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Hearing of the Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises of the House Financial Services Committee - Perspectives on Hedge Fund Registration

Chaired By: Rep. Paul E. Kanjorski

Witnesses: Todd Groome, Chairman, Alternative Investment Management Association; Richard H. Baker, President, Managed Funds Association; James S. Chanos, Chairman, Coalition Of Private Investment Companies; Orice Williams, Director, Financial Markets And Community Investment Team, Government Accountability Office; Britt Harris, Chief Investment Officer, Teacher Retirement System Of Texas.

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REP. KANJORSKI: The hearing of the Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises will come to order. Pursuant to committee rules, each side will have 15 minutes for opening statements. Without objection, all members' opening statements will be made a part of the record.

During the past two years, our markets have experienced tremendous turmoil as an economic tidal wave crushed down and resulted in the loss of trillions of dollars for investors, the drowning of several companies, and the disappearance of some products and industries. Because we need to decrease the likelihood of similar situations occurring again in the future, regulatory reform has become a topic for considerable debate in Washington.

Today, we will examine one sector of our markets in need of greater oversight, hedge funds. Our singular focus on hedge funds at this hearing, however, should not be taken to mean that we will not revisit the need for oversight of other pools of unregulated capital, including private equity and venture capital.

We must also recognize that hedge funds are not villains as some might seek to infer, although there are almost certainly a very small number of bad ones. As has happened many times before, this latest financial crisis has revealed that our system of capitalism cannot thrive without a responsible and thoughtful degree of transparency. The question before us today is how Congress can wisely improve hedge fund oversight.

We must not regulate for the sake of regulation. Moreover, we should refrain from adding layers of an antiquated, patchwork structure that has become, in some instances, counterproductive. In my current view, hedge funds deserve a narrowly tailored regulatory treatment. If they want to continue to swim in our capital markets, they must, at a minimum, fill out the forms and get an annual pool pass.

In this regard, Congressmen Capuano and Castle have drafted a good bill to accomplish the goal of registering hedge fund and investment advisers. Registration generally makes sense, although we may need to customize the rules to treat small firms differently from big ones. We can best achieve this objective by providing the Securities and Exchange Commission with some flexibility in the implementation of the hedge fund registration law.

As we work to put a place -- in place, a system to obtain greater transparency for the hedge fund industry, we must also make other important decisions about who will monitor them and how. Because of their sophistication, we should allow hedge funds to continue swimming in the deep end of the pool. However, we also do not want to see them down -- drown, especially in some future financial crisis. As such we need to determine whether they need a lifeguard on watch at all times, or whether they can merely follow some general behavioral rules posted on a wall.

Moreover, we must consider how to protect less experienced swimmers in our markets who might be overwhelmed by the wave created when one hedge fund jumps into the pool with a cannonball dive. Hedge funds activities directly affect the fortunes of pension funds and institutional investors. Indirectly, teachers and other hardworking Americans are heavily invested in hedge funds, but many of them were unaware of the risks involved until this crisis.

When the market soars and hefty returns are made, no one really cares. But business cycles happen, and fortunes can fade fast. We need a system that better protects individuals' retirement funds. We must ensure that nest eggs do not disappear as a result of excessive risk taken by pension managers. We have painfully witnessed enough of that last year.

In sum, investors need to regain trust and confidence in our markets, and legislation aimed at shining a light on a previously unregulated, $1.5 trillion corner of the market will help to accomplish that end. Striking a balance of all of these complicated questions is the task before us. I look forward to working in a bipartisan manner with other members to design an effective, transparent, regulatory system to govern hedge funds going forward.

And now I'd like to recognize our ranking member Mr. Garrett for five minutes -- for four minutes for his opening statement.

REP. SCOTT GARRETT (R-NJ): Thank you. I thank the Chairman, and I thank all the witnesses who are about to testify, and I certainly look forward to delving into the issues raised by -- in the registration legislation by Congressman Castle and Capuano.

But before I do, I want to take a moment to address President Obama's recent comments about the hedge fund industry and as it relates to the Chrysler bankruptcy. And I was troubled by the president's recent statements that singled out a particular class of Chrysler's creditors.

President's comments displayed a complete disregard for the rule of law, as well as practices which govern our bankruptcy code. Furthermore, the comments, to me, showed a fundamental misunderstanding of just who hedge fund managers represent, as well as the fiduciary responsibilities these managers have to their investors.

You know, millions of retired teachers and other public employees had their retirement savings invested in these funds. And it was due to investors like these that Chrysler was able to stay out of bankruptcy as long as it did. And it wasn't just the president's public comments that were concerning. There were also reports that members of this administration bullied and threatened investors to accept the administration's terms or else.

As we examine the potentially increasing regulation on hedge funds, reportedly to protect investors in the broader economy, perhaps we should also be looking at ways to protect hedge funds, the retirees and the teachers that invested them -- for -- and other parts of the economy as well, from the overzealous, strong-arming and inappropriate meddling on the part of some in the federal government.

But let's get back to the topic of our hearing today; hedge fund registration. We will no doubt hear from members of this committee and maybe the panel that registration is a good thing. My hope that others here today however, will indulge me as I raise some concerns that I have with this approach.

First, let's step back for a moment. And remember that it was -- hedge funds were not the cause of our financial sector difficulties. And in fact, they are now being called upon by the government to help pull out the banking sector, which as we know is one of the most heavily regulated sectors, out of our current hole.

Secondly, the due diligence performed by sophisticated institutions that invest in hedge funds is significantly more rigorous than anything that will be subject to under a registration regime. Some worry that the perceived government imprimatur provided by mandatory registration may now undermine or deemphasize that due diligence over time.

And perhaps more importantly, without mandatory registration, there is no current expectation by the financial markets that taxpayers would ever be required to bail out a hedge fund. But once you introduce government oversight, expectations change.

An additional concern with this approach is that it approaches reform in a piecemeal fashion rather than a part of a comprehensive plan to address reform of the entire financial sector. All the pieces of reform should get together and should be pursued as a part of one complete package.

And finally, while registration may not seem overly onerous to an industry where many of the participants already voluntarily registered, I'm concerned that mandatory registration is a proverbial camel's nose under the tent. In fact, earlier this week SEC Chairman Schapiro announced her intention to go further.

She said, it's probably not enough just to register hedge funds. And it won't be necessary to put in place particular kinds of rule. She went on to say, it's certainly possible that the SEC should consider forcing hedge funds to publicly to slow short sale positions, impose restrictions on leverage, and restrict what hedge funds could invest in. Is that what we are leading to?

So finally again, big banks are among the most heavily regulated firms in our economy, yet are the root cause in many of our problems. But at least with banks there's a rationale that regulation is there to protect the individuals' insured deposits.

With hedge funds, investment managers are sophisticated. And there's no insured deposits to protect. So let's be very careful about regulations and registrations that could ultimately lead to fundamentally changing the nature of a very important investment option that's available now for millions of Americans.

And with that, I yield back, and I just ask for unanimous consent to enter into the record a IBD editorial into the -- Investment Business Daily editorial from earlier this week with regard to -- headline, "Don't Demonize Chrysler's Debt Holders for Standing Up for Their Shareholders." Okay.

REP. KANJORSKI: Thank you Mr. Garrett. And now we'll have, for three minutes, Mr. Capuano.

REP. MICHAEL E. CAPUANO (D-MA): Thank you, Mr. Chairman, and Chairman, thank you very much for organizing this hearing. Ladies and Gentlemen, I'm looking forward to your testimony, and I'm -- I think that most thoughtful people have now come to the conclusion that transparency in our large economic plans, our large financial plans is essential to an effective market.

Let me be very clear. My interest is not in targeting hedge funds at all. My interest in hedge fund started, because a few years ago, five, six years ago, hedge funds were the major players in the entire financial world. They were not subject to regulation or oversight, or even registration -- anyway, it's become clear now that you're just one of many -- private equity funds, sovereign wealth funds -- there might be others.

And I want to be clear, I am not interested, really terrible too much in any one or even a small number of hedge funds. I'm not interested all that much in a few wealthy players gambling their own money at their own risk as they see fit. Those things don't bother me.

What bothers me is the herding mentality that happens. What bothers me is the growth, and again of hedge funds, only because you're here today, you're not the only one. When I start looking at this nobody knew, but people thought there might be fewer than a thousand hedge funds. Today, nobody knows, but they think there might be upwards of 8,000 to 10,000 hedge funds. Now, if there are 8,000 brilliant sophisticated investors out there that can beat the system every time, you're going to have to prove that to the world, because no one really believes that.

We're here today to talk about how to move forward. And moving forward to me is not overregulation. I know that any time anybody in government suggests a little transparency, those who want to keep the opaqueness of anything argue, oh, government regulation will ruin everything.

SEC did a pretty good job for a long time with reasonable regulation. That's the concept here; simply allowing investors to know what they're investing in. I don't think that's that difficult. Simply allowing -- especially, if we end up with a systemic regulator, which I think and hope we will, that they understand how the system works.

We cannot have major players in the financial world completely operating in the dark answerable to no one. It's not just for the individual investors. Again, if some billionaire wants to risk a $100 million and lose it, it doesn't jeopardize my life, it doesn't jeopardize my mother's pension, but it does, when those players expand exponentially and start getting money out of pension funds, when they start getting money out of other public funds. That's when I believe we have a societal interest in what's going on. And that's really what this is all about today.

And the bill that Mr. Castle and I filed, in my opinion, is simply a beginning. It is a bill based on some old concept. In my mind, it actually changed and got a little tighter with -- understating the new problems that we have. But I want to be very clear. Today's hedge funds -- I do not see hedge funds as evil, I do not see them as the major cause of any problems. They participated in it like anyone else.

I also want to be very clear in my opinion, regulated banks did not cause this problem. They played with it, no question about it. But the problems we had today were caused by a lack of transparency and credit default swaps and collateralized debt obligations and other such items, where everyone was playing. And all I want in the final analysis is a little transparency, so that the market can honestly judge what's being done for it and to it.

With that Mr. Chairman, I yield back, and thank you very much.

REP. KANJORSKI: Thank you very much. And now we will hear from Governor Castle for three minutes.

REP. MICHAEL N. CASTLE (R-DE): Thank you very much, Mr. Chairman. I thank you and the Ranking Member for holding this hearing today. We appreciate it.

Mr. Chairman, over the last decade a number of hedge funds has got, as we've already heard earlier, the assets that they have under management obviously has grown and their ability to shake up the marketplace has undoubtedly grown too. And as I looked over new stories in industry literature and discussed these issues with fund managers, investors back home, it struck me that time was probably ripe to examine hedge funds more carefully and understand more precisely their role in the marketplace.

The popularity of hedge funds among sophisticated investors speaks for itself, and I have no particular agenda here. But I do think the time has come, and I think most in the industry would agree that knowing some very basic information about the funds and the managers is not too much to ask. Furthermore, providing the Securities and Exchange Commission with this information and the ability to examine the funds from time to time seems prudent to me.

Finally, Mr. Chairman, I want to thank my colleague from Massachusetts' Mr. Capuano for joining me in the introduction of several hedge fund bill proposals. I also listened to the opening statement of our distinguished ranking member Mr. Garrett, and I happen to be in agreement with him on certain aspects of that.

While I think there should be transparency, we're looking for a way of reaching that. Clearly, as he's indicated, sometimes when you get government oversight expectations changed -- and I hope bailing out hedge funds would not be one of those potential expectations that might be reached. In fact I think it should be legislated out specifically if we were to do anything. But we do have to be careful about that. I mean, he's essentially correct when we get the government involved in anything, even simple oversight and transparency, we need to be careful not to be overreaching with respect to what we are doing.

So I understand we need to be in balance. I would hope that we could strike that balance. I've read the testimony of most of the witnesses here today, and I believe that there may be a middle ground which we can find in which we can accommodate the interest of the industry market and the interest of the public and hopefully we can do that.

With that I yield back the balance of my time.

REP. KANJORSKI: Thank you very much Mr. Castle. We'll now hear from Mr. Scott for three minutes.

REP. DAVID SCOTT (D-GA): Thank you very much Mr. Chairman.

Hedge funds now constitute $1.3 trillion in terms of their value as an industry. And I think as we move forward, we have to understand that we have a free enterprise system. That has been the grounding that has made our nation as great as it is. So as we move forward, we want to be mindful of how we can keep an emphasis on the word "free." But I do believe we certainly need to, as a respect to the hedge funds industry, have the ability to inspect and examine the books and records of hedge fund as well as acquire some increased rule making authority.

Now, we do not need to spend our time here today simply having a comprehensive berating session berating the hedge funds industry. We need to take this time today to bounce ideas and solutions back and forth, and to remember that we must all work together on these important issues affecting our economy, and respect the significance of this $1.3 trillion industry, and the impact that it has on our economy, and the taxpayers, and the people of our country.

I do agree that legislation is necessary to compel hedge fund managers to provide information. But to be fair, many hedge fund operators have already voluntarily registered. And many hedge fund operators are not all bad actors. There are some bad actors. But they all are not bad actors. It is of utmost importance that we continue to assess systemic risk related to these funds as well as how the -- their processes might be improved to ensure our financial markets are more secure in the future.

Hedge funds indeed hold unmatched sway over our markets. And I believe supervisors must have the necessary tools to effectively monitor the systemic risk posed by hedge funds, improve market surveillance, assure effective oversight, and improve transparency of the level of risk in the financial market related to hedge funds.

There are a couple of key questions. One of which is very important, especially with the global impact of this industry, for they are a global industry. Their businesses' activity is linked to foreign entities. So the question has to be to what extent should our interaction be with foreign regulators as well.

There are some very profound questions Mr. Chairman, I appreciate this opportunity, and I look forward to the hearing.

REP. KANJORSKI: Thank you very much, Mr. Scott. And now we'll hear from Mr. Royce, California for three minutes.

REP. EDWARD R. ROYCE (R-CA): Well, thank you Chairman Kanjorski for holding this hearing today.

While hedge funds have experienced losses, they have not asked for, or received any direct government bailouts in an era where the government has become the savior of all things failed. And in the view of the Fed, the losses that have been borne by hedge funds -- and their investors, did not pose a threat to our capital markets or the financial system.

A major reason why this was the case was because of the general lack of leverage within the hedge fund sector. Recently, we saw a commentary by the chairman of London's financial services authority. He said he found that the average leverage of hedge funds was 2 or 3 to 1. Now, that's a staggeringly low number, a staggeringly low amount of leverage if you consider that our most heavily regulated institutions like the government sponsored enterprises, Fannie Mae and Freddie Mac, they were leveraged here in the U.S. by a 100 to 1. And this was with Congress telling them how to invest, and Congress encouraging them.

Members of Congress, to roll the dice on risk, encourages them to leverage a 100 to 1. I remember this quite vividly, because we have Richard Baker, former member of Congress here who tried to support the position of the Federal Reserve to allow the Fed or the regulators to de-leverage these institutions for systemic risk. But that was bought by the members of Congress.

So we contrast that situation with that kind of over leverage. And thus far, it appears counterparty risk management, which places the responsibility for monitoring risk on the private market participants who have the incentives and capacity to monitor the risks taken by hedge funds. We see that that's held up pretty well.

As we move forward with the revamping of the regulatory framework overseeing our financial system, I think it's worth noting that the role hedge funds and other private pools of capital played in our financial system is a pretty extensive one. They helped the pension funds. They helped the endowments and charities and other institutional investors and they helped them in diversifying their risk.

