WASHINGTON WEEKLY
Keeping the Markets Informed from the Capital
July 11, 2008
During the House Financial Services Committee’s first hearing on financial regulatory restructuring, Chairman Barney Frank (D-MA) said it was a complex issue and while the Committee would begin its work now, legislative action is not likely until next year. Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson agreed the current regulatory structure would be enough to bridge the gap until Congress could develop a new regulatory structure.
Comprehensive housing legislation advanced in the Senate this week. After a week of procedural delays, the Senate was expected to vote on final passage of the Housing and Economic Recovery Act of 2008 (H.R.3221) later today.
The House approved legislation that would make technical corrections to the Pension Protection Act (PPA) by voice vote.
The House Agriculture Committee held a three-day series of hearings on legislative proposals to address excessive speculation in the energy and commodities markets.
The Senate Agriculture Committee approved the nomination of Walter Lukken to be chairman of the Commodity Futures Trading Commission (CFTC) and Scott O’Malia and Bart Chilton to be commissioners of the CFTC.
Financial regulators told the Senate Banking Subcommittee on Securities, Insurance and Investment they have sufficient regulatory tools and informational access to oversee the credit derivatives markets.
HFSC Begins Examination of Financial Regulatory Restructuring
Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson told the House Financial Services Committee this week that while the current financial regulatory system is not optimal, the financial regulators are working within the current statutory framework to adequately address the issues in the financial markets. During the House Financial Services Committee’s first hearing on financial regulatory restructuring, Paulson and Bernanke said, however, broad reforms to the financial regulatory structure are necessary in the long term, and called on Congress to begin exploring potential ways to improve the regulatory system. Chairman Barney Frank (D-MA) said he believes the financial regulators have sufficient powers to respond to crises, and the job of Congress is to develop a regulatory structure that will make crises less likely in the future. Frank noted consensus seems to point to creating a macro-stability regulator. Ranking Member Spencer Bachus (R-AL) expressed support for establishing a macro-stability regulator, but said lawmakers should not create a regulatory structure where all firms are considered "too big to fail." He said financial regulation should ensure market discipline, protect the taxpayer and protect against systemic risk.
Chairman Bernanke recommended Congress consider requiring consolidated supervision of investment banks and other large securities dealers and providing the regulator the authority to set standards for capital, liquidity holdings and risk management. Bernanke said Congress must take into account the distinctive features of investment banking and ensure reforms do not inhibit innovation. Chairman Bernanke also suggested Congress consider granting the Federal Reserve explicit oversight authority for systemically important payment and settlement systems. Treasury Secretary Henry Paulson outlined his proposals for creating a resolution process that ensures the financial system can withstand the failure of a large complex financial firm. He said this would require giving regulators additional, flexible emergency authority to limit temporary disruptions. Bernanke agreed it was important for Congress to consider whether new resolution tools are needed to ensure an orderly liquidation of a systemically important securities firm on the verge of bankruptcy and a more formal process for deciding when to use those tools. He said it might be appropriate for the Treasury to take the lead in a resolution process.
Chairman Bernanke said the Fed is currently reviewing whether to extend the Primary Dealers Credit Facility (PDCF) past September. Responding to questions about the Fed's supervision of investment banks, Bernanke said the Fed, working with the Securities and Exchange Commission (SEC), is already receiving information about the investment banks and has asked the firms to raise more capital. He said it is up to Congress to determine how these firms should be regulated going forward. Chairman Frank said the Committee will hold additional hearings on financial regulatory restructuring. Securities and Exchange Commission Chairman Christopher Cox and New York Federal Reserve President Timothy Geithner will appear before the committee in two weeks.
Senate Expected to Approve Housing Legislation
The Senate was expected to vote later today on comprehensive housing legislation (H.R.3221). The Senate voted 84-12 earlier this week to move to a vote on final passage. The Housing and Economic Recovery Act of 2008 establishes a new program that would allow the Federal Housing Administration (FHA) to insure up to $300 billion worth of refinanced mortgages for borrowers facing foreclosure. The bill would also create a new regulator for the government sponsored enterprises (GSEs) and the Federal Home Loan Banks (FHLBs). The new regulator would be required to issue regulations establishing criteria governing the portfolio holdings of the GSEs to ensure the holdings are backed by sufficient capital and are consistent with the mission and the safety and soundness of the GSEs, and would allow the regulator to temporarily increase the minimum capital levels of the GSEs if the regulator determines it is necessary and consistent with the safety and soundness of the enterprise. The Housing and Economic Recovery Act would set the high cost loan limit for the loans the GSEs can purchase to 150 percent of the conforming loan limit (currently $625,000). The bill also increases the FHA loan limit from 95 percent to 110 percent of area median home price with a cap at 150 percent of the GSE limit (currently, $625,000).
