WASHINGTON WEEKLY
Keeping the Markets Informed from the Capital
February 15, 2008
Paulson, Bernanke and Cox Testify on State of Economy
It was a busy week on Capitol Hill as lawmakers prepared to leave for the week-long President’s Day recess. Treasury Secretary Henry Paulson, Federal Reserve Chairman Ben Bernanke and Securities and Exchange Commission (SEC) Chairman Christopher Cox discussed the cause of problems in the subprime mortgage market and possible solutions, the bond insurance industry, sovereign wealth funds and credit rating agency reform during an appearance before the Senate Banking Committee this week.
The Senate Banking Committee approved industrial loan company (ILC) legislation along party lines 11-10.
SIFMA sent a letter of support for the Small Businesses Add Value for Employees (SAVE) Act of 2008 (H.R.5160), which provides key enhancements to SIMPLE IRA plans.
Testifying before the House Financial Services Subcommittee on Capital Markets on the bond insurance industry, New York Governor Eliot Spitzer called on the bond insurers to recapitalize as soon as possible.
The House Financial Services Committee began the process of modernizing the thirty-year old Community Reinvestment Act (CRA) with a hearing this week.
Sovereign wealth fund investment continues to be a hot topic on Capitol Hill. The Joint Economic Committee (JEC) held a hearing on sovereign wealth funds and the potential economic and national security impacts. Senate Banking Committee Chairman Chris Dodd (D-CT) and Ranking Member Richard Shelby (R-AL) sent a letter to members of the Senate discussing the Committee’s ongoing oversight of sovereign wealth funds.
Paulson, Bernanke and Cox Testify on State of Economy
Treasury Secretary Henry Paulson, Federal Reserve Chairman Ben Bernanke and Securities and Exchange Commission (SEC) Chairman Christopher Cox appeared before the Senate Banking Committee this week to discuss the state of the economy. Secretary Paulson said the economy is fundamentally strong, diverse and resilient and current difficulties are a result of a necessary housing correction after years of unsustainable home price appreciation. Paulson said he is focused on two main aspects of the subprime effort 1) ensuring the American Securitization Forum (ASF) framework is adopted throughout the lending and servicing industry and 2) ensuring Hope NOW produces timely metrics to evaluate progress and make adjustments as necessary. Paulson and Chairman Bernanke called on Congress to act quickly to enact government sponsored enterprise (GSE) reform and Federal Housing Administration (FHA) modernization legislation. SEC Chairman Cox said the SEC is looking at the role of the credit rating agencies to see if they diverged from their stated practices in order to produce higher ratings and if their role in the collateralized debt obligation (CDO) market impaired their ability to be objective. Cox said he has directed his staff to explore alternatives to ratings where feasible and to develop proposals for new rules to respond directly to the recent actions of the credit rating agencies.
Chairman Bernanke said the losses in the housing sector affected the value of CDOs, which hurt bond insurance corporations, which in turn hurt their guarantees for municipal bonds and student loans. Bernanke said the good news is the underlying quality of bonds and student loans is generally very good and he does not think it will be a long-term situation. Paulson said the Treasury Department is closely watching the student loan market. The Treasury Department supports a private-sector effort to help the bond insurers and is watching the situation closely. Sen. Chuck Schumer (D-NY) said he is considering offering a bill to establish federal regulation of bond insurers who expand into non-traditional lines of business. In response to questions from Sen. Evan Bayh (D-IN) on increasing transparency requirements for sovereign wealth funds, Secretary Paulson said the U.S. is actively engaging with sovereign wealth funds about their motives, their governments and procedures and is encouraging them to address these concerns by developing and following best practices.
Senate Banking Committee Approves ILC Bill
The Senate Banking Committee approved industrial loan company (ILC) reform legislation along party lines 11-10. The Industrial Bank Holding Company Act of 2008 would prohibit commercial companies from owning industrial banks with an exception for certain durable-goods manufacturers, would ban current commercially-owned ILCs from interstate branching and would expand the authority of the Federal Deposit Insurance Corporation (FDIC) over ILCs. The bill also includes an exemption to ensure industrial bank owners that are supervised by the SEC as “consolidated supervised entities” (CSEs) are not subject to duplicative holding company supervision by the FDIC. Prior to adopting the measure, the Committee adopted two amendments offered by Sen. Charles Schumer (D-NY)—one would insert language to assure that a passive change of control for grandfathered industrial banks would not trigger a loss of the grandfather; the other would assure that savings and loan holding companies supervised by the Office of Thrift Supervision (OTS) would not be subject to dual supervision by the OTS and the FDIC. The Committee also approved an amendment offered by Sen. Tom Carper (D-DE) that would specifically allow automakers Ford and Chrysler to own ILCs, but would not allow the ILCs to offer any new products for a year. A number of other amendments were offered and then withdrawn. SIFMA sent a letter to Chairman Dodd in support of the Industrial Bank Holding Company Act and Sen. Schumer’s change of control amendment. SIFMA said it appreciates the bill recognizes the SEC’s consolidated supervised entity oversight (CSE) regime.