They are an important source of capital formation and liquidity to the broader financial system. New regulation should take into account the benefits hedge funds have provided and avoid restricting the ability of institutional investors to take advantages of all alternative investments.

And I yield back the balance of my time Mr. Chairman.

REP. KANJORSKI: Thank you very much Mr. Royce. And now we have a vote on -- we're going to hear from Mr. Klein for two minutes now, then we're going to recess, take the vote, come back and see who else we have.

Mr. Klein.

REP. RON KLEIN (D-FL): Thank you. Thank you, Mr. Chairman, for holding this important hearing.

Given the current turmoil in financial markets in the broader economy, it is important to examine hedge funds in the proper way to regulate these entities. Hedge funds can be stabilizing market forces or can pose systemic risk to the financial system. We've seen the liquidity problems that can arise when hedge funds with similar market positions, particularly those with large amounts of leverage are forced to sell assets in the market at the same time.

Long-Term Capital Management is the most famous example of how the failure of one highly leveraged hedge fund can threaten ruin to its counterparts and break down the normal functionings of market. Given the global nature of financial markets and the speed at which transactions can be made, governments -- government has a compelling interest to regulate hedge funds.

Yet, not all hedge funds are the same and these hedge funds cover a wide range of leverage and investment strategies. As the GAO acknowledges, the hedge funds generally add liquidity to many markets, and hedge funds can play an important role in price discovery. They also allow other market participants to prudently hedge risk.

We must be careful to create a regulatory system that allows hedge funds to remain dynamic market participants, but assure at the same time their positions don't threaten the stability of the financial system. Given the diversity of hedge funds and the difficulty of classifying all hedge funds under one definition, it may be more useful to impose regulations on leverage, short sales in offshore entities across all private pools of capital and do it in the proper way.

I think the registration of hedge funds with the SEC or other proper regulatory authority is a good first step, and there seems to be a growing consensus on the necessity of registration.

I look forward to a fruitful discussion today on the best way to fit hedge funds into developing systematic risk regulatory framework. Thank you Mr. Chairman.

REP. KANJORSKI: Thank you very much, Mr. Klein.

We're going to take a recess now for 15 minutes, and then return for the remainder of the closing -- opening remarks, and then go to the panel.

The committee stands in recess.

(Sounds gavel)

(Recess)

(Sounds gavel)

REP. KANJORSKI: The subcommittee will reconvene, and for an opening statement will now recognize the gentleman from California, Mr. Sherman.

REP. BRAD SHERMAN (D-CA): I thank the Chairman.

Three basic points. One, in drafting this bill, we should not be so over inclusive as to include family partnerships or family trusts. I'm not sure the bill would do that. But I'd want to be sure before we proceed.

Second, in general, we want to preserve the cowboy capitalism that has started so many new companies in this country, and not impose excessive regulation on those entities that are small enough not to affect the system systemically and whose investors is sophisticated enough not to need the full measure of regulation.

Finally, even if hedge funds register under the act, that is not the end of the discussion of the role that hedge funds play in the system and systemic risk. And I look forward to other hearings on that issue to see how we do not see a repeat of 2008. I yield back.

REP. KANJORSKI: Thank you very much, Mr. Sherman. We've had now all our opening statements, and we'll move into the panel. First of all, thank you very much for being part and appearing before the subcommittee today. And without objection, your written statements will be made part of the record. You will each be recognized for five minutes summary of your testimony.

And first, we have Ms. Orice Williams, director financial markets and community investment team, Government Accountability Office. Ms. Williams.

MS. WILLIAMS: Thank you. Mr. Chairman, Ranking Member Garrett, and members of the subcommittee, I'm pleased to be here to participate in today's hearing on hedge funds. As you know, a hedge fund is a pooled investment vehicle that is privately managed and often engages in active trading of various types of securities, commodity futures and options among others.

In general, hedge funds qualify for exemption from certain security law -- securities laws and regulations, including the requirement to register as an investment company. When we issued our reports on hedge funds, the hedge fund sector was growing in importance and continuing to evolve within the financial system.

Hedge funds, largely driven by investments from institutional investors such as endowments, foundations, insurance companies and pension plans seeking to diversify their risk and increase returns have grown dramatically over the last decade.

From 1998 to early 2007, the estimated number of funds grew for more than 3,000 to more than 9,000 and assets under management grew from an estimated $200 billion to more than $2 trillion globally. About $1.5 trillion of these assets were managed by U.S. hedge fund advisors. But the exact number of hedge funds and assets under management is largely unknown.

Hedge funds has significant business relationships with the largest regulated banking organizations. The funds act as trading counterparties for a wide range of over-the-counter derivatives and other financing transactions. They also act as clients through their purchase of clearing and other services, and as borrowers through their use of margin loans from prime brokers. However, much has happed in financial markets since we issued our last -- our report last year.

According to an industry survey, most hedge fund strategies produce double-digit losses in 2008. And hedge funds saw approximately $70 billion in redemptions in the second half of the year. Some observers have blamed hedge funds for dramatic volatility in stock and commodity markets. And some funds of hedge funds were heavily invested in the alleged Madoff fraud.

Nevertheless, an industry survey of institutional investors suggests that these investors are still committed to investing in hedge funds in the long term. The general view on regulation of hedge funds appears to be shifting as well, perhaps signaling recognition that hedge funds have become an integral part of the financial marketplace, including the Treasury Secretary calling for greater oversight of hedge fund advisors and possible increased disclosure to regulators.

Despite changes surrounding the hedge fund sector, the issues and concerns related to regulatory oversight of hedge funds and challenges posed by hedge fund investing that were raised in our hedge fund reports, and more recently our regulatory framework report, remain relevant today. First, the oversight of hedge fund related activities provided by federal financial regulators under their existing authorities varies and continues to raise concerns about the adequacy of that oversight.

Second, pension funds plays -- face a combination of potential benefits, risks and challenges in investing in hedge funds that some plans, particularly smaller ones, may not be equipped to manage. Third, while investors, creditors and counterparties have taken a number of measures to impose market discipline on hedge funds over the past decade, market discipline has its limits especially in good times.

And finally, while hedge funds have not surfaced as a major player to date in the current crisis, the potential for systemic risk from hedge fund related activities remains given their interrelationships with other market participants.

In closing, I would like to note the importance of this discussion as Congress considers how best to modernize the regulatory system. Ensuring that any revised regulatory system is comprehensive and includes a system wide focus is vital to helping ensure that regulators are able to monitor markets and identify and mitigate issues before the crisis occurs. And having sufficient information about all the relevant participants' risks and products is critical to achieving that goal, regardless of their legal structure or label. Thank you.

And I will respond to any questions the subcommittee may have at the appropriate time.

REP. KANJORSKI: Thank you very much, Ms. Williams. And next, we'll have the Honorable Richard H. Baker, president, Managed Funds Association, and our former colleague. Mr. Baker, welcome.

MR. BAKER: Good morning Mr. Chairman, Mr. Garrett, members. I appreciate the opportunity to visit with you this morning as president and CEO of Managed Funds.

We represent a significant number of hedge funds globally, and remain a primary advocate for sound business practices and industry growth professionals and hedge funds.

We do provide liquidity and price discovery to markets, capital to allow companies to grow, and sophisticated risk management to investors-wide pension plans. I should note as the GAO testimony indicated that our funds were not the proximate cause of the ongoing difficulties in our financial markets. But our firms and investors have suffered like many others as a result of the current downturn.

Despite these challenges, some of our firms then continue to experience difficulty. We have not sought a dollar of taxpayer money. Nor to my knowledge have any hedge funds been a significant concern in the current market environment as to a contributor to potential systemic risk. That's in part the result of our relative side to the broader financial universe with an estimated $1.5 trillion, and that number varies depending on market conditions.

Our industry is significantly smaller than the $9.4 million -- $9.4 trillion mutual fund industry, or the $13.8 trillion U.S. banking system. It is also a function of our strength; hedge fund managers are some of the best in assessing financial market risk and in managing their own. Our managers' interests are also aligned with those of our investors; their money is engaged in the same investment strategy.

And it's also a function of how we deploy credit. Today, many hedge funds use little or no leverage, and this has been a repetitive mischaracterization of our industry in reports, the highly leveraged hedge fund industry, it's a continued source of frustration. A recent study which I'll be happy to provide the committee found that 26.9 percent of hedge funds used zero leverage.

And a 2009 report by the chairman of the Financial Services Authority in London, not something we should be able to control, that hedge fund leverage was on average between 2 and 3 to 1 industry wide for a five-year period, significantly below many of our other financial service sectors. As a result of these factors, losses at hedge funds have not posed systemic risks the way that losses at more highly leveraged institutions have.

Hedge funds have a shared interest with policymakers in establishing a sound financial system and restoring investor confidence. We only do well when markets function efficiently. The MFA and its members recognize that mandatory SEC registration for investment advisors is among many options being considered by the Congress.

In our view, registering investment advisors including advisors to all private pools of capital under the Investment Advisers Act is the right approach. While not a panacea, it can play an important role toward the shared goals of promoting efficiency in the markets, market integrity and providing a measure of investor protection.

Mr. Chairman, we didn't come to this decision very easily at all. It's been debated for considerable amount of time. But I should point out that over half our members and over 70 percent of assets under management already voluntarily register with the SEC. What we're recommending today however goes beyond what Treasury Secretary Geithner proposed. The secretary suggested only the largest fund advisors for the purpose of systemic risk register; what we are supporting today will subject the vast majority of investment advisers above some de minimis standard, which we do not define, to require registration.

And it is significant. The notification letter that goes out to members that pursuant to registration, the initial opening is a 20- page letter that represents hundreds of questions.

We are required to make publicly available disclosures to the SEC, detailed disclosures to clients, procedures and policies to prevent insider trading, maintaining extensive sets of books and records, periodic inspections and examinations requiring chief compliance officer in a written code of professional conduct are among only the major principle points of registration requirement.

We believe it important to consider the role of a smaller investment advisers through consideration of a de minimis threshold, and such exemption should be narrowly constructed.

Mr. Chairman, I look forward to working with the committee as you move forward. We want to be a valued resource in this most difficult task. Thank you.

REP. KANJORSKI: Thank you very much Mr. Baker. We appreciate your offer, and I'm sure we're going to take upon it.

And next we'll hear from Mr. Todd Groome, chairman, the Alternative Investment Management Association.

Mr. Groome?

MR. GROOME: Thank you Chairman, thank you Ranking Member, and other members of the subcommittee for inviting AIMA to participate today in this hearing, and your considerations of these issues related to hedge fund registration and related matters.

AIMA is a very diverse association representing people -- professionals within the industry from all over the world, different parts of world, over 40 countries our members come from. And professionals within our membership are both hedge fund managers, investors and other professionals, lawyers, accountants and administrators involved in the industry. So we represent both geographic and professionally a very diverse group of professionals involved in the hedge fund industry.

After the November G20 meeting in Washington DC, we actively engaged our members around the globe as well as policymakers nationally and internationally, as well as other associations like the MFA, the Hedge Fund Standards Board, the President's Working Group to try to come together as an industry and think about the issues that were raised by the G20 and the Financial Stability Forum on their behalf as well as the national authorities in looking to take forward a way for the industry to respond to the financial stability related concerns raised by the G20.

On February 24th, having completed substantially that consultation, we issued a new policy statement emphasizing consistent with some of the opening statements I've today, an emphasis on increasing the transparency of hedge fund activities in markets and within our own portfolio. What I like to do now with the remainder of the time is to highlight three or four of the key points from that policy statement.

First, we support the registration of hedge fund managers within the jurisdictions in which they're principally based. So for example, as currently structured in the United States, a hedge fund manager operating in the United States would register with the SEC, much as they've done with the U.K. for a number of years and other jurisdictions. We provide in an appendix 3 of our written testimony, a wide variety of examples of how that registration and preauthorization process may look like.

We don't think that any particular one is better than the other per se, but the key point that I would bring from all of those and is consistent as well with some of the opening statements, is whatever process is agreed upon, it needs to create an informed and ongoing dialogue between the hedge fund manager and the supervisory authority they report to. Without that informed dialogue, the exercise just increases cost and doesn't increase benefit to society.

Second, and consistent with that informed dialogue, we support periodic reporting requirement by larger -- and I'll come back to that -- hedge fund managers. This information should be designed to improve their understanding of what's happening within the hedge fund industry and the portfolios of hedge funds, but also what's happening in the broader markets as well as improve financial stability analysis.

The hedge fund managers within our membership support this, see it as a mature and established industry, it's time to contribute to that analysis on a national and international basis to financial stability considerations.

And in this sense help build the G20's early warning system, as they called it.

The information that we would recommend would be strategy by strategy, or asset class by asset class, and focus not just on leverage but yes leverage as well, but also look at the liquidity in portfolios, liquidity in markets, which can be measured in a variety of ways, look at volatility in markets by asset class and strategy, and look at concentrations within portfolios and how concentrations tend to build in certain pockets of the market.

We think this information is sufficiently important that we would encourage you to have a similar template for banks and other non banking institutions operating in our global market.

Third, we've called for and we've been working on a harmonization of hedge fund standards. MFA, AIMA, Hedge Fund Standards Board, IOSCO and others, President's Working Group, have created standards over the last 5 and 10 years. And we think it's time now to try to harmonize those in a more global basis. On our website, you can see a Hedge Fund Matrix where we've attempted to do that.

And in the last eight weeks, we've been working with all of those associations I named, to try to provide some input by mid-May to the Financial Stability Forum on how that process may look going forward. Supervisors may then use these converged standards in their dialogue with registered managers and even set the larger hedge funds to trying to meet those standards or explain why they do not meet them; to essentially incorporate them into the registration and the dialogue that we have contemplated.

Finally, we think there should be a de minimis test as well; probably for registration, but certainly for some of this reporting and other standards that I've just talked about. In our paper, we've suggested 500 million of assets under management as a de minimis test on a manager and the broader hedge fund family that he or she manages. There's nothing magic about that number, and in many cases, I think it makes more sense as a registration hurdle than it does for the other hurdles.

For example, the other hurdles could arguably be much larger. If you set that hurdle at a billion dollars AUM, you would have over 300 hedge funds today which would meet that criteria, representing 80 percent of the assets in the industry, so that we can get a full and clear picture of what's happening. However, we have to also think about creating that informed dialogue that I suggested and with 311 hedge fund managers, 70 percent of which in this country, we have to also ensure that we have the supervisory capacity to compile and analyze and execute on that information.

Thank you very much, and I look forward to your questions.

REP. KANJORSKI: Thank you very much, Mr. Groome. And next we'll hear from Mr. James Chanos, chairman, the council of Private Investment Companies. Mr. Chanos?

MR. CHANOS: There we go, thank you. Good afternoon Chairman Kanjorski, Congressman Garrett, members of the committee. I'm here today testifying as chairman of the Coalition of Private Investment Companies; thank you for the opportunity to testify in this important subject.

The damage done by the collapse of global equity, credit, and asset backed markets has been staggering in scope. There's not a single market participant from banker to dealer to end-user to investor that does not have to absorb some degree of responsibility to the difficulties confronting us today. But while there's plenty of blame to spread around, there is little doubt that the root cause of the financial collapse we've experienced lies at the large global diversified investment in commercial banks, insurance companies and government sponsored enterprises under direct regulatory scrutiny today.

