WASHINGTON WEEKLY
Keeping the Markets Informed from the Capital
December 14, 2007
Flurry of Activity as Congress Prepares for the End of the Year
With Congress scheduled to adjourn sometime next week for the year, there was a flurry of activity this week on Capitol Hill. Commodity Futures Trading Commission (CFTC) reauthorization legislation saw action this week. The Senate approved by voice vote an amendment to the Farm Bill Extension Act of 2007 which would reauthorize the CFTC and increase CFTC oversight of electronic trading facilities (ETFs). Also this week, the House Agriculture Committee approved a bill that would reauthorize the CFTC for seven years.
The Senate approved the Farm Bill Extension Act of 2007 (H.R.2419) by a vote of 79-14.
The House approved a revised alternative minimum tax (AMT) bill this week by a vote of 226-193. The bill would extend the AMT patch for one year.
After failing to receive the necessary votes to move forward on the energy bill with a modified tax title, the Senate approved energy legislation without the $21 billion tax title by a vote of 86-8.
The House approved a seven-year extension of the Terrorism Risk Insurance Act (TRIA) by a vote of 303-116.
The Senate approved legislation that would allow states, asset and pension fund managers to divest from companies doing business with Sudan by voice vote.
The House Judiciary Committee approved the Emergency Home Ownership and Mortgage Equity Protection Act of 2007 (H.R.3609) by a vote of 17-15. SIFMA joined other financial services trade associations in a letter of opposition to the bill.
Michael Decker, Senior Managing Director, Research and Public Policy, SIFMA, testified before a Senate Finance Committee hearing on issues in the housing market.
SIFMA submitted testimony for the record of the Senate Judiciary Subcommittee on the Constitution, Civil Rights and Property Rights hearing on arbitration.
SIFMA sent a letter to Treasury Secretary Henry Paulson in support of Treasury’s proposal to allow State and local governments to use qualified Mortgage Revenue Bonds (MRB) to assist troubled homeowners.
In a letter to Federal Reserve Chairman Ben Bernanke, nineteen Democrats on the House Financial Services Committee urged the Federal Reserve to ensure proposed rules under the Home Ownership and Equity Protection Act (HOEPA) address four specific products and practices.
House Financial Services Subcommittee on Capital Markets Chairman Paul Kanjorski (D-PA) sent a letter asking Securities and Exchange Commission (SEC) Chairman Christopher Cox to ensure any decisions the SEC makes on the issue of market data do not ultimately produce unintended consequences.
Action on CFTC Reauthorization
Two years after the Commodity Futures Modernization Act (CFMA) expired, legislation to reauthorize the Commodity Futures Trading Commission (CFTC) advanced in the Senate and the House Agriculture Committee this week. The Senate approved an amendment to the Farm Bill Extension Act (H.R.2419) that would grant the Commodity Futures Trading Commission (CFTC) increased oversight authority of the electronic energy markets and reauthorize the CFTC through 2013. The Senate approved the farm bill by a vote of 79-14. Under the amendment, electronic trading facilities (ETFs) would be required to prevent manipulation and price distortion by monitoring trading, ensuring contracts are not susceptible to manipulation, limiting the size of positions to prevent excessive speculation and reducing holdings of traders in violation of position limits. Electronic exchanges would also have to collect information on trading activity, supply large trader reports to the CFTC and publish price, trading volume and other trading data on a daily basis. The CFTC is required to review all electronic contracts to identify that those that perform a significant price discovery function are regulated appropriately.
The amendment also includes a number of provisions recommended by the President’s Working Group on Financial Markets (PWG), which clarify the CFTC’s authority over certain retail foreign currency transactions, the CFTC’s anti-fraud authority over principal-to-principal transactions, and the CFTC’s enforcement powers. The bill also calls on the PWG to ensure the Securities and Exchange Commission (SEC) and the CFTC issue joint rulemaking on portfolio margining for security option and security futures products by September 30, 2008 and joint rulemaking resolving issues concerning foreign and debt security indices by June 30, 2008. The bill also includes a provision recommended by the PWG granting the CFTC have exclusive jurisdiction over significant price discovery contracts on Exempt Commercial Markets (ECMs).
