
for their data storage needs?
Ms. Brainard. Thank you for the question. A lot of
financial institutions, like large institutions that have
tremendous needs for processing data, across the economy,
including government entities, are looking at questions about
how much of their infrastructure, how much of their core
systems versus their software services should they hold in-
house, on-premise, or move to cloud providers? So, this is the
beginning, or the middle of a trend that I think will continue.
What authorities we have, as bank supervisors and
examiners, come to us through the Bank Service Company Act,
which does provide the Federal Financial Institutions
Examination Council (FFIEC), the bank regulators, some ability,
under circumstances where providers are significant providers,
to examine some of the third-party providers.
There is also a lot of work on this issue because of the
concentration of some of the cloud provisions in international
force. So this is also an area that we are looking at in the
Financial Stability Board internationally, but it is certainly
something that we are very focused on.
Ms. Velazquez. So is it fair to say that an event like the
one that occurred at Capital One earlier this summer has the
potential to pose a serious threat to the financial system?
Ms. Brainard. The particulars of that breach have to do
with both the institution as well as its cloud migration. I
think we do recognize that migrating to the cloud mitigates
some risks, and adds other risks, and so we need to hold our
institutions accountable for making that risk assessment in a
very well-informed way, and taking that migration very
seriously.
Ms. Velazquez. Thank you. Director Falaschetti, the OFR's
2018 report identifies cybersecurity as a continuing concern.
Can you explain how the potential impacts of cyber risks are
compounded by banks' own operational practices?
Mr. Falaschetti. Thank you for that question. I would put
the cloud question with cyber risk. What we are really worried
about here are the interconnections. If we have a cyber-attack
on a particular organization, that organization has channels of
transmission of that risk to other organizations. And our
researchers are developing a network analysis that would help
bring transparency to understand, okay, well, if this
particular organization finds itself in difficulty from a cyber
attack, who else is downstream, and share that information with
FSOC to take appropriate action.
Ms. Velazquez. Thank you. This question is for both of you.
While crypto assets remain relatively small, they are growing
fast in size, numbers, adoption, and applications. As you are
both aware, earlier this year we held a hearing on Libra, which
is the cryptocurrency being developed by Facebook and its
association members. What risks to financial stability does the
Libra cryptocurrency pose? Governor, let's start with you.
Ms. Brainard. Thank you. I think the advent of Libra really
sharpened the set of questions that regulators, officials need
to think about in terms of stable coins, their potential
adoption for payments, what does this mean in terms of, if you
are a consumer, your social media platform having information
on payments? Will they keep your data private? Will they keep
it secure?
For regulators such as the Fed, the potential for this to
be across many jurisdictions, and the potential to have very
incomplete regulatory authorities.
Ms. Velazquez. Yes-or-no answer, do you have the regulatory
authority that you need to monitor this?
Chairman Meeks. The gentlelady's time has expired.
Ms. Velazquez. It was to you, Governor.
Chairman Meeks. I now recognize the gentleman from North
Carolina, the ranking member of the full Financial Services
Committee, Mr. McHenry, for 5 minutes.
Mr. McHenry. I appreciate the chairman for yielding.
So, Governor, let's go to this question of cybersecurity.
On balance, a well-regulated migration to the cloud can be a
better decision for financial institutions. Is that correct, in
your view, in the Fed's view?
Ms. Brainard. I think each individual institution is going
to make that assessment. They just need to do it--
Mr. McHenry. No, I am asking for your assessment on it.
Ms. Brainard. It can be.
Mr. McHenry. It can be. Director, is that your view, in
terms of research?
Mr. Falaschetti. I'm sorry. Can you repeat the question?
Mr. McHenry. Never mind. We will just keep moving.
So, Governor, about cyber, currently we don't have any
reportage from the Fed to this committee and policymakers on
the Hill about what your institution is doing to protect itself
from cyber threats. Do you see any reason why the Fed shouldn't
report this information to policymakers on the Hill?
Ms. Brainard. I think this is a critically important issue.
We do, of course, get assessed at the Federal level, like any
other Federal agency. But, of course, we agree this is
critically important.
Mr. McHenry. And you have a strong IG that reviews this
too, so we do get independent reporting.
So about the repo market, back to the chairman's question,
I think there is real interest on both sides of the aisle about
what happened in the repo market. And what you report is very
similar to what I have read in the Financial Times, and in the
Wall Street Journal, so in terms of your outline, it is very
clear.
The question is, what does it mean, and what does it mean
for average, everyday investors? Just distill that.
Ms. Brainard. Because we do have the ability to provide
that liquidity, at moments like this it is a very standard set
of procedures. At the moment, it really doesn't have
implications. But going forward, it does pose questions about
whether reserves in the system do need to be allowed to grow
again, and whether there is that demand for reserves, to make
sure that we don't see this kind of volatility, because it is
very disruptive.
Mr. McHenry. What does it mean, reserves? What does that
effectively mean?
Ms. Brainard. My inclination is we are in an ample-reserve
regime. That is the monetary framework that the committee
adopted. Ample reserves means there are enough reserves in the
system that you don't see this kind of short-term volatility.
So, one of the things it may mean--
Mr. McHenry. So the assumption is, because of ample
reserves, that this shouldn't happen. Okay. This is then the
question for the Fed: How long are we going to continue open-
market operations?
Ms. Brainard. I think for the foreseeable future, the New
York Fed has provided sufficient liquidity, and they have done
it on a term basis, for anticipating needs at quarter ends,
which tend to be periods of higher demand.
Mr. McHenry. Or coming to a quarter end, as well, right? So
this is a quirk that is happening outside of that tighter
timeframe.
Let's move on to China. The assessment here, what we know
from public reporting is that reserve ratio was reduced by 50
basis points. This basically injects $126 billion into Chinese
institutions.
What does that mean? What is your assessment? This
signifies an economic slowdown in China, clearly, and there are
ramifications for that. We are seeing outflows of capital to
the United States in recent weeks, especially. Could such a
slowdown affect the U.S. economy, and how?
Ms. Brainard. China is a really important part of the
global economy. We are in a global economy. Many of our firms
are interacting on international markets. China affects the
economies that it trades with, commodity producers. Exports
from Germany have gone down. So yes, when China slows, it is a
drag on the global economy and it can hurt our producers here.
Mr. McHenry. What is your view on modern monetary theory?
Ms. Brainard. Modern monetary theory really goes to the
fiscal kind of framework that the country operates in, which is
outside of our monetary policy frameworks. I will say--
Mr. McHenry. But the intent with modern monetary theory is
to control inflation through taxation rather than the Federal
Reserve interest rate-setting. So what is your view of modern
monetary theory?
Ms. Brainard. My general sense is we are a well-tested,
effective institutional framework for monetary policy, separate
from fiscal policy. Currently, that has worked well for us over
many decades. And my general assessment is that this is also an
institutional framework that has worked pretty well around the
world.