Hedge funds and investors have generally absorbed the painful losses of the past year without any government cushion or taxpayer assistance. And as our government looks for ways to bring more capital into our markets, hedge funds are now seen as part of the solution.

While private investment companies were not the primary catalyst for our current situation, I believe we should not be exempt from the regulatory modernization and improvement that you are developing based on lessons learned from this crisis.

I would point out that increasing the regulation of private investment companies carries both risks and benefits. For example, if institutional investors believe they can rely upon the fact of direct regulation in lieu of conducting their own due diligence, it will undermine those parts of private sector that continue to work well.

But while there will always be a need for investor due diligence, Congress can give investors better tools, and also provide direct federal oversight of private investment funds without trying to wedge them under statutes written 70 years ago for other purposes; the Investment Advisors Act and the Investment Company Act.

Attempting to shoestring hedge funds, the hedge fund regulation under either of these acts will not serve to protect investors or to address or mitigate those activities that could potentially disrupt markets.

On the strong support of the SEC, its dedicated staff in its mission, if we are going to put more work on the plate of this already overburdened agency, we need to provide it with a statute designed for unique characteristics and activities of private investment funds.

Such a statute could, of course, draw upon the established regulatory practices. To guide the development of such an oversight regime, we offer the following principles for your consideration. First, any new regulation should treat all private investment funds similarly, regardless of the investment strategy, including hedge funds, private equity and venture capital.

Second, a regulatory regime for private funds could draw upon the work of the President's Working Group Asset Managers' and Investors' Committee. Their report suggests many specific areas for improvements crafted for the unique nature of private investment companies, and a number of the proposed standards exceed the standards for other market participants currently.

Third, regulation for systemic risk and market stability should be scaled to the size of the entity, with a greater focus placed upon the largest funds or family of funds. Now, let me briefly turn to what is perhaps the most important role that hedge funds play in our market, the role of investor.

Because of this role, CPIC believes that maximum attention should be paid to maintaining and increasing the transparency and accuracy of financial reporting to shareholders, counterparties, and market as a whole. Undermining accounting standards, for example, may provide an illusion of temporary relief, but will ultimately result in less market transparency and will undermine investor confidence thereby lengthening the possibility of recovery.

Private investment companies also play an important role in providing pricing efficiency and liquidity to our markets. And funds that engage in fundamental directional short selling, for example, often play the role of financial detectives when covering overvalued securities and uncovering fraud.

Government actions that discourage investors from being skeptical or that seek to throw sand in the gears of price discovery ultimately harm investor's interest. Indeed, some have conjectured that if Madoff Securities had been a public entity, short sellers would've blown a whistle a long time ago.

I would close by saying that honesty and fair dealing are at the foundation of investor confidence. A sustainable economic recovery will not occur until investors can again feel certain that their interests come first and foremost with the company's asset managers, and others with whom they invest their money, and until they believe that the regulators are effectively safeguarding them against fraud. CPIC is committed to working with the committee and other policymakers to achieve this difficult, but necessary goal.

Thank you very much.

REP. KANJORSKI: Thank you very much, Mr. Chanos.

And finally, we'll hear from, Mr. Britt Harris, chief investment officer, Teacher Retirement System of Texas --

MR. HARRIS: Thank you, Mr. Chairman. Good afternoon ladies and gentlemen. My name is Britt Harris and I am the chief investment officer for the Teacher's Retirement System of Texas. I'm also a current member of the President's Working Group on financial markets. The former chairman of CIEBA's Investment Committee, and also the former CEO of Bridgewater Associates, which is perhaps the largest hedge fund in the world today.

The Texas Teachers' fund is valued at approximately ($)80 billion, serves 1.2 million people. We have a long-term mandate. We have an 8 percent annualized return target and few liquidity requirements. The trust is widely diversified, utilizes a variety of risk management systems, but for the purposes of this morning's meeting, we have approximately 5 percent of the total trust invested in a wide variety of hedge funds, 45 in total represent approximately $4 billion.

When you think about the industry backdrop, I'm sure you all know that hedge funds are not new. In fact, we're aware that both John Maynard Keynes and Benjamin Graham both engaged in investment activities during the 1930s that would've been called hedge funds under today's nomenclature.

With that said, however, until the early 1990s the hedge fund industry was relatively small and served primarily high net worth individuals. In the early part of the 1990s, those individuals were joined by foundations and endowments from the smaller set of private pension funds, and then particularly in the early 2000 when hedge funds performed extremely well during an equity market correction, institutional investors, you know, began to use hedge funds in a much more dramatic fashion.

And since that time they have grown significantly and are now, as others have said, you know, over 8,000 in number, and at their peak had more than $2 trillion of assets under management. It should also be noted that the evolution of the hedge fund client has also occurred. Today, approximately 50 percent of hedge fund clients are now institutional investors whereas in previous periods that number would've been vastly smaller.

Texas Teachers uses diversified portfolio of hedge funds as an overall portion of its total strategy for three reasons. First, hedge funds are employed as a direct source of diversification particularly during down-markets. Last year's, major market declines produced hedge fund returns that were approximately 50 percent less than, you know, what our domestic stock market produced. That was not the absolute performance that we desired, but it was vastly better than the S&P 500.

Second, properly structured hedge funds have posted returns of approximately 8 percent over time as the return target for the vast majority of pension plans and have done so with less volatility. And then finally, they helped us to achieve our long term return target. Hedge funds earn returns that are not fully dependant on the overall market result and provided different means for achieving returns.

Looking at 2008, it was clearly a difficult year for global equity investors among others. However, as many have already stated the hedge fund industry was not the principal source of the systemic risk that developed within our market. That risk came through our banking system, our insurance system, and our real estate markets.

Still, it will be hard to conclude that hedge funds as a whole covered themselves with glory, you can -- Warren --Barton Biggs terms, and it's likely that the redemptions and the -- (inaudible) -- that occurred in hedge funds during the fourth quarter exacerbated that decline.

We also know that difficult periods always have revealed rogue participants and that was the case in 2008. And although the vast majority of its participants in the industry operate ethically, a small fraction of unethical characters surfaced within the hedge fund community.

While many were directly affected, the vast majority of those, most affected were not the sophisticated institutional investors that I citied a moment ago. What is different about hedge funds? Rather than trying to track the movements of the markets, most hedge funds try to seek return through positive returns regardless of market condition.

Their typical benchmark is generally some version of a cash proxy rather than something like the S&P 500. Hedge funds are able to create a certain amount of downside protection through the use of short selling thereby reducing market exposure. Then in order to bring their returns back to a targeted level they used -- they introduced the practice of leverage.

Thus equity oriented risks are replaced by increased leverage. This generally works reasonably well when practiced by professional investors with good judgment, high ethical standards, sound investment policies and solid risk control.

Because the investment approach relies more on skill than on the overall market, the compensation is often different and frankly more expensive and more performance-oriented. These different objectives and different routes of investment performance have both strengths and weaknesses. I've already cited some of the strengths.

The relative weaknesses are the reliance on leverage. A more fragile business model, lack of transparency in some cases. In most cases, there's also a -- the fact that they operate in perhaps the most competitive market in the world. So turning to regulation as a result of the recent events, renewed discussions are again underway regarding modifications to regulation and government oversight.

At the same time, it must be pointed out that many believe that regulations that are already in place are more than adequate, and was only ineffective enforcement that was lacking due particularly to the lack of resources, and in certain instances potential blind spots in the agencies themselves.

So what is the proper response? Now, the first objective should be to do no harm. The -- when regulation is effective it is generally because it's -- it's ineffective it is only because it's either inadequate or excessive. The two bimodal outcomes are too common and are -- and one generally results from an overreaction to the other.

Effective regulation does not overreach its reasonable bounds -- (inaudible) -- is always better approach. Nor does this excessively regulate those who are not large enough to comply with the regulations and are not designed that are -- and that are designed to prevent outcomes that they could never realistically create. That's what encouraged everyone to proceed with caution, thoughtful deliberation and in collaboration with others.

Congress can best achieve its mission by focusing on a limited, but unusually important set of key factors and also on the types of investment organizations that might realistically create large prolific and systemic problems. We also now know that the oversight must be properly matched with the resources supplied.

Excessive bureaucracy in the scope and the scope that is too broad will likely result in nothing but long term disappointment and continued frustration to everyone. But one side fits all process is not appropriate, and it's unlikely to work. While it's my belief that all investment organizations should be encouraged to apply for SEC registration, it is not appropriate to force all organizations to do so.

And moreover, excessive reporting requirements would likely overwhelm smaller organizations and discourage competition and innovation. It also might reduce the access for smaller investors to small high quality hedge funds. Three of the primary risk issues are undoubtedly systemic risk, fraud, and favoritism of large investors at the cost of smaller ones.

Regarding systemic risks, it should be kept in mind the hedge fund is highly decentralized and comprise primarily of investment organizations managing relatively small amounts of money for investors who are defined by statute as sophisticated.

At the same time, the vast majority of assets are controlled by approximately 15 funds. These funds are generally very well-managed and are very highly resourced. However -- and collectively, they're large enough to disrupt mark-to-market activity and should be carefully monitored.

These are the most likely sources of systemic risk, and they are also -- and they also have very sophisticated standards. You also will be pleased to know it's already been stated that the vast majority of these are currently registered with the SEC today.

The set of risks that should be monitored and disclosed should be focused on a relatively short list of key factors that have largely defined every catastrophic outcome on record. These risk categories are well-known and they are well-recognized. They include the following:

Assets under management in a notional sense, leverage and access to leverage, liquidity, concentration, counterparty risk, valuation, trends in all the -- all that I've just mentioned and the opportunity set within their work -- with their work.

The formula for unusually negative outcomes is almost always the same. Excessive leverage places an unattractive or misguided opportunity of either too concentrated or too illiquid. But those are the factors that should be carefully monitored.

From conclusion, I'd recommend you consider the following first. I understand that hedge funds are not the primary cause of systemic risk that we've just experienced. Although, it cannot be said they do not contribute to its power. Thus my first request if you could say it could do no unwarranted harm.

Second, do not seek the one size fits all solution, but rather focus on the funds that are large enough to individually or collectively create the systemic risk that most -- threatens the largest number of investors. Next keep your oversight practical and simple, don't try to focus on so many things that you distract yourselves from the very short list of key factors that truly matter.

Next, don't overreach the level and quality of resources that you're prepared to allocate to this area. And before coming up with a litany of new and potentially complex disruptive rules and regulations, look carefully at the ones that are already in place and determine whether they could've been applied more effectively. So with that said, I conclude my remarks. I would be happy to take questions.

REP. KANJORSKI: Thank you very much, Mr. Harris.

I want to thank the whole panel for their testimony, and certainly the committee -- sub committee will have some questions and I'll start on mine initially.

It seems to me it's almost unanimous everybody agrees that we should have registration. Everybody agrees that we should exercise some control and constraint on those hedge funds that may cause or contribute to a systemic risk. And obviously, that's our big problem. How much regulation do we impose, and how do we determine what size or what manner of operation would trigger in the regulatory response of the government.

I for one could care less about high-wealth individuals who want to contribute their money to a group of investors and if they want to take the shot of losing it, it doesn't really affect the rest of society. Our problem would only be if those high net worth people invested hugely in a fund that's leveraged it up like a long term capital. And become so large and so pervasive, and then have the capacity to make so many loans from insured institutions, that they put at risk, or cause a systemic risk to result.

Now, that poses a question, how large is too large, and when does a triggering mechanism for governmental involvement come in place? And I'm not going to direct it to anybody in particular. But maybe you could just take some shots at it as members of the panel. Mr. Baker probably has some ideas on that, and Mr. Harris certainly just addressed them.

Mr. Baker, go on, tell us how large is too large?

MR. BAKER: I don't know that there's a too large answer. I do believe that the regulators should be constantly vigilant, because there are a number of variables beyond assets under management, which could trigger systemic consequences. It was some number of years ago there was a small bank in Germany called a Herstatt Bank that was involved in currency conversions and was exchanging deutschemarks into U.S. dollars for a bunch of New York banks.

In between, receipt of the deutschemarks and conversion of those into New York -- U.S. dollars, they went bankrupt leaving the New York banks unfulfilled. Now, that's now known in regulatory world as the Herstatt risk. No one would've looked at that institution and that activity and thought it could in any way have a relationship that would consequently affect so many people.

Interconnectedness, leverage, assets under management, there are array of things and even market timing. If you look at the Lehman arrangement, no one knew the number of firms that were all engaged with that particular counterparty at that time. So what may not be systemically relevant today may become relevant next month or next year.

And so for that reason, we view the role of that systemic regulator, whoever that poor person will be, to be given broad authority to make those judgments based on current market condition.

REP. KANJORSKI: Okay. AIGFP would fall in the same categories you're talking about. Who would ever have suspected that they put counterparty positions in place of $2.7 trillion dollars without really having first line assets at risk, but using the corporate assets of the insurance company bank here in the States.

That being the case though, how do we structure a situation that doesn't get charged with being too intrusive, and are we going to make every one of your 8,000 hedge funds disclose in some way all possible circumstances and situations that potentially could be, or could contribute to a systemic risk.

I sort of make this argument when I hear people argue for a systemic risk regulator is that to me systemic risk is an after the fact conclusion. If it were discernible before the fact, that -- it wouldn't happen.

Our problem is that if you really want to stop systemic risk as a regulation beforehand, you'd have to have the authority -- legal authority to examine every transaction engaged in by every company and individual in the economy, which means we'd have a totally controlled economy that is the only time we could literally say that we will prevent systemic risk.

That's sort of stupid and incapable of us doing that. And so our measure is going from that extreme down where do we parcel out regulatory control, size of the organization, assets that we're going to look at, but I think more in the future rather than size of the organization or assets.

I got -- and I think, Mr. Harris is making this point. The convoluted nature of the investments, the conduits that are going to be developed particularly after this disaster. I would say that there's going to be 50 entrepreneurs worldwide looking at insurance companies of middle-size that could be acquired and used as methodologies of being highly -- (inaudible).

If there isn't a downturn in the market they'll be making fortunes, if there's a downturn in the market we'll discover they don't have any trunks on, but we don't want to go through that discovery. We don't want to have that problem. So where do we as the Congress, where do we as the government not become too intrusive, and yet not get caught up in a problem just looking at size as opposed to the convolutions that can be gone through. And what would your opinion be, and I think all of the panel as to prevent that being too intrusive.

MR. BAKER: Mr. Chairman, if that's directed to me. My observation is we have come to a very considered opinion that disclosure of the registration information is sufficient to give the tools to a well-funded and properly staffed regulator, the information they need to make those assessments.

And it would not require that regulator to be constantly involved in an individual firm's business, and I would point out, Mr. Chairman, that in the current environment for our currently regulated, registered -- voluntarily registered firms, that examinations can take well over a year.

They can take up to two years.

There's something not appropriate about that model, and so we enter into this with great reservation, but we believe that disclosure of the information that is now required by the registration model are the appropriate items that we should disclose to a regulator to make those difficult judgments. And I'm also very glad I'm not sitting on your side of the dais.

MR. HARRIS: Just -- you know, with respect I think that's unrealistic to expect any organization to oversee, you know, 8,000 to 10,000 individual funds that's spread all throughout the world with the limited resources they're going to have. So I would suggest a practical approach, which is, you know, the proverbial 80/20 rule. What you've heard here is that, you know, 80 percent of the assets are with less than 20 percent of the participants.

