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Public Statements

Restoring American Finacial Stability Act of 2010 - Continued

Floor Speech

By:
Date:
Location: Washington, DC

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Mr. GREGG. Mr. President, I wish to speak briefly on the bill that is before us and how I think it can be improved.

First, I congratulate the chairman of the committee, working with the ranking member. I understand they have reached an agreement on how to do the issue of resolution, which addresses the issue of too big to fail, which is a very critical part of this bill. I congratulate them for making that type of initiative. I hope the rumors are true and that such an amendment will address strong too-big-to-fail language so the American taxpayers will not be on the hook for institutions that overextend themselves and take on too much risk but are institutions that are so large it is felt they are too big to fail, that concept will no longer be part of our lexicon, and we will essentially put an end to that. I congratulate the chairman and ranking member.

There are, however, other major issues in this bill that need to be addressed. They are substantial and rather complex. A few that are not even in the bill--for example, how we address Fannie Mae and Freddie Mac. We know that the American taxpayers today are on the hook for somewhere between $400 billion and $500 billion--$400 billion to $500 billion--that we are going to have to underwrite in order to stabilize those two entities on the credits which they have run up which have gone bad and they have purchased. That is serious.

There will be a proposal that comes from our side of the aisle. It will not totally be structured to Fannie and Freddie. It should. I would like to see that. It is too complex to do in this bill. It will at least address some of the core issues that ought to be addressed. For example, we ought to tell the American people upfront and forthrightly how much they owe. It should be put on budget. We ought to put on budget what the obligations are, because they are scoreable, relative to the costs the American taxpayers are going to have to bear to bail out and maintain Fannie and Freddie. It is going to be somewhere around $400 billion to $500 billion additional debt. It is coming. We do not want to talk about it because it affects other debt obligations of this country in a lot of different ways, primarily in crowding out.

Second, the bill has language on underwriting but it is not strong enough. If you want to look at what caused this event at the end of 2008, what caused this traumatic event which almost brought the entire financial system of America down, which almost put us into a depression and put us into a very severe recession, cost a lot of people their jobs--and there are still a lot of people experiencing trauma because of it--there are three or four main causes.

I have talked about them before:

One, of course, is that I believe the money was made too easy to get, at too low a price, for too long by the Fed.

Another was the fact that the Congress specifically encouraged and, in fact, forced lenders, for all intents and purposes, to lend to people who couldn't afford the homes they were buying because it became congressional policy to do that.

Another was that people were shopping for the weakest regulators. This is what happened in the derivatives market, and the derivatives were not structured in a way that actually put capital or liquidity or margin behind derivatives.

The fourth and I think probably the most significant was that there was a total breakdown in underwriting standards. In other words, the people who were making the loans on subprime mortgages and on other types of exotic instruments so that people could buy houses who couldn't afford them were making those loans and not looking at the underlying value of the asset, and they weren't looking at the ability of the person to pay back that loan. What they were doing, quite simply, was making the loan because they were going to get a fee for it and then they were going to sell the loan, securitize it. It was going to be chopped up, sent out, and syndicated, and they didn't really care what the loan did because they were basically making a loan for the purpose of making a fee. Those were the one-off lenders.

In the banking industry, you had a complete breakdown. Banks were lending to people they knew couldn't repay when these loans reset, and they knew the value of the asset could only support that loan if there was an appreciation in the market, which was a gamble.

This happens every time we go through one of these events, by the way, one of these real estate-driven recessionary events. It happened in the late 1970s; it happened in the late 1980s when I was Governor of New Hampshire and New England went through a horrific contraction as a result of an expansive effort of lending money in the real estate markets--underwriting standards break down.

There needs to be a clear national definition of what proper underwriting standards are. Senator Isakson and I and a number of other people--Senator Corker--are going to put forward an amendment in that area.

One of the core areas here that needs to be addressed and hopefully will be included in this bill and improve the bill in this area--one area of this bill that simply has to be changed if it is to be effective in doing what it is supposed to do is the language of derivatives.

Most Americans don't understand derivatives. It is understandable. They are complex products. But basically think of it this way: You are on Main Street, and you have a business--usually a fairly large business--and you are making a product. You want to be able to sell that product to somebody at the price you quote that person and make the profit you expected at that quoted price.

