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Restoring American Financial Stability Act Of 2010 - Motion To Proceed

Floor Speech

Location: Washington, DC


Mr. GREGG. Mr. President, I rise to speak on the bill. This is such a complex piece of legislation, it is difficult to debate in a sense that is understandable because there is so much of a technical aspect to the bill.

Let's start with the purpose or what I believe the purpose should be. Our purpose should be, one, to do as much as we can to build a regulatory regime which will reduce the potential for another event, the type of which we had at the end of 2008 where we had a massive breakdown in the financial system and, as a result of huge systemic risk being built into the system, which wasn't properly regulated and certainly was not handled correctly by either the financial institutions or by the Congress--the Congress maintains a fairly significant responsibility for the meltdown that occurred at the end of 2008, for the policies that we had running up to that period in the area of housing. That should be our first goal, prospectively, trying to reduce systemic risk as much as possible in the system and putting in place policies which will accomplish that.

The second goal, however, should be that we maintain what is a unique and rare strength which America has, which is that we have the capacity as a country to create capital and credit in a very aggressive way so entrepreneurs who are willing to go out and take risks have access to capital and credit, that creates jobs, and that creates the dynamics of our economy.

We should not put in place a regulatory regime that overly reacts and, as a result, significantly dampens our capacity to have the most vibrant capital and credit markets in the world while still having safe and sound capital and credit markets.

The bill the Senator from Connecticut is bringing forward, I presume, is going to have a lot of different sections in it. I want to focus on one because it has become a point of significant contention, and that is the derivatives section. Derivatives are extraordinarily complex instruments, and there are a lot of different variations of derivatives. They are basically insurance policies on an underlying product that is occurring somewhere in the economy. Their notional value is almost staggering. There is $600 trillion of notional value out there in derivatives, which is a number that nobody can comprehend. But you can understand it is a pretty big issue.

Notional value means, of course, that if everything were to go wrong at the same time, you would have $600 trillion of insurance sitting out there that had to be paid off. That obviously is never going to happen. But the fact is, it shows the size of the market and what its implications are. There are all sorts of different elements to this market. It is not one monolithic market. It is not even a hundred, it is thousands--tens of thousands--of different and various things that are having derivatives written against them, although they divide into pretty understandable categories.

Within the bill that came out of the Agriculture Committee, there was, for lack of a better word, an antipathy expressed toward the entities which presently manage the derivatives market in this country, which are essentially the large financial houses. There was an equal antipathy expressed relative to the entities that use these derivatives, including large amounts of manufacturing companies in this country, people who are dealing with financial debt instruments in this country, people who are dealing with the housing markets in this country.

It was almost as if somebody sat back and said: We dislike these folks, and we are going to put in place a regime which will sort of gratuitously penalize them for the business they do because we do not like it. It is too big. It is too complicated. I think the people who wrote it felt it was not understandable and, therefore, they decided to put forward proposals which would fundamentally undermine the capacity to do derivatives in this country.

Is that bad? Yes, it is very bad because derivatives basically are used for the purpose of making commerce work in our Nation, of making it possible for people to borrow money in our Nation, of making it possible for companies in our Nation to sell overseas, of making it possible for people to put a product in the stream of commerce and to presume that when they enter into an agreement on that product, the price would not be affected by extraneous events, such as the fluctuation of currency costs or fluctuations in material costs. So it is critical we get the derivatives language right.

There needs to be a significant new look at the regulatory regime of derivatives. The essence of the exercise should be transparency, maintaining adequate capital for the counterparties and margins, liquidity. That should be where we focus our energy: trying to make sure the different derivatives products that are brought to the market are as transparent as possible and also have behind them the support they need in the form of collateral, capital, and margin, so if something goes wrong they will be paid off, for lack of a better word.

This proposal, as it came out of the Agriculture Committee, does not try to accomplish that. Rather, it tries to essentially eviscerate the use of derivatives as products amongst a large segment of our economy. It sets up something called section 106, where it essentially says the people who are doing derivatives today, which are, for the most part, financial markets, must spin those products off from their financial houses.

That sounds, in concept, like a reasonable idea, especially if you were in Argentina in the 1950s and working for the Peron government. But as a very practical matter, it is a concept which will do fundamental harm to the vitality of our economy. Why? Because you will not have a lot of derivative products in this country that will be able to pass the test of being spun off. You do not have to listen to me to believe this. Let me quote from a message that was sent to us by the Federal Reserve, which is a reasonably fair arbiter in this exercise. They do not have a dog in the fight other than the financial stability of our country. This is the Fed talking, not me:

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

That is about as accurate and succinct a statement as to what the effect of this section would be as I could have said. I did not say it. Nobody would probably believe me. The Fed said it. The fair arbiter said it.

Why did they say that? Well, it is pretty obvious if you know anything about the way these products work. But essentially, if you spin off these products, you are going to have to create entities out there to replicate the entities they were spun off of. So if a large financial institution is now doing derivatives, and you spin the derivatives desk off, the swap desk off, from that financial entity, that spun-off event is going to have to replicate the capital structure of the financial institution which was basically underpinning the derivatives desk. That capital structure is estimated to be somewhere in the vicinity of a quarter of a trillion dollars to a half a trillion dollars of capital, which will have to be created.