Mr. McHenry. What is your view of the economy right now? Is
the economy strong?
Ms. Brainard. When you look at the economy, you see strong
consumers. You see a continued, pretty strong labor market,
with payrolls continuing to grow above the pace needed to
absorb new entrants.
Mr. McHenry. Wages growing.
Ms. Brainard. You see wages growing above the rate of
inflation. But you also see business sitting on the sidelines,
CapEx is flattening out a lot of uncertainty out there. And, of
course, you see a global environment, that you alluded to
earlier, which could be a drag on our economy. So we are
watching that very closely. In my own view, it poses downside
risks, and that is why it made sense to soften the path of
monetary policy.
Mr. McHenry. Thank you, Mr. Chairman.
Chairman Meeks. The gentleman's time has expired. I now
recognize the gentleman from Illinois, Mr. Foster, for 5
minutes.
Mr. Foster. Thank you, Mr. Chairman, and thank you to our
witnesses.
Governor Brainard, the Capital One hack was essentially a
failure by, I believe, the firm itself, what is called a server
side request forgery, due to a misconfigured firewall, and not
the cloud provider. And so, this is an example of something
that I think will continue forever. If a company does something
dumb, whether they are in the cloud or not, that is a problem.
There is a second class of things having to do with, if you
are completely dependent on one cloud provider and that cloud
provider goes down. And so my question here is, has the Fed
specifically looked at this risk, and is there a merit to
potentially requiring major financial firms to connect to more
than one cloud provider so they can fail over to the second
one, in the case that one of them goes down? Has that been
looked at, both from a cost point of view and a feasibility
point of view?
Ms. Brainard. Thank you for your question. I think the
principle of resiliency through redundancy is well-established,
particularly for systemic infrastructures. Certainly, there is
work internationally that we are participating in, thinking
about precisely this question that you raise about the ability
to fail over, and I think there are some technologies that are
out there, or developing, that would provide mechanisms for
being able to do so, so that that lock-in is less of a risk.
Mr. Foster. And there is also the possibility of a
completely correlated risk. For example, last year's Spectre
and Meltdown bugs that allowed processors to see into
essentially arbitrary memory locations, called into question
the whole concept of cloud computing and having multiple
processes, potentially from other companies working on the same
processor.
Moreover, that bug, it is my understanding, was applied to
a range of hardware, so that it worked--the bug was applied to
Intel x86 and ARM processors and IBM POWER processors, and
everything. So there was no--even using different hardware did
not protect you from that bug.
And what you saw there was a correlated risk, where one bug
can be uncovered that applies to all cloud hardware as well as
all non-cloud hardware. How do you evaluate that correlated
risk and how do you defend the financial system against it?
Ms. Brainard. I certainly believe there are a variety of
different ways that we could see threats to the system of our
financial institutions, whether they are in the cloud or
whether they are on-premise, or whether they are in their
private cloud. So, it is a constantly evolving, I think, set of
dynamic challenges, and the best that we can do is seek to
understand them ourselves, and--
Mr. Foster. Well, do you believe that the Fed examiners
have enough technical horsepower to identify this kind of risk?
You are talking about very skilled people who could earn big
paychecks elsewhere in industry.
Ms. Brainard. My own perspective has been to fortify our
own internal technical resources, and that is going to be a
continued area of high priority for me.
Mr. Foster. Okay. Let's see. Another completely unrelated
question is, many of your positive comments about financial
stability had to do with the relative quality of debt ratings,
and all of these debt ratings still rely on the issuer-pays
model, which was pointed to by many people as one of the core
failings that led to the financial crisis. And to my belief, it
has not really been solved.
Are there solutions to this that are potentially workable,
that maybe Congress should start thinking about?
Ms. Brainard. It is a good question. I know there are a
variety of initiatives that have been kind of looked at in this
space. There is not one in particular that I would say I would
put my strong support against. But as was true going into the
crisis, we also wouldn't want institutions to be overly reliant
on a set of ratings alone. We want institutions to be making
risk assessments using additional mechanisms.
Mr. Foster. Yes, but even in your comments on financial
stability you were using implicitly the ratings of the debt
instrument.
Ms. Brainard. Obviously, when we do our aggregate
assessments, to some degree we are looking at patterns in the
overall data, so we need public sources of data to do that, but
then we drill down. So to the extent that we have individual or
multiplicity of balance sheets, we do some drilling down, and
we describe that more qualitatively, particularly when it
relies on data sources that are not public.
Mr. Foster. And are you worried about the rebirth of
mortgage-backed securities, which has been the subject of
several--
Chairman Meeks. The gentleman's time has expired.
Mr. Foster. Thank you. I yield back.
Chairman Meeks. I now recognize the gentleman from
Kentucky, Mr. Barr, for 5 minutes.
Mr. Barr. Thank you, Mr. Chairman. And Director Falaschetti
and Governor Brainard, thank you for your service and for your
valuable insights on financial stability today.
I want to drill down a little bit on this issue of
leveraged lending, and I want to draw an important distinction
between credit risk and systemic risk. Credit risk, of course,
is the cost of doing business for investors. There is a
possibility, of course, that a borrower might default. That
possibility is priced into the product, and investors are aware
of potential downsides.
But just because a product is risky does not mean that it
is a contagion that will spread to other parts of the financial
system and bring down our economy. That is what systemic risk.
Leveraged loans are, of course, not without risk, but that is
the idea. Risk is how investors earn returns and how businesses
access credit to finance their operations.
During yesterday's Full Committee hearing, SEC Chairman
Clayton testified that he believes leveraged lending does not
pose a systemic threat. Other regulators, including the
Chairman of the Fed and the Vice Chairman of Supervision, have
made similar statements. However, many of my Democratic
colleagues maintain that leveraged lending poses a systemic
threat to our financial system.
At approximately $1.2 trillion, leveraged loans represent
only about 4 percent of the entire U.S. fixed income market.
That is compared to $15.2 trillion in non-financial business
debt like commercial loans and bonds, $10.3 trillion in
household mortgage debt, $4 trillion in consumer debt, and $1.6
trillion in student loan debt.
Director Falaschetti, can you speak to this distinction
between credit risk and systemic risk, in reference to
leveraged lending, and can you also talk about the features of
CLOs (collateralized loan obligations), namely that these are
long-only, non-mark-to-market, term-financed, actively managed
funds in senior-secured commercial and industrial loans, and
can you speak to whether or not those features of CLOs enhance
financial stability or undermine it?
Mr. Falaschetti. Thank you for the question, and I know you
have done a lot of good work on this particular issue.
Before I was confirmed, the FSOC had this issue before
then. This was in March of 2019, and there was a really nice
presentation during that FSOC meeting. On one side, we had an
OFR economist, and we also had an economist from the Federal
Reserve, and each one of them took different sides of the
balance sheet, which I think is where you are going with this.