The tax title of the Housing and Economic Recovery Act of 2008 includes an $11 billion increase in the private-activity bond volume cap for mortgage revenue bonds (MRBs) and private activity bonds for qualified low-income rental housing in 2008. The bill also allows MRB proceeds to be used to refinance certain subprime loans. The bill would also permanently exempt interest from tax-exempt housing bonds (including MRBs) from the alternative minimum tax (AMT). Under the bill, states would be allowed a one-time refunding of bonds used to finance low-income housing projects that are reissued within four years of the original issuance. The bill would also update the tax-exempt housing bond rules to conform certain aspects of these rules to the low-income housing tax credit rules. In addition, the tax title temporarily allows municipal bonds guaranteed by FHLBs to be treated as tax-exempt, regardless of their use. The cost of the bill is offset with: 1) a modified credit card reporting provision, 2) a reduction in the capital gains exclusion for homes that are not used as a principle residence, and 3) several increased penalty provisions relating to the filing of tax returns. The House could take up the Senate-passed bill as early as next week. The House previously passed its housing bill in May. The administration has threatened to veto the Senate bill.
House Approves PPA Technical Corrections Bill
The House approved legislation (H.R.6382) that would make technical corrections to the Pension Protection Act (PPA) by voice vote. H.R.6382 would clarify that distributions from tax-qualified retirement plans, tax-sheltered annuities and governmental Section 457 plans are allowed to be rolled over directly into Roth IRA accounts, subject to certain conditions, among other things. The bill clarifies Congress’ intent to preserve 24-month asset smoothing in the calculation of the value of pension assets. The House previously passed the PPA Technical Corrections Act (H.R.3361) in March without the smoothing provision. The Senate passed its version of the PPA Technical Correction Act (S.1974) by unanimous consent on December 19, 2007, including the asset smoothing rule. However, the Senate bill does not include several provisions included in H.R.6382, such as a provision easing the interest rate to calculate the benefits under certain small defined benefit pension plans and a modification to the interest rate calculation with respect to the market rate of return requirements for certain governmental plans.
House Ag Holds Three Days of Hearings on Proposals to Amend the CEA
The House Agriculture Committee held a three-day series of hearings on legislative proposals to amend the Commodity Exchange Act. During the first day’s session, the Committee heard from members of the House who have introduced legislation to address energy speculation. Rep. Jim Matheson (D-UT) said the goal of legislation should be to make sure the CFTC has the ability to ensure manipulation isn't taking place in the energy markets. He said his bill, The Close the London Loophole Act (H.R.6284), would effectively codify the CFTC's recent action to require ICE Futures to report U.S. energy commodity trades and to impose comparable speculative limits. Rep. Chris Van Hollen (D-MD) and Rep. Rosa DeLauro (D-CT) said their bill, the Energy Markets Anti-Manipulation and Integrity Restoration Act (H.R.6341), represents the three most important steps Congress can take to eliminate the possibility of any outright manipulation occurring in unregulated markets and to drive excessive speculation out of the energy markets. Rep. Bart Stupak (D-MI) said he introduced his bill, the Prevent the Unfair Manipulation of Prices Act (H.R.6330), to end the exemption for certain energy trades from CFTC action to curb excessive speculation. He said it was especially important to eliminate the swaps exemption from position limit requirements. Rep. John Larson (D-CT) said his legislation, the Consumer Oil Price Protection Act (H.R.6264), should be part of a comprehensive approach to reform these markets, because it would help "shed light" on the speculators.
During the second day’s session, Greg Zerzan, counsel and head of global public policy, International Swaps and Derivatives Association (ISDA) said the new CFTC oversight provisions contained in the Farm Bill should be allowed to be realized before further legislative action is taken. Zerzan said ISDA is concerned H.R.6330 would increase costs, decrease market efficiencies, decrease market liquidity and price discovery and encourage dealer migration to non-U.S. markets. Dr. Craig Pirrong, professor of finance, University of Houston, said speculation helps allocate risk and facilitates price discovery and said there is no evidence of oil market manipulation. Dr. Scott Irwin, professor, University of Illinois at Urbana-Champaign, said the CFTC’s commodity index trader reports indicate participation by index funds in the futures markets is not overwhelming. Rep. Bob Etheridge (D-NC) asked Paul Cicio, president, Industrial Energy Consumers of America, if investment banks were using funds obtained through the Federal Reserve’s Primary Dealer Credit Facility to increase speculation in the futures market. Cicio said he was not sure if that was the case, but noted the coinciding timelines between the access to lower interest rates and the ramp up of the commodity prices.