Well, what is the effect of that? When you start putting capital like that into the system, that capital comes from somewhere--assuming it comes at all--it comes from somewhere, and where it comes from, quite honestly, is the creditworthiness of other activity. It is not new capital. It is taking capital and recreating an event, a freestanding entity here, of which capital is not around.

It will also mean there would be a contraction--and this is an estimate not of the Fed but of the group of entities that actually do this business and, therefore, it can be called suspect, but I think it is in the ballpark, give or take a couple hundred billion dollars--it will also cause a contraction of about $700 billion of credit in this country, to say nothing of the fact that if you are looking for a derivatives contract and you cannot go to the financial houses that usually do it in the United States, and you are a commercial entity or a hedging group, you are going to go overseas and do it because they are not going to have these types of restrictions and you are going to be able to buy that contract in Singapore.

So a large amount of entities, a large amount of business, will move offshore almost immediately upon the passage of this bill, should this section be kept in it.

Is it necessary, is the question. Is it necessary to make the derivatives market work right in this country? Absolutely not. This is punitive language put in out of spite because there is a movement in this country, and in this Congress, unfortunately, which I call pandering popularism, which simply dislikes anything that has to do with Wall Street.

I am sure they did a lot of things wrong and they caused a lot of problems. But if you are going to apply the problems that occurred around here fairly, we should be looking in our own mirror, at ourselves, for some of the problems we caused to the American economy, by forcing a lot of lending in a housing market that could not sustain it. It is penal. That is the purpose of this: punitive. In the end, it is going to cut off our nose to spite our face because it will be our credit that contracts, and business can be done and could be done in a very effective way, here in the United States, overseas.

What should be done here? What should be done rather than this exercise, as the Fed has said, in causing a ``highly disruptive and costly'' effect on banks and their customers, and having serious consequences on the competitiveness of the United States? Remember, we are competing in the world. That may have escaped the attention of the Agriculture Committee when they wrote this language, but we are in a world competition. Derivatives are not a unique American product. They are a world product. So these are jobs that go overseas. This is credit that goes overseas. This is business that goes overseas. This is Main Street that will be affected by this language.

How should it have been done? Well, it should have been done in a rational way, not in a punitive way. We know the derivatives market was not transparent enough. We know there was not enough capital, liquidity, margin--whatever you want to call it--behind the products and the counterparties that were exchanging products in the derivatives market in the over-the-counter system. We know--because we have AIG as example No. 1--a tremendous amount of CDs, especially, were being written with nothing behind them except a name.

We can fix all that. It can be fixed in a way that almost everybody is comfortable with by, first, making sure the exempted products from going on a clearinghouse are only products which have a specific commercial use and are customized and are narrow, and that the people doing those products are not large enough in their business so there are systemic issues. Secondly, we put everybody else in a clearinghouse.

What does a clearinghouse mean? It essentially means there will be a third party insurer or holder of the basket of assets necessary to support the derivatives contracts so we are fairly confident when a trade is made in a clearinghouse, the counterparties have the liquidity in the margin behind their positions to support their trades. At the same time, the clearinghouse itself must be structured in a way that it has adequate capital.

Where is that capital going to come from? It can only come from one place. It comes from the people who trade in these instruments. They are going to have to put up the capital. The regulators--the SEC, the CFTC--will have direct access to controlling and making sure that capital is adequate in the clearinghouses and making sure the clearinghouses are adequately monitoring the contracts.

Then as the contracts become more standardized--and they can and they will; we all accept that--they move over to exchanges where they are basically traded like stock. Then you have absolute transparency, price disclosure, and you do not have the issue of the over-the-counter market that causes so much problem for us. That will happen. That will happen almost naturally, but you could have the regulators stand up and say: Well, we think this group of derivatives is standardized enough and you have to move it to an exchange. We could give that power to the regulators, and that makes sense. But it would happen naturally anyway as these clearinghouses become more effective and standardized in the products, and people become more comfortable with standardized products in these areas.

Of course, there would have to be real-time disclosure to the regulators of what the prices were, if they are OTC prices or clearinghouse prices, so they know what is going on. Then it would be up to the regulators to decide when that information should be disclosed to the markets, depending on how you make these markets. Sometimes you cannot disclose the information immediately; otherwise, you would not be able to make a market; otherwise, you would not be able to do the contracts and, therefore, you would not be able to do the business, which underlies the need for the derivative.

So all of that could be done. All of that could be done, and it does not require creating this entity or these series of entities out there which the Federal Reserve has described as impairing the ``financial stability and strong prudential regulation of derivatives.''

In other words, what the Federal Reserve is saying is, when you go in the direction of what is being proposed from the Agriculture Committee in the area of derivatives and set up this independent swap desk, you are not making things stronger in our financial structure; you are making them weaker. You are significantly reducing the strength of the regulatory arms that guide derivatives or oversee derivatives. You are also, as I mentioned earlier, creating an almost guaranteed-to-fail situation relative to the need for capital to support these derivative transactions. It is just--it just makes no sense at all.