Those are the -- that is -- you know, it's highly unlikely that you're going to get a serious systemic risk from a hedge fund who's less than a $1 billion. The -- and the resources that are going to be applied to this are not sufficient to, you know, fish in every single pond in the entire country. And I think you divert your resources and make them less effective unless you focus on the areas where they're -- you're really truly likely to get a serious issue.

MR. BAKER: Mr. Chairman, if I may just add one concern about that view though. Once you identify a systemic category that is deemed too big to fail or systemically risky, and that the Congress may likely take action, they will have a preferential pricing advantage in the marketplace, a la Fannie and Freddie. And so that standard should be very malleable and not definitive, or otherwise you will create that advantage in capital markets.

REP. KANJORSKI: Let me just -- I know I'm over my time now, but suppose that we run across this situation, the sizes causing extraordinary exposure to systemic risk, should we empower the regulator with the power to cause a dissolving of that fund or breaking it into parts just as a regulatory power?

MR. BAKER: I would be very cautious, Mr. Chairman about dissolution of business merely because of its size or assets under management. There should be very careful examination and thought given to the president's steps --

REP. KANJORSKI: I agree with thought, but should the power adjust?

MR. BAKER: Well, although size is a considerable contributor to potential to systemic risk, I do not believe size in and of itself is of the concern that would warrant a regulator to take that action --

REP. KANJORSKI: Granted convoluted connections are opportunities that lend itself, creation of the wormholes out there. If the regulator sees that and says that if this is exacerbated by a factor of two, or three, or four, it could be a systemic risk. Should we empower the regulator to step in and give an order of dissolving that size or those convoluted activities to prevent that future?

MR. BAKER: There would be a number of alternative remedies that should be available to a regulator before you would get to that adverse conclusion, but at some point under the most adverse of circumstances perhaps, but that would be a very remote and improbable outcome.

REP. KANJORSKI: I agree with you, but anyone else that wants --?

MR. GROOME: Just one point, Chairman. In response to that last discussion, between yourself and Mr. Baker, we also -- I actually like to think about this more as supervision as opposed to regulation. And so that's why you heard me talk a lot in my remarks in our written testimony about providing better information to create a more informed conversation and understanding that the supervisor has.

If a non-bank institution such as a hedge fund or any other were suddenly deemed to be presenting some sort of systemic risk as I heard someone say in their opening comments it's very unlikely someone's going to bailout or protect a hedge fund.

What the supervisor will do therefore I imagine particularly given Secretary Geithner's initiatives on the resolution of non-banks is to wind down those institutions and protect the systemically important institutions, which are more likely to be their counterparties such as banks or brokers.

So I don't think you need to think about it in the way of how do I wind down a hedge fund. How do I dissolve a hedge fund or think about that. The supervisory authority at the end of the day collectively, beyond hedge funds, but collectively still be looking at systemic risk on those institutions that provide some public good that we've deemed them to be systemically important such as banks.

REP. KANJORSKI: Sorry to have taken the excess time.

Mr. Garrett, New Jersey, you're recognized, I'll be lenient.

REP. GARRETT: There you go. To Mr. Baker's comment. Yeah, I wish you were on this side of the dais too with -- when our discussion goes involved with this and also with the GSEs (ph) issue. The chairman made his opening comments with regard to the unanimity of -- on decision of regulation. And I think there might be unanimity on the issue of regulation, may not be unanimity on it whether it should be voluntary or mandatory.

Listening to all this, I come away with two, or three or four takeaways. The first one from everyone starting with you, Ms. Williams was that hedge funds were not the ultimate cause -- the underlying cause of the problems that we're in right now. I think your comment was they were not players to date in the current crisis, which I think is important in our entire discussion here. Does anyone disagree that hedge funds were the fundamental problems here?

No. So that's, I think, an important takeaway as we try to spend much of our time to try to deal with the global economic situation, let us focus our attentions on what was the cause and not as much time on those areas that was not the cause.

And Ms. Williams also made the comment, there is dangers from relationships with other market players however as far as what the underlying cause was, and I assume what you meant by that is that hedge funds did deal with some of these other parties which were systemically important.

And so isn't the answer there so much -- not so much to direct our attention on looking at the hedge fund, but we do have I think your other testimony in other hearings was we do have regulators in place for these other regulated market place, the banks and what have you, and if we looked a little more closely at them on what they're doing with the hedge funds and the derivative trade was your earlier discussion in another panel, we could've probably -- possibly avoided some of those. Is that not your previous testimony and that comment here as well?

MS. WILLIAMS: I think that's accurate.

REP. GARRETT: Yeah. So focus on where we -- where the problem is and focus on give authority to those regulators and make sure those regulators actually do their job in those other areas.

MS. WILLIAMS: That's definitely part of it.

REP. GARRETT: Second takeaway is whether or not regulation would've stopped the current situation we're in right now. Now, Mr. Harris, you point out -- maybe you can help with some statistics or something like that -- we have voluntary regulation today, correct?

MR. HARRIS: Right.

REP. GARRETT: A number of those larger institutions I believe you said are already registered. How long has the significant number of the larger institutions already been registered?

MR. HARRIS: For quite a while. I mean, the large -- you know, my guess is 70 percent to 80 percent of the largest hedge funds are fully registered and have been for many years.

REP. GARRETT: Many years.

So if the issue is -- and I know there's a little bit of a debate whether we should register everybody or dis-register systemically important ones. Either way, we have already registered, for a number of years, the significantly important hedge funds, and so we see that that registration apparently didn't prevent us from getting into the situation.

So we have to step back for a second and thank well, mandating the registration of the insignificant funds -- hedge funds, whether that will have any impact other than out of the -- other than creating some of the other dilemmas. The bailout dilemma that was referenced before, the potential of a stepping in, to wind down a question that has been re-alluded to before whether -- will -- Congress will come back and say whether we should create authority to start winding down these things.

So I think that's another question we have to take that way and to consider is that -- we've already had registration of most of those entities out there and have them solve the problem. The other takeaway is that this is just -- from most of your opinion just the start of the process as far as registration? Well, I say that because the opening comments from the panel was from Mr. Capuano, this is just the beginning.

Mr. Sherman, said this is not the end of the discussion, and so that were we to have a markup today, and were we to pass this bill with registration, is it any of your understanding that Congress would not, and you had to see certain of my comments as well, be looking back to say registration is really not just the be all and end all here. We really need to have the overall supervision and some of these other constraints put in place that everything is going to end at registration.

Yeah, Mr. Baker.

MR. BAKER: I just would hope so Mr. Garrett.

REP. GARRETT: Okay. But what's the feedback from your --

MR. : No one, no one believes that.

REP. GARRETT: Excuse me.

MR. : No one believes this would be the final word.

REP. GARRETT: Okay. And Mr. Chanos, you made some sort of comment with regard to -- and you made a couple of good ones I can't get them all right now, but we're looking at hedge funds here, but I think you also made response to venture capital, equity funds, and the like.

Expense of just 10 seconds on that. We are looking at this. You are saying that we should -- if we do something we should be looking at all these guys.

MR. CHANOS: I think that it's important that we look at all the actors in the financial stage who are structured the same way, because attempts to single out different groups because it's the concern at the moment, doesn't really help us sometimes prospectively. And if we are going to be looking at all private investment funds, I think there should be a framework in which we look at all of them in the same way.

Having said that, I don't think the '40 Act are appropriate for today's financial reality. In fact, I've long personally felt that all of our securities acts need to be overhauled. Unfortunately, sometimes it takes a crisis for us to bring that to the fore again, but we really keep trying to put a 21st century financial system into an early 20th century regulatory framework.

REP. GARRETT: Right.

MR. CHANOS: And I think that that leaves a lot of things lacking on both ends, both in the regulatory side and on the investor side.

REP. GARRETT: And I think that all -- and I see my time is up, and I'm on latitude he is given me here, but I appreciate it. I think that's a good takeaway to end with is that the overall chairman -- Chairman Frank has said that we need a comprehensive look and we've been doing this ourselves -- at all the issues out there.

And if we try to fit a square peg in a round hole, I guess, it is an expression on just this one, we may be making a mistake -- mistake, and if we try to do it just today and then we're going to come back tomorrow where someone else comes up with the idea with venture capital funds or equity trades and do them into another square hole, and then later on we'd come up with the idea of a systemic regulator.

But by the time we do that, we may have already created a whole new -- well, maybe we wouldn't have created a mechanism, maybe we'll have used your analogy of the old law, which may not be the good one, and then we'll be coming back and say let's revisit it again.

So I think, you raise a great point, and Mr. Groome, you also raised a great point. I can't get into it with regard to an informed dialog, I don't know where we actually have any informed dialogs at all outside in the real world between them and the government.

But I think all those things really have to be -- come together in a comprehensive way rather than a piecemeal approach. But I appreciate the latitude and I appreciate the answers.

REP. KANJORSKI: Thank you very much Mr. Garrett.

And now we'll hear from Mr. Capuano, five minutes.

REP. CAPUANO: Thank you, Mr. Chairman.

Ladies and gentlemen, has any of you ever robbed a bank?

No? Have any of you ever murdered anyone?

MR. : I've seen a bank robbery does that count?

(Laughter)

REP. CAPUANO: Have any of you ever murdered anyone? No. Well, did you not do it because there was a law or did you not do those things because you didn't think it was the right thing to do? Did you -- did any of you not do it because the law says you can't?

MR. : No, of course, not.

REP. CAPUANO: You did it because you thought it -- well, you didn't do it because you thought it was the right thing to do. So therefore, you would agree that on some things, a societal line that says you cannot cross this line through the versions of a law works. Because those laws are written not for the good people of society or the good people of any group, but for the handful of people who would break that law, who would cross that line.

Is that a fair statement or you think that's an unfair statement? I assume that from your silence, you assume it's a fair statement? That's what regulation is. It is not about the 80, the 90, the 99 percent of any group of people who do the right thing, and do it well, and do it professionally and adequately.

It's about the 1, or 2, or 3, or 5 percent of the people who don't. That's what regulation is. Do any of you think that the SEC, over the last 80 years, has destroyed the economy? Do any of you think that Fed has destroyed the economy?

MR. : Well, we could debate that one.

(Laughter)

REP. CAPUANO: (Cross talk) -- reasonable regulation works. Reasonable regulation works, that's what we're talking about here. Is it a fair discussion to decide and debate, where the appropriate line is, of course is. And those lines change over time because the economy changes, the situation changes, society changes.

Absolutely. We all agree with that. But to say that there should be no regulation on some segment of any group, belies the fact that humans have frailties. There's always somebody willing to cross the line. And I'd just ask another question.

How many of you can tell me how many hedge funds are in the United States of America right now? How many are there? Not an estimate, and not a range, how many?

MR. HARRIS: I think that's an unfair question.

REP. CAPUANO: How is it an unfair question? How many are there?

MR. HARRIS: No one would know exactly.

REP. CAPUANO: I can tell you how many corporations there are.

MR. HARRIS: Not -- can you tell me how many private corporations there are?

REP. CAPUANO: I can tell you how many corporations there are that sells stock. Yes, I can.

MR. HARRIS: So we know that --

REP. CAPUANO: So, you can't -- can you tell me how much money is under management by those hedge funds, not an estimate, and not a range, tell me? Can you tell me how much of that money is put forth by institutional investors, so-called sophisticated investors who apparently weren't so sophisticated in the last year or so.

Can you tell me how much money has been put forth by public institutional investors such as pension funds such as yours? Yes, because you can't. I don't think those are unreasonable questions?

MR. HARRIS: No, with due respect, you can, I don't have that number right in front of me.

REP. CAPUANO: You can -- well, then I would ask -- if you can I would ask you to submit that later on. I understand you may not stop you -- (cross talk) -- because if you can, you are the only person in the America who can.

MR. HARRIS: But just keep in mind, you know, for better or worse, every pension fund that's public, you know, has to report. So that information is available -- -- (cross talk.)

REP. CAPUANO: I understand that the pension funds are not the only ones who do it, number one.

MR. HARRIS: I'm just referring to -- (cross talk.)

REP. CAPUANO: And number two, they don't all report uniformly. And number three, they don't report to a singular group. So I would love you to put together, I would, I really would, I'd appreciate it if you could get every pension fund in America, especially the public ones, I would love to see that number, because you'd be the first one that ever put it together. And I would hope that you have the staff to do that and I hope you do.

How is it unreasonable to simply say we want a general look, I'm not trying to be prurient, I'm certainly not trying to find out the investment ideas of individuals, that's not what we are looking for. I don't ask that from mutual funds. I don't ask that from banks. I don't ask that from pension fund.

What we simply say is when you get to the point, when you can move the economy, it is reasonable for society to say show us something, tell us what it is, yes sir, Mr. Baker.

MR. BAKER: Thank you, Mr. Capuano. I just want to point out, although I don't dispute the public need for understanding of something that is significant in the market, there are a lot of venture capital, private equity --

REP. CAPUANO: Totally agree.

MR. BAKER: -- private partnerships and small hedge funds, which should not be economically subjected to a rigorous registration regime.

REP. CAPUANO: Totally agree.

MR. BAKER: And that -- where that standard or that line is drawn is of course your decision, but we would like to be involved in that discussion.

REP. CAPUANO: Absolutely. We're on the exact same page. We may not be on the same page on what the answer is those are fair questions and reasonable questions. I would also argue that the 80-20 rule is a nice place to start.

But again, without knowing the exact number here, it seems everybody agrees that hedge funds -- just hedge funds -- I agree, private equity shouldn't be treated any different to anybody who is -- who can put enough money together on the table to move a market, should be subject to some transparency.

But if the number $1 trillion, 20 percent of that is $200 billion, if it's $1 trillion, it might be $2 trillion, we may be talking $400 billion. Now, if I were to sit here and suggest that $200 billion be used, oh, say for housing, my expectation of some of my colleagues might find that a little bit too much money.

Two hundred billion dollars is a lot of money, at least in my district. So, I'm not saying that 80-20 is not a good place to start, but to simply say that that's the line, don't look below that and they're subject to nothing, especially if they act as a herd, which many of them do, and you all know it, we all know it, and I don't blame them. I don't blame them.

I don't think that these proposals, especially the one on the table, can be considered radical by anybody except those who are just absolutely beholden to the total idea of an absolute free market, which is fine, I respect that view. I just, number one, don't agree with it, and number two, think it's been proven wrong time and time, time again.

Reasonable regulation is necessary for an effective, efficient, and equitable, and stable economy. Where those lines are, as Mr. Baker points out, totally agreed, that's the discussion we need to have. That's the discussion. The discussion is no longer, I think amongst reasonable people, about whether there should be some transparency.

For those who want to hold to that, good luck. You go home and explain it to the people that you represent.

Thank you, Mr. Chairman. I -- (off mike.)

REP. KANJORSKI: Thank you very much.

Now, we'll hear for five minutes from Governor Castle. Governor?

REP. CASTLE: Thank you, Mr. Chairman. Let me thank all of you. I felt your comments were very thoughtful and gives some things to think about in terms of what we think we need to do here in our committee and in the Congress of the United States.

One concern I have, I guess it's a concern, is you've cited this -- a couple of you two or three of you -- cited that you know, you are not as big as other entities, obviously, you know, banks but also mutual funds et cetera. But and this is maybe not the right time to be mentioning growth in this world of investments.