On the other side, you are looking at really risky assets,
and if that is the only thing that you are looking at, you are
going to say, ``Hey, you know what? This is a lot of trouble.''
But on the right-hand side, what you heard from this brief to
the FSOC, is exactly what you are alluding to, is that there is
patient capital on the right-hand side, and so patient capital
doesn't run at a sign of smoke and the tiering of the losses
locks people in to mitigate that risk.
Mr. Barr. Governor Brainard, a question for you on this.
With a collateralized loan obligation, the risk of loss is held
mostly by insurance companies, asset management firms, hedge
funds, and other similar non-banks that are better able to
absorb it. If there are larger than expected losses they won't
impair the banking system or banks' critical role in managing
the payment system and credit availability that is crucial for
a healthy economy.
AAA CLOs are empirically risk-free--not low-risk but risk-
free--based on their structure and absence of defaults in the
30-year history of the market. Now, I am just talking about the
AAA tranche here--zero defaults, zero impairments in the 30-
year history of the market. So, it does seem a bit misplaced to
point to AAA CLOs as a source of concern.
Does the Fed agree or disagree that having banks fund loans
indirectly through owning AAA CLO bonds, which have a 35 to 45
percent loss of absorption cushion below them, and have never
been impaired in the 30-year history of the market, is better
and safer for the banking system than having banks fund loans
directly and taking 100 percent of that credit risk?
Ms. Brainard. Thank you. I think you are making very
important distinctions, and, of courses, we do think very much
about individual assets and the credit risk embodied in them
quite differently than we try to track what might happen if a
number of investors behaved the same way under stress
circumstances. And so that is really kind of the spirit of our
financial stability work, to think about what might happen
during very stressed conditions that might lead what looks like
a set of very secure investments, investors to behave in a kind
of run dynamic, in a fire sale dynamic.
For instance, there are a large amount of leveraged loans
sitting in loan funds, and we had a little mini stress test
event back in the fourth quarter of last year. And what we saw
is that there was a lot of redemptions in those funds, which
worked out pretty well. On the other side of that we had a lot
of CLOs picking up those leveraged loans that were coming out
of those structures.
Chairman Meeks. The gentleman's time has expired. I now
recognize the gentleman from Florida, Mr. Lawson, for 5
minutes.
Mr. Lawson. Thank you, good morning, and welcome to the
committee. Thank you, Mr. Chairman, and I thank the ranking
member as well for today's hearing.
My question to both of you is centered around--and it is
important--what impact does a trade war have on the health of
our economy, and what would the long-term effects be on our
financial market?
Mr. Falaschetti. As noted, we addressed this in our 2018,
our most annual report. And there is some uncertainty
surrounding trade policy. That said, our economy continues to
be strong, and our job is really to monitor these kinds of
events on the stability of our financial sector, and that is
continually ongoing in our shop.
Ms. Brainard. Thank you for the question. We, in terms of
our monetary policy assessments of the economy, one of the
factors that I think you will see cropping up most frequently
in the minutes of our meetings, for instance, is that we are
hearing from business contacts all over the country, in all of
our districts, from businesses who are saying that the
uncertainty about the rules of the game on trade are really
leading them to sit by the sidelines. They are rethinking
supply chains, global supply chains, but they are not quite
sure how to reconfigure them. And so we do see it in the
business investment numbers. We do see it in CapEx, in
particular, which has flatlined and looks like it is softening
further.
We have some of our independent research that was recently
released suggesting that trade policy uncertainty itself, just
the uncertainty about what trade policy will look like, does
actually have a material negative impact on the health of the
economy.
And so it is something that I think has been one of those
prominent downside risks that has led the committee to reassess
the path of the economy.
Mr. Lawson. And one of the reasons why I asked that
question is I also sit on the Agriculture Committee, and we
realize all of the problems that we have with a lot of our
farmers, what is going on with China and so forth. And from a
budgetary standpoint, we have been subsidizing the farmers in
this country on a regular basis, either because of natural
disasters or because of the downturn in the economy.
And so I wanted you all to--and I know you probably
confront this from time to time in your deliberation--comment
on what effects this is having on the economy with our
agricultural industry in the United States?
Ms. Brainard. We talk a lot about the pain that is being
felt in the farm economy in the FOMC. Of course, we have a lot
of agricultural represented on our boards of directors at our
reserve banks, and I certainly hear a lot as I travel around
the country, about just how difficult conditions have been.
Trade is clearly a big piece of that picture, but as you know,
for some parts of the country, weather has been a huge factor
as well. So it is something that I think has been prominent in
our discussions.
Mr. Lawson. Are you going to comment, Director?
Mr. Falaschetti. Sure. The OFR has a very narrow remit, and
so with trade, you look at--we have a monitor for market risk,
and that would fall under that market risk monitor. And our
researchers would dig down and consider, okay, well, what are
the growth effects of this issue and how might that impact our
financial sector, and we would communicate that to the FSOC
principals.
Mr. Lawson. Okay. Thank you. Mr. Chairman, I yield back.
Chairman Meeks. The gentleman yields back. I now recognize
the gentleman from Colorado, Mr. Tipton, for 5 minutes.
Mr. Tipton. Thank you, Mr. Chairman. Director Falaschetti,
I wanted to give you an opportunity to talk about some of the
LIBOR transition that has been going on. What is OFR looking
at? What type of plans do you have in terms of some of that
transition to SOFR?
Mr. Falaschetti. Thank you for the question. The LIBOR
transition is, in a lot of people's eyes, a critical risk. I
would put it under contracting risk. You can think of Brexit as
a contracting risk issue as well. If everything works smoothly,
great, but recontracting at such large scales is very
difficult. And if I recall my figures correctly, the notional
value of contracts that are now indexed to LIBOR are an order
of magnitude higher than for SOFR.
So, we have 2 years to pull the switch on this, and people
are developing fallback language, but, as you and I discussed
in your office, my fallback language might not jive with your
fallback language, and so, how long does that process take
place and where does that settle? There is a lot of work to be
done there, and we are monitoring the potential implications
for systemic risk from that issue.
Mr. Tipton. It does create somewhat of a challenge because
some of the LIBOR securities cannot be amended without 100
percent investor consent. That has to be creating some real
challenges for transition.
Mr. Falaschetti. Oh, absolutely.
Mr. Tipton. Did you have a comment on that, Governor?
Ms. Brainard. No. I entirely agree with Director
Falaschetti's comments there. It is a very big issue. The
International Swaps and Derivatives Association (ISDA)
obviously has put out some protocols. The more sophisticated
players in this space are recontracting, but there are a lot of
frictions in doing that, as you say, which creates risk.