But there are a lot of things that affect that product that you can't control. If you are selling it to another country, you can't control what the dollar is going to do in relationship to the currency of that country--for example, if you are selling it to Brazil, whether their currency goes up or down vis-a-vis the dollar. If you enter into a contract today and can't sell your product for 6 months, your whole profit could be wiped out by the market devaluing as relates to that currency. The materials you buy to make that product may change in value or viability. The person you are getting a loan from to allow you to expand your business to build that product may have financial troubles and you may have an issue there or, vice versa, you may have an issue with that person. All of these are things which are usually beyond the ability of the individual who is making the product--and in this case, I am talking about making products--to control.

So there is something called a derivative, which is an insurance item. Basically, someone insures for you over those risks. There is a lot of complexity to this because these insurance items mutate into all sorts of different instruments. They can affect financial instruments, they can affect commodities, they can affect goods, they can affect just plain currencies, but they are critical instruments--derivatives--for making the economic engine work. They are sort of the grease you put in the economic engine to make sure it doesn't seize up, to allow the economic engine to move down the road. They are so critical, in fact, that they are approximately $600 trillion--trillion--of notional value. Notional value is not really what the risk is because there are underlying assets here, but that is a big number--a big number.

So we have to make sure that when we amend the derivatives section of this bill to try to have a stronger derivatives industry, we don't make big mistakes and basically undermine the ability of people to use this type of instrument to get credit and to make the markets work and to create jobs on Main Street because these all tie back to jobs on Main Street. Even if you are not working for the company that uses the derivatives, you are probably working for somebody who does business with a company that does derivatives. In Nashua, NH, there are a bunch of big companies that do derivatives. There are a lot more smaller companies that sell products to those companies on Main Street. So it will affect Main Street if we do this wrong because credit will contract.

The unique advantage America has is that we are the place in the world where, if you have a good idea and you are willing to take a risk yourself and you are an entrepreneur, you can usually get capital and credit to allow you to do that idea, to take that risk and thus create jobs, which is the bottom line for all of us; we want to create jobs. So derivatives play a large role in making that system work. This bill, unfortunately, adopted language which was put forward in the Agriculture Committee which literally undermines the safety and soundness of the derivatives market and, secondly, the ability of America to be a leader in the derivatives market.

Our goal here should be very simple. Our goal should be two steps: One, make our banking and financial system safer, sounder, and a system which will, to the extent we can anticipate it, avoid systemic risk. While doing that, our second goal must be to have a vibrant credit market and capital market and be the primary place in the world where people come to create credit and capital because that gives us a competitive advantage over the rest of the world. That creates jobs here in the United States. Unfortunately, this bill, as structured, doesn't accomplish that. In fact, it undermines that.

A good derivatives reform bill would essentially create an atmosphere where derivatives are more transparent, where the pricing is more transparent, and where there is standing behind the two parties to an agreement on a derivatives contract--assets, liquidity, margin--something that can be turned to should one of the parties fail to perform on the contract. This can be done by creating a reasonable exception for end-use derivatives--those are the ones where you basically have a purely commercial purpose--and if people don't fall into that reasonable exception, then requiring essentially all the other derivatives to go through what is called a clearinghouse.

The clearinghouse becomes basically the situation where the two parties to the contract--there are multiple parties to the contract--essentially put up collateral, margin, liquidity, so that the contracts are supported--the counterparties are supported. The clearinghouse itself also has to be collateralized adequately, capitalized adequately, so that it doesn't become a risk because it is going to be the insurer, basically, of these contracts--all very doable through new regulatory restructure or a modified regulatory restructure.

Then, as these contracts become more standardized or are standardized, they move over to an exchange. A lot of them could do that right now, but some simply can't because their contracts are too customized to move directly to an exchange. But over time, most of them probably will. And that is the way it should be structured.

Unfortunately, in this bill, it is directed that we set up a new process for doing these derivatives by taking basically the market makers in these derivatives--which are the swap desks--and moving them out of the financial institutions into separate institutions. Where this idea came from is hard to fathom because on its face it makes absolutely no sense. I mean, it is so counterproductive to the purpose of making the derivatives market safer, sounder, and more efficient and, as a result, a better market which creates credit in a transparent, fair, effective, and sound way. It is so counterproductive to that on its face, you would think anybody who suggested it would have it immediately pointed out that this doesn't work. But for some reason, it has found its way into this bill.

The practical effect of doing this is that you will create these separate entities. These separate entities are going to have to be capitalized because you have to have capital behind these derivatives desks. That is the whole point. You have to have something standing behind these desks to make them viable so that you don't end up with an AIG. What was the AIG problem? There was nothing behind the derivative contracts except for the name AIG. You don't want to do that again. You want capital.