But I think, you are probably in as much of a growth area as any of those entities ultimately as we see more institutional type investments going into to hedge funds with some of the gains that have been made when the markets are stronger, I think that could return in 1, 2, 3, 5, 10 years something of that nature.

So my sense is that it is something we need to pay a lot of attention to. We can't be dismissive just because hedge funds aren't as big as something else. And one concern I have is that a lot of what you do, deals in fairly rapid market turnover, a volatility either in selling short, or in rapid gains, or whatever it may be, and while it may not be leveraged as you have well pointed out here today, it still could be a great influence in terms of what is happening to our markets out there.

And I'm not trying to be an expert on the markets. I don't really know a lot about that, or who the real buyers are, or whatever it may be. But my impression is, just from the little bit I know about hedge funds, is you are dealing with a lot more volatility and sort of a welcome aspect of what you do.

And that concerns me somewhat because that volatility, I mean, you could talk about it as stability, but I may talk about it as a matter of volatility, which may not necessarily be all good. I'd be interested in your comments on that.

MR. CHANOS: If I could take a shot at that, since I think I'm the actual only investor up on the panel here. In my day job, I actually run a hedge fund. First of all, as a couple of my colleagues on the panel have pointed out, hedge funds are less volatile than traditional investment funds, often by quite a bit.

REP. CASTLE: But let me, I don't mean to interrupt you but -- I do mean to interrupt you I guess -- but with respect to that, while you may be less volatile per se, but you are -- aren't you interested in volatility. I mean you may have a -- maybe not you -- but somebody may have a hedge fund that's selling short, they want to see volatility --

MR. CHANOS: Which is what we do actually.

REP. CASTLE: But somebody else may want volatility on the up side. Now, but you are looking for volatility.

MR. CHANOS: But in fact, we are often the cushion to the volatility against it. When people are selling in a hall, my fund, for example, would often be buying and vice versa providing liquidity. And the other side of the market, the volatility would be worse without players like that in the marketplace. So that's an important factor.

And number two, investors have lost far less money in volatile times in hedge funds than in more plain vanilla investment vehicles like mutual funds, which are highly regulated. Leverage is a concern, as a couple of people on the panel have expressed, and I agree with that. And it also needs to be in conjunction with the interconnectedness to bring back a previous theme of the financial system, for example, the banking system with the hedge fund industry.

Going back to 1998, in the long-term -- in the LTCM crisis, what made it so bad was not simply LTCM's positions, which were considerable, but the fact that their lenders had actually also followed them into similar positions for their own account. You know, someone have expressed concern about the rise of the shadow banking industry over the past five years.

I know one professor, Andrew Lo at MIT, remarked that he was more concerned by the rise of the shadow hedge fund industry as banks and brokers became increasingly trading entities for their own accounts. So all of this is interconnected, it is not just hedge funds.

And when you say trading patterns of volatility, the largest hedge funds we saw were the trading desks of the banks and brokers. And so, it is all of our markets which have seen increased turnover. But hedge funds specifically are not simply the only vehicles for either enhancing or dampening volatility.

REP. CASTLE: Let me call on Mr. Baker because I want to get in another question.

MR. BAKER: Just to follow up on Mr. Chanos' observation, the goal of well-run hedge funds is to minimize potential volatility. For example, if you are going to go long or buy a computer stock A, you may go short on computer stock B just because of your skills, you do your good analytics and you think you are right.

But just in case you're wrong, if the market goes sideways, and you're short B, that pays off some -- or mitigate your losses on being long on A. And so there are firms out there calling themselves hedge funds, which really don't deploy that kind of analytic skill or hedging that are in the market.

But the members of our association do that with the exact intent of minimizing the downside risks. That's why in the current marketplace, as Mr. Chanos has referenced, the hedge funds losses, although we've lost in broad measure, are far less than you will see in other regulated financial sectors because of that strategy.

REP. CASTLE: Mr. Chairman, may I ask another question briefly?

Mr. Groome, if you can give a very brief answer because I do want this question quickly.

MR. GROOME: Yeah, a lot of questions have been raised about high net worth individuals versus pension funds and such as that. One of the over -- and I'm also in the industry as well, I'm in a $3 billion fund of funds and a hedge fund business as well. And our fund of funds clients, in particular, are very large public and private pension funds and a few sovereign wealth funds.

When you ask them early stage why they're considering hedge fund exposure, or even more broadly alternative exposure, their overriding reason is to reduce volatility. So that diversification benefit is to reduce volatility in their overall portfolio.

The second very quick point I would make, you asked about the size of the industry hedge fund versus, mutual funds versus banks, I think size does matter to some respect, but size alone, as you heard me talk about the information template we would propose, we're talking about a variety of risk metrics.

And when you think about the banking industry, as I think previously noted, hedge funds may have been and may currently be somewhere between one and three times leverage, while banks even in their ongoing de-leveraging process are still well over 30 times leveraged in many of the major institutions of the world, which we have been concerned about started off in the fall of '08 close to the 50 or 60 times leveraged and it moved down.

So it's that leverage, by definition, will create the volatility in those institutions if you had equal transparency of their balance sheet that you have with hedge fund balance sheet.

REP. CASTLE: Thank you. I appreciate it. Let me ask another question, and this -- I am going to need very brief answers. My time is really up, but I -- you made some suggestions about the hedge funds. But I'm concerned about private equity funds, in general, and in venture capital. Some of the other things that you've alluded to as well in terms of their impact on the markets and the things that we may not -- we being the whole investing world as well as the public in general, and us in Congress, and the regulating agencies may not know a lot about.

And I just don't know what your thoughts are about how we can deal with systemic risk and investor protection issues beyond anything we've talked about today. We've talked about registration and other things that we could do. But there's a lot of which is happening out there, and a heck of a lot of it is simply unreported at this time. Do you have any thoughts about that even perhaps beyond hedge funds?

MR. HARRIS: I guess, outside the --

REP. CASTLE: You have to be brief -- (cross talk.)

MR. HARRIS: I will. It's unlikely that there -- my opinion is that there's not a lot of systemic risks from private equity. There may be a lot of losses, you know, over the course of the next year or two, but not a lot of systemic risk. The reason for that is there is $1 trillion of dry powder that has not yet -- that's been committed by investors, but not invested into the private equity area.

So there are high leverage transactions, but it's unlikely that their -- that they'll require any kind of governmental support.

REP. CASTLE: Yes, sir, Mr. Groome?

MR. GROOME: I would echo a couple of things. Number one, I don't think regulation, in any form that I've ever really truly observed, has taken a huge step to preventing systemic risk in and of itself, which is why in my earlier remarks, I said it's the informed conversation.

It's informing supervisors, getting supervisors to understand the business models that they're supervising and be more engaged, whether it's a hedge fund, a bank, insurance company, a pension fund or what have you, that informs the supervisor and the behavioral changes they can have on the managers of that institution through their ongoing conversations by asking intelligent good questions will change the behavior of those institutions much more than set rules or regulations will do.

Unfortunately, I think in the last 15 years, the model has moved much more to almost a rule-based system in a number of jurisdictions, not just the United States and not just hedge funds, in banking and elsewhere. And when I have gone to some of those supervisors and said, why aren't you still have someone who, 45 or 55 years old and for 15 years been involved with one institution and understands that institution so well, they understand it better than the CFO and the CEO.

And the answer seems to be that they've changed their models consciously because they think there's no system, quite frankly, in the world that can prevent outright fraud. And so what they get criticized for as supervisors are fraud, and missing fraud.

But they don't get credit, in this person's words, who is a longstanding bank regulator in a G-7 country, he said, "We never got credit for the institutions that never failed. We never got credit for telling this to the board that CFO meets the goal. We never get credit for that. We only got criticized when somebody committed fraud far a field from anything we ever had rules to deal with or supervisory capacity to understand."

So we kind of need to be careful, and in my opinion, I've argued for a number of years, we need to hire better supervisors, we need to pay them more, we need to give them better systems. The playing field is not level.

The institutions they're trying to monitor and supervise are so far ahead of them that they're always playing catch up. And it's supervision, not regulation, which will help systemic risk and financial stability.

REP. CASTLE: Thank you all. I -- just a final -- I don't disagree with you, Mr. Groome on that. But we, as a committee are sort of scouting it, how we better can handle systemic risk. So we're very interested in the insight for this sector at issue as well.

And I yield back, Mr. Chairman. Thank you, sir, for the extra time.

REP. KANJORSKI: Thank you very much, Mr. Castle.

Now, Mr. Lynch.

REP. STEPHEN F. LYNCH (D-MA): Thank you, Mr. Chairman. I want to thank the witnesses for their willingness to help the committee with its work. I do agree with one -- what was just said, and that is that government hasn't had the ability to keep up from the regulatory side.

We are basically operating with the same set of rules or constitution and statutes that -- we may have gotten rid of the powdered wigs up here, but we are still acting and dealing with a lot of the same issues we have for the past hundred or so years.

I do want to say though, one of the victories, I think, of regulation was the FDIC that stopped a lot of bank failures and created a lot of stability in that market. And I actually see the opposite, Mr. Groome, that we had Glass-Steagall, when we had a somewhat boring solid banking industry. And then when we got it away from that with Gramm-Leach-Bliley, it was a deregulation model that led us into this mess.

And as well, there are a couple of things that play here. One is the opacity of some of our institutions and hedge funds, especially, and complexity. The complexity of the instruments that people are investing in now have just made it very difficult.

I'm on the oversight committee as well and trying to make heads or tails out of these collateral debt obligations and other very complex derivatives. It's a pretty tough task for the average person, I would say. That much being said, I think that there is a role for responsible regulation here.

And I think all hedge funds should have to at least register to say, hey, we're in this business. This is what we are doing. And, you know, regardless of their size, I think everybody ought to step up and say we're in this business and we're doing this in a public market.

One of the things that kind of ticked me off was the president's working group asked for a recommendation. They set up a couple of panels there to offer recommendations about going forward. And most of their recommendations, all of them actually, just talk upon market discipline and say, folks got to understand more about what they are investing in. They got to do this, they got to do that and put the onus on the basic buyer beware, and at the same time, you do have all those complexity and opacity.

You know, you really can't get the information as a market participant on a lot of this stuff. And a lot of these pension funds that it just are -- representing regular people there, fiduciary responsibility is there of course, but their ability to conduct this research is highly problematic.

How do we get at that? Look, you got a bunch of hedge funds and market participants who take major positions, highly leveraged on one side of a trade, and it goes bad. And they all scramble to liquidate their positions and we got a major problem. It's, you know, this is a $1.4 trillion industry, and you can have definite systemic risk when those things happen as we've seen.

How do we get at that with just market discipline, be careful of what you're buying.

MR. CHANOS: Well, let me take a shot of that. Again, I have pension fund clients, and I have endowments as clients, and I have high net worth family as clients. And I have to tell you they are some of the most sophisticated investors who come in regularly, look at our books, look at our positions, ask questions, do the kind of work, that I think you would hope that people do from the investor side in our fund and they do a pretty good job.

I don't have all my clients do that, but the vast majority representing over 90 percent of my assets do that regularly and do a good job because in many cases, they are required to on behalf of their fiduciary clients. So I think it does happen. It does happen and hedge fund is -- (cross talk.)

REP. LYNCH: I can say as someone who has sat on a pension fund as a trustee with the IN (ph) office, I can tell there are a lot of funds out there that folks meet once a month for about an hour. And they are representing other people in the pension funds, and sure, you know, what percentage is going to hedge funds but trying to figure out what the hedge funds -- and actually hedge funds do provide a valuable opportunity for some of these pension funds.

I don't disagree with that, but what I'm saying is that that fiduciary responsibility is to understand what the investment is, and what the value of the assets are and how those values were arrived at, that's a deeper understanding than I think the great majority of these pension funds have. And --

MR. CHANOS: Most hedge funds allow their investors the right to do that if that work is not being done, it is not the fault of the hedge fund industry, it is their advisors --

REP. LYNCH: Right. I agree with that, I understand.

MR. CHANOS: It's the pension fund advisors who you should be talking to.

REP. LYNCH: Yeah. I'm sorry. Mr. Groome.

MR. GROOME: I would echo that. Our client base is also very heavily in the pension fund side of the world and they come in and have stringent due diligence on a very frequent basis and they get all the information they ask for. We provide it extensively in advance so when they come in, they have free rein of asking what they wish to receive and they will receive it. And we know that if they don't, they have the ability to take their money and go elsewhere.

I'm not sure if you were here for our statement, but just to repeat. In February, we came out very clearly at our organization at AIMA, and said, we support registration. But registration alone is not the answer. It really requires a transparency improvement and it requires -- and that in itself will lead to an informed dialog, an intelligent dialog between the supervisory entity and the hedge fund manager that is being supervised and has registered.

We, therefore, to compliment that, also recommended periodic reporting by larger hedge funds. We can debate, as we have, about what larger means and where that cut off should be, but I think if that number is too low, if that cut off is too low, the entrepreneurial nature of the industry will be endangered.

The economics of a small hedge fund will be challenged to meet some of the standards we're talking about putting in place or the reporting requirements we're putting in place. But transparency -- market discipline without transparency doesn't work.

REP. LYNCH: Right, we agree.

MR. GROOME: Market discipline needs transparency.

REP. LYNCH: Okay.

MR. : And just to follow up on your comments. And there is always a resource issue in some of these funds that you're talking about. And so I agree that, you know, many times it's -- the hedge fund is perfectly willing to show you their books; there's just nobody on your side to look at them.

The -- and that's got to be stated. The -- if you go to a fully resourced fund like ours, we require full transparency. We have access to the books any time that we want it, we take advantage of that. I'm on the president's working group.

We are requiring all of our hedge funds to be fully compliant with the president's working group by the end of the year, 37 of the 45 are already compliant. And the high watermark issue that's associated with pension funds will take some of these pension funds out of the game, and the market will work its way through, you know, back to a response that they will bring us back into parity.

MS. WILLIAMS: Could I jump in for a minute. I'll also like to echo that we found, in our report, where we looked at pension fund investment, and hedge funds, and private equity that resources were an issue. But I think you've also heard on this panel the issue of we provide any information that's requested.

So that requires knowing what information to ask for and then knowing what to do with the information once you get it. And that is a -- we found that to be a challenge for many smaller pension funds.

REP. LYNCH: I agree.

MR. BAKER: Mr. Lynch?

REP. LYNCH: Sure.

MR. BAKER: If I may join in. Ten years ago or a little over, when the first president's working group report came out. A member of Congress took that, turned it into the Hedge Fund Transparency Act, had a hearing and everybody came down from the MSA and opposed it.

I was the congressman who had that bill. Ten years subsequent to that, we now have just finished, at great expense and lengthy process of incorporating all of the president's working group sound practices -- recommendations into our own sound practices document.

That in itself is not of note. What is of note is that we send that out broadly to all investor groups, to pensions, to individual investors we can identify and say to them, measure your potential investment opportunity against these minimum standards

You can go beyond what we recommend, but if there's an aberration in what we recommend and they are significant. I'd be happy to provide them to the committee. They are on our website. We are also working very closely with AIMA on an international harmonization of those sound practices so that there is a global standard.

And there are some regional disparities where we won't ever come together. But in large measure what we are doing is in response to our investors. They are demanding these standards of disclosure, and we are providing them because it's what the market is asking for, and we believe them to be very high standards of responsible conduct.