Mr. Tipton. Governor Brainard, while I have you there, you
mentioned earlier in your testimony regarding LIBOR, that
financial institutions should be paying attention. Of
particular interest to me are some of our smaller banks, our
regional banks, as well. I am concerned whether or not they are
going to be less prepared, potentially, for that transition. Do
you have any comments?
Ms. Brainard. We always try to provide as much technical
assistance and education as we can through our examiner kind of
interactions with our smaller institutions, recognizing that
they don't have the same kind of resources. And in many cases,
they may not have the same kinds of exposures. But we want to
make sure that they are well-equipped to deal with these
transitions. So, we try to do that through our educational
materials, through examinations, discussions, and, of course,
we do that in conjunction with the other banking agencies,
through the FFIEC.
Mr. Tipton. Great. I appreciate you talking about some of
the collaborative efforts through the other agencies. Another
issue that we have with a lot of our regional banks, and
community banks as well, is the Community Reinvestment Act
(CRA). It is being substantially updated. Do you believe that
modernizing the CRA--do you foresee the Federal Reserve joining
your fellow regulators in terms of that pursuit?
Ms. Brainard. We have been working really diligently with
the OCC and the FDIC, and it would be my preferred outcome that
we all find an approach that is responsive to the comments that
we received on the OCC's ANPR and really does strengthen the
ecosystem around CRA. I wouldn't want to do anything that would
harm that ecosystem, because I think our community banks, our
community development organizations, our large banks, they all
generally are really committed to the CRA and want to see it
improved, but not disrupted in a kind of way that might lead to
uncertainty about their ratings.
Mr. Tipton. I think we can certainly agree, though, that
uncertainty can create some real problems in terms of that
compliance, in terms of some of the reviews that are going to
be going on. Would you agree?
Ms. Brainard. Yes.
Mr. Tipton. Great. I wanted to also follow up just a little
bit, Governor Brainard, if we can, just in terms of the ability
of some of our banks to be well-capitalized. Do you agree with
the Fed report that came out, substantially, at least, the
Federal Reserve Report stating that banks appear well-
positioned to exposures related to leveraged banking?
Ms. Brainard. Are you talking about the supervision report?
Mr. Tipton. Yes.
Chairman Meeks. The gentleman's time has expired. I now
recognize the gentlelady from California, the Chair of the full
Financial Services Committee, Chairwoman Maxine Waters, for 5
minutes.
Chairwoman Waters. Thank you very much, Mr. Chairman. This
is a very, very important hearing that you have organized.
Under the Trump Administration, financial regulators have
been advancing a number of deregulatory proposals rather than
addressing financial stability concerns. For example, the
Financial Stability Oversight Council (FSOC) plans to make it
harder to designate large, non-bank financial companies like
AIG for enhanced oversight. In response, former Fed Chairs
Bernanke and Yellen, along with former Treasury Secretaries
Geithner and Lew warned, ``Though framed as procedural changes,
these amendments amount to a substantial weakening of the post-
crisis reforms. These changes would make it impossible to
prevent the build-up of risk in financial institutions whose
failure would threaten the stability of the system as a
whole.''
Furthermore, additional concerns have been raised about
weakening rules regarding capital, leverage, stress testing,
and living wills for banks. These efforts, in the words of
former Federal Reserve Governor Dan Tarullo, were ``a kind of
low-intensity deregulation consisting of an accumulation of
nine headline-grabbing changes and an opaque relaxation of
supervisory rigor.''
Mr. Chairman, as you know, I have said to some of our
biggest banks and financial institutions that they had a big
win with, I believe it was H.R. 2155. There was gross
deregulation. I asked them, and even warned them, not to come
to the Financial Services Committee seeking other deregulatory
efforts. And what has happened is there has been an end run
around this committee, going straight to the regulators to do
the bidding of those who are all focused on continuing to get
deregulation in any shape or form.
And I am concerned about stress testing and living wills
and capital and all of that. So, this is an opportunity, rather
than ask a question, to say to regulators, don't keep doing
that. Don't keep being used to promote deregulation based on
the fact that this committee has decided that we are going to
do everything that we can to protect consumers, we are going to
do everything that we can to stop the deregulation efforts of
our major institutions in this country that has been a
detriment to the people that we are serving.
So, no matter how they frame it, the Chair is not happy
with what has been going on, and, of course, in the event that
this keeps up, we are going to have to deal with some
legislation that would limit the ability of our deregulatory
agencies to do that.
With that, I yield back the balance of my time.
Chairman Meeks. The gentlelady yields back the balance of
her time. I now recognize the gentleman from Texas, Mr.
Williams, for 5 minutes.
Mr. Williams. Thank you, Mr. Chairman, and before I go into
my questions, I just wanted to confirm something with both of
you. This will be the 20th hearing that I have asked this
question, and so far I have gotten the same answer from every
single witness.
Given both of your positions I assume I know the answer,
but I still must ask, starting with you, Governor Brainard, are
you a capitalist or are you a socialist?
Ms. Brainard. Thank you for your question. I certainly have
viewed markets that are well-regulated, that are competitive,
as providing really important benefits in terms of innovation
and dynamism.
Mr. Williams. Well, are you a capitalist or a socialist?
Ms. Brainard. Again, I would say that markets that are
well-regulated--
Mr. Williams. It is 20 to nothing right now--
Ms. Brainard. --where we have seen strong competition--
Mr. Williams. Okay.
Ms. Brainard. --I certainly have seen important benefits.
Mr. Williams. Are you a capitalist or a socialist?
Ms. Brainard. And--
Mr. Williams. Okay.
Ms. Brainard. --I don't really think--
Mr. Williams. Okay. All right.
Ms. Brainard. --about it in those terms.
Mr. Williams. All right. Director Falaschetti, are you a
capitalist or are you a socialist?
Mr. Falaschetti. Capitalist.
Mr. Williams. Okay. Thank you.
When Dodd-Frank was signed into law it created new agencies
and departments that greatly expanded the reach of the Federal
Government. During the previous Administration, some of these
entities drifted away from their core missions that were
granted to them in Dodd-Frank. While some of the most serious
examples of government overreach have come out of the Consumer
Financial Protection Bureau (CFPB), I am still concerned about
this practice in other areas of the government.
So, Director Falaschetti, can you please tell us the core
mission that was granted to the Office of Financial Research in
Dodd-Frank, and will you commit to working within these granted
perimeters while you are the Director?
Mr. Falaschetti. Absolutely, sir. We have a narrow remit,
and that narrow remit allows us to do very good work. We
collect data to inform the FSOC, and we create research
products to inform FSOC, period. And that narrow remit lets us
be a trusted advisor to the FSOC. We don't have people pulling
us one way and the other way. It is data and research.
Mr. Williams. I know we have touched on this briefly in the
hearing already, but I think it is important to reiterate.
There has been instability in the repo markets for over a week
now. The Fed has injected $278 billion to meet the liquidity
needs of Wall Street. This is the first time that the Fed has
had to intervene in the repo market since 2008.