During the final session, Committee Chairman Collin Peterson (D-MN) said he opposed raising margin requirements. Mark Young, appearing on behalf of the Futures Industry Association (FIA) said the FIA is concerned proposals to amend the requirements for foreign boards of trade (FBOT) would harm the CFTC’s ability to prevent manipulation and would harm the global competitiveness of the U.S. brokerage firms, while potentially triggering reciprocal regulation by foreign governments against U.S. exchanges. Gerry Ramm, testifying on behalf of the Petroleum Marketers Association of America, said the PMAA supports raising margin requirements for non-commercial entities, requiring non-commercial traders to take physical delivery of a portion of the product, banning participants unable to take direct physical possession and significantly raising the funding for the CFTC.
Senate Ag Approves CFTC Nominees
The Senate Agriculture Committee approved the nomination of Walter Lukken to be chairman of the Commodity Futures Trading Commission (CFTC) this week. Lukken has been acting chairman since June 2007. The Senate Agriculture Committee also approved the nominations of Scott O’Malia and CFTC Commissioner Bart Chilton to the Commission. The nominations must now be approved by the full Senate. Also this week, Elisse Walter was sworn in as a commissioner of the Securities and Exchange Commission (SEC). In addition, the president indicated his intention to nominate Anthony Ryan to be Undersecretary of the Treasury for Domestic Finance. Ryan would replace Robert Steel who resigned earlier this week.
Regulators Say They Have Sufficient Regulatory Tools to Oversee Credit Derivatives Markets
Patrick Parkinson, deputy director, Division of Research and Statistics, Board of Governors, Federal Reserve System, James Overdahl, senior economist, Securities and Exchange Commission (SEC) and Kathryn Dick, deputy comptroller for credit and market risk, Office of the Comptroller of the Currency (OCC), told members of the Senate Banking Subcommittee on Securities, Insurance and Investment, their respective agencies have sufficient regulatory tools and informational access to oversee the credit derivatives markets. Dick added the increased interagency and international cooperation during the credit crisis has expedited the process for regulators to identify potential market problems. Subcommittee Chairman Jack Reed (D-RI) said a clearinghouse or an exchange would help mitigate counterparty risk and provide the necessary infrastructure to enhance transparency and overall risk management, but the clearinghouse oversight needs further consideration. Reed said further action is necessary to increase automation with the credit default markets to cover all of the credit instruments. Ranking Member Wayne Allard (R-CO) said the current credit default market is immature and lacks the necessary infrastructure and transparency. Allard said he is encouraged market participants and regulators are developing an agenda to improve the structure of the credit default markets.
Parkinson said the Federal Reserve Bank of New York convened a meeting of supervisors and market participants to develop an agenda to improve the over-the-counter (OTC) derivatives market infrastructure by addressing the recommendations of the President’s Working Group on Financial Markets (PWG). Parkinson said the market participants will forward a letter to the regulators at the end of July with recommendations on how to achieve the agenda goals. He said the establishment of a central counterparty (CCP) for the derivatives market would reduce counterparty risks to the OTC markets and systemic risks to the financial markets. James Overdahl said a central counterparty would be better to manage innovative products and serve to eliminate any source of market participant rumors. Overdahl told Reed the success of the energy OTC market demonstrates the value of a clearinghouse approach, and that market participants will migrate to the system because of its overall benefits.
Bills Introduced This Week
The Commodity Speculation Reform Act of 2008 (S.3248), introduced by Sen. Joe Lieberman (I-CT), Sen. Susan Collins (R-ME) and Sen. Maria Cantwell (D-WA), would impose speculative position limits to all food and energy-related contracts, including over-the-counter holdings and futures positions on foreign exchanges. The bill requires the CFTC to establish the speculative position limits. Also under S.3248, foreign futures exchanges would be required to provide the CFTC with daily trading information comparable to the information provided by domestic exchanges.
The Week Ahead
- Federal Reserve Chairman Ben Bernanke will present the semi-annual monetary report to Congress next week. Bernanke will appear before the Senate Banking Committee on Tuesday, July 15, and the House Financial Services Committee on Wednesday, July 16.
- On Tuesday, July 15, the CFTC Global Markets Panel will hold an Advisory Committee Meeting.
- Also on Tuesday, July 15, the House Judiciary Subcommittee on Commercial and Administrative Law is expected to markup a number of bills, including the Arbitration Fairness Act (H.R.3010).
- The Senate Special Committee on Aging will hold a hearing on saving for retirement on Wednesday, July 16.
- On Thursday, July 17, the Senate Homeland Security and Governmental Affairs Subcommittee on Permanent Investigations will hold a hearing on tax-haven banks and U.S. tax compliance.
- Also on Thursday, July 17, the House Financial Services Subcommittee on Oversight and Investigations will hold a hearing on the Government Accountability Office (GAO) report on Regulation B.