REP. LYNCH: Fair enough.

Thank you for your forbearance, Mr. Chairman. I yield back the balance of my time.

REP. KANJORSKI: Thank you very Mr. Lynch.

See, we're trying to be fair up here.

Mr. Posey, for five minutes.

REP. BILL POSEY (R-FL): Thank you, Mr. Chairman. It's my belief, based on observation and experience that government will never get ahead of the leading edge of technology or creativity. I just think it's an unrealistic expectation.

But when that creativity or technology is misused, I think that's where we have laws like racketeering laws that should come in and set the record straight on what is an acceptable standard of use or misuse of that creativity with that technology.

You know, I think the standards overall, obviously, is, are you treating the people who are paying you or are you treating the public fairly. I think that's a pretty well-recognized standard that could be used and should be used. And as an example, I think somebody referred to earlier, of how the public reacts to different laws.

And, you know, if you are late for your plane flight and there is a five-mile stretch that if you did a speed limit you'll miss the flight, if you exceed it you'll probably make the flight. If you know the police are all over that road and they run radar regularly, you're probably going to miss your flight. If you know nobody ever gets a ticket on that road, you're probably going to make your flight.

And so, I think the public expects us, and the creative people, and the techy people expect us to set a boundary. And I think, we have kind of failed to do that. I use the example and I think a couple of you mentioned it in your writings. I know, Mr. Chanos that you did of Markopolos going to the SEC almost a decade ago.

Now, they were empowered to do most of the things I believe you said we need to look out for, but they failed to do it. They had 1,100 lawyers who file an average of one case every other year. And so it's just like having no police on the highway. You're going to expect people to speed if they know that there is no consequence.

And the chairman said before that, you know, we need to have people and be able to pay people to meet the standards that we expect to challenge. But I think it's almost going to be impossible to try and get ahead of the technology and the creativity curve. Again, I think we need to have laws in place for the abuse of that stuff.

And, you know, to my knowledge after the Markopolos screw up and $70 billion evaporate or however many it was I don't know that anybody was even reprimanded, I don't think anybody was fired. I mean, if it was any of your companies or any of our companies our senior management would have been gone in 24 hours. But somehow it's just acceptable to lug along and not do your job up here and the consequences are that we're looking at pointed fingers and over regulate down the road in the future. If my logic is bad I'd like one of you to point it out, where.

MR. CHANOS: It gets back to my comment about smart regulation, not more regulation. I mean, we have a body of people that are trying, I think, trying their best, but in many cases are overmatched or just don't have the financial experience to look at what they are regulating.

I mean, quite frankly we have an army of attorneys trying to oversee an army of market participants and there are some flaws in that quite frankly.

REP. POSEY: My thought was not that we try and regulate how you build the car if it's capable of exceeding the speed limit, but if, in fact, you use it to exceed the speed limit, you abuse people just like Enron does or just like other people have. If people have been abusing this process, they haven't been dealt with fairly, there should be consequences for that.

Don't try and re-engineer the car, don't try and reinvent the wheel, enforce the law, enforce a standard of fairness and whether the public or individual clients have been dealt with fairly I think that's a reasonable standard, a bottom-line standard that we should the Justice Department, the SEC, the FTC and everybody else on top of it right now to start cleaning -- (cross talk.)

MR. CHANOS: But my point is they don't even see the crime. That's -- and one of the ideas that's been banding around in our industry more and more, I heard, refers to the ranking member's, I think, concern earlier is in law enforcement, to use the metaphor, and military we have academies, we have colleges to teach our officers, our law enforcement people the latest in law enforcement techniques and military theory as they get -- go on in their career.

I mean, we need this in our financial area as well. We need financial boot camp. We need retired hedge fund managers and traders to come in pro bono and a lot would do it quite frankly to help teach junior regulators, middle regulators, and senior how to detect fraud, how to detect malfeasance on a trading desk, how to spot some of these things. There are patterns that occur down through history that it just -- I think over, and over, and over again our government regulators admit, again, smart regulation, not more regulation.

REP. POSEY: Mr. Chairman time for a follow-up.

Good. Well, actually, you know, we did that in another state. We had a problem cracking down on fraud and the excuse was we couldn't get confident people because they get hired away as soon as you train them and so instead of going out and just searching for these people we started training our own. And I think that's a real good suggestion maybe that we might take into consideration and think about that.

MR. CHANOS: I have people in our industry who are coming forward to me to my organization and we would volunteer or retired people. I would be happy to do that as a public policy.

REP. POSEY: That's good idea. Thank you.

REP. KANJORSKI: I think it's an excellent idea. Can you give us a little -- two page around that?

MR. CHANOS: I would love to submit something on that.

REP. KANJORSKI: I appreciate it.

MR. GROOME: Mr. Chairman, if I just one -- if I may.

REP. KANJORSKI: Oh, yes.

MR. GROOME: You might also reach out on the same topic to the FSA in the U.K. because they too reach out to the industry and have people come as -- (inaudible) -- into the FSA for some time period, where they benefit from their knowledge and understanding of the industry. I mean, I would just echo everything that Jim just said, but rephrase it differently. We really want to have supervisors who understand what the right questions are. It's understanding the questions even more than the answers that are really, really important.

REP. KANJORSKI: And before I --

MR. BAKER: Mr. Chairman, if I can jump in just to tail into that process. I just wanted to volunteer the MFA staff will be meeting with the SEC staff next week on exactly that discussion, how to improve the accuracy of their examination process.

We have found that all too often they spend an inordinate amount of our time for no apparent end result. We think they can get in and get out with the right tools much quicker and go to the material facts that really make a difference. And we have voluntarily reached out to the agency to help in that effort.

REP. KANJORSKI: Yeah, that's pretty good. Mr. Baker, may I make a suggestion. When you talk with the agency that way perhaps we could have staff from the committee or even members of the committee knowledgeable about this conversation that is occurring because what you may put their hands never tends to get here.

And in reality, you know, we're the ones that are in right -- in charge of what has to be done. So if you think about it and maybe we could have a better line of communication by getting some -- I don't think that violates any separation of power.

MR. : Mr. Chairman, subject to appropriate ethical oversight, always say yes to a chairman.

(Laughter)

REP. : Mr. Chairman.

MS. WILLIAMS: I would -- I've got one thing to add about SEC. SEC, when they first require registration, they had hedge fund -- members from the hedge fund industry come in and teach OC and enforcement staff when they first moved toward registration that was ultimately turned over by the courts. So they have been engaging in some of these types of activity in the past.

MR. HARRIS: I would just counsel you that when you do that you need to discriminate between two types of risk. One type is risk monitoring which, frankly, is a huge distraction to what you're doing. The other type which is for lack of a better term I call bullet-to- the-brain risk is what you need to focus on. And that list of questions is probably no more than 10. It's not 100. And when you go beyond your 10 or 12 key questions to 100 or 200 or 300, you diminish the effect of the 10 that really matter.

REP. KANJORSKI: Very good. I just -- before I recognize Mr. Foster he -- I think we had him to start -- get ready to start on here several times but I am not trying to -- (off mike.) All right. What I don't understand -- and if someone later on after this session if we could hear from you on the point -- with the Madoff disaster that the amount involved and the 13,000 victims and most of the victims were very sophisticated people.

And how due diligence failed there shocks my understanding of what we can do to improve the situation of examination or knowing what's going to happen just the size and the sophistication of the victim. So, if you could just give that and then we --

MR. HARRIS: Can I give -- first of all, just to give an institutional perspective, I've been doing this since 1985. I've run three or four of the biggest funds in the country. I never heard of Madoff in my life. I'd never heard of Madoff in my entire life. So he was not operating in the realm where this kind of due diligence was being done.

The individuals that you're citing are sophisticated, but they are not financially sophisticated. This was Country Club, you know, this guy does great, puts the money with him, it was no -- as far as I can see and I've just read what you've read in the papers, there was no due diligence being done. He was operating outside the system with individuals, mouth-to-mouth, you know, a long-term Ponzi Scheme. People like me who operate in an institutional world he never came across our doorstep once.

MR. GROOME: Or to say the same thing in a different way, we had someone actually approach our organization several years ago and ask us if we knew that fund, knew that person and if we would mind on their behalf to meet them and because there was an existing client in a different part of the business they did so.

Prior to the meeting our due diligence team was told these are the questions you're allowed to ask. And we said, we're not interested in the meeting. So the signal can be quite clear this is about my point about, know the questions, much more important sometimes than the answers.

REP. : And Mr. Chairman, I --

(Cross talk)

REP. KANJORSKI: -- but I'm going to stop it right here. And say Mr. Foster, you've been kind to -- and diligent to give us the time. You're recognized for five minutes or more as the case may be.

REP. FOSTER: Okay, thank you.

I guess the first question is for Mr. Baker, you'd characterized the hedge fund industry as a relatively small $1.3 trillion or $1.5 trillion industry with the leverage in the range of two to three industry average. And I was wondering what is the notional value of all the swaps and off-balance-sheet obligations in the hedge fund industry.

MR. BAKER: It would be difficult if possible for me to give you an accurate estimate, but I'll try to get back to you subsequent to the --

REP. FOSTER: Can you assure me it's under ($)10 trillion, for example?

MR. BAKER: I won't make a representation to you this morning until I do some analysis, but I'll be happy to get back and, of course, forward it to the chairman as well and the ranking member.

REP. FOSTER: And, you know, one of the -- I guess it was Ben Bernanke and others have made the analogy between AIG as a healthy insurance company with an unregulated hedge fund grafted on to it. And that from that point of view the collapse of AIG is sort of a preview of what the collapse of a big hedge fund will look like. And I was wondering if you have a reaction to that analogy and is that -- (cross talk.)

MR. BAKER: I was hoping that the chairman was misquoted that he was hoping the AIG was a hedge fund because its losses would not have been so precipitous. Had they been exercising any standard of due diligence in their investment activity? No, I -- in serious a mode took affront that for our industry that we would be characterized in such a fashion.

The one closer it gets to the taxpayer's wallet I understand the regulatory encroachment, but hedge funds raise their money, they invest their money, and their investment advice is on the table with their investors. And if the fund makes money, sure, they make money. If they lose money, guess what, they lose money. And in the unfortunate event occurs where they go out of business strange people show up and sell your furniture. That's the end of the story.

REP. FOSTER: Right.

MR. BAKER: There is no --

REP. FOSTER: That's the model that works as long as they don't have off credit sheet obligations that are enormous compared to actual assets --

MR. BAKER: And today --

REP. FOSTER: And there is huge counterparty risk. And can you assure me that there are no AIG financial products out there in the guise of the hedge fund --

MR. BAKER: And today there has been not one -- (cross talk.)

REP. FOSTER: I understand, I understand they have not -- well, they have not yet blown up. The question is can you assure me that there is not an equivalently violent explosion waiting in the links.

MR. BAKER: If the question is, do I believe there will be some failures in the future that I cannot name with probability, will those be -- will those future failures result in some systemically significant event, very unlikely.

REP. FOSTER: Okay, let's see. Mr. Groome, you said you supported periodic reporting by large hedge funds. And I was wondering what exactly periodic might mean, or you had some discussion at large. We've learned in the collapse that the time scale for a collapse is hours to days.

And so it seems to me that that periodic reporting has to be the same sort of thing that happens internally to the investment banks that still exist and also I presume large hedge funds where they net out the enterprisewide exposure to various things almost on an hourly basis.

And I was wondering if -- is there anything short of that -- sort of very frequent reporting that will actually allow a systemic risk regulator to do its job.

MR. GROOME: Yes, I think so. I mean, in the conversations we've had in this country and elsewhere with our membership, we've heard everything from monthly to annual. And that includes all parts of that spectrum. Annual is clearly not enough, monthly is probably too frequent for the cost involved and the ability of the supervisor to analyze it and use it. And so what I tended to hear is people gravitating towards quarterly or maybe semi-annually. But that tends to be the timeframe people are talking about. Now, I hear --

REP. FOSTER: Now, why then do investment banks and large hedge funds, do it, you know, at least daily. And so why is it not useful for something that is responsible for the stability of the whole government -- the whole financial system? Why is that a less stringent requirement than just for the survival of an individual firm?

MR. GROOME: Well, you could, I mean, I would phrase it this way. Systemic risk doesn't occur overnight. It builds up over time as it has in our system over the last several year to the detriment of what we experienced in the fall of 2008.

And in the business, for example, a number of hedge funds dedicated to the short selling effort were the canaries in a coal mine as far back of 2006 telling us exactly what those risks look like and executing transactions to demonstrate their disbelief in the valuations of certain bank portfolios and mortgage value.

What the system we're contemplating, we're proposing, we've discussed the supervisors, we think it has two benefits. It has a national benefit to say an SEC or the FSA where they can identify outliers in the system. They can look across strategies and see consistency as they usually will among the approach to that based on liquidity, leverage, and other thing -- to the extend somebody stands out that's where Ms. Schapiro or others have said that will be very useful to take a rifle out and now not have the shot gun approach and be able to identify those outliers.

On the international stage, the financial stability board as well as the Treasury and the Fed in this country would take that information and monitor developments over time and asset classes and you can clearly see the buildup as we did see and everyone has talked about for years in the structured credit and the mortgage markets which ultimately did explode.

REP. FOSTER: So you don't believe that it's possible -- a logical possibility for a systemic risk to buildup on a time scale of days?

MR. GROOME: Well, I wouldn't say it's impossible, but I can't contemplate it right now. What I'm saying is the risk in the system doesn't just generate over the course of hours or days. The risk has to build up to such an extent that you're exposed over the edge. And we've seen that occur time and again.

REP. FOSTER: Okay. I yield back.

REP. KANJORSKI: Thank you, Mr. Foster.

Mr. Royce, California, five minutes.

REP. ROYCE: Thank you, Mr. Chairman.

I was going to ask Mr. Baker.

You had mentioned in your opening remarks there about the extensive training rules and reporting requirements that hedge funds are subject to under existing law. As I understand it on top of that, the majority of hedge funds now register voluntarily with the SEC. And I think it is about three-quarters of the assets that hedge funds have in their portfolio, but could you expand on the requirements themselves?

MR. BAKER: Sir, I'd be happy to provide you and the committee with the document that gets distributed to an office when the SEC is about to visit. The historic document is about 20 pages. It is very extensive in the disclosures that are required. It is not named rank and serial number only and that is the beginning of the process.

Obviously, the agency after entering a firm as it discovers areas that it has interests will even expand the scope of those enquiries as it deems appropriate. I mentioned earlier in the hearing to the chairman that it's not uncommon for those examination processes to extend months, in fact, longer than a year is not that unusual.

So that contrary to most public perception about the current oversight system, voluntary though it is, it is very extensive, very time consuming, and very difficult for the firm to be responsive to all of the questions that are raised. That being said, others on the panel have indicated that SEC resources are very limited and that the experience of the examiners all too often is not appropriate for the business models layer examining.

And we believe that that leads to unproductive work for the -- on the government side. And that a sharper focused examination trigger and then a sharper set of skills being involved in the examination process would yield benefits to everyone.

REP. ROYCE: Let me ask the witnesses this, we witnessed some gross negligence on behalf of the SEC, I guess, is the way you would view it in terms of the Bernie Madoff circumstance and Mr. Markopolos testified here and we had an opportunity to talk with the investigators for the SEC. Do you believe that the SEC and other financial services regulators are currently equipped to conduct examinations and other necessary regulatory steps?

