WASHINGTON WEEKLY
Keeping the Markets Informed from the Capital
July 18, 2008
Financial regulators appeared on Capitol Hill this week to detail their responses to recent events in the financial markets. Appearing before the Senate Banking Committee, Treasury Secretary Henry Paulson called on Congress to act quickly on the three-part proposal he announced over the weekend to assist the housing-related government sponsored enterprises (GSEs). Paulson and Fed Chairman Ben Bernanke said the proposal would help to restore market confidence in the GSEs so they can do more to help with the current housing situation. Also appearing before the Banking Committee, Securities and Exchange Commission (SEC) Chairman Christopher Cox announced the SEC would issue a 30-day emergency order limiting naked short-selling of shares of Fannie Mae, Freddie Mac and the primary dealers.
Federal Reserve Board Chairman Ben Bernanke delivered the Fed’s Semi-Annual Report on Monetary Policy to the Senate Banking Committee and the House Financial Services Committee.
The Federal Reserve unanimously approved mortgage lending rules. The final rules establish a new category of “higher-priced mortgages” which includes most closed-end subprime loans secured by a consumer’s principal dwelling.
The U.S. Department of Labor (DOL) released guidance to help plan administrators and service providers comply with the new requirements for reporting fee information for the 2009 Form 5500.
SIFMA and a number of other financial trade associations sent a joint letter to Members of Congress this week saying speculation and the futures and derivatives markets are not the cause of rising oil prices. The trade associations warned harming the ability of companies to manage rising oil costs through derivatives will only lead to increased costs for consumers.
The House Judiciary Subcommittee on Commercial and Administrative Law approved by voice vote legislation which would essentially eliminate pre-dispute mandatory arbitration agreements.
The Senate Banking Committee voted 19-2 in favor of legislation that would expand sanctions on business activities with Iran to cover financial institutions, insurers and oil and gas pipelines and tankers.
In conjunction with a hearing on tax haven banks, the Senate Committee on Homeland Security and Governmental Affairs Permanent Subcommittee on Investigations released a staff report, which estimates the U.S. loses $100 billion annually because of offshore tax abuses and details many of the techniques allegedly used by banks to assist U.S. taxpayers in evading taxpayers.
During the Senate Special Committee on Aging hearing on saving for retirement, Committee members expressed concern with 401(k) debit cards.
Financial Regulators Discuss Responses to Recent Events in the Financial Markets
Federal Reserve Chairman Ben Bernanke, Treasury Secretary Henry Paulson and Securities and Exchange Commission (SEC) Chairman Christopher Cox appeared before the Senate Banking Committee to discuss the regulatory responses to the recent events in the financial markets. Over the weekend, Treasury Secretary Henry Paulson announced a legislative proposal to assist the housing-related government sponsored enterprises (GSEs). The three-part plan would increase the amount of GSE debt the Treasury Department can purchase; grant the Treasury Department the authority to purchase equity in either of the two GSEs; and establish a consultative process between the new GSE regulator and the Federal Reserve in setting capital requirements and other prudential standards. The debt and equity purchase authority would be granted for eighteen months. Also, the Fed announced it would give the Federal Reserve of New York the authority to lend to the GSEs if necessary. During the hearing, Chairman Chris Dodd (D-CT) said the Committee would need to thoroughly examine the Treasury’s GSE proposal and said he was particularly concerned about the proposed close relationship between the new GSE regulator and the Federal Reserve. Ranking Member Richard Shelby (R-AL) said Congress needs more information on the proposals before it moves forward. He said preserving the viability of the GSEs is critical to the capital markets and it is important to make sure they are well-capitalized, well-managed and well-regulated.