The day after the markup, Chairman Chris Dodd (D-CT) announced that due to a technical glitch in the vote on the Industrial Bank Holding Company Act of 2008, the Committee would need to vote again on the bill before it could be reported out of the Committee. The re-vote has not yet been scheduled.
SIFMA Supports SAVE ACT
SIFMA sent a letter of support for the Small Businesses Add Value for Employees (SAVE) Act of 2008 (H.R.5160) to Rep. Ron Kind (D-WI). SIFMA said H.R.5160 addresses a critical retirement savings issue—expanding the number of small businesses that sponsor a retirement plan for their workers—and provides key enhancements to the SIMPLE IRA. Specifically, SIFMA applauded the inclusion of provisions which increase the contribution limit to be consistent with the limit for 401(k) plans; permit the plan sponsor to make additional non-elective contributions to participant accounts; allow a plan sponsor to move from a SIMPLE plan to another plan during the year; and lower the twenty-five percent penalty for distributions in the first two years. SIFMA said the SIMPLE IRA can be even more effective in getting small employers to maintain retirement plans for their employees if the reforms included in H.R.5160 are enacted into law.
Kanjorski Suggests Applying Universal Rating Standards for Corporate and Municipal Debt
During the House Financial Services Subcommittee on Capital Markets hearing on the bond insurance industry, Chairman Paul Kanjorski (D-PA) suggested one way to quickly help municipalities who are facing higher costs as a result of the downgrades of the bond insurance companies would be to temporarily apply the same rating standards used for corporate debt issuers to municipal debt issuers. Kanjorski said going forward Congress should consider prohibiting bond insurers from guaranteeing complex structured financial products; creating a federal bond insurance corporation modeled after the Federal Deposit Insurance Corporation; creating a federal insurance regulator; enacting legislation allowing the Federal Home Loan Banks to enhance municipal bonds with letters of credit; and imposing new requirements on credit rating agencies. House Financial Services Ranking Member Spencer Bachus (R-AL) commended Securities and Exchange Commission Chairman Christopher Cox's initiatives for increased municipal bond disclosure and called on the Committee to consider Cox's recommendations. New York State Governor Eliot Spitzer (D) said the first preference is to find ways to infuse capital into the bond insurers so they can maintain their credit ratings. Spitzer said he did not think Congressional action or the development of a federal guarantor could happen quickly enough to make a difference. He said the bond insurers need to recapitalize within the coming days. Eric Dinallo, Superintendent of Insurance, State of New York, said if a private sector solution does not work, the insurers could split their companies into two--one focused on the sound municipal bond business, the other on the troubled structured finance portion of their portfolios.
Richard Larkin, senior vice president, Herbert J. Sims & Co., recommended assigning underlying ratings on municipal bonds as standard procedure to allow more bonds to keep ratings of Aa/AA or higher after an insurer's downgrade and allowing them to be retained by money market funds. He also suggested Congress act on legislation (H.R.2091) to allow the Federal Home Loan Banks to issue letters of credit. William Ackman, managing member, Pershing Square Capital Management, recommended rating agencies be required to rate municipal bonds on the same scale as corporate bonds, which will lead to a wholesale upgrade of municipal bond issues helping to avoid the forced sale of these securities and reducing the cost of future municipal borrowings. Ackman told Kanjorski there is no reason an EDGAR type electronic disclosure system could not exist for CDOs, asset-backed securities or municipal bonds. He said it is much better for investors to do their own due diligence.
HFSC Begins CRA Review
House Financial Services Committee Chairman Barney Frank (D-MA) said the Community Reinvestment Act (CRA) has worked remarkably well, but it is time to examine whether or not to expand CRA to include other institutions and how to improve the enforcement of the CRA. Frank said CRA modernization is one of the Committee's most important initiatives, although noted Congress may not be able to complete work on legislation this year. Rep. Maxine Waters (D-CA) expressed concern that the Community Reinvestment Act only covers less than one third of participants in the credit market and said Congress must analyze extending CRA's reach. Rep. Mel Watt (D-NC) expressed interest in expanding the CRA to include securities firms. Montrice Godard Yakimov, managing director for compliance and consumer protection, Office of Thrift Supervision (OTS), said OTS believes all depository institutions should participate in CRA to increase the availability of financial services to low- and moderate-income families and communities. Ann Jaedicke, deputy comptroller for compliance policy, Office of the Comptroller of the Currency (OCC), said the regulators have not worked out the details of how an expansion of the CRA would work. Sandra Braunstein director, Division of Consumer and Community Affairs, Federal Reserve, warned as Congress looks to amend the CRA to remember that one of the reasons the CRA has worked so well is because of the flexibility of the statute.