One of the -- to me one of the interesting aspects of this is the amount of market discipline and due diligence that you see in institutions. And I guess Britt Harris would have some -- Britt, you might have some observations on this with the Texas Teachers, you know, the pension funds. The amount of examination you do I opened my remarks this morning just contrasting this -- you are leveraged 2 or 3:1.

Fannie Mae or Freddie Mac, the government sponsored enterprises that we had oversight with, we allowed them to go into arbitrage pushed them into leveraging 100:1. And at the same time Congress against my advice, as certainly against Mr. Baker's, Congress did not heed the request of the federal -- of the Fed when they said these need to be regulated for systemic risk you have to deleverage these portfolios.

So here you're contrasting leveraging 2 or 3:1 to leveraging 100:1, which was done under perhaps the most regulated environment. But one with the regulation by the Congress came something else, came also the ability of the Congress to direct those investments, to set those goals for subprime, to set those goals for all pay loans, to set those goals in terms of who you're going to loan to, and to build up the risk between the over-leveraging and the type of activity.

And I suspect that one of the concerns is always with congressional oversight comes the assumption that the regulators that are involved in this have the expertise. And I guess one of the real questions looking at the SEC as a result of the investigations that, you know, and the hearings that we held this was a sobering hearing, when we had Mr. Madoff here with a loss of $65 billion over something that the SEC failed to catch. Any observations on that?

MR. BAKER: Mr. Royce, I would jump in and say from a market discipline perspective the regulatory team should be viewed as -- I hope it's not an inappropriate characterization -- as the law enforcement official who get called when the act is obvious to everyone. In my home state we have a lot of neighborhood watch subdivisions, where the community itself reports suspicious activity to law enforcement because they can't be everywhere all the time. That's the function of the private market in the financial world.

Mr. Chanos engages in his work and determines that values are inappropriately inflated. He takes a financial position on that matter. When the pension fund -- Mr. Harris does his examination, he goes through a series of sophisticated steps to make sure that when he writes the check for his pensioners, dependent on his judgment that he's asked all the right questions and gotten responsible answers. That's the neighborhood watch response.

Sure, you do need to have some police around, but they can't be in every neighborhood on everyday to stop every violation when you're trying to get to the airport on schedule. So, I think the responsible way to balance this is to rely on a strong neighborhood watch program and where market participants do the due diligence. And, frankly, I didn't get in on the Madoff matter and how it got that far advanced.

Members of our association looked at the Madoff matter and voluntarily decided this wasn't a place for their client's money to be placed. There were a lot of warning signals. But the attractiveness of inflated returns over a long period of time and having such -- you may remember from the Fannie and Freddie days the steady Freddie's label.

Anybody who promises no volatility in returns for a decade or more, you need to be careful. And just that alone should have been sufficient for people to have exercised better judgment, but the man was a great fraud, one of the best ever and he made up the trade. He reported non-factual figures. Everybody did what they should have done appropriately, but the man lied and the result is a lot of people got hurt.

REP. ROYCE: Thank you, Mr. Baker.

Thank you, Mr. Chairman.

REP. KANJORSKI: Let's see. We'll start one -- hold on. Mr. Himes, we're going to give you your five minutes.

REP. JIM HIMES (D-CT): Thank you, Mr. Chairman. And thank you very much for the witnesses assuming those doors stay closed you are less than five minutes away from being done. I appreciate your testimony. I've got a small question and a big question. I appreciate much of what you've said.

I take small exception though. There was a lot of discussion about the average level of leverage in the hedge fund industry. And when the witness said -- I forget who said it -- I was reminded of that old song, never ever try to walk across the river that is not in average, four feet deep. We do not care about the average, we obviously care about that institution which once every year or once every two years is going to get itself into trouble. So that's what we're focused on here.

And my small question is I'm even a little -- were this is simply an industry of high net worth investors, I would be a lot less worried than I am. It is an industry in which we've seen pension and other public monies come in where there is a whole set of issues there. I want to set that aside, it is a little beyond the scope of this hearing. But what really does worry me are those entities that are employing the kind of leverage that we saw with long-term capital management and what not.

So my question is this, I'm not convinced that assets under management is necessarily what we want to watch. How do we best watch those entities that are taking on a lot of leverage? And I'll ask from it one or two responses because I have a larger question behind this one. What is the number? Do we watch the banks? Do we watch a set of -- what is the number at which we should make a cut off of who we watch for this purpose?

MR. CHANOS: Well, one of the ways in which the Fed, both Chairman Bernanke and Chairman Greenspan, pointed out was the one way to monitor leverage in the hedge fund industry is to be looking at the prime brokers, the banks and brokers that domicile their accounts, they typically are in banks and brokers not in trust accounts.

So you can, in fact, monitor from a systemic point of view from the other side of the telescope, the amount of leverage relative to equity in major accounts in the top 20 percent with 80 percent of the assets, for example.

There are ways to get at this from the -- from where the accounts are housed from a practical point of view. Now, you still might miss various forms of hidden leverage or derivative exposure, which was alluded to earlier.

REP. HIMES: I'd like to come to that, but just -- and in fact, I want to come to that right now. But just ballpark figure, give me a sense, give the committee a sense if we're really after those hedge funds capable of employing the leverage that produces a systemic risk order of nine to two are we talking about 10, 100, 1000 -- how many hedge funds are we talking about?

MR. GROOME: Well, I'd come out -- let me try to answer that. In my testimony I said that, you know, we proposed 500 million or some sort of cut off for registration. And then I think that actually needs some real thought for ongoing reporting or standard required. And I gave an example if you change that to a billion assets under management by the hedge fund manager, you still are capturing 311 hedge funds worldwide by our account, appropriately 215 of those are in the United States.

That group would represent 80 percent of assets under management so you get a feel for the industry. Two comments, I guess, qualitatively and that -- and if you move that number, by the way, to 2 billion you really only go down to about 200 hedge funds and 70 percent of assets. So you don't get a lot of bang for your buck by that move.

REP. HIMES: Thank you. Thank you, okay. Larger question, I direct this to Mr. Baker. Mr. Baker, I'm also interested in synthetic leverage. And I want to pick up on an example that you used. You go long in computer company A, short in computer company B where -- let us take a huge position because we've leveraged out all but the risk that we want to take.

Well, as you and I know, occasionally you get whipsawed and you are short in computer B -- company B rises and your long falls and you're now in a position where you're effectively taking on an awful lot of synthetic leverage. I really worry about that probably because even though I spend time in the industry, I'm not sure I can identify all of those generators at synthetic leverage if you will.

So I'm going to ask you, can we -- I wonder if you have done any work, the organization has done any work identifying those areas and in the very limited time that remain can we -- can you talk a little bit about those areas where it's not bank lending, but it's significant leverage.

MR. BAKER: Sure -- excuse me -- sure, I can. We don't have any studies particularly on the point, but we can certainly provide you with a more detailed response. Quick answer would be, don't forget the manager's money is on the table with his investors. That's an extremely important factor in taking outsize risk.

Secondly, where you do have bank lending the Fed has supervision over the bank holding companies, which is a way in which Mr. Bernanke and others can get access to look exactly inward at those activities and make judgments about risk. Ultimately, I think it is the management of the entity and his responsibility to his investors that attempts to seek some sort of operational balance on a given day. Yes, people are going to lose money.

I go back to the observation that the government role traditionally, is not to preclude business failure it is to make sure that a failure of an entity doesn't affect innocent third parties. And I think we can do that with appropriate operational standards conduct.

REP. HIMES: Thank you, thank you. And I see I'm out of time, but if your organization perhaps are working with the other witnesses could generate nothing more complex than perhaps a list of mechanisms that can create, if you will, synthetic debt or synthetic credit exposure that would -- (cross talk) -- thank you very much.

REP. KANJORSKI: I think we're down to Mr. Grayson now. Mr. Grayson, five minutes.

REP. ALAN GRAYSON (D-FL): Thank you, Mr. Chairman. I think the lesson of the past year has been that we have to try to avoid systemic risk. And I'd like to explore with some of you, in the time that we have available, what the substantive role should be to prevent institutions from creating risks that lead to taxpayers having to shell out $100 billion or more to AIG in one instance and many other instances that we have seen from the past year.

So, I'd like to know not simply about honestly clichés like best practices, but rather what the limit should be. How much leverage is too much? At what size does an institution become counterproductive because of the institution instituting systemic risks that puts the whole system at risk? Tell me what you think the limit should be. Let's start with Mr. Baker.

MR. BAKER: I can't give you a direct response to your question, Congressman. In that simply an asset under management test isn't really sufficient for the systemic risk concerns in my view that there are other elements to that consideration as in the prior conversation discussing leverage.

A smaller firm, highly leveraged can have just as much effect as a larger firm that is not. The interrelatedness of counterparties is certainly very important in this current environment. My members spent a lot of time analyzing the financial stability of the broker dealers in which we are engaged. That didn't use to be the case.

Everybody is watching everybody, is the best way to describe the current market condition because apparently innocuous not significantly large by any standard or asset under management measure can become systemically significant in the right set of market conditions.

REP. GRAYSON: All right, let's assume that there are a number of different variables that need to be factored and of course, making it sound complicated often leads to inaction. So let's assume that we've identified an institution that pose a systemic risk, what would you do about it?

MR. BAKER: Well, if I was Mr. Chanos, I would probably short him -- no, I'm kidding. The inconsequence of this question is one that has plagued the Congress for 25 years. We've debated what actions would one take if you identify a potentially harmful event. Who should make this judgment and what authority should they be given to act in that consequence.

There isn't an easy answer to what you are posing in that. I will put it in this context, if you went back prior to LTCM, LTCM never had back to back two days of trading losses. They were run by Nobel Laureates, they took money for three years and don't call them.

They were having outsized rates of returns and because of a unexpected soviet currency crisis, that no one could have predicted, they went bankrupt in a matter of a few days. How one could have gone back, 30 days in advance of LTCM and given a regulator authority to forecast that and then decide what action should have been taken to preclude losses is a difficult question.

REP. GRAYSON: Is it really, I mean, in the case that you are mentioning, there was 100:1 leverage used with billions of dollars as their capital base, don't you think that would make most people a little nervous?

MR. BAKER: There were people lined up wanting to invest in LTCM that couldn't meet their investment criteria. So, I go back to Chuck Prince at Citi, as long as the music is playing it's hard to quit dancing. And when you are having outsized gains, to exercise caution is a very difficult thing.

REP. GRAYSON: Well, the right answer cannot possibly be do nothing so let's go on to Mr. Groome, and if we have time, Mr. Chanos. So you can tell me when big is too big.

MR. GROOME: Well, I would -- it's really continuation of the conversation we had with Mr. Himes in some respect. And you can set a threshold for what basically, as someone is going to provide information to supervisors. But within that you have to qualitatively understand the business model after I question.

So for example, to specifically address your question, I would, if I were in a supervisory seat, think very differently, for example, within the hedge fund world about long, short equity funds which are acted in very large liquid markets. And I would think differently about much smaller hedge funds, which are in markets where the margin of their trading is very tight.

The liquidity of their assets is very sporadic. And therefore, sometimes, they maybe highly leveraged to try to maximize what's going on in that environment. That to me would send off, the supervisor, a greater signal of concern than just simply someone who is very large size.

REP. GRAYSON: But again, complication leads to inaction. Mr. Chanos, can you give us an answer?

MR. CHANOS: I'll go out on a limb 100:1 in anything is too much.

REP. GRAYSON: I agree with you.

(Laughter)

But let's try to explore that a little bit further. Why can't we develop a system, or can't we develop a system, where we can say with reliability that an institution that poses system threat will be barred. Why haven't we done that yet and what do we need to do to get to the point where that actually happens in a reliable basis?

MR. CHANOS: I mean, that is beyond my little expertise, Congressman. I don't know at what point someone with the authority to do wind-down in a systemically important institution says, "I've got to do it here," based on just level of that -- level of leverage versus perhaps incurred losses or interconnecting this which was also part of the LTCM problem.

Again, it wasn't just the leverage, which was, as you point out considerable, and by the way inter-reporting as well. Some of these entities gear up in between periodic reports and then gear gave back down including current regulated entities like banks and brokers. So all these things are part of a mosaic of risk that my quip of about a 100:1, which I was serious about only, you know, underscored that there does seem -- you need to see just how interconnected some of these entities are, and how much additional leverage the herding accounts for. And I don't know, I don't know what the answer is for a systemic risk regulator, or a Fed, or a comptroller of the currency to come in and step in at some cutoff level.

REP. GRAYSON: All right. My time is up but I think this is the fundamental question that's facing us right now. We need to have somebody who is willing to say, "Enough is enough." Thank you.

REP. KANJORSKI: Thank you very much, Mr. Grayson.

The gentle lady from California, Ms. Speier.

REP. JACKIE SPEIER (D-CA): Thank you, Mr. Chairman.

I have an article from the Washington Post dated October 19, 2005, which I would like to submit for the record without objection.

REP. KANJORSKI: No objections, so ordered.

REP. SPEIER: All right, it's an article by Steven Pearlstein, "Hedge funds get tangled in bad business cycle." And it underscores just an -- a number of hedge funds that were in trouble, back in 19 -- in 2005. And at the end of the article he says, "With $1 trillion in assets, hedge funds have become a dominant force in capital markets, accounting for as much as half the daily trading on the stock market, hundreds of billions of dollars in bank loans and a healthy chunk of profits of Wall Street brokerages. Federal regulators cannot guard against systemic risk to global markets if they don't know what hedge funds are doing."

Now, this was back in 2005, when it was only $1 trillion, today it's $2 trillion. And I must tell you that I am not at all sanguine by your comments today that some how registration is enough because I don't think it's enough. This is very reminiscent of what the Congress said with the Modernization Act, when we prohibited the regulation of derivatives.

So with that said, I would like the auditor, Ms. Williams, to tell us what kind of regulation you would recommend?

MS. WILLIAMS: I would really point to our regulatory framework that GAO laid out earlier in the year, that any regulatory structure needs to address several elements. And I'll briefly note two, one is that it needs to be comprehensive. That is, in order to deal with another element of having a system-wide focus, the regulator or the regulators have to have a view of the entire system and all of the players in the system.

So, with hedge funds, what comes to mind is here we're dealing with the known unknown. We know that hedge funds are players in the market but specifics about the hedge funds, the number of assets under management as well as the strategies specifically and their impact on the market is largely unknown. If you dealt with some of the known unknowns, that would allow a systemic risk regulator to begin to focus on the unknown unknowns.

So I think, information to the regulators that provides insights about hedge funds from their lowest investors in the market is key, because that's what we're currently seeing with hedge funds being involved in kind of, come and bring us out of the current crisis that we're in through TALF, for example, is that the markets had come to rely on them as investors.

So therefore it's important to know where they are investing because they can move their assets, to different assets depending on what's going on in any particular market. They move -- can move in and out of equities, they can move in and out of commodity futures and have impacts on those markets when they are there and also when they move to another market.

REP. SPEIER: All right, having heard that from the representative from the GAO's office, I would like to have each of you respond to whether you would object to that kind of regulation?

MR. BAKER: If I may, Congresswoman, I think the registration proposal as I understand it would provide much of the information, if not all, just to make sure I'm not overstating the case. That the GAO has indicated, would be helpful for regulator to make an informed determination about actions that might be required.