The House Agriculture Committee approved similar legislation by voice vote earlier in the week. The CFTC Reauthorization Act of 2007 would reauthorize the CFTC through 2013. The bill clarifies the CFTC’s authority over foreign currency transactions, clarifies the CFTC’s anti-fraud authority of principal-to-principal transactions and requires retail foreign exchange dealers to register with the CFTC and be subject to CFTC rules and anti-fraud authority. The bill would also increase the civil and criminal penalties for certain Commodity Exchange Act (CEA) violations. The CFTC Reauthorization Act increases the oversight of Exempt Commercial Markets (ECMs). It establishes large trader position reporting, position limits, self-regulatory oversight, and emergency anti-manipulation authority for certain ECM contracts that serve a significant price discovery function. During consideration of the bill, the Committee also adopted a clarifying amendment offered by Rep. David Scott (D-GA), which directs the CFTC to consider the unique way electronic trading facilities (ETFs) operate and take into account the difference between cleared and noncleared contracts. SIFMA joined the International Swaps and Derivative Association (ISDA), the Futures Industry Association (FIA), and the Managed Funds Association (MFA) in a letter of support for the bill. In the letter to House Agriculture Chairman Collin Peterson (D-MN), Ranking Member Bob Goodlatte (R-VA), Subcommittee on General Farm Commodities and Risk Management Chairman Bob Etheridge (D-NC) and Ranking Member Jerry Moran (R-KS), the trade associations said the House Agriculture bill follows in the tradition of legal certainty and modern, principles-based regulatory structure created by the Commodity Futures Modernization Act (CFMA) while addressing areas which have been identified by the PWG as warranting attention.
Senate Approves Farm Bill
The Senate approved the Farm Bill Extension Act (H.R.2419) by a vote of 79-14. The bill includes $17 billion in tax-exempt bond and conservation tax provisions, which are offset with several provisions, including 1) codification of the economic substance doctrine; 2) retroactively disallowing losses for certain Sale-in, Lease-Out (SILO) transactions entered into on or before March 12, 2004; 3) reducing the ethanol tax credit from 51 cents-per-gallon to 46 cents-per-gallon beginning in the first year after ethanol production reaches 7.5 billion gallons; and 4) denying deductions for expenses associated with settling claims with the government. The bill authorizes $1.5 billion in tax-exempt facility bonds for forest conservation projects. The bill would also expand the eligibility for qualified small issue bonds for first-time farmers to a $450,000 maximum and indexes the cap for inflation. Currently an individual does not qualify as a first-time farmer if he/she has received more than $250,000 of qualified small issue bond financing. The farm bill also authorizes $400 million in tax-credit bonds to finance qualified rural electric/utilities projects.
Prior to approving the farm bill, the Senate agreed by voice vote to include an amendment that would remove the private-payment test for bonds used to finance professional sports facilities. Under the tax code, tax-exempt private-activity bonds may be used to finance projects which meet two tests—the private-use test, which requires that more than 10 percent of the bond proceeds are used to finance a private business, or the private-payment test, which requires that more than 10 percent of the repayment of principal and interest is derived from private parties. If bonds fail both tests, they can be declared taxable. Sports stadium projects typically receive private-activity bond financing by satisfying the private payment test. The amendment to H.R.2419, introduced by Senate Minority Leader Mitch McConnell (R-KY), would remove the private-payment test, therefore eliminating the ability to use tax-exempt bonds to fund professional sports stadiums. The private-payment test provision is used to offset a provision that would reduce the capital gains holding period and the depreciation period for racehorses.