To begin with, derivatives are, by definition, a bank product, so the idea that they have to be spun out of banks and financial institutions is, on its face, absurd, truly absurd, and counterproductive to the whole purpose of doing derivatives, which are very important. The Congress recognizes that. In Gramm-Leach-Bliley, we called derivatives a bank product. We understood that then. We seem to have forgotten it now.

I have been trying to figure out what is behind this type of language because it is so destructive to our competitiveness as a nation. This is the type of thing, as I said earlier, we would have seen in Argentina in the 1950s, this almost virulent populist attack on entities simply because they are large and because obviously there is a populous feeling against them, which ends up, by the way, significantly impacting Main Street in a negative way. Look at Argentina. In 1945, I believe, or 1937, somewhere in that period, they were the seventh best economy in the world, the seventh most prosperous people in the world. Now they are like 54th. It is because of this populous movement which has driven basically their ability to be competitive offshore. So now we have this huge populous movement here, and I am trying to think what is behind it. What is the rationale here, other than just rampant pandering populism? A vote occurred in the Budget Committee last week, of which I happen to be ranking member, which crystallized the situation. Senator Sanders from Vermont--whom I consider a friend and I enjoy immensely. He is a great guy. He has a great sense of humor, but we disagree on a lot of things. He runs as a Socialist. I run as a conservative. Senator Sanders offered an amendment which said that the government--and the government, I assume, would be four or five people down at Treasury or four or five people down at--I don't know where they would be, some new offices somewhere--has the right to break up large corporations. It didn't say break up large corporations which had problems, which had overextended themselves, which everybody agrees should happen. That is what Senator Warner was talking about. He has done extraordinary work in this area and I am supportive of his efforts on resolution authority, where if a big bank, a big financial house or a big entity gets into trouble, if they overextend themselves or they are essentially insolvent, they get broken up. There is no--the taxpayers do not come in, in any way, shape or manner and support that entity. That is what the Warner-Corker language does, and I believe the Senator from Connecticut has tried to incorporate a large amount of that. That should be our policy. But what the Sanders amendment said was anything--any financial house--could be
broken up simply because it was deemed to be big, no matter how resilient or strong it is; no matter if it is a major player for our Nation in being more competitive internationally.

Remember, when an American company goes overseas, they want to use an American bank. They don't want to have to use the Credit Suisse or the Bank of Singapore. They want to use an American bank to follow them around the world, and those banks have to be pretty big to do that. Some of them are quite profitable and quite strong. Well, this language would have said no matter how strong and profitable you are and how robust you are and how much you contribute to the American economic system by giving us one level of financial services--which we need as a country, large financial institutions that can support very complex, sophisticated, international economic activity and domestic economic activity--that they would be broken up because a group of people in Washington didn't like them for social policy, social justice reasons. They didn't lend enough money to some group they wanted them to lend to or they lent too much money to some group they didn't want money lent to. For social justice reasons, we will go in and break up this company, even though it is totally solvent, strong, fiscally responsible.

That is the policy that was proposed in the Budget Committee. Ten people voted for that policy. Ten. Ten out of the twenty-two people who voted, voted for that policy. Incredible. Where does that stop? Where does that stop? Where does this section 106 stop? Do we break up Walmart because they are not union? Do we break up McDonald's because they sell food that some people think makes you too fat? Do we break up Coca-Cola because they have too much sugar in their products? Does anything that is big in this country get broken up because there is an attitude that big is bad, whether it contributes or not? Unless you happen to be big and union, in which case you get saved, of course, as the UAW was able to work out with GM and Chrysler.

That is the essence of this language. This language isn't about fixing the derivatives market at all. You can fix the derivatives market in a most comprehensive and substantive and effective way that keeps America the best place to create these types of products in the most sound and safe way. You can do that, and I have outlined pretty specifically how you would do it, without this section. I will close by reading one more time how the fair arbiter has defined it, the Federal Reserve. This is such a damaging section that it cannot be underestimated the damage to our economy were it to be approved.

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

Remember, their customers are the people who work on Main Street for the companies that use derivatives, and almost every company in this country of any size uses a derivative to hedge their risks. Ironically, this is all done in the name of social justice because Wall Street is bad, so we are going to go out and cut off our nose to spite our face.

It is incomprehensible that a nation which has become as strong and as vibrant as we have by promoting a market economy would decide to go down this route, which is the antipathy of a market economy, but that is where we are. That is what has happened here, and that is the direction we are going. It is unnecessary, by the way, as I said earlier; unnecessary, because derivatives can be made safer and sounder by simply restructuring the transparency and the manner in which they are put on clearinghouses, limiting the amount of those that are subject to exemption, and pushing people toward exchanges, to the fullest extent possible and to the extent it will work. All that can be done without this type of language which is so destructive and, as the Fed has said, will have the exact opposite effect of what it is alleged to be doing.

Mr. President, I yield.


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