Chairman Frank asked if other financial institutions, such as firms who financed securitization of subprime loans, should have CRA requirements. Ellen Seidman, director, Financial Services and Education Project, New America Foundation, said the suitability standards on the securities side of these firms works to some extent, the question is how to better regulate products and responsibility on the investment side. Ronald Homer, Chief Executive Officer, Access Capital Strategies, said a first step should be to look at the activities of bank holding companies and all of the underlying organizations and provide incentives for helping certain neighborhoods and borrowers.
Capitol Hill Examines SWF Investment
During the Joint Economic Committee (JEC) hearing this week on sovereign wealth funds (SWFs), Chairman Charles Schumer (D-NY) said the initial focus of Congress is correctly on the transparency of sovereign wealth funds and whether that is best achieved voluntarily through the International Monetary Fund (IMF) best practices framework or through legislation. Schumer said he prefers not to consider legislation, but said it may be necessary if voluntary efforts fail to improve SWF transparency. Schumer wants to examine whether the implementation of the Foreign Investment and National Security Act (FINSA) is sufficient to address unique risks associated with investments by sovereign wealth funds. Rep. Carolyn Maloney (D-NY) said the growing clout of sovereign wealth funds requires they receive greater scrutiny from Congress. David McCormick, Treasury Under Secretary for International Affairs, said legislation is not needed to deal with the potential risks of sovereign wealth investments on national security. He said as Treasury moves forward implementing FINSA, it is also considering non-national security issues related to potential distortions from a larger role of foreign governments in the markets--including inefficient allocation of capital, perceived unfair competition with private firms and the pursuit of broader strategic rather than strictly economic investments.
Also this week, Senate Banking Committee Chairman Chris Dodd (D-CT) and Ranking Member Richard Shelby (R-AL) sent a letter to members of the Senate to inform them of the Banking Committee’s ongoing oversight of sovereign wealth funds. Dodd and Shelby said as the Committee continues to monitor implementation of FINSA, they are also considering the effects of sovereign wealth fund investments on U.S. economic and financial security. As part of its examination, the Committee held a hearing last November, is reviewing a forthcoming Government Accountability Office study on SWFs and plans to hold future hearings to examine the implications for workers, businesses and investors. Dodd and Shelby said the Committee will consider appropriate legislative authority under its jurisdiction to ensure the strength and security of the U.S. economy.
Bills Introduced This Week
Senate Majority Leader Harry Reid (D-NV) introduced the Foreclosure Prevention Act of 2008 (S.2636). S.2636 includes changes to the bankruptcy code to allow bankruptcy judges to modify residential mortgage loans in bankruptcy proceedings. The bill would also allow the proceeds of qualified mortgage revenue bonds (MRBs) to be used for refinancings and for multi-family housing. It would provide an additional $10 billion increase in the private-activity bond volume cap for MRBs 2008, and would allow it to be carried over for two years; and would exempt MRBs issued after the date of enactment and before January 1, 2011 from the alternative minimum tax (AMT). The Foreclosure Prevention Act also includes additional funding for housing counseling and Community Block Development Grants (CBDG), a five-year carryback of net-operating losses incurred in 2006, 2007 and 2008, and would require lenders to give firm disclosures about the mortgage terms at least seven business days before closing. The Senate is expected to consider S.2636 during the week of February 25.
House Ways and Means Chairman Charles Rangel (D-NY) and thirty-two Democrats introduced energy tax legislation (H.R.5351) that would extend and modify several energy-related tax provisions, including a three-year extension of the section 45 production tax credit, would repeal several current-law tax incentives for oil and gas companies, and would require the Treasury Department to study which existing tax provisions contribute to carbon and greenhouse gas emissions. The Renewable Energy and Energy Conservation Tax Act authorizes $2 billion of new clean renewable energy bonds (CREBs) for public power providers and electric cooperatives and creates a new category of tax credit bonds for green community programs and initiatives designed to reduce greenhouse gas emissions. The bill also requires Davis-Bacon labor standards apply to any project financed with tax-credit bonds. The House is expected to consider H.R.5351 when it returns from the President’s Day recess.
The Week Ahead
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The House and Senate are in recess next week.