House Approves AMT Relief Bill
The House approved the AMT Relief Act of 2007 (H.R.4351) by a vote of 226-193. The $55.72 billion bill would 1) extend the alternative minimum tax (AMT) patch for one year; 2) provide retroactive AMT relief for individuals who were affected by the AMT because they exercised incentive stock options; and 3) increase eligibility for the refundable child credit in 2008. To offset the cost, the bill includes current taxation of certain offshore deferred compensation arrangements, an eight-year delay in the effective date of the worldwide interest allocation election, codification of the economic substance doctrine, penalties for failure to file partnership and S corporation returns and an increase in the general failure to file penalty. Prior to final passage, House Ways and Means Ranking Member Jim McCrery (R-LA) offered a motion to recommit that would have inserted language from the Senate-approved AMT bill. The motion failed after a point of order ruled the bill would increase the deficit. Last week, the Senate approved a one-year extension of the alternative minimum tax (AMT) patch without any revenue offsets by a vote of 88-5. In a Statement of Administration Policy (SAP) this week, the administration threatened to veto the House AMT bill in its current form. In particular, the administration opposes the bill’s provisions that would delay the effective date of the worldwide interest allocation election, that would impose current taxation on certain offshore deferred compensation arrangements and that codify the economic substance doctrine.
Senate Approves Energy Bill without Basis Reporting
The Senate approved energy legislation without a $21 billion tax title this week by a vote of 86-8. After the Senate failed to receive the necessary votes to move forward on the House-approved energy bill last week, the Senate dropped the bill’s renewable electricity mandate from the bill and modified the $21 billion tax title. The tax title of the energy bill included a number of new tax credit bond programs and is largely paid for by a repeal of tax incentives for the oil and gas industry, an extension of the Federal Unemployment Tax Act (FUTA) and basis reporting requirements for brokers. Under the basis reporting provision, brokers would be required to report the adjusted basis of securities sold by their customers and report this information to the Internal Revenue Service. Although SIFMA supported an earlier version of this proposal, SIFMA opposed the provision in H.R.6 because of a new requirement to report gross proceeds to customers that are S corporations. The modified tax title included a provision that would have allowed states to issue tax-exempt private-activity bonds to finance electricity transmission projects and would have removed Davis-Bacon requirements from the tax-credit bond programs included in the bill. While the changes to the bill attracted support of additional members of the Senate, a procedural vote to move forward failed 59-40. As a result, the tax title was stripped from the bill. Although the revised bill does not include any energy tax incentives, it does include an increase in fuel efficiency standards, which is offset with two revenue raisers: 1) an increase in the amortization period for geological and geophysical expenses from five to seven years and 2) a one-year extension of the FUTA surtax. The House is expected to vote on the energy bill without the tax title next week.
House Approves 7-Year TRIA Extension Bill
The House approved compromise legislation (H.R.4299) to extend the Terrorism Risk Insurance Act for seven years by a vote of 303-116. The House previously approved a fifteen-year extension (H.R.2761) by a vote of 312-110 in September. Prior to the Thanksgiving recess, the Senate approved legislation to extend the terrorism risk insurance program for seven years by unanimous consent. The revised House bill would amend the Senate-approved bill to lower the threshold at which the government is obligated to help pay for losses from terrorist attacks from $100 million to $50 million. It also includes a provision to broaden TRIA to include group life insurance, but does not include a provision from the original House bill, which would expand the program to include coverage for nuclear, biological, chemical and radiological attacks. The revised House bill would also reduce deductibles in areas already hit by a terrorist attack. TRIA is currently scheduled to expire by December 31.
Senate Approves Sudan Divestment Bill
The Senate passed by voice vote legislation (S.2271) that would allow states, asset and pension fund managers to divest from companies doing business with Sudan. Under the bill, federal contractors are required to certify they do not work with the Sudanese government. The House approved a similar bill (H.R.180) by a vote of 418-1 in July. Unlike H.R.180, the Senate bill does not require the Treasury Department to establish a list of companies who do business with the Sudanese government.