So, Governor Brainard, what is causing this cash crush in
the short-term interest rate markets, and do you believe this
to be an indicator of future financial instability?
Ms. Brainard. Thanks for the question. I think we are still
making sure that we fully understand whether, in fact, there
are some factors that we have not yet heard about. What we have
heard about is an unexpected mismatch between the supply and
demand, which would suggest that maybe we are in a period where
reserves are more scarce than we intended with our monetary
policy framework being one of ample reserves. And so, among
other things, it may simply suggest that it is time to allow
the balance sheet to start growing again, to supply the amount
of reserves that the short-term funding markets are demanding.
Mr. Williams. In OFR's 2018 annual report, it states that
the migration of IT systems from local servers to the cloud
should be completed by 2019, which will ultimately save $2
million annually, moving forward. I am happy to see these
modernization and cost-saving efforts take place, but I am
always concerned about the cybersecurity implications.
So, Director Falaschetti, can you give us a status update
on this initiative, the benefits you see from the transition,
and how OFR will ensure that the data stored in this new system
is protected from bad actors?
Mr. Falaschetti. Yes, sir. We take cybersecurity very
seriously, and the protection of our data very seriously. We
collect data from our regulators, and we do so, again, with the
goal of providing good research insights to the FSOC. And we
take that data and we provide it to the FSOC.
Every time that we collect a dataset from one of the
regulators, we have to protect that data at the level or higher
than the protection that they give those data.
Mr. Williams. Okay. Thank you, and I yield back.
Chairman Meeks. The gentleman yields back. I now recognize
Chairwoman Waters for a unanimous request.
Chairwoman Waters. Thank you very much, Mr. Chairman. I
would like to enter into the record a letter from myself and
Sherrod Brown, relative to swaps margins, and then a press
statement regarding the FDIC's proposal to eliminate inter-
affiliate swaps. I would appreciate entering these into the
record.
Chairman Meeks. Without objection, it is so ordered.
Chairwoman Waters. Thank you.
Chairman Meeks. I now recognize the gentlewoman from
Virginia, Ms. Wexton, for 5 minutes.
Ms. Wexton. Thank you, Mr. Chairman. Director Falaschetti,
you spoke in your remarks a little bit about the history of the
creation of the OFR. In particular, you said that ``a prominent
economist and former central banker issued calls for increased
regulation of an already heavily regulated sector. Instead, he
focused on opportunities for data analysis and monitors to
increase transparency for inter-institution exposures and
concentrations of risk in the financial system.''
Is that correct?
Mr. Falaschetti. That is correct.
Ms. Wexton. And, thus, OFR was kind of created to advise
the regulators about those risks. Is that correct?
Mr. Falaschetti. That is correct. It was sort of a
prescient call for the services that OFR actually delivers
today.
Ms. Wexton. Okay. And you speak a lot, or some, in your
remarks about personnel and workforce issues, and I appreciate
that, especially at a time when so many in the Administration
are targeting our civil servants. So, I want to dig in a little
bit more on this.
Mr. Falaschetti. Sure.
Ms. Wexton. Under Treasury Secretary Mnuchin, the Office of
Financial Research was downsized significantly. Is that
correct?
Mr. Falaschetti. It was.
Ms. Wexton. Okay. The 2017 budget estimated that OFR would
employ a full-time staff of 255 full-time employees. Is that
correct?
Mr. Falaschetti. I believe--I mean, that sounds right. I
don't know the exact number.
Ms. Wexton. And the 2020 budget estimates OFR will only
employ 145 full-time employees. Does that sound right to you?
Mr. Falaschetti. That is correct.
Ms. Wexton. Okay. So how many current full-time employees
does OFR have at this time?
Mr. Falaschetti. We have about 100 right now, and again,
earlier--I am not sure if you were on the dais yet--I said that
we are vigorously recruiting. As we sit here today, the folks
over at OFR right now are looking for our new IT director.
Ms. Wexton. So that is about a 60 percent reduction from
255 to 100. Is that correct? Doing the math.
Mr. Falaschetti. Okay. I will trust--
Ms. Wexton. It is less than half.
Mr. Falaschetti. It sounds right.
Ms. Wexton. Okay. And I know that this report precedes you,
but I took a look at it and there doesn't seem to be any
justification in here, or any sort of footnoting of why such a
drastic cut was necessary, even from 255 to 145. Can you
explain the rationale behind gutting the OFR in this way, or
reducing the workforce in this way?
Mr. Falaschetti. I cannot; I wasn't there. It was well
before I was confirmed. But I can make this commitment to this
chamber today, is that the way Dodd-Frank works is that the
Director consults with the Treasury Secretary at the end of
each year to re-evaluate what resources we need, how is the
office working, and, you can see in my opening statement that I
am very serious about the good work that our people do in that
building, in making sure that they have everything they need.
I strongly agree with Mr. Meeks. I don't want to see 2008
again. I grew up on the south side of Chicago. The S&L crisis--
I thought that was the worst thing in the world. I don't want
to go through that again. I taught money and banking, and the
S&L crisis blew our undergraduates' heads open on how bad that
was. We don't want to do that again. So I promise that I will
ask for the resources that we need going forward.
Ms. Wexton. OFR is not taxpayer-funded, though, is it?
Mr. Falaschetti. It is not taxpayer-funded. It is funded by
an appropriation, or from the large banks.
Ms. Wexton. So are you committing to this committee--are
you telling us here today that if you anticipate that you will
need additional resources, you will go to the Administration
and advocate vociferously for those resources?
Mr. Falaschetti. Absolutely. We are about 100 strong, as we
sit here today. We are looking to expand to 150. When we get to
150, or when we start approaching 150, I should say--I mean,
145, 150--we will re-evaluate, see where we are, and make that
determination then.
Ms. Wexton. Okay. But as far as the reductions that you
have seen so far, you don't have any analysis or study or
anything like that which would justify the current staffing
level. Is that correct?
Mr. Falaschetti. I am unaware of how the one--again, it was
well before I was confirmed that the 145 number--I wasn't part
of those conversations.
Ms. Wexton. Okay. Thank you very much. I have no further
questions. I will yield back the remainder of my time.
Chairman Meeks. The gentlelady yields back the balance of
her time. I now recognize the gentleman from Georgia, Mr.
Loudermilk, for 5 minutes.
Mr. Loudermilk. Thank you, Mr. Chairman. I do have some
questions I would like to ask, but first of all I want to
follow up on something that my good friend, Mr. Luetkemeyer,
brought up regarding CECL and moving forward with an untested
rule or regulation that could have a significant impact on our
nation, on our banking system, and on our economy. I think it
is imperative that we do some research and studies, and it
seems like, with several that we bring in, it is like banging
your head against a brick wall. I don't understand what is the
problem with looking into this before we launch it, and it
seems like there is a lot of hesitation on that.