REP. SPEIER: Let me ask you -- just go down the line and I refer the question for all of you.

MR. GROOME: We too have said that registration is not the end that the second component of registration has to be better information gathering, and periodic reporting. And we've been working over the last several months with people of the G20 and the Financial Stability Forum and authorities in this country sharing ideas on what that template should look like. And in fact, starting last week, there was an experiment undertaken, if you will, of a consultation with the FSA and 20 large hedge funds to get their feedback directly on what that template may look like. So we're very -- our members are very open to starting to provide that systemically relevant information to a supervisor.

REP. SPEIER: All right, my time is going to be up very soon. So I think what I would like to do is just ask all of you this final question. Warren Buffet files audited quarterly financial statements, would you be supportive, as a part of registration, a responsibility to do that, that were indeed financial statements that are audited. Just go down the line and if you would respond.

MR. BAKER: I guess I should start --

MS. WILLIAMS: Correct.

MR. BAKER: I would say that disclosure to a regulator as long as it is nonpublic, we would provide the regulator with any information they would ask us for.

MR. GROOME: We would do the same thing. Our members have said they would -- they would support a periodic reporting system quarterly has been mentioned as the appropriate deadline, time period, two supervisors. We've also acknowledged that on a confidential basis that information should be aggregated and shared at a broader level such as the Financial Stability Forum, but obviously on a confidential aggregated basis.

MR. CHANOS: I would agree with that.

MR. HARRIS: I would just say -- first of all, warn about the dozen short so that -- whether this nondisclosure is the most sensitive. The -- if you were to go down that and I also would modify maybe what I thought I heard you say, because of the -- I think there were many people here who are for -- for proper disclosure at the right organization.

The problem with the comprehensiveness is, you would dilute your effectiveness. You won't be able to -- you will be monitoring somebody who is much too small to make a difference and diluting your ability to monitor people who are large enough to make a difference. The --

REP. SPEIER: I think my time is expired. Thank you, Mr. Harris.

Thank you, Mr. Chairman.

REP. KANJORSKI: All right. Thank you very much Ms. Speier.

We have a few more moments. We're anticipating a vote. If there is no objection, if you want to continue for a few minutes? I would have a few more questions so -- in the responses to some of the examiners earlier, I heard an overtone that there wasn't a great deal of respect for the professionalism and success of the SEC, is that something I'm detecting is correct, or in fact is there --

MR. CHANOS: I think they are trying hard, Chairman. I really do, and I think they are working hard. And I think they don't have enough resources but its not for lack of effort and not for lack of trying to do the right thing on behalf of the American people. But I think they are just over-gunned and overmatched.

REP. KANJORSKI: That's a good political answer, but is that the real -- I mean -- (cross talk) -- I'm sure you will understand. Now, the question I'm asking though is, we're going to have the opportunity to do some patchwork in some of these areas that we've discovered or already lend themselves to systemic risk and other difficulties. And we've -- and a lot of legislation here is occurring to cover that patchwork. On the other hand, as we approach regulatory reform we also have a great opportunity now, I think. And I'm saying opportunity to fundamentally have comprehensive reform.

And I think one of the things I heard mentioned was the FSA in the U.K. and it sounded as if there was an opinion that they maybe doing a superior job because of their structure, being a single regulator having capacities to do things perhaps look at the systemic risk regulation because it's all under one context as opposed to our separate regulators.

Do you think that we should speed along patchwork legislation to fill the voids and the holes that we've already discovered regardless whether or not these are in conflict in some instances with long-term comprehensive reform, or should we keep our eye on the long-term comprehensive reform to take us out of the 20th century and bring us into the 21st century, which I think I heard one of the witnesses talk about, yes.

MR. GROOME: I would -- my view on that, Chairman, would be to take your time and to come up with a comprehensive proposal and identify very clearly what these risks are that we are trying to address, and how best to address them. And to repeat something that I said earlier, I think better supervision is welcomed, increased regulation without better supervision tends not to achieve the goal.

I believe, I probably made the comment about the FSA. The FSA is also doing some self-examination. They've had difficult time with their banking system and elsewhere. And so there is a real self- examination going on there. And I think, as a part of that, they are also looking across at the Bank of England and saying what is the appropriate division of responsibilities and coordination between our two bodies. So you might find there is a very similar examination going on.

REP. KANJORSKI: Okay. Just as a little add-on to that, I recently made a presentation in Prague to about a dozen members of the EU and with a -- about a dozen members of the Congress, where we were trying to look at international regulation and the need for it. Are we significantly behind the curve by having to meet the needs of the global economy and dealing from a state by -- or nation by nation basis of regulation, or do we have to speedily move to some international regulation, do you have a --

MR. BAKER: I would suggest and I know Mr. Groome can address this perhaps better than I that there is considerable ongoing debate on the continent, at the moment, as to the measure of oversight and the level of accountability that hedge funds should have there. And it has been a very contentious discussion lasting now for considerable period of time. I don't know that the current directive which was issued this April 30.

MR. GROOME: Last week.

MR. BAKER: That has come out will ultimately be adopted by the member states in the form in which it was proposed, but suffice it to say their discussion of financial reform has been ongoing longer than it has here. And we are attempting as an MFA to reach out to AIMA to harmonize those standards as best we can suggest to policymakers because your concerns about the global consequences are right on target.

MR. GROOME: We agree. We think it is time to move to a more global set of standards on a variety of issues including hedge funds, and not just hedge funds. And second, that is not the answer either in and of itself. Due to different legal systems, tax systems and even the desire, quite frankly, for an intelligent, informed supervisor to maintain some discretion, that national authorities need to maintain the ability to interpret and have discretion on the implementation of those international standards.

But at some level, I think in today's world, and today's very interconnected markets around the world, it's increasingly important to have a global standard with, as I said, some degree of national discretion just recognizing the obvious differences in tax, legal, but also I think very healthy for a supervisor to understand their jurisdictions and employ those rules.

MR. CHANOS: One of the things we noticed about the EC proposals that I mentioned in my written testimony, Chairman, is that it -- one of the positive aspects of it is, it does attempt, as we called for today, to craft a specific set of regulation and legislation for private investment funds keeping them distinct from mutual funds in the continent or unit trusts and so on and so forth.

So that would be along the same lines as we were advocating in our written and oral testimony today about, and maybe even amplifying on the going slow versus patchwork and doing it right, and doing it tailored to the various private investment funds and their differences from public investment funds. The EC is apparently trying to do that.

MR. HARRIS: Let me add that that I totally agree that you should take it slow -- slow go approach and deal with the long-term issues rather than a reaction and a short term response. The -- and with regard to the global integration, there are some good ideas that are coming out of the U.K. and places like that. But I would much prefer, I mean, 70 percent of the investors in the hedge fund world are here, they are not there. And 70 percent of the world's hedge funds investors, not investment organizations are there and not here.

The vast majority of the trouble in hedge funds redemptions and so on comes out of Europe, it doesn't come out of U.S. So I would not -- I would, you know, look at what they are doing, take the best of what they are doing, but I would not assume a follower position relative to what they are doing over there.

REP. KANJORSKI: Right, just one last thing. Just prior to the economic crisis that occurred in the last year in this country, we were getting tremendous pressure from both Wall Street and internationally that there was a competition between London and New York and if we didn't take -- make some concessions in this country we were going to lose the financial wherewithal of the New York market.

Now, they have gone into a hiatus, truly, that competition until we get over the international crisis and the national crisis reflected by the recession. But do you see when the recession is over, and we get to recovery that that competition is going to rear suddenly yet again and we're going to be in a race to the bottom for regulation has an attractive feature to draw that industry either to London or to New York.

MR. CHANOS: I live in both cities, Mr. Chairman. And then run offices in both cities, and in Utah I'd represent a group based in London. I like our chances, better than theirs right now. I think that -- I'm concerned by more of the things I see going on in London as it relates to the financial capitals than I do in New York or our cities.

I still think there is a strong sense of free enterprise here that I'm seeing erode very quickly in London, personally. And a move towards immediate higher taxation over there, and they are actually beginning to worry about losing their ascendancy to places like Geneva or Dubai or other places. So it's all relative, as the grass is always greener. But as someone who lives and almost commutes between the two cities, I like our chances better.

MR. GROOME: I would just add that it's not a race. There will always be competition between two cities like that and I think we could arguably see one or two cities in Asia emerge not too long in the distant future who want to compete for that same sort of financial center type of mantle, that's all for the healthy.

Chairman, I would say though, that it's not the winner who will not be the one who races to the bottom of regulation. The winner, in my opinion, will be the one who sets very clear rules, very clear standards and stays with those standards. To the extend that rules and regulations and capital structures start to be redefined and renegotiated on the run, people like Mr. Harris will vote with their dollars and yens, and euros, and renminbis and go somewhere else. They will be the arbiters at the end of the day.

MR. BAKER: I think there is a significant flight to quality. And that if there is a particular incident in recent months that has created difficulties in the U.K., it's been the apparent difficulty in the Lehman resolution and that many people's fortunes are, to a great extend, tied to the ultimate resolution, which appears at this moment to be many months away. And that is an unfortunate development.

And so at the end of the process, if we get back to normal in the next 18 months, I still think the memory of '08 '09 will be quite vivid to most investors and they will demand levels of conduct until we get back in the years when profits run unexpectedly high. But these things are cycled. When we came here in the '80s we were coming out of the S&L crisis the tech bubble. I foresee at some future point, not near term, we'll have concerns. But I believe the U.S. system offers quality that folks have difficulty finding elsewhere today.

REP. KANJORSKI: Thank you, Mr. Baker.

Thanks very much Mr. Garrett.

REP. GARRETT: Just I want -- I -- first of all, I appreciate the closing comments as most of you assume with regards to the chairman's comment as far as whether we need patchwork or comprehensive, and I hear it comprehensive thoughtful well throughout; I'm hearing from the panel, so I appreciate that.

A gentleman from the other side of the aisle made that, inaction is not the answer but the wrong action directed in the wrong place could actually end up doing more harm -- I assume the panel agrees -- than no action at all. I see you all nodding. And also I take away from this is, so many people said registration is not the end it's only going to be the beginning.

Because with registration, as Mr. Harris pointed out before, we've already had registration. And registration didn't prevent us from getting to where we are right now, even though it's a voluntary registration. And then along with Mr. Harris' comment as well, reporting -- and, Mr. Baker's comments in between -- reporting can do one of two things.

If you go to next step from registration to reporting, Mr. Groome's was saying, is that you either have everybody reporting, in which case Mr. Harris made the argument that we will be diluting our resources. And we've already heard how the SEC can't get the job done with all due respect to Mr. Chanos' good comments about the SEC, they have not been able to get the job done.

And I guess we still are going to be -- bringing back the SEC to try to get an explanation why when somebody usually comes to that entity and tells them of a problem they can't get the job done. I don't know how they are going to get the job done if we dilute it to such an extent that we're going to have everybody reporting. But I think Mr. Baker makes a very good point on the flip side of that, if we say that we are only going to pick a segment of that then you get into potentially too big to fail.

And then you have that situation there and that we may create a whole other host of problems where will we be bailing out, or as a suggestion being made, will we be forced to wind them down. Is anybody on the panel agreed with the thought that the government should be able to step in and wind down any of your clients, or any of your hedge funds if we see the potential for systemic risks.

MR. : No.

MR. : No.

REP. GARRETT: Okay. So at the end of the day, I'll walk away from here looking -- if they -- we need to look at comprehensive reform. And I guess my last question is that -- because I have to run to a bell -- is there other areas in the global market -- and I was going to ask you when are we going to get out of this recession and to get you to give an expert opinion on that but I'll let you put -- submit that in writing.

But the end of the day, looking at the global economic -- global issues that this committee looks at -- I know Mr. Baker knows them all -- but you can presume what we look at. We're looking at hedge funds right now, for the last couple of hours. Where would you, if you were sitting up here, Mr. Baker, if you are sitting up there, what issues would you be looking and saying, this should have been -- this should be your number one or number two priority.

If it's not hedge funds and registrations that are -- where would you say our focus should be on trying to get the economic health back in order of our hedge funds. I will start with Mr. Harris and run down. We don't have a minute so you --

MR. HARRIS: I would -- my guess is looking at the investment practice of insurance companies.

REP. GARRETT: Okay. Mr. Chanos.

MR. CHANOS: I would look at the long-term structural liabilities that we have overall and how we are fooling ourselves in how we are going to fund those just broad concept of funding our future health and retirement liabilities that -- that's going to drive everything in every financial institution going forward.

REP. GARRETT: Our $57 trillion liabilities or what have you.

MR. CHANOS: Yeah.

MR. GROOME: I would approach it from the liabilities side as well. And I would think about it from an entity standpoint about our insurance industry or our pension fund industry. And the increasing transfer of risks to the household sector and trying to actually bring it back, in a sense, to a more balanced management of risks within our system between institutions, government and households, a more balanced system. We have seen this swing back and forth. In the pension world, for example, we've gone from a DB heavy to a DC heavy. I think getting some of that back in balance would be very helpful.

REP. GARRETT: All right, thank you.

MR. BAKER: And I also share concerns about that -- the business environment going forward because of the uncertainty of government resolution in the current matter. We've had modifications in TARP and TALF that make it difficult for business judgments to be made with certainty. If we can get past those issues, then I hope it's proper to suggest that I'd survey the top 25 or 50 CEOs of the companies who are dealing with that exact same question --

REP. GARRETT: Yeah.

MR. BAKER: -- in trying to figure out how their survival will be facilitated and then focus on that liability side, how do we get a business plan together for the next 10 years that has any hope of getting future folks out of debt.

REP. GARRETT: Exactly.

MS. WILLIAMS: I would look at the interconnections among institutions in the system but also I would broaden the discussion away from just focusing on institutions and look at other sources of risk to the system by looking at products, and how certain products are overseen.

MR. : Can I just add one more.

REP. GARRETT: Yeah.

MR. : The financing of our deficits by foreigners is going to -- could potentially be a huge problem.

REP. GARRETT: Sure. I appreciate all your comments. Thank you very much gentlemen -- and ladies.

REP. KANJORSKI: And thank you very much, Mr. Garrett.

And let me say for a second before we go into the formality. This panel really has been exceptional, my information. I think we have a much better record than I imagined we'd come out of today's session with. And it's because we slipped off just at the stage questions of what's involved. We really went into some of the theory and some of the critical analysis of what we face.

So I want to thank you for going with us that way. This subcommittee, I think, has a big role to fill in comprehensive reform. And I think we're going to try and do it. And I want to complement my ranking member because we're trying to bring civility, and I think to this extend we have, to the Congress and to the committee, and we are going to keep along that line.

But we do appreciate each -- the collective members of this panel and each of you. And I would invite you to do one thing. We're one telephone call away, we're one letter away, you all have some great ideas, please feel free to critique us and to inform us along the line. Because what we're attempting to lift is very heavy. And I'm not sure either Mr. Garrett or I are physically fit to do it on our own, we need your help.

So thank you very much. And with that the chair notes that some members may have additional questions for the panel, which they may wish to submit in writing. Without objection the hearing record will remain open for 30 days for members to submit written questions to these witnesses and to place their responses in the record. With no further statements necessary for the record the panel is dismissed and this hearing is adjourned.


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