House Judiciary Approves Bankruptcy Bill
The House Judiciary Committee approved the Emergency Home Ownership and Mortgage Equity Protection Act of 2007 (H.R.3609) by a vote of 17-15. Prior to approving the bill, the Committee adopted a substitute amendment offered by Chairman John Conyers (D-MI) and Rep. Steve Chabot (R-OH). Under the substitute amendment, bankruptcy judges would be authorized to reduce the principal of a debtor’s mortgage on a primary residence to the “value of the property interest of the debtor” during Chapter 13 bankruptcy proceedings if 1) the loan was made between January 1, 2000 and the enactment date of the bill; 2) the debtor’s current monthly income is insufficient to cure all defaults while staying current on the mortgage and 3) the lender has served notice it may commence foreclosure. The bill applies to debtors who file under Chapter 13 within seven years of the bill’s date of enactment. Under the bill, bankruptcy judges would also be permitted to extend the term of a covered mortgage to thirty years minus the time in which the loan has been outstanding. SIFMA joined a number of other financial services trade associations in a letter sent to Judiciary Chairman Conyers in opposition to H.R.3609. The trade groups warned H.R.3609 would actually cause harm to future homebuyers.
Senate Finance Committee Examines Housing Decline
Testifying before the Senate Finance Committee on the housing decline, Michael Decker, Senior Managing Director, Research and Public Policy, SIFMA, said the evolution of mortgage securitization has been one of the most remarkable developments in the financial markets in the last twenty-five years. Decker said the mortgage securities market has brought benefits to homebuyers and has reduced risks for banks, thrifts and others engaged in home lending. He also testified despite the downturn in the subprime mortgage market and the broader real estate sector, securitization will continue to provide a ready supply of capital to consumers and others. Decker urged the Committee to adopt the Treasury’s proposal to allow State and local government Housing Finance Authorities to issue tax-exempt mortgage revenue bonds (MRBs) to refinance existing subprime loans. Decker also asked the Finance Committee to consider exempting refinancing MRBs from the alternative minimum tax (AMT) to ensure market demand for these securities.
During the hearing, Senate Finance Chairman Max Baucus (D-MT) offered support for temporarily mortgage forgiveness debt relief. Jack Kemp, principal, Kemp Partners, Deborah A. Geier, professor of law, Cleveland State University, and Decker also supported temporary tax relief for mortgage debt forgiveness. Decker added, the permanence provision in The Mortgage Forgiveness Debt Relief Act (H.R.3468), approved by the House, was not appropriate and recommended Congress consider including a sunset provision after two years to compare the market condition to the relief necessity. Kemp said proactive measures by Congress, the administration and the Federal Reserve are necessary to minimize adverse consequences of the changing credit markets. Michael Decker said the secondary markets are still providing a robust environment for conforming loans, but said the creation of non-conforming loans have slowed. Decker said credit is now available for non-conforming prime loans, but not available for non-conforming subprime loans.
SIFMA Submits Testimony for Record of Arbitration Hearing
SIFMA submitted testimony for the record of the Senate Judiciary Subcommittee on the Constitution, Civil Rights and Property Rights hearing on the Arbitration Fairness Act of 2007 (S.1782). In the testimony, which was identical to that submitted for the record for the House Judiciary Subcommittee on Commercial and Administrative Law hearing in October, SIFMA said S.1782 would undermine a highly evolved forum with a proven track record of outstanding service to investors. For thirty years, securities arbitration has been closely regulated by the SEC and the Financial Industry Regulatory Authority (FINRA). The tight regulation and strict oversight has resulted in a number of procedural safeguards that protect investors and ensure fairness. SIFMA said securities arbitration allows investors to pursue small claims, provides a friendly forum for pro se investor claimants, lowers overall costs borne by investors and securities firms and secures the oversight of expert regulators, all within a framework that was specifically designed for investor claims and has demonstrated fairness for decades. SIFMA urged Congress not to disturb a system that is working successfully. SIFMA also submitted its white paper on arbitration for the record.
During the hearing, Subcommittee Chairman Russell Feingold (D-WI), who introduced the Arbitration Fairness Act, said arbitration takes away the right of consumers to a fair hearing and a choice of how to settle disputes. He stressed he is not opposed to arbitration, but that consumers should have the right to choose and should not be forced into arbitration. He added that he will rewrite the Arbitration Fairness Act to ensure it covers securities contracts. Tanya Solov, director, Securities Department, Illinois Secretary of State, representing the National Association of Securities Administrators Association (NASAA) said mandatory arbitration is beginning to impact investor confidence and called for a voluntary securities arbitration system. NASAA said S.1782 us a step in the right direction.