Treasury Secretary Paulson said he has no plan to use the proposed authority, but its existence is necessary to restore market confidence. He assured Ranking Member Shelby the Treasury Department would consult with the Congress before exercising its authority. Secretary Paulson said giving the Fed a visible and consultative role with the new GSE regulator would increase market confidence and would not undercut the authority of the new regulator. Fed Chairman Bernanke said the Treasury proposal is based on the goals of protecting the mortgage system, protecting the taxpayer and supporting the housing market. He said a world-class regulator is needed to make certain the GSEs are well-capitalized and supported sufficiently to meet their mission. SEC Chairman Cox announced the Commission’s 30-day emergency order limiting naked short-selling of shares of Fannie Mae, Freddie Mac and broker-dealers. He said more rule-making is planned to focus on short-selling in the broader market and noted the SEC’s new initiative to investigate the intentional spreading of rumors to damage a stock. He said the SEC will also look at the question of whether some other kind of price test that is not in pennies and not related to a tick, might be useful for circumstances like the one currently facing the financial markets. Chairman Cox also urged Congress to require the GSEs to register under the Securities Act of 1933, so they are required to periodically report their financial statements to the SEC
Bernanke Delivers Semi-Annual Report on Monetary Policy
Appearing before the Senate Banking Committee and the House Financial Services Committee to present the Federal Reserve’s Semi-Annual Report on Monetary Policy, Fed Chairman Ben Bernanke advised Congress to act quickly on housing issues, including improving the oversight of the housing-related government sponsored enterprises (GSEs). He said the GSEs are well-capitalized, however, there is a lack of market confidence in the GSEs, which is making it difficult for them to raise capital. Bernanke said it is important to restore market confidence in the GSEs so they can be proactive in working to strengthen the housing market. Chairman Bernanke said the price of oil is being predominately driven by growth in demand and a tightening of supply conditions, as well as the decline in the value of the U.S. dollar. Bernanke said he does not see financial speculation impacting oil prices, but said useful steps could be taken to improve the transparency and functioning of the futures markets. He warned against legislative proposals to change margin requirements. Chairman Bernanke said speculation is good for the markets, because it spreads risk and provides price discovery.
Chairman Bernanke suggested three steps to constrain moral hazard in the markets: 1) establish in legislation consolidated supervisory oversight for investment banks; 2) strengthen the financial infrastructure and 3) clarify the resolution process for financial institutions going forward. He noted the Securities and Exchange Commission (SEC) with the support of the Fed, the President’s Working Group on Financial Markets (PWG) and international regulators, has been active in the area of credit rating agencies. He said while a lot of work is being done in this area, there is no substitute for due diligence. Addressing the topic of a second economic stimulus package, Bernanke said the first economic stimulus package has had some positive effects on the economy, but it is premature to think of a second stimulus package. He also warned Congress against taking action to prohibit short-selling.
Fed Finalizes Mortgage Lending Rules
The Federal Reserve unanimously approved revisions to provisions of Regulation Z that implement the Home Ownership and Equity Protection Act (HOEPA). The final rules establish a new category of “higher-priced mortgages,” which includes most closed-end subprime loans secured by a consumer’s principal dwelling. The Fed asked for comment by August 29 on a new index that will determine which loans qualify as “higher-priced.” Under the final rules, for new “higher-priced mortgage loans” secured by a consumer’s principal dwelling, lenders must make loans based on the borrower’s ability to repay the loan from income and assets other than the home’s value. Lenders are required to verify the income and assets. Prepayment penalties are prohibited if the monthly loan payment can change in the initial four years (two years for some other higher-priced loans). The rules also require escrow accounts to cover property taxes and homeowner’s insurance for all first-lien mortgages.
For all closed-end mortgages secured by a consumer’s principal dwelling, servicers are prohibited from failing to credit a payment to a consumer’s account as of the date the payment is received, failing to provide a payoff statement within a reasonable period of time, and pyramiding late fees. Under the rules, creditors and brokers are prohibited from coercing or encouraging an appraiser to misrepresent the value of a home. Creditors are also required to provide a good faith estimate of loan costs, including a schedule of payments, within three days after a consumer applies for any mortgage loan secured by the consumer’s principal dwelling. For all mortgages, advertising is required to contain additional information about rates, monthly payments and other loan features. The rules also prohibit deceptive or misleading advertising practices. The final rules do not include a provision included in the proposed rule regarding yield spread premiums. The Fed said it is analyzing alternative approaches. Compliance with the new rules, other than the escrow account, is mandatory for all applications received on or after October 1, 2009. The escrow requirement is effective April 1, 2010 for site-built homes and October 1, 2010 for manufactured homes.