Since we have covered CECL, I don't want to go down that
path anymore, but I would hope, Governor Brainard, that you
will encourage Chairman Powell and the FSOC to do exactly what
we are talking about. For some reason, I don't know why, we
want to rush forward with something that is unproven. All we
are asking is, let's do a little bit more research on the
economic impacts of CECL.
With that, I will move on to something that, even though
CECL is important, I still believe that the most dangerous, the
most important issue facing our nation's economic system is
cybersecurity, and it seems to be something that doesn't always
rise to the top of the list of concerns. And because it is a
significant impact on our financial system, or a threat to our
economy, it is a significant threat to every American business,
to our government, to our military, and to every individual.
Mr. Falaschetti, you and I have had a recent conversation,
and you told me that you thought that this is the biggest
threat to our nation's financial system. So could I get your
thoughts on what you think needs to be done to address this
growing cybersecurity risk that we have?
Mr. Falaschetti. Sure, and thank you for the question. I
enjoyed our conversation. You noted that the long history that
we have been studying this issue at the OFR, the first annual
report that we published in 2012, evaluated this risk and put
it at top of mind. Going forward, we are making progress. We
have some really good researchers that look at network
analysis. And so to bring some transparency to, if your
organization is subject to an attack, what other firms are
connected to your organization, and how could that metastasize
into something that could potentially be a systemic risk?
This is a new monitoring tool that we are developing as we
sit here today, and it will really give us a lot more
transparency on the nature and the magnitude of this risk.
Mr. Loudermilk. There are two other elements that I think
are important that don't seem to get a whole lot of attention.
One, as I brought up to the Securities and Exchange Commission
yesterday, in discussing my grave concerns with the
consolidated audit trail, is--basically, I have spent 30 years
in information technology, including Intelligence in the Air
Force, where we closely guarded America's secrets--you don't
have to secure what you don't have. So unless you absolutely
need the data, don't collect it. Don't store it. That is a
concern that I have.
We are in this age where we just want to obtain more data,
and then we are responsible for securing it. And my thought is,
if the government wasn't immune from lawsuits against them for
data breaches, maybe they would think a little differently
about not only obtaining the data but requiring others to
obtain it.
The other part of that, which I would like for you to
briefly comment on is the patchwork of conflicting State data
security breach notifications. This is problematic. It leaves
gaps in the system that those who are seeking to do harm can
exploit. And I think that we need some type of uniform national
standard that is flexible enough to keep up with technology.
Mr. Falaschetti, could you comment briefly on that?
Mr. Falaschetti. On the data security, we don't collect
data to collect data. That is the wrong way to do financial,
or, literally, any research. You have a question that you want
to answer, and then you ask yourself, well, what data could
help me address this question? So, we are very careful about
that process.
Mr. Loudermilk. Thank you.
Chairman Meeks. The gentleman's time has expired. I now
recognize the gentlewoman from Michigan, Ms. Tlaib, for 5
minutes.
Ms. Tlaib. Thank you so much. My district--and I am not
sure what others talked about, but I do want to talk about
specifically my district, which is probably the most polluted
district in the State of Michigan.
We have some of the highest levels of asthma and
respiratory issues among some of our residents, and dozens of
polluting facilities that are hurting residents, like Dr.
Dolores Leonard in my district, and Emma Lockridge, who just
recently testified at a field hearing in my district, just a
couple of weeks ago. She constantly lives in fear that an
explosion or toxic chemical could claim her life. She even went
on to tell us, in committee, that she couldn't sleep without
being interrupted with gagging and coughing, due to the toxic
smell of fumes that enter her home.
Emma is one of countless Americans fighting for their
lives. So the financial institutions that continue to ignore
the lives that they are putting at stake with their fossil fuel
investments while just causing instability to our financial
market is a concern of mine.
Many energy analysts see a significantly negative
performance outlook for the fossil fuel industry in the coming
years, particularly given the past decade of bankruptcies in
the coal industry, as the world transitions to clean energy
sources. Yet, financial institutions continue to invest in
unstable fossil fuel companies that continue to expand their
dirty energy production.
This question is for Dr. Falaschetti, if there was a sudden
urgency to sell off stranded fossil fuel assets, what impact
would that have on our financial system?
Mr. Falaschetti. Taking your assumption, I suspect having
to do something on such a large scale, and so quickly, could
create some risks.
Ms. Tlaib. How would such a sudden urgency impact the
shareholders and clients of financial institutions, which
include pension funds that everyday Americans rely on for their
retirement savings?
Mr. Falaschetti. Right. And again, I am taking your
assumptions, and I haven't really--
Ms. Tlaib. I am not making this stuff up. It is actually
happening.
Mr. Falaschetti. Right. But the assumption that you are
going to have this quick break, if that were to happen, sitting
here today I can't think about how that would not create some
downstream effects.
Ms. Tlaib. Looking for a moment at the coal industry, the
recent example which went from King Coal to widespread
bankruptcy in the span of just a few years as the world
transitioned to alternative and cheaper forms of energy, which
were the financial entities hardest hit? Who took the losses?
Mr. Falaschetti. I'm sorry. Can you repeat that please?
Ms. Tlaib. Looking, for a moment, you know, the King--so
basically when the coal industry, as a recent example, as
they--you saw bankruptcy, obviously, in the industry, who was
hit the most?
Mr. Falaschetti. Right now, I don't know. I would be happy
to work with you and your staff to dig into this.
Ms. Tlaib. Okay. Two questions for Governor Brainard. Most
financial institutions continue to invest heavily in fossil
fuels, as I talked about. Is your agency conducting stress
testing for climate risk?
Ms. Brainard. I think the kinds of valuation impacts that
you are talking about are important ones for us to understand.
I will say that we have a variety of research that is being
undertaken by economists at the Federal Reserve, to think about
what is the long-run impact on our economy from climate change,
what could be the impact on our financial system. There is very
interesting work that is being done internationally. I have
certainly, in conversations with my colleagues at the Bank of
England, who are undertaking a stress test over the next 2
years of their financial systems, to look at climate exposures.
It is something, certainly, that I want to learn about and see
whether it is something that we might want to look at.
And we are actually hosting a conference out at our San
Francisco Federal Reserve Bank in a few weeks on this set of
issue.
Ms. Tlaib. I appreciate that. Thank you so much. This is my
last question and we can follow up, but why are banks and
insurers and other financial institutions in Europe taking more
of an aggressive action on climate change than many of our U.S.
counterparts?
Mr. Falaschetti. In the annual report that I believe that
you have from 2018, we do address the risk to financial systems
from climate.
Ms. Tlaib. Okay. Thank you, Mr. Chairman.
Chairman Meeks. The gentlelady yields back. I now recognize
the gentleman from Virginia, Mr. Riggleman, for 5 minutes.
Mr. Riggleman. Thank you, Mr. Chairman. I appreciate it.