SIFMA Supports MRB Program
SIFMA sent a letter to Treasury Secretary Henry Paulson in support of the recent Treasury proposal to allow State and local governments to use qualified Mortgage Revenue Bonds (MRBs) to assist troubled homeowners. Under the Treasury proposal, State and local government authorities could issue tax-exempt MRBs to refinance existing loans. Currently proceeds from MRBs can be used only to finance new mortgages for first-time homebuyers for owner-occupied single family homes. SIFMA suggested Congress consider exempting these refinancing MRBs from the alternative minimum tax (AMT) to ensure there is market demand. SIFMA said the MRB proposal will help struggling homeowners find efficient and flexible solutions.
Members of HFSC Urge Fed to Include Specific Products and Practices
In a letter to Federal Reserve Chairman Ben Bernanke, nineteen Democrats on the House Financial Services Committee urged the Federal Reserve to ensure proposed rules under the Home Ownership and Equity Protection Act (HOEPA) address four specific products and practices. The Federal Reserve Board is expected to release proposed new rules next week. Specifically the members of the Financial Services Committee asked the new rules 1) prohibit prepayment penalties for subprime loans and require any remaining prepayment penalties be limited in size and duration; 2) require realistic underwriting of the borrower’s ability to repay a mortgage for the entire term; 3) eliminate incentives to steer consumers into more expensive loans and 4) improve disclosures.
Kanjorski Calls on SEC to Be Careful Regarding Market Data Decisions
House Financial Services Subcommittee on Capital Markets Chairman Paul Kanjorski (D-PA) sent a letter asking Securities and Exchange Commission (SEC) Chairman Christopher Cox to ensure any decisions the SEC makes on the issue of market data do not ultimately produce unintended consequences, such as effectively conferring exclusive product rights to a select few entities. Kanjorski noted the major exchanges have evolved in recent years from mutually owned organizations into competitive, profit-seeking companies. He said it is important to consider how the evolution of the securities markets affects the market data regime. He asked the SEC to consider its alternatives—for example to adopt an economically neutral position by making all raw trading data available on equal terms to any party or to identify other viable policy options that will promote fairness and equity.
Bills Introduced This Week
The Defined Contribution Fee Disclosure Act (S. 2473), introduced by Sen. Tom Harkin (R-IA) and Sen. Herbert Kohl (D-WI), would require 401(k) plan providers to disclose the overall level of fees to plan participants when they choose investment options. The bill also requires that the pre-selection notice and quarterly statements include information such as historical returns, the level of risk and basic investment guidance. Plan providers would also be required to disclose relationships between all parties with financial interest in the plan.
Senate Banking Committee Chairman Chris Dodd (D-CT) introduced the Homeownership Preservation and Protection Act of 2007. The bill tightens the definition of a “high cost mortgage,” and for all high cost loans, prohibits a creditor from directly or indirectly financing any portion of the points, fees or prepayment penalties on high cost mortgages, prohibits prepayment penalties, prohibits yield spread premiums, prohibits balloon payments, and requires an originator to determine that a high-cost refinance loan provides a net tangible benefit to the borrower. The bill also creates a new definition of subprime and nontraditional mortgages. It requires for all subprime or nontraditional mortgages that originators establish a borrower has the ability to repay the loan based on the fully-indexed rate, requires escrows for taxes and insurance and would deem loans with a higher than 45 percent debt-to-income ration as unaffordable. The bill also prohibits prepayment penalties and yield-spread premiums on subprime or nontraditional mortgages. The bill would extend assignee liability to the trust that holds the loan and would allow borrowers to cure or rescind a loan that failed to meet the bill’s standards. Class actions would be prohibited for assignees who perform due diligence to ensure they are not buying loans in violation of the law.
The Week Ahead
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No hearings of relevance are scheduled currently.