DOL Issues Additional Guidance on Form 5500
The U.S. Department of Labor (DOL) released additional guidance this week to help plan administrators and service providers to comply with the new requirements for reporting fee information for the 2009 Form 5500. The DOL provided guidance through 40 Frequently Asked Questions, which respond to many questions raised by SIFMA members and plan sponsors. Among the key issues addressed by DOL include plan administrators are not required to report service providers on Schedule C as failing to provide fee and compensation information for 2009 reports if the service provider furnishes the plan administrator with a written statement that (i) the service provider made a good faith effort to make any necessary recordkeeping and information system changes in a timely fashion, and (ii) despite such efforts, the service provider was unable to complete the changes for the 2009 plan year. DOL confirmed the “eligible indirect compensation” alternative method can be used to report compensation paid or received in separately managed investment accounts. Underlying portfolio commissions paid by a mutual fund and similar vehicles are not separately reportable. Soft dollar arrangements may be disclosed using existing securities disclosure, such as an ADV if all of the required disclosures are contained in the separate documents and the plan administrator is told where to find the information
Trade Associations Send Joint Letter to Congress on Oil Prices
In a joint letter sent to members of Congress this week, SIFMA and a number of other financial trade associations, said speculation and the futures and derivatives markets are not the cause of rising oil prices. SIFMA, the International Swaps and Derivatives Association (ISDA), the Futures Industry Association (FIA), the Commodity Markets Council (CMC), the Managed Funds Association (MFA) and the Financial Services Roundtable (FSR) said derivatives help reduce the cost of energy by enabling companies to manage the risk of rising prices. They warned harming the ability of companies to manage rising oil costs through derivatives will only lead to increased costs for consumers. The trade associations said oil prices can be lowered by increasing supply or reducing demand, or both.
House Subcommittee Approves Arbitration Bill
The House Judiciary Subcommittee on Commercial and Administrative Law approved the Arbitration Fairness Act (H.R.3010) by voice vote. The bill, which would effectively eliminate pre-dispute mandatory arbitration agreements, was introduced last July by Rep. Hank Johnson (D-GA). Sen. Russ Feingold (D-WI) introduced a companion measure in the Senate. SIFMA sent a letter to Subcommittee Chair Linda Sanchez (D-CA) and Ranking Member Chris Cannon (R-UT) in opposition of the bill. SIFMA said H.R.3010 would undermine a unique and highly evolved dispute resolution tool with a proven track record of outstanding service to investors—the securities arbitration forum. SIFMA said prohibiting pre-dispute arbitration agreements would produce more protracted, costly litigation resulting in higher transaction costs for all.
The Subcommittee also approved narrower arbitration bills—including the Fairness in Nursing Home Arbitration Act of 2008 (H.R.6126) and the Automobile Arbitration Fairness Act of 2008 (H.R.5312). SIFMA cosigned a letter with a number of other organizations, including the U.S. Chamber of Commerce, the American Bankers Association, the National Association of Manufacturers and the Financial Services Roundtable, in opposition of the Arbitration Fairness Act (H.R.3010), the Automobile Arbitration Fairness Act of 2008 (H.R.5312) and the Fairness in Nursing Home Arbitration Act of 2008 (H.R.6126). The organizations said the bills are unwarranted and would wreak havoc on a long-standing and effective form of alternative dispute resolution.