Thank you for calling this hearing today and thank you to both
of our witnesses for being here today.
Dr. Falaschetti, thank you for your service. As the OFR
Director, while it might not be as well-known of an agency as
the Federal Reserve, it is certainly important in maintaining
and improving our robust economy. Thank you for that.
As you are charged with the data collection and analyses
that FSOC uses to make designation decisions, I would say that
it is a job that we in Congress are appreciative that you are
doing. So, thank you for that.
My first question for you is simple: Do you want to see
United States go through another financial crisis?
Mr. Falaschetti. Absolutely not, and I think I mentioned
that before, that you and I are of a similar age. We both
remember the S&L crisis. We thought that was the worst that it
could get, and it got worse still.
Mr. Riggleman. I think you look younger than I do. And
thank you, and I am glad to hear that.
Prior to your appointment, OFR had previously only had one
Director. Is that correct?
Mr. Falaschetti. That is correct. We had a confirmed
Director, and then we had an acting Director in an interim
period.
Mr. Riggleman. Okay. And as I understand it, under previous
leadership, OFR had been criticized for taking a unilateral or
a one-dimensional approach to risk assessment that sometimes
worked counterintuitive to your agency's mission. This was most
explicit in OFR's 2013 Asset Management Report, which was
widely criticized by individuals from varying political
viewpoints as arbitrary, vague, and of little value. And, by
the way, I thank you for the 2018 report you sent me. I started
to read it and you are correct, it is a little bit easier. So,
here we go.
What changes do you think, can you make on your own, and
what changes should Congress work on to ensure that you have
the necessary but appropriate methods to execute your mission?
Mr. Falaschetti. We are subject to the oversight of
Congress. That is why we are sitting here today. In terms of--
I'm sorry--you had a little bit more there and I--
Mr. Riggleman. Right, and what I am talking about is
actually process. What do you think, as far as Congress, do you
have the necessary but appropriate methods to execute your
methods, when you were talking about your analysis, when we
talked a little bit earlier about what you are looking at as
far as oversight. What changes should Congress make for you to
help with methods to execute your mission?
Mr. Falaschetti. I am reluctant to opine on what Congress
should do, having sat on the other side of this dais
previously. I am dedicated, and I know our staff are, to follow
the rules that we are given and the mandates that we are given
here. We will dutifully execute on this.
Mr. Riggleman. And as far as your background, I would like
to just ask you a couple of the background questions, and I
know we went through this before. What things have you done to
make you qualified for this position right now, sir?
Mr. Falaschetti. Sure. I mentioned in my opening statement
the President's 2006 Economic Report. I was at the Council of
Economic Advisors at that time. I co-authored a couple of
chapters in that report, and we were thinking about how
important the financial sector is to everyday Americans and how
systemic risks could really put a big dent into those
opportunities. We raised the flag, but as I mentioned in my
opening statement, there were some really credible warnings
about 2008, and for one reason or another those flags were not
chased down.
Mr. Riggleman. Thank you. And, Governor Brainard, I also
want to thank you for your amazing transparency, coming to see
me and talking to me. You know where I stand on some things, so
I do appreciate everything that you are doing.
I had some questions here and I want to talk about
ubiquity. And there was something that I had read, and I do
read a lot, talking about that the Board--and we are talking
about the Fed Board--and we are going to talk about faster
payments quickly, and the FedNow service, and as that were a
private sector service.
In the November 2018 FRB notice, you stated that it is
possible that the Reserve Bank entry could add to market
fragmentation and lower the prospects for ubiquitous, faster
payments in the United States, especially in the short run. I
know a lot of this is a conversation based on what we
continued, and I know we only have 20 seconds. So right now,
based on the Fed's own publication, ubiquity will be chilled,
especially in the short run, and it means thousands of
institutions considering signing on to the private sector
platform, could be waiting to see how FedNow works, effectively
cut off millions of consumers from real-time payments. That is
something I would like to follow up with you on, and I am
probably going to have to do questions for the record, so I
apologize for that.
So, anyhow, I guess my time has expired, so I yield back to
the Chair.
Chairman Meeks. The gentleman's time has expired. I now
recognize the gentleman from Illinois, Mr. Garcia, for 5
minutes.
Mr. Garcia of Illinois. Thank you, Mr. Chairman, and I want
to thank both of our witnesses here today. I would like to talk
a little bit about FSOC and shadow banks in my comments and
questions.
The 2008 financial crisis was a painful reminder that it is
not just commercial banks that can make risky choices,
threatening the stability of our entire financial system. Hedge
funds, insurance giants, and asset managers are all closely
connected to basic financial stability.
My constituents cannot afford another crash, for many of
them are still recovering from the last one. Many people in my
immediate neighborhood, throughout my congressional district,
and throughout the City of Chicago lost the equity in their
homes, they lost their jobs, many became underemployed, and
many had to double up in apartments, and in homes throughout
the area. Buildings became vacant throughout neighborhoods in
Chicagoland. As a matter of fact, we had to establish a
foreclosure mediation court in the County of Cook, in the metro
area. People fell behind on utilities, car payments, and there
were more repossessions. Retail business strips had higher
vacancy rates. There were empty storefronts throughout the
commercial areas in the district. The informal economy
increased as people took to the streets to peddle food, fruits,
and on and on. There was real, real pain.
Yet, during Secretary Mnuchin's tenure, the FSOC has voted
to remove systemic risk designation from AIG and Prudential.
FSOC has also voted to drop the appeal of the district court's
decision in the MetLife lawsuit. Taken together, these
decisions remove protections from non-bank financial companies
with a combined $2 trillion in assets.
There are no longer any non-banks designated as
systemically important. I am worried that we failed to learn
the lessons of 2008 and are making the same mistakes. Large
financial non-banks like Prudential and AIG were central to the
last crisis. In fact, during the 2008 crash, AIG became the
recipient of the largest government bailout in American
history.
Governor Brainard, do you think it is appropriate that
Prudential, a company with over $800 billion in assets, has, as
its chief regulator, the New Jersey Department of Banking and
Insurance?
Ms. Brainard. Thank you for your question. I certainly have
traveled around your district and other places in the country
where I think the effects of the foreclosure crisis are still
evident.
With regard to the designation authority under FSOC,
personally I thought it was a very important authority. I am no
longer close to it. I am not the Board's representative to the
FSOC so I can't speak to any particular decisions, but I
certainly believe that non-bank activities were important, and
could be, in the future, important sources of systemic risk.
Mr. Garcia of Illinois. The Fed's Financial Stability
Report warned about leveraged loans to corporations, and noted
that, ``the more risky tranches are primarily held by asset
managers, insurance companies, hedge funds, and structured
credit funds.'' In light of these findings, do you really
believe that there is not a single insurance company, asset
management firm, hedge fund, finance company, or standalone
investment bank whose failure could threaten financial
stability today?