It is estimated that it would cost $250 billion to set up these separate desks. What does that mean? That means that capital is not going to be available for the creation of credit. You will see an immediate contraction. It is estimated by the industry--and again, this is an industry number, not mine, so you can take it with a grain of salt--that will cause a $ 3/4 trillion contraction in credit. That is Main Street not being able to get credit. Let's even say they have exaggerated. Say it is only going to contract 80 percent. That is still $600 billion to $700 billion of credit that is not available on Main Street to do business, to create jobs, to take risk. It is foolish to do that type of contraction and to set up this structure.

Plus, you have nobody who is going to oversight this as effectively as the people who oversight the present derivative market makers. The FDIC won't be able to get on top of this. The Fed probably will have trouble getting on top of this. You will create a less stable platform from which to view these markets, when the whole purpose of the bill was to make it more stable. It makes absolutely no sense.

This is section 106 in the Agriculture bill. I think it is section 714 in this bill. And you don't have to believe me on this. I mean, two of the major, premier regulatory agencies--which are the fair arbiters here, really; I mean, they are the umpires--have come out in a very unusual way, because they do not usually comment in the middle of a legislative process such as this, and said that this--this is my paraphrasing--is a stupid idea, a counterproductive idea, the type of idea which, if it were to be put in place, would be cutting off your nose to spite your face and we would end up with a less sound system.

Let me read to you from the commentary of the Federal Reserve staff on section 106, which is now, I believe, section 714. Here is what the Federal Reserve staff said about this approach:

Section 106 would impair financial stability and strong prudential regulation of derivatives; would have serious consequences for the competitiveness of United States financial institutions; and would be highly disruptive and costly, both for banks and their customers.

That is pretty specific. That is pretty damning testimony as to the effect of this language. It is going to reduce our competitiveness because a lot of these derivatives will go overseas. It is going to make it much more difficult to have sound regulatory policy toward derivatives, and it will be highly disruptive and costly not only for the banks but for their customers. That is called Main Street--the people who create the jobs. This is a very inappropriate idea that has been put in this bill.

But don't just rely on the Fed if you are a Fed hater--and there appear to be a number in this body, for reasons I still have trouble fathoming. They must have something against having a sound money policy. But if you don't like the Fed, listen to the FDIC. I don't think anybody around here doesn't give great credibility to the way Sheila Bair, the Chairman of the FDIC, handled the bank crisis. Very honestly, they stepped in, they settled out a lot of major banks, and they did it in a way that was extraordinarily professional. As a result, the markets remained calm, people got their money back, and deposits were not at risk.

This is an agency which has high credibility, and this is what Chairman Sheila Bair has specifically said about this:

If all derivatives market-making activities were moved outside the bank holding companies, most of the activities would no doubt continue, but in less regulated and more highly leveraged venues.

In other words, be much more risky.

Such affiliates would have to rely on less stable sources of liquidity which--as we saw during the past crisis--would be destabilizing to the banking organizations in times of financial distress, which in turn would put additional pressure on the insured banks to provide stability.

In other words, bad idea. It undermines the banking industry to do it this way.

Finally: ``Thus, one unintended''--actually, this is not finally. The whole letter is three pages long and has a lot of strong points. But the final part I am going to read:

Thus, one unintended outcome of this provision would be weakened, not strengthened, protection of the insured bank and the Deposit Insurance Fund, which I know is not the result any of us want.

That is pretty specific. So you have the Fed on one side, one of the major regulators, saying this idea doesn't work, it will undermine the structure of the banking industry. You have the FDIC on the other side saying this proposal doesn't work, it is going to undermine the insurance deposit system.
So you do not have to listen to myself or others who pointed out the failure of this section. Listen to these regulators. This section has to be removed from this bill.

There are other things that need to be done in the derivatives areas which would improve the language. For example, once you are on a clearinghouse, you should not be mandated to go directly to an exchange because it simply will not work. There needs to be an intermediary step as standardization and then the best thing to do would be to require regulators to look at these different instruments and then, if they feel they can be standardized, tell the people producing them they can be standardized and then move them over. To unilaterally say everything has to go to an exchange is, I think, going to be counterproductive and again push a lot of business offshore.

But clearly this one section is damaging to our efforts to produce a safer, sounder, more transparent derivatives regime which has adequate liquidity and capital behind it and which keeps America as the primary place to do credit in the world so our entrepreneurs can get credit at a reasonable price, so they can go out and take the risks to create the jobs in America.

I ask unanimous consent to have both these statements printed in the Record, and I yield the floor.

There being no objection, the material was ordered to be printed in the RECORD

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