Senate Banking Approves Iran Sanctions Bill
By a vote of 19-2 the Senate Banking Committee approved legislation that would expand sanctions on business activities with Iran to cover financial institutions, insurers and oil and gas pipelines and tankers. The Comprehensive Iran Sanctions, Accountability and Divestment Act of 2008 would also impose sanctions on independent foreign subsidiaries of U.S. companies that do business with Tehran. The bill would codify in law the current Executive Orders prohibiting imports and exports, with the exception of food, medicine and other humanitarian aid; mandate the freezing of U.S. funds and assets of Iranian diplomats and representatives of other government, military or quasi-governmental institutions; and provide millions in new funding for the Treasury Department to combat terrorist financing. The legislation encourages state and local governments to divest from any company that invests $20 million or more in Iran’s energy sector or extends $20 million or more in credit for investment in that sector. The Committee also approved two amendments by voice vote—the first amendment would encourage divestment from shipping firms that deal with Iran; the second amendment encourages the administration to designate Iran’s central bank as a sponsor of terrorism.
Senate PSI Examines Tax Haven Banks
In conjunction with a hearing on tax haven banks, the Senate Committee on Homeland Security and Governmental Affairs Permanent Subcommittee on Investigations released a staff report, which estimates the U.S. loses $100 billion annually because of offshore tax abuses and details many of the techniques allegedly used by banks to assist U.S. taxpayers in evading taxes. During the hearing, Chairman Carl Levin (D-MI) and Ranking Member Norm Coleman (R-MN) said many foreign banks operate under a wall of secrecy and employ practices that have resulted in tax evasion by U.S. citizens. Both spoke in favor of the Stop Tax Haven Abuse Act (S.681), which they introduced with Sen. Barack Obama (D-IL), to establish new reporting requirements and rebuttable evidentiary presumptions in tax and securities legal proceedings in order to reduce offshore tax havens. Sen. John Kerry (D-MA) warned making the tax system too onerous for U.S. taxpayers could create unintended consequences in the current global environment.
IRS Commissioner Doug Shulman said the IRS is modifying and tightening the Qualified Intermediary (QI) program to close existing loopholes and called on Congress to enact the IRS budget for FY09 and the recommendations included in the budget. He also called on Congress to provide additional time for authorities to work on tax evasion cases beyond the current three-year statute of limitations. Kevin O’Connor, associate attorney general counsel, Department of Justice, said he would favor a change in the law along the lines of S.681. He noted there are limitations for U.S. authorities investigating tax evasion, including the fact the U.S. does not have tax information exchange agreements with every country and in some cases the Mutual Legal Assistance Treaties exclude tax crimes altogether. The Senate Finance Committee will hold a hearing on offshore tax havens on Thursday, July 24. The Senate Committee on Homeland Security and Governmental Affairs Permanent Subcommittee on Investigations will hold a second hearing on tax haven banks on Friday, July 25.
Senate Special Aging Committee Examines 401(k) Debit Cards
Senate Special Committee on Aging Chairman Herbert Kohl (D-WI) said during a hearing this week, he opposes 401(k) debit cards, because the potential casual withdrawals grossly distort the retirement savings intent of the 401(k). Kohl said 401(k) loans can be ill-advised and the individual needs to be made aware of the negative consequences. Kohl introduced a bill this week with Sen. Charles Schumer (D-NY) that would prohibit 401(k) debit cards and limit the number of loans participants can take from their retirement plans. Ranking Member Gordon Smith (R-OR) said he is not surprised many Americans are accessing their retirement savings to survive the current difficult economic environment, but he believes Americans need to save more for retirement. Smith applauded the concept of the automatic IRA. Sen. Schumer said he understands there are conditions, such as terrible illness where access to retirement accounts should be granted, but said he believes there should be barriers to minimize more casual retirement account spending. Christian Weller, senior fellow, Center for American Progress, said foreclosures, bankruptcies, increased cost of living and decreased retirement contributions by employers are all contributing to decreased retirement savings. Mark Iwry, principal, Retirement Security Project, suggested making the savers’ credit refundable, creating an auto-IRA, and not allowing easy access to accounts through debit cards or other devices.
Bills Introduced This Week
Senate Majority Leader Harry Reid (D-NV) introduced the Stop Excessive Energy Speculation Act (S.3268), which would change the definition of “legitimate hedge trading” to include only those producers and purchasers of physical energy commodities and places limits on trading by those who are not trading actual physical petroleum products. S.3268 also requires U.S.-based oil traders to comply with U.S. trading regulations even if they are trading on foreign exchanges. The bill requires institutional traders to provide more detailed and disaggregated reporting on their over-the-counter (OTC) transactions. Also under the bill, the Commodity Futures Trading Commission (CFTC) is required to routinely collect detailed information from index traders and swap dealers. The bill establishes working groups to study the long-term trends in the domestic and international energy markets and the Federal Energy Regulatory Commission (FERC) to conduct a study on the role of financial institutions on the natural gas markets. The Senate could vote on the Stop Excessive Energy Speculation Act (S.3268) early next week.
The Over-the-Counter Speculation Act (S.3255), introduced by Sen. Carl Levin (D-MI) and Sen. Dianne Feinstein (D-CA), authorizes the Commodity Futures Trading Commission (CFTC) to require large traders in the over-the-counter (OTC) market to reduce holdings or suspend trading. The bill would extend the large trader reporting requirements under the Commodity Exchange Act to trading in the over-the-counter market. It also imposes recordkeeping requirements on persons required to report large OTC transactions.
Rep. Gary Ackerman (D-NY) and Rep. Mike Castle (R-DE) introduced legislation (H.R.6482), which would require the Securities and Exchange Commission (SEC) to determine the type of structured finance investments eligible to receive NRSRO ratings from Nationally Recognized Statistical Rating Organizations (NRSROs). Under the bill, eligible structured finance investments would include securities whose future performances can be reasonably predicted, such as those with established track records and proven default rates and securitizations that are comprised of homogeneous securities. Under H.R.6482, the SEC has the authority to strip credit rating agencies of their registration as a NRSRO if they fail to comply with the eligibility criteria and other proposed requirements.
Sen. Chuck Schumer (D-NY), Senate Special Committee on Aging Chairman Herb Kohl (D-WI) and Ranking Member Gordon Smith (R-OR) introduced legislation (S.3278) that would prohibit 401(k) debit cards and limit the number of loans that may be made from the plan to a plan participant or beneficiary. The bill amends Tax Code 72(p) to provide that a loan is not treated as a distribution, and therefore is not taxed as one, if the participant has three or fewer loans. In addition, a refinanced loan would be considered a new loan for purposes of the three-loan limit.
Rep. Gary Ackerman (D-NY) introduced legislation (H.R.6517) that requires the Securities and Exchange Commission (SEC) to reinstate the uptick rule within 90 days of passage of the legislation. The SEC repealed the uptick rule, which required all short-sale stock transactions to be conducted at a price higher than the price of the previous trade, last year.
The Week Ahead
- On Wednesday, July 23, the Joint Economic Committee will hold a hearing to examine the impact of rising household costs.
- The Senate Finance Committee will hold a hearing on offshore tax evasion on Thursday, July 24.
- On Thursday, July 24, the Senate Finance Subcommittee on Energy, Natural Resources and Infrastructure will hold a hearing titled “Tax and Financing Aspects of Highway Public-Private Partnerships.”
- Also on July 24, New York Federal Reserve President Timothy Geithner and SEC Chairman Christopher Cox will testify on financial regulatory restructuring before the House Financial Services Committee.
- The House Financial Services Committee will also hold a hearing on the implication of a weaker dollar for oil prices and the U.S. economy on Thursday, July 24.
- The Senate Homeland Security and Governmental Affairs Permanent Subcommittee on Investigations will hold a second hearing on tax haven banks and U.S. tax compliance on Friday, July 25.