Ms. Brainard. I certainly would feel more confident if we
had greater lines of sight into where some of those non-bank,
non-supervised entity holdings are sitting, and that is why we
supported work through the Financial Stability Board (FSB),
because, of course, this is an international market, to better
understand where those holdings are sitting.
Mr. Garcia of Illinois. And on the subject of leveraged
loans, I will skip my introduction to the question, and let me
cut to the chase, if I may. Do you think that it makes sense
for Congress to act and restore risk retention or arrangers of
CLOs?
Ms. Brainard. I think that issue is one for you in Congress
to decide. I think risk retention has been shown to be an
important risk mitigant.
Mr. Garcia of Illinois. Thank you. I yield back, Mr.
Chairman.
Chairman Meeks. The gentleman's time has expired. I now
recognize the gentleman from Missouri, Mr. Cleaver, who is also
the Chair of our Subcommittee on National Security,
International Development and Monetary Policy, for 5 minutes.
Mr. Cleaver. Thank you, Mr. Chairman. I would like to ask
either of you, are you members of the Federalist party or the
Whigs or the anti-Federalist party?
Mr. Falaschetti. No.
Ms. Brainard. No.
Mr. Cleaver. It is critical to this hearing, but I just
thought I needed to find out. We have found out, whether we
have subversives, people with subversive opinions in here. So I
will get to that non-subversive stuff.
I am wondering if there is a policy, Mr. Falaschetti, that
the OFR would--do you have a deadline for letters to be
answered to Members of Congress, particular the committee of
jurisdiction?
Well, that is okay. I sent a letter on August 27th that I
considered to be extremely important to me, asking for
information I sought, and I just--I was actually mayor of a
large city and we always said, I said get deadlines for the
City Hall stuff in Kansas City to respond to members of the
council.
Mr. Falaschetti. Right, and we are. We have received your
letter and it is being considered as we speak by our FSOC.
Mr. Cleaver. I appreciate it. I appreciate you doing that.
Here is the other issue. I am sure that you believe that
your role at the OFR is critical. I was here--
Mr. Falaschetti. I agree.
Mr. Cleaver. --during the last financial crisis, sitting
right over here, and it was a tough time. I don't ever want to
see that again. And so with the value that I place in your
department and the value that you do, I am trying to understand
why we would cut staff from the monitoring of systemic risk.
Mr. Falaschetti. Per my previous testimony, it was well
before my confirmation.
Mr. Cleaver. I didn't hear you make that comment.
Mr. Falaschetti. I commit, going forward, to get the
resources that we need to be effective. Your colleague just
left. I grew up in south Chicago. I know what it is like to be
underbanked. I take this job very seriously. We have a
fantastic team of employees back at the OFR who are watching us
right now. They are doing great work, and I am dedicated to
fulfilling the letter of the law here.
Mr. Cleaver. Well, I like your answer, sir, and I
appreciate that. It would seem to me--and you didn't make the
decision--but it would just seem to me that if there is any
place we are going to have some economic leniency, it ought to
be in the prevention of us repeating what happened in 2008. I
was in here when Ben Bernanke, Christopher Cox, Sheila Bair,
and Henry Paulson walked in to tell us that the financial
system of this country was going down the drain by Monday. This
was on a Friday. I don't want to do that again, so I appreciate
your answer.
To both of you, as my time runs down, do you believe that
financial regulators should be aggressive in regulating? For
example, Facebook, should we wait until they come to an agency
or should we be aggressive and go and say, if you are getting
ready to do something significant, run some kind of new
program, some kind of product, do we wait until they do it? I
have a letter from David Marcus, head of Calibra, and he
doesn't want to launch this project until regulators have
looked at it, and it appears that the regulators are saying,
``Well, we will wait until Facebook comes to us.'' And it is
just kind of confusing, Ms. Brainard, Mr. Falaschetti, either
of you?
Ms. Brainard. I--
Chairman Meeks. The gentleman's time has expired. I thank
the gentleman for his questions.
[laughter]
Chairman Meeks. And now, I am going to recognize the
ranking member for a one-minute closing statement.
Mr. Luetkemeyer. I just want to thank the chairman for
having this hearing today. I think this is extremely important
to our mission here, and for he and I, as the leaders of our
parties, to be able to assess the threats to the system that we
basically oversee, the financial services system, and the
constituents that we serve and the customers and consumers who
take advantage of those services.
Today, we heard a lot of testimony with regards, and
questions with regards to what is going on, different threats,
and there are a lot of threats to our system. Our changing
financial services environment is under a threat constantly,
and we appreciate your direct responses to those questions. But
obviously, you are going to have to continue to assess those
threats in order to be able to thwart them.
And there are two things that I hope you continue to do.
Number one, listen to and watch what is going on in the
industry that you oversee, and commit to do the work of finding
the solutions, and get all the information and then act on it.
Don't give me the ``Fed twostep.'' Act on what is going on.
Don't give me a ``may,'' ``might,'' or ``could,'' because after
each one of those words, I can say, ``may not,'' ``might not,''
or ``could not.'' I want you to be able to--don't couch those
terms to defend your inaction, but I want you to take action
when you need to.
Recently, in the past 2 or 3 weeks here, you have taken
quick action to solve the liquidity problem in the markets. I
commend you for that. But I brought up an issue today that I
think is extremely important that needs your action. I hope
that you take those kinds of actions.
I appreciate you being here today, and we will certainly
follow up and watch what goes on.
Thank you. I yield back.
Chairman Meeks. Thank you. I now recognize myself for one
minute for a closing statement.
Governor and Director, I recognize that the work you do is
especially complex, and the challenges faced in anticipating
risk and crises that have yet to manifest. As you have heard
today, Members of Congress from both sides of the aisle are
genuinely concerned about repeating mistakes of the past. It is
no exaggeration to say that our experience living through the
financial crisis was traumatic, not only for us in government
but for the American public.
The Fed and the OFR are meant to rise about politics and
partisanship, and focus truly on the financial stability and
well-being of the American economy at large. Ultimately, every
American family expects you and your organizations to take your
responsibilities seriously, and I believe that you do, to
approach them with intellectual honesty, rigor, and discipline,
and to hold accountable those financial firms that have the
potential to fundamentally disrupt our economy and those of our
economic partners.
So please, I implore you to staff your organizations to the
level needed to fulfill your missions, fight for the necessary
budgets required to do your job well, on behalf of the American
families, and provide us with the data and information
necessary to force a strong, resilient, stable economy going
forward.
Again, thank you for your work and your admirable careers
of public service, and my colleagues and I look forward to
continuing to work with the both of you.
I would now like to thank, again, our witnesses for your
testimony.
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 is now adjourned.
[Whereupon, at 12:07 p.m. the hearing was adjourned.]
A P P E N D I X
September 